Lesson 14 Managerial Accounting Applications

Task Team of FUNDAMENTAL ACCOUNTING

School of Business, Sun Yat-sen University

Lesson Notes

Lesson 14 Managerial Accounting: Applications

Learning objectives

1. Describe segmented reporting and responsibility accounting system

2. Explain the main aspects of Cost-volume-profit analysis

3. Analyze budgeting and budgetary control

4. Describe standard costs and variance analysis

5. Explain the use of managerial accounting in decision making

Teaching hours

Students major in accounting 0 hours

Other students 6 hours

Teaching contents

Introduction

Let’s look at the XYZ Company example. A manager at XYZ Company wants to replace an

old machine with a new, more efficient machine.

New machine:

List price 900000

Annual variable expenses 800000

Expected life in years 5

Old machine:

Original cost 720000

Remaining book value 600000

Disposal value now 150000

Annual variable expenses 1000000

Remaining life in years 5

XYZ’s sales are $2000000 per year. Fixed expenses, other than amortization, are $700000

per year. Should the manager purchase the new machine? The manager recommends that the

company not purchase the new machine since disposal of the old machine would result in a loss:

Remaining book value 600000

Disposal value -150000

Loss from disposal 450000

1 Is it correct?

2 What’s your comment to the manager’s decision?

After learning this chapter, you will know how to employ the tools of managerial accounting

and make decisions correctly.

Segmented Reporting and Responsibility Accounting Systems

Segmented Reporting Organizations may break down their operations into various segments,

such as divisions, stores, services, or departments. Thus, management needs reports on each



segment for cost management and performance evaluation.

Segments may be evaluated as a cost centre, a profit centre, where profit centre reports

include information on a segment’s revenues and costs, and an investment centre.

Some costs are direct and some are indirect, and indirect costs may be allocated to various

departments. Service department costs are shared indirect expenses of operation departments.

They may be allocated using a variety of bases. Please refer to the following table:

Service Department Common Allocation Bases

General Office Number of employees

Personnel Number of employees

Payroll Number of employees

Advertising Sales

Purchasing

Number of Purchase

Orders

Cleaning Floor space occupied

Maintenance Floor space occupied

Responsibility Accounting System Responsibility accounting system is an accounting system

which assigns managers the responsibility for costs and expenses under their control.

Responsibility accounting budgets are prepared prior to each accounting period.

Responsibility accounting performance reports compare actual costs and expenses to budgeted

amounts

Cost-volume-profit Analysis

CVP analysis is used to answer the questions such as (1) How much must I sell to earn my

desired income? (2) How will income be affected if I reduce selling prices to increase sales

volume? (3) How will income be affected if I change the sales mix of my products?.... The basic assumptions of CVP analysis is that CVP analysis assumes relations can be

expressed as straight lines within the relevant range, which means that unit selling price remains

constant, unit variable costs remain constant, and total fixed cost remain constant. If the expected

cost and revenue behaviour is different from the assumptions, then the results of CVP analysis are

of limited use.

The objective of the cost analysis is determination of total fixed cost and the variable unit

cost. The basic methods to estimate the total costs equation include: (1) scatter diagram; (2)

high-low method; and (3) least-squares regression. Here least-squares regression is usually

covered in advanced cost accounting courses. It is commonly used with computer software

because of the large number of calculations required.

Break-even Analysis The break-even point is the unique sales level at which a company

neither earns a profit nor incurs a loss. The break-even point may be expressed in units or in

dollars of sales.

Break-even point in units =

Contribution margin per unit

Fixed Costs



Computing Income from Expected Sales The income given a predicted level of sales can be

computed as follows:

Sales Volume Needed to Earn a Target Income Break-even formulas can be adjusted to

show the sales volume needed to earn any amount of income.

Break-even point in dollars =

Contribution margin ratio

Fixed Costs

= Sales – [Fixed costs + Variable costs]

Pre-tax

Income = Sales –Fixed costs - Variable costs

or

Pre-tax

Income

Income

Contribution margin ratio

Contribution margin per unit Unit sales =

Fixed costs + Target income

Dollar sales = Fixed costs + Target income



Margin of Safety Margin of safety is used to estimate how much sales can decrease before

the company incurs a loss?

Sensitivity Analysis Sensitivity analysis is used to estimate the effects of changes in variables

such as sales price, variable costs, and fixed costs. CVP analysis can be used to show the effects of

such changes.

Budgeting and Budgetary Control

Budgets Budgets are formal statements of a company’s plans expressed in monetary terms,

which attempt to capture the future activities of an organization. They are used by businesses,

not-for-profit, government, educational, and other types of organizations.

The importance of budgeting include (1) defines goals and objectives; (2) promotes analysis

and a focus on the future; (3) motivates employees; (4) provides a basis for evaluating

performance; (5) coordinates business activities; (6) communicates plans and instructions.

Budget Committee consists of managers from all departments of the organization. It provides

central guidance to insure that individual budgets submitted from all departments are realistic and

coordinated. Flow of budget data is a bottom-up process.

Budget horizons are usually for one year, but may extend for several years. The annual

operating budget may be divided into quarterly or monthly budgets.

Rolling budgets mean that the budget may be a twelve-month budget that rolls forward one

month as the current month is completed.

Master Budget Master budget is a formal, comprehensive plan for the future of a company. It

consists of several budgets linked together to form a coordinated plan for the organization.

Expected sales

Margin of safety, percent

Expected sales - Break-even sales =

New contribution margin ratio

New

break-even

point in dollars

New fixed costs

=



Sales Budget Sales budget is the starting point in the budgeting process. Most of the other

budgets are linked to the sales budget. Sales personnel are often involved in developing the sales

budgets.

Merchandise Purchases Budget Merchandise purchases budget provides detailed

information about the purchases necessary to fulfill the sales budget and provide adequate

inventories.

The quantity purchased is affected by: (1) Just-in-time inventory systems, which enable

purchases of smaller, frequently delivered quantities; (2) Safety stock inventory systems, which

provide protection against lost sales caused by delays in supplier shipments.

Selling Expense Budget Selling expense budget lists the types and amounts of selling

Prepare

sales

budget

Develop

production

budget

Prepare

financial

budgets

Prepare

capital

expenditure

budget

Prepare

selling and

general

administrative

budgets

Prepare

manufacturing

budgets

Sales

Budget

Estimated

Unit Sales

Estimated

Unit Price

Analysis of economic and market conditions

+

Forecasts of customer needs from marketing personnel

Merchandise

inventory to

be purchased

Budgeted

ending

inventory

Budgeted

sales for the

period

Budgeted

beginning

inventory

= + _



expenses. Predictions of expenses are based on the sales budget and past experience.

General and Administrative Expense Budget General and administrative expense budget

lists the predicted operating expenses not listed in the sales budget. It includes both cash and

non-cash expenses and is often prepared by the office manager or person responsible for general

administration.

Capital Expenditures Budget Capital expenditures budget lists the cash inflows or outflows

pertaining to the disposal or acquisition of capital equipment, and it is usually affected by the

organization’s long-term plans.

Cash Budget Cash Budget lists the expected cash inflows and outflows for the period. It is a

tool used by management to avoid excess cash balances or cash shortages. Information from other

budgets is used in its preparation. Information from the cash budget is used to prepare the

budgeted income statement and balance sheet.

Production and Manufacturing Budgets Manufacturing companies need to prepare

additional budgets that include: production budgets, direct materials purchase budgets, direct

labour budgets, and manufacturing overhead budgets.

Production and manufacturing budgets provides detailed information about the production

necessary to fulfill the sales budget and provide adequate inventories.

Direct materials budget provides detailed information about the purchases of raw materials

necessary to fulfill the production budget and provide adequate inventories.

Direct labour and manufacturing overhead budgets provides information about the labour and

manufacturing overhead costs given the level of production for the period.

Preparing Financial Budgets

Units of raw

materials to

be purchased

Materials

needed for

production

Budgeted

ending

inventory

Budgeted

beginning

inventory

= + _

Cost of raw

materials to

be purchased

Units of raw

materials to

be purchased

Material price

per unit of

raw material

= x

Number of

units to be

produced

Budgeted

ending

inventory

Budgeted

sales for the

period

Budgeted

beginning

inventory

= + _



Budgetary Control

Capital Budgeting Capital budgeting analyzes alternative long-term investments and

deciding which assets to acquire or sell. These decisions require careful analysis since: (1) The

outcome is uncertain; (2) Large amounts of money are usually involved; (3) Investment involves a

long-term commitment; (4) Any decision may be difficult or impossible to reverse.

Zero-based Budgeting Zero-based budgeting are prepared assuming no previous activities

for the activities being planned. Managers must justify the amounts budgeted for each activity. It

is popular among government and non-profit organizations.

Fixed Budget Fixed budgets are prepared for a single, predicted level of activity.

Performance evaluation is difficult when actual activity differs from the predicted level of activity.

For example: How much of the unfavourable cost variance is due to higher activity, and how

much is due to poor cost control? To answer these questions, we must flex the budget to the actual

level of activity

Flexible (Variable) Budgets Flexible budgets are prepared after a period’s activities are

complete. They show revenues and expenses that should have occurred at the actual level of

activity. Flexible budgets reveal cost variances due to good cost control or lack of cost control,

which improve performance evaluation.

Since flexible budgets prepare a budget for different activity levels, we must know how

costs behave with changes in activity levels. Total variable costs change in direct proportion to

changes in activity; Total fixed costs remain unchanged within the relevant range.

Standard Costs and Variance Analysis

Standard Costs Standard costs are preset costs for delivering a product or service under

normal conditions, which are established through personnel, engineering, and accounting studies

using past experience. Standard costs are benchmarks used in evaluating performance, and are

often used in setting budgets.

A standard cost card:

Cost factor

Standard

Quantity or

Hours

Standard Price or

Rate

Standard

Cost

Cash

Budget

Expected

Receipts

and

Disbursement

s

Budgeted

Income

Statement

Budgete

d

Balance

Sheet



Direct materials 1 kg $ 25 per kg $ 25.00

Direct labour 2 hours $ 20 per hour $ 40.00

Variable mfg.

overhead 2 hours $ 10 per hour $ 20.00

Total standard unit

cost $ 85.00

Variance Analysis The process of variance analysis can be listed as follows:

Standard cost accounting provides management with information about costs that differ from

budgeted amounts (variances). Management may choose to focus only on variances that are

significant. This approach is referred to as management by exception.

Material variances: Please refer to ppt page 51.

Labour variances: Please refer to ppt page 52.

Variable overhead variances: Please refer to ppt page 53.

Fixed overhead variances: Please refer to ppt page 54.

Standard costs accounting systems record variances in the accounts, which can simplify

recordkeeping and help in the preparation of reports.

Discussions

ABC Company has the following direct material standard to manufacture one unit product:

3.0 kilograms per unit at $8.00 per kilogram. Last week 6600 kilograms of material were

purchased and used to make 2000 units. The material cost a total of $53000.

What is the actual price per kilogram paid for the material?

a. $7.26 per kilogram.

b. $8.13 per kilogram.

c. $8.03 per kilogram.

d. $8.00 per kilogram.

AP = $53000 6600 kg

AP = $8.03 per kg

Take action

Prepare standard

cost performance

reports

Investigate

causes

Analyze

variances



ABC s material price variance (MPV) for the week was:

a. $198 favourable.

b. $198 unfavourable.

c. $189 favourable.

d. $189 unfavourable.

MPV = AQ(AP - SP)

MPV =6600 kg ($8.03 - 8.00)

MPV = $198 unfavourable

The standard quantity of material that should have been used to produce 2000 units is:

a. 6500 kilograms.

b. 6000 kilograms.

c. 7000 kilograms.

d. 5000 kilograms.

SQ = 2000 units 3 kg per unit

SQ = 6000 kg

ABC s material quantity variance (MQV) for the week was:

a. $4300 unfavourable.

b. $4300 favourable.

c. $4800 unfavourable.

d. $4800 favourable.

MQV = SP(AQ - SQ)

MQV = $8.00(6600 kg - 6000 kg)

MQV = $4800 unfavourable

Managerial Decision Making

Cost accounting information is often used by management for short-term decisions. Decision

making involves five steps: (1) Define the problem; (2) Identify alternatives; (3) Collect relevant

information on alternatives; (4) Select the preferred alternative; (5) Analyze decisions made.

Accepting additional business This decision making should be based on incremental costs

and incremental revenues. Incremental amounts are those that occur if the company decides to

accept the new business

.

Make or Buy Decisions Incremental costs also are important in the decision to make a

product or purchase it from a supplier. The cost to produce an item must include direct materials,

direct labour, and incremental overhead. We should not use the predetermined overhead rate to

determine product cost.



Scrap or Rework Defects Costs incurred in manufacturing units of product that do not meet

quality standards are sunk costs and cannot be recovered. As long as rework costs are recovered

through sale of the product and rework does not interfere with normal production, we should

rework rather than scrap.

Sell or Process Further This decision making is related to sell partially completed products

vs. process them to completion. As a general rule, process further only if incremental revenues

exceed incremental costs.

Selecting Sales Mix When a company sells a variety of products, some are likely to be more

profitable than others. To make an informed decision regarding sales mix, management must

consider (1) the contribution margin of each product; (2) the facilities required to produce each

product and any constraints on the facilities, and (3) the demand for each product.

Eliminating a Segment A segment is a candidate for elimination if its revenues are less than

its avoidable expenses.

Qualitative Factors in Decisions Qualitative factors are involved in most all managerial

decisions, including quality, delivery schedule, supplier reputation, employee morale, customer

opinions, etc.

Discussions

Consider the beginning XYZ case

Relevant Cost Analysis

Savings in variable

expenses provided by the

new machine ($200000 × 5

yrs.) 1000000

Cost of the new machine (900000)

Disposal value of old

machine 150000

Net effect 250000

Case Study

ABC Corporation, a merchandising company, has provided the following budget data:

Purchases Sales

May $84000 $144000

June $96000 $132000

July $72000 $120000

August $108000 $156000

September $120000 $132000



Collections from customers are normally 75% in the month of sale, 15% in the month

following the sale, and 8% in the second month following the sale. The balance is expected to be

uncollectible. ABC pays for purchases in the month following the purchase. Cash disbursements

for expenses other than merchandise purchases are expected to be $28,800 for September. ABC's

cash balance on September 1 was $44,000.

Required:

1) Compute the expected cash collections during September.

2) Compute the expected cash balance on September 30.

Key points

1. cost-volume-profit analysis

2. budgets

3. variance analysis

4. decision making

Reading material

1. Charles T. Horngren, George Foster and Srilant Datar, Cost Accounting: A Managerial

Emphasis (Tenth Edition), Prentice Hall Inc., 2000.

2. Anthony A. Atkinson, Rajiv D.Banker, Robert S. Kaplan, S. Mark Young, Management

Accounting , Prentice Hall Inc., 2001.

Lesson 14 Managerial Accounting Applications

Documents

Transcript of Lesson 14 Managerial Accounting Applications