Outline • Segmented Reporting and Responsibility Accounting System • Cost-Volume-Profit Analysis • Budgeting and Budgetary Control • Standard Costs and Variance Analysis • Managerial Decision Making
Introduction • Let’s look at the XYZ Company example. • A manager at XYZ Company wants to replace an old machine with a new, more efficient machine.
Introduction • XYZ’s sales are Rs2000000 per year. • Fixed expenses, other than amortization, are Rs700000 per year. • Should the manager purchase the new machine?
Introduction • The manager recommends that the company not purchase the new machine since disposal of the old machine would result in a loss:
Introduction • Is it correct? • What’s your comment to the manager’s decision? • After learning this chapter, you will know how to employ the tools of managerial accounting and make decisions correctly.
Segmented Reporting • Organizations may break down their operations into various segments • divisions, stores, services, or departments. • Management needs reports on each segment for • cost management • performance evaluation
Segmented Reporting • Segments may be evaluated as • a cost centre • a profit centre • Profit centre reports include information on a segment’s revenues and costs. • an investment centre. • Some costs are direct and some are indirect. • Indirect costs may be allocated to various departments.
Segmented Reporting • Service department costs are shared indirect expenses of operation departments. • They may be allocated using a variety of bases.
Responsibility Accounting System • Responsibility Accounting System • An accounting system • assigns managers the responsibility for costs and expenses under their control.
Responsibility Accounting System • Responsibility accounting budgets • are prepared prior to each accounting period • Responsibility accounting performance reports • compare actual costs and expenses to budgeted amounts
Cost-Volume-Profit Analysis (CVP) • CVP analysis is used to answer: • How much must I sell to earn my desired income? • How will income be affected if I reduce selling prices to increase sales volume? • How will income be affected if I change the sales mix of my products? • ……?
Assumptions of CVP Analysis • CVP analysis assumes relations can be expressed as straight lines within the relevant range. • Unit selling price remains constant. • Unit variable costs remain constant. • Total fixed cost remain constant. • If the expected cost and revenue behaviour is different from the assumptions, then the results of CVP analysis are of limited use.
Change in costChange in units Unit Variable Cost = Slope = 20 * * * Vertical distance is the change in cost. * * * * * Total Cost in1,000’s of Dollars * * 10 Horizontal distance is the change in activity. 0 0 1 2 3 4 Activity, 1,000’s of Units Produced Scatter Diagram
30 - 20 5 - 1 Unit Variable Cost = = Rs2.50/unit * * Vertical distance is the change in cost. (30 - 20) 30 * * * * * * Total Cost in1,000’s of Dollars * * 20 Horizontal distance is the change in activity. (5 - 1) 10 0 0 1 2 3 4 5 Activity, 1,000’s of Units Sold High-Low Method
Least-Squares Regression • Least-squares regression • is usually covered in advanced cost accounting courses. • is commonly used with computer software because of the large number of calculations required. • The objective of the cost analysis remains the same: determination of total fixed cost and the variable unit cost.
Sales Costs and Revenuein Dollars Total costs Volume in Units Break-Even Analysis • The break-even point is the unique sales level at which a company neither earns a profit nor incurs a loss.
Fixed Costs Break-even point in units = Contribution margin per unit Unit sales price less unit variable cost Break-Even Analysis • The break-even point may be expressed in units or in dollars of sales.
Fixed Costs Break-even point in dollars = Contribution margin ratio Unit sales price Unit variable cost Break-Even Analysis • The break-even formula may also be expressed in sales dollars.
Pre-tax Income = Sales – [Fixed costs + Variable costs] or Pre-tax Income = Sales –Fixed costs - Variable costs Computing Income from Expected Sales • What is the income given a predicted level of sales?
Fixed costs + Target income Unit sales = Contribution margin per unit Fixed costs + Target income Dollar sales = Contribution margin ratio Sales Volume Needed toEarn a Target Income • Break-even formulas can be adjusted to show the sales volume needed to earn any amount of income.
Margin of safety, percent Expected sales - Break-even sales = Expected sales Margin of Safety • Margin of safety • How much sales can decrease before the company incurs a loss?
Sensitivity Analysis • The effects of changes in variables such as sales price, variable costs, and fixed costs. • CVP analysis can be used to show the effects of such changes. New break-even point in dollars New fixed costs = New contribution margin ratio
Budgets • Budgets • formal statements of a company’s plans expressed in monetary terms • attempt to capture the future activities of an organization • are used by businesses, not-for-profit, government, educational, and other types of organizations.
Defines goals and objectives Promotes analysis anda focus on the future Communicates plansand instructions Advantages Coordinates business activities Motivates employees Provides a basis forevaluating performance Importance of Budgeting
Budget Committee • Budget Committee • Consists of managers from all departmentsof the organization • Provides central guidance • to insure that individual budgets submitted from all departments are realistic and coordinated.
Flow of budget data isa bottom-up process. Budget Committee
Operating Budget 2005 2006 2007 2008 The annual operating budget may be divided into quarterly or monthly budgets. Budget Cycle • Budget horizons are usually for one year • but may extend for several years.
Continuous or Rolling Budget 2005 2006 2007 2008 The budget may be a twelve-month budget that rolls forward one month as the current month is completed. Rolling Budgets
Master Budget • Master Budget • A formal, comprehensive plan • for the future of a company • consists of several budgets linked together • to form a coordinated plan for the organization
Prepare manufacturing budgets: • material • labour • overhead Preparesalesbudget Developproductionbudget • Prepare financial budgets: • cash • income • balance sheet Prepareselling andgeneraladministrativebudgets Preparecapitalexpenditurebudget Master Budget
Sales Budget • Sales budget • the starting point in the budgeting process. • Most of the other budgets are linked to the sales budget. • Sales personnel are often involved in developing the sales budgets.
Sales Budget Estimated Unit Price Estimated Unit Sales Analysis of economic and market conditions+Forecasts of customer needs from marketing personnel Sales Budget
Budgeted beginning inventory Merchandise inventory to be purchased Budgeted ending inventory Budgeted sales for the period _ + = Merchandise Purchases Budget • Merchandise Purchases Budget • Provides detailed information about the purchases • necessary to fulfill the sales budget and provide adequate inventories.
Merchandise Purchases Budget • The quantity purchased is affected by: • Just-in-time inventory systems • enable purchases of smaller, frequently delivered quantities. • Safety stock inventory systems • provide protection against lost sales caused by delays in supplier shipments.
Selling Expense Budget • Selling Expense Budget • lists the types and amounts of selling expenses • Predictions of expenses are based on the sales budget and past experience.
General and Administrative Expense Budget • General and Administrative Expense Budget • lists the predicted operating expenses not listed in the sales budget • Includes both cash and non-cash expenses • Often prepared by the officemanager or person responsiblefor general administration
Capital Expenditures Budget • Capital Expenditures Budget • lists the cash inflows or outflows pertaining to the disposal or acquisition of capital equipment. • is usually affected by the organization’s long-term plans.
Cash Budget • Cash Budget • lists the expected cash inflows andoutflows for the period • a tool used by management toavoid excess cash balances orcash shortages • Information from other budgets is used in its preparation • Information from the cash budget is used to prepare the budgeted income statement and balance sheet
Production and Manufacturing Budgets • Manufacturing companies need to prepare additional budgets that include: • Production budgets • Direct materials purchase budgets • Direct labour budgets • Manufacturing overhead budgets
Number of units to be produced Budgeted ending inventory Budgeted sales for the period _ Budgeted beginning inventory = + Production and Manufacturing Budgets • Production and Manufacturing Budgets • Provides detailed information about the production necessary to fulfill the sales budget and provide adequate inventories.
Units of raw materials to be purchased Materials needed for production Budgeted ending inventory Budgeted beginning inventory _ = + Cost of raw materials to be purchased Units of raw materials to be purchased Material price per unit of raw material × = Production and Manufacturing Budgets • Direct Materials Budget • Provides detailed information about the purchases of raw materials necessary to fulfill the production budget and provide adequate inventories.
Production and Manufacturing Budgets • Direct Labour and Manufacturing Overhead Budgets • Provides information about the labour and manufacturing overhead costs given the level of production for the period.
Cash Budget ExpectedReceipts andDisbursements BudgetedIncomeStatement BudgetedBalanceSheet Preparing Financial Budgets
Develop the budgetfrom planned objectives. • Compareactual with budget andanalyze anydifferences. • Reviseobjectivesand preparea newbudget. This is an ongoing process. • Take corrective andstrategic actions. Budgetary Control
Capital Budgeting • Capital Budgeting • Analyzing alternative long-term investments and deciding which assets to acquire or sell. • These decisions require careful analysis since: • The outcome is uncertain. • Large amounts of money are usually involved. • Investment involves a long-term commitment. • Any decision may be difficult or impossible to reverse.
Zero-based Budgeting • Zero-based Budgeting • are prepared assuming no previousactivities for the activities beingplanned • Managers must justify the amounts budgeted for each activity • is popular among government and non-profit organizations.
Fixed Budget • Fixed budgets • are prepared for a single, predicted level of activity • Performance evaluation is difficult when actual activity differs from the predicted level of activity. • Example: How much ofthe unfavourable costvariance is due to higheractivity, and how much is dueto poor cost control? • To answer these questions, we must flex the budget to the actual level of activity.
Flexible (Variable) Budgets • Flexible budgets • are prepared after a period’s activities are complete. • Show revenues and expenses that should have occurred at the actual level of activity. • Reveal cost variances due to good cost control or lack of cost control. • Improve performance evaluation.
Flexible (Variable) Budgets • Flexible budgets • To prepare a budget for different activity levels • we must know how costs behave with changes in activity levels • Total variable costs changeindirect proportion tochanges in activity. • Total fixed costs remainunchanged within therelevant range. Variable Fixed