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A. Cost Behavior in Management Accounting

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A. Cost Behavior in Management Accounting Overview Study Material Management Accounting for BE 2017-2018 A. Cost behavior in management accounting Financial accounting and managerial accounting differ from each other. The information financial accounting provides, is used by the outsiders, while managerial accounting is used by the insiders. Table 1: Financial accounting and managerial accounting. Financial Accounting Managerial Accounting Users Gives information to external Gives information to internal users. users. Use of General economic information. Information that can help plan, information direct and control business operations. Type of Global information that shows Detailed information about specific information the performance of the departments of the company. company. Regulations SEC – FASB – GAAP* Value-added principle. Characteristics Financial accounting information Managerial accounting information is objective, reliable and is timeliness and relevant. The focus consistent. The focus is on is on the future, therefore using less history, therefore using facts. facts and more estimates. Time of report At the end of a certain period, To plan, direct and control there is mostly a year. need for managerial accounting information to be reported continuously. *The securities and exchange commission (SEC) has been set up to protect the public interest. This commission regulates public financial reporting practices. SEC however, has left much of its authority to the private sector Financial accounting standards board (FASB). FASB works with a system, GAAP. GAAP provides guidelines for accounting procedures and practices. Cost Average cost per unit (cost per unit): The cost per each unit may differ. For some units to produce there is more need for labor, materials or tools than others. Average cost per unit = Total cost Units The costs that are necessary to produce are called product costs. Three different kinds of product cost: • Direct raw materials (to make products); • Direct labor (Necessary employees to make products); • Manufacturing overhead (other cost necessary to produce, such as equipment). Product cost on balance sheet The costs of producing a product aren’t considered as expenses. The product costs are paid with cash. This means that the asset account “cash” will decrease. The payments of these cash are transferred into products. These products are hold in the asset account finished good inventory. Facebook.com/SlimStuderenfeb 1 Overview Study Material Management Accounting for BE 2017-2018 What happens to the product costs if products are sold? When products are sold, the average cost of the products will be transferred. The inventory will decrease and the Cost of Goods Sold account on the income statement will increase. Costs that aren’t product costs, become expenses on the income statement. These cost are expensed in the period in which they occur. They are called period cost: • The materials that are used to make products are called raw materials. When it is easy to trace the cost of materials to the products, the cost of materials are called direct raw materials cost; • In labor there is a difference between administrative and selling employees and production employees. The wages of administrative and selling employees aren’t part of the production process and become directly an expense on the income statement. In contrast, the wages of the production employees are part of the production process. These wages become part of the inventory and eventually after the products are sold, they become part of Cost of Goods Sold; • Also, there exists a difference in overhead cost. The depreciation of the equipment that is not directly used to manufacture products, becomes a direct expense on the income statement. However, the depreciation of the manufacturing equipment is processed in inventory and eventually Costs of Goods Sold. If costs are not easy to trace to the product, they are called indirect costs. When these indirect costs are related to manufacture products, they are called manufacturing overhead (can include indirect materials, indirect labor, factory utilities, rent of manufacturing facilities, and depreciation on manufacturing assets). To allocate indirect cost to a product, the cost allocation method is used. Cost allocation is a process of dividing total cost into particular parts. For example: To produce a chair 2 hours of labor are required. To produce a table 6 hours of labor are required. The cost of producing for these 8 hours is $120. $120/8=$15 per hour, so a chair will require (2 x $15) $30 and a table will require (6 x $15) $90. Costs occur before and after production. The costs that occur before production are called upstream cost and costs that occur after production are called downstream cost (such as advertising and transportation). While these upstream and downstream costs are not part of the product cost, they are important for cost-plus pricing decisions. All costs must be covered to make profit. Different kinds of organizations There are three kinds of categories in which a business can be classified: • Service business (provides services); • Merchandise business (retail/wholesale companies: buy goods from other companies and sell them again); • Manufacturing business (make products and sell them). The difference between manufacturing and service organizations is that the product of the service organization is the product utilized at the moment the product is produced, while in manufacturing organizations the products will be hold in inventory after production until it is bought. Facebook.com/SlimStuderenfeb 2 Overview Study Material Management Accounting for BE 2017-2018 A merchandise organization can be seen as a service business, because the production cost these companies have, such as labor, arise from offering assistance to consumers. Holding inventory brings along cost, holding inventory cost, such as warehouse space, theft and damage. For this reason, many operate with a just in time (JIT) system, reduce inventory and in the meantime increase customer satisfaction by producing just in time for customer consumption. Opportunity cost is the cost of a lost opportunity. Position of management accountants The network between the board of directors, management, shareholders, auditors, and other stakeholders, is called corporate governance. The management accountants have the important job to assemble the information for the financial statements. These management accountants are assessed on the financial statements. Strong financial statements can raise their position, while weak financial statements can demote them. For this reason, management accountants can manipulate the financial statements, resulting in a scandal. Management accountants can manipulate the financial statements by classifying the cost in the wrong category. Instead of classifying costs as selling and administrative expenses, costs can be classified as product costs (or vice versa). Because product costs first include inventory, they aren’t expenses yet, but assets. Eventually the product cost will be expensed through Cost of Goods Sold when the products are sold. So, when half of the products are sold, half of the product costs are expensed, while other half is still in assets. However, non-product cost will be expensed immediately. In this case there will be more expenses, resulting in a lower income. Net income will only temporary be affected, because when all goods are sold, the same expenses will arise. However, this temporary effect has some other influence: • Availability of financing: when the financial statements are strong, more creditors are willing to invest; • Motivations of management: if managers will get a 10% of the net income as bonus, a higher net income is more favorable for them; • Timing of income tax payments: tax is paid over the net income, so for the tax payments a lower net income is more favorable. Ethics The Institute of Management Accountants has set up the ‘Statement of Ethical Professional Practice’ In this statement there are several rules and guidelines for ethical behavior. Furthermore, the management accountants should behave by the organizational code of ethics. How does fraud arise? • An opportunity is available: the company can prevent the availability of opportunities by internal controls. These internal controls consist of policies and procedures that reduce opportunities; • Pressure: someone who will get fired if the numbers are not getting better, is more likely to defraud; • Rationalization to justify wrong behavior: “Everybody does it”. Facebook.com/SlimStuderenfeb 3 Overview Study Material Management Accounting for BE 2017-2018 The fraud triangle After a couple of scandals the US government established a new law: the Sarbanes- Oxley (SOX) act: • The CEO and the CFO are responsible for the internal controls. These internal controls must be reported. External auditors must review these reports; • The CEO and the CFO are responsible for the content of the financial statements; • The management is required to set up a code of ethics and to make a report on this code; • It must be possible to report fraud anonymously and these whistleblowers cannot be punished for reporting fraud. Value chain Because of competition, many companies have to reengineer their system of production. For successful reengineering the system, benchmarking is necessary. Benchmarking involves studying the best-practices by competitors and imitate them. Best-practices consist of total quality management (TQM), activity-based management
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