BMGT 221 Exam 1

Examples of companies that would use job-order costing

- Boeing (aircraft manufacturing) - Bechtel international (large scale construction) - Walt Disney Studios (movie production)

Examples of manufacturing overhead

- Depreciation of manufacturing equipment - Utility costs - Property taxes - Insurance premiums incurred to operate a manufacturing facility

Use of quality cost information

- Help managers see the financial significance of defects. - Help managers identify the relative importance of the quality problems. - Help managers see whether their quality costs are poorly distributed.

Manufacturing product costs

- Raw materials - Work in process - Finished goods

Limitations of quality cost information

- Simply measuring and reporting quality cost problems does not solve quality problems. - Results usually lag behind quality improvement programs. - The most important quality cost, lost sales, is often omitted from quality cost reports.

Transfer of product costs

- When direct materials are used in production, their costs are transferred from Raw Materials to Work in Process. - Direct labor and manufacturing overhead costs are added to Work in Process to convert direct materials into finished goods. - Once units of product are completed, their costs are transferred from Work in Process to Finished Goods. - When a manufacturer sells its finished goods to customers, the costs are transferred from Finished Goods to Cost of Goods Sold.

Two keys to building segmented income statements

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

Activity-based absorption costing: key definitions 1. Activity 2. Activity cost pool 3. Activity measure 4. Activity rate

1. An activity is an event that causes the consumption of overhead resources. 2. An activity cost pool is a "bucket" in which costs are accumulated that relate to a single activity. 3. An activity measure is an allocation that is used as the denominator for an activity cost pool. 4. An activity rate is used to assign costs from an activity cost pool to products.

Steps for computing POHR

1. Estimate the total amount of the allocation base (denominator) that will be required for next period's estimated level of production. 2. Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. 3. Use the following equation to estimate total manufacturing overhead: Y=a+bX 4. Compute the predetermined overhead rate

Two methods of disposing overapplied/underapplied overhead

1. It can be closed to Cost of Goods Sold 2. It can be closed proportionally to Work in Process, Finished Goods, and Cost of Goods Sold

We use an allocation base because:

1. It is impossible or difficult to trace overhead costs to particular jobs. 2. Manufacturing overhead consists of many different items ranging from the grease used in machines to the production manager's salary. 3. Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.

Job-order costing are used when:

1. Many different products are produced each period. 2. Products are manufactured to order. 3. The unique nature of each order requires tracing or allocating costs to each job, and maintaining records for each job.

Four types of quality costs

1. Prevention costs 2. Appraisal costs 3. Internal failure costs 4. External failure costs

CVP analysis: key assumptions

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 multi-product companies, the mix of products sold remain constant.

If sales increase by 10% with an operating leverage of 5, how much would net income increase by?

50%

Absorption costing

A costing method that includes all manufacturing costs - direct materials, direct labor, and both variable and fixed manufacturing overhead - in the cost of a product.

Normal costing

A costing system in which overhead costs are applied to a job by multiplying predetermined overhead rate by the actual amount of the allocation base incurred by the job.

Job-order costing

A costing system used in situations where many different products, jobs, or services are produced each period.

Job cost sheet

A form that records the direct materials, direct labor, and manufacturing overhead cost charged to a job.

Allocation base (definition)

A measure of activity that is used to assign costs to cost objects.

Operating leverage

A measure of how sensitive net operating income is to percentage changes in sales. It is a measure, at any given level of sales, of how a percentage change in sales volume will affect profits.

Activity base (cost driver)

A measure of what causes the incurrence of a variable cost. Ex. Machine hours, labor hours, units produced, miles driven

Predetermined overhead rate

A rate used to charge manufacturing overhead cost to jobs that is established in advance for each period.

Which method will produce the highest values for work in process and finished goods inventories? Absorption or variable costing

Absorption costing

Absorption costing vs. Variable costing Product costs and Period costs

Absorption costing: all production costs, variable and fixed, are included in unit product cost. Product costs = direct materials, direct labor, variable MOH, fixed MOH Period costs = variable S&A, fixed S&A Variable costing: only the variable production costs are included in unit product cost. Product costs = direct materials, direct labor, variable MOH Period costs = fixed MOH, variable S&A, fixed S&A

Which costing format is required by GAAP and IFRS for external reporting?

Absorption. Since absorption costing is required for external reporting, most companies also use it for internal reports rather than incurring the additional cost of maintaining a separate variable cost system for internal reporting.

Activity-based absorption vs. Traditional absorption costing

Activity-based absorption costing differs from traditional absorption costing in two ways: 1. The activity-based approach uses more cost pools than a traditional approach. 2. The activity-based approach includes some back-level and product-level activities and activity measures that do not relate to the volume of units produced, whereas the traditional approach relies exclusively on volume-related overhead allocation.

Administrative costs

All executive, organizational, and clerical costs. Administrative costs can be either direct or indirect costs.

Manufacturing overhead

All manufacturing costs except direct material and direct labor. These costs cannot be readily traced to finished products. - Includes indirect materials that cannot be easily traced to specific units of product. - Includes indirect labor costs that cannot be easily traced to specific units of product. - Only those indirect costs associated with operating the factory are included in manufacturing overhead.

Job cost sheets: a subsidiary ledger

All of a company's job cost sheets collectively form a subsidiary ledger.

Product costs

All the costs that are involved in acquiring or making a product. Product costs "attach" to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sale.

Job-order costing in service companies

Although our attention has focused upon manufacturing applications, it bears re-emphasizing that job-order costing is also used in service industries. Job-order costing us used for many different types of service companies. Ex. law firms, accounting firms, medical treatment

High fixed cost (low variable cost) structure vs. Low fixed cost (high variable cost) structure

An advantage of high fixed cost structure is that income will be higher in good years compared to companies with lower proportion of fixed costs. A disadvantage of a high fixed cost structure is that income will be lower in bad years compared to companies with lower proportion of fixed costs. Companies with low fixed cost structures enjoy greater stability in income across good and bad years.

Raw materials

Any materials that go into the final product

Segment

Any part or activity of an organization about which a manger seeks cost, revenue, or profit data.

Traceable fixed costs

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 business segment at PepsiCo. Ex. The maintenance cost for the building in which Boeing 747s are assembled is a traceable fixed cost of the 747 business segment of Boeing.

Common fixed costs

Arise because of the overall operating of a company and would remain if any particular segment were eliminated. Common costs should not be allocated to segments. These expenses would remain even if one of the divisions were eliminated. Ex. The salary of the CEO of General Motors is a common fixed cost of the various divisions of General Motors. Ex. The cost of heating a Safeway grocery store is a common fixed cost of the various departments.

Activity-based absorption costing

Assigns all manufacturing overhead costs to products using activity cost pools instead of plantwide of department cost pools.

CM ratio and VC ratio

CM ratio = 1 - VC ratio VC ratio = 1 - CM ratio

Direct costs and job-order costing

Charge direct material and direct labor to each job as work is performed.

Types of fixed costs

Committed: Long-term, cannot be significantly reduced in the short term. Discretionary: May be altered in the short-term by current managerial decisions.

Common costs and segments

Common costs should not be arbitrarily allocated to segments based on the rationale that "someone has to cover the common costs" for two reasons: 1. This practice may make a profitable business segment appear unprofitable. 2. Allocating common fixed costs forced managers to be held accountable for costs they cannot control.

Structuring sales commissions

Companies generally compensate salespeople by paying them either a commission based on sales or a salary plus a sales commission. Commissions based on sales dollars can lead to lower profits in a company. Ex. Product A = lower selling price, higher CM Product B = higher selling price, lower CM Salespeople will try to sell more of Product A, which is not as profitable for the company. Commission should be based on contribution margin rather than selling price alone.

Finished goods

Completed units of product that have not yet been sold to customers

Mixed costs

Contains both variable and fixed elements. Ex. Utility cost (fixed monthly charge + cost per kilowatt)

Contribution margin ratio

Contribution margin as a percentage of sales. CM ratio = Contribution margin / Sales CM ratio = Contribution margin per unit / Selling price per unit Ex. CM ratio = .4 or 40% For each $1 increase in sales, contribution margin increases by 40 cents.

Formula for cost of goods sold

Cost of goods manufactured + Beginning finished goods inventory - Ending finished goods inventory = Cost of goods sold

Cost structure and profit stability

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

Quality costs

Costs incurred to prevent defects or that result from defects in products are known as quality costs. Many companies are working hard to reduce their quality costs.

Selling costs

Costs necessary to secure the order and deliver the product. Selling costs can be either direct or indirect costs.

Batch-level activities

Costs that are incurred only when a new batch is processed; doesn't matter how many units are in the batch. Ex. Setting up machines, moving materials, loading machines

Direct costs

Costs that can be easily and conveniently traced to a unit of product or other cost object. Ex. direct material, direct labor

Indirect costs

Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Ex. manufacturing overhead

Sunk costs

Costs that have already been incurred and cannot be changed now or in the future. These costs should be ignored when making decisions.

Product-level activities

Costs that relate to specific products and must be carried out regardless of how many batches or units of product are produced or sold. Ex. Designing a product, advertising a product, maintaining a product manager or staff, parts administration

Cost classifications for decision making

Decisions involve choosing between alternatives. the goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. To make decisions, it is essential to have a grasp on three concepts: differential costs, sunk costs, and opportunity costs.

Formula for degree of operating leverage

Degree of operating leverage = Contribution margin / Net operating income

Conversion cost

Direct labor + Manufacturing overhead

Prime cost

Direct material + Direct labor

Three basic manufacturing cost categories

Direct materials, direct labor, manufacturing overhead

Formula for dollar sales to attain target profit

Dollar sales to attain target profit = (Target profit + Fixed expenses) / CM ratio

Formula for dollar sales to break even

Dollar sales to break even = Fixed expenses / CM ratio

Inappropriate methods of allocating costs among segments

Failure to trace costs directly - Costs that can be traced directly to specific segments of a company should not be allocated to other 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 drive the cost being allocated.

Cost behavior

How a cost will react to changes in the level of activity. - Variable costs - Fixed costs - Mixed costs

Job-order costing: accurately vs. inaccurately assigning costs to jobs

Inaccurately assigning manufacturing jobs adversely influences planning and decisions made by managers. 1. Job-order costing systems can accurately trace direct materials and direct labor costs to jobs. 2. Job-order costing systems often fail to accurately allocate the manufacturing overhead costs used during the production process to their respective jobs.

External failure costs

Incurred as a result of defective products being delivered to customers. Examples: - Cost of field servicing and handling complaints - Warranty repairs - Lost sales - Allowances

Internal failure costs

Incurred as a result of identifying defects before they are shipped. Examples: - Scrap - Spoilage - Rework

Appraisal costs

Incurred to identify defective products before the products are shipped to customers. Examples: - Testing and inspecting incoming materials - Final product testing - Depreciation of testing equipment - Inspection - Supervision of testing and inspection

Common costs

Indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object.

ISO 9000 Standards

International measures of quality

Job-order costing: choosing an allocation base

Job-order costing systems often use allocation bases that do not reflect how jobs actually use overhead resources. The allocation base in the predetermined overhead rate must drive the overhead cost to improve job cost accuracy. A cost driver is a factor that causes overhead costs.

Direct labor

Labor costs that can be easily traced to individual units of product. Ex. Wages paid to automobile assembly workers

Cost of goods manufactured

Manufacturing costs associated with the goods that were finished during the period.

Indirect costs and job-order costing

Manufacturing overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job.

Plantwide overhead rate

Many companies use a single predetermined plantwid overhead rate to allocate all manufacturing overhead costs to jobs based on their usage of direct-labor hours. 1. It is often overly-simplistic and incorrect to assume that direct-labor hours is a company's only manufacturing overhead cost driver. 2. If more than one overhead cost driver can be identified, job cost accuracy is improved by using multiple predetermined overhead rates.

Formula for margin of safety in dollars

Margin of safety in dollars = Actual sales - Break-even sales

Formula for margin of safety in units

Margin of safety in units = Margin of safety / selling price per unit

Formula for margin of safety percentage

Margin of safety percentage = Margin of safety / Sales

Estimate profits at a particular sales volume

Multiply the number of units sold above break-even by the contribution margin per unit.

Nonmanufacturing costs

Not assigned to individual jobs, rather they are expensed in the period incurred; selling costs and administrative costs. Examples: 1. Salary expense of employees who work in marketing, selling, or administrative capacity. 2. Advertising expenses

Use of POHR

Predetermined overhead rates that rely upon estimated data are often used because: 1. Actual overhead for the period is not known until the end of the period, thus inhibiting the ability to estimate job costs during the period. 2. Actual overhead costs can fluctuate seasonally, thus misleading decision makers.

Cost classifications for preparing financial statements (product cost vs. period cost)

Product cost Inventory (balance sheet) --> Cost of Goods Sold (income statement) Period cost Expense (income statement)

CVP equation (Profit equation)

Profit = (Sales - Variable expenses) - Fixed expenses Profit = (Selling price/unit - Variable expense/unit) * Quantity - Fixed expenses Profit = Unit CM * Quantity - Fixed expenses Profit = (CM ratio * Sales) - Fixed expenses

Direct materials

Raw materials that become an integral part of the product and that can be conveniently traced directly to it. Ex. A radio installed in an automobile

Fixed cost

Remains constant, in total, regardless of changes in the level of activity. If expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity.

Variable costing contribution format income statement

Sales (Variable cost of goods sold) (Variable S&A expenses) Contribution margin (Fixed MOH) (Fixed S&A expenses) Net operating income

Segmented income statement format

Sales (Variable expenses) Contribution margin (Traceable fixed expenses) Segment margin (Common fixed expenses) Net operating income

Segment margin

Segment margin = Contribution margin - Traceable fixed costs It is the best gauge of the long-run profitability of a segment.

Prevention costs

Support activities whose purpose is to reduce the number of defects. Examples: - Quality training - Quality circles - Statistical process control activities - Supervision of prevention activities

Under/Overapplied overhead

The amount of overhead applied to all jobs during a period will differ from the actual amount of overhead costs incurred during the period. 1. When a company applies less overhead to production than it actually incurs, it results in underapplied overhead. 2. When a company applies more overhead to production than it actually incurs, it results in overapplied overhead.

Overapplied overhead

The amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period.

Underapplied overhead

The amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period.

Contribution margin

The amount remaining from sales revenue after variable expenses have been deducted. It is first used to cover fixed expenses, then any remaining CM contributes to net operating income. Can also be expressed on a per unit basis. For each additional unit sold, net operating income increases by the Unit CM.

Uses of the contribution format

The contribution income statement format is used as an internal planning and decision-making tool. We will use this approach for: - Cost-volume-profit analysis (ch.5) - Segmented reporting of profit data (ch.6) - Budgeting (ch.8) - Special decisions such as pricing and make-or-buy analysis (ch.12)

Financial adjustments for applied overhead

The cost of goods sold reported on a company's income statement must be adjusted to reflect underapplied or overapplied overhead. 1. The adjustment for underapplied overhead increases cost of goods sold and decreases net operating income. 2. The adjustment for overapplied overhead decreases cost of goods sold and increases net income.

Differential costs (Differential revenue)

The difference in cost between any two alternatives. (also called incremental costs) A difference in revenue between two alternatives is called differential revenue. Both are always relevant to decisions. Differential costs can be either fixed or variable.

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.

Job cost sheets: income statement reporting

The job cost sheets provide an underlying set of financial records that explain what specific jobs comprise the amounts reported in Cost of Goods Sold on the income statement.

Job cost sheets: balance sheet reporting

The job cost sheets provide an underlying set of financial records that explain what specific jobs comprise the amounts reported in Work-in-Process and Finished goods on the balance sheet.

Example of a traceable fixed cost of one segment as a common fixed cost of another segment

The landing fee paid to land an airplane at an airport is traceable to the particular flight, but it is not traceable to first-class, business-class, and economy-class passengers.

Opportunity cost

The potential benefit that is given up when one alternative is selected over another. These costs are not usually found in accounting records but must be explicitly considered in every decision.

Manufacturing overhead application (POHR)

The predetermined overhead rate (POHR) is used to apply overhead to jobs and is determined before the period begins. POHR = Estimated total manufacturing overhead / Estimated total units of allocation base The allocation base is the cost driver that causes overhead.

Overhead application

The process of assigning overhead costs to specific jobs using the formula: Overhead applied to a particular job = Predetermined overhead rate * Amount of actual allocation base incurred by the job

Sales mix

The relative proportion in which a company's products are sold. Different products have different selling prices, cost structures, and contribution margin. When a company sells more than one product, break-even analysis becomes more complex.

Relevant range

The relevant range of activity pertains to fixed cost as well as variable cost - definition??

Break-even point

The sales level when profit is zero. Contribution margin = Fixed expenses

Formula for cost of goods manufactured

Total manufacturing costs + Beginning work in process inventory - Ending work in process inventory = Cost of goods manufactured

Traditional vs. Contribution format income statement

Traditional: used primarily for external reporting. Sales (Cost of goods sold) Gross margin (Selling & admin. expenses) Net operating income Contribution: used primarily by management. Sales (Variable expenses) Contribution margin (Fixed expenses) Net operating income

Formula for unit sales to attain target profit

Unit sales to attain target profit = (Target profit + Fixed expenses) / Unit CM

Formula for unit sales to break even

Unit sales to break even = Fixed expenses / Unit CM

Work in process

Units of product that are only partially complete and will require further work before they are ready for sale to the customer

Relationship between units produced and units sold under absorption vs. variable incomes

Units produced = Units sold --> No change in inventory --> Absorption income = Variable income Units produced > Units sold --> Inventory increases --> Absorption income > Variable income Units produced < Units sold --> Inventory decreases --> Absorption income < Variable income

Allocation base

Used to assign manufacturing overhead to individual jobs. Ex. direct labor dollars, machine hours

Target profit analysis

Used to estimate what sales volume is needed to achieve a specific target profit.

Formula for the high-low method

Variable cost per unit = Change in cost / Change in units Variable cost per unit = (High total cost - Low total cost) / (High total units - Low total units)

CVP analysis and variable vs. absorption costing

Variable costing categorizes costs as variable and fixed so it is much easier to use this income statement format for CVP analysis. Because absorption costing assigns fixed manufacturing overhead costs to units produced, a portion of fixed manufacturing overhead resides in inventory when units remain unsold. This potential result is positive net operating income when the number of units sold is less than the break-even point.

Decision making: variable vs. absorption costing

Variable costing correctly identifies the additional variable costs incurred to make one more unit. It also emphasizes the impact of total fixed costs on profits. Because absorption costing assigns fixed manufacturing overhead 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.

Changes in net income: variable vs. absorption costing

Variable costing income is only affected by changes in unit sales. It is not affected by the number of units produced. As sales go up, net operating income goes up, and vice versa. Absorption costing income is influenced 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.

Reconcile the difference between absorption and variable income

Variable costing net operating income Add (Deduct): Fixed MOH deferred in (released from) inventory Absorption costing net operating income

Variable expense ratio

Variable expenses as a percentage of sales. Variable expense ratio = Variable expenses / Sales Variable expense ratio = Variable expense per unit / Selling price per unit

Variable cost

Varies, in total, in direct proportion to changes in the level of activity. Constant per unit.

Activity-based costing

When a company creates overhead rates based on the activities that it performs. Activity-based costing is an alternative approach to developing multiple predetermined overhead rates. Managers use activity-based costing systems to more accurately measure the demands that jobs, products, customers, and other cost objects make on overhead resources.

Quality of Conformance

When the overwhelming majority of products produced conform to design specifications and are free from defects.

Equation for mixed cost line

Y = a + bX Y = total mixed cost a = total fixed cost (vertical intercept) b = variable cost per unit of activity (slope) X = level of activity