Professional Documents
Culture Documents
Fourth Edition, Prentice Hall. Alnoor Bihimani Charles T. Horngren Srikant M. Datar George Foster
Inhaltsverzeichnis
Chapter 1: The accountants in the organization ................................................................ 4
Accounting, costing and strategy ................................................................................................................................ 4 Cost management and accounting systems ........................................................................................................... 5 Accounting systems and management controls ................................................................................................... 5 Forces of change in management accounting ....................................................................................................... 7 Professional ethics............................................................................................................................................................ 7
Chapter 12: Pricing, target costing and customer profitability analysis ............................. 45
Major influences on pricing ........................................................................................................................................ 45 Costing and pricing for the short run ..................................................................................................................... 46 Costing and pricing for the long run ....................................................................................................................... 46 Target costing for target pricing ............................................................................................................................... 46
Cost-plus pricing.............................................................................................................................................................. 47 Life-cycle product budgeting and costing ............................................................................................................. 48 Customer-profitability analysis ................................................................................................................................ 49 Customer revenues ........................................................................................................................................................ 49 Customer costs ................................................................................................................................................................. 49 Assessing customer value ............................................................................................................................................ 50
Chapter 15: Flexible budgets, variances and management control (I) ............................... 55
Static budgets and flexible budgets ......................................................................................................................... 55 Static-budget variance .................................................................................................................................................. 55 Steps in developing a flexible budget ..................................................................................................................... 56 Flexible budget variances and sales-volume variances .................................................................................. 56 Price variances and efficiency variances for inputs.......................................................................................... 56 Management uses of variance.................................................................................................................................... 57 Benchmarking .................................................................................................................................................................. 58
Organisation structure and decentralisation ...................................................................................................... 68 Choices about responsibility centres ...................................................................................................................... 69 Transfer pricing ............................................................................................................................................................... 69 Market-based transfer prices ..................................................................................................................................... 70 Cost-based transfer prices........................................................................................................................................... 70 Negotiated transfer prices........................................................................................................................................... 71 A general guideline for transfer-pricing decisions............................................................................................ 71 Transfer pricing and tax considerations ............................................................................................................... 71
Financial accounting focuses on external reporting that is directed by authoritative guidelines Organisation are required to follow these guidelines in their financial reports to outside parties. Cost accounting measures and reports financial and non-financial information related to the organisations acquisition or consumption of resources. It provide s information for both management accounting and financial accounting. Differences between financial and management accounting: Management accounting usually for internal purposes, whereas financial accounting has to comply with regulations for external purposes. Management acc very detailed, financial acc broad based, providing an overview of the position and performance of an organization over a time period. Management acc reports are produced continuously, whereas financial acc only for specific time periods. Management acc reports may contain historical, current and expected future information, however financial acc only contains the information for a specific past period.
Planning: choosing goals, predicting results under various ways of achieving those goals, and the deciding how to attain the desired goals. 5
Budget is the quantitative expression of a plan of action and an aid to the coordination and implementation of the plan. Control covers both the action that implements the planning decision and deciding on performance evaluation and the related feedback. Management by exception is the proactive of concentrating on areas not operating as expected and placing less attention on areas operating as expected. Variance refers to the difference between the actual results and the budgeted amounts. Management Decisions Management accounting systems Planning: increase Budgets: expected advertising rates advertising pages sold, rates per page and revenue Control: Accounting systems: Source Action-implement a increase documents (invoices and in advertising rates payments received), Performance evaluationrecoding in general and advertising revenues actually subsidiary ledgers lower than budgeted Performance reports: actual Feedback to planning advertising pages sold, average rate per page and revenue
Financial representation of plans Recording transactions and classifying them in accounting records
Scorekeeping refers to the accumulation of data and the reporting of reliable results to all levels of management (for example recording of sales, purchases of materials, and payroll payments). Attention directing attempts to make visible both opportunities and problems on which managers need to focus. Problem solving refers to the comparative analysis undertaken to identify the best alternatives in relation to the organisations goals. Key themes in management decision-making: 1. Customer focus 2. Value chain and supply chain analysis Research and development Design of products, services or processes Production Marketing Distribution Customer service 3. Key success factors Cost Quality Time Innovation 6
4. Continuous improvement
Professional ethics
Summary of CIMAs ethical guidelines 1. Integrity: Straightforward and honest 2. Objectivity 3. Professional competence and due care: Continuing duty to maintain professional knowledge and skill; should act in accordance with technical and professional standards 4. Confidentiality 5. Professional behaviour Typical ethical challenges 1. Proposals by clients or managers for tax evasion 2. Conflicts of interest 3. Proposals to manipulate financial statements 4. Integrity in admitting mistakes made by oneself 5. Coping with superiors instructions to carry out unethical acts
Managers assign costs to designated cost objects to help decision-making. An accounting system typically accumulates cots by some classification such as material, labour, fuel, advertising or shipping and then assigns these costs to cost objects in order to help in decision-making.
Relevant range is the range of the cost driver in which a specific relationship between cost and the level of activity or volume is valid. A fixed cost is fixed only in relation to a given relevant range (usually wide) of the cost driver and a given time span (usually a particular budget period).
Service-sector companies
provide services or intangible products to their customers (for example legal advice or audit). These companies typically have any stock or tangible product at the end of an accounting period. Labour costs are typically the most significant cost category. The operating-cost line items for service companies will include costs from all areas of the value chain, and no item for costs of goods sold.
Stock-related cots (inventoriable costs) are those costs associated with the purchase of goods for resale or costs associated with the acquisition and conversion of materials and all other manufacturing inputs in to goods fro sale. Inventoriable costs become part of cost of goods sold in the period in which the stock item is sold. Operating cost are all costs associated with generating revenues, other than cost of goods sold. Direct materials stock: Direct materials in stock and awaiting use in the manufacturing process. Work in progress stock: Goods partially worked on but not yet fully completed. Finished goods stock: goods fully completed but not yet sold. Direct material costs are the acquisition costs of all materials that eventually become a part of the cost object and that can be traced to the cost object in an economically feasible way. (for example inward delivery charges, sales taxes and customs duties). Direct manufacturing labour costs include the compensation of all manufacturing labour that is specifically identified with the cost object and that can be traced to the cost object in an economically feasible way. (For example wages, fringe benefits paid to assembly line workers). Indirect manufacturing costs (manufacturing overhead costs, factory overhead costs) are all manufacturing costs considered to be part of the cost object, but that cannot be individually traced to that cost object in an economically feasible way. (For example: indirect manufacturing labour, plant rent, plant insurance, property taxes, plant depreciation). Prime costs are all direct manufacturing costs (direct materials, direct manufacturing labour) Conversion costs are all manufacturing costs other than direct materials costs. Cost of goods sold = opening finished goods stock + cost of goods manufactured closing finished goods stock
Classification of costs
1. Business function: 10
2. 3. 4. 5.
a. Research and development b. Design of products, services and processes c. Production d. Marketing e. Distribution f. Customer service Assignment to a cost object a. Direct costs b. Indirect costs Behaviour pattern in relation to changes in the level of a cost driver a. Variable costs b. Fixed costs Aggregate or average a. Total costs b. Unit costs Assets or expenses a. Inventoriable costs b. Period costs
input(s) and allocates indirect costs based on the actual indirect-cost rate(s) times the actual quantity of the cost-allocation base. General approach to job costing (applicable to all sectors): Step 1: Identify the job that is the chosen cost object. Step 2: Identify the direct costs for the job. Direct costs=actual direct-cost rate x the actual quantity of the direct-cost input. Step 3: Identify the indirect-cost pools associated with the job. The actual indirect-cost rate can often only be calculated on an actual basis at the end of the year. Step 4: Select the cost-allocation base to use in allocating each indirect-cost pool to the job. Step 5: Develop the rate per unit of the cost-allocation base used to allocate indirect costs to the job. Actual indirect-cost rate = (actual total costs in indirect-cost pool, step 3) / (actual total quantity of cost-allocation base, step 4) Step 6: Assign the costs to the cost object by adding all direct costs and all indirect costs. Source documents: Managers and accountants gather the information that goes into their cost systems through source documents, which are the original record that support journal entries in an accounting system (for example time records for the labour costs).
Normal costing
The difficulty of calculating actual indirect-costs for each job means that the company has to wait until the end of the year. In order to derive with a job costing more timely to the job, normal costing is used. Normal costing: This method traces direct costs to a cost object by using the actual direct-cots rate(s) times the actual quantity of the direct-cost input (as in actual costing method) and allocates indirect costs based on the budgeted indirect-cost rate(s) times the actual quantity of the cost-allocation base(s). Budgeted indirect-cost rate = budgeted total costs in indirect-cost pool / budgeted total quantity of cost-allocation base
General ledger and subsidiary ledgers (needs more research in depth) A job-costing system has a separate job cost record for each job. This record is typically found in a subsidiary ledger. The general ledger combines these separate job cost records in the work-n-progress control account, which pertains to all jobs undertaken. General ledger accounts with the word control in their titles are supported by underlying subsidiary ledgers. Manufacturing overhead allocated: this is the record of manufacturing overhead allocated to individual jobs on the basis of the budgeted rate multiplied by actual units used of the allocation base. It comprises all manufacturing costs that are assigned to a product or service using a cost-allocation base, because they cannot be traced to it in an economically feasible way. The transactions in a job-costing system in manufacturing track (a) the acquisition of materials and other manufacturing inputs, (b) their conversion into work in progress, (c) their eventual conversion into finished goods, and (d) the sale of finished goods. Each of the stages in the manufacture/sale cycle can be represented by journal entries in the costing system.
Proration approach Is the term we use to refer to spreading of under- or overallocated overhead among closing stocks and cost of goods sold. Method 1 Proration is based on the total amount of indirect costs allocated (before proration) in the closing balances. (Percentage of individual item of indirect costs allocated of total amount of indirect costs allocated) Method 2 Proration is based on the total closing balances (before proration). (Percentage individual item in closing balance of total closing balance) Method 3 Proration is based on year-end write-off to cost of goods sold. Here the total under- or overallocated overhead is included in this years cost of goods sold. Choice among methods Choice among the approaches should be guided by how the resultant information is to be used. Allocation method: If managers wish the most accurate record of individual job costs for profitability analysis purposes, the adjusted allocation rate approach is preferred. Proration Method 1: If the purpose is confined to reporting the most accurate stock and cost of goods sold figures. Gives the same ending balances as allocation method. Proration Method 2: Approximation of method 1. Proration method 3: Simplest with similar results as the other methods.
Total assembly costs *=cost categories Assembly cost per unit Direct material costs per unit Conversion costs per unit Assembly cost per unit 32 000 / 400 = 80 24 000 / 400 = 60 56 000 / 400 = 140
56 000 euro
Case 2: Process costing with no opening but a closing work in progress stock
In this case some units are not yet completed and are assigned the name work in progress, closing stock. As they are only partially assembled, the costs are not the same as of a fully completed and transferred out unit. Therefore only a certain percentage of the costs not added at the beginning of the process are included in the cost calculations of the work in progress stock. This percentage has to be determined by the people in charge of the process. In order to calculate the cost of fully assembled units and of partially completed units the following steps are necessary: 1. 2. 3. 4. 5. Step 1: Summarise the flow of physical units of output Step 2: Compute output in terms of equivalent units Step 3: compute equivalent unit costs Step 4: Summarise total costs to account for Step 5: Assign total costs to units completed and to units in closing work in progress.
Equivalent units is derived amount of output units that takes the quantity of each input (factor of production) in units completed or in work in progress, and converts it into the amount of completed output units that could be made with that quantity of input. Physical units for accounting period Work in progress, opening stock beginning of accounting period Started during acc period Completed and transferred out during acc period Work in progress, closing stick end of period Total costs for accounting period Direct material costs added during acc period * Conversion costs added during acc period * Total assembly costs 32 000 euro 18 600 euro 50 600 euro 0 units 400 units 175 units 225units
Step 1 and 2 (in this example conversion costs are not fully assembled) Flow of production Physical units Equivalent units (step 2) (step 1) Direct Materials Conversion costs Work in progress, opening 0 15
Started during acc period 400 To account for 400 Completed and transferred out 175 175 175 Work in progress, closing* 225 225 (225x100%) 135 (225x60%) Accounted for 400 Worked done in current period 400 310 only *Degree of completion in this department: direct materials 100%, conversion costs 60% Step 3, 4 and 5 (called production cost worksheet) Total production costs Step 3 Costs added during acc period 50 600 Divide by equivalent units of work done in current period Cost per equivalent unit Step 4 Total costs to account for 50 600 Step 5 Assignment of costs: Completed and transferred out 24 500 (175 x 80 (175 units) +175 x 60) Work in progress, closing (225 units): Direct materials 18 000 (225 x 80) Conversion costs 8100 (135 x 60) Total work in progress 26 100 Total costs accounted for 50 600 Journal entries Needs further study T-account records as in job-costing systems: Received (debits) Balance: Issues (credits) Direct materials 32 000 /400 80 Conversion costs 18 600 /310 60
Case 3: process costing with both some opening and some closing work in progress stock
Physical units for accounting period Work in progress, opening stock beginning of accounting period Started during acc period Completed and transferred out during acc period Work in progress, closing stick end of period Total costs for accounting period Work in progress, opening stock Direct materials (225 x 80) 16 18 000 225 units 275 units 400 units 100 units
Conversion costs (135 x 60) 8 100 Direct material costs added during acc period * 19 800 euro Conversion costs added during acc period * 16 380 euro Total assembly costs 62 280 euro We will use now the Five-step approach again with two alternative stock cost flow methods: Alternative 1: Weighted average method Weighted average process costing method calculates the equivalent unit cost of the work done to date and assigns this cost to equivalent units completed and transferred out of the process and to equivalent units in closing work in progress stock. The weighted average cost is the total of all costs entering the work in progress account divided by total equivalent units of work done to date. Step 1 and 2: Flow of production Step 1 Physical units Equivalent units (Step 2) Direct Conversion materials costs
Work in progress, opening 225 Started during current period 275 To account for 500 Completed and transferred out 400 400 400 Work in progress, closing* 100 100 x 100%, 100 x 50% 100 50 Accounted for 500 Work done to date 500 450 *Degree of completion in this department: direct materials 100%, conversion costs 50% Step 3,4 and 5: Total production Direct costs materials Work in progress, opening 26 100 18 000 COST ADDED IN CURRENT 36 180 19 800 PERIOD Cost incurred to date 37 800 Divide by equivalent units of /500 work done to date Cost per equivalent unit 75.60 Total cost to account for 62 280 Assignment of costs: Completed and transferred out 52 000 (400 x 75.60 + 400 x 54.40) Work in progress, closing: Direct materials 7 560 (100 x 75.60) Conversion costs 2 720 (50 x 54.40) Total work in progress 10 280 Conversion costs 8 100 16 380 24 480 /450 54.40
Step 3
Step 4 Step 5
17
62 280
Alternative 2: First-in, first-out method FIFO process costing method assigns the cost of the previous periods equivalent units in opening work in progress stock to the first units completed and transferred out of the process, and assigns the cost of equivalent units worked on during the current period first to complete beginning stock, then to start and complete new units, and finally to units in closing work in progress stock. Again the 5-step model will be applied for the FIFO method: Step 1 and 2: Flow of production Work in progress, opening Step 1 Physical units 225 Step 2: Equivalent units Direct Conversion materials costs Work done before current period
Started during current period 275 To account for 500 Completed and transferred: From opening work in progress* 225 225 x (100% - 100%), 225 x (100% 0 90 60%) Started and completed 175 175 x 100%, 175 x 100% 175 175 Work in progress, closing:** 100 100 x 100%, 100 x 50% 100 50 Accounted for 500 Work done in current period only 275 315 *Degree of completion in this department: direct material 100%, conversion costs 60% ** Degree of completion in this department: direct materials 100%, conversion costs 50% 400 units are completed in total (see case 3 description), among them are 225 units from opening work in progress, and 175 from started units during current period. 100 units of the 275 units started during the current period are closing work in progress. Step 3, 4 and 5: Total prod- Direct Conversion uction costs materials costs Work in progress, opening 26 100 Costs of work done before current period Costs added in current period 36 180 19 800 16 380 Divide by equivalent units of work done /275 /315 in current period Costs per equivalent unit of work done 72 52 Total costs to account for 62 280 Assignment of costs: 18
Step 3
Step 4 Step 5
Completed and transferred out (400): Work in progress, opening (225) Direct materials added in current period Conversion costs added Total from opening stock Started and completed (175)
0 x 72 90 x 52 175 x 72 175 52 x
Total costs of units completed and 52 480 transferred Work in progress, closing (100): Direct materials 7 200 Conversion costs 2 600 Total work in progress, closing 9 800 Total costs accounted for 62 280
100 x 72 50 x 52
Comparison weighted average and FIFO methods Cost of units completed and hence operating income can differ materially between the two methods when (1) the direct materials or conversion costs per unit vary significantly from period to period and (2) the physical stock levels of work in progress are large in relation to the total number of units transferred out of the process. Thus, as companies move towards longer-term procurement contracts that reduce differences in unit costs from period to period, and reduce stock levels, the difference in costs of units completed under both methods will decrease. The major advantage of FIFO is that it provides managers with information about changes in costs per unit from one period to the next. The major advantages of the weighted-average method however are its computational simplicity and its reporting of a more representative average unit cost when input prices fluctuate markedly form month to month.
Work in progress, opening stock beginning of accounting period Started during acc period Completed and transferred out during acc period Work in progress, closing stick end of period Total costs for accounting period 19
Work in progress, opening stock Direct materials (225 x 74) 16 650 Conversion costs (135 x 54) 7 290 Total costs opening stock 23 940 Actual Direct material costs added during acc period * 19 800 euro Actual Conversion costs added during acc period * 16 380 euro We will use now the Five-step approach again for the standard costing method: Step 1 and 2: Flow of production Work in progress, opening Step 1 Physical units 225 Step 2: Equivalent units Direct Conversion materials costs Work done before current period
Started during current period 275 To account for 500 Completed and transferred: From opening work in progress* 225 225 x (100% - 100%), 225 x (100% 0 90 60%) Started and completed 175 175 x 100%, 175 x 100% 175 175 Work in progress, closing:** 100 100 x 100%, 100 x 50% 100 50 Accounted for 500 Work done in current period only 275 315 *Degree of completion in this department: direct material 100%, conversion costs 60% ** degree of completion in this department: direct materials 100%, conversion costs 50% Step 3, 4 and 5 Total prod- Direct uction costs materials 74 Conversion costs 54
Step 3
Step 4 Step 5
Work in progress, opening 23 940 Costs added in current period at 37 360 standard costs Costs to account for 61 300 Assignment of costs at standard costs: Completed and transferred out (400) Work in progress, opening (225) Direct materials added Conversion costs added 20
23 940 0 4 860
0 x 74 90 x 54
Total from opening stock Started and completed (175) Total costs of units transferred out Work in progress, closing (100) Direct materials Conversion costs Total work in progress, closing Total costs accounted for Summary of variance for current performance Costs added in current period at standard prices Actual costs incurred Variance
175 x 74
175 x 54
100 x 74 50 x 54
Accounting for variances Variance arise under standard costing method because the standard costs assigned to products on the basis of work done in current period do not equal the actual costs incurred in the current period. Process costing systems using standard costs usually accumulate actual costs incurred separately from the stock accounts with separate entries for the variances. The final entry transfers out the completed goods are at standard costs. Direct materials and conversion costs control entries are recorded at actual costs. Work in progress at standard costs, recording the variances in separate variance entries.
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Cost objects can be products, distribution channels, customers, and research projects. A costing system can be designed so that they include more than one cost object. This simplifies and helps achieving the above-mentioned purposes of different cost allocation.
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Single-rate and dual-rate methods Single rate cost allocation method pools all costs in one cost pool and allocates them to cost object using the same rate per unit of the single allocation base. There is no distinction between costs in the cost pool in terms of cost variability (such as fixed or variable costs). With this method fixed costs are transformed into variable costs, by adding it to the variable cost and then dividing the total by the allocation base. Dual rate cost allocation method first classifies costs in one cost pool into two subpools (typically into a variable-cost subpool and a fixed-cost subpool). Each subpool has a different allocation rate or a different allocation base. One benefit of using the single rate method is the low cost of implementation. It avoids the expensive analysis to classify the individual cost items into fixed and variable categories. However, a single rate method may lead division to take action that appear to be in their own best interest but are not in the best interest of the organisation as a whole (for example a supplier or outsourcer could be cheaper for one department, but not cheaper when seeing the whole company). The dual rate method on the other hand would show the effect of decisions for the department and for the company as a whole. Budgeted versus actual rates User departments prefer generally budgeted rates because then they dont face uncertainty in costs and planning and they dont face extra costs at the end of the period. Budgeted rates also help to motivate the support department to be efficient. As the costs at the end of the period can be substantially higher, some companies divide them among the user and support department. Budgeted versus actual usage allocation base The choice between actual usage and budgeted usage for allocating department fixed costs also can affect a managers behaviour. When budgeted usage is the allocation base, user division will know their allocated costs in advance. This information helps the user divisions with both short-run and long run planning. Organisations commit to infrastructure costs on the basis of long-range planning. Some organisations offer rewards to managers who make accurate forecasts in the long-range usage (carrot approach). Alternatively some organisations impose cost penalties for underpredicting long-range usage (stick approach).
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Support department cost-allocation methods Direct allocation method Direct allocation method (direct method) is for its simplicity the most widely used method of allocating support department costs. This method allocates each support departments costs directly to the operating departments, ignoring the other support departments it may support as well. The allocation base is the budgeted usage of all the operating departments together. You then divide the usage of a specific operating department by the total usage of all operating departments in order to get the percentage of costs of the support department allocated to the specific operating department. Step down allocation method Step down allocation method (also step allocation method or sequential allocation method) allows for partial recognition of the services rendered by support departments to other support departments. This method requires the support departments to be ranked in the order, which the step-down allocation is to proceed. The costs in the firstranked support department are allocated to the other support departments and to the operating departments. The costs in the second-ranked department are allocated to those support departments not yet allocated and to the operating departments. This procedure is followed until the costs in the last-ranked support department have been allocated. Once a support departments costs have been allocated, no subsequent support department costs are allocated back to it. This method results in the highest costs for the operating departments and is therefore good for cost reimbursement. Two ways determine the ranking: A) Rank support departments on the percentage of the support departments total support provided to other support departments. The support department with the highest percentage is allocated first. B) Rank support departments on the total Euros of service provided to other support departments. The support department with the highest amount is allocated first. Reciprocal allocation method Reciprocal allocation method allocates costs by explicitly including the mutual services provided among all support departments. This method enables us to incorporate interdepartmental relationships fully into the support department costs allocations. This method is seldom used because its hard to understand and the figures derived differ little from the two other methods. 1 Step) Express support department costs and reciprocal relationships in linear equation form. This is called the complete reciprocated cost. This means the actual costs incurred by a support department plus a part of the costs of the other support departments that provide service to it. This complete costs figure is called the artificial costs of the support departments. Its always larger than the actual costs. 2 Step) Solve the set of simultaneous equations to obtain the complete reciprocated costs of each support department. With two departments substitution can be used, more than two departments require a matrix.
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3 Step) Allocate the complete reciprocated costs of each support department to all other departments on the basis of the usage proportions.
leads to a preference for methods under approach 1. Revenues are a better indictor of benefits received than are physical measure such as weight or volume. In the following two scenarios are taken in order to explain the different methods: Example 1: the joint products are sold at the split-off point without further processing Sales value at split-off method 1. Determine sales value at split-off point of each product 2. Assign weighting to each product, which is a percentage of total sales 3. Allocate joint costs to the individual product: weighting x total costs 4. Determine joint production costs per unit: joint costs allocated/units produced Exhibit 6.4 and 6.5 on page 175 shows the joint cost allocation and the income statement The sales value at split-off point is less complex than the estimated NRV, however it is not always feasible to use the sales value at split-off method, because there may not be any market prices at split-off point. Physical measure method 1. Determine physical measure of production 2. Assign weighting to each product, which is the production in units of total production 3. Allocate joint costs to the individual product: weighting x total costs 4. Determine joint production cost per unit: joint costs allocated/total production in units Exhibit 6.6 and 6.7 show the allocation of joint costs and the income statement. This method however is less preferred, as it may have blown up profits for one product and extremely small profits for another products as an outcome in the income statement. Furthermore obtaining comparable physical measures for all products is not always straightforward. Example 2: the joint products are further processed after the split-off point. Estimated net realisable value method Estimated net realisable value: expected final sales value in the ordinary course of business minus the expected separable costs of production and marketing of the total production of the period. 1. Determine expected final sales value of production and individual products 2. Deduct expected separable costs to complete and sell from each individual product 3. Determine estimated NRV at split-off point: expected final sales value separable costs 4. Assign weighting: estimated NRV of each individual/total NRV 5. Allocate joint costs: weighting x joint costs 6. Determine production costs per unit: (separable costs + allocated joint costs) / units produced Constant gross-margin percentage NRV method 1. Calculate the overall gross-margin percentage 27
2. Use the overall gross-margin percentage and deduct the gross margin from the final sales values to obtain the total costs that each product should bear 3. Deduct the expected separable costs from the total costs to obtain the join-cost allocation. Some products may receive negative allocations of joint costs to bring their grossmargin percentages up to the overall company average. Main advantage of this method is that it is easy to implement. However this method is rarely seen, because no individual profit margins are determined. Exhibit 6.11 and 6.12 show the detailed calculations and the income statement. Comparison of methods The benefits-received criterion leads to a preference for the sales value at split-off point method (or other related revenue or market-based methods). Additional benefits of this method include: 1. No anticipation of subsequent steps 2. Availability of a meaningful common denominator to calculate the weighing factors (currency of sales value) 3. Simplicity. In contrast the estimated NRV method can be very complex in operations with multiple products and multiple split-off points.
C D
Sale Sale
Exhibit 6.17 shows the income statement for each individual method.
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Two alternative formulae can be used if we assume that all manufacturing variances are written off as period costs, that no change occurs in working-progress stock and that no change occurs in the budgeted fixed manufacturing overhead rate between accounting periods: Formula 2: (absorption-costing operation income) (variable-costing operating income) = (units produced units sold) x (Budgeted fixed manufacturing cost rate) Formula 3: (absorption-costing operation income) (variable-costing operating income) = (closing stick in units operating stock in units) x (budget fixed manufacturing cost rate) Effect of sales and production on operating profit The period-to-period change in operating profit under variable costing is driven solely by changes in the unit level of sales, given a constant contribution margin per unit. Note that under variable costing, managers cannot increase operating profit by production for stock. Under absorption costing, however, period-to-period change in operating profit is driven by variations in both the unit level of sales and the unit level of production. Production = sales Production > sales Production < sales Variable costing Operating profit Equal < > Absorption costing Operating profit
Capsule comparison of stock-costing methods Variable costing has been a controversial subject among accountants, because there is a question about using variable costing for external reporting. Those favouring variable costing for external reporting maintain that the fixed portion of manufacturing costs is more closely related to the capacity to produce than to the production of specific units. Supporters of absorption costing maintain that stock should carry a fixed manufacturing cost component, because both variable and fixed manufacturing costs are necessary to produce goods, both should be inventoriable. Performance measures and absorption costing Undesirable stockbuilding Absorption costing enables mangers to increase operating profit in the short run by increasing the production schedule independent of customer demand for products. 1. A manager may switch production to those orders absorbing the highest amount of fixed manufacturing costs (cherry picking). Some other orders may be delayed. 2. A manager may accept an order to increase production even though another plant in the same company may be better suited. 3. A manager may delay maintenance work. Proposals for revising performance evaluation 1. Change accounting system or charge a fee for stock holdings. 2. Change time periods used to evaluate performance: for example 3 or 5 year performance instead of quarterly or annually. 3. Careful budgeting and stock planning, so that stock build-ups are recognized.
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4. Include also non-financial variables in evaluation basis: for instance, closing stock in units this period/closing stock in units last period; sales in units this period/closing stock in units this period
zero. The breakeven point depend on (1) fixed costs, (2) unit contribution margin, (3) sales level in units, (4) production level in units and (5) the denominator level chosen to set the fixed manufacturing costs rate.
CVP Assumptions
Total costs are divided in to a fixed component and a variable one, with respect to level of output. The behaviour of total revenues and total costs is linear in relation to outputs units within relevant range The unit selling price, unit variable costs and fixed costs are known and are constant The analysis either covers a single product or assumes that the proportion of different products when multiple products are sold will remain constant as the level of total units sold changes. All revenues and costs can be added and compared without taking into account the time value of money Changes in the level of revenues and costs arise only because of changes in the number of products units produced and sold. Its the only revenue and cost driver.
Equation method In the following equation, operating profit has to be set equal to zero in order to determine the breakeven point in output units: Revenues variable costs fixed costs = operating profit (Unit selling price [USP] x Q) (Unit variable costs [UVP] x Q) FC = OP Contribution margin method Breakeven number of units = (FC)/(unit contribution margin) = (FC)/(USP-UVC) The unit contribution margin is the amount of money each additional unit sold contributes to the operating profit, above the breakeven point. Contribution income statement groups line items by cost behaviour pattern to highlight the contribution margin: Revenues Variable costs Contribution margin Fixed costs Operating profit Xxx -xxx =xxx -xxx =xxx
Graph method Here we plot the total costs line and the total revenue line. Their point of intersection is the breakeven point. Target operating profit This operation answers the question: How many units must be sold to earn a certain operating profit? Revenues variable costs fixed costs = target operating profit (USP x QT) (VC x QT) FC = Target operating profit (TOP); solve for QT. Alternatively: QT = (FC + TOP)/(UCM)
The PV Graph
PV Graph shows the impact on operating profit of changes in the output level. The PV line can be drawn using two points. One convenient point (X) is the level of fixed costs at zero output xxxx, which is also the operating loss at this output level. A second convenient point (Y) is the breakeven point. The PV line is drawn by connecting these two points and extending the line beyond Y. This line shows clearly the operating loss/profit and the contribution to operating profit of each additional item sold.
Margin of safety is one aspect of sensitivity analysis, which is the excess of budgeted revenues over the breakeven revenues. The margin of safety is the answer to the what-if question: if budgeted revenues are above breakeven and drop, how far can they fall below budget before the breakeven point is reached? Uncertainty is defined here as the possibility that an actual amount will deviate from an expected amount. Sensitivity analysis is one approach to recognise uncertainty, another one is to calculate expected values using probability distributions. Sample spreadsheet of sensitivity analysis: Fixed costs Variable costs per Revenue required at xxx selling price to earn unit OP of Xxxx Xxx
The following approach can be used when it is assumed that the budgeted revenue mix will not change at different levels of total revenue: Take operating profit calculations from earlier and introduce two variables, depending on the budgeted revenue mix (For example: Product 1=Q; Product 2=2Q; if budgeted revenue mix is that you sell double the amount of product 2 than 1). Solve for the variable. If the mix shifts towards units with higher contribution margins, operating profit will be higher.
Manufacturing sector The two areas of difference between contribution margin and gross margin for companies in the manufacturing sector are fixed manufacturing costs and variable nonmanufacturing costs. An example: Contribution margin format Revenues Variable manufacturing costs Variable non-manufacturing costs Contribution margin Fixed manufacturing costs Fixed non-manufacturing costs 1000 250 270 160 138 35 520 480 298 Gross margin format Revenues Cost of goods sold Gross margin Non-manufacturing costs Operating profit 1000 410 590 408 182
Operating profit 182 Explanation: Fixed manufacturing costs are not deducted from revenues when computing contribution margin but are deducted when computing gross margin. Cost of goods sold in manufacturing company includes entirely manufacturing costs. Variable non-manufacturing costs are deducted from revenues when computing contribution margins but are not deducted when computing gross margins. Contribution margin percentage is the total contribution margin divided by revenues. Variable-cost percentage is the total variable costs divided by the revenues. Gross margin percentage is the gross margin divided by revenues.
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Basic terms Cost estimation is the attempt to measure past cost relationships between total costs and the drivers of those costs. Cost predictions are forecasts about future costs.
2. Identify the independent variable(s) or cost driver(s). The independent variable (level of activity or cost driver) is the factor used to predict the dependent variable (costs). It should have an economically plausible relationship to the dependent variable and be accurately measurable. Ideally all the individual items included in the dependent variable should have the same cost drivers. 3. Collect data on the dependent variable and the cost drivers. The time periods used to measure the dependent variable and the cost drivers should be identical. Data can be either time-series data or cross-sectional. Cross sectional data pertain to different entities for the same time period. 4. Plot the data. The plot highlight extreme observations that analysts should check and it can also provide insight into whether the relation is approximately linear and what the relevant range of the cost function is. 5. Estimate the cost function. Two methods used: high-low and regression method 6. Evaluate the estimated cost function. See later section. High-low method The high-low method entails using only the highest and lowest observed values of the cost driver within the relevant range. The line between these two points becomes the estimated cost function. Slope coefficient b = (Difference between costs associated with highest and lowest observations of the cost driver) / (difference between highest and lowest observations of the cost driver) Constant a = y bX, where we use either the highest or the lowest observation of the cost driver. The constant, or intercept, term does not serve as an estimate of the fixed costs, because it may be outside the relevant range. Sometimes the high-low method is modified so that the two observations chosen are representative high and a representative low. The reason is that management wants to avoid having extreme observations affecting the cost function. Even with such a modification this method ignores information from all but two observations when estimating the cost function. Regression analysis method Regression analysis is a statistical method that measures the average amount of change in the dependent variable that is associated with a unit change in one or more independent variables. This method uses all available data. Simple regression analysis estimates the relationship between the dependent variable and one independent variable Multiple regression analysis estimates the relationship between the dependent variable and multiple independent variables. Residual term is the difference between actual and predicted cost. Regression analysis is done by computer programs, such as SPSS. It is necessary however to be able to interpret such a graph.
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Incremental unit-time learning model In this model, the incremental unit time (the time needed to produce the last unit) declines by a constant percentage each time the cumulative quantity of units produced doubles. See book for detailed calculations: page 289.
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Using regression output to choose cost drivers of cost functions We can use regression line analysis to choose cost driver of cost function, by comparing the output and analysing the criteria. The one that satisfies most criteria is the one to be chosen. Economic plausibility criterion is especially important. Multiple regression and cost hierarchies In many cases basing the estimation on more than one independent variable is more economically plausible and improves accuracy. Y = a +b1X1 + b2X2 + + u; where y=cost variable to be predicted, x=independent variables on which the prediction is based, a and b = estimated coefficients of the regression model, u=residual term that includes the net effect of other factors not in the model and measurement errors in the dependent and independent variables. Multicollinerarity Multicollinearity exists when two or more independent variables are highly correlated with each other. Generally, a coefficient of correlation between independent variables greater than 0.70 indicates multicollinearity. If severe multicollinearity exists, try to obtain new data that does not suffer from these problems. Do not drop an independent variable that should be included in a model. Omitting such a variable will cause the estimated coefficient of the independent variable included in the model to be biased away form its true value.
Concept of relevance
Relevant costs and relevant revenues Relevant costs are those expected future costs that differ among alternative courses of action. The two key aspects to this definition are that the costs must occur in the future and that they must differ among the alternative courses of action. Relevant revenues are those expected future revenues that differ among alternative courses of action. Differential cost is the difference in total cost between two alternatives.
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Qualitative factors can be relevant Quantitative factors are outcomes that are measured in numerical terms. They can be financial and non-financial. Qualitative factors are outcomes that cannot be measured in numerical terms. These factors should not be ignored even though they are not measurable. There are two common problems in relevant-cost analysis: (a) assuming all variable costs are relevant and (b) assuming all fixed costs are irrelevant. Incremental costs are additional costs to obtain an additional quantity, over and above existing or planned quantities, of a cost object. Make-or-buy decisions: Decisions about whether a producer of goods or services will insource or outsource. Opportunity cost is the contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use. Deciding to use a resource in a particular way causes a manger to give up the opportunity to use the resource in alternative ways. The lost opportunity is a cost that the manager must take into account when making a decision. Product mix decisions under capacity constraints: Managers should aim for the highest contribution margin per unit of the constraining factor, that is the scarce, limiting or critical factor. The constraining factor restricts or limits the production or sale of a given product. The problem of formulating the most profitable production schedules and the most profitable product mix is essentially that of maximising the total contribution margin in the face of many constraints. Expected future revenues and costs are the only revenues and costs relevant in any decision model. The book value of existing equipment in equipment-replacement decisions represents past (historical) cost and therefore is irrelevant. Sunk cost: past costs that are unavoidable because they cannot be changed, no matter what action is taken.
Product-cost cross-subsidisation means that at least one miscosted product is resulting in the miscasting of other products in the organisation. A classic example arises when a cost is uniformly spread across multiple users without recognition of their different resource demands (restaurant bill example).
This chapter describes three guidelines for refining a costing system: Direct-cost tracing: Classify as many of the total costs as direct costs of the cost object as is economically feasible. Indirect-cost pools: Expand the number of indirect-cost pools until each of these pools is more homogeneous Cost-allocation bases: use the cause-and-effect criterion to identify the costallocation base for each indirect-cost pool.
Facility-sustaining costs are resources sacrificed on activities that cannot be traced to individual products or services but which support the organisation as a whole.
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Costs The study of cost-behaviour patterns gives insight into the income that results form different combinations of price and output quantities sold for a particular product. In competitive markets companies must accept the prices determined by the market. In less competitive markets products are differentiated and all three factors affect the price. As competition lessens even more, the key factors affecting pricing decisions is the customers willingness to pay; costs and competitors become less important in pricing decisions.
1. Develop a product that satisfies the needs of potential customers 2. Choose a target price based on customers perceived value for the product and the prices competitors charge, and a target operating profit per unit 3. Derive a target cost per unit by subtracting the target operating profit per unit from the target price 4. Perform value engineering to achieve target costs. Value engineering is a systematic evaluation of all aspects of the value-chain business functions, with the objective of reducing costs while satisfying customer needs. Value engineering can result in improvements in product designs, changes in materials, specifications or modifications in process methods. Category Examples Value-added costs Costs of assembly, design, tools and machinery Non-value-added costs Costs of rework, expediting, special delivery and obsolete stock Grey area Costs of testing, materials movement and ordering Value engineering seeks to reduce or eliminate non-value-added activities and hence non-value-added costs by reducing the cost drivers of the non-value-added activities. Two important aspects in value engineering: Cost incurrence occurs when a resource is sacrificed or used up. Costing systems emphasise cost incurrence. They recognise and record costs only when costs are incurred. Cost-reduction activities can be successful right up to the time that costs are incurred, if they are not locked-in. The key to lowering costs is improved operational efficiency and productivity rather than better design. Locked-in costs or designed-in costs are those costs that have not yet been incurred but that will be incurred in the future on the basis of decisions that have already been made. It is difficult to alter or reduce costs that have already been locked in. When a sizable fraction of the cots are locked in at the design stage, the focus of value engineering is on making innovations and modifying designs at the product design stage. The best way is to organise cross-functional teams. Unless managed properly, value engineering and target costing can have undesired consequences: The cross-functional team may add too many features in an attempt to accommodate the different wished of team members Long development times may result as alternative designs are evaluated endlessly Organisational conflicts may develop as the burden of cutting costs falls unequally on different parts of the organisation To avoid these pitfalls, target-costing efforts should always focus on the customer, pay attention to schedules and build a culture of teamwork and cooperation across business function.
Cost-plus pricing
The general formula for setting a price adds a mark-up to the cost base: Cost base + mark-up component = Prospective selling price 47
How is the mark-up determined? Target rate of return on investment is one approach. This is the target operating profit that an organisation must earn divided by invested capital. Invested capital can be defined in many ways. In this chapter we define it as total assets (long-term or fixed assets plus current assets). The total target operating profit is calculated through the target rate of return on investment is then divided by the number of units of the product. This is then the mark-up for the formula above. However there are also other cost bases to calculate the mark-up for each product unit. Mark-ups and profit margins tend to be lower the more competitive the market. Another approach to calculate the mark-up is to use total product cost as a cost basis. The advantages cited by many companies for including fixed costs per unit for pricing decisions include the following: Full product cost recovery Price stability Simplicity However, including unit fixed costs when pricing is not without its problems. Allocating fixed costs to products can be somewhat arbitrary. Moreover there are instances where non-cost factors are relevant in price setting. Examples include price discrimination (charging some customers a higher price than is charged to other customers), or peak load pricing (charging a higher price for the same product or service when demand approaches physical capacity limits).
1. The full set of revenues and costs associated with each product becomes visible. 2. Differences among products in the percentage of their total costs incurred at early stages in the life cycle are highlighted. The higher this percentage, the more important it is for managers to develop, as early as possible, accurate predictions of the revenues for that product. 3. Interrelationships among business function cost categories are highlighted, and can prevent causally related changes among business function costs (for example: lower R&D costs can cause higher service costs).
Customer-profitability analysis
Customer-profitability analysis refers to the reporting and analysis of customer revenues and customer costs. Managers need to ensure that customers contributing sizably to the profitability of an organisation receive a comparable level of attention form the organisation.
Customer revenues
Customer revenues are inflows of assets form customers received in exchange for products or services being provided to those customers. It is necessary here to trace revenue items to individual customers as detailed as possible. This becomes especially important with price discounting, which is the reduction of selling prices below listed levels in order to encourage an increase in purchases by customers. There are tow options to account for price discounting: Option A: Recognise the list price and the discount from this list price as separate line items. This highlights the extent of discounting for customers and of sales persons. Option B: Record only the actual price when reporting revenues. This disables us from further analysis of discounting.
Customer costs
Customer cost hierarchy categorises costs related to customers into different cost pools on the basis of different types of cost drivers (or cost allocation bases) or different degrees of difficulty in determining cause-and-effect (or benefits received) relationships. Examples of categories are: Customer output-unit-levels costs: resources sacrifice on activities performed to sell each unit to a customer. Customer batch-level costs: resources sacrificed on activities that are related to a group of units sold to a customer. Customer-sustaining costs: resources sacrificed on activities undertaken to support individual customers, regardless of units or batches delivered. Distribution-channel costs: resources sacrificed on activities that are related to a particular distribution channel rather than to each unit product, batches or specific customers. Corporate-sustaining costs: resources sacrificed on activities that cannot be traced to individual customers or distribution channels. The uses of customer-level analysis are among others: Guidance for pricing policies Renegotiation of customer contracts 49
Guidance for customer relations policies Influence cost control in respect of customers
Roles of budgets
Current thinking concerning budgetary control systems suggests two opposite views. On the one hand, there is the view that espouses incremental improvement to budgetary processes in terms of linking such processes more closely to operational requirements and planning systems and increasing the frequency of budget revisions and the deployment of rolling budgets. Conversely, an alternative view advocates the abandonment of budgetary control and its replacement with alternative techniques to enable firms to become more adaptive and agile. 50
Four major roles of budgets: 1. Compel strategic planning including the implementation of plans (Strategy can be viewed as describing how and organisation matches its own capabilities with the opportunities in the marketplace to accomplish its overall objectives) 2. Provide performance criteria (overcomes tow key limitations of past performance as a criteria: (1) past results incorporates past miscues and substandard performance; (2) future may be expected to be very different from the past) 3. Promote communication and coordination within the organisation (Coordination is the meshing and balancing of all factors of productions or service and of all the departments and business functions so that the company can meet its objectives. Communication is getting those objectives understood and accepted by all departments and functions) 4. Affect motivating and wider organisation processes.
Types of budget
Rolling budget is a budget or plan that is always available for a specified future period by adding a month, quarter or ear in the future as the month, quarter or year just ended is dropped. Operating budget is the budgeted profit statement and its supporting budget schedules (part of the master budget) Financial budget is that part of the master budget that comprises the capital budget, cash budget, budgeted balance sheet and budgeted statement of cash flows. Pro forma statements: same as budgeted financial statements. Steps in preparing a budgeted profit statement Step 1: Revenue budget. The revenue budget is the usual starting point for budgeting, because production and stock levels generally depend on the forecast level of revenue. Padding the budget or introducing budgetary slack refers to the practice of underestimating budgeted revenues (or overestimating budgeted costs) in order to make budgeted targets more easily achievable. Occasionally, revenues are limited by available production capacity. Step 2: Production budget (in units). The total finished goods units to be produced depends on planned sales and expected changes in stock levels: Budgeted production (units) = budgeted sales (units) + target closing finished goods stock (units) opening finished goods stock (units) When unit sales are not stable throughout the year, managers must decide whether (1) to adjust production levels periodically to minimise stock held, or (2) to maintain constant production levels and let stock rise and fall. Step 3: Direct materials usage budget and direct materials purchases budget. The decision on the number of units to be produced is the key to computing the usage of direct materials in quantities and capital. Purchases of direct materials = usage of direct materials + target closing stock of direct materials opening stock of direct materials 51
Step 4: Direct manufacturing labour budget. These costs depend on wage rates, production methods and hiring plans. Step 5: Manufacturing overhead budget. The total of these costs depends on how individual overhead costs vary with the assumed cost driver. Step 6: Closing stock budget. First calculate the unit costs for the products, and then calculate the costs of target closing stock of direct materials and finished goods. Step 7: Cost of goods sold budget. Cost of goods sold = opening finished goods stock + cost of goods manufactured closing finished goods stock Step 8: Other (non-production) cost budget. Step 9: Budgeted operating profit statement.
Kaizen budgeting
Kaizen budgeting is a budgetary approach that explicitly incorporates continuous improvement during the budget period into the resultant budget numbers.
Activity-based budgeting
Activity-based budgeting focuses on the cost of activities necessary to produce and sell products and services. It separates indirect costs into separate homogeneous activity cost pools. Management uses the cause-and-effect criterion to identify the cost drivers for each of these indirect-cost pools. Four key steps in activity-based budgeting are: 1. Determine the budgeted costs of performing each unit of activity at each activity area 2. Determine the demand for each individual activity based on budgeted, production, ne product development and so on 3. Calculate the costs of performing each activity 4. Describe the budgets costs of performing various activities Benefits: 1. 2. 3. 4. 5. Ability to set more realistic budgets Better identification of resource needs Linking of costs to outputs Clearer linking of costs with staff responsibilities Identification of budgetary slack
To attain the goals described in the master budget, an organisation must coordinate the efforts of all its employees. This means assigning responsibility to managers who are accountable for their actions. Responsibility centre is a part, segment or subunit of an organisation whose manager is accountable for a specified set of activities. The higher the managers level, the broader the responsibility centre he or she manages and generally the larger the number of subordinates who report to him or her. Responsibility accounting is a system that measures the plans (by budgets) and actions (by actual results) of each responsibility centre. Four major types of responsibility centre are: 1. 2. 3. 4. Cost centre: manager accountable for costs only (i.e. maintenance department) Revenue centre: manager accountable for revenues only (i.e. sales department) Profit centre: manager accountable for revenues and costs (i.e. hotel manager) Investment centre: manager accountable for investments, revenues and costs (i.e. regional manager in hotel chain)
The responsibility accounting approach traces costs to either (1) the individual who has the best knowledge about why the costs arose, or (2) the activity that caused the costs. Feedback Budgets coupled with responsibility accounting provide systematic help for managers, through looking at variances. Variances can be helpful in four ways: 1. Early warning. Variances alert managers early to events not easily or immediately evident. Managers can then take corrective actions or exploit available opportunities. 2. Performance valuation. Variances inform managers about how well the company has performed in implementing its strategies. 3. Evaluating strategy. Variances sometimes signal to managers that their strategies are ineffective. 4. Communicating the goals of the organisation. The budget-making exercise and budgeting information are useful in conveying to managers across the organisation the goals of subunits and the wider corporate goals.
2. With a long enough time span, all costs will come under somebodys control. However, most performance reports focus on periods of a year or less. A current manager may have inherited problems and inefficiencies from his or her predecessor. Mangers should avoid overemphasising controllability. Responsibility accounting is more far-reaching. It focuses on information and knowledge, not control. Who is the person who can tell us the most about the specific item in question, regardless of that persons ability to exert personal control? Performance reports for responsibility centres may also include uncontrollable items because this approach could change behaviour in the directions top management desires (i.e. change the cost centre into a profit centre).
Tailor the budget cycle to the purpose of budgeting Budget is preoccupied with financial aspects Balance financial aspects with both nonof events in the budget period financial aspects (quality, time) Budgets are not used until end of budget Signals to all employees the need for period to evaluate performance continuous improvement of performance
disbursements plus the minimum closing cash balance desired. The financing plans will depend on the relationship between total cash available for needs and total cash needed. If there is excess cash, loans may be repaid or temporary investments made. The outlays for interest expense are usually shown in this section of the cash budget. d. The closing cash balance. The total effect of the financing decisions on the cash budget, may be positive (borrowing) or negative (repayment). Self liquidating cycle (working capital cycle or cash cycle or operating cycle) is the movement from cash to stock to debtors and back to cash. The budgeted balance sheet is projected in light of the details of the business plan as expressed in all the previous budget schedules. The budgeted operating profit statement is the budgeted operating profit statement expanded to include interest expense and income taxes.
Static-budget variance
The static-budget-based variance analysis presents actual results; next to static-budget variance and the static budget for a given period. Static-budget variance = actual results static-budget amount 55
Obtaining budgeted input prices and input quantities Two main sources of information about budgeted input prices and budgeted input quantities are: 1. Actual input data from past periods. The limitations of using this source are: (a) past data include past inefficiencies and (b) past data do not incorporate any expected changes planned to occur in the budget period. 2. Standards developed by the company: A standard is a carefully predetermined amount; it is usually expressed on a per unit basis. Companies can use time-andmotion and engineering studies to determine its standard amounts. The advantages of using standard amounts are: (a) they can exclude past inefficiencies, (b) they can take into account expected changes in the budget period. Standard input is a carefully predetermined quantity of input required for one unit of output. Standard cost is a carefully predetermined cost that can relate to units of inputs of units of outputs.
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Benchmarking
Benchmarking is the continuous process of measuring products, services and activities against the best levels of performance. Benchmarking enables companies to use the best levels of performance within their organisation or by competitors or other external companies to gauge the performance of their own managers.
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Variable-overhead flexible-budget variance = actual amount flexible-budget amount (shows the variance that is due to a difference in manufacturing overhead costs) The following two variances together split the flexible-budget variance, in order to gain additional insight. Variable-overhead efficiency variance Variable-overhead efficiency variance measures the efficiency with which the cost allocation base is used. Level 3 analysis: Variable overhead efficiency variance = (Actual units of variableoverhead cost allocation base used for actual output units achieved budgeted units of variable-overhead cost allocation base allowed for actual output units achieved) x budgeted variable-overhead cost allocation rate Possible causes of an unfavourable variance (higher-than-budgeted cost allocation base): Less skilful workers than budgeted Inefficient production schedules Not enough maintenance, resulting in poor operating condition Budgeted allocation rate was set without careful analysis of the operating conditions A rushed delivery resulted in higher machine usage than budgeted Variable-overhead spending variance Variable-overhead spending variance is the difference between the actual amount of variable overhead incurred and the budgeted amount allowed for the actual quantity of the variable-overhead allocation base used for the actual output units achieved. Level 3 analysis: Variable-overhead spending variance = (Actual variable-overhead cost per unit of cost allocation base budgeted variable-overhead cost per unit of cost allocation base) x actual quantity of variable-overhead cost allocation base used for actual output units achieved Two main causes for a spending variance: 1. The actual prices of individual items included in variable overhead differ form their budgeted prices 2. The actual usage of individual items included in variable overhead differs from the budgeted usage
Production-volume variance
We now discuss a new variance for fixed-overhead costs. Production-volume variance is the difference between budgeted fixed overhead and the fixed overhead allocated. Fixed overhead is allocated based on the budgeted fixed overhead rate times the budgeted quantity of the fixed-overhead allocation base for the actual output units achieved (also: denominator-level variance or output-level overhead variance) Production volume variance = budgeted fixed overhead (fixed overhead allocated using budgeted input allowed for actual output units achieved x budgeted fixed overhead rate) The amount used of budgeted fixed overhead will be the same lump sum shown in the static budget and also in any flexible budget within the relevant range. Fixed-overhead costs allocated is the sum of the individual fixed-overhead costs allocated to each of the products manufactured during the accounting period. Interpreting the production-volume variance The production-volume variance arises whenever actual production differs from the denominator level used to calculate the budgeted fixed-overhead rate. Be careful not to attribute much economic significance to this variance. Additionally it is rarely a good measure of the opportunity cost on unused capacity. For example, the plant capacity level may exceed the budgeted level; hence some unused capacity may not be included in the denominator. Moreover, the production-volume variance focuses only on costs. It does not take into account any price changes necessary to spur extra demand that would in turn make use of any idle capacity.
Variable overhead Fixed manufacturing Xxx U/F Never a Xxx U/F overhead variance 3-variance analysis: the variances from the 4-variances analysis have been combined (also combined variance analysis) 60
Flexible-budget variance Production-volume variance Total manufacturing overhead Xxx U/F Xxx U/F 1-variance analysis Total manufacturing overhead Total overhead variance Xxx U/F
Budgeted fixed set-up overhead cost rate = budgeted total costs in overhead cost pool [step 3] / budgeted total quantity of cost-allocation base [step 2] Production-volume variance for fixed set-up overhead costs = budgeted fixed set-up overhead costs fixed set-up overhead allocated using budgeted input allowed for actual output units produced
Input variances
Here we focus on variance analysis for inputs in manufacturing organisations. Manufacturing processes often require that a number of different direct materials and different direct manufacturing labour skills be combined to obtain a unit of finished product. In some cases this combination must be exact. We refer to these materials as nonsubstitutable materials. In other cases a manufacturer has some leeway in combining the materials. We refer to these as substitutable materials. When inputs are substitutable, mix refers to the relative proportion or combination of the different inputs used within an input category such as direct materials or direct manufacturing labour to produce a quantity of finished output. Yield refers to the quantity of finished output units produced from a budgeted or standard mix of inputs within an input category. Yield and mix variances are useful when examining direct materials and direct-labour inputs. Budgeted figures discussed in this chapter can be obtained form: Internally generated actual costs from the most recent accounting period, sometimes adjusted for expected improvement Internally generated standard costs based on best performance standards or currently attainable standards Externally generated target cost numbers based on an analysis of the cost structures of the leading competitors in an industry
output, and (2) using a cheaper mix to produce a given output. The direct materials yield and mix variances divide the efficiency variance into two variances: the yield variance focusing on total inputs used (differences in actual and budgeted total input quantity used) and the mix variance focusing on how the inputs are combined (differences in the mix of inputs used: budgeted vs. actual). Given the budgeted input mix is unchanged, the total direct materials yield variance is the difference between two amounts: (1) the budgeted cost of direct materials based on the actual total quantity of all direct materials inputs used and (2) the flexible-budget cost of direct materials based on the budgeted total quantity of direct materials inputs for the actual output achieved. The total direct materials yield variance is the sum of the direct materials yield variances for each input. Direct materials yield variance for each input = (actual total quantity of all direct materials inputs used budgeted total quantity of all direct materials inputs allowed for actual output achieved) x budgeted direct materials input mix percentage x budgeted price of direct materials input. Given that the actual quantity of all direct materials inputs used is unchanged, the total direct materials mix variance is the difference between two amounts: (1) the budgeted cost for the actual direct materials input mix, and (2) the budgeted cost if the budgeted direct materials input mix had been unchanged. The total direct materials mix variance is the sum of the direct materials mix variances for each input. The mix variance of an individual input is favourable (unfavourable) if the company uses a smaller (greater) percentage of that input in its actual mix relative to the budgeted mix. Direct materials mix variance for each input = (actual direct materials input mix percentage budgeted direct materials input mix percentage) x actual total quantity of all direct materials inputs used x budgeted price of direct materials input.
percentage) x actual total quantity of all direct manufacturing labour inputs used x budgeted price of direct manufacturing labour input
Variance analysis for multiple products Static-budget variance The static-budget variance for revenues is the difference between the actual revenues and the budgeted revenues for the static budget. Flexible-budget and sales-volume variances The flexible budget variance for revenues is the difference between the actual revenues and the flexible-budget amount for the actual unit volume sales The sales-volume variance shows the effect of the difference between the actual and budgeted quantity of the variable used to flex the flexible budget. Sales-volume variance of revenues = (actual sales quantity in units budgeted sales quantity in units) x budgeted selling price per unit Sales-quantity variance The Sales-quantity variance is the difference between two amounts: (1) the budgeted amount based on actual quantities sold of all products and the budgeted mix, and (2) the amount in the static budget (which is based on the budgeted quantities to be sold of all products and the budgeted mix). This variance is favourable when the actual units of product sold exceed the budgeted units of product sold. Sales-quantity variance of revenues = (actual units of all products sold budgeted units of all products sold) x budgeted sales-mix percentage x budgeted selling price per unit Sales-mix variance The sales-mix variance is the difference between two amounts: (1) the budgeted amount for the actual sales mix, and (2) the budgeted amount if the budgeted sales mix had been unchanged. A favourable sales-mix variance arises at the individual product level when the actual sales-mix percentage exceeds the budgeted sales-mix percentage. The concept behind a favourable sales-mix variance is best explained in terms of the budgeted selling prices per composite unit of the sales mix. A composite product unit is a hypothetical unit with weights related to the individual products of the company.
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Budgeted selling price per composite unit for actual mix: budgeted selling price per unit x actual sales-mix percentage. Budgeted selling price per composite unit for budgeted mix = budgeted selling price per unit x budgeted sales-mix percentage. An increase in the budgeted selling price per composite unit, translates into a favourable sales-mix variance. Sales-mix variance = actual units of all products sold x (actual sales-mix percentage budgeted sales-mix percentage) x budgeted selling price per unit Market-size and market-share variances The market-size variance is the difference between two amounts: (1) the budgeted amount based on the actual market size in units and the budgeted market share, and (2) the static-budget amount based on the budgeted market size in units and the budgeted market share. Market-size variance in revenues = (actual market size in units budgeted market size in units) x budgeted market share x budgeted average selling price per unit The market-share variance is the difference between two amounts: (1) the budgeted amount at budgeted mix based on the actual market size in units and the actual market share, and (2) the budgeted amount at budgeted mix based on actual market size in units and the budgeted market share. Market-share variance for revenues = actual market size in units x (actual market share x budgeted market share) x budgeted average selling price per unit
Important elements of management control systems: Recognizes both financial and non-financial information Information comes form inside or outside the company Can be present both in a single report, for instance a balanced scorecard The levels indicate the different kinds of information that are needed by managers performing different tasks Contain both formal and informal components
The formal management control system includes those explicit rules, procedures, performance measures and incentive plan that guide behaviour of its managers and employees. The formal control system itself consists of several systems. The management accounting system is a formal accounting system that provides information on costs, revenues and income. Other formal control systems are human resource systems (providing information on recruiting, training, absenteeism and accidents) and quality systems (providing information on scrap, defects, rework and late deliveries to customers). The informal part of the management control system includes such aspects as shared values, loyalties and mutual commitments among members of the organisation and the unwritten norms about acceptable behaviour for promotion that also influence employee behaviour.
Benefits of decentralisation 1. Creates greater responsiveness to local needs 2. Leads to quicker decision making 3. Increases motivation 4. Aids management development and learning 5. Sharpens the focus of managers Costs of decentralisation 1. Leads to suboptimal (also incongruent) decision making: Arises then a decisions benefit to one subunit is more than offset by the costs or loss of benefits for to the organisation as a whole. Suboptimal decisions making may occur (1) when there is a lack of harmony or congruence among the overall organisation goals, the subunit goals and the individual goals of decision makers, or (2) when no guidance is given to subunit managers concerning the effects of their decisions on other parts of the organisation. Suboptimal decisions most likely occur when the subunits are highly interdependent. 2. Results in duplication of activities 3. Focuses managers attention on the subunit rather than the organisation as a whole (for instance in information sharing) 4. Increases costs of gathering information
Transfer pricing
In decentralised organisations, management control systems often use transfer prices to coordinate actions and to evaluate performance of the subunits. Intermediate product is a product transferred form one subunit to another subunit of the same organisation. This product may be processed further and sold to an external customer. Transfer price is the price one subunit of an organisation charges for a product or service supplied to another subunit of the same organisation. The transfer price creates revenue for the selling subunit and a purchase cost of the buying subunit, affecting operating profit for both units. There are three general methods for determining transfer prices: 1. Market-based transfer prices: Prices charged for similar products from other companies or prices charged to outside customers. 2. Cost-based transfer prices. 3. Negotiated transfer prices. Negotiated transfer prices are often employed when market prices are volatile and change occurs constantly. Ideally the chosen transfer-pricing method should lead each subunit manager to make optimal decisions for the organisation as a whole. I should promote goal congruence, and a sustained high level of management effort. If top management favours a high 69
degree of decentralisation, transfer pricing should promote a high level of subunit autonomy.
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pricing, using two separate transfer-pricing methods to price each interdivisional transaction. An example of dual pricing arises when the selling division receives a full cost plus mark-up-based price and the buying division pays the market price for the internally transferred products. Dual pricing is not widely used in practice because: The manger of the supplying division does not have sufficient incentive to control costs The dual-price system confuses division managers about the level of decentralisation top management seeks. It tends to insulate managers form the frictions of the marketplace
countries, companies can increase the funds paid out of these countries without appearing to violate income or dividend restrictions.
The answers of the questions raised at each step depend on top managements beliefs about how cost-effectively and how well each alternative fulfils the behavioural criteria of goal congruence, employee effort and subunit autonomy.
ROI (also called accounting rate of return) can be compared to the rate of return on opportunities elsewhere, inside or outside the company. DuPont method of profitability analysis: (income/investment) = (Revenues/investment) x (income/ revenue). This approach recognises that there are two basic ingredients in profit making: using assets to generate more revenue and increasing income per euro of revenue. ROI highlights the benefits that managers can obtain by reducing their investments in current or fixed assets. Reducing investments means decreasing idle cash, managing credit judiciously, determining proper stock levels and spending carefully on fixed assets. However it may induce managers to reject projects, because their ROI might decrease in the short-run that, from the viewpoint of the organisation as a whole, should be accepted. Residual income Residual income is income minus a required euro return on the investment: Residual income = income (required rate of return x investment) = income imputed cost of the investment Imputed costs are costs recognised in particular situations that are not regularly recognised by accrual accounting procedures. Some firms favour the residual-income approach because managers will concentrate on maximising an absolute amount rather than a percentage. The objective of maximising residual income assumes that as long as a division earns a rate in excess of the required return for investments, that division should expand. Economic Value Added (EVA) EVA is a specific type of residual income calculation that has recently attracted considerable attention. Economic value added = after-tax operating profit (weighted average cost of capital x (total assets current liabilities)) EVA substitutes the following numbers in the residual-income calculations: (1) income equal to after-tax operating profit, (2) a required rate of return equal to the weightedaverage cost of capital and (3) investment equal to total assets minus current liabilities. Long term assets current liabilities = long-term assets + current assets current liabilities + long term assets + working capital To improve Eva managers must earn more operating profit with the same capital, use less capital or invest capital in high-return project. Return on sales Return on sales (ROS) = income/ revenue
Working capital (current assets minus current liabilities) plus long-term assets: this definition excludes that portion of current assets financed by short-term creditors Shareholders equity
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Timing of feedback Timing of feedback depends largely on how critical the information is for the success of he organisation, the specific level of management that is receiving the feedback and the sophistication of the organisations information technology.
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Performing multiple tasks Most employees perform more than one task as part of their job. In some situations, one aspect of a job is easily measured (for example, the quantity of work done), while another aspect is not (for example, the quality of work done). Creating incentives to promote the aspect of the job that is easily measured (quantity) may cause workers to ignore an aspect of their job that is more difficult to measure (quality). Steps must be taken to motivate workers to balance both aspects.
Cost of quality
Costs of quality (COQ) are costs incurred to prevent or costs arising as a result of, the production of a low-quality product. These costs focus on conformance quality and are incurred in all business functions of the value chain. COQ are classified into four categories: 1. Prevention costs: costs incurred in precluding the production of products that do not conform to specifications 2. Appraisal costs: costs incurred in detecting which of the individual units of products do not conform to specifications 3. Internal failure costs: costs incurred when a non-conforming product is detected before it is shipped to customers 4. External failure costs: costs incurred when a non-conforming product is detected after it is shipped to customers. 76
Items pertaining to costs of quality reports Prevention costs Design engineering Process engineering Quality engineering Supplier evaluations Preventive equipment maintenance Quality training New materials used to manufacture products Appraisal costs Inspection Online product manufacturing and process inspection Product testing Internal failure costs Spoilage Rework Scrap Breakdown maintenance Manufacturing/ process engineering on internal failure External failure costs Customer support Transportation costs Manufacturing/ process engineering Warranty repair costs Liability claims
Steps in preparing a COQ report: Step 1: Identify all quality-related activities and activity cost pools Step 2: determine the quantity of the cost-allocation base for each quality-related activity. Step 3: Calculate the rate per unit of each cost-allocation base. Step 4: Calculate the costs of each quality-related activity by multiplying the quantity of the cost-allocation base determined in step 2 by the rate per unit of the cost-allocation base calculated in step 3. Step 5: Obtain the total costs of quality by adding the costs of all quality-related activities in all value-chain business functions COQ reports typically exclude opportunity costs, such as forgone contribution margins and profit from lost sales, lost production or lower prices that result from poor quality, because they are difficult to estimate and generally not recorded in accounting systems.
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2. Investments (stock), equal to the sum of materials costs of direct materials stock, work-in-progress stock and finished goods stock; R&D costs; and costs of equipment and buildings 3. Operating costs, equal to all operating costs (other than direct material costs) incurred to earn throughput contribution. Operating costs include salaries and wages, rent, utilities and depreciation. The objective of TOC is to increase throughput contribution while decreasing investments and operating costs. The theory of constraints considers short-run time horizons and assumes other current operating costs to be fixed costs. The key steps in managing bottleneck resources are as follows: Step 1: Recognise that the bottleneck resource determines throughput contribution of the plant as a whole Step 2: Search and find the bottleneck resource by identifying resources with large quantities of stock waiting to be worked on. Step 3: Keep the bottleneck operation busy and subordinate all non-bottleneck resources to the bottleneck resource. That is, the needs of the bottleneck resource determine the production schedule of non-bottleneck resources. Step 4: A Take action to increase bottleneck efficiency and capacity the objective is to increase throughput contribution minus the incremental costs of taking such actions. Possible actions to be taken: Eliminate idle time (time when the machine is neither being set up to process products nor actually processing products) Process only those parts or products that increase sales and throughput contribution, not parts or products that remain in finished goods or spare parts stock Shift products that do not have to be made on the bottleneck machine to nonbottleneck machines or to outside facilities Reduce set-up time and processing time at bottleneck operations Improve the quality of parts or products manufactured at the bottleneck operation
Throughput accounting is a management tool, which is partly informed by the theory of constraints. The primary concern of TA is the rate at which a business can generate profits. A key point of focus is return per bottleneck, which underscores an important management accounting concern to maximise contribution per unit of a given limiting factor.
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Strategy could be described in terms of how an organisation matches its own capabilities with the opportunities in the marketplace in order to accomplish its overall objectives. Porters five forces model for the profitability analyses of the industry: 1. 2. 3. 4. 5. Competitors Potential entrants into the market Equivalent products Bargaining power of customers Bargaining power of input suppliers
Two basic strategies: 1. Product differentiation is an organisations ability to offer products or services that are perceived by its customers to be superior and unique relative to those of its competitors. 2. Cost leadership is an organisations ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste, and tight cost control.
4. Learning and growth Reengineering is the fundamental rethinking and redesign of business processes in seeking to achieve improvements in critical measures of performance such as cost, quality, service, speed and customer satisfaction. Several features of a good balanced scorecard: 1. It tells the story of a companys strategy by articulating a sequence of cause -andeffect relationships 2. It helps to communicate the strategy to all members of the organisation by translating the strategy into a coherent and linked set of understandable and measurable operational targets. 3. A balanced scorecard emphasises non-financial measures as part of a programme to achieve future financial performance. 4. The balanced scorecard limits the number of measures used by identifying only the most critical ones 5. The scorecard highlights suboptimal trade-offs that managers may make when they fail to consider operational and financial measures together. Another study found the following factors as playing a significant role in the successful deployment of a scorecard system: ABcosting is in place with recognised value to the organisation Two important objectives of a BS system are to communicate strategy and to align employees with strategy Formal ties exist between strategy and the scorecard system The scorecard system is sued at many levels: corporate office, individual managers/teams/divisions/customers/functional areas/product or service functions Compensation and reward systems are linked to measures used in the scorecard system Employees accept and use the scorecard system Pitfalls when implementing a balanced scorecard: Do not assume the cause-and-effect linkages to be precise, these are merely hypotheses Scorecards evolve over time To not seek improvements across all of the measures all of the time Do not use only objective measures in the scorecard Do not fail to consider both costs and benefits of initiatives Do not ignore non-financial measures when evaluating managers and employees The distinctive features of French and American societies and related differences in performance management systems see book page 785.
and hierarchical lines of authority are respected. The TdB is an ad-hoc tool, completely custom designed for a firm and for every one of its managers. TdBs report forecasts, actual result and variances in the conventional manner, but this information relates to non-financial data as well as to financial data. TdB include externally sourced information and general information of the business environment.
The objectives are the following: To assist the board in the oversight of the companys process To allow dealing with strategic choice and transformational change To give a true and fair view of a companys strategic position and progress To track actions into, and outputs form, the strategic process
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