TOPIC 1: MANAGERIAL ACCOUNTING
A. Managerial accounting provides economic
and financial information for managers and other
internal users.
Comparing Managerial and Financial Accounting:
Determining the unit cost of manufacturing a
product is part of managerial accounting.
Reporting the total cost of goods manufactured
and sold is part of financial accounting.
Management Functions:
(1) Planning - look ahead and to establish
objectives.
(2) Directing - coordinating a company’s diverse
activities and human resources to produce a
smooth-running operation.
(3) Controlling - process of keeping the company’s
activities on track.
B. Manufacturing Costs - Manufacturing consists
of activities and processes that convert raw
materials into finished goods. It is incurred to
produce a product are classified as direct
materials, direct labor, and manufacturing
overhead.
Direct Materials - Raw materials that can be
physically and directly associated with the
finished product during the manufacturing
process are direct materials. Some raw materials
cannot be easily associated with the finished
product. These are called indirect materials.
Direct Labor
The work of factory employees that can be
physically and directly associated with converting
raw materials into finished goods is direct labor.
Indirect labor refers to the work of employees
that has no physical association with the finished
product or for which it is impractical to trace costs
to the goods produced.
Manufacturing Overhead
Manufacturing overhead consists of costs that
are indirectly associated with the manufacture of
the finished product. Overhead costs also include
manufacturing costs that cannot be classified as
direct materials or direct labor. Manufacturing
overhead includes indirect materials, indirect
labor, depreciation on factory buildings and
machines, and insurance, taxes, and maintenance
on factory facilities.
C. Product Costs vs Period Costs
As the term suggests, product costs are costs that
are a necessary and integral part of producing the
finished product.Companies record product costs,
when incurred, as an asset called inventory. These
costs do not become expenses until the company
sells the finished goods inventory. At that point,
the company records the expense as cost of goods
sold. Period costs are costs that are matched with
the revenue of a specific time period rather than
included as part of the cost of a salable product.
These are nonmanufacturing costs. Period costs
include selling and administrative expenses. In
order to determine net income, companies deduct
these costs from revenues in the period in which
they are incurred.
Cost function - Y = A + Bx (linear cost function)
Cost behavior. It refers to the relationship
between cost and activity. It is how costs react to
change in level of business activity.
Activity index – selected activity level that
changes with costs (ex. Seat count, head count,
square meter, etc.)
Cost behavior assumptions and limitations
Relevant range – refers range of activity within
cost behavior pattern is valid. It’s a range over
which company expects to operate during the
period.
Time assumption – cost behavior pattern is
valid for specified period of time.
Linearity assumption

D. Top Trends in Management Accounting
1. Expansion from product to demand and
customers profitability analysis
2. Management accounting’s expanding role with
enterprise performance management (EPM)
3. Shift to predictive accounting (see the taxonomy
of acctg)
4. Business analytics embedded in EPM
Introduce to VUCA (see next slide)
5. Co-existing and Improved Management
Accounting Methods
6. Managing information technology & shared
services as business
7. Need for better skills and competency with
Behavioral Cost Mgt
Cost Estimation:
A. High Low Method:
B. Scatter diagram - Plot observations of cost at
various activity level and based on sound
judgment draw a line (regression line or visually
fit) to represent the line function.
C. Least-Square Regression – draw cost line so as
to make the deviations between cost line and data
points as small as possible. It predicts a and b
using the activity level.
Manual computation steps:
1. You have X and Y, get product of X and Y and X
square and then sum your
(a) X, (b) Y, (c) X*Y, and (d) X^2.
2. Compute for variable cost per unit.
Use the formula below:
n (Sum XY) – Sum (Y)* Sum (X) / n (Sum X^2) –
(Sum X)^2
3. Compute Fixed cost.
Use formula below: Sum (Y) – vcu (Sum X) / n
4. Plot cost function based on # 2 and 3.
Total cost (Y) = Fixed cost less Variable cost per
unit (X)
Other cost estimation methods
Account-Classification Method (aka Account
Analysis). Involves careful examination of ledger
accounts. The (cost) analysts classifies each cost
item in the ledger as a variable, fixed, or mixed
cost.
Industrial Engineering Method. This method
studies the process that results in cost incurrence.
It asks how
much material should be needed and how much it
should cost.
Time and motion studies – determines the steps
required for people to perform the manual tasks
that are part of the production process.
Conference Method. Costs are classified based
on the opinions from various departments, such
as HR, supply chain/ purchasing, production or
operations, etc.
TOPIC 2: COST VOLUME PROFIT ANALYSIS
Cost behavior analysis is the study of how
specific costs respond to changes in the level of
business activity. As you might expect, some costs
change when activity changes and others remain
the same.
Variable costs are costs that vary in total directly
and proportionately with changes in the activity
level. If the level increases 10%, total variable
costs will increase 10%. It remains the same per
unit at every level of activity. Constant on a per
unit basis but varies when presented as a total.
Fixed costs are costs that remain the same in
total regardless of changes in the activity level.
Examples include property taxes, insurance, rent,
supervisory salaries, and depreciation on
buildings and equipment. Because total fixed costs
remain constant as activity changes, it follows that
fixed costs per unit vary inversely with activity:
As volume increases, unit cost declines, and vice
versa. Constant when presented as a total, but
varies on a per unit basis.
Relevant Range The relevant range is also
called the normal or practical range. The linear
assumption produces useful data for CVP
analysis as long as the level of activity remains
within the relevant range.
Mixed costs are costs that contain both a
variable- and a fixed-cost element. Mixed
costs, therefore, change in total but not
proportionately with changes in the activity
level. Ex: Utilities
For purposes of cost-volume-profit analysis,
mixed costs must be classified into their fixed
and variable elements. The high-low method
uses the total costs incurred at the high and low
levels of activity to classify mixed costs into fixed
and variable components. The difference in costs
between the high and low levels represents
variable costs, since only the variable-cost
element can change as activity levels change.
Compute variable cost per unit as Change in
total costs ÷ (High − low activity level) =
Variable cost per unit.
• Compute fixed cost as Highest total cost −
(Variable cost per unit × Highest Units
produced) = Total fixed cost.
Cost-volume-profit (CVP) analysis is the study
of the effects of changes in costs and volume
on a company’s profits. CVP analysis is important
in profit planning. It also is a critical factor
in such management decisions as setting selling
prices, determining product mix, and maximizing
use of production facilities.
Components of CVP Analysis:
1. Volume or level of activity
2. Unit Selling prices
3. Variable Costs per unit
4. Total Fixed Costs
5. Sales mix
The following assumptions underlie each CVP
analysis.
1. The behavior of both costs and revenues is
linear throughout the relevant range of the
activity index.
2. Costs can be classified accurately as either
variable or fixed.
3. Changes in activity are the only factors that
affect costs.
4. All units produced are sold.
5. When more than one type of product is sold, the
sales mix will remain constant. That is, the
percentage that each product represents of total
sales will stay the same. Sales mix complicates
CVP analysis because different products will have
different cost relationships. In this chapter, we
assume a single product. In Chapter 6, however,
we examine the sales mix more closely.
When these assumptions are not valid, the CVP
analysis may be inaccurate.
The CVP income statement classifies costs as
variable or fixed and computes a contribution
margin. Contribution margin (CM) is the amount
of revenue remaining after deducting variable
costs. It is often stated both as a total amount and
on a per unit basis.
FORMULAS:
* Subtract variable costs from sales to
determinecontribution margin. Subtract fixed costs
fromcontribution margin to determine net income.
* Express sales, variable costs and contribution margin
on a per unit basis.
2. Computed by using contribution margin.

A key relationship in CVP analysis is the level of

activity at which total revenues equal total
costs (both fixed and variable)—the break-even
point. At this volume of sales, the company
will realize no income but will suffer no loss. The 3. Derived from a cost-volume-profit (CVP) graph.
process of finding the break-even point is Margin of safety is the difference between actual or
called break-even analysis. Knowledge of the expected sales and sales at the break-evenpoint. It
break-even point is useful to management measures the “cushion” that a particular level of sales
when it considers decisions such as whether to provides. It tells us how far sales could fall before the
introduce new product lines, change sales prices company begins operating ata loss. The margin of safety is
on established products, or enter new market expressed in dollars or as a ratio.
areas.
Break-even analysis indicates the amount of
sales units or sales dollars that a company
needs to cover its costs.
The break-even point can be:
1. Computed from a mathematical equation.

The higher the margin of safety in dollars orthe

2. Computed by using contribution margin.
3. Derived from a cost-volume-profit (CVP) graph.
The break-even point can be expressed either in salesvariable costs for a mixed-cost situation. An advantage of
units or sales dollars.
An effective way to find the break-even point is to
prepare a break-even graph. Because this graph
also shows costs, volume, and profits, it is referred not just the highest and lowest ones. While it involves
to as a cost-volume-profit (CVP) graph. The CVP
graph also shows both the net income and net loss
areas. Thus, the amount of income or loss at each
level of sales can be derived from the sales and
total-cost lines. A CVP graph is useful because the
effects of a change in any element in the CVP
analysis can be quickly seen.
Target Net Income and Margin of Safety
percentage, the lower the risk that the company will
operate at a loss. Managementevaluates the adequacy of
the margin of safety in terms of such factors as the
vulnerability of the product to competitive pressures and
to downturns in the economy.
Regression Analysis
The high-low method is often used to estimate fixed and
the high-low method is that it is easy to apply. Regression
analysis is a statistical approach that estimates the cost
equation by employing information from all data points,
mathematical analysis taught in statistics courses (which
we will not address here), we can provide you with a basic
understanding of how regression analysis works.
Break-Even Sales in UnitsCompanies can
compute break-even sales for amixof two or more
products by determining the weighted-average
unit contribution margin of all the products.

Rather than simply “breaking even,” management

usually sets an income objective often called
target net income. It then determines the sales
necessary to achieve this specified level
of income.

1. Computed from a mathematical equation.


*The sales mix is the relative percentage of each
product sold in units.
• The weighted-average unit contribution
margin is the sum of the unit contribution
margins multiplied by the respective sales mix
percentage.
• Determine the break-even point in units by
dividing the fixed costs by the weighted-average
unit contribution margin.
Sales Mix with Limited Resources
Determining the contribution margin per unit of
limited resource helps managers decide which
product should receive any additional capacity of
the limited resource. The limited resource may be
floor space in a retail department store, or raw
materials, direct labor hours, or machine capacity
in a manufacturing company. When a company
has limited resources, management must decide
which products to make and sell in order to
maximize net income. CM alone is not enough to
make this decision. The key factor is CM per
unit of limited resource.
company’s net income reacts to a givenchange in
sales. Companies that have higher fixed costs
relative to variable costs have higher operating
leverage. When a company’s sales revenue is
increasing, high operating leverage is a good thing
because it means that profits will increase rapidly.
But when sales are declining, too much operating
leverage can have devastating consequences. The
degree of operating leverage provides a measure
of a company’s earnings volatility and can be used to
compare companies. Degree ofoperating leverage is
computed by dividing contribution margin by net
income.
ACTION PLAN
• Divide contribution margin by net income to
determine degree of operating leverage.
• A higher degree of operating leverage will result in a
higher change in net income with a given change in
sales.

The theory of constraints is a specific approach

used to identify and manage constraints in order
to achieve the company’s goals. According to this
theory, a company must continually identify its
constraints and find ways to reduce or eliminate
them, where appropriate.
To maximize net income, shift sales mix to the
product with the highest contribution margin
per
unit of limited resource.

Operating Leverage and Profitability

Cost structure refers to the relative proportion of
fixed versus variable costs that a company incurs.
Cost structure can have a significant effect on
profitability.

Operating leverage refers to the extent to which a


TOPIC 3: STANDARD COSTING AND VARIANCE
ANALYSIS
Standards are common in business. Thoseimposed
by government agencies are often called
regulations. They include the Fair Labor Standards
Act, the Equal Employment Opportunity Act, and a
multitude of environmental standards. In
managerial accounting, standard costs are
predetermined unit costs, which companies use as
measures of performance. We focus on
manufacturing operations in this chapter. But
youshould recognize that standard costs also apply
to many types of service businesses as well.
Distinguishing Between Standards and
Budgets
Both standards and budgets are
predeterminedcosts, and both contribute to
managementplanning and control. There is a
difference,however, in the way the terms are
expressed. A standard is a unit amount. A budget
is a total amount.
Companies set standards at one of two levels:
ideal or normal. Ideal standards represent
optimum levels of performance under perfect
operating conditions. Normal standards
represent efficient levels of performance that are
attainable under expected operating conditions.
Direct Materials. The direct materials price
standard is the cost per finished unit of incurred.
This standard is based on the purchasing
department’s best estimate of the cost of raw
materials. This cost is frequently based on
current purchase prices. The price standard also
includes an amount for related costs such as
receiving, storing, and handling.
The direct materials quantity standard is the
quantity of direct materials that management
determines should be used per unit of
finishedgoods. This standard is expressed as a
physical measure, such as pounds, barrels, or
board feet.
The standard direct materials cost per unit is
the standard direct materials price times the
standard direct materials quantity
The direct labor quantity standard is the time
that management determines should be
required to make one unit of the product. This
standard is especially critical in labor-intensive
companies. Allowances should be made in this
standard for rest periods, cleanup, machine setup,
and machine downtime. The direct labor
quantity standard is also called the direct labor
efficiency standard. The standard direct labor
cost per unit of finished product is the
standard direct labor rate times the standard
direct labor hours.
Manufacturing Overhead. For manufacturing
overhead, companies use a
standardpredetermined overhead rate in
setting the standard. This overhead rate is
determined by
dividing budgeted overhead costs by an expected
standard activity index. Normal capacity is the
average activity output that a company should
experience over the long run.
Total Standard Cost per Unit. After a company
has established the standard quantity
and price per unit of finished product for each cost
element, it can determine the total standard
cost. The total standard cost per unit is the sum of
the standard costs of direct materials, direct
labor, and manufacturing overhead.
Direct Materials Variances
Analyzing and Reporting Variances. One of the
major managements uses of standardcosts is to
identify variances from standards.Variances are
the differences between total actual costs and
total standard costs. When actual costs exceed
standard costs, the variance is unfavorable. If
actual costs are less than standard costs, the
variance is favorable. A favorable variance has a
positive connotation. It suggests efficiencies in
incurring manufacturing costs and in using direct
materials, direct labor, and manufacturing
overhead.

Direct Labor. The direct labor price standard is

the rate per hour that should be incurred for
direct labor. This standard is based on current
wage rates, adjusted for anticipated changes such
as cost of living adjustments (COLAs).
The direct labor price standard is also called
the direct labor rate standard.

Direct Labor and Manufacturing Overhead
Variances
Causes of Labor Variances
Labor price variances usually result from two
factors: (1) paying workers different wages
than expected, and (2) misallocation of
workers.
Labor quantity variances relate to the efficiency
of workers.
To find the total overhead variance in a standard
costing system, we determine the overhead costs
applied based on standard hours allowed.
Standard hours allowed are the hours that
should have been worked for the units produced.
The name usually given to the price variance is the
overhead controllable variance; the quantity
variance is referred to as the overhead volume
variance.
Causes of Manufacturing Overhead Variances
One reason for an overhead variance relates to
over- or underspending on overhead items.
ACTION PLAN
• Use the formulas for computing each of the
variances:
Total labor variance = (AH × AR) – (SH × SR)
Labor price variance = (AH × AR) – (AH × SR)
Labor quantity variance = (AH × SR) – (SH ×
SR)
Total overhead variance = Actual overhead –
Overhead applied*
*Based on standard hours
allowed.
Reporting Variances
All variances should be reported to appropriate
levels of management as soon as possible. The
sooner managers are informed, the sooner they
can evaluate problems and take corrective action.
The form, content, and frequency of variance
reports vary considerably among companies. One
approach is to prepare a weekly report for each
department that has primary responsibility for
cost control. Under this approach, materials price
variances are reported to the purchasing
department, and all other variances are reported
to the production department that did the work.
A standard cost accounting system is a double-
entry system of accounting. In this system,
companies use standard costs in making entries,
and they formally recognize variances in the
accounts. Companies may use a standard cost
system with either job order or process costing.
In this appendix, we will explain and illustrate a
standard cost, job order cost accounting
system. The system is based on two important
assumptions:
1. Variances from standards are recognized at the
earliest opportunity.
2. The Work in Process account is maintained
exclusively on the basis of standard costs.
Each debit balance in variance accounts
indicates an
unfavorable variance; each credit balance
indicates a favorable variance.
Overhead Controllable Variance
The overhead controllable variance shows
whether overhead costs are effectively controlled.
To compute this variance, the company compares
actual overhead costs incurred with budgeted
costs for the standard hours allowed. The
budgeted costs are determined from a flexible
manufacturing overhead budget.
Overhead Volume Variance The overhead
volume variance is the difference between
normal capacity hours and standard
hours allowed times the fixed overhead rate. The
overhead volume variance relates to whether
fixed costs were under- or overapplied during the
year.

Benefits of standard costing:

1. Facilitate management planning
2. Promote greater economy by making
employees more “cost-conscious”
3. Useful in setting selling prices
4. Contribute to management control by providing
basis for evaluation of cost control
5. Useful in highlighting variances in management
by exception
6. Simplify costing of inventories and reduce
clerical costs