Man Acc Notes
Man Acc Notes
Man Acc Notes
i.
e Identify the major differences and similarities
between financial and managerial accounting.
e Explain the key principles and relevance of
management accounting both under local and
global setting.
e Describe how management accounting creates
value to the finn.
oe Identify. recognize, and analyze the different roles
of Management Accountants in cross-functional
teams and in the organization os a whole.
o Determine the career options that calls for a wide
range of skils of management accountants
including graduates of BSMA.
e Understand the importance of upholding ethical
standards and apply such standards.
e Compare the functions of the controller and the
treasurer/CFO
e = Identify the requisites to obtain a CMA centcae
Six Key Areas of Focus for organizations: Coping with COVID-19 Pandemic
Managerial Accounting 1
INTRODUCTION
In life, we make decisions. People hired to manage the business have to make decisions.
For some, it takes a lot of time and effort to make a decision. In times of dilernma, you
ore pressured to make a spur of the moment decision. Others consider a lot of factors
before they decide. They secure the right information needed to support their decision.
If they plan to expand their business, what type of information do they need to get? If
they plan to diversify their products, which product must be given the first priority for
production? Some stakeholders may ask “Is the company on the red?" The phrase “an
the red" is used to describe a business that is operating at a loss. Naturally, you want to
run your business profitably.
However, a newly opened business commonly finds itself on the red for a period of time
until it generates enough revenue to cover or even exceeds its expenses. If your business
is consistently operating on the red, this calls for your immediate action as it scares away
potential investors or creditors.
This book introduces the managerial use of accounting information which will be of help
in preparing you to become an effective manager by explaining how to make intelligent,
data-driven decisions. It covers the general overview of management accounting, how
it adds value to the company, and includes a thorough study of the concepts, standards,
techniques and methods which can be utilized by managers and even management
accountants. Managers must oversee the day-to-day activities and keep the company
functioning smoothly. Think about the various stakeholders who will alsa use this
information. In one way or another, these users of accounting information tend to be
concemed about their own interests in the entity.
The diversity of interested parties leads to a logical classification of accounting into two
(2) main segments: financial accounting and management accounting. Hansen and
Mowen (1994:8) state that it is virtually impossible for managers to function without
accounting information. Managers need to know how to interpret and use such
accounting information. They need to understand accounting in order to fulfill certain
organizational roles and responsibilities such as to plan, organize, lead and control.
Harrison and Hongren (2001:4) agrees with Hansen and Mowen (2005:4), in describing
accounting as an information system that measures business activities, processes
information into reports, and communicates the results ta decision makers. Hence, the
ultimate purpose of management accounting is to aid in decision making.
The roles that management accountants play in their organizations, their leadership
position in cross-functional teams, and the skills required to meet the needs of the
changing business environment will also be discussed. Management accounting
provides the detailed analysis of the cost incurred and assist managers to develop
strategies in order to reduce costs and likewise increase profits. Costing is a function
which links both financial and management accounting. Without proper product cast
information, a manufacturing, wholesale or retail organization will not be able to
Managerial Accounting 2
segregate the cost of sold and unsold outputs. Such segregation is essential to obtain
periodic measurement of the company's profitability.
In 1981, the Institute of Management Accountants or IMA (then the National Association
of Accountants) issued its first SMA (Statement on Management Accounting) where
Management Accounting (also known as Managerial Accounting) was defined as the
process of identification, measurement, calculation, analysis, preparation, interpretation
and communication of information used by management to plan, evaluate and control
within an entity and to ensure appropriate use of and accountability for its resources.
Management accounting also comprises the preparation of financial reports for non-
management groups such as shareholders, creditors, regulatory agencies, and tax
authorities. Such definition explains the role of the management accountant as an
information provider, one who gathers, summarizes, analyzes, and reports information to
management decision makers—a role that has largely been taken over by technology,
é.g.. highly integrated Enterprise Resource Planning (ERP) systems. This has caused an
“identity crisis" for the profession because they are inconsistent with the views that
practicing management accountants believe in. The traditional role of management
accountants as information providers has been transformed to that of a strategic
business partner. That prompted IMA to develop a new definition to better represent and
describe the role of today’s management accountant.
Managerial Accounting 3
management team working within the company at various levels: from supportlevel
accounting and finance professionals to top-level management. Every management
accountant is a vital team player who participates in strategic management decision
making, thus contributing to the company's success through the implementation of the
company's strategy.
To carry out the manager's control function, he has to ensure that the plan is being
followed. Feedback is the key to effective control. Controlling involves gathering
feedback to ensure that the plan is being properly executed or modified as
circumstances change. It is the process of keeping the company's activities on track. In
controlling operations, managers determine whether the planned activities are aligned
with the company's goals or objectives. If deviations exist, then the manager has to
decide what action must be taken or what changes must take place to get back on
track. In sophisticated entities, this feedback is provided by detailed reports of various
types. One of these reports, which compares budgeted to actual results, is called
a performance report. Performance report suggest where operations are not
proceeding as planned and where some parts of the company may require additional
attention.
Managerial Accounting 4
Distinctions as to: Financial Accounting Management Accounting|
Internal users like managers
Primary Users External users and officers
2. Types and frequency of Financial statements Internal reports tailored fit
reports covering to the needs of the
the required time period of intended internal users
the various external prepared as frequently as
stakeholders needed
3. Purpose of generated General-purpose Special purpose for specific
reports needs of intended users
4. Content of reports Pertains to business as a Highlights segment
whole and highly reporting; provides
aggregated (condensed) detailed and
disaggregated information
about a segment
§. Overriding Criteria Used Based on GAAP/PAS/PFRS Situational relevance or
usefulness: flexibility and
application of cost-benefit
analysis
6. Primary Reporting Focus Focuses on the company Focuses on a_particular
as a whole (aggregate) part or segment
7. Behavioral Implication Measurement of economic Influence on managerial
entity behavior
8. Time Orientation Historical or Past | Forward looking or future
Orientation Oriented
9. Flexibility of Information | Less flexible More Flexible
10. Recordkeeping Formal recordkeeping Combination of formal and
informal recordkeeping
11. Basis in presenting data Based on objective facts Based on facts or estimates
12. Necessity of Financial Required or Mandatory Optional
Statement (FS)
Preparation
Oftentimes, management may dictate the parameters under which such information is
to be accumulated and presented. That is their prerogative. Hopefully, internal reporting
is being done logically and rationally, hence it need not follow GAAP or any particular
set of mandatory quidelines. Management accounting is not mandatory in the sense
that a company is free to do as much or as little as it likes and no regulatory bodies or
Managerial Accounting
agencies specify what is to be done, or, for that matter, whether anything is to be done
atall. Management accounting is all about helping the stakeholders and the company
make the best decision possible given the information available to them.
Financial accounting requires that records be kept with considerable precision which is
needed to keep the financial statements reliable whereas management accounting
frequently deals with estimates, rather than proven and verifiable facts.
Financial accounting requires that financial statements be issued following the end of an
accounting period while in management accounting, it may issue reports much more
frequently, for it to decide on a timely basis and keep the information relevant to the
individual managers.
It makes use of information that is drawn from the company's accounting information
system and may even extend beyond the boundaries of traditional accounting. It has
played a secondary role to financial accounting and is considered by many as a by-
product of the financial reporting process. It has a very wide scope incorporating several
disciplines which considers both monetary as well as non-monetary information.
Therefore, it includes all information which is provided to the management for analysis
and interpretation of the company's operations.
Managerial Accounting 6
Skills of Management Accountants
Ee
You have to know also how to make use of the
information contained in those reports. Management
accounting jobs require that accountants exercise a
greater level of responsibility to internal business
stakeholders. The knowledge of broad business tapics
such as economics and logistics as well as technical skills
=a helps a management accountant to suggest
customized, creative solutions for their employer and/or clients as well that align with the
company’s goals. Business managers need accounting information to make sound
decisions for the best interest of those they're working for.
The role of management accountant requires a different set of skills. What skills ore
important to be a management accountant? The skills or abilities we look for among the
management accountants which differentiate them from other business consultants in
the workplace are:
Strategic Thinking Skills. Strategic thinking ought to be everyone's skill, not just that
of a CEO or leaders. It shoula be part of building your competencies. Be a strategic
thinker who looks far beyond the whole picture as you do long-term planning.
Accountants help companies of all sizes create strategic plans to maximize success ar
limit chances of failure. You review and set goals and priorities as well as identify potential
risks and opportunities. As strategic thinker, you are creative, long-term focused,
adaptable, life-long learner. The top players in accounting are generally known for their
being visionary — for making logical decision that involves a bit of creativity. So the ability
to look ahead is the key.
Managerial Accounting 7
and making yourself approachable and available to the people you're responsible for.
You have ta balance being a role model and the person in charge while still being part
of the team. It also takes confidence, patience, and the ability to delegate — traits which
don't come easily to most people. The core leadership skills include organizing skills,
innovation skills, decision-making and problem-solving skills. Being well-organized is a
great way to demonstrate that you are reliable, competent and able to get the job
done. Start honing your organizational skills now.
Time Management Skills. Managing your workload is only effective if you also
know how to budget your time. As an accountant, you should know how to manage
competing priorities and juggle myriad tasks while cormnpleting everything on time. The
ability to work within deadlines and continually re-prioritize your to-do list will take you far.
Not only will it impress your boss, co-workers and clients, it will also help you in maintaining
a healthy work/life balance and keep your day-to-day productive.
Analytical Skills. Having a strong analytical skill is one of the crucial skills in the
workplace. Analytical skills refer to your ability to collect and gather the right information
required for a specific situation, visualize and analyze information in details. It will also
include your ability to see a problem or situation from different points of view. It can be
improved through constant practice. Remember, the quality of life depends on the
quality of our logical and analytical thinking and on how good we are in decision-making
and problem-solving. All these skills can be learned, developed and enhanced!
Technical Skills. Many accounting jobs require technical skills which will enable
you to apply your accounting knowledge, work with spreadsheets, perform research and
review the accounting or finance work of others. Such skills are initially acquired or
developed in your undergraduate years of study and further enhanced as you acquire
practical work experience in various sectors.
Communication Skills. No matter where you work, what your job entails or who
you work with, strong communication skills are incredibly valuable. Being able to
communicate well in writing and in person will help you to get a job, work as a team with
Managerial Accounting 8
your colleagues and interact with clients. Communicate clearly and tactfully with the
people around you.
Management accountants are key figures in determining the status and success of a
company. Some choose to become a Certified Management Accountant (CMA), a
similar credential to CPA, but with a greater focus on cost accounting, financial planning,
and management issues. Management accountants will be presented with many
opportunities for innovative actions in the global economic environment. In addition to
their role of providing oaccurate, timely and relevant information, management
accountants aré expected to participate as business consultants and partners with
management in the strategic planning process.
In practice, the management accountant is asked to work directly under the Managing
Director or Chief Executive Officer (CEQ).The functions of management accountant
depend upon his status in the organization, agreement with the organization, experience
and capacity of the management accountant. He has to prepare the necessary
procedures to implement the plan effectively. The top management requests the
management accountant to prepare the report for the root causes of an unfavorable
event or operations. In this report, the accountant can pinpoint the real reasons and the
persons who are responsible. He has to evaluate the effectiveness of policies,
organization structure and procedures adopted for attaining the objectives. He has to
advise management in order to improve the performance of operations. He will have to
supervise all the statements and returns which are to be submitted to the government
periodically within the due date. The extent of impact of policy changes and
amendments has to be assessed by the management accountant. He has to make
economic appraisal and find the influence of economic condition over the business
activities. In this aspect, he can prepare a report to be submitted to top management
along with his comments. The management accountant keeps a record of the functions
that take place in the company. For example, it keeps a track record of the work in
progress and the stage of completion attained. Further, it also helps in calculating and
analyzing the cost of production for the month. Through an effective management
accounting system, it is possible to enhance the overall performance of the campany.
Professional Designations
There are two (2) major professional designations for management accountants which
may help you eam a higher salary. First is the Certified Management Accountant (CMA)
designation offered by the Institute of Management Accountants (IMA) where you are
required to complete a bachelor's degree, pass the two-part CMA exam and acquire
two continuous years of professional experience in management accounting or financial
Managerial Accounting 3
management. The professional status of management accounting is affirmed by the fact
that management accountants undergo a figorous exam to qualify as Certified
Management Accountant (CMA). Considerable prestige is attached to the professional
designation of CMA. According to IMA's 2019 Global Salary Survey, the median total
compensation is 55% higher for CMAs over nan-CMAs. CMAs of all ages earn more than
non-CMAs. Those aged 30-39 receive a median salary 61-67% greater than their non-
CMA peers. CMAs believe their certification creates career opportunities and
strengthens their ability to move across business areas.
AS advanced credentials, the CGMA letters after your name will add power to your
resume by demonstrating to employers that you have strong business acumen,
experience, ethics, commitment, and skills. In addition, becaming a CGMA will connect
you with a global community of other management accountants to share practices,
create innovation, conduct research, and better prepare you for global challenges. In
2014, CIMA created the Global Management Accounting Principles (GMAPs}, the result
of research from across 20 countries in five continents. The principles aim to quide the
best practices in the discipline. For more information, visit these websites: www.cgma.org
or www.imanet.org or www.cimaglobal.com
Many people are looking for a career path that combines good financial incentives with
a sustainable work-life balance. A management accountants role includes diverse
responsibilities, such as advising managers about the financial implications of projects,
formulating business strategies to negotiate a competitive landscape, conducting
internal business audits and monitoring corporate spending. To guide strategy, a pro-
active and forward-looking attitude is essential, Management accountants are
increasingly called upon to advise the board and guide effective decision-making. Work
experience, preferably in the business or financial sector, is important in demonstrating
your willingness to learn and develop your knowledge of the business environment. As
they gain experience, they are given more responsibility and are often put in charge of
others.
Many of the entry-level staff accountants have only bachelor's degrees. High-end
management consultants tend to have Master of Business Administration (MBA) or Master
of Accountancy degrees. Almost without exception, public accounting firms want new
Managerial Accounting 10
hires to have passed the Certified Public Accountant (CPA) exam, or at the very least,
be eligible to take it.
Nobody starts as a controller immediately after getting a CPA license, and it can take
several years of dedicated work to earn the title. Many controllers spent years as auditors
or accountants with local accounting, auditing or consulting firms. Contemporary
controllerships actually begin after a few years as an assistant controller. Some employers
place special emphasis on industry experience. This diversity makes it possible to ascend
to a controller position.
CMAs are employed by a vast number of different industries. Most of them work in
general accounting and finance, but many also have management roles. They work in
a wide variety of work places such as family-run businesses, commercial establishments,
manufacturing firms, export processing zone, small and large publicly listed companies
and multinational corporations. There are also CMAs in not-for-profit organizations,
government and academic institutions. Private companies are where a management
accountant thrives. As an independent adviser, you might be able to work with smaller
companies on a consultancy basis but as the company expands, they will move towards
having an internal management accounting team.
There is a distinction between the treasury function (focuses on cash flow) and financial
reporting function of the controller. Treasury functions include cash management,
investment and debt management, financial risk management and investor relations. It
may also deal with complex financial areas such as foreign exchange rates, derivatives
and interest rate swaps, among other things. Both the treasurer and controller are
responsible to the top managemert.
Managerial Accounting 11
In many organizations, the designation chief finance officer (CFO) is given to the
executive responsible for all accounting and finance functions. In small companies, they
are oftentimes called controller or in non-profit or governmental organizations, they are
called the comptroller. In some companies, the controller is called Chief Accounting
Officer who is responsible for the maintenance of adequate internal control and for the
preparation of accounting records. A controller is also required to be a licensed CPA,
with an extensive experience in accounting and finance jobs as he will be mainly
responsible for internal and external financial reporting, analysis, and such other internal
finance functions.
The CFO is the organization's top managerial and financial accountant. He is responsible
for supervising the accounting and finance personnel throughout the company and for
preparing the information and reports used in both managerial and financial
accounting. The controller is the chief accountant of the company who supervises his
accounting staff and oversees the preparation of financial reports. In large entities, the
controller reports to the chief finance officer (CFO). However, in small entities, the
controller may be assigned as the head of the Finance Department. He also takes part
in analyzing financial data, as well as in preparing the budget. He is also in charge of the
company's tax compliance and see to it that deadlines and regulations are strictly
followed. As the organization's chief management accountant, the CFO interprets
accounting information for liné managers and participates as an integral member of the
management team.
Generally, the treasurer has the custody of the company's funds entrusted to his care
and responsible for planning and controlling the company's cash position. He serves as
the protector of the company's finances from financial risks that arises from business
activities. Traditionally, a treasurer is Under the Accounting Department, but has now
been renamed as a new segment called Treasury Department. The treasury department
is responsible for the timely availability of funds needed to support the business. Actual
performance should be compared with the targeted performance to evaluate how the
treasury department has functioned during the period.
The duties of a treasurer include interacting with shareholders, bankers, current and
potential investors. He is primarily responsible for obtaining investment capital and
managing the cash flow of the business. He takes charge of obtaining loans and credit
from outside sources. He builds and maintain healthy business relationships with banks
and other lending institutions and raise equity capital. He is responsible for investing the
company's funds making sure that financial goals are met and cammunicating with
shareholders. The Treasurer is also responsible for ensuring that effective financial systems
and procedures have been established, consistently followed and are in line with best
practices and legal requirements. The financial duties undertaken by his personnel in the
Treasury Department should reflect levels of authority and responsibility. He should
identify which tasks need to be performed, who will undertake the tasks and how will they
be monitored.
Managerial Accounting 12
Most CFOs and controllers are involved in planning and decision making at all levels and
across all functional areas of the entity. This broad role has enabled many managerial
accountants to rise to the top level of the hierarchy. Former accountants have served as
top executives in companies like General Motors, Singer, and General Electric Corp.
Shown below are the functions of the controller and the treasurer summarized in table
form:
CONTROLLER REASURER
CMA Certification
Globally, IMA supports the profession through research, the CMA® (Certified
Management Accountant) program, continuing education, networking and advocacy
of the highest ethical business practices. IMA has regional offices in eight cities outside
the United States: three in China, two in Eurape, one in India, one in Singapore, and one
in Dubai. Today, more than half of IMA's approximately 120,000 members outside the U.S.
IMA has a global network in 140 countries and 300 professional and student chapters.
Headquartered in Montvale, N.J., USA, IMA provides localized services through its four
global regions: The Americas, Asia/Pacific, Europe, and Middle East/Africa. For more
information about IMA, please visit www.imanet.org. Are you ready now to assess your
skills, plan your career path and see your future?
ICMA conducted the latest job analysis study in the first half of 2018. The purpase of this
study was to confirm that the CMA exam continues to test the knowledge and skills that
are most important for management accounting and finance professionals. The results
of this study will be reflected in the CMA exam effective January 2020.
It is the responsibility of the employer to foster a corporate climate that supports ethical
behavior by all employees. This is achieved by continuous training in the ethical policies
and guidelines of the company, positive reinforcement of ethical actions and exercises
ethical leadership by example. Behavior modification is the act of shaping how
employees should behave in the workplace and bring out the best in them which will
ultimately benefit the company as well. Most managers practice behavior modification
by using positive reinforcement such as rewarding those who excel and providing them
a merit pay incentive. Warnings and suspension of employment are examples of
behavior modification through negative reinforcement. Such modification
Managerial Accounting 14
techniques may either encourage or discourage behaviors in the workplace. Ethical
issues come into play when you consider possible adverse effects of behavior
modification on other employees in the office and your own ability as a manager to use
positive and negative reinforcement objectively.
Employees can make better decisions in less time with business ethics as a quiding
principle. This will lead to increased productivity and overall employee morale. Infraction
of the company policy may call for a need to conduct an internal audit, take
appropriate legal action and instituting corrective actions. These consequences will mast
certainly have a financial impact due to time and costs involved, and may also
negatively impact employee morale as business operations are strained under the
pressure. Noncompliance with ethical standards may destroy the image or reputation
of the business, the consequences of which may include loss of customers, employee
turnover and loss of staff loyalty.
Ethics, in its broader sense, deals with human conduct in relation to what is morally good
or bad, right or wrong. Due to the relevance of the accounting information provided,
management accountants should observe certain professional ethical standards. IMA is
a member organization of the International Federation of Accountants (IFAC) and it
provides ethical standards for practitioners of Management Accounting and Financial
Management to govern their professional career. Setting professional ethical standards
is important because:
* they provide trust in the employee-employer relationship:
* standards represent a reference for management accountants facing ethical
dilernmas;
* they provide a guarantee as to the quality of the information provided to the
various Users.
IMA'S ethical principles are based on honesty, fairness, objectivity and responsibility. IMA
members who constantly face ethical dilemmas must use these ethical principles every
time they engage in accounting services for their company and the general public. For
example, if the accountant's immediate superior instructs the accountant to record
inventory at original cost when it is obvious that the inventory has a reduced value due
to obsolescence, what should the accountant do? To help make such a decision, the
decision maker must then estimate the outcome of the decision and be responsible for
its results. When faced with an ethical dilemma, ask these questions: “Will my actions be
fair and just to all the parties affected?" and "Would | be pleased to have my closest
friends learn of my actions?"
To determine whether a decision is good or bad, the decision maker must compare
his/her options with some standard of perfection. This standard of perfection requires the
decision maker to assess the situation and the values of the parties affected by the
decision. Practitioners in management accounting and financial management have a
unique set of circumstances relating to their employment. To help them assess their
Managerial Accounting 15
situation, the IMA Helpline is designed to provide clarification of provisions in the IMA
Statement of Ethical Professional Practice, which contains suggestions on how to resolve
ethical conflicts. The helpline cannot be considered a hotline to report specific
suspected ethical violations.
COMPETENCE 0) ee ne
=a ie Or.
STANDARDS
aC Sam CREDIBILITY
The Statement of Ethical Professional Practice sets forth principles and standards for the
ethical conduct of accounting and finance professionals, and all IMA members ore
expected to abide by them no matter what country orregion they're in. Practitioners of
management accounting and finance professionals have an obligation to the public,
their profession, the organization they serve, and themselves to maintain the highest
standards of ethical conduct. IMA's first code of conduct for members was issued in the
1980s. In 2005, the original IMA Statement of Ethical Professional Practice was created as
a response to the Sarbanes-Oxley Act of 2002. This was followed by a revised version in
2017 that's shorter and easier to apply and reflects a more principles-driven approach.
The ethical standards set by IMA as shown in Figure 1 are: competence, confidentiality,
integrity and credibility. Competence is an accountant's ability to use professional
expertise and develop his accounting knowledge and skills. Confidentiality requires
accountants to disclose information only at their supervisor's discretion. Integrity prohibits
managerial accountants from engaging in unethical conduct. Credibility refers to the
accountant's ability to communicate accounting information fairly and objectively to all
business stakeholders.
The sources of ethical problems can be: (1) the management's expectations opposed
fo the principles of professional ethics; (2) the desire to be promoted: (3) the desire to
eam money quickly; and (4) personal obligations. Unlike external auditors, management
accountants are employees of the company and due to this aspect, the company
expects them to be loyal. Managers who want to be appreciated by the Board of
Directors may put pressure on the accountant in order to make a facelift of the financial
statements. Many times, accountants are tempted to give in to such pressures.
Accountants have the obligation to present the statement of financial position in which
they should depict the financial status or condition of the company with maximum
accuracy, even if this is not in favor of the management team or of the campany itself.
Principles
Standards
A member's failure to comply with the following standards may result in disciplinary
action.
I. Competence
Each member has a responsibility to:
1. Maintain an appropriate level of professional expertise by continually developing
knowledge and skills.
2. Perform professional duties in accordance with relevant laws, regulations, and
technical standards.
3. Provide decision support information and recommendations that are accurate,
clear, concise, and timely.
4. Recognize and communicate professional limitations or other constraints that
would preclude responsible judgment or successful performance of an activity.
ll. Confidentiality
Each member has a responsibility to:
1. Keep information confidential except when disclosure is authorized or legally
required.
2. Inform all relevant parties regarding appropriate use of confidential information.
Monitor subordinates’ activities to ensure compliance.
3. Refrain from using confidential information for unethical or illegal advantage.
Managerial Accounting 17
Ill. Integrity
Each member has a responsibility to:
1. Mitigate actual conflicts of interest. Regularly communicate with business
associates to avoid apparent conflicts of interest. Advise all parties of an potential
conflicts.
2. Refrain from engaging in any conduct that would prejudice carrying out duties
ethically.
3. Abstain from engaging in or supporting any activity that might discredit the
profession.
IV. Credibility
Fach member has a responsibility to:
1. Communicate information fairly and objectively.
2. Disclose all relevant information that could reasonably be expected to influence
an intended user's understanding of the reports, analyses, or recommendations.
3. Disclose delays or deficiencies in information, timeliness, processing, or internal
contrals in conformance with organization policy and/or applicable law.
In applying the Standards of Ethical Professional Practice, you may encounter problems
identifying unethical behavior or resolving an ethical conflict. When faced with ethical
issues, you should follow your organization's established policies on the resolution of
such conflict. If these policies do not resolve the ethical conflict, you should consider
the following courses of action:
1. Discuss the issue with your immediate supervisor except when it appears that the
supervisor is involved. In that case, present the issue to the next level. If you cannot
achieve a satisfactory resolution, submit the issue to the next management level.
lf your immediate superior is the chief executive officer or equivalent, the
acceptable reviewing authority may be a group such as the audit committee,
executive committee, board of directors, board of trustees, or owners. Contact
with levels above the immediate superior should be initiated only with your
superior's knowledge, assuming he or she is not involved. Communication of such
problems to authorities or individuals not employed or engaged by the
organization is not considered appropriate, unless you believe there is a clear
violation of the law.
2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA
Ethics Counselor or other impartial advisor to obtain a better understanding of
possible courses of action.
3. Consult your own attorney as to legal obligations and rights conceming the
ethical conflict.
Managerial Accounting 18
Accountants who fail to abide by the IMA's accounting ethical code face a variety of
punishments. Accountants may lose their professional certification, be removed from
accounting positions and face legal penalties depending on their inappropriate actions.
Managerial accountants who do not disclose inappropriate accounting operations in
their company also can be held liable. Maintaining the general public's trust in
companies is a primary responsibility of management accountants.
Whistleblowing
Whistleblowing is the act of reporting suspected wrongdoing at work to draw the
attention of somebody in authority or even drawing public attention. Corruption, fraud,
bullying. health and safety violation, cover-ups and discrimination are common activities
highlighted by whistleblowers. This is making a disclosure in the public interest. As with
conflict of interest, gifts and hospitality should not be accepted or offered if they are likely
to compromise you or your firm's impartiality or integrity.
Whistleblower is o person who exposes any kind of information or activity that is deemed
illegal, unethical, or not correct within an organization that is either private or public.
Sometimes they are regarded as selfless martyrs for public interest and organizational
accountability; others view them as “traitors” or "defectors." Some even accuse them of
solely pursuing personal glory and fame, or view their behavior as motivated by greed.
They can be employees, suppliers, contractors, clients or any individual who somehow
becomes aware of illegal activities taking place in a business either through witnessing
the behavior or being told about it.
Whistleblowers face legal action, criminal charges, social stigma, and termination from
any position, office, or job. Whistleblowers are often protected under law from employer
retaliation, but in many cases punishment has occurred, such as termination, suspension,
demotion, wage garnishment, and/or harsh mistreatment by other employees. Many
whistleblowers have stated that they were motivated to take action to put an end to
unethical practices, after witnessing injustices in their businesses or organizations. A 2012
study identified that individuals are more likely to blow the whistle when several others
know about the wrongdoing, because they would otherwise fear consequences for
keeping silent. In cases when one person is causing an injustice, the individual who
notices the injustice may file a formal report, rather than confronting the wrongdoer,
because confrontation would be more emotionally and psychologically stressful. Others
Managerial Accounting 19
may be motivated to report unethical behavior when they believe that their company
will support them. Professionals in management roles may feel responsibility to blaw the
whistle in order to uphold the values and rules of their organization. Questions about the
legitimacy of whistleblowing, the moral responsibility of whistleblowing, and the appraisal
of the institutions of whistleblowing are part of the field of political ethics.
As workers attempt to address concerns, they are often met with a wall of silence and
hostility by management. Some whistleblowers speak of overwhelming and persistent
distress, drug and alcohol problerns, paranoid behavior at work, acute anxiety,
nightmares, flashbacks, posttraumatic stress disorder and intrusive thoughts. Depression is
often reported by whistleblowers, and may even lead to suicidal attempts. General
deterioration in health and self-care has been described. Increased stress related
physical illness has also been described in whistleblowers.
Retaliatory actions include laying off the employee, reducing the employee's pay,
cutting back his hours, moving the employee to another job that is, in effect, a demotion.
Other actions that affect the employee's current or future employment status or work
environment can also be considered retaliatory. The stresses involved in whistleblowing
can be huge. As such, workers remain afraid to blow the whistle, for fear that no ane will
believe them or they have lost faith in believing that anything will happen if they do speak
out. Loss of job, questioning the whistleblower's mental health, vindictive tactics to make
the individual's work more difficult and/or insignificant, character assassination, formal
reprimand, and difficult court proceedings may happen. The ethical implications of
whistleblowing can be negative as well as positive. Sometimes employees may blow the
whistle as an act of revenge. The negative results of being a whistleblower could be one
being seen as a traitor, a hero, or just one of the majority whistleblowers who are simply
disgruntled with a perceived but not true unfairness. The list of negative consequences
to whistleblowing seems endless.
Situations in which a person may blow the whistle are in cases of violated laws or
company policy, such as sexual harassment or theft but these instances are small
compared to money laundering or fraud charges on the stock market. Whistleblowing in
the private sector is typically not as high-profile or openly discussed in major news outlets,
though occasionally, third parties expose human rights violation and exploitation of
workers.
Managerial Accounting 20
Exercise 1-1
Divide the class into five (5) groups and assign the following graded group activities:
2 Demonstrate your understanding about the functions of the controller and the
treasurer.
3 Demonstrate your knowledge on how to construct a concept map about the code
of ethics in your college or university and explain it to the class. Identify also the
common violations that you have encountered in the school campus and provide
recommendations to address or resolve such issue/s.
4 Prepare a talk show with an audio-video clip where you will summarize the
important facts about CMA certification.
Managerial Accounting 21
Exercise 1-2 (True or False)
Instruction: Encircle the numbers with false statements. (False - Bold items)
Managerial Accounting 22
Exercise 1-3 (Multiple Choice)
Managerial Accounting 23
lll - Establishing systerns which facilitate planning and control of tine firm's
resources, excluding tax planning and compliance.
IV —- Designing and developing overall management information system.
V - Application of internal audit procedures to assure the accuracy and reliability
of information derived from the accounting system and related sources.
a. Only one item
b. Only two items
c. Only three iterns
d. Only four items
e. All of the items are correct
Under the IMA's Code of Conduct for Management Accountants, which of the
following does not describe INTEGRITY?
a. Abstain from engaging in or supporting any activity that might discredit the
profession.
b. Disclose all relevant information that could reasonably be expected to
influence an intended user's understanding of the reports, analyses or
recommendations.
c. Mitigate actual conflicts of interest. Regularly communicate with business
associates to avoid apparent conflicts of interest .
d. Refrain from engaging in any conduct that would prejudice carrying out
duties ethically.
e. All of the above describes integrity.
Managerial Accounting 24
6. A packaging supplier, bidding for a new contract, offers the management
accountant of the purchasing company an all expense paid weekend to the
Super Bowl. The supplier does not mention the new contract when extending the
invitation. The accountant is not a personal friend of the supplier. The accountant
knows cost issues are critical in approving the new contract is concerned that the
supplier will ask for details about bids by competing packaging companies. Based
on the case above what ethical dilemma where in the management accountant
is facing?
a. Integrity and Credibility
b. Confidentiality and Credibility
ec. Confidentiality and Integrity
d. Competence and Integrity
e. Competence and Confidentiality
Managerial Accounting 25
bonuses. Which of the following is correct with regards the failure to report the
nature of the inventory.
9. Bambamis a financial manager who has discovered that her company is violating
environmental regulations. If her immediate superior is involved, her appropriate
action is to:
a. Confront her immediate superior.
b. Present the matter to the next higher managerial level.
c. Do nothing since she has a duty of loyalty to the organization.
d. Consult the audit committee.
Managerial Accounting 26
12. If a financial manager or management accountant has a problem in identifying
unethical behavior or resolving an ethical conflict, the first action(s) he should
normally take is to
a. Consult the board of directors.
b. Resign from the company.
c. Discuss the problem with his/her immediate superior.
d. Notify the appropriate law enforcement agency.
14. The Code of Ethics for Management Accountants includes an integrity standard,
which requires the financial manager/management accountant to
a. Disclose confidential information when authorized by his/her firm or
required under the law.
b. Refuse to accept gifts from anyone.
c. Identify and make known anything that may hinder his/her judgment or
prevent satisfactory completion of any duties.
d. Report any relevant information that could influence users of financial
statements.
15. Engaging in or supporting an activity that would discredit the profession would
relate to which part of the IMA Code of Conduct?
a. competence c. independence
b. credibility d. integrity
17. Under the express terms of the Code of Ethics for Management Accountants, a
financial manager/management accountant may not
a. Disclose confidential information unless authorized or legally obliged.
b. Accept other employment while serving as a __ financial
manager/management accountant.
c. Advertise
d. Encroach on the practice of another financial manager/management
accountant.
Managerial Accounting 27
18. A financial manager/management accountant discovers a problem that could
mislead users of the firm's financial data and has informed his/her immediate
superior. He/She should report the circumstances to the audit committee and/or
the board of directors only if
a. The immediate superior, who reports to the CEO, knows about the situation
but refuses to correct it.
b. The immediate superior assures the financial manager/management
accountant that the problem will be resolved.
e. The immediate superior reports the situation to his/her superior.
d. The irmmediate superior, the firm's CEO, knows about the situation, but
refuses to correct it.
20. Engaging in or supporting an activity that would discredit the profession would
relate to which part of the IMA Code of Conduct?
a. competence c. integrity
b. independence d. credibility
Managerial Accounting 28
Exercise 1-4 (Identification)
Instruction: For each item given below, write Tif it is a function of the Treasurer: write C
if it is a function of the Controller.
1. Prepares the master budget and supervise accounting and auditing work.
7. Has the authority to utilize the surplus cash of the company whenever there is
any type of short term beneficial investments.
10. Signs checks (with a second signatory from the Board or staff).
Managerial Accounting 29
Case Study A: Incorrect Declaration of Income
You are a sole practitioner who used to provide a range of accountancy services for a
small company. The previous external accountant died a month ago and you are hired
by the company to certify the accuracy of the financial statements for renewal of
business permit. The company operates a total of 20 branches with 120 employees. You
have been informed by the company's accountant that the company maintains two (2)
sets of books, one for internal use and the other one for BIR reporting. This had been
practiced since the business started 25 years ago. As a result, the company paid lower
income tax to the BIR.
There is a possibility that the company's funds will not suffice to pay whatever is due to
the government. In addition, it will result to job losses if the BIR Assessment will be
conducted and the correct amount shall be paid. You have discussed this with the Chief
Operating Officer (COC) but he expressed not to disclose the misdeclaration of the
Taxable Income. He also mentioned that they have contacts inside the BIR who receives
monthly alowance to facilitate all statutory requirements and future BIR assessments of
the company.
Based on the case facts mentioned above, what ethical standards have been violated
by the company, the BIR and the accounting practitioners? Explain and identify the
alternative courses of action for the affected stakeholders.
My manager has asked me to deal with a task in relation to a contract in a way thatlam
uncomfortable with. Carrying out the task in this way seems wrong to me and | believe
the approach being suggested by my manager may even be illegal in some of the
jurisdictions in which we do business. | have been thinking about talking to a senior
manager in another department for advice, but I'm not sure if | should. | feel as though |
should tell someone who can look into this, but I'm afraid that my line manager will make
my job difficult for me and possibly take me off the contract if they find out I've spoken
to someone else. What should | do?
Managerial Accounting 30
CHAPTER TWO: After studying this chapter, you will be able to:
oO
variable costing and absorption costing.
o Anolyse and reconcile variable casting and
absorption costing net operating income
ond explain the resulting differential profit or
lass.
COSTING V§ Understand the advantages and
o
dtadvantages of both variable and
absorption costing.
o 6 Identify, describe and apply throughput
DIRECT COSTING —
Over the next five years, the airline company is not expecting to add any flights at Manila due to slot
constraints but aiming to grow the average seat capacity per departure from 195 seats to 280 seats.
Increasing density is a strategy of Cebu Pacific, to lower unit costs in order to maintain very low fare in a
price sensitive market while maximizing the slots at its main hub.
In order to achieve this, the company will stop operating turboprops at Manila and will double the size of
its wide body fleet and transition most of its Manila-based narrow body flights from A320s to A321s. The
airline group's overall seat capacity has grown marginally in the last three and half years as it has waited
for the delivery of new generation aircraft.
Source: https://centreforaviatian.cam/analysis/reports/cebu-pacific-air-upgauging-drives-40-growth-at-cangested-manila-
485423
Managerial Accounting 31
Product Costs vs. Period Costs
All production and non-production casts can be classified as either product costs or
period costs. Product cost is a cost attributable or directly associated with the product
as it is produced. Such costs are involved in the purchase of goods or manufacture of
products. They are included in inventory valuation that is why it is alsa known as
inventoriable costs. It is considered as costs of production and such product costs are
assigned to Work in process as production occurs which will be subsequently transferred
to Finished Goods as the products are completed. Once the product is sold, the product
costs are recognized as an expense (as itis charged to Cost of Goods Sold) and matched
with the related Sales for the said period. At the point of sale, the costs are released from
inventory and treated as expenses (typically called CGS).
It diminishes current income by that portion identified with the sales volume only, the
balance of which is deferred to the next accounting period as part of ending inventory.
In contrast, period casts are not assigned to the product but are recognized as expense
in the period in which it is incurred.
In other words, period cost is not related to production as it cannot be assigned to the
product but rather charged to the period in which they arise. All non-production costs
such as General and Administrative Expenses as well as Selling Expenses are period costs.
These costs are matched against revenues on a time period basis. It does not form part
of the cost of inventory and it diminishes income for the current period by its full amount.
In general, the variable manufacturing cost is considered as product cost because they
change with the change in activity level. Conversely, the fixed cost is regarded as period
costs because they remain unchanged regardless of what activity level the company
operates. However, if you consider the type of product costing approach used by the
company, the breakdown of total fixed costs and expenses will vary. Under AC, the fixed
manufacturing cost or the fixed factory overhead is part of the costs of production
chargeable to the product being produced.
Hence, its period costs consist only of all the Operating Expenses or commercial
expenses. In short term decisions, period costs are not relevant as the amount will not
change regardless of what option or alternative you are going to choose.
Under DC, the total fixed costs and expenses include the fixed factory overhead or the
fixed manufacturing cost, therefore treated as period cost together with all Operating
Expenses. Shown in Figure 1 below is the composition of unit production cost under the
two (2) alternative product costing approaches.
Managerial Accounting 32
ABSORPTION PRODUCT COSTS
COSTING
|sss Oo 7 70 5 -\ 37\ =
Te | PRODUCT COSTS
COSTING
Figure 1. Breakdown of product costs and period costs under absorption costing and
variable costing
The cost assigned to unsold units or ending inventory as well as the cost assigned to Cast
of Goods Sold (CGS) will vary depending on what unit production cost is applied. The
composition of such unit production cost (UPC) will tell you whether the company is using
AC or DC.
Case # 1: The following data were taken from the records of Hershe Inc. in 2019:
Beginning Ending
Direct material P 20 P 20
Direct labor 25 25
Factory Overhead:
Variable 15 15
Fixed 12 10
P #2 P 70
The production volume in 2018 was greater by 2,000 units compared to the 10,000 units
produced in 2019. Selling price per unit is PIOO. Variable Selling and Administrative
Expenses (VSAE] is P8 per unit sold while Fixed Selling and Administrative Expenses (FSAE)
is P90,000.
Managerial Accounting 33
Based on the data presented in Case #1,
UPC under DC | DM P20 + DL P25 + VFO P15 DM P20 + DLP25 + VFO PIS
= P60 = P60
As you can see in Case #1, the difference in Unit Production Cost (UPC) between AC
and DC is found in the cost element Fixed Factory Overhead (FFO) of P12 per unit in 2018
and P10 per unit in 2019. That also explains why the UPC under AC is greater than the
UPC under DC due to the inclusion of FFO in its production cost. The UPC under DC of
P40 per unit is also called Variable Manufacturing Cost (WMC) per unit or Variable
Production Cost per unit.
Total
Period Costs | VSAEP87,200 + FSAEP90,000 | VSAE P87.200 + FSAE?0,000 + FFO
in 2018 P144,000
Total
Period Costs | VSAEP71,200+ FSAEP90,000 | VSAE P71,200 + FSAE90,000 + FFO
in 2019 P100,000
The total FFO is computed based on normal capacity. If normal capacity is not explicitly
stated in the problem, then assume that it is equal to the actual production capacity
which in Case #1 is equal to 12,000 units in 2018 and 10,000 units in 2019. You will notice
that FFO is a product cost under AC while under DC, FFO is a period cast. So the
treatment or the classification of FFO is the key difference between AC and DC. At this
point, you can make a comparison chart wherein you indicate the basis for comparison
between product cost and period cost.
Managerial Accounting 34
is the only generally accepted method for external reporting and for preparing Income
Tax Returns (ITRs). Most managers would prefer to use AC because their performance in
any given reporting period, at least in the short run, is influenced by the volume of
production scheduled near the end of a period. In AC, inventories include both variable
factory overhead (VFO) and fixed factory overhead (FFO). Bue to the treatment of FFO,
cost of inventory under DC is less than the cost of inventory under AC.
As early as 1908, there were firms using the alternative product costing approach called
Direct Casting (DC) which is also known as variable costing or marginal casting. The term
Direct Costing is a misnomer for variable costing because variable costing does not
include all direct costs as product costs. Only variable direct manufacturing costs are
included. Any fixed direct manufacturing costs, and any direct nonmanufacturing costs,
(either variable or fixed) are excluded fram product costs. Variable costing includes as
product costs not only direct manufacturing costs but also some indirect costs (variable
indirect manufacturing costs).
The essential difference between AC and DC centers on TIMING (that is, when to
recognize FFO as an expense) which is at the time the finished units are sold (under AC)
or the proper timing of the release of FFO as period costs whichis at the time of incurrence
(under DC). In terms of cost segregation, DC segregates all costs (manufacturing, selling
and administrative) into fixed and variable items. In other words, DC requires the
classification of costs and expenses as either variable or fixed. This segregation is seldom
found in AC. Since variable costs have a linear relationship to output within the defined
relevant range of production, they are equal to marginal costs.
The merits of DC can be stated in terms of the relevance of the data provided by its
application. Some managers believe that DC provides more understandable data
about costs, volume, revenues and profits to those who do not have formal training in
accounting. Others also believe that DC helps management in their planning function
because it shows a clearer picture of how changes in production volume affects costs
and income. Product costs under AC include all variable costs and fixed manufacturing
costs which are matched with the Sales in the period in which the products are sold. DC
however, matches only the variable manufacturing costs at the time of sale while the
fixed manufacturing costs were reported as period costs at the time it was incurred.
Managerial Accounting 35
Net Income under DC may differ from Net Income under AC because of variations
between production and sales volume. Over an extended period of time, the NI
reported by both casting methods will tend to be the same. The reason is that over the
long run, sales cannot continuously exceed production, nor can
production continuously exceed sales. The shorter the time period, the more that the NI
will tend to differ.
2 . Data needed for breakeven and CVP analysis are readily available.
3. Eliminates the problem involved in allocating fixed costs.
5 . DC reports provide useful information for pricing decisions and other decision making
Managerial Accounting 36
can be made to the inventory amounts to reflect absorption costs on published financial
reports while retaining the benefits of direct costing for internal decision-making
purposes.
In 2018, the unit production cost (UPC) under DC was P40 and P72? as UPC under AC. If
P46,000 was the 2018 ending inventory under DC, the equivalent cost of 2018 ending
inventory under AC will be computed as follows:
Since AC is 120% of direct costing (P72 divided by P40), so ending inventory would
be adjusted as follows:
or
Including or excluding fixed costs from inventories and from CGS causes Gross Profit (GP)
or Gross Margin to differ from Gross Contribution Margin (CM). Gross CM (Sales less
Variable Manufacturing Costs) is considerably greater than GP. In the Theory of
Constraints (TOC) approach, direct labor is generally considered a fixed cost for the
following reasons:
1. Even though DL workers may be paid on an hourly basis, many companies have a
commitment (sometimes enforced in labor contracts or by law) to guarantee workers
a minimum number of paid hours:
2. In TOC companies, DL is not usually the constraint (it's either machine constraint or
policy constraint):
3. TOC emphasizes continuous improvement ta maintain competitiveness. Without the
committed and enthusiastic employees, sustained continuous improvement is virtually
impossible. Managers involved in TOC are extremely reluctant to lay off employees.
TOC companies believe that direct labor is much more like a committed fixed cost than
variable cost. Hence, in the modified form of Variable Costing used in TOC companies,
DL is not included as part of product costs.
Managerial Accounting 37
Effect of Changes in Production on Net Income
Net Income under DC is not affected by changes in production. Using DC, reported NI
moves in the same direction as Sales. Net Income under AC is affected by changes in
production. NI will increase as production increases and decrease as production
decreases. As inventories grow, FFO is deferred in inventories but as inventories shrink,
FFO is released to the income statement. These changes in NI are a major drawback of
AC since a company can increase its reported NI by simply increasing production.
Fluctuations in NI can be due to changes in inventories rather than to changes in sales.
IfP =§
Inventory increases:
Inventory decreases:
Managerial Accounting 38
Profit (Loss) Reconciliation
Differential profit (loss) is the difference in profit (loss) between Absorption Costing (AC)
and Direct Costing (DC). The profit or loss shown by one product costing approach may
not agree with that shown by the alternative product costing approach used by a
manufacturing company. Therefore, it becomes necessary that periodically the profit or
loss shown by AC and DC be reconciled.
Before showing the marginal incorne statement for Case #1, let us first determine the
sales volume for each year as follows:
2019 2018
Units in PGI beQINNING ..... ccc cee nee eee eeeeeene es 1,100 units -O-
+ Units currently produced ...........0..
0c. cc cece scence ees 10,000 units 12,000 units
Units available for sale... oc... ee cee cece eeee eee eee 11,100 units 12,000 units
- Units in PG) Gnd oo... eee eee eee eee eee eeeeeeeee sees (2,200 units) 1,100 units
Units SOL oo. cce cece cece cee cceceeeeeceseesceseseaecescessuaeeeees 8,900 units 10,900 units
lf ending inventory (El) is greater than beginning inventory (Bl), then there is increase in
inventory level. Such increase in inventory level shall be multiplied by the FFO per unit in
order to get the differential profit which is to be added to the Profit computed under DC
or Variable Costing in order to get the equivalent profit under AC. However, if El is less
than Bl, then there is decrease in inventory level which is then multiplied by the FFO per
unitin order to get the differential profit which is to be deducted from the Profit computed
under DC or Variable Casting.
The difference between ending inventory in units and beginning inventory in units
represents the increase (decrease) in inventory level. Such change in inventory level can
also be computed by the difference between sales volume and production volume. This
change in inventory level will be multiplied by the FFO per unit to get the differential profit.
Let us use the data in Case #1 to prepare the marginal income statement or the income
statement under DC or Variable Costing used for internal reporting and illustrated as
follows:
Hershe Inc.
Managerial Accounting 39
For the year ended December 31, 2018
Sales (P100 per unit x 10,900 units sold) ....... 0.0.00 e cece c eee eee neee ees P1,090,000
Less Variable CGS (P60 per unit x 10,900 units sold)........0.000.0.00. eee 654,000
Final Contribution MOrgin ... 2.0.0... cece ccc ec cece ec ees ecesseesueceeseeeseuees P 348,800
Less Total Fixed Costs and Expenses:
Fixed Factory Overhead (P12 per unit x 12,000 units) ........... P144,000
Fixed Selling and Administrative Expenses .............00..c.cc
cee 90,000 234,000
Profit under DC or Variable Costing ........ ccc cece cece eee eee eens P 114,800
The short-cut way of computing the Variable CGS is shown above. However, if you opt
to show the detailed way of presenting it, it would appear as follows:
2018 was the first year of operations, so there was no beginning inventory. The differential
profit in 2018 is P13.200 which is the amount of FFO deferred in inventory. The 2018 profit
under absorption costing is computed in the form of a reconciliation report:
Profit using Direct Costing or Variable Casting P 114,800
Add: FFO in Ending Inventory P12 x 1,100 units unsold = 13,200
Less: FFO in Beginning Inventory -0- 13,200
Managerial Accounting 40
volume tends to equal the sales volume because products are produced in response to
customers’ orders, thereby eliminating work in process inventories and finished goods
inventories.
Hershe Inc.
Income Statement - Absorption Costing
Sales (P100 per unit x 10,900 Units Sold) «0.00... e cues P1,070,000
Less Cost of Goods Sold (P72 per unit x 10,900 units sold)* 784,800
The 2018 Cost of Goods Sold was computed using the short-cut way wherein the UPC
under AC amounting to P72 was multiplied by its sales volume. If instead you use the
detailed format of computing Cost of Goods Sold, then it shall be presented as follows:
To get the 2018 equivalent profit using Direct Costing or Variable Costing approach,
follow this format:
Managerial Accounting 41
2018 Profit under Direct Costing or Variable Costing P114,800
Production is greater than Sales in both 2018 and 2019, hence inventories increase. In
2018, production exceeds sales by 1,100 units x FFO per unit @ P12 = Differential profit of
P13,200. In 2019, production exceeds sales by 1,100 units. In both years, ending inventory
is greater than beginning inventory by 1,100 units. That is why the profit under AC is
greater than the profit under DC for both years.
Hershe Inc.
Sales (P100 per unit x 8,900 Units SOld) oo. cee cee ceca teat ee eae P 890,000
Less Total Variable Costs and Expenses:
Variable CGS [ P40 per unit x 8,900 units Sold) .......0..000. P534,000
Final Contribution Margin ......... 0... cc cece cece cece cee ee cee ee eeesceeaeeesueeeeeeeaaaeeers P 284,800
Fixed Factory Overhead (P10 per unit x 10,000 units) .......... P100,000
Fixed Selling and Administrative Expenses ...........00.....0..006 90,000 _190,000
Profit under DC or Variable Costing oo... ccccceeesceeseneeeeeeeeeees P $4,800
OR
Hershe Inc.
Sales (P100 per unit x 8,900 Units soldl*) oo. cece eee eeeeeeueeeeewerewee P 890,000
Less Variable CGS [P60 per unit x 8,700 units SOI)... eee cece cece eee ee 534,000
Contribution Margin fram Manufacturing or Grass CM P 356,000
Managerial Accounting 42
LESS VSAE ooo. cccccccccccescseeecesueeeeeeesueeeueacssueaeseuvauseeueeeneneaeuees 71,200
Final Contribution MOrgin ........000c cece cece cece eee cee ces cose suasecuesesuecesusaeauenes P 284,800
Fixed Factory Overhead (P10 per unit x 10,000 units) ........... P100,000
Fixed Selling and Administrative Expenses .............0....0..0... 90,000 _ 190,000
The Variable Cost af Goods Sold is computed based on the Unit Production Cost of Pé0
multiplied by the sales volume. This can also be calculated in detail as follows:
Finished Goods Inventory beginning 1,100 units x P40 = P 66,000
+ Current Production Costs 10,000 units x P40 = __ 600,000
Variable Cost of Goods Available for Sale P6466,000
If you want to know the resulting profit using the alternative product costing approach
which is absorption costing, then use this reconciliation method:
The differential profit is P8,800 which is the difference in Profit between AC and DC. 50
even without preparing the income statement under AC, the bottomline figure will still be
obtained using the reconciliation method. Let us check this amount by preparing the
income statement using AC:
Managerial Accounting 43
Hershe Inc.
Sales (P100 per unit x 8,900 units $oled*) oo... ec scene neste eee P 890,000
Profit UNCGEr AC occ cece cece cece cee cee ec eee cee cee eeaeeeaeeseeeaeeeseeeaeeaes P 103,400
The short-cut way of computing Cost of Goods Sold is no longer applicable in 2019
because the UPC under AC at the beginning of the year is not the same as the UPC
under AC at the end of the year. In other words, you can use the short-cut only when
the UPC is the same all throughout the year.
To get the equivalent profit using the alternative product costing approach, follow this
format:
Profit under Absorption Costing ............ccccccececeee
neces P103,600
Add: FFO in Beginning Inventory P12 * 1,100 units = 13,200
Less: FFO in Ending Inventory P10x 2,200 units unsold = (22,000)
Profit under Direct Costing or Variable Casting P 94,800
Approaches used to reduce the negative aspects associated with using AC include:
Managerial Accounting 44
« Adopt an inventory holding charges for managers who tie up funds in inventory.
2. Extend the time period used to evaluate performance. By evaluating performance
over a longer time period (like 3 to 5 years), the incentive to take short-run actions that
reduce long-term income is lessened.
3. Include non-financial as well as financial variables in the measures used to evaluate
performance.
The company may use either theoretical capacity or normal capacity to compute the
budgeted fixed overhead rate. The theoretical capacity and practical capacity
denominator-level concepts emphasize what a plant can supply. The normal utilization
and master budget utilization concepts emphasize what customers demand for products
produced by a plant. Theoretical capacity is based on the production of output at
maximum efficiency or at 100% level. Practical capacity reduces theoretical capacity
for unavoidable operating interruptions such as scheduled maintenance, shutdowns for
holidays and other days, and so on.
The smaller the denominator, the higher is the overhead costs capitalized for inventory
units. Thus, if the plant manager wishes to adjust plant operating income by building
inventory, master budget utilization or normal utilization would be preferred.
1. Upon conversion:
a) Determine the FFO per unit of the base period and deduct this from the unit cost
of the beginning inventory.
b) Compute the FFO per unit for the current period and deduct it from the unit cost
of ending inventory.
Case #2:
Lexi Manufacturing Co. asked you to convert the income statement given below to
conform with the contribution margin approach or direct costing method:
Managerial Accounting 45
Lexi Manufacturing Co.
Income Statement
® Fixed factory overhead in 2018 was P55,000 with production volume of 50,000 units.
» Operating expenses of 2019 included variable selling expenses of P3.00 per unit.
Managerial Accounting 46
Less Cast of Goods Sold:
Managerial Accounting AT
It assumes that there is always one bottleneck operation in a production process that
commands the speed with which products or services can be completed. This operation
becomes the defining issue in determining what products should be manufactured first,
since this in turn results in varying levels of profitability.
Throughput costing treats only Direct Materials([(DM) as trué variable cost and other
remaining costs as period costs to be charged in the period in which they are incurred.
Only DM casts are inventoriable costs. Direct labor costs, factory overhead (both variable
and fixed) and all operating expenses cre period costs. Throughput contribution or
throughput margin is equal to revenue minus all variable direct materials cost of goods
sald. It is not used for external reporting because it gives significant different net income
figures than in AC. Hence, it has relevance only for internal uses of management.
The following table illustrates three alternative rules for determining which costs are
capitalized. All three are used in managerial accounting practice. The 3 methods are
AC, VC, and TC (throughput costing). The comparison of the absorption, variable, and
throughput costing methods is summarized in the table below:
Managerial Accounting 48
External Reporting GAAP Not GAAP Not GAAP
Internal Reporting | Used to save costs |Used to evaluate) Used for short-term
performance and) capacity decisions
for decision
making
5G&A expenses
For internal reporting purposes, survey data suggests that approximately half of
manufacturing companies use AC and approximately half use DC. Throughput costing is
a relatively recent phenomenon, and does not seem to be used extensively yet.
Managerial Accounting 49
Fixed manufacturing costs P5.00 per unit
Problem 2. Tick Tock produces and sells a mantel clack for P80 per unit. In 2019, 42,000
clocks were produced and 41,000 were sald. Beginning inventory consisted of 1,400
clocks. Other information for the year includes:
Managerial Accounting 50
Exercise 2-1. Modified True or False. Use the following choices for your answers.
a.Both statements are true c. Only 2™4 statement is true
b.Only 1* statement is true d. Both statements are false
2. 1% statement: A product cost should not appear in the income statement until the
period in which the product sold.
2" statement: Variable costing is more widely Used than the full costing in published
financial statement.
3. 1% statement: Under variable costing, all fixed costs are treated as a period cost.
2™ statement: Factory overhead includes all manufacturing costs except labor and
raw materials.
5. 1% statement: Product cost associated with goods in process and unsold inventories
of finished goods appear on the balance sheet as current assets until the goods are
sold.
2" statement: All cost and expenses incurred by a manufacturing company are
considered product cost rather than period cost.
6. 1% statement: The costs that are treated as product costs under variable costing are
all variable costs.
2 statement: Direct costing is not in accordance with GAAP because fixed
manufacturing costs are assumed to be period costs.
7. 1% statement: In variable costing, fixed factory overhead forms part of the inventory
value.
24 statement: Under the direct costing method, the contribution margin discloses the
excess of revenues over fixed costs.
Managerial Accounting 51
9. 1% statement: Often referred to as absorption costing, it is a concept wherein only the
variable manufacturing costs are assigned to the product and fixed manufacturing
costs are written off as period costs.
10. 1% statement: For a company that uses direct costing, the cost of a unit of product
changes because of changes in the number of units manufactured.
2 statement: In an income statement prepared as an internal report using the
variable costing method, the term gross margin is used.
Exercise 2-2 (Multiple Choice). Instruction: Encircle the letter of your chosen best answer.
2. The basic assumption made in a direct costing system with respect to fixed casts
is that fixed costs are
a. Asunk cost c. A product cost
b. Fixed as to the total cost d. A period cast
3. Abasic tenet of direct costing is that period costs should be currently expensed.
What is the basic rationale behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific
product
b. Period costs are generally immaterial in amount and the cost of assigning
the amounts to a specific products outweigh the benefits
c. Allocation of period costs is arbitrary at best and could lead to erroneous
decisions by management
d. Period costs will occur whether or not production occurs and so it is
improper to allocate these costs to production and defer a current cost of
doing business.
Managerial Accounting 52
These are coasts that will change in per unit basis when production volume
increases or decreases within the relevant range.
a. Variable cost c. Fixed costs
b. Relevant costs d. Period Costs
Which of the following is more descriptive term of the type of cost accounting
called “direct costing"
a. Out of pocket costing c. Relevant Costing
b. Variable Costing d. Prime Costing
When monthly production is constant and sales volume is less than production,
income determined with variable costing procedures will
a. Always be greater than income determined using absorption costing
b. Always be less than income determine using absorption costing
c. Be equal to income determined using absorption costing
d. Be equal to contribution margin per unit times unit sold
Managerial Accounting 53
11. Which of the following statements are true?
a. Expenses are not usually separated into variable and fixed elements in
externally reported income statements.
b. Even if there is no change in units sold, selling price, or cost structure, a
company can increase its absorption costing net operating income fram
one year to the next just by producing more units.
c. When finished goods inventory decreases during a period, a
manufacturing company's absorption costing net operating income for
that period will Usually be greater than variable costing net operating
income.
d. Both Aand B
12. The gross margin for a manufacturing company is the excess of sales over
a. Costs of goods sold, excluding fixed manufacturing overhead
All variable costs, including variable selling and admin expenses
ao og
13. Which of the following is correct about the concept of variable costing?
a. The variable costing net operating income for each period can always be
computed by multiplying the number of units sold by the gross income per
unit and then subtracting the total operating expenses.
b. If unit sold is greater than the units produced for the current year, the
income Under absorption costing is greater than the variable costing.
c. Under variable costing if all other things the same, when sales go up,
income go up and the other way around. The number of units produced
does not affect net operating income.
d. Under variable costing, a product cost is composed of direct material,
direct labor and factory overhead.
e. Variable costing is sometimes referred to full cast method.
14. Parker Products Inc., a manufacturer, reported P123 million in sales and a loss of
P18 million in its annual report to shareholders. According to a CVP analysis
prepared for management, the company's break-even point is P115 million in
sales. Assuming that the CVP analysis is correct, we can conclude that the income
statement prepared
a. Under absorption costing there is a net loss while under variable costing
there is a net income.
b. Under absorption costing there is a net loss while under variable costing
there is also a net loss.
Managerial Accounting 54
c. Under absorption costing there is a net income while under variable costing
there is also a net income
d. Under absorption costing there is a net income while Under variable costing
there is a net loss.
15. Which of the following statement is true for a firm that uses direct costing?
a. The cost of a unit product changes because of changes in number of
units manufactured.
b. Product costs include direct administrative costs
c. Profit fluctuate with sales
d. An idle facility variation is calculated by a direct cost system.
14. Which of the following inventory costing methods shown below is LEAST likely to
cause undesirable incentives for managers to build up finished goods inventory?
a. absorption costing c. throughput casting
b. variable costing d. direct costing
Managerial Accounting 55
21. lf direct material cost of goods sold is P7.500, and throughput contribution is
P15,650, then revenues will be
a. P8,150 b. P13,150 c. P23,150 d. P33,150
23. Areason why absorption costing income statements are sometimes difficult for the
manager to interpret is that:
a. they omit variable expenses entirely in computing net operating income.
b. they shift portions of fixed manufacturing overhead from period to period
according to changing levels of inventories.
c. they include all fixed manufacturing overhead on the income statement
each year as a period cost.
d. they ignore inventory levels in computing income charges.
24. What will be the difference in net income between AC and DC if the number of
Work in process and Finished Goods inventories increase?
a. There will be no difference in net income
b. Net income computed using DC will be higher.
c. The difference in net income cannot be determined from the information
given.
d. Netincome computed using DC will be lower.
25. When sales are constant but the production level fluctuates, net operating
incame determined by the variable casting method will:
a. fluctuate in direct proportion to changes in production level.
b. remain constant.
c. fluctuate inversely with changes in production.
d. be greater than net operating income under AC.
Managerial Accounting 56
Exercise 2-3. (Basic Computation). Raine Company manufacturers a professional grade
vacuum cleaner and began its operation in 2019. For 2020, the company had no price,
spending. or efficiency variances and writes off production-volume variance to cost of
goods sold. Actual data for 2020 are given as follows: Units produced —- 18,000; Units sold
- 18,500; Unit Selling Price - P280; Materials - P30; Manufacturing labor - P25;
Manufacturing Overhead — P50; Variable Marketing and Admin Expense —- P45; Fixed
Manufacturing Cost - P900,000; Fixed Selling and Administration Expense - P750,000.
Requirements:
a. Compute the inventoriable unit cost for internal and external reporting purposes
b. Compute the operating income for 2020 under variable and absorption costing.
c. Provide a reconciliation in income under the two casting methods.
Exercise 2-4 (Basic Computation) CAPITANA CO. Began its operations on January 1, and
produces a single product that sells for P10 per unit. CAPITANA uses an actual cost system.
During the year, 100,000 units were produced and 80,000 units were sold. There was no
work in process inventory at December 31. Manufacturing and selling, administrative
expenses for the year were as follows:
Requirements:
Managerial Accounting 57
Exercise 2-5 (Multiple Years). Information for the year 2016- 2018 are as follows:
Beginning Inventory 0 ? @
Ending inventory 2? ? ?
Costs incurred are as follows: Direct materials - P10/unit; Direct labor — P3.00/unit;
Variable manufacturing overhead —- P3/unit; Fixed manufacturing overhead — P8,000;
Variable Marketing Expense - P2/unit: Fixed marketing Expense — P12,000; Unit Selling
Price - PSO.
Requirements:
a. Compute the unit product cost under absorption costing, variable costing and
throughput coasting.
b. Compute the net income under Absorption Costing, Variable Costing and
Throughput Costing for 2016- 2018
c. Prepare a reconciliation for the three methods
Exercise 2-6. (Reconciliation) Pasta Corp. manufactures a variety of products. The ff.
data pertain to the company's operations over the last 2 years;
Variable Costing Net Operating Income, last year ........0.00.... P 82,700
Variable Costing Net Operating Income, this year ............0.000.. 87,800
Increase in ending inventory last yeor ...........0..ceccs
ec ccee ee eeee ees 900
Decrease in ending inventory this Yeor ..........0...0.06c.cccececse
sees 3,100
Requirement:
Determine the absorption costing net operating income last year and this year.
Supply the necessary computation and amount to be added or deducted:
Managerial Accounting 58
Last Year This Year
Variable Costing Net Operating Income ......................0...5 P 82,700 P&7,800
Add FFO deferred in inventory under AC:
Exercise 2-7 (With Variances). The president of Toblerone, Inc. has been reviewing the
income statements of the two most recent months. She is puzzled because sales rose and
profits fellin March, and she asks you, the controller, to explain.
February March
Sales (P30 per case} P 540,000 P 660,000
The standard fixed cost per case is P10, based on normal capacity of 20,000 cases per
month.
Requirements:
Managerial Accounting 59
Exercise 2-8. (With Variances) Pro-Pinoy Products presents the following data from
absorption costing income statements for the last two years:
20A 208
SOUS ose ceeeeseseneeneeceseceeneeseneseeeeseeetsesetsesseaesenaesensesensaeeseeseesaeesaeas P2,000,000 P2,500,000
Cost of goods sald (at standard) 00... ccc ccseeeseeeeeeeseeeeees 800,000 950,000
Operating MCOME 0.0.0.0... cece cece cesses esses esses eeseeeseeseeeessessueee 675,000 1,050,000
Required: Prepare the direct costing income statements for each year, assuming that
there were no changes in capacity between years and that the unit variable costs are
constant. (Hint: Use the high- and low-points method to determine the fixed and
variable portions of each cost element.)
Exercise 2-9. Cadbury Co. uses a standard cast system in accounting for its only product
which it sells @ P22 per unit. The standard unit cost is:
Direct Materials... eee cece e cece eeeeeeaeeaeeeeseeeeeseaeeceaseesseeeeeeeeeeeeeeenaees P 4
Dire Ctl OP .cccecceccececseececeecseeeeeesesessessansessuaeueuseesessaeeseuscausseeseeease é
Vorinbble factory OVE@M@ OG... ceccee ese ceeeeeesseeceeeeseeessssetessseceuees 2
P15
All variances are closed to Cost of Goods Sold. On October |, there were 10,000
units on hand. During October, 50,000 units were produced and 45,000 were sold. Costs
incurred during October were:
Managerial Accounting 60
Direct materials P 198,000
Required: (1) Explain whether the company uses direct or absorption costing.
(2) Prepare an income statement for October, using direct casting.
(3) Compute the operating income for October if absorption costing is used.
Exercise 2-10. K Corp. developed the following standard unit casts @ 100% of its normal
production capacity, which is 50,000 units per year:
Direct moterials.......0.... P3
Direct labor... 3
The selling price of each unit of product is P20. Variable commercial expenses are P] per
unit sold and fixed commercial expenses total P 150,000 for the period. During the year,
49,000 units were produced and 52,000 units were sold. There are no work in process
beginning or ending inventories, and finished goods inventory is maintained at standard
cost, which has not changed from the preceding year. For the current year, there is a net
favorable variable cost variance of P1,000.
(3) Reconcile the differential profit for the current year Under AC and DC.
Managerial Accounting 61
Exercise 2-11. Multiple Choice (Problems and Theory Questions)
7. The gross income ratio, contribution margin ratio and throughput margin ratio
respectively, will be?
a. 10.87%: 26.08% and 73.91% respectively
b. 26.08%: 26.08% and 26.08% respectively
c. 26.08%; 21.74% and 73.91% respectively
d . 10.87%; 26.08% and 26.08% respectively
e . 10.87%; 21.74% and 73.71% respectively
& How much is the cost of ending inventory Under absorption costing, variable
costing and throughput costing respectively?
a. P410,000; P340,000 and P120,000 respectively
b. P340,000: P340,000 and P340,000 respectively
c. P340,000; P360,000 and P120,000 respectively
d . P410,000; P340,000 and P340,000 respectively
e . P410,000; P360,000 and P340,000 respectively
9. How much is the difference of the net income under income statement prepared
for external purposes and the supervariable costing?
a. P290,000 b.P318,000 c.P410,000 d.P70,000 e.None
Managerial Accounting 62
10. Assuming that the number of units produced is equal to number of units sold
a. The income under absorption costing will be equal to variable costing but
higher than throughput costing
b. The income under absorption costing will be equal to variable costing but
lower than throughput costing.
c. The income under absorption costing will be equal to variable costing and
throughput costing.
d. The income under absorption costing will be equal to variable costing but
no general conclusion will be made on throughput costing as there is no
relationship existed between the three.
e. No conclusion can be made due to lack of information.
11. lf the selling price increases by 12%, variable expense decrease by P1.40 per unit,
and the number of units sold increase by 15%. What will be the effect in net income
under direct costing approach¢
a. P593,340 increase c. P4651,300 increase e. P509,340 increase
b. P735,300 increase d. Pé677,340 increase
12. lf the company using the contribution margin approach wanted a net income
before tax of P475,000 with a tax rate of 30%. How much will be the net income
after tax under absorption costing?
a. P214,765 c. P153,700 e. P381,500
b. P150,336 d. P107,590
13.A manufacturing company that produces a single product has provided the
following data concerning its most recent month of operations:
Beginning Inventory 0 | Fixed SAE per month P25,700
What is the total period cost for the month under throughput costing?
a. P151,800 c. P379,800 e. P341,490
b. P362,700 d. P381,900
14. Roberts Company produces a single product. During the year just ended, the
company's net operating income under absorption costing was P3,000 lower than
under variable casting. The company sold 9,000 units during the year, and its
variable costs were P? per unit, of which P3 was variable selling expense and P2
Managerial Accounting 63
was direct material. If production cost is Pll per unit under absorption costing
every year, then how much is the net income under throughput costing?
a. P3,000 higher than variable costing
b. P2,400 higher than absorption costing
c. P3,000 lower than variable costing and same as the income of absorption
costing
d. P5,400 higher than absorption costing
e. P1,200 higher than the variable costing
Johnson Realty bought a 2,000 acre island for P10,000,000 and divided it into 200
equal size lots:
« As the lots are sold, they are cleared at an average costs of P5,000
« Storm drains and driveways are installed at an average cost of P8,000 per
site
« Sales commissions are 10% of selling price.
« Administrative costs are P850,000 per year
« The average selling price per lot was P140,000 per lot during 2015 when 50
lots were sold
During 2016, the company bought another 2,000 acre island and developed it exactly
the same way. Lot sales in 2014 totaled 300 with an average selling price of P140,000. All
costs were the same as in 2015.
15. The income under variable casting in 2015: P3,200,000 and P23,450,000
a. P3,200,000 c. P5,700,000 e. P(5,500,000)
b. P(4,300,000) d. P2,000,000
17. A company produces a single product. Production is done only when orders are
received from customers. Thus, no inventory is kept at the end of the period. For
the last period, the following data were available: Sales - P48,000; Materials -
P10,860; Labor - P7,260;Rent (90% factory; 10% office) - P3,600; Depreciation (80%
factory, 20% office) - P3,000; Supervision(2/3 factory, 1/3 office) - P1,800;
Salesmen's salaries commission - P1,560; Insurance (60% factory. 40% office) -
P1,440; Office Supplies — P900; Advertising — P840. If the company is using variable
costing, the total variable cost to be used in computing the contribution margin
will be:
a. P?5,824 c. P18,120 e. P?0,520
b. P27,384 d. P19,480
Managerial Accounting 64
Gulliver Company manufactures and sells one product and uses FIFO system. The
following information provided by the company. Total costs were given on the first year,
however no data on cost on year ? and year 3. Fixed manufacturing costs are applied
to units of product on the basis of the number of units produced each year.
18. If the company uses the absorption costing method, which of the following best
describes the computation of the unit production cost.
a. The total unit product cost will be the same from year | to year 3 regardless
of the changes of the units produced and the unit sald every year.
b. The total unit production cost will change over the years which are directly
related to the units produced. The higher the units produced, the higher the
unit product cost.
c. The total Unit production will change over the years but are inversely
related to the units produced. The higher the units produced, the lower the
unit product cost.
d. The total variable portion of the product cost will remain the same however
the fixed overhead will change and will be directly proportional to the units
produced.
e. The total variable portion of the product will remain the same however the
fixed overhead will change and will be indirectly proportional to the units
produced.
19. lf the company uses the variable costing method, which of the following best
describes the unit production cost?
a. The total unit product cost will be the same from year | to year 3 regardless
of the changes of the units produced and the unit sold every year.
Managerial Accounting 65
b. The total unit production cost will change over the years which are directly
related to the units produced. The higher the units produced, the higher the
unit product cost.
c. The total unit production will change over the years but are inversely
related to the units produced. The higher the units produced, the lower the
unit product cast.
d. The total variable portion of the product cost will remain the same however
the fixed overhead will change and will be directly proportional to the units
produced.
e. The total variable portion of the product will remain the same however the
fixed overhead will change and will be indirectly proportional to the units
produced.
20. lf the company uses the supervariable method, which of the following best
describes the unit production cast?
a. The total unit product cost will be the same from year | to year 3 regardless
of the changes of the units produced and the unit sold every year.
b. The total unit production cost will change over the years which ore directly
related to the units produced. The higher the units produced, the higher the
unit product cost.
c. The total Unit production will change over the years but are inversely
related to the units produced. The higher the units produced, the lower the
unit product cast.
d. The total variable portion of the product cost will remain the same however
the fixed overhead will change and will be directly proportional to the units
produced.
e. The total variable portion of the product will remain the same however the
fixed overhead will change and will be indirectly proportional to the units
produced.
21. How much is the net income under Absorption Costing Year 2?
a. P1,921,000 c. P2,008,750 e. None of the above
b. P1,791,000 d. P1,948,000
22. How much is the net income under Variable Costing Year 22
a. P1,678,000 c. P1,548,000 é. None of the above
b. P1,705,000 d. P1,765,750
23. How much is the net income under Throughput Costing Year 2?
Managerial Accounting 66
a. P1,570,000 c. P1,430,750 eé. None of the above
b. P1],543,000 d. P1,413,000
Shell Corporation manufactures bottled vinegar. Data pertaining to the company's 2017
operations follow: Actual price and cost data for 2017 are as follows:
Selling price P50 | Variable Selling cost per unit P2.80
24.How much is the amount to be adjusted to the cost of goods sold under
absorption costing and variable costing, respectively, due to cost variances?
a. P42,000 over and P42,000 over
6b. P42,000 uncer and P42,000 under
c. PO and PO
d. P42,000 over and PO
e. P42,000 under and PO
25. How much is the net income using the absorption costing?
a. P1,199,250 c. P1,241,250 e. None of the above
b. P1,283,250 d. P1,195,425
Managerial Accounting 67
Problem 2-1. Ichiro Company produces a single product provided the following data
concerning its most recent month of operations: Unit Selling Price - P126; Units Produced
- 3,100; Units Sold - 3,000; Direct Materials per unit - P22; Direct Labor per unit - P43;
Variable Manufacturing Overhead — P3; Variable Selling and admin expense — P10; Fixed
Manufacturing Overhead = P89,900; Fixed Selling and Administrative Expense -— P42,000
Problem 2-2. Yuki Company was organized just a year ago. The results of the company’s
first year of operations are shown below under absorption costing:
Income Statement
Managerial Accounting 68
The company's selling and administrative expense consist of P32,000 per year in
fixed expenses and P5 per unit sold in variable expenses. The company's unit product
cost is computed as follows: Variable manufacturing cost — P32; Fixed Manufacturing cost
(Based on normal capacity of 2,500 units) - P10. Compute the net income under variable
costing.
Problem 2-3. Eiji Corporation, developed the following standard unit cost at 100% of its
normal production capacity, which is 20,000 units per year: Prime cost — P4.00; Factory
overhead (60% fixed) - P5.00.
The product cost is sold for P14 per unit. Variable commercial expenses are P? per
unit sold, and fixed commercial expenses total P50,000 for the period. During the year,
19,000 units were produced and 71,000 units were sold. There is no work in process
beginning or ending inventories, and finished goods inventory is maintained at standard
cost, which has not changed from the preceding year. In the current year, there is a net
favorable variable cost variance in the amount of P5,000. All standard cost variances are
written off to cost of goods sold at the end of the period. Compute the net income under
Absorption costing and Variable Casting.
Managerial Accounting 69
Additional information for the curent year are as follows: Sales - 19,000 units;
Production = 19,200 units; Net unfavorable variance for standard variable manufacturing
cost - P10,000.
Requirements:
Compute the net income under Absorption Costing and Variable Costing
oObwON
Problem 2-5. Kutsinta Motors assembles and sells miniature toy motor vehicles and uses
standard costing. Actual data relating to April and May 2020 are as follows:
April May
Beginning Inventory in units 0 150
Production in units 500 400
Sales in units 350 520
Variable Costs:
Manufacturing cost per unit P10,000 P10,000
Selling and Admin per unit 3,000 3,000
Fixed Costs:
Manufacturing Cost P?,000,000 | P2,000,000
Selling and Admin Cost 400,000 600,000
The selling price per toy vehicle is P24,000. The budgeted level of production used
to calculate the budgeted fixed manufacturing cost per unit is 500 units. There are no
price, efficiency, or spending variance. Any production - volume variance is written off
to cost of goods sold in the month in which it occurs.
Managerial Accounting 70
Requirements:
1. Prepare the April and May income statement under Absorption and Variable
Costing.
?. Reconcile the costing methods
3. The variable manufacturing costs of Kutsinta Motors are as follows:
April May
Prepare the financial statement for Kutsinta in April and May Under throughput
costing.
Managerial Accounting 71
Case 2-1 “Now this doesn't make any sense at all," said Florence Gale, financial vice
president for Warmer Bros. Company. “Our sales have been steadily rising over the last
several months, but profits have been going in the opposite direction. In September we
finally hit P2,000,000 in sales, but the bottom line for that month drops off to a P100,000
loss. Why aren't profits more closely correlated with sales?"
Klein, a new graduate from a USCE who has just been hired by Warner, has stated to Ms.
Gole that the contribution margin approach, with variable costing, isa much better way
to report profit data to management. Sales and production data for the last quarter
follow:
Managerial Accounting 72
d. The company uses FIFO inventory flow assumption. Work in process inventories are
insignificant and can be ignored.
“| know production is somewhat out of step with sales,” said Karla E, the company’s
controller. “But we had to build inventory early in the quarter in anticipation of a strike in
September. Since the union settled without a strike, we than had to cut back production
in September in order to work off the excess inventories. The income statements you have
are completely accurate.
Requirements:
1. Compute the net income for each month using variable costing
?. Compute the monthly breakeven point Under variable costing
3. Explain to Ms. Gale why profits have moved erratically over the three month
period shown in the absorption costing statements above and why profits have
not been more closely rated to changes in sales volume.
Managerial Accounting 73
11 be able fo:
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After studying this terms used in s
(HAPTE identify and define
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Contrast the head
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i
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ANALYSIS
Based on the survey, 31% expects that COVIDI9 will influence fhe hofel's operating
performance for 4-6 months. Ofher general expectations from the majority of the
respondents are as follows: A decline of 71% or more on the occupancy rate for the first
half of 2020 as compared to first half of 2019, 41%-50% decline in average room rate, 41-
50% decline in total revenue, 51-60% decline in occupancy. These expectations and
actual performance are yet to.be compared and monitored fo analyze the variances
and the full effect of COVID 19 in hotel industry.
Introduction
The opening vignette presents the importance of managing cost to attain the financial
objectives of an organization. That is why in order to stay competitive, profit-oriented
companies should be able to provide high-quality goods and services at low cost.
It is but a great challenge for companies to manage costs amidst the uncontrollable.
external and internal, factors that affect such costs. So to counter such uncertainties in
the global market and in order to meet their financial goals, some companies resort to
the use of standard.
67
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the objective eval
dosage in treating |
used not just by profit-oriente companies, but by hoy itative oF qualitative anny
manufacturing, merchandising or service-oriented co or-Profi Companies 2 SM sats
gre related. When the budget is broken down on a SMES. Standard and © aed.
standard costs are budgeted costs on a unit basis. Unit basis, it is called a 5
Standard Costing
Setting-up of Standard
s
Standg set .
compared 1 nye emer of managers and workers
€Nnsure credibility c ote s very Important in order toe A gs Performance will be
Standards gs cist True and fo motivate eaoeh a Sense of ownership
Stand
Sclentifig €. 30,system,
Cost accounting whenever a co
cost dander e
any decides ° . ©Perate close to the
compa Process of research and study cond S are de etmineg Adopt and install ¢ ©
chemical
QNd other for the purpose. This and
groupA is COMPoseq
ee GOUp p of Set UPhired
through
economists, marketing of ©xperts by th?& |
Progg ho eat totes from cost descurecn ent ad Engineers (industrial and a
- Purchasing and management MNS. industry i, labor specialists, oa s
ering, personnel. da” ”
68
me approach followed in developing standards is to estimate the amount and cost of
material, labor, and overhead required to efficiently produce one unit of product in the
current period. The standards are used by accountants to value inventories of raw
process, and : finished goods and to value the cost of goods
materials.; work inteiriel sold.
peveloping a standard cost involves judgment and practicality in identifying the
material and labor types, quantities, and Prices as well as understanding the types of -
organizational overhead and how they behave. : i
in addition, appropriateness and attainability need to be considered when standards
gre established. Appropriateness considers the basis on which the standards are
developed and how long they are expected to |
i ast while attainability pertains to the
beliefd.about the degree of difficulty or rigor that should be incurred in
management's standar
achieving the
furhemore, standards are developed from past and current information, and they
should reflect technical and environmental factors expected during the period in which
the standards are to be applied. Factors such as the materials quality, normal ordering
quantities of materials,| expected employee wage rates, de.egree of plant automation,
facility layout, and mix of employee skills should be considered.
Standards are usually computed for a 6 or 12 month period although a longer period is
sometimes used. Once standards are set, STANDARD COST CARDS should be prepared,
on which the itemized cost of each material, labor & OH cost is shown. A master
siandard cost card gives the standard unit cost of a product.
Standa rd Cost Card. Below is a sample standard cost card for a company that
manufactures window curtains of two sizes.
: Large Small
bets. ee ; Curtain Curtain
‘Sik fabric material needed for each
' Curtain* . 2.9 yd. 1.5 yd.
Dl
Time required to cut and
sew each
Cur tain 0.5 hr. 0.4 hr.
|Los
Alectrig; 4
Geet and supplies used per hour Pa0 | ;
frie” i
'Rent¢
‘heat,
| Sal/air) Pace Per month (includes
eee ee,
. Pé, 000
Types of Standards
i ch bo th expected and actual
- is a gauge agains
t wh h all
1) Fixed or Basic Standard
an ind ex nu mber against whic
, similar to t constant
performances are evaluated
com par ed. Thes e: sta ndards represen
subsequent resulfs are ntage of
left unc han ge d over lo ng periods. The main adva
standards that are arison with actual costs
a base is provide d for a comp
basic standards is that
stan dard and from which efficiency
through a period of years with the same
trends can be established over time. .
2
—
ad Standards
Material, Labor and Overhe om the
di ve rs e grou p of people fr
. participate d by the
In the standard setting pro’ cess tran sl at ing in to monetary terms
plays a vital ro le in on which
organization, the accountan t
ess. Ho we ve r, mo st of the information
activities involve in the production proc Factors such
in sour ces © ut si de the accounting dept.
standards are base d will be foun d
materials, expec ted
employee
y, norm al order ing quan titi es of
as the materials qualit
and mix of employee skills
wage rates, degree of plant automation, facility la yout,
idered. The following is representative of the standara-set
ting process in
should be cons
most companies.
Materials Standards
i ; . :
The first step
Aine! smi . “) ee material standards is to identify and list the specifi
actur
manufare produc
e thewhat t:ty what Paceof
y of toinputs
quantitused
inputs are used? eee used? quali ae oe
used? . inputs are
Additional y, mana
Cost Accountants, te saad seek the advic
Aecisions: quanti 9 Personne! © of mater
dente
“cisions, Then Hees COSt esting} nd Possibly supniia. - ert
of materials soba become eee o Making
eloped Ctio
72
ld re fl ec t the final, delivered
aterial ; shou
it for direct M standard quan tity per unit
The
The standard price Pet oe discounts taken. unit
terial required for each
cost of the materials. net of Hk the amount of materia
dable waste, spoilage,
for direct materials should refiec allowance for unave!
of finished product, as well a8 47
and other normal inefficiencies:
Labor Standards
The standard rate per hour for direct labor includes not only wages earned but
also fringe benefits and other labor costs. Many companies prepare a single rate
for all employees within a department that reflects the "mix" of wage rates
eamed. .
The standard hours per unit reflects the labor hours required to complete one
unit of product. Standards can be determined by using available references that
estimate the time needed to perform a given task, or by relying on time and
motion studies.
Overhead Standards
' Overhead should be assigned to separate cost pools based on the cost drivers,
and allocations to products are made using various activity drivers in order to
provide the most appropriate costing information.
The price standard for variable manufacturing overhead comes from the
variable portion of the predetermined overhead rate. The quantity standard for
variable manufacturing overhead is expressed in
either direct labor hours or
machine hours depending on which is u ; :
predetermined overhead rate. Sed as the allocation base in the
73
flow document, and
The d evelop ' of materials, operations
topment of the bill e of a standard cost card,
pre by the preparation
determined overhead rates is followed
All nd ards are approved by top managemen!.
sta
Variance Analysis
system is that
d costing
of a standar begins with
Another important benefit from the implementation The control process
tool . costs can
ef fe ct iv e control and evaluation is ag ainst which actual
it is considered an os pas and the
of sta nda rds which provide difference betwee e n th e actual
the establish men t ion. The centers. The
ed to det erm ine any deviat usu all y for ind ividual co st
be meas ur ulated
the variance isc alc of acos t center.
standard costs. called for me d sur ing perform ance
t
ed is a key elemen
variance comput or able or unfavora
ble) of
na tu re (fa v for
is a process of ca
tegorizing th e ing the reasons
ri ance ana lys is actu al cos ts and de termin ned cos ts,
fa rd and an
between standa ent from their pl
the differences wh ich actu al costs were differ ma tc he s th e expected
s. It identifies ac tual cost
thos e di ff er en ce
except io n; if an ount differ from
s
ws yo u to manage by at e it. When actua | am
wh ic h al lo ed to in ve st ig assigned to the
cos t, th en there is no ne va ri an ce should be
(sta nd ar d) rded , the causes the
am ou nt s, a variance is reco co nt ro l th e activity that
standard that has. the abi
lity to le so that
or div isi on co rd ed as soon as possib
departme nt riances should
be re
|s useful to
variance. As a ge
neral rule, all va
By do in g so, variance analysis of
in need
rr ec tive acti on may be taken. ea s of operations most
co it points to th
e ar
because ;
management
tent io n,
management's at generally
dards a re loose, varian
ces are
d that wh en st an rable. |n
It may therefore be
conclude
s are strict they are generally unfavo
se where standa rd should call attention to
favorable and in ca nt by exception, reports to managem ent - solving process.
observing manage
me
ma y be gi ve n pri ority in the p roblem
s so that they nt can
significant variance e wo rt hy of in vestigation. so manageme
large variances ar
Only costs causing ems each month.
cu s its attention on a small number of it
fo
Variances
ance re fers to any dif
ference between an
vi ‘ous sec tio n, va ri tis
As mentioned in the pre
dg et ed cos t. Itisc onsiderec-favorable if actual cos
or bu
actual cost and a standard
unfavorable. if ac tua l cos t is greater than standard cost.
less than standard cost, an
d
ce variance + difference bet
ween
era lly broken down into, pri the
The variance can be gen at s hould-have been paid for inputs during
for inputs and wh
what was actually paid e between the quantity
of actual
period and usage ‘va riance which is the differenc of the period.
nti ty of sta nda rd inputs allowed for. the actual output
inputs and the qua
on the eff ici ency of res u Its (the relationship of inputs fo
uses
The usage variance foc h cos t elements namely material var
iances.
are co mp ut ed for eac
outputs). Variances are illustrated_in the -next sectio
ns. The
ov er he ad var ian ces and
labor variances and
var iances is called variance analys
is. Below
put ing and int erp ret ing
process of com usage
var iance ana lysis mod el that shows the formuta-for-price and
the general
variances.
74
e not Worth
Ail Yar
ances aren
as include: lookj
h invect :
investigating, Methods for highlighting a subset of variances
sxoe tions : Ng at the sizei
pa’ relati to the amou ze
of spen of the he vari j
ve nt ding ance and looking at the size of the
Model for Variance
Analysis
T
actual Price * Actual Quantity Std. Price x Actual Quant ' STANDARD COST
ity Std. Price x Std. Quantity
l_scepRale Variance Usage/Quaniity VWen
cnen
Total Variance
Material Variances
Basically, material cost is affected by two factors: quantity and price. Price and
quantity variances are considered separately because different managers are
usually responsible for buying and for using inputs (e.g. the purchasing manager
is responsible for raw material purchase prices and the production manager is
responsible for the quantity of raw material used) and the buying and using
activities occur at different points in time (e.g. raw material purchases may be
held in inventory for a period of time before being used in production).
Material price variance (MPV) is equal to the total actual cost of materials
Purchased minus (actual quantity of materials x standard price) or is define as
the amount of money spent below (favorable) or in excess (unfavorable) of the
ondard price for the quantity of materials purchased; it can be computed:
ae on the actual quantity of materials purchased or the actual quantity
ation in
me Possole Causes of material price variance are as follows: a.) fluctu
hecunee of materials; b.) failure to take purchase discounts: c.)
aa on cost higher than expected; d.) different grade of DM purchased;
rable or unfavorable Purchase contract
terms.
Materig)
lMovoreyernY varlance (MQV) standard cost saved (favorable) or expended
Ysed ond in oi lo the difference between the actual quantity of materials
“Uing the endian quantity of materials allowed for the goods produced
| » IIs equal to (actual quantity x standard price) minus
75
The standard price is used to
quantity allowed * standard price).
(standard
is not held
production manager
the quant ity variance so that the
comp ute asing mana g er.
rmance of the purch
responsible for the perfo
a.) defects in
qua nti ty var ia nee are os follows:
material 4d.) lack of
The possible causes of ed wor ker s: c.) poor supervision:
b.) Inexperienc Wa ste or spoilage.
direct materials; hines; and e.) good or poo rcontrol over
Prop er tools or mac
jonces:
in computing material var
There are different methods
od
; Formul
Me|th a Based favorable
(AP-SP]"AQ = Pxxx Favorable/Un
MPV rable
(AQ-SQ)*SP XxX Favorable/Unfavo
= Xxx
MQV Unfavorable
Cost Variance Pxxx Favorable/
Material
sp x AQ. SP x SQ
AP x AQ vail
| fl MOV
MPV uw
l
Total Material Variance
SP = Standard Price
MPV = Material Price Variance
AQ= Actual Quantity
MQvV = Material Quantity Variance
_ MPQV =Material Price-Quantity Variance
' §$Q= Standard Quantity
AP = Actual Price
Method 1: ph ae | |
’ MPV (P5.65-P5.80) *"4,4,250 Ibs = P637.50
.50 Favorable
MQV (4,250 - (2 lbs/unit * 2,100 units))* P5.80/unit = 290.00 Unfavorable
Total Material Variance sa = P347.50 Favorable
Method 2:
ane 4,250*P5.80= (2,100*2Ibs)*P5.80=
24,012.50 P24,650 P24,360
716
L__- P637.50F (MPV) J |__P290. 00
U (MQV) =
L
Using Method 2: Cost line Method to illustrate the model, the modified formula for the
computation of the material variances when quantity purchased and used is not the
same are illustrated below:
,
APxAQu -. SP x AQu SP
x SQ
Es J | J
Material Price Material Quantity
Usage Variance _ Variance
ee |
Total Material Variance
77
Labor Variances
Labor variances will be computed using the one
material variances and will result to two es os that of the
basic variances: rate and CHficienc,
vanances.
AR x AH Pak ce : “SRR AB
{. - SR SH
Se | ie
LRV gee BBY
ee]
LK: i ae .
Total Labor Variance
Method 3: Three Way
Analysis
ag
LRV {AR-SR)*SH Pxxx Favorable/ Unfavo
EV ~ (AH-SH)*SR_ rable
= xxx Favorable/Unfa
LREV (AR-SR) *(AH-SH) vorable
Labor Cost Variance = %« Favorable/Unfa
vorable
Pxxx Favorable/Unfavorabl
e
78
LRV = Labor Ra
te Variance
LEV = Labor Ef SR = Standard Rate
ficien cy Variance
LREV =Labor Rate. AH= Actual Hours
AR = Actual Rate Efficiency Variance SH = Standard Hours
79
“a
Fixed Overhead Va
riances
Budgeted FOH
Actual FOH
(budgeted)
Applied FOH
{=shore a SP x SQ
FOH
4
~
Spending Variance ~ Volume Variance
J
Total Fixed Overhead Variance
(Underapplied or Overapplie
d Fixed Overhead)
The above analyses. shows
that the fofal fixed overhead varian
. difference between actual fixed ce is equal to the
overhead costs incured and standa
cost app
lied to the period's actual Production. THe rc+ixed overhead
fixed overhead spending variance
represents the difference between the total actual
fixect overhead-and budgeted fixed
overhead while the fixed overhead volume varian
ce is the difference between
budgeted and applied fixed: overhead:and is equal to the
overhead volume vari ance,
and also called the non-controllable variance.
X
80
ie SAS Se
ces
ad varia n
mputing overhe
ve Method of Co
pudgeelded
PRA
mati
Oveh
pased on i
:
standar
quantity Total appelde
pudgeted Allowed Pe
ovemn
ACO
Ov ermhea
d
Output (SP * 5Q)
rota
ayenead Basedon pate We Ed
OH + FOH) Actual Hours
_ Overhead
= Overhead st Overhead
aa,
g Efficiency Volume
; Spendin Variance §:
Variance Variance
+ WAY d Volume
:
—— Overhea
Budget Varia
nce rollable)
ble Variance) Variance (Non Cont
> WAY (Controlla sal
ea d Variance
Total O v e r h ;
way a ead
1- r en ce b e t w e e n total actual overh
ia nce — diff e sum of
Overhead spending var at a ct ua l inpu t activity; equal to the
overhe ad
and total budgeted ces an
erhead spe nding vari ed
the variable and fixed ov - di ff er en ce betwe en total budget
ian ce
Overhead efficiency var ty and total budgeted overhe
ad at standard
ual inp ut act ivi efficiency
overhead at act sa me as variable overhead
(output activi ty) :
input allowed
dgeted
variance
ence be tw ee n tot al actual overhead and bu
Budget variance — dif fer oduction achieved;
rs allowed for the pr
andard hou
overhead based on st
controllable variance and
also referred to as the enc e between total actual overhead
ce - dif fer
Total overhead varian ed under the one-
overhead; only variance comput
the
total applied
variance approach
ce Approach
Ov er h ead Var ian ce Approaches - Four Vari an
Atemative way approach,
oa ch is the sa me with the alt ernative three-
pr Idle
This ap
me Var ian ce is div ide d in to Fixed Efficiency and
except that the Volu
Capacity.
Idle Capacity
Allowance based on Actual
=Budget
Hours* : ad Rate
-Actual Hours x Factory Overhe
Volume Variance
Fixed Efficiency .
= Actual Hours x Factory Overhead
Rate
i Standards AllowedxFactory Overhead
81
I
THe:
a
; re me that Exodus Company uses © standary
¢ 5
P ! process “ene
juction cree
sees applies overhead based on direct lab.,
°20 Fee is available for September when Exodus producag
Seis.. The teak
‘ollow tenner
5,000 units:
Standard:
DLH per unit d hours
Variable overhead per DLH P1.80
Fixed overhead per DLH P3.25
Budgeted variable overhead P27,250
Budgeted fixed overhead P49,500
Actual:
Direct labor hours 16,000
Variable overhead P31,325
Fixed overhead P49,750
(5.000*3hrs) *P3.25=
P49,500 cere
im
P250 U 3 P750 U
FOH _ toe FOH
Spending Variance | Volume Variance
oF Halse ak miié
x ii
x st ann
cn n quantity
i x stan
dard Prici e)
* pre
pree
s rnd
fii nancialj effect associ
amount of higher ated with changing
* (actual Mix or lower paid work the
x acty al ho ers in production
actual hours
* x standard ra i
(labor yield va te oe
riance o e
* shote : oe
Te Teer nate
imi pact Of Using mo
re or fewer total hou
rs than
* (standard mix
x actual hours x st
standard hours x st andard rate) minus (s
andard rate) tandard mix x
Multi-materials costs
variance analysis
(Materials price, mix,
and yield variances)
AQ AQ AQ 5
x AM x AM xX SM x SM
x AP x SP x SP x SP
L_ JL : JL
MPV MMV MYV J
L J
Total Material Variance
Alternative:
Price Variance AQ Purchased x AP P XxX
-AQP Purchased x SP Xx
Where: : to
Standard Input Cost (SIC): Budgeted materials cost/Budgeted materials input — P. xx
Standard Output Cost (SOC): Budgeted materials/Standard Output Pxx
llon
@ P1.50 per ga
sed and u sed
10.716 gallons purcha
Actual:
Material A: us ed @ P1.90 per gallon
gall ons pu rc ha sed and
Material B: 17,484
per hour
Skilled Lab or: 1,950 h ours @ P11.90
per hour 500 55-gallon
kil led Labor: 1,3 00 hours @ P7.15 manufactured
Uns ng Co mp an y
! c Cleani
ssi
the current mont h Cla the nearest whole pe
sos).
ro un de d to
Answers are
A=(500*30.25)xP1.25
'
;
jances: 00x559XP1.25
A=28,2 0
20: - A=10,716xP1.
25 B=(500*24.75)xP2.0
B=17,484xP2.00 - B=28,200x4 5%xP2.00 ; P43,656
484xP1.90 P44,767
P48,363 aeet f
: poll
: __Jj | PITT UMYV
P3,596 UMMV
P931U MPV Sud
| P5,638 U Total Material
Variance
,
,
a
Labor Variances: .00 $=(500*4 hrs) xP 12.00
$=1,950xP 12.00 $=3,250x66.666%xP 12
$=1,950 xP11.90 .00 U= (500*2hrs)xP7 .00
U=1,300XP7.00 U=3,2.50X33.3332xP7
U=1,300xP7.15 P31,000
-P33,583
P32,500 tod
P32,500 ee
| Re dd P2,583U LYV
© P1,083F LMV
-POLRV ra
|
ance
| P1,500 U Total Labor Vari
84
JOURNAL ENTRIES
3
To record the use ofmaterial
s:
WiP (SQu x SP}
Mat. Usage Variance- xx
unfav (AQu - SQu) x
Mat. Usage Variance Sp XX
- fay (AQu - SQu
Materials (AQu x SP) ) x SP
3
To charge DL cost to Wip:
WIP (SH x SR)
Labor Rate Variance Unf XX
av.(AR-SR) x AH
Labor Eff. Vari ance Unfav.(AH-SH} Xx
x SR XX
Labor Rate Variance
fav.(AR-SR) x AH
Labor-Eff. Variance fav
.(AH-SH) x SR
Payroll (AH
3g
x AR)
DISPOSITION OF VARIANCES
Example: ;
variance resulted ito,
An unfavorable overhead ce resultes
reases. The overh :
ead varian
unanticipp ated pr price inc verhead rate. ; In this case ththe overhe,,
from an inappropriate ©
causes work in process, finished goc
rate was too low which
stated. These are
inventory and cost of good sold to be underance
head vari among them,
corrected by allocating the over head in each,
of over
based on'the relative amounts
(b) For year-end statements: At the year-end, a decision is made as ty
the materiality of the variance.
nces and tg
(1) If material, it is allocated to relevant inventory bala
t nts of each. ~
cost of goods sold based on the relative amou
(2) If not material. it is closed directly into cost of goods sold or |S.
Cot Gan
ee ne (the standard cost of units sold + the variance}
86
The treatment of varian
ce depends upon the:
1) the type of variance (M.
<}
L or FO}
siz e of variance
3) experience with std. cos
t
5 Se of variance ( €.g. inc
orr
ect standards)
IMINg of variance (e.g. a
variance caused by season
al fluctuations)
Thavorianves may be lance from std. must be disposed
in the accounting records.
1) viewed as losses due to ine
fficie ney & closed to Income
2) allocated as adjustments to the Summary; or
recorded cost of Work in Proces
Goods & Cost of Goods Sold s, Finished
or
3) closed to Cost of Goods Sold.
APPENDIX
In an earlier discussion, the main focus was the cost analysis comprising the material,
laber and overhead variances. GP Variance uses the same concept however
extending the analysis that will explain the change in gross profit as brought by the
variation in revenue and costs of goods sold. In analyzing the change in gross profit,
management will be able to assess the effectiveness of their purchasing policies,
pricing and markup policies.
87
Sales Variances :
Standard Quantity Soi
Qty
Actual Sold Actual Qty Sold Standard USP
x standard USP”
X Actual USP
Sales Oly
Sales Price
Hlustration:
:
P247,500
135,000
Cost of Sales
Gross Proldfit __——«|._—*1.000 P112,500
units | _ 1,500 units
‘Units So P165
Unit Selling Price P90
Unit Cost | _
Compute the following: ce and Sale Qua ty Variance)
nti
a. Sales Variances (S dles Pri
b. Cost Variances (Cost P
rice and Cost Quantity Variances)
e and GP Qu antity Variances)
c. GP Variances (GP Pric
:
ales Variances
1,500 units x P150
P225,000 P150,000
fo J
Nf
P22,500 F P75,000 F
Sales Price Sales Qty
B. Cost Variances
1,500 units x P75
P eure P112,500 P75,000
a jJ
P22,500 U P37,500 U
Cost Price a Cost Qty
“%Ch
*% Change ini Cost Price
fr :
= P22,500/P112 900 =20% increase
i
% Change in Quantity = P37,500/P75,000 = 50% increase
88
Cc. Gross Profit Variance
89
~*~,
™
After studying
« . this chapter, you will be able to: \
* a 8
discuss the basic principles, relationship and
-: ; ts of different costs as they behave
COVID-b 19 is impacting
seen how wor
We have iee-ond: g
the globa
global economy. A lot of changes happened not only in the
—
way we tl ork but also in interacting with people. As businesses h igat
co
centia! You cannot
col are essential. nn ed
as usual”
“business cleesre whileuiol
ttanest 7 y pro t ‘ocols
maintaining safet afford to make the wrong
moves y up losing your-customers, employees, your money and ultimately your business.
where a significant portion
Think about the range of operational options open for you. Expect scenarios
360-degree exposure assessment, how will you be
of your workforce will have to work from home. In your
a decision?
D-19? What information is vital nowadays to make
able to meet the challenges posed b y COVI your
e employed, keep
do things diff erently toda y to keep revenues flowing, keep your peopl
How can you be
t to bear in mind that as the pandemic runs its course, there will
customers, and so on. It’s importan you do so.
reco ve ry. Make your plans accordingly and be strategic as
' successive waves of infection and that comes your
aris e and there is nothi ng wrong with pursuing a chance
Unexpected opportunities may will not last
could have on.This COVID-19 pandemic
but mak e a jud gme nt call on what impact i t
way Hi !
forever, so plan for the company’s economic recovery’
109
efore 2 decision is ma
analysls ccou ent accountant may 4 ;
Airline Passenger-miles
Hospital Patient-days
Hotels/ Motels/ Hostels Room-nights occupied
Universities or any learning institution Student-credit hours or academic units
*
o,
selection of marketing strate
gies to be Used
110
in using CVP anata. yy.
assumptions are Made. follow
1. All costs (eith :
INGS buit
Ouillin .. ;
identified as el
N set of assurnptions or underlying
ion ©
2. The Selling tic "fixed Varian Produc stion costs) can be Accurately
throughout the © Per unit is Ce Ve
3. : Change
98S s inin acti
. va,VaNt tangs TAN. Costs $ and revenu
4. All units
nuees are linee ar
Prody "Y are the 0
n i
5. When more thew Ore sold, 'Y factors that affect costs.
6. Worker ang ne t
throughout th Machine hale Sf product
,
© relevant range Nity and isefsold, the sales mix is constant.
ficiency do not chan
ge
:
roduction
or targeted sales mix. The main
objective of br eak-even analysis j
even point) sufficient to Cover culate the min im sales
all fixed and variable costs. To definelevel (called break-
(BEP), it is the level of activity whe break-even point
re cost
s and revenues are in equilibrium, thus
_tono profit and no loss at all. In other word resulting
s, BEP is the level of sales where the sum of
total fixed costs (TFC) and total variable costs (IVC) would be
equal to total revenues.
you have to determine the relationship between costs and production volume in order
to forecast profit accurately at various levels of operations.
111
ey produce 2,000 Un;
( if they Fine company a
| eyniblt4-1 d goes Foced, the total fie
y if 4,001 1 units wil}wil)
Units
000. sts rem ain the sa Mej5
Let us say, the companywill
nets remat
inate o, Wan | be © i FIXE °© the yolume Is be: n
less.e Hoe
oror less. COs \ aduction
thethe fixed 1 costs oy Ve volume Te
most likely increase ifs >PIO Pf72hs 000 we instore ls “|Di goo. The nge
= if f f Vv volume Whe reis
nge °
th
@
“pecome tena to
is the fi jotal fixed COSTS CAN van,
P
casts will no longer
S on
be a
produced, the total fixed costs On ge and oT ne
total within a particular relevar’ er pe main const an differ in various relevan,
i
range nit ¢
~ ynit le F cost
aetria relevant
that rele al . riab e cost per per U yant range. you rneny’ INCUrg
constant vary
vary | constant
Exhibit 4-2 Cost Classification According to Behavior
112
ag pointed out eanier, fj
llvary ON A per Uni ST is g C
wempany Produces enon SSIS Within
er unit produced is P36, the. a remains the same or constant in total
fs © otal 4 e hee eee but
range. For example
cost remains the same S b
if the
ess P72,000
¥ deco ides to Produc and the resulting fixed cost
: . an d
yolume increases, fixed ;
P72.009 e 1,000 units, the total fixe
- per unitae increases, Cos} pe
nit * d
de e res Ulting fixed cost per unit is P72.
S€S; gs the volu So as the
me decreases, the fix
ed cost
A variable Cost relative on
another act .
‘ ivity, A fixe Cos t reje
cost relative to another activity, nt®y to SUone
ld acti
be vity
clas sified das a fixed cost relati
ve to
could be classified as a var
iable
For example, a Phamaceutic
med rep for short) and the‘ Mon mM
thly je for its medical representative (or
medicines produced, jg the ; fas
Coste is P25, " 00 pe rcar.
Regardless of the qvantity Produced
Relative to the quantity of
the amount is constant oe Considered a fixed cost or vari
ey ery month, able coste
© Company, the lease cost is a fixed
cost as
me
a variable cost in relation to
the none nate Cost Soe pence
for2med reps, the lease Cost
, the lease cost becomes wou
the lease cost becomes
0 Pap
reps dbe Pp 50,0ned reps. Like if the
p 75.0 00 while if 3 cars will becompany
i l e j : leases 2 cars
leased for
lease costs per month, the 3 med
p €r month,h. The more med reps,
thee high
hi er iis the
The basic equation used in breakeven analysis is actually taken from the marginal
income statement or the income statement prepared
using Direct Costing (DC) or
Variable Costing (VC) as shown below:
"
a
Sales USP. x SV ; P_xx
—Tot G8teble sy
VMC
per unit x SV
=
_G
Vese
‘
mi
Orga ee
p eea
le r Expn
ibution Margin
ctti ee es | VSAeME XSper unit SY
eensg
nix tSV
—_ XX
Fiwal onribw
ibution
ie Margin | <x unis produced@ NC
|
__
ed Cost
__ s: ____+5 per unix unis produces 2°
P x
Fixed Factory Overhead _
113
__Fixed Operaling(LossExpenses on Margin
Operating Profit nd administrative
Expense
. rrative Expense
Legend: USP = Unit Selling Price = = Fixed Factory overhe
a
inistr
SV_ = Sales Volume exe _ Fixod solling and Adm
ring Cost
VMC= Variable Manufactu a al, per uni
nit
Gross CM = Gross Cont
.
ribution Margin
ent can be ®
' tated i!n tot
| ONd jn
income statem
The first three items on the
d be like th
me statement woul
.
percentage
s:
marginal inco
Another way of presenting the data ona
Caption P
=
Sales
Total Variable Costs: .. | PP ox
Variable Production Costs [P xx
Variable OE a
Contribution Margin P x __
a Ne me
Fixed Costs:
per unitx units produced @ x
FEO units produced
Factory Overhead x
FSAE per unit
Fixedd Operating
Fixe Expenses
114
yolume arwhieh there jg Hits wanes
less than 2,000 units, that w Profit ang the . /
ge {Is+ would result to gq reo Uld resyy hes re is NO loss is at 2,000 Units. If the company
sales
- Total Variable
Cosjs
P 100,000
contribution Margin
60,000
"Fixed Costs
_— —
|P__ 40,000
| 40,000
P +0-
pelationship between Conti
Contribution Margin or CM is
After the fixed costs have been recovered, the profit will be equal to the UCM of every
additional ‘unit sold beyond the BEP of 2,000 units. The contribution margin is often called
marginal income. . .
Itcan also be expressed as a percentage of sales calculated as follows:
be sold
if you WOU Id like to kno w how many uni ts must
n earlier,
Based on the data give tax of P16 0,0 00, then you may use the
equation
d profit bef ore
in order to get the desire
stated above: .
116
Pxs
P59 P 50x V)s FC + (UVC x sv)+ DP
90 X P30x . = P 40.000 4 P30
40.000 * X + P140.000
P160,000
200 000
Breakeven Sa
les IN Pesos =
Fi
xed Cost
osts
CM% or Profit
Volume %
Ifyou remove the wo
rd « breakeven”, what is left is:
Sales in units or Sales Vo
lume = Fixed Costs + Desired Prof
it before tax
UCM or CM per unit
Sales in units or Sales Volu
me = Fixed Costs - Estimated or Ant
icipated Loss
UCM or CM per unit
Sales iN pesos = Fixed Costs + Desired Profit before tax
CM% or Profit Volume %
. ‘ te
ity. When should businesses continue to opera
a . ee ‘
having 7 piencune=s ¢ Fora Pong as they generate a positive; CM, then they
eee
losses Sect s their losses would be greater if they stopped
‘nould continue to op
operating.
s based on their profit, itis important to
ince
i the business is ee
i a estore
tax tax and desired
e
. profitit after
after tax. The !desired or
Stinguish between desire
117
site
aqual to dé
target profit after tax 's — ied O
desired profit before tax Is
' re tax © -
Desired profit before t AfteLfr a
x or 3
“os ied ia
1
-
et of tax
red profit js n
n
s i
' t
i v e n d e
Ifthe g
= Fixe
Volume
Sales in units or Sa les
1 Tax or
Afte rate or ITR
4
- pesiredl-
profit
ne IO
|nco q,
ue or Profit volume /°
Sales in pesos = Fixed Costs
118
1e profit % is
he p 3 2 % SOM
pute
Pg
d as folle Ww
NP% =
© 40% oXM OSy,
= 30¢7, x BO% Op NPY a=: NP + Sales
= P160,000+ P500.000
= 999,
MOSzcoS becom Uted USING ~
P500,000
40%
"
| 4%“en, Ze
Mee TC ijine
$0,000
45,000 | Be |
ig. 8
$9,000 : “e, =
35,000 . , &
. , a =
WO eat . .
15,000 et a FC line
a 6 i le } &
17,0800 Lote. e
LF a ; ; &
5,000 - . . :
i ° . ‘ : B
st at
Pesos a
Units
another graph that you ¢
an
joss at a particular sales Volu
ee Profit-Volume Graph which shows the profit or
i €d
ae intoTheUpper
X axisandMaylower
showY axes,
either the sales volurne or peso
The upper Y axis shows the
example of a Profit-
fi Graph:Y axis sh Ows
Volume OWer | the amount of losses. Shown below is an
“PROFIT-VOLUME
&
8 6+
= 6
ce eS Profit
=s
2
E
a Volume
Loss
421
' margin) isH ae mpa Ass
We ny' degreg
Operating leverage
is is saf
slysled
) acal MPelyO relng
the nni
itari in e pla i
ationship new
betwag
Closely related to margin of safety
of Operating leverage or DOL. he scloses the company's COs}
potentia yent
Manufacturing technologies that oveihe
have ! come state ariable costs.
fixed and variable costs. The marginal eof its fixe v .
structure, which is the relative proportion vc and low FC, thus having a iow,
ave high V& anies. Conversely,
It is normal for labor-intensive companies io sional ervice rae. they have q acs
Operati 5 ; sh as those © , apita . : :
companies become more automated oF NORTry,
) ec
structure consisting of a low VC and hig
ighand pro
ine with
FC. AC ey ore
autom pom Ta eed
nes,
as airline
costs has relatively high operating levers Oo fe can generate 7 ee overage
The result of high operating leverage is that t increase In SO becom ©. The
increase in net income from a relatively That is why companies DECOMe more
higher is the OL, the higher would be its BEF: any with high FC is riskier because
3
depende ‘
nt on volume to add profits. Clearly, a compactivity. The OP timal s
cost structure
profits are very strongly affected by ae ok lng benefits of high oe leverage
involves a trade-off. Management must We associated hig .
against the risks of large committed fixed costs and the |
. ts which were unkno wn
Tet al eecie d level.
MOS and OL are considered as measures OF ISK.
when plans are made, that can lower sales below the origin
5Ic vels, SSas influenc
measure ed
d :
The potential effect of the risk that sales wil fall shor pene can
the relative proportion of fixed to Eee eA to hati financial terms, OL i
operating leverage, which is the ratio o
‘ : i tity. It is some times possible to trade:
concerned with the relative mk of FC and VC inan entity. | a a
each unit
off FC for VC. As VC decrease, the UCM increases, making the contribution or
effect on
sold much greater. In such a case, fluctuations in sales have an increase
FC will
profitability. Thus, firms that have realized lower VC by increasing the proport ion of
es with lower
benefit with greater increases in profits as sales increase than those compani
proportion of FC. OL serves.as a multiplier. If OL is high, a small percentage increase in
sales can yield a larger percentage increase in operating profit. Hence, FC are being
used as leverage to increase profits. A high OL indicates a high risk in the sense that a
given change in sales will have a relatively greater impact on‘profits. When sales volume
is strong, a high level of leverage is desirable, but when sales. begin to fall, a lower level
of leverage is preferable. Each firm chooses the level of OL that is consistent with its
competitive strategy. For example, a firm with a dominant position in its market might
choose a high level of leverage to exploit its advantage. In contrast, a weaker firm might
choose the less risky low-leverage strategy.
The DOL measures how a percentage change in sales from the current level will affect
the company's profits. It indicates how sensitive the company is to changes in sales
volume or in the firm's revenues. Such calculation assumes that FC do not increase when
sales incréase. The DOL decreases as volume increases beyond the BEP Thus when the
MOS is small, the DOL is large. In fact, at breakeven, the DOL is infinite because any
increase from zero is an infinite percentage change. As the company moves
away from
122
, ven
ake sales, the ;
pre rocal of the ope, Os |; NCrease,
thena
n ge
even smallwill cs
Ofte te
S@s a Pil
In Sales c ve the DoL declines. MOS will always be the
ate ma ment
why Work ve
(OLF) or DOL, lfa
company is
“ON Viele large increases in profit fairly near its
s.
“for only ¢ small increase in sal This explains
let us illustrate the Salculati es volume,
on ot
Caption grea of ,
Operating le verage (DOL
):
Sales
Total PHOS
Ssaes Variable
= Costs @PSO P35per un
Unit pte
[Pp
et @ 3,300 u
cal P1509 ae
contribution Margin
Per Doe P3000 ux TT 0% = 3,300 u
oe P 165,000
% Of Sales
: 99 000
: FGGE
ie 40% of Sales
P ee
NP P 66,000 |
}
DOL = CH S p—=.900 _|
a i] P_26,000 |
=
Tr.
BA IN OF = DOLX% A in Sales DOL = CM= OP 2.53846
pee |
= xX 10% |—____|
= Note:
30% 7 pin Op |---| . Roe
As volume increases, the
: ‘
a er DOL. or Operating
ee Leverage
‘ Ptin Sales P6,000+ P20,000 >| Factor (OLF) decreases.
= 30%} in op ——--
;-———__|_ "4" means change
change May either be
P20,000 x 1.3 = increase
O
New Op P26,000 | ———————_____
|
N
+ =
8 |V
decrease
(I
,
ie neoreee
|
1+DOL_ = MOS%
1+ MOS% = DOL pa33.33% DOLis the reciprocal of
Proiecied
Projected Sales
Sdlew
pee : vice-versa,
MOS% or _|
P 150,000 | 100
SE
% |
- Breakeven Sales 100,000 | _67% | _|
Margin of Safety P 50,000 | 33% |
Ss
LS eam annie soreness
+
|
If the DOL is 3, the company's profit grows
3 times as fast as its sales. So if you plan to
increase the sales volume by 10%, then the resulting oper
ating profit will also increase
by 30%. If two competing companies have similar total revenues
and similar total
costs and expenses but have different cost structures, then the one with
the higher
proportion of fixed costs in its cost structure will have higher operating leverage
. As
sales volume and profit increase, you will notice that the DOL decreases, the farther
moves away from the breakeven point. The margin of ae tee Are
leverage have a reciprocal relationship: Operating ee trecieeue teed oe
the break-even point or when sales volume is close to
123
rgin r%
or the Margin of safety jg
Th and gets larger OS sales Volumeie
dec reases as sales volu me increases.
ne break-eV oin
np
the Opposite. MOS is low Nea!
The ratio of sales for each product compared with the overall sales volume of alll the
products is called sales mix ratio. There are products that are sold and used together 5°
124
that the sales of these
together, Products gy,
ae thotghie i ables . ae cane ciated, For example, some products
are normally
the sales of one bree +45 are ng ake SUPS and saucers, wallpaper and paste, In other
films, Tazors. and blest fluence the OYS sold together, they are used together so that
mplementa £8, toot] Ne sales of the other products such as cameras and
Seit can SeineS€ Products,
total Profits toshi slingeosh aNd foothpaste. These
ae sales mix from high-margin are what we call
ite
ilems to low-margin
Case 1: Alza Company ; even though total sales may increase,
unit a
Chip P ame Units of Chik, Cie Ye
P250,000 . he ° Of sales for Chip | ie and sell 100,000 units of Chip P at P8 per
Unit. Variable costs are 30% of sales for
Approach as Foe ees Costs will Because
ee -—_
eetmChiaup|tion Margin:
. ne Fore 100.000 units) = P 560,000
Less Operating Profit. 000 units) = __900,000P 1,460,000
Total Fixed Costs
cenit
sttssssettosntttenecnn,
Ln eetseeenettitan
nee, eee eee
P1,210,000
—— 250,000
Sales Mix or
Product USP x Sales Ratio = Weighted Sales
L P20 x 2 = P4Q
Q P15 x 3 = P45
P85 per set
Sales Mix or
_ Product UCM x Sales Ratio = Weighted CM
L (20-12)= P8& x 2 = Plé
Q (15- 10)= P5 x 3 = _15)
P31 per set
125
nsists Of 2 Units of
e seh ets, 5, then it Willwi b 8
ven. =~ 49,000 sel".
reakev™
w, order to P more 1 nan tg 14an oP erating loss.
The company has oe 12,000 sets in
the company sel it W
Sr then wil re5U
for every 3 units of Q. f sold,
é ats will b wat
profitable, If less than 12,000 se 1,020,000
=~ PP 72,000 5 peeees™
, ir oreo
\
1 go |
i
i
, sakes s P93,00
Sales= FC + Desired Profit before tax = P372,000 36.4706%
BbATOCE :
Weighted CM %
“= P 1,275,000
Indifference Point:(IP)
A cost structure refers to the company's relative composition ofits variable Cost and fixed
cost which strongly influences the degree to which its profit respond fo changes in sales
volume. Another tool used by.managers to choose between alternative cost structures
is the indifference point, which is the volume at which total costs are the same Under both
_ cost structures, thus resulting to the same amount of profit. If the company operated at
IP, the alternative used would not matter because resulting profit would be the same
in
either alternative. To calculate the indifference point, set Up an equation where each
side represents the total cost of an alternative.
126
recctly traceable
pire ‘ j NCre
machine wi me .
marketing Manager Mtal
of what sts and Peay
seconde an infoy nehead is expected to be P3,720
Machine Will be
be P900.009
er ye © Old machine wil 000 if the
oe BEP of this ney, NE iNcreme
UC l be Used, Kinna'
omental fixed unit selling price of P50. Regardle s
A St plus lory
Sduct UdadeVat
r iq ss
@ le arke Marketing expe
Ach Altemating ©xPense of P4.00 nses are estimated
tive for every unit
shall be: sold.
= 231,000 7 units
Sooiif toann
s
UCM P16
alatielmativead
htghee9 high om = 218,750
Units
Exes:an +, the co
mpany
Costs are fo | Must pro
duce
r the comp
any W Fixed Cost.
| Qnd sell
more in
, the low he os The lower the Fi
ree
akeven Quan
tity xed )
is.
~Altearnvae
tive#]
1 _
AlAletrenmat ivee ##22
FC +VC
4,620,000+3 =. Fo+VC
0y. _ 3,500,000 + 34 x
4,620,000 — 3,5
00,000= “34 X-~30 x
1,120,000 =
1,120,000+4 = 4x
280,000u x
= ,
annual sales volume
| at which the choice
nas a difference is at i between the two
| mac hines would not
280,000 units which means
the same total costs, henc that the two alternatives will
e resulting to the same profit have.
choose either alternative . So @ 280,000 Units, you ca
1 or alternative 2. To n
Validate this statement:
Alternative # ]
Alternativ
# e2.
PlahGesis=:TCa TG: 0,000 u)
Total Costs= TFC +1VC
= P4 ,620,000 + (P30 x “ oe P3,500,000 + (P34 x 280,000 u)
= P4,620,000 + P8 ,400,0 = P3,500,000 + P9,520,000
= P13,020,000 = P13,02 0,000 i
000
3,020 00
= (260. 00014,000,0 *50) = i.3700
alternative with the |g ‘
ap aa at 000g units: i the actual sales Volume i
y1 of 260.005 0, 0,
a with the higher Fixed Co,sti
Ata volume below
,
the ‘indifle
arence poin
1 (he ri ihe
emda
alternaalive
’
Fixed Cost gives {he highel ey: 080. 5000
above the indifference poin! of f
ive i. alternativ‘ e
more profitable and that is All emal Oo
2. The operating prog,
if the actual sales volume is 250.0 00 units, then on
its shall be:
of each alternative @ 250,000 un!
P500,00
308.000 OR
OP=CM-FC oo
= (USP P50— UVC 34= UCM P16 x 250, 000 u = TCM P4,000,000 - TFC P3,500,000
= P500,000 °
Therefore: age
At a volume below the IP, the alternative with ae lower FC is more profitable.°
If the actual sales Jaume is 300, 000 units, then choose Alternative 1. The operating profit
of each alternative @ 300, 000 units shall be:
128
op = CM-FC OR
(USP PSO ~ UVC 3, _
P1,380,000
Wow
ThereAfore:
ta volume
above the
Ip ' the alte
ma tive with the higher
cVvP Comparison Between Capital ini FC is more p rofitable Z
. -Inten
The comparison below is 5 etween ty sive and Labor-| ntensi Com ve i
panies
identical products for °
the same market 2) Companies in the same indus
its facilities (capital intensive) ang the. One of the companies try that produce
inputs (labor intensive), has chose n to automate
=
Capital-intensive
ITEM (Automated) Labor-Intensive
mo Company Company
The CM ratio for a given product will tend to
be .
relatively...
high low
Operating leverage will tend to be.... high low
Inpertiods of increasing sales, net income will
fend to increase ... - Rapidly | Slowl
129
he Margin ot Sately (MOS) ala given \
Sales will tend to be...
TERMINOLOGIES revenues
at wh ich the total revenues and ¢
‘eit ag Ost
Break-even point (Sales Peso). The ens uted by dividing fixed cog S by
It is COMP
are equal and the operation breaks €
contribution margin ratio.
be sold to fo recover all Associg teg
Break-even point (Units). The number unitsits th that MU stntripution margin.
of by unit co
Costs. It is computed by dividing fixed costs
all variable costs.
Contribution Margin. The difference between : sales and :
ue, and profit
CVP Analysis. The technique used to determine how costs, reven PFOHl Change
when an organization's sales volume change
CVP Graph. A graph that shows how costs, revenue, and profits change as sales Volume
changes:
Fixed Cost. These are costs that do not vary as sales volume changes.
Indifference Point. This is the volume at which total costs are the same under both cos
structures, thus resulting to the same amount of profit.
130°
et Sale
‘arg s (Unit
s), It is
! the des
Targe t Sales ( S a l e s
ireg NU
Mber Of
Peso), units to be
It is th sold to achieieve
profit.
e the targe + profit
* .
Peso Sales
to be me t in
fr z 6
it Cont or cer Oacnieve
Jtion Marg} } 1a arg t
.
variable
Ihe Unni Se
Cost, Ility 1] bri C. 2
t \ese ar © the 1 Winus Ihei uniti
COsts vo tia
idkl eSOcost
IST.
ighted Ave that
rage Unit qa
N pr
po ft lion
e e r t
con ributiioon Marg
~ h
to cn ng
ange s
SAIN $e
| salees volume.
in wei Mtibution Marg
in, The Av
Shteq by the erage of t he : it
Weigig ht ed Average Contti sal &S Mix in Units, pro ducts’ uni
bution
con tributio tion margin Margin Ratio. The
ratio, Weighteg
by the Sales mixAverage of me p roducts'
in p ix in peso sales.
131
Exercise 4.] ,
d toby the statement give,
e
e
phrase ©
Fill in the blanks (m x 1) Write the word oF p
below, w close projected operations Ore ty
fesel for
0
—__—_ |. It gives management ° npoln
the company's break-€
———_____7. The point of equilibriv m between two cost scenarios which can be
expressed| in units-or in peso amount.
—_______10. This describes a company that has more ated costs in1 their cost
structure.
exercise 4-2
instruction: Encircle
. Tif th
Qs tate
T F 1. Ment is
the les n Wailaby
i direct ~ Vatignjg cole
"
ACh Unitnj
ENCircle F if the statement is false
Cost,
Of salas to cover
m Sriq| fixed cost and
profit is
_lfa bus; SO$t Der Una.
eink Ss Sells l
tye Prochien NCreases, {
5, :
he breakeven Point ;
a will decrease.
*. tis not Possible to
ow OP erating leVer, estimate the breakeven
>
ag
Contibuti
on , IS low
th
degree of ©p
compan IN does erating leve
y rage js high
Not pr OVid :
e an INsigh
t in to the Profi
- After th t Potentia
e leve| Of l of q
Margini e vol
JIN Me exe eds th
exceeds the tot a| Fixed costs ong ‘
aeeven Point, the total contributi
enses, on
12.
13.
- There is an inverse re
lationship between degr
The margin of safety. ee of operating leverage
ang
133
e following Numbere
igns or symbols: P for
ently le foand sl
Exercise 4-3 ivel lait ANSWER
nfo ,anya of am eS
Instruction: Based on the g yust ha ,
unit, (0 7 - a
items, Your answer"
on oh pl nn
\
\
oe
1 div jided byA7 MOS%
ts divided
b y actual sales
Tc of safety it y uni
ofit ee
< % changein )
| |
oniribution Margi ee eee
|6._ | Total C [ et
nal in come
of
of t net rofit a i ded by Mar
[ 2. | Amount
:
C
16. |, Netprofit % divided by. MOS ratio
|
1 UCM mulipice by Break-even vsales| in Units
|
[188. PsProfit-volume ratio multiplied by BES percentage
Tat
134 wf
Exercise 4-4
Instruction: Based Or
AMeount ofye
ag scanty TWO
informr e
Ch itemY.Irequ
Nformatio N given in each
ired: case below, determine the
E ) BES %is
() 64%; : Net profit
| is 12% of sales:
. Fixed
’ costs, P128 3,000
.
.
425
I tes studying this chapter, you will be able to:
In your personal life, you might have tried budgeting your money. But why make a budget? Some people
have experienced overspending which resulted in unnecessary debt. So how much do you need to earn in
order to have the lifestyle that you want? Will you allow your desired lifestyle dictate your allocation of
your hard-earned money? In making your budget, do you save first and spend only what’s left? Or is it the
other way around?
145
ETING e so
OVERVIEW OF BUDG fe el that their operations ar
iness owners that
e sn ee da bu dg et? Some b us ise a | activities. They believe
Do all business rsonally superv far better
-c on ta in ed that they can pe . t. Ho we ver, planning gets
small or se lf
wi i g a budget
i out usin
th ads. The size of
your
an be made even neral ideas on their he
carrying around ge 7 an for
do in di vi du al s The procedures a
esis than e need for planning. : oud SS
company has no be ar in g on th
portant. Without a budge’
ni zati on s oF ent ity, but no less im is headed. Even wit
h a OU get,
smaller or ga ness
ne ve r kn ows where the busi control gives
flounders. Mana ge me nt exist, budgetary
ations
t reach its goals but if devi the budget. Budg
etary
a company may no ge t ba ck in lin e with
ce to take action to able tolerances whic
h
management a chan ing plan within accept
keeping the operat ions (activities). Contro
l consists
control is a means of la ti ng business operat
et in regu ing promotes
involves the use of budg ugh control, budget
results with plans and thro e ffers.
of comparing actual th at means mo re mo ney in the corporat co
waste and
efficiency and prevents
n of action
s of pre par ing a bud get . A budgetis a numerical pla
Budgeting is the proces how resources will be acquir
ed, allocated
ed in adv anc e, art iculat ing
which is prepar nning of actual
used wit hin a spe cif ied per iod of time as it aids in the pla resources in
and
get s are cre ate d to pla n the use of the company's limited
operations. Bud
order to achieve their goals. It has 5 primary purposes:
Planning
Facilitating communication and coordination;
Cie
Allocating resources;
Controlling profit and operations; and
Evaluating performance and providing incentives.
i
Typically, the budget is for a one-year period correspondingi to the fi
alah Yearly. budgets are broken down into queried) eee one Deny
udgets are broken down into monthly budgets. The use of smaller time periods allows
managers to compare actual data with budget
may be noticed and solved sooner. Sateen Se eS alee Species
The scenarios mentioned above illustrate the need for planning and proper coordination.
Such synchronization will be achieved by integrating budget into their planning process.
Budget promotes goal congruence which is an integration of multiple goals, either within
an organization or between multiple groups, resulting to the alignment of goals to
achieve an overarching mission.
if you are an impulse buyer, you have the tendency to buy something at the spur of the
moment, an unplanned decision to buy. In making your personal budget, consider first
your priorities and define your boundaries.
—sioRiT
ee
toa Ci~)
l>: voo ee MAAS F |
ls -
= <a
147
. 4
Fi " Not important —
and
The average amount to save in a reverse budget is 10% of your monthly take-home pay.
Second priority in reverse budgeting will be your Essential Expenses: Prioritize your most
necessary expenses and pay those items first. Stick to a definite savings plan, live within
your means and curtail your expenses. Third priority in reverse budgeting will be your
Discretionary Cash which can be used for personal non-essential items such as
entertainment and buying of luxury items. So, the underlying concept of reverse
budgeting is to prioritize savings and eliminate debt.
If traditional budgeting is applied in business, the process of projecting their revenues and
expenses will be based on the previous year's budget, plus or minus any adjustments to
be made depending on the prevailing economic conditions.
Even the Philippine government does budgeting which involves four (4) distinct processe
s
or phases: budget preparation, budget authorization, budget execution and
accountability. Budget preparation for the next budget period proceeds while
government agencies are executing the budget for the
current year and at the same
time engaged in budget accountability and review
of the past year's budget. Budget
implementation starts with the release of funds to the
agencies. Government budgeting
is important because it enables the government
to plan and manage its financial
resources, to support the implementation of various programs and projects that best
promote the development of the country.
Through the budget, the government can
prioritize and put into action its plans, Program
s and policies within the constraints
financial capability as dictated of its
by economic conditions. (https://www.dbm.gov
ph)
.GENERAL PRINCIPLES OF BUDGETING
Budget should pe aa part of a form
be al strategy incorporated in all | level
rather than an intuitive, ad hoc approach to oper s
two major uses ations. Planning areiceni ore
of the budget and essential in achi the
becomes the eving the company's goal. The
guid b i t
: : ing light and the road map : in which eve manaGcemcn!
traverse into. It is a chart of course
where business aaeu k
_ let them know when the company is strayin g Aw operations sau lew as ci
ay from its plan ned route.
148
ADVANTAGES OF BUDGETING
The first dimension concerns the mechanics of budget preparation. The second -
dimension involves how individuals within an organization react to a budgetary system.
In fact, the success or failure of budgeting depends on how well management considers
its behavioral implications. :
Itis the schedule of activities for the development and adoption one ee by non
include a list of dates indicating when specific information is to be p
information source to others. It is not associated with sales,
There are three (3) objectives of budgeting, namely: planning, coordination and control.
Planning and Control are closely linked and are among the four responsibilites of every
manager. Planning is looking ahead to see what actions should be taken to achieve a
specific goal while Control is. looking backward, assessing what had happened
and
comparing what was expected with the actual outcome. Comparison of
the budget
with the actual outcome may be used as an important input for
decision making. The
relationship between the two are illustrated below.
Investigation
LL
ie Corrective Action
150
Gust RELATIONSHIPS AMONG PLANNING PROCESSES
ccounting, 6' Edition — Raiborn/Kinney/Prather-Kinsey)
oe ae
and fy
The second illustration shows the details of the planning stage and the key people
involved on this phase. Note how budgeting involves almost all levels of management
and its impact to the organization as a whole.
The Budget Committee is responsible in the preparation of the budget which usually
composed of sales managers, production manager, chief engineer, treasurer and
controller. Its principal functions are as follows:
Top
monetary statements and efficiently: indicate a
Management:
that coordinate commitment to objectives:
Midmanageme Budgeting
company activities provide a monetary control
nt and
fora year or less device
Operational
Management
STS
ESI
152
3: Other factors such as normal turnover periods, seasonal cycles, length of production
period, type of budget, the nature of the organization, the need for periodic
appraisal and prevailing business conditions.
Finding what budgeting method works best for the company requires an understanding
of the alternative budgeting methods to choose from. Generally, traditional or
incremental budgeting is commonly used. in incremental or baseline budgeting, the’
budgeted amount of the previous year is used as the base or starting point in determining
the budget for the current year. In other words, it starts with last year's budget and adds
or subtracts from that budget to reflect changing assumptions for the coming year. In
accepting the existing base, only the increment is subject to examination. It does not
encourage innovation.
Nowadays, this, ZBB procedure has gained increased attention and wide acceptance
among government agencies and business organizations. However, this approach is time
consuming and costly.
Activity based budgeting is a method of budgeting in which the activities that incur costs
in every functional areas of an organization are recorded and their relationship are
defined and analyzed. It aligns activities with objectives, streamline costs and improve
business practices.
|
y enhance the entire
conditions Ma
e of local tential
whose knowledg problems:
icipative budgeting has 3 PO
‘ . e . . |
ofplaninvolving Indic
ning process. Parti
Ww; gel)
ing ds that are either too hig h or too lo padding the bud
Dn budget (often referred to as
Building slack into the
2.
3. Pseudo participation
. nd performance may
If goals are too easily achieved, a manager may ] lose interest oi ‘ chieve the
actually drop. Similarly, setting the budget too tight ea st Peo performance
ea :
standards and frustrates the manager. This frustration can
oa Sodacteee
ck or pad din g the budget exists when a m
Budgetary sla ce g 2 50
enu es or ove res tim ate s cost s and expenses. Soe
underestimates rev y a ere.
ril y ties up res ources that cou ld have been used more produc
unnecessa dictate lower
ck in bud get s can be virt uall y eli minated by having top management
Sla eed the costs
efits from participation may far exc
expense budgets; however, the ben s
oci ate d with pad din g the bud get. Top ma nagement should carefully review budget
ass
provide input, where needed, in order to
proposed by subordinate managers and
get. Slack must be avoided if a budget
decrease the effects of building slack into the bud
is to have its desired effects.
the budgeting
The 3rd problem occurs when top management assumes total control of
process, seeking only superficial participation from lower-level managers. This practice
is termed pseudo-participation. Top management simply obtains form al acceptance
of the budget from subordinate managers but not really seeking real input.
Types of Budgets
1. Fixed budget/ Static budget - a budget that projects cost for a particular level,
usually at normal capacity, for a definite period of time.
2. Flexible budget- a budget that projects cost at different levels of production for a
definite period of time.
3. Periodic Budget “a budget prepared for a fixed period of fee: normally one year
SALES BUDGET
The first step in the budgeting process is the preparation of the sales budget. This budget
budget period.
details the expected sales (volume of sales in units and in pesos) for the
As the first step, it is important to be as accurate as possible as it will affect the rest of the
operating budgets. The budgeted sales are based on the company's estimate of sales
which may require simple analysis fo complicated mathematical models, like
probabilities and statistical tools.
SAMPLE EXERCISE:
AB Works t o sell 250,000 romantic organizers for the year with the
planned
is assumed
intended selling price of P| 25.00 each. The quarterly sales of the company
units (2"¢ quarter); 50,000 units (3'¢ quarter)
as follows — 75,000 units (1* quarter); 25,000
r). Fu rthermore, based on experience 70% of the quarterly
and 100,000 units (4'" quarte next month.
sales are paid in cash while 30% are on cre dit and will be collected
155
SCHEDULE1
AB WORKS
Sales Budget
20A
For the Year Ended December 31,
Quarter
Ist ond _ 4th. —sTofal
75,000 25,000 oe oe oe
Budgeted Sales in units USO
price per unit P125 P125 PIZo —Fl4Zo
Selling
P9,375,000 P3,125,000 P6,250,000 P12,500,000 P31,250,000
itch cals?
Two supporting computations are made for the 1s schedule. The sales budget
which is
sch prom by multiplying the number of units sold to the unit selling price
per quarter
while the cash collection budget schedule uses the expected sale
estimate the collection every quarter. “tn
The sales budget will ; be used in the Income Statement i Bud et lat
ees nd collection every quarter will be part of the Cash
Budge! Fee nace
Sociae
amount for the year will be the Acc ountst Receivable
i i
Ending ;in the: Balance Sheet
Sales Forecasting
156
Sales forecasting is
the foun dation on which a comprehensive budget rests. In order that
it will be Useful the value
udget is bei f the indicator must be known or predictable in advance for
which a b °
prepared. Otherwise, the budgets may seem to be made
asis andis a Being
without ; basi waste of effort. The historical analysis, judgmental methods,
expected values are tools can be used to predict, however complicated predicting ete
Le awe iS
models will not be exhaustively di in a marketing
course subject. ely discussed in this book as it will be taken up
SAMPLE EXERCISE:
Supposed the vice president for sales and regional managers believe there's a
sales being
40% probability of sales being P5,000,000 next year, a 50% probability of
P6,000,000 and 10% probability that they will be P7,000,000. Using the expected value by
applying the probability assesssment to each number of set of possible future events, the
expected sales for next year will be P5,700,000.
PRODUCTION BUDGET
The production budget is prepared after the sales budget. It lists the number of units that
must be produced to satisfy sales needed and to provide for the desired ending
inventory.
OTe Maced Ueto) tem LU Ce) Koi <r SSC mal Ke RoeeXE)
Ending — Finished Goods Beginning
SAMPLE EXERCISE:
157
SCHEDULE 2
AB WORKS
Production Budget
For the Year Ended December 31, 20A
Quarter
Ist 2nd 3rd 4th Year
Budgeted Sales (Sked 1} 75,000 425,000 50,000 1 Dao mee
Add: Ending Inventory of finished goods 5,000 10,000* 20,000 15,0 5,000
Total needs 80,000\, 35,000\, 70,000\, 115,000 265,000
Less: Beginning Inventory of finished goods 12,000 5,000 10,000 20,000 __12,000
Production Budget (units) 68,000 30,000 60,000 95,000 253,000
Solution:
Ending Inventory FG, 1 Quarter = 25,000 x 20%
Ending Inventory FG, 2°9 Quarter = 50,000 x 20%
- Ending Inventory FG, 3 Quarter = 100,000 x 20%
Ending Inventory FG, 4! Quarter = 15,000 units as provided by the problem
The Ending Inventory for the current quarter will be the Beginning Inventory of the
next quarter. The Beginning Inventory for the 1! quarter is provided by the problem.
After the production budget is completed, the budgets for direct materials, direct labor
and overhead can be prepared. The material purchases budget will provide the quantity
and the cost of raw materials to be purchased.
SAMPLE EXERCISE:
158
SCHEDULE 3
AB WORKS
Material Purchases Budget
For the Year Ended December 31, 20A
Quarter
]st Qnd 3rd 4th Year
Solution:
Ending Inventory DM, 1* Quarter= 7,500 CBM x 10%
Ending Inventory DM, 2 Quarter = 15,000 CBM x 10%
Ending Inventory DM, 3 Quarter = 23,750 CBM x 10%
Ending Inventory DM, 4'* Quarter = 2,100 CBM as provided by the problem
The Ending Inventory for the current quarter will be the Beginning Inventory of the
next quarter. The Beginning Inventory for the 1 quarter is provided by the problem.
The same with the Sales Budget, two supporting computations are needed for Direct
Material Purchase Budget. The first will be the total units and cost of direct material to
be
purchased every quarter and the second will be the quarterly cash payments for these
purchases.
The Material Purchases Budget will be used in the computation of Cost of Goods Sold
Budget later on while the expected cash disbursement every quarter will be part of the
159
will be the Accounts Payable Ending in
Cash Budget. The unpaid amount for the year
the Projected Statement of Financial Position.
SAMPLE EXERCISE: ;
Assume that AB Works requires 0.40 direct labor hours for every units produced and
the direct labor cost per hour is P30.00.
SCHEDULE 4
AB WORKS
Direct Labor Cost Budget
For the Year Ended December 31, 20A
Quarter
-Ist 2nd 3rd 4th Year
Budgeted Production in units . ‘
(Schedule 2) 68,000 30,000 60,000 95,000 253,000
‘Direct Labor hours per unit 0.4 0.4 0.4 0.4 0.4
Total Direct Labor hours needed 27,200 12,000 24,000 38,000 101,200
Cost per Direct labor hour P30 P30 P30 P30 P30
Total Direct Labor Cost P816,000 P360,000 P720,000 P1,140,000 P3,036,000.
The overhead budget shows the expected cost of all production costs other than the
direct materials and direct labor. There are two kinds of overhead, variable and fixed
overhead. Most of the companies use direct labor hours as the driver for the variable
overhead.
Overhead Budget ( in Pesos) = (Direct Labor Hours x Variable Overhead Rate per Hour) +
Total Fixed Overhead
\
SAMPLE EXERCISE:
160
SCHEDULE 5
AB WORKS
Manufacturing Overhead Budget
For the Year Ended December 31, 20A _
Quarter
; ] st Qnd 3rd 4th Year
Budgeted Direct labr hours (Sked 4) 27,200, 12,000 24,000 38,000 101,200
Variable OH rate per DLH PS "PS P5 PS PS
Total Variable OH 190,000
P190,00 P506,000
Total Fixed OH P136,000 P60,000 P120,000
: 80,000 _ 80,000 _ 80,000 _—80,000__ 320,000
Total Manufacturing Overhead P216,000 P140,000 P200,000 P270,000 P826,000
Less: Noncash expense (depreciation) 10,000 10,000 10,000 10,000 40,000
Cash Disbursement for Overhead P206,000 P130,000 P190,000 P260,000 P786,000
The total manufacturing overhead amounting to P826,000 will be reflected in the Income
Statement Budget. The total cash disbursement for overhead amounting to P786,000
after deducting the noncash expenses will be reflected in the Cash Budget later on.
The ending finished goods budget supplies the information needed for the balance sheet
and also serves as an important input for the preparation of cost of goods sold budget.
This budget also brings together the information from the production, direct labor and
overhead budgets to compute the unit product cost for the year. The total unit product
cost that will be computed will be used also in the preparation of the cost of goods sold
budget.
SCHEDULE6
AB WORKS
Ending Finished Goods Inventory Budget
For the Year Ended December 31, 20A
Production cost per case: Qty per Unit Cost per Qty Total
Direct Materials — 0.25 CBM P250 perCBM P62.50
Direct Labor 0.4 DLH P30 perDLH 12.00
Manufacturing Overhead 0.4 DLH P8.16 PerDLH 3.26482
Total Unit product Cost P77.76482
161
SCHEDULE 7
AB WORKS ‘Sgt
Cost of Goods Sold Budge
31, 20A
For the Year Ended December
SCHEDULE 8
sett AB WORKS
elling and Administrative Expense Budget
For the Year Ended December 31, 20A
Quarter
. : = 2nd 300 4th Year
a ae in units 75,000 25,000 50,000 100,000 250,000
FoRIVeRE P2.00 P2.00 P2.00 P2.00 P2.00
Figed)
‘ bling GUE aaa P150,000 P50,000 P100,000 )
200,000 P500 ,000
Expense
Advertising P50,000 P50,000 50,000 50,000 P200,0000
Finance Salaries 137,500 137,500 137,500 137,500 550,000
Insurance 25,000 25,000 25,000 25,000 100,000
Rent Expense 10,000 10,000 10,000 10,000 40,000
Depreciation Expense 25,000 25,000 25,000 25,000 100,000
Total FSAE P247,500 247,500 247,500 P247,500 P990,000
The total selling and admin expense amounting to P1,490,000 will be reported in the
Income Statement Budget while the Cash Disbursement for Selling and Admin Expense
will be reported in Cash Budget.
Schedule?
AB WORKS
Budgeted Income Statement
For the Year Ended December 31, 20A
(Sked 1} P31,250,000
Sales
Less: Cost of Good Sold
(Sked 7) 19,441,205
11,808,795
Gross Income
Less: Selling and Admin Expens
e (Sked 8) _ __1,490,000
Income Before Tax _P10,318,795_
163
FINANCIAL BUDGET . .
It is
ets in the mast er b udget are considere d the financial budget.
The remaining budg for capital
of cash budget, bu dg et ed ba la nce sheet and budget
usually composed
ver, only cash budge and budgeted
balance sheet will be illustrated,
expenditure. Howe
CASH BUDGET
rlier. Thi
The cash budget combines most of the data developed and pe cae bon
‘
budget is composed of four: The receipt section, the disbursemen
excess or deficiency section and the financing section.
: . ‘ ditio nal financing
SHGHie i
The cash receipt sections, lists all the cash. inflow except for the ad
needed by the company. The general source for this is the schedule 1,
budgeted sales.
The disbursement sections, lists all the cash outflow except for the payment of borrowings"
and its interest. Including in this sections are cash payments for materials, labor,
overhead, selling and admin cost.
The difference between the cash receipt including the cash beginning balance and the
cash disbursement is the cash excess and deficiency. This is the section where
management will be able to get information of the sufficiency of cash after all the
operations involved.
The last section details the financing program of the company as it tries to evaluate the
deficiency of cash as computed earlier. It also list, when the payment should take place
and the applicable interest for such borrowings.
SAMPLE EXERCISE:
AB Works has a beginning cash balance for the year of P550,000. Other cash
payments for purchases of equipment were: 1‘ quarter— P150,000: 2nd quarter—
P200,000;
3 quarter — P160,000; 4'» quarter— P300,000. It is the company policy that
the cash end
for every quarter should not be lower than P3,000,000. In case
the amount will not met,
the company will borrow some funds in the bank in the denom
inations of of P100,000. The
interest is 5% every quarter.
Schedule 1
AB WORKS
Cash Budget
For the Year Ended December 31 ,
20A
Quarter ;
st - 2nd Sra
feck 4th
con
Beginni beecise
ng Cash Balance P550,000 P3,05. 055,500 P4,180,500 P4,894,250 ‘oot
550,000
Collections from customers (Sked 1} 562, 0
6,562,50 5,000,00
O0, 0 5,312,500
Total Cash Available 10,62. J
P7,112,500 P8.055,500 P9,.493,000
Less: Cash Disbursements P15,5 4 on
Direct Materials 192.250 228,050,000
(Sked 3) 512,2,500
P2,51 912, 00
P2,912,5 P3,206,250
Direct Labor (Sked 4) 816,000
Factory Overhead 360,000 720,000 ce, ee
(Sked 5) 206,000 130,000 190,000
Selling and Admin Expense oaeeee 20S
(Sked 8) 372,500 272,500
Other Dee. 322,500 oe ee
; 150,000
Total Cash 200,000 160,000 300,000
Disbursements P4,057,000 toe.
P3,875,000 P4,598,750 P8,288,000 P19. a 000
164
Excess (deficiency) of Cash
available
Over
disbursements
Financing
Borrowings P4,180,500 P4,894,250 ° P 8,288,000 P8,288,000
Repayments
Interests 0
ojOCO0
eojOoo°o
ojOoo0°0
Total Financing 0
Cash Ending Balance 0
0
: A P4,180,500 P4,894, 250 P8,288,000 8,288,000
SAMPLE EXERCISE:
AB Works
Balance Sheet
December 31, 20A
Cash (Sked 10)
P8,288,000 Accounts Payable (Sked 3)
Accounts Receivable (Sked 1} P2,347,500
3,750,000
Inventory:
RM (Sked 7) . P525,000.00
Finished Goods (Sked 6) 1,166,472. 1,691,472.30
Equipment P1,210,000 Retained Earnings 12,451,972.30
Less: Depreciation : 140,000:
Total Assets
_____1,070,000 _ eee ae
P14,799,472.30 Total Liabilities and Equity __P14,799,472.30
Solutions:
Equipment = Beg Balance + Quarterly Purchases
Accumulated Depreciation = Quarterly Depreciation ( Overhead Budget and Selling and Admin Budget)
Retained Earnings = Beg Balance + Net Income
TERMINOLOGIES
Budget: is a plan, expressed in quantitative terms, on how to acquire and use the
resources of the entity during a certain period of time.
Budget Committee: is responsible in the preparation of the budget which usually
Composed of sales managers, production manager, chief engineer, treasurer and
atigst inant describes how a budget is prepared and it includes a budget plannin
calendar and distribution instructions for all the budget schedules. .
Budget Planning Calendar: the schedule of activities for the development and adoption
of the budget. » -
165
Budget Slack: the intentional overestimation and underestimation of budget
Continuous Budget: is a process of continually adding one more month to the end of g
multi-period budget as each month goes by.
Direct materials budget: A budget that will provide the amount and the cost of raw
materials to be purchased in each time period for a manufacturing industry
Direct labor budget: A budget that shows the total labor hours and the direct labor Cost
needed for the number of units in the production budget
Fixed Budget: these are budgets where the projection of cost will be only for a particular
level or one level of production only, usually at normal capacity, for a definite period of
time.
Flexible Budget: these are budgets where the projection of cost will be at different levels
of production for a definite period of time.
Life Cycle Budget: a budget that estimates product revenues and expenses overits entire
life cycle beginning with research and development, introduction and growth stage, into
maturity and eventually into the decline stage.
Master budget: represents the overall plan of the organization for a given budget period.
Overhead budget: A budget that shows the expected cost of all production costs other
than the direct materials and direct labor.
Participative Budget: is a budget which |is developed through joint, decision making by
top management and operating personnel.
' Periodic Budget: a budget prepared for a fixed period of time, normally one year.
Production Budget: A budget that lists the number of units that must be produced to
satisfy sales needed and to provide for the desired ending inventory.
Sales Budget: A budget that detailed the expected sales (volume of sales in units and in
pesos) for the budget period
Selling and administrative budget: A budget which outlines planned expenses for.
nonmanufacturing activities, like the marketing department, executive department,
accounting department, HR departments and the likes.
166
Zero Based Budgetnca-
assumption of n © geting:
activity aand system of establishing financial plans beginning with an
justifying each program or activity level.
Comprehensive
Illustration:
jon ‘and een cy produces kiddie ride on toy products. Their red, toy wagon
qualities make them
has been
Os everyone. Their Simplicity and striking beauty and
easy to ride
market. The enmpig accessible. They are also some of the safest ride-
on-toys out on the
for tie conn y 'S completing its current year and is preparing to build its master budget
reat year (2020). The budget will detail each quarter's activity and the activity for
ielvyear \nitetal. The master budget will be based on the following information:
a. Fourth quarter sales
for 2019 are 27,500 unit
b. Uni t sales by quarter (2020) are pro s.
jected as follows: 1%t - 32,500; 2™
~ 37,500; 4% — 45 ooo. - 35,000; 34
The selling price is P4009 per unit. All
sales are credit sales. John Isaac collec
all sal
es within the quarter in which they are realiz t 85%
of
ed; the other 15% is collected in
the following quarter, There are
no bad debts.
‘Cc. There is no beginning inventory of finished goods.
John Isaac is planning the following .
ending finished goods for each quarter: 1* - 6,500
units; 2"¢ - 7,500; 3% - 10,000;
4" - 5 000.
d. Each ride on toy products uses five hours of direct
labor and three units of. direct
materials. Laborers are paid 10 per hour, and one unit of direc
t materials costs P80.
e. There are 32,850 units of direct materials in beginning invent
ory as of January 1,
2020. At the end of each quarter, John Isaac plans to have 30% of the direct
materials
needed for next quarter’s raw materials need. John Isaac will end the
year with the
same level of direct materials found in this year’s beginning inventory.
f. John Isaac buys direct materials on account. Half of the purchases are paid for in the
quarter of acquisition, and the remaining half are paid for in the following quarte
r.
Wages and salaries are paid on the 15" and 30% of each month.
g. Fixed overhead totals P500,000 each quarter. Of this total, P175,000 represents
depreciation. All other fixed expenses are paid for in cash in the quarter incurred. The
fixed overhead rate is computed by dividing the year’s total fixed overhead by the
year’s budgeted production in units.
h. Variable overhead is budgeted at P6 per direct labor hour. All variable overhead
expenses are paid for in the quarter incurred.
Fixed selling and administrative expenses total P125,000 per quarter, including
P25,000 depreciation.
Variable selling and administrative expenses are budgeted at P10 per unit sold. All
selling and administrative expenses are paid for in the quarter incurred.
k. The balance sheet as of December 31, 2019, is as follows:
167
Assets ____ liabilities and |Equity _
‘Cash ~ | P125,000 | Accounts Payable P3,624,000|
DM Inventory 2,628,000 | Share Capital 13,500,000 |
Accounts ' 1,650,000 | Retained Earnings 4,029,000 |
Receivable ; et ee ee
PPE, net |_16,750,000 _
Total Assets | P21,153,000 | Total Liab and Equity | P21, 153,000
|. John Isaac will pay quarterly dividends of P150,000. At the end of the 4" quarter,
Pimillion of equipment will be purchased.
Solution:
Quarterly Collections
[st
2nd 3rd 4th Total
AR 2019 P1,650,000 P1,650,000
Ist Quarter 11,050,000 1,950,000 13,000,000
2nd Quarter 11,900,000 P2,100,000 14,000,000
3rd Quarter 12,750,000 P2,250,000 ‘15,000,000
4th Quarter 15,300,000 15,300,000
Total P12,700,000- P13,850,000 P14, 850,000 . P17,550,000 P58,950,000
Accounts Receivable, End = Beginning Accounts Recei
vable + Total Sales— Total Collection
=P 1,650,000+P60,000,000-P58,950,000
= P2,700,000
Unit
Add:
s Sol e 32.500
1* Quarter
35000.” 3: 37500 7 Ath eget Yeah,
2°¢ Quarter
Ending FG 6,500
Total Needs 7,500 10,000 5,000 5.000
Less: Beg FG 39,000 42,500 47,500
. 9. +... 6500 50,000 155,000
Production Budget (units)___ 39,000 7.500 10,000 0
36,000 40,000__ 40,000 155,000
168
After studying this chapter, you will be able fo:
Oo Define, describe and demonstrate
RESPONSIBILITY :
the different responsibility centers.
Identify, apply, evaluate and prepare
responsibility accounting reports for revenue,
ACCOUNTING =|
cost, profit and investment centers.
Define, compute and evaluate the rate of return
on investment, the residual income, economic
value added (EVA) and the balanced
scorecard for an investment center; and
contrast them as criteria for judging the
performance of organization segments.
© Define, describe and demonstrate the
Balanced Scorecard and its applications.
© Define, explain and demonstrate the principle of
transfer pricing
in an interview with Knowledge @Wharton at the 2008 Wharton Leadership Conference, William Weldon,
chairman and CEO of the New Brunswick, N.J.-based firm spoke about the challenges of running the Johnson -
& Johnson family of companies. Consumers tend to associate Johnson & Johnson with Band-Aids and baby
shampoo, but fhose wellknown products are only part of a much larger picture, according to him.
In fact. Mr. Weldon has the mind-boggling task of overseeing more than 200 operating. companies across
three secfors, including the consumer products that have made Johnson & Johnson a household name;
pharmaceuticals like Tylenol; and medical devices. He elaborafed on how J&J's decentralized structure
informs his leadership style and what he sees as key issues for fhe health care industry in the coming decade,
among other topics. -
corporate environment,
Further, Mr.Weldon shared about the main challenges in leading a decentralized
very interest ing and percelved it more of a ea.
including across countries and culfures which he deemed
is due fo the fact that!
benefit, rather than a challenge. This
person makesone mistake,
acentralized environment, isifone
Furthermore, the field
if can cripple the whole organization.
eh
is into requires a heavy focus
where Johnson & Johnson's s
ahead. Johnson & Johnson
innovation in order to stay it
e helps in innovation for
decentralized corporate structur different though .
allaws different people with different skills,
and technologies 7
together different products
fo bring
or customers. (Johnson
satisfy the unmet needs of patients in a Decentralized
Leadership
Johnson CEO William Weldon:
June 25, 2008)
Company, Knowledge@wnarton.
189
OVERVIEW
One of the vital ingredients in attaining organization's financial goals and success is to
have an effective and efficient management processes. This entails the establishment of
a system of proper planning, control, evaluation and decision-making. The system should
embed management accounting tools to gather and report data and to assess
performance. The need for these critical processes becomes inevitable as organizations
expand their respective businesses. As illustrated in the Johnson & Johnson's, managers
in large organizations have to delegate some critical processes to those who are atlower
levels in the organization. Thus, as regards the said delegation, one management ~
accounting tool which is very useful is Responsibility Accounting. It is concerned with
designing reports that would help motivate managers to make decisions and to take
actions that are in the best interests of the overall organization.
DECENTRALIZATION vs CENTRALIZATION
190
Advantages of dece
ntralization
a. Taking of some burden from top
concentrate on stra
management- it enables top
tegy, higher- level decision management to
The long-run survival maki ng, and coor dinating activities.
of the firm s hould be of mor
than its day to day Op e imp ort anc e to to management
erations.
b. Fase in expansion- it acknow
ledges that lower-level man
information about local condit agers have more detailed
ions (e.g. local culture and gov
them to make better ope ernment) that enable
rational decisions.
c. Efficiency in decision making
- it enables lower-level manage
rs to quickly respond to
customers.
d. Opportunity to develop peo
ple- it provides lower-level man
agers with the decision-
making experience they will nee
d when promoted to higher leve
e. Empowering mid l positions. It
-level and lower level management:
it often increases motivation,
resulting in increased job satisfaction and retention, as well as improved
performance.
,
Disadvantages of decentralization
a. Inefficient and ineffective decision-making- lower level
managers may not
understand the “big picture", leading to deci
sions that are inconsistent with the
company's strategy.
b. Decentralized decision-making may lead to
a lack of coordination among
autonomous managers in business segments.
c. Goal incongruence or sub-optimization- lower level mana
gers may have different
objectives than top managers and may pursue their own objectiv
es to the detriment
of the objectives of the overall organization.
d. Necessity of more effective communication abilities- if decentra
lized segments are
really independent-minded and autonomous, there may be little communication
and cooperation among the segments. Innovative ideas may spread more slowly
through a highly decentralized organization than an organization in which top
managers feel free to impose innovation.
Cost-benefit considerations usually require that some management decisions are highly
decentralized and others centralized. Decentralization is most successful when an
organization's segments are relatively independent of one another (i:e., decisions of a
manager in one segment will not affect the fortunes of another segment). In Johnsons
and Johnson's, which is probably the reference company for being decentralized, the
pluses of decentralization exceed over the minuses according to its CEO, Mr. Weldon. To
reiterate, in a decentralized firm, top management delegates decision-making authority
but retains ultimate responsibility for decision outcomes. Thus, an accounting and
information reporting system must be implemented to provide top management with
information about the overall accountability of the sub-units known as RESPONSIBILITY
191
ACCOUNTING SYSTEM. It is an important tool in making decentralization work effectively.
Decentralization leads to performance evaluation. In general, companies will conduct
performance evaluation for 2 reasons: to identify successful operations and eres
needing improvement and to motivate subunit managers to take actions that maximize
the value of the firm.
RESPONSIBILTY ACCOUNTING
All costs are controllable to some degree and by somebody over the
long-run.
Controllability is a matter of degree affected
by the managerial area of responsibility
the time period in question. The reporting of costs and
and revenues under Responsibility
Accounting differs from budgeting in
2 respects: 1.) a distinction is made
controllable and non-controllable item between
s and; 2.) performance reports eith
or include only items controllable by er emphasize
the individual manager.
192
Responsibility Center
REVENUE CENTER - is a subunit in which a manager is responsible only for sales. The
marketing department may be evaluated as a revenue center. Direct costs of the
marketing department and overall sales are the responsibility of the sales manager.
PROFIT CENTER - is a subunit that has responsibility for generating revenue as well as for
controlling costs. The performance of the profit center can be evaluated in terms
of profitability. Income earned in the current year may be compared with the target
or its budgeted amount. It may also be compared with the income eamed in the
prior year. Relative performance evaluation of profit centers involves evaluating the
profitability of each profit center relative to the profitability of other, similar profit
centers.
193
on
isional assets, the divisi
significantly influence decisions affecting investmen tin div stment
should be considered an investment center. If he ca nnot influence inve
vestment center head
decisions, then it should be considered as a profit cente r. In
of inventory, the level of —
play a major role in determining the level
the investment in equipment and other assets held by 7
receivable and
Tools used for evaluating the performance of an invesimen
investment center.
center include the retum on investment (ROI} and residual income (RI).
The setup of responsibility centers is unique to each firm. Such factors as size, industry,
operating characteristics and managerial philosophy influence the organizational
structure of the firm. The way that the firm is organized, influences its reporting system.
Jo:
‘An organizational view of responsibility centers:
J&J provides an example of the various kinds of responsibility centers that exist in
A
an organization.
I. The President and CEO as well as the Vice President of Operations
manage investment centers. ‘
2. The Chief Financial Officer, General Counsel, and Vice President of
Personnel all manage cost centers.
3. Each of the three product managers that report to the Vice
President of Operations (e.g., consumer products, pharmaceuticals and
medical services) manages a profit center.
4. The production plant. manager, warehouse manager, and
NN
distribution manager all manage cost centers that report to the Consumer |
product manager. “yy
In‘a responsibility accounting program, the following principles of good organization must
be followed:
1. Every necessary function is assigned to a unit of the organization
.
The assignment of responsibilities is specific and understood.
aARwWHN
194
Autonomy may make low
erlevel managers have objectives that differ from those of the
entire organizati
on. This pr oblem
systems that motiva can be reduced by designing performance evaluation
te m anagers to make decisions that are in the best interests of the
comp any.
Segment Reporting
Traceable costs are those costs that arise because of the existence
of a particular
segment. If a fixed cost is avoidable if a segment were discontinued
, then itis aq traceable
cost of that segment. In other words, a traceable
fixed cast of a segment is a fixed cost
that is incurred because of the existence of the segment. If the segmen
t were eliminated,
the fixed cost would disappear. Examples of traceable
fixed costs include: (1). The salary
of the Accountancy department's secretary at USC
is a traceable fixed cost of the said
department; (2). The insurance cost for
the production building in which bottles
are
produced is a traceable fixed cost of the beverage business segment of SMC,
Fixed
Conta Don't allocate
common costs to
segments.
Traceable (op)
195
ne
A common fixed cost is a fixed cost that supports the operations of more than o
t. A ee are
segment, but is not traceable in whole or in part to any one segmen
common to a particular segment would continue even if that particular seg ete
discontinued. Examples of common fixed costs include: (1). The salary of the CE 0 ..
isa common fixed cost of the various divisions of SMC. (2). The cost of salary paid to the
Vice President for Operations of a consumer products company is a common fixed cost
of the various departments — shampoo, soap, diaper, etc.
It is important to realize that the traceable fixed costs of one segment may be ial
fixed cost of another segment. For example, the landing fee paid to land an airplane at
an dirport is traceable to a particular flight, but it is not traceable to first-class, business-
class, and economy-class passengers.
- However, in practice, a great deal of disagreement exists about what costs are
traceable and what costs are common. Some people claim that except for direct
materials, virtually all costs are common fixed costs that cannot be traced to products.
Others assert'that all costs are traceable to products: there are no common costs. The
truth probably lies somewhere in the middle — many costs can be traced to products but
not all costs.
196
Segmented Income
Statements- Illustrat
ion
Illustrative Problem
1
ModelA Model B
Sales in UNIS ecco,
5,000 3,000
Selling price per unit...
P50 P100
Variable production costs per unit
.... P10 P26
Traceable fixed production costs ......
P100,000 P150,000
Variable selling expenses per unit ....
P5 Pé
Traceable fixed selling expenses...... _P5,000 . P7,500
Allocated division administrative
EXPENSES ...eeee e P50,000. P60,000
Samsong Corporation
Contribution Margin Income Statement
Segments
Total Company ModelA / Model B
Sales P550,000 100% 250,000 100% P300,000 100.0%
Variable expenses 171,000 31 75,000 30 96,000 32.0
Contribution margin - P379,000 69% 175,000 70% P204,000 68.0%
Traceable fixed expenses 262,500 48 105,000 42 157,500 52.5 |
Segment margin ...... P116,500 21% P70.000 28% P46500 15.5% |
_20 |
‘Common fixed expenses ...110,000
|
Net Income .... P_6,500 _1%
Sales for each individual segment should be identified. Related variable cost are
deducted from sales, resulting in a eonmioarign margin figure for each segment. Costs
that can be traced directly to specific segments
ofa company should not be allocated
to other segments. Rather, such costs should eS charged directly to the responsible
segment. For example. the rent for a branch office of an insurance company
ts fly against the branch office rather should be
than included in a companywide
charged sy nd then spread throughout the company.
Some companies allocate
aes using arbitrary bases. Costs should
be allocated to segments for
costs to
197
: i he cost
internal decision making purposes only when the alloc
ation base SS ie Sie and
being allocated. For example, sales are frequently used to oa a fecwk ive fades
administrative expenses to segments. This should only be done ! sa
expenses.
Common costs should not be arbitrarily allocated to segments based on the raliencle
that “someone has to cover the common costs" for two reasons: First, this practice Paty
make a profitable business segment appear to be unprofitable. If mie segment is
eliminated the revenue lost may exceed the traceable costs that are avoided. Second,
allocating common fixed costs forces managers to be held accountable for costs that
they cannot control.
Return On Investment
Illustrative Problem 2
Let us use the financial data of ARYA Company for last year that appear
below:
ARYA Company
Statements of Financial Position
Beginning Ending
Balance Balance
Assets: .
Cash P 50,000 P 70,000
Accounts receivable 20,000 25,000
Inventory 30,000 35,000
Plant and equipment (net) 120,000 110,000
Investment in Cedar Company 80,000 ~ 100,000
Land (undeveloped) 170,000 170,000
Total assets P470.000 P510.000
198
Liabilities and owners’ equity:
Accounts payable > P 70,000 P 90,000
Long-term debt 250,000 250,000
Owners’ equity 150,000 170,000
Total liab. and owners' equity P470,000 _P510,000
ARYA Company
Income Statement
Sales . seibstielleetes ts Mbecitcecetes . P414,000
Less operating expenses ....... - 351,900
_ Net operating income ......:.... 62,100
Less interest and taxes:
Interest expense ................ P30,000
Tax Expense ....... ee saedeces 10,000 40,000
~ NOt INCOME oo. ceeeseeeeeeeees P.22,100
199
“Average operating assets = (P220,000 + P240,000) * 2= P230,000
In practice, corporate headquarters expenses and other common costs are often
allocated to divisions. Only those allocations.that reflect -the costs of actual services
provided by central headquarters that the divisions would otherwise have
had to provide
for themselves should be included in RO! computations. Arbitrary allocations of other
headquarters expenses should be avoided in RO!
computations. They undermine the
200
credibility of the Measur
e of performance
cory
serve NO apparent useful _ generate arguments among managers, and
purpose ; : ,
| ;
However, th of criticisms of the use of ROI in evaluating managerial
ne ere are a number
p eta These are as follows:
RO! ‘ : rmance. Managers
non ane to emphasize shortOrun rather than long-run perfo
a.
hurt the company
can often improve short-term profitability by taking actions that
in the lang-run.
A manager who takes over an. investment center typically inherits many
reels costs over which the manager has little control.
. vision Whose ROI is larger than the ROI of the entire company may reject an
alternative that would lower its own ROI even though it would increase the ROI for
the entire company.
Residual Income
Residual income is the net income that an investment center is able to earn above the
minimum required rate of return on its operating assets. Ideally. the minimum required
funds. When
rate of return should be the form's cost of capital or opportunity cost of
the total
residual income is used to measure performance, the goal is to maximize
income computation
amount of residual income generated for period. The residual
relative to the investment
differs from ROI. RO! measures net operating income earned
is that there will be profitable
in average operating assets. The downside of ROI
is evaluated based on the ROI formula.
investments that may be rejected if a segment
income earned less the minimum required
Residual income measures net operating
residual income approach encourages
retum on average operating assets. The
for the entire company but that would
managers to make investments that are profitable
the ROI formula. In other words,
be rejected by managers who are evaluated using
to pursue investments where the ROI
residual income approach motivates managers required retum but
the company's minimum
associated with those investments exceeds
eamed by the managers.
is less than the ROI being
Average ae .
Net : Minimum required
i
Ren anme = oper me g
atin - oper
asse ts g
atin =< rate of re
inco inco
dual
information in Illu stra tive Problem 2, let us illustrate the computation of resi
Using the
income.
me P62, 100
Net operating inco ‘
required retum
Less: Minimum 46,000
,
(20% X P230,000)
_—
Residual income __
201
A major disadvantage of the residual income approach is that it cannot be easily used
to compare the performance of divisions of different sizes. Residual income can be used
to track the performance of a division over time and actual residual income can be
compared fo target residual income. The minimum required rate of return is ordinarily the
weighted average cost of capital (WACC) but it may be an arbitrary hurdle rate.
Projects with a positive residual income should be accepted, and projects with a
negative residual income should be rejected. Residual income is often touted as superior
than ROI. It may be more consistent with maximizing profit.
Economic Value Added (EVA) calculates the excess of after-tax operating profit over the
total annual cost of capital. The concept of economic value added (EVA) is most similar
io residual income. If EVA is positive, wealth is created.
EVA= Net Operating Profit After Tax [ EBIT x (1- TxR) ] minus [WACC x IB]
Using the information in Illustrative Problem 2 and assuming that the WACC is 12%,
economic value added is computed as follows, -
EVA represents the business unit's true economic profit primarily because a charge for
the cost of equity capital is implicit in the cost of capital. The cost of equity is an
opportunity cost, that is, the return that could have been obtained on the best
alternative invesiment of similar risk. Hence, the EVA measures the marginal benefit
obtained by using resources in a particular way. It is useful for determining whether a
segment of a business is increasing shareholder value. EVA is only one method for
measuring managerial performance regarding creation of shareholder value. The other
methods include: EQUITY SPREAD, TOTAL SHAREHOLDER RETURN, MARKET VALUE ADDED.
202
BALANCED SCORECARD
As organizations tend to rely on financial indices (e.g., ROI, net income) as indices of total
organization performance, .this narrow focus ignores with other important aspects of
performance and lends itself to a myopic preoccupation the short run. In addition,
es managers to consider a
The scorecard provides a balanced structure which enabl
fically to
nce indicators which are tailored speci
variety of relevant integrated performa
achievement of an organization's
measure a short list of items which are critical to
secondary objectives. The balanced
strategic goals, relating to both its primary and
targets and an approach to performance
scorecard is a set of performance
tion's objectives relating to both its
measurement that stresses meeting all the organiza
balance. To achieve this balance, the
primary and secondary obj ectives — hence, the
four different but related
balanced scorecard exa mines the organization activity from
perspectives:
olders?:
look to external [and internal] financial stakeh
1. Financial: (how do we e, operating income,
ured by s hareholders?) Indices includ
how is success meas
and EVA.
‘ROI, residual income are their individual
Cu st om er : (h ow do we loo k to our customers, and what
2. how do we
y? how do customers see us and
contributions to our profitabilit itability, customer
val ue for the m®) Ind ices include customer prof
create share.
act ion , cus tom er retention and market
satisf customers
improve processes to add value to
3. Business processes: (how can we
per for man ce? Wha t is the short list of things that we must
and improve financial s and aciivities at
t is the short list of int ernal processes, procedure
excel at? wha at olders?) Measures include
h we mus t exc el | to satisfy customers and shareh
whic technologies.
t s in in ter nal pr ocesses, measures of critical
improvemen
203
4. Learning and growth: (how does the organization evolve to continue fo meet
the challenges of competitors and changes in the marketplaces what changes
In employee capabilities, Information systems, and organizational climate are
necessary in order to continuously improve our infernal processes and customer
relationships?) Indices include such characteristics as: employee satisfaction,
employee retention and training.
j
> ’
’ 3 x aed
What business Process must we excel “ye
at? ?
@ Develop Now Products ‘ @ Service - Excoltence
@ Understanding Customer gee! id ‘ ,
STRATEGY @ Trusted Busing ss Portace
Seaquuvents
@ Reduce Cycle Time
@ Provide Rapid Response
@ Cross Sell the product Line
@ Shift to Appropriate Channel
||
How will we sust
cur abitity
ain to change ond
improve?
@ Hire Key Technical Talent
@ Implement Cross-Training {
@ Provide Access to Transaction }
Information
|
@ Align Personal Goals |
@ Incroase E mployee Productivity
|
204
2
3. Make strategy
4 Make Strategy
=. QO Continual pr.
5 - Mobilize leade ; pisces
rship for change
Complication S to be avoide
i d :in Balanced Scorecard impl
ementation:
Use of too many
measu res diffuses management's focus; it's better to focus on a
smaller number of measures that
can have a real impact.
2 7 00 few measures are a problem aswell.
Too few measures provide an iincomplete
(and perhaps distorted) picture.
3 hn commitment by senior management is required. As in virtually all management
initiatives, support from the top is a necessary but not sufficient condition for
success.
4 A Balanced Scorecard is an organization-wide effort, not a task for a single
manger or small group.
i
Scorecard responsibilities must filter down to middle managers and lower level
workers. Everyone in the organization needs to be on board.
6 Attempts to develop the perfect scorecard are likely to end in failure. The
scorecard should be an evolutionary process.
7 The Balanced Scorecard should not be treated as a "systems project.” While
information is an essential part of the scorecard process, mere automation of data
recording and observations does not provide a sound basis for a scorecard.
TRANSFER PRICING
nt of an organization for a
Transfer refers f o amounis charged by one segme
Price
nt of ie same organization. It is
product or service that it supplies to another segme
e, and it ‘ a cost fo the acquiring
revenue to the segment providing ihe product ot servic to ca ne s data that will lead
exist within organizations
department. Transfer prices
They should help guide lk e make the best possible
ons. total
and services inside or outside the
to goal-congruent decisi
buy or sell products
decisions regarding whether to
205
organization. They are also used to help in evaluating segment performance and, thus,
motivate both the selling manager and buying manager toward goal-congruent
decisions. Finally, multinational companies use transfer pricing to minimize their
worldwide taxes, duties, and tariffs.
206
could lead to suboptimization which is a situation in which individual managers pursue
goals and objectives that are in their own and/or their segments particular interests
as a profit center,
rather than in the company's best interests. If a sub-unit is operated
the process of
carnal should guard against suboptimization. It exists when in
maximizing profit contribution of that sub-unit, the overall results of operations of the
or
company as a whole are adversely affected. For suboptimization to be limited
minimized, top management must-be aware that it can occur and should develop ways
it like communicating corporate goals to all organizational units and using
to avoid
price should ensure
appropriate transfer prices between units. The appropriate transfer
optimal resource allocation and promote operating efficiency.
er pricing:
Disadvantages of transf among organization unit
often is) disagreement
1. There can be (and most
nsfer price should be set.
managers as to how the tra additional
prices in the accounting system requires
9. Implementing transfer
organizatio n costs and employee time.
+ work equally well for all departments or divisions.
3. Transfer prices do no
may cause dysfunctional behavior among segments or may
4. The transfer price or over utilized.
rv ices to be under-
induce certain se
207
Transfer Pricing Methods
Five basic methods of pricing intracompany transfers are: (1) cost-based; (2) market-
based; (3) negotiated market; (4) arbitrary; and (5) dual. No one method of setting a
transfer price is best in all instances. Perhaps the best method is defined best for a
particular purpose. For decision-making purposes, what is important is to determine the
differential cost involved regardless of the transfer price method used. Transfer-prices are
not permanent: they are frequently revised in relation to changes in costs, supply,
demand, competitive forces and other factors.
1. COST-BASED TRANSFER PRICE. A cost-based transfer price is usually sufficient in
situation where an operation of the company is totally centralized. Aside from
being simple and easy to apply, it is widely used when there is no reliable market
price that can be used as a basis for transfer price. And as such, the transferred
cost can readily be used to measure production efficiency by comparing actual
figures with budgeted figures. Likewise, it avoids the trouble of eliminating
intracompany profits in consolidating financial statements and for income tax.
However because of its limitations, it is not applicable to decentralized operations
for it lacks the required factor, like margin, necessary to allow planning,
motivation, -evaluation, and objectivity necessary for a good performance
standards. However, problems with the use of actual cost are that the buying
division is hindered in planning because actual cost cannot be known in advance,
and the supplying division has no incentive to control its costs since any
inefficiencies are simply passed on to the buying division. The use of budgeted or
standard costs is preferred.
In determining the transfer price based on cost, the cost used may be the actual
or standard, and may further be equal to total cost, total cost plus markup, or
marginal cost plus markup. Total cost plus markup approximates the market price
and is considered practical substitute and is better known as synthetic price. If cost
only is used as a transfer price, the selling unit cannot earn a profit. Another version
of cost-based transfer pricing is variable cost. With VC ‘transfer prices, only variable
production costs are transferred. They have the major advantage of encouraging
maximum profits for the entire firm when excess capacity exists. Transfers are
priced at cost when the transferring division is viewed as a cost center. However,
if the transferor is a profit center, MV or cost plus TP are typically used. Cost + TP is
often used when a market price is not available. In a sense, it is a surrogate for a
_ market price.
2. MARKET-BASED TRANSFER PRICE is the price at which the goods are sold on the
open (intermediate) market. Intermediate market means a market in which a
transferred product or service is sold in its present form to outside customers. This
208
is the best TP since it will maximize the profits of the company as a whole provided
that: (1} a competitive MP exists and (2) divisions are independent of each other.
In determining the transfer price based on market, the prevailing market price,
current replacement cost or NRV, whenever clearly determinable, serves as the
ceiling for transfer price and may be reduced by the selling costs. In conducting
divisional performance, the market-based transfer price is considered the best
because it attempts to approximate an arm's length, bargained, open-market
price. Goods and services transferred are priced based on what is prevailing in an
outside market or based on how much to pay the outsiders. From the point of
view of the transferor, it approximates its opportunity cost because the market
price is the amount of revenue if can realize from the sale of goods to outsiders.
This method may be adopted only when there is a perfectly competitive market
for the intermediate product. In the absence thereof, the “puying" and "selling"
divisions may resort to negotiated transfer price, which is a refinement of the
market based transfer price. If a competitive market exists for the product or
service being transferred internally, the use of market price as a transfer price will
generally lead to the desired goal congruence and managerial effort. Some
adjustments to market prices can be made for things like selling and delivery
expenses that are not necessary if an internal transfer takes place.
. However, market prices are not always available for items transferred internally.
When market prices are not available, are inapplicable, or are impossible to
determine, versions of “cost-plus-a-profit" are often used in order to provide a "fair"
or "equitable" substitute for regular market prices.
209
may be considered in the negotiations, but no policy requires this.. Supporters
claim that, since these managers have the best knowledge of what a company
will gain or lose by producing and transferring the product or service, RE GONaveN
allows managers to make optimal decisions. Even if a competitive market exists,
the negotiated market transfer price demonstrates the authority and control of
managers over the profit of their respective unit.
However, critics focus on the time wasted in negotiations because the negotiation
procedure is time consuming and may even create conflict of opinion diverting
the efforts of the managers to those affecting their end results rather than the
company as a whole. Besides, breakdown in negotiation may even involve
executive management to act as mediator only to arrive at an arbitrary price.
4. ARBITRARY TRANSFER PRICE Neither the buying division nor the selling division
controls the TP. Top management sets the transfer price ata level considered best
for the overall interests of the company. The use of an arbitrary transfer price may
indicate a step toward centralization and the inability of division managers to
operate smoothly on a decentralized basis. It hampers the autonomy and: profit
incentive of division managers.
5. DUAL TRANSFER PRICE. Under this system, the transferor may value their products
or services in the same manner as they value the same when dealing with outside
customers. On the other hand, the transferee would value the goods and services
received at a price that will clearly reflect the actual cost and would not include
an artificial profit for them to be aware of the total cost implications.
Virtually any type of transfer pricing policy can lead to dysfunctional behavior. For
example, a certain division insists on the market price asa transfer
price even when it has
excess capacity, the company as a whole forgoes the profit that is possible
if an internal
transfer were to occur. On the other hand, if variable cost is used as the transfer price
and the said division could sell all it wants to at the market price, an internal
transfer would
not take place because the division will devote all of its product
ion to outside sales.
Solutions offered for these dilemmas are the setting
of “fair transfer prices by top
management or the negotiation of transfer prices by
the segment managers. Also, in
order to promote transfers that are in the best interest
of the company as a whole,
210
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Itustrative Problem 3. Department A buys 5.000 units of its raw material requirement from
Depariment 8 of the same company for P10 each. Department B produces 25,000 units
of the raw material item and is able to sell 20,000 units ta customers at P12 each. An offer
from an outside supplier (Company X} te supply Department A with the same kind of raw
maternal for PS each was received. if Department A chooses to buy from Company X,
Department 8 has to operate at the production level of 20.000 units only. An analysis of
the current production casts per unit of Department 8 shows:
Based on the given breakdown of production costs per unit, the incremental out-of-
pocket cost must be P7 per unit which consists of the variable costs. The fixed factory
overhead of P3 per unit based on 25,000 units (or P75.000) should be considered irrelevant
inasmuch as the amount thereof is assumed fo remain constant. On the other hand.
cost of P8 per unit. the quoted
buying from the outside supplier requires an out-of-pocket
the second altemative.
orice. Therefore. the base case has an advantage of P5.000 over
This is arrived ai as follows:
P 8.00
X
Price quotation from Company 66
Dept. B
incremental cost per unit, P oF00
Difference
00 0unit s
x P3.05,00
Advantage of buying from Dept. 8
211
In the given illustration, Department B has no other use for its facilities so that if
Department A chooses to buy from Company X, part of the facilities would be idle.
However, if they can be utilized in the production of a more profitable product line, it
would be advisable to buy from the outside supplier provided there is assurance of
continuity of supply and maintenance of quality.
Suppose a firm is organized into two segments, manufacturing and selling and each
segment is a profit center. The manufacturing segment "sells" to the selling segment
which, in turn, sells to outsiders. Data for the two segments are as follows:
Manufacturing Selling
- If the firm produces and sells 200,000 units, an income statement by segment would show
the following. The variable costs for the selling division are the P3 selling costs plus the P20
the segment is charged by the manufacturing division.
Manufacturing Selling
212
Manufacturing Selling
213
Pricing Internal Services .
refer to departments that carry out central purposes eton
Operating departments
organization while service departments do not directly engage in operating
service
activities as they provide support to operating departments. The
department charges can be viewed as a transfer price that is charged for services
provided by service departments to operating departments. Whenever possible,
variable and fixed service department costs should be charged separately.
214
6) Allocation is done at the end
of the year
=
S ; nD
Healthy Beverages
Ginger beer production capacity per month 10.000 barreis
Variable cost per barrel of ginger beer P 800 per barre
Fixed costs per month P 70,000
Outside Selling price of Healthy Beverages ginger beer P 2,000 per Sarre:
Pizza Mother :
Monthly consumption of ginger beer 2,000 barrels
Selling price P 2,500 per barre!
Fixed costs per month P 10,000
Requirement.1: Suppose that Healthy Beverages is currenily selling 7,000 barrels fo outside
customers, and that the purchase price of a reguiar brand of ginger beer outside Oasis
P1,800, calculate the highest and lowest acceptable transfer price.
There is sufficient idle cap acity, so TP > UVC; therefore, minimum TP = P&00
There is outside supplier, so TP < Cost of buying from oviside supplier Thus
maximum TP = P1,800
Requirement 2: Suppose that Healthy Beverages is currently selling 10.000 barrels !iO
¢ Nel~)
outside customers, and that there is no other supplier other than Pizza Mother. ate
able transfer price.
the highest and lowest accept
245
There is insufficient (0) idle capacity, so TP > UVC + {Total CM on Lost Sales/Units
Transferred); Therefore, minimum TP = 800 + [(2,000 x (2000 - 800)/2,000] =
P2,000
There is no outside supplier, so TP < Profit to be earned per unit sold (excluding the
TP); Therefore, maximum TP = 4,990,000/2,000 = P2,495
There is insufficient (1,000) idle capacity, so TP > UVC + (Total CM on Lost Sales/Uni
ts
Transferred). Therefore, minimum TP = 800 + [(1,000 x (2,000 — 800) /2,000] = P1,400
There is outside supplier, so TP < Cost of buying from outside supplier: Thus,
maximum TP = P1,800 ,
There is outside supplier, so TP < Cost of buying from outside supplier; Thus,
maximum TP = P1,800
216
Multinational Transfer
Pricing
The Bantayan division determined that transfer price should be P500 per unit. However,
the US division -begged to differ and insisted that the transfer price should be P800 per
unit. Becaus e both divisions could not reach a decision, management is called on to set
How shoul d management set the transfer price?
an arbitrary transfer price.
217
PROOF:
218
SUMMARY OF TERMS
performance
Balanced Scorecard- is a set of performance targets and an ap proach to
measurement that stresses meeting all the or gani
zation's objectives
objectives — henc e, the
relating to both its primary and secondary
balance.
Common fixed cost- is a fixed cost that supports more than one business segment, but is
not traceable in whole or in part to any one of the Business
‘segments.
profit over
Economic Value Added (EVA)- calculates the excess of after-tax operating
business unit's
the total annual cost of capital. EVA represents the
for the cost of
true economic profit primarily because a charge
equity capital is implicit in the cost of capital.
responsible.
Responsibility Center- is an organization unit for which a manager is made
Return on Investment- investment centers are usually evaluated based upon some
measure of the rate of return on investment; that is, some measure
of profits divided by some measure of investment.
219
Revenue center- is a responsibility center whose members control revenues but do
not
control the cost of the product or service they sell or the level of
investment in the responsibility center.
Traceable costs- are those costs that arise because of the existence of a particular
segment.
220
PRETEST CHAPTER 1
Preparation of financial statements is necessary
in management accounting.
________ is the key to effective control.
True
Feedback False
Competence
It enjoins disclosure of delays or deficiencies in _______ is also known as marginal costing.
information, timeliness, processing, or internal
controls in conformance with organization policy Direct costing or Variable costing
and/or applicable law.
These kind of costs are not assigned to the
Credibility product but are recognized as expense in the
period in which it is incurred.
Dodol is a financial manager who has discovered
that her company is violating environmental Period costs
regulations. If his immediate superior is involved,
his appropriate action is to: Under this costing method, its period costs
consist only of all the operating expenses or
o Present the matter to the next higher commercial expenses.
managerial level
o Confront his immediate superior Absorption costing
o Do nothing since he has a duty of loyalty to the
organization
o Consult the audit committee Under absorption costing, product cost is
composed of direct material, direct labor and
manufacturing overhead costs.
_________ requires that IMA member shall keep
information confidential except when disclosure is True
authorized or legally required. False
True True
False False
Distinctions between absorption costing and _____ is the only generally accepted method for
direct costing is relevant to a merchandising external reporting purposes.
company.
Absorption costing
True
False
Net income under absorption costing is not ______ is equal to revenue minus all variable
affected by changes in production. direct materials cost of goods sold.
Differential profit (loss) is the difference in profit Cost of inventory under variable costing is less
(loss) between absorption costing and direct than the cost of inventory under absorption
costing. costing.
True
True False
False
PROBLEM-SOLVING:
Information for the year 2019-2021 operations are shown below:
Beginning Inventory 0 ? ?
Ending Inventory ? ? 0
b. Compute for unit product cost under super-variable costing for year 2019.
10
c. Compute for unit product cost for year 2020 under absorption costing.
26
d. Compute for unit product cost for year 2021 under direct costing.
16
e. How much is the cost of ending inventory under absorption costing in year 2021?
6300
f. How much is the net income for year 2020 under throughput accounting?
48200
g. How much is the throughput margin in 2019?
225000
j. Compute for the operating income under absorption costing for year 2020.
49800
True
False
True
False
Pre Test Master Budget Chapter 5
A budget is a means of keeping the operating plan A budget prepared for a fixed period of time.
within acceptable tolerance which involve the use
of budget in regulation business Periodic Budget
Fixed Budget
operations/activities.
Imposed budget
True or False Flexible budget
True
False
The following are the objectives of budgeting,
except:
This involves the determining of the organizational
planning plans of 1-18 months.
coordination
control Strategic planning
execution Tactical planning
Budgeting
Periodic Budget
It is a behavioral, communications-oriented
responsibility approach to employee self-direction.
Budget
Budget Planning Calendar
Management by Objective
Budget Control
Zero-bas budgeting
Pre Test Responsibility Accounting Chapter 6
Delegation is an important concept in A manager can usually improve ROI by
responsibility accounting. increasing sales, by reducing expenses, or by
reducing assets.
True
False True
False
Decentralization is most successful when an
organization's segments are relatively Excessive funds tied up in operating assets
independent of one another. depress turnover and lower ROI.
True True
False False
Necessity of more effective communication A manager who takes over an investment center
abilities is one of the advantages of typically inherits many committed costs over
decentralization. which the manager has little control.
True True
False False
All costs are controllable to some degree. If economic value added is positive, wealth is
created.
True
False True
False
Common costs should be allocated to segments.
The residual income approach
True discourages managers to make investments that
False are profitable for the entire company but that
Contribution margin is obtained by deducting the would be accepted by managers who are
evaluated using the ROI formula.
traceable fixed cost of a segment from the
segment's margin. True
False
True
False A key role of the scorecard is its linkage to
Profit centers' responsibility includes controlling organizational mission and strategy.
costs. True
True False
False Transfer price refers to charged by one segment
Return on investment is one of the tools used to of an organization for a product or service that it
evaluate the performance of revenue centers. supplies to another segment of the same
organization.
True
True
False
False