Cost Accounting.

Chapter 1 Management accounting measures, analyzes, and reports financial and no financial information that helps managers make decisions to fulfill the goals of an organization. Financial accounting focuses on reporting to external parties such as investors, government agencies, banks and suppliers. It measures and records business transactions and provides financial statements that are based on GAAP. Cost accounting measures, analyzes, and reports financial and no financial information relating to cost of acquiring or using resources in an organization. Value-chain analysis: sequence of business functions in which customer usefulness is added to products and services. 1. Research and development 2. Design of products, services, or processes 3. Production 4. Marketing 5. Distribution 6. Customer service. Supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Five step decision making process: 1. Identify the problem and uncertainties. 2. Obtain information. 3. Make predictions about the future. 4. Make decisions by choosing among alternatives. 5. Implement the decision, evaluate performance, and learn. Steps 1-4 are collectively referred to as planning. Planning comprises selecting organization goals, predicting results under various alternative ways of achieving those goals, deciding how to attain them. Most important planning tool is budget, quantitative expression of a proposed plan of action by management and is an aid to coordinating what needs to be done to implement that plan. The comparison of actual performance to budgeted performance is the control or post decision role of information. Control comprises taking actions that implement planning decisions, deciding how to evaluate performance, and providing feedback and learning to help future decision making. Chapter 2 - Cost terms and purposes. Direct costs of a cost object are related to the particular cost object and can be traced to it in an economically feasible (cost-effective) way. Cost tracing is used to describe the assignment of direct costs to a particular cost object. Indirect costs of a cost object are related to the particular cost object but cannot be traced to it in an economically feasible (cost effective) way. Cost allocation is used to describe the assignment of indirect costs to a particular cost object. Cost assignment is a general term that encompasses both tracing direct costs and allocating indirect costs. Factors affecting direct/indirect cost classification: Materiality of the cost in question - the smaller the amount of cost, the more immaterial the cost is, the less likely that it is economically feasible to trace the cost to a particular cost object. Available information-gathering technology. Design of operations. Variable cost changes in total in proportion to changes in the related level of total activity or volume. Fixed cost remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume. Cost driver is a variable, such as the level of activity or volume, that causally affects costs over a given time span. Relevant range is the band of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost. Cost of goods sold: Beginning finished goods inventory Cost of goods manufactured Cost of goods available for sale Deduct: ending finished goods inventory Cost of goods sold Schedule of cost of goods manufactured Direct materials: Beginning inventory Add: purchases of DM = Cost of DM available for use Deduct: ending inventory Direct materials used Direct manufacturing labor Manufacturing overhead costs = Manufacturing costs incurred Add: Beginning work in process inventory Total manuf. Costs to account for Deduct: ending work in process inventory = Cost of goods manufactured Prime costs are all direct manufacturing costs. Prime costs = direct material + direct labor. Conversion costs are all manuf. Costs other than direct material costs. Costs incurred to convert DM into finished product. Conversion costs = DL + MOH Overtime premium and idle time classified as indirect labor costs. Product cost is the sum of the costs assigned to a product for a specific purpose. Chapter 3 - Cost-Volume-Profit analysis CVP analysis examines the behavior of total revenues, total costs and operating income as changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs of a product. Breakeven point is that quantity of output sold at which total revenues equal total costs. Breakeven in units = Fixed costs/contribution margin per unit. Breakeven revenues = fixed costs/CM%. Target operating income. Qty of units required to sold = (fixed costs + target op income) / CM per unit. Revenues needed to earn = Fixed costs + target op income / CM%. Target operating income = target net income / (1-tax rate). Revenues - VE - FE = Target net income/ (1-tax rate). Qty of units required to be sold = FE+ (Target net income/(1- tax rate))/CM per unit. Sensitivity analysis is a what-if technique that managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes. Margin of safety - the amount by which budgeted (or actual) revenues exceed breakeven revenues. Margin of safety = Budgeted (or actual) revenues - breakeven revenues. Margin in safety in units = Budgeted sales in units - breakeven sales in units. Margin of safety % = Margin of safety in dollars/ budgeted(or actual) revenues.

Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold and contribution margin. Organizations with high proportion of fixed costs in their cost structures have high operating leverage. Degree of operating leverage = CM/operating income Sales mix is the quantities of various products that constitute total unit sales of a company. Breakeven point in bundles = FE/ CM per bundle. Chapter 7 - Flexible budgets, direct-cost variances, management control Variance is the difference between actual results and expected performance. Management by exception is the practice of focusing management attention on areas that are not operating as expected and devoting less time to areas operating as expected. Static budget, or master budget, is based on the level of output planned at the start of the budget period. Static-budget variance is the difference between the actual result and the corresponding budgeted amount. Flexible budget calculates budgeted revenues and budgeted costs based on the actual output in the budget period. Sales-volume variance is the difference between a flexible-budget amount ant the corresponding static-budget amount. Flexible-budget variance is the difference between an actual result and the corresponding flexiblebudget amount. Selling price variance = (actual selling price-budgeted selling price)*actual units sold. Price variance is the difference between actual price and budgeted price multiplied by actual input quantity, such as direct materials purchased or used. (sometimes called input-price var, rate var). Efficiency variance is the difference between actual input qty used and budgeted input qty allowed for actual input, multiplied by budgeted price (also usage var). Price variance = (actual price input - budgeted price input)*actual qty of input. Efficiency variance = (actual qty of input used - budgeted qty of input allowed for actual output)*budgeted price of input. Journal entries - page 238 Benchmarking is the continuous process of comparing the levels of performance in producing products and services and executing activities against the best levels of performance in competing companies or in companies having similar process. A standard cost is a carefully determined cost used to benchmark for judging performance. The purposes of a standard cost are to exclude part inefficiencies and to take into account changes expected to occur in the budget period. Managers use variances for control, decision implementation, performance evaluation, organization learning and continuous improvement. Chapter 8 - Flexible budgets, overhead cost variances, management control Standard costing is a costing system that traces direct costs to output produced by multiplying the standard prices or rates by the standard quantities of inputs allowed for actual outputs produced and allocates overhead costs on the basis of the standard overhead-cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced. Budgeted variable overhead cost rate per output unit = budgeted input allowed per output unit x budgeted variable overhead cost rate per input unit. Variable overhead flexible-budget variance measures the difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts. Variable overhead efficiency variance is computed the same way as the efficiency variance for direct-cost items, but the interpretation differs. The efficiency variance for VOH is based on the efficiency with which the cost-allocation base is used. Variable overhead spending variance is the difference between actual variable overhead cost per unit of the cost allocation base and budgeted VOH cost per unit of costallocation base, multiplied by the actual qty of VOH cost allocation base used for actual output. Journal entries for VOH cost and variances - page 267. Fixed overhead flexible-budget variance is the difference between actual FOH and FOH in the flexible budget. Flexible budget amount is the same as in static budget, because fixed costs are unaffected by changes in the output level within the relevant range. There is no efficiency variance for FOH. FOH spending variance is the same amount as the FOH flexible-budget variance. Production volume variance arises only for fixed costs, denominator level variance, difference between budgeted FOH and FOH allocated on the basis of actual output produced. Production volume var = budgeted FOH - FOH allocated for actual output units produced. Chapter 11 - Relevant costs Managers usually follow a decision model for choosing among different courses of action. A decision model is a formal method of making a choice, and it often involves both quantitative and qualitative analyses. Five-step decision-making process to make decisions (Ch1). Relevant costs are expected future costs and relevant revenues are expected future revenues that differ among the alternative courses of action being considered. Past costs are called sunk costs, because they are unavoidable and cannot be changed no matter what action is taken. Quantitative factors are outcomes that are measured in numerical terms, qualitative factors are outcomes that are difficult to measure accurately in numerical terms. One-time-only Special Orders - one type of decision that affects output levels is accepting or rejecting special orders when there is idle production capacity and special orders have no long-run implications. Make-or-Buy decisions - decisions whether a producer of goods or services will insource or outsource. Incremental cost is the additional total cost incurred for an activity. A differential cost is the difference in total cost between two alternatives. Opportunity cost is the contribution to operating income that is forgone by not using a limited resource in its next-best alternative use. Carrying costs of inventory - page 399. Product-mix decisions with capacity constraints - decisions made by a company about which products to sell and in what quantities. x y Contribution margin per unit Mhs required to produce one unit Contribution margin per MH (240/2; 375/5) Total contribution margin for 600 Mhz (600*120; 600*75) 240 2 mhs 120/mh 72000 375 5 mhs 75/mhr 45000

Adding or dropping costumers or business segments/branches, relevant-revenue and relevant-cost analysis, page 403. Equipment replacement decisions - book value and depreciation of old machine is irrelevant, loss on disposal that is the difference between book value and disposal value of old machine is irrelevant, relevant are current disposal value of old machine and cost of new machine.

Keep
Operating costs Current disposal value of old machine New machine

Replace 920000 (40000) 600000

Difference (1-2) 680000 40000 (600000)

1600000 -

Total relevant costs

1600000

1480000

120000

Chapter 14 - cost allocation, customer-profitability analyses, sales-variance analysis Purpose of allocating indirect costs: 1. To provide information for economic decisions 2. To motivate managers and other employees 3. To justify costs or compute reimbursement amounts 4. To measure income and assets. Criteria to guide cost- allocation decisions: 1. Cause and effect - managers identify the variables that cause resources to be consumed. 2. Benefits received - mangers identify the beneficiaries of the outputs of the cost object. The costs of the cost object are allocated among the beneficiaries in proportion to the benefits each receives. 3. Fairness or equity - often cited in government contracts when cost allocations are the basis for establishing a price satisfactory to the government and its suppliers. 4. Ability to bear - allocating costs in proportion to the cost objects ability to bear cost allocated to it. The presumption is that more-profitable divisions have a greater ability to absorb corporate headquarters costs. Customer profitability analysis is the reporting and analysis of revenues earned from customers and the costs incurred to earn those revenues. Managers use this information to ensure that customers making large contributions to the operating income of the company receive a high level of attention from the company. Revenues can differ because of differences in quantity purchased and the price discounts given. Customer-cost analysis. C-c hierarchy categorizes costs related to customers into different cost pools on the basis of different types of cost drivers, or cost-allocation bases, etc. Some costs are assigned to individual customers, other costs to distribution channels or to corporate wide effects. Sales-volume variance can be subdivided into the sales-mix variance (variance arises because actual sales mix differs from budgeted sales mix) and the sales-quantity variance (variance arises because actual total unit sales differ from budgeted total unit sales) Sales-mix variance is the difference between budgeted contribution margin for the actual sales mix and budgeted contribution margin for the budgeted sales mix.

Actual units of all product sold x

Wholesale retail

(actual sales-mix % budgeted sales-mix %)x (0.84-0.80) (0.16- 0.20) x x

Budgeted CM per unit = 0.49 per unit = 0.98 per unit = Total sales-mix variance

Sales-Mix variance 17640 F 35280 U 17640 U

900000 units 900000 units

x x

Sales-quantity variance is the difference between budgeted contribution margin based on actual units sold of all products at the budgeted mix and contribution margin in the static budget.

(Actual units of All products sold - budgeted units of all product sold) x
Wholesale Retail

Budgeted salesmix % x 0.80 0.20 x x

Budgeted CM per unit = 0.49 per unit = 0.98 per unit = Total salesquantity variance

Sales-quantity variance 3920 F 1960 F 5880 F

(900000 -890000) units x (900000-890000) x

Market-share and market-size variances - page 519. Chapter 15 - allocation of support-department costs, common costs, and revenues. Operating department (production dept) directly adds value to a product or service. Support department (service dept.) provides services that assist other internal departments in the company. Single-rate method makes no distinction between fixed and variable costs. It allocates costs in each cost pool to cost objects using the same rate per unit of a single allocation base. Dual-rate method partitions the cost of each support department into two pools- a variable cost pool and a fixed cost pool - and allocates each using different cost allocation base. A) budgeted rate and hours budgeted to be used by operating divisions b) budgeted rate and actual hours used. Allocation based on supply of capacity - the single rate and dual rate methods allocate, respectively, only the actual fixed cost resources used or the budgeted fixed cost resources to be used by divisions. Unused resources are highlighted but usually not allocated to the divisions. Allocating costs of multiple support departments: direct method, step-down method, reciprocal method. Direct method allocates each support departments costs to operating departments only, it does not allocate support-dept costs to other support-depts. Step-down method (sequential allocation method) allocates support-dept costs to other support departments and to operating departments in a sequential manner that partially recognizes the mutual service provided among all support depts. This method requires support depts to be ranked. Reciprocal method allocates support-dept costs to operating depts by fully recognizing the mutual services provided among all support depts. 1) PM = 6300000+0.1IS; IS = 1452150+0.2PM; to get the number of complete reciprocated costs of PM and IS. 2) allocate the complete reciprocated cost of each support dept to all other depts (support and operating) on the basis of the usage %. Common cost is a cost of operating a facility, activity, or like cost object that is shared by two or more users. Stand-alone cost-allocation method determines the weights for cost allocation by considering each user of the cost as a separate entity. Incremental cost-allocation method ranks the individual users of a cost object in the order of users most responsible for the common cost and then uses this ranking to allocate cost among those users. Revenue allocation methods: stand alone method, incremental method. Stand-alone revenue-allocation method uses product specific information on the products in the bundle as weights for allocating the bundled revenues to the individual products. Three types of weights: selling prices, unit costs, physical units. Incremental revenueallocation method ranks individual products in a bundle according to criteria determined by management - such as the product in the bundle with the most sales - and then uses this ranking to allocate bundled revenues to individual products.

Chapter 16 - cost allocation: joint products and byproducts. Joint costs are the costs of a production process that yields multiple products simultaneously. Split off point is the juncture in a joint production process when two or more products become separately identifiable. Separable costs are all costs incurred beyond split off point that are assignable to each of the specific products identified at the split off point. Main product - joint production process yields one product with a high total sales value. Joint products - two or more products with high sales value. The products of a joint production process that have low total sales values compared with the total sales value of main product or of joint products are called byproducts. Allocating joint costs: 1. Using market based data: sales value at split off method, net realizable value (NRV) method, constant gross margin percentage NRV method 2. Using physical measures. Sales value at split off method allocates joint costs to joint products on the basis of the relative total sales value at the split off point, costs are allocated to products in proportion to their revenue generating power. Physical measure method allocates joint costs to joint products on the basis of a comparable physical measure such as the relative weight, quantity, volume at the split off point. The NRV method allocates joint costs to joint products on the basis of relative NRV - final sales value minus separable costs. The NRV method is typically used in preference to the sales value at split off method only when selling prices for one or more products at split off do not exist. Constant Gross margin % NRV method - allocates joint costs to joint products in such a way that each individual product achieves an identical gross margin %. The method works backward in that the overall gross margin is computed first. Then, for each product, this gross margin % and any separable costs are deducted from the final sales value of production in order to back into the joint cost allocation for that product. Sell-or-process further decision - decision to incur additional costs for further processing should be based on the incremental operating income attainable beyond the split off point. Joint costs are irrelevant in a sell-or-process further decision because joint costs are the same whether or not further processing occurs. Incremental revenues 300000 Deduct incremental processing costs 280000 Increase in operating income 20000 The production method recognizes byproducts in the financial statements at the time production is completed. The sales method delays recognition of byproducts until the time of sale. Page 585 schedules. Production method reports the byproduct inventory in the balance sheet at its selling price (4000 units-1200 units (sold))*selling price $1 per unit = $2800. Sales method makes no journal entries for byproducts until they are sold. Revenues of byproducts are reported as a revenue item in the income statement at the time of sale. Chapter 18 - spoilage, rework, scrap. Spoilage is units of production that do not meet the specifications required by customers for good units that are discarded or sold at reduced prices. Rework is units of production that do no meet the specifications required by customers but which are subsequently repaired and sold as good finished products. Scrap is residual material that results from manufacturing a product. It has low sales value compared with the total sales value of the product. Normal spoilage is spoilage inherent in a particular production process. The costs of normal spoilage are typically included as a component of the cost of good units manufactured because good units cannot be made without also making some units that are spoiled. Normal spoilage rates are computed by dividing units of normal spoilage by total good units completed. Abnormal spoilage is spoilage that is not inherent in a particular production process and would not arise under efficient operating conditions. Counted separately in Loss from Abnormal Spoilage account. Five-Step procedure for Process costing with spoilage: 1. Summarize the flow of physical units. Total spoilage = (units in beg work in process inventory + units started) - (good units completed and transferred out + units in ending WIP inventory) Normal spoilage = % of good units completed. Abnormal spoilage = total spoilage - normal spoilage. 2. Compute output in terms of equivalent units. Example page 644.

Step 1 (physical units)

Work in process ending (2000x100%; 2000x50%)

Step 2 Equivalent units Direct materials 2000

Conversion Costs 1000

2000

3. Summarize total costs to account for - all costs debited to work in process. 4. Compute cost per equivalent unit. 5. Assign total costs to units completed, to spoiled units, and to units in ending WIP. Weighted average method of process costing with spoilage

Total production costs

Step 3

Direct materials 12000 76500 88500 88500 /10000 8.85

Conversion costs 9000 89100 98100 9800 /9000 10.90

WIP, beginning Costs added in current period Total costs to account for

21000 165600 186600

Step 4

Cost incurred to date Divided by equivalent units of work done to date Cost per equivalent unit

Step 5

Assignment of costs: Good units completed and transferred out (7000 units)

Costs before adding normal spoilage Normal spoilage (700 units)

(A) (B) C A+B+C

138250 13825 152075 5925 28600 186600

(7000*8.85) + (700*8.85) +

(7000*10.90) (700*10.90)

Total cost of good units completed and transferred out Abnormal spoilage (300 units) Work in process, ending (2000 units) Total costs accounted for

(300*8.85) (2000*8.85) 88500 +

(300*10.90) (1000*10.90) 98100

FIFO method and spoilage - FIFO keeps the costs of the beginning work in process separate and distinct from the costs of work done in the current period. All spoilage costs are assumed to be related to units completed during this period, using unit costs of the current period. Page 645. Standard-costing method - steps 1 and 2 the same as for FIFO method, steps 3-5 cost to account for are at standard cost, hence, they differ from the costs to account for under weighted-avg and FIFO methods, which are at actual costs. Equivalent-unit cost calculation is unnecessary. Job costing and spoilage: normal spoilage attributable to a specific job - the job bears the cost of the spoilage minus the disposal value. Normal spoilage common to all jobs - allocated indirectly to the job as manufacturing overhead. Abnormal spoilage - net loss is charged to the Loss from Abnormal spoilage account, not included to part of the cost of good units produced. Written of in the accounting period. If rework is normal but occurs because of the requirements of a specific job, the rework costs are charged to that job. D WIP K materials K wages payable K MOH. If rework is normal, but not attributable to a specific job ( common to all jobs), the costs of rework are charged to MOH and spread through allocation. (D MOH K materials etc). Abnormal rework is recorded by charging abnormal rework to loss account D loss from abnormal rework K materials etc. Recognizing scrap at the time of its sale - when dollar amount is immaterial D cash K revenue. When dollar amount is material and is sold quickly after it is produced scrap attributable to a specific job. At sale: D Cash or AR K work in process. Scrap common to all jobs D Cash K manufacturing overhead. Recognizing scrap at the time of its production - if value is not immaterial and takes time to sell, assigned an inventory cost to scrap. Specific job: D materials K work in process. Common to all jobs: D materials K MOH. Chapter 21 - capital budgeting and cost analysis Capital budgeting analyzes each project by considering all the lifespan cash flows from its initial investment through its termination. Capital budgeting is the process of making long-run planning decisions for investments in projects. Five stages to the capital budgeting process: 1. Identify projects 2. Obtain information 3. Make predictions 4 make decisions by choosing among alternatives 5. Implement the decision, evaluate performance and learn (obtain funding and make the investments selected in no4; track realized cash flows, compare against estimated numbers, and revise plan if necessary) Discounted cash flow methods measure all expected future cash inflows and outflows of a project discounted back to present period. Time value of money - a dollar received today is worth more than a dollar received at any future time. Two DCF methods are net present value (NPV) method and internal rate-of-return (IRR) method. Both use required rate of return (RRR), the minimum acceptable annual rate of return on an investment. Net present value (NPV) method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to present point in time using the required rate of return. Internal rate of return (IRR) method calculates the discount rate at which an investments present value of all expected cash inflows equals the present value of its expected cash outflows. IRR is the discount rate that makes NPV = 0. When cash inflows are constant: IRR = initial investment/cash inflow per year. If the factor falls between the factors, use straight-line interpolation. Page 753.

Present value factors

18% IRR 20% Difference

3.127 2.991 0.136

3.127 3.019 0.108

IRR = 18% + 0.108+0.136(2%) = 19.6% per year Project is accepted only if IRR equals or exceeds RRR. NPV advantage: in dollars, so NPVs of individual projects can be summed. IRRs of individual projects cannot be added or averaged. NPV of a project can always be computed and expressed as a unique number, under IRR it is possible that more than one IRR may exist for a given project, especially when signs of cash flows switch over time. NPV can be used when the RRR varies over the life of a project, not possible to use IRR method. IRR method can be prone to indication erroneous decisions. Payback method measures the time it will take to recoup, in the form of expected future cash flows, the net initial investment in a project. Uniform cash flows - payback period = net initial investment/ uniform increase in annual future cash lows. Payback method highlights liquidity. Managers prefer projects with shorter payback periods if all other things are equal. Weaknesses: fails to explicitly incorporate the time value of money, does not consider a projects cash flows after the payback period. Nonuniform cash flows - cash flows over successive years are accumulated until the amount of net initial investment is recovered. Payback period = 2 years + (40000/80000 x 1 year) = 2,5 years. Accrual accounting rate of return (AARR) method divides the average annual (accrual accounting) income of a project by a measure of the investment in it. AARR= increase in expected average annual after-tax operating income / net initial investment. (( total cash inflow over 5 years/ 5 years - annual depreciation)/net initial investment. After-tax flows: operating cash inflows from investment in machine 120000 PAGE 746 Deduct income tax cash outflow at 40% 48000 schedule After-tax cash flow from operations 72000 (excluding depreciation effect) Additional depreciation deduction, 70000.

Income tax cash savings from additional depr. At 40% 28000 Cash flow from operation, net of income taxes 100000 Net initial investment: a) cash outflow to purchase the machine b) cash outflow for working capital c) after-tax cash inflow from current disposal of the old machine. Tax consequences of disposing of the old machine: Current disposal value of old machine 6500 Deduct current book value of old machine 40000 Loss on disposal of machine (33500) Current disposal value of old machine 6500 Tax savings on loss (0.40*33500) 13400 After tax cash inflow from current disposal of old machine 19900 Terminal disposal of investment - after tax cash flow from terminal disposal of machines. Similar to computing after-tax inflow from disposal of old machine. Chapter 22 - management control systems, transfer pricing and multinational considerations. Management control system is a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behavior of its managers and other employees.