Cost Accounting Test 2
Production Quantity =
Total Departmental production for a period
Contribution Margin per unit=
Unit Selling Price-Variable Cost per unit
Note for CVP Analysis we do not
separate expenses into COGS and SG&A. They are divided, rather based in their behavior (FC,VC, SVC) Also operating income does NOT equal net income as it does not include income tax expense and non operating gains and losses
The use of separate variable and fixed OH rates and accounts allows the calculation of
separate variances for each type of overhead, providing managers with maximum detail and optimal flexibility for control and performance evaluation purposes -The use of separate rates permits a four variance approach to be taken in analyzing overhead.
Why are standard cost systems used? (6)
1) Clerical Efficiency 2) Motivation 3) Planning 4) Controlling 5) Decision Making 6) Performance Evaluation
Contribution Margin Ratio =
Contribution Margin per Unit/Unit Sales price
Cost Volume=
FC + VC + SVC
Formula Need to Memorize
Sales - VC =CM -FC =Operating Income
Unit Costs = (Formula)
Sum of Production Costs/Production Quantity
A decrease in CM could arise due to
a reduction in selling price, and increase in the variable cost per unit or a combination of the two.
A cost must be assigned to goods that
are transferred form WIP to FG (or another department) and a value must be assigned to goods that are partially completed in WIP at the end of each period.
A company can improve its average contribution ration and its overall profitability by
shifting its sales mix to include more products with high contribution margin ratios
Standard Cost Usage
simplifies process costing and allows variances to be measured during the period
Unit cost are transferred
so that a total production cost is accumulated by the end of production
The accumulated departmental costs are
spread or assigned to all units produced that flowed through the department during the period
Total Variance for Materials and Labor are
subdivided into price and usage variances in order to help managers in controlling costs
A Standard Costs Card
summarizes the DM,DL, OH necessary to complete one unit of the product.
The units started and completed equals
the difference between the number of units completed for the period and the units in beginning inventory; it can also be computed as the number of units started during the period minus the units in ending inventory
The total variance is =
the difference between the total actual cost incurred and the total standard cost output produced during the period. A total variance may be computed for each product cost element (Price and Quantity)
Standard Costing eliminates
the periodic recomputation of production cost that is required under actual costing
Sales Mix
the relative percentage of total sales generated by each type of product that a business sells
The Average Rate is calculated as
the total wage per hour divided by the number of workers
Alternative activity measures
theoretical capacity, practical capacity, normal capacity, expected capacity
Process Costing
a method of accumulating and assigning costs to units of production in companies that make large quantities of homogeneous goods.
Variance definition
A variance is any difference between an actual costs and a standard or budget cost
Variable Costing
(Also Known as Direct Costing) is a cost accumulation and reporting method that includes ONLY variable production costs (DM, DL and Variable OH) as inventoriable costs. It treats fixed OH as a PERIOD Cost This Method is not acceptable for external reporting purposes or for tax returns
Absorption Costing
(Also known as full costing) is a cost accumulation and reporting method that treats ALL manufacturing components (DM,DL,OH variable and Fixed) as inventoriable or product costs. It is the traditional approach to product costing and must be used for external financial statements and tax returns
Breakeven Point in units =
(FC + Operating Income) / Unit CM
Breakeven Point in Dollars =
(FC + Operating Income)/ CM Ratio
Overhead Variances First a discussion on Capacity
(any measure of activity) In developing OH application rates, a company must specify an operating level or capacity.
Considerations in establishing Standards (2)
1) Appropriateness 2) Attainability
6 Steps are followed in process Costing
1) Calculate the Physical Units to Account for 2) Calculate the physical units accounted for (Verify that step 1 = step2) 3) Determine EPU 4) Determine the total cost per equivalent unit 5) Calculate the cost per equivalent unit 6) Assign the costs to inventories (verify that the total costs transferred out plus the costs in ending inventory equals step 4)
Changes in standard usage are (2)
1) Ideal and theoretical standards are high level benchmarks rarely, if ever attained +/-s to this approach 2) Historically standards were set and retained for at least one year. Depending upon the volatility of materials, labor, and overhead prices (rates) and usage. standard cost revisions may need to be more often, (quarterly/monthly)
Steps in developing standards 4
1) Material Costs 2) Labor Costs 3)Overhead costs 4) Standard cost card
2 Basic differences between Job Order and Process Costing
1) The quantity of Production for which costs are being accumulated at any one time, and 2) the cost object to which the costs are assigned
General Questions that can be answered with CVP (4)
1) What level of sales must be reached to cover all expenses, that is, break even? 2) How many units of a product must be sold to earn a specific operating income? 3) What will happen to our profitability if we expand capacity? 4) What will the effect of changing salespeople's compensation from fixed months salaries to a commission of 10% sales?
How is breakeven defined? What are the differences among the formula, graph,and income statement approaches for break even
1. The break-even point is the starting point for CVP analysis, because before a company can earn profits, it must first cover all of its variable and fixed costs; the point at which all costs are just covered is the break-even point. The formula approach requires solving for the exact breakeven using the following algebraic equation: R(X) - V(X) - FC = 0; where R is revenue per unit, X is volume, V is variable cost per unit, and FC is fixed cost. The graph approach provides a visual relationship between revenues and costs. The break-even point is where the total revenue line intersects the total cost line on the traditional or cost-volume-profit graph or where the profit line intersects the x-axis on the profit-volume graph. Unlike the formula approach, the graph approach does not provide a precise solution because exact points cannot be determined from a visual view of the graph. The income statement approach requires preparing an income statement to prove the accuracy of the computations of breakeven. Only by trial-and-error can the exact breakeven be determined using the income statement approach
What information provided by a variable costing income statement is used in computing breakeven point? Is this information on an absorption costing income statement? Explain your answer
1. The variable costing income statement classifies costs by the way they react relative to changes in volume. Variable costs are deducted from revenues to determine contribution margin and then fixed costs are deducted from contribution margin to determine operating profit. Break-even analysis involves a study of fixed costs, variable costs, and revenues to determine the volume at which total costs equal total revenues. Hence, variable costing provides the variable and fixed cost classifications needed to compute breakeven. The absorption costing income statement uses functional classifications—manufacturing and nonmanufacturing costs—to compute gross profit and operating income, respectively. A functional classification requires a cost to be classified based on the reason it was incurred, i.e., selling, administrative, or production. This classification does not separate variable from fixed costs and is therefore not useful in computing breakeven.
Sum of Production costs =
Actual DM, DL and Actual or predetermined OH
Average Unit cost is found by the following formula
Beginning Inventory Costs + Current Period Costs / Weighted Average Equivalent units of Production
Fixed Cost
Costs that do not vary in response to changes in the activity base. Average fixed costs per unit of activity base change as the units of the activity base change (don't change to amount of production, but change per unit more produced = less fixed cost per unit)
Variable Cost
Costs that in total increase and decrease in direct proportion to changes in the activity base. The average variable cost per unit of an activity base does not significantly in response to changes in the activity base. (Total cost varies with amount of production but per unit does not change)
Actual Cost < Standard Cost =
Favorable Variance
The FIFO Method does NOT
NOT commingle units and costs of different periods, so that equivalent units and costs of beginning inventory are withheld from the computation of average current period cost
The Weighted Average Method is Not
NOT concerned about what quantity of work was preformed in the prior period on the units in beginning inventory; it focuses on units that are completed in the current period and units remaining in ending inventory.
Contribution Margin =
Sales - VC The portion of sales revenue that is not consumed by variable costs and therefore is available to cover fixed costs and contribute to operating income
What is contribution Margin ratio? How is it used to calculate the break even point?
The contribution margin ratio is contribution margin per unit divided by selling price per unit. It represents the proportion of revenue that remains after variable costs are covered. The contribution margin ratio can be used to calculate break- even in sales dollars by dividing fixed costs by the contribution margin ratio.
The Break Even Point will decrease if there is
a decrease in total fixed cost or an increase in unit (or percentage) contribution Margin
Economies of Scale
a reduction in unit costs achieved through higher volume of output
Any factor that causes a change in the break even point will also cause
a shift in total profits or losses at any activity level
Standard definition
a standard is a benchmark or norm for planning and control purposes; it is a model or budget against which actual results are compared and evaluated
The total units to account for represent
all units that were worked on in the department during the current period, which consists of beginning inventory plus units started
A standard Cost is developed
by departments including: cost accountants, industrial engineering , personal, data processing, purchasing, management, etc
An operation flow document
can be prepared which lists all of the operations to complete one unit of the product and they corresponding time allowed for the operation.
The weighted average method does not
distinguish between units in beginning inventory and units entering production during a period.
Margin of Safety is the
dollar amount by which actual sales volume exceeds the break even sales volume
Equivalent unit calculations
for standard process costing are identical to those of FIFO costing system
Process Costing System
is a costing system un which costs are accumulated by COST Component in each department and assigned to all units that flow through the department (DM,Dl,MFOH)
A bill of materials
is a document that contains information about the product material components and their specifications
FIFO Method
is a method of processes costing that computes an average cost per equivalent unit of production using only current period production and cost information. Units and Costs in Beginning Inventory are separately sent to the next department or to finished goods inventory, as is appropriate.
Weighted Average Method
is a method of processing costing that computes an average costs per equivalent unit of production; it combines beginning inventory units and costs with current production and costs, respectively, to compute the average
A usage variance shows
the difference between the quantity of actual inputs and the quantity of standard inputs allowed for equal output of the period. Focus here is efficiency
A price variance reflects
the difference between what was actually paid for the inputs and what should have been paid for inputs during the period.
The Break Even Point will Increase if
there is an increase in total fixed cost or a decrease in unit or (percentage) contribution margin
Units in the Beginning WIP were started Last Period, but
will be completed during the current period. -Some Costs related to these units were incurred last period and additional costs will be incurred in the current period.
Partially Completed Units in the Ending WIP inventory were started in the current period, but
will not be completed until the next period. -Costs were incurred in this period and additional costs will be incurred next period, due to current production efforts on the ending WIP inventory
Standard Cost Card, Bill Of materials and Operations Flow Document and how related
1. A standard cost card summarizes the direct material, direct labor, and overhead standard quantities and prices needed to complete one unit of output. The bill of materials specifies the quality and quantity of each raw material needed to complete one unit of output. The standard cost card shows the assignment of standard costs to each raw material in the bill of materials to determine the total standard material cost of one unit of output. The operations flow document details all necessary operations to make a unit of output or summarizes the time to make one unit of output. Time details are used to develop standard labor cost and time and overhead rates for production of one unit of output.
Why is CVP analysis generally used as a short term tool? Would CVP ever be appropriate in the long run?
3. The usefulness of CVP analysis is its ability to clearly forecast income expected to result from the short-run interplay of cost, volume, price, and quantity. It is often useful in analyzing current problems regarding product mix, make or buy, sell or process further, and pricing. In the long run, however, all of these factors and their relationships and the assumptions that underlie CVP regarding these factors are likely to change. This emphasizes that CVP only holds true for the short run. Results must be recalculated periodically to maintain validity.
Define and Explain the relationship between margin of safety and degree of operating leverage
5. Margin of safety is the difference between actual or projected sales and break-even level sales. Margin of safety can be expressed in units, in dollars, or as a percentage of total sales dollars. It identifies the amount by which sales could fall and still leave the firm's bottom line in the black. Margin of safety measures provide either comfort or risk depending on whether the margin of safety is positive or negative. Operating leverage refers to the amount of fixed costs relative to variable costs in a company's cost structure. It indicates how sensitive a company's sales are to sales volume increases and decreases. Higher operating leverage is associated with a higher proportion of fixed costs; lower operating leverage is associated with a lower level of fixed costs. The level of operating leverage varies with the level of revenues. Further, operating leverage provides information about how profit will change when revenue changes. High operating leverage indicates that the level of profit is very sensitive to a change in revenue level. The reverse is true for low operating leverage. Margin of safety percentage is 1 ÷ Degree of operating leverage; degree of operating leverage is 1 ÷ Margin of safety percentage. Thus, the margin of safety percentage is the reciprocal of the degree of operating leverage and the degree of operating level is the reciprocal of the margin of safety percentage.
Standard Cost Card
After Bill of Material and Operation Flow Document and Predetermined Oh Rates per activity have been measure have been developed a standard cost card is prepared Standard Cost Card is prepared that summarizes the standard quantities and costs needed to produce a unit.
Actual Cost > Standard Cost =
Unfavorable variance
FIFO Average Formula
Unit Costs= Current Period Costs/ EUP
Equivalent Units of Production is
an approximation of the number of whole units of output that could have been produced during a period from actual effort expended during that period
Cost Accumulation (which manufacturing costs are recorded as part of product cost)
and Cost presentation (how costs are shown on external financial statements or internal reports) procedures are accomplished using one of the following two methods: Absorption Costing or Variable Costing
Cost Volume Profit Analysis
is a predictive tool used by management to plan and control the activities of a business. Management is able to forecast future costs, revenues, and profits at various levels of business activity using CVP
A standard cost system
is a product costing system that determines product costs by using standards or norms for quantities and/or pricing of component elements
A standard cost
is budgeted or estimated cost to manufacture a single unit of product or preform a single service.
Focus of FIFO
is specifically on the work performed during the current period, and the EUP Schedule shows only that work.
Relevant Range
is the range of volume levels (or production levels) over which assumptions made about CVP relationships remain valid
Labor Costs
list specific operations necessary to manufacture one unit of the product.
Material Costs
lists the specific direct material components used to manufacture the product (type, quantity, and quality)
Separate EPU calculations must be
made for each cost component (DM,DL,OH)
Semi variable Costs
mixed costs Costs include both fixed and variable elements. The high low method is often used to breakout the variable and fixed portion
A Variable Costing Income Statement
presents expenses according to cost behavior (variable and fixed) although it may present expenses by functional classification within the behavioral categories
Operating Leverage is the
proportionate relationship between a companies variable and fixed costs
The FIFO Method more
realistically reflects the way in which most goods actually flow through the production system.
Attainability
refers to managements belief about the degree of difficulty or rigor that should be incurred in achieving the standard. Expected, practical, and ideal are different levels of standards by degree or rigor
Appropriateness
refers to the basis on which the standards are developed (current and past information) and how long they are expected to last
Labor rates should
reflect the wages paid to employees as well as related EMPLOYER costs such as fringe benefits, FICA, and unemployment taxes.
Overhead Costs are
represented by predetermined factory OH application rates