Management Accounting 6 and 12

First, only rarely will enough information be available to prepare a detailed income statement for both alternatives. Second, mingling irrelevant costs with relevant costs may cause confusion and distract attention from the information that is really critical. Furthermore, the danger always exists that an irrelevant piece of data may be used improperly, resulting in an incorrect decision. These reasons pertains to why ____________

isolate relevant costs

This makes all of the remaining segments appear to be less profitable—possibly resulting in dropping other segments.

when common fixed costs that are allocated to the segment and they don't disappear; they are reallocated to the remaining segments of the company

Companies use arbitrary allocation bases to allocate costs to segments. For example, some companies allocate selling and administrative expenses on the basis of sales revenues. This is called the Inappropriate allocation base, which is under the ___________ common mistake.

Inappropriate Methods for Assigning Traceable Costs among Segments

T or F The general guideline is to treat as traceable costs only those costs that would not disappear over time if the segment itself disappeared.

False - that would disappear

T or F Division manager's salary is common, while company presidents salary is traceable.

False - traceable;common

If either the upstream or downstream costs are omitted in profitability analysis, then the product is over costed and management may unwittingly develop and maintain products that in the long run result in losses.

False - undercost

a fixed cost that is incurred because of the existence of the segment—if the segment had never existed, the fixed cost would not have been incurred; and if the segment were eliminated, the fixed cost would disappear.

Traceable Fixed Cost

A fixed cost that is incurred because of the existence of a particular business segment and that would be eliminated if the segment were eliminated.

Traceable fixed cost

terms to prepare segmented income statements using the contribution approach

Traceable fixed cost Common fixed cost Segment margin

Formula of Dollar Sales for company to break even

Traceable fixed expenses + Common Fixed expenses/Overall CM Ratio

T or F A cost is considered traceable to a segment only if the cost is caused by the segment and could be avoided by eliminating the segment.

True

T or F All of the costs attributable to a segment—and only those costs—should be assigned to the segment.

True

T or F Allocating common fixed costs can make a product line (or other business segment) look less profitable than it really is. In this instance, allocating the common fixed costs among all product lines makes the housewares product line appear to be unprofitable.

True

T or F Any allocation of common costs to segments reduces the value of the segment margin as a measure of long-run segment profitability and segment performance.

True

T or F If a segment can't cover its own costs, then that segment probably should be dropped (unless it has important side effects on other segments).

True

T or F The decision to retain or discontinue a business segment should be based on the sales and expenses that would disappear if the segment were dropped.

True

T or F Distinction between traceable and common fixed costs is crucial in segment reporting because traceable fixed costs are charged to segments and common fixed costs are not.

True

T or F Traceable Costs Can Become Common Costs

True as Fixed costs that are traceable to one segment may be a common cost of another segment.

is required for external reports according to U.S. generally accepted accounting principles (GAAP).

Absorption Costing

can be used to help identify potentially relevant costs for decision-making purposes. improves the traceability of costs by focusing on the activities caused by a product or other segment.

Activity-based costing

Decisions relating to whether product lines or other segments of a company should be dropped and new ones added are among the most difficult that a manager has to make.

Adding and Dropping Product Lines and Other Segments

We need to recognize a fundamental concept from the outset of our discussion—costs that are relevant in one decision situation are not necessarily relevant in another. This means that managers need ________________________. For one purpose, a particular group of costs may be relevant; for another purpose, an entirely different group of costs may be relevant. Thus, each decision situation must be carefully analyzed to isolate the relevant costs. Otherwise, irrelevant data may cloud the situation and lead to a bad decision. The concept of ___________________ is basic to managerial accounting;

"different costs for different purposes"

The capacity of a bottleneck can be effectively increased in a number of ways, these are:

- Working overtime on the bottleneck. - Subcontracting some of the processing that would be done at the bottleneck. - Investing in additional machines at the bottleneck. - Shifting workers from processes that are not bottlenecks to the process that is the bottleneck. - Focusing business process improvement efforts on the bottleneck. - Reducing defective units. Each defective unit that is processed through the bottleneck and subsequently scrapped takes the place of a good unit that could have been sold.

What are the three mistakes commonly done by companies in Segmented Income Statements

1. Omission of Costs 2. Inappropriate Methods for Assigning Traceable Costs among Segments 3. Arbitrarily Dividing Common Costs among Segments

They argue that fixed manufacturing costs are not really the costs of any particular unit of product. These costs are incurred to have the capacity to make products during a particular period and will be incurred even if nothing is made during the period. Moreover, whether a unit is made or not, the fixed manufacturing costs will be exactly the same. Therefore, _________ advocates argue that fixed manufacturing costs are not part of the costs of producing a particular unit of product, and thus, the matching principle dictates that fixed manufacturing costs should be charged to the current period.

Advocates of variable costing

leads to distorted segment costs is the practice of assigning non traceable costs to segments. For example, some companies allocate the common costs of the corporate headquarters building to products on segment reports.

Arbitrarily Dividing Common Costs among Segments

A cost that can be eliminated by choosing one alternative over another in a decision. This term is synonymous with differential cost and relevant cost.

Avoidable cost

A machine or some other part of a process that limits the total output of the entire system.

Bottleneck

If you want to increase the strength of a chain, what is the most effective way to do this? a. concentrate your efforts on strengthening the strongest link, b. all the links c. only the weakest link

Clearly, focusing your effort on the weakest link will bring the biggest benefit.

fixed cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one segment. Even if a segment were entirely eliminated, there would be no change in a true common fixed cost.

Common Fixed Cost

Unfortunately, companies often make mistakes when assigning costs to segments. They omit some costs, inappropriately assign traceable fixed costs, and arbitrarily allocate common fixed costs. What are these called?

Common Mistakes in segmented income statements

A limitation under which a company must operate, such as limited available machine time or raw materials, that restricts the company's ability to satisfy demand.

Constraint

useful in decisions involving temporary uses of capacity such as special orders. These types of decisions often involve only variable costs and revenues—the two components of contribution margin.

Contribution Margin

A difference in cost between any two alternatives.

Differential cost

are also referred to as relevant costs or avoidable costs.

Differential costs

A difference in revenue between any two alternatives.

Differential revenue

T or F A company's common fixed expenses should be allocated to segments when performing break-even calculations because they will change in response to segment-level decisions.

F - A company's common fixed expenses should not be allocated to segments when performing break-even calculations because they will not change in response to segment-level decisions.

T or F Unavoidable costs are relevant costs. Avoidable costs are irrelevant costs.

F - Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.

T or F Fixed common costs are allocated to segments. The segment margin consists of revenues, less variable expenses, less fixed common expenses of the segment.

F - Fixed common costs are not allocated to segments. The segment margin consists of revenues, less variable expenses, less traceable fixed expenses of the segment.

T or F If a bottleneck machine breaks down or is ineffectively utilized, the losses to the company can be quite small.

F - If a bottleneck machine breaks down or is ineffectively utilized, the losses to the company can be quite large.

T or F It is profitable to not continue processing a joint product after the split-off point so long as the incremental revenue from such processing does not exceed the incremental processing cost incurred after the split-off point.

F - It is profitable to continue processing a joint product after the split-off point so long as the incremental revenue from such processing exceeds the incremental processing cost incurred after the split-off point.

T or F Opportunity costs are recorded in the organization's general ledger because they do represent actual dollar outlays, and they represent economic benefits that are forgone as a result of pursuing some course of action.

F - Opportunity costs are not recorded in the organization's general ledger because they do not represent actual dollar outlays. Rather, they represent economic benefits that are forgone as a result of pursuing some course of action. The opportunity cost for Mountain Goat Cycles is sufficiently large in this case to change the decision.

Opportunity costs are usually found in accounting records, as they are costs that must be explicitly considered in every decision a manager makes.

F - Opportunity costs are not usually found in accounting records, but they are costs that must be explicitly considered in every decision a manager makes.

T or F if a cost is traceable to a segment, then the cost is automatically an avoidable cost.

F - That is not true because the costs provided by a well-designed activity-based costing system are only potentially relevant. Before making a decision, managers must still decide which of the potentially relevant costs are actually avoidable. Only those costs that are avoidable are relevant and the others should be ignored.

T or F The benefits from relaxing the constraint are often enormous and can be easily quantified—the key is the contribution margin per unit of the profitable resource

F - The benefits from relaxing the constraint are often enormous and can be easily quantified—the key is the contribution margin per unit of the constrained resource that we have already computed.

T or F If some products must be cut back because of a constraint, the key to maximizing the total contribution margin may seem obvious—favor the products with the highest unit contribution margins.

F - Unfortunately, that is not quite correct. Rather, the correct solution is to favor the products that provide the highest contribution margin per unit of the constrained resource.

T or F adding a share of common costs to the real costs of a segment may make an otherwise profitable segment appear to be profitable

F - adding a share of common costs to the real costs of a segment may make an otherwise profitable segment appear to be unprofitable

T or F If the difference in the net operating incomes does equal to the sum of the differences for the individual items, any cost or benefit that is the same for both alternatives will have no impact on which alternative is preferred.

F - because the difference in the net operating incomes equals the sum of the differences for the individual items, any cost or benefit that is the same for both alternatives will have no impact on which alternative is preferred.

T or F The key to successful decision making is to focus on sunk costs and future costs and benefits that do not differ between the alternatives.

F - relevant costs and benefits as well as opportunity costs while ignoring everything else—including sunk costs and future costs and benefits that do not differ between the alternatives.

T or F the contribution margin must be not be viewed in relation to the amount of the constrained resource each product requires.

F - the contribution margin must be viewed in relation to the amount of the constrained resource each product requires.

T or F Adhering to tradition is the only reason why absorption approach is used

F - you may wonder why the absorption approach is used at all. While the answer is partly due to adhering to tradition, absorption costing is also attractive to many accountants and managers because they believe it better matches costs with revenues. Advocates of absorption costing argue that all manufacturing costs must be assigned to products in order to properly match the costs of producing units of product with their revenues when they are sold.

T or F When assigning costs to segments, The key point is to allocate costs (such as depreciation of corporate facilities) that are clearly common and that will continue regardless of whether the segment exists or not.

False - The key point is to resist the temptation to allocate costs (such as depreciation of corporate facilities) that are clearly common and that will continue regardless of whether the segment exists or not.

T or F Costs should be allocated to segments for external decision-making purposes only when the allocation base does not drive the cost being allocated (or is not correlated with the real cost driver).

False - Costs should be allocated to segments for internal decision-making purposes only when the allocation base actually drives the cost being allocated (or is very highly correlated with the real cost driver).

The first step is to calculate the profit impact of the Retail Stores sales channel disappearing. Then, if sales channel disappears, we assume its sales, variable expenses, and traceable fixed expenses would remain.

False - If this sales channel disappears, we assume its sales, variable expenses, and traceable fixed expenses would all disappear.

T or F Before preparing a contribution format segmented income statement, to provide and use its statements and make decisions, break-even analysis must performed first

False - Once a company prepares contribution format segmented income statements, it can use those statements to make decisions and perform break-even analysis.

T or F "cover the company's common fixed expenses," includes allocating common fixed expenses to business segments that do not artificially inflates each segment's break-even point.

False - business segments artificially

T or F traceable fixed costs are not allocated to segments.

False - common fixed cost are not

T or F only manufacturing costs are included in product costs under absorption costing, which is widely regarded as required for internal financial reporting. To avoid having to maintain two costing systems and to provide consistency between internal and external reports, many companies also use absorption costing for their internal reports such as segmented income statements.

False - external

T or F in a multiproduct company, single product is likely to be responsible for any significant amount of this cost.

False - in a multiproduct company, no single product is likely to be responsible for any significant amount of this cost. Even if a product were eliminated entirely, there would usually be no significant effect on any of the costs of the corporate headquarters building. In short, there is no cause-and-effect relation between the cost of the corporate headquarters building and the existence of any one product.

T or F The segment margin is not the best gauge of the long-run profitability of a segment because it includes only those costs that are caused by the segment.

False - it is the best gauge

T or F common fixed expenses will persist even if a business segment is dropped, they should be allocated to business segments when making decisions.

False - should not be allocated

Costs that can be traced directly to a specific segment should be charged directly to that segment and should not be allocated to other segments. For example, the rent for a branch office of an insurance company should be charged directly to the branch office rather than included in a company wide overhead pool and then spread throughout the company. This is the failure to trace costs directly, which is under ____________- common mistake.

Inappropriate Methods for Assigning Traceable Costs among Segments

First, they do not trace fixed expenses to segments even when it is feasible to do so. Second, they use inappropriate allocation bases to allocate traceable fixed expenses to segments. This is what type of common mistake?

Inappropriate Methods for Assigning Traceable Costs among Segments - In addition to omitting costs, many companies do not correctly handle traceable fixed expenses on segmented income statements.

an undyed wool is called an intermediate product because it is not finished at this point. Nevertheless, a market does exist for undyed wool—although at a significantly lower price than finished, dyed wool.

Intermediate product

explicitly require companies to use absorption costing. Probably because of the cost and possible confusion of maintaining two separate costing systems—one for external reporting and one for internal reporting—most companies use absorption costing for their external and internal reports.

International Financial Reporting Standards

Two or more products that are produced from a common input are known as joint products.

Joint Products

Costs that are incurred up to the split-off point in a process that produces joint products.

Joint costs

are always irrelevant in decisions concerning what to do from the split-off point forward.

Joint costs that have already been incurred up to the split-off point

Two or more products that are produced from a common input.

Joint products

The term joint cost is used to describe the costs incurred up to the split-off point. are common costs that are incurred to simultaneously produce a variety of end products. are often allocated among the different products at the splitoff point. are a common cost of all of the intermediate and end products and should not be allocated to them for purposes of making decisions about the individual products.

Joint-cost

A decision concerning whether an item should be produced internally or purchased from an outside supplier.

Make or buy decision

In such decisions, many qualitative and quantitative factors must be considered. Ultimately, however, any final decision to drop a business segment or to add a new one hinges primarily on the impact the decision will have on ________________________

NOI

the joint costs have already been incurred and nothing can be done to avoid them., what stage is this?

Once the split-off point is reached

The potential benefit that is given up when one alternative is selected over another.

Opportunity cost

An action that increases the amount of a constrained resource. Equivalently, an action that increases the capacity of the bottleneck.

Relaxing (or elevating) the constraint

it is when a manager increases the capacity of the bottleneck

Relaxing or elevating the constraint

A benefit that differs between alternatives in a decision. Differential revenue is a relevant benefit.

Relevant benefit

A difference in cost between any two alternatives. Synonyms are avoidable cost, differential cost, and incremental cost.

Relevant cost

_____________________, combined with the ___________________approach to the income statement, provides a powerful tool for making decisions.

Relevant cost analysis, combined with the contribution approach to the income statement, provides a powerful tool for making decisions.

It represents the margin available after a segment has covered all of its own costs.

Segment Margin

Obtained by deducting the traceable fixed costs of a segment from the segment's contribution margin.

Segment Margin

Dollar Sales for company to break even

Segment fixed expenses/Segment CM Ratio

A segment's contribution margin less its traceable fixed costs. It represents the margin available after a segment has covered all of its own traceable costs.

Segment margin

Variable expenses are deducted from sales to yield the contribution margin for the segment is in what preparation?

To prepare a segmented income statement

U.S. GAAP and IFRS require that publicly traded companies include ___________ financial and other data in their annual reports and that the _____________reports prepared for external users must use the same methods and definitions that the companies use in internal __________ reports that are prepared to aid in making operating decisions. This is a very unusual stipulation because companies are not ordinarily required to report the same data to external users that are used for internal decision-making purposes. This requirement creates incentives for publicly traded companies to avoid using the contribution format for internal ________________ reports. _____________ contribution format income statements contain vital information that companies are often very reluctant to release to the public (and hence competitors). In addition, this requirement creates problems in reconciling internal and external reports.

Segmented Financial Information

are useful for analyzing the profitability of segments, making decisions, and measuring the performance of segment managers

Segmented Income Staement

A decision as to whether a joint product should be sold at the split-off point or sold after further processing.

Sell or process further decision

A one-time order that is not considered part of the company's normal ongoing business.

Special order

The split-off point is the point in the manufacturing process at which the joint products can be recognized as separate products. This does not occur at companiesl until the raw wool has gone through the separating process.

Split-off

That point in the manufacturing process where some or all of the joint products can be recognized as individual products.

Split-off point

Any cost that has already been incurred and that cannot be changed by any decision made now or in the future.

Sunk cost

are always the same no matter what alternatives are being considered; therefore, they are irrelevant and should be ignored when making decisions.

Sunk costs

T or F A typical approach is to allocate the joint costs according to the relative sales value of the end products.

T

T or F Every decision involves choosing from among at least two alternatives. In making a decision, the costs and benefits of one alternative must be compared to the costs and benefits of other alternatives.

T

T or F Fixed costs are not affected by the decision of which products or services make the best use of the constrained resource.

T

T or F Joint costs are irrelevant in decisions regarding what to do with a product from the splitoff point forward.

T

T or F Managers should focus much of their attention on managing the bottleneck. Managers should emphasize products that most profitably utilize the constrained resource.

T

T or F Only those costs and benefits that differ in total between alternatives are relevant in a decision. If the total amount of a cost will be the same regardless of the alternative selected, then the decision has no effect on the cost, so the cost can be ignored.

T

T or F not all costs are avoidable

T

T or F the course of action that will maximize the company's total contribution margin should ordinarily be selected.

T

T or F Idle space that has no alternative use has an opportunity cost of zero.

T

"cover the company's common fixed expenses" is a mistake that companies use

TRUE

has created a single source of authoritative non- governmental U.S. generally accepted accounting principles (GAAP) called the __________ Accounting Standards Codification (__________ codification). Although the ___________ codification does not explicitly disallow variable costing, it does explicitly prohibit companies from excluding all manufacturing overhead costs from product costs. It also provides an in-depth discussion of fixed overhead allocation to products, thereby implying that absorption costing is required for external reports. Although some companies expense significant elements of fixed manufacturing costs on their external reports, practically speaking, U.S. GAAP requires absorption costing for external reports.

The Financial Accounting Standards Board (FASB)

Under the________________, variable costs and fixed costs are clearly distinguished from each other and only those costs that are traceable to a segment are assigned to the segment.

Under the contribution approach, variable costs and fixed costs are clearly distinguished from each other and only those costs that are traceable to a segment are assigned to the segment.

Providing a product or service to a customer involves many steps.

Value chain

A costing method that includes only variable manufacturing costs—direct materials, direct labor, and variable manufacturing overhead—in unit product costs.

Variable costing

To prepare a segmented income statement:

Variable expenses are deducted from sales to yield the contribution margin for the segment.

The involvement by a company in more than one of the activities in the entire value chain from development through production, distribution, sales, and after-sales

Vertical integration

It is when a company is involved in more than one activity in the entire value chain.

Vertically integrated

I. Concentrate improvement efforts on strengthening the weakest link. II. Identify the weakest link, which is the constraint. III. if the improvement efforts are successful, eventually the weakest link will improve to the point where it is no longer the weakest link. At that point, the new weakest link (i.e., the new constraint) must be identified, and improvement efforts must be shifted over to that link. IV. Do not place a greater strain on the system than the weakest link can handle—if you do, the chain will break. Arrange the steps: a. II-IV-I-III b. IV-I-II-III c. III-IV-I-II

a.

The key to making such comparisons is ___________—focusing on the costs and benefits that differ between the alternatives. a. differential analysis b. differential cost c. differential revenue

a. differential analysis

is a cost that can be eliminated by choosing one alternative over another.

avoidable cost

This occurs if the segment break-even calculations do not include the company's common fixed expenses.

if sum of he segment break-even sales figures is less than the companywide break-even point

A difference in cost between any two alternatives is known as a a. differential analysis b. differential cost c. differential revenue

b. differential cost

The constraint, or , in the system is determined by the step that limits total output because it has the smallest capacity

bottleneck

Effectively managing an organization's constraints is a key to ____________

increased profits

A difference in revenue between any two alternatives is known as a. differential analysis b. differential cost c. differential revenue

c. differential revenue

What is the first step in calculating the profit impact of a decision?

calculate the profit impact of the Retail Stores sales channel disappearing.

anything that prevents you from getting more of what you want. Every individual and every organization faces at least one _____________.

constraints

This may cause managers to erroneously discontinue business segments where the inflated break-even point appears unobtainable.

cover the company's common fixed expenses

managers will often allocate common fixed expenses to business segments when performing break-even calculations and making decisions.

cover the company's common fixed expenses

These are the three methods that increase the capacity of the bottleneck that are particularly attractive because they are essentially free and may even yield additional cost savings. 1. Focusing business process improvement efforts on the bottleneck. 2. Reducing defective units. Each defective unit that is processed through the bottleneck and subsequently scrapped takes the place of a good unit that could have been sold. 3. Subcontracting some of the processing that would be done at the bottleneck. 4. Investing in additional machines at the bottleneck. 5. Shifting workers from processes that are not bottlenecks to the process that is the bottleneck. 6. Working overtime on the bottleneck. a. 1-2-3 b. 5-3-2 c. 6-1-4 d. 5-1-2

d.

By pooling demand from a number of companies, a supplier may be able to enjoy _______________________. These _________________________ can result in higher quality and lower costs than would be possible if the company were to attempt to make the parts or provide the service on its own.

economies of scale

In computing the profit impact of a decision, what is the quickest way to summarize financial impacts?

focus on the segment margin.

What does a company do if it has more than one potential constraint? The proper combination or "mix" of products can be found by use of a quantitative method known as ___________________, which is covered in quantitative methods and operations management courses.

linear programming

A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier, is called a _______________ decision. Quite often these decisions involve whether to buy a particular part or to make it internally. ______________ decisions also involve decisions concerning whether to outsource development tasks, after-sales service, or other activities.

make or buy

also need to be considered when making decisions. is the potential benefit that is given up when one alternative is selected over another.

opportunity cost

A ________________number in the Differential Costs and Benefits column indicates that the difference between the alternatives favors the new machine; a _________________number indicates that the difference favors the current situation. A _____________in that column simply means that the total amount for the item is exactly the same for both alternatives.

positive; negative; zero

Differential costs and revenues are relevant to decision making, whereas costs and revenues that do not differ between alternatives are irrelevant to decision making. Because differential costs and differential revenues are the only inputs that are relevant to decision making, they are also often referred to as ________________________

relevant costs and relevant benefits.

From a decision-making point of view, the ________ is most useful in major decisions that affect capacity such as dropping a segment. By contrast, as we noted earlier, the _____________ is most useful in decisions involving short-run changes in volume, such as pricing special orders that involve temporary use of existing capacity.

segment margin ; contribution margin

provide information for evaluating the profitability and performance of divisions, product lines, sales territories, and other segments of a company.

segmented income statements

They should also make sure that products are processed smoothly through the bottleneck, with minimal lost time due to breakdowns and _____________.

set ups

Managers must often evaluate whether a ________________ should be accepted, and if the ___________ is accepted, the price that should be charged. A ________________ is a one-time order that is not considered part of the company's normal ongoing business.

special order

is a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do.

sunk cost