Chapter1-Focusondecisionmaking Man. Acc.

Managerial Accounting
0. Getting Started
1. Focus on Decision Making

1.1 Managerial Accounting and the Business Organization
1.2 Cost Behavior and Cost-Volume-Profit Relationship
1.3 Measurement of Cost Behavior
1.4 Cost Management Systems and Activity-Based Costing
1.5 Relevant Information and Decision Making: Focus on Pricing Decisions
1.6 Relevant Information and Decision Making: Operational Decisions
2. Accounting for Planning and Control

2.1 Introduction to Budgets and Preparing the Master Budget
2.2 Flexible Budgets and Variance Analysis
2.3 Management Control Systems and Responsibility Accounting
2.4 Management Control in Decentralized Organizations
3. Product Costing
3.1 Cost Allocation
3.2 Accounting for Overhead Costs
3.3 Job-Costing and Process-Costing Systems
© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | FACHBEREICH WIRTSCHAFTSWISSENSCHAFTEN | WWW.FH-AACHEN.DE | 12

Learning Objectives
When you have finished studying this chapter, you should be able to:
1. Explain why accounting is essential for decision makers and managers.
2. Describe the major users and uses of accounting information.
3. Understand the key differences between managerial and financial

accounting
4. Explain the cycle of planning and control and the use of budget and
performance reports in planning and control.
5. Identify current trends in management accounting.
Horngren et al, p. 20
Decision making based on accounting information
• Accounting information is used in decision making for planning and control.
• Planning: Setting objectives and outlining how the objectives will be

obtained
• Control: Process of implementing plans and using feedback to

evaluate the achievement of objectives.
• Accounting provides a common language to help managers around the

world to communicate and coordinate their actions and thus to help
organizations to achieve its goals
Horngren et al, p. 20-21

Types of Accounting Information
• Management Accounting:
Process of identifying, measuring, accumulating, analyzing,
preparing, interpreting, and communicating information that helps
managers within an organization to fulfill organizational objectives
• Financial Accounting:
Develops information for external decision makers such as
Investors, Suppliers, Banks, Government Authorities,…

Managerial and Financial Accounting, Eight Key Differences
blank Managerial Accounting Financial Accounting
Managers who plan for and External persons such as inves-

1. Primary Users
control an organization tors, banks and gov. agencies
No constraints (benefits > costs Must follow GAAP/IFRS and
2. Freedom/Rules
of accounting system) prescribed formats
3. Choice of Choice should consider how Choice based on how to
accounting measurements and reports measure and communicate
measures influence managers behavior economic phenomena
4. Time focus Future emphasis, timely Historical perspective
5. Time span Flexible, from hours to 10 years

past
Usually one year or one quarter
Focus on segment reports, e.g. Primary focus is on
6. Types of report
products, departments, regions companywide reports
7. Requirement Not Mandatory Mandatory for external reports
8. Verifiability Emphasis on objectivity and
LLC or pr
versus relevance
Emphasis on relevance
verifiability
companies
p more
specific
whatand How Some companiesmake the

Cycle of planning and control planning but notthe control
The Management Process Internal Accounting System
Budgets, Special Reports

Corrections and Revisions of Plans and Actions
Planning • Customer surveys

Increase profitability • Competitor analysis
through product growth • Advertising cost/impact
analysis Other information
and improved marketing systems
• Revenue/advertising
eating
your
budgets
Customer
ntrol Control
Accounting System
• Source documents such as
surveys
Competitors
hangs Actions
• Expand number of
invoices from ad agencies,
register tapes
analysis
• Actual revenue/advertising Advertising
drinks by 20% impact
expenses from general and
• Increase advertising
subsidiary ledgers Drink sales
expense by 50%
Evaluation report
• Percent increase in Performance Reports
drinks sold • Drink sales report
• Percent increase in • Actual versus budgeted
advertising revenue
• Percent increase in • Actual versus budgeted
revenue advertising expense
Performance report
- compares actual results with budgeted amounts
- provides feedback by comparing results with plans
- highlights variances
is better it or worm
budgeting or wrong
Example (Sales Store Report):wrong
execution
Exercise: Management by Exception using Performance Reports

You plan a party to welcome your friends back after the semester
break. You expect 80 persons and prepared the following budget:
Item Amount Actual Variance
Room rental $ 170
170 O
Food $ 660
DJ $ 570
875 215 U
570 O
Decorations $ 210
Total $1,610 270 600
1885 275 Unfaoourab
After you have paid all the bills for the party, you find that actual
costs for room were $170, for food $875, for DJ $570, and $270 for
decorations.
1) Prepare a performance report such as on previous’ slide
2) Which costs deserves further explanation and why?
Solution: Management by Exception using Performance Reports

Performance Report:
2 Answer Food and decoration deservesfurther explanation

because we spent more than what was planned
Managerial Accounting b Cx a x e
costlotit fixedcosts
Introduction cost behavior

Assume that 90 instead of the planned 80 guests attended the party.
• What is your view on the variance in cost for food?
budgeted
• What has been the expected and what is the actual cost for room
T rental per guest?
Standard Costs 8,25 person
for food budget 6801
Actual costs personforfood
87,4 9,70 person
room rental
Budgeted costs person
17,1 2,101person
Actual cost 17g 5,89 person
Requirements on an Accounting System
1. Cost-Benefit Balance
Weighing estimated costs against probable benefits, i.e. value of a
system must be seen as exceeding its cost.
2. Behavioral Implications
Accounting system’s effects on the behavior (decisions) of
managers. A system that managers believe in and trust will be
used more in making decisions than one they distrust.
Management Accountant’s Role as Consultant withinthe

- Collecting and compiling information comp ny
- Preparing standardized reports
- Interpreting and analyzing information
- Being involved in decision making but not making the decision
Excursus Functional Organization (Example)
Features: Management
The organisation is based on primary Board
activities (functions)
Pros:
• Clear lines of
Production,
Procurement,
Sales and Finance and
Personnel
HR
command, specified Marketing Accounting
Logistics
tasks and
responsibilities
• Economics of scale, Managerial
Product A Market X
Accounting
standardisation of
processes
• Synergies couldshare
Financial
Product N Market Z
equipment Accounting
Cons:
• Little communication and interaction with
other units Finance,
• Low product and market orientation / identification Taxes
• The decision process may take too long
KPI's s Key performance indicators
Excursus Divisional Organization (Example)
Features: Management
The organization is structured on basis of Board
divisions (business units, products, customer
groups, geographical areas as stand-alone) Finance and Strategicpurposes
Accounting
Pros:
• Higher degree of autonomy,
identification with a product Division A Division B Division N
or market, employee
motivation
• Quick response to market Production Production Production
changes
• Flexibility
Sales Sales Sales
Cons:
• Divisional selfishness
Division Division Division
• Loss of synergy, risk of
Controller Controller Controller
duplicating activities
• Higher needs to coordinate
Trends in Managerial Accounting require adaption to change
- Shifting from a manufacturing-based to a service-based economy impossible to

Inventorize
- Advances in technology (such as digitalization, software solutions)
- Changes in business processes
- Increased global competition
- Changes resulting from new government regulations and public

awareness

Section questions
1. Which of the following statements about management accounting is FALSE?
a. Management accounting is the process of identifying, measuring,
accumulating, analyzing, preparing, interpreting and communicating
information.
b. Management accounting helps managers fulfill organizational
objectives.
0c. Management accounting is used by managerial accountants to make

strategic and operational decisions.
x
d. Management accounting produces information for managers in an
organization.
2. Which of the following should be considered in the selection of an

accounting system?
a. behavioral effects of the system on managers
b. costs of buying and operating the system
c. improved decision-making power resulting from the system
d. All of the above

Section questions
3. When comparing management accounting and financial accounting, which
of the following statements is FALSE?
a. Management accounting has a future orientation whereas financial
accounting has a past orientation.
b. Management accounting prepares detailed reports whereas financial
accounting prepares summary reports.
Management accountants are constrained by the constraints no
Oc.
x
principles of
reporting promulgated by the Institute of Management Accountants
whereas financial accountants are constrained by Generally Accepted
Accounting Principles.
d. Behavioral considerations are of primary importance in management
accounting, but not in financial accounting.
4. The major internal users of accounting information are

0a.b. managers who use information for day-to-day operating decisions
investors for investment decisions
c. government authorities
d. none of the above

Learning Objectives
1. Explain how cost drivers affect cost behavior.
2. Show how changes in cost-driver levels affect variable and fixed costs.
3. Explain step- and mixed-cost behavior.
4. Create a cost-volume-profit (CVP) graph and understand the assumptions

behind it.
5. Calculate break-even sales volume in total dollars and total units.
6. Calculate sales volume in total dollars and total units to reach a target
profit.
7. Differentiate between contribution margin and gross margin

Approach to predict and control costs is to identify
- key activities performed
- resources used in performing these activities
- cost of the resources used, and
- cost drivers, measures of activities that require the use of

resources and thereby cause costs
In other words:
- Activities use resources and these resources have costs.
- We measure this relationship between activity and cost using cost

drivers.
Resources Activities
Output
(Cost) (Measures)
Resource A
Activity 1
Resource B
Product or
Service
Resource C
Activity 2
Resource D
Example:
- key activity: installing seats in an aircraft
- resources used: 1) seats, 2) labor hours
- cost of the resources used: 1) 100$ per seat,
2) 0.5 labor hours per seat at 40$ per hour
- cost driver: Number of seats installed
100 360 t 0,5 360 40
t 7200
36000
Managerial Accounting 43,200
Example: Calculating costs using cost drivers
Calculate the costs for the activity “installing a total of 360 seats in
an aircraft”?
180hoon x 40 7200
labor 360 x 0,5hseat
Seats 360 100 36000
total 93,200
What are the total costs for purchasing the seats and for the
manpower for the pure installation?
Purchasing 36000
Manpower 7100
Variable and Fixed Cost Behavior (1/2)
Variable Cost (Example: cost for installing seat)

- Changes in direct proportion to changes in the cost-driver level
- Think of variable costs on a per-unit basis, i.e. per-unit variable
cost remains unchanged per unit of the cost-driver
- Total variable costs change on direct proportion to the cost-driver
activity
Fixed Cost (Example: factory rental cost)

- Not immediately affected by changes in the cost-driver level
- Think of fixed costs on a total-cost basis, i.e. total fixed costs
remain unchanged regardless of changes in the cost-driver activity
- Per-unit fixed cost depend on the cost-driver-activity
Total Variable and Fixed Cost Behavior (2/2)
total variable Cu x 120x total fix

Co CF 20.000
cost cost
20.000
Jez0
# of units # of units
produced produced
Cost Function Equations

1) Total Cost :
, where
𝑥: number of units produced,
𝐶: total fix costs
𝑐 : variable cost per unit
𝐶 (𝑥) = 𝑐 𝑥: total variable cost when producing 𝑥 units
2) Cost per part
( )
, where
𝑐 𝑥 = : fixed costs per part when producing 𝑥 units

Exercise: Variable and Fixed Cost Behavior (1/4)
1. A producer of premium ice cream uses “gallons of ice cream

produced” as a cost driver for the production activity. One of the
main resources this activity uses is dairy ingredients. Is the cost 3gallon
of dairy ingredients a variable or fixed cost with respect to
production volume?
2.
variable with more production you need more input
because
Another resource used by this activity is supervisory salary. If
supervisory salaries do not change with the level of production of
ice cream, is the supervisory cost variable of fixed with respect to
production volume?
Fixed

A manager is looking at a monthly report of plant costs. He notices that
receiving activity costs vary substantially from month to month (depending on
the number of parts received) and is interested in knowing more about the
total cost and unit cost of the receiving activity change. Suppose that
equipment and fuel costs are the only two costs incurring with this activity.
We further assume fix equipment costs of $45,000 and unit cost of $0.80 for
variable fuel cost, i.e. variable cost that increase by $0.80 with each
additional part received.
1. Prepare a table that shows the cost of equipment, the cost of fuel, the
total equipment and fuel cost (total cost), and the cost per-part-received
(unit cost) for 10,000 and 30,000 parts per month, using increments of
5,000
2. Draw the graphs of a) total equipment and fuel cost and b) cost per-part-
received for the interval between 10,000 and 30,000 parts per month
3. Prepare a brief explanation of why total and unit cost patterns change
Unit Equipment fuel Equipttrel cox
10.000 45000 0,80 10000 53,000
8000 8988
5,30 unit
30.000 45,000 0,8 30000 69,000 69000
24.000 130000
2,30 unit
a total
895in

(1) (2) (3) (4) (5)
0,80 4d
Parts Equipment 9 Fuel Total Cost per part
received Cost Cost Cost received
10,000
95,000 8000 53,000
15,000
95,000 12000 571000
20,000
95,000 16000 61,000
25,000
95,000 20,000 65,000
30,000
95,000 24,000 69,000
Total Cost 0,8x 45000 Cost per part 0,8 4590

Cost ($) Cost ($ per part)
w 1
20k G
LK Lok x # of parts # of parts

received received
Complicating factors for Fixed and Variable Costs
Fixed and variable cost may change if certain activity levels are
exceeded or fallen short off
The relevant range is the limit of cost-driver activity level within

which a specific relationship between costs and the cost driver is
valid.
Even within the relevant range, fixed cost and unit cost for variable
cost remain fixed only over a given period of time — usually the
budget period because
afterthat inputs may
rise in price
Many costs cannot accurately be described as simply fixed or
variable
Step- and Mixed-Cost Behavior Patterns

Step cost: A cost that changes abruptly at different intervals of
activity because the resources and their costs come in indivisible
chunks. A. Lease Cost of Drilling Equipment B. Supermarket Checker Wage Cost
Relevant Relevant Range

Range
Actual-Cost
Behavior
Lease Cost
Wage Cost
Actual-cost
Behavior
Veriable-Cost
Fixed-cost Approximation
Approximation
Oil and Gas Exploration Activity 40 Shopper per Hour 440
Mixed Cost: A cost that contains elements of both fixed- and

variable-cost behavior
Cost-Volume-Profit Analysis
Cost-volume-profit (CVP) analysis is the study of the effects of output

volume on revenue (sales), expenses (costs), and net income (net profit).
output RCA Ca Pex RA CA
The break-even point is the level of sales at which revenue equals
expenses and thus net profit (=sales - cost) is zero
where PCH O Ra E
Example: Cost-Volume-Profit Analysis (1/5)
CVP-Scenario Per Unit % of sales

selling price $ 1.50 100%
Variable cost $ 1.20 80%
Unit contribution margin $ 0.30 20%
has to
Monthly fixed expenses
L
overCt
Rent $ 3,000
Wages $ 13,500
Other fixed expenses $ 1,500
Total fixed expenses per months $ 18,000
1130 60.000units
a) Finding sales function, cost function, and profit function
Sales function (based on the number of units ):
RG S St
Cost function (based on the number of units ):
E S Lx 18000
Profit function (based on the number of units ):

RA CA
PG 15 1 2x Pa
x 0,3 18000
PCA 1,5x S2x
1180
Horngren et al, p. 65-67 PLA 0,3 18000

Rate
b) Calculating break-even sales in units
I Sx 1,2 58000 FixedCost

ContributionMargin
0,3x 58.000
X 60.000 units

c) Calculating break-even sales in total dollars
60.000mi ss 90.000
RCA


d) Graph
Cost/Sales in $ 000 RN P'G 0,3
cc whenproducin
140 SM oneunit more t

loss AM
incremental profit
c
no is 93
area
profit
60
no
20
# of units
60 80 100 120 140
Horngren et al, p. 64 in ‘000
Target net profit and sales
Managers use CVP analysis to determine the – in units and dollars –

needed to reach a target net profit.

Exercise: Target net profit and sales (1/2)

Find the target sales in units corresponding to target profit of $ 1,440
Calculate x so that PCN 1940 E target point

58000 5440
0,3 x
0,32 19940
units
69800
0,3 10000
px
1440 0,3 18000
so
X 64,800units
Exercise: Target net profit and sales (2/2)

Find the target sales in dollars corresponding to target profit of $ 1,440
RC69800 64.800 1,5 97200
R 64,800 1,5 64,800

RCA 97200

Impact of Changes in Fixed Expenses & Contribution Margin
Impact on break-even
sales volume
Increase in fixed expenses Break-even sales volume
increases
Increase in unit contribution Break-even sales volume
margin decrease
Break even FC
volume contrmargin

Example: Impact of changes in contribution margin
Calculate the break-even sales volume in units if contribution margin

increases by 10%:
Breakeven
volume
18000
54,565 units
o
930 10
in maths
CFC CMp.olgntp.to F
song
X'Fc Fl Mpo I
CMp.u
Additional Uses of CVP Analysis
1. Margin of Safety: Measure how far sales can fall below planned
level before losses occur
margin of safety in units = planned unit sales
– break-even unit sales
margin of safety in dollars = planned dollar sales

– break-even dollar sales
2. Operating leverage:
Operating leverage is a firm’s ratio of fixed costs to variable costs
Highly leveraged firms have high fixed costs and low variable costs
⇒ high contr. margin per unit
⇒ small change in sales volume results in large change in net income since P x GM
Companies to select best combination of variable and fixed-cost resources (Best
Cost Structure)
IF youhavemanysales you rely onfixed costs then

your CM increases
C 160000 20.000
12.000
Cz 40000 Managerial Accounting
12000
S 400001 1.2 Cost Behavior and Cost-Volume-Profit Relationship
Exercise: Impact of operational leverage on CVP relationship
Cost/Sales in $
8001 55
30,000
20,000
i
i
10,000
2,000
10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 # Cia
of units
Breakevenforce Breakeven
forCy
Contribution Margin and Gross Margin
Variable Costs Fixed Costs
Production or A B Total
Acquisition Costs Variable Production or Fixed Production or Production or
(CoGS) Acquisition Costs Acquisition Costs Acquisition Costs
C D Total
Selling, General &
Variable Selling & Fixed Selling & Admin Selling &
Admin
Admin Costs Costs Admin Costs
(SG&A)Costs
Total Variable Costs Total Fixed Costs
Contribution margin = sales – all variable expenses = sales – (A+C)
Gross margin = sales – cost of goods sold = sales – (A+B)
Summary Problem for Your Review

The budgeted income statement of Port Williams Gift Shop follows:
Position Amount
Net revenue $800,000
Less expenses, incl. 400k fixed expenses $880,000
Net loss -$ 80,000
The manager believes that an additional outlay of $200,000 for

advertising will increase sales but is wondering how much sales will
have to increase in order to achieve
1 Expenses 1080,000
1) breakeven 800,000
2) a $40,000 profit. 280,000 DadditionalRevenue
2 New expenses CGI 1080,00
Horngren et al, p. 77 PEEWEE'RE sooo RGKHZ
Section questions
1. Janitors clean the factory with scrubbing machines and polishing
machines. Scrubbing machines scrub the factory floor and polishing
machines polish the floor. The cost associated with cleaning the factory is
treated as a product cost. What is a good cost driver for the Depreciation
Expense associated with the scrubbing and polishing machines?
a) number of janitors operating machines
b) number of labor hours put in by janitors
c) number of kilowatt hours used
d) number of machine hours used
2. Why is it important to identify the most appropriate cost drivers for a

particular product?
a) so managers can identify the activities necessary to manufacture a
product
b) so managers can control product costs better
c) so managers can predict product costs better and make better
decisions
d) B and C

Section questions
3. Within the relevant range, the total amount of ________ cost changes in
direct proportion to changes in the cost driver. Within the relevant range,
the total amount of ________ cost does not change in direct proportion
to changes in the cost driver.
a) fixed; variable
b) variable; fixed
x
c) step; mixed
d) mixed; step
4. As cost-driver level decreases in the relevant range, fixed costs per unit
of cost driver ________, but total fixed costs ________.
x
a) increase; do not change
b) decrease: do not change
c) do not change; increase
d) do not change; decrease

Learning Objectives
1. Explain management influences on cost behavior.
2. Measure and mathematically express cost functions and use them to

predict costs.
3. Describe the importance of activity analysis for measuring cost functions.
4. Measure cost behavior using the analysis and regression methods.

Cost Drivers and Cost Behavior
Accountants and managers often assume that cost behavior is

linear over some relevant range of activity or cost-driver levels.
We can graph linear-cost behavior with a straight line because we

assume each cost to be either fixed or variable.
Recall that the relevant range specifies the interval of cost-driver

activity within which a specific relationship between a cost and its
driver will be valid.
Managers usually define the relevant range based on their previous

experience operating the organization at different levels of activity.

Example: Managements’ Influence on Cost Behavior (1/3)
A facility maintenance department of the local Medical Center has

monthly fixed costs of $10,000 and variable cost of $5 per patient-
day. The Medical Center has the opportunity to invest in highly
efficient floor cleaning equipment. In consequence fixed cost would
increase to $34,000 and variable cost would decrease by $2 to $3
per patient-day.
1) Describe how such management decision would impact cost

behavior.
2) At which patient levels (measured in patient-days per month)

would such decision reduce overall monthly cost.

1) Impact on cost behavior:

Inpatients
ColdG 108
Chew x 34000 t 3 x
impact on costbehaviour
FC t 29.000
Vc 2 pu Ipatientday

2) At which patient levels (measured in patient-days per month)

would such decision reduce overall monthly cost.
Calculate x so that C new Cx E Cold x
34000 3 1 10000 Sx
24000 E 2x
12000 E X

Managements’ Influence on Cost Behavior
Managers influence cost through:

- Product and service decisions along the value chain
- Capacity decisions (e.g. production, inventory)
- Technology decisions
- Cost control incentives
Managers must consider the costs and benefits of each decision, e.g.
impact on flexibility in meeting varying demand
Gri Vw produces a cars lot of them due andstore to highrelian
on fixed costs

Committed versus Discretionary Fixed Costs
Committed Fixed Costs:

- Arise from the possession of facilities, equipment, and a basic
organization
Discretionary Fixed Costs:

- Fixed costs at certain levels only because management decided
that these levels of cost should be incurred to meet organization’s
goals
- Determined as part of the periodic planning process
- Each planning period, management will determine how much to
spend on discretionary items. These costs then become fixed until
the next planning period.

Cost Functions
Estimating or predicting costs as a function of appropriate cost

drivers allows for
- Planning and controlling the activities of an organization
- (Better) operating, marketing, and production decisions
First step: Measure cost behavior as a function of appropriate

cost drivers.
CG axt b
Second step: Use these cost measures to estimate future costs at
expected levels of cost-driver activity
o0000
i 500.01
Cost Function Requirements
Plausible: The cost function must be believable with a

plausible relationship between a resource cost and
its cost driver
Reliable: A cost function’s estimates of costs at actual levels

of activity must reliably conform with actually
observed costs.

Choice of Cost Drivers: Activity Analysis
Choosing a cost function starts with choosing cost drivers.
Activities use resources and these resources have costs.
Managers therefore use activity analysis to identify appropriate

cost drivers.
Activity analysis directs management accountants to the

appropriate cost drivers for each cost.

Example: Using Activity Analysis to identify Cost Driver (1/2)

(Automation at Northwestern Computers)
Two products: Mozart-Plus and Powerdrive
Three cost components: material costs, labor costs and support costs
In the past, most work done by hand with labor costs being the
primary driver for support costs
After upgrade (automatization) of production function, reduction in

labor cost and increase in support costs and thus no longer
relationship between both costs.
no plausible link anymore
Activity analysis reveals that number of components added to
products (measure for product complexity) is the primary driver for
support costs such as engineering and maintenance
Example: Using Activity Analysis to identify Cost Driver (2/2)
1) Support costs estimation using labor costs:

Mozart-Plus Powerdrive
Labor cost per unit $8.50 $130.00
Predicted support
cost (2x labor cost) 17,00 260,00
2) Support costs estimation using number of components
(with $20 for each component):
Mozart-Plus Powerdrive
Number of 5 9
components
Predicted support
cost 100,00 180,00
Methods of Measuring Cost Function: Account Analysis
1. Classifies each account as a variable or fixed cost.
2. Selects plausible cost driver to explain variable cost
3. Calculate estimated variable cost and estimated fixed costs

Example: Account Analysis (1/2)

Assume that the local medical center has the following accounts for
maintenance costs. Suppose further that the medical center recorded
3,700 patient-days and that patient-days is used as cost-driver.
Use account analysis to find the respective cost function. X
local Medical Center V

F
Monthly cost in USD Amount Fixed Variable
Supervisor’s salary 3,800
x
Hourly workers’ wages 14,674
x
Equipment depreciation and rentals 5,873
x
Equipment repairs 5,604 x
Cleaning supplies 7,472
x
Total maintenance costs 37,423
9637 27750
Fixed costs
c A gu ble c
Example: Account Analysis (2/2)
Total Fixed-cost ( ):
9,673
Variable-cost per unit ( ):
27750 patientday
3700 750
Cost function:
Cx 9623 7,50 x

Summary Problem for Your Review (1/2)

InsureCo processes a variety of insurance claims for losses, accidents, thefts, and so on.
Account analysis using one cost driver has estimated variable cost of processing the
claims for each automotive accident at 0.5% of the dollar value of all claims related to a
particular accident. The estimate seems reasonable because high-cost claims often
involve more analysis before settlement. To control processing cost better, however,
InsureCo conducted an activity analysis of claims processing. The analysis suggested that
there are three main cost drivers for the costs of processing claims for automotive
accidents. The drivers and cot behavior are as follows
0.2% of InsureCo policyholders’ property claims
+ 0.6% of other parties’ property claims
+ 0.8% of total personal injury claims 1
Data from two recent automotive accident claims follow:
Automobile Claim Automobile Claim
No. 607788 No. 607991
Policyholders claims 4,500 23,600
other parties’ property claims 0 3,400
personal injury claims 12,400 0
Total 16,900 27,000
Variable costs
for processing
claims Ost at allclaimslaccide
Policy holders claims 02
Other parties claims 0,6
total personal injuries claims 70,8
Estimate thecost of processing

a
Single cost driver analysis
Jst claim 2nd Claim
16900 0.5 89 s 27000 0,5 135
b three cost driver analysis

Ist claim I 2nd Claim
4500 9 23600 92 47,2
0,2
12400 0,8 egg 2 3400 96 20 4t
108,2 67,6
Summary Problem for your Review (2/2)
1) Estimate the cost of processing each claim using data from (a) single-cost-
driver analysis and (b) three-cost-driver analysis
2) How would you recommend that InsureCo estimate the cost of processing
claims?
A I would recommendthatthey use three cost driver

analysis

analysis
Activity
Regression analysis
Method of Measuring Cost Function: Regression Analysis
Measures a cost function more objectively by using statistics to fit

a cost function to all the data.
Uses observed data points to estimate variable and fixed cost
Measures cost behavior more reliably than other cost

measurement methods
Provides a quality measure for the appropriateness of the cost

drivers

Regression Analysis (Example)

Plotting data to identify potential cost drivers
Number of Value of Room Facility Mainte- Number of Value of Room Facility Mainte-
Month Month
Patient-Days Charges nance Dpt Cost Patient-Days Charges nance Dpt Cost
January 3.700 $ 2.183.000 $ 37.000 July 3.500 $ 3.023.000 $ 32.000
February 1.600 $ 2.735.000 $ 23.000 August 4.000 $ 2.352.000 $ 33.000
March 4.100 $ 2.966.000 $ 37.000 September 1.200 $ 1.825.000 $ 17.000
April 4.900 $ 2.846.000 $ 47.000 October 1.300 $ 1.515.000 $ 18.000
May 3.300 $ 2.967.000 $ 33.000 November 1.800 $ 1.547.000 $ 22.000
June 4.400 $ 2.980.000 $ 39.000 December 1.600 $ 2.117.000 $ 20.000
Number of patient-days seems to be a more appropriate cost-driver than

value of room charges Horngren et al, p. 121
Regression Analysis (Example, continued)

$50,000
$45,000
$40,000
Facility Maintenance
Department Costs
$35,000
$30,000
$25,000
$20,000
Slope $6.951 (per patient-day)
$15,000
$10,000
Intercept $9,329 (per month)
$5,000
$-
- 1,000 2,000 3,000 4,000 5,000 6,000
number of patient-days
C(patient-days) =$9,329 per month + $6.951 ∙ patient-days
Account Analysis 9,673 FL
7,5 C
VAccounting
Managerial
Regression Analysis (Example, continued)

Regression Output:
constant/intercept: fixed-
Facility Maintenance Department Cost costs
explained by Number of Patient-Days
Constant/Intercept 9329 x-coefficient: variable cost
per unit
R2 0,955
R2 measures how well cost
x-coefficient 6,951
function fits the actual cost
data
Facility Maintenance Department Cost R2 ranges between 0 and 1
(the higher the better) O O
explained by Value of Room Charges
Constant/Intercept 924 R2=0 no explanatory
power
R2 0.511
x-coefficient 0.012 R2=1 cost driver explain
perfectly the variability in
cost

Comtell makes computer peripherals (disk, drives, tape drives, and printers).
Until recently, managers predicted production scheduling and control (PSC)
costs to vary in proportion to labor costs according to the following cost
function:
𝑃𝑆𝐶 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡𝑠 = 200% 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡𝑠 = 2 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡𝑠
Because PSC costs have been growing at the same time that labor cost has
been shrinking, Comtell is concerned that its cost estimates are neither
plausible nor reliable. Comtell‘s controller has just completed regression
analysis to determine the most appropriate drivers of PSC costs- She obtained
two cost function using different cost drivers:
𝑃𝑆𝐶 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡𝑠 = 2 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡𝑠

𝑅 = 0.233
and
𝑃𝑆𝐶 # 𝑜𝑓 𝑐𝑜𝑚𝑝𝑜𝑛𝑒𝑛𝑡𝑠 𝑢𝑠𝑒𝑑 = $10,000 𝑝𝑒𝑟 𝑚𝑜𝑛𝑡ℎ + 11 # 𝑜𝑓 𝑐𝑜𝑚𝑝𝑜𝑛𝑒𝑛𝑡𝑠 𝑢𝑠𝑒𝑑
0
𝑅 = 0.782


1. How should the controller determine which cost function better predicts
PSC costs? of componentsused as a costdriver becauseR2is
byadopting higher
2. During a subsequent month, Comtell‘s labor costs were $12,000, and it
used 2,000 product components. Actual PSC costs were $31,460. Using
each of the preceding cost functions, prepare reports that show predicted
and actual PSC costs and the difference or variance between the two
3. What is the meaning and importance of each cost variance?
Actual 31,660 31460
I poselabor 2x 12,000 29,000 predicted 35.9 variance Contaoor

able
2 Psc l components 32 0000 n 540 variance
10,000 t
11 800 Favorable
A thefirst variant meansthat the predictiontifjar
from actual s
the second variance showsthat adopting of components is a better
cost driver becausethe variance betweenpredictionandactual
Horngren et al, p. 123 was small
Section questions
1) The use of high technology equipment to manufacture products instead of
highly skilled labor usually results in ________.
a) higher fixed costs
b) lower variable costs
c) higher variable costs
d) a and b (and thus higher operating leverage)
2) Many organizations use a linear relationship with a single cost driver to

describe a cost even though the cost may have multiple cost drivers.
Why?
a) This approach is easier and less expensive.
b) The cost of developing a more complex function is greater than the
benefit.
c) Cost estimates from the simple function are accurate enough for most
decisions.
d) All of the above

4 unit
releceau
Managerial Accounting 155.000 is in
the
range thus thecostis the
same
Section questions
4 115.000 460000
O
3) Simon Inc. currently produces 110,000 units at a cost of $440,000. The
cost is variable. Next year Simon Inc. expects to produce 115,000 units. o
Simon's relevant range for production is 100,000 to 120,000 units. If
115,000 units are produced next year, what is the expected variable cost?
a) $420,000
110 940
0
b) $460,000
c) $430,000 115
go 600 I
d) $440,000
x 460,00
4) Which of the following costs can be canceled in the short run and are thus
discretionary fixed costs?
a) management consulting services engaged to change company logo t
0
b) salary of CEO of company
c) mortgage payment on factory t building
t
d) lease payments on two-year lease for leased equipment in factory
t

1.4 Cost Accounting and Activity-Based Costing
Learning Objectives
1. Explain the relationship among costs, cost objects, cost accumulation,
and cost assignment.
2. Distinguish between direct and indirect costs.
3. Explain the major reasons for allocating costs.
4. Identify the main types of manufacturing costs: direct materials, direct
labor, and indirect production costs.
5. Explain how the financial statements of merchandisers and manufacturers
differ because of the types of goods they sell.
6. Understand the main differences between traditional and activity-based
costing (ABC) systems and why ABC systems provide value to managers.
7. Use activity-based management (ABM) to make strategic and operational
control decisions.
8. Describe the steps in designing an activity-based costing system

Cost Accounting
Process and techniques of measuring and assigning costs

• For which objects (products, services, customers,…) do we
want to measure costs?
• How to assign/allocate cost to such objects?

Cost Object (=cost objectives)

• Decision makers want more than simply cost of a resource used
(e.g. cost for labor resource)
• Decision makers desire to know cost of something in particular,
such as product or service
Cost object (objective) is anything for which a separate measurement

of costs is desired, e.g.
- products
- services
- customers
- departments
- territories
- activities such as processing orders

Two Processes in Cost Accounting System
1. Cost accumulation: Collecting costs by some “natural”

classification such as materials or labor
2. Cost assignment: Tracing costs to one or more cost objects

Cost Material costs (metals)
Accumulation
Cost Assignment to Machining Department Finishing Department
Cost Objects
Activity Activity Activity Activity
1. Departments
2. Activities
Activity
I Activity Activity Activity
Cabinets Cabinets
3. Products
activity Desks Desks
60 Tables Tables
Horngren et al, p. 143 20 activity z
20 activity3
Cost Terms used: Direct and Indirect Costs
Direct costs can be identified specifically and exclusively with a

given cost objective in an economically feasible way (traceable).
Examples: Parts and materials included in a product
Indirect costs cannot be identified specifically and exclusively with

a given cost objective in an economically feasible way.
Examples: facility rental costs, depreciation on equipment,

and many staff salaries.
How to assign indirect costs to cost objects?

Cost Terms used: Cost Allocation and Cost-Allocation Base

Cost Allocation: Assignment of indirect costs to cost objects in
proportion to cost object’s use of a particular cost-allocation base.
Cost-allocation base: Measure of input or output that determines
the amount of cost to be allocated to a particular cost object. Ideal
cost-allocation base measures how much of the particular resource
is consumed by the cost object and thus associated cost to be
services inFHaachen
assigned.
Most cost-allocation bases are cost drivers
Ex IT
student
Indirect Costs
divide by no
of
ineachcourse
Cost objects
Cost-allocation base:
Cost driver: machine hrs
assembly- assembly- Dell Latitude
machine hrs
equipment equipment
value depreciation Dell
Ultrabook
Four Purposes of Cost Allocation/Cost Assignment

Predict economic effects of strategic and operational control decisions
Provide desired motivation and feedback for performance evaluation
Compute income and asset valuations for financial reporting
Justify costs or obtain reimbursement
Cost Pool
- Group of individual indirect costs that a company allocates to cost objects
using a single cost-allocation base
Costs Method Cost Objects
Direct
physically traced
Cost
Products/
Services/
Customers/
Indirect allocated using a cost-allocation base Activities
Cost potentially using cost pooling
Exercise: Cost Pooling and Cost Allocation (1/3)
Suppose that Dell has assembly-equipment depreciation of $400,000

and electricity costs of $250,000. Assume further that Dell used
2,000 machine hours to make Ultrabook laptops and 3,000 machine
hours to make Latitude laptops. Assume further that it takes one
hour to make a Dell Ultrabook and 2 hours to make a Dell Latitude.
1. Calculate the portion and amount of assembly-equipment

depreciation allocated to Ultrabook and to Latitude?
Hrabook 900000 soooo
3880 40
Assembly
depreciation 3880 60 Latitude 400000 290.000
400.000
Cp. Horngren et al, p. 146


Apply cost pooling for assembly-equipment depreciation and
electricity costs
2. What are the total allocated costs to Ultrabook and to Latitude
Cost pooling Cost allocation
assembly- allocated cost
equipment Ultrabook
depreciation
260.000
400.000
Total indirect 40
cost
Electricity 650000 allocated cost

cost 60to Latitude
390.000
250.000
3. What are the allocated costs per Ultrabook and Latitude produced?
Ultrabook Latitude
total allocated 260000 390000 totalcos

a cost
number of 2000units309nowhEnitlsoounits
hn
121 units produced 3181
allocated cost
d G per unit 130 260

Cost Terms used: Unallocated Costs
• Some costs lack of identifiable relationship to a cost object

• Often it is best to leave such costs unallocated
• Costs that an accounting system records but does not allocate to
any cost object are called unallocated costs
Examples for unallocated costs:

• Research and development (R&D)
• Legal expenses
• Executive salaries

Contribution
cabinets tables chain
51,8 22 4,4
Sales Managerial Accounting unstopselling
chairs
Example: Cost Allocation and Unallocated Costs
49,6 21,3 salt
40,9 2713 35,8
89 13,5 2,51
Cp. Horngren et al, p. 147-149

Cost Terms Used for External Reporting Purposes
Cost management systems provide aggregate measures of inventory

value and cost of goods manufactured.
Four attributes of these costs:

1.Manufacturing Costs
2.Product versus Period Costs
3.Costs on the balance Sheet
4.Costs on the income Statement

Categories of Manufacturing Costs

Manufacturing operations transform raw materials, the basic
materials from which a product is made, into other goods through
the use of labor and factory facilities.
1) direct-material costs:
Acquisition cost of raw materials that a
company traces to the manufactured
goods
+
2) direct-labor costs: Total
Wages of all labor that a company can
trace specifically and exclusively to the = manufacturing
cost
manufactured goods
+
3) indirect-production costs
(manufacturing overhead):
Costs associated to the production process
but not traceable to the goods or service
produced in economically feasible manner.
Product versus Period Costs (1/2)

When preparing balance sheets and income statements, accountants
frequently distinguish between product costs and period costs
Product Costs (Inventoriable costs):
• costs identified with goods produced or purchased for resale
• costs first become part of the inventory
• expenses in the form of cost of goods sold only when inventory is
sold
• Examples for manufacturing company: manufacturing costs
Period Costs:
• deducted as expenses in P&L statement during the current period
without going through an “inventory stage”
• Period costs are associated with nonproduction value-chain
functions (R&D, design, marketing, distribution, and customer
service)
• Most of these costs are reported as selling and administrative
expenses.
Product versus Period Costs (2/2)

Balance Sheet Income Statement
Merchandising Company (Retailer or Wholesaler) Sales
Product Merchandise Merchandise
Expiration -
(Inventoriable) purchased Inventory
CoGS Contof
Cost = gross margin
-
SG&A expenses
good So
Manufacturing Company
= operating income
Raw (direct) Raw (direct)
Material Material
Puchases Inventory
Product
(Inventoriable) Direct Labor Work-in
Cost Process
Indirect Inventory
Production Sales
Finished Expiration -
Goods CoGS
Inventory
= gross margin
-
SG&A expenses
= operating income
Presentation of Costs in Balance Sheet and Income Statement

Balance Sheet
Manufacturer Retailer
Cash $ 4,000 Cash $ 4,000
Receivables $ 25,000 Receivables $ 25,000
Finished goods $ 32,000
Work in process
Direct material
$ 22,000
$ 23,000
notfinishedyet
Total inventories $77,000 Merchandise Inventory $77,000
Other current assets $1,000 Other current assets $1,000
Total current assets $ 107,000 Total current assets $ 107,000
Income Statement
Manufacturer Retailer
Beginning merchandise
Beginning finished goods inventory $ 4,000 $ 4,000
inventory
Cost of goods manufactured: Purchases $ 40,000
Direct materials used $ 20,000
Direct labor $ 12,000
Indirect production $ 8,000 $ 40,000
Cost of goods available for sale $ 44,000 Cost of goods available for sale
Ending finished goods inventory $ 8,000 Ending merchandise inventory $ 8,000
Cost of good sold $ 36,000 Cost of good sold $ 36,000

Cost and expenses
Costs
Broad term that describes the amount paid for an activity, product, or
service
Expenses
Specifically denotes the costs deducted from revenue on an income
(profit&loss) statement
All costs (such manufacturing cost) become expenses, but they are
not expenses (such as COGS) until accountants deduct them from
revenue in the income statement.

Two General Types of Cost Accounting System

1. Traditional costing systems
Allocation of indirect production costs straight to cost objects
Often use of only one single cost pool (labor-based or machine-
based) to allocate all indirect production costs
Works well with simple production processes where indirect
production costs are a small percentage of total costs
2. Activity-based costing (ABC) systems

First, accumulation of indirect costs for each activity
Second, assignment of costs of each activity to the costs objects
that require that activity
More complex but also more accurate cost estimates for respective
cost objects such as products and services
Requires a clear process map, i.e. a schematic diagram capturing
the relation between resources, activities and cost objects

Direct allocation tothe costs
t
Example: Traditional costing system at Lopez Plastics (1/2)
Process Map Traditional Cost System # of labor hours:

Pen casings 4,500 90
All Indirect Production All Unallocated Value Cell phone casings 500
Costs: $220,000 Chain Costs: $100,000 no
allocation of all indirect
production cost:
Pen casings
Cost-Allocation Base
[Direct-Labor Hours]
220.000 9500 198000
10 5000
90
Direct Direct Labor Direct Mate- Direct Labor
Materials for for Pen rials for Cell for Cell
Pen Casings Casings Phone Phone Cell phone casings
$22,500 $135,000 Casings Casings
$12,000 $15,000
220000 500
Pen casings Cell phone casings Unallocated 5000 22.000
(Sales $360,000) (Sales $80,000) $100,000
Example: Traditional costing system at Lopez Plastics (2/2)
Statement of Operative Income Contribution to Coprorate Costs & Profit

External Reporting Purpose Internal Strategic Decision Making Purpose
Pen Casings Cell Phone Casings
Sales $ 440,000 $ 360,000 $ 80,000
Cost of Good Sold:
- Direct Material $ 34,500 $ 22,500 $ 12,000
- Direct Labor $ 150,000 $ 135,000 $ 15,000
- Indirect Production
220.000 198000 22000
Total CoGS
404,500 355500 49,000
Gross Profit
Corporate Expenses
35,500 4,500 31,000
(Unallocated)
Operating Profit or Loss
Gross Profit Margin

8,07 1,259 38,75
20 01 16,22 28,63
include
Managerial Accounting you
where
activities
Basic Concept Process Map for ABC Accounting System

Ex 40.000
Stage 1:
Resource A Resource B
Accumulation
of indirect Cost-Allocation Base 1
costs from
resources to
30 70
activities 12.000 20000
Activity 1 Activity 2 Activity 3
Stage 2: Cost-Allocation Cost-Allocation

Assignment of 40 60 Base 2 Base 3
costs of each 11.200 16,800
activity to the Product T Product U Product W
Product V
costs objects
that require Example 1: Resource A is an Example 2: Resource B is a direct cost
that activity indirect cost with respect to with respect to activity 3 but an indirect
activities and product cost with respect to both products
LEGEND
Flow of Activity or Product or
Resources
Costs Process Customer
ABC n Activity based costing
Example: ABC-system at Lopez Plastics (1/2)

allocation of
Engineers and CAD All Unallocated Value-
Plant and Machinery
Equipment Resource Chain Costs a) processing activity
$180,000
$40,000 $100,000 costs:
20% 80% Pen casings
25% 193.000 4
75%
Production Support
08 1281700
Processing Activity
$135,000
Activity
$45,000
+ 8,000
+ 32,000
Cell phone casings
$143,000
$77,000
143000 19,300
30
Cost-Allocation Base Cost-Allocation Base
[Direct-Labor Hours] [Distinct Parts]
Direct Materials
b) production support
Direct Labor for Direct Mat. Cell Direct Labor Cell
Pen Casings Pen Casings Phone Casings Phone Casings activity costs :
$22,500 $135,000 $12,000 $15,000
Pen casings
Pen Casings
Cell Phone
Casings
Unallocated
$100,000
77000 15.400
# of labor hours: # of distinct parts:
Pen casings 4,500 Pen casings 5 Cell phone casings
Cell phone casings 500 Cell phone casings 20
Cp. Horngren et al, p. 157 77,000 2251 61.600
Example: ABC-system at Lopez Plastics (2/2)
Statement of Operative Income Contribution to Coprorate Costs & Profit

External Reporting Purpose Internal Strategic Decision Making Purpose
Sales $ 440,000 $ 360,000 $ 80,000
Cost of Good Sold:
- Direct Material $ 34,500 $ 22,500 $ 12,000
34
- Direct Labor $ 150,000 $ 135,000 $ 15,000
1281700415400 19300 61,600

- Indirect Production
220000 44,100 751900
Total CoGS
409500 301600 102906 7
Gross Profit
Corporate Expenses
35.500 58,400 22,900
(Unallocated)
10.0.000
Operating Profit or Loss
64,500
Gross Profit Margin
8,07 16,22 28,63

Based on the reports of Lopez Plastics using a traditional cost system, a
marketing manager has proposed a plan that emphasizes cell phone casings
due to their large gross profit margin (38.75%) compared to that of pen
casings (1.25%).
Now, management implements ABC system. In the first stage of the two-
stage ABC system, all indirect resource costs have already been allocated to
the two activities, namely processing activity ($143,000) and production-
support activity ($77,000). You need to perform the second-stage allocation
to determine the profitability of each product line (=cost object). The cost-
allocation base for processing activity is direct-labor hours and the cost-
allocation base for production-support activity is number of distinct parts.
Data on the use of these cost-allocation bases for the last quarter are as
follows:
Direct-labor hours 4,500 500

Distinct parts 5 20
Indirectcost
Pratap
I Cellphone 77.000 295 61,60
8143,600 ProductionsupportD77,000Pencaring 77000 15400

Processing
Fifasingallphorting cellphone 143000 5

0
14300
Pencasings 128700415900 199100 open casings 143,000 45
0
Cell phone 61,600 19300 75,900 128700
canings
Pen Casings Cell phone casings
3601000 80,000
Stint material 22500 12000
Direct Labor 135,000
t 144100
15000
Indirect costs 75900
Total CO 65 301 600 102900
gross Profit 58,400

16,2240
22,900
28,62
fromProfit
margin
it differs because in traditional accounting system we use

number of Labor hours as costallocationbasewhile in ABC we
only
use different cost allocation base more than one
it wouldbe better to market pen casings duetothe higher

prof tability
1 I
ABC is more difficult but more detailed

1. Calculate the gross profit and gross profit margin for each product based
on ABC.
2. Explain why your results differ significantly from those based on the
traditional cost accounting system?
3. Evaluate marketing‘s plan.
4. Propose a product-mix strategy for the company.

Activity-Based Management (ABM)

Output of ABC-system
Aids strategic decision making and improves operational control
Typical application of ABM

Distinguishing between value-added and non-value-added costs
and optimizing non-value-added activities
Benchmarking
Applications for and benefits of ABC-systems and ABM

estimate profit margins of new products
determine consumption of shared resources
identify potential efficiency increases and cost reduction
estimate costs more accurately
Computer technology has reduced cost of operating ABC Systems

Four Steps to Design an ABC Accounting System

Step 1: Determine the key components of the cost accounting system
• Accumulate resources consumed
• Identify key activities performed
• Select cost objects
• Identify cost drivers to assign cost
(resources -> activities -> cost objects)
Step 2 (Stage 1): Allocation of cost from resources to activities:

• Determine relationships between resources and activities
• Collect relevant data concerning costs and the physical flow of the cost-
driver units among resources and activities
• Calculate the cost per activity
Step 3 (Stage 2): Allocation of cost from activities to cost objects:

• Determine relationships between activities and cost objects
• Collect relevant data concerning costs and the physical flow of the cost-
driver units among activities and cost objects
• Calculate the cost per cost object
Step 4: Calculate and interpret the new activity-based information.

Example: Design an ABC Accounting System (1/9)

AT&T‘s billing department uses traditional CAS based on # of inquires to assign
indirect production cost to its customers, residential and commercial accounts
Indirect Production Cost Amount
Telecommunications (TelCo) $58,520
All Indirect Production
Computer (PC) $178,000
Costs: $687,500
Supervisors (SV) $33,600
Paper (Pap) $7,320 Cost-Allocation Base
[Number of Inquires]
Occupancy (Occ) $47,000
Account Inquiry Labor (AIR) 173,460
80% 20%
Printing Machines (PM) $55,000
Billing Labor Expenses (BLE) $56,250
Residential Accounts Commercial
Billing Verification labor (BVL) $11,250 $550,000 Accounts $137,500
Other resources (OR) $67,100
Total $687,500
Numbers of Cost/Inquiry Total costs Number of Cost/Account

Inquiries allocated Accounts
Residential 20,000 $27.50 $550,000 120,000 $4.58
Commercial 5,000 $27.50 $137,500 20,000 $6.88

Step 1: Determine the key components of the cost accounting
system
• Resources consumed TelCo PC SV Pap Occ
(allocation bases on $58,520 $178,000 $33,600 $7,320 $47,000
questionnaire results) AIR Printers BillLab VerLab OR

$173,460 $55,000 $56,250 $11,250 $67,100
Account Bill Account Corres- Other

• Activities performed billing Verification inquiry pondence activities
(allocation base) # printed # accounts # inquiries # letters # printed

pages verified pages
• Cost objects selected Residential Commercial

Accounts Accounts

Example: Design an ABC Accounting System (3/9) t

Step 2 (First-Stage): Determine relationships between resources and activities
and collect relevant data concerning costs and the physical flow of the cost-
driver units among resources and activities(based on questionnaire results)
Ressource used to Activity Performed

perform activity Account Corres- Verifi-
Billing Other Total
Inquiry pondence cation
Telecommunication 90% 0% 0% 0% 10% 100%
Computer 45% 5% 35% 10% 5% 100%
Supervisors 40% 10% 30% 0% 20% 100%
Paper 0% 0% 100% 0% 0% 100%
Occupancy 65% 0% 15% 0% 20% 100%
Account inquiry labor 90% 10% 0% 0% 0% 100%
Printers 0% 5% 90% 0% 5% 100%
Billing labor 0% 0% 30% 70% 0% 100%
Verification labor 0% 0% 0% 100% 0% 100%
Other resources 0% 0% 0% 0% 100% 100%


Step 2 (First-Stage): Calculate the cost per activity
Activity Cost Pool
Account Corres-
Ressource Cost Billing Verification Other
Inquiry pondence
Tele-
$ 58,520 $ 52,668 90% $ - 0% $ - 0% $ - 0% $ 5,852 10%
communication
Computer $ 178,000 $ 80,100 45% $ 8,900 5% $ 62,300 35% $ 17,800 10% $ 8,900 5%
Supervisors $ 33,600 $ 13,440 40% $ 3,360 10% $ 10,080 30% $ - 0% $ 6,720 20%
Paper $ 7,320 $ - 0% $ - 0% $ 7,320 100% $ - 0% $ - 0%
Occupancy $ 47,000 $ 30,550 65% $ - 0% $ 7,050 15% $ - 0% $ 9,400 20%
Account inquiry
$ 173,460 $ 156,114 90% $ 17,346 10% $ - 0% $ - 0% $ - 0%
labor
Printers $ 55,000 $ - 0% $ 2,750 5% $ 49,500 90% $ - 0% $ 2,750 5%
Billing labor $ 56,250 $ - 0% $ - 0% $ 16,875 30% $ 39,375 70% $ - 0%
Verification
$ 11,250 $ - 0% $ - 0% $ - 0% $ 11,250 100% $ - 0%
labor
Other resources $ 67,100 $ - 0% $ - 0% $ - 0% $ - 0% $ 67,100 100%
Total cost $ 687,500 $ 332,872 $ 32,356 $ 153,125 $ 68,425 $ 100,722


Step 3 (Second-Stage): Determine relationships among activities and cost
objects
Determine which activities are needed by each cost object and respective
cost-allocation base
Account Corres- Account Bill Other

activities billing Verification activities
inquiry pondence
printed Accounts Printed

cost Inquiries Letters
pages verified Pages
allocation
base
Residential Accounts Commercial Accounts


Step 3 (Second-Stage): Collect relevant data concerning costs and the
physical flow of the cost-driver units among activities and cost objects
Activity Performed Cost Driver Units Residential Commercial Total

Account
Inquiries 20,000
809 10
5,000
1001
25,000
Inquiry
Corres- 1009
pondence Letters 1,800 1,000 2,800
Billing Printed Pages 120,000 40,000 160,000
Verification Accounts verified - 20,000 20,000
Other Printed Pages 120,000 40,000 160,000


Step 3 (Second-Stage): Calculate the cost per cost object
(1) (2)
Total Numbers of
(1)/(2)
Cost per
332,872 20000
Activity Total Cost
Driver Units Driver Unit 25000
Account Inquiry
Correspondence
$ 332.872
$ 32.356
25,000 inquiries
2,800 letters
$
$
13,31
11,56 266,298
7
Billing
Verification
$ 153.125
$ 68.425
160,000 printed pages
20,000 accounts verified
$
$
0,96
3,42
on 20000inquin
Other $ 100.722 160,000 printed pages $ 0,63 X 13,31
Cost per Customer Class (Cost Object)
Residential Commercial
(3) (4) (3)*(4) (5) (3)*(5)
Cost per Total Numbers of Total Numbers of
Cost Cost
Driver Unit Driver Units Driver Units
Account Inquiry $ 13,31 20,000 inquiries $ 266.298 5,000 inquiries $ 66.574
Correspondence $ 11,56 1,800 letters $ 20.800 1,000 letters $ 11.556
Billing $ 0,96 120,000 printed pages $ 114.844 40,000 printed pages $ 38.281
Verification $ 3,42 0 accounts verified $ - 20,000 accounts verified $ 68.425
Other $ 0,63 120,000 printed pages $ 75.542 40,000 printed pages $ 25.181
Total Cost $ 477.483 $ 210.017


Step 4: Calculate and interpret the new activity-based information.
Cost analysis per Customer Class (Cost Object)

Residential Commercial
Total Cost $ 477.483 $ 210.017
Number of Accounts 120.000 20.000
Cost per Account ABCAcc $ 3,98 $ 10,50
Sys
Cost per Account, traditional system $ 4,58 $ 6,88
What is your interpretation?

absolute
difference 0,60 3,62
relative
difference 9988 13 36,64 52,69
ABC the cost for by 13 and residential customers decrease
A Using
the cast commercial customers increase 5216
for by

Process Map with Two—Stage Cost Allocation
sour SV AIR BLE BVL Pap
$33,600 $173,460 $56,250 $11,250 $7,320
PC TelCo Occ PM OR
$178,000 $58,520 $47,000 $55,000 $67,100
ctivities S C A T B O V PD P OR
S A C T O S A C PD S B P C O PD B V C S C T O PD OR
40% 90% 45% 90% 65% 10% 10% 5% 5% 30% 30% 100% 35%15% 90% 70% 100% 10% 20% 5% 10% 20% 5% 100%
Account Inquiry Correspondence Billing Activity Verification Other Activities
Activity Cost Pool Activity Cost Pool Cost Pool Activity Cost Pool Cost Pool
Printed Pages Accounts verified

Inquiries Letters Printed Pages
Residential Accounts Commercial Accounts

costobject 20,000 Inquiries
1,8000 Letters
5,000 Inquiries
1,000 Letters
120,000 Accounts 20,000 Accounts
120000 Printed Pages 40,000 Printed Pages

Refer to previous example. Suppose that the management at AT&T of a local
area customer care center is implementing an ABC System. The center has
98,000 residential customers and 25,000 commercial customers. An ABC
team has collected the following data
Activity Performed
Monthly Account Corres- Veri-
Ressource Billing Other Total
Cost Inquiry pondence fication
Telecommunication $ 49,620.00 0% 85% 0% 0% 15% 100%
Computer $ 143,000.00 30% 48% 7% 10% 5% 100%
Supervisors $ 30,500.00 40% 35% 8% 0% 17% 100%
Paper $ 5,800.00 100% 0% 0% 0% 0% 100%
Occupancy $ 56,000.00 15% 70% 0% 0% 15% 100%
Account inquiry labor $ 102,000.00 0% 85% 15% 0% 0% 100%
Billing labor $ 45,000.00 70% 0% 0% 30% 0% 100%
Printers $ 75,000.00 80% 0% 5% 0% 15% 100%
Other resources $ 59,000.00 0% 0% 0% 0% 100% 100%


1. Prepare schedules to determine the cost per driver unit for each activity
and the activity-based cost per account for each customer type
2. Consider the verification activity. Suppose the cost per account verified is
$0.45. The center verifies 50% of residential and commercial bills. Given
that there are, on average, 50 lines on each commercial bill and only 12
lines on each residential bill, criticize the use of accounts verified as a cost
driver and suggest a more plausible and reliable cost driver

42177
I7
I I
1 Costper dries unit
Billing Arc Inquiry Correspondence Verification other

1 42777 7443
7 42500 68.690 10.010 14300 7150
3 12200 10675 2440 5185
9 5000
35200 I
5 840 8400
6 86700 15300
7 3156 23500 I
8 60,900 I 3750 I 11250
g 59000
atal 560800 297392 31500 27800 98928
owwehave
hepools
Thesidential a
Come'ncial
separate
Bje Billing 75 720600 25 90700

Acting 80 197,913,60 20 49978,40
Corn 69 20160 36 11390
100 77800
Vevit
Other 75 pg 75 24607
Totalcost 412994,60 153425,40
neofalcounts 120,060 26,000
Cost account 3,43 7167
508 ofall accounts are unified 70,000 ace
9EEsacaant
Section questions
1) Which of the following is an example of a strategic management decision

that uses cost information?
a) determining the ending balance of Merchandise Inventory for financial
reporting to external users
b) determining the product mix
c) determining overall sales
d) determining the amount of Cost of Goods Sold for financial reporting to
external users
2) A product such as Sure-Fine Graham Crackers, and a customer such as an

Internet customer, are both examples of ________.
a) cost accounting
b) cost management system
c) cost assignment
d) cost objects

Section questions
3) Which of the following types of costs cannot be specifically and exclusively

identified with a cost object in an economically feasible manner?
a) variable costs
b) fixed costs
c) indirect costs
a
d) direct costs
4) Activity-based costing systems should be used instead of traditional costing

systems if ________.
a) indirect production costs are a large percentage of production costs
b) different products consume resources at different rates
c) only one product is produced
d) A and B

Tradionalcosting accounting
Managerial Accounting ABC
Absorbnionapproach
1.5 Relevant Information for Decision Making with a Focus on contribution
Pricing Decisions
Learning Objectives
1. Construct absorption and contribution-margin income statements, and

identify their relevance for decision making.
2. Decide to accept or reject a special order using the contribution-margin

approach.
3. Compute a sales price by various methods, and compare the advantages

and disadvantages of these methods.
4. Use target costing to decide whether to add a new product.

1.5 Relevant Information for Decision Making with a Focus on Pricing Decisions
Contribution and Absorption Approach for Income Statements

Contribution Approach
- Separates fixed costs from variable costs
- First deduction of variable costs from sales to compute a
contribution margin
- Second, deduction of fixed costs to measure profit
operating income
- Useful in situations where decisions affect variable costs differently
than they affect fixed costs, such as in short-run pricing decisions
- Not allowed by regulators for external financial reporting
Absorption Approach
- Separates manufacturing long term
costs from nonmanufacturing costs
- First deduction of manufacturing cost of goods sold from sales to
compute a gross margin
- Second, deduction of nonmanufacturing costs to measure profit
copincome
- Well-suited for long-run pricing decisions
- Used for external reporting
It takes var and cos fixed
Horngren et al, p. 204 intoaccount
Cost behaviour
fixed cost variableCost
Business COGS
manufacturing
A B
function
SG A C D
Selling general
Admin
Absorption approach sales CA B gross profit
contribution approach Sales Bt D contribution

marg
Sales ATB Ct D operating income
contribution approach fixed costs flame

Salescontiniambalegitate
Aboorbition approach cost

Salgyptatingatopoincimentacturing
Cordell Company (numbers in thousands of dollars) (1/2)

1. Manufacturing Costs
Direct costs
Direct material costs (variable) $14,000
Direct labor costs (variable) $ 6,000
Total direct costs
Indirect costs
O
$ 20,000
Yodo
Variable Costs
info
Supplies (lubricants, expendable tools, coolants, sandpaper) $ 600
Materials-handling labor (forklift operators)
Repairs on manufacturing equipment
$ 2,800
$ 400 soo
Power for factory $ 200 $ 4,000
Fixed Costs
Managers' salaries in factory $ 400 Fixed
Factory employee training $ 180 20
Factory picnic and holiday party
Factory supervisory salaries
$ 20
$ 1,400
6000
Depreciation, plant and equipment
Property taxes on plant
$ 3,600
$ 300 total 30000
Insurance on plant $ 100 $ 6,000
Total indirect costs $ 10,000
Total manufacturing costs $ 30,000
Cordell Company (numbers in thousands of dollars) (2/2)

2. Selling Expenses (non-manufacturing costs)
Variable selling expenses
Sales commissions $ 1,400 frongquation
Shipping expenses for products sold
Fixed selling expenses
$ 600 $ 2,000
78
Advertising $ 1,400 var 2000 3
Sales sallaries $ 2,000
Other $ 600 $ 4,000 Fixed4000 66
Total selling expenses $ 6,000
total 6000
3. Administrative Expenses (non-manufacturing costs)
Variable admin expenses
Some clerical wages $ 160
1800 9
Computer time rented $ 40 $ 200
Fixed admin expenses
Office salaries $ 200 fixed
Other sallaries
Depreciation on office facilities
$
$
400
200 total2000
Public-accounting fees $ 80
Legal fees $ 200
Other $ 720 $ 1,800
Total administrative expenses $ 2,000
Sales manufacturingcosts
Grop
Managerial Accounting Mary
Example: Income Statement using the Absorption Approach

Primary classification of costs on the income statement by the three
major management functions:
- manufacturing,
- selling and
- (general and) administrative expenses
Sales $ 40,000
Less: (manufacturing) cost of goods sold
Direct materials $ 14,000
Indirect manufacturing $ 10,000 $ 30,000
Gross margin or gross profit $ 10,000
Less: Selling expenses $ 6,000
Less: Administrative expenses $ 2,000 $ 8,000
Operating Income $ 2,000
Gross Margin = Sales – Manufacturing cost of good sold

Example: Income Statement using the Contribution Approach

Emphasizes the distinction between variable and fixed costs (not
by business functions)
Approach allows to easier understand impact of changes in sales
volume on operating income
Sales $ 40,000
Less: variable expenses
Direct materials $14,000
Variable indirect manufacturing $ 4,000
Total variable manufacturing cost of goods sold $24,000
Total variable selling expenses $ 2,000
Total variable administrative expenses $ 200 $ 26,200
Contribution margin $ 13,800
Less: fixed expenses
Total fixed manufacturing cost of goods sold
Total fixed selling expenses
$ 6,000
$ 4,000
Ctaxessalaries etc
Total fixed administrative expenses $ 1,800 $ 11,800
Operating Income $ 2,000
Contribution Margin = Sales – Total variable expenses

Contribution a internal
Absorbtion D external
Ex.: Pricing Special Orders using Contribution Approach (1/2)

Cordell Company makes and sells 1,000,000 seat covers
Total manufacturing cost is $30,000,000, or $30 per unit
Cordell is offered a special order of $26 per unit for 100,000
To
units.
ooo
Accepting such special offer
1. would not affect Cordell’s regular business.
2. would not raise any antitrust issues.
3. would not affect total fixed costs.
4. would not require additional variable selling and administrative
expenses.
5. would use some otherwise idle manufacturing capacity

Ex.: Pricing Special Orders using Contribution Approach (2/2)

Without Special Order Effect of Special Order With Special Order
1,000,000 units 100,000 units 100,000 units
Total Total Per Unit Total
Sales $ 40,000,000
Less: variable expenses

2600.000 26 42,600,000
Manufacturing costs $ 24,000,000
Selling expenses $ 2,000,000

2.400.000 24 26,900,000
Administrative expenses $ 200,000

8 8
24
Total variable expenses $ 26,200,000
2.900.000 28,600,00
Contribution margin $ 13,800,000
200.000 2 14,000,000
Less: fixed expenses
O O
Manufacturing costs $ 6,000,000
O O
Selling expenses $ 4,000,000
O O
Administrative expenses $ 1,800,000
O O
Operating Income
$
$
11,800,000
2,000,000
O O 11,800,000
200,000 2 21200,000
Sales Compensation
mage inkl.p.ae
so
glop
100.006
80000
Slope
40000 4
1.000.000
É
I I l 1 I 1 I g.gg balls
my insp a
Incorrect Analysis: Misuse of Unit Cost
Without Effect of With

Special Order Special Order, Special Order,
Incorrect Analysis 1,000,000 units 100,000 units 1,100,000 units
Total Per Unit
Sales $ 40,000,000 $ 2,600,000 $ 26 $ 42,600,000

Less: Manufacturing cost of
good sold @$30 $ 30,000,000 $ 3,000,000 $ 30 $ 33,000,000
Gross Margin $ 10,000,000 $ -400,000 $ -4 $ 9,600,000
Less: Selling expenses $ 6,000,000 $ 6,000,000
Less: Administrative expenses $ 2,000,000 $ 2,000,000
$ 8,000,000 $ 8,000,000
Operating Income $ 2,000,000 $ -400,000 $ -4 $ 1,600,000


Suppose Nike produces and sells 500,000 units of a T-Shirt. The
selling price is $35, and there is excess capacity to produce an
additional 300,000 shirts. The variable manufacturing costs is
$7,000,000 and the fixed manufacturing costs is $3,000,000.
Variable selling and administrative costs are $3 per shirt, and fixed
selling and administrative costs are $2,000,000. Assume Nike
receives an order to sell 100,000 T-Shirts at a price of $18 per shirt.
If Nike accepts the order, it would not incur any additional variable
selling and administrative costs, but it would have to pay a flat fee of
$80,000 to the manufacturer’s agent who had obtained the potential
offer.
Should Nike accept the special order?
yes
300000unit o excesscapacity
Nike Tshirt unit soothits
Sales 35 17500000
Variable manufCosts 14 71000,000
ixedmanut Costs 3,000,000 a Absorbition approach is the

grossProfit
wrong one in this case
SellingandAdm 3 1500000
Variable costs
SellingandAdm 2,0001000
fixed Costs
Tadditional
units lunit
100,000 250000units
Sales 1800,000 18 13
Variable 1,400,000 14 14
Costs
manuf
Variable
Costolnon O O O
manofact
Agent 80,000
gooooo b profit
contribution no
margin

What if the order was for 250,000 units at a selling price of $13 and
A No
there was no $80,000 agent’s fee? One manager argued for
acceptance of such an order as follows: “Of course, we will lose $1
each on the variable costs but we will gain $2 per unit by spreading
our fixed manufacturing costs over 750,000 shirts instead of 500,000
shirts. Consequently, we should take the offer because it represents
an advantage of $1 per shirt.” The manager’s analysis follows:
Old fixed manufacturing cost per unit ($3,000,000 / 500,000 units) $ 6

Old fixed manufacturing cost per unit ($3,000,000 / 750,000 units) $ 4
"Savings" in fixed manufacturing cost per unit $ 2
Loss on variable manufacturing cost per unit ($13-$14) $ -1
Net savings per unit in manufacturing cost $ 1
Explain why this is faulty thinking.

because
we must first cover the variable expenses and
they are alnedy higher Withoutthevariable we can'tmake

thefinished goods
Example: Using ABC for Special Orders (1/3)

Variable manufacturing
costs ($24 mln) 24 unit
214583 setup
Processing activity Setup activity 3000000 500setups
($21 mln) ($3 mln)
million million
I
Units Number of
cont unit
produces production setups
cost objects Processing
Assume Cordell produces 1,000,000 units using 500 setups. 4888.88 21 10
Calculate the change in operating income that results from a special
order to sell a 100,000 units at a price of $26 each in case
a) The manufacturing of such special order requires only 5 setups
b) The manufacturing of such special order requires 100 setups
a) In case of 5 additional setups
Revenues 26 100.000 2.600.000
Processing activity, i.e.

additional unit-based 21 100.000 2100.000
variable manufacturing cost
Setup activity, i.e. additional
setup-based variable
J ftp.ttupesinetor
30000
manufacturing cost
Total additional variable 2130.000
manufacturing cost
change in operating income 470.000 Profit

b) In case of 100 additional setups
Revenues
2 600.000 26 unit
Processing activity, i.e.
additional unit-based
variable manufacturing cost
2.100.000 21 unit
Setup activity, i.e. additional
setup-based variable 6000 setup 100setups 600.000
manufacturing cost
Total additional variable
manufacturing cost 2700.000
change in operating income 100.000

Cost-Plus Pricing Using Various Approaches

Setting price by selecting a cost basis and adding a markup as a
percentage of respective cost basis, i.e.
Price = Cost basis + Cost basis markup

= Cost basis (1 + markup)
i.e.
Possible cost bases:

• variable manufacturing costs
contribution approach
• total variable costs
• total manufacturing cost
absorbtion approach
• full costs

Price costbase
Markup cost bad
Example: Relation of Costs to Same Target Price

(assumption 1,000,000 units)
Alternative Markup Percentages
to Achieve Same Sales price
Sales price $ 20.00
Variable cost:
20
(1) Manufacturing
Selling and administrative
$ 12.00
$ 1.10
12 66,671
(2) Unit variable costs $ 13.10 1013,1610 52,67to
Fixed costs:
Manufacturing $ 3.00
Selling and administrative $ 2.90
Unit fixed costs $ 5.90
(4) Full costs $ 19.00 295 5,26

Desired operating income $ 1.00
selling and administrative costs include costs of all value-chain functions other than production
(3) (sales price - total manufacturing costs) ÷ total manufacturing costs
=
20,31
33,33
12 3
Contribution Approach in Cost-Plus Pricing

• Price formula allows managers to prepare price schedules at
different volume levels
• Due to separation of variable and fixed costs, total unit costs
correctly captured
• Offers insights into the short-term versus long-run effects of
cutting prices in special orders
Volumes in units
In excel
900,000 1,000,000 1,100,000
at't
Sales at $20.00 $18,000,000 $20,000,000 $22,000,000
Unit variable costs at $13.10 $11,790,000 $13,100,000 $14,410,000
Contribution Margin $6,210,000 $6,900,000 $7,590,000
Fixed costs $5,900,000 $5,900,000 $5,900,000
Target Operating Income $310,000 $1,000,000 $1,690,000
Fixed costs = 1,000,000 units * ($5.9 per unit) = $5,900,000

Minimum and Maximum Price

• Maximum price is not a matter of costs at all. It is what you think
you can obtain (i.e. your customer is willing to pay).
• The minimum price should equal the total variable cost (see
special orders)
Contribution Approach Absorption Approach

total variable range of maximum total full range of maximum
cost margin price cost margin price
0-3
0-7
15 15
12
8

Summary Problem for Your Review

Custom Graphics is a Chicago printing company that bids on a variety of
design and printing jobs. The owner of the company, Jane Solomon, prepares
the bids of most jobs. Her cost budget follows:
Solomon has a target profit of $250,000.

Compute the average target markup percentage for setting prices as a
percentage of the following: 1. Materials plus labor 3. All variable costs
2. Variable production 4. All costs
costs of jobs
I 250,0000 250000 RA 1,250,000
99.5 RG
1588
8 or 150
1,500,000
2 1,59 08 J 40
or 400
3 11388898 5 1.0
or 1000
188944 1 92
Or 20
Concept of Target Costing

Take a product’s market price as given and determine the maximum
cost the company can spend to make the product and still achieve
the desired profitability.
• Sets a cost before the product is created or even designed

• Improvement in product design and manufacturing process so that
product’s cost does not exceed its target cost (value engineering)
Improvement
to athieul
• After product implementation, continuous improvement during
thetargetcost
manufacturing (kaizen costing)
• Use activity based management (ABM) to further reduce costs
• Use target costing to decide whether to add a new product

Example: Target Costing valueengineering

Existing Cost
Structure
200min
Price Gross Part A
Target
(Set by Margin
Part B Cost
Market) (Set by Structure
Mgmt.)
Part C
Target Part A
Cost Reduction Methods:
pricing 600 Product Direct Part C
slithlyredodygiting
Cost Labor • Value Engineering
(during design and Direct
Indirect development) Labor
Cost 1*
400 • Kaizen Costing Indirect
Indirect
max Cost 2*
(during production)
• Activity-Based
Cost 2
Indirect Indirect
Cost 3*
Management Cost 3
(during all stages of
Indirect Indirect
product life) Cost 4
Cost 4*
*Each indirect cost is associated with an indirect activity.
• Design changes -> Elimination of part B (value engineering)
• Cost reduction for part A and C (kaizen costing)
• Indirect cost 1 was eliminated in the cost reduction process (ABM)
Target Costing versus Cost-Plus Pricing
pfftit
Target Costing: Market Paid
• product’s market price as starting point
• target product cost to be achieved via value engineering, kaizenis
negotiate
costing and activity based management suppliers with
Cost-Plus Pricing:
resource view
• product’s cost as starting point
• market price as markup of cost basis
Increasing popularity of target costing:

• global market competition limits companies’ influence on market
prices
• cost management becomes key to profitability
• target costing forces managers to focus on costs to achieve
desired profitability

Section questions
1) It is misleading to use the absorption costing income statement to predict

the effect of changes in sales volume because ________.
a) variable production costs per unit do not change with small changes in
sales volume
A
b) total fixed production costs do not change with small changes in sales
volume
c) fixed production costs per unit do not change with small changes in
sales volume
d) total variable production costs do not change with small changes in
sales volume
2) Fixed selling expenses affect the calculation of ________ on the

contribution income statement. Fixed selling expenses do NOT affect the
calculation of ________ on the absorption income statement.
a) contribution margin; gross margin
b) gross margin; contribution margin
c) operating income; gross margin
d) operating income; contribution margin
164.5000
Section questions
Cost
3) Wisconsin Company has a current production capacity level of 200,000 1 89000
units per month. At this level of production, variable costs are $1.00 per
unit and fixed costs are $0.50 per unit. Current monthly sales are 164,500
units. Gates Company has contacted Wisconsin Company about
purchasing 20,000 units at $2.00 each. Current sales would not be
affected by the special order and no additional fixed costs would be
incurred on the special order. Variable costs would increase $0.10 per unit
(for such additional units only) with the special order. If the order is
accepted, what is Wisconsin Company's increase in operating income?
a) $8,000
b) $18,000 heh 20000 2
I
c) $20,000 40.000
x 6,10 20,000 22,000
100 20.0 440.000
d) $24,000
Y't 1886900
Different 18,000 10x 209000 18,000

setupcont
Section questions
500 710 60000
I
4) Kansas Company uses activity-based costing. The company produces and
sells 20,000 units at $22 per unit. Kansas Company's product cost is 1
calculated as follows: VC1101 50,000 VC 5.000
60 No 7200
Variable costs $10 per unit HER
Fixed costs
Setup costs
$2 per unit
$3 per unit 500 120 6000
Total costs $15 per unit 3 20,000
609 0 120setup
A total of 500 setups at a cost of $120 per setup are required to produce
the 20,000 units. Kansas Company has received a special order to sell
5,000 units at $12 per unit. Kansas Company has excess capacity available,
but these 5,000 units would require 60 setups. If Kansas Company accepts
the special order, what is the increase or decrease in net income?
a) $0
b) decrease $5,000
Sales x 5000 60,000 12
c) decrease $15,000
d) increase $2,800
variableCosts 5000 10 50,000
0 Setup Costs 120 60 7200
21800
Section questions
5) In imperfect competition, firms should produce and sell units until the
________ equals the ________.
a) marginal revenue; marginal cost
b) average revenue; marginal cost
c) marginal revenue; average revenue
d) average revenue; average cost
6) In the short run, when managers set prices for products, the minimum
selling price should be equal to ________.
a) all variable costs of producing, selling and distributing the good or
service
b) all fixed costs of producing, selling and distributing the good or service
c) all fixed and variable costs of producing, selling, and distributing the
good or service
d) all manufacturing costs

Section questions
70 IC
7) Management cannot influence the price of a new product. The market price
is $100 per unit. The estimated production cost is $30 per unit. The
estimated nonproduction cost is $40 per unit. If the gross profit is 40
percent of the market price, what is the target cost of the new product?
a) $30
b) $40 grassProfit 40
c) $60
A
d) $70
8) If the projected cost for a new product to be manufactured exceeds the

target cost, what measures can the company undertake to reduce the
projected cost?
a) kaizen costing
b) value engineering
c) supplier negotiations
d) all of the above
X
1.6 Relevant Information for Decision Making with a Focus on Operational Decisions
Learning Objectives
1. Use a differential analysis to examine income effects across alternatives

and show that an opportunity-cost analysis yields identical results.
decidewhich
2. Decide whether to make or to buy certain parts or products.
projectyouwill
3. Choose whether to add or delete a product line using relevant invest
incremental analysis
information.
4. Compute the optimal product mix when production is constrained by one
scarce resource only.
5. Decide whether to process a joint product beyond the split-off point.
6. Decide whether to keep or replace equipment.
7. Discuss how performance measures can affect decision making.

Examples of Operational Decisions
• Should Dr. Pepper operate own bottling facilities or contract with

existing beverage co-packers?
• Should Toyota make the tires it mounts on its cars, or should it

buy them from suppliers?
• Should General Mills sell the flour it mills, or should it use the flour
to make more breakfast cereal?
• Should Air France add routes to use idle airplanes, or should it sell
the planes?
otioso

Greenfield approach
got
Differential and Incremental Analysis
Differential analysis:
• Decision process that compares differential revenues and costs of
alternatives
• Take alternative creating maximum “benefits minus cost” amount
• Example: Which of two machines to purchase
what is thebenefit
Incremental analysis: a bit more information on top
• Analyzing incremental revenues and costs between the existing
situation and proposed alternatives
• Take alternative with the highest increment in “benefits minus costs”
• Example: Increase production from 1,000 to 1,200 units per day
Example of Differential and Incremental Analysis (1/3)

Nantucket Nectars has idle machine capacity that can either be used
to produce Papaya Mango juice or Peach juice. Alternatively
Nantucket Nectars can sell the machine.
r r
The outlay costs for items such as materials and labor for producing
Papaya Mango juice and Peach juice is $400,000 and $300,000 while
the total revenues over the machine’s lifetime are $500,000 and
$360,000 respectively. The selling price of the machine is $50,000.
Perform an Differential Analysis and an Incremental Analysis. Use the

scenario “sale of machine” as starting point for the Incremental
Analysis. C R R C
Palata 500,00 900,600 100,000 n Produce
Peak 36900 300,00 60,000
sell
Horngren et al, p. 245 50000 50,000

Differential Analysis
Pap Mango Peach Sale
Benefits 500.000 360.000 50.000
Costs 400.000 300.000 0
Netbenefit 100.000 60.000 50.000

opportunity costs
Ca Produce
payapa
mangothen
Horngren et al, p. 245 Incrementalbenefit
Incremental Costs

Incremental Analysis using “sale of machine” as starting point
Sale DapMango Sale Peach

juice
Peach Papaya Mango
Incremental 500.000 50.000 360.000 50.000 500.000 360.000
benefits 450.000 310.000 160.000

Incremental 400.000
gooooo 0 30.0.000 0 300.000
costs 100.000
Incremental
net 50.000 10.000 40.000
benefit
Horngren et al, p. 245 Produce Papaya Mango instead
© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | FACHBEREICH WIRTSCHAFTSWISSENSCHAFTEN | WWW.FH-AACHEN.DE |
of
157
selling
Opportunity Cost
• Deciding to use the machine for producing Papaya Mango means to
decide against producing Peach juice or selling the machine
• Opportunity cost is the maximum available benefit forgone (or
passed up) by using such a resource for a particular purpose
instead of the best alternative use.
Revenues
5000000
Less: Outlay costs
400.000
Financial benefit before opportunity
costs 100.000
Less: Opportunity costs
Ethel 60.000
Thotgiving
Net financial benefit up the
bestoption
yo yo
Example: Make-or-Buy Decisions with Idle Facilities (1/2)

• Managers often must decide whether to produce a product or
service within the firm or purchase it from an outside supplier.
Total Cost for Cost

1,000,000 bottles per bottle
Direct material $ 60,000 $ 0.06
Direct labor $ 20,000 $ 0.02
Variable factory overhead
electricity $ 40,000 $ 0.04
Fixed factory overhead (OH) $ 80,000 Saeed $ 0.08
Total costs $ 200,000 $ 0.20
refutal
• Another manufacturer offers to sell Nantucket Nectars the bottles
for $.18. Should Nantucket Nectars make or buy the bottles?
• Nantucket Nectars can eliminate $50,000 of fixed costs if the
company buys the bottles instead of making them.
Horngren et al, p. 248-249 O18x Imi
180.000
159
Example: Make-or-Buy Decisions with Idle Facilities (2/2)

• Should Nantucket Nectars outsource the production?
Make Buy
cost in '000 USD Total per Bottle Total per Bottle
Purchase cost
O O 180.000 0118
Direct material 60.000 0,06
Direct labor
20.000 0,02
Variable overhead (OH) 90.000 0,04
Fixed OH 80.000 0108 80 538 013
Total costs 200,000 0,20 210 2,1
Difference in favor of making
10.000
making is stillmore attractive
Example: Make-or-Buy Decisions with the Use of Facilities (1/2)

• Previous example implies opportunity cost of zero
• Suppose Nantucket can use the released facilities in other
manufacturing activities to produce a contribution to profits of
$55,000, or can rent them out for $25,000
Buy and Use

Buy and Leave Buy and Rent
in '000 USD Make Facilities for
Facilities Idle Out Facilities
Other Products
Rent revenue
Contribution from
$— $—
25
$— $—
other products
Variable cost of
I 55
-200 -210
bottles 210 210
Net relevant costs $(200) $(210)
185 J 55
best alternative buybottles andonefacilitiesfor another production
Question
EXAM 1.6 Relevant Information for Decision Making with a Focus on Operational Decisions

Block Company makes industrial drills. The following table shows the costs of
the plastic housing separately from the costs of the electrical and mechanical
components.
A B A+B
Electrical and Mechanical Plastic Industrial
Components* Housing Drills
Sales: 100.000 units at $100 $ 10,000,000
Variable Costs
Directs Materials $ 4,400,000 $ 500,000 $ 4,900,000
Direct labor $ 400,000 $ 300,000 $ 700,000
Variable factory overhead $ 100,000 $ 200,000 $ 300,000
other variable costs $ 100,000 $ 100,000
Sales commissions, at 10% of sales $ 1,000,000 $ 1,000,000
in
Total variable costs $ 6,000,000 $ 1,000,000 $ 7,000,000
Contribution margin $ 3,000,000
Total fixed costs $ 2,220,000 $ 480,000 $ 2,700,000
Operating income $ 300,000
*Not including the costs of plastic housing (column B)

1. During the year, a prospective customer in an unrelated market offered
$282,000 for 1,000 drills. The drills would be manufactured in addition to
the 100,000 units sold. Block Company would pay the regular sales
commission rate on the 1,000 drills. The president rejected the order
because „it was below our costs of $97 per unit“. What would operating
income have been if Block Company has accepted the order?
2. A supplier offered to manufacture the year‘s supply of 100,000 plastic

housings for $12.00 each. What would be the effect on operating income if
the Block Company purchased rather than made the housings? Assume
that Black Company would avoid $350,000 of the fixed costs assigned to
housings if it purchases the housings.

For1000drill
init282,000
us 4888
3 3000
I
219
to
18 8
Onew prospect
282,000 for 1000drils
inaddition tothe 100.000sold
drills cont
Block willpay Cominion on 1000
what isthe op income including the neworder 300000 593.000 99310
Plastic each x 100.000units

for 12 1209000
What is effectonop income A increaseof 150,000
avoidance
of 350,000 atfixedcosts
buying totalafter
housing 10,000,000
1200,000 7,2001000
43501000
450,000
350,00 To increase
1501000

3. Suppose that Block Company could purchase the housings for $13.00 each
and use the vacated space for the manufacture of a deluxe version of its
drill. Assume that it could make 20,000 deluxe units (and sell them for
$130 each in addition to the sales of the 100,000 regular units) at a unit
variable cost of $90, exclusive of housings and exclusive of the 10% sales
commission. The company could also purchase the 20,000 extra plastic
housings for $13.00 each. All the fixed cost pertaining to the plastic
housings would continue because the costs relate primarily to the
manufacturing facilities used. What would operating income have been if
Block Company had bought the housings and made and sold the deluxe
units?
Sales
housings 13,00unit 20,400 130 2,600,000
costs
20000 50 18,00900
20000 13 260,000
Cominion 260,000
totalafter
10,000,000
o o o
Sales
A B Unit DeluxeRory
130 4600900
180000
YE
minion 269000260,000
otalve2061000 260,000 4661000
CMM
2134000
anew opiprofit
ired
Fotaltor Additional
100,000 buying
houses
µ Matic
boy Hyogo 2,660,000
DM 9,400,000 1300900 1800,000 unit V0
DV 400,000 260,000 housing
VCOH 100,000
OtherVC 100,000
Cominion 1,000,000 2601000Ccominion
total Cm 6,000,000 app 2801000
FL 7,200,000 1000,000 3,200,000
OpIncome 9,100,000
taste
Deletion or Addition of Products, Services, or Departments

• Decisions to add or to drop products or whether to add or to drop
departments will use the same analysis: examining all costs and
revenues.
Departments
General
in '000 USD Total Groceries Drugs
Merchandise
Sales $ 1,900 $ 1,000 $ 800 $ 100
Variable expenses $ 1,420 $ 800 $ 560 $ 60
ontribution
Contribution margin $ 480 (25%) $ 200 (20%) $ 240 (30%) $ 40 (40%)
pproach Fixed expenses:
Avoidable $ 265 $ 150 $ 100 $ 15
Unavoidable $ 180 $ 60 $ 100 $ 20
Total fixed expenses $ 445 $ 210 $ 200 $ 35
Operating income $ 35 $ (10) $ 40 $5
$
Example Deletion of Grocery Department (no opportunity cost)

• Assume that the only alternatives to be considered are dropping or
continuing the grocery department
• Assume further that the total assets invested would be unaffected by the
decision
• The vacated space would be idle and the unavoidable costs would continue
Total Before Impact of dropping Total After
Change Groceries Change
Sales $ 1,900 1000,00 900,60
Variable expenses $ 1,420
Contribution margin $ 480
000,00 620,00
Avoidable fixed expenses $ 265
200,00 180100
130,00 135,00
Profit contribution $ 215
50,00 865,00
Unavoidable expenses $ 180
Operating income $ 35 to s's
no impact
wouldreduceoperating incomeby 15
Droppinggrocery
Example Deletion of Grocery Department (opportunity cost)

• Assume that the store could use the space made available by the dropping of
groceries to expand the general merchandise department. t
• This will increase sales by $500,000, generate a 30% contribution margin,
and have avoidable fixed costs of $70,000.
Effects of Changes
Total Before Drop Expand General Total After Change
in '000 USD
Change (a) Groceries (b) Merchandise (c) (a)-(b)+(c)
Sales $ 1,900 $ 1,000 500,000 1600
Variable expenses
Contribution margin
$ 1,420
$ 480
$ 800
$ 200
350 970
Avoidable fixed expenses $ 265 $ 150
150 430
70 185
I 30 80
Profit contribution $ 215 $ 50
245
Unavoidable expenses $ 180 $-
0 180
Operating income $ 35 $ 50
merchandise
80 65
Answer expandgeneral which increases operations
income
by 30
Optimal Use of Limited Resources

• A limiting factor or scarce resource restricts or constrains the
production or sale of a product or service.
Possible limiting factors:

• labor hours and machine hours (in manufacturing firms)
• square feet of floor space or cubic meters of display space (in sales
stores)

Example for Optimal Use of Limited Resources

Air Court Air Max
Selling price per pair $ 80 $ 120
Variable costs per pair $ 60 $ 84
ContributionMargin 20 36
• Machine time is the measure of capacity in this factory, and there is a
maximum of 10,000 hours of machine time. The factory can produce 10
pairs of Air Court shoes or 5 pairs of Air Max shoes in 1 hour of machine time.
• If the limiting factor is demand what would be the optimal production strategy?
000 unit
irma
• Suppose that demand for either shoe would exceed the plant’s capacity. Now,
capacity is the limiting factor. Which shoe is more profitable?

AirCourt AirMax
Sellingprice 80 120
perpain
Variablecosts 60 89
papain
contribution
margin pair 20 36
Contribution
machine
20 perunit loonits 36penpain Spain
margin perhour hour
per
hour
200 180
If demand is the serve first

limiting factor
Air mat due to the highest contribution margin
machine capacity in the scarce resource
sellfirst IfAIR Court and after entire domandforain
Court is being satisfied AIR Max thereafterfuntil
the machine capacity is fully utilized
Joint Product Cost: Sell or Process Further

• Dow Chemical Company produces two chemical products, X and Y,
• The joint processing cost is $100,000 before reach of split-off point
• At the split-off point, Dow either sells X and Y or processes them
further before selling them to the petroleum industry
1,000,000 Liters
of X at Selling
Joint Processing Cost, Price of $.09 $90,000
$100,000
500,000 Liters of
Y at Selling Price
Split-Off
of $.06 $30,000
Point
Total Sales Value

at Split Off
$120,000
Illustration of Sell or Process Further

• Suppose the 500,000 liters of Y can be processed further and sold to the
plastics industry as product YA
• The additional processing cost would be $ 0.08 per liter for manufacturing
and distribution
908 500,000 90,000
• The net sales price of YA would be $0.16 per liter
• Should Dow Chemical Company sell Y or process Y to YA and sell YA instead?
Sell at Split-off Process Further
Difference
as Y and Sell as YA
30000 50.000
Revenues
1006 500.000 o 8 888000
Separable costs beyond

split-off at $0.08 I 40.000 40.000
Income effects
30.000 40.000 10,000 Soit
100.000 is incurred profitable toprodo
anyway
Horngren et al, p. 256-257 UYA
Example Keeping or Replacing Equipment (1/2)

• A manager has to decide if an 6 years old machine should be
replaced by a new one
• The original lifetime of the machine was originally estimated to be
10 years. The original cost had been $ 10,000 and depreciations
have been made accordingly
Replacement
Old Machine
Machine
Original cost $ 10,000 $ 8,000
Useful life in years 10 4
Current age in years 6 0
Useful life remaining in years 4 4
Accumulated depreciation $ 6,000 N/A
Book value $ 4,000 N/A
Disposal value (in cash) now $ 2,500 hypotheticN/A
Disposal value in 4 years 0 0
Annual cash operating costs (main-
$ 5,000 $3,000
tenance, ower, repairs, coolants, etc.)
Example Keeping or Replacing Equipment (2/2)
Four Years Together

keep Replace
Keep Replace Difference
Cash operating costs
5000 49 20.000 12.000 8000
Old equipment (book value):
Periodic-write-off as depreciation, or
noentendi
4000
Lump-sum write-off yapping O
Disposal value
2,500 21500
New machine
acquisition cost
I 8000 8000
Total costs
24,000 21500 2500
should then replace the machine
you
Sunk Cost
Historical or past cost that the company has already incurred and,
therefore, is irrelevant to the decision-making process.
• In previous example, the book value of asset is a sunk cost
0
• It is sometimes difficult to accept the proposition that past or sunk
costs are irrelevant to decision “we have to continue as we have
already put a significant amount of money in the project”
• In decision making, only future costs and revenues that differ

among alternative course of action are of interest

Conflicts between Decision Making and Performance Evaluation

• Methods of evaluating managers’ performance should be consistent
with the appropriate decision model for the company
Year 1 Year 2, 3, and 4 (p.a.)

Keep Replace Keep Replace
Cash operating costs
5000 3000 5000 3000
Depreciation 009 2000
1000 1000 2000
Loss on disposal
I 1500 1
Total cost
6000 6500 6000 5000
• Assume that top management uses accounting income to measure a
manager’s performance.
• If the machine is kept rather than replaced, first-year costs will be
$ 500 lower (6500 6000), and first-year income will be $500 higher.
Section questions
1) Differential cost is the difference in ________ between two alternatives.

a) average cost
b) marginal cost
c) median cost 500am
d) total cost
Uc
2) Jeffrey Company wants to double production of Product X from 1,000 units
to 2,000 units. The variable manufacturing cost per unit is $10. The
variable nonmanufacturing cost per unit is $20. There are no fixed costs.
The selling price per unit is $50. What is the incremental revenue of the
proposed change?
a) $10,000
b) $20,000
c) $30,000
1000 22000
I
VCFIsales
x shale
d) $50,000 non ma 20 VC 1000650 RCA
959750 RGood50,000
R 2000 1001000
Section questions
3) Nancy Company has an idle machine that originally cost $200,000. The
book value of the machine is $100,000. The company is considering three
alternative uses of the idle machine:
Alternative 1: Disposal of machine. Disposal value of machine is $50,000.
Alternative 2: Use the idle machine to increase production of Product A.
Contribution margin from additional sales of Product A is estimated to be
$60,000.
Alternative 3: Use the idle machine to increase production of Product B.
Contribution margin from additional sales of Product B is estimated to be
$70,000.
When considering the opportunity cost of the idle machine, what is the net
financial benefit from Alternative 3? I 2 3
I
a) $10,000
b) $20,000
aogisition 200,000
DEREK 501000
c) $50,000
bu 100,000
d) $70,000
MA 601000
on noooo
pest 70,000
2 best 601000
benefit
1
Section questions
4) The salary foregone by a person who quits a job to start a business is an

example of a(n) ________.
a) sunk cost
b) opportunity cost
c) depreciable cost
d) outlay cost
5) In a make-or-buy decision, which of the following is the fundamental

question that is asked in making the decision?
a) What is the difference in present costs between the two alternatives?
b) What is the difference in present revenues between the two
alternatives?
c) What is the difference in future revenues between the two
alternatives?
d) What is the difference in future costs between the two alternatives?

Section questions
8000unit 568,000
21
0
6) Bonneville Company is producing a subassembly used in the production of a
product. The costs incurred for the subassembly follow:Produce
Per Unit 18 0 000 252,000
A Direct materials
Direct labor
Variable factory overhead
$6.00
$4.00
$1.00
Fixed supervisor salary $3.00
Depreciation expense on factory equipment $2.00
General fixed factory overhead allocated $5.00
Total costs $21.00
The above per unit costs are based on 8,000 units. An outside supplier will
provide 8,000 subassemblies for $19 per unit. The supervisor will be terminated
if the subassemblies are not produced in house. The idle factory will be used to
I
manufacture another product with a contribution margin of $60,000. What
should Bonneville do?
a) make the subassemblies and save $20,000
b) make the subassemblies and save $40,000
c) buy the subassemblies and save $20,000
d) buy the subassemblies and save $40,000
supervisor3
8,000 24000179
in hoon
Kost 15 000
ax sea son
Current Production
unit
is
doodnit 8000 19
DM 69
DL 32.000
V OH I 8000
Fixedsat 3
DepExp 16,000
Dixedott 99000
ontos total 168006 152,0001 16,000
Benefits n 90,000 A 12,000

saving
Section questions
7) Sahara Industries has three product lines: A, B and C. The following

annual information is available:
Sales
Product A
$100,000
Product B
$90,000
Product C
$88,000 TA t Ctotal Cit15,00
Variable costs 76,000 48,000 79,000
Contribution margin 24,000 42,000 9,000
Avoidable fixed costs 9,000 18,000 3,000
Unavoidable fixed costs 6,000 9,000 9,400
Operating income(loss) $9,000 $15,000 $(3,400)
2060029,000t550
Sahara Industries is thinking about dropping Product C because it is
reporting a loss. Assume Sahara Industries drops Product C and the space 39,000
formerly used to produce Product C is rented out for $15,000 per year.
What will happen to operating income?
a)
b)
increase
increase
by
by
$6,600
$9,000
15,068
80
c) increase by $14,400
d) increase by $15,000
© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | FACHBEREICH WIRTSCHAFTSWISSENSCHAFTEN | WWW.FH-AACHEN.DE | 180 6600

I
fatalop income 9000415000 3400 20600
now
total new 8000115000 6600 30,600
9000415000 t 15060 39000
Section questions
8) Assume no opportunity costs. When deciding whether to add or delete a

department, managers should keep the department as long as ________
from the department exceeds ________.
a) contribution margin; variable costs
b) contribution margin; common costs
c) contribution margin; avoidable fixed costs
d) contribution margin; unavoidable fixed costs
x
9) Joint products should be processed beyond the split-off point if ________.
a) sale of the products are guaranteed
b) additional revenue from further processing exceeds additional
expenses from further processing
c) additional revenue from further processing exceeds the joint costs
d) the marginal revenue of the joint products before the split-off point
exceeds the marginal cost of the joint products

Section questions
10) If demand is the limiting factor, and there are no other scarce resources,
managers should emphasize the product with ________.
a) the highest selling price per unit
b) the lowest variable costs per unit
c) the highest contribution margin per unit
d) the highest contribution margin per hour

Section questions
11)A company has 100,000 hours of capacity and manufactures two products,
Product X and Product Z. Neither product has enough demand to utilize
the entire capacity, but the combined demand of both products exceeds
the capacity of the plant. It takes one hour to make one unit of Product X
and two hours to make one unit of Product Z. The following information is
available:
Product X Product Z
Units produced from capacity available 100,000 50,000
Contribution margin per unit $20 $30
What product or products should be made?
a) only make Product X
b) only make Product Z
Oc) make Product X to meet customer demand and then make Product Z
d) make Product Z to meet customer demand and then make Product X

9000
Thour X 148
É Ys
2010.000
hours D Z Than I I 38 1 150,000
Section questions
12) Which of the following cost is relevant to an equipment replacement

decision?
a) cost of old equipment
b) cost of new equipment
c) book value of old equipment
d) depreciation expense on old equipment
13) A widespread problem in practice is that the decision model used by

managers for ________ and the model used by their superiors in
________ are different.
a) outsourcing; incremental analysis
b) outsourcing; differential analysis
c) decision making; performance evaluation
d) operational decisions; joint costing

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Managerial Accounting

1. Focus on Decision Making

2. Accounting for Planning and Control

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | FACHBEREICH WIRTSCHAFTSWISSENSCHAFTEN | WWW.FH-AACHEN.DE | 12

1. Explain why accounting is essential for decision makers and managers.

2. Describe the major users and uses of accounting information.

3. Understand the key differences between managerial and financial

5. Identify current trends in management accounting.

Decision making based on accounting information

• Accounting information is used in decision making for planning and control.

• Planning: Setting objectives and outlining how the objectives will be

• Control: Process of implementing plans and using feedback to

• Accounting provides a common language to help managers around the

Horngren et al, p. 20-21

Types of Accounting Information

Horngren et al, p. 21-22

Managerial and Financial Accounting, Eight Key Differences

blank Managerial Accounting Financial Accounting

Managers who plan for and External persons such as inves-

5. Time span Flexible, from hours to 10 years

whatand How Some companiesmake the

Budgets, Special Reports

Planning • Customer surveys

Exercise: Management by Exception using Performance Reports

Solution: Management by Exception using Performance Reports

2 Answer Food and decoration deservesfurther explanation

Introduction cost behavior

Actual cost 17g 5,89 person

Requirements on an Accounting System

Management Accountant’s Role as Consultant withinthe

- Interpreting and analyzing information

- Being involved in decision making but not making the decision

Excursus Functional Organization (Example)

Excursus Divisional Organization (Example)

Trends in Managerial Accounting require adaption to change

- Shifting from a manufacturing-based to a service-based economy impossible to

- Changes in business processes

- Increased global competition

- Changes resulting from new government regulations and public

Horngren et al, p. 33-35

0c. Management accounting is used by managerial accountants to make

2. Which of the following should be considered in the selection of an

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | FACHBEREICH WIRTSCHAFTSWISSENSCHAFTEN | WWW.FH-AACHEN.DE | 27

4. The major internal users of accounting information are

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | FACHBEREICH WIRTSCHAFTSWISSENSCHAFTEN | WWW.FH-AACHEN.DE | 28

1. Explain how cost drivers affect cost behavior.

3. Explain step- and mixed-cost behavior.

4. Create a cost-volume-profit (CVP) graph and understand the assumptions

5. Calculate break-even sales volume in total dollars and total units.

7. Differentiate between contribution margin and gross margin

Approach to predict and control costs is to identify

- key activities performed

- resources used in performing these activities

- cost of the resources used, and

- cost drivers, measures of activities that require the use of

- Activities use resources and these resources have costs.

- We measure this relationship between activity and cost using cost

Example: Calculating costs using cost drivers

Variable and Fixed Cost Behavior (1/2)

Variable Cost (Example: cost for installing seat)

Fixed Cost (Example: factory rental cost)

Total Variable and Fixed Cost Behavior (2/2)

total variable Cu x 120x total fix

Cost Function Equations