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Summary Management Accounting & ControlLecture 1 Nature of cost and opportunity costs (chapter 1 & 2)
1. Multiple roles of accounting
Accounting has several roles it fulfils, we will distinguish between:
- External = financial accounting accounting used by external individuals or organisations
- Internal = management accounting more used for the internal decision making or control
We focus on internal accounting
Main point: accounting reports are used for multiple purposes.
We can see different organisations or people and they use different reports or have different kinds of
access to reports. They use them also for different purposes.
2. External reports & internal reports
Use of external reports:
- Shareholders, bondholders, banks and analysts Taxing authorities
- Regulatory authorities (SEC, FASB, IASB, ECB)
- Board of directors
- Suppliers, employees and other stakeholders
Objectives in external reporting:
- Comparability between firms
- Historical accounting
- Auditors can verify reports
Use of internal reports:
- Managers at all levels
Objectives of internal reporting:
- Useful for decision making about future activities
- Measure performance that is relevant to the firm
- Focus on projects or processes within a firm
3. The role of management accounting & controller
Board of Directors supervises the CEO. From the CEO, we have a whole bunch of other groups.
The role of the controller:
- Reports to chief financial officer (CFO)
- Administers internal and external accounting
- Budget planning
- Controls financial data collection and reporting
- Growing role as internal consultant or business analysts to the point of being viewed as
business partners
Balance between providing information to other managers for decision making against providing
monitoring information used to control behaviour of lower-level-managers.
Main task of a controller: identify relevant costs for the firm he is working for. And coming up
with solutions and better decision makings (why are these costs larger than expected?)
4. Cost examples: average cost & opportunity costs
Average cost per unit at current production volume is usually not an accurate estimate of the cost
per unit at other levels of production.
Average cost include:
, - Fixed costs that do not change with volume - - > even if you produce zero, you have these
costs
- Variable costs per unit that can change with volume - - > the more you produce, these costs
will increase
Cost per unit may increase when production volume is near or above normal operating capacity.
(decrease your profit if you use average costs = total cost / units)??
EXAMPLE: are the university fees the only relevant costs? - - > NO, you can’t work much in these
school years so that are also costs. And you probably rent a room etc. these are opportunity costs.
5. Opportunity costs & sunk costs
Opportunity set = set of alternative actions available to decision maker
Opportunity cost = benefits forgone by choosing one alternative from the opportunity set rather than
the best non-selected alternative
Opportunity costs:
- Include tangible and intangible assets
- Measured in cash equivalents
- Rely on estimates of future benefits forward looking
- Useful for decision making
Accounting expenses:
- Costs consumed to generate revenues
- Rely on historical cost of resources actually expended
- Designed to match expenses to revenues
- Useful for control
Example sunk costs:
If you put 2000 dollar in a gambling game, you lost 2000 dollars - - > reaction: ‘’I need to get it back.’’
- The reality is the second your money is in the middle, it’s not your money anymore, but that
is very hard to realize in the moment.
o Future decisions should not be based on these sunk costs
The costs of sox = The Sarbanes-Oxley Act of 2002
- The Public Company Accounting Reform and Investor Protection Act
- Direct costs of compliance expected to grow to $8 billion in 2005
- Other costs included:
, o Increases as large as 50% in director’s fees and premiums for directors and officer
insurance policies
o Innovative projects are being abandoned due to risk and/or delayed due to time
spend on compliance.
6. Cost variation & breakeven analysis
Fixed costs: costs incurred when there is no production. A fixed cost is not an opportunity cost of the
decision to change the level of output (on a cost graph, the fixed costs are the total costs when is
production is zero).
Marginal costs: opportunity cost of producing one more unit, or the opportunity cost of producing
the last unit (on a cost curve graph, the marginal cost is the slope of the tangent at one particular
production level).
Average cost: total opportunity costs divided by the number of units produced (on a cost curve
graph, the average cost is the slope of the line drawn from the origin to total cost for a particular
production level).
Cost drivers: measure of physical activity most highly associated with total cost in an activity center.
Example of cost drivers:
- Quantity produced
- Direct labor hours
- Number of set-ups
- Number of different orders produced
Use different activity drivers for different decisions.
Cost could be fixed, variable, or semi-variable in different situations
Breakeven analysis:
Price per case – variable cost per case = contribution margin per case
Contribution margin per case: the amount of products we need to sell, to cover the fixed cost
Contribution margin = represents the incremental money generated for each product/unit sold after
deducting the variable portion of the firm's costs.
Take the contribution margins together for the whole bundle
Fixed costs divided by the contribution margin of the whole bundle = breakeven number of bundles
, Formule
Incremental costs
and profit
costs or profit of
2000 extra units
Incremental cost per unit = change in total cost / change in volume
- Change in total cost = total costs if producing 2000 units more – total costs
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