Managerial Accounting 1: Calculating Product Profitability

Calculating Profitability

• To calculate profitability per product/service, it's essential to calculate the cost of those products and services to subtract from sales.
• There are several ways to calculate costs.

Cost Classification

• Direct Costs: Costs that can be unambiguously traced to a cost object.
• Indirect Costs: Costs that represent a resource consumed by several cost objects, requiring allocation to each concerned cost object.
• Variable Costs: Costs that change in total in proportion to changes in the related level of total activity.
• Fixed Costs: Costs that remain unchanged for a given time period, despite wide changes in the related level of total activity.
• Relevant Costs: Expected future costs that differ among alternative courses of actions being considered.
• Relevant Revenues: Expected future revenues that differ among alternative courses of actions being considered.
• Sunk Costs: Past costs that are unavoidable because they will be incurred no matter what action is taken.
• Avoidable Costs: Costs that will not be incurred if an activity is suspended.

Management Accounting

• Management Accounting provides information to help managers make decisions to fulfill the strategic goals of the organization.
• It measures, analyzes, and reports financial and non-financial information.
• It also provides information to Financial Accounting.

Decision-Making Questions

• Should a company launch or drop an activity based on profitability?
• What is the minimum cost if a company accepts an additional order?
• What is the minimum activity to avoid losing money?
• How do costs behave in relation to volume?
• Should a company outsource an activity or carry it out internally?
• Should a company prefer a cost structure with variable or fixed costs?
• How to share the cost of headquarters between different products/services?
• Will decreasing price to gain volume offset the price decrease?
• How to decide which products/services to focus on when constrained by production capacity or raw materials?

Characteristics of Management Accounting Information

• Forward-looking: Instead of historical, Management Accounting information is focused on future decisions.
• Model-based: With a degree of abstraction to support decision making, rather than case-based.
• Intended for managers: instead of being intended for shareholders, creditors, and public regulators.
• Confidential: Usually confidential and used by management, instead of publicly reported.
• Computed by reference to manager needs: Often using management information systems, instead of by reference to general financial accounting standards.

Cost Accounting vs. Management Accounting

• Cost Accounting: Determination of cost and cost control are the primary roles of cost accounting, using cost-related data from financial accounting.
• Management Accounting: Provides necessary information to the management in the process of planning, controlling, and performance evaluation, and decision-making, using both quantitative and qualitative data.

Accounting and Financial Information

• Accounting is a discipline that provides financial information to various stakeholders.
• Financial accounting has the primary purpose of providing information to shareholders to assess a company's financial situation.
• Financial accounting information can be used as the legal basis for calculating certain obligations, such as dividends, and as evidence in case of litigation to detect fraud.

Management Accounting vs. Financial Accounting

• Management accounting (cost accounting) is focused on internal decision-making, whereas financial accounting (general accounting) is focused on external reporting.

Objectives of Financial Accounting

• The primary objective of financial accounting is to provide information to external users, such as investors and lenders, which is useful for making decisions.
• The financial information has to meet certain quality criteria, including comparability, reliability, and relevance.

External Users of Financial Accounting Information

• The two main external user groups of financial accounting information are investors and lenders.
• Investors are interested in information about a company's performance, profitability, and financial position.
• Lenders are interested in information about a company's creditworthiness and ability to repay debts.

Internal Users of Financial Accounting Information

• Internal users of financial accounting information include management and employees.
• Internal users create a dilemma, as they require detailed and timely information, while external users require summarized and periodic information.

Financial Statements

• The balance sheet provides information about a company's financial position, including the level of debt.
• The income statement provides information about a company's performance, including profit, for a given period.
• The cash flow statement provides information about a company's cash inflows and outflows, including cash flow generated by operations, investments, and financing activities.