Discussion—Responsibility Centers

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Assignment 3: Discussion—Responsibility Centers

As we conclude our study of managerial accounting this week, reflect on the knowledge you have gained through the various assignments in this course and how these concepts can be applied to your current and future work situations. What do you think were the three most interesting managerial accounting concepts we covered over the past 5 weeks? What were the three most challenging concepts presented? Explain your choices in a 2-3 paragraph reflective essay and submit to the week 5 discussion area.

Below is a few topics to choose from when explaining the most interesting and challenging concepts. However, you may elect to discuss the below topics with your knowledge and encounter with them.

Floral bloom Case Study

The master budget is a coordinated effort among all departments and divisions of an organization to develop plans that can be used as a blueprint for operations. The master budget is broken down into an operating budget component and a financial budget component. The operating budget includes sales, inventory, purchases/production costs, cost of goods sold, operating expenses, and the budgeted income statement. The financial budget includes the cash budget, budgeted balance sheet, and budgeted statement of cash flows.

Management should take great care to ensure that budget projections are as realistic as possible if they are to be useful in planning and controlling operations and in making projections. The master budget is meant to be a blueprint for operations. Budgets are used to estimate and plan for production, hiring, administrative support, salaries, etc. Unrealistic budgets can wreak havoc on the planning process and make it difficult to use variance analysis for control purposes. In addition, it can have a significant impact on employee morale. Budgets are compared to actual results in preparing and analyzing performance reports for each department or division of the organization.

Organizations have traditionally used either a top-down or bottom-up approach to budgeting. In a top-down approach, the upper echelons of management determine budgets and present them to lower level managers to execute. In a bottom-up approach, the budgeting process begins with lower level managers and works its way up to the top. Quite often, these budgets are sent back down the line for refinement. Top-down budgeting tends to be more congruent with the overall goals of the organization while bottom-up budgeting tends to be more realistic.

Whether an organization uses a top-down or bottom-up approach to budgeting depends on the management philosophy. Centralized organizations tend to use a top-down approach to budgeting while decentralized organizations tend to use a bottom-up approach. Employees tend to buy in and work harder to achieve budgets in a bottom-up approach where they have had input in the budgeting process.

Activity-Based Costing

Traditional methods of overhead allocation such as a single plant-wide rate or separate overhead rates for each department use traditional activity bases that are typically related to direct labor hours or cost (labor-intensive processes) or machine hours (highly automated processes). For example, a company that was basically labor-intensive would base its single plant-wide rate on direct labor hours or direct labor cost, whereas a company that was highly automated would use machine hours. A company in which some departments were labor-intensive and others were highly automated would use separate overhead rates for each department.

Activity-based costing (ABC) uses both traditional and nontraditional activity bases such as number of purchase orders, number of setups, or number of inspections. For example, a company that has heterogeneous products using activities within a department in differing ways would benefit from separating departmental overhead into separate activity pools, each with its own activity base.

The formula for calculating overhead rates is the ratio of estimated annual overhead and estimated annual activity base. Traditional and ABC methods of allocating overhead are similar because they all use the same formula for calculating respective overhead rates. They differ in the use of estimated overhead in various calculations. A single plant-wide rate includes total estimated overhead for the entire plant in the rate calculation.

In calculating departmental rates, total estimated overhead is broken down into separate overhead pools for each department. ABC further breaks down department estimated overhead into separate overhead pools for each identified activity in calculating overhead rates for each activity. As organizations consider whether to use a single plant-wide rate, departmental rates, or activity rates for the purpose of allocating overhead, they need to consider cost versus benefits of each allocation method. In evaluating cost versus benefit, organizations need to examine how products use resources in each department or process. If products are very homogeneous and use resources in similar ways, then a single plant-wide rate might suffice. For example, consider a soft drink manufacturer like PepsiCo. The basic production process is the same for all soft drink products.

If products consume resources in differing ways or to different degrees, then multiple rates may be beneficial. For example, a manufacturer of small electrical tools has variation in the design and purpose of various tools. Therefore, the production process could be significantly different. Variance in resource use occurs when products produced are more heterogeneous in nature. In this case, department rates or activity rates may be more appropriate.

Managers may prefer to use ABC because of its focus on activities that drive resource consumption. A more accurate allocation of overhead is achieved in situations where activity use varies among products. Also, ABC encourages managers to focus on specific activities within departments. In doing so, managers can identify non-value-added activities and determine ways to eliminate or reduce them. A good example of cost savings from eliminating non-value-added activities is found in organizations that have implemented a just-in-time inventory system to eliminate the cost of storing and moving raw materials and finished goods.

Standard Cost Decisions and Variance Analysis

Managers use flexible budgets as part of the control process. Flexible budgets compare actual results to budgeted outcomes. Flexible budgets categorize items on the basis of cost behavior. Variable costs are stated on a unit basis while fixed costs are presented in total. It is important when preparing a flexible budget that static budget figures are not used. Rather, budget figures need to be restated on the basis of actual volume for comparability purposes. When analyzing budget variances, managers typically use management by exception and analyze all significant variances (favorable and unfavorable).

Analyzing these variances helps management to control the productive process by taking corrective action where needed. For example, an unfavorable materials quantity variance could have occurred because the purchasing department purchased substandard materials, or the production manager used less-skilled workers resulting in more wasted material. By investigating the specific situation, management could determine the exact cause of the unfavorable materials quantity variance and take corrective steps.

Standard costs are used by manufacturing organizations to project unit product costs. Managers use standards developed for direct material, direct labor, and manufacturing overhead to control operations and to determine product selling prices. Organizations use information provided by the purchasing and human resources departments, as well as time and motion studies, to gather data needed to establish standards.

For example, a manufacturer of fine furniture could use a time and motion study to determine the amount of time it should take to complete each stage in the production process. This information would then be used to set the direct labor efficiency standard for a particular product. Using the collected data, managerial accountants develop direct material price and quantity standards, direct labor rate and efficiency standards, and variable and fixed overhead standards per unit for each product manufactured.

Actual manufacturing data from each period is compared to budgets (prepared on the basis of established standards) and a variance analysis is prepared. Managers use the variance analysis as a tool to control operations. Based on the results of the variance analysis, corrective action is taken where needed in the production process. Managers compare actual costs to standard costs for the same level of activity to determine variances. Variance analysis is then used to break down overall variances to component parts (e.g., material price and quantity, labor rate, and efficiency) to determine the cause of the variances. Corrective action can then be taken based on the cause of the variance.

Manufacturing organizations typically prepare income statements in two different formats: variable costing and absorption costing.

Cost-Volume Profit Analysis

Cost-volume-profit (CVP) analysis uses a contribution margin format and focuses on cost behavior to aid managers and accountants in projecting revenues, costs, and operating income based on various business scenarios. Costs are classified as fixed and variable to evaluate the impact of changes in volume.

Total fixed costs do not change in relationship to changes in volume over the relevant range of activity. For example, monthly rent on the factory building would be the same regardless of the volume of production for the month. However, total variable costs increase or decrease in direct proportion to the changes in volume.

Managers and accountants use CVP analysis to predict the impact of changes in sales price, volume, unit variable costs, and total fixed costs on operating income. For example, the manager of a local coffee shop might consider lowering the sales price of drinks hoping that the reduced cost will increase the volume of customer purchases by 10%. CVP analysis can be used to evaluate the impact of this strategy on operating income. Managers could also determine the volume of sales that would be needed to achieve a certain level of operating income.

Consider a proposal to add a new location to a restaurant chain. You would need to project expenses such as rent, salaries, food cost, advertising, and insurance. In addition, the volume of customers would need to be projected to determine potential revenues. CVP analysis could be used to assess the degree of risk associated with the proposal. Based on market analysis, projections are made concerning revenues, costs, and operating income in the first year of operations.

In analyzing this proposal, management will want to initially calculate the breakeven point in units or sales i.e., the point at which total revenue exactly equals total costs (fixed and variable). A sales level above this point results in a profit, while a sales level below this point results in a loss. Breakeven sales can be compared to the projected sales level in the first year to determine degree of risk. The larger the difference between breakeven sales and projected sales, the less the risk of loss, if projections prove inaccurate.

Cost Accounting Systems and Cost Accumulation

Manufacturers use costing systems to accumulate product costs and allocate those costs to units produced. Job order and process costing systems are similar in their purpose, which is to accumulate the cost of direct materials, direct labor, and manufacturing overhead and allocate those product costs to the units produced. However, the approach differs according to the cost accumulation process.

A job costing system accumulates costs on the basis of each job or job lot. This system works well with organizations that produce unique, high-dollar value products such as those in the construction, shipbuilding, and airplane manufacturing industries. For example, a shipbuilder might contract to build a cargo ship, a luxury passenger liner, or a nuclear submarine. Each of these vessels will have unique features and the cost of building each vessel would be significantly different. The shipbuilder would benefit from accumulating costs on a vessel-by-vessel basis which would facilitate the comparison of costs and contract price in determining profit or loss on each job.

A process costing system accumulates product costs by department or process and then allocates those costs to products on the basis of equivalent units at each stage of production. This system works well for products that are more homogeneous and mass-produced in an assembly-line fashion. A soft drink manufacturer like Coca-Cola is a good example. Each bottle of a particular soft drink (Coke, Sprite, etc.) goes through the same manufacturing process. It would be very costly and extremely impractical to accumulate product costs on a unit basis (one bottle of soft drink). Instead, soft drink manufacturers accumulate costs by department or process (mixing, bottling, etc.) and then allocate those costs on the basis of equivalent units of production.

Cost Classification

Cost classification is an important consideration in the preparation and analysis of the income statement when considering differences among service, merchandising, and manufacturing organizations.

Consider the following examples:

· A service organization would benefit from distinguishing between direct and indirect costs.

· A merchandiser would want to distinguish between selling expenses and general and administrative expenses.

· A manufacturer would find it important to properly classify expenses as period or product costs. In addition, manufacturing organizations must subdivide product costs into direct material, direct labor, and manufacturing overhead. Manufacturing organizations use a cost-of-goods manufactured statement to determine the cost of products manufactured during the accounting period.