Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Lesson Notes
Lesson 14 Managerial Accounting: Applications
Learning objectives
1. Describe segmented reporting and responsibility accounting system
2. Explain the main aspects of Cost-volume-profit analysis
3. Analyze budgeting and budgetary control
4. Describe standard costs and variance analysis
5. Explain the use of managerial accounting in decision making
Teaching hours
Students major in accounting
0 hours
Other students
6 hours
Teaching contents
Introduction
Let’s look at the XYZ Company example. A manager at XYZ Company wants to replace an
old machine with a new, more efficient machine.
New machine:
List price
900000
Annual variable expenses
800000
Expected life in years
5
Old machine:
Original cost
720000
Remaining book value
600000
Disposal value now
150000
Annual variable expenses
1000000
Remaining life in years
5
XYZ’s sales are $2000000 per year. Fixed expenses, other than amortization, are $700000
per year. Should the manager purchase the new machine? The manager recommends that the
company not purchase the new machine since disposal of the old machine would result in a loss:
Remaining book value
Disposal value
Loss from disposal
600000
-150000
450000
（1）Is it correct?
（2）What’s your comment to the manager’s decision?
After learning this chapter, you will know how to employ the tools of managerial accounting
and make decisions correctly.
Segmented Reporting and Responsibility Accounting Systems
Segmented Reporting Organizations may break down their operations into various segments,
such as divisions, stores, services, or departments. Thus, management needs reports on each
segment for cost management and performance evaluation.
Segments may be evaluated as a cost centre, a profit centre, where profit centre reports
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
include information on a segment’s revenues and costs, and an investment centre.
Some costs are direct and some are indirect, and indirect costs may be allocated to various
departments. Service department costs are shared indirect expenses of operation departments.
They may be allocated using a variety of bases. Please refer to the following table:
Service Department
Common Allocation Bases
General Office
Number of employees
Personnel
Number of employees
Payroll
Number of employees
Advertising
Sales
Number
of
Purchase
Purchasing
Orders
Cleaning
Floor space occupied
Maintenance
Floor space occupied
Responsibility Accounting System Responsibility accounting system is an accounting system
which assigns managers the responsibility for costs and expenses under their control.
Responsibility accounting budgets are prepared prior to each accounting period.
Responsibility accounting performance reports compare actual costs and expenses to budgeted
amounts
Cost-volume-profit Analysis
CVP analysis is used to answer the questions such as (1) How much must I sell to earn my
desired income? (2) How will income be affected if I reduce selling prices to increase sales
volume? (3) How will income be affected if I change the sales mix of my products?....
The basic assumptions of CVP analysis is that CVP analysis assumes relations can be
expressed as straight lines within the relevant range, which means that unit selling price remains
constant, unit variable costs remain constant, and total fixed cost remain constant. If the expected
cost and revenue behaviour is different from the assumptions, then the results of CVP analysis are
of limited use.
The objective of the cost analysis is determination of total fixed cost and the variable unit
cost. The basic methods to estimate the total costs equation include: (1) scatter diagram; (2)
high-low method; and (3) least-squares regression. Here least-squares regression is usually
covered in advanced cost accounting courses. It is commonly used with computer software
because of the large number of calculations required.
Break-even Analysis The break-even point is the unique sales level at which a company
neither earns a profit nor incurs a loss. The break-even point may be expressed in units or in
dollars of sales.
Break-even point in units
Break-even point in dollars
=
Fixed Costs
Contribution margin per unit
=
Fixed Costs
Contribution margin ratio
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Computing Income from Expected Sales The income given a predicted level of sales can be
computed as follows:
Pre-tax
Income
= Sales – [Fixed costs + Variable costs]
or
Income
Pre-tax
Income = Sales –Fixed costs - Variable costs
Sales Volume Needed to Earn a Target Income Break-even formulas can be adjusted to
show the sales volume needed to earn any amount of income.
Fixed costs + Target income
Unit sales
=
Dollar sales
=
Contribution margin per unit
Fixed costs + Target income
Contribution margin ratio
Margin of Safety Margin of safety is used to estimate how much sales can decrease before
the company incurs a loss?
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Margin of
Expected sales - Break-even sales
safety,
=
Expected sales
percent
Sensitivity Analysis Sensitivity analysis is used to estimate the effects of changes in variables
such as sales price, variable costs, and fixed costs. CVP analysis can be used to show the effects of
such changes.
New
break-even
=
point in dollars
New fixed costs
New contribution margin ratio
Budgeting and Budgetary Control
Budgets Budgets are formal statements of a company’s plans expressed in monetary terms,
which attempt to capture the future activities of an organization. They are used by businesses,
not-for-profit, government, educational, and other types of organizations.
The importance of budgeting include (1) defines goals and objectives; (2) promotes analysis
and a focus on the future; (3) motivates employees; (4) provides a basis for evaluating
performance; (5) coordinates business activities; (6) communicates plans and instructions.
Budget Committee consists of managers from all departments of the organization. It provides
central guidance to insure that individual budgets submitted from all departments are realistic and
coordinated. Flow of budget data is a bottom-up process.
Budget horizons are usually for one year, but may extend for several years. The annual
operating budget may be divided into quarterly or monthly budgets.
Rolling budgets mean that the budget may be a twelve-month budget that rolls forward one
month as the current month is completed.
Master Budget Master budget is a formal, comprehensive plan for the future of a company. It
consists of several budgets linked together to form a coordinated plan for the organization.
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Prepare
Prepare
Develop
manufacturing
sales
production
budgets
budget
budget
Prepare
Prepare
Prepare
financial
selling and
capital
budgets
general
expenditure
administrative
budget
budgets
Sales Budget Sales budget is the starting point in the budgeting process. Most of the other
budgets are linked to the sales budget. Sales personnel are often involved in developing the sales
budgets.
Sales
Budget
Estimated
Unit Price
Estimated
Unit Sales
Analysis of economic and market conditions
+
Forecasts of customer needs from marketing personnel
Merchandise Purchases Budget Merchandise purchases budget provides detailed
information about the purchases necessary to fulfill the sales budget and provide adequate
inventories.
Merchandise
inventory to
be purchased
=
Budgeted
ending
inventory
+
Budgeted
sales for the
period
_
Budgeted
beginning
inventory
The quantity purchased is affected by: (1) Just-in-time inventory systems, which enable
purchases of smaller, frequently delivered quantities; (2) Safety stock inventory systems, which
provide protection against lost sales caused by delays in supplier shipments.
Selling Expense Budget Selling expense budget lists the types and amounts of selling
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
expenses. Predictions of expenses are based on the sales budget and past experience.
General and Administrative Expense Budget General and administrative expense budget
lists the predicted operating expenses not listed in the sales budget. It includes both cash and
non-cash expenses and is often prepared by the office manager or person responsible for general
administration.
Capital Expenditures Budget Capital expenditures budget lists the cash inflows or outflows
pertaining to the disposal or acquisition of capital equipment, and it is usually affected by the
organization’s long-term plans.
Cash Budget Cash Budget lists the expected cash inflows and outflows for the period. It is a
tool used by management to avoid excess cash balances or cash shortages. Information from other
budgets is used in its preparation. Information from the cash budget is used to prepare the
budgeted income statement and balance sheet.
Production and Manufacturing Budgets Manufacturing companies need to prepare
additional budgets that include: production budgets, direct materials purchase budgets, direct
labour budgets, and manufacturing overhead budgets.
Production and manufacturing budgets provides detailed information about the production
necessary to fulfill the sales budget and provide adequate inventories.
Number of
units to be
produced
=
Budgeted
ending
inventory
+
Budgeted
sales for the
period
_
Budgeted
beginning
inventory
Direct materials budget provides detailed information about the purchases of raw materials
necessary to fulfill the production budget and provide adequate inventories.
Units of raw
materials to
=
be purchased
Cost of raw
materials to
be purchased
Materials
needed for
+
production
Budgeted
ending
inventory
Units of raw
=
materials to
be purchased
_
Budgeted
beginning
inventory
Material price
x
per unit of
raw material
Direct labour and manufacturing overhead budgets provides information about the labour and
manufacturing overhead costs given the level of production for the period.
Preparing Financial Budgets
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Cash
Budget
Expected
Receipts
and
Disbursement
s
Budgeted
Income
Statement
Budgete
d
Balance
Sheet
Budgetary Control
Capital Budgeting Capital budgeting analyzes alternative long-term investments and
deciding which assets to acquire or sell. These decisions require careful analysis since: (1) The
outcome is uncertain; (2) Large amounts of money are usually involved; (3) Investment involves a
long-term commitment; (4) Any decision may be difficult or impossible to reverse.
Zero-based Budgeting Zero-based budgeting are prepared assuming no previous activities
for the activities being planned. Managers must justify the amounts budgeted for each activity. It
is popular among government and non-profit organizations.
Fixed Budget Fixed budgets are prepared for a single, predicted level of activity.
Performance evaluation is difficult when actual activity differs from the predicted level of activity.
For example: How much of the unfavourable cost variance is due to higher activity, and how
much is due to poor cost control? To answer these questions, we must flex the budget to the actual
level of activity
Flexible (Variable) Budgets Flexible budgets are prepared after a period’s activities are
complete. They show revenues and expenses that should have occurred at the actual level of
activity. Flexible budgets reveal cost variances due to good cost control or lack of cost control,
which improve performance evaluation.
Since flexible budgets prepare a budget for different activity levels, we must know how
costs behave with changes in activity levels. Total variable costs change in direct proportion to
changes in activity; Total fixed costs remain unchanged within the relevant range.
Standard Costs and Variance Analysis
Standard Costs Standard costs are preset costs for delivering a product or service under
normal conditions, which are established through personnel, engineering, and accounting studies
using past experience. Standard costs are benchmarks used in evaluating performance, and are
often used in setting budgets.
A standard cost card:
Cost factor
Standard
Quantity or
Hours
Standard Price or
Rate
Standard
Cost
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Direct materials
1 kg
$
25
per kg
$
25.00
Direct labour
2 hours
$
20
per hour
$
40.00
2 hours
$
10
per hour
$
20.00
$
85.00
Variable mfg.
overhead
Total standard unit
cost
Variance Analysis The process of variance analysis can be listed as follows:
Prepare standard
cost performance
reports
Analyze
variances
Take action
Investigate
causes
Standard cost accounting provides management with information about costs that differ from
budgeted amounts (variances). Management may choose to focus only on variances that are
significant. This approach is referred to as management by exception.
Material variances: Please refer to ppt page 51.
Labour variances: Please refer to ppt page 52.
Variable overhead variances: Please refer to ppt page 53.
Fixed overhead variances: Please refer to ppt page 54.
Standard costs accounting systems record variances in the accounts, which can simplify
recordkeeping and help in the preparation of reports.
Discussions
ABC Company has the following direct material standard to manufacture one unit product:
3.0 kilograms per unit at $8.00 per kilogram. Last week 6600 kilograms of material were
purchased and used to make 2000 units. The material cost a total of $53000.
What is the actual price per kilogram paid for the material?
a. $7.26 per kilogram.
b. $8.13 per kilogram.
c. $8.03 per kilogram.
d. $8.00 per kilogram.
AP = $53000 ÷ 6600 kg
AP = $8.03 per kg
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
ABC’s material price variance (MPV) for the week was:
a. $198 favourable.
b. $198 unfavourable.
c. $189 favourable.
d. $189 unfavourable.
MPV = AQ(AP - SP)
MPV =6600 kg × ($8.03 - 8.00)
MPV = $198 unfavourable
The standard quantity of material that should have been used to produce 2000 units is:
a. 6500 kilograms.
b. 6000 kilograms.
c. 7000 kilograms.
d. 5000 kilograms.
SQ = 2000 units × 3 kg per unit
SQ = 6000 kg
ABC’s material quantity variance (MQV) for the week was:
a. $4300 unfavourable.
b. $4300 favourable.
c. $4800 unfavourable.
d. $4800 favourable.
MQV = SP(AQ - SQ)
MQV = $8.00(6600 kg - 6000 kg)
MQV = $4800 unfavourable
Managerial Decision Making
Cost accounting information is often used by management for short-term decisions. Decision
making involves five steps: (1) Define the problem; (2) Identify alternatives; (3) Collect relevant
information on alternatives; (4) Select the preferred alternative; (5) Analyze decisions made.
Accepting additional business This decision making should be based on incremental costs
and incremental revenues. Incremental amounts are those that occur if the company decides to
accept the new business
.
Make or Buy Decisions Incremental costs also are important in the decision to make a
product or purchase it from a supplier. The cost to produce an item must include direct materials,
direct labour, and incremental overhead. We should not use the predetermined overhead rate to
determine product cost.
Scrap or Rework Defects Costs incurred in manufacturing units of product that do not meet
quality standards are sunk costs and cannot be recovered. As long as rework costs are recovered
through sale of the product and rework does not interfere with normal production, we should
rework rather than scrap.
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Sell or Process Further This decision making is related to sell partially completed products
vs. process them to completion. As a general rule, process further only if incremental revenues
exceed incremental costs.
Selecting Sales Mix When a company sells a variety of products, some are likely to be more
profitable than others. To make an informed decision regarding sales mix, management must
consider (1) the contribution margin of each product; (2) the facilities required to produce each
product and any constraints on the facilities, and (3) the demand for each product.
Eliminating a Segment A segment is a candidate for elimination if its revenues are less than
its avoidable expenses.
Qualitative Factors in Decisions Qualitative factors are involved in most all managerial
decisions, including quality, delivery schedule, supplier reputation, employee morale, customer
opinions, etc.
Discussions
Consider the beginning XYZ case
Relevant Cost Analysis
Savings in variable
expenses
provided by the
new machine
($200000 × 5
yrs.)
1000000
Cost of the new machine
(900000)
Disposal value of old
machine
150000
Net effect
250000
Case Study
ABC Corporation, a merchandising company, has provided the following budget data:
Purchases
Sales
May
$84000
$144000
June
$96000
$132000
July
$72000
$120000
August
$108000
$156000
September
$120000
$132000
Collections from customers are normally 75% in the month of sale, 15% in the month
following the sale, and 8% in the second month following the sale. The balance is expected to be
uncollectible. ABC pays for purchases in the month following the purchase. Cash disbursements
for expenses other than merchandise purchases are expected to be $28,800 for September. ABC's
cash balance on September 1 was $44,000.
Task Team of FUNDAMENTAL ACCOUNTING
School of Business, Sun Yat-sen University
Required:
1) Compute the expected cash collections during September.
2) Compute the expected cash balance on September 30.
Key points
1. cost-volume-profit analysis
2. budgets
3. variance analysis
4. decision making
Reading material
1. Charles T. Horngren, George Foster and Srilant Datar, Cost Accounting: A Managerial
Emphasis (Tenth Edition), Prentice Hall Inc., 2000.
2. Anthony A. Atkinson, Rajiv D.Banker, Robert S. Kaplan, S. Mark Young, Management
Accounting , Prentice Hall Inc., 2001.