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acc410 chpt 1-5.docx

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Ryerson University
ACC 410
Santoso Sugianto

Chapter 1 – Info Systems and Relevant info in Management Decision Making Cost accounting: involves the process of tracking, recording, analyzing and determining the cost of an organization’s project, process or activity - Helps managers understand the costs of operating a business so that they can use the info to make sound business decisions, mainly to reduce the company’s costs and to improve its profitability and productivity Management accounting: the process of gathering, summarizing, and reporting financial and nonfinancial info used internally by managers to make decisions - Since the info is mainly for internal users, it doesn’t follow IFRS or ASPE - Helps managers plan, control, and measure performance - Future oriented and concerned with reporting on a segment of an organization Financial accounting: the process of preparing and reporting financial info that is used most frequently by decision makers outside the organization, such as shareholders and creditors - Since the info is for external users, must follower IFRS or ASPE Relevant info: helps decision makers evaluate and choose among alternative courses of action – concerns the future and varies with the action taken Irrelevant info: doesn’t vary with the action taken and isn’t useful for decision making Relevant cash flows are incremental cash flows: they occur under one course of action or decision alternatives but not under another - Also called avoidable cash flows b/c they are avoided if the course of action or decision alternative is not taken Irrelevant cash flows are unavoidable cash flows: occur regardless of which course of action or decision alternative is chosen - They are irrelevant b/c they don’t help managers choose among alternatives Product costs: the total manufacturing costs of units that are sold during the period usually called costs of goods sold - Example: direct materials, direct labour, manufacturing overhead Period costs: other operating costs like marketing, advertising, and administration Biases: systematic distortions in judgment 1) Information bias: errors in judgement caused by data that are consistently overestimated, underestimated, or misrepresented 2) Cognitive bias: errors in judgement caused by the way people’s minds process info 3) Predisposition bias: errors in judgement caused by preferences, attitudes, or emotions that prevent objective analysis Chapter 2: Cost Concepts, Behaviour, and Estimation Costs are classified by: Relevance – relevant cost vs. irrelevant cost Behaviour – fixed cost vs. variable cost Traceability – direct cost vs. indirect cost Function – manufacturing cost (product cost) vs. nonmanufacturing cost (period cost) Controllability – controllable cost vs. uncontrollable cost Relevant revenues and costs: the revenues and costs that differentiate between alternatives that will occur in the future - Opportunity cost is a relevant cost b/c it’s the potential benefit given up by not taking one alternative over another o It’s the benefits we forgo when we choose one alternative over the next best alternative Irrelevant revenues and costs: don’t make a difference to either alternative, and have no bearing on the decision - Sunk cost is an irrelevant cost b/c the cost had already been incurred and can’t now be avoided o They are expenditures made in the past Fixed cost: the total cost won’t chance within a certain range of activity – the relevant range Variable cost: varies in proportion to the production level Mixed costs: partly fixed and partly variable Cost object: a thing or activity for which we measure costs - Include things such as individual products, product lines, projects, customers, departments, and the entire company Direct cost: a cost that can be directly traced to a cost object and is incurred for the benefit of a particular cost object - A clear cause-and-effect relationship generally exists between the cost object and the cost Indirect cost: incurred for the benefit of more than one cost object and can’t be easily and economically traced to a particular cost object - Relate to multiple products or services Manufacturing costs: direct materials, direct labour, manufacturing overhead costs - Prime costs: direct materials and direct labour - Conversion costs: direct labour and manufacturing overhead Relevant range: a span of activity for a given cost object, where total fixed costs remain constant and variable costs per unit of activity remain constant Marginal cost: the incremental cost of an activity, such as producing a unit of goods or services - Within the relevant range, variable costs approximates marginal cost, so variable cost is usually a measure of marginal cost - Marginal cost is often relevant in decision making Cost behaviour: the variation in costs relative to the variation in an organization’s activities such as production, merchandise sales, and services Cost function: an algebraic representation of the total cost of a cost object over a relevant range of activity - We assume that within a relevant range of activity, the total fixed costs remain fixed and the variable cost per unit remains constant TC = VQ + FC - Piecewise linear cost function: when the slope of a variable function changes at some point but remains linear after the change, - Stepwise linear cost function: when a fixed cost function changes at some point but remains constant after the change Cost driver: some input or activity that causes changes in total cost for a cost object Discretionary costs: reflect periodic (usually annual) decisions about the maximum amount that will be spent on costs for activities such as advertising, executive travel, or research and development - They are managed FC or managed VC, b/c managers decide the amount to spend on them Two-point method: uses any two sets of data points for cost and a cost drive to calculate a mixed cost function Change in cost driver / change in the cost driver $ / units = VC - After finding VC, find FC by using any point and then create the cost function TC = V(Q) + F High-low method: uses the highest and lowest data points of the cost driver Regression: - Regression analysis provides the best estimate of the cost function in cases with a strong positive linear relationship between the cost and the cost driver - R squared reflects an estimate of the percentage of variation in the cost that is explained by the cost driver Chapter 3: Cost-Volume-Profit (CVP) Analysis Cost-volume profit (CVP) analysis: a technique that examines changes in profits in response to changes in sales volumes, costs, and prices - Often perform CVP analysis to plan future levels of operating activity and provide info about: o Which products/services to emphasize o The volume of sales needed to achieve a targeted level of profit o The amount of revenue required to avoid losses o Whether to increase fixed costs o How much to budget for discretionary expenditures o Whether fixed costs expose the organization to an unacceptable level of risk Profit = Total Revenue – Total Costs Profit = Total Revenue – Total Variable Costs – Total Fixed Costs Contribution margin: the total revenue – the total variable costs Contribution margin per unit: the selling price per unit – the variable cost per unit - Tells us how much revenue from each unit sold can be applied toward fixed costs or contributed over to them - Once enough units have been sold to cover all fixed costs, the CM per unit from all remaining sales becomes profit EBT = SQ – VQ – FC Solving for Q: F + EBT = quantity (units) required to obtain target profit (S-VC) Contribution Margin Ratio (CMR): the % by which the selling price (or revenue) per unit exceeds the variable cost per unit CMR = CM SP To get CVP in terms of total revenue instead of units, we use CMR instead of CM Sales Revenue = F + EBT CMR Breakeven Point: where revenues cover all fixed and variable costs, resulting in zero profit - The CM is the same as FC, which leaves no profit - Sales Revenue = F + EBT CMR or CM A CVP Graph: shows the relationship between total revenues and total costs, it illustrates how an organization’s profits are expected to change under different volumes of activity CVP with Income Taxes EAT = EBT x (1 – Tax Rate) To know the pre-tax earnings needed to achieve a target level of after-tax earnings: EBT = EAT (1- Tax) CVP with Variable Amount of Earning - Managers may want to set an earning amount as a variable amount of sales - Before-tax earnings of % of sales o EBT = SQ – VQ – FC = x%S - After-tax earnings of % of sales o EBT = EAT / (1-Tax) X%S = y%S / (1-Tax) EBT (S) = SQ Sales Mix: the proportion of different products or services that an organization sells. - When performing CVP computations for sales mix, assume that the products a company sells are in a constant ratio - Sales Revenue = FC / CM = composite units - To determine the number of units to be sold to BE, multiply the number of composite units by the sales mix Planning, Monitoring and Motivating with CVP - CVP analyses are useful for planning and monitoring operations and for motivating employee performance - Results can be compared to identify differences in revenue levels and cost functions - When the owner analyzes the reasons for differences in profitability, emphasis can be placed on increasing revenues, reducing costs, or both - The owner can also hold managers accountable for performance, which should motivate their work efforts toward the owner’s goals Assumptions and Limitations of CVP – pg. 109 CVP for Not-for-Profit Organizations - Not-for-profit organizations often receive grants and donations and are usually offset against FC - They may be included in revenues or subtracted from VC - The treatment depends on the nature of the grant or donation Margin of Safety: the excess of an organization’s expected future sales (in either revenue or units) above the breakeven point - It indicates the amount by which sales could drop before profits reach the breakeven point - MOS (#) = Actual or estimated units of activity – units at breakeven point - MOS ($) = Actual or estimated revenue – revenue at breakeven point - To evaluate future risk when planning, use estimated sales - To evaluate actual risk when monitoring operations, use actual sales - If MOS is small, managers may put more emphasis on reducing costs and increasing sales to avoid potential losses - Larger MOS gives managers greater confidence in making plans such as incurring additional fixed costs - Margin of safety %: indicates the extent to which sales can decline before profits become zero o MOS% (#) = MOS in units / Actual or estimated units o MOS% ($) = MOS in revenue / Actual or estimated revenue Degree of operating leverage: the extent to which the cost function is made up of fixed costs - Organizations with high operating leverage incur more risk of loss when sales decline - When operating leverage is high, an increase in sales (After fixed costs are covered) quickly contributes to profit - DOL in terms of CM = CM / EBT - DOL in terms of FC = F/EBT + 1 - Managers use DOL to gauge the risk associated with their cost function and to explicitly calculate the sensitivity of profits to changes in sales (units or revenues): o % Change in profit = % change in sales x DOL - DOL and MOS are reciprocals o MOS % = 1/DOL o DOL = 1/MOS% o If MOS% is small then DOL is large o As the level of operating activity increases above the breakeven point, MOS increases, DOL decreases Indifference point: the level of activity at which equal cost or profit occurs across multiple alternatives - Set two cost functions equal to each other and solve for Q CM = Sales – VC Gross Margin = Sales – COGS CM Format GM Format Revenue Revenue VC COGS – manufacturing expenses CM GM FC Nonmanufacturing expenses EBT EBT Chapter 4 – Relevant Info for Decision Making Identifying Relevant Info Quantitative info: is numerical info that is available for addressing a problem - To be relevant, cash flows must (1) arise in the future and (2) vary with the action taken - We identify cash flows by first analyzing the decision alternatives and then selecting cash flows that are unique to each alternative - We ignore irrelevant (unavoidable) cash flows – those that don’t differ among alternatives ex. Sunk costs (costs that were incurred in the past) are always irrelevant Qualitative info: factors that are not valued in numerical terms – is vital to good decision making - Can be difficult to identify, b/c no formula assures us that we have considered the important info - Might be identified from experience with similar past decisions, through research into business risks and other factors that might affect the outcomes of a decision, or of discussions with managers or other personnel - Ex. Outsourcing – ability of the outside vendor to provide a good or service at the same level of quality and in a timely manner Product Line and Business Segment (Keep or Drop) Decisions - The general rule is that we want to be at least as well off after we discontinue a product or business segment as we were before we dropped it - Usually, this means that we discontinue a product or segment when the incremental profit from keeping it is negative - The decision rule is to drop if: CM < relevant FC + Opportunity cost - Consider whether the cost is avoidable if we drop the product or segment or unavoidable whether we do or not - VC are often avoidable and relevant to the decision, FC usually include both avoidable and unavoidable costs Customer Profitability - Customers are increasingly demanding additional services, such as timely delivery of small amounts of inventory or large amounts of support. Sometimes the seller’s cost to maintain these relationships are larger than the benefits. - A customer should be dropped if: Customer CM < Relevant FC + Opp. Cost - Relevant cash flows include the revenues that will be forgone if the customer is dropped along with the costs to maintain the customer and deliver products or services - Relevant costs include: o Avoidable costs of products manufactured or services provided o Marketing, sales-order, and delivery costs o Cost for equipment or other assets devoted to particular customers o Product technical support, warranty costs, and product return handling o Inventory carrying costs (material handling, warehousing, and insurance) o Avoidable admin costs for labour, facility, or other resources needed to satisfy customer demands o Alternative uses for capacity devoted to customers Costs of Carrying Inventory - Costs of carrying inventory are avoidable if a firm drops a customer or product - These costs can be relevant to keep or drop decisions - Are separate from general overhead costs - These costs include: o Costs to process purchase orders o Avoidable costs invested in the inventory (FM, FL, VOH, FOH) o Inventory shrinkage o Opp. Cost of forgone sales from inventory shortages Keep or Drop Summary: Insource or Outsource (Make or Buy) Decisions Outsourcing: the practice of finding outside vendors to supply products and services has become in
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