Managerial Accounting Survival Cheat Sheet, Exams of Medicine

Download Managerial Accounting Survival Cheat Sheet and more Exams Medicine in PDF only on Docsity! lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 1 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING (UNIVERSITY OF SOUTHERN CALIFORNIA) ACCOUNTING 281: INTRO TO MANAGERIAL ACCOUNTING SURVIVAL CHEAT SHEET Class 2 - 1/11/23 - Core Concepts of Management Accounting ● Measuring Cost ○ Types of Costs ■ Financial Accounting Perspective ● Product Costs: direct labor, direct materials, and manufacturing overhead ● Period Costs: selling, general, and administrative costs ■ Managerial Accounting Perspective ● Variable Costs: Costs that vary with sales volume ● Fixed Costs: Costs that do not vary over the relevant range ■ Economics Perspective ● Costs are classified according to decision relevance ○ Relevant Costs: Differential costs and opportunity costs ○ Irrelevant Costs: Sunk costs ○ Basic Cost Terminology ■ Cost- resources sacrificed to achieve a specific objective ■ Cost Object - anything of interest for which a measure of cost is desired ○ Classification Based on Traceability to a Cost Object ■ Direct Cost: a cost that can be traced directly and completely to a specific cost object, in a cost effective way ● A direct cost is traced to a cost object ■ Indirect Cost: A cost that cannot be traced directly and completely to a specific cost object (Indirect costs are also referred to as Overhead costs (MOH)) ● An indirect cost is allocated to a cost object lOMoAR cPSD|22896205 2 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ■ ○ Cost Classifications for Preparing Financial Statements ■ Product Costs include direct materials, direct, labor, and manufacturing overhead ■ Period Costs include all selling costs and administrative costs ■ ■ Product cost or period cost? ● Will the cost go away if you stop producing immediately? ○ If yes, product cost, if no then period cost ○ Classifications of Manufacturing Costs ■ Direct Material, Direct Labor, Manufacturing Overhead ■ ■ Prime costs, fundamental cost ■ Conversion cost, processing cost ○ Classifications based on Behavior ■ Cost Driver- a factor whose change “causes” a change in the total amount of cost lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 5 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ ○ ● Manufacturing Overhead Application ○ Manufacturing Overhead - Manufacturing costs other than direct materials and direct labor (All indirect costs that are still product costs) ○ The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins ○ POHR = (Estimated total manufacturing overhead cost for the coming period)/(Estimated total units in the allocation base for the coming period) ■ ^tells how much company will allocate to a given job ○ Overhead Applied = (Amount of Application base actually incurred on the job) x POHR ■ AKA number of hours of manufacturing x POHR ○ Generic Calculation Sheet Direct Materials (Materials x amount) Direct Labor (Labor hours x rate) Manufacturing Overhead (hours x POHR) Total Cost (stuff combined) Class 4- 1/23/17 - Product Costing Systems lOMoAR cPSD|22896205 6 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ● Key Definitions ○ Raw Materials - include any materials that go into the final product ○ Work in process- consists of units of production that are only partially ○ Finished goods- consists of completed units of product that have not been sold to customers ○ Cost of goods manufactured - include the manufacturing costs associated with the goods that were finished during the period ● Flow of Costs: A Conceptual Overview ○ ● The Purchase and Issue of Raw Materials: T-Account Form ○ ○ When raw materials are purchased, Class 5 - 1/25/17 - Product Costing Systems (Continued) ● Underapplied and Overapplied Overhead - A closer look ○ The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is referred to as either underapplied or overapplied overhead ○ Underapplied Overhead- exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 7 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ Overapplied Overhead- exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period ● Different T accounts when doing Managerial Accounting ○ Accounts in order of transfer of Funds ■ Raw Materials ■ Work in Process ● Credits are Cost of Goods Manufactured (debit same amount in finished goods) ■ Finished Goods ● Credits of Finished goods are “cost of goods sold” ■ Manufacturing Overhead ● Holding spot for indirect costs ● Can put in and take out funds at ANY time ○ Disposition of Under- or Overapplied Overhead ■ Complex Approach ● Allocate a portion of the over- or underapplied overhead to work in progress inventory, finished goods inventory, and cost of goods sold ● Allocation would be based on the relative dollar value in each of the three accounts involved Class 6 - Activity Based Costing (ABC) Systems - 1/30/12 ● Conventional Product Costing SYstems vs. ABC Systems ○ Conventional Costing ■ In a conventional product costing system, direct labor and material costs are traced to the cost object (the “job” or the department) ■ However, overhead costs are accumulated into relatively few cost pools and are allocated to a cost object using a corresponding small number of (typically, readily observable) allocation bases/drivers, typically related in some way to the volume of production (such a direct labor hours or machine hours) ● lOMoAR cPSD|22896205 1 0 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ■ ■ Income Statement ■ Step 1: Define activity, activity, cost pools, and activity measures ● ■ Step 2: Assign overhead costs to activity cost pools ● ■ Step 3: Calculate Activity Rates ● ■ Step 4: Assign overhead costs to cost objects lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 1 1 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ● ● ● Calculate Activity Rates ○ The activity rate for each cost pool is computed by dividing the total cost for an activity cost pool by the total activity for that pool ■ Activity Rate = Total Cost for an Activity / Total activity for that pool ■ ○ Notice, the “other” cost pool does not have an activity rate ■ Because the organization-sustaining costs will not be assigned to products or customers ● Flow chart of Baxter example ○ Fill this in later ○ Baxter Battery More info lOMoAR cPSD|22896205 1 2 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ■ ○ Assigning Overhead to these products ■ ● Application of ABC: Customer Profitability Analysis ○ Customer Profitability- reporting and analysis of revenues earned from customers and costs incurred to earn those revenues ○ An analysis of customer differences and revenues and costs can provide insight into why differences exist in the operating income earned from different customers ○ Conventional cost management focused on production costs and did not assign SG&A costs to products and customers ○ Whale Curve ■ lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 1 5 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ● 2. It does not use all the available data, coefficient estimates are inefficient ○ Cost Estimation Analysis Using Linear Regression ■ Uses all the available data ● Much more accurate estimate of the cost function ■ C = α + β X + ε ̃ ● Ε̃ represents the effect of random factors ■ Linear regression creates a line where the distance from each point to the line is minimized (creating an accurate cost estimation line) ■ ■ Coefficients: ● Intercept= a value constant = fixed cost ● variable=estimated cost per variable ■ ■ Goodness of Fit- the R2 statistic ● ● A high R2 (0 ≤ R2 ≤ 1), indicates a better fit ● R2 is a measure of how well changes in the cost-driver(s) explain changes in the cost lOMoAR cPSD|22896205 1 6 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ● YOU WANT THIS VALUE TO BE CLOSE TO 1 ● Higher value=stronger relationship between cost and variable ■ Significance of the independent variable(s) - the P value ● ● The smaller the p-value for the coefficient, the more “significant” is the relationship between the cost driver and the cost ● Typically, criterion for the p-value is in the range 0.0 ≤ p ≤ 0.20 ● YOU WANT THIS VALUE CLOSEST TO ZERO ■ Multiple Cost Drivers ● ● If P values for multiple drivers fit the criteria, 0.0 ≤ p ≤ 0.20, then costs are driven by two factors Class 10 - 2/13/17 - Cost Volume Profit (CVP) Analysis ● Review of Income Statement ○ ○ Focus on product vs. period costs ● Basics of Cost-Volume-Profit Analysis ○ With the contribution format Income Statement, the emphasis is on cost behavior lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 1 7 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ ○ Contribution Margin (CM)- the amount remaining from sales revenue after variable expenses have been deducted ■ Variable expenses are separated from fixed expenses ■ CM = Sales - Variable Expenses ■ CM is used FIRST to cover fixed expenses ■ Any remaining CM contributes to net operating income ■ Net operating income total is always the same between traditional and contribution income statements ■ COGS=Product costs ● CVP Relationships in Equation Form ○ Profit = (Sales- Variable Expenses) - Fixed Expenses ○ ○ When the company has only one product, the profit equation is: ○ ■ Profit = (P x Q - V x Q) - Fixed Expenses ■ Profit - (P-V) x Q - Fixed Expenses ■ Profit = Unit CM x Q - Fixed Expenses ○ Preparing the CVP Graph lOMoAR cPSD|22896205 2 0 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ Operating Leverage - measures the sensitivity of net operating income to a 1% change in sales ○ The degree of operating leverage is the elasticity of net operating income with respect to sales ○ Tells us how, at ANY GIVEN LEVEL OF SALES, a percentage change in sales volume will affect profits ○ Degree of Operating Leverage ■ Degree of Operating Leverage = (CM/Net operating income) ■ Provides a measure of company’s earnings volatility ■ (%ΔSales) x (Operating Leverage)=(%Δnet operating income) Class 12 - 2/22/17 - More Cost Volume Profit (CVP) Analysis ● Automated vs. Manual Production Systems: Impact on CVP Analysis ○ Switching from a manual system to an automated production system will usually have the following effects on CVP Analysis ○ ● CVP Analysis in a Multiproduct Company ○ When a company sells more than one product, break-even analysis becomes more complex ● Multi-Product Break Even Analysis ○ ○ ○ 5/11 and 6/11 is given information ● Key Assumptions of CVP Analysis lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 2 1 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ 1. Revenues are linear ■ The selling price is constant ○ 2. Costs are Linear ■ Can be accurately divided into variable (constant per unit) and fixed) constant in total) elements ○ 3. In multiproduct companies, the sales mix is constant ■ This is related to rules 1 and 2 ○ 4/ In manufacturing companies, inventories do not change (i.e., units produced = units sold) Class 13 - 2/27/17 - Variable vs. Absorption Costing - End of Content for Midterm 2 ● Absorption Costing ○ Under absorption (i.e. traditional) costing, all product costs, variable and fixed, are included when determining product cost ○ Example: ■ ○ Product Cost/Unit ■ Product cost per unit = Variable cost per unit + Fixed cost per unit ■ ^SGA costs are NOT product costs ■ Example: ● ○ Absorption Costing Income Statements ■ Example: ● 20k units sold during the year @$30 unit price ● No beginning inventory ■ Absorption: ● lOMoAR cPSD|22896205 2 2 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ■ If cost per unit changes, Net operating income changes by sales*change in cost per unit ○ Overview of Variation and Absorption Costing ■ ● ONLY DIFFERENCE IS FIXED MANUFACTURING OVERHEAD ■ Example differences: ● ● Under ABSORPTION costing, ALL product costs, variable and fixed, are included when determining unit product cost ● Under VARIABLE costing, ONLY the VARIABLE production costs are included in product costs ○ NO FIXED MOH ● REMEMBER: SGA COSTS ARE NOT PRODUCT COSTS and NOT included in either method ■ Variation Costing in Income Statement ● ■ Comparison between Variable and Absorption Costing lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 2 5 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ ○ ○ Summary of Key Insights!!! ■ ○ Explaining Changes in Net Operating Income ■ Variable Costing income is only affected by changes in unit sales ● Not affected by number of units produced ● When sales go up, net operating income goes up, and vice versa ■ Absorption costing income is influenced by changes in unit sales and units produced ● Net operating income can be increased simply by producing more units even if units are not sold ○ Formatting of Contribution Margin Income Statement ■ Sales ■ Less: variable costs (product and period) ■ =Contribution margin ■ Less: fixed costs (both product and period) ■ =Operating Income ○ CVP Formulas ■ Profit = (P-V)Q-FC ● P-V=CM per unit ■ Profit= CMR*Sales-FC ■ CMR= (P-V)/P ■ CMR= CM/Sales lOMoAR cPSD|22896205 2 6 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING Class 15 - 3/8/17 - Relevant Costs for Decision Making ● Management’s Decision Making Process ○ Considers both financial and non-financial information ■ Financial Information - includes revenues and costs as well as their effect on overall profitability ■ Non-financial information- captures effects on employee turnover, the environment, overall company image, etc. ● Characteristics of Relevant Information ○ ○ Why do we use Relevant info?- to limit our effort in making a decision, and to avoid considering irrelevant items that may cause us to make an incorrect decision ● Identifying Relevant Cost ○ Avoidable Cost- a cost that can be eliminated, in whole or in part, by choosing one alternative over another ■ Avoidable costs are relevant costs ■ Unavoidable costs are irrelevant costs ○ Two broad categories of costs are NEVER relevant in any decision. They include: ■ 1. Sunk Costs ■ 2. A future cost that does not differ between the alternatives ● Relevant Costs and Time Horizon ○ Whether or not a cost is relevant (differs across alternatives) depends on the time horizon under consideration ○ When a short term horizon is chosen, resources cannot be adjusted in the short term and will be irrelevant for each alternative ■ Note: Some fixed costs may be relevant in the s.t.: ● E.g. Discretionary fixed costs are relevant (they are often “avoidable fixed costs”) ■ However, many fixed costs will be irrelevant in the s.t. ● Beware of allocations of committed fixed costs ● Note: traceable fixed costs can be irrelevant in s.t. lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 2 7 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ○ E.g. depreciation on a custom built machine with no resale value ● Short Term Planning ○ Most short term decisions focus on temporary gaps between the demand for and supply of available capacity ■ These gaps arise because, in the short term, business have a fixed supply of capacity but confront changing demand ○ We can classify most short term decisions into two broad categories: ■ 1. Decisions involving an excess supply of capacity ● Excess supply means that capacity has zero opportunity cost and is irrelevant for decision making ■ 2. Decisions involving an excess demand for capacity ● Excess demand means that capacity has positive opportunity cost and is relevant for decision making ○ Example of two income statements showing difference results of decision making ■ ● Non-routine, non-recurring special decisions ○ 1. Dropping products, departments, and/or territories ○ 2. Outsourcing production (make or buy) ○ 3. Accepting or rejecting a special order ○ 4. Selecting product mix when resources are constrained ○ 5. Selling the product “as is” or processing further ● Making Decisions in non-recurring special decisions ○ Dropping Products/departments/territories ■ Example 1 ● XYZ Company produces three models of tennis rackets, fixed costs are unavoidable ● lOMoAR cPSD|22896205 3 0 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ● ■ Stuff to consider ● ● Whether these decisions are short term or long term is ambiguous because managers may be interested in considering both the short and long term effects on profitability ○ Special Decision 2: Outsourcing (make vs. buy) decisions ■ ■ Example 1: lOMoAR cPSD|22896205 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING 3 1 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING ● ● ■ Opportunity Cost ● The benefit that is foregone as a result of pursuing some course of action ● Not actually cash outlays and are not recorded in the formal accounts of an organization ■ Another Make or Buy Example ● lOMoAR cPSD|22896205 3 2 BUAD 281 - COMPLETE NOTESINTRODUCTION TO MANAGERIAL ACCOUNTING Class 16 - 3/20/17 - Relevant Costs for Decision Making ● Making Decisions in non-recurring special decisions ○ Special Decision 3: Non-Recurring Special Sales Orders ■ Decision Rule ● ○ Special Decision 4: Product Emphasis Under Constraints ■ Example ● ● Choose B90 ■ Decision Rule ● lOMoAR cPSD|22896205 35 ● My customers might not pay you immediately, so some of the cash I collect in this month will depend on sales made last month ○ The Assumptions ■ % of sales made on credit ● This assumption will depend on the characteristic of the company’s customers ■ % of credit sales that are uncollectable ● Will also depend on characteristics of the company’s customers ■ Credit terms for sales made on credit ● This assumption affects the timing of cash collections ○ Mathematical Relationship ■ Current Period Cash Collections = ● +Current period cash sales ● +Current period credit sales collected in the current period ● +Prior period credit sales collected in the current period ● The Production Budget: Developing a Feasible Production Plan ○ The Production Budget ■ The intuition ● The goal: figure out how many units of finished goods need to be produced in each period ● Basic idea: the amount I need to produce equals the amount that I want to sell plus the desired change in finished goods inventory ■ The assumption ● Desired ending finished goods inventory ○ Will depend on the company’s FG inventory policy ○ Usually based on next period’s expected sales ■ Mathematical Relationship ● Units to be produced= ○ Budgeted Unit sales ○ + Desired Ending Finished Goods ○ - Beginning Finished goods ● ● The Direct Material Purchases Budget and the Schedule of Expected Cash Disbursements for Materials: ○ The Direct Materials Purchases Budget lOMoAR cPSD|22896205 36 ● ■ Intuition ● The goal: Determine the cost of materials that need to be purchased in each period Basic Idea: the amount of materials I will need to purchase equals the amount that I plan to “use up” plus the desired change in direct materials inventory ■ The Assumptions ● Amount of direct materials required for each unit of output ● Desired ending direct materials inventory ○ Usually based on next period’s production ● Cost of each unit of direct materials ■ Mathematical Relationships ● Quantity of Material Needed for Production = ○ Units to be produced*quantity of Material Budgeted per unit ● Quantity of Material to be Purchased = ○ Quantity of Material Needed for Production ○ + desired ending material inventory ○ - Beginning material Inventory ● Budgeted Cost of Material Purchases= ○ Quantity of Material to be Purchased*Budgeted Material Prices ○ Schedule of Expected Cash Disbursements for Materials ■ The intuition ● The DM purchases budget tells you when the purchases are made ● This budget tells you when the cash is paid out to suppliers ■ The assumptions ● % of purchases made on credit ● Credit terms for purchases made on credit ○ This assumption affects the timing of cash payments ■ Mathematical Equations ● Cash Payments for Direct Material Purchases= ○ Current period purchases paid in current period ○ + Prior period purchases paid in current period lOMoAR cPSD|22896205 37 ● Class 18 - The Master Budget Part 2 - 3/27/17 ● The Direct Labor Budget: ○ Mathematical Relationships ■ Direct Labor Hours Needed for Production ● Units to be produced * DL Hours Budgeted per Unit ■ Budgeted Direct Labor Cost ● DL Hours needed for production* Budgeted Rates per Hour ● The Manufacturing Overhead Budget ○ Mathematical Relationship ■ Budgeted MOH Costs= ● (DL Hours needed for production*variable overhead rate) +Budgeted Fixed Overhead ■ Cash Payments for MOH= ● Budgeted MOH Cost ● +Noncash MOH Cost Class 19 - 3/29/17- The Master Budget Part 3 ● The Cash Budget ○ The Cash Budget vs. The Statement of Cash Flows ■ Similarities ● Both reconcile the cash portion of a company at the beginning of a period to the cash position at the end of the period ■ Differences ● Cash Flow Statement: ○ Prepared at the end of the period, and reports past cash inflows and outflows ● Cash Budget: ○ Prepared at the beginning of the period and reports forecasted cash inflows and outflows (basically, a projected CF statement) ○ Presents a plan of cash inflows and outflows at a more detailed level, such as when and how much cash is expected from customers, when cash is to be paid to suppliers, and working capital requirements ○ The Format of the Cash Budget ■ Four Sections lOMoAR cPSD|22896205 4 0 ● ■ Analysis ● ● Flexible Budget ○ The flexible budget is constructed using CVP tools ○ CVP can provide useful information for control ○ ○ Characteristics of Flexible Budgets ■ Flexible budgets use the same cost assumptions and equations as the static budget ● Only difference: Flexible budget is adjusted for DIFFERENT VOLUME LEVELS ○ May be prepared for any activity level in the relevant range ○ Shows costs that should have been incurred at the actual level of activity, enabling “apples to apples” cost/revenue comparisons ■ Best analyzed using contribution margin format lOMoAR cPSD|22896205 4 1 ● Variable costs change, fixed costs do not ● Basically, apply the CVP model ■ Flexible budgets can be prepared for each type of budget in the master budget ■ Helps managers control cost ■ Facilitates performance evaluation Class 20 - 4/3/17 - The Flexible Budget and Variance Analysis Budgetary Control ● Budgetary Control ○ A major function of management is to control operations ■ Managers analyze differences between actual and planned results and determine causes ● Provides management with feedback on operations ● Allows managers to update the assumptions used in their planning models ■ Reports can be made as frequently as needed ● Total Profit Variance ○ Compares actual profit to the budgeted profit from the profit plan ○ ● CVP Tools ○ ● Activity Variances and Flexible Budget Variances ○ The difference between the planning (static) budget and the flexible budget is an “activity variance” or a “planning variance” ○ The difference between the flexible budget and actual results is called a flexible budget variance lOMoAR cPSD|22896205 4 2 ■ For the profit plan (i.e. the budget income statement), there are two types of flexible budget variances: ● Revenue variances ● Spending Variances ● Budgeted and Actual Results ○ Variances Analysis ● Why do we need new tools to analyze the spending variance ○ Accountants focus separately on input prices and input quantities because in most organizations: ■ One department is responsible for the acquisition of a resource and determining the actual price ■ A different department uses the resource and determines how efficiently it is used ○ A variance is a signal that is part of a control system for monitoring results ■ We want to know where the un ■ usual activity is taking place and we want to know ASAP ● Variable Manufacturing Cost ○ ○ New Terminology lOMoAR cPSD|22896205 4 5 ■ The VMOH rate variance mixes input price and input quantity effects ● E.g., if we consume more supplies for a given amount of DLH, we’ll have an unfavorable VMOH rate variance - even if the price of each supply was unchanged ● This problem is most severe when the relation between VMOH and cost driver is weak ○ The actual direct labor rate captures : ■ 1. the price variance (price we actually pay for the overhead per direct labor hour) ■ 2. The quantity variance (how much overhead we actually incur per direct labor hour) ■ For this reason, it is difficult to interpret these VMOH rate variances in straightforward manner ● Labor Efficiency ○ Labor Efficiency Variance ■ LEV = SR (AH - SH) ○ Labor Rate Variance ■ LRV = AH (AR - SR) Class 22 - 4/10/17 - Variance Analysis ● Decentralization and Organizational Structure ○ Organizational design is driven by three factors: ■ 1. Information Asymmetry: Local managers know more about local operations than do top managers ■ 2. Costly Information: It is costly for local managers to communicate their superior information to top managers ■ 3. Incentive Problems: Employees prefer to use their superior information for their own benefit rather than the firm’s ● To minimize cost that results from these three factors (which increase with the size of the firm), modern large firms are almost always decentralized and organized around responsibility centers ○ Top management is freed from day to day decisions, can focus more on long term issues ○ Decisions relating to local operations can be made by local managers who are better informed to make those decisions ● Degree of Decentralization ○ The extent to which decision making authority is delegated by top management to local managers is partly determined by the relative costs of acquiring and communicating needed information ○ The move to more decentralized organized results from higher information costs ○ A tradeoff in decentralized organizations: ■ Centralized decisions are generally best for the firm as a whole, but may be made too slowly (because of the time and cost of obtaining the necessary information) to be fully effective lOMoAR cPSD|22896205 4 6 ■ Local decisions can be made quickly (because the necessary information is available at lower cost), but those decisions may not be best for the firm as a whole ● Basic Elements of a Well Designed Organization ○ 1. An organizational structure, that locates decision making authority at those points where the info necessary to make a decision can be obtained in a timely and economically efficient way ○ 2. A system of incentives (positive and/or negative) that “aligns” the interests of those who have decision making authority with those of the firm, so that the decisions they make serve not only their own, individual, interests but also those of the firm (minimize any conflicts of interest) ○ 3. A managerial accounting system that ■ A. communicates the firm’s goals (objectives) in a clear and comprehensible way to those who have decision making authority and can affect the firm’s ability to achieve those goals ■ B. Provides feedback such that the effects of the decisions made are allocated to those organizational units (managers) that made them and are responsible for their outcomes ● Responsibility Accounting ○ Manufacturing a product requires many different activities, which are the responsibility of different business units ○ To ensure accountability for financial results and outcomes, costs, and revenues should be assigned to the business units that are responsible for incurring them ■ A business unit’s accounting report should reflect the degree of responsibility it has over revenues, costs, and investment ● Four Basic Types of Responsibility Centers ○ 1. Cost Center: responsible for controlling costs - to minimize costs while meeting output requirements ■ Examples: HR Department, product fabrication department ○ 2. Revenue Center: responsible for controlling revenues - to maximize revenue with the resources provided ■ Example: Sales department ○ 3. Profit Center: responsible for controlling costs and revenues - consisting of two or more cost and revenues. It has a fixed amount of capital but it has the authority and responsibility to make decisions about pricing and input mix ○ 4: Investment Center: responsible for controlling revenues, costs, and capital investment - usually consisting of several profit centers - “a firm within a firm” ● Responsibility Centers lOMoAR cPSD|22896205 4 7 ○ ● Segment Reporting ○ Segment Reporting is the process of developing accounting reports for separate responsibility centers ■ Responsibility centers are often referred to as “segments” ○ Segment reporting is a key component of a responsibility accounting system ● Evaluating Responsibility Centers: Investment Centers ○ Investment Center managers should be held responsible for not only generating profit but also for making the best use of the investment center’s assets ○ Measuring investment center performance using profit variances can create dysfunctional incentives to overinvest ■ Investment center managers may take projects that boost profits, but fail to earn an adequate risk-adjusted rate of return ● Return on Investment ○ Margin = Income/Sales ○ ○