Accounting for Management: Concepts & Tools v.2.0- Course Transcript Presented by: TeachUcomp, Inc.

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1 Accounting for Management: Concepts & Tools v.2.0- Course Transcript Presented by: TeachUcomp, Inc. Course Introduction Welcome to Accounting for Management: Concepts and Tools, a presentation of TeachUcomp, Inc. This course introduces concepts related to Managerial Accounting. We will discuss the role of a managerial accountant, costing systems used by managerial accountants, and how managerial accountants assist in decision-making. In addition, the course will cover budgeting and profit planning. This course contains three chapters and six learning objectives. By the end of this course, you should be able to do all of the following: Describe the role of managerial accountants; name three key areas of focus for managerial accountants; list four commonly-applied business costing systems; describe cost objects, cost pools, and cost drivers; list five types of budgets that are commonly-created by managerial accountants; and describe profit planning and profit management methods employed by managerial accountants. We recommend printing the course transcript and using it to follow along and take notes during the video lessons. We will also be referencing the review questions, which can be accessed and printed through the training interface. We strongly recommend that you complete the review questions independently. The evaluative feedback that is provided tells us why a question was right or wrong and further assists in the retention of material. Once you have completed each of the video lessons and the review, you will be required to take a final exam. Please complete the final exam and submit it to us, using the instructions in the Submittal Form which can also be accessed in the training interface. Now, please select the next video lesson to continue with the rest of the course. Page 1 of 14

2 CHAPTER 1- INTRODUCTION TO MANAGERIAL ACCOUNTING 1.1- Chapter One Learning Objectives and Key Terms In this chapter, we will introduce basic concepts related to managerial accounting. Let s begin by reviewing the learning objectives for Chapter One. By the end of this chapter, you should be able to describe the role of managerial accountants. You should also be able to name three key areas of focus for managerial accountants. There are two key terms for Chapter One. They are analysis and management. The first key term for this chapter is analysis. In broad terms, analysis describes a detailed examination of some system or object. Analysis is typically performed as a basis for discussion, interpretation, or improvement. In this course, we will focus primarily on the types of analyses that take place in business settings; such as the analysis of financial data, risk, and performance. The next key term for Chapter one is management. As used in this course, management describes activities that are undertaken for the purpose of accomplishing a business-related goal. In business settings, management typically includes many different types of activities; including planning, staffing, organizing, and controlling people, processes, and other organizational resources What is Managerial Accounting? In this lesson, we will introduce basic concepts related to managerial accounting. Also called management accounting, managerial accounting describes the process of identifying, recording, analyzing, and presenting a company s internal and operational financial information to its business leaders to facilitate the process of making business decisions. The goal of managerial accounting is to help business leaders make better decisions about various aspects of organizational operations by analyzing the financial information available. Unlike financial accounting, which focuses on making information about a business available to outside interests such as investors, lenders, and governmental regulatory agencies, the focus of managerial accounting is internal. The financial research, calculations, and reports generated by a managerial accountant are not shared with outside interests, even though the data derived by managerial accounting is often very similar to data found in public financial reporting. Managerial accountants focus solely on providing financial information about an organization to the internal leadership of the organization, so that leaders can make more informed financial decisions. Ultimately, managerial accountants help business leaders to develop and meet organizational goals The Managerial Accountant s Role The main role of a managerial accountant is to help business leaders make internal decisions related to planning for and managing various aspects of an organization such as costs, budgets, and profit. Page 2 of 14

3 Some of the duties of a managerial accountant are past focused. For example, managerial accountants evaluate organizational performance by comparing actual performance against planned performance, which involves looking at data from the past. Managerial accountants also track the use of organizational resources, which is another example of examining data from the organization s past. Other duties performed by managerial accountants are future focused. For example, a managerial accountant might use information from an organization s past supply costs to plan the coming year s supply budget for the organization. Even though data from the past is examined, it is used to extrapolate and predict future events. The ability to use past information for predictive purposes is essential for managerial accountants, because much of managerial accounting involves planning for various financial aspects of an organization s future. Managerial accountants are both advisors and decision-makers. In some cases, a managerial accountant might research the past financial data of an organization in order to spot trends in labor costs, and then prepare a report of findings, conclusions, and recommendations for management within the organization s payroll department. The payroll department management would then make decisions based, at least in part, on the managerial accountant s report. In other cases, the managerial accountant might do the same labor cost research, and then the managerial accountant would make decisions based on the research. For example, the managerial accountant might decide to limit the number of overtime hours being worked in the organization s manufacturing facility, and the new policy would be implemented. Although the exact role and duties of a managerial accountant might vary slightly between organizations, all managerial accountants are seen as value-creators for the organizations which employ them. As such, most managerial accountants work in partnership with organizational managers on a variety of decision-making issues Key Areas of Focus within Managerial Accounting Managerial accountants perform a variety of duties within an organization, most of which relate to either planning or managing organizational operations. Where managing an organization is concerned, most tasks performed by a managerial accountants fall into one of three categories: strategic management, risk management, and performance management. Strategic management involves implementing a set of continuing processes and activities for the purpose of aligning organizational goals with organizational operations. Although there are no hard and fast rules that determine strategic management methodology, most managerial accountants apply strategic management using four basic, repeating steps. First, the managerial accountant performs an assessment of the organization s current state. This assessment includes analyzing the internal workings of the organization, such as comparing projected costs against actual costs; as well as analyzing how the organization is performing externally, such as comparing the organization s performance against another organization of the same size and type. The second step of strategic management, in broad terms, is the formulation of an organizational strategy to address issues that came up during the assessment and analysis undertaken in step one. This second step is theoretical in nature, and can be thought of as the brainstorming part of strategic management. The third step of strategic management is the Page 3 of 14

4 implementation of the organizational strategy at the operational level. For example, if a managerial accountant developed an organizational strategy to address high supply costs, the strategy might be expressed as simply as, reduce supply costs. During step three of strategic management, the strategy is implemented on the operational level. This might be accomplished in any number of ways, such as changing ordering policies so that volume discounts could be obtained, or changing suppliers. The fourth basic step in strategic management relates to the ongoing evaluation of operations so that the impact of changing policies can be observed. This allows for the refinement of organizational strategies. Risk management is another key focus for managerial accountants. From an accounting perspective, business risk involves financial decisions that may bring loss, injury, or some other harm to an organization. Managerial accountants understand that business risk is unavoidable, and some risks, called tolerable risks, are even acceptable. However, some risky financial behavior can be avoided or eliminated, which increases the financial security of an organization. Managerial accountants provide risk assessments and evaluations to determine which financial behaviors are putting the organization most at risk, and which of those behaviors can be reduced or eliminated. Managerial accountants use tools such as probability distributions, ratio analyses, and pricing models to identify and resolve financial risks in accordance with organizational goals. Performance management is a third key area of focus for managerial accountants. Performance management involves ensuring that an organization s employees are working as efficiently as possible to meet organizational goals. It also involves ensuring that products and services are being created and provided in a cost-efficient manner. As in other areas, managerial accountants accomplish performance management by analyzing the current state of the organization, developing strategies to increase organizational performance, and continuing to evaluate employee performance so that policies can be refined. In order to assist in performance management, many managerial accountants use information from cost accounting to make decisions. Cost accounting is the system of calculating and forecasting the cost per unit of a good or service produced by a company through the application of a costing system. As such, for all practical purposes, cost accounting is considered a part of managerial accounting, as the two systems are so closely intertwined. However, cost accounting is still technically a separate type of accounting. One costing system often applied to performance management by managerial accountants is standard costing, which is useful when evaluating departmental and organizational performance. Standard costing is a cost accounting system that establishes cost standards for activities performed by the company and its employees in the production of products and services. The managerial accountant can then periodically examine the cost standards to look for any existing cost variance. They can then assist the company by taking actions, or recommending actions to take, that will control any cost variance that may arise to keep costs in line with the forecasted cost expectations Relevant Costs in Decision-Making One of the most basic concepts in financial analysis for managerial accountants is the concept of relevant costs when making business decisions. In managerial accounting, relevant costs are the costs related to making a business decision. Relevant costs are also often described as the costs that will change, depending on which choice is made when choosing between alternatives when making a business Page 4 of 14

5 decision. The relevance of data used in any analysis will directly affect the usefulness of the information derived from the analysis. In other words, even if key ratios and metrics are applied in mathematically appropriate ways to perform an analysis, the results of the analysis will be useless if irrelevant data is used to calculate the ratios and metrics. For this reason, managerial accountants must always evaluate the relevance of data used in any analysis. As mentioned in the preceding paragraph, in managerial accounting, relevant costs are defined as costs that will change based on which choice is made when choosing between alternatives when making a business decision. They are also situational in nature. A cost may be considered relevant to one business decision, but not to another. When a business decision is considered, some costs will change based on the choice made, and some costs will stay the same. For example, assume you purchased a discount card for $50 at a local burger restaurant, named Burger Boys, that offered a 20% discount on their standard $10 double-cheeseburgers. With the discount card, when you purchase a double-cheeseburger from Burger Boys, you will only pay $8. Then assume that a new burger restaurant, named Better Burgers, opened and offered their double-cheeseburger, which is almost identical to the double-cheeseburger offered at Burger Boys, for $6. When deciding where to order a double-cheeseburger from in the future, from a managerial accounting standpoint when considering relevant costs, the answer is obviously Better Burgers. This is because their equivalent product costs $2 less. The $50 that you initially paid for the discount card is irrelevant to the decision, as that is an example of a sunk cost. Real-world examples of the consideration of relevant costs are rarely so straightforward, and it can often be difficult for analysts to determine exactly which costs should be included in analyses. Generally, any cost that will not change, regardless of which choice is made when considering alternatives in a business decision, should be considered irrelevant. Although there are always exceptions, several other generalizations about which costs are relevant to a financial analysis include the following examples. Generally, sunk costs are not considered relevant, because they cannot be avoided. Historical costs are not considered relevant, because they will not change regardless of which choice within a business decision is made. (The major exception to this generalization is the impact of historical costs on an organization s taxes.) Finally, in a make or buy situation, any costs or revenues that differ between the option to make and the option to buy are generally considered relevant. CHAPTER 2- COSTING SYSTEMS 2.1- Chapter Two Learning Objectives and Key Terms In this chapter, we will explore costing systems. Let s begin by reviewing the learning objectives for Chapter Two. By the end of this chapter, you should be able to list four commonly-applied business costing systems. You should also be able to describe cost objects, cost pools, and cost drivers. There are two key terms for Chapter Two. They are overhead and vendor. Page 5 of 14

6 The first key term for this chapter is overhead. As used in this course, overhead describes ongoing business expenses that are largely administrative costs. Overhead includes expenses incurred by a business that are necessary for the business to function, but which cannot be definitively attributed to revenuegenerating activities or units of output. As such, overhead describes business expenses not related to direct labor, materials, or third-party expenses that are passed on directly to customers. The next key term for Chapter Two is vendor. In broad terms, a vendor describes a person or entity that provides goods for sale. As used in this course, a vendor is a person or company that is primarily engaged in selling products, supplies, or equipment to businesses About Costing Systems This chapter will introduce concepts related to costing systems. A costing system is a framework of processes, controls, and reporting that is designed to track the costs incurred by an organization. As is the case with other duties performed by managerial accountants, the development and use of costing systems is for an organization s internal use, and is not part of public financial reporting. In a broad sense, costing systems are used to determine the cost of goods produced by an organization. These systems are useful for accomplishing the performance management aspects of a managerial accountant s job. Because organizations must constantly evaluate which organizational products or services are profitable, it is necessary to know how much it costs to produce each product or service. While often associated with the costs of creating products or providing services, a costing system can monitor and report upon many different areas of an organization, including organizational facilities, departments, processes, customers, or even geographical sales regions. Managerial accountants and organizational leadership use reports generated from costing systems for several purposes. In a broad sense, costing system reports are used to make decisions that will increase an organization s profitability. These decisions can relate to which costs can be eliminated or reduced, which policies must be adjusted, which products to discontinue, and so forth. In this regard, costing system analysis also affects the strategic management aspect of a managerial accountant s job, as well. There are many types of costing methods used in business. This lesson will present brief summaries of some of the most commonly applied business costing methods within the U.S. The first is known as a job costing system. In a job costing system, all relevant costs (including, but not limited to, overhead costs, material costs, and labor costs, for example) are compiled for an individual job or unit. Maintaining a job costing system is a very labor-intensive process, because the cost accumulation involved in such a system is very detailed. Job costing systems are best applied by businesses that produce custom products or services that are unique. For example, construction and remodeling companies often perform job costing analysis. Another type of costing system used in business is known as a process costing system. In a process costing system, all the relevant costs related to the process used to create a product are first aggregated for an entire production process, and then allocated to individual production units. Process costing systems are best applied to products which must move through many departments or production stages Page 6 of 14

7 before creating a finished product. For example, a chemical manufacturer may use process costing. In addition to job costing and process costing systems, some businesses have developed unique costing systems that are hybrids between both costing systems. Another increasingly popular type of costing system is known as activity-based costing, or ABC. Activitybased costing systems calculate the cost of each activity required to provide a service or create a product. The costs to provide a service or create a product are then calculated by determining the consumption rate of each activity required to create the product or provide the service. Activity-based accounting has increased in popularity and use in recent years, and has evolved from a method of product-costing to a system that is useful for planning, monitoring and controlling other types of business costs, as well. The final costing system to mention is the standard costing system. In standard costing systems, standard costs are created that determine how to perform an activity, provide a service, or create a product, and also determine how much it should cost per unit of activity performed, service provided, or product created. As actual work on performing activities, providing services, or creating products is accomplished, the actual costs incurred are then compared to the standard costs in order to note any variance between the two amounts. This then allows the managerial account to take actions, or recommend actions to take, which will assist the company in more closely adhering to the standards or adjusting the standards. This helps the company by eliminating variance when accomplishing their business goals. Standard costing systems work very well for businesses that repetitively produce a consistent product or repetitively provide a consistent service. Standard costing can also be used in conjunction with job costing, process costing, and activity-based costing methods Cost Objects Defining cost objects is the first step when determining the cost of services, products, or activities within many costing systems. The cost object is an essential part of the activity-based costing system. The following lessons in this chapter will discuss concepts related to activity-based costing. Note, however, that some of the concepts, such as the cost object, are also important to other accounting systems, such as reporting full costing (also known as absorption costing ) of inventory for public companies. The full costing method is required for financial reporting within U.S. GAAP and IFRS for financial accounting. A cost object is any item for which you want to know the cost and for which costs are separately measured. Cost objects are categorized by type, which include operational cost objects, business relationship cost objects, and output cost objects. Examples of operational cost objects include departments or company processes. Operational cost objects track operational costs. For example, if you wanted to determine the costs associated with operating an Accounting department within a company, the Accounting department would be considered the operational cost object. Examples of business relationship cost objects include customers and vendors. Business relationship costs objects track and determine the costs associated with interacting with different types of businessrelated entities. For example, if you wanted to determine the costs associated with acquiring raw Page 7 of 14

8 materials from vendor Supplies, Inc., the vendor named Supplies, Inc. would be considered the business relationship cost object. The most commonly used type of cost object is the output cost object. Output cost objects track and determine the costs associated with output of a business, meaning its products and/or services. Output cost objects are the most common cost objects, because determining costs related to producing a product or service is necessary in order to set prices and analyze profitability. For example, if you wanted to determine the costs associated with producing a product named Widget X, the product named Widget X would be considered the output cost object Cost Pools When applying activity-based costing, direct costs, meaning the costs required to create or produce the cost object, are relatively simple to measure. However, activity-based costing also requires indirect costs be applied to the cost object, as well. A cost pool is a grouping of indirect costs from which cost allocations are made. Cost allocation is the assignment of cost from a cost pool to cost objects. A cost object is any object for which you want to know the cost. In activity-based costing, cost pools represent indirect costs from each activity. Costs attributed to each cost pool relate to one indirect cost grouping, which are most commonly indirect materials, indirect labor, and overhead. After indirect costs are assigned to a cost pool, appropriate cost drivers (which are discussed in the next lesson) for each cost pool can then be identified. Costs are then allocated from the cost pool to the cost object in proportion to the amount of the activity consumed by the production of the cost object. Indirect material cost pools categorize costs necessary for the production of a cost object, but which are not directly traceable to any one cost object. For example, if you purchased conveyor belt lubricant because it was required to apply it to all of the conveyor belts used to create all of your different products in order to keep them operational, the cost of the conveyor belt lubricant is an indirect material cost. Any similar indirect material costs, necessary to production but not directly traceable to any one cost object, will also fall under the indirect materials cost pools for later cost allocation. Indirect labor cost pools categorize labor costs necessary for the production of a cost object, but which are not directly traceable to any one cost object. In other words, indirect labor costs are usually related to the costs related to employees who do not have a direct impact on the production of the cost object. For example, a manufacturer might hire general quality control inspectors who are not directly involved in the production process. The costs associated with the general quality control inspectors would be indirect labor costs. Any other such indirect labor costs which are not directly traceable to any one cost object, such as general production supervisors, will also fall under the indirect labor cost pools for later allocation. Page 8 of 14

9 Overhead cost pools categorize many different types indirect costs necessary for the production of a cost object, but which are not directly traceable to any one cost object. Because of the large variability of the types of costs found within this cost pool, this can be a troublesome cost pool for internal auditors. Overhead costs can generally be broken down into two separate types of overhead costs: administrative overhead costs and manufacturing overhead costs. Administrative overhead costs are not related to the production or development of the cost object. Manufacturing overhead costs are all of the overhead costs related to the production or development of the cost object that are NOT direct costs, indirect materials costs, or indirect labor costs. Examples of administrative overhead costs include, but are not limited to, sales costs and front-office costs. Examples of manufacturing overhead costs include, but are not limited to, depreciation of equipment used to manufacture the cost objects and costs to repair the equipment used to manufacture the cost object. Overhead costs are aggregated into one or more overhead cost pools for later allocation Cost Drivers In activity-based costing, a cost driver is a factor, or characteristic of an activity, that can cause a change in the cost of a business activity. In other words, cost drivers are the factors that cause the overall cost in an activity s cost pool to increase or decrease. Once a managerial accountant has set the cost pools for an activity, they can then determine which cost drivers are the factors responsible for driving the cost of the activity. An activity may have one, or more than one, cost driver. Valid cost drivers must have a causal relationship between the cost driver and the costs incurred. This means that as the cost driver increases, the resulting costs incurred should increase, as well. Cost drivers can be generally categorized into three basic types: volume, time, and charge. Volume-based cost drivers increase the costs in the associated cost pools as the units of work of the volume-based cost driver increases. An example of a volume based cost driver, if considering a product as the output cost object, could be the number of units produced of the product. For example, increasing the number of units of the product created could also increase the costs within the indirect material costs pool. Timebased cost drivers increase the costs in associated cost pools as the duration of time increases. For example, if considering a product as the output cost object, increasing the operating hours of the machine used to create the product could results in an increase to costs in a manufacturing overhead cost pool for machine repair costs as the hours of machine use increases. The least-used type of cost driver is the charge cost driver. An example of this may be attributing the depreciation expense of a machine used to create a product to the products produced. As mentioned above, cost drivers are most often measured in numeric units. The number often represents various increments of volume or time, such as the number of product manufactured or the number of labor hours associated with an activity. When identifying cost drivers, managerial accountants must match cost drivers and cost pools carefully. This is done by considering the extent to which costs will change based on cost driver values changing. The more direct the correlation between the cost driver and the cost pool, the more accurately the managerial accountant will be able to track expenses. Additionally, as the number of cost drivers used to describe an activity increases, the accuracy of the information derived from the costing system will also increase. However, the development of a highly-complex costing system Page 9 of 14

10 will incur expenses of its own, so managerial accountants must also be sensible as cost pools and cost drivers are identified Cost Allocation Cost allocation is a fundamental aspect of activity-based costing systems. Cost allocation describes the process of assigning indirect costs within cost pools to cost objects. While it is easy to assign directs costs to the appropriate cost object, the same is not true of indirect costs. Because indirect costs cannot be directly traced to any one cost object, they must be allocated, or distributed, among one or more cost objects. Cost allocation is important because it should, if done well, accurately apportion indirect costs to related cost objects. Cost allocation is referred to by many terms, including spreading costs, apportioning costs, and assigning costs, just to name a few. Whatever term is used, cost allocation is the basic process of matching indirect costs within cost pools with cost objects. Because there is no exact way to determine how much of an indirect cost is directly attributable to one cost object, cost drivers are used as the basis of cost allocation. Cost allocation procedures are often refined over time, as information becomes available that makes it possible to refine the cost drivers used and to make more relevant cost allocations. Using cost drivers that most accurately reflect the causal links between indirect costs in a cost pool and related cost objects is the best method of cost allocation. CHAPTER 3- BUDGETING AND PROFIT PLANNING 3.1- Chapter Three Learning Objectives and Key Terms In this chapter, we will explore basic concepts related to budgeting and profit planning. Let s begin by reviewing the learning objectives for Chapter Three. By the end of this chapter, you should be able to list five types of budgets that are commonly-created by managerial accountants. You should also be able to describe profit planning and profit management methods employed by managerial accountants. There are two key terms for Chapter Three. They are budget and profit. The first key term for this chapter is budget. In this course, we use the word budget as both a noun and a verb. When used as a noun, a budget describes a financial forecast or plan. When used as a verb, budgeting describes the process of developing such a forecast or plan. The next key term for Chapter Three is profit. In a broad sense, the word profit describes financial gain. As used in this course, profit specifically describes the difference between the amount of income earned by a business and the money spent by the business to earn the income. In other words, and in very simple terms, if the total cost to produce, market, and sell a product is $100, and the product sells for $120, the overall profit would be $20. Page 10 of 14

11 3.2- Key Budgeting Concepts As part of their organizational planning responsibilities, managerial accountants use budgets to quantitatively plan and/or forecast future business operations. When used as a noun, the word budget describes the forecast or plan that shows an organization s predicted income and expenditures over a set period, usually one year. When used as a verb, budget describes the process of allocating a specific amount of money to a specific use for a period. Most organizational budgets are preceded by a strategy session attended by an organization s top leadership and accountants, during which organizational goals are identified. However, some companies have recently adopted the practice of developing their budgets from the ground up, which involves allowing employees and managers from every level of the organization to submit their own personal and departmental budgets for review. The theory behind this practice is that employees will be more enthusiastic about, and more receptive to, budgets that were prepared with employee input. Additionally, organizational leaders recognize that employees and management in various departments often have more expert information about the inner workings of those departments, and so can better predict departmental expenses. Whichever method is used initially to identify organizational goals, those strategic goals are developed into a series of departmental budgets and a master budget. Departmental managers are tasked with running their departments using the resources allocated by the budget Types of Budgets There are many type of budgets used by businesses and this lesson briefly discusses five types of budgets commonly created by managerial accountants. The first type of budget to mention is the master budget. An organization s master budget is the comprehensive budget that contains the detailed budget information for all departments in the entire organization. All business expected to be conducted during the coming year is included in an organization s master budget as revenue inflows and cash outflows. The master budget is an aggregation of many other budgets for each department, as well as several other budgets, including the cash budget, budgeted income statement, and a budgeted balance sheet, among others. The budgets included within a master budget are interrelated, and the numbers flow from one budget to another within it. The budgets included within a master budget for an organization will vary by industry, as the budgets required for inclusion in the master budget for a manufacturing company will not be the same as the budgets required for a service company. For example, a direct materials budget may appear within the master budget for a manufacturing company, but not for a service company. Managerial accountants and organizational managers in all types of industries, however, rely on the master budget as they develop objectives and goals for the organization and its various departments based on the master budget s forecasted revenue inflows and cost outflows. An organization s operational budget is concerned with the revenue inflows and cost outflows of the dayto-day operations of the organization. Revenues include the sales amounts from products sold or services provided. Costs include operational expense, such as the cost of goods sold, overhead expenses, and the administrative costs related to products sold and services provided. Creating an operating budget, by its very definition, also results in an income statement forecast called a pro forma income statement. Page 11 of 14

12 Unlike other budgets, operating budgets usually cover a shorter reporting period, such as weekly or monthly. Managerial accountants regularly compare forecasts in operational budgets to actual results to measure progress and adjust the operational budget forecast to account for variations that may occur. An organization s cash flow budget displays the inflows and outflows of organizational cash on a day-today basis. The cash flow budget is used to predict whether an organization will bring in more money than it pays out in any given year. The cash flow budget is fundamentally important to an organization, and must be carefully and regularly monitored to ensure that the organization has enough liquidity to meet current demands. Additionally the cash flow budget must be monitored for any shortfalls where inflows and outflows of cash do not match, which may require additional financing be obtained. Cash flow budgets can also help determine production cycles and inventory levels, which allows for the monitoring of resources and stock. An organization s static budget focuses on expenditures which remain unchanged regardless of variations to sales activity. Static budgets focus on fixed costs that will be incurred no matter how well the organization is performing. Static budgets are also found in individual departments of an organization which have been allocated a fixed amount of money to spend. A static budget is prepared at the start of a budgeting period, and is valid only for the planned level of activity. Actual results are compared to budgets results, and the resulting variance is called the static budget variance. Static budgets are suitable for planning, but are not as suitable for evaluating how well costs are being controlled. This is due to significant variations within the static budget variance when evaluating cost center performance, as well as a loss of accuracy to static budget figures within time periods occurring further in the future from the static budget creation date. An organization s financial budget contains budgeted amounts for all of the balance sheet line items. This encompasses all of the assets, liabilities, and equity for a company. Organizational managers use financial budgets to acquire financing when needed. Financial budgets can also be used to provide the organization s value for mergers and public offerings of stock Profit Planning All organizations, regardless of industry, must maintain an adequate state of liquidity. This means having enough money on hand at all times to meet expense obligations. One way to accomplish this is through profit planning. When organizational revenues exceed organizational expenses, the organization recognizes profit. However, the occurrence of profit is not the same as profit planning. Managerial accountants use profit planning to set profit goals for an upcoming time period, usually a fiscal year. A profit plan begins by forecasting sales and the desired target percentage for gross sales determined by management and market conditions. The profit plan is like an estimated income statement for the period. Profit planning involves developing an operational budget in such a way that the maximum amount of profit can be generated for an organization. During profit planning, managerial accountants and business Page 12 of 14

13 leaders examine different aspects of the organization, such as the costs of labor, raw materials, and facility maintenance. The overall goal of these examinations are to improve the efficiency with which each aspect of the organization is being handled. Improved efficiency has many benefits, including increased production and lower overhead costs, which grows the profit of an organization. In other words, profit planning strives to maximize efficiency and resources, so that the difference between organizational earnings and expenditures is as great as possible. In many organizations, profit planning is used as a performance benchmark for reaching organizational objectives Managing Profit Along with profit planning, profit management is necessary to promote increased profit within an organization. Managerial accountants apply various types of controls to ensure profitability. Within an organization, profit is related to cash resources, but they are not the same; as a consequence, many profitable organizations become insolvent due to cash flow problems. Managerial accountants control cash flow budgets by patching leaks in organizational cash flow, which helps to manage profit as the profit is being made. Managerial accountants also manage profit by controlling the cost of raw materials. This can be done by identifying new supply sources, purchasing supplies in large quantity in order to receive volume discounts, or changing the materials used during production. As is the case with cash resources, managing the cost of raw materials helps to manage profit as the profit is being made. Another way that managerial accountants manage profit is by controlling labor costs. This can be done by introducing organizational policies which restrict overtime hours, additional employees, and outsourcing. Again, by controlling labor costs throughout the year, profit is managed and maintained by the organization Further Reading and Conclusion In this lesson, we ll wrap up our study of managerial accounting. Let s take a look at some other materials that may be helpful to you as you continue learning about this topic. When studying the application of accounting principles, it can be very helpful to supplement your learning with relevant IRS publications. Specifically, you may wish to reference current IRS Publication 538- Accounting Periods and Methods; and IRS Publication 542- Corporations, as further reading. IRS publications can be viewed and downloaded for free by visiting There is also a special IRS telephone hotline especially for those who are licensed to practice before the IRS, including CPAs. The Practitioner Priority Service is a toll-free, national hotline that provides support for practitioners with account-related questions. The number for the Practitioner Priority Service is This concludes the video portion of TeachUcomp Inc. s Accounting for Management: Concepts and Tools. Please take some time to review the video lessons it may be helpful to replay the lessons which Page 13 of 14

14 contained a lot of information or complicated concepts. Please also take time to complete the review questions independently of the video presentation, and study all of the evaluative feedback provided with the Review Questions Answer Key. Printable versions of both the Review Questions and the Answer Key can be found in the training interface. When you have completed a thorough review of the included course materials, please complete the final exam and submit it to us, using the instructions in the Submittal Form which can be accessed in the training interface. Thank you for using TeachUcomp training materials! If you have any questions about this course, or need help submitting your final exam, please call us toll-free at Page 14 of 14

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