Documents
Resources
Learning Center
Upload
Plans & pricing Sign in
Sign Out

Managerial_Accounting_English

VIEWS: 1 PAGES: 46

									           Accounting Master
               Program
                                    2007
By: Isam Rimawi
irimawi@hotmail.com
http://www.geocities.com/irimawi/
     Master Program                          Advanced Managerial accounting               last update 9/29/2011



Managerial Accounting and the Business Environment                                  Chapter One

Work of Management
Planning
Identify alternatives. Select alternative that does the best job of furthering organization’s objectives.
Develop budgets to guide progress toward the selected alternative.

Directing and Motivating
Directing and motivating involves managing day-to-day activities to keep the rganization running
smoothly.
            Employee work assignments.
            Routine problem solving.
            Conflict resolution.
            Effective communications.

Controlling
 The control function ensures that plans are being followed.
 Feedback in the form of performance reports that compare actual results with the budget are an
    essential part of the control function


Planning and Control Cycle

                                                                                  Begin
                               Formulating long-and short-
                                  term plans (Planning)




   Comparing actual                          Decision                     Implementing
to planned performance                                                 plans (Directing and
      (Controlling)                           Making                       Motivating)



                                   Measuring performance
                                       (Controlling)




Prepared by:   Isam Rimawi irimawi@hotmail.com      http://www.geocities.com/irimawi/   Page 2 of 46
     Master Program                       Advanced Managerial accounting                 last update 9/29/2011



Comparison of Financial and Managerial Accounting
                              Financial Accounting               Managerial Accounting
 1. Users                  External persons who               Managers who plan for
                           make financial decisions           and control an organization
 2. Time focus             Historical perspective             Future emphasis
 3. Verifiability versus   Emphasis on verifiability          Emphasis on relevance
 relevance                                                    for planning and control
 4. Precision versus       Emphasis on precision              Emphasis on timeliness
    timeliness
 5. Subject                Primary focus is on                Focuses on segments
                           the whole organization             of an organization
 6. GAAP                   Must follow GAAP                   Need not follow GAAP
                           and prescribed formats             or any prescribed format
 7. Requirement            Mandatory for external reports     Not Mandatory




Organizational Structure

       Decentralization is the delegation of decision-
        making authority throughout an organization.
                  Corporate Organization Chart
                                 Board of Directors


                                       President


    Purchasing              Personnel          Vice President          Chief Financial
                                                Operations                 Officer


                                                                 Treasurer         Controller




Line and Staff Relationships
Line positions are directly related to achievement of the basic objectives of an organization.
             Example: Production supervisors in a manufacturing plant
Staff positions support and assist line positions.
             Example: Cost accountants in the manufacturing plant.

Prepared by:   Isam Rimawi irimawi@hotmail.com     http://www.geocities.com/irimawi/   Page 3 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011



The Chief Financial Officer (CFO)
A member of the top management team responsible for:
          Providing timely and relevant data to support planning and control activities.
          Preparing financial statements for external users.


The Changing Business Environment
Business environment changes in the past twenty years
   1. Just-in-time production
   2. Total quality management
   3. Process reengineering
   4. Theory of constraints
   5. International competition
   6. E-commerce

Just-in-Time (JIT) Systems

                                                               Complete products
  Receive customer                                               just in time to
       orders.                                                  ship customers.


       Schedule
      production.



  Receive materials                                         Complete parts just in
   just in time for                                         time for assembly into
     production.                                                   products.


JIT Consequences
    1. Improved plant layout
    2. Reduced setup time
    3. Zero production defects
    4. Flexible workforce
JIT purchasing
Fewer, but more ultra reliable suppliers. Frequent JIT deliveries in small lots. Defect-free supplier
deliveries.



Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 4 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011


Benefits of a JIT System
Reduced inventory costs
Higher quality products
Increased throughput
Freed-up funds
Greater customer satisfaction
More rapid response to customer orders

Total Quality Management (TQM)
TQM improves productivity by encouraging the use of fact and analysis for decision making and
if properly implemented, avoids counter-productive organizational infighting.
 Systematic problem solving using tools such as benchmarking
 Continuous Improvement
 Central Focus is Serving Customers

Process Reengineering
    1. A business process is diagrammed in detail.
    2. Every step in the business process must be justified.
    3. The process is redesigned to eliminate all non-value-added activities

Anticipated results:
    1.   Process is simplified.
    2.   Process is completed in less time.
    3.   Costs are reduced.
    4.   Opportunities for errors are reduced.

Process Reengineering versus TQM
         Process Reengineering                    Total Quality Management
  • Radically overhauls existing            • Tweaks existing processes to realize
    processes.                                gradual improvements.
  • Likely to be imposed from above and     • Uses a team approach involving people
    to use outside consultants.               who work directly in the process.


Theory of Constraints
A constraint (also called a bottleneck) is anything that prevents you from
getting more of what you want.


      The constraint in a system is determined
     by the step that has the smallest capacity.
Theory of Constraints
Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 5 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011




 Only actions that                               2. Allow the weakest
 strengthen the                                  link to set the tempo.
 weakest link in the
 “chain” improve the
 process.
                                1. Identify                                           3. Focus on
                               the weakest                                           improving the
                                   link.                                              weakest link.

                                                  4. Recognize that the
                                                         weakest link
                                                       is no longer so.


International Competition
                              Increasing sophistication
                              in international markets.


  Fewer tariffs,                                                         Improvements
   quotas, and                      Competition has                         in global
  other barriers                   become worldwide                      transportation
  to free trade.                   in most industries.                      systems.



               An excellent management accounting system is needed
                to succeed in today’s competitive global marketplace.




E-Commerce

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 6 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011


In recent years, many dot.com businesses failed that might have benefited from the application of
managerial accounting tools:
            Cost concepts (Chapter 2)
            Cost estimation (Chapter 5)
            Cost-volume-profit (Chapter 6)
            Activity-based costing (Chapter 8)
            Budgeting (Chapter 9)
            Decision-making (Chapter 13)
            Capital budgeting (Chapter 14)
Code of Conduct for Management Accountants
The Institute of Management Accountant’s (IMA) Standards of Ethical Conduct for Practitioners
of Management Accounting and Financial Management have two major parts offering guidelines
for:
 Ethical behavior.
 Resolution for an ethical conflict.
IMA Guidelines for Ethical Behavior
                                         Follow applicable laws, regulations and
                                                       standards.

     Maintain
   professional                                        Competence
   competence.



                                           Prepare complete and clear reports
                                               after appropriate analysis.



IMA Guidelines for Ethical Behavior
                                       Do not disclose confidential information
                                          unless legally obligated to do so.

 Do not use confidential
     information for                                Confidentiality
  personal advantage.


                                       Ensure that subordinates do not disclose
                                               confidential information.



IMA Guidelines for Ethical Behavior
Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 7 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011



                                    Avoid conflicts of interest and advise
                                        others of potential conflicts.


     Do not subvert
 organization’s legitimate
       objectives.
                                                 Integrity


                                Recognize and communicate personal and
                                        professional limitations.



IMA Guidelines for Ethical Behavior
                              Avoid activities that could
                             affect your ability to perform
                                        duties.

  Refrain from                                                            Refuse gifts or
  activities that                                                          favors that
 could discredit                                                              might
 the profession.                      Integrity                             influence
                                                                            behavior.

                            Communicate unfavorable as
                            well as favorable information.




IMA Guidelines for Ethical Behavior

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 8 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011


           Communicate information fairly and objectively.



                             Objectivity

  Disclose all information that might be useful to management.



IMA Guidelines for Resolution of an Ethical Conflict
    •   Follow established policies.
    •   For unresolved ethical conflicts:
            Discuss the conflict with immediate superior or next highest uninvolved manager.
            Make reference to the Sarbanes-Oxley Act passed by Congress in 2002 in part to give
              legal protection to those reporting corporate misconduct.
            If immediate superior is the CEO, consider the board of directors or the audit committee.


IMA Guidelines for Resolution of an Ethical Conflict
    •   Follow established policies.
    •   For unresolved ethical conflicts:
            Except where legally prescribed, maintain confidentiality.
            Clarify issues in a confidential discussion with an objective advisor.
            Consult an attorney as to legal obligations.
            The last resort is to resign.




Why Have Ethical Standards?



Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 9 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011


       Ethical standards in business are essential for a
       smooth functioning advanced market economy.



           Without ethical standards in business, the
          economy, and all of us who depend on it for
            jobs, goods, and services, would suffer.



       Abandoning ethical standards in business would
            lead to a lower quality of life with less
       desireable goods and services at higher prices.




Codes of Conduct on the International Level
The Guidelines on Ethics for Professional Accountants, issued by the International Federation of
Accountants (IFAC), govern the activities of professional accountants worldwide
In addition to competence, objectivity, independence, and confidentiality, the IFAC’s code deals
with the accountant’s ethical responsibilities in:
    • Taxes
    • Fees and commissions
    • Advertising and solicitation
    • Handling of monies
    • Cross-border activities.


Certified Management Accountant
A management accountant who has the necessary qualifications and who passes a rigorous
professional exam earns the right to be known as a Certified Management Accountant (CMA).
Information about becoming a CMA and the CMA program can be accessed on the IMA’s website
at www.imanet.org or by calling 1-800-638-4427.

                                                                                      End of Chapter 1



Costs Terms, Concepts and Classifications                         Chapter Two
Manufacturing Costs

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 10 of 46
     Master Program                        Advanced Managerial accounting               last update 9/29/2011


    1. Direct Materials
    2. Direct Labor
    3. Manufacturing Overhead
Direct Materials
Raw materials that become an integral part of the product and that can be conveniently traced
directly to it.
Example: A radio installed in an automobile
Direct Labor
Those labor costs that can be easily traced to individual units of product.
Example: Wages paid to automobile assembly workers
Manufacturing Overhead
Manufacturing costs that cannot be traced directly to specific units produced.

                     Examples: Indirect labor and indirect materials


   Wages paid to employees who are                    Materials used to support the
   not directly involved in production                    production process.
                   work.
   Examples: maintenance workers,                  Examples: lubricants and cleaning
     janitors and security guards.                  supplies used in the automobile
                                                            assembly plant.

Classifications of Costs

          Manufacturing costs are often classified as follows:

    Direct                        Direct                      Manufacturing
   Material                       Labor                        Overhead




                    Prime                        Conversion
                    Cost                           Cost




Non-manufacturing Costs
Marketing or Selling Cost : Costs necessary to get the order and deliver the product.

Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 11 of 46
     Master Program                      Advanced Managerial accounting                 last update 9/29/2011


Administrative Cost : All executive, organizational, and clerical costs.

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



   Balance                     Income
    Sheet                     Statement                                Income
                                                                      Statement
Quick Check 
Which of the following costs would be considered a period rather than a product cost in a
manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production facility.
E. Sales commissions.                                                           , B, E,

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


Balance Sheet
         Merchandisers . . .                       Manufacturers . . .
    Current assets                        Current Assets
     Cash                                 Cash
     Receivables                          Receivables
     Prepaid Expenses                     Prepaid Expenses
     Merchandise Inventory                Inventories
                                                    Raw Materials
                                                    Work in Process
                                                    Finished Goods
Raw Materials   Materials waiting to be processed.
Work in Process Partially complete products – some material, labor, or overhead has been added.


Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 12 of 46
     Master Program                       Advanced Managerial accounting                last update 9/29/2011


Finished Goods        Completed products awaiting sale.

The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.


    Merchandising Company                     Manufacturing Company
   Cost of goods sold:                       Cost of goods sold:
      Beg. merchandise                          Beg. finished
          inventory    $ 14,200                     goods inv.     $ 14,200
      + Purchases        234,150                + Cost of goods
      Goods available                               manufactured     234,150
          for sale     $ 248,350                Goods available
      - Ending                                      for sale       $ 248,350
          merchandise                           - Ending
          inventory      (12,100)                   finished goods
      = Cost of goods                               inventory        (12,100)
          sold         $ 236,250                = Cost of goods
                                                    sold           $ 236,250



Inventory Flows


  Beginning                          Additions                           Available
   balance                   +         $$$                     =          $$$$$
      $$


    Available                 _       Withdraw                              Ending
     $$$$$                               als                     =          balance
                                         $$$                                   $$


Quick Check 
If your inventory balance at the beginning of the month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would be the balance at the end of the month?

Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 13 of 46
     Master Program                            Advanced Managerial accounting                    last update 9/29/2011


A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200. .                                 , B, $1,000 + $100 = $1,100          $1,100 - $300 = $800

Schedule of Cost of Goods Manufactured
 Calculates the cost of raw material, direct labor and manufacturing overhead used in
  production
 Calculates the manufacturing costs associated with goods that were finished during the period.
Product Cost Flows
                                     Manufacturing              Work
         Raw Materials                  Costs                In Process                      Finished Goods

     Beginning raw                    Direct materials                                    Beginning finished
       materials inventory                                                                   goods inventory
 +   Raw materials                                                                   +    Cost of finished
       purchased
                                        As items are removed from                            goods mfg.
                                        raw materials inventory and
 =   Raw materials                                                                   =    Finished goods
                                         placed into the production
       available for use                                                                    available for sale
                                          process, they are called
       in production                                                                  -   Ending finished
 –   Ending raw materials
                                              direct materials.                             goods inventory
       inventory                                                                     =    Cost of finished
 =   Raw materials used                                                                     goods sold
        in production

                                                                            Work In
     Raw Materials                   Manufacturing Costs                    Process

 Beginning raw                       Direct materials
   materials inventory       +       Direct labor
 Raw materials               +       Mfg. overhead                           Conversion costs are costs
   purchased                 =       Total manufacturing                     incurred to convert the direct
 Raw materials                         costs                                 material into a finished product.
   available for use
   in production
 Ending raw materials
   inventory
 Raw materials used
   in production
                                       Manufacturing                       Work
        Raw Materials                     Costs                         In Process                Finished Goods

     Beginning raw                    Direct materials              Beginning work in             Beginning finished
       materials                 +    Direct labor                    process inventory             goods inventory

Prepared by:   Isam Rimawi irimawi@hotmail.com           http://www.geocities.com/irimawi/    Page 14 of 46
      Master Program                       Advanced Managerial accounting                      last update 9/29/2011


       inventory
 +     Raw materials           +   Mfg. overhead             +   Total manufacturing      +     Cost of finished
          purchased            =   Total manufacturing             costs                           goods mfg.
 =     Raw materials                 costs                   =   Total work in            =     Finished goods
                                                                                                   available for
         available for use                                          process for the             sale
         in production                                              period                 -    Ending finished
 –     Ending raw materials                                                                        goods inventory
         inventory                     All manufacturing costs incurred during            =     Cost of finished
 =     Raw materials used
                                        the period are added to the beginning                      goods sold
                                             balance of work in process.
         in production



                                    Manufacturing                       Work
         Raw Materials                 Costs                         In Process                 Finished Goods

       Beginning raw               Direct materials              Beginning work in              Beginning finished
          materials
       inventory               +   Direct labor                    process inventory               goods inventory
 +     Raw materials           +   Mfg. overhead             +   Total manufacturing      +     Cost of finished
          purchased            =   Total manufacturing             costs                           goods mfg.
 =     Raw materials                  costs                  =   Total work in            =     Finished goods
                                                                                                   available for
         available for use                                         process for the              sale
         in production                                             period                  -    Ending finished
                                                             –   Ending work in                    goods inventory
                                                                   process inventory      =     Cost of finished
                                                             =   Cost of goods                     goods sold
       Costs associated with the goods that are                     manufactured
      completed during the period are transferred
             to finished goods inventory.




         Work In Process                 Finished Goods

       Beginning work in                Beginning finished
         process inventory                goods inventory
  +    Manufacturing costs         +    Cost of goods

Prepared by:   Isam Rimawi irimawi@hotmail.com        http://www.geocities.com/irimawi/   Page 15 of 46
      Master Program                        Advanced Managerial accounting                 last update 9/29/2011


         for the period                    manufactured
  =   Total work in process         =    Cost of goods
        for the period                     available for sale
  –   Ending work in                 -   Ending finished
        process inventory                  goods inventory
  =   Cost of goods                      Cost of goods
        manufactured                       sold




Manufacturing Cost Flows

                                            Balance Sheet                        Income
               Costs                         Inventories                        Statement
                                                                                Expenses
  Material Purchases                          Raw Materials


        Direct Labor                             Work in
                                                 Process
      Manufacturing
        Overhead                                                                   Cost of
                                                Finished
                                                                                   Goods
                                                 Goods
                                                                                    Sold

       Selling and                          Period Costs                      Selling and
      Administrative                                                         Administrative

Quick Check 
Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was
purchased. A count at the end of the month revealed that $28,000 of raw material was still
present. What is the cost of direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $2,000 .                           ,C
The Answer C
      Beg. raw materials        $    32,000
 +    Raw materials
        purchased                   276,000
 =    Raw materials


Prepared by:   Isam Rimawi irimawi@hotmail.com       http://www.geocities.com/irimawi/   Page 16 of 46
     Master Program                         Advanced Managerial accounting               last update 9/29/2011


     available
        for use in
     production                 $ 308,000
 –   Ending raw materials
        inventory                  28,000
 =   Raw materials used
        in production           $ 280,000


Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory
overhead was $180,000. What were total manufacturing costs incurred for the month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined. .                           ,B

The Answer B
     Direct Materials            $280,000
 +   Direct Labor                 375,000
 +   Mfg. Overhead                180,000
 =   Mfg. Costs Incurred
        for the Month            $835,000

Beginning work in process was $125,000. Manufacturing costs incurred for the month were
$835,000. There were $200,000 of partially finished goods remaining in work in process inventory
at the end of the month. What was the cost of goods manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined. .                        C   ,
The Answer C
     Beginning work in
       process inventory         $ 125,000
 +   Mfg. costs incurred
       for the period              835,000
 =   Total work in process
       during the period         $ 960,000
 –   Ending work in
       process inventory           200,000
 =   Cost of goods
       manufactured              $ 760,000
Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month
was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods
sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000. .                        ,B

Prepared by:   Isam Rimawi irimawi@hotmail.com     http://www.geocities.com/irimawi/   Page 17 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011



The Answer B
$130,000 + $760,000 = $890,000
$890,000 - $150,000 = $740,000



Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in the level of activity within the relevant range.
          Total variable costs change when activity changes.
          Total fixed costs remain unchanged when activity changes.

Total Variable Cost
Your total long distance telephone bill is based on how many minutes you talk
   Total
   Long
 Distance
 Telephon
   e Bill




                       Minutes Talked

Variable Cost Per Unit
  Per
 Minute
Telepho
   ne
Charge




                        Minutes Talked

Total Fixed Cost
Your monthly basic telephone bill probably does not change when you make more local calls.




Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 18 of 46
     Master Program                          Advanced Managerial accounting               last update 9/29/2011



  Monthly
   Basic
 Telephon
   e Bill




                 Number of Local Calls

Fixed Cost Per Unit
The average fixed cost per local call decreases as more local calls are made.
 Monthly
  Basic
Telephon
e Bill per
Local Call




                 Number of Local Calls



Cost Classifications for Predicting Cost Behavior
                     Behavior of Cost (within the relevant range)
  Cost                    In Total                              Per Unit
 Variable      Total variable cost changes           Variable cost per unit remains
                as activity level changes.       the same over wide ranges of activity.
  Fixed         Total fixed cost remains            Average fixed cost per unit goes
                the same even when the               down as activity level goes up.
                 activity level changes.



Quick Check 
Which of the following costs would be variable with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers .                           C , D ,B


Prepared by:   Isam Rimawi irimawi@hotmail.com      http://www.geocities.com/irimawi/   Page 19 of 46
     Master Program                      Advanced Managerial accounting                 last update 9/29/2011


Assigning Costs to Cost Objects
Direct costs                                     Indirect costs
 • Costs that can be                               • Costs that cannot be easily and
   easily and conveniently traced to a unit          conveniently traced to a unit of
   of product or other cost object.                  product or other cost object.
 • Examples: direct material and direct            • Example: manufacturing overhead
   labor



Cost Classifications for Decision Making
    •   Every decision involves a choice between at least two alternatives.
    •   Only those costs and benefits that differ between alternatives are relevant in a decision. All
        other costs and benefits can and should be ignored.


Differential Costs and Revenues
Costs and revenues that differ among alternatives
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a
neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
Differential revenue is:
$2,000 – $1,500 = $500
Differential cost is:
$300

Opportunity Costs
The potential benefit that is given up when one alternative is selected over another
Example: If you were not attending college, you could be earning $15,000 per year.
Your opportunity cost of attending college for one year is $15,000

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.




Quick Check 
Suppose you are trying to decide whether to drive or take the train to Portland to attend a
concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the
cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket
affect the decision of whether you drive or take the train to Portland?

Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 20 of 46
     Master Program                       Advanced Managerial accounting                last update 9/29/2011


A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.           A,


Suppose you are trying to decide whether to drive or take the train to Portland to attend a
concert. You have ample cash to do either, but you don’t want to waste money needlessly. Is the
annual cost of licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant            B,

Suppose that your car could be sold now for $5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.                     B,

Summary of the Types of Cost Classifications
    •   Financial reporting
    •   Predicting cost behavior
    •   Assigning costs to cost objects
    •   Decision making

Idle Time
                Machine Breakdowns
                Material Shortages
                Power Failures
The labor costs incurred during idle time are ordinarily treated as manufacturing overhead.

Overtime
The overtime premiums for all factory workers are usually considered to be part of
manufacturing overhead

Labor Fringe Benefits
Fringe benefits include employer paid costs for insurance programs, retirement plans,
supplemental unemployment programs, Social Security, Medicare, workers’ compensation and
unemployment taxes.
 Some companies include all of these costs in manufacturing overhead.
 Other companies treat fringe benefit expenses of direct laborers as additional direct labor
   costs.
Quality of Conformance
When the overwhelming majority of products produced conform to design specifications and are
free from defects.

Prevention and Appraisal Costs

Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 21 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011




   Prevention Costs                                    Support activities whose purpose
                                                       is to reduce the number of
                                                       defects


    Appraisal Costs                                    Incurred to identify defective
                                                       products before the products are
                                                       shipped



Internal and External Failure Costs
                                                        Incurred as a result of identifying
   Internal Failure                                      defects before they are shipped
        Costs

                                                        Incurred as a result of defective
  External Failure                                        products being delivered to
       Costs                                                      customers



Examples of Quality Costs
Prevention Costs
    • Quality training
    • Quality circles
    • Statistical process control activities
Internal Failure Costs
    • Scrap
    • Spoilage
    • Rework
Appraisal Costs
    • Testing & inspecting incoming materials
    • Final product testing
    • Depreciation of testing equipment
External Failure Costs
    • Cost of field servicing & handling complaints
    • Warranty repairs
    • Lost sales

Distribution of Quality Costs


Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 22 of 46
     Master Program                         Advanced Managerial accounting                      last update 9/29/2011


                When quality of conformance is low, total quality cost is high and consists mostly of
                 internal and external failure.
                Companies can reduce their total quality cost by focusing on prevention and
                 appraisal. The cost savings from reduced defects usually swamps the costs of the
                 additional prevention and appraisal efforts.

Quality cost reports provide an estimate of the financial consequences of
the company’s current defect rate.
                      Ventura Company Quality Cost Report For Years 1 and 2
                                                  Year 2                    Year 1
                                            Amount       Percent*      Amount      Percent*
 Prevention costs:
    Systems development                     $      400,000       0.80%       $    270,000          0.54%
    Quality training                               210,000       0.42%            130,000          0.26%
    Supervision of prevention activities            70,000       0.14%             40,000          0.08%
    Quality improvement                            320,000       0.64%            210,000          0.42%
 Total prevention cost                           1,000,000       2.00%            650,000          1.30%

 Appraisal costs:
    Inspection                                     600,000       1.20%             560,000         1.12%
    Reliability testing                            580,000       1.16%             420,000         0.84%
    Supervision of testing and inspection          120,000       0.24%              80,000         0.16%
    Depreciation of test equipment                 200,000       0.40%             140,000         0.28%
 Total appraisal cost                            1,500,000       3.00%           1,200,000         2.40%

 Internal failure costs:
    Net cost of scrap                              900,000       1.80%             750,000         1.50%
    Rework labor and overhead                    1,430,000       2.86%             810,000         1.62%
    Downtime due to defects in quality             170,000       0.34%             100,000         0.20%
    Disposal of defective products                 500,000       1.00%             340,000         0.68%
 Total internal failure cost                     3,000,000       6.00%           2,000,000         4.00%

 External failure costs:
    Warranty repairs                               400,000      0.80%              900,000         1.80%
    Warranty replacements                          870,000      1.74%            2,300,000         4.60%
    Allowances                                     130,000      0.26%              630,000         1.26%
    Cost of field servicing                        600,000      1.20%            1,320,000         2.64%
 Total external failure cost                     2,000,000      4.00%            5,150,000        10.30%
 Total quality cost                         $    7,500,000     15.00%        $    9,000,000       18.00%

 * As a percentage of total sales. In each year sales totaled $50,000,000.
Quality Cost Reports: Graphic Form
Quality reports can also be prepared in graphic form.




Prepared by:   Isam Rimawi irimawi@hotmail.com       http://www.geocities.com/irimawi/        Page 23 of 46
                               Master Program                           Advanced Managerial accounting                                                   last update 9/29/2011



                                                                                                                        20
                                 $10




                                                                                Quality Cost as a Percentage of Sales
                                                                                                                        18
                                   9
                                                                                                                        16
                                   8
  Quality Cost (in millions)




                                                                                                                        14
                                   7
                                                                                                                              External            External
                                        External            External
                                                                                                                        12    Failure              Failure
                                   6     Failure             Failure

                                   5                                                                                    10

                                   4                        Internal                                                     8                        Internal
                                                             Failure                                                                               Failure
                                   3    Internal                                                                         6    Internal
                                         Failure                                                                               Failure
                                   2                                                                                     4
                                                           Appraisal                                                                             Appraisal
                                       Appraisal                                                                         2   Appraisal
                                   1
                                       Prevention          Prevention                                                    0   Prevention          Prevention
                                   0
                                           1                   2                                                                 1                   2
                                                    Year                                                                                  Year


Uses of Quality Cost Information
                               1. Help managers see the financial significance of defects.
                               2. Help managers identify the relative importance of the quality problems
                               3. Help managers see whether their quality costs are poorly distributed.

Limitations of Quality Cost Information
                               1. Simply measuring quality cost problems does not solve quality problems.
                               2. Results usually lag behind quality improvement programs.
                               3. The most important quality cost, lost sales, is often omitted from quality cost reports.
ISO 9000 Standards
ISO 9000 standards have become an international measure of quality. To become ISO 9000
certified, a company must demonstrate:
    1. A quality control system is in use, and the system clearly defines an expected level of
        quality.
    2. The system is fully operational and is backed up with detailed documentation of quality
        control procedures.
    3. The intended level of quality is being achieved on a sustained basis.

                                                                                                                                                             End of Chapter 2




Prepared by:                           Isam Rimawi irimawi@hotmail.com         http://www.geocities.com/irimawi/                                      Page 24 of 46
     Master Program                          Advanced Managerial accounting                 last update 9/29/2011



Cost Behavior : Analysis and Use                                                      Chapter Five


Types of Cost Behavior Patterns
Recall the summary of our cost behavior discussion from an earlier chapter.
                   Summary of Variable and Fixed Cost Behavior
   Cost                       In Total                              Per Unit
               Total variable cost is proportional   Variable cost per unit remains the
 Variable      to the activity level within the      same over wide ranges of activity.
               relevant range.
               Total fixed cost remains the same     Fixed cost per unit goes down as
  Fixed        even when the activity level          activity level goes up.
               changes within the relevant range.


The Activity Base


       Units                                                                    Machine
     produced                                                                    hours

                                 A measure of what
                                    causes the
                                  incurrence of a
                                   variable cost



          Miles                                                                    Labor
          driven                                                                   hours




Prepared by:   Isam Rimawi irimawi@hotmail.com        http://www.geocities.com/irimawi/   Page 25 of 46
     Master Program                       Advanced Managerial accounting                 last update 9/29/2011


True Variable Cost Example
A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity
level. Your total long distance telephone bill is based on how many minutes you talk.
   Total
  Long
 Distanc
     e
 Telepho
  ne Bill




                      Minutes      Talked
Types of Cost Behavior Patterns
Recall the summary of our cost behavior discussion from an earlier chapter.

Variable Cost Per Unit Example
A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant.
For example, 10 cents per minute.



  Per
 Minute
 Teleph
  one
 Charge




                            Minutes Talked

Extent of Variable Costs
The proportion of variable costs differs across organizations. For example . . .
   1. A public utility with large investments in equipment will tend to have fewer variable costs.
   2. A service company will normally have a high proportion of variable costs.

Prepared by:   Isam Rimawi irimawi@hotmail.com     http://www.geocities.com/irimawi/   Page 26 of 46
     Master Program                      Advanced Managerial accounting                 last update 9/29/2011


    3. A manufacturing company will often have many variable costs.
    4. A merchandising company usually will have a high proportion of variable costs like cost of
       sales.

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

True Variable Cost
Direct materials is a true or proportionately variable cost because the amount used during a period will
vary in direct proportion to the level of production activity.




 Cost




                            Volume

Step-Variable Costs
A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs
increase or decrease only in response to fairly wide changes in activity is known as a step-variable cost.

 Cost
                                         Small changes in the level of production are not likely to have
                                         any effect on the number of maintenance workers employed.


                                         Only fairly wide changes in the activity level will cause a
                                         change in the number of maintenance workers employed


                                                       Volum
                                                         e
The Linearity Assumption and the Relevant Range



Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 27 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011



                                          Economist’s      A straight line
                                                              closely
                                         Curvilinear Cost approximates a
                                            Function        curvilinear
                                                                           variable cost
                                                                          line within the
T                       Relevant                                         relevant range.
ot                       Range
al
                                                    Accountant’s Straight-Line
C                                                  Approximation (constant unit
os                                                        variable cost)
t

                            Activity

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

The Trend Toward Fixed Costs
The trend in many industries is toward greater fixed costs relative to variable costs.
As machines take over many mundane tasks previously performed by humans, “knowledge workers” are
demanded for their minds rather than their muscles
Knowledge workers tend to be salaried, highly-trained and difficult to replace. The cost to compensate
these valued employees is relatively fixed rather than variable.

Is Labor a Variable or a Fixed Cost?
 The behavior of wage and salary costs can differ across countries, depending on labor regulations,
  labor contracts, and custom. In France, Germany, China, and Japan anagement has little flexibility
  in adjusting the size of the labor force.
 Labor costs are more fixed in nature. In the United States and the United Kingdom management has
  greater latitude. Labor costs are more variable in nature.



Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 28 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011


Fixed Costs and Relevant Range
  Rent         90
 Cost in
 Thousa                                                       Total cost doesn’t
 nds of                                Relevant               change for a wide
 Dollars
               60                        Range                range of activity,
                                                             and then jumps to a
                                                             new higher cost for
               30                                              the next higher
                                                              range of activity.

                 00           1,000          2,000             3,000
                               Rented Area (Square Feet)


Fixed Costs and Relevant Range
The relevant range of activity for a fixed cost is the range of activity over which the graph of the
cost is flat.
Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 square
feet. As the business grows more space is rented, increasing the total cost.

Fixed Costs and Relevant Range
How does this type of fixed cost differ from a step-variable cost?
  1. Step-variable costs can be adjusted more quickly and . . .
  2. The width of the activity steps is much wider for the fixed cost.

Quick Check 
Which of the following statements about cost behavior are true?
          1. Fixed costs per unit vary with the level of activity.
          2. Variable costs per unit are constant within the relevant range.
          3. Total fixed costs are constant within the relevant range.
          4. Total variable costs are constant within the relevant range. 1 , 2 , 3 ,




Mixed Costs
A mixed cost has both fixed and variable components. Consider the example of utility cost.




Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 29 of 46
     Master Program                             Advanced Managerial accounting                    last update 9/29/2011



   Total
   Utility
                   Y
   Cost            Total mixed cost

                                                                                                 Variable
                                                                                               Cost per KW


                                                                                              Fixed Monthly
                   Activity (Kilowatt Hours)                        X                         Utility Charge



 The total mixed cost line can be expressed as an equation: Y = a + bX

 Where:        Y   =   the total mixed cost
               a   =   the total fixed cost (the
                       vertical intercept of the line)
               b   =   the variable cost per unit of
                       activity (the slope of the line)
               X   =   the level of activity



Mixed Costs Example
If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?



 Y = a + bX

 Y = $40 + ($0.03 × 2,000)


 Y =                   $100


Analysis of Mixed Costs
Account Analysis and the Engineering Approach


Prepared by:   Isam Rimawi irimawi@hotmail.com            http://www.geocities.com/irimawi/     Page 30 of 46
     Master Program                        Advanced Managerial accounting                  last update 9/29/2011


 Each account is classified as either variable or fixed based on the analyst’s knowledge of how the
  account behaves.
 Cost estimates are based on an evaluation of production methods, and material, labor and overhead
  requirements.
The Scatter graph Method
Plot the data points on a graph (total cost vs. activity).

                      Y
Mainte
                20
                                                          * ** *
nance
 Cost
1,000’                         * *
 s of                                                    **
Dollar
  s             10           * *

                  0                                                                       X
                      0           1              2               3               4
                                         Patient-days in 1,000’s


The Scatter graph Method
Draw a line through the data points with about an equal numbers of points above and below the line.




Prepared by:   Isam Rimawi irimawi@hotmail.com       http://www.geocities.com/irimawi/   Page 31 of 46
     Master Program                        Advanced Managerial accounting                  last update 9/29/2011



                      Y
Mainte
                20
                                                          * ** *
nance
 Cost
1,000’                         * *
 s of                                                    **
Dollar
  s             10           * *

                  0                                                                       X
                      0          1              2                3               4
                                         Patient-days in 1,000’s


Use one data point to estimate the total level of activity and the total cost.

                  Y Total maintenance cost = $11,000
  Maint         20
                                                           * ** *
  enanc
  e Cost
  1,000’                       * *
   s of                                                   **
  Dollar
     s          10           * *
                            Intercept = Fixed cost: $10,000

                  0                                                                       X
                      0           1              2              3                4
                                    Patient-days in 1,000’s
 Patient days = 800




Prepared by:   Isam Rimawi irimawi@hotmail.com       http://www.geocities.com/irimawi/   Page 32 of 46
     Master Program                      Advanced Managerial accounting                 last update 9/29/2011


Make a quick estimate of variable cost per unit and determine the cost equation.
Total maintenance at 800 patients                         $ 11,000
 Less: Fixed cost                                            10,000
 Estimated total variable cost for 800 patients           $ 1,000



                                                 $1,00
                Variable cost per unit =                    = $1.25/patient-
                                                  080
                                                            day
                                                  800
                               Y = $10,000 + $1.25X

 Total maintenance                                               Number of patient
 cost                                                            days



The High-Low Method
Assume the following hours of maintenance work and the total maintenance costs for six months.
   Month            Hours of   Total maintenance
                   maintenance        Cost                        The variable cost
Jan                     625                 7,950                     per hou r o f
Feb                     500                 7,400                  m a i n te n a n c e i s
Mar                     700                 8,275
Apr                     550                 7,625
                                                                     e q u a l to th e
May                     775                 9,100                  c hange i n c o s t
Jun                     800                 9,800                  d i v i d e d b y th e
High Level              800                 9,800                 change in hours.
Low Level               500                 7,400
Change                  300                 2,400


        $2,400
               = $8.00/hour
         300



Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/   Page 33 of 46
     Master Program                              Advanced Managerial accounting                 last update 9/29/2011


 Total Fixed Cost = Total Cost – Total Variable Cost
 Total Fixed Cost = $9,800 – ($8/hour × 800 hours)
 Total Fixed Cost = $9,800 – $6,400
 Total Fixed Cost = $3,400

                    The Cost Equation for Maintenance
                          Y = $3,400 + $8.00X
Quick Check 
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is the variable portion of sales salaries and
commission?
                              a. $0.08 per unit
                              b. $0.10 per unit
                              c. $0.12 per unit
                              d. $0.125 per unit     ,b,



 High level
                  Units
                  120,000
                                Cost
                            $ 14,000
                                               $4,000 ÷ 40,000 units
 Low level
 Change
                   80,000
                   40,000   $
                                10,000
                                    4,000
                                                    = $0.10 per unit


Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?
                              a. $ 2,000
                              b. $ 4,000
                              c. $10,000
                              d. $12,000    ,a,

                   Total cost        =      Total fixed cost +
                                         Total variable cost
                  $14,000       =        Total fixed cost +
                                         ($0.10 × 120,000 units)
 Total fixed cost               =        $14,000 - $12,000
 Total fixed cost               =        $2,000



Least-Squares Regression Method
Prepared by:   Isam Rimawi irimawi@hotmail.com            http://www.geocities.com/irimawi/   Page 34 of 46
     Master Program                       Advanced Managerial accounting            last update 9/29/2011


A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship
between the X and Y variables.
 This method uses all of the data points to estimate the fixed and variable cost components of a mixed
   cost
 The goal of this method is to fit a straight line to the data that minimizes the sum of the squared
   errors.


    •   Software can be used to fit a regression line through the data points.
    •   The cost analysis objective is the same: Y = a + bX
Least-squares regression also provides a statistic, called the R2, that is a measure of the
goodness of fit of the regression line to the data points.

          R2 is the percentage of the variation in
            total cost explained by the activity.



               Y
         20
 Total
 Cost                                          * ** *
                         * *                  **
         10            * * R varies from 0% to 100%, and
                                      2

                                the higher the percentage the better.

                                                                          X
           0 0              1         2      3                    4
                                    Activity

Comparing Results From the Three Methods
 The three methods just discussed provide slightly different estimates of the fixed and
  variable cost components of the mixed cost.
 This is to be expected because each method uses differing amounts of the data points
  to provide estimates.
 Least-squares regression provides the most accurate estimate because it uses all the
  data points.
                                                                            Let’s put our
The Contribution Format                                                 knowledge of cost
                                                                      behavior to work by
Prepared by:   Isam Rimawi irimawi@hotmail.com                                       Page 35
                                                                             preparing a of 46
                                                   http://www.geocities.com/irimawi/

                                                                       contribution format
                                                                        income statement.
     Master Program                       Advanced Managerial accounting               last update 9/29/2011


                                  Total      Unit
 Sales Revenue                   $ 100,000   $ 50
 Less: Variable costs               60,000     30
 Contribution margin             $ 40,000    $ 20
 Less: Fixed costs                 30,000
 Net operating income            $ 10,000




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


Uses of the Contribution Format
The contribution income statement format is used as an internal planning and decision making tool. We
will use this approach for:
    1. Cost-volume-profit analysis (Chapter 6).
    2. Budgeting (Chapter 9).
    3. Segmented reporting of profit data (Chapter 12).
    4. Special decisions such as pricing and make-or-buy analysis (Chapter 13).

                Comparison of the Contribution Income Statement
                      with the Traditional Income Statement
       Traditional Approach                        Contribution Approach
    (costs organized by function)               (costs organized by behavior)
 Sales                        $ 100,000 Sales                         $ 100,000
 Less cost of goods sold         70,000    Less variable expenses       60,000
 Gross margin                 $ 30,000     Contribution margin        $ 40,000
 Less operating expenses         20,000    Less fixed expenses          30,000
 Net operating income         $ 10,000     Net operating income       $ 10,000




          Used primarily for                      Used primarily by
          external reporting.                      management.




Appendix 5A

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 36 of 46
     Master Program                      Advanced Managerial accounting                  last update 9/29/2011


Least-Squares Regression Using Microsoft Excel.

Simple Regression Analysis Example
Matrix, Inc. wants to know its average fixed cost and variable cost per unit.
Using the data to the right, let’s see how to do a regression using Microsoft Excel.


Simple Regression Using Excel
You will need three pieces of information from your regression analysis:
   1. Estimated Variable Cost per Unit (line slope)
   2. Estimated Fixed Costs (line intercept)
   3. Goodness of fit, or R2

To get these three pieces information we will need to use three different Excel functions.
LINEST, INTERCEPT, & RSQ
we will determine the “goodness of fit”, or R2, by using the RSQ function.


                                                                                           End of Chapter 5




Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/    Page 37 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011


Cost-Volume-Profit Relationships                                                 Chapter Six

Basics of Cost-Volume-Profit Analysis
Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses
have been deducted.
CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income
Example -


The Contribution Approach
Sales, variable expenses, and contribution margin can also be expressed on a per unit
basis. If Racing sells an additional bicycle, $200 additional CM will be generated to
cover fixed expenses and profit.




The Contribution Approach
Each month Racing must generate at least $80,000 in total CM to break even.




If Racing sells 400 units in a month, it will be operating at the break-even point.

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 38 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011




If Racing sells one more bike (401 bikes), net operating income will increase by $200.




We do not need to prepare an income statement to estimate profits at a particular sales volume.
Simply multiply the number of units sold above break-even by the contribution margin per unit.
                     If Racing sells 430 bikes, its net income will be $6,000.
CVP Relationships in Graphic Form

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 39 of 46
         Master Program                       Advanced Managerial accounting                    last update 9/29/2011


   The relationship among revenue, cost, profit and volume can be expressed graphically by preparing a
   CVP graph. Racing developed contribution margin income statements at 300, 400, and 500 units sold.
   We will use this information to prepare the CVP graph.

                                         Income         Income             Income
                                        300 units      400 units          500 units
    Sales                              $ 150,000     $ 200,000           $ 250,000
    Less: variable expenses                90,000        120,000           150,000
    Contribution margin                $ 60,000      $ 80,000            $ 100,000
    Less: fixed expenses                   80,000         80,000            80,000
    Net operating income               $ (20,000)    $        -          $ 20,000


   CVP Graph


            450,000
                                    In a CVP graph, unit volume is usually
            400,000
                                  represented on the horizontal (X) axis and
            350,000                     dollars on the vertical (Y) axis.

            300,000                                                             Profit Area
                                             Total Sales
            250,000

            200,000           Total Expenses
Dollar      150,000                                          Fixed Expenses
  s         100,000
                           Loss Area
             50,000
                                               Units
                   -
                       -        100    200     300     400         500      600       700      800


                                                     Units




   Contribution Margin Ratio

   Prepared by:   Isam Rimawi irimawi@hotmail.com    http://www.geocities.com/irimawi/        Page 40 of 46
     Master Program                      Advanced Managerial accounting                    last update 9/29/2011




                                          Total CM
                       CM Ratio =
                                           Total
                                   $80,000 sales
                                              = 40%
                                  $200,000
          Each $1.00 increase in sales results in a total
              contribution margin increase of 40¢.



 Or, in terms of units, the contribution margin ratio is:
                                               Unit CM
                      CM Ratio =
                                          Unit selling price

                  For Racing Bicycle Company the ratio is:

                                        $200 = 40%
                                        $500


                                   400 Bikes      Per Unit        500 Bikes            Per Unit
 Sales                            $ 200,000                      $ 250,000           $    500
 Less: variable expenses            120,000                        150,000                300
 Contribution margin                80,000                         100,000           $    200
 Less: fixed expenses               80,000                         80,000
 Net operating income             $     -                        $ 20,000



                      A $50,000 increase in sales revenue
                      results in a $20,000 increase in CM.
                          ($50,000 × 40% = $20,000)

Changes in Fixed Costs and Sales Volume

Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/      Page 41 of 46
     Master Program                        Advanced Managerial accounting                  last update 9/29/2011


What is the profit impact if Racing can increase unit sales from 500 to 540 by increasing the monthly
advertising budget by $10,000?

$80,000 + $10,000 advertising = $90,000
Sales increased by $20,000, but net operating income decreased by $2,000.
The Shortcut Solution
 Increase in CM (40 units X $200)             $ 8,000
 Increase in advertising expenses              10,000
 Decrease in net operating income             $ (2,000)


Change in Variable Costs and Sales Volume
What is the profit impact if Racing can use higher quality raw materials, thus increasing variable costs
per unit by $10, to generate an increase in unit sales from 500 to 580?
580 units × $310 variable cost/unit = $179,800
Sales increase by $40,000, and net operating income increases by $10,200.



Change in Fixed Cost, Sales Price and Volume
What is the profit impact if Racing (1) cuts its selling price $20 per unit, (2) increases its advertising
budget by $15,000 per month, and (3) increases unit sales from 500 to 650 units per month?

Sales increase by $62,000, fixed costs increase by $15,000, and net operating income increases
by $2,000.


Change in Regular Sales Price
What is the profit impact if Racing (1) pays a $15 sales commission per bike sold instead of paying
salespersons flat salaries that currently total $6,000 per month, and (2) increases unit sales from 500 to
575 bikes?

Sales increase by $37,500, variable costs increase by $31,125, but fixed expenses decrease by
$6,000.

Change in Regular Sales Price
If Racing has an opportunity to sell 150 bikes to a wholesaler without disturbing sales to other customers
or fixed expenses, what price would it quote to the wholesaler if it wants to increase monthly profits by
$3,000?

 $ 3,000      ÷      150 bikes =           $ 20           per bike
 Variable cost per bike        =             300          per bike
 Selling price required        =           $ 320          per bike
  150 bikes      × $320 per bike      =   $ 48,000
 Total variable costs                 =     45,000
 Increase in net income               =   $ 3,000


Prepared by:   Isam Rimawi irimawi@hotmail.com       http://www.geocities.com/irimawi/   Page 42 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011




Quick Check 
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month
is $1,300. 2,100 cups are sold each month on average. What is the CM Ratio for Coffee Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139                                             ,b,


                                Unit contribution margin
    CM Ratio =
                                    Unit selling price
                              ($1.49-$0.36)
                            =     $1.49
                                 $1.13
                            =          = 0.758
                                 $1.49




Break-Even Analysis
Break-even analysis can be approached in two ways:
         1. Equation method
         2. Contribution margin method
Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 43 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011




Equation Method
Profits = (Sales – Variable expenses) – Fixed expenses
OR
Sales = Variable expenses + Fixed expenses + Profits

 At the break-even point
    profits equal zero




Break-Even Analysis
Here is the information from Racing Bicycle Company:
                                      Total        Per Unit      Percent
 Sales (500 bikes)                 $250,000       $ 500             100%
 Less: variable expenses            150,000           300            60%
 Contribution margin               $100,000       $ 200              40%
 Less: fixed expenses                80,000
 Net operating income              $ 20,000



Equation Method
We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits
$500Q = $300Q + $80,000 + $0

Where:
                                        Q = Number of bikes sold
                                     $500 = Unit selling price
                                     $300 = Unit variable expense
                                  $80,000 = Total fixed expense
$500Q = $300Q + $80,000 + $0
$200Q = $80,000
    Q = $80,000 ÷ $200 per bike
    Q = 400 bikes

       The equation can be modified to calculate the break-even point in sales
  dollars.
Sales = Variable expenses + Fixed expenses + Profits
X = 0.60X + $80,000 + $0



Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 44 of 46
     Master Program                      Advanced Managerial accounting                last update 9/29/2011



X = 0.60X + $80,000 + $0

        Where:
              X = Total sales dollars
           0.60 = Variable expenses as a % of sales
        $80,000 = Total fixed expenses


        The equation can be modified to calculate the break-even point in
        sales dollars.
Sales = Variable expenses + Fixed expenses + Profits
       X = 0.60X + $80,000 + $0
  0.40X = $80,000
       X = $80,000 ÷ 0.40
       X = $200,000


Contribution Margin Method
The contribution margin method has two key equations.




     Break-even point                           Fixed expenses
                      =
       in units sold                         Unit contribution margin

 Break-even point in                         Fixed expenses
  total sales dollars =                          CM ratio




Let’s use the contribution margin method to calculate the break-even point in total sales dollars at
Racing

    Break-even point in                                   Fixed
        total sales dollars                      =
                                                          expense
Prepared by:   Isam Rimawi irimawi@hotmail.com            s
                                                 http://www.geocities.com/irimawi/   Page 45 of 46

                                                                      CM
                                                          ratio
     Master Program                      Advanced Managerial accounting                last update 9/29/2011



Quick Check 
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month
is $1,300. 2,100 cups are sold each month on average. What is the break-even sales in units?
    a. 872 cups
    b. b. 3,611 cups
    c. c. 1,200 cups
    d. d. 1,150 cups                              ,d,

                                        Fixed expenses
    Break-even =                            Unit CM
                                $1,300
                 =       $1.49/cup - $0.36/cup
                    $1,300
                 =
                   $1.13/cup

                 = 1,150 cups




Prepared by:   Isam Rimawi irimawi@hotmail.com   http://www.geocities.com/irimawi/   Page 46 of 46

								
To top