Managerial Accounting English

Accounting Master Program 2007
By: Isam Rimawi irimawi@hotmail.com
Master Program
Advanced Managerial accounting
12/20/2010 last update
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Prepared by: Isam Rimawi
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Managerial Accounting and the Business Environment
Chapter One
Work of Management
Planning
Identify alternatives. Select alternative that does the best job of furthering organizations objectives. Develop budgets to guide progress toward the selected alternative.
Directing and Motivating

Directing and motivating involves managing day-to-day activities to keep the rganization running smoothly. 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 an
essential part of the control function
Planning and Control Cycle

Formulating Formulatinglong-and long-andshortshortterm plans (Planning) term plans (Planning)
Begin
Comparing Comparingactual actual to planned performance to planned performance (Controlling) (Controlling)
Decision aking
M
Implementing Implementing plans plans(Directing (Directingand and Motivating) Motivating)
Measuring Measuringperformance performance (Controlling) (Controlling)
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Comparison of Financial and Managerial Accounting

Financial Accounting
1. Users 2. Time focus 3. Verifiability versus relevance 4. Precision versus timeliness 5. Subject 6. GAAP 7. Requirement External persons who make financial decisions Historical perspective Emphasis on verifiability Emphasis on precision Primary focus is on the whole organization Must follow GAAP and prescribed formats Mandatory for external reports
Managerial Accounting
Managers who plan for and control an organization Future emphasis Emphasis on relevance for planning and control Emphasis on timeliness Focuses on segments of an organization Need not follow GAAP or any prescribed format Not Mandatory
Organizational Structure
Decentralization Decentralizationis isthe thedelegation delegationof ofdecisiondecisionmaking makingauthority authoritythroughout throughoutan anorganization. organization. C o r p o r a t e O r g a n i z a t i o
B o P P u r c h a s i nP g e r s o a r d o f D i r e c t o r s
r e s i d
e n t n c i a l
n n V e ilc e P r e s C i d h ei e n f t F i n a O p e r a t i o n O s f f i c e r T r e a
s u C r eo r n t r o
ll e r
Line and Staff Relationships

Line positions are directly related to achievement of the basic objectives of an organization. Example: Production supervisors in a manufacturing plant Staff positions support and assist line positions. Example: Cost accountants in the manufacturing plant.
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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 Environment

Business environment changes in the past twenty years 1. Just-in-time production 2. Total quality management 3. Process reengineering 4. Theory of constraints 5. International competition 6. E-commerce
Just-in-Time (JIT) Systems

Receive Receivecustomer customer orders. orders. Schedule Schedule production. production. Complete Completeproducts products just justin intime timeto to ship customers. ship customers.
Receive Receivematerials materials just in time just in timefor for production. production.
Complete Completeparts partsjust justin in time for assembly into time for assembly into products. products.
JIT Consequences
1. Improved plant layout 2. Reduced setup time 3. Zero production defects 4. Flexible workforce JIT purchasing Fewer, but more ultra reliable suppliers. Frequent JIT deliveries in small lots. Defect-free supplier deliveries.
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Benefits of a JIT System

Reduced inventory costs Higher quality products Increased throughput Freed-up funds Greater customer satisfaction More 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 Reengineering
1. 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. 2. 3. 4. Process is simplified. Process is completed in less time. Costs are reduced. Opportunities for errors are reduced.
Process Reengineering versus TQM

Process Reengineering
Radically overhauls existing processes. Likely to be imposed from above and to use outside consultants.
Total Quality Management

Tweaks existing processes to realize gradual improvements. Uses a team approach involving people who work directly in the process.
Theory of Constraints
A constraint (also called a bottleneck) is anything that prevents you from getting more of what you want.
The constraint in a system is determined by the step that has the smallest capacity. Theory of Constraints
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Only actions that 2. 2.Allow Allowthe theweakest weakest strengthen the link to set the link to set thetempo. tempo. weakest link in the chain improve the process. 3. 1. 3.Focus Focuson on 1.Identify Identify improving the the weakest improving the the weakest weakest link. weakestlink. link. link.
4. 4.Recognize Recognizethat thatthe the

weakest weakestlink link is no longer is no longerso. so.
International Competition
Increasing Increasing sophistication sophistication in in international international markets. markets.
Fewer Fewer tariffs, tariffs, quotas, quotas, and and other barriers other barriers to to free free trade. trade.
Competition has become worldwide in most industries.
Improvements Improvements in in global global transportation transportation systems. systems.
An Anexcellent excellentmanagement managementaccounting accountingsystem systemis isneeded needed to succeed in todays competitive global marketplace. to succeed in todays competitive global marketplace.
E-Commerce
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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 Accountants

The 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
Follow applicable laws, regulations and Follow applicable laws, regulations and standards. standards. Maintain Maintain professional professional competence. competence.
Competence
Prepare complete and clear reports Prepare complete and clear reports after appropriate analysis. after appropriate analysis.
IMA Guidelines for Ethical Behavior

Do not disclose confidential information Do not disclose confidential information unless legally obligated to do so. unless legally obligated to do so. Do not use confidential Do not use confidential information for information for personal advantage. personal advantage.
Confidentiality
Ensure that subordinates do not disclose Ensure that subordinates do not disclose confidential information. confidential information.
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Avoid conflicts of interest and advise Avoid conflicts of interest and advise others of potential conflicts. others of potential conflicts. Do not subvert Do not subvert organizations legitimate organizations legitimate objectives. objectives.
Integrity
Recognize and communicate personal and Recognize and communicate personal and professional limitations. professional limitations.

Avoid Avoidactivities activitiesthat thatcould could affect your ability to perform affect your ability to perform duties. duties. Refrain Refrainfrom from activities activitiesthat that could discredit could discredit the theprofession. profession. Refuse Refusegifts giftsor or favors that favors that might might influence influence behavior. behavior.
Integrity
Communicate Communicateunfavorable unfavorableas as well as favorable information. well as favorable information.
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Communicate information fairly and objectively. Communicate information fairly and objectively.
Objectivity
Disclose all information that might be useful to management. Disclose all information that might be useful to management.
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?

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Ethical Ethicalstandards standardsin inbusiness businessare areessential essentialfor fora a smooth functioning advanced market economy. smooth functioning advanced market economy.
Without ethical standards in business, the economy, and all of us who depend on it for jobs, goods, and services, would suffer.
Abandoning ethical standards in business would lead to a lower quality of life with less desireable goods and services at higher prices.
Codes of Conduct on the International Level

The 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 Accountant

A 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
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1. Direct Materials 2. Direct Labor 3. Manufacturing Overhead
Direct Materials
Raw 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 Labor
Those labor costs that can be easily traced to individual units of product. Example: Wages paid to automobile assembly workers
Manufacturing Overhead
Manufacturing costs that cannot be traced directly to specific units produced. Examples: Examples: Indirect Indirect labor laborand and indirect indirectmaterials materials Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.
Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards.
Classifications of Costs
Manufacturing costs are often classified as follows: Direct Direct Material Material Direct Direct Labor Labor Manufacturing Manufacturing Overhead Overhead
Prime Cost
Conversion Cost
Non-manufacturing Costs
Marketing or Selling Cost : Costs necessary to get the order and deliver the product. Administrative Cost : All executive, organizational, and clerical costs.
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Product Costs Versus Period Costs
Product costs include direct

Sale labor, and materials, direct manufacturing overhead.
Inventory
Cost of Good Sold
Expense Period costs include all
marketing or selling costs and administrative costs.
Balance Sheet
Quick Check
Income Statement
Income Statement
Which 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 . . . Buy finished goods. Sell finished goods. Manufacturers . . . Buy raw materials. Produce and sell finished goods.
Balance Sheet
Manufacturers . . . 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.
Merchandisers . . . Current assets Cash Receivables Prepaid Expenses Merchandise Inventory
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The Income Statement

Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.
Merchandising Company
Cost of goods sold: Beg. merchandise inventory $ 14,200 + Purchases 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
Inventory Flows
Beginning balance $$
+ _
Additions $$$
Available $$$$$
Available $$$$$
Withdraw als $$$
Ending balance $$
Quick Check
If 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.
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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

Raw Materials
Beginning raw materials inventory Raw materials purchased Raw materials available for use in production Ending raw materials inventory Raw materials used in production
Manufacturing Costs
Direct materials
Work In Process
Finished Goods
Beginning finished goods inventory Cost of finished goods mfg. Finished goods available for sale Ending finished goods inventory Cost of finished goods sold
+ =
As items are removed from raw materials inventory and placed into the production process, they are called direct materials.
+ = =
Raw Materials
Beginning raw materials inventory Raw materials purchased Raw materials available for use in production Ending raw materials inventory Raw materials used in production + + =
Manufacturing Costs
Direct materials Direct labor Mfg. overhead Total manufacturing costs
Work In Process
Conversion costs are costs incurred to convert the direct material into a finished product.
Raw Materials
Beginning raw materials inventory Raw materials purchased
Manufacturing Costs
Direct materials + + = Direct labor Mfg. overhead Total manufacturing
Work In Process
Beginning work in process inventory Total manufacturing costs
Finished Goods
Beginning finished goods inventory Cost of finished goods mfg.
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= Raw materials available for use in production Ending raw materials inventory Raw materials used in production

costs = Total work in process for the period

= Finished goods available for sale Ending finished goods inventory Cost of finished goods sold
All manufacturing costs incurred during the period are added to the beginning balance of work in process.
Raw Materials
Beginning raw materials inventory Raw materials purchased Raw materials available for use in production
Manufacturing Costs
Direct materials + + = Direct labor Mfg. overhead Total manufacturing costs
Work In Process
Beginning work in process inventory Total manufacturing costs Total work in process for the period Ending work in process inventory Cost of goods manufactured
Finished Goods
Beginning finished goods inventory Cost of finished goods mfg. Finished goods available for sale Ending finished goods inventory Cost of finished goods sold
+ =
+ =
+ =
Costs associated with the goods that are completed during the period are transferred to finished goods inventory.
Work In Process
Beginning work in process inventory Manufacturing costs for the period Total work in process for the period Ending work in
Finished Goods
Beginning finished goods inventory Cost of goods manufactured Cost of goods available for sale Ending finished http://www.geocities.com/irimawi/
+ =
+ = -
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process inventory Cost of goods manufactured

goods inventory Cost of goods sold
Manufacturing Cost Flows Balance Sheet Inventories

Raw Materials Work in Process Finished Goods Cost of Goods Sold Selling and Administrative
Costs
Material Purchases Direct Labor Manufacturing Overhead
Income Statement Expenses
Selling and Administrative
Period Costs
Quick Check
Beginning 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 . ,C The Answer C
+ Beg. raw materials Raw materials purchased Raw materials available for use in production Ending raw materials inventory $ 32,000 276,000
$ 308,000 28,000 irimawi@hotmail.com http://www.geocities.com/irimawi/
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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 B
+ + = Direct Materials Direct Labor Mfg. Overhead Mfg. Costs Incurred for the Month $280,000 375,000 180,000 $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 Mfg. costs incurred for the period Total work in process during the period Ending work in process inventory Cost of goods manufactured $ 125,000 835,000 $ 960,000 200,000 $ 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
Total Long Distance Telephone Bill
Minutes Talked
Variable Cost Per Unit

Per Minute Telephone Charge
Minutes Talked
Total Fixed Cost

Your monthly basic telephone bill probably does not change when you make more local calls.
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Monthly Basic Telephone Bill

Number of Local Calls
Fixed Cost Per Unit

The average fixed cost per local call decreases as more local calls are made.
Monthly Basic Telephone Bill per Local Call

Number of Local Calls
Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)
Cost Variable Fixed In Total Total variable cost changes as activity level changes. Total fixed cost remains the same even when the activity level changes. Per Unit Variable cost per unit remains the same over wide ranges of activity. Average fixed cost per unit goes down as activity level goes up.
Quick Check
Which 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.)
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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 Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples: direct material and direct labor Indirect costs 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 Revenues

Costs 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 a neighboring 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 Costs
The 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 Costs
Sunk 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 sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.
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Quick Check
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 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.
Overtime
The overtime premiums for all factory workers are usually considered to be part of manufacturing overhead
Labor Fringe Benefits

Fringe 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 Prevention Costs

Support activities whose purpose is to reduce the number of defects Incurred to identify defective products before the products are shipped
Appraisal Costs
Internal and External Failure Costs
Internal Failure Costs External Failure Costs

Examples of Quality Costs
Incurred as a result of identifying defects before they are shipped
Incurred as a result of defective products being delivered to customers
Prevention Costs Quality training Quality circles Statistical process control activities Internal Failure Costs Scrap Spoilage Rework Appraisal Costs Testing & inspecting incoming materials Final product testing Depreciation of testing equipment External Failure Costs Cost of field servicing & handling complaints Warranty repairs
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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 Quality training Supervision of prevention activities Quality improvement Total prevention cost Appraisal costs: Inspection Reliability testing Supervision of testing and inspection Depreciation of test equipment Total appraisal cost Internal failure costs: Net cost of scrap Rework labor and overhead Downtime due to defects in quality Disposal of defective products Total internal failure cost External failure costs: Warranty repairs Warranty replacements Allowances Cost of field servicing Total external failure cost Total quality cost $ 400,000 210,000 70,000 320,000 1,000,000 0.80% 0.42% 0.14% 0.64% 2.00% $ 270,000 130,000 40,000 210,000 650,000 0.54% 0.26% 0.08% 0.42% 1.30%
600,000 580,000 120,000 200,000 1,500,000
1.20% 1.16% 0.24% 0.40% 3.00%
560,000 420,000 80,000 140,000 1,200,000
1.12% 0.84% 0.16% 0.28% 2.40%
900,000 1,430,000 170,000 500,000 3,000,000
1.80% 2.86% 0.34% 1.00% 6.00%
750,000 810,000 100,000 340,000 2,000,000
1.50% 1.62% 0.20% 0.68% 4.00%
400,000 870,000 130,000 600,000 2,000,000 7,500,000
0.80% 1.74% 0.26% 1.20% 4.00% 15.00%
900,000 2,300,000 630,000 1,320,000 5,150,000 9,000,000
1.80% 4.60% 1.26% 2.64% 10.30% 18.00%
* As a percentage of total sales. In each year sales totaled $50,000,000.
Quality Cost Reports: Graphic Form

Quality reports can also be prepared in graphic form.
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Quality Cost as a Percentage of Sales
$10 9 Quality Cost (in millions) 8 7 6 5 4 3 2 1 0 Internal Failure Appraisal Prevention 1 Year Internal Failure Appraisal Prevention 2 External Failure External Failure
20 18 16 14 12 10 8 6 4 2 0 Internal Failure Appraisal Prevention 1 Year Internal Failure External Failure External Failure
Appraisal Prevention 2
Uses of Quality Cost Information

1. 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 Standards

ISO 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
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Cost Behavior : Analysis and Use
Chapter Five
Types of Cost Behavior Patterns

Recall the summary of our cost behavior discussion from an earlier chapter. Summary of Variable and Fixed Cost Behavior
Cost Variable Fixed In Total Total variable cost is proportional to the activity level within the relevant range. Total fixed cost remains the same even when the activity level changes within the relevant range. Per Unit Variable cost per unit remains the same over wide ranges of activity. Fixed cost per unit goes down as activity level goes up.
The Activity Base
Units produce d A measure of what causes the incurrence of a variable cost
Machine hours
Miles driven
Labor hours
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True Variable Cost Example

A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Your total long distance telephone bill is based on how many minutes you talk.
Total Long Distance Telephone Bill
Minutes
Talked
Types of Cost Behavior Patterns

Recall the summary of our cost behavior discussion from an earlier chapter.
Variable Cost Per Unit Example

A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant. For example, 10 cents per minute.
Per Minute Telephone Charge
Minutes Talked
Extent of Variable Costs

The proportion of variable costs differs across organizations. For example . . . 1. A public utility with large investments in equipment will tend to have fewer variable costs. 2. A service company will normally have a high proportion of variable costs.
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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 Cost

Direct materials is a true or proportionately variable cost because the amount used during a period will vary in direct proportion to the level of production activity.
Co st
Volume
Step-Variable Costs
A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs increase or decrease only in response to fairly wide changes in activity is known as a step-variable cost.
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 a change in the number of maintenance workers employed
The Linearity Assumption and the Relevant Range
Volum e
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A A straight straight line line Economists closely closely Curvilinear Cost approximates approximates a a Function curvilinear curvilinear
Total Cost
Relevant Range
variable variable cost cost line line within within the the relevant range. relevant range.
Accountants Straight-Line Approximation (constant unit variable cost)
Activity
Types of Fixed Costs

1. Committed
Long-term, cannot be significantly reduced in the short term. Examples Depreciation on Equipment and Real Estate Taxes
2. Discretionary
May be altered in the short-term by current managerial decisions Examples Advertising and Research and Development
The Trend Toward Fixed Costs

The trend in many industries is toward greater fixed costs relative to variable costs. As machines take over many mundane tasks previously performed by humans, knowledge workers are demanded for their minds rather than their muscles Knowledge workers tend to be salaried, highly-trained and difficult to replace. The cost to compensate these valued employees is relatively fixed rather 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. In France, Germany, China, and Japan anagement has little flexibility in adjusting the size of the labor force. Labor costs are more fixed in nature. In the United States and the United Kingdom management has greater latitude. Labor costs are more variable in nature.
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Fixed Costs and Relevant Range
90 Relevant Range
Total Total cost cost doesnt doesnt change change for for a a wide wide range range of of activity, activity, and and then then jumps jumps to to a a new new higher higher cost cost for for the the next next higher higher range of activity. range of activity.
3,000

The 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 square feet. As the business grows more space is rented, increasing the total cost.

How 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 Check
Which 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 Costs
A mixed cost has both fixed and variable components. Consider the example of utility cost.
Rent Cost in Thousands of Dollars
60
30 00
1,000 2,000
Rented Area (Square Feet)
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Total Utility Cost
Y
lm a t To
ix
t s o c ed
Variable Cost per KW Fixed Monthly Utility Charge
Activity (Kilowatt Hours)
The total mixed cost line can be expressed as an equation: Y = a + bX

Where: Y a b X = = = = the total mixed cost the total fixed cost (the vertical intercept of the line) the variable cost per unit of activity (the slope of the line) the level of activity
Mixed Costs Example

If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?
Y = a + bX Y = Y = $40 + ($0.03 2,000) Y = Y = $100 $100
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Analysis of Mixed Costs

Account Analysis and the Engineering Approach Each account is classified as either variable or fixed based on the analysts knowledge of how the account behaves. Cost estimates are based on an evaluation of production methods, and material, labor and overhead requirements.
The Scatter graph Method

Plot the data points on a graph (total cost vs. activity).
Y 20
Maintenance Cost 1,000s of Dollars
10
* * * *
0 1 2
* ** * **
X
Patient-days in 1,000s
The Scatter graph Method

Draw a line through the data points with about an equal numbers of points above and below the line.
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Y 20
10
* * * *
0 1 2
* ** * **
X
Use one data point to estimate the total level of activity and the total cost.
Y Total maintenance cost = $11,000 20

10
* * * *
0 1 2
* ** * **
X
Intercept = Fixed cost: $10,000
Patient days = 800
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Master Program
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
Variable cost per unit =
$1,00 800 800
= $1.25/patientday
Y Y= = $10,000 $10,000 + + $1.25X $1.25X

Total Total maintenance maintenance cost cost Number Number of of patient patient days days
The High-Low Method

Assume the following hours of maintenance work and the total maintenance costs for six months.
Month
Jan Feb Mar Apr May Jun High Level Low Level Change
Hours of maintenance
625 500 700 550 775 800 800 500 300
Total maintenance Cost

7,950 7,400 8,275 7,625 9,100 9,800 9,800 7,400 2,400
The variable cost per hour of maintenance is equal to the change in cost divided by the change in hours.
$2,400 = $8.00/hour 300
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Total Fixed Cost = Total Cost Total Variable Cost Total Fixed Cost = $9,800 ($8/hour 800 hours) Total Fixed Cost = $9,800 $6,400 Total Fixed Cost = $3,400
The Cost Equation for Maintenance Y = $3,400 + $8.00X

Quick Check
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units 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 unit c. $0.12 per unit d. $0.125 per unit ,b,
Units High le ve l Low le ve l Cha nge 120,000 80,000 40,000 $ Cost $ 14,000 10,000 4,000
$4,000 40,000 units = $0.10 per unit
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 ,a,
Total cost $14,000 Total fixed cost Total fixed cost = = = = Total fixed cost + Total variable cost Total fixed cost + ($0.10 120,000 units) $14,000 - $12,000 $2,000
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Least-Squares Regression Method

A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables. This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost The goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors. 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 the goodness of fit of the regression line to the data points. R2 is the percentage of the variation in total cost explained by the activity.
Y
Tota l Cost
20
10
* * * * R varies from 0% to 100%, and

2
* ** * **
4
the higher the percentage the better.
0 0
2 3 Activity
Comparing Results From the Three Methods

The three methods just discussed provide slightly different estimates of the fixed and variable cost components of the mixed cost. This is to be expected because each method uses differing amounts of the data points to provide estimates. Least-squares regression provides the most accurate estimate because it uses all the data points.
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Advanced Managerial accounting Lets
The Contribution Format

Total
Sales Revenue Less: Variable costs Contribution margin Less: Fixed costs Net operating income $ 100,000 60,000 $ 40,000 30,000 $ 10,000
Unit
$ 50 30 $ 20
12/20/2010 put our last update knowledge of cost behavior to work by preparing a contribution format income statement.
The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income. Uses of the Contribution Format
The contribution income statement format is used as an internal planning and decision making tool. We will 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 Statement Traditional 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
Used primarily for external reporting.
Used primarily by management.
Appendix 5A
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Least-Squares Regression Using Microsoft Excel.
Simple Regression Analysis Example

Matrix, 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 Excel

You 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, or R2, by using the RSQ function.
End of Chapter 5
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Cost-Volume-Profit Relationships
Chapter Six
Basics of Cost-Volume-Profit Analysis

Contribution 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 Approach

Sales, 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 to cover fixed expenses and profit.
The Contribution Approach

Each month Racing must generate at least $80,000 in total CM to break even.
If Racing sells 400 units in a month, it will be operating at the break-even point.
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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

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The relationship among revenue, cost, profit and volume can be expressed graphically by preparing a CVP 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 units $ 150,000 90,000 $ 60,000 80,000 $ (20,000) Income 400 units $ 200,000 120,000 $ 80,000 80,000 $ Income 500 units $ 250,000 150,000 $ 100,000 80,000 $ 20,000
Sales Less: variable expenses Contribution margin Less: fixed expenses Net operating income
CVP Graph
In a CVP graph, unit volume is usually represented on the horizontal (X) axis and dollars on the vertical (Y) axis.
Total Sales Total Expenses
fit A Pro
rea
450,000 400,000
D oll ar s
Fixed Expenses
r ea sA s o L
350,000 300,000 250,000 200,000 150,000
Units
Units
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Master Program
Contribution Margin Ratio
Total CM CM Ratio = Total sales $80,000 = 40% $200,000

Each $1.00 increase in sales results in a total contribution margin increase of 40.
Or, in terms of units, the contribution margin ratio is:

CM Ratio = Unit CM Unit selling price
For Racing Bicycle Company the ratio is:

$200 = 40% $500
Sales Less: variable expenses Contribution margin Less: fixed expenses Net operating income
400 Bikes $ 200,000 120,000 80,000 80,000 $ -
Per Unit
500 Bikes $ 250,000 150,000 100,000 80,000 $ 20,000
Per Unit 500 300 $ 200 $
A $50,000 increase in sales revenue results in a $20,000 increase in CM. ($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 monthly advertising budget by $10,000? $80,000 + $10,000 advertising = $90,000 Sales increased by $20,000, but net operating income decreased by $2,000.
The Shortcut Solution

Increase in CM (40 units X $200) Increase in advertising expenses Decrease in net operating income $ 8,000 10,000 $ (2,000)
Change in Variable Costs and Sales Volume

What is the profit impact if Racing can use higher quality raw materials, thus increasing variable costs per 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 Volume What is the profit impact if Racing (1) cuts its selling price $20 per unit, (2) increases its advertising budget 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 increases by $2,000.
Change in Regular Sales Price

What is the profit impact if Racing (1) pays a $15 sales commission per bike sold instead of paying salespersons flat salaries that currently total $6,000 per month, and (2) increases unit sales from 500 to 575 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 customers or fixed expenses, what price would it quote to the wholesaler if it wants to increase monthly profits by $3,000?
$ 3,000 150 bikes = Variable cost per bike = Selling price required = 150 bikes $320 per bike Prepared by: Isam Rimawi $ 20 300 $ 320 $ 48,000 per bike per bike per bike
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Total variable costs Increase in net income = =

45,000 $ 3,000
Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the CM Ratio for Coffee Klatch? a. 1.319 b. 0.758 c. 0.242 d. 4.139 ,b,
CM Ratio =
Unit contribution margin Unit selling price
($1.49-$0.36) = $1.49 = $1.13 = 0.758 $1.49
Break-Even Analysis
Break-even analysis can be approached in two ways:
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1. Equation method 2. Contribution margin method
Equation Method
Profits = (Sales Variable expenses) Fixed expenses OR Sales = Variable expenses + Fixed expenses + Profits
At the break-even point profits equal zero
Break-Even Analysis
Here is the information from Racing Bicycle Company:
Sales (500 bikes) Less: variable expenses Contribution margin Less: fixed expenses Net operating income Total $250,000 150,000 $100,000 80,000 $ 20,000 Per Unit $ 500 300 $ 200 Percent 100% 60% 40%
Equation Method
We 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 = $80,000 Q = $80,000 $200 per bike Q = 400 bikes
The equation can be modified to calculate the break-even point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits
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X = 0.60X + $80,000 + $0
X = 0.60X + $80,000 + $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 in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits X = 0.60X + $80,000 + $0 0.40X = $80,000 X = $80,000 0.40 X = $200,000
Contribution Margin Method

The contribution margin method has two key equations.
Break-even point = in units sold Break-even point in total sales dollars =
Fixed expenses Unit contribution margin Fixed expenses CM ratio
Lets use the contribution margin method to calculate the break-even point in total sales dollars at Racing
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Break-even point in
total sales dollars
Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the break-even sales in units? a. 872 cups b. b. 3,611 cups c. c. 1,200 cups d. d. 1,150 cups ,d,
Fixed expense s CM ratio
Break-even = = =
Fixed expenses Unit CM
$1,300 $1.49/cup - $0.36/cup $1,300 $1.13/cup
= 1,150 cups
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Accounting Master Program 2007

By: Isam Rimawi irimawi@hotmail.com

Advanced Managerial accounting

12/20/2010 last update

Prepared by: Isam Rimawi

Advanced Managerial accounting

12/20/2010 last update

Managerial Accounting and the Business Environment

Directing and Motivating

Planning and Control Cycle

Comparing Comparingactual actual to planned performance to planned performance (Controlling) (Controlling)

Implementing Implementing plans plans(Directing (Directingand and Motivating) Motivating)

Measuring Measuringperformance performance (Controlling) (Controlling)

Prepared by: Isam Rimawi

Advanced Managerial accounting

12/20/2010 last update

Comparison of Financial and Managerial Accounting

Line and Staff Relationships

Advanced Managerial accounting

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The Chief Financial Officer (CFO)

The Changing Business Environment

Just-in-Time (JIT) Systems

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Advanced Managerial accounting

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Benefits of a JIT System

Total Quality Management (TQM)

Process Reengineering versus TQM

Total Quality Management

Advanced Managerial accounting

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4. 4.Recognize Recognizethat thatthe the

Competition has become worldwide in most industries.

Improvements Improvements in in global global transportation transportation systems. systems.

Advanced Managerial accounting

12/20/2010 last update

Code of Conduct for Management Accountants

IMA Guidelines for Ethical Behavior

Prepared by: Isam Rimawi

Advanced Managerial accounting

12/20/2010 last update

IMA Guidelines for Ethical Behavior

IMA Guidelines for Ethical Behavior

Prepared by: Isam Rimawi

Advanced Managerial accounting

12/20/2010 last update

IMA Guidelines for Ethical Behavior

IMA Guidelines for Resolution of an Ethical Conflict

IMA Guidelines for Resolution of an Ethical Conflict

Why Have Ethical Standards?

Advanced Managerial accounting

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Codes of Conduct on the International Level

Certified Management Accountant

Costs Terms, Concepts and Classifications

Advanced Managerial accounting

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1. Direct Materials 2. Direct Labor 3. Manufacturing Overhead

Advanced Managerial accounting

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Product Costs Versus Period Costs