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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 Other students 0 hours 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 Annual variable expenses Expected life in years Old machine: Original cost Remaining book value Disposal value now Annual variable expenses Remaining life in years 720000 600000 150000 1000000 5 900000 800000 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 Disposal value Loss from disposal 600000 -150000 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 Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 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 General Office Personnel Payroll Advertising Purchasing Cleaning Maintenance Common Allocation Bases Number of employees Number of employees Number of employees Sales Number Orders Floor space occupied Floor space occupied of Purchase 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. Fixed Costs Break-even point in units = Contribution margin per unit = Fixed Costs Contribution margin ratio Break-even point in dollars Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University Computing Income from Expected Sales The income given a predicted level of sales can be computed as follows: Pre-tax Income = Sales – [Fixed costs + Variable costs] or Income Pre-tax Income = Sales –Fixed costs - Variable costs 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. Fixed costs + Target income Unit sales = Contribution margin per unit Fixed costs + Target income Dollar sales = Contribution margin ratio Margin of Safety Margin of safety is used to estimate how much sales can decrease before the company incurs a loss? Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University Margin of Expected sales - Break-even sales safety, = Expected sales percent 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. New break-even = point in dollars New fixed costs New contribution margin ratio 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. Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University Prepare Prepare sales budget Develop production budget manufacturing budgets Prepare financial budgets Prepare capital expenditure budget Prepare selling and general administrative budgets 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. Sales Budget Estimated Unit Sales Estimated Unit Price Analysis of economic and market conditions + Forecasts of customer needs from marketing personnel Merchandise Purchases Budget Merchandise purchases budget provides detailed information about the purchases necessary to fulfill the sales budget and provide adequate inventories. Merchandise inventory to be purchased = Budgeted ending inventory + Budgeted sales for the period _ Budgeted beginning inventory 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 Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 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. Number of units to be produced = Budgeted ending inventory + Budgeted sales for the period _ Budgeted beginning inventory Direct materials budget provides detailed information about the purchases of raw materials necessary to fulfill the production budget and provide adequate inventories. Units of raw materials to be purchased Cost of raw materials to be purchased = Materials needed for production + Budgeted ending inventory _ Budgeted beginning inventory = Units of raw materials to be purchased Material price x per unit of raw material 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 Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University Cash Budget Expected Receipts and Disbursement s Budgeted Income Statement Budgete d Balance Sheet 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 Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University Direct materials Direct labour Variable mfg. overhead Total standard unit cost 1 kg 2 hours 2 hours $ $ $ 25 20 10 per kg per hour per hour $ $ $ $ 25.00 40.00 20.00 85.00 Variance Analysis The process of variance analysis can be listed as follows: Prepare standard cost performance reports Take action Analyze variances Investigate causes 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 Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 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. Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 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 yrs.) Cost of the new machine Disposal value of old machine Net effect 150000 250000 provided by the ($200000 × 5 1000000 (900000) new machine Case Study ABC Corporation, a merchandising company, has provided the following budget data: Purchases May June July August September $84000 $96000 $72000 $108000 $120000 Sales $144000 $132000 $120000 $156000 $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. Task Team of FUNDAMENTAL ACCOUNTING School of Business, Sun Yat-sen University 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.
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