Summary chapter 1

Accounting systems take economic events and transactions and processes the
data into information helpful to managers. Provide information for five broad
purposes: formulating over all strategies and long term plans, Resource
allocation decisions, Cost planning and control, Performance measurement
and reporting requirements.
Financial accounting focuses on reporting to external parties such as investors,
government agencies, banks and suppliers
Management accounting measures, analyzes, and reports financial and
nonfinancial information that helps managers make decisions to fulfill the goals of an
organization
Cost Accounting measures, analyses, and reports financial and nonfinancial
information relating to the costs of acquiring or using resources in an organization.

Strategy describes how an organization will compete and the opportunities its
managers should seek and pursue (continue doing an activity). Management
accountants provide information about the source of competitive advantage

Questions to help form a strategy:

Who are our most important customers?
What substitute products exist in the marketplace, how do they differ from our
products in price and quality?
What is our most critical capability (technology, production, marketing)?
Will cash be available to fund the strategy?

Value chain analysis: Sequence of business functions in which customers

usefulness is added to products or services.
Research and development: generating and experimenting with ideas
related to new products, services, or processes.
Design of products and processes: the detailed planning, engineering, and
testing of products and processes.
Production: procuring, transporting, storing and assembling resources to
produce a product or deliver a service.
Marketing: promoting and selling products or services to customers or
prospective customers.
Distribution: processing orders and shipping products or services to
customers.
Customer service: providing after-sales service to customers.

Management accountants track the costs incurred in each value-chain category. The
purpose is to reduce costs and improve efficiency.

Supply chain describes the flow of goods, services, and information from the
initial sources of materials and services to the delivery of products to consumers,
regardless of whether those activities occur in the same organization or in other
organizations.
Key success factors:
1. Cost efficiency: pressure to reduce costs, global competition is placing even
more pressure.
2. Quality: Customers expect high levels of quality
3. Time: development time, cost and benefits during products life cycle, customer
response time.
4. Innovation: basis for ongoing company success

Decision making, planning, controlling: the five step decision making progress.
1. Identify the problem and uncertainties.
2. Obtain information
3. Make predictions about the future
4. Make decisions choosing among alternatives: (planning using budgets (most
important planning tool))
A Budget is the quantitative expression of a proposed plan of action by
management and is an aid to coordinating what needs to be done to execute
that plan
5. Implement the decision, evaluate performance and learn by compare actual
performance to budgeted performance control role of information
Control comprises taking actions that implement the planning decisions,
deciding how to evaluate performance, and providing feedback and learning to
help future decision making
Learning is examining past performance (the control function) and
systematically exploring alternatives ways to male better-informed decisions
and plans in the future

Key management accounting guidelines:

Cost benefit approach: resources should only be spent, if the expected
benefits exceed the expected costs.
Behavioral and technical considerations:
o Technical: helps managers make wise decisions.
o Behavioral: motivate managers and employees to aim their goals with
the organization
Use different costs for different purposes: use alternative ways to compute
costs in different decision-making situations

Organization structure and the management accountant:

Line and staff relationships: directly responsible for attaining goals of the
organization (production, marketing).
Line management: production, marketing
Staff management: management accountants, HR management
Chief financial officer and controller: responsible for overseeing the financial
operations of an organization. Controller responsible for management
accounting and financial accounting.
Chapter 2

Cost: resource scarified or foregone to achieve a specific objective.

Actual cost is the cost incurred <-> budgeted cost is predicted/forecast cost

Cost object: anything for which a measurement of cost is desired.

Cost accumulation: collection of cost data in some organized way by means of an

accounting system. (assigned to a cost object)

Direct cost: can be traced to the cost object in a feasible or economical way (parts
used to create a BMW) cost tracing

Indirect cost: cannot be traced to the cost object in a feasible or economical way
(plant administration costs) cost allocation

Cost assignment: general term that encompasses both.

Factors affecting direct/indirect costs:

The materiality of the cost in question: smaller the cost, the more immaterial,
the less likely it is economically feasible
Available information-gathering technology: make it possible to consider more
and more costs as fixed.
Design of operations: classifying a cost as direct is easier if a companys
facility is used exclusively for a specific cost object, such as a specific product
or customer.

A useful rule to remember is that the broader the definition of the cost object, the
assembly department rather than the X5 SAV, the higher the proportion of total costs
that are direct costs and the more confidence a manager has in the accuracy of the
resulting cost amounts

Variable cost changes in total in proportion to changes in the related level of total
activity or volume.

Fixed cost remains unchanged in total for a given time period, despite wide changes
in the related level of total activity or volume.

Some costs have both fixed and variable elements and are called mixed costs
(telephone cots can have a fixed monthly as well as a variable minute cost)

Cost driver: a variable such as the level of activity or volume that causally affects
costs over a given time span.

Relevant range: Band of the normal activity level or volume in which there is a
specific relationship between the level of activity or volume and the cost in question

Unit cost = average cost per unit

Managers should think in terms of total costs instead of unit costs for many decisions

Manufacturing-sector companies: purchase materials and components and

convert them into various finished goods.

Merchandising-sector companies: purchase and then sell tangible products

without changing their basic form.

Service-sector companies: provide services (intangible products)

Types of inventory:
1. Direct materials inventory: in stock and waiting for use.
2. Work-in-progress inventory: partially worked-out but not yet completed.
3. Finished goods inventory: completed but not yet sold.

Commonly used manufacturing costs: (see exhibit page 61 & 62)

1. Direct material costs: acquisition cost of all materials that eventually become
part of the cost object.
2. Direct manufacturing labor costs: compensation of all manufacturing labor that
can be traced to the cost object.
3. Indirect manufacturing costs: all manufacturing costs that are related to the
cost object but cannot be traced to that cost object in an economical feasible
way (supplies, indirect materials).
4. Inventoriable costs: all cost of a product that are considered as assets in the
balance sheet when they are incurred and that become cost of goods sold
only when the product is sold. No inventoriable costs for service-sector
companies, all costs in the income statement are period costs
5. Period costs: all costs in the income statement other than cost of goods sold.
Are treated as expenses of the accounting period in which they are incurred
6. Prime costs: all direct manufacturing costs (labor&material)
7. Conversion costs: all manufacturing costs other than direct material costs.
direct labor costs + factory overhead costs
8. Idle time: wages paid for unproductive time caused by lack of orders, machine
breakdown, and material shortage. Considered overhead costs
9. Overtime premium: wage rate paid to workers in excess of their straight-time
wage rates, usually considered to be a part of indirect costs or overhead,
10. Product costs: sum of the costs assigned to a product or a specific purpose.

Operating Income equals total revenues from operations minus cost of goods sold
and operating costs or equivalently gross margin minus period costs.

Product costs are computed in different ways, because of pricing and product-mix
decisions, government contracts, and financial statements

The managers tasks are to understand why differences between actual and planned
performances arise and to use the information provided by these variances as
feedback to promote learnings and future improvements.

When making strategic decisions about which product to produce, managers must
know how revenues and costs vary with changes in output levels. For this purpose
managers need to distinguish fixed costs from variable costs.
Chapter 13

Strategy specifies how an organization matches its own capabilities with the
opportunities in the marketplace to accomplish its objective. In other words, how an
organization can create value for its customers while differentiating itself from its
competitors.

Industry analysis focuses on five forces:

Competitors
Potential entrants into the market
Equivalent products
Bargaining power of customers
Bargaining power of input suppliers

Product differentiation: an organizations ability to offer products or services

perceived by its customers to be superior and unique relative to the products or
services of its competitors.

Cost leadership: an organizations ability to achieve lower costs relative to

competitors through productivity and efficient improvements, eliminations of waste,
and tight cost control. Lower selling prices, rather than unique products or services,
provide a competitive advantage for these cost leaders.

Reengineering is the fundamental rethinking and redesign of business processes to

achieve improvements in critical measures of performance, such as cost, equality,
service, speed, and customer satisfaction.

The experience of many companies indicate that the benefits from reengineering are
most significant when it cuts across functional lines to focus on an entire business
process. Successful reengineering efforts focus on changing roles and
responsibilities, eliminating unnecessary activities and tasks, using information
technology, and developing employee skills.

The balance scorecard: translates an organizations mission and strategy into a set
of performance measures that provides the framework for implementing its strategy.
It measures an organizations performance from four perspectives:

1. Financial: evaluates the profitability of the strategy

2. Customer: identifies targeted customers and market segments and measures
the companys success in the segment.
3. Internal business processes: focuses on internal operations that create
value for customers that, in turn, help achieve financial performance.
a. Innovation process: Creating products, services, and processes that will
meet the customers needs (product differentiating strategy)
b. Operations process: Producing and delivering existing products and
services that will meet the needs of customers
c. Post sale service process: providing service and support to the
customer after the sale of a product or service.
 4. Learning and growth: Identifies the capabilities the organization must excel
at to achieve superior internal processes that create value for customers and
shareholders.

The goal of a balanced scorecard is to improve a companys overall financial

performance. Non-financial measures simply serve as leading indicators for the hard-
to-measure long run financial goals.

Companies frequently use balance scorecards to evaluate and reward managerial

performance and thereby influence a managers behavior

Features of a good balanced scorecard:

1. It tells the story of a companys strategy, articulating a sequence of cause-and-
effect relationship
2. Helps to communicate the strategy to all members of the organization by
translating the strategy into a coherent and linked set of understandable and
measurable operational targets.
3. In for profit companies, it should motivate managers to take actions that
eventually lead into improving financial performances.
4. Limits the number of measures , identifying only the most critical ones
5. Highlights less-than-optimal trade-offs that managers may make when they fail
to consider operational and financial measures together

Pitfalls in implementing a Balances scorecard

1. Managers should not assume the cause-and-effect linkages are precise, they
are merely hypothesis.
2. Managers should not seek improvements across all of the measures all the
time, not beyond a point where it gets too costly.
3. Managers should use both objective (operating income), and subjective
(customer and employee satisfaction ratings) measures in the balanced
scorecard, not only objective measures.
4. Top management should not ignore nonfinancial measures when evaluating
managers and other employees.

Managers and management accountants need to evaluate the success of a strategy

by linking the sources of operating income increases, to the strategy.
Management accountants analyze three main factors:
Growth components: measures the change in operating income attributable
solely to the change in the quantity of output sold.
The price recovery component: measures the change in output price
compared with changes in input price.
Productivity component: Measures the amount by which operating income
increases by using inputs efficiently to lower cost.

Chapter 4
Job costing system: In this system, the cost object is a unit or multiple units of a
distinct product or service called a job and accumulate costs separately for each
product or service.
Process costing system: In this system, the cost object is masses of identical or
similar units of a product or service and divides the total costs of producing by the
number of units produced to obtain a per-unit cost.
Actual costing is a system that traces direct costs to a cost object by using the
actual direct cost rates times the actual quantities of the direct cost inputs. It allocates
indirect costs based on actual indirect costs times the actual quantities of the cost
allocation base.
Normal costing is a costing system that traces direct costs to a cost object by using
the actual direct-cost rates times the actual quantities of the direct-cost inputs. It
allocates indirect costs based on the budgeted indirect-cost rates time the actual
quantities of the cost-allocation base.

General Approach to Job Costing

Step 1: Identify the job that is the chosen cost object
Step 2: Identify the direct costs of the job (Direct materials, Direct manufacturing
labour)
Step 3: Select the cost allocation bases to use for allocating indirect costs to the job
Step 4: Identify the indirect costs associated with each cost allocation base.
Step 5: Compute the rate per unit of each cost allocation base used to allocate
indirect costs to the job. For each cost pool, the actual indirect cost rate is calculated
by dividing actual total indirect costs in the pool by the actual total quantity of the cost
allocation base.
Step 6: Compute the indirect costs allocated to the job.
Step 7: Compute the total cost of the job by adding all direct and indirect costs
assigned to the job.
Budgeted Indirect Costs and End of Accounting Year adjustments
Underallocated indirect costs occur when the allocated amount of indirect costs in
an accounting period is less than the actual amount.
Overallocated costs occur when the allocated amount of indirect costs in an
accounting period is greater than the actual amount.
Chapter 5
Broad Averaging: Allocating overhead costs was simple: use broad averages to
allocate costs uniformly regardless of how they are actually incurred results in:
Product overcosting: A product consumes a low level of resources but is reported
to have a high cost per unit
Product undercosting: A product consumes a high level of resources but is reported
to have a low cost per unit
Product-Cost Cross-Subsidization means that if a company undercosts one of its
products, it will overcost at least one of its other products and other way around.
Simple Costing system using a single indirect cost pool
A refined costing system reduces the use of broad averages for assigning the cost
of resources to cost objects and provides better measurement of the costs of indirect
resources used by different cost objects.
There are three guidelines for refining a costing system:
1. Direct cost tracing: Classify as many of the total costs as direct costs as is
economically feasible.

2. Indirect cost pools: Expand the number of indirect cost pools until each of
these pools is more homogenous.
3. Cost allocation base: Use the cause-and-effect criterion, when possible, to
identify the cost-allocation base for each indirect-cost pool.

Activity based costing: Refines a costing system by identifying individual activities

as the fundamental cost objects.
In order to identify the costs of each activity the three guidelines (see above) need to
be applied.
Activity is an event, task, or unit of work with a specified purpose
Cost hierarchy: Categorizes various activity cost pools on the basis of different
types of cost drivers, or cost allocation basis or difficulty degrees in determining
cause and effect relationships.
Four levels of ABC:
1. Output unit level costs: Are the costs of activities performed on each individual
unit of a product or service.
2. Batch level costs: Are the costs of activities related to a group of units or
products or services rather than to each individual unit or service.
3. Product-sustaining costs: Are costs of activities undertaken to support
individual products or services regardless of the number of units or batches
in which the units are produced.
4. Facility-sustaining costs: Are the costs of activities that cannot be traced to
individual products or services but that support the organization as a whole.
There are three important facts when comparing costing systems:
1. ABC systems trace more costs as direct costs
2. ABC systems trace homogenous cost pools linked to different activities, and
3. For each activity cost pool, ABC systems seek a cost allocation base that has
a cause and effect relationship with costs in the cost pool.

Chapter 7
Management by exception is the practice of concentrating on areas not operating
as expected and giving less attention to areas operating as expected.
Variance is the difference between actual results and expected performance. The
expected performance is also called budgeted performance, which is a point of
reference for making comparisons.
Variances lie at the point where the planning and control functions of management
come together. They assist managers in implementing their strategies by enabling
management by exception.
Static budget or master budget is based on the level of output planned at the start of
the budget period.
Flexible budget calculates budgeted revenues and budgeted costs based on the
actual output in the budget period.
Static-budget variance is the difference between the actual result and the
corresponding budgeted amount in the static budget
Favorable variance has the effect, when considered in isolation, of increasing
operating income relative to the budgeted amount. Cost items: F means actual costs
are less than budgeted.
Unfavorable variance has the effect, when viewed in isolation, of decreasing
operating income relative to the budgeted amount. Cost items: U means actual costs
exceed budgeted costs.
A static budget can have two variances:

Flexible budget variance difference between actual result and flexible budget
amount
Sales-volume variance difference between flexible budget and static budget
amount

The flexible budget variance for revenues is called the selling price variance because
it arises solely from the difference between the actual selling price and the budgeted
selling price.

Price variance reflects the difference between an actual input price and a budgeted
input price.

Efficiency variance reflects the difference between an actual input quantity and a
budgeted input quantity.
To calculate price and efficiency variances, a company needs to obtain budgeted
input prices and budgeted input quantities. 3 main sources are:
1. Actual input data from past periods
2. Data from other companies that have similar processes
3. Standards developed by the company

Standard costing provides valuable information for the management and control of
materials, labor, and other activities related to production. A standard cost is a
carefully determined cost used as a benchmark for judging performance. The
purpose of a standard cost is to exclude past inefficiencies and to take into account
changes expected to occur in the budget period.

Management uses variances to evaluate performances after decisions are

implemented, to trigger organizational learning, and to make continuous
improvements. Variances serve as an early warning system to alert managers to
existing problems or to prospective opportunities.

Causes of variances
Poor design of products or processes
Poor work on the production line because of under skilled workers or faulty
machines
Inappropriate assignment of labor or machines to specific jobs
Congestion due to scheduling a large number of rush orders
Suppliers dont manufacture materials of uniformly high quality

Performance measurement using variances

Effectiveness: the degree to which a predetermined objective or target is met.
Efficiency: the relative amount of inputs used to achieve a given output level.

Benchmarking is the continuous process of comparing the levels of performance in

producing products and services and executing activities against the best level or
performance in competing companies or in companies having similar processes.
Benchmarking measures how well a company and its managers are doing in
comparison to other organizations.

Chapter 8

To effectively plan variable overhead costs for a product or service, managers must
eliminate the activities that do not add value to the product or service.

Planning fixed overhead costs is similar to effective planning for variable overhead
costs, but in planning fixed overhead costs there is one more strategic issue that
managers must take into consideration: choosing the appropriate level of capacity of
investment that will benefit the company in the long run. The one main difference
with variable overhead cost planning is timing. At the start of the budget period,
management will have made most of the decisions that determine the level of fixed
overhead costs to be incurred.
Standard costing is a costing system that traces direct costs to output produced by
multiplying the standard prices or rates by the standard quantity of inputs allowed for
actual outputs produced, and allocates overhead costs on the basis of the standard
overhead cost rates times the standard quantities of the allocation bases allowed for
the actual outputs produced.

Actual Costing Standard Costing

Direct costs Actual prices Standard prices
Actual inputs used Standard inputs allowed for actual
Indirect costs Actual indirect rate output
Standard indirect cost-allocation rate
Actual inputs used Standard quantity of cost-allocation
base allowed for actual output

Budgeted variable overhead cost allocation rates can be developed in 4 steps:

1. Choose the period to be used for the budget
2. Select the cost allocation bases to use in allocating variable overhead costs to
output produced
3. Identify the variable overhead costs associated with each cost allocation base
4. Compute the rate per unit of each cost allocation base used to allocate
variable overhead costs to output produced

The variable overhead flexible budget variance measures the difference between
actual variable overhead costs incurred and flexible budget variable overhead
amounts.

The variable overhead efficiency variance is the difference between actual

quantity of the cost allocation base used and budgeted quantity of the cost allocation
base that should have been used to produce the actual output, multiplied by
budgeted variable overhead cost per unit of the cost allocation base.

The variable overhead spending variance is the difference between actual variable
overhead cost per unit of the cost allocation base and the budgeted variable
overhead cost per unit of the cost allocation base, multiplied by the actual quantity of
variable overhead cost allocation base used for actual output.

Developing the budgeted fixed overhead cost allocation rate in 4 steps:

1. Choose the period to be used for the budget
2. Select the cost allocation bases to use in allocating fixed overhead cost to out
output produced
3. Identify the fixed overhead costs associated with each cost allocation base
4. Compute the rate per unit of each cost allocation base used to allocate fixed
overhead costs to output produced

The flexible budget amount for a fixed cost item is also the amount included in the
static budget prepared at the start of a period. There is no efficiency variance for
fixed overhead costs.
The fixed overhead flexible-budget variance is the difference between actual fixed
overhead costs and fixed overhead costs in the flexible budget.

The fixed overhead spending variance is the same amount as the fixed overhead
flexible budget variance.

The production volume variance arises only for fixed costs. This variance is the
difference between budgeted fixed overhead and fixed overhead allocated on the
basis of actual output produced.

VOC no production-volume variance

FOC no efficiency variance

See page 299 for overview

Chapter 15

Supporting (Service) Department provides the services that assist other internal
departments in the company

Operating (Production) Department directly adds value to a product or service

Single-rate method allocates costs in each cost pool (service department) to cost
objects (production departments) using the same rate per unit of a single allocation
base

Dual-Rate method segregates costs within each cost pool into two segments: a
variable-cost pool and a fixed-cost pool.

Direct method allocates support costs only to Operating Departments. No

Interaction between Support Departments prior to allocation
Step-down method allocates support costs to other support departments and to
operating departments that partially recognizes the mutual services provided among
all support departments. One-Way Interaction between Support Departments prior to
allocation
Common Cost the cost of operating a facility, activity, or like cost object that is
shared by two or more users at a lower cost than the individual cost of the activity to
each user

Chapter 17

The situations in which process-costing systems are appropriate are, when masses
of identical or similar units are produced
Process-costing systems separate costs into cost categories according to when
costs are introduced into the process.
Equivalent units a derived amount of output units that:
Takes the quantity of each input in units completed and in unfinished units of
work in process and
Converts the quantity of input into the amount of completed output units that
could be produced with that quantity of input

Weighted-Average Method
Calculates cost per equivalent unit of all work done to date (regardless of the
accounting period in which it was done)
Assigns this cost to equivalent units completed & transferred out of the
process, and to incomplete units in still in-process

First-in, First-out Method

Assigns the cost of the previous accounting periods equivalent units in
beginning work-in-process inventory to the first units completed and
transferred out of the process
Assigns the cost of equivalent units worked on during the current period first to
complete beginning inventory, next to start and complete new units, and lastly
to units in ending work-in-process inventory

Chapter 23

Return on Investment (ROI) is an accounting measure of income divided by an

accounting measure of investment
ROI = income/investment
RI = Income (RRR x Investment)
EVA = OI ( WACC(Current Assets-Current Liabilities))