1. Comparison of Financial and Managerial Accounting

2. Opportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending college, you could be earning $15,000 per year. Your opportunity cost of attending college for one year is $15,000.

3. Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.

4. The Product Direct Materials Direct Labor Manufacturing Overhead Manufacturing Costs

5. Non-manufacturing Costs Marketing or Selling Cost Costs necessary to get the order and deliver the product. Administrative Cost All executive, organizational, and clerical costs.

6. Product Costs Versus Period Costs Product costs include direct materials, direct labor, and manufacturing overhead. Period costs include all marketing or selling costs and administrative costs. Inventory Cost of Good Sold Balance Sheet Income Statement Sale Expense Income Statement

7. Comparing Merchandising and Manufacturing Activities Merchandisers... –Buy finished goods. –Sell finished goods. Manufacturers... –Buy raw materials. –Produce and sell finished goods.

8. Types of Product Costing Systems Process Costing Job-order Costing  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.  A company produces many units of a single product.  One unit of product is indistinguishable from other units of product.  The identical nature of each unit of product enables assigning the same average cost per unit.

9. Types of Product Costing Systems Process Costing Job-order Costing  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.  Many different products are produced each period.  Products are manufactured to order.  The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

10. Manufacturing Overhead Job No. 1 Job No. 2 Job No. 3 Charge direct material and direct labor costs to each job as work is performed. Direct Manufacturing Costs Direct Materials Direct Labor

11. Manufacturing Overhead, including indirect materials and indirect labor, are allocated to jobs rather than directly traced to each job. Indirect Manufacturing Costs Direct Materials Direct Labor Job No. 1 Job No. 2 Job No. 3 Manufacturing Overhead

12. The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins. Manufacturing Overhead Application Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR = Ideally, the allocation base is a cost driver that causes overhead.

13. Using a predetermined rate makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until the end of the period. The Need for a POHR

14. Actual amount of the allocation based upon the actual level of activity. Based on estimates, and determined before the period begins. Application of Manufacturing Overhead Overhead applied = POHR × Actual activity

15. For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job. Overhead Application Rate POHR = $4.00 per DLH $640,000 160,000 direct labor hours (DLH) POHR = Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period POHR =

16. Job-Order Cost Accounting

17. Cost Classifications for Predicting Cost Behavior How a cost will react to changes in the level of activity within the relevant range. –Total variable costs change when activity changes. –Total fixed costs remain unchanged when activity changes. How a cost will react to changes in the level of activity within the relevant range. –Total variable costs change when activity changes. –Total fixed costs remain unchanged when activity changes.

18. Cost Classifications for Predicting Cost Behavior

19. The Activity Base A measure of what causes the incurrence of a variable cost Units produce d Miles driven Labor hours Machine hours

20. Extent of Variable Costs The proportion of variable costs differs across organizations. For example... A public utility with large investments in equipment will tend to have fewer variable costs. A manufacturing company will often have many variable costs. A merchandising company usually will have a high proportion of variable costs like cost of sales. A merchandising company usually will have a high proportion of variable costs like cost of sales. A service company will normally have a high proportion of variable costs. A service company will normally have a high proportion of variable costs.

21. Examples of Variable Costs 1.Merchandising companies – cost of goods sold. 2.Manufacturing companies – direct materials, direct labor, and variable overhead. 3.Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. 4.Service companies – supplies, travel, and clerical. 1.Merchandising companies – cost of goods sold. 2.Manufacturing companies – direct materials, direct labor, and variable overhead. 3.Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. 4.Service companies – supplies, travel, and clerical.

22. Relevant Range A straight line closely approximates a curvilinear variable cost line within the relevant range. Activity Total Cost Economist’s Curvilinear Cost Function The Linearity Assumption and the Relevant Range Accountant’s Straight-Line Approximation (constant unit variable cost)

23. Examples Advertising and Research and Development Examples Advertising and Research and Development Examples Depreciation on Equipment and Real Estate Taxes Examples Depreciation on Equipment and Real Estate Taxes Types of Fixed Costs Discretionary May be altered in the short-term by current managerial decisions Discretionary May be altered in the short-term by current managerial decisions Committed Long-term, cannot be significantly reduced in the short term. Committed Long-term, cannot be significantly reduced in the short term.

24. The Trend Toward Fixed Costs The trend in many industries is toward greater fixed costs relative to variable costs. As machines take over many mundane tasks previously performed by humans, “knowledge workers” are demanded for their minds rather than their muscles Knowledge workers tend to be salaried, highly-trained and difficult to replace. The cost to compensate these valued employees is relatively fixed rather than variable.

25. Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet) 0 30 60 Fixed Costs and Relevant Range 90 Relevant Range Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity.

26. Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.

27. The Contribution Format The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.

28. The Contribution Format Used primarily for external reporting. Used primarily by management.

29. Break-Even Analysis Here is the information from Racing Bicycle Company:

30. Contribution Margin Method The contribution margin method has two key equations. Fixed expenses Unit contribution margin = Break-even point in units sold Fixed expenses CM ratio = Break-even point in total sales dollars

31. Contribution Margin Method Let’s use the contribution margin method to calculate the break-even point in total sales dollars at Racing. Fixed expenses CM ratio = Break-even point in total sales dollars $80,00040% = $200,000 break-even sales

32. Contribution Margin Method Let’s use the contribution margin method to calculate the break-even point in units sold at Racing. Fixed expenses Unit CM = Break-even point in Units sold $80,000$200/unit = 400 break-even units

33. Target Profit Analysis The contribution margin method can be used to determine the sales volume needed to achieve a target profit. Suppose Racing Bicycle Company wants to know how many bikes must be sold to earn a profit of $100,000.

34. The Contribution Margin Approach The contribution margin method can be used to determine that 900 bikes must be sold to earn the target profit of $100,000. Fixed expenses + Target profit Unit contribution margin = Unit sales to attain the target profit $80,000 + $100,000 $200/bike = 900 bikes

35. Cost Structure and Profit Stability Cost structure refers to the relative proportion of fixed and variable costs in an organization. Managers often have some latitude in determining their organization’s cost structure.

36. Operating Leverage A measure of how sensitive net operating income is to percentage changes in sales. Contribution margin Net operating income Degree of operating leverage =

37. Operating Leverage Example Low-Lev CompanyHigh-Lev Company (1,000,000 units) Amount% % Sales$1,000,000100$1,000,000100 Var. Costs750,00075250,00025 CM250,00025750,00075 Fixed Costs50,0005550,00055 Operating Profit 200,00020200,00020 Breakeven Point 200,000 units733,334 CM per unit$0.25/unit$0.75/unit Operating Leverage 1.253.75

38. Operating Leverage Example Low-Lev CompanyHigh-Lev Company (1,100,000 units) Amount% % Sales$1,100,000100$1,100,000100 Var. Costs825,00075275,00025 CM275,00025825,00075 Fixed Costs50,0005550,00055 Operating Profit 225,00020275,00020 Breakeven Point 200,000 units733,334 CM per unit$0.25/unit$0.75/unit Operating Leverage 1.253.75 10% increase in sales 10% * 1.25 = 12.5% increase in profit 10% * 3.75 = 37.5% increase in profit

39. Cost Structure and Profit Stability There are advantages and disadvantages to high fixed cost (or low variable cost) and low fixed cost (or high variable cost) structures. An advantage of a high fixed cost structure is that income will be higher in good years compared to companies with lower proportion of fixed costs. A disadvantage of a high fixed cost structure is that income will be lower in bad years compared to companies with lower proportion of fixed costs.

40. The Basic Framework of Budgeting A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. 1.The act of preparing a budget is called budgeting. 2.The use of budgets to control an organization’s activity is known as budgetary control.

41. Planning and Control Planning – involves developing objectives and preparing various budgets to achieve these objectives. Control – involves the steps taken by management that attempt to ensure the objectives are attained.

42. Advantages of Budgeting Advantages Define goal and objectives Uncover potential bottlenecks Coordinateactivities Communicateplans Think about and plan for the future Means of allocating resources

43. Responsibility Accounting Managers should be held responsible for those items — and only those items — that the manager can actually control to a significant extent. Managers should be held responsible for those items — and only those items — that the manager can actually control to a significant extent.

44. Human Factors in Budgeting The success of budgeting depends upon three important factors: 1.Top management must be enthusiastic and committed to the budget process. 2.Top management must not use the budget to pressure employees or blame them when something goes wrong. 3.Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets. The success of budgeting depends upon three important factors: 1.Top management must be enthusiastic and committed to the budget process. 2.Top management must not use the budget to pressure employees or blame them when something goes wrong. 3.Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets.

45. The Master Budget: An Overview Production Budget Production Budget Selling and Administrative Budget Selling and Administrative Budget Direct Materials Budget Direct Materials Budget Manufacturing Overhead Budget Manufacturing Overhead Budget Direct Labor Budget Direct Labor Budget Cash Budget Cash Budget Sales Budget Sales Budget Budgeted Financial Statements Ending Finished Goods Budget Ending Finished Goods Budget

46. Budgeting Example  Royal Company is preparing budgets for the quarter ending June 30.  Budgeted sales for the next five months are: April 20,000 units April 20,000 units May 50,000 units May 50,000 units June 30,000 units June 30,000 units July 25,000 units July 25,000 units August 15,000 units. August 15,000 units.  The selling price is $10 per unit.  Royal Company is preparing budgets for the quarter ending June 30.  Budgeted sales for the next five months are: April 20,000 units April 20,000 units May 50,000 units May 50,000 units June 30,000 units June 30,000 units July 25,000 units July 25,000 units August 15,000 units. August 15,000 units.  The selling price is $10 per unit.

47. Expected Cash Collections All sales are on account.All sales are on account. Royal’s collection pattern is:Royal’s collection pattern is: 70% collected in the month of sale, 70% collected in the month of sale, 25% collected in the month following sale, 25% collected in the month following sale, 5% uncollectible. 5% uncollectible. The March 31 accounts receivable balance of $30,000 will be collected in full.The March 31 accounts receivable balance of $30,000 will be collected in full. All sales are on account.All sales are on account. Royal’s collection pattern is:Royal’s collection pattern is: 70% collected in the month of sale, 70% collected in the month of sale, 25% collected in the month following sale, 25% collected in the month following sale, 5% uncollectible. 5% uncollectible. The March 31 accounts receivable balance of $30,000 will be collected in full.The March 31 accounts receivable balance of $30,000 will be collected in full.

48. Expected Cash Collections

49. From the Sales Budget for April.

50. Expected Cash Collections From the Sales Budget for May.

51. Quick Check What will be the total cash collections for the quarter? What will be the total cash collections for the quarter? a. $700,000 b. $220,000 c. $190,000 d. $905,000 What will be the total cash collections for the quarter? What will be the total cash collections for the quarter? a. $700,000 b. $220,000 c. $190,000 d. $905,000

52. The Production Budget Production must be adequate to meet budgeted sales and provide for sufficient ending inventory.

53. The Production Budget The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. On March 31, 4,000 units were on hand. On March 31, 4,000 units were on hand. Let’s prepare the production budget. Let’s prepare the production budget. The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. On March 31, 4,000 units were on hand. On March 31, 4,000 units were on hand. Let’s prepare the production budget. Let’s prepare the production budget.

54. The Production Budget

55. March 31 ending inventory March 31 ending inventory

56. Quick Check What is the required production for May? What is the required production for May? a. 56,000 units b. 46,000 units c. 62,000 units d. 52,000 units What is the required production for May? What is the required production for May? a. 56,000 units b. 46,000 units c. 62,000 units d. 52,000 units

57. The Cash Budget

58. The Budgeted Income Statement

60. Cost, Profit, and Investments Centers Responsibility Center Responsibility Center Cost Center Cost Center Profit Center Profit Center Investment Center Investment Center Cost, profit, and investment centers are all known as responsibility centers.

61. Cost, Profit, and Investments Centers Cost Center A segment whose manager has control over costs, but not over revenues or investment funds.

62. Cost, Profit, and Investments Centers Profit Center A segment whose manager has control over both costs and revenues, but no control over investment funds. Revenues Sales Interest Other Costs Mfg. costs Commissions Salaries Other

63. Cost, Profit, and Investments Centers Investment Center A segment whose manager has control over costs, revenues, and investments in operating assets.

64. Evaluating Investment Center Performance: Return on Investment (ROI) Formula ROI = Net operating income Average operating assets Cash, accounts receivable, inventory, plant and equipment, and other productive assets. Cash, accounts receivable, inventory, plant and equipment, and other productive assets. Income before interest and taxes (EBIT) Income before interest and taxes (EBIT)

65. Calculating Residual Income () This computation differs from ROI. ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets.

66. Residual Income – An Example The Retail Division of Zepher, Inc. has average operating assets of $100,000 and is required to earn a return of 20% on these assets. In the current period the division earns $30,000. Let’s calculate residual income.

67. Residual Income – An Example

68. ROI vs. Residual Income The residual income numbers below suggest that the Wholesale Division outperformed the Retail Division because its residual income is $10,000 higher. However, the Retail Division earned an ROI of 30% compared to an ROI of 22% for the Wholesale Division. The Wholesale Division’s residual income is larger than the Retail Division simply because it is a bigger division.

69. The Balanced Scorecard Management translates its strategy into performance measures that employees understand and accept. Performance measures Customers Learning and growth Internal business processes Financial

70. The Balanced Scorecard: From Strategy to Performance Measures Exh. 10-11 Financial Has our financial performance improved? Customer Do customers recognize that we are delivering more value? Internal Business Processes Have we improved key business processes so that we can deliver more value to customers? Learning and Growth Are we maintaining our ability to change and improve? Performance Measures What are our financial goals? What customers do we want to serve and how are we going to win and retain them? What internal busi- ness processes are critical to providing value to customers? Vision and Strategy

71. The Balanced Scorecard: Non-financial Measures The balanced scorecard relies on non-financial measures in addition to financial measures for two reasons:  Financial measures are lag indicators that summarize the results of past actions. Non-financial measures are leading indicators of future financial performance.  Top managers are ordinarily responsible for financial performance measures – not lower level managers. Non-financial measures are more likely to be understood and controlled by lower level managers.

72. The balanced scorecard lays out concrete actions to attain desired outcomes. A balanced scorecard should have measures that are linked together on a cause-and-effect basis. If we improve one performance measure... Another desired performance measure will improve. The Balanced Scorecard Then

73. The Balanced Scorecard and Compensation Incentive compensation should be linked to balanced scorecard performance measures. You get the behavior you reward!!

74. The Balanced Scorecard Jaguar Example Employee skills in installing options Number of options available Time to install option Customer satisfaction with options Number of cars sold Contribution per car Profit Learning and Growth Internal Business Processes Customer Financial Exh. 10-13

75. The Balanced Scorecard Jaguar Example Employee skills in installing options Number of options available Time to install option Customer satisfaction with options Number of cars sold Contribution per car Profit Increase Options Time Decreases Strategies Satisfaction Increases Increase Skills Results

76. Employee skills in installing options Number of options available Time to install option Customer satisfaction with options Number of cars sold Contribution per car Profit Increase Options Strategies Satisfaction Increases Results Cars sold Increase The Balanced Scorecard Jaguar Example

77. Employee skills in installing options Number of options available Time to install option Customer satisfaction with options Number of cars sold Contribution per car Profit Strategies Results The Balanced Scorecard Jaguar Example Time Decreases Increase Skills Contribution Increases

78. The Balanced Scorecard Jaguar Example Employee skills in installing options Number of options available Time to install option Customer satisfaction with options Number of cars sold Contribution per car Profit Results Time Decreases Increase Skills Contribution Increases Profits Increase If number of cars sold and contribution per car increase, profits increase. Increase Options Strategies Satisfaction Increases