Management in Engineering

Managerial vs. Financial Accounting Lecture

► Business Math 101
► Accounting for Decision-Making

Dr. Abbott Weiss

Senior Lecturer

1
 Today’s Agenda

► Introduce concepts of break-even analysis, gross

margin, pricing, and the time value of money

► Discuss the uses of Managerial Accounting for

decision-making within an operation
• Compare costing systems and financial accounting
• Understand activities which drive costs
• Understanding profitability in the real world

2
3
Goal for this class

Understand (and can apply) the difference

between financial accounting

and

Financial analysis for managerial /

operational decision-making

4
There’s accounting, and there’s accounting….

◆ Financial Accounting
◆ Managerial Accounting
What is Managerial Accounting?
– Managerial accounting is concerned with providing information to
managers – that is, to those who are inside an organization and
who direct and control its operations. Managerial accounting can
be contrasted with financial accounting, which is concerned with
providing information to stockholders, creditors and others who
are outside an organization (Garrison and Noreen, 1999).

– Activity Based Costing – approximately right vs. precisely wrong,

as a basis for decision-making

5
6
Different purpose, different audiences…

one of the tools…

7
Think of the company Income Statement…

Direct costs

Overhead
expenses

Traditional Activity Based

cost system Costing

8
Agenda for Today

◆ Review traditional cost systems

◆ Understand Activity-Based Costing

◆ Explore Managerial Decision-Making

– example: computer cables

9
Activity Based Costing

What are the key principles?

How does this work?
Example: computer cables

Three cables
- lengths of 2, 10 and 30 feet
Labor
- 5, 6 or 7 mins per unit @ $6/hr
Material
- $2 per unit connectors, $0.10/ft for wire
Overheads
- building, equipment, plant staff = $210,000 per year
- purchasing and materials managers = $105,000 per year
- inventory obsolescence = $30,000 per year

12
*image taken from US Cables image (c) Alibaba.com
Product Characteristics

Cable Length Units per Labor Direct Price per Sales

Feet Yr Mins/unit cost/unit unit Revenue/yr

A 2 5,000 6 $2.80 $8.00 $40K

B 10 85,000 5 $3.50 $10.00 $850K

C 30 10,000 7 $5.70 $12.00 $120K

Totals 100,000 $1,010,000

13
Cable Company Income Statement

Sales $ 1,010,000 100.0%

COGS $ 368,500 36.5%

Gross Margin $ 641,500 63.5%

Overhead $ 345,000 34.2%

Net Profit $ 296,500 29.4%

14
 Cable Company Income Statement

Sales $ 1,010,000 100.0%

COGS $ 368,500 36.5%

Gross Margin $ 641,500 63.5%

Note: these are
the costs we are
concerned with

Overhead $ 345,000 34.2%

Net Profit $ 296,500 29.4%

15
Allocation of Overheads

Traditional costing

Cable overhead/yr total cost/yr cost/unit

A $ 17,250 $ 31,250 $ 6.25

B $ 293,250 $ 590,750 $ 6.95

C $ 34,500 $ 91,500 $ 9.15

$ 345,000 $ 713,500

16
Income Statement by Product

Traditional costing

Cable A Cable B Cable C

Sales $ 1,010,000 100.0%
$ 40,000 $ 850,000 $ 120,000
CGS $ 368,500 36.5%
$ 14,000 $ 297,500 $ 57,000
Gross Margin $ 641,500 63.5%
$ 26,000 $ 552,500 $ 63,000

Overhead $ 345,000 34.2% $ 17,250 $ 293,250 $ 34,500

Net Profit $ 296,500 29.4% $ 8,750 $ 259,250 $ 28,500

Is that OK?
17
Product Characteristics again…

Cable Length Units per Labor Direct Price per Sales

Feet Yr Mins/unit cost/unit unit Revenue/yr

A 2 5,000 6 $2.80 $8.00 $40K

B 10 85,000 5 $3.50 $10.00 $850K

C 30 10,000 7 $5.70 $12.00 $120K

Totals 100,000 $1,010,000

18
Suppose we believe that:

◆ Materials and purchasing effort is directly related to

the number of different part numbers…it’s not
variable with unit volume
◆ Low-volume parts are much more variable in
demand, harder to forecast, and have three times as
much obsolescence as high volume products
◆ Plant overhead is related to space (i.e. materials and
volume) and total output (production volume and
product cost)

19
Allocation of Overheads

Activity-based costing

Cable overhead/yr total cost/yr cost/unit

A $ 55,835 $ 69,835 $ 13.97

B $ 208,824 $ 506,324 $ 5.96

C $ 80,340 $ 137,340 $ 13.73

$ 345,000 $ 713,500

20
 Product Profit and the implications…

Traditional costing Activity-based costing

P&L A B C A B C

Sales $ 40,000 $ 850,000 $ 120,000 $ 40,000 $ 850,000 $ 120,000

CGS $ 14,000 $ 297,500 $ 57,000 $ 14,000 $ 297,500 $ 57,000

Gross Margin $ 26,000 $ 552,500 $ 63,000 $ 26,000 $ 552,500 $ 63,000

Overhead $ 17,250 $ 293,250 $ 34,500 $ 55,835 $ 208,824 $ 80,340

Net Profit $ 8,750 $ 259,250 $ 28,500 $(29,835) $ 343,676 $ (17,340)

Profitable or Not? 21
So what?
Implications for Cable Company?

◆ Pricing?

◆ Pruning the product line?

◆ Cost reduction activities?

◆ Re-assessing ABC assumptions?

22
Takeaways for our purpose (business management)

◆ Look at activities that drive cost and profit

◆ Understand alternative use of resources

◆ Evaluate different options, look at profit impact

◆ Decide what matters, measure it….

◆ Make improvements and see the results

◆ Iterate…
30