Accounting Test 4

To identify costs that are avoidable in a particular decision and are therefore relevant,

1.Eleminate costs and benefits that do not differ between alternatives. These irrelevant costs consist of: sunk costs and future costs that do not differ between alternatives. 2. Use the remaining costs and benefits that do differ between alternatives in making the decision. The costs that remain are the differential, or avoidable costs.

Two categories of cost that are never relevant in decisions.

1.Sunk Costs, 2.Future costs that do not differ between the alternatives

Segment

A segment is a part or activity of an organization about which managers would like cost, revenue or profit data. (Cost, profit and investement centers are segments as are sales territories, individual stores, service centers, manufacturing plants, marketing departments, individual customers and product lines.)

Reduce Expenses

Add to Net Operating Income

Average Operating Assets

Beginning Balance + Ending Balance / 2 = Average Operating Assets

Contribution Margin per DLH

Contribution Margin/Direct Labor per unit

Direct Labor hours per unit

Direct Labor per unit/Direct Labor Rate (per hour)

Constrained Resource by Contribution Margin

Divide Contribution Margin per unit by constrained resource

ROI (also be expressed in terms of margin and turnover)

Margin x Turnover

Residual Income

Net Operating Income - (Average operating assets x minimum required rate of return)

Margin

Net operating income/sales

Segmented margin

Revenue - variable costs = contribution margin - total fixed costs = segmented margin - common fixed costs = net operating income

Turnover

Sales/Average operating assets

Operating Assets

Variable expenses - fixed expenses

Avoidable cost

a cost that can be eliminated in whole or in part by choosing one alternative over another.

Sunk Cost

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

Purchases to machinery and equipment, reducing costs.

add to average operating assets and add the reduction of costs to net operating income.

using less materials

add to net operating income

Contribution Margin per unit of constrained resource

computed by dividing a product's contribution margin per unit by the amount of the constrained resource required to make a unit of the product.

Reducing or lessening the average level of inventory

decreases average operating assets

Investment Center

has control over cost, revenue and investments in operating assets. Investment center managers are usually evaluated using return on investment (ROI) or residual income measures, as discussed later in the chapter.

Profit Center

has control over costs and revenue, but not over the use of investment funds. Profit center managers are often evaluated by comparing actual profit to targeted or budgeted profit.

Cost Center

has control over costs, but not over revenue or the use of investment funds. The managers of cost centers are expected to minimize costs while providing the level of products and services demanded by other parts of the organization.

Operating Assets

include cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes.

Relaxing (or elevating) the constraint

increasing the capacity of the bottleneck

Traceable fixed cost

is a fixed cost that is incurred because of the existence of the segment and would disappear if the segment were eliminated. (Would disappear if the segment were eliminated.)

Common Fixed cost

is a fixed cost that supports the operations of more than one segment, but is not traceable in whole or in part to any one segment. (Would not disappear if the segment were eliminated.)

Special Order

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

Segment Margin

is the difference between the revenue generated by a segment and its own traceable costs.

Residual Income

is the net operating income that an investment center earns above the minimum required return on its operating assets.

Transfer Price

is the price charged when one segment of an organization provides a good or service to another segment in the organization.

Net operating income

is used in the ROI formula and is income before interest and taxes and is sometimes referred to as EBIT (earnings before interest and taxes.)

Bottleneck

machine or process that is limiting overall output.

Target Costing

management estimates how much the market will be willing to pay for the new product even before the new product has been designed.

Fundamental concept of managerial accounting

managers need different costs for different purposes.

ROI

net operating income/Average operating assets

The reduction in resale value of an asset through use over time is often called

real or economic depreciation.

Obsolete inventory written as a loss

reduce net operating income and average operating assets

In general, a special order is profitable if

the incremental revenue from the special order exceeds the incremental costs of the order.

Cost-based approach (Cost plus)

the product is first designed and produced, then its cost is determined and its price is computed by adding a markup to the cost.

Constraint

when a limited resource of some type restricts the company's ability to satisfy demand,

Make or Buy decision

whether to produce a part internally or to buy the part externally from a supplier.