Management

Accounting
Major Differences Between
Financial and Managerial Accounting
Managerial Accounting Financial Accounting

Communicate financial
Purpose Decision making
position to outsiders

Primary Users Internal managers External users

Focus/Emphasis Future-oriented Past-oriented

Do not have to follow GAAP; GAAP compliant;

Rules
cost vs. benefit CPA audited
Ultra current to very long Historical monthly,
Time Span
time horizons quarterly reports
Behavioral Designed to influence Indirect effects on
Issues employee behavior employee behavior
Basic Cost Terminology

 Cost—sacrificed resource to achieve a specific objective

 Actual cost—a cost that has occurred
 Budgeted cost—a predicted cost
 Cost object—anything of interest for which a cost is
desired
Basic Cost Terminology

 Cost accumulation—a collection of cost data in an

organized manner
 Cost assignment—a general term that includes gathering
accumulated costs to a cost object. This includes:
 Tracing accumulated costs with a direct relationship to the
cost object and
 Allocating accumulated costs with an indirect relationship
to a cost object
Direct and Indirect Costs

 Direct costs can be conveniently and economically

traced (tracked) to a cost object.
 Indirect costs cannot be conveniently or economically
traced (tracked) to a cost object. Instead of being
traced, these costs are allocated to a cost object in a
rational and systematic manner.
Cost Behavior

 Variable costs—changes in total in proportion to changes

in the related level of activity or volume.
 Fixed costs—remain unchanged in total regardless of
changes in the related level of activity or volume.
 Costs are fixed or variable only with respect to a
specific activity or a given time period.
Types of Manufacturing
Inventories
 Direct materials—resources in-stock and available for
use
 Work-in-process (or progress)—products started but not
yet completed, often abbreviated as WIP
 Finished goods—products completed and ready for sale
Accounting Distinction Between Costs

 Inventoriable costs—product manufacturing costs. These costs are

capitalized as assets (inventory) until they are sold and transferred to Cost
of Goods Sold.
 Period costs—have no future value and are expensed in the period
incurred.
 Job Costing

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Costing Systems

 Job-costing—system accounting for distinct cost objects

called jobs. Each job may be different from the next,
and consumes different resources.
 Wedding announcements, aircraft, advertising
 Process-costing—system accounting for mass production
of identical or similar products.
 Oil refining, orange juice, soda pop
Journal Entries

 All product costs are accumulated in the work-in-

process control account.
 Direct materials used
 Direct labor incurred
 Factory overhead allocated or applied
 Actual indirect costs (overhead) are accumulated in the
manufacturing overhead control account.
Accounting for Overhead

 Actual costs will almost never equal budgeted costs.

Accordingly, an imbalance situation exists between the
two overhead accounts.
 If Overhead Control > Overhead Allocated, this is called
Underallocated Overhead
 If Overhead Control < Overhead Allocated, this is called
Overallocated Overhead
Three Methods for Adjusting
Over/Underapplied Overhead
 Adjusted allocation rate approach—all allocations
are recalculated with the actual, exact allocation
rate.
 Proration approach—the difference is allocated
between cost of goods sold, work-in-process, and
finished goods based on their relative sizes.
 Write-off approach—the difference is simply
written off to cost of goods sold.
 Activity-Based Costing
and
Activity-Based Management
Over and Undercosting

 Overcosting—a product consumes a low level of

resources but is allocated high costs per unit.
 Undercosting—a product consumes a high level of
resources but is allocated low costs per unit.
Cost Hierarchies

 ABC uses a four-level cost structure to determine how

far down the production cycle costs should be pushed:
 Unit-level (output-level)
 Batch-level
 Product-sustaining-level
 Facility-sustaining-level
ABC vs. Simple Costing
Schemes
 ABC is generally perceived to produce superior costing
figures due to the use of multiple drivers across
multiple levels.
 ABC is only as good as the drivers selected, and their
actual relationship to costs. Poorly chosen drivers will
produce inaccurate costs, even with ABC.
Activity-Based Management

 A method of management that uses ABC as an integral

part in critical decision-making situations, including:
 Pricing and product-mix decisions
 Cost reduction and process improvement decisions
 Design decisions
 Planning and managing activities
Signals that Suggest that ABC
Implementation Could Help a Firm:
 Significant overhead costs allocated using one or
two cost pools
 Most or all overhead is considered unit-level
 Products that consume different amounts of
resources
 Products that a firm should successfully make and
sell consistently show small profits
 Operations staff disagreeing with accounting over
manufacturing and marketing costs
 Allocation of
Support Department Costs,
Common Costs,
and Revenues
Allocating Costs of a Supporting
Department to Operating Departments
 Supporting (service) department—provides the services that assist other
internal departments in the company
 Operating (production) department—directly adds value to a product or
service
 Methods of Allocating Support
Costs to Production
Departments
1. Direct
2. Step-down
3. Reciprocal
Direct Method

Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting
Step-Down Method

Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting
Reciprocal Method

Support Departments Production Departments

Information Systems

Manufacturing

Packaging

Accounting
Choosing Between Methods

 Reciprocal is the most precise.

 Direct and step-down are simple to compute and understand.
 Direct method is widely used.
Allocating Common Costs

 Common cost—the cost of operating a facility, activity, or like cost object

that is shared by two or more users at a lower cost than the individual
cost of the activity to each user.
 Cost Allocation:
Joint Products and Byproducts
Joint Cost Terminology

 Main product—output of a joint production process that

yields one product with a high sales value compared to
the sales values of the other outputs
 Joint products—outputs of a joint production process
that yields two or more products with a high sales value
compared to the sales values of any other outputs
 Byproducts—outputs of a joint production process that
have low sales values compare to the sales values of the
other outputs
Joint Cost Allocation Methods

 Market-based—allocate using market-derived data

(dollars):
1. Sales value at splitoff
2. Net realizable value (NRV)
3. Constant gross-margin percentage NRV
 Physical measures—allocate using tangible attributes
of the products, such as pounds, gallons, barrels, and
so on
Method Selection

 If selling price at splitoff is available,

use the sales value at splitoff method.
 If selling price at splitoff is not
available, use the NRV method.
 If simplicity is the primary
consideration, physical-measures
method or the constant gross-margin
method could be used.
 Despite this, some firms choose not to
allocate joint costs at all.
Process Costing
Process Costing

 Process costing is a system where the unit cost of

a product or service is obtained by assigning total
costs to many identical or similar units.
 Each unit receives the same or similar amounts of
direct materials costs, direct labor costs, and
manufacturing overhead.
 Unit costs are computed by dividing total costs
incurred by the number of units of output from
the production process.
Equivalent Units

 A derived amount of output units that:

1. Takes the quantity of each input in units completed and
in unfinished units of work in process and
2. Converts the quantity of input into the amount of
completed output units that could be produced with
that quantity of input
 Are calculated separately for each input (direct
materials and conversion cost)
Transferred-In Costs

 Are costs incurred in previous

departments that are carried forward
as the products cost when it moves
to a subsequent process in the
production cycle.
 Also called previous department
costs.
Hybrid Costing Systems

 A Hybrid-costing system blends characteristics from

both job-costing and process-costing systems.
 Many actual production systems are in fact hybrids.
 Examples include manufacturers of televisions,
dishwashers, and washing machines, as well as Adidas.
Spoilage, Rework, and Scrap
Basic Terminology

 Spoilage—units of production, either fully or partially

completed, that do not meet the specifications required
by customers for good units and that are discarded or
sold for reduced prices
Basic Terminology

 Rework—units of production that do not meet the

specifications required by customers but which are
subsequently repaired and sold as good finished goods.
 Scrap—residual material that results from
manufacturing a product. Scrap has low total sales
value compared with the total sales value of the
product.
 Inventory Management,
Just-in-Time,
and Simplified Costing Methods
Costs Associated with
Goods for Sale
 Managing inventories to increase net income requires
effectively managing costs that fall into these six
categories:
1. Purchasing costs
2. Ordering costs
3. Carrying costs
4. Stockout costs
5. Quality costs
6. Shrinkage costs
The First Step in Managing
Goods for Sale
 The first decision in managing goods for sale is how
much to order of a given product.
 Economic order quality (EOQ) is a decision model that
calculates the optimal quantity of inventory to order
under a given set of assumptions.
Just-in-Time Purchasing

 Just-in-time (JIT) purchasing is the purchase of

materials or goods so they are delivered just as needed
for production or sales.
 JIT is popular because carrying costs are actually much
greater than estimated because warehousing, handing,
shrinkage, and investment costs have not been correctly
estimated.
Backflush Costing

 Backflush costing omits recording some

or all of the journal entries relating to
the stages from the purchase of direct
materials to the sale of finished goods.
 Because some stages are omitted, the journal
entries for a subsequent stage use normal or
standard costs to work backward to “flush out”
the costs in the cycle for which journal entries
were not made.
 Contrasts to traditional normal and
standard costing systems using
sequential tracking: recording journal
entries at each trigger point in the
production process.
Cost of Quality
Prevention and Appraisal Costs

Incurred to identify
defective products
Appraisal Costs before the products are
shipped to customers
Internal and External Failure Costs

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

Incurred as a result of
External Failure
defective products being
Costs delivered to customers
Cost-Volume-
Profit
Relationships
Preparing the CVP Graph

Break-even point Profit

Profit Area
Area
Dollars

Loss
Loss Area
Area Units
 The Formula Method

The formula uses the following equation.

Unit sales to attain Target profit + Fixed expenses

=
the target profit CM per unit
Variable Costing:
A Tool for
Management
Overview of Absorption and Variable Costing
Absorption C osting Variable C osting
Income State me nt Income State me nt
Sale s Sale s
Dire ct mate rials

Dire ct labor C ost of Goods Sold

( V a ri a b l e P ro d uc t C o s t s )

C ost of Goods Sold Variable manufacturing ove rhe ad

(Fixe d and variable
product costs)
Variable
Se lliing &
Administrative
e xpe nse s
Gross Profit
Fixe d manufacturing ove rhe ad C ontribution Margin
(Gross Margin)
Fixe d
Manufacturing
ove rhe ad
Fixe d
Se lling &
Se lling &
Adminstrative Se lling & Administrative e xpe nse s
Administrative
e xpe nse s
e xpe nse s
Ne t O pe rating Income Ne t O pe rating Income

KEY: = Pe riod e xpe nse s

Profit Planning
The Basic Framework of Budgeting

A budget is a detailed quantitative plan for

acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.
The Master Budget: An Overview

Sales
Sales budget
budget

Selling
Selling and
and
Ending
Ending inventory
inventory administrative
administrative
Production
Production budget
budget
budget
budget budget
budget

Direct
Direct materials
materials Direct
Direct labor
labor Manufacturing
Manufacturing
budget
budget budget
budget overhead
overhead budget
budget

Cash
Cash Budget
Budget

Budgeted
Budgeted Budgeted
Budgeted
income
income balance
balance sheet
sheet
statement
statement
Characteristics of Flexible Budgets

Hmm! Comparing
static planning budgets
Planning budgets with actual costs
are prepared for is like comparing
a single, planned apples and oranges.
level of activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
Characteristics of Flexible Budgets

May be prepared for any activity

level in the relevant range.

Show costs that should have been

incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.

Help managers control costs.

Improve performance evaluation.

Activity Variances

Planning Flexible
budget revenues budget revenues
and expenses and expenses

The differences between

the budget amounts are
called activity variances.
Revenue and Spending Variances

Flexible budget revenue Actual revenue

The difference is a revenue variance.

Flexible budget cost Actual cost

The difference is a spending variance.

Standard Costs and
Operating
Performance
Measures
 Standard Costs
Standards are benchmarks or “norms” for
measuring performance. In managerial accounting,
two types of standards are commonly used.

Quantity standards Price standards

specify how much of an specify how much
input should be used to should be paid for
make a product or each unit of the
provide a service. input.

Examples: Firestone, Sears, McDonald’s, hospitals,

construction and manufacturing companies.
A General Model for Variance Analysis

Variance Analysis

Price Variance Quantity Variance

Difference between Difference between

actual price and actual quantity and
standard price standard quantity
 A General Model for Variance
Analysis
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

(AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP)

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
 Understand how to construct
and use a balanced scorecard.
The Balanced Scorecard
Management
Management translates
translates its
its strategy
strategy into
into
performance
performance measures
measures that
that employees
employees
understand
understand and
and influence.
influence.

Financial Customers

Performance
measures
Internal Learning
business and growth
processes
 The Balanced Scorecard: From
Strategy to
Performance Performance Measures
Measures
Financial What are our
Has our financial
financial goals?
performance improved?

Customer What customers do Vision

we want to serve and
Do customers recognize that
how are we going to and
we are delivering more value? win and retain them? Strategy

Internal Business Processes What internal busi-

Have we improved key business ness processes are
processes so that we can deliver critical to providing
more value to customers? value to customers?

Learning and Growth

Are we maintaining our ability
to change and improve?
Transfer Pricing
Key Concepts/Definitions

A transfer price is the price

charged when one segment of a
company provides goods or
services to another segment of
the company.

The fundamental objective in

setting transfer prices is to
motivate managers to act in the
best interests of the overall
company.
Three Primary Approaches

There are three primary

approaches to setting
transfer prices:
1. Negotiated transfer prices;
2. Transfers at the cost to the
selling division; and
3. Transfers at market price.
Relevant Costs for
Decision Making
Cost Concepts for Decision
Making
A relevant cost is a cost that differs
between alternatives.

2
1
Identifying Relevant Costs
An
An avoidable
avoidable cost
cost is
is aa cost
cost that
that can
can be
be eliminated,
eliminated, inin whole
whole or
or in
in part,
part, by
by
choosing
choosing one
one alternative
alternative over
over another.
another. Avoidable
Avoidable costs
costs are
are relevant
relevant
costs.
costs. Unavoidable
Unavoidable costs
costs are
are irrelevant
irrelevant costs.
costs.

Two
Two broad
broad categories
categories of
of costs
costs are
are never
never relevant
relevant in
in any
any decision.
decision. They
They
include:
include:

 Sunk
Sunk costs.
costs.

 Future
Future costs
costs that
that do
do not
not differ
differ between
between the
the alternatives.
alternatives.
Decision Making

 Keep or Drop
 Make or Buy
 Accept or Reject
 Sell or Process Further

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