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Managerial

Accounting:
A pplications
Outline
Segmented Reporting and Responsibility
Accounting System
Cost-Volume-Profit Analysis
Budgeting and Budgetary Control
Standard Costs and Variance Analysis
Managerial Decision Making

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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

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Introduction
XYZ’s sales are Rs2000000 per year.
Fixed expenses, other than amortization, are
Rs700000 per year.
Should the manager purchase the new machine?

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Introduction
 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 600000


Disposal value -150000
Loss from disposal 450000

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Introduction
Is it correct?
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.

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Segmented Reporting
Organizations may break down their
operations into various segments

 divisions, stores, services, or departments.
Management needs reports on each
segment for
cost management
performance evaluation

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Segmented Reporting
Segments may be evaluated as

 a cost centre
a profit centre
→Profit centre reports include information on a segment’s
revenues and costs.
an investment centre.
Some costs are direct and some are indirect.
Indirect costs may be allocated to various
departments.

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Segmented Reporting
Service department costs are shared indirect expenses
of operation departments.
They may be allocated using a variety of bases.

Service Department Common Allocation Bases


General Office Number of employees
Personnel Number of employees
Payroll Number of employees
Advertising Sales
Purchasing Number of Purchase Orders
Cleaning Floor space occupied
Maintenance Floor space occupied

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Responsibility Accounting System

 Responsibility Accounting System


 An accounting system
 assigns managers the responsibility for
costs and expenses under their control.

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Responsibility Accounting System

Responsibility accounting budgets


are prepared prior to each accounting period
Responsibility accounting performance
reports
compare actual costs and expenses to budgeted
amounts

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Cost-Volume-Profit Analysis (CVP)

CVP analysis is used to answer:


How much must I sell to earn my desired
income?
How will income be affected if I reduce selling
prices to increase sales volume?
How will income be affected if I change the
sales mix of my products?
……?

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Assumptions of CVP Analysis

CVP analysis assumes relations can be


expressed as straight lines within the
relevant range.
Unit selling price remains constant.
Unit variable costs remain constant.
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.

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Scatter Diagram

Change in cost
Unit Variable Cost = Slope =
Change in units

20
1,000’s of Dollars

* ** *
Total Cost in

Vertical
* * distance
**
* *
is the
10 change in
cost.
Horizontal distance is
the change in activity.
0
0 1 2 3 4
Activity, 1,000’s of Units Produced
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High-Low Method

Unit Variable Cost = 30 - 20 =


5 - 1 Rs2.50/unit

*
1,000’s of Dollars

30
* ** Vertical
Total Cost in

* * distance
20 * * ** is the
change
Horizontal distance is
10 in cost.
the change in activity.
(5 - 1)
(30 - 20)
0
0 1 2 3 4 5
Activity, 1,000’s of Units Sold Khalid Aziz-0322-3385752
Least-Squares Regression
Least-squares regression

 is usually covered in advanced cost accounting
courses.
is commonly used with computer software
because of the large number of calculations
required.
The objective of the cost analysis remains the
same: determination of total fixed cost and the
variable unit cost.

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Break-Even Analysis
The break-even point
is the unique sales level
at which a company

Costs and Revenue


Sales
neither earns a profit

in Dollars
nor incurs a loss.
Total costs

Volume in Units

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Break-Even Analysis
The break-even point may be expressed in
units or in dollars of sales.

Fixed Costs
Break-even point in units =
Contribution margin per unit

Unit sales price less unit variable cost

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Break-Even Analysis
The break-even formula may also be
expressed in sales dollars.

Fixed Costs
Break-even point in dollars =
Contribution margin ratio

Unit sales price


Unit variable cost

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Computing Income from
Expected Sales
What is the income given a predicted level
of sales?

Pre-tax
= Sales – [Fixed costs + Variable costs]
Income
or
Pre-tax
= Sales –Fixed costs - Variable costs
Income

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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 =
Contribution margin per unit

Fixed costs + Target income


Dollar sales =
Contribution margin ratio

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Margin of Safety

Margin of safety
How much sales can decrease before the
company incurs a loss?

Margin of Expected sales - Break-even sales


safety, =
percent Expected sales

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Sensitivity Analysis

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- New fixed costs


even point =
in dollars New contribution margin ratio

Khalid Aziz-0322-3385752
Budgets
Budgets
formal statements of a company’s plans
expressed in monetary terms
attempt to capture the future activities of an
organization
are used by businesses, not-for-profit,
government, educational, and other types of
organizations.

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Importance of Budgeting
Defines goals
and objectives

Promotes analysis and


Communicates plans
a focus on the future
and instructions

Advantages

Coordinates
business activities Motivates employees

Provides a basis for


evaluating performance
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Budget Committee
Budget Committee
Consists of managers from all departments
of the organization
Provides central guidance
→to insure that individual budgets submitted from all
departments are realistic and coordinated.

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Budget Committee

T o p M a n a g e m e n t

M i d d l e M i d d l e
M a n a g e m e nMt a n a g e m e

S u p e r Sv i us po re r Sv i us op re r Sv i us op re r v i

Flow of budget data is a bottom-up process.


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Budget Cycle
Budget horizons are usually for one year

but may extend for several years.
Operating Budget

2005 2006 2007 2008

The annual operating budget


may be divided into quarterly
or monthly budgets.
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Rolling Budgets

Continuous or
Rolling Budget

2005 2006 2007 2008

The budget may be a twelve-month


budget that rolls forward one month
as the current month is completed.
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Master Budget
Master Budget
A formal, comprehensive plan
→for the future of a company
consists of several budgets linked together
→to form a coordinated plan for the organization

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Master Budget
Prepare
manufacturing
Prepare Develop budgets:
sales production ● material
budget budget ● labour
● overhead

Prepare Prepare
financial Prepare
selling and
budgets: capital
 cash general
expenditure
 income administrative
budget
 balance sheet budgets

Khalid Aziz-0322-3385752
Sales Budget

Sales budget
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.

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Sales Budget

Sales Budget

Estimated Unit Price


Estimated Unit Sales

Analysis of economic and market conditions


+
Forecasts of customer needs from marketing personnel

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Merchandise Purchases Budget

 Merchandise Purchases Budget


Provides detailed information about the
purchases
necessary to fulfill the sales budget and provide
adequate inventories.

Merchandise Budgeted Budgeted Budgeted


inventory to = ending + sales for the _ beginning
be purchased inventory period inventory

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Merchandise Purchases Budget

The quantity purchased is affected by:


Just-in-time inventory systems
→enable purchases of smaller, frequently delivered
quantities.
Safety stock inventory systems
→provide protection against lost sales caused by
delays in supplier shipments.

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Selling Expense Budget

Selling Expense Budget


lists the types and amounts of selling expenses
Predictions of expenses are based on the sales
budget and past experience.

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General and Administrative
Expense Budget
General and Administrative Expense
Budget
lists the predicted operating expenses not listed
in the sales budget
Includes both cash and non-cash expenses
Often prepared by the office
manager or person responsible
for general administration

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Capital Expenditures Budget

Capital Expenditures Budget



 lists the cash inflows or outflows
pertaining to the disposal or acquisition
of capital equipment.
is usually affected by the organization’s
long-term plans.

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Cash Budget

Cash Budget
lists the expected cash inflows and
outflows for the period
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
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Production and Manufacturing Budgets

Manufacturing companies need to prepare


additional budgets that include:
Production budgets
Direct materials purchase budgets
Direct labour budgets
Manufacturing overhead budgets

Khalid Aziz-0322-3385752
Production and Manufacturing Budgets

Production and Manufacturing Budgets


Provides detailed information about the
production necessary to fulfill the sales budget
and provide adequate inventories.

Number of Budgeted Budgeted Budgeted


units to be = ending + sales for _ beginning
produced inventory the period inventory

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Production and Manufacturing Budgets

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 Budgeted Budgeted


materials to = needed for + ending
_ beginning
be purchased production inventory inventory

Cost of raw Units of raw Material price


materials to = materials to × per unit of
be purchased be purchased raw material

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Production and Manufacturing Budgets

 Direct Labour and Manufacturing


Overhead Budgets
Provides information about the labour and
manufacturing overhead costs given the level of
production for the period.

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Preparing Financial Budgets

Cash
Budget Budgeted Budgeted
Expected Income Balance
Receipts Statement Sheet
and
Disbursements

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Budgetary Control

 Develop the budget


from planned objectives.

 Revise  Compare
objectives actual with
This is an ongoing
and prepare budget and
process.
a new analyze any
budget. differences.

 Take corrective and


strategic actions.
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Capital Budgeting
Capital Budgeting

 Analyzing alternative long-term investments
and deciding which assets to acquire or sell.
These decisions require careful analysis since:
→ The outcome is uncertain.
→ Large amounts of money are usually
involved.
→ Investment involves a long-term
commitment.
→ Any decision may be difficult or
impossible to reverse.
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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
is popular among government and non-profit
organizations.

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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.
→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.

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Flexible (Variable) Budgets

Flexible budgets
are prepared after a period’s activities are
complete.
Show revenues and expenses that should have
occurred at the actual level of activity.
Reveal cost variances due to good cost control or
lack of cost control.
Improve performance evaluation.

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Flexible (Variable) Budgets

Flexible budgets

 To 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 ble
ri a
unchanged within the Va
relevant range. Fixed

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Standard Costs
Standard Costs
are preset costs for delivering a
product or service under normal
conditions.
are established through personnel,
engineering, and accounting studies
using past experience.
are benchmarks used in evaluating
performance.
are often used in setting budgets.

Khalid Aziz-0322-3385752
Standard Costs
 Example: A standard cost card

Standard Standard
Quantity Price Standard
Cost factor or Hours or Rate Cost
Direct materials 1 kg $ 25 per kg $ 25.00
Direct labour 2 hours $ 20 per hour 40.00
Variable mfg. overhead 2 hours $ 10 per hour 20.00
Total standard unit cost $ 85.00

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Variance Analysis

Prepare standard
cost performance
reports

Analyze
Take action variances

Investigate
causes
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Variance Analysis
Management By Exception
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.

Khalid Aziz-0322-3385752
Variance Analysis
Material Variances
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance


AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity

Khalid Aziz-0322-3385752
Variance Analysis
Labour Variances
Actual Hours Actual Hours Standard Hours
× × ×
Actual Rate Standard Rate Standard Rate

Rate Variance Efficiency Variance


AH(AR - SR) SR(AH - SH)
AH = Actual Hours SR = Standard Rate
AR = Actual Rate SH = Standard Hours
Khalid Aziz-0322-3385752
Variance Analysis
Variable Overhead Variances
Actual Flexible Budget Applied
Variable for Variable Variable
Overhead Overhead at Overhead at
Incurred
AH × AVR Actual Hours
AH × SVR Standard
SH × SVR
Hours

Spending Efficiency
Variance Variance
AH = Actual Hours of Activity
AVR = Actual Variable Overhead Rate
SVR = Standard Variable Overhead Rate
SH = Standard Hours Allowed
Khalid Aziz-0322-3385752
Variance Analysis
Fixed Overhead Variances
Actual Fixed Fixed Fixed
Overhead Overhead Overhead
Incurred Budget Applied
SH × SFR

Spending Volume
Variance Variance
SFR = Standard Fixed Overhead Rate
SH = Standard Hours Allowed
Khalid Aziz-0322-3385752
Standard Costs
Standard cost accounting systems
record variances in the accounts
simplify recordkeeping and help in the preparation
of reports

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Discussions

ABC Company has the following direct


material standard to manufacture one unit
product:
3.0 kilograms per unit at Rs8.00 per kilogram

Last week 6600 kilograms of material were


purchased and used to make 2000 units. The
material cost a total of Rs53000.

Khalid Aziz-0322-3385752
Discussions

What is the actual price per kilogram


paid for the material?
a. Rs7.26 per kilogram.
b. Rs8.13 per kilogram.
c. Rs8.03 per kilogram.
d. Rs8.00 per kilogram.

Khalid Aziz-0322-3385752
Discussions

What is the actual price per kilogram


paid for the material?
a. Rs7.26 per kilogram.
b. Rs8.13 per kilogram.
c. Rs8.03 per kilogram.
d. Rs8.00 per kilogram.
AP = Rs53000 ÷ 6600 kg
AP = Rs8.03 per kg

Khalid Aziz-0322-3385752
Discussions

ABC’s material price variance (MPV)


for the week was:
a. Rs198 favourable.
b. Rs198 unfavourable.
c. Rs189 favourable.
d. Rs189 unfavourable.

Khalid Aziz-0322-3385752
Discussions

ABC’s material price variance (MPV)


for the week was:
a. Rs198 favourable.
b. Rs198 unfavourable.
c. Rs189 favourable.
d. Rs189 unfavourable.
MPV = AQ(AP - SP)
MPV =6600 kg × (Rs8.03 - 8.00)
MPV = Rs198 Rs
Khalid Aziz-0322-3385752
Khalid Aziz-0322-3385752
Discussions

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.

Khalid Aziz-0322-3385752
Discussions

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
Khalid Aziz-0322-3385752
Discussions

ABC’s material quantity variance (MQV)


for the week was:
a. Rs4300 unfavourable.
b. Rs4300 favourable.
c. Rs4800 unfavourable.
d. Rs4800 favourable.

Khalid Aziz-0322-3385752
Discussions

ABC’s material quantity variance (MQV)


for the week was:
a. Rs4300 unfavourable.
b. Rs4300 favourable.
c. Rs4800 unfavourable.
d. Rs4800 favourable.
MQV = SP(AQ - SQ)
MQV = Rs8.00(6600 kg - 6000 kg)
MQV = Rs4800 unfavourable
Khalid Aziz-0322-3385752
Managerial Decision Making

Managerial Decision Making


Cost accounting information is often used by
management for short-term decisions.
Decision making involves five steps:
→ Define the problem.
→ Identify alternatives.
→ Collect relevant information on alternatives.
→ Select the preferred alternative.
→ Analyze decisions made.

Khalid Aziz-0322-3385752
Managerial Decision Making
Accepting additional business
should be based on incremental costs and
incremental revenues
Incremental amounts are those that occur if the
company decides to accept the new business

Khalid Aziz-0322-3385752
Managerial Decision Making
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
 incremental overhead
→We should not use the predetermined overhead rate
to determine product cost
Khalid Aziz-0322-3385752
Managerial Decision Making
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.

Khalid Aziz-0322-3385752
Managerial Decision Making
Sell or Process Further
sell partially completed products vs. process
them to completion
As a general rule, process further only if
incremental revenues exceed incremental costs

Khalid Aziz-0322-3385752
Managerial Decision Making
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
...
→ The contribution margin of each product,
→ The facilities required to produce each
product and any constraints on the facilities, and
→ The demand for each product.

Khalid Aziz-0322-3385752
Managerial Decision Making
Eliminating a Segment
A segment is a candidate for
elimination if its
 revenues are less than its
avoidable expenses

Khalid Aziz-0322-3385752
Managerial Decision Making
Qualitative factors in decisions
Qualitative factors are involved in most all
managerial decisions
→Quality
→Delivery schedule
→Supplier reputation
→Employee morale
→Customer opinions
→……

Khalid Aziz-0322-3385752
Summary
 Segments may be evaluated as a cost centre, a profit
centre, and an investment centre.
 CVP Analysis: break-even analysis, computing income
from expected sales, sales volume needed to earn a target
income, margin of safety, and sensitivity analysis.
 Importance of budgeting, master budget, and budgetary
control
 Standard costs, variance analysis and standard cost
accounting systems
 Managerial decision making: accepting additional
business, make or buy decisions, scrap or rework defects,
sell or process further, selecting sales mix, eliminating a
segment
Khalid Aziz-0322-3385752
Discussions
Consider the beginning XYZ case

Khalid Aziz-0322-3385752
Discussions
Relevant Cost Analysis
Savings in variable expenses
provided by the new machine
($200000 × 5 yrs.) 1000000

Net effect

Rs1000000 - Rs800000 = Rs200000 variable cost savings

Khalid Aziz-0322-3385752
Discussions

Relevant Cost Analysis


Savings in variable expenses
provided by the new machine
($20 0000 × 5 yrs.) 1000000
Cost of the new machine (900000)
Disposal value of old machine 150000
Net effect 250000

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