CHAPTER 1: STRATEGIC COST MANAGEMENT AND
MANAGEMENT ACCOUNTING
Management
The process of achieving organizational objectives.
Involves:
1. Planning
- One of the two important functions of
management.
- Setting goals and developing strategies and
tactics to achieve them.
2. Organizing
3. Leading
4. Controlling
- One of the two important functions of
management
- Determining whether goals are being met,
and if not, what can be done.
- Performance evaluation is a must.
Decision Making
Selecting one alternative from a set of choices
Making the best choice depends on:
1. Manager’s goals
2. Expected results from each alternative
3. Information available when decision is made
Decisions made are highly information dependent
Management Accounting
The process of identifying, measuring, accumulating,
analyzing, preparing, interpreting, and communicating
information
Information provided to internal users
Not governed by GAAP; manager must define which data are
relevant for a particular purpose and which are not.
Indispensable part of the system that provides information to
managers - the people whose decisions and actions determines
the success or failure of the organization.
Objectives of Management Accounting
1. Providing managers with information for decision
making and planning
2. Assisting managers in directing and controlling
operations
3. Motivating managers toward achieving organization’s
goals
4. Measuring performance of managers and sub-units
within the organization.
Strategic Cost Management
Application of cost management techniques which aims to
reduce costs while strengthening the strategic position of a
business.
It would be beneficial to increase costs that support the
strategic position of the business. It is not good to cut costs in
strategically important areas, as it reduces customer
satisfaction and experience.
3 ways to institute cost management techniques
1. Develop systems that would streamline the
transactions between corporate support department
and the operating units.
2. Establish transfer pricing systems to coordinate the
buyer-supplier interactions between decentralized
organizational operating units.
3. Utilize pseudo profit centers to create profit
maximizing behavior in what were formerly cost
centers.
The Relationship of Management Accounting with
Financial and Cost Accounting as provider of information
3 functions of Accounting Information:
1. To provide information to external parties such as
stockholders, creditors and various regulatory bodies
for investment and credit purposes
2. To estimate the cost of products produced or services
rendered
3. To provide information useful for making decisions
and controlling operations
Financial Accounting
The field of Accounting that develops information for external
decision-makers such as stockholders, suppliers, banks, and
government regulatory agencies.
Primary Financial Accounting reports:
Balance sheet, Statement of Income, Statement of Cash Flows
GAAP is provided for strict adherence of financial accounting
reports.
Cost Accounting
Field of Accounting that creates an overlap between financial
accounting and management accounting.
Integrates Financial Accounting by:
Providing product costing information for financial statements
Integrated Management Accounting by:
Providing some of the quantitative, cost-based information
managers need to perform their functions.
Functions of Cost Accounting:
1. Focuses primarily on the determination of the cost of
making products or performing services
2. Determines the cost of products or services by direct
measurement, arbitrary assignment, and systematic or
rational allocation of such costs.
3. An Integral part of the broader field of Management
Accounting and its overlap causes the Financial and
Management Accounting systems to be more
integrated to form a complete informational network.
Accounting System
One part of the organization’s Management Information
System
Cost Accounting System
One part of the organization’s Overall Accounting System
Management Accounting
Preparation of information
for Planning, directing,
controlling organization’s
operations, and decisionmaking
Financial Accounting
Preparation of published
financial statements and
other financial reports
Internal Users
External Users
Managers at all levels in the
organization
Stockholders, financial
analysts, lenders, unions,
consumer groups,
government agencies
Cost-benefit analysis
Analytical process of comparing the relative costs and benefits
that result from a specific course of action, which the
managers should apply.
Basis
Management
Accounting
Financial
Accounting
Users of
information
Internal
External
Regulations to
Follow
Not required and
unregulated
GAAP
Sources of Data
Organization’s
basic Accounting
System plus
various other
sources, such as
Data are drawn
exclusively from
the organization’s
basic Accounting
System, which
Nature of
Reports and
Procedures
external
information
accumulates the
Financial
Information
Reports often
focus on subunits
within the
organization.
Reports are based
on a combination
of historical data,
estimates and
projection of
future events.
Reports focus on
the company in its
entirety. Reports
are based almost
exclusively on
historical
transactions or
data.
The Need for Accounting Information
Information comes from various sources:
Economics, finance, marketing, research, production,
personnel, and accounting.
Accounting System
A Formal mechanism for gathering, organizing, and
communicating information about an organization’s activities.
Managers need information to make decisions about:
➢ Acquiring and financing production capacity
➢ Determining which products to produce and market
➢ Pricing products, jobs or services
➢ Determining the best method of distributing goods
and services to the target market
➢ Locating the best property for production facilities
➢ Financing the costs of production and operations
Managers should provide both:
● Quantitative information
Allows managers to know the number of impact of
every alternative choice.
●
Qualitative information
Furnishes the facts that help eliminate some of the
inherent uncertainties related to such alternative
choices.
Managers are information users, while Accountants are
information providers.
Management functions or process:
➢ Planning
Process of translating the goals and objectives of an
organization and developing a strategy for achieving
those goals in a systematic manner.
➢ Controlling
Process of setting performance standards, measuring
performance, periodically comparing actual
performance with standards, and taking corrective
measures or actions when operations do not conform
with what is expected.
➢ Performance evaluation
Process of determining the degree of success in
accomplishing the plan. It is done to determine if the
actual results materially differ with what was set by
the firm.
Tries to equate both:
● Effectiveness
A measure of how well an organization’s
goals and objectives are achieved. Compares
actual output results to desired results.
●
Efficiency
A measure of the degree to which tasks were
performed to produce the best yield at lower
cost from the resources available.
➢ Decision making
Process of choosing among the possible solutions
available to a given problem situation.
The Changing Role of a Traditional Accountant’s Function
to a Financial Manager’s Function
Competition among firms: Information system and Financial
management
Good financial management will help any business provide:
● Better products or services to its customers
● Pay higher wages and salaries to its workers and
employees, and even managers
● Greater returns to the investors who put up capital
needed to form the company and then operate the
firm
Traditional Accountant’s function is to provide information
about the firm’s financial activities for decision making.
Management accountants became users of this information
and introduced many changes towards better management
decisions. Changes include:
➢ A Shift toward addressing the needs of service
companies and improving practices to better serve
and meet the needs of managers
➢ Improved practices which include a focus on
managing the value chain through techniques such as
JIT system and ERP (Enterprise Resource Planning)
➢ The use of the balanced scorecard in order to attain a
more comprehensive view of the company’s
operations.
Organizational Structure
Refers to how authority as well as responsibility for making
decisions is distributed in the organization.
Financial Management Responsibilities
Line of going down - line of authority
Line of going up - line of responsibility
Primary task of financial manager:
Plan for the acquisition and use of funds so as to maximize the
value of the firm, that is, he or she makes decisions about
alternative sources and uses of funds.
Most common officers involved in the financial information:
● Chief Executive Officer (CEO)
● Chief Financial Officer (CFO)
● The Treasurer
● The Comptroller or Controller
● The Chief Accountant
➢ Forecasting and planning
Financial managers must interact with other
executives as they jointly look ahead and formulate
plans, which will shape the firm’s future position.
CFO reports to the President or CEO
➢ Capital investment and financing decisions
Financial manager must raise the capital needed to
support growth.
Treasurer
Has direct responsibility for managing the firm’s cash and
marketable securities, for planning its capital structure, for
selling stock and bonds to raise capital, and for overseeing the
corporate pension fund.
Controller
Responsible for the activities of the accounting and tax
departments.
Financial officer must help determine the optimal rate
of sales growth, and decide on the specific
investments to be made as well as on the types of
funds to be used to finance these investments
(internal vs. external funds; long term vs. short term
debt)
➢ Controlling and coordinating
Financial manager must interact with other
executives so that the firm could operate as
efficiently as possible.
The organizational chart of the company shows the corporate
governance.
Basic Duties of Controller
● Planning, controlling, designing, installing and
maintaining the cost accounting system
● Predicting future costs
● Coordinating the development of the budget
● Accumulating and analyzing actual costs
● Preparing and analysing performance reports
● Preparing reports for external users
● Providing information for special decisions
● Consulting with management as to cost information
● Internal auditing
● Tax administration
● Protection of assets
● Economic appraisal
Ethical Conduct (CCIO)
1. Competence
● Maintain an appropriate level of
professional competence by ongoing
development of their knowledge and skills.
● Perform their professional duties in
accordance with laws, regulations, and
technical standards.
● Prepare complete and clear reports and
recommendations after appropriate analyses
of relevant and reliable information.
2.
Confidentiality
● Refrain from disclosing confidential
information acquired in the course of their
work, except when authorized, unless
legally obliged to do so
● Inform subordinates as appropriate
regarding the confidentiality of information
acquired in the course of their work and
monitor their activities to assure the
maintenance of that confidentiality.
● Refrain from using or appearing to use
confidential information acquired in the
course of their work for unethical or illegal
advantage either personally or through third
parties.
3.
Integrity
● Avoid actual or apparent conflicts of interest
and advise all appropriate parties of any
potential conflict.
● Refrain from engaging in any activity that
would prejudice their ability to carry out
their duties ethically
● Refuse any gift, favor, or hospitality that
would influence or would appear to
influence their actions.
● Refrain from either actively or passively
subverting the attainment of the
organization’s legitimate and ethical
objectives.
● Recognize and communicate professional
limitations or other constraints that would
preclude responsible judgement or
successful performance of an activity.
● Communicate unfavorable as well as
favorable information and professional
judgments or opinions.
● Refrain from engaging in or supporting any
activity that would discredit the profession.
Basic Duties of Treasurer
● Financial planning or fund management
● Obtaining funds to finance the acquisition of fixed
assets
● Evaluating the acquisition of fixed assets
● Short term finance sourcing or managing working
capital needed
● Banking and custody
● Managing the pension fund
● Managing foreign exchange transactions
● Credits and collection
● Distribution of corporate earnings to owners
Major responsibilities of financial management involves
decision such as:
1. Which investments the firm should make
2. How their projects should be financed
3. How managers of the firm can most effectively
protect and manage its existing resources
Professional Ethics for Management Accountants
Maximizing shareholders’ wealth should be achieved subject
to ethical constraints.
In the United States, Sarbanes-Oxley Act of 2002 has been
passed to reduce the apparent conflicts of interest that exist in
many corporate structures.
Companies developed guidelines for good corporate
governance.
Corporate Governance
A system of organizational control that is used to define and
establish lines of responsibility and accountability among
major participants in the corporation.
4.
Objectivity
● Communicate information fairly and
objectively
● Disclose fully all relevant information that
could reasonably be expected to influence an
intended user’s understanding of the reports,
comments, and recommendations presented.
Resolution of Ethical Conflict
When faced with significant ethical issues, management
accountants should follow the established policies of the
organization. If these policies do not resolve ethical conflict,
management accountants should consider the ff:
●
●
●
●
Discuss such problems with the immediate superior
except when the superior is involved. If satisfactory
resolution cannot be achieved when the problem is
initially presented, submit to the next higher
managerial level.
If the immediate superior is the CEO, or equivalent,
the acceptable reviewing authority may be a group
(audit committee, BOD, board of trustees).
Clarify relevant concepts by confidential discussions
with an objective advisor to obtain an understanding
of possible courses of action.
If the ethical conflict still exists after exhausting all
levels of internal review, the management accountant
may have no other recourse on significant matters
than to resign and submit an informative
memorandum.
Type of strategy that focuses on action plans for managing a
particular functional area within a business in a way that
supports the business-level strategy
Goal commitment
One’s attachment to, or determination to reach
Operating plans
Contain the details necessary to implement and maintain an
organization’s strategies
Strategic goals
Broadly defined targets or future end results set by top
management
Strategic management
Process through which managers formulate and implement
strategies geared toward optimizing strategic goal
achievement, with given available environmental and internal
conditions
Grand strategy
Master strategy that provides the basic strategic direction at
the corporate level
Strategy formulation
Process of identifying the missions and strategic goals,
conducting competitive analysis, and developing specific
strategies. Foundation level of organization planning.
Strategy implementation
Process of carrying out strategic plans and maintaining control
over how those plans are carried out
Terms in management process:
Administrative Management
An approach that focuses on principles that can be used by
managers to coordinate the internal activities of organization
Total Quality Management (TQM)
Aimed at continually improving product and service quality so
as to achieve high levels of customer satisfaction and build
strong customer loyalty.
Management Accounting Information System
Functional authority
Authority of staff departments over others in matters directly
related to their respective functions
Functional managers
Managers who have responsibility for a specific specialized
area and supervise mainly individuals with expertise and
training in that area
Functional structure
Structure in which positions are grouped according to their
main functional or specialized area
Functional-level strategy
Definitions of Management Information System:
➢ A business system that provides past, present and
projected information about a company and its
environment (David M. Kroenke and Kathleen A.
Nolan)
➢ A formal method of making available to management
the accurate and timely information necessary to
facilitate the decision-making process and enable the
organization’s planning, control and operational
functions to be carried out effectively (James A F.
Stoner)
➢ System that monitors and retrieves data from the
environment, captures data from transactions and
operation within the firm, filters, organizes and
selects data and presented them as information to
managers, and provides the means for managers to
generate information as desired (Robert G. Maudrick)
Management Control System (MCS)
Guides the organizations in designing and implementing
strategies such that the organizational goals and objectives are
achieved.
Designing a Management Accounting System
Each firm requires a management accounting system that is
tailored to its circumstances, such as: organizational form,
structure and culture.
➢ The firm’s legal nature must be reflected in its
organizational form (proprietorship, partnership, or
corporation)
➢ The firm’s organizational structure refers to how
authority and responsibility for decision making are
distributed (centralized or decentralized form)
➢ The firm’s organizational culture refers to the
underlying set of assumptions about an entity and the
goals, processes, practices and values that are shared
by its members
Systems should be evaluated to determine the answers to the
following questions:
1. What is being gathered and in what form?
2. What outputs are being generated and in what form?
3. How to current systems interact with one another and
how effective are those interactions?
4. Is the current chart of accounts appropriate for the
management accounting information desired?
5. What significant information issues are not presently
being addressed by the information system and could
those issues be integrated into the current system?
Proper incentives and reporting systems must be incorporated
into the system for managers to make appropriate decisions.
System must be composed of three primary elements:
1. Motivational elements
Includes performance measures, reward structure,
support of organizational mission and competitive
strategy
2.
3.
Informational elements
Includes all necessary information related to
budgeting, cost control, value added and non-value
added activities, and assessment of core
competencies and analysis of make-or-outsource
decisions
Reporting elements
Includes the preparation of financial statements for
both financial and management accounting purpose
4 primary components:
1. A detector or sensor
Identifies what is actually happening in the process of
being controlled
2.
An assessor
Device for determining the significance of what is
happening
3.
An effector
Device that alters behavior if the assessor indicates
the need for doing so. “Feedback”
4.
A communication network
Transmits information between the detector and the
assessor and between the assessor and the effector
Cost Management System (CMS)
Consists of a set of formal methods developed for planning
and controlling an organization’s cost-generating activities
relative to its goals and objectives.
CMS helps managers:
➢ Identify the cost of resources consumed in
performing significant activities of the firm - the
accounting models and practices
➢ Determine the efficiency and effectiveness of the
activities performed - performance measurement
➢ Identify and evaluate new activities that can improve
the future performance of new firm - investment
management, and
➢ Accomplish the first three functions stated above in
an environment characterized by changing
technology - adapting the firm in the changes of
technologies
Essential characteristics and qualities of information
We describe information in terms of:
1. Accuracy and Verifiability
The degree to which information is free from error
2.
Completeness
Refers to the degree to which it is free from
omissions
Benefit-cost analysis is a good example of the
importance of considering the completeness of
information in the decision-making process.
Orderly, efficient scheme for providing accurate financial
information and controls
Referred to as sufficient information
3.
Relevance
Refers to the appropriateness of the information as
input for a particular decision to be made
4.
Timeliness
Refers to the time sensitivity of information.
Sensitivity refers to the effect of decision that should
have been mad if the information was given on time
or not given on time.
Components of Information Systems (Computer Based
System)
Systems
A group of components that interfere with and complement
one another to achieve one or more predefined goals.
Information system is normally referred to as computer-based
system that provides:
a. Data processing (DP) capabilities of a department or
perhaps an entire company, and
b. Information - as people need to make better, more
informed decision is inevitable
Major components of a system: (ITOF)
1. Inputs
Various human, material, financial, equipment and
informational resources put together required to
produce goods and services
2.
Classified into:
1. Operating results
Accounting information enables both internal and
external users evaluate organizational performance
2.
Setting priorities
Accounting information, by way of accounting
reports, enables the management to focus on
operating problems, imperfections, inefficiencies, and
opportunities.
3.
Problem solving
Commonly related with non-recurring decisions or
situations that require special accounting analyses or
reports.
Uses of Accounting System
➢ Routine reporting to management, primarily for
planning and controlling current operations
➢ Special reporting to management, primarily for longrange planning and short-term but non-recurring
decisions
➢ Routine reporting on financial and operating results,
primarily for external parties
Components of an Accounting System (FEPP)
1. Forms
Documents on which data is recorded(O.R., sales
invoices, checks)
2.
Equipment
Devices and machines (computers, cash registers,
vaults, filing cabinets)
3.
Procedures
Series of operations or steps that must be performed
to complete a task (sales form)
4.
People
An accounting system can only function efficiently
and effectively if the people who are involved in it
perform their duties carefully and accurately
Transformation processes
Organization’s managerial and technological abilities
that are applied to convert inputs into outputs
3.
Outputs
Products, services, information or any other
outcomes produced by the organization
4.
Feedback
Information about the results and organizational
status relative to the environment
Purpose of Accounting Information and Need for
Accounting Systems
Ultimate use: help someone make decisions
Accounting System
General Guidelines in Setting Good Accounting System
Design
➢ Flexibility
System must be adaptable to meet changing
circumstances and demands
➢ Reliability
System must be strong and can stand up to misuse,
both deliberate and accidental
6.
Job rotations and forced leaves and bonds
Key employees handling custodianship functions
should be forced to take some vacation leaves and be
rotated occasionally and if possible to place bonds.
7.
Periodic review of the system
Periodic review of all phases of the system by
internal or external auditors are necessary.
8.
Physical safeguards
Safe boxes, locks and other safety measures must be
installed, and limited access to authorized personnel
will minimize asset and record losses.
9.
Routine and spot checks
Routine but unscheduled checks must be done to
prevent commission of fraud at any time.
➢ Simplicity
System must be simple and easy to understand
➢ Helpfulness
It is also about the usefulness of the system to those
who have to work with it.
➢ Economy
It is always related to the idea of cost-benefit
analysis. An accounting system may be too good but
too costly for an organization
➢ Control Mechanisms
Accounting system must contain controls to ensure:
● Accuracy
Records are checked at various stages of the
accounting cycle
●
●
Honesty
Effective controls are needed to prevent
temptation of mishandling, theft and other
possible commission of fraud and
irregularities
Efficiency and speed
More than one person can work on related
records at the same time. Refers to the
theory of “check and balance”.
Elements of Good Internal Control
1. Reliable personnel
Personnel should be given duties appropriate to their
interests, experience and capabilities.
2.
3.
4.
5.
Separation of duties
Recording and custodianship of assets should not be
handled by one person. No one person must be in
total control of any activity.
Supervision
Each supervisor oversees and appraises the
performance of his subordinates.
Responsibility
Must be clearly laid out to trace who should be
praised or punished.
Document control
Immediate, complete and tamper-proof recording
10. Cost feasibility
Benefits should outweigh costs
Sources of Accounting Data
Common transaction systems in a typical firm are:
➢ Order (Sales or service) Entry System
Sales orders from customers are processed and filed,
and customers are billed for their purchases.
➢ Cash Receipts System
Cash receipts from customers are recorded, and cash
is deposited intact.
➢ Purchases System
Items for sale or for production use are ordered,
received and recorded.
➢ Production Planning and Control System
In manufacturing firms, production schedules are set;
purchases are made; materials, labor and equipment
are scheduled; and production output is monitored.
➢ Cash Disbursement System
All payments for purchases and any other are made
and recorded.
➢ Personnel System
All personnel events are recorded, including hiring,
giving benefits, evaluation and payroll activities.
➢ General Accounting System
Data from all other transaction systems are brought
together, and most management reports and financial
statements are generated.
Matched against revenues in the time period in which
it is incurred. These are the normal operating
expenses of the firm.
Elements of a Computerized Accounting System
Input Data → Process → Output Information
Data
Customer’s name, details of items needed by customer, terms
of sale
Processing
Invoice prepared and approved, recording and billing
prepared. TOTAL sales summarized
Information
Sales reports generated. Daily, weekly or monthly by product
line or by territory whatever is applicable
CHAPTER 2: COST CONCEPTS, CLASSIFICATIONS
AND COST BEHAVIOR
Product and period costs are useful in income statement using
variable costing method.
Costs classified in relation to management controlling
functions, particularly in managing cost.
Classifying costs as direct or indirect would be meaningless,
unless the firm first identifies some organizational segment to
which these costs are to be related. The segment could be a
product line, a functional department, a division, a branch, or
some other sub-unit.
A. As to Traceability
● Direct cost
Can be traced to a particular plant or
department.
“Cost is sacrifice”
●
Sacrifice - something of value for an expected benefit greater
than its cost.
Cost classified by the functional areas of the organization to
which the costs relate
●
Manufacturing cost
Incurred in the production. Composed of direct
material, direct labor and manufacturing overhead.
●
Nonmanufacturing cost
Incurred in administering the operation of the
business and commercializing the product or service.
Called operating expenses.
Service - consumed as it is produced
Manufactured product - can be stored in inventory
Indirect cost
Not directly traceable to a particular
department or sub-unit.
Cost classified as to direct or indirect is useful to:
Cost Management System
- Aims to trace as many costs as possible directly to
the activities to which costs are incurred.
- Sometimes called “Activity Accounting”.
- Vital to the objective of eliminating “non-value
added costs,'' which are costs that can be eliminated
without deterioration of service quality, performance
or perceived value. Achieved by AB Costing.
B. As to Controllability
● Controllable cost
Manager can significantly or heavily
influence the level of incurrence of such
cost.
Cost classified as to timing of charges to revenue in an
accounting period
●
●
Product cost
Cost assigned to goods or services until sold. Also
known as inventoriable cost.
Viewed as “attaching” to units of product as the
goods are purchased or manufactured and they
remain to be the cost of goods in inventory awaiting
sale.
When sold, expensed (COGS) and matched against
sales revenue.
Period cost
●
Uncontrollable cost
Manager cannot significantly influence its
incurrence. Costs allocated to his department
by the higher authority.
Cost classified in relation to decision making
●
Opportunity cost
Benefit sacrificed/foregone in choosing one
alternative over another.
●
Differential cost/Incremental cost/Decremental cost
Amount by which cost differs under two alternative
actions.
●
●
Relevant cost
Cost incurred in one alternative, but will not be
incurred in another.
Marginal cost
Extra cost incurred when one additional unit is
produced. Differ across different ranges of production
quantities because the efficiency of production
process changes.
Inversely proportional to the changes in activity/cost
driver
●
Mixed or semi-variable cost
Management assumes that mixed cost has been
segregated using different cost segregation technique.
Cost function
Formula to which the total cost of the firm will be computed
Y = A + B(X)
●
●
Average cost per unit
Total cost to produce divided by no. of units
manufactured
Sunk cost
Cost that has been paid or incurred. They do not
affect future costs and cannot be changed by any
current or future actions, such as historical or
committed costs.
Other terms commonly used in the study of Management
Accounting
● Cost Allocation
Process of assigning costs in a cost pool. TRacing
and reassigning costs to one or more cost objectives
such as departments, customers, or products.
●
Cost Objective
Activity or resource for which a separate
measurement of costs is desired. Ex: departments,
products, and segments or territories.
●
Cost Object
Activity for which costs are accumulated and
measured.
●
Cost Measurement
First step in estimating or predicting costs as a
function of appropriate cost drivers.
●
Cost Accounting
Calculation of costs for the purpose of planning and
controlling activities, improving quality and
efficiency, and making decisions.
●
Control
Management’s systematic effort to achieve objectives
by comparing performance to plans and acting to
correct differences between them.
●
Cost Estimate
Process of determining how a particular cost behaves
Relevant Range - assumed range of activity, which
reflects the company’s normal operating levels and
the relationship of cost behaviour is valid.
●
Cost Pool
Collection of costs to be assigned to a set of cost
objectives
Fixed cost
Total = constant
Per unit = varies
●
Common Costs
Cost of facilities and services that are shared by
Ex: long-term lease contracts
●
Out-of-pocket costs
Cost that requires the payment of cash or other assets
in the future as a result of their incurrence.
Costs classified in relation to organization’s activity and its
behaviour
Cost behaviour
How cost will react to changes in the level of activity
Activity
Measure of the organization’s output of products and services
Cost driver
Activity that causes costs to change or activity that incur costs
●
Variable cost
Total = varies
Per unit = constant
Directly proportional to the changes in activity/cost
driver.
●
users.
●
Capacity Costs
Fixed costs of being able to achieve a desired level of
production or to provide a desired level of service
while maintaining product or service attributes, such
as quality.
●
Committed Fixed Costs
Expenditures that require a series of payments over a
long-term period of time.
●
Common Costs
Non-traceable costs incurred for the benefit of one or
more than one functional classification or business
unit.
●
Discretionary Fixed Costs
Programmed costs. Expenditures which are fixed as a
result of management policy.
●
Marginal Costing
Variable costing. Assigns only variable
manufacturing cost to products.
●
Job Order Costing
Costing method in which costs are accumulated for
each job, batch or customer order.
CHAPTER 3: PRODUCT COSTING
●
“How income be correctly measured?”
Process Costing
Materials, labor and FOH are charged to cost centers.
Absorption Costing Method
Costs the product with all manufacturing costs regardless of
whether the manufacturing cost is variable or fixed.
Cost assigned to each unit = Total cost charged to the
cost center/no. of units produced
Fixed OH is treated as unexpired costs to be held back as
inventory, and charge to revenue later as goods are sold.
This method cannot be used to prepare a segment income
reporting under contribution margin which is one of the best
measures in evaluating the performance of a segment.
●
Direct Materials, Direct Labor, Variable and Fixed
OH are initially applied to inventory. Considered as
Product cost. Becomes expense as sold; COGS.
Income Statement
Sales
Less: COGS
Gross Profit
Less: Selling and Admin Exp.
Variable
Fixed
Net Income
xx
xx
xx
xx
xx
xx
xx
Fixed OH per unit = Total Fixed costs/Units produced
COGS = (VC per unit + FC per unit) x units sold
Ending inventory = Ending units x COGS
will decrease and Fixed OH that were previously
deferred in inventory under Absorption Costing are
released, plus the current Fixed OH charged against
income.
Variable (Direct) Costing Method
Cost of the product must include only those production costs
that vary directly with the volume of production.
Under Variable Costing, only Fixed OH for the
current year have been charged against revenues.
Fixed OH is not treated as product costs, rather, as an expired
cost to be immediately charged to revenue as incurred.
●
●
Only Direct Materials, Direct Labor and Variable OH
are initially applied to Inventory and considered as
Product Cost. Becomes expense as sold; COGS.
Fixed OH is charged immediately to revenues as
Period Cost. Expense as incurred.
➢ Production > Sales
Net Income: AC > VC
When more units are produced than sold, part of the
Fixed OH of the current period are deferred in
inventory to the next period under Absorption
Costing. Only that portion is charged against income
for the year.
Under Variable Costing, all Fixed OH for the current
year are immediately charged against income as
period cost.
Income Statement presentation using Standard Costing
Income Statement
Sales
Less: Variable Costs
Variable COGS
Variable Selling & Admin Exp.
Contribution Margin
Less: Fixed Costs
Fixed Manufacturing OH
Fixed Selling & Admin Exp.
Net Income
xx
xx
xx
xx
xx
xx
xx
xx
xx
xx
COGS = Variable Cost per unit x units sold
Ending inventory = Ending units x COGS
Absorption Method and Variable Method
*Net Income variance = Ending inventory variance
*This variance is comprised of the Fixed OH
Observations regarding sales and production of units:
In Absorption Costing Method, production volume variance
appears whenever actual production deviates from the
expected volume of production, which was used in computing
the predetermined fixed OH rate.
When using standard costs, all production must be stated at
standard.
It is important to note that:
➢ Expected production volume = Actual production
volume
No variance
➢ Expected volume > Actual volume
Variance is unfavorable because usage of facilities is
less than expected, and fixed OH is underapplied.
➢ Expected volume < Actual volume
Variance is favorable because usage of facilities is
more than expected, and fixed OH is overapplied.
➢ Production = Sales
Same net income will be realized regardless of the
method used.
Reconciliation of Variable Costing and Absorption Costing
➢ Production < Sales
Net Income: AC < VC
Absorption to Variable Costing
Net Income per Absorption Costing
Add: Fixed OH in beginning inventory
Less: Fixed OH in ending inventory
When more units are sold than produced, inventories
Pro forma reconciliation:
xx
xx
xx
Net Income per Variable Costing
Variable Costing to Absorption
Net Income per Variable Costing
Less: Fixed OH in beginning inventory
Add: Fixed OH in ending inventory
Net Income per Absorption Costing
xx
xx
xx
xx
xx
➢ Relevant range
Limit within which the volume of activity can vary
where sales and costs relationship remain valid.
➢ Sales mix
Relative combination of products that compose a
company’s total sales. Applicable only in a multiple
product line companies.
CHAPTER 4: COST VOLUME PROFIT ANALYSIS
CVP Analysis
● Key factor in planning and controlling, and the best
tool to profit maximization.
● Study of effects of volume of output on revenues,
expenses and net income.
● Analytical technique for studying the relationship
between fixed costs, variable costs, sales volume and
profits.
Breakeven Point in CVP analysis
The point at which total sales will just cover total costs - no
profit, no loss.
Breakeven analysis would help management determine:
➢ The number of unit sales required to breakeven
➢ The peso amount of revenues needed to achieve a
specified profit level.
➢ The effect on profits if selling price, fixed cost, and
variable cost changes.
➢ The required selling price needed to cover a projected
fixed cost change.
Basic CVP terms:
➢ Break-even point
Point where no profit, no loss.
Total sales = total cost
➢ Contribution Margin
Excess of sales over all variable costs
➢ Contribution Margin ratio
Contribution margin divided by total sales
➢ Contribution Margin per unit
Selling price per unit less all variable cost per unit
➢ Margin of safety
Excess of actual or budgeted sales over break-even
sales.
The amount by which sales could decrease before
losses may occur.
➢ Margin of safety ratio
Margin of safety divided by actual or budgeted sales
Basic CVP Equation:
Sales - Variable Cost = Contribution Margin - Total Fixed
Costs = Profit
Some basic underlying assumptions about CVP analysis
➢ Relevant range
CVP analysis is valid only within the company’s
relevant range of activity. If an activity was made
beyond this point, the relationship of fixed cost,
volume and variable costs may vary.
➢ Cost behaviour identified
Costs are classified as fixed and variable only, no
more mixed cost, as mixed cost was assumed to have
been segregated already.
➢ Linearity
The selling price and the unit variable costs are
constant over all sales volumes within the company’s
relevant range of activity.
➢ Sales and production volume are equal
If sales and production are not equal, some amount of
variable and fixed costs are treated as assets
(inventories) rather than expense. If inventories
remain fairly stable between adjacent time periods,
there will be no significant effect on the CVP
analysis.
CVP assumes no beginning, no ending inventory.
➢ Activity measure
Volume of units produced is the only cost driver.
➢ Constant sales mix
In a multiple product line, sales mix is assumed to be
constant throughout the year.
Uses of CVP analysis
➢ It will provide management with cost and profit data
for profit planning, policy formulation and decision
making.
➢ It will provide data in determining the optimal level
and mix of output to be produced with available
resources.
➢ It will help the management to predetermine the
required volume of production and sales to achieve a
desired profit.
Basic formulas of Break-even Point (BEP)
Single product line:
Equation approach
BEP = Sales - Variable costs - Fixed costs
Contribution margin approach
BEP in units = Total fixed costs/CM per unit
BEP in pesos = Total fixed costs/CM ratio
Desired sales if net income is after income tax
Desired sales in units =
Total fixed costs + (Desired profit after tax/1-tax rate)
CM per unit
Highly mechanized process has large investment in plant and
equipment, which results in a cost structure dominated by
fixed costs.
Desired sales∈units=
Total FC +Desired pre−
CM per unit
Breakeven point for multiple product lime
The company has to pre-determine the sales mix where such
sales mix will be considered as one package (composite unit)
as in a single product line. The following steps should be
done:
1. Determine the sales mix or set the planned sales mix
2. Determine the contribution margin for each product
3. Determine the weighted contribution margin(WCM)
per unit
No. of unit in the mix for each product x
Corresponding cm per unit
4.
5.
6.
Some limitations of Breakeven analysis
➢ Total revenue function is based on the assumption
that the price per unit is constant regardless of the
volume of sales and production, which is normally
not realistic.
➢ At very low outputs, the cost per unit might be high
because the labor force would not be producing
enough units and learn how to produce them
efficiently, and since the demand is low, the company
will produce at low volume and will not buy raw
materials in bulk, thus it cannot take advantage of
quantity discounts.
At high volumes, the firm might have to employ
labor on an overtime basis, on rush jobs, or to utilize
its equipment which are less efficient, both of which
would lead to a higher variable unit costs.
Cost Structure
The relative proportion of its fixed and variable costs.
Determining the desired sales to earn a desired profit
a. Desired sales if net income is before income tax
b.
*At the breakeven point, the total contribution margin = total
fixed costs.
Get the sum of the WCM per unit to get the total
weighted contribution margin(TWCM) and considers
that as the single CM per unit.
Determine the combined units by
Total Fixed costs
TWCM
If the amount to be determined is the desire sales
with profit, the same approach will be done, except
that the numerator will be Total FC + desired profit
before tax.
Multiply the combined units derived from step 5 with
the no. of each product in the mix.
The greater the proportion of fixed costs in a firm’s structure,
the greater will be the impact on profit from a given
percentage change in sales revenue.
Operating Leverage
Extent to which the organization uses fixed costs in its cost
structure.
OL is greater in firms with a large proportion of fixed costs,
low proportion of variable costs, and the resulting high
contribution margin ratio.
High % of FC = High degree of Operating Leverage
In business, high degree of OL means that relatively small
amount or percentage of change in sales will result in a
relatively large change in operating income.
To the management accountant,
● OL is the ability of the firm to generate an increase in
net income when sales revenue increases.
● It is the firm’s ratio of fixed cost to variable cost
Operating Leverage factor:
Contribution Margin
Net Income
Degree of operating leverage:
Percent change in Net Income
Percent change in sales
Operating Leverage factor
A measure, at a particular level of sales, of percentage impact
on net income of a given percentage change in sales revenue.
Percentage change in NI:
% change in sales x Operating Leverage factor
*Since a firm with relatively high Operating Leverage has
proportionally high fixed expenses, the firm’s break-even
point will be relatively high.
The optimal cost structure for an organization involves a
trade-off. Management must weigh the benefits of high
operating leverage against the risks of large committed fixed
costs and the associated high break-even point.
CHAPTER 5: ACTIVITY BASED COSTING AND
SERVICE COST ALLOCATION
Activity Based Costing (ABC) System
Cost allocation system that focuses on activities performed to
manufacture a product or service. It is a transaction based
costing.
Activities
Fundamental cost accumulation point
Activity Based Management
Activities defined for ABC can also be used for cost
management and performance evaluation purposes.
Eliminates costs that are Non-value-added
Non-value-added activities
● Add cost to, or increase the time spent on a product
or service without increasing its market value.
● Can be eliminated without deterioration of product
quality and value through reduced total production
time and thus, increases profitability.
● Example: use of JIT production systems
Purpose of Activity-Based Costing
Trace costs to products/service instead of arbitrarily allocating
costs.
Major components of ABC and their relationships
➢ Activity center
Management wants the costs of a set of activities to
be reported separately.
ABC requires that all activities in the company must
be grouped or pooled to similar activities for a socalled activity centers so that a single cost driver will
be used.
➢ Cost driver
Mechanism used to link a given activity’s pool of
costs.
Any factor that causes costs to change in that pool of
costs. It measures the amount of resources used by a
specific product.
➢ Cost function
Created from the activity’s costs and the planned cost
driver activity level.
Reasons or Factors affecting the use of Activity-Based
Costing
➢ The competitive environment, which will impact the
degree of accuracy needed and the level or degree of
product costing errors the company could tolerate.
➢ The homogeneity or heterogeneity of the products
produced.
➢ The complexity of the production process.
➢ The volumes of each product produced.
➢ The costs of measuring and collecting activity and
cost data.
➢ The impacts that more accurate and relevant data will
have on managerial behavior.
Steps in developing ABC system
➢ Assemble similar actions and classify costs
Classify the major activities that pertain to the
manufacture of specific products and allocate
overhead costs to the appropriate cost pools.
➢ Select cost drivers
Identify the cost driver that has a strong correlation to
the accumulated in the activity cost pool
➢ Identify cost functions
Compute the activity-based overhead rate per cost
driver.
➢ Assign costs to products
Assign overhead costs for each activity cost pool to
products or services using the cost drivers.
Comparing ABC to the Traditional Volume-based Costing
Traditional Costing System
Allocates unit-based overhead to products on the basis of
Budgeted cost is usually the basis of allocating costs.
predetermined plant-wide or department-wide volume of unitbased output rates.
Allocating actual costs burdens the operating
departments with the inefficiencies of the service
department managers.
ABC System
Allocates overhead to the identified activity cost pools, and
costs are then assigned to products using related cost drivers.
Advantages of Activity-Based costing
➢ ABC could accurately measure profitability of
products because it has more number of cost pools
used to assign overhead. As global competition
increases, product mix, pricing, and other decisions
require better product cost information.
➢ ABC points out efficiency and effectiveness of the
measures for all costs generating activities.
➢ Many managers have discovered that control of costs
is best accomplished by focusing directly on efficient
uses of activities, not by focusing on products, and
therefore, can make better management decisions.
Limitations of Activity-Based Costing system
➢ The higher analysis and measurement of costs that
accompany multiple activity center and cost drivers,
and
➢ The necessity still to allocate some costs arbitrarily
Service or Support Department’s Cost Allocation to
Operating Departments
After allocating service department’s costs, such
amounts are added to the operating departments own
costs and are now included in its performance
evaluations and in the determination of their
individual profitability.
CHAPTER 6: STANDARD COSTING FOR COST
CONTROL
Standards
Benchmark or Norm for measuring performance.
In management accounting: It relates to the quantity and cost
of inputs used in manufacturing goods or providing service.
Managers are expected to:
● Pay the lowest possible prices that are consistent with
the quality of output desired.
This is a question of how much should be paid for the
quantity of the input to be used.
●
Operating departments
Include sub-units to which the main activities are carried out.
Service departments
Departments within an organization that do note engage
directly in the operation of the business, but provide assistance
to the operating department.
Procedures in Allocation Service Department Costs
➢ Proper selection of allocation base
Measure of activity that acts as a cost driver.
➢ Allocating the costs of interdepartmental services
Also called reciprocal services where a particular
service department provides services for each other.
Most common methods used are direct method and
step method.
➢ Allocating costs by behavior
Variable cost can be directly allocated to the
departments using a cost driver, while fixed costs can
be allocated using predetermined rates or lump-sum
amounts.
➢ Deciding to allocate the actual or budgeted costs
Consume quantity of materials at the minimum
possible, again, at desired quality of output.
This is a question of how much of the input should be
used per unit of output.
Setting Standard Costs
No single form of standard is appropriate for all situations.
Data must be adjusted in terms of changing economic
conditions, changing demand and supply situations, and
changing technologies.
Accounting and Disposition of Standard costs
Variance
Difference between actual and standard cost
“When such variances be investigated?”
Answer is based on subjective judgements, hunches and rules
of thumb only.
The management must set an acceptable range of performance
to serve as basis in determining whether a variance should be
investigated or not.
● Variance is within the range
They are assumed to be caused by normal factors.
●
Variance falls outside the range
It is more likely to be caused by abnormal factors.
General rule: Variance should only be investigated if the
anticipated benefits are greater than expected costs.
Management may set its top and bottom measures of the
allowable limits, called control limits, which will be used in
determining whether the variance is significant or not.
Functions of Standard Costing System
➢ Accumulating of the actual costs of manufacturing
operations or service activities.
➢ Following through manufacturing operations and its
progress.
➢ Evaluating performance using the reports of
variances from standard.
Benefits of using standard costing system
➢ Motivation
The basic criterion in setting standards is
“achievability”. As standards are achievable, and
workers are informed of rewards for standards
attainment, those workers are likely to be motivated
to strive and do their best to accomplish the tasks
assigned to them.
➢ Clerical efficiency
A company using standard costs usually utilize less
clerical time and effort in determining costs
necessary for decision making than in an actual cost
system.
➢ Planning
Managers can use current standards to estimate what
future amounts or quantities and costs in the next
period of operation. This is best achieved through
flexible budgets.
➢ Controlling
Controlling function starts with the establishment of
standards that provide a basis of comparing actual
costs to determine variances, if any.
Variance analysis -The process of comparing actual
and standards and identifying the variance as
favorable or unfavorable and trying to seek
explanations for those differences.
➢ Decision making
Standard cost information facilitates many decision
makings. Use of actual cost information in such a
decision could be inappropriate because the actual
cost may fluctuate from period to period.
➢ Performance evaluation
When top management receives variance reports
highlighting the operating performance of
subordinate managers, the top management would be
able to know when costs were not controlled and by
which managers.
Overhead variances:
A company must specify an operating level of capacity.
Capacity
Refers to any measures of activity.
Kinds of capacities:
➢ Theoretical capacity
Estimated maximum potential activity for a specified
period. Assumes that all factors are operating in a
technically and humanly perfect manner. It disregards
realities such as machinery breakdowns work
stoppage such as special holidays and disturbances.
➢ Normal capacity
Based on historical and estimated future production
levels and cyclical fluctuations. It represents a
reasonably attainable level of activity, but will not
provide costs that are most similar to actual historical
costs.
➢ Expected capacity
Represents the short-run anticipated level of activity
by the firm for the upcoming period. However,
practical capacity may be a more appropriate base to
calculate a predetermined overhead rate.
Practical capacity
Reflects the cost of unused resources.
The concept of unused resources makes a distinction
between the cost of resources attainable for
manufacturing and the costs of resources actually
used for that purpose.
➢ Practical capacity
Highlights the fact that some capacity is idle.
Idle capacity
Indicated by the size of the underapplied overhead at
the end of the period.
Practical capacity is the theoretical capacity is
reduced by ongoing, regular operating interruptions
(such as holidays, downtime, and set up time) that
could be achieved during regular working hours.
The production or service volume that a firm could
achieve during normal working hours with
consideration given to ongoing-expected operating
interruptions.