Managerial Accounting

1. Managerial Accounting An Overview

2. Role in Decision-Making • Provides economic and financial information to management • Focus on resources, costs, profit and liquidity management • Focus on short run performance

3. Management Functions 1. Planning • Looking forward and establishing objectives • Profit maximization versus utility? • Market share maximization? • Adding value to the business 2. Directing • Implementation of objectives • Coordinating activities and resources

4. Management Functions 3. Controlling • Keeping activities on track • Role of the CFO • Managerial accounting • Strategic planning

5. Vital Truths in Management • “The true cost and profit picture for each product, for each product/market segment, and for all key customers must always be known.” • “A business must concentrate on cash flow and balance sheet strengths as much as profits.” Quotes from article by Ames and Hlavacek in the Harvard Business Review

6. Common Foundation • Different industries and businesses within industries often require different management accounting information • However, the expected results are fundamentally the same….to more efficiently and effectively manage the business.

7. Understanding Performance • Must be able to track the value added at each process and the costs associated with those processes, • Must seek to avoid/minimize non-value added activities and their associated costs, • Some managers don’t want to know the results from accounting indicators, • Some think that financial planning is all a bunch of “funny money”; not real!!!

8. Managerial Cost Concepts • Direct materials: raw materials physically associated with the final product • Direct labor: employees physically and directly associated with the final product • Overhead: costs indirectly associated with the final product

9. More Concepts • Period costs: costs matched with revenue for a specific time period. (i.e., net income for a specific period (i.e., quarterly, annual). • Product costs: costs associated with producing the final product. Not considered an expense until the product (i.e., cost of goods sold). • Total costs: equals product costs (direct and indirect materials and labor) plus period costs (selling and administrative expenses).

10. Total Costs Period Costs Non-manufacturing Costs Production Costs Manufacturing Costs Selling Expenses Direct Materials Direct Labor Administrative Expenses • Manufacturing • Overhead: • Indirect materials • Indirect labor • Other indirect costs

11. Cost of Goods Sold Determination Merchandising Firm Beginning Merchandise Inventory Cost of Goods Purchased Cost of Goods Available For Sale Ending Merchandise Inventory - + = Cost of Goods Sold Manufacturing Firm Beginning Finished Goods Cost of Goods Manufactured Cost of Goods Available For Sale Ending Merchandise Inventory - + =

12. Cost Accounting Concepts • Process cost accounting • Job order cost accounting • Activity based cost accounting

13. Process Cost Accounting • Tracking costs associated with a specific process • Direct materials and labor • Manufacturing overhead costs • Assigning costs to finished goods

14. Process Costs in Making Bread Raw Materials Factory Labor Manf. Overhead Mixing Department WIP Baking Department WIP Packaging Department WIP Finished Goods Production Cost Report Production Cost Report Production Cost Report

15. Job Order Cost Accounting • Tracking costs associated with a specific order or job • Direct materials and labor • Manufacturing overhead costs • Assigning costs to finished goods

16. Comparison of Cost Systems

17. Comparison of Cost Systems

18. Activity Based Cost Accounting • An approach for allocating overhead • An activity is any event, action, transaction or work sequence that incurs when producing a product or providing a service • An activity cost pool is a distinct type of activity (e.g., ordering materials) • A cost driver is any factor or activity that has a direct cause-effect relationship with resources consumed (e.g., machine hours)

19. Steps in ABC Accounting • Identify and classify activities and allocate overhead to cost pools • Identify cost drivers – correlation between driver and use • Compute overhead rates – ABC rate • Assign overhead costs to products – use of cost drivers • Comparison of unit costs across products

20. Activity Based Cost (ABC) System Overhead Costs Activity cost pools: Ordering and Receiving Materials Cost Pool Setting Up Machines Cost Pool Machining Cost Pool Assembly Cost Pool Inspecting and Testing Cost Pool Painting Cost Pool Cost drivers: # of Tests # of Direct hours # of Machine hours # of Parts # of Setups # of Purchase orders Products

21. Example of ABC Accounting ABC Overhead rate = Overhead per activity ÷ Cost driver per activity Initial status: Activity Cost Pool Overhead Driver AB overhead activity rate Setting up machines $300,000 1,500 setups $200/setup Machining $500,000 50,000 hours $10/hour Inspecting $100,000 2,000 inspection $50/inspection Total $900,000 Step 1: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500

22. Example of ABC Accounting Step 1: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 2: Partitioning of overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (33%) $25,000 (67%) $75,000 33% = 500/1,500 and $100,000 = 500 units x $200/setup

23. Example of ABC Accounting Step 1: Assigning overhead driver activity to products: Activity Cost Pool Cost driver Driver Product 1Product 2 activity Setting up machines # setups 1,500 500 1,000 Machining Hours 50,000 30,000 20,000 Inspecting # inspections 2,000 500 1,500 Step 2: Partitioning of overhead: OverheadProduct 1 Product 2___ Setting up machines $300,000 (33%) $100,000 (67%) $200,000 Machining $500,000 (60%) $300,000 (40%) $200,000 Inspecting $100,000 (33%) $25,000 (67%) $75,000 67% = 1,000/1,500 and $200,000 = 1,000 x $200/setup

24. Example of ABC Accounting Step 2: Partitioning of overhead: OverheadProduct 1Product 2 Setting up machines $300,000 $100,000 $200,000 Machining $500,000 $300,000 $200,000 Inspecting $100,000$25,000$75,000 Total $900,000 $425,000 $475,000 Step 3: Overhead costs per unit: Units produced 25,000 5,000 Overhead cost per unit $17 $95 Traditional overhead cost per unit*$30 $30 * $900,000 divided by 30,000 units Avoids overstating profitability of some enterprises and understating profitability of others

25. Example of ABC Accounting Product 1 Product 2 COP unit costs with ABC costing: Direct materials $40 $30 Direct labor $12 $12 ABC overhead $17$95 Total unit costs $69 $137 COP unit costs with traditional costing: Direct materials $40 $30 Direct labor $12 $12 Traditional overhead *$30$30 Total unit costs $82 $72 * $900,000 divided by 30,000 units Traditional overhead costing suggests that Product 2 is cheaper to produce than Product 1, which is not true!

26. Another Approach… Product #1 Variable expenses Fixed expenses Product #n Variable expenses Fixed expenses Product #2 Variable expenses Fixed expenses ………….. 1 2 1 2 1 2 2 1 Total fixed expenses • Two approaches: • Allocate total fixed expenses using ABC accounting procedures • Sum the budgeted fixed expenses at the product level and check for consistency at the firm level. Reallocate if necessary.

27. Decision-Making Concepts • Cost behavior analysis • Cost-volume-profit analysis • Marginal analysis • Pricing

28. Cost Behavior Analysis • Variable costs –costs that vary with the level of production • Fixed costs – costs that do not vary with the level of production • Relevant range – relevant segment of cost curves • Mixed costs – sometimes called semi-variable costs (e.g., rental rates)

29. Cost-Volume-Profit Analysis • Contribution margin per unit: unit selling price minus unit variable cost • Contribution margin ratio: units vs. $$$ • Degree of operating leverage: contribution margin ÷ net income • Breakeven analysis: entity vs. enterprise level

30. Marginal Analysis • Short profit associated with input use • Single versus multiple input usage • Productivity and prices • Product/enterprise selection

31. Product Pricing • Target costing (TC = P – desired profit) • Cost Plus pricing • Cost plus a markup • Markup percentage (desired ROI per unit divided by total unit cost) • Variable cost pricing (excludes SR fixed costs) • Internal pricing • Cost-based transfer price • Market-based transfer price • Pricing power (Price takers vs. price setters)

32. Cash Management and LOC • Identifying monthly cash flow surpluses and deficits • Determining the required LOC – maximum monthly cash flow deficit • Remember, cash is King!!!