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Management Accounting

accounting break even analysis budgeting controlling cost decision making finance management accounting planning

1.           Intro to Management Accounting

a.    Definition 

“Management accounting is a system which analyses historical, actual and forecast data to provide managers the information for decision making.”

  

b.   The management accounting department

The department provides management information for: 

  • Planning: budget for the year, budget updates during the year, long term plan beyond the year. 
  • Controlling: how do the revenues and costs compare with the budgeted ones and those of the previous periods. What are the variances? What are the reasons for the variances? 
  • Decision Making: profitability assessment, buildup of selling prices, product costs comparisons (inventory, manufacturing, labor etc..), make or buy decisions, capital replacement decisions, feasibility of new projects. 

c.    Management Accounting Systems 

A management accounting system forms the base of a company’s internal financial information system that will be used by managers for their decision making as well as for planning and controlling activities. The information provided should be accurate and detailed. The management accounting system should provide the following capabilities: 

  • Value Inventories (raw materials, work in progress & process, finished goods)
  • Generates Profit & Loss as well as Balance Sheet statements
  • Provides forecast: product, department, company by month, quarter, year.
  • Variance analysis to compare revenues and costs with budgeted or standard costs.
  • Actual cost & revenue KPIs readily available to assist with decision making. 

d.   Differences between Financial & Management Accounting

  • Management accounts are for internal stakeholders (managers and C-Levels) while financial accounts are for external stakeholders (shareholders, customers, suppliers, employees, banks, government)
  • Financial accounting is legally required while management accounting is not
  • Financial accounting is a standardized reporting based on a set of accounting rules (IFRS, US GAAP) while management accounting is adapted to the company’s activity to assist decision making
  • Financial accounts view the company as a whole presenting aggregate revenues and costs from different business operations while management accounting is focused on the value drivers of the business and examines separately the various business operations’ performance.
  • Financial accounting mainly presents the dollar value of each item, while management accounting also includes non-dollar KPIs (dollar per tons, hours, miles, employees).
  • Financial accounting is a postmortem analysis (only presenting historical data), while management accounting is focused on both planning (future), controlling (past) and decision making (present).   

e.   Cost Accounting Terminology

  • Cost object: the subject of a cost analysis. For example, a product, service, center, activity, customer, department, channel.
  • Cost center: at which level are costs aggregated. For example, costs can be aggregated by department, machine, project, new product launch, managers.
  • Cost units: it is a unit of output which absorbs the cost center’s overhead cost for example (tons, billable hours, service rendered, visits, calls, passengers, vehicles, kms etc…) and depends on the business operations and drivers.
  • Cost elements: direct cost (can be completely attributed to the production of specific goods, services or other cost objects), indirect costs (overhead that cannot be attributed entirely to the production of specific goods, services or other cost objects).
  • Cost classification: arrangement of costs elements according to their nature (materials, labor, expenses further split into direct and indirect), function (production, sales, marketing, administration…), or by decision making (fixed, variable, semi-variable). 

f.      Cost Classification according to cost element’s nature

  • Direct Costs: a cost that can be fully attributed to a cost object. For example, a cost that is an integral part of a product, a service etc. Direct costs can be further split into material costs (raw materials, component parts, semi-finished work, factory packing materials), labor costs (i.e. time spent on working for the product), and other expenses (i.e. costs incurred as a consequence of the production of a product such as renting the production space, renting of tools, etc…).
  • Prime Costs: is the sum of direct material, labor and other expenses.
  • Indirect Costs / Overheads: costs that cannot be directly attributed to specific cost objects (cleaning supplies, accountants, salesmen etc…)

g.    Cost Classification according to decision making 

Fixed & Variable Costs 

  • Fixed Costs: a cost that is not affected by changes in the level of activity or output level (rents, utilities of headquarters, etc)   
  • Variable Costs: costs that change with different levels of activity (raw materials, packaging materials, sales commissions, etc)
  • Semi-Variable Costs (or Mixed):  cost that is partly affected by a change in activity and contains both fixed and variable elements. Production labor is a semi variable cost since it is stable for similar level of activities (+ / - small changes) and as long as the shifts remain the same the cost can be considered fixed, however if a significant drop or increase in production occurs the shifts would have to decrease or increase respectively making the cost variable.

 A template for evaluating the impact of fixed and variable costs on profitability is the “Break Even Analysis” model which you can find here: https://www.big4wallstreet.com/products/break-even-analysis-model  

 

Other costs for decision making 

  • Relevant costs: future incremental cash flows that are directly linked with a management decision.
  • Avoidable Costs: costs which would not occur if the activity to which they are linked (i.e. new product) did not exist (usually variable costs and some specific fixed costs).
  • Differential costs: difference in total cost between various decision scenarios.
  • Opportunity costs: the value that must be foregone when one decision is taken versus another. For example, the opportunity cost of studying full time is the wages lost during your study time.
  • Sunk cost: a cost which occurred in the past and is not relevant with the decision making contemplated.

 



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