7 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 7
8 Decentralization in Organizations Benefits of Decentralization Top management freed to concentrate on strategy. Top management freed to concentrate on strategy. Lower-level managers gain experience in decision-making. Lower-level managers gain experience in decision-making. Decision-making authority leads to job satisfaction. Decision-making authority leads to job satisfaction. Lower-level decision often based on better information. Lower-level decision often based on better information. Improves ability to evaluate managers. Improves ability to evaluate managers.
9 Decentralization and Segment Reporting segment 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 An Individual Store 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 companys goals To control goal congruence, companies evaluate the performance of subunit managers
12 Copyright (c) 2009 Prentice Hall. All rights reserved. Advantages of decentralization Disadvantages of decentralization 12
13 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 Responsibility Centre Responsibility Centre Cost Centre Cost Centre Profit Centre Profit Centre Investment Centre Investment Centre Cost, profit, and investment centres are all known as responsibility centres.
17 Cost Centre A segment whose manager has control over costs, but not over revenues or investment funds. Cost
18 Profit Centre A segment whose manager has control over both costs and revenues, but no control over investment funds. Revenues 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 Subunit of an organization whose manager is accountable for specific activities Copyright (c) 2009 Prentice Hall. All rights reserved. Responsibility Center Manager is responsible for: Cost centerControlling costs Revenue centerGenerating sales revenue Profit centerProducing profit by generating sales and controlling costs Investment center Producing profit and managing the divisions invested capital 21
24 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 Copyright (c) 2009 Prentice Hall. All rights reserved.24
25 Financial Accounting measures tend to be lag indicators After the fact Management Accounting are lead indicators Before the fact 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
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 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.
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.
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.
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
40 Semi Variable Costs Include a variable and fixed cost elements.
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 Chapter 10 Operating Budget
43 Chapter 10 Financial Budget
44 Chapter 10 Budget Objectives
45 Chapter 10 Budget Cycle
46 COSTING Cost accounting system provides information about cost Aim : best use of resources and maximization of returns
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 Fixed Costs TraceableCommon Costs arise because of the existence of a particular segment. Costs arise because of overall operating activities.
51 Traceable and Common Fixed Costs Fixed Costs Traceable Common Costs arise because of the existence of a particular segment. Costs arise because of overall operating activities. Dont allocate common costs.
52 Traceable Costs Can Become Common Costs ProductLines SalesTerritories Webbers Television Division
53 Inappropriate Methods of Allocating Costs Among Segments Segment 3 Segment 4 Failure to trace costs directly Arbitrarily dividing common costs among segments Inappropriate allocation base Segment 2 Segment 1
54 Costing Methods
55 Standard Costing The forecasted expected cost per unit. Example: A ball point pen manufacturer: Cost of Plastic case 0.07p Cost of Cartridge 0.04p Labour to assemble 0.15p Packaging 0.01p Standard Cost 0.27p
56 benchmarks for measuring performance. the expected level of performance. used for planning labour and material requirements. Standard costs are based on carefully predetermined amounts. Using Standard-Costing Systems for Control
57 STANDARD COST a budget for the production of one unit of product or service STANDARD COST 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 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 COST VARIANCE the difference between the actual cost and the standard cost Using Standard-Costing Systems for Control
58 Product cost Standard A standard cost variance is the amount by which an actual cost differs from the standard cost. This variance is unfavorable because the actual cost exceeds the standard cost. Using Standard-Costing Systems for Control
59 Direct materials Managers focus on quantities and costs that deviate significantly from standards (a practice known as management by exception). Type of Product Cost Amount Direct labor Standard Management by Exception
60 Take the time to investigate only significant cost variances. What is significant? Depends on the size of the organization Depends on the size of the organization Depends on the type of the organization Depends on the production process Depends on the production process Management by Exception
61 Prepare standard cost performance report Conduct next periods operations Analyze variances Identify questions Receive explanations Take corrective actions Begin Variance Analysis Cycle
62 Analysis of historical data Analysis of historical data Task analysis Task analysis Used in a mature production process Used in a mature production process Analyze the process of manufacturing the product Analyze the process of manufacturing the product What DID the product cost? What DID the product cost? What SHOULD the product cost? What SHOULD the product cost? Combined approach Combined approach Analyze the process for the step that has changed, but use historical data for the steps that have not changed Analyze the process for the step that has changed, but use historical data for the steps that have not changed Setting Standards
63 Marginal Costing
64 The laymans language The only cost of driving my car on a 200 mile trip today is $12 for gasoline. Marginal Costing
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
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 Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Marginal Costing Absorption Costing Product Costs Period Costs Product Costs Period Costs
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: a. Investing in long term assets b. Controlling costs c. Generating revenues d. All of the above Answer: d. All of the above
78 Question 2 An cost center is responsible for: a. Investing in long term assets b. Controlling costs c. Generating revenues d. All of the above Answer: b Controlling Costs
79 Question 3 An profit center is responsible for: a. Investing in long term assets b. Controlling costs c. Generating revenues d. B and C Answer: d. Controlling revenues and costs
80 Question 4 An investment center is responsible for: a. Investing in long term assets b. Controlling costs c. Generating revenues d. All of the above Answer: d. All of the above
81 Question 5 Absorption Costing: a. Ignores all fixed costs b. Is a better way to evaluate cost centres. c. Includes variable and fixed manufacturing costs d. B and c are correct. Answer: d.
82 Question 6 Gross Profit is defined as a. Sales less cost of sales b. Sales less purchases c. Sales less overheads Answer: a.
83 Question 7 Contribution is another expression of?: a. Net Profit b. EBIT c. 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?: a. To ensure we can correctly allocate costs b. To divide up Variable costs c. To divide up fixed costs d. All above are correct Answer: d.
85 Question 9 Standard Costing is creating?: a. A forecasted summary of expected costs b. A tool for evaluating performance c. Reveals a variance when actual is compared to forecasted. d. All the above are correct Answer: d.
86 Question 10 A variance shows?: a. Either a Favourable or Unfavourable departure from Budgeted activity. b. A tool for evaluating performance c. Enables management by exception. d. All the above are correct Answer: d.
87 Question 11 Marginal Costing?: a. Takes only the costs that vary with production. b. Takes the variable and fixed costs that are traceable to production. c. Only takes the Fixed costs. Answer: b.
88 Question 12 Absorption Costing?: a. Takes all costs both variable and fixed. b. Is a good management tool as it allocates all costs to the product. c. Both a and b are correct Answer: c.