ACCT 221 - WEEK 3 NOTES

Income statement for a manufacturing company

Involves the calculation of cost of goods sold; added as a line item on the income statement

*CHAPTER 17*

*NOTES*

*CHAPTER 19*

*NOTES*

Review of Cost Flow Concepts

*see image*

Kaizen

A Japanese term used to describe a blitz-like approach to study processes and install efficiency within an organization Frontline employees provide input for "quick fix" suggestions relating to business processes Strategic finance, managerial accounting, and engineering teams conduct focus sessions to listen and learn from employees to develop solutions

Additional points

A company's results of operations are sensitive to proper cost assignment Much of the direct material, direct labor, and factory overhead costs can end up in inventory The FASB has external reporting rules requiring the allocation of production overhead to inventory For US tax purposes, there are specific "uniform capitalization" rules

Total Quality Management (TQM)

A key driver of customer satisfaction and business success Incorporates detailed standards into processes The International Organization for Standardization provides guidelines relating to process that drive quality ISO certifications are awarded for successful implementation Benchmarking is a process entities use to compare products and processes to "world-class" firms

Disposing of overhead

A more theoretically correct approach would reduce cost of goods sold, work in process, and finished goods on a pro-rata basis GAAP require that underapplied overhead relating to idle facilities, wasted material, the allocation of fixed production overhead, and so forth, be charged to current period as illustrated

Manufacturing Overhead

All costs of manufacturing other than direct materials and direct labor Ex) Indirect materials, indirect labor, and factory related depreciation, repair, insurance, utilities, taxes, etc. Difficult to trace to specific units

COGs Formula

Beginning finished goods inventory + cost of goods manufactured - ending finished goods inventory

Direct Materials Used Formula

Beginning raw materials inventory + raw material purchases - ending raw materials inventory - indirect materials used

Job costing concepts

Best suited to those situations where goods and service are produced upon receipt of a customer order, according to specifications or in separate batches Each job is somewhat unique

Decision Making

Business value results from good decisions Decisions must occur across a spectrum of planning, directing, and controlling activities Quality decision making can only consistently occur by reliance on information

Directing - Costing

Collection, assignment, and interpretation of cost Cost Methods - Job Costing: Actual labor and material costs are tracked for each specific job or product Ex) Home construction Process Costing: Costs are pooled and assigned to aggregate output Ex) Paint production Activity-Based Costing: Costs are traced to activities and then activities are allocated to production Ex) Many other activities that drive costs but do not produce revenues Cost Concepts - Absorption: Units assigned full cost, including overhead. Overhead includes depreciation, utilities, maintenance, and other shared costs. Required method for external reporting under GAAP Direct: Units assigned only direct costs of production. Direct costs include direct materials, direct labor, and variable overhead

Prime Costs

Components direct in nature Direct material + direct labor

Conversion costs

Components to change raw materials into finished good Direct labor + manufacturing overhead

Costs in the corporate ledger

Costs flow through the accounting system Direct labor is also required in the process Overhead costs must also be attached to products How a job's cost appears on the financial statements depends on its condition at the financial statement date

Planning

Deciding on a course of action to reach a desired outcome Occurs at all levels Three major components: Strategy, positioning, and budgets

Total Manufacturing Cost Formula

Direct materials + direct labor + overhead applied

Information Systems

Direct materials may have individual serial numbers, barcodes, or other unique identifiers Component IDs would be scanned into a database and matched with the serial number of the finished unit A listing of direct material cost for each unit produced could be created The data would also be helpful for warranty processing, product recalls, and other inventory issues Direct labor can be tracked via login clocks Systems may require biometric validation (fingerprints) Can ensure employees who claim time on a job are in fact working on the job Can limit access to inventory On assembly lines, it may take more time to measure and record labor for each job than it takes to perform tasks themselves Cost may be assigned based on average or standard time for each activity Ex) An employee is expected to work on 60 units per hour, so 1 minute of direct labor time/cost would be assigned to each unit for the employee's specific task

Cost Components

Direct materials, direct labor, overhead

Managing

Duties go beyond dealing with problems at hand Requires vision, leadership, the ability to procure and mobilize resources, and tolerance to challenges Good decision making is crucial

Planning - Positioning

Helping the organization achieve its goals Involves gathering and evaluating information Will consider such things as: Cost/volume/profit analysis and scalability (Calculate break-even points; Determine how to achieve target income levels) Global trade and transfer (Research laws about tariffs, taxes, and shipping; Set transfer prices between affiliated units) Branding/pricing/sensitivity/competition (Prepare prospective information based upon alternative scenarios; Analyze effects of changing market conditions)

Subsidiary Accounts

It is imperative to know the total dollar value of all jobs A company must also be able to pinpoint the amount attributable to each job This may be accomplished via subsidiary accounts and account numbering The leading digits indicate the control account The trailing digits indicate the subsidiary account

Job costing - Overhead

It would be difficult to trace all items of overhead Overhead may be tracked using a predetermined application rate Overhead application is arbitrary. One tries to establish some correlation between the application base and overall cost incurrence Differences between actual overhead and the amount applied to production are expected. Actual overhead costs and direct labor hours will likely differ from the estimates

Job costing - databases

Job cost systems may be manual An electronic database is a more powerful tool Data can be entered via a user-friendly input form with predetermined slots for entering information Information is only entered once and does not need to be transferred to other forms Reports can extract data meeting certain parameters Ex) A report with all jobs on which billboard light bulbs were used during the past 18 months

Job costing - Larger jobs

Jobs may require multiple employees and extend over several days Costs broken up per day but on same sheet

lean manufacturing

Lean is an environment where waste has been trimmed It also entails a focus on response time, continuous improvement, inventory reduction, and standardization Extensive, in-depth studies are conducted to improve efficiency, while adding customer value Ex) Automakers had many options for each car produced, and customers spent considerable time selecting options This complicated the manufacturer's production and inventory management The process could be improved by bundling options into 2 or 3 packages

Controlling - Monitor

Maintain awareness of where the business is headed Standards: Benchmarks against which actual productive activity is compared Variances: Deviations from standards Provide warning of situations requiring corrective action Flexible Tools: Compensate for changes in operating environment Attempt to sort out confusing signals

Just in time (JIT)

Maintaining raw materials inventory entails considerable upfront investment and the potential for costly damage and obsolescence Just in time (JIT) inventory systems receive materials just as they are needed in production Requires a complete and reliable logistics system Strong information systems often link manufacturers directly with suppliers in automated procurement Kanban is a Japanese term to signal that a particular inventory is ready for replenishment

Direct Materials

Materials that are an integral part of a finished product and that have a physical presence that is readily traced to that finished product. Ex) Cost of circuit boards in a computer Not minor materials, such as wire strands (indirect materials).

Controlling

Monitoring and adjusting for deviations Certifying the accuracy of financial reports Controller: The primary person responsible for the cost and managerial accounting functions

SG&A (Selling, General and Administrative) Costs

Nonmanufacturing and not part of overhead Ex. procurement, advertising, accounting, etc.

Period Costs

Not attributable to inventory SG&A activities Do not benefit multiple years (PP&E expenditures) Expensed when incurred

Planning - Budgets

Outline the financial plans for an organization. Includes - Operating budget: Expected revenues and expenses Show allowable levels of expenditures for departments Capital expenditure: Expected long-term expenditures relating to new PP&E Evaluate whether an investment can be justified Financial budget: Expected cash needs Demonstrate why/when lending support may be needed

Overapplied overhead

Overapplied overhead is deemed "favorable" Less has been spent than anticipated for the level of achieved production The balance must be transferred out One approach is to offset Cost of Goods Sold

Job costing in other environments

Perhaps as few as 10% of workforce members are now actively producing a tangible end product Private sector services, not-for-profits, and governmental entities are growing in size Job costing methods are still highly relevant "Jobs" may be more abstract: client, seat mile, fire call, etc. Direct materials become less significant but overhead can be increasingly important Ex) A hospital visit may include amounts for pills at high costs due to the administration, documentation, and billing overhead costs

Directing - Analysis

Provide calculations and models to support decisions Components: outsourcing, contribution margin, special orders

Categories of inventory

Raw Materials: Components to be used in products Work in Process: Goods in production but not complete Accumulation of direct material, direct labor, and applied manufacturing overhead Finished Goods: Completed products awaiting sale (Goods available for sale is *NOT* a category of inventory)

Directing

Realization of a plan requires initiation and direction Actions must be well coordinated and timed Deals with cost accounting, production accounting, and analysis accounting

What is Financial Accounting

Reporting to external parties Well defined and standardized Summarized or aggregated data (Uses historical (or past) data) Must comply with generally accepted accounting principles

What is Managerial Accounting

Reporting to managers and internal personnel Tailored to specific decision-making tasks Focused on products, departments, and activities; Presents more detailed data about product Often uses real-time data for quick responses Forecasted outcomes for planning; May use estimates of the future for budgeting and decision making No generally accepted accounting principle requirements

Product costs

Result from manufacturing process Direct Material + Direct Labor + Factory Overhead Costs constitute inventory on the balance sheet. Also known as "inventoriable" costs. Not expensed until final goods are sold

Directing - Production

Running a "lean" business model Costs minimized and efficiency maximized Output and quality standards enhanced ERP (Enterprise Resource Packages): Comprehensive database software that track an array of business and accounting data B2B (Business to Business): Systems that enable data interchange between companies RFID (Radio Frequency Identification): Processors embedded in inventory that enable automatic computer tracking of inventory quantity and location M2M (Machine to Machine): Systems that enable connected devices to communicate information without human engagement Inventory: Overstocking increases costs and risks obsolescence. Understocking halts production and dissatisfies customers. Management techniques JIT (Just-In-Time) EOQ (Economic Order Quantity)

Schedules

Schedule of Raw Materials: Shows how much of the available raw material supply was transferred into production during the period Schedule of Work in Progress: Shows conversion costs added to raw materials transferred in Cost of Goods Manufactured: The above two schedules combined Schedule of COGS: Determines COGS for the income statement Supporting schedules: Typically for internal use only documents; could result in loss of trade secrets

Six Sigma

Six Sigma is a disciplined approach designed to achieve nearly "zero defects" "Sigma" measures deviation from a norm Near zero defects reflect a defect rate that is at least six standard deviations from the norm Defects relate not only to final products but also to all business processes Management provides controls to drive toward goal Defects can be very costly Direct corrective actions, including warranty work Indirect costs, including lost customer satisfaction

Planning - Strategy

Strategy setting can take many forms Key things including setting the mission and the core values Core values: Involve concepts of ethics, employment/compensation, quality, customer service, environmental awareness, etc. Lack of understanding of values leads to "profit-centric" and short-term focuses that are potentially disastrous Institute of Management Accountants (IMA) established a set of ethical standards for its members that are part of the core values for the profession (also issues CFM and CMA designations). Mission: Defines the purpose and direction of the company Managerial accounting is used to determine: Achievement of profit objectives. Cost-effective methods to police core values. Controls to monitor operations.

Modern Management

Technologically advanced systems mean less time needs to be spent on data capture, and more time can be devoted to analyzing data and making sound business decisions Business success can be driven by a fixation on metrics such as quality, employee involvement, customer satisfaction, etc. Profit is the result not the objective

Cost drivers

The cost driver is the factor that is viewed as causing costs to be incurred within an organization It is abstract, as there are too many individual variables for any single factor to fully explain all costs Labor hours may not be the most significant cost driver in a mechanized setting Machine hours, number of bar code scans, fuel consumption, or number of assembly steps could be more appropriate The choice must be logical, as it will govern the allocation of total overhead costs to individual products

Job cost sheets

The information on the daily time sheets and materials requisition forms can be logically transferred to appropriate job cost sheets. The form references other source documents.

Cost of Goods Manufactured Formula

Total manufacturing cost (direct materials + direct labor + overhead applied) + beginning work in process inventory - ending work-in-process inventory

Job costing - Materials

Tracked on a materials requisition form showing what material is put into production on various jobs Costs may not always be shown Instead, a part or serial number could be used to identify the cost

Job costing - Labor

Tracked on a report documenting time spent on each job and other tasks Ex. Employee timesheet

Capacity utilization

Traditional job costing allocates overhead based on expected output It may make more sense to charge based on full capacity utilization Capacity utilization refers to the degree to which an organization's output capabilities are being deployed

Controlling - Scorecard

Traditional monitoring has focused on financial measures, which alone may not be sufficient Scorecards: Custom systems for evaluating elements that are important to the organization and under the control of a specific position Balance: Identify and focus on various components of performance that can be measured and improved. Spend time on tasks that further goals and create value Improvement - TQM (Total Quality Management): Continuous improvement by focusing on customer service and systematic problem solving via teams made up of front-line employees. Reengineering: Entire processes mapped and studied with the goal of identifying any steps that are unnecessary or that do not add value TOC (Theory of Constraints): Efficiency is improved by seeking out and eliminating constraints/bottlenecks

Transfer Pricing

Transfer pricing issues revolve around how to assess costs and set prices for goods produced in one venue and transferred to an affiliate in another Companies may attempt to shift profits from high-tax jurisdictions to low-tax jurisdictions by shuffling costs and prices between entities Rules attempt to require "fair and equitable" job costing and that transfers be based on "arm's length" pricing Issues also revolve around divisional profit incentives

Underapplied Overhead

Underapplied overhead is deemed "unfavorable" Not enough jobs were produced to absorb all of the overhead incurred This might result from lower levels of output or overspending The balance must be transferred out One approach is to charge Cost of Goods Sold

Direct Labor

Wages paid to those who physically and directly work on the goods being produced. Ex) Wages of a welder in a bike factory. Not wages of guards, supervisors, etc. who do not work directly on the product (indirect labor).

Actual and Applied Overheard

Work in process is debited Factory Overhead is credited for the application of overhead at a predetermined rate Factory Overhead is debited for actual costs as incurred Logical offsetting accounts are credited Note that SG&A costs are separately expensed and are not part of factory overhead The Factory Overhead account is not a typical account It does not represent an asset, liability, expense, or any other element of financial statements It is a "suspense" or "clearing" account Amounts go into the account and are then transferred out to other accounts Actual overhead goes in Applied overhead goes out