managerial accounting english

8/8/2019 Managerial Accounting English

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Accounting MasterProgram

2007

By: Isam [email protected]
mailto:[email protected]:[email protected]


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last update12/20/2010Advanced Managerial accountingMaster Program

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Prepared by:Isam Rimawi [email protected] http://www.geocities.com/irimawi/ Page 2 of47
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Managerial Accounting and the Business Environment Chapter One

Work of ManagementPlanningIdentify alternatives.Select alternative that does the best job of furthering organizations objectives.Develop budgets to guide progress toward the selected alternative.

Directing and MotivatingDirecting and motivating involves managing day-to-day activities to keep the rganization runningsmoothly.

Employee work assignments.

Routine problem solving.

Conflict resolution.

Effective communications.

Controlling

The control function ensures that plans are being followed.

Feedback in the form of performance reports that compare actual results with the budget are anessential part of the control function

Planning and Control Cycle


DecisionMaking

Formulating long-and short-term plans (Planning)

Formulating long-and short-term plans (Planning)

Measuring performance(Controlling)

Measuring performance(Controlling)

Begin

Comparing actualto planned performance

(Controlling)

Comparing actualto planned performance

(Controlling)

Implementingplans (Directing and

Motivating)

Implementingplans (Directing and

Motivating)
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Comparison of Financial and Managerial Accounting

Financial Accounting Managerial Accounting1. Users External persons who

make financial decisions

Managers who plan for

and control an organization2. Time focus Historical perspective Future emphasis

3. Verifiability versusrelevance

Emphasis on verifiability Emphasis on relevancefor planning and control

4. Precision versustimeliness

Emphasis on precision Emphasis on timeliness

5. Subject

Primary focus is onthe whole organization

Focuses on segmentsof an organization

6. GAAP Must follow GAAPand prescribed formats

Need not follow GAAPor any prescribed format

7. Requirement Mandatory for external reports Not Mandatory

Organizational Structure

Line and Staff RelationshipsLine positions are directly related to achievement of the basic objectives of an organization.

Example: Production supervisors in a manufacturing plantStaff positions support and assist line positions.

Example: Cost accountants in the manufacturing plant.


Decentralization is the delegation of decision-making authority throughout an organization.

Decentralization is the delegation of decision-making authority throughout an organization.

C o r p o r a t e O r g a n i z a t i o n

P u r c h a P e r s o n V i c e P r e

O p e r a t i

T r e a s C o n t r

C h i e f F i n

O f f i c e

P r e s i d e

B o a r d o f D


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The Chief Financial Officer (CFO)A member of the top management team responsible for:

Providing timely and relevant data to support planning and control activities.

Preparing financial statements for external users.

The Changing Business EnvironmentBusiness environment changes in the past twenty years

1. Just-in-time production2. Total quality management3. Process reengineering4. Theory of constraints5. International competition6. E-commerce

Just-in-Time (JIT) Systems

JIT Consequences1. Improved plant layout

2. Reduced setup time3. Zero production defects4. Flexible workforce

JIT purchasing

Fewer, but more ultra reliable suppliers. Frequent JIT deliveries in small lots. Defect-free supplier

deliveries.


Complete parts just intime for assembly into

products.

Complete partsjust intime for assembly into

products.

Schedule

production.

Scheduleproduction.

Receive materialsjust in time for

production.

Receive materialsjust in time for

production.

Receive customerorders.

Receive customerorders.

Complete productsjust in time to

ship customers.

Complete productsjust in time to

ship customers.


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Benefits of a JIT SystemReduced inventory costs

Higher quality products

Increased throughput

Freed-up funds

Greater customer satisfactionMore rapid response to customer orders

Total Quality Management (TQM)TQM improves productivity by encouraging the use of fact and analysis for decision making and

if properly implemented, avoids counter-productive organizational infighting.

Systematic problem solving using tools such as benchmarking

Continuous Improvement

Central Focus is Serving Customers

Process Reengineering1. A business process is diagrammed in detail.2. Every step in the business process must be justified.3. The process is redesigned to eliminate all non-value-added activities

Anticipated results:

1. Process is simplified.

2. Process is completed in less time.

3. Costs are reduced.

4. Opportunities for errors are reduced.

Process Reengineering versus TQMProcess Reengineering Total Quality Management

Radically overhauls existing

processes.

Likely to be imposed from above and

to use outside consultants.

Tweaks existing processes to realize

gradual improvements.

Uses a team approach involving people

who work directly in the process.

Theory of ConstraintsA constraint (also called a bottleneck) is anything that prevents you fromgetting more of what you want.

Theory of Constraints


The constraint in a system is determinedby the step that has thesmallest capacity.


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International Competition

E-Commerce


1. Identifythe weakest

link.

1. Identifythe weakest

link.

2. Allow the weakestlink to set the tempo.

2. Allow the weakestlink to set the tempo.

3. Focus onimproving theweakest link.

3. Focus onimproving theweakest link.

4. Recognize that theweakest link

is no longer so.

4. Recognize that theweakest link

is no longer so.

Only actions thatstrengthen theweakest link in the

chain improve theprocess.

Competition has

become worldwidein most industries.

Fewer tariffs,quotas, and

other barriersto free trade.

Fewer tariffs,quotas, and

other barriersto free trade.

Improvementsin global

transportationsystems.

Improvementsin global

transportationsystems.

An excellent management accounting system is neededto succeed in todays competitive global marketplace.

An excellent management accounting system is neededto succeed in todays competitive global marketplace.

Increasing sophisticationin international markets.

Increasing sophisticationin international markets.


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In recent years, many dot.com businesses failed that might have benefited from the application of

managerial accounting tools:

Cost concepts (Chapter 2)

Cost estimation (Chapter 5)

Cost-volume-profit (Chapter 6)

Activity-based costing (Chapter 8) Budgeting (Chapter 9)

Decision-making (Chapter 13)

Capital budgeting (Chapter 14)

Code of Conduct for Management AccountantsThe Institute of Management Accountants (IMA) Standards of Ethical Conduct for Practitioners

of Management Accounting and Financial Management have two major parts offering guidelines

for:

Ethical behavior. Resolution for an ethical conflict.IMA Guidelines for Ethical Behavior

IMA Guidelines for Ethical Behavior


Competence

Follow applicable laws, regulations andstandards.

Follow applicable laws, regulations andstandards.

Maintainprofessionalcompetence.

Maintainprofessionalcompetence.

Prepare complete and clear reportsafter appropriate analysis.

Prepare complete and clear reportsafter appropriate analysis.

Confidentiality

Do not disclose confidential informationunless legally obligated to do so.

Do not disclose confidential informationunless legally obligated to do so.

Ensure that subordinates do not discloseconfidential information.

Ensure that subordinates do not discloseconfidential information.

Do not use confidential

information forpersonal advantage.

Do not use confidentialinformation for

personal advantage.


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Avoid conflicts of interest and adviseothers of potential conflicts.

Avoid conflicts of interest and adviseothers of potential conflicts.

Recognize and communicate personal andprofessional limitations.

Recognize and communicate personal andprofessional limitations.

Do not subvertorganizations legitimate

objectives.

Do not subvertorganizations legitimate

objectives.Integrity

Integrity

Avoid activities that couldaffect your ability to perform

duties.

Avoid activities that couldaffect your ability to perform

duties.

Communicate unfavorable aswell as favorable information.

Communicate unfavorable aswell as favorable information.

Refrain fromactivities that

could discreditthe profession.

Refrain fromactivities that

could discreditthe profession.

Refuse gifts orfavors that

might

influencebehavior.

Refuse gifts orfavors that

might

influencebehavior.


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IMA Guidelines for Resolution of an Ethical Conflict Follow established policies.

For unresolved ethical conflicts:

Discuss the conflict with immediate superior or next highest uninvolved manager. Make reference to the Sarbanes-Oxley Act passed by Congress in 2002 in part to give

legal protection to those reporting corporate misconduct.

If immediate superior is the CEO, consider the board of directors or the audit committee.

IMA Guidelines for Resolution of an Ethical Conflict Follow established policies.

For unresolved ethical conflicts:

Except where legally prescribed, maintain confidentiality.

Clarify issues in a confidential discussion with an objective advisor.

Consult an attorney as to legal obligations.

The last resort is to resign.

Why Have Ethical Standards?


Communicate information fairly and objectively.Communicate information fairly and objectively.

Disclose all information that might be useful to management.Disclose all information that might be useful to management.

Objectivity


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Codes of Conduct on the International LevelThe Guidelines on Ethics for Professional Accountants, issued by the International Federation of

Accountants (IFAC), govern the activities of professional accountants worldwide

In addition to competence, objectivity, independence, and confidentiality, the IFACs code deals

with the accountants ethical responsibilities in:

Taxes

Fees and commissions

Advertising and solicitation

Handling of monies

Cross-border activities.

Certified Management AccountantA management accountant who has the necessary qualifications and who passes a rigorous

professional exam earns the right to be known as a Certified Management Accountant (CMA).

Information about becoming a CMA and the CMA program can be accessed on the IMAs website

at www.imanet.org or by calling 1-800-638-4427.

End of Chapter 1

Costs Terms, Concepts and Classifications Chapter Two

Manufacturing Costs


Abandoning ethical standards in business wouldlead to a lower quality of life with less

desireable goods and services at higher prices.

Without ethical standards in business, theeconomy, and all of us who depend on it for

jobs, goods, and services, would suffer.

Ethical standards in business are essential for asmooth functioning advanced market economy.

Ethical standards in business are essential for asmooth functioning advanced market economy.
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1. Direct Materials2. Direct Labor3. Manufacturing Overhead

Direct MaterialsRaw materials that become an integral part of the product and that can be conveniently traced

directly to it.Example: A radio installed in an automobile

Direct LaborThose labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workers

Manufacturing OverheadManufacturing costs that cannot be traced directly to specific units produced.

Classifications of Costs

Non-manufacturing CostsMarketing or Selling Cost : Costs necessary to get the order and deliver the product.

Administrative Cost : All executive, organizational, and clerical costs.


Examples: Indirect labor and indirect materialsExamples: Indirect labor and indirect materials

Wages paid to employees who arenot directly involved in production

work.Examples: maintenance workers,

janitors and security guards.

Materials used to support theproduction process.

Examples: lubricants and cleaningsupplies used in the automobile

assembly plant.

DirectMaterial

DirectMaterial

DirectLabor

DirectLabor

ManufacturingOverhead


Prime

Cost

Conversion

Cost

Manufacturing costs are often classified as follows:


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Product Costs Versus Period Costs

Quick CheckWhich of the following costs would be considered a period rather than a product cost in a

manufacturing company?

A. Manufacturing equipment depreciation.

B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the production facility.

E. Sales commissions. , B, E,

Comparing Merchandising and Manufacturing Activities

Merchandisers . . . Manufacturers . . . Buy finished goods.

Sell finished goods.

Buy raw materials.

Produce and sell finished

goods.

Balance SheetMerchandisers . . . Manufacturers . . .

Current assets

Cash

Receivables

Prepaid Expenses Merchandise Inventory

Current Assets

Cash

Receivables

Prepaid Expenses Inventories

Raw Materials

Work in Process

Finished Goods

Raw Materials Materials waiting to be processed.Work in Process Partially complete products some material, labor, or overhead has been added.Finished Goods Completed products awaiting sale.


Product costs include directmaterials, direct labor, andmanufacturing overhead.

Period costsinclude allmarketing or selling costs

and administrativecosts.

Inventory Cost of Good Sold

BalanceSheet

IncomeStatement

Sale

Expense

IncomeStatement


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The Income StatementCost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

Inventory Flows

Quick CheckIf your inventory balance at the beginning of the month was $1,000, you bought $100 during the

month, and sold $300 during the month, what would be the balance at the end of the month?

A. $1,000.

B. $ 800.


Merchandising Company

Cost of goods sold:

Beg. merchandise

inventory 14,200$

+ Purcha ses 234,150

Goods available

for sale 248,350$

- Ending

merchandise

inventory (12,100)

= Cost of goods

sold 236,250$

Manufacturing Company

Cost of goods sold:

Beg. finished

goods inv. 14,200$

+ Cost of goods

manufactured 234,150

Goods available

for sale 248,350$

- Ending

finished goods

inventory (12,100)

= Cost of goods

sold 236,250$

Beginningbalance

$$

Additions$$$+

Available$$$$$=

Endingbalance

$$=

Withdrawals$$$

_Available$$$$$


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C. $1,200.

D. $ 200.. , B, $1,000 + $100 = $1,100 $1,100 - $300 = $800

Schedule of Cost of Goods Manufactured Calculates the cost of raw material, direct labor and manufacturing overhead used in

production Calculates the manufacturing costs associated with goods that were finished during the period.

Product Cost Flows Manufacturing Work

Raw Materials Costs In Process Finished Goods

Beginning raw Direct materials Beginning finished

materials inventory goods inventory

+ Raw materials + Cost of finished

purchased goods mfg.

= Raw materials = Finished goods

available for use available for sale

in production - Ending finished

Ending raw materials goods inventor

inventory = Cost of finished

= Raw materials used goods sold

in production

Raw Materials Manufacturing Costs Work InProcess

Beginning raw Direct materialsmaterials inventory + Direct labor

Raw materials + Mfg. overhead

purchased = Total manufacturing

Raw materials costs

available for use

in production

Ending raw materials

inventory

Raw materials used

in production

Manufacturing Work Raw Materials Costs In Process Finished Goods

Beginning raw Direct materials Beginning work in Beginning finished

materials

inventory + Direct labor process inventory goods inventory

+ Raw materials + Mfg. overhead + Total manufacturing + Cost of finished

purchased = Total manufacturing costs goods mfg.


As items are removed from

raw materials inventory andplaced into the production

process, they are calleddirect materials.

Conversion costs are costsincurred to convert the directmaterial into a finished roduct.


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= Raw materials costs = Total work in = Finished goods

available for use process for theavailable for

sale

in production period - Ending finished

Ending raw materials goo

inventory = Cost of finished

= Raw materials used goods sold

in production

Manufacturing Work

Raw Materials Costs In Process Finished Goods

Beginning raw Direct materials Beginning work in Beginning finished

materials

inventory + Direct labor process inventory goods inventory

+ Raw materials + Mfg. overhead + Total manufacturing + Cost of finished

purchased = Total manufacturing costs goods mfg.

= Raw materials costs = Total work in = Finished goods

available for use process for theavailable for

sale

in production period - Ending finished

Ending work in goods inventory

process inventory = Cost of finished

= Cost of goods goods sold

manufactured

Work In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory

+ Manufacturing costs + Cost of goods

for the period manufactured

= Total work in process = Cost of goods

for the period available for sale

Ending work in - Ending finished


All manufacturing costs incurred during

the period are added to the beginningbalance of work in process.

Costs associated with the goods that arecompleted during the period are


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process inventory goods inventory

= Cost of goods Cost of goods

manufactured sold

Manufacturing Cost Flows

Quick CheckBeginning raw materials inventory was $32,000. During the month, $276,000 of raw material was

purchased. A count at the end of the month revealed that $28,000 of raw material was still

present. What is the cost of direct material used?

A. $276,000

B. $272,000

C. $280,000

D. $2,000 . , CThe Answer C

Beg. raw materials $ 32,000+ Raw materials

purchased 276,000

=Raw materialsavailable

for use inproduction $ 308,000

Ending raw materials

inventory 28,000


FinishedGoods

Cost ofGoodsSold

Selling andAdministrative

Period CostsSelling andAdministrative


Work inProcessDirect Labor

Balance SheetCosts Inventories

IncomeStatementExpenses

Material Purchases Raw Materials


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= Raw materials used

in production $ 280,000

Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory

overhead was $180,000. What were total manufacturing costs incurred for the month?

A. $555,000

B. $835,000

C. $655,000

D. Cannot be determined. . , B

The Answer BDirect Materials $280,000

+ Direct Labor 375,000

+ Mfg. Overhead 180,000

= Mfg. Costs Incurred

for the Month $835,000

Beginning work in process was $125,000. Manufacturing costs incurred for the month were

$835,000. There were $200,000 of partially finished goods remaining in work in process inventory

at the end of the month. What was the cost of goods manufactured during the month?

A. $1,160,000

B. $ 910,000

C. $ 760,000

D. Cannot be determined.. C ,The Answer C

Beginning work in

process inventory $ 125,000

+ Mfg. costs incurredfor the period 835,000

= Total work in process

during the period $ 960,000

Ending work in

process inventory 200,000

= Cost of goods

manufactured $ 760,000

Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month

was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods

sold for the month?

A. $ 20,000.

B. $740,000.C. $780,000.

D. $760,000. . , B

The Answer B$130,000 + $760,000 = $890,000

$890,000 - $150,000 = $740,000



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Cost Classifications for Predicting Cost Behavior

How a cost will react to changes in the level of activity within the relevant range. Total variable costs change when activity changes.

Total fixed costs remain unchanged when activity changes.

Total Variable Cost

Your total long distance telephone bill is based on how many minutes you talk

Variable Cost Per Unit

Total Fixed CostYour monthly basic telephone bill probably does not change when you make more local calls.


Minutes Talked

TotalLong

Distance

Telepho

neBill

Minutes Talked

PerMinute

Telephone

Charg

e


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Fixed Cost Per UnitThe average fixed cost per local call decreases as more local calls are made.

Cost Classifications for Predicting Cost BehaviorBehavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains

as activity level changes. the same over wide ranges of activity.

Fixed Total fixed cost remains Average fixed cost per unit goesthe same even when the down as activity level goes up.

activity level changes.

Quick CheckWhich of the following costs would be variable with respect to the number of cones sold at a

Baskins & Robbins shop? (There may be more than one correct answer.)


Number of Local Calls

MonthlyBasic

Telep

hone

Bill

Number of Local CallsMonthlyBasicTeleph

one

B

illperLoc

alCall


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A. The cost of lighting the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers . C , D ,B

Assigning Costs to Cost Objects

Direct costs Indirect costs

Costs that can be

easily and conveniently traced to a unit

of product or other cost object.

Examples: direct material and direct

labor

Costs that cannot be easily and

conveniently traced to a unit of

product or other cost object.

Example: manufacturing overhead

Cost Classifications for Decision Making Every decision involves a choice between at least two alternatives.

Only those costs and benefits that differ between alternatives are relevant in a decision. All

other costs and benefits can and should be ignored.

Differential Costs and RevenuesCosts and revenues that differ among alternatives

Example: You have a job paying $1,500 per month in your hometown. You have a job offer in aneighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.

Differential revenue is:$2,000 $1,500 = $500

Differential cost is:

$300

Opportunity CostsThe potential benefit that is given up when one alternative is selected over another

Example: If you were not attending college, you could be earning $15,000 per year.

Your opportunity cost of attending college for one year is $15,000

Sunk CostsSunk costs have already been incurred and cannot be changed now or in the future. They should

be ignored when making decisions.

Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunkbecause whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.



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Quick CheckSuppose you are trying to decide whether to drive or take the train to Portland to attend a

concert. You have ample cash to do either, but you dont want to waste money needlessly. Is the

cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket

affect the decision of whether you drive or take the train to Portland?

A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant. A ,

Suppose you are trying to decide whether to drive or take the train to Portland to attend a

concert. You have ample cash to do either, but you dont want to waste money needlessly. Is the

annual cost of licensing your car relevant in this decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant B,

Suppose that your car could be sold now for $5,000. Is this a sunk cost?

A. Yes, it is a sunk cost.B. No, it is not a sunk cost. B,

Summary of the Types of Cost Classifications Financial reporting

Predicting cost behavior

Assigning costs to cost objects

Decision making

Idle Time

Machine Breakdowns

Material Shortages

Power Failures

The labor costs incurred during idle time are ordinarily treated as manufacturing overhead.

OvertimeThe overtime premiums for all factory workers are usually considered to be part of

manufacturing overhead

Labor Fringe BenefitsFringe benefits include employer paid costs for insurance programs, retirement plans,supplemental unemployment programs, Social Security, Medicare, workers compensation and

unemployment taxes.

Some companies include all of these costs in manufacturing overhead.

Other companies treat fringe benefit expenses of direct laborers as additional direct labor

costs.

Quality of Conformance



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When the overwhelming majority of products produced conform to design specifications and are

free from defects.

Prevention and Appraisal Costs

Internal and External Failure Costs

Examples of Quality CostsPrevention Costs

Quality training Quality circles Statistical process control activities

Internal Failure Costs

Scrap Spoilage

ReworkAppraisal Costs

Testing & inspecting incoming materials Final product testing Depreciation of testing equipment

External Failure Costs

Cost of field servicing & handling complaints Warranty repairs


Prevention CostsSupport activities whose purposeis to reduce the number ofdefects

Appraisal CostsIncurred to identify defectiveproducts before the products areshipped

Internal FailureCosts

Incurred as a result of identifyingdefects before they are shipped

External FailureCosts

Incurred as a result of defectiveproducts being delivered to

customers


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Lost sales

Distribution of Quality Costs When quality of conformance is low, total quality cost is high and consists mostly of

internal and external failure.

Companies can reduce their total quality cost by focusing on prevention and

appraisal. The cost savings from reduced defects usually swamps the costs of the

additional prevention and appraisal efforts.

Quality cost reports provide an estimate of the financial consequences of

the companys current defect rate.Ventura Company Quality Cost Report For Years 1 and 2

Year 2 Year 1

Amount Percent* Amount Percent*

Prevention costs:

Systems development $ 400,000 0.80% $ 270,000 0.54%Quality training 210,000 0.42% 130,000 0.26%

Supervision of prevention activities 70,000 0.14% 40,000 0.08%

Quality improvement 320,000 0.64% 210,000 0.42%

Total prevention cost 1,000,000 2.00% 650,000 1.30%

Appraisal costs:

Inspection 600,000 1.20% 560,000 1.12%

Reliability testing 580,000 1.16% 420,000 0.84%

Supervision of testing and inspection 120,000 0.24% 80,000 0.16%

Depreciation of test equipment 200,000 0.40% 140,000 0.28%

Total appraisal cost 1,500,000 3.00% 1,200,000 2.40%

Internal failure costs:

Net cost of scrap 900,000 1.80% 750,000 1.50%

Rework labor and overhead 1,430,000 2.86% 810,000 1.62%

Downtime due to defects in quality 170,000 0.34% 100,000 0.20%

Disposal of defective products 500,000 1.00% 340,000 0.68%

Total internal failure cost 3,000,000 6.00% 2,000,000 4.00%

External failure costs:

Warranty repairs 400,000 0.80% 900,000 1.80%

Warranty replacements 870,000 1.74% 2,300,000 4.60%

Allowances 130,000 0.26% 630,000 1.26%

Cost of field servicing 600,000 1.20% 1,320,000 2.64%Total external failure cost 2,000,000 4.00% 5,150,000 10.30%

Total quality cost $ 7,500,000 15.00% $ 9,000,000 18.00%

* As a percentage of total sales. In each year sales totaled $50,000,000.

Quality Cost Reports: Graphic FormQuality reports can also be prepared in graphic form.



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Uses of Quality Cost Information1. Help managers see the financial significance of defects.

2. Help managers identify the relative importance of the quality problems

3. Help managers see whether their quality costs are poorly distributed.

Limitations of Quality Cost Information

1. Simply measuring quality cost problems does not solve quality problems.2. Results usually lag behind quality improvement programs.

3. The most important quality cost, lost sales, is often omitted from quality cost reports.

ISO 9000 StandardsISO 9000 standards have become an international measure of quality. To become ISO 9000

certified, a company must demonstrate:

1. A quality control system is in use, and the system clearly defines an expected level of

quality.

2. The system is fully operational and is backed up with detailed documentation of quality

control procedures.

3. The intended level of quality is being achieved on a sustained basis.

End of Chapter 2


QualityCost(inmillio

ns)

$10

9

8

ExternalFailure

7 ExternalFailure

6

5

4 InternalFailure

3 InternalFailure

2 Appraisal

1 Appraisal

0

Prevention Prevention

1 2 Year

QualityCostasaPercentageofSales

20

18

16

ExternalFailure

14

ExternalFailure

12

10

8 InternalFailure

6 InternalFailure

4 Appraisal

2 Appraisal

0 Prevention Prevention 1 2

Year


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Cost Behavior : Analysis and Use Chapter Five

Types of Cost Behavior PatternsRecall the summary of our cost behavior discussion from an earlier chapter.

Summary of Variable and Fixed Cost BehaviorCost In Total Per Unit

VariableTotal variable cost is proportionalto the activity level within therelevant range.

Variable cost per unit remains thesame over wide ranges of activity.

FixedTotal fixed cost remains the sameeven when the activity levelchanges within the relevant range.

Fixed cost per unit goes down asactivity level goes up.

The Activity Base


A measure of whatcauses the

incurrence of a

variable cost

UnitsUnitsproduceproduce

dd

Milesdriven

Laborhours

Machinehours


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True Variable Cost ExampleA variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activitylevel. Your total long distance telephone bill is based on how many minutes you talk.

Types of Cost Behavior PatternsRecall the summary of our cost behavior discussion from an earlier chapter.

Variable Cost Per Unit ExampleA variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant.For example, 10 cents per minute.

Extent of Variable CostsThe proportion of variable costs differsacross organizations. For example . . .

1. A public utility with large investments in equipment will tend to havefewervariable costs.2. A service company will normally have a high proportion of variable costs.


Minutes Talked

TotalLon

gDistan

ce

Telephon

eBill

Minutes Talked

PerMinu

te

Telephone

Charge


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3. A manufacturing company will often have many variable costs.4. A merchandising company usually will have a high proportion of variable costs like cost of

sales.

Examples of Variable Costs

1. Merchandising companies cost of goods sold.2. Manufacturing companies direct materials, direct labor, and variable overhead.3. Merchandising and manufacturing companies commissions, shipping costs, and clerical costs

such as invoicing.4. Service companies supplies, travel, and clerical.

True Variable CostDirect materials is a true or proportionately variable cost because the amount used during a period willvary in direct proportion to the level of production activity.

Step-Variable CostsA resource that is obtainable only in large chunks (such as maintenance workers) and whose costsincrease or decrease only in response to fairly wide changes in activity is known as astep-variable cost.

The Linearity Assumption and the Relevant Range


Volume

Co

st

Volume

Cost Small changes in the level of production are not likely to have

any effect on the number of maintenance workers employed.

Only fairly wide changes in the activity level will cause achange in the number of maintenance workers employed


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Types of Fixed Costs1. Committed

Long-term, cannot be significantly reduced in the short term.

Examples

Depreciation on Equipment and Real Estate Taxes

2. DiscretionaryMay be altered in the short-term by current managerial decisions

Examples

Advertising and Research and Development

The Trend Toward Fixed CostsThe trend in many industries is towardgreater fixed costs relative to variable costs.As machines take over many mundane tasks previously performed by humans, knowledge workers aredemanded for their minds rather than their musclesKnowledge workers tend to be salaried, highly-trained and difficult to replace. The cost to compensatethese valued employees is relatively fixedrather than variable.

Is Labor a Variable or a Fixed Cost? The behavior of wage and salary costs can differ across countries, depending on labor regulations,

labor contracts, and custom. InFrance, Germany, China, andJapan anagement has little flexibilityin adjusting the size of the labor force.

Labor costs are more fixed in nature. In the United States and the United Kingdom management hasgreater latitude. Labor costs are more variable in nature.


Activity

TotalCost

EconomistsCurvilinear Cost

Function

RelevantRange

A straight lineclosely

approximates acurvilinear

variable costline within the

relevant range.

A straight lineclosely

approximates acurvilinear

variable costline within the

relevant range.

Accountants Straight-LineApproximation (constant unit

variable cost)


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Fixed Costs and Relevant Range

Fixed Costs and Relevant RangeThe relevant range of activity for a fixed cost is the range of activity over which the graph of the

cost is flat.

Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 squarefeet. As the business grows more space is rented, increasing the total cost.

Fixed Costs and Relevant RangeHow does this type of fixed cost differ from a step-variable cost?

1. Step-variable costs can be adjusted more quickly and . . .

2. The width of the activity steps is much wider for the fixed cost.

Quick CheckWhich of the following statements about cost behavior are true?

1. Fixed costs per unit vary with the level of activity.

2. Variable costs per unit are constant within the relevant range.

3. Total fixed costs are constant within the relevant range.

4. Total variable costs are constant within the relevant range. 1 , 2 , 3 ,

Mixed CostsA mixed cost has both fixed and variable components. Consider the example of utility cost.


Re

ntCost

in

Th

ousands

of

Dollars

0 1,000 2,000 3,000Rented Area (Square Feet)

0

30

60

90

RelevantRange

Total cost doesntchange for a widerange of activity,

and then jumps to anew higher cost for

the next higherrange of activity.

Total cost doesntchange for a widerange of activity,

and then jumps to anew higher cost for

the next higherrange of activity.


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The total mixed cost line can be expressed as an equation: Y = a + bX

Where: Y = the total mixed cost

a = the total fixed cost (the

vertical intercept of the line)

b = the variable cost per unit of

activity (the slope of the line)

X = the level of activity

Mixed Costs ExampleIf your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and yourmonthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?


Fixed MonthlyUtility Charge

VariableCost per KW

Activity (Kilowatt Hours)

Total

U

tility

Cost

Total

mixedco

st

X

Y

Y = a + bX

Y = $40 + ($0.03 2,000)

Y = $100$100

Y =

Y = $100$100


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Analysis of Mixed CostsAccount Analysis and the Engineering Approach

Each account is classified as either variable or fixed based on the analysts knowledge of how theaccount behaves.

Cost estimates are based on an evaluation of production methods, and material, labor and overhead

requirements.

The Scatter graph MethodPlot the data points on a graph (total cost vs. activity).

The Scatter graph MethodDraw a line through the data points with about an equal numbers of points above and below the line.


0 1 2 3 4

*

Maintena

nceCos

t

1,000so

fD

ollars

10

20

0

*** *

*

**

*

*

Patient-days in 1,000s

X

Y


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Use one data point to estimate the total level of activity and the total cost.


0 1 2 3 4

*

Maintena

nceCo

st

1,000so

fDolla

rs

10

20

0

***

* ** **

*


X

Y

Intercept = Fixed cost: $10,000

0 1 2 3 4

*

Maintena

nceCos

t

1,000so

fDollar

s

10

20

0

***

* ** ***


X

Y

Patient days = 800Patient days = 800

Total maintenance cost = $11,000Total maintenance cost = $11,000


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Make a quick estimate of variable cost per unit and determine the cost equation.

Total maintenance at 800 patients $ 11,000

Less: Fixed cost 10,000

Estimated total variable cost for 800 patients $ 1,000

The High-Low MethodAssume the following hours of maintenance work and the total maintenance costs for six months.

Month Hours of

maintenance

Total maintenance

CostJan 625 7,950

Feb 500 7,400

Mar 700 8,275

Apr 550 7,625May 775 9,100

Jun 800 9,800

High Level 800 9,800

Low Level 500 7,400

Change 300 2,400


Variable cost per unit =$1,00800800

= $1.25/patient-$1.25/patient-dayday

Y = $10,000 + $1.25XY = $10,000 + $1.25XY = $10,000 + $1.25XY = $10,000 + $1.25X

Total maintenanceTotal maintenancecostcostTotal maintenanceTotal maintenancecostcost

Number of patientNumber of patientdaysdaysNumber of patientNumber of patientdaysdays

TheThe variable costvariable costper hourper hourofof

maintenance ismaintenance isequal to theequal to the

change in costchange in costdivided by thedivided by the

chan e in hours.

=$8.00/hour$8.00/hour$2,400

300


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Quick CheckSales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what is the variable portion of sales salaries and

commission?a. $0.08 per unit b. $0.10 per unitc. $0.12 per unitd. $0.125 per unit , b ,

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?

a. $ 2,000 b. $ 4,000c. $10,000d. $12,000 , a ,

Total cost = Total fixed cost +Total variable cost

$14,000 = Total fixed cost +

($0.10 120,000 units)

Total fixed cost = $14,000 - $12,000

Total fixed cost = $2,000


Total Fixed Cost = Total Cost Total Variable CostTotal Fixed Cost = Total Cost Total Variable Cost

Total Fixed Cost = $9,800 ($8/hour 800 hours)Total Fixed Cost = $9,800 ($8/hour 800 hours)

Total Fixed Cost = $9,800 $6,400Total Fixed Cost = $9,800 $6,400

Total Fixed Cost =Total Fixed Cost = $3,400$3,400

Y = $3,400 + $8.00XY = $3,400 + $8.00X

The Cost Equation for Maintenance

$4,000 40,000 units= $0.10 per unit

Units Cost

High le ve l 120,000 14,000$

Low level 80,000 10,000

Change 40,000 4,000$


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Least-Squares Regression MethodA method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationshipbetween the X and Y variables.

This method uses allof the data points to estimate the fixed and variable cost components of a mixedcost

The goal of this method is to fit a straight line to the data that minimizes the sum of the squarederrors.

Software can be used to fit a regression line through the data points.

The cost analysis objective is the same: Y = a + bX

Least-squares regression also provides a statistic, called the R2, that is a measure of thegoodness of fit of the regression line to the data points.

Comparing Results From the Three Methods

The three methods just discussed provide slightly different estimates of the fixed andvariable cost components of the mixed cost.

This is to be expected because each method uses differing amounts of the data pointsto provide estimates.

Least-squares regression provides the most accurate estimate because it uses all thedata points.


0 1 2 3 4

Tota l

Cost

10

20

0Activity

*

****

*

*

***

R2 varies from 0% to 100%, andthe higher the percentage the better.

X

R2

is the percentage of the variation intotal cost explained by the activity.

Y


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The Contribution Format Total UnitSales Revenue $ 100,000 $ 50

Less: Variable costs 60,000 30

Contribution margin $ 40,000 $ 20

Less: Fixed costs 30,000Net operating income $ 10,000

Uses of the Contribution Format

The contribution income statement format is used as an internal planning and decision making tool. Wewill use this approach for:

1. Cost-volume-profit analysis (Chapter 6).2. Budgeting (Chapter 9).3. Segmented reporting of profit data (Chapter 12).4. Special decisions such as pricing and make-or-buy analysis (Chapter 13).

Comparison of the Contribution Income Statement

with the Traditional Income StatementTraditional Approach Contribution Approach

(costs organized by function) (costs organized by behavior)

Sales $ 100,000 Sales $ 100,000

Less cost of goods sold 70,000 Less variable expenses 60,000

Gross margin $ 30,000 Contribution margin $ 40,000

Less operating expenses 20,000 Less fixed expenses 30,000

Net operating income $ 10,000 Net operating income $ 10,000

Appendix 5A


Lets put ourknowledge of cost

behavior to work bypreparing a

contribution formatincome statement.

The contribution margin format emphasizesThe contribution margin format emphasizescost behavior. Contribution margin coverscost behavior. Contribution margin covers

fixed costs and rovides for income.fixed costs and provides for income.

Used primarily forUsed primarily forexternal reporting.external reporting.

Used primarily byUsed primarily bymanagement.management.


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Least-Squares Regression Using Microsoft Excel.

Simple Regression Analysis ExampleMatrix, Inc. wants to know its average fixed cost and variable cost per unit.Using the data to the right, lets see how to do a regression using Microsoft Excel.

Simple Regression Using ExcelYou will need three pieces of information from your regression analysis:

1. Estimated Variable Cost per Unit (line slope)2. Estimated Fixed Costs (line intercept)3. Goodness of fit, or R2

To get these three pieces information we will need to use three different Excel functions.LINEST, INTERCEPT, & RSQ

we will determine the goodness of fit, orR2, by using theRSQ function.

End of Chapter 5



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Cost-Volume-Profit Relationships Chapter Six

Basics of Cost-Volume-Profit AnalysisContribution Margin (CM) is the amount remaining from sales revenue after variable expenses

have been deducted.

CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income

Example -

The Contribution ApproachSales, variable expenses, and contribution margin can also be expressed on a per unit

basis. If Racing sells an additional bicycle, $200 additional CM will be generated tocover fixed expenses and profit.

The Contribution Approach

Each month Racing must generate at least $80,000 in total CM tobreak even.

If Racing sells 400 units in a month, it will be operating at the break-even point.



40/47


If Racing sells one more bike (401 bikes), net operating income will increase by $200.

We do not need to prepare an income statement to estimate profits at a particular sales volume.Simply multiply the number of units sold above break-even by the contribution margin per unit.

If Racing sells 430 bikes, its net income will be $6,000.

CVP Relationships in Graphic Form



41/47


The relationship among revenue, cost, profit and volume can be expressed graphically by preparing aCVP graph. Racing developed contribution margin income statements at 300, 400, and 500 units sold.We will use this information to prepare the CVP graph.

Income

300 unitsIncome

400 unitsIncome

500 units

Sales $ 150,000 $ 200,000 $ 250,000

Less: variable expenses 90,000 120,000 150,000

Contribution margin $ 60,000 $ 80,000 $ 100,000

Less: fixed expenses 80,000 80,000 80,000

Net operating income $ (20,000) $ - $ 20,000

CVP Graph

Units


D oll

ar

s

Units350,000

400,000

450,000

Fixed Expenses

Total Expenses

Total Sales

In a CVP graph,In a CVP graph, unit volumeunit volume is usuallyis usuallyrepresented on therepresented on the horizontal (X) axishorizontal (X) axis andand

dollarsdollars on theon the vertical (Y) axisvertical (Y) axis..

Loss

Area

Profit

Area


42/47


Contribution Margin Ratio

400 Bikes Per Unit 500 Bikes Per Unit

Sales $ 200,000 $ 250,000 $ 500

Less: variable expenses 120,000 150,000 300

Contribution margin 80,000 100,000 $ 200

Less: fixed expenses 80,000 80,000

Net operating income $ - $ 20,000


Total CMTotal

sales

CM Ratio =

Each $1.00 increase in sales results in a totalcontribution margin increase of 40.

= 40%$80,000$200,000

Or, in terms ofunits, the contribution margin ratiois:

For Racing Bicycle Company the ratio is:

$200$500 = 40%

Unit CMUnit selling price

CM Ratio =

A $50,000 increase in sales revenueA $50,000 increase in sales revenueresults in a $20,000 increase in CM.results in a $20,000 increase in CM.

($50,000 40% = $20,000)($50,000 40% = $20,000)


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Changes in Fixed Costs and Sales Volume

What is the profit impact if Racing can increase unit sales from 500 to 540 by increasing the monthlyadvertising budget by $10,000?

$80,000 + $10,000 advertising = $90,000Sales increasedby $20,000, but net operating income decreasedby $2,000.The Shortcut SolutionIncrease in CM (40 units X $200) $ 8,000

Increase in advertising expenses 10,000

Decrease in net operating income $ (2,000)

Change in Variable Costs and Sales VolumeWhat is the profit impact if Racing can use higher quality raw materials, thus increasing variable costsper unit by $10, to generate an increase in unit sales from 500 to 580?

580 units $310 variable cost/unit = $179,800

Sales increase by $40,000, and net operating income increases by $10,200.

Change in Fixed Cost, Sales Price and VolumeWhat is the profit impact if Racing (1) cuts its selling price $20 per unit, (2) increases its advertisingbudget by $15,000 per month, and (3) increases unit sales from 500 to 650 units per month?

Sales increase by $62,000, fixed costs increase by $15,000, and net operating income increasesby $2,000.

Change in Regular Sales PriceWhat is the profit impact if Racing (1) pays a $15 sales commission per bike sold instead of payingsalespersons flat salaries that currently total $6,000 per month, and (2) increases unit sales from 500 to575 bikes?

Sales increase by $37,500, variable costs increase by $31,125, but fixed expenses decrease by$6,000.

Change in Regular Sales Price

If Racing has an opportunity to sell 150 bikes to a wholesaler without disturbing sales to other customersor fixed expenses, what price would it quote to the wholesaler if it wants to increase monthly profits by$3,000?

$ 3,000 150 bikes = $ 20 per bike

Variable cost per bike = 300 per bike

Selling price required = $ 320 per bike

150 bikes $320 per bike = $ 48,000



44/47


Total variable costs = 45,000

Increase in net income = $ 3,000

Quick CheckCoffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup ofcoffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per monthis $1,300. 2,100 cups are sold each month on average. What is the CM Ratio for Coffee Klatch?a. 1.319b. 0.758

c. 0.242d. 4.139 , b ,

Break-Even AnalysisBreak-even analysis can be approached in two ways:


Unit contribution marginUnit selling price

CM Ratio =

=($1.49-$0.36)

$1.49

=$1.13$1.49

= 0.758


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1. Equation method2. Contribution margin method

Equation MethodProfits = (Sales Variable expenses) Fixed expensesOR

Sales = Variable expenses + Fixed expenses + Profits

At the break-even pointAt the break-even pointprofits equal zeroprofits equal zero

Break-Even AnalysisHere is the information from Racing Bicycle Company: Total Per Unit Percent

Sales (500 bikes) $250,000 $ 500 100%

Less: variable expenses 150,000 300 60%

Contribution margin $100,000 $ 200 40%

Less: fixed expenses 80,000

Net operating income $ 20,000

Equation MethodWe calculate the break-even point as follows:Sales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $0

Where:

Q = Number of bikes sold

$500 = Unit selling price

$300 = Unit variable expense

$80,000 = Total fixed expense

$500Q = $300Q + $80,000 + $0

$200Q = $80,000Q = $80,000 $200 per bike

Q = 400 bikesThe equation can be modified to calculate the break-even point in sales

dollars.Sales = Variable expenses + Fixed expenses + Profits



46/47


X = 0.60X + $80,000 + $0

X = 0.60X + $80,000 +X = 0.60X + $80,000 + $0$0

Where:X = Total sales dollars

0.60 = Variable expenses as a % of sales$80,000 = Total fixed expenses

The equation can be modified to calculate the break-even point inThe equation can be modified to calculate the break-even point insales dollars.sales dollars.

Sales = Variable expenses + Fixed expenses + ProfitsX = 0.60X + $80,000 + $0

0.40X = $80,000

X = $80,000 0.40

X = $200,000

Contribution Margin MethodThe contribution margin method has two key equations.

Lets use the contribution margin method to calculate the break-even point in total sales dollars at

Racing


Fixed expensesUnit contribution margin

=Break-even point

in units sold

Fixed expensesCM ratio

=Break-even point intotal sales dollars


47/47


Quick CheckCoffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup ofcoffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per monthis $1,300. 2,100 cups are sold each month on average. What is the break-even sales in units?

a. 872 cupsb. b. 3,611 cupsc. c. 1,200 cupsd. d. 1,150 cups , d ,

Fixedexpenses

CMratio

=Break-even point in

total sales dollars

Fixed expensesUnit CMBreak-even =

$1,300$1.49/cup - $0.36/cup

=$1,300

$1.13/cup

= 1,150 cups

=

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