WEEK 1
What is MAC?
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Managerial accounting involves the process of preparing and
analyzing (non-)financial information to help managers make informed
business decisions within an organization.
The main topic areas are:
1. Cost Analysis: Determining the costs associated with producing
goods or services, such as direct materials, labor, and overhead costs.
2. Budgeting and Forecasting: Creating budgets and financial
forecasts to plan and allocate resources effectively.
3. Performance Evaluation: Comparing actual performance against
budgets and analyzing variances to identify areas for improvement or
corrective actions.
Cost Accounting
Suppose that in March a manufacturing company spend:
– €100k on raw materials
– €200k on wages
– €50k on other stuff
• The company finished 10,000 units in March
• What is the cost per unit?
– (100,000+200,000+50,000)/10,000 = €35?
• No! This cannot be determined from the information provided
1. We do not know if more or less materials were used than the €100k
that were purchased (i.e. the company likely has inventory of
materials).
1. We do not know if all expenses are manufacturing related.
2. We do not know if all 10,000 units were produced this month (e.g. parts
could have been produced previously, with only assembly taking place
3. this month).
Manufacturing costs could be much higher or lower than €35/unit
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A big chunk of managerial accounting has to do with costs and
assigning costs
Assigning costs is the process of figuring out what units of output
costs belong to
It involves keeping track of flows of costs and production
• Cost accounting is crucial in order know if you are making a profit
– Suppose the product in the example is sold for €40/unit
– If actual production costs are €45/unit, the company is in trouble
Types of Costs
There are big differences between types of companies in how costs
must be classified
– A service company does not need to worry about inventory or
production
– A merchandising company does not need to worry about production
– A manufacturing company needs to worry about both inventory and
production
Inventory at Manufacturing Companies
• A manufacturing company generally has three kinds of inventory: raw
materials (RM), work-in-process inventory (WIP), and finished
goods inventory (FG)
Direct vs. Indirect Costs
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Direct costs are costs that can be (easily/cost-effectively) traced to
specific cost objects
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Cost objects are anything for which a manager might be
interested to know how much it costs
Indirect costs are then costs that cannot be (easily/cost-effectively)
traced to specific cost objects
Manufacturing Costs
In manufacturing, we distinguish between three types of costs:
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Direct materials (DM), e.g. resources/components used in production
Direct labor (DL), e.g. assembly workers, machine operators
Manufacturing overhead (MOH)
• – Indirect materials, e.g. oil to lubricate the machines, safety
equipment for factory workers
• – Indirect labor, e.g. factory supervisors, maintenance crew
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Recall that the difference between direct/indirect lies in whether money
spend on these things can be easily/cost-effectively traced to individual
cost objects (e.g. units of output)
Product and Period Costs
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Direct materials, direct labor, and manufacturing overhead are all
examples of product costs
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These are costs that follow from the production process
If we stop producing, these costs would not occur
In addition, there are period costs
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These are non-manufacturing costs: costs that the company has,
that do not depend on the manufacturing process
For example: selling expenses, interest, taxes, wages of support
staff, rent for offices.
Overview of Costs
Flow of Costs
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To figure out how much a manufactured unit actually costs, you need to
understand how and where costs occur: the flow of costs
This involves keeping track of RM, WIP, and FG
In general:
• – You have some amount at the start of the month, called
beginning inventory (1)
• – Throughout the month, you keep track of how much is added to
the inventory (2)
• – At the end of the month, you check the amount you still have,
called ending inventory (3)
The amount that was used/produced/sold is then (1)+(2)-(3)
WEEK 2
We distinguish between three types of costs:
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Direct materials (DM), e.g. resources/components used in production
Direct labor (DL), e.g. assembly workers, machine operators
Manufacturing overhead (MOH)
– Indirect materials, e.g. oil to lubricate the machines,
safetyequipment for factory workers
– Indirect labor, e.g. factory supervisors, maintenance crew
Cost Assignment
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Ultimately, a manager wants to know how much their product actually
costs to make
For direct costs this is fairly simple
– If it takes 10 labor hours to produce something, and the wage is
€30/hour, it costs
• For indirect costs this is harder, because these costs do not (directly)
increase when you produce more units
– The rent for your production plant is the same, regardless of
how many units you produce
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This is especially true if a company sells/produces more than one product
or service
Cost Accounting
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Cost accounting
– This involves keeping track of costs to determine the actual production
costs of a company’s goods/services
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You will learn about three different approaches to cost assignment:
– Job order costing (this week)
• Costs are assigned to specific jobs or batches
– Process costing (next year)
• Costs are assigned to different stages within the production process
– Activity based costing (next week)
o Costs are assigned to activities that are shared between different
products
Different Types of Costing
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Job order costing is generally in companies that deliver unique, nonstandardized goods/services
• For example: consultancy; wood working; architecture;
construction
• Every job is different
Process costing is used by companies that deliver standardized
goods/services that have different stages of production
• For example: food production; oil refining; manufacturing
• Units of output are (mostly) identical
Activity based costing is used by companies that deliver a few
different goods/services that have overlap in production methods used
– For example: hospitals; education; manufacturing
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The main difference between the types of cost accounting lies in what
costs are actually assigned to
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Job order costing: costs are tracked separately for each job, i.e. you
determine how much a particular unit of output costs
Process costing: costs are assigned to different stages of the
production process, e.g. manufacturing, assembly, painting
Activity based costing: costs are assigned to different activities, which
can be almost anything that is a cost-driver, e.g. machine usage,
maintenance, handling
Different Types of Costing
Job order
• Unique, non-standardized
• Small-scale production
• Any number of different production lines
Process
• Highly standardized
• Large-scale production
• Any number of different production lines
Activity based
• Standardization between production lines
• Overlap in production process/activities between production lines
• Intermediate-scale production
• A few different production lines
Job Order Costing Example
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In April, an architecture company has designed two buildings: a house
and a mansion
In total, 100 hours of labor went into the design of the house and 200
hours into the design of the mansion
The architects cost the company €150 per hour
In addition, the company has the following indirect costs (per month):
– Office rent; €5,000
– Office support staff: €8,000
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What are the costs of the different designs?
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In total, 100 hours of labor went into the design of the house and 200
hours into the design of the mansion
The architects cost the company €150 per hour
The direct costs are straightforward:
• House:
• Mansion:
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In total, 100 hours of labor went into the design of the house and 200
hours into the design of the mansion
In addition, the company has the following indirect costs (per month):
– Office rent: €5,000
– Office support staff: €8,000
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But how can we divide the indirect costs?
By identifying a cost driver and using this to allocate the overhead
In this case, costs are likely driven by the amount of direct labor hours
that go into each job à we can allocate overhead based on DL hours
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In total, 100 hours of labor went into the design of the house and 200
hours into the design of the mansion
In addition, the company has the following indirect costs (per month):
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– Office rent: €5,000
– Office support staff: €8,000
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Total overhead =
Total DL hours = hours
Overhead per DL hour = per hour of DL
In total, 100 hours of labor went into the design of the house and 200
hours into the design of the mansion
Overhead per DL hour = per hour of DL
Overhead allocation:
– House:
– Mansion:
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Because more labor hours are needed to design the mansion, the
mansion receives a greater share of the overhead costs
• Total costs:
– House:
– Mansion:
Overhead per DL hour = per hour of DL
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What we calculated here is called the overhead allocation rate
In practice, this is usually calculated based on expected or budgeted
costs
• Why? Because you need to know how much each job costs in
advance, so you know what price to quote to your customer
For this reason, it is usually called the predetermined overhead
allocation rate
Predetermined Overhead Allocation Rate
In general, you allocate overhead in two steps:
1. Calculate the predetermined overhead allocation rate as:
2. Multiply this rate with the amount of the allocation base used by a
certain job or unit of output.
Allocation Bases
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It depends on the type of company what is used as the allocation base
The key question is: what is the primary factor that drives the costs?
In practice, this is usually:
– Direct labor hours or costs (for labor-intensive work)
– Machine hours or costs (for machine-intensive work
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What’s the difference between hours and costs? e.g.100hours of DL vs.
€5,000inDLcosts
These will give similar results, provided the company pays a similar
wage everywhere e.g.€50/hour
But results may be quite different, if there are large wage differences!
• Suppose the company is active in two different cities, and wage
rates are €40/hour in one and €60/hour in the other.
Which to use depends on what the actual cost driver is: is overhead
increasing with labor hours or costs?
Week 3
Recap: Job Order Costing
When selling your product, you need to make sure that the price covers
all of your expenses
• Cost assignment is the way in which we calculate the actual cost
of a product
• Job order costing involves calculating the cost of a particular job
or batch of a product
– This includes the direct cost
– But also the indirect – overhead costs!
A producer of custom tables has the following costs:
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Estimated total manufacturing overhead costs: €60,000
Estimated total direct labor hours: 3,000 hours
Direct labor costs €30 per hour
What is the cost of a table that takes 30 hours to craft?
• It’s not ! à this ignores the overhead
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Overhead is per direct labor hour
This is the predetermined overhead allocation rate
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Actual cost for 30 hours:
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Activity based costing
Same idea as job order costing, but divides shared overhead costs
between different products
Activity Based Costing
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Job order costing only makes sense if a company is producing unique,
non-standardized products or services
When a company instead produces a single, standardized product, it
would likely use process costing instead
Today we will consider what to do when a company is producing
several more standardized products, that are produced in a similar way
For example: different types of cars may be produced in one production
facility
• Activity based costing (ABC) involves dividing overhead costs between
different products based on activities
– Activities is a very broad term, that can be anything that is a costdriver
ABC: Example
• TechGadget Inc. manufactures two types of electronic devices: Smartphones
and Tablets.
TechGadget identifies two main activities that drive overhead costs:
1. Prototype Development: Costs associated with designing and
prototyping new electronic devices.
2. Production Assembly: Costs related to the actual assembly of
electronic components into finished devices
Costs:
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Total Prototype Development Costs: €50,000
Total Production Assembly Costs: €100,000
Activity Drivers:
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Number of prototype designs: 5 designs
Total machine hours for production assembly: 2,000 hours
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Smartphone: Involves 2 prototype designs and requires 800 machine
hours for production assembly.
Tablet: Involves 3 prototype designs and requires 1,200 machine hours
for production assembly.
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How should the €150,000 in overhead be divided between smartphones
and tablets?
Costs:
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Total Prototype Development Costs: €50,000
Total Production Assembly Costs: €100,000
Activity Drivers:
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Number of prototype designs: 5 designs
Total machine hours for production assembly: 2,000 hours
Calculate the predetermined overhead allocation rates:
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Prototypes: per design
Assembly: per machine hour
Predetermined overhead allocation rates:
• Prototypes: per design
• Assembly: per machine hour
• Smartphone: Involves 2 prototype designs and requires 800 machine
hours for production assembly.
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Multiply allocation rates with amounts of allocation bases:
Smartphone overhead costs =
Predetermined overhead allocation rates:
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Prototypes: per design
Assembly: per machine hour
Tablet: Involves 3 prototype designs and requires 1,200 machine hours
for production assembly.
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Multiply allocation rates with amounts of allocation bases:
Tablet overhead costs =
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ABC Steps
• In general, ABC works through four steps:
1. Identify activities and estimate their total indirect costs
2. Identify the allocation base for each activity and estimate the total
quantity of each allocation base
3. Compute the predetermined overhead allocation rate for each activity
4. Allocate indirect costs to the cost object
WEEK4
Variable and Fixed Costs
• A key question for firms is how their costs change, when their
production volume changes
• Costs that change with volume, are called variable costs
• Costs that do not change are called fixed costs
Contribution Margin
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The difference between the (selling) price of a product and the variable
cost, is called the contribution margin
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If a company has €100,000 in sales and variable costs of €50,000;
contribution margin is
Or: if a company sells a product for €100 that has variable cost of €50,
contribution margin per unit is
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• The contribution margin (CM) is a key figure for two reasons:
1. It tells us how profits will change, if production changes.
- CM per unit of €50, suggests that producing 1 additional unit,
increases operating income by €50
2. It shows us how much income is available to cover our fixed costs
- CM needs to be higher than fixed costs in order to make a profit
Mixed Costs
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Not all costs can be cleanly classified as being variable or fixed costs
Many costs have elements of both: we call those mixed costs
Examples:
• You pay €50 to have access to electricity, plus €0.20 per kWh
• A company pays Microsoft €10,000 to have access to its services, plus
€50 per employee
• A company pays a marketeer €35,000 for a campaign, that includes a
fee for the design of the campaign, plus 100 radio ads
Separating Mixed Costs
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In order to work with mixed costs (and calculate things like a
contribution margin), we need to separate them into the variable and
fixed component
Sometimes this can be easy, like with your electricity contract
Other times it is harder, as a company may not keep track of the
variable and fixed components separately
Separating Mixed Costs: Example
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A company spends money on fuel to power the machines in their
production facility
Before producing anything, the machines need to idle for 1 hour,
regardless of how much is being produced
When actually producing, the machines consume more fuel
This makes fuel consumption here a mixed costs:
– Fuel consumption while idling is a fixed cost
– Fuel consumption while producing is a variable cost
The company only tracks total fuel consumption and production:
How much are fixed and how much are variable costs?
High-Low Method
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This kind of problem can be solved with the high-low method
This involves comparing the highest and lowest production levels and
seeing how costs change between them
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Once you know the variable cost per unit, you can easily figure out total
variable cost
From there, you can figure out the fixed cost component as:
High-Low Method: Example
• Back to our example:
Production was highest in January and lowest in February
To find the fixed cost, we can use either the data from January or February
(you get the same result); here we’ll use January:
We now know production costs for this firm consist of a €10,000 fixed cost (for
idling the machines) plus a cost of €3 per unit produced
Breakeven Point
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Contribution margins are frequently used by firms to perform a
breakeven point analysis
This involves trying to figure out how many units need to be sold, in
order to break even, i.e. just cover all costs such that profit is €0
Once you know your contribution margin per unit, figuring out the
breakeven point is easy:
Breakeven Point with Profit
• The formula can also easily be expanded to calculate how many units must
be sold to make a certain amount of profit:
Week 5
What is budgeting?
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A budget is a financial plan that should help the company achieve its
goals
Key benefits of budgeting are:
– It forces managers to explicitly think about the company’s future
– It helps coordinate the activities of a company
– It helps managers evaluate performance, by comparing the
budget against actual outcomes
• In general, budgets are a useful form of management control
Master budget
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The master budget is a collection of budgets
The illustration shows the order in which a merchandising company
would prepare its budgets
1. Sales
2. Inventory and related expenses
3. Other expenses
4. Total amount of money coming in / going out
5. Other financial statements
Sales budget
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A sales budget is just a projection of how much stuff the company
expects to sell
For example:
– January: 10,000 units (or €50,000)
– February: 11,000 units (or €55,000)
– March: 10,000 units (or €50,000)
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How is such a projection created?
– Predicted from past sales data (e.g. using regression)
– Predicted from market research
– Predicted from sales data of similar firms
– Some combination of the above
Inventory, Purchases, and COGS
• The inventory, purchases and cost of goods sold budget is all about
making sure that you have enough inventory to sell to customers
– If you expect to sell 50,000 units, you need to think about where
those 50,000 units are coming from
• Moreover, companies typically want to ensure that they always have
some inventory left over (in case another customer shows up)
– The budget must also include the minimum amount of inventory
that is considered acceptable
Example
• Suppose a company uses the following information:
– COGS is 75% of sales
– Minimum inventory is €10,000 plus 100% of budgeted COGS for
the next month
– Starting inventory is €30,000
– Expected sales for June, July and August are: €40,000; €60,000;
€44,000.
• How do we create an inventory, purchases and cost of goods sold
budget for June and July?
June
40,000
30,000
July
60,000
45,000
August
44,000
33,000
55,000
(10,000+45,000)
43,000
(10,000+33,000)
x
Merchandise
inventory
required (1)+(2)
85,000
(30,000+55,000)
88,000
(45,000+43,000)
x
(3) Less:
beginning
merchandise
inventory
30,000 (given)
55,000 (from
June)
x
Budgeted
purchases
(1)+(2)-(3)
55,000
33,000
x
Sales
(1) COGS (75%
of sales)
(2) Plus:
minimum
inventory
(10,000+100% of
COGS for next
month)
Selling and Administrative Expense
• A selling and administrative expenses budget keeps track of other
expenses the company might have
– Sales commissions
– Salaries
– Rent
– Depreciation
• Some of these may be fixed, some of them may be variable
• Example fixed cost: rent is €3,000 per month
• Example variable cost: commissions are 10% of sale
Cash Budget
• The most important budget we will focus on is the cash budget
• This keeps track of actual cash coming in and going out
• This is crucial, because a company might appear to be doing well
(i.e.make a good profit), but still run out of cash
– For example: if your expenses occur before you are paid by your
customers
• A cash budget keeps track of when how much cash enters or leaves
the company
• It incorporates a lot of information from the previously discussed
budgets: sales, purchases and expenses
Schedule of Cash Payments
• From the previous budgets we know for each month:
– Expected sales
– Expected purchases of inventory
– Expected expenses
• Problem: just because a revenue or expense occurs in a certain month,
does not mean the cash is received/paid in that month
• We need to identify: 1) when customers pay their bills, and 2) when we
pay our bills
• These are called the schedule of cash receipts and cash payments
Schedule of Cash Receipts
Consider our previous example:
Sales
June
40,000
July
60,000
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If all sales are in cash, then we are done
But what if some customers pay later?
Suppose: 60% of customers pay in cash, 40% of customers buy on
credit and pay next month
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We can prepare a schedule of cash receipts to show how much cash
is expected to be received each month
• Suppose: 60% of customers pay in cash, 40% of customers buy on
credit and pay next month
• Suppose sales in May were €30,000
Sales
Cash sales (60%)
Credit sales (40%), one
month after sale
Total cash receipts
June
40,000
24,000
July
60,000
36,000
(0.6x40,000)
12,000
(0.6x60,000)
16,000
(0.4x30,000
36,000
(0.4x40,000)
52,000
(24,000+12,000)
(36,000+16,000)
Cash Budget
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In the seminar you will practice with making a full cash budget
• Schedule of cash receipts
• Schedule of payments for purchases
• Schedule of payments for selling and administrative expenses
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The result of the cash budget tells you how much cash the company
has left over at the end of the month
This can be a negative number, suggesting the company has a cash
shortage
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If that is the case, the company knows it will need short-term financing
and can prepare accordingly (e.g. call their bank)
Budgeted Financial Statements
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Budgeted variants of the income statement, statement of retained
earnings, and balance sheet are prepared last
These show the overall expected income of the company and how the
balance sheet accounts are affected by the operations of the firm
These draw information from all previously prepared budgets
This can be quite detailed: see the book p.383-385 for an overview
Week 6 in exam -->
Short-Term vs. Long-Term
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The short-term is usually defined as any period of one year or less
The long-term is usually defined as any period of more than one year
You may encounter situations where different definitions are used
When to focus on the short-term?
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Short-term: if it doesn’t make us a profit right now, we get rid of it
• Useful when a company is doing poorly
• Useful when a company needs to produce results quickly (e.g. to
convince investors, or lenders)
Long-term: we may keep projects that make a loss, if we expect profits
in the future
• Strategic considerations
• Growth over multiple years
Ideally, companies would maintain a long-term perspective, but
sometimes it is necessary to focus on the short-term
Short-term business decisions
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In the short-term, business decisions are quite simple
We figure out what does (not) make money
We try to do more of what makes us money and less of what does not
We will use a method called differential analysis to figure out what
(not) to do
Differential Analysis
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Differential analysis is a simple method that compares two scenarios:
– Current situation
– Alternative situation
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It then analyses all differences between the situations step by step, in
order to calculate how profits would change
“Differential” just means that we look at the differences
Differential Analysis: Example
Consider the following example:
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Suppose you have a job in Groningen and currently make €30,000
You have an offer for a job in Amsterdam that would pay €35,000
Monthly living expenses in Groningen are around €1,500, but in
Amsterdam would be €2,000
You only care about the short-term financial picture
What should you do?
Differential analysis:
Wage
Expenses
Disposable
income
Groningen
30,000
(12 x 1,500) =
18,000
12,000
Amsterdam
35,000
(12 x 2000) =
24,000
11,000
Difference
5,000
6,000
-1,000
• Conclusion: you do not take the job in Amsterdam, because your expenses
would increase more than your wage
Differential Analysis
• In the context of a company, we are usually interested in how decisions
will change operating income
– This is the income resulting from the regular operations of the
company
– This includes production, sales, and (non-financial) expenses
• We will consider three types of scenarios:
– Special orders
– Dropping a product
– Outsourcing
Fixed costs do not change if you increase your production
Special Orders
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Suppose that you are running a webshop that sells smartphones and
cases directly to consumers
One day a large company calls you and offers to buy a large quantity of
cases at a price that is slightly lower than what you list on your website
We call this a special order, because the price is different
– Special orders can also include a customer asking for a
different product, or otherwise asking you to change your product
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In the short-term, whether or not you fulfill the special order depends on
one thing: does it make you a profit?
Dropping a Product Line
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Suppose that you are still running a webshop selling smartphones and
cases
You find that smartphones are returned much more often than cases,
and general costs of customer supports are also higher
You consider whether it is worth it to keep selling smartphones, or
whether you should only sell cases
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In the short-term, the answer again only depends on: do I make more
money if I stop selling smartphones?
Outsourcing
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You are still running your webshop
Thus far, you have been buying neutral smartphone cases in bulk and
printing custom designs on them yourself
– You have found a printing company that could do this work for
you
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You consider whether you should keep printing designs yourself, or
whether you should outsource this to the other company
In the short-term, this decision again depends on one thing: do I make
more or less money printing them myself?
Key lessons
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If a cost does not change under the different scenarios, it is not relevant
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Fixed costs are often fully or partially unavoidable
Unavoidable fixed costs are irrelevant for the analysis!
Short-term business decisions are purely about profit maximization in
the here and now
There are no strategic concerns regarding the long-term development of
the company
Companies may miss valuable opportunities if they only focus on the
short-term, but sometimes it is necessary to do so
In the short term you can’t do anything about the fixed cost