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Management Accounting is a Prerequisite for Financial Accounting

Many companies base their choice of software modules to be used for ERP and accounting on legal requirements. Financial accounting must be kept because profit or loss as well as assets and liabilities must be reported at least once a year. At the same time, accounting regulations must be complied with (local commercial and tax law, internal settlements between companies of a group).

In addition, the rules of the international accounting standards (IFRS, US GAAP and the like) mostly assume the following basic structure of the income statement:

Management Accounting is a Prerequisite for Financial Accounting — Full cost structure of the profit and loss account

This is the usual form of the profit and loss account presented externally and very often internally. It can be created with auxiliary calculations from financial accounting. All consumptions incurred in a period for the plant (material, personnel, external services, depreciation and even pro rata interest costs) are debited to the plant cost center (simplified all costs incurred within the fence of the plant). This results in the full cost of goods sold after accrual of inventory changes. Similarly, all marketing and sales costs are concentrated in the collective cost center for marketing and sales. Also, the costs for administration and management and possibly for research and development are added as a percentage of the full costs of products sold. This presentation mostly meets the requirements of the mentioned external standards of financial accounting.

However, the executives of a company, especially the product and cost center managers plan and decide quantities, activities and prices and create new products and services by means of input factors such as working time, material or energy. Corporate management expects all managers of lower levels to take responsibility for the costs of their area. To this end, it must be ensured that there is a causation-based relationship between costs and the units created and sold.

Cost, performance, revenue and profitability accounting

The relationship to quantities, consumption and values can only be established in a management accounting that presents cost, activity, revenue and earnings. This system calculates how much the consumed quantities and services did or should have cost per product or service unit. Accounting for management is a matter of calculating the plan, target and actual of the units produced and sold. Because both the cost and the revenue side are included, the term management accounting became established.

The figure below shows that in the various auxiliary accounts and in the summarizing general ledger accounting, the focus is on the period view for the company. In the right-hand management accounting section, on the other hand, the order or unit view is decisive. Managers at all levels want to know how much it cost to manufacture a product or service unit in their management area. In order to calculate the result for the period, it must also be known by how much the inventory quantities of raw materials, semi-finished and finished products have changed per item. Costing per product unit is a prerequisite for this valuation.

In the accounting-based full cost structure of profitability analysis, both unit and period costs are deducted from net revenues to arrive at Gross Profit. Example:

full product costs per unit — Full product costs per unit

In month 1,100 pieces were produced and sold. This resulted in full production costs of 500, taking into account the cost center costs of production,warehousing and purchasing. In month 2, 120 pieces were produced and sold at the same material purchase price of 2.00 per piece. According to accounting, the personnel costs remained at 300 (the existing employees had enough capacity for the additional production). As a result, the full manufacturing cost per piece dropped from 5.00 to 4.50.

Questions:

- Is the finished goods inventory receipt to be posted at a different valuation each month (moving average)?
- If yes, does the gross profit per unit change each month because the capacity utilization is different? What is the correct valuation approach for planning and managing sales?
- The differing full costs of goods sold per unit are the result of the utilization of the production cost centers. The staffing and machinery of these cost centers is determined by production managers, not by sales.

Planned and actual costing are core functions of management accounting.

The calculated values are not only used for inventory valuation but above all are compared with the net revenues generated by sales. As the sales organization is not responsible for variances in production and procurement this requires that direct material consumption is valued at planned purchase prices and work plan positions are valued at the planned proportional cost rates of the cost centers. Splitting cost center costs into their proportional part (driven by the products) and their fixed part (driven by the dimensions of the cost centers) is a key requirement for decision-relevance.

Controllers and management accountants must therefore set up their system in such a way that a distinction can already be made in the standard cost estimate between proportional costs directly caused by the products manufactured and fixed costs that are mainly the result of management decisions. This is because the net revenue from a sale to a customer must first be compared with those costs that can be allocated to this order in a manner that reflects their cause. In the absence of a direct cause-and-effect relationship, fixed costs can only be allocated to a product or a customer by applying allocation keys that are arbitrarily chosen by the majority. Only small proportions of marketing and selling costs and other cash out costs can be allocated to an individual product or customer on the basis of causation.

In Accounting for Management rules such as IFRS, US GAAP or tax laws do not apply. They lead to incorrect decisions.

Example: A product with a high proportion of material or external activity costs must bear a higher proportion of the fixed costs of purchasing and the warehouse cost centers, even if its procurement is uncomplicated and can be handled with a telephone call or an e-mail. This increases the full manufacturing costs of this product, with the result that the markups for marketing and sales costs and for other cash costs and depreciation also increase. This is because such surcharges are calculated on the basis of the full manufacturing costs. The product then no longer looks particularly worthy of promotion because it is “broken” by surcharges.

Conclusion: A management accounting system is built to support all managers of a company in their decision-making so that they can achieve an overall improvement in the company’s results. Fixed cost allocation does not help in this optimization process. According to the current state of knowledge, it is recommended to set up management accounting as marginal costing, combined with multi-level contribution margin accounting .

The Institute for Management Accounting IMA still trains and propagates the “full cost structure of profit and loss accounting”. The focus is still on external reporting, not on internal decision making. These non-decision-making guidelines led to the establishment of the Profitability Analytics Center of Excellence (PACE). Find practical examples and technical papers on how management accounting can increasingly fulfill its mandate to show executives ways to improve results on their homepage.

Variators for Cost Splitting

In many textbooks and partly also in cost accounting software the variator method is recommended to split cost center costs into their proportional and their fixed part. The planned proportional costs are given as a percentage of the planned costs of a cost type in a cost center and the complement is the fixed costs of this cost type. Using variators for cost splitting should be omitted because it generates incorrect cost rates. The example explains this:

Initial situation in annual planning

The annual production plan shows that the cost center to be planned should work 14,400 hours on production orders. The cost center manager plans, including himself, a staff of 10 persons, each working 1,600 hours per year. The planned yearly personnel costs will amount to 480,000 EUR, the average rate per presence-hour and employee thus to 30.00 EUR. 90% of the planned 16,000 presence time hours are to be used for manufacturing (14,400 hours) and 10% for organization ant training. Thus the variator of 90% results (row 6).

The planned non-personnel costs (including depreciation) amount to 100,000, of which it is estimated that 5.00 are to be used per hour of planned employment. This corresponds to proportional non personnel costs of 72,000 and thus a variator-rate of 72% (rows 9 and 10).

Comparing the variator method and direct activity-based planning shows (still) the same planned cost rates, e.g. 35.00 proportional hourly cost rate.

But the executives and the cost center manager expect stronger fluctuations of the production quantities in the plan year. They decide to equip the cost center with an eleventh employee (security variant). This increases the installed capacity to 17,600 hours and the planned personnel costs to 528,000. But the planned employment remains at 14,400 hours per year. Due to the variator of 90% the higher personnel costs raise the proportional hourly rate from 35.00 to 38.00, although the same number of hours is worked for the products to be manufactured.

It is the fixed cost-rate that has to change from 5.61 to 8.61 as more fixed costs are included in the products. The proportional planned costs per unit remain the same. This is appropriate, since the costs of the additional employee only become proportional costs when his hours are used for manufacturing.

Variators belong to the master data of cost accounting and it is not intended that they be adjusted by cost element each time there is a change in normal capacity or planned employment. The variant with 11 employees results in incorrect cost rates. This is because also in the second variant, 30.00 personnel costs and 5.00 material costs are incurred for each hour worked on order; it is the same people with the same wages who perform this work. If, as a result of a revised sales plan, plan employment were increased, each variator would also have to be adjusted.

If in the subsequent plan year, non-personnel costs increase from 100,000 to 120,000 because fixed depreciation and non-personnel costs increase, a portion of the fixed costs will be “shifted” to the proportional plan cost rate if the 72% variator remains the same. As a result, period fixed costs are understated.

Conclusion: Variators are unsuitable for the design of a flexible budget costing and a real contribution margin accounting. They have to be adjusted cost type by cost type in the master data with every activity change. Flexible budgeting produces the correct values. In addition, it ensures that the proportional planned cost rate remains the same even with changes in the production program and thus with other planned activities.

Target and Actual of Production Orders

Product costing follows the planning and control process of a company:

1. In sales, the quantity-based annual sales plan is drawn up per finished item, be it a physical product or a service unit.
2. Production management determines the quantities to be produced per item on the basis of the sales plan. In doing so, it takes into account the existing inventory, the machine and personnel capacities of the production cost centers as well as expected interruption times due to vacations, public holidays and machine maintenance. Production management wants to have enough semi-finished products in inventory at all times in order to deliver the units sold on time and still manage with minimum average inventory levels. Therefore, production management must determine the lot sizes of the individual production orders.
3. Purchasing ensures that the material requirements resulting from production and sales planning are available in stock on time. In addition, it negotiates with the potential suppliers in good time the planned purchase prices of the products and services to be bought. This is necessary to calculate the planned costs of the products and services.
4. The managers of the manufacturing cost centers prepare the planning of their cost center on the basis of the planned activities resulting from the production plan. To do this, they need the planned production quantities, the standard times from the work plans for the items they produce and the setup-times to be scheduled for each production order. With this information they determine the planned activity of their cost center, i.e. the activity that is to be performed directly for the production orders to be processed.In the next step, the cost center managers consider how much auxiliary or operating materials will be required from the warehouse or directly from the suppliers in order to be able to perform the planned activity. They also plan which services will have to be procured from internal auxiliary cost centers (e.g. energy, water, compressed air, repairs and maintenance) depending on the planned employment.

The sum of these planned costs is divided by the planned activity, which results in the proportional planned cost rate of the cost center. This rate is used for the calculation of proportional product costs in planning as well as in actual (5). This data can be used to calculate the planned proportional (standard) costs of an item and the precalculation of a real production order. If these are deducted fromnet sales, the contribution margin I per product and summarized per product or customer group can be calculated, also in planned and actual data.

The precalculations of the orders of a month are decisive for the calculation of the monthly flexible budgets of the production cost centers. If the actual costs deviate from the flexible budget, consumption variances arise (per cost element). The cost center manager is responsible for these. He must ensure that corrections are made so that the company can achieve its profit targets.

See also “Management Control with Integrated Planning“, Chapters 4 and 5.

Order Variances

Only a few variance types can clearly be assigned to the individual production order:

A lot size variance occurs when the production lots ordered deviate from the planned lot size in the annual plan. If the quantity ordered in a production order is larger than the quantity planned in the standard cost estimate for the article in question, the setup costs are spread over more units. As a result, the item produced costs slightly less per unit.

Yield variances occur when more or fewer “good quality” pieces result from the production order than planned. This happens primarily in process manufacturing, e.g. in the production of chips for processors or in chemical processes.

Material quantity variances occur when the input material did not fully meet the specifications or when the processing machines were not precisely adjusted. They lead to cost overruns in the respective production order.

Work time variances occur in the cost centers of production when more or less process time has been used than in the plan-calculation of the order. These over- or under-consumptions can be assigned to the individual order if the processing cost centers record their output per order.

Purchase price variances occur when the really price paid for raw materials and purchased services does not correspond to the planned price (especially in the case of inflation). They can be calculated in purchasing when the supplier invoice is recorded. Because the purchasing department negotiates the contracts with the suppliers, it is also responsible for purchase price variances.

As the same material can be used for different products and in many production orders, most purchase price variances can neither be assigned to an individual production order nor to a cost center according to cause. Direct assignment is only possible when materials or services are procured directly for a production order or a cost center.

Usually, raw materials and supplies are first stored in inventory and are only assigned to the production orders or cost centers when they are taken from the warehouse (material withdrawal slip). If actual purchase prices are used to value the inventory, the same material is in stock at different purchase prices. As a result, production would encounter a different average purchase price for the material each time they use this material.

If the production orders are debited according to the first in – first out principle, the order processed earlier still benefits from the lower-priced material, while the subsequent order is charged the higher prices. Valuing inventories with moving average prices does not help either. This is because each production order delivered to inventory results in new (proportional) unit costs and thus different valuation approaches in the warehouse for the same finished item.

If all warehouse receipts and issues are valued at standard purchase prices, this dilemma can be avoided. Production and sales can then (internally) purchase the materials throughout the year at the standard purchase price, and purchasing can determine the purchase price variance at the moment of purchase, i.e. when it occurs.

In the cost centers, the flexible budget costs, i.e. the planned costs of the actual activity performed, must be adhered to. The cost center managers are responsible to avoid negative differences between target and actual costs, i.e. spending variances, and for ensuring that these variances disappear in subsequent periods.

The example below has already been presented in a similar form in the post “Complete variance analysis“. All variances from the target are presented at the lowest hierarchical level to which they can be clearly assigned. This is also the place to intervene if these variances are to be avoided in the future.

Order variances — Different types of variances

This illustration only shows internal variances within the company. Changes in net sales are analyzed in contribution accounting.

Job Order Costing

Initial situation: In the annual plan derived from strategy and medium-term plans, it is determined which items (services or physical products) are to be manufactured at what cost. For this purpose, the planned proportional production costs per unit are to be calculated in the costing system. In the sense of Management by Objectives the responsible persons have the task of adhering to these planned proportional product costs in each production order. This requires that each responsible person (e.g., production managers and project managers) must be able to track which costs were directly caused by an order. This is because they can only take responsibility for the cost elements that they can directly influence.

Three types of costing are distinguished because they serve different purposes:

- Standard costing: Determination of the planned costs of a unit of an item (physical product or service) as part of annual planning. This costing results in the (annual) planned costs per unit produced.
- Precalculation: On the basis of the planned costs and the actual quantities ordered, the planned costs of an order to be actually executed are calculated. This is because the actual incoming orders rarely match the planned quantities. Precalculation forms the basis for the target to actual comparison of a production order that has been placed.
- Post-calculation: Comparison of the costs incurred in the actual order compared to the precalculation.

With this target to actual comparison managers are enabled to identify the order items that have deviated from the plan. With this information they can intervene in the next periods and find measures that will lead to achieving the target costs again in the following periods. In addition, it must be ensured that cost variances are not passed on to subsequent levels. This is because these are only responsible for their own variances.

Cost center-managers as well as production- and project-managers are responsible for variances in the production area. In decision-relevant management accounting the variances of production and all cost centers should not be charged on, neither to the warehouse nor to the sales organization, since the latter cannot be responsible for such variances. For management-relevant Profitability Analysis (step-by-step contribution accounting), it follows that during the year all warehouse receipts should be valuated at proportional planned production costs and the variances should be shown in the (monthly) Profitability Analysis. This is because the variance types mentioned can neither be allocated to the products nor to the sales organization nor to the individual customers according to their cause.

Cf. the posts “Multdimensional Contribution Accounting” and “Complete Variance Analysis“.

The next two posts show how the various types of variances are shown in Profitability Analysis in a way that is appropriate to the levels and responsibilities, where they are to be shown, and how inventories are to be valued.

Decisions – Responsibility – Causality

Useful Management accounting systems must provide the data relevant for decision-making.

Decisions – Responsibility – Causality

CZSG Controller Zentrum St. Gallen/Switzerland introduced many decision-relevant planning and control systems mainly in German speaking countries. The basis was always “Grenzplankostenrechnung GPK” and the further developments arising from it. The applied management accounting principles correspond almost 100% to the recommendations for the design of “Resource Consumption Accounting RCA” according to Larry R. White (Journal of Corporate Accounting & Finance, Volume 20, Issue 4) and of the Profitability Analytics Center of Excellence PACE.

Who decides what?

Many chief financial officers and cost accountants see the purpose of management accounting primarily as presenting an organization’s financial results in accordance with the requirements of local accounting laws, IFRS and USGAAP, local tax laws and regulations for setting transfer prices between related companies, and other regulations.

In our eyes the purpose of management accounting is first and foremost to provide decision support for managers at all hierarchical levels. After all, they are responsible for the results to their superiors. The focus is on management support, not on external reporting.

Decisions - Responsibility - Causality — Decisions – Responsibility – Causality

Customers decide whether they want to place an order and at what price. In this way, they also indirectly decide the proportional costs of the products or services to be sold and manufactured. Managers at all levels decide how the necessary offers are to be made and what personnel and machine capacities will be required to process the orders won and, in doing so, to achieve a profit with the company in line with the complete market.

In strategic and operational planning, managers at all levels must define activities, quantities and capacities. Consequently, consumption according to bills of materials and work plans as well as activity-based cost center budgets are required for planning and subsequent control. Only when these quantities and activities are known can they be valued in monetary terms. A management accounting system that is suitable for decision-making must therefore provide those quantities, activities and valuations which a responsible manager can control himself and thus take responsibility for. This also requires that the manager can always compare the planned values with the actual values of his area.

This starting position applies to manufacturing companies, service providers, hospitals, retailers as well as banks and government institutions.

No financial accounting system can provide this data, as it only represents values. Valuation regulations from tax law, from accounting standards (US GAAP, IFRS) or from specifications for the determination of international transfer prices are also irrelevant in accounting for management, because cost center managers, product managers and salespersons cannot change these values themselves.

Responsibilities of different managers

Since managers are responsible for achieving their objectives, it is recommended to list their responsibilities.

Production manager:

- Timely processing of dispatched production orders
- Ensuring stock receipts of semi-finished and finished products (valued at proportional standard production costs)
- Adherence to target consumption rates for materials and cost center activities in accordance with the pre-calculation of released production orders, valuation of consumption at planned purchase prices and proportional planned cost rates
- Compliance with the planned costs of its own cost center(s)
- Notify other areas when capacity constraints become apparent.

Cost Center Manager:

- On-time completion of manufactured work
- Adherence to the pre-calculated times in the production orders to be processed
- Adherence to target costs (flexible budget) of own cost center, taking into account pre-calculated times and work performed.

Sales Manager:

- Achievement of planned net revenues per period (invoiced).
- Compliance with the planned costs of his own cost center(s)
- Meeting the agreed delivery dates to the customers.

Purchasing Manager:

- Procurement and on-time availability of all goods and services to be purchased.
- Determination of planned prices (standard prices) for raw and auxiliary materials as well as services to be purchased (on this basis the standard cost calculations are prepared)
- Informing sales and production in the event of major variances between actual and planned cost prices.

Who is responsible for depreciation?

- The manager in whose cost center the asset is located,
- the managers who determined the planned useful life of an asset on the occasion of the investment decision,
- the financial manager or the controller who determines the depreciation method (preferably fixed depreciation from the replacement value of an equally efficient asset)
- Depreciation is mainly a period cost, since most assets do not need to be replaced because they no longer function, but because they are technologically obsolete.

In the stratified presentation of the origin of results and profit, the contribution of the individual responsibles and their employees becomes apparent:

Who is responsible for idle capacity?

- The managers who bought too large a plant,
- the salespeople who sold too little
- possibly cost center managers, if they do not point out idle capacity to their colleagues.

From this it can be deduced that it makes little sense to allocate costs of idle capacity (especially personnel and depreciation costs) to cost centers or product groups. As mentioned, imputed depreciation and personnel costs are charged to cost centers because they are observed there.

Strong and weak causalities

In our opinion, a strong causality is given if the consumption of an input good, e.g. the output of a cost center or an employee, is directly caused by the storable or saleable product. This is the case if a routing or/and a bill of materials can be created for the product or the service unit performed. In Grenzplankostenrechnung GPK, therefore, only proportional costs are charged to products or services, and the remaining fixed costs are transferred to stepwise contribution accounting. This is because fixed costs can only be changed by management decisions, such as firing an employee or purchasing a machine.

Weak causalities do not show a direct dependency between output and input.

Example 1: Because the headcount has increased, the HR department needs an additional employee for everyday personnel support. There is no rule how many employees one person in the personnel department can supervise. It is a management decision whether to hire the person or not. The costs directly attributable to a manufactured product do not change as a result of the increase in staffing levels, since no changes are required in either the bills of materials or the routings. But the fixed costs of the company increase.

Example 2: A company fills gas cylinders and delivers them to customers by trucks (see the case study “Le Petomane Gas in the PACE homepage“). Delivering to a remote customer requires an additional hour of travel time, resulting in corresponding fuel and labor costs. These could be saved if the customer is no longer served. On the other hand, the net sales minus the proportional costs for the delivered gas cylinders, i.e. the contribution margins I of this customer would be eliminated. This results in: + omitted transport costs – omitted contribution margins.

The proportional product costs per filled gas cylinder in the finished goods warehouse can be clearly determined since material consumption and work schedule for filling are defined in the technical bases (strong causality).

Example 3: Most companies have a central IT cost center for the implementation, operation and maintenance of applications and data. The resulting data and evaluations are used (to varying degrees) by many cost centers. In cost accounting, therefore, a search is often made for cause-effect chains by means of which the IT costs can be charged to the receiving cost centers. Mostly this search is unsuccessful because both the data sets and the applications are used by a wide variety of cost centers (very weak causality).

Nevertheless, many financial managers and cost accountants try to allocate the fixed costs of the IT department (including depreciation) to the various cost centers and from there to the manufactured products by means of one or more allocation keys. After all, according to the widespread opinion that each product must bear its share of the total fixed costs. However, the IT manager plans and controls the costs of the IT department and is consequently also responsible for them to the management. There is no need to allocate costs to individual cost centers and products. The contribution margin from sales must be sufficient to cover all fixed costs plus the target profit.

Insight:

In Grenzplankostenrechnung GPK, only proportional costs are allocated to manufactured products because they were directly caused by the products (only strong causalities). Therefore, in management-oriented cost and revenue accounting, inventories should also be valued only at proportional (standard proportional product costs). This is because fixed costs are period costs and, as such, should be shown as blocks in the contribution margin accounting. They are to be controlled in the cost centers.

Precisely: In GPK and in Resource Consumption Accounting RCA, fixed cost allocations have no place because these allocations are an attempt to delegate cost responsibility to units that have no direct possibility of influencing the costs at the point of origin.

Of course, it makes sense to include fixed costs in pricing for individual customers. However, in our view, this is activity-based pricing, not costing. Therefore, considerations about setting offer prices and conditions should be made outside the management accounting system, especially in the sales organization.

If in the Costing Levels Continuum Maturity Model from Gary Cokins the levels 11 and 12 are to be reached, all allocations of fixed costs must be eliminated, because otherwise no useful simulations are possible. IFAC-Evaluating-the-Costing-Journey_0.pdf

Target to Actual Comparison

Target to Actual Comparison shows the difference between the should be-costs and the actual costs in a cost center

Target to Actual Comparison

The great benefit of comparing the flexible budget with actual costs is that cost center managers can see every month how well they succeeded in implementing the plan, taking into account the orders processed. The financial goal of a cost center is to meet the cumulative flexible budget costs for the year. If the flexible budget and the actual costs are determined as described in the post “Flexible Budget”, corrective measures can be sought quickly. These should bring the cumulative spending variances back to zero in the next periods, if possible. Theoretically, a target to actual comparison could be made “real time”, i.e. daily. But because the real personnel costs and other cost types can only be calculated after the end of each month, it is recommended to create monthly comparisons per cost center.

The example shows the monthly target to actual comparisons of the cost center Stamping:

The spending variances show how well the cost center manager succeeded in keeping to the planned costs adjusted to the effective performance in the individual months. A positive spending variance means a productivity gain compared to the plan, a negative the contrary. These variances are corrections of the planned fixed costs.

In the month of July, Ringbook Ltd. is on vacation. Therefore, no activity is listed there, but parts of the fixed costs, especially depreciation, are also incurred in this month. The flexible budget costs are calculated according to the formula “actual output times proportional planned cost rate + planned fixed costs”, the actual costs according to the real charges.

For the year as a whole, the flexible budget was undercut by 6,164.

Actual costs

The costs charged to a cost center for a reporting period (usually a month) are recorded in various subsystems:

- Invoices from external suppliers: Recording of the invoice receipt in accounts payable with specification of the consuming cost center.
- Consumption of auxiliary and operating materials from the warehouse: Recording by means of material consumption slips by multiplying the purchased quantity, valuated with the planned purchase price of the auxiliary or operating material. The planned purchase price is used for valuation because the purchase price variances are reported to the purchasing department, since this department triggers the purchase orders.
- Personnel costs: Debit of the presence hours of the month of the employees of the cost center, valued in each case with their planned presence hour rate (data source is the personnel cost plan).
- Charging of activities of other cost centers: Units consumed during the reporting period (mostly hours, kWh, km) valued at the proportional planned cost rate of the providing cost center. As a result, neither the fixed costs of the issuing cost center nor the variances incurred there are passed on.

Overall: The fixed costs and the purchase price variances remain in the sender cost centers, since they can only be recorded and accounted for there. In this way, target to actual comparisons are created in the receiving cost centers without including price or cost-rate changes from serving areas. The resulting variances are the responsibility of the respective cost center manager.

Flexible Budget

Calculating the planned costs of the actual services provided.

Flexible Budget

When performing a target to actual comparison, cost center managers should be able to check monthly as to whether or not costs they can manage themselves are “under control”. Given that the annual plan is approved by the organization’s management who releases the cost center budgets, the budget must be adhered to. However, during the year various factors can deviate from the plan, including:

- Sales and production quantities,
- Purchase prices,
- Manufacturing processes efficiencies, and
- Employees retention rate.

A simple comparison between planned and actual costs does not help cost center managers in their search for possible corrective measures because they lack a reference to the actual performance of the period under review. As a benchmark the flexible budget of the cost center should be calculated:

Flexible budget costs =

actual activity x proportional planned cost rate + planned fixed costs.

The flexible budget shows the planned cost of work actually performed in a period. If the activity performed in the period under review deviates from the planned activity, the proportional costs of the cost center will change, but the planned fixed costs should not. In the example below, actual employment is slightly less than planned employment. Therefore, the proportional plan costs is less than the annual plan, but the planned activity capacity (fixed) costs remain the same.

The flexible budget cost is thus the cause-related yardstick for assessing the total costs actually incurred by the cost center. If the cost center managers keep to their flexible budget, they will have achieved their cost target. If negative variances from the target costs occur, ways must be found to cumulatively reach the flexible budget again in the following months.

If cost centers perform activities that are not directly caused by a production order, a customer order, or by internal projects (e.g. research and development), they also have no planned or actual activity and consequently only fixed costs. In these cases, the flexible budget corresponds to the planned costs.

For the wire bending cost center in the example company the annual plan is as follows:

The installed capacity of the production equipment is 7,264 hours, which is sufficient for the planned production time.

The cost center has a planned workforce of 4 people who are planned to work a total of 6,800 net hours. This includes the working time of the cost center manager for planning and controlling the cost center.

The complete planned personnel costs of the cost center totals 387,600. The average hour worked (including the cost center manager) will thus cost 57.00 per hour (presence time).

According to production planning 5,870 employee hours will be necessary to execute the planned activity. This means that 5,870 hours at 57.00 per hour will “slip” into the products to be manufactured. This corresponds to 334,590 planned proportional personnel costs. The 53,010 difference between the planned personnel costs represents the costs for work not directly related to the products, i.e. the planned fixed personnel costs for the year.

In line with this, the other planned costs were divided into their proportional and fixed portions. Dividing the proportional budgeted cost of 363,940 by the planned activity of 5,870 hours yields a budgeted hourly proportional cost rate of 62.00 for wire bending. This rate is used to calculate the proportional costs of all products that will be processed in this cost center (see the post “Standard Cost Calculation of Products”).

If the activity of the issuing cost center is caused by a direct order of the receiving cost center or by its activity, there is a direct cause-and-effect link between the serving and the receiving centers. The planned proportional cost-rates can thus be charged to the receiving cost centers. The issuing cost center has its own planned and actual activity. The activities it performs for other cost centers can be measured. (Examples include repair and maintenance shop, laboratory, and energy cost centers). Thus, the respective cost center also has a proportional plan cost rate and its flexible budget is dependent on the activity performed for others during the period.

If the activities of a cost center are performed for the entire company, there is no direct cause-and-effect relationship between the producer of the activity and the users of the output. Therefore, the costs of such cost centers cannot be allocated to other cost centers according to their cause (e.g. reception, personnel administration, internal training, sales, production planning, finance, the majority of IT costs and top management). The IT costs for the ERP- or for the management accounting system are incurred for all cost center managers who use ERP data. The costs of generally used services cannot be charged to the users according to their origin (forced consumption). Due to this lack of causation, the allocation of fixed costs to other cost centers makes no sense. In other words, fixed costs should not be allocated to other cost centers, cost center managers should assume responsibility for their own flexible budget.

Flexible budgets are thus a prerequisite for the introduction of a Resource Consumption Accounting system RCA and for Contribution Accounting.

Personnel Costs in Cost Accounting

Include the non-wage personnel costs in the hourly presence rate of employees.This simplifies cost accounting.

Personnel costs in Cost Accounting

In this post we understand personnel costs as the costs for the work done by the employed persons . The costs of external persons who work for the organization are not included since the wages of these persons are accounted for and paid out in the performing organization.

Each person employed by an organization is assigned to a cost center, usually the cost center of the person’s boss. If employees perform work for projects, their personnel costs are incurred in the cost center of origin and, as far as measurable, are charged to the projects as internal services with corresponding hourly rates. Each employee is assigned to one and only one cost center. Should a person have two employment contracts in the same company, these are to be assigned to the respective cost centers.

Cost center managers are responsible for the costs of their personnel . Therefore they want to know the monthly personnel costs of their management area in plan and actual.

Requirements for the personnel department, financial accounting and software

Payroll accounting is becoming increasingly complicated, since different types of non-wage labor costs have to be taken into account and since payments occur at different times, e.g. monthly salary, vacation pay, Christmas bonus, child allowances, gratuity, bonus. For each employee, the payroll must usually be created monthly in the payroll system for each wage type and wage deduction type. This detail is necessary that employees can understand what net amount is due to them and is to be paid out per payroll period.

The payroll accounting system must also be structured in such a way that the social insurance companies, the governmental control organizations and the auditors can understand whether all wage and wage deduction items have been calculated correctly. For the company’s own financial accounting, this system must prepare the expenditures for wages and salaries and deductions according to expense types so that they can be posted and checked on an accrual basis.

In most countries, employees receive a monthly pay slip. This shows the contractual gross wage earned in the period and which allowances for overtime and shift work have been accounted for and credited. If supplements for 13th month wages, vacation or Christmas bonuses have been agreed in the employment contract, these items are also listed in the wage statement for the month of payment.

Deductions to be borne by the employee are subtracted from the resulting wage total, e.g. employee contributions for social security and health or accident insurance, in various countries the wage taxes, contributions to pension insurance and similar. This results in the net wage to be paid out for the individual. The company must pass on these deductions to the relevant governmental organizations or insurance companies.

In cost center accounting, however, it is not the cash flows and settlements that are relevant, but the consumption of a reporting period.

Information requirements of cost center managers

Cost center managers are responsible for the costs incurred in their management area that can be directly influenced by them. Consequently, cost accounting must be designed that the personnel costs of a period can be compared with the work performed in the period.

For this purpose, it must be calculated in planning how much a certain person should cost per hour of presence according to the employment contract, if all wage components and the non-wage costs to be paid by the employer are included. Example:

In the example, it is assumed that the person, including the 13th month’s salary and possibly other fringe benefits, is to receive an annual salary of 58,620.90 and is to be present for 1,700 hours (212.5 working days of 8 hours each) in accordance with the annual work calendar. For the non-wage costs to be paid by the employer (i.e. unemployment insurance, pension plan, possibly health insurance), a surcharge rate of 16% on the gross wage sum was calculated. In total, this employee costs the company EUR 68,000 per year or EUR. That is 40.– EUR per planned hour of presence. This is the key information for the cost center manager: For each work/presence hour, this person costs the company EUR 40.

If this person works exactly the 1,700 hours during the year (line 7), the following personnel costs result according to the recording of the presence time (line 8), for which the cost center manager is responsible:

In the example the company is closed for company vacations during July. Since the employee does not have any presence hours in July, no personnel costs are debited for him, although he receives a salary payment. This is because the hours were worked in the other months (the total presence hours in line 7 is 1,700 hours). Even if the employee is paid the same wage every month, it makes sense for the cost center manager to see the personnel costs based on the really worked hours .

However, in payroll accounting and consequently in financial accounting, the payment values can be found. They differ from the costs:

In the payrolls, Monthly Payments to Employee 1/12 appears as the gross monthly wage, cf. line 1. Vacation and Christmas bonuses are also included in personnel costs but are paid in June and November. Payments of child allowances are not listed because they are reimbursed to the company by Social Security. Social security costs charged to the company are included in the 16% for non wage costs (line 4). They represent the amounts the company (not the employees) must pay for unemployment insurance, retirement benefits, and possibly health insurance (9,379.34).

The monthly personnel costs are calculated by multiplying the hourly presence rate (line 6) by the time worked. Thus the personnel cost for the work done in a period is charged to the cost center, not the amount from the pay slip (line 8). The data source for charging personnel costs to the cost centers are the amounts from cost center planning and the presence times, not the payrolls for the employees.

Necessary personnel cost-types in management accounting

In many companies it is sufficient to set up only one cost type “personnel costs” in management accounting. This is because in most cases, a person’s hourly presence rate includes all compensation, as shown in line 6. Cost center managers cannot influence the conditions for non wage labor costs because they are governed by regulations. Therefore, as shown in line 4, they can be included directly in the planned hourly rate. This facilitates planning and control for cost center managers.

Additional personnel cost types indicated by

- Shift bonuses and/or bonuses for weekend work
- Bad weather bonuses (construction industry)
- Danger bonuses
- Overtime bonuses and
- Bonuses on achieved sales or contribution margins

are to be aligned. This is because these bonuses are planned and settled on the basis of hours actually worked or sales results achieved.

Imputed Depreciation

Imputed depreciation

“Imputed depreciation is the cost equivalent of the value depletion of long-term usable operating resources (Wolfgang Kilger, Flexible Plankostenrechnung und Deckungsbeitragsrechnung, 9th improved edition, Wiesbaden, Germany, 1988, p. 398)”.

Imputed depreciation should lead to corresponding amounts of money for replacement investments being “bunkered” in financial assets in the operating profit and loss account in order to be able to procure replacement equipment if necessary and thus continue to fulfill the purpose of the business. The depreciation equivalents mentioned by W. Kilger must be calculated on the basis of the replacement values of the investments from the point of view of value preservation.

The result is that imputed depreciation should not be calculated o from the basis of the historical acquisition value of equipment that can be used in the long term, but on the basis of the amount that would have to be paid at the end of the year for equipment with the same performance. In our view, the profit potential of a company is only maintained when equally efficient resources can be bought again. Only when the existing elements of the fixed assets can be procured again at current purchase prices is the substance preserved. Only the profit after deducting depreciation that preserves substance can be distributed to the owners / shareholders with a clear conscience.

The valuation at replacement value and the derivation of imputed depreciation from this requires that it be clarified before the annual financial statements what changes in purchase prices are to be expected for the various parts of the fixed assets. There are many reasons for impending cost price increases or expenditure for updates:

- Inflation in the procurement markets
- New technical or legal regulations to be complied with
- Changes in safety regulations for the operation of systems (and buildings)
- Adaptation of computer programs, program extensions and release changes
- Change to another machine supplier because the previous one no longer exists.

On the other hand, systems to be replaced can become cheaper to purchase because physical system parts are replaced by electronics or metal by plastic.

Both with expected rising and falling purchase prices of assets and intangible assets, imputed depreciation must be recalculated for the year to plan and taken into account in the planned cost calculations. This is because in management accounting, like other costs, depreciation is one of the factors determining the level of profit.

Imputed depreciation should not only be calculated for long-term assets such as buildings, equipment, machinery and vehicles. Operating resources also increasingly include rights and potential benefits of a non-physical nature such as ERP and CRM systems, rights of use and usage and sale, purchased customer addresses and time-limited usage licenses. If such potential benefits lose their value over time and new investments are required to maintain them, the corresponding estimated amounts must be included in the replacement value, which in turn leads to higher imputed depreciation.

Sustainably successful corporate management requires the inclusion of imputed depreciation in the internal income statement. This prevents money from being distributed to the owners that will be needed to maintain the company’s potential for success and thus its continued existence.