Cost Accounting: Information for Decision Making

Cost Accounting: Information for Decision Making
Chapter 1 Cost Accounting: Information for Decision Making We start the study of the Fundamentals of Cost Accounting with a review and overview of information necessary for decision making. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Value Chain L.O. 1 Describe the way managers use accounting
information to create value in organizations. The Value Chain describes a set of activities that transforms raw materials and resources into the goods and services end users purchase and consume. – Value added activities – Non value added activities The value chain describes the set of activities that increase the value of an organization’s products or services. Value-added activities are activities that customers perceive as valuable because the activity adds utility to the goods or services they purchase. In other words, customers define value. 1 - 2

The Value Chain Components
LO1 The Value Chain Components Research & Development Design Purchasing Production All products start with research and development. Is research and development (creating and developing ideas related to a new product) value-added or nonvalue-added? Once we have the idea for a new product, the product must be developed and engineered. Does this add value? The purchasing department is responsible for acquiring all of the necessary components and supplies in order to produce the product. Does this add value? We must produce the product or deliver the service in order for the product or service to have value to a customer. We need to inform potential customers about the attributes of our product or service. Delivering the product or service to the customer adds value. If the customer does not have the product or service, it has no value. Finally, chances are you have experienced the value of customer service. Have you ever called the technical support line for a software application you installed on your computer? If so, I hope the support added value to your product. Marketing Distribution Customer Service 1 - 3

Accounting Systems L.O. 2 Distinguish between the uses and users of cost accounting and financial accounting information. Financial accounting position and income Reports Financial accounting information is designed for decision makers who are not directly involved in the daily management of the firm. Cost accounting information is designed for managers. Cost accounting Information about costs Reports 1 - 4

Managerial Decisions L.O. 3 Explain how cost accounting information is used for decision making and performance evaluation in organizations. Individuals make decisions. Decisions determine the performance of the organization. Managers use information from the accounting system to make decisions. The key question is: What adds value to the firm? Let’s look at how cost information adds value to the organization. Cost information adds value to the organization if that information improves managers’ decisions. Owners evaluate organizational and managerial performance with accounting information. 1 - 5

Costs for Decision Making
LO3 Costs for Decision Making Carmen’s Cookies has been making and selling cookies through a small store downtown. One of her customers suggests that she expand operations and sell to wholesalers and retailers. Should Carmen expand operations? Now we are going to look at an example involving decision making. Carmen’s Cookies. 1 - 6

Carmen’s Cost Drivers Cost Rent Insurance Labor Ingredients Driver
LO3 Carmen’s Cost Drivers Cost Rent Insurance Labor Ingredients Driver Number of stores What drives the cost of rent and the cost of insurance? The number of storefronts Carmen has drives rent and insurance. If Carmen opens a new storefront, her rent and insurance costs will increase. On the other hand, what drives the cost of labor or the cost of the ingredients for the cookies? How many cookies Carmen makes will determine how many employees she needs and how much flour and sugar are required. Number of cookies 1 - 7

Differential Costs, Revenues, and Profits
LO3 Differential Costs, Revenues, and Profits Sales revenue Costs: Food Labor Utilities Rent Other Total costs Operating profits $6,300 1,800 1,000 400 1,250 $5,450 $ 850 $8,505a 2,700b 1,500b 600b 1,200c $7,250 $1,255 $2,205 900 500 200 -0- $1,800 $ 405 (1) Status Quo Original Shop Sales Only (2) Alternative Wholesale & Retail Distribution (3) Difference Carmen’s Cookies Projected Income Statement for One Week Look at Carmen’s projected income statement. If Carmen maintains the status quo and does not expand, revenue will be $6,300. However, she expects revenues to increase 35% if she expands. Differential revenue is $2,205. If food, labor and utilities costs all increase 50%, Carmen has differential costs of $900, $500, and $200 for those costs. Carmen determines she currently has room for increased cookie production so she will not be required to rent additional space. Therefore rent is not a differential cost. However, her other costs also increase 20% for differential costs of $200. Using this cost information to analyze revenues and costs, Carmen determines that she has differential profits of $405 if she expands rather than maintaining the status quo. (a) 35 percent higher than status quo (b) 50 percent higher than status quo (c) 20 percent higher than status quo 1 - 8

Responsibility Centers, Revenues, and Costs
LO3 Responsibility Centers, Revenues, and Costs Carmen Diaz President Ray Adams Vice-President Retail Operations Cathy Peterson Wholesale Operations This is an example of an organization’s chart. Please notice that Ray Adams is in charge of retail operations and Cathy Peterson is in charge of wholesale operations. Are these responsibility centers? 1 - 9

LO3 Responsibility Centers, Revenues, and Costs Carmen’s Cookies Income Statement For the Month Ending April 30 Sales revenue Department costs: Food Labora Utilities Rent Total department costs Center marginb General and admin. costs: General manager’s salaryc Other (administrative) Total general and admin. costs Operating profit $28,400 13,500 4,500 1,800 5,000 $24,800 $ 3,600 $23,600 9,800 3,200 2,100 2,500 $17,600 $ 6,000 $52,000 23,300 7,700 3,900 7,500 $42,400 $ 9,600 $ 8,200 $ 1,400 Retail Operations Wholesale Total Do you think that general and administrative costs should be distributed to the two operations? (a) Includes department managers’ salaries but excludes Carmen’s salary (b) The difference between revenues and costs attributable to a responsibility center (c) Carmen’s salary 1 - 10

LO3 Responsibility Centers, Revenues, and Costs Carmen’s Cookies Retail Responsibility Center Budgeted versus Actual Costs For the Month Ending April 30 Food: Flour Eggs Chocolate Nuts Other Total food Labor: Manager Total labor Utilities Rent Total cookie costs Number of cookies sold $ 2,100 5,200 2,000 2,200 $13,500 3,000 1,500 $ 4,500 1,800 5,000 $24,800 32,000 $ 2,200 4,700 1,900 $12,900 $24,200 $ (100) 500 100 -0- $ 600 $ -0- $ 600 Actual Budget Difference A budget, or a financial plan for the revenues and resources needed to meet financial goals, is an important tool for the financial success of both individuals and organizations. Do you have a budget? Another important use of cost accounting information is the evaluation of the performance of an organization. Comparing the actual results to the budgeted results allows managers to evaluate the performance of the organization and owners to evaluate the performance of individual managers. For example, look at Carmen’s actual activity and costs compared to her budgeted activity and costs. If Carmen budgeted selling 32,000 cookies and actually sold 32,000 cookies in the month of April, why were her food costs $600 higher than she anticipated? In evaluating activities for April, Carmen is also interested in seeing that actual labor costs equaled the amount budgeted. As part of the planning and control process, managers prepare budgets containing expectations about revenues and costs for the coming period. At the end of the period, managers compare actual results with the budget. This allows them to see whether changes can be made to improve future operations. 1 - 11

Trends in Cost Accounting
L.O. 4 Identify current trends in cost accounting. Research and development Design Purchasing Production Marketing Distribution Customer service 8. ERP – Enterprise resource planning 9. Creating value in the organization Cost accounting continues to experience dramatic changes. Developments in information technology (IT) have nearly eliminated manual bookkeeping. Emphasis on cost control is increasing in all types of organizations. 1 - 12

Enterprise Resource Planning
LO4 Enterprise Resource Planning Information technology linking various processes of the enterprise into a single comprehensive information system Purchasing Production Technology Human Resources Finance Enterprise resource planning (ERP) uses information technology to link the various processes of the enterprise into a single comprehensive information system. Because all the company’s processes are integrated, ERP has significant potential for providing information on the cost of products and services. However, implementation problems are keeping many companies from realizing this potential. Marketing 1 - 13

Ethical Issues for Accountants
L.O. 5 Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career. The design of the cost accounting system has the potential to be misused to defraud customers, employees, or shareholders. Accountants report information that can have a substantial impact on the careers of managers who are generally held accountable for achieving financial performance targets. Failure to achieve a target can have serious negative consequences for a manager. Therefore, accountants may find themselves under pressure by management to make accounting choices that improve performance reports rather than accurately reflect performance. As a professional accountant, manager, or business owner, you will face ethical situations on an everyday basis. 1 - 14

Sarbanes-Oxley Act of 2002 Address problem What is the of corporate
LO5 Sarbanes-Oxley Act of 2002 What is the intent? Address problem of corporate governance Who is impacted? Accounting firms and corporations When there is a public perception of widespread ethical problems, the result is often legislation making certain conduct is not only unethical, but also illegal. Congress passed the Sarbanes-Oxley Act of 2002 to address some of the more serious problems of corporate governance that surfaced in the late 1990s and early 2000s. How are corporations impacted? Corporate responsibility 1 - 15

Appendix 1 Institute of Management Accountants’ (IMA)
Code of Ethics: Standards Competence Confidentiality Integrity Credibility In Appendix 1 to Chapter 1 is the Institute of Management Accountants’ Code of Ethics. The code of ethics addresses four standards; competence, confidentiality, integrity, and credibility. 1 - 16

End of Chapter 1 McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Cost Concepts and Behavior
Chapter 2 Cost Concepts and Behavior Chapter 2 covers cost concepts and behavior. You want to be certain that you have a thorough understanding of these concepts before going forward. Understanding of the concepts in Chapter 2 is critical for success in this course. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

What is a Cost? L.O. 1 Explain the basic concept of “cost.”
Cost is a sacrifice of resources. Let’s start with the basic concept of cost. A cost is a sacrifice of resources. When we buy one thing, we give up (sacrifice) the ability to use these resources, for example cash, to buy something else. 2 - 19

Cost versus Expenses Cost Outlay Cost Past, present, or future cash
LO1 Cost versus Expenses Cost Outlay Cost Past, present, or future cash outflow Opportunity Costs Forgone benefit from the best alternative course of action Expense Cost charged against revenue in an accounting period A cost can be an outlay cost, that is, a past, present, or future outflow of cash, or it can be an opportunity cost. An opportunity cost does not require an outlay of cash, but rather represents the foregone benefit from the best alternative course of action. Because an outlay cost represents an outflow of cash, it will ultimately end up on your financial statements. On the other hand, an opportunity cost will never show up on your financial statements. Are cost and expense the same thing? No. A cost is a sacrifice of resources. An expense, on the other hand, is a cost that is charged against revenue in a accounting period. Can you identify a cost that is never an expense? Remember, an expense shows up on your income statement. An outlay cost, an outflow of cash, that is never an expense, is the purchase of land. 2 - 20

Presentation of Costs in Financial Statements
L.O. 2 Explain how costs are presented in financial statements. Income Statements Service company Revenues – Cost of services sold = Gross margin – Marketing and administrative costs = Operating profit Cost of billable hours Now let’s look at recording costs in financial statements. Cost accounting focuses on operating profit, the excess of operating revenues over the operating costs incurred to generate those revenues. Operating profit is not the same as net income. Net income is operating profit adjusted for interest, income taxes, extraordinary items and other adjustments required to comply with GAAP or other regulations. The basic income statement is the same for a service company and a merchandise company. For both a service company and a merchandise company, revenue minus cost of goods or services sold equals gross margin and gross margin minus marketing and administrative costs equal operating profit. A service company generates service revenue. A service company’s cost of services sold is the cost of billable hours. The excess of operating revenue over costs necessary to generate those revenues 2 - 21

LO2 Presentation of Costs in Financial Statements Income Statements Merchandising company Revenues – Cost of goods sold = Gross margin – Marketing and administrative costs = Operating profit Expense assigned to products sold during a period A merchandise company generates sales revenues. A merchandise company’s cost of goods sold is the cost incurred to purchase the goods that are sold. The excess of operating revenue over costs necessary to generate those revenues 2 - 22

LO2 Presentation of Costs in Financial Statements Income Statements Cost incurred to manufacture the product sold Product costs recorded as “inventory” when cost is incurred Manufacturing company Sales revenue – Cost of goods sold = Gross margin – Marketing and administrative costs = Operating profit Expensed when sold A manufacturing company is a little more complicated than a service company or merchandise company because a manufacturing company makes the product it sells. Financial reporting distinguishes costs in a manufacturing firm based on when the costs are recognized as expenses on the financial statements. Product costs are those costs incurred to manufacture a product. A product cost is recorded as an asset in inventory when the cost is incurred and recognized as an expense on the income statement when the product is sold. Period costs recorded as an expense in the period the cost is incurred 2 - 23

Direct and Indirect Manufacturing Costs
LO2 Direct and Indirect Manufacturing Costs Direct costs: Costs that, for a reasonable cost, can be directly traced to the product. Direct materials: Materials directly traceable to the product Direct labor: Work directly traceable to transforming materials into the finished product Let’s look at product costs more closely. Remember, product costs are manufacturing costs that are recognized as assets in inventory when the costs are incurred and as expenses when the products are sold. These costs are also referred to as manufacturing costs or inventory costs. Our product costs consist of both direct costs and indirect costs. Costs are either direct or indirect with reference to a cost object. Direct product costs are those costs that can be directly traced to the product. Make this connection, direct cost can be directly traced to the product. The direct costs are direct materials and direct labor. 2 - 24

Direct and Indirect Manufacturing Costs
LO2 Direct and Indirect Manufacturing Costs Indirect costs: Costs that cannot reasonably be directly traced to the product. Manufacturing overhead: All production costs except direct materials and direct labor. Indirect costs are costs that cannot be directly traced to the product. These costs are called manufacturing overhead. Manufacturing overhead is comprised of all the production costs except direct materials and direct labor. These costs include indirect materials, indirect labor, and all other indirect costs. Indirect materials Indirect labor Other indirect costs 2 - 25

Prime Costs and Conversion Costs
LO2 Prime Costs and Conversion Costs Prime costs: The “primary” costs of the product Direct materials labor Conversion costs: Costs necessary to “convert” materials into a product Direct labor Manufacturing overhead It is useful in managing costs for a manufacturing company to look at product costs as either prime costs or conversion costs. Prime costs are direct materials and direct labor. Prime costs are the primary costs of the product. Once again, make this connection. Prime costs are the primary costs of the product. Direct materials and direct labor can be directly traced to the product and are the primary costs of the product. Conversion costs are the costs necessary to convert materials into a product. Again make the connection. Conversion costs convert materials into a product. What costs are necessary to convert material into a product? Direct labor and manufacturing overhead. So direct labor and manufacturing overhead are the conversion costs. 2 - 26

Cost Allocation L.O. 3 Explain the process of cost allocation.
It is the process of assigning indirect costs to products, services, business units, etc. Because indirect costs cannot be traced directly to a cost object, they need to be allocated to the cost object. Let’s look at the process of cost allocation. The process of assigning indirect costs to a cost object consists of three steps: defining the cost pool, determining the cost allocation rule, and finally, assigning the costs to the cost object. The cost pool is a collection of all the indirect costs to be assigned to the cost object. The cost allocation rule is the method used to assign the costs in the cost pool to the cost object. The cost object is the end to which the cost is to be assigned. For example, indirect costs might need to be assigned to various products or product lines for costing purposes. Or management may want to assign costs to departments or customers. 2 - 27

Details of Manufacturing Cost Flows
L.O. 4 Understand how material, labor, and overhead costs are added to a product at each stage of the production process. Product costs are recorded in inventory when costs are incurred. A manufacturing company has three inventory accounts: 1. Raw Materials Inventory: Materials purchased to make a product How do manufacturing costs get added to a product? Remember product costs are recorded in inventory when the costs are incurred. A manufacturing company has three inventory accounts: raw materials, work-in-process, and finished goods. Raw materials inventory is comprised of materials purchased to make the product. Work-in-process inventory includes products in the production process that are not yet complete. Finished goods inventory contains products that are fully completed but are not yet sold. 2. Work-in-Process Inventory: Products currently in the production process, but not yet completed 3. Finished Goods Inventory: Completed products that have not yet been sold 2 - 28

Inventory Accounts – The Balance Sheet
LO4 Inventory Accounts – The Balance Sheet Beg. RM inventory + Purchases = Raw materials available for production – Ending RM inventory transferred to WIP Direct Materials Inventory Beg. WIP inventory + Direct materials transferred from raw materials + Direct labor = Total manufacturing costs – Costs of goods completed and transferred to finished goods (or cost of goods manufactured + Manufacturing overhead = Ending WIP inventory Work-in-Process Inventory Beg. FG inventory + Cost of goods completed and transferred from WIP = Goods available for sale – Cost of goods sold = Ending FG inventory Finished Goods Inventory Inventory accounts are assets on the balance sheet. Product costs go into inventory when the costs are incurred. Look at the three inventory accounts. To the raw materials beginning balance, we add purchases to calculate raw materials available for production. Purchasing material is a cost that goes into inventory when the cost is incurred. Subtract ending raw material inventory from raw materials available for production to obtain the raw materials that are transferred to work-in-process and you have your ending raw material inventory. When raw materials are transferred to work-in-process, the cost of those materials is transferred from one inventory to another inventory account. To beginning work-in-process inventory, we add our product costs: direct materials, direct labor, and manufacturing overhead. From this total, our total manufacturing cost, we subtract the ending work-in-process inventory to obtain cost of goods completed and transferred to finished goods. The cost of goods completed and transferred to finished goods is also called the cost of goods manufactured. Again, note, product costs are transferred from one inventory account, work-in-process, to another inventory account, finished goods. Finally, beginning finished goods inventory plus the cost of goods manufactured equals the goods available for sale. Subtracting ending finished goods inventory from the goods available for sale gives us the cost of goods sold. Remember, product costs become expenses when the goods are sold. Note, the cost of goods sold, or the transfers out of finished goods, go to the income statement. At this time the product costs become an expense. To the Income Statement 2 - 29

Cost Behavior L.O. 5 Define basic cost behaviors, including fixed,
variable, semivariable, and step costs. Cost behavior: How costs respond to a change in activity level within the relevant range Now let’s talk about cost behavior. Cost behavior refers to how costs respond to a change in activity level within the relevant range. What is the relevant range? The relevant range is the range of activity where the total fixed costs or unit variable costs remain unchanged. Let’s clarify this. It is how costs respond to changes in activity within the relevant range that determine if a cost is variable or fixed. Relevant range: Activity levels within which a given total fixed cost or unit variable cost will be unchanged 2 - 30

Components of Product Costs
L.O. 6 Identify the components of a product’s costs. Full cost: The sum of all costs of manufacturing and selling a unit of the product Full absorption cost: The sum of all variable and fixed costs of manufacturing a unit of the product We have looked at various cost concepts. Some of these concepts make cost information more useful for managerial decision making. Others were determined by financial accounting rules. Now let’s identify components of a product’s cost and look at those components from a managerial decision-making perspective and from financial reporting rules. Full cost refers to all costs of manufacturing and selling a unit of product. Full absorption cost is the sum of all variable and fixed costs of manufacturing a unit of product. Variable cost is the sum of all variable costs of manufacturing and selling a unit of product. Let’s look at what this means. Variable cost: The sum of all variable costs of manufacturing and selling a unit of the product 2 - 31

Components of Product Costs
LO6 Components of Product Costs Direct materials = $8 Variable manufacturing cost = $23 Direct labor = $7 Full absorption cost per unit = $29 Variable manufacturing overhead = $8 Unit variable cost = $27 Full cost per unit = $40 Fixed manufacturing overhead = $6 Here is an example. If the per unit costs of a product consists of direct materials of $8, direct labor of $7, variable manufacturing overhead of $8, fixed manufacturing overhead of $6, variable marketing and administrative cost of $4, and fixed marketing and administrative cost of $7, what is the full cost per unit? The full absorption cost per unit? And the variable cost per unit? Start with the full cost per unit. The full cost per unit is all costs of manufacturing and selling a unit of product. Full cost includes direct materials, direct labor, variable manufacturing overhead, fixed manufacturing overhead, variable marketing and administrative, and fixed marketing and administrative cost. The full cost per unit in our example is $40. What is the full absorption cost per unit? The full absorption cost per unit includes all variable and fixed costs of manufacturing a unit of the product. In this example the variable and fixed costs of manufacturing a unit of product includes direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. The full absorption cost per unit is $29. What is the variable cost per unit? The variable cost per unit is all variable costs of manufacturing and selling a unit of product. In this example, variable costs include direct materials, direct labor, variable manufacturing overhead, and variable marketing and administrative costs. The variable cost per unit in this example is $27. Variable marketing and administrative costs = $4 Variable marketing and administrative costs = $4 Fixed marketing and administrative costs = $7 2 - 32

Making Cost Information Useful
L.O. 7 Understand the distinction between financial and contribution margin income statements. Full absorption costing: Required by GAAP Used for: – Financial purposes – External reporting Variable costing: Used for: – Managerial purposes – Internal decision making In preparing income statements for financial purposes and external reporting, Generally Accepted Accounting Principles (GAAP) require the use of full absorption costing. On the other hand, for managerial purposes and internal decision making, variable costing is used. A financial income statement, using full absorption costing, has sales revenue minus cost of goods sold equals gross margin. A contribution margin income statement, using variable costing, has sales revenue minus variable costs equals contribution margin. We will see in Chapter 3 how valuable the contribution margin is for decision making. Remember, when we are talking about variable costs, we are talking about those costs that remain the same on a per unit basis as long as we are in the relevant range. Sales revenue – Cost of goods sold = Gross margin Sales revenue – Variable costs = Contribution margin 2 - 33

Fundamentals of Cost-Volume-Profit Analysis
Chapter 3 Fundamentals of Cost-Volume-Profit Analysis In order to be a well prepared leader and manager, one must have a systematic method of analyzing the ever changing environment. Chapter 3 focuses on how decision-makers analyze changes in the volume of sales. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Cost-Volume-Profit Analysis
L.O. 1 Use cost-volume-profit (CVP) analysis to analyze decisions. What is CVP? CVP analysis explores the relationship between revenue, cost, and volume and their effect on profits. Managers must make decisions about volume, pricing and costs and are concerned about the impact of their decisions on profit. Therefore, they need to understand the relations among revenues, costs, volume and profit. Cost-volume-profit, or CVP, analysis provides managers with information for decision making. 3 - 36

Profit Equation The Income Statement Total revenues – Total costs
LO1 Profit Equation The Income Statement Total revenues – Total costs = Operating profit The Income Statement written horizontally Operating profit Profit = Total revenues – TC Total costs TR In studying CVP we will start with the profit equation. The profit equation is: Operating profit = Total revenues – Total costs. Don’t let the profit equation confuse you. It is nothing more than the income statement written horizontally. 3 - 37

LO1 Contribution Margin This is the difference between price and variable cost. It is what is leftover to cover fixed costs and then add to operating profit. Contribution margin = Price per unit – Variable cost per unit P – V Let’s review the contribution margin from Chapter 2. The unit contribution margin is the difference between the sales price per unit and variable costs per unit. That is (P-V). 3 - 38

CVP Summary: Break-Even
LO1 CVP Summary: Break-Even Break-even volume (units) = Fixed costs Unit contribution margin Break-even volume (sales dollars) = Fixed costs Contribution margin ratio In summary, at break-even target profit is zero. Therefore, break-even sales volume in units equals fixed costs divided by unit contribution margin and break-even sales volume in dollars equals fixed costs divided by contribution margin ratio. 3 - 39

CVP Summary: Target Volume
LO1 CVP Summary: Target Volume Target volume (units) = Fixed costs + Target profit Unit contribution margin Target volume (sales dollars) = Fixed costs + Target profit Contribution margin ratio Now we will review the contribution margin ratio. The contribution margin ratio is the contribution margin as a percentage of sales revenue. The total contribution margin ratio equals total contribution margin as a percent of total sales revenue. The unit contribution margin ratio equals the contribution margin per unit as a percent of sales price per unit. Recall our discussion in Chapter 2 of relevant range? A relevant range is a range of activity where our cost structure remains constant. Therefore, as long as we are in the relevant range, the total contribution margin ratio and the unit contribution margin ratio will be the same. Again let’s look at U-Develop. 3 - 40

Use of CVP to Analyze the Effect of Different Cost Structures
L.O. 2 Understand the effect of cost structure on decisions. Cost structure: The proportion of fixed and variable costs to total costs. Operating leverage: The extent to which the cost structure is comprised of fixed costs. Let’s talk about cost structure. Cost structure is the proportion of fixed and variable costs to total costs. An organization’s cost structure has a significant effect on the sensitivity of its profits to changes in volume. You are probably starting to see just how important cost behavior is in decision making. Fixed costs remain the same in total regardless of the activity level. This means that even if there is no activity fixed costs remain the same. However, variable costs vary with the activity level and, remember, no activity means no variable costs. Operating leverage describes the extent to which an organization’s cost structure is made up of fixed costs, those costs that do not change when the level of activity changes. 3 - 41

Margin of Safety or The excess of projected or actual sales
LO2 Margin of Safety The excess of projected or actual sales volume over break-even volume or The excess of projected or actual sales revenue over break-even revenue Suppose U-Develop sells 8,000 prints. Margin of safety is the excess of projected or actual sales volume over break-even volume or the excess of projected or actual sales revenue over break-even revenue. In other words, the margin of safety indicates the risk of losing money that a company faces. How much can sales decrease in either volume or revenue before the company experiences a net loss? Suppose U-Develop sells 8,000 prints. Recall that U-Develop’s break-even was 6,250 prints. The margin of safety is 1,750 prints (8,000-6,250), or in dollars $1,050 ($4,800 -$3,750). At a break-even volume of 6,250, its margin of safety is: Sales – Break-even = 8,000 – 6,250 = 1,750 prints 3 - 42

CVP Analysis with Spreadsheets
L.O. 3 Use Microsoft Excel to perform CVP analysis. A spreadsheet program is ideally suited to performing CPV routinely. 1. Choose “Tools: Goal Seek…” from the menu bar. $0.60 $0.36 $1,500 ($300) 5,000 U-Develop Price Variable cost Fixed cost Profit Volume $0.00 6,250 2. In the “Set cell” edit field, enter the cell address for the target profit calculation. 3. In the “To value” edit field, enter the target profit. It is important to be able to do CVP analysis and understand the relations and it is important to work examples and do problems by hand at first. However, a spreadsheet program is ideally suited to doing CVP routinely. 4. In the “By changing cell” edit field, enter the cell address of the volume variable. 5. Click “OK” and the program will find the break-even volume. 3 - 43

Extensions of the CVP Model: Income Taxes
L.O. 4 Incorporate taxes, multiple products, and alternative cost structures into the CVP analysis. The owners of U-Develop want to generate after-tax operating profits of $1,800. The tax rate is 25%. What is the target operating profit? So far we have ignored taxes. What if U-Develop is in a 25% tax bracket and wants a profit of $1,800 after paying income taxes? Now what needs to be covered by the contribution margin per unit? Fixed cost and the before-tax profit required to earn an after-tax profit of $1,800. Dividing the after-tax profit of $1,800 by one minus the tax rate results in the before-tax profit required for an after-tax profit of $2,400. Target operating profit = TOP ÷ (1 – Tax rate) TOP = $1,800 ÷ (1 – 0.25) = $2,400 3 - 44

Extensions of the CVP Model: Multiproduct Analysis
LO4 Extensions of the CVP Model: Multiproduct Analysis Management expects to sell 9 prints at $.60 each for every enlargement it sells at $1.00. Selling price Less: Variable cost Contribution margin $0.60 .36 $0.24 $1.00 .56 $0.44 Prints Enlargements What happens when a company has multiple products? Suppose U-Develop sells both prints and enlargements. Prints have a contribution margin of $0.24 per unit. Notice that enlargements have a contribution margin of $0.44 per unit. Assume total fixed costs are $1,820. To calculate break-even divide total fixed costs by the contribution margin per unit. In order to use the single product mix method, managers must define a package or bundle of products and compute break-even or target volume for the package or bundle. And, because prints have a contribution margin per unit of $0.24 and enlargements have a contribution margin per unit of $0.44 we need a weighted average contribution margin. Total fixed costs = $1,820 3 - 45

LO4 Extensions of the CVP Model: Multiproduct Analysis What is the contribution margin of the mix? (9 × $0.24) + (1 × $0.44) = $ $0.44 = $2.60 What is the weighted-average contribution margin of the mix? (.90 × $0.24) + (.10 × $0.44) = $0.26 If for every nine prints sold U-Develop sells one enlargement, the package or bundle is ten. Nine of the bundle of ten are prints and one of the bundle of ten is an enlargement. To calculate the weighted average contribution margin multiply the $0.24 contribution margin per unit of prints by 9/10 and the contribution margin of $0.44 per unit of enlargements by 1/10. The weighted average contribution margin of the package or bundle is $0.26 per unit. What is the breakeven of the mix? 3 - 46

LO4 Extensions of the CVP Model: Multiproduct Analysis 7000 × 90% = 6,300 prints 7000 × 10% = enlargements Total units = 7,000 $1,820 fixed costs ÷ $0.26 = 7,000 units Now divide fixed costs of $1,820 by the weighted average contribution margin per unit of $0.26 and you find that 7,000 units must be sold to break-even. Of the 7,000 units 6,300 (or 9/10) are prints and 700 (or 1/10) are enlargements. 3 - 47

Extensions of the CVP Model: Alternative Cost Structures
LO4 Extensions of the CVP Model: Alternative Cost Structures Given: Fixed costs of $1,500 are sufficient for monthly volumes less than or equal to 5,000 prints. For every additional 5,000 prints U-Develop must rent a machine for $480 per month. Original break-even was 6,250 units. That’s a lot of information! But we are not finished yet. Sometimes firms need to rent more equipment and therefore their fixed costs change. Let’s assume that U-Develop can make 5,000 prints a month with their existing equipment. This would mean that they could not breakeven using only their equipment since breakeven was 6,250 units. If U-Develop can rent a machine for $480 and increase their production by 5,000 prints per machine rented, then their breakeven calculation would change. ($0.24 x 6,250) – ($1,500 + $480) = ($480) 3 - 48

Extensions of the CVP Model: Alternative Cost Structures
LO4 Extensions of the CVP Model: Alternative Cost Structures What is the break-even using new fixed cost containing the rental of the additional machine? Break-even units = ($1,500 + $480) ÷ $0.24 = 8,250 New fixed costs are now ($1, ) or $1,980. Sales price and variable costs are not changing, so the CM per unit remains at $0.24. The new breakeven is: $1,980 /$0.24 = 8,250! 3 - 49

Assumptions and Limitations of CVP Analysis
L.O. 5 Understand the assumptions and limitations of CVP analysis. Although the CVP model is a very strong tool, the output is dependent upon the assumptions made by cost analysts. These assumptions include which costs are fixed and which are variable. As with all models, there are assumptions and limitations. CVP is a very powerful tool, yet it is only as strong as the assumptions made by the analyst. The analyst must make assumptions with respect to which costs are fixed and which are variable. 3 - 50

Fundamentals of Cost Analysis for Decision Making
Chapter 4 Fundamentals of Cost Analysis for Decision Making Now that you are comfortable with CVP analysis and the impact of fixed versus variable costs, we can extend the concepts and apply the theories to a multitude of business conditions. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Differential Analysis
L.O. 1 Use differential analysis to analyze decisions. Differential analysis: The process of estimating revenues and costs of alternative actions available to decision makers and of comparing these estimates to the status quo Now that you see the value of CVP analysis for decision-making, let’s move on to other decisions. In Chapter 1 we discussed differential costs and differential revenues. Today, every decision that a manager makes requires comparing one or more proposed alternatives with the status quo. Differential analysis is the process of estimating revenues and costs of alternative actions and comparing these estimates to the status quo. Differential analysis is used for both short-run decisions and long-run decisions. Short run is defined as the period over which capacity will be unchanged. Short run: The period of time over which capacity will be unchanged, usually one year 4 - 53

Differential Costs With two or more alternatives, costs that differ
LO1 Differential Costs With two or more alternatives, costs that differ among or between alternatives Costs that change in response to an alternative course of action Differential costs differ between actions. Remember from Chapter 1, differential costs differ between actions. In Chapter 1, Carmen was trying to decide whether she should expand her cookie operations or not. In Chapter 1, you looked at Carmen’s differential revenues and differential costs to determine if it was beneficial for Carmen to expand. If a cost is differential, or differs between alternatives, it is relevant to the decision-making analysis. Differential costs are sometimes called relevant costs. If the cost does not differ between alternatives it is not relevant to the decision making analysis. Alternative A Alternative B 4 - 54

Sunk Costs Costs incurred in the past that cannot be
LO1 Sunk Costs Costs incurred in the past that cannot be changed by present or future decisions A sunk cost is NOT relevant for making decisions. An important category of cost to identify when making decisions includes costs that were incurred in the past and cannot be changed regardless of the decision made. These costs are called sunk costs and are not relevant for a decision. 4 - 55

Differential Analysis and Pricing Decisions
L.O. 2 Understand how to apply differential analysis to pricing decisions. Variable costs must always be covered. Differential analysis is useful for many decisions that managers make about pricing because it provides information about the likely impact of these decisions on profit. Variable costs must always be covered and fixed costs must be covered in the long run. Fixed costs must be covered in the long run. 4 - 56

Short-Run Pricing Decisions: Special Orders
An order that will not affect other sales and is usually a one-time occurrence Value of option 1 option 2 Accept special order? Is > option 2? Option 1 Option 2 Status quo: Reject special order Alternative: Accept special order A special order is an order that will not affect other sales and is usually a one-time occurrence. The manager has two alternatives. One alternative is to reject the special order and maintain the status quo. Another alternative is to accept the special order. 4 - 57

Long-Run Pricing Decisions
L.O. 3 Understand several approaches for establishing prices based on costs for long-run pricing decisions. Full cost is the total cost to produce and sell a unit. Full costs are relevant for the long-term pricing decisions. Most firms rely on full cost information reports when setting prices. 4 - 58

Life-Cycle Product Costing and Pricing
LO3 Life-Cycle Product Costing and Pricing Product life-cycle is concerned with covering costs in all categories of the life cycle. R & D Design Manufacturing Product life-cycle is the time from initial research and development of the product to the time that support to the customer ends and the product is disposed of. Life-cycle costing is concerned with covering costs in all categories of the life-cycle. To be profitable, companies must generate enough revenue to cover costs incurred in all categories of the value chain. Marketing and distribution Customer service Take back (disposal) 4 - 59

Target Costing from Target Pricing
LO3 Target Costing from Target Pricing Target price: The price based on customers’ perceived value for the product and the price that competitors charge What would a customer pay? How much profit do I need? Can I make it at this cost? Target costing is the concept of “price-based costing” instead of “cost-based pricing.” A target price is the estimated price for a product or service that potential customers will be willing to pay. A target cost is the estimated long-run cost of a product or service whose sale enables the company to achieve a targeted profit. Target price – Desired profit = Target cost 4 - 60

Use of Differential Analysis for Production Decision
L.O. 4 Understand how to apply differential analysis to production decisions. Make or buy Decision to make goods or services internally or purchase them externally Add or drop a segment Decision to add or drop a product line or close a business unit We now apply our cost analysis concepts to production and operating decisions. Typical production and operating questions that managers often ask are: Should we make the product internally or buy it from an outside source? Should we add to or drop parts of our operations? Which products should we continue to produce and which should we drop? To make these decisions, the manager asks what costs and revenues will differ as a result of the choices made and which course of action would be the most profitable for the company? Product choice Decision on what products or services to offer (product mix) 4 - 61

Fourth Quarter Product Line Income Statement
LO4 Add or Drop Decisions U-Develop Fourth Quarter Product Line Income Statement Sales revenue Cost of sales (all variable) Contribution margin Less fixed costs: Rent Salaries Marketing and administrative Operating profit (loss) $80,000 53,000 $27,000 4,000 5,000 3,000 $15,000 $10,000 8,000 $ 2,000 1,000 500 $ (500) $50,000 30,000 $20,000 2,000 2,500 1,500 $14,000 Total 15,000 $ 5,000 $ 1,500 Prints Cameras Frames Managers often must decide whether to add or drop a product line or close a business unit. Product lines or business units that were formerly profitable may no longer be profitable. In fact, U-Develop is looking at their product line income statement and sees that prints are no longer profitable. They are considering dropping prints. It appears that operating profit would increase by $500 if they discontinued the prints. So the accountant was asked to do a differential analysis. 4 - 62

Differential Analysis
LO4 Add or Drop Decisions U-Develop Differential Analysis Sales revenue Cost of sales (all variable) Contribution margin Less fixed costs: Rent Salaries Marketing and administrative Operating profit (loss) $80,000 53,000 $27,000 4,000 5,000 3,000 $15,000 $70,000 45,000 $25,000 2,750 $14,250 $10,000 decrease 8,000 decrease $ 2,000 decrease -0- 1,000 decrease 250 decrease $ decrease Status quo: Keep prints Alternative: Drop prints Difference The differential analysis shows that rent is not relevant for the decision. The rent must be paid whether the prints are dropped or not. Therefore, profits would decrease $750 if prints are dropped. Profits decrease $750, so keep prints. 4 - 63

Product Choice Decisions
LO4 Product Choice Decisions U-Develop Revenue and Cost Information $50 8 4 $30 Price Less: Variable costs per unit Material Labor Overhead Contribution margin per unit Fixed costs Manufacturing Marketing and administrative $80 22 24 Metal frames Total $3,000 1,500 $4,500 Wood Let’s look at the revenue and cost information for U-Develop’s metal and wood frames. Metal frames require a half an hour of machine time and wood frames require an hour. The revenue and cost information indicates that both metal and wood frames have a contribution margin per unit of $30. Fixed manufacturing costs are $3,000 per month and fixed marketing and administrative costs are $1,500 per month. Are metal and wood frames equally profitable? 4 - 64

LO4 Product Choice Decisions U-Develop Revenue and Cost Information $ 30 ÷ 0.5 $ 60 Per unit: Contribution margin Machine hours required Contribution margin per machine hour ÷ 1.0 Metal frames Wood If metal frames require half an hour of machine time, U-Develop can produce two metal frames per hour. This means that even though the contribution margin per unit is $30, the contribution per machine hour is $60 for the metal frames. However, U-Develop can only produce one wood frame per hour. So the contribution margin per machine hour is $30 for wood frames. Metal Frames have a higher contribution margin per machine hour. 4 - 65

LO4 Product Choice Decisions Suppose U-Develop has 200 machine hours per month available. 400 × $30 $12,000 3,000 1,500 $ 7,500 Capacity Contribution margin per unit Total contribution margin Less: Fixed manufacturing costs Less: Fixed marketing and admin. costs Operating profit 200 $6,000 $1,500 Metal frames Wood Machine hours is a constrained resource. Suppose U-Develop has 200 machine hours available per month. U-Develop can produce 400 metal frames for operating profit of $7,500. Only 200 wood frames can be produced for operating profit of $1,500. Selling metal frames will result in higher profits than selling wooden frames. 4 - 66

The Theory of Constraints
L.O. 5 Understand the theory of constraints. Theory of constraints: Focuses on revenue and cost management when faced with bottlenecks Bottleneck: Operation where the work required limits production The bottleneck is the constraining resource. The theory of constraints focuses on revenue and cost management when faced with bottlenecks. In essence, bottlenecks are constraints. Throughput contribution: Sales dollars minus direct materials costs and variables such as energy and piecework labor 4 - 67

Cost Estimation Chapter 5
When managers make decisions they need to compare the costs (and benefits) among alternative actions. In this chapter, we discuss how to estimate the costs required for decision making. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Basic Cost Behavior Patterns
L.O. 1 Understand the reasons for estimating fixed and variable costs. Costs Fixed costs Variable costs Total fixed costs do not change proportionately as activity changes. Total variable costs change proportionately as activity changes. By now you understand the importance of cost behavior. Cost behavior is the key distinction for decision making. Costs behave as either fixed or variable. Fixed costs are fixed in total; variable costs vary in total. On a per-unit basis, fixed costs vary inversely with activity and variable costs stay the same. Are you getting the idea? Cost behavior is critical for decision making. Per unit fixed costs change inversely as activity changes. Per unit variable cost remain constant as activity changes. 5 - 70

Methods Used to Estimate Cost Behavior
LO1 Methods Used to Estimate Cost Behavior Charlene, owner of Charlene’s Computer Care (3C), wants to estimate the cost of a new computer repair center. 3 Methods: Engineering estimates Account analysis Let’s meet Charlene, the owner of Charlene’s Computer Care (3C). In this chapter we are going to help Charlene estimate costs. Three methods used to estimate costs are: engineering estimates, account analysis, and statistical methods. Statistical methods 5 - 71

Engineering Estimates
L.O. 2 Estimate costs using engineering estimates. Cost estimates are based on measuring and then pricing the work involved in a task. Identify the activities involved: – Labor – Rent – Insurance Engineering cost estimates are based on measuring and then pricing the work involved in a task. Managers first identify activities such as labor, rent, and insurance and then estimate the time and cost required for each activity. Estimate the time and cost for each activity. 5 - 72

Account Analysis L.O. 3 Estimate costs using account analysis.
Review each account comprising the total cost being analyzed. Identify each cost as either fixed or variable. Fixed Variable Estimating costs using account analysis involves a review of each account making up the total costs being analyzed. Then, each cost should be identified as either fixed or variable, depending on the relation between the cost and some activity. Fixed costs are those costs that are fixed in total regardless of the activity level and variable costs. Variable costs are those costs that vary in total as activity changes. 5 - 73

Statistical Cost Estimation
L.O. 4 Estimate costs using statistical analysis. Analyze costs within a relevant range, which is the limits within which a cost estimate may be valid. Relevant range for a projection is usually between the upper and lower limits (bounds) of past activity levels for which data is available. A statistical cost analysis analyzes costs within the relevant range using statistics. Do you remember how we defined relevant range? A relevant range is the range of activity where a cost estimate is valid. The relevant range for cost estimation is usually between the upper and lower limits of past activity levels for which data is available. 5 - 74

Hi-Low Cost Estimation
This is a method to estimate cost based on two cost observations, the highest and lowest activity level. High Low Change $12,883 $ 9,054 $ 3,829 568 200 368 Month Overhead costs Repair- hours A simple approach to estimating the relation between cost and activity is to choose two points on the scattergraph. This approach is the high-low method. Using the high-low method, we estimate cost based on costs at the highest activity level and costs at the lowest activity level. Using these two points we can draw the total cost. 5 - 75

Variable cost per unit (V) = (Cost at highest activity level – Cost at lowest activity level) (Highest activity level – Lowest activity level) Fixed cost (F) = Total cost at highest activity – (Variable cost × Highest activity level) The slope of the total cost line estimates the variable cost per unit. Remember from statistics, the slope of the line is the change in Y divided by the change in X. So we calculate the slope, or the variable cost per unit as the change in costs divided by the change in activity. The change in cost is cost at the highest activity level minus the cost at the lowest activity level. The change in activity is the highest activity minus the lowest activity. After calculating the variable cost per unit we use the activity level and calculate total variable costs. Total costs minus total variable costs equals fixed cost. We can use the highest activity level or the lowest activity level to calculate fixed costs. Let’s put the numbers in the equations. or Total cost at lowest activity – (Variable cost × Lowest activity level) 5 - 76

Variable cost per RH (V) = ($12,883 – $9,054) 568 RH – 200 RH $3,829 368 RH $10.40 per RH Fixed costs (F) = ($12,883 – ($10.40 × 568 RH) $6,976 Fixed costs (F) = ($9,054 – ($10.40 × 200 RH) $6,974 To prepare a high-low analysis, select the high and low points and calculate the change in both OH Cost ($3,829) and repair hours (368). Since the OH cost change is due to a change in volume (repair hours), it is assumed to be strictly a variable cost. To calculate the variable cost per unit all we need to do is divide the change in OH cost by the change is repair-hours ($3,829 ÷ 368) which is $10.40 variable cost per unit. Now all we have to do is use either the high or low point and plug in the known values to the total cost equation: Fixed costs = (High cost – ($10.40 × High activity) or $12,883 – ($10.40 × 568) = $6,976. Fixed costs = (Low cost – ($10.40 × Low activity) or $9,054 – ($10.40 × 200) = $6,974. The difference is simply due to rounding. So, our equation estimating total cost is: Total cost = ($10.40 × Repair hours) + $6,976. Rounding difference 5 - 77

Regression Analysis Regression is a statistical procedure to
LO4 Regression Analysis Regression is a statistical procedure to determine the relation between variables. It helps managers determine how well the estimated regression equation describes the relations between costs and activities. Regression statistically measures the relationship between two variables, activities and costs. Regression techniques are designed to generate a line that best fits a set of data points. In addition, regression techniques generate information that helps a manager determine how well the estimated regression equation describes the relations between costs and activities. 5 - 78

Interpreting Regression
L.O. 5 Interpret the results of regression output. Independent variable: – The X term, or predictor – The activity that predicts (causes) the change in costs Activities: – Repair-hours Dependent variable: – The Y term – The dependent variable – The cost to be estimated For 3C, repair-hours are the activities, the independent variable, or predictor variable. In regression, the independent variable or predictor variable is identified as the X term. Overhead costs is the dependent variable, or Y term. What we are saying is: overhead costs are dependent on repair-hours, or predicted by repair-hours. Costs: – Overhead costs 5 - 79

Practical Implementation Problems
L.O. 6 Identify potential problems with regression data. Effect of: – Nonlinear relations – Outliers – Spurious relations – Using data that do not fit the assumptions of regression analysis It’s easy to be over confident when interpreting regression output. It all looks so official. But beware of some potential problems with regression data. We already discussed in earlier chapters that costs are curvilinear and cost estimations are only valid within the relevant range. Data may also include outliers and the relationships may be spurious. Let’s talk a bit about each. 5 - 80

Statistical Cost Estimation
L.O. 7 Evaluate the advantages and disadvantages of alternative cost estimation methods. Advantages: Reliance on historical data is relatively inexpensive. Computational tools allow for more data to be used than for non-statistical methods. Disadvantages: Using regression to estimate costs relies on past data that is relatively inexpensive. Computational tools allow for more data to be used than for nonstatistical methods. However, analysts must be alert to cost-activity changes. Reliance on historical data may be the only readily available, cost-effective basis for estimating costs. Analysts must be alert to cost-activity changes. 5 - 81

Data Problems Missing data Outliers Allocated and discretionary costs
Inflation No matter what method is used to estimate costs, the results are only as good as the data used. Collecting appropriate data is complicated by missing data, outliers, allocated and discretionary costs, inflation, and mismatched time periods. Mismatched time periods 5 - 82

Appendix A: Microsoft as a Tool
L.O. 8 (Appendix A) Use Microsoft Excel to perform a regression analysis. Many software programs exist to aid in performing regression analysis. In order to use Microsoft Excel, the Analysis Tool Pak must be installed. Data is entered and the user then selects the data and type of regression analysis to be generated. As we saw in Chapter 3 (CVP), there are software packages that allow users to easily generate a regression analysis. If, however, the user has little or no knowledge regarding regression, the output will be of little use. The analyst must be well schooled in regression in order to determine the meaning of the output. 5 - 83

Learning Phenomenon L.O. 9 (Appendix B) Understand the mathematical relationship describing the learning phenomenon. This is the systematic relationship between the amount of experience in performing a task and the time required to perform it. First unit Second unit Fourth unit Eighth unit 100.0 hours 80.0 hours 64.0 hours 51.2 hours (assumed) 80% × 100 hours 80% × 80 hours 80% × 64 hours Unit Time to produce Calculation of time Another element that can change the shape of the total cost curve is the notion of a learning phenomenon. As workers become more skilled they are able to produce more output per hour. This will impact the total cost curve since it leads to a lower per unit cost, the higher the output. Impact: It causes the unit price to decrease as production increases. This implies a nonlinear model. 5 - 84

Chapter 7 Job Costing In Chapter 6, we developed the basics of a cost management system designed to report the costs of products and services. In this chapter we describe a job costing system used in many service and discrete manufacturing settings. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Defining a Job L.O. 1 Explain what job and job shop mean. Job:
Unit of a product that is easily distinguishable from other units Job shop: Firm that produces jobs A job is an easily distinguished cost object for which a cost is desired. A job shop is a firm that produces jobs. 7 - 87

Production Process at InShape
L.O. 2 Assign costs in a job cost system. Suppose InShape, Inc. manufactures custom workout and training equipment for schools and gyms. Suppose InShape produces custom sports equipment for schools and athletic facilities. Suppose InShape begins with jobs 12-3, 01-01, and 7 - 88

Records of Costs at InShape
LO2 Records of Costs at InShape Materials Work-in-process Direct materials Raw Indirect Overhead 12-03 01-01 01-02 Total WIP Transfers out of raw materials inventory are direct materials into jobs 12-03, 01-01, and (work-in-process subsidiary accounts). Indirect materials are recorded in an overhead control account. 7 - 89

LO2 Records of Costs at InShape Labor Work-in-process Direct labor 12-03 Total WIP 01-01 Labor 01-02 Direct labor is recorded to jobs 12-03, 01-01, and (work-in-process subsidiary accounts). Indirect labor is recorded in the overhead control account. Indirect labor Overhead 7 - 90

LO2 Records of Costs at InShape Overhead Work-in-process 12-03 Total WIP 01-01 Overhead 01-02 And, remember, overhead costs will be charged to and recorded in the subsidiary ledger accounts for jobs 12-03, 01-01, and using a predetermined overhead rate. OH costs are applied to each job using the POHR. 7 - 91

Predetermined Rate Why?
L.O. 3 Account for overhead using predetermined rates. The estimated manufacturing overhead predetermined rate is the estimated overhead divided by the estimated activity for the allocation base. InShape uses estimates based on annual manufacturing overhead and annual production volume. Why? Job shops use predetermined rates to assign manufacturing overhead to jobs. InShape uses estimates based on annual manufacturing overhead and annual production volume. Because it does not want erratic or monthly costs or production volumes to affect the long-run production costs. 7 - 92

An Alternative Method of Recording and Applying Manufacturing Overhead
LO3 An Alternative Method of Recording and Applying Manufacturing Overhead Assume InShape maintains two manufacturing overhead accounts: Manufacturing Overhead Control Used to track all actual overhead expenses Applied Manufacturing Overhead Used to allocate overhead to jobs based on the predetermined OH rate Some companies use an alternative method to record and apply manufacturing overhead. Assume InShape uses this method. The two overhead accounts are: One, “Manufacturing Overhead Control” to track actual overhead expenses incurred (this account will be debited for actual overhead incurred), and the second account (already discussed), “Applied Manufacturing Overhead” to allocate the overhead using the predetermined overhead rate times the actual direct labor hours used. The Applied Manufacturing Overhead account will be credited when overhead is applied to job tickets. Some companies combine these two accounts into one account. 7 - 93

An Alternative Method of Recording and Applying Manufacturing Overhead
LO3 An Alternative Method of Recording and Applying Manufacturing Overhead Underapplied overhead The excess of actual overhead costs incurred over applied overhead costs Overapplied overhead The excess of applied overhead costs over actual overhead costs incurred Indirect costs are recorded in the overhead control account when they are incurred and applied to products based on a predetermined overhead application rate. When overhead is applied, the overhead control account is credited and the work-in-process subsidiary accounts are debited. Underapplied overhead is the excess of actual overhead costs incurred over the overhead costs applied. Overapplied overhead is the excess of applied overhead costs over actual overhead costs incurred. 7 - 94

Writing Off Over- or Underapplied Overhead
LO3 Writing Off Over- or Underapplied Overhead Some firms use only one OH account. In this condition, the debit side of the OH account contains actual data and the credit side contains applied data. For either condition of under- or overapplied, actual must equal applied in the Overhead control account at the end of the period. Overhead 12,000 9,500 13,750 5,000 11,200 51,450 49,000 2,450 Cost of Goods Sold 104,000 2,450 106,450 Some firms prefer to use only one overhead account. If that is the case, then the debit side of the overhead account will contain the actual overhead incurred and the credit side will contain overhead applied. You would still transfer any over/under overhead applied to Cost of Goods Sold at the end of the period. 7 - 95

Allocating Over- or Underapplied Overhead
Some companies prorate the over/under applied MOH to WIP, FG, and COGS. Work-in-Process Inventory Finished Goods Inventory Cost of Goods Sold Total $ 31,500 208,500 104,000 $344,000 9.2% 60.6% 30.2% 100.0% Costs % of Total Accounts at January 31 Another option for adjusting under- or overapplied overhead is to adjust the accounts that contain the cost of the products worked on during the period. At the end of the month, where are the goods that had overhead applied to them during the period? The goods are either still in work-in-process, finished goods, or cost of goods sold. At January, Cost of Goods Sold has costs of $104,000 or 30.2% of the total product costs for the period. Finished Goods Inventory has cost of $208,500 or 60.6%. And Work-in-Process Inventory has $31,500 or 9.2% of the total product costs of $344,000 for the month of January. 7 - 96

Using Normal, Actual, and Standard Costing
LO3 Using Normal, Actual, and Standard Costing Normal: Cost of job determined by actual direct material, actual direct labor, and applied overhead using the POHR and the actual allocation base. Actual: Cost of job determined by actual direct material, actual direct labor, and applied overhead using actual overhead rate and the actual allocation base. When InShape recorded manufacturing overhead to the individual jobs, actual direct labor dollars were multiplied by the predetermined overhead rate of $0.50 per direct labor dollar. This is called normal costing. Using normal costing, the cost of a job is determined by actual direct material and actual direct labor costs and applied overhead using the predetermined overhead rate times the actual allocation base. Normal costing uses estimates for the cost of overhead. An alternative costing method is actual costing. Actual costing is actual direct cost plus overhead applied using a rate based on actual overhead and actual allocation base. Actual costing requires management to wait until actual costs are known before costing the product, but does provide more current information. A third method is standard costing. Using standard costing, the cost of the job is determined by standard or budgeted direct cost and applied overhead using the predetermined overhead rate and a standard allocation base. Standard: Cost of job determined by standard (budgeted) direct material, standard direct labor, and applied overhead using the POHR and a standard (budgeted) allocation base. 7 - 97

Using Job Costing in Service Organizations
L.O. 4 Apply job costing methods in service organizations. Service organizations use fewer direct materials than manufacturing companies. Service companies’ overhead accounts have slightly different names. Finished goods (or services) are charged to Cost of Services Billed. Service organizations are labor intensive and use fewer direct materials than manufacturing companies. 7 - 98

Using Job Costing in Service Organizations
LO4 Using Job Costing in Service Organizations Labor Work in process Direct labor Client A Total WIP Client B Labor Client C Applying job costing methods in a service organization works the same way. The subsidiary ledger accounts are clients rather than jobs. Direct costs are traced directly to the client and indirect costs are applied to the client’s work-in-process account using a predetermined overhead rate. Indirect labor Overhead 7 - 99

Ethical Issues L.O. 5 Understand the ethical issues in job costing.
Improprieties Include: – Misstating the stage of completion – Charging costs to the wrong jobs – Misrepresenting the cost of jobs Some of the more common improprieties regarding job costing are the misstatement of the stage of completion, charging costs to wrong jobs or categories, and misrepresenting costs.

Managing Projects L.O. 6 Describe the difference between jobs and projects. A project is a complex job that often takes months or years to complete and requires the work of many departments, divisions, or subcontractors. The terms “project” and “job” are sometimes used to mean the same thing. Yet, projects and jobs are different. A project is frequently comprised of many jobs. Projects are complex and often take months or even years to complete. They require the work of many departments, divisions, or subcontractors.

Process Costing Chapter 8
We continue our discussion of the details of a product costing system in Chapter 8 by developing a process costing system. As we discussed in Chapter 6, the difference between job order and process costing is the level at which costs are aggregated before they are assigned to the individual units of product. Process costing assumes that all units are homogeneous and follow the same path through the production process. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Determining Equivalent Units
L.O. 1 Explain the concept and purpose of equivalent units. Equivalent units: Number of complete physical units to which units in inventories are equal in terms of work done to date. When manufacturing a product using a continuous process we assume all units have the same costs. The problem: some units are not completed. The answer: equivalent units. Equivalent units were introduced in Chapter 6.

Using Product Costing in a Process Industry
L.O. 2 Assign costs to products using a five-step process. Step 1: Measure the physical flow of resources. Step 2: Compute the equivalent units of production. Step 3: Identify the product costs for which to account. In chapter 6, we applied costs to products that had been transferred out of work-in-process and units that remained in work-in-process ending inventory. We will do the same thing in this chapter. The approach we follow is summarized in five steps: 1. Measure the physical flow of resources. 2. Compute the equivalent units of production. 3. Identify the product costs for which to account. 4. Compute the cost per equivalent unit. And 5. Assign product cost to batches of work. Step 4: Compute the costs per equivalent unit. Step 5: Assign product cost to batches of work.

Steps 4 and 5 L.O. 3 Assign costs to products using weighted-average costing. Compute the costs per equivalent unit: Weighted-average (Step 4) First, Steps 1, 2, and 3 must be revisited. Now we are going to assign costs to products using the weighted-average costing method. We need to go over steps 1, 2, and 3.

Measure the Physical Flow of Resources (Step 1)
Work in process, March 1 + Gallons of adhesive started Total gallons to account for =Transferred out to Coating Department + Work-in-process, March 31 Total units accounted for 20,000a 92,000 112,000 96,000 16,000b Gallons of Compound a 25% complete with respect to conversion costs b 30% complete with respect to conversion costs Step 1: Measure the physical flow of resources. We have 112,000 total gallons to account for: 20,000 gallons that were in beginning inventory at March 1 and 92,000 gallons that were started during March. Where are the 112,000 gallons at March 31? 96,000 gallons have been transferred out and into the next processing department. 16,000 gallons are still in ending inventory.

Compute the Equivalent Units of Production (Step 2)
LO3 Compute the Equivalent Units of Production (Step 2) Transferred out Work-in-process, March 31 Total work 96,000 16,000 16,000a 112,000 4,800b 100,800 Physical units Materials Conversion Equivalent units a 16,000 units × 100% (all materials added in beginning) Compounding Department, March: Equivalent Units b 16,000 units × 30% Step 2: Compute the equivalent units of production. 96,000 units were transferred out. Remember, using weighted-average we do not care where those 96,000 units came from. Were they units started last month and in our beginning inventory balance at March 1 or were they units started during March? We don’t care. We will combine our units and our costs for a weighted average. We do know that if 96,000 units were transferred out they are 100% complete. If they were not complete they would still be in ending inventory. 16,000 units are still in ending inventory. These 16,000 units are 100% complete with respect to materials for equivalent units of materials of 16,000. They are 30% complete with respect to conversion costs for equivalent units of 4,800 for conversion costs. Total equivalent units for materials are 112,000. Total equivalent units for conversion costs are 100,800.

Identify the Product Costs for Which to Account (Step 3)
LO3 Identify the Product Costs for Which to Account (Step 3) Work in process, March 1 Current costs, March Total $ 24,286 298,274 $322,560 $ 16,160 84,640 $100,800 $ 8,126 213,634 $221,760 costs Materials Conversion Step 3: Identify costs for which to account. Total beginning inventory costs equaled $24,286 ($16,160 of materials and $8,126 of conversion costs). During March $84,640 of material costs and $213,634 conversion costs were incurred for total March costs added of $298,274. Total costs to account for are $322,560 ($100,800 of materials and $221,760 of conversion costs).

Compute the Cost per Equivalent Unit (Step 4)
LO3 Compute the Cost per Equivalent Unit (Step 4) Total costs (Step 3) Total equivalent units (Step 2) Cost per equivalent unit $322,560 $100,800 112,000 $ $221,760 100,800 $ Total costs Materials Conversion Step 4: Compute the cost per equivalent unit. Total materials costs of $100,800 divided by 112,000 equivalent units of material gives a cost per equivalent unit for material of $0.90. Total conversion costs of $221,760 divided by 100,800 equivalent units gives a cost per equivalent unit for conversion costs of $2.20.

Assign Product Costs to Batches of Work (Step 5)
LO3 Assign Product Costs to Batches of Work (Step 5) Transferred out: Equivalent units Cost per equivalent unit Cost assigned Work-in-process, March 31 Total cost assigned $297,600 24,960 $322,560 96,000 $ $ 86,400 16,000 14,400 $100,800 $ $211,200 4,800 10,560 $221,760 Total Materials costs Conversion Step 5: Assign product cost to batches of work. 96,000 units transferred out times $0.90 per equivalent unit for materials, gives material cost transferred out of $86, ,000 units transferred out times $2.20 per equivalent unit gives $211,200 conversion cost transferred out. 16,000 equivalent units for materials times $0.90 per unit gives $14,400 materials cost in ending work-in-process inventory. 4,800 equivalent units for conversion cost times $2.20 per unit gives $10,560 conversion cost in ending work-in-process inventory. So where are the $322,560 of costs to account for at March 31? $297,600 are assigned to units transferred out of the adhesive department and $24,960 are assigned to the units in ending inventory. Total costs accounted for are $322,560.

The Production Cost Report
L.O. 4 Prepare and analyze a production cost report. The production cost report summarizes the production and cost results for a period. It is used by managers to monitor production and cost flows Following is 2T’s Compounding Department production cost report (weighted-average processing costing) for March. The production cost report summarizes production and costs for a period and is used by managers to monitor production and cost flows.

Production Cost Report: Weighted-Average Process Costing
LO4 Production Cost Report: Weighted-Average Process Costing Physical units Materials Conversion Equivalent units a 100 % complete with respect to materials b 30% complete with respect to conversion Flow of units Units to be accounted for: In work-in-process beginning inventory Units started this period Total units to account for 20,000a 92,000 112,000 Units accounted for: Completed and transferred out In work-in-process ending inventory Total units accounted for 96,000 16,000 16,000a 4,800b 100,800 Here is the production cost report for the Compounding Department for the month ending March 31. Does this look familiar? It should. The production cost report is the five-step process that we just used to account for costs. The first part of the production cost report shows units to be accounted for and units accounted for.

Production Cost Report: Weighted-Average Process Costing
LO4 Production Cost Report: Weighted-Average Process Costing Costs to be accounted for: Work-in-process beginning inventory Current period costs Total costs to be accounted for $ 24,286 298,274 $322,560 $ 16,160 84,640 $100,800 $ 8,126 213,634 $221,760 Total Materials Costs Conversion Flow of costs Cost per equivalent unit $ c $ d Costs accounted for: Costs assigned to transferred-out units Costs assigned to WIP ending inventory Total costs accounted for $297,600 24,960 $ 86,400e 14,400g $211,200f 10,560h c $100,000 ÷ 112,000 EU d $221,760 ÷ 100,800 EU e 96,000 EU × $0.90 per EU f 96,000 EU × $2.20 per EU g 16,000 EU × $0.90 per EU h 4,800 EU × $2.20 per EU The second part shows costs to be accounted for and costs accounted for. We just did all these calculations. The production cost report is the five-step process in report format.

Assigning Costs Using FIFO
L.O. 5 Assign costs to products using first-in, first-out (FIFO) costing. Use the same five-step process. Step 1: Measure the physical flow of resources. Step 2: Compute the equivalent units of production. Step 3: Identify the product costs for which to account. Step 4: Compute the costs per equivalent unit. Step 5: Assign product cost to batches of work. It should come as no surprise that assigning costs using FIFO will follow the same five-step process. 1. Measure the physical flow of resources. 2. Compute the equivalent units of production. 3. Identify the product costs for which to account. 4. Compute the cost per equivalent unit. And, finally, 5. assign product cost to batches of work. Remember the difference between weighted-average and FIFO is that using FIFO we separate what was done last period from what was done this period.

Determining Which is Better: FIFO or Weighted-Average?
L.O. 6 Analyze the accounting choice between FIFO and weighted-average costing. Weighted-average: Does not separate prior period and current period activities and costs. Take a moment to compare FIFO and weighted-average. FIFO separates prior period and current period activities and traces the prior period and current period costs to the respective units. Weighted-average does not separate prior period and current period activities and costs. FIFO: Separates prior period and current period activities and traces the prior period and current period costs to the respective units.

Choosing between Job and Process Costing
L.O. 7 Know when to use process or job costing. Job Costing An accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods. Custom homes Movies Services Process Costing An accounting system used when identical units are produced through a series of uniform production steps. Corn flakes Beverages Paint In job costing, costs are collected for each unit produced. In process costing, costs are accumulated by department for an accounting period and then spread evenly, or averaged, over the units produced that period.

Operation Costing L.O. 8 Compare and contrast operation costing
with job costing and process costing. Operation costing is a hybrid of job and process costing. It is used in manufacturing goods that have some common characteristics plus some individual characteristics. Operation costing is used in manufacturing goods that have some common characteristics and some individual characteristics.

Activity-Based Costing
Chapter 9 Activity-Based Costing Chapters 7 and 8 described product costing systems. In the last 15 years or so, many companies have experimented with and implemented costing systems based on production processes rather than accounting systems. One such system is activity-based costing, or ABC, which aids managers in the decision making process. Chapter 9 describes activity-based costing. McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Product Costs and Decision Making
L.O. 1 Understand the potential effects of using externally reported product costs for decision making. Units produced Direct labor-hours Costs: Direct materials Direct labor Manufacturing overhead 120%) Total Cost per unit 10 2,000 $ 40,000 72,000 86,400 $198,400 $ 19,840 30 3,000 $ 36,000 78,000 93,600 $207,600 $ 6,920 40 5,000 $ 76,000 150,000 180,000 $406,000 C-27s C-20s The cost per unit of C-27 is $19,840 and Grange is considering dropping it. Grange is considering dropping C-27s.

Product Costs and Decision Making
LO1 Product Costs and Decision Making Direct materials Direct labor Manufacturing overhead Total costs $ 76,000 150,000 180,000 $406,000 $ 36,000 78,000 163,800 $277,800 Original C-20s only The cost per unit for the C-20s will increase from $6,920 to $9,260. Grange’s total cost estimate when producing both C-20s and C-27s was $406,000, $198,400 for C-27s, and $207,600 for C-20s. However, if Grange produces only C-20s, total cost estimate is $277,800. If Grange continues the current production of 30 C-20s the per unit cost will go from $6,920 to $9,260 per unit. How can this be?

Two-Stage Cost Allocation
L.O. 2 Explain how a two-stage product costing system works. Allocate overhead costs to departments. First stage: Allocate department overhead costs to the products or services. Second stage: Let’s look at a two-stage cost allocation system. First, allocate overhead costs to departments and then allocate the department overhead costs to the products or services.

Plantwide versus Department-Specific Rates
L.O. 3 Compare and contrast plantwide and department allocation methods. Plantwide allocation method All overhead costs are recorded in one cost pool and applied to products using one overhead allocation rate. Using a plantwide allocation method, all overhead costs are recorded in one cost pool and applied to products using one predetermined overhead rate. There is one cost pool for the factory. One cost pool for the factory

Activity-Based Costing (ABC)
L.O. 4 Explain how activity-based costing and a two-stage product system are related. ABC is a costing method that first assigns costs to activities and then assigns them to products based on the products’ consumption of activities. Assign costs to activities. Stage 1: Activity-based costing is a two-stage allocation method that first assigns overhead costs to activities rather than departments, and then allocates the cost of those activities to products based on the use of each activity. Assign costs to products based on the use of each activity Stage 2:

Developing Activity-Based Costs
Step 1: Identify the activities that consume resources and assign costs to them. Step 2: Identify the cost driver(s) associated with each activity. Step 3: Compute a cost rate per cost driver unit or transaction. Developing an activity-based costing system consists of four steps. First, identify activities that consume resources and assign costs to them. Second, identify the cost drivers associated with each activity. Third, compute a cost rate per cost driver unit or transaction. And finally, fourth, allocate the cost of the activities to products by multiplying the cost driver rate by the volume of cost driver units consumed by the product. Step 4: Assign costs to products by multiplying the cost driver rate by the volume of cost driver units consumed by the product.

Activity-Based Costing Illustrated
L.O. 5 Compute product costs using activity-based costing. Number of units Machine hours – Assembly Direct materials Direct labor – Assembly Direct labor – Packaging Total direct labor Total direct cost Overhead costs: Assembly Packaging Total overhead Total costs 100,000 6,000 $1,500,000 $ 750,000 990,000 $1,740,000 $3,240,000 40,000 30,000 $2,400,000 $ 600,000 360,000 $ 960,000 $3,360,000 140,000 36,000 $3,900,000 $1,350,000 1,350,000 $2,700,000 $6,600,000 $1,620,000 810,000 $2,430,000 $9,030,000 J25P J40X Total Third Quarter – Production and Cost Data Let’s go back to the Port Arthur Manufacturing Facility. Total direct costs, that is direct materials and direct labor, are $6,600,000. Total manufacturing overhead costs are $2,430,000. Let’s cost the two products, the J25P and the J40X, using activity-based costing.

Activity-Based Costing Illustrated Step 1: Identify the Activities
LO5 Activity-Based Costing Illustrated Step 1: Identify the Activities Assembly Department Setting up machines Handling material Product Assembly Packaging Department Inspection Packing Shipping The first step in activity-based costing is to identify the activities. Activities in the Assembly Department include machine set up, material handling and product assembly. Activities in the Packaging Department include inspection and packing, and shipping.

Activity-Based Costing Illustrated Step 2: Identify the Cost Drivers
LO5 Activity-Based Costing Illustrated Step 2: Identify the Cost Drivers Assembly building: Assembling Setting up machines Handling material Packaging building: Inspecting and packing Shipping Machine-hours Setup hours Production runs Direct labor hours No. of shipments 6,000 40 8 60,000 100 30,000 400 22,800 200 J25P J40X Total Cost Driver Volume 36,000 440 48 82,800 300 Activity Cost Driver After identifying the activities, the second step in activity-based costing is to identify the cost drivers and the expected volume of each cost driver. Product assembly costs are driven by machine hours and the expected volume of machine hours is 36,000. The cost driver for machine setup costs is setup hours. Port Arthur Manufacturing Facility expects 440 setup hours. The cost driver for material handling is production runs and Port Arthur Manufacturing Facility expects 48 production runs. In the Packaging Department, inspection and packing costs are driven by the number of direct labor hours. Total direct labor hours expected are 82,800. And finally, shipping costs are driven by the number of shipments: expected number of shipments, 300.

LO5 Activity-Based Costing Illustrated Step 3: Compute the Cost Driver Rates Assembly building: Assembling Setting up machines Handling material Total assembly overhead Packaging building: Inspecting and packing Shipping Total packaging overhead Total overhead $1,080,000 396,000 144,000 $1,620,000 $ 414,000 $ 810,000 $2,430,000 36,000 machine hour 440 hours 48 runs 82,800 direct labor hour 300 shipments $ /machine hour $ 900/setup hour $3,000/run $ /direct labor hour $ 1,320/shipment Building and Activity Overhead Cost Cost Driver Volume Rate Third step: compute the cost driver rates. For product assembly we have $30 per machine hour. If costs assigned to machine setup equals $396,000 and the expected volume of setup hours is 440, the overhead rate is $900 per setup hour. Computing the cost driver rate for material handling gives us $3,000 per production run. In the Packaging Department, we have overhead rates of $5 per direct labor hour for inspection and packing and $1,320 per shipment for shipping.

Activity-Based Costing Illustrated Step 4: Assign Costs Using ABC
LO5 Activity-Based Costing Illustrated Step 4: Assign Costs Using ABC Assembly building: $30/machine hour Machine $900/setup hour Handling $3,000/run Packaging building: Inspection and $5/direct labor hour $1,320/ shipment Total ABC overhead $180,000 36,000 24,000 300,000 132,000 $672,000 $ 900,000 360,000 120,000 114,000 264,000 $1,758,000 J25P J40X Overhead Finally, allocate costs to the products using the predetermined overhead rate per activity. Product assembly at $30 per machine hour allocated $180,000 and $900,000 to J25P and J40X respectively. Machine setup at $900 per set-up hour allocates $36,000 and $360,000 to J25P and J40X respectively. Material handling at $3,000 per production run allocates $24,000 and $120,000 to J25P and J40X respectively and so on. Inspecting and packing at $5 per direct labor hour allocated $300,000 and $114,000 to J25P and J40X respectively. Finally, shipping is allocated at $1,320 per shipment which attributed $132,000 and $264,000 to J25P and J40X respectively. Allocating costs to the products using the predetermined overhead rate per activity results in total overhead costs allocated to J25P of $672,000 and to J40X of $1,758,000.

Comparison of Reported Unit Product Costs
Unit Costs Compared L.O. 6 Compare activity-based product costing to traditional department product costing methods. Plantwide rate Department (building) rate Activity-based costing $48.06 $41.04 $39.12 $105.60 $123.15 $127.95 J25P J40X Comparison of Reported Unit Product Costs Take a moment to compare the per-unit product cost using a plantwide rate, a department rate and activity-based costing for allocating overhead. The J25P has a per-unit product cost of $48.06 using a plantwide allocation rate for overhead costs, $41.04 using a department rate, and $39.12 using activity-based costing. The J40X has a per-unit product cost of $ using a plantwide allocation rate for overhead costs, $ using a department rate, and $ using activity-based costing. Notice using volume to allocate overhead costs results in over costing high-volume products like the J25P and under costing low-volume products like the J40X.

Cost Flows through Accounts
L.O. 7 Demonstrate the flow of costs through accounts using activity-based costing. Let’s see ABC cost flow for the Assembly Department. It's T-account time! Let’s see how costs flow through the accounts in the Assembly Department using activity-based costing.

Overhead Costs Assembling 180,000 900,000 1,080,000 Assembly WIP J25P
LO7 Overhead Costs Assembling 180,000 900,000 1,080,000 Assembly WIP J25P DM 1,500,000 DL ,000 OH ,000 Setting Up 36,000 360,000 396,000 Assembly WIP J40X DM 2,400,000 DL ,000 OH1,380,000 The overhead control account for each activity is credited for the cost allocated to the individual products. The assembling control account is credited and the assembly work-in-process account for the J25P is debited for $180,000. It is credited and the assembly work-in-process account for the J40X is debited for $900,000. The machine setup control account is credited and the assembly work-in-process account for the J25P is debited for $36,000. It is credited and the assembly work-in-process account for the J40X is debited for $360,000. The material handling control account is credited and the assembly work-in-process account for the J25P is debited for $24,000. It is credited and the assembly work-in-process account for the J40X is debited for $120,000. Total overhead allocated to the J25P product is $240,000 ($180,000 assembling costs plus $36,000 set-up costs plus $24,000 material handling costs). Total overhead allocated to the J40X product is $1,380,000 ($900,000 assembling, $360,000 set-up and $120,000 material handling). Remember, the overhead control accounts were originally debited for the cost assigned to that activity. Handling Material 24,000 120,000 144,000

ABC Costing in Administration
L.O. 8 Apply activity-based costing to marketing and administrative services. The same four-step process: Step 1: Identify the activities that consume resources. Step 2: Identify the cost driver associated with each activity. Step 3: Compute a cost rate per cost driver for each unit or transaction. Applying activity-based costing to marketing and administrative services involves the same four-step process. First, identify the activities that consume resources and assign costs to them. Second, identify the cost drivers associated with each activity. Third, compute a cost rate per cost driver unit or transaction. And finally, fourth, assign the cost of the activities to marketing or administration by multiplying the cost driver rate by the volume of cost driver units consumed by the activity. Step 4: Assign costs to the marketing or administration activity by multiplying the cost driver rate by the volume of cost driver units consumed by the product.

Cost Accounting: Information for Decision Making

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