Institute of Graduate Program Education

MASTER IN BUSINESS ADMINISTRATION (MBA)

BA – 103 (Managerial Accounting)

LEARNING
NOTES
MANAGERIAL
ACCOUNTING (BA – 103)
RHEA ALLETTE D. CLAVERIA/MBA – 1

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

LEARNING
NOTES
MODULE I
MANAGEMENT ACCOUNTING –
A PERSPECTIVE

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

A. Definition and Scope:

It is a process of identification, measurement, accumulation, analysis, preparation,

interpretation and communication of financial information by which used by the

management in order to plan, evaluate and control current and future activities of an

organization. This is also to assure the appropriate use of and accountability for its

resources. It also comprises the preparation of financial reports for non-management

groups such as shareholders, creditors, regulatory agencies and tax authorities.

Management accounting is the process of measuring and reporting information about

economic activity within organizations, for use by managers in planning, performance

evaluation, and operational control.

 Planning: For example, deciding what products to make, and where and when to

make them. Determining the materials, labor, and other resources that are needed

to achieve desired output. In not-for-profit organizations, deciding which programs

to fund.

 Performance Evaluation: Evaluating the profitability of individual products and

product lines. Determining the relative contribution of different managers and

different parts of the organization. In not-for-profit organizations, evaluating the

effectiveness of managers, departments and programs.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 Operational Control: For example, knowing how much work-in-process is on

the factory floor, and at what stages of completion, to assist the line manager in

identifying bottlenecks and maintaining a smooth flow of production.

 Management is concerned with identifying, presenting and interpretation of

information used for:

o Formulating strategy

o Planning and controlling activities

o Decision making

o Optimizing use of resources

o Disclosure to shareholders and others external to the entity

o Disclosure to employees

o Safeguarding assets

 Management needs to perform the following in order to achieve such tasks:

o Formulate plans to meet objectives (Strategy planning)

o Formulate short term operation plans (Budgeting/profit planning)

o Acquire and use finance (financial management) and record transactions

(Financial Accounting and Cost Accounting)

o Communicate financial and operating information

o Take corrective action to bring plans and results into line (Financial control)

o Reviewing and reporting on systems and operation (Internal audit)

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

The following are some of the areas of specialization included within the ambit of

management accounting:

1. Financial Accounting

This pertains to recording of all business transactions in the books of prime entry,

posting them into respective ledger accounts, balancing then and preparing a trial

balance, from and out of which a profit and loss account showing the results of

the business and also a balance sheet depicting assets and liabilities of the

business concern are prepared. This in turn forma the basis for analysis and

interpretation for furnishing meaningful data to the management.

2. Cost Accounting

Costing refers to the classification, recording and allocation of expenditures for the

determination of the cost of products or services, ensuring management control

over the same. This includes the determination of cost or every order, job,

contract, process, or unit as may be required. This helps in the sharpening of the

internal aspects of financial accounting.

3. Forecasting and Budgeting

This refers to the formulation of budgets and forecasts, using standard norms in

cooperation with operating and other departments of a business concern. The

ultimate success of any budgeting depends on the proper setting of target figures

in the budgets and the actual realization of the same in practice, without even a

slight deviation due to external reasons beyond the control of the management.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

4. Cost Control Techniques

These serve as effective tools for comparing the actual results with the

predetermined figures as laid down in budgets. They greatly help in translating the

budgets into operating plans.

5. Statistical Data

It is concerned with the supply of necessary statistical data and particulars needed

various departments of the business concern. This includes statistical compilation

of case studies, engineering records, minutes of meetings, special surveys and

many other business documents.

6. Taxation

This necessitates the computation of profits in accordance with the provisions of

the Income Tax Act and also prompt filing of returns periodically and payment of

taxes.

7. Methods and Procedures

They are concerned with standardization of methods and procedures in all fields

of management for improving efficiency as well as for reducing the cost

considerably. This involves the preparation and issuance of accounting and other

manuals which will provide the guidelines for others.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

8. Office Services

This mainly relates to the maintenance of data processing and other office

management services, stencilling and duplicating, dealing inward and outward

mails, and others.

9. Internal Audit

The effectiveness of the final audit depends in turn on the internal audit coverage

in existence in any business concern.

B. Difference between Management Accounting and Financial Accounting:

Financial Accounting

It’s the discipline concerned with the provision of information to external parties

outside the organization. It’s the process of measuring, classifying, summarizing and

reporting financial information used in making economic decisions. It’s also

concerned with the preparation of financial statements to be used by the firm’s

stakeholders.

There are five key differences between management accounting and financial

accounting. These are explained in more detail in table below.

Issue Management Accounting Financial Accounting

Primary Users  Internal management of  Wide and varied range of
the organization external users (shareholders,
investors, lenders, employees
etc.) and internal management
of the organization.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Format and Content  More detailed reporting,  Summarized financial

at product, department, information prepared based on
customer level etc. Company Law and Accounting
 May provide financial and Standards.
nonfinancial information.
 No set format for
reporting – every
company may have
different reports and
gather different
information based on
their own particular
requirements.

Frequency  No requirement to  Financial statements must be

prepare management produced annually. In
accounts for any addition, regulation may
particular period. require some companies to
Management accounting prepare half yearly or
reports may be prepared quarterly financial statements.
daily, weekly, monthly or
at any time when
required.

Focus  Focus is more forward  Focus is on historic

looking; using past information, reporting what
information to prepare has happened in the past.
projections of future
trends and to control the
performance of the
business.

Legal Requirements  No legal requirement for  Company law requires limited

management accounts to companies to prepare financial
be prepared. Nor is there statements on an annual
a requirement for basis, in accordance with
management accounts to accounting principles, and
be audited. which may require to be
audited.

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

C. The Management Accountant

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.

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:

o 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.

o 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.

o Coordinating

He consults all segments of management responsible for policy or action.

Such consultation might concern any phase of the operation of the business

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

having to do with attainment of objectives and the effectiveness of the

organizational structures and policies.

o 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.

D. Factors influencing management accounting information

The type, quantity and quality of management accounting information required by

companies is affected by following factors,

o Increased competition – it is now more important than ever to have

accurate cost information as companies are competing not just in terms of

product price but also other factors such as product quality and customer

service.

o Global marketplace – with improvements in transportation and

communication the market for customers has expanded and so too have

company operations. Management accounting enables cost information to be

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

provided and analysed across divisions, segments and countries to support

overall activities of the organisation.

o Focus on customer satisfaction – customers have become more

discerning and it is now more important to have pertinent information relating

to customers and their profitability to a business.

o New management approaches – to facilitate placing the focus on

customer satisfaction companies are adopting a variety of new management

approaches such as Total Quality Management, Value Chain Analysis and

Benchmarking. In addition, companies are adopting a philosophy of

continuous improvement and promoting employee empowerment.

o Changing product lifecycles – due to intense competition and changing

customer needs product lifecycles are becoming shorter. Companies need to

be ready and able to introduce new products quickly and management

accounting can facilitate this process by providing essential information for

costing and decision making.

o Changing cost structures – in the past materials and labour comprised

the highest product costs but this has changed, overheads are now more

significant and need to be carefully monitored. The changing cost structures

have prompted companies to revise and update their information

requirements. Management accounting facilitates the provision of

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

information reflecting the changes that have occurred and enabling better

monitoring and control of costs.

o Information technology – over the past few decades, significant

technological change has occurred in production design and technology, and

in the delivery of products and services to customers. There have also been

substantial changes in information preparation, processing and

dissemination; reports and analyses that previously took days to produce may

now be obtained at very short notice, sometimes in minutes. Hence, a greater

volume of more detailed information is required and may be prepared and

disseminated quickly.

o Internet opportunities – as result of significant improvements in

information technology, the internet has created e-commerce, providing

companies with greater opportunities to buy and sell products and services

more easily, and to monitor competitors and consumer trends.

o Management styles and organisational forms – a company’s

organisational structure and way of working can affect the management

accounting information that is produced.

o Environmental and ethical matters – in recent times, due to many financial and

business scandals, and operational disasters, there has been increased attention

focused on ethics and the environment.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

LEARNING
NOTES
MODULE II
COST FOR PLANNING,
CONTROL AND DECISION -
MAKING

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Definition

To an economist, the cost of producing any good or service is its opportunity cost.

Therefore the opportunity cost of obtaining a commodity is the foregone utility which

could have been derived from the forgone alternatives.

Cost is best described as a sacrifice made in order to get something. In business, cost is

usually a monetary valuation of all efforts, materials, resources, time and utilities

consumed, risk incurred and opportunities forgone in production and delivery of goods

and services. More explicitly, the costs attached to resources that a firm uses to produce

its product are divided into explicit costs and implicit costs. All expenses are costs but not

all costs are expenses. Those costs incurred in the acquisition of income generating assets

are not considered as expenses. The theory of costs is better categorized under the

traditional and modern theory of cost.

Type of Costs

Costs can be categorized into seven types:

1. Accounting and economic costs

Accounting cost (money or explicit) is the total monetary expenses incurred by a

firm in producing a commodity and this is what an entrepreneur takes into

consideration in making payments for various items including factors of production

(wages and salaries of labor), purchase of raw materials, expenditures on machine,

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

including on capital goods, rents on buildings, interest on capital borrowed,

expenditure on power, light, fuel, advertisement, etc.

2. Production cost

In the production process, many fixed and variable factors (inputs) usually capital

equipment are used. They are being employed at various prices. The expenditures

incurred on them are the total costs of production of a firm. Such costs are divided

into two: total variable cost and total fixed costs.

3. Real costs

It tells us what lies behind money cost, since money cost are expenses of production

from the point of view of the producer. Thus, according to Marshall, the efforts and

sacrifices made by various members of the society in producing a commodity are

the real costs of production. The efforts and sacrifices made by business men to

save and invest, workers foregoing leisure, and by the landlords in the use of land,

all these constitute real cost.

4. Opportunity cost

This is the cost of the resources foregone, in order to get or obtain another. The

opportunity cost of anything is the next best alternative that could be produced

instead by the same factors or by an equivalent group of factors, costing the same

amount of money. E.g. the real cost of labour is what it could get in some alternative

employment. Opportunity cost includes both explicit and implicit cost.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

5. Private and social cost

Private costs are the costs incurred by a firm in producing a commodity or service.

It includes both implicit and explicit cost. However, the production activities of a

firm may lead to economic benefit or harm for others. For instance, production of

commodities like steel, rubber and chemical pollute the environment which leads to

social costs. The society suffers some inconveniences as a result of the production

exercise embarked upon by the firm.

6. Sunk costs

This refers to all the costs that have been incurred and definitely not recoverable or

changeable whether the particular project or business goes on or not. For instance,

if a road project already commissioned is abandoned or not, the money has already

been spent and there is no way of recovering it. This cost is undiscoverable if not

considered in economic decision making.

7. Incremental cost

This is the change in cost owing to a new decision. For example, a firm may decide

to buy its equipment instead of leasing it and because of this the expenditure made

in the production process will alter. If cost increases because of the change, the

incremental cost will be positive. If the new decision does not alter the overall cost,

then, the incremental cost will be negative.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Classification of Costs

This may be defined as the logical grouping of the various categories of cost items

according to a particular parameter, yardstick or basis. Cost may therefore be classified

according to:

A. Behavior

B. Nature

C. Degree of control

D. Functions

E. Responsibilities center

F. Economic characteristics

A. Bahavioral Pattern of Costs

1. Variable Cost

Items of cost which tends to vary in direct proportion to changes in the

volume of output of cost centres to which they relate. (Example: material

cost)

2. Fixed Cost

A cost which is incurred for a period and which certain output and turn over

limits. It tends to be unattracted by fluctuations in the level of

activities. (Example: wages of supervisors, storekeepers in a factory).

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

B. Nature Classification

This may be described as a situation where the physical feature or characteristics

of the cost items are used in its classification.

1. Material cost

2. Labor cost

3. Overhead cost

C. Functional Classification

The cost centre structure of the business normally reflects the delegation of

responsibilities within a limited number of main functional areas of the business,

each of which will be under the control of senior manager.

1. Production cost

2. Marketing cost

3. Administrative cost

D. Controllability Classification

The degree of influence that an operating manager is able to exert on a particular

item of cost can be used as a basis of cost classification.

1. Controllable cost - Item of cost that an operating manager can

control or manipulate.

2. Non controllable cost - By their nature, these categories of cost items are

not within the influence or control of the operating manager.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

E. Economic Characteristics Classification

In this case, cost items are classified based on their impact on a particular decision

to be taken.

1. Opportunity cost

2. Incremental cost

3. Avoidable cost

4. Relevant cost

5. Sunk cost

F. Responsibility Classification

Cost items may also be classified according to the specific responsibility

center in which cost is incurred under this classification responsibility centers are

identified as follows:

1. Cost center

2. Profit center

3. Investment center

G. Other Classes of Cost

1. Period cost - Period costs are all cost in the income statement other

than cost of goods sold.

2. Inventoriable cost - These are all cost of a product that are regarded

as an asset when they are incurred and then as cost of goods sold

when the product is sold.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

LEARNING
NOTES
MODULE III
VARIABLE COSTING

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Definition

Absorption Costing

It is also called as also called full costing, conventional 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 treats fixed manufacturing

overhead as a product cost.

Variable Costing (also called direct costing)

A costing method that includes only variable manufacturing costs (direct materials, direct

labor and variable manufacturing overhead) in the cost of a unit of product. It treats fixed

manufacturing overhead as a period cost.

Advantages of Variable Costing

The advantages of variable costing can be summarized as follows:

1. Operations Planning

Variable costing can readily supply data on variable costs and contribution margin,

which management needs each day to make decisions relating to special order,

expansion of capacity, shut-down of production, etc.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

2. Cost-volume-profit analysis

Income statements under variable costing give data relating to “Gross contribution

margin,” “Contribution margin,” and “Total fixed costs.” These data can easily be

used in the c-v-p analysis.

3. Product pricing

The variable cost of production is considered at the time of fixing the selling price

for a special order. Variable costing can readily supply data relating to the variable

cost of production.

4. Management decisions

Variable costing income statements enables management to see and understand

the effect that period costs have on profits and facilitates better decision-making.

5. Management control

The reports based on variable costing are far more effective for management control

than those based on absorption costing because;

a. Variable costing reports are related to profit objectives,

b. It can pinpoint responsibility according to organizational lines.

6. Cost control

Cost control becomes easier because only variable manufacturing costs are
considered.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

7. Change in profit

Variable costing net income changes with sales. As a result, it becomes easily

understandable as to how much additional profit will be earned from how much

additional sales.

Difference between Variable Costing and Absorption Costing

Subject Absorption Costing Variable Costing

Absorption costing is a
method of product costing It is a costing method that
that includes all includes only variable
manufacturing costs- direct manufacturing costs-direct
Definition materials, direct labor, and materials, direct labor and
both variable and fixed variable factory overhead
manufacturing overhead in in the cost of a unit of
the cost of a unit of product
product.
Direct materials,
Direct materials,
Direct labor,
Computation of cost of Direct labor,
Direct expenses,
production Direct expenses,
Variable factory overhead,
Variable factory overhead.
Fixed factory overhead
Fixed factory overhead is Fixed factory overhead is
Fixed factory overhead
regarded as product cost. regarded as a period cost.
Inventory includes all Inventory includes the only
variable cost of production variable cost of production.
and a portion of fixed As a result, the value of
Value of inventory
factory overhead. As a inventory is lower as
result, the value of compared with absorption
inventory is higher. costing

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Subject Absorption Costing Variable Costing

Gross profit is the excess Gross C/M is the excess of

Gross profit and gross C/M of sales over cost of goods sales over the variable cost
sold. of goods sold.

Absorption costing net Variable costing net

Net income income changes with income changes with sales,
production and sales. not with production.

Variable costing plays an

Absorption costing is not
important role in
Utility suitable for managerial
management decision -
decision-making.
making.

Absorption costing is
Variable costing is required
Reporting required for external
for internal reporting.
reporting.

Variable costing is useful in

It is not useful for break- break-even analysis as it
Break-even analysis
even analysis provides information on
C/M and fixed costs.

Variable manufacturing
cost variance and under or Only variable
over-allocated fixed factory manufacturing cost
Variance adjustment
overhead (volume variances are adjusted in a
variance) are adjusted in variable costing.
absorption costing.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Uses of Variable Costing

Variable Costing focuses attention on the product and its costs. This interest moves in

two directions:

A. To internal uses of the fixed-variable cost relationship and the contribution margin

concept, and

B. To external uses involving the costing of inventories, income determination, and

financial reporting.

 Variable costing as a profit-planning tool

A profit plan, often called a budget or plan of operations covers all phases of future

operations to attain a stated profit goal. Although such a plan includes both long-

term and short-term operations, Variable Costing is quite useful in planning for short

periods, in pricing special orders, or in making current operation decisions

 Variable costing as a guide to product pricing

The best or optimum price is that which will yield the maximum excess of total

revenue over total cost. The volume at which the increase in total cost due to the

addition of one more unit of volume is just equal to the increase in total revenue,

or a zero increase in total profit, is the optimum volume. The price at which this

volume can be obtained is the optimum volume. A higher price will lower the

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

quantity demanded and decrease total profit. A lower price will increase the quantity

sold but decrease total profit.

 Arguments for variable costing in managerial decision making

Similar to financial accounting, managerial accounting accumulates and analyzes

data to make logical economic decisions. "Variable costing" is an accounting decision

- making tool that managers utilize for internal reporting purposes (Polimeni, 1991).

As opposed to "absorption costing," which is a system that considers all

manufacturing costs for reporting purposes, many managers argue that variable

costing is more effective for decision making because this method excludes fixed

overhead costs of goods sold (Rouf,2013).

 Variable costing as a control tool

The Variable Costing procedure is said to be the product of an allegedly

incomprehensible income statement prepared for management. By adopting

Variable Costing, management and marketing management in particular believe that

a more meaningful and understandable income statement can be furnished by the

accountant. However, reports issued should serve not only the marketing

department but all divisions of an enterprise (Rayburn, 1996).

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

LEARNING
NOTES
MODULE IV
DIFFERENTIAL COST ANALYSIS

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Definition

 Differential costing is a technique where mainly differential costs are considered

relevant. Differential cost is the difference in total costs between two acceptable

alternative courses of action.

 The differential cost analysis is a useful tool for the management to know the results

of any proposed changes in the level or nature of activity. Under this method, the

differential costs are ascertained for each proposal and compared with the expected

changes in revenue associated with each proposal.

 When there is net excess revenue, the proposal will be accepted; otherwise it will

be rejected. The determination of differential cost is simple. It represents the

difference in the relevant costs for the alternative proposal under consideration.

Decision Making

The process of choosing a course of action from at least two following alternatives:

1. Short – term non – routine cases

 Accept or reject a special order or a business proposal

 Sell or process further a product line

 Make or buy a part, sub assembly or product line

 Continue operating or close a business segment

 Product combination

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 Utilization of scarce resources

 Change in profit factors

2. Long term cases (example: capital investment decisions)

Decision – Making Process involves the following:

o Defining the problem

o Specifying the objective and criteria

o Identifying the alternative courses of action

o Determining and evaluating the possible consequences of the alternatives

o Choosing the best alternative and making the decisions

o Evaluating the results of the decisions

Approaches in Decision Making

1. Total Approach

The revenues and costs are determined for each alternative and the results are

compared to serve as a basis for decision – making.

2. Differential Approach

Only the differences or changes in costs and revenues are considered.

Types of Costs Used in Decision Making

 Relevant Costs - Future costs that are expected to be different

between or among alternatives.

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 Differential Costs - Increases (increments) or decreases

(decrements) in total costs that result from selecting one alternative instead of

another.

 Avoidable Costs - Costs that will be saved or those that will not be

incurred if a certain decision is made. (relevant)

 Sunk Cost - Costs that are incurred already and cannot be

avoided regardless of what decision is made. (irrelevant)

 Out – of – Pocket Costs - Costs that will require expenditure of cash or

incurrence of a liability as a consequence of a management decision. (relevant)

 Opportunity Costs - Income sacrificed or forgone when a certain

alternatives is chosen over another alternative. (relevant)

 Joint Costs - Costs incurred in simultaneously manufacturing

two or more (joint) products that are difficult to identify individually as separate

types of products until the products reach a certain processing stage known as the

split – off point. (irrelevant)

 Further Processing Costs - Cost incurred beyond the split off point as

separately joint products are to be processed further. (relevant)

 Postponable Costs - Costs that may be deferred or shifted to a future

date or period of time without adversely affecting current operations.

 Imputed Costs - Assumed or hypothetical costs representing the

costs or value of a resource that is utilized for a specific purpose.

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

LEARNING
NOTES
MODULE V
RESPONSIBILITY ACCOUNTING

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Concept

 It is used to measure performance of divisions of an organisation rather than

organisation as a whole.

 Responsibility Accounting is a system of control where responsibility is assigned for

the control of costs. The persons are made responsible for the control of costs.

 Proper authority is given to the persons so that they are able to keep up their

performance. In case the performance is not according to the predetermined

standards then the persons who are assigned this duty will be personally responsible

for it. In responsibility accounting the emphasis is on men rather than on systems.

 Responsibility Accounting collects and reports planned and actual accounting

information about the inputs and outputs of responsibility centres”

 Responsibility Accounting must be designed to suit the existing structure of the

organization.

 Responsibility should be coupled with authority. An organization structure with clear

assignment of authorities and responsibilities should exist for the successful

functioning of the responsibility accounting system. The performance of each

manager is evaluated in terms of such factors.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Definition

 Responsibility accounting is a system of management accounting under which

accountability is established according to the responsibility delegated to various

levels of management and a management information and reporting system

instituted to give adequate feedback in terms of the delegated responsibility.

 Under this system, divisions or units of an organisation under a specific authority in

a person are developed as responsibility centres & evaluated individually for their

performance.

 Horngreen: defines “Responsibility accounting is a system of accounting that

recognizes various responsibility centres throughout the organisation and reflects

the plans and actions of each of these centres by assigning particular revenues and

costs to the one having the pertinent responsibility. It is also called profitability

accounting and activity accounting”. According to this definition, the organisation is

divided into various responsibility centres and each centre is responsible for its costs.

The performance of each responsibility centre is regularly measured.

 Institute of Cost and Works Accountants of India defines Responsibility accounting

as “a system of management accounting under which accountability is established

according to the responsibility delegated to various levels of management and a

management information and reporting system instituted to give adequate feedback

in terms of the delegated responsibility. Under this system divisions or units of an

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

organisation under a specified authority in a person are developed as responsibility

centres and evaluated individually for their performance.”

Essential Features of Responsibility Accounting

1. Inputs and Outputs or Costs and Revenues:

• The implementation and maintenance of responsibility accounting system is

based upon information relating to inputs and outputs.

• The physical resources utilized in an organization such as quantity of raw

material used and labor hours consumed, are termed as inputs. These inputs

expressed in the monetary terms are known as costs.

• Similarly, outputs expressed in monetary terms are called revenues.

2. Planned and Actual Information or Use of Budgeting:

• It is not only the historical cost and revenue data but also the planned future

data which is essential for the implementation of responsibility accounting

system.

• It is through budgets that responsibility for implementing the plans is

communicated to each level of management.

• The use of fixed budgets, flexible budgets and profit planning are all

incorporated into one overall system of responsibility accounting.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

3. Identification of Responsibility Centers:

• The whole concept of responsibility accounting is focused around identification

of responsibility centres.

• The responsibility centers represent the sphere of authority or decision points

in an organization. In a small firm, one individual or a small group of

individuals, who are usually the owners may possibly manage or control the

entire organization.

• For effective control, a large firm is, usually, divided into meaningful segments,

departments or divisions. These sub- units or divisions of organization are

called responsibility centers.

• A responsibility center is under the control of an individual who is responsible

for the control of activities of that sub-unit of the organization.

• This responsibility center may be a very small sub-unit of the organization, as

an individual could be made responsible for one machine used in

manufacturing operations, or it may be very big division of the organization,

such as a divisional manager could be responsible for achieving a certain level

of profit from the division and investment under his control.

• The general guideline is that “the unit of the organization should be separable

and identifiable for operating purposes and its performance measurement

possible”.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

4. Relationship between Organisation Structure and Responsibility

Accounting System:

• A sound organization structures with clear-cut lines of authority—responsibility

relationships are a prerequisite for establishing a successful responsibility

accounting system.

• Responsibility accounting system must be so designed as to suit the

organisation structure of the organisation.

• It must be founded upon the existing authority- responsibility relationships in

the organization.

• Responsibility accounting system should parallel the organization structure and

provide financial information to evaluate actual results of each individual

responsible for a function.

5. Assigning Costs to Individuals and Limiting their Efforts to Controllable

Costs:

• After identifying responsibility centres and establishing authority-responsibility

relationships, responsibility accounting system involves assigning of costs and

revenues to individuals.

• Only those costs and revenues over which an individual has a definite control

can be assigned to him for evaluating his performance

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

6. Performance Reporting:

• A control system to be effective should be such that deviations from the plans

must be reported at the earliest so as to take corrective action for the future.

The deviations can be known only when performance is reported.

• Responsibility accounting system is focused on performance reports also

known as ‘responsibility reports’, prepared for each responsibility unit.

• The reports should contain information in comparative form as to show plans

(budgets) and the actual performance and should give details of variances

which are related to that center.

• To be effective, the reports should be clear and simple. Use of diagrams,

charts, illustrations, graphs and tables may be made to make them attractive

and easily understandable.

Responsibility Center

 The main focus of responsibility accounting lies on the responsibility centres.

 A responsibility centre is a sub unit of an organization under the control of a

manager who is held responsible for the activities of that centre.

 It is like a small business to achieve the objectives of a large organisation

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

1. Cost Centre

 A cost or expense center is a segment of an organization in which the

managers are held responsible for the cost incurred in that segment but not

for revenues.

 Responsibility in a cost center is restricted to cost.

 For planning purposes, the budget estimates are cost estimates; for control

purposes, performance evaluation is guided by a cost variance equal to the

difference between the actual and budgeted costs for a given period.

 Cost center managers have control over some or all of the costs in their

segment of business, but not over revenues.

 In manufacturing organizations, the production and service departments are

classified as cost centre. Also, a marketing department, a sales region or a

single sales representative can be defined as a cost center.

2. Revenue Center

 It is a segment of the organization which is primarily responsible for generating

sales revenue.

 A revenue centre manager does not possess control over cost, investment in

assets, but usually has control over some of the expense of the marketing

department.

 The revenue center manager will control the selling price, promotion mix and

product mix

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 The performance of a revenue center is evaluated by comparing the actual

revenue with budgeted revenue, and actual marketing expenses with

budgeted marketing expenses.

 Sales department is an example of Revenue Center

3. Profit Centre

 Also called business centre

 It is a segment of an organization whose manager is responsible for both

revenues and costs.

 In a profit center, the manager has the responsibility and the authority to make

decisions that affect both costs and revenues (and thus profits) for the

department or division.

 The managers are encouraged to act as if they were running their own

separate business.

 The main purpose of a profit centre is to maximize profit by making decisions

relating to production volume, product mix, selling price, marketing strategy.

 Profit center managers aim at both the production and marketing of a product.

4. Investment Center

 It is responsible for both profits and investments.

 The investment center manager has control over revenues, expenses and the

amounts invested in the center’s assets.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 He also formulates the credit policy which has a direct influence on debt

collection, and the inventory policy which determines the investment in

inventory.

 The manager of an investment center has more authority and responsibility

than the manager of either a cost center or a profit center.

 ‘Investment on asset’ responsibility means the authority to buy, sell and use

divisional assets.

Advantages of Responsibility Center

 Some responsibility is given to each individual and he is held accountable for his

performance. No person can assign his responsibility to others. In this system,

responsibility is fixed individually

 Facilitates stricter control on costs & revenue along with helping in planning and

decision making

 When responsibility is fixed for each department, managers consider themselves

important part of the organization. It helps in developing spirit of initiative among

employees and increases their motivation

 A mechanism for presenting information is provided. A framework for managerial

performance appraisal systems can be established on that basis, besides motivating

managers to act in the best interest of the enterprise

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 Relevant and up to the minute information is made available which can be used to

estimate future costs &/or revenue and fix up standards for departmental budgets.

Problems in Responsibility Center

 For responsibility accounting to be effective, a proper classification between

controllable and non-controllable costs is a prime requisite. But practical difficulties

arise while doing so on account of the complex nature & variety of costs.

 Separate departmental pursuits may lead to inter-departmental rivalry and it may

be prejudicial to the interest of the enterprise as a whole. Managers may act in the

best interest of their own, but not in the best interest of the enterprise

 Can’t be relied upon completely as a tool for management control. It is a system

just to direct the attention of management to those areas of performance which

require further investigation

 Preparation of an organization chart which clearly delineates lines of responsibility

and authority is a difficult task

 Responsibility accounting reports may be overloaded with all available information

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

LEARNING
NOTES
MODULE VI
FINANCIAL STATEMENTS
ANALYSIS AND
INTERPRETATION

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Definition

The term ‘financial analysis’, also known as analysis and interpretation of

financial statements’, refers to the process of determining financial strengths and

weaknesses of the firm by establishing strategic relationship between the items of the
balance sheet, profit and loss account and other operative data.

“Analyzing financial statements,” is a process of evaluating the relationship between

component parts of a financial statement to obtain a better understanding of a firm’s

position and performance.

Financial statement analysis is a process which examines past and current financial

data for the purpose of evaluating performance and estimating future risks and potential.

Financial statement analysis is used by investors, creditors, security analysts, bank

lending officers, managers, auditors, taxing authorities, regulatory agencies, labor unions,

customers, and many other parties who rely on financial data for making economic
decisions about a company.

Objective of Financial Statement Analysis

The major objectives of financial statement analysis are to provide decision makers

information about a business enterprise for use in decision-making. Users of financial

statement information are the decision-makers concerned with evaluating the economic

situation of the firm and predicting its future course.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Importance of Financial Statement Analysis

Financial statement is prepared at a certain point of time according to established

convention. These statements are prepared to suit the requirement of the proprietor. For

measuring the financial soundness, efficiency, profitability and future prospects of the

concern, it is necessary to analyze the financial statement. Following purposes are served

by the financial analysis:

o Help in Evaluating the operational efficiency of the Concern - It is

necessary to analyze the financial statement for matching the total expenses

incurred in manufacturing, advertising, selling and distribution of the finished

goods and total financial expanses of the current year comparing with the total

expanses of the previous year and evaluate the managerial efficiency of concern.

o Help in Evaluating the short and long term financial position - It is

necessary to analyze the financial statement for comparing the current assets and

current liabilities to evaluate the short term and long term financial soundness.

o Help in calculating the profitability - It is necessary to analyze the financial

statement to know the gross profit and net profit.

o Help in indicating the trend of achievements - Analysis of financial statement

helps in comparing the financial position of previous year and also compare various

expenses, purchases and sales growth, gross and net profit.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Problems with Financial Statement Analysis

While financial statement analysis is an excellent tool, there are several issues to be aware

of that can interfere with your interpretation of the analysis results. These issues are:

 Comparability between periods

The company preparing the financial statements may have changed the accounts in

which it stores financial information, so that results may differ from period to period.

For example, an expense may appear in the cost of goods sold in one period, and in

administrative expenses in another period.

 Comparability between companies

An analyst frequently compares the financial ratios of different companies in order to

see how they match up against each other. However, each company may aggregate

financial information differently, so that the results of their ratios are not really

comparable. This can lead an analyst to draw incorrect conclusions about the results

of a company in comparison to its competitors.

 Operational information

Financial analysis only reviews a company's financial information, not its operational

information, so you cannot see a variety of key indicators of future performance, such

as the size of the order backlog, or changes in warranty claims.

Thus, financial analysis only presents part of the total picture.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

Techniques in Financial Statement Analysis

o Trend analysis

Trend analysis is also called time-series analysis. Trend analysis helps a firm's

financial manager determine how the firm is likely to perform over time. Trend

analysis is based on historical data from the firm's financial statements and forecasted

data from the firm's pro forma, or forward looking, financial statements. One popular

way of doing trend analysis is by using financial ratio analysis. If you calculate

financial ratios for a business firm, you have to calculate at least two years of ratios

in order for them to mean anything. Ratios are meaningless unless you have

something to compare them to, in this case other years of data. Trend analysis is

even more powerful if you have and use several years of financial ratios.

o Common size financial statement analysis

Common size financial statement analysis is analyzing the balance sheet and income

statement using percentages. All income statement line items are stated as a

percentage of sales. All balance sheet line items are stated as a percentage of total

assets. For example, on the income statement, every line item is divided by sales and

on the balance sheet, every line item is divided by total assets. This type of analysis

enables the financial manager to view the income statement and balance sheet in a

percentage format which is easy to interpret.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

o Percentage Change Financial Statement Analysis

Percentage change financial statement analysis gets a little more complicated. When

you use this form of analysis, you calculate growth rates for all income statement

items and balance sheet accounts relative to a base year. This is a very powerful form

of financial statement analysis. You can actually see how different income statement

items and balance sheet accounts grew or declined relative to grows or declines in

sales and total assets.

o Benchmarking

Benchmarking is also called industry analysis. It involves comparing a company to

other companies in the same industry in order to see how one company is doing

financially compared to the industry. This type of analysis is very helpful to the

financial manager as it helps to see if any financial adjustments need to be made.

o Financial ratio analysis

Are usually used for benchmarking analysis. Financial ratios for other companies can

be obtained from a number of sources.

Methods of Financial Statement Analysis

There are two key methods for analyzing financial statements.

o The use of horizontal and vertical analysis.

Horizontal analysis is the comparison of financial information over a series of

reporting periods, while vertical analysis is the proportional analysis of a financial

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

statement, where each line item on a financial statement is listed as a percentage of

another item. Typically, this means that every line item on an income statement is

stated as a percentage of gross sales, while every line item on a balance sheet is

stated as a percentage of total assets. Thus, horizontal analysis is the review of the

results of multiple time periods; while vertical analysis is the review of the proportion

of accounts to each other within a single period.

o Use of Various Financial Ratios

Use ratios to calculate the relative size of one number in relation to another. After

the calculation of ratio, compare it to the same ratio calculated for a prior period, or

that is based on an industry average, to see if the company is performing in

accordance with expectations. There are several general categories of ratios, each

designed to examine a different aspect of a company's performance. The general

groups of ratios are:

 Liquidity ratios - This is the most fundamentally important set of ratios,

because they measure the ability of a company to remain in business.

 Cash coverage ratio - Shows the amount of cash available to pay interest.

 Current ratio - Measures the amount of liquidity available to pay for

current liabilities.

 Quick ratio - The same as the current ratio, but does not include inventory.

 Liquidity index - Measures the amount of time required to convert assets

into cash.

RHEA ALLETTE D. CLAVERIA – Student ID: 2020 - 15010

 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 Activity ratios - These ratios are a strong indicator of the quality of

management, since they reveal how well management is utilizing company

resources.

 Accounts payable turnover ratio - Measures the speed with which a

company pays its suppliers.

 Accounts receivable turnover ratio - Measures a company's ability to

collect accounts receivable.

 Fixed asset turnover ratio - Measures a company's ability to generate

sales from a certain base of fixed assets.

 Inventory turnover ratio - Measures the amount of inventory needed to

support a given level of sales.

 Sales to working capital ratio - Shows the amount of working capital

required to support a given amount of sales.

 Working capital turnover ratio - Measures a company's ability to

generate sales from a certain base of working capital.

 Leverage ratios - These ratios reveal the extent to which a company is relying

upon debt to fund its operations, and its ability to pay back the debt.

 Debt to equity ratio - Shows the extent to which management is willing

to fund operations with debt, rather than equity.

 Debt service coverage ratio - Reveals the ability of a company to pay its

debt obligations.

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 Institute of Graduate Program Education
MASTER IN BUSINESS ADMINISTRATION (MBA)
BA – 103 (Managerial Accounting)

 Fixed charge coverage - Shows the ability of a company to pay for its

fixed costs.

 Profitability ratios - These ratios measure how well a company performs in

generating a profit.

 Breakeven point - Reveals the sales level at which a company breaks

even.

 Contribution margin ratio - Shows the profits left after variable costs are

subtracted from sales.

 Gross profit ratio - Shows revenues minus the cost of goods sold, as a

proportion of sales.

 Margin of safety - Calculates the amount by which sales must drop before

a company reaches its breakeven point.

 Net profit ratio - Calculates the amount of profit after taxes and all

expenses have been deducted from net sales.

 Return on equity - Shows company profit as a percentage of equity.

 Return on net assets - Shows company profits as a percentage of fixed

assets and working capital.

 Return on operating assets - Shows company profit as percentage of

assets utilized.

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