Appunti Managerial Accounting Zoni

Financial statement analysis and managerial accounting

Managerial accounting

Managerial accounting: an overview

Managerial accounting is something different from financial accounting: the only thing that they have in common is the term accounting, that entails working with numbers, collecting data, organizing, and classifying data, and so on. As regards to managerial accounting, the audience is the management, from the top management up to the operating one: so, we’re talking about quantitative information that are used at all levels of the organization (internal audience). If managerial accounting addresses the management with this information, the management will not need detailed information, but just aggregate measures of the company.

The scope of this subject broadens very much, and differently from financial accounting, for which there were principles to organize the information, in managerial accounting we have free formats (basically there's no accounting principles). However, the fact that there are more or less correct doesn’t mean that there are practices that are more or less correct, so instead of having principles institutionalized by an accountancy body, there are methodologies that are suggested by best practices.

With regards to managerial accounting, we do have both historical, past data, but also forward-looking data, while in financial accounting we were just looking about the past. If this data has to exert an influence, of course it will exert an influence on the audience that is addressed, so internally for managerial accounting and externally for financial accounting.

Financial and managerial accounting: seven key differences

Work of management

If we have to produce data that are meaningful for the managerial activity, we have to know which is the managerial activity implied:

• Planning: identifying a target (an objective)
  • Establish goals
  • Specify how goals will be achieved
  • Develop budgets
• Controlling: the control function gathers feedback to ensure that plans are being followed
  • Feedback in the form of performance reports that compare actual results with the budget are an essential part of the control function
• Decision making: decision making involves making a selection among competing alternatives
  • What should we be selling?
  • Who should we be serving?
  • How should we execute?

Planning

• Marketing majors
  • How much should we budget for TV, print, and internet advertising?
  • How many salespeople should we plan to hire to serve a new territory?
• Supply Chain Management Majors
  • How many units should we plan to produce next period?
  • How much should we budget for next period's utility expense?
• Human Resource Management Majors
  • How much should we plan to spend for occupational safety training?
  • How much should we plan to spend on employee recruitment advertising?

Controlling

• Marketing majors
  • Is the budgeted price cut increasing unit sales as expected?
  • Are we accumulating too much inventory during the holiday shopping season?
• Supply Chain Management Majors
  • Did we spend more or less than expected for the units we actually produced?
  • Are we achieving our goal of reducing the number of defective units produced?
• Human Resource Management Majors
  • Is our employee retention rate exceeding our goals?
  • Are we meeting our goal of completing timely performance appraisals?

Decision making

• Marketing majors
  • Should we sell our services as one bundle or sell them separately?
  • Should we sell directly to customers or use a distributor?
• Supply Chain Management Majors
  • Should we transfer production of a component part to an overseas supplier?
  • Should we redesign our manufacturing process to lower inventory levels?
• Human Resource Management Majors
  • Should we hire an on-site medical staff to lower our healthcare costs?
  • Should we hire temporary workers or full-time employees?

Accounting majors

The IMA estimates that more than 80% of professional accountants in the U.S. work in non-public accounting environments. Employers expect accounting majors to have strong financial accounting skills, but they also expect application of the planning, controlling, and decision-making skills that are the foundation of managerial accounting.

Certified Management Accountant (CMA)

To become a CMA requires membership in the Institute of Management Accountants, a bachelor’s degree from an accredited college, two continuous years of relevant professional experience, and passage of the CMA exam.

CMA exam content specifications

Part 1 Financial Reporting, Planning, Performance, and Control

• External financial reporting decisions
• Planning, budgeting, and forecasting
• Performance management
• Cost management
• Internal controls

Part 2 Financial Decision Making

• Financial statement analysis
• Corporate finance
• Decision analysis
• Risk management
• Investment decisions
• Professional ethics

Chartered Global Management Accountant (CGMA)

The CGMA designation is co-sponsored by the American Institute of Certified Public Accountants (AICPA) and the Chartered Institute of Management Accountants (CIMA). One pathway to the CGMA requires a bachelor’s degree in accounting (accompanied by a total of 150 college credit-hours), passage of the Certified Public Accountant (CPA) exam, membership in the AICPA, three years of relevant management accounting work experience, and passage of the CGMA exam—which is a case-based exam that focuses on technical skills, business skills, leadership skills, people skills, and ethics, integrity, and professionalism.

Managerial accounting: planning, controlling, and decision making

The primary purpose of this course is to teach measurement skills that managers use to support planning, controlling, and decision-making activities.

Managerial accounting and cost concepts

Needs of management

• Financial accounting is concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators.
• Managerial accounting is concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions.

Cost classification

Purposes of Cost Classification:

• Assigning costs to cost objects
• Accounting for costs in manufacturing companies
• Preparing financial statements
• Predicting cost behavior in response to changes in activity
• Making decisions

"Different costs for different purposes": there is not one cost that is right and one that is wrong, but the essence of this slogan is to identify the costs that are relevant for the purpose of the analysis. Managerial accounting is all about running analysis, and for each purpose we need to frame a different type of information.

Learning Objective 1: Assigning costs to cost objects: direct costs and indirect costs

Direct costs are costs that can be easily and conveniently traced to a unit of product or other cost object.

• Examples: direct material and direct labor

Indirect costs are costs that cannot be easily and conveniently traced to a unit of product or other cost object (therefore, if we want to assign this indirect cost to the cost object, we must implement particular criteria).

• Example: manufacturing overhead

Whether the cost is direct or indirect depends on how we define the cost object. The direct versus indirect cost is not a constant classification, but it depends on how we define the cost object. Therefore, first you have to say what is the cost object, and then with reference to the specific cost object I can tell whether the cost is direct or indirect. The fact that costs are indirect, originates the phenomenon of common costs (for example the cost of shared personnel). Common costs are costs incurred to support a number of cost objects; these costs are not directly associated to the product and cannot be traced to any individual cost object.

Learning Objective 2: Classifications of manufacturing costs

We are so concerned about manufacturing costs because cost accounting is very relevant anywhere, but it started in the manufacturing environment. If you think about 30/40/50 years ago, most companies were manufacturing ones, and the question they all had was "how much does this product that we are manufacturing cost?" They defined the single product as the cost object.

The manufacturing costs associated to the product (cost object) are:

• Direct Materials
  • Direct materials are 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
  • Direct labor costs are those labor costs that can be easily traced to individual units of product
  • Example: Wages paid to automobile assembly workers
• Manufacturing Overhead
  • Manufacturing overhead includes all manufacturing costs except direct material and direct labor.
  • These costs cannot be readily traced to finished products
    • Includes indirect materials that cannot be easily or conveniently traced to specific units of product
    • Includes indirect labor costs that cannot be easily or conveniently traced to specific units of product
  • Examples: Depreciation of manufacturing equipment, Utility costs, Property taxes, Insurance premiums incurred to operate a manufacturing facility
  • Only those indirect costs associated with operating the factory are included in manufacturing overhead

However, there are also non-manufacturing costs. Therefore, there is a first classification between direct or indirect cost, and then a second classification between manufacturing or non-manufacturing costs. There are two types of non-manufacturing costs:

• Selling costs: costs necessary to secure the order and deliver the product. Selling costs can be either direct or indirect costs
• Administrative costs: all executive, organizational, and clerical costs. Administrative costs can be either direct or indirect costs

Learning Objective 3: Cost classifications used to prepare financial statements: product costs and period costs

To prepare financial statements, what is relevant is the distinction between product costs and period costs.

Product costs include all costs that are involved in acquiring or making a product; therefore, they include direct materials, direct labor, and manufacturing overhead. They are costs that when you prepare the financial statements, and mainly the income statement and the balance sheet, will be included in the evaluation of cost of goods sold and inventory. Product costs attach to a unit of product as it is purchased or manufactured, and they stay attached to each unit of product as long as it remains in inventory awaiting sale. Basically, you cost a product and you decide which are the product costs: if the product is sold, this cost per unit will go to cost of goods sold; if the product is not sold, the cost per unit will be included into the inventory cost.

For manufacturing companies, product costs include:

• Raw materials: includes any materials that go into the final product
• Work in process: consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer
• Finished goods costs: consists of completed units of product that have not yet been sold to customers

Transfer of product costs:

1. When direct materials are used in production, their costs are transferred from raw materials to work in process
2. Direct labor and manufacturing overhead costs are added to work in process to convert direct materials into finished goods
3. Once units of product are completed, their costs are transferred from work in process to finished goods
4. When a manufacturer sells its finished goods to customers, the costs are transferred from finished goods to cost of goods sold

Period costs are all the other costs, and they include all selling and administrative costs. They will inevitably be assigned to the period when the cost is incurred.

What is the difference between the two? The difference is that anything that you define as product cost, has two options to show up: one in the income statement through the cost of goods sold, and the other one in the balance sheet as cost of the inventory. On the other hand, the period cost has only one way to show up, and that is in the P/L account.

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 (product cost)
• B. Property taxes on corporate headquarters
• C. Direct materials costs (product cost)
• D. Electrical costs to light the production facility (product cost)
• E. Sales commissions

Learning Objective 4: Cost classifications for predicting cost behavior: variable costs, fixed costs, and mixed costs

Cost behavior refers to how a cost will react to changes in the level of activity, and it is essential to do that since we are interested in seeing how the cost structure will react to changes in the volume of activity.

The most common classifications are:

• Variable costs
  • A cost that varies, in total, in direct proportion to changes in the level of activity
  • A variable cost per unit is constant, even though it changes as the volume of activity changes
  • Example: Raw materials
• Fixed costs
  • A cost that remains constant, in total, regardless of changes in the level of the activity
  • If expressed on a per-unit basis, the average fixed cost per unit varies inversely with change in activity
  • Two types of fixed costs:
  • Committed: Long-term, cannot be significantly reduced in the short term
  • Discretionary: May be altered in the short term by current managerial decisions
• Mixed costs

Learning Objective 5: Cost classifications for decision making: relevant costs and irrelevant costs

This topic is very interesting to observe and very peaky to implement since relevant vs. relevant depends on the decision-making setting, so costs are not born relevant or irrelevant, but it depends on how the company frames its analysis. Decisions involve choosing between alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision.

To make decisions, it is essential to have a grasp on the concepts of differential costs and revenues, opportunity costs, and sunk costs.

• Differential Costs
  • Differential costs (or incremental costs) are the difference in cost between any two alternatives (basically, it means looking for the costs that change between the two alternatives)
  • A difference in revenue between two alternatives is called differential revenue
  • Both are always relevant to decisions
  • Differential costs can be either fixed or variable
• Opportunity Cost
  • The potential benefit that is given up when one alternative is selected over another (it means that, by selecting activity A instead of activity B, you give up the benefit associated with B)
  • These costs are not usually found in accounting records but must be explicitly considered in every decision, so for managerial accounting purposes it is very important to detect those costs as well in order to make decisions
• Sunk Costs
  • Sunk costs have already been incurred and cannot be changed now or in the future
  • These costs should be ignored when making decisions

Learning Objective 6: Prepare income statements for a merchandising company using the traditional and contribution formats

We want to deal with managerial accounting because we want to prepare Income Statements using the so-called cost Behavior Income Statement, so Contribution Margin Income Statement. Depending on how costs are classified, there may be Income Statements by nature of the costs, by function or by cost behaviour, even if it is not very frequent that companies disclose their Income Statement by cost behavior for external reporting purposes, but for internal reporting purposes or for managerial purposes it is very frequent.

The Traditional and Contribution Formats

The traditional format is more for external reporting purposes, whereas the contribution format is used primarily for managerial purposes.

However, we may even end up with an Income Statement that uses simultaneously the two classification criteria.

Uses of the Contribution Format

The Contribution Income Statement format is used as an internal planning and decision-making tool.

We will use this approach for:

• Cost-volume-profit analysis (Chapter 2)
• Segmented reporting of profit data (Chapter 4)
• Special decisions such as pricing and make-or-buy analysis (Chapter 6)
• Budgeting (Chapter 8)