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2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 1

Introduction to Management Accounting


2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 2

Introduction to Management Accounting

Chapter 2
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 3

Cost Drivers and Cost Behavior
Traditional View of Cost Behavior Activity-Based View of Cost Behavior
Resource A
Cost Driver =
Units of
Resource
Output
Resource B
Cost Driver =
Units of
Resource
Output
Activity A
Cost Driver =
Units of
Activity Output
Activity B
Cost Driver =
Units of
Activity Output
Resource B
Cost Driver =
Units of
Resource
Output
Resource A
Cost Driver =
Units of
Resource
Output
Product or Service
Cost Driver = Units of Final
Product or Service
Product or Service
Cost Driver = Output of Final
Product or Service
Learning
Objective 1
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 4

Cost Drivers and Cost Behavior
Cost behavior is how the activities
of an organization affect its costs.
Any output measure that causes
the use of costly resources
is a cost driver.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 5

Value Chain Functions, Costs, and Cost Drivers
Value Chain Function and Example Costs Example Cost Drivers
Research and development
Salaries marketing research personnel Number of new product proposals
costs of market surveys
Salaries of product and process engineers Complexity of proposed products

Design of products, services, and processes
Salaries of product and process engineers Number of engineering hours
Cost of computer-aided design equipment Number of parts per product
Cost to develop prototype of product
for testing
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 6

Value Chain Functions, Costs, and Cost Drivers
Value Chain Function and Example Costs Example Cost Drivers
Production
Labor wages Labor hours
Supervisory salaries Number of people supervised
Maintenance wages Number of mechanic hours
Depreciation of plant and machinery Number of machine hours
supplies
Energy cost Kilowatt hours

Marketing
Cost of advertisements Number of advertisements
Salaries of marketing personnel, Sales dollars
travel costs, entertainment costs
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 7

Value Chain Functions, Costs, and Cost Drivers
Value chain function and Example costs Example Cost Drivers
Distribution
Wages of shipping personnel Labor hours
Transportation costs including Weight of items delivered
depreciation of vehicles and fuel

Customer service
Salaries of service personnel Hours spent servicing
products
Costs of supplies, travel Number of service calls

2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 8

Variable and Fixed Cost Behavior
A variable cost
changes in direct
proportion to changes
in the cost-driver level.
A fixed cost is
not immediately
affected by changes
in the cost-driver.
Think of variable
costs on a per-unit basis.
The per-unit variable
cost remains unchanged
regardless of changes in
the cost-driver.
Think of fixed costs
on a total-cost basis.
Total fixed costs remain
unchanged regardless of
changes in the cost-driver.
Learning
Objective 2
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 9

Relevant Range
The relevant range is the limit
of cost-driver activity level within which a
specific relationship between costs
and the cost driver is valid.
Even within the relevant range, a fixed
cost remains fixed only over a given
period of time Usually the budget period.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 10

Fixed Costs and Relevant Range
20 40 60 80 100
$115,000
100,000
60,000
Total Cost-Driver Activity in Thousands
of Cases per Month
T
o
t
a
l

M
o
n
t
h
l
y

F
i
x
e
d

C
o
s
t
s

Relevant range
$115,000
100,000
60,000
20 40 60 80 100
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 11

CVP Scenario
Per Unit Percentage of Sales
Selling price $1.50 100%
Variable cost of each item 1.20 80
Selling price less variable cost $ .30 20%

Monthly fixed expenses:
Rent $3,000
Wages for replenishing and
servicing 13,500
Other fixed expenses 1,500
Total fixed expenses per month $ 18,000

Cost-volume-profit (CVP) analysis is the study of the effects of output
volume on revenue (sales), expenses (costs), and net income (net profit).
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 12

Break-Even Point
The break-even point is the level of sales at which
revenue equals expenses and net income is zero.
Sales
- Variable expenses
- Fixed expenses
Zero net income (break-even point)

Learning
Objective 3
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 13

Contribution Margin Method
$18,000 fixed costs $.30
= 60,000 units (break even)
Contribution margin
Per Unit
Selling price $1.50
Variable costs 1.20
Contribution margin $ .30
Contribution margin ratio
Per Unit %
Selling price 100
Variable costs .80
Contribution margin .20
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 14

Contribution Margin Method
$18,000 fixed costs
20% (contribution-margin percentage)
= $90,000 of sales to break even
60,000 units $1.50 = $90,000
in sales to break even
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 15

Equation Method
Sales variable expenses fixed expenses = net income
$1.50N $1.20N $18,000 = 0
$.30N = $18,000
N = $18,000 $.30
N = 60,000 Units
Let N = number of units
to be sold to break even.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 16

Equation Method
S .80S $18,000 = 0
.20S = $18,000
S = $18,000 .20
S = $90,000
Let S = sales in dollars
needed to break even.
Shortcut formulas:
Break-even volume in units = fixed expenses
unit contribution margin

Break-even volume in sales = fixed expenses
contribution margin ratio
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 17

Cost-Volume-Profit Graph
18,000
30,000
90,000
120,000
138,000
$150,000
0
10 20 30 40 50 60 70 80 90 100
Units (thousands)
D
o
l
l
a
r
s

60,000
Total
Expenses
Sales
Net Income Area
Break-Even Point
60,000 units
or $90,000
Net Loss
Area
A
C
D
B
Fixed Expenses
Variable
Expenses
Net Income
Learning
Objective 4
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 18

Target Net Profit
Managers use CVP analysis
to determine the total sales,
in units and dollars, needed
To reach a target net profit.
Target sales
variable expenses
fixed expenses
target net income
$1,440 per month
is the minimum
acceptable net income.
Learning
Objective 5
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 19

Target sales volume in units =
(Fixed expenses + Target net income)
Contribution margin per unit
($18,000 + $1,440) $.30 = 64,800 units
Target Net Profit
Selling price $1.50
Variable costs 1.20
Contribution margin per unit $ .30
Target sales dollars = sales price X sales volume in units
Target sales dollars = $1.50 X 64,800 units = $97,200.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 20

Sales volume in dollars = 18,000 + $1,440 = $97,200
.20
Target Net Profit
Target sales volume in dollars = Fixed expenses + target net income
contribution margin ratio
Contribution margin ratio
Per Unit %
Selling price 100
Variable costs .80
Contribution margin .20
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 21

Operating Leverage
Operating leverage: a firms ratio of fixed costs to variable costs.
Margin of safety = planned unit sales break-even sales
How far can sales fall below the planned level before losses occur?
Highly leveraged firms have high fixed costs and low variable costs.
A small change in sales volume = a large change in net income.
Low leveraged firms have lower fixed costs and higher variable costs.
Changes in sales volume will have a smaller effect on net income.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 22

Contribution Margin
and Gross Margin

Sales price Cost of goods sold = Gross margin

Sales price - all variable expenses = Contribution margin
Per Unit
Selling price $1.50
Variable costs (acquisition cost) 1.20
Contribution margin and
gross margin are equal $ .30
Learning
Objective 6
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 23

Contribution Margin and Gross Margin

Contribution Gross
Margin Margin
Per Unit Per Unit
Sales $1.50 $1.50
Acquisition cost of unit sold 1.20 1.20
Variable commission .12
Total variable expense $1.32
Contribution margin .18
Gross margin $.30

Suppose the firm had to pay a commission of $.12 per unit sold.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 24

Nonprofit Application
Suppose a city has a $100,000
lump-sum budget appropriation
to conduct a counseling program.
Variable costs per prescription
is $400 per patient per day.
Fixed costs are $60,000 in the
relevant range of 50 to 150 patients.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 25

If the city spends the entire budget
appropriation, how many patients
can it serve in a year?
$100,000 = $400N + $60,000
$400N = $100,000 $60,000
N = $40,000 $400
N = 100 patients
Nonprofit Application
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 26

Nonprofit Application
If the city cuts the total budget
Appropriation by 10%, how many
Patients can it serve in a year?
$90,000 = $400N + $60,000
$400N = $90,000 $60,000
N = $30,000 $400
N = 75 patients
Budget after 10% Cut
$100,000 X (1 - .1) = $90,000
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 27

Sales Mix Analysis
Sales mix is the relative proportions or
combinations of quantities of products
that comprise total sales.
Learning
Objective 7
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 28

Sales Mix Analysis
Ramos Company Example
Sales in units 300,000 75,000 375,000
Sales @ $8 and $5 $2,400,000 $375,000 $2,775,000
Variable expenses
@ $7 and $3 2,100,000 225,000 2,325,000
Contribution margins
@ $1 and $2 $ 300,000 $150,000 $ 450,000
Fixed expenses 180,000
Net income $ 270,000
Wallets
(W)
Key Cases
(K) Total
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 29

Sales Mix Analysis
Break-even point for a constant sales mix
of 4 units of W for every unit of K.
sales variable expenses - fixed expenses = zero net income
[$8(4K) + $5(K)] [$7(4K) + $3(K)] $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 0
6K = 180,000
K = 30,000
W = 4K = 120,000
Let K = number of units of K to break even, and
4K = number of units of W to break even.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 30

Sales Mix Analysis
If the company sells only key cases:
break-even point = fixed expenses
contribution margin per unit
= $180,000
$2
= 90,000 key cases
If the company sells only wallets:
break-even point = fixed expenses
contribution margin per unit
= $180,000
$1
= 180,000 wallets
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 31

Sales Mix Analysis
Suppose total sales
were equal to the
budget of 375,000 units.
However, Ramos sold
only 50,000 key cases
And 325,000 wallets.
What is net income?
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 32

Sales Mix Analysis
Ramos Company Example
Sales in units 325,000 50,000 375,000
Sales @ $8 and $5 $2,600,000 $250,000 $2,850,000
Variable expenses
@ $7 and $3 2,275,000 150,000 2,425,000
Contribution margins
@ $1 and $2 $ 325,000 $100,000 $ 425,000
Fixed expenses 180,000
Net income $ 245,000
Wallets
(W)
Key Cases
(K) Total
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 33

Impact of Income Taxes
Suppose that a company earns
$480 before taxes and pays
income tax at a rate of 40%.
What is the after-tax income?
Learning
Objective 8
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 34

Impact of Income Taxes
Target income before taxes = Target after-tax net income
1 tax rate
Target income before taxes = $ 288 = $480
1 0.40
Suppose the target net income
after taxes was $288.
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 35

Impact of Income Taxes
Target sales Variable expenses Fixed expenses
= Target after-tax net income (1 tax rate)
$.50N $.40N $6,000 = $288 (1 0.40)
$.10N = $6,000 + ($288/.6)
$.06N = $3,600 + $288 = $3,888
N = $3,888/$.06
N = 64,800 units
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 36

Impact of Income Taxes
Suppose target net income after taxes was $480
$.50N $.40N $6,000 = $480 (1 0.40)
$.10N = $6,000 + ($480/.6)
$.06N = $3,600 + $480 = $4080
N = $4,080 $.06
N = 68,000 units
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 37

End of Chapter 2
The End