BU247 Managerial Accounting <br />with Natasha Neumann-Causi and Mike Pegutter<br />
Updated Presentation<br />This presentation is up to date<br /><ul><li>Uses material from new textbook
Follows course outline
Contains examples from prior exams and from textbook questions
If I miss something, let me know and I will explain it now or in an email </li></li></ul><li>General Study Tips<br />DON’T...
Exam Outline<br />Multiple Choice Questions<br />Definitions<br />Smaller calculations <br />Theories<br />Journal Entries...
Agenda<br />PART I: Introduction and CVP Analysis<br /><ul><li>What is management accounting?
Cost behaviour
Cost-Volume-Profit Analysis</li></ul>PART II: Cost Behaviour<br /><ul><li>Variations in cost behaviours
Income Statement approaches</li></ul>PART III: Cost Allocation<br /><ul><li>Overhead Rate Calculation
Applying Overhead</li></ul>PART IV: System Design and Allocation<br /><ul><li>Job Order vs. Process
Service Departments </li></ul>PART V: ABC Costing<br />
INTRODUCTORY MATERIALPart I<br />
Managerial Accounting<br />For management purposes only<br />Cost allocations and calculations<br />Budgeting and future p...
Framework of Cost Accounting<br />Strategic Planning – focus on company objectives<br />Factory location<br />Mergers & ac...
Central Layout <br />Management accounting involves:<br />planning (alternative identification and budgeting)<br />control...
Financial vs. Management<br />
   Decisions & Information<br />Decision Process<br />Accounting Information Types<br />Identify the problem<br />Understa...
Key Success Factors<br />Critical for an organization’s success <br />Example: excellent customer service for fast food co...
Professional Ethics<br />Competence: be able to recognize limitations, follow laws, provide accurate and timely informatio...
Professional Ethics<br />Resolution Conflict: follow official   policies, or talk to supervisors<br />confidentially shoul...
Process Management<br />Approaches to improving processes:<br />Lean Production – minimize inventory and “pull” units thro...
Cost Behaviour<br />A cost driveris source of your total costs<br />Example: the number of man hours clocked in a laborato...
Relevant Range<br />Relevant rangeand Step Variable Costs are ranges where your per unit variable costs and your fixed cos...
Cost – Volume – Profit Analysis<br />Total Sales<br />Total Costs<br />Breakeven Point<br />Fixed Costs<br />
Breakeven Analysis<br />Calculating how many units need to be sold before you can start making some profits<br />Equation ...
CVP Analysis Example<br />A Playstation3 console is priced at $300 but costs about $250 each to make. Sony’s fixed costs f...
Changes in Volume and Sales<br />It helps to create simple income statements to help show what the contribution margin is ...
CM Changes Example<br />Assume basketballs can be made at a variable cost of $5/unit and with fixed costs totalling $50,00...
Margin of Safety<br />The excess of budgeted (or actual) sales over the break-even volume of sales<br />Sports Illustrated...
CVP with Product Mixes<br />Companies which sell more than one product involves a ratio called a ‘sales mix’ <br />Managem...
Multiproduct Example<br />Bob’s tree farm sells two types of trees: pine and maple. The sales mix is 3:1 respectively. Eac...
Cost Structure and Operating Leverage<br />Cost structure is relative proportion of fixed costs and variable costs<br />Op...
Cost Structure and Operating Leverage<br />Sales<br />Sales<br />$<br />$<br />Total<br />Expenses<br />Total<br />Expense...
COST BEHAVIOUR AND COST SYSTEMSPart II<br />
Cost Behaviours<br />Step costschange abruptly at intervals of activity because the resources and their costs come in indi...
Measuring Cost Behaviour<br />The mixed cost function is an equation of the cost and its driver; a linear equation looks l...
Activity Analysis Methods<br /><ul><li>Engineering Analysis– review of costs from past experiences
Account Analysis– review of accounting records and the subjective evaluation of patterns
High-Low Analysis– simple linear algebra method (unreliable results)
Scattergraph Analysis– line of fit method on a graph; where the intercept  is the total fixed costs and every point on the...
High-Low Analysis Example<br />Given the following information, determine the cost equation for custodial services<br />St...
Regression Analysis<br />All the points are considered whereas the scattergraph considers only the points on the line of b...
Cost Behaviour: Product and Period Costs<br />Product Costs– all costs involved in the purchase or manufacture of products...
Cost Methods: Absorb & Vary<br />Absorption Costing –includes manufacturing overhead in the costs which are assigned to in...
Cost Methods: Absorb & Vary<br />Variable  Costing – this approach tries harder to separate fixed costs from variable cost...
Absorption vs. Variable<br />ABC Company<br />Absorption Income Statement<br />Sales			$75,000<br />Cost of Goods Sold:<br...
Absorption vs. Variable<br />Variable costingstatements are considered easier to understand because net operating income i...
Segmented Income Statements<br />Income statements for parts of a whole company <br />A contribution format is used and tr...
Segmented Income Statements<br />Segment margin is the best gage of the long-run profitability of a segment<br />Traceable...
COST ALLOCATIONPart III<br />
Cost Management Systems<br />Costs are sacrifices of resources for a particular purpose (such as money for materials)<br /...
Cost Management Systems<br />Differential Costs (Revenues) are the difference in cost (revenue) between two alternatives<b...
Manufacturing Costs<br />For companies who create their inventory from scratch, there are three main categories of costs:<...
Cost Allocation<br />Cost Allocationis the process of linking costs or cost pools (multiple costs grouped together) with o...
Manufacturing Overhead Cost Allocation<br />The POHR is used no matter what the real overhead costs are and what the actua...
Underapplied / Overapplied<br />Since the POHR contains estimates, the manufacturing overhead that we actually incur and t...
Overhead Application Example<br />Toyota has incurred a total of $15.0M in manufacturing overhead this month with a total ...
POHR and Capacity<br />Biggest criticisms of using the POHR:<br />Using estimates and budgeted activity levels will result...
Professional Ethics<br />How will understating the estimated direct labour hours in the base for the POHR affect operating...
Overapplied overhead  debit balance in manufacturing overhead account
This will reduce COGS when the account is closed
This will result in higher net income</li></ul>Not in Handout<br />
SYSTEM DESIGN AND ALLOCATIONPart IV<br />
Product Costing Systems<br />Process Costing– the company mass produces one homogenous product<br />Costs are accumulated ...
Process Costing<br />A processing departmentis any part of a company where work is performed on a product<br />Transferred...
Equivalent Units (Weighted Average Method)<br />The number of complete units you could get from putting together all the p...
Equivalent Units Example (Weighted Average Method)<br />Given the information below, calculate the equivalent units both i...
Service Department Cost Allocations<br />Operating departmentsare the ‘heart and soul’ of the organization and carry out i...
Service Allocation Methods: Direct<br />Ignore transactions between service departments and assume service departments onl...
Direct Method Example<br />The accounting department of Cars Inc. has incurred $2.5M in costs over the year. Management ha...
Service Allocation Method: Step-Down<br />Service Department “A” provides services to Service Department “B” (but no recip...
Step-Down Method Example<br />The accounting department of Cars Inc. has incurred $2.5M in costs over the year. Management...
Service Allocation Method: Reciprocal<br />Service Department “A” provides services to Service Department “B” and vice ver...
ABC COSTINGPart V<br />
Activity-Based Costing<br />A non-traditional way of allocating costs<br />ABC costing is more careful about which costs a...
Activity Costing<br />An activity is an event that causes the consumption of overhead resources (i.e. taking customer orde...
General Structure of ABC<br />
Implementation of ABC<br />Identify and define activities<br />There is no ‘right’ or ‘wrong’, there is ‘accurate’ and ‘le...
Management Reports<br />Product Margin Calculation<br />These costs are assigned using other cost systems<br />Calculated ...
Management Reports<br />Customer Profitability Analysis<br />Calculated using the ABC Costing process (Stage 4)<br />Notic...
ABC vs. Traditional Costing<br />Traditional costing uses one plant wide manufacturing overhead rates<br />All shipping, m...
Cons of ABC Costing<br />ABC costing is not typically used for external reporting because<br />Don’t need all the detail<b...
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SOS Session: BU247 Midterm

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Intermediate Managerial Accounting Course:
Midterm material covered in SOS sessions in the Fall of 2010

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SOS Session: BU247 Midterm

  1. 1. BU247 Managerial Accounting <br />with Natasha Neumann-Causi and Mike Pegutter<br />
  2. 2. Updated Presentation<br />This presentation is up to date<br /><ul><li>Uses material from new textbook
  3. 3. Follows course outline
  4. 4. Contains examples from prior exams and from textbook questions
  5. 5. If I miss something, let me know and I will explain it now or in an email </li></li></ul><li>General Study Tips<br />DON’T PANIC! <br />USE YOUR HANDOUT!<br />Know the theory well, do not memorize calculations!<br />Practice homework with time constraints<br />If you get stuck on a question, leave it and come back later<br />When in doubt, GUESS! Never leave a question blank<br />Make sure you have answered everythingthe question asked for!!!<br />
  6. 6. Exam Outline<br />Multiple Choice Questions<br />Definitions<br />Smaller calculations <br />Theories<br />Journal Entries<br />True / False or Fill in the Blank<br />Theories and Definitions <br />Short Answers<br />Big Calculations <br />Writing out Steps to Calculations <br />
  7. 7. Agenda<br />PART I: Introduction and CVP Analysis<br /><ul><li>What is management accounting?
  8. 8. Cost behaviour
  9. 9. Cost-Volume-Profit Analysis</li></ul>PART II: Cost Behaviour<br /><ul><li>Variations in cost behaviours
  10. 10. Income Statement approaches</li></ul>PART III: Cost Allocation<br /><ul><li>Overhead Rate Calculation
  11. 11. Applying Overhead</li></ul>PART IV: System Design and Allocation<br /><ul><li>Job Order vs. Process
  12. 12. Service Departments </li></ul>PART V: ABC Costing<br />
  13. 13. INTRODUCTORY MATERIALPart I<br />
  14. 14. Managerial Accounting<br />For management purposes only<br />Cost allocations and calculations<br />Budgeting and future planning <br />Production decisions<br />Product decisions<br />Always keep in mind:<br />Benefit versus cost tradeoff<br />Will the systems aid management?<br />
  15. 15. Framework of Cost Accounting<br />Strategic Planning – focus on company objectives<br />Factory location<br />Mergers & acquisitions<br />Management Control – focus on resource efficiency<br />Budget analysis<br />Variance analysis<br />Operational Control – task efficiency<br />Inventory control<br />Cash management<br />
  16. 16. Central Layout <br />Management accounting involves:<br />planning (alternative identification and budgeting)<br />controlling (actions and evaluations of those actions)<br />directing and motivating (smooth operations, conflict resolution, etc.)<br />
  17. 17. Financial vs. Management<br />
  18. 18. Decisions & Information<br />Decision Process<br />Accounting Information Types<br />Identify the problem<br />Understand the Key Success Factors of the company<br />Identify alternative solutions <br />Quantitative and qualitative analyses <br />Evaluation solutions and chose one<br />Implementation of the plan <br />Problem Solving Information– used for long-range planning <br />Attention Directing Information– used for controlling routine operations <br />Scorekeeping Information– used by investors, tax collectors, etc. <br />
  19. 19. Key Success Factors<br />Critical for an organization’s success <br />Example: excellent customer service for fast food companies<br />Differ depending on the industry and the company <br />Managed carefully to maintain or improve the success of a business<br />Considered in decision-making processes and always at the forefront<br />
  20. 20. Professional Ethics<br />Competence: be able to recognize limitations, follow laws, provide accurate and timely information<br />Confidentiality: do not use confidential information and do not give that information<br />Integrity: be open about conflicts of interest, avoid actions that would jeopardize reputation <br />Credibility: communicate, <br /> disclose problems and all <br /> relevant information that <br /> others need to know<br />
  21. 21. Professional Ethics<br />Resolution Conflict: follow official policies, or talk to supervisors<br />confidentially should be maintained, consult legal professionals <br />Corporate Governance: is the set of processes, customs, policies and laws which affect the way a company is directed, administrated or controlled<br />should provide incentives for the pursuit of goals which benefit the stakeholders<br />
  22. 22. Process Management<br />Approaches to improving processes:<br />Lean Production – minimize inventory and “pull” units through processes in response to customer orders<br />Six Sigma – reduce defective products to near zero by using feedback and numerical data<br />Define, Measure, Analyze, Improve, Control<br />Computer Technology – refers to the growing popularity of E-commerce and enterprise systems<br />Enterprise systems– software program that combines all data<br />Risk Management – proactively seeking out potential sources of risk, preparing yourself, or prevent it<br />
  23. 23. Cost Behaviour<br />A cost driveris source of your total costs<br />Example: the number of man hours clocked in a laboratory will make your total cost of R&D rise<br />Variable costsare costs that change in direction relation to changes in cost drivers (per unit)<br />Example: lab technicians are paid more depending on how many hours they work<br />Fixed costsare not immediately affected by changes in the driver (total amounts)<br />Examples: rent, insurance payments, taxes<br />
  24. 24. Relevant Range<br />Relevant rangeand Step Variable Costs are ranges where your per unit variable costs and your fixed costs will stay constant<br />Outside of this range these costs will change <br />As long as Brick Brewery is making between 30,000 and 75,000 cases of beer, it costs $3.00 a beer to produce and fixed costs are $1.5M a month. <br />30<br />75<br />
  25. 25. Cost – Volume – Profit Analysis<br />Total Sales<br />Total Costs<br />Breakeven Point<br />Fixed Costs<br />
  26. 26. Breakeven Analysis<br />Calculating how many units need to be sold before you can start making some profits<br />Equation Approach:<br />Contribution Margin Method: <br />
  27. 27. CVP Analysis Example<br />A Playstation3 console is priced at $300 but costs about $250 each to make. Sony’s fixed costs for its gaming departments total about $17M a month and they manage to sell about 1M consoles a month. Calculate Sony’s breakeven point in dollars<br />Step 1: Which formulas?<br />We need to end up with a breakeven, <br />point in dollars, which means we need to <br />To calculate contribution margin as a %.<br />Step 2: Contribution Margin %<br />CM = $300 - $250 = $50/unit<br />CM% = $50/$300 = 0.16667<br />Step 3: BEP in Dollars<br />$17M x 12 months = $204M/year fixed costs<br />$204M/0.16667 = $1,123.976M <br />Step 4: Concluding Sentence<br />Sony will have to sell $1,123,976,000<br />worth of PS3 in order to breakeven<br />
  28. 28. Changes in Volume and Sales<br />It helps to create simple income statements to help show what the contribution margin is and how it changes when multiple components are changing<br />Also consider using this formula:<br />
  29. 29. CM Changes Example<br />Assume basketballs can be made at a variable cost of $5/unit and with fixed costs totalling $50,000 per month. Each basketball is sold for $15/each and current sales total 5,000 units per month. Consider the following:<br />A) What is the profit impact if variable costs decrease by $2/unit, advertising costs are increased by $25,000 per month and therefore sales increase by 1,500 units? <br />B) What price should be charged in order to achieve $75,000 in monthly profits (keeping everything else the same)?<br />Condition B<br />Required: $75,000 in Net Income<br />$75,000 = (Price - $5)(5,000 units) – $50,000<br />$125,000 = Price(5,000 units) - $25,000<br />$150,000 = Price(5,000)<br />Price = $30<br />
  30. 30. Margin of Safety<br />The excess of budgeted (or actual) sales over the break-even volume of sales<br />Sports Illustrated sells 3.5 million magazines a month at an average price of $5. The cost to produce one magazine is approximately $0.50. Fixed expenses per month are $15M. What is their margin of safety?<br />Step 1: Breakeven Unit Sales<br />Breakeven Point in Units = (Fixed Costs)/(CM per unit) <br />Breakeven Point in Units = $15M/(5-0.5) = 3,333,333.33 <br />Round up to 3,333,334 units <br />Step 2: Margin of Safety<br />Margin of Safety = Total Sales – Breakeven Sales<br />MOS = 3.5M – 3.33M <br />Margin of Safety is 166,667 units<br />
  31. 31. CVP with Product Mixes<br />Companies which sell more than one product involves a ratio called a ‘sales mix’ <br />Management will try playing around with ratios like these to see which combination is more profitable<br />In situations with sales mixes the calculations for CM will change to ‘average contribution per unit’:<br />
  32. 32. Multiproduct Example<br />Bob’s tree farm sells two types of trees: pine and maple. The sales mix is 3:1 respectively. Each pine tree sells for $20 and each maple sells for $30. Bob estimates that each pine tree costs about $12 to grow and maintain until it is sold and about $15 for maples since they need more water. Bob’s fixed costs are $27,000 per year. Calculate Bob’s breakeven point in units. <br />Step 1: Contribution Margin for Each Product<br /> Maple = $30-$15 = $15<br /> Pine = $20 - $12 = $8 <br />Step 2: Average Contribution Margin per Unit<br />=(CM of pines x Sales mix %) + (CM of maples x Sales mix %)<br />= ($8 x 75%) + ($15 x 25%)<br />= $9.75<br />Step 3: Breakeven Point in Units<br />BEP = Fixed Costs / Average CM per Unit<br />BEP = $27,000 / $9.75<br />BEP = 2,769.23<br />Bob needs to sell 2,770 trees to breakeven<br />
  33. 33. Cost Structure and Operating Leverage<br />Cost structure is relative proportion of fixed costs and variable costs<br />Operating leverage shows the proportion of your fixed costs<br />The higher the operating leverage, the higher a company’s fixed costs are compared to variable costs so small changes in the volume of sales will result in large changes in income (and opposite)<br />
  34. 34. Cost Structure and Operating Leverage<br />Sales<br />Sales<br />$<br />$<br />Total<br />Expenses<br />Total<br />Expenses<br />Volume<br />Volume<br />High Operating Leverage<br />High Fixed / Low Variable Costs<br />Higher CM/Unit<br />Higher Break-even Point<br />Greater Risk<br />Greater Potential Returns<br />Low Operating Leverage<br />Low Fixed / High Variable Costs<br />Lower CM/Unit<br />Lower Break-even Point<br />Reduced Risk<br />Lower Potential Returns<br />
  35. 35. COST BEHAVIOUR AND COST SYSTEMSPart II<br />
  36. 36. Cost Behaviours<br />Step costschange abruptly at intervals of activity because the resources and their costs come in indivisible chunks (example: salaries) <br />Mixed costscontain both variable and fixed cost elements <br />Example: maintenance costs – supplies + labour <br />Management Influenced Costs<br />Capacity costs- fixed costs incurred when achieving a desired production level (example: building a plant)<br />Committed fixed costs-large indivisible chunks of cost that the company is obligated to pay<br />Example: mortgage payments<br />Discretionary fixed costsare heavily influenced by management’s decisions each period on how much to spend on things like advertising, research and development, training, etc. <br />Example: no more lavish award ceremonies every quarter for top salesmen <br />These costs do not have clear connections to production output levels<br />Every cost could essentially be committed / discretionary but it depends on contracts you have and your ability to change it<br />
  37. 37. Measuring Cost Behaviour<br />The mixed cost function is an equation of the cost and its driver; a linear equation looks like this<br />Salesmen are paid guaranteed salaries of $50,000 per year plus 2% commission on sales. The dollar value of sales each salesman brings in is the cost driver. Calculate the total cost of wages given the following situations:<br />Situation A<br />Total Cost = $50,000 + ($400,000)2% = $58,000<br />Situation B <br />Total Cost = $50,000 + ($600,000)2% = $62,000<br />
  38. 38. Activity Analysis Methods<br /><ul><li>Engineering Analysis– review of costs from past experiences
  39. 39. Account Analysis– review of accounting records and the subjective evaluation of patterns
  40. 40. High-Low Analysis– simple linear algebra method (unreliable results)
  41. 41. Scattergraph Analysis– line of fit method on a graph; where the intercept is the total fixed costs and every point on the line is an estimated total level of activity (X) and total costs (Y)</li></ul>- this method heavily uses the mixed cost function<br /><ul><li>Regression Analysis– a process of finding the equation that best fits the data</li></ul>Activity analysesare used to identify appropriate cost drivers for each individual activity and their effects on the costs of making a product <br />Measuring Cost Behaviour<br />
  42. 42. High-Low Analysis Example<br />Given the following information, determine the cost equation for custodial services<br />Step 1: High and Low Levels of Activity<br />High  500 hours at $6,345<br />Low  250 hours at $4,375<br />Step 2: Change in Activity and Variable Cost<br />Change in Cost = $6,345 - $4,375 = $1,970 <br />Change in Hours = 500 – 350 = 250 hours<br />Variable cost = $1,970/250 hours = $7.88<br />Step 3: Fixed Cost Estimate (Using July Numbers)<br />Total Fixed Cost = Total Cost – Total Variable Cost<br />Total Fixed Cost = $5,570 – (360 x $7.88) = $2,733.20<br />Step 4: Cost Equation<br />Y = $2,733.20 + $7.88X<br />
  43. 43. Regression Analysis<br />All the points are considered whereas the scattergraph considers only the points on the line of best fit<br />The goal is to minimize the sum of the square errors <br />This is the most accurate method<br />Regression Analysis Output<br />- The word “Constant” which appears on an output is the fixed cost<br />- “R-squared” is an indicator of the accuracy of the results, the closer this number is to 1, the more X (independent) explains changes in Y (dependent)<br />- “X-Coefficient” is the variable cost which is multiplied by the cost driver<br />Excel Commands<br />- LINEST() gives the slope of the line of best fit<br />- INTERCEPT () gives the intercept of the line (fixed cost)<br />- RSQ() gives the ‘r-squared’ value<br />
  44. 44. Cost Behaviour: Product and Period Costs<br />Product Costs– all costs involved in the purchase or manufacture of products which are expensed when the product is sold <br />For a manufacturer these would include direct labour, direct materials, etc. <br />Inventory for a manufacturer (DM, WIP, FG)<br />For a retailer these would include freight costs, purchases, etc.<br />Period Costs– costs expensed immediately without ever being included in inventory <br />Selling & administrative costs<br />
  45. 45. Cost Methods: Absorb & Vary<br />Absorption Costing –includes manufacturing overhead in the costs which are assigned to inventory<br />“Full Costing”, in accordance with GAAP<br />Costs are classified by function (selling vs. manufacturing)<br />Inventory costs consider both variable and fixed costs<br />This method produces a higher inventory value since it includes fixed costs<br />With this method, fixed manufacturing overhead costs are included in inventory, and a formula is used in order to allocate costs to ‘work-in-process’<br />
  46. 46. Cost Methods: Absorb & Vary<br />Variable Costing – this approach tries harder to separate fixed costs from variable costs and uses a style of income statements which highlights the total fixed costs<br />“Direct Costing”<br />Costs are classified by behaviour (variable vs. fixed)<br />Inventory costs consider only variable costs<br />This method helps with CVP analyses<br />Production does not affect operating income under this approach <br />Under variable costing fixed costs can be attributed to separate divisions and therefore controlled more easily<br />
  47. 47. Absorption vs. Variable<br />ABC Company<br />Absorption Income Statement<br />Sales $75,000<br />Cost of Goods Sold:<br /> Direct Material 10,000<br /> Direct Labour 15,000<br /> Overhead 7,000<br />Gross Profit $43,000<br />Selling Expenses 15,000<br />Admin. Expenses 17,000<br />Operating Income $11,000<br />ABC Company<br />Variable Costing Income Statement<br />Sales $75,000<br />Variable Expenses:<br /> Direct Material 10,000<br /> Direct Labour 15,000<br /> Overhead 3,000<br /> Variable Selling 8,000<br /> Variable Admin 8,000 <br />Contribution Margin $31,000<br />Fixed Expenses:<br /> Overhead 4,000<br /> Selling & Admin 16,000<br />Operating Income $11,000<br />
  48. 48. Absorption vs. Variable<br />Variable costingstatements are considered easier to understand because net operating income is only affected by changes in unit sales<br />We cannot do CVP analysis with absorption costingbecause it considers overhead to be a variable cost<br />Both methods can be used when filing tax returns, but only absorption costingis allowed for external purposes<br />For absorption costing we use units produced; whereas with variable costing we use units sold<br />
  49. 49. Segmented Income Statements<br />Income statements for parts of a whole company <br />A contribution format is used and traceable fixed costs should be separated from common fixed costs to allow for CVP analysis and segment margin calculations<br />Absorption formation may be used anyway<br />Traceable fixed costsare fixed costs incurred by that particular segment alone such as the rent for its facility<br />Common fixed costsare incurred by the whole company such as the executive salaries or patent protection legal fees<br />Common costs cannot be arbitrarily assigned to segments because managers will be put in charge of costs they have no control over<br />
  50. 50. Segmented Income Statements<br />Segment margin is the best gage of the long-run profitability of a segment<br />Traceable costs of one segment may be common costs to another<br />Not in Handout<br />
  51. 51. COST ALLOCATIONPart III<br />
  52. 52. Cost Management Systems<br />Costs are sacrifices of resources for a particular purpose (such as money for materials)<br />Acost objectiveis a department or product for which cost information is collected <br />Direct costscan be identified exclusively with a given cost objective (i.e. – a product) in an economical way (can be easily and reliable measured)<br />Indirect costs cannot... <br />Overtime premium– an indirect cost which includes wages paid to workers in excess of their regular hours<br />Idle time– wages paid for unproductive time (when everyone is standing around) <br />Defects– scrap, warranty claims, the cost of poor customer relationships (if you can figure out a $ for that)<br />
  53. 53. Cost Management Systems<br />Differential Costs (Revenues) are the difference in cost (revenue) between two alternatives<br />Example: If you are decided between buying a car that costs $20,000 or buying a bus pass for the next 5 years which will in total cost $15,000<br />The differential cost is $5,000<br />Opportunity Costsare the potential benefit that is given un when one alternative is selected over another<br />Example: You are deciding to either buy a car that costs $20,000 or spend the money on a college diploma which would raise your salary from $10,000/year to $25,000/year<br />The opportunity cost of buying the car would be the $15,000 in increased wages. <br />Sunk Costsare costs already incurred and paid for that are in the past and cannot be changed and therefore have no bearing on future decisions<br />Example: If you are decided between buying a car that costs $20,000 or buying a bus pass for the next 5 years which will in total cost $15,000 but you’ve already bought your bus pass for this month which cost $80. <br />You’ve bought the pass already, it’s in the past and shouldn’t affect your decision here.<br />
  54. 54. Manufacturing Costs<br />For companies who create their inventory from scratch, there are three main categories of costs:<br />Direct Material Costs– cost of acquiring materials used<br />Direct Labour Costs – wages or labour that is exclusive to production <br />Factory Overhead Costs – all other costs (utilities, equipment depreciation, etc.)<br />These costs can be combined and reduced to two categories<br />Prime Costsinclude direct labour and material costs<br />Conversion Costsinclude the costs of converting material into finished products (direct labour and factory overhead costs) <br />Prime Costs<br />Direct Materials<br />Direct Labour<br />Factory Overhead<br />Conversion Costs<br />
  55. 55. Cost Allocation<br />Cost Allocationis the process of linking costs or cost pools (multiple costs grouped together) with one or more cost objects through identifying and selecting cost drivers<br />Synonyms of cost allocation  cost tracing, assignments, distributions, apportionment<br />Synonyms of cost drivers  allocation base, activity measure <br />
  56. 56. Manufacturing Overhead Cost Allocation<br />The POHR is used no matter what the real overhead costs are and what the actual allocation activity is<br />The per unit cost calculated above ≠ marginal cost of the product; if an additional unit was produced the per unit cost would slightly decrease<br />Journal Entry Examples in “Extras”<br />
  57. 57. Underapplied / Overapplied<br />Since the POHR contains estimates, the manufacturing overhead that we actually incur and the amount applied to Work in Process using the POHR will differ 99% of the time<br />Underapplied overhead- overhead applied to jobs is less than the total amount of overhead actually incurred<br />this will result in a remaining debit balance in the manufacturing overhead account<br />Overapplied overhead- overhead applied to jobs is greater than the total amount of overhead actually incurred<br />this will result in a remaining credit balance in the manufacturing overhead account<br />The difference between applied overhead and actual overhead can be dealt with in three ways:<br />Close directly to Cost of Goods Sold Expense<br />Allocate proportionately between WIP, Finished Goods, and COGS Expense<br />based on their relative dollar value<br />Carry the balance in manufacturing overhead over to the next year<br />
  58. 58. Overhead Application Example<br />Toyota has incurred a total of $15.0M in manufacturing overhead this month with a total of 500,000 labour hours worked on cars. Calculate the manufacturing overhead applied to Work-in-Progress cars over the month using a predetermined overhead rate of $12/hour. Was the manufacturing overhead overapplied, underapplied, or perfect ? Provide the journal entry required to close any unapplied overhead to cost of goods sold.<br />Step 1: Apply Overhead<br />Applied Overhead = POHR X Actual Direct Labour Hours<br />Applied Overhead = $12/hour X 500,000<br />Applied Overhead = $6.0M<br />Step 3: Journal Entry<br />Debit : Cost of Goods Sold $9M<br />Credit : Manufacturing Overhead $9M<br />Step 2: Over/Underapplied?<br />= Actual Overhead – Applied Overhead<br />= $15M - $6M = $9M Underapplied<br />
  59. 59. POHR and Capacity<br />Biggest criticisms of using the POHR:<br />Using estimates and budgeted activity levels will result in product costs that fluctuate all the time<br />Applies costs that had nothing to do with products like idle time<br />Using capacity limits instead of the estimated number of allocation base will reduce the overhead rate<br />the difference between the capacity rate and the POHR is the idle capacity cost<br />Equipment is leased for $400,000 / year. A plant working at full capacity can produce 80,000 units, but the company estimates 60,000 will be made. <br />The POHR will be $6.67/unit using the regular formula but if we use capacity units instead it will only be $5/unit. <br />
  60. 60. Professional Ethics<br />How will understating the estimated direct labour hours in the base for the POHR affect operating income?<br />Remember: <br /><ul><li>Artificially high overhead rate
  61. 61. Overapplied overhead  debit balance in manufacturing overhead account
  62. 62. This will reduce COGS when the account is closed
  63. 63. This will result in higher net income</li></ul>Not in Handout<br />
  64. 64. SYSTEM DESIGN AND ALLOCATIONPart IV<br />
  65. 65. Product Costing Systems<br />Process Costing– the company mass produces one homogenous product<br />Costs are accumulated by departments and thus calculates <br />unit costs by department as well<br />Production is uniform on all units <br />Job – Order Costing System– the company builds to order a range of unique products<br />Direct materials and labour will be allocated to each job <br />as they are incurred<br />Indirect costs (like overhead) will accumulate over <br />time and then be allocated<br />
  66. 66. Process Costing<br />A processing departmentis any part of a company where work is performed on a product<br />Transferred-in costsare those that were used in one department and then sent to another department<br />The Processing Story in “Extras”<br />
  67. 67. Equivalent Units (Weighted Average Method)<br />The number of complete units you could get from putting together all the partially complete units that are sitting around in Work in Process inventory at the end of a period <br />Example: one unit that is 70% done put together with another unit 30% complete makes one completely finished equivalent unit<br />
  68. 68. Equivalent Units Example (Weighted Average Method)<br />Given the information below, calculate the equivalent units both in terms of materials and conversion costs and also calculate the total cost per equivalent unit. <br />(answer in the handout)<br />
  69. 69. Service Department Cost Allocations<br />Operating departmentsare the ‘heart and soul’ of the organization and carry out its purpose in life<br />Service departmentssupport the company and its operating departments; their costs incurred by these departments are allocated unto the operating departments which in turn allocate all costs to units produced<br />Reciprocal Servicesis the term used to describe the concept of service departments and operating departments provided services to each other <br />
  70. 70. Service Allocation Methods: Direct<br />Ignore transactions between service departments and assume service departments only provide to operating departments<br />All costs are allocated to operating departments based on the proportion of total allocation base <br />
  71. 71. Direct Method Example<br />The accounting department of Cars Inc. has incurred $2.5M in costs over the year. Management has calculated that the accounting team has worked 50,000 hours this year and employs 110 people. <br />The cafeteria has incurred $1M in costs over the year, employs 20 and has worked 8,000 hours. <br />Cars Inc.’s manufacturing plant has incurred $10M in costs this year, has worked 60,000 hours and employs 200 people. <br />The customization plant incurred $15M in costs, has worked 40,000 hours and employs 100 people.<br />Assume the allocation bases for accounting and cafeteria departments are hours and employees, respectively.<br />
  72. 72. Service Allocation Method: Step-Down<br />Service Department “A” provides services to Service Department “B” (but no reciprocation) and both pass on to the Operating Departments<br />All costs incurred by service departments are allocated to operating departments based on the proportion of total allocation base <br />TIPS<br />- Order matters, we need to know which service department serves the other<br />
  73. 73. Step-Down Method Example<br />The accounting department of Cars Inc. has incurred $2.5M in costs over the year. Management has calculated that the accounting team has worked 50,000 hours this year and employs 110 people. <br />The cafeteria has incurred $1M in costs over the year, employs 20 and has worked 8,000 hours. <br />Cars Inc.’s manufacturing plant has incurred $10M in costs this year, has worked 60,000 hours and employs 200 people. <br />The customization plant incurred $15M in costs, has worked 40,000 hours and employs 100 people.<br />Assume the allocation bases for accounting and cafeteria departments are hours and employees, respectively.<br />
  74. 74. Service Allocation Method: Reciprocal<br />Service Department “A” provides services to Service Department “B” and vice versa<br /> Know what it is, but not how to do it.<br />
  75. 75. ABC COSTINGPart V<br />
  76. 76. Activity-Based Costing<br />A non-traditional way of allocating costs<br />ABC costing is more careful about which costs are considered; only costs that are affected by product-related decisions are used<br />not all manufacturing costs, some non-manufacturing costs<br />ABC costing has the highest number of cost pools and overhead application rates<br />POHR applies to the entire factory and all its departments<br />Process costing uses different overhead rates for departments<br />ABC costing has as many rates as there are activities <br />The ABC costing method has the ability to segregate costs associated with unused capacity<br />
  77. 77. Activity Costing<br />An activity is an event that causes the consumption of overhead resources (i.e. taking customer orders)<br />Five Levels of Activity<br />Unit-Level Activities– activities that arise each time a product is produced (i.e. electricity)<br />Batch-Level Activities– activities that involve processing or handling batches of product (i.e. moving them) <br />Product-Level-Activities – activities related to products that must be done regardless of production (i.e. marketing and engineering design)<br />Customer-Level-Activities – have to do with the customers themselves (i.e. customer service)<br />Organization-Sustaining-Activities – are done no matter what else is going on<br />This is the only type of activity directly related to volume of production<br />
  78. 78. General Structure of ABC<br />
  79. 79. Implementation of ABC<br />Identify and define activities<br />There is no ‘right’ or ‘wrong’, there is ‘accurate’ and ‘less accurate’<br />Assign overhead costs to activity cost pools<br />Only overhead, no direct or indirect<br />Calculate activity rates<br />Using total activity estimates for each activity<br />Assign overhead costs to cost objects<br />Common cost objects: products, orders, customers <br />Prepare management reports<br />
  80. 80. Management Reports<br />Product Margin Calculation<br />These costs are assigned using other cost systems<br />Calculated using the ABC Costing process <br />This company is losing money every time it makes Product B<br />With this we can make big decisions such as whether we should consider cutting out Product B<br />Product A did not do any product design <br />
  81. 81. Management Reports<br />Customer Profitability Analysis<br />Calculated using the ABC Costing process (Stage 4)<br />Notice that we now add customer relations costs<br />Here we can make decisions such as whether or not it is worth keeping this customer<br />
  82. 82. ABC vs. Traditional Costing<br />Traditional costing uses one plant wide manufacturing overhead rates<br />All shipping, marketing and administrative expenses are not allocated to the product<br />Same in for traditional and ABC <br />Only one cost pool: overhead <br />We are not losing money on this product according to this method <br />Product B is “undercosted” giving it a much higher product margin than it should <br />
  83. 83. Cons of ABC Costing<br />ABC costing is not typically used for external reporting because<br />Don’t need all the detail<br />Cost too muchto start using ABC Costing<br />GAAP standards don’t like ABC<br />There is a lot of subjectivity<br />ABC costing has its own limitations too<br />It costs a lot of money<br />Resistance from the employeeswhen new systems are put in place<br />Misinterpretation of the results<br />Many companies like to allocate all their costs to the productsrather than to customers and orders<br />Everyone needs to conform to GAAP<br />
  84. 84. Final Study Tips<br /><ul><li>Your textbook is good
  85. 85. Read your end-of-chapter summaries posted on MyLearningSpace
  86. 86. Practice questions in order to understand concepts better
  87. 87. Do not memorize how to </li></ul> do calculations<br />
  88. 88.
  89. 89. EXTRA EXAMPLES AND CONCEPTSPart VI<br />
  90. 90. Manufacturing Overhead Entries<br />All costs incurred by a company will be recorded as expenses in the accounting books over the year<br />Direct materials used are taken out of ‘Raw Materials’ and placed into ‘Work-in-Process’<br />Materials that are indirectly used over the course of the period are also taken out of ‘Raw Materials’ but are instead placed in ‘Manufacturing Overhead’<br />Wage costs are added to ‘Work-in-Process’ or ‘Manufacturing Overhead’ depending on whether they are direct or indirect labour expenses<br />Any other costs that are incurred by the manufacturing facilities are also debited to manufacturing overhead over the course of the period <br />Any other costs that are incurred by the manufacturing facilities are also debited to manufacturing overhead over the course of the period <br />When the product is complete, all the costs incurred to produce it are sent to ‘Finished Goods Inventory’ until the product is sold; at which time those costs then go to ‘Cost of Goods Sold Expense’ <br />
  91. 91. The Processing Story<br />Raw materials are bough by the company and are debited to the ‘raw materials inventory’ asset account<br />When processing departments need raw materials, a journal entry is recorded to show where the materials went<br />The workers of the company do their jobs and are paid; but when a company has different processing departments, the cost of labour is assigned to the department the employee works in<br />Manufacturing overhead is incurred randomly over the course of the period<br />Manufacturing overhead is applied to each processing department using a predetermined rate<br />When department A has completed its job, it passes on its inventory to department B (transferred-in costs)<br />When the last department is done making the product, all its inventory is passed into “Finished Goods Inventory” (storage)<br />When the products are sold, their cost is finally debited to Cost of Goods Sold Expense and that’s the end!<br />
  92. 92. BACK TO THE BASICSPart VII<br />
  93. 93. The Basics<br />Debits and credits just represent the sides of a “general ledger” which is a book used to record transactions<br />DO NOT think of them as positives and negatives<br />These are used in a double-entry accounting system to create a logical method of financial reporting<br />“Normal balances” for accounts refer to which side of the general ledger represents an increase for the account<br />debits = assets, expenses <br /> credits = liabilities, owner’s equity, revenue <br />
  94. 94. The Basics<br />Assets are future benefits to the company which resulted from past events<br />Objects that will be used to make money<br />Objects that will be sold for money<br />Cash to spend on more objects<br />Liabilities are sacrifices the company will have to make, or IOUs they have from the past<br />Equity is what is left over when assets are netted against liabilities; or, what is left for the owners of the company to claim as theirs<br />See part II<br />
  95. 95. The Basics<br />Everything is based around the same simple formula:<br />Assets = Liabilities + Owner’s Equity<br />When writing any transaction, this formula must apply. <br />
  96. 96. Transaction Examples<br />On December 1, $25,000 of office supplies was bought on credit. What is the transaction?<br />On April 10, $100,000 worth of cash dividends was paid out to shareholders. What is the transaction?<br />A new employee was hired on October 22, 2010. What is the transaction?<br />NOTICE: Transactions are never written with negative numbers. <br />
  97. 97. Accounting Cycle<br />Something happens – is it a transaction or not? <br />Journalization – writing transactions down in a journal<br />Posting – calculating totals for all accounts on a daily or monthly basis (or automatically)<br />Trial Balance – making sure all debits equal all credits and all accounts have their correct balances<br />must always net to zero<br />Adjustments – updating accruals, expensing prepaid accounts, calculating depreciation, unearned revenue, inventory, etc.<br />Adjusted Trial Balance<br />Financial Statements<br />some people like to use work sheets to help them create financial statements<br />Closing – wiping out temporary accounts (expenses and revenues) to get ready for the new year<br />Post-Closing Trial Balance<br />Reversing Entries – If necessary.. usually only if you’ve made a mistake and have to go back and fix it<br />
  98. 98. Adjusting Entry Examples<br />On April 1, 2010 XYZ spent $24,000 for a year’s worth of insurance. Prepare the adjusting journal entries for December 31.<br />In August 2010 Magazines Inc. received $36,360 for year-long subscriptions which started September 1. Prepare the adjusting journal entries for December 31. <br />ABC’s employees are paid $12,000 every other Friday. December 31, 2010 is the company’s year end, but also halfway through a pay-period. Which accounts are affected by this and what amounts should appear on the company’s financial statements? <br />

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