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lOMoARcPSD|11350337 Managerial Accounting Financial statement analysis and managerial accounting (Università Cattolica del Sacro Cuore) Studocu is not sponsored or endorsed by any college or university Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement An...
lOMoARcPSD|11350337 Managerial Accounting Financial statement analysis and managerial accounting (Università Cattolica del Sacro Cuore) Studocu is not sponsored or endorsed by any college or university Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi MANAGERIAL ACCOUNTING MANAGERIAL ACCOUNTING: AN OVERVIEW Managerial accounng is something dierent from nancial accounng: the only thing that they have in common is the term accounng, that entails working with numbers, collecng data, organizing, and classifying data, and so on. As regards to managerial accounng, the audience is the management, from the top management up to the operang one: so, we’re talking about quantave informaon that are used at all levels of the organizaon (internal audience). If managerial accounng addresses the management with this informaon, the management will not need detailed informaon, but just aggregate measures of the company. The scope of this subject broadens very much, and dierently from nancial accounng, for which there were principles to organize the informaon, in managerial accounng we have free formats (basically there’s no accounng principles). However, the fact that there are more or less correct doesn’t mean that there are pracces that are more or less correct, so instead of having principles instuonalized by an accountancy body, there are methodologies that are suggested by best pracces. With regards to managerial accounng, we do have both historical, past data, but also forward-looking data, while in nancial accounng we were just looking about the past. If this data has to exert an inuence, of course it will exert an inuence on the audience that is addressed, so internally for managerial accounng and externally for nancial accounng. FINANCIAL AND MANAGERIAL ACCOUNTING: SEVEN KEY DIFFERENCES FINANCIAL ACCOUNTING External persons who make nancial decisions Historical perspecve Emphasis on objecvity and veriability MANAGERIAL ACCOUNTING Managers who plan for and control an organizaon Future emphasis Emphasis on relevance Emphasis on precisions Emphasis on meliness Primary focus is on companywide reports Must follow GAAP/IFRS and prescribed formats Mandatory for external reports Focus on segment reports Not bound by GAAP/IFRS or any prescribed format Not mandatory USERS TIME FOCUS VERIFIABILITY VERSUS RELEVANCE PRECISION VERSUS TIMELINESS SUBJECT RULES REQUIREMENTS WORK OF MANAGEMENT If we have to produce data that are meaningful for the managerial acvity, we have to know which is the managerial acvity implied: – – Planning: idenfying a target (an objecve) • Establish Goals • Specify How Goals Will Be Achieved • Develop Budgets Controlling: the control funcon 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 essenal part of the control funcon Decision making: decision making involves making a selecon among compeng alternaves • What should we be selling? • Who should we be serving? • How should we execute? PLANNING – Markeng majors 1 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi – – • How much should we budget for TV, print, and internet adversing? • 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 ulity expense? Human Resource Management Majors • How much should we plan to spend for occupaonal safety training? • How much should we plan to spend on employee recruitment adversing? CONTROLLING – – – Markeng majors • Is the budgeted price cut increasing unit sales as expected? • Are we accumulang 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 defecve units produced? Human Resource Management Majors • Is our employee retenon rate exceeding our goals? • Are we meeng our goal of compleng mely performance appraisals? DECISION MAKING – – – Markeng 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 producon 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 sta to lower our healthcare costs? • Should we hire temporary workers or full-me employees? ACCOUNTING MAJORS The IMA esmates that more than 80% of professional accountants in the U.S. work in non-public accounng environments. Employers expect accounng majors to have strong nancial accounng skills, but they also expect applicaon of the planning, controlling, and decision making skills that are the foundaon of managerial accounng. CERTIFIED MANAGEMENT ACCOUNTANT (CMA) To become a CMA requires membership in the Instute of Management Accountants, a bachelor’s degree from an accredited college, two connuous years of relevant professional experience, and passage of the CMA exam. CMA EXAM CONTENT SPECIFICATIONS Part 1 Financial Reporng, Planning, Performance, and Control External nancial reporng decisions Planning, budgeng, and forecasng Performance management Cost management Internal controls Part 2 Financial Decision Making Financial statement analysis Corporate nance 2 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Decision analysis Risk management Investment decisions Professional ethics CHARTERED GLOBAL MANAGEMENT ACCOUNTANT (CGMA) The CGMA designaon is co-sponsored by the American Instute of Cered Public Accountants (AICPA) and the Chartered Instute of Management Accountants (CIMA). One pathway to the CGMA requires a bachelor’s degree in accounng (accompanied by a total of 150 college credit-hours), passage of the Cered Public Accountant (CPA) exam, membership in the AICPA, three years of relevant management accounng 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 acvies. MANAGERIAL ACCOUNTING AND COST CONCEPTS 3 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi NEEDS OF MANAGEMENT – – Financial accounng is concerned with reporng nancial informaon to external pares, such as stockholders, creditors, and regulators. Managerial accounng is concerned with providing informaon to managers within an organizaon so that they can formulate plans, control operaons, and make decisions. COST CLASSIFICATION Purposes of Cost Classicaon 1. 2. 3. 4. 5. Assigning costs to cost objects Accounng for costs in manufacturing companies Preparing nancial statements Predicng cost behavior in response to changes in acvity Making decisions “Dierent costs for dierent 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 dierent type of information. Learning Objecve 1: Assigning costs to cost objects: direct costs and indirect costs DIRECT COSTS 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 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 parcular criteria) – Example: manufacturing overhead Whether the cost is direct or indirect depends on how we dene the cost object. The direct versus indirect cost is not a constant classicaon, but it depends on how we dene the cost object. Therefore, rst you have to say what is the cost object, and then with reference to the specic 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 Objecve 2: Classicaons of Manufacturing Costs We are so concerned about manufacturing costs because cost accounng 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 queson they all had was “how much does this product that we are manufacturing cost?” They dened 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 nished products → Includes indirect materials that cannot be easily or conveniently traced to specic units of product 4 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi → Includes indirect labor costs that cannot be easily or conveniently traced to specic units of product • Examples: Depreciaon of manufacturing equipment, Ulity costs, Property taxes, Insurance premiums incurred to operate a manufacturing facility • Only those indirect costs associated with operang the factory are included in manufacturing overhead However, there are also non-manufacturing costs. Therefore, there is a rst classicaon between direct or indirect cost, and then a second classicaon 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 Administrave costs: all execuve, organizaonal, and clerical costs. Administrave costs can be either direct or indirect costs Learning Objecve 3: Cost classicaons used to prepare nancial statements: product costs and period costs To prepare nancial statements, what is relevant is the disncon 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 nancial statements, and mainly the income statement and the balance sheet, will be included in the evaluaon of cost of goods sold and inventory. Product costs aach to a unit of product as it is purchased or manufactured, and they stay aached to each unit of product as long as it remains in inventory awaing 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 nal product Work in process: consists of units of product that are only parally 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 producon, 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 nished goods 3. Once units of product are completed, their costs are transferred from work in process to nished goods 4. When a manufacturer sells its nished goods to customers, the costs are transferred from nished goods to cost of goods sold Period costs are all the other costs, and they include all selling and administrave costs. They will inevitably be assigned to the period when the cost is incurred. What is the dierence between the two? The dierence is that anything that you dene as product cost, has two opons 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 depreciaon (product cost) B. Property taxes on corporate headquarters C. Direct materials costs (product cost) 5 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi D. Electrical costs to light the producon facility (product cost) E. Sales commissions Learning Objecve 4: Cost classicaons for predicng cost behavior: variable costs, xed costs, and mixed costs Cost behavior refers to how a cost will react to changes in the level of acvity, and it is essenal to do that since we are interests in seeing how the cost structure will react to changes in the volume of acvity. The most common classicaons are: – – – Variable costs • A cost that varies, in total, in direct proporon to changes in the level of acvity • A variable cost per unit is constant, even though it changes as the volume of acvity changes E.g. Raw materials Fixed costs • A cost that remains constant, in total, regardless of changes in the level of the acvity • If expressed on a per unit basis, the average xed cost per unit varies inversely with change in acvity • Two types of xed costs: COMMITTED Long-term, cannot be signicantly reduced in the short term Mixed costs DISCRETIONARY May be altered in the short-term by current managerial decisions Learning Objecve 5: Cost classicaons for decision making: relevant costs and irrelevant costs This topic is very interesng to observe and very peaky to implement since relevant vs. relevant depends on the decision-making seng, so costs are not born relevant or irrelevant, but it depends on how the company frames its analysis. Decisions involve choosing between alternaves. The goal of making decisions is to idenfy those costs that are either relevant or irrelevant to the decision. To make decisions, it is essenal to have a grasp on the concepts of dierenal costs and revenues, opportunity costs, and sunk costs. – – – Dierenal Costs • Dierenal costs (or incremental costs) are the dierence in cost between any two alternaves (basically, it means looking for the costs that change between the two alternaves) • A dierence in revenue between two alternaves is called dierenal revenue • Both are always relevant to decisions • Dierenal costs can be either xed or variable Opportunity Cost • The potenal benet that is given up when one alternave is selected over another (it means that, by selecng acvity A instead of acvity B, you give up the benet associated with B) • These costs are not usually found in accounng records but must be explicitly considered in every decision, so for managerial accounng 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 Objecve 6: Prepare Income Statements for a merchandising company using the tradional and contribuon formats 6 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi We want to deal with managerial accounng because we want to prepare Income Statements using the so-called cost Behavior Income Statement, so Contribuon Margin Income Statement. Depending on how costs are classied, there may be Income Statements by nature of the costs, by funcon or by cost behaviour, even if it is not very frequent that companies disclose their Income Statement by cost behavior for external reporng purposes, but for internal reporng purposes or for managerial purposes it is very frequent. The Tradional and Contribuon Formats The tradional format is more for external reporng purposes, whereas the contribuon format is used primarily for managerial purposes. However, we may even end up with an Income Statement that uses simultaneously the two classicaon criteria. Uses of the Contribuon Format The Contribuon Income Statement format is used as an internal planning and decision-making tool. We will use this approach for: 1. 2. 3. 4. Cost-volume-prot analysis (Chapter 2) Segmented reporng of prot data (Chapter 4) Special decisions such as pricing and make-or-buy analysis (Chapter 6) Budgeng (Chapter 8) COST-VOLUME-PROFIT RELATIONSHIPS Learning Objecve 1: Explain how changes in acvity aect contribuon margin and net operang income 7 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi APPLICATIONS OF THE COST-VOLUME-PROFIT ANALYSIS Costs classicaon can be used for dierent informave items and, parcularly we use the classicaon regarding variable versus xed costs to start talking about the cost-volume prot analysis, whose applicaons are the following: 1. What a company doesn’t want to target, bur wants to know in order to be on the safe side is the quanty of break-even or the sales of break-even, which is the minimum requirement for a business to stay alive: – – There is a formula to determine the quanty of break-even or for the purposes of moving ahead, we may say that the formula is based on one very simple equaon that we solve for me to me dening what is the unknown. The equaon based on which we determine the pre-set formula is: and so, the prot can be itemized by using this classicaon of variable to xed costs in this way. Just to show that the formula is derived from that, let’s suppose that the prot is equal to 0 and what we want to idenfy (unknown) is the quanty of break-even: if we solve the equaon in this way, we would nd that: 2. Maybe the company doesn’t want to just recover the xed costs, but it has a target in terms of targeted income, and so this formula changes because of that in this way: so, in this case the unknown is sll the quanty, but instead of pung prot equal to zero we put prot equal to the targeted income, so the formula will be: 3. This cost-volume-prot analysis can be used in other ways, such as simulaon kind of what if analysis, in the sense that the equaon is always the same but what changes is the unknown, that is no more the quanty. 4. The cost-volume-prot analysis can be used to determine the margin of safety, which means how above or how below is the company currently versus the quanty or the sales of break-even, so the idea is to determine how safe the company is in terms of reaching the break-even point or even exceeding the breakeven point. 5. The degree of operang leverage (DOL) indicates a level of operang risk, so it measures the percentage change in prot associated with a percentage change in volume or sales (it tells what is the change in prot given the fact that there has been a change in quanty or sales, which can be posive or negave), but the relave size of the increase of the prot depends heavily on the rao of xed to variable costs. COST-VOLUME-PROFIT ANALYSIS: KEY ASSUMPTIONS To simplify CVP calculaons, managers typically adopt the following assumpons with respect to these factors: 1. Selling price is constant. The price of a product or service will not change as volume changes. 2. Costs are linear and can be accurately divided into variable and xed components. The variable costs are constant per unit and the xed costs are constant in total over the enre relevant range. 3. In mulproduct companies, the mix of products sold remains constant. BASICS OF COST-VOLUME-PROFIT ANALYSIS The contribuon income statement is helpful to managers in judging the impact on prots of changes in selling price, cost, or volume. The emphasis is on cost behavior. – The Contribuon Margin (CM) is the amount remaining from sales revenue aer variable expenses have been deducted 8 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi – The Contribuon Margin is used rst to cover xed expenses; any remaining Contribuon Margin contributes to net operang income THE CONTRIBUTION APPROACH Sales, variable expenses, and contribuon margin can also be expressed on a per unit basis. The contribuon margin per unit does not change but is constant since – – Price per unit is constant Variable costs per unit are constant so, even the contribuon margin is constant, and this is an assumpon that we take, but what changes is the total contribuon margin since it depends on the volume (number of units). If Racing sells an addional bicycle, $200 addional CM will be generated to cover xed expenses and prot. Each month, RBC must generate at least $80,000 in total contribuon margin to break-even (which is the level of sales at which prot is zero). If RBC sells 400 units in a month, it will be operang at the break-even point. If RBC sells one more bike (401 bikes), net operang income will increase by $200, since any addional unit aer the break-even is basically an addion to the end prot, and this is because with 400 bicycles the company has the break-even, while with 401 bicycles it adds incrementally the contribuon margin to its prot. We do not need to prepare an income statement to esmate prots at a parcular sales volume. Simply mulply the number of units sold above break-even by the contribuon margin per unit. If Racing sells 430 bikes, its net operang income will be $6,000 (30 units x $200 per unit) CVP RELATIONSHIPS IN EQUATION FORM The contribuon format income statement can be expressed in the following equaon: 9 Downloaded by Chiara Davoli ([email protected])
