Management accounting summary
Chapter 1 - Differences between managerial and financial accounting
Financial accounting provides information used by investors, creditors and others outside a
business. Managerial accounting is for executives, managers and employees inside a business
who need to plan, direct and control operations.
External users desire global information of the company as a whole; internal users are interested
in subdivisions’ performance.
Financial accounting is designed for the general public and adheres to the GAAP, while
management accounting adheres only to the value-added principle: Information gathering is only
done as long as it adds value in excess of its costs. Managerial accounting is less objective,
reliable and consistent, and more relevant and not just historical but also predictive. It’s done
continuously, not just periodically like financial accounting.
Financial accounting: Past performance, external stakeholders, transactions between company
and third parties.
Management accounting: Internal transactions, future oriented, estimates, non-financial too.
Chapter 2 - Cost behaviour, operating leverage and profitability analysis
Operating leverage magnifies small revenue changes in large profitability changes.
Operating leverage = Contribution Margin / Operating Income
Higher levels of fixed costs means higher operating leverage and more earnings volatility. Cost
structures determine the way revenues influence operating income.
The contribution margin is the amount available to cover fixed expenses and provide profits.
Net income = Contribution margin - Fixed costs.
Contribution margin = Sales revenue - Variable costs.
The relevant range is the range of activity over which the definitions of fixed and variable costs are
valid, so within this region there’s a linear relationship between quantity and costs. In the relevant
range, unit variable and fixed costs are constant.
The high-low method of estimating fixed and variable costs selects the highest and lowest
number of units sold/produced, not the lowest and highest costs. First we estimate the variable
cost per unit: Difference in total cost / Difference in volume. Using this we can find the fixed cost,
since this is Total cost - Variable cost * Units sold. It’s simple but inaccurate.
Scattergraphs are slightly more accurate methods of estimating costs using the high and low
point or the least total distance between the line and the data points.
Least-squares regression is even more accurate, but is also vulnerable to outliers. The R2 statistic
represents the percentage change of the dependent variable explained by the change in the
independent variable. So R2 statistic = %∆ Total Cost explained by ∆Units sold.
If R2 is 86, 86% of costs are explained by the quantity of units sold.
Multiple regression analysis permits analysis of how several independent variables simultaneously
affect dependent variables.
Cost drivers are selected using two criteria:
-A causal relationship between the measure of activity (quantity produced) and the costs.
-High correlation between measure of activity and corresponding costs. So more goods produced
should mean more materials consumed; and high correlation between goods and total costs.
Fixed costs can be both capacity costs (incurred to maintain capacity and not varying over the
period such as factory rent) and discretionary costs which are made at the discretion of the
manager (vary but not proportional to volume, e.g. marketing expenses).
Chapter 3 - Analysis of cost, volume, and pricing to increase profitability
The break-even point is where profit is zero. It can be found using some different methods:
-The equation method equates Sales - VC - FC to zero to find the number of sales.
, -The contribution margin per unit method finds the sales price per unit - VC per unit, which is the
contribution margin, and divided fixed costs by CM.
-The contribution margin ratio method uses the contribution margin ratio, CM / Sales, and divides
Fixed costs by this ratio to find the break-even point in dollars.
The margin of safety measures the cushion between budgeted sales and break-even point,
quantifying by how much sales can fall short without incurring losses.
Margin of safety = (Budgeted sales - Break-even sales) / Budgeted sales. So the percentage sales
in excess of the break-even sales.
Chapter 4 - Cost accumulation, tracing and allocation
Knowing a product cost is vital to among other things cost-plus pricing. It consists of materials,
labor and overhead costs.
Expenses are assets used in producing revenue. That’s why costs of labor for units not yet sold is
stored in inventory, only when these are sold will they generate revenue and the average cost is
transferred from Inventory to Cost of Goods Sold.
Cost objects are things we want to determine costs of. A cost driver has a cause-and-effect
relationship with a cost object: The number of goods is the cost driver of the cost of those goods,
which is the cost object.
Direct costs can easily be traced to a cost object in a cost-effective manner. A manager’s salary is
directly traceable to a certain store, so a direct cost for this store’s operations.
Indirect costs aren’t easily traced to a cost object, or overhead costs. The store manager’s salary
is not traceable to a certain department within the store, so indirect.
Whether a cost is direct or indirect is independent of fixed or variable.
Product costs are resources consumed to make products, and is expended once goods are sold.
Period costs not, but to design/sell/administer and is immediately expended.
Indirect costs include common costs (not traceable cost-effectively) and joint costs (untraceable).
Common costs support multiple cost objects and can’t be traced directly to any specific object,
e.g. renting a store with several departments. We can allocate such costs by assigning it to cost
objects. The allocation base is the cost driver, so store square meters for example, and then we
can compute the allocation rate which is how much of the rent costs is assigned to each
department for each square meter it uses.
Instead of allocating every single indirect cost, many individual costs are often accumulated into
cost pools. The total of this is allocated to cost objects. E.g. gas, water and electricity pooled as
utilities, and then allocated the cost objects. Requirements are:
-Cost pool homogeneity: Only pool costs with the same underlying driver.
-Underlying cost driver as allocation base: As many cost pools as cost drivers. Volume measures
are good cost drivers for overhead costs since a causal relationship exists between them.
Joint costs are common costs for making tow or more joint products: Raw milk is a joint cost of
producing both skim and whole milk. Joint costs include not just material but also labor and
overhead costs of converting the materials into separate products. The split-off point is the point
in the production process where products become separate and identifiable. Overhead costs
incurred after the split-off point are assigned to the related product.
Joint costs are allocated using the net realisable value of the joint products. Net realisable value =
Market value of the joint product - Transformation costs incurred after the split-off point.
So direct costs are traceable,
indirect costs not.
Product costs are incurred in
making a product, period costs
not directly.
