Management Accounting.pdf

Management Accounting Module 1 TOT REV/AsseTS/Income CLASS 1: 08.01.2020. ↳ it is used by managers to evaluate their results MA010 – MANAGEMENT CONTROL...

Management Accounting Module 1 TOT REV/AsseTS/Income CLASS 1: 08.01.2020. ↳ it is used by managers to evaluate their results MA010 – MANAGEMENT CONTROL SYSTEMS AND BUSINESS ORGANIZATION managers and branch of Some accounting measures, that account for the success of Starbucks are:by total MANAGEMENT red Acc is a revenues, net =. , accounting income, total assets, etc. ↓ -ERNAL produces infor used by managers inside They are used by managers to control their activities and operations and to treevaluate organization their to results. and take decisions Management accounting is a branch of accounting that produces information ↓ reports to proporefor managers who blend and control their activity and to evaluate their performances. It Managementthe "opposite"accounting to financial is - accounting produces information for internal reporting, for managers to make decisions. Financial accounting EXTLRNAL = The accounting instead produces information that is used for external reporting informations (stockholders, from banks, regulatory, different comes 2 PLANNING etc.) So, what is management accounting: it is responsible for managerial identifying, processes measuring, accumulating, STRATEGIC ↓ * analyzing preparing, interpreting and communicating information PLANNING that help managers AND process CONTROLLING to fulfill to define made where and the is where organizational objectives. It is though for managers to support their company define activity and align them to to how to process use the it want to in withgo future gad reach the organizational objectives. The use of management accounting helps managers, from around the the effort minimum future and in the possible shortest time lusually made every years) 4 - 5 world, what are the company’s objectives are and helps them to coordinate between each other. Where do accounting measures come from? What processes do these measures support? They I come from two different managerial processes: 1. Strategic Planning: the process that companies undertake (every 3-5 years) to define where they are and where they want to go in the future. It is a process used to set where they are and to define where they want to go in the future. It is a thinking and planning activity. What does it mean for a company to decide where to move in time, in operational terms? Have to consider revenues, costs, etc. which have to be represented in measures (financial and non- financial). An example of a non-financial measure is the customer satisfaction. 2. Planning and Controlling: once we have strategically thought of the final destination, what should we do? Each company has to decide how to get to the far objective in the future using the minimum amount of resources. I have to maximize the efficiency. A company should display shorter-term plans (usually on an annual basis). Companies that adopt a rational and anticipatory approach, as they move towards the objective, it controls to be on track. Companies that do not plan and control, go blind. Planning and controlling means to think before acting; thinking of competitors, market, etc. in advance. It is a wise process because it allows companies to check if they are on track to point B (final destination). All these accounting measures that support managerial processes are produced by management accounting, that works on the previous two processes. Why the carrot? If you have clear objectives and know what the company expects from you, it is more likely that you have a higher motivation. Is the ‘go-blind’ always negative? Not really, many companies especially small ones use this method. They don’t need to do strategic planning if they have a small company and maybe a unique product. Not all organizations need a strategic planning. PLANNING: setting the objectives and outlining how the objectives will be obtained. CONTROL: is the activity of implementing plans and using feedback to evaluate the attainment of objectives. The activities of planning and control are really linked, it is difficult to separate them. I It 1. Setting goals a ↓ includes steps includes these steps: * The planning and controlling process SETTING GOALS AND TARGETS and targets. I have the strategic planning, now I · : PLAN · AND ExECUTE have to decide how to complete the first years, so, the goals · MESURE , MONITOR AND REPORT · EVALUATE THE REWARD of the first year. Ex. the company wants to exceed guests’ expectations, maximize revenue yield and focus on innovation. The goal has to be translated into what, how and when. Goals have to be translated into measures. 2. Once I have defined the goals and targets I have to plan how to reach the goal and execute the plan. Ex. it might mean to define how to exceed guest’s expectation. I need a plan/an idea to reach the objective. Saying the objective is not enough, I need to take initiatives to reach the objective. 3. Once I have deployed my plan and started to execute it, I have to measure, monitor and report the progress towards the goal. 4. Finally, once I have recorded the actual result I can evaluate my performance and reward good managers. Evaluate means to prepare actual results against targets. If goals are not reached some intervention is essential. Technical dimension of management accounting MANAGEMENT CONTROL SYSTEMS. A management control system is a logical integration of techniques for gathering and using information in order to make planning and control decisions, motivate employees’ behaviors and evaluate performance. Any management control system comprises three elements: 1. The technical tools. Different tools have different aims. 2. The process. Each accounting tool has to be used within a well-defined process. The planning and control process above is a generic one; each company has to: Management control system e a. define who will be involved in the process, sistema usato per b. who will receive the report, raggrappor un utilizzare le informazioni e c. it has to define the role of each actor in the process, per pianificare decisioni anche e controllare le Questo for motivare d. define the timing in the process dipend in modo di i. valutare prestazioni e le e. define the way to solve conflicting units, comprende elementi 3 : · Technical tools : diff E. took Process diff utilizzo f. etc. · :. Responsability Acconting. ↓ 3. Responsibility Accounting. It is the organizational structure of control, it means to define for Identifica ogni tool per registrare usato each tool who will be involved for recording and analyzing data, who will see the report, etc. i dati I chi report, vedié i These elements might differ from one organization to another. What is a responsibility etc. center? It is an organizational unit that it is assigned some responsibility. In other words, it is a set of activities, assigned to a manager, a group of managers or other employees that are responsible for some result. When we design a management control system we have to define which responsibility center will participate in the budgeting process. Responsibility centers might be assigned various objectives, they can only control costs or costs and revenues. Or they can be investment centers: costs, revenues and long term investments. The COST ACCOUNTING SYSTEM is a formal mechanism for gathering, organizing and communication information’s about an organization’s activities. This system has the responsibility to record the cost and revenues generated by activity and sales. It is used to track actual result (how the company is actually doing) but also to provide information for the budgeting. I use the data from the accounting system to budget. It is key to monitor performance and evaluate performance. un'attività, guadagni vendita di servizio generaty da Il identifica che i costi i dovati dalla System raccoglie , un o AccountiNG a cost e : è un processo per fare analisi della situazione della Fornisce anche importanti informazioni per il budget ed è spesso usato un compagnia. L Può essere considerata la chiave per monitorare le performance e por valutarle  abbiettivo quantitativo trasformate/tradurre : piani I in un il rudo di ha BUDGETING SYSTEM : il budgeting system di pieno sistema de sia il costace. System sie ↳ espressione quantitativa un usa è , un System aziendali. : creare valutazione dettagliata della performance I Report una per i risultati raggiunti con Viene usato por comparare. dal budget dell'azienda quelli prefissati Y feedback sull'andamento Procura un The BUDGETING SYSTEM. The budget is the quantitative expression of a plan of action. The role is to translate plans in quantitative goals/objectives. The REPORTING SYSTEM uses both information from budgeting activity and the actual result coming from the accounting system to evaluate performance. It is used to compare actual results against budgeting targets. It is a tool to get feedback and it is used to analyze variances (difference from plans: expected results and actual results). Issues of management control systems. NB. Not all organizations need to have a management control system, but when do they need it? When they satisfy the cost benefit balance. Companies should introduce this system gradually. The system should provide DECISION MAKING: the purposeful choice from among a set of alternative courses of action designed to achieve some objectives. It is the core of management process. BEATRICE: F MANAGEMENT CONTROL SYSTEM is the technical part. All the procedures of the planning and control are produced by the MCS. A well-designed management control system supports and coordinates the decision-making process and motivates individuals throughout the organization to act in concert. The MSC is a logical integration of techniques for gathering and using information in order to: - make planning and control decisions; - motivate employees’ behaviors; - evaluate performance. Any management control system comprises three elements: 1. the technical tools used in planning and control, that can go from the very basic to the more evolved ones; 2. the process, each accounting tool has to be used within a well-defined process; 3. the responsibility accounting of MSC, is the organizational structure of control; it means to define for each tool who is the person involved. MANAGEMENT ACCOUNTING TOOL By assigning costs to different cost objects (e.g. products, regions, markets,...), the cost accounting system figures out the main drivers of company’s profitability. The cost accounting system is a formal mechanism for gathering, organizing and communicating information about an organization’s activity. Used both to track actual result and to provide information for the budgeting process. Key device for evaluating performances. The budget system is the quantitative expression of a plan of action. it is the key device of planning; it translates the plans in quantitative goals/objectives, both financial and non. The reporting system using information from.. to: - compare actual result against actual targets; - to get feedbacks by comparing results with plans; - to analyze variances, which are differences from expected target and actual result. RESPONSIBILITY CENTERS MCS produce information that are address to managers, people entitle of some kind of responsibilities; this is why when there is a manager there is a responsibility accounting. Responsibility centers are involved in the budgeting process, in the reporting system and so in the planning and control system. resp centers vary from one organization to another. GEMENT [ - Mcs = Ro SYSTEM A responsibility center is an organizational unit; it is a set of activities assigned to a manager, or a group of managers, or employees that are responsible for some results. Such managers are given resources needed to complete their activities. MSCs designers apply responsibility accounting to identify what part of the organization has the responsibility for each action. COST-BENEFIT BALANCE and behavioral implications of using MCS Not all organization need an MCS. A company uses the MCS when it satisfies the cost-benefit balance. The benefit is to have increased profit, to have people which are more motivated; which is not very easy to calculate. MCS modifies behavior, so the system should provide accurate timely budget and performance report; that need to be useful to managers. They need to provide relevant information, that are not too complex to understand, that have been previously selected and that are provided in time. DECISION MAKING The decision-making processes is the essential of managerial processes. Decision making is the intentional choice from among a set of alternatives to achieve some objectives. Even strategic SCORENEEPING planning is a decision-making process. Azienda performa bene ? Valuta la performance aziendate : > - Scorekeeping question: is the company performing well or poorly? Take in consideration only the ‘budget’ and the ‘actual’, first two columns  evaluate organizational performance. Attention directing question: which area of performance requires further investigation? MCS help answering this question by reporting, analyzing data that help managers to focus on operational issues, inefficiencies. Evaluate more in detail the causes that are behind some variances (third ATTENTION DIRECTING columns).  compare actual results to the expected ones. Quale avea ? necessita più Confronta quelli prestabiliti attenzione - i risultati con Problem-solving question: of the several ways of doing a job, which is the best? It is the activity of assessing all the possible courses of action and choses one alternative; this activity can be done using some techniques, like the differential analysis  assess possible courses of action Problemsocinssibili azionio e se PRODUCT LIFE-CYCLE The focus of MCS is on the all product lifecycle; accountants and managers should consider all the product lifecycle when planning and controlling. The product lifecycle generally encompasses four stages: product development (no sales), introduction to market (sales growth), mature market (stable sales), phase-out product (low/no sales). The focus should be also on all the value-chain: R&D, …., information should be collected/tracked in all these stages. MANAGEMENT ACCOUNTANT’S ROLE Management accountants are committed to helping their organization achieve its strategic goals by providing decisions support, planning and control for business operations. Management accounting provides a common language to help managers around the world communicate and coordinate their actions. A management accountant is the owner of the MCS, he is responsible to produce and address the information to the manager, like an internal consultant for managers. He generally performs four type of activities: - collects and complies information; - prepares standardized reports; - interprets and analyzes information; - is involved in decision making. His role changes as the company becomes larger and more complex. He works more frequently with line managers, which involve him directly in the decision-making; with the staff managers and with cross-functional teams, generally this happens in more flatter organizations.  Cost valore delle risorse usate per fare una T : S certa attività che alla creazione porte di beni e serviti la Cost BeMAVIOUR : è divisa in 2 parti , prima si utilizzare le informazioni riferisce a come (BEATRICE) insresti ed familiare ai costi esserci , T funzione il cost seconde insegue la come CLASS 2: 09.01.2020 invece l'accounting system MA020 – INTRODUCTION TO COST BEHAVIOUR The costing account system is divided in two parts, the first part refers on how to use the information of costs, be familiar with the usage of costs. We need to consider the CVP (allow us to use information of cost in decision-making), the differential analysis, and also pricing decisions. Prices are often based on producing costs, and not just on markets. Then we will learn how the cost accounting system work; this is the system that build the information of costs; in particular the traditional cost accounting system and the ABC cost accounting system. Cost: value of the resources used in performing activities in order to produce goods and services. This definition has 4 keywords: value (something a company need to quantify with a currency), resources used (we consider a cost when the resources is actually used – in contrast with financial accounting), goods and services (in MA a cost always refer to something useful, that we want to measure; typically, products and services, which are called cost objects: something for which we want a separate measurement of cost). Every company should consider the cost-benefit balance; to consider only the relevant cost objects. Which are the determinants of cost of an iPhone? Raw materials, software, brand image (marketing cost), labor, energy to run machines, development costs, machines’ depreciation, plant’s costs (rent, heating). Are these costs all of same kind? No, they differ. Depreciation is a capacity cost, is independent from the volume of production, it is a fixed cost; the cost of raw materials on the other hand depends on production, it is a variable cost. The energy cost is similar to raw materials, it depends on the volume of production, it is a cost driver. The development costs don’t depend on the volume of production, they are variable but related to the hour’s engineers have used to develop the product. A cost from a MA prospective is an intentional value; it is something that we build for a specific aim. We can have many different configurations of cost, depending on the aim for which we are configuring the cost – different costs for different aims. The task of any management accounting system is to build proper information of cost. All the decisions undertaken by managers are referred to different consideration of costs. To determine a cost, we have to define which activities have been performed; each activity will require resources (thus if we want to consider the production cost of an iPhone, we don’t have to consider for example the marketing costs); for each resource we have to consider the cost drivers, which is the measure of the level of activity that requires the use of resources and therefore causes cost. To identify a specific cost driven we need a more specific information of costs. BOEING Example: determine the cost of installing 100 seats on a Boeing. Spapa Activity: installing the seats Two type of resources: 100 seats and labor Costs: each seat cost $100 dollar; 1 labor hour cost $20; 1 labor hour required for each seat; Costs of 100 seats: 100*$100 = $10,000 Per identificare abbiamo bisogno : costi Cost of labor: 100*$20 = $2,000 di capire che tipo di attività stata è Total cost of installing seats: $10,000+$2,000= $12,000 state utilizzate fatta che risorse e sono determinata attività per fare quella  Cost driver: number of seats the need to be installed (it is the level of activity) and the labor hours required to physically installing the seats. The total cost varies depending on these cost drivers. The $12,000 used to install 100 seats is a variable cost; it may vary as the cost drivers vary (for instance more seats needed or more hours required to complete the job). tramite Product life cycle è il il processo della quate il prodotto passe suacreazione , anche la VALUE CHAIN FUNCTIONS, COSTS AND COST DRIVERS fino al ritiro dal mercato Questo. comprende value chain Product life cycle refers to the various stages through which a product passes: conception and product development; introduction into the market; maturation of the market; and, finally, withdrawal from the market. At each stage, managers face differing costs and potential returns. In addition to considering a product’s life cycle, managers must recognize those activities necessary for a company to create the goods or services that it sells. These activities comprise the value chain, the set of business functions or activities that add value to the products or services of an organization. HOW TO CLASSIFY COSTS? So far we only consider two types of costs: variable and fixed. A cost may be either variable or fixed, depending on how they behave as the level of a particular cost driver changes. A VARIABLE COST is a cost that changes in direct proportion to changes in the cost driver level, referring to the total variable costs. - We assume that the per-unit variable cost remains unchanged regardless of the changes in the cost-driver; - It is useful to think of variable costs on a per-unit basis. Add graph A FIXED COST is not immediately affected by changes in the cost-driver. - The total of fixed cost remains unchanged regardless of variation in the cost-drivers; - It is useful to think of fixed costs on a total-cost basis. Cost crastification : i costi possono essere erabili sia che si cost il cambiare dei drivers - i costi FIXED sono costi che non cambiano con ai cost drivers - i costi VARIABLE sono invece costi che cambiam in proporzione Add graph What happens to a per-unit amount of a fixed cost? Changes as the level of production changes. BOEING Example: activity of receiving parts that the Boing install of the airplane. How these activity affects the variable and fixed cost behavior? Two kind of resources required: - equipment resources ($45,000) – fixed cost; - fuel to move the equipment ($0.8 x each part received) – variable cost; Cost drivers: number of parts received; Cost per part received, making different hypothesis on the number of parts received: (1) (2) (3) (4) (5) (4) / (1) PARTS EQUIPMENT $0.8 * (1) (2) + (3) COST PER PART RECEIVED COST FUEL COST TOTAL COST RECEIVED 10.000 $45,000 $8,000 $53,000 $5.30 15.000 45,000 12,000 57,000 3.80 20.000 45,000 16,000 61,000 3.05 25.000 45,000 20,000 65,000 2.60 30.000 45,000 24,000 69,000 2.30 As the number of parts received increases, the per-unit variable cost decreases. RELEVANT RANGE The description of variable and fixed costs holds true only under some limitations; the linearity between the total cost and the cost drivers is a reasonable approximation of reality only under some limitations, which are called relevant range. The relevant range is the limit of cost-driver level within which a specific relationship between costs and the cost driver is valid. BOEING Example. Back on the example of the equipment; the fixed cost (equipment cost – $45,000) will be fixed/constant within a specific level of production/activity. It is constant between 10,000 and 30,000 units. More than 30,000 units we may need more equipment; and thus the fixed cost of equipment will raise. Under 10,000 units it is possible that we need a smaller equipment, which costs less. Each of the 3 columns represents a different relevant range. # Il relevant range è il range di attività o produzione entro it quale i costi fissi e variabili i produzione in cui costanti. In altre parole è l'intervallo di quantità di rimangono costi di un'azienda non cambiano in modo significativo. (esempio fabbrica 0-1000 pezzi)  TFC C $70,000 $45,000 $15,000 10,000 30,000 Level of Activity The same is true for variable costs; in our example the per-unit variable cost of fuel is $0.8, and that amount is constant per each number of units received between 10,000-30,000. We can assume that the price of the fuel will raise a little bit (e.g. $1) if we order less units; on the other hand if we have more than 30,000 units we may have a discount and thus pay the fuel less (e.g. $0.5). TVC $0.5 The relevant range is the limit of cost-driver level $0.8 within which a specific relationship between costs and the cost driver is valid. $1 10,000 30,000 Level of Activity For the unit variable cost this behavior is due to two main reason: - the price of acquiring variable resources, that may change ( economies in purchasing goods) - efficiency: the cost of variable resource may decrease because the company becomes more productive/efficient (worker may become more efficient and take less than one hour per seat to install it) del volume di cup = cost volume proft : è l'effetto produzione sui ricavi , sulle ANALYSIS e sul reddito metto spese MA030 – COST VOLUME PROFIT ANALYSIS ↳ E modello che mette , ricavi relazione in profit: costi ! e un CVP – cost volume profit model , The CVP analysis is the study of the effects of output volume on revenue, expenses and net income. Used to make decisions in situation where changes in volume of goods and services, produced and sold, affects revenues, cost and profits. It’s a model that put in relation these three factors. Why companies use the CVP? It has different applications, but it has a main specific application that is called the breakeven analysis; for this reason, this model is also called breakeven model. E utilizzato principalmente per fare la potQuale breakeven un model  analisi che viene fatto Breakeven point : è un ad azienda far capire una per ottenere fare per ↑& devono quanto la quali ai profitti punto in cui spese sono dei è il - > Il break point even i vicavi sono 0 - Ci sono 2 modi per farla guadagni, quindi e sono : THE THE EQUATION METHOD CONTRIBUTION MARGIN METHOD Companies want to compute their breakeven point, because they need to know how much effort they have to put to make some profit. The BREAKEVEN POINT is the level of production at which total revenues equals total expenses and therefore net income is zero. It is the point at which companies recap all there fixed and variables costs. There are two basic method to compute the breakeven point: the equation method and the contribution margin method (which derives from the former one). BOEING Example: let’s imagine the managers of the Boeing are deciding wheatear to install vending machines of the airplanes; they want to know how many snacks they have to sold to recap the costs of offering such service. Selling price of each snack: $1.5 (we consider only one kind of product) Variable cost: - Cost of each snack: $1.2 Fixed costs: - Renting cost: $300/month - Wages: $13,500/m - Other fixed costs: $1500/m Compute the breakeven point: This model only applies in relevant ranges. X: level of activity, volume of snacks sold Y: total costs and total revenue Y TR $150 $138 T C BEP $18 TFC 60 100 X Revenues: (Quantity of snacks sold; Revenues; TVC total variable costs) If Q=0  R=0  TVC= 0 If Q=1  R=$1.5 If Q=100,000  R=$150,000  TVC=$120,000 With these points I can draw the TR total revenues line (0;0 and 100,000;150,000). Fixed costs: $(300+13,500+1,500) = $18,000  flat line TFC We can add variable and fixed cost to obtain the total costs. Total costs: total fixed costs + total variable costs Q=0  TC=18,000 Q=100,000  TC=18,000+120,000=138,000   thus, we get the TC line BEP: 60,000 units Where the two lines meet we have the breakeven point. Before costs are higher than revenues, in this section we have the ‘loss area’; after the BEP, revenues are more than costs, thus the company start making profit if it sells more than 60,000 units. (> BEP). Given the cost structure we can determine the impact on profit. For each level of sales, we can determine the net profit. For instance, at 80,000 units the difference between revenues and costs gives the net profit: & GENERAL EQUATION Let’s translate this in the general equation of the model, which is similar to the income statement equation. Total sales – total variable costs – total fixed costs = net income Total sales = unit price * volume of sales Total variable costs = unit variables cost * volume of sales Total Fixed costs are expenses independent from the volume  unit price * volume – unit variables cost * volume – total fixed costs = net income · Apply the general equation to the example to find the BEP. We have to solve for the volume (N) of the snacks sold. Put net income equal to zero. unit price * volume – unit variables cost * volume – total fixed costs = 0 $1.5 * N – $1.2 *N – 18,000 = 0 N = (fixed costs) / (unit price-unit variables cost) N = 18,000 / ($1.5 – $1.2) = 60,000 units  BEP Sales level in order to breakeven = 60,000 * $1.5 = $90,000 The CONTRIBUTION MARGIN METHOD derives from the general equation, and says that the BEP= fixed costs / unit contribution margin Where Unit contribution margin = $(1.5-1.2) = $0.3 The concept of unit contribution margin is very important and in this specific application, this formula says that the number the UCM refers to each contribution that each units brings to cover fixed costs covered by the company. method that I contribution margin says contribution BEP : fixed costs/unit margin ↓ la è 0 3 cioè questa , fro il differenze prezzo di vendita del prodottode il a pubblico - prezzo lo (1 5 -1 2 0 3) è il margine gestgr pago = , , , ↳  FIXED costs NeT Income SALES-VARIABLE = COSTS - CLASS 3: 13.01.2020 Cost have to be divided into variable costs and fixed costs. So, sales – variable costs – fixed costs is equal to net income. The break even in units is given by the following ratio:. Another way to find the break-even point is in sales dollars. We have to compute the variable costs in terms of the sales. If we want to find the sales dollars, instead of the quality, the formula becomes sales (depending variable), less variable costs in terms of sales, less fixed costs. In this case, the variable costs are 80% of sales/revenues (1.2/1.5). So, the formula becomes S- 0,8S-18,000=0. If we , solve for S we have that S is equal to , = 90,000. How do we find the unit from sales dollars? , We divide by the unit price: = 60,000 𝑠𝑛𝑎𝑐𝑘𝑠. , TARGET NET PROFIT Here we want to target the profit, which in this case is 1,440. This calculation examines the number of snacks she needs to sell in order to have 1,440 of profit. The cost structure, the unit variable cost and the total fixed costs are exactly the same and also the unit selling price are the same. So now N becomes the variable we have to solve for. The sales and the total variable costs both depend on N. So, in this case the target sales volume (units) formula is:. The same happens if we want to find the break-even point in sales if we want to target profit. Here the variable cost is in terms of Sales. The equation is the same, but you have to adjust the variable cost depending on either sales or units. CUP : Cost VOLUME PROFIT h CVP ANALYSIS – Assumptions (could be a theoretical question). This analysis works only within relevant ranges. So, in order to apply this model a company has to be able to divide its costs into variable and fixed (fully divide). So, this model works within relevant ranges. If we work in relevant ranges, it means that the behavior of expenses is linear: we can draw a line for the variable cost and a parallel line for the fixed expenses. Also, the revenues have to be linear. This means that when we use this model the unit price has to be constant. If the functions are linear it means that there are no changes in efficiency or productivity. Another condition is the inventory level. We suppose that there are no changes in the inventory level, when we apply the break-even model. This is another simplification: sales equal to production volume. Another assumption is that the sales mix has to remain constant. L'analisi costo-volume-prezzo (CVP) è un modo per scoprire come le variazioni dei costi variabili e fissi OPERATING LEVERAGE influenzano il profitto di un'impresa. The CVP analysis may help managers to assess what might happen if there are downturns to sales volumes. With the CVP analysis we can have operating leverage and margin of safety, useful to assess risk. This table shows the income statement of three companies. At first, if you look at the number, the three companies might seem similar. But what is the difference between the three companies? They differentiate in fixed and variable costs. They have a different cost structure. Having a different cost structure impacts on risk? Yes. You are less flexible if you have many fixed costs. La CVP analisi è utile ai manager per poter te possibili ripercussioni capice quali potrebbero essere decrescita nel volume di vendita. in caso ci fosse un'improvvisa il di sicurezza e identificare un margine può poi creare con il cup si rischio. L Questo è chiamato operating leverage I  ↓ tra E il rapporto income tot. contribution margin / net Looking at the ratio fixed expenses/total expenses, we see that company A is a leveraged company (greater fixed costs than variable ones). Company C instead is more flexible; it incurs most of its costs if it produces. The rigidity can be read in terms of the operating leverage. The operating leverage is the ratio between the total contribution margin and the net income. Leverage company A has a high operating leverage. Company C, which has only 50 dollars of fixed costs, has an operating leverage which is 1,5 (less than company A). What does this mean? If the volume of production in company A increased by 10% the impact of this increase in volume will impact net income 2,4 times. So, if the operating leverage is 2,4 and we have an increase in production by 10%, we can estimate what will be the impact on net income: the impact will be 10% x 2,4. The operating leverage acts as a multiplier: the net income will raise by 24%. Is this a good situation? If the sales increase it is a good situation (the increase in income will be more than double). What if the sales decrease? Ex. they decrease by 10%: the impact on income will be -24%. So, leverage companies are companies that gain a lot, after the break-even point, if the sales increase but that are very risky if there is a downturn. Analyzing Company C, they have a smaller increase in income if the sales increase but if there is a downturn the impact on net income is smaller. The break-even point in units is higher for leverage companies, instead, it is smaller for not leverage companies because they have a smaller amount of fixed costs. In company A we have to sell at least 6 units to break even, in company C we have to sell 4 units. - Imarginof Safety e > una vendita può prima diminuire di perdite avre MARGIN OF SAFTY – index used by managers to assess their risk It shows how far sales can fall below any planned level before losses occur. Here we compare some planned unit sales with the break-even point. Ex. a company has planned to sell 10 units and the break-even point is 6. In this case the margin of safety is 4: the company can lose 4 units sales before it goes below the break-even point. So, the margin of safety shows how far sales can fall below the planned level before losses occur. In other words, it can be the difference between the planned level minus the break-even, all divided by the planned level of unit sales. CONTRIBUTION VS GROSS MARGIN 1. Managers often confuse the two terms. The Contribution Margin is the difference between the sales price and the total variable expenses. What is the gross margin? It is the difference between the sales price and the cost of goods sold. What is the Cost of Goods Sold? It comprises both variable and fixed costs, but only the producing costs. No producing costs are also called selling and administrative costs. The contribution margin is the difference between sales and TOTAL (production and non-production) variable costs. It is what remains after all variable costs are paid. Gross margin is the difference between sales and the cost of goods sold (considers the production costs only – both variable and fixed). In the contribution margin we have to deduct all the variable costs (production and nonproduction), the gross margin is different: it is the difference between sales and production costs (what lasts after all production costs have been covered). NON-PROFIT APPLICATION OF CVP- read in book page 71. GROSS MARGIN CONTRIBUTION MARGIN sales price - good etized sales price sol - cost of for production costs variable variable 1both total & only costs I production e monmoduction but  CONTRIBUTION MARGIN INCOME STATEMENT The Ramos company sells two products, and this is the expected costs and revenues of the next year. So, it is a budgeting income statement. The company is expected to sell 300,000 units of wallets and 75,000 of key cases, with a total of 375,000 units sold. The plan unit price is 8 dollars for the wallets and 5 for the key cases. Furthermore, it expects to earn 2,400,000 dollars for the wallets and 375,000 for the key cases. In conclusion, the revenues expected are: 2,775,000. The company has to divided costs in variable and fixed (both producing and selling). The estimation is that the variable cost per unit for the wallet is 7 and the one for hey cases is 3 dollars. The total variable costs can be both producing and non-producing, so, total variable costs amount to 2,325,000. Since variable costs are smaller than the revenues we expect to have a positive total contribution margin. The total contribution margin is the difference between the sales and the variable costs, or the unit contribution margin times the sales in units. After we have calculated the total contribution margin (450,000) and we know that the fixed costs are 180,000 we expect the net income to be positive. This income statement is also called Direct/Variable Income statement, because we are only computing the variable cost of the products. Only the variable costs are assigned to wallets and key case. It is called variable costing. We are assigning direct/variable costs, we do not allocate them. utità w - of SALES MIX ANALYSIS Revenues are given by the volume of sales, but also by the volumes of sales of the sales mix. The sales mix is the relative proportions or combinations of quantities of products that comprise total sales. Looking at the table above, for 4 wallets there is one case. We have 300,000 of wallets that we plan to sell and we have 75,000 key cases that we plan to sell in the same time. So, the sales mix , , is , = 4 or , = 0,25. The sales mix can be written as 0,25 key case every wallet or 4 wallets for one key case. So, what is the Break-Even point in Units of Cases and Wallet? Sales – total variable costs – fixed costs = 0. We have to suppose that the sales mix is constant. If in our budget process we have planned to sell 4:1 wallets/key cases. We will determine the BEP with the same sales mix we have planned. This is an assumption we need to consider in order to calculate the BEP. So, this means that our dependent variable (units) will be computed based on the sales mix. Ex. We will let the: - K = key case (the dependent variable) e - So, 4K = wallets We could have used the other proportion: if we sell 1 wallet we sell 0.25 key case. W= wallet and 0.25W = key case. So, REVENUES: - ((8*4K) +(5K)): revenues of wallet + revenues of key cases = total revenues - MINUS ((7*4K) +(3K)): variable costs of wallet + variable costs of key case: total variable cost. - MINUS the fixed costs: 180,000. p # So, total revenues are 37K -31K-180,000=0. The contribution margin for the mix is 6K, which is equal , to the fixed costs. So, the value of K: = 30,000 𝑢𝑛𝑖𝑡𝑠. This is the value of K, the cases. The number of wallets instead is 4K so it is 30,000*4= 120,000 units of wallet. These are the amounts that the company has to sell in order to break-even. What happens if we put 120,000 and 30,000 in the sales in units column of the table above, and we recompute everything? The net income will be zero. CLASS 5: 16.01.2020 MA040 - INFORMATION FOR DECISION MAKING: PRICING DECISIONS MAIN CONCEPTS: 1. Issue of relevance 2. Decision process take place 3. Analyze how financial information can be written. So, we will analyze the contribution margin approach and the absorption approach. In the short run it is better to use the contribution margin approach. 4. Decision on how to price special order Why pricing decisions are important? Pricing decisions are important because they allow companies to gain profits, if they are properly formulated. Pricing decisions should attract customers and they also have to consider what competitors do. Pricing decisions could be how to price a new product, how to set differentiating prices (discounts to some customers, etc.), how to price a product that has been improved and how to price a special order. All these decisions require different accounting information. We have to be able to select the relevant information for us. Le PRICING DECISIONS sono decisoni importanti incremente it permettonoalleaziendedi perche be · t The Concept of Relevance A relevant information is the predicted future costs and revenues that changes among the alternatives. A decision-making process is about choosing among alternatives. We can choose if we have information of the alternatives, but managers need to select relevant information. Managers need to analyze all accounting information regarding different alternatives, pick only the relevant one. The relevant ones are those that differ among alternatives. Then they will choose the ones that allows them to minimize costs or maximize profits. Managers often have many accounting information to select. How to select, and determine whether information is relevant? Two criteria: 1. Relevant information’s are only expected revenues or costs. It means that relevant information’s are only future information of costs and revenues. Past information is not relevant. Past information is used mainly to determine/predict future information. 2. The information to be relevant must have an element of difference among the alternative. Any item that remains the same, regardless the alternative, is not relevant and should not be taken in consideration. The decision-making activity can be seen as a process. And this process can be applied to different types of decisions. It required four steps: 1. Gather information. In order to make any decision you need to have information, which can be both accounting information or any other type of information. The information can also come from outside. EX. pricing decision requires information from the outside, such as price of competitors. Information help company predict future figures. 2. This information is usually applied to prediction models. The CVP is a decision model. 3. Once manages have the model and the information, they can simulate and make decision using the model.  4. After decisions are taken they need to implement it. From the implementation they receive feedback. They evaluate the impact of the decision. The feedback is really important because they help to improve the decision models. ↑ RIPASSO - A Stu & One issue is the accuracy and relevance of information. In the best of all possible worlds, information used for decision making would be perfectly relevant and accurate. In real world information are not always relevant and accurate. Which is more important? An information that is accurate but not relevant is worthless in decision making. In contrast, relevant information that is not accurate can be useful. Though, they should be reasonably accurate. The degree to which the information is relevant depends on the type of information. Quantitative financial information is more accurate, as they are financial. Though, managers have to also deal with qualitative information which are less accurate as they are subjective. Focusing on financial information we will need to use income statement information (revenues and costs). This will become the relevant information for us. Why we will use income statement information? Because it specifies how alternative choices impact income. Additionally, since executives use income statements to evaluate performance, managers need to know how their decisions will affect income as reported on the statements. There are different ways to organize income statement information: 1. Some income statements track fixed and variable costs using the contribution approach. 2. Whereas others adopt the absorption approach used in reporting to external parties. Absorption Income Statement VS. Contribution Income Statement In short run decision, comprising pricing decision of special order, the better approach is to use the contribution approach. Cardell company is a company that produces and sells covers seats of airplanes. So, their customers are for example Boing. In the first table we have the costs of manufacturing/producing, in the second we have selling expenses and in the third we have the administrative costs. In all of the three tables, costs are organized and divided in variable and fixed cost behavior. This information is for 1,000,000 seat covers produced and sold. And for a total revenue of 40,000,000 dollars. Moreover, among the manufacturing costs we have indirect costs and some direct costs (that are not shown in the table). So, the direct costs amount to 20,000,000 dollars and they are divided into direct labor costs which are 6,000,000 and direct material costs which amount to 14,000,000 dollars. Manufacturing Expenses: - What are the total variable costs, indirect and direct? 4,000,000 (indirect variable) + 20,000,000 (direct variable costs). In order to produce 1,000,000 products, we incur 24$ per unit of variable cost (only related to the manufacturing). - Looking at the total fixed manufacturing costs, they amount to 6,000,000. What is the per unit fixed cost to produce 1,000,000 units? 6$. - The total manufacturing cost including fixed and variable costs is 24,000,000 of variable cost plus 6,000,000 of fixed costs: total manufacturing cost is 30,000,000 and the per unit is 30$. Selling Expenses: - Variable costs amount to 2,000,000$ - Fixed costs which amount to 4,000,00$ - The total selling expenses, both fixed and variable, are 6,000,000$ Administrative Costs: - Variable costs amount to 200,000$ - Fixed costs of administrative expenses amount to 1,800,000$ - Total administrative expenses, including both fixed and variable, are 2,000,000$ Now, prepare and Absorption Income Statement: - We have to report the revenues, the total manufacturing costs (variable and fixed) in order to highlight the gross margin. After the gross margin we will report the non-manufacturing costs (fixed and variable) in order to highlight the net income. Income statement with Absorption Approach Sales/Revenues 40,000$ Manufacturing costs Direct materials 14,000$ Direct labor 6,000$ Indirect manufacturing 10,000$ Total Manufacturing Costs 30,000$ (which can also be called Cost of Goods Sold). Gross Profit/Margin 10,000$ Non-Manufacturing Costs Selling expenses 6,000$ Administrative Expenses 2,000$ Total Selling and Administrative Expenses 8,000$ Net Income 2,000$ Now, we prepare the Contribution Approach Income Statement - Separate variable and fixed costs, not depending on if they manufacturing or not. Observe that, if we have a positive net income it means that the total fixed costs are lower than the total contribution margin. Income statement with Contribution Approach Sales/Revenues 40,000$ Variable Costs Direct materials 14,000$ Direct labor 6,000$ Variable Indirect Manufacturing Costs 4,000$ Variable Selling Expenses 2,000$ Variable Administrative Expenses 200$ Total Variable Costs 26,200$ (includes both producing and non-producing). Total Contribution Margin 13,800$ Total Fixed Costs Manufacturing fixed Costs 6,000$ Selling Fixed Costs 4,000$ Administrative Fixed Expenses 2,000$ Total Fixed Costs 11,800$ Net Income/Operating Income 2,000$ We then have to analyze the Special Sales Orders: - Cordell is offered a special order of 26$ per unit for 100,000 units. is it convenient to accept the special order? To answer we have to analyze the relevant information. We need to know that accepting the special order: o Will not affect Cordell’s regular business o Would not raise any antitrust issues o Will not affect total fixed costs: Cordell has enough capacity to produce the special order. o Would not require additional variable selling and administrative expenses. The special order will need the company to incur additional variable manufacturing costs but it will not raise additional variable selling and administrative expenses. Furthermore, fixed costs will not be relevant, as they will not change. o Would use some otherwise idle manufacturing capacity.  CLASS 6: 20.01.2020 In order to analyze pricing decisions, it is important to select relevant information. The first information that we have to consider is the unit price (26$). Is the volume for the special-order relevant information? Yes, it is because we have to check if the company has enough capacity to take the special order. What about the variable manufacturing costs which is 24$? It is relevant because the cost comprises the direct material, the direct labor and other variable manufacturing indirect costs. What about the variable non-manufacturing cost? The amount to 2.2$ per unit. They are not relevant because the problem states that variable selling expenses and administrative expenses will not be affected by the decision; the variable non-manufacturing cost are not relevant. Do we have to consider the fixed costs, both the manufacturing and the non-manufacturing? No because the problem says that the fixed costs are not affected by the decision – this happens frequently with special sales order cases. Fixed costs, since they are capacity costs and past costs as they company has already incurred them, are not relevant in pricing special orders. It we prepare an income statement for this situation we will have: Income Statement Unit Total Volume 100,000 Unit Price 26$ Revenues 2,600,000$ V.M.C 24$ 2,400,000$ T.C.M 2$ 200,000$ NB: Always consider the total amount. The column on the left is a contribution margin income statement, of the normal business. In the second and third column we add the special order, both the total and the per unit analysis. If you add to the regular business the special order (fourth column) you can read the total impact on the net income. So, the best way to solve the problem is using the contribution margin. If you had used the absorption approach you would have come to the wrong solution, most likely. The per unit analysis includes both the variable costs, that are relevant, and those costs (fixed) that are not relevant. So, in pricing special order (decisions where you have to evaluate to further the capacity) is better to use the contribution margin approach. When should we use the absorption approach? When also the fixed costs are relevant. In pricing special orders è sempre il contribution margin meglio sere ↳ invece l'absorption per quanto riguarda anche i fined approach costs è meglio usarlo quando sono importanti SKIP SLIDE 10. Pricing decisions: - Setting the price of a new or refined product - Setting the price of products sold under private labels - Responding to a new price of a competitor - Pricing bids in both sealed and open bidding situations In conclusion, both formats of the income statement are valid but they apply to different situations, depending on the decision that has to be made. - When variable costs are affected and fixed costs stay the same the contribution approach if of - great value. Applied to short-run decision. - - The absorption approach is used for long-time pricing decisions, where it is important that - price covers all costs (both fixed and variable). When it is important for managers to consider - - all costs of producing and selling. deve che un'azienda Questa teoria dice il margin cont Finche The Economic Theory on Pricing produceT e vende revenue This theory says that company should produce and sell until the margin cost equals the marginal revenue. Accountants seldom compute marginal revenue and marginal cost curves. They do not examine all the possible ranges of volume. Accountants do not consider all the possible volumes they consider only selected ranges of volumes. So, accountants: - They use estimates based on judgement - They examine selected volumes, not the range of possible volumes. È tecnica che aziende di una permette il alle costo medio e Questa verrà deciso in avantitàdel cliente di pagare prodotto facendo un volontà selezionare prezzo per Cost-Plus Pricing - un e base alla che sa s i i speri quantità che aquello i costi acifre inbase successivamente markup un = una e aggiungera A technique that allows companies to select prices by computing an average cost and adding a markup (the amount by which sales price exceeds cost). P= COSTS + MARKUP The markup will depend on the customer willingness to pay and on what the competitors do. What is challenging is to define the size of the markup. In the following example we can see that we can set different markups for the same target price/selling price. The size