Terms
Management Accounting involves various terms that are essential for understanding the processes and practices within the field. Below is a list of some key management accounting terms, along with their definitions:
Allocated Fixed Costs (also called common fixed costs) are fixed costs that cannot be traced directly to a product or product line, and therefore are assigned to products and product lines using
an allocation process.
Average Rate Of Return (ARR): The average rate of return (ARR) is a capital budgeting method that calculates the average annual percentage return on an investment.
Break-Even Analysis: A calculation that determines the point at which a company's revenue equals its total fixed and variable costs.
Budgeting: The process of creating a detailed financial plan for a specific period, outlining projected income and expenses.
Capacity Constraints also known as bottlenecks, are factors that limit the maximum output of a production system or process.
Capital Budgeting : Capital budgeting is the process a company uses to evaluate and select long-term investment projects, focusing on the cash inflows and outflows rather than just profits
Cash Forecast: An estimate of your business's cash inflows and outflows over a certain period of time. .
Committed fixed costs: Costs relating to the basic facilities and organizational structure that a company must have to continue operations.
Common Size Statement Analysis: Method of presenting financial information as a percentage of a common base figure such as total sales or total assets.
Contribution Margin: Contribution margin is a business’s sales revenue less its variable costs. The resulting contribution dollars can be used to cover fixed costs, and once those are covered,contribute to profit.
Contribution Margin Ratio : The contribution margin ratio (CM ratio) of a business is equal to its revenue less all variable costs, divided by its revenue. It represents the marginal benefit of producing one more unit
Controllable Costs: Expenses that a manager or company can directly influence or adjust through operational decisions. These costs are typically related to the day-to-day operations and can be managed to improve financial performance. Examples include labor costs, marketing expenses, and certain variable costs.
Contribution Margin Income Statement: A contribution margin income statement is an income statement that groups costs into fixed and variable categories.
Cost-Benefit Analysis: A process used to compare the costs and benefits of two or more alternatives in order to estimate which one is the most profitable.
Cost Of Capital: The cost of capital is the minimum return a company must earn to justify the expense of financing a project or investment. In other words, the cost of capital determines the rate of return required to persuade investors to finance a capital budgeting project. The cost of capital is heavily dependent on the type of financing used in the business. A business can be financed through debt or equity. However, most companies employ a mixture of equity and debt financing. Therefore, the cost of capital comes from the weighted average cost of all capital sources.
Cost of Debt: Interest rate a company pays on borrowed funds.
Cost of Equity: Return investors expect for providing capital.
Cost Object: Any segment for which cost information is desired—this could be a product, service, project, activity, department, division, or customer.
Degree of Operating Leverage (DOL) : The DOL number is an important number because it tells companies how net income changes in relation to changes in sales numbers. More specifically, the number 5 means that a 1% change in sales will cause a magnified 5% change in net income. DOL = CM / Net Income
Depreciation: A reduction in the value of an asset with the passage of time, due in particular to wear, tear, and obsolescence.
Differential Cost: The difference between the cost of two alternative decisions. The cost occurs when a business faces several similar options, and a choice must be made by picking one option and dropping the other. When business executives face such situations, they must select the most viable option by comparing the costs and profits of each option.
Direct Cost: Costs that can be directly traced to a specific cost object; such as labor and materials, that would be eliminated if the cost object were eliminated.
Direct Fixed Costs: Fixed costs that can be traced directly to a product or product line.
Discount Rate: Rate used in Present Value (PV) and Net Present Value (NPV) calculations which is often the cost of capital.
Discretionary Fixed Cost: Costs that can be adjusted at the discretion of management; examples include advertising and employee training expenses.
Economic Inventory Quantity (EIQ) :Economic Order Quantity (EOQ) is a formula used in inventory management to determine the ideal order size for a product to minimize total inventory costs. It helps businesses find the balance between ordering costs and holding costs.
Expense: An expired cost recognized in financial statements; typically refers to costs like cost of goods sold and wages.
Equivalent Annual Annuity (EAA): A method used in capital budgeting to compare mutually exclusive projects with different lifespans by calculating the constant annual cash flow that would be equivalent to the project's overall profitability. It effectively converts a project's total net present value into an annual equivalent.
Fixed Cost: Costs that remain constant regardless of changes in activity levels; examples include salaries and property taxes.
Full Cost: The total of direct plus indirect costs associated with producing a product or service.
Horizontal Statement Analysis: A financial statement analysis method that presents changes in the amounts of financial statement items over a period of time. The analysis uses two or more periods.
Incremental Analysis (Differential Analysis): Incremental analysis, sometimes called marginal or differential analysis, is used to analyze the financial information needed for decision making. It identifies the relevant revenues and/or costs of each alternative and the expected impact of the alternative on future income.
Incremental (Marginal) Costing: A costing technique that differentiates between fixed and variable costs, focusing on the additional cost of producing one more unit of a product.
Incremental Revenue: Incremental revenue is the additional revenue a business gains from an increase in sales resulting from actions such as additional advertising or introducing new products.
Independent Projects: Investment options that allow you to select any combination of projects without impacting the others.
Indirect Costs: Costs that cannot be directly attributed to the production of a specific product or service, such as overheads and administrative expenses.
Internal Rate of Return IRR: A discounted cash flow technique used in capital budgeting decisions. IRR can be defined as that rate which equates the present value of cash inflows with the present value of cash outflows of an investment proposal. It is the rate at which the net present value of the investment proposal is zero.
Make-or-buy decision: A decision concerning whether to manufacture or purchase a part or material used in manufacturing another product.
Manufacturing overhead, also known as factory overhead or factory burden, are the indirect costs associated with a company's manufacturing operations
Margin of Safety (Breakeven Analysis)
1. In Dollars: Actual (expected) Sales – Break-even Sales = Margin of Safety in Dollars
2. In Units: Current Sales (expected) Units s - Break-even Units =Margin of Safety in Units
3. As a Ratio: Margin of Safety in Dollars / Actual (expected) Sales = Margin of Safety
Master Budget:a comprehensive financial plan that integrates all of a company's individual departmental and functional budgets into a single, unified plan.
Mutually Exclusive Projects: Investment options where selecting one prevents the selection of others. It means that if a company chooses one project from a group of mutually exclusive projects, they cannot simultaneously choose any of the remaining options, even if those other projects might seem financially sound on their own.
Net Present Value: A discounted cash flow method used to figure out if an investment will make a profit, considering that money today is worth more than money in the future. It compares the current value of expected future cash flows (like revenue or savings) with the initial investment cost.
Operating Expenses: The daily operational costs not associated with the direct selling of products or services
Opportunity Cost: The value of the next best alternative that is given up when a decision is made. To calculate it, you subtract the return of the chosen option from the return of the best foregone option. In simple terms, it's the "what you could have had" minus "what you actually have". A negative opportunity cost means the chosen option provides a greater benefit than the next best alternative.
Payback Method (Period): The payback method is a capital budgeting technique that determines how long it takes for an investment to recoup its initial cost. It's a simple and quick way to assess the profitability of an investment by calculating the time it takes for the cash flow from the investment to equal its original cost.
Performance Measurement: The process of evaluating the performance of an organization, department, or individual, often using metrics such as ROI, productivity, and efficiency.
Present Value (PV): The Present Value (PV) of an investment is what that investment’s future cash flows are worth TODAY based on the annualized rate of return you could potentially earn on other, similar investments (called the “Discount Rate”).
Production Capacity: The maximum amount of output a company can achieve within a specific time frame using its current resources, including labor, equipment, and materials. It represents the upper limit of what a business can produce before needing to invest in additional capacity.
Product Mix: A product mix refers to the complete set of all the product lines and individual items that a business offers for sale.
Product Mix Ratio: Percentage of sales contributed by each individual product or product line within a company's overall product mix. It essentially shows how much revenue each product or line contributes to total sales.
Profitability Index (PI): A financial metric that assesses the attractiveness of an investment by comparing the present value of future cash flows to the initial investment. It essentially measures how much value is created per dollar invested.
Relevant Range: The normal or practical range of operation where a company reasonably expects to operate during a specific period. Outside this range, cost assumptions may no longer hold, and costs might behave differently.
Ratios: Mathematical comparisons of financial statement account balances or categories. Most of these ratios result from dividing one account balance or financial measurement by another.
Relevant revenues or costs: Revenues or costs that will differ in the future depending on which alternative course of action is selected.
Return on Investment (ROI): A financial metric that calculates the return or profit that an investment generates in relation to its cost.
Sales Mix: The proportion or percentage of total sales attributed to each product or service in the product mix.
Sunk Cost: Past costs that cannot be recovered and should not influence current decision-making processes since they are irrelevant to future decisions.
Uncontrollable Costs: Expenses that a company cannot directly influence or change, even through managerial decisions or actions. These costs are often determined by external factors like market conditions, government regulations, or contractual obligations. Examples include rent, insurance premiums, property taxes, and depreciation.
Variable Cost: Costs that change directly with changes in activity levels; typically includes direct materials and direct labor used in production.
Vertical Statement Analysis: A method of analyzing financial statements that shows each item on a statement as a percentage of a base figure within the statement.
Weighted Average Cost of Capital (WACC): A blended rate combining debt and equity costs, used to assess investment feasibility. Companies use the cost of capital to determine whether a project will generate sufficient returns to cover financing costs and create value.