Managerial accounting pt.1, Appunti di Programmazione e controllo

Scarica Managerial accounting pt.1 e più Appunti in PDF di Programmazione e controllo solo su Docsity! Managerial accounting Financial accounting Managerial accounting Objectives To communicate company’s state of health To deliver information for decision making process Output Balance sheet Income statement Statement of cash flow Managerial reports Users External (stakeholders, consumers, …) Internal (managers, …) Focus Company as a whole Company as a segment Time/frequency Low High Rules Laws General accepted accounting principles None, each company is different from the others Cost categories 1 Cost object Any activity for which a separate measurement of costs is desired. If the users of accounting information want to know the cost of something this something, this something is called cost object: product, department, activity, process, customer. If cost object is different, we tend to talk in terms of specific and common costs. Direct cost Costs (objectively measured) can be referred to our cost object directly without any kind of calculation or assumption. E.g. Material employed to produce a specific product. Indirect cost (overheads) Costs that can’t be directly traced to a cost object so we need to find a method to allocate them. Cost allocation F 0 E 0 process of assigning costs when a direct measure does not exist for the quantity of resources consumed by a particular cost object. E.g. Salary of the supervisor of the production activity. 2 Manufacturing costs Costs referred to the production functions. If you have a merchandising activity, you can’t have manufacturing costs. Prime costs Direct materials costs Those material costs that can be specifically identified with a particular cost object. Direct labor costs Those labor costs that ca be specifically identified with a particular cost object. Conversion costs Direct labor costs Manufacturing overheads ? Non manufacturing costs Are generally non marketing and administration costs. This is representative only for manufacturing companies! Manufacturing costs Direct It depends on the cost objectIndirect Non manufacturing costs Direct Indirect The only direct cost referring to non manufacturing costs is the sales commission. 3 Product costs Cost identifies with good purchased or produced for resale They are included in the inventory valuation until they are sold. They are recorded as expenses and matched against sales for calculating profits. Period costs Costs that are not included in the inventory valuation and as a result are treated as expenses in the period in which they are incurred. 4 Variable costs Costs that in total vary in direct proportion to changes in volume of activity F 0 E 0 they increase with the increasing of the level of activity. E.g. direct materials. They are non incurred if the level of activity is 0. Fixed costs Costs that in total are constant within the relevant range as the level of production varies. They don’t increase with the increase of the level of activity. E.g. depreciation. Semi-variable or mixed costs Costs that have both a fixed and a variable component. E.g. sales representatives (salary + commissions on sales). 5 Avoidable costs Those costs that can be saved by not adopting a given alternative, whereas unavoidable costs can’t be saved. customers, regions F 0 E 0 a company is made up by many different things; segment results help to understand the origin of profits. C. Strategy of the company: what we analyze result by segment, the first data we get is to verify the success of the strategy we have defined and to implement it. If you want to verify the success of your strategy, segments need to be consistent with the strategy defined and implemented. We can define strategy distinguishing 2 kinds of measures: Product strategy Strategy focused on the quality, feature of the product or service it sells. According to this strategy investments are mainly focused on the improvement of quality of the product. Market strategy We don’t want to leave the best product, we want to give the complete satisfaction of consumers’ needs. According to this strategy, investments are mainly focused on specific markets: specific needs of industries or geographic needs (referring to needs of cultures). If you want to verify the success of your strategy with segment profit analysis you have to design segments consistently with the way you define strategy. If you are oriented to product, technologies, segments have to be defined according to this kind of strategy. The main question we need to answer: which of the 2 criteria is more useful? If we look at the case, the focus of international region brands grows in local brands. Crodari wants to focus its strategy on specific needs of given market. Considerations: I. Probably the strategy of the company is more focused on the market side than on the product side. II. If we look at the profitability by product line, we see that spirits are very profitable. How can you match these two kinds of information Because spirits are higher in terms of margin and in America 93% of sales are spirits, so we expect in America that the gross margin is higher than in Europe. How can you explain the fact that gross margin by region is more or less the same? Only one way: different commercial policies, different prices, so different cultures F 0 E 0 adapt your commercial policies to the region cultures. D. Organization: in this case segment and profitability are useful to assign objectives/targets to manager. If we have a manager for the Italian market, this segment is useful to assign objectives on targets for managers. Organization is also by region and inside each business unit we have the same functions. Segment are useful to define regional segmentation criteria. Income statement Gross margin = Revenues - Cost of good sold We need to identify costs that enter in cost of good sold and other, so manufacturing towards non manufacturing costs. Then we need to identify non manufacturing costs divided in specific (with reference to the segment) and common costs. Common costs in this case are not allocated because the hypothesis here that cause and effects have no relationship with the segment. The second structure of an income statement is the so-called contribution margin. To understand the contribution margin there is a measure that allows to classify costs between variable and fixed costs. The structure of the income statement in this case will be: Revenues - Variable costs CONTRIBUTION MARGIN - Fixed specific costs SEGMENT MARGIN This is a different structure because there is the distinction between variable and fixe costs. Each company can define different levels of activity. To distinguish between variable and fixed costs the first important decision in the company is how can we define in our case the level of activity? This kind of structure reminds managers that some kind of costs are fixed so they don’t vary with the variation of the level of activity. Other costs depend on the level of activity so increasing the level of activity, in cost side determines the cost grace. Contribution margin is what remains after the coverage of variable costs and its what is generated by each single sell, and each single volume of activity. TEATRO LIRICO DUCALE case Which is the level of activity of the theatre and how can we measure it? The new manager wants to implement a new management accounting system, to better understand the economics of the theatre. We try to better understand the origin of profit or losses by developing a segmented income statement. Seasons Opera Ballet Sinfonica Canto New staging F 0 E 0 we have to set up a new stage, higher costs. Revival F 0 E 0 lower costs. Hospitality F 0 E 0 other theatres come to us. In symphony and singing we don’t have the stage. The aim is to prepare a segment profitability analysis so that first the operative result can be studied by artistic area, and more analytically for single event to asses the impact of single artistic initiative, it’s useful to use an income statement format in which volume of activity is highlighted in terms of impact or profits. So it is useful the structure that highlights variable and fixed costs. In the first case we don’t allocate common fixed costs. Structure of the income statement Let's consider, for example, the 'Fanst'. Sales € 924.250 Revenues Programs € 96.000 TV rights € 300.000 TOTAL REVENUES € 1.320.250 Copyrights € 0,00 Variable costs Artists € 720.000 Technical staff € 64.000 8.000 * (6+2) Printing costs € 92.000 11.500 * (6+2) TV rights € 100.000 CONTRIBUTION MARGIN € 344.250 Artists € 60.000 Fixed specific costs Staging costs € 700.000 SEGMENT MARGIN -€ 415.750 What does this income statement tell us? We highlight the contribution margin → the meaning of the contribution margin is: the more you sell, the more you improve the level of activity, the more this figure will increase, because the contribution margin measure the difference between revenues and variable costs. The difference between the 2 is the contribution margin. This measure is important because measures the distance between the two lines and tells you the more you increase the level of activity, the more you move on the right if this graphic, the more you increase your contribution margin and so the more you increase your ending results because costing vary with the vary of the level of the activity and we will have higher profits. We will focus on the relationship between volume and results. If your mission is making high profits looking at this kind of report means making high profits looking at the opera with highest results: Traviata, Don Giovanni. This report means: if you want to make high profits choose big operas very well known all over the world, try to deliver an high number of evenings and do always the same. But the problem I always: what is the strategy of a theater? Make well and so always the best. So probably the mission of a theater isn't always to make high profits. If you are a manager of a theater, the problem from an economic point of view is that you have to accomplish to your mission (you can't give only Traviata and Don Giovanni) but you need to pay attention to opera that allow you to get mainly, and new things more consistent with strategy, innovation and so on. If you want to improve a single program, you have to pay attention to the policies of single ticket prices, try to tell programs as much as you can. The most important differences between the two cases: 1. Crodari is a manufacturing company with manufacturing products that are sold in different countries, in the second case we have a theater, so a non manufacturing company. 2. Strategies are important: • In the first case we have a market strategy because the company differentiates the commercial strategy to be consistent to different tastes. • In the second case we have a product strategy because investments are driven by the necessity to deliver great performances in terms of opera, ballet, ... • in the first case the segment need to be defined by segments which are geographical. 3. Mission: it is important for a controller to understand the mission of a company. CONTRIBUTION MARGIN = € 10.290.000 Director = 1 * 120.000 = € 120.000 F 0 E 0 n° of directors*director’s salary Chief editors = 2 * 65.000 = € 130.000 F 0 E 0 n° of chief editors*chief editors’ salary Journalist = 18 * 45.000 = € 810.000 F 0 E 0 n° of journalists*journalist’s salary Third parties collaborations = € 850.000 Advertising = € 1.850.000 Total fixed specific costs = € 3.760.000 FIRST SEGMENT MARGIN = € 6.530.000 Common costs allocation to segment Marketing: let’s imagine the allocation base is the number of copies sold. We have to allocate costs which are € 559.500. We have chosen an allocation base which is represented by the number of copies sold. The value of allocation base is € 18.650.000. Allocation rate = 559.500 / 18.650.000 = 0,03 F 0 E 0 total cost to allocate / total value of allocation base The meaning of this rate is: marketing costs are € 0,03/copy. Administration: in this case the allocation base is the yearly numbers issue. Costs: € 535.000 Allocation base value: 107 Allocation rate = € 535.000 / 107 = € 5.000 F 0 E 0 total cost to allocate / allocation base value Administrative costs are € 5.000/issue. Total marketing allocated costs = € 0,03 * 11.900.000 = € 357.000 F 0 E 0 allocation rate*copies sold Total administrative allocated costs = € 5.000 * 50 = € 250.000 F 0 E 0 allocation rate*number of issues Choosing an allocation base means to distribute costs in proportion of the value of this base. N° of copies “Il dado è tratto” ÷ Total copies sold = 11.900.000 / 18.650.000 = 0,638 = 64% F 0 2 4 We can allocate costs in proportion of this. Allocated marketing = 64% * 357.000 = 228.480 Total allocated costs = € 607.000 NET SEGMENT MARGIN = 1st segment margin – common costs allocated = € 6.530.000 – € 607.000 = € 5.923.000 Cost volume and profit analysis The methodology uses the distinction between variable and fixed costs. The name refers to the fact that the methodology wants to support managers in understanding that there are relationships between the cost structure, which means the proportion between variable and fixed costs, the activity level and the profits. The methodology links together cost structure, level of activity and results. Example on the Giulio Cesare Editore case Referring to one single product we don’t talk about first segment margin but about operating margin. Breakeven analysis supports managers in understanding how many copies they need to sell if they want to avoid losses or reach an operating profit equal to zero. Breakeven revenues are not how many copies, but how much in terms of revenues we need to have to get the operative profit equal to zero. F 0 E 0 in other words: which quantity we need to sell if we want to reach a target operative profit? This is called sensibility analysis: what happens to our outcomes and results if we change prices, volumes, level of costs, … To answer to all those questions we have to distinguish between variable and fixed costs. Unit selling price = Revenues / Tot volume = 45.850.000/11.900.000 = € 3,85 Unit variable costs = Tot variable costs / Tot volume = 35.560.000/11.900.000 = € 2,99 Unit contribution margin = Unit selling price – Unit variable costs = € 3,85 - € 2,99 = € 0,86 F 0 2 4 The company gets a contribution margin of € 0,86 by selling each copy For each copy sold we contribute in making profit for €0,86. The unit contribution margin is the same if you calculate it by dividing the total contribution margin by the total volume. The unit contribution margin is the contribution, so it represents what remains to improve profits by the selling of one single product of the company. One magazine sold brings on average to the company € 3,85 of revenues (unit price) and determine € 2,99 of variable costs. € 3,85 enter and € 2,99 need to exit. What remains of each unit sold is the difference between these two. There is another way, another key performance indication which uses the contribution margin F 0 E 0 contribution margin index: is the contribution margin in percentage of selling price. Contribution = Unit = € 0,86 / € 3,85 = 22,44% margin index or Profit Volume Ratio contribution margin / Unit selling price For each euro of revenues, we get € 0,2244 of margin F 0 E 0 the margin is the 22,44% of revenues. This can be calculated on unit value: Contribution margin index = Contribution margin / Total revenues = 10.290.000 / 45.850.000 = 22,44% The unit contribution margin measures a euro value, so how many euro remains for each sell unit. The contribution margin index indeed, it’s a percentage so what’s the value of the contribution margin upon revenues. This company has also fixed costs which we say do not vary with volume, so that means that you can’t express fixed costs in unit terms, it would be a nonsense dividing fixed costs by the total volume because fixed costs do not vary with volume so fixed costs need to be considered in their total amount. Fixed costs = € 3.760.000 We can express the so-called cost function of this company. It is the function that describes costs in dependence of volume of activity. Total costs = fixed costs + variable costs = € 3.760.000 + € 35.560.000 = € 39.320.000 F 0 E 0 way to determine cost function because fixed costs are not linked to the volume so you can only express in total amount but variable costs depends on volume so each added volume means € 2,99 of variable costs. This is very useful because it is what is normally reported in cost volume profit chart where on the horizontal asset you report the volume of activity (in this case number of copies), while in the vertical asset you report costs or revenues. Even if the company doesn’t sell anything we have € 3.760.000 of fixed costs. Fixed costs are also called capacity costs, because are costs you need to incur because you have set up a given strategy. For each copy the cost curve increase of 2,99, which are our variable costs. Starting from a volume of 11.900.000 of copies at that level of activity which are the total costs of our company? They are: € 3.760.000 + 2,99 * 11.900.000 = € 39.320.000 F 0 E 0 at this level of activity (11.900.000) total costs are € 39.320.000 Total cost are the difference between profits and revenues. Total costs = € 45.850.000 - € 6.530.000 = € 39.320.000 It is useful for us to consider our cost and revenue curve as linear, even if we know in reality these are not linear and just to remain in this situation: 1. Revenues are also linked to advertising that doesn’t depends on number of copies sold. These are revenues that depends on number of issue, so probably they are not perfectly linear. 5. Quantity to obtain an OP of € 7.000.000 after taxes of 40% We want to get a profit that after taxes is € 7.000.000. 1. PROFITS X – X * 0,4 = € 7.000.000 X = profits X = € 7.000.000 / (1- 0,4) = € 11.666.666,67 2. QUANTITY BE(Q) = (fixed costs + target profits) / unit contribution margin = (€ 3.760.000 + € 11.666.666,67)/ € 0,86 = 17.937.984,5 6. Quantity to obtain an OP of 15% of sales Q * 3,85 – Q * 2,99 - 3.760.000 = 0,15 * Q * 3,85 Q * 0,2825 = 3.760.000 Q = 3.760.000 / 0,2825 = 13.309.735 If you want a target profit expressed in terms of return on sales (ROS) of 15% you need to sell 13.309.735 copies. Once you determine your functions linear, make this kind of calculation. Let’s imagine our target return on sales is 20%. We have to substitute 0,15 with 0,20. F 0 E 0 Q * 3,85 – Q * 2,99 - 3.760.000 = 0,20 * Q * 3,85 Q * 0,09 = 3.760.000 Q = 41.777.777 F 0 E 0 these are not inside the relevant range. If you want to sell 41.777.777 copies you need to probably produce new magazines, try to reach other customers, hire new journalists, changing cost structure. This has not be considered short term decisions but long term decisions because you are changing the level of capacity F 0 E 0 strategic decisions. We need to look at different alternatives, we need to find a way to reach this target by changing inside the relevant range which is relevant in short term. 8. Unit variable costs to obtain an OP of 15% of sales In this case the only variable is the unit variable costs. 3,85 * 11.900.000 – X * 11.900.000 – 3.760.000 = 0,15 * 11.900.000 * 3,85 45.815.000 – X * 11.900.00 – 3.760.000 = 6.872.250 X = 35.182.750 / 11.900.000 = € 2,956 F 0 E 0 unit variable costs Unit margin = € 3,85 - € 2,956 = € 0,894 Contribution margin = € 0,894 * 11.900.000 = € 10.638.600 Profit = € 10.638.600 - € 3.760.000 = € 6.878.600 9. 0 profit if the price +0,25 and volumes -100.000 Unit contribution margin = € 0,86 + € 0,25 = € 1,11 Contribution margin = € 1,11 * 11.800.000 = € 13.098.000 Profit = € 13.098.000 - € 3.760.000 = € 9.338.000 If we just change prices and we have no impact on all the other variables, we will have an increase value in terms of revenues and this increase will be transmitted on our profit because all the rest will remain the same. So we’ll never make hypothesis of simply changing prices. When a company changes prices normally has an impact in terms of quantity. The distance between cost curve and revenues curve is increasing, because the unit contribution margin is passed from € 0,86 to € 1,11. You will register an increase of the level of profits. 11. Margin on safety (quantity) We are talking about risk indicators: they measure the risk of the company in terms of profits and losses area. Margin of safety: how much in terms of quantity or revenues a company can loose before entering in the losses area. Margin of safety (Q) = Quantity – BE (Q) = 11.900.000 – 4.348.299,32 = 7.551.700,68 The company can lose 7.551.700,68 copies before entering in the losses area. You can express this value in percentage: Margin of safety (Q) % = (Quantity – BE (Q)) / Quantity = (11.900.000 – 4.348.299,32) / 11.900.000 = 63,45% 12. Margin of safety (revenues) Margin of safety (R) = Revenues – BE (R) = € 45.850.000 - € 16.755.793,23 = € 29.094.206,77 Margin of safety (R) % = (Revenues – BE (R)) / Revenues = (€ 45.850.000 - € 16.755.793,23) / € 45.850.000 = 63,45% These are risk indicators because the higher is the margin of safety, the lower is the risk for the company to fall in the losses area. Another risk indicator is the so-called degree of operating leverage: it measures the impact that a change in volumes determine on profits F 0 E 0 links the variation in revenues in terms of quantity with revenues in terms of operative profits. The DOL works by this way: variation in percentage in terms of quantity multiply by the degree of operation leverage equal variation in percentage of our profits. Degree of operating leverage = Contribution margin / Operative profits = € 10.290.000 / € 6.530.000 = 1,58 Δ % Revenues * Degree of operating leverage = Δ % Operative profits 10 % * 1,58 = 15,8% You can use DOL not doing income statement again on different level of activity but simply applying it. With a DOL of 1,58 what happens? Volume increase by 10%. The variation in percentage of the operative profit will be operative profit * 10%. If you increase again your volumes, you will increase also your variable costs F 0 E 0 what happens in revenues with decrease of 8%? Determine DOL. Why the degree of operating leverage in a risk indicator? If we don’t have a higher DOL the impact on our profits will be higher. What determines the fact that this DOL is higher or lower? It is higher when the distance between contribution margin and the breakeven quantity is higher and between the 2 we have fixed costs. So the higher fixed costs are, the higher the DOL is. RIGID FLEX If you have a lot of fixed costs the variation in terms of quantity determines a higher variation in terms of quantity determines a higher variation in terms of revenues. On the contrary, if you have low fixed costs the same variation in terms of quantity determines a smaller impact on your profits. When perspectives are good, the company has more fixed costs. If it isn’t so, they have more variable costs (outsourcing). Non solo oscar case VAT = Value Added Taxes Question 1 Ticket price € 7,5 Advertising € 0,30 Bar € 1,50 TOTAL REVENUES € 9,30 Music nights € 0,12 Renting € 2,80 Tickets € 0,08 VAT € 0,70 COGS bar € 0,30 TOTAL VARIABLE COSTS € 4 UNIT CONTRIBUTION MARGIN € 5,30 Salaries € 900.000 Cleaning € 150.000 Marketing € 300.000 Maintenance € 300.000 Utilities € 250.000 Service € 300.000 TOTAL FIXED COSTS € 2.200.000 BE (Q) = fixed costs / unit contribution margin = €2.200.000 / € 5,30 = 415.094 Question 2 The breakeven point in terms of quantity will be lower in the second option because fixed costs are lower and will be higher for the first option. Which is the best option? The best option is the one that gives lower risks. In a few years should we buy or should we rent? Expectations in time. So how long wants Mr. Morphews remain in this cinema? Probably not short period. Leasing and depreciation in the first period will disappear. CVP is a short term methodology. Cost volume profit analysis in multiproduct companies We will refer to the “Non Oscar” example. Multiproduct = we are considering a company with many different products, or many different segments. We will answer to our questions with reference to the entire Mix (R) A = revenues A / revenues tot = € 360.000 / € 480.000 = 75% Of revenues comes from product A Mix (R) B = revenues B / revenues tot = € 120.000 / € 480.000 = 25% The weighted average contribution margin index can be expressed as WACMI. Focus on the overall company F 0 E 0 also common costs! BE (Q) A = BE (Q) tot * Mix (Q) A = 1200 * 66,67% = 800 BE (Q) B = BE (Q) tot * Mix (Q) B = 1200 * 33,33% = 400 BE (Q) tot = (fixed costs + common costs) / unit contribution margin = (€ 117.000 + € 39.000) / € 130 = 1200 BE (R) A = BE (R) tot * Mix (R) A = € 320.000 * 75% = € 240.000 BE (R) B = BE (R) tot * Mix (R) B = € 320.000 * 25% = € 80.000 BE (R) tot = (fixed costs + common costs) / contribution margin index = (€ 117.000 + € 39.000) / 48,75% = € 320.000 A company however has to consider the mix between the 2 products. The unit contribution margin is based on the mix of quantity between product A and product B. these is only one way for the company to sell this quantity and get to breakeven, which is selling the 2 products respecting the quantity mix which bring us to 130. so it is not enough to say the company need to sell 1.200. how many products A? product A has to be always 66,67% of the quantity. Let’s imagine a different mix in terms of quantity. A B TOT Mix (Q) 40% 60% 114 150 * 40% + 90 * 60% F 0 E 0 contribution margin If you produce 130 but you get only 114 you don’t cover fixed costs. F 0 E 0 what can they ask during the exam? Next year, the company expects to change something, in volumes, price, … Batches: methodology useful when you have to do with quantity, not revenues. A way to consider the mix is referring to batch. The company we have seen has sells for 1.200 product A and 600 product B. another way to express the mix is to say that for each product B sold, the company sells 2 products A. the company sells batches or products that are made up by 2 products A and 1 product B. By this way we are respecting the mix in terms of quantity, so we can determine the contribution margin coming from each batch. Contribution margin per batch = unit contribution margin A * 2 + unit contribution margin B * 1 = 150 * 2 + 190 * 1 = € 390 By selling one single batch the company gets € 390 of contribution margin. How many batches should the company sell to reach the breakeven? BE (Q) in terms of batch = = (fixed costs + common costs) / contribution margin per batch = (€ 117.000 + € 39.000) / € 390 = 400 The company sells 1.200 and 600 so we can say that any 2 products B sold, the company sells 1 product A. SUM UP ABOUT CVP ANALYSIS III. LINEARITY III..i In REVENUES: price is considered as a constant; unit selling price is considered a constant in our relevant range. III..ii In COSTS: unit variable costs are considered as a constant, fixed costs are considered as a constant too, so they don’t change in our relevant range. IV. INVENTORY UNCHANGE We produce what we sell because revenues depend on sales but costs depend on production se to keep this analysis meaningfully we have to assume that inventory does not change during the period so cost and revenues can be compared. V. In multiproduct companies MIX is assumed to be CONSTANT. Traditional costing system We know that: 1. Cost measurement system wants to measure the cost of an object (product, department, activity, customer); sometimes the company wants to measure in terms of costs. 2. We have different kinds of costs: some are directly assigned to the cost object because they are direct or specific, other costs are indirect or overhead and these costs need an allocation process. The problem now is to enter to allocation process in management accounting. 3. the first distinction is between manufacturing costs and non manufacturing costs. Manufacturing costs are considered as product costs which means that in production companies they are allocated. Non manufacturing costs are period costs, and they are allocated to products just for pricing decisions but not for inventory evaluation or cost of good sold evaluation. Non manufacturing costs always enter in income statement in its overall value. Which are the most common manufacturing costs? a. Direct materials Directly traced to our cost objectb. Direct labor c. Overhead They can’t be directly traced so they need an allocation process If you want to measure variable or fixed costs, direct materials are variable (because they are incurred only with production; one more product determines direct material costs). The same is for direct labor. Overhead costs are both variable and fixed. So for example our energy consumed in production of a product can be considered as variable cost, but it is not completely and always traced as variable. So it s indirect cost because we can’t measure precisely the consumption for each single product. We tend to consider energy costs as overhead or indirect costs. Non manufacturing costs are usually: commercial, administrative, general. Normally administrative costs are fixed, general costs are fixed, commercial costs are fixed but they should be variable in the commercial area for example sales commissions (agents). Or in some cases transports are costs that can be considered variable. So normally variable costs are manufacturing. The allocation process refers to overhead manufacturing and to non manufacturing costs which are indirect and need to be allocated. With reference to the single product is the full manufacturing costs or full production costs, for pricing purposing companies need to allocate product to non manufacturing costs, in order to find the overall cost of the production. Manufacturing costs + Non manufacturing costs = Full company costs So in this part of the program we will focus on the full manufacturing costs and talking about cost assignment, means to define the alternatives in terms of overhead allocation to product. We can distinguish between traditional cost measurement system and others. Traditional cost measurement system are 2 mainly kinds: 1. Blanket rate: for all the overhead manufacturing costs the company defines are single rate. The company calculates one single rate putting together all the overheads manufacturing costs and dividing them by a unique allocation base. Allocation rate = Overhead manufacturing costs / Unique allocation rate Example: We have a company with overheads which are € 900.000 and chooses as allocation base direct labor hours, let’s imagine are 60.000 Allocation rate = Overhead manuf. costs / Unique allocation rate = € 900.000 / 60.000 = € 15 / d.l.h. If this company has 2 products, A and B, and the number of direct labor hour for each product is 10 and 10, the company will allocate overhead costs (10*15) € 150 for product A and € 150 for product B. We need to consider a more complex situation. Let’s imagine this company has a production process with 3 different departments. D1 D2 D3 Overhead € 200.000 € 600.000 € 100.000 Direct labor hours 20.000 20.000 20.000 F 0 2 4 Weight of allocation Machine hours 15.000 10.000 - - - The problem here is that refectory, maintenance and ICT don’t produce products. If we identify an allocation base, we cannot use the allocation base to allocate costs to the products. Normally traditional cost system tend to operate in this way: 1. Identify costs for each cost center because it is useful for responsibility of each cost center. 2. If these cost centers are service cost centers, it means that they offer services to the final cost centers. So instead of allocating them to product, the traditional cost measurement system allocate these costs to final cost center F 0 E 0 this allocation is between the first and the second step. We can have 2 different methods: 1. DIRECT METHOD Let’s assume the number of people workers are tot, personal computers are tot and machine hours are tot. The direct method F 0 E 0 service cost centers are allocated only to final cost centers and if there are services delivered to other cost centers, these are ignored. This method allocates costs only to final cost center. Exercise A Refectory allocation € 12.000 (Costs allocated) € 12.000 = € 100 / workers 80 + 40 (Allocation rate) 120 Cutting costs = € 100 * 80 = € 8.000 Allocation to final Assembly costs = € 100 * 40 = € 4.000 B Maintenance allocation € 12.000 = € 12.000 = € 0,48 / machine hours15.000 + 10.000 25.000 Cutting costs = € 0,48 * 15.000 = € 7.200 Assembly costs = € 0,48 * 10.000 = € 4.800 C Production ICT allocation € 50.000 = € 50.000 = € 2.500 / personal computers8 + 12 20 Cutting costs = € 2.500 * 8 = € 20.000 Assembly costs = € 2.500 * 12 = € 30.000 TOT CUTTING COSTS = (€8.000 + €7.200 + €20.000 + €60.000) = € 95.200 TOT ASSEMBLY COSTS = (€100.000 + €4.000 + €4.800 + €30.000) = € 138.800 Machine hours = € 95.000 = € 6,34 / mh € 138.800 = € 13,88/ mh 15.000 10.000 6,34/mh and 13,88/mh are used to allocate costs to products. 2. STEP METHOD It tries to overcome some limits of this method which are both in terms of accuracy and responsibility. The step method takes into account relationships between service centers F 0 E 0 companies normally allocates cost centers with higher level of costs. In this case, if you have to decide to allocate refectory of ICT, you start considering that ICT costs are higher than refectory cost F 0 E 0 ICT. Exercise Cutting Assembly Quality control Maintenance Guardian Costs 130.00 249.000 35.748 37.920 75.500 n. of maintenance 64 48 16 n. of quality controls 5.748 2.700 Sq. meters 456 752 190 112 Guardian 22.800 37.600 9500 5600+37.920 =43.520 costs to allocate Maintenance 21.760 16.320 5.440+9.500 +35.748 =50.688 costs to allocate Quality control 34.488 16.200 Based on cost we allocate (in order from highest to lowest): guardian, maintenance and quality control. A Guardian allocation € 75.500 = € 75.500 = € 50 / sqm 456+752+190 +112 1.510 Cutting costs = €50*456 = € 22.800 Assembly costs = €50*752 = € 37.600 Quality control = €50*190 = € 9.500 Maintenance = €50*112 = € 5.600 B Maintenance allocation € 43.520 = € 43.520 = € 340 / maintenance64+48+16 128 Cutting costs = €340*64 = € 21.760 Assembly costs = €340*48 = € 16.320 €340*16 = € 5.440 C Quality control allocation € 50.688 = € 50.688 = € 6 / quality control 5.748+2.700 8.448 Cutting costs = €6*5.748 = € 34.488 Assembly costs = €6*2.700 = € 16.200 Explain when departmental rates are preferred 1. Overheads are relevant. 2. You want to be accurate in your cost measurement system. 3. You have many different departments with different costs and products consume differently the resources of each single department. Explain the differences between direct and step method in service center allocation Direct method allocated directly costs to production centers; other services centers are ignored. The step method is more accurate but requires to select the exchanges of services to be measured identifying a sequence in allocation process. Why do you need to use budgeted overhead rates? 1. Need to understand costs if you want to set price. 2. Actual costs, measured each month, in terms of overhead, the allocation rates are based on costs and on the value you choose. In each month costs and value of allocation base can be different. What’s the need for managers and is it most useful for a manager to have different allocation rates each month or not? NO because managers don’t need to have different allocation rates each month, otherwise they don’t understand anything: you cannot change each month prices. What is required is to define a normal value which is an average between different months on different levels of costs you can have. Each month you can have a normal variation F 0 E 0 normal allocation rate based on your normal capacity, set cost level which you can use each month to allocate you cost and which is an average (estimated) of the normal variation you should have in different months. 3. Cost measurement system works continuously inside the company, so each single day it has the need to allocate costs F 0 E 0 continuous cost allocation. This is represented in the cart: manufacturing companies every single day produce products. They normally produce by batch (a job order), it is an activity planned for today. We want to produce 10.000 products and we send the order to produce 10.000. this is a batch composed by 10.000 products. With this order someone goes to raw material store to take them. Someone else starts to produce and employs direct labor hours, machine hours in different departments and the cost measurement system measure these costs through allocation to the job order. Manufacturing overheads need to be allocated to our job order together with direct materials and direct labor to define the manufacturing costs. The allocation rates are continuous because companies have a lot of allocation rate. Example 10.000 felt pens Direct materials = € 1 (for each unit) Raw materials warehouse = € 10.000 Direct labor = 1 min. Direct labor cost = € 0,2/min TOT direct labor = 10.000 * 1 min * € 0,2 = € 2.000 To define production costs we need also to allocate overhead. In the traditional cost measurement system we have different department service/final department: • cutting F 0 E 0 receive costs from service department, the final department defines a proper allocation base (direct labor hours, machine hours, …) and we have many different overhead allocation rate. • assembly • packing