managerial accounting: applications

Managerial Accounting:Applications

Managerial Accounting:Applications

Khalid Aziz-0322-3385752Khalid Aziz-0322-3385752

OutlineOutline

Segmented Reporting and Responsibility Accounting System

Cost-Volume-Profit AnalysisBudgeting and Budgetary Control Standard Costs and Variance AnalysisManagerial Decision Making

Segmented Reporting and Responsibility Accounting System

Cost-Volume-Profit AnalysisBudgeting and Budgetary Control Standard Costs and Variance AnalysisManagerial Decision Making


IntroductionIntroduction

Let’s look at the XYZ Company example. A manager at XYZ Company wants to replace an old

machine with a new, more efficient machine.

Let’s look at the XYZ Company example. A manager at XYZ Company wants to replace an old

machine with a new, more efficient machine.

New machine: List price 900000 Annual variable expenses 800000 Expected life in years 5Old machine: Original cost 720000 Remaining book value 600000 Disposal value now 150000 Annual variable expenses 1000000 Remaining life in years 5

New machine: List price 900000 Annual variable expenses 800000 Expected life in years 5Old machine: Original cost 720000 Remaining book value 600000 Disposal value now 150000 Annual variable expenses 1000000 Remaining life in years 5



XYZ’s sales are Rs2000000 per year.Fixed expenses, other than amortization, are

Rs700000 per year.Should the manager purchase the new machine?

XYZ’s sales are Rs2000000 per year.Fixed expenses, other than amortization, are

Rs700000 per year.Should the manager purchase the new machine?



The manager recommends that the company not purchase the new machine since disposal of the old machine would result in a loss:

The manager recommends that the company not purchase the new machine since disposal of the old machine would result in a loss:

Remaining book value 600000Disposal value -150000Loss from disposal 450000

Remaining book value 600000Disposal value -150000Loss from disposal 450000



Is it correct?What’s your comment to the

manager’s decision? After learning this chapter,

you will know how to employ the tools of managerial accounting and make decisions correctly.

Is it correct?What’s your comment to the

manager’s decision? After learning this chapter,

you will know how to employ the tools of managerial accounting and make decisions correctly.


Segmented ReportingSegmented Reporting

Organizations may break down their operations into various segments divisions, stores, services, or departments.

Management needs reports on each segment for cost management performance evaluation

Organizations may break down their operations into various segments divisions, stores, services, or departments.

Management needs reports on each segment for cost management performance evaluation


Segmented ReportingSegmented Reporting

Segments may be evaluated as a cost centre a profit centre→Profit centre reports include information on a

segment’s revenues and costs.

an investment centre.

Some costs are direct and some are indirect. Indirect costs may be allocated to various

departments.

Segments may be evaluated as a cost centre a profit centre→Profit centre reports include information on a

segment’s revenues and costs.

an investment centre.

Some costs are direct and some are indirect. Indirect costs may be allocated to various

departments.


Service Department Common Allocation BasesGeneral Office Number of employeesPersonnel Number of employeesPayroll Number of employeesAdvertising SalesPurchasing Number of Purchase OrdersCleaning Floor space occupiedMaintenance Floor space occupied

Service Department Common Allocation BasesGeneral Office Number of employeesPersonnel Number of employeesPayroll Number of employeesAdvertising SalesPurchasing Number of Purchase OrdersCleaning Floor space occupiedMaintenance Floor space occupied

Segmented ReportingSegmented ReportingService department costs are shared indirect Service department costs are shared indirect

expenses of operation departments.expenses of operation departments.They may be allocated using a variety of bases.They may be allocated using a variety of bases.


Responsibility Accounting SystemResponsibility Accounting System

Responsibility Accounting System Responsibility Accounting System An accounting system An accounting system assigns managers the responsibility for assigns managers the responsibility for

costs and expenses under their control.costs and expenses under their control.


Responsibility Accounting SystemResponsibility Accounting System

Responsibility accounting budgets Responsibility accounting budgets are prepared prior to each accounting periodare prepared prior to each accounting period

Responsibility accounting performance Responsibility accounting performance reports reports compare actual costs and expenses to budgeted compare actual costs and expenses to budgeted

amountsamounts

Responsibility accounting budgets Responsibility accounting budgets are prepared prior to each accounting periodare prepared prior to each accounting period

Responsibility accounting performance Responsibility accounting performance reports reports compare actual costs and expenses to budgeted compare actual costs and expenses to budgeted

amountsamounts


Cost-Volume-Profit Analysis (CVP)Cost-Volume-Profit Analysis (CVP)

CVP analysis is used to answer: How much must I sell to earn my desired

income? How will income be affected if I reduce selling

prices to increase sales volume? How will income be affected if I change the

sales mix of my products? ……?

CVP analysis is used to answer: How much must I sell to earn my desired

income? How will income be affected if I reduce selling

prices to increase sales volume? How will income be affected if I change the

sales mix of my products? ……?


Assumptions of CVP AnalysisAssumptions of CVP Analysis

CVP analysis assumes relations can be CVP analysis assumes relations can be expressed as straight lines within the expressed as straight lines within the relevant range. relevant range.

Unit selling price remains constant.Unit selling price remains constant. Unit variable costs remain constant.Unit variable costs remain constant. Total fixed cost remain constant.Total fixed cost remain constant.

If the expected cost and revenue behaviour is If the expected cost and revenue behaviour is different from the assumptions, then the results of different from the assumptions, then the results of CVP analysis are of limited use.CVP analysis are of limited use.

CVP analysis assumes relations can be CVP analysis assumes relations can be expressed as straight lines within the expressed as straight lines within the relevant range. relevant range.

Unit selling price remains constant.Unit selling price remains constant. Unit variable costs remain constant.Unit variable costs remain constant. Total fixed cost remain constant.Total fixed cost remain constant.

If the expected cost and revenue behaviour is If the expected cost and revenue behaviour is different from the assumptions, then the results of different from the assumptions, then the results of CVP analysis are of limited use.CVP analysis are of limited use.


Scatter DiagramScatter Diagram

Vertical Vertical distance distance

is the is the change in change in

cost.cost.Horizontal distance is the change in activity.

0 1 2 3 4

*

To

tal

Co

st i

nT

ota

l C

ost

in

1,00

0’s

of

Do

llar

s1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units ProducedActivity, 1,000’s of Units Produced

Unit Variable Cost = Slope =Unit Variable Cost = Slope = Change in costChange in unitsChange in costChange in units


High-Low MethodHigh-Low Method

0 1 2 3 4 5

*

To

tal

Co

st i

nT

ota

l C

ost

in

1,00

0’s

of

Do

llar

s1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units SoldActivity, 1,000’s of Units Sold

30 Vertical Vertical distance distance

is the is the change change in cost. in cost. (30 - 20)(30 - 20)

Horizontal distance is the change in activity.

(5 - 1)

Unit Variable Cost =Unit Variable Cost = 30 - 2030 - 20 5 - 1 5 - 1

= = Rs2.50/unitRs2.50/unit


Least-Squares RegressionLeast-Squares Regression

Least-squares regression is usually covered in advanced cost accounting

courses. is commonly used with computer software

because of the large number of calculations required.

The objective of the cost analysis remains the same: determination of total fixed cost and the variable unit cost.

Least-squares regression is usually covered in advanced cost accounting

courses. is commonly used with computer software

because of the large number of calculations required.

The objective of the cost analysis remains the same: determination of total fixed cost and the variable unit cost.


Break-Even AnalysisBreak-Even Analysis

The break-even point is the unique sales level at which a company neither earns a profit nor incurs a loss.

The break-even point is the unique sales level at which a company neither earns a profit nor incurs a loss.

SalesSales

Total costsTotal costs

Volume in UnitsVolume in Units

Co

sts

an

d R

eve

nu

eC

os

ts a

nd

Rev

en

ue

in D

olla

rsin

Do

llars



The break-even point may be expressed in units or in dollars of sales.

The break-even point may be expressed in units or in dollars of sales.

Break-even point in units = Contribution margin per unit

Unit sales price less unit variable costUnit sales price less unit variable cost

Fixed Costs



The break-even formula may also be expressed in sales dollars.

The break-even formula may also be expressed in sales dollars.

Unit sales price Unit sales price Unit variable costUnit variable cost

Break-even point in dollars = Break-even point in dollars = Contribution margin ratioContribution margin ratio

Fixed CostsFixed Costs


Computing Income from Expected Sales

Computing Income from Expected Sales

What is the income given a predicted level of sales?

What is the income given a predicted level of sales?

Pre-taxPre-taxIncomeIncomePre-taxPre-taxIncomeIncome = Sales – [Fixed costs + Variable costs]= Sales – [Fixed costs + Variable costs]= Sales – [Fixed costs + Variable costs]= Sales – [Fixed costs + Variable costs]

Pre-taxPre-taxIncomeIncomePre-taxPre-taxIncomeIncome = Sales –Fixed costs - Variable costs= Sales –Fixed costs - Variable costs= Sales –Fixed costs - Variable costs= Sales –Fixed costs - Variable costs

orororor


Contribution margin ratio

Contribution margin per unitUnit sales =

Fixed costs + Target incomeTarget income

Dollar sales = Fixed costs + Target incomeTarget income

Sales Volume Needed toEarn a Target Income

Sales Volume Needed toEarn a Target Income

Break-even formulas can be adjusted to show the sales volume needed to earn any amount of income.

Break-even formulas can be adjusted to show the sales volume needed to earn any amount of income.


Margin of SafetyMargin of Safety

Margin of safety How much sales can decrease before the

company incurs a loss?

Margin of safety How much sales can decrease before the

company incurs a loss?

Expected salesExpected sales

Margin of Margin of safety, safety, percentpercent

Expected sales - Break-even salesExpected sales - Break-even sales==


New contribution margin ratio

New break-even point in dollars

New fixed costs

Sensitivity AnalysisSensitivity Analysis

The effects of changes in variables such as sales price, variable costs, and fixed costs.

CVP analysis can be used to show the effects of such changes.

The effects of changes in variables such as sales price, variable costs, and fixed costs.

CVP analysis can be used to show the effects of such changes.

=


BudgetsBudgets

BudgetsBudgets formal statements of a company’s plans formal statements of a company’s plans

expressed in monetary termsexpressed in monetary terms attempt to capture the future activities of an attempt to capture the future activities of an

organizationorganization are used by businesses, not-for-profit, are used by businesses, not-for-profit,

government, educational, and other types of government, educational, and other types of organizations.organizations.

BudgetsBudgets formal statements of a company’s plans formal statements of a company’s plans

expressed in monetary termsexpressed in monetary terms attempt to capture the future activities of an attempt to capture the future activities of an

organizationorganization are used by businesses, not-for-profit, are used by businesses, not-for-profit,

government, educational, and other types of government, educational, and other types of organizations.organizations.


Advantages

Communicates plansCommunicates plansand instructionsand instructions

Promotes analysis andPromotes analysis anda focus on the futurea focus on the future

Motivates employeesMotivates employees

Provides a basis forProvides a basis forevaluating performanceevaluating performance

CoordinatesCoordinatesbusiness activitiesbusiness activities

Defines goalsDefines goalsand objectivesand objectives

Importance of Budgeting Importance of Budgeting


Budget CommitteeBudget Committee

Budget Committee Consists of managers from all departments

of the organization Provides central guidance→to insure that individual budgets submitted from all

departments are realistic and coordinated.

Budget Committee Consists of managers from all departments

of the organization Provides central guidance→to insure that individual budgets submitted from all

departments are realistic and coordinated.


Flow of budget data isFlow of budget data is a a bottom-upbottom-up process. process.

S u p erviso r S u p erviso r

M id d leM an ag em en t

S u p erviso r S u p erviso r

M id d leM an ag em en t

Top M an ag em en t

Budget CommitteeBudget Committee


2005 2006 2007 2008

Operating Budget

The annual operating budget may be divided into quarterly

or monthly budgets.

Budget CycleBudget Cycle

Budget horizons are usually for one yearbut may extend for several years.


Continuous or Rolling Budget

The budget may be a twelve-month The budget may be a twelve-month budget that rolls forward one month budget that rolls forward one month as the current month is completed.as the current month is completed.

2005 2006 2007 2008

Rolling BudgetsRolling Budgets


Master BudgetMaster Budget

Master BudgetMaster Budget A formal, comprehensive planA formal, comprehensive plan→for the future of a companyfor the future of a company

consists of several budgets linked togetherconsists of several budgets linked together→to form a coordinated plan for the organizationto form a coordinated plan for the organization

Master BudgetMaster Budget A formal, comprehensive planA formal, comprehensive plan→for the future of a companyfor the future of a company

consists of several budgets linked togetherconsists of several budgets linked together→to form a coordinated plan for the organizationto form a coordinated plan for the organization


Preparesales

budget

Developproduction

budget

Prepare financial budgets: cash income balance sheet

Preparecapital

expenditurebudget

Prepareselling and

generaladministrative

budgets

Prepare manufacturing budgets: material labour overhead

Master BudgetMaster Budget


Sales BudgetSales Budget

Sales budgetSales budget the starting point in the budgeting process.the starting point in the budgeting process. Most of the other budgets are linked to the sales Most of the other budgets are linked to the sales

budget. budget. Sales personnel are often involved in developing Sales personnel are often involved in developing

the sales budgets.the sales budgets.

Sales budgetSales budget the starting point in the budgeting process.the starting point in the budgeting process. Most of the other budgets are linked to the sales Most of the other budgets are linked to the sales

budget. budget. Sales personnel are often involved in developing Sales personnel are often involved in developing

the sales budgets.the sales budgets.




Estimated Unit SalesEstimated Unit SalesEstimated Unit PriceEstimated Unit Price

Analysis of economic and market conditionsAnalysis of economic and market conditions++

Forecasts of customer needs from marketing personnelForecasts of customer needs from marketing personnel


Merchandise Purchases BudgetMerchandise Purchases Budget

Merchandise Purchases Budget Provides detailed information about the

purchases necessary to fulfill the sales budget and provide

adequate inventories.

Merchandise Purchases Budget Provides detailed information about the

purchases necessary to fulfill the sales budget and provide

adequate inventories.

Merchandise Merchandise inventory to inventory to

be purchasedbe purchased

Budgeted Budgeted ending ending

inventoryinventory

Budgeted Budgeted sales for the sales for the

periodperiod

Budgeted Budgeted beginning beginning inventoryinventory

= + _


Merchandise Purchases BudgetMerchandise Purchases Budget

The quantity purchased is affected by:The quantity purchased is affected by: Just-in-time inventory systemsJust-in-time inventory systems→enable purchases of smaller, frequently delivered enable purchases of smaller, frequently delivered

quantities. quantities.

Safety stock inventory systemsSafety stock inventory systems→provide protection against lost sales caused by provide protection against lost sales caused by

delays in supplier shipments.delays in supplier shipments.

The quantity purchased is affected by:The quantity purchased is affected by: Just-in-time inventory systemsJust-in-time inventory systems→enable purchases of smaller, frequently delivered enable purchases of smaller, frequently delivered

quantities. quantities.

Safety stock inventory systemsSafety stock inventory systems→provide protection against lost sales caused by provide protection against lost sales caused by

delays in supplier shipments.delays in supplier shipments.


Selling Expense BudgetSelling Expense Budget

Selling Expense Budget lists the types and amounts of selling expenses Predictions of expenses are based on the sales

budget and past experience.

Selling Expense Budget lists the types and amounts of selling expenses Predictions of expenses are based on the sales

budget and past experience.


General and Administrative Expense Budget

General and Administrative Expense Budget

General and Administrative Expense Budget lists the predicted operating expenses not listed

in the sales budget Includes both cash and non-cash expenses Often prepared by the office

manager or person responsiblefor general administration

General and Administrative Expense Budget lists the predicted operating expenses not listed

in the sales budget Includes both cash and non-cash expenses Often prepared by the office

manager or person responsiblefor general administration


Capital Expenditures BudgetCapital Expenditures Budget

Capital Expenditures BudgetCapital Expenditures Budget lists the cash inflows or outflows lists the cash inflows or outflows

pertaining to the disposal or acquisition pertaining to the disposal or acquisition of capital equipment.of capital equipment.

is usually affected by the organization’s is usually affected by the organization’s long-term plans.long-term plans.

Capital Expenditures BudgetCapital Expenditures Budget lists the cash inflows or outflows lists the cash inflows or outflows

pertaining to the disposal or acquisition pertaining to the disposal or acquisition of capital equipment.of capital equipment.

is usually affected by the organization’s is usually affected by the organization’s long-term plans.long-term plans.


Cash BudgetCash Budget

Cash Budget Cash Budget lists the expected cash inflows andlists the expected cash inflows and

outflows for the periodoutflows for the period a tool used by management toa tool used by management to

avoid excess cash balances oravoid excess cash balances orcash shortagescash shortages

Information from other budgets is used in its Information from other budgets is used in its preparationpreparation

Information from the cash budget is used to Information from the cash budget is used to prepare the budgeted income statement and prepare the budgeted income statement and balance sheetbalance sheet

Cash Budget Cash Budget lists the expected cash inflows andlists the expected cash inflows and

outflows for the periodoutflows for the period a tool used by management toa tool used by management to

avoid excess cash balances oravoid excess cash balances orcash shortagescash shortages

Information from other budgets is used in its Information from other budgets is used in its preparationpreparation

Information from the cash budget is used to Information from the cash budget is used to prepare the budgeted income statement and prepare the budgeted income statement and balance sheetbalance sheet


Manufacturing companies need to prepare Manufacturing companies need to prepare additional budgets that include:additional budgets that include: Production budgetsProduction budgets Direct materials purchase budgetsDirect materials purchase budgets Direct labour budgetsDirect labour budgets Manufacturing overhead budgetsManufacturing overhead budgets

Manufacturing companies need to prepare Manufacturing companies need to prepare additional budgets that include:additional budgets that include: Production budgetsProduction budgets Direct materials purchase budgetsDirect materials purchase budgets Direct labour budgetsDirect labour budgets Manufacturing overhead budgetsManufacturing overhead budgets

Production and Manufacturing BudgetsProduction and Manufacturing BudgetsProduction and Manufacturing BudgetsProduction and Manufacturing Budgets


Production and Manufacturing BudgetsProduction and Manufacturing Budgets

Production and Manufacturing Budgets Provides detailed information about the

production necessary to fulfill the sales budget and provide adequate inventories.

Production and Manufacturing Budgets Provides detailed information about the

production necessary to fulfill the sales budget and provide adequate inventories.

Number of Number of units to be units to be producedproduced


inventoryinventory

Budgeted Budgeted sales for sales for

the periodthe period


== ++ __



Direct Materials Budget Provides detailed information about the purchases of

raw materials necessary to fulfill the production budget and provide adequate inventories.

Direct Materials Budget Provides detailed information about the purchases of

raw materials necessary to fulfill the production budget and provide adequate inventories.

Units of raw Units of raw materials to materials to

be purchased be purchased

Materials Materials needed for needed for productionproduction


inventoryinventory


== ++ __

Cost of raw Cost of raw materials to materials to

be purchased be purchased

Units of raw Units of raw materials to materials to

be purchasedbe purchased

Material price Material price per unit of per unit of

raw materialraw material== ××



Direct Labour and Manufacturing Overhead Direct Labour and Manufacturing Overhead BudgetsBudgets Provides information about the labour and Provides information about the labour and

manufacturing overhead costs given the level of manufacturing overhead costs given the level of production for the period.production for the period.

Direct Labour and Manufacturing Overhead Direct Labour and Manufacturing Overhead BudgetsBudgets Provides information about the labour and Provides information about the labour and

manufacturing overhead costs given the level of manufacturing overhead costs given the level of production for the period.production for the period.


CashCashBudgetBudget

ExpectedExpectedReceiptsReceipts

andandDisbursementsDisbursements

BudgetedBudgetedIncomeIncome

StatementStatement

BudgetedBudgetedBalanceBalance

SheetSheet

Preparing Financial BudgetsPreparing Financial Budgets


Take corrective andTake corrective andstrategic actions.strategic actions.

This is an ongoingThis is an ongoing process.process.

Develop the budgetDevelop the budgetfrom planned objectives.from planned objectives.

CompareCompareactual withactual with budget and budget andanalyze anyanalyze anydifferences.differences.

ReviseReviseobjectivesobjectives

and prepareand preparea newa new

budget.budget.

Budgetary ControlBudgetary Control


Capital BudgetingCapital Budgeting

Capital BudgetingCapital Budgeting Analyzing alternative long-term investments Analyzing alternative long-term investments

and deciding which assets to acquire or sell.and deciding which assets to acquire or sell. These decisions require careful analysis since:These decisions require careful analysis since:

→ The outcome is uncertain.The outcome is uncertain.→ Large amounts of money are usually Large amounts of money are usually

involved.involved.→ Investment involves a long-term Investment involves a long-term

commitment.commitment.→ Any decision may be difficult or Any decision may be difficult or

impossible to reverse.impossible to reverse.

Capital BudgetingCapital Budgeting Analyzing alternative long-term investments Analyzing alternative long-term investments

and deciding which assets to acquire or sell.and deciding which assets to acquire or sell. These decisions require careful analysis since:These decisions require careful analysis since:

→ The outcome is uncertain.The outcome is uncertain.→ Large amounts of money are usually Large amounts of money are usually

involved.involved.→ Investment involves a long-term Investment involves a long-term

commitment.commitment.→ Any decision may be difficult or Any decision may be difficult or

impossible to reverse.impossible to reverse.


Zero-based BudgetingZero-based Budgeting

Zero-based Budgeting Zero-based Budgeting are prepared assuming no previousare prepared assuming no previous

activities for the activities beingactivities for the activities beingplannedplanned

Managers must justify the amounts budgeted Managers must justify the amounts budgeted for each activityfor each activity

is popular among government and non-profit is popular among government and non-profit organizations.organizations.

Zero-based Budgeting Zero-based Budgeting are prepared assuming no previousare prepared assuming no previous

activities for the activities beingactivities for the activities beingplannedplanned

Managers must justify the amounts budgeted Managers must justify the amounts budgeted for each activityfor each activity

is popular among government and non-profit is popular among government and non-profit organizations.organizations.


Fixed BudgetFixed Budget

Fixed budgetsFixed budgets are prepared for a single, predicted level of are prepared for a single, predicted level of

activityactivity Performance evaluation is difficult when actual Performance evaluation is difficult when actual

activity differs from the predicted level of activity differs from the predicted level of activity.activity.→Example: How much of the unfavourable costExample: How much of the unfavourable cost

variance is due to higher activity, and how much is variance is due to higher activity, and how much is due to poor cost control?due to poor cost control?

→To answer these questions, we must flex the budget To answer these questions, we must flex the budget to the actual level of activity.to the actual level of activity.

Fixed budgetsFixed budgets are prepared for a single, predicted level of are prepared for a single, predicted level of

activityactivity Performance evaluation is difficult when actual Performance evaluation is difficult when actual

activity differs from the predicted level of activity differs from the predicted level of activity.activity.→Example: How much of the unfavourable costExample: How much of the unfavourable cost

variance is due to higher activity, and how much is variance is due to higher activity, and how much is due to poor cost control?due to poor cost control?

→To answer these questions, we must flex the budget To answer these questions, we must flex the budget to the actual level of activity.to the actual level of activity.


Flexible (Variable) BudgetsFlexible (Variable) Budgets

Flexible budgetsFlexible budgets are prepared after a period’s activities are are prepared after a period’s activities are

complete. complete. Show revenues and expenses that should have Show revenues and expenses that should have

occurred at the actual level of activity. occurred at the actual level of activity. Reveal cost variances due to good cost control or Reveal cost variances due to good cost control or

lack of cost control. lack of cost control. Improve performance evaluation.Improve performance evaluation.

Flexible budgetsFlexible budgets are prepared after a period’s activities are are prepared after a period’s activities are

complete. complete. Show revenues and expenses that should have Show revenues and expenses that should have

occurred at the actual level of activity. occurred at the actual level of activity. Reveal cost variances due to good cost control or Reveal cost variances due to good cost control or

lack of cost control. lack of cost control. Improve performance evaluation.Improve performance evaluation.


Flexible budgets To prepare a budget for different activity levels

→we must know how costs behave with changes in activity levels

Total variable costs change indirect proportion tochanges in activity.

Total fixed costs remainunchanged within therelevant range.

Flexible budgets To prepare a budget for different activity levels

→we must know how costs behave with changes in activity levels

Total variable costs change indirect proportion tochanges in activity.

Total fixed costs remainunchanged within therelevant range. FixedFixed

Variable

Variable

Flexible (Variable) BudgetsFlexible (Variable) Budgets


Standard Costs Standard Costs Standard Costs Standard Costs

Standard Costs Standard Costs are preset costs for delivering a are preset costs for delivering a

product or service under normal product or service under normal conditions.conditions.

are established through personnel, are established through personnel, engineering, and accounting studies engineering, and accounting studies using past experience.using past experience.

are benchmarks used in evaluating are benchmarks used in evaluating performance.performance.

are often used in setting budgets.are often used in setting budgets.

Standard Costs Standard Costs are preset costs for delivering a are preset costs for delivering a

product or service under normal product or service under normal conditions.conditions.

are established through personnel, are established through personnel, engineering, and accounting studies engineering, and accounting studies using past experience.using past experience.

are benchmarks used in evaluating are benchmarks used in evaluating performance.performance.

are often used in setting budgets.are often used in setting budgets.


Example: A standard cost cardExample: A standard cost card

Standard StandardQuantity Price Standard

Cost factor or Hours or Rate Cost

Direct materials 1 kg 25$ per kg 25.00$ Direct labour 2 hours 20$ per hour 40.00 Variable mfg. overhead 2 hours 10$ per hour 20.00 Total standard unit cost 85.00$

Standard StandardQuantity Price Standard

Cost factor or Hours or Rate Cost

Direct materials 1 kg 25$ per kg 25.00$ Direct labour 2 hours 20$ per hour 40.00 Variable mfg. overhead 2 hours 10$ per hour 20.00 Total standard unit cost 85.00$

Standard CostsStandard Costs


Variance AnalysisVariance Analysis

Take actionTake action

Prepare standard Prepare standard cost performance cost performance

reportsreports

Analyze Analyze variancesvariances

Investigate Investigate causescauses



Management By ExceptionManagement By Exception Standard cost accounting provides management Standard cost accounting provides management

with information about costs that differ from with information about costs that differ from budgeted amounts (variances). budgeted amounts (variances).

Management may choose to focus only on Management may choose to focus only on variances that are significant. variances that are significant.

This approach is referred to asThis approach is referred to asManagement by Exception.Management by Exception.

Management By ExceptionManagement By Exception Standard cost accounting provides management Standard cost accounting provides management

with information about costs that differ from with information about costs that differ from budgeted amounts (variances). budgeted amounts (variances).

Management may choose to focus only on Management may choose to focus only on variances that are significant. variances that are significant.

This approach is referred to asThis approach is referred to asManagement by Exception.Management by Exception.


AActual ctual QQuantity uantity AActual ctual QQuantityuantity SStandardtandard QQuantityuantity × × × × × × AActualctual PPrice rice SStandardtandard PPrice rice SStandardtandard PPricerice

Price VariancePrice Variance Quantity VarianceQuantity Variance

AQAQ((APAP - - SPSP) ) SPSP((AQAQ - - SQSQ))

AQAQ = Actual Quantity = Actual Quantity SPSP = Standard Price = Standard Price APAP = Actual Price = Actual Price SQSQ = Standard Quantity = Standard Quantity


Material VariancesMaterial Variances


Actual Hours Actual HoursActual Hours Actual Hours Standard Hours Standard Hours × × × × × × Actual Rate Standard Rate Standard Rate Actual Rate Standard Rate Standard Rate

Rate VarianceRate Variance Efficiency VarianceEfficiency Variance

AH(AR - SR) SR(AH - SH)AH(AR - SR) SR(AH - SH)

AH = Actual HoursAH = Actual Hours SR = Standard Rate SR = Standard Rate AR = Actual RateAR = Actual Rate SH = Standard Hours SH = Standard Hours


Labour VariancesLabour Variances


Spending Spending VarianceVariance

EfficiencyEfficiencyVarianceVariance

AH × SVR AH × SVR

AH × AVRAH × AVR

AHAH = Actual Hours of Activity = Actual Hours of Activity AVR AVR = Actual Variable Overhead Rate = Actual Variable Overhead Rate SVR SVR = Standard Variable Overhead Rate = Standard Variable Overhead Rate SH SH = Standard Hours Allowed = Standard Hours Allowed

SH × SVR SH × SVR

Actual Flexible Budget AppliedActual Flexible Budget Applied Variable for Variable Variable for Variable Variable Variable Overhead Overhead at Overhead at Overhead Overhead at Overhead at Incurred Actual Hours Standard Incurred Actual Hours Standard Hours Hours


Variable Overhead VariancesVariable Overhead Variances


Spending Spending VarianceVariance

VolumeVolumeVarianceVariance

SFRSFR = Standard Fixed Overhead Rate= Standard Fixed Overhead Rate SH SH = Standard Hours Allowed= Standard Hours Allowed

SH × SFR SH × SFR

Actual Fixed Fixed FixedActual Fixed Fixed Fixed Overhead Overhead Overhead Overhead Overhead Overhead Incurred Budget Applied Incurred Budget Applied


Fixed Overhead VariancesFixed Overhead Variances


Standard CostsStandard Costs

Standard cost accounting systemsStandard cost accounting systems record variances in the accountsrecord variances in the accounts simplify recordkeeping and help in the simplify recordkeeping and help in the

preparation of reportspreparation of reports


ABC Company has the following direct material standard to manufacture one unit product:

3.0 kilograms per unit at Rs8.00 per kilogram

Last week 6600 kilograms of material were purchased and used to make 2000 units. The material cost a total of Rs53000.

Discussions


Discussions

What is the actual price per kilogramWhat is the actual price per kilogrampaid for the material? paid for the material?

a.a. Rs7.26 per kilogram.Rs7.26 per kilogram.

b.b. Rs8.13 per kilogram.Rs8.13 per kilogram.

c.c. Rs8.03 per kilogram.Rs8.03 per kilogram.

d.d. Rs8.00 per kilogram.Rs8.00 per kilogram.


What is the actual price per kilogramWhat is the actual price per kilogrampaid for the material? paid for the material?

a.a. Rs7.26 per kilogram.Rs7.26 per kilogram.

b.b. Rs8.13 per kilogram.Rs8.13 per kilogram.

c.c. Rs8.03 per kilogram.Rs8.03 per kilogram.

d.d. Rs8.00 per kilogram.Rs8.00 per kilogram.

Discussions

AP = Rs53000 ÷ 6600 kgAP = Rs53000 ÷ 6600 kgAP = Rs8.03 per kg AP = Rs8.03 per kg


ABC’s material price variance (MPV)ABC’s material price variance (MPV)for the week was:for the week was:

a.a. Rs198 favourable.Rs198 favourable.

b.b. Rs198 unfavourable.Rs198 unfavourable.

c.c. Rs189 favourable.Rs189 favourable.

d.d. Rs189 unfavourable.Rs189 unfavourable.

Discussions


ABC’s material price variance (MPV)for the week was:

a. Rs198 favourable.

b. Rs198 unfavourable.

c. Rs189 favourable.

d. Rs189 unfavourable.

MPV = AQ(AP - SP)MPV = AQ(AP - SP) MPV =6600 kg × (Rs8.03 - 8.00) MPV =6600 kg × (Rs8.03 - 8.00) MPV = Rs198 Rs MPV = Rs198 Rs

Discussions


The standard quantity of material thatThe standard quantity of material thatshould have been used to produceshould have been used to produce2000 units is:2000 units is:

a.a. 6500 kilograms.6500 kilograms.

b.b. 6000 kilograms.6000 kilograms.

c.c. 7000 kilograms.7000 kilograms.

d.d. 5000 kilograms.5000 kilograms.

Discussions


The standard quantity of material thatshould have been used to produce2000 units is:

a. 6500 kilograms.

b. 6000 kilograms.

c. 7000 kilograms.

d. 5000 kilograms.

SQ = 2000 units × 3 kg per unitSQ = 2000 units × 3 kg per unit SQ = 6000 kg SQ = 6000 kg

Discussions


ABC’s material quantity variance (MQV)ABC’s material quantity variance (MQV)for the week was:for the week was:

a.a. Rs4300 unfavourable.Rs4300 unfavourable.

b.b. Rs4300 favourable.Rs4300 favourable.

c.c. Rs4800 unfavourable.Rs4800 unfavourable.

d.d. Rs4800 favourable.Rs4800 favourable.

Discussions


ABC’s material quantity variance (MQV)ABC’s material quantity variance (MQV)for the week was:for the week was:

a.a. Rs4300 unfavourable.Rs4300 unfavourable.

b.b. Rs4300 favourable.Rs4300 favourable.

c.c. Rs4800 unfavourable.Rs4800 unfavourable.

d.d. Rs4800 favourable.Rs4800 favourable. MQV = SP(AQ - SQ)MQV = SP(AQ - SQ) MQV = Rs8.00(6600 kg - 6000 kg) MQV = Rs8.00(6600 kg - 6000 kg) MQV = Rs4800 unfavourable MQV = Rs4800 unfavourable

Discussions


Managerial Decision MakingManagerial Decision Making

Managerial Decision Making Cost accounting information is often used by

management for short-term decisions. Decision making involves five steps:

→ Define the problem.

→ Identify alternatives.

→ Collect relevant information on alternatives.

→ Select the preferred alternative.

→ Analyze decisions made.

Managerial Decision Making Cost accounting information is often used by

management for short-term decisions. Decision making involves five steps:

→ Define the problem.

→ Identify alternatives.

→ Collect relevant information on alternatives.

→ Select the preferred alternative.

→ Analyze decisions made.



Accepting additional business Accepting additional business should be based on should be based on incremental costsincremental costs and and

incremental revenuesincremental revenues Incremental amountsIncremental amounts are those that occur if the are those that occur if the

company decides to accept the new businesscompany decides to accept the new business

Accepting additional business Accepting additional business should be based on should be based on incremental costsincremental costs and and

incremental revenuesincremental revenues Incremental amountsIncremental amounts are those that occur if the are those that occur if the

company decides to accept the new businesscompany decides to accept the new business



Make or Buy DecisionsMake or Buy Decisions IncrementalIncremental costs also are important in the costs also are important in the

decision to make a product or purchase it from decision to make a product or purchase it from a suppliera supplier→The cost to produce an item mustThe cost to produce an item must

includeincludedirect materialsdirect materialsdirect labourdirect labour incremental overheadincremental overhead

→We should We should notnot use the predetermined overhead rate use the predetermined overhead rate to determine product costto determine product cost

Make or Buy DecisionsMake or Buy Decisions IncrementalIncremental costs also are important in the costs also are important in the

decision to make a product or purchase it from decision to make a product or purchase it from a suppliera supplier→The cost to produce an item mustThe cost to produce an item must

includeincludedirect materialsdirect materialsdirect labourdirect labour incremental overheadincremental overhead

→We should We should notnot use the predetermined overhead rate use the predetermined overhead rate to determine product costto determine product cost



Scrap or Rework DefectsScrap or Rework Defects Costs incurred in manufacturing units of Costs incurred in manufacturing units of

product that do not meet quality standards are product that do not meet quality standards are sunk costs and cannot be recovered.sunk costs and cannot be recovered.

As long as rework costs are recovered through As long as rework costs are recovered through sale of the product and rework does not sale of the product and rework does not interfere with normal production, we should interfere with normal production, we should rework rather than scrap. rework rather than scrap.

Scrap or Rework DefectsScrap or Rework Defects Costs incurred in manufacturing units of Costs incurred in manufacturing units of

product that do not meet quality standards are product that do not meet quality standards are sunk costs and cannot be recovered.sunk costs and cannot be recovered.

As long as rework costs are recovered through As long as rework costs are recovered through sale of the product and rework does not sale of the product and rework does not interfere with normal production, we should interfere with normal production, we should rework rather than scrap. rework rather than scrap.



Sell or Process Further Sell or Process Further sell partially completed products vs. process sell partially completed products vs. process

them to completionthem to completion As a general rule, process further only if As a general rule, process further only if

incremental revenues exceed incremental costsincremental revenues exceed incremental costs

Sell or Process Further Sell or Process Further sell partially completed products vs. process sell partially completed products vs. process

them to completionthem to completion As a general rule, process further only if As a general rule, process further only if

incremental revenues exceed incremental costsincremental revenues exceed incremental costs



Selecting Sales Mix Selecting Sales Mix When a company sells a variety of products,When a company sells a variety of products,

some are likely to be more profitable thansome are likely to be more profitable thanothers. To make an informed decision others. To make an informed decision regarding sales mix, management must consider regarding sales mix, management must consider . . .. . .→ The The contribution margincontribution margin of each product, of each product,

→ TheThe facilitiesfacilities required to produce each required to produce eachproduct and any constraints on the facilities, andproduct and any constraints on the facilities, and

→ The The demanddemand for each product. for each product.

Selecting Sales Mix Selecting Sales Mix When a company sells a variety of products,When a company sells a variety of products,

some are likely to be more profitable thansome are likely to be more profitable thanothers. To make an informed decision others. To make an informed decision regarding sales mix, management must consider regarding sales mix, management must consider . . .. . .→ The The contribution margincontribution margin of each product, of each product,

→ TheThe facilitiesfacilities required to produce each required to produce eachproduct and any constraints on the facilities, andproduct and any constraints on the facilities, and

→ The The demanddemand for each product. for each product.



Eliminating a SegmentEliminating a Segment A segment is a candidate for A segment is a candidate for

elimination if its elimination if its revenues are less than itsrevenues are less than its

avoidableavoidable expensesexpenses

Eliminating a SegmentEliminating a Segment A segment is a candidate for A segment is a candidate for

elimination if its elimination if its revenues are less than itsrevenues are less than its

avoidableavoidable expensesexpenses



Qualitative factors in decisions Qualitative factors are involved in most all

managerial decisions→Quality

→Delivery schedule

→Supplier reputation

→Employee morale

→Customer opinions

→……

Qualitative factors in decisions Qualitative factors are involved in most all

managerial decisions→Quality

→Delivery schedule

→Supplier reputation

→Employee morale

→Customer opinions

→……


SummarySummary

Segments may be evaluated as a cost centre, a profit centre,Segments may be evaluated as a cost centre, a profit centre, and an investment centre. and an investment centre.

CVP Analysis: CVP Analysis: break-even analysis, computing income frobreak-even analysis, computing income from expected sales, sales volume needed to earn a target incom expected sales, sales volume needed to earn a target income, margin of safety, and sensitivity analysis.me, margin of safety, and sensitivity analysis.

Importance of budgeting, master budget, and Importance of budgeting, master budget, and budgetary budgetary control control

Standard costs, variance analysis and standard cost accounStandard costs, variance analysis and standard cost accounting systemsting systems

Managerial decision making: accepting additional business,Managerial decision making: accepting additional business, make or buy decisions, scrap or rework defects, sell or pro make or buy decisions, scrap or rework defects, sell or process further, selecting sales mix, eliminating a segment cess further, selecting sales mix, eliminating a segment

Segments may be evaluated as a cost centre, a profit centre,Segments may be evaluated as a cost centre, a profit centre, and an investment centre. and an investment centre.

CVP Analysis: CVP Analysis: break-even analysis, computing income frobreak-even analysis, computing income from expected sales, sales volume needed to earn a target incom expected sales, sales volume needed to earn a target income, margin of safety, and sensitivity analysis.me, margin of safety, and sensitivity analysis.

Importance of budgeting, master budget, and Importance of budgeting, master budget, and budgetary budgetary control control

Standard costs, variance analysis and standard cost accounStandard costs, variance analysis and standard cost accounting systemsting systems

Managerial decision making: accepting additional business,Managerial decision making: accepting additional business, make or buy decisions, scrap or rework defects, sell or pro make or buy decisions, scrap or rework defects, sell or process further, selecting sales mix, eliminating a segment cess further, selecting sales mix, eliminating a segment


DiscussionsDiscussions

Consider the beginning XYZ caseConsider the beginning XYZ case


Discussions

Relevant Cost AnalysisSavings in variable expenses provided by the new machine ($200000 × 5 yrs.) 1000000

Net effect

Relevant Cost AnalysisSavings in variable expenses provided by the new machine ($200000 × 5 yrs.) 1000000

Net effect

Rs1000000 - Rs800000 = Rs200000 variable cost savingsRs1000000 - Rs800000 = Rs200000 variable cost savings


Discussions

Relevant Cost AnalysisSavings in variable expenses provided by the new machine ($200000 × 5 yrs.) 1000000Cost of the new machine (900000)Disposal value of old machine 150000Net effect 250000

Relevant Cost AnalysisSavings in variable expenses provided by the new machine ($200000 × 5 yrs.) 1000000Cost of the new machine (900000)Disposal value of old machine 150000Net effect 250000

ATTENTION COMMERCE STUDENTS

ACCOUNTING(FINANCIAL & COST) OFACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4 (CRASH CLASSES)ICMAP STAGE 1,2,3,4 (CRASH CLASSES)

CA..MODULE A,B,C,DCA..MODULE A,B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)PIPFA (FOUNDATION,INTERMEDIATE,FINAL)

ACCA-F1,F2,F3ACCA-F1,F2,F3BBA,MBABBA,MBA

B.COM(FRESH),M.COMB.COM(FRESH),M.COMMA-ECONOMICS..O/A LEVELSMA-ECONOMICS..O/A LEVELS

KHALID AZIZ…..0322-3385752KHALID AZIZ…..0322-3385752http://finance.groups.yahoo.com/group/cost-http://finance.groups.yahoo.com/group/cost-

accountantsaccountants

ATTENTION COMMERCE STUDENTS

ACCOUNTING(FINANCIAL & COST) OFACCOUNTING(FINANCIAL & COST) OFICMAP STAGE 1,2,3,4 (CRASH CLASSES)ICMAP STAGE 1,2,3,4 (CRASH CLASSES)

CA..MODULE A,B,C,DCA..MODULE A,B,C,DPIPFA (FOUNDATION,INTERMEDIATE,FINAL)PIPFA (FOUNDATION,INTERMEDIATE,FINAL)

ACCA-F1,F2,F3ACCA-F1,F2,F3BBA,MBABBA,MBA

B.COM(FRESH),M.COMB.COM(FRESH),M.COMMA-ECONOMICS..O/A LEVELSMA-ECONOMICS..O/A LEVELS

KHALID AZIZ…..0322-3385752KHALID AZIZ…..0322-3385752http://finance.groups.yahoo.com/group/cost-http://finance.groups.yahoo.com/group/cost-

accountantsaccountants

managerial accounting: applications

Documents

indirect costs

cost analysis

tools of managerial

actual costs

cost centre

new machine

old machine

unit variable costs