Managerial/Cost
Accounting
Pre Reading Comment – page 387
Read the definition of
managerial accounting on page 387 of the text.
Unfortunately, out text has nothing else to say about this topic/
Lecture Notes
Lecture Summary
·
Analysis of
costs:
o Product costing
o Cost behavior and cost types
o Decision analysis including CostVolumeProfit(CVP)
o Cost allocations
o Activity based costing
·
Budgeting
Major Points
Analysis of costs
It may seem obvious that
managers need to know what their costs are for products or services they sell,
but in truth it may be fairly complicated to understand costs. For instance, if you operate a retail store,
you may pay 56 cents for a candy bar and sell it for 75 cents, so it would seem
like you make a profit of 19 cents on each bar.
But don’t you have other costs?
You have to rent the store, pay employees to work the cash register, pay
utilities, shipping, and lots and lots of other things. So what does it really cost you to
sell that candy bar? A significant
aspect of managerial accounting involves answering that question.
Why is the question so
important? It will tell you if you are
really losing money on sales, or which products are most profitable. For most managers, though, the real value is
in finding where costs are located, analyzing them, and reducing or eliminating
those costs that can be changed. This is
a principle activity for business managers.
Product costing
Costs can be classified in
two ways: direct costs and indirect
costs. Direct costs are resources
(parts) or activities (labor) that go into a particular product. For a restaurant, direct costs would be all
the ingredients in the food, plus all the labor to make and serve the
food. Indirect costs are resources used
for more than one product. For instance
in a restaurant, a stove is used for more than one menu item, so it would be an
indirect cost for each item (and very difficult to allocate to either product). To determine the total cost of a product, you
need to calculate both the direct and indirect costs. In the restaurant example, the cost of a
hamburger includes all the direct costs -- the ingredients plus the labor of
the person who makes and serves it – and all the indirect costs of shared items
– the stove, the cooking utensils, reusable plates, etc.
Activity #1: Make a list of the direct and indirect costs
that would be included in the cost of your textbook.
Nonmanufacturing Costs
(Period costs – both direct and indirect)
Organizations have
additional costs beyond what it takes to actually make a product. Here is a list of common cost areas:
Each of these areas adds
costs to a business.
Activity #2:
What non-manufacturing costs do you think are incurred by the textbook
publishing company?
Activity #3: Make a list of the costs you will incur for the
manufacturing of any of the products you plan to sell in your business. Then list the non-manufacturing costs you
need to cover. How would you reduce any
of these costs?
Cost-Volume-Profit Analysis
Another aspect of cost to
consider is volume. The actual cost to
produce one unit varies with the volume being produced. This is because some costs are fixed and have
to be paid whether you produce one unit or one thousand. Take the example of the restaurant. You need to buy a stove whether you cook one
burger, or 500. If the stove cost $1000
and has an expected life of ten years, it costs you $100 per year, or about $8
per month. If you only cook one burger a
month on that stove, the burger will cost you $8 plus the cost of the meat and
other ingredients. You will probably
lose money when you sell that burger.
When would you make money? You do
a volume analysis to find out. Here are
the formulas to use:
Profit = Revenue – cost
Profit = Revenue – (variable
(“direct or marginal”) costs + capacity-related (“fixed or indirect”) costs)
“Variable” costs change with
volume. The more burgers you sell, the
more meat you will need. But
capacity-related costs are fixed in that you will need a stove whether you cook
one burger or one thousand. So costs for
the first hamburger we sell look like this:
Profit = $2.89 (what we
charge customers for the burger) - $1.15 (costs for the bun and meat and
catsup) - $8 (monthly cost for the stove)
In this example, if we just
sell one burger a month and only use the stove for that one burger, we lose money
on the sale: $2.89-$1.15 - $8
If we change volume, we
start getting closer to making a profit:
|
Number of Burgers Sold |
Revenue |
Variable costs |
Capacity-related costs |
Profit |
|
1 |
2.89 |
1.15 |
8 |
(6.26) |
|
5 |
14.45 |
5.75 |
8 |
0.30 |
|
10 |
28.90 |
11.50 |
8 |
9.40 |
|
20 |
57.80 |
23.00 |
8 |
26.80 |
Activity #4: So far, the only capacity- related expense we
have listed is the cost of the stove.
But we could also put labor costs there since you will need a person
working the grill whether you sell one burger a month, or if you sell 1000 burgers. Assuming you pay a grill worker $1000 per
month, what profit do you make if you sell 500, 1000, or 2000 burgers in a
month?
Breakeven Analysis
You may be interested to
know how many burgers you have to sell to breakeven. These are the formulas to determine that:
Breakeven ($0) = (units sold
* contribution margin per unit)- capacity-related
costs
Units sold to breakeven =
capacity-related costs / contribution margin per unit
In our example, the
contribution margin per unit is $1.74 (2.89-1.15) and the capacity related
costs are $1008 (the labor costs for the grill person and the monthly cost for
the stove)
Units sold to breakeven =
1008/1.74
[579.3]
So in this example, the
restaurant would have to sell 580 burgers before it could start making a
profit.
Activity #5: Because of heavy competition, you decide to
cut your hamburger price to $2.39. Now
how many do you need to sell before you break even for the month?
Activity #6: You agree to raise the wages of your grill
person to $1200 per month. Now what is
your breakeven point?
Cost allocations
Some costs are shared by
multiple departments, or by multiple products.
In order to fully understand the costs of particular departments or
particular products, you need to determine how best to allocate those shared
costs. In our restaurant example, you
might have a cleaning service that charges the owners $2000 per month, but
works in three restaurants – fifteen hours in the first two and just ten hours
per week in the smallest store. So you
would divide the costs out proportionally, with $500 allocated to the smallest
restaurant and $750 allocated to the larger restaurants.
The same process could be
used to allocate the cost to different products. For instance, if we used the stove 5 hours
per day to make burgers, but used it three hours in the morning to make eggs, we
would now allocate the stove cost to the two products -- $5.00 per month to
burgers, and $3.00 per month to eggs. [Incidentally this allocation of capacity
is exactly what happened about ten years ago when fast-food restaurants started
opening for breakfast. They used the
same store and the same cooking facilities to make additional products, thus
reducing their costs per unit.]
Activity #7: You make your grillman
an offer – you will raise his pay to $1500 per month, but he now also has to
watch the French fry machine. If you
assume half his time will go to the fry machine, what is the new breakeven
point for burgers?
Budgeting:
There are two primary types
of budgets kept by companies: operating
budgets and financial budgets. Operating
budgets provide the level of activity to be expected by various units such as
production, sales, and purchasing.
Financial budgets show the expected financial consequences of the
budget, for example increased sales leading to expected increasing profits.
The operating budget often
has these components:
One of the main purposes of
an operating budget is to ensure coordination amongst units. For instance, if the company plans to create
a new product line, that should be reflected in the capital spending plan, and
all the other plans. If the labor plan
does not include the budget to hire and train the new workers for the
additional product, the product will never be launched.
Activity 10: Assume you want to expand your restaurant to
add a new set of healthy foods such as salads.
What items would you have to add to each of the operating budget areas?
Business Plan Aspects