BA 204 - Managerial Accounting - Chapters 5, 7 and 8

Nonunit-Level Activity Drivers

(i.e. batch, product-sustaining and facility-sustaining) are factors that measure the consumption of nonunit-level activities by products and other costs objects.

Production, Sales and Income Relationships

1. Production > Sales Absorption Income > Variable Income 2. Production < Sales Absorption Income < Variable Income 3. Production = Sales Absorption Income = Variable Income

Value-added Activities vs. Nonvalue-Added

1. Value added activities add Value to the product (welding, manufacturing, painting, sewing, cutting, etc). 2. Non Value added activities include do not add value (testing, wait time to go to another machine, storing, inspecting, moving, etc.). 3. To reduce costs, reduce non value activity time.

Process-Costing System

A costing system that accumulates production costs by process or by department for a given period of time.

Materials Requisition Form

A source document that records the type, quantity, and unit price of of the direct materials issued to each job.

Absorption Costing Product Cost

Absorption Costing Product Cost = DM + DL + VOH + FOH

Causal Factors (Drivers)

Activities or variables that invoke service costs. Generally, it is desirable to use causal factors as the basis for allocation service costs.

Unit-Level Activities

Activities that are performed each time a unit is produced.

Cost Reduction

Activity management can reduce costs in four ways. - activity elimination. - activity selection. - activity reduction. - activity sharing.

Adjusted Cost of Goods Sold

Adjusted COGS +- Overhead Variance Applied Overhead >Actual Overhead means Overapplied Overhead; subtract from COGS Applied Overhead < Actual Overhead means Underapplied Overhead; add to COGS

Nonvalue-Added Activities

All activities other than those that are absolutely essential to remain in business, and therefore considered unnecessary.

Actual Costing System

An approach that assigns actual costs of direct materials, direct labor and overhead to products.

Activity Inputs

Are the resources consumed by the activities in producing its output.

Departmental Overhead Rate

Departmental Overhead Rate = Estimated Department Overhead / Estimated Departmental Activity Level

Normal Cost System

Determines unit cost by adding actual direct materials, actual direct labor, and estimated overhead. Overhead can be estimated by approximating the year's actual overhead at the beginning of the year and then using a predetermined rate throughout the year to obtain the needed unit cost information. Virtually all firms use normal costing.

Job-Order Production and Costing

Firms operating in job order industries produce a wide variety of services or products and it is easy to keep track of cost by job for a customer. Each job keeps track of costs separately. Examples: - Printing - Automobile - House Builder - Car repair - Medical Services - Lawyer Services

Activity Elimination

Focuses on nonvalue-added activities. Activites that fail to add value are identified, measures must be taken to rid the organization of these activities.

Underapplied Overhead

If actual overhead is greater than applied overhead. (Product understated)

Overapplied Overhead

If actual overhead is less than applied overhead. (Product Overstated)

Stockout Costs

If demand is not known with certainty, this is the third category of inventory costs. Are costs of not having a product available when demanded by a customer or the cost of not having a raw materials available when needed for production. (Examples: lost sales, expediting "i.e. increased transportation charges overtime"and the cost of interrupted production "i.e idled workers.")

Comparison of Job-Order and Process Costing

Job-Order Costing - Wide variety of distinct products. - Costs accumulated by job. - Unit Cost = Total Job Costs/Output Process Costing - Homogeneous products. - Costs accumulated by process or department. - Unit Cost = Process Costs/Output

Process Production and Costing

Mass produces large quantities and keep track of cost by DEPRARTMENT rather than individual job. Examples: - Food (like potato chips) - Soda Pop - Oil refineries - Manufacturing Overhead

Overhead Rate

Overhead Rate = Total Overhead Costs / Total Direct Labor Hours

Applied Overhead

Overhead assigned to production using predetermined rates. (Applied Overhead = Predetermined Overhead Rate x Actual Activity Level)

Comparison of Variable and Absorption Costing Methods

Product Costs: Absorption Costing: DM, DL, VOH and FOH Variable Costing: DM, DL and VOH Period Costs: Absorption Costing: Selling Expenses and Administrative Expenses Variable Costing: FOH, Selling Expenses and Administrative Expenses

Support Departments

Provide essential services for producing departments, but they do not actually make the product or service being sold. (Examples include the maintenance, grounds, engineering, housekeeping, personnel, and photocopying departments.)

Adjusted Cost of Goods Sold

The cost of goods sold after all adjustments for overhead variances are made.

Normal Cost of Goods Sold

The cost of goods sold before an adjustment for an overhead variance.

Costs of Quality

The cost of performing quality-related activities. Quality-related activities imply four categories: - Prevention costs. - Appraisal costs. - Internal failure costs. - External failure cots

Common Costs

The costs of resources shared by two or more services or products. (Example: the cost of a maintenance department is shared by producing departments that use these services.)

Overhead Variance

The difference between actual overhead and applied overhead. (Overhead Variance = Actual Overhead - Applied Overhead)

Time Ticket

The means by which direct labor costs are assigned to individuals jobs is the source document.

Economic Order Quantity (EOQ)

The number of units in the optimal size order quantity. = Squared 2 x CO x D / CC CO = The cost of placing one order D = The annual demand for the item in units CC = The cost of carrying one unit in inventory for a year

Segment Margin

The profit contribution each makes toward covering a firm's common fixed costs.

Consumption Ratio

The proportion of each activity consumed by a product. = Amount of Activity Driver per Product / Total Driver Quantity

Activity Performance Measurement

Theses measures are designed to assess how well an activity was performed and the results achieved. They also designed to reveal if constant improvement is being realized. Centers on three major dimensions: 1. Efficiency - focuses on the relationship of activity inputs to activity outputs. 2. Time - The time required to perform an activity is critical. 3. Quality - is concerned with doing the activity right the first time it is performed.

Just-in-time (JIT)

This approach maintains that goods should be pulled through the system by present demand rather than being pushed through on a fixed schedule based on anticipated demand. (Example: Many fast-food restaurants, like McDonald's, use a pull system to control their finished goods inventory. When a customer orders a hamburger, it is taken from the warming rack. When the number of hamburgers gets too low, the cooks cook more hamburgers.)

Value-Added Activities

Those activities necessary to remain in business. (i.e legal mandates or discretionary).

Total Normal Product Costs

Total Normal Product Costs = Actual Direct Materials + Actual Direct Labor + Applied Overhead

Activity-Based Costing (ABC) Hierachy

Unit Level - Varies with output volume (units); traditional variable costs (Example: Cost of indirect materials for labeling each bottle of Victoria's Secret perfume). Batch Level - Varies with the number of batches produced. (Example: Cost of setting up laser engraving equipment for each batch of Epilog key chains). Product-sustaining - Varies with the number of product lines. (Cost of inventory handling and warranty servicing of different brands carried by Best Buy electronics store.) Facility-sustaining - Necessary to operate the plant facility but does not vary with units, batches, or product lines. (Cost of General Motors plant manager salary).

Variable Costing Product Cost

Variable Costing Product Cost = DM + DL + VOH

Activity-Based Costing (ABC) System

a cost assignment approach that first uses direct and driver tracing to assign costs to activities and then uses drivers to assign costs to cost objects. Is also a two-stage process: 1. Trace costs to activities. 2. Trace activity costs to cost objects.

Job-Order Costing System

a costing system in which costs are collected and assigned to units of production for each individual job. (Example: Prices frequently are based on costs in a job-order environment.)

Sequential (or Step) Method

a method that allocates service costs to user departments in a sequential manner. It gives partial consideration to interactions among support departments.

Reciprocal Method

a method that simultaneously allocates service costs to all user departments. It gives full consideration to interactions among support departments.

Absorption Costing

a product costing method that assigns all manufacturing costs to the product: direct materials, direct labor, variable overhead and fixed overhead. GAAP usually requires this type costing for external reporting.

Variable Costing

a product-costing method that assigns only variable manufacturing costs to production: direct materials, direct labor, and variable overhead. Fixed overhead is treated as a period cost.

Nonunit-Level Activities

activities that are not performed each time a unit of product is produced. The costs associated with these activities are unlikely to vary (i.e. increase or decrease) with units produced. These costs vary with other factor(s), besides units, and identifying such factor(s) is helpful in predicting and managing these costs.

Environment Costs

are associated with the creation, detection, remediation, and prevention of environmental degradation. Environment costs include four analogous categories: - prevention costs. - detection costs. - internal failure costs. - external failure costs.

Unrealized External Failure Costs (Societal Costs)

are caused by the firm but are incurred and paid for by parties outside of the firm. (Examples: receiving medical care because of polluted air, losing a lake for recreational use because of contamination, losing employment because contamination, and damaging ecosystems from solid waste disposal.)

Environmental Internal Failure Costs

are costs of activities performed because contaminants and waste have been produced but not discharged into the environment.

Nonvalue-Added Costs

are costs that are caused either by nonvalue-added activities or the inefficient performance of value-added activities.

Producing Departments

are directly responsible for creating the products or services sold to customers. (Example: a public accounting firm might have producing departments devoted to auditing tax, and management advisory services. In a factory, producing departments are those that work directly on the products being manufactured, such as the grinding and assembly departments.

Activity Drivers

are factors that measure consumption of activities by products and other cost objects and can be classified as either unit-level or nonunit level.

Resource Drivers

are factors that measure the consumption of resources by activities. Once identified, then the costs of the resource can be assigned to the activity.

Activity Attributes

are financial and nonfinancial information items that describe individual activities. What attributes are used depends on the purpose. (Examples of activity attributes associated with a costing objective include the following: - types of resources consumed. - amount (percentage) of time spent on an activity by workers. - cost objects that consume the activity output (reason for performing the activity) - measure of the activity output (activity driver) - activity name.)

Direct Fixed Expenses

are fixed expenses that are directly traceable to a segment. These are sometimes referred to as a available fixed expenses or traceable fixed expenses because they vanish if the segment is eliminated.

Appraisal costs

are incurred to determine whether products and services are conforming to their requirements or customers needs. (inspection and testing of raw materials)

Prevention Costs

are incurred to prevent poor quality in the products or services being produced.

Internal Failure Costs

are incurred when products and services do not conform to specifications or customers needs.

External Failure Costs

are incurred when products and services fail to conform to requirement or satisfy customer needs after being delivered to customers.

Common Fixed Expenses

are jointly caused by two or more segments. These expenses persist even if one of the segments to which they are common is eliminated.

Failure Activities

are performed by an organization or its customers in response to poor quality (poor quality does exist).

Control Activities

are performed by an organization to prevent or detect poor quality (because poor quality may exist). Are made up of prevention and appraisal activities.

Failure Costs

are the costs incurred by an organization because failure activities are performed.

Environmental Prevention Costs

are the costs of activities carried out to prevent the production of contaminants and/or waste that could cause damage to the environment.

Environmental Detection Costs

are the costs of activities executed to determine if products, processes, and other activities within the firm are in compliance with appropriate environment standards.

Environmental External Failure Costs

are the costs of activities performed after discharging containments and waste into the environment.

Carrying Costs

are the costs of keeping and storing inventory. One of two major costs associated with inventory. (Example: insurance, inventory taxes, obsolescence, opportunity cost of funds tied up in inventory, handling costs and storage space.)

Control Costs

are the costs of performing control activities.

Ordering Costs

are the costs of placing and receiving an order. One of two major costs associated with inventory. (Example: order processing -"i.e. clerical costs and documents," the cost of insurance for shipments, and unloading and receiving costs.)

Value-added costs

are the costs to perform value-added activities with perfect efficiency.

Realized External Failure Costs (Private Costs)

are those incurred and paid for by the firm. (Examples: cleaning up a polluted late, cleaning up oil spills, etc)

Activity Reduction

decreases the time and resources required by an activity. This approach to cost reduction should be primarily aimed at improving the efficiency of necessary activities or a short-term strategy for improving nonvalue-added activities until they can be eliminated.

Process Value Analysis

focuses on cost reduction instead of cost assignment and emphasizes the maximization of systemwide performance. Is concerned with: - Driver Analysis - Activity Analysis - Performance Measurement

Work Distribution Matrix

identifies the amount of labor consumed by each activity and is derived from the interview process (or a written survey).

Activity Sharing

increases the efficiency of necessary activities by using economics of scale. Specifically, the quantity of the cost driver is increased without increasing the total cost of the activity itself.

Activity Selection

involves choosing among different sets of activities that are caused by competing strategies.

Segment

is a sub-unit of a company of sufficient importance to warrant the production of performance reports. Can be divisions, departments, product lines, customer classes and so on.

Activity-based Management

is a system wide, integrated approach that focuses management's attention on activities with the objective of improving customer value and profit achieve by providing this value.

Activity

is action taken or work performed by equipment or people for other people. Identifying usually is accomplished by interviewing managers or representative of functional work areas (departments).

Predetermined Overhead Rate

is calculated at the beginning of the year by dividing the total estimated annual overhead by the total estimated level of associated activity activity or cost driver. (Predetermined Overhead Rate = Estimated Annual Overhead / Estimated Annual Activity Level)

Discretionary Activity

is classified as value-added provided it simultaneously satisfies all of the following conditions: - The activity produces a change of state. - The change of state was not achievable by preceding activities. - The activity enables other activities to be performed.

Departmental Overhead Rate

is estimated overhead for a department divided by the estimated activity level for that same department. (Departmental Overhead Rate = Estimated Department Overhead/Estimated Departmental Activity Level

Safety Stock

is extra inventory carried to serve as insurance agaisnt changes in demand. Is computed by multiplying the lead time by the difference between the maximum rate of usage and the average rate of usage. (= (Maximum Daily Usage - Average Daily Usage) x Lead Time)

Job

is one distinct unit or set of units. For example, a job might be a kitchen remodel for the Ruiz family, or a set of 12 tables for the children reading room at a local library. Common job-order process include: - printing - construction - furniture making - medical and dental services - automobile repair - beautician services

Job-Order Cost Sheet

is prepared for every job; it is subsidiary to the work-in-process account and is the primary document for accumulating all costs related to a particular job. See Exhibit 5.3.

Plantwide Overhead Rate

is single overhead rate calculated by using all estimated overhead for a factory divided by the estimated activity level across the entire factory.

Driver Analysis

is the effort expended to identify those factors that are the root causes of activity costs. (Example: an analysis may reveal that the root cause of the cost of moving materials is plant layout. Once the root cause is known, then action can be taken to improve the activity. Specifically, reorganizing plant layout can reduce the cost of moving materials).

Cycle Time

is the length of time that it takes to produce a unit of output from the time raw materials are received (starting point of the cycle) until the goods is delivered to finished goods inventory (finishing point of the cycle). (Time / Units Produced)

Activity Output Measure

is the number of times the activity is performed. It is the quantifiable measure of the output. (Example: the number of moves or distance moved are possible output measures for the material moving activity).

Velocity

is the number of units of output that can be produced in a given period of time (Units produced / Time).

Reorder Point

is the point in time when a new order should be placed (or setup started). It is a function of the EOQ, the lead time, and the rate at which inventory is used. = Rate of Usage x Lead Time

Activity Analysis

is the process of identifying, describing, and evaluating the activities that organization performs. Activity analysis produces four outcomes: 1. What activities are done. 2. How many people perform the activities. 3. The time and resources required to perform the activities. 4. An assessment of the value of the activities to the organization, including a recommendation to select and keep only those that add value.

Activity Output

is the result or product of an activity. (Example: if the activity is moving materials, the inputs would be such things as a forklift driver, fuel (for the forklift) and crates. The output would be moved goods and materials.

Direct Method

is the simplest and most straightforward way to assign support department costs. It ignores department interactions and assigns support department costs only to the producing departments. No cost from one department is given to another support department. Thus, no support department interaction is recognized.

Lead Time

is the time required to receive the economic order quantity once an order is placed or a setup is started.

Activity Dictionary

lists the activities in an organization along with some critical activity attributes.

Product Diversity

means that products consume overhead activities in systematically different proportions. This may occur for several reasons, including differences in: - product size - product complexity - setup time - size of batches

Unit-level Activity Drivers

measures the consumption of unit level activities.