Exam 2 Review

Use the high-low method to determine the cost equation. Volume level:............................Units produced................Total cost Lowest..........................................1600..................................................9800 Highest........................................4000.................................................17,000

$3 per unit produced. Total costs = $5,000 + $3 per unit. Change in costs / Change in units 17,000 = fixed costs + ($3 x 4000) 17,000 - 12,000 = 5,000 fixed costs. Total costs = 5000 + $3 per unit

Direct materials, $6 per unit; Direct labor, $14 per unit; Variable overhead, $220,000,and Fixed overhead, $680,000. 20,000 units produced. 1) Compute the total product cost per unit under absorption costing. 2) Compute the total product cost per unit under variable costing.

1) $65 per unit 2) $31.00 per unit.

Budgets can be a positive motivating force when:

1) Affected employees are consulted 2) Goals are challenging but attainable 3) Evaluations offer opportunities to explain differences between actual and budgeted amounts.

Calculating Direct Labor Budget

1) Budgeted production units using production budget formula. 2) Labor requirements 3) Labor rate

Three step process of setting prices

1) Determine the product cost per unit using absorption costing. ($25) 2) Determine the target markup on product cost per unit. $25 x 60% = ($15). Sixty percent of absorption cost. 3) Add the target markup to the product cost to find the target selling price. $40

Potential negative outcomes of a budget include:

1) Employees may understate sales and overstate expenses to allow cushion 2) Pressure to meet results may lead to unethical behavior or fraud. 3) Employees may purchase unnecessary items to ensure budget is not reduced next period.

Part 1. A manufacturer's absorption cost per unit is $60. Compute the target selling price per unit if markup is targeted a 30%

1) absorption cost per unit x targeted mark up percentage. 60 x 30% = $18. $60 + 18 = $78 target price per unit.

The sales mix of a company's two products, X and Y, is 2:1. Unit variable costs for both products are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs. 1) What is the contribution margin per composite unit? 2) What is the break-even point in composite units? 3) How many units of X and how many units of Y will be sold at the break-even point?

1) we need to first find what the selling price per composite unit is and what the variable cost per composite unit is. Then subtract the two. Product X = $5 x 2 = $10 Product Y = $4 x 1 = $4 composite selling price per unit = $14 Composite variable cost: Product X = $2 x 2 = $4 Product Y = $2 x 1 = $2 Composite variable cost per unit = $6 $14-$6 = $8. Contribution margin per composite unit = $8. 2) = Fixed Costs/Contribution margin per unit. 640,000 / $8 = $80,000 break-even point in composite units 3) Product X : $80,000 composite units x 2 units per composite unit = 160,000 units Product Y: $80,000 composite units x 1 unit per composite unit = 80,000 units.

A manufacturer predicts fixed costs of $400,000 for the next year. Its one product sells for $170 per unit, and it incurs variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year. 1. Compute the contribution margin per unit. 2. Compute the break-even point (in units). 3. Prepare a contribution margin income statement.

1. 20 per unit. 2. 20,000 units 3. ..............................................Units.............per unit...........Total Sales.....................................20,000.............$170...............3.4 mill Variable Costs.................20,000.............$150...............3.0 mill Contribution margin.................................$20...............400,000 Fixed costs...........................................................................400,000 Net income............................................................................$0

A direct materials budget requires:

1.Number of units to produce from the production budget ( Budgeted Sales) 2.Materials requirements per unit 3.Budgeted ending inventory in units of direct materials 4.Beginning inventory in units of direct materials 5.Cost per unit of direct materials

Uncontrollable costs

: are not within the manager's control or influence (ex: depreciation expense, their own salaries, etc.)

Absorption costing

A costing approach in which all manufacturing costs are charged to the product.

Degree of Operating Leverage

A measure of the extent to which fixed costs are being used in an organization; A measure of how a percentage change in sales will affect profits

Two product costing methods

Absorption and Variable Costing

Setting the price of a product is most effective using the

Absorption method because it reflects the full costs that sales must exceed for the company to be profitable.

Examples of ABB

Auditing, Tax Reporting, Financial Reporting,

cash budget formula

Beginning Cash Balance + Budgeted Cash Receipts - Budgeted Cash Payments = Preliminary Cash Balance

Use the following information to prepare a cash budget for the month ended January 31 for Garcia Company. The company requires a minimum $30,000 cash balance at the end of each month. Any preliminary cash balance above $30,000 is used to repay loans (if any). Garcia has a $2,000 loan outstanding at the beginning of January. Need to know (20-5) a. January 1 cash balance, $30,000 b. Cash receipts from sales, $132,000 c. Budgeted cash payments for materials, $63,500 d. Budgeted cash payments for labor, $33,400 e. Other budgeted cash expenses,* $8,200 f. Cash repayment of bank loan, $2,000 *Including loan interest for January.

Beginning Cash Balance: $30,000 Add: Cash Receipts from sales: $132,000 Total cash available: $162,000 Less Cash Payments for: Direct materials: 63,500 Direct Labor: 33,400 other cash payments: 8,200 Preliminary cash balance: 56,900 Loan activity: Repayment of a loan: 2000 Ending cash balance: 54,900. Have money to repay loans b/c 54,900>30,000

Production budget formula (Units to produce)

Budgeted ending inventory units + Budgeted sales units - beginning finished goods inventory units.

Master Budget (Investing)

Capital expenditures

Master Budget (Financing)

Cash

Change in income percentage

DOL x Change in sales %

Fixed costs per unit

Decreases as volume levels increase

Advantage of high-low method

Easier to apply and might be useful for obtaining a quick cost equation estimate.

Calculating Sales Budget

Estimated Unit Sales x Estimated Unit Price

Margin of Safety (in percent) =

Expected sales - break-even sales / Expected sales

Variable Costing Income Statement

Expenses grouped in terms of cost behavior. Reports contribution margin instead of COGS. Does not group fixed expenses and variable together. Reports each expense separately. Sales (Less) Variable Costs = Contribution Margin (Less) Fixed Expenses =Net Income

Unit sales at target income formula

Fixed costs + Target income / Contribution margin per unit

Break-even point in units formula

Fixed costs / contribution margin per unit.

Three methods to find break-even point:

Formula Contribution margin income statement Cost-volume-profit chart

Absorption costing is covered by

GAAP and can be used for external reporting purposes.

Diaz Co. predicts sales of $80,000 for January and $90,000 for February. Seventy percent of Diaz's sales are for cash, and the remaining 30% are credit sales. All credit sales are collected in the month after sale. January's beginning accounts receivable balance is $20,000. Compute budgeted cash receipts for January and February.

January: $76,000 February: $87,000

Variable costing includes fixed overhead as a

Period Cost (COGS reported on income statement)

In Variable Costing, Fixed overhead is not included when finding the

Product cost per unit. Or can be subtracted from the total.

Contribution Margin income statement

Sales - Variable costs = Contribution margin - Fixed Costs Income (pretax)

Absorption Costing Income Statement

Sales Revenue -COGS (DM, DL, VOH, FOH) = unit product cost x #units =Gross Profit -Selling and administrative expenses (including variable and fixed selling admin. expenses) =Net income

Break-Even Point

Sales level at which total sales equal total costs. Company does not incur profit nor loss.

Master Budget (Operating)

Sales, Production, DM, DL, FOH, Selling expenses and general admin expenses.

Three method of measuring cost behavior

Scatter diagram High-low method Regression

A manufacturing company budgets sales of $70,000 during July. It pays sales commissions of 5% of sales and also pays a sales manager a salary of $3,000 per month. Other monthly costs include depreciation on office equipment ($500), insurance expense ($200), advertising ($1,000), and office manager salary of $2,500 per month. For the month of July, compute the total (a) budgeted selling expense and (b) budgeted general and administrative expense. (Need to know 20-4)

Selling expenses are costs that are targeting the customer, vs. general and administrative expenses which are non-customer related. Sales commissions are selling expenses. 5% of $70,000 is $3,500. The sales manager's salary is also a selling expense. Depreciation on office equipment is non-customer related; it's considered a general and administrative expense. Insurance expense is also considered general and administrative expense. Advertising expense is customer related; it's included as part of the budgeted selling expense. And the office manager's salary is a general and administrative expense. Total budget selling expenses; $7,500. Total budgeted general and administrative expense; $3,200.

Sales Budget

Shows the planned units and the expected dollars from these sales. Is first in the process because plans for most departments are linked to sales.

Master Budget Components (Check Slide 9)

Slide 9

Managers should accept special order provided (long run)

Special order price must be high enough to cover all costs including variable costs and fixed costs and still provide an acceptable return to the owners.

A manufacturing company predicts sales of 220 units for May and 250 units for June. The company wants each month's ending inventory to equal 30% of next month's predicted unit sales. Beginning inventory for May is 66 units.Compute the company's budgeted production in units for May.

The budgeted ending inventory for May equals 30% of 250 units, June's expected sales. 75 units need to be on hand as of May 31. They also need to produce enough units to cover the budgeted sales for May, 220 units. The total required units of available production is 295. We subtract the number of units that are already on hand in beginning inventory, 66, to calculate the total number of units to be produced, 229.

Variable Costing

The costing method that assigns only variable manufacturing costs to products. All fixed manufacturing costs (fixed MOH) are expensed as period costs.

Cost-Volume-Profit Analysis

The systematic examination of the relationships among selling prices, volume of sales and production, costs, expenses, and profits.

Adjusting the CVP for multiple products

The unit contribution margin is replaced with the contribution margin for a composite unit.

Total costs formula

Total Costs = Fixed Costs + Variable Costs Per Unit

Degree of leverage formula

Total contribution margin (in dollars) / pretax income

Finding fixed cost (High low method)

Total cost = Fixed cost (call it "x") + (Variable cost per unit x Units) Calculate the slope to find the cost per unit.

Part 2. A hotel rents its 200 luxury suites at a rate of $500 per night per suite. The hotel's cost per night is $400, consisting of: Variable costs: $160 Fixed Costs (allocated): 240 Total cost per night per room: $400 The hotel's manager has received an offer to reserve a block of 40 suites for $250 per suite per night during the hotel's off-season, when it has many available suites. Determine whether the offer should be accepted or rejected.

When evaluating a special offer, the allocated fixed costs should be ignored. Since the hotel is not at full capacity, the revenue from the special offer must simply be greater than its variable costs. Because the offer price of $250 per suite is greater than the variable costs of $160 per suite, the offer should be accepted. This special offer has a contribution margin of $90 per suite ($250 revenue less $160 variable costs). Net income will be higher by $3,600 (40 suites at $90 per suite).

Continuous Budgeting

a company continually revises its budgets as time passes.

Coordination

activities of all units contribute to meeting the company's overall goals

Rolling budget

adding a new quarterly budget to replace the quarter that just elapsed. if you finish one quarter you must calculate the next quarter for the next year.

Scatter Diagrams

are graphs of unit volume and cost data.Each point on the scatter plot represents the cost and number of units for a prior period.

Direct materials budget translates the units to be produced into

budgeted costs

Once the cash budget is completed, we can prepare a

budgeted income statement

Variable costs

change in proportion to changes in volume of activity. Ex: Rubber used to manufacture tennis balls $0.50 per ball.

A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit, and it incurs variable costs of $126 per unit. Its target income (pretax) is $200,000. 1. Compute the contribution margin ratio. 2. Compute the dollar sales needed to yield the target income. 3. Compute the unit sales needed to yield the target income. 4. Assume break-even sales of 9,296 units. Compute the margin of safety (in dollars) if the company expects to sell 10,000 units.

contribution margin ratio = contribution margin per unit / selling price per unit. 1) (180-126) / 180 = 30% 2) Dollar sales to achieve target income = (fixed costs + pretax income) / contribution margin ratio. ($502,000 + 200,000) / .30 ) = $2,340,000 3) Units to yield target income = (fixed costs + target pretax income) / contribution margin per unit (502,000 + 200,000) / (180-126) = 13,000 units 4) Margin of safety in dollars = expected sales - break-even sales. Expected sales = 10,000 x $180 = 1.8 million Break-even sales = 9,296 x $180 = 1,673,280 Margin of safety = 126,720

After we classify costs as fixed or variable we can compute the

contribution margin.

Variable production costs are

controllable by production supervisors.

Managers are responsible for

controllable costs

The budgeted product cost per unit is used to prepare the

cost of goods sold budget and budgeted income statement.

A production budget does not show

costs; it is always expressed in units of product.

Contribution margin contributes to

covering fixed costs and generating profits. "Contribution" represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs.

When selling prices can be increased without impacting unit variable costs or total fixed costs break even point in units

decreases

Total Cost per unit

decreases as the volume increases

Special order pricing may be used to

deeply discount a service.

Absorption costing includes

direct materials, direct labor, and both variable and fixed overhead. All as product costs.

Variable Costing includes

direct materials, direct labor, and variable overhead as product costs. Fixed overhead expensed as period cost.

Find the fixed overhead rate per unit by

dividing the fixed overhead by the units produced

Find the variable overhead rate per unit by

dividing the variable overhead by the units produced.

The ABB method better assesses how

expenses will change to accomodate changes in activity level

Dollar sales at target income formula

fixed costs + target income / contribution margin ratio

Break-even point in composite units

fixed costs / contribution margin per composite unit

Break-even point in dollars formula

fixed costs / contribution margin ratio

Plan

focuses on the future opportunities and threats to the organization.

None of the sales on account are collected in the month of sale. However they are expected to be collected in the month

following the sale

The cost equation expresses total costs as a

function of fixed costs plus variable cost per unit.

Coordinate

helps employees and departments work toward company's overall goals

Fixed costs are controllable by

higher-level managers.

Disadvantage of the high-low method

ignores all data points except the highest and lowest volume levels.

When units produced exceed units sold

income under absorption costing is greater because expenses are less.

when units produced are less than units sold

income under variable costing is greater because the expenses are less. More units being sold than produced. Units produced < Units Sold

If the preliminary cash balance is too low,

increase short-term loans.

Curvilinear Costs

increase when activity increases, but in a nonlinear manner. Ex: A salesperson's commission is 7% for sales of up to $100,000, and 10% of sales above $100,000. (The graph takes a sudden jump that cannot be explained in a linear manner).

Increases in variable costs or fixed costs, if they cannot be passed on to customers via higher selling prices, will

increases break-even.

Budget

is a formal statement of a company's plans, expressed in monetary terms. Are useful in controlling operations

Budgeted Income Statement

is a managerial accounting report showing predicted amounts of sales and expenses for the budget period

Budgeted income statement

is a managerial accounting report showing predicted amounts of sales and expenses for the budget period.

Selling Expense Budget

is an estimate of the types and amounts of selling expenses expected during the budget period

Activity-Based Budgeting

is based on activities rather than traditional items such as salaries, supplies, depreciation, and utilities.

A composite unit

is composed of specific numbers of each product in proportion to the product sales mix.

Contribution margin per unit

is the amount by which a product's unit selling price exceeds its total variable cost per unit

Margin of Safety

is the excess of expected sales over the break-even sales level.

Contribution margin ratio

is the percent of a unit's selling price that exceeds total unit variable cost. Contribution margin per unit / selling price per unit

Under variable costing, even if a manager produces more units

it doesn't effect the reported net income. The manger has to sell more units to increase the net income.

Communicate

management plans throughout the organization

A cost is controllable if a

manager can determine or affect the amount incurred.

Service providers also use

master budgets, but typically need fewer operating budgets than manufacturers.

A disadvantage of absorption costing is

misleading information and poor managerial decisions.

Unlike long-term strategic plans, budgets typically cover short periods such as a

month, quarter, or year.

Managers use the sales budget, combined with knowledge about how frequently customers pay on credit sales, to budget

monthly cash receipts

The CVP formulas can be modified for use when a company sells more than

one product

The absorption costing method can result in

overproduction because producing more and selling less drives down the fixed overhead costs, which drives down the total production per unit cost.

Benefits of budgeting include

plan, control, coordination, communicate, coordinate, and motivate.

Budgets benefit the key managerial functions of

planning and control

Absorption Costing includes fixed overhead as a

product cost

Control

provides a benchmark for evaluating performance.

Fixed Costs

remain unchanged despite variations in the volume of activity within a relevant range. Ex: Depreciation (straight line method).

Variable costs per unit

remains constant as volume changes.

If the preliminary cash balance exceeds the balance the company wants to maintain, the excess is used to

repay loans (if any) or to acquire short-term investments.

In order to use ABB an understand of the

resources required to perform the activitiesthe costs associated with these resources,and the way resource use changes with changes in activity levels allows management to better assess how expenses will change to accommodate changes in activity levels.

Many companies apply continuous budgeting by preparing

rolling budgets.

The master budgeting process typically begins with the

sales budget and ends with a cash budget and budgeted financial statements.

Management must assess whether the margin of safety is adequate in light of factors such as

sales variability, competition, consumer tastes, and economic conditions.

Managers use the beginning balance sheet and the direct materials budget prepared earlier,to help prepare a

schedule of cash payments for materials.

Contribution margin per composite unit

selling price per composite unit - variable cost per composite unit

Contribution margin per unit formula

selling price per unit - Total variable costs per unit

Variable costing applies to

service firms.

Capital Expenditures Budget

shows dollar amounts estimated to be spent to purchase additional plant assets and amounts to be received from plant asset disposals.

Cash budget

shows expected cash inflows and outflows during the budgeted period.

Budgeted Balance sheet

shows predicted amounts for the company's assets, liabilities, and equity as of the end of the budget period

Budgeted Balance Sheet

shows predicted amounts for the company's assets, liabilities, and equity as of the end of the budget period.

factory overhead budget

shows the budgeted costs for factory overhead that will be needed to complete the estimated production for the period

Direct labor budget

shows the budgeted costs for the direct labor that will be needed to satisfy the estimated production for the period

Direct Materials Budget

shows the budgeted costs for the direct materials that will need to be purchased to satisfy the estimated production for the period.

Production budget

shows the number of units to be produced in a period.

Selling expenses are costs that are

targeting the customer

The differences in income of the two methods is because of

the different timing with which fixed overhead costs are reported in income under the two methods.

In a cost-volume-profit chart

the horizontal axis is the number of units produced and sold, and the vertical axis is dollars of sales and costs

If the discounted price is greater than variable cost

the sale will increase contribution margin and net income.

When the units produced are equal to units sold, the absorption method and variable method net incomes are

the same for both methods because there is not a difference in the expenses reported.

CVP analysis helps to determine the sales level needed to achieve

the target income.

When budgeting a service companyw

there are no DM or FOH included because a service company does not develop finished goods.

A manufacturer can compute product cost per unit from the

three manufacturing budgets (direct materials, direct labor, and factory overhead)

Motivate

through participation in the budgeting process and establishment of attainable goals.

Step-wise costs

total cost increases to a new higher cost for the next higher range of activity, but remains constant within a range of activity. Ex: Supervisory salaries 4,000 units per shift, $5000 per mo. per supervisor.For every 4000 units produced the cost increases by $5000.

Contribution margin formula

total sales - total variable costs

To develop the sales budget, companies must estimate

units sales and the selling price per unit

Budgeting

• is the process of planning future business actions and expressing them as formal plans to help achieve coordination.

CVP analysis relies on several assumptions

•Costs can be classified as variable or fixed•Costs are linear within the relevant range•All units produced are sold•Sales mix is constant

managers should accept special orders provided (short run)

•the special order price exceeds variable cost.