Managerial Accounting For Dummies
Managerial accounting helps managers and other decision-makers understand how much their products cost, how their companies make money, and how to plan for profits and growth. To use this information, company decision-makers must understand managerial-accounting terms. When planning for the future, they follow a master budgeting process. To prepare this budget, and to understand how costs behave, the decision-makers should understand cost-volume-profit relationships, which explain how changes in volume or price affect profits.
Key Costs Related to Managerial Accounting
In accounting, a cost measures how much you pay/sacrifice for something. Managerial accounting must give managers accurate cost information relevant to their management decisions. Here are several cost-related terms you encounter in managerial accounting:
Direct cost: Cost that you can trace to a specific product
Indirect cost: Cost that you can't easily trace to a specific product
Materials: Physical things you need to make products
Labor: Work needed to make products
Overhead: Indirect materials, indirect labor, and other miscellaneous costs needed to make products
Variable costs: Costs that change in direct proportion with activity level
Fixed costs: Costs that don't change with activity level
Mixed costs: Combination of fixed and variable costs
Contribution margin: Sales less variable costs
Product costs: Costs needed to make goods; considered part of inventory until sold
Period costs: Costs not needed to make goods; recorded as expenses when incurred
Work-in-process cost: How much you paid for goods that are started but not yet completed
Finished goods cost: How much you paid for goods completed but not yet sold
Cost of goods manufactured: The cost of the goods completed during a period
Cost of goods sold: The cost of making goods that you sold
Controllable costs: Costs that you can change
Noncontrollable costs: Costs that you can't change
Conversion costs: Direct labor and overhead
Incremental costs: Costs that change depending on which alternative you choose; also known as relevant costs and marginal costs
Irrelevant costs: Costs that don't change depending on which alternative you choose
Opportunity costs: Costs of income lost because you chose a different alternative
Sunk costs: Costs you've already paid or committed to paying
Historical cost: How much you originally paid for something
Cost per unit: Cost of a single unit of product
Expense: Costs deducted from revenues on the income statement
Cost driver: Factor thought to affect costs
Process cost: Cost of similar goods made in large quantities on an assembly line
Job order cost: Cost of a batch of specially made goods
Absorption cost: Cost that includes fixed and variable product costs
Target cost: Cost goal set for engineers designing a product
Budgets that Go into Creating a Master Budget
A master budget is a plan created to manage a company's manufacturing and sales activity to meet profit and cash flow goals. Creating a master budget requires careful coordination of several smaller budgets covering all parts of the organization; that way, the master budget is realistic but not complacent.
The master budget contains the following elements:
Direct materials budget
Direct labor budget
Manufacturing overhead budget
Selling and administrative budget
Capital acquisitions budget
Budgeted financial statements
Cost-Volume-Profit Relationships for Managerial Accounting
Managerial accounting provides useful tools, such as cost-volume-profit relationships, to aid decision-making. Cost-volume-profit analysis helps you understand different ways to meet your company’s net income goals. This image describes the relationship among sales, fixed costs, variable costs, and net income:
The bottom axis indicates the level of production — the number of units you make.
The left axis indicates value in dollars.
Where total sales equals total costs, the company breaks even (which is why that’s called the break-even point).
The shaded area to the upper right of this break-even point is profit.
The shaded region to the lower left is net loss.
Total variable costs are a diagonal line because the higher the production, the greater the variable costs.
The total fixed costs line is horizontal because regardless of the production level, fixed costs stay the same.
Total costs equal the sum of total variable costs and total fixed costs.