Managerial and Cost Accounting

TM 661Engineering Economics for

Managers

Know the major differences between financial accounting and Managerial Accounting

Given a set of factory overhead data, be able to use the high-low method to compute the fixed and variable factory overhead rates.

Given appropriate cost figures, be able to compute associated cost tables using either the job order costing or the process costing method.

Understand the different pricing strategies

Learning Objectives

Characteristic Managerial Accounting Financial Accounting

Service Perspective

Internal to Managers External to stockholders

Time Frame Present and Future for planning and control

Past financial statements are historical

Reporting Frequency and promptness

Control reports issued frequently (daily) and promptly (one day after period end)

Most financial statements issued monthly a week or more after month end

Degree of Precision of data used

Reasonable accuracy desired, but “close counts” relevance is often more important than reliability

High accuracy desired, with time usually available to achieve it – reliability is of utmost importance

Reporting Standards

None imposed because of internal data

Imposed by generally accepted accounting principles and FASB

Breadth of Concern

Micro- individual units of the organizational plan and act

Macro—financial Statements are for the whole organization

Managerial Vs Financial Accounting

Different from accounting used for your tax preparation

Tax Accounting: tells you HOW MUCH you sold and What you spent it on

Managerial accounting: tells you Where your income came from and Why you spent it

Two aspects of Managerial AccountingGetting accurate informationUnderstanding what that information is telling

Managerial Accounting

For cost accounting purposes:Product CostPeriod Cost

Relationship to product or activity:Direct CostIndirect Cost

Relationship between total cost and volume of activityVariable costFixed Cost

Cost Classification

Time-Frame perspectiveControllable costNon-controllable cost

For other analytical purposesDifferential costAllocated costSunk CostOpportunity cost

Cost Classification Continued

Owner Equity = Assets - Liabilities

Accounting Equation

K-Corp Consolidated Balance1997 1996

Current Assets Cash $22,300 $16,800 Accounts Receivable 46,800 38,600 Inventories 54,200 48,200 Total Current Assets $123,300 $103,600Other Assets Land 100,000 100,000 Building 85,400 94,600 Equipment 78,400 85,600

Total Assets $387,100 $383,800

Current Liabilities Accounts Payable $62,400 $55,600

Notes 5,000 20,000Total Current Liabilities $67,400 $75,600 Mortgage 125,800 132,300Total Liabilities $193,200 $207,900Owner's Equity Paid In Capital 100,000 100,000 Retained Earnings 93,900 75,900Total Liabilities & Owner Equity $387,100 $383,800

K-Corp Income Statement

Net Sales $574,800Cost of Goods Sold 428,300Gross Margin 146,500Operating Expenses Sales Expenses 87,400 Depreciation Equip 7,200 Depreciation Bldg 9,200 Administrative 14,500 Utilities 4,600

Total Operating $122,900Income from Operations 23,600Taxes 5,600Net Income $18,000

K-Corp Schedule of Cost of Goods SoldDirect MaterialsInvnetory, Dec. 1996 $48,200Purchases 130,000Cost of Direct materials available for use 178,200Inventory, Dec. 1997 54,200Direct Materials Used $124,000Direct Labor 209,500Facotry Overhead: Indirect labor 43,000 Indirect material 27,000 Utilities 5,000 Depreciation 16,200 Miscellaneous 4,000 95,200Total Manufactirng Costs $428,700

K-Corp Schedule of Cost of Goods SoldDirect MaterialsInventory, Dec. 1996 $48,200Purchases 130,000Cost of Direct materials available for use 178,200Inventory, Dec. 1997 54,200Direct Materials Used $124,000Direct Labor 209,500Factory Overhead: Indirect labor 43,000 Indirect material 27,000 Utilities 5,000 Depreciation 16,200 Miscellaneous 4,000 95,200Total Manufactirng Costs $428,700Add: Work in Process 1996 38,000Less: Work in Process 1997 (41,000)Cost of Goods Manufactured $425,700

K-Corp Income Statement

Net Sales $574,800Less: Cost of Goods Sold Finished Goods, Dec. 1996 $42,000 Cost of Goods Manuf. 425,700 Cost of Goods Avail for sale $467,700 Finished Goods, Dec. 1997 39,400Cost of Goods Sold 428,300Gross Margin 146,500Operating Expenses Sales Expenses 87,400 Depreciation Equip 7,200 Depreciation Bldg 9,200 Administrative 14,500 Utilities 4,600Total Operating $122,900Income from Operations 23,600Taxes 5,600Net Income $18,000

Mixed costs are a function of fixed & variable costsCost-Volume formula

Y = a + bx

where Y = mixed cost to break upx = a measure of activity (machine

hrs)a = fixed cost componentb = variable rate per unit x

Cost Behavior & Flexible Budgeting

High-Low Method

Suppose we have the following:

Factory DirectMonth Overhead Labor HrsApril 2750 250May 2480 280June 2690 230July 2330 190

August 2610 210September 2910 270

X YHigh 280 2480Low 190 2330Difference 90 150

Variable rate = 150/90 = $1.67 per DLH

High-Low Method

Fixed Cost Portion

Total Mixed - Variable = $2,480 - 1.67(280) = $2,012

High-Low Method

Fixed Cost Portion

Total Mixed - Variable = $2,480 - 1.67(280) = $2,012

Total Mixed Cost = $2,012 + 1.67 X

High-Low Method

Least Squares

Factory Overhead vs Direct Labor Hrs.

2000

2250

2500

2750

3000

150 200 250 300

Laobr Hrs

Ov

erh

ea

d

Least Squares

Factory Overhead vs Direct Labor Hrs

2000

2250

2500

2750

3000

150 200 250 300

Labor Hrs

Ov

erh

ead

Y = $1,900.27 + 3.054 x

Geared towards a range of activitiesDynamic rather than static

Flexible Budgeting

Geared towards a range of activitiesDynamic rather than static

Need to understand rudiments of cost accounting

Job order costingProcess costingActivity based costing

Flexible Budgeting

K-Corp collects its cost data by the job order cost system. For each job, they know the amount and material costs. Direct labor costs are $9.50 per hour. Factory overhead rate is computed at $4.50 per hour.

Job Order Costing

Job Order CostingDirect Materials Hrs Rate Cost7/14 Issued $1,2007/20 Issued 8007/25 Issued 500 Total $2,500Direct Labor Week 7/20 180 $9.50 / hr $1,710Week 7/26 160 $9.50 / hr 1,520 Total Labor $3,230Cost Sumamry Direct Material $2,500 Direct Labor 3,230 Factory Overhead 340 $4.50 / hr 1,530 Total Cost $7,260Sell PriceJob Price Cost + 40% $10,164

A Company produces and sells a chemical product. During a given month the company purchases 15,000 gallons of chemicals at a cost of $30,000. 10,000 gallons are completed and transferred to the next department. 5,000 gallons are 20% complete as to conversion. Factory overhead for the month is $20,000.

Process Costing

Process Order CostingItems Units Cost Cost/UnitChemicals 15,000 $30,000 $2.00Conversion Costs Chemicals Transferred 10,000 Work in Process (20% of 5,000) 1,000 Total Conversion 11,000 $20,000 $1.82Total Costs $50,000 $3.82

Ending Work in Process Units Cost/Unit CostMaterials 5,000 $2.00 $10,000Conversion Cost 1,000 $1.82 1,818 Total Work in Process $11,818Completed & Transferred 10,000 $3.82 38,182 Total Costs Accounted $50,000

Historicallydirect labor & material constitute significant elements of cost of goods sold

Currentoverhead costs dominate the cost of production

Activity-based costing is designed to meet the challenge of a changing cost mix by associating manufacturing costs with activities which drive them

Activity Based Costing

Define Cost Pools(usually support functions)

Identify Cost Drivers(trace costs to the cost pools)

ABC Two-Step Process

A multinational firm uses traditional accounting to allocate manufacturing and management support costs. However, travel is typically allocated on the basis of employees at plants in France, Germany, Italy, and Greece. Consequently, some plants are likely generating much more management travel than others. The ABC system is chosen to more precisely allocate travel costs to major product lines.

ABC Example

ABC ExampleTotal Travel $500,000Total Employment 29,100Total Vouchers 500Travel Rate $17.18

Traditional CostingTravel

Plant Employees AllocationFrance 12,500 $214,777Italy 8,600 147,766Germany 4,200 72,165Greece 3,800 65,292

Indirect t ratetravel budget

total workforcecos

$500,

,$17.

000

29 10018

Indirect t ratetravelbudget

total workforcecos

$500,

,$17.

000

29 10018

ABC Example

1. Determine Cost Pool

ABC Cost PoolPlant

Plant Employees Budget % to Travel TravelFrance 12,500 $2,000,000 5.0% $100,000Italy 8,600 500,000 15.0% 75,000Germany 4,200 1,000,000 17.5% 175,000Greece 3,800 500,000 30.0% 150,000

Total $500,000

ABC Example

2. Determine Cost Driver

ABCratetravel travel t pool

total vouchers

cos

$500,$1,

000

500000

ABC Example

Driver Distribution

Travel Vouchers

Plant 1 2 3 4 5 Total

France 50 25 75Italy 80 30 30 140Germany 100 25 20 145Greece 140 140

Total Vouchers 230 50 30 20 170 500

Product Line

ABC Example

Allocation of Costs

Travel Vouchers

Plant 1 2 3 4 5 Total

France 50,000 25,000 $75,000Italy 80,000 30,000 30,000 140,000Germany 100,000 25,000 20,000 145,000Greece 140,000 140,000Total Vouchers $230,000 $50,000 $30,000 $20,000 $170,000 $500,000

Product Line

Examines the difference between the net operating profit (after tax) and the cost of capital

Four ways to create value for shareholderincrease profit margins without increasing

capitalinvest in projects that earn more than cost of

capitalfree-up capital than earns less than cost of

capitaluse debt to reduce the cost of capital

Value Added

Which is the better firm from a shareholder’s point of view?

Value Added

A BAssets (millions) $100 $200Owner Equity 100 200Net Income 24 42ROA 24% 21%ROE 24% 21%

Firm B has largest Economic Value Added (EVA)

Value Added

A BAssets (millions) $100 $200Owner Equity 100 200Net Income 24 42ROA 24% 21%ROE 24% 21%

Cost of Capital (12%) 12 24EVA ( NI - CoC ) $12 $18

Firm B has largest Economic Value Added (EVA)

Value Added

A BAssets (millions) $100 $200Owner Equity 100 200Net Income 24 42ROA 24% 21%ROE 24% 21%

Cost of Capital (12%) 12 24EVA ( NI - CoC ) $12 $18

Maximizing ROI is not the right objective!

Product Pricing is different than Product Cost!

Cost-based pricingCompetitive-based pricingDemand-based pricing

Product Pricing vs Product Cost

Recognizes a relation ship between pricing and the costs of running a business

The higher your costs…. The higher your prices must be

Pricing = COS * mark-up factor = price

Example $10 * 2 = $20 or 100/50 = 2For 50% COS

Cost Based Pricing

Recognizes that some products are more price – sensitive to consumers than others, therefore competition is a concern.

GroceriesMilk, bread, butterCan of Artichokes

Competitive-Based Pricing

Recognizes the viability of charging as much as the market will bear.

The greater demand, the more you can charge

The fewer providers, the more you can charge

The greater the perceived value, the more you can charge!

Demand based pricing

Home Studios30% cost of goods30% general expenses40% owner’s compensation + net profit

Different per industry

Benchmarks

Marshall and McManus, Accounting What The Numbers Mean 3rd Edition, Irwin, 1994. Page 12-13

Business Breakthroughs Workshop, Studio Management Services

References