Engineering Management Accounting Lecture 5

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Engineering ManagementAccounting Lecture 5
ELE 22EMT
George Alexander G.Alexander_at_latrobe.edu.au http/
/www.latrobe.edu.au/eemanage/
5 September, 2003
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Last week

• The budget process in more detail
• Budget for a manufacturing organisation
• The different types of budget involved
• Applying the budget data to product cost
  calculation
• MRP II and its capabilities

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This week

• Management Accounting
• The impact on the budget of volume variations
• Calculating the hourly rate for an RD or Service
  organisation
• Financial Accounting
• TELSTRA results for 2002/03

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Example Profit Loss Statement
Net Sales 69,160,000 Less cost of goods
sold 33,250,000 Gross Margin (gross profit)
35,910000 Less operating expenses
31,813,600 Net Profit 4,096,400
Note Tax is calculated on the Net Profit
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One method of calculating direct labour and
overhead costs

• Determine the total number of direct hours i.e.
  those budgeted hours directly spent on production
  - H.
• Determine total budgeted costs associated with
  the budgeted direct hours C.
• Determine all other budgeted expenses E.
• Direct labour rate C/H per hour
• Overhead rate E/H per hour
• The labour and overhead costs of each unit are
  then determined by applying the rates to the unit
  direct hours.

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For example

• 1 Total number of direct hours
• H 100,000
• 2 Total budgeted costs associated with the
  budgeted direct hours
• C 5,000,000
• All other budgeted expenses
• E 8,333,000
• 4 Direct labour rate C/H 50.00 per hour
• 5 Overhead rate E/H 83.33 per hour
• For a unit with direct labour content of 0.3
  hours,
• direct labour cost 0.3 x 50 15
• overhead cost 0.3 x 83.33 25
• Assume material cost 60.
• Total standard cost 100

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Impact of volume variations

• This occurs when actual sales vary from budget.
• The most serious consequence is when sales fail
  to meet budget.
• As a rule, direct costs are variable and can be
  adjusted to changed volumes.
• This rule may not apply if the volume variation
  is significant but temporary.
• The major problem arises with overhead costs
  which are relatively fixed.

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Example but 10 volume reduction

• 1 Total number of direct hours
• H 90,000
• 2 Assume that the total budgeted costs
  associated with the direct hours is totally
  variable
• C 4,500,000
• All other budgeted expenses
• E 8,333,000
• 4 Direct labour rate C/H 50.00 per hour
  no change

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Example but 10 volume reduction(continued)

• Assume overhead costs are fixed
• Actual overhead rate E/H 92.59 per hour
  (was 83.33)
• For a unit with direct labour content of 0.3
  hours,
• direct labour cost 0.3 x 50 15
• actual overhead cost 0.3 x 92.59 27.78
• Assume material cost 60.
• Total standard cost 102.78
• an increase in cost of 2.8

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Impact on Profit Loss Statement
Budget Actual Net Sales
69,160,000 62,244,000 Less cost of goods
sold 33,250,000 30,613,000 Gross Margin
(gross profit) 35,910,000 31,631,000
Less operating expenses 31,813,600
31,813,600 Net Profit 4,096,400
(182,600)
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How to react?

• Scrutinise all budget elements for cost-cutting
  possibilities.
• Actions will depend on the size of the volume
  variation, and how sustained it is expected to
  be.
• Increase the price to restore the margin???

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Impact of price changes

• Monopoly situation? - No competitor impacts
• Concept of Price Elasticity
• High elasticity means that demand is very
  sensitive to price.
• Low elasticity means that demand is has limited
  sensitivity to price.
• This means that we have to assess market reaction
  to price changes before implementing.
• Market reaction will depend too on how sustained
  the prices are expected to be.

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Hourly rate for RD or Service organisation

• The principles are similar to the manufacturing
  cost calculation.
• The total operating budget is determined for the
  budgeted volumes (expressed in hours).
• Hourly rate Total Expenses/Budgeted hours
• The same impact of volume variation applies.

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TELSTRA 02/03 Report

• The aim is to provide some insight into Telstras
  financial reports through
• CEO report
• CFO report
• Media comments (AFR 29.8.03)
• Another pleasantly dull day at the office Adam
  Shand
• Telstra offers sweetener on 3.4 billion profit
  Katrina Nicholas
• Key assets performing to plan Katrina
  Nicholas
• Telco focuses on lost ground - Katrina Nicholas
• Telstra seeking to slash IT bill in half Emma
  Connors (2.9.03)

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Thanks for your attention