Accounting #10 Management Accounting

[samvara]

Went to a seminar with Peter Thompson called "How Leaders Communicate" which was a rambling discussion about this and that. A tangent we didn't get to explore was how social media is replacing 'official' news sources in generation X, Y and presumably Z. I am wondering if this is a natural response to the lack of credibility of 'official' news.

Management Accounting: Managers need more than annual reports to make business decisions. Information needs to be regular, detailed and relevant. Managers also need forecasts and to accomplish this magnificent objective we buy expensive and sophisticated CMISs (Cost Management Information Systems). Small businesses may not feel the need but often struggle due to ineffective cash management and forward planning.

You can report on Cost Centers (spending), Profit Centers (spend and revenue) or Investment Centers (spend, revenue and investment of profit)

What kind of costs do we recognise?

• Direct costs: materials, labour, fuel etc.
• Indirect costs: advertising, maintenance etc.

We can measure costs by: product, customer, department, project, activity and we do this so we can measure them.

Cost-volume-profit analysis:

• Fixed Costs: do not change in response to level of activity. Rent, Depreciation of buildings, Rates, Salary of administrators. ie university premises - lecture theaters don't care if you use them every day or every second day.
• Variable costs: change in response to changes in the level of activity. Raw materials, sales commission, contract labour.

NB: Some costs are both - telephone has a base rate and a usage rate.

Cost-Volume-Profit equation (CVP)

• P = Sx - FC - VCx  where P = profit, S = selling price, x = number of units, FC = Fixed Costs and VC = Variable Costs

Example: how many units do you need to sell to break even if fixed costs are $40k, sale price is $10 per unit and it costs $6 per unit to make them?

• P = 0 = 10x -  40,000 -6x... rearrange and x = 10,000

Lots of algebra followed.

Other fun ways to slice'n'dice:

• Contribution Margin (CM) per unit = SP per unit - VC per unit
• B/E units = FC / Unit CM
• CM ratio = CM / Sale price
• B/E $ Sales = FC / CM ratio

Contribution Margin is important because it highlights the distinction between variable and fixed costs and can be used to make decisions about production. It is a bit simplistic and assumes linear behaviour which are not always accurate.