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Managerial and Cost Accounting

Overview of Management and

Cost Accounting
Definitions, Applications
Management Accounting
(National Association of Accountants)
the process of identification, measurement,
accumulation, analysis, preparation,
interpretation, and communication of financial
information, which is used by management to
plan, evaluate, and control within an
Cost Accounting
(National Association of Accountants)
a systematic set of procedures for recording
and reporting measurements of the cost of
manufacturing goods and performing services in
the aggregate and in detail. It includes methods
for recognizing, classifying, allocating,
aggregating and reporting such costs and
comparing them with standard costs
Financial Accounting
concerned mainly with the historical aspects
of external reporting, that is, providing financial
information to outside parties such as investors,
creditors, and government
Financial Accounting Managerial
Primarily provides data Objective Internal use
for external use
Subject to GAAP Compliance Not subject to GAAP
Emphasis on the past Emphasis More emphasis on future
Required (BIR, SEC, etc) Compliance with Law Not mandatory
For the company as a Reporting Requirements Parts or segments
All purpose reports with Relevance and Flexibility Special reports
historical data of Data containing both
(summarized) historical and projected
data (detailed)
Chief Financial Officer/Finance
• The executive responsible for overseeing the
financial operations of an organization
• Responsibilities usually include:
▫ Controllership (Chief Mgt Acct/Chief Accounting
Executive/Chief Accounting Officer/
Controller/Comptroller) – includes providing
financial information for reports to managers and
reports to shareholders and overseeing the overall
operation of the accounting system
▫ Treasury – includes banking and short/long-term
financing, investments, and management of cash
▫ Risk Management – includes managing the
financial risk of interest-rate and exchange-rate
changes and derivatives management
▫ Taxation – includes income taxes, sales taxes, and
international tax planning
▫ Internal Audit – includes reviewing and analyzing
financial and other records to attest to the
integrity of the organization’s financial reports
and to adherence to its policies and procedures
Changes in the Business Environment
• Advances in Technology
• Globalization
• Customer Focus
Contemporary Management Techniques
• Just-in-Time (JIT)
▫ Materials are purchased and units are produced
only as needed to meet actual customer demand
▫ Emphasis on simplifications and increased
visibility to identify activities that do not add value

• Total Quality Management

▫ Stresses listening to the needs of customers,
making products right the first time, reducing
defective products that must be reworked, and
encouraging workers to continuously improve
their production process
• Process Reengineering
▫ A more radical approach to improvement than
▫ Main objective is the simplification and
elimination of wasted effort and the central idea is
that all activities that do not add value to product
or service should be eliminated

• Theory of Constraints
▫ Emphasizes the importance of managing the
organization’s constraints or barriers that hinder
or impede progress toward an objective
• Target Costing
▫ involves the determination of the desired cost for a
product or the basis of a given competitive price so
that the product will earn a desired profit

• Computer-aided Design and Manufacturing

• Automation
• E-Commerce
Current Focus of Management
• Customer Value
• Value Chain and Supply Chain Analysis
▫ Business Functions Making Up the Value Chain
• Key Success Factors
• Cross-functional Teams
• Computer-integrated Manufacturing
• Global Competition
• Cost Management System
Research and Product Customer
Manufacturing Marketing Distribution
Development Design Service

Management Accounting
• Continuous Improvement and Benchmarking
▫ Continuous improvement targets are often set by
benchmarking in measuring the quality of the
products, services and activities of the company
against the best levels of performance found in
competing companies
Cost Concepts and Classification
• Value forgone for the purpose of achieving some
economic benefit which will promote the profit-
making ability of the firm
Cost Pools
• Costs collected into meaningful groups

▫ By type of cost
▫ By source
▫ By responsibility
▫ etc
Cost Objects
• Any product, service or organizational unit to
which costs are assigned for some management


Product Service
Cost Drivers
• Any factor that has the effect of changing the
level of total cost
Cost Classification
Nature of Mgt Manufacturing Costs
Function Non Manufacturing Costs

Ease of Direct Costs

Traceability Indirect Costs
Cost Data Timing of Product Costs
Recognition as
Period Costs
Variable Costs
Cost Behavior Fixed Costs
Semi variable Costs
Controllable Costs
Non controllable Costs
Standard Costs
Relevance to Incremental Costs
Planning, Control, Sunk Costs
and Decision- Opportunity Costs
Making Relevant Costs

Financial Balance Sheet

Income Statement
Cost Data
Balance Sheet
Merchandising Manufacturing

Merchandising Inventory Inventory

Raw Materials


Finished Goods
Income Statement
Merchandising Manufacturing

Beg. Inventory P xx Beg. FG Inventory P xx

Add: Purchases xx Add: COG Mfd xx
Total Available for Sale P xx Total Available for Sale P xx
Less: End. Inventory xx Less: End. FG Inventory xx
Illustrative Problem
Bettina Cabrera is the production manager of a ready-to-
wear manufacturing outfit. A decision needs to be made
about the type of clothing material or fabric to be used to
make a shirt. The fabric that has been used in the previous
production costs P40 per yard but it is not available
currently. Similar material from another supplier will cost
p50 per yard.

Identify the costs of the fabric according to the

classifications discussed.
Types of Inventory System
1. First In, First Out (FIFO)
• Assumes that the items bought first are also
used/sold first
• Fewer inventory layers since oldest layers are
continually used up
• Ex: first 10 units costs P20 each, then another
1o units for P22 each; first 10 units sold will be
charged P20, then P22 for the next 10 units
2. Last In, First Out (LIFO)
• Assumes that the items bought last are sold
• Banned under International Financial
Reporting Standards
• More inventory layers since the oldest layers
may not be flushed out for years
• Ex: first 10 units sold will be charged P22, then
P20 for the next 10 units
3. Average Cost Method
• Frequently adjusted as more inventory is
• Only one inventory layer
• Applicable when inventory items are
intermingled/commoditized that there is no way
to assign a cost to an individual unit
Ex: Milagro Corp. uses weighted-average method
for the ff:
Qty Change Actual Unit Actual
Cost Total Cost
Beginning +150 $220 $33,000
Sale -125 - -
Purchase +200 270 54,000
Sale -150 - -
Purchase +100 290 29,000
Ending 175
Perpetual Inventory System (Moving Average)

Units on Purchases Cost of Sales Inventory Inventory

Hand Total Cost Moving-Ave
Unit Cost
Beginning 150 - - $33,000 $220
Sale (125 at 25 - $27,500 5,500 220
Purchase (200 225 $54,000 - 59,500 264.44
at $270)
Sale (150 at 75 - 39,666 19,834 264.44
Purchase (100 175 29,000 - 48,834 279.05
at $290)
4. Specific Identification Method
• perfectly matches inventory costs with units sold
• Not suited for businesses with high volumes of
relatively homogenous products
Cost Behavior: Analysis and Use
Cost Behavior
• How a cost will react as changes in the level of
business activity take place
• Essential to adequate decision making in the
planning and control of firm activity
Types of Cost Behavior Patterns
1. Variable Costs
- the cost must be variable with respect to its
activity base (cost drivers)
-ex: DM, DL, some OH (indirect materials,
energy costs, supplies), sales commission
2. Fixed Costs
-reacts inversely with change in activity
(decrease per unit as activity rises)
a. Committed FC – long term in nature
- they can’t be significantly reduced even for
short periods of time without seriously
impairing the profitability or long-run goals of
the organization
- ex: straight-line depreciation, taxes on real
estate, rent
b. Discretionary FC (Managed FC)
- management is not locked into a decision
regarding such costs
- ex: advertising, research, public relations
-usually arise from annual decisions by the
3. Semi variable Cost (Mixed Cost)
- contains both variable and fixed cost

y = a + bx
y = total mixed cost
a = total fixed cost
b = variable cost per unit of activity
x = level of activity
Cost Estimation for Mixed Cost
1. Account Analysis
- Uses experience and judgement of managers and
accountants who are familiar with company
operations and the way costs react to changes in
activity level
- Step1: Review each cost account used to record
the costs that are of interest. Each cost is
identified as either fixed or variable depending
on the relationship between the cost and some
 Step2: Each major class of manufacturing OH or
other mixed cost is itemized. Each cost is then
divided into its estimated variable and fixed
components. This is done on the basis of the
experience and judgement of accounting and other
 Advantage: involves detailed examination of the data
base by accountants and managers who are familiar
with it
 Disadvantage: subjective, judgemental approach
2. High-Low Method
- Based on costs observed at both the high and low
levels of activity within the relevant range
- Step1: Select the highest pair and lowest pair (cost
and activity level)
- Step2: Compute the variable rate, b, by using the
- VC = (difference in cost y)/(difference in activity x)
- Step3: Compute the fixed cost portion as
- FC portion = total mixed cost – variable cost
- Advantage: simple and easy
- Disadvantage: uses only 2 data points (may not be
representative of normal conditions)
3. Least-Squares Method
- a statistical technique which is often used in separating
mixed costs into their fixed and variable components
- a line of regression is determined by solving two
simultaneous linear equations which are based on the
condition that the sum of deviations above the line
equals the sum of deviations below the line
- includes all the observed data and attempts to find a
line of best fit
- advantage: uses all data
easy to use with computers and
sophisticated calculators
a measure of goodness of fit of the line is
- disadvantage: requires that several relatively strict
assumptions be satisfied for results to be valid
4. Scatter Graph or Visual Fit
- rough guide for cost estimation which plot the cost against
past activity levels (fitted regression line by visual inspection)
-Step1: plot actual costs (on y-axis) during the period under
study against the volume levels (x-axis)
-Step2: draw line of best fit by visual inspection
-Step3: FC is estimated by extending the left end of the line
-Step4: Variable cost rate or slope of the cost line is
determined by dividing the difference between any two costs
by the difference of the corresponding level of activities
-Advantage: uses all observations of cost data
relatively easy to understand and apply
-Disadvantage: fitting of line is subjective
difficult where several independent variables are to be used
The Contribution Approach to the IS
Traditional Approach
- shows functional classification of costs
(manufacturing vs non manufacturing)
Sales $ 15,000
Less: COGS 7,000
Gross Margin 8,000
Less: OpEx
Selling (2,100)
Admin (1,500)
Contribution Approach
- looks at cost behavior
- provides data useful for managerial planning
and decision making
- highlights the concept of contribution margin
Sales $15,000
Less: Variable Expense
Mfg (4,000)
Selling (1,600)
Admin (500)
Contribution Margin 8,900
Less: Fixed Expense
Mfg (3,000)
Selling (500)
Admin (1,000)
Net Income 4,400
Variable Costing
Variable Costing
• Also known as Direct Costing
• Only variable manufacturing costs are included
in product costs
• Income statement under this approach
highlights the contribution margin of the
• Preferred by managers for cost-volume-profit
• Shows costs that can be traced and controlled by
each strategic business unit
• Appraisal of performance of product line or
other segments of the business can be facilitated
without the need for allocations of fixed cost
• Analysis of costs relevant to pricing is likewise
simplified and enhanced
• Tends to give the impression that variable costs
are recovered first, that fixed costs are recovered
later and finally profits are realized
• Not acceptable for external reporting and tax
Comparison between Variable Costing
and Absorption Costing (Traditional)

Absorption Variable Costing

Product Costs Direct Materials Product Costs
Direct Labor
Variable MOH
Fixed MOH Period Costs
Period Costs Variable Selling & Admin
Fixed Selling & Admin
Comparison between Variable Costing
and Absorption Costing
Relationship between Production and Sales Net Income
P< S AC < VC

Inventory value under absorption costing would be higher than under

variable costing.
Reconciliation of Net Income Under
Variable Costing with Net Income
Under Absorption Costing
Net Income, Absorption Costing P XX
Add: Fixed OH, beg inventory XX
Total XX
Less: Fixed OH, end inventory XX
Net Income, Variable Costing P XX
Karen Corp.
January February
Beginning Inventory 0 100
Production 1000 1000
Sales 900 1100
Finished Goods Ending Inventory 100 0
Variable Manufacturing costs (per unit):
Direct Materials P 10 P 10
Direct Labor 5 5
Variable Manufacturing OH 3 3
Fixed Manufacturing Costs per month 8000 8000
Variable Marketing Cost (per unit sold) 2 2
Fixed Selling and Admin Cost per month 12000 12000
Price Per Unit Sold P 50 P 50
• Prepare Income Statements for each month and
two-months combined under
▫ Variable Costing
▫ Absorption Costing
• Reconcile the net income under absorption
costing with under variable costing
Blasek Company
Basic Production Data at Standard Cost:
Direct Materials P 1.30
Direct Labor 1.50
Variable Overhead .20
Fixed Overhead ( P150000 / 150000 units of normal vol) 1.00
Total Factory Cost at Standard P 4.00

Selling Price at P 5.00 per unit.

Selling and Administrative Expenses is assumed for simplicity as being all fixed at
P 65,000 yearly, except for sales commission at 5% of peso sales.
In units 2005 2006
Beginning Inventory 0 30000
Production 170000 140000
Sales 140000 160000
Ending Inventory 30000 10000

a. Income statement for 2005 and 2006 under variable costing and absorption
b. A reconciliation of the difference in net income for 2005 and 2006 and the two
years as a whole.
Systems Design and Costing
Flow of Cost in a Merchandising
Costs Balance Sheet Income Statement

Merchandise Merchandise COGS

Purchases Inventory

Selling & Period Expense Selling &

Administrative Administrative
Flow of Cost in Manufacturing
Cost Balance Sheet Income Statement
Merchandise Raw Materials
Direct Labor
Work in Process
Manufacturing OH

Finished Goods

Period Expense
Selling and
Selling and Admin.
Manufacturing Cost Accounting System
4 Decisions:
1. Will the system use historical costs or
standard costs?
2. Job order or Process costing?
3. Full absorption or direct costing of inventory?
4. What system will be used to assign OH costs
or products? Plant-wide or Activity-based
predetermined OH rates? How many cost
Job Order Costing System
• Costs are assigned by jobs, contracts, or orders
• DM and DL are traced to a particular job
• FOH applied to individual jobs using
predetermined OH rate
• Uses job sheet which records various production
costs for WiP inventory (summarizes all
manufacturing costs)
Accounting Procedures Using Job Order
Costing to a Manufacturing Company
1. Record the purchase and issue of materials
with journal entries.
2. Record Labor Costs with journal entries.
3. Calculate predetermined OH and use it to
assign OH costs to a job.
4. Record applied manufacturing OH costs with
journal entries.
5. Complete a job cost sheet and calculate the
average cost per unit of a job.
6. Record actual MOH costs with journal entries.
7. Compute over and under applied OH.
-any differences are closed to COGS
under applied = applied < actual
over applied = applied > actual

8. Calculate COGM and COGS

Illustrative Problem
Palmera Co. is a manufacturing firm that uses job-
order costing. On January 1, the beginning of its fiscal
year, the company’s inventory balances were as
Raw Materials...................P200,000
Work in Process................ 150,000
Finished Goods................. 300,000
The company applies OH cost to jobs on the basis of
machine-hrs worked. For the current year, the
company estimated that it would work 750,000
machine-hours and incur P4,500,000 in
manufacturing OH cost. The following transactions
were recorded for the year:
a. Raw materials were purchased on account, P4,100,000
b. Raw materials were requisitioned for use in production, P3,800,000 (P3,600,000
direct materials and P200,000 indirect materials)
c. The following costs were incurred for employee services: direct labor, P750,000;
indirect labor, P1,100,000; sales commissions, P900,000; and administrative
salaries, P2,000,000
d. Sales travel costs were P170,000
e. Utility costs in the factory were P430,000
f. Advertising costs were P1,800,000
g. Depreciation was recorded for the year, P3,500,000 (80% relates to factory
operations, and 20% relates to selling and administrative activities)
h. Insurance expired during the year, P100,000 (70% relates to factory operations,
30% relates to selling and administrative activities)
i. Manufacturing OH was applied to production. Due to greater than expected
demand for its products, the company worked 800,000 machine-hours during the
j. Goods costing P9,000,000 to manufacture according to their job cost sheets were
completed during the year
k. Goods were sold on account to customers during the year at a total selling price of
P15,000,000. The goods cost P8,700,000 to manufacture according to their job
cost sheets.
1. Prepare journal entries to record the
preceding transactions.
2.Post the entries above to T-accounts
3.Is manufacturing OH under applied or over
applied for the year? Prepare a journal entry
to close any balance in the MOH account to
4.Prepare an income statement for the year.
Process Costing System
• Costs are accumulated for each department for a
time period and allocate them among all the
products manufactured during the period
(usually a month)
Differences Between Job-Order
Costing and Process Costing
Job-Order Costing Process Costing
Cost unit Job, order, or contract Physical unit
Costs are accumulated By jobs By department
Subsidiary record Job Cost Sheet Cost of Production
Report/ Cost Summary
Used by Custom manufacturers Processing Industries
Permits computation of a) A unit cost for A unit cost to be used to
inventory costing compute the costs of
purposes goods completed and
b) A profit or loss on WiP
each job
Steps in Process Costing Calculations
1. Summarize the flow of physical units.
2. Compute output in terms of equivalent units (EU-
measure of how many whole units of production
are represented by the units completed plus the
units partially completed)
3. Summarize the total costs to be accounted for by
cost categories.
4. Compute the unit cost per equivalent unit.
5. Apply total costs to units completed and
transferred out and to units in ending WiP (either
by Moving Average or FIFO).
Illustrative Problem
Wallguard Home Paint Co. produces exterior latex
paint, which it sells in one-gallon containers. The
company has two processing departments-
Processing and Finishing. White paint, which is
used as a base for all the company’s paints, is mixed
from raw ingredients in the Processing Department.
Pigments are then added to the basic white paint,
the pigmented paint is squirted under pressure into
one-gallon containers, and the containers are
labelled and packed for shipping in the Finishing
Department. Information relating to the company’s
operations for April follows:
a. Raw materials were issued for use in production: Processing Dept,
P85,100; and Finishing Dept, P62,900
b. Direct labor costs were incurred: Processing Dept, P33,000; and
Finishing Dept, P27,000
c. Manufacturing OH cost was applied: Processing Dept, P66,500; and
Finishing Dept, P40,500
d. Basic white paint was transferred from the Processing Dept to the
Finishing Dept, P185,000
e. Paint that had been prepared for shipping was transferred from the
Finishing Dept to Finished Goods, P320,000

1. Prepare journal entries
2. Post the journal entries from above to T-accounts. The balance in the
Processing Dept’s WiP account on April 1 was P15,000; the balance in the
Finishing Dept’s WiP account was P7,000
3. Prepare a production report for the Processing Department for April. The
following additional information is available regarding production in the
Processing Department during April:
Production Data

Units (gal) in process, April 1: materials 100% 3,000

complete, conversion 60% complete
Units (gal) started into production during 42,000
Units (gal) completed and transferred to the 37,000
Finishing Department
Units (gal) in process, April 30: materials 50% 8,000
complete, conversion 25% complete

Cost Data
Work in Process Inventory, April 1:

Materials P 9,200
Cost Added During April Labor 2,100
Materials P85,100 Overhead 3,700
Labor 33,000 Total P15,000
Overhead 66,500
total P184,600
Illustrative Problem
Camia Co. manufactures a product that goes
through three departments, A, B, and C.
Information relating to activity in department A
during October is given below:
Percent Completed
Units Materials Conversion
WiP, Oct 1 50,000 90 60
Started into Production 390,000
Completed and transferred to Dept B 410,000
WiP, Oct 31 30,000 70 50

Compute the equivalent units for October using Average Method and FIFO.
Cost-Volume-Profit Analysis
Answers the questions:

• What sales volume is required to break even?

• What sales volume is necessary in order to earn
a desired profit?
• What profit can be expected on a given sales
• How would changes in selling price, variable
costs, fixed costs, and output affect profits?
• How would a change in the mix of products sold
affect the break-even and target income volume
and profit potential?
• Helps understand the interrelationship between
cost, volume, and profit in an organization by
focusing on interactions between: prices of
products, level of activity within relevant range,
variable costs per unit, total fixed costs, and mix
of product sold
Assumptions and Limitations:
• Valid for a limited range of values and a limited
period of time
• Revenues change proportionately with volumes
assuming selling price remains constant
• There is a constant product mix
• Changes in volume alone are responsible for
changes in costs and revenues
• Inventories do not change significantly from
period to period
Applications of CVP Analysis

• For Breakeven Planning

• For Revenue and Cost Planning

Concepts to Remember:
• Contribution Margin (CM) – excess of sales over
the variable costs of the product; amount of
money available to cover fixed costs
CM = S – VC
• Unit CM – excess of unit selling price over unit
variable cost
unit CM = p – v
• CM Ratio – contribution margin as percentage
of sales
CM Ratio = CM/S = (S-VC)/S = 1- (VC/S)
= unit CM/p = (p-v)/p = 1- (v/p)
Per Unit Total Percentage
Sales (1,500 units) Php 30 Php 45,000 100%
Less: Variable Costs 10 15,000 33.33%
Contribution Margin Php 20 Php 30,000 66.67%
Less: Fixed Costs 18,000
Net Income Php 12,000

CM, unit CM, CM Ratio

Breakeven Analysis
• Breakeven Point – level of sales volume where
total revenues and total expenses are equal

• The equation and contribution margin approach:

S = VC + FC
1. Breakeven (units) = Total FC/CM per unit
2. Breakeven (pesos) = Breakeven in units x
Unit sales price
= Total FC/CM Ratio
3. Breakeven sales for multi-product firm
(combined units) = FC/Weighted CM per unit

Weighted CM per unit =

Σ(Unit CM x # of units per mix)
Total Number of Units per Sales Mix

4. Breakeven sales for multi-product firm

(combined pesos) = FC/Weighted CM ratio

Weighted CM Ratio = Σ (unit Sales mix ratio x

unit CM ratio)
• The graphical approach:
Profit-volume Chart
Compute for Breakeven Point:

Per Unit Total Percentage

Sales (1,500 units) Php 30 Php 45,000 100%
Less: Variable Costs 10 15,000 33.33%
Contribution Margin Php 20 Php 30,000 66.67%
Less: Fixed Costs 18,000
Net Income Php 12,000
Compute for Breakeven Point (Multi Products):
Combined BE (units), Combined BE (pesos), BE
(pesos) for each

Unit selling price P 10 P5
Unit variable cost 6 3
Total Fixed Cost P 420,000
Target Income Volume
Sales (units) = (Total FC + Desired Profit)
CM per unit

Sales (pesos) = (Total FC + Desired Profit)

CM Ratio

Sales (units) = FC + [Target after-tax profit/(1-tax rate)]

CM per unit
The Don Company sold 100,000 units of its product
at P20 per unit. Variable costs are P14 per unit
(manufacturing costs of P11 and marketing costs of
P3). Fixed costs are incurred uniformly throughout
the year and amount to P792,000 (manufacturing
costs of P500,000 and marketing costs of
a. Compute for Breakeven point in units and in pesos
b. Number of units that must be sold to earn an
income of P60,000 before tax
c. Number of units that must be sold to earn an
after-tax income of P90,000 (tax rate 40%)
• Margin of Safety
▫ Excess of actual or budgeted sales over breakeven
▫ Indicates the amount by which sales could decrease
before losses are incurred
▫ Used as a measure of risk

Margin of Safety = Budgeted Sales – Breakeven Sales

Margin of Safety Ratio = Margin of Safety

Actual or Planned Sales
Amflor Manufacturing Company’s budget for the
coming year revealed the following unit data:
Budgeted net income for the year P875,000
Unit Costs: Variable Fixed
Manufacturing cost P14 P12
Selling cost 2.50 5.50
General cost .25 7
Unit selling price P 50

Budgeted sales volume in units
Margin of safety in pesos and percentage
• Operating Leverage
▫ the ratio of the contribution margin to profit
▫ Measures the potential effect of the risk that sales
will fall short of planned levels as influenced by
the relative proportion of fixed to variable
manufacturing costs

Operating leverage = CM/ Profit or Net Income

These sales and cost data (000’s) are for two
companies in the transportation industry:
Company A Company B
Amount % of Sales Amount % of Sales
Sales P 100,000 100% P 100,000 100%
Variable Cost 60,000 60 30,000 30
CM 40,000 40% 70,000 70%
Fixed Cost 30,000 60,000
Net Income 10,000 10,000

1. Operating leverage for each company. If sales increase, which
company benefits more?
2. Assume sales rise 10% in the next year. Calculate the percentage
increase in profit for each company.
Responsibility Accounting
Responsibility Accounting
• is the system for collecting and reporting
revenue and cost information by areas of
• also called profitability accounting and activity
• Objective: Managers will be compelled to set
managerial targets and formulate strategies to
attain the firm’s overall objectives. Control
mechanism will be provided which will serve as
the basis in evaluating actual results or
1. It facilitates delegation of decision making.
2. It helps management promote the concept of
management by objective wherein managers agree on
a set of goals and their performance is then evaluated
based on his or her attainment of these goals.
3. It provides a guide to the evaluation of performance
and helps to establish standards of performance which
are then used for comparison purposes.
4. It permits effective use of the concept of management
by exception, which means that the manager’s
attention is concentrated on the important deviations
from standards and budgets.
Basic Conditions for an Effective
Responsibility Accounting System
1. The organization structure must be well defined.
2. Standards of performance in revenues, costs, and
investments must be properly determined and well
3. The responsibility accounting reports (or
performance reports) should include only the
items that are controllable by the manager of the
responsibility center. Also, they should highlight
items that call for managerial attention.
responsibility center is defined as a unit in the
organization which has control over costs,
revenues, and/or investment funds

• Cost center - is the unit within the organization

which is responsible only for costs
ex: maintenance department of a
manufacturing company; library section of a
▫ Performance measure: performance reports or
variance analysis reports based on standard costs
and flexible budget
• Profit center - is the unit which is held
responsible for the revenues earned and costs
incurred in that center
ex: ladies wear section of a department
store; sales office of a publishing company
▫ Performance measure: income statement using
contribution approach
• Investment center - is the unit within the
organization which is held responsible for the
costs, revenues, and related investments made in
that center
ex: corporate headquarters or division
of a large decentralized organization
▫ Performance measure: ROI, Residual Income
▫ ROI = Net Operating Income
Average Operating Assets

=Margin x Capital Turnover

=(Operating Income) x ( Sales )
Sales Operating Assets

▫ Residual Income = Operating Income –

(MARR x Average Operating Assets)
▫ Economic Value Added (EVA) = Operating Income – (Cost
of Capital x Ave Operating Assets)
 Cost of Capital = Weighted Ave of Firm’s Sources of Funds (rate
of return required)

▫ Objectives of an investment center:

 Motivate managers to exert high level of effort to achieve the
goals of the firm
 Provide the right incentive for managers to make decisions that
are consistent with the goals of top management
 Determine fairly the rewards earned by the managers for their
effort and skill
• Revenue center – is a unit or segment within an
organization where the manager is responsible
for selling budgeted quantities of various
products or services at budgeted price
ex: sales representative selling bread to
supermarkets; sales manager distributing
automobile to dealers in specific areas
▫ Performance measure: variance analysis (use for
controlling operations)
▫ Sales Price Variance
= (Actual Sales Price – Standard Price) x Actual Sales
▫ Sales Volume Variance
= (Actual Sales Qty – Standard Sales Qty) x Standard
Ave. CM per Unit
*Standard Ave CM per Unit = Total Standard CM/
Standard Sales Qty
▫ Sales Mix Variance
= (Flexible Standard Ave CM per Unit – Standard Ave
CM per Unit) x Actual Qty Sales
Transfer Pricing
• Goal congruence. Will the transfer price
promote the goals of the company as a whole?
• Performance evaluation. Will the transfer price
hurt the performance of the selling division?
• Autonomy. Will the transfer price preserve
autonomy, the freedom of the selling and buying
division managers to operate their divisions as
decentralized entities?
Transfer prices can be based on:
• Market Price
• Cost-based Price (Variable or Full Cost)
• Negotiated Price
Market Price
• Best transfer price if the following conditions are
▫ There exists a competitive market price
▫ Divisions are independent of each other
Cost-based Price (Variable or Full Cost)
• Easy to understand and convenient to use
• Disadvantages:
▫ Treats divisions as cost centers rather than profit
or investment centers
▫ Inefficiencies of the selling divisions are passed
on to the buying divisions with little incentive to
control costs
Negotiated Price
• This method is widely used when no
intermediate market price exists for the product
transferred and the selling division is assured of
a normal profit
General Formula
• It is generally agreed that some form of
competitive market price is the best approach to
the transfer pricing problem. The following
formula may be helpful in this effort:

Transfer Price = Variable costs per unit +

Opportunity costs per unit for the company as a
Company X has just purchased a small company that specializes in
the manufacture of part no. 323. Company X is a decentralized
organization, and will treat the newly acquired company as an
autonomous division called Division B, with full profit
responsibility. Division B’s fixed costs total $30,000per month,
and variable costs per unit are $18. Division B’s operating capacity
is 5,000 units. The selling price per unit is $30. Division A of
Company X is currently purchasing 2,500 units of part no. 323 per
month from an outside supplier as $29 per unit, which represents
the normal $30 price less a quantity discount. Top management of
the company wishes to decide what transfer price should be used.
Top management may consider the following alternative prices:
(a) $30 market price
(b) $29, the price that Division A is currently paying to the outside
(c) $23.50 negotiated price, which is $18 variable cost plus half of
the benefits of an internal transfer [($29 -$18)X 1/2]
(d) $24 full cost, which is $18 variable cost plus $6 ($30,000/
5,000 units) fixed cost per unit
(e) $18 variable cost
Division A normally purchases its parts from Division B of the same
company. Division A has learned that Division B is increasing its
price to $110 per unit. As a result, the Division A manager has
decided to purchase the parts from an outside supplier at a unit cost
of $100, $10 less than it would cost to purchase the same part from
Division B. The Division B manager has explained that inflation is
the cause of the price increase and that the loss of parts normally
transferred to Division A will hurt the division as well as the
company profits. The Division B manager feels that the company as
a whole would benefit from the sale of parts to Division A. The
following costs and unit purchases represent the normal annual
Units purchased 1,000
Division B’s variable costs per unit $95
Division B’s fixed cost per unit $10
1. Will the company as a whole benefit if Division A purchases the
units from the outside supplier for $100 per unit? Assume that
there are no alternative uses for Division B’s facilities.
2. What would be the effect if the outside selling price decreases by
$8.00 per unit, assuming that Division B remains idle?
3. If Division B’s facilities could be put into production for other
sales at an annual cost saving of $14,500, should Division A still
purchase from the outside?
Budgeting Terminologies

• Budget – a financial plan of the resources

needed to carry out tasks and meet financial
goals. It is also a quantitative expression of the
goals the organization wishes to achieve and the
cost of attaining these goals
• Master budget – summary of all phases of a
company’s plans and goals for the future
• Budgeted Income • Program Budget
Statement • Operating Budget
• Cash Budget • Responsibility Budget
• Financial Budget • Rolling Budget
• Fixed Budget • Sales Budget
• Flexible (Variable) • Traditional Budgeting
Budget • Zero-based Budgeting
• Participative Budget
• Physical Budget
• Planning Budget
(Static Budget)
• Production Budget
Purposes of Budget
• Planning Function
• Coordination and Allocating Resources Function
for Goal Congruence
• Communication Function
• Motivation Function
• Control Function
• Standards in Evaluating Performance
Types of Budget
• Operating Budget
▫ Budgeted Income Statement (traditional or
contribution format)
▫ Sales Budget (including expected cash receipts)
▫ Production Budget
▫ Direct Material Budget (including expected cash
▫ Direct Labor Budget
▫ Factory Overhead Budget
▫ Inventory Budget
▫ Selling and Administrative Expenses Budget
• Financial Budget
▫ Cash Budget
▫ Budgeted Balance Sheet
• Capital Budget
Steps in Preparing the Master Budget
• Prepare a Sales Forecast
• Determine Production Volume
• Estimate Manufacturing Costs and Operating
• Determine Cash Flow and Other Financial
• Formulate Projected Financial Statements
Flexible Budgeting
• Alternative to the fixed budget
• Adjusts revenues, costs and expenses to the
actual volume experienced and compares these
to actual results
RON Company
Fixed Budget
For the month ending January 31
Budget production (units) 10,000
Budgeted Variable OH Costs:
Indirect Materials Php 4,000
Lubricants 1,000
Power 3,000
Total 8,000

Assume actual production of 9,400 units during the month

Capital Budgeting
• Long range budgets
• Incorporates plans for major expenditures for
plant and equipment or the addition of product
• Replacement decisions in terms of replacing
existing facilities with new facilities
• Some techniques used: RoR, Payback Period,
NPV, Profitability Index
Standard Costs and
Operating Performance
• Standard Costs
▫ Represents what costs should be under attainable,
acceptable performance (not what the cost would
be if perfection in performance had actually been
▫ Based on physical (Quantity Standards) and
dollar/peso measures (Cost Standards)
• Provides measurement which calls attention to
cost variations, thus, guides management
towards improvement
• For budgeting purposes
• Coordination is encouraged in the process of
setting standards
• Can save data-processing costs
• Difficulty in determining which variances are
• Trends and other useful information may be
• Management by exception may encourage
subordinates to cover up unfavorable results and
may affect supervisory employees in a negative
Setting Standands
• Considerations
▫ Normal machine breakdown
▫ Normal material loss
▫ Expected lost time
▫ Reasonable and efficient employee rest periods

Above considerations set on a less demanding level

(light but attainable)
Variance Analysis
Materials Variances
• Materials Purchase Price Variance

• Materials Quantity (Usage) Variance

Labor Variances
• Labor Rate Variance

• Labor Efficiency Variance

Variable Overhead Variances
• Variable Overhead Spending Variance

• Variable Overhead Efficiency Variance

Methods of Variance Analysis for
Factory Overhead
• Two-way Method
▫ Budget variance = Variable spending variance +
Fixed spending (budget) variance + Variable
efficiency variance
▫ Volume variance = Fixed volume variance
• Three-way Method
▫ Spending variance = Variable spending variance +
Fixed spending (budget) variance
▫ Efficiency variance = Variable efficiency variance
▫ Volume variance = Fixed volume variance
• Four-way Method
▫ Variable spending variance
▫ Fixed spending (budget) variance
▫ Variable efficiency variance
▫ Fixed volume variance
• The following events took place at Certified
Containers Inc during the month of December:
1. Produced and sold 50,000 plastic water
containers at a sales price of P10 each. (Budget
were 45,000 units at P10.15)
2. Standard Variable Cost per Unit:
Direct Materials: 2lbs at P1 P2.00
Direct Labor: 0.10hrs at P15 1.50
Variable Mfg OH: 0.10hrs at P5 0.50
P4.00 each
3. Fixed Mfg OH cost: Budget of P80,000/month
4. Actual Production Costs
DM purchased: 200,000lbs at P1.20 P240,000
DM used: 110,000lbs at P1.20 132,000
DL: 6,000hrs at P14 84,000
Variable OH 28,000
Fixed OH 83,000

1. Compute the direct materials, labor and
variable mfg overhead price and efficiency
2. Compute the fixed mfg overhead price variance
Relevant Costs for
Decision Making
Types of Decisions
• Make or Buy
• Add or Drop a Product or Other Segments
• Sell Now or Process Further
• Special Sales Pricing
• Utilization of Scarce Resources
• Shut-down or Continue Operations
• Pricing
Relevant Costs
• Any cost that is avoidable (cost that can be
eliminated, in whole or in part) as a result of
choosing one alternative over another
• Expected future costs
• Incremental or differential costs
• All costs are considered relevant, except:
▫ Sunk costs
▫ Future costs that do not differ between alternatives
Approaches in Analyzing Alternatives
• Incremental or Differential Analysis Approach
▫ Compares differential revenues, costs and
contribution margins
▫ Shows only relevant amounts
▫ Steps:
 Gather all costs associated with each alternative.
 Drop the sunk costs and non-differential costs.
 Select the best alternative based on the remaining
cost data.
• Total Project Analysis Approach
▫ Aka Comparative Statement Approach
▫ Shows all items of revenue and cost data and
compares net income result
▫ Prepared in Contribution Format
• Opportunity Cost Approach
▫ Opportunity cost – net revenue lost by rejecting
some alternative course of action
▫ More effective when there are excessive
alternatives available
A company owns a milling machine that was purchased three
years ago for $25,000. Its present book value is $17,500. The
company is contemplating replacing this machine with a new
one which will cost $50,000 and have a five-year useful life.
The new machine will generate the same amount of revenue
as the old one but will cut down substantially on variable
operating costs. Annual sales and operating costs of the
present machine and the proposed replacement are based on
normal sales volume of 20,000 units and are estimated as
Present Machine New Machine
Sales $60,000 $60,000
Variable Cost 35,000 20,000
Fixed Cost:
Depreciation 2,500 10,000
Taxes, Ins, Etc 4,000 4,000
Net Income $18,500 $26,000
Make or Buy
• Point of indifference cost volume
▫ Total cost to make = total cost to buy
Adding or Dropping Products/Segments
Sell Now or Process Further
• Joint product cost
▫ All manufacturing costs incurred prior to the point
where the joint products are identified as
individual products
• Split-off Point
▫ Point in the manufacturing process at which joint
product can be recognized as separate products
Special Sales Pricing
• Considered if:
▫ Operating in a distress situation
▫ There is idle capacity
▫ When faced with sharp competition or in a
competitive bidding situation
Utilization of Scarce Resources
• Constraint – when capacity becomes pressed
because of scarce resource
• Fixed costs are usually not affected, therefore
apply contribution margin per unit of scarce
resource used
Shut Down or Continue Operations
• Cost-Plus Pricing
▫ Price of product or service should cover all costs
▫ Target Selling Price = [ Cost + (Markup % x Cost) ]
▫ Either by Absorption Approach or Contribution
• Target Costing
▫ Target Cost = Anticipated Selling Price – Desired Profit