Sources and References

Primary textbook — Garrison, R.H., Libby, T., Webb, A., Noreen, E.W., & Brewer, P.C. (2024). Managerial Accounting (13th Canadian ed.). McGraw-Hill Ryerson. Supplementary — Horngren, C.T., Datar, S.M., & Rajan, M.V. (2015). Cost Accounting: A Managerial Emphasis (15th ed.). Pearson. Online resources — MIT OpenCourseWare 15.501: Introduction to Financial and Managerial Accounting; CPA Canada practice resources.

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Chapter 1: Introduction to Managerial Accounting

What is Managerial Accounting?

Managerial accounting differs fundamentally from financial accounting in both audience and purpose. Financial accounting produces reports—income statements, balance sheets, cash flow statements—intended for external stakeholders such as investors, creditors, and regulators, and it must conform to generally accepted accounting principles (GAAP). Managerial accounting, by contrast, generates information for internal decision-makers: managers, executives, and operational teams who need timely, relevant data to plan operations, control costs, and make strategic choices. There are no GAAP constraints on managerial reports; they are shaped by whatever format makes the information most useful.

The three core functions that managerial accounting serves are:

1. Planning — setting objectives and determining how to achieve them (e.g., preparing budgets, forecasting revenues).
2. Controlling — measuring actual performance against planned targets and investigating variances.
3. Decision-making — evaluating alternative courses of action using relevant cost and benefit information.

Managerial vs. Financial Accounting

Feature	Financial Accounting	Managerial Accounting
Primary audience	External parties	Internal managers
Reporting frequency	Quarterly/annually	As needed (daily, weekly)
Standards	GAAP / IFRS	No mandatory standards
Focus	Historical results	Future-oriented
Scope	Entire organization	Segments, products, decisions
Verification	Audited	Not required

Cost Classifications

Before any managerial analysis can occur, costs must be classified precisely. The same expenditure can belong to different categories depending on context.

Manufacturing vs. Non-Manufacturing Costs

Manufacturing costs are those incurred to produce a physical product:

• Direct materials — raw materials traceable to the finished product (e.g., steel in an automobile).
• Direct labour — wages of employees whose work can be traced directly to the product (e.g., assembly-line workers).
• Manufacturing overhead — all other production costs that cannot be directly traced, including factory rent, depreciation of machinery, indirect materials, and indirect labour.

Non-manufacturing costs (also called period costs) are expensed in the period incurred:

• Selling costs — advertising, commissions, shipping.
• Administrative costs — executive salaries, accounting department.

Product Costs vs. Period Costs

Prime Costs and Conversion Costs

• Prime costs = Direct materials + Direct labour
• Conversion costs = Direct labour + Manufacturing overhead (costs required to “convert” raw materials into finished goods)

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Chapter 2: Cost Behaviour

Fixed, Variable, and Mixed Costs

Understanding how costs respond to changes in activity is fundamental to managerial accounting. Activity is usually measured in terms of units produced, units sold, machine-hours, or direct labour-hours.

The equation for a mixed cost is:

\[ Y = a + bX \]

where \(Y\) is the total cost, \(a\) is the total fixed cost, \(b\) is the variable cost per unit of activity, and \(X\) is the level of activity.

The Relevant Range

Fixed costs are fixed only within a relevant range—the band of activity within which cost behaviour assumptions hold. Outside this range, fixed costs may step up (e.g., a second factory must be rented if production exceeds current capacity).

Methods of Separating Mixed Costs

High-Low Method

The high-low method uses only the highest and lowest activity data points to estimate the variable rate:

\[ b = \frac{\text{Cost at high activity} - \text{Cost at low activity}}{\text{High activity level} - \text{Low activity level}} \]

The fixed component is then:

\[ a = \text{Total cost at high activity} - (b \times \text{High activity level}) \]

Least-Squares Regression

Regression analysis uses all data points to determine the line of best fit, minimizing the sum of squared residuals. It produces more reliable estimates than the high-low method when data contain outliers or variability. Most spreadsheet software (Excel, Google Sheets) can perform this automatically.

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Chapter 3: Cost-Volume-Profit Analysis

The CVP Model

Cost-volume-profit (CVP) analysis examines the relationship among costs, volume, and profit to answer “what-if” questions. It is one of the most widely used managerial accounting tools for short-term decisions.

Key Concepts

The CVP Income Statement

\[ \text{Net Operating Income} = \text{Sales} - \text{Variable Costs} - \text{Fixed Costs} \]

Or equivalently, using the unit contribution margin \(cm\) and the number of units sold \(Q\):

\[ \text{NOI} = (cm \times Q) - \text{Fixed Costs} \]

where \( cm = \text{Selling price per unit} - \text{Variable cost per unit} \).

Break-Even Analysis

The break-even point (BEP) is the level of sales at which total revenues equal total costs and profit is zero.

\[ \text{BEP (units)} = \frac{\text{Total Fixed Costs}}{\text{Contribution Margin per Unit}} \]\[ \text{BEP (dollars)} = \frac{\text{Total Fixed Costs}}{\text{CM Ratio}} \]

Target Profit Analysis

To find the required unit sales to achieve a target profit \(\pi\):

\[ Q = \frac{\text{Fixed Costs} + \pi}{\text{CM per Unit}} \]

If income taxes must be considered:

\[ Q = \frac{\text{Fixed Costs} + \frac{\pi_{\text{net}}}{1 - t}}{\text{CM per Unit}} \]

where \(t\) is the tax rate and \(\pi_{\text{net}}\) is the desired after-tax profit.

Margin of Safety

Operating Leverage

For example, if DOL = 4, a 10% increase in sales will produce a 40% increase in net operating income, and vice versa for decreases.

Multi-Product CVP

When a company sells multiple products, a sales mix must be assumed. A weighted-average contribution margin per unit (or CM ratio) is computed based on the expected proportion of each product in total sales.

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Chapter 4: Job-Order Costing

Overview

Job-order costing is used when products or services are unique and produced in small, discrete batches or custom jobs (e.g., construction projects, custom furniture, legal cases). Costs are accumulated by job on a job cost sheet.

Cost Flows in Job-Order Costing

1. Direct materials are requisitioned from the raw materials inventory and charged to the job.
2. Direct labour is recorded via time tickets and charged to the job.
3. Manufacturing overhead is applied to the job using a predetermined overhead rate (POHR).

\[ \text{POHR} = \frac{\text{Estimated Total Manufacturing Overhead}}{\text{Estimated Total Allocation Base}} \]

Common allocation bases include direct labour-hours, machine-hours, or direct labour cost.

Applied vs. Actual Overhead

Because actual overhead is unknown until year-end, overhead is applied throughout the year using the POHR:

\[ \text{Applied Overhead} = \text{POHR} \times \text{Actual Activity} \]

At year-end, the difference between actual and applied overhead is either:

• Underapplied (actual > applied) — cost of goods sold is understated; adjust upward.
• Overapplied (actual < applied) — cost of goods sold is overstated; adjust downward.

Gross Margin by Job

Once all costs are accumulated on the job cost sheet, gross margin for that job is:

\[ \text{Gross Margin} = \text{Job Revenue} - \text{Job Cost (DM + DL + Applied OH)} \]

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Chapter 5: Variable Costing and Absorption Costing

The Two Methods Compared

Income Difference

The key difference arises when production volume differs from sales volume:

• If production > sales: Absorption costing income > Variable costing income (some fixed overhead is deferred in ending inventory under absorption costing).
• If production < sales: Absorption costing income < Variable costing income (fixed overhead from prior periods flows out through inventory under absorption costing).
• If production = sales: Both methods produce identical income.

The difference in net operating income equals:

\[ \Delta \text{NOI} = \text{Fixed OH rate} \times (\text{Units Produced} - \text{Units Sold}) \]

Advantages and Disadvantages

	Absorption Costing	Variable Costing
GAAP compliance	Yes	No
Inventory valuation	Higher (includes fixed OH)	Lower
Profit manipulation	Possible (produce more to defer costs)	Not possible
CVP compatibility	No	Yes
Decision usefulness	Less	More

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Chapter 6: Activity-Based Costing

Limitations of Traditional Costing

Traditional overhead allocation uses a single, volume-based allocation base (e.g., direct labour-hours). This works reasonably well when products consume overhead resources in proportion to volume. When products differ substantially in complexity, batch size, or product-sustaining activities, traditional costing produces distorted product costs.

ABC Methodology

ABC Implementation Steps

1. Identify activities — list all significant activities (machine setup, quality inspection, order processing, customer visits).
2. Assign overhead costs to activity cost pools — gather costs associated with each activity.
3. Determine the activity rate — divide each pool’s cost by the cost driver quantity.

\[ \text{Activity Rate} = \frac{\text{Cost Pool Total}}{\text{Total Cost Driver Quantity}} \]

4. Assign overhead to products — multiply the activity rate by the actual cost driver quantity used by each product.

Activity Hierarchy

Level	Description	Example Cost Driver
Unit-level	Performed for each unit	Machine-hours, DLH
Batch-level	Performed for each batch	Number of setups, purchase orders
Product-level	Sustain a product line	Product specs, engineering changes
Facility-level	Sustain the factory	Square footage

ABC for Customer Profitability

The same logic extends to customers. A customer who places many small orders, requires extensive after-sale support, or demands custom modifications consumes more batch-level and customer-level activities than a customer who places large standard orders. ABC reveals the true profit contribution of each customer.

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Chapter 7: Budgeting

The Master Budget

The master budget is a comprehensive financial plan for a given period (typically one year). It consists of several interrelated sub-budgets.

Operating Budgets (flow)

1. Sales budget — the starting point; estimates units and dollars of sales.
2. Production budget — units to produce = sales units + desired ending inventory − beginning inventory.
3. Direct materials budget — raw materials to purchase.
4. Direct labour budget — DLH and cost of labour.
5. Manufacturing overhead budget — estimated overhead by activity level.
6. Selling and administrative expense budget.
7. Budgeted income statement.

Financial Budgets

8. Capital expenditure budget — planned investments in long-term assets.
9. Cash budget — cash receipts, disbursements, and ending balances.
10. Budgeted balance sheet.

Production Budget Formula

\[ \text{Required Production (units)} = \text{Budgeted Sales} + \text{Desired Ending FG Inventory} - \text{Beginning FG Inventory} \]

Flexible Budgets

A static budget is prepared for only one level of activity. A flexible budget is adjusted for the actual level of activity achieved, making it a fair benchmark for performance evaluation.

\[ \text{Flexible Budget Cost} = (b \times \text{Actual Activity}) + a \]

where \(b\) is the variable rate and \(a\) is fixed cost — exactly the mixed cost equation.

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Chapter 8: Standard Costs and Variance Analysis

Standard Costs

Direct Materials Variances

\[ \text{Materials Price Variance (MPV)} = (AQ \times AP) - (AQ \times SP) = AQ \times (AP - SP) \]\[ \text{Materials Quantity Variance (MQV)} = (AQ \times SP) - (SQ \times SP) = SP \times (AQ - SQ) \]

Where: AQ = actual quantity, AP = actual price, SP = standard price, SQ = standard quantity allowed for actual output.

Direct Labour Variances

\[ \text{Labour Rate Variance (LRV)} = AH \times (AR - SR) \]\[ \text{Labour Efficiency Variance (LEV)} = SR \times (AH - SH) \]

Where: AH = actual hours worked, AR = actual rate, SR = standard rate, SH = standard hours allowed.

Manufacturing Overhead Variances

For variable overhead:

\[ \text{Variable OH Spending Variance} = AH \times (AR - SR) \]\[ \text{Variable OH Efficiency Variance} = SR \times (AH - SH) \]

For fixed overhead:

\[ \text{Fixed OH Budget Variance} = \text{Actual Fixed OH} - \text{Budgeted Fixed OH} \]\[ \text{Fixed OH Volume Variance} = \text{Budgeted Fixed OH} - \text{Applied Fixed OH} \]

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Chapter 9: Reporting for Control and Performance Evaluation

Segmented Reporting

Segmented income statements separate the organization into meaningful units (product lines, geographic regions, divisions) to evaluate each segment’s contribution to overall profitability.

Traceable vs. Common Fixed Costs

A segment’s segment margin = Sales − Variable costs − Traceable fixed costs. This is the best measure of a segment’s profitability and its long-run contribution to the overall firm.

Return on Investment (ROI)

ROI can be decomposed (DuPont analysis):

\[ \text{ROI} = \text{Margin} \times \text{Turnover} = \frac{\text{NOI}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Average Operating Assets}} \]

This decomposition is useful for diagnosing performance: a low ROI can result from thin margins, slow asset turnover, or both.

Residual Income

RI avoids the “suboptimization” problem of ROI (managers rejecting positive-NPV investments that would lower their division’s ROI below the current level).

Balanced Scorecard

The Balanced Scorecard helps managers avoid the trap of focusing exclusively on short-term financial metrics at the expense of long-term value drivers such as employee skills, customer satisfaction, and process quality.

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Chapter 10: Relevant Costs for Decision-Making

The Relevant Cost Concept

Common Decision Contexts

1. Make or Buy (Outsourcing) Compare the incremental costs of making internally against the purchase price. Relevant costs include variable costs of production, avoidable fixed costs, and opportunity costs of capacity freed up.

2. Keep or Drop a Segment Drop only if the traceable fixed costs saved exceed the segment margin sacrificed. Common fixed costs that will continue regardless are irrelevant.

3. Accept or Reject a Special Order If idle capacity exists, accept if: Special Order Price ≥ Variable cost per unit. Relevant costs include variable production and selling costs; fixed costs are typically irrelevant (already incurred).

4. Sell as Is or Process Further (Joint Products) For joint products past the split-off point: process further only if the incremental revenue from further processing exceeds the incremental processing cost. Joint costs before the split-off are sunk and irrelevant.

5. Product Mix with a Constrained Resource When a single scarce resource limits production, rank products by contribution margin per unit of the scarce resource, not by total contribution margin per unit.

\[ \text{Rank by:} \quad \frac{\text{CM per unit}}{\text{Units of scarce resource per unit}} \]

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Chapter 11: Capital Budgeting

Time Value of Money

Capital budgeting decisions involve cash flows spread over many years. The time value of money principle holds that a dollar received today is worth more than a dollar received in the future, because today’s dollar can be invested to earn a return.

The present value of a future cash flow is:

\[ PV = \frac{FV}{(1 + r)^n} \]

where \(r\) is the discount rate (required rate of return) and \(n\) is the number of periods.

Net Present Value (NPV)

Decision rule: Accept the project if NPV ≥ 0; reject if NPV < 0. A positive NPV means the project earns more than the required rate of return and increases firm value.

Internal Rate of Return (IRR)

Decision rule: Accept if IRR ≥ minimum required rate of return; reject otherwise.

The IRR is found by solving:

\[ 0 = \sum_{t=1}^{n} \frac{CF_t}{(1+\text{IRR})^t} - \text{Initial Investment} \]

This typically requires iteration (or a financial calculator / spreadsheet).

Payback Period

The payback period is simple and intuitive but ignores the time value of money and all cash flows after the payback point. It is best used as a supplementary screening tool, not as the primary decision criterion.

Comparison of Capital Budgeting Methods

Method	Considers TVM?	Considers all cash flows?	Decision criterion
NPV	Yes	Yes	NPV ≥ 0
IRR	Yes	Yes	IRR ≥ hurdle rate
Payback Period	No	No	Payback ≤ threshold

NPV is generally considered the most theoretically sound method because it directly measures the increase in firm value created by the investment.