MODULE 1

1. Intended Learning Outcomes (ILOs)

Mabuhay and welcome to Module 1: Overview, cost concepts, and Variable costing. 

As we all know, this course is the epicenter of Management Advisory Services (MAS). MAS is one of the subjects to be taken in the CPA Licensure
exam.

Under this course, we will focus on the management accounting side of MAS.

Always remember to have a paper, pen, and basic calculator while studying every page of this canvas course so you can practice the illustrative
problems. As we all know, practice makes better.

So future CPAs, let us all started by reading the ILOs.             

Intended Learning Outcomes (ILOs):

At the end of the topic, the students are expected to be able to:                   

1. Understand cost according to nature and behavior;

2. Separate fixed cost from a variable cost using the high-low method;
3. Prepare Income statement under Absorption costing;
4. Prepare Income statement under Variable costing;
5. Reconcile the difference between Variable costing to Absorption costing.

1.1 Strategic cost management

Strategic cost management is the process of reducing total costs while improving the strategic position of a business.

This goal can be accomplished by having a thorough understanding of which costs support a company's strategic position and which costs either
weaken it or have no impact.

Big names that use strategic cost management techniques are Toyota and Ford.

Both Toyota and Ford use Total Quality Management (TQM), Just-in-time (JIT), and Kaizen costing to manage its cost properly and be more
competitive.

1. Total Quality Management (TQM) was developed by William Deming, which is the continual process of detecting and reducing or
eliminating errors in manufacturing, streamlining supply chain management, improving the customer experience, and ensuring that employees
are up to speed with training. 
2. Just-In-Time (JIT) inventory system is a management strategy that aligns raw-material orders from suppliers directly with production
schedules. Hence, converting available raw materials into finished goods, thereby, removing the work in process inventory that would lessen
the entity's product cost.
3. Kaizen is a Japanese term meaning "change for the better" or "continuous improvement." It is a Japanese business philosophy regarding
the processes that continuously improve operations and involve all employees. Kaizen sees improvement in productivity as a gradual and
methodical process.

As we move forward with this canvas course, we will learn more strategic cost management tools that managers use for sound decision making.

1.2 Management accounting

As stated earlier, strategic cost management is one of the core courses under Management Advisory Services (MAS).

Other core courses are:

1. Strategic business analysis

2. Financial management
3. Financial market
4. Management science

Strategic cost management strategic business analysis and management science represent the Management accounting side of MAS and we will
focus on management accounting in this course.
To discuss the overview of management accounting, let us recall the work of management in the organization, which is planning, controlling, and
decision making.

For the management to perform their work most effectively and efficiently, they need the aid of management accounting.

Because management accounting aid the management in performing their works, let us enum

Because management accounting aid the management in performing their works, let us enumerate them one by one:

1. Management accounting prepares budget reports to help management in planning.

2. Management accounting analyzes financial statements to help management in control.
3. Management accounting performs cost volume profit analysis, relevant costing, variable costing to name a few, to help
management in decision making.

In this regard, management accounting plays an important role in the business world.

But, what is the difference in management accounting in financial accounting? The answer lies in the organization chart of the finance and
accounting department. 

1.2.1 Finance and accounting organizational chart

The organization chart of a company's management team includes the Chief Executive Officer (CEO) as head of the management team, under CEO
is the Chief Operating Officer (COO) as the head of the operation and the Chief Financial Officer (CFO) as the head of finance and accounting. 

Since our course subject is Management accounting, let us focus on the side of CFO:

Under the CFO is the Controller as the head of Accounting and Treasury director as the head of Cash management and investment.

The controller is the top position of the company's accounting function and under controllership, generally are Financial Accounting, Taxation, and
Management Accounting.

1.2.2 Management Accounting, financial accounting, auditing and taxation

The table below shows the difference between the branches of accounting:
Auditing is hidden since it is not under the controllership but coordinates directly to the controller.

As a BSA or BS AIS student, you can be a Financial accountant, Tax specialist, Auditor, or a Management Accountant soon.  Excelling in your
position can promote you to Controller and excelling as a controller and promote you to the highest position under the Finance and accounting
function - the CFO.

The above table also shows the difference between the group:

1. The financial accountant prepares the financial statements using Philippine Financial Reporting Standards (PFRS) and Philippine
Accounting Standards (PAS) as the basis, the tax specialist prepares the tax return using tax code, BIR rulings, and memorandum as the basis,
and the management accountant prepares management reports such as Budgets using Management policy.
2. The time frame of Financial accounting and taxation are both historical because we prepare last year's financial statement today (e.g. 2019
Financial statements as early as 2020). On the other hand, Management accounting is more on the future, on projection, that is why they
prepare the budget for 2020 as early as 2019.
3. In management accounting, we study and prepare reports that cater to the needs of the management (internal users) such as financial
statement analysis, cost volume profit analysis, variable costing, and budgeting to name a few while financial accounting and taxation cater to
external users.

As we move along on this online course, we will explore the work of a Management Accountant. 

Who knows, you can be a Management accountant in the future and one of the major work is to analyze the financial statements.

1.3 Product cost and period cost

We start by looking at the pictures below:

Image 1: Wooden house Image 2: Carpenters or Laborer and lumbers

The above images represent the cost of production.

The cost can be categorized as to nature and as to behavior.

Cost as to nature are:

1. Product cost
2. Period cost

Product costs are costs related to the production of goods. It is subdivided into direct materials, direct labor, and manufacturing overhead. The sold
portion is charged to the Cost of goods sold while the unsold portion is part of ending finished goods inventory. 

Period costs are cost related to support the production such as selling and administrative expenses.

From the above picture, the wooden house as our product, we can determine the product cost and period cost:

We already learn about this in cost accounting but as a management accountant, we need to incorporate this to cost as to behavior.

So let us move on to the next page.

1.4 Fixed cost and variable cost

To further analyze cost, management accountants categorized cost according to behavior, namely: 

1. Fixed cost and

2. Variable cost

An activity base (also called a cost driver and cost pools) is a measure of what causes the incurrence of variable costs.

It can be machine hours, labor hours, etc.                                                                

Keynotes:                                                                    

1. Total Variable cost varies directly proportional to the activity level.

2. Total Fixed cost is constant regardless of activity level
3. Fixed cost per unit varies inversely proportional to the activity level
4. Variable cost per unit is constant regardless of activity level         

Lumber as direct materials for a wooden house is a product cost and a period cost.

Nails are indirect materials for a wooden house product. It is a product cost and a variable cost.

Rent expense of a store is a period cost and fixed cost.

Accordingly, the activity level can be sales volume or production volume.

As sales volume increases, total variable cost also increases but total fixed cost remains constant.
Now, we incorporate fixed and variable cost to the product cost and period cost:

We justify, as the company constructs more wooden houses, they need to purchase more wood and nails and even hire more carpenters but as the
company constructs a fewer wooden house, they only need to purchase fewer woods and nails and even hire fewer carpenters. However, the
variable cost per unit remains constant regardless if sales volume increases or decreases.

But the total rent expense of the factory site under normal capacity will still be the same regardless of the company construct more or less wooden
houses. However, the fixed cost per unit will decrease if sales volume increases and vise versa.

Generally, direct materials, direct labor, and indirect materials are variable costs.

Why does the management need to identify variable cost and fixed cost? Because fixed costs are irrelevant to decision making, once the contract is
already entered, whether you like it or not, you need to incur the same amount of fixed cost. While the management can control variable cost and is
relevant to decision making if sales are large, they need to purchase more and if sales are low, they need to purchase less.

1.5 High - low method

We now understood that in management accounting, cost behavior is important.

Variable costs are controllable by management while fixed costs are non-controllable.

However, some costs can either be a variable or fixed cost.  We call such costs as a mixed cost.

The taxi fare is an example of a mixed cost. The flat down rate is fixed cost while every peso charged per kilometer is variable. Thus, the taxi fare
from TIP to the Araneta center is lower compare to the taxi fare from TIP to Ayala center.

It would be better if, at first glance, the management accountant can separate variable costs from fixed costs. However, in cases wherein, it is
difficult to do so, the management accountant can perform the High-low method to separate it. 

Let us have an illustration of the High-low method:

Hence, the management accountant can now report that from the P9,800 maintenance cost, P5,100 is the variable portion or the controllable cost.

1.6 Absorption costing versus Variable costing

We learn from cost accounting and financial accounting (or Intermediate accounting), the traditional presentation of an Income statement. In
management accounting, we call this traditional presentation of the income statement as Absorption costing.

But in management accounting, we present Income statement in another manner. This is called Variable costing Income statement.

Variable costing emphasizes fixed cost and variable cost which what management needs.

The comparative presentation between Absorption costing and Variable costing are:

***S and A stands for Selling and Administrative expenses.

Notice that under absorption costing, the cost of goods sold (product cost) is deducted from net sales to arrive at gross margin. The gross margin is
then reduced by selling and administrative expenses to arrive at net operating income (NOI).

While under the variable costing income statement, the variable cost is now deducted from net sales to arrive at the contribution margin. The
contribution margin replaces the gross margin. The contribution margin is further reduced by fixed cost to arrive at NOI.
The further difference shows that Fixed factory overhead is a product cost in absorption costing while it is a period cost in variable costing.

This reiterates that in Management accounting, we classify cost as to its behavior namely fixed cost and variable cost. Because management can
control variable cost and fixed cost is constant throughout the activity level.

Both income statement presentations are correct, however, variable costing caters more to the needs of the management. 

1.7 Absorption costing

We apply the concepts by preparing the Income statement of Mimi Company using Absorption costing.

Solution:

Step 1: Compute for the product cost per unit.

Hence, product cost per unit for Absorption costing is P36 while for Variable costing is only P33, the difference lies in the treatment of fixed
overhead.

Note: If the total cost is provided then you divide it with units produced.

Simply stated, the total product cost divided by Units produced.

We move forward and use the product cost per unit to prepare the income statement.

Step 2: Prepare an Income statement.

Net operating income is called Income before income tax in financial/intermediate accounting.

This presentation is familiar to you, now we continue to variable costing on the next page.

1.8 Variable costing

This time, we prepare the Mimi Company's income statement using the variable costing method.

Step 1: Compute for the product cost per unit.

Under variable costing, we remember that product cost per unit is P33 and we will be using that in preparing for the income statement.

Step 2: Prepare for Variable costing's income statement.

Differences:

1. Under variable costing, variable cost is deducted to sales to arrive at the contribution margin. Under absorption costing, the cost of goods
sold is deducted to sales to arrive at gross margin.
2. Fixed manufacturing overhead is included in the upper portion (COGS) under absorption costing but under variable costing, it is included in
the lower portion (fixed cost).
3. The net operating income (NOI) under absorption costing is P16,000 but under variable costing, NOI is P17,500.

Let us reconcile the difference on the next page.

1.9 Reconciliation between absorption costing and variable costing

We apply the concept by computing the difference between Absorption costing and variable costing.

Keynotes:

1. Units produced are P1,000 which is lower than units sold of P1,500, this would mean the net operating income under variable costing is
higher than absorption costing.
2. The opposite is true if the units produced is greater than units sold, therefore, net operating income under absorption costing is higher than
that of variable costing,
3. The P1,500 difference is due to the treatment of fixed manufacturing overhead. Because under absorption costing, all the 1,500 units sold
are charged with P3 fixed overhead per unit. This is equal to P4,500  while under variable costing, the P3,000 fixed overhead is only charged.
4. Which is correct? Both, absorption costing is used for external users while variable costing is used for internal users (the management).
Why? Because for management, categorizing the cost according to behavior will lead to better decision making.

1.10 Summary

1. Strategic cost management as part of management accounting will focus on the future and how it will aid management in better decision
making. 
2. Cost as to nature is product and period cost while cost as to behavior is a fixed and variable cost.
3. In Cost accounting and financial accounting, the income statement is prepared using absorption costing while in management accounting
the income statement is prepared using variable costing.
4. The main difference between absorption costing and variable costing income statement lies within the unsold portion of fixed
manufacturing overhead. Because under variable costing, fixed manufacturing overhead is considered period cost, whereas, under absorption
costing, it is considered as product cost.
5. Units sold jive with variable costing while units produced jive with absorption costing. If the unit sold is higher than units produced, then,
variable costing’s net operating income is higher than absorption costing’s net operating income and vise versa.