The Controlling Function

1. The Controlling Function • After devising Business Plans &Ogzn structure to attain firm's goals, mgers must measure firm’s progress toward its goals. This requires controlling function. • The fields of economics & accounting concepts are used in controlling process. • Of cousre mgers do not have to be professional economists or CPA,but it is important that they understand the basic principles used in each profession.

2. Cost Controls & Break-Even Analysis • Objective = show how to manage costs & determine most profitable level of pdn & sales that satisfies consumer needs • Cost assists mger to assess how bus. has performed in past & to plan for the future • This requires a good mgmt info system that will provide • (1) acctg info that allows mgmt to determine cost in various ways • (2) a means for effectively monitoring & controlling costs of the business.

3. Mger use costs in decision making, thus need to know how costs will respond to changes in business activities. • Mgmt Info:Acctg records are sources of mgmt info as they summarize transactions like inventory turnover, eqpt purchases etc • Mgmt Info as Control Function: Mgmt info is used in controlling resources obtained & used by firm. • Defining Costs • A firm's info system must provide data needed for cost control to ensure that costs are being allocated properly & that all relevant costs are being considered.

4. Implicit and Explicit Costs • Explicit Cost: Costs that are directly traceable to the end product – e.g. cost of input purchased at open market for which explicit payments are made. • Implicit Cost: Are costs that firms incur that do not involve explicit payments. They relate to firm's use of its own assets – e.g. cost for using building, eqpt, labor, dep. interest must be added to determining final cost of producing pdts.

5. Controllable and Non-controllable Costs • Uncontrollable costs: Costs firms cannot easily influence – e.g. implicit costs that mgers have limited control. • Controllable cost:Those regulated totally by mgers – e.g. explicit costs • Fixed & Variable Costs • Costs vary according to two concepts: • (1) the passage of time, and • (2) the level of activity. • Fixed Costs:Stay same over time regardless of the level of output -e.g. rent • Variable Costs: change with the level of activity (materials, labor, shipping).

6. TC Cost Fixed cost TVC TFC • The figure shows that TC = TVC + TFC. • The Contribution Concept • Price & profit are determined on per unit basis that shld cover FC & VC. • SP per unit = TC per unit + Profit per unit • SP per unit =FC/unit +VC/unit+Profit/unit Output

7. Fixed costs are usually referred as overhead cost. • SP/unit=Overhead cost/unit+VC/unit+ Profit/unit • SP/unit - VC/unit = Overhead cost/unit + Profit/unit

8. e.g. if a rice producer has the ff cost • Materials $55/bag; Direct labor $20/bag Then TVC is $75/bag • If SP/bag is $125, then $50 is left after paying for TVC to contribute to overhead (TFC) & profit • Selling Price $125/bag 100% - TVC $75/bag-60% Contribution $50/bag 40% (profit & overhead)

9. Contribution covers profit & overhead • SP/unit - TVC/unit = Contribution = Overhead/unit + Profit/unit • If a firm know its contribution margin to be 40%, its SP for any item can easily be computed, once its VC/unit is known • If a firm’s contribution is 60%, its VC is $200/unit then its • SP = 100% = VC + Con = 40% + 60% • If VC 40% = $200 then SP100% = 100%/40% x $200 = $500

10. Break Even Analysis • Helps to find sales/output level that yields no profits or losses - i.e. where TR =TC • Calculation:Profit = 0 = Revenue – TC • Profit = 0 = (P x Q) – (VC x Q) – FC • 0 =Q(P-VC) – FC • Q(P-VC) = FC • Q =FC/(P-VC)

11. If rice SP is $200/bag with $120 VC, & $1mil FC then how many can be sold to break even? • Calculation: • Break-Even = • Q =FC/(P-VC) • Q =100,000/(200-120) = 1000000/80 =12,500 bags