3Strategy of Management The Present The Past The Future Environmental Scanning of current product/service mixBudgetsForecastsAnnual ReportAnnual ReportAnnual Report
4The Functions of Management StrategyEvaluationPlanningPlanning – Choosing goals and deciding how to achieve themActing – carry out planControlling – evaluating results by comparing the actual results to the plan.You work for Baskin Robins – one of its goals is to increase operating incomeHow do you do it?Incr sales priceIncr sales volumeLower costsThe accounting system, by tracking costs, helps managers evaluate performanceFeedback
7Decentralized Operations Companies decentralize as they growSplit operations into different divisions or operating unitsTop management delegates decision-making to unit managersDecentralization may be based on:Geographic areaProduct lineCustomer baseBusiness functionIn 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
8Decentralization in Organizations Benefits ofDecentralizationTop managementfreed to concentrateon strategy.Lower-level managersgain experience indecision-making.Decision-makingauthority leads tojob satisfaction.Lower-level decisionoften based onbetter information.Improves ability toevaluate managers.
9Decentralization and Segment Reporting An Individual StoreA segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. A segment can be . . .Canadian TireA Sales TerritoryA Service Centre
10Advantages of Decentralization Better information leading to superior decisionsManagers can respond quicker to changing circumstancesIncreased motivation of managersProvides excellent training for future top-level executivesFrees top management time
11Disadvantages of Decentralization Costly duplication of activitiesLack of goal congruenceManagement pursues personal goalsPersonal goals are incompatible with the company’s goalsTo control goal congruence, companies evaluate the performance of subunit managers
12Advantages Outweigh Disadvantages Disadvantages of decentralizationAdvantages of decentralizationAs this picture illustrates, the many advantages of decentralization usually outweigh the disadvantages.Copyright (c) 2009 Prentice Hall. All rights reserved.12
13Reasons for evaluating subunit managers: Why Companies Evaluate the Performance of Subunits and Subunit ManagersA company evaluates subunits in order to decide if it should expand or contract them or change their operationsA company evaluates subunit managers in order to motivate them to take actions that maximize the value of the firmReasons for evaluating subunit managers:Identifies successful operations and areas needing improvementInfluences the behavior of managers
14Responsibility Accounting and Performance Evaluation Responsibility accounting is a technique that holds managers responsible only for costs and revenues that they can controlTo implement responsibility accounting in a decentralized organization, costs and revenues are traced to the organizational level where they can be controlled
16Cost, Profit, and Investment Centres centres are allknown asresponsibilitycentres.ResponsibilityCentre
17A segment whose manager has control over costs, Cost CentreA segment whose manager has control over costs,but not over revenues or investment funds.CostCostCost
18A segment whose manager has control over both costs and revenues, Profit CentreA segment whose manager has control over both costs and revenues,but no control over investment funds.SalesInterestOtherCostsMfg. costsCommissionsSalariesOther
19Investment CentreA segment whose manager has control over costs, revenues, and investments in operating assets.Corporate Headquarters
20Cost CentresParts of the business to which particular costs can be attributedIn large businesses this can be a particular location, section of the business, capital asset or human resource/sEnable a business to identify where costs are arising and to manage those costs more effectively
21Responsibility Centers Subunit of an organization whose manager is accountable for specific activitiesResponsibility CenterManager is responsible for:Cost centerControlling costsRevenue centerGenerating sales revenueProfit centerProducing profit by generating sales and controlling costsInvestment centerProducing profit and managing the division’s invested capitalDecentralized 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
24Performance Measurement When companies decentralize, top management needs a system to communicate goals to subunit managersPrimary goals:Promoting goal congruence and coordinationCommunicating expectationsMotivating unit managersProviding feedbackBenchmarkingOnce 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
25Limitations 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
27Total Revenue Total Revenue = Price x Quantity Sold Price can be raised or lowered to change revenue – price elasticity of demand important hereDifferent pricing strategies can be used – penetration, psychological, etc.Quantity Sold can be influenced by amending the elements of the marketing mix
28Manufacturing Companies: Income Statement Sales- Cost of goods soldGross profit- Operating expensesOperating incomeOpening InventoriesAdd PurchasesLess Closing InventoriesThe 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
29Manufacturing (Product) Costs Direct Manufacturing Costs are easily traced to the product. These include:Direct MaterialsDirect LaborIndirect Manufacturing Costs are not as easily traced to the product and are usually pooled together in Manufacturing Overhead (MOH)
30What is ContributionContribution is the management accounting term for gross profit.In other words, sales less the cost of goods sold.
31Contribution Contribution Margin Per Unit Contribution Margin Ratio This is Gross Profit that each unit contributes towards the general overheads and net incomeContribution Margin RatioThe contribution margin as a % of sales. (Same as Gross Profit Margin %.
37Variable CostsThese 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
39Stepped CostsThese are costs that are variable but not directly proportionate to production.Example:Rental of a warehouse. Once full, another is required so costs step up39
40Semi Variable CostsInclude a variable and fixed cost elements.40
41Budgeting & 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
48CostsAnything incurred during the production of the good or service to get the output into the hands of the customerThe customer could be the public (the final consumer) or another businessControlling costs is essential to business successNot always easy to pin down where costs are arising!
49Common Types Of Cost Behavior Fixed Costs: Costs that fundamentally are not driven by changes in volumeVariable Costs: Costs that change directly and proportionately with the volume of activitySemi Variable Costs: Costs that contain both a fixed and a variable component. Also called Semi Variable or stepped.Others
50Traceable and Common Fixed Costs Costs arise becauseof the existence ofa particular segment.Costs arise becauseof overall operatingactivities.
51Traceable and Common Fixed Costs Don’t allocatecommon costs.TraceableCommonCosts arise becauseof the existence ofa particular segment.Costs arise becauseof overall operatingactivities.
52Traceable Costs Can Become Common Costs Webber’s Television DivisionProductLinesSalesTerritories
53Inappropriate Methods of Allocating Costs Among Segments Arbitrarily dividingcommon costsamong segmentsInappropriateallocation baseFailure to tracecosts directlySegment1Segment2Segment3Segment4
55Standard Costing The forecasted expected cost per unit. Example: A ball point pen manufacturer:Cost of Plastic case pCost of Cartridge pLabour to assemble pPackaging pStandard Cost p
56Using Standard-Costing Systems for Control based on carefully predetermined amounts.Standard costs areused for planning labourand material requirements.the expected level of performance.benchmarks for measuring performance.
57Using Standard-Costing Systems for Control a budget for the production of one unit of product orserviceACTUAL COSTincurred and recorded in the production of the product or serviceCOST VARIANCEthe differencebetween theactual cost andthe standard cost
58Using Standard-Costing Systems for Control This variance is unfavorable because the actual cost exceeds the standard cost.StandardA standard cost variance is the amount by which an actual cost differs from the standard cost.Product cost
59Management by Exception Managers focus on quantities and costs that deviate significantly from standards(a practice known as management by exception).StandardAmountDirect materialsDirect laborType of Product Cost
60Management by Exception Take the time to investigate only significant cost variances.What is significant?Depends on the size of theorganizationDepends on the productionprocessDepends on the type of the organization
61Variance Analysis Cycle Take corrective actionsIdentify questionsReceive explanationsConduct next period’s operationsAnalyze variancesPrepare standard cost performance reportBegin
62Setting Standards Analysis of historical data Task analysis Combined What DIDthe productcost?Used in a matureproduction processWhatSHOULD the product cost?TaskanalysisAnalyze the processof manufacturingthe productCombinedapproachAnalyze the process for the step thathas changed, but use historical datafor the steps that have not changed
64The layman’s languageThe only cost of driving my car on a 200 mile trip today is $12 for gasoline.Marginal Costing64
65Marginal or Variable Costing Used for internal planning and decision makingDoes not include fixed factory overhead as a product cost
66Advantages of variable/marginal costing Variable costing is simple to understandIt provides more useful information for decision-makingAvoids fixed overheads being incorporated into the costs
67Disadvantages of variable/marginal costing The separation of costs into fixed and variable is difficult and sometimes gives misleading resultsIt underestimates the importance of fixed costsApplication of fixed overhead depends on estimates. There may be under or over absorption of the sameA system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costingIn 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
69No! You must consider these costs too! Absorption Costing69
70Absorption/CostingIncludes direct materials, direct labour, variable factory overhead, and allocates fixed factory overhead as part of total product cost
71Absorption costingCosting 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 costsAlso known as “Full costing”
72Absorbing OverheadsHaving 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.
73Overview of Absorption and Marginal Costing Absorption CostingMarginal CostingProduct CostsPeriod CostsDirect MaterialsDirect LaborVariable Manufacturing OverheadFixed Manufacturing OverheadVariable Selling and Administrative ExpensesFixed Selling and Administrative ExpensesProduct CostsPeriod Costs73
74SummaryVariable/Marginal Costing Solves the Forecasting Problem in PricingVariable/Marginal Costing focuses on Variable and Incremental CostsWith Variable/Marginal Costing you will be able to calculate:Floor PriceOut of Pocket PriceBreak Even PriceTarget Profit PriceMost profitable sales mixProfitable Sales Strategies
77Question 1 An investment center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above
78Question 2 An cost center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:b Controlling Costs
79Question 3 An profit center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesB and CAnswer:d. Controlling revenues and costs
80Question 4 An investment center is responsible for: Answer: Investing in long term assetsControlling costsGenerating revenuesAll of the aboveAnswer:d. All of the above
81Question 5 Absorption Costing: Answer: d. Ignores all fixed costs Is a better way to evaluate cost centres.Includes variable and fixed manufacturing costsB and c are correct.Answer:d.
82Question 6 Gross Profit is defined as Answer: a. Sales less cost of salesSales less purchasesSales less overheadsAnswer:a.
83Question 7 Contribution is another expression of?: Answer: Net ProfitEBITGross ProfitAnswer:c. It is the management accounting expression for gross profit
84Question 8Why should be distinguish between Traceable and non traceable costs?:To ensure we can correctly allocate costsTo divide up Variable costsTo divide up fixed costsAll above are correctAnswer:d.
85Question 9 Standard Costing is creating?: Answer: d. A forecasted summary of expected costsA tool for evaluating performanceReveals a variance when actual is compared to forecasted.All the above are correctAnswer:d.
86Question 10 A variance shows?: Answer: d. Either a Favourable or Unfavourable departure from Budgeted activity.A tool for evaluating performanceEnables management by exception.All the above are correctAnswer:d.
87Question 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.
88Question 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 correctAnswer:c.