Chapter 1: Accounting • Financial (GB201) •

8/14/2019 Chapter 1: Accounting Financial (GB201)

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Chapter 1:

Accounting Financial (GB201)

Users of information are external Managerial (GB202)"Cost Accounting"

Users of information are internalCost for production

3 components Direct Materials Direct Labor Manufacturing Overhead

(indirect costs) Indirect Materials Indirect Labor

Prime Costs Direct Materials + Direct Labor

Conversion Cost Direct Labor + Manufacturing Overhead How we convert raw materials into finished product

Upstream costs Incur before production Research and Development, attorney fees, licensing, ect.

Production Costs 3 components

Downstream costs Incur after production Marketing, Delivery, ect

Period Costs General, Selling, and Administration costs (G, S, & A) All costs outside ofProduction Costs

We need to know Product cost to determine the Selling Price

Value Chain Research and Development Obtain Materials Manufacturing Marketing Delivery

Value-added activities Includes steps involved in the actual processing of goods or services

Production Cost

If not sold then it is an inventory and is an Asset If it is sold it is a Cost of goods sold and is an Expense

Fixed Cost


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Set costs that do not change with quantity Higher the quantity = less cost per unit i.e Rent

Chapter 2:

Cost Behavior Fixed Cost

Total Will remain the same depending on quantity

Per Unit Changes inversely as output changes Inverse relationship

Operation Leverage How managers magnify small changes in revenue into dramatic

changes in profitability

Uses fixed cost as a lever (alternative measure - base measure) / base measure = % change Variable Cost

Total Varies with level of output Changes proportionally as output changes

As sales increase there is no magnification in profitability only adirect correlation

Contribution margin Subtract variable costs from revenue Represents the amount available to cover fixed expenses and

thereafter to provide company profits

Operation leverage using contribution margin Magnitude of operating leverage = contribution margin / net income

Shows percent change in revenue as profitability increases Operating Leverage x change in sales = change in net income

Mixed Cost

Includes both fixed and variable components Total cost = fixed cost + (variable cost per unit x number of units)

Relevant range Range of activity over fixed and variable costs are valid

High-low method How to separate mixed cost from variable cost Assemble sales volume and cost history for an existing store Select the high and low points in the data set Determine the estimated variable cost per unit

Variable cost per unit = difference in total cost / difference in volume Determine the estimated total fixed cost

Fixed cost + Variable cost = total cost

R2 statistic


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Represents the percentage of change in the dependent variable (totalcost) that is explained by a change in the independent variable (unitssold).

Chapter 3:

Break-even point where profit equals zero (= fixed costs/ Contribution margin per unit)

Multiply by sales price per unit to obtain the dollar amount Total fixed cost + total variable cots = break even point

Contribution Margin Ratio Contribution margin / revenue

Equation Method (most important approach)

Fixed Cost / Contribution Margin Ratio Sales revenue- Variable costs - Fixed costs = Profit (Net Income)

Contribution margin per unit (sales price per unit) - (variable cost per unit)

Target Profit (Fixed Cost + Target Profit)/ Contribution Margin per Unit To find the additional units

Minus Break Even Units from Target Units To find target profit

FC+TP/ contribution Ratio Minus break even point to find Profit

Pricing Strategies Cost plus pricing - sets the selling price at cost plus a markup equal

to a percentage of the cost Prestige pricing - sets the selling price at a premium under the

assumption that customers will pay more because of its prestigiousbrand name, media attention, etc


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Cost-Volume-Profit Analysis1. Break-even analysis

i. Break even in unitsi. Break even in dollars

1. Target Profit1. Sensitivity Analysis(what if situation)

Chapter 4:

Cost accumulation Cost of product Cost of advertising and promotion Cost of labor

Cost objects Primary cost object is cost of promotion

Cost driver How many units How many advertisements How many labor hours

Cost tracing Assigning costs to the departments(cost objects)

Direct Costs Can be traced to cost objects in a cost-effective manner Direct Materials

Receipts, statements can tell us how much raw materials were purchased Direct Labor

Payroll can tell us how much people worked and how much they will bepaid

Indirect Costs Cannot be traced to objects in a cost-effective manner Cannot be accurate until end of the production cycle

Must ESTIMATE

When a cost is incurred to the company it is classified as an indirect cots When a cost is incurred to a department it is a direct cost

Common costs Support multiple cost objects, but cannot be directly traced to any specific

objectsControllable costs Costs that can be influenced by a manager's decisions and actions

Cost allocation


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Dividing a total cost into parts and assigning the parts to designated costobjects

Number of sales transactions is more accurate as a cost driver Unless number of sales transactions per department are kept, we must used

total sales volume

Volume measures are good cost drivers for allocating variable costs Supplies such as glue, staples (variable costs) depend on how many desks

there are The most accurate allocations of indirect costs may actually require using

multiple cost drivers Such as units, labor hours, direct material costs

Predetermined overhead rate Overhead allocation rate is determined before actual cost and volume data are

availableCost pool When a company groups individual costs into a single cost i.e utilities Limited to costs with common drivers

Joint costs Common costs incurred in the process of making two or more joint products i.e raw milk into cream, 2%, 1%, fat free Include not only material costs but labor and overhead costs Point where product become separate and identifiable called split off point

In classCost accumulation and allocationStep 1

Predetermined overhead rate (POHR)Step 2

Allocate the cost to the department or products being producedCost accumulation

Cost of product Cost of advertising and promotion Cost of labor

Cost objects Primary cost object is cost of promotion

Cost driver How many units How many advertisements How many labor hours

Cost tracing Assigning costs to the departments(cost objects)

Direct Costs

Can be traced to cost objects in a cost-effective manner Direct Materials


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Receipts, statements can tell us how much raw materials werepurchased

Direct Labor Payroll can tell us how much people worked and how much they will

be paidIndirect Costs

Cannot be traced to objects in a cost-effective manner Cannot be accurate until end of the production cycle

Must ESTIMATE

When a cost is incurred to the company it is classified as an indirect cots When a cost is incurred to a department it is a direct cost

Common costs

Support multiple cost objects, but cannot be directly traced to any specificobjects

Controllable costs Costs that can be influenced by a manager's decisions and actions

Cost allocation Dividing a total cost into parts and assigning the parts to designated cost

objectsNumber of sales transactions is more accurate as a cost driver

Unless number of sales transactions per department are kept, we mustused total sales volume

Volume measures are good cost drivers for allocating variable costs

Supplies such as glue, staples (variable costs) depend on how many desks

there are The most accurate allocations of indirect costs may actually require using

multiple cost drivers Such as units, labor hours, direct material costs

Predetermined overhead rate

Overhead allocation rate is determined before actual cost and volumedata are available

Cost pool When a company groups individual costs into a single cost i.e utilities Limited to costs with common drivers

Joint costs Common costs incurred in the process of making two or more joint

products i.e raw milk into cream, 2%, 1%, fat free Include not only material costs but labor and overhead costs Point where product become separate and identifiable called split off

point


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Utility bill of $120 Can split it up by appliances, hours used, time spend

Appliance MethodRoommate 1- 5 50% $60Roommate 2 - 2 20% $24Roommate 3 -3 30% $36

Step 1. POHR = total estimated overhead / Total estimated activityStep 2. Allocation = rate x weight (number of units)

We want to allocate costs to determine Pricing Performance evaluation Contracts (out sourcing)

Mixed Cost to Allocate

Go back to Overhead costs and group similar costs Machinery cost ---machine hours Workers costs ----- labor hours

Chapter 5:

Relevant Cost for Decision-Making Cost must be avoidable (Overhead Cost) Has to be future oriented Differs among the alternative

Cannot be the sameSunk Cost

Past costs

Not relevant costsTypes of decisions

Special offers Outsourcing ( Make or Buy Decisions)

How reliable is the supplier Opportunity costs for vacancy Questionable quality of the product

Old vs. New Equipment Continuing to use the equipment

may cause resale value will decrease Longer we keep the equipment more repairs

Operating costs will increase Buying new equipment

Salvage value will be higher Decrease in operating costs

Segment Elimination If we eliminate a product line

The contribution margin will be lost Then fixed costs will be distributed among other projects


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Cost hierarchy for Avoidable costs Unit-Level Costs

Avoiding costs of materials and labor A product that is produced one at a time

Batch-Level Costs Setup Costs Inspection costs

Product-Level Costs Legal costs

Ie to publish a book Engineering costs

Facility-Level Costs Depreciation of factories machines utilities Not relevant for decision making Very difficult to get rid of i.e. shutting down the company

Chapter 7:

Planning for Profit and Cost ControlPlanning and ControlPlanning cyclePlan ->Do -> Check against your plan -> Act (performance review)

3 Categories of Planning

Strategic Planning Long-term decisions such as defining the scope of the business,

determining which products to develop or discontinue, and identifying themost profitable market niche

Top level management budgeting Long term planning (more then a year) Participative Budgeting

When you start from the bottom These employees know the costs better then top level

management Top level management might create an Ideal Budget

Realistic Budget When the employees set a budget that is suitable for the job

Slack Budget When the company puts the budget too high and it is easy for

employees Employees will take breaks and be non productive


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Capital Budgeting Pay-Back Period

Analyse each project and determine how long they will earn theircapital back

Pick the project that will pay back the fastest (Bird in Hand theory) Net Present Value

Discount all future cash in flows to "today's money" Highest npv is the one that the company will pick

Accounting Rate of Return Accounting analysis Looking for highest net income

Profitability Index

Capital Asset Pricing Model Operational Budgeting

Direct firms activity in the short range One year or less

Advantages of Budgeting Planning

Goals of the company Budgeting formalizes and documents managerial plans in order to

clearly communicate objectives to superiors and subordinates. Coordination

Different departments cooperate to promote overall good Budgeting process forcers coordination among departments to

promote decisions in the best interests of the company as a whole Enhances Performance Measurements

Comparing budgeted expectations to actual performance

Enhance Corrective Actions Provides advance notice of potential shortages, bottlenecks, or other

weaknesses in operating plans Advises managers of potential problems in time for them to carefully

devise effective solutionsPerpetual (continuous) budgeting Covers a 12-month reporting period Advantage of keeping management constantly focused on thinking ahead

to the next 12 monthsConsideration for the Human Factor

Involving employees in budgeting process Achieve better production

Participative budgeting Participation in the budget process by personnel at all levels of the

organization, not just upper-level managers Information flows from both bottom to top and top to bottom Can help set more realistic targets


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Master Budget Compilation of various budgets Group of detailed budges and schedules representing the company's

operating and financial plans for a future accounting period Includes

Operating budgets Capital budgets

Describes the company's intermediate-range plans forinvestments in facilities, equipment, new products, store outlets,and lines of business

Pro forma financial statements Uses operating budgets to prepare Projected rather then historical information Balance sheet, income statement, cash flows

Order for a manufacturing budget Sales Budget- we need to know what quantity we will need to sell Purchase of Raw Materials Budget - we know how much product we need Production- we know how much each will cost Selling and Administration Budget Cash Budget

Purchases BudgetBudgeted Sales (COGS) xxx+Desired Ending Inventory xxx

Total inventory Needed xxx-Beginning Inventory (xxx)Required Purchases XXX

Cash Budget Alerts management to anticipated cash shortages or excess cash balances Divided into three sections

Cash receipts section Beginning cash balance Add cash receipts (sales budget)

Cash payments section Cash payments from inventory purchases For S&A expense For interest Expense For purches of store fixtures

Financing section Surplus (shortage) Borrowing (Repayment)

Chapter 8:


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Flexible budget Extension of the master budget discussed previously Show expected revenues and costs at a variety of volume levels

Variances Difference between standard and actual amounts Can be favorable or unfavorable

Actual sales revenue is greater then expected sales revenue = favorable Actual sales revenue is less then expected sales revenue = unfavorable Actual costs exceed standard costs = unfavorable Actual costs are less than standard costs = favorable

Sales volume variance Difference between the static budget and a flexible budget based on actual

volumeVariable cost volume variances Differences between the static and flexible budget amounts

Spending variances Differences between budgeted fixed costs and actual fixed costs

i.e. an unexpected raise

Fixed cost volume variance Used to monitor the effects of volume on fixed cost per unit

Flexible budget variances Differences between the flexible budget figures and the actual results

Management by exception Managers should concentrate on areas not performing as expected Management should attend to the exceptions Using standard costing shows differences between actual and standard costs

Focus attention on the items that show significant variancesStandard Represents the amount that a price, cost, or quantity should be under certain

anticipated circumstances Uses historical data is a good start to establish standards

Ideal standards Represent flawless performances What costs should be under the best possible circumstances Do not allow for normal materials waste and spoilage or ordinary labor

inefficiencies caused by machine downtime, cleanups, breaks, or personalneeds

Meeting these standards are beyond the capabilities of most, if not all,employees

Can help strive for better performance or discouragePractical standards Reasonable effort; they are attainable for most employees Allows for normal levels of inefficiency in materials and labor usage Promotes a feeling of accomplishment and produces meaningful variances

Lax standards Easily attainable goals Achieve with minimal effort Do not motivate; can lead to boredom and lackluster performance Variances lose meaning

Material variances


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Could influence management decisions Establish materiality guidelines for selecting variances to analyze Frequency

Frequent and large variations Capacity to control

Whether management action can influence the variance Concentrate on controllable variances

characteristics Closely analyzed Can invite management abuse

I.e. delays for maintenanceBudget slack Difference between inflated and realistic standards When management tries to gain praise by manipulating the standard budget

Price Variance = |actual price - standard price| x actual quantityUsage Variance = |actual quantity - standard quantity| x standard priceFixed manufacturing overhead cost spending variance Differences between the actual fixed costs and the budgeted fixed costs

Budgeted fixed manufacturing overhead cost / planned volume ofproduction Predetermined overhead rate

Performance EvaluationStatic Budget Master Budget Based on one level of activity

Flexible Budget Based on more then one level of activity

Use Budgets to evaluate performance of managers Profit based

Cost based

Must give managers Planning and Control Managers and employees know costs better then upper-management

Budget vs. Actual When there are differences these are called variances Can be two choices

Favorable Unfavorable

Variances Materials

Material Quantity Variances Material Price Variances


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Chapter 1: Accounting • Financial (GB201) •

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