Accounting: What the Numbers Mean

1. Accounting: What the Numbers Mean Study Outlines and Overhead Masters Chapter 12

2. MANAGERIAL ACCOUNTING COMPARED TO FINANCIAL ACCOUNTING • KEY CHARACTERISTICS THAT DIFFER • SERVICE PERSPECTIVE • BREADTH OF CONCERN • REPORTING FREQUENCY AND PROMPTNESS • DEGREE OF PRECISION OF DATA USED • REPORTING STANDARDS

3. COST CLASSIFICATIONS • KEY IDEA • DIFFERENT COSTS FOR DIFFERENT PURPOSES. • COST CLASSIFICATIONS • FOR COST ACCOUNTING PURPOSES (CH 12, 14, & 15): • PRODUCT COST • PERIOD COST • RELATIONSHIP TO PRODUCT OR ACTIVITY (CH 13): • DIRECT COST • INDIRECT COST • RELATIONSHIP BETWEEN TOTAL COST AND VOLUME OF ACTIVITY (CH 13): • VARIABLE COST • FIXED COST • TIME-FRAME PERSPECTIVE (CH 14 & 15): • COMMITTED COST • DISCRETIONARY COST • CONTROLLABLE COST • NONCONTROLLABLE COST • FOR OTHER ANALYTICAL PURPOSES (CH 16): • DIFFERENTIAL COST • ALLOCATED COST • SUNK COST • OPPORTUNITY COST

4. RELATIONSHIP OF TOTAL COST TO VOLUME OF ACTIVITY • KEY IDEA • COST BEHAVIOR PATTERN DESCRIBES HOW TOTAL COST VARIES WITH CHANGES IN ACTIVITY. • KEY RELATIONSHIPS • VARIABLE COST g FIXED COST • KEY ASSUMPTIONS • RELEVANT RANGE • LINEARITY

5. COST FORMULA • KEY POINT • A COST FORMULA DESCRIBES THE EXPECTED TOTAL COST FOR ANY VOLUME OF ACTIVITY, USING COST BEHAVIOR INFORMATION. • KEY RELATIONSHIP • TOTAL = FIXED + VARIABLE •   COST COST COST • = FIXED + (VARIABLE COST RATEPER UNIT * ACTIVITY) • KEY IDEA • WHENEVER POSSIBLE, AVOID UNITIZING FIXED COSTS, BECAUSE THEY DO NOT BEHAVE THAT WAY!

6. INCOME STATEMENT MODELS • TRADITIONAL MODEL • REVENUES • - COST OF GOODS SOLD • GROSS PROFIT • - OPERATING EXPENSES • OPERATING INCOME • CONTRIBUTION MARGIN MODEL • REVENUES • - VARIABLE EXPENSES • CONTRIBUTION MARGIN • - FIXED EXPENSES • OPERATING INCOME • KEY IDEAS • THE TRADITIONAL MODEL CLASSIFIES EXPENSES BY FUNCTION, AND THE CONTRIBUTION MARGIN MODEL CLASSIFIES EXPENSES BY COST BEHAVIOR PATTERN. • THE CONTRIBUTION MARGIN MODEL IS USEFUL FOR DETERMINING THE EFFECT ON OPERATING INCOME OF CHANGES IN THE LEVEL OF ACTIVITY.

7. EXPANDED CONTRIBUTION MARGIN MODEL • PER UNIT X VOLUME = TOTAL % • REVENUE $ 1. $ 100% • VARIABLE EXP. $ 1. • CONT. MARGIN $ 1. X 2. = 2. • FIXED EXPENSES 3. • OPERATING INCOME $ 3. • KEY IDEAS • THE PREFERRED ROUTE THROUGH THE MODEL IS: • TO ENTER PER UNIT REVENUE AND VARIABLE EXPENSES TO GET UNIT CONTRIBUTION MARGIN. • THEN MULTIPLY UNIT CONTRIBUTION MARGIN BY VOLUME (QUANTITY SOLD) TO GET TOTAL CONTRIBUTION MARGIN. • FIXED EXPENSES ARE NOT EXPRESSED ON A PER UNIT BASIS; THEY ARE SUBTRACTED FROM TOTAL CONTRIBUTION MARGIN TO GET OPERATING INCOME. • THE CONTRIBUTION MARGIN RATIO EXPRESSES CONTRIBUTION MARGIN AS A PERCENTAGE OF REVENUES, ON EITHER A PER UNIT OR TOTAL BASIS.

8. BREAK-EVEN POINT ANALYSIS • KEY IDEA • MANAGERS FREQUENTLY WANT TO KNOW THE NUMBER OF UNITS THAT MUST BE SOLD, OR THE TOTAL SALES DOLLARS REQUIRED, TO BREAK-EVEN (HAVE ZERO OPERATING INCOME). • BREAK-EVEN GRAPH • KEY POINT • ONCE THE BREAK-EVEN POINT HAS BEEN REACHED, OPERATING INCOME INCREASES BY THE AMOUNT OF CONTRIBUTION MARGIN FROM EACH ADDITIONAL UNIT SOLD.

9. KEY ASSUMPTIONS TO REMEMBER WHEN USING CONTRIBUTION MARGIN ANALYSIS • COST BEHAVIOR PATTERNS CAN BE IDENTIFIED. • COSTS ARE LINEAR WITHIN THE RELEVANT RANGE. • ACTIVITY REMAINS WITHIN THE RELEVANT RANGE. • SALES MIX OF THE FIRM’S PRODUCTS WITH DIFFERENT CONTRIBUTION MARGIN RATIOS DOES NOT CHANGE. • KEY POINT • IF THESE SIMPLIFYING ASSUMPTIONS ARE NOT VALID, THE ANALYSIS IS MADE MORE COMPLICATED BUT THE CONCEPTS ARE STILL APPLICABLE.