3-1.1. Measuring Profitability According to Cost Behavior

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En provenance du cours de University of Illinois at Urbana-Champaign

Accounting for Business Decision Making: Measurement and Operational Decisions

58 notes

University of Illinois at Urbana-Champaign

Accounting for Business Decision Making: Measurement and Operational Decisions

58 notes

Cours 3 sur 5 dans Specialization Fundamentals of Accounting

Accounting information is the lifeblood of the organization as it facilitates and influences operational and strategic decisions intended to achieve organizational goals. Organizations benefit from three decision-oriented roles of accounting: measurement, control, and communication. This course provides an introduction to accounting’s measurement role inside of an organization and how accountants communicate information that helps managers and employees make operational decisions. In particular, you will learn how cost information is created and organized to help managers and employees conduct profitability analyses, develop and choose products, make pricing decisions, and make common business decisions. Upon successful completion of this course, you will be able to: • Identify the nature, purpose, and importance of different types of decision-useful accounting information. • Create, organize, and communicate cost information to best suit common operational decisions. • Use accounting information to manage products, control costs, and leverage other drivers of operational success. If you enjoy this business course and are interested in an MBA, consider applying to the iMBA, a flexible, fully-accredited online MBA at an incredibly competitive price offered by the University of Illinois. For more information, please see the Resource page in this course and onlinemba.illinois.edu.

À partir de la leçon

Module 3: Managing Products and Profitability

Making decisions can be quite daunting. You need to be able to make predictions about the consequences of your actions so that you can make the best decision. Where do you start? Crystal balls are in short supply. So, how about the next best thing? Jump into Module 3 to learn about cost-volume-profit analysis!

3-1.1. Measuring Profitability According to Cost Behavior4:37

3-1.2. Defining and Using Cost-Volume-Profit Analysis4:50

3-1.3. Application and Extension6:13

3-1.4. What We’ve Learned0:41

Rencontrer les enseignants

Gary Hecht, Ph.D.
Associate Professor of Accountancy
Department of Accountancy, College of Business

Welcome to the next module.

In this lesson, we'll pursue the following objectives.

You should be able to measure profitability with costs

organized by behavior.

We'll define cost-volume-profit analysis, and then of course,

we'll use it to facilitate decisions.

Let's start off with a view of profit.

Now, from a financial accounting perspective,

we can look at the income statement or how revenues and

costs are organized in the income statement from the financial perspective.

We'll start off with revenue.

That's the value that the firm obtains in exchange for its goods or

services that it sells to customers.

And next on the income statement would be a series of costs.

For a manufacturing entity,

you would see direct materials, direct labor, and overhead.

In a service-based organization, you're less likely to see something referred to

as direct materials since the product is a service and not material-based.

These three costs collectively are generically referred to as cost of

goods sold, and

they represent the cost associated with the core business function.

Subtracting the cost of goods sold from revenue yields gross margin.

Some firms refer to it as gross profit.

And then, after gross margin or

gross profit, you have all of the other expenses that support the core business.

So these are not core functions, but rather,

supporting processes, things like accounting, legal, and finance.

Subtracting these other expenses from gross margin

yields the bottom line profit.

Now, that's the financial accounting perspective.

And if you were to look at financial statements from a firm,

being outside of that firm, this is likely the organization that you would see.

But for decision making inside of the firm,

we can adopt a different perspective of the income statement.

Now, from the managerial or

internal perspective, we start and end with the same numbers.

We begin with revenues, and we end with the same profit number.

So to make the point very clear, we're not cooking the books here,

we're basically just reorganizing the information, and

it's the information that lies between the revenues and the bottom line profit.

So we're going to organize this information according to cost behavior.

And so starting with revenues, we'll first subtract all of the variable costs,

the costs that change with the activity of interest, in this case,

the production of our good or service.

So we'll have direct materials,

because those are correlated with the production volume.

We'll have direct labor, that also is correlated.

And then we'll have the overhead costs that are variable in nature,

as well as the other expenses, which from the financial perspective,

we'll refer to at the bottom of the statement.

We'll move those up in the order, because some of these expenses are variable.

So collectively,

subtracting of the variable costs from revenue yields a different type of margin.

We'll refer to it as contribution margin.

Now, we call it contribution margin,

because it is the portion of our revenues that is left over after covering

all of our variable costs that contribute towards covering our fixed costs.

So that's what we have left in the managerial perspective.

From the contribution margin, we'll subtract all of our fixed expenses.

No matter whether they were reported above or below gross margin in the financial

perspective, the fixed expenses are subtracted from the contribution margin,

and that will yield a bottom line profit.

From these two perspectives, you can use this information for different purposes.

And we'll find it very useful inside the organization to use that managerial

perspective, the income statement organized around cost behavior.

Let's have a check point to make sure that we understand these fundamental

principles.

So inside this managerial perspective, things are ordered this way,

because revenues and variable cost tend to correlate with one another.

That is revenues themselves are variable.

So subtracting the variable costs from

variable revenues yields a variable oriented contribution margin.

And then what's left is the fixed expenses,

very different from the behavior of revenue and variable costs.

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