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15/11/2016 Lecture 7 Management accounting in SMEs: an introduction ACCOUNTING AND GOVERNANCE IN SMES PROF. ENRICO BRACCI Managerial Accounting Managerial accounting is designed for internal users The goal of Managerial Accounting is to provide the information managers need for Planning Control Decision making Overall it steers/influence organizational and individual behavior Prof. Enrico Bracci 2 1 15/11/2016 Planning Budgets for planning Profit budget - Indicates planned income Cash flow budget - Indicates planned cash inflows and outflows Production budget - Indicates the planned quantity of production and expected costs Prof. Enrico Bracci 3 Control Organizations achieve control by: Evaluating managers to determine how their performance should be rewarded or not Evaluating operations to provide information as to whether they should be changed or not Prof. Enrico Bracci 4 2 15/11/2016 Planning and Control Process Strategic Operational Prof. Enrico Bracci 5 Managerial vs Financial Accounting Unlike Financial Accounting, Managerial Accounting: Is directed at internal users May deviate from accounting standards OIC/IFRS/GAAP) Presents more detailed information May present more nonmonetary information Places more emphasis on the future Prof. Enrico Bracci (ex. 6 3 15/11/2016 Cost Terminology Variable Costs - Change in proportion to changes in volume or activity Prof. Enrico Bracci 7 Cost Terminology Fixed Costs - Do not change in response to changes in volume or activity Prof. Enrico Bracci 8 4 15/11/2016 Cost Terminology Direct and indirect costs - Direct costs are directly traceable to a product, activity, or department - Indirect costs are not traceable and are allocated through certain criteria Controllable & noncontrollable costs - A manager can influence controllable costs but cannot influence non- controllable costs Prof. Enrico Bracci 9 Direct and Indirect Cost But, how and through which criteria? Prof. Enrico Bracci 10 5 15/11/2016 Purposes of Cost Allocation Prof. Enrico Bracci 11 Cost Terminology Differential cost: is the difference between the cost of two alternative decisions, or of a change in output levels. The concept is used when there are multiple possible options to pursue, and a choice must be made to select one option and drop the others. Within this category: a) Sunk Costs - Costs incurred in the past, not modifiable in the short term - Not relevant to present decisions b) Opportunity Costs - Values of benefits foregone when selecting one alternative over another Prof. Enrico Bracci 12 6 15/11/2016 In the past year, Williams Mold & Machine had sales of $8,000,000 and total production costs of $6,000,000. In the coming year, the company believes that production can be increased by 30%, but this will require adding a second shift to work from 4:00 pm to 1:00 am. 1. Indicate three production costs that are likely to increase because of adding a second production shift. Material costs, workers’ salaries, and benefits are all likely to increase. Prof. Enrico Bracci 13 In the past year, Williams Mold & Machine had sales of $8,000,000 and total production costs of $6,000,000. In the coming year, the company believes that production can be increased by 30%, but this will require adding a second shift to work from 4:00 pm to 1:00 am. 2. What production cost most likely will not increase when the second shift is added? Depreciation of the building will not increase. It can be considered a sunk cost Prof. Enrico Bracci 14 7 15/11/2016 Differential/Incremental Analysis Incremental analysis: Differences in revenues and costs between alternatives are incremental Incremental revenue minus incremental cost equals incremental profit Prof. Enrico Bracci 15 Control is important but… Prof. Enrico Bracci 16 8 15/11/2016 You Get What you Measure Performance measures greatly influence the behavior of managers Prof. Enrico Bracci 17 You Get What you Measure Prof. Enrico Bracci 18 9 15/11/2016 Control is important but…… Prof. Enrico Bracci 19 Production types and consequences on cost of product/service Prof. Enrico Bracci 20 10 15/11/2016 Merchandising and Manufacturing Firms Prof. Enrico Bracci 21 Manufacturing Costs Direct Materials - Cost of materials directly traceable to items produced -Materials not directly traceable are indirect materials Direct Labor - Cost of labor directly traceable to items produced - Labor costs not directly traceable are indirect labor Manufacturing Overhead - Cost of manufacturing activities other than direct materials and direct labor Prof. Enrico Bracci 22 11 15/11/2016 Common Manufacturing Overhead Costs Prof. Enrico Bracci 23 Non-manufacturing Costs Selling Costs - Costs associated with securing and filing customer orders e.g. advertising, sales salaries, depreciation of sales equipment General and Administrative Costs - Costs associated with the firm’s general management e.g. Human resources, accounting, corporate headquarters and other support costs Prof. Enrico Bracci 24 12 15/11/2016 Product and Period Costs Product Costs - Costs assigned to goods produced (i.e. direct materials, direct labor, and manufacturing OH) - Included in inventory until goods sold Period Costs - Costs identified with accounting periods (i.e selling and administrative expenses) - Expensed in period incurred Prof. Enrico Bracci 25 Relationships among Cost Categories Prof. Enrico Bracci 26 13 15/11/2016 Balance Sheet Presentation of Product Costs Eastlake Motorboat Company Partial Balance Sheet As of December 31, 2009 Assets Cash Accounts receivable Inventory Raw Material Work in Process Finished Goods Equipment(net) Total assets Prof. Enrico Bracci $20,000 40,000 Raw materials inventory includes cost of materials on hand Work in includes completed $50,000 100,000 60,000 210,000 $480,000 process goods inventory partially Finished goods inventory includes cost of items ready for sale 27 Income Statement Presentation of Product Costs Prof. Enrico Bracci 28 14 15/11/2016 Income Statement Presentation of Product Costs Prof. Enrico Bracci 29 Beginning work-in-process plus total manufacturing costs minus ending work-in-process equals? a. b. c. d. Cost of materials used Finished goods inventory Cost of goods manufactured Cost of goods sold Answer: d. Cost of goods manufactured Prof. Enrico Bracci 30 15 15/11/2016 Cost of Goods Manufactured is $200,000, beginning Finished Goods is $50,000, ending Finished Goods is $100,000, and ending Work in Process is $10,000. What is the Cost of Goods Sold? a. $100,000 b. $250,000 c. $50,000 d. $150,000 Answer: d. $150,000 (50,000 + 200,000 – 100,000) Prof. Enrico Bracci 31 Job-Order Costing Job Order Costing Companies produce goods to a customer’s unique specifications e.g. construction, shipping The cost of job is unique Cost of job accumulated on job cost sheet Prof. Enrico Bracci 32 16 15/11/2016 Job-Order Costing System Prof. Enrico Bracci 33 Job Costs – Manufacturing Overhead Apply manufacturing overhead to jobs: • Choose an allocation base e.g. direct labor hours or direct labor cost • Calculate overhead allocation rate as: Estimated overhead /estimated quantity of the allocation base • Use rate to apply overhead to jobs based on actual quantity of base used Prof. Enrico Bracci 34 17 15/11/2016 Lollah Mfg Company expects annual mfg. overhead to be $800,000, 50,000 direct labor hours costing $1,600,000 and machine run time of 25,000 hours. Calculate overhead allocation rates based on direct labor hours, direct labor cost, and machine time. OH allocation rate (Direct labor): $800,000/ 50,000 = $16 per direct labor hour OH allocation rate (Direct labor cost): $800,000 / $1,600,000 = 50% of direct labor cost OH allocation rate (MH): $800,000 / 25,000 = $32 per machine hour Prof. Enrico Bracci 35 Job Cost Sheet Prof. Enrico Bracci 36 18 15/11/2016 Allocating Overhead to Jobs Most firms use a single overhead rate Activity Based Costing (ABC) assigns overhead costs to products using a number of allocation bases: -The major activities which create overhead costs are identified and grouped (pools) -Multiple rates calculated by dividing each pool by its corresponding activity (driver) Prof. Enrico Bracci 37 Allocating Overhead to Jobs Predetermined Overhead Rates: • Utilize estimates rather than actual costs and quantities • Allows decisions to be made based on budgeted amounts Prof. Enrico Bracci 38 19 15/11/2016 Process Costing • Companies produce large quantities of identical items e.g. producers of paints and plastics • Cost accumulated by each production operation, not for a single unit • Unit cost of items determined dividing costs of production by number of units produced Prof. Enrico Bracci 39 Process Costing System Prof. Enrico Bracci 40 20 15/11/2016 Cost Flows through Departments Manufacturing operations typically pass through two or more production departments Costs are accumulated in each department Easy to identify when materials are added Harder to identify when labor and overhead are added -Often grouped together as conversion costs -Assumed to be added evenly Prof. Enrico Bracci 41 Flow of Costs Between Processing Departments Prof. Enrico Bracci 42 21 15/11/2016 Calculating Unit Cost Equivalent Units Equivalent units is the result of: Units completed + Ending work in process Ending work in process units need to be converted to a comparable number of completed units, called equivalent units e.g. 100 units that are 50% complete are equivalent to 50 complete units (100 x 50%) Equivalent units may be different for material and conversion costs if materials and conversion costs enter production at different times. Prof. Enrico Bracci 43 Equivalent Units – Material and Conversion Costs Prof. Enrico Bracci 44 22 15/11/2016 Calculating Unit Cost Cost Per Equivalent Unit: The average unit cost is referred to as cost per equivalent unit Prof. Enrico Bracci 45 Beginning Work in Process 500 units % complete = 65% materials, 45% conversion Units started: 2,300 Units finished: 2,500 Ending Work in Process 300 units % complete = 85% materials, 50% conversion 1. Calculate equivalent units for materials Units finished Ending Work in Process Equivalent Units - Materials Prof. Enrico Bracci 2,500 X 100% 300 X 85% 2,500 255 2,755 46 23 15/11/2016 Beginning Work in Process 500 units % complete = 65% materials, 45% conversion Units started: 2,300 Units finished: 2,500 Ending Work in Process 300 units % complete = 85% materials, 50% conversion 2. Calculate equivalent units conversion Units finished 2,500 X 100% Ending Work in Process 300 X 50% Equivalent Units - Conversion Costs Prof. Enrico Bracci 2,500 150 2,650 47 Equivalent units(EU): Materials =2,755EU, conversion=2,650EU Costs in beginning Work in Process Materials = $3,180, conversion = $3,306 Costs incurred: Materials = $18,020, conversion = $13,224 1. Calculate materials cost/equivalent unit Costs in beginning WIP 3.180 Materials costs incurred 18.020 Total materials cost 21.200 $21,200 / 2,755 EU Prof. Enrico Bracci 7,695 per EU 48 24 15/11/2016 Equivalent units(EU): Materials =2,755EU, conversion=2,650EU Costs in beginning Work in Process Materials = $3,180, conversion = $3,306 Costs incurred: Materials = $18,020, conversion = $13,224 2. Calculate conversion cost/equivalent unit Costs in beginning WIP Conversion costs incurred Total materials cost $21,200 / 2,650 EU Prof. Enrico Bracci 3.306 13.224 16.530 6,238 per EU 49 Equivalent units(EU): Materials =2,755EU, conversion=2,650EU Costs in beginning Work in Process Materials = $3,180, conversion = $3,306 Costs incurred: Materials = $18,020, conversion = $13,224 3. Calculate total manufacturing cost per unit Material unit cost Conversion unit costs Total Unit cost Prof. Enrico Bracci 7,695 6,238 13,93 50 25 15/11/2016 Calculating Cost per Equivalent Unit Mixing Department Beginning Work in Process: 80% complete -Direct material costs = $18,000 -Direct labor =$7,800 -Overhead = $23,400 60,000 gallons completed, 20,000 ending work in process (100% complete for Direct material, 50% complete Direct labor and overhead). -Direct material costs = $142,000 -Direct labor cost = $62,200 - Overhead cost = $186,600 Prof. Enrico Bracci 51 Cost per EU – Mixing Department Prof. Enrico Bracci 52 26 15/11/2016 Costs Transferred Out • 60,000 gallons completed by the Mixing Department • Unit cost is $6 per gallon • $360,000 (60,000 X $6) of cost transferred to the Packaging Department Prof. Enrico Bracci 53 Ending Work in Process Prof. Enrico Bracci 54 27 15/11/2016 Summary of Cost Activity – Mixing Department Prof. Enrico Bracci 55 Basic Steps in Process Costing Step 1: Account for the number of physical units Step 2: Calculate the cost per equivalent unit for materials, labor, and overhead Step 3: Assign cost to items completed and items in ending Work in Process Step 4: Account for the amount of product cost Prof. Enrico Bracci 56 28 15/11/2016 Readings Jiambalvo, J. (2015), Management accounting, Wiley&Sons, parts of Ch 2 and 3 Additional Reading Jiambalvo, J. (2015), Management accounting, Wiley&Sons, Ch 1 Prof. Prof. Enrico Enrico Bracci Bracci 57 29