Management Accounting Midterm Review

1. Management Accounting Midterm Review Smiti Tolani

2. Chapter 1 Introduction to Managerial Accounting

3. Management Accounting for Managers Process of identifying, measuring, accumulating, analyzing, preparing, interpreting and communicating information that helps managers fulfill organizational objectives Problem Solvinglong range strategic plans Attention-Directing controlling routine operations Scorekeeping  accumulating and classifying data

4. Distinctions Between Management Accounting and Financial Accounting Primary Users Reporting Choices Behavioural Implications Time Focus Time Span Reporting Detail Activities Management Accounting Organization Managers Costs versus benefits Influence on managerial behaviour Future orientation Flexible Detailed Less sharply defined Financial Accounting External parties G.A.A.P. Measurement of economic activity Past orientation Less flexible Summary reports More sharply defined

5. Management Decision Process 1. Identify the problems/issues. 2. Understand the Key Success Factors of the company. 3. Identify alternative solutions to the problem. 4. Perform the necessary quantitative and qualitative analyses. 5. Evaluate the alternative solutions and recommend one. 6. Implement the recommendation.

6. Key Success Factors (KSF’s) • Factors that must be managed successfully if the organization is to be successful. • Many of these factors tie-in to the Value Chain. (for example, timely delivery of product, exceptional customer service, low cost/efficient production, etc.) • Differ with each industry and organization.

7. Two major issues to remember when designing Management Accounting systems: The “Cost-Benefit” Philosophy: “The benefits of better decisions should exceed the cost of the system” The “Behavioural” Philosophy: Management Accountants should consider behavioural issues (ie. How will Management Accounting systems affect managers and their decisions?) These behavioural issues may affect the benefit Management Accounting systems

8. A management accounting system should provide accurate, timely budgets and performance reports in a form useful to Shareholders Bankers Revenue Canada Managers

9. Financial Accounting is constrained by GAAP, Managerial Accounting is constrained by: Revenue Canada The Controller Cost Benefit GAAS

10. Chapter 2 Cost Behavior and Cost Volume Relationships

11. Cost Behaviour • Variable Cost • a cost which changes in direct proportion to changes in the cost driver • is constant per unit as volume changes • Fixed Cost • a cost which is not influenced by changes in the cost driver over the relevant range • per unit fixed costs change as volume changes Cost Driver • an activity which influences how a cost is incurred $ Volume $ Volume

12. Cost-Volume-Profit Analysis • the study of the relationships between revenues, costs, volume and profits • Break-Even Point- level of sales at which revenue equals expenses, and income is zero • Margin of Safety- equal to the planned unit sales less the breakeven unit sales; it shows how far sales can fall below planned level before losses occur • Margin of Safety= planned unit sales- break-even unit sales 2 Techniques: • Contribution margin approach • Income Statement Approach

13. EG. Amy Winston is trying to decide whether to rent a line of food vending machines She has determined: Selling price/unit $0.50 Variable cost of each item $0.40 Selling price less variable cost $0.10 (cont. margin) Total fixed per month $6000

14. Selling price/unit $0.50 Variable cost of each item $0.40 Selling price less variable cost $0.10 (cont. margin) Total fixed per month $6000 Contribution Margin Approach CM (per unit) = P – VC when enough units have been sold to generate total contribution margin equal to fixed costs, break-even point is reached FC/CM = Break even units 6000/0.1 = 60,000 units Break even in Dollars: CM% = CM/P 0.1/0.5 = 20% FC/CM% = Break even in Dollars 6000/0.2 = 30,000

15. Selling price/unit $0.50 Variable cost of each item $0.40 Selling price less variable cost $0.10 (cont. margin) Total fixed per month $6000 Income Statement Approach Sales – VC – FC = Net Income X = # of units S = Sales P(X) – VC(X) – FC = Net Income 0.5X-0.4X-6000=0 0.1X=6000 X=6000/0.1 = 60,000 units S – 0.8S-FC = Net Income 0.2S = 6000 S = 30,000 Dollars

16. Break-Even Point Summary: Break-even units = FC/CM Break-even sales = FC/CM%

17. Cost-Volume-Profit Graph $ Break-even Point Sales Total Expenses Net income area Net loss area Relevant Range of volume Volume

18. Decrease Variable Costs Sales Expenses $ Volume Decrease Fixed Costs Increase Fixed Costs Sales Expenses Sales Expenses $ $ Volume Volume Basic Model Changes in CVP Model Factors Sales Expenses $ Volume

19. Target Net Income and Income Taxes Target Net Income of $480 : Target Sales in Units Target Sales in Dollars = (Fixed costs + Target income) = (Fixed costs + Target income) / CM per unit / CM% = ($6,000 + $480) / $0.10 = ($6,000 + $480) / 20% = 64,800 units = Sales $32,400 Income Taxes • convert desired ‘after-tax’ net income to its ‘before-tax’ equivalent before calculating the target sales formula Target income before income taxes = Target after-tax net income / (1 - tax rate) = $288 / (1 - .40) = $288 / .6 = $480

20. Cost-Volume-Profit AnalysisMultiple Product Situations Sales Mix- the relative proportions or combinations of quantities of products that comprise total sales EG: Ramos Retail Company sells two products wallets (W) and key cases (K) IF Constant mix is 4 units of W for every unit of K What is Break Even?

21. Operating Leverage Sales Sales $ $ Total Expenses Total Expenses Volume Volume High Operating Leverage High Fixed / Low Variable Costs Higher CM/Unit Higher Break-even Point Greater Risk Greater Potential Returns Low Operating Leverage Low Fixed / High Variable Costs Lower CM/Unit Lower Break-even Point Reduced Risk Lower Potential Returns

22. If fixed expenses are doubled, the break even point in units would be doubled, and break even points in sales would be cut in half TRUE/FALSE

23. As the level of activity increases within the relevant range Total variable costs remain unchanged Variable costs per unit decrease Total fixed costs increases Fixed costs per unit decrease

24. Chapter 3 Measurement and Cost Behavior

25. Variations in Cost Behaviour • Step Costs • change abruptly at intervals of activity because the resources and their costs come in indivisible chunks • supervisory salaries • Mixed Costs • contain both variable and fixed cost elements • maintenance costs $ Volume $ Volume

26. Management Influence on Cost Functions Management has influence over 3 general categories of cost: • Capacity Costs • Committed Fixed Costs • Discretionary Fixed Costs Capacity Costs: • fixed costs of being able to achieve a desired level of production or service • once capacity is set, the company is committed to the fixed costs of that capacity level • setting capacity is very important if long-run demand fluctuates –> decisions must be made to increase investment in facilities and equipment and, therefore, increase long-term capacity costs, or to pay a premium (outsource or pay overtime) at times of peak demand

27. Management Influence on Cost Functions II Committed Fixed Costs: • arise from the possession of facilities, equipment, and a basic organization • large, indivisible chunks of cost that the organization is obligated to incur and usually would not consider avoiding • mortgage payments, lease payments, property taxes, insurance, salaries of key personnel • committed fixed costs can only be changed by changing the basic philosophy, scale or scope of the organization's operations

28. Management Influence on Costs Functions III Discretionary Fixed Costs: • each planning period, management will determine how much to spend • advertising, promotion, research and development, employee training • the amount of spending may vary, but only because management has decided to spend more or less • management can influence spending on these costs in the short run

29. Measuring Cost Behavior Cost Function • algebraic equation of the cost and its cost driver • linear cost function is as follows: Y = F + VX where • Y is the total cost • F is the intercept of the vertical axis or the fixed cost • V is the slope or the variable cost per unit of activity • X is the cost driver (in units) Example: Total Maintenance Costs per month Given: Monthly Maintenance Salaries of $10,000; Cost Driver is (units are) Mechanic Hours; Cost per Mechanic Hour is $15.00 What is the Monthly Maintenance Cost at500 Mechanic Hrs.? What is the Monthly Maintenance Cost at 650 Mechanic Hrs.?

30. Measuring Cost Behavior Criteria for Choosing A Cost Function: • Use activity analysis to determine which cost driver best explains how the cost behaves • Economic plausibility (it must make sense that X causes Y) • Reliability (the estimates derived by the cost equation must conform with actually observed costs)

31. Methods of Measuring Cost Functions: Engineering Analysis • systematic review of costs based on past experience Account Analysis • review of accounting records and the subjective determination of cost behavior patterns High-Low Analysis • use of simple linear algebra to determine variable and fixed costs • may yield unreliable results Visual Fit Analysis • fit a representative line to the data as shown in a scatter diagram Regression Analysis • using mathematical formula, determine the cost equation which best fits the data • may be simple least squares regression with one X variable or multiple least squares regression with more than one X variable • enables user to measure the "quality" of the predictive equation

32. High-Low Approach to Cost Analysis Equation: Y = F + VX Variable cost = change in cost / change in volume = $30,000 / 3,700 = $8.108 per patient-day Fixed cost = total mixed cost - variable cost = $40,000 - ($8.108 x 4,900) = $40,000 - $39,730 = $270 per month Maintenance Costs = $270 + $8.108 per square meter (cost driver)

33. Regression Analysis Check for Economic Plausibility • Does it make sense that X and Y are related? Plot the data • to see if basic relationship is linear and identify "outliers" Generate Regression Output Constant $9,329 Std Error of Y Estimate $2,145 Observations 12 R-Squared 0.954 Degrees of Freedom 10 X Coefficient(s) $6.95 Std Error of Coefficent 0.479 Interpret Regression Output • R-squared (R2) varies between 0 and 1 • The closer to R2 is to 1 the more X explains the changes in Y • Standard error of Y estimate and standard error of X coefficient(s) can be used to set confidence intervals for the cost function estimates and the predicted value of the variable cost per unit

34. T/F QUESTIONS When graphing a cost function, the Total Variable cost is the intercept? Plausibility and reliability are 2 important factors to consider to ensure accurate and useful cost functions

35. Costs that change abruptly at intervals of activity because the resources and their costs come in indivisible chunks are called Step costs Intangible costs Variable costs Mixed costs

36. A cost function does not explain past cost behaviour should be a reliable predictor of future costs should include only personal observations of costs and activities need not have a cause-and-effect relationship

37. ___ is a method in which the analyst would place a straight line through a plot of available data Engineering Analysis Accounting Analysis Visual Fit Least Square Regression Method

38. Chapter 4 Cost Management Systems

39. Cost Management Systems Cost Object • a department, service or product for which cost information is collected Direct Cost • a cost which can be identified specifically and exclusively with a given cost objective in an economically feasible way • examples: direct material and direct labour • ASSIGNED Indirect Cost • a cost which cannot be identified specifically and exclusively with a given cost objective in an economically feasible way • factory overhead cost (or factory burden) • all factory costs other than direct material and direct labour • power, supplies, indirect labor, supervisory salaries, property taxes, rent, insurance and depreciation • ALLOCATED A COST CAN BE BOTH DIRECT AND INDIRECT DEPENDING ON COST OBJECT

40. Manufacturing Costs Prime Costs • Direct Material and Direct Labour costs • in many companies direct labour has become so insignificant that it is simply lumped in with overhead Conversion Costs • Direct Labour and Factory Overhead costs • cost of converting material into finished product Prime Costs Direct Materials Direct Labour Factory Overhead Conversion Costs

41. Product and Period Costs - Retailer Product Costs • also called ‘Inventoriable Costs’ • all costs involved in the purchase or manufacture of goods • are expensed only when product is sold Period Costs • costs which are expensed during the period they are incurred (without going through an inventory stage) Balance Sheet Income Statement Cost of Goods Sold Merchandise Inventory Product Costs Selling & Administrative Expenses Period Costs

42. Product and Period Costs - Manufacturer Product Costs • also called ‘Inventoriable Costs’ • all costs involved in the purchase or manufacture of goods • are expensed only when product is sold Period Costs • costs which are expensed during the period they are incurred (without going through an inventory stage) Balance Sheet Income Statement Direct Material Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Selling & Administrative Expenses Product Costs Period Costs

43. Product and Period Costs • Contribution • Costing • Variable Manufacturing • Fixed Manufacturing • Overhead • Variable Selling • & Administrative • Fixed Selling • & Administrative Absorption Costing Variable Manufacturing Fixed Manufacturing Overhead Variable Selling & Administrative Fixed Selling & Administrative Product Costs Period Costs

44. Absorption Income Statement Sales $20,000 Cost of Goods Sold: Direct material $7,000 Direct labour 4,000 Factory overhead 4,00015,000 Gross margin 5,000 Selling expenses 3,000 Administrative expenses 1,000 Total selling & administrative expenses 4,000 Operating Income $1,000 Contribution Income Statement Sales $20,000 Variable expenses: Direct material $7,000 Direct labour 4,000 Variable overhead 1,000 Variable selling 1,000 Variable administrative 100 Total variable expenses 13,100 Contribution margin 6,900 Fixed expenses: Manufacturing $3,000 Selling 2,000 Administrative 900 Total fixed expenses 5,900 Operating Income $1,000 Cost Behaviour and Income Statements

45. Absorption & Variable Costing Revenue Cost of Goods Sold Gross Margin Sell & Admin Costs Net Income Absorption Costing Income Statement • Also called "full" costing • Classify costs by function - selling & administration versus manufacturing • Inventory comprised of variable and fixed production costs • Net income is a function of sales and production Variable Costing Income Statement • Also called "direct" or "variable" • Classify costs based on behaviour • Inventory comprised of only variable production costs • Net income is a function of sales Converting Between the Two Models of Income • Difference in net income is equal to the difference in the values assigned to inventories on the two statements • Absorption’s inventory value will be higher since it includes an allocation of fixed production costs and Variable’s does not Revenue Variable Costs Contribution Margin Fixed Costs Net Income

46. Cost Flows: Absorption Costing Inventoried Costs on Balance Sheet Expense on Income Statement Costs to Account For Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead Initially applied to inventory as unexpired costs Become expenses when inventory is sold As goods are sold Become expenses immediately Expires immediately All selling & administrative costs

47. Cost Flows: Variable Costing Inventoried Costs on Balance Sheet Expense on Income Statement Costs to Account For Direct material Direct labour Variable manufacturing overhead Initially applied to inventory as unexpired costs Become expenses when inventory is sold As goods are sold Fixed manufacturing overhead Become expenses immediately Expires immediately All selling & administrative costs

48. Fixed Manufacturing Overhead & Absorption Costing • Firms use a fixed overhead rate to smooth the application of fixed overhead to ‘work in process’ and to determine "full" product costs Fixed = Budgeted fixed manufacturing overhead overhead rate Expected volume of production Production Actual - Expected x fixed-overhead volume = volume volume rate variance

49. Flow of Fixed Manufacturing Costs - Variable Inventoried Costs on Balance Sheet Expense on Income Statement Fixed Manufacturing Overhead Incurred None $150,000 $150,000

50. Flow of Fixed Manufacturing Costs - Absorption Inventoried Costs on Balance Sheet Expense on Income Statement Fixed-overhead costs in beginning inventory: $30,000 Fixed Manufacturing Overhead Incurred $140,000 $150,000 Cost of goods sold: $30,000 + $140,000 - $10,000 = $160,000 Costs added to product: $140,000 Fixed-overhead costs in ending inventory: $10,000 Unfavourable production volume variance: $10,000 $10,000 • When inventory increases, absorption will yield higher income • When inventory decreases, absorption will yield lower income • IF amount charged is GREATER than budgeted, favorable variance (subtract from COGS) Total expense = $170,000