Accounting 2620 Exam 1 + 2 + 3 + 4
There's a catch...
The wage expense could have been higher because we PAID A HIGHER WAGE RATE (e.g. overtime) OR because our employees WORKED LONGER HOURS. Similarly, the unfavorable variance for supplies expense could have occurred because WE USED MORE SUPPLIES than we thought we would OR because SUPPLIES COST MORE than we thought they would.
Drawback to the weighted-average method
The weighted-average method merges units and costs in beginning inventory with units and costs of work done in the current period. This makes cost control and performance measurement more difficult. When you're evaluating a manager's performance for the current period, the data are ACTUALLY from several periods blended together (diff managers). It would be ideal to see how the manager did controlling costs THIS SPECIFIC PERIOD. to address this issue, firms can use the FIFO method of process costing.
ABC is most helpful when...
There is a paradox (products the company produces well are not profitable according to the traditional cost system, but products that it struggles to produced are deemed profitable) There are large disparities in resource usage (e.g. one product is clearly using more resources than another, but the traditional system is not capturing this) The industry is characterized by fierce price competition (you can't afford to price your product incorrectly and need the most accurate information possible) Your firm is highly automated (if a high proportion of costs are overhead, finding a better way to allocate those costs instead of one arbitrary measure) is critical
Key Takeaways Transfer Pricing
There is no transfer pricing system that works well in all situations. The goal is always to maximize the total profit of the entire firm.
The weighted-average method of process costing
This method averages all costs (across multiple periods) and assigns them to units . This produces a cost/equivalent unit. SIMPLEST METHOD, BUT LEAST ACCURATE (because it blends costs from multiple periods) *we will use the weighted-average method for all computations*
Production method example
Timber is harvested (300,000 cost)--> Timber is processed (100,000 cost)--> lumber (800,000 sales value) and wood chips (10,000 sales value). WOODCHIPS= BYPRODUCT. We don't need to allocate any costs (no joint costs, since the wood chips aren't a joint product--> the lumber gets the entire 400k in costs). However, the SALES value of the woodchips (10K) reduces this period's TMC by 10K.
Sales Method example
Timber is harvested (300,000 cost)--> Timber is processed (100,000 cost)--> lumber (800,000 sales value) and wood chips (10,000 sales value). We don't need to allocate any costs (no joint costs, since the wood chips aren't a joint product--> the lumber gets the entire 400k in costs). When we do sell the woodchips, we recognize $10,000 of "other revenue", and the journal entry isn't made until the woodchips are SOLD.
The basics of job-order costing
To determine the production cost per unit at a manufacturing company, you would: 1) assign manufacturing costs to a specific job, 2) divide the total cost of the job by the number of units produced in that specific job (ASSIGN MANUFACTURING COSTS TO JOB, DIVIDE COST/# UNITS IN JOB)
Traceable vs. common fixed costs
Traceable fixed cost of a segment would disappear if the segment were eliminated (e.g. Walmart's corporate office in France. fixed cost, but traceable to walmart international). A common fixed cost supports one or more segments, but would not disappear if one particular segment were eliminated (e.g. CEO of Walmart Doug McMillan's fixed cost, but salary cannot be traced to one specific segment of Sam's club, Walmart International, and Walmart US).
Transfer Pricing issue
Transfer pricing is a contentious issue. Every divisional manager wants their division to look good, so disputes over the transfer price occur frequently. People try to maximize the performance of their division at the expense of the firm. *the goal of transfer pricing is to get the divisional managers to act in the best interests of the company as a whole*
Types of variable costs
True variable cost: the cost of the resource varies in DIRECT PROPORTION to the activity level. Step-variable cost: the resource is obtained in large chunks, so the total costs vary when the activity level reaches certain thresholds
Work in Process (WIP) Inventory
Tumbleweed employees use the lumber to begin physically constructing the home (DIRECT LABOR) The factory also incurs other costs such as the electric bill (MOH). Some of the Raw Materials Inventory is reduced (transferred to WIP inventory). WIP inventory consists of PARTIALLY COMPLETED UNITS (like partially completed tiny home)
Finished goods inventory
Tumbleweed finishes the home. COSTS are transferred from WIP--> finished goods.
Who sets the managerial accounting standards?
US Financial accounting standards are set by the FASB. MANAGERIAL ACCOUNTING DOES NOT HAVE FORMAL STANDARDS (exception: companies that procure government contracts must follow cost accounting standards set by the federal government; this is to prevent firms from overcharging the government, since most government contracts are on a cost-plus basis--> paid more (plus) a specific agreed amount of money for profit)
ABC for a service provider
US postal service. frequently criticized for inefficiency. US postal service--comparing how much it costs to serve 2 diff routes (729 and 451). cost pool/activity level=activity rate. assign costs to each route (using level). Route 451=more expensive (more overhead), perhaps more mileage with greater distance between boxes.
Why the differential effect?
Under absorption costing, when a company produces more than it sells in a period, some of the fixed MOH is not immediately expensed--it attaches to inventory and is not expensed until the inventory is sold later. variable costing expenses all FMOH immediately.
Rate Variance (Labor) WHY UNFAVORABLE
Unfavorable rate variances may be caused by: -not factoring the effects of a pay raise into the standard rate -overtime wages -staffing issues (e.g. someone quit, and an employee who makes more money is doing the work of the person who quit)
Assumption of Constant Costs
Variable costing is often used to determine whether to increase production by a specific amount to accept an additional customer order. when making the decision, it is usually assumed that the variable costs/unit will be the same. But what if the employees are already working at full capacity, and accepting the extra order would force them to work overtime (where they get paid time and a half?)
Real-World Application
Variance analysis is common. One former student was asked to analyze variances at AB InBev. Marygrove consulting group analyzes variances for IT departments using Apptio.
Analyzing variances
Variances are inevitable, so investigating every single variance is a waste of resources. Some companies come up with a decision rule (e.g., they only investigate variances that exceed a certain dollar amount)
Additional issues with standard costing
Variances can be misleading. "Favorable" can sometimes be unfavorable. (e.g. Using less ingredients, but there is more water in the soup. want variance at 0 b/c more is waste and less is unhappy customers). Managers can engage in suboptimal behavior to improve variances
Example 1: make or buy
Walmart laid off 569 accounting and finance workers and outsources the work to the NY firm Genpact. Walmart's operating margin had been shrinking, so it outsourced this work to (hopefully reduce operating expenses).
Example: walmart
Walmart says that each segment's expenses include "certain corporate overhead allocations". would the corporate overhead disappear if walmart sold off one of its segments? Why then might Walmart allocate corporate overhead to each segment? Walmart wants to remind its divisional managers that corporate-level costs exist and need to be covered for the company to remain in business.
Ending Inventory Budget
We also need to calculate COGS for the budgeted income statement ending inventory for the budgeted balance sheet.
Key takeaway
We shouldn't compare the actual results to the results budgeted at the beginning of the year. (SHOULD NOT COMPARE ACTUAL AND BUDGETED)
Relevant Costs
We want to focus on costs that are relevant (avoidable). 2 types of costs are NOT relevant when making decisions: 1. sunk costs 2. future costs that do not differ between alternatives
*Note about job order costing*
We will assume companies use ABSORPTION costing. It means that they assign BOTH variable and fixed MOH costs to jobs. Also, service companies can use job-order costing as well, but the calculations only use nonmanufacturing costs (law firms=costs/case)
Accounting for byproducts
We will discuss 2 methods of accounting for byproducts: the production method and sales method
Methods of Allocation
We will discuss three ways of allocating joint costs: 1. Relative Sales Value Method 2. Physical Units Method 3. Net Realizable Value Method
Example: DeLorean EXCESS CAPACITY
We'll do an example with DeLorean. Assume it has two departments. Engine department (sells engines)--> car department. Excess capacity: engine department has 1200 in variable costs. would be happy receiving at LEAST 1200 from the car department. the car department won't pay more than 1450 b/c can supply from outside the firm. If the engine department can only sell 30,000 engines to outside customers, there is EXCESS CAPACITY because it makes 70,000 engines. Thus, any transfer price ranging from 12500-1450 would be acceptable.
Comparison: FIFO vs Weighted Avg.
Weighted Average: EU production are found by EU= units transferred out + EU in ending WIP FIFO: EU production are found by EU= units transferred out + EU ending WIP + EU in beginning WIP to be completed (e.g. 100 units, 80% done, 20 units to be completed)
Why is this relevant?
When Tesla's battery division sells a battery to Tesla's automotive division, what price should the battery division charge? The price charged by one division to another is called a TRANSFER PRICE. battery division (charges a transfer price) to automotive division.
How do we assign costs to a job?
When a customer places an order, we create a job ticket. We then: charge DIRECT COSTS to that job, allocate INDIRECT COSTS to that job
When to use process costing
When a large volume of an identical product is produced, it would be inefficient to track the cost of each individual product. Process costing avoids this inefficiency by assigning every unit the same cost. (IDENTICAL, so can assign all SAME)
Example 2: make or buy
When an Airbnb cofounder set up the initial payments system, he used a cloud payment system developed by Amazon. The other cofounders didn't like the Amazon system because it: wasn't user friendly, promoted amazon too much. Airbnb ditched the system (temporarily going with paypal) and built its own payment system. (AWS--> OWN! made rather than bought).
Example (SG&A Budget)
When calculating the actual cash disbursements, we BACK OUT DEPRECIATION (it's a non-cash charge). use budgeted sales to calculate, subtract depreciation.
Allocating joint costs
When deciding when to sell a joint product or process it further, we ignore joint costs because they occurred before the split-off point and are sunk. However, we MAY need to allocate joint costs to joint products in order to: calculate ENDING INVENTORY and COGS, determine the product cost so we know what to charge for COST-PLUS government contracts, submit a defensible INSURANCE CLAIM if our inventory is destroyed in a fire or a natural disaster. Joint costs are also relevant when you're evaluating the profitability of the entire firm.
Origins of accounting
accounting records have been kept for thousands of years. Some of the earliest forms of writing are accounting records written on clay tablets. Over time, a system of double-entry accounting came into common use. A venetian monk discussed the basic principles of this system in a textbook in 1494. These principles formed the basis for Financial accoutnign as we know it today
examples of activity measures
activity: set-ups, customer orders, order size, customers, product designs, suppliers activity measure: number of set-ups, number of customer orders, machine hours, number of customers, number of products, number of suppliers, number of visits to suppliers, number of shipments
Joint costs
allocated to products for the purpose of determining the ending inventory balance and COGS. Joint costs are irrelevant in decisions regarding what to do with a product after the split-off point. Once the split-off point is reached, joint costs are SUNK. This is critical to rememver when deciding when to: 1. sell a product as is or 2. process the product further and sell it at a higher price (sell or process further)
Profit margins in the grocery industry
amazon bought whole foods--very low contribution margin/unit, don't get much from each sale. also, high fixed cost. Thus, breakeven point (UNITS)= HIGH. grocery stores have to sell a lot of product to break even. Grocery stores don't want to hear that amazon is in their industry. Razor thin margins and high breakeven point. For Kroger--> you buy $200 groceries, they make $3. Can't enter a price war, amazon doing bricks and mortar is worrisome.
Example 2
an accounting firm says the standard time to complete an individual tax return for a filer who is single and does not itemize is one hour. Fitz's root beer says the standard amount of beef per burger us .25 pounds.
Cost Driver
an activity that causes a cost to be incurred. (e.g., the number of orders DRIVES labor costs at amazon. When amazon receives more orders for the holidays, Amazon hires more pickers for its warehouses (more orders lead to more warehouse picks, which requires more pickers))
Example
analyzing a hospital, cost driver=patient days. This is the total number of days spent in the hospital for each patient who was admitted during the period and left the hospital during the period. (e.g. tom was in the hospital for 10 days and Rachna for 37 days, the total patient days would be 47). Static planning budget--assuming 25,000 patient days. actual patient days= 27,000 days, flexible budget is different. compare the flex budget to actual results and there are unfavorable and favorable variances.
joint costs
any costs incurred before the split-off point
the linearity assumption
aside from step-variable costs, we typically assume a LINEAR RELATIONSHIP between TVC and volume. but in the real world, they may exhibit other patterns (e.g. curvilinear)
FIFO method of process costing
assigns costs to units BASED ON THE PERIODS IN WHICH THE COSTS WERE INCURRED. work done on beginning inventory (before the current period) is treated SEPARATELY from work done in the current period. This method is more accurate. It doesn't mix costs incurred in the current period w those in the prior period. *MORE ACCURATE, check on specific managers*
High-Low Method
assuming there is a linear relationship between the cost and the activity, we can calculate the VARIABLE COST/UNIT by finding the slope of the line. CALCULATION: (COST @ high activity level - COST @ low activity level)/(high activity level- low activity level). Once we know the variable cost at a certain level, we can back out the fixed cost
Example: CVP many products
baby friendly airlines. has 1 plane, 2 types of tickets: 1st class and coach. we have data for selling price/unit, VC/unit, unit contribution margin, number of seats available on plane. can use to create SALES mix.
Gymboree case
bain capital did an LBO (leverage buyout). Doing well until LBO from bain capital. 2017 went bankrupt, 2018 went bankrupt again. $1.2 billion borrowed. Needed collateral when Bain acquires gymboree---> gymboree's assets are its collateral ($ that is borrowed is secured by assets of target that is acquired). GYMBOREE PAYS NOT BAIN. LBO: want a company with hard assets that can serve as collateral and a predictable stream of cash flow to service debt (e.g. mortgage, house itself is also collateral). Bain capital will turn around this company--even in recession, can still buy? BUT PERFORM POORLY. KPI decreases, before bain, downward trend, change in consumer preferences, bain wants to turn around. often, consulting companies are SEAGULLS--> fly in, leave a dump on a manager's desk, and leave. BCG split into three parts, Blue, red, green. Stayed for longer and promised results (e.g. a higher stock price). Bill bain started bain & co not as many clients, but long term results. "bain capital" equity in these companies but also get capital. Working capital and cash decreases, didn't happen on purpose!
Alternative Applications of the Balanced Scorecard: Discussion
balanced scorecard and policing. the number one metric typically used is number of arrests--i.e. more crime problems lead to more money. but, would arrest people for minor offenses (not really serving the community). Rewarded the more arrests you make. should administer surveys to assess the quality of policing (can be used in alternative contexts)
Example with Journal Entries: sequential process costing
bookman makes books using 2 sequential departments: printing and binding. the book pages are first printed, then transferred to the binding department. The books are transferred to finished goods inventory after they are bound. (PRINTING--> BINDING --> FINISHED GOODS). If the period began with 0 WIP for printing and 0 WIP for binding, the ending balances of WIP would be 150,000 and 620,000 respectively). PROCESS: DM placed into production: printing. DL incurred: printing. MOH applied: printing. printing transfers partially-completed books to binding. DM placed into production: binding. DL incurred: bining. MOH applied: binding. ENDING WIP PRINTING: DM + DL + MOH - Cost of goods completed and transferred out. ENDING FINISHED GOODS: cost of goods completed printing + DMbinding + DL + MOH - cost of goods completed and transferred out
Connecting Pinterest and Facebook
both continuing to grow, but driven by international users. Downside is that they have a hard time monetizing these international users. Don't get a lot of money from users internationally. Pinterest's income statement: we see that revenue increased by 60%, but the previous analysis gave more detail.
is budgeting a waste of time?
budgeting itself is not the problem. the compensation to budget people low ball you an try and get people to hit this budget. outlined problems with budgeting and said the problem is not budgeting itself, but when WE TIE REWARDS TO NUMBERS IN THE BUDGET. "bonus to hit target"
demoralized workforce
budgets that are unrealistic (too ambitious) can demoralize employees or encourage them to engage in bad behavior
Direct costs
can be EASILY traced to a cost object. e.g., the cost of aluminum used to produce a soda can is a direct cost of the soda can. E.g. Dean Taylor's salary is easily traceable to the Olin Business School
how is contribution margin ratio useful?
can calculate the break-even point in terms of sales dollars--the amount of sales revenue we must generate to break even. (COMPARED TO THE NUMBER OF UNITS)
margin of safety percentage
can calculate the percentage by which sales revenue can drop before we start losing money
Subdividing product costs
can divide into prime cost and conversion cost
Budgeted Income Statement
can use the information from the other budgets to prepare the budgeted income statement (sales, COGS, gross profit (sales-COGS), SG&A expense, operating profit, interest expense, net income)
committed fixed costs
cannot be reduced in the short term without making fundamental changes to the business (e.g. your factory is located in NJ where it pays a substantial amount of real estate taxes). you could reduce these taxes, but you'd have to make a major change (shut down your factory and outsource production, relocate your factory to a different state. these are SUBSTANTIAL CHANGES, so cannot change in the short run. e.g. borders and radioshack, went bankrupt, but year before still had profitable stores. did not have money to close unprofitable stores, can't do that when you have a 20 MONTH LEASE (severance, lease termination)
Example (cash budget)
cash (beginning balance)= the cash you start with. add cash receipts, get total cash available. subtract cash disbursements (DM, DL, MOH, SG&A), get excess (deficiency) of cash available. Financing=borrowings/repayments. Cash (ending balance) is cash you end with. (CASH ADD RECEIPTS SUBTRACT DISBURSEMENTS, GET AVAILABLE CASH. ADD FINANCING= ENDING CASH BALANCE). Example, the company has a CASH DEFICIENCY Q1 and Q2, can compensate for this by borrowing money.
selling costs
commissions paid to Tumbleweed's sales force. Rent or depreciation expense for SALES OFFICE (cost to SELL PRODUCT)
Types of fixed costs: committed and discretionary
committed: CANNOT be reduced in the short term (depreciation on buildings and equipment). discretionary: CAN be reduced in the short term (advertising, R&D--> e.g. higher education, easier to cut the cost of advertising than it is to change the fixed cost of a lease. in the short run, ^ profit, but in the long run, not good to spend less on R&D and ads.)
types of segment reporting
companies may disaggregate their financial information by: Geographic region (US vs International), Product line (cars vs trucks), and Customer type (personal clients vs corporate clients)
CVP with multiple products
companies often have more than one product. the sales mix refers to the combination of products sold by the company. the sales mix is important because different products have DIFFERENT selling prices and contribution margins.
EXAMPLE: TDABC
consider a customer service department with 567,000 in total costs and 3 cost pools. 1. calculate the practical capacity (employees*workdays*minutes) 2. calculate the capacity cost rate ($cost to supply capacity/practical capacity = capacity cost rate) 3. estimate the time it takes for each activity (can use stopwatch) *CAN ALLOCATE COSTS. multiple unit time * quantity for total minutes. then take total cost and multiply by capacity cost rate
Application: M&A cost savings
consultants are sometimes hired to estimate the cost savings from a merger. As part of this process, consultants: analyze cost behavior (fixed vs variable), assess which costs can be eliminated b/c they are redundant (e.g. if pepsi acquires a small soda company doesn't need trucks). estimate cost savings from reduction in headcount (don't need 2 HR departments, can combine)
side by side comparison (absorption vs variable)
cost per unit for absorption is different each month. in feb, some of the fixed MOH is deferred to march. but for VARIABLE, cost is same per month because FMOH is immediately expensed (period). Absorption shows a PROFIT for feb, but variable shows a LOSS because FMOH is expensed and not deferred (operating profit is diff)
Strange Donuts discussion
costs: rent, labor, equipment/assets, raw materials, utilities, branded materials (sign), PR/marketing, Trademark! (stay strange), license selling food manager: want someone who s honest, extra cost for new business Throwing away donuts already produced is NOT a sunk cost because can sell the donut, but it will cost MORE in the long run. Cares about quality, doesn't want a bad donut. Employees: if it's not a good donut, throw it out and don't ask, made employees know that they are valued, low turnover, people stay for YEARS! Franchising=less costly. Teaching new owners/franchisees, building a brand, uniform experience/standardization of product(e.g. McDonalds quality food) pitch concepts to find franchisees, legal contracts with franchisees, Costs SHIFT (sugar/rent --> training, ads, standardizing processes)
Case Study: Boeing
Why does managerial accounting matter to Boeing? Boeing uses managerial accounting to: Know its costs, calculate its inventory balance, and for the useful metrics. 89% of revenue is from the US government, global services=34%. cost-plus contracts versus fixed-price contracts (cost plus= what happens if you don't give $? Profit at end? fixed price= you want to build a fighter jet, what can you build it for) If Boeing has COST OVERRUNS, IT CAN LOSE $. Boeing builds its own inventory. inventorial costs: Raw materials, WIP, finished goods. add three amounts together to get costs. flow into COGS. Boeing uses non-GAAP measures of earnings (core operating earnings, core operating margin, core EPS--> excludes pension and post retirement) Deliveries--> tracks # of deliveries. Backlog--> someone ordered a plane, hasn't been delivered. Why is this valuable? NUMBER OF DELIVERIES TRENDING DOWN, BACKLOG UP. PRODUCTION ISSUE! Divisions: -Boeing commercial airplanes -Defense, space, and security -Global services (sometimes provides service to other segments) -Boeing Capital *majority of revenue and profits come from commercial airplanes, but revenue growth, profit margin, and ROA is global services* Transfers within Boeing--> boeings divisions sell products to each other. Market-based transfer price (whatever you would charge another company) Cost-based (how much does it cost) Negotiated--> work it out amongst yourself PREDICT FUTURE 20 year forecast in 10K (most people do 5!)
Nonmanufacturing costs
With a manufacturing firm, Job-order costing typically focuses on manufacturing costs ONLY. However, it might make sense to include nonmanufcaturing costs if they ARE RELATED TO A SPECIFIC JOB. (e.g. the cost of a marketing campaign, warranty costs, field service repair costs, customer service costs, sales commission costs.) Inclusion of nonmanufacturing costs would NOT be acceptable when it comes to GAAP (e.g., for calculating COGS), but it can be useful for internal decision-making.
The regression model
Y= a + bX. Y (dependent variable)= total cost. a (intercept)= the estimate of fixed cost. the coefficient (b) is the variable cost per unit of activity. the activity (x) is the independent variable. more specifically, we are regressing the following model: Total cost= intercept + number of guests + residual. OLS fits a line by minimizing the sum of the squared residuals.
Additional notes about budgeting
You can do flexible budgeting with MULTIPLE COST DRIVERS. DONT assume that ALL COSTS ARE FIXED. this is what happens when you compare the static planning budget to actual results; you're assuming that costs don't change based on the activity level. DON'T ASSUME THAT ALL COSTS ARE VARIABLE. This is what happens when you assume that a 10% increase in activity level would result in a 10% increase in costs (and therefore a 10% increase in operating profit)
What if materials purchased does not equal materials used?
You can't compute a total variance, but you can still compute a price variance and quantity variance separately. FOR PRICE VARIANCE USED MATERIALS PURCHASED FOR QUANTITY USE MATERIALS USED.
A third approach to under/overapplied MOH
You could hypothetically go back and remeasure the cost of each job once you know what the actual MOH is at the end of the period. This is the ADJUSTED ALLOCATION-RATE APPROACH. We will not do this method in class/a company does NOT have to do this.
Job-order costing for a service firm: Ashley Madison
You have been hired as a consultant to...Ashley Madison. They want to develop an image that is "family friendly".
Charging direct costs to a service job
You might incur the following direct costs (CONSULTING/service). Employee wages (aka, billable hours), travel costs, lodging and meal costs, office supplies.
Variable costing GAAP
You need to prepare two sets of financial statements. Absorption costing for EXTERNAL use and variable costing for INTERNAL use. variable costing doesn't comply with GAAP
Participative Budgeting
You prepare the budget with the cooperation and participation of managers at all levels. Some organizations impose budgets from the TOP DOWN. While high level managers know the company's strategy, front-line managers have more accurate information about day-to-day activities. MOTIVATION IS HIGHER when people are included in a process that affects them.
Continuous Budgeting
You roll the budget forward each month (or quarter) after the current month (or quarter) is completed. (ROLL IT FORWARD WHEN MONTH IS COMPLETED). Let's say you have a budget that begins with January 2019 and ends with December 2019. After January 2019 is over, you roll the budget forward one month. Now the budget begins with February 2019 and ends with January 2020. You have to spend time updating forecasts every month/quarter, more time-consuming.
Schedule of Expected Cash Disbursements for Inventory
You should also prepare a schedule of cash disbursements for inventory purchases. For simplicity, BB of a/p is 0. purchasing one unit is $13, company pays for inventory the same quarter it purchases it.
Prorating example
Your company had 2 jobs: Job A and Job K. $100 MOH= Job A (WIP) $300 MOH= Job K (WIP) Job K was completed (finished goods) 50% of the Job K units were sold (COGS) THUS: Job A: 100--> WIP Job K: 150 finished goods, 150 COGS ACTUAL MOH is $450, but SHOULD BE $400 by proration. Underapplied by $50. We didn't allocate enough overhead. WIP, FG, and COGS are LOWER than they should be. We fix this by adding a PORTION TO EACH AMOUNT. (take the percentage of estimated MOH and apply appropriate percentage to the underapplied. (table: amount, percentage, underapplied overhead, (%*underapplied/overapplied) amount to be added--> should total to underapplied overhead)
Example: sunk cost
Your friend Kubo borrowed 100,000 in student loans to get a master's in puppetry. No longer wants to be a puppeteer-- wants to work at taskrabbit. "I have to become a puppeteer, or the 100,000 was a waste of money! Is this correct?. No the 100,000 is a SUNK cost! not recoverable!
The return of ZBB
ZBB made a comeback in the past few years. Hundreds of large firms (Kraft Heinz, Walgreens, Coca-Cola) have adopted ZBB. All large consulting firms offer ZBB. ZBB CAN REDUCE SG&A BY 25% IN MONTHS
Negative Stigma of ZBB
ZBB was pioneered at Texas Instruments in the 1970s, but it fell out of favor. ZBB=draconian. People didn't like having to justify how much money they were spending on copies, corporate travel, or gatorade. ZBB also leads to LAYOFFS.
Example: customer profitability
a bank offers special benefits to "premier" customers. traces direct costs to each consumer type. allocates support costs based on each customer type's relative share of total revenue. this analysis implies premier customers are more profitable than other customers. BUT could use ABC and separate into cost pools. find activity that causes the support costs, subdivide the support costs into cost pools, calculate activity rates for each cost pools. then get activity levels, find NON PREMIER CUSTOMERS ARE MORE PROFITABLE. premier are profitable too, but aren't as valuable as we thought
inaccuracy
a budget is only as good as the assumptions that go into making it
Example: cost behavior
a company wishes to reduce its manufacturing costs. Thus, it has decided to cut production of one of its product lines. Will this reduce the cost of: direct materials? YES direct labor? YES equipment maintenance? if we reduce production, there will be less maintenance, but still some maintenance factory rent? NO. janitorial? NO.
mixed costs (aka semivariable)
a mixed cost contains both a variable and a fixed component. SEMIVARIABLE
merchandise purchases budget
a retailer must prepare a budget to figure out how much INVENTORY it should purchase. I assume the desired ending inventory is 20% of next quarter's budgeted sales. SIMILAR TO PRODUCTION BUDGET IN FORMAT. required purchases instead of required production.
Job-order costing
a system for assigning costs to a job or project. A "job" could be: an order for a piece of furniture, catering for an event, the construction of a building
what is activity-based costing?
a system that provides more accurate information for internal decision-making can be used by any type of firm, but NOT ALL FIRMS USE IT
A cost system
a way to calculate the cost of producing a good or service
Byproducts
When the production process creates 2 or more products (from the same input) that have high sales values, they are known as JOINT PRODUCTS. If there is an additional product produced that has a relatively low sales value, it is known as a BYPRODUCT. We NEVER assign joint costs to a byproduct! So how do we account for it?
Why do we use the budgeted overhead? Wouldn't it be better to use actual overhead?
When we are completing the job cost sheet, we don't yet know what the actual overhead for the period will be. Thus, we use the amount we estimated at the beginning of the period. This is called "normal costing" (as opposed to "actual costing")
What is decentralization?
When we say that an organization is "decentralized", we mean the authority to make decisions in spread THROUGHOUT the organization rather than being confined to a few top executives
Real life examples of Time-Driven ABC article
hospital doing procedure, struggled to keep less than the medical reimbursement rate. used TDABC to calculate a rate/min of diff job category (doctor vs technologists). mapped process--> improvement is that MRI technologists give hormone instead of doctor, doctor makes more $ and is not always available. LOWER COST AND WAIT TIME. but users might not see related benefits. TDABC NOT JUST USED FOR MANUFACTURERS
standard costing
how do we know whether we got a good price or used too many resources? we compare the price paid (or the amount of resources used) to a STANDARD. Why it is called standard costing
Degree of operating leverage
how sensitive sleepbox's operating profit is to a given percentage change in dollar sales. DOL= contribution margin/operating profit. it is a measure, at a given level of sales, of how a % change in sales volume will affect profit.
How are manufacturing costs capitalized to inventory? TUMBLEWEED TINY HOMES
how we take costs and put them to inventory?
ideal vs practical standards
ideal standards are achievable under the best circumstances (everything goes right) Practical standards allow for machine downtime, employee rest, bathroom breaks, etc. (there is an inherent conflict here. We want to aim for perfection (zero waste) but this can be DEMORALIZING for employees who don't achieve the goal))
conversion costs: side note
if MOH costs are allocated based on DL costs, you can combine DL + MOH into conversion costs. (if allocated based on something else --> e.g. machine hours--> need to calculate EU for DL and MOH separately)
issue
if a company uses a fixed completion percentage (the solution to the previous issue raised) a manager can say that more goods are now in process (even though no work is being done on those goods) to reduce the amount of costs transferred out of the department in the current period (to make the division appear more profitable). solution: set up a NOTIFICATION to alert you whenever a large amount of units suddenly becomes "in process" the last week of a period. Alternatively become friends w/ line workers in production and ask for heads up
Note about sales budgets: credit
if some of your sales are CREDIT sales, you MIGHT NOT COLLECT all your Q1 sales in Q1. Thus, you need to create a SUPPORTING SCHEDULE to estimate how much cash will be collected each quarter. Use this when preparing the cash budget.
why does unit contribution margin matter?
if the unit contribution margin is $500, it means that every tuime we sell one unit we can generate $500 that can be contributed towards our fixed costs. It tells us how many units we need to cover our total fixed costs and break even.
The total variance
if we just look at the spending variance, we see that we paid for and used $43,200 of aluminum to make 800,000 cans. But the cost to make 800,000 cans SHOULD have been 35200. Thus, the total variance is 8,000 (UNFAVORABLE, 43200-35200). can also put price and quantity together to get total, but want to break up into TWO PARTS
why is cost behavior important?
if we understand how costs behave, we can predict how costs will change under various scenarios (cost behavior: understand the nature of the cost--> cost prediction: predict how the cost will change in response to your action)
Example: sunbeam
in the 2nd quarter of 1997, an analyst noted that Sunbeam's inventory increased from $148 million (in Q1) to $208 million. plants were running faster than orders received, sunbeam producing more than it could sell. GROSS MARGIN PERFORMANCE WAS ARTIFICIALLY INFLATED. PRODUCTION>SALES
raw materials assumption
in this class, we assume 100% OF RAW MATERIALS ARE DIRECT MATERIALS (unless the case facts state otherwise). This is the same as saying that none of the raw materials were used as indirect materials.
Disadvantages of budgeting
inaccuracy, biased forecasts, use-it-or-lose-it mentality, rigid decision-making, large investments of time, a demoralized workforce
most important part of flexible budgeting
investigating the source of large variances and addressing potential problems.
Responsibility Accounting
is the person who PURCHASES the supplies responsible for the unfavorable variance? (perhaps not purchasing the supplies at the best price. should speak with the purchasing manager. Are the people who USE the supplies responsible for the unfavorable variance? (perhaps staff members are using more supplies than they should. If so, we should speak with the head nurse.) (USING TOO MUCH OR PURCHASING AT AN UNFAIR PRICE?)
is labor cost fixed or variable?
it depends on how much flexibility management has to adjust the workforce. amazon hires "workampers" just for the holidays. other firms (e.g. Barry-Wehmiller) are reluctant to lay off employees because it hurts morale (LABOR has elements of fixed and variable costs), in this class, DL=variable
caveat: variable costing
it does NOT include all of a company's variable costs in the product cost. it only includes VARIABLE MANUFACTURING COSTS in the product cost. Direct costing is also misleading. Variable costing (aka Direct Costing) includes variable MOH costs, which contain INDIRECT COSTS (e.g. the cost of indirect materials used)
Example: Rent-a-mourner
it has 37 employees and one HR person. If it hires 10 more people, it won't hire another HR person. Thus, the cost of HR wages appears to be fixed. But the cost behaves differently when we hit different thresholds. (50 people, have to hire an HR person)
How good of a fit is out model
it is a very good fit--the number of guests explains about 97% of the variation in total costs. R^2 tells you the percentage of variation in the DV that is explained by the IVs. The adjusted R^2 is sometimes used in lieu of R^2 when the model has a large number of IVs.
Sell or process further
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 costs incurred after the split-off point. (INCREMENTAL REVENUE > INCREMENTAL COST)
Quick Review: joint costs
joint costs are allocated to products for purposes of determining the ending inventory balance and COGS. However, joint costs are IRRELEVANT in deciding what to do with a product after the SPLIT-OFF POINT. Once the split-off point is reached, joint costs are SUNK. This is critical to remember when deciding (sell or process further) to: 1. sell a product as is 2. process the product further and sell it for a higher price
Financial
key questions: are we increasing cash flow for the long-term? are we creating long-term, sustainable value for our shareholders? Measures: revenue growth, revenue per customer, operating profit, earnings per share, return on investment, economic value added
responsibility centers
large organizations create responsibility centers to hold people accountable. COST CENTER: the manager has responsibility for COSTS (e.g. an IT department). REVENUE CENTER: the manager has a responsibility for REVENUES (e.g. a sales office). PROFIT CENTER: the manager has responsibility for COSTS AND REVENUES (e.g. a Panera). INVESTMENT CENTER: the manager has responsibility for COSTS, REVENUES, AND INVESTMENTS IN OPERATING ASSETS (e.g. Walmart Mexico)
example of balanced scorecard: pizza hut
learning and growth: learn about what people want or too long to get pizza. Internal processes: make a pizza people want or train our staff to reduce wait time. Customer: customer happy or customer happy because wait less. Financial: increase performance, more likely to come back. "if you make sure the customer is happy, money will follow"
comparing firms using DOL
let's assume sleepbox and airpod have the same sales revenue and total costs. but higher % of total costs comes from fixed costs (^ contribution margin). airpod has HIGHER DOL
Example: regression analysis
look at data from hut (# of guests, cost of running). can use excel to run a regression or STATA, SPSS, SAS, etc.
Example: Fluffy love
makes clothing for oversized cats. makes overalls and panties. want to compare per-unit product costs. 1. cost pool: customer orders, shipping and handling, customer order size. activity measures: number of customer orders, number of shipments, number of machine hours 2. assign overhead to cost pools (percentage defines time spent on each activity, multiply by overhead to be allocated). 3. Calculate activity rates: divide the costs by activity level and get the rate. 4. assign overhead to cost objects--> multiply activity level by rate and the sum is total overhead allocated. directly assign DL and DM to each product. are not "allocated" because directly traceable to each product. 5. prepare a report: the panty division is losing money. much more shipments and profit is negative (selling price-cost per unit). Analysis: why might one division have more shipments, yet the same number of units sold (and roughly the same number of customer orders) as the other division? panties are back-ordered and back-ordered items are shipped later? talk to shipping people.
supplemental cost system
manufacturers that use ABC MUST ALSO use traditional costing. Traditional costing is required to calculate COGS for external financial statements. Thus, a manufacturer that adopts ABC would need to maintain 2 separate cost systems.
Analyzing mixed costs
mixed costs are quite common. we can analyze them using: -visual-fit method -high-low method -regression method
Sequential departments
most firms have several processing departments through which a product passes. at those firms, costs are accumulated for EACH DEPARTMENT. (e.g. assembly, testing, packaging)
Cost of goods manufactured (COGM)
need for COGS, it is the total manufacturing cost of GOODS THAT WERE FINISHED during the period. COGM= WIP (bb) + TMC - WIP (eb)--> work in process beginning balance + total manufacturing cost (direct materials USED + direct labor + MOH) - work in process ending balance
SG&A budget: retailer
no different than a manufacturer. SG&A= variable SG&A + Fixed SG&A. subtract depreciation because it is a non-cash charge
Process costing
not all manufacturers use job-order costing. Some companies use PROCESS COSTING. The decision on which method to use is based on the nature of the products being manufactured.
comprehensive example: strange donutes
not just "increase sales" as a goal. start with TRAINING, go from training then to process (prompt service), then to satisfaction (customer) and then to sales
using the flexible budget
now that we have determined what revenues and costs should have been (given the actual activity level) we can COMPARE THE FLEXIBLE BUDGET TO THE ACTUAL OPERATING RESULTS.
Can a firm achieve sustained growth?
one way is to compare two things: Lifetime value of a customer (LTV) and cost to acquire a customer (CAC). The LTV should be several times higher than the CAC!
The costs of education
online courses, Mook's=cheaper. "that's it, that's the end of higher education". ^ marginal cost to add students for brick and mortar institutions, but doesn't exist for online classes. coursera= a LOT cheaper than wash u, cost advantage. will mook's undercut on price? NO. ^ dropout rates, how seriously do people take it (e.g. University of Phoenix Online)? issues about perceived quality. Author's argument: Moocs was never going to disrupt/challenge an elite university like Harvard, as we're not paying the money for the lectures, but we're paying for an extensive alumni network, brand, career center, exclusive dating? No matter how cheap the mooc is, is still going to choose Harvard. *ELITE UNIVERSITIES SHOULD NOT FEAR, BUT LESS SELECTIVE ONES SHOULD--"I just need a college degree", moocs can provide that.
Profit Comparison
operating profit was higher under actual than it was budgeted, sales rev ^. The differences: we can look at each line item to see how it is different. For instance, let's examine wages expense. It's HIGHER than we planned. Does this imply we did a bad job controlling the cost?
Olin : quiz A
outsourcing= yes! don't include depreciation, costs allocated to the university, and salary is NOT relevant. only relevant if salary increases or you have to hire another person.
Comparison: participative vs non participative
participative: budget is developed in a collaborative effort among all managers. PRO: motivation is high and low level managers are included and feel like they have some control over the process by which they are judged. CON: low-level managers might try to set targets that are easy to achieve. Non-participative: budget is imposed from the top down; managers are given a profit target. PRO: low-level managers have no opportunity to build slack into the system. CON: low-level managers have more accurate information than executives, yet their input is ignored.
Overhead applied to a job formula
predetermined rate * actual activity for the job
Visual fit method
create a scatter plot and identify a pattern. "quick and dirty method". Example: upper limits organizes mountaineering expeditions. we have data on # of climbers and cost of the expedition (per those climbers). The scatter plot of the data is created. if you draw a line through it, it would intersect the y-axis at around 45,000. FIXED COST OF 45,000/expedition. Can analyze that way.
Large investments of time
creating budgets is time consuming. it can also lead to fights between departments.
Relevant costs case
data centers and investing data. could be cheaper through AWS. but moral implications? MUCH cheaper to use AWS, company involved is large, publicly traded in St. Louis. Data centers are a sunk cost, already invested $50 million in centers. Should they shut down the data centers and use AWS considering the final paragraph when considering if they should shut down (number of people who would lose their jobs, friends). Company DID NOT end up shutting down data centers. From a financial perspective, AWS made sense. but "these people are our friends"--we want to delay this and not let them go (culture). Feels obligation to employees. DOWNSIDE: losing $ but don't want to lay off, end result is bankrupt, ALL FIRED "kicking can down the curb".
the dupont method
decomposing ROI into 2 components: return on sales/profit margin and investment turnover/capital turnover/asset turnover
Rate variance
difference between (AQ x AR) and (AQ x SR). Quantity stays the same, rate changes
Efficiency variance
difference between (AQ x SR) and (SQ x SR), quantity changes, rate stays the same
Price Variance
difference between (AQxAP) and (AQxSP) (price is what is changed and quantity stays same)
Quantity Variance
difference between (AQxSP) and (SQxSP) (where quantity is what is changed and price stays same)
Conversion cost
direct labor + MOH
period costs
do NOT pertain to manufacturing and are NOT capitalized to the company's inventory account.
variation in the time demands for different types of transactions
do we think it takes the same amount of time to service each customer order? (e.g. new vs existing and w each, standard vs expedited) can do regular ABC, but would need 4 more cost pools.
Netflix case discussion
domestic growth vs international growth. International is growing a LOT faster, but not as profitable. Why is international losing money? COST OF REVENUE (cost of creating content, licensing content--> spread over many years, amortization). 2013--> 110% cost of revenue but brought it down to 74% but STILL higher than US. *Growing fastest outside of US. but, until recently, not profitable. bringing down cost of revenue, in future international will be more profitable*. Difference between paid membership= ^ in subscribers, $1 billion in mkt spend to get them this, divide and get cost to acquire. International vs US CAC: 2014 43 vs 52, 3014 59 vs 81. Low hanging fruit, US market is gone, whoever wants netflix already snatched it up. Netflix has SATURATED the US market. Very expensive to get new customers. International, a lot of room to grow b/c still relatively cheap.
automation
due to increased automation, DL has become less important to the manufacturing process. the allocation of overhead using DL costs or hours can lead to distorted product costs.
High Cost of Data Entry
even if you successfully track all of the costs, the cost of data entry will be HIGH if you have millions of jobs
Objectives and Key Results (OKR)
everyone should have their own OKRs. For each objective, key results needed. (e.g. zoom pizza's was to complete their truck delivery fleet). Helps people FOCUS (google, linkedin, slack all implemented). need clear results, everyone should have objectives and there are clear results. (e.g. McLaughlin=exams, work for that company). GIVE SPECIFICS not "we're going to be world class in education".
net realizable value
expected selling price minus any costs incurred AFTER the split off point
What is operation costing?
firms can use a hybrid costing system that includes features of both job-order and process costing. it is helpful when a company manufactures products with SIMILAR CONVERSION PROCESSES and DIFFERENT MATERIALS. direct materials can be tracked by BATCH, conversion costs can be tracked by DEPARTMENT.
note about budgets
firms have many more types of budgets. we will limit the number of budgets we discuss so we don't get overwhelmed. if you come to understand the process, you can make any number of budgets once you enter the workforce. Budgets outlined in BUDGETARY CONTROL
The time frame
firms usually create a budget for a SPECIFIC TIME PERIOD, which is then broken into SUBPERIODS. Most companies have a budget that covers the next fiscal year and is divided into quarters or months. You could create a budget that extends BEYOND one year, but it becomes MORE DIFFICULT to forecast sales the further you look into the future. This is important, because everything depends on the accuracy of the sales forecast.
Trend more towards fixed costs
fixed costs account for an increasing percentage of firms' overall cost structures due to automation (e.g. accounting firms have reduced headcount by using tax software to do tax returns--> previously, firms hired more labor during tax season (labor was variable), the tax software is now purchased at a flat fee, which doesn't change based on how many tax returns are prepared (DON't NEED TO HIRE MORE PEOPLE)
Grocery Store Layouts Discussion
grocery stores don't want a price war. Low CM/unit, high fixed costs, high breakeven point. Deliberately make grocery stores DIFFICULT TO LEAVE (one way doors, checkout/impulse buys, spray fruit, "impulse racks", milk is in the back, music so that you are kept in the store, only windows in front--want you to LOSE TRACK OF TIME. After 40 min, decision-making process breaks down. size of shopping cart is double the size, people buy 40% more.
Outcome of Rumelt case
half of the company's stores were being subsidized by the other half of the stores (cross-subsidization). Rumelt advised the client to close the worst stores and fix the others--the client listened and profit increased DRAMATICALLy
other issues with traditional costing
product costs may be distorted by: increased automation, batch-level costs, large proportion of overhead relative to allocation base
Fixed costs & the relevant range
recall from earlier in the semester: the relevant range is the band of normal activity level or the volume for the cost in question. a fixed cost is FIXED ONLY FOR A GIVEN RANGE OF ACTIVITY LEVELS and for a SPECIFIC TIME SPAN.
step-variable cost
remains constant within a narrow range of activity. the total cost increases when a certain threshold (the next step) is reached
examples of fixed costs
rent, property tax, property insurance, depreciation expense, executive salaries (e.g. CEO). (fixed doesn't mean the CEO's salary will never change, it just means it won't fluctuate during the period in response to the volume of goods and services provided)
Zoom case
revenue, cost of revenue, R&D, pre-covid--> post-covid, sales&marketing, G&A (likely to be fixed). cost of revenue ^, more than triple. more users, more revenue, but also FREE ACCOUNTS. R&D higher in dollars, but lower as a % of revenue. sales and marketing ^, but lower as a % of revenue. G&A up, had to onboard new people. which cost is most likely to be a variable cost? cost of revenue. which cost is most likely to be a fixed cost? R&D. which cost will increase fastest relative to sales rev? cost of rev. if microsoft were to acquire zoom, G&A would decrease fastest (mergers, headcount reduction)
zoom case
revenue--subscription agreements w customers for video-first communications and services. cost of revenue: hosting video-first communications and providing general operating support services--data centers, cloud hosting, etc. R&D: research and development. Sales and marketing: ads, promos, awareness. G&A: personnel-related expenses for finance, legal, HR. COVID-19 on cost of revenue: cost of revenue increased a lot faster than sales b/c expanded data center capacity and third party cloud hosting. COVID-19 on sales and marketing: costs increased but decreased as a percentage of revenue b/c cost of acquiring new customers during pandemic decreased. COVID-19 on R&D: costs increased, but decreased significantly as a percentage of revenue--benefitted from economies of scale. COVID-19 on G&A: G&A costs doubled (more people) as a % of revenue increased slightly and then returned to typical. VARIABLE COST: COST OF REVENUE FIXED COST: R&D another pandemic? cost of revenue will ^ fastest If microsoft were to acquire zoom, G&A would decrease as a % of revenue b/c can eliminate redundant positions.
Budgeted income statement
sales revenue (budgeted sales), expenses (budgeted expenses)--> wages, cleaning, supplies, utilities, rent, insurance, advertising, legal.
Types of period costs
selling costs and administrative costs
Performance Evaluation
some firms primarily evaluate managers based on whether they meet budgeted (or actual) financial targets. This could lead to managers manipulating financial information to get bonuses, win a promotion, etc. These actions destroy value and hurt the company as a whole.
Note on MOH rate
some firms use a single plantwide MOH rate. Other firms use a DIFFERENT MOH RATE for each department using a 2 stage allocation process. Stage 1: allocate MOH to departments. Stage 2: assign manufacturing overhead to jobs using the departmental rate when a job passes through a department
Example: netflix
spent 1.5 billion on tech in the last 12 months. MAJORITY=fixed costs. lots of fixed costs--> riskier. but once you cover all of the fixed costs, can keep the revenue.
process costing shortcut method
split into DM + conversion. convert to EU. completed: (completed/total * total cost), for both DM + conversion. WIP: (WIP/total units * total cost) for both DM + conversion.
Standard costing and product costing
standard costs can be integrated into a manufacturer's financial reporting system (e.g. if you pay $800 cash for raw materials, but the standard says you should have paid $650, you should increase raw materials inventory by $650. This would seem counterintuitive, since you actuallypaid $800, but the other $150 would be recorded in a variance account which is temporary and closed to COGS at the end of the period (e.g. direct materials price variance))
overview of the process
step 1: adjust the static planning budget to what the sales and costs SHOULD have been, given the actual activity level. This revised budget is called the FLEXIBLE BUDGET. step 2: compare the flexible budget to the company's actual results. step 3: identify large differences ("variances") between the actual results and the flexible budget. Determine the root cause and take corrective action.
how do you apply overhead?
step 1: calculate the PREDERMINED MANUFACTURING OVERHEAD RATE: (total manufacturing overhead cost (budgeted for the period))/(total activity level of the allocation base (budgeted for the period)) ***ESSENTIALLY: MOH cost/activity level*** step 2: multiply the predetermined overhead rate by the actual activity level (of the COST DRIVER) for the job (e.g., if the job takes 4 machine hours, $60 of MOH would be applied to the job--> $60=$15*4)
Steps in creating the flexible budget.
take static assumptions and apply the actual number of client visits. FLEXIBLE BUDGET: what should have happened. changed activity level. compare: static budget is based on the BUDGETED activity level, and flexible budget is based on the ACTUAL activity level. Activity variance is the difference between the two.
Example: transferred-in costs
textile company. product must go through the spinning department BEFORE it goes through weaving. Thus, DM and Conversion from spinning are transferred to weaving department's WIP inventory account. When the spinning department finishes working on a unit, it transfers the partially-completed unit (and its associated costs) to the weaving department. (spinning: DM + conversion --> weaving: transferred-in + DM + conversion)
understanding the DOL
the DOL is NOT constant. it is greatest at sales levels near the break even point, and it decreases as sales and profits rise. (when you're barely breaking even, a small increase in sales causes a large percentage increase in profit!). people use the DOL as a quick way to determine the effect various percentage changes in sales would have on operating profit (without having to create income statements)
Economic Value Added (EVA)
the amount by which company profits (revenues, minus expenses, minus taxes) exceed the cost of capital in a given year. Two primary differences between residual income and EVA are: 1. EVA subtracts current liabilities from total assets. EVA uses WACC as the charge for capital. WACC= companywide average cost of capital. total assets--> some firms deviate from GAAP and count R&D spending as an asset.
creating a balanced scorecard
the balanced scorecard should provide a clear picture of the company's strategy and how it will execute that strategy. We need to identify CAUSE AND EFFECT relationships. (no evaluating managers, id we look at nonfinancial metrics, can lead to increased financial performance). If the cause and effect relationships do not exist, we cannot achieve our outcome.
Benefits of vertical integration
the company gains greater control over its supply chain. This can reduce transaction costs (all complex contracts will be incomplete--there will be gaps, errors, omissions, and the like) and can eliminate the hold-up problem.
Allocating indirect costs to a service job
the cost of administrative staff (e.g. receptionist), depreciation of furniture and computers, office rent
step-variable cost example
the cost of instruction at Johns Hopkins. It pays its professors 5,000 per course taught, class size limited to 25. offers courses based on student demand. 25 or fewer enroll, TC=5000. 26th enrolls, TC=10,000. 27th enrolls, TC=10,000. 51st, TC=15,000.
Transferred-in costs
the costs of the product transferred to the next department are called TRANSFERRED IN COSTS. they are treated the same as raw materials by the department that is receiving them; thus, they are assumed to be 100% complete at the start of the process. However, they are presented separately from raw materials and represent partially-completed products.
discretionary fixed costs
the decision of how much to spend is made on a periodic basis. (e.g. Stanford's MBA program budgets $3 million for digital advertising--once set, the amount does not change based on the number of Stanford MBA students (FIXED COST), next year though, can reduce from $3 million to $1 million).
Spending variance
the difference between a cost incurred and the cost that SHOULD HAVE BEEN INCURRED (flex budget). (e.g. supplies expense was 2,360 higher than it should have been, even AFTER accounting for the higher activity level. unfavorable, put a U)
Direct labor
the labor that built the product "touch labor" (the assembly line workers who build the car aka "touch labor")
Regression analysis
the most precise (and most difficult) method for analyzing mixed costs is to run a regression. Assuming certain assumptions are met, we can estimate a regression using OLS (ordinary least squares)
static vs flexible vs actual budget
the operating profit turned out to be higher than the amount that was budgeted. however, the profit was not as high as it SHOULD have been , after adjusting for the higher number of client visits. To determine why profit was lower, we should examine how the actual revenues and costs differ from what should have occurred--> REVENUE AND SPENDING VARIANCES.
Split-off point
the point in the manufacturing process where joint products can be recognized as separate products (can recognize as milk vs cream)
Price and quantity variance favorable and unfavorable
the price variance is favorable; we paid less than the standard. The quantity variance, however, has an 8,800 unfavorable variance. We should only have needed 32,000 pounds of aluminum to make 80,000 cans, yet it took 40,000 pounds (we used 25% more than standard, WORTH LOOKING INTO)
Segment margin
the profit margin for each segment (same as segment profit or segment profit margin). segment CM- segment TFC
Direct Materials
the raw materials used to create the product (the steel used to build a car)
Mixed costs graph
the slope is the variable cost/unit of activity. The y intercept is the FIXED COST (notice it is not 0 as true variable cost is)
what is the standard quantity?
the standard quantity per unit reflects the amount of resources required for each unit of finished product, plus an allowance for waste (RESOURCES REQUIRED + ALLOWANCE FOR WASTE). (the allowance for waste contradicts the zero defects goal & is contradictory to Six Sigma). At many firms, the engineering department creates a "bill of materials" that specifies the amount of resources required to produce a unit
Batch-level costs
there is often a large amount of overhead associated with each BATCH of units produced. example: each time a publisher does book printing, they spend time setting up the printer for the exact specifications of that book. The set up costs to print 3 books are the same as 30,000. If we allocate based on machine hours, the order for 30,000 copies will be allocated significantly more overhead, *SMALL-BATCH JOBS APPEAR LESS COSTLY ON A PER-UNIT BASIS*
Advantages of Budgets
they force people to think about the future. They allow firms to model how different scenarios would play out. They predict cash flows so the company can take steps to make sure it doesn't run out of cash. Can be used to reduce costs with cost reduction targets. They provide forecasted earnings that can be shared with investors.
quantity variance
this measures how well the resources were used (QUANTITY=USED WELL?)
price variance
this measures whether we got a good price (PRICE=GOOD?)
SG&A Budget
to make the SG&A budget, we need the BUDGETED SALES. The VARIABLE component of SG&A is usually a function of sales. More sales means more commissions, shipping, etc.
After Tax Target Profit (units)
total fixed costs + (target after tax profit/1- tax rate)/ unit contribution margin
Target profit level (sales dollars)
total fixed costs + target profit level / contribution margin ratio
Target profit level (units)
total fixed costs + target profit level / unit contribution margin
Break-even point (sales dollars)
total fixed costs/contributionmargin ratio
Breakeven point (units)
total fixed costs/unit contribution margin
TMC
total manufacturing costs= direct materials USED (not purchased) + direct labor + MOH
traditional costing vs activity-based costing
traditional: consistent with GAAP, only manufacturing costs are assigned to products, no manufacturing costs are excluded from products, one overhead cost pool, not based on cause-and-effect relationships activity-based: NOT consistent with GAAP, nonmanufacturing costs might be assigned to products, some manufacturing costs may be excluded from products, multiple overhead cost pools, based on cause-and-effect relationships
Raw materials inventory:
tumbleweed first purchases the lumber it needs to build a home (DIRECT MATERIALS).
Joint products
two or more products from a common input (e.g. wood can make timber or woodchips, raw milk can make milk or cream)
Efficiency variance (LABOR)
unfavorable efficiency variances may be caused by: employees who have been poorly trained (and thus require more time to perform tasks) or did not receive instruction (and thus are figuring things out on their own)
Price variance (materials). WHY UNFAVORABLE?
unfavorable price variances may be caused by: - an industry shortage, which is driving up the price -the use of a new supplier, who is charging a higher price -the use of rush shipping -purchases being made in a lower volume than usual, which means the company isn't getting a volume discount -A purchasing manager who isn't negotiating well
Quantity Variance (materials) WHY UNFAVORABLE?
unfavorable quantity variances may be caused by: -high amounts of spoilage, scrap, and shrinkage -switching to a lower quality of material, which can lead to more rejections for quality control reasons
weighted-average contribution margin
unit contribution margin * % of total, add all together
Contribution margin ratio
unit contribution margin/selling price per unit
Unit Contribution Margin
unit contribution margin= sales price per unit-Variable cost per unit
What about turning a profit? Great to know how much to sell to break even, but ultimately want to MAKE A PROFIT.
use the unit contribution margin to see how many units we must sell to reach a target profit level. can use contribution margin ratio to see how much sales revenue we must generate to reach a target profit.
Example of segment reporting:
walmart's consolidated income statement, shows total revenue for 2015-2017. If you are the CEO of Walmart and are trying to assess total revenue growth, what might you think? Total revenue has been fairly stable for the past 3 years. But if we only look at total revenue for Walmart as a whole, what types of differences are we missing? Walmart tracks financial data by 3 segments: walmart US, walmart international, Sam's club. All three segments are profitable, we can calculate the ROI of each division (profits/assets). a full analysis would also examine same-store sales. US is growing but sam's club and international are not really growing.
Example: sales per square foot
walmart, target, costco. 3 retailers. Costco is getting better, walmart is getting worse, something happened to target in 2016 (bathroom controversy?) Costco's sales per square foot is SUBSTANTIALLY higher than competitors. costco is STACKED VERTICALLY, good use of space.
underapplied or overapplied overhead
we apply MOH using a predetermined rate based on BUDGETED costs and the BUDGETED activity level. Thus, the actual MOH incurred WILL DIFFER from the budgeted amount. We might apply too much (or too little) overhead. This is NORMAL and doesn't mean the accountant screwed up
present value
we can determine what a dollar received in the future is worth today. This is called the PRESENT value of the cash flow. We can take the present value of: 1. a single amount, 2. an annuity (a series of cash flows over multiple periods) 3. a perpetuity (an infinite series of cash flows)
customer profitability analysis
we can measure the profitability of each customer. A costly customer: orders small quantities, requires special packaging, demands expedited service, complains frequently, often changes orders. *SOME CUSTOMERS MORE PROFITABLE THAN OTHERS*
Capital Budgeting
we discussed how companies create budgets. But how do firms choose the projects for which they will invest funds? This process is called CAPITAL BUDGETING. The capital budgeting process has been described as "search for investments with positive net present value" ACCEPT JOBS WITH POSITIVE NPV
Ending Finished Goods (FG) Inventory Budget
we make this budget to calculate the UNIT PRODUCT COST, which we use to determine COGS and the ENDING INVENTORY BALANCE (the firm uses Absorption costing)
Example: spotify
web infrastructure costs are fixed WITHIN A RELEVANT RANGE. if you start a website, you can pay $10/month for shared hosting, but if it grows and you have 100,000+ visitors/month, shared hosting cannot handle this level of traffic--> need to upgrade to a dedicated server, costs more money
rigid decision-making
what if an excellent investment opportunity comes up in the middle of the fiscal year, but there aren't any funds budgeted to take advantage of that opportunity?
Margin of safety
what if we don't reach our budgeted sales target? The margin of safety tells us the amount by which sales can drop before we start losing money. Margin of Safety= Budget Sales $ - Breakeven Sales $
segmented income statement
what would happen if the company allocated 50% of the common fixed costs to each division? would the common fixed expenses disappear if the nerf division went away? Let's pretend this is the segmented income statement for a toy company that has 2 segments: Nerf and Play-Doh. Our allocation method shows that the Nerf division is losing money. should we shut down the Nerf division? NO because the 125,000 would shift to play doh (make it lose $)!
Application: corporate turnarounds
when CEOs take over struggling firms, they often slash discretionary fixed costs. For example, they may reduce spending on R&D, Advertising, and Equipment maintenance. (e.g. Al Dunlap's "turnarounds" of Scott Paper and Sunbeam are great examples of short-sighted reductions in discretionary cost-cutting. he tried to fire people, downsize, close 18 plants, was good in the short run but bad in the LONG RUN.
Decision Factors: make or buy
when deciding whether to make or buy something, companies consider: -quality (will it decrease if we outsource?) -speed (will it take too long if we outsource?) -cost There are other factors. Coca-cola doesn't outsource the production of concentrate because it wants to protect the secrecy of its formula.
verification of DOL
when sales increased by 10%, operating profit increased by $230,000. this is an increase of 76.7%. see how operating profit changes with a 10% increase in sales
Fixed costs
when the activity level changes, TFC remains constant, but fixed cost/unit changes.
variable cost
when the activity level changes, TOTAL variable cost changes, but variable cost PER-UNIT may remain constant. (e.g. builder specializes in luxury treehouses. cost of lumber depends on the number of treehouses built.
Variable Costing & JIT
when the company has a just-in-time inventory system, the firm deliberately carries very low levels of inventory. Thus, the number of units sold in a period will be very close to the number of units produced. For this reason, such a company wouldn't benefit much from using variable costing (operating profit would be very similar to absorption costing)
cost behavior
when we say we want to know how a cost behaves, we want to figure out how THE COST WILL CHANGE IF ACTIVITY LEVEL CHANGES. we can use this information to classify costs by behavior: variable cost (true versus step), fixed cost (committed vs discretionary), mixed cost
Revenue variance
when you generate more (or less) revenue than expected
Spending variance
when you spend more (or less) on a cost than expected
Need to educate employees
when you switch to variable costing, the sales team will see the production cost per unit decrease (because it no longer includes FMOH). This could lead them to believe the product has become cheaper to produce, and they can sell the product for less money and still make a profit. *BUT FALSE, COSTS DIDN'T GO DOWN, just the way we are allocating them are changing*
use of residual income
why would a company use residual income instead of ROI? When managers are evaluated based on ROI, they DONT have an incentive to take on a project if its ROI is lower than the divisional ROI. When managers are evaluated based on RESIDUAL INCOME, they have an incentive to take on any project that earns more than the required rate of return.
Tri-board case
why would the cost to produce a unit differ based on the month? heating bill in the winter, MOH.
exclusion of some manufacturing costs
with ABC, manufacturing overhead costs that are organization-sustaining might not be included. (e.g., if you're calculating the cost of two different products produced at the same facility, it doesn't make sense to allocate the salary of the factory's security guards to products--> salary=product cost)
inclusion of some nonmanufacturing costs
with ABC, you assign nonmanufacturing costs to products if there is believed to be a CAUSE-AND-EFFECT RELATIONSHIP. if producing the product (or providing the service, serving the customer, etc.) increases costs, then those costs should be assigned to the product, or service, or customer. e.g. sales commissions, warranty costs, shipping costs (NONMANUFACTURING)
Multiple cost pools and rates
with ABC, you identify the various activities responsible for causing MOH costs. you group the MOH costs by activity (these subgroups of MOH are called cost pools). activity rates are calculated for each cost pool.
Time Equations
with TDABC, can make adjustments for variations in time demands. can set up a time equation as follows: customer order time= 6 + 2(if new customer) + 1(if expedited). (if it takes an additional 2 minutes when a customer orders an oversize item, can easily update our time equation)
large amount of overhead relative to the allocation base
with traditional costing, if the predetermined overhead rate is very high, a tiny change in the cost driver could lead to a large change in the amount of overhead applied.
single cost pool and rate
with traditional costing, the company allocates MOH using a single cost pool and one plantwide overhead rate (or one rate for each dept.) MOH is allocated on the basis of direct labor hours or machine hours. These activities may lack a strong cause and effect relationship with MOH which can lead to distorted product costs
The key difference between absorption and variable
with variable costing, you expense the fixed portion of MOH IMMEDIATELY. With absorption costing, the fixed portion of MOH becomes attached to the product and is expensed through COGS when the product is sold. (PRODUCT COST vs PERIOD COST, fixed cost is a product cost in absorption)
can the DOL be negative
yes, it is negative when the sales level is BELOW BREAKEVEN. if the DOL is negative, the absolute value of the DOL is multiplied by the expected % increase in sales will tell you the expected reduction in the company's loss.
Hypothetical scenario
you have gone into business as a consultant. your first client wants to dominate a growing industry. The executive team at The Pet Whisperer has given you an important task: compare the actual results to amounts they had budgeted at the beginning of the year.
Example: Accept or reject
you start a company that makes self-driving baby strollers. for the 200th anniversary of washU, the university bookstore offers to purchase specially modified strollers that say: made by an olin grad (the stroller, not the baby). The normal selling price of a strollers is $699, but the bookstore offers to buy 100 strollers for $500/stroller. Should you accept the order? Job sheet: cost/unit is $564. implies we should reject, but NOT RIGHT. There aren't any customer acquisition costs for this order (we already have the customer lined up) and the fixed overhead will be incurred whether or not we accept this order (GET RID OF FIXED OVERHEAD AND CUSTOMER ACQUISITION). Thus, cost is $474 and should accept. *key takeaway*: IF THE INCREMENTAL REVENUES FROM A SPECIAL ORDER EXCEED THE INCREMENTAL COSTS, ACCEPT THE ORDER.
Determining the cost of a job
1) determine the cost of direct materials used for the job 2) determine the cost of direct labor that was performed for the job 3) apply MOH to the job
Calculating COGS process
1. Calculate the amount of direct material used 2. Calculate the TMC 3. Calculate COGM 4. Calculate COGS
Advantages of Decentralization
1. Executives can focus on strategy and delegate less important tasks. 2. Lower-level managers have better information. 3. Reduces bureaucracy and enables the firm to act more quickly. 4. provides lower-level managers with experience for higher roles 5. increases job satisfaction and motivation for lower-level managers
Advantages of Flexible Budgeting
1. It's useful in businesses where COSTS ARE LINKED TO THE LEVEL OF ACTIVITY (e.g., a hospital) 2. It can be used to model what the results SHOULD be at different activity levels (for sensitivity analysis)
Schedule of Cash Disbursements for Direct Materials
A company may not pay for all of its direct material purchases in the same period. Assuming the company has a beginning balance of $25,800 for accounts payable and pays for 50% of purchases in the current quarter and 50% in the next quarter, we would have the following: 50% of 47,400 (Q1 purchases of raw materials)
Seasonal Overhead Costs
A company might incur more overhead during certain months of the year (e.g., utility costs might be higher in winter). If the predetermined overhead rate is determined on a MONTHLY basis, the same job could appear more expensive in one month than another month. SOLUTION: compute the overhead rate using ANNUAL budgeted costs
Wood textile factory example
1. Shearing 2. Cleaning 3. Spinning 4. Weaving 5. Finishing prior to factories, this was done by separate people. with factories, they are brought together under one roof and pay an hourly wage (from independent--> one roof, all of these processes are done in a factory now)
Determining the cost of a job: service
A consulting engagement can be treated as a "job" just like regular Job-order costing. There are no manufacturing costs, but: you charge direct costs to the job, and you allocate indirect costs to the job (the sum of these two amounts is the cost of the job. e.g. in consulting, no manufacturing costs, but there are OTHERS)
How does ABC work?
1. define the cost pools and activity measures 2. assign overhead costs to cost pools (with ABC, we refer to costs being allocated as "overhead" even though the costs may be distinct from "manufacturing overhead") 3. calculate activity rates (there is a different activity rate for each cost pool) 4. assign overhead to cost objects using the activity rates 5. prepare a report for management
Advantages of Variable Costing
1. operating profit is not affected by changes in inventory 2. the data required for CVP analysis can be taken directly from a variable costing income statement 3. it is easy for executives to understand. if you sell more units, you become more profitable 4. some managers assume the cost/unit under absorption costing is entirely a variable cost (it is not) 5) operating profit calculated during variable costing is closer to cash flow than operating profit calculated using absorption costing. this is important if the company has cash flow problems
Four Reasons that the balanced scorecard is useful
1. takes into consideration nonfinancial objectives, which reduces the tendency to exclusively focus on hitting short-term financial targets. 2. It links seemingly unrelated corporate functions (e.g., customer service, corporate finance, employee training) together in a single report. 3. It focuses managers' attention on the most critical measures. 4. It provides a clear picture of how the company intends to achieve its strategy.
invert the churn rate
1/monthly churn rate tells you the average number of months a customer will remain a customer. a 2% monthly churn rate implies the average customer sticks around 50 months
Example: social media
3 social media companies: facebook, snapchat, twitter. We can examine the quarterly % growth of active users. Year-over-year growth is more appropriate when the business is seasonal. (ad rev/#users=avg rev/user)
Facebook Case
39/55 billion in revenue came from US & Europe, but 1/3 of users live in those regions. Revenue/user is LOWER outside of the US. Most revenue is in ADS. Target convincingly: "i'll target people that will actually/specifically buy something". *most of facebooks growth, has not been able to monetize well but can do this can continue to grow*. in the next 5-10 years, most growth will come from Asia etc. because US/canada will hit a ceiling and there are a LOT more people in other regions.
Flexible Budgeting
A FLEXIBLE BUDGET tells you what revenues and expenses should have been, given the level of activity (e.g. the number of units sold). Once you know the actual activity level, you can ignore the static planning budget.
Sunk Cost
A cost incurred in the past THAT CANNOT BE CHARGED BY ANY FUTURE DECISION. sunk costs are IRRELEVANT to decision making! A sunk cost isn't JUST a prior investment. It's a cost you incurred that cannot be recovered
Example: Peapods and MOH
A customer orders 2 peapods. To build the two PeaPods, the company used $75 of direct materials, used 10 hours of direct labor at $15/hr, MOH=? applies using direct labor hours. MOH budgeted= 200,000. direct labor hours budgeted= 50,000 hours. MOH RATE: $200,000/50,000 DLH, $4/DLH $4*10 direct labor hours= $40 MOH. (RATE*HOURS). Job ticket= product cost and product cost/unit
Example of job-order costing: hammocks
A customer orders 3 blackbird hammocks from Warbonnet. What is the cost to produce each hammock? Order is job #357. Uses $50 direct materials, employees paid $20/hour and spend 5 hours assembling, and $125 MOH allocated. Total product cost: 275 ($50 + (20* 5 hours) + 125 MOH) Per-unit cost: 275/3 (3 units/hammocks)
What is a budget?
A budget is a quantitative forecast that shows how a company plans to acquire and use resources over one or more future periods. companies create BUDGETED FINANCIAL STATEMENTS that are based on figures obtained from several smaller budgets (the sales budget, the SG&A budget).
What is the master budget?
A number of separate but INTERDEPENDENT budgets that project a company's sales, production, and financial goals. The master budget includes the budgeted financial statements and the lower-level budgets used to prepare the financial statements.
Example (sales budget)
A quarterly sales budget is used to determine: HOW MANY UNITS TO PRODUCE --> production budget (if manufacturer). HOW MANY UNITS TO PURCHASE--> merchandise purchases budget (if you're a retailer). HOW MUCH CASH WE'LL HAVE (cash budget). HOW MUCH SG&A EXPENSE WILL BE (SG&A budget). total sales goes on the ANNUAL income statement. IF we expect to sell 10,000 units in Q1, we need to make sure at least 10,000 units are available for sale. ON BUDGET: budgeted sales (in units) and selling price/unit per quarter.
Example of additional issues: Favorable vs Unfavorable
A regional manager at Panera noticed a $9000 F quantity variance for the ingredients to make soup at one of its stores. The store manager says "the corporate office told me to reduce costs, so that's what I did." What is tom doing? He might be watering down the soup, resulting in a favorable quantity variance for the soup ingredients but will decrease the quality of the soup and potentially drive customers away. (F QUANTITY VARIANCE BUT UNHAPPY CUSTOMERS)
What is a cost?
A resource sacrificed or forgone to achieve a particular objective
What is process costing?
A system for assigning costs in which you: 1. Accumulate the cost of a large number of units produced over a period 2. Then, allocate the entire cost across all units produced. it is a simplified form of job-order costing. it treats the entire production process as a single job! Job-order costing is a cost system for assigning costs to JOBS (DM + DL + MOH--> WIP inventory--> finished goods --> cogs) Process costing is a cost system for assigning costs to DEPARTMENTS (DM + DL + MOH --> WIP department A, WIP department B--> finished goods--> COGS)
What is absorption costing?
A system which treats ALL manufacturing costs as product costs, regardless of whether they are fixed or variable. REQUIRED by GAAP. Also known as FULL COSTING.
What is variable costing?
A system which treats only VARIABLE costs as product costs. FMOH is a PERIOD cost and expensed immediately. it does NOT become attached to inventory. Variable costing is also known as DIRECT COSTING.
Segment Reporting
A segment is any component of an organization for which a manager seeks cost, revenue, or profit data. The financial statements are prepared on a consolidated basis, but can also be prepared on a segmented basis. Disaggregated information is helpful because it tells you which organizational subunits are doing well. Analysts are able to better create forecasts when they have access to disaggregated information.
Accept or Reject a Special Order
A special order is a one-time order that is not considered part of the company's normal business
Successful implementation: ABC
ABC is most likely to work if you: Use cross-functional teams to develop the system (get buy ins from each department) Don't use more than a dozen cost pools (do cost-benefit analysis, drop the ones that fail the test) Identifying existing activities that the company already tracks (e.g. the number of customer orders)--> reduces the new data the company needs to track
Absorption vs Variable costing
Absorption--> product costs include: DM used, DL, VMOH, FMOH Variable costing--> product costs include: DM used, DL, VMOH (VARIABLE DOES NOT INCLUDE FIXED MOH IN PRODUCT COSTS)
KPIs
All companies track and monitor several key performance indicators (KPIs). there are thousands of KPIs. Some KPIs are specific to certain industries (e.g. Wash U closely watches its "melt rate")
Manufacturing overhead
All other manufacturing costs--> indirect materials used, indirect labor, insurance and utility expense for the factory, depreciation of factory building, machines, and equipment (EVERYTHING THAT IS NOT DIRECT MATERIALS + LABOR) (the cost of WD-40, indirect materials, the wages of the factory's security guard (indirect labor), the factory's electric bill, depreciation of the factory--> includes cost of INDIRECT labor and INDIRECT materials)
Product costs name
Also known as INVENTORIABLE costs because they get attached to inventory
Amazon's segment reporting
Amazon has 3 segments: north america, international, and AWS. which segment has the highest sales growth? Which segment do you think has the highest profit? All have sales growth, but AWS has he highest (43%) and profit in 2017. Amazon international is actually LOSING money. AWS= cloud computing, web infrastructure. If this went down, 1/3 of the internet would STOP, pay as you need it. In 2018, hald of the profit came from north america, the other half from AWS. International lost money again. Also revenue by product type. 2017 includes whole foods from the date of acquisition (8/28/17 through 12/31/17). Online stores (most), physical stores (whole foods), third party seller services, subscription services, AWS, and other (advertising). Also revenue by geographic region (70% from US!) US, Germany, UK, Japan, R.O.W.
Disadvantages of the balanced scorecard
-It takes time to create a balanced scorecard -the assumed CAUSE AND EFFECT relationships might not hold up
problems with variable costing
-can't use it for GAAP -it assumes constant, per-unit variable costs -not necessary if the firm uses JIT -need to educate employees when implementing
Advantages of the balanced scorecard
-links seemingly unrelated corporate functions together in a single report to show how the company will achieve its long-term goals. -Focuses managers' attention on the most critical measures.
What is a cost object?
Anything to which you can assign a cost. Tesla can measure the cost of producing a car. WashU can measure the cost of its IT department. Netflix can measure the cost of acquiring a customer. Common cost objects: a product or service, a department or process, a customer. We are cost objects--the university knows how much it costs to service one student
Transferring over/underapplied MOH to COGS Example
Applied: 95,000 MOH Actual: 102,000. Underapplied by 7,000. Dispose of the underapplied balance by increasing COGS by 7000!! Underapplied= increase COGS, overapplied=lower COGS (journal: debit COGS 7000 credit MOH 7000 --> and vice versa for overapplied)
The effects of automation
As companies replace employees with machines, direct labor costs decrease and MOH increases. THUS, MOH is becoming extremely important (MACHINES= ^MOH, replacing direct labor)
ROI
As firms became larger and created divisions, there was a need to evaluate the performance of those divisions. The dupont company introduced the concept of ROI in the early 1900s (return on investment). There should be "no expenditures for earning equipment if the same amount of money could be applied to some better purpose in another branch of the company's business". (ROI EVALUATES PERFORMANCE OF DIVISIONS)
Why does the actual activity level matter?
Assume our original budget was developed under the assumption that we would have 1,000 client visits. We then projected our sales revenue and variable costs using this budgeted figure of 1,000 client visits. But it turns out we ACTUALLY had 1,100 client visits. Wage expense is VARIABLE cost, and we have more client visits than expected, shouldn't we expect to have HIGHER WAGE COSTS than was budgeted?
Example: transfer costs
Assume that apple makes and sells iphones using 3 divisions: -division 1 manufactures the components -division 2 assembles the components -division 3 sells the iPhone in apple stores (Manufacturing --> Assembly --> Retail). The transfer price is cost-based. Each division marks up additional costs incurred by 50% (thus, division 3 pays $855 to division 2). Each division has an incentive to state as high a cost as possible, because higher costs means higher revenue for the selling division! if division 3 were to mark up its costs by 50%, it would sell iPhones for 1,080/unit. But let's say the market price is $1000/unit, division 3 will lose $5 on each iPhone sold. Yet, the company as a whole makes $280/unit! (rev-additional costs incurred). Division 3s manager will say this outcome is unfair; the other divisions are each showing a profit, having foisted their costs downstream.
Fixed cost per unit
BUT, fixed cost per unit DECREASES as the activity level rises. This is because the total fixed cost is being spread across a larger number of units! (spreading total fixed cost across more units, so fixed cost PER unit will decrease when you produce more)
Case 1: Lester's Fixins
Bacon cotton candy. all sold so goes to COGS vs inventory --> COGS reduces the profit. timing of expensed/when it is expensed. COSTS WILL EVENTUALLY BE EXPENSED/CATCH UP WITH YOU (SEE CASE)********* Issue: a manager can manipulate the WIP completion percentage to reduce the amount of costs transferred out of the department in the current period (to make the division appear more profitable). solution: use a FIXED completion percentage
Example of service: Batman Law Firm
Batman's client was given the wrong pair of pants from the cleaners. The client hired Batman to sue for $67 million. The case resulted in the following DIRECT costs: -25,000 in printing costs and filing fees -Two attorneys from Batman's staff worked on the case for 200 hours at a rate of 150/hour The case also required assistance from staff (e.g. paralegals, assistants, and receptionists. These indirect costs CANNOT BE TRACED to this specific case. However, the company expected to incur $1 million of these costs (for the entire firm) at the beginning of the year. The firm ALLOCATES these costs to cases on the basis of BILLABLE HOURS. At the beginning of the year, the firm expected to have 20,000 billable hours (for the whole firm) over the course of the year. TOTAL COST: 65,000 (25,000 + 30,000 + 10,000 (200 hours @ 50/hour--> calculated from the total costs/billable hrs ratio)
Example (decentralization)
Bed, Bath, & Beyond allows its local store managers to choose 70% of their store's merchandise. This allows managers to respond to local tastes.
Boeing Case Solution
Boeing uses Managerial Accounting to... 1. Know its costs 2. Calculate its inventory balance 3. Create useful metrics 4. Evaluate the performance of its divisions 5. Coordinate transfers between its divisions 6. Predict the future 1. Boeing needs to estimate costs well because a substantial amount of Boeing's revenue comes from fixed-price contracts. If Boeing has cost overruns, it could lose money! Boeing has multiple government contracts. Boeing must adhere to cost accounting standards when allocating costs to government contracts. 2. Boeing is a manufacturer, so can't use LIFO or FIFO to value inventory. Inventory consists of inventoriable costs: raw materials, WIP, finished goods. These materials flow into COGS. Boeing's most important raw materials are aluminum and titanium (sensitive to changes in their price and supply) 3. To evaluate past performance, Boeing uses 3 non GAAP measures of earnings performance. Core operating earnings, Core operating margin, Core EPS (excludes elements of pension and postretirement costs). Boeing tracks the number of deliveries (to see if there are production issues). Boeing tracks its total backlogs (unfulfilled orders, useful in forecasting revenue). 4. Boeing has 4 divisions: commercial airplanes, defense, space, and security, global services, and capital. MAJORITY OF REVENUE + PROFIT= commercial airplanes. BIGGEST REVENUE GROWTH, PROFIT MARGIN, and ROA: GLOBAL SERVICES. 5. Boeing's divisions sell products to each other. Coordinates transfers with "transfer price", either market-based, cost-based, or negotiated. 6. Boeing creates budgets for the cost of raw materials, sales, etc. Makes predictions that extend into the future. Why is it helpful to make budgets? · The budgets are helpful in determining... o How many aircraft should be produced o What prices Boeing must charge o Which cost targets Boeing must meet o What Boeing's cash needs are (will it need to borrow?) In 2019, · Boeing's product sales declined by 26.7% · Boeing's cost of providing services increased by 7.7% o Both of these were related to the grounding of Boeing's 737
Example 4: No excess capacity
But what if the engine department avoids $200 in variable costs per unit on transfers within the firm? (maybe it saves money on shipping costs). The engine department would need at least 1400 from the car department (the variable cost of $1000 plus forgone CM of 400). Thus, any transfer price ranging from 1400 to 1450 would be acceptable. The $35 on the left-hand side of the equation above was calculated as follows:($22 variable cost - $5 cost savings) + $18 forgone contribution margin (selling price - original variable cost)
Strange Donuts Discussion
CASE ON CANVAS. TFC= 50,000 annually. must make 104 donuts/day to break even.
Calculating COGS (Tumbleweed)
COGS= FG (bb) + COGM - FG (eb) FG (bb)--> beginning balance of finished goods COGM=cost of goods manufactured FG (eb) ending balance of finished goods
Indirect costs
Can not be easily traced to a cost object. The factory manager's salary is an INDIRECT cost of the soda can. Is Chancellor Martin's salary easily traceable to the Olin Business School? NO
MOH Budget
Can use the MOH budget to calculate the predetermined MOHR. This will be helpful when we calculate the production cost/unit. Predetermined MOHR is MOH/DL hours.
Budget Aggressiveness
Choosing the right level of aggressiveness (e.g. how high of a sales target to set) is critical. Too aggressive, and employees are demoralized. Not aggressive enough, and employees have too much slack.
Tax Avoidance
Companies artificially set transfer prices to shift income to low-tax jurisdictions. (minimizes the amount of taxes they need to pay--international/state tax). FYI: many companies use DIFFERENT transfer prices for tax purposes than they use for internal accounting purposes. This practice is called DECOUPLING.
Transfer pricing methods
Companies generally set transfer prices based on: -market prices -cost -negotiation (cost could mean variable cost, full cost, or cost plus a markup)
Make or Buy Decision
Companies must determine whether to make an input internally or to outsource it from another firm. e.g., a CPA firm must decide whether to: develop its own tax preparation software in-house or purchase the right to use tax preparation software from another firm.
same-store sales
Any company can increase total sales by opening new stores. Thus, we shouldn't just examine sales growth, but should also look at the sales growth of EXISTING stores.
This distinction is important! Distinction in supplies variance
If the supplies variance is due to using more supplies than necessary, this is NOT the fault of the purchasing manager. If the supplies variance is due to paying more more money for supplies, this is NOT the fault of the person using the supplies. (PURCHASING MANAGER vs PEOPLE USING SUPPLIES)
Cost behavior: variable cost
If the total cost changes with the level of activity, it is a VARIABLE cost (lemons at a lemonade stand--more people buy, more lemons)
Cost behavior: fixed cost
If total cost does NOT change with the level of activity, it is a FIXED cost (rent)
Example of standard price
If we were supposed to pay $70 for a battery but actually paid $95, we would have UNFAVORABLE price variance. (paid more than we should have)
Equivalent units (EU)
If you have 80 units that are 50% complete with respect to Direct Materials, , you have 40 EQUIVALENT UNITS (80 * .5) with respect to direct materials. EU= units transferred out + EU in ending WIP
Example: the hold-up problem
In 1939, Ralston Purina built a factory specifically to manufacture private-label cereal for A&P. After the factory was built, A&P demanded steep discounts for the cereal. A&P threatened to build its own factory to manufacture the cereal if Ralston Purina didn't comply. Ralston Purina had few options, so it gave A&P the discounts.
barclays + balanced scorecard
In 2012, barclays was implicated in the Libor scandal (manipulating interest rates). Barclays responded by implementing a BALANCED SCORECARD in 2013 to focus the company on its values.
Example (production budget)
In Q1, the company plans to sell 10,000 units. Assuming it begins Q1 with 2,000 units and wants to have 6,000 in inventory at the end of Q1, it will need to produce 16,000 units in Q1. The company aims to have an ending inventory balance that is 20% of next quarter's budgeted sales. NOTE: the year column is not always the sum of quarters
The Goal Book
In the book, a production manager increases production to reduce per-unit costs to make his department more "efficient". the goal of a company is to earn a profit, not simply decrease per-unit production costs. GOAL IS TO MAKE MONEY! excessive production to reduce per-unit costs not only distorts the financial statements, but leads to higher inventory carrying costs and waste. *in class notes: "alex" runs a factory. the factory is having issues, machines running 24 hrs/day, makes clickers: one makes the backing plate, one makes the other piece. behind on orders, customers not happy, running around and trying to make them happy. GOAL is to make a profit. BOTTLENECK= most constrained resource in a plant. 1 hr lost on the bottleneck is an hour lost on the plant. excess inventory is a serious problem!! want a clean plant so people don't have to look for things/get injured, conceals defects, wife was bottleneck on appalachian trail. want to IDENTIFY the bottleneck and INCREASE CAPACITY to make a profit.
Relevant costs and decision making
In this lesson, we will discuss three types of decisions which hinge on your ability to correctly identify which costs are relevant. 1. the decision to produce something in-house or buy it from a supplier (MAKE OR BUY) 2. The decision to accept or reject a special order (ACCEPT OR REJECT) 3. The decision to sell a product as-is or process it further (SELL OR PROCESS FURTHER)
The Master Budget
Contains 2 parts: the operating budget and the financial budget. OPERATING BUDGET: budgeted income statement and the budgets used to create it. (OPERATING=INCOME STATEMENT + ACCOMPANYING BUDGETS) FINANCIAL BUDGET: the cash budget, the CAPX budget, the budgeted balance sheet, and the budgeted statement of cash flows.
Budgeting Strategies
Continuous budgeting (aka rolling budget, perpetual budget), participative budgeting (aka self-imposed budget), and zero-based budgeting.
Caveat: relevant range
Costs may change their behavior OUTSIDE of the relevant range. For example, the cost of rent of kaldi's coffee doesn't change whether kaldi's has 0 or 500 customers per month. If Kayak's were to have 50 MILLION customers per month, it would need to expand to additional locations and the total cost of rent would increase. THE COST IS ONLY FIXED WITHIN A CERTAIN RANGE! When you get to numbers like 500 customers, it's gonna change
Prime cost
Direct Materials + Direct Labor
Job Order costing diagram
Direct materials: traced directly to each job Direct labor: traced directly to each job MOH: applied to each job using a predetermined rate POHR
Cash Budgets and Increasing Dividends
Doesn't matter if company is OUT OF BUSINESS IN Q2. NO CASH, IT IS AN ISSUE.
Example of a demoralized workforce
During a turnaround at sunbeam in the late 1990s, CEO Al Dunlap gave people wildly unrealistic targets. Dunlap laid off the 5-person sales staff of one executive. He then assigned 1 person with no sales experience to help the executive, and told them to increase sales from $1.5 to $25 million. The executive managed to achieve $8 million in sales, but Dunlap was livid because he fell $17 million short. Dunlap came up with the targets based on what he thought analysts and investors would like too hear, not based on the business' true capabilities. Dunlap then told the people to hit the targets or be fired. People tolerated his abuse because he offered stock options and promised people he would make them rich if they could just stick with the turnaround for a few months
The sales budget
EVERYTHING BEGINS WITH THE SALES BUDGET. The sales budget forecasts how many units the company will sell (this is sometimes called a revenue budget, not all companies have "sales" e.g. a bank) The MARKETING STAFF develops the sales forecast. *if the sales budget is inaccurate, the other budgets will be inaccurate*
Why don't all firms use ABC?
It is costly to maintain two cost systems (manufacturers), it's time consuming to interview employees, employees overstate the amount of time they spend on activities, it results in a MASSIVE amount of data (difficult to store and takes multiple employees to analyze). The payoff is not immediate--it may take years to adopt the system. Employees may resist ( e.g. a manager whose product line looks profitable with traditional costing, but not with ABC)
Interpreting the Segment Margin
It is the best indicator of long-run profitability of the segment because it only includes costs that are caused by the segment. If a segment can't cover its own costs and is supported by other segments, it may have difficulty in the long run. This is called "cross-subsidization" and is a common problem
Time-consuming
It is time-consuming to keep track of the costs billed to each job and to keep track of all of the different jobs (e.g. imagine being asked to track how many minutes you spend on each job throughout the workday--sometimes people jump back and forth between tasks without thinking about it)
General Electric Discussion
Jack Welch CEO of GE. Ranked performance of all managers at GE. Top 10%, promoted, and bottom= GONE. 400,000 employees--> 270,000 employees. Stock prices soared, GE owned NBC, made aircraft engines, fridges, financial services. CONGLOMERATE MODEL: many businesses with no relation between them "that's fine because we have good managers and a good manager can run any company. We're going to be #1 or #2 and get out". After he left, GE DID HORRIBLY. Some people said it is not good to have some conglomerate, some said GE didn't have the financial services company after the recession which was a loss but believed there should be a relationship.
Job order vs process costing
Job order: many different jobs are worked on each period. Each job has different production needs. Costs are accumulated by JOB, unit costs are computed by JOB Process costing: a single product is produced in a continuous flow. All units of the product are identical. Costs are accumulated by DEPARTMENT/PROCESS, unit costs are computed by DEPARTMENT
Job order costing vs process costing
Job order: used when a company produces several different products in low volumes (e.g. a custom furniture, different furniture customly produced in diff volumes). You assign manufacturing costs to a specific job, then divide the total cost of the job by the number of units produced in that job. Process costing: used when a company produces large amounts of an IDENTICAL product (e.g. an oil company). You accumulate costs by department for an entire period (e.g., a year) and then divide the total cost by the number of units produced during the period
Example: whole milk and cream
Joint cost allocation is about finding a way to split the $400,000 of joint costs among the whole milk and the cream. Production of raw milk (300,000 cost)--> separation process (100,000 cost) --> whole milk + cream (whole milk: 240,000 sales value, cream: 360,000 sales value). Remember, when you are deciding (for internal decision-making) whether to sell a joint product or process it further, you ignore any costs that occurred before the split-off point (you only look at incremental revenues and incremental costs)
Customer
Key Questions: are we satisfying the needs of our customers? Are we attracting new customers? Measures: customer satisfaction, customer retention percentage, number of customer complaints/refunds, number of customer referrals, number of net new customers
Internal processes
Key Questions: which business processes must we excel at? How will we know if we are mastering those processes? Are we developing new processes? Measures: percentage of on-time deliveries, defect rates, number of new products/services, percentage of sales from new products/services, number of patents, time to respond to customer inquiry
Learning and Growth
Key questions: are we changing and improving? Are we building the capabilities of our employees? Measures: number of training hours for employees, employee satisfaction, employee turnover, number of suggestions made by employees
Key Takeaway
Knowing that there is a spending variance is not enough; we want to know WHY the variance occurred so we can take action. we can decompose a spending variance into TWO parts. PRICE VARIANCE AND QUANTITY VARIANCE.
LTV to CAC ratio
LTV:CAC<1, you're spending too much to acquire customers. LTV:CAC>5, you're not spending enough to acquire customers.
What are a hospital's costs?
Lab tests--> found them to be unnecessary costs. Patients were ordering too many--had people JUSTIFY their lab tests, orders dropped. If there is no cost, everyone will do it. Cost=time, save money on tests. ENDED UP SAVING 200,000/yr on lab tests. Bandages, sutures, medications--hospital started tracking use of bandages, sutures, and medications. employees often going through too many bandages, it's an unnecessary cost. Started tracking them and saved money. *EVEN IN HEALTHCARE, IT IS IMPORTANT TO CONTROL COSTS* (other costs= rent, furniture/beds, tech., wages, etc) Labor costs--started timing how long people were with patients--too long! Hired lower cost scribes. Bypass surgery--had nurses lead the care, people stayed in hospital for shorter period of time and costs fell
Why can't you just divide by # of units for process costing?
Even though all of the units are identical, NOT ALL UNITS ARE 100% COMPLETE on the last day of the period. We need to make adjustments by calculating something called EQUIVALENT UNITS (we can't use total production cost/# units for a manufacturing firm!)
Transfer Pricing and Taxation
Everything we've discussed thus far pertains to internal transfer pricing for decision-making. However, transfer pricing is also a significant TAX issue.
Example: Terrafugia variable costing
FMOH is not included in the product, so cost-per-unit is the same each month. With variable costing, the company reports the same loss in January and February--the company sold one unit each month and the variable cost/unit was the same each month. profitable in march? sold more products in march than january. with variable costing, FMOH is expensed EACH PERIOD. profit ^ when company sold more products
Financial vs Managerial Accounting
Financial: For external use, MANDATORY, must follow GAAP, focuses on the past, emphasizes objectivity, presents information for the company AS A WHOLE Managerial: for INTERNAL use, NOT mandatory, need NOT to follow GAAP, focuses on the FUTURE, emphasizes relevance, presents info by segment, product line, customer
Strategy Map balanced scorecard
Financial: sales, firm value, profits (objectives: grow profits, grow revenues, increase firm value. measurement: net income, sales growth, market value). Customer: customer satisfaction, customer retention (objectives: make customers happy, keep customers coming back. measurements: satisfaction survey rating, percent of customers who return). Process: prompt service, product variety (objectives: provide fast customer service, offer many interesting products. measurement: seconds to serve a customer, number of SKUs). Learning: train employees, stay current with (donut) trends. (Objectives: build employees' skills, stay informed of consumer tastes. Measurement: hours of training, number of FB polls)
Using costs to value inventory
Firms soon had another innovation. Why not use the cost of direct materials, direct labor, and overhead to compute inventory's cost for the balance sheet and COGS for the income statement? (DIRECT MATERIALS, DIRECT LABOR, MOH) *this is required by GAAP for manufacturing firms* Manufacturers can't just use FIFO or LIFO because they don't buy inventory from suppliers, they BUILD THEIR OWN INVENTORY. --> WIP-->finished-->COGS
How do you find the fixed cost from variable cost/guest?
Fixed cost= total cost-TVC (or total cost= variable + fixed. use total cost from data, calculate fixed cost and can either use the high or the low data point. it's easy, but you're using 2 points and throwing away a lot of info.
Balanced scorecard example 2
Learning and growth: invest in employee training and improve employee satisfaction (measure: reduced turnover). Internal processes: provide prompt, informative responses to customer inquiries (time to response). Customer: increase customer satisfaction and retention (reduced customer churn). Financial: customers spend more on our products and services (increased revenue per customer) and our profit increases (increased net income)
Favorable vs. Unfavorable
Less revenue/more expense than expected is unfavorable ("U") More revenue/less expense is favorable ("F"). The favorable/unfavorable distinctions don't mean as much in this context (if sales are higher, variable costs should of course be higher) but the favorable/unfavorable distinction will become important later
Schedule of cash collections
Let's assume you collect 70% of the cash in the period of the sale and 30% of cash in the next period. BB of A/R is 90,000. sales=200,000, so 140,000 in Q1 and 60,000 (30%) in Q2
Accounting for byproducts (journal entries example)
Let's do an example with journal entries. One main product= lumber, one byproduct=wood chips. 4,000 pounds of wood chips. 1,200 sold prior to year end (12/31), 2,800 after year end (12/31). PRoduction method: byproduct inventory Sales method: revenue-wood chips. PRODUCTION: debit A/R, credit byproduct inventory--wood chips. SALES: debit A/R, credit revenue--wood chips
Quick Review
Flexible budgeting shows us revenue and spending variances
Disadvantages of Flexible Budgeting
Flexible budgets are difficult to create because many costs are MIXED COSTS (coming up with cost formulas is difficult). Revenue (Per the flexible budget) is USUALLY similar to the actual revenue. Thus, the flexible budget is more about comparing costs Companies with very few variable costs have NO NEED for a flexible budget. For such companies, the flexible budget would be NEARLY IDENTICAL to the static planning budget.
Comparison
Let's pretend there is an oil company with two divisions: transportation and refining. The transportation division purchases crude oil and transports it to the refining division. The refining division uses the crude oil to create and sell gasoline. (transportation division--> crude oil --> refining division). The price charged to the buying division (the refinery) could be: -market ($85) -full cost, plus a 5% markup (79.80) negotiated (82). NEGOTIATED IS MOST EQUAL. (600 operating profit for both). Each division's operating profit changes based on the method of transfer pricing.
The Time Value of Money
Let's review the time value of money. If you are being interviewed and someone asks you to choose between two projects with the same total cash flows: Project A: cash flows of $1, $2, $3 Project B: cash flows of $3, $2, $1 CHOOSE PROJECT B. same total cash flow, but the cash is received SOONER. A dollar today is worth more than a dollar tomorrow!
Transfer Pricing
Let's say Tesla has: -an automotive division that produces cars -a battery division that produces batteries A battery is an intermediate product that is installed in cars The battery division is the "upstream" or "selling" division. Sells batteries to the AUTOMOTIVE division. That is the "downstream" or "buying" division. (battery/upstream/selling --> automotive/downstream/buying)
High-Low method example
Let's say the Appalachian Mountain Club (AMC) has hired you to determine the variable cost (per guest) of running a hut in the white mountains. You get data w/ months, guests, and costs. TO verify a linear relationship between guests and total cost, you make a scatter plot. apply high low method, get $12,400/43 guests, $288/guest. Variable cost/guest.
Example: sell or process furhter
Let's take a company that produces three types of wool: coarse, fine, superfine. There are joint costs incurred to produce and process the wool. After producing the wool, the firm must decide whether to dye each type of wool (process further). Wool + separating process are both joint costs (incurred before split-off point). Sales value shows what we can get for these products as-is. Costs of further processing are the costs to dye each type of wool. Sales value after further processing: what we can get for these products IF we dye them. Incremental value of further processing:
Pinterest Case
Like Twitter, Pinterest tracks Monthly Active Users (MAUs). Pinterest tracks its MAUs by geographic region. International is the primary driver of user growth, will get most avg rev/user. We've seen that Pinterest's user growth is primarily being driven by users outside the US. But Pinterest doesn't just track user growth. it also tracks AVERAGE REVENUE PER USER. Gets most average revenue per user in the FOURTH QUARTER. Pinterest has been most successful at monetizing its US users--international is almost NOTHING. International MAUs>US, but avg rev/user US>international.
Traditional Income Statement vs. Contribution Format Income Statement
Income statement items are sorted by function, but we could instead arrange the income statement items by the way COSTS BEHAVE. Contribution format separates fixed and variable costs. Variable: DM used, DL, VMOH, VSG&A. Fixed: FMOH, SG&A
Analyzing a spending variance
Given the actual activity level of 27,000 patient days, supplies expense should have been $189,000, however, it was $300,000. This is worth investigating. But with whom should we speak?
Goldman Sachs Case Solution
Goldman Sachs uses Managerial Accounting to... 1. Identify cost drivers 2. Allocate indirect costs to its divisions 3. Evaluate the performance of its divisions 4. Predict how costs change due to regulation 5. Predict how costs change due to economic shifts 1. What are Goldman Sachs' most important cost drivers? Headcount--more employees=^ cost. The level of business activity--more business=^ cost. 2. Allocating indirect costs: Overhead expenses not directly allocable to specific segments are allocated RATABLY based on direct segment expenses. (if one division has 40% direct costs, then 40% indirect costs.) Goldman doesn't need to follow GAAP. Before 2019, allocated to all segments except for corporate charitable contributions, then switched (b/c no GAAP had freedom) 3. Goldman's 4 divisions: IB, Global Markets, Asset Management, Consumer and Wealth Management. GLOBAL MARKETS: largest share of net revenue. IB: ~25% of pretax profit. The CONSUMER AND WEALTH MANAGEMENT has done poorly. Its pretax profit margin is the lowest and it is on a downward trend. It also has the lowest return on average common equity. ASIA division has lowest net revenue and also the lowest net revenue growth. 4. Dodd-Frank Act·: -Restricts investments in hedge funds and private equity funds, giving non-U.S.-based banking firms "greater flexibility to trade outside the U.S." Goldman Sachs must therefore give up possibly higher returns (GIVE UP HIGH RETURNS) ·-Requires issuers of asset-backed securities to retain economic exposure to the underlying asset. This could result in Goldman Sachs incurring higher losses in a recession (HIGH LOSSES IN RECESSION) 5. Interest expense is Goldman's largest expense (higher than compensation). B/c of this, borrowing costs could change if its credit rating decreases or if there is a large increase in interest rates A recession could: increase Goldman Sachs' loan losses, decrease merger activity, decrease number of IPOs
STIHL switches to variable costing
HQ in Germany with US subsidiaries. US GAAP for reporting. VARIABLE for INTERNAL, wanted US to do this. however, reported a lower cost/unit and had to educate employees about the change who were well-versed in absorption costs. lower numbers could've resulted in a lower amount of profitability and decision-making. would've assumed it is cheaper to make this, thus can decrease price and still make a profit, but NOT TRUE. not cheaper to make!! contribution margin vs gross profit margin reporting--differences between the 2.
Example 3: make or buy
Hennessy sells hammocks for camping. With each hammock sold, it includes a free tarp. Hennessy has been making tarps in house, but is thinking about buying the tarps from a 3rd suppliers instead. Note: assume that cost is the ONLY consideration, and ignore taxes. Hennessy needs to make or buy 8000 tarps this year. Internal information (need to consider raw materials, direct labor, variable MOH, supervisor of tarp production, IGNORE DEPRECIATION, COMMON FIXED COSTS, SUNK COSTS (e.g. paid 10,000 last year).) external information: Hennessy can simply buy 8000 tarps for 152,000. 112,000 vs 152,000. HENNESSY SHOULD MAKE THE TARPS
Example of a byproduct
Hermes has scrap leather left over from its production process. While most companies discard scraps, Hermes uses the scrap leather to make wallets, card holders, and key rings. Hermes may account for the products made from scrap as byproducts.
Sleepbox example
Hired as an analyst for sleepbox. Sells each unit for 10,000, VC/unit=9,500, Contribution margin/unit sold=$500
Variable cost per unit
However, variable cost PER UNIT remains CONSTANT as the activity level changes (as produce more units, variable cost per unit stays same)
Total fixed cost
If a cost is FIXED, the total fixed cost does not change as the activity level increases. (Netflix's cost to stream videos to you DOESN'T increase if you decide to watch 3 movies versus 1, rent of a factory doesn't increase if you produce more)
Total variable cost
If a cost is variable, the total variable cost INCREASES as the activity level increases (as you produce more units, the total variable cost is going to INCREASE)
SUMMARY of underapplying/overapplying MOH
If manufacturing overhead is underapplied (applied OH<actual overhead), ^ WIP finished goods and COGS or close to COGS by increasing COGS. If manufacturing overhead is overapplied, actual<applied OH, decrease WIP, FG, and COGS and close to COGS by decreasing COGS
Example 2: EXCESS CAPACITY, transfer price at full cost
If the engine department can only sell 30,000 engines to outside customers, there is EXCESS CAPACITY (because it makes 70,000 engines). But if the company dictated that the transfer price be FULL COST (fixed plus variable), the engine department would need 1500 from the car department. However, the car department won't pay more than 1450. Thus, NO TRANSFER TAKES PLACE. this is suboptimal, because the company ends up paying 1450 for engines that were readily available at a cost of just 1200.
Analysis of Hennessey make or buy
If the equipment had salvage value, the salvage value would be relevant. Depreciation is a sunk cost and therefore irrelevant. Allocated overhead and raw material ALREADY on hand won't disappear if we outsource, so they are irrelevant. raw material on hand is a SUNK COST--the only raw materials that matter are the 48,000 we'd pay going forward.
Disadvantages of Decentralization
Lower-level managers might not be aware of the organization's strategy (does the manager of a McDonald's know the overall corporate strategy?) If lower-level managers make their own decisions, it could become difficult to coordinate their activities to achieve organization-wide objectives (what if every McDonald's manager chose how much beef to put in a burger? Standardization of processes makes it easier for top management to ensure quality)
What about managerial accounting??
Managerial accounting did not develop until the industrial revolution. The rise of large-scale factories where multiple processes were performed under one roof created a demand for new types of accounting information (MANUFACTURING UNDER ONE ROOF, WHEN FACTORIES BUILT/INDUSTRIAL REV)
The complete analysis
Managers focus most of their attention on the revenue and spending variances. (F and U for favorable and unfavorable)
Biased forecasts
Managers have an incentive to lobby for sales targets to be set low and lobby for expenditure targets to be set high. This gives managers BUDGETARY SLACK. (can spend more, not reach as many sales)
Use-it-or-lose-it mentality
Managers may believe (in some cases, rightly so) that if they don't spend the full amount of money they have been allocated, they will receive less money the next period. This incentivizes them to spend the full amount. (EG OFFICE CLIP)
Signals a Cost System is Obsolete
Managers want to drop "profitable" product lines. Profit margins are hard to explain. Difficult-to-produce products have high margins, even though the company doesn't charge a premium price. Departments create their own cost systems. You have a high-margin niche all to yourself. Customers don't mind price increases. Costs change due to a new regulation.
Example: Terrafugia Absorption costing
Manufactures flying cars. with absorption costing, the $70,000 fixed MOH is allocated to the one unit produced, but in february/march, the 70,000 fixed MOH is spread across the 2 units produced. (35,000 each). company reports a loss in January because 100% of fixed overhead that month was allocated to the units sold. In February, however, 2 units are produced but only one unit is sold. FMOH was allocated to produced, but not all units sold, so some of this cost is not expensed this period and VOGS is lowered. 50% is deferred.
Decentralized Decision-Making Structure
Many critical decisions are PUSHED DOWN to lower-level managers. Lower-level managers gain more authority--pushed down to middle management + supervisors
Metrics
Many of the metrics developed during the 1800s and early 1900s are still used today. Each metric was about EFFICIENCY. Railroads--> cost per ton mile Manufacturers--> conversion cost Retailers--> inventory turnover
Using the market price
Market prices are generally regarded as the best basis for transfer pricing. The market price most closely approximates the opportunity cost of the resource. However: we don't always know the market price, and the market price might not work well if the selling division has excess capacity.
The Unit Cost
"Watch the costs and the profits will take care of themselves (Andrew Carnegie)" people who worked at the textile factories figured out that it was useful to know the cost per unit. Who cares? Why does it matter? Well, if the US army offers to purchase some wool blankets from your firm, you want to know your price per unit SO YOU DON'T SET PRICE BELOW COST**
sales per square foot
(A measure of space productivity used by most retailers since rent and land purchases are assessed on a per-square-foot basis.) A popular metric in the retail industry, tells you how well the company is using its space to generate sales. Sales per square foot can be improved by increasing the number of customers or increasing the average transaction value. Retailers also track foot traffic (# of visits per customer during a quarter).
cost per equivalent unit
(Cost of beginning WIP inventory + Cost added during period) / (units completed and transferred + units in process)
Netflix Case: segment reporting
(Now, only one segment.) Domestic DVD (declining since 2013). don't spend money on this segment anymore. Why do they still have? Still making money from it!! (only 5% of it, but). No competition because dying industry, not competing on price, wanting to milk $. Still gonna take the $ (DVD BY MAIL HAS A lower cost of revenue) but still adds value. Declining business but still adds value to netflix. Streaming vs DVD-Mail? streaming= advantage of instantly getting the movie, and economies of scale--doesn't cost netflix anything when a new subscriber signs up, but DVDs are more expensive.
The three types of product costs
(costs involved in manufacturing, expensed POST-SALE, EXPENSED TO COGS AS INVENTORY IS SOLD) Direct materials, direct labor, MOH
Production cost/unit:
(direct materials used + direct labor incurred + MOH applied) / (# of units produced in this specific job). This equation tells you the production cost PER UNIT for this specific job
Why create a flexible budget?
Once we adjust the static budget to what it should have been (given the activity level that occurred), we can compare the adjusted ("flexible") budget to the company's actual results (COMPARE STATIC TO FLEXIBLE)
DM, DL, and MOH budgets
Once you determine your production needs for each quarter with the production budget, you can make budgets for: DM, DL, MOH
Direct on Time Services case
Marsha. normally, would be in nursing homes. discretionary fixed costs: facebook ads. ^ profitability, facebook ads. Mixed costs= telephone verification service that ensures that caretakers are actually providing the services that they are being paid (flat fee + charge per phone call). Step-variable costs: payroll firm that charges a flat fee based on the number of caretakers, according to a sliding scale (0-25--> this, 25+--> something else). Committed fixed cost: rent. Discretionary fixed cost: facebook marketing. expands? salary of employee, fixed cost of rent, "registered agent": businesses outside of geographic boundaries, other restrictions.
Example: coffee companies
McDonalds, Dunkin, Starbucks. Same-store sales growth: McDonald's looked like it was in trouble, but it appears to be making a comeback. Starbucks had very strong growth, but this has leveled off. Dunkin's stores don't appear to be growing.
Examples of variable costs
Merchandise company: SOME administrative costs, sales commissions, shipping costs, COGS. Manufacturing company: SOME administrative costs, sales commissions, shipping costs, DM, DL, SOME MOH costs (indirect materials, power, etc.)
Prorating among accounts
More ACCURATE approach to under/overapplied MOH. allocate among WIP inventory, Finished goods inventory, and COGS. MOH passes through these 3 accounts, so you prorate the amount to each account as it should have been done (had the estimate BEEN CORRECT)
Centralized Decision-Making Structure
Most critical decisions are made by TOP MANAGEMENT. Top management--> middle management--> supervisor.
PERIOD COSTS PART 2
NOT RELATED TO MANUFACTURING, EXPENSED WHEN INCURRED
Sales Budget: Retailer
No different than a sales budget for a manufacturing company. Budgeted sales (in units) and selling price per unit.
Sales method
No journal entries are made for the byproduct UNTIL IT IS SOLD. When it is sold, revenue is recognized (nonoperating item).
Now what?
Now we can make the financial statements. (budgeted income statement, but can make others as well)
Manufacturing overhead rate
Numerator: total manufacturing overhead cost (budgeted for period)--> the total amount of manufacturing overhead your firm expects to incur this period (an estimate made by the company at the beginning of the period) Denominator: the total activity level of the allocation base (ALLOCATION BASE: the cost driver your company uses to apply overhead). It could be# of machine hours, # of direct labor hours etc. that your company expects to have this period (this is an estimate made at the beginning of the period)
MOH SUMMARY
OHR= budgeted MOH cost/budgeted amount of cost driver. Overhead applied= OHR (based on estimates, determined before the period begins) *ACTUAL activity (e.g. the # of direct labor hours that occurred during the period)
Two solutions to overapplied or underapplied MOH
Option 1 (THE EASY OPTION): transfer the over-or underapplied overhead to COGS Option 2 (harder): allocate the over-or underapplied overhead among WIP inventory, finished goods inventory, COGS (don't allocate MOH to raw materials inventory because raw materials inventory doesn't include any MOH!!! It's just raw materials). *option 1 is easier, option 2 is more accurate*
Why do firms create budgets?
PLANNING (goal setting). All companies have goals, and budgets show how a company plans to achieve those goals. Budgets also help to coordinate the various departments of a company as they work towards organization-wide goals. CONTROL (making sure goals are achieved). Once a plan is in place, managers compare the company's performance to the budgeted projections. If the performance deviates from what was intended, managers can take corrective action.
Disadvantages of Standard Costing
POLITICAL ISSUES: creating the standards can be a political process. Managers want to look good, and they will lobby to have standards set accordingly. If standards are set based on politics, variances are meaningless!! TIME LAG: the accounting department calculates variances after the period has ended, so there is a delay ROOT CAUSE: variances tell you the problem (e.g. we used too much material) but they don't tell you precisely why the problem occurred (e.g., there was spoilage) (NO WHY THE PROBLEM OCCURRED. JUST WHAT)
Example (weighted average method)
Pepsi has launched a new brand. Pepsi needs to figure out how much cost to assign to units completed during the year AND how much to assign to units still in process @ year end. 200 units still in process are 100% complete w respect to DM.however, only 30% complete w respect to conversion costs (DL + MOH). THREE STEP PROCESS: 1. convert to EU 500 + 200(.30)=60 2. calculate cost/unit costs in WIP added to costs incurred to get TOTAL COST. total cost/EU = cost/EU 3. assign costs to completed units and units still in process multiply cost/EU by # units completed and still in process. tells us cost assigned.
example of cost to acquire customers
Plurk spends $500,000 on digital advertising to acquire 500 new customers. The CAC is 1,000
The critical change for Managerial accounting
Pre-factory: the various processes required to produce a product (e.g. clothing) were produced by independent artisans. Thus, the cost of producing an article of clothing was simply the market price paid to each of the artisans for their contribution. Post-factory: all artisans were brought under one roof as "employees" and paid a "wage" in exchange for their labor
How might a firm reduce its breakeven point?
Reduce TFC by outsourcing. Outsource production (e.g. you don't need the fixed costs of production (e.g. factory rent) and instead incur variable costs when you order units to fulfill sales orders. Increase the unit contribution margin by reducing variable costs per unit (REDUCE VC, ^ UCM. FIND CHEAP LABOR)
Residual income
Residual income shows the amount of profit a division (or project) earns, over and above the required return. It is a dollar amount, NOT a percentage like ROI. (kind of like each division being charged interest for the capital it uses)
How would things be different for a retailer?
Retailers don't produce goods. Thus, they don't prepare a production, DM, DL, or MOH budget. Instead, they prepare a MERCHANDISE PURCHASES BUDGET.
Real-life case
Richard Rumelt was hired as a consultant for Denton's, a garden and landscape business with 28 locations. Rumelt wanted to compare the performance of the various locations, but he couldn't rely on ROI in this case. This is because one location had cost $5000/acre when purchased in 1950, whereas another location cost $95,000/acre when purchased in 1989. Thus, ROI would make older stores look BETTER. *EVA has the same problem too because it is invested capital measured at historical cost*. Rumelt created his own measure, which he called Gain to Operating (GTO). Rumelt ranked each store based on GTO and created a graph with the cumulative GTO. the graph exhibited a hump pattern, implying that there is cross subsidization--middle companies were profitable enough that it was masking the later companies. CLOSE WORST STORES.
How do we resolve issues in figuring out why there is a supplies expense variance?
STANDARD COSTING. discussed later.
Master Budget (Manufacturer)
Sales Budget--> production budget--> DM budget, DL budget, MOH budget--> cash budget --> budgeted financial statements
Master budget (retailer)
Sales budget--> merchandise purchases budget--> cash budget--> budgeted financial statements
Budgeted Income Statement
Sales comes from the sales budget, COGS is calculated using the unit product cost from the ENDING INVENTORY budget, SG&A expense from the SG&A budget, Interest expense comes from the cash budget.
Actual income statement
Sales revenue (actual sales), expenses (actual expenses): wages, cleaning, supplies, utilities, rent, insurance, advertising, legal
Schedule of Cash Collections: Retailer
Same as manufacturer.
Issues/drawbacks related to job-order costing
Seasonal overhead costs, infrequent overhead costs, time-consuming, high cost of data entry
Example of costs
Senthil is deciding whether to accept a job paying 40,000 a year as a professional cuddler or a full tuition scholarship to get a master's in bagpiping. "I might as well get a master's degree since it's free!" OPPORTUNITY COST OF 40,000 FROM BAGPIPING, NOT TRUE
Tips for setting the level of aggressiveness
Set the growth rate equal to or just above the industry growth rate. This avoids setting a growth rate that erodes market share. Look outside the industry and compare the costs that other firms incur for different functional areas. if other firms perform well with a lower level of administrative costs, your firm might be able to do the same. Your firm's managers can't say "this is impossible" because another company is already doing it.
The problem with comparison
Simply comparing the actual results to the initial budget ignores a significant fact. The ACTUAL activity level may be different from the BUDGETED.
Active users: social media firms
Social media firms closely track the # of active users. There are high fixed costs (but low variable costs) in building an app or website. This creates a strong incentive to add users because: -it doesn't cost very much to serve an additional user - the company needs to cover its high fixed costs or it will run out of cash and go bankrupt
Cost Allocation
Some companies allocate nontraceable corporate HQ costs to segments. Companies do this to REMIND lower-level managers that HQ costs must be covered. This is problematic for two reasons: 1. it's not fair. you are holding lower-level managers responsible for costs they can't control. 2. It could lead to bad decisions. The allocation could make a segment appear unprofitable; if you then eliminate that segment, however, the HQ costs will simply be allocated to the remaining segments, making them appear less profitable in turn.
Using the cost
Some companies have the selling division use the intermediate product's cost (or cost plus a markup) as the transfer price. -people like this because it's easier to determine cost than the market price -however, this can lead to bad behavior. The selling division has less incentive to control costs (if it's no longer being evaluated based on profit) and may even try to shift non-product costs to the product to pass them on to the next division. (full-cost transfer prices, which incorporate variable and fixed costs, result in suboptimal decisions and are NOT recommended. If you are going to use cost-based transfer pricing, you want to focus on VARIABLE costs).
Using Negotiated Prices
Some firms allow the managers of the buying division and selling division to negotiate the price. This preserves divisional autonomy. However, there are two significant drawbacks: 1. the managers waste time arguing about the price and 2. a division may appear to be performing well simply because its manager is a good negotiator, NOT because the division is actually doing well. ALSO, can lead to bickering between divisions.
Vertical Integration
Some firms are VERTICALLY INTEGRATED. This means the company produces not just the final product, but also makes the components that go into the final product. "vertical integration is the merging together of two businesses that are at different stages of production" (the economist). (A car company that produces not just cars, but also the engines that go into cars, would be vertically integrated.)
Zero-based budgeting
Some organizations peg budgeted amounts to the amount spent during the prior period (we spent 200,000 on advertising last year, so we increase that amount by 10% for our budget this year). ZERO-BASED: sets each budgeted amount to 0 and requires each expenditure to be justified for the new period. set it at 0, DETERMINE FROM SCRATCH. ZBB is a cost-cutting strategy. However, it is time consuming because you need to discuss whether each and every line item is necessary.
An important point: labor costs
Some people assume that all labor costs are immediately expensed. For a non-manufacturer, this is TRUE! FOR A MANUFACTURER, IT DEPENDS ON THE NATURE OF THE LABOR PROVIDED> Labor that is a manufacturing cost (product cost) is attached to the inventory, it is not expensed until the inventory is SOLD. Non-manufacturing labor (e.g. an accountant's salary) is IMMEDIATELY EXPENSED(b/c period cost, expensed when incurred).
Advantages of Standard Costing
Standard costing allows you to perform variance analysis, which raises red flags about potential problems. A manager can review a list of variances and quickly identify areas of concern. The manager can then take corrective action. This is called "Management by Exception". (LOOK AT VARIANCES AND SEE AREAS OF CONCERN)
New accounting tools
Starting with railroads, firms began to: -divide the company into divisions, and evaluate the performance of each separate division -Develop useful metrics (e.g., cost per ton-mile) that are not required for GAAP -set transfer prices to coordinate exchanges within the firm
Contribution Margin
Subtotal in the contribution format. Sales revenue minus all variable costs. Contribution Margin does not equal gross profit. MANUFACTURERS SUBTRACT FMOH in gross profit
breakeven point for weighted average CM
TFC/Weighted-average CM. Tells you that the company must sell X units to break even. Assumes that 12.5% first class and 87.5% sold are coach. Make assumptions based on percentages.
Direct Materials Budget (DM Budget)
The DM production needs are based on the projected PRODUCTION NEEDS (from the production budget) and the AMOUNT (e.g. pounds) of raw material needed per unit (PRODUCTION NEEDS + AMOUNT). e.g. required production=14,000, and 15lbs/unit, so 210,000 lbs of raw materials for production needs.
Example: Toys R Us
The Geoffrey case and "nowhere income". To avoid paying state income tax in South Carolina, Toys R Us set up a subsidiary in Delaware called "Geoffrey". -Toys R Us then has to pay licensing fees to Geoffrey to use its trademarks -The licensing fees were a deductible expense that reduced the taxable income in South Carolina -royalty income is not taxed in Delaware, so Geoffrey paid no tax on the royalties received _Thus, Toys R Us created "Nowhere income". The money it paid to Geoffrey wasn't taxed ANYWHERE. Companies set up IP (doesn't even need to be, could be consulting) and move from a high tax jurisdiction to a low tax jurisdiction.
Example (MOH Budget)
The MOH needs are based on the projected PRODUCTION NEEDS (from the production budget) and the amount of MOH needed per unit. DL hours=cost driver. DEPRECIATION IS SUBTRACTED when we're calculating the amount of cash disbursed (b/c it's a non-cash charge). Use DL hours and the rate to get VMOH, add FMOH and get total MOH, minus depreciation= cash disbursements.
Revenue Variance
The difference between the actual revenue and the revenue that SHOULD HAVE BEEN (flex budget) is the revenue variance. (e.g., actual revenue was 3800 lower than what it should have been; this is unfavorable so we put a "U" next to it.
Example (DL budget)
The direct labor needs are based on the projected production needs (from the production budget) and the amount of DL needed per unit (PRODUCTION NEEDS * DL NEEDED PER UNIT)
Example 3: no excess capacity
The engine department would need at least 1600 from the car department. However, the car department won't pay more than 1450. (LOOK AT SELLING PRICE FOR 1600). Thus, no transfer takes place. If the engine department can sell all 70,000 engines to outside consumers, there is NO EXCESS CAPACITY. Thus, any transfers made will cause the engine department to forgo some contribution margin.
Opportunity cost
The benefit forgone (given up) by choosing one alternative over another
Static Planning Budget
The budgets we develop at the beginning of the year are excellent for PLANNING. but the units sold or services provided are going to differ from what was planned. Comparing a manager's performance to a static budget that was based on an activity level different from what actually occurred would be unfair. (STATIC= unchanged since development at beginning of period. "static" or "unchanged")
Infrequent overhead costs
The bunching of overhead costs in certain periods might distort the overhead rate (e.g., if you overhaul equipment at year-end, this would lead to a higher predetermined overhead rate for the final month of the year--> this doesn't make sense b/c the equipment overhaul benefits multiple periods)! SOLUTION: compute the overhead rate using ANNUAL budgeted overhead costs
Cash Budget
The cash budget has 4 main sections: cash receipts, cash disbursements, cash excess (or deficiency), financing. The cash budget is VERY important. Firms go BANKRUPT when they run out of cash!
Regression results
The coefficient estimate for the independent variable (number of guests) is 290.16. This is the VARIABLE COST/UNIT. The p value of .00 means it is statistically significant (not likely due to chance). the intercept is 1,396.15. This is the FIXED COST.
shipping containers
The advent of shipping containers (1960s) had 2 effects: 1. reduced freight costs 2. reduced transit time -one ship can transport 9000 40 ft containers. A crane can load and unload 30-40 containers in an hour. A container can be directly placed onto a truck or a train, without requiring any handling. This seamless transition is called intermodal transport. (REDUCED FREIGHT COSTS/TRANSIT TIME, easier and less freight costs for standard cost)
Production Budget
The company next prepares a production budget according to its projected PRODUCTION NEEDS for each quarter. The production needs are the sum of the budgeted sales and the desired ending inventory (BUDGETED SALES + DESIRED ENDING INVENTORY). Sales forecast wrong, produce TOO MUCH/TOO LITTLE.
What are the manufacturing costs?
The cost of DIRECT MATERIALS USED for the job, the cost of DIRECT LABOR for the job, and the cost of MOH applied to that specific job.
Freight Costs
The cost of overseas shipping used to be very high, which was a major barrier to international trade. (more than 50% of costs were incurred at the shipping dock. Dockworkers unloaded crates piece-by-piece, it could take days to unload a ship. the life of the dockworkers was one of the themes of the movie ON THE WATERFRONT with Marlon brando)
Marginal cost
The cost to produce one additional unit (this is more of an economic term)
What is managerial accounting?
The creation of accounting information to help managers make better decisions (INTERNAL)
accounting for byproducts: the production method
The manufacturing cost of the main products is REDUCED by the expected sales value of the byproduct in the period the byproduct is produced. (some offset by NRV, but we'll do sales). Offsetting the manufacturing cost of the main products ultimately reduces COGS--subtracting sales value of byproduct. (COST - SALES BYPRODUCT)
The factory process
The factory process converts raw materials (e.g. wool) and labor into a finished good (e.g. fabric) (RAW MATERIALS + LABOR--> finished good). QUESTION: what is the cost if producing one square foot of fabric? COST ATTRIBUTION IS DIFFICULT
Similarities (job order v process)
The goal of both process costing + job-order costing is to determine the cost of manufacturing a product. Both systems allow you to: -find the product cost per-unit -compute COGS -compute ending inventory balance (NOTE: can also use to find cost of providing a service, but focus on manufacturing firms today_)
Responsibility Accounting
The idea behind RESPONSIBILITY ACCOUNTING is that managers should ONLY be held accountable for the items they control. Each line item (revenue or cost) is the responsibility of some manager. If we don't hold managers responsible for costs, they will spiral out of control. (if no one is responsible for keeping costs down, then no one will take the action to keep costs down)
Example: Olin EMBA
The olin business school has an EMBA program in Mumbai. Managerial accounting helps with..... PLANNING: how much money should wash U budget for its program in Mumbai? How much does it cost to acquire one student/serve one student? How many students does the program need to break even? CONTROL: how much cost did the Mumbai program incur compared to what had been budgeted? Did the Mumbai program spend more on technology costs than anticipated? PERFORMANCE EVALUATION: did the person responsible for the Mumbai program do a good job? Should Wash U keep the mumbai program? (PLANNING, CONTROL, AND PERFORMANCE EVALUATION)
Churn Rate
The percentage of customers who stop being a customer in a given period (e.g., if Plurk has 1,000 customers and every month 20 decide to cancel, the monthly churn is 2% (20/1000)
Idle Capacity
The preceding analysis assumes that you have idle capacity (accepting the special order isn't displacing another activity). If you are giving up an action (e.g. selling 100 strollers at the regular price of $699) by accepting the special order, then the forgone profit of the action you gave up is an opportunity cost of accepting the special order.
What is financial accounting?
The preparation and disclosure of financial statements and the accompanying notes FOR EXTERNAL parties, such as the firm's owners and creditors
Example (no decentralization)
The price of a Dairy Queen sundae is $3. A customer tastes a free sample. A customer tries to bargain with the manager, offering $1. The manager tells the customer to leave. The manager of a Dairy Queen does not have the authority to change the price; this decision can only be made by senior executives.
The main difference
The primary difference between process costing and job order costing is the EXTENT OF AVERAGING used to compute costs for products and services. With job order costing, different jobs use different amounts of resources, so it wouldn't be right to cost each job @ the same production cost. With process order costing, identical units are mass-produced so you can approximate the AVERAGE COST for all units produced. (PROCESS CAN AVERAGE)
One more wrinkle to the Hennessey case
The prior analysis the space used to make the tarps inside Hennessey's factory was IDLE (it would not be used if the tarps weren't made). But what if NOT making the tarps in house means we can use the space to make additional hammocks, which would yield an extra 60,000 in profit. The production of the tarps in-house would cause the company to forgo 60,000 of profit. this is an OPPORTUNITY COST and is relevant to our decision. With opportunity costs, should BUY TARPS.
Example of additional issues: Distorted Incentives
The purchasing manager for a furniture manufacturer proudly boasts of achieving a $42,000 F price variance. She was able to get a better price on lumber by purchasing 25x the typical amount the company orders. Is this a good thing? It depends, does the company ACTUALLY NEED the lumber or is it simply stockpiling raw materials? Remember, the goal is to MAKE MONEY not simply to achieve favorable variances at a low per-unit cost!
relevant range
The range of activity within which assumptions about variable and fixed cost behavior are valid.--> the range in which the cost is fixed
Assumptions of CVP Analysis
The selling price/unit is CONSTANT throughout the relevant range. Costs are LINEAR over the relevant range. For companies with multiple products, the SALES MIX IS CONSTANT. For manufacturing companies, INVENTORY DOESN'T CHANGE (UNITS PRODUCED=UNITS SOLD).
Additional developments
The rise of railroads further increased the demand for INTERNAL accounting information. Railroads were significantly larger than other companies and had multiple divisions. Railroads were the first companies when you had managers managing other managers. MANAGER FOR EACH DIVISION, INTERNAL BREAKUP
the 4 perspectives of the balanced scorecard
Financial (traditional financial measures), customer, internal process, and learning and growth (nonfinancial measures)
Goldman sachs case study
*COME BACK TO THIS*
Case 2: Red bull
*SEE CASE DOCUMENT*
Case
*solution on canvas*
The Balanced Scorecard as a Solution
A balanced scorecard shows how the company will create long-term value by measuring financial AND nonfinancial goals and measures. It focuses attention on the most critical measures. (financial perspective--revenue, expenses, net income, customer perspective, internal process perspective, learning/growth perspective)
Financial Statement Comparison: Production vs Sales method
Profit was lower in the sales method (b/c not all the byproduct was sold in december). Sales method ending inventory=0, production it has a price. Note: revenue from the sale of a byproduct (per sales method) is a NONOPERATING item
Custom Cat Furniture Example
Custom cat furniture. Firm's 1st month in business. On 1/3, firm purchases 20,000 of raw materials for cash. On 1/7, the firm puts 17,000 of raw materials into production (as direct materials)--> 12,000 of the raw materials are traceable to job A, and 5,000 are traceable to Job Z. On 1/14, the firm incurs 10,000 in costs related to laborers who begin working on raw materials to build products. 8,000 traceable to job A, 2,000 traceable to Job Z. Company uses $100 of glue to build furniture. Cannot be traced to specific jobs (don't know how much was used in Job Z. Just know that $100 total was used (MOH). 2,000 in salary costs for its production supervisor (MOH). Incurs 900 of janitorial costs (MOH) and 700 of janitorial costs for sales (SG&A--> MOH). 4,000 rent for factory MOH. FIRM APPLIES 5,000 MOH Job A, 1,000 Job Z. (MOH is applied using a predetermined MOH rate). Company completes Job A and sells units produced in jobs A (finished goods--> COGS). Was MOH over or underapplied? The company incurred 7000 of MOH during the month of Jan., but ONLY APPLIED 6000 of MOH. Thus, MOH is underapplied by 1,000.
why does a company have a ^ ROI?
DECOMPOSE ROI (dupont). See if it is the profit margin or the investment turnover that is pushing it higher.
Product costs
DIRECTLY RELATED TO MANUFACTURING. manufacturing costs that are capitalized to the company's inventory account (product costs are expensed through COGS WHEN THE INVENTORY IS SOLD!! expensed when sold, through cogs). E.g. janitor in a Tesla manufacturing plant
Predicting the future
Despite these advances, firms in the late 1800s still didn't do budgeting or forecasting. It wasn't until James McKinsey's 1922 book "Budgetary Control" that businesses started using accounting information to predict the future.
Now what? After get variances,
Determine WHY the variances occurred. Why did we spend 1200 more on wages than we expected to spend? This isn't large (it's about 1% of total wages) but we still might want to know why we overspent
Time-driven ABC
Developed by Robert Kaplan to address drawbacks. BASICS: 1. estimate the time it takes to perform each activity (w a stopwatch), don't need to interview people and can collect less data. people can't overstate how much time they spend b/c you're not asking. 2. can calculate a capacity cost rate for each resource (cost to supply capacity (e.g. cost to run a department))/(practical capacity--the number of minutes departmental employees spend working) (COST TO RUN/ACTUAL WORKING MINUTES) 3. You set up systems of equations to allocate costs when a process is complex (e.g. processing an order from a new vs existing customer) *USED IN HEALTH CARE*
The expensing of product and period costs
Product costs--> COGS Period costs--> operating expense
Net Realizable Value Method example
Production of raw milk (300,000 cost)--> separation process (100,000 cost)--> Whole milk and cream (whole milk: 110,000 NRV, cream: 330,000 NRV. Whole milk is 25% of the total NRV, so it is allocated 25% of the joint costs (400,000). Cream is 75% of the NRV, it gets allocated 75% of the joint costs.
Relative sales value method example
Production of raw milk (300,000 cost)--> separation process (100,000 cost)--> Whole milk and cream (whole milk: 240,000 sales value, cream: 360,000 sales value. Whole milk is 40% of the total sales value, 240/600, so it is allocated 40% of the joint costs (40% of 400,000). Cream is 60% of the total sales value, so it is allocated 60% of the total costs (60% of 600,000).
Physical Units Method example
Production of raw milk (300,000 cost)--> separation process (100,000 cost)--> Whole milk and cream (whole milk: 70,000 gallons, cream 30,000 gallons. Whole milk is 70% of the total units (gallons), so it allocated 70% of the 400,000 joint costs. Cream is 30% of the total units, so it is allocated 30% of the joint costs.
REI case
REI limited its return policy. Used to have a lifetime return policy--> "we stand behind gear". revenue was up but profit was not. customer profitability--> some customers were unprofitable because they were returning all of this gear. losing $ on customers, one year return limit on customers. many customers were unhappy with this, but REI was losing money from their business. Why you MIGHT use profitibility analysis
Improving ROI
ROI can be increased in 3 ways: increasing revenues (hardest to do, easier said than done), decreasing expenses (cost cutting), and decreasing capital invested (if you maintain the same profit while using less capital, ROI will go up)
use of ROI
ROI can be used to determine which divisions made the best use of their capital. it can also be used to evaluate a project
Return on investment
ROI is the most popular measure of performance. It is calculated as follows: ROI= income/invested capital. companies calculate ROI DIFFERENTLY. income could be operating profit or net income (profit of the investment center--division/department). Invested capital could be the capital given to the investment center. total assets could be in the denominator, some use total assets-total liabilities. CAPITAL GIVEN TO INVESTMENT CENTER
Drawback to ROI
ROI may lead to suboptimal behavior if managers are evaluated strictly based on ROI. Assume that Tom's division has an ROI of 40%. Tom would reject all projects with an ROI of less than 40% because they would lower his division's ROI.
Product costs process
Raw materials inventory--> WIP inventory (consisting of direct labor and MOH)--> finished goods inventory. stored there until sold and then expensed to COGS
COGS
The product costs are expensed to COGS when the tiny home is sold and the customer drives it away (WHEN IT IS SOLD, EXPENSED TO COGS, costs are stored in finished goods until products are sold.
sales vs production method
The production method reduces TMC when the byproduct is produced, while the sales method increases nonoperating revenue when the byproduct is sold. Thus, there is a diff in timing (sold vs produced) and classification (reducing manufacturing cost vs nonoperating rev)
Administrative costs
The salary of Tumbleweed's staff accountant. Rent or depreciation expense for the corporate HQ (cost of CORPORATE HQ)
What is the standard price?
The standard price per unit reflects the final cost of the resource plus any freight costs (costs to ship) (e.g. iron ore costs $60/ton, but it costs $80/ton for shipping. Thus, the standard price would be $140/ton).
