Cost & Budgets: tools and practices

Prof. Dr. Shanming Liu

 All about cost

 Think about the following question:

•How to estimate the cost of an iPhone

 [Link]

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Why it is important to understand the cost

 If miscalculation

•Costs or products / services will be underestimated, overestimated

•Profitability will not be understood

•Wrong strategic decisions will be made on the basis of wrong calculation

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 You need to think about costs when…

 Setting prices

 Deciding on our portfolio of customers. Do we have

non-profitable customers?

 Accepting or rejecting a special order

 Decision on outsourcing. Which is the most profitable

option? To do or to get it done?

 Choosing the most profitable product when there are

production constraints or fixed resources

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 Course general objectives

 Understand what is a cost

 Understand the consequences of different methodologies for

cost accounting

 Analyze the economic impact of managerial decisions

 Contrast different dimensions of profitability (by products,

clients, projects, activities)

 Prepare a simple budget and analyze gaps

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 The Program

 Introduction: the role of management accounting (S1)

 The different notions of cost (S1)
 Full costing and ABC costing (S2&3)
 Job costing and costs-volume-profit relationship (break-even point) (S4)
 Marginal costs, differential costs (S5)
(mid-term exam)
 Budgets: structure, stages, variance analysis (S6-S9)
 Revision (S10)
(final exam)

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 Material

 Exercises required for each class

 For further understanding:

- C. Horngren, S. Datar, M.V. Rajan: Cost Accounting: A
Managerial Emphasis, Pearson Education
Available at the library

 Bring your calculator to every class

 You don’t need your phone

 Bring your charged laptop starting session 3 (or latter if specified)

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 Evaluation and rules

 In class participation: 20% of final grade

 Intermediary work (session 5): 30% of final grade

 Final exam: 50% of final grade

 Don’t come when more than 15 minutes late (wait for the
break)

 Cases and exercises will be corrected in class. Solutions

will be also posted to the Moodle.

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 Contact information

 Shanming Liu, [Link]@[Link] (Professor)

 Bruno Cazenave, cazenave@[Link] (Coordinator)

 Pascaline Juste, juste@[Link] (Program manager)

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MANAGEMENT ACCOUNTING
IS NOT FINANCIAL
ACCOUNTING

 BTW how do you define financial accounting?

 What are the differences you see?

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 Questions addressed today

 The role of management accounting

•Which objectives?
•Who uses management accounting? How?
•Management accounting and Financial accounting

 Different notions of costs

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 Links but different functions

 Financial accounting informs on:

• Company’s financial position: Balance Sheet
• Global performance: Profit & Loss Statements

 But Financial accounting does not inform on:

• The reasons for performance (why we earned or lost money)
• If a particular activity in the company is profitable or not
• How to choose between different options
• How to simulate results according to some assumptions

 Management accounting gives that information because:

• More detailed understanding of costs
• Non financial information (e.g. volumes)
• Different viewpoints (axis of analysis)
 Different users
 Financial accounting
•Inside the firm: accountants record transactions while managers take financing
decisions on the short and long-run
•Outside the firm: shareholders, auditors, financial analysts, potential investors,
banks, suppliers and customers (in order to assess the durability of commercial
relationships). Consequently, this information needs to be audited (approved)

 Management accounting
•Only for internal use: management accountants, financial accountants, cost
controllers, marketing department, production department, every responsibility
center in its own perimeter

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 Example: Product Managers using Management Accounting

You are responsible for sales, margins and product mix

 You monitor and analyze business activity

•Contribution of each product
•Sales variance analysis
•Promotion and campaign performance
 You decide on investment projects or launching of new products
•Forecasting
•Scenario and simulations
 You monitor a budget
•Expenses, available resources
•Budget negotiation with supervisors

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 Structural differences between management
accounting and financial accounting (1/2)

 There are no compulsory accounting principles for management accounting

•No legal standardization
•No need for external comparability
•But need for internal comparability (between units, products, along time)

 A “custom-made” system
•According to the specific needs of the economic sector, particularly strategic ones
•According to available information systems, management culture and historical
context

 As a consequence
•Management accounting depends on the strategy
•Provides strategic information

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 Structural differences between management
accounting and financial accounting (2/2)

 Extent and precision of the information is very variable

•Management accounting includes and makes use of non financial information
(regarding activity, productivity, quality,…)
•Information can be very general or detailed, depending on the goals defined

 The time dimension:

•The periodicity of management accounting reports depends on the user needs:
hourly, daily, weekly, monthly, yearly,…
•These reports deal with historical information, real activity but also with expected
results (objectives, previsions, simulations, opportunity costs,…)

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Different types of costs

Variable costs - Fixed costs

Direct costs - Indirect costs
Total costs - Partial costs
Product costs
Standard costs - Actual costs
 Differences between value, price, cost

 Value: perceived worth for them by the consumers. Opinion by

the user, results in willingness to pay
 Price: How much you charge the consumer.

 Costs: Expenses related to the product or service

 Price will depend on what the producer perceives from the

value consumer see in the product. Pricing will depend on
value.
 Costs will have to be covered by the price

 Margin is the difference between the cost and the price

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 Cost object and methods vary
Cost object: Something (product, service, department) to which
costs are related

 Methods will vary depending on the cost object

 Some examples

•In standardized manufacturing (L’Oreal, Nestle): each product

•In standardized service firms (SNCF, AXA): each type of service

•In non-standardized manufacturing (Boeing, Airbus): each project

•In tailored service firms (EY, Cap Gemini, EuroRSCG): each project

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 Costs according to different business
models(1/3)

Commercial firm: distribution of merchandises

Costs of stock
C
Supplying costs
h Stocks
a Costs of goods
r Distribution costs sold
g
e Administrative costs
s

Supply Phase Stock Phase Sales Phase

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 Costs according to different
business models(2/3)
Standardized manufacturing (consumer goods)

Cost of
produced
goods
C
Supplying costs Stocks
h of raw Produc- Stocks
(raw materials)
a materials tion of end Distribution Costs of goods sold
r costs products cost
g
e Administration
s cost

Supply Phase Manufacturing Phase Sales Phase

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 Costs according to different
business models(3/3)
Non standardized manufacturing firm: focus on projects

P1 P2 P3 P4 Pn

Direct allocation
Direct charges
Allocation according to a key

•Raw materials
•Working time

Indirect charges
•General expenses
•Expenses from functional services (eg. HHRR)

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Variable costs – Fixed costs

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Variable costs – Fixed costs

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 Variable costs – Fixed costs

 Variable : Amount is directly proportional to produced or sold quantities

ex. raw material, packaging, production labor, agent commissions (variable), carriage
outwards,…

 Fixed: do not change with an increase of decrease of production or sell

•Discretionary (ex. advertisement, consulting)

•Overhead (ex : machinery depreciation)

 For a same cost object, costs can be fixed or variable depending on the
type of contract chosen

• Ex : telephone costs = > fixed if package; variable if charged to the minute consumed
• Ex: cars. Bought or hired

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 Variable costs – Fixed costs

Notice: a fixed cost does not change in total, but per-unit fixed cost become
progressively smaller as the volume increases

Example: I bought a Nespresso machine for 100 Euros (Fixed Cost)

€ 100
If I drink 100 cups of coffee = €1
100 𝑐𝑢𝑝𝑠

€ 100
If I drink 500 cups of coffee = €0.2
500 𝑐𝑢𝑝𝑠

€ 100
If I drink 1,000 cups of coffee = €0.1
1000 𝑐𝑢𝑝𝑠

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 Fixed costs and volume

Fixed costs will not vary depending on volume

during a given range of activity

Cost per unit

Variable cost per unit is constant

Fixed cost per unit decreases

(economies of scale)

Cost per unit=

0 Volume Total cost/ Volume
(quantity)

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Variable costs – Fixed costs

Total Cost
VARIABLE COSTS

FIXED COSTS
(in stages)

0
Volume
(quantities)

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Case Study: Innovation & Creation

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 Direct costs – Indirect costs
 Example: APPLE produces more iPhone

•Cost object: An iPhone

•Apple buys and uses more resources (costs):

-Battery, screen, sensor, camera and labor (Direct Cost)

-Salaries of managers, advertisement, transportation, R&D (Indirect Cost)

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 Direct costs – Indirect costs

Direct Costs: Unequivocally attached to a cost object

 Direct costs can be directly traced to a cost object

 Indirect costs: Can not be directly attributed to a specific cost object.

Typically benefit to multiple cost objects
 Indirect costs cannot be directly traced to a cost object

Tracing: Physically identifying the amount of a direct cost that relates

exclusively to a particular cost object.

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 Applications

Super Cergy


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