Summary Managerial Accounting - Chapter 1-13 PDF

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Chapter 1-13...

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Chapter(2:(Managerial(Accounting(&(Cost(Concepts( ' Direct(costs'–'can'be'conveniently'traced'to'a'cost'object' Indirect(costs'–'cannot'be'conveniently'traced' ' Manufacturing'costs ' ' ' Direct' Indirect' ' ' Manufacturing' Direct' ' Direct'Labor' Overhead' Materials' ' Prime(costs(–'DM'+'DL'(think:'“prime”'à฀'“primer;”'includes'raw'materials)' Conversion(costs'–'DL'+'MOH'(costs'to'convert'materials'into'a'product)' ' Product(costs'–'attached'to'a'product,'costs'to'produce'item'(recorded'when'sold)' Period(costs'–'incurred'when'expensed'during'period;'normal'accrual'rules'apply' ' Manufacturing(costs( Manufacturing(overhead'–'depreciation,'insurance'on'factory,'property'tax,'costs'of' operating'factory' Raw(materials'–'direct(if'integral'to'product,'otherwise'indirect' Direct(labor(–'“touch'labor”' ( Indirect(labor'–'impossible'to'trace' ( Nonmanufacturing(costs'(SG&A)( ( Selling(costs(–'orderIgiving,'orderIfilling,'delivery' ' Administrative(costs'–'management' ' Mixed(costs(–'the'“cost'structure”'or'cost'proportions'of'FC'vs.'VC'' Fixed(costs'–'constant'in'total' ( Committed(FC(–'can’t'reduce'easily'(meant'for'long'haul)' ( Discretionary(FC(–'can’t'be'cut'in'the'short'term' Variable(costs'–'constant'per'unit'' ' MC'='FC'+'VC'*'number'of'units'

' Relevant(range(–'where'assumptions'that'cost'behavior'is'linear'are'valid' *outside'of'the'relevant'range,'fixed'costs'may'go'up'or'down'into'another'tier'of'FC' (think'of'it'like'a'step'function)' ' To(estimate(proportions(of(FC(to(VC:( ( HighKlow(method(–'find'VC,'then'plug'in'to'MC'equation'to'find'FC' VC/unit'='(High'cost'–'low'cost)'/'(high'activity'–'low'activity)' MC'='FC'+'VC'*'activity'

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Differentials((concept'of'marginal'costs/revenues)' ' Differential(cost'–'difference'in'costs'between'two'alternatives' Differential(revenue'–'difference'in'revenues'between'two'alternatives' Incremental'–'an'increase'in'a'cost'from'one'alternative'to'another' Decremental(–'a'decrease'in'a'cost'from'one'alternative'to'another' '

Chapter 7: Activity-based Costing (ABC) - Internal supplement to usual costing system - While a usual system uses all manufacturing costs as product costs and nonmanufacturing costs as period costs, ABC uses all direct costs, and includes some indirect + nonmanufacturing costs on a cost-effect basis with products (the difference between manufacturing and nonmanufacturing doesn’t matter at all for ABC, it’s about linking costs to products. If there’s a causation, the cost is included.) - Costs must be caused by the product - There are many cost pools, with unique measures of activity - Links to rewards/evaluations - Strong top management support necessary - Cross-functional involvement Purpose of using ABC - Used to identify areas that would benefit from process improvements - Tries to eliminate waste, lost time, and defects - Activity rates help us understand where waste comes from and opportunities for improvement - Affects business decisions - Has you look at your activities & see what’s not adding value Do not assign these to products: - Organization-sustaining costs (these are considered period costs for this system) - Costs of unused capacity  excluding these allows for a more stable unit product cost “Overhead” in ABC costing means all indirect costs - If the cost is caused by the product  product cost - If the cost is not caused by the product  period cost - (Depends on if its traceable to the product) Activity – something that consumes resources Cost pool – where costs related to one activity measure accumulate - Each cost pool has its own unique activity measure - Flexible; can be whatever the company feels is generating activity Activity measure – Another word for allocation base - Transaction driver – # times an activity occurs (iterations) - Duration driver – length of time it takes to do an activity (how long, longevity) Levels of activity (these are unrelated to volume) 1. Unit-level – proportional to the number of units produced 2. Batch-level – incurred per batch/order (shipping, placing orders, setting up equipment) 3. Product-level – related to a specific product type (not number of units. Examples: design, advertising, paying product manager) 4. Customer-level – specific customers (sales calls, catalog mailing)

5. Organization-sustaining – carried out regardless of output (Heat, computer network, preparing annual reports) Cost Pool examples Customer orders – taking / processing orders Design changes – resources consumed by design changes Order size – based on # units produced Customer relations – self explanatory (maintaining customer relations) Other – all other unused capacity / organization sustaining costs How to do ABC costing 1. Define your cost pools and activity measures 2. 1st stage allocation  Assign your overhead (indirect) costs to your cost pools using estimated percentages. o What portion of each overhead cost (production, etc.) belongs in which cost pool? (customer relations, design changes, etc.)  Then convert the percentages to actual numbers  Horizontal totals are from financials, totals for each overhead cost; percentages should = 100  Vertical totals are how much is allocated to each cost pool o Goal here is to find the total cost of each cost pool (add vertically) 3. Calculate activity rates (how much each unit of activity costs) Activity Rate of Cost Pool = Total of Cost Pool / Total Activity of Cost Pool (Similar to POHR, but that was one calculation; this is several calculations because you have several different bases)

4. 2nd stage allocation Apply rates to overhead; assigning costs to cost objects* thru activity rates ABC cost of cost pool = activity rate * actual activity Total overhead cost = sum of ABC costs of all the cost pools *Cost objects may include customers, customer orders, and products.

Product Margin: 1. Gather product cost data—direct costs & costs from cost pools (except for customer relations pool & unused capacity/organization sustaining pool) and delegate those costs to the products they’re associated with 2. Subtract product costs from sales to get product margin 3. To get net income, subtract all other non-product costs from product margin Customer Margin: same as product, but you include customer relations pool Key Distinctions ABC – only assigns MOH costs related to specific products as product costs Traditional – allocates all MOH to products as product costs

ABC – non-volume allocation bases Traditional – uses volume allocation bases (DL/Machine hrs) to allocate overhead costs to products ABC – includes direct SG&A costs as product costs Traditional – SG&A are period costs Why is ABC used for internal and not external reporting? - Internal report  more detailed - Does not conform to GAAP because you are including some sg&a as product costs, & you may be omitting some moh from your product costs - Used to help with costing & pricing - Choosing allocation bases is more subjective than volume-based cost drivers Limitations of ABC - Lots of resources needed to maintain - May be met with resistance - Unfamiliar numbers may be misinterpreted - Might be a desire to allocate ALL costs to products - Will need two costing systems

Chapter 8 – Master Budgeting Budget – detailed plan for the future in numbers Purposes of Budgeting Planning – developing goals and budgets to get there Control – getting feedback to make sure plan is going well, even if there are changes Advantages of Budgeting - Communicating management’s plans - Forcing managers to plan for future - Way to allocate resources effectively - Uncover bottlenecks before they happen - Coordinate activities of organization, integrating different departments - Pulls everyone in the same direction - Defines goals/benchmarks for evaluation Responsibility Accounting – the manager is responsible for only the items they can significantly control - Personalizes accounting info by holding individuals responsible - Can respond quickly to deviations, learn from feedback in comparing budget to results - Not supposed to penalize managers for not meeting budget Budget Periods - Operating Budgets o 1 year (FY of company) o 4 quarters; each quarter divided into months as year progresses o little participation from lower-level managers - Continuous (Perpetual) Budget – 12 mo. budget, as each month/quarter is completed, the budget adds one month/quarter to the end of the budget o Keeps managers focused on long-term Self-imposed (Participative) Budget – prepared with all managers on deck (they help participate in the process) - Individuals at all levels are involved - Higher motivation because of self-imposed goals (creates commitment) - The front-line managers are best at estimating what they need - Managers can’t say the budget is unrealistic because they made it themselves - Limitations o Lower-level managers may not be thinking in the big picture o Lower-level managers may create too much slack (they’re going to be held accountable, so might as well make the budget easy to attain) - Problems with not using self-imposed budgets o Top managers setting goals too high  motivation suffers o Too much slack/too little slack  waste

Human Factors in Budgeting - Budgets unfortunately used to pressure/blame employees; should instead be used to establish goals and evaluate results - Some bonuses based on achieving/exceeding budgets - Highly achievable budgets may build confidence & commitment to budgeting, less likely to cheat to meet target Master Budget – separate but interdependent budgets that detail company’s sales, production, & financial goals 1. Sales budget (expected) a. Schedule of cash collections 2. Production budget (how much to produce) o Would be a merchandise purchases budget instead for a merchandising company 3. Manufacturing cost budgets a. DM budget + cash disbursements for material purchases b. DL budget c. MOH budget 4. Ending FG Inventory budget 5. SG&A budget 6. Cash budget (how cash resources are acquired and used) 7. Budgeted income statement & balance sheet (estimated net income & ALE) There’s also a beginning balance sheet & budgeting assumptions Excel sheet, which is where a lot of numbers are derived from. Sales budget – includes budgeted unit sales & estimated sale prices. Also includes expected cash collections; there’s often a beginning A/R amount, which is how much they were scheduled to receive—this is in the beginning balance sheet. Other collections are based on estimated percentages of (usually credit) sales for subsequent months. Production budget – based on the cost flow below. - Desired EI can usually be computed; it’s often a percentage of next month’s sales - *keep in mind that the amounts listed under “Year” aren’t just sums; the BI and EI are the BI for the first quarter/month and the EI for the last quarter/month - If it was a merchandising company, it would be COGS instead of sales (because COGS are based on sales); instead of anticipated production, it’s budgeted purchases o Schedule of cash disbursements, just like the one that goes in DM o If it’s a schedule of units, not money, it’s called budgeted “unit sales”

Cost flow: Budgeted sales (how much you need) + Desired EI -------------------Total Needs — BI -------------------Production Direct materials budget – details raw materials to be purchased - Calculate how much raw materials you’ll need for production, then calculate how much you’ll need to buy (use the DM-specific cost flow below). Then, calculate the cost of the raw materials you need to buy - Cash disbursements analogous to cash collections - Last column in DM budget will be the same as the total first-quarter/month purchases Cost flow specific to DM: RM needed for production + Desired EI -----------------------------------Total Needs — BI -----------------------------------How much to buy Direct labor budget – includes required dl hours per unit of production, cost of dl hours - Some companies have minimum wage policies—keep this in mind (if there’s a minimum wage, compare the number of hours worked to hours required) Manufacturing overhead budget – all costs of production other than DL/DM - Subtract depreciation to find cash disbursements - Variable & fixed MOH (fixed costs tend to be the costs of supplying capacity to make operations happen; can be adjusted during budgeting) - Includes POHR on schedule below disbursements Ending FG inventory budget – includes unit product cost and $ value of ending inventory - Unit product cost helpful to determine COGS later on SG&A budget – variable + fixed SG&A expenses - remember to subtract depreciation from total SG&A expenses to get cash disbursements for SG&A Cash budget – four major sections 1. Receipts – all cash inflows (except from financing)

2. Disbursements – all cash outflows (dm/dl/moh payments, equipment purchases, dividends) 3. Cash excess/deficiency (= receipts – disbursements) o If deficiency: must borrow money to meet minimum requirement for cash on hand o If excess: invest the excess funds, or repay principal and interest 4. Financing – details all borrowings/principal/interest repayments projected to take place during budget period o Borrowings should = repayments at the end, if possible o Pay attention to bank’s loan terms; sometimes they’ll require you to borrow in certain kinds of increments (e.g. increments of $10,000) o Assume company will repay loan + interest on last day of final period, as far as it is able to Desired ending cash balance + Deficiency of cash available = Minimum required borrowings (then adjust for bank stipulations)

Budgeted income statement - Sales budget  Sales - Ending FG Inventory  COGS - SG&A  SG&A expenses - Cash budget  operating income

Chapter 9: Flexible Budgets & Performance Analysis - How to adjust budgets to ensure meaningful comparisons between actual results Variance – difference between actual & expected (budgeted) Variance Analysis Cycle – used to evaluate & improve performance. 1. Prepare performance report, highlighting good and bad variances 2. Analyze variances 3. Raise questions – why did the variance occur? 4. Identify root causes 5. Take actions – eliminate or replicate root causes, depending on if the variance was good or bad 6. Conduct next period’s operations, & repeat Management by exception – management system that focuses on most important variances and puts less emphasis on more trivial variances. - Compares actual results to budget - Significant deviations flagged as exceptions and further looked into - Pay attention to unusually large variances or a pattern of variances (Ex. Steadily mounting variances) Planning budget – prepared before period begins, only valid for the planned (budgeted) level of activity - Static - Best suited for planning, not good for evaluation of cost control - Comparing actual results to a planned budget when the two data sets show different levels of activity is like comparing apples & oranges. - “How much of the cost variances are due to higher activity and how much are due to cost control?” - This is where the flexible budget comes in: Flexible budget – estimates what revenues & costs should have been based on actual level of activity - Good for evaluating actual results - Keep in mind that even though fixed costs don’t vary with activity, they can still differ from whatever you estimated them to be *Both planning and flexible budgets are hypothetical, although planning tends to be further off from the actual results because it often accounts for a different level of activity *Keep in mind that sometimes unfavorable variances don’t necessarily indicate bad performance and vice versa. Sometimes a variance will be a necessary cost of serving more customers, and thus may be “unfavorable” but not because the company performed poorly Activity Variances – difference between actual level of activity and level in planning budget

*Keep in mind that fixed costs will probably not increase with increased activity; so if sales were to increase 10%, these costs would not increase. As a result, net income would increase by more than 10%. In other words, existence of fixed costs  income doesn’t change in proportion to changes in activity level Flex < Planning revenue: U Flex > Planning revenue: F Flex < Planning costs: F Flex > Planning costs: U Revenue Variances – difference between actual total revenue and flex budget revenue (what total revenue should have been) Actual < Expected: U Actual > Expected: F Spending Variances – difference between actual total costs and flex budget costs (what total costs should have been) Actual < Expected: F Actual > Expected: U Performance Reports in Nonprofits - Basically the same for regular companies, but may have significant funding outside “sales” Performance Reports in Cost Centers Cost Center – organizations or departments with costs but not outside revenues - No revenue or income reported Flexible Budgets with Multiple Cost Drivers - More cost drivers = more accurate cost formulas = more accurate variances - Example: cost formula for wages & salaries more accurate if stated in terms of a second cost driver (hours of operation), instead of the original cost driver (client-visits) - Another example: cost formula for electricity more accurate if in terms of both clientvisits and hours of operation rather than just client-visits Common Errors - Assuming all costs are fixed: e.g. Comparing planning budget costs to actual costs without adjusting for actual activity (Here, you’re mistakenly assuming costs don’t vary with activity at all, which is false. This strategy only makes sense if a cost is fixed) - Assuming all costs are variable: some costs are fixed (e.g. rent), so if your activity is 10% more than expected, you can’t just inflate the fixed costs by 10% more.

Chapter 10 – Standard Costs & Variances Standards – benchmark for performance Quantity standard – how much should be used Price standard – how much should be paid Direct Materials Standards Standard quantity/unit – materials/unit of product  Allowances for spoilage/scrappage Standard price/unit – price of materials/unit of product  Reflects final + delivery costs Standard DM cost/unit = SQ/unit * SP/unit Direct Labor Standards Standard hours/unit – direct labor hours/unit  Includes allowances for breaks, personal needs, cleanup, downtime Standard rate/hour – expected dl/hr rate ($/hr)  Includes fringe benefits, employment taxes  Reflects mix of workers Standard DL/unit = standard dl hrs/unit * standard rate/hr Variable Manufacturing Overhead Standards Standard hrs/unit – amount of allocation base to make 1 unit (often in dl hrs) Standard rate/unit – variable portion of POHR Standard VMOH/unit = SH/unit * SR/unit Standard Cost Card – shows standard quantity (hours) and standard price (rate) of inputs needed to make one unit (what’s needed to make one unit) Can split spending variances into price & quantity Price variance – difference between actual paid & standard paid, x actual purchased Quantity variance – difference between actual used and standard used; stated in $ using standard price Why two categories?  Price & quantity variances may have different causes  Different managers buy & use inputs Notes  Price & quantity variances can be calculated for DL, DM, & VMOH but have different names sometimes  Based on actual output

DM Variance Formulas Materials Price Variance (MPV) = AQ (AP-SP) Materials Quantity Variance (MQV) = SP (AQ-SQ allowed) SQ allowed = actual produced units * materials/unit

DL Variance Formulas Labor Rate Variance (LRV) = AH (AR-SR) Labor Hours Variance (LHV) = SR (AH-SH allowed) SH allowed = actual produced units * hours/unit

VMOH Variance Formulas Labor Rate Variance (LRV) = AH (AR-SR) Labor Hours Variance (LHV) = SR (AH-SH allowed) SH allowed = actual produced units * hours/unit

How to know if it’s favorable or unfavorable: If actual > standard: U If actual < standard: F

Chapter 10A: POHR & Overhead Analysis in a Standard Costing System Predetermined overhead rate = budgeted MOH / budgeted allocation base* *or denominator activity (which is the same whether it’s total, variable, or fixed POHR)  POHR can be broken down into...