BEYOND THE

NUMBERS
CEU BUSINESS SCHOOL
MS LAURA IPACS MA MBA FCCA

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Course outline
•  How does management accounting deliver
value?
•  Cost classification and behaviour
•  Cost-volume-profit analysis
•  Relevant costs for decision-making
•  Value of costing systems
•  Considerations for making decisions
•  Managing performance

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Session 1

HOW CAN MANAGEMENT 3

ACCOUNTING ADD VALUE?

Lecturer: Laura Ipacs
Slide 4
Background Slide 5
Management accounting
and financial accounting
v Management accounting is concerned with the
provision of information intended to be useful to
management within the enterprise.
v Financial accounting is intended for users outside
the enterprise itself.

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Management Accounting
Management accounting measures and reports
financial and non-financial information that
helps managers make decisions to fulfil the
goals of an organisation.

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 Cycle of Planning & Control

Control Planning
Objectives

Compare actual
with Plan / budget Plan / Budget

Operate in line with

objectives
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Roles of management
accountant

•  Information
•  Control
•  Targets
•  Rewards

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Key Guidelines

1.  Cost-benefit approach

2.  Full recognition to behavioural as well as
technical considerations
3.  Use of different costs for different purposes

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Accounting now
•  Was: Is:

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Traditional vs.
strategic management
accountancy

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Strategic management
accounting

"a form of management accounting

in which emphasis is placed on
information which relates to factors
external to the firm, as well as non-
financial information and internally
generated information"

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Session 2

COSTS AND BEHAVIOUR 16

Definition of cost
•  What is ‘COST’?

•  Why do we need to know the cost?

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What Does Cost Mean?
•  There is no single definition of cost
•  Costs are developed and used for some specific
purpose
•  The way the cost is to be used will define the way it
should be computed

•  Management accountants have used different

systems, or classifications, to develop cost
information

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Objectives of costs…

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Cost Object
•  Management accounting concept

•  A cost object is something for which we want to

compute a cost:
•  A product
•  A product line
•  An organizational unit

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 Cost classification
Direct
€ Prod’n cost

Production costs X Indirect

Prod’n cost

Admin costs
Non-production costs X
Selling &
TOTAL COST/EXPENSES X Distribution
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Cost classification
Direct Production costs
Direct materials X
Direct labour X
Direct expenses X
Total direct cost = PRIME COST X

Indirect Production costs

Indirect materials X
Indirect labour X
Indirect expenses X
Total indirect cost = OVERHEADS X
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Total Production cost X
Cost behavior
Flexible resources are resources whose costs
are proportional to the amount of the resources
used
•  Wood used to make furniture in a factory
•  Electrical power to operate machinery
•  Fuel used to deliver the furniture to
customers

Variable costs – proportional to the amount

of resource used
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Cost behavior
•  Capacity-related resources are acquired in
advance of the work being done

•  Capacity-related costs depend upon how much

of the resource is acquired, not used

•  Fixed costs

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The full cost of any particular job is the sum of those costs that can be measured specifically in respect of the job (direct
costs) and a share of those costs that create the environment in which production (of an object or service) can take place,
but which do not relate specifically to any particular job (overheads).

The relationship between direct costs and indirect costs

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Analysis of the number of cost centres within a business
Source: Based on information taken from Drury and Tayles
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Flow of costs in an absorption costing system

The relationship between direct, indirect, variable and fixed costs of a particular job
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Breakeven Point Analysis

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The sloping line starting at zero represents the sales revenue at various volumes of activity. The point at which this finally
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catches up with the sloping total cost line, which starts at F, is the break-even point (BEP). Below this point a loss is made,
above it a profit.

Break-even chart
Example BEP

Cottage Industries Ltd makes baskets. The fixed

costs of operating the workshop for a month
total £500. Each basket requires materials that
cost £2. Each basket takes two hours to make,
and the business pays the basket makers £5 an
hour. The basket makers are all on contracts
such that if they do not work for any reason,
they are not paid. The baskets are sold to a
wholesaler for £14 each.

What is the BEP for basket making for the

business? 32
Example continued

The BEP (in number of baskets):

Fixed costs
=
(Sales revenue per unit – Variable costs per unit)

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Break even and load factors in the airline industry 34
Source: Derived from information contained in ‘Ryanair alert hits shares’ by Jon Ashworth, The Times, 4 June 2003, p. 21. The data in the article
are based on the year ended 31 March 2003.
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The sloping line is profit (loss) plotted against activity. As activity increases, so does total contribution (sales revenue less variable costs). At zero 36
activity there are no contributions, so there will be a loss equal in amount to the total fixed costs.

Profit–volume chart
Example
Total Sports Sports General
equipment clothes clothes

£000 £000 £000 £000

Sales 534 254 183 97

Variable costs (344) (167) (117) (60)
Contribution 190 87 66 37
Fixed costs (rent and so on) (138) (46) (46) (46)
Profit/(loss) 52 41 20 (9)

Should General be discontinued?

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Sessions 3

ASPECTS OF COSTING 38
 Traditional Absorption Costing

PRODUCTION OVERHEADS

PRODUCTION SETUP COSTS

MACHINE OIL
COST CENTRE
SUPERVISORS SALARY PRODUCTION OAR=
DEPT. A
MACHINE REPAIRS £ PER
BASIS OF MACHINE
FACTORY RENT & RATES ABSORPTION
MACHINE HOUR
APPORTIONED
HOURS
(Basis: Floor Area)
ELECTRICITY & POWER
APPORTIONED
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(Basis: Volume of Space
occupied)
 ACTIVITY BASED COSTING

PRODUCTION NO. OF PRODUCTION

OAR
SET UP COSTS SET UPS

MACHINE OIL
NO. OF MACHINE
& MACHINE HOURS OAR
REPAIRS

SUPERVISORS NO. OF LABOUR

OAR
SALARY HOURS
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ACTIVITIES COST DRIVERS

ABC
ž Activities generate transactions
ž Transactions generate costs
ž ABC traces costs to activities

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Undercosting and
Overcosting
•  Product undercosting:
A product consumes a relatively high
level of resources but is reported to
have a relatively low total cost.

•  Product overcosting:
A product consumes a relatively low
level of resources but is reported to
have a relatively high total cost.

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Undercosting and Overcosting

•  Jane, Mercedes and Cherie meet

occasionally for lunch.
•  Each one orders separate items.
•  Jane’s order amounts to 14
•  Mercedes consumed 30
•  Cherie’s order is 16
•  Total £60

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Undercosting and Overcosting

•  Assuming they divide the bill equally,

what is the average cost per lunch?
•  £60 ÷ 3 = £20
•  Jane and Cherie are overcosted.
•  Mercedes is undercosted.

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Story of three friends…
•  Joe, Jack and Josh share a flat. They decide to
share the costs of living. Common costs per
month are €:
Groceries (dinners) 200
Internet 30
Utilities 50
Cable TV 20
Total: 300 per month, i.e.
€ 100 per person.

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A few months later…

ž Joe finds a girlfriend and always has dinner in her house.

ž Jack also finds a girlfriend. She always comes to eat at
the friends’ house. He also monopolises the internet as he
works from home.
ž Josh never uses the internet, as he surfs on it all day in
his studio. He, however, likes to watch the TV when he
gets home and has a peculiar taste of films which nobody
else can stand.
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ž Solution??
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 Customer profitability analysis
Information for value

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Customer profitability
example
ž  Carver and Delta are customers generating about equal
revenue and seen as equally valuable customers

ž  A conventional cost accounting system, marketing,

selling, distribution, and administrative (MSDA)
expenses were allocated to customers at a rate of 35%
of Sales

CARVER DELTA
Sales $320,000 $315,000
CGS 154,000 156,000
Gross Margin $166,000 $159,000
MSDA expenses (@35% of Sales) 112,000 110,250
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Operating profit $ 54,000 $ 48,750
Profit percentage 16.9% 15.5%
Carver – Delta Example
ž  Delta required a great deal of hand-holding
and was continually inquiring whether the
company could modify products to meet its
specific needs

ž  Delta also:

¡  Tended to place many small orders for special products
¡  Required expedited delivery
¡  Tended to pay slowly
¢ All of which increased the demands on the order
processing, invoicing, and accounts receivable
process 52
Carver – Delta Example
•  Carver, on the other hand:
•  Ordered only a few products and in large
quantities
•  Placed its orders predictably and with long
lead times
•  Required little sales and technical support

•  The Accounting Manager in Marketing

suspected that Carver was a much more
profitable customer than the financial
statements were currently reporting 53
 Carver – Delta
Example
•  The picture of relative profitability of Carver and
Delta shifted dramatically
Carver Delta
Gross Margin (as previously) $166,000 $159,000
Marketing & tech. support 7,000 54,000
Travel to customer 1,200 7,200
Distribute sales catalog 100 100
Service customers 4,000 42,000
Handle customer orders 500 18,000
Warehouse inventory 800 8,800
Ship to customers 12,600 42,000
Total activity expenses 26,200 172,100
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Operating profit $ 139,800 $ (13,100)
Profit percentage 43.7% (4.2%)
Carver – Delta Example
•  As the manager suspected, Carver was a
highly profitable customer
•  Its ordering and support activities placed few
demands on the company’s marketing,
selling, distribution, and administrative
resources
•  Almost all the gross margin earned by selling
to Delta dropped to the operating margin
bottom line

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Customer Profitability
•  A whale curve for cumulative profitability typically reveals:
•  The most profitable 20% of customers generate between
150% and 300% of total profits
•  The middle 70% of customers break even
•  The least profitable 10% of customers lose 50% - 200%
of total profits, leaving the company with its 100% of total
profits

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Managing Customer
Profitability
•  What could be some reasons for low
profitability of customers?

•  How could it be improved?

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Session 4

DECISION-MAKING 60
Note in particular that future outlay costs may be either relevant or irrelevant costs depending on whether they vary with
the decision. Future opportunity costs and outlay costs, which vary with the decision, are relevant; future outlay costs,
which do not vary with the decision, and all past costs, are irrelevant.

Summary of the relationship between relevant and irrelevant costs

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One-Time-Only Special
Order
•  Gabriela & Co manufactures bath towels in
Jersey.
•  The plant has a production capacity of
44,000 towels each month.
•  Current monthly production is 30,000
towels.
•  The assumption is made that costs can be
classified as either variable with respect to
units of output or fixed.
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One-Time-Only Special
Order
Variable Fixed
Costs Costs
Per Unit Per Unit
•  Direct materials £6.50
•  Direct labour 0.50 1.50
•  Manufacturing costs 1.50 3.50
•  Total £8.50 £5.00

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One-Time-Only Special
Order
•  Total fixed direct manufacturing labour:
•  Total fixed overhead:

•  Marketing costs per unit are £7 (£5 of which is

variable).
•  What is the full cost per towel?

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One-Time-Only Special
Order

•  Variable:
•  Fixed:
•  Total:
•  A hotel in Southampton has offered to buy
5,000 towels from Gabriela & Co at £11.50
per towel for a total of £57,500.

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One-Time-Only Special
Order

•  No marketing costs will be incurred for this

one-time-only special order.
•  Should Gabriela & Co accept this order?
•  Why?

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Opportunity Costs,
Outsourcing
and Constraints

•  Opportunity costs are not recorded in formal

accounting records since they do not generate
cash outlays.
•  These costs also are not ordinarily
incorporated into formal reports.

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 ACCOUNTING
FOR QUALITY
Strategic management accounting

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Cost of
Nonconformance
and Quality Issues
ž Cost reduction has become a significant factor in
the management of most organizations

ž The premise underlying cost reduction efforts

today is to decrease costs while maintaining or
improving product quality in order to be
competitive

ž If the quality of products and services does not

conform to quality standards, then the
organization incurs a cost known as the cost of
nonconformance (CONC) to quality standards
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Quality
ž  Quality usually may be viewed as
hinging on two major factors:

1.  Satisfying customer expectations

regarding the attributes and
performance of the product
2.  Ensuring that the technical aspects
of the product’s design and
performance conform to the
manufacturer’s standards
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Costs Of Quality Control
ž  Classification of quality costs:
¡ Prevention costs
¡ Appraisal costs
¡ Internal failure costs
¡ External failure costs

ž  Experience shows that it is much less expensive

to prevent defects than to detect and repair them
after they have occurred

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Prevention Costs
Prevention costs are incurred to ensure that
companies produce products according to quality
standards:
•  Quality engineering
•  Training employees in methods designed to
maintain quality
•  Statistical process control
•  Training and certifying suppliers so that they
can deliver defect-free parts and materials
and better, more robust, product designs
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Appraisal Costs
•  Appraisal costs relate to inspecting products to
make sure they meet both internal and
external customers’ requirements

•  Inspection costs of purchased parts and

materials

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Internal Failure Costs
•  An internal failure occurs when the
manufacturing process detects a defective
component or product before it is shipped to an
external customer

•  Reworking defective components or products is

a significant cost of internal failures

•  The cost of downtime in production is another

example of internal failure
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External Failure Costs
•  External failures occur when customers discover
a defect

•  All costs associated with correcting the problem

•  For many companies, this is the most critical

quality cost to avoid

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Quality costs

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 Product Lifecycle
volumes

Maturity
Growth Decline

Introduce Sales
revenue
Develop Profit
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time
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Cost Control in the RD&E
Cycle  
•  By some estimates, 80% to 85% of a product’s
total life costs are committed by decisions made
in the RD&E cycle

•  Decisions made in this cycle are critical:

•  An additional dollar spent on activities that
occur during this cycle can save at least $8 to
$10 on manufacturing and post-manufacturing
activities:
•  Design changes
•  Service costs 81
Implications
•  True costs of product are identified
•  Price will change according to demand
•  Assess profitability over product life not by
period

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Lifecycle Impact

Shorter Clear
product Planning
lifecycles needed

90% cost Need to ensure

incurred before return can
product be achieved
reaches market in the timescale
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 Lifecycle Costs

ž The following table illustrates four types of

products and the percentage of life-cycle costs
incurred in each cycle

Combat Commercial Nuclear Computer

Jets Aircraft Missiles Software
RD&E 21% 20% 20% 75%*
Manufacturing 45% 40% 60% *
Service & Disposal 34% 40% 20% 25%
Average Years in
Life Cycle 30 25 2 to 25 5

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Target Costing
ž  A method of profit planning and cost
management that focuses on products with
discrete manufacturing processes

ž  Its goal is to design costs out of products in

the RD&E stage of a product’s total life cycle

ž  It is a relevant example of:

¡  How a well-designed MACS can be used for strategic
purposes
¡  How critical it is for organizations to have a system in
place that considers performance measurement across 85

the entire value chain

Target costing
Traditionally:
The focus
mark-up is internal
(2nd)

selling
price
Cost (3rd)
(1st)

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Target costing
Target costing:
The focus is
Profit external
(2nd)
selling
price
target (1st)
cost
(3rd)

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Target Costing Method
Although the initial steps appear similar to
traditional costing, there are some notable
differences:
•  Marketing research is customer-driven
•  Costs are managed using concurrent
design and engineering
•  The total-life-cycle concept is used by
making it a key goal to minimize the cost of
ownership of a product over its useful life

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Target costing

Estimated
cost - Target cost = Cost Gap

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Target costing success
•  Toyota
•  Mercedes
•  Boeing
•  Eastman Kodak
•  Daimler Chrysler
•  Texas Instruments

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Environmental and total
cost accounting
•  Environmental costs fall into two categories:
•  Explicit costs

•  Captured and understood in accounting and

budgeting

•  Implicit costs

•  Not so obviously understood

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Session 5

MEASURING PERFORMANCE 96
What are Financial
Controls?
Financial control involves the use of financial
measures to assess organization and
management performance
•  The focus of attention could be a product, a
product line, an organization department, a
division, or the entire organization
•  Focuses only on financial results
•  external stakeholders have traditionally relied
on financial performance measures to assess
organization potential
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The Environment of

Financial Control
•  Financial measures do not identify what is
wrong, but they do provide a signal that
something is wrong and needs attention

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Responsibility Center
Types
•  The accounting report prepared for a
responsibility center reflects the degree to which
the responsibility center manager controls
revenue, cost, profit, or return on investment

•  Three types of responsibility centers:

•  Cost centers
•  Profit centers
•  Investment centers

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 The Efficacy of

Financial Control
Critics of financial control have argued that:
•  Financial information is delayed—and highly aggregated—
information about how well the organization is doing in
meeting its commitments to its shareowners
•  This information measures neither the drivers of the
financial results nor how well the organization is doing in
meeting its other stakeholders’ requirements

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The Balanced
Scorecard
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Achieving Success in the

Information Era
•  To achieve success in the information era,
companies need more than prudent investment
in physical assets and excellent management of
financial assets and liabilities

•  Companies mobilize and create value from their

intangible assets as well as their physical and
financial ones

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Intangible Assets
•  An organization’s intangible assets
include:
•  Loyal and profitable customer relationships
•  High-quality processes
•  Innovative products and services
•  Employee skills and motivation
•  Databases and information systems

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Balanced Scorecard

The ‘balanced scorecard’ was developed by Kaplan

and Norton in 1992 as a tool to translate an
organisation’s vision and strategy into objectives
and measures. 106
Advantages of Balanced
Scorecard
•  Considers all strategic measures
•  Holistic view
•  Avoids short term arguments
•  Considers business activity
linkages
•  Forces organisation to look
externally
•  Useful for risk assessment

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Balanced Scorecard

Features
–  Broad outlook
–  Internal & external matters
–  Financial & non-financial
–  Identifies customer needs
Development
–  Specific to company
–  Can be created at all levels of management

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Strategic Mapping

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Connecting the Four
Perspectives
•  A strategy map provides a visual representation of
the linkages in the four perspectives of the BSC
Financial Perspective Return on Investment

Customer Perspective Customer Loyalty

On-Time Delivery

Internal Perspective Process Quality Cycle Time

Learning & Growth 110

Employees’ Process Improvement Skills
Perspective
Connections
•  Return on investment (ROI) is a widely
recognized measure of financial success

•  Repeated and expanded sales from existing

customers, the result of a high degree of
loyalty among existing customers, could be one
driver of this financial measure

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Connections
•  Analysis of customer preferences may reveal that
on-time delivery (OTD) of orders is highly valued
by customers
•  The company must excel at internal processes to
achieve exceptional OTD

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KPI Scorecards
•  Some organizations identify key performance
indicators (KPIs) and classify them into the four
BSC perspectives
•  KPIs typically are common measures, such as
customer satisfaction, quality, cost, employee
satisfaction, and morale

•  Companies may expand their compensation

system to reward executives for a broader set
of performance than simply short-term financial
results based on KPIs
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