Traditional Cost Management Traditional Cost Management C H A P T E R 6

Learning Objective 1 Outline the different cost flow patterns in manufacturing, merchandising, and service organizations and understand how these costs are reflected in the income statement and balance sheet.

What are Cost Flow Patterns of Manufacturing, Merchandising, and Service Organizations? Direct Materials Direct Labor Manufacturing Overhead Supplies Wages & Salaries Overhead Manufacturing Merchandising Inventory Purchase Cost Inventory Shipping Cost Service Work-in- Process Inventory Cost of Goods Sold Finished Goods Inventory Cost of Goods Sold Merchandise Inventory Work-in- Process Services Cost of Services Sold

Learning Objective 2 Interpret a cost of goods manufactured schedule and analyze the levels of raw materials, work-in- process, and finished goods inventories in a manufacturing organization.

Cost of Goods Manufactured Schedule  Shows specific costs incurred to manufacture goods.  Provides calculations that support flow of costs.  Total costs of goods manufactured should include only those costs that have gone through work-in-process during the period.  Underapplied MOH is subtracted from actual MOH costs. Overapplied MOH is added to actual MOH costs.  Cost of goods available for sale = beginning finished goods inventory (adjusted for over- or underapplied MOH) + total cost of goods manufactured.

Analyzing COGS z COGS is not useful for internal decision making. z Management wants to determine cost of goods manufactured z on a product-by-product basis; z on a department-by-department basis; z on a period-by-period basis. z Other criteria examined besides cost: z product quality. z speed of production.

Learning Objective 3 Understand how merchants manage cost information in their organization.

Inventory Management Issues Carrying Too Much Inventory n Increased overhead costs n Increased financial holding costs n Increased risk of loss of market value n Decreased inventory flexibility n Increased inventory shrinkage Carrying Too Little Inventory n Increased risk of lost sales n Increased ordering costs n Increased risk of supplier price increases n Increased exposure to nondelivery n Decreased bulk order discounts

Return on Investment n It is just as important to manage the money outflow for asset investment as it is to manage the money inflow from profits. n Good management accounting can provide real value in the management effort to improve a merchandising operation. Profit margin X Asset turnoverROI = Profit Revenue Profit margin = Revenue Total assets Asset turnover =

Define Net Operating Profit The difference between normal business sales and normal business expenses.

Learning Objective 4 Measure profitability and personnel utilization in a service organization.

Describe the Characteristics of Service Organizations Professional Services Service Shops Mass Services PeopleEquipmentProcessProduct High Customization Low Customization

What Two Concepts Are Used to Develop Cost Management Evaluation Tools for Service Organizations? 1) Profitability 2) Efficiency - While management of materials inventories, equipment, and building space are important in a service organization, where must the emphasis be placed? - Management of the people and their related cost to obtain the most efficient use of this critical resource.

What is the Formula for Profit Percentage from Professionals (PPP)? What is a Personnel Utilization Report (PUR)? PUR = Actual billable hours Budgeted billable hours PPP = Revenue – Professional compensation cost Revenue

Learning Objective 5 Calculate and interpret holding costs in merchandising and service businesses.

Match These Terms with Their Correct Formula or Definition Economic Profit Cost of Capital Financial Holding Cost The Cost of Using Money Average Investment x Annual Rate x Number of Periods Net Operating Profit – Holding Cost of Inventory and Other Asset Investments

Match These Terms with Their Correct Formula or Definition Economic Profit Cost of Capital Financial Holding Cost The Cost of Using Money Average Investment x Annual Rate x Number of Periods Net Operating Profit – Holding Cost of Inventory and Other Asset Investments

Define Segment and Economic Value Added _____________________ is a commercialized performance measurement system emphasizing incremental profits above the profit necessary to meet cost of capital requirements. __________ is a part of a business that requires separate reports by management for evaluation purposes. Segment Economic Value Added

Expanded Material Learning Objective 6 Use classic quantitative tools in inventory management (economic order quantity, reorder point, and safety stock).

Economic Order Quantity What must firms balance? costs of carrying too much inventory costs of carrying too little inventory EOQ attempts to balance these costs: overhead costs, holding costs, risk of lost market values, shrinkage, etc. EOQ attempts to answer what questions? How much inventory should we order? When do we place the inventory order?

Calculating EOQ EOQ C QP2  Q=The market demand in units for the period P=The overhead cost of placing one order C=The total carrying cost for one unit for the period Q=The market demand in units for the period P=The overhead cost of placing one order C=The total carrying cost for one unit for the period How much inventory should we order? What is the formula for EOQ? What do the terms mean? How much inventory should we order? What is the formula for EOQ? What do the terms mean?

Reorder Point When do we place the inventory order? What is the formula? Reorder point =Average lead time in days x Average daily sales Define Lead Time: time lag between initiating a purchase order and when inventory is delivered and ready for sale.

Safety Stock Because a surge in customer demand or problems in order processing or shipping may cause fulfillment problems, a manager may see the need for a little cushion in reorder point. Safety stock — calculation has two parts: 1. To handle possible problems in the reorder process. 2. To handle an unexpected spike in sales demand. Why does a business want to hold safety stock?

Define Safety Stock The minimal level of inventory required to ensure against the organization running out of inventory in the case of unforeseen problems in receiving its next purchase order. Reorder point = (Average lead time in days xAverage daily sales) +Safety stock Combining the two calculations is acceptable, assuming management is not interested in knowing the specific level for safety stock. However, management usually wants to know when sales are eating into the safety stock.

EOQ, Reorder Points, and Safety Stock Inventory Levels EOQEOQ Reorder Point Safety Stock Inventory (Units) 0 units 3 days 6 days 9 days 12 days Average Lead Time (3 days) Reorder Point with Safety Stock