Managerial Accounting

1
Managerial Accounting

• Part 4 Cost Concepts and Analysis

2
Managerial Accounting

• Designed primarily for internal users
• Like who?
• Use information to assess current performance and
  to plan strategically
• what if scenario analysis

3
From Financial Accounting - Profitability Based
on I/S

• Net Sales
• less Cost of Goods Sold
• Gross Margin
• less Operating Expenses
• Income from Operations
• add/subtract Interest Income/Expense
• Income Before Taxes
• less Taxes
• Net Income

4
Relation to Income Stmt

• Sales
• Cost of Goods Sold (DM, DL, OH)
• Gross Profit
• Selling and Administrative (Non-manuf.)
• Net Income

5
Managerial view of cost

• Our initial focus is on Current Costs - the
  dollar value of what is given up to engage in
  economic activity. Current Costs are basically
  equivalent to all of the costs that make up the
  income statement.

6
Product vs. Period Costs

• Current Costs can be segregated into 2 types
• Product Costs
• Costs that attach to a product
• Direct Materials, Direct Labor, Overhead (an
  allocated cost)
• Stay with product until sold
• Period Costs
• Non-Manufacturing (e.g. admin)
• Expensed in period incurred
• Generally selling and administrative

7
Managerial view of cost

• Other Costs that you might have heard of
• Opportunity Costs Cost of the second best
  alternative, i.e. the true cost of something is
  what you give up to get it.
• Sunk Costs osts that have been incurred and can
  not be recovered, these costs are irrelevant when
  making decisions about the future.
• Ex. Should the fact that you have spent x on
  advertising affect whether you keep a product on
  the market?

8
Examination of cost from an Internal perspective

• Focus is not on the function (i.e. payee) any
  longer - rather on cost variability (how the cost
  behaves).
• Some costs vary with volume/sales
• Others costs are fixed over time
• Assumption - We are in a single period world

9
Examination of cost from an Internal perspective

• Examples?
• Variable Costs Fixed Costs

10
Nature of Costs

• Total Costs

Variable Costs

Fixed
VOLUME
11
Examination of cost from an Internal perspective

• Are costs only variable or fixed in a single
  period world?
• What else is there?
• Step costs cost is fixed upto a certain level
  of production or usage i.e. assume a supervisor
  is needed for every 10 line workers
• Joint costs part fixed / part variable
• ex. Sales staff base salary plus commission

12
Examination of cost from an Internal perspective

• Are costs only variable or fixed in a
  Multi-period world?
• In a multi-period are all costs variable? At
  least in the long-run

13
Cost Profit Equations

• Cost Equation
• Total Cost F ( Volume x VC)
• Where F Fixed Costs VC Var Cost per
  unit
• Profit Formula
• Revenues (F (Volume x VC))

14
Presentation AlternativeContribution Income
Statement

• Sales
• less Variable Costs
• Contribution Margin
• less Fixed Costs
• Net Income
• Note Financial Acct I/S Functional format
• Managerial Acct I/S Behavioral format
• Same Net Income, just different presentation

15
Contribution Margin

• Difference between
• Sales Unit Price - Variable Unit Cost
• 15 - 12 3 contribution margin
• Can be computed based as a
• Sales 1,000,000
• -Var Costs 800,000
• Contribution Margin 200,000 or 20
• Which makes Variable Cost Margin (1 20 80)

16
Using Contribution Margin

• As volume/sales grows, the contribution margin
  grows to cover fixed costs with excess as profit
• Useful to determine how profitable we might be.
• Current What If Sales 1,200,000?
• Sales 1,000,000 Sales 1,200,000
• Var Cost 800,000 Var Costs ????
• Cont. Mar 200,000 Cont Margin? (20 x 1.2m)
• Fixed Cost 150,000 Fixed Costs 150,000
• Net Income 50,000 Net Income ????

17
Breakeven Point Analysis

• Volume or Sales where profits 0
• Computed based on contribution margin
• Fixed Costs____ Sales Required
• Contribution Margin

Then Divide by Sales Unit Price to determine
volume needed to break even.
18
Cost/Volume/Profit Graphs
Revenues/Costs
Revenues
Profits
TOTAL COSTS (Variable Fixed)
Losses
Volume
Breakeven Pt
19
Can Use for Profit Analysis

• Determine Desired Profits
• Add to Fixed Costs
• Fixed Costs Desired Profit Sales Required
• Contribution Margin

20
Cost Volume Profit Analysis

• CVP Analysis relies on an ability to identify
  variable and fixed costs and then recasting the
  income statement as
• Revenues
• -Variable Costs
• Contribution Margin
• -Fixed Costs
• Profit

21
CVP Analysis

• Example analysis with Corner Lunch Counter and
  Sweet Grove Citrus

22
Other uses of Cost information

• Performance Measurement - Budgeted vs. Actual
• Product Mix - which product mix produces most
  profit.
• Pricing - Cost plus pricing
• Cost of services - what is the cost of add-ons

23
Using External F/S to Determine Cost Structures

• Change in Oper. Expenses Est. Var. Cost
  Margin Ratio
• Change in Revenues
• Estimate of Fixed Costs
• Operating Expenses (Revenues x Est. Var. Cost
  Margin Ratio)
• Use to Determine Break Even in Sales
• Fixed Costs Sales Needed
• (1 Var Cost Ratio)

24
Operating Leverage

• Represents extent that operating costs are fixed.
• High Fixed Costs High Operating Leverage
• Measure of Risk and Opportunity
• Computed as follows
• Contribution Margin
• Before Tax Profits in
• The more Fixed Costs are substituted for Variable
  Costs, the higher the contribution margin
• Strategy When high fixed costs, increases in
  sales generate larger returns (and vice versa as
  sales decrease.the Risk increases due to fixed
  costs)

25
Cost Structure and Operating Leverage
26
Related Contribution Margin Assumptions

• All costs either fixed or variable
• Fixed costs are fixed over relevant range
• Revenues and variable costs functions are linear
  over relevant range (sales price is fixed)
• Unit or volume is only driver

Relevant Range
Volume
27
Using Regression analysis to determine
variable/fixed mix

• Regression analysis is used to determine the
  fixed component and variable component of most
  costs.
• Let the costs be the dependent variables
• Let the output/volume be the independent
  variables
• The intercept will be the fixed component
• The slope will be the variable component

28
Prestige Data - Power/Hours
29
Prestige Data - Power/Hours
30
Next step for cost analysis

• Classifying costs as direct or indirect.
• What is a direct cost?
• What is an indirect cost?
• Indirect costs are the problem area
• How to allocate to products, costs centers, cost
  pools, etc.