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DDW 2243MANAGERIAL ACCOUNTING

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1. MANAGERIAL ACCOUNTINGAND BUSINESS ENVIRONMENT

Definition- Concerned with providing information

to managers.

- Provides essential data with which

organizations are actually run.- Managerial accountant prepare a

variety of reports focus on how wellmanagers or business units have

performed.

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Concept

- Several approaches have been developed toassist organizations in meeting challenges.The approaches include:

(a) Just-In-Time (JIT)

(b) Total Quality Management (TQM)

(c) Process Reengineering

(d) Theory of Constraints (TOC)

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JIT

- Emphasizes on the importance of reducinginventories to the barest minimum possible.

- This reduces working capital requirements,frees up space, reduces throughput time,

reduces defects and eliminates waste.

TQM

- Involves focusing on the customer, and itemploys systematic problem solving usingteams made up of front-line workers.

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- Specific TQM tools include benchmarkingand the plan-do-check-act (PDCA) cycle. By

emphasizing teamwork, a focus on thecustomer, and facts, TQM can avoid theorganizational infighting that might otherwiseblock improvement.

Process Reengineering

- Involves completely redesigning a business

process in order to eliminate non-value-added activities and to reduce opportunitiesfor errors.

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- Relies more on outside specialists than TQM

and is more likely to be imposed by topmanagement.

TOC

- Emphasizes the importance of managing theorganizations constraints. Since theconstraints is whatever is holding back the

organization, improvement efforts usuallymust be focused on the constraint in order tobe really effective.

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2. COST TERMS, CONCEPTS ANDCLASSIFICATIONS

Cost Classification

- Costs are associated with all types oforganizations: business, non-business,manufacturing, retail and service.

1.Manufacturing costs

Most companies divide manufacturing costs

into 3 broad categories:- Direct material

- Direct labor

- Manufacturing overhead

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2. Non-manufacturing costs

-Marketing or selling costs all costs necessary

to secure customer orders.-Administrative costs include all costs

associated with general management of anorganisation.

3. Product costs

Include all the costs that are involved in acquiring

or making a product. Since product costs areinitially assigned to inventories, they are also

known as inventoriable costs.

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4. Period costs

All the costs that are not included in productcosts. These costs are expensed on the

income statement in the period in which they

are incurred, using the usual rules of accrual

accounting.Examples of period costs include:

- sales commissions

- office rent- advertising

- executive salaries

- public relations

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5. Opportunity costs

The potential benefit that is given up when

one alternative is selected over another. For

example, Steve is employed with a company

that pays him a salary of $30,000 per year.

He is thinking about leaving the company and

returning to school. Since returning to school

would require he give up his $30,000 salary,

the forgone salary would be an opportunity

costs of seeking further education.

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6. Fixed Costs

A cost that remains constant, in total,regardless of changes in the level of activityfor example rent.

7. Variable CostsA cost that varies, in total, in directproportion to changes in the level of activityfor example the cost of direct materialsused during a period will vary in proportionto the number of units produced.

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8. Sunk cost

A cost that has already been incurred andthat cannot be changed by any decision

made now or in the future for example

depreciation on assets.

Cost classifications for decision making

- Costs are important feature of many

business decisions. In making decisions, itis essential to have a firm grasp of theconcepts differential costs, opportunitycosts and sunk costs.

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3. SYSTEMS DESIGN: JOB-ORDER COSTING

Job-order Costing

- Used in situations where many differentproducts are produced each period.

- For example, a Levi Strauss clothing factorywould typically make many different types ofjeans for both men and women during amonth.

- A particular order might consist of 1,000stonewashed womens super low rise bluejeans, style M593 with 26-inch waist.

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- This order of 1,000 jeans is called a batch ora job. In a job-order costing system, costs

are traced and allocated to jobs and thencosts of the job are divided by the number ofunits in the job to arrive at an average costper unit.

Process Costing

- Used in situations where the companyproduces many units of a single product(such as Maggi Instant Noodles) for longperiods.

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- The basic approach in process costing is toaccumulate costs in a particular operation or

department for an entire period (month,quarter, year) and then divide this total costby the number of units produced during theperiod.

Unit product cost = Total manufacturing costTotal units produced

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Measuring direct materials cost

- A bill of materials is a document that lists thetype and quantity of each item of materialneeded to complete a unit of the product.

- Materials requisition form is a detailed source

document that:Specifies the type and quantity of materials

to be drawn.

Identifies the job to which the costs of thematerials are to be charged.

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Measuring direct labor cost

- Direct labor cost is handled in much the sameway as direct materials cost.

- Direct labor consists of labor charges that areeasily traced to a particular job.

- Labor charges that cannot be traced directlyto any job are treated as part ofmanufacturing overhead.

- The latter category of labor costs is calledindirect labor and includes tasks such asmaintenance, supervision and cleanup.

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Similarities between Job-order and Process

Costing

- Both systems have the same basic purposesto assign material, labor and overhead cost toproducts and to provide a mechanism forcomputing unit product costs.

- Both systems use the same basicmanufacturing accounts, includingManufacturing Overhead, Raw Materials,Work In Process (WIP) and Finished Goods.

- The flow of costs through the manufacturingaccounts is basically the same in bothsystems.

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Differences between Job-Order and

Process Costing1. Many different jobs are worked

period, with each job havingdifferent production requirements.

1. A single product is produced

either on a continuous basisor for long period of time. Allunits of product are identical.

2. Costs are accumulated byindividual job.

2. Costs are accumulate bydepartment.

3. The job cost sheet is the key

document controlling the

accumulation of costs by a job.

3. The department production

report is the key document

showing the accumulation

and disposition of costs by a

department.

4. Unit costs are computed by job on

the job order cost sheet.

4. Unit costs are computed by

department on the departmentproduction report.

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DDW 2243MANAGERIAL ACCOUNTING 19

Application of Manufacturing Overhead

- It must be included with direct materials and

direct labour on the job cost sheet sincemanufacturing overhead is also a productcost.

- 3 reasons for difficulty in assigning

manufacturing overhead to units of product:It is an indirect cost.

It consists of many different items.

It remains relatively constant due to thepresence of fixed costs.

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- The only way to assign overhead costs toproducts is to use an allocation process.

- An allocation base is a measure of such asdirect labour hours (DLH) or machine hours(MH) that is used to assign overhead costs toproducts and services.

Predetermined overhead rate = Estimated total manufacturingoverhead costEstimated total units in theallocation base

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- Predetermined overhead rate is based onestimates rather than actual results.

- The process of assigning overhead cost tojob is called overhead application.

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Overhead applied to a particular job =Predetermined overhead rate x Amount of the allocation baseIncurred by the job

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- Several reasons for using predeterminedoverhead rates instead of actual overhead

rates:Managers would like to know the accounting

systems valuation of completed jobs before theend of accounting period.

If actual overhead rates are computed frequently,seasonal factors in overhead costs or in theallocation base can produce fluctuations in theoverhead rates.

The use of a predetermined overhead rate

simplifies record keeping.

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- Equivalent units is defined to be the productof the number of partially completed units and

the percentage completion of these units.- The equivalent units is the number of

complete units that could have been obtainedfrom the materials and effort that went into

the partially complete units.

Equivalent units =

Number of partially completed units x Percentage completion

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- Under the weighted average method, adepartments equivalent units are computed

as follows:

- FIFO method of process costing differs from

the weighted average as it is more accurate,though it is more complex.

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Equivalent units =Units transferred to the next department or to finished goods

+

Equivalent units in ending work in process inventory

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- Under the FIFO method, it is necessary toconvert both beginning and ending

inventories to an equivalent unit basis.- For the beginning inventory, the equivalent

units represent the work done to complete theunits; for the ending inventory, the equivalent

units represent the work done to bring theunits to a stage of partial completion at theend of the period.

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4. COST-VOLUME-PROFITRELATIONSHIP

Definition

- CVP analysis is one of the most powerfultools that managers have at their command.

It helps them to understand theinterrelationship between cost, volume andprofit in an organization by focusing oninteractions among the following 3 items:

(a) Prices of products(b) Volume or level of activity

(c) Per unit variable costs

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Concept

- The concept developed in this chapterrepresent a way of thinking rather than amechanical set of procedures that is to puttogether the optimum combination of costs,

selling price and sales volume, the mangermust be trained to think in terms of:

(a) Unit contribution margin (CM)

(b) Break-even point (BEP)

(c) CM ratio

(d) Margin of safety (MOS)

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Contribution margin (unit)

- The amount remaining from sales revenueafter variable expenses have been deducted.

- Example:Total

($)

Per Unit

($)

Sales (1 speaker)

Less: Variable expenses

Contribution margin

Less: Fixed expenses

Net operating loss

Working to be shown on

whiteboard

250

150

100

35,000

(34,900)

250

150

100

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Contribution margin (ratio)

- The contribution margin as a percentage oftotal sales is referred to as the contributionmargin ratio (CM ratio). This ratio iscomputed as follows:

Working to be shown on whiteboard

Contribution marginSales

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Break-even Analysis

- CVP analysis is sometimes referred to simplyas break-even analysis.

- 2 methods are equivalent. There are:

(a) Equation method


Sales = Variable expenses+

Fixed expenses+

Profits

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(b) Contribution margin method


BEP (unit) = Fixed expensesUnit contribution

margin

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BEP (dollars) =

Fixed expenses

Contribution margin (ratio)

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Margin of safety (MOS)


MOS = Total budgeted(actual) sales

-Break-even sales

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MOS (%) =MOS in dollars

Total budgeted (actual) sales

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- Thus, with this CVP analysis which involvesfinding the most favorable combination ofvariable costs, fixed costs, selling price, salesvolume, and mix of products sold provide the

manager with a powerful tool for identifyingthose courses of action that will improveprofitability.

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5. SEGMENT REPORTING ANDDECENTRALIZATION

Decentralization and SegmentReporting

- A decentralized organization is one inwhich decision making is not confined

to a few top executives but rather isspread throughout the organization.

- Effective decentralization requiressegmental reporting. A segment

report is a part or activity of anorganization about which managerswould like cost, revenue or profit data.

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- A companys operations can be segmented inmany ways for example, a grocery store

chain like Safeway or Kroger can segment itsbusiness by geographic region, individualstore, brand name and so on.

Cost center- It is a business segment whose manager has

control over costs but not over revenue orinvestment funds.

- Example: Service departments likeaccounting, finance, general administration,

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legal and personnel are usually considered to

be cost centers.- The managers of cost centers are expected

to minimize cost while providing the level ofservices or the amount of products demand

by the other parts of the organization.

Profit center

- In contrast to a cost center, a profit center isany business segment whose manager hascontrol over both cost and revenue.

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- Profit center managers are often evaluated by

comparing actual profit to targeted orbudgeted profit.

- Segmented income statements, should beused to evaluate profit center managers.

Activity-Based Costing (ABC)

- Is a costing method that is designed to

provide managers with cost information forstrategic and other decisions that potentiallyaffect capacity and therefore fixedcosts.

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- Most organizations that use ABC have 2costing systems: the official costing system

that is used for preparing external financialreports and the ABC system that is used forinternal decision making and for managingactivities.

- In ABC:

1. Non-manufacturing and manufacturingcosts may be assigned to products.

2. Some manufacturing costs may beexcluded from product costs.

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3. A number of overhead cost pools are used,each which is allocated to products and othercosting objects using its own unique measureof activity.

4. The allocation bases often differ from those

used in traditional costing systems.5. The overhead rates, or activity rates, maybe based on the level of activity at capacityrather than on the budgeted level of activity.

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Steps for implementing ABC

1. Identify and define activities and activitycost pools.

2. Wherever possible, directly trace costs toactivities and cost objects.

3. Assign costs to activity cost pools.

4. Calculate activity rates.

5. Assign costs to cost objects using the

activity rates and activity measures.6. Prepare management reports.

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Segmented Financial Information on External

Reports

- The Financial Accounting Standards Board(FASB) requires companies includesegmented financial and other data in annual

reports and that the segmented reportsprepared for external users must use thesame methods and definitions that the

companies use in internal segmented reports

that are prepared to aid in making operatingdecisions.

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Measuring managerial performance

1. Return on investment (ROI)

or

Net operating income

Average operatingassets

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Net operating incomeSales

X

SalesAverage operating assets

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2. Margin

- Margin a measure ofmanagements ability to

control operating expenses in relation tosales

Net operating incomeSales

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3. Turnover

- Turnover is a measure of the sales that are

generated for each dollar invested inoperating assets.

SalesAverage operating assets

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- ROI can be increased in 3 ways:

1. Increase sales

2. Reduce expenses

3. Reduce assets

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6. PROFIT PLANNING

Definition

- In this chapter, we focus on the steps takenby businesses to achieve their desired levels

of profit: a process that ca be called profitplanning.

- Profit planning is accomplished through the

preparation of a number of budgets, whichwhen brought together, form an integratedbusiness plan known as the master budget.

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Responsibility accounting

- The basic idea behind responsibilityaccounting is that a manager should be heldresponsible for those items and only thoseitems that the manager can actually control to

a significant extent.- Each line item (i.e., revenue or cost) in the

budget is made the responsibility of amanager, and that manager is held

responsible for subsequent deviationsbetween budgeted goals and actual results.

0

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Planning and control

- The terms planning and control are often

confused. Actually, planning and control are2 distinct concepts.

- Planning involves developing objectives andpreparing various budgets to achieve those

objectives.- Control involves the steps taken bymanagement to increase the likelihood thatthe objectives set down at the planning stage

are attained and that all parts of theorganizations are working together towardthat goal.

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Preparing the master budget

- In planning for a budgeting process, there arelist of documents that need to be drawn up asa part of a master budget. They are asfollows:

1. Sales budget2. Production budget

3. Direct material budget

4. Direct labor budget

5. Manufacturing overhead budget6. Finished good budget

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7. Selling and administrative expense budget

8. Cash budget9. Budgeted income statement (P & L)

10. Budgeted balance sheet

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7. STANDARD COSTS AND THEBALANCE SCORECARD

Definition- A standard is a benchmark ornormfor measuring performance.Standards are set for both the cost

and the quantity of inputs needed tomanufacture good or to provideservices.

- Quantity standards indicate how

much of cost element, such as labortime or raw materials, should be usedto make a product or provide aservice.

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- Cost standards indicate what the cost of thetime or the materials should be.

- Standards are normally set so that they canbe attained be reasonable though highlyefficient, efforts.

- Such practical standards are generally felt

to positively motivate employees.

Who uses standard costs?

- Manufacturing- Service

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- Fast-food outlets (i.e., McDonald)

- Non-profit organizations

Are Standards the same as Budgets?

- Standards and budgets are very similar.

- The major distinction between the 2 terms isthat a standard is a unitamount, whereas abudget is a totalamount.

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Variance Analysis

- An important reason for separating standardsinto 2 categories: price and quantity is thatdifferent managers are usually responsible forbuying and using inputs and these 2 activities

occur at different points in time.- Differences between standard prices and

actual prices and standard quantities andactualquantities are called variances.

- The act of computing and interpretingvariances is called variance analysis.

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- A general model for computing standard cost

variances for variable costs is presented inExhibit 10-3, pg 431, Managerial Accountingby Garrison Noreen (please refer to it).

- Materials price variance measures the

difference between what is paid for a givenquantity of materials and what should havebeen paid according to the standard that hasbeen set.

= AQ (AP SP)

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- Materials quantity variance measures the

difference between the quantity of materialsused in production and the quantity thatshould have been used according to thestandard that has been set.

= SP (AQ

SQ)- Labour rate variance measures any deviation

from standard in the average hourly rate paidto direct labour workers.

= AH (AR SR)

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- Labour efficiency variance measures the

productivity of labour time.= SR (AH SH)

- Manufacturing overhead variances:

Variable overhead spending variance =

AH (AR SR)

Variable overhead efficiency variance =

SR (AH SH)

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Planning investments

- Typical budgeting decisions include:

1. Cost reduction decisions. Should newequipment be purchased to reduce costs?

2. Expansions decisions. Should a new plant,warehouse or other facility be acquired toincrease capacity and sales?

3. Equipment selection decisions. Which ofseveral available machines would be the

most cost effective to purchase?

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4. Lease or buy decisions. Should newequipment be leased or purchased?

5. Equipment replacement decisions. Should

old equipment be replaced now or later?

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BUDGET

MANY BUSINESS

FAIL FOR LACK OF CASHTHAN FOR WANT

OF PROFIT

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Management of cash

- Cash is the life blood of an enterprise.

- Good cash management assists:1. In the control of financial risk.

2. Provides for profit opportunities.

3. Generates confidence with creditors andshareholders / stakeholders.

What is Cash Flow Management (CFM)?

- Is the process whereby cash inflow andoutflow are controlled so that current

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obligations will be met in time and any excesscash with earn income.

- It also includes the ability to obtain credit sothat enterprise can have access to cash tofinance temporary cash deficits.

- CFM overall activities include billingcustomers as quickly as possible, disbursingpayments only when they come due (exceptwhen cash discount in given by suppliers andaccepted by the company), collection of cashon overdue accounts, impose interest on latepayment and investing idle cash.

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CFM objectives

- Accelerating cash inflows wherever possible.- Delaying cash outflow until they come due.

- Investing surplus cash to earn a rate ofreturn.

- Borrowing cash at the best possible terms.

- Maintaining an optimal level of cash that isneither excessive nor deficient.

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How to reduce the cash operating cycle?

- Reduce average stockholding periods byreducing the stock level.

- Reduce collection period through efficientcredit policies/management.

- Extend payment period to supplier but bevery extra careful.

Planning for cash management

- A cash flow projection charts the amount of

money your business expects to receive andpay out each month in a rolling 6 or 12months period.

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- A well-prepared cash flow projection will allowyou to plot anticipated cash flow positions

over time. It will help you anticipate shortfallsin time and to do something about them,protecting you from a cash flow crisis.

- Also, a cash flow projection can help you spot

sales trends, tell you if your customers aretaking too long to pay, and help you plan formajor asset purchases.

- In addition, should you decide to seek loan,

banks will ask to see 1 year cash flowprojection by month, and 3 to 5 yearprojections by quarter.

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Transfer pricing

- Is the price charged when one segment of acompany provides goods or services toanother segment of the company.

- 3 common approaches are used to set

transfer prices.1. Allow the managers involved in the transferto negotiate their own transfer price.

2. Set transfer prices at cost using variablecost and full (absorption) cost.

3. Set transfer prices at the market prices.

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9. RELEVANT COST FOR DECISIONMAKING

Cost concept for decision making- Costs have been defined by

accountants as resources sacrificedin order to achieve a specific

objective.- Cost accounting is primarily

concerned with meeting the costinformation requirements of a

business in order that effective controlover each element of cost can beexercised.

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- The main purposes for preparing cost dataare for cost planning and control, and

decision making.- Other than deciding which product to

produce, the cost data accumulated from a

reliable basis for a host of decisions include:1. Should the business manufacture its ownproduct component or should it buy fromexternal sources?

2. What prices should a business charge forits products?

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3. Should the business buy the proposedequipment?

4. Should the business increase itsproduction capacity?

5. Should the business accept a certain

contract?

The elements of costs

- Costs are classified by functions: production,selling and distribution, research anddevelopment and administration.

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- Within each function, the costs are collectedby cost centers and cost units.

- A cost center is a location, person or an itemof equipment for which costs areaccumulated for the purpose of cost control.

- A cost unit is a unit of product, service or timein respect of which cost can be ascertained.Examples of cost units are job, batch contractand product group. All costs accumulated by

cost centers have to be allocated to,apportioned to, or absorbed by cost units.

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- The cost elements within a cost center or costunit are:

1. Material cost2. Labour cost

3. Other expenses (Overhead expenses)

Variable costs, fixed costs and semi-variable

Costs

- Costs can also be classified into 3 categories

in terms of their behavior in relation tochanges in the volume of production:

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Fixed costs

- Cost which are not affected by the changes in

the volume of production. Examples are rentpaid for factory premises, insurance andsupervisors salaries.

Semi-variable costs- Costs which are not perfectly variable nor they

entirely fixed in relation to production volume.Examples include electricity where there is afixed chare up to a given number of units anda variable charge after that point.

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Decision making process

- Manager needs different costs for different

purposes. For one purpose, a particulargroup of costs may be relevant, for anotherpurpose, an entirely different group of costsmay be relevant.

- Decision making process involve thefollowings:

1. Making or buying a component.

2. Adding or dropping a product line.

3. Processing a joint product

4. Using a constrained resource.

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Applying relevant costs

- Make versus buy

- Equipment replacement- Relevant cost of materials

How human resource and accounting affectbusiness performance?

- In accounting terms, people are treated aslabour, a resource is consumed.

- How to assign a value to a trademark?i.e., Coca-cola.

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10. CAPITAL BUDGETING

Definition

- The term capital budgeting is used todescribe how managers plansignificant outlays on projects thathave long-term implications such asthe purchase of new equipment andthe introduction of new products.

- Capital budgeting involvesinvestment: a company must commitfunds now in order to receive a returnin the future.

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Typical capital budgeting decisions

1. Cost reduction decisions. Should new

equipment be purchased to reduce costs?2. Expansions decisions. Should a new plant,

warehouse or other facility be acquired toincrease capacity and sales?

3. Equipment selection decisions. Which ofseveral available machines would be themost cost effective to purchase?

4. Lease or buy decisions. Should newequipment be leased or purchased?

5. Equipment replacement decisions. Shouldold equipment be replaced now or later?

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The time value of money

- A dollar today is worth more than a dollar a

year from now.- The same concept applies in choosing

between investment projects

Discounted cash flows: The NPV method- Under the NPV method, the PV of a projects

cash inflows is compared to the PV of theprojects cash outflows.

- The difference between the PV is anacceptable investment.

- Working to be shown on whiteboard

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Choosing a discount rate

- What is a companys minimum required rate

of return?

- The companys cost of capital is usuallyregarded as the minimum required rate of

return.- The cost of capital is the average rate of

return the company must pay to its long-termcreditors and to shareholders for the use of

their funds.- Working to be shown on whiteboard.

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Internal rate of return (IRR)

- The formula is as follows:

- Working to be shown on whiteboard.

Investment requiredNet annual cash

inflow

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Payback method

- The payback period is the length of time thatit takes for a project to recoup its initial costout of the cash receipts that it generates.

- Formula is as follows:

Investment requiredNet annual cash

inflow*

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*If new equipment is replacing old equipment, this becomes

incremental net annual cash inflow.

- Working to be shown on whiteboard.

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