Accounting Exam 2

is absorption costing used for internal or external reporting? how about variable costing?

absorption costing is primarily used for external reporting, variable costing is primarily used for internal reporting

what are product-level activities? what are some common activities at the product-level and some product-level activity measures?

activities that involve products related to a certain product line activities: -testing new products -administering parts inventories -maintaining parts of inventories activity measures: -hours of testing time -number of part types -hours of design time

in what situations is a contribution margin income statement useful? what does it emphasize?

it is helpful to managers in judging the impact on profits or changes in selling price, cost, or volume; the emphasis is on cost behavior

what is the formula methods for target profit analysis dollar sales?

(target profit + fixed expenses )/ cm ratio

absorption vs variable costing income statements makeup? how do the two differ in terms of categorization?

-absorption: sales - COGS = gross margin -->gross margin - sg&a = net income -variable: sales - variable expenses = CM -->contribution margin - fixed mfg OH - fixed SG&A = net operating income -absorption costing categorizes costs by function, variable costing categorizes costs by behavior -variable costing income cannot be manipulated by changes in inventory

what are some disadvantages of departmental overhead rates

-departmental rates will not correctly assign overhead in situations where a company has a range of products and complex overhead costs -the departmental approach relies on a single measure of activity as the allocation base while some overhead costs may not be caused by factors that are not directly proportional to the volume of production -->allocation base is usually related to volume of production, but the actual cause of OH may have little to do with production volume -activity-based costing is used to account for these other factors and more accurately assigns overhead costs to products; it ackwoledges the fact that different products consume resources differently

why has direct labor traditionally been used as the allocation base for overhead

-direct labor information was already being recorded -direct labor was a large component of product costs -managers believed direct labor and overhead costs were highly correlated

what are some common mistakes made while allocating costs to certain segments?

-failure to trace costs directly - costs that can be traced directly to specific segments of a company should not be attributed to other business segments -arbitrarily assigning common costs among segments -inappropriate allocation base - some companies allocate costs to segments using arbitrary bases; costs should be allocated to segments only when the allocation base actually drives the cost being allocated

how is the margin of safety calculated (in units, dollars, and as a percentage)

-margin of safety in dollars = total budgeted (or actual) sales - break-even dollars -margin of safety as a percentage = margin of safety in dollars/total budgeted or actual sales dollars -margin of safety in units = margin of safety in dollars/ selling price -->the margin of safety is usually calculated as a percentage because it is easier to benchmark between products/companies when it is a percentagee

when will net income differ under variable and absorption costing? when will they be the same?

-they will be the same when units produced = units sold -absorption costing net income will exceed variable costing net income when units produced > units sold (inventory stacks up and is deferred, less COGS) -variable costing net income will exceed absorption costing net income when units sold > units produced (inventory released, more COGS)

how do variable costing and absorption costing systems impact decision-making?

-variable costing correctly identifies the additional variable cost incurred to make one more unit; it also emphasizes the impact of total fixed costs on profits -since absorption costing assigns fixed manufacturing overhead costs to units produced, it gives the impression that fixed manufacturing overhead is variable with respect to the number of units produced, but it is not. the result can be inappropriate pricing decisions and product discontinuation decisions

how is variable and absorption income influenced by changes in unit sales and units produced?

-variable costing is only affected by changes in unit sales, not number of units produced; as a general rule, when sales go up, net operating income goes up, and vice versa -absorption costing net income is affected by changes in unit sales and units of production; net operating income can be increased simply by producing more units even if those units are not sold

what are the two important points to keep in mind when creating segmented income statements?

1. a contribution format should be used because it separates fixed costs from variable costs and enable the calculation of a contribution margin 2. traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin

what are the three key concepts of absorption vs variable costing?

1. both formats include product and period costs, but cost classifications and defined differently 2. variable costing income statements are grounded in the contribution format and categorize expenses based on cost behavior 3. both methods' net operating incomes often differ because of the fact that the methods account for fixed mfg. overhead differently

why may direct labor may no longer be a satisfactory base for the allocation of overhead

1. most companies sell a variety of products that consume different products that consume differing amounts of overhead 2. as a percentage of costs, direct labor has been declining and overhead has been increasing; many of these overhead costs may not be correlated with direct labor 3. technological advancements have reduce the costs and complexity of gathering diverse sources of data 4. a plantwide overhead allocation system may not be optimal for many companies in today's business environment

what modifications should be made if an ABC system is used for internal-decision making rather than external?

1. selling and administrative costs should be assigned to products, where appropriate 2. facility-level costs should be removed from product costs

what assumptions do managers adopt to simplify cost-volume profit calculations

1. selling price is constant - the price of a product or service will not change as volume changes 2. costs are linear and can be accurately divided into variable and fixed components; the variable costs are constant per unit and the fixed costs are constant in total over the entire relevant range 3. in multiproduct companies, the mix of products sold remains constant -cost-volume profit analysis is broad-based planning to analyze break-even profit, target profit, etc.

do the cost of low-volume or high-volume products change more when shifting from a traditional to abc costing system?

When a company changes from a traditional costing system to an activity-based costing system, the unit product costs of low-volume products typically increase more than the unit product costs of high-volume products decrease because low-volume costs are undercosted so much under a traditional system

activity cost pool

a "cost pool" in which costs related to a particular activity are accumulated

what is a challenge of activity-based costing? what can we do to solve this challenge?

a challenge of ABC is that it is difficult to select a reasonably small number of jobs that explain the bulk of the variation in OH costs -we can help choose only a few activities by combining related activities and asking several managers which activities they think consume most of the organization's resources -an activity dictionary defines each of the activities that will be included in the system and how they will be measured

segment

a component of a business that generates its own revenues and creates its own product, product lines, or service offerings

operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales; it is a measure of how a percentage change in sales volume affects profits at any given level of sales -when operating leverage is high, a small percentage change in unit sales leads to a large percentage increase in profits

what is the high-low method? what must we remember when using this method?

a method of estimating total costs by analyzing cost and activity data for the highest and lowest months -formula = (cost at high activity level - cost at low activity level)/(high activity level - low activity level) -then plug into y = a+bx -->where y = total mixed cost, a = total fixed cost, b = variable cost per unit of activity, and x = the level of activity -we must remember to choose the months with the highest activity levels, NOT with the highest costs because they may not line up properly

activity rate

a predetermined overhead rate for each activity cost pool

plantwide overhead rate

a single overhead rate that is used throughout the entire factory -formula = total estimated OH for period/total estimated amount of allocation base for period

activity-based costing

a technique that attempts to assign overhead costs more accurately to products -it uses multiple allocation bases for assigning costs to products -each activity has an activity cost pool to accumulate costs for a particular activity; each activity will have a different activity measure (allocation base) -each base represents a major activity -->activity-based costing can better accounts for external factors not included in departmental and plantwide overhead costing - assigns overhead based on how production uses overhead

what are batch-level activities? what are some common activities at the batch-level and some batch-level activity measures?

activities where costs are incurred when a batch of units is processed activities: -processing purchase orders -processing production orders -setting up equipment -handling materials activity measures: -purchase orders processed -production orders processed -number of setups -pounds of materials handled

what costing system may be a better alternative to plantwide and departmental overhead rates? why is this system usually more accurate?

activity based costing because it helps account for diverse factors that may affect overhead costs besides the allocation base, such as lot size, setup time involved, production complexity, number of units produced, etc.

how to find activity rate in activity-based costing

activity rate = (estimated OH cost for the activity)/activity measure (total expected activity)

what is activity-based management? what are the steps involved in activity-based management?

activity-based management focuses on managing activities to eliminate waste and reduce processing time and defects -can help identify areas where the company can benefit from improving its current processes -activity rates can be used to target areas where costs seem excessively high -benchmarking can also be used to compare activity cost information with world-class standards of performance achieved by other organizations

how to allocate overhead per-unit under activity-based costing?

after calculating the activity rate, multiply the activity rate x the expected activity level -then, if we need to find per unit cost, we divide total overhead cost assigned/number of units produced to get unit cost

activity

any event that causes the consumption of overhead resources examples include setting up machines, admitting hospital patients, billing customers, opening a bank account

how are all manufacturing costs treated under absorption costing?

as product costs - includes direct labor, direct materials, and MOH - only good on income statement when products are sold -SG&A are separated and expensed directly to IS

why may income differ under variable and absorption costing

because under absorption costing, fixed MOH is only expensed for the number of units sold and unsold units can have stored fixed MOH in it - full amount of fixed MOH may not be charged in period; however, with variable costing, fixed MOH is treated as a period cost and its full amount is expensed on the income statement in the same period in which it is incurred

break-even point for a business segment

break-even point in dollars = traceable fixed expenses/CM ratio -does NOT include common fixed costs because these costs are not traceable to particular business segments

what is the formula for segment margin? why is segment margin important?

contribution margin (aka sales - variable expenses) - traceable fixed costs -the segment margin helps gauge long-term profitability of a segment

degree of operating leverage formula

contribution margin/net operating income

activity-based costing process

cost objects-->activities-->resources consumed-->consumption of resources incurs cost cost objects drive activities costs, activities consume resources, consumption of resources incur cost

what should costs assigned to a segment include?

costs assigned to a segment should include all costs attributable to that segment from the company's entire value chain -value chain is made up of R&D, product design, manufacturing, marketing, distribution, and customer service

what are common fixed costs? give examples

costs that arise because of the overall operation of the company and would not disappear if any particular segment were eliminated -ex. the salary of the CEO of GM is a common fixed cost of the various divisions at general motors -ex 2. the cost of heating a safeway or kroger grocery store is a common fixed cost of the various departments

how to create an activity rate for each activity

create activity cost pools for each activity and compile costs in there; then divide the total cost in pool/ the total activity measure

what steps are involved in ABC costing?

creating activity cost pools and assigning activity costs to cost pools, creating OH rates for every activity based on activity measure, and assigning them to production

how to determine how spending money on a certain action will impact net income?

determine the effect on contribution margin and do increase in cm- amount spent on action = change in profit

what is the break-even formula for units with both the equation method and formula method?

equation method: profit = unit cm x q - fixed costs (Set profit to 0) formula method: fixed expenses/unit cm

what are the equation and formula methods for target profit analysis unit sales?

equation method: profit.= unit cm x q - fixed expenses (solve for unknown q), which represents the quantity that must be sold to attain the target profit formula method: unit sales to attain target profit = (target profit + fixed expenses / CM per unit)

activity measure

expresses how much of the activity is carried out and is used as the allocation base for applying OH costs

what are facility-level activities? what are some common activities at the facility-level and some facility-level activity measures?

facility-level activities are carried out regardless of production and include costs like salaries, property taxes, building depreciation, etc. - these are the organizational-sustaining activities activities: -general factory administration -plant building and grounds activity measures: -direct labor hours

how to find the average number of units processed for batch for batch-level costs? how to find the average batch processing cost per unit?

for average number of units processed per batch: divide the number of units/number of batches for average batch processing cost per unit: cost per batch/average number of units processed per batch

how is activity-based costing similar to job-order costing

for each activity in isolation, an activity-based costing system works exactly like the job-order costing system described in previous chapters -a predetermined overhead rate is computed for each activity and then applied to jobs and products based on the amount of activity consumed by the job or product

when calculating selling costs, what number of units are the calculations based on? what about for administrative costs?

for sales and cogs: based on number of units sold (includes variable selling costs per unit like marketing) for administration: based on number of units produced (includes costs like fixed admin expense)

what is the break-even formula for dollar sales with both the equation method and formula method?

formula method: dollar sales break-even = fixed expenses/cm ratio equation method: dollar sales to break-even: profit = cm ratio x sales - fixed expenses (set profit to 0)

what are some advantages and disadvantages of high fixed cost structures and some advantages of low fixed cost structures?

high fixed cost (or low variable cost): -advantage: with a high cost fixed structure, income will be higher in good years compared to companies with a lower proportion of fixed costs -->after fixed costs are covered, the company will earn more profit per-unit, more high-income potential, but company cannot survive without covering these costs -disadvantage: income will be lower in bad years compared to companies with lower proportions of fixed costs low fixed cost (or high variable cost): companies with low fixed costs enjoy greater stability in income across good and bad years -->easier to cover low fixed costs, but less profit per-unit so less potential for high-profit

what are the benefits of activity-based costing

it improves the accuracy of product costing by: 1. increasing the number of cost pools used to accumulate OH costs 2. using activity cost pools that are more homogenous than departmental cost pools 3. assigning costs based on activity measures that use those costs, rather than solely relying on direct labor hours 4. activity-based costing also highlights activities that could benefit most from process-improvement efforts

what is the formula for absorption costing total manufacturing cost per unit

it is equal to (fixed MOH/number of units produced) + direct materials + direct labor +var. manufacturing overhead

how does the activity-based costing method shift costs compared to traditional costing methods?

it leads products with fewer units per batch to have higher unit product costs and products with more units per batch to have lower units costs -when switching to abc costing, costs often shift from high volume products to low volume products, with a higher product cost per unit resulting for the low volume products

how does predetermined OH rates distort costs

it results in high OH costs for products with higher allocation bases and low OH costs for products with a lower allocation base

how do many companies divide up overhead rates? what does the allocation base depend on in each department

many companies divide up overhead so that department has its own overhead rate (using departmental overhead rates) -under a departmental overhead allocation system, the allocation base depends on the nature of the work performed in each department; for example, in the machining department, overhead may be based on machine hours, but in the assembly department, overhead may be based on direct labor hours

how to find percentage change in net operating income from the degree of operating leverage?

multiply the degree of operating leverage by the percentage change in sales

what is a weakness of absorption costing? what is a better alternative to this

net income can fluctuate with changes in inventories; does not correlate very well to changes in sales -variable costing system can better correlate sales and net income and eliminate the effect of inventory fluctuations on net income

once the break-even point is reached, what happens to net income for every additional unit sold?

net income increases by the amount of contribution margin for each additional unit sold AFTER BREAK-EVEN POINT IS REACHED

under absorption costing, what can happen to income when the number of units sold is less than the break-even point

net operating income may be positive when the number of units sold is less than the break-even point because a portion of fixed MOH remains in inventory with unsold units

can you plug any point in the mixed cost equation to compute fixed cost of production?

no, only the high or the low points used in the high-low method formula can be plugged into equation

under absorption costing, which costs are product costs and which costs are period costs?

product: -direct materials -direct labor -variable manufacturing overhead -fixed manufacturing overhead period: -variable selling and administrative expense -fixed selling and administrative expense

under variable costing, which costs are product costs and which costs are period costs?

product: -direct materials -direct labor -variable manufacturing overhead period: -fixed mfg overhead -variable selling and administrative expenses -fixed selling and administrative expenses

what is the formula for profit

profit = (sales [p x q] - variable expenses [v x q]) - fixed expenses

cost structure

refers to the relative proportion of fixed and variable costs in an organization

what is the formula for contribution margin? what does contribution margin tell us

sales revenue - variable expenses -contribution margin tells us how much money is left to cover fixed expenses and provide net income

contribution margin

the amount remaining from sales revenues after all variable expenses have been deducted -is first used to cover fixed expenses, any remaining contribution margin then contributes to net income

when cost systems were first developed in the 1800s, what was the emphasis on and why?

the emphasis was on simplicity because cost and activity data had to be collected and all calculations were done with paper and pencil (1) and most companies produced a limited variety of similar products, so there was little difference in the overhead costs consumed by each product

what is the margin of safety?

the excess of budgeted or actual sales dollars over the break-even volume of sales dollars; it is the amount by which sales can drop before losses are incurred -the higher the margin of safety, the lower the risk of not breaking even and incurring a loss -this calculation helps management understand what they can change or modify without incurring a net loss

what is a sales mix? why is it significant?

the proportion in which. company's products are sold -companies that sell multiple products and thus have a sales mix must consider the sales mix in estimates and explicitly consider any expected changes to it

how should common fixed costs be allocated to segment divisions?

these costs should not be allocated to segment divisions because they would remain even if one of the divisions were eliminated -this should not be done because it can make a profitable business segment appear unprofitable and forces managers to be held accountable for costs they cannot control

how does the sum of segment break-even points compare to the company's overall break-even point?

they will not be equal because the segment break-even points don't include common fixed costs, while the company's overall break-even point includes all costs - both traceable fixed costs and common fixed costs

how to find the increase in net income from a certain change in sales after the break-even point is reached

to estimate profit at a particular sales volume: multiply the number of units sold above break-even x the contribution margin per-unit

what is the formula for contribution margin ratio on a total basis and on a per-unit basis?

total: contribution margin/sales per-unit: unit contribution margin/unit selling price -the CM ratio tells you how much profit increases by for every $1.00 change in sales

what are traceable fixed costs? give examples

traceable fixed costs are costs that arise because of the existence of a particular segment and would disappear over time if the segment itself disappeared -ex. the salary of the fritos product manager at Pepsico is a traceable fixed cost of the fritos segment of Pepsico -ex 2. the maintenance cost for the building in which boeing 747s are assembled is a traceable fixed cost of the 747 business segment of boeing -->traceable fixed costs of one segment can be common fixed costs of another segment

what are unit-level activities? what are some common activities at the unit-level and some unit-level activity measures?

unit-level activities are performed/incurred each type a unit is produced -OH costs depend on volume at the unit level activities: -processing units on machines -processing units by hand -consuming factory supplies activity measure: -machine hours -direct labor hours -units produced

which income statement is best for CVP analysis and why?

variable costing income statement because it categorizes costs as variable and fixed

what is the variable expense ratio? what is this ratio equivalent to

variable expense ratio = variable expenses/sales -indicates how much money, for every dollar of sales, goes towards covering variable costs -also equal to 1- CM ratio (and cm ratio = 1- variable expense ratio)

what costs does a variable costing system include

variable mfg costs - includes direct materials, direct labor, variable manufacturing overhead -difference from absorption costing is that absorption costing includes fixed OH, variable costing does not -SG&A costs (both fixed and variable) and fixed MOH are separated and treated as period costs

how to reconcile differences between absorption and variable costing

when AC net income > VC net income: add the amount of fixed MOH deferred under absorption costing to variable costing net income when VC net income > AC net income: we have to deduct fixed manufacturing overhead released from inventory from variable costing net income -when fixed manufacturing overhead cost is deferred in inventory, it is added to the variable costing income figure and when fixed manufacturing cost is released from inventory, it is deducted from the variable costing income figure.

when would using ABC be the most useful/reasonable?

while the costs of an ABC system often outweigh the benefits, the benefits are likely to outweigh the costs when: 1. products differ substantially in volume, product size, and in activities required 2. conditions have changed substantially since the existing system was established 3. overhead costs are high and increasing and no one seems to understand why 4. management does not trust the existing system and ignores cost data when making decisions 5. the cost in each activity pool is strictly proportional to its activity measure; when this assumption is violated, the accuracy of an ABC system can be called into question -->for example, managers should be particularly alert to product costs that contain allocated facility-level costs -if these assumptions are not true, the abc system may not be as useful or reliable