academic-corner-of-unicattl - Tumblr blog

academic-corner-of-unicattl · 14 days ago

Text

Managerial Accounting and Control – Key Concepts

Financial vs. Managerial Accounting

Financial accounting and managerial accounting serve different purposes.

Users:

Financial accounting produces standardized reports (balance sheet, income statement, cash flows) for external users – investors, creditors, regulators – and follows GAAP/IFRS rules .

In contrast, managerial accounting provides detailed analyses to internal management to aid decisions .

Time focus:

Financial reports are wholly historical (past periods) , whereas managerial accounting uses historical data plus budgets and forecasts to look forward . Precision & Detail: Financial statements aggregate data into broad categories (e.g. total “Cost of Goods Sold”), while managerial reports drill down into products, segments, or activities with granular detail .

Regulation:

Financial accounting is highly regulated for public disclosure; managerial accounting is flexible and not bound by external standards . Common mistakes include treating managerial data as audited (it may involve estimates) or ignoring relevant internal details in financial reports.

Planning, Controlling, and Decision-Making Framework

Managerial accounting is built on three pillars:

Planning,

Controlling,

Decision-making .

In planning, managers set targets and budgets (sales forecasts, production schedules). In controlling, they compare actual performance to these targets and use variance analysis to identify issues. Decision-making uses cost analyses (e.g. break-even, make-or-buy) to choose among alternatives. For example, a sales budget drives production and labor plans; exceeding the sales target might trigger bonuses, while falling short can reduce compensation . Overall, this framework ensures efficient use of resources and aligns operations with strategy. (Common errors include not updating budgets when conditions change or ignoring both quantitative and qualitative decision factors.)

Cost Classifications: Direct vs Indirect; Fixed vs Variable vs Mixed

Costs are classified by traceability and behavior. Direct costs can be traced easily to a product or service (e.g. raw materials in a product, wages of assembly workers) . Indirect costs cannot be traced to one product (e.g. factory rent, electricity, supervisor salaries) and are usually allocated as overhead . By behavior, variable costs change in total with volume (e.g. shipping costs per unit, $1 per unit cups) , while fixed costs stay the same in total across the relevant range (e.g. $3,500 rent per month) . A mixed (semi-variable) cost has both parts (e.g. a utility bill with a fixed base fee plus usage charge) . Within the relevant range, total cost can be modeled as:

Total Cost = Fixed Cost + (Variable Cost per Unit × Number of Units)

Manufacturing vs. Non-manufacturing Costs

In manufacturing firms, manufacturing (product) costs include three categories:

Direct Materials: Raw materials that become part of the finished product (e.g. wood for furniture) .

Direct Labor: Labor costs of workers who physically make the product (e.g. machine operators) .

Manufacturing Overhead: All other factory costs (indirect materials, indirect labor, utilities, depreciation of equipment, factory insurance, etc.).

The sums of these are often grouped: Prime cost = DM + DL , Conversion cost = DL + MOH , and Total manufacturing cost = DM + DL + MOH . Non-manufacturing (period) costs include selling and administrative expenses. For example, marketing/advertising and sales staff salaries are selling costs, while executive pay and office utilities are administrative costs . These are not tied to production.

Product Costs vs. Period Costs

All costs are ultimately either product costs or period costs. Product costs are the manufacturing costs (DM, DL, MOH) that are inventoriable: they are capitalized on the balance sheet as inventory and expensed as Cost of Goods Sold when sold . For example, direct materials and factory overhead on a product become part of inventory. In contrast, period costs are non-manufacturing expenses that are expensed in the period incurred . These include SG&A like office rent, advertising, and CFO salary . In short: if a cost is related to making a product, it’s a product cost; otherwise it’s a period cost . A common error is mislabeling costs (e.g. treating office rent as product cost instead of period).

Managerial Perspectives

Managers use accounting within broader business contexts. Key perspectives include:

Ethics: Managerial accounting depends on trust and integrity. Ethical behavior is “the foundation of managerial accounting” – biased or falsified data render all analysis meaningless . Professional accountants follow codes (IMA/CIMA) that stress honesty, fairness, and responsibility . Always question whether data is complete and reported objectively.

Strategy: Accounting supports strategy by linking numbers to the company’s competitive plan. Strategy is a firm’s “game plan for attracting customers by distinguishing itself from competitors” . Cost reports help choose which products or segments to invest in. For instance, a low-cost producer strategy would emphasize activity-based costing to cut unnecessary overhead, while a differentiation strategy might allocate more to quality metrics.

Enterprise Risk Management (ERM): Managers identify and quantify risks (market, credit, operational) and plan responses. ERM is defined as “a process used by a company to identify its risks and develop responses to them to be assured of meeting its goals” . Relevant costs include potential losses, insurance, or contingency budgets. Accounting data is used to forecast how different risk scenarios affect profits.

Corporate Social Responsibility (CSR): Companies consider social, environmental, and stakeholder impacts. CSR means managers consider “the needs of all stakeholders when making decisions” . For example, waste disposal or carbon emissions may be tracked as part of costs (using full-cost or environmental costing methods). Non-financial metrics (customer satisfaction, community impact) complement financial reports in a CSR perspective.

Process Management: This involves streamlining business processes (like Lean). A business process is “a series of steps followed to carry out some task” . Managerial accounting measures costs and performance at each process step (e.g. cost per production line, cycle time). By analyzing process costs, managers can eliminate bottlenecks. For example, tracking cost per unit by process highlights inefficiencies.

Leadership: Beyond numbers, managerial accountants often advise and lead teams. Leadership skills help interpret data, communicate insights, and motivate employees toward goals. As one teaching note suggests, leadership skills allow managers to unite people and implement the firm’s strategy (e.g. fair compensation systems that reward performance) .

Each perspective guides what and how information is reported. For example, ethical issues remind managers to exclude sunk costs and report honestly; strategic context determines which segments matter most; ERM reminds us to include contingency costs; CSR adds measures beyond profit; process management focuses on continuous cost reduction; and leadership ensures the data drives action.

Cost Behavior Analysis and Relevant Range

Understanding cost behavior is crucial for forecasting. The relevant range is the normal operating span in which our cost assumptions hold . Within this range, fixed costs are fixed (in total) and variable costs scale linearly. For example, if a machine produces up to 1,000 units/day, costs (like depreciation or utilities) can be estimated reliably up to that point; beyond it, new costs (a second machine) would emerge, altering the cost function . Typical mistake: applying a fixed-cost assumption far outside the relevant range (e.g. assuming one factory rent covers 200% capacity).

The high-low method estimates mixed costs using only the highest- and lowest-activity data points . Steps: (1) Identify the periods with highest and lowest activity and note their total costs. (2) Compute the variable cost per unit as:

( Cost_high – Cost_low ) ÷ ( Activity_high – Activity_low )

For example, if maintenance cost was $1,060 at 1,460 units and $932 at 1,100 units, the variable cost/unit = (1,060–932)/(1,460–1,100) = $0.356 . (3) Calculate fixed cost by subtracting total variable cost from one of the totals. Using the high point: $1,060 – (1,460×0.356) = $540 fixed . (4) Write the cost formula: Total Cost = $540 + $0.356 × Units . Note this approximation uses only two points (ignoring the shape between), so it may be rough if data are erratic .

Differential, Opportunity, and Sunk Costs

When making decisions, not all costs are relevant.

Differential (Incremental) Cost: The difference in cost between two alternatives. E.g. if Option A costs $10,000 and B costs $8,000 annually, the differential cost of A vs. B is $2,000 . Similarly, differential revenue is the revenue difference. Decisions are based on comparing differential revenues and costs.

Opportunity Cost: The foregone benefit when one alternative is chosen over another. It isn’t recorded in accounting books but is crucial. For example, quitting a $25,000 job to return to school incurs an opportunity cost of $25,000 (the lost salary) . Every choice has one – e.g. using a machine for product A means losing whatever B it could have made. Managers should include opportunity costs as relevant (e.g. the rental income given up by using a building for production).

Sunk Cost: A cost already incurred and unchangeable by current decisions. For example, a machine bought years ago is now obsolete; its original purchase price cannot be recovered . Sunk costs should be excluded from decision analysis because they remain the same regardless of the choice . A common pitfall is letting sunk costs (like past R&D) influence new decisions; instead, focus on future costs and benefits.

In summary: use differential and opportunity costs in “what-if” analyses (they are relevant), but ignore sunk costs (they are irrelevant) .

Contribution Margin and Income Statement Formats

Contribution Margin (CM) is defined as Sales – Variable Costs .

It represents the amount available to cover fixed costs and contribute to profit. For example, if a product sells for $100 and has $40 of total variable cost (materials, labor, commissions), the contribution margin is $60 per unit . CM can be expressed in total, per unit, or as a ratio (% of sales) . It’s widely used for break-even and target-profit analysis (e.g. Break-even units = Total Fixed Costs ÷ CM per unit).

There are two common income statement formats: Traditional (absorption) and Contribution (variable costing). Both yield the same net income, but differ in presentation .

Traditional Income Statement: Used for external reporting. It first subtracts product (COGS) from sales to get Gross Profit, then subtracts period costs (selling & admin) to get net income. Expenses are grouped as product vs. period costs.

Contribution Income Statement: Used internally for decision-making. It first subtracts all variable costs from sales to get Total Contribution Margin, then subtracts total fixed costs to arrive at net income. Here expenses are classified by behavior (variable vs. fixed) .

Both statements reconcile to the same profit, but the contribution format highlights how volume affects profit. A typical mistake is misallocating fixed costs or failing to separate variable costs when preparing these statements, which can obscure break-even analysis.

0 notes