Accounting for Decision Making (ADM) Notes PDF

# Accounting for Decision Making (ADM) ## Financial Accounting vs. Cost & Mngt. Accounting | | | | | | :-------------------- | :--------------------------------- | :------------------...

# Accounting for Decision Making (ADM) ## Financial Accounting vs. Cost & Mngt. Accounting | | | | | | :-------------------- | :--------------------------------- | :-------------------- | :----------------------------------- | | Purpose | | Reporting Format | | | Users | | Information Precision | | | Orientation | | Reporting Entity | | | Information Content | | | | | Underlining Structure | | | | | Framework | | | | | Reporting Frequency | | | | ## What is the course all about? Accounting for Decision Making [Cost & Management Accounting (CMA)] **Information System** that **Creates Value** for **Internal Users** ## Management Decisions & CMA A diagram of a flow chart showing the relationship between management decisions and the CMA system. * **Management Decision** * Planning * Organizing * Implementation & Control * Feedback * **CMA System** * Budgets * Accounting System * Performance Reports ## Value Created by CMA Information * **Measurement purpose.** * Measurement of revenues, costs, and assets. * **Control purpose.** * Evaluate operations and (if needed) assign corrective action to person/organization unit responsible. * **Alternative courses of action purpose.** * Analyze information and choose best course of action. ## Course Learning Outcomes (CLO) 1. Explain the various concepts of costs and classify the elements of cost based on various classifications. 2. Estimate the full cost of a product/service and determine the basis of allocating overhead costs. 3. Analyze the impact of cost, volumes and selling price on profits by applying the concept of relevant cost for decision-making.. 4. Formulate a master budget as a tool for planning and appraise the actual performance with the help of variance analysis. ## Value Created by CMA Information - Course * **Measurement purpose.** (CLO 2) * Full Cost Accounting - Module I * **Control purpose.** (CLO 4) * Responsibility Accounting – Module III * **Alternative courses of action purpose.** (CLO 3) * Differential Cost Accounting – Module II ## Syllabi – CLOs – Sessions – Assessment Scheme | No. | Module Name | CLO Mapped | #Sessions Mapped | | :--- | :-------------------------------------------------- | :---------- | :--------------- | | I | Full Cost & Overhead Allocation | 1, 2 | 2 to 12 | | II | CVP Analysis & Relevant Cost for Short Run Decision Making | 1, 3 | 13 to 21 | | III | Using Budgets & Variance Analysis for Operational Performance Evaluation | 1, 4 | 22 to 30 | ## CMA Guidelines * **Cost - Benefit approach** is commonly used: benefits generally must exceed costs as a basic decision rule * **Behavioral & Technical Considerations** – people are involved in decisions, not just money * **Different definitions of cost** may be used for different applications ## General Observations on CMA * **Different numbers for different purposes.** * **Different types of costs:** historical, standard, overhead, variable, fixed, differential, marginal, opportunity, direct, estimated, full, etc. * **Accounting numbers** are approximations. * **Accounting evidence** is only partial evidence. * **Working with incomplete data.** * **People not numbers** get things done. * **How you use the numbers** is as important as how the numbers are produced. ## CLO - 1 Explain the various concepts of costs and classify the elements of cost based on various classifications. ## Cost & Cost Concepts - Agenda 1. What is Cost? 2. What is Cost Object? 3. Direct and Indirect Cost - Traceability of Cost to Cost Object 4. Flexible (variable) and Fixed Cost - Behaviour of cost to Volume * Relationship b/W Direct-Indirect & Flexible-Fixed 5. Elements of Product Cost 6. Manufacturing and Non-Manufacturing Costs 7. Period Cost and Product Cost 8. Marginal Cost and Opportunity Cost 9. Prime Cost and Conversion cost 10. Full Cost and Unit Cost ## Cost and Cost Object * **Cost** is a resource sacrificed, used-up or forgone to achieve a specific objective. * **A cost object** is something for which we want to compute a cost. * **A cost object** can be any unit of analysis including product, product line, customer, department, division, geographical area, country, or continent. For example; * A product * A pair of pants * A product line * Women's boot cut jeans * An organizational unit * The on-line sales unit of a clothing retailer ## Costs and Elements of Cost * GAAP defines cost as the monetary value of goods and services expended to obtain current or future benefits. * Costs incurred to receive future benefits are recorded as assets. Also known as Capital Expenditure (Capex). * Expenses are the costs of goods or services that have expired. i.e., used up in the process of creating and selling goods or services. Also known as Operating Expenses (Opex). * **Elements of Costs (examples)** * Material (Direct and Indirect) * Labour (Direct and Indirect) * Manufacturing Overheads * Other Non-Manufacturing Expenses (Sales, General Administration-SGA, Finance cost etc.) * ## Classification of Cost Based on TRACEABILITY 1. Direct Cost 2. Indirect Cost ## Direct Cost * A cost of a resource or activity that is acquired for or used by a single cost object * EXCLUSIVELY caused by a particular cost object * DIRECTLY ATTRIBUTABLE to a particular cost object * can be traced to a cost object in an economically feasible manner * **Cost object = A dining room table** * Cost of the wood that went into the dining room table * **Cost object = Line of dining room tables** * A manager's salary would be a direct cost if a manager were hired to supervise the production of dining room tables and only dining room tables. ## Indirect Cost * The cost of a resource that was acquired to be used by more than one cost object * Cannot be traced to a single cost object * Cost of resource jointly/commonly consumed by more than one cost objects * Either not feasible or not desirable to trace to a single cost object * The cost of a saw used in a furniture factory to make different products * It is used to make different products such as dining room tables, china cabinets, and dining room chairs ## Direct or Indirect...??? * A cost classification can vary as the chosen cost object varies. * Consider a factory supervisor's salary * If the cost object is a product, the factory supervisor's salary is an indirect cost * If the factory is the cost object, the factory supervisor's salary is a direct cost. * Direct Costs are traced to a cost object. * Indirect Costs are allocated to a cost object using a suitable base of allocation. ## Assignment of Costs to a Cost Object This image shows a diagram of a two-sided flow chart. * **Type of Cost** * **Direct Costs** * Example: Cost of steel and tires for the BMW X6 * **Indirect Costs** * Example: Lease cost for Spartanburg plant where BMW makes the X6 and other models of cars * **Cost Assignment** * **Cost Tracing** * based on material requisition document * **Cost Allocation** * No requisition document * **Cost Object** * Example: BMW X6 ## Classification of Cost based on BEHAVIOUR 1. Variable (Flexible) Cost 2. Fixed (Capacity Related) Cost ## Cost Behavior * **Variable costs** - change in total in proportion to changes in the related level of activity or volume of output produced. * **Fixed costs** - remain unchanged in total, for a given time period, despite changes in the related level of activity or volume of output produced. * **Variable costs** are constant on a per-unit basis. * **Fixed costs per unit** change inversely with the level of production. As more units are produced, the same fixed cost is spread over more and more units, reducing the cost per unit. ## Graphs of variable and fixed costs * **Panel A: Variable Cost of Steering Wheels at $60 per BMW X6 Assembled** * A graph showing a straight line from the origin to $2,000,000 at 4,000 units. The line is labelled "Total Cost of Steering Wheels". The x-axis is labelled "Number of X6s Assembled" in intervals of 1,000 units. The y-axis is labelled "Total Cost of Steering Wheels in intervals of $500,000. * **Panel B: Supervision Costs for the BMW X6 assembly line (in millions).** * A graph showing a horizontal line at $3,000,000 from 0 to 60,000 units. The line is labelled "Total Supervision Costs" The x-axis is labelled "Number of X6s Assembled" in intervals of 20,000 units. The y-axis is labelled "Total Supervision Costs" in intervals of $1,000,000. ## Fixed or Variable...? * Costs are fixed or variable only with respect to a specific activity level or a given time period. * **Relevant range** - the band or range of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and the cost in question. * Fixed costs are considered fixed only within the relevant range. * All costs in long run are variable (not proportionately though!) ## Cost Behavior Summarized | | Total Cost | Cost Per Unit | | :----------------------- | :--------------------------------------------------------------------- | :------------------------------------------------------------------------------------------------- | | Variable Costs | Change proportionately with volume of output. More output = More cost | Unchanged in relation to output | | Fixed Costs | Unchanged in relation to output | Change inversely with output. More output = lower cost per unit | ## Multiple Classifications of Costs * **Assignment of Costs to Cost Object** * **Direct Costs** * Cost object: BMW X6s produced * Example: Tires used in assembly of automobile * Cost object: BMW X6s produced * Example: Salary of supervisor on BMW X6 assembly line * **Indirect Costs** * Cost object: BMW X6s produced * Example: Power costs at Spartanburg plant. Power usage is metered only to the plant, where multiple products are assembled. * Cost object: BMW X6s produced * Example: Annual lease costs at Spartanburg plant. Lease is for whole plant, where multiple products are produced. ## Cost Classification Exercise Handout. ## Other Classifications of Cost 1. Product (Inventoriable) Cost and Periodic Cost 2. Prime Cost and Conversion Cost 3. Unit Cost and Full Cost 4. Marginal Cost and Opportunity Cost 5. Sunk Cost 6. Differential Cost and Non-Differential Cost 7. Standard Cost and Actual Cost 8. Engineered Cost and Discretionary Cost ## Product Cost & Periodic Cost – Reinforcement This image shows a diagram of a flow chart showing the relationship between inventoriable costs, product cost and periodic costs. * **Inventoriable Costs** * Direct Material Purchases $73,000 * Direct Manufacturing Labor $9,000 * Manufacturing Overhead costs $ 20,000 * Direct Material Inventory * Beg. inv.. $11,000 * End. inv.. $8.000 * Total Manufacturing Costs Incurred in 2011 $105,000 * Direct Material Used $76,000 * Work in Process Inventory * Beg, inv., $6,000 * End. inv., $7.000 * Cost of Goods Manufactured $104,000 * Finished Goods Inventory * Beg. inv., $22,000 * End. inv., $18,000 * **Income Statement** * Revenues $210,000 * Cost of Goods Sold (an expense) $108,000 * Equals Cross Margin $102,000 * R & D Costs * Design Costs * Marketing Costs * Distribution Costs * Customer-Service Costs * Equals Operating Income $32,000 * Period Costs * $70,000 ## Prime Cost and Conversation Cost | | | | :------------------------- | :---------------- | | Direct Material | A | | Direct Labour | B | | Prime Cost or Direct Cost | A + B | | Indirect Material, Labour and Manufacturing costs | C | | Full Factory Cost or Full Cost of Production | A + B + C | | General Administrative, Selling and finance costs | D | | Full Cost | A + B + C + D | **Conversation Coat =** Direct Mnfg. Labour + Indirect Material, Labour and other Manufacturing costs ## CLO - 1 So far... Explain the various concepts of costs and classify the elements of cost based on various classifications. ## CLO – 2 Estimate full cost of a product/service and determine the bases of allocating overhead costs. ## Uses of Full Unit Cost of Products/Services 1. **Pricing** * Price Followers and Price Influencers 2. **Profitability Assessments** * For examining the profitability of a segment/division/function. * Does it "carry its own weight" i.e. recover its share of costs plus a profit? 3. **Comparative Analysis** * For comparing the profitability of a segment/division/function with that of similar segments/divisions/functions. 4. **Other Uses** ## What is Full Cost Per Unit of Product/Service? **Full Cost per unit =** **It's Direct Costs +** **A fair share of Indirect Costs** ## Calculating Full Cost Per Unit 1. Identify the Cost Object 2. Determine Cost Center(s)/Pool(s) 3. Classify elements of costs into Direct and Indirect costs 4. **Assigning Cost to the Cost Object** * Tracing the Direct costs to the Cost Object * Deciding the base of allocating the Indirect Costs * Allocating Indirect costs to the Cost Object Collectively, the mechanism of computing full cost per unit of product/service is known as a Costing System ## Costing System – Full Cost & Unit Cost * **Cost Assignment** * **Cost Tracing** * Direct Costs * **Cost Allocation** * Indirect Costs * **Cost Object** * **Cost Center (Pool) & Cost Allocation Base**