MODULE 1 - UPDATES IN MANAGERIAL ACCOUNTING

SESSION TOPIC 1: MANAGEMENT ACCOUNTING

Management Accounting is the area of accounting managers which helps the management of the organization to formulate
policies, plan, and control the business operations.

Comparison of Financial Accounting Management Accounting

Definition Financial accounting is the system that The accounting system which provides
focuses on the preparation of the relevant information to the managers to
financial statements of the organization make decision involving policies, plans
and strategies of the business

Required This is required and mandatory Not mandatory

Focus information Information generally is monetary and Included in the reports are monetary
from past event and non-monetary information – and
may include future amounts

Objective To provide financial reports to external To assist the management in planning

users and decision making by giving detailed
information on various matters

Format In accordance with financial reporting No specific format, it will depend on the
standards needs and wants of the managers and
decision-makers

Users Primarily for external users For internal users

Reports Summarized and consolidated report Complete and detailed report, a

involving the general needs of the tailored-fit report, regarding various
external users information
Regularity The financial reports should be Internal reports are not required to be
published regularly, at least per annum published regularly, but it is according
to the need of the user.

Five Functions of management include:

(1) Planning

• Planning is future-oriented and determines an organization’s direction.

• It is a rational and systematic way of making decisions today that will affect the future of the company.
• It is a kind of organized foresight as well as corrective hindsight.
• It involves predicting of the future as well as attempting to control the events.
• It involves the ability to foresee the effects of current actions in the long run in the future.

Peter Drucker has defined planning as follows:

• “Planning is the continuous process of making present entrepreneurial decisions systematically and with best possible
knowledge of their futurity, organizing systematically the efforts needed to carry out these decisions and measuring the results
of these decisions against the expectations through organized and systematic feedback”.

An effective planning program incorporates the effect of both external as well as internal factors.

• The external factors are shortages of resources; both capital and material, general economic trend as far as interest rates and
inflation are concerned, dynamic technological advancements, increased governmental regulation regarding community
interests, unstable international political environments, etc.
• The internal factors that affect planning are limited growth opportunities due to saturation requiring diversification, changing
patterns of the workforce, more complex organizational structures, decentralization, etc.

(2) Organizing:

• Organizing requires a formal structure of authority and the direction and flow of such authority through which work
subdivisions are defined, arranged and coordinated so that each part relates to the other part in a united and coherent manner
so as to attain the prescribed objectives.
• According to Henry Fayol, “To organize a business is to provide it with everything useful or its functioning i.e. raw material,
tools, capital and personnel’s”.
• Thus the function of organizing involves the determination of activities that need to be done in order to reach the company
goals, assigning these activities to the proper personnel, and delegating the necessary authority to carry out these activities in
a coordinated and cohesive manner.

It follows, therefore, that THE FUNCTION OF ORGANIZING is concerned with:

• Identifying the tasks that must be performed and grouping them whenever necessary
• Assigning these tasks to the personnel while defining their authority and responsibility.
• Delegating this authority to these employees
• Establishing a relationship between authority and responsibility
• Coordinating these activities

(3) Staffing

• Staffing is the function of hiring and retaining a suitable work-force for the enterprise both at managerial as well as non-
managerial levels.
• It involves the process of recruiting, training, developing, compensating and evaluating employees and maintaining this
workforce with proper incentives and motivations.
• Since the human element is the most vital factor in the process of management, it is important to recruit the right
personnel.
• According to Kootz & O’Donnell, “Managerial function of staffing involves manning the organization structure through
the proper and effective selection, appraisal & development of personnel to fill the roles designed in the structure”.
• This function is even more critically important since people differ in their intelligence, knowledge, skills, experience, physical
condition, age and attitudes, and this complicates the function. Hence, management must understand, in addition to the
technical and operational competence, the sociological and psychological structure of the workforce.
(4) Directing

• The directing function is concerned with leadership, communication, motivation, and supervision so that the employees
perform their activities in the most efficient manner possible, in order to achieve the desired goals.
• The leadership element involves issuing of instructions and guiding the subordinates about procedures and methods.

(5) Controlling

• The function of control consists of those activities that are undertaken to ensure that the events do not deviate from the pre-
arranged plans.
• The activities consist of establishing standards for work performance, measuring performance and comparing it to these set
standards and taking corrective actions as and when needed, to correct any deviations.
• According to Koontz & O’Donnell, “Controlling is the measurement & correction of performance activities of subordinates
in order to make sure that the enterprise objectives and plans desired to obtain them as being accomplished”.

The controlling function involves:

a. Establishment of standard performance.

b. Measurement of actual performance.
c. Measuring actual performance with the pre-determined standard and finding out the deviations.
d. Taking corrective action.
• All these five functions of management are closely interrelated. However, these functions are highly indistinguishable and
virtually unrecognizable on the job. It is necessary, though, to put each function separately into focus and deal with it.
 Functions and Positions of Management Accountants:

Controllership vs Treasurership

• The management accountant, often referred to as

controller, is the manager of accounting information
used in planning, control and decision-making areas.
He is responsible for collecting, processing and
reports; g information that will help
managers/decision makers in their planning,
controlling and decision-making activities. He
participates in all accounting activities within the
organization.

Line vs. Staff Position:

The role and responsibility of a management
accountant is one of support. They provide help to
those managers who have primary responsibility to
fulfil basic mana-gerial functions.

• Positions that have direct responsibility for the basic objectives of an organization are known as line positions.
• Positions that are-supportive in nature and have only indirect responsi-bility for an organization’s basic objectives are called
staff positions.
• For instance, a manager of a production department holds a line position and has responsibility and authority to make
decisions concerning his department.
• The production manager and similar other managers holding line positions formulate policies and goals and make decisions
that have impact on production.
• The management accountant, however, has no authority over the production manager and other line positions managers.
• But since the management accountants have the responsibility of providing and interpret-ing accounting information, they
can have significant influence on the policies and decisions made by production and similar line managers.

Functions: Management accountants perform many vital responsibilities and functions within an organization such as:

i. Providing help in the design of an accounting information system.

ii. Collecting data.

iii. Helping in the maintenance of accounting records, preparation of financial statements.

iv. Helping in the budget preparation.

v. (v) Preparation of performance reports, control reports, special managerial reports/analyses for planning, control and decision-
making.

vi. Coordinating budget-making and report preparation activities.

vii. Interpreting accounting data based on the particular requirements of a manager in a given situation.

viii. Ensuring that the accounting information system is adequate and useful in accordance with the budgets, plans, polic ies and
decision requirements.

• The communication must be open both ways so that the information can be passed on to the subordinates and the feedback
received from them.
• Motivation is very important since highly motivated people show excellent performance with less direction from superiors.
• Supervising subordinates would lead to continuous progress reports as well as assure the superiors that the directions are
being properly carried out.

TOOLS OF MANAGEMENT ACCOUNTING

Management accounting employs various tools to forecast business trends, and may include the:

a) Ratios
b) Skills and ability to read and analyze financial statements
c) Management information systems (MIS)
d) Key performance indicators (KPIs)
e) Simulations
f) Financial modeling
g) Game theory
h) Balance scorecards, and any other set of data that the company can produce can be used to complete the analysis.

Cost Management

• Cost management systems are used a basic transaction reporting system and for external reporting.
• Cost management provide not only reliable financial reporting, but they also track costs tin order to provide information for
management decision making.
• The most important function of cost management is to help management focus on factors that make the firm successful.

As compared with management accounting:

Difference Cost Accounting Management Accounting

Inherent Meaning Cost accounting revolves around Management accounting helps

cost computation, cost control and management make effective decisions
cost reduction. about business.

Application Cost accounting prevents a Management accounting offers a big

business from incurring cost picture of how management should
beyond budget. strategize.

Scope Scope is much narrow Scope is much broader

Measuring grid Quantitative Both quantitative and qualitative

Sub-set Cost accounting is one of the many Management accounting itself is

sub-sets of management pretty vast.
accounting.

Basis of decision Historic information is basis of Historic and predictive information

making decision making are basis of decision making

Statutory Statutory audit of cost accounting Audit of management accounting has

requirement is a requirement in big business no statutory requirement.
houses.
 Dependence Cost accounting isn't dependent on Management accounting is dependent
management accounting to be on both cost and financial accounting
successfully implemented. for successful implementation.

Used for Management, shareholder and Only for management

vendors

CLASSIFICATION OF COSTS:

• Costs and expenses are similar terms but for differences under management accounting
• Cost is defined as resources given up achieving an objective.
• Expenses are costs that have been charged against revenue in a specific period.

• Cost is an economic concept while expenses is an accounting concept.

• A cost need not be an expense, but every expense was a cost before it become an expense.

DIRECT COSTS & INDIRECT COSTS

a) Direct costs
• are directly involved in producing goods.
• That means direct costs can be directly identified as being used in the production of goods. For example, we can talk about
direct material and direct labor that is used in producing goods. These costs we can identify as direct costs.

b) Indirect costs
• are costs that can’t be identified easily.
• The reason these costs can’t be identified separately because these costs assist in functioning multiple activities.
• For example, the renting business pays for running a production operation would be called indirect costs since we can’t
identify how much portion of the rent is used for the production of goods, how much is used for preparing the raw material,
how much is used to install the simulation systems that can train the workers.

Understanding these two types of costs is important since we would be using these costs in the computation of the cost of sales
per unit for a particular product.

FIXED COSTS, VARIABLE COSTS, & SEMI-VARIABLE COSTS

a) Fixed costs
• are costs that don’t change with the increase or decrease of production units.
• That means these costs remain similar within a broad range of the spectrum.
• Plus, the per-unit fixed cost changes as the production increases or decreases. For example, rent is a fixed cost. Even if the
production increases or decreases, the business needs to pay the same rent month in and month out.
b) Variable cost
• is the exact opposite of fixed cost. Variable cost changes as per the increase or decrease of production units. But even if the
total variable cost changes, per unit cost per unit, remain same irrespective of changes in production units. For example, the
cost of raw material is a variable cost. The total cost of raw material changes if the production increases or decreases. But the
per-unit cost of raw material remains the same even if the production increases or decreases.
c) Semi-variable costs
• both components are present.
• Semi-variable costs are a combination of fixed costs and variable costs.
• Let’s say that you pay $1000 per month as fixed salary to all your workers and the workers who produce more than 50 units
of toys every month, they get an additional $5 for every additional unit produced. This sort of wages will be called semi -
variable wages.

PRODUCTION VS PERIOD COSTS:

a. Product costs
• are also called inventoriable costs, are those costs that go directly into the production process, without which the product
could not be made.
• Product costs are “attached to each unit and will be carried on the balance sheet as inventory when production is completed.
• The main types of product cost are:
1. Direct materials, 2. Direct Labor and 3. Manufacturing Overhead. These different costs combined.

b. Period costs or nonmanufacturing overheads

• are costs for activities other than production costs of the product.
• Even if these costs were not incurred the product could still be manufactured. Period costs are usually expensed as they are
incurred.

IN ADDITION TO THE COSTS AND CLASSIFICATION STATE ABOVE, OTHER TYPES OF COSTS INCLUDE THE

Explicit Costs Or out-of-pocket costs, involved payment of cash and include wages and salaries,
office supplies, interest paid on loans, payments to vendors and so on.

Implicit Costs Or imputed costs, is a cost that does not involve any specific cash payment is not recorded
in accounting records.

Opportunity Costs Is an imputed costs, this is the cost of benefits foregone for not choosing the alternatives.

Carrying Costs Are the costs the company incurs when it holds inventory.

Sunk Costs Are costs that have already been incurred and cannot be recovered.

Committed Costs Are costs required to establish and maintain the readiness to do business

Discretionary Are costs that may or may not be spent, at the discretion of the manager
Costs

Marginal Costs Are the additional costs necessary to produce one more unit

Engineered Costs Are cost that have a definite physical relationship to the activity base or measure. They
result from activities that have well defined cause and effect relationships between inputs
and outs and between costs and benefits.

SUMMARY
• Management Accounting are of great significance, in fact, they help the organization in various ways. the management
accounting is helpful in analyzing the performance, making a strategy, taking an effective judgement and preparation of
policies for the future.

• Cost and management accounting have differences and similarities. Understanding costs and classification helps manager
in formulating business policies that promotes efficiency of the business.

MANAGEMENT ACCOUNTING (PPT)

Managerial Accounting (also called Management Accounting or Internal Accounting)
• a field of accounting that provides economic and financial information for internal users, particularly the managers or
decision-makers in an organization.

Management Functions:

1. Planning

2. Directing and Motivating

3. Controlling

Management Accounting vs. Financial Accounting

Where did they differ?

a) Users of report
b) Purpose
c) Types of reports
d) Standards of presentation
e) Reporting entity

STANDARDS OF ETHICAL CONDUCT FOR MANAGEMENT ACCOUNTANTS

1. COMPETENCE

Management accountants have the responsibility to:

• maintain an appropriate level of professional competence by ongoing development of their knowledge and skills.

• perform their professional duties in accordance with relevant laws, regulations and technical standards.

• prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information.

2. CONFIDENTIALITY

Management accountants have the responsibility to:

• refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally
obligated to do so.

• inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and
monitor their activities to assure the maintenance of that confidentiality.

• refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal
advantage either personally or through third parties.

3. INTEGRITY

Management accountants have the responsibility to:

• avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict.

• refrain from engaging in any activity that would prejudice their ability to carry out their duties ethically.

• refuse any gift, favor or hospitality that would influence or would appear to influence their actions.

• refrain from actively or passively subverting the attainment of the organization's legitimate and ethical objectives.
• recognize and communicate professional limitations or other constraints that would preclude responsible judgement or
successful performance of an activity.

• communicate unfavorable, as well as favorable information and professional judgements or opinions.

• refrain from engaging in or supporting any activity that would discredit the profession.

4. OBJECTIVITY

Management accountants have the responsibility to:

• communicate the information fairly and objectively.

• disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the
reports, comments and recommendations presented.

CONTROLLER: The Chief Management Accountant

Controller - the chief management accounting executive of an organization who is mainly responsible for the accounting aspects
of management planning and control.

Functions of the Controller:

• Planning for control

• Reporting and interpreting
• Evaluating and consulting
• Tax administration
• Government reporting
• Protection of assets
• Economic appraisal

Current Focus of Managerial Accounting

1. Customer value

2. Total Quality Management (TQM)

3. Just in Time (JIT)

4. Business Process Re-engineering (BPR)

5. Theory of Constraints (TOC)

6. Activity based costing (ABC)

7. Balance scorecard

8. Corporate social responsibility (CSR)

Customer Value

• the difference between what is received and given up by the customer when buying a product or service.

Value Chain

• the set of activities required to design, develop, produce, market and deliver products and services to customers.

Total Quality Management

• an approach to continuous improvement that focuses on serving customers and uses front-line workers to identify and solve
problems systematically.

Quality Costs

• cost incurred on quality related process; these are costs incurred to prevent defects, or incurred as a result of defects occurring.

1. Conformance costs

2. Non-conformance costs

Conformance Costs

• incurred to keep defective products from falling into the hands of customers.

a. Prevention costs - costs relating to any activity that reduces the number of defects in products and services.

Examples: quality training, quality engineering, systems development, statistical process control activities.

b. Appraisal costs - costs incurred in activities relating to inspection to make sure that the products/services meet quality
standards.

Examples: inspection/testing of incoming materials/ supplies, in-process-goods; maintenance of test equipment; process control
monitoring.

Non-Conformance Costs

• incurred because defects are produced despite efforts to prevent them.

a. Internal failure costs - result from identification/discovery of defects during the appraisal/inspection process.

Examples: cost of scrap/spoilage; rework costs; downtime caused by quality problems; disposal of defective products.

b. External failure costs - result when a defective product is delivered to a customer.

Examples: returned products; repair costs in the field; product liability lawsuits, warranty claims, service calls, lost sales arising
from a reputation for poor quality.

Just-in-time (JIT)

• What you need becomes available just in time you will use it.

JIT Purchasing

• raw materials are received just in time to go into production. For merchandising firms, goods for sale are received just in time
to be delivered to customers.

JIT Manufacturing

• manufactured parts are completed just in time to be assembled into the company's products, and products are
manufactured/completed just in time to be delivered to customers.

Business Process Re-engineering (BPR)

• redesigning or elimination of inefficient business process.

Business Process

• any series of steps that are followed to carry out some tasks or activities in a business organization.
PR Procedures

• a business process is diagrammed in detail, analyzed and then redesigned.

Objectives:

a) Simplification of the business process

b) Elimination of non-value-added activities
c) reduction of opportunities for errors
d) cost reduction

Theory of Constraints (TOC)

• states that a key to success is the effective management of constraint.

Constraint

• anything that prevents an individual or a business organization from getting more of what the individual or organization
wants; it prevents an individual or organization from achieving higher performance relative to its goal.
• TOC is a process of continuous improvement

Basic Steps:

1. Identify the constraint (may be internal or external)

2. Study the constraint and decide on how to exploit or overcome such limitation.

3. Prioritize effective management of the existing constraint

4. Introduce improvement into the system to break the constraint

MODULE 2 - UPDATES INMANAGERIAL ACCOUNTING

SESSION TOPIC 2: STANDARD COSTING

Introduction
One of the basic functions of management is to have control in a business unit or organization. Including in this control
is process of evaluating performance and correcting measures if required so that the organization will achieve its goal and
objective. Including in this control is the Standard costing – that aims to eliminate waste and increase efficiency of performance
by setting up standards.

Standard Costing
• The word ‘standard’ means a benchmark or gauge.
• The ‘standard cost’ is a predetermined cost which determines in advance what each product or service should cost under
given circumstances.
• For example, budget or plan for a single unit of a product or a service can be considered as the standard cost of the product
or service. A standard cost is developed for each component of product cost. In addition, each component consists of two
separate standards—a standard quantity (the budgeted amount of materials, labor, and overhead in a product) and a standard
price (budgeted price of the materials, labor, or overhead for each unit of input).

1. Standards can be determined in a couple of ways.

  Management can analyze historical cost and production data to determine how much materials and labor were used in
each unit of product and how much the materials and labor cost. Likewise, historical data can be used to determine the
amount of overhead costs incurred in producing a certain number of units.
 Task analysis, the other method, examines the production process to determine what it should cost to produce a product.
It typically involves time-and-motion studies to determine how much material should be used in a product, how long it
takes to perform certain labor tasks in manufacturing the product, how much electricity is consumed, and so on.
 Typically, some combination of task analysis and historical cost analysis will be used in determining standard costs.
2. Ideal versus Practical Standards
• The type of standard (practical or ideal) chosen to evaluate performance can have significant effects on employee morale and
behavior.

 An ideal standard is one that is attained only when near-perfect conditions are present. It assumes that every aspect of the
production process, from purchasing through shipment, is at peak efficiency. Some managers think ideal standards motivate
employees to achieve more while others argue that employees are discouraged by unattainable ideal standards.

 A practical standard should be attainable under normal, efficient operating conditions. It factors in machines break down
time, waste in materials, occasional below par work efficiency etc. Most managers agree that practical standards encourage
employees to be more positive and productive.

3. Use of Standards by Nonmanufacturing Organizations

• Standard costing applies to merchandising and service organizations as well.
• For example, Law firms have standards for the amount of time needed to prepare certain types of pleadings, appeals and
other related activities; salons and barbershops have standards for the time needed to make each services, and so on. The use
of standards is common in all types of businesses.

• Variable Manufacturing Cost Variances

1. Variable manufacturing cost variances
• generally classified into three components- direct material variances, direct labor variances, and variable overhead variances.

2. The Variance Analysis Model

• The direct material, direct labor, and variable overhead variances can be broken into their components (a price variance and a
usage, or quantity, variance), using the basic variance analysis model.
 Price Variance: The price variance is the difference between the actual quantity multiplied by the actual price (AQ × AP)
and the actual quantity multiplied by the standard price (AQ × SP). Simplifying, we have:
(AQ × AP) − (AQ × SP) = AQ (AP − SP)

The price variance is simply the difference in price multiplied by the actual quantity.

Key Formula
Price variance = Actual quantity (AQ) × [Actual price (AP) −
Standard price (SP)]
  Usage Variance:
• The usage variance is the difference between the actual quantity multiplied by the standard price (AQ × SP) and the standard
quantity multiplied by the standard price (SQ × SP). Simplifying, we have:
(AQ × SP) − (SQ × SP) = SP (AQ − SQ)

The usage variance is simply the difference in quantity multiplied by the standard price.

Key Formula
Usage variance = Standard price (SP) × [Actual quantity (AQ)
− Standard quantity (SQ)]

• Direct Material Variances:

Direct material variance can be broken into direct material price variance and direct material usage variance.

1. Direct Material Price Variance: The direct material price variance is calculated by multiplying the actual amount of material
purchased by the difference in the actual price paid and the standard, or budgeted, price per unit of direct material.

Key Formula
Direct Material Price Variance = Actual Quantity × (Actual Price − Standard Price)

 The direct material price variance is said to be favorable (unfavorable) when the actual price is less (more) than the standard
price.
 Possible reasons for a favorable price variance include taking advantage of unexpected quantity discounts or negotiating
reduced prices with suppliers.
 Unfavorable material price variances might result from rush orders (requiring faster delivery and higher prices), purchasing
in small lot sizes (and not taking advantage of quantity discounts), and purchasing higher quality materials than budgeted.
 Purchasing managers are often held responsible for material price variances.

2. Direct Material Usage Variance: The direct material usage variance is calculated by multiplying the standard price by the
difference in the actual quantity used and the standard quantity allowed. The standard quantity allowed is the amount of
direct material that should have been used to produce the actual output (the flexible budget amount).

Key Formula
Direct Material Usage Variance = Standard Price × (Actual Quantity − Standard Quantity)
  The direct material price variance is said to be favorable (unfavorable) when the actual quantity used is less (more) than
the standard quantity allowed.
 Favorable material usage variances are likely a result of highly efficient workers and well-maintained machinery and
equipment.
 Unfavorable material usage variances can be caused by a number of reasons: poorly trained workers, machine
breakdowns, or perhaps even the use of low quality materials if they result in more defective units, machine downti me,
rework, and so on.
 Production managers are held responsible for usage variances.

3. Direct Material Variances When Amount Purchased Differs from Amount Used
• If the amount of material purchased is not the same as the amount of material used in production, the variance model for
materials must be modified slightly.

 The price variance should be calculated by using the total amount of material purchased (not material used), whereas the
usage variance should be calculated on the basis of the amount of material actually used in production.
 Note that when the amount of material purchased is not equal to the amount of material used, the price and usage variances
should not be added together to calculate the total direct material variance.

Key Concept
Purchasing managers are often held responsible for price variances; production managers
are held responsible for usage variances.

• Direct Labor Variances

Direct labor variances are calculated with the same basic variance model used to calculate direct material variances.
However, we substitute rates for price (AR and SR instead of AP and SP) and hours for quantity (AH and SH instead of
AQ and SQ). In addition, the direct labor usage variance is often referred to as an efficiency variance.

Key Formulas
Direct Labor Rate Variance = Actual Hours × (Actual Rate − Standard Rate)
Direct Labor Efficiency Variance = Standard Rate × (Actual Hours − Standard Hours)
1. Hiring workers at a lower wage rate is one obvious reason for a favorable direct labor rate variance. However, that may be
problematic if the workers are less skilled than required.
2. Potential causes of unfavorable direct labor rate variances include the use of workers paid at a rate higher than budgeted,
unexpected increases in wages owing to union negotiations, and so on.
3. Favorable labor efficiency variances most often result from using highly skilled workers.
4. Potential causes of an unfavorable direct labor efficiency variance include poorly trained workers, machine breakdowns, the
use of poor quality raw materials (resulting in more time spent in production), or just general employee inefficiencies resulting
from poor supervision.
5. Personnel managers and production managers are often responsible for direct labor variances.

Key Concept
Personnel managers and production managers are often responsible for
direct labor variances.

• Variable Overhead Variances

With slight modifications, we can calculate variable overhead variances with the same variance model we used for direct
material and labor variances. Actual overhead cost is used instead of (AQ x AP) or (AH x AR). SR is the variable
predetermined overhead rate (sometimes called SVR). Because variable overhead was estimated with direct labor used as
the cost driver, AH is simply the actual number of labor hours incurred. Likewise, SH is the standard number of labor
hours allowed for actual production. (SH × SVR) is the amount of applied variable overhead. The price and usage variances
for variable overhead are called variable overhead spending variance, and variable overhead efficiency variance
respectively.

Key Formulas
Variable Overhead Spending Variance = Actual Overhead − (Actual Hours × Standard Variable Rate)
Variable Overhead Efficiency Variance = Standard Variable Rate × (Actual Hours − Standard Hours)

6. A spending variance for variable overhead indicates that the actual price of variable overhead items was more or less than
the flexible budget amount. However, it also gets affected by excessive usage of overhead caused by inefficient operations or
waste.
7. The variable overhead efficiency variance does not measure the efficient use of overhead at all; instead, it measures the
efficient use of the cost driver, or overhead allocation base that appears in the flexible budget.
8. The unfavorable variable overhead efficiency variance tells us simply that more direct labor hours were used than budgeted.
It does not tell us anything about the efficient use of electricity, supplies, or repairs and maintenance.
 Key Concept
The variable overhead efficiency variance does not measure the efficient use of overhead; instead, it
measures the efficient use of the cost driver, or overhead allocation base, that appears in the flexible
budget.

Fixed Overhead Variances

• Fixed overhead variances consist of a budget variance and a volume variance.
• The budget variance (or spending variance) is simply the difference between the amount of fixed overhead actually incurred
and the flexible budget amount.

Key Formula
Fixed overhead budget (spending) variance = Actual fixed overhead − Budgeted fixed overhead

The volume variance

• is the difference between the flexible budget amount and the amount of fixed overhead applied to products. Overhead is applied
by multiplying the predetermined overhead rate (for fixed overhead) by the number of standard hours (or budgeted hours)
allowed to complete the actual units produced.

Key Formula
Fixed overhead volume variance = Budgeted fixed overhead − Applied fixed overhead

 A company using variable (direct) costing rather than absorption (full) costing treats fixed overhead as a period cost and
expenses it immediately. In these companies, there will not be a fixed overhead volume variance, because fixed overhead
is not “applied” to products rather is simply expensed in the period incurred.
 The fixed overhead volume variance is calculated primarily as a method of reconciling the amount of overhead applied to
products under an absorption-costing system with the amount of overhead actually incurred—and, consequently, the over-
or underapplied overhead.
 The total amount of the variable overhead spending variance, variable overhead efficiency variance, fixed overhead
spending variance, and fixed overhead volume variance will equal the company’s over- or underapplied overhead for a
period.
 The fixed overhead volume variance generally should not be interpreted as favorable or unfavorable and should not be
interpreted as a measure of over or underutilization of facilities.
SUMMARY

• Standard costing set standards and enables to determine efficiency on the basis of standards and actual performance. The
standards are being constantly analyzed and an effort is made to improve efficiency. Whenever a variance occurs the reasons
are studied, and immediate corrective measures are undertaken.
• A summary of the variance formulas is as follows:
Variance Formula
Flexible Budget Variance Flexible Budget − Actual Results
Sales Price Variance Actual − Expected Sales Price) × Actual Volume
Direct Material Price Variance Actual Quantity × (Actual Price − Standard Price)
Direct Material Usage Variance Standard Price × (Actual Quantity − Standard Quantity)
Direct Labor Rate Variance Actual Hours × (Actual Rate − Standard Rate)
Direct Labor Efficiency Variance Standard Rate × (Actual Hours − Standard Hours)
Variable Overhead Spending Variance Actual Overhead − (Actual Hours × Standard Variable Rate)
Variable Overhead Efficiency Variance Standard Variable Rate × (Actual Hours − Standard Hours)
Fixed Overhead Spending Variance Actual Fixed Overhead − Budgeted Fixed Overhead
Fixed Overhead Volume Variance Budgeted Fixed Overhead − Applied Overhead

COST CONCEPT | PPT

Cost

• the monetary measure of the amount of resources given up or used for some purpose.

• the monetary value of goods and services expended to obtain current or future benefits.

COST TERMS USED IN MANAGERIAL ACCOUNTING

a) Cost Object
• anything for which cost is computed
• examples: product, product line, segment of the organization

b) Cost Driver
• any variable such as level of activity or volume that usually affects costs over a period of time.
• examples: production, sales, number of hours

c) Cost Pool
• a grouping of individual cost items; an account in which a variety of similar costs are accumulated.
• examples: work in process, factory overhead control

d) Activity
• an event, action, transaction, task or unit of work with a specified purpose.
i. Value Adding Activities
 ✓ activities that are necessary to produce the products
✓ example: assembling the components of the product
ii. Non-value Adding Activities
✓ activities that do not make the product or service more valuable to the customer
✓ example: moving materials and equipment parts from/to the stockroom or a workstation

CLASSIFICATION OF COSTS

• Costs may be classified into various categories as follows:

1. by Nature

2. by Variability

3. by Types of Inventory

4. according to Traceability to Cost Objective

5. according to Managerial influence

6. according to the generally accepted accounting treatment

7. Costs terminologies for planning and control

8. according to a Time-frame perspective

9. according to time period for which the cost is incurred

10. Costs classifications for other analytical purposes

COST CLASSIFIED BY FUNCTION

1. Manufacturing Costs – Manufacturing costs are frequently classified as direct materials, direct labor, and factory overhead.
Since costs attached to the products or groups of products as they are manufactured, expenditures, regardless of their nature,
usually are capitalized as inventory assets and do not become “expired costs” or “expenses” until the goods are sold.

a. Direct Materials – All raw materials that become an integral part of the finished product and that can be conveniently
and economically assigned to specific units manufactured.
b. Direct Labor – All labor costs related to time spent on products that can be conveniently and economically assigned to
specific units manufactured.
c. Factory Overhead – Indirect materials, indirect labor, property taxes, insurance, supervisor’s salaries, depreciation of
factory building and factory equipment, and power are examples of factor overhead.

2. Non-manufacturing costs – Include costs related to selling and other activities not related to the production of goods.

a. Marketing or Selling costs – all costs associated with marketing or selling a product, or all costs incurred by the
marketing division from the time the manufacturing process is completed until the product is delivered to the customer
or all costs necessary to secure customer orders and get the finished product or service into to hands of the customer;
also called order getting and order-filing costs.
b. General Administrative costs – all organizational and clerical costs associated with the general management of the
organization

3. Common costs – Costs that benefit two or more operations, products, or services. Thus, the electricity used to head a
building where several products are manufactured is a common cost.
COSTS CLASSIFIED BY VARIABILITY

1. Variable Costs – Costs that change directly in proportion to changes in activity (volume).
examples: direct labor and direct materials

2. Fixed Costs – Costs that remain unchanged for a given time period regardless of the change in activity (volume).
examples: rent, insurance on property, maintenance, and repairs of buildings, and depreciation of factory equipment

3. Mixed Costs – Costs that contain both fixed and variable elements.

COSTS CLASSIFIED BY TYPES OF INVENTORY

1. Raw Materials Inventory – the cost of all raw materials and production supplies that have been purchased but not used
at the end of the period.

2. Work-in-process Inventory – the cost associated with goods partially completed at the end of the period.

3. Finished Goods Inventory – the cost of completed goods that have not been sold at the end of the period.

TRACEABILITY TO COST OBJECTIVE

1. Direct costs (traceable; separable) – Costs that can be economically traced to a single cost object.

• Direct materials

• Direct labor

2. Indirect costs – costs that are not directly traceable to the cost object.

• Indirect materials

• Indirect labor

MANAGERIAL INFLUENCE

1. Controllable cost – Cost that is subject to significant influence by a particular manager within the time period under
consideration

2. Noncontrollable cost – Cost over which a given manager does not have a significant influence.

GENERALLY ACCEPTED ACCOUNTING TREATMENT

1. Product Costs – All costs that “attach” or “cling” to the units that are produced and are reported as assets until the goods
are sold.

2. Period Costs – A cost that must be charged against income in the period incurred an cannot be inventoried.

USED FOR PLANNING AND CONTROL

1. Standard Costs – A predetermined cost estimate that should be attained; usually expressed in terms of cost per unit.

2. Budgeted Cost – used to represent the expected/planned cost for a given period.

3. Absorption Costing – A costing method that includes all manufacturing costs – direct materials, direct labor and both
variable and fixed manufacturing overhead – in the cost of a unit of product. It is also referred to as the full cost method.
4. Direct Costing – a type of product costing where fixed costs are charged against revenue as incurred and are not assigned to
specific units of product. Also referred to a variable costing.

5. Information costs – Costs of obtaining information.

6. Ordering Costs – Costs that increase with the number of orders placed for inventory.

7. Out-of-pocket costs – Costs that must be met with a current expenditure or cash outlay.

TIME-FRAME PERSPECTIVE

1. Committed cost – Cost that is inevitable consequence of a previous commitment.

2. Discretionary Cost (programmed; management cost) – Cost for which the size or the time of incurrence is a matter of choice.

TIME PERIOD FOR WHICH THE COST IS INCURRED

1. Historical costs (past costs) – Costs that were incurred in a past period.

2. Future costs – Budgeted costs that are expected to be incurred in a future period.

OTHER ANALYTICAL PURPOSES

1. Relevant Costs – Future costs that are different under one decision alternative than under another decision alternative.

2. Differential Costs (Incremental/Decremental) – The difference in cost between two or more alternatives.

3. Sunk Costs – past costs that have been incurred and are irrelevant to a future decision.

4. Opportunity Costs – the value of the best alternative foregone as the result of selecting a different use of resource or by
choosing a particular strategy.

5. Marginal Costs – Costs associated with the next unit or the next project or incremental cost associated with an additional
project as opposed to the next discrete unit.

6. Value Added Costs – cost that add value to the product. These costs result from activities that are necessary to satisfy the
requirements of the customer.

COST ACCOUNTING

• a part of accounting system that measures costs for decision making and financial reporting purposes.

COST ACCOUNTING PROCESSES

1. Cost Accumulation - involves collecting costs by natural classification, such as materials or labor.

2. Cost Allocation or Cost Assignment - involves tracing and assigning costs to objects, such as departments or products.

COST ACCOUNTING SYSTEMS

1. Job Order Costing

• This product costing is used by firms that provide limited quantities of products or services unique to a customer's need or
specifications. Costs are assigned or traced to individual products.
• examples: automobile repair shops, tailoring/dress making business

2. Process Costing
• This system is used by firms that produce many units of a single product for long periods at a time.
• In this costing system, costs are accumulated in a particular operation or department for an entire period. The total cost
incurred in each operation or department is then divided by the total number of units produced to determine the average cost
per unit of product.
• examples: soft drinks company, toy manufacturers

3. Standard Costing

• This can be used with the other cost accounting systems, such as job-order costing and process costing.
• This costing method uses predetermined factors (quantity and price) to compute the standard cost of materials, labor, and
factory overhead, so that such costs may be assigned to the various inventory accounts and cost of goods sold.

4. Activity-Based Costing System

• This costing system is a two-stage procedure that uses multiple drivers to predict and allocate costs to products and services.

Stage 1 - Significant activities are identified and costs are assigned to activity cost pools based on the way resources are consumed
by such activities.

Stage 2 - Costs are allocated from each activity cost pool to each cost target (jobs, products, customers) in proportion to the
amount of cost driver consumed by the cost target.

ACTIVITY LEVELS

Type of Activity Levels

1. Unit level - activity that must be done for each unit of production. (inspection)

2. Batch level - performed for each batch of product produced, rather than each unit. (e.g., set up, material handling, packaging)

3. Product level - activities that are needed to support the entire product line regardless of the number of units and batches
produced. (e.g., product development cost)

4. Facility level - performed in order for the entire production process to occur. (e.g., plant maintenance, plant management,
DUYA, JUSTINE
property ERICKA
taxes andT.insurance)
BSBA - MA 401
ACTIVITY 2

Identification of Variable, Fixed and Semivariable Costs. Place a check mark in the
appropriate column to indicate whether the following costs are variable, fixed, or
semivariable.

ITEM Variable Fixed Semivariable

1. Small Tools
2. Patent amortization
3. Health and accident insurance
4. Heat, light, and power
5. Straight-line depreciation
6. Maintenance of buildings and grounds
7. Royalties
8. Materials handling
9. Property and liability insurance
10. Maintenance of factory equipment
DUYA, JUSTINE ERICKA T.
BSBA - MA 401
ACTIVITY 3

Classification of Cost: Place a check mark in the appropriate column to indicate the proper classification of each the following costs.

Other Indirect
Item
Indirect Material Indirect Labor Factory Costs Marketing Expenses Administrative Expenses
1. Factory heat, light, and power
2. Advertising
3. Wages of stockroom clerk
4. Freight out
5. Oil for machines
6. Salary of Vice president of human relations
7. Legal Expenses
8. Salary of the factory manager
9. Employer payroll taxes on controller's salary
10. Idle time due to assembly line breakdown

DUYA, JUSTINE ERICKA T.

BSBA - MA 401
ACTIVITY 4

Determination of per Unit Total Costs. The estimated unit costs for Hoteling Industries, when operating at a productionans sales
level of 10,000 units, are as follows:

Cost Item Estimated Unit Cost

Direct materials $ 15
Direct Labor 10
Variable factory overhead 8
Fixed factory overhead 5
Variable Marketing 4
Fixed Marketing 3

Required:
(1) Identify the estimated conversion cost per unit
(2) Identify the estimated prime cost per unit.
(3) Determine the estimated total variable cost per unit.

(1) Direct Labor $ 10.00

Variable factory overhead 8.00
Fixed factory overhead 5.00
CONVERSION COST PER UNIT $ 23.00

(2) Direct materials $ 15.00

Direct labor 10.00
PRIME COST PER UNIT $ 25.00

(3) Direct materials $ 15.00

Direct labor 10.00
Variable factory overhead 8.00
Variable Marketing 4.00
VARIABLE COST PER UNIT $ 37.00

COST-VOLUME-PROFIT (CVP) ANALYSIS - SINGLE PRODUCT

COST-VOLUME-PROFIT (CVP) ANALYSIS

• Is a powerful tool that helps managers understand the relationships among cost, volume, and profit.

• CVP analysis focuses on how profits are affected by the following five factors:

a) Selling prices.

b) Sales Volume.
 c) Unit variable costs.

d) Total fixed costs.

e) Mix of products sold.

• Because CVP analysis helps managers understand how profits are affected by these key factors, it is vital tool in many
business decisions.

• These decisions include what products and services to offer, what prices to charge, what marketing strategy to use, and what
cost structure to implement.

Contribution Margin

• The amount remaining from sales revenue after variable expenses have been deducted.

• It is the amount to cover fixed expenses and then to provide profits for the period.

• Contribution margin is used first to cover the fixed expenses, and then whatever remains goes toward profits. If the
contribution margin is not sufficient to cover the fixed expenses, then a loss occurs for the period.

Contribution Income Statement

Sales of 1 Speaker

Total Per Unit

Sales (1 speaker) P 250 P 250

Variable expenses 150 150

Contribution Margin 100 100

Fixed expenses 35,000

Net operating loss P (34,900)

CONTRIBUTION MARGIN AS A PERCENTAGE OF SALES

• It shows how the contribution margin will be affected by a change in total sales.

CM: SALES – VARIABLE EXPENSES

CM RATIO: CONTRIBUTION MARGIN/SALES

Contribution Income Statement

Sales of 1 Speaker
 Total Per Unit Percent of Sales

Sales (400 speakers) P 100,000 P 250 100%

Variable expenses 60,000 150 60%

Contribution Margin 40,000 100 40%

Fixed expenses 35,000

Net Income P 5,000

If this company plans a P 30,000 increase in sales during the coming month, the contribution margin should increase by P 12,000
(P 30,000 increase in sales x CM ratio of 40%).

Sales Volume

Present Expected Increase Percent of Sales

Sales (400 speakers) P 100,000 P 130,000 P 30,000 100%

Variable expenses 60,000 78,000* 18,000 60%

Contribution Margin 40,000 52,000 12,000 40%

Fixed expenses 35,000 35,000 0

Net operating income P 5,000 P 17,000 P 12,000

• P 130,000 expected sales / P 250 per unit = 520 units.

• 520 units x P 150 per unit = P 78,000

SOME APPLICATIONS OF CVP CONCEPTS

• Change in Fixed Cost and Sales Volume

The sales manager of Acoustic Concepts feels that a P 10,000 increase in the monthly advertising budget would increase monthly
sales by P 30,000 to a total of 520 units. Should the advertising budget be increased?
 Present Sales With Increase Percent of Sales
additional
advertising budget

Sales (400 speakers) P 100,000 P 130,000 P 30,000 100%

Variable expenses 60,000 78,000* 18,000 60%

Contribution Margin 40,000 52,000 12,000 40%

Fixed expenses 35,000 45,000** 10,000

Net operating income P 5,000 P 7,000 P 2,000

(loss)

• 520 units x P 150 per unit = P 78,000

• P 35,000 + additional P 10,000 monthly advertising budget = P 45,000.

BREAK-EVEN COMPUTATIONS

• Break-even point as the level of sales at which the company’s profit is zero.

• The break-even point can be computed using either the equation method or the contribution margin method – the two
methods are equivalent.

1. THE EQUATION METHOD

• Translates the contribution format income statement into equation form as follows:

a. Profits = (Sales – Variable expenses) – Fixed expenses

b. Sales = Variable expenses + Fixed expenses + Profits
BREAK-EVEN
Contribution Income Statement

Sales of 350 Speaker

Total Per Unit

Sales (350 speaker) P 87,500 P 250

Variable expenses 52,500 150

Contribution Margin 35,000 100

Fixed expenses 35,000

Break-even P (0)

2. THE CONTRIBUTION MARGIN METHOD

• Shortcut version of the equation method already described.

• BREAK-EVEN POINT in UNITS SOLD = FIXED EXPENSES/UNIT CM

• BREAK-EVEN POINT IN TOTAL SALES PESOS = FIXED EXPENSES/ CM RATIO
CONTRIBUTION MARGIN APPROACH
• UNIT SALES TO ATTAIN THE TARGET PROFIT = FIXED EXPENSES + TARGET PROFIT/UNIT CM

TARGET PROFIT
Contribution Income Statement

Sales of 750 Speaker

 Total Per Unit

Sales (750 speaker) P 187,500 P 250

Variable expenses 112,500 150

Contribution 75,000 100

Margin

Fixed expenses 35,000

Net income P 40,000

THE MARGIN OF SAFETY

• The excess of budgeted (or actual) sales peso over the break-even volume of sales peso. It is the amount by which sales can
drop before losses are incurred. The higher the margin of safety, the lower the risk of not breaking even and incurring a
loss.

• MARGIN OF SAFETY = TOTAL BUDGETED (OR ACTUAL) SALES –BREAK-EVEN SALES

• MARGIN OF SAFETY PERCENTAGE = MARGIN OF SAFETY IN PESOS / TOTAL BUDGETED (OR

ACTUAL) SALES IN PESO
Sales (at the current volume of 400 speakers) (a) P 100,000

Break-even sales (at 350 speakers) 87,500

Margin of safety (in peso) (b) P 12,500

Margin of safety as a percentage of sales, (b) / (a) 12.5%

• This margin of safety means that at the current level of sales and with the company’s current prices and cost structure, a
reduction in sales of P 12,500, or 12.5%, would result in just break-even.

OPERATING LEVERAGE
• A measure of how sensitive net operating income is to a given percentage change in peso sales.

• It acts as a multiplier. If operating leverage is high, a small percentage increase in sales can produce a much larger percentage
increase in net operating income.

• The degree of operating leverage is a measure, at a given level of sales, of how a percentage change in sales volume will affect
profits.

• DEGREE OF OPERATING LEVERAGE = CONTRIBUTION MARGIN/NET OPERATING INCOME

• If two companies have the same total revenue and same total expense but different cost structures, then the company with
the higher proportion of fixed costs in its cost structure will have higher operating leverage.

COST-VOLUME-PROFIT ANALYSIS - SALES MIX

Sales Mix
• refers to the relative proportions in which a company 's products are sold.

• CVP analysis is more complex with multiple products.

• The assumption is sales mix is expected to remain steady or constant.

TWO COMPLICATIONS ENCOUNTERED WHEN MULTIPLE PRODUCTS ARE SOLD BY COMPANIES:

1. Companies rarely sell exactly the same number of units of each product.

2. Most products differ in their selling price and variable cost per unit.

SALES MIX CAN BE STATED TWO DIFFERENT WAYS:

1. Sales Mix in Units

2. Sales Mix in Pesos

SALES MIX IN UNITS

• differs from sales mix in revenue pesos because both the selling price of products and the number of products sold differ.

The sales mix in units is:

8,000 : 6,000 >> 4 : 3 >> For every 4 units of Product A sold there is 3 units of Product B sold.

Product A:

8,000 / 14,000 = 57.14%

Product B:

6,000 / 14,000 = 42.86%

• Out of the 14,000 units sold 57.14% is composed of Product A and 42.86% is composed of Product B.

SALES MIX IN PESOS

The sales mix in pesos is:

48,000 : 66,000 >> 8 : 11 >> For every P8 revenue from Product A, there is P11 revenue from Product B.

Product A:

48,000 / 114,000 = 42.11%

Product B:

66,000 / 114,000 = 57.89%

• Out of the 114,000 revenue of the firm, 42.11% is from Product A while 57.89% is from Product B.

CONTRIBUTION MARGIN INCOME STATEMENT - MULTIPLE PRODUCT

Sweet Delicacies Inc.

Contribution Margin Income Statement

For the Month Ended September 31, 2013

Cakes (2,000u) Pies (6,000u) TOTAL (8,000u)

Unit Amount Percent Unit Amount Percent Amount Percent

Sales 12 24,000 100% 6 36,000 100% 60,000 100%

Variable 2.25 4,500 18.75% 1.8 10,800 30% 15,300 25.5%

Expenses

Contribution 9.25 19,500 81.25% 4.2 25,200 70% 44,700 74.5%

Margin

Fixed Cost 15,645

Net Income 29,055

WEIGHTED AVERAGE CONTRIBUTION MARGIN RATIO (WACMR)
Two ways to compute WACMR:

1. Total Contribution Margin / Total Sales

2. ∑(CMRn x Sales Mix Ratio in Pesosn)

1) WEIGHTED AVERAGE CONTRIBUTION MARGIN RATIO (WACMR) – METHOD 1

Cakes (2,000u) Pies (6,000u)

Unit Amount Percent Unit Amount Percent

Sales 12 24,000 100% 6 36,000 100%

Variable Expenses 2.25 4,500 18.75% 1.8 10,800 30%

Contribution Margin 9.25 19,500 81.25% 4.2 25,200 70%

WACMR = Total Contribution Margin / Total Sales

Total Contribution Margin = 19,500 + 25,200 = 44,700

Total Sales = 24,000 + 36,000 = 60,000

WACMR = 44,700 / 60,000 = 74.5%

 2) WEIGHTED AVERAGE CONTRIBUTION MARGIN RATIO (WACMR) – METHOD 2
Cakes (2,000u) Pies (6,000u)

Unit Amount Percent Unit Amount Percent

Sales 12 24,000 100% 6 36,000 100%

Variable Expenses 2.25 4,500 18.75% 1.8 10,800 30%

Contribution Margin 9.25 19,500 81.25% 4.2 25,200 70%

WACMR = ∑(CMRn x Sales Mix Ratio in Pesosn)

Product A: SMRP = 24,000 / 60,000 = 0.40

Product B: SMRP = 36,000 / 60,000 = 0.60

WACMR = (81.25% x 0.40) + (70% x 0.60)

= 74.5%

Example: *WACMR*
A company sells 3 products; Lipstick, Press Powder and Eyeliner which generated sales of 600,000 250,000 and 330,000
respectively. Also, its contribution margin ratios are 35%, 65% and 40% respectively. Find the weighted average contribution
margin ratio (WACMR) of the company' multiple products.

Method 1: WACMR = Total Contribution Margin / Total Sales

Total Contribution Margin:

= (600,000 * 35%) + (250,000 * 65%) + (330,000 * 40%)

= 210,000 + 162,500 + 132,000= 504,500

Total Sales:

600,000 + 250,000 + 330,000 = 1,180,000

WACMR: 504,500 / 1,180,000= 42.75%

Method 2: WACMR = ∑(CMRn x Sales Mix Ratio in Pesosn)

(35% * 600,000/1,180,000) + (65% * 250,000/1,180,000) + (40% * 330,000/1,180,000)

WACMR: 17.79% + 13.77% + 11.19% = 42.75%

WEIGHTED AVERAGE UNIT CONTRIBUTION MARGIN (WAUCM)

Two ways to Compute WAUCM:

1. Total Contribution Margin / Total Units

2. ∑ (UCMn x Sales Mix Ratio in Unitsn)

Cakes (2,000u) Pies (6,000u)

Unit Amount Percent Unit Amount Percent

Sales 12 24,000 100% 6 36,000 100%

Variable Expenses 2.25 4,500 18.75% 1.8 10,800 30%

Contribution Margin 9.25 19,500 81.25% 4.2 25,200 70%

1. WAUCM: Total Contribution Margin / Total Units

Total Contribution Margin: 19,500 + 25,200 = 44,700

Total Unit: 2,000 + 6,000 = 8,000

WAUCM = 44,700 / 8,000 = 5.5875

Cakes (2,000u) Pies (6,000u)

Unit Amount Percent Unit Amount Percent

Sales 12 24,000 100% 6 36,000 100%

Variable Expenses 2.25 4,500 18.75% 1.8 10,800 30%

Contribution Margin 9.25 19,500 81.25% 4.2 25,200 70%

2. WAUCM = ∑(UCMn x Sales Mix Ratio in Unitsn)

Product A: SMRU = 2,000 / 8,000 = 0.25

Product B: SMRU = 6,000 / 8,000 = 0.75

WAUCM = (9.75 * 0.25) + (4.2 * 0.75)

= 5.5875

Example: *WAUCM*
Alpha Mfg sells 2 products; ABC DVD and QRS TV which generated sales of P1,120,000 and P2,500,000 respectively. The
company sold 3,500 units of ABC DVD while 2,800 units for QRS TV. Also, its contribution margin ratios are 45% and 60%
respectively. Compute the weighted average unit contribution margin of Alpha Mfg products.

Method 1: WAUCM = Total Contribution Margin / Total Units

Total Contribution Margin:

(1,120,000 * 45%) + (2,500,000 * 60%) = 2,004,000

Total Units:

3,500 + 2,800 = 6,300 units

WAUCM: 2,004,000 / 6,300 = 318.10

Method 2: WAUCM = ∑(UCMn x Sales Mix Ratio in Unitsn)

UCM: Product A -> 504,000 / 3,500 = 144

Product B -> 1,500,000 / 2,800 = 531.71

WAUCM: (144 * 3,500/6,300) + (535.71 * 2,800/6,300)=318.10

BREAKEVEN POINT (MULTIPLE PRODUCT)
1. Breakeven Point in Pesos (BEP)

• Fixed Cost / WACMR

2. Breakeven Point in Units (BEU)

• Fixed Cost / WAUCM

BREAKEVEN POINT IN PESOS (BEP)

Cakes (2,000u) Pies (6,000u) TOTAL (8,000u)

Unit Amount Percent Unit Amount Percent Amount Percent

Sales 12 24,000 100% 6 36,000 100% 60,000 100%

Variable 2.25 4,500 18.75% 1.8 10,800 30% 15,300 25.5%

Expenses

Contribution 9.25 19,500 81.25% 4.2 25,200 70% 44,700 74.5%

Margin

Fixed Cost 15,645

Net Income 29,055

BEP: Fixed Cost / WACMR

Fixed Cost = 15,645

WACMR = 74.5%

BEP: 15,645 / 74.5% = 21,000

Distribution:

Cakes = 21,000 * 40% = 8,400

Pies = 21,000 * 60% = 12,600

BREAKEVEN POINT IN UNITS (BEU)

Cakes (2,000u) Pies (6,000u) TOTAL (8,000u)
 Unit Amount Percent Unit Amount Percent Amount Percent

Sales 12 24,000 100% 6 36,000 100% 60,000 100%

Variable 2.25 4,500 18.75% 1.8 10,800 30% 15,300 25.5%

Expenses

Contribution 9.25 19,500 81.25% 4.2 25,200 70% 44,700 74.5%

Margin

Fixed Cost 15,645

Net Income 29,055

BEU: Fixed Cost / WAUCM

Fixed Cost = 15,645

WAUCM = 5.5875

BEU: 15,645/5.5875 = 2,800u

Distribution:

Cakes = 2,800 * 25% = 700u

Pies = 2,800 * 75% = 2,100u

PROOF:
Cakes (700u) Pies (2,100u) TOTAL (2,800u)

Unit Amount Percent Unit Amount Percent Amount Percent

Sales 12 8,400 100% 6 12,600 100% 21,000 100%

Variable Expenses 2.25 1,575 18.75% 1.8 3,780 30% 5,355 25.5%

Contribution 9.25 6,825 81.25% 4.2 8,820 70% 15,645 74.5%

Margin

Fixed Cost 15,645

Net Income -0-

(BREAK-EVEN POINT IN PESOS) BEU: 2,800u

BEP: P21,000 Cakes = 700 units

Cakes = P8,400 Pies = 2,100 units

Pies = P12,600

(BREAK-EVEN POINT IN UNITS)

DETERMINING THE MARGIN OF SAFETY
1. Margin of Safety in Pesos

• Total Sales - Breakeven Sales

2. Margin of Safety in Units

• Total Units - Breakeven Units

3. Margin of Safety Ratio
• Breakeven Sales / Total Sales
• Breakeven Units / Total Units

MARGIN OF SAFETY IN PESOS (MSP)

Margin of Safety in Pesos MSP: 60,000 - 21,000 = 39,000

• Total Sales - Breakeven Sales Distribution:

Total Sales: 60,000 Cakes = 39,000 * 40% = 15,600

Breakeven Sales: 21,000 Pies = 39,000 * 60% = 23,400

ACTUAL Cakes (2,000u) Pies (6,000u) TOTAL (8,000u)

Unit Amount Percent Unit Amount Percent Amount Percent

Sales 12 24,000 100% 6 36,000 100% 60,000 100%

15,600 23,400
AT Cakes (700u) Pies (2,100u) TOTAL (2,800u)
BREAKEVEN

Unit Amount Percent Unit Amount Percent Amount Percent

Sales 12 8,400 100% 6 12,600 100% 21,000 100%

Margin of Safety in Units (MSU)

Margin of Safety in Units Total Units: 8,000

• Total Units - Breakeven Units Breakeven Units: 2,800

 Cakes = 5,200 * 25% = 1,300 u

ACTUAL Cakes Pies (6,000u) TOTAL Pies = 5,200 * 75% = 3,900 u

(2,000u) (8,000u)

1,300 3,900
MSP: 8,000 – 2,800 = 5,200

Distribution:

AT Cakes Pies TOTAL

BREAKEVEN (700u) (2,100u) (2,800u)

MARGIN OF SAFETY RATIO

• Breakeven Sales / Total Sales

• Breakeven Units / Total Units

EXAMPLE:

✓ BREAK-EVEN SALES/TOTAL SALES

Total Sales: 60,000

Breakeven Sales: 21,000

-> 21,000 / 60,000 = 35%

✓ BREAK-EVEN UNITS/TOTAL UNITS

Total Units: 8,000

Breakeven Units: 2,800

-> 2,800 / 8,000 = 35%

The sales or units sold by the company could decrease by 35% before the company will become unprofitable.

REQUIRED SALES IN UNITS WITH DESIRED PROFIT (RSU)

1. Before Tax
• RSU = (FC + DP) / WAUCM
2. After Tax
• RSU=(FC + (DP / 1 - TR) ) / WAUCM

EXAMPLE: REQUIRED SALES IN UNITS WITH DESIRED PROFIT (RSU) – B4 TAX

Before Tax

RSU = (FC + DP) / WAUCM

Fixed Cost = 15,645

Desired Profit = 29,055

WAUCM = 5.5875

RSU: (15,645 + 29,055) / 5.5875 = 8,000 units

Distribution:

Cakes = 8,000 * 25% = 2,000

Pies = 8,000 * 75% = 6,000

EXAMPLE: REQUIRED SALES IN UNITS WITH DESIRED PROFIT (RSU) – AFTER TAX

After Tax

-> RSU=(FC + (DP / 1 - TR) ) / WAUCM

Fixed Cost = 15,645

Desired Profit = 20,338.5

WAUCM = 5.5875

Tax rate = 30%

RSU: (15,645 + (20,338.5 / 1 - 0.30) ) / 5.5875 = 8,000units

Distribution:

Cakes=8,000 * 25%=2,000

Pies=8,000 * 75%=6,000

REQUIRED SALES IN PESOS WITH DESIRED PROFIT (RSP)

1. Before Tax

• RSP = (FC + DP) / WACMR

2. After Tax
• RSP=(FC + (DP / 1 - TR)) / WACMR

EXAMPLE: REQUIRED SALES IN PESOS WITH DESIRED PROFIT (RSP) – B4 TAX

Before Tax

-> RSP = (FC + DP) / WACMR

Fixed Cost = 15,645

Desired Profit = 29,055

WACMR = 74.5%

RSP: (15,645 + 29,055) / 74.5% = 60,000

Distribution:

Cakes = 60,000 * 40% = 24,000

Pies = 60,000 * 60% = 36,000

EXAMPLE: REQUIRED SALES IN PESOS WITH DESIRED PROFIT (RSP) – AFTER TAX

After Tax

-> RSP=(FC + (DP / 1 - TR) ) / WACMR

Fixed Cost=15,645

Desired Profit = 20,338.5

WACMR=74.5%

Tax Rate = 30%

RSP: (15,645 + (20,338.5 / 1 – 0.30) ) / 74.5% = 60,000

Distribution:

Cakes=60,000*40%=24,000

Pies=60,000*60%=36,000

ACTIVITY

Home Builders Inc.

Contribution Margin Income Statement
For the Month Ended July 31, 2013

Cement A (8,000u) Cement B (12,000u) TOTAL (20,000u)

Unit Amount Percent Unit Amount Percent Amount Percent
Sales 125 1,000,000 100% 110 1,320,000 100% 2,320,000 100%
Variable Expenses 65 520,000 52% 45 540,000 40.91% 1,060,000 45.69%
Contribution Margin 60 480,000 48% 65 780,000 59.09% 1,260,000 54.31%
Fixed Cost 845,000
Net Income 415,000
1.Find the Weighted Average Contribution Margin Ratio

2.Find the Weighted Average Unit Contribution Margin

3.Find the Breakeven Sales in Pesos

4.Find the Breakeven Sales in Units

1) WACMR = Total Contribution Margin / Total Sales

Total Contribution Margin ₱ 1,260,000.00
Total Sales 2,320,000.00
WACMR 54.31%

2) WAUCM = Total Contribution Margin / Total Units

Total Contribution Margin ₱ 1,260,000.00
Total Units 20,000.00
WAUCM 63
3) Break-even Sales in Pesos Distribution:
Fixed Cost ₱ 845,000.00 Cement A 43.10% ₱ 670,639.18
WACMR 54.31% Cement B 56.90% ₱ 885,243.72
Break-even Sales in Pesos ₱ 1,555,882.89

4) Break-even Sales in Units Distribution:

Fixed Cost 845,000 Cement A 40% 5,365.08
WAUCM 63 Cement B 60% 8,047.62
Break-even Sales in Units 13,412.70

Quiz 1
1. Madel Company Manufactures

1. 2022Answer: 22000
2. 2021 Answer: 22407
 3. Glareless Company manufactures

Answer: 97500
4. Claremont Company had is a manufacturer of its only one product line. It had sales of P400,000 for 2002
with a contribution margin ratio of 20 percent. Its margin of safety ratio was 10 percent. What are the
company’s fixed costs?
Answer: 72000
5. The Didang Company has an operating leverage of 2. Sales for 2001 are P2,000,000 with a contribution
margin of P1,000,000. Sales are expected to be P3,000,000 in 2002. Net income for 2002 can be expected to
increase by what amount over 2001?

Answer: 500000
6. Elvin Corporation manufactures and sells T-shirts inspired with college names and slogans. Last year, the
shirts sold for P7.50 each, and the variable expenses was P2.25 per unit. The company needed to sell 20,000
shirts to breakeven. The net operating income last year was P8,400. Elvin’s expectations for the coming year
include the following:
The selling price of the t-shirts would be P9.00
Variable expenses would increase by one-third.
Fixed expenses will increase by 10%.
The number of t-shirts Elvin Corporation must sell to breakeven in the coming year is:
Answer: 19250
7. Using no. 6,
Sales for the coming year are expected to exceed last years by 1,000 units. if this occurs, Elvin’s sales volume
in the coming year will be:
Answer: 22600
8. Using no. 6
If Elvin wishes to earn P22,500 in net operating income for the coming year, the company’s sales volume in pesos
must be:
 Answer: 207000
9. Using no. 6
The selling price needed next year to maintain the same contribution margin ratio as last year is:
Answer: 10
10. A company sells two products, X and Y. The sales mix consists of a composite unit of two units of X for
every five units of Y (2:5). Fixed costs are P49,500. The unit contribution margins for X and Y are P2.50
and P1.20, respectively. Considering the company as a whole, the number of composite units to break even
is
Answer: 4500
11. Using problem no. 10, if the company had a profit of $22,000, the unit sales must have been
Answer: 13000
12. Using problem no. 10, if the company had a profit of $22,000, the unit sales must have been
Answer: 32500

13. The Bruggs & Strutton Company

Answer: 20000
14. Using no. 13,
Calculate the break-even point in peso.
Answer: 800000
15. Using no. 13
Calculate the margin of safety.
 Answer: 800000
16. Using no. 13
Bruggs & Strutton received an order for 6,000 units at a price of P25.00. There will be no increase in fixed costs, but
variable costs will be reduced by P0.54 per unit because of cheaper packaging. Determine the projected increase or
decrease in profit from the order.
Answer: 20.46

Determine the impact of these operating changes (increase, decrease, no effect) on the item(s) noted.
17. An increase in the contribution margin on the break-even point.
Answer: Decrease
18. A decrease in the variable cost per unit on the sales volume needed to achieve Gladstone's $68,000 target net
profit.
Answer: Decrease
19. An increase in sales commissions on the break-even point and the contribution margin.
Answer: Decrease, Increase
20. A decrease in anticipated advertising outlays on fixed cost and the break-even point.
Answer: Decrease, Increase