Lecture 2 Flashcards
Decentralization
Can improve decision making by giving authority to the people who understand the situation
Responsibility center
Organizational unit directed by a single party (individual or committee) that is evaluated based on its own set of managerial reports
Each responsibility center has its own targets, budgets and evaluation
Four types of responsibility centers:
Cost: Accountable for costs only (e.g. production, IT, HR)
Revenue: Accountable for revenues only (e.g. sales)
Profit: Accountable for revenues and costs (E.g. a combined production and sales department
Investment: Accountable for investments, revenues and costs (e.g. a whole company division)
Responsibliity centers deal with questions such as
Profit and investment centers are better cost and revenue center: why
How would you evaluate a revenue center
How might someone game the system
-Decrease the sales price to increase sales
-Tons of unprofitable sales cost center gets blamed for high costs
Profit and investment centers are better than cost and revenue centers; why?
Managers can be held responsible for their own profit/loss and their return on investment
So if you want to improve performance reporting, change cost and revenue centers into investment centers by having them “sell” their goods to each other
feedback function
Use responsibility centers along with budgeting to create feedback for your organization
Differences relative to budget/norms are variances
Variances are useful information
-Early warning
_Evaluate performance and strategy
-Communicate goals and priorities
Make and encourage necessary adjustments
Bloomfields law of measure management:
Measure management arises when incentivized measures capture performance constructs with error, the people being evaluated know the details of how performance is measured and people have discretion to distort either operations or reporting
Performance measures:
Good performance measures have:
Goal congruence/alignment:
The measure encourages your employees to do what you want them to do
controllability
Employees are held accountable for things within their own control
Balanced scorecard
Kaplan and norton developed the balanced scorecard as a way to focus on overall strategy rather than just financial end results
Balanced scorecard strategy map
Learning and growth –>
Internal business –>
Customer –>
Financial
Doesn’t just work on and measure the end goal (financial success), work on the steps before that
Have performance measures for each goal
Leading measure
A variable whose change is associated with a later change in another (lagging) varaible. On time delivery leads to improvements in customer satisfaction
Lagging measure
A variable whose change is associated with a previous change in another (leading) variable. improvements in customer satisfaction lag behind on time delivery
Four methods of estimating costs industrial engineering (work-measurement method)
Break out the stopwatch and scale
Time consuming
Watching people may change their behavior
four methods for estimating costs conference method
Ask experts for the cost function
Fast but experts aren’t always right
four methods for estimating costs Account analysis method:
use accounting theory to classify costs
Quantitative analysis (e. high-low, regression)
Data driven, mathematical; only works within a relevant range
Independent variables: cost drivers
Dependent variable: cost of a cost object
High-low method
Find the highest and lowest production levels and compare price –> variable and fixed costs
Very fast and easy
Overly simplistic, often inaccurate
CPV: cost volume profit
Given our cost structure how much volume do we need to achieve profit of X$
Managers want to know how profits will change as the number of units sold of a product or service changes
Managers like to use what if analysis to examine the possible outcomes of different decisions so they can make the best one
Total contribution margin (TCM) formula
(p-v)*Q
breakeven point (units)
The Q such that (p-v)*Q-F = 0
often denoted as Qbe
Target units
The Q such that (p-v)*Q - F = pi
Often denoted as Q*
fter tax profit (net income) can be calculated by
Net income = operating income * (1-tax rate)
Operating income = Net income / 1 - tax rate
argin of safety (mos)
Budget sales - Qbe
a low MOS means were at risk of losing money. Can also be expressed as a ratio of budgeted sales
Tradeoff point
Suppose we have two options
Option 1 has F1 and v1
Option 2 has F2 and v2
To find the indifference point
(I.e. the point where we like both options equally), set the two equations equal to each other and solve for Q
pQ – v1Q – F1 = PQ – v2Q -F2Q
–> Q = F2 -F1/v1-v2
Government/non-profit
Formula changes a little bit
Pi always equals 0
R is set by the budget, not by Q
So lets find the cost structure that allows for the highest Q!
0 = R - F - vQ
Overhead
All indirect and fixed costs
Allocating costs
Allocating costs means assigning them to inventory
both U.S. GAAP and IFRS require us to allocate all production costs, even overhead
That easy to do with direct costs, but how do we allocate overhead
Steps to cost a job (figuring out the cost of a single job/unit
1) Identify cost object
2) Identify direct costs of the job
3) Trace direct costs to the job
4) Accumulate overhead (indirect) costs in cost pools
5) Accumulate overhead (indirect) costs in cost pools
6) Select an allocation base (preferably cost driver)
7) Calculate the overhead rate per unit
8) Allocate overhead costs to jobs based on application base (cost driver)
Cost pool
Grouping of cost items for temporary purposes
Cost allocation base
Way to apply cost from the cost pool to the cost object
Cost driver
What actually causes cost in the cost pool to increase
ideally the cost driver and cost allocation base are the same thing
Sometimes its really hard to measure the cost driver (or we dont know what it is, or there isnt one) so we use some other allocation base instead
How to allocate overhead
actual costing
end of period
Add up all actual overhead costs and divide by actual allocation base to calculate a rate
Apply overhead to jobs by multiplying the rate by actual allocation usage
very few firms use actual costing: why?
Actual rates arent known until the end of the period
Moving standard
the customer for job 1 wants to know how much his project costs. With actual costing, your reply is “ i wont know until I finished it and all my other projects this year!”
normal costing
beginning of period
Add up all estimated overhead costs and divide by estimated allocation base
Apply overhead based on actual allocation usage
True costs vs allocated costs
Allocated costs were based on estimated numbers while true costs are actual numbers
Numberator effects
we budgeted the wrong amount of costs
Denominator effects
We budgeted the wrong amount of allocation base
Adjusted allocation rate approach
At the end of the year, recalculate all allocation based ona ctual numbers
Most accurate approach
Same problem as actual costing - moving benchmarking
Proration approach
The difference is allocated proportionally across work in progress inventory, finished goods inventory and cost of goods sold
write off appraoch
The difference is written off to COGS
Most important approach
Technically wrong but close enough to the right answer that we are usually okay with
standard costing
Just use budgeted number
Everything gets a standard cost
Standard costing
Instead of assigning costs based on what actually happend (actual costing) or a combination of budgetted rates and actual usage, lets assign costs based on waht they should be
We should use 5$ of direct materials, 8$ of direct labor and 3$ of overhead, so well say each item costs 5 + 8 + 3 = 16
At the end of the period we will compare actual costs with these “standard costs” the difference are variances
