The Master Budget (Managerial Accounting Series) Ricardo Aguilar

Managerial Accounting Standard Costs and Variance Ricardo Aguilar

Must Know Formulas for Cost Accounting

To reduce and eliminate costs in a business, you need to know the formulas that are most often used in cost accounting. When you understand and use these foundational formulas, you’ll be able to analyze a product’s price and increase profits.

Breakeven Formula

Profit ($0) = sales – variable costs – fixed costs

Target Net Income

Target net income = sales – variable costs – fixed costs

Gross Margin

Gross margin = sale price – cost of sales (material and labor)

Contribution Margin

Contribution margin = sales – variable costs

Pre-Tax Dollars Needed for Purchase

Pre-tax dollars needed for purchase = cost of item ÷ (1 - tax rate)

Price Variance

Price variance = (actual price - budgeted price) × (actual units sold)

Efficiency Variance

Efficiency variance = (Actual quantity – budgeted quantity) × (standard price or rate)

Variable Overhead Variance

Variable overhead variance = spending variance + efficiency variance

Ending Inventory

Ending inventory = beginning inventory + purchases – cost of sales

Definition of 'Cost Accounting'

A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step of production as well as fixed costs such as depreciation of capital equipment. Cost accounting will first measure and record these costs individually, then compare input results to output or actual results to aid company management in measuring financial performance. 

Investopedia explains 'Cost Accounting'

While cost accounting is often used within a company to aid in decision making, financial accounting is what the outside investor community typically sees. Financial accounting is a different representation of costs and financial performance that includes a company's assets and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost control programs, which can improve net margins for the company in the future. 

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Definition of 'Cost-Volume Profit Analysis'

A method of cost accounting used in managerial economics. Cost-volume profit analysis is based upon determining the breakeven point of cost and volume of goods. It can be useful for managers making short-term economic decisions, and also for general educational purposes. 

Investopedia explains 'Cost-Volume Profit Analysis'

Cost-volume profit analysis makes several assumptions in order to be relevant. It often assumes that the sales price, fixed costs and variable cost per unit are constant. Running this analysis involves using several equations using price, cost and other variables and plotting them out on an economic graph. 

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Definition of 'Tangible Cost'

A quantifiable cost related to an identifiable source or asset. Tangible costs represent expenses arising from such things as purchasing materials, paying employees or renting equipment.

Investopedia explains 'Tangible Cost'

Tangible costs are often associated with items that also have related intangible costs. An intangible cost consists of a subjective value placed on a circumstance or event in an attempt to quantify its impact. 

For example, let's examine the costs associated with a customer who has received broken merchandise. The company will usually refund the value of the product to the customer, paying a tangible cost. If the customer is still upset over the event, he or she may complain about the poor service to friends. The potential loss of sales, resulting from the friends hearing the complaints, consists of an intangible cost relating to the broken merchandise.

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Definition of 'Intangible Cost'

An unquantifiable cost relating to an identifiable source. Intangible costs represent a variety of expenses such as losses in productivity, customer goodwill or drops in employee morale. While these costs do not have a firm value, managers often attempt to estimate the impact of the intangibles.

Investopedia explains 'Intangible Cost'

Ignoring intangible costs can have a significant effect on a company's performance. For example, let's examine a potential decision for a widget company to cut back on employee benefits. To improve profits, the firm wants to cut back $100,000 in employee benefits. When news reaches the employees of the cut-back, worker morale will likely drop. The widget production will likely be diminished, as employees focus on losing benefits instead of making products. The loss in production represents an intangible cost, which may be great enough to offset the gain in profits created by reducing employee benefits.

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Accounting Alternatives for Private Companies Simplify Reporting

For the first time, private companies will be able to make two accounting elections that will simplify their reporting requirements and still be in compliance with U.S. GAAP.

Users of financial statements should be aware of this election as it will cause differences between public company and private company reporting.

On January 16, the FASB issued its final standards for two accounting alternatives approved by its Private Company Council, or PCC. The first alternative provides private companies with an alternative accounting model for goodwill. The second alternative provides a simplified hedge accounting approach for qualifying interest rate swaps. The alternatives are effective for annual periods beginning after December 15, 2014, and early adoption is permitted

In 2011, the PCC was created by FASB to improve the standard-setting process for private companies and determine whether and under what circumstances alternatives are warranted for private companies. According to FASB, “The PCC determines alternatives to existing nongovernmental U.S. GAAP to address the needs of users of private company financial statements, based on criteria mutually agreed upon by the PCC and the FASB. Before being incorporated into U.S. GAAP, PCC recommendations will be subject to a FASB endorsement process.
The PCC also serves as the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB’s technical agenda.”
Who Can Elect the Alternatives
Under the new guidance, any nonpublic entity is eligible to adopt the goodwill alternative. A nonpublic entity that is not a financial institution is eligible to adopt the simplified hedge accounting approach to certain interest rate swaps.
In the Accounting Standards Update (ASU) No. 2013-12, Definition of a Public Business Entity: An Addition to the Master Glossary, FASB updates the definition of a public business entity, or PBE.
The criteria for the definition of a PBE are for the most part the same as existing definitions in the Codification. However, some differences do exist, and thus, there may be limited cases in which entities previously considered nonpublic will qualify as PBEs. On the other hand, since a subsidiary of a public company is not automatically by extension a PBE under the ASU, there may be instances in which an entity previously viewed as public will not qualify as a PBE for purposes of its financial statements.
Goodwill Alternative
The goodwill alternative, Accounting for Goodwill Subsequent to a Business Combination, allows a private company to amortize goodwill over a period of 10 years, or less under certain circumstances, and to apply a simplified impairment model to goodwill. Once this election is made, it will need to be used for all transactions resulting in goodwill.
The main provisions of the goodwill alternative are as follows:
• Amortization of goodwill - A company can amortize goodwill over a period of 10 years,
or less than 10 years if the entity can show that another useful life is more appropriate. The amortization period will need to be determined  for each transaction resulting in goodwill.
• Frequency of impairment testing - An entity is required to test goodwill only when a
triggering event occurs, unlike the current rules, which mandate that goodwill must be
tested annually, or more frequently if impairment indicators exist.
• Method of impairment testing - The impairment test can be performed at either the
entity level or the reporting unit level.       
• Quantification of impairment – If an impairment test is required, the amount of
impairment would be measured by calculating the difference between the carrying
amount of the entity (or reporting unit) and its fair value. Step two of the impairment test
would no longer be required.  
Issues for Private Companies Planning to Go Public
Companies preparing to go public or that may consider going public in the future need to weigh whether electing one of the alternatives makes sense since FASB and the SEC have not provided any transition guidance. Without specific transition guidance, companies that become PBEs after using the alternatives would have to retrospectively apply the public entity requirements.
A public company that acquires or invests in a private company which has applied one or more private company accounting alternatives in its historical financial statements should be aware that when it includes the private company’s financial statements in a regulatory filing, the private company’s financial statements would also need to be retrospectively adjusted to unwind previously elected accounting alternatives.
Will Financial Statement Users Accept the Alternatives?
One of the concerns among those opposed to the PCC’s accounting alternatives is whether users of financial statements will accept statements that use the alternatives. Private companies often prepare financial statements in accordance with U.S. GAAP to satisfy the terms of their lending agreements.
In a comment letter to the FASB and the SEC, one of the nation’s largest banks expressed significant concerns about accounting alternatives for private companies. The bank said that financial statements of companies that are otherwise comparable will look different if the accounting alternatives are elected because of recognition and measurement differences between the alternatives and U.S. GAAP. The bank went on to say that this lack of comparability will increase its costs for performing credit and lending analyses and make its investment decisions more difficult. The PCC has acknowledged that stakeholders may not accept financial statements that use accounting alternatives for private companies.
Jane Myung, CFA, is senior vice president of Valuation Research Corporation, where she specializes in financial valuations, including valuations of business enterprises and intangible assets.



Gabriela Mayorga Cordero.