Comparison of Financial and Managerial Accounting

1. Comparison of Financial and Managerial Accounting

2. Opportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you werenot attending college,you could be earning$15,000 per year. Your opportunity costof attending college for one year is $15,000.

3. Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions. Example:You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.

4. DirectMaterials DirectLabor ManufacturingOverhead Manufacturing Costs The Product

5. Marketing or Selling Cost Administrative Cost Costs necessary to get the order and deliver the product. All executive, organizational, and clerical costs. Non-manufacturing Costs

6. Inventory Expense Cost of Good Sold Sale BalanceSheet IncomeStatement IncomeStatement Product Costs Versus Period Costs Product costs include direct materials, direct labor, and manufacturing overhead. Period costs include all marketing or selling costs and administrative costs.

7. Comparing Merchandising and Manufacturing Activities Merchandisers . . . • Buy finished goods. • Sell finished goods. Manufacturers . . . • Buy raw materials. • Produce and sell finished goods.

8. A company produces many units of a single product. • One unit of product is indistinguishable from other units of product. • The identical nature of each unit of product enables assigning the same average cost per unit. Types of Product Costing Systems ProcessCosting Job-orderCosting

9. Many different products are produced each period. • Products are manufactured to order. • The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job. Types of Product Costing Systems ProcessCosting Job-orderCosting

10. Direct Manufacturing Costs Charge direct material and direct labor costs to each job as work is performed. Direct Materials Job No. 1 Direct Labor Job No. 2 Manufacturing Overhead Job No. 3

11. Indirect Manufacturing Costs Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job. Direct Materials Job No. 1 Direct Labor Job No. 2 Manufacturing Overhead Job No. 3

12. Estimated total manufacturingoverhead cost for the coming period POHR = Estimated total units in theallocation base for the coming period Ideally, the allocation base is a cost driver that causes overhead. Manufacturing Overhead Application The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins.

13. The Need for a POHR Using a predetermined rate makes itpossible to estimate total job costs sooner. Actual overhead for the period is notknown until the end of the period.

14. Overhead applied = POHR × Actual activity Application of Manufacturing Overhead Based on estimates, and determined before the period begins. Actual amount of the allocation based upon the actual level of activity.

15. Estimated total manufacturingoverhead cost for the coming period POHR = Estimated total units in theallocation base for the coming period $640,000 POHR = 160,000 direct labor hours (DLH) Overhead Application Rate POHR = $4.00 per DLH For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.

16. Job-Order Cost Accounting

17. Cost Classifications for Predicting Cost Behavior How a cost will react to changes in the level of activity within the relevant range. • Total variable costschange when activity changes. • Total fixed costsremain unchanged when activity changes.

18. Cost Classifications for Predicting Cost Behavior

19. Unitsproduced Machine hours Miles driven Labor hours The Activity Base A measure of what causes the incurrence of a variable cost

20. Extent of Variable Costs The proportion of variable costs differs across organizations. For example . . . A public utility withlarge investments inequipment will tendto have fewervariable costs. A manufacturing companywill often have manyvariable costs. A merchandising companyusually will have a high proportion of variable costs like cost of sales. A service companywill normally have a high proportion of variable costs.

21. Examples of Variable Costs • Merchandising companies – cost of goods sold. • Manufacturing companies – direct materials, direct labor, and variable overhead. • Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. • Service companies – supplies, travel, and clerical.

22. A straight line closely approximates a curvilinear variable cost line within the relevant range. RelevantRange Accountant’s Straight-Line Approximation (constant unit variable cost) The Linearity Assumption and the Relevant Range Economist’sCurvilinear Cost Function Total Cost Activity

23. Types of Fixed Costs Committed Long-term, cannot be significantly reduced in the short term. Discretionary May be altered in the short-term by current managerial decisions Examples Depreciation on Equipment and Real Estate Taxes Examples Advertising and Research and Development

24. The Trend Toward Fixed Costs The trend in many industries is toward greater fixed costs relative to variable costs. As machines take overmany mundane taskspreviously performedby humans, “knowledge workers”are demanded fortheir minds ratherthan their muscles Knowledge workerstend to be salaried,highly-trained anddifficult to replace. Thecost to compensatethese valued employeesis relatively fixedrather than variable.

25. Fixed Costs and Relevant Range 90 Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. Relevant Range 60 Rent Cost in Thousands of Dollars 30 0 0 1,000 2,000 3,000 Rented Area (Square Feet)

26. Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.

27. The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income. The Contribution Format

28. Used primarily forexternal reporting. Used primarily bymanagement. The Contribution Format

29. Break-Even Analysis Here is the information from Racing Bicycle Company:

30. Break-even point in units sold Fixed expenses Unit contribution margin = Break-even point in total sales dollars Fixed expenses CM ratio = Contribution Margin Method The contribution margin method has two key equations.

31. $80,000 40% Break-even point in total sales dollars = $200,000 break-even sales Fixed expenses CM ratio = Contribution Margin Method Let’s use the contribution margin method to calculate the break-even point in total sales dollars at Racing.

32. $80,000 $200/unit Break-even point in Units sold = 400 break-even units Fixed expenses Unit CM = Contribution Margin Method Let’s use the contribution margin method to calculate the break-even point in units sold at Racing.

33. Target Profit Analysis The contribution margin method can be used to determine the sales volume needed to achieve a target profit. Suppose Racing Bicycle Company wants to know how many bikes must be sold to earn a profit of $100,000.

34. Unit sales to attain the target profit Fixed expenses + Target profit Unit contribution margin = $80,000 + $100,000 $200/bike =900 bikes The Contribution Margin Approach The contribution margin method can be used to determine that 900 bikes must be sold to earn the target profit of $100,000.

35. Cost Structure and Profit Stability Cost structure refers to the relative proportion of fixed and variable costs in an organization. Managers often have some latitude in determining their organization’s cost structure.

36. Degree of operating leverage Contribution margin Net operating income = Operating Leverage • A measure of how sensitive net operating income is to percentage changes in sales.

37. Operating Leverage Example

38. Operating Leverage Example 10% increase in sales 10% * 1.25 = 12.5%increase in profit 10% * 3.75 = 37.5%increase in profit

39. Cost Structure and Profit Stability There are advantages and disadvantages to high fixed cost (or low variable cost) and low fixed cost (or high variable cost) structures. An advantage of a high fixedcost structure is that incomewill be higher in good yearscompared to companieswith lower proportion offixed costs. A disadvantage of a high fixedcost structure is that incomewill be lower in bad yearscompared to companieswith lower proportion offixed costs.

40. The Basic Framework of Budgeting A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. • The act of preparing a budget is called budgeting. • The use of budgets to control an organization’s activity is known as budgetary control.

41. Planning and Control Planning – involves developing objectives and preparing various budgets to achieve these objectives. Control– involves the steps taken by management that attempt to ensure the objectives are attained.

42. Define goal and objectives Communicate plans Think about and plan for the future Coordinate activities Means of allocating resources Uncover potential bottlenecks Advantages of Budgeting Advantages

43. Responsibility Accounting Managers should be held responsible for those items — and only those items — thatthe manager can actually controlto a significant extent.

44. Human Factors in Budgeting The success of budgeting depends upon three important factors: • Top management must be enthusiastic and committed to the budget process. • Top management must not use the budget to pressure employees or blame them when something goes wrong. • Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets.

45. The Master Budget: An Overview Sales Budget EndingFinished Goods Budget Selling and Administrative Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Cash Budget Budgeted Financial Statements

46. Budgeting Example • Royal Company is preparing budgets for the quarter ending June 30. • Budgeted sales for the next five months are: • April 20,000 units • May 50,000 units • June 30,000 units • July 25,000 units • August 15,000 units. • The selling price is $10 per unit.

47. Expected Cash Collections • All sales are on account. • Royal’s collection pattern is: • 70% collected in the month of sale, • 25% collected in the month following sale, • 5% uncollectible. • The March 31 accounts receivable balance of $30,000 will be collected in full.

48. Expected Cash Collections

49. From the Sales Budget for April. Expected Cash Collections

50. From the Sales Budget for May. Expected Cash Collections