BASICS
OF MANAGERIAL ACCOUNTING
Purpose
of the course - familiarize you with:
1. Managerial
accounting concepts.
2. Managerial
accounting practices.
3. Use
of managerial accounting information for decision making.
4. Pitfalls.
Accounting is a branch of study
concerned with the generation ( identification & measurement ) and
provision (Communication) of information.
Managerial
accounting is in particular accounting for the internal management of organizations.
A.
Financial versus Managerial Accounting
Financial Accounting Management
Accounting
Approach !
unifying concept: assets=equities ! no underlying unity-- many approaches
Rules
! G.A.A.P. !
no general principles
!
mandatory ! mostly optional
Measurement ! almost exclusively $ ! many non-financial elements
!
emphasis on precision, objectivity !
subjective estimates
Past/Future ! based on past ! many future
estimates and forecasts
Aggregation ! overall summary of business ! very segmented
!
general purpose information !
specific purpose reports
Frequency ! less/mandatory frequency !
more frequent and optional
Similarity ! basic data source same
End result !
ends with financial statements !
integral part of other business aspects
B.
Cost Accounting Terminology
1.
Nature of Cost
Cost - A sacrifice of resources: Cost is a measurement in monetary
terms of the amount of resources used for some purpose.
Expense - The cost
charged against revenue in a particular accounting period.
2.
Purposes of Gathering Cost Information
Routine
decision making:
Managerial control
Accounting
Nonroutine
decision making
Cost
Accounting
Cost of Goods Sold
Financial Product
Accounting Costing
Inventory Valuation
B.
Three Aspects (Basic costs) of
Managerial Accounting:
1.
Decision Making (Differential Costs)
Interface with decision models from
operations research, economics and finance, competitive analysis of costs and
prices, cost of capital calculations and investment decisions.
Example : Dominos Pizza almost bankrupt 6' pizza making losses
2.
Product Costing (Full Costs)
Associating a $
value for the resources sacrificed in obtaining a product or service.
- used for financial
reporting - valuation of inventory, COGS.
- used for
internal decision making - product pricing, optimal product mix.
Example -poor costing led Rockwell
International Inc., to overcharge customers - high volume product - heavy duty
truck axles - attract competitors selling at lower prices hence trouble.
-automobile
industry controllable costs.
-steel industry
died because of high wages.
3.
Planning, Control & Performance Evaluation (Responsibility Costs)
- Quantification
of goals, strategies and forecasts in the
form of budgets - develop pro forma financial statements.
- Measure to
what extent managers and organizational subunits (responsibility centers) did achieve their
goals.
a) Informal control - social psychology.
b) Formal control - performance evaluation,
incentive provisions, compensation, promotions and dismissals.
Example: Reimbursement mechanisms for
hospitals,
NOTE:
DIFFERENT COSTS
FOR DIFFERENT PURPOSES IS A RECURRENT THEME IN MANAGERIAL ACCOUNTING
3.
What types of costs are incurred in a Manufacturing Firm?
O/I
│
Raw
┌──────┐
Materials--->│ R/M │
R/M
Purchased
│Invty │ Used
└──┬───┘
│
C/I
O/I O/I
│ │
Labor ┌─────┐ ┌─────┐ ┌─────┐
Purchases
──── Wages ──── │ WIP │──── │ F/G │─── │SOLD │
│Invty│ COGM
│Invty│COGS │ │
└──┬──┘ └──┬──┘ └─────┘
Equipment │ │
Purchases
Depreciation
C/I C/I
Other Other
Costs───────── Overhead
Consider the above diagram in terms of:
* the flow of physical
units (materials, labor, machine usage,
etc.)
* the flow of costs
NOTE that the accumulation of costs is associated with
the accumulation of physical units.
Hence: Is there a relationship between
flow/accumulation of costs and the flow/accumulation of physical units: it is
this relationship which we call cost classification.
To use cost information effectively, we
need to know how costs change or relate to the physical units or volume of activity.
Cost Objects are anything
for which a separate measurement of cost is desired.
Cost Accumulation and Cost
Assignment. Two stages in which an
accounting system accounts for costs are:
[1] cost accumulation and
[2] assignment to various cost
objects in order to provide manager needed information for decision making
purposes.
Cost Classification: Now consider some ways of classifying
costs:
A. Based on business function (R&D,
Design, Production, Marketing, Distribution, Customer service)
B. Based on financial statement
presentation (capitalized, noncapitalized, inventoriable,
non-inventoriable: product vs. period)
C. Based on assignment to cost object
(direct vs. indirect)
D. Based on behavior in relation to cost
driver (variable vs. fixed)
E. Based on aggregation (total vs. unit)
Product vs Period
During a given year all costs incurred by the firm can be classified
into:
* costs that can be matched with the process of production: these
are called product costs.
* costs that cannot be matched with
units as they are manufactured: these are called period costs. (They can only be matched with the given period.)
GAAP:
all costs of manufacturing are product costs; all selling and
administrative expenses are period costs;
Why is this difference important? . . . . . . . . .
Product cost is the sum of
the costs assigned to a product for a specific purpose. Exhibit 2-9 – Panel A & B (page 44) illustrates three different
purposes:
! Product pricing and product emphasis production costs
! Contracting with government agencies + design & R&D costs
! Financial statements +
mktg, distbn, & customer service costs
Manufacturing Costs: Three
manufacturing cost categories
1. Direct materials costs -
acquisition costs of all materials that eventually become part of the cost
object (usually final product) that can be traced in an economically feasible
way.
2. Direct manufacturing labor costs
- compensation of all manufacturing labor that is specifically identified with
the cost object that can be easily traced in an economically feasible way.
3. Indirect manufacturing costs -
all other manufacturing costs that cannot be individually traced to the
cost object (final product) in an economical way.
Other terms used for indirect
manufacturing costs include factory overhead, manufacturing overhead,
factory burden.
Three-part and Two-Part Cost
Classifications. Manufacturing-cost accounting systems
normally classify costs into either three or two categories.
! In a three-part system, costs are
classified as direct material, direct labor, and indirect manufacturing costs.
! In a two-part system, costs are
classified as direct materials costs and indirect manufacturing costs. (Refer
to Concepts in Action on page 41 regarding Harley-Davidson's decision to
move to a two-part system.)
C. Prime
costs include all direct manufacturing costs.
D. Conversion costs are all
manufacturing costs other than direct materials. They include direct labor and indirect
manufacturing costs.
Direct vs Indirect - Within the category of product costs we
classify costs into:
* costs for which there is a direct link to individual
units of product: these are called direct costs;
e.g. . . . . . . . . . . . . . . . . . . . . .
. .
* all other product costs: these are called indirect costs;
e.g. . . . . . . . . . . . . . . . . . . . . .
. .
A. Cost Tracing and Cost Allocation
1. Direct costs of a cost object
are related to and can be traced to a given cost object [product, department,
etc.] in an economically feasible way.
2. Indirect costs of a cost object
are related to but cannot be traced to a given cost object; therefore, indirect
costs are allocated to the cost object.
3. Factors affecting classification of a
cost as direct or indirect:
a. Materiality of the cost in question
b. Information-gathering technology
available
c. Design of operations
d. Contractual arrangements
Materials
can be direct or indirect.
Labor
can be direct or indirect.
Overhead
is always indirect.
Direct Costs - Costs
that can be directly related to a cost
object, e.g. a particular unit of output.
Indirect Costs - Costs
that cannot be directly related to a
cost object.
Direct
Materials
- materials used in production which
end up as part of the finished
product. For example, in the
manufacture of automobiles, steel is a
direct material.
Indirect
Materials
- materials used in production which do
not end up as part of the finished
product. For example, in the manufacture
of steel, the oil used to fire the furnaces is an indirect material.
Direct
Labor
- costs of the workers who work
directly on the production
process. An assembly line worker is
considered direct labor.
Indirect
Labor
- costs of workers who work in the
factory but not directly on the
production process. The factory foreman
is considered indirect labor.
Overhead - all costs that are not direct materials or
direct labor. Overhead includes indirect materials,
indirect labor, depreciation on the
factory building and equipment, insurance
and taxes on the factory, etc.
Product
Cost =
Direct material + Direct labor + Manufacturing Overhead
=Prime
Cost +
Manufacturing Overhead
=Direct
Material + Conversion Cost
Cost Drivers and Cost Management
Cost Drivers:
A. Due to increased competition,
organizations are attempting to continuously reduce costs by:
1. Performing only value added
activities - those that customers perceive as adding value, and
2. Efficiently managing the use of cost
drivers in those value-added activities.
Cost Behavior Patterns: Variable Costs
and Fixed Costs
1. Variable cost is a cost that
changes in total in direct proportion to changes of a cost driver: i.e.
a cost is variable if in total it varies in proportion to changes in the
level of production.
2.
Fixed
costs, in total, do not change as the related cost driver
changes, i.e; a cost is fixed if
in total it remains fixed (for a given time period) regardless of changes in
the level of production (within a relevant range of production
3.
Semi-Variable/Semi-Fixed:
Assumptions: 1. costs
behavior is dependent on a specified cost object
2. the time span must be specified
3. total costs are linear
4. there is only one cost driver
5. variations of the level of the cost driver are within a
relevant range
4. A relevant range is the range of the cost driver in
which a specific relationship between cost and the driver is valid
5. Relationships of Types of Costs (Refer
to Exhibit 2-5.)
│
Cost of
Fertilizer │
│ (The cost of fertilizer per kiwifruit
is fixed.)
│
│
└───────────────────────────────
Volume of Kiwifruit
Production
│
Cost of Farm Rent │
│
│ | |
│ | |
└───────────────────────────────
Volume of
Kiwifruit Production
Relevant Range
(The cost of
rent per kiwifruit varies with the level of production: this is a
"spurious" (meaningless?) calculation
anyway. Why? - not controllable
on a per unit basis.)
An information
system which breaks down costs into VC and FC is costly. (Running regressions is more expensive than
not running regressions.) Why might this
classification be valuable? . . .
Total Costs
and Units Costs: Pitfalls of UNIT Costs:
A. Unit cost is computed by dividing some cost total by
some number of units. It is also called average
cost.
B. It is important to use caution when using unit costs. Whenever fixed costs are present, the unit
cost will change at different volume levels. See bottom of page 34 of the text
for an illustration of this point.
Financial
Statements and Cost Terminology
A. Capitalized costs are those that are presumed to have
future benefits and are first recorded as assets when incurred.
B. Noncapitalized costs are recorded as expenses of the
accounting period when they are incurred.
Service-sector
companies provide services or intangible products
to their customers - for example, an audit or legal advice.
A. These firms do not have inventories at the end of an
accounting period, and labor is the most significant cost category.
B. A service-sector income statement and the treatment of
capitalized and noncapitalized cost in a manufacturing sector company are
presented in panels A and B respectively of Exhibit 2-6 on pageXX of the
text.
Merchandising-
and Manufacturing-Sector Companies
Merchandising-sector
companies provide tangible products they have previously purchased in the same
basic form from suppliers. Examples
include retailers, distributors, and wholesalers.
Manufacturing-sector
companies provide tangible products that have been converted to a different
form from that of the products purchased from suppliers. These firms can have direct materials,
work in process, or finished goods inventories at the end of an
accounting period.
! Capitalized
inventoriable costs (also called inventoriable costs) are those either
associated with the purchase of goods for resale (merchandising) or with the
acquisition and conversion of materials and other manufacturing inputs into
goods for sale (manufacturing). These
costs become Cost of Goods Sold (COGS) when the inventory is sold.
! Capitalized
noninventoriable costs are those associated with any aspect of the business
other than inventory, example: depreciation.
Operating
costs include noncapitalized costs and
the periodic expensing of capitalized noninventoriable costs (e.g.
depreciation) and are consumed in the generation of revenue.
Income
Statements of Merchandising-Sector firm and Manufacturing-Sector firm are
presented in Exhibit , panel A
on page xx and Exhibit 2-x, panel A on page xx,
respectively. A separate Schedule of
Cost of Goods Manufactured must be prepared for the manufacturer (see panel
B of Exhibit 2-x).
Diagrams
illustrating the flow of capitalized inventoriable, capitalized
noninventoriable, and noncapitalized costs are presented in panel B of Exhibit
2-x for a merchandising-sector company and in Exhibit 2-x for a
manufacturing-sector company, respectively.
Summary
of Cost Classifications
PRODUCT
|
PERIOD
|
|||
Direct Materials
|
Direct Labor
|
Factory Overhead
|
||
F I X E D
|
||||
VARIABLE
|
Direct Costs Indirect
Costs
Fixed Indirect
Variable Direct
Benefits of
Defining Accounting Terms
A. It is important to clearly define what is meant by or is
includible in different cost accounting terms.
For instance, the example in the text indicates that the treatment of
fringe benefits for manufacturing employees as either direct labor or indirect
manufacturing costs may have important tax consequences.
B. Other items that present classification difficulties
include: compensation for training time, idle time, vacation pay, sick leave,
and extra compensation for overtime.
C. In order to prevent disputes, contracts and laws should be
as specific as possible regarding definitions and measurements of accounting
terms.
Summary Cost
Concepts & Definitions
CONCEPT DEFINITION
Cost A sacrifice of
resources
Expense The cost charged
against revenue in a particular accounting period. We
generally use the term expense only
when speaking of financial reports;
expired
cost.
Cost
Concepts for Cost Accounting Systems
Product costs Costs that firms can
more easily attribute to products; costs that are part of inventory.
Period costs Costs that firms
can more easily attribute to time intervals.
Prime cost The
component of product cost that constitutes direct labor & direct
materials.
Conversion
cost The component of product cost that constitutes
direct labor & overhead.
Absorption Cost A
method of inventory valuation in which cost firms use all manufacturing
costs - both fixed and variable - in computing a unit product cost.
(also called full cost)
Variable cost A method of
inventory valuation in which firms use
only variable manufacturing costs
in computing the unit product cost. (also called direct cost)
Cost object Any item for
which the manager wishes to measure cost (e.g., product department).
Direct costs Costs directly related to cost
object.
Indirect costs Costs not directly related to a
cost object.
Common costs Cost shared by more than one cost object.
CONCEPT DEFINITION
Cost
Concepts Used in Decision Making
Variable costs Cost
that vary with the volume of activity.
Fixed costs Costs
that do not vary with volume of activity
over a specified time span.
Differential
Costs Costs that change
in response to a particular course of action.
Sunk Costs Costs that
result from an expenditure made in the past and that cannot be changed by
present or future decisions.
Opportunity cost: The return that
one could realize from the best foregone alternative use of a resource.
Miscellaneous
Cost Concepts
Controllable
Costs Costs that can be
influenced or affected by a particular
individual.
Noncontrollable Costs Costs that cannot be influenced or
affected by a particular individual.
Average Costs A
division of the total costs for the period by some unit of operations such as
number of hours worked or number of units produced. The most frequently used
average cost is the average unit cost.
Question: How would you classify overtime premium cost?
NOTE:
It is
important to recognize that the above cost classifications are not mutually exclusive. Furthermore, often we
cannot uniquely determine the nature of a given cost item.
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