Managerial Accounting An Overview. Role in Decision-Making Provides economic and financial...

Managerial Accounting

An Overview

Role in Decision-Making

Provides economic and financial information to management

Focus on resources, costs, profit and liquidity management

Focus on short run performance

Management Functions

1. PlanningPlanning– Looking forward and establishing objectives– Profit maximization versus utility?– Market share maximization?– Adding value to the business

2. DirectingDirecting– Implementation of objectives– Coordinating activities and resources

Management Functions

3. ControllingControlling– Keeping activities on track– Role of the CFO

• Managerial accounting • Strategic planning

Vital Truths in Management

• “The true cost and profit picture for each product, for each product/market segment, and for all key customers must always be known.”

• “A business must concentrate on cash flow and balance sheet strengths as much as profits.”Quotes from article by Ames and Hlavacek in the Harvard Business Review

Common Foundation

• Different industries and businesses within industries often require different management accounting information

• However, the expected results are fundamentally the same….to more to more efficiently and effectively manage the efficiently and effectively manage the businessbusiness.

Understanding Performance

Must be able to track the value added at each process and the costs associated with those processes,

Must seek to avoid/minimize non-value added activities and their associated costs,

Some managers don’t want to know the results from accounting indicators,

Some think that financial planning is all a bunch of “funny money”; not real!!!

Managerial Cost Concepts

1.1. Direct materialsDirect materials: raw materials physically associated with the final product

2.2. Direct laborDirect labor: employees physically and directly associated with the final product

3.3. OverheadOverhead: costs indirectly associated with the final product

More Concepts

1.1. Period costsPeriod costs: costs matched with revenue for a specific time period. (i.e., net income for a specific period (i.e., quarterly, annual).

2.2. Product costsProduct costs: costs associated with producing the final product. Not considered an expense until the product (i.e., cost of goods sold).

3.3. Total costsTotal costs: equals product costs (direct and indirect materials and labor) plus period costs (selling and administrative expenses).

Total CostsTotal Costs

Production CostsManufacturing Costs

Direct Materials

Direct Materials

SellingExpenses

SellingExpenses

Period CostsNon-manufacturing Costs

Direct Labor

Direct Labor

AdministrativeExpenses

AdministrativeExpenses

Manufacturing Overhead:

Indirect materialsIndirect laborOther indirect costs

Manufacturing Overhead:

Indirect materialsIndirect laborOther indirect costs

BeginningMerchandise

Inventory

BeginningMerchandise

Inventory

Cost of Goods

Purchased

Cost of Goods

Purchased

EndingMerchandise

Inventory

EndingMerchandise

Inventory

Cost of GoodsSold

Cost of GoodsSold

Cost of GoodsAvailableFor Sale


BeginningFinishedGoods

BeginningFinishedGoods

Cost of Goods

Manufactured

Cost of Goods

Manufactured

EndingMerchandise

Inventory

EndingMerchandise

Inventory



+

+

=

-=

Merchandising FirmMerchandising Firm

Manufacturing FirmManufacturing Firm

Cost of Goods Sold Determination

-

Cost Accounting Concepts

ProcessProcess cost accounting cost accountingJob orderJob order cost accounting cost accountingActivity basedActivity based cost accounting cost accounting

Process Cost Accounting

Tracking costs associated with a specific a specific processprocess

Direct materials and laborManufacturing overhead costsAssigning costs to finished goods

Raw MaterialsFactory Labor

Manf. Overhead

Raw MaterialsFactory Labor

Manf. Overhead

MixingDepartment

MixingDepartment

BakingDepartment

BakingDepartment

Production CostReport


PackagingDepartment

PackagingDepartment

FinishedGoods

FinishedGoods

WIP WIP WIP





Process Costs in Making Bread

Job Order Cost Accounting

Tracking costs associated with a specific specific order or joborder or job

Direct materials and laborManufacturing overhead costsAssigning costs to finished goods

Comparison of Cost Systems

Features

Job Order Cost System

Process Cost System

Work in process accounts

One work in process account

Documents used Job cost sheets

Determination of total manf. costs

Each job

Unit-cost computations

Cost of each job/ units produced for

the job

Comparison of Cost Systems

Features

Job Order Cost System

Process Cost System

Work in process accounts

One work in process account

Multiple work in process accounts

Documents used Job cost sheets Production cost reports

Determination of total manf. costs

Each job Each period

Unit-cost computations

Cost of each job/ units produced for

the job

Total manf. costs/ units produced

during the period

Activity Based Cost Accounting

An approach for allocating overhead An activity is any event, action, transaction or

work sequence that incurs when producing a product or providing a service

An activity cost pool is a distinct type of activity (e.g., ordering materials)

A cost driver is any factor or activity that has a direct cause-effect relationship with resources consumed (e.g., machine hours)

Steps in ABC Accounting

1. Identify and classify activities and allocate overhead to cost pools

2. Identify cost drivers – correlation between driver and use

3. Compute overhead rates – ABC rate4. Assign overhead costs to products – use

of cost drivers5. Comparison of unit costs across

products

Overhead Costs

Overhead Costs

Orderingand

ReceivingMaterialsCost Pool

Orderingand

ReceivingMaterialsCost Pool

Setting Up

MachinesCostPool

Setting Up

MachinesCostPool

MachiningCostPool

MachiningCostPool

# ofPurchase

orders

# ofPurchase

orders

AssemblyCostPool

AssemblyCostPool

Inspectingand

TestingCostPool

Inspectingand

TestingCostPool

PaintingCostPool

PaintingCostPool

# ofSetups

# ofSetups

# ofMachine

hours

# ofMachine

hours

# ofParts

# ofParts

# ofTests

# ofTests

# ofDirecthours

# ofDirecthours

Products

Products

Activity cost pools:Activity cost pools:

Cost drivers: Cost drivers:

Activity Based Cost (ABC) SystemActivity Based Cost (ABC) System

Example of ABC AccountingABC Overhead rate = Overhead per activity ABC Overhead rate = Overhead per activity ÷ Cost driver per activity÷ Cost driver per activityInitial status:Initial status:Activity Cost Pool Overhead Driver AB overhead activity rateSetting up machines $300,000 1,500 setups $200/setupMachining $500,000 50,000 hours $10/hourInspecting $100,000 2,000 inspection $50/inspection Total $900,000

Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2

activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500



Step 2: Partitioning of overhead:Step 2: Partitioning of overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (33%) $25,000 (67%) $75,000

33% = 500/1,500 and $100,000 = 500 units x $200/setup33% = 500/1,500 and $100,000 = 500 units x $200/setup

Example of ABC Accounting



Step 2: Partitioning of overhead:Step 2: Partitioning of overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (33%) $25,000 (67%) $75,000

67% = 1,000/1,500 and $200,000 = 1,000 x $200/setup67% = 1,000/1,500 and $200,000 = 1,000 x $200/setup


Step 2: Partitioning of overhead:Step 2: Partitioning of overhead: Overhead Product 1 Product 2Setting up machines $300,000 $100,000 $200,000Machining $500,000 $300,000 $200,000Inspecting $100,000 $25,000 $75,000 Total $900,000 $425,000 $475,000Step 3: Overhead costs per unit:Step 3: Overhead costs per unit:Units produced 25,000 5,000 Overhead cost per unit $17 $95

Traditional overhead cost per unit* $30 $30

* $900,000 divided by 30,000 units

Avoids overstating profitability of some enterprises and

understating profitability of others

Avoids overstating profitability of some enterprises and

understating profitability of others


Product 1 Product 2COP unit costs with COP unit costs with ABC costingABC costing::Direct materials $40 $30Direct labor $12 $12ABC overhead $17 $95 Total unit costs $69 $137

COP unit costs with COP unit costs with traditional costingtraditional costing::Direct materials $40 $30Direct labor $12 $12Traditional overhead * $30 $30 Total unit costs $82 $72

* $900,000 divided by 30,000 unitsTraditional overhead costing

suggests that Product 2 is cheaper to produce than

Product 1, which is not true!

Traditional overhead costing suggests that Product 2 is cheaper to produce than

Product 1, which is not true!


Product #1Variable expensesFixed expenses




Product #nVariable expensesFixed expenses

Product #nVariable expensesFixed expenses

Total fixed expensesTotal fixed expenses

Two approaches:1. Allocate total fixed expenses using ABC accounting procedures2. Sum the budgeted fixed expenses at the product level and check

for consistency at the firm level. Reallocate if necessary.

1 2 1 2 1 2

1 2

…………..

Another Approach…

Decision-Making Concepts

Cost behavior analysisCost-volume-profit analysisMarginal analysisPricing

Cost Behavior Analysis

Variable costsVariable costs –costs that vary with the level of production

Fixed costsFixed costs – costs that do not vary with the level of production

Relevant rangeRelevant range – relevant segment of cost curves

Mixed costsMixed costs – sometimes called semi-variable costs (e.g., rental rates)

Cost-Volume-Profit Analysis

• Contribution margin per unitContribution margin per unit: unit selling price minus unit variable cost

• Contribution margin ratioContribution margin ratio: units vs. $$$

• Degree of operating leverageDegree of operating leverage: contribution margin ÷ net income

• Breakeven analysisBreakeven analysis: entity vs. enterprise level

Marginal Analysis

Short profit associated with input useSingle versus multiple input usageProductivity and pricesProduct/enterprise selection

Product Pricing

Target costingTarget costing (TC = P – desired profit)Cost Plus pricingCost Plus pricing

Cost plus a markup Markup percentage (desired ROI per unit divided by

total unit cost)Variable cost pricingVariable cost pricing (excludes SR fixed costs) Internal pricingInternal pricing

Cost-based transfer price Market-based transfer price

Pricing powerPricing power (Price takers vs. price setters)

Cash Management and LOC

• Identifying monthly cash flow surpluses and deficits

• Determining the required LOC – maximum monthly cash flow deficit

• Remember, cash is King!!!Remember, cash is King!!!

Managerial Accounting An Overview. Role in Decision-Making Provides economic and financial...

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