Lesson 14
Managerial Accounting:
Applications
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun yat-sen University
2
Outline
?Segmented Reporting and Responsibility
Accounting System
?Cost-Volume-Profit Analysis
?Budgeting and Budgetary Control
?Standard Costs and Variance Analysis
?Managerial Decision Making
3
Introduction
?Let’s look at the XYZ Company example.
?A manager at XYZ Company wants to replace an old
machine with a new,more efficient machine.
N e w m a c h i n e,
L i s t p r i c e 900000
A n n u a l v a r i a b l e e x p e n s e s 800000
E x p e c t e d l i f e i n y e a r s 5
O l d m a c h i n e,
O r i g i n a l c o s t 720000
R e m a i n i n g b o o k v a l u e 600000
D i s p o s a l v a l u e n o w 150000
A n n u a l v a r i a b l e e x p e n s e s 1000000
R e m a i n i n g l i f e i n y e a r s 5
4
Introduction
?XYZ’s sales are $2000000 per year.
?Fixed expenses,other than amortization,are
$700000 per year.
?Should the manager purchase the new machine?
5
Introduction
? The manager recommends that the
company not purchase the new machine
since disposal of the old machine would
result in a loss:
R e m a i ni ng book v a l ue 600000
D i s pos a l v a l ue - 1 5 0 0 0 0
Los s f r om di s pos a l 450000
6
Introduction
?Is it correct?
?What’s your comment to the
manager’s decision?
?After learning this chapter,
you will know how to employ
the tools of managerial
accounting and make decisions
correctly.
7
Segmented Reporting
?Organizations may break down their
operations into various segments
?divisions,stores,services,or departments.
?Management needs reports on each segment
for
?cost management
?performance evaluation
8
Segmented Reporting
?Segments may be evaluated as
?a cost centre
?a profit centre
→ Profit centre reports include information on a
segment’s revenues and costs.
?an investment centre.
?Some costs are direct and some are indirect.
?Indirect costs may be allocated to various
departments.
9
S e r v i c e D e p a r t m e n t C o m m o n A l l o c a t i o n B a s e s
G e n e r a l O f f i c e N u m b e r o f e m p l o y e e s
P e r s o n n e l N u m b e r o f e m p l o y e e s
P a y r o l l N u m b e r o f e m p l o y e e s
A d v e r t i s i n g S a l e s
P u r c h a s i n g N u m b e r o f P u r c h a s e O r d e r s
C l e a n i n g F l o o r s p a c e o c c u p i e d
Ma i n t e n a n c e F l o o r s p a c e o c c u p i e d
Segmented Reporting
? Service department costs are shared indirect
expenses of operation departments.
? They may be allocated using a variety of bases.
10
Responsibility Accounting System
? Responsibility Accounting System
?An accounting system
?assigns managers the responsibility for
costs and expenses under their control.
11
Responsibility Accounting System
?Responsibility accounting budgets
?are prepared prior to each accounting period
?Responsibility accounting performance
reports
?compare actual costs and expenses to budgeted
amounts
12
Cost-Volume-Profit Analysis (CVP)
?CVP analysis is used to answer:
?How much must I sell to earn my desired
income?
?How will income be affected if I reduce selling
prices to increase sales volume?
?How will income be affected if I change the
sales mix of my products?
?……?
13
Assumptions of CVP Analysis
?CVP analysis assumes relations can be
expressed as straight lines within the
relevant range,
?Unit selling price remains constant.
?Unit variable costs remain constant.
?Total fixed cost remain constant.
?If the expected cost and revenue behaviour is
different from the assumptions,then the results of
CVP analysis are of limited use.
14
Scatter Diagram
Vertical
distance
is the
change in
cost.
Horizontal distance is
the change in activity.
0 1 2 3 4
*
To
ta
l Co
st
in
1,0
00
’s
of
Do
lla
rs
10
20
0
*
** *
*
* **
*
Activity,1,000’s of Units Produced
Unit Variable Cost = Slope = Change in costChange in units
15
High-Low Method
0 1 2 3 4 5
*
To
ta
l Co
st
in
1,0
00
’s
of
Do
lla
rs
10
20
0
*
** *
*
* **
*
Activity,1,000’s of Units Sold
30 Vertical
distance
is the
change
in cost,
(30 - 20)
Horizontal distance is
the change in activity,
(5 - 1)
Unit Variable Cost = 30 - 205 - 1 = $2.50/unit
16
Least-Squares Regression
?Least-squares regression
?is usually covered in advanced cost accounting
courses,
?is commonly used with computer software
because of the large number of calculations
required.
?The objective of the cost analysis remains the
same,determination of total fixed cost and the
variable unit cost.
17
Break-Even Analysis
?The break-even point
is the unique sales
level at which a
company neither earns
a profit nor incurs a
loss,
Sales
Total costs
Volume in Units
Co
sts
an
d R
eve
nu
e
in
D
ol
lar
s
18
Break-Even Analysis
?The break-even point may be expressed in
units or in dollars of sales,
Break-even point in units = Contribution margin per unit
Unit sales price less unit variable cost
Fixed Costs
19
Break-Even Analysis
?The break-even formula may also be
expressed in sales dollars.
Unit sales price
Unit variable cost
Break-even point in dollars = Contribution margin ratioFixed Costs
20
Computing Income from
Expected Sales
?What is the income given a predicted level
of sales?
Pre-tax
Income = Sales – [Fixed costs + Variable costs]
Pre-tax
Income = Sales –Fixed costs - Variable costs
or
21
Contribution margin ratio
Contribution margin per unitUnit sales =
Fixed costs + Target income
Dollar sales = Fixed costs + Target income
Sales Volume Needed to
Earn a Target Income
?Break-even formulas can be adjusted to
show the sales volume needed to earn any
amount of income,
22
Margin of Safety
?Margin of safety
?How much sales can decrease before the
company incurs a loss?
Expected sales
Margin of
safety,
percent
Expected sales - Break-even sales
=
23
New contribution margin ratio
New break-
even point
in dollars
New fixed costs
Sensitivity Analysis
?The effects of changes in variables such as
sales price,variable costs,and fixed costs.
?CVP analysis can be used to show the effects
of such changes,
=
24
Budgets
?Budgets
?formal statements of a company’s plans
expressed in monetary terms
?attempt to capture the future activities of an
organization
?are used by businesses,not-for-profit,
government,educational,and other types of
organizations.
25
Advantages
Communicates plans
and instructions
Promotes analysis and
a focus on the future
Motivates employees
Provides a basis for
evaluating performance
Coordinates
business activities
Defines goals
and objectives
Importance of Budgeting
26
Budget Committee
?Budget Committee
?Consists of managers from all departments
of the organization
?Provides central guidance
→ to insure that individual budgets submitted from all
departments are realistic and coordinated.
27
Flow of budget data is a bottom-up process.
S u p e r v i so r S u p e r v i so r
M i d d l e
M a n a g e m e n t
S u p e r v i so r S u p e r v i so r
M i d d l e
M a n a g e m e n t
T o p M a n a g e m e n t
Budget Committee
28
2005 2006 2007 2008
Operating Budget
The annual operating budget
may be divided into quarterly
or monthly budgets.
Budget Cycle
?Budget horizons are usually for one year
?but may extend for several years.
29
Continuous or
Rolling Budget
The budget may be a twelve-month
budget that rolls forward one month
as the current month is completed.
2005 2006 2007 2008
Rolling Budgets
30
Master Budget
?Master Budget
?A formal,comprehensive plan
→ for the future of a company
?consists of several budgets linked together
→ to form a coordinated plan for the organization
31
Prepare
sales
budget
Develop
production
budget
Prepare
financial
budgets:
? cash
? income
? balance sheet
Prepare
capital
expenditure
budget
Prepare
selling and
general
administrative
budgets
Prepare
manufacturing
budgets:
? material
? labour
? overhead
Master Budget
32
Sales Budget
?Sales budget
?the starting point in the budgeting process.
?Most of the other budgets are linked to the sales
budget,
?Sales personnel are often involved in developing
the sales budgets.
33
Sales Budget
Sales Budget
Estimated Unit Sales
Estimated Unit Price
Analysis of economic and market conditions
+
Forecasts of customer needs from marketing personnel
34
Merchandise Purchases Budget
? Merchandise Purchases Budget
?Provides detailed information about the
purchases
?necessary to fulfill the sales budget and provide
adequate inventories.
Merchandise
inventory to
be purchased
Budgeted
ending
inventory
Budgeted
sales for the
period
Budgeted
beginning
inventory= +
_
35
Merchandise Purchases Budget
?The quantity purchased is affected by:
?Just-in-time inventory systems
→ enable purchases of smaller,frequently delivered
quantities,
?Safety stock inventory systems
→ provide protection against lost sales caused by
delays in supplier shipments.
36
Selling Expense Budget
?Selling Expense Budget
?lists the types and amounts of selling expenses
?Predictions of expenses are based on the sales
budget and past experience.
37
General and Administrative
Expense Budget
?General and Administrative Expense
Budget
?lists the predicted operating expenses not listed
in the sales budget
?Includes both cash and non-cash expenses
?Often prepared by the office
manager or person responsible
for general administration
38
Capital Expenditures Budget
?Capital Expenditures Budget
?lists the cash inflows or outflows
pertaining to the disposal or acquisition
of capital equipment.
?is usually affected by the organization’s
long-term plans.
39
Cash Budget
?Cash Budget
?lists the expected cash inflows and
outflows for the period
?a tool used by management to
avoid excess cash balances or
cash shortages
?Information from other budgets is used in its
preparation
?Information from the cash budget is used to
prepare the budgeted income statement and
balance sheet
40
?Manufacturing companies need to prepare
additional budgets that include:
?Production budgets
?Direct materials purchase budgets
?Direct labour budgets
?Manufacturing overhead budgets
Production and Manufacturing Budgets
41
Production and Manufacturing Budgets
?Production and Manufacturing Budgets
?Provides detailed information about the
production necessary to fulfill the sales budget
and provide adequate inventories.
Number of
units to be
produced
Budgeted
ending
inventory
Budgeted
sales for
the period
Budgeted
beginning
inventory
= + _
42
Production and Manufacturing Budgets
? Direct Materials Budget
?Provides detailed information about the purchases of
raw materials necessary to fulfill the production budget
and provide adequate inventories.
Units of raw
materials to
be purchased
Materials
needed for
production
Budgeted
ending
inventory
Budgeted
beginning
inventory
= + _
Cost of raw
materials to
be purchased
Units of raw
materials to
be purchased
Material price
per unit of
raw material
= ×
43
Production and Manufacturing Budgets
? Direct Labour and Manufacturing Overhead
Budgets
?Provides information about the labour and
manufacturing overhead costs given the level of
production for the period.
44
Cash
Budget
Expected
Receipts
and
Disbursements
Budgeted
Income
Statement
Budgeted
Balance
Sheet
Preparing Financial Budgets
45
?Take corrective and
strategic actions.
This is an ongoing
process.
?Develop the budget
from planned objectives.
?Compare
actual with
budget and
analyze any
differences.
?Revise
objectives
and prepare
a new
budget.
Budgetary Control
46
Capital Budgeting
?Capital Budgeting
?Analyzing alternative long-term investments
and deciding which assets to acquire or sell.
?These decisions require careful analysis since:
→ The outcome is uncertain.
→ Large amounts of money are usually
involved.
→ Investment involves a long-term
commitment.
→ Any decision may be difficult or
impossible to reverse.
47
Zero-based Budgeting
?Zero-based Budgeting
?are prepared assuming no previous
activities for the activities being
planned
?Managers must justify the amounts budgeted
for each activity
?is popular among government and non-profit
organizations.
48
Fixed Budget
?Fixed budgets
?are prepared for a single,predicted level of
activity
?Performance evaluation is difficult when actual
activity differs from the predicted level of
activity.
→ Example,How much of the unfavourable cost
variance is due to higher activity,and how much is
due to poor cost control?
→ To answer these questions,we must flex the budget
to the actual level of activity.
49
Flexible (Variable) Budgets
?Flexible budgets
?are prepared after a period’s activities are
complete,
?Show revenues and expenses that should have
occurred at the actual level of activity,
?Reveal cost variances due to good cost control or
lack of cost control,
?Improve performance evaluation.
50
?Flexible budgets
?To prepare a budget for different activity levels
→ we must know how costs behave with changes in activity levels
?Total variable costs change in
direct proportion to
changes in activity.
?Total fixed costs remain
unchanged within the
relevant range,Fixed
Flexible (Variable) Budgets
51
Standard Costs
?Standard Costs
?are preset costs for delivering a
product or service under normal
conditions.
?are established through personnel,
engineering,and accounting studies
using past experience.
?are benchmarks used in evaluating
performance.
?are often used in setting budgets.
52
?Example,A standard cost card
St a n d a r d St a n d a r d
Q u a n ti ty Pr i c e St a n d a r d
C o s t fa c to r o r H o u r s o r R a te C o s t
D i r e c t m a t e r i a l s 1 k g 25$ pe r k g 2 5, 0 0$
D i r e c t l a bo ur 2 ho ur s 20$ pe r ho ur 4 0, 0 0
V a r i a bl e m f g,ov e r he a d 2 ho ur s 10$ pe r ho ur 2 0, 0 0
To t a l s t a nd a r d un i t c os t 8 5, 0 0$
Standard Costs
53
Variance Analysis
Take action
Prepare standard
cost performance
reports
Analyze
variances
Investigate
causes
54
Variance Analysis
?Management By Exception
?Standard cost accounting provides management
with information about costs that differ from
budgeted amounts (variances),
?Management may choose to focus only on
variances that are significant,
?This approach is referred to as
Management by Exception.
55
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
Price Variance Quantity Variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
Variance Analysis
?Material Variances
56
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
Rate Variance Efficiency Variance
AH(AR - SR) SR(AH - SH)
AH = Actual Hours SR = Standard Rate
AR = Actual Rate SH = Standard Hours
Variance Analysis
?Labour Variances
57
Spending
Variance
Efficiency
Variance
AH × SVR AH × AVR
AH = Actual Hours of Activity
AVR = Actual Variable Overhead Rate
SVR = Standard Variable Overhead Rate
SH = Standard Hours Allowed
SH × SVR
Actual Flexible Budget Applied
Variable for Variable Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
Variance Analysis
?Variable Overhead Variances
58
Spending
Variance
Volume
Variance
SFR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
SH × SFR
Actual Fixed Fixed Fixed
Overhead Overhead Overhead
Incurred Budget Applied
Variance Analysis
?Fixed Overhead Variances
59
Standard Costs
?Standard cost accounting systems
?record variances in the accounts
?simplify recordkeeping and help in the
preparation of reports
60
?ABC Company has the following direct
material standard to manufacture one unit
product:
3.0 kilograms per unit at $8.00 per kilogram
?Last week 6600 kilograms of material were
purchased and used to make 2000 units,The
material cost a total of $53000,
Discussions
61
Discussions
What is the actual price per kilogram
paid for the material?
a,$7.26 per kilogram.
b,$8.13 per kilogram.
c,$8.03 per kilogram.
d,$8.00 per kilogram.
62
What is the actual price per kilogram
paid for the material?
a,$7.26 per kilogram.
b,$8.13 per kilogram.
c,$8.03 per kilogram.
d,$8.00 per kilogram.
Discussions
AP = $53000 ÷ 6600 kg
AP = $8.03 per kg
63
ABC’s material price variance (MPV)
for the week was:
a,$198 favourable.
b,$198 unfavourable.
c,$189 favourable.
d,$189 unfavourable.
Discussions
64
ABC’s material price variance (MPV)
for the week was:
a,$198 favourable.
b,$198 unfavourable.
c,$189 favourable.
d,$189 unfavourable.
MPV = AQ(AP - SP)
MPV =6600 kg × ($8.03 - 8.00)
MPV = $198 unfavourable
Discussions
65
The standard quantity of material that
should have been used to produce
2000 units is:
a,6500 kilograms.
b,6000 kilograms.
c,7000 kilograms.
d,5000 kilograms.
Discussions
66
The standard quantity of material that
should have been used to produce
2000 units is:
a,6500 kilograms.
b,6000 kilograms.
c,7000 kilograms.
d,5000 kilograms.
SQ = 2000 units × 3 kg per unit
SQ = 6000 kg
Discussions
67
ABC’s material quantity variance (MQV)
for the week was:
a,$4300 unfavourable.
b,$4300 favourable.
c,$4800 unfavourable.
d,$4800 favourable.
Discussions
68
ABC’s material quantity variance (MQV)
for the week was:
a,$4300 unfavourable.
b,$4300 favourable.
c,$4800 unfavourable.
d,$4800 favourable.
MQV = SP(AQ - SQ)
MQV = $8.00(6600 kg - 6000 kg)
MQV = $4800 unfavourable
Discussions
69
Managerial Decision Making
?Managerial Decision Making
?Cost accounting information is often used by
management for short-term decisions.
?Decision making involves five steps:
→ Define the problem.
→ Identify alternatives.
→ Collect relevant information on alternatives.
→ Select the preferred alternative.
→ Analyze decisions made.
70
Managerial Decision Making
?Accepting additional business
?should be based on incremental costs and
incremental revenues
?Incremental amounts are those that occur if the
company decides to accept the new business
71
Managerial Decision Making
?Make or Buy Decisions
?Incremental costs also are important in the
decision to make a product or purchase it from
a supplier
→ The cost to produce an item must
include
?direct materials
?direct labour
?incremental overhead
→ We should not use the predetermined overhead rate
to determine product cost
72
Managerial Decision Making
?Scrap or Rework Defects
?Costs incurred in manufacturing units of
product that do not meet quality standards are
sunk costs and cannot be recovered.
?As long as rework costs are recovered through
sale of the product and rework does not
interfere with normal production,we should
rework rather than scrap,
73
Managerial Decision Making
?Sell or Process Further
?sell partially completed products vs,process
them to completion
?As a general rule,process further only if
incremental revenues exceed incremental costs
74
Managerial Decision Making
?Selecting Sales Mix
?When a company sells a variety of products,
some are likely to be more profitable than
others,To make an informed decision
regarding sales mix,management must
consider,,,
→ The contribution margin of each product,
→ The facilities required to produce each
product and any constraints on the facilities,and
→ The demand for each product.
75
Managerial Decision Making
?Eliminating a Segment
?A segment is a candidate for
elimination if its
?revenues are less than its
avoidable expenses
76
Managerial Decision Making
?Qualitative factors in decisions
?Qualitative factors are involved in most all
managerial decisions
→ Quality
→ Delivery schedule
→ Supplier reputation
→ Employee morale
→ Customer opinions
→ ……
77
Summary
? Segments may be evaluated as a cost centre,a profit centre,
and an investment centre.
? CVP Analysis,break-even analysis,computing income
from expected sales,sales volume needed to earn a target
income,margin of safety,and sensitivity analysis.
? Importance of budgeting,master budget,and budgetary
control
? Standard costs,variance analysis and standard cost
accounting systems
? Managerial decision making,accepting additional business,
make or buy decisions,scrap or rework defects,sell or
process further,selecting sales mix,eliminating a segment
78
Discussions
?Consider the beginning XYZ case
79
Discussions
R e l e v a nt C os t A na l y s i s
S a v i ng s i n v a r i a bl e e x pe ns e s
pr ov i de d by t he ne w m a c hi ne
( $ 2 0 0 0 0 0 × 5 y r s, ) 1000000
N e t e f f e c t
$1000000 - $800000 = $200000 variable cost savings
80
Discussions
R e l e v a nt C os t A na l y s i s
S a v i ng s i n v a r i a bl e e x pe ns e s
pr ov i de d by t he ne w m a c hi ne
( $ 2 0 0 0 0 0 × 5 y r s, ) 1000000
C os t of t he ne w m a c hi ne ( 9 0 0 0 0 0 )
D i s po s a l v a l ue of ol d m a c hi ne 150000
N e t e f f e c t 250000
81
Case Study
?ABC Corporation,a merchandising company,has
provided the following budget data:
Purchases Sales
May $84000 $144000
June $96000 $132000
July $72000 $120000
August $108000 $156000
September $120000 $132000
82
Case Study
?Collections from customers are normally 75% in
the month of sale,15% in the month following the
sale,and 8% in the second month following the
sale,The balance is expected to be uncollectible,
ABC pays for purchases in the month following
the purchase,Cash disbursements for expenses
other than merchandise purchases are expected to
be $28,800 for September,ABC's cash balance on
September 1 was $44,000,
83
Case Study
?Required:
?Compute the expected cash collections
during September.
?Compute the expected cash balance on
September 30,
The End of Lesson 14
Managerial Accounting:
Applications
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun yat-sen University
2
Outline
?Segmented Reporting and Responsibility
Accounting System
?Cost-Volume-Profit Analysis
?Budgeting and Budgetary Control
?Standard Costs and Variance Analysis
?Managerial Decision Making
3
Introduction
?Let’s look at the XYZ Company example.
?A manager at XYZ Company wants to replace an old
machine with a new,more efficient machine.
N e w m a c h i n e,
L i s t p r i c e 900000
A n n u a l v a r i a b l e e x p e n s e s 800000
E x p e c t e d l i f e i n y e a r s 5
O l d m a c h i n e,
O r i g i n a l c o s t 720000
R e m a i n i n g b o o k v a l u e 600000
D i s p o s a l v a l u e n o w 150000
A n n u a l v a r i a b l e e x p e n s e s 1000000
R e m a i n i n g l i f e i n y e a r s 5
4
Introduction
?XYZ’s sales are $2000000 per year.
?Fixed expenses,other than amortization,are
$700000 per year.
?Should the manager purchase the new machine?
5
Introduction
? The manager recommends that the
company not purchase the new machine
since disposal of the old machine would
result in a loss:
R e m a i ni ng book v a l ue 600000
D i s pos a l v a l ue - 1 5 0 0 0 0
Los s f r om di s pos a l 450000
6
Introduction
?Is it correct?
?What’s your comment to the
manager’s decision?
?After learning this chapter,
you will know how to employ
the tools of managerial
accounting and make decisions
correctly.
7
Segmented Reporting
?Organizations may break down their
operations into various segments
?divisions,stores,services,or departments.
?Management needs reports on each segment
for
?cost management
?performance evaluation
8
Segmented Reporting
?Segments may be evaluated as
?a cost centre
?a profit centre
→ Profit centre reports include information on a
segment’s revenues and costs.
?an investment centre.
?Some costs are direct and some are indirect.
?Indirect costs may be allocated to various
departments.
9
S e r v i c e D e p a r t m e n t C o m m o n A l l o c a t i o n B a s e s
G e n e r a l O f f i c e N u m b e r o f e m p l o y e e s
P e r s o n n e l N u m b e r o f e m p l o y e e s
P a y r o l l N u m b e r o f e m p l o y e e s
A d v e r t i s i n g S a l e s
P u r c h a s i n g N u m b e r o f P u r c h a s e O r d e r s
C l e a n i n g F l o o r s p a c e o c c u p i e d
Ma i n t e n a n c e F l o o r s p a c e o c c u p i e d
Segmented Reporting
? Service department costs are shared indirect
expenses of operation departments.
? They may be allocated using a variety of bases.
10
Responsibility Accounting System
? Responsibility Accounting System
?An accounting system
?assigns managers the responsibility for
costs and expenses under their control.
11
Responsibility Accounting System
?Responsibility accounting budgets
?are prepared prior to each accounting period
?Responsibility accounting performance
reports
?compare actual costs and expenses to budgeted
amounts
12
Cost-Volume-Profit Analysis (CVP)
?CVP analysis is used to answer:
?How much must I sell to earn my desired
income?
?How will income be affected if I reduce selling
prices to increase sales volume?
?How will income be affected if I change the
sales mix of my products?
?……?
13
Assumptions of CVP Analysis
?CVP analysis assumes relations can be
expressed as straight lines within the
relevant range,
?Unit selling price remains constant.
?Unit variable costs remain constant.
?Total fixed cost remain constant.
?If the expected cost and revenue behaviour is
different from the assumptions,then the results of
CVP analysis are of limited use.
14
Scatter Diagram
Vertical
distance
is the
change in
cost.
Horizontal distance is
the change in activity.
0 1 2 3 4
*
To
ta
l Co
st
in
1,0
00
’s
of
Do
lla
rs
10
20
0
*
** *
*
* **
*
Activity,1,000’s of Units Produced
Unit Variable Cost = Slope = Change in costChange in units
15
High-Low Method
0 1 2 3 4 5
*
To
ta
l Co
st
in
1,0
00
’s
of
Do
lla
rs
10
20
0
*
** *
*
* **
*
Activity,1,000’s of Units Sold
30 Vertical
distance
is the
change
in cost,
(30 - 20)
Horizontal distance is
the change in activity,
(5 - 1)
Unit Variable Cost = 30 - 205 - 1 = $2.50/unit
16
Least-Squares Regression
?Least-squares regression
?is usually covered in advanced cost accounting
courses,
?is commonly used with computer software
because of the large number of calculations
required.
?The objective of the cost analysis remains the
same,determination of total fixed cost and the
variable unit cost.
17
Break-Even Analysis
?The break-even point
is the unique sales
level at which a
company neither earns
a profit nor incurs a
loss,
Sales
Total costs
Volume in Units
Co
sts
an
d R
eve
nu
e
in
D
ol
lar
s
18
Break-Even Analysis
?The break-even point may be expressed in
units or in dollars of sales,
Break-even point in units = Contribution margin per unit
Unit sales price less unit variable cost
Fixed Costs
19
Break-Even Analysis
?The break-even formula may also be
expressed in sales dollars.
Unit sales price
Unit variable cost
Break-even point in dollars = Contribution margin ratioFixed Costs
20
Computing Income from
Expected Sales
?What is the income given a predicted level
of sales?
Pre-tax
Income = Sales – [Fixed costs + Variable costs]
Pre-tax
Income = Sales –Fixed costs - Variable costs
or
21
Contribution margin ratio
Contribution margin per unitUnit sales =
Fixed costs + Target income
Dollar sales = Fixed costs + Target income
Sales Volume Needed to
Earn a Target Income
?Break-even formulas can be adjusted to
show the sales volume needed to earn any
amount of income,
22
Margin of Safety
?Margin of safety
?How much sales can decrease before the
company incurs a loss?
Expected sales
Margin of
safety,
percent
Expected sales - Break-even sales
=
23
New contribution margin ratio
New break-
even point
in dollars
New fixed costs
Sensitivity Analysis
?The effects of changes in variables such as
sales price,variable costs,and fixed costs.
?CVP analysis can be used to show the effects
of such changes,
=
24
Budgets
?Budgets
?formal statements of a company’s plans
expressed in monetary terms
?attempt to capture the future activities of an
organization
?are used by businesses,not-for-profit,
government,educational,and other types of
organizations.
25
Advantages
Communicates plans
and instructions
Promotes analysis and
a focus on the future
Motivates employees
Provides a basis for
evaluating performance
Coordinates
business activities
Defines goals
and objectives
Importance of Budgeting
26
Budget Committee
?Budget Committee
?Consists of managers from all departments
of the organization
?Provides central guidance
→ to insure that individual budgets submitted from all
departments are realistic and coordinated.
27
Flow of budget data is a bottom-up process.
S u p e r v i so r S u p e r v i so r
M i d d l e
M a n a g e m e n t
S u p e r v i so r S u p e r v i so r
M i d d l e
M a n a g e m e n t
T o p M a n a g e m e n t
Budget Committee
28
2005 2006 2007 2008
Operating Budget
The annual operating budget
may be divided into quarterly
or monthly budgets.
Budget Cycle
?Budget horizons are usually for one year
?but may extend for several years.
29
Continuous or
Rolling Budget
The budget may be a twelve-month
budget that rolls forward one month
as the current month is completed.
2005 2006 2007 2008
Rolling Budgets
30
Master Budget
?Master Budget
?A formal,comprehensive plan
→ for the future of a company
?consists of several budgets linked together
→ to form a coordinated plan for the organization
31
Prepare
sales
budget
Develop
production
budget
Prepare
financial
budgets:
? cash
? income
? balance sheet
Prepare
capital
expenditure
budget
Prepare
selling and
general
administrative
budgets
Prepare
manufacturing
budgets:
? material
? labour
? overhead
Master Budget
32
Sales Budget
?Sales budget
?the starting point in the budgeting process.
?Most of the other budgets are linked to the sales
budget,
?Sales personnel are often involved in developing
the sales budgets.
33
Sales Budget
Sales Budget
Estimated Unit Sales
Estimated Unit Price
Analysis of economic and market conditions
+
Forecasts of customer needs from marketing personnel
34
Merchandise Purchases Budget
? Merchandise Purchases Budget
?Provides detailed information about the
purchases
?necessary to fulfill the sales budget and provide
adequate inventories.
Merchandise
inventory to
be purchased
Budgeted
ending
inventory
Budgeted
sales for the
period
Budgeted
beginning
inventory= +
_
35
Merchandise Purchases Budget
?The quantity purchased is affected by:
?Just-in-time inventory systems
→ enable purchases of smaller,frequently delivered
quantities,
?Safety stock inventory systems
→ provide protection against lost sales caused by
delays in supplier shipments.
36
Selling Expense Budget
?Selling Expense Budget
?lists the types and amounts of selling expenses
?Predictions of expenses are based on the sales
budget and past experience.
37
General and Administrative
Expense Budget
?General and Administrative Expense
Budget
?lists the predicted operating expenses not listed
in the sales budget
?Includes both cash and non-cash expenses
?Often prepared by the office
manager or person responsible
for general administration
38
Capital Expenditures Budget
?Capital Expenditures Budget
?lists the cash inflows or outflows
pertaining to the disposal or acquisition
of capital equipment.
?is usually affected by the organization’s
long-term plans.
39
Cash Budget
?Cash Budget
?lists the expected cash inflows and
outflows for the period
?a tool used by management to
avoid excess cash balances or
cash shortages
?Information from other budgets is used in its
preparation
?Information from the cash budget is used to
prepare the budgeted income statement and
balance sheet
40
?Manufacturing companies need to prepare
additional budgets that include:
?Production budgets
?Direct materials purchase budgets
?Direct labour budgets
?Manufacturing overhead budgets
Production and Manufacturing Budgets
41
Production and Manufacturing Budgets
?Production and Manufacturing Budgets
?Provides detailed information about the
production necessary to fulfill the sales budget
and provide adequate inventories.
Number of
units to be
produced
Budgeted
ending
inventory
Budgeted
sales for
the period
Budgeted
beginning
inventory
= + _
42
Production and Manufacturing Budgets
? Direct Materials Budget
?Provides detailed information about the purchases of
raw materials necessary to fulfill the production budget
and provide adequate inventories.
Units of raw
materials to
be purchased
Materials
needed for
production
Budgeted
ending
inventory
Budgeted
beginning
inventory
= + _
Cost of raw
materials to
be purchased
Units of raw
materials to
be purchased
Material price
per unit of
raw material
= ×
43
Production and Manufacturing Budgets
? Direct Labour and Manufacturing Overhead
Budgets
?Provides information about the labour and
manufacturing overhead costs given the level of
production for the period.
44
Cash
Budget
Expected
Receipts
and
Disbursements
Budgeted
Income
Statement
Budgeted
Balance
Sheet
Preparing Financial Budgets
45
?Take corrective and
strategic actions.
This is an ongoing
process.
?Develop the budget
from planned objectives.
?Compare
actual with
budget and
analyze any
differences.
?Revise
objectives
and prepare
a new
budget.
Budgetary Control
46
Capital Budgeting
?Capital Budgeting
?Analyzing alternative long-term investments
and deciding which assets to acquire or sell.
?These decisions require careful analysis since:
→ The outcome is uncertain.
→ Large amounts of money are usually
involved.
→ Investment involves a long-term
commitment.
→ Any decision may be difficult or
impossible to reverse.
47
Zero-based Budgeting
?Zero-based Budgeting
?are prepared assuming no previous
activities for the activities being
planned
?Managers must justify the amounts budgeted
for each activity
?is popular among government and non-profit
organizations.
48
Fixed Budget
?Fixed budgets
?are prepared for a single,predicted level of
activity
?Performance evaluation is difficult when actual
activity differs from the predicted level of
activity.
→ Example,How much of the unfavourable cost
variance is due to higher activity,and how much is
due to poor cost control?
→ To answer these questions,we must flex the budget
to the actual level of activity.
49
Flexible (Variable) Budgets
?Flexible budgets
?are prepared after a period’s activities are
complete,
?Show revenues and expenses that should have
occurred at the actual level of activity,
?Reveal cost variances due to good cost control or
lack of cost control,
?Improve performance evaluation.
50
?Flexible budgets
?To prepare a budget for different activity levels
→ we must know how costs behave with changes in activity levels
?Total variable costs change in
direct proportion to
changes in activity.
?Total fixed costs remain
unchanged within the
relevant range,Fixed
Flexible (Variable) Budgets
51
Standard Costs
?Standard Costs
?are preset costs for delivering a
product or service under normal
conditions.
?are established through personnel,
engineering,and accounting studies
using past experience.
?are benchmarks used in evaluating
performance.
?are often used in setting budgets.
52
?Example,A standard cost card
St a n d a r d St a n d a r d
Q u a n ti ty Pr i c e St a n d a r d
C o s t fa c to r o r H o u r s o r R a te C o s t
D i r e c t m a t e r i a l s 1 k g 25$ pe r k g 2 5, 0 0$
D i r e c t l a bo ur 2 ho ur s 20$ pe r ho ur 4 0, 0 0
V a r i a bl e m f g,ov e r he a d 2 ho ur s 10$ pe r ho ur 2 0, 0 0
To t a l s t a nd a r d un i t c os t 8 5, 0 0$
Standard Costs
53
Variance Analysis
Take action
Prepare standard
cost performance
reports
Analyze
variances
Investigate
causes
54
Variance Analysis
?Management By Exception
?Standard cost accounting provides management
with information about costs that differ from
budgeted amounts (variances),
?Management may choose to focus only on
variances that are significant,
?This approach is referred to as
Management by Exception.
55
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price
Price Variance Quantity Variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
Variance Analysis
?Material Variances
56
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate
Rate Variance Efficiency Variance
AH(AR - SR) SR(AH - SH)
AH = Actual Hours SR = Standard Rate
AR = Actual Rate SH = Standard Hours
Variance Analysis
?Labour Variances
57
Spending
Variance
Efficiency
Variance
AH × SVR AH × AVR
AH = Actual Hours of Activity
AVR = Actual Variable Overhead Rate
SVR = Standard Variable Overhead Rate
SH = Standard Hours Allowed
SH × SVR
Actual Flexible Budget Applied
Variable for Variable Variable
Overhead Overhead at Overhead at
Incurred Actual Hours Standard Hours
Variance Analysis
?Variable Overhead Variances
58
Spending
Variance
Volume
Variance
SFR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
SH × SFR
Actual Fixed Fixed Fixed
Overhead Overhead Overhead
Incurred Budget Applied
Variance Analysis
?Fixed Overhead Variances
59
Standard Costs
?Standard cost accounting systems
?record variances in the accounts
?simplify recordkeeping and help in the
preparation of reports
60
?ABC Company has the following direct
material standard to manufacture one unit
product:
3.0 kilograms per unit at $8.00 per kilogram
?Last week 6600 kilograms of material were
purchased and used to make 2000 units,The
material cost a total of $53000,
Discussions
61
Discussions
What is the actual price per kilogram
paid for the material?
a,$7.26 per kilogram.
b,$8.13 per kilogram.
c,$8.03 per kilogram.
d,$8.00 per kilogram.
62
What is the actual price per kilogram
paid for the material?
a,$7.26 per kilogram.
b,$8.13 per kilogram.
c,$8.03 per kilogram.
d,$8.00 per kilogram.
Discussions
AP = $53000 ÷ 6600 kg
AP = $8.03 per kg
63
ABC’s material price variance (MPV)
for the week was:
a,$198 favourable.
b,$198 unfavourable.
c,$189 favourable.
d,$189 unfavourable.
Discussions
64
ABC’s material price variance (MPV)
for the week was:
a,$198 favourable.
b,$198 unfavourable.
c,$189 favourable.
d,$189 unfavourable.
MPV = AQ(AP - SP)
MPV =6600 kg × ($8.03 - 8.00)
MPV = $198 unfavourable
Discussions
65
The standard quantity of material that
should have been used to produce
2000 units is:
a,6500 kilograms.
b,6000 kilograms.
c,7000 kilograms.
d,5000 kilograms.
Discussions
66
The standard quantity of material that
should have been used to produce
2000 units is:
a,6500 kilograms.
b,6000 kilograms.
c,7000 kilograms.
d,5000 kilograms.
SQ = 2000 units × 3 kg per unit
SQ = 6000 kg
Discussions
67
ABC’s material quantity variance (MQV)
for the week was:
a,$4300 unfavourable.
b,$4300 favourable.
c,$4800 unfavourable.
d,$4800 favourable.
Discussions
68
ABC’s material quantity variance (MQV)
for the week was:
a,$4300 unfavourable.
b,$4300 favourable.
c,$4800 unfavourable.
d,$4800 favourable.
MQV = SP(AQ - SQ)
MQV = $8.00(6600 kg - 6000 kg)
MQV = $4800 unfavourable
Discussions
69
Managerial Decision Making
?Managerial Decision Making
?Cost accounting information is often used by
management for short-term decisions.
?Decision making involves five steps:
→ Define the problem.
→ Identify alternatives.
→ Collect relevant information on alternatives.
→ Select the preferred alternative.
→ Analyze decisions made.
70
Managerial Decision Making
?Accepting additional business
?should be based on incremental costs and
incremental revenues
?Incremental amounts are those that occur if the
company decides to accept the new business
71
Managerial Decision Making
?Make or Buy Decisions
?Incremental costs also are important in the
decision to make a product or purchase it from
a supplier
→ The cost to produce an item must
include
?direct materials
?direct labour
?incremental overhead
→ We should not use the predetermined overhead rate
to determine product cost
72
Managerial Decision Making
?Scrap or Rework Defects
?Costs incurred in manufacturing units of
product that do not meet quality standards are
sunk costs and cannot be recovered.
?As long as rework costs are recovered through
sale of the product and rework does not
interfere with normal production,we should
rework rather than scrap,
73
Managerial Decision Making
?Sell or Process Further
?sell partially completed products vs,process
them to completion
?As a general rule,process further only if
incremental revenues exceed incremental costs
74
Managerial Decision Making
?Selecting Sales Mix
?When a company sells a variety of products,
some are likely to be more profitable than
others,To make an informed decision
regarding sales mix,management must
consider,,,
→ The contribution margin of each product,
→ The facilities required to produce each
product and any constraints on the facilities,and
→ The demand for each product.
75
Managerial Decision Making
?Eliminating a Segment
?A segment is a candidate for
elimination if its
?revenues are less than its
avoidable expenses
76
Managerial Decision Making
?Qualitative factors in decisions
?Qualitative factors are involved in most all
managerial decisions
→ Quality
→ Delivery schedule
→ Supplier reputation
→ Employee morale
→ Customer opinions
→ ……
77
Summary
? Segments may be evaluated as a cost centre,a profit centre,
and an investment centre.
? CVP Analysis,break-even analysis,computing income
from expected sales,sales volume needed to earn a target
income,margin of safety,and sensitivity analysis.
? Importance of budgeting,master budget,and budgetary
control
? Standard costs,variance analysis and standard cost
accounting systems
? Managerial decision making,accepting additional business,
make or buy decisions,scrap or rework defects,sell or
process further,selecting sales mix,eliminating a segment
78
Discussions
?Consider the beginning XYZ case
79
Discussions
R e l e v a nt C os t A na l y s i s
S a v i ng s i n v a r i a bl e e x pe ns e s
pr ov i de d by t he ne w m a c hi ne
( $ 2 0 0 0 0 0 × 5 y r s, ) 1000000
N e t e f f e c t
$1000000 - $800000 = $200000 variable cost savings
80
Discussions
R e l e v a nt C os t A na l y s i s
S a v i ng s i n v a r i a bl e e x pe ns e s
pr ov i de d by t he ne w m a c hi ne
( $ 2 0 0 0 0 0 × 5 y r s, ) 1000000
C os t of t he ne w m a c hi ne ( 9 0 0 0 0 0 )
D i s po s a l v a l ue of ol d m a c hi ne 150000
N e t e f f e c t 250000
81
Case Study
?ABC Corporation,a merchandising company,has
provided the following budget data:
Purchases Sales
May $84000 $144000
June $96000 $132000
July $72000 $120000
August $108000 $156000
September $120000 $132000
82
Case Study
?Collections from customers are normally 75% in
the month of sale,15% in the month following the
sale,and 8% in the second month following the
sale,The balance is expected to be uncollectible,
ABC pays for purchases in the month following
the purchase,Cash disbursements for expenses
other than merchandise purchases are expected to
be $28,800 for September,ABC's cash balance on
September 1 was $44,000,
83
Case Study
?Required:
?Compute the expected cash collections
during September.
?Compute the expected cash balance on
September 30,
The End of Lesson 14
