bu247 managerial accounting
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BU247 Managerial Accounting
with Natasha Neumann-Causi and Mike Pegutter
Updated Presentation
This presentation is up to date
- Uses material from new textbook- Follows course outline- Contains examples from prior exams
and from textbook questions- If I miss something, let us know and we
will explain it now or in an email
General Study Tips1. DON’T PANIC! 2. USE YOUR HANDOUT!3. Know the theory well, do not memorize
calculations!4. Practice homework with time constraints!!!!!5. If you get stuck on a question, leave it and
come back later6. When in doubt, GUESS! Never leave a
question blank7. Make sure you have answered everything
the question asked for!!!
Exam Outline• Multiple Choice Questions
– Definitions– Smaller calculations – Theories
• Short Answers– Big Calculations – Writing out Steps to Calculations
• Case Question– Combo
AgendaPART I: Controlling
• Transfer Pricing• Return on Investment (ROI)• Balanced Scorecard
PART II: Relevant Costs• Game-Changing Decisions• Product Pricing and Costing
PART III: Budgeting• Sales/Cash/Production/Labour Budgets• Flexible Budgets
PART IV: Analysis• Standard Costs, Variance Analysis• Profitability Analysis
PART V: Capital Budgeting• IRR, NPV, Payback
PART VI: Case Analysis
+ Midterm Review
Case AnalysisIssues
– Identify root causes of problem(s)– Primary issue: issue which needs to be
solved• Phrase in term of a question, such as, Which
special orders should the firm accept?– Secondary issues: other issues which
exist in the case
Case AnalysisKey Success Factors (KSF)• Factors critical to the success of
this specific firm • Will be part of criteria used
when evaluating solutions • These factors differ depending
on the industry and even between companies
Customer Focus
R&D
Process Design
Production
Marketing
Distribution
Customer Service
Case AnalysisIdentification of Alternatives• Make a list of feasible alternatives • Doing nothing can be an option, but it’s not
recommended
Quantitative Analysis• Analyze all of your alternatives • This will incorporate a variety of tools learnt in class
such as breakeven, contribution margin, variances....• Determine which costs are relevant and which are
not – i.e. ignoring sunk costs• Understand what the qualitative position is telling
you
Case AnalysisSensitivity Analysis• Re-do calculations if there is a 10-20% increase in
costs
Qualitative Analysis• Analyze all of your alternatives• Look back at your key success factors and see how
each alternative is contributing or taking away from KSF’s
• Can use your quantitative to guide qualitative analysis
Case AnalysisRecommendation • Based on above analysis determine the best solution • Briefly state recommended course of action • Tie back to key success factors and issue
Circumvention of Potential Problems • If you foresee any problems state them with
solutions• DO NOT say everything won’t work
BROKEN ISLAND KAYAKS
Answers on Laurier
SOS website!
Do They Have Capacity?
This has nothing to do with
capacity issues but showed up when I Googled
Kayaks!
Do Profits Increase?
Some Sensitivity
CONTROLLINGPart I
Decentralization • Decentralization is the process of spreading
decision-making authority• Responsibility Centres is the section of the
company a manager is responsible for– Cost Centres control only costs
• Examples: Accounting Department– Profit Centres costs and revenues
• Example: Cafeteria– Investment Centres costs, revenues and investments in assets
• Example: Corporate HQ
Investment CentresProfit Centres
Cost Centres
Transfer Pricing• A transfer price is the price charged by one segment
of a company to provide products to another segment– Example: KPMG Canada sharing contract fees with other
KPMG offices in different countries to help them complete an audit.
• There are three ways to calculate transfer prices1. Negotiated 2. Market Value3. Cost
Transfer Pricing: Negotiated
• This method lets each division work independently which helps promote decentralization of authority– This way is only successful if managers cooperate with each
other
• This method will produce a range of acceptable prices; – The highest point is the most the buying division is willing to
pay
– The lowest point will be as low as the selling division can afford
Negotiated Transfer Price Example
Unoriginal Inc. is a company which owns multiple grocery store chains including the famous Value Market chain, and also owns
a bakery franchise called Bakery Plus. Value Market stores strive to provide its customers with fresh produce everyday
and has recently expanded to include a baked goods aisle that sells (among other things) freshly baked pies. Given the
following information, determine the transfer price range for Value Market’s purchase of Bakery Plus pies.
Bakery PlusPie Production Capacity per Month Pie Sales per MonthVariable Cost per PieFixed Costs per MonthSelling Price
55,000 pies
45,000 pies$6/pie$80,000$15/pie
Value MarketPurchase Price of PiesMonthly Pie Sales
$12/pie20,000
Step 1: Does Bakery Plus have the capacity?No. Bakery Plus uses all of its capacity every month to serve its own customers and would therefore have to sacrifice customers to serve Value Market.
Step 2: Bakery Plus lowest transfer priceTransfer Price ≥ VC + (CM on lost sales / # of Transferred Units)Contribution of Lost Sales = ($15-$6)x 10,000 units of lost sales = $90,000Transfer Price ≥ $6 + ($90,000/20,000 units) = $6 + $4.5 = $10.5
Note: If Bakery Plus is not missing out on sales by providing to Value Market then “CM on lost sales” doesn’t apply and will equal $0
Step 3: Value Market’s highest transfer priceTransfer Price ≤ Outside Supplier CostTransfer Price ≤ $12
Step 4: RangeThe range of acceptable transfer prices is $10.5 - $12.
Transfer Pricing• Transferring at cost the transfer price to cost
or the full absorption cost*• There are a lot of problems with this:
– If cost is used for transfer price, the selling division will never get a profit out of it
– Cost-based transfer prices give the selling division no incentive to lower costs
• Market price is the price for a product on the open market and is often the best solution
Return on Investment (ROI)
• Where “Operating Income” is Earnings Before Interest and Taxes (EBIT)
• Where “Average Operating Assets” is (beginning assets + ending assets) / 2– Net Book Value (Cost – Accumulated Amortization)
• This will cause ROI to over time as the book value of assets • Adding a new asset will cause ROI
– Purchase Cost can be used as well to value assets which would make ROI impervious to asset purchases
• There are three ways to improve ROI– Increase Sales– Reduce Operating Expenses– Reduce Operating Assets
Return on Investment (ROI)• Another way to calculate:
• Criticisms of ROI– Management may not know good ways to
increase ROI– Managers of segments take on a lot of costs they
have no control over– Acts as a negative incentive for investment out of fear of skewing ROI
ROI
Margin = Operating
Income/ SalesTurnover =
Sales/Average Operating
Assets
Residual Income• Residual income is the operating income
that an investment centre earns above the minimum required return on its assets
The Old Navy division of The Gap has average operating assets of $220,000 and is required to earn
a return of 14%. In 2010, Old Navy has earned $60,000. Calculate residual income.
Step 1: Minimum Required ReturnOperating Assets x Required ROI = Minimum Return$220,000 x 14% = $30,800
Step 2: Residual IncomeActual Income – Minimum Required Return = Residual Inc.$60,000 - $30,800 = $29,200
The Balanced Scorecard• The balanced scorecard method uses
multiple interconnected perspectives of performance measurement to come up with one comprehensive measure
• Uses both financial and non-financial measures
• Can be an excellent performance review tool if done right
Balanced
Financial
Customers
Learning and
Growth
Internal Processes
Quality Costs• Quality of Conformance is when the majority of products
conform to design specifications and are defect-free – Anything that does not meet design specifications is a defect and
is indicative of low quality of conformance
• There are four categories of quality costs:– Prevention Costs – Activities done to reduce the number of
defects • (i.e. Training)
– Appraisal Costs – The cost of identifying defects • (i.e. Testing)
– Internal Failure Costs – The cost of fixing defective products before they are shipped
• (i.e. Reworking costs)– External Failure Costs – The costs which result from defective
products they have been shipped • (i.e. Warranty costs)
• Four key points on the relationships between these costsi. When the quality of conformance is low, total
quality cost is highii. Total quality costs drop rapidly as the quality of
conformance increasesiii. Reduce their total quality costs by spending on
prevention and appraisaliv. Total quality costs are minimized when the
quality of conformance is slightly less than (or equal to) 100%
RELEVANT COSTSPart II
Relevant Costs• Relevant costs are those that differ between
alternatives – These costs are avoidable because they are eliminated
through choosing one alternative over another– Costs that are relevant in one decision may not be relevant
in another context• Unavoidable costs are irrelevant to decision
making because they’re going to be incurred no matter what– Sunk Costs which are costs already incurred and were
paid for and cannot be changed; therefore they have no bearing on future decisions
– Future Costs that do not differ between alternatives
Game Changing Decisions1) Add or Drop segments of a company2) Make or Buy decisions3) Special Orders4) Joint Costs (Sell or Process)
Add or Drop Segments• Decision Rule: Drop the segment if overall profits
increase– Drop the segment if fixed cost savings > lost contribution
margin• It’s sometimes more profitable to keep a division
even when it’s losing money• The decision to keep this division lies in the way
common fixed costs are allocated– Example: If unavoidable costs are included in the analysis the product linemay appear to be less profitable than it actually is
Add or Drop ExampleConsider the following financial information for RCA
which is losing money on its CD Player division. Should RCA drop it?CD
PlayersSales $375,000Less Variable Expenses:
Manufacturing Expenses
$100,000
Contribution Margin
$275,000
Less Fixed Costs:Factory Rent
Fixed OverheadDepreciation
Direct AdvertisingGeneral Admin
ExpensesTotal Fixed Expenses
$45,000$10,000$80,000$100,000$50,000
$285,000
Net Loss ($10,000)
Drop CD Players$ -
$ -
$ -
$ - $ 10,000$80,000$ -$50,000
$140,000($140,000)
Difference$375,000
$100,000
$275,000
$ 45,000$ - $ - $ 100,000$ -
$145,000$130,000
Game Changing DecisionsMake or Buy Decisions
– Do an activity internally or outsource it– A company is vertically integrated when it takes care of
multiple functions within its value chain • The main drawback is losing out on cost savings because other
companies have economies of scale
Special Orders– A special order is a one-time order that is not normally
received– Decision Rule: incremental benefits > incremental costs– Steps
1. Do we have the available capacity?• If not, we will have to sacrifice regular business to make this order
2. Is it worth it? Yes, as long as you’re making a profit
Example in handout!
Joint Costs• Joint Products are produced from a common input • The Split-off Point is the point in manufacturing
where the products can be distinguished – Example: Mined ore
• Joint costs are allocated between these products at the split-off point (but are sunk costs)
• It is profitable to continue processing if increase in value > extra costs
Joint Costs ExampleSawmill Inc. cut logs from which unfinished lumber and sawdust
are the immediate joint products. Unfinished lumber is sold “as is” or processed further into finished lumber. Sawdust can also be sold “as is” to gardening wholesalers or processed further into “presto-logs”. Should Sawmill Inc sell or process these
products?Lumber SawdustSales Value at Split Off $140 $40Sales Value after ProcessingAllocated Joint Product CostsCost of Further Processing
$270$176$50
$50$24$20
Step1: Incremental Value of ProcessingIncremental Value = Sale Value after Process – Sale Value at Split Off Lumber = $270 - $140 = $130Sawdust = $50 - $40 = $10
Step 2: Profit from Processing FurtherProfit after Processing = Incremental Value – Cost of ProcessingLumber = $130 - $50 = $80Sawdust = $10 - $20 = ($10)Conclusion: Lumber should be processed further and sawdust should be sold as it is
Constrained Resources• A constraint is a limited resource that
restricts a company’s abilities – The specific thing constraining the activity is
called the bottleneck• Pick the product mix that maximizes
contribution margin
Constrained Resource Example
In Proctor & Gamble’s Crest division, there is a mixing machine that is working at 100% capacity. It has a
capacity of 90,000 minutes per week and is used to mix the ingredients for Crest’s special extra whitening
toothpaste and its regular toothpaste. Should P&G focus machine time on the whitening toothpaste or regular
toothpaste?Whitening
Regular
Selling PriceLess Variable ExpensesContribution MarginCurrent Weekly Demand Contribution Margin RatioMixing Time Required
$7.00$3.00$4.006,00036%10 minutes
$4.00$2.00$2.003,00050%15 minutes
Step 1: Contribution Margin per MinuteCM/minute = Contribution Margin per Unit / Mixing TimeWhitening CM per Minute = $4.00 ÷ 10 minutes = $0.40 / minuteRegular CM per Minute = $2.00 ÷ 15 minutes = $0.13 / minuteConclusion: Make all the whitening toothpaste needed first then make the regular toothpaste with the remaining capacity.
Step 2: Allocating Constrained Resource6,000 units x 10 minutes = 60,000 minutesTime Remaining = 90,000 mins – 60,000 mins = 30,000
mins30,000 minutes ÷ 15 minutes per regular toothpaste =
2,000 toothpaste
Step 3: Total Contribution MarginWhitening Toothpaste = 6,000 x $4.00 = $24,000Regular Toothpaste = 2,000 x $2.00 = $4,000Total CM = $28,000
Product Pricing• The Cost Plus Pricing method uses the product
markup to determine price– Markup is the difference between its selling price and its
cost• The Absorption Costing method uses the
absorption cost per unit rather than the variable cost to calculate markup– Steps
• Divide fixed costs by number of units produced• Add up all per unit costs to come up with the total unit cost• Multiple the unit cost by the markup percentage and add it on
to get the target selling price
BUDGETINGPart III
Budgeting• A budget is a detailed quantitative plan for acquiring
and using resources over the next period• An operating budget covers one year of the
company’s life at a time • A continuous budget always has the next 12 months
planned out by adding a month on the end• The most effective budget is one where managers
are only responsible for the costs they have control over– Participative budgets achieve this because all levels
contribute– Other benefits: creating a team environment, better
accuracy, increased motivation and the elimination of excuses for poor performance
Budgeting• The master budget is the summary of
many smaller budgets which are all interrelated
Sales Budget
Production Budget
Cash Budget
Direct Materials Budget
Direct Labour Budget
Overhead Budget
Cash Collections S&A
Expenses
Sales Budget & Cash Collections
Company ABC makes custom coffee mugs and is getting ready to make its sales budget for the quarter ended June 30, 2011.
The sales forecast is given below and the average price for a mug is $15. Only 5% of Royal York’s sales are in cash. The rest
of the sales are typically collected as follows: 60% collected within the month, 35% collected in the following month, 5%
uncollectibleApril May June July1M units 0.85M
units1.35M units
0.9M units
Step 1: Dollar Value of Estimated SalesApril = $15 x 1M mugs = $15M, May = $15 x 0.85M mugs = $12.75M, June = $15 x 1.35M mugs = $20.25M
Step 2: Cash and Sales on AccountApril Cash = $15M x 5% = $750,000 May Cash = $12.75M x 5% = $637,500April A/R = $15M x 95% = $14.25M May A/R = $12.75M x 95% = $12,112,500
June Cash = $20.25M x 5% = $1,012,500June A/R = $20.25M x 95% = $19,237,500
AprilCash $750,000
Within Month 60% x 14.25M = $8,550,000
Next MonthTotal Cash $9,300,000
May$637,50060% x 12,112,500 = $7,267,50035% x 14.25M = $4,987,500
$12,892,500
June$1,012,50060% x 20.25M= $11,542,50035% x 1,211,250 = $4,239,375
$16,794,375
Production BudgetUsing the projected sales, determine how many coffee
mugs need to be produced by Company ABC during the next quarter (ending June 30). Assume ending
inventory for March was 500,000 units. Assume that management wants ending inventory to equal 15%
of the next month’s budgeted sales.April May June July
1M units 0.85M units
1.35M units
0.9M unitsStep 1: Total Demand for Each MonthTotal Demand = Targeted Sales + Desired Ending InventoryApril = 1M units + (0.85M x 15%) = 1,127,500 unitsMay = 0.85M units + (1.35M x 15%) = 1,052,500 unitsJune = 1.35M units + (0.9M x 15%) = 1,485,000 units
AprilBudgeted Sales 1,000,000
Add: Desired End Inv.
127,500
Total Demand 1,127,500Less: Begin
Inventory500,000
Production 627,500
May
850,000202,5001,052,500127,500925,000
June
1,350,000135,0001,485,000202,5001,282,500
Quarter
3,200,000135,0003,335,000500,0002,835,000
Materials/Labour Budgets• The Direct Materials budget outlines all the raw
materials that are required to meet the production budget
• The Direct Labour Budget outlines all the labour hours required to meet the production budget
• The Manufacturing Overhead Budget estimates how much overhead will be incurred during the forthcoming period – Include all other costs besides direct labour and direct
materials involved with production
Direct Labour Budget Example
Using the production budget determined above, create the direct labour budget for Company ABC for the next quarter (ending June 30). Assume each coffee mug required 0.5 hours of labour and about $0.75
worth of materials. Company ABC currently has 2000 employees which work at least 40 hours a week at a
rate of $12/hour. There are no plans to layoff anyone.
AprilProduction 627,500
unitsDirect Labour/
Unit0.5 hours
Labour Hours Req’d
313,750 hours
Minimum Hours 320,000 hours
Labour Hours Paid
320,000 hours
Hourly Wage Rate
$12
Total Labour Cost
$3.84M
May925,000 units0.5 hours462,500 hours320,000 hours462,500 hours$12$5.55M
June Quarter1,282,500 units
2,835,000 units
0.5 hours 0.5 hours641,250 hours 1,417,500
hours320,000 hours 960,000 hours641,250 hours 1,423,750
hours$12 $12$7.695M $17.085M
Step 1: Minimum Labour CostSince ABC Inc. is not going to lay anyone off, they will have to pay 2000 employees for 40 hour work weeks (assuming 4 weeks in a month).
Minimum Labour Hours = 2000 employees x 40 hours/week x 4 weeks/month = 320,000 hoursMinimum Labour Cost = 320,000 hours x $12/hour = $3,840,000 per month
Manufacturing Overhead Budget
Using the direct labour budget determined above, create the manufacturing overhead budget for Company ABC for the next quarter (ending June 30). Assume manufacturing overhead is applied based on labour hours (cost driver). Company ABC believes about $1.7 of overhead costs are
incurred per direct labour hour. Fixed manufacturing overhead costs total $2,000,000 (including $1,000,000 of
amortization).April May June Quarter
Labour Hours Req’d
313,750
462,500
641,250
1,417,500
Step 1: Variable Manufacturing OverheadApril = 313,750 hours x $1.7/hour = $533,375May = 462,500 hours x $1.7/hour = $786,250June = 641,250 hours x $1.7/hour = $1,090,125
Step 2: Total Manufacturing OverheadApril = $533,375 + $2,000,000 = $2,533,375May = $786,250 + $2,000,000 = $2,786,250June = $1,090,125+ $2,000,000 = $3,090,125Quarterly Total = $8,409,750
Step 3: Predetermined Overhead Rate (POHR)Total Overhead for the Quarter = $8,409,750Total Labour Hours Required = 1,417,500 hoursPOHR = $5.93
Step 4: Monthly Cash DisbursementsApril = $2,533,375 - $1,000,000 amortization = $1,533,375May = $2,786,250 - $1,000,000 amortization = $1,786,250June = $3,090,125 - $1,000,000 amortization = $2,090,125Quarterly Total = $5,409,750
Ending Finished Goods Budget
• The Ending Finished Goods Budget determines the expected value of the ending inventory for the upcoming period for which all of these budgets have been made– This is typically referred to when estimating storage costs
• Sum the per unit production costs– From the “Company ABC” example, “total per unit cost”
would be $6.30:• $12 hourly direct labour x 0.5 hours required in production = $6• $0.75 direct materials per mug • $5.93 manufacturing overhead per mug
• Multiply the per unit cost by expected leftover inventory– From “Company ABC” example, June ending inventory is
135,000 coffee mugs– Value of ending inventory will be ($12.68 x 135,000 units =
$1,711,800)
Cash Budget• The Cash Budget pulls everything together
into one nice summary! There are four sections:1. Cash receipts listing all cash inflows
• excluding borrowing, so basically just cash from sales2. Cash disbursements listing all payments
• excluding repayments of principal and interest3. Cash excess or deficiency
• resultant of step 1 – step 24. The financing section listing all borrowings,
repayments and interest
Cash Budget Example• Create an entire cash budget for Company ABC!!
– A line of credit of up to $2,000,000 is available at a 10% interest rate
– Company ABC aims to maintain a minimum of $50,000 in cash at the end of each month
– Borrowing are on the first day of the month and are repaid on the last day of the month (for simplicity)
– Company ABC paid a dividend of $1M in June– Company ABC purchased equipment for $6.2M in cash in May– Opening cash balance for April 1 is $70,000– Assume monthly Selling and Administrative costs of $1M,
$1.5M and $2M in April, May and June respectively– Assume monthly Direct Material expenses of $0.75M, $1.25M
and $1.75M in April, May and June respectively
Flexible Budgets• Static budgets are prepared for a single planned
level of activity which is hard to work with• Flexible budgets address this problem by
simultaneously showing multiple activity levels– Planned level of activity and the actual level of activity
• This method therefore exposes variances related to cost controls
Example in handout!
ANALYSISPart IV
Standard Costs• Standards are the per unit costs used in
budgeting– Quantity Standards say how much input should
be used• These are found in a “Bill of Materials”• Example: Each Toyota car should have four Bridgestone
tires– Cost Standards are how much each input should
cost• Includes delivery costs, final price with discounts
deducted• Example: Each Bridgestone tire should cost Toyota about
$20 each
Pros/ Cons in
handout!
Standard CostsDirect Labour Standards• Direct Labour Rate Standards will include wages, benefit costs
(rate per hour) • Time Standards are the time required to build a product (hours
per unit)Variable Overhead Standards• Manufacturing Overhead Rate Standards represent the
variable cost portion of the Predetermined Overhead Rate (POHR)
• Activity Standards are the estimates of allocation base occurrences used in the denominator of the POHR – Such as # of direct labour hours expected or # of products
expected to be made, etc.Direct Materials• There will be expected or ‘standard’ prices for direct materials
as well as a ‘standard’ amount of materials used per unit as indicated by the design specifications of the product
Variance AnalysisPrice Variance• (actual – standard price)
– Materials Price Variance– Labour Rate Variance– Variable Manufacturing
Overhead Variance
Quantity Variance• (actual – standard
quantity)– Materials Quantity
Variance– Labour Efficiency Variance– Variable Manufacturing
Overhead Efficiency Variance
Analysis
Q Variance
Standard Q X Standard
PActual Q x Standard P
P Variance Actual Q x Actual P
Material Variance ExampleIn order to make light bulbs, Company XYZ requires
about 20g of glass at an expected price of about 2 cents per gram. Company XYZ spent $500,000
buying 21,000 kgs of glass to make 1 million light bulbs in March. Calculate the quantity and price
variances. Step 1: Quantity VarianceQuantity Variance = (Standard Q x Standard P) – (Actual Q x Standard P)
Standard Quantity = 20g/bulb x 1 million bulbs = 20 million grams of glass (or 20,000 kgs)
Standard Price Conversion = 1000 grams/kg x $0.02/gram = $20/kg
Quantity Variance = (20,000 kgs x $20/kg) – (21,000 kgs x $20/kg) = $20,000 unfavourable
Step 2: Price VariancePrice Variance = (Actual Q x Standard P) – (Actual Q x Actual P)Actual Price = $500,000/(21,000 kgs) = $23.81/kgPrice Variance = (21,000 kg x $20/kg) – (21,000 kg x $23.81/kg) = $80,010 unfavourable
Note: In this example the amount of material bought was the same about
used. If these two quantities differ the price variance is calculating using
quantity purchased; whereas the quantity variance is calculated using
quantity used.
Variable Manufacturing Overhead Variance
ExampleIn order to make light bulbs, Company XYZ requires variable manufacturing overhead of about 6 minutes
per bulb at a standard price of $4 per hour. Company XYZ hired 620 employees working 40 hour
weeks (4 weeks a month) to make 1 million light bulbs in March and spent a total of $0.5M. Calculate
the quantity and price variances. Step 1: Quantity VarianceQuantity Variance = (Standard Q x Standard P) – (Actual Q x Standard P)
Standard Quantity = 6 minutes ÷ 60 mins/hour =10 bulbs/hour 1M bulbs ÷ 10 bulbs/hour = 100,000 hours
Actual Quantity = 620 employees x 40 hr week x 4 weeks = 99,200 hours
Quantity Variance = (100,000 hours x $4/hour) – (99,200 hours x $4/hour) = $3,200 favourable
Step 2: Price VariancePrice Variance = (Actual Q x Standard P) – (Actual Q x Actual P)Actual Price = $0.5M/99,200 hours = $5.04/hour Price Variance = (99,200 hours x $4/hour) – (99,200 hours x $5.04/hour) = $103,200 unfavourable
Profitability Analysis• Compares sales from budgeted sales to
actual results using flexible budgets
Actual versus Flexible
Actual Results•Actual
Quantities•Actual Selling
Price & Costs
Flexible Budget•Actual
Quantity•Budgeted
Selling Price & Costs
Master Budget•Budgeted
Quantity•Budgeted
Selling Price & Costs
Profitability Analysis• Compares sales from budgeted sales to
actual results using flexible budgets
Flexible versus Master
Actual Results•Actual
Quantities•Actual Selling
Price & Costs
Flexible Budget•Actual
Quantity•Budgeted
Selling Price & Costs
Master Budget•Budgeted
Quantity•Budgeted
Selling Price & Costs
Sales Volume Calculations
Alterative Calculation #1
Sales Volume Calculations
Alterative Calculation #2
Profitability Analysis Example
• Calculate:a) Sales Price Varianceb) Sales Volume Variancec) Sales Volume Variance
using market volume and market share
d) Sales Volume Variance using sales mix and quantity
Budget ActualSales in
Units:Ceramic
PlatesChina Plates
20,0008,000
18,00010,000
Price per Unit:
Ceramic PlatesChina Plates
$10$25
$12$20
Budget ActualMarket
Volume:Ceramic
PlatesChina Plates
80,00032,000
90,00028,000
Variable Cost per
Unit:Ceramic
PlatesChina Plates
$7$12
$7$12
Profitability Analysis Example
• Calculate:a) Sales Price Variance
Budget ActualSales in
Units:Ceramic
PlatesChina Plates
20,0008,000
18,00010,000
Price per Unit:
Ceramic PlatesChina Plates
$10$25
$12$20
Budget ActualMarket
Volume:Ceramic
PlatesChina Plates
80,00032,000
90,00028,000
Variable Cost per
Unit:Ceramic
PlatesChina Plates
$7$12
$7$12
Profitability Analysis Example
• Calculate:b) Sales Volume Variance
Budget ActualSales in
Units:Ceramic
PlatesChina Plates
20,0008,000
18,00010,000
Price per Unit:
Ceramic PlatesChina Plates
$10$25
$12$20
Budget ActualMarket
Volume:Ceramic
PlatesChina Plates
80,00032,000
90,00028,000
Variable Cost per
Unit:Ceramic
PlatesChina Plates
$7$12
$7$12
Profitability Analysis Example
• Calculate:c) Sales Volume Variance using market volume and market
share Budget ActualSales in
Units:Ceramic
PlatesChina Plates
20,0008,000
18,00010,000
Price per Unit:
Ceramic PlatesChina Plates
$10$25
$12$20
Budget ActualMarket
Volume:Ceramic
PlatesChina Plates
80,00032,000
90,00028,000
Variable Cost per
Unit:Ceramic
PlatesChina Plates
$7$12
$7$12
Profitability Analysis Example
• Calculate:c) Sales Volume Variance using sales mix and quantity
varianceBudget ActualSales in
Units:Ceramic
PlatesChina Plates
20,0008,000
18,00010,000
Price per Unit:
Ceramic PlatesChina Plates
$10$25
$12$20
Budget ActualMarket
Volume:Ceramic
PlatesChina Plates
80,00032,000
90,00028,000
Variable Cost per
Unit:Ceramic
PlatesChina Plates
$7$12
$7$12
CAPITAL BUDGETINGPart V
Capital Budgeting Decisions
• Capital Budgeting involves making decisions on projects and equipment that are really expensive!– Screening decisions are when we are trying to figure out
if the project meets our standards– Preference decisions are when we are picking the best
candidate from a group of possible projects
• Most common types of capital budget decisions:– Plant Expansion– Equipment Selection– Lease or Buy– Cost Reduction– Equipment Replacement
Time Value of Money “A dollar received today is worth more
than a dollar received tomorrow”
Time Value of Money “A dollar received today is worth more
than a dollar received tomorrow”
Not in
Handout
The Payback Method• One of two methods used to determine if a
project is worth while• A payback period is the time that it takes for
a project to earn enough money to recover its cost
Remember: You need to calculate partial years.
Payback ExampleDairy Queen is contemplating ice cream slurry
machines which will cost $1M and last approximately 4 years. The company expects these machines to improve operational efficiency which equates to a
$200,000 cash flow in the first year, $250,000 cash flow in the 2nd, and $275,000 and $300,000 in the 3rd
and 4th year, respectively. If the standard payback period is 3 years, will they take it on?
Year 1 + Year 2 + Year 3 = $725,000 $1,000,000 needed - $725,000 earned = $275,000 still requiredYear 4 earn $300,000 in total but only need $275,000 therefore3 years + (275,000/300,000) = 3.92 years
Dairy Queen will not take on this project.
Net Present Value• Steps to Calculate:
1. Calculate present value of cash inflows (cash received)• (i.e.) salvage value, cost reductions, revenues
2. Calculate present value of cash outflows (cash paid)• (i.e.) repairs, working capital required, operating costs• Depreciation is not an outflow
3. Subtract (1) from (2)• If the answer is zero or positive, the project is
acceptable• The cost of capital is the minimum required rate of
return• Three methods of NPV
1. Total-Cost Method NPV of all costs and revenues (highest NPV wins)
2. Incremental-Cost Method NPV of the differences (NPV > 0, 1 wins)
3. Least-Cost Method used when you only have costs (lowest NPV wins)
NPV ExampleEmpire Theatres is considering installing a new popcorn maker. The average popcorn maker costs
$70,000 and lasts for 5 years. As a result of installing this new popcorn maker will increase
capacity, reduce operating costs and increase profits by $20,000 with a cost of capital of 10%. At the end of 5 years Empire Theatres will be able to sell the
popcorn maker for $10,000.Map Out the Cash Flows:•Time 0: Cash Outflow of $70,000 to purchase the machine •Yrs 1-5: Cash Inflows of $20,000 of increased profits•Yr 5: Cash Inflow of $10,000 when sold at salvage value
Calculate NPV Values:-present value of annuity table, for 20,000 pmt each yr•Periods=5•N=10%•Annuity factor = 3.791•$20,000 x 3.791= $75,820
Calculate overall NPV:(70,000) + 75,820+ 6,210 = $12,030
Calculate NPV Values:-present value of salvage value, present value of single future amount •Period: 5•n=10%•factor: 0.621•$10,000 x 0.621 = $6,210
Internal Rate of Return• Is the rate of return which will make the NPV
of a project equal zero• If the IRR is greater than the company’s
targeted rate of return, it is acceptable• The higher the IRR, the more desirable the
project
IRR ExampleCheapCar2Go is looking to invest in a new car
washing facility. It will cost $104,320 and will save $20,000 per year in operating costs.
Assume that the new facility will last for 10 years. The company has a policy that all
projects must have an IRR of 20%. Investment required Net annual cash flows
PV factor for theinternal rate of return =
$104, 320 $20,000 = 5.216
Corresponds to an IRR value of 14%
(see Present Value Annuity Table)
Final Study Tips- Your textbook is good- Read your end-of-chapter summaries
posted on MyLearningSpace- Practice questions in order to
understand concepts better- Do not memorize how to do calculations- Look over in-class cases
MIDTERM REVIEWPart VII
Cost – Volume – Profit Analysis
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
- 100 200 300 400 500 600 700 800
Total Sales
Total Costs
Fixed Costs
Breakeven Point
Relevant Range• Relevant range and Step Variable
Costs are ranges where your per unit variable costs and your fixed costs will stay constant– Outside of this range these costs will
change As long as Brick Brewery is making between 30,000 and 75,000 cases of beer, it costs $3.00 a beer to produce and fixed costs are $1.5M a month. 30 75
Breakeven Analysis• Calculating how many units need to be sold
before you can start making some profits• Equation Approach:
• Contribution Margin Method:
CVP with Product Mixes• Companies which sell more than one product
involves a ratio called a ‘sales mix’ • Management will try playing around with ratios like
these to see which combination is more profitable• In situations with sales mixes the calculations for CM
will change to ‘average contribution per unit’:
Cost Behaviours• Step costs change abruptly at intervals of activity because
the resources and their costs come in indivisible chunks (example: salaries)
• Mixed costs contain both variable and fixed cost elements – Example: maintenance costs – supplies + labour
Management Influenced Costs• Capacity costs - fixed costs incurred when achieving a
desired production level (example: building a plant)• Committed fixed costs -large indivisible chunks of cost that
the company is obligated to pay– Example: mortgage payments
• Discretionary fixed costs are heavily influenced by management’s decisions each period on how much to spend on things like advertising, research and development, training, etc. – Example: no more lavish award ceremonies every quarter for top
salesmen – These costs do not have clear connections to production output
levels
Every cost could essentially be committed /
discretionary but it depends on contracts
you have and your ability to change it
Cost Methods: Absorb & Vary
Absorption Costing –includes manufacturing overhead in the costs which are assigned to
inventory– “Full Costing”, in accordance with GAAP– Costs are classified by function (selling vs. manufacturing)– Inventory costs consider both variable and fixed costs– This method produces a higher inventory value since it
includes fixed costs• With this method, fixed manufacturing overhead costs are
included in inventory, and a formula is used in order to allocate costs to ‘work-in-process’
Cost Methods: Absorb & Vary
Variable Costing – this approach tries harder to separate fixed costs from variable costs
and uses a style of income statements which highlights the total fixed costs
– “Direct Costing”– Costs are classified by behaviour (variable vs.
fixed)– Inventory costs consider only variable costs– This method helps with CVP analyses– Production does not affect operating income
under this approach – Under variable costing fixed costs can be
attributed to separate divisions and therefore controlled more easily
Absorption vs. Variable
ABC CompanyAbsorption Income Statement
Sales $75,000Cost of Goods Sold:
Direct Material 10,000Direct Labour 15,000Overhead 7,000
Gross Profit$43,000Selling Expenses 15,000Admin. Expenses 17,000Operating Income $11,000
Product Costs Period CostsAbsorption Costing Variable Manufacturing
Costs+ Fixed Manufacturing Overhead
Variable Selling & AdministrativeFixed Selling & Administrative
Variable Costing Variable Manufacturing Costs
Variable Selling & AdministrativeFixed Selling & Administrative+ Fixed Manufacturing Overhead
ABC CompanyVariable Costing Income Statement
Sales $75,000Variable Expenses:
Direct Material 10,000Direct Labour 15,000Overhead 3,000Variable Selling
8,000Variable Admin 8,000
Contribution Margin $31,000Fixed Expenses:
Overhead 4,000Selling & Admin 16,000
Operating Income $11,000
Absorption vs. Variable• Variable costing statements are considered easier
to understand because net operating income is only affected by changes in unit sales
• We cannot do CVP analysis with absorption costing because it considers overhead to be a variable cost
• Both methods can be used when filing tax returns, but only absorption costing is allowed for external purposes
• For absorption costing we use units produced; whereas with variable costing we use units soldRelationships b2n
Product and SalesInventory Effects Comparison b2n
IncomeProduction > Sales Inventory Absorption > VariableProduction < Sales Inventory Absorption < VariableProduction = Sales No Change Absorption = Variable
Manufacturing Overhead Cost Allocation
• The POHR is used no matter what the real overhead costs are and what the actual allocation activity is
• The per unit cost calculated above ≠ marginal cost of the product; if an additional unit was produced the per unit cost would slightly decrease
Underapplied / Overapplied• Since the POHR contains estimates, the manufacturing overhead that
we actually incur and the amount applied to Work in Process using the POHR will differ 99% of the time
• Underapplied overhead - overhead applied to jobs is less than the total amount of overhead actually incurred– this will result in a remaining debit balance in the manufacturing overhead
account• Overapplied overhead - overhead applied to jobs is greater than
the total amount of overhead actually incurred– this will result in a remaining credit balance in the manufacturing overhead
account
• The difference between applied overhead and actual overhead can be dealt with in three ways:1. Close directly to Cost of Goods Sold Expense2. Allocate proportionately between WIP, Finished Goods, and COGS
Expense• based on their relative dollar value
3. Carry the balance in manufacturing overhead over to the next year
Product Costing Systems• Process Costing – the company mass produces one
homogenous product– Costs are accumulated by departments and thus calculates unit costs by department as well– Production is uniform on all units
• Job – Order Costing System – the company builds to order a range of unique products– Direct materials and labour will be allocated to each job as they are incurred– Indirect costs (like overhead) will accumulate over time and then be allocated
Equivalent Units (Weighted Average
Method)• The number of complete units you could get
from putting together all the partially complete units that are sitting around in Work in Process inventory at the end of a period
Example: one unit that is 70% done put together with another unit 30% complete makes one completely
finished equivalent unit
Service Department Cost Allocations
• Operating departments are the ‘heart and soul’ of the organization and carry out its purpose in life
• Service departments support the company and its operating departments; their costs incurred by these departments are allocated unto the operating departments which in turn allocate all costs to units produced
• Reciprocal Services is the term used to describe the concept of service departments and operating departments provided services to each other
Service Department Costs
Operating Department Costs
Products
Service Allocation Methods: Direct
Ignore transactions between service departments and assume service
departments only provide to operating departments
All costs are allocated to operating departments based on the proportion of total
allocation base
Service
Operating
Service Allocation Method: Step-Down
Service Department “A” provides services to Service Department “B” (but no reciprocation) and both pass
on to the Operating Departments
All costs incurred by service departments are allocated to operating departments based on the proportion of
total allocation base
TIPS- Order matters, we need to know which service
department serves the other
Service
A
Service
B
Operating
Service Allocation Method: Reciprocal
Service Department “A” provides services to Service Department “B” and vice versa
Know what it is, but not how to do it.
Service A
Service BOperating
Activity-Based Costing• A non-traditional way of allocating costs• ABC costing is more careful about which costs are
considered; only costs that are affected by product-related decisions are used– not all manufacturing costs, some non-manufacturing costs
• ABC costing has the highest number of cost pools and overhead application rates– POHR applies to the entire factory and all its departments– Process costing uses different overhead rates for
departments– ABC costing has as many rates as there are activities
• The ABC costing method has the ability to segregate costs associated with unused capacity
Activity Costing• An activity is an event that causes the consumption
of overhead resources (i.e. taking customer orders)
Five Levels of Activity1. Unit-Level Activities – activities that arise each time a
product is produced (i.e. electricity)2. Batch-Level Activities – activities that involve processing or
handling batches of product (i.e. moving them) 3. Product-Level-Activities – activities related to products that
must be done regardless of production (i.e. marketing and engineering design)
4. Customer-Level-Activities – have to do with the customers themselves (i.e. customer service)
5. Organization-Sustaining-Activities – are done no matter what else is going on
This is the only type of activity
directly related to volume of production
Implementation of ABC1. Identify and define activities
– There is no ‘right’ or ‘wrong’, there is ‘accurate’ and ‘less accurate’
2. Assign overhead costs to activity cost pools
– Only overhead, no direct or indirect3. Calculate activity rates
– Using total activity estimates for each activity4. Assign overhead costs to cost objects
– Common cost objects: products, orders, customers
5. Prepare management reports
Cons of ABC Costing• ABC costing is not typically used for external
reporting because– Don’t need all the detail– Cost too much to start using ABC Costing– GAAP standards don’t like ABC– There is a lot of subjectivity
• ABC costing has its own limitations too– It costs a lot of money– Resistance from the employees when new systems are
put in place– Misinterpretation of the results– Many companies like to allocate all their costs to the
products rather than to customers and orders– Everyone needs to conform to GAAP
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