Managerial Accounting Overview:

Group Members:
Muhammad Adeel Rana

Nawazish Mehdi Zaidi

Asad Omer Khan

What is Managerial Accounting?
 Managerial accounting is the process of identifying,
measuring, analyzing, interpreting and
communicating information for the pursuit of an
organization's goals.
 The key difference between managerial and financial
accounting is managerial accounting information is
aimed at helping managers within the organization
make decisions, while financial accounting is aimed at
providing information to parties outside the
organization.
 Basic Managerial accounting
Terminologies:
 Cost – sacrificed resource to achieve a specific
objective

 Actual Cost – a cost that has occurred

 Budgeted Cost – a predicted cost

 Cost Object – anything of interest for which a cost is

desired

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 Basic Cost Terminology:
 Cost Accumulation – a collection of cost data in an
organized manner

 Cost Assignment – a general term that includes

gathering accumulated costs to a cost object

 Cost Driver – a variable that causally affects costs over

a given time span

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Direct and Indirect Costs:
 Direct Costs – can be conveniently and economically
traced (tracked) to a cost object.

 Indirect Costs – cannot be conveniently or

economically traced (tracked) to a cost object. Instead
of being traced, these costs are allocated to a cost
object in a rational and systematic manner.

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 Cost Behavior:
 Variable Costs – changes in total in proportion to changes
in the related level of activity or volume
For example, a bike factory would classify bicycle tire costs as
a variable cost. Every bike that is produced must have two
tires. The more units produced, the more tire costs
increase.

 Fixed Costs – remain unchanged in total regardless of

changes in the related level of activity or volume
 An example of a fixed cost is rent. It doesn’t matter how
many units the assembly line produces. The rent expense
will always be the same.
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 Types of Inventories:
 Direct Materials – resources in stock and available for
use
 Work-in-Process (or progress) – products started
but not yet completed.

 Finished Goods – products completed and ready for

sale

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Distinctions Between Costs:
 Inventoriable Costs – product manufacturing costs.
These costs are capitalized as assets (inventory) until
they are sold and transferred to Cost of Goods Sold

 Period Costs – have no future value and are expensed

as incurred

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Cost Volume Profit analysis:
 CVP analysis assists managers in understanding the
behavior of a product’s or service’s total costs, total
revenues, and operating income as changes occur in
the output level, selling price, variable costs, or fixed
costs.
 Cost Volume Profit (CVP analysis), also commonly
referred to as Break Even Analysis, is a way for
companies to determine how changes in costs
(both variable and fixed) and sales volume affect a
company’s profit.
 With this information, companies can better
understand overall performance by looking at how
many units must be sold to break even or to reach a
certain profit threshold or the margin of safety.
CVP in decision making:
 Managers compare how revenues, costs, and
contribution margins change across various
alternatives. They then choose the alternative that
maximizes operating income.
Breakeven point:
 The breakeven point is the quantity of output at which
total revenues equal total costs.
 The three methods for computing the breakeven point
and the quantity of output to achieve target operating
income are :
1. Equation method
2. Contribution margin method
3. Graph method.
 Cost Functions:
 A cost function is a mathematical representation of
how a cost changes with changes in the level of an
activity relating to that cost
The Linear Cost Function
y = a + bX
The Dependent The Independent
Variable: Variable:
The cost that is The cost driver
being predicted

The Slope of
The Intercept: the Line:
Fixed costs Variable cost
per unit
Cost Estimation Methods
1. Industrial Engineering Method
2. Conference Method
3. Account Analysis Method
4. Quantitative Analysis Methods
1. High-Low Method
2. Regression Analysis
Costing System:
 The building-block concepts of a costing system are:

1. cost object
2. direct costs of a cost object
3. indirect costs of a cost object
4. cost pool
5. cost-allocation base
Costing-system overview diagram:
Job Costing and Process Costing:
 Job-costing system: In this system, the cost object is
a unit or multiple units of a distinct product or service
called a job. Each job generally uses different amounts
of resources.
 Process-costing system: In this system, the cost
object is masses of identical or similar units of a
product or service.
Costing Approaches
 Actual Costing – allocates:
 Indirect costs based on the actual indirect-cost rates
times the actual activity consumption

 Normal Costing – allocates:

 Indirect costs based on the budgeted indirect-cost rates
times the actual activity consumption
Product Over- and Undercosting
 Product Overcosting – a product consumes a low
level of resources but is allocated high costs per unit

 Product Undercosting – a product consumes a high

level of resources but is allocated low costs per unit

 The results of overcosting one product and

undercosting another is cross-subsidization.
 Broad Averaging:
 Broad averaging, or peanut-butter costing, a
common cause of undercosting or overcosting,is the
result of using broad averages that uniformly assign, or
spread, the cost of resources to products when the
individual products use those resources in a
nonuniform way.
Refining costing system:
• Refining a costing system means making changes
that result in cost numbers that better measure the
way different cost objects, such as products, use
different amounts of resources of the company.
Activity-based costing (ABC):
 Activity-based costing (ABC) refines a costing
system by identifying ‘individual activities’ as the
fundamental cost objects.
Activity-Based Management:
 A method of management that used ABC as an
integral part in critical decision-making situations,
including:
 Pricing and product-mix decisions
 Cost reduction and process improvement decisions
 Design decisions
 Planning and managing activities
 Cost Allocation:
 Assigning indirect costs to cost objects
 These costs are not traced
 Indirect costs often comprise a large percentage of
Total Overall Costs
Purposes of Cost Allocation
1. To provide information for economic decisions
2. To motivate managers and other employees
3. To justify costs or compute reimbursement amounts
4. To measure income and assets for reporting to tax
authorities
Customer-profitability analysis:
 Customer-profitability analysis is the reporting and
assessment of revenues earned from customers and
the costs incurred to earn those revenues.

 An analysis of customer differences in revenues and

costs can provide insight into why differences exist in
the operating income earned from different customers.
Allocating Costs of a Supporting Department
to Operating Departments:

 Supporting (Service) Department – provides the

services that assist other internal departments in the
company

 Operating (Production) Department – directly

adds value to a product or service
 Methods to Allocate
Support Department Costs:
 Single-Rate Method – allocates costs in each cost
pool (service department) to cost objects (production
departments) using the same rate per unit of a single
allocation base
 No distinction is made between fixed and variable costs
in this method
 Methods to Allocate
Support Department Costs:
 Dual-Rate Method – segregates costs within each
cost pool into two segments: a variable-cost pool and a
fixed-cost pool.
 Each pool uses a different cost-allocation base
Methods of Allocating Support Costs :

 There are three methods of allocating support costs to

product departments:
• direct method
• step-down method
• reciprocal method.
Main Product & Joint Product:
 Main Product – output of a joint production process
that yields one product with a high sales value
compared to the sales values of the other outputs.

 Joint Products – outputs of a joint production process

that yields two or more products with a high sales
value compared to the sales values of any other
outputs
Joint Cost Allocation Methods
 Physical Measures – allocate using tangible
attributes of the products, such as pounds, gallons,
barrels, etc.
 Market-Based – allocate using market-derived data
(dollars):
1. Sales value at splitoff
2. Net Realizable Value (NRV)
3. Constant Gross-Margin percentage NRV
 Byproducts:
 Byproducts – outputs of a joint production process
that have low sales values compare to the sales values
of the other outputs
 Methods for accounting for
byproducts:
 Production Method – recognizes byproduct
inventory as it is created, and sales and costs at the
time of sale

 Sales Method – recognizes no byproduct inventory,

and recognizes only sales at the time of sales:
byproduct costs are not tracked separately
 Decision Models:
 A decision model is a formal method of making a
choice, often involving both quantitative and
qualitative analyses.

 Quantitative factors (DM,DL, Marketing etc)

 Qualitative factors (Employee moral, satisfaction etc)
 Five-Step
Decision-Making Process:
Step 2:
Make Step 3: Step 4:
Step 1: Step 5:
Predictions Choose Implement
Obtain Evaluate
About An The
Information Performance
Future Alternative Decision
Costs

Feedback
 Relevance:
 Relevant Information has two characteristics:
 It occurs in the future
 It differs among the alternative courses of action

 Relevant Costs – expected future costs

 Relevant Revenues – expected future revenues
 Types of Decisions:
 One-Time-Only Special Orders
 Insourcing vs. Outsourcing
 Make or Buy
 Product-Mix
 Customer Profitability
 Branch / Segment: Adding or Discontinuing
 Equipment Replacement
 Opportunity cost:
 Opportunity cost is the contribution to income that
is forgone by not using a limited resource in its next-
best alternative use.

 Opportunity cost is included in decision making

because the relevant cost of any decision is
1. the incremental cost of the decision plus
2. the opportunity cost of the profit forgone from
making that decision.
 Budget :
 The quantitative expression of a proposed plan of
action by management for a specified period, and

 An aid to coordinating what needs to be done to

implement that plan

 May include both financial and nonfinancial data

 Master or Static Budget:
 The master budget summarizes the financial forecast
of all the company’s budgets.

 It expresses management’s operating and financing

plans
 the formalized outline of the company’s financial
objectives
 and how they will be attained.
Components of Master Budgets
 Operating Budget – building blocks leading to the
creation of the Budgeted Income Statement

 Financial Budget – building blocks based on the

Operating Budget that lead to the creation of the
Budgeted Balance Sheet and the Budgeted Statement
of Cash Flows
Advantages of Budgets
 Provides a framework for judging performance

 Motivates managers and other employees

 Promotes coordination and communication among

subunits within the company
 Variance:
 Variance – difference between an actual and an expected
(budgeted) amount.
 Static-Budget Variance (Level 0) – the difference
between the actual result and the corresponding static
budget amount
 Favorable Variance (F) – has the effect of increasing
operating income relative to the budget amount
 Unfavorable Variance (U) – has the effect of
decreasing operating income relative to the budget
amount
 Flexible Budget:
 A flexible budget calculates budgeted revenues and
budgeted costs based on the actual output in the
budget period.

 The flexible budget is prepared at the ‘end’ of the

period after the actual output is known.
 Variance Sub-Division:
 The static-budget variance can be subdivided into:

1. flexible-budget variance: the difference between an

actual result and the corresponding flexible-budget
amount.
2. sales-volume variance: the difference between the
flexible-budget amount and the corresponding static-
budget amount.
Planning and Overhead
 Variable Overhead: Variable overhead is those
manufacturing costs that vary roughly in relation to
changes in production output.(e.g. production
supplies, equipment utilities)

 Fixed Overhead: Fixed overhead is a set of costs that

do not vary as a result of changes in activity. These
costs are needed in order to operate a business.(e.g.
rent, insurance)
 Standard Costing:
 Standard costing is the establishment of cost
standards for activities and their periodic analysis to
determine the reasons for any variances.

 Standard costing is a tool that helps management

account in controlling costs.
A Roadmap: Variable Overhead
Flexible Budget: Allocated:
Actual Costs
Budgeted Input Budgeted
Incurred: Actual Inputs
Allowed for Input Allowed for
Actual Input X
Actual Output Actual Output
X Budgeted Rate
X X
Actual Rate
Budgeted Rate Budgeted Rate

Spending Efficiency Never a

Variance Variance Variance

Flexible-Budget Never a
Variance Variance

Total Variable Overhead Variance

Over/Under Allocated Variable Overhead
A Roadmap: Fixed Overhead Same Budgeted Flexible Budget: Allocated:
Lump Sum Same Budgeted Budgeted
Actual Costs (as in Static Lump Sum (as in Input Allowed for
Incurred Budget) Static Budget) Actual Output
Regardless of Regardless of X
Output Level Output Level Budgeted Rate
Production-
Spending Never a Volume
Variance Variance Variance

Production-
Flexible-Budget
Volume
Variance
Variance

Total Fixed Overhead Variance

Over/Under Allocated Fixed Overhead