Managerial Accounting

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# Managerial Accounting - PowerPoint PPT Presentation

Managerial Accounting. Week 5 Notes David B. Hamm, MBA, CPA June, 2002 Revised Nov. 2003 & June 2004. Cost-Volume-Profit Analysis (1).

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### ManagerialAccounting

Week 5 Notes

David B. Hamm, MBA, CPA

June, 2002

Revised Nov. 2003 & June 2004

Cost-Volume-Profit Analysis (1)
• Because of the unique patterns of fixed and variable costs, we can use these patterns to assist us in forecasting costs and planning optimal production activities.
• This can be done graphically by plotting FC and VC for various production levels, or can be done with simple algebra
• Break even costs: S = VC + FC where S=PxQ and VC=Cost x Q
C-V-P Analysis (2)
• Illustration: Selling price= \$10 per unit, VC=\$6 per unit, and FC=\$100,000. What is break even sales level?
• Formula 10q = 6q + 100,000
• Thus: 4q = 100,000 (contribution margin is S – VC or \$4 per unit)
• q = 25,000 units (to break even)
C-V-P Analysis (3)
• Suppose we desire a \$2 profit per unit? Just add to the formula:
• Sales = VC + FC + Profit, or
• 10q = 6q + 100,000 + 2q
• 2q = 100,000
• q = 50,000 units required sales to make a \$2 profit per unit sold
Estimating Costs: High-Low
• Previous data assumed FC and VC were easily obtained, but what if costs are “mixed”—elements of both fixed and variable costs combined?
• Linear regression—most accurate method to break out costs
• High-Low: quick method to estimate variable and fixed cost portions
High-Low: Illustration (1)

There is a clear relationship between quantity and cost, but it is not yet specified

High-Low: Illustration (2)

Thus VC estimated = \$30 per unit and VC estimate =\$120 K

or Total costs = \$30q + \$120,000

Segment Reporting
• Many firms today offer multiple products or are conglomerates of divisions or other entities selling differentiated products or services.
• Sometimes this is done to capitalize on seasonal activities and seasonal cash flows (offsetting ‘downtime’ of one product with another product’s ‘uptime’)
Segment Reporting (continued)
• Some joint costs (facilities, top management etc.) may be allocable to multiple segments.
• But—preparing reports that assign only “controllable” costs to each segment will better evaluate each segment’s profitability.
Segment Reporting Example

Pause for Segment Illustration/ Problem

Standard Costs (brief overview)
• In the budgeting process, “standard costs” may be assigned to materials, labor, overhead cost components
• Standard costs are then compared to actual costs, and variances are evaluated, for planning and control purposes
Standard Costs (continued)
• Types of variances
• Price/Rate variances—measure effectiveness of volume purchasing, etc.
• Quantity/Efficiency variances—measure effectiveness of production, reducing waste, etc.
• Volume variances (may depend upon orders, etc. and may not be controllable)
• See Module Note 14 for more detail
Standard Costs (conclusion)
• Standards can be based upon
• “Ideal” performance—probably not attainable and failure to achieve may be discouraging
• “Attainable” performance—a higher, yet achievable goal
• Past performance—may not be an incentive for improvements
Capital Budgeting
• Proposed capital expenditures represent costs to be allocated over multiple accounting periods
• We should, appropriately, consider the time value of money (present value analysis) when evaluating proposed capital expenditures
Capital Budgeting (continued)
• Net Present Value analysis (NPV):
• Requires the following
• The amount to be invested (current)
• Expected cash returns over investment’s life
• An interest rate (cost of capital)
• Is the present value of future cash flows, discounted by cost of capital, at least equal to the current cost of the investment?
• If yes, then the investment should be made
Capital Budgeting (continued)
• Internal Rate of Return (IRR)
• Calculate the interest rate at which the present value of future cash flows equals the investment required.
• This is the investment’s ROI or internal rate of return (IRR)
• (Difficult to do without a computer)
• If IRR = or > cost of capital, do the investment. If not, don’t.
Using Excel =NPV Function:

=NPV function inputs data and interest rate and calculates discount automatically for the given periods. No need to refer to a present value table and make individual years’ calculations.

Capital Budgeting Exercise

Pause to work capital budget problem in class & review.

Solution for NPV Exercise
• NPV of savings exceeds current cost, so investment should be undertaken
Final Project for Managerial Accounting Module:
• Develop a Master Budget report for a calendar or fiscal year for a fictional company.
• May be based on a real firm but must be your creation—no “real” firms allowed
• May be for profit, not-for-profit, corporation, partnership, proprietorship—your choice!
• Any industry you choose—manufacturing, service, etc.
Final Project (continued)
• Report should begin with 4-5 page narrative (word processed, double –spaced)
• Identify your firm, location, industry, owners, no. of employees, etc.
• Key sources of financing (investors, loans, etc.)
• SWOT analysis
• Strengths—what firm does and does well
• Weaknesses—problem areas, concerns
• Opportunities—new markets, etc,
• Threats—competition, regulation, etc.
Final Project (continued):
• Brief written summary of budget figures and summary paragraph regarding plans for the future
• Appendix—your spreadsheets of budgets for the next year containing (at least)
• Sales budget
• Production budget(s) to support sales
• Cash Budget
• Pro-forma Income Statement
• Your budgets should correspond to your narrative—if you’re a service business, don’t show your budget manufacturing widgets, etc. Numbers should be “realistic”.
Final Project (conclusion):
• An “A” paper will also include a capital budget proposal with a Net Present Value analysis included (you may decide to implement or not implement the proposal, but include the analysis)
• Due date—two weeks from end of module
• See DBH if you have questions
END OF MODULE!

You’ve made it to the mountain-top! Enjoy the view!