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Term Paper

On
Managerial Accounting
ACT 202
Term Paper on Managerial Accounting

Submitted to

Suman Paul Chowdhury


Senior Lecturer
BRAC Business School

Submitted by

Rezwanur Rahim (09104020)

Syeda Nabila Kaiser (09104169)

Syed Nazmus Sakib (09104138)

Md. Ashrafullah (09104129)

S.M. Shakeel Ahmed (09104127)

Date of submission: August 11, 2010


Letter of Transmittal

August 11, 2010


Suman Paul Chowdhury
Senior Lecturer, BRAC Business School
BRAC University

Subject: Submission of term paper

Dear Mr. Chowdhury,


Here is the term paper that we were required to write as part of the course Managerial
Accounting (ACT 202) that was undertaken by the under design in the spring 2010
semester.
This term paper is about the implementation of the learning from managerial
accounting course and we hereby submit it for you to read.

Truly Yours,

Syed Nazmus Sakib (ID 09104138) Syeda Nabila Kaiser (ID 09104169)

Md. Ashrafullah (ID 09104129) Rezwanur Rahim (ID 09104020)

S.M. Shakeel Ahmed (ID 09104127)


Acknowledgement

We all the group members would like to express our thanks and gratitude to people
who have helped us all the way through to complete our group term paper on
Managerial Accounting (ACT 202).

At first we want to thank our course instructor Suman Paul Chowdhury, lecturer,
BRAC Business School, BRAC University to guide us and for his necessary support
to commence this report in the first instance, to do the required work on an
appropriate term paper.

Our entire group members are heartily apologizing of any omitted name whose
contribution was also complementary for any possible aspect.
Executive Summary
We are going to introduce a hypothetical company Woodland Furniture and show
their financial condition. Through the schedule cost of good manufactured, income
statement and high – low method we have shown an overall idea about the company
financial condition. We have even done the Break Even Analysis for the company and
found out the break even point in units and sale revenue. Operating leverage and
margin of safety was calculated for the company also.

Certain observations have been done after going through the financial condition of the
company. Like, we have seen that their variable cost is much higher than its fixed
cost. That’s why the break even point level is not high in comparison on its sales.

We also have done the variable costing and absorption costing income statement and
found out the difference in them. We have also focused on the theoretical part of
accounting and try to relate it with the financial condition of our hypothetical
furniture company. Some terminologies that we learned are attached with the term
paper. We have focused to analyze the situation from different financial situation.
Objective
The objectives of this assessment are

1. To learn about the elements of managerial accounting

2. To learn about the financial condition of a company

Methodology

We have collected data from usually from primary medium i.e. from the book.

Managerial Accounting (12th Edition) Garrison, Noreen and Brewer

Company Overview
The company we have chosen is a hypothetical company named The Woodland
Furniture. The Woodland Furniture’s main mission is to generate more sales for
making higher profit. It’s a manufacturing company and it’s not dependent on its
fixed asset .It uses huge variable costs and tries to produce quality furniture.
Accounting information Amount
selling unit 8000
selling price per unit 437.5
selling expense 60000
ending raw material 120000
Beginning Raw material 500000
utilities, factory 80000
direct labor 200000
depriciation, factory 50000
purchase of RM s 1000000
sale 3500000
insurance, factory 60000
supplies, factory 40000
administration expense 200000
indirect labor 50000
maintenance, factory 50000
work in process, beg 800000
work in process, end 500000
finished good, beg 800000
finished good, end 300000
tax 10000
other expenditure 20000
interest 30000
per unit total cost 378.75
The entire amounts are in US dollar (USD)

Schedule cost of good manufactured


schedule cost of good manufactured Amount($)

Direct material
Raw material, beginning 500000
Add: Purchase 1000000
Raw material available fro use 1500000
less: Raw material, end 120000
Raw material used in production 1380000

Direct labor 200000


MOH
Utilities, factory 80000
Depreciation, factory 50000
Insurance, factory 60000
supplies, factory 40000
Indirect labor 50000
Maintenance, factory 50000
Total Manufacturing overhead 330000

Total manufacturing cost 1910000

Add: Work in progress, Beg 800000


Less: work in progress. End 500000
cost of good manufactured 2210000

Cost of good sold

Cost of good sold Amount($)

Finished good, beginning 800000

Add:cost of good manufactured 2210000

Good available for sale 3010000

Less:Finished good, end 300000

cost of good sold 2710000


The Woodland Furniture
Income statement
For the year ended, 2010

Income statement Amount($)

sales 3500000

less: cost of good sold 2710000

gross profit 790000

selling expense 60000

administrative expense 200000

Less: selling expense & administrative expense 260000

Net operating income 530000

Less: other expenditure 20000

EBIT 510000

Less:Interest 30000

EBT 480000

Less: Tax 10000

Net income 470000

Contribution Margin Income Statement

Contribution margin Amount($)

sales 3500000

less: variable cost 2640000

contribution margin 860000

less: fixed cost 390000

Net income 470000

Total Variable Cost & Fixed Cost


variable cost Amount($)

Selling expense (50%) 30000


utilities 80000
direct labor 200000
purchase of RM 1000000
supplies, factory 40000
Indirect labor 50000
Tax 10000
RM beg - RM end 380000
WIP beg - WIP end 300000
FG beg - FG end 500000
Other expenditure 20000
interest 30000

total variable cost 2640000

Fixed cost

selling expense (50%) 30000


Depriciation, factory 50000
Insurance, factory 60000
administration expense 200000
maintenance, factory 50000

total fixed cost 390000

Break Even Analysis


Break even analysis Amount($)

CM ratio 0.245714286
Break even point (sale revenue) 1587209.302

Break even point (unit) 3628

operating leverage 1.829787234

Margin of safety 1912790.698


Margin of safety ratio 0.546511628

High – Low Method

High - low method

Months Labor Hour Total Cost

January 475 179906.25


February 575 217781.25
March 700 265125
April 650 246187.5
May 600 227250
June 850 321937.5
July 368.75 170437.5
August 1000 378750
September 750 284062.5
October 800 303000
November 550.5 227250
December 600.75 258000
7920 3030000

Highest 1000 378750


lowest 368.75 170437.5

difference 631.25 208312.5

per unit variable cost 330

Equation: Y=330 X + a
Y (Total Mixed Cost) 378750
X (No. of units) 1000
a (Fixed cost) 48750

Equation: Y=330 X+ 48750

Regression Line

400000
350000
300000
250000
Total Cost

200000
150000
100000
50000
0
0 200 400 600 800 1000 1200
Labor Hour

Variable costing & Absorption Costing


Beginning Inventory 800
production 10000
sale 8000
Ending inventory 2800

Variable costing

Variable cost per unit

Direct material 172.5


Direct labor 25
MOH
variable 21.25
Fixed

Total 218.75

Variable costing income statement

sales 3500000
Less: Variable cost
Variable cost of good sold
Beginning inventory 175000
Add: Production 2115000

Variable cost available for sale 2290000


Less: Ending Inventory 200000
Variable cost of good sold 2490000
Add: variable operating expense 210000
Total variable cost 2700000
Contribution margin 860000
Less: Fixed cost
MOH
operating expense 270000
Operating Income 530000

Absorption costing

Direct material 172.5


Direct labor 25
MOH
variable 21.25
Fixed 20

Total 238.75

Absorption costing income statement

sales 3500000
Less: CGS

Beginning inventory 191000


Add: Cost of good manufactured 1910000
cost of good available for sale 2101000
Gross profit 1399000
Less: operating expense 320000
Variable 210000
Fixed 110000

Operating Income 1079000

Terminology
Chapter: 1
Managerial Accounting: Managerial accounting provides information for managers
inside an organization who direct and control its operations.

Financial Accounting: Financial accounting provides information to stockholders,


creditors and others who are outside the organization.

Just-in-Time production (JIT): A production and inventory control system in which


material are purchased and units are produced only as needed to meet actual customer
demand.

Total Quality Management: A sequential process of identifying and removing


constraints in a system.

Theory of Constraints (TOC): Is based on the insight that effectively managing the
constraints is a key to success.

International Competition: Managers must make decisions to plan, direct, and


control a world-class organization.

Planning: The process of establishing goals and a suitable course of action to achieve
those goals. Developing plans (those for the organization and for those who work in
it), and forecasting.

Directing and Motivating: Managers assign task to employees, arbitrate disputes,


answer questions, solve on-the-spot problems and make many small decisions that
affect customers and employees.

Organizing: Organizing is identifying jobs to be done, hiring people to do them,


establishing departments, delegating or pushing authority down to subordinates,
establishing a chain of command (channels of authority), and coordinating the work
of subordinates.

Leading: Leading means influencing other people to get the job done, maintaining
morale, molding company culture, and managing conflicts and communication.

Controlling: The process of ensuring that actual activities conform to planned activities.
CHAPTER 2: COST TERMS, CONCEPTS and CLASSIFICATIONS

Manufacturing Costs:

Direct Materials: Those materials that become an integral part of the product and
that can be conveniently traced directly to it.

Direct Labor: Those labor costs that can be easily traced to individual units of
product.

Manufacturing Overhead: Manufacturing costs that cannot be traced directly to


specific units produced.

No manufacturing Costs:

Marketing and Selling Cost: Costs necessary to get the order and deliver the
product.

Administrative Cost: All executive, organizational, and clerical costs.

Product costs: Include direct materials, direct labor, and manufacturing overhead.

Period costs: Are not included in product costs. They are expensed on the income
statement

Prime cost: Is the sum of direct material and direct labor cost.

Conversion cost: Is the sum of direct labor cost and manufacturing overhead cost.

Raw materials: Are the materials that are used to make a product.

Work In Process: Consists of units of products that are only partially complete and
will require further work before they are ready for sale to a customer.

Finished Goods: Consist of completed units of product that have not yet been sold to
a customer.

Cost Classifications for Predicting Cost Behavior

Variable costs: A variable cost is a cost that varies in total in direct proportion to
changes in the level of activity.
Fixed Cost: A fixed cost is cost that remains constant in total regardless of changes in
the level of activity.

Direct costs: Costs that can be easily and conveniently traced to a unit of product or
other cost objective.

Indirect costs: Costs cannot be easily and conveniently traced to a unit of product or
other cost object.

Differential Costs and Revenues

Differential Cost: A difference in costs between any two alternatives is known as


differential costs.

Differential Revenues: A difference in revenues between any two alternatives is


known as differential revenues.

Incremental Cost: A differential cost is known as an incremental cost.

Opportunity Costs: The potential benefit that is given up when one alternative is
selected over another.

Sunk Costs: Sunk costs cannot be changed by any decision. They are not differential
costs and should be ignored when making decisions.

Chapter: 5
Cost structure: The expenses that a firm must take into account when
manufacturing a product or providing a service. Types of cost structures
include transaction costs, sunk costs, marginal costs and fixed costs. The
cost structure of the firm is the ratio of fixed costs to variable costs.

Activity base: Applicable to the production activity used to relate factory overhead to
production (e.g., units produced, direct labor hours, direct labor cost, machine hours).

Step-variable Cost: Direct cost that changes dramatically at certain points because it


involves a large expenditure which cannot be spread over an accounting period.

Relevant range: The upper and lower levels of activity within which the business
expects to be operating within the short-term planning horizon (the budget period). It
is the specified range of activity over which a
variable cost per unit remains constant or a fixed cost remains
fixed in total; it is generally assumed to be the normal
operating range of the organization.

Committed Fixed cost: Committed fixed costs are those fixed costs that are difficult
to adjust and that relate to the investment in facilities, equipment, and the
basic organizational structure of a firm.

Discretionary fixed cost: Fixed costs that change because of managerial decisions,
also called management (fixed) costs or programmed (fixed) costs. Examples of this
type of fixed costs are advertising outlays, training costs, and research and
development costs. Management sometimes unjustly reduces these costs below
normal levels in order to pad current net income, which may place the future net
income of the company at risk.

Account analysis: In cost accounting, this is a way for an accountant to analyze and
measure the cost behavior of a firm. The process involves examining cost drivers and
classifying them as either fixed or variable costs. The cost accountant then uses the
company’s data to figure out the estimated variable cost per cost-driver unit or fixed
cost per period.

Engineering approach: A detailed analysis of cost behavior based on an industrial


engineer's evaluation of the inputs that are required to carry out a particular activity
and of the prices of those inputs.

Dependent variable: A dependent variable is what you measure in the experiment


and what is affected during the experiment. The dependent variable responds to the
independent variable. It is called dependent because it "depends" on the independent
variable. In a scientific experiment, you cannot have a dependent variable without an
independent variable.

Independent variable: An independent variable is that variable which is presumed to


affect or determine a dependent variable. It can be changed as required, and its values
do not represent a problem requiring explanation in an analysis, but are taken simply
as given. 
High-low method: Algebraic procedure used to separate a Semi variable Cost or
Mixed Cost into the fixed and the variable components. The high-low method, as the
name indicates, uses two extreme data points to determine the values of a (the fixed
cost portion) and b (the variable rate) in the Cost-Volume Formula y = a + bx. The
extreme data points are the highest and lowest x - y pairs.

Least-squares Regression Method: Uses all of the data to separate a mixed cost into
its fixed and variable components.

Contribution Approach: Contribution approach is an income statement format that


is geared to cost behavior in that costs are separated into variable and fixed categories
rather than being separated according to the functions of production, sales, and
administration.

Contribution Margin: Contribution margin is the calculation that gives the


profitability of an individual product. 

Chapter: 9

Master Budget: The master budget is a summary of company's plans that sets


specific targets for sales, production, distribution and financing activities. This budget
consists of management's plans for future and how these plans are to be
accomplished. It usually consists of a number of separate but interdependent budgets. 

Responsibility Accounting: The basic idea of responsibility accounting is that large


diversified organizations are difficult, if not impossible to manage as a single
segment, thus they must be decentralized or separated into manageable parts.

Continuous or perpetual budget: Budget that rolls ahead each month or period
without regard to the fiscal year so that a twelve-month or other periodic forecast is
always available.

Self-imposed budget: A method of preparing budgets in which managers prepare


their own budgets. These budgets are then reviewed by the manager's supervisor, and
any issues are resolved by mutual agreement.
Budget Committee: A group of people who discusses and plans a budget. They
discuss, plan, research, and present the budget plan to whoever assigned them the
committee job. 

Sales Budget: A sales budget is a detailed schedule showing the expected sales for
the budget period

Cash Budget: The cash budget is an accounting device that is used to effectively


monitor and manage the immediate cash flow of a home or business budget.

Merchandise purchases budget: A budget used by a merchandising company that


shows the amount of goods that must be purchased from suppliers during the period.

Direct materials budget: Schedule showing how much material will be required for
production and how much material must be bought to meet this production
requirement.

Direct labor budget: Schedule for expected labor cost.

Manufacturing overhead budget:  The manufacturing overhead budget lists all


production costs other than direct materials and direct labor.

Ending finished goods inventory budget:  This budget details the amount and value
of ending inventory on the budgeted balance sheet. The unit product cost from this
budget is also used to compute the cost of goods sold for the budgeted income
statement. The details of the computations will depend upon whether variable or
absorption costing is used.

Selling and administrative expense budget: The selling and administrative budget
lists the anticipated non-manufacturing expenses for the budget period. This budget is
usually made up of many smaller individual budgets.

Chapter: 6

Break-even point-The level of sales at which profit is zero.The break-even point can
also defined as the point where total revenue equals total expense.
Contribution margin method: A method of computing the break-even point in
which the fixed expenses are divided by the contribution mergin per unit.

Contribution margin ratio: A ratio computed by dividing contribution margin by


doller sales.

Degree of operating leverage: A type of leverage ratio summarizing the effect a


particular amount of operating leverage has on a company's earnings before interest
and taxes (EBIT). Operating leverage involves using a large proportion of fixed costs
to variable costs in the operations of the firm. The higher the degree of operating
leverage, the more volatile the EBIT figure will be relative to a given change in sales,
all other things remaining the same. The formula is

Equation method: A method of computing the break-even point that relies on the
equation sales= variable expense + fixed expense + profits.
Margin of safety: The excess of budgeted (or actual) dollar sales over the break-even
dollar sales.
Operating leverage: A measure of how sensitive net operating income is to a given
percentage change in dollar sales.

Chapter: 7
Absorption costing: A costing method that includes all manufacturing costs-direct
materials, direct labor, and both variable and fixed manufacturing overhead-in unit
product costs.
Fixed manufacturing overhead cost deferred in inventory- The portion of the
fixed manufacturing overhead cost of a period that goes into ending inventory under
the absorption costing method.
Fixed manufacturing cost released from inventory: The fixed manufacturing
overhead cost of a prior period that becomes an expense of the current period under
the absorption costing method.

Chapter: 12
Market price: The current price at which an asset or service can be bought or sold.
Economic theory contends that the market price converges at a point where the forces
of supply and demand meet. Shocks to either the supply side and/or demand side can
cause the market price for a good or service to be re-evaluated. For example, suppose
that the market price for a widget has been $10 for a number of years. Suddenly, the
market price shifts to $20 when it is announced that only half of this year's widgets
will be sold in stores. In this case, a drop in supply causes the market price to
increase.

Common fixed cost: A common fixed cost is a fixed cost that supports the operations
of more than one segment, but is not traceable in whole or in part to any one segment.
Even if a segment were entirely eliminated, there would be no change in true common
fixed cost. Such as: The salary of general manager who controls all the segments. The
salary of CEO at Grameenphone is also an example of common fixed cost. No single
segment can be regarded as the sole reason of this cost.

Traceable fixed cost: A traceable fixed cost is a fixed cost that is incurred because of
the existence of a segment. If the segment had never existed, the fixed cost would
have not been incurred; and if the segment were eliminated, the fixed cost would
disappear. For
Example; The salary of the Fritos product manager at Pepsi Co. is traceable fixed cost
of the Fritos business segment of Pepsi Co.

Cost center: A department or other section of a company where managers are directly
responsible for costs. For example, consider a company that has a manufacturing
department, a research and development department, and a payroll department. Each
department could be a cost center, and the directors of each department would be
responsible to keep costs to as low a level as possible. The company thus accounts for
each cost center separately, which allows managers to take immediate responsibility
for cost growth and credit for cost cutting.

Investment center: Department or an area of responsibility, where a manager


controls revenues and associated costs, assets, and liabilities. His or her performance
is assessed largely on the basis of return on investment (ROI) achieved. The corporate
headquarters or division in a large decentralized organization would be an example of
an investment center.

Operating assets: Asset acquired for or used in the income generating operations of
the business (such as cash, inventory, prepaid expenses) and various fixed, long-term
assets (such as plant and equipment.

Residual income: The amount of income that an individual has after all personal
debts, including the mortgage, have been paid. This calculation is usually made on a
monthly basis, after the monthly bills and debts are paid. Also, when a mortgage has
been paid off in its entirety, the income that individual had been putting toward the
mortgage becomes residual income.

Responsibility center: Unit in the organization that has control over costs, revenues,
or investment funds. For accounting purposes, responsibility centers are classified as
Cost Centers, Revenue Centers, Profit Centers, and Investment Centers. A well-
designed responsibility accounting system should clearly define responsibility centers
in order to collect and report revenue and cost information by areas of responsibility.

Return on investment: A performance measure used to evaluate the efficiency of


an investment or to compare the efficiency of a number of different investments. To
calculate ROI, the benefit (return) of an investment is divided by the cost of the
investment; the result is expressed as a percentage or a ratio. 

The return on investment formula:

Return on investment is a very popular metric because of its versatility and simplicity.


That is, if an investment does not have a positive ROI, or if there are other
opportunities with a higher ROI, then the investment should be not be undertaken.
Turnover: the ratio of annual sales to inventory; or equivalently, the fraction of a
year that an average item remains in inventory. Low turnover is a sign of inefficiency,
since inventory usually has a rate of return of zero. Here also called inventory
turnover. For a mutual fund, the number of times per year that an average dollar of
assets is reinvested.

Chapter: 13

Avoidable cost: Cost that will not be incurred if an activity is suspended; also called
escapable cost. For example, it is the cost that can be saved by dropping a particular
product line or department (e.g., salaries paid to employees working in a particular
product line or department).

Constraint: A limitation under which a company must operate .Such as limited


available machine time or raw materials that restricts the company’s ability to satisfy
the demand.

Differential cost: Any cost that differs between alternatives in a decision making
situation. Such as If the work is done in machine the cost is $. 2,55,000/- if the work
is done with the labor the cost will be $. 2,00,000/- the differential cost is $. 55,000.

Joint cost: Costs that are interrupted up to the split off point in a process that
produces joint products. Such as Product A and Product B processed by one input and
till to the split off point the cost is $4000.that is the joint cost.

Joint products: Cost of two or more products that arise from the same manufacturing
process, as when silver and gold are taken from the same mine. It is impossible to
distinguish the cost of mining each, so costs are generally allocated based on the
relative selling price of each product.

Make or buy decision: Business decision that compares the costs and benefits of
manufacturing a product or product component against purchasing it. If the purchase
price is higher than what it would cost the manufacturer to make it, or if the
manufacturer has excess capacity that could be used for that product, or the
manufacturer's suppliers are unreliable, then the manufacturer may choose to make
the product. This assumes the manufacturer has the skills and equipment necessary,
access to raw materials, and the ability to meet its own product standards. A company
who chooses to make rather than buy is at risk of losing alternative sources, design
flexibility, and access to technological innovations.

Relevant cost: A managerial accounting term that is used to describe costs that are
specific to management's decisions. The concept of relevant costs eliminates
unnecessary data that could complicate the decision-making process. Such as: . I want
to go to France by car... my relevant costs are petrol cost for my car, Insurance for
driving in France, Hotel costs in France. ....Now let’s say I decide to fly to France....
petrol cost for my car and insurance are no longer relevant costs. Hotel cost is still a
relevant cost, and now other relevant costs are airline ticket costs, travel to and from
airport etc.

Sell or process further decision: Short-term, non routine decision about whether to
sell a product at a particular stage of production or to process it further in the hope of
obtaining additional revenue. When two or more products are produced
simultaneously from the same input by a joint process, these products are called Joint
Products. The term Joint Costs is used to describe all the manufacturing costs incurred
prior to the point where the joint products are identified as individual products,
referred to as the Split-Off Point. At the split-off point some of the joint products are
in final form and salable to the consumer, whereas others require additional
processing. In many cases, the company might have the option to sell the products at
the split-off point or process them further for increased revenue. In connection with
this type of decision, joint costs are considered irrelevant, since the joint costs have
already been incurred at the time of the decision, and therefore are Sunk Costs. The
decision will rely exclusively on additional revenue compared to the additional costs
incurred due to further processing.

Special orders: Short-term and non routine decisions such as whether to accept a
production order at an offered price that is below the normal selling price, or what
price to charge for a product that could be produced with otherwise idle facilities.
Such as : assume that a company with 100,000-unit capacity is currently producing
and selling only 90,000 units of product each year with a regular price of $2. If the
variable cost per unit is $1 and the annual fixed cost is $45,000, the income statement
looks as follows: For example, assume that a company with 100,000-unit capacity is
currently producing and selling only 90,000 units of product each year with a regular
price of $2. If the variable cost per unit is $1 and the annual fixed cost is $45,000, the
income statement looks as follows:

The company has just received an order that calls for 10,000 units at $1.20, for a total
of $12,000. The acceptance of this special order will not affect regular sales.
Management is reluctant to accept this order because the $1.20 price is below the
$1.50 factory unit cost ($1.50 = $1.00 + $0.50). Is it advisable to refuse the order?

Split off point: Juncture in a production process where the product stream splits into
two or more distinct products which become identifiable as joint products. Such as: at
what point crude oil splits and become diesel and petrol that is the point of split.

Sunk cost: A cost that has been incurred and cannot be reversed. Also referred to as
"stranded cost. Such as: A worn-out piece of equipment bought several years ago is a
sunk cost because the cost of buying it cannot be reversed.

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