COO – FORM 12

SUBJECT TITLE: MANAGEMENT ACCOUNTING 1

INSTRUCTOR: ANNA MARIE VILLAMOR-GALFO, CPA
SUBJECT CODE: PFE3-MA1

PRELIM MODULE

TOPIC 1: INTRODUCTION TO MANAGEMENT ACCOUNTING

LEARNING OBJECTIVES:

At the end of this topic, the students would be able to:

1. Define what is management accounting.

2. Evaluate the objectives, scope, functions, and limitations of management accounting.
3. Differentiate managerial accounting from financial accounting.
4. Describe what is a management accountant and what are its functions.
5. Enumerate the stages in a management process.
6. Understand the importance of upholding ethical standards

NOTES:

A. OBJECTIVES, ROLE AND SCOPE OF MANAGEMENT ACCOUNTING

 Definition of Management Accounting

Management Accounting may be defined as “the presentation of accounting information in

such a way as to assist the management in the creation of the policy and day-to-day operation
of an undertaking” – Management Accounting of the Anglo-American to productivity.

The Institute of Chartered Accountants of England has defined it –

“Any form of accounting which enables a business to be conducted more efficiently can be
regarded as Management Accounting”.

Robert N. Anthony has defined Management Accounting as follows-

“Management Accounting is concerned with accounting information that is useful to
management.”

According to American Accounting Association, “Management Accounting includes the

methods and concepts necessary for effective planning for, choosing among alternative
business actions and for control through the evaluation and interpretation of performance”.
This definition is fairly illustrative.

According to Kohler, Forward Accounting includes “Standard costs, budgeted costs and
revenues, estimates of cash requirements, break even charts and projected financial

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statements and the various studies required for their estimation, also the internal controls
regulating and safeguarding future operating.”

Blending together into a coherent whole financial accounting, cost accounting and all aspects
of financial management”. He has used this term to include “the accounting methods, systems
and techniques which, coupled with special knowledge and ability, assist management in its
task of maximizing profits or minimizing losses.” – James Batty.

Thus all accounting which directly or indirectly providing effective tools to managers in
enterprises and government organizations lead to increase in productivity is “Management
Accounting.”

 Objectives of Management Accounting

The basic objective of Management Accounting is to assist the management in carrying out
its duties efficiently.

The objectives of Management Accounting are:

1. The compilation of plans and budgets covering all aspects of the business e.g.,
production, selling, distribution research and finance.
2. The systematic allocation of responsibilities for implementation of plans and budgets.
3. The organization for providing opportunities and facilities for performing
responsibilities.
4. The analysis of all transactions, financial and physical, to enable effective comparisons
to be made between the forecasts made and actual performance.
5. The presentations to management, at frequent intervals, of up-to-date information in
the form of operating statements.
6. The statistical interpretation of such statements in a manner which will be of utmost
assistance to management in planning future policy and operation.

To achieve the above objectives, Management Accounting employs three principles devices,
viz., -

1. Forward Looking Principle – basis on the past and all other available data, forecasting
the future and recommending wherever appropriate, the course of action for the future.

2. Target Setting Principle – fixation of an optimum target which is variously known as

standard, budget etc., and through continuous review ensuring that the target is achieved
or exceeded.

3. The Principle of Exception – instead of concentrating on voluminous masses of data,

Management Accounting concentrates on deviations from targets (which are usually
known as variances) and continuous and prompt analysis of the causes of these deviations
on which to base management action.

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  Scope of Management Accounting

The scope of Management Accounting is wide and broad based. It encompasses within its fold
a searching analysis and branches of business operations. However, the following facets of
Management Accounting indicate the scope of the subject.

1. Financial Accounting.
2. Cost Accounting
3. Budgeting & Forecasting
4. Cost Control Procedure
5. Statistical Methods
6. Legal Provisions
7. Organization & Methods

1. Financial Accounting: This includes recording of external transactions covering receipts

and payments of cash, recording of inventory and sales and recognition of liabilities and
setting up of receivables. It also preparation of regular financial statements. Without a
properly designed accounting system, management cannot obtain full control and co-
ordination.
2. Cost Accounting: It acts as a supplement to financial accounting. It is concerned with
the application of cost to job, product, process and operation. It plays an important role
in assisting the management in the creation of policy and the operation of undertaking.

3. Budgeting & Forecasting: These are concerned with the preparation of fixed and
flexible budgets, cash forecast, profit and loss forecasts etc., in co-operation with
operating and other departments. Management is helped by them.

4. Cost Control Procedure: It is concerned with the establishment and operation of

internal report in order to convert the budget in to operating service. Management is
helped by them by measuring actual results budgetary standards of performance.

5. Statistical Methods: These are concerned with generating statistical and analytical
information in the form of graphs charts etc. of all department of the organization.
Management need not waste time in understanding the facts and more time and energy
can be utilized in sound plans and conclusions.

6. Legal Provisions: Many management decisions depend upon the provisions of various
laws and statutory requirements. For example, the decision to make a fresh issue of
shares depends upon the permission of controller of capital issues. Similarly, the form of
published accounts, the external audit the authority to float loans, the computation and
verification of income, filing tax returns, making tax payments for excise, sales, payroll
income etc., all depend on various rules and regulations passes from time to time.

7. Organization & Methods: They deal with organization, reducing the cost and improving
the efficiency of accounting as also of office operations, including the preparation and
issuance of accounting and other manuals, where these will prove useful.

It is clear that Management Accounting has a vital relation with all those areas explained
above.

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B. BASIC MANAGEMENT FUNCTIONS AND CONCEPTS

 Functions of Management Accounting

The functions of management accounting may be said to include all activities connected with
collecting, processing, interpreting and presenting information to management. The
Management Accounting satisfies the various needs of management for arriving at
appropriate business decisions. They may be described as follows:

1. Modification of Data:
Accounting data required for decision – making purposes is supplied by management
accounting through resort to a process of classification and combination which enables to
retrain similarities of details without eliminating the dissimilarities (e.g.) combination of
purchases for different months and their breakup according to class of product, type of
suppliers, days of purchase, territories etc.

2. Analysis & Interpretation of Data:

The data becomes more meaningful with the analysis and interpretation. For example, when
Profit and Loss account and Balance Sheet data are analyzed by means of comparative
statements, ratios and percentages, cash-flow-statements, it will open up new directions for
its use by management.

3. Facilitating Management Control:

Management Accounting enables all accounting efforts to be directed towards control of
destiny of an enterprise. The essential features in any system of control are the standards for
performance and measure of deviation therefrom. This is made possible through budgetary
control and standards costing which is an integral part of Management Accounting.

4. Formulation of Business Budgets:

One of the primary functions of management is planning. It is done by Management
Accounting through the process of budgeting. It involves the setting up of objectives and the
selection of the most appropriate strategies by comparing them with reference to some
discriminating criteria. Probability, Probability, forecasting, and trends are some of the
techniques used for this purpose.

5. Use of Qualitative Information:

Management accounting draws upon sources, other than accounting, for such information as
is not capable of being readily convertible into monetary terms. Statistical compilations,
engineering records and minutes of meeting are a few such sources of information.

6. Satisfaction of Informational Needs of Levels of Management:

It serves management as a whole according to its requirements it serves top middle and lower
level managerial needs to subserve their respective needs. For instance, it has a system of
processing accounting data in a way that yields concise information covering the entire field
of business activities at relatively long intervals for the top management, technical data for
specialized personnel regularly and detailed figures relating to a particular sphere of activity
at short intervals for those at lower rungs of organizational ladder.

The gist of Management Accounting can be expressed thus, it is a part of overall managerial
activity – not something grafted on to it from outside – guiding and servicing management
as a body, to derive the best return from its resources, both the itself and for the super system
within which it functions.

From the above discussions, one may come to the following conclusions about the
fundamental approach in Management Accounting.

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Firstly, the Management Accounting functions is a managerial activity and it puts its finger in
very pie without itself making them it guides and aids setting of objectives, planning
coordinating, controlling etc. But it does not itself perform these functions.

Secondly it serves management as a whole – top middle and lower level – according to its
requirements. But in doing so it never fails in keeping in focus the macro-approach to the
business as a whole.

Thirdly, it brings in the concept of cost-benefits analysis. The basic approach is to split all
costs and benefits into two groups – measurable and non-measurable. It is easy to deal with
measurable costs which are expressed in terms of money. But there are several ventures
such as office canteens where the cost-benefits may not be monetarily measurable.

 Limitations of Management Accounting

Comparatively, Management Accounting is a new discipline and is still very much in a state
of evolution. Therefore, it comes across the same impediments as a relatively new discipline
has to face-sharpening of analytical tools and improvement of techniques creating uncertainty
about their applications.

1. There is always a temptation to make an easy course of arriving at decision to intuition

rather than taking the difficulty of scientific decision-making.
2. It derives its information from financial accounting, cost accounting and other records.
Therefore, strength and weakness of Management Accounting depends upon the strength
and weakness of basic records.
3. It is one thing to record, interpret and evaluate an objectives historical event converted
into money figures, while it is something quite different to perform the same function in
respect of post possibilities, future opportunities and unquantifiable situation. Execution
of the conclusions drawn by the management accountant will not occur automatically.
Therefore, a continuous effort to achieve the goal must be made at all levels of
management.
4. Management Accounting will not replace the management and administration. It is only
a tool of management. Of course, it will save the management from being immersed in
accounting routine and process the data and put before the management the facts
deviating from the standard in order to enable the management to take decisions by the
rule of exception.

Managerial Accounting in the Management Process

As a staff department, managerial accounting supports management and the management

process. The management process has the following five basics:

1. Planning 4. Improving
2. Directing 5. Decision making
3. Controlling

Planning Management uses planning in developing the company’s objectives (goals) and
translating these objectives into courses of action. For example, a company may set an
objective to increase market share by 15 percent by introducing three new products. The
actions to achieve this objective might be as follows:
1. Increase the advertising budget
2. Open a new sales territory
3. Increase the research and development budget

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Planning may be classified as follows:
1. Strategic planning, which is developing long-term actions to achieve the company’s
objectives. These long-term actions are called strategies, which often involve periods of 5 to
10 years.
2. Operational planning, which develops short-term actions for managing the day-to-day
operations of the company.

Directing The process by which managers run day-to-day operations is called directing. An
example of directing is a production supervisor’s efforts to keep the production line moving
without interruption (downtime). A credit manager’s development of guidelines for assessing
the ability of potential customers to pay their bills is also an example of directing.

Controlling Monitoring operating results and comparing actual results with the expected
results is controlling. This feedback allows management to isolate areas for further
investigation and possible remedial action. It may also lead to revising future plans. This
philosophy of controlling by comparing actual and expected results is called management by
exception.

Improving Feedback is also used by managers to support continuous process improvement.

Continuous process improvement is the philosophy of continually improving employees,
business processes, and products. The objective of continuous improvement is to eliminate
the source of problems in a process. In this way, the right products (services) are delivered
in the right quantities at the right time.

Decision Making Inherent in each of the preceding management processes is decision

making. In managing a company, management must continually decide among alternative
actions. For example, in directing operations, managers must decide on an operating
structure, training procedures, and staffing of day-to-day operations.
NOTE: Decision making is inherent in all management functions.

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C. DISTINCTION AMONG MANAGEMENT ACCOUNTING, COST ACCOUNTING AND
FINANCIAL ACCOUNTING

Both management accounting and financial accounting assist decision makers by identifying,
measuring, and processing relevant information and communicating this information through
reports. Both provide managers with key measures of a company’s performance and with cost
information for valuing inventories on the balance sheet.

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THE MANAGEMENT ACOUNTANT

Management Accounting provides significant economic and financial data to the management
and the Management Accountant is the channel through which this information efficiently and
effectively flows to the management. The Management Accountant has a very significant role
to perform in the installation, development and functioning of an efficient and effective
management information system. He designs the framework of the financial and cost control
reports that provide each management level with the most useful data at the most appropriate
time.

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A. Functions of the Management Accountant

It is the duty of the management accountant to keep all levels of management informed of
their real position. He has, therefore, varied functions to perform. His important functions can
be summarized as follows:

(i) Planning: He has to establish, coordinate and administer as an integral part of

management, an adequate plan for the control of the operations. Such a plan would include
profit planning, programmes of capital investment and financing, sales forecasts, expenses
budgets and cost standards.

(ii) Controlling: He has to compare actual performance with operating plans and standards
and to report and interpret the results of operations to all levels of management and the
owners of the business. This is done through the compilation of appropriate accounting and
statistical records and reports.

(iii) Coordinating: He consults all segments of management responsible for policy or action.
Such consultation might concern any phase of the operation of the business having to do with
attainment of objectives and the effectiveness of the organizational structures and policies.

(iv) Other functions:

􀂾 He administers tax policies and procedures.

􀂾 He supervises and coordinated the preparation of reports to governmental agencies.
􀂾 He ensures fiscal protection for the assets of the business through adequate internal control
and proper insurance coverage.
􀂾 He carries out continuous appraisal economic and social forces and the government
influences, and interprets their effect on the business

In most companies, departments or similar organizational units are assigned responsibilities

for specific functions or activities. The operating structure of a company can be shown in an
organization chart.

The departments in a company can be viewed as having either of the following:

1. Line responsibilities
2. Staff responsibilities

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A line department is directly involved in providing goods or services to the customers of the
company.

A staff department provides services, assistance, and advice to the departments with line or
other staff responsibilities. A staff department has no direct authority over a line department.

As shown above, the chief financial officer (CFO) and the controller occupy staff positions. In
most companies, the controller is the chief management accountant. The controller’s staff
consists of a variety of other accountants who are responsible for specialized accounting
functions such as the following:

1. Systems and procedures 4. Special reports and analysis

2. General accounting 5. Taxes
3. Budgets and budget analysis 6. Cost accounting

B. Code of Conduct of Management Accountants

Members of IMA shall behave ethically. A commitment to ethical professional practice

includes: overarching principles that express our values, and standards that guide our
conduct.

PRINCIPLES
IMA’s overarching ethical principles include: Honesty, Fairness, Objectivity, and
Responsibility. Members shall act in accordance with these principles and shall encourage
others within their organizations to adhere to them.

STANDARDS
A member’s failure to comply with the following standards may result in disciplinary action.

I. COMPETENCE
Each member has a responsibility to:
1. Maintain an appropriate level of professional expertise by continually developing knowledge
and skills.
2. Perform professional duties in accordance with relevant laws, regulations, and technical
standards.
3. Provide decision support information and recommendations that are accurate, clear,
concise, and timely.
4. Recognize and communicate professional limitations or other constraints that would
preclude responsible judgment or successful performance of an activity.

II. CONFIDENTIALITY
Each member has a responsibility to:
1. Keep information confidential except when disclosure is authorized or legally required.
2. Inform all relevant parties regarding appropriate use of confidential information. Monitor
subordinates’ activities to ensure compliance.
3. Refrain from using confidential information for unethical or illegal advantage.

III. INTEGRITY
Each member has a responsibility to:
1. Mitigate actual conflicts of interest. Regularly communicate with business associates to
avoid apparent conflicts of interest. Advise all parties of any potential conflicts.
2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.
3. Abstain from engaging in or supporting any activity that might discredit the profession.

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IV. CREDIBILITY
Each member has a responsibility to:
1. Communicate information fairly and objectively.
2. Disclose all relevant information that could reasonably be expected to influence an intended
user’s understanding of the reports, analyses, or recommendations.
3. Disclose delays or deficiencies in information, timeliness, processing, or internal controls
in conformance with organization policy and/or applicable law.

C. Resolution of Ethical Conflict

In applying the Standards of Ethical Professional Practice, you may encounter problems
identifying unethical behavior or resolving an ethical conflict. When faced with ethical issues,
you should follow your organization’s established policies on the resolution of such conflict. If
these policies do not resolve the ethical conflict, you should consider the following courses of
action:

1. Discuss the issue with your immediate supervisor except when it appears that the
supervisor is involved. In that case, present the issue to the next level. If you cannot achieve
a satisfactory resolution, submit the issue to the next management level. If your immediate
superior is the chief executive officer or equivalent, the acceptable reviewing authority may
be a group such as the audit committee, executive committee, board of directors, board of
trustees, or owners. Contact with levels above the immediate superior should be initiated only
with your superior’s knowledge, assuming he or she is not involved. Communication of such
problems to authorities or individuals not employed or engaged by the organization is not
considered appropriate, unless you believe there is a clear violation of the law.

2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA Ethics
Counselor or other impartial advisor to obtain a better understanding of possible courses of
action.

3. Consult your own attorney as to legal obligations and rights concerning the ethical conflict.

D. ROLE AND ACTIVITIES OF CONTROLLER AND TREASURER

The Controller
The management accountant is an important member of the management team. In most
business organizations the chief management accountant is called the controller. The
controller is the chief management accounting executive of an organization who is mainly
responsible for the accounting aspects of management planning and control.

The controller is the executive manager responsible for a widely diverse set of activities.
Although they vary from organization to organization, the duties most frequently assigned to
the controller’s office include the following:

 Designing, installing, and maintaining the accounting system

 Preparing financial statements for external users
 Coordinating the development of the project
 Accumulating and analyzing cost data
 Preparing and analyzing performance reports
 Providing information for problem solving and special decisions
 Consulting with management about the meaning of accounting information
 Planning and administrating taxes
 Internal auditing

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  Designing, installing, and maintaining computer based information systems

The Treasurer
The treasurer is the officer responsible for money management and serves chiefly as the
custodian of the organization’s funds.

Typical duties of the treasurer include:

 Receiving, maintaining custody of, and disbursing monies and securities
 Investing the organization’s funds
 Directing the granting of credit
 Maintaining sources of short-term borrowing
 Establishing and maintaining a market for the organization’s debt and equity securities

Controller vs. the Treasurer’s Functions

CONTROLLER’S FUNCTIONS TREASURER’S FUNCTIONS
1. Planning and control 1. Provision of capital
2. Reporting and interpreting 2. Short-term financing
3. Evaluation and consulting 3. Banking and custody of funds
4. Tax administration 4. Credit and collections
5. Government reporting 5. Investor relations
6. Protection of assets 6. Investments
7. Economic appraisal 7. Insurance

NOTE: Generally, the above functions should NOT be combined on the same person.

Organization of the Controller’s Department

 Controllership is a staff function. It has the responsibility of providing line managers

and other staff members with specialized service including advice and help in
budgeting, controlling, pricing, and making special decisions. It does not exercise
direct authority over line departments.

 The controller’s department may be subdivided into the following sections:

 General/financial accounting
 Cost accounting
 Systems and procedures
 Internal auditing
 Budgeting
 Tax reporting
 Financial analysis

E. INTERNATIONAL CERTIFICATIONS IN MANAGEMENT ACCOUNTING

Numerous forms of certification are available to management accountants. We will briefly

describe three of the major types: a Certificate in Management Accounting, a Certificate in
Public Accounting, and a Certificate in Internal Auditing. Each certification offers particular
advantages to management accountant. In each case, an applicant must meet specific
educational and experience requirements and pass a qualifying examination to become
certified. Thus, all three certifications offer evidence that the holder has achieved a minimum
level of professional competence.

Furthermore, all three certifications require the holders to engage in continuing professional
education in order to maintain certification. Because certification reveals a commitment to

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professional competency, most organizations encourage their management accountants to
become certified.

The CPA

The Certificate in Public Accounting is the oldest and best known certification in accounting.
Its purpose is to provide minimal professional qualification for external auditors. The
responsibility of external auditors is to provide assurance concerning the reliability of a firm's
financial statements. A certified public accountant (CPA) is permitted (by law) to serve as an
external auditor. CPAs must pass a national examination and be licensed by the state in which
they practice. Although the Certificate in Public Accounting does not have a management
accounting orientation, it is held by many management accountants.

The CIA

The other certification available to internal accountants is the Certificate in Internal Auditing.
The forces that led to the creation of this certification in 1974 are similar to those that resulted
in the CMA. Internal auditing differs from external auditing and management accounting and
many internal auditors felt a need for a specialized certification. The certified internal auditor
(CIA) has passed a comprehensive exanimation designed to ensure technical competence and
has gained two years of experience.

The CMA

In 1974, the Institute of Management Accountants (IMA) sponsored a new certification called
the Certificate in Management Accounting. This certificate was designed to meet the specific
needs of management accountants. A certified management accountant (CMA) has passed a
rigorous qualifying examination, has met an experience requirement and participates in
continuing education.

One of the key requirements for obtaining the CMA is passing a qualifying examination. Four
areas are emphasized: (1) economics, finance, and management (2) financial accounting and
reporting; (3) management reporting. analysis, and behavioral issues; and (4) decision
analysis and information systems. The parts to the examination reflect the needs of
management accounting and underscored the earlier observation that management
accounting has more of an interdisciplinary flavor than other areas of accounting.

One of the main purposes of the CMA was to establish management accounting as a
recognized, professional discipline, separate from the profession of public accounting. Since
its inception, the CMA program has been very successful. Many firms now sponsor and pay
for classes that prepare their management accountants for the qualifying examination, as well
as provide other financial incentives to encourage acquisition of the CMA.

The CMA Program or Certificate in Management Accounting

The CMA Program or Certificate in Management Accounting is a program for management

accountants designed to recognize their unique qualifications, high standards, and
professional expertise in the field of management accounting.

Qualified management accountants earn the designation Certified Management Accountant

(CMA), the internal accountant’s counterpart to the Certified Public Accountants (CPA).

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The Organization Involved

In the United States, the CMA Program is conducted by the Institute of Management
Accountants (IMA), the largest US Professional organization of accountants.

In the Philippines, the Philippine Association of Management Accountants (PAMA) conducts

the Certificate in Management Accounting (CMA) through its continuing education arm, the
Philippine Institute of management Accountants (PIMA).

The PAMA is affiliated with the Institute of Management Accountants or IMA.

The PAMA was founded primarily to provide its members with professional and educational
activities that enhance their knowledge of management accounting principles and methods.

The Certified Management Accountant (CMA) qualification is available to both accountants

and non-accountants in managerial and executive positions, who are interested in gaining
advanced knowledge in strategic management information and performance reporting area.

Accountants who wish to obtain the CMA certification must take up two advanced
electives/subjects, namely Strategic Business Analysis and Strategic Cost Management.

Those without an accounting background, who are nevertheless interested in obtaining a

professional qualification in this field, will only be able to take up the two aforementioned
advanced electives/subjects after completing a conversion program, consisting of four (4)
coursework units, two of these being core subjects in the MBA.

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The four-coursework units are the following: Financial Statement Analysis, Management
Accounting, Financial Modelling, and Financial Management. Upon completion of the
conversion program, the participants will have to take up the two advanced units required to
all prior to certification.

F. GLOBAL TRENDS IN MANAGAMENT ACCOUNTING

Trend#1 - Expansion from product to channel and customer profitability analysis

The reporting of more accurate product and standard service-line cost and profitability
information using Activity-based costing (ABC) traces expenses into cost with resource and
activity drivers and provides much cost visibility that is traditionally hidden. Sadly, many
organizations continue to use a single indirect and shared expense “pool” that allocates
resource expenses into costs based on a single cost factor, which violates cost accounting’s
causality principle. The result is products and service-lines are simultaneously over- and
under-costing because allocations always have a zero sum error. It’s baffling how accountants
can accept this deficient practice when ABC is a better alternative.
Today customers view the offerings of suppliers in most industries as commodities. For
example, most banks offer similar checking and deposit services. Consequently, the
importance of services rises, which results in a shift from product-driven differentiation toward
service-driven differentiation to differentiated customer microsegments in order to gain a
competitive advantage.
The objective for the marketing and sales functions should no longer be solely about
increasing market share and growing sales but about growing profitable sales. That requires
tracing expenses below the product gross profit margin line, including channel distribution,
selling, marketing, and customer service costs to serve.
Trend number 1 is that management accounting must help the sales and marketing functions.
A company needs to know the best types of customers to retain, grow, win back, and acquire
– and those who aren’t.
Trend #2 – Management accounting’s expanding role with enterprise performance
management (EPM)
Enterprise performance management (EPM) can be defined as the integration of multiple
methods (such as strategy maps, balanced scorecard, performance measures, driver-based
budgeting, lean management, and customer relationship management) to achieve the
executive team’s strategy, improve control, and increase financial profits – all through making
better decisions. The output of a management accounting system is always the input to use
in gaining insights and managing activities and operations.
Trend number 2 is about integration. The various components of EPM are like gears in a
machine – they are interconnected.
Trend #3 – The shift to predictive accounting
A gap is widening between what management accountants report and what managers and
employee teams want. The gap is being caused by a shift in managers’ needs – from needing
to know what things cost (such as a product cost) and what happened to a greater need for
detailed information about what their future costs will be and why. The past reflects decisions
already made. Decisions that will be made are the ones that impact the future.
The value-add, utility, and usefulness of accounting information increases, arguably at an
exponential rate, as one shifts from financial accounting (i.e., for regulatory compliance) to
cost reporting to decision support with cost planning.
When the cost reporting shifts to decision support with cost planning, analysis shifts to
economic analysis. For example, one needs to understand the impact that changes will have
on future expenses, so the focus shifts to the needed changes in resources and their
capacities. This involves classifying the behavior of resource expenses as sunk, fixed, step-
fixed, semi-variable, variable, and discretionary with changes in service offerings, volumes,
mix, processes, and the like.

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Trend number 3 reveals a major transition from management accounting for reporting costs
and profits to managerial economics for decision support and analysis that impact the future.
Trend #4 – Business analytics imbedded in EPM methods
Business analytics and Big Data are hot topics. They are here to stay because complexity,
uncertainty, and volatility are on the rise. Today the need for analytics may be the only
sustainable long term competitive advantage. This is because the traditional generic
strategies, like being the lowest cost supplier or product or customer differentiation, are
vulnerable to agile competitors who can quickly match a supplier’s price or invade your
customer base.
Business analytics can generate questions, stimulate more complex and interesting questions,
and have the power to answer the questions.
Trend number 4 recognizes that progressive accounting functions now realize that
competency and capabilities with analytics provides a competitive edge.
Trend #5 – Co-existing and improved management accounting methods
There are debates in the management accounting community about what is the most
appropriate costing method. There can be rival camps such as lean accounting and activity-
based costing (ABC) advocates. The solution is accept having two or more co-existing
management accounting methods. There can be different costs for different purposes used
by different types of managers and employee teams.
Trend number 5 demonstrates that the more progressive CFOs and their management
accounting staff are considering the various needs of different types of managers in their
organization.
Trend #6 – Managing Information Technology and Shared Services as a Business
It is human nature that when something is free one doesn’t care how much one consumes
whatever the item or service may be. There is a trend toward using management accounting
for internal chargebacks (like an invoice) from internal service providers to service users.
Line-item IT charge back invoices create a service provider a market for pricing. This
information also serves for establishing what are effectively “transfer prices” based on cost
consumption rates for service level agreements (SLAs).
Trend number 6 is for management accounting to support internal IT and shared services to
be managed as a business.
Trend #7 – The need for better skills and competency with behavioral cost
management
An evolving trend is that activist management accountants, those who are promoting
progressive methods as described in the trends already mentioned, are encountering
obstacles to get buy-in and acceptance of their ideas. They are realizing they need to improve
their behavioral change management skills and capabilities.
Today’s primary barrier is no longer technical, such as “dirty data” and disparate data sources.
The barrier is social, behavioral and cultural. There are many examples of this type obstacle,
including people’s natural resistance to change; not wanting to be measured or held
accountable; fear of knowing the truth (or of someone else knowing it); reluctance to share
data or information; and “we don’t do that here.”
Trend number 7 requires change agent management accountants to motivate mid-level
managers and other “champions” to demonstrate to their co-workers that progressive
management accounting and EPM methodologies make sense to implement.

16 | P a g e
EXERCISES:

1. It is a field of accounting that provides financial information and nonfinancial information

to an organization's managers and other internal decision makers.

a. Cost accounting c. Managerial accounting

b. Bookkeeping d. Financial accounting

2. That type of accounting which deals with how accounting and other financial data can be
used for decision-making in controlling, monitoring and directing business activity is
called

a. Management accounting c. Financial accounting

b. Responsibility accounting d. General accounting

3. Which of the following statements is/are correct?

a. Managers carry out their planning function by mobilizing the organization's

resources and overseeing day-to-day operations.
b. Managers carry out their decision-making function by obtaining feedback to
ensure that the plans are being followed.
c. The planning, directing and motivating, and controlling functions of a manager
are kept separate from such manager's decision-making activities.
d. The manager's planning function involves setting of the organization's goals
and identifying alternatives and selecting the alternative that best furthers
such goals set for the organization.

4. Management accounting is used by a company’s management for a multitude of

purposes which are as follows, except

a. evaluation c. marketing
b. planning d. reporting

5. Management accounting includes the following processes, except

a. measurement c. interpretation
b. communication d. delegation

6. Controllers are ordinarily concerned with

a. investor relations.
b. credit extension and collection of bad debts.
c. short-term financing.
d. Preparation of tax returns.

7. The treasury function includes

a. preparation of tax returns c. reporting to government

b. cash custody and banking d. financial reporting

8. Provisions in this Section of Ethical Standards for Management Accountants forbid

management accountants to act on, or even appear to act on, confidential information
they acquire in doing their work, except when authorized or when legally obligated to do
so.

17 | P a g e
 a. Competence c. Integrity
b. Confidentiality d. Objectivity

9. Which of the following statements relating to Standards of Ethical Conduct for

Management Accountants is correct?

a. A management accountant should refuse all gifts and hospitality offered by one
of the company’s suppliers.
b. A management accountant should inform his superiors regarding the
confidentiality of information acquired in the course of their work and monitor
their activities to assure the maintenance of that confidentiality.
c. A management accountant should prepare complete and clear reports and
recommendations before appropriate analyses of relevant and reliable
information.
d. Management accountants have a responsibility to disclose fully all relevant
information that could reasonably expected to influence an intended user's
understanding of the reports, comments, and recommendations presented.

10. If a management accountant has a problem in resolving an ethical conflict, the first
action that should normally be taken is to

a. resign from the company.

b. notify the police.
c. discuss the problem with his/her immediate superior.
d. remain silent.

11. Statement 1: Managerial control and engineering control are synonymous.

Statement 2: Control from the viewpoint of management accounting is defined as the
process of setting maximum limits on financial expenditures.

a. True, True c. True, False

b. False, False d. False, True

12. In which of the following aspects is managerial accounting similar to financial accounting?

a. users of reports
b. emphasis between the past and future
c. type of data provided to users
d. reliance on the accounting database

13. Financial and managerial accounting differ in a number of ways. In contrast to financial
accounting, managerial accounting

a. focuses on providing data for external users.

b. emphasizes relevance and flexibility rather than precision.
c. is mandatory.
d. is governed by Generally Accepted Accounting Principles.

14. In comparing management and financial accounting, which of the following more
accurately describes management accounting information?

a. Comparable, verifiable, monetary

b. Budgeted, informative, adaptable
c. Required, estimated, internal
d. Historical, precise, useful

18 | P a g e
15. Which of the following statements is false?

a. Financial accounting reports are general-purpose and intended for external

users.
b. Managerial accounting reports are special-purpose and issued as frequently as
needed.
c. Top managers must certify that a company maintains an adequate system of
internal control.
d. Management accountants have a single role within an organization - collecting
and reporting costs to management.

16. Which of the following statements is true?

a. The management information system is part of an organization's accounting

system.
b. The cost accounting system is part of an organization's overall accounting
system.
c. Management accounting accumulates cost information for both cost accounting
and financial accounting.
d. Two primary hallmarks of cost and management accounting are
standardization of procedures and use of generally accepted accounting
principles.

17. One certification available to management accountants is the Certificate in Management

Accounting (CMA). In the Philippines, the Philippine Association of Management
Accountants (PAMA) conducts the CMA Program, which has the following objectives,
except:

a. to establish Management Accounting as a recognized profession in the field of

business.
b. to encourage stricter and high quality educational standards in Management
Accounting.
c. to provide objective means for measuring the Management Accountant's
knowledge and competence.
d. to supervise or coordinate the Management Accountant's preparation of
reports to government agencies.

- - - END OF TOPIC 1 - - -

19 | P a g e
TOPIC 2 COST TERMS, CONCEPTS AND BEHAVIOR

LEARNING OBJECTIVES:

At the end of this topic, the students would be able to:

1. Determine the nature and classification of costs.

2. Figure out how different costs behave.
3. Explain the different ways to split mixed costs.

NOTES:

A. NATURE AND CLASSIFICATION OF COSTS

I. AS TO TYPE

1. PRODUCT COST – cost incurred to manufacture the product

 Product costs of the units sold during the period are recognized as expense
(cost of goods sold) in the income statement.
 Product costs of the unsold units become the costs of inventory and treated as
asset in the balance sheet.

2. PERIOD COST – the non-manufacturing costs that include selling, administrative, and
research and development costs. These costs are expensed in the period of incurrence
and do not become part of the cost of inventory.

II. AS TO FUNCTION

1. MANUFACTURING COSTS – all the cost incurred in the factory to convert raw materials
into finished goods.
 Direct manufacturing costs – material and labor
 Indirect manufacturing costs – the manufacturing overhead or factory overhead
costs

2. NON-MANUFACTURING COSTS – all costs which are not incurred in transforming

materials to finished goods.
 Research and Development – incurred in designing and bringing new
products to the market
 Marketing costs – advertising and promotion expenses
 Distribution costs – cost incurred in delivering the products to the customer
 Selling costs – salaries and commission of sales staff and other selling
expenses
 After-sales costs – costs incurred in dealing with customers after sales.
Examples are warranty, repair costs and costs incurred in
receiving/entertaining/acting on customers’ complaints.
 General and Administrative costs – all the non-manufacturing costs that do
not fall under categories above.

III. AS TO TRACEABILITY/ ASSIGNMENT TO COST OBJECT

1. DIRECT COSTS – costs that are related to a particular cost object and can economically
and effectively be traced to that cost object.

20 | P a g e
 2. INDIRECT COSTS – costs that are related to a cost object, but cannot practically,
economically, and effectively be traced to such cost object. Cost assignment is done
by allocating the indirect cost to the related cost objects.

IV. FOR DECISION-MAKING

1. RELEVANT COSTS – future costs that will differ under alternative courses of action.

2. DIFFERENTIAL COSTS – difference in costs between any two alternative courses of

action.
 Incremental cost – increase in cost from one alternative to another
 Decremental cost –decrease in cost from one alternative to another

3. OPPORTUNITY COSTS – income or benefit given up when one alternative is selected

over another.

4. SUNK/PAST OR HISTORICAL COSTS – already incurred and cannot be changed by any

decision made now or to be made in the future.

V. AS TO BEHAVIOR

1. VARIABLE COST – within the relevant range and time period under consideration, the
total amount varies directly to the change in activity level or cost driver, and the per
unit amount is constant.

2. FIXED COST - within the relevant range and time period under consideration, the total
amount remains unchanged and the per unit amount varies inversely or indirectly with
the change in the cost driver.
 Committed Fixed Costs – long-term in nature and cannot be eliminated even
for short period of time without affecting the profitability or long-term goals of
the firm.
 Discretionary or managed fixed costs

3. MIXED COST – this cost has both a variable and a fixed component

4. STEP COST – when activity changes, a step cost shifts upward or downward by a
certain interval or step.

B. ANALYSIS OF COST BEHAVIOR

Cost behavior is the manner in which a cost changes as a related activity changes. The
behavior of costs is useful to managers for a variety of reasons. For example, knowing how
costs behave allows managers to predict profits as sales and production volumes change.
Knowing how costs behave is also useful for estimating costs, which affects a variety of
decisions such as whether to replace a machine.

Cost behavior analysis is the study of how specific costs respond to changes in the level of
business activity

Understanding the behavior of a cost depends on:

1. Identifying the activities that cause the cost to change. These activities are called activity
bases (or activity drivers).

21 | P a g e
2. Specifying the range of activity over which the changes in the cost are of interest, this
range of activity is called the relevant range.

Relevant range is the range of activity within which the assumptions made about cost behavior
is reasonably valid.

Costs are normally classified as variable costs, fixed costs, or mixed costs.

Variable costs are costs that vary in proportion to changes in the activity base. When the
activity base is units produced, direct materials and direct labor costs are normally classified
as variable costs.

Fixed costs are costs that remain the same in total dollar amount as the activity base changes.
When the activity base is units produced, many factory overhead costs such as straight-line
depreciation are classified as fixed costs. It has two kinds committed fixed cost and
discretionary fixed cost

Mixed costs are costs that have characteristics of both a variable and a fixed cost. Mixed costs
are sometimes called semi variable or semi fixed costs.

C. SPLITTING MIXED COST

Ways in separating fixed and variable component in a mixed cost

1. Scattergraph method

2. High-low method

3. Least square method

This crucial distinction between fixed and variable costs is at the heart of the contribution
approach to constructing income statements. The unique thing about the contribution
approach is that it provides managers with an income statement that clearly distinguishes
between fixed and variable costs and therefore facilitates planning, control, and decision
making.

The contribution income statement approach separates costs into fixed and variable
categories, first deducting variable expenses from sales to obtain the contribution margin.
The contribution margin is the amount remaining from sales revenues after variable expenses
have been deducted. This amount contributes toward covering fixed expenses and then
toward profits for the period. The contribution format income statement is used as an internal
planning and decision-making tool.

Contribution margin income statement

Sales xx
Variable cost (xx)
Contribution margin xx
Fixed cost (xx)
Net income (xx)

A. The Scatter Diagram Method

When there is doubt about the behavior pattern of a particular cost, especially a mixed cost,
it helps to plot past costs and related measures of volume in a scatter diagram. A scatter
diagram is a chart of plotted points that helps determine whether a linear relationship exists
between a cost item and its related activity measure. It is a form of linear approximation. If
the diagram suggests a linear relationship, a cost line can be imposed on the data by either
visual means or statistical analysis.

22 | P a g e
B. The High-Low Method

The high-low method is a common, three-step approach to determining the variable and fixed
components of a mixed cost. It is based on the premise that only two data points are
necessary to define a linear cost-volume relationship. It is a relatively crude method since it
uses only the high and low data observations to predict cost behavior. The disadvantage of
this method is that if one or both data points are not representative of the remaining data
set, the estimate Of variable and fixed costs may not be accurate. Its advantage is that it can
be used when only limited data are available. The method involves three steps.

High –low method – a method of analyzing mixed costs based on costs observed at both the
high and low levels of activity within the relevant range.

Cost equation:

y = a + bx y = total cost (the dependent variable)

a= fixed cost component (the intercept parameter)
b= variable cost per unit (the slope parameter)
x= activity level (the independent variable)

𝑐𝑜𝑠𝑡 𝑜𝑓 ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 − 𝑐𝑜𝑠𝑡𝑠 𝑎𝑡 𝑙𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 =
ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 − 𝑙𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 = 𝑡𝑜𝑡𝑎𝑙 𝑚𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡

C. The Least-Squares Regression Method

The least-squares regression method, unlike the high-low method, uses all of the data to
separate a mixed cost into its fixed and variable components. A regression line of the form
Y= a + bx is fitted to the data, where a represents the total fixed cost b represents the
variable cost per unit of activity.

The following linear equations are to be used:

(1) Σy = na + bΣx

(2) Σxy = aΣx + bΣx2

23 | P a g e
EXERCISES:

1. Cost is the monetary measure of the amount of resources given up in obtaining goods
and services. Costs may be classified as unexpired or expired.
Which of the following costs is not always considered to be expired immediately upon
being recognized?
a. men's commission
b. depreciation expense for factory equipment
c. cost of goods sold
d. salary of the company president

2. An activity that causes resources to be consumed is called a

a. Non-value added activity c. Just-in-time activity

b. Cost driver d. Extracurricular activity

3. It refers to anything (a product, product line, a business segment) for which cost is
computed.

a. Cost object c. Cost control

b. Cost driver d. Cost variance

4. It is a grouping of individual cost items, or an account in which a variety of similar costs

are accumulated.

a. Cost driver c. Income statement

b. Cost variance d. Cost pool

5. It is an event, action, transaction, task, or unit of work that consumes resources and with
a specified purpose.

a. Cost object c. Cost driver

b. Activity d. Direct labor

6. An activity that adds costs to the product or service, but does make such product or
service more valuable to customers is called

a. Non-value adding activity c. Costly activity

b. Value adding activity d. Valuable activity

7. Product costs or inventoriable costs

a. are charged to expense when products become part of the finished goods
inventory.
b. include only the prime costs of producing a product.
c. are treated as assets before the products are sold.
d. include only the conversion costs of producing the products.

8. Manufacturing costs do not include

a. prime cost
b. conversion cost
c. indirect materials
d. salary of the company president, under whom is the vice president for
production

24 | P a g e
9. For product costing purposes, an indirect factory cost

a. is not directly chargeable to the company

b. is chargeable to prime costs
c. is chargeable to conversion costs
d. is never included in the computation of product cost

10. Differential costs

a. are variable costs

b. are anticipated future costs that will differ among various alternatives
c. are the differences in costs between any alternative courses of action
d. are costs that differ under alternatives

11. An income or benefit that is given up when one alternative is selected over another is
called

a. loss c. relevant cost

b. opportunity cost d. differential cost

12. Sunk costs

a. are relevant costs

b. can be changed by a decision made now or to be made in the future
c. are irrelevant for decision-making purposes
d. are decreases in costs from one alternative to another

13. Which of the following statements about cost behavior is correct?

a. Within the relevant range, total variable costs may vary directly with activity,
while total fixed costs remain unchanged for a given period despite fluctuations
in activity.
b. Within the relevant range, variable cost per unit varies directly with activity,
while fixed cost per unit remains unchanged for a given period despite
fluctuations in activity.
c. Within the relevant range, fixed cost per unit varies directly with activity, while
variable cost per unit remains unchanged for a given period despite
fluctuations in activity.
d. Within the relevant range, total variable costs may vary inversely with activity,
while total fixed costs remain unchanged for a given period despite fluctuations
in activity.

14. These costs are long-term in nature and cannot be eliminated even for short periods of
time without affecting the profitability or long-term goals of the firm

a. Avoidable cost c. Variable costs

b. Committed fixed costs d. Controllable cost

15. This type of fixed costs usually arises from periodic decisions by management to spend
in certain fixed costs area. They may be changed by management from period to period
or even within the period if circumstances demand such change

a. Period cost c. Variable costs

b. Committed fixed costs d. Discretionary fixed costs

25 | P a g e
16. Mixed costs are costs that have

a. variable and fixed costs components.

b. manufacturing and administrative costs components.
c. selling and administrative costs components.
d. direct and indirect costs components.

17. The fixed and variable components of mixed costs may be separated by using any of the
following methods, except

a. High-low method c. Least squares method

b. Scatter graph method d. Weighted-average method

ITEMS 18 and 19 ARE BASED ON THE FOLLOWING INFORMATION:

Following are costs incurred by Abtina Manufacturing Corporation during the previous month:

Direct materials ₱ 5,000

Indirect materials 2,000
Direct labor 6,000
Indirect labor 1,000
Factory utilities 4,000
Advertising costs 8,000
Sales commission 12,000
Depreciation on administration building 3,000
Sales of administrative personnel 20,000
Depreciation – delivery equipment 2,000
Overtime pay – factory workers 1,500
Rework cost on defective products 2,500
discovered during quality inspection

18. Total product cost:

a. ₱67,000 c. ₱22,000
b. ₱45,000 d. ₱18,000

19. Total period cost:

a. ₱67,000 c. ₱49,000
b. ₱45,000 d. ₱22,000

ITEMS 20 to 24 ARE BASED ON THE FOLLOWING INFORMATION:

Data about Anabelle Company’s production and inventories for the month of June are as
follows:

Purchases – direct materials ₱ 143,440

Freight-in 5,000
Purchase returns and allowances ₱ 2,440
Direct labor 175,000
Actual factory overhead 120,000

26 | P a g e
 Inventories: June 1 June 30
Finished goods ₱ 68,000 ₱ 56,000
Work in process 110,000 135,000
Direct Materials 52,000 44,000

Annabelle Company applies factory overhead to production at 80% of direct labor cost. Over-
or under applied overhead is closed to cost of goods sold at year end. The company’s
accounting period is on the calendar year basis.

20. Annabelle Company’s prime cost for June was

a. ₱154,000 c. ₱198,000
b. ₱329,000 d. ₱315,000

21. Annabelle Company’s conversion cost for June was

a. ₱315,000 c. ₱329,000
b. ₱295,000 d. ₱444,000

22. For the month of June, Annabelle Company’s total manufacturing cost was

a. ₱469,000 c. ₱644,000
b. ₱444,000 d. ₱449,000

23. For June, Annabelle Company’s cost of goods transferred to the finished goods inventory
account was

a. ₱579,000 c. ₱469,000
b. ₱461,000 d. ₱444,000

24. Annabelle Company’s cost of goods sold for June was

a. ₱441,000 c. ₱456,000
b. ₱481,000 d. ₱444,000

25. When 10,000 units are produced, fixed costs are P14 per unit. Therefore, when 20,000
units are produced, fixed costs

a. Will increase to P28 per unit.

b. Will remain at P14 per unit.
c. Will decrease to P7 per unit.
d. Will total P280,000.

26. When 10,000 units are produced, variable costs are P6 per unit. Therefore, when 20,000
units are produced

a. Variable cost will total P120,000.

b. Variable cost will total P60,000.
c. Variable unit costs will increase to P12 per unit.
d. Variable unit costs will decrease to P3 per unit.

27 | P a g e
27. Kirsten Manufacturing provided the following information for last month.

Sales P10,000
Variable costs 3,000
Fixed costs 5,000
Operating income P 2,000

If sales will double next month, what is the projected operating income?

a. ₱4,000 c. ₱9,000
b. ₱7,000 d. ₱12,000

ITEMS 28 to 30 ARE BASED ON THE FOLLOWING INFORMATION:

Meng Company is preparing a flexible budget for next year and requires a breakdown of the
factory maintenance cost into fixed and variable elements.
The maintenance costs and machine hours (the selected cost driver) for the past six months
are as follows:

Maintenance Costs Machine Hours

January ₱ 15,500 1,800
February 10,720 1,230
March 15,100 1,740
April 15,840 2,190
May 14,800 1,602
June 10,600 1,590

28. If Meng Company uses the high-low method of analysis, the estimated variable rate of
maintenance cost per machine hour is

a. ₱7.23 c. ₱5.46
b. ₱8.73 d. ₱5.33

29. The average annual fixed maintenance cost amounts to

a. ₱4,160 c. ₱49,920
b. ₱8,320 d. ₱5,120

30. What is the average rate per hour at a level of 1,500 machine hours?

a. ₱5.33 c. ₱7.23
b. ₱8.11 d. none of the choices

ITEMS 31 to 35 ARE BASED ON THE FOLLOWING INFORMATION:

As part of cost study, the cost account of Shinly Corporation has recorded the cost of
operations at seven different levels of materials usage. The records show the following:

28 | P a g e
 Kilos of Materials Cost of Operation
80 ₱ 800
60 480
20 320
120 1,200
140 1,280
40 480
100 1,040

Sum of kilos (Σx) 560

Sum of costs (Σy) P5,600
Sum of kilos multiplied by cost (Σxy) P545,600
Sum of kilos squared (Σx2) 56,000

31. Using the high-low points method, the variable cost of operations per kilo of materials
used is

a. ₱8.00 c. ₱16
b. ₱9.14 d. ₱10

32. Using the same high-low points method, the fixed cost of operations is

a. ₱320 c. ₱160
b. ₱103 d. ₱206

33. Using the least square method, the average rate of variability per kilo of materials used
is

a. ₱8.00 c. ₱10.00
b. ₱0.11 d. ₱8.71

34. Using the least square method, the fixed portion of cost is

a. ₱320 c. ₱160
b. ₱103 d. ₱206

35. The projected cost of operations for 90 kilos of materials is

a. ₱886.90 if the high-low method is used.

b. ₱880.00 if the method of least squares is used.
c. ₱886.90 if the method of least squares is used.
d. ₱880.00 regardless of the method used.

- - - END OF TOPIC 2 - - -

29 | P a g e
TOPIC 3 COST VOLUME PROFIT ANALYSIS

LEARNING OBJECTIVES:

At the end of this topic, the students would be able to:

1. Explain how changes in activity affect contribution margin and net operating income.
2. Determine the break-even point in sales units and in sales pesos/dollars.
3. Determine the level of sales needed to achieve a desired target profit.

NOTES:

A. USES, ASSUMPTIONS AND LIMITATIONS OF CVP ANALYSIS

Cost-volume-profit (CVP) analysis is a powerful tool that helps managers understands

the relationships among cost, volume, and profit.

Some of the ways cost-volume-profit analysis may be used include:

1. Analyzing the effects of changes in selling prices on profits

2. Analyzing the effects of changes in costs on profits
3. Analyzing the effects of changes in volume on profits
4. Setting selling prices
5. Selecting the mix of products to sell
6. Choosing among marketing strategies

The following assumptions underlie each CVP analysis.

1. Costs are classified as variable or costs.

2. Variable costs change at linear rate.
3. Fixed costs remain unchanged over relevant range.
4. Selling price does not change as sales volume changes.
5. For multi- products, the sales mix remains constant.
6. Product efficiency does not change.
7. Inventory remains constant, production equals sales.
8. Volume is the only relevant factor affecting costs.
9. Relevant range for which all the underlying assumptions and concepts are valid.

B. FACTORS AFFECTING PROFIT

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

1. Selling prices.
2. Sales volume.
3. Unit variable costs.
4. Total fixed costs.
5. Mix of products sold.

30 | P a g e
CVP Relationships in Equation Form

The contribution format income statement can be expressed in equation form as follows:

𝑝𝑟𝑜𝑓𝑖𝑡 = (𝑠𝑎𝑙𝑒𝑠 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡) − 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠

Refine the equation as follows:

It is often useful to express the simple profit equation in terms of the unit contribution margin
(Unit CM) as follows:

The contribution margin as a percentage of sales is referred to as the contribution margin

ratio (CM ratio). The contribution margin ratio, sometimes called the profit-volume ratio,
indicates the percentage of each sales peso available to cover fixed costs and to provide
income from operations. This ratio is computed as follows:

𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁 𝑀𝐴𝑅𝐺𝐼𝑁
𝐶𝑀 𝑅𝐴𝑇𝐼𝑂 =
𝑆𝐴𝐿𝐸𝑆

Unit Contribution Margin

The unit contribution margin is also useful for analyzing the profit potential of proposed
decisions. The unit contribution margin is computed as follows:

Unit Contribution Margin = Sales Price per Unit -Variable Cost per Unit
The mathematical approach to cost-volume-profit analysis uses equations to determine the
following:

1. Sales necessary to break even

2. Sales necessary to make a target or desired profit

31 | P a g e
C. BREAK EVEN POINT IN UNIT AND PESO SALES

Break-even Analysis (Single Product)

The break-even point is the level of operations at which a company’s revenues and expenses
are equal. At breakeven, a company reports neither an income nor a loss from operations.

Break- even analysis is the process of finding the break-even point.

Break-even point is the level of sales at which profit is zero.

The break-even point can be:

1. Computed from a mathematical equation.

2. Computed by using contribution margin.
3. Derived from a cost-volume-profit (CVP) graph

The BEP can be expressed in pesos and in units.

The break-even point in sales units is computed as follows:

𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇
𝐵𝐸𝑃 (𝑈𝑁𝐼𝑇𝑆) =
𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁 𝑀𝐴𝑅𝐺𝐼𝑁 𝑃𝐸𝑅 𝑈𝑁𝐼𝑇

The break-even point in sales dollars can be determined directly as follows:

𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇
𝐵𝐸𝑃 (𝑃𝐸𝑆𝑂𝑆) =
𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁 𝑀𝐴𝑅𝐺𝐼𝑁 𝑅𝐴𝑇𝐼𝑂

Break-even is the point where revenue is equal to the cost.

Sample Problem:

Simple Company establishes the following information for its profit planning activities:

Unit sales price P 200 Total fixed costs P400,000

Unit variable costs 120 Units sold 8,000 units

Determine the following for Simple Company’s profit planning analysis:

1. Unit contribution margin, contribution margin rate, and variable cost rate.
2. Break-even point in units and in pesos.

1)

Units Unit Amount Rate

Price
Sales 8,000 P 200 P 1,600,000 100% Sales Rate
Less: Variable costs 8,000 120 960,000 60% VC Rate
Contribution margin 8,000 80 640,000 40% CM Rate
Less: Fixed costs 400,000

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2)
𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇 𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇
𝐵𝐸𝑃 (𝑈𝑁𝐼𝑇𝑆) = 𝐵𝐸𝑃 (𝑃𝐸𝑆𝑂𝑆) =
𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁 𝑀𝐴𝑅𝐺𝐼𝑁 𝑃𝐸𝑅 𝑈𝑁𝐼𝑇 𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁 𝑀𝐴𝑅𝐺𝐼𝑁 𝑅𝐴𝑇𝐼𝑂

400,000 400,000
𝐵𝐸𝑃 (𝑈𝑁𝐼𝑇𝑆) = 𝐵𝐸𝑃 (𝑃𝐸𝑆𝑂𝑆) =
80 0.40
𝐵𝐸𝑃 (𝑈𝑁𝐼𝑇𝑆) = 5,000 𝑢𝑛𝑖𝑡𝑠 𝐵𝐸𝑃 (𝑃𝐸𝑆𝑂𝑆) = 𝑃1,000,000

D. REQUIRED SELLING PRICE, UNIT SALES AND PESO SALES TO ACHIEVE A TARGET
PROFIT

One of the key uses of CVP analysis is called target profit analysis. In target profit analysis,
we estimate what sales volume is needed to achieve a specific target profit. It indicates the
sales necessary to achieve a specific level of income.

Methods used:

1. Equation method (mathematical method)

2. Formula method (contribution margin method)
3. Graphic presentation

Equation method:

𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑢𝑛𝑖𝑡 𝐶𝑀 𝑥 𝑄 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 OR 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝐶𝑀 𝑟𝑎𝑡𝑖𝑜 𝑥 𝑠𝑎𝑙𝑒𝑠 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠

Formula method:

𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 + 𝑓𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒

𝑢𝑛𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑡𝑡𝑎𝑖𝑛 𝑡ℎ𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 =
𝑢𝑛𝑖𝑡 𝐶𝑀

𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 + 𝑓𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒

𝑝𝑒𝑠𝑜 𝑠𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑡𝑡𝑎𝑖𝑛 𝑎 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 =
𝐶𝑀 𝑟𝑎𝑡𝑖𝑜

𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑢𝑛𝑖𝑡𝑠 𝑠𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑡𝑡𝑎𝑖𝑛 𝑡ℎ𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 =
𝐶𝑀𝑅 − 𝑝𝑟𝑜𝑓𝑖𝑡 𝑟𝑎𝑡𝑖𝑜

𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑝𝑒𝑠𝑜 𝑠𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑡𝑡𝑎𝑖𝑛 𝑡ℎ𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 =
𝐶𝑀𝑈 − 𝑝𝑟𝑜𝑓𝑖𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

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EXERCISES:

1. It involves a systematic examination of the relationships among costs, cost driver, and
profit.

a. financial statement analysis c. cost – benefit analysis

b. cost – volume – profit - analysis d. profit planning
2. The elements of CVP analysis include the following, except

a. total fixed cost c. volume or number of units

b. unit variable cost d. relevant range

3. Which of the following statement is correct?

a. Gross margin and contribution margin are the same.

b. Contribution margin is the excess of sales over variable costs, and this is the
amount available for the recovery of fixed assets and generation of profit.
c. One inherent, simplifying assumption in CVP analysis is that production equals
sales.
d. Unit variable costs change directly with the cost driver or activity level

4. In CVP analysis, it is assumed that

a. All costs are classifiable as either direct or indirect.

b. Cost and revenue relationships are predictable and linear over any range of
activity.
c. Selling prices per unit and market condition remain unchanged.
d. Total fixed costs are constant over relevant range, but fixed costs per unit vary
directly with the cost driver or volume.

5. In a contribution income statement,

a. Costs are classified as to function.

b. Fixed and variable manufacturing costs are combined as one level item.
c. Fixed costs are shown separately from variable costs.
d. Fixed manufacturing costs are shown separately from variable manufacturing
costs, but fixed and variable operating costs are combined as one-line item.

6. It is the level of output or sales at which total revenues equal total costs that, is the
point at which operating income is zero.

a. indifference points c. sangley point

b. break-even point d. order point

7. A calculation used in CVP analysis is the break – even point. At this point, total revenue
equals total costs. Beyond the break-even point, operating income will increase by the

a. Variable cost per unit for each additional unit.

b. Selling price per unit for each additional unit.
c. Contribution margin per unit of each additional unit.
d. Gross profit per unit for each additional unit.

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8. Which of the following statements is not correct?

a. All others factors remaining constant, a 10% decrease in the selling price of a
given product will have the same effect on profit as 10% increase in the unit
variable cost of such product.
b. Other things as they are, a P10,000 decrease in fixed costs will increase
operating profit by the same amount.
c. A change in the amount of fixed costs will not affect the ratio of variable costs
to sales.
d. A change in the fixed costs has no effect on the contribution margin.

9. Which of the following statements is not correct?

All other things remaining the same,

a. Equal percentage increases in both the selling price and variable cost per unit
will cause the break-even point in sales pesos to remain unchanged.
b. Equal percentage increases in both the selling price and variable cost per unit
will cause the contribution margin ratio to remain unchanged.
c. Equal peso increases in both the selling price and variable cost per unit will
cause the break-even point in units to remain unchanged.
d. Equal peso increases in both the selling price and variable cost per unit will
cause the break-even point in pesos to remain unchanged.

10. Which of the following statements is not correct?

At break-even,

a. Profit equals zero.

b. Gross profit equals zero.
c. Sales equal total costs.
d. Fixed costs equals contribution margin.

ITEMS 11 TO 19 ARE BASED ON THE FOLLOWING INFORMATION:

Basic Illustration Corp. produces and sells a single product. The selling price is P25 and
the variable cost is P15 per unit. The corporation’s fixed costs is P100,000 per month.
Average monthly sales is 11,000 units.

11. The corporation’s contribution margin per unit and as a percent of sales (CMR) is

a. P10 per unit; 40% c. 10 units; 40%

b. P40 per unit; 160% d. P40 per unit; 60%

12. The corporation’s break-even point

a. P10,000 c. 10,000 units or P250,000

b. 250,000 units d. 250,000 units or P10,000

13. If the corporation desires to earn a profit of P20,000 before tax, it must generate sales
of

a. P12,000 c. 10,000 units or P250,000

b. 300,000 units d. 12,000 units or P300,000

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14. If the corporation pays a corporate income tax at the rate of 30%, and it desires to
earn after tax profit of P21,000, it must generate sales of

a. P325,000 or 13,000 units c. 12,040 units or P301,000

b. P13,000 or 325,000 unit d. 16,375 units or P409,375

15. How much sales (in pesos) must be generated to earn profit that is 8% of such sales?

a. P270,000 c. P208,333.33
b. P312,500 d. P230,000

16. How many units must be sold to earn profit of P2 per unit?

a. 8,333.33 c. 12,500
b. 10,000 d. 312,500

17. If fixed costs will increase by P20,000, the break-even point in units will increase
(decrease) by

a. 12,000 c. 50,000
b. 10,000 d. 2,000

18. If the variable costs per unit will go up by P5, the peso break- even sales will increase
(decrease) to

a. P500,000 c. (P500,000)
b. P250,000 d. (P250,000)

19. If selling price will increase to P30, the break-even point in units’ will

a. remain unchanged c. decrease to 6,666.67

b. decrease by 166,666.75 d. decrease by 6,666.67

20. A product has a selling price of P20 and unit variable cost of P14. The effect of a P2 per
unit increase in variable cost is to increase the break-even level capacity by

a. 33 1/3% c. P2 per unit

b. 50% d. 66.67%

- - END OF PRELIM MODULE- - -

References:

Reviewer in Management Advisory Services (RODELIO S. ROQUE, BSBAA,CPA)

Reviewer in Management Advisory Services (MA. ELENITA BALATBAT CABEREA,
BBA, MBA, CPA, CMA and GILBERT ANTHONY B. CABRERA, BBA, MBA, CPA)

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