MANAGERIAL ACCOUNTING – INTRODUCTION

FINANCIAL ACCOUNTING

• FA is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof.

• Reporting to External Parties

MANAGEMENT/COST ACCOUNTING• In ordinary language, any system of accounting which assists

management in carrying out its functions more efficiently may be termed as Management Accounting.

• MA measures, analyses and reports Financial & Non-financial information that helps managers make decisions to fulfill organisation’s goal.

• Cost Accounting provides information for MA and FA. (e.g. Cost of the product)

• CA measures, analyses and reports Financial & Non-financial information relating to the cost of acquiring or using resources in an organisation.

• Modern CA perspective.

FA v/s MA• Users• Purpose of Information• Overall v/s Detailed Reporting• Periodicity• Following Regulations• Type of Information• Preciseness - Approximations

COST CONCEPT AND TERMINOLOGY• Cost – Resource sacrificed or forgone to achieve a specific

objective.

• Cost Accumulation – Collection of Cost Data in some organized way by means of an accounting system.

• Cost Object – Anything for which a measurement of cost is desired.

• Cost Unit - A unit of product, service or time (or combination of these) in relation to which costs may be ascertained or expressed.

• Cost Drivers - A "cost driver" is the unit of an activity that causes the change of an activity cost. A cost driver is any activity that causes a cost to be incurred.

COST DRIVER EXERCISE

FUNCTION REPRESENTATIVE COST DRIVER

A. Accounting 1. No. of computer transactions

B. Personnel 2. No. of invoices sent

C. Data Processing 3. No. of Research Scientists

D. R & D 4. No. of transactions processed

E. Purchasing 5. No. of new hires

F. Billing 6. No. of Purchase Orders

• Responsibility Center - A division or unit of an organization for which a manager is held responsible – may be a cost center, revenue center, profit center or investment center.

• Cost Center – manager is accountable for costs only.

• Revenue Center – manager is accountable for revenues only.

• Profit Center - manager is accountable for revenues & costs.

• Investment Center - manager is accountable for investments, revenues & costs.

CLASSIFICATION OF COSTS1. Acc. to ELEMENTS:- Direct & Indirect according to

elements viz, Material, Labour & Other Expenses.

2. Acc. to FUNCTIONS/OPERATIONS:- Production, Administration, Selling, Distribution, Research, Development.

3. Acc. to NATURE/BEHAVIOUR:- Fixed, Variable, Semi-variable/Step/Mixed.

4. Acc. to CONTROLLABILTY:-

Discuss COST ALLOCATION & COST ABSORPTION Controllable & Uncontrollable

5. Acc. to ASSOCIATION WITH PRODUCT:- Product & Period

Product Costs: - are those costs which are associated with & directly identified with the product . Cost that are included in the cost of manufacturing a product.

Period Costs:- are those that are reported as expenses of the period in question. These are costs which are not assigned to the product but are charged against revenue of the period in which they are incurred.

Eg:- administration exps., selling & distribution exps.

OVERHEADS

PRODUCTION / WORK OVERHEADS

ADMINISTRATION OVERHEADS

SELLING OVERHEADS

DISTRIBUTION OVERHEADS

OTHER MANUFACTURING COSTS• Overtime Premium: -

The extra compensation paid to an employee who works beyond the time normally scheduled.

• Idle Time: -Time that is not spent productively by an employee due to events such as equipment breakdowns, power failure.

COST CLASSIFICATION EXERCISEABC Entertainment Co. operates a large store in Mumbai. The store has both

Video & Music section. ABC reports revenues for the video section separately from the music section. Classify each of the following cost items as:-

1. Direct or Indirect costs w.r.t. the total no. of videos sold.2. Variable or Fixed costs w.r.t. how the total cost of video section

change as the total no. of videos are sold changes.

Cost Items: - a) Annual retainer paid to video distributorb) Electricity costs of ABC store (single bill covers entire store)c) Costs of videos purchased for sale to customersd) Subscription to video trends maganizee) Leasing of computer software used for financial budgeting at ABC storef) Cost of popcorn provided free to all customers of the storeg) Insurance policy for the storeh) Transportation costs of videos purchased by the store

COST TRACING, ALLOCATION & ABSORPTION

COST TRACING: - defined as the assignment of DIRECT COSTS to the chosen cost object.

COST ALLOCATION:- defined as the assignment of INDIRECT COSTS to the chosen cost object.

COST ABSORPTION: - defined as the process of absorbing all INDIRECT COSTS ALLOCATED to or APPORTIONED over a particular cost centre or production department by the units produced.

• Hence, while allocating, the relevant cost objects would be the concerned cost centre or the concerned department, while, the process of absorption would consider the units produced as the relevant cost object.

• Cost Absorption can take place only after Cost Allocation.

• DIFFERENTIAL COSTS (INCREMENTAL OR DECREMENTAL COSTS): - The amount by which the cost differs under two alternative actions.

• CAPITALISED COSTS: - These are costs which are initially recorded as assets and subsequently treated as expenses.

• OPPORTUNITY COSTS: - This cost refers to the benefit that is sacrificed when choice of one action precludes taking an alternative course of action.

• SHUT DOWN COSTS: - Those costs, which continue to be, incurred even when a plant is temporarily shutdown. All fixed costs, which cannot be avoided during the temporary closure of a plant, will be known as shut down costs.

• SUNK COSTS: - Historical costs incurred in the past are known as sunk costs. They play no role in decision making in the current period.

• OUT OF POCKET COSTS: -Those that require the payment of cash or other assets as a result of their incurrence.

• MARGINAL COST: -The extra cost that is incurred when one additional unit is produced.

• AVERAGE/UNIT = Total Cost .

COST No. of units manufactured

The following costs are incurred by the Loan Dept. of a Bank. For each cost, indicate which of the following classifications best describe the cost. More than one classification may apply to the same cost item.

Cost Classifications: -• Controllable by the Loan Dept. Manager• Uncontrollable by the Loan Dept. Manager• Direct Cost of the Loan Dept.• Indirect Cost of the Loan Dept.• Differential Cost• Marginal Cost• Opportunity Cost• Sunk Cost

COST CLASSIFICATION EXERCISE

Cost Item C/U D/I Dif. M Op. S

1 Salary of the Loan Dept. Manager

2 Cost of office supplies used in the Loan Dept.

3 Cost of the dept.’s PCs purchased by the Loan Dept. Manager last year

4 Cost of general advertising by the Bank, which is allocated to the Loan Dept.

5 Revenue that the Loan Dept. would have generated for the Bank if a branch loan office had been located in a posh locality instead of a village

6 Difference in the cost incurred by the Bank when one additional loan application is processed.

THREE DOG BAKERY – Understanding Cost Terms“Going to the Dogs” has been good for Mark Beckloff & Dan Dye. Back in 1989, they founded the first bakery just for four legged canine friends with little more than the desire to satisfy the finicky palate of their beloved 114-pound, deaf Great Dane, Gracie.

The small venture has grown from a single store in downtown Kansas City to more than 40 locations worldwide, including Japan & Korea. Their dog treats are made from wholesome ingredients such as flour, eggs, carrots, spinach, peanut butter, & carob, & have clever names such as Rollovers, Pup Tarts, Scottie Biscottis, & Great Danish. Some treats are even frosted with honey-yogurt icings & decorated with colourful, edible flourishes. Special-occasion carrot or carob cakes can be personalized by an in-store pastry chef. The company regularly updates its 100+ product line to entice dog lovers everywhere back to the stores again & again. Selling prices range from a few cents for a small biscuit to more than $20 for a special-order cake.

Three Dog Bakery has an 80,000 Sq. Ft. warehouse in Kansas City, containing manufacturing, distribution & corporate offices, that prepares 70 % of the goods sold.

Except for slow summer months, the manufacturing operation runs 24 hours a day, 7 days in a week, producing baked biscuits & carob-dipped items that can pack & ship well. There is one main assembly-line with stations for mixing ingredients, mechanized cutting of shapes, extruding doughnut-shaped biscuits, placing biscuits on baking sheets, baking in ovens, cooling, carob-dipping (for selected biscuits), hand packing into trays or containers, shrink-wrapping & boxing. Most trays hold 12 specialty biscuits that are hand-packed. A conveyor belt is used for automated packing of small biscuits into 7-ounce tubs. Employees are cross-trained to perform multiple assembly-line functions & can work on every type of product produced at the plant.

For remaining 30 % of finished goods, each store has specially outfitted kitchen used for preparing cakes, brownies, tarts & other delicate or frosted items. Prepackaged mixes created back at the production facility are used to assure consistent quality across all stores. The retail outlets also sell nonfood products such as bowls, leashes, books, mugs & T-shirts. Some stores even host “yappie hours” & in-store birthday parties for dog socialization. Customers don’t have to visit a Three Dog Bakery to enjoy the treats, however. The company has a whimsical Web site at www.threedog.com that is home to the “dogalog” (well, it can’t be called a “cat-alog,” can it?).

The site features all kinds of treats available for immediate shipping & accounts for 10 % of the company’s business now. In addition to its retail & e-commerce channels, Three Dog Bakery places heavy emphasis on its expanding wholesale business. The products were originally offered through national chains, such as PetsMart & Target, but are now finding success with high-end grocery stores that have lost much of their pet business to “big box” specialty pet stores & want a higher-end quality product to offer their shoppers. Even Wal-Mart can’t ignore the appeal of Three Dog Bakery products. Dog lovers can find Lick ‘n Crunch Cookies on the shelves there.

Annual revenues exceed $20 million for this privately held company. As for the pet market itself, there are more than 60 million pet dogs in the United States alone, with nearly every owner buying anywhere from one to five packages of treats per month. Two-thirds of pet owners give their pets gifts, more than half give Christmas presents, & 25 % give birthday gifts. Pet owners spend in excess of $20 billion each year in industry that includes animal products, food & services. Owners who spend more than $300 per year on their dogs tend to be younger, more affluent, married & have no children.

QUESTIONS1. To what cost objects Three Dog Bakery trace its costs?2. Classify the following items as Direct / Indirect & Fixed / Variable w.r.t. the

Production Dept.Cost Item D/I F/V

a) Salary of the Production Dept. Manager who oversees manufacturing

b) Salaries of founders Dan Dye & Mark Beckloff

c) Cardboard trays used to package sets of specialty biscuits

d) Salary of the Web graphics designer who prepares the online dogalog illustrations & layout

e) Annual maintenance service agreement for the conveyor belt

f) Wages paid to assembly line workers who mix Scotti Biscotti ingredients in batches

g) Utilities (water, electricity, waste) for the entire Kansas City warehouse

h) Cost of flour, eggs, & honey-yogurt icing for Pup Tarts

3. What sectors – manufacturing, merchandising, or service – does Three Dog Bakery operate in? Why are they classified this way?

4. When Wal-Mart purchases Lick ‘n Crunch Cookies for sale in its stores, is the purchase considered a period cost or an inventoriable cost? Why? What costs can Wal-Mart include as part of the purchase cost?