Cost Accounting AGEC Spring 2010

Managerial Cost Concepts 1.Direct materials 1.Direct materials: raw materials physically associated with the final product 2.Direct labor 2.Direct labor: employees physically and directly associated with the final product 3.Overhead 3.Overhead: costs indirectly associated with the final product

More Concepts 1.Period costs 1.Period costs: costs matched with revenue for a specific time period. (i.e., net income for a specific period (i.e., quarterly, annual). 2.Product costs 2.Product costs: costs associated with producing the final product. Not considered an expense until the product is sold. 3.Total costs 3.Total costs: equals direct materials, direct labor and manufacturing overhead plus indirect costs (selling and administrative expenses).

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget Selling and Administrative Expense Budget Selling and Administrative Expense Budget Budgeted Income Statement Budgeted Income Statement Budgeted Cash Flow Statement Budgeted Balance Sheet Budgeted Balance Sheet Pro Forma Financial Statements Capital expenditures Capital expenditures Cash Budget

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Enterprise #n Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Enterprise #n Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Enterprise #n Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Enterprise #n Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Enterprise #n Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead

Sales Budget Production Budget Direct Materials Budget Direct Materials Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Enterprise #n Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead

The Master Budget and Pro Forma Financial Statements Enterprise #1 Unit sales and expected price Unit production and inventory Direct materials used Direct labor used Manufacturing overhead Examples of direct materials: Purchase of corn. Purchase of natural gas. Purchase of other inputs used in the production process. Examples of manufacturing overhead: Other expenses directly related to production of a specific product. Examples include property taxes, rent and depreciation

The Master Budget and Pro Forma Financial Statements Indirect expenses are those expenses not associated with manufacturing a product or providing a service. Some examples include: Marketing and selling expenses Transportation expenses outside the factory Management salaries and other administrative expenses

Total Costs Production Costs Manufacturing Costs DirectMaterialsDirectMaterials Period Costs Non-manufacturing Costs

Total Costs Production Costs Manufacturing Costs DirectMaterialsDirectMaterials Period Costs Non-manufacturing Costs DirectLaborDirectLabor

Total Costs Production Costs Manufacturing Costs DirectMaterialsDirectMaterials Period Costs Non-manufacturing Costs DirectLaborDirectLabor ManufacturingOverheadManufacturingOverhead

Total Costs Production Costs Manufacturing Costs DirectMaterialsDirectMaterials SellingExpensesSellingExpenses Period Costs Non-manufacturing Costs DirectLaborDirectLabor ManufacturingOverheadManufacturingOverhead

Total Costs Production Costs Manufacturing Costs DirectMaterialsDirectMaterials SellingExpensesSellingExpenses Period Costs Non-manufacturing Costs DirectLaborDirectLabor AdministrativeExpensesAdministrativeExpenses ManufacturingOverheadManufacturingOverhead

Total Costs Production Costs Manufacturing Costs DirectMaterialsDirectMaterials SellingExpensesSellingExpenses Period Costs Non-manufacturing Costs DirectLaborDirectLabor AdministrativeExpensesAdministrativeExpenses ManufacturingOverheadManufacturingOverhead Other Indirect Expenses Expenses

Three Cost Accounting Concepts 1. Process cost accounting 2. Job order cost accounting 3. Activity based cost accounting

1. Process Cost Accounting a specific process Tracking costs associated with a specific process Direct materials and labor associated with the specific process Manufacturing overhead costs associated with the specific process Assigning costs to finished goods

Direct Materials Direct Labor Variable Overhead Direct Materials Direct Labor Variable Overhead Mixing Department Mixing Department Baking Department Baking Department Production Cost Report Production Cost Report Packaging Department Packaging Department Finished Goods Finished Goods WIP Example: Process Costs in Making Bread

Direct Materials Direct Labor Variable Overhead Direct Materials Direct Labor Variable Overhead Mixing Department Mixing Department Baking Department Baking Department Production Cost Report Production Cost Report Packaging Department Packaging Department Finished Goods Finished Goods WIP Production Cost Report Production Cost Report Example: Process Costs in Making Bread

Direct Materials Direct Labor Variable Overhead Direct Materials Direct Labor Variable Overhead Mixing Department Mixing Department Baking Department Baking Department Production Cost Report Production Cost Report Packaging Department Packaging Department Finished Goods Finished Goods WIP Production Cost Report Production Cost Report Production Cost Report Production Cost Report Example: Process Costs in Making Bread

Comparison of Cost Systems Features Process Cost System Work in process accounts Multiple work in process accounts Documents usedProduction cost reports Determination of total manf. costs Each period Unit-cost computations Total manf. costs/ units produced during the period

2. Job Order Cost Accounting specific order or job Tracking costs associated with a specific order or job Direct materials and labor associated with a specific order or job Manufacturing overhead costs associated with a specific order or job Assigning costs to finished goods

Comparison of Cost Systems Features Process Cost System Job Order Cost System Work in process accounts Multiple work in process accounts One work in process account Documents usedProduction cost reports Job cost sheets Determination of total manf. costs Each periodEach job Unit-cost computations Total manf. costs/ units produced during the period Cost of each job/ units produced for the job

3. Activity Based Cost Accounting An approach for allocating overhead. An activity is any event, action, transaction or work sequence that incurs when producing a product or providing a service. An activity cost pool is a distinct type of activity (e.g., ordering materials). A cost driver is any factor or activity that has a direct cause-effect relationship with resources consumed (e.g., machine hours).

Steps in ABC Accounting 1.Identify and classify activities and allocate overhead to cost pools. 2.Identify cost drivers – correlation between driver and use. 3.Compute overhead rates – ABC rate. 4.Assign overhead costs to products – use of cost drivers. 5.Comparison of unit costs across products.

Overhead Costs Ordering and Receiving Materials Cost Pool Ordering and Receiving Materials Cost Pool Setting Up Machines Cost Pool Setting Up Machines Cost Pool Machining Cost Pool Machining Cost Pool # of Purchase orders # of Purchase orders Assembly Cost Pool Assembly Cost Pool Inspecting and Testing Cost Pool Inspecting and Testing Cost Pool Painting Cost Pool Painting Cost Pool # of Setups # of Setups # of Machine hours # of Machine hours # of Parts # of Parts # of Tests # of Tests # of Direct hours # of Direct hours Products Activity cost pools: Cost drivers: Activity Based Cost Allocation

Example of ABC Accounting ABC Overhead rate = Overhead per activity ÷ Cost driver per activity Initial status: Activity Cost Pool Process Driver AB overhead overhead activity rate Setting up machines$300,000 1,500 setups $200/setup Machining$500,000 50,000 hours $10/hour Inspecting$100,000 2,000 inspection $50/inspection Total$900,000 Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines# setups 1, ,000 MachiningHours 50,000 30,000 20,000 Inspecting# inspections 2, ,500

Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1, ,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2, ,500 Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (25%) $25,000 (75%) $75, /1,500 x $300,000 or 500 units x $200/setup Example of ABC Accounting

Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1, ,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2, ,500 Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (25%) $25,000 (75%) $75,000 1,000/1,500 x $300,000 or 1,000 x $200/setup Example of ABC Accounting

Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1, ,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2, ,500 Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (25%) $25,000 (75%) $75,000 30,000/50,000 x $500,000 or 30,000 x $10/hour Example of ABC Accounting

Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1, ,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2, ,500 Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (25%) $25,000 (75%) $75,000 20,000/50,000 x $500,000 or 20,000 x $10/hour Example of ABC Accounting

Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1, ,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2, ,500 Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (25%) $25,000 (75%) $75, /2,000 x $100,000 or 500 x $50/inspection Example of ABC Accounting

Step 1: Assigning overhead driver activity to products: Activity Cost PoolCost driver Driver Product 1 Product 2 activity Setting up machines # setups 1, ,000 Machining Hours 50,000 30,000 20,000 Inspecting# inspections 2, ,500 Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___ Setting up machines$300,000 (33%) $100,000 (67%) $200,000 Machining$500,000 (60%) $300,000 (40%) $200,000 Inspecting$100,000 (25%) $25,000 (75%) $75,000 1,500/2,000 x $100,000 or 1,500 x $50/inspection Example of ABC Accounting

Step 2: Partitioning of process overhead: Overhead Product 1 Product 2 Setting up machines$300,000 $100,000$200,000 Machining$500,000 $300,000$200,000 Inspecting$100,000 $25,000 $75,000 Total$900,000 $425,000 $475,000 Step 3: Process overhead costs per unit: Units produced25,000 5,000 Process overhead cost per unit $17 $95 Traditional process overhead cost per unit* $30 $30 * $900,000 divided by 30,000 units Avoids overstating profitability of some enterprises and understating profitability of others Example of ABC Accounting

Product 1 Product 2 COP unit costs with ABC costing: Direct materials $40 $30 Direct labor $12 $12 ABC overhead $17 $95 Total unit costs $69 $137 COP unit costs with traditional costing: Direct materials $40 $30 Direct labor $12 $12 Traditional overhead * $30 $30 Total unit costs $82 $72 * $900,000 divided by 30,000 units Traditional overhead costing suggests that Product 2 is cheaper to produce than Product 1, which is not true! Example of ABC Accounting

LOC and the Master Budget  Identifying monthly cash flow surpluses and deficits  Determining the required LOC – summation of monthly draws less monthly repayments  Role of the Master Budget; LOC is derived from the cash budget.

Cash Management Strategies  Acceleration of cash receipts  Pre-addressed stamped envelopes  Obtain deposits on large orders  Charge interest on overdue receivables  Delay cash payments  Pay with check (float)  Delay frequency of paying employees  Just in time inventories