chapter 2
elements of the value chain
(the activities that add value to the company's products and services) research and development, design, production or purchases, marketing, distribution, customer service - must include the costs of ALL these activities - costs incurred in each element of the value chain
Finished goods inventory
Completed goods that have not yet been sold!!! Toyota is in business to sell completed cars, not work in process. Once the vehicles are completed, they are no longer considered work in process, but rather they become part of finished goods inventory.
Marketing with integrity
Consumers are driving much of the sustainability movement by demanding that companies produce environmentally friendly products and limit or eliminate operational practices that have a detrimental impact on the environment and society. The LOHAS (Lifestyles of Health and Sustainability) market segment is estimated at $355 billion per year.7 Thus, many companies are successfully spotlighting their sustainability initiatives in order to increase market share as well as attract potential investors and employees.
Costs for External Reporting
For external reporting purposes, management must follow Generally Accepted Accounting Principles (GAAP). For external reporting purposes, GAAP requires that certain costs of the company be attached, or assigned, to units of product in inventory, while other costs are treated as operating expenses of the period.
Costs for Internal Decision Making
When making internal decisions, managers must consider all costs incurred across the value chain. For example, when determining a suitable selling price for a Prius, Toyota must consider the cost to research, design, manufacture, market, distribute, and service that model.
A cost object
is anything for which managers want to know the cost
Direct labor
is the cost of compensating employees who physically convert raw materials into the company's products. ((At Toyota, direct labor includes the wages and benefits of machine operators and technicians who build and assemble the vehicles. Toyota can trace the time each of these employees spends working on specific units or batches of vehicles; thus, the cost of this labor is considered a direct cost of the vehicles.))
Many people describe Toyota, General Mills, and Apple as manufacturing companies. But it would be more accurate to say that these are companies that do manufacturing. Why? Because companies that do manufacturing also do many other things. For example, even though Apple is a manufacturing company, it may be best known for its technological design innovations. Likewise, although Toyota is a manufacturer, it also conducts research to determine what type of new technology to integrate into next year's models. Toyota designs the new models based on its research and then produces, markets, distributes, and services the cars. These activities form Toyota's value chain
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Most companies have both fixed and variable costs
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The Same Cost Can Be Direct or Indirect, Depending on the Cost Object
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managers should control costs over the value chain as a whole
true; For example, Toyota spends more in R&D and product design to increase the quality of its vehicles, which in turn reduces customer service costs. Even though R&D and design costs are higher, the total cost of the vehicle—as measured throughout the entire value chain—is potentially lower as a result of this trade-off. Enhancing its reputation for safe, high-quality, innovative products has also enabled Toyota to increase its market share.
a company's total costs can be divided into two categories: product costs (those costs treated as part of inventory until the product is sold) and period costs (those costs expensed in the current period regardless of when inventory is sold).
true; GAAP requires this distinction for external financial reporting.
Which costs are useful for internal decision making, and how are costs classified for external reporting?
Managers use total costs for internal decision making. However, GAAP requires companies to distinguish between product costs and period costs for external reporting purposes.
Production or Purchases
Resources used by manufacturers to produce a product or by merchandising companies to purchase finished merchandise intended for resale!! ((For Toyota, the production activity includes all costs incurred to make the vehicles. These costs include raw materials (such as steel), plant labor (such as machine operators' wages), and manufacturing overhead (such as factory utilities and depreciation). As you can imagine, factories are very expensive to build and operate. For a merchandiser such as Best Buy, this value chain activity includes the cost of purchasing the inventory that the company plans to sell to customers. It also includes all costs associated with getting the inventory to the store, including freight-in costs and any import duties and tariffs that might be incurred if the merchandise was purchased from overseas.))
What Are the Most Common Business Sectors and Their Activities? let's consider the THREE MOST COMMON of companies and the business activities they perform.
Service, Merchandising, and Manufacturing Companies
Customer Service
Support provided for customers AFTER the sale!! ((Toyota incurs substantial customer service costs, especially in connection with warranties on new car sales. Toyota generally warranties its vehicles for the first three years and/or 36,000 miles, whichever comes first. Historically, Toyota has had one of the best reputations in the auto industry for excellent quality. However, 2009-2010 proved to be costly and difficult years for the company, as recalls were made on over 14 million vehicles. In addition to the cost of repairing the vehicles, the company incurred millions of dollars in costs related to government fines, lawsuits, and public relations campaigns. However, as a result of the company's commitment to building safe and reliable vehicles, Toyota once again regained the title of the number-one carmaker in the world in 2012 and has continued to hold the number one position for the last four years, selling over 10 million vehicles per year.))
Additional Labor Compensation Costs
The cost of labor, in all areas of the value chain, includes more than the salaries and wages paid to employees. The cost also includes company-paid fringe benefits such as health insurance, retirement plan contributions, payroll taxes, and paid vacations. These costs are very expensive.
Distributing using fossil-fuel alternatives and carbon offsets.
While the biofuel industry is still in its infancy, the production and use of biofuels, especially those generated from nonfood waste, are expected to grow exponentially in the near future. Companies whose business is heavily reliant upon fossil fuels, such as oil companies (Valero), airlines (United), and distribution companies (UPS), are especially interested in the development of sustainable fuel sources. In fact, many companies, such as UPS and Walmart, are investing in hybrid fleets in order to reduce energy consumption, which thereby reduces their costs. In addition, manycompanies are investing in carbon offsets through such measures as reforestation projects. For example, in 2013 UPS planted 1.3 million trees, and in 2014 it pledged to plant 2 million trees as part of its efforts to offset greenhouse gas emissions.8United Airlines offers a carbon-offset program that allows customers, as soon as they purchase their ticket, to offset the carbon emissions resulting from their air travel by donating to reforestation and renewable energy projects. The website automatically calculates the donation amount needed to offset the greenhouse gas emissions.
Service companies
are in business to sell intangible services—such as health care, insurance, banking, and consulting; make up the LARGEST SECTOR of the U.S. economy. Because these types of companies sell services, they generally don't carry inventory. Some service providers carry a minimal amount of supplies inventory; however, this inventory is typically used for internal operations—not sold for profit. (GENERALLY DON'T CARRY INVENTORY AND IF DO, ITS FOR INTERNAL. PURPOSES AND NOT SOLD FOR PROFIT).
Product costs
are the costs incurred by manufacturers to produce their products or incurred by merchandisers to purchase their products. Notice how these costs relate to obtaining inventory, either through manufacturing the products or purchasing them. Thus, these costs are incurred in the production or purchases function of the value chain. For external financial reporting, GAAP requires that these costs be assigned to inventory until the related products are sold. When the products are sold, these costs are removed from the company's inventory and expensed as Cost of Goods Sold.
Think of the last time you made a purchase from an online website, such as Amazon.com. The website may have shown the product's price as $15, but by the time you paid the shipping and handling charges, the product really cost you around $20. Likewise, merchandising companies pay freight-in charges to get the goods to their place of business. If they purchased the goods from overseas, there is a good chance they also had to pay import duties to bring the goods into the United States. These charges become part of the cost of their inventory.
true; records these costs in an asset account—Inventory—until it SELLS the merchandise. Once the merchandise is sold, it belongs to the customer, not The Home Depot. Therefore, The Home Depot takes the cost out of its inventory account and records it as an expense—the cost of goods sold. The Home Depot expenses all other costs incurred during the period, such as salaries, utilities, advertising, and property lease payments, as "operating expenses."
For example, companies can integrate sustainability throughout the value chain by:
Researching and developing environmentally safe packaging, Designing products using life-cycle assessment and biomimicry, Adopting sustainable purchasing practices, Marketing with integrity, Distributing using fossil-fuel alternatives and carbon offsets, Providing customer service past the warranty date.
Research and Development (R&D)
Researching and developing new or improved products or services and the processes for producing them!!!! ((Toyota continually engages in researching and developing new technologies to incorporate in its vehicles (such as fuel cells, artificial intelligence, and pre-crash safety systems). Much of the R&D is aimed at safety and accessibility; improving how machines and humans work together. Toyota also researches and develops new technologies to use in its manufacturing plants (such as advanced manufacturing robotics). In 2014, Toyota spent 910.5 billion yen (approximately $7.7 billion) on R&D.)) - costs associated
How do you distinguish among service, merchandising, and manufacturing companies? How do their balance sheets differ?
Service companies: Provide customers with intangible services Have no inventories on the balance sheet Merchandising companies: Resell tangible products purchased ready-made from suppliers Have only one category of inventory Manufacturing companies: Use labor, plant, and equipment to transform raw materials into new finished products Have three categories of inventory: Raw materials inventory Work in process inventory Finished goods inventory
What costs are treated as product costs under GAAP?
Service companies: Usually no product costs since they don't carry inventory Merchandising companies: The cost of merchandise purchased for resale plus all of the costs of getting the merchandise to the company's place of business (for example, freight-in and import duties) Manufacturing companies: Direct materials, direct labor, and manufacturing overhead
What type of company is Chipotle?
Some companies don't seem to fit nicely into one of the three categories previously discussed. For example, Chipotle has some elements of a service company (it serves hungry patrons), some elements of a manufacturing company (employees convert raw ingredients into finished meals), and some elements of a merchandising company (it sells ready-to-serve bottled drinks). Despite all of these different operating activities, restaurants are considered to be in the service sector.
However, Toyota CANNOT TRACE INDIRECT COSTS, such as utilities, to specific vehicles.
Therefore, Toyota must ALLOCATE these indirect costs among all of the vehicles produced at the plant.
total cost
includes the costs of ALL resources used throughout the value chain; For Toyota, the total cost of a particular model, such as the Prius, is the total cost to research, design, manufacture, market, distribute, and service that model. Before launching a new model, managers predict the total cost of the model to set a selling price that will cover all costs plus return a profit. By comparing each model's sales revenue with its total cost across the value chain, Toyota can determine which models are most profitable; Marketing can then focus on advertising and promoting the most profitable models.
Manufacturing overhead has three components:
indirect materials, indirect labor, and other indirect manufacturing costs.
A direct cost
is a cost that can be traced to the cost object, meaning the company can readily identify or associate the cost with the cost object. For example, say the cost object is one Prius. Toyota can easily trace, or associate, the cost of four tires with one specific Prius. Therefore, the tires are a direct cost of the vehicle.
An indirect cost
is a cost that relates to the cost object but cannot be traced specifically to it. Think of an indirect cost as a cost that is jointly used or shared by several cost objects. For example, Toyota incurs substantial cost to run a manufacturing plant, including utilities, property taxes, and depreciation. Toyota cannot build a Prius without incurring these costs, so the costs are related to the Prius. However, it's impossible to trace a specific amount of these costs to one Prius. These costs are shared by all of the vehicles produced in the plant during the period. Therefore, these costs are considered indirect costs of a single Prius.
Retailers
sell to consumers like you and me
operating income
simply the company's earnings before interest and income taxes.
Merchandising Companies
such as Walmart and Best Buy resell tangible products they buy from manufacturers and suppliers. (For example, Walmart buys clothing, toys, and electronics and resells them to customers at higher prices than what it pays for these goods.); Merchandising companies include retailers (such as Walmart) and wholesalers.
value chain
the activities that add value to the company's products and services; The value chain activities also cost money. To set competitive, yet profitable selling prices, Toyota must consider all of the costs incurred along the value chain, not just the costs incurred in manufacturing vehicles.
triple bottom line
the company's performance is evaluated not only in terms of profitability, but also in terms of its impact on people and the planet.
differential cost
the difference in cost between two alternative courses of action.
Manufacturers convert raw materials into finished products. Direct materials are
the primary materials that become a physical part of the finished product. ((The Prius's direct materials include steel, tires, engines, upholstery, and so forth. Toyota can trace the cost of these materials (including freight-in and any import duties) to specific units or batches of vehicles; thus, they are considered direct costs of the vehicles.))
greenwashing
the unfortunate practice of overstating a company's commitment to sustainability, can ultimately backfire as investors and consumers learn the truth about company operations. Hence, honesty and integrity in marketing are imperative. - might not actually be going green, just saying they are
Companies typically generate profit through one of three basic business models:
they provide a service, they sell merchandise, or they manufacture products.
trace
to assign a DIRECT cost to a cost object; being able to directly trace the cost to the item -- a specific vehicle is the cost object. Toyota can easily identify direct costs, such as tires, with specific vehicles. Therefore Toyota is able to trace direct costs to each vehicle manufactured in the plant. This results in a very precise cost figure, giving managers great confidence in the the amount of direct cost assigned to each vehicle.
assign
to attach a cost to a cost object
A cost object is anything for which managers want to know the cost. Toyota's cost objects may include the following: Individual units (a specific, custom-ordered Prius) Different models (the Prius, Rav4, and Corolla) Alternative marketing strategies (television advertising, sponsorship of athletic events) Geographic segments of the business (United States, Europe, Japan) Departments (human resources, R&D, legal) Sustainability initiatives ("Toyota TogetherGreen" conservation programs)
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All activities in the value chain are important, yet each costs money to perform. Managers must understand how decisions made in one area of the value chain will affect the costs incurred in other areas of the value chain!!
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Most business decisions depend on how costs are expected to change at different volumes of activity. Managers can't make good decisions without first understanding how their costs behave
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Period costs are often called "operating expenses" or "selling, general, and administrative expenses" (SG&A) on the company's income statement. Period costs are always expensed in the period in which they are incurred and never become part of an inventory account.
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Product costs are costs assigned to the company's inventory on the balance sheet. In essence, they are the costs of manufacturing or purchasing the company's products.
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The allocation process results in a less precise cost figure being assigned to each vehicle.
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The beginning inventory balances were simply last year's ending balances. The purchases of direct materials and the incurrence of direct labor and manufacturing overhead would have been captured in the company's accounting records when those costs were incurred. Finally, the ending inventory balances come from doing a physical inventory count at the end of the year.
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The cost of the truck is a sunk cost. Sunk costs are costs that have already been incurred. Nothing you do now can change the fact that you already bought the truck. Thus, the cost of the truck is not relevant to your decision of whether to choose between the Sentra and the Corolla. The only thing you can do now is (1) keep your truck or (2) sell it for the best price you can get.
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The difference between product costs and period costs is important because these costs are treated differently in the financial statements.
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When managers make decisions, they focus on only those costs and revenues that are relevant to the decision.!!!!
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all companies are seeming to be moving towards the service sector!!
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costs incurred by these different business activities: costs that both managers and accountants must understand in order to make profitable business decisions.
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different types of costs are useful for different purposes. Both managers and accountants must have a clear understanding of the types of costs that are relevant to the decision at hand.
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for a business to flourish and grow in the long run, it will need to generate economic profits that are sufficiently large to attract and retain investors, as well as fuel future business expansion.
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indirect costs - not directly measured to item, may be considered sharing with something else and not just the item
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management accountants typically participate in these cross-functional teams.
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managerial accounting provides information that managers use to run their businesses more efficiently. Managers must understand basic managerial accounting terms and concepts before they can use the information to make good decisions. This terminology provides the common ground through which managers and accountants communicate. Without a common understanding of these concepts, managers may ask for (and accountants may provide) the wrong information for making decisions.
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not all companies are strictly service, merchandising, or manufacturing firms.
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product costs - inventory
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the U.S. economy is shifting more toward service-based companies. Many traditional manufacturers, such as General Electric (GE) and Ford, have developed profitable service segments that add additional profit to the company's bottom line. Even merchandising firms are getting into the "service game." For example, retailers often sell extended warranties on products ranging from furniture and major appliances to sporting equipment and consumer electronics. While the merchandiser recognizes a liability for these warranties, the price charged to customers for the warranties greatly exceeds the company's cost of fulfilling its warranty obligations, thus providing additional profit to the merchandiser.
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think of allocation as dividing up the total indirect costs over all of the units produced, just as you might divide a pizza among friends.
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total costs of something = indirect and direct costs assigned to it
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Whether a cost is direct or indirect depends on the specified cost object !!!!
true ((In this chapter, we'll be talking about a unit of product (such as one Prius) as the cost object.))
As a manager making decisions, you'll need different types of cost information for different types of decisions. To get the information you really want, you'll have to communicate with the accountants using precise definitions of cost.
true - accounting lingo
ALLOCATE - INDIRECT COSTS (because cannot trace them directly)
true - will result in a less precise figure!! allocation - less precise
the same costs can be indirect with respect to one cost object, yet direct with respect to another cost object.
true!! For example, plant depreciation, plant property taxes, and plant utilities are indirect costs of a single Prius. However, if management wants to know how much it costs to operate the Prius manufacturing plant, the plant becomes the cost object; so the same depreciation, tax, and utility costs are direct costs of the manufacturing facility. Whether a cost is direct or indirect depends on the specified cost object.
Because merchandising companies are in business to sell tangible goods, they carry a substantial amount of inventory. The cost of inventory includes the cost merchandisers pay for the goods plusall costs necessary to get the merchandise in place and ready to sell, such as freight-in costs and any import duties or tariffs paid on merchandise purchased from overseas suppliers.
true; A merchandiser's balance sheet has just one inventory account called "Inventory" or "Merchandise Inventory." Besides incurring inventory-related costs, merchandisers also incur costs to operate their retail stores and websites, advertise, research new products and new store locations, and provide customer service.
Progressive companies will incorporate sustainability throughout EVERY FUNCTION of the value chain. However, experts estimate that 90% of sustainability occurs at the DESIGN stage.
true; At the design stage, companies determine how the product will be used by customers, how easily the product can be repaired or eventually recycled, and the types of raw materials and manufacturing processes necessary to produce the product. Thus, good design is essential to the creation of environmentally friendly, safe products that enhance people's lives.
If a company wants to know the TOTAL COST attributable to a cost object, it must assign all direct and indirect costs to the cost object. Assigning a cost simply means that you are "attaching" a cost to the cost object.
true; For example, if Toyota wants to know the entire cost of manufacturing a Prius, it will need to assign both direct costs (such as the tires on the car) and indirect costs (such as factory utilities) to the vehicle. Similarly, if the university wants to know the total cost of having a football team, it will have to consider both the direct and indirect costs related to the team.
Manufacturing companies
use labor, plant, and equipment to convert raw materials into new finished products. (For example, Toyota converts steel, tires, and fabric into high-performance vehicles using production labor and advanced manufacturing equipment. The vehicles are then sold to car dealerships at a price that is high enough to cover costs and generate a profit.)
Why is this important?
All employees should have an understanding of their company's basic business model. The Enron scandal was finally brought to light as a result of someone seriously asking, "How does this company actually make money?" If the business model does not make logical sense, something fishy may be going on."
What business activities add value to companies?
All of the elements of the value chain, including the following: R&D Design Production or purchases Marketing Distribution Customer service
Raw materials inventory
All raw materials that will be used in manufacturing!!! Toyota's raw materials include steel, glass, tires, upholstery fabric, engines, and other automobile components. They also include other physical materials used in the plant, such as machine lubricants and janitorial supplies.
Direct Labor (DL)
Although many manufacturing facilities are highly automated, most still require some direct labor to convert raw materials into a finished product.
What costs should be assigned to cost objects such as products, departments, and geographic segments?
Both direct and indirect costs are assigned to cost objects. Direct costs are traced to cost objects, whereas indirect costs are allocated to cost objects.
Distribution
Delivery of products or services to customers!!! ((On the one hand, Toyota sells most of its vehicles through traditional brick-and-mortar dealerships. On the other hand, Amazon sells and distributes its products almost entirely using a web-based sales platform and then ships the products directly to customers. Other industries use different distribution mechanisms, such as catalog sales and home-based parties.))
Design
Detailed engineering of products and services and the processes for producing them!!! ((Toyota's goal is to design vehicles that create total customer satisfaction, including satisfaction with vehicle style, features, safety, and quality. As a result, Toyota updates the design of older models (such as the Corolla) and designs new prototypes on a regular basis (such as the i-Road, a three-wheel electric commuter vehicle, and the Mirai, the first fuel cell vehicle for the mass market). Part of the design process also includes determining how to mass-produce the vehicles. Because Toyota produces over 8 million vehicles per year, engineers must design production plants that are efficient, yet flexible enough to allow for new features and models.))
Providing customer service past the warranty date.
Environmentally conscious companies don't want customers discarding products that are in need of repair, or no longer serve the customer's needs or wants, thus, they provide the customer with other options. REI Co-op and Patagonia provide customers with free repair tips and offer repair services at a nominal charge. Best Buy recycles any electronic equipment regardless of where the customer bought it, and Apple buys back iPhones, iPads, and iPods by issuing credit toward the purchase of a new device.
Work in process inventory
Goods that are partway through the manufacturing process but not yet complete!! At Toyota, the work in process inventory consists of partially completed vehicles.
Manufacturing Companies' Product Costs
Manufacturing companies' product costs include ONLY those costs related to producing, or manufacturing, their products.
How are product costs treated on the financial statements?
Product costs are initially treated as an asset (inventory) on the balance sheet. These costs are expensed (as cost of goods sold) on the income statements when the products are sold.
Marketing
Promotion and advertising of products or services!! The goal of marketing is to create consumer demand for products and services. ((Toyota uses print advertisements in magazines and newspapers, billboards, television commercials, and the Internet to market its vehicles in both existing and emerging global markets. Some companies use star athletes and sporting events to market their products. Each method of advertising costs money but adds value by reaching different target customers.))
What is the difference between raw materials, direct materials, and indirect materials?
Raw materials are materials that have not yet been used. Once used, materials can be classified as direct or indirect. Direct materials are the primary physical components of a product. Indirect materials are materials used in the production plant that don't become part of the product (such as machine lubricants) or materials that do become part of the product but are insignificant in cost (such as the price sticker on a car). DIRECT MATERIALS ARE DIRECTLY A PART OF THE PRODUCT; INDIRECT MATERIALS AREN'T
manufacturers carry three types of inventory:
Raw materials inventory, Work in process inventory, Finished goods inventory
Indirect materials
include materials used in the plant that are not easily traced to individual units. -- For example, indirect materials often include janitorial supplies, oil and lubricants for the machines, and any physical components of the finished product that are very inexpensive. (these things may be used for other things and not just the specific thing, so that is why it is indirect); For example, Toyota might treat the invoice sticker placed on each vehicle's window as an indirect material rather than a direct material. Even though the cost of the sticker (roughly 10 cents) could be traced to the vehicle, it wouldn't make much sense to do so. Why? Because the cost of tracing the sticker to the vehicle outweighs the benefit management receives from the increased accuracy of the information.
Other indirect manufacturing costs
include such plant-related costs as depreciation on the plant and plant equipment, plant property taxes and insurance, plant repairs and maintenance, and plant utilities. Indirect manufacturing costs have grown tremendously in recent years as manufacturers automate their plants with the latest advanced manufacturing technology.
Manufacturing Overhead (MOH) -- INDIRECT COSTS!!
includes all manufacturing costs other than direct materials and direct labor; manufacturing overhead includes ALL INDIRECT manufacturing costs. Manufacturing overhead is also referred to as factory overhead because all of these costs relate to the factory.
Researching and developing environmentally safe packaging
Many companies are actively researching ways to reduce the amount of packaging used with their products as well as developing new types of packaging that are LESS HARMFUL TO THE ENVIRONMENT. In 2015, McDonald's achieved the goal of sourcing 100% of its packaging for its European operations from recycled sources or from forests certified by the Forest Stewardship Council. That same year, the company also pledged to end deforestation across the company's entire global supply chain.
Coordinating Activities Across the Value Chain
Many of the value chain activities occur in the order discussed here. However, managers cannot simply work on R&D and not think about customer service until after selling the car. Rather, cross-functional teams work on R&D, design, production, marketing, distribution, and customer service simultaneously. (LOTS OF TIMES ACTIVITIES IN VALUE CHAIN WILL HAPPEN SIMULTANEOUSLY - CROSS FUNCTIONAL TEAMS!! - management accountants typically participate in these cross-functional teams.); As the teams develop new model features, they also plan how to produce, market, and distribute the redesigned vehicles. They also consider how the new design will affect warranty costs.
Adopting sustainable purchasing practices.
Many of the world's largest companies, such as Walmart, Costco, and The Home Depot, are now actively assessing the sustainability level of potential suppliers as a factor in selecting suppliers. As leading retailers in the world, these companies' purchasing policies are forcing other companies to adopt more sustainable business practices. - PURCHASING FROM SUPPLIERS THAT UPHOLD SUSTAINABLE PRACTICES
Merchandising Companies' Product Costs
Merchandising companies' product costs include only the cost of purchasing the inventory from suppliers plus any costs incurred to get the merchandise to the merchandiser's place of business and ready for sale. Typically, these additional costs include freight-in costs and import duties or tariffs, if the products were purchased from overseas.
But how does a merchandising company calculate the Cost of Goods Sold?
Most likely, the company uses bar coding to implement a perpetual inventory system during the year. If so, all inventory is labeled with a unique bar code that reflects (1) the sales price that will be charged to the customer, and (2) the "product cost" of the merchandise to the store. Every time a bar-coded product is scanned at the checkout counter, the company's accounting records are automatically updated to reflect (1) the sales revenue earned, (2) the cost of goods sold, and (3) the removal of the product from merchandise inventory. However, at the end of the period, merchandisers must also calculate Cost of Goods Sold using the periodic inventory method. Why? Because the company's accounting records only reflect those products that were scanned during checkout. Thus, the records would not reflect any breakage, theft, input errors, or obsolescence that occurred during the year.
prime costs
refer to the combination of DIRECT MATERIALS AND DIRECT LABOR ((Prime costs used to be the primary costs of production. However, as companies have automated production with expensive machinery, manufacturing overhead has become a greater cost of production.))
Indirect labor
includes the cost of all employees working in the plant other than those employees directly converting the raw materials into the finished product. -- working for the factory specifically and not making the product specifically; For example, at Toyota, indirect labor includes the salaries, wages, and benefits of plant forklift operators, plant security officers, plant janitors, and plant supervisors. - this cost is split between other things they make too, so that is why it is indirect
Period costs
are the costs incurred by the company that do NOT get treated as inventory, but rather, are expensed immediately in the period in which they are incurred. These costs do NOT relate to manufacturing or purchasing product. Rather, they include costs incurred in every other function of the value chain, including R&D, design, marketing, distribution, and customer service. In essence, ANY cost that is NOT treated as inventory, is treated as a period cost. While accountants refer to these costs as "period costs," most other people refer to them as "operating expenses" or "selling, general, and administrative expenses" (SG&A). These terms are essentially synonymous and arise from the fact that these are costs of operating the business over a specific period of time. COSTS FROM OPERATING THE BUSINESS OVER A SPECIFIC PERIOD!! OF TIME
manufacturers such as Toyota incur three types of manufacturing costs when making a vehicle:
direct materials, direct labor, and manufacturing overhead.
Biomimicry
means that a company tries to mimic, or copy, natural biological features and processes. ((For example, Ford Motor Company and P&G are studying the gecko, nature's perfect example of a creature able to stick to surfaces without any liquids or adhesive substances, and then release from the surface, without any leaving sticky residue. The companies envision innovative adhesive applications from this research that will generate revenue, save money, and be more environmentally friendly.)); Another aspect of biomimicry revolves around eliminating the concept of waste by creating "cradle-to-cradle" product life cycles. For example, Ricoh's copiers were designed so that at the end of a copier's useful life, Ricoh would collect and dismantle the product for usable parts, shred the metal casing, and use the parts and shredded material to build new copiers. The entire copier was designed so that nothing is wasted, or thrown out, except the dust from the shredding process. PT Tirta Marta has developed a "plastic" bag made from tapioca that can biodegrade in as little as two weeks,5 whereas traditional plastic bags, according to the Environmental Protection Agency (EPA), can take as long as 1,000 years.
Life-cycle assessment
means the company analyzes the environmental impact of a product, from "cradle-to-grave," in an attempt to minimize negative environmental consequences throughout the entire lifespan of the product. ((For example, after studying the life cycles of its products, Procter & Gamble (P&G) discovered that about three-quarters of the energy used by consumers in washing their clothes comes from heating the water. As a result, the company developed Coldwater Tide, which is effective for laundering in cold water, thereby conserving energy. This product is a win-win for the environment and the company: the product is saving energy while also generating millions in annual sales revenue.))
Wholesalers
often referred to as "middlemen," buy products in bulk from manufacturers, mark up the prices, and then sell those products to retailers.
Costs for External Reporting
product costs and period costs
Service companies incur costs to
provide services, advertise, and develop new services. For many service providers, salaries and benefits make up the majority of their costs.
Conversion costs
refer to the combination of direct labor and manufacturing overhead. These are the costs of converting raw materials into finished goods. - CONVERSION FROM RAW MATERIALS TO GOODS
Although sustainability reporting is still in its infancy, the Global Reporting Initiative, or GRI, has become the dominant framework for sustainability reporting. The GRI report follows the triple-bottom-line approach (people, planet, profit) by specifying metrics that companies should report on related to each of the three pillars of sustainability: Social performance metrics—for example, fair labor and human rights practices Environmental performance metrics—for example, greenhouse gas emissions and total water use Economic performance metrics—for example, revenues, operating costs, and so forth. Sustainability reporting is not just for external reporting; companies also use it as a tool for internal change management. The GRI reporting process helps an organization illuminate areas of social and environmental impact that need improvement. It also helps management track the company's social and environmental progress by comparing baseline performance metrics with those achieved over time. The old adage proves just as true for nonfinancial data as it does for financial data: "You can't manage what you don't measure." Finally, in a 2014 survey, Verdantix found that the Big Four accounting firms dominated both the sustainability consulting and sustainability assurance services markets.12Thus, students who wish to enter the accounting profession should be aware of these reporting developments.
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Based on your analysis, the differential cost is $1,782 in favor of the Corolla. Does this mean that you will choose the Corolla? Not necessarily. The Sentra may have some characteristics you like better, such as a particular paint color, more comfortable seating, or more trunk space. When making decisions, management must also consider qualitative factors, such as effect on employee morale, in addition to differential costs.
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Because the average product cost per unit is NOT appropriate for predicting total costs at different levels of output.
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Costs are classified as either direct or indirect with respect to the cost object.
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Costs are relevant to a decision when they differ between alternatives and affect the future. Thus, differential costs are relevant, whereas sunk costs and costs that don't differ are not relevant.
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Costs generally behave as fixed costs or variable costs.
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Dell engages in manufacturing when it assembles its computers, merchandising when it sells them on its website, and support services such as start-up and implementation services.
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Direct costs of the football team would include their uniforms, footballs, coach's salary, and travel to away games.These costs are easily identifiable with and traceable to the football team, so they are considered direct costs of the football team.
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Health insurance premiums, which have seen double-digit increases for many years, often amount to $500-$1,500 per month for each employee electing coverage. Many companies also contribute an amount equal to 3% to 6% of their employees' salaries to company-sponsored retirement 401(k) plans. Employers must pay Federal Insurance Contributions Act (FICA) payroll taxes to the federal government for Social Security and Medicare, amounting to 7.65% of each employee's gross pay. In addition, most companies offer paid vacation and other benefits. Together, these fringe benefits usually cost the company an additional 35% beyond gross salaries and wages. Thus, an employee making a $40,000 salary actually costs the company about $54,000 to employ ($40,000×1.35).($40,000 × 1.35).These fringe-benefit costs are expensed as period costs for all non-manufacturing employees. However, they are treated as a product cost if they relate to employees working in the manufacturing plant.
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In addition to generating a full set of financial statements for external users, many companies are now preparing and issuing Corporate Social Responsibility, or CSR, reports. These reports provide sustainability-related information to a variety of stakeholders, including investors and creditors, customers, government regulators, non-governmental organizations (NGOs), and the general public. Although these reports are still voluntary in the United States, the move toward providing stakeholders with more sustainability-related data is growing. For example, the following issued CSR reports: 92% of the world's 250 largest companies (2015)10 75% of the S&P 500 companies (2014)11
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In the LONG RUN, MOST COSTS ARE CONTROLABLE, meaning management is able to influence or change them.
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In this textbook, we will always be evaluating the company's "operating income" rather than its "net income." Why? Because internal managers are particularly concerned with the income generated through the company's ongoing, primary operations. To arrive at net income, we would need to add or subtract non-operating income and expenses, such as interest, and subtract income taxes. In general, operating income is simply the company's earnings before interest and income taxes.
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Indirect costs would include costs shared by the football team and other university athletic teams, such as the athletic director's salary, shared training facilities, and shared locker rooms. Since these resources are jointly used or shared by several athletic teams, not just the football team, they are considered indirect costs of the football team.
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Let's now consider how managers define the cost of one of their most important cost objects: their products. Managers need this information to determine the profitability of each product as well as to make other important business decisions. Managers define costs based on how the information will be used. Will the information be used for 1) internal decision making, or for 2) external reporting?
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Managers and accountants sometimes talk about certain combinations of manufacturing costs.
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Managers like to operate near 100% capacity in order to spread fixed costs over more units. By doing so, they are able to reduce the average cost per unit. The average cost per unit is valid only at ONE level of output—the level used to compute the average cost per unit. NEVER use average costs to forecast costs at different output levels; if you do, you will miss the mark. IMPORTANT!!!
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Managers often have trouble ignoring sunk costs when making decisions, even though they should. Perhaps they invested in a factory or a computer system that no longer serves the company's needs. Many times, new technology makes managers' past investments in older technology look like bad decisions, even though they weren't at the time. Managers should ignore sunk costs because their decisions about the future cannot alter decisions made in the past.
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