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Dr. Clive Vlieland-Boddy FCA FCCA MBA

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1 Dr. Clive Vlieland-Boddy FCA FCCA MBA
Costing 1 Dr. Clive Vlieland-Boddy FCA FCCA MBA

2 Functions of Management

3 Strategy of Management The Present The Past The Future Environmental
Scanning of current product/service mix Budgets Forecasts Annual Report Annual Report Annual Report

4 The Functions of Management
Strategy Evaluation Planning Planning – Choosing goals and deciding how to achieve them Acting – carry out plan Controlling – evaluating results by comparing the actual results to the plan. You work for Baskin Robins – one of its goals is to increase operating income How do you do it? Incr sales price Incr sales volume Lower costs The accounting system, by tracking costs, helps managers evaluate performance Feedback

5 Decentralised Operations

6 Functional organizational structure
© 2000 Colin Drury

7 Decentralized Operations
Companies decentralize as they grow Split operations into different divisions or operating units Top management delegates decision-making to unit managers Decentralization may be based on: Geographic area Product line Customer base Business function In a small company, the owner or top manager often makes all planning and operating decisions. Small companies can use centralized decision making because of the smaller scope of their operations. However, when a company grows, it is impossible for a single person to manage the entire organization’s daily operations. Therefore, most companies decentralize as they grow. Companies that decentralize split their operations into different divisions or operating units. Top management delegates decision-making responsibility to the unit managers. Top management determines the type of decentralization that best suits the company’s strategy. For example, decentralization may be based on geographic area, product line, customer base, business function, or some other business characteristic. 7

8 Decentralization in Organizations
Benefits of Decentralization Top management freed to concentrate on strategy. Lower-level managers gain experience in decision-making. Decision-making authority leads to job satisfaction. Lower-level decision often based on better information. Improves ability to evaluate managers.

9 Decentralization and Segment Reporting
An Individual Store A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . . Canadian Tire A Sales Territory A Service Centre

10 Advantages of Decentralization
Better information leading to superior decisions Managers can respond quicker to changing circumstances Increased motivation of managers Provides excellent training for future top-level executives Frees top management time

11 Disadvantages of Decentralization
Costly duplication of activities Lack of goal congruence Management pursues personal goals Personal goals are incompatible with the company’s goals To control goal congruence, companies evaluate the performance of subunit managers

12 Advantages Outweigh Disadvantages
Disadvantages of decentralization Advantages of decentralization As this picture illustrates, the many advantages of decentralization usually outweigh the disadvantages. Copyright (c) 2009 Prentice Hall. All rights reserved. 12

13 Reasons for evaluating subunit managers:
Why Companies Evaluate the Performance of Subunits and Subunit Managers A company evaluates subunits in order to decide if it should expand or contract them or change their operations A company evaluates subunit managers in order to motivate them to take actions that maximize the value of the firm Reasons for evaluating subunit managers: Identifies successful operations and areas needing improvement Influences the behavior of managers

14 Responsibility Accounting and Performance Evaluation
Responsibility accounting is a technique that holds managers responsible only for costs and revenues that they can control To implement responsibility accounting in a decentralized organization, costs and revenues are traced to the organizational level where they can be controlled

15 Responsibility Centres

16 Cost, Profit, and Investment Centres
centres are all known as responsibility centres. Responsibility Centre

17 A segment whose manager has control over costs,
Cost Centre A segment whose manager has control over costs, but not over revenues or investment funds. Cost Cost Cost

18 A segment whose manager has control over both costs and revenues,
Profit Centre A segment whose manager has control over both costs and revenues, but no control over investment funds. Sales Interest Other Costs Mfg. costs Commissions Salaries Other

19 Investment Centre A segment whose manager has control over costs, revenues, and investments in operating assets. Corporate Headquarters

20 Cost Centres Parts of the business to which particular costs can be attributed In large businesses this can be a particular location, section of the business, capital asset or human resource/s Enable a business to identify where costs are arising and to manage those costs more effectively

21 Responsibility Centers
Subunit of an organization whose manager is accountable for specific activities Responsibility Center Manager is responsible for: Cost center Controlling costs Revenue center Generating sales revenue Profit center Producing profit by generating sales and controlling costs Investment center Producing profit and managing the division’s invested capital Decentralized companies delegate responsibility for specific decisions to each subunit, creating responsibility centers. Recall from Chapter 21 that a responsibility center is a part or subunit of an organization whose manager is accountable for specific activities. The table on this slide reviews the goals of each type of responsibility center. Copyright (c) 2009 Prentice Hall. All rights reserved. 21

22 Functional organizational structure
IC= Investment Centre CC = Cost Centre RC = Revenue Centre © 2000 Colin Drury

23 Performance Management

24 Performance Measurement
When companies decentralize, top management needs a system to communicate goals to subunit managers Primary goals: Promoting goal congruence and coordination Communicating expectations Motivating unit managers Providing feedback Benchmarking Once a company decentralizes operations, top management is no longer involved in running the subunits’ day-to-day operations. Performance evaluation systems provide top management with a framework for maintaining control over the entire organization. When companies decentralize, top management needs a system to communicate its goals to subunit managers. Additionally, top management needs to determine whether the decisions being made at the subunit level are effectively meeting company goals. The primary goals of performance evaluation systems follow: Promoting Goal Congruence and Coordination: Decentralization increases the difficulty of achieving goal congruence. Unit managers may not always make decisions consistent with the overall goals of the organization. A company will be able to achieve its goals only if each unit moves, in a synchronized fashion, toward the overall company goals. The performance measurement system should provide incentives for coordinating the subunits’ activities and direct them toward achieving the overall company goals. Communicating Expectations: To make decisions that are consistent with the company’s goals, unit managers must know the goals and the specific part their unit plays in attaining those goals. The performance measurement system should spell out the unit’s most critical objectives. Motivating Unit Managers: Unit managers are usually motivated to make decisions that will help to achieve top management’s expectations. For additional motivation, upper management may offer bonuses to unit managers who meet or exceed performance targets. Top management must exercise extreme care in setting performance targets. For example, a manager measured solely by his ability to control costs may take whatever actions are necessary to achieve that goal, including sacrificing quality or customer service. But such actions would not be in the best interests of the firm as a whole. Providing Feedback: In decentralized companies, top management is no longer involved in the day-to-day operations of each subunit. Performance evaluation systems provide upper management with the feedback they need to maintain control over the entire organization, even though they have delegated responsibility and decision-making authority to unit managers. If targets are not met at the unit level, upper management will take corrective actions, ranging from modifying unit goals (if the targets were unrealistic) to replacing the unit manager (if the targets were achievable, but the manager failed to reach them). Benchmarking: Performance evaluation results are often used for benchmarking, which is the practice of comparing the company’s achievements against the best practices in the industry. Comparing results against industry benchmarks is often more revealing than comparing results against budgets. To survive, a company must keep up with its competitors. Copyright (c) 2009 Prentice Hall. All rights reserved. 24

25 Limitations of Financial Performance Measures
Financial Accounting measures tend to be lag indicators “After the fact” Management Accounting are lead indicators “Before the fact” In the past, performance measurement revolved almost entirely around financial performance. On the one hand, this focus makes sense because the ultimate goal of a company is to generate profit. On the other hand, current financial performance tends to reveal the results of past actions rather than indicate future performance. For this reason, financial measures tend to be lag indicators (after the fact), rather than lead indicators (before the fact). Management needs to know the results of past decisions, but they also need to know how current decisions may affect the future. To adequately assess the company, managers need both lag indicators and lead indicators. Another limitation of financial performance measures is that they tend to focus on the company’s short-term achievements, rather than on long-term performance. Why is this the case? Because financial statements are prepared on a monthly, quarterly, or annual basis. To remain competitive, top management needs clear signals that assess and predict the company’s performance over longer periods of time. Copyright (c) 2009 Prentice Hall. All rights reserved. 25

26 Trading Statement

27 Total Revenue Total Revenue = Price x Quantity Sold
Price can be raised or lowered to change revenue – price elasticity of demand important here Different pricing strategies can be used – penetration, psychological, etc. Quantity Sold can be influenced by amending the elements of the marketing mix

28 Manufacturing Companies: Income Statement
Sales - Cost of goods sold Gross profit - Operating expenses Operating income Opening Inventories Add Purchases Less Closing Inventories The Income Statement for a Manufacturing Company is similar to that of a Merchandising company. Sales minus Cost of Goods Sold minus Operating Expenses equals Operating Income. 28

29 Manufacturing (Product) Costs
Direct Manufacturing Costs are easily traced to the product. These include: Direct Materials Direct Labor Indirect Manufacturing Costs are not as easily traced to the product and are usually pooled together in Manufacturing Overhead (MOH)

30 What is Contribution Contribution is the management accounting term for gross profit. In other words, sales less the cost of goods sold.

31 Contribution Contribution Margin Per Unit Contribution Margin Ratio
This is Gross Profit that each unit contributes towards the general overheads and net income Contribution Margin Ratio The contribution margin as a % of sales. (Same as Gross Profit Margin %.

32 Costs and Budgeting

33 Cost Behaviour Costs can be a function of units of production or time.

34 34

35 Fixed Costs These costs do not vary with production levels.
Example: Property costs like rent Municipal taxes and insurance have to be paid even if you only produce one ice cream. 35

36 36

37 Variable Costs These are as it says, costs that will vary with production. Example: A manufacture of Ice Cream will have costs of milk that are directly proportionate to the production. Ie say 10 gallons of milk to11 gallons of ice cream. 37

38 38

39 Stepped Costs These are costs that are variable but not directly proportionate to production. Example: Rental of a warehouse. Once full, another is required so costs step up 39

40 Semi Variable Costs Include a variable and fixed cost elements. 40

41 Budgeting & Forecasting
Strategy needs to be taken and developed into a financial plan. There needs to be objective for the future. Benchmarks need to be created so as to be able to evaluate the business against its planned path

42 Operating Budget Chapter 10 42

43 Financial Budget Chapter 10 43

44 Budget Objectives Chapter 10 44

45 Budget Cycle Chapter 10 45

46 COSTING Cost accounting system provides information about cost
Aim : best use of resources and maximization of returns

47 Costs

48 Costs Anything incurred during the production of the good or service to get the output into the hands of the customer The customer could be the public (the final consumer) or another business Controlling costs is essential to business success Not always easy to pin down where costs are arising!

49 Common Types Of Cost Behavior
Fixed Costs: Costs that fundamentally are not driven by changes in volume Variable Costs: Costs that change directly and proportionately with the volume of activity Semi Variable Costs: Costs that contain both a fixed and a variable component. Also called Semi Variable or stepped. Others

50 Traceable and Common Fixed Costs
Costs arise because of the existence of a particular segment. Costs arise because of overall operating activities.

51 Traceable and Common Fixed Costs
Don’t allocate common costs. Traceable Common Costs arise because of the existence of a particular segment. Costs arise because of overall operating activities.

52 Traceable Costs Can Become Common Costs
Webber’s Television Division Product Lines Sales Territories

53 Inappropriate Methods of Allocating Costs Among Segments
Arbitrarily dividing common costs among segments Inappropriate allocation base Failure to trace costs directly Segment 1 Segment 2 Segment 3 Segment 4

54 Costing Methods

55 Standard Costing The forecasted expected cost per unit.
Example: A ball point pen manufacturer: Cost of Plastic case p Cost of Cartridge p Labour to assemble p Packaging p Standard Cost p

56 Using Standard-Costing Systems for Control
based on carefully predetermined amounts. Standard costs are used for planning labour and material requirements. the expected level of performance. benchmarks for measuring performance.

57 Using Standard-Costing Systems for Control
a budget for the production of one unit of product or service ACTUAL COST incurred and recorded in the production of the product or service COST VARIANCE the difference between the actual cost and the standard cost

58 Using Standard-Costing Systems for Control
This variance is unfavorable because the actual cost exceeds the standard cost. Standard A standard cost variance is the amount by which an actual cost differs from the standard cost. Product cost

59 Management by Exception
Managers focus on quantities and costs that deviate significantly from standards (a practice known as management by exception). Standard Amount Direct materials Direct labor Type of Product Cost

60 Management by Exception
Take the time to investigate only significant cost variances. What is significant? Depends on the size of the organization Depends on the production process Depends on the type of the organization

61 Variance Analysis Cycle
Take corrective actions Identify questions Receive explanations Conduct next period’s operations Analyze variances Prepare standard cost performance report Begin

62 Setting Standards Analysis of historical data Task analysis Combined
What DID the product cost? Used in a mature production process What SHOULD the product cost? Task analysis Analyze the process of manufacturing the product Combined approach Analyze the process for the step that has changed, but use historical data for the steps that have not changed

63 Marginal Costing

64 The layman’s language The only cost of driving my car on a 200 mile trip today is $12 for gasoline. Marginal Costing 64

65 Marginal or Variable Costing
Used for internal planning and decision making Does not include fixed factory overhead as a product cost

66 Advantages of variable/marginal costing
Variable costing is simple to understand It provides more useful information for decision-making Avoids fixed overheads being incorporated into the costs

67 Disadvantages of variable/marginal costing
The separation of costs into fixed and variable is difficult and sometimes gives misleading results It underestimates the importance of fixed costs Application of fixed overhead depends on estimates. There may be under or over absorption of the same A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of variable/marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer

68 Absorption Costing

69 No! You must consider these costs too!
Absorption Costing 69

70 Absorption/Costing Includes direct materials, direct labour, variable factory overhead, and allocates fixed factory overhead as part of total product cost

71 Absorption costing Costing method which involves or “absorbs” all the costs necessary to produce the product into its saleable form. It is both the marginal and the fixed costs Also known as “Full costing”

72 Absorbing Overheads Having fixed the overhead consumption rate based on forecast. If we under produce we recover insufficient overheads. If we overproduce we recover excessive overheads. In essence we under or over absorb the overheads.

73 Overview of Absorption and Marginal Costing
Absorption Costing Marginal Costing Product Costs Period Costs Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Product Costs Period Costs 73

74 Summary Variable/Marginal Costing Solves the Forecasting Problem in Pricing Variable/Marginal Costing focuses on Variable and Incremental Costs With Variable/Marginal Costing you will be able to calculate: Floor Price Out of Pocket Price Break Even Price Target Profit Price Most profitable sales mix Profitable Sales Strategies

75 Managements Use of Costing

76 MANAGEMENT DECISIONS Controlling Costs Pricing Planning Production
Analyzing Market Segments Analyzing Contribution Margins ACTUAL PLANNED

77 Question 1 An investment center is responsible for: Answer:
Investing in long term assets Controlling costs Generating revenues All of the above Answer: d. All of the above

78 Question 2 An cost center is responsible for: Answer:
Investing in long term assets Controlling costs Generating revenues All of the above Answer: b Controlling Costs

79 Question 3 An profit center is responsible for: Answer:
Investing in long term assets Controlling costs Generating revenues B and C Answer: d. Controlling revenues and costs

80 Question 4 An investment center is responsible for: Answer:
Investing in long term assets Controlling costs Generating revenues All of the above Answer: d. All of the above

81 Question 5 Absorption Costing: Answer: d. Ignores all fixed costs
Is a better way to evaluate cost centres. Includes variable and fixed manufacturing costs B and c are correct. Answer: d.

82 Question 6 Gross Profit is defined as Answer: a.
Sales less cost of sales Sales less purchases Sales less overheads Answer: a.

83 Question 7 Contribution is another expression of?: Answer:
Net Profit EBIT Gross Profit Answer: c. It is the management accounting expression for gross profit

84 Question 8 Why should be distinguish between Traceable and non traceable costs?: To ensure we can correctly allocate costs To divide up Variable costs To divide up fixed costs All above are correct Answer: d.

85 Question 9 Standard Costing is creating?: Answer: d.
A forecasted summary of expected costs A tool for evaluating performance Reveals a variance when actual is compared to forecasted. All the above are correct Answer: d.

86 Question 10 A variance shows?: Answer: d.
Either a Favourable or Unfavourable departure from Budgeted activity. A tool for evaluating performance Enables management by exception. All the above are correct Answer: d.

87 Question 11 Marginal Costing?: Answer: b.
Takes only the costs that vary with production. Takes the variable and fixed costs that are traceable to production. Only takes the Fixed costs. Answer: b.

88 Question 12 Absorption Costing?: Answer: c.
Takes all costs both variable and fixed. Is a good management tool as it allocates all costs to the product. Both a and b are correct Answer: c.

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