PART THREE

Managerial Accounting

Reading
1 . J e r r y J . We y ga n d t , e t a l . ( 2 0 1 0 ) , M a n a g e r i a l A c c o u n t i n g : To o l s f o r b u s i n e s s d e c i s i o n m a k i n g
(Chapter 1-6 and Chapter 9
Cost & Management accounting
 Cost accounting provides the detailed cost information that management
needs to control current operations and plan for the future.
 Cost accounting information is commonly used in financial
accounting information, and by managers to make decisions.
 Management accounting is a field of accounting that provides economic and
financial information for managers and other internal users.
the development and interpretation of accounting information intended
specifically to assist managing in operating the business
Cost concepts and Cost Behavior
Introduction:
 Resources are needed to manufacture products.
 Resources need to be properly managed to enhance profitability of the products or
services considered.
 How much of the resources consumed for each product need to be known.
 That is we need to know:
1. What are the type of resources needed for the product
2. For what purpose resources are used
3. What is the condition of their traceability
Cost Concepts

 Cost: is a resource sacrificed or forgone to achieve a specific objective. A cost is

usually measured as the monetary amount that must be paid to acquire goods and
services.

 A Cost object: is anything for which a separate measurement of costs is desired.

Example; product, department, customer, geographical area, process etc.

 Cost pool: A cost pool is a grouping of individual cost items possessing identical
nature. Cost pools can range from broad, such as all costs within a manufacturing
plant, to narrow, such as the costs of operating machine.
Cost Concepts

Cost accumulation: is the collection of costs in some organized way by

means of an accounting system, i.e., by some natural or self descriptive
classification.
Eg. material cost, labor cost, fuel, Advertisement cost etc.
Cost assignment: is a general term that includes:
a. Tracing accumulated costs: For direct costs
b. Allocating accumulated costs: For indirect costs
Cost driver is a variable, such as an activity level or volume, the change of
which causally affect costs over a given time span. That is, there is a
specific cause-and-effect relationship between change in level of activity or
volume and change in level of cost.
Classification of costs:

 Different cost classifications are used to develop cost information for a given
purpose.
 Managers use this information to support product and service decisions, enables
cost control, provide historical data for cost management.
 Thus, different classification of costs provide different information that helps for
decision making.
1. By natural element: Direct material, Direct labor & MOH
Classification of costs:

2. By function/operation/purposes:
production(manufacturing); direct materials, direct labor and manufacturing
overhead), and Non manufacturing costs( selling, distribution, administration,
R&D)
3. Based on their traceability to a particular cost object:
Direct: costs that have a relationship with the cost object and can be traced to
that cost object in an economically feasible (cost effective) way. And
Indirect: costs that have a relationship with the cost object but cannot be traced
to that cost object in an economically feasible way.
Classification of costs:

4. Based on their behavior pattern :

Fixed: costs that remain constant regardless of the level of activity up to a certain
relevant range but unit costs vary according to the level of activity.
Variable: costs that changes in direct proportion to changes in the level of activity
but unit costs remain constant.
Semi-variable or semi-fixed (Mixed)
 Classification of costs:

5. By control ability:
Controllable : costs that can be influenced by management action
Uncontrollable: cost beyond the control of management.
6. By normality:
Normal: costs incurred in the normal course of activity for producing normal level
of out put under normal circumstances.
Abnormal: costs incurred on account of abnormal conditions or abnormal activity.
 Classification of costs:

7. Based on timing they are charged against revenue

Product costs: are costs that are necessary and integral part of producing
(acquiring) the finished product. They are considered as an asset/inventory
when they are incurred. Under the matching principle, these costs do not
become expenses until the finished goods inventory is sold.
Example: Cost of direct material
Period Costs: are costs of income statement other than cost of goods sold. They
are treated as expense of the period in which they are incurred because they are
expected to benefit revenue in the current period.
Example: Advertising costs
Accounting for Manufacturing Operations

Steps in the Manufacturing Process:

Buy raw Convert raw materials Sell finished

materials. into finished goods. goods.

Direct Direct labor and

Cost of goods
materials manufacturing
sold.
costs. overhead costs.
Direct Materials
Raw materials &
component parts Can be traced
that become an directly and
integral part of conveniently to
finished products. products.

If materials cannot be traced directly to products, the materials are

considered indirect and are part of manufacturing overhead.
Direct Labor
Includes the payroll cost of direct workers.

Those employees who

Direct labor Wage work directly on the
× goods being
hours rate
manufactured.

The cost of employees who do not work directly on the goods is

considered indirect labor and is part of manufacturing overhead.
Product Cost

The cost to produce a unit of

product includes:
Direct material
Direct labor
Manufacturing overhead
Product Cost: Manufacturing Overhead

The cost to
produce a unit of
product includes: Manufacturing overhead
Direct material must be mathematically
allocated to each unit of
Direct labor product using a
predetermined overhead
Manufacturing application rate.
overhead
Product Costs Versus Period Costs
Balance Sheet
Product Costs
(manufacturing Current assets and
costs)
as inventory
incurred
When goods are
sold.
Income Statement

Period Costs Revenue

(operating expenses COGS
and income taxes.) Gross profit
Expenses
as Net income.
incurred
Inventories of a Manufacturing Business

Raw materials - inventory on Work in process -

hand and available for use. partially completed
goods.

Finished goods- completed goods

awaiting sale.
Costing systems: Overview

1. Job order costing

2. Process costing
Contemporary Developments
Just-In-Time Processing
A processing system that is dedicated to having the right products or parts as they are
needed.

 Objective: To eliminate all manufacturing inventories to make funds and space

available for more productive purposes.

 Elements of JIT: Dependable suppliers; Multi-skilled workforce; Total quality

control system.

 Benefits of JIT: Reduced inventory; Enhanced product quality; Reduced rework

and storage costs; Savings from improved flow of goods.
Contemporary Developments
Activity-Based Costing
An overhead cost allocation system that focuses on activities performed in
producing a product.

 ABC System: More than one basis of allocating activity costs to products is
needed.

 Assumptions of ABC: All overhead costs related to the activity

► must be driven by the cost driver used to assign costs to products.
► should respond proportionally to changes in the activity level of the cost
driver.
Cost-Volume-Profit Analysis
Cost-volume-profit (CVP) analysis is the study of the effects of changes in
costs and volume on a company’s profits.

 Important in profit planning.

 Critical factor in management decisions as

► Setting selling prices,

► Determining product mix, and

► Maximizing use of production facilities.

Basic Components
 Basic Components - Assumptions
 Behavior of both costs and revenues is linear throughout the relevant
range of the activity index.

 Costs can be classified accurately as either variable or fixed.

 Changes in activity are the only factors that affect costs.

 All units produced are sold.

 When more than one type of product is sold, the sales mix will remain
constant.
 CVP Income Statement

 A statement for internal use.

 Classifies costs and expenses as fixed or variable.

 Reports contribution margin in the body of the statement.

► Contribution margin – amount of revenue remaining after deducting variable costs.

 Reports the same net income as a traditional income

statement.
 CVP Income Statement

Illustration: Vargo Video Company produces a high-definition digital

camcorder with 15x optical zoom and a wide-screen, high-resolution
LCD monitor. Relevant data for the camcorders sold by this company
in June 2014 are as follows.
 CVP Income Statement

Illustration: The CVP income statement for Vargo Video

therefore would be reported as follows.
 Contribution Margin per Unit
 Contribution margin is available to cover fixed costs and to
contribute to income.

 Formula for contribution margin per unit and the computation for
Vargo Video are:
 Contribution Margin per Unit
Vargo’s CVP income statement assuming a zero net income.
 Contribution Margin per Unit
Assume that Vargo sold one more camcorder, for a total of 1,001 camcorders sold.
 Contribution Margin Ratio
 Shows the percentage of each sales dollar available to apply toward
fixed costs and profits.
 Formula for contribution margin ratio and the computation for
Vargo Video are:
Contribution Margin Ratio
 Contribution Margin Ratio
Assume Vargo Video’s current sales are $500,000 and it wants to know
the effect of a $100,000 (200-unit) increase in sales.
Break-Even Analysis
 Process of finding the break-even point level of activity at which
total revenues equal total costs (both fixed and variable).
 Can be computed or derived
► From a mathematical equation,

► By using contribution margin, or

► From a cost-volume profit (CVP) graph.

 Expressed either in sales units or in sales dollars.

 Mathematical Equation
Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net
income is zero

Computation of
break-even
point in units.
 Contribution Margin Technique

 At the break-even point, contribution margin must

equal total fixed costs

(CM = total revenues – variable costs)

 Break-even point can be computed using either

contribution margin per unit or contribution margin
ratio.
 Contribution Margin in Units

 When the break-even-point in units is desired, contribution

margin per unit is used in the following formula which shows
the computation for Vargo Video:
 Contribution Margin Ratio
 When the break-even-point in dollars is desired, contribution
margin ratio is used in the following formula which shows the
computation for Vargo Video:
 Graphic
Presentation

Because this graph also

shows costs, volume,
and profits, it is
referred to as a cost-
volume-profit (CVP)
graph.
 Target Net Income

 Level of sales necessary to achieve a specified income.

 Can be determined from each of the approaches used to

determine break-even sales/units:
► from a mathematical equation,

► by using contribution margin technique, or

► from a cost-volume profit (CVP) graph.

 Expressed either in sales units or in sales dollars.

Mathematical Equation
Formula for required sales to meet target net income.
Mathematical Equation
Using the formula for the break-even point, simply include the
desired net income as a factor.
Contribution Margin Technique

To determine the required sales in units for Vargo Video:

Contribution Margin Technique

To determine the required sales in dollars for Vargo Video:

 Margin of Safety
 Difference between actual or expected sales and sales at the break-even
point.

 Measures the “cushion” that a particular level of sales provides.

 May be expressed in dollars or as a ratio.

 Assuming actual/expected sales are $750,000:

Margin of Safety

 Computed by dividing the margin of safety in dollars by the actual (or expected)
sales.

 Assuming actual/expected sales are $750,000:

 The higher the dollars or percentage, the greater the margin of safety.
Decision Making

 Decision-making is a fundamental part of management.

 Managers are constantly faced with problems of deciding what
product to sell, what production method to use, whether to make
or buy component parts, what prices to charge, what channels of
distribution to use, whether to accept special orders at special
prices, and so forth.
 This section covers the role of management accounting information
in a variety of marketing and production decisions.
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End of Part Three