Managerial Accounting 1-5

Direct and Indirect Costs

*Direct costs* can be conveniently and economically traced (tracked) to a cost object. *Indirect costs* cannot be conveniently or economically traced (tracked) to a cost object. Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner. Example for Mfg Firm: Direct: cost of materials and labor (DMU and DL) Indirect: Utilities, depreciation of plant equipment, insurance, property taxes, inspection, supervision, maintenance of machinery, storage, and handling (do not include overall company expenses in the manufacturing overhead!! only indirect costs of manufacturing a product!)

Basic Cost Terminology

- Cost—sacrificed resource to achieve a specific objective - Actual cost—a cost that has occurred - Budgeted cost—a predicted cost - Cost object—anything of interest for which a cost is desired - Cost accumulation—a collection of cost data in an organized manner - Cost assignment—a general term that includes gathering accumulated costs to a cost object. This includes: > Tracing accumulated costs with a direct relationship to the cost object and > Allocating accumulated costs with an indirect relationship to a cost object - Cost driver—a variable that causally affects costs over a given time span - Relevant range—the band of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and a given cost > For example, fixed costs are considered fixed only within the relevant range.

Types of Manufacturing Inventories

- Direct materials—resources in-stock and available for use - Work-in-process (or progress)—products started but not yet completed, often abbreviated as WIP - Finished goods—products completed and ready for sale

Different Types of Firms

- Manufacturing-sector companies purchase materials and components and convert them into finished products. - Merchandising-sector companies purchase and then sell tangible products without changing their basic form. - Service-sector companies provide services (intangible products).

Cost Flows

-The Cost of Goods Manufactured and the Cost of Goods Sold section of the Income Statement are accounting representations of the actual flow of costs through a production system. -Note the importance of inventory accounts in the following accounting reports, and in the cost flow chart _Shortcuts:_ DMU = matBI + purchased - matEI COGM = wipBI + TMC - wipEI where, TMC = DMU + DL + applied MOH COGS = finBI + COGM - finEI

Key Assumptions of CVP

1) selling price is constant 2) costs are linear and can be accurately divided into variable and fixed elements 3) sales mix is constant 4) units produced = units sold (inventories do not change)

Management Accounting Guidelines

1. cost benefit approach (benefits exceed costs) 2. behavioral and technical considerations (management is a human activity) 3. different costs for different purposes

Product Costs

= inventoriable costs: product manufacturing costs. These costs are capitalized as assets (inventory) until they are sold and transferred to Cost of Goods Sold. Direct materials—acquisition costs of all materials that will become part of the cost object. Direct labor—compensation of all manufacturing labor that can be traced to the cost object. Indirect manufacturing—factory costs that are not traceable to the product in an economically feasible way. Examples include lubricants, indirect manufacturing labor, utilities, and supplies.

Activity Based Costing (ABC)

ABC is generally perceived to produce superior costing figures due to the use of multiple drivers across multiple levels. It is generally considered to be more accurate and more costly to implement. ABC is only as good as the drivers selected, and their actual relationship to costs. Poorly chosen drivers will produce inaccurate costs. Using ABC does not guarantee more accurate costs! Because a number of critical decisions, such as pricing, whether or not one product should be "pushed" over another, whether or not a product should be dropped, etc. will be made using cost information, best efforts should be used to arrive at a cost that is fair and reasonable for each product. ----- Three principal reasons have accelerated the demand for refinements to the costing system. 1. Increase in product diversity 2. Increase in indirect costs with different cost drivers 3. Competition in product markets ---- Signals that suggest that ABC Implementation could help a Firm: 1. Significant amounts of indirect costs are allocated using only one or two cost pools. 2. All or most indirect costs are identified as output unit-level costs. 3. Products make diverse demands on resources because of volume, process steps, batch size or complexity. 4. Products that a company is well-suited to make show small profits whereas products that a company is less suited to make show large profits. 5. Operations staff has substantial disagreement with the reported costs of manufacturing and marketing products or services

Cost-Volume-Profit Analysis

An examination of the cost behavior patterns that underlie the relationships among cost, volume of output, and profit. Variable costs: Vary with volume or operating activity Fixed costs: Remain fixed as volume changes If managers can predict how costs will behave, then costs become manageable

Applied MOH

BMOHR x Actual Quantity When calculating Total Manufacturing Cost = DMU + DL + MOH, you are using *applied MOH* (budgeted) and not actual!!!

NEED TO GO OVER

Ch 1 Ch 2 Ch 3 - EVERYTHING Ch 4 - proration, flow of journal entries, write off to COGS, etc. Ch 5 -

Conversion Cost

DL + MOH total cost = DMU + conversion cost

Prime Cost

DMU + DL term referring to all direct manufacturing costs (materials and labor). total cost = prime cost + MOH

Degree of Operating Leverage

DOL = CM / Net Operating Income Net Operating Income = CM - F DOL = CM / CM - F Notice! If you have a DOL of 5, and sales increase 10%, your net income will increase 10%*5 = 50%

Multi Product Break Even Analysis

First find the total CM ratio of total contribution margin over total sales Now find the percentages of your sales mix (45% horns, 55% bikes) If the unit CM can be calculated for each product, then unit contribution must be weighted by the sales mix To calculate the breakeven point for each product, we divide the total fixed cost by weighted sales mix. The solution will be split into the sales mix ratio. Step 1: Weighted Average CM = CM * % Sales Mix Step 2: Weighted Average BE units = TFC / WACM Step 3: Product BE = Weighted Average BE x Sales Mix %

Broad Averaging

Historically, firms produced a limited variety of goods and at the same time, their indirect costs were relatively small. Allocating overhead costs was simple: use broad averages to allocate costs uniformly regardless of how they are actually incurred. Generally known as "Peanut-butter costing" The end-result is *Cross-Subsidization*: The over-costed product absorbs too much cost, making it seem less profitable than it really is. The under-costed product is left with too little cost, making it seem more profitable than it really is. OVERCOSTING occurs when a product consumes a low level of resources but is allocated high costs per unit. UNDERCOSTING occurs when a product consumes a high level of resources but is allocated low costs per unit.

Incremental CM Analysis

If CM goes up and Fixed Expense goes down Change in CM - Change in Fixed Cost = Change in Net Operating Income

Flow of Journal Entries

Know where each purchase moves credits/debits from one account to the next Example: Indirect and direct labor wages Work in Process +DL MOH +IL Cash -(DL+IL)

Sarbanes-Oxley Act (SOX)

Legislation was passed in 2002 in response to a series of corporate scandals. CEOs and CFOs must certify that the financial statements of their firms fairly represent the results of their operations. The act focuses on improving: Internal controls Corporate governance Monitoring of managers Disclosure practices of public companies

line-and-staff organization

Line management is directly responsible for achieving the goals of the organization. Staff management provides advice, support and assistance to line management

Margin of Safety (Percentage)

Margin of Safety % = Margin of Safety / Total Sales

Margin of Safety (Dollars)

Margin of Safety = Total Sales - Breakeven Sales

Margin of Safety (Units)

Margin of Safety in units = Dollar Margin of Safety / Price per Unit Or Margin of Safety = Total Units Sold - Breakeven Units

Why use normal costing?

Normal costing enables Amesbury to report a job cost as soon as the job is completed, assuming that both the direct materials and direct labor costs are known at the time of use. Once the 960 direct labor-hours are known for the Laguna Model (June 2011), Amesbury can compute the $191,710 cost figure using normal costing. Amesbury can use this information to manage the costs of the Laguna Model job as well as to bid on similar jobs later in the year. In contrast, Anderson has to wait until the December 2011 year-end to compute the $182,110 cost of the Laguna Model using actual costing.

Breakeven (CM approach)

Operating Income = 0 0 = Q(p-v) - F Q* = F/(p-v) Trick: CM = F when you're at Q* unit CM = (p-v) Also note, you only need to multiply CM by the number of units above breakeven to get your final operating income! Fixed costs are already covered at Q*

Factory Overhead

Overhead application is the process of allocating overhead costs to individual jobs There are two approaches to allocating overhead: actual and normal. Under the actual application method, overhead costs are tracked for each job and are transferred to WIP and Finished Goods Inventory in the exact amounts incurred Under the normal application method, overhead costs are applied to various jobs using a predetermined factory overhead rate The predetermined factory overhead rate is an estimated factory overhead rate used to apply factory overhead cost to a job The amount of overhead assigned to a job using this rate is called factory overhead applied

Overtime and Idle Time

Overtime = hours*base rate + hours x(overtime rate) first part is DL cost, second part is indirect labor cost (MOH) Idle Time = hours*base rate all idle time is indirect labor cost, do NOT put in DL

Plantwide and Departmental Overhead

Plantwide: Total MOH / Total Base Department Dep MOH / Dep Base

Breakeven (Dollar Sales)

Profit = CM Ratio x Sales - Fixed Expense Π = Q(p-v)/Qp x Dollar Sales - Fixed Expense Dollar Sales = Fixed Expense / CM Ratio

Financial Accounting Income Statement

Revenues - COGS (Var + Fix mfg) = Gross Margin - Operating Expenses (Var + Fix Nonmfg) = Operating Income

Contribution Income Statement

Revenues - Variable Mfg Costs - Variable Nonmfg Costs = Contribution Margin - Fixed Mfg - Fixed Nonmfg = Operating Income

Multiple-step income statement

Sales - COGS = gross margin - operating expenses = operating income net income / (1 - tax rate) = operating income

Sales Mix

Sales mix is the relative proportion in which a company's products are sold. Different products have different selling prices, cost structures, and contribution margins. When a company sells more than one product, break-even analysis becomes more complex as the following example illustrates.

Job Costing System

System accounting for distinct cost objects called jobs. Each job may be different from the next, and consumes different resources. Steps: 1. identify the job that is the chosen cost object 2. identify the direct costs of the job 3. select the cost-allocation bases to use for allocating indirect costs to the job 4. match indirect costs to their bases 5. calculate an overhead allocation rate: BMOHR = budgeted MOH / budgeted Quantity of base 6. allocate overhead cots to the job: BMOHR * actual Quantity of base 7. compute total job costs by adding all direct and indirect costs together

Target Operating Income (TOI)

TOI is the level of sales needed to attain a specified dollar amount of operating income. In order to determine TOI, add the desired operating income to fixed cost in the breakeven calculation. Fixed Cost + TOI / Unit CM = Q* What if tax rate is given? F + (NI/1-TR) / CM = Q Net Income = Operating Income x (1-TR) Operating Income = NI/(1-T)

Contribution Margin

The amount remaining from sales revenues after all variable expenses have been deducted. The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume. The emphasis is on cost behavior. CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income. Remember! Op Income = CM - Fixed Π = Q(p-v) - F Π = Q*CM - F

Cost Hierarchies

The four levels in the cost hierarchy are: Output unit-level costs (related to the individual units of a product or service) Batch-level costs (related to a group of units) Product (or service)-sustaining costs (related to support a particular product or service without regard to the number of units or batches) Facility-sustaining costs (related to costs of activities that cannot be traced to individual products or services)

Standards of Ethical Conduct

The four standards of ethical conduct for management accountants as advanced by the Institute of Management Accountants (IMA) are: Competence Confidentiality Integrity Objectivity

predetermined factory overhead rate

The predetermined factory overhead rate is obtained using a four-step process: 1. Estimate total factory overhead costs for the operating period, usually a year 2. Select the appropriate cost driver(s) that will be used to apply factory overhead costs 3. Estimate the total amount or activity level of the chosen cost drivers for the operating period (this is also referred to as the "denominator activity level") 4. Divide the estimated factory overhead costs by the estimated amount of the chosen cost driver(s) to obtain the predetermined overhead rate.

Value Chain and Key Success Factors

The value chain is the sequence of business functions by which a product is made progressively more useful to customers. The value chain consists of: - Research & Development - Design of Products and Processes - Production - Marketing (including Sales) - Distribution - Customer Service Note: supply chain is production and distribution only Value Adding Activity: adds cost and value, Non Value Adding Activity: adds cost but no customer value Key Success Factors: Customers want companies to use the value chain and supply chain to deliver ever-improving levels of performance when it comes to several (or even all) of the following: Cost and efficiency; Quality; Time; Innovation; Sustainability

Variable Expense Ratio

The variable expense ratio is the ratio of variable expenses to sales. It can be computed by dividing the total variable expenses by the total sales, or in a single product analysis, it can be computed by dividing the variable expenses per unit by the unit selling price. CM / Sales = CM Ratio Q*(p-v) / Q*p = CMR unit CM / unit price = unit CMR (p-v) / p = unit CMR

Refining a Costing System

There are three main guidelines for refining a costing system: 1. Direct-cost tracing - identify as many direct costs as is economically feasible 2. Indirect-cost pools - expand the number of indirect-cost pools until each pool is more homogeneous. (All costs in a homogeneous cost pool have the same or a similar cause-and-effect relationship with a single cost driver) 3. Cost-allocation bases - whenever possible, use the cost-driver as the cost-allocation base for each homogeneous indirect-cost pool

Disposition of Under- or Overapplied MOH

Two treatments are possible: 1. *Write-off Approach:* Adjust the Cost of Goods Sold (CGS) account , that is, the difference is simply added to (when underapplied) or subtracted from (when overapplied) the CGS account) 2. *Proration Approach:* Adjust the production costs of the period (i.e., prorate the difference to the ending balances of Work in Process Inventory, Finished Goods Inventory, and the CGS account)

Cost Behavior

Variable costs—changes in total in proportion to changes in the related level of activity or volume. (Variable costs are constant on a per-unit basis. If a product takes 5 pounds of materials each, it stays the same per unit regardless if one, ten, or a thousand units are produced.) Fixed costs—remain unchanged in total regardless of changes in the related level of activity or volume. (Fixed costs change inversely with the level of production. As more units are produced, the same fixed cost is spread over more and more units, reducing the cost per unit.) Costs are fixed or variable only with respect to a specific activity or a given time period.

Performance Report

a report that compares budgeted data to actual data to highlight instances of excellent and unsatisfactory performance Actual Result - Budgeted Amount / Budgeted Amount = Difference as % of Budget You want this % to be "favorable" (if costs, want them to be small negative. If revenues, want them to be large positive)

Under or Overallocated MOH

actual MOH - applied MOH actual cost x Q - BMOHR x Q

Managerial Accounting

aka management accounting - used by managers/directors to make decisions about daily operations of company - measures, analyzes and reports financial and nonfinancial information that helps managers make decisions to fulfill organizational goals used to: - develop, communicate, and implement strategies - coordinate product design, production, and marketing decisions and evaluate a company's performance

Actual Costing

allocates indirect costs based on the actual indirect-cost rates times the actual activity consumption actual cost rate * actual quantity

Normal Costing

allocates indirect costs based on the budgeted indirect-cost rates times the actual activity consumption BOHR * actual quantity

Financial Accounting

focuses on reporting financial information to *external parties* such as investors, governmental agencies, banks, and suppliers, based on GAAP. This allows the board of directors, stockholders, potential investors and financial institutions to see how the company has performed during a specific period of time in the past. These reports are filed on an annual basis. unique traits: - purpose: communicates an organization's financial information to external parties. - focus: past-oriented. - rules: in accordance with GAAP and certified by independent audit - reports: annual and quarterly reports on entire company - end-use: used to determine manager's compensation

Period Costs

have no future value and are expensed in the period incurred. = variable operating costs + fixed operating costs = ALL NONMANUFACTURING COSTS

Cost Accounting

measures, analyzes and reports financial and nonfinancial information related to the costs of acquiring or using resources in an organization. used by *internal parties* such as management as well as financial accounting professionals unique traits: - purpose: help management make decisions to fulfill firm's goals - focus: future-oriented - rules: no GAAP but follows cost-benefit analysis - reports: hourly to 15/20yr span, financial and nonfinancial, no template - end-use: used to influence behavior of managers and employees during operations

Cost Structure

refers to the relative proportion of fixed and variable costs in an organization. Managers often have some latitude in determining their organization's cost structure. High Fixed Cost: income will be higher in good years, but lower in bad years (debt leverage) Low Fixed Cost: income will be stable in good and bad years, but you might miss out on the increased profit of a high fixed cost structure during good years Rule of thumb! Use high fixed cost if you are confident future sales will be high. Use low fixed cost if you have worries about future sales!

Strategy

specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives. There are two broad strategies: *Cost Leadership*—outperform competitors by producing at the lowest cost, consistent with quality demanded by the consumer *Product Differentiation*—creating value for the customer through product innovation, product features, customer service, etc. The customer is willing to pay more for these added values

Process-Costing

system accounting for mass production of identical or similar products.

Budget

the quantitative expression of a proposed plan of action by management and is an aid to coordinating what needs to be done to execute that plan note: control is about implementing the plan (budget), evaluating performance, and providing feedback. the control function ensures that plans are being followed.