Sessions 1 and 2 Flashcards
What is the difference between MA and Financial Accounting?
– Aimed at internal users
– Not governed by GAAP rule book (but numbers common to both
MA and external/statutory reporting should agree if at all possible)
– Concerned with financial and nonfinancial information
Why do we need nonfinancial information in MA?
– Balanced perspective e.g. metrics re customers, processes
– Deconsolidate
– Leading versus lagging measures
e.g. ‘sales in €’ a function of ‘new customers numbers’, ‘churn’ etc.
Why do we say ‘you get what you measure’?
• In most organisations, metrics heavily influence employee
behaviour…shifting attention to what’s measured…and
away from what’s not measured
• Effect intensified if measures rigidly linked to compensation
=> caution e.g. ‘road-test’ for unintended consequences.
What are the descriptors of a good measure?
– Valid e.g. measure what they’re supposed to (aka ‘goal congruent’)
– Reliable e.g. objective, accurate
– Long term i.e. don’t encourage short termism
– Controllable or at least influenceable by accountable manager
Plus: Balanced, Leading, Strategic, Feasible, Clear, Agreed
What is incremental revenue?
The amount of profit associated with how many products where manufactured for one production unit. If the product costs $2 to produce and 50 products were completed, then $100 will be considered a profit. Revenue can increase or decrease if a decision alternative is selected.
What is incremental cost?
Incremental cost is the total cost incurred due to an additional unit of product being produced. Incremental cost is calculated by analysing the additional expenses involved in the production process, such as raw materials, for one additional unit of production. Understanding incremental costs can help companies boost production efficiency and profitability. It can refer to costs that increase or decrease if a decision alternative is selected.
- Incremental cost is the amount of money it would cost a company to make an additional unit of product.
- Companies can use incremental cost analysis to help determine the profitability of their business segments.
- A company can lose money if incremental cost exceeds incremental revenue.
What is incremental analysis?
An analysis of the revenues and costs that will change if a decision alternative is selected. This analysis should never be neglected. Ensure that incremental costs are not underestimated alongside incremental revenue (e.g. do new products take sales away from old products, do fixed costs remain the same)?
Also called the relevant cost approach, marginal analysis, or differential analysis, incremental analysis disregards any sunk cost or past cost. Incremental analysis is useful for business strategy including the decision to self-produce or outsource a function.
Companies use incremental analysis to decide whether to accept additional business, make or buy products, sell or process products further, eliminate a product or service, and decide how to allocate resources.
- Incremental analysis helps to determine the cost implications of two alternatives.
- It is also known as the relevant cost approach, marginal analysis, or differential analysis.
- Non-relevant sunk costs, or past costs, are not included in the analysis.
- Incremental analysis also assists with allocating limited resources to product lines to ensure a scarce asset is used to maximum benefit.
What are relevant versus non-relevant costs in incremental analysis?
Analysis models include only relevant costs, and these costs are typically broken into variable costs and fixed costs. Incremental analysis considers opportunity costs—the missed opportunity when choosing one alternative over another—to make sure the company pursues the most favourable option.
Non-relevant sunk costs are expenses already incurred. Because the sunk costs will remain regardless of any decision, these expenses are not included in incremental analysis. Relevant costs are also called incremental costs because they are only incurred when an activity of relevance has been increased or initiated.
Opportunity costs and avoidable costs are relevant.
Sunk costs are irrelevant.
What is “cost”?
…the monetary amount of the resources sacrificed to achieve a specific corporate objective.
… but different concepts depending on question being
addressed
…cost likely different for (1) historic profit measurement (2)
decision making (3) planning and control.
What is a variable cost?
- Change in proportion to changes in volume or activity
- Typically: accumulate, express and use on a ‘per unit’ basis
Variable costs fluctuate as the level of production output changes, contrary to a fixed cost. This type of cost varies depending on the number of products a company produces. A variable cost increases as the production volume increases, and it falls as the production volume decreases. For example, a toy manufacturer must package its toys before shipping products out to stores. This is considered a type of variable cost because, as the manufacturer produces more toys, its packaging costs increase, however, if the toy manufacturer’s production level is decreasing, the variable cost associated with the packaging decreases.
What is a fixed cost?
– Do not change in response to changes in volume or activity
– Typically: accumulate, express and use as ‘absolute’ amounts
Fixed costs do not vary with the number of goods or services a company produces over the short term. For example, suppose a company leases a machine for production for two years. The company has to pay $2,000 per month to cover the cost of the lease, no matter how many products that machine is used to make. The lease payment is considered a fixed cost as it remains unchanged.
What are controllable and non-controllable costs?
– A manager can influence controllable costs but
cannot influence non-controllable costs
– Mix these together in your measurement/reporting
and you fundamentally compromise it
What are direct and indirect costs?
– Direct costs are directly traceable to a product,
activity, or department
– Indirect costs are not traceable (or are too immaterial
to be worth tracing)
What are sunk costs?
Sunk costs are historical costs that have already been incurred and will not make any difference in the current decisions by management. Sunk costs are those costs that a company has committed to and are unavoidable or unrecoverable costs. Sunk costs are excluded from future business decisions.
What are avoidable costs?
Avoidable costs are expenses that can be eliminated if a decision is made to alter the course of a project or business. For example, a manufacturer with many product lines can drop one of the lines, thereby taking away associated expenses such as labor and materials. Corporations looking for methods to reduce or eliminate expenses often analyse avoidable costs associated with underperforming or non-profitable product lines. Fixed costs such as overhead are generally not preventable because they must be incurred whether a company sells one unit or a thousand units. In reality, variable costs are not entirely avoidable in a short timeframe. This is because the company may still be under contract or agreement with workers for direct labor or a supplier of direct materials. When these agreements expire, the company will be free to drop the costs.
