CHAPTER I: MANAGERIAL ACCOUNTING OVERVIEW

AND COST CONCEPT

1.1. Managerial Accounting – an overview

1.2. Cost concept and cost classification

 1.1. Managerial Accounting – an overview
/me nít zơ ri ồ/

1.1.1.The accounting information of managerial

activities
Activity Target of Business Organization
đi tơ mừn

- Determine the target

sờ trơ ti gíc

- Determine the strategic plan

- Implement plan to achieve the identified target
1.1.2. The concept and nature of Managerial Accounting

The concept of Management Accounting:

- Based on Institute of Management Accounting
- Based on R.H. Garrison
- Based on CIMA
- this concept was not known to the business world until 1950.
- The term was first formally described in a report entitled management accounting in 1950.
- The report was pusblished by the Anglo american council of productitvity management accounting team after its visit to
US in first quater of 1950

--> The process of identification, measurement, accumulation, analysis, preparation and communication of financial
information used by management to Plan, Evaluate and control within the organization and to assure appropriate use and
accountability for its resources.
 Nature of Management Accounting
- Management Accounting is a component of accounting
system kế toán quản trị là bộ phận cấu thành lên hệ thống kế toán (hệ thống kế toán bao gồm 2 phần đó là báo cáo tài
chính và kế toán quản trị

- Administrators need information of Management Accounting

nhà quản trị cần thông tin kế toán quản trị để đưa ra quyết định
to make decisions
- Management Accounting only provides information on the
financial and economic activities in the scope and
requirements of internal management of the business
- Management Accounting is one part of the accounting and
is an indispensable tool in the management activities
 Exh.
1-2
1.1.3. Distinguish management accounting and
financial accounting

Financial Accounting Managerial Accounting

1. Users External persons who Managers who plan for
make financial decisions and control an organization

2. Time focus Historical perspective Future emphasis

3. Verifiability Emphasis on Emphasis on relevance

versus relevance verifiability for planning and control

4. Precision versus Emphasis on Emphasis on

timeliness precision timeliness

5. Subject Primary focus is on Focuses on segments

the whole organization of an organization

6. GAAP Must follow GAAP Need not follow GAAP

and prescribed formats or any prescribed format
7. Requirement Mandatory for Not
external reports Mandatory
 1.2. Cost concept and cost classification
1.2.1. The concept and nature of cost
Concept of cost
The cost of the business is understood as all
costs related to living labor, materialized labor
and other cost that businesses need to pay out
during business operations, represented by
cash and for a certain period.
 1.2.2. The nature of cost
- From the business perspective, the cost has always been isolated
- Costs paid out in exchange for a thing in the future (purchase - sale;
pay money - get services ...)
- The cost of the business must be measured and calculated by the
money in a specified time period
- The magnitude of costs depends on two factors
+ The volume of labor and means of production consumed in a certain
time.
+ Prices of production materials consumed and the wages of labor per
unit
 1.2.2.1 Categorize cost by function operation
• Manufacturing Costs and Non-manufacturing Costs

Manufacturing Costs are the costs incurred in the workshop

(department) which is directly related to the manufacturing activities of
enterprises

- Classification of the purposes and uses of the costs

- Classification according to the inputs

Non Manufacturing Costs are the cost that an enterprise has to pay to
carry out the product consumption, goods and provide services and
spend for business management system
 Direct Materials Cost
Raw materials that become an integral part of the product
and that can be conveniently traced directly to it.

Direct Labor Cost

Those labor costs that can be easily traced to individual

units of product.

Manufacturing Overhead
Manufacturing costs that cannot be traced directly to
specific units produced.
1.2.2.2. Categorizing cost based on relationship with the
determined period results

- Product costs: the expenses associated with the

process of manufacturing the product or process of
buying goods for sale
- Period costs: are costs of doing business in the
period, not making up the value of inventories, which
directly reduce the profit of the period they arise
1.2.3. Categorizing cost based on behavior.
– Total variable costs change when activity changes.
– Total fixed costs remain unchanged when activity changes.
– Total mixed costs
 Proportionately variable cost
Direct materials is a true or proportionately variable cost
because the amount used during a period will vary in direct
proportion to the level of production activity

Step-variable cost
A resource that is obtainable only in large chunks (such as
maintenance workers) and whose costs increase or decrease
only in response to fairly wide changes in activity is known as a
step-variable cost.
 Fixed costs
Fixed costs are the costs that do not
change in total when activity levels
change in a relevant range.
A relevant range: is the distance
between the minimum activity level
and maximum level of activity that
companies can implement with
existing operational capacity.
 Types of Fixed Costs
Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced short-term by current
in the short term. managerial decisions

Examples Examples
Depreciation on Advertising and
Equipment and Research and
Real Estate Taxes Development
 Mixed cost (semi - variable cost)
Mixed costs are costs that contain both
fixed and variable cost elements
+ Fixed costs: Reflect the basic
minimum cost to maintain service and
keep the service ready to serve.
+ Variable costs: reflect the actual
service or the use higher than normal
 Least - Squares Regression Method
A method of separating a mixed cost into its fixed
and variable elements by fitting a regression line
that minimizes the sum of the squared errors
Contents:
• LSR method based on the calculation of the
linear equation (for mixed costs): Y = A + bx
• Conducting mixed cost survey in different
levels.
Σy = nA + bΣx
Σxy = AΣx + bΣx2
 The High-Low Method
The procedures for conducting methods:
 Gathering information of mixed costs in the
different activity levels in the appropriate limit.
 Selecting 2 points with the:
- Lowest level: x min in propotion to y min
ymin = A + b xmin
- Highest level: x max in propotion to y max
ymax = A+ b xmax
1.2.2.4. Categorizing expenses as relationships
based on collection cost objects
- Direct costs : are the costs that are directly
related to the cost objects.
- Indirect costs : are the costs that incurred in
relation to a variety of business service.
 1.2.2.5. According to the controllable ability of
manager

• Controllable cost: is a cost that can be

influenced by management decisions and
actions
• Uncontrollable cost: is a cost that cannot be
affected by management within a given
period of time
 1.2.2.6. Cost Classifications for Decision Making
Differential Cost
A future cost that differs between any two alternatives is known
as a differential cost.

Opportunity Costs
The potential benefit that is given up when one alternative is
selected over another.
Sunk Costs
Sunk costs have already been incurred and cannot be
changed now or in the future. They should be ignored when
making decisions.
 CHAPTER 2

JOB – ORDER COSTING METHOD

 2.1. Job order costing – AN OVERVIEW

2.1.1. The concept of job order costing

Job costing is the method using to appropriate where
each seperately identifiable cost unit or job is of
relatively short duration.
Each job would be allocated a separate job
number and costs would be accumulated against this
number in order to determine the total cost of job
 2.1.2. The CHARACTERISTIC OF Job order costing

- Direct material cost would be charged to each job

- Direct labor cost would be determined from detailed

time records kept for each employee

- Overhead would be absorbed into the total cost of

each job using the predetermined overhead
absorption rate for each cost centre through which
the job passes.
 2.2. Job-Order Costing Flow

Employee Indirect
Time Ticket Labor

Other Manufacturing Applied Job Cost

Actual OH Overhead Overhead Sheets
Charges Account

Materials Indirect
Requisition Material
 2.2.1. Material cost

The materials requisition form is a document

that specifies the type and quantity of materials to
be drawn from the storeroom and identifies the job
that will be charged for the cost of the materials.
The form is used to control the flow of materials
into production and also for making journal entries
in the accounting records
 2.2.2. direct labor cost
A completed time ticket is an hour-by-hour summary of the
employee’s activities throughout the day
 2.2.3. overhead cost
Assigning manufacturing overhead to a specific job is
complicated by three circumstances:
1. It is impossible or difficult to trace overhead costs
to particular jobs.
2. Manufacturing overhead consists of many
different items ranging from the grease used in
machines to production manager’s salary.
3. Many types of manufacturing overhead costs are
fixed eventhough output fluctuates during the
period.
 2.2.3. overhead cost
Allocation is used to assign overhead costs to
products. Allocation is accomplished by selecting
an allocation base

An allocation base, such as direct labor hours,

direct labor dollars, or machine hours, is used to
assign manufacturing overhead to individual jobs.
 2.2.3. overhead cost
There are 4 steps to compute predetermined overhead rate
(POHR):
1.Estimate the total amount of the allocation base (the denominator) that will
be required for next period’s estimated level of production

2. Estimate the total fixed manufacturing overhead cost for the coming period
and the variable manufacturing overhead cost per unit of the allocation
base
3. Use the cost formula: Y = A + bX to estimate the total manufacturing
overhead cost (the numerator) for the coming period

4. Compute the predetermined overhead rate

 Manufacturing Overhead Application

The predetermined overhead rate (POHR) used

to apply overhead to jobs is determined before
the period begins.
Estimated total manufacturing
overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

Ideally, the allocation base is a

cost driver that causes
overhead.
 Application of Manufacturing Overhead

Based on estimates,
and determined before
the period begins.

Overhead applied = POHR × Actual activity

Actual amount of the allocation

based upon the actual level of
activity.
 Defining Under and Overapplied Overhead

The difference between the overhead cost

applied to Work in Process and the actual
overhead costs of a period is termed either
underapplied or overapplied overhead.
Underapplied overhead Overapplied overhead exists
exists when the amount of when the amount of overhead
overhead applied to jobs applied to jobs during the
during the period using the period using the
predetermined overhead predetermined overhead rate
rate is less than the total is greater than the total
amount of overhead amount of overhead actually
actually incurred during the incurred during the period.
period.
 CHAPTER 3

PROCESS COSTING METHOD

 3.1. The process costing – AN OVERVIEW

3.1.1. The concept of Process costing

Process costing is a method of costing used

mainly in manufacturing where units are
continuously mass-produced through one or
more processes.
 3.1. The process costing – an overview
This is an appropriate system to use when:
- Units do not differ from each other
- Unit cycle time is relatively short
- The production process is continuous
Process costing is used most commonly in industries
that convert raw materials into homogeneous
 3.1.2. characteristic of Process costing

- Direct material cost would be charged to each job

- Direct labor cost would be determined from detailed time

records kept for each employee

- Overhead would be absorbed into the total cost of each

job using the actual overhead absorption rate for each
cost centre.
 3.2. The process costing flow
3.2.1. Processing department
A processing department is an organizational
unit where work is performed on a product and
where materials, labor, or overhead costs are
added to the product
 3.2.1. Processing department
The features of processing department:
- The activity in the processing department is performed uniformly on all of the
units passing through it.
- The output of the processing department is homogeneous; in other words,
all of the units produced are identical.
- Materials costs can be added in any processing department, although it is
not unusual for materials to be added only in the first processing department.
- Labor costs are traced to departments — not to individual jobs
 3.2.2. The flow of Manufacturing Cost

Manufacturing overhead cost is applied

according to the amount of the allocation base
that is incurred in the department.
 Process Cost Flows
(in T-account form)
Work in Process
Department A
Manufacturing •Direct
Overhead Materials
•Direct
•Actual •Overhead Labor
Overhead Applied to •Applied
Work in Overhead
Process
Work in Process
Department B
•Direct
Materials
•Direct
Labor
•Applied
Overhead
 3.3. Production report
Production report (statement) is the report
that reflects the production situation incurring in
each particular department (workshop)
There are 3 sections in a production report:
 3.3. The PRODUCTION REPORT
Production Report
A quantity schedule showing the
flow of units and the computation
Section 1 of equivalent units.

A computation of
Section 2 cost per equivalent unit.

 Cost Reconciliation section

shows the reconciliation of all
Section 3 cost flows into and out of the
department during the period.
 3.3. The PRODUCTION REPORT
Step 1: Prepare quantity schedule
- Beginning work in process (WIP) (1)
- Ending WIP (2)
- Units started into production in period (3)
- Units completed and transferred out (4)
- Units started into production and completed in
period (5)
(5) = (4) – (1) or
= (3) – (2)
 3.3. The PRODUCTION REPORT
Step 2: Calculate equivalent unit costs
Equivalent units are the product of the number of
partially completed units and the percentage
completion of those units.

Equivalent units of production always equals:

Units completed and transferred + Equivalent units
remaining in work in process
 Equivalent Units of Production
Weighted- Average Method

Total Units completed Equivalent

equivalent = and transferred + units of
units out in period ending WIP

Equivalent Ending Percent

units of ending = WIP X Completed
WIP (%)
 Equivalent units
The FIFO method (generally considered more
accurate that the weighted - average method)
differs from the weighted - average method in two
ways:

1. The computation of equivalent units.

2. The way in which the costs of beginning inventory
are treated in the cost reconciliation report.
 Equivalent units
Total Equivalent Units started Equivalent
equivalent = of beginning + into production + of ending
units WIP completed in WIP
period

Equivalent units Beginning Percent

of beginning WIP = WIP x Uncompleted

Equivalent units of ending WIP: same formula in

Weighted – Average method
 Step 3, 4: Determine total costs to account for
(Weighted – Average Method)

Total Costs for the period consist:

- Cost of beginning WIP
- Cost added in the period
To calculate the cost per equivalent unit for the period:

Cost per Costs for the period

equivalent =
unit Equivalent units of production
for the period
 Step 3, 4: Determine total costs to account for
(FIFO Method)

Total Costs for the period consist only cost added

in the period

Costs for the period

Cost per
equivalent =
unit Equivalent units of production
for the period
 Step 5: Cost Reconciliation

Cost flows = Allocated costs

Costs of + Costs added = Costs for + Costs for

beginning during the Completed equivalent
WIP period units units
 Cost Reconciliation
- Calculate the total cost from beginning inventory
transferred to the next department.
- Calculate the cost of units started and completed
during the period.
- Calculate the costs in ending work in process
inventory and the sum of the cost accounted for.
 Cost Reconciliation
• Weighted – Average Method:
Cost flows consists of:
- Costs of beginning WIP
- Costs added to production during the
period
Allocated cost:
- To completed units
- To equivalent units of ending WIP
 Cost Reconciliation
Costs for Quantity of Total Unit
completed and = completed X cost
transferred units units

Costs for Equivalent Cost per

equivalent units = units X equivalent
of ending WIP unit
 Cost Reconciliation
• FIFO method
Cost flows consists of:
- Costs of beginning WIP
- Costs added to production during the period
Allocated cost:
- To completed units
- To equivalent units of beginning and ending WIP
Costs that allocated to equivalent units of beginning WIP
had 2 parts:
- Cost in prior period
- Costs added in current period to complete beginning
WIP
 Cost Reconciliation
Costs for equivalent Equivalent Cost per
units of beginning = units of X equivalent unit
WIP beginning WIP

Costs for units started Quantity of units Total Unit

and completed in the = started and X cost
period completed in the
period

Costs for equivalent Equivalent units Cost per

units of ending WIP = of ending WIP X equivalent unit
CHAPTER 4: Activity-Based Costing

4.1. Activity- Based Costing: An overview

4.2.Designing an Activity-Based Costing system

4.3. The limitation of Activity -Based Costing

 4.1. Activity- Based Costing: An overview

Activity-based costing (ABC) is a costing method

that is designed to provide managers with cost information
for strategic and other decisions that potentially affect
capacity and therefore “fixed” as well as variable costs.

Most organizations that use activity-based costing have

two costing systems —the official costing system that is used
for preparing external financial reports and the activity-based
costing system that is used for managing activities.
 4.1. Activity- Based Costing: An overview

In activity-based costing, many nonmanufacturing costs relate

to selling, distributing, and servicing specific products

First, ABC systems trace all direct nonmanufacturing costs to

products

Second, ABC systems allocate indirect nonmanufacturing costs

to products whenever the products have presumably caused
the costs to be incurred
4.1. Activity based costing – an overview

Manufacturing Nonmanufacturing
costs costs

Traditional ABC
product costing product costing

ABC assigns both types of costs to products.

4.1. Activity based costing – an overview

Nonmanufacturing
costs

some
All

Traditional ABC
product costing product costing

ABC does not assign all manufacturing costs to products.

4.1. Activity based costing – an overview

The most commonly used allocation base

in traditional costing is direct labor hours.

Direct labor hours work well when overhead increases

as direct labor hours increase.

Problems:
 In many processes, overhead is increasing while direct
labor is decreasing.
 Variety and complexity of products is increasing.
 4.1. Activity based costing – an overview

An activity is any event that causes the consumption of

overhead resources.
An activity cost pool is a “bucket” in which costs are
accumulated that relate to a single activity measure in the ABC
system.
An activity measure is an allocation base in an activity-based
costing system
Cost driver is also used to refer to an activity measure
because the activity measure should “drive” the cost being allocated
 Exh.
1-2

4.1. Activity based costing – an overview

ABC uses more allocation bases.

4.2.Designing an Activity-Based Costing system

There are three essential characteristics of a successful

activity-based costing implementation.
First, top managers must strongly support the ABC
implementation
Second, top managers should ensure that ABC data is
linked to how people are evaluated and rewarded.
Third, a cross-functional team should be created to
design and implement the ABC system
4.2.Designing an Activity-Based Costing system
Steps for Implementing ABC
 Identify and define activities and activity cost pools.
 Trace costs to activities and cost objects.
 Assign costs to activity cost pools.
 Calculate activity rates.
 Assign costs to cost objects.
 Prepare management reports.
4.2.Designing an Activity-Based Costing system

Unit-Level Batch-Level
Activity Activity

Manufacturing
companies typically combine
their activities into five
classifications.

Product-Level Customer-Level
Activity Organization- Activity
sustaining
Activity
 4.2.Designing an Activity-Based Costing system

Activities
should only be
combined within a level
if they are highly
correlated.

When combining
activities, they should be
grouped together only at
the appropriate
level.
 4.2.Designing an Activity-Based Costing system

An Activity Cost Pool is a “bucket” in which costs are

accumulated that relate to a single activity measure in the
ABC system.

Two types of activity measures:

Transaction Duration
driver driver
Simple count A measure
of the number of of the amount
times an activity of time needed
occurs. for an activity.
4.2.Designing an Activity-Based Costing system
Direct Direct Shipping
Materials Overhead Costs
Labor Costs

Traced Traced Traced

Cost Objects:
Products, Customer Orders, Customers
4.3. The limitation of Activity -Based Costing

Substantial resources Resistance to

required to implement unfamiliar numbers
and maintain. and reports.

Desire to fully Potential

allocate all costs misinterpretation of
to products. unfamiliar numbers.

Does not conform to

GAAP. Two costing
systems may be needed.
 CHAPTER 5
Cost – Volume – Profit
Relationships ( CVP)
 5.1 . The Basic concepts

a. Contribution Margin (CM)

Contribution Margin (CM) is the amount remaining
from sales revenue after variable cost have been
deducted.
CM = Total sales revenue – Total Variable cost
Contribution margin per unit equals sales price per
unit minus variable costs per unit or it can be
calculated by dividing total contribution margin by
total units sold.
 Contribution Income statement
Total Per unit Percentage
Sales
Less: Variable
expenses
Contribution Margin
Less: Fixed expenses

Net income
 b. Contribution Margin Ratio

Contribution margin ratio (CMR) equals contribution margin

expressed as a percentage of total sales.

c. Cost Structure
Cost structure refers to the relative proportion of fixed and
variable costs in an organization.

d. Operating Leverage

Operating leverage is: A measure of how sensitive net

operating income is to percentage changes in sales.
 5.2. Application CVP CONCEPTS

At Klatch Inc, the average selling price of a bike is $250,

the average variable expense per bike is $150, and the
average fixed expense per month is $35,000. 500 bikes
are sold each month on average.
Sale Department proposes to the manager some options
for the next month:
 5.2. Application CVP CONCEPTS
1. What is the profit impact if Klatch increases variable costs per unit by
$10, to generate an increase in unit sales from 500 to 580?1.

2. What is the profit impact if Racing (1) cuts its selling price $20 per unit, (2)
increases its advertising budget by $15,000 per month, and (3) increases unit
sales from 500 to 650 units per month?

3. What is the profit impact if Racing (1) pays a $15 sales commission per
bike sold instead of paying sales person flat salaries that currently total
$6,000 per month, and (2) increases unit sales from 500 to 575 bikes?

4. If Klatch has an opportunity to sell 150 bikes to a wholesaler without

disturbing sales to other customers or fixed expenses, what price would it
quote to the wholesaler if it wants to increase monthly profits by $3,000?
5.3. Break-Even Point and target profit
Analysis
Break-even analysis can be approached
in two ways:
1. Equation method
2. Contribution margin method
 Equation Method
Profits = (Sales – Variable expenses) –
Fixed expenses
OR
Sales = Variable expenses + Fixed
expenses + Profits

At the break-even point, profits equal zero

 CVP Graph
450,000

400,000

350,000

300,000

250,000

200,000

150,000

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
 The Concept of Sales Mix
• Sales mix is the relative proportion in which a company’s
products are sold.
• If a company sells more than one product, break-even
analysis is more complex. The reason is that different
products will have different selling prices, different costs,
and different contribution margins. Consequently, the
break-even point depends on the mix in which the
various products are sold.
 Key Assumptions of CVP Analysis

Selling price is constant.

Costs are linear.
In multi-product companies, the sales mix is
constant.
In manufacturing companies, inventories do
not change (units produced = units sold).
 CHAPTER 6

VARIABLE COSTING AND

SEGMENT REPORTING
 6.1. Overview of Absorption and Variable Costing

Variable costing (also called direct/marginal costing) is a

method that charges products with only the variable
manufacturing costs. The cost of a unit of product consists of
the three variable manufacturing costs — direct material, direct
labor, and variable manufacturing overhead.
6.1. Overview of Absorption and Variable Costing

Absorption costing (also called full costing) is a method that

charges products with all manufacturing costs, regardless of
whether the costs are fixed or variable. The cost of a unit of
product consists of all four types of manufacturing costs —
direct material, direct labor, variable manufacturing overhead,
and fixed manufacturing overhead.
6.1. Overview of Absorption and Variable Costing

Direct Materials

Direct Labor
Product
Product Costs
Costs Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Variable Selling and Administrative Expenses

Period
Period Costs
Costs Fixed Selling and Administrative Expenses
 6.2. Income Comparison of
Absorption and Variable Costing

Let’s assume the following additional information

for Harvey Company.
– 20,000 units were sold during the year at a price of $30
each.
– There were no units in beginning inventory.
Now, let’s compute net operating income using
both absorption and variable costing.
 6.2. Income Comparison of
Absorption and Variable Costing

Income Statement of Absorption Costing

 6.2. Income Comparison of
Absorption and Variable Costing

Income Statement of Variable Costing

 6.2. Income Comparison of
Absorption and Variable Costing

The diffirence from Income of 2 methods

 6.2. Income Comparison of
Absorption and Variable Costing
Opponents of absorption costing argue that shifting
fixed manufacturing overhead costs between periods
can lead to misinterpretations and faulty decisions.

Those who favor variable costing argue that the income

statements are easier to understand because net operating
income is only affected by changes in unit sales. The
resulting income amounts are more consistent with
managers’ expectations.
 6.3. Segment income statement
A segment is any part or activity of an organization
about which a manager seeks cost, revenue, or
profit data. A segment can be . . .
 6.3. Segment income statement
Traceable and Common Fixed Costs and the Segment
Margin
A traceable fixed cost of a segment is a fixed cost that
is incurred because of the existence of the segment— if the
segment had never existed, the fixed cost would not have
been incurred; and if the segment were eliminated, the fixed
cost would disappear.
 6.3. Segment income statement
Traceable and Common Fixed Costs and the Segment
Margin
A common fixed cost is a fixed cost that supports
the operations of more than one segment, but is not
traceable in whole or in part to any one segment. Even if a
segment were entirely eliminated, there would be no
change in a true common fixed cost
 6.3. Segment income statement
The segment margin is obtained by deducting
the traceable fixed costs of a segment from the
segment’s contribution margin. It represents the
margin available after a segment has covered all of
its own costs
 6.3. Segment income statement
There are two keys to building segmented
income statements:

A contribution format should be used

because it separates fixed from
variable costs and it enables the
calculation of a contribution margin.

Traceable fixed costs should be

separated from common fixed costs to
enable the calculation of a segment
margin.
 CHAPTER 7

BUDGETING PROCESS

7.1. Master budget

7.2. Flexible budget
7.3. Standard costs
 7.1. Master budget
7.1.1. Definition and characteristic of master budget

A master 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.
 Advantages of Budgeting
Define goal
and objectives
Communicate Think about and
plans plan for the future

Advantages

Coordinate Means of allocating

activities resources
Uncover potential
bottlenecks
 7.2. Preparing master budget
Ending Sales
Finished Goods Budget
Budget

Selling and
Production Administrative
Direct Budget Budget
Materials
Budget
Direct Manufacturing
Manufacturing
Labor Overhead
Overhead
Budget Budget
Budget

Cash
Budget

Budgeted Financial Statements

 The Sales Budget
The individual months of April, May, and June are summed to obtain the total
projected sales in units and dollars for the quarter ended June 30th
 The Production Budget

Sales
Budget Production
and Budget
Expected
Cash
Collections

Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.
 The Direct Materials Budget

At Royal Company, five pounds of material are

required per unit of product.
Management wants materials on hand at the
end of each month equal to 10% of the
following month’s production.
On March 31, 13,000 pounds of material are on
hand. Material cost is $0.40 per pound.
Let’s prepare the direct materials budget.
The Direct Materials Budget
 The Direct Labor Budget
At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
The Company has a “no layoff” policy so all employees will
be paid for 40 hours of work each week.
In exchange for the “no layoff” policy, workers agree to a
wage rate of $10 per hour regardless of the hours worked
(No overtime pay).
For the next three months, the direct labor workforce will
be paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget.
The Direct Labor Budget
 Format of the Cash Budget
The cash budget is divided into four sections:
1. Cash receipts listing all cash inflows excluding
borrowing
2. Cash disbursements listing all payments excluding
repayments of principal and interest
3. Cash excess or deficiency
4. The financing section listing all borrowings, repayments
and interest
 7.2. Flexible budget
7.2.1. Definition and characteristic of flexible budget
A flexible budget is an estimate of what revenues and costs
should have been, given the actual level of activity for the period
When a flexible budget is used in performance evaluation,
actual costs are compared to what the costs should have been for
the actual level of activity during the period rather than to the static
planning budget
 7.2.2. Flexible budget variance

All of the variances are solely due to the difference between

the actual level of activity and the level of activity in the planning
budget from the beginning of the period, they are called activity
variances

The most important activity variance appears at the very

bottom of the report; namely, the favorable variance for net operating
income. This variance says that because activity was higher than
expected in the planning budget, one would expect some costs to be
higher as a consequence of more business.
 7.3. Standard costs
7.3.1. Definition and setting standard cost
Standards are benchmarks or “norms”
for measuring performance. Two types
of standards are commonly used.

Quantity standards Cost (price)

specify how much of an standards specify
input should be used to how much should be
make a product or paid for each unit
provide a service. of the input.
 Variance Analysis Cycle

Take
Identify Receive corrective
questions explanations actions

Conduct next
Analyze period’s
variances operations

Prepare standard Begin

cost performance
report
 Setting Standard Costs
Accountants, engineers, purchasing agents, and production
managers combine efforts to set standards that encourage
efficient future production.

In recent years, TQM advocates have sought

to eliminate all defects and waste, rather than
continually build them into standards.

As a result allowances for waste and

spoilage that are built into standards
should be reduced over time.
 7.3.2. Using standard cost to analysis variance

Variance Analysis

Price Variance Quantity Variance

Materials price variance Materials quantity variance

Labor rate variance Labor efficiency variance
VOH spending variance VOH efficiency variance
 7.3.2. Using standard cost to analysis variance

Actual Quantity Actual Quantity Standard Quantity

× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

 7.3.3. Evaluation of controls based on standard costs
All variances are not worth investigating. Methods for
highlighting a subset of variances as exceptions include:
• Looking at the size of the variance.
• Looking at the size of the variance relative to the amount of
spending.

The materials price variance is computed using the

entire amount of material purchased during the period. The
materials quantity variance is computed using only the
portion of materials that was used in production during the
period.
 7.3.3. Evaluation of controls based on standard costs
The standard price is used to compute the quantity variance so
that the production manager is not held responsible for the performance of
the purchasing manager.

Labor variances are partially controllable by employees within the

production department. For example, production managers/supervisors
can influence the:
• Deployment of highly skilled workers and less skilled workers on tasks
consistent with their skill levels.
• Level of employee motivation within the department.
• Quality of production supervision.
• Quality of the training provided to the employees.
CHAPTER 8
8.1. Decentralization in Organizations

Lower-level managers
gain experience in
decision-making.

Lower-level decision
often based on
better information.
8.1. Decentralization in Organizations
May be a lack of
coordination among
autonomous
managers.

Lower-level managers
may make decisions
Lower-level manager’s without seeing the
objectives may not “big picture.”
be those of the
organization.
May be difficult to
spread innovative ideas
in the organization.
 8.2. Responsibility Accounting
• Based on Charles T. Horngreen
• Based on Anthony and Reece
8.2. Responsibility Accounting
 8.2. Responsibility Accounting
Responsibility center is any part of an
organization whose manager has control
over and is accountable for cost, profit, or
investments.
Cost, Profit, and Investments Centers
Cost, Profit, and Investments Centers
 8.3. Evaluating Responsibility Performance
a. Evaluating cost center

A cost variance is the difference between the actual

amount of the cost and how much a cost should have been,
given the actual level of activity

- If the actual cost is greater than what the cost should have
been, the variance is labeled as unfavorable

- If the actual cost is less than what the cost should have
been, the variance is labeled as favorable.
 8.3. Evaluating Responsibility Performance

b. Evaluating profit center

A profit variance is the difference between the actual

total profit and what the total profit should have been, given
the actual level of activity for the period
- If actual revenue exceeds what the revenue should have
been, the variance is labeled favorable

- If actual revenue is less than what the revenue should have

been, the variance is labeled unfavorable.
 8.3. Evaluating Responsibility Performance

c. Evaluating investment center

An investment center is responsible for earning an adequate

return on investment. The following two sections present two
methods for evaluating this aspect of an investment center’s
performance.

- The first method, is called return on investment (ROI).

- The second method, is called residual income (RI)

Return on Investment (ROI) Formula

Net operating income

ROI =
Average operating assets
 Residual Income - Another Measure of Performance

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.
 CHAPTER 9
Differential Analysis
9.1. Identifying Relevant cost and benefit

9.2. The application of analyzing relevant cost

and benefit
 9.1. Identifying Relevant cost and benefit

9.1.1. Definition and characteristic of relevant

cost and benefit
A future cost that differs between any two alternatives is known
as a differential cost.

Differential costs are always relevant costs

Future revenue that differs between any two alternatives
is known as differential revenue.
9.1.1. Definition and characteristic of relevant
cost and benefit

An incremental cost is an increase in

cost between two alternatives
An avoidable cost is a cost that can be
eliminated by choosing one alternative over
another
 9.1.2. Analysing relevant cost and benefit
Relevant cost and benefit are cost and
benefit that differ between alternatives.
Criteria of relevant cost and benefit:
- Aim to future
- Differ between alternatives
 Total and Differential Cost Approaches

Step 1 Eliminate costs and benefits that do not

differ between alternatives.
Step 2 Use the remaining costs and benefits
that do differ between alternatives in
making the decision. The costs that
remain are the differential, or avoidable
costs.
 Total and Differential Cost Approaches

Two broad categories of costs are never

relevant in any decision and include:
 Sunk costs.

 Future costs that do not differ between the

alternatives.
 9.2. The application of analyzing relevant
cost and benefit
Case 1: Adding/Dropping Segments
One of the most important decisions managers make
is whether to add or drop a business segment such as
a product or a store.

Case 2: The Make or Buy Decision

When a company is involved in more than one activity
in the entire value chain, it is vertically integrated.
A decision to carry out one of the activities in the value
chain internally, rather than to buy externally from a
supplier is called a“make or buy” decision.
 Case 3: Sell or Process Further
Joint Costs:
In some industries, a number of end products are produced from a single
raw material input.
Two or more products produced from a common input are called joint -
product
The point in the manufacturing process where each joint product can be
recognized as a separate product is called the split – off joint

Case 4: Utilization of a Constrained Resource

• When a constraint exists, a company should select a product mix
that maximizes the total contribution margin earned since fixed
costs usually remain unchanged.
• A company should not necessarily promote those products that
have the highest unit contribution margin.
• Rather, it should promote those products that earn the highest
contribution margin in relation to the constraining resource.
 CHAPTER 10

10.1. An overview about capital budgeting

10.2. Methods in analyzing capital budgeting

decisions
 10.1. An overview about capital budgeting

Any decision that involves a cash outlay now to obtain a future

return is a capital budgeting decision
Typical capital budgeting decisions include:
1. Cost reduction decisions
2. Expansion decisions
3. Equipment selection decisions
4. Lease or buy decisions
5. Equipment replacement decisions
 10.1.1. Typical Capital Budgeting Decision
Capital budgeting tends to fall into two broad
categories . . .
 Screening decisions: Does a proposed project
meet some present standard of acceptance?
 Preference decisions: Selecting from among
several competing courses of action.
 10.1.2. Cash flows

CASH OUTFLOW
Most projects have at least three types of cash outflows:
- They often require an immediate cash outflow in the
form of an initial investment in equipment, other assets,
and installation costs
- Some projects require a company to expand its working
capital
- Many projects require periodic outlays for repairs and
maintenance and additional operating costs.
 10.1.2. Cash flows

CASH INFLOW
Most projects have at least three types of cash inflows:
- A project will normally increase revenues or reduce costs
- Cash inflows are also frequently realized from selling
equipment for its salvage value when a project ends
- Any working capital that was tied up in the project can be
released for use elsewhere at the end of the project and should
be treated as a cash inflow at that time
 10.1.3. Time Value of Money
There are 2 types:

- Single cash flow: is the cash flow that happens

in one period

- Compound cash flow: is the cash flow that

happens regularly
 10.1.3. Time Value of Money
The capital budgeting techniques that best
recognize the time value of money are those that
involve discounted cash flows.
Discounting cash flows is a method to translate
the value of future cash flows to their present value
 10.2. Methods in analyzing capital budgeting
decisions

• The Payback Period Method (PP)

• The Net Present Value Method (NPV)

• The Internal Rate of Return Method (IRR)

• The Simple Rate of Return Method (SRR)

 10.2.1. The Payback Method

The payback period is the length of time that it

takes for a project to recover its initial cost out of
the cash receipts that it generates.
The payback period is expressed in years
 10.2.2.The Net Present Value Method

The net present value is the difference between the

present value of the cash inflows and the present
value of the cash outflows of an investment project

There are 5 steps to apply NPV method:

 10.2.2.The Net Present Value Method
- Step 1: classify cash flows of the project:
+ Cash outflows include:
Initial investment (including installation costs)
Increased working capital needs
Repair and maintenance
Incremental operating costs
+ Cash inflows:
Incremental revenues
Reduction in cost
Salvage value
Release of working capital
Refund VAT
 10.2.2.The Net Present Value Method
- Step 2: Choosing a discount rate
Bases on cost of capital: It is the average rate of return the
company must pay to its long term creditors, shareholders for
using their funds
- Step 3: Calculate Cash flow Present Value
Present Value = Cash flow Value X Discount rate
- Step 4: Calculate Net Present Value

NPV = Total cash inflows PV – Total cash

Outflows PV
 10.2.2.The Net Present Value Method
Step 5: Select projects:
NPV < 0: not acceptable because its return is
less than the required rate of return

NPV = 0: acceptable

NPV > 0: acceptable because its return is

greater than the required rate of return
 10.2.3. Internal Rate of Return Method

• The internal rate of return is the rate of return

promised by an investment project over its useful
life.

• It is computed by finding the discount rate that will

cause the net present value of a project to be
zero.
10.2.3. Internal Rate of Return Method

When using the internal rate of return,

the cost of capital acts as a hurdle rate
that a project must clear for acceptance.
 10.2.4. The Simple Rate of Return
The simple rate of return is the rate of the annual
incremental net operating income generated by a project is
divided by the initial investment in the project

Annual Incremental net operating income

SRR =
Initial Investment