Learning Objective 1 Identify the major differences and similarities between financial and managerial accounting.

Basics Managerial accounting concepts are most relevant for manufacturing companies, although it can be applied to merchandising and service companies, as well. Reports are prepared mainly for internal use and decision-making No required format; in whatever is desired by management

Comparison of Financial and Managerial Accounting

Learning Objective 2 Identify and give examples of each of the three basic manufacturing cost categories.

The Product Direct Materials Direct Labor Manufacturing Overhead Manufacturing Costs

Direct Materials Raw materials that become an integral part of the product and that can be conveniently traced directly to it. Example: A radio installed in an automobile

Direct Labor Those labor costs that can be easily traced to individual units of product. Example: Wages paid to automobile assembly workers

Manufacturing costs that cannot be traced directly to specific units produced. Manufacturing Overhead Examples: Indirect materials and indirect labor Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards. Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Other cost considerations 1. Product vs period costs 2. Differences in the current assets of a merchandising company and a manufacturing company 3. Presentation of the income statement under various considerations 4. Variable and fixed costs 6. Cost classifications for predicting cost behavior 7. Direct and indirect costs 8. Cost-Volume-Profit analysis 8. Variable costing and absorption costing

Product Costs Versus Period Costs Product costs include direct materials, direct labor, and manufacturing overhead. Period costs include all selling costs and administrative costs. Inventory Cost of Good Sold Balance Sheet Income Statement Sale Expense Income Statement

Quick Check Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions.

Cost classifications for predicting cost behavior How a cost will react to changes in the level of activity within the relevant range.  Total variable costs change when activity changes.  Total fixed costs remain unchanged when activity changes.  Some costs are semi-variable or mixed. ( Relevant range is defined as the range of activity over which a company expects to operate during a year)

Cost Classifications for Predicting Cost Behavior

Mixed Costs Costs that have both a variable cost element and a fixed cost element Sometimes called semivariable cost Change in total but not proportionately with changes in activity level Illustration 18-5

Mixed or Semi-variable costs Methods of breaking the cost down into its fixed and variable components: 1.Scattergraph method 2.High-low method 3.Least-squares regression analysis 4.Multiple regression analysis

Quick Check Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.

Examples of Variable Costs 1.Merchandising companies – cost of goods sold. 2.Manufacturing companies – direct materials, direct labor, and variable overhead. 3.Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. 4.Service companies – supplies, travel, and clerical. 1.Merchandising companies – cost of goods sold. 2.Manufacturing companies – direct materials, direct labor, and variable overhead. 3.Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. 4.Service companies – supplies, travel, and clerical.

Quick Check Which of the following statements about cost behavior are true? a.Fixed costs per unit vary with the level of activity. b.Variable costs per unit are constant within the relevant range. c.Total fixed costs are constant within the relevant range. d.Total variable costs are constant within the relevant range.

Contribution format income statement The contribution margin format emphasizes cost behavior. All items in the income statement are re-classified as to fixed and variable costs. Starting item (Sales) and the bottom line (Net Income) are the same in both the traditional income statement and a contribution format income statement. The difference is how the costs in between these two items contribute to the analysis. In the latter, after all costs have been re-classified, variable costs are subtracted from total sales to arrive at the contribution margin. This margin covers fixed costs and a certain level of profit, thus the term contribution margin. (Note that some operating expenses may be variable.) As you will see, this is a very powerful analysis tool and answers “what if?” questions. The contribution margin format emphasizes cost behavior. All items in the income statement are re-classified as to fixed and variable costs. Starting item (Sales) and the bottom line (Net Income) are the same in both the traditional income statement and a contribution format income statement. The difference is how the costs in between these two items contribute to the analysis. In the latter, after all costs have been re-classified, variable costs are subtracted from total sales to arrive at the contribution margin. This margin covers fixed costs and a certain level of profit, thus the term contribution margin. (Note that some operating expenses may be variable.) As you will see, this is a very powerful analysis tool and answers “what if?” questions.

Uses of the Contribution Format The contribution income statement format is used as an internal planning and decision-making tool. This approach will be used for: 1.Cost-volume-profit analysis 2.Budgeting 3.Segmented reporting of profit data 4.Special decisions such as pricing and make-or-buy analysis. Here, we will only look at #1 above. The contribution income statement format is used as an internal planning and decision-making tool. This approach will be used for: 1.Cost-volume-profit analysis 2.Budgeting 3.Segmented reporting of profit data 4.Special decisions such as pricing and make-or-buy analysis. Here, we will only look at #1 above.

The Contribution Format The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.

The Contribution Format Used primarily for external reporting. Used primarily by management.

Basics of Cost-Volume-Profit Analysis Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted. The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume. The emphasis is on cost behavior.

Basics of Cost-Volume-Profit Analysis The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume The emphasis is on cost behavior. Example: Racing Bicycle Company Contribution Income Statement For the Month of June 2011 Sales (500 bicycles) 250,000 Less: Variable expenses 150,000 Contribution margin 100,000 Less: Fixed expenses 80,000 Net Income 20,000

Basics of Cost-Volume-Profit Analysis Suppose there is a 10% increase in sales, how would it affect net income? Racing Bicycle Company Contribution Income Statement For the Month of June bicycles Sales (500 bicycles) 250,000 $275,000 Less: Variable expenses 150, ,000 Contribution margin 100, ,000 Less: Fixed expenses 80,000 80,000 Net Income 20,000 30,000

Basics of Cost-Volume-Profit Analysis Suppose the company believes that by increasing advertising by $10,000 next month, sales would increase by 25 bicycles. Should the company spend for the additional advertising? Racing Bicycle Company Contribution Income Statement For the Month of June 2011 Sales (500 bicycles) 250,000 Less: Variable expenses 150,000 Contribution margin 100,000 Less: Fixed expenses 80,000 Net Income 20,000

CVP/Profit Graph Prepare and interpret a cost- volume-profit (CVP) graph and a profit graph.

CVP/Profit/Breakeven Graph

Use the contribution margin ratio (CM ratio) to compute changes in contribution margin and net operating income resulting from changes in sales volume.

Short problems Gayne Corporation's contribution margin ratio is 12% and its fixed monthly expenses are $84,000. If the company's sales for a month are $738,000, what is the best estimate of the company's net operating income? Assume that the fixed monthly expenses do not change. A)$565,440 B)$654,000 C)$88,560 D)$4,560

Short problems Data concerning Kardas Corporation's single product appear below: Per Unit Percent of Sales Selling price $ % Variable expenses 28 20% Contribution margin $112 80% The company is currently selling 8,000 units per month. Fixed expenses are $719,000 per month. The marketing manager believes that a $20,000 increase in the monthly advertising budget would result in a 180 unit increase in monthly sales. What should be the overall effect on the company's monthly net operating income of this change? (show shortcut). A)decrease of $160 B)increase of $20,160 C)decrease of $20,000 D)increase of $160

Variable Costing What are variable costing and absorption costing? Absorption costing is what we learned in cost accounting, i.e., consider all costs in determining unit cost ; therefore, fixed overhead manufacturing costs are product costs. Variable costing considers only variable costs; therefore, all fixed expenses are considered as period costs. (The difference is in the computation of unit product cost.)

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

Harvey Company produces a single product with the following information available: Unit Cost Computations

Unit product cost is determined as follows: Under absorption costing, all production costs, variable and fixed, are included when determining unit product cost. Under variable costing, only the variable production costs are included in product costs. Unit Cost Computations

Income Comparison of Absorption and Variable Costing Let’s assume the following additional information for Harvey Company. –20,000 units were sold during the year at a price of $30 each. –There is no beginning inventory. Now, let’s compute net operating income using both absorption and variable costing.

Absorption Costing Fixed manufacturing overhead deferred in inventory is 5,000 units × $6 = $30,000.

Variable manufacturing costs only. All fixed manufacturing overhead is expensed. Variable Costing

What is the difference between variable costing and absorption costing? The difference is only in the treatment of fixed manufacturing overhead in inventory. Why is absorption costing not appropriate in decision making? Absorption costing does not dovetail with CVP analysis, nor does it support decision making. It treats fixed manufacturing overhead as a variable cost. It assigns per unit fixed manufacturing overhead costs to production. (Explain: “fixed manufacturing overhead deferred in inventory”, and “fixed manufacturing overhead released from inventory”.) When do the net operating incomes under both approaches equal?

Quick Check Which method will produce the highest values for work in process and finished goods inventories? a. Absorption costing. b. Variable costing. c. They produce the same values for these inventories. d. It depends... Which method will produce the highest values for work in process and finished goods inventories? a. Absorption costing. b. Variable costing. c. They produce the same values for these inventories. d. It depends...