Managerial Accounting
Direct costs: usually applicable to a product identified by units
Indirect: more complex, costs cannot be divided to the units, not directly related to production
Examples: R&D, marketing, PR, RM = indirect
HR hunter = direct cost
Fixed Cost: rent, salary (when salary not based on the amount they produced)
Variable Cost: the more you produce the higher the cost
*** fixed cost can be direct or indirect, variable cost can be direct / indirect
Manufacturing costs (product costs): related to the product
Non-manufacturing cost (period cost): promotion, marketing, administrative, documents, not
directly related to the product
DMC: prime cost
DLC (direct labor cost): prime cost
Manufacturing overhead: electricity, rent, indirect materials
DLC & Manufacturing overhead = conversion costs
All of the costs added up together (manufacturing costs) / number of units = cost per unit
Formula for COGS from financial accounting point of view:
BB + purchases – EB = COGS
COGS – selling – administrative costs = operating expenses
Gross margin = sales revenue – COGS
Gross margin – operating expenses (not related to the manufacturing of product) = operating
income
Revenue – variable cost = profit margin (same as contribution margin)
Profit margin – fixed cost = operating income
Mixed cost (ex. For salesperson their salary is based on this, because salary based on amount of
units sold)
!!! pay attention that for costs per volume numbers are in relevant range
Increase in volume means:
Unit fixed cost decreases
Unit variable cost stays the same
Total fixed cost stays the same
Total variable cost decreases
Committed costs: cannot change in short term (ex. Depreciation)
Discretionary costs: can change in short term (ex. Marketing, you can fire people, R&D)
Y = a + bX
a = fixed cost
b = variable cost per unit, or the slope
X = number of units produced (activity level)
Y = total mixed cost
When slope is steeper there is higher variable cost
Mixed cost analysis
1. Account analysis
a. Slide 20 for Section 3
2. Engineering approach
3. Scattergraph method
a. LINEAR
b. Watch out when you have two
relevant ranges, start trendline
from where the points start
rising
4. High-low method
a. Find highest cost
b. Find lowest cost
c. Connect the highest & lowest
i. Make graph with those
two points
ii. (y2-y1)/(x2-x1) = b = variable cost
1. Y2= total cost at highest level
2. Y1= total cost at lowest level
3. X2= activity at highest level
4. X1= activity at lowest level
5. Least Square regression method
a. Trendline, linear (for this course)
Contribution margin
In short run you care about total variable cost, in the long run you care about total cost
CM = fixed expenses this is your = breakeven point
Breakeven point: when total revenue = total cost
- Revenue is just able to cover costs
Safety margin: difference between breakeven point & budget revenue
- Usually breakeven is lower than budget revenue (goal revenue)
Example: slides 46, Section 3
- Find all the variable costs
- COGS in this example is also a VC
- Calculate total variable cost
- Revenue – total variable cost = contribution margin
- CM – fixed cost = operating income
- Find total cost function Y = a +bX
o “b” = total variable cost / quantity sold
- Contribution margin = selling price – b
- CM / selling price * 100% = CM %
o Profit margin %
Contribution margin = TR – TVC (total variable costs)
** the more you sell the more comes from contribution margin. After you hit breakeven, the extra
generated revenue are solemnly from the contribution margin
CM% * units * selling price = extra revenue you are generating margin of safety, when
low = generating not a lot of revenue and very close to breakeven
Leverage sensitivity of operating income, if I sell one more product what is the extra profit you
make
High variable cost = low contribution margin
Low variable cost = higher CM
Operating leverage is higher for a firm with high FC
(DOL): Degree of operating leverage = CM per unit / total profit
Total profit = total revenue – total cost
Price * quantity – TC = profit
Total variable cost = (quantity / VC) * units
Margin of safety = total sales – breakeven point
Margin of safety % = margin of safety $ / sales
In a graph: the steeper the slope, the more sensitive
the operating leverage
- Negatives of being sensitive: low season mean
more drastic fall in revenue, you rely highly on
demand of customers
Example: Menlo Company manufactures and sells a
single product, company sales are…. Question 4 & 5
1. Calculate the breakeven point
a. Total contribution margin = fixed
costs
b. Contribution margin = sales – variable
costs
c. Contribution margin * quantity = fixed expenses
d. So then when multiplying result by price that = total revenue
e. Then use your actual sales (given in the problem) and subtract the breakeven point
i. Tells you how much more or less your producing than your breakeven
ii. = margin of safety
f. Margin of safety percentage = margin of safety / total actual sales
i. ** rule of thumb: should be around 20%
2. Contribution margin ratio
a. Contribution margin per unit / cost per unit
b. OR total contribution margin / total sales
3. When sales increase: calculate how many more units you produced additional
revenue/sales price per unit
a. Then multiply the contribution margin per unit * the additional amount of units you
have
4. OR contribution margin ratio * additional revenue
Job Order Costing
- Happens at the beginning of the period
- Predetermined overhead rate = estimated overhead cost / units of allocation base
o Usually $ per unit
o Units of allocation based could be quantity, hours worked, employees, headcount
etc etc.
o For each product you are producing how much are you spending
- Overhead applied to job = predetermined overhead rate * estimated quantity
o Estimated quantity = labor hours etc.
- Flow of costs
o Indirect costs also known as overhead
o See diagram, the purchase and issue of materials
o Underapplied vs. overapplied
When underapplied you need to add this to your accounts
Add to account where number too low
When overapplied; subtract from accounts
Categorize them
- 3 Methods for cost allocation
o Differentiate between service &
operating
o 1. Direct Method
Do not care about
distribution within service
departments
Allocate all service costs
to operating costs
Service
department costs
should then be 0
o 2. Step Method
Allocating a service
department to both
another service
department & operating
departments
Always allocate the
service department with
the largest cost (break
that one up)
Problem will tell you
based on what (ex.
Employee hours)
See diagram
Relevant costs for decision making
- Relevant cost = avoidable cost = differential cost = incremental cost
o Ex. The tuition for either EPFL or EHL
o As managers we can only change these
Replace human by machines
- Non relevant cost
o Ex. cost of housing, food etc.
- Compare the contribution with the fixed cost to decide whether you want to keep
something or not
o You can also add the margin of safety to the fixed cost to take into consideration
when managerial accounting
- Utilization of constrained resource
o Bottlenecks: SOM course
- ** usually produce product with the highest contribution margin first
Budgeting
- Zero based budgeting
o New budget for each year
o Government or non profit organizations
- Incremental budgeting
o Based on previous years
o Companies do this
o Master budget
Precise with all accounts
People involved, revenues, quantities
10 steps for completion
Total cash sales for the period = total sales – accounts receivables
Total cash collection for the period = accounts receivable for last period +
total sales – accounts receivable for the period
Also look at quantities: total needs = budgeted sales + desired ending
inventory
Required production = total needs – beginning inventory
Raw materials needed = raw materials needed to meet production schedule
+ desired inventory of raw materials
Raw materials to be purchase = total raw material needs – beginning
inventory of raw materials
o Flexible budgets
Range given
Optimistic
Pessimistic
Neutral = estimation
