Chapter 2

Conformance failure

Improve materials or processes better to conform to existing product or service standards

Labor fringe benefits

Include as part of direct labor if it relates to direct labor

Idle Time

Include in all overhead to spread these costs over all production rater than the jobs that happen to be in process when breakdowns or other disruptions occur.

Overtime premium

Include in overhead unless the particular job was a rush order that had to be produced overtime.

Finished Goods Inventory -->

Income Statement as COGS.

Selling and Administrative Expenses go to the

Income Statement as Selling and Administrative Expenses

Selling and Administrative costs (period costs) --->

Income Statement as Selling and Administrative Expenses

Periods costs are expensed on the _________ ___________.

Income Statement following the rules of accrual accounting.

Focus of MA

Information

Cost of Poor Quality

Internal Failure Costs, External Failure Costs

Costs incurred because defective products were produced or defective services were provided

Internal failure costs (scrap, spoilage, rework) and External Failure Costs (warranty costs, service calls, product liability)

Direct Labor (PC)

Labor costs of all manufacturing labor that can be economically traced to individual units of product.

Indirect Labor

Labor costs that cannot be physically traced to particular products or that can be traced only as great cost inconvenience are termed indirect labor.

Raw Materials

Materials that go into the final product

Design

Meeting customer's expectations

Committed fixed costs (capacity costs)

Organizational investments with a multi-year planning horizon that can't be significantly reduced even for short periods without making fundamental changes, investments in facilities and equipment

Non-manufacturing costs

Period Costs

Main managing activities

Planning, directing, motivating and controlling

Costs incurred to keep defective products or services away from customers

Prevention costs and Appraisal Costs (Testing, inspection, maintenance)

Manufacturing Costs

Product Costs

Product Costs definition

Product costs are all costs involved in acquiring or making a product.

ISO Standards

Quality control guidelines known as the ISO 9000 standards

High/ Low

RELATED TO HIGH AND LOWEST LEVEL OF ACTIVITY not cost

The Big Scheme of Things

Raw Materials ---> Raw Materials Inventory (BS) ------> Direct Materials used in production + direct labor + manufacturing overhead -------> Work in Process Inventory (BS) ------> Goods completed (COGS Manufactured) ------> Finished Good Inventory (BS) -----> Goods Sold ---------> Costs of Good Sold (IS)

Raw Material Purchases (Product Cost) Goes on BS as what?

Raw Materials Inventory

Period costs

Recorded straight on the income statement

Design Failure Response

Redesign the product, change product features to conform more closely to customer's expectations.

Relationship between activity and cost

Regression

Differential Costs (aka avoidable, incremental or relevant) revenues and costs

Revenues and costs that differ between alternatives under consideration Can be fixed or variable Revenues and costs that are the same between alternatives can be ignored

High Low Method

Rise/Run

Contribution Margin

Sales Revenues - variable expenses

Number 1

Satisfying customer expectations-price, quality, functionality and features, service

Selling Costs

Selling costs include all costs that are incurred to to secure customer orders and get the finished product to the customer. "order getting and order filling costs"

Caution: Changes in technology and operating environment

Structural changes may alter the relationship between activity and cost

Relevant Range

The activity level over which fixed costs remain constant.

Opportunity Cost

The contribution to operating income that is foregone or rejected by not using a limited resource in its next best alternative use

Cost

The estimated value of the resources sacrificed by the organization to acquire an asset or settle a liability

Variable and fixed costs are acquired, paid for and managed directly.

The purchase and consumption of variable costs can be adjusted to demand.

Capital expenditure-charge an asset account

The revenue-generating capacity of that which is received is expected to be longer than one year or the operating cycle whichever is longer.

Operating Expenditure - charge an expense account

The revenue-generating capacity of that which is received is expected to be shorter than one year or the operating cycle whichever is longer.

Conversion Cost

The sum of direct labor cost and manufacturing overhead cost. Direct Labor + Manufacturing Overhead

Prime cost

The sum of direct materials cost and direct labor cost. Direct materials + direct labor cost

On the Balance Sheet

The sum total of these three categories of inventories is the only amount shown on the balance sheet in external reports, footnotes provide more details.

Manufacturing Overhead

The third element of manufacturing cost, includes, all manufacturing cots except direct materials and direct labor. Includes: indirect materials; indirect labor; maintenance and repairs on production equipment; and heat and light, property taxes, depreciation, and insurance on manufacturing facilities

Direct Materials (PC)

Those materials that become an integral part of the finished product and whose cost can be economically traced to the final product.

Indirect Materials (PC)

Those materials that become an integral part of the finished product and whose cost cannot be economically traced to the final product

Manufacturing Costs

Three broad categories: direct materials, direct labor, and manufacturing overhead

Direct Labor is also called

Touch labor

Idle Time

Treated as a manufacturing overhead cost

How many types of fixed costs?

Two

Rise/Run

Value of dependent variable (Y) at the highest value of X-Value of dependent variable (Y) at the lowest value of X / Highest value of independent variable (X) - Lowest value of independent variable (X)

Estimate the fixed cost

Value of dependent variable at a particular activity level - variable cost at that activity level

Labor Costs: Hourly paid piece system

Variable Cost

When is a cost indirect?

When it cannot be economically traced to a specific cost object

Direct Labor and Manufacturing Overhead (BS as what they are product costs)

Work in Process inventory

Direct Labor and Manufacturing Costs go to

Work in process Inventory on the Balance Sheet -----> Finished Good Inventory -----> COGs (on the Income Statement)

Direct Cost

a cost that can be traced to a cost object in an economically feasible way

Indirect costs are

allocated

An indirect cost

also called common cost

Raw Materials Definition (PC)

any materials that are used in the final product

Period costs

are all the costs that are not product costs. (like adminstrative and selling) They are not included as part of the cost of either purchased or manufactured goods.

Direct Materials

are those materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product.

Indirect costs

cannot be economically traced to a specified cost object. They are allocated to cost objects.

Overtime premium

considered manufacturing overhead

Controlling involves

ensuring that the plan is actually carried out and is appropriately modified as circumstances change

When the goods are sold, the costs are released from inventory as __________ (typically COGS) and matched against ____________.

expenses, sales revenue

Cost Classification

fixed cost, variable cost, mixed cost, direct cost, etc.

Managerial accounting has a huge focus on the ______.

future

Retail Companies have only one class of inventory called

goods purchased from suppliers for resale to customers

Administrative costs

include all costs associated with the general management of an organization rather than with manufacturing or selling. (general accounting, executive compensation, public relations, etc)

Product costs are also called

inventoriable costs

Directing and motivating

involves mobilizing people to carry out plans and run routine operations

The planning and control cycle

involves the smooth flow of management activities from planning through directing and motivating, controlling, and then back to planning again.

Conformance

meeting company standards

Manufacturing Companies have three classes of inventories

raw materials, work in process, and finished goods.

Types of Quality Behavior

two

Mixed Cost

y=a+bx B: the variable cost of the slope of the line. A: THE FIXED COST

Indirect costs are still ALLOCATED

1. GAAP mandates such allocations for external financial statements 2. These allocations make managers aware of the total cost of providing products or services. 3. Customers see lower markups on cost 4. Useful for reimbursements on cost plus contracts

How are allocation bases chosen?

1.Cause and effect relationship between indirect manufacturing costs and cost objects-rarely is this very strong. 2. Benefits received 3. Fairness or equity 4. Ability to bear

Common Cost

A common cost is a cost that is incurred to support a number of cost object but cannot be traced to them individually. A common cost is a type of indirect cost.

Indirect Cost

A cost that cannot be economically traced to a cost object. These costs are allocated to cost objects.

Sunk Costs:

A cost that has already been incurred and that cannot be changed by any decision now or in the future. IRRELEVANT to decisions and should be ignored

Fixed Cost

A cost that remains constant, in total, despite changes in levels of total activity.

Variable Cost

A cost that varies, in total, in proportion to changes in the level of some particular activity. That activity is called an activity base or cost driver. Variable costs are constant on a per unit basis as production volume changes. PROFITS CAN CHANGE

Differential costsss

A difference in costs between any two alternatives, also called an incremental cost, or decremental costs. Marginal costs and revenue are also used.

Quality of Conformance

A product that meets or exceeds its design specifications and is free of defects that mar its appearance or degrade its performance

ALL COSTS OTHER THAN PRODUCT COSTS

ARE TREATED AS PERIOD COSTS UNDER GAAP

Caution Relevant Range

Activity levels outside those used in your high-low or regression analyses may affect costs differently.

Selling Costs (Period Costs)

All costs incurred to secure customer orders and get the finished product to the customer. Advertising, showroom rental, sales, commissions, sales force travel

Products Costs

All costs involved in acquiring or making a product.

Expenditure

An exchange of assets (such as cash) or liabilities (such as debt) for something of value

Cost Object

Anything for which costs information is desired. Products, customers, individual jobs completed for customers, projects, services, departments.

Cost of good Quality

Appraisal Costs, Prevention Costs

Products costs are assigned initially to the _________ as an ________ account.

Balance Sheet, Inventory

Matching Principle

Based on the accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized

Another way to look at it

Beginning Balance + Additions to Inventory - Withdrawals from Inventory = Ending Balance

Equation for Inventory Accounts

Beginning Balance + Additions to Inventory = Ending Balance + Withdrawals from Inventory

COGS for Merchandising Company

Beginning Merchandise Inventory + Purchases = Ending Merchandise Inventory + COGS

COGs equation for a Manufacturing Equation

Beginning finished goods inventory + COGS of good manufactured = Ending finished goods inventory + COGS

Another way to look at it (1)

COGS= Beginning finished goods inventory + Costs of Goods Manufactured - Ending Finished Good Inventory

Another equation

COGs= Beginning Merchandise Inventory + Purchases - Ending Merchandise Inventory

Direct Costs

Can be economically traced to a specified cost object-they are caused by the cost object

Fixed costs are usually

Capacity related resources that are bought before work is done. "How much work is planned not how much is actually performed."

Direct Labor

Consists of labor costs that can be easily traced to individual units of production

To assign costs to cost objects

Costs are classified as either direct or indirect

General and Administrative Costs (Period Costs)

Costs associated with the general management of the firm. General Accounting, public relations, legal.

Goods completed

Costs of Good Manufactured

Expense

Costs that have been used in the current period to help generate revenue.

Loss

Costs that have no future revenue-generating capacity. Also, decreases in equity arising from peripheral or incidental transactions of the entity.

Characteristics of Quality

Design and Conformance

Work in Process Inventory

Direct Labor and Manufacturing are the product costs.

Raw Materials

Direct materials used in production

Product Costs for Manufacturing Goods

Direct materials, direct labor, and manufacturing overhead.

Products Costs in Manufacturing

Direct materials, direct labor, and manufacturing overhead. They attach to units of production as the goods are purchased or manufactured.

Number 2

Ensuring that design and performance features conform to company standards

Product Costs

Expensed when the related products are sold

SEC

Financial accounting is mandatory because they require financial statements. Managerial accounting is not mandatory.

Labor Costs: Hourly paid employees who-for scheduling or union contract reasons-have a guaranteed annual wage.

Fixed Cost

Discretionary fixed costs

Fixed costs that can be cut for short periods of time with minimal damage to the achievement of the organization's long term goals. EX: research, public relations, internship programs, management training programs.

Do Allocations of Indirect Manufacturing Costs Lead to Better Decisions?

Generally no because the association between indirect manufacturing cost incurrence and the cost object is so week as to add little value.

Hint High Low Method

Get the slope first, then solve for A.

Product Costs

Go through the balance sheet

Estimating the Relationship Between Activity and Cost

High low method

Cost

"Cost" has different meanings because managers use different costs for different purposes. No single way of computing costs.

Cost Flow Example

$1,500 of the insurance Goes through Work in process Inventory (BS) ----> Finished Goods Inventory (BS)----> COGS on IS

Direct Costs Must BE

(1) caused by the cost of the object (2) tracing the cost of the cost object must be economically worthwhile

Manufacturing overhead (PC)

(aka indirect manufacturing costs, factory overhead and factory burden) all manufacturing cots other than direct materials and direct labor. Examples: factory insurance, property taxes, utilities, repairs and maintenance.

4. Making Decisions

-Differential costs (differs between alternatives) -Sunk costs (costs that cannot be altered) -Opportunity costs (what is foregone by choosing a different option)

3. Assigning costs to cost objectives like products, departments, customers

-Direct costs (can be economically traced) -Indirect costs (cannot be economically traced)

Treatment of Labor Related Costs

-Idle Time -Overtime premium -Labor fringe benefits

1. Preparing external financial statements

-Product costs (carried in inventory until sold) *Direct Materials *Direct Labor *Manufacturing overhead -Period Costs (expensed law the matching principle) *Selling costs *Administrative Costs

2. Predicting cost behavior in response to changes in activity levels

-Variable costs (proportional to activity) -Fixed costs (constant in total) -Mixed Costs (contains variable and fixed components)

First Use: Cost Classifications on the Financial Statements

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