Managerial Accounting

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1. Basic Concepts

Product cost = Direct Labor (DL) + Direct Materials (DM) + Manufacturing Overhead (MOH)

Financial accountingManagerial Accounting

+ Sales+ Sales

- COGS- Variable Costs

= Gross Profit= Contribution Margin

- SG&A- Fixed Costs

= Net Profit= Net Profit

COGS (Cost of Goods Sold) is an “inventoriable cost” ( recorded in the Balance Sheet as inventory and expensed (Income Statement) when goods are sold

SG&A (Selling, General & Administrative) are periodical costs ( expensed as incurred directly in the Income Statement

Economic Value: ROCE – WACC (ROCE = Return on Capital Employed)

2. Seligram Case and Anagene Case - Effective cost systems

Classical cost systems: Overhead allocated based on DL$

Products that absorb many machine-hours are undercosted; vice-versa for labor-intensive products

If the total overhead is allocated to products, we enter the DEATH-SPIRAL: the more we eliminate unprofitable products, the less profitable become the remaining products (because they absorb the cost of excess capacity)

Possible paradox: very expensive machines are bought to automate production of one single product ( direct labor required for the product is reduced thanks to automation ( the driver for overhead allocation (which is DL$) decreases ( overhead cost for the product decreases! (rationally, it should increase of the cost of the machine)

Effective cost systems: allocation of overhead based on drivers

Steps to perform:

1) Quantify the total amount of resources

2) Identify the cost pools and quantify their costs

3) Identify suited drivers for each cost pool

4) For each driver, calculate the burden rate (beware of excess capacity!)

5) Allocate the cost pools to the cost objects (products) using the drivers

- Accuracy of managerial decision (pricing)
- Better allocation of resources
- Complexity
- Tracking / metering costs
- Expensive to be implemented
When should we implement such system?
- Heterogenic allocation of resources
- Big Overhead (Willy Sutton in house!)

Considerations on capacity:
- Excess capacity:
- Never allocate to products (risk of DEATH SPIRAL! Remember Youngstown exercise) - Outsource if possible, or fill somehow
- If impossible, get rid of it!
- Always make calculations based on PRACTICAL CAPACITY!
- The capacity of a system corresponds to the capacity of the BOTTLENECK!

- Business: electronic components testing, mostly in the captive market - Problem: use of cost accounting based on DL only, consequently Seligram seems more competitive on complex testing (because less labor intensive), but simple types of testing are penalized by the excessive allocation on costs related to machines. In other words, the labor intensive testing subsidize the machine intensive one - Solution:2 phases of improvement:

1. 2 cost pools: one for machines (driver: machine hours) and one for engineering and administration (driver: DL$) 2. 3 cost pools: the one for machines is split into one for the main testing room and one for the mechanical room (dedicated to one or two customers in the foreseeable future)

- Business: manufacturing of gene sequencing devices (including cartridges); start up company - Problem: great fluctuation in monthly sales; forecasted sales used as driver for cost allocation ( decrease in sales vs expected implies revision of burden rates ( pricing is adjusted to maintain margins ( customers are even more alienated ( DEATH SPIRAL! - Solution: practical capacity must be used to calculate the burden rates to be used for cost accounting purposes. Moreover, consider that the practical capacity of the system corresponds to the one of the bottleneck!

3. Wilkerson Case - Activity Based Costing (ABC)

Steps to perform:
1) IDENTIFY activities that generate costs
2) IDENTIFY cost of the activities
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