MANAGERIAL ACCOUNTING MODULE 3 a Managerial Accounting Costing

MANAGERIAL ACCOUNTING MODULE 3 a : Managerial Accounting : Costing Part 2 ZCMA 6022 : Managerial Accounting Prepared by: Nasuha Nordin

ABSORPTION VS. VARIABLE COSTING Absorption Costing Sales Cost of good sold Beginning inventory + Cost of good manufactured Goods available for sale - Ending inventory Gross margin - Selling & administrative expenses Net operating income p - Variable costing Sales Variable costs Variable Costs of good sold Beginning inventory - + Cost of good manufactured Goods available for sale - Ending inventory Selling & administrative Contribution margin - Fixed costs Manufacturing overhead Selling & administrative Net operating income

ACTIVITY BASED COSTING SYSTEM (ABC) ABC systems follow a two-stage procedure to assign overhead costs to products. 3 Stage One Identify significant activities and assign overhead costs to each activity in proportion to resources used. Stage Two Identify cost drivers appropriate to each activity and allocate overhead to the products.

TWO STAGES OH APPLICATION DEPARTMENTAL RATE VS. ABC Total Man OH (Estimated) RM 100, 000 Stage 1: Cost Assignme nt to Dept. /Activity Stage 2: Cost Assignme nt to Products Production Dept. X RM 64, 000 Production Dept. Y RM 36, 000 OH Rate Product A Product B Total Man OH (Estimated) RM 100, 000 Service Dept. Activity 1 RM 20, 000 Activity 2 RM 30, 00 0 Activity Rate Product A Activity 3 RM 50, 000 Activity Rate Product B

HOW COSTS ARE TREATED UNDER ACTIVITY–BASED COSTING Unit-Level Activity Batch-Level Activity Cost pools are generally fall in four broad categories Product – sustaining Level activity Facility-level Activity

HOW COSTS ARE TREATED UNDER ACTIVITY–BASED COSTING Unit level – this type of activity must be done for each of unit of production. E. g. direct material, quality inspection for microchip processor Batch level – these activities must be performed for each batch of products rather than each unit. E. g. setup, purchasing, material handling, quality assurance and packing/shipping Product sustaining level – this category includes activities that are needed to support an entire product line but are not performed every time a new unit or batch of products is produced. E. g. engineering design costs. Facility (or general operations) level – these are required in order for the entire production process to occur.

STAGE ONE: OH COSTS ASSIGN TO COST POOLS Overhead Costs Total budgeted cost = $4, 896, 000 Unit Level Setup cost pool $210, 000 A c ti v i ty Co st Pools Purchasing cost pool $300, 000 Material-Handling cost pool $340, 000 Quality-Assurance cost pool $110, 000 Packaging/Shipping cost pool $264, 000 Facility Level 7 Machinery cost pool $1, 242, 000 Batch Level Engineering cost pool $130, 000 Product. Sustaining Level Facility cost pool $2, 300, 000

STAGE ONE: COSTS ASSIGN TO COST POOLS Activity cost pool Maintenance Lubrication Depreciation Electricity Computer Support Calibration 8 Various overhead costs related to machinery Machine Related Cost Pool Total budgeted cost = $1, 242, 000

COLLECTING ABC DATA INTERVIEWS AND PAPER TRAILS - The information STORYBOARDING - A procedure used to develop a detailed process flow chart, which visually represents activities and the relationships among activities. MULTIDISCIPLINARY ABC PROJECT TEAMS – To gather information from all facets of an organizations operations, it is essential to involve personnel from a variety of functional areas. A typical ABC project team includes ACCOUNTING, FINANCE, PRODUCTION, OPERATIONS, ENGINEERS, MARKETING etc. 9 for ABC systems initially comes from interviews with employees in the support departments and a review of each department’s records.

ACTIVITY BASED MANAGEMENT • Process of using information from activitybased costing to analyse activities, cost drivers and performance so that customer value and profitability are improved • Customer value – The value that customers place on particular features of a product • Addresses the vertical view on the activitybased costing model

ACTIVITY-BASED MANAGEMENT 11 Activity-based costing establishes relationships between overhead costs and activities so that we can better allocate overhead costs. Activity-based management focuses on managing activities to reduce costs.

ELIMINATION OF NON-VALUE-ADDED COSTS Activities 12 Nonvalueadded activities Unnecessary Necessary Reduce or Eliminate Continually Evaluate and Improve

USING ABM TO ELIMINATE NON-VALUEADDED ACTIVITIES AND COSTS 1. Identify Activities. 2. Identify Non-Value-Added Activities. 3. Understand Activity Linkages, Root Causes, and Triggers. Specify parts Select vendor Receive parts Produce goods 4. Establish Performance Measures. 5. Report Non-Value-Added Costs. Inspect finished goods Rework defective products

IDENTIFY ACTIVITIES Identifies all of the organization’s significant activities

IDENTIFY NON VALUE ADDED ACTIVITIES Is the activity necessary? If it’s a duplicate or nonessential operation, it is non value added. Is the activity efficiently performed? Compare the actual performance of the activity to a value added baseline establishment. Is an activity sometimes value added and sometimes non value added? It is may necessary to move WIP unit between production operations but unnecessary to move raw materials around while in storage.

UNDERSTANDING ACTIVITY LINKAGES, ROOT CAUSES AND TRIGGERS Non value added activity = Rework of defective units. Triggers = identification of defective product during inspection. Root causes = any number of preceding activities e. g part specification were wrong, unreliable vendor was selected, wrong part is recevies

ESTABLISHING PERFORMANCE MEASURES Continually measuring the performance of all activities, and comparing performance with benchmark, management’s attention may directed to unnecessary or inefficient activities

REPORTING NON VALUE ADDED COST One of the approach – categorize the ways which time is spent in production process. Normally time spent in manufacturing operation in five ways � � � Process time. The time which product is undergoing conversion activity. Inspection time. The amount of time spent ensuring the product is of high quality. Move time. The time spent moving raw materials, WIP or finished goods between operations. Waiting time. The amount of time that raw materials or WIP spend waiting for the next period. Storage time. The time during which materials, partially completed products or finished goods are held in stock before further processing or shipment to customers.

ACTIVITY 1 : GROUP PROJECT DISCUSSION : INDIVIDUAL ASSIGNMENT III Team Name: Team Cost Estimation Member 1 Absorption Costing 2 Contribution Margin Costing 3 Activity Based Costing 4 Target Costing - Absorption Costing 5 Target Costing - Activity Based Costing Team Member Name

WHAT IS OPERATING LEVERAGE?

OPERATING LEVERAGE Extent to which an organization uses fixed costs in its cost structure Firms with higher proportion of FC than VC resulting in high contribution margin benefits the most from this method Refers to ability of firm to generate an increase in net income when sales revenue increases Operating leverage provides information on a company’s risk profile Higher OPERATING LEVERAGE could lead to HIGHER PROFIT MARGIN when companies increase the sales without incurring additional cost

OPERATING LEVERAGE Operating Leverage Factor = Contribution Margin Net Income

ACTIVITY 2 : EXERCISE 3 Please complete the Question Distributed and Submit before you leave using softcopy in IFOLIO or Handwritten Hardcopy Operating Leverage (35 minutes) Problem 7 -43 (Hilton and Platt 2015) 5% of total Assessment Marks Good Luck!

MANAGERIAL ACCOUNTING EXERCISE 3 ANSWER : OPERATING LEVERAGE ZCMA 6022 : Managerial Accounting Prepared by: Nasuha Nordin

EXERCISE 3 ANSWER 1 Plan A break-even point = fixed costs ÷ unit contribution margin = $33, 000 ÷ $33* = 1, 000 units Plan B break-even point = fixed costs ÷ unit contribution margin = $99, 000 ÷ $45** = 2, 200 units * $120 - [($120 x 10%) + $75] ** $120 - $75

EXERCISE 3 ANSWER 2 Operating leverage refers to the use of fixed costs in an organization’s overall cost structure. An organization that has a relatively high proportion of fixed costs and low proportion of variable costs has a high degree of operating leverage.

EXERCISE 3 ANSWER 3 Calculation of contribution margin and profit at 6, 000 units of sales: Sales revenue: 6, 000 units x $120………………. Less variable costs: Cost of purchasing product: 6, 000 units x $75…………. …… Sales commissions: $720, 000 x 10%……. . . Total variable cost……………. . Contribution margin……………… Fixed costs……………………. Net income……………………. Plan A Plan B $720, 000 $450, 000 72, 000 $522, 000 $198, 000 33, 000 $165, 000 $720, 000 $450, 000 ----__ $450, 000 $270, 000 99, 000 $171, 000 Plan A has a higher percentage of variable costs to sales (72. 5%) compared to Plan B (62. 5%). Plan B’s fixed costs are 13. 75% of sales, compared to Plan A’s 4. 58%. Operating leverage factor = contribution margin ÷ net income Plan A: $198, 000 ÷ $165, 000 = 1. 2 Plan B: $270, 000 ÷ $171, 000 = 1. 58 (rounded) Plan B has the higher degree of operating leverage.

EXERCISE 3 ANSWER 4 & 5 Calculation of profit at 5, 000 units: Sales revenue: 5, 000 units x $120………………. Less variable costs: Cost of purchasing product: 5, 000 units x $75……………. . Sales commissions: $600, 000 x 10%……. . . Total variable cost……………. . Contribution margin……………… Fixed costs…………………… Net income……………………. Plan A $600, 000 $375, 000 60, 000 $435, 000 $165, 000 33, 000 $132, 000 Plan B $600, 000 $375, 000 ---- __ $375, 000 $225, 000 99, 000 $126, 000

EXERCISE 3 ANSWER 4 & 5 ( CONTD) Plan A profitability decrease: $165, 000 - $132, 000 = $33, 000; $33, 000 ÷ $165, 000 = 20% Plan B profitability decrease: $171, 000 - $126, 000 = $45, 000; $45, 000 ÷ $171, 000 = 26. 3% (rounded) Pneumo. Tech would experience a larger percentage decrease in income if it adopts Plan B. This situation arises because Plan B has a higher degree of operating leverage. Stated differently, Plan B’s cost structure produces a greater percentage decline in profitability from the drop-off in sales revenue. Note: The percentage decreases in profitability can be computed by multiplying the percentage decrease in sales revenue by the operating leverage factor. Sales dropped from 6, 000 units to 5, 000 units, or 16. 67%. Thus: Plan A: 16. 67% x 1. 2 = 20. 0% Plan B: 16. 67% x 1. 58 = 26. 3% (rounded)

EXERCISE 3 ANSWER 6 Heavily automated manufacturers have sizable investments in plant and equipment, along with a high percentage of fixed costs in their cost structures. As a result, there is a high degree of operating leverage. In a severe economic downturn, these firms typically suffer a significant decrease in profitability. Such firms would be a more risky investment when compared with firms that have a low degree of operating leverage. Of course, when times are good, increases in sales would tend to have a very favorable effect on earnings in a company with high operating leverage.

MANAGERIAL ACCOUNTING MODULE 3 : Managerial Accounting : Costing Part 2 ZCMA 6022 : Managerial Accounting Prepared by: Nasuha Nordin

WHAT IS RELEVANT?

1. RELEVANT RANGE I. RELEVANT INFORMATION II. RELEVANT RANGE

II. RELEVANT INFORMATION Why do we need information in an organization?

II. RELEVANT INFORMATION What are the characteristics of information?

Information for decision making need to be: Relevant Accurate Timeliness

II. RELEVANT INFORMATION Whether particular costs and revenues are relevant for decision making depends on the decision context and the alternatives available

Criteria of relevant information: Bearing on future Different under competing alternative

II. RELEVANT RANGE The range of activities within which management expects the company to operate

II. RELEVANT RANGE Management is always interested to know the cost behavior within the Company’s relevant range

How do we know what is the Company’s relevant range? 7, 000 6, 000 5, 000 4, 000 3, 000 2, 000 1, 000 - - 20 40 60 80 100 DOZENS OF DONUTS SOLD 120 140 Thousands II. 8, 000 RELEVANT RANGE EXAMPLE UTl. LITIES

What is CVP?

COST-VOLUME-PROFIT ANALYSIS Study of the effects of changes of costs and volume on a company’s profits Ø A critical factor in management decisions Ø Important in profit planning Ø

ASSUMPTIONS UNDERLYING CVP ANALYSIS Ø Behavior of both costs and revenues is linear throughout the relevant range of the activity index Ø All costs can be classified as either variable or fixed with reasonable accuracy Ø Changes in activity are the only factors that affect costs Ø All units produced are sold Ø When more than one type of product is sold, the sales mix will remain constant

CVP ANALYSIS Breakeven Point (BEP) (units and $) doesn’t convey how profit changes as activity changes Graph CVP graph – over FC 2. CVP graph – over VC 3. Profit-Volume graph shows BEP Shows Profit and Loss areas 1. Sensitivity Analysis Safety Margin (MOS) Operating Leverage

CVP ANALYSIS BEP Sensitivity Analysis Margin of Safety

CVP INCOME STATEMENT Absorption Costing Statement Contribution Costing Statement doesn’t disclose breakdown between FC / VC/ Semi-Variable Cost highlights distinct values of FC/ VC/ Semi -VC Highlights CVP relationships Able to identify Cost Structure (Cost domination – VC or FC)

CVP ANALYSIS - BREAKEVEN Breakeven Point ($) Breakeven Point (unit) 1. Contribution Margin Approach 2. Formula

CVP ANALYSIS - BREAKEVEN Breakeven Point ($) Breakeven Point (unit) 1. Contribution Margin Approach 2. Formula

CVP GRAPH CVP graph over FC CVP graph over VC

CVP GRAPH CVP graph over FC Profit Volume Graph

ACTIVITY 3 : GROUP PROJECT DISCUSSION : GROUP ASSIGNMENT III COST-VOLUME-PROFIT ANALYSIS MODULE 2

MANAGERIAL ACCOUNTING MODULE 3 b : Managerial Accounting : Decision Making ZCMA 6022 : Managerial Accounting Prepared by: Nasuha Nordin

DECISION MAKING What Could be Some of the Decisions to be Made within an Organization?

DECISION MAKING 1. 2. 3. 4. 5. Special Order : Accept / Reject Special Decision : Limited Resources Special Decision : Outsourcing – Make or Buy Special Decision : Add or Drop Service/ Product / Department Special Decision : Sell or Process Further

Accept / Reject Limited Resources Outsourcing Add or Drop Sell or Process Further

ACTIVITY 4 : GROUP PROJECT DISCUSSION : INDIVIDUAL ASSIGNMENT IV Team Name: Team DECISION MAKING Member 1 Special Order: Make or Buy 2 Special Decision: Limited Resources Special Decision: Add, Drop a Service, 3 Team Member Name Product of Department 4 5 Special Decision: Outsourcing – Make or Buy Special Decision: Sell or Process Further