Accounting project

Managerial accounting helping managers with decision making

Find a company on www.sec .gov and apply the managerial moves you have learned in class. (here are the PPT)

Job Costing

Chapter 3

Objective 1
Distinguish between job costing and process costing
2

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Process Costing
Mass production
Similar items
Total costs are averaged over all units
Examples
Paint manufacturers
Oil refineries
Cereal manufacturers
3

Job Costing
Unique, custom products or small batches
Total costs are accumulated by job
Examples
Hospitals
Custom home builders
Advertising agencies
4

Now turn to S3-1
5

A manufacturer of fiberglass insulation
A residential plumbing contractor
A manufacturer of fiber optic cable
A custom home builder
A hospital

S3-1: Examples of Process and
Job Costing
6
Process costing
Job costing
Job costing
Job costing
Process costing

Objective 2
Understand the flow of production and how direct materials and direct labor are traced to jobs
7

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Flow of Inventory Through a Manufacturing System
8
Raw Materials

Storeroom
Work in process

Production
department

Finished Goods

Ready for sale

Cost of Goods Sold

Sold

Exhibit 3-3: Production Schedule
for the Month of December
9
Job Model Number Stock or Customer Quantity Scheduled
Start Date Scheduled End date
603 X4 Cross-Trainer For stock 50 12/2 12/6
604 T5-0 Treadmill For stock 60 12/7 12/17
605 Custom T6-C Treadmill Bears 15 12/18 12/21
606 Custom S3-C Stair-Climber Bears 12 12/22 12/24
FACTORY CLOSED FOR HOLIDAYS
and ANNUAL MAINTENANCE 12/25 12/31

Exhibit 3-4: Bill of Materials
10
Part Number Description Quantity Needed
HRM50812 Heart rate monitor 50
LCD620 LCD entertainment screen 50
B4906 Front and rear rolling base 100
HG2567 Hand grips 100
FP689 Foot platform 100
Etc.

Purchasing Process
11
Purchasing determines ordering needs
Shipping and receiving prepares receiving report
Accounting matches invoice with purchase order
Purchasing issues purchase order
Accounting pays the invoice

Job Cost Record
Job Number: 603
Customer: For stock
Job Description: 50 units of X4 Elliptical Cross-Trainers
Date Started: Dec. 2 Date Completed: _________
Manufacturing Cost Information: Cost Summary
Direct Materials $
Direct Labor $
Manufacturing Overhead $
Total Job Cost $
Number of Units ÷ 50 units
Cost per Unit $

Shipping Information:
Date Quantity Shipped Units Remaining Cost Balance

Exhibit 3-7: Job Cost Record
12

Exhibit 3-8: Work in Process Inventory
13
JOB 560-
Direct Materials
Direct Labor
MOH
Total Job Cost

Life Fitness
Balance Sheet
November 30
Assets: Liabilities and Owners Equity:
Cash Accounts Payable
Accounts Receivable Wages and Salaries Payable
Raw Materials Inventory Other Liabilities
Work in Process Inventory
Finished Goods Inventory Common Stock
Retained Earnings
Property and Equipment
Total Assets Total Liabilities and Owner’s Equity

JOB 561-
Direct Materials
Direct Labor
MOH
Total Job Cost

JOB 562-
Direct Materials
Direct Labor
MOH
Total Job Cost

JOB 563-
Direct Materials
Direct Labor
MOH
Total Job Cost

The job cost records on incomplete jobs sum to the total Work in Process Inventory shown on the balance sheet

Exhibit 3-9: Materials Requisition
14
Materials Requisition
Number: #7568
Date: 12/2
Job: 603
Part Number Description Quantity Unit Cost Amount
HRM50812 Heart rate monitor 50 $60 $3,000
LCD620 LCD entertainment screen 50 $100 5,000
B4906 Front and rear rolling base 100 $5 500
Total $8,500

Exhibit 3-10: Raw Materials Record Updated for Materials Received and Used
15
Raw Materials Record
Item No. HRM50812 Description: Heart rate monitor
Received Used Balance
Date Units Cost Total Requisition
Number Units Cost Total Units Cost Total
11-25 100 $60 $6,000 100 $60 $6,000
11-30 #7235 70 $60 $4,200 30 $60 $1,800
12-1 75 $60 $4,500 105 $60 $6,300
12-2 #7568 50 $60 $3,000 55 $60 $3,300

Direct Labor Costs Are Traced
to Individual Jobs
16
Labor Time Record
Employee: Hannah Smith Week: 12/2- 12/9
Hourly Wage Rate: $20 Record #: 324
Date Job Number Start Time End Time Hours Cost
12/2 602 3 $ 60
12/2 603 5 $ 100
12/3 603 8 $ 160
12/4 etc.

Ex 3-13: Direct Labor and Materials Posted to Job Cost Record
17
Job Cost Record
Job Number: 603
Customer: For stock
Job Description: 50 units of X4 Elliptical Cross-Trainers
Date Started: Dec. 2 Date Completed: Dec. 6_________
Manufacturing Cost Information: Cost Summary
Direct Materials
Req. #7568: $ 8,500
Req. #7580: $ 14,000
Req. # 7595: $ 13,500
Req. # 7601: $ 4,000 $ 40,000
Direct Labor
No. #324 (30 hours): $ 100, $ 160, etc.
No. #327 (40 hours): $ 240, $ 240, etc.
No. #333 (36 hours): $ 80, $ 120, etc.
Etc. (a total of 500 direct labor hours) $ 10,000
Manufacturing Overhead $
Total Job Cost $
Number of Units ÷ 50 units
Cost per Unit $

Objective 3
Compute a predetermined manufacturing overhead rate and use it to allocate MOH to jobs
18

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Calculating Predetermined Manufacturing Overhead Rate
19
POHR*=
Total estimated mfg overhead costs
Total estimated amount of allocation base
*POHR stands for “Predetermined Manufacturing Overhead Rate”

Allocating Manufacturing Overhead (MOH) to Individual Jobs
Allocated MOH =
POHR x Amount of cost allocation activity used
20
*POHR stands for “Predetermined Manufacturing Overhead Rate”

Allocating MOH to Individual Job (Example)
21
POHR =
$1,000,000 estimated overhead costs
62,500 direct labor hours
= $16 per direct labor hours
Example:
Total estimated manufacturing overhead costs = $1,000,000
Cost allocation base is direct labor hours (DLH)
Total estimated direct labor hours for the year = 62,500 DLHs
Job #603 used 500 DLHs
*POHR stands for “Predetermined Manufacturing Overhead Rate”

Allocating MOH to Individual Job
(continued from prior slide):
Allocated MOH
for Job #603

= $16 x 500 DLHs
= $8,000

22
*POHR stands for “Predetermined Manufacturing Overhead Rate”

Exhibit 3-14: Completing the Job Cost Record

23
Job Cost Record
Job Number: 603
Customer: For stock
Job Description: 50 units of X4 Elliptical Cross-Trainers
Date Started: Dec. 2 Date Completed: _________
Manufacturing Cost Information: Cost Summary
Direct Materials
Req. #7568: $ 8,500
Req. #7580: $ 14,000
Req. # 7595: $ 13,500
Req. # 7601: $ 4,000 $ 40,000
Direct Labor
No. #324 (30 hours): $ 100, $ 160, etc.
No. #327 (40 hours): $ 240, $ 240, etc.
No. #333 (36 hours): $ 80, $ 120, etc.
Etc. (a total of 500 direct labor hours) $ 10,000
Manufacturing Overhead
$16/ DL hour × 500 DL hours= $8,000 $ 8,000
Total Job Cost $ 58,000
Number of Units ÷ 50 units
Cost per Unit $1,160

When Is Manufacturing Overhead Allocated?
24
Work in
Process
Cost of
Goods
Sold
Labor
Materials
Indirect
Finished
Goods
Factory
Overhead

Direct

Direct
Allocate
Indirect

Cost Flow
25
Work in
Process
Finished
Goods
Cost of
Goods
Sold
Direct
Materials
Direct
Labor
Manufacturing
Overhead

Objective 4
Determine the cost of a job and use it to make business decisions
26

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Reasons Why Management Needs Product Cost
Reduce future job costs
Assess and compare profitability of models
Pricing decisions
Discounts on high-volume sales
Bids for custom orders
Financial statement preparation
27

Sustainability and Job Costing
Job cost record captures the essential resources required to manufacture a product
Job cost record can be enhanced with information about
Product/production’s effect on the environment
Employees involved in manufacturing process
Future consumers
Future disposal
Subcategories
Extended Producer Responsibility (EPR)
28

Now turn to E3-18A
29

E3-18A
What is Raymond’s predetermined manufacturing overhead rate based on
direct labor cost?
Total direct labor cost = $35 x 22,000 hours = $770,000
POHR = $485,100 ÷ $770,000
= 63% of direct labor cost
30

E3-18A (cont.)
Calculate the manufacturing overhead to be allocated based on direct labor cost to
Job 371.
Direct labor hours used = 180 x $35 per hour
= $6,300 direct labor cost
POHR = 63% x $6,300 = $3,969
Allocated MOH for Job 371 = $3,969
31

E3-18A (cont.)
What is the total cost of Job 371?
Direct materials used $14,500
Direct labor cost (180 x $35) 6,300
Manufacturing overhead allocated 3,969
Total cost of Job 371 $24,769
32

Objective 5
Compute and dispose of overallocated or underallocated manufacturing overhead
33

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Overhead Allocation Example
FedCorp allocates manufacturing overhead based on direct labor hours. Total estimated manufacturing overhead for the year is projected to be $200,000. Total estimated direct labor cost is $140,000, while total estimated direct labor hours to be worked are 10,000.
What is FedCorp’s predetermined manufacturing overhead rate?
34

FedCorp allocates manufacturing overhead based on direct labor hours. Total estimated manufacturing overhead for the year is projected to be $200,000. Total estimated direct labor cost is $140,000, while total estimated direct labor hours to be worked are 10,000.
What is FedCorp’s predetermined manufacturing overhead rate?
POHR = $200,000 ÷ 10,000 = $20 per DLH
35
Overhead Allocation Example (cont.)

Overhead Allocation Example (cont.)
FedCorp’s actual manufacturing overhead for the year was $190,000. A total of 11,000 direct labor hours were worked.
Using FedCorp’s predetermined manufacturing overhead rate of $20 per direct labor hour, how much overhead was allocated to all of FedCorp’s jobs during the year?
36

Now we look at what to do if (WHEN) actual MOH does not equal allocated MOH
Continuing same example (FedCorp)
38

Overhead Allocation Example (cont.)
39
FedCorp’s actual overhead
FedCorp’s allocated overhead
Difference
$190,000
“Target” was $190,000;
actually allocated $220,000. Overapplied by $30,000.
$220,000
$ 30,000

Underallocated or Overallocated Manufacturing Overhead
Underallocated (undercosted)
– Not enough allocated to jobs
– Too little expense
Overallocated (overcosting)
– Too much allocated to jobs
– Too much expense
40

Underallocated or Overallocated Manufacturing Overhead
Why/How?
Estimated manufacturing overhead costs were higher or lower than actual
Used more or less of the estimated allocation base than projected
Two Solutions
Adjust cost of goods sold
OR
Prorate between Cost of Goods Sold, Work in Process Inventory, Finished Goods Inventory
41

How Do Manufacturers Treat Non-Manufacturing Costs?
GAAP – only inventoriable product costs added to the cost of assets (inventory)
Internal decision-making – management wants to know the total cost of the product across the value chain
42

Now turn to E3-24A
43

E3-24A (cont.)
Req 1: Predetermined manufacturing overhead rate = $650,000 / 81,250 = $8/machine hour
Req 2: Allocated MOH = 54,500 machine hours x
$8 per machine hour = $436,000
44

E3-24A (cont.)
Req 3:
45
Depreciation on plant and equipment……. $485,000
Property taxes on plant………………………… 21,500
Plant janitors’ wages……………………………. 11,000
Total manufacturing overhead………………. $517,500

E3-24A (cont.)
Req 3:
46
Depreciation on plant and equipment
…..
$485,000
Property taxes on plant
………………………..
21,500
Plant janitors’ wages
……………………………..
11,000
Total manufacturing overhead
……………….
$517,500

E3-24A, pp.
Req 4:
47
Actual manufacturing overhead……………
$517,500
Allocated manufacturing overhead……….
436,000
Underallocated
manufacturing overhead
$ 81,500

Objective 6
Prepare the journal entries for a manufacturer’s job costing system
48

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Purchase of Raw Materials
Raw Materials Inventory 90,000
Accounts Payable 90,000
(to record purchase of raw materials)
49

Use of Direct Materials
Work in Process Inventory 112,000
Raw Materials Inventory 112,000
(to record the use of direct materials on jobs)
50

Use of Indirect Materials
Manufacturing Overhead 2,000
Raw Materials Inventory 2,000
(to record the use of indirect materials in the factory)
51

Use of Direct Labor
Work in Process Inventory 30,000
Wages Payable 30,000
(to record the use of direct labor on jobs)
52

Use of Indirect Labor
Manufacturing Overhead 13,000
Wages Payable 13,000
(to record the use of indirect labor in the factory)
53

Incurring Other MOH Costs
Manufacturing Overhead 10,000
Accounts Payable (for electric bill) 3,000
Accumulated Depreciation – Plant and Equipment 4,000
Prepaid Plant Insurance (for expiration of prepaid insurance) 1,000
Plant Property Taxes Payable (for taxes to be paid) 2,000
(to record other indirect manufacturing costs incurred during the month)
54

Allocating MOH to Jobs
Job 603: $16 per DL hour x 500 DL hours = $8,000
Job 604: $16 per DL hour x 1,000 DL hours = $16,000
Work in Process Inventory ($8,000+$16,000) 24,000
Manufacturing Overhead 24,000
(to allocate manufacturing overhead to specific jobs)
55

Completion of Jobs
56
Job 604: Treadmills
Direct Materials $ 72,000
Direct Labor 20,000
Manufacturing Overhead 16,000
Total Job Cost $108,000
Number of Units ÷ 60
Cost per Unit $ 1,800

Finished Goods Inventory 166,000
Work in Process Inventory 166,000
(to move the completed jobs out of the factory and into
Finished Goods)

Sale of Units
Accounts Receivable (40x$1,425)+(60x$2,500) 207,000
Sales Revenue 207,000
(to record the sale of 40 cross-trainers and 60 treadmills)
Cost of Goods Sold (40x$1,160)+(60x$1,800) 154,400
Finished Goods Inventory 154,400
(to reduce finished goods inventory and record CGS)
57

Operating Expenses
Salaries and Commission Expense 20,000
Rent Expense 3,300
Marketing Expenses 9,400
Salaries and Commissions Payable 20,000
Rent Payable 3,300
Accounts Payable 9,400
(to record all non-manufacturing costs incurred during the month)
58

Closing Manufacturing Overhead
Cost of Goods Sold 1,000
Manufacturing Overhead 1,000
(to close the manufacturing overhead account)
59

Income Statement, Exhibit 3-18
Life Fitness
Income Statement
December 31
Sales Revenue $207,000
Less: Cost of Goods Sold 155,400
Gross Profit 51,600
Less: Operating Expenses 32,700
Operating Income $ 18,900

Objective 7
(Appendix) Use job costing at
a service firm as a basis for
billing clients
61

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Job Costing at a Service Firm
Similar to job costing at a manufacturer
Main difference is that company is allocated indirect period costs to each client rather than manufacturing costs
Since no inventory, no journal entries necessary
62

End of Chapter 3
63

Introduction to Managerial Accounting

Chapter

Objective 1
Identify managers’ three primary responsibilities
2

2
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Managers’ Responsibilities
Setting goals and
objectives
Overseeing day-to-day operations
Evaluating results
of operations
Directing
Controlling
Decision
Making

Planning
3

3
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Planning
Setting goals and objectives and how to achieve them
Examples of planning
Generate more sales via opening new stores
Reduce labor costs by reducing store hours
Budgets
4

Directing
Overseeing company’s day-to-day operations
Examples
Using daily/weekly sales reports to adjust marketing strategies
Using product cost reports to adjust
raw material usage
5

Controlling
Evaluating results of operations against plans and making adjustments as needed
Examples
Comparing budgeted sales with actual sales to take corrective actions
Comparing budgeted product costs against actual product costs to take corrective actions
6

Objective 2
Distinguish financial accounting from managerial accounting
7

7
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Managerial vs. Financial Accounting
Issue Managerial Financial
Primary users Internal External
Purpose of information Plan, direct, control, decide Users make investing and lending decisions

8
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Managerial vs. Financial Accounting
Issue Managerial Financial
Primary accounting product Internal reports useful to management General purpose financial statements
What is included? Defined by management Determined by GAAP

9
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Managerial vs. Financial Accounting
Issue Managerial Financial
Underlying basis of information Internal and external transactions, focus on future Based on historical transactions with external parties
Emphasis Data must be relevant Data must be reliable and objective

10
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Managerial vs. Financial Accounting
Issue Managerial Financial
Business unit Segments of the business Company as a whole
Preparation Depends on management needs Annually and quarterly
Verification Internal audit External audit

11
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Managerial vs. Financial Accounting
Issue Managerial Financial
Information requirements No requirement SEC requires publicly traded companies to issue audited financial statements
Impact on employee behavior Careful consideration Adequacy of disclosure

12
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Objective 3
Describe organizational structure and the roles and skills required of management accountants within the organization
13

13
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Organizational Structure
Board of
Directors
Chief Executive
Officer
Chief Operating
Officer
Chief Financial
Officer
Vice Presidents
of Various
Operations
Treasurer
Controller

Internal Audit
Audit
Committee

14
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Changing Roles of Management
Accountants
Impact of technology
Ensuring accurate financial records
Planning, analyzing, and interpreting accounting data
Providing decision support
15

15
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Required Skills of Managerial Accountants
Knowledge of financial and managerial accounting
Analytical skills (critical thinking)
Knowledge of how a business functions
Ability to work on a team
Oral and written communications skills
16

16
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Objective 4
Describe the role of the
Institute of Management Accountants (IMA) and use its ethical standards to make reasonable ethical judgments
17

17
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Institute of Management Accountants (IMA)
Professional association for management accountants
IMA’s functions
Certification (CMA)
Practice development
Education
Networking
Ethical standards
Public education
18

18
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Summary of IMA Ethical Standards
19
Competence Confidentiality
Integrity Credibility

19
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Ethical Behavior
Means doing the right thing, regardless of consequences
Examples of unethical behavior
Allowing reimbursement of false expense reports
Manipulating income
Performing tasks not qualified to perform
20

Steps to Resolve Ethical Dilemmas
Follow company’s policies for reporting unethical behavior
If not resolved
Discuss with immediate supervisor
Discuss with objective advisor
Consult an attorney
21

21
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Unethical Versus Illegal Behavior
Not all unethical behavior is illegal, but all illegal behavior is unethical.
Unethical behavior includes
Dishonesty
Unfairness
Lack of objectivity
Irresponsible
22

Objective 5
Discuss and analyze the implications of regulatory and business trends
23

23
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Regulatory and Business Issues
Sarbanes-Oxley Act of 2002 (SOX)
International Financial Reporting Standards (IFRS)
Extensible Business Reporting Language (XBRL)
Sustainability
Shifting economy
24

24
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Sarbanes-Oxley Act of 2002 (SOX)
Restore trust in publicly traded corporations, management, financial statements, and auditors
CEO /CFO requirements
Financial statements
Internal control structure
Annual assessment
Independent audit committee
Increases white-collar crime penalties
25

International Financial Reporting Standards (IFRS)
Results of globalization
Consistent reporting standards needed worldwide
SEC is studying IFRS
26
Current IFRS information:
www.IFRS.com or www.IASB.org

Extensible Business Reporting Language (XBRL)
Standardized tagging system for financial reports
Advantages
Decreases retrieval time
Decreases conversion time
Facilitates comparisons
Customizes information
27

Sustainability and Managerial Accounting
Sustainability
Social responsibility
Triple bottom line
Profit
People
Planet
28

Shifting Economy
Shift away from manufacturing toward service
Managerial accounting has expanded
29

Competing in Global Marketplace
Barriers to international trade have fallen
More accurate and timely information needed
30

Advanced Information Systems
Enterprise resource planning (ERP)
Lean production
Just-in-time (JIT)
Total quality management (TQM)

Enterprise Resource Planning (ERP)
System that integrates a company’s functions, departments, and data
Advantages
Streamline operations
Respond quickly to changes
Replace separate software systems
Disadvantage: expensive
32

Lean Operations
A philosophy and business strategy of manufacturing without waste
Lowers costs
Increases competitive position
33

Just in Time Inventory (JIT)
Manufacture “just in time” to fill orders
Reduces
Raw materials inventory
Finished goods inventory
Storage costs
Handling costs
34

TQM – Total Quality Management
Goal to provide customers with superior products and services
Continually set higher goals for quality
International Organization for Standardization (ISO) – ISO 9001:2008
35

End of Chapter 1
36

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Building Blocks of Managerial Accounting

Chapter 2

Objective 1
Distinguish among service, merchandising, and manufacturing companies
2

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Three types of companies
Service
Merchandisers
Manufacturers
3

Service Companies
Provide a service only
No inventory
Examples
Accountants
Banks
Doctors
Lawyers
4

Merchandisers
Resell products purchased from suppliers
One inventory account
Examples
Amazon.com
J. C. Penney
Sears
Retailers vs. Wholesalers
5

Manufacturers
Use labor and other inputs to convert raw materials into finished products
Examples
Crayola Crayons
Dell Computers
Craftsman Tools
3 inventory accounts
6

Manufacturers
3 inventory accounts
Raw materials
Work in process
Finished goods
7

Objective 2
Describe the value chain
and its elements
8

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Value Chain
Activities that add value to products and services and cost money.
R&D
Production/
Purchases
Marketing
Design

Distribution
Customer Service
9

Now turn to E2-16A
10

E2-16A
Research on selling satellite radio service
Purchases of merchandise
Rearranging store layout

E2-16A
Research on selling satellite radio service R & D
Purchases of merchandise
Rearranging store layout

E2-16A
Research on selling satellite radio service R & D
Purchases of merchandise Purchases
Rearranging store layout

E2-16A
Research on selling satellite radio service R & D
Purchases of merchandise Purchases
Rearranging store layout Design

E2-16A (cont.)
Newspaper advertisements
Deprec. expense on delivery trucks
Payment to consultant for advice on location of new store

E2-16A (cont.)
Newspaper advertisements Marketing
Deprec. expense on delivery trucks
Payment to consultant for advice on location of new store

E2-16A (cont.)
Newspaper advertisements Marketing
Deprec. expense on delivery trucks Distribution
Payment to consultant for advice on location of new store

E2-17A (cont.)
Newspaper advertisements Marketing
Deprec. expense on delivery trucks Distribution
Payment to consultant for advice on location of new store R & D

E2-16A (cont.)
Freight-in
Salespersons’ salaries
Customer complaint department

E2-16A (cont.)
Freight-in Purchases
Salespersons’ salaries
Customer complaint department

E2-16A (cont.)
Freight-in Purchases
Salespersons’ salaries Marketing
Customer complaint department

E2-16A (cont.)
Freight-in Purchases
Salespersons’ salaries Marketing
Customer complaint department Customer service

Objective 3
Distinguish between direct and indirect costs
23

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Cost Object
Anything for which managers want a separate measurement of cost
Direct cost
Indirect cost
24

Now turn to S2-4
25

The wages of store employees

The cost of operating the corporate payroll department

The cost of carpet steamers offered for rent

The cost of gas and oil sold at the store

S2-4
26
Direct
Direct
Indirect
Direct

S2-4 (cont.)
Store utilities
The CEO’s salary
The cost of chainsaws offered for rent
The cost of national advertising

27
Indirect
Direct
Direct
Indirect

Objective 4
Identify the inventoriable product costs and period costs of merchandising and manufacturing firms
28

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Two definitions of product cost
Total costs – used internally only (will see this in later chapters)
Inventoriable product costs – used for external reporting
29

R&D
Design
Marketing
Distribution
Customer Service

Production/
Purchases
Inventoriable Product Costs
Inventoriable product costs
30

Period Costs: All costs incurred in the other stages of the value chain
Period Costs
Marketing
Distribution
Customer Service
R&D
Design
31

Inventoriable Product Costs — Merchandiser
+ Purchase price from suppliers
+ Cost to get ready for sale
+ Freight-in
+ Import duties or tariffs
32

Inventoriable Product Costs — Manufacturer
Direct materials
Direct labor
Manufacturing overhead
Direct Costs
Indirect Costs
33

Manufacturing Overhead
Indirect costs related to manufacturing that are not direct materials or direct labor
Indirect materials
Indirect labor
Other indirect manufacturing overhead
34

Now turn to S2-7
35

Company president’s annual bonus
Plastic gallon containers in which milk is packaged
Depreciation on marketing department’s computers
Wages and salaries paid to machine operators at dairy processing plant

S2-7
Period
Period
Product, DM
Product, DL
36

Research and Development on improving milk pasteurization process
6. Cost of milk purchased from dairy farmers Product, DM

Lubricants used in running bottling machines
Depreciation on refrigerated trucks used to collect raw milk from dairy farms

S2-7 (cont.)
Product,MOH
Period
Product,MOH
37

Property tax on dairy processing plant
Television advertisements for DairyPlains’ products
Gasoline used to operate refrigerated trucks used to deliver finished dairy products to grocery stores

S2-7 (cont.)
Period
Product,MOH
Period
38

Prime and Conversion Costs
Manufacturing Overhead
Direct Materials

Prime Costs
Direct
Labor

Conversion Costs
39

Direct and indirect labor costs include
Salaries and wages
Fringe benefits
Payroll taxes
40

Objective 5
Prepare the financial statements for service, merchandising and manufacturing companies
41

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Income Statement – Service Company
Simplest income statement
All costs are period costs
Service Revenues
– Operating expenses
Operating income
42

Cost of Goods Sold Calculation – Merchandiser
+ Beginning inventory
+ Purchases
+ Import duties or tariffs
+ Freight-in
= Cost of goods available for sale
Ending inventory
= Cost of goods sold
43

Now turn to S2-9
44

S2-9
45

Cost of Goods Sold Computation
Beginning
inventory
$ 4,200
Purchases
$42,000
Import
duties
1,100
–
Freight
in
3,600
46,700
Cost
of goods
avail
for sale
50,900
Ending
inventory
(5,400
)
Cost of goods sold
$45,500

Income Statement – Merchandiser
+ Sales
– Cost of goods sold
= Gross profit
– Operating expenses
= Operating income
46

Now turn to S2-10
47

S2-10
48

Salon Secrets
Income Statement
Sales revenue
$39,330,000
Cost of goods sold:
Beginning inventory
$ 3,350,000
Purchases
23,975,000
Cost
of
goods avail.
27,325,000
Ending inventory
(4,315,000
)
Cost of goods sold
(23,010,000
)
Gross profit
16,290,000
Operating expenses
(6,150,000
)
Operating income
$ 10,140,000

2010 Product costs
2010 Balance Sheet
2010 Income Statement
2011 Income Statement
Cost of goods sold
Cost of goods sold

Inventory

Inventory sold in 2010

Inventory sold in 2011
Product costs
49

Cost of Goods Manufactured Calculation – Manufacturer
+ Beginning work in process inventory
+ Direct materials used
+ Direct labor
+ Manufacturing overhead
= Total manufacturing costs to account for
Ending work in process inventory
= Cost of goods manufactured
50

How to calculate
Beginning Inventory + Net Purchases =
Cost of Goods Sold + Ending Inventory
51

Cost of Goods Sold Calculation –
Manufacturer
+ Beginning finished goods inventory
+ Cost of goods manufactured
= Cost of goods available for sale
– Ending finished goods inventory
= Cost of goods sold
52

Now turn to E2-25A
53

E2-25A (COGM)
54

Beginning work in process inventory
$ 36,000
Add:
Direct materials used:
Beginning
raw materials inventory
$ 29,000
Purchases
of direct materials
73,000
Available
for use
102,000
Ending
raw materials inventory
(31,000
)
Direct materials used
$71,000
Direct labor
89,000
Manufacturing overhead:
Indirect labor
$ 42,000
Insurance on plant
10,500
Deprec
–
plant bldg & equip
13,000
Repairs and
mtnce
–
plant
4,000
69,500
Total manufacturing costs incurred
229,500
Total manufacturing costs to acct for
265,500
Less: Ending work in process inventory
(30,000
)
Cost of goods manufactured
$235,500

E2-25A (cont.)
55
*From schedule of cost of goods manufactured.

Quality Aquatic Company
Schedule of Cost of Goods Sold
Beginning finished goods inventory
$ 22,000
Cost of goods manufactured*
235,500
Cost of goods available for sale
257,500
Ending finished goods inventory
(28,000
)
Cost of goods sold
$229,500

Income Statement – Manufacturer
+ Sales
– Cost of goods sold
= Gross profit
– Operating expenses
= Operating income
56

Now turn to E2-26A
57

E2-26A
58

Quality Aquatic Company
Income Statement
For Last Year
Sales revenue (33,000
×
$14)
$462,000
Cost of goods sold
229,500
Gross profit
232,500
Operating expenses:
Marketing
expenses
$ 83,000
General and administrative expenses
26,500
109,500
Operating income
$ 123,000

Direct Materials Used Calculation –
Manufacturer
+ Beginning raw materials inventory
+ Purchases of raw materials
+ Freight in
= Materials available for use
Ending raw materials inventory
= Direct materials used
59

Now turn to S2-11
60

S2-11
61

Allterrain
Computation of Direct Materials Used
Direct materials used:
Beginning
raw materials inventory
$ 3,900
Purchases of direct materials
$15,600
Import
duties
900
Freight
–
in
600
17,100
Direct
materials available for use
21,000
Ending
raw materials inventory
(2,000
)
Direct materials used
$19,000

Product and Period Costs
62

Type of
Company
Inventoriable
Product Costs
Period
Costs
Service Company
None
All costs along the
value chain
Merchandiser
Purchases plus cost of
freight, import duties,
etc.
All costs except total
purchases
Manufacturer
DM, DL, MOH
All costs except DM,
DL, MOH
Accounting
Treatment
Inventory on balance
sheet until sold
Immediately
expense

Manufacturing Companies’
Inventory Accounts
63

Raw Materials Inventory
+ Beginning inventory
+ Purchases & freight
= Ending inventory
– Materials used in work in process

Manufacturing Companies’
Inventory Accounts
64

Work in Process Inventory
+ Beginning inventory
+ Matls used from raw matls
= Ending inventory
– Cost of goods manufactured and sent to finished goods
+ Direct Labor
+ Manufacturing overhead

Manufacturing Companies’
Inventory Accounts
65

Finished Goods Inventory
+ Beginning inventory
+ Cost of goods manufactured
= Ending inventory
– Cost of goods sold

Balance Sheet Differences
66
Type of Company Inventory Accounts
Service Company None
Merchandiser Merchandise Inventory
Manufacturer Raw materials, work in process,
and finished goods inventory

Objective 6
Describe costs that are relevant and irrelevant for decision making
67

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Controllable and Uncontrollable Costs
Controllable Management can influence or change cost
Uncontrollable Management cannot change or influence cost in the short run

Relevant and Irrelevant Costs
69
Relevant Differential costs, which are costs that differ between alternatives
Irrelevant Costs which do not differ between alternatives
-or-
Sunk costs – costs incurred in the past which cannot be changed

Objective 7
Classify costs as fixed or variable and calculate total and average costs at different volumes
70

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Cost Behavior
71
Variable costs Change in total cost in direct proportion to changes in volume
Fixed costs Stay constant in total cost over a wide range of activity levels

Total Variable Costs
Assume we pay 5% sales commissions on all sales.
The cost of sales commissions increases proportionately with increases in sales.

Total Fixed Costs: Stay Constant in Total Over a Wide Range of Activity Levels
73

Total Cost
Total cost = Fixed costs + (Variable cost per unit x number of units)
74
Example:
Fixed costs = $20,000
Variable cost per unit = $50 per unit
Number of units = 100
Total Cost = $20,000 + ($50 x 100)
= $25,000

Average Cost
Total cost ÷ number of units = Average cost

The average cost per unit is NOT appropriate for predicting total costs at different levels of output.
75
Example:
$25,000 = $250 per unit
100 units

Marginal Cost
Cost of making one more unit
76

End of Chapter 2
77

$0
$500
$1,000
$1,500
$2,000
$2,500
$0$10,000$20,000$30,000$40,000
Total Sales
Total Sales
Commissions
$0
$500
$1,000
$1,500
$2,000
$2,500
$0$10,000$20,000$30,000$40,000
Total Sales
Total Sales Salaries

Activity-Based Costing, Lean Operations, and the Costs of Quality

Chapter 4

Objective 1
Develop and use departmental overhead rates to allocate indirect costs
2

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Why and How do Companies Refine Their Cost Allocation Systems?
Why refine?
Mismatching resources
Cost distortion
Who can refine?
Manufacturing operations
Service companies and governmental agencies

Plantwide Overhead Rate –
example in textbook
Using one predetermined manufacturing overhead rate for all operations
Predetermined MOH rate =
Total estimated manufacturing overhead costs
Total estimated amount of the allocation base
Predetermined MOH rate =
$1,000,000
62,500 DL hours
= $16 per DL hour
4

Plantwide Overhead Rate
Using one predetermined manufacturing overhead rate to allocate MOH to units
5

Plantwide
Overhead Rate
Actual Use of
Allocation Base
MOH
Allocated to
One Unit
Elliptical
×
$16 per DL hour
10 DL hours
=
$160
Treadmill
×
$16 per DL hour
10 DL hours
=
$160

Departmental Overhead Rates
Separate predetermined manufacturing overhead rates for each department

Manufacturing Plant with $1,000,000 of total estimated MOH and 2 departments
Machining Department
($400,000 of MOH) Assembly Department
($600,000 of MOH)
$400,000 ÷ departmental allocation base
yields a MOH rate for this department ONLY $600,000 ÷ departmental allocation base
yields a MOH rate for this department ONLY

Departmental Overhead Rates
When to use
Departments incur different amounts and types
of MOH
Different jobs or products use the department resources to a different extent
7

Departmental Overhead Rates – Example on pages 182 – 187
Department Total Departmental Manufacturing Overhead Costs Total Departmental Labor Hours Departmental Overhead Rate
Machining $400,000 12,500 hrs
Assembly $600,000 50,000 hrs
TOTAL $1,000,000

Departmental Overhead Rates Example –
Exhibit 4-8 (p.186) – Ellipticals
Department Departmental Overhead Rate Actual Use of Departmental
Allocation Base MOH
Allocated to One Elliptical
Machining $32 per DL hour × 1 DL hours =
Assembly $12 per DL hour × 9 DL hours =
Total

Departmental Overhead Rates Example – Exhibit 4-9 (p.186) – Treadmills
Department Departmental Overhead Rate Actual Use of Departmental
Allocation Base MOH
Allocated to OneTreadmill
Machining $32 per DL hour × 4DL hours =
Assembly $12 per DL hour × 6DL hours =
Total

Departmental Overhead Rates Example – Exhibit 4-11 (p.187)
Plantwide
Overhead Rate
MOH Allocation
(from Exhibit 4-2) Departmental Overhead Rates MOH Allocation
(from Exhibit 4-10) Amount of Cost Distortion
Elliptical $ 160 $ 140 $20 overcosted
Treadmill $ 160 $ 200 $40 undercosted

Now turn to S4-3

S4-3 – Compute Departmental Overhead Rates
What is Gerbig’s plantwide overhead rate?

$3,762,000 manufacturing overhead
17,100 machine hours
= $220 per machine hour

Total estimated manufacturing overhead costs
Total estimated amount of the allocation base
16

S4-3 (cont.)
Calculate the departmental overhead rates for Gerbig’s three production lines. Round all answers to the nearest cent.

Department Overhead Cost Machine Hours Overhead Rate
Potato chips $2,147,000 11,300 MH
Corn chips $959,000 2,600 MH
Cheese puffs $ 656,000 3,200 MH

17
$190.00
$368.85
$205.00

S4-3 (cont.)
Which products had been overcosted by the plantwide rate? Which products had been undercosted by the plantwide rate?
Plantwide Rate = $220.00 per machine hour
Departmental Rate:

18
Potato
Chips
= $190.00
Overcosted
Corn Chips
= 368.85
Undercosted
Cheese
Puffs
= 205.00
Overcosted

Objective 2
Develop and use activity-based costing (ABC) to allocate indirect costs
19

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Activity-Based Costing
Allocates indirect costs to production
Focuses on activities and costs of activities
Separate allocation rate for each activity
Manufacturing
Activities
Machine Setup
Materials
Handling
Fabricating
Parts
Supervising
Assembly
Inspecting
Products
Packaging
Products
20

Activity MOH Costs for the Activity Total Activity Cost Pool
Machine Setup Indirect labor to set up machines $80,000
Materials Handling Forklifts, gas, operators’ wages 200,000
Fabricating Parts Machine lease payments, electricity, repairs 300,000
Supervising Assembly Production engineers’ labor 150,000
Inspecting Testing equipment, inspection labor 170,000
Packaging Packaging equipment 100,000
$1,000,000

Activity-Based Costing Steps
Step 1: Identify and estimate indirect costs
21

Activity-Based Costing Steps
Step 2: Select an allocation base for each activity
22
Activity Allocation base Total Cost Pool Total Estimated Amount of Allocation Base
Machine Setup Number of setups $80,000 8,000 setups
Materials Handling Number of parts moved 200,000 400,000 parts
Fabricating Parts Machine hours 300,000 12,500 machine hours (MH)
Supervising Assembly Direct labor hours 150,000 DL hours
Inspecting Number of inspections 170,000 Inspections
Packaging Cubic feet packaged 100,000 Cubic feet
$1,000,000

Activity-Based Costing Steps
Step 3: Compute cost allocation rate for each activity
23
Activity Allocation base Total Cost Pool Cost Allocation Rate
Machine Set-up Number of set-ups $80,000 $80,000 / 8000 = $10 per setup
Materials Handling Number of parts moved 200,000 200,000/ 400,000 = $0.50 per part
Fabricating Parts Machine hours 300,000 300,000/ 12,500 = $24 per MH
Supervising Assembly Direct labor hours 150,000 150,000 / 50,000 = $3 per DLH
Inspecting Number of inspections 170,000 170,000 / 34,000 = $5 per inspection
Packaging Cubic feet packaged 100,000 100,000 / 400,000 =$0.25 per cubic foot
1,000,000

Step 4: Allocate some manufacturing overhead for each
activity to the individual jobs that use the activities.
Activity-Based Costing Steps
24
Info for 1 Elliptical

Activity
Activity Cost
Allocation
Rate
Actual Use of
Activity
Allocation Base (collected
on job)
MOH Allocated
to One
object
Machine Setup
$10 per setup
×
2 setups
=
$20
Materials
Handling
$0.50 per part
×
20 parts
=
10
Fabricating
$24 per machine
hour
×
1 machine hour
=
24
Supervising
Assembly
$3 per DL hour
×
9 DL hours
=
27
Inspecting
$5 per inspection
×
3 inspections
=
15
Packaging
$0.25 per cubic
foot
×
52 cubic feet
=
13
Total
$109

Step 4: Allocate some manufacturing overhead for each
activity to the individual jobs that use the activities.
Activity-Based Costing Steps
25
Info for 1 Treadmill

Activity
Activity Cost
Allocation
Rate
Actual Use of
Activity
Allocation Base (collected
on job)
MOH Allocated
to One
object
Machine Setup
$10 per setup
×
4 setups
=
$40
Materials
Handling
$0.50 per part
×
26 parts
=
13
Fabricating
$24 per machine
hour
×
4 machine hour
=
96
Supervising
Assembly
$3 per DL hour
×
6 DL hours
=
18
Inspecting
$5 per inspection
×
6 inspections
=
30
Packaging
$0.25 per cubic
foot
×
60 cubic feet
=
15
Total
$212

Examples of Cost Drivers
Activities: Cost Drivers:
Material purchasing # of purchase orders
Material handling # of parts
Production scheduling # of batches
Quality inspections # of inspections
Photocopying # of pages copied
Warranty service # of service calls

Now turn to E4-36B ABC Example
27

E4-36B ABC Example
Step 1: Identify each activity and estimate the total indirect costs of each activity.
Material handling $6,400
Machine setup $9,000
Insertion of parts $54,400
Finishing $89,700
28

E4-36B Example (cont.)
Step 2: Select an allocation base for each activity and estimate the total that will be used during the year.
Activity Total Est.
Cost Est. Quant. of Cost Allocation Base
Mat. handling $6,400 ÷ 3,200 parts
Machine setups $9,000 ÷ 25 setups
Insertion of parts $54,400 ÷ 3,200 parts
Finishing $89,700 ÷ 2,300 hrs

E4-36B Example (cont.)
Step 3. Compute cost allocation rate for each. activity

Activity Total Est.
Cost Est. Quant. of Cost Allocation Base Allocation
Rate
Mat. handling $6,400 ÷ 3,200 parts
Machine setups 9,000 ÷ 25 setups
Insertion of parts 54,400 ÷ 3,200 parts
Finishing 89,700 ÷ 2,300 hrs

$ 2.00/part
$360.00/setup
$17.00/part
$39.00/hr

E4-36B Example (cont.)
Step 4. Allocate some manufacturing overhead from each activity
to the individual jobs that use the activities.
Job 420
Material handling 250 parts $ 2.00 $ 500
Machine setup 3 setups 360.00 1,080
Insertion of parts 250 parts 17.00 4,250
Finishing 130 finishing hours 39.00 5,070
Total $10,900

E4-36B Example (cont.)
Step 4. Allocate some manufacturing overhead from each activity
to the individual jobs that use the activities.
Job 420
Material handling 250 parts $ 2.00 $ 500
Machine setup 3 setups 360.00 1080
Insertion of parts 250 parts 17.00 4,250
Finishing 130 finishing hours 39.00 5,070
Total $10,900

32
Job 510
Material handling 425 parts $ 2.00 $850
Machine setup 6 setups 360.00 2,160
Insertion of parts 425 parts 17.00 7,225
Finishing 320 finishing hours 39.00 12,480
Total $22,715

Cost Hierarchy
33

Now turn to S4-9
34

S4-9 Classifying Costs Within the
Cost Hierarchy
Each container is cut from the mold once the plastic has cooled and hardened.
Patents are obtained for each new type of container mold.
Plastic resins are used as the main direct material for the containers.
A plant manager oversees the entire manufacturing operation.
The sales force incurs travel expenses to attend various trade shows throughout the country to market the containers.

35
Unit-level
Unit-level
Product-level
Facility-level
Facility-level

S4-9 (cont.)
Each container product line has a product line manager.
The extrusion machine is calibrated for each batch of containers made.
Each type of container has its own unique molds.
Routine maintenance is performed on the extrusion machines
Rent is paid for the building that houses the manufacturing processes.

36
Facility-level
Facility-level
Product-level
Product-level
Batch-level

Objective 3
Understand the benefits and limitations of ABC/ABM systems
37

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Activity-Based Management (ABM)
Using ABC information to make decisions
Pricing and product mix
Cost cutting
Planning and control
38

Pricing and Product Mix Decisions
Change the prices for products after identifying the different total cost
Decide to market the higher profitability product
Shift the product mix away from less-profitable products
39

Cutting Costs
Analyze costs in value chain
Value-added activities
Non–value-added activities
Value-added vs. non–value-added
40

Planning and Control Decisions
Uses the costs of activities to create budgets
Compare with actual activities to see if goals are being met

Using ABC Outside of Manufacturing
Merchandising and service: find the most profitable product or service
Manufacturers: allocate operating activities
42

Sustainability and Refined Costing Systems
Environmental overhead should be allocated to different activities that drive their costs.
Creates better transparency
43

Cost Benefit Test
Do the benefits of adopting ABC/ABM exceed the costs?
Benefits are higher for companies in competitive markets:
Accurate product cost information is essential
ABM can pinpoint cost savings opportunities
Benefits are higher when risk of cost distortion high:
Many different products, many different types/amounts of resources
High indirect costs
High- and low-volume products
44

Costs of Adopting ABC
Generally lower with
Accounting and information system expertise to develop the system
Information technology
Are companies glad they adopted ABC?
89% of the companies say that it was worth the cost
Not a cure-all, helps managers understand costs better

Signs the Old System May Be Distorting Costs
Cost system may need repair when
Managers don’t understand costs and profits
Bids are lost when expected to win
Win bids expected to lose
Competitors price similar products much higher or much lower
The cost system may be outdated if there is a diversified product line

Objective 4
Describe lean operations
47

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Traditional Production Systems
Keep large inventories on hand
Problems:
Storage cost
Hide quality
Bottlenecks and obsolete products
Solution: Lean Productions System
48

Lean Thinking
Philosophy and a business strategy
Primary goal: eliminate waste and cost
Focus of JIT
Purchase raw materials just in time for production
Finish goods just in time for delivery
49

Lean Production/Just-in-Time
Common characteristics of Just-in-Time (JIT)
Production occurs in self-contained cells
Broad employee roles
Small batches produced just in time –
“demand-pull system”
Shortened setup times
Shortened manufacturing cycle times
Emphasis on quality
Supply-chain management
50

Drawbacks to Lean Production Systems
Vulnerable when problems strike suppliers or distributors
Examples
Delays in delivery
Personnel problems – union strikes
Shortage of parts due to recalled products
Weather related issues
51

Sustainability and Lean Thinking
Both seek to reduce waste
Lean focus on internal
Green focus on external
Lean and Green
52

Objective 5
Describe and use the cost of quality framework
53

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Total Quality Management
Goal: Provide customers with superior products and services
Continuous improvement
More investment up front to generate savings in the back end of the value chain
54

Four Types of Quality Costs
Prevention costs – avoid poor quality goods or services
Employee training
Improved materials
Preventive maintenance
Appraisal costs – detect poor quality goods or services
Inspection throughout production
Inspection of final product
Product testing
55

Four Types of Quality Costs (cont.)
Internal failure costs – avoid poor quality goods or services before delivery to customers
Production loss caused by downtime
Rejected product units
External failure costs – incurred after defective product is delivered
Lost profits from lost customers
Warranty costs
Service costs at customer sites
Sales returns due to quality problems
56

Non-Manufacturing Costs of Quality
Service firms and merchandising companies also incur costs of quality
Prevention
Professional training to their staff
Develop standardized service checklists
Appraisal costs
Review work continuously
Inspect before releasing
57

Cost of Quality Report
Identifies, categorizes, and quantifies all of the costs it incurs relating to quality.
Calculate the percentage of total costs of quality that are incurred in each cost category
Use as a framework for decisions
58
Prevention Costs
Appraisal Costs

Internal Failure Costs
External Failure Costs

59
Exhibit 4-27

Now turn to E4-34A
60

E4-34A
Prevention costs
Training employees in TQM
Training suppliers in TQM
Identifying preferred suppliers who commit to
on-time delivery of perfect quality materials
61

E4-34A (cont.)
Appraisal costs
Strength testing one item from each batch
of panels
Avoid inspection of raw materials
Internal failure costs
Avoid rework and spoilage
62

E4-34 (cont.)
External failure costs
Avoid lost profits from lost sales due to disappointed customers
Avoid warranty costs
63

E4-34A (cont.)
Costs of Adopting New Quality Program:

Prevention costs:
Training employees in TQM $ 29,000
Training suppliers in TQM 33,000
Identifying preferred suppliers 59,000
Appraisal costs:
Strength testing 64,000
Savings on inspection of raw materials (51,000)

E4-34A (cont.)
Quality report (continued from prior slide):

Internal failure costs:
Savings on rework and spoilage (65,000)
External failure costs:
Savings on formerly lost profits (92,000)
Savings on warranty costs (16,000)
Net (Benefit) ($39,000)

End of Chapter 4
66

Process Costing

Chapter5

Objective 1
Distinguish between the flow of costs in process costing and job costing
2

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Process Costing Benefits
Benefits
Cost trends
Budget to actual
Pricing
Financial statements

Job and Process
Costing Differences?
Job Cost Systems
Individual job cost records
DM, DL, and MOH assigned to individual jobs
Cost of finished jobs flow into FG Inventory
Cost of sold jobs flow out of FG Inventory into COGS
4

Job Costing
5
Cost of
Goods
Sold
Direct labor
Direct materials
Finished
Goods
Manufacturing
overhead

Work in
Process
Job 100
Job 101
Job 102

Job Costing and
Process Costing Differences?
Process Cost Systems
Series of manufacturing processes
Cost per process is accumulated and moved from one process to another process
Costs transferred to FG Inventory only from the WIP Inventory of the LAST manufacturing process
When units are sold, cost is transferred out of FG Inventory into COGS
6

Process Costing
7
Cost of
Goods
Sold
Manufacturing Wages
Finished
Goods
Work in Process,
Centers Dept
Work in Process,
Shells Dept
Work in Process,
Packaging Dept

Manufacturing
Overhead

Materials Inventory

Building Blocks of Process Costing
Conversion costs
DL + MOH
Equivalent units
Inventory flow assumptions
Weighted average
FIFO (not covered in this textbook)
8

Objective 2
Compute equivalent units
9

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Building Blocks of Process Costing
Equivalent units
Amount of work done during a period in terms of fully complete units of output
10

The Building Blocks of Process Costing
Inventory flow assumptions
Weighted average
FIFO (not covered in the textbook)
Cost-benefit standpoint
11

Objective 3
Use process costing in the first production department
12

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How Does Process Costing Work
Using weighted average assumption
Five steps to process costing:
Summarize the flow of physical units.
Compute output in terms of equivalent units.
Summarize total costs to account for.
Compute the cost per equivalent unit.
Assign total costs to units completed and to units in ending WIP inventory.
13

Step 1: Summarize the Flow of Physical Units – Exhibit 5-5 on p. 264
Total physical units to account for?
How many individual (physical) units were worked on (completed or not)
Total physical units accounted for?
What happened to those products ? (Finished or still in process)
14

Now turn to S5-4
15

S5-4 Determine the Physical Flow of Units (Process Costing Step 1)
16
Flow of Production Step 1
Flow of Physical Units
Units to account for:
Beginning work in process 21,000
Started in production during June 1 120,000
Total physical units to account for Not given
Units accounted for:
Completed and transferred out during October Not given
Ending work in process, June 31 28,000
Total physical units accounted for Not given

S5-4 Determine the Physical Flow of Units (Process Costing Step 1)
17
Flow of Production Step 1
Flow of Physical Units
Units to account for:
Beginning work in process 21,000
Started in production during June 1 120,000
Total physical units to account for $141,000
Units accounted for:
Completed and transferred out during October Not given
Ending work in process, June 31 28,000
Total physical units accounted for Not given

S5-4 Determine the Physical Flow of Units (Process Costing Step 1)
18
Flow of Production Step 1
Flow of Physical Units
Units to account for:
Beginning work in process 21,000
Started in production during June 1 120,000
Total physical units to account for $141,000
Units accounted for:
Completed and transferred out during October Not given
Ending work in process, June 31 28,000
Total physical units accounted for $141,000

S5-4 Determine the Physical Flow of Units (Process Costing Step 1)
19
Flow of Production Step 1
Flow of Physical Units
Units to account for:
Beginning work in process 21,000
Started in production during June 1 120,000
Total physical units to account for 141,000
Units accounted for:
Completed and transferred out during October 113,000
Ending work in process, June 31 28,000
Total physical units accounted for 141,000

Step 2: Compute Output in Terms of Equivalent Units – Exhibit 5-5
20

S5-6
21

S5-6
22
Step 2
Equivalent Units
Direct
Materials Conversion
Cost
Units to account for:
Beginning work in process
Started in production
Total physical units to account for
Units accounted for:
Completed and transferred out 1,100,000
Ending work in process 85,000
Total physical units accounted for 1,185,000
Total equivalent units

S5-6 (cont.)
23
Step 2
Equivalent Units
Direct
Materials Conversion
Cost
Units to account for:
Beginning work in process
Started in production
Total physical units to account for
Units accounted for:
Completed and transferred out 1,100,000 1,100,000 1,100,000
Ending work in process 85,000 85,000 52,700
Total physical units accounted for 1,185,000
Total equivalent units 1,185,000 1,152,700

Step 3: Summarize Total Costs to Account For – Exhibit 5-7
24

Now turn to S5-7
25

S5-7
26
Direct Materials Conversion
Costs Total
Beginning work in process, May 1
Costs added during May:
Total costs to account for

S5-7
27
Direct Materials Conversion
Costs Total
Beginning work in process, May 1 $ 42,000 $ 21,000 $ 63,000
Costs added during May: $101,000 $172,000 $273,000
Total costs to account for $143,000 $193,000 $336,000

Step 4: Compute the Cost per Equivalent Unit – Exhibit 5-8
28

Step 5: Assign Total Costs to Units Completed and to Units in Ending Work in Process Inventory – Exhibit 5-9
29

Now turn to S5-10
30

S5-10
Determine the total cost that should be assigned to the following:
Units completed and transferred out
370,000 x (5.00 + 2.25) = $2,682,500
31

S5-10 (cont.)
32
Determine the total cost that should be assigned to the following:
Units completed and transferred out
370,000 x (5.00 + 2.25) = $2,682,500
Units ending work in process inventory
(74,000 x 5.00) + (48,000 X 2.25) = $478,000

S5-10 (cont.)
33
Determine the total cost that should be assigned to the following:
Units completed and transferred out
370,000 x (5.00 + 2.25) = $2,682,500
Units ending work in process inventory
(74,000 x 5.00) + (48,000 X 2.25) = $478,000
What was the total costs accounted for?
$2,682,500 + $478,000 = $3,160,500

S5-10 (cont.)
34
Determine the total cost that should be assigned to the following:
Units completed and transferred out
370,000 x (5.00 + 2.25) = $2,682,500
Units ending work in process inventory
(74,000 x 5.00) + (48,000 X 2.25) = $478,000
What was the total costs accounted for?
$2,682,500 + $478,000 = $3,160,500
What was Oscar’s average cost of making one unit of its product?
$5.00 + $2.25 = $7.25

Sustainability and Process Costing
Employs lean and green practices
Efficient and environmentally friendly?
Many parties benefit
35

S5-8
36

S5-8
37
Direct
Materials Conversion
Costs
Total costs to account for
Divided by total equivalent units
Cost per equivalent unit

$ 287,155
$ 468,547
52,210
45,490
$ 5.50
$ 10.30

Objective 4
Prepare journal entries for a process costing system
38

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Journal entries used in
a process costing system
Similar to job order system except:
The manufacturing costs (direct materials, direct labor, and manufacturing overhead) are assigned to processing departments, rather than jobs.
At the end of the month a journal entry must be made to transfer cost to the next processing department.
Example:
Direct materials were requisitioned for use by department 1.
Debit Credit
Oct. 31 Work-in-process – Department 1 140,000
Direct Materials 140,000
Materials requisitioned to department 1

Journal entries used
Labor time records show that $21,250 of direct labor was used in department 1 during October, resulting in this journal entry

Manufacturing overhead is allocated to the department using the company’s predetermined overhead rate. department’s overhead rate is $50 per machine hour and the department used 935 machine hours
Debit Credit
Oct. 31 Work-in-process – Department 1 46,750
Manufacturing Overhead 46,750

Debit Credit
Oct. 31 Work-in-process – Department 1 21,250
Wages Payable 21,250

T – Account
Work in Process Inventory—Department 1
Balance – Oct 1 $ 0
Direct Materials 140,000
Direct Labor. 21,250
Manufacturing
Overhead 46,750
$176,000
Debit Credit
Oct. 31 Work-in-process – Department 2 176,000
Work-in-process – Department 1 176,000

$32,000

Turn to E5-28A
42

E5-28A, Req. 1
Debit Credit
May 31 Work-in-process – Blending 5,980
Raw Materials Inventory 5,980
To record direct materials used by Blending

Debit Credit
May 31 Work-in-process – Blending 850
Wages Payable 850
To record direct labor used in Blending

Debit Credit
May 31 Work-in-process – Blending 1,733
Manufacturing Overhead 1,733
To record Mfg overhead allocated to Blending

Debit Credit
May 31 Work-in-process – Packaging 6,600*
Work-in-process – Blending 6,600*
To record transfer of cost out of Blending into Packaging

E5-28A, Req. 1 (cont.)
*Average cost per unit from Req. 4 of E5-27A is $1.00 per gallon; 6,600 gallons are being transferred

E5-28A, Req. 2
Work in Process Inventory— Blending
Balance – May 1 $ 0
Direct Materials 5,980
Direct Labor 850
Mfg Overhead 1,733
$6,600
$1,963

Objective 5
Use process costing in a second or later production department
46

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Process Costing in a Second or Later Processing Department
Same five-step process
Include cost of units transferred in when calculating equivalent units (EU) and cost
per EU
Transferred-in costs
47
$208,000
$176,000
$32,000

Step 1: Summarize Flow of Physical Units – Exhibit 5-12
48

Step 1 Step 2: Equivalent Units
Flow of Physical Units Transferred In Direct Materials Conversion
Cost

Step 2: Compute Output in Terms of Equivalent Units – Exhibit 5-12
49

See Exhibit 5-12 on page 276 for additional details

Steps 3 and 4: Summarize Total Costs to Account For and Compute the Cost per Equivalent Unit – Exhibit 5-13
50
Transferred In Direct Materials Conversion Costs Total
Beginning work in process, October 1 $ 22,000 $ 0 $ 1,100 $ 23,100
Costs added during October 176,000 19,000 12,935 207,935
Total costs to account for
Divide by total equivalent units
Cost per equivalent unit *

Steps 3 and 4: Summarize Total Costs to Account For and Compute the Cost per Equivalent Unit – Exhibit 5-13
51
Transferred In Direct Materials Conversion Costs Total
Beginning work in process, October 1 $ 22,000 $ 0.00 $ 1,100 $ 23,100
Costs added during October 176,000 19,000 12,935 207,935
Total costs to account for $ 198,000 $ 19,000 $ 14,035 $ 231,035
Divide by total equivalent units 45,000 38,000 40,100
Cost per equivalent unit $ 4.40 $ 0.50 $ 0.35

Step 5: Assign Total Costs to Units Completed and to Units in Ending Work in Process Inventory –
Exhibit 5-14
Transferred In Direct Materials Conversion Cost Total
Units completed and transferred out to Finished Goods Inventory (38,000) [ 38,000 x ( 4.40 + 0.50 + 0.35) = $199,500
Ending work in process, October 31(7,000)
Transferred-in costs [ 7,000 x 4.40] 30,800
Direct materials [ 0 x 0.50 ] 0
Conversion costs [ 2,100 x 0.35] 735
Total ending work in process, October 31 $ 31,535
Total costs accounted for $ 231,035

End of Chapter 5
53

Cost Behavior

Chapter 6

Objective 1
Describe key characteristics and graphs of various cost behaviors
2

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Cost Behavior
Cost behavior—how costs change as volume changes.
There are three common cost behaviors:
Variable costs
Fixed costs
Mixed costs
3

Key Characteristics of Variable Costs
Total variable costs change in direct proportion to changes in volume
Variable cost per unit remains constant
Slope
Total variable cost (y) =
Variable cost per unit of activity (v) x Volume of activity (x)
or
y=vx

Cost Graphs
Vertical (y-axis) always shows total costs
Horizontal axis (x-axis) shows volume of activity
5

Total
Costs
Total volume of activity
Note that the variable cost per customer remains constant in each of the graphs.

Total Variable Costs

Objective 2
Use cost equations to express and predict costs
7

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Cost Equation
Is a mathematical equation for a straight line, to predict total cost
Total cost = total variable cost + total fixed cost or Y = vx + f
Where
Y = total mixed cost
v = variable cost per unit of activity
x = volume of activity
f = fixed cost over a given period of time
8

Key Characteristics of Fixed Costs
Total fixed costs stay constant over relevant range*
Fixed costs per unit of activity vary inversely with changes in volume
Total fixed cost (y) = Fixed amount over a period of time (f)
y = f
*Relevant range is the normal operating range of activity
9

Total Fixed Costs

Costs and Decisions
Committed fixed costs
Discretionary fixed costs

Key Characteristics of Mixed Costs
Total mixed costs increase as volume increases
Total mixed costs can be expressed as a combination of the variable and fixed cost equations:
Total mixed cost = total variable cost + total fixed cost
or Y = vx + f
Where
Y = total mixed cost
v = variable cost per unit of activity
x = volume of activity
f = fixed cost over a given period of time
12

Mixed Costs
Variable
Fixed
13

Now turn to S6-1
14

S6-1 Identify Cost Behavior

Cost A
Cost B
Cost C

15
Variable Cost
Fixed Cost
Mixed Cost

Relevant Range
Band of volume where total fixed costs remain constant at a certain level
Variable costs per unit remain constant at a certain level
16

Other Cost Behaviors
Step Costs

Other Cost Behaviors
Curvilinear Costs

Now turn to E6-22A
19

E6-22A
Garments
4,500 6,000 7,500
Total Variable Costs $5,100
Total Fixed Costs
Total Operating Costs

Variable Cost/garment
Fixed Cost/garment $2.40
Average cost/garment

E6-22A (cont.)
Garments
4,500 6,000 7,500
Total Variable Costs $5,100
Total Fixed Costs
Total Operating Costs

Variable Cost/garment $0.85 $0.85 $0.85
Fixed Cost/garment $2.40
Average cost/garment

E6-22A (cont.)
Garments
4,500 6,000 7,500
Total Variable Costs $3,825 $5,100 $6,375
Total Fixed Costs
Total Operating Costs

Variable Cost/garment $0.85 $0.85 $0.85
Fixed Cost/garment $2.40
Average cost/garment

E6-22A (cont.)
Garments
4,500 6,000 7,500
Total Variable Costs $3,825 $5,100 $6,375
Total Fixed Costs $14,400 $14,400 $14,400
Total Operating Costs

Variable Cost/garment $0.85 $0.85 $0.85
Fixed Cost/garment $2.40
Average cost/garment

E6-22A (cont.)
Garments
4,500 6,000 7,500
Total Variable Costs $3,825 $5,100 $6,375
Total Fixed Costs $14,400 $14,400 $14,400
Total Operating Costs $18,225 $19,500 $20,775

Variable Cost/garment $0.85 $0.85 $0.85
Fixed Cost/garment $2.40
Average cost/garment

E6-22A (cont.)
Garments
4,500 6,000 7,500
Total Variable Costs $3,825 $5,100 $6,375
Total Fixed Costs $14,400 $14,400 $14,400
Total Operating Costs $18,225 $19,500 $20,775

Variable Cost/garment $0.85 $0.85 $0.85
Fixed Cost/garment $3.20 $2.40 $1.92
Average cost/garment

E6-22A (cont.)
Garments
4,500 6,000 7,500
Total Variable Costs $3,825 $5,100 $6,375
Total Fixed Costs $14,400 $14,400 $14,400
Total Operating Costs $18,225 $19,500 $20,775

Variable Cost/garment $0.85 $0.85 $0.85
Fixed Cost/garment $3.20 $2.40 $1.92
Average cost/garment $4.05 $3.25 $2.77

E6-22A (cont.)
27
The average cost per garment changes as volume changes, due to the fixed component of the dry cleaner’s costs. The fixed cost per unit decrease as volume increases, while the variable cost per unit remains constant.
Actual costs at 4,500 garments
$12,465 Total predicted costs ($2.77 × 4,500 garments)
(18,225) Actual costs at 4,500 garments
$5,760 Difference (underestimated)

Now turn to E6-25A
28

E6-25A
Data: Freedom Mailbox produces decorative mailboxes. The company’s average cost per unit is $24.43 when it produces 1,300 mailboxes.

29
1. 1,300 x $24.43 $31,759

2. Total costs $31,759
Less total fixed costs (21,359)
Total variable costs $10,400
÷ 1,300
Variable cost per mailbox $8.00

E6-25A
3. y = $8.00x + $21,359
4. $24.43 x 1,700 mailboxes = $41,531
5. y = ($8.00 x 1,700) + $21,359 = $34,959
30

E6-25A
6. Using average at 1,700 $41,531
Using cost equation $34,959
$6,572
31

Sustainability and Cost Behavior
32
Sustainable companies and changes in cost behavior
E-banking and e-billing drive down variable costs
Greener lifestlyes
Environmental Impact

Objective 3
Use account analysis and scatter plots to analyze cost behavior
33

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Cost Behavior Analysis
Four methods to analyze cost behavior
Account Analysis
Scatter Plots
High-Low Method
Regression Analysis
34

Account Analysis
Use of judgment to classify each general ledger account as variable, fixed, or mixed
Subjective
35

Scatter Plots
Use historical data to determine a cost’s behavior
Scatter plot is the graph of historical cost data on the y-axis and volume data on the x-axis
Helps managers visually determine how strong the relationship is between the cost and the volume of the chosen activity base
36

Scatter Plot Example
Miles Driven
Total Cost

Objective 4
Use the high-low method to analyze cost behavior
38

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High-Low Method
Step 1: Find variable cost per unit (slope) of cost line
Step 2: Find the fixed costs (vertical intercept)
Step 3: Create the cost equation
Advantage: Easy to use
Disadvantage: Only uses 2 data points
39

Turn to E6-28A
40

High-Low Method: E6-28A
Step 1: Find slope of the mixed cost line
(variable cost/unit) = Δ in cost (y) / Δ in volume (x)
The slope represents the variable cost per unit of activity
($5,730 -$5,040) ÷ (18,500-15,500)
$690 ÷ 3,000 = $0.23
41

High-Low Method: E6-28A (cont.)
Step 2: Find the vertical intercept
Fixed costs = Total mixed cost – Total variable cost
$5,730 – ($0.23 • 18,500) = $1,475
OR
$5,040 – ($0.23 • 15,500) = $1,475
42

High-Low Method: E6-28A (cont.)
Step 3: Create and use an equation to show the behavior of a mixed cost
Y = $0.23 per mile + $1,475
Predicted operating costs at 16,000 miles:
($0.23 x 16,000) + $1,475 = $5,155
43

Objective 5
Use regression analysis to analyze
cost behavior
44

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Regression Analysis – Exhibit 6-15
Statistical procedure to find the line that best fits data (cost equation)
Uses all data points
R-square, Intercept, X Variable 1
45

Regression Analysis – Exhibit 6-15
Intercept = Fixed cost
X Variable 1 = Variable cost per activity unit
R Square = goodness of fit
46

Regression Analysis – Exhibit 6-15
Utilities monthly cost equation =
y = $7.85x + $14,538
where y = total monthly utilities cost
x = number of guests
47

R-Square Value
“Goodness of fit”
How well does the line fit the data points?
Ranges from 0 to 1
48

Predicting Costs & Data Concerns
Data Concerns
Only valid within relevant range
Seasonal variations
Inflation
Outliers – abnormal data points

Objective 6
Describe variable costing and prepare a contribution margin income statement
50

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Absorption Costing
Required by GAAP for external reporting
Assign all manufacturing costs to products (DM, DL, Variable MOH, and Fixed MOH)
Traditional (conventional) income statement
51

Traditional (Conventional) Income Statement
Sales
– Cost of Goods Sold
Gross Margin
– Selling, general, and administrative costs
Operating Income
52

Variable Costing
Assigns only variable manufacturing costs to products (DM, DL, and Variable MOH)
Fixed manufacturing overhead = period cost
For internal management decisions
Contribution Margin income statement
53

Contribution Margin Income Statement
Sales
– Variable Costs
Contribution Margin
– Fixed Costs
Operating Income
54

Reconciling Operating Income Between the Two Costing Systems
55
Difference in Operating Income = (Change in inventory level, in units) x (Fixed MOH per unit)

Now turn to E6-44A
56

E6-44A
Conventional (Absorption Costing) Income Statement

E6-44A
Conventional (Absorption Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000

E6-44A
Conventional (Absorption Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000
Less: Cost of Goods Sold (205,000 x $26) ( 5,330,000)

Fixed mfg per unit = $2,475,000 fixed MOH / 225,000 units produced = $11 per unit
Variable MOH per unit $15 (given)
Total manufacturing cost per unit = $11 + $15 = $26

E6-44A
Conventional (Absorption Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000
Less: Cost of Goods Sold (205,000 x $26) ( 5,330,000)
Gross Profit 3,690,000

Fixed mfg per unit = $2,475,000 fixed MOH / 225,000 units produced = $11 per unit
Variable MOH per unit $15 (given)
Total manufacturing cost per unit = $11 + $15 = $26

E6-44A
Conventional (Absorption Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000
Less: Cost of Goods Sold (205,000 x $26) ( 5,330,000)
Gross Profit 3,690,000
Operating Expenses [(205,000 x $6) + $250,000] (1,480,000)

Fixed mfg per unit = $2,475,000 fixed MOH / 225,000 units produced = $11 per unit
Variable MOH per unit $15 (given)
Total manufacturing cost per unit = $11 + $15 = $26

E6-44A (cont.)
Now we turn to the Contribution Margin Income Statement (VARIABLE COSTING STMT)
First need to calculate:
Variable cost of goods sold
63

E6-44A (cont.)
Variable cost of goods sold:
Beginning finished goods inventory $ 0
Variable cost of goods manufactured ($15 x 225,000) 3,375,000
Variable cost of goods available
for sale 3,375,000
Ending fin. goods inv. ($15 x 20,000) (300,000)
Variable cost of goods sold* $3,075,000
64
*Also can calculate as 205,000 units x $15 = $3,075,000

E6-44A (cont.)
Contribution Margin (Variable Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000

E6-44A (cont.)
Contribution Margin (Variable Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000
Variable expenses:
Variable COGS (from prior calculation) $3,075,000*

E6-44A (cont.)
Contribution Margin (Variable Costing) Income Statement
Sales revenue (205,000  $44) $9,020,000
Variable expenses:
Variable COGS (from prior calculation) $3,075,000*
Sales comm expense ($6×205,000) 1,230,000 (4,305,000)
Contribution margin $4,715,000

E6-44A (cont.)
71
Req. 2
Difference between the two methods:
Change in inventory x Fixed MOH per unit =
(20,000 x $11*) = $220,000
*$11 is the fixed MOH per unit ($2,475,000 / 225,000)
Traditional method produces the higher operating income because of the fixed MOH still remaining in inventory.
Proof:
Traditional operating income $2,210,000
Contribution margin operating income 1,990,000
Difference $ 220,000

E6-44A (cont.)
Req. 3
Incremental analysis:
Increase in contribution margin $460,000
[($44-$21)*20,000 goggles]
Increase in fixed costs (145,000)
Increase in operating income $315,000
72

Now turn to S6-16
73

Patricia’s Quilt Shoppe
Traditional Income Statement
Month Ended February 28
Sales revenue (75 × $380) $28,500
Less: Cost of goods sold (75 × $230) (17,250)
Gross profit 11,250
Less: Operating expenses:
Sales commissions (10% × $28,500) (2,850)
Payroll costs (1,200)
Lease (800)
Operating income $ 6,400

S6-16
74

S6-16 (cont.)
75
Patricia’s Quilt Shoppe
Contribution Margin Income Statement
Month Ended February 28
Sales revenue (75 × $380) $28,500
Less: Variable costs:
Cost of goods sold (75 × $320) (17,250)
Sales commissions (10% × $28,500) (2,850)
Contribution margin 8,400
Less: Fixed costs:
Payroll costs (1,200)
Lease (800)
Operating income $ 6,400

Absorption Costing and
Manager Incentives
When inventories increase, absorption costing income is higher than variable costing income.
When inventories decrease, absorption costing income is lower than variable costing income.
Therefore…managers may increase production to build up inventory to maximize income and, therefore, their own bonus.
76

End of Chapter 6
77

Chart1

0
10000
20000
30000
40000

Total Sales Commissions
Total Sales
Total Sales Commissions
0
500
1000
1500
2000

Sheet1

$0 $10,000 $20,000 $30,000 $40,000
Total Sales Commissions $0 $500 $1,000 $1,500 $2,000

Chart1

0
10000
20000
30000
40000

Total Sales Salaries
Total Sales
Total Sales Salaries
2000
2000
2000
2000
2000

Sheet1

Total Sales $0 $10,000 $20,000 $30,000 $40,000
Total Sales Salaries $2,000 $2,000 $2,000 $2,000 $2,000

Chart1

0 0
10000 10000
20000 20000
30000 30000
40000 40000

Total Sales Salaries
Total Sales Compensation
Total Sales
Sales Compensation
2000
2000
2000
2500
2000
3000
2000
3500
2000
4000

Sheet1

Total Sales $0 $10,000 $20,000 $30,000 $40,000
Total Sales Salaries $2,000 $2,000 $2,000 $2,000 $2,000
Total Sales Compensation $2,000 $2,500 $3,000 $3,500 $4,000

Chart1

0 0
0 0
0 0
0 0
0 0

Total Costs
Number of Units
Total Costs

Sheet1

Number of Units
Total Costs

Chart1

0 0
0 0
0 0
0 0
0 0

Total Costs
Number of Units
Total Costs

Sheet1

Number of Units
Total Costs

Cost-Volume-Profit Analysis

Chapter 7

Objective 1
Calculate the unit contribution margin and the contribution margin ratio
2

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2
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Cost-Volume-Profit (CVP) Analysis
Is a powerful tool that helps managers make important business decisions
Is a relationship among costs, volume, and profit or loss
Determines how much the company must sell each month just to cover costs or to break even
Helps managers decide how sales volume would need to change to achieve the same profit level
3

Components of CVP Analysis
CVP analysis relies on the interdependency of five components, or pieces of information
Sales price per unit
Volume sold
Variable costs per unit
Fixed costs
Operating income
4

CVP Assumptions
No volume discounts
Costs are linear throughout relevant range
Revenues are linear in relevant range
Inventory levels will not change
Sales mix will not change
5

CVP Example Facts – Kay’s Posters
Kay has an e-tail poster business. She currently sells each poster for $35, while each poster has a variable cost of $21. Kay has fixed costs of $7,000. Kay is currently selling 550 posters.
6

Contribution Margin Income Statement
Kay’s e-tail poster example from prior slide
Sales revenue (550 posters)………………………………. $ 19,250
Less: Variable expenses …………………………………….. (11,550)
Contribution margin ……………………………………………. 7,700
Less: Fixed expenses………………………………………….. (7,000)
Operating income……………………………………………….$ 700

Unit Contribution Margin
8
Kay’s e-tail poster example from previous slides

Now assume sales are 650 units:
Sales price per unit $35
– Variable costs per unit (21)
Contribution margin per unit $14

Contribution margin (650 sales X $14) $9,100
– Fixed cost (7,000)
Operating Income $2,100

Contribution Margin Ratio
Contribution margin ratio= percentage of each sales dollar that is available for covering fixed expenses and generating a profit.

Numbers above are from the Kay’s e-tail poster example on previous slides.
9
Contribution
margin ratio Unit contribution margin
Sales price per unit = $14
$35 = 40%

Contribution
margin ratio Contribution margin
Sales revenue = $ 7,700
$19,250 = 40%

Now turn to S7-1
10

S7-1
What is the contribution margin per passenger?
Sales revenue (1 passenger)……………………….. $ 120
Less: Variable expenses ………………………………. (48)
Contribution margin ………………………………….. $ 72
11

S7-1 (cont.)
What is the contribution margin ratio?

c. Use the unit contribution margin to project operating income if monthly sales total 10,000 passengers.
10,000 x $72 = $720,000 – fixed costs of $270,000 = $450,000

d. Use the contribution margin ratio to project operating income if monthly sales revenue totals $650,000.
Contribution margin ( $650,000 sales X 60%) $ 390,000
Fixed cost (270,000)
Operating income $ 120,000

12
Contribution
margin ratio

= Unit contribution margin
Sales price per unit

= $72
$120 = 60%

Now turn to S7-2
13

S7-2
If Luxury Cruiseline sells an additional 300 tickets, by what amount will its operating income increase (or operating loss decrease)?
Contribution Margin per unit × additional tickets
300 tickets × $72 = $21,600
14

Objective 2
Use CVP analysis to find breakeven points and target profit volumes
15

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall.
15
Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall.

Breakeven Point
Breakeven point:
Sales level at which operating income is zero
If sales above breakeven, then profit
If sales below breakeven, then loss
Fixed expenses = total contribution margin
Total sales = total expenses
16

Using Unit Contribution Margin to Calculate Breakeven Point in Units
17

Fixed expenses + Operating income
Contribution margin per unit
Units sold =
$7,000 + $0
$14
Units sold =
= 500 posters

Using Contribution Margin Ratio to Calculate Breakeven Point in Sales Dollars
18
Fixed expenses + Operating income
Contribution margin ratio
Sales in $ =
$7,000 + $0
0.40
Sales in $ =
= $17,500

Finding Volume Needed for Target Profit Using Unit CM
19
Fixed expenses + Operating income
Contribution margin per unit
Units to be sold =
= 850 posters
$7,000 + $4,900
$14
Units to be sold = =
$11,900
$14
= 850 posters × $35 = $29,750 (Sales $ needed to achieve target profit)

Finding the Volume Needed for a Target Profit Using CM Ratio
CVP analysis helps managers determine what they need to sell to earn a target amount of profit
20
Fixed exp + Target operating income
Contribution margin ratio
Sales $ needed =
= $29,750
$7,000 + $4,900
0.40
Sales $ needed =
$11,900
0.40
=

Now turn to S7-3
21

S7-3
Breakeven number of passengers:
22
Fixed expenses + Operating income
Contribution margin per unit
Units to be sold =
$270,000 + $0
$72
Units to be sold =
= 3,750 passengers
$270,000
$72
Units to be sold =

S7-3 (cont.)
23
Fixed expenses + Operating income
Contribution margin ratio*
Sales in $ =
$270,000 + 0
0.60
Sales in $ =
= $450,000
Sales revenue needed to break even:
3,750 units to breakeven × $120 sales price = $450,000
Alternatively:
*CM ratio = $72/ $120 = .60

Graphing the CVP Relationships
Step 1:
Choose a sales volume (Units x $Price)
Plot point for total sales revenue
Draw sales revenue line from origin through the plotted point
24

Preparing a CVP Chart

Preparing a CVP Chart
Step 2:
Draw the fixed cost line
26

$4,000

Preparing a CVP Chart
Step 3:
Draw the total cost line (fixed plus variable)

Preparing a CVP Chart
Step 4:
Identify the breakeven point and the areas of operating income and loss

Breakevenpoint
28

Preparing a CVP Chart
Step 5:
Mark operating income and operating loss areas on graph
Operating Loss
Operating Income

Breakeven point
Operating Income
Operating Loss
29

Objective 3
Perform sensitivity analysis in response to changing business conditions
30

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall.
30
Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall.

Sensitivity Analysis
Managers need to be prepared for increasing costs, pricing pressure from competitors, and other changing business conditions.
Sensitivity analysis
Conducts “What if” analysis
What if the sales price changes?
What if costs change?
What if the sales mix changes?
31

What if the sales price changes?
Contribution margin will change
Breakeven point will change
32

What if variable costs change?
Contribution margin changes
Breakeven point changes
33

What if fixed costs change?
Will not affect contribution margin
Will change breakeven point
34

Sustainability and CVP
Reducing costs and helping the environment
For example, decreasing use of plastic in bottles reduces Variable Costs
Decreasing Variable Costs makes it easier to reach a target profit

Objective 4
Find breakeven and target profit volumes for multiproduct companies
36

Breakeven in Sales Revenue – Multiproduct Firm Example, Exhibit 7-8
37

Breakeven in Sales Revenue – Multiproduct Firm Example (cont.)
38
Fixed expenses + Operating income
Weighted-avg contribution margin per unit
Units sold =
= 350 posters
Units sold = =
$7,000
$20
$7,000 + 0
$20

Breakeven in Sales Revenue – Multiproduct Firm Example (cont.)
39
Breakeven sales of regular posters (350 x 5/8) 218.75 regular posters
Breakeven sales of large posters (350 x 3/8) 131.25 large posters
Since partial posters cannot be sold, the number of each to be sold is rounded UP (to avoid a loss)

Now turn to S7-9
40

S7-9
Assuming that Luxury Cruiseline expects to sell four regular cruises for every executive cruise, compute the weighted-average contribution margin per unit.
41
Sales Mix Calculation Regular Executive Total
Sales price per unit …………………… $ 120 $240
Less: Variable cost per unit ……….. (48) (180)
Contribution margin per unit …….. $ 72 $ 60
Sales mix ………………………………… x 4 x 1 5
Contribution margin ………………… $288 $ 60 $348
Weighted-average contribution
margin per unit ($348/5) ……….. $ 69.60

Now turn to S7-10
42

S7-10
43
Fixed expenses + Operating income
Weighted Average Contribution margin per unit
Sales in units =
$270,000 + 0
$69.60*
Sales in units =
= 3,880 tickets
*from S7-9 on prior slide
Breakeven sales of regular cruises (3,880 × 4/5)……… 3,104
Breakeven sales of executive cruises (3,880 × 1/5)…… 776
Total cruise passengers………………………….……….. 3,880

Now turn to E7-28A
44

45
E7-28A
Step 1: Calculate weighted-average contribution margin

Twig Oak
Sale price per unit $18 $38
Variable costs per unit 3 8
Contribution margin per unit $15 $30
Sales mix in units x4 x1
Contribution margin $60 $30
Weighted average contribution $90
Margin per unit ($90 /5) $18

E7-28A (cont.)
Step 2: Calculate the breakeven point in units
Fixed costs + Operating income
Weighted average contribution margin per unit
($360 + $0) ÷ $18 = 20 composite units
46

E7-28A (cont.)
Step 3: Calculate the breakeven point in units for each product line
Twig Stands: 20 units x 4/5 = 16 units
Oak Stands: 20 units x 1/5 = 4 units
47

Objective 5
Determine a firm’s margin of safety and operating leverage
48

Common Indicators of Risk
Margin of Safety
The excess of expected sales over breakeven sales
Operating Leverage
The relative amount of fixed and variable costs that make up a company’s total costs
49

Margin of Safety
Excess of expected sales over breakeven sales
Drop in sales that the company can absorb before incurring a loss
Used to evaluate the risk of current operations as well as the risk of new plans
50

Margin of Safety — Units and Sales Dollars — Example
Margin of safety in units = Expected sales
in units _ Breakeven sales in units
= 950 units _ 500 units
= 450 units

Margin of safety in dollars = Expected sales _ Breakeven sales
= $33,250 _ $17,500
= $15,750

Margin of Safety – Percentage — Example
52
Margin of safety
as a percentage
Margin of safety in units
Expected sales in units
=
450 Units
950 Units
=
47.4% (rounded)
=
Margin of safety
as a percentage
Margin of safety in dollars
Expected sales in dollars
=
=
$15,750
$33,250
47.4% (rounded)
=

Now turn to S7-13
53

S7-13 (cont.)
Margin of safety in units = Expected sales
in units _ Breakeven sales in units
= 1,000 units _ 600 units
= 400 units

Margin of safety in dollars = Expected sales _ Breakeven sales
= $31,000 _ $18,600
= $12,400

54
a.
b.

S7-13 (cont.)
55
Margin of safety
as a percentage
Margin of safety in dollars
Expected sales in dollars
=
=
$12,400
$31,000
40%
=
c.

Operating Leverage Factor
How responsive a company’s operating income is to changes in volume
Lowest possible value for this factor is 1, if the company has no fixed costs
56
Operating leverage factor
=
Contribution margin
Operating income
Operating leverage factor
=
$13,300
$13,300
=
1.00

Operating Leverage Factor –
Change in Fixed Costs
How responsive a company’s operating income is to changes in volume
Lowest possible value for this factor is 1, if the company has no fixed costs
57
Operating leverage factor
=
Contribution margin
Operating income
Operating leverage factor
=
$13,300
$6,300
=
2.11 (rounded)

High Operating Leverage
High operating leverage companies have:
Higher levels of fixed costs and lower levels of variable costs
Higher contribution margin ratios
Higher risk
Higher potential for reward
58

Low Operating Leverage
Low operating leverage companies have:
Higher levels of variable costs and lower levels of fixed costs
Lower contribution margin ratios
For low operating leverage companies, changes in volume do NOT have as significant an effect on operating income, so they face:
Lower risk
Lower potential for reward
Examples include merchandising companies.
59

Now turn to S7-14
60

S7-14 (cont.)
61
Contribution margin (1,000 × $10 / poster)……. $10,000
Less: Fixed expenses…………………………. (6,000)
Operating income……………………………….. $ 4,000

Operating Leverage Factor = Contribution margin
Operating income

= $10,000
$ 4,000

= 2.5

If volume increases 10%, operating income will increase 25% (operating leverage factor of 2.5 multiplied by 10.)

S7-14 (cont.)
62
Original volume (posters)………………………….. 1,000
Add: Increase in volume (10% × 1,000)……… + 100
New volume (posters)………………………………. 1,100
Multiplied by: Unit contribution margin…………. × $10
New total contribution margin…………………….. $ 11,000
Less: Fixed expenses……………………………… (6,000)
New operating income……………………………… $ 5,000
vs. Operating income before change in
volume (from above)………………………….. 4,000
Increase in operating income……………………… $ 1,000

Percentage change ($600 / $2,400)…………….. 25%

Proof:

End of Chapter 7
63

$0
$5,000
$10,000
$15,000
$20,000
05001,0001,500
Volume of Units
Dollars
Revenues
Chart1

0 4000
5000 4000
10000 4000
15000 4000

Revenues
Fixed Cost
Volume of Units
Dollars

Sheet1

Volume in units 0 500 1,000 1,500
Revenues $0 5,000 10,000 15,000
Fixed Cost 4,000 4,000 4,000 4,000

$0
$5,000
$10,000
$15,000
$20,000
05001,0001,500
Volume of Units
Dollars
Revenues
Fixed costs
Total cost
$0
$5,000
$10,000
$15,000
$20,000
05001,0001,500
Volume of Units
Dollars
$0
$5,000
$10,000
$15,000
$20,000
05001,0001,500
Volume of Units
Dollars

Relevant Costs for Short-Term Decisions

Chapter 8

Objective 1
Describe and identify information relevant to short-term
business decisions
2

How Managers Make Decisions
Define business goals
Identify alternative courses of action
Gather and analyze relevant information
Choose best alternative
Implement decision
Follow-up: Compare actual with anticipated results
3

Relevant and Irrelevant Information
Relevant
Expected future (cost and revenue) data
Differs among alternative courses of action
Is both quantitative and qualitative
Irrelevant
Costs that do not differ between alternatives
Sunk costs – incurred in past and cannot be changed
4

Relevant Nonfinancial Information
Nonfinancial, or qualitative factors, also play a role in managers’ decisions.
laying off employees
outsourcing, reduced control over delivery time and product quality
discounted prices to select customers
Managers who ignore qualitative factors can make serious mistakes.

Six Short-Term Special Decisions
Special sales orders
Pricing
Discontinuing products, departments, and stores
Product mix
Outsourcing (make or buy)
Selling as is or processing further
6

Keys to Making Short-Term
Special Decisions
Decisions approach
Relevant information approach or incremental analysis approach
Two keys in analyzing short-term special business decisions
Focus on relevant revenues, costs, and profits
Use contribution margin approach that separates variable costs from fixed costs
7

Sustainability and Short-term Business Decisions
View every decision as having an impact on
People
Planet
Profitability
Timberland, “doing well and doing good”
Example: Employees given PTO to volunteer
Costly
8

Objective 2
Decide whether to accept a
special order
9

A customer requests a one-time order at a reduced sale price, often for a large quantity:
Special Order Considerations
10

DECISION RULE:
Do we have excess capacity available to fill this order?

Yes

Consider further

Reject the special order

Special Sales Order
11

DECISION RULE:
Is the special reduced sales price high enough to cover the incremental costs of filling the order?

If revenues are greater than expected cost increase

Accept the special order

If revenues are less than expected cost increase

Reject the special order

Special Sales Order
12

DECISION RULE:
Will the special order affect regular sales
in the long run?

If no to these questions

Accept the special order

If yes to these questions

Reject the special order

Incremental Analysis of Special
Sales Order, Exhibit 8-6

Expected increase in revenues—sale of 20,000 oil filters x $1.75 each $ 35,000
Expected increase in expenses—variable manufacturing costs:
20,000 oil filters $1.20 each (24,000)
Expected increase in operating income $ 11,000

Now turn to E8-16A
14

E8-16A
Prepare an incremental analysis to determine whether Collectible Cards should accept the special sales order assuming fixed costs would not be affected by the special order.

Would accept the special order because the cost per part to make it is only $0.30 per part versus the $0.40 per part selling price being offered by the buyer.

Variable costs:
Direct Materials
Direct Labor
Variable Overhead $0.13
0.06
0.11
Total Cost $0.30

E8-16A (cont.)
Now assume that the Hall of Fame wants special hologram baseball cards. Collectible Cards must spend $5,000 to develop this hologram, which will be useless after the special order is completed. Should Collectible Cards accept the special order under these circumstances? Show your analysis.

Expected increase in revenues—sale of 57,000 cards x $0.40 each $ 22,800
Expected increase in expenses—variable manufacturing costs:
57,000 cards x $0.30 each
Special hologram cost (17,100) (5,000)

Expected increase in operating income $ 700

Objective 3
Describe and apply different approaches to pricing
17

Regular Pricing Considerations
What is our target profit?
How much will customers pay?
Are we a price-taker or a price-setter for this product?
18

Price-Taker vs Price-Setter
Price-Takers Price-Setters
Product lacks uniqueness Product is more unique
Heavy competition Less competition
Pricing approach emphasizes target costing Pricing approach emphasizes cost-plus pricing

Target Costing – Exhibit 8-9
Market price minus desired profit = target cost
Target Cost includes:
Development cost – Marketing cost
Design cost – Delivery cost
Production cost – Service cost
20
Calculations Total
Revenue at market price 250,000 units x $3.00 price = $ 750,000
Less: Desired profit 10% x $1,000,000 of assets (100,000)
Target total cost $650,000

Two potential outcomes when using target costing
Actual cost less than target total cost
Actual cost greater than target total cost

Other Strategies
Increase sales
Use CVP analysis to compute target sales to achieve its target profit.
Change or add to its product mix
Offer levels of the same product
Offer new items to the product mix with high CM
Remove items with the lowest CM
Differentiate its products – (make it unique)
Branding
Quality
Service packs
22

Cost-Plus Pricing
The opposite of the target-pricing approach
Starts with the company’s full costs
Adds the desired profit to determine a
cost-plus price

Total cost
Plus: Desired profit
Cost –plus price

Calculating Cost-Plus Price,
Exhibit 8-12

If the current price is $3.00, can the company charge $3.20?
Total
Current variable costs 250,000 units x $1.50 per unit = $ 375,000
Plus: Current fixed costs + 325,000
Current total costs $700,000
Plus: Desired profit 10% x $1,000,000 of assets + 100,000
Target revenue $800,000
Divided by number of units ÷ 250,000
Cost-plus price per unit $ 3.20

Pricing Decisions
25

DECISION RULE:
How to Approach Pricing?

If company is a price-taker for the product:

Emphasize target costing approach

If the company is a price-setter for the product:

Emphasize cost-plus pricing approach

Now turn to E8-19A
26

E8-19A
Which approach to pricing should Smith Builders emphasize? Why?
Target costing – Firm is a price taker, product lacks uniqueness and there is heavy competition
27

E8-19A (cont.)
Will Smith Builders be able to achieve its target profit levels? Show your computations.

The answer is no, the target cost is less than variable cost.

Calculations Total
Revenue at market price $ 206,000
Less: Desired Profit 14% of the variable cost
$190,000 (26,600)
Target cost $ 179,400

E8-19A (cont.)
If Smith Builders upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner? Show your analysis.

Yes, they should customize – they will achieve their target profit levels with the cost-plus price.

Total
Current total costs ($190,000 + $18,000) $208,000
Plus: Desired profit (14% x variable cost of $208,000) + 29,120
Cost-plus price $237,120

Objective 4
Decide whether to discontinue a product, department, or store
30

Other Short-term Business Decisions Managers Face
When to discontinue a product, department, or store
How to factor constrained resources into product mix decisions
When to make a product or outsource it
When to sell as is or process further
31

Considerations for Discontinuing Products,
Departments or Stores, Exhibit 8-14
Does product provide positive contribution margin?
32

Considerations for Discontinuing Products,
Departments or Stores
Will the total fixed costs continue to exist even if the product line is discontinued?
Can any direct fixed costs of the product be avoided if the product line is discontinued?
Can any direct fixed costs of the product be avoided if the product line is discontinued?
Use incremental analysis for discontinuing a product
33

Discontinuing Products,
Departments or Stores
34

DECISION RULE:
Discontinue a product, department, or store?

If lost revenues from discontinuing a product, department, or store exceed the cost savings from discontinuing:

Do not discontinue

If total cost savings exceed the lost revenues from discontinuing a product, department, or store:

Discontinue

Now turn to E8-20A
35

E8-20A
Prepare an incremental analysis to show whether Entertainment Plus should discontinue the DVD product line. Will discontinuing DVDs add $18,000 to operating income? Explain.

Expected decrease in revenues:
Sale of DVDs $136,000
Expected decrease in expenses:
Variable manufacturing expenses 86,000
Expected decrease in operating income $50,000

E8-20A (cont.)
Assume that Entertainment Plus can avoid $20,000 of fixed expenses by discontinuing the DVD product line (these costs are direct fixed costs of the DVD product line). Prepare an incremental analysis to show whether Entertainment Plus should stop selling DVDs.
37

Expected decrease in revenues:
Sale of DVDs $136,000
Expected decrease in expenses:
Variable manufacturing expenses $86,000
Direct fixed expenses $20,000
Expected decrease in total expenses 106,000
Expected decrease in operating income $30,000

E8-20A (cont.)
Now, assume that all $68,000 of fixed costs assigned to DVDs are direct fixed costs and can be avoided if the company stops selling DVDs. However, marketing has concluded that Blu-ray disc sales would be adversely affected by discontinuing the DVD line . Blu-ray disc production and sales would decline 10%. What should the company do?
38
Expected decrease in revenues:
Sale of DVDs $136,000
Sale of Blu-rays 14,300 $150,300
Expected decrease in expenses:
Variable manufacturing expenses $86,000
Direct fixed expenses $68,000
Expected decrease in total expenses 154,000
Expected increase in operating income $3,700

Objective 5
Factor resource constraints into product mix decisions
39

Product Mix Considerations – Example from pages 477 – 479
Data Per Unit
Shirts Jeans
Sale price
Less: Variable expenses
Contribution margin
Contribution margin ratio:
Product A —
Product B —

40
$30
$60
(12)
(48)
$18
$12
60%
20%
$18 ÷ $30
$12 ÷ $60

Product Mix Considerations –
Exhibit 8-18
Shirts Jeans
(1) Units that can be produced each machine hour 10 20
(2) Contribution margin per unit x $18 x $12
Contribution margin per machine hour
(1) x (2) $ 180 $ 240
Available capacity—number of machine hours x 2,000 x 2,000
Total contribution margin at full capacity $360,000 $480,000

Product Mix
42

DECISION RULE:
Which product to emphasize?

Emphasize the product with the highest contribution margin per unit of constraint

Product Mix When Demand Is Limited or Fixed Costs Change
What if demand is limited, due to competition or other factors? [In this example, company has demand for only 30,000 jeans, which consume in total 1,500 hours (30,000 jeans/20 jeans per hour)]

What if fixed costs are different when a different product mix is emphasized?

Example Shirts Jeans
Contribution margin per machine hour $ 180 $ 240
Machine hours devoted to product x 500 x 1,500
Total contribution margin at full capacity $90,000 $360,000

Now turn to E8-22A
44

E8-22A
What product mix will maximize operating income?
Get Fit
Product Mix Analysis
Deluxe Regular
Sale price per unit
Variable costs per unit
Contribution margin per unit
Units produced with equivalent
number of machine hours
Contribution margin for equivalent
number of machine hours

E8-22A
What product mix will maximize operating income?
Get Fit
Product Mix Analysis
Deluxe Regular
Sale price per unit $1,010 $560
Variable costs per unit 781a 427b
Contribution margin per unit 229 133
Units produced with equivalent
number of machine hours × 1 × 3
Contribution margin for equivalent
number of machine hours $ 229 $399

a ($310 + $ 88 + $264 + $119)
b ($90 + $184 + $ 88 + $ 65)
Get Fit should produce only the Regular model.
46

Objective 6
Analyze outsourcing (make-or-buy) decisions
47

Outsourcing (Make or Buy) Considerations
To buy a product or service or produce
it in-house
The heart of the decisions : how best to use available resources
How do our variable costs compare to the outsourcing cost?
Are any fixed costs avoidable if we outsource?
What could we do with the freed capacity?
48

Outsourcing
49

DECISION RULE:
Should the company outsource?

If the incremental costs of making exceed the incremental costs of outsourcing:

Outsource

If the incremental costs of making are less than the incremental costs of outsourcing:

Do not outsource

Now turn to E8-25A
50

E8-25A
Given the same cost structure, should OptiSystems make or buy the switch?
OptiSystems
Incremental Analysis for Outsourcing Decision
Make Unit Buy Unit Cost to Make Minus Cost to Buy
Variable cost per unit:
Direct materials
Direct labor
Variable overhead
Purchase price from outsider
Variable cost per unit

E8-25A
Given the same cost structure, should OptiSystems make or buy the switch?
OptiSystems
Incremental Analysis for Outsourcing Decision
Make Unit Buy Unit Cost to Make Minus Cost to Buy
Variable cost per unit:
Direct materials $ 10.00a $ — $ 10.00
Direct labor 2.50b — 2.50
Variable overhead 3.00c — 3.00
Purchase price from outsider — 17.00 (17.00)
Variable cost per unit $15.50 $17.00 $ (1.50)

a $720,000 / 72,000 = $10.00/unit
b $180,000 / 72,000 = $2.50/unit
c $216,000 / 72,000 = $3.00/unit
52

E8-25A (cont.)
Now, assume that OptiSystems can avoid $100,000 of fixed costs a year by outsourcing production. In addition, because sales are increasing, OptiSystems needs 77,000 switches a year rather than 72,000. What should OptiSystems do now?
Make switches Buy switches
Variable cost per unit (from part 1)
× Units needed
Total variable costs
Fixed costs
Total relevant costs

E8-25A (cont.)
Now, assume that OptiSystems can avoid $100,000 of fixed costs a year by outsourcing production. In addition, because sales are increasing, OptiSystems needs 77,000 switches a year rather than 72,000. What should OptiSystems do now?
Make switches Buy switches
Variable cost per unit (from part 1) $ 15.50 $ 17.00
× Units needed 77,000 77,000
Total variable costs $ 1,193,500 1,309,000
Fixed costs 468,000 368,000*
Total relevant costs $1,661,500 $1,677,000

*($468,000 − $100,000 avoidable)
54

E8-25A (cont.)
Given the last scenario, what is the most OptiSystems would be willing to pay to outsource the switches?

Cost if making switches = Cost of outsourcing switches

* Where x = outsourcing cost per switch
55
($15.50 × 77,000) + $468,000 = (x)* (77,000) + $368,000

Variable costs + fixed costs = Variable costs + fixed costs

$1,193,500 + $468,000 = 77,000x + $368,000

$1,293,500 = 77,000x

$16.80(rounded) = x

Objective 7
Make sell as-is or process further decisions
56

Sell As-Is or Process Further Considerations
How much revenue is generated if we sell the product as is?
How much revenue is generated if we sell the product after processing it further?
How much will it cost to process the product further?
57

Analysis for Sell As Is or Process Further Decision – Exhibit 8-25
Sell As-Is Process
Further Additional Revenue/(Costs) from Processing Further
Expected revenue from selling 50,000 quarts of regular olive oil
at $5.00 per quart $250,000
Expected revenue from selling 50,000 quarts of gourmet dipping oil at $7.00 per quart $350,000
$100,000

Additional costs of $0.75 per quart to convert 50,000 quarts of plain olive oil into gourmet dipping oil (37,500) (37,500)
Total net benefit $250,000 $312,500 $62,500

Sell As-Is or Process Further
59

DECISION RULE:
Sell as-is or process further?

If extra revenue (from processing further) exceeds extra cost of processing further:

Process further

If extra revenue (from processing further) is less than extra cost of processing further:

Sell as is

Now turn to E8-28A
60

E8-28A
Sell as is (gallons) Process further
Sales revenue per unit $ 6.00 $ 0.50
Additional process costs per unit – packaging (0.10) (0.05)
Additional process costs per unit – fruit (0.00) (0.15)
Net benefit per unit $ 5.90 $ 0.30
Number of units produced per batch × 600 × 12,800
Net benefit per batch $3,540 $ 3,840

End of Chapter 8
62

Performance Evaluation

Chapter

Objective 1
Understand decentralization and describe the different types of responsibility centers
2

Decentralization
Splitting operations into different operating segments
Advantages
Frees top management’s time
Use of expert knowledge
Improves customer relations
Provides training
Improves motivation and retention
Disadvantages
Duplication of costs
Potential problems achieving goal congruence
3

Performance Evaluation Systems
Provide upper management with feedback
To be effective, should
Clearly communicate expectations
Provide benchmarks that promote goal congruence
and coordination between segments
Motivate segment managers
4

Responsibility Accounting
Responsibility Center – part of an organization whose manger is accountable for planning and controlling activities
Responsibility Accounting – system for evaluating performance of each responsibility center and its manger.
5

Types of Responsibility Centers
Cost Center
Revenue Center
Profit Center
Investment Center
6

Objective 2
Develop performance reports for different responsibility centers
7

Responsibility Center Performance Reports
Performance Report – compares actual revenues and expenses to budgeted figures
Variance – difference between actual and budget
Favorable variance: causes operating income to be higher than budgeted
Unfavorable variance: causes operating income to be lower than budgeted
Management by exception
8

Exhibit 10-3: Partial Performance Report for Revenue Center
9

Segment Margin
The operating income generated by a profit or investment center before subtracting common fixed costs that have been allocated to the center
10

Exhibit 10-4: Performance Report Highlighting Segment Margin
11

Organization-Wide Performance Reports
Performance reports for each level of management flow up
Controllable vs. uncontrollable variances
12

Objective 3
Calculate ROI, Sales Margin, and Capital Turnover
13

Evaluation of Investment Centers
Duties of Investment center manager similar to CEO
To assess performance
Return on Investment (ROI)
Residual Income (RI)
14

Return on Investment (ROI)
Measures the amount of income an investment center earns relative to the size of its assets
ROI = Operating Income
Total Assets
15

Sales Margin and Capital Turnover
ROI = Operating Income x Sales___
Sales Total Assets

(ROI = Sales Margin x Capital Turnover)

S10-6
17

S10-6
18
Functional Ingredients
Sales margin $5,445 / $21,780 = 25.0%
Capital turnover $21,780 / $12,100 = 1.8
ROI 25.0% x 1.8 = 45.0%
Consumer Markets
Sales margin $2,075 / $20,750 = 10.0%
Capital turnover $20,750 / $8,300 = 2.5
ROI 10.0% x 2.5 = 25.0%
Performance Markets
Sales margin $3,000 / $15,000 = 20.0%
Capital turnover $15,000 / $10,000 = 1.5
ROI 20.0% x 1.5 = 30.0%

Residual Income
Determines whether the division has created any excess (residual) income above management’s expectations
Incorporates Target Rate of Return
RI = Operating Income – Minimal acceptable income
RI = Operating Income – (Target rate of return x Total assets)

S10-9
20

S10-9
21
Snow Sports RI = $1,040,000 − ($4,000,000 × 16%) = $400,000

Non-Snow Sports RI = $1,680,000 − ($6,000,000 × 16%) = $720,000

Goal Congruence
Residual Income enhances goal congruence, whereas ROI may or may not
22

Measurement Issues
Which balance sheet data should we use?
Should we include all assets?
Should we use gross book value or net book value of the assets?
Should we make other adjustments to income or assets?
23

Limitations of Financial Performance Evaluation
Short-term focus
Potential Remedy: management can measure financial performance using a longer time horizon
Incentivizes segment managers to think long term rather than short term
24

Transfer Pricing
The price charged for the internal sale between two different divisions of the same company
Encourage transfer only if the company would benefit by the exchange
Vertical Integration
25

Exhibit 10-9: Strategies to Determine Transfer Price
Advantages Disadvantages Considerations
Market Price Usually viewed as fair by both parties. Can only be used if an outside market exists. The market price could be reduced by any cost savings occurring from the internal sale..
Negotiated Allows division managers to act autonomously rather than being dictated a transfer price by top management. Takes time and effort. May lead to friction (or better understanding) between division managers. Negotiated transfer price will generally fall in the range between variable cost (low end) and market price( high end).
Cost or Cost-plus a markup Useful if a market price is not available. Selling division has no incentive to control costs. A “fair” markup may be difficult to determine. Several definition of cost could be used, ranging from variable cost to full absorption cost.

Global Considerations
Do the divisions operate under different taxing authorities such that income tax rates are higher for one division?
Would the amount paid to customs and duties be impacted by the transfer price used?
27

Objective 4
Prepare and evaluate Flexible Budget Performance Reports
28

Flexible Budget
A budget prepared for a different level of volume than that which was originally anticipated
Master Budget Variance – Difference between the actual revenues and expenses and the master budget
“Apples-to-oranges” comparison

Exhibit 10-11 Creating a Flexible Budget Performance Report
30

Volume Variance
The difference between the master budget and the flexible budget
Arises only because the actual volume differs from the volume originally anticipated in the master budget
31

Exhibit 10-12 Volume Variances
32

Flexible Budget Variance
The difference between the flexible budget and the actual results
33

Exhibit 10-13 Flexible Budget and Volume Variances
34

Underlying Causes of the Variances
Management by exception
Use performance reports to see how operational decisions affected company’s finances
35

Master Budget Variance: A Combination of Variances
36

Flexible Budget Variance
Volume Variance
Master Budget Variance

Objective 5
Describe the balanced scorecard and identify KPIs for each perspective
37

Nonfinancial Performance Measurement
Lag indicators – reveal the results of past actions and decisions
Lead indicators – predict future performance
38

The Balanced Scorecard
Management must consider both financial and operational performance measures
Major shift: financial indicators are no longer the sole measure of performance

Four Perspectives of the Balanced Scorecard
Financial
Customer
Internal Business
Learning and Growth
40

Key Performance Indicator (KPI)
Summary performance metric; assesses how well the company is achieving its goals
Continually measured
Reported on performance scorecard or performance dashboard
41

Financial Perspective
“How do we look to shareholders?”
Must continually attempt to increase profits
Increase revenues
Control costs
Increase productivity
42

Customer Perspective
“How do customers see us?”
Customers concerned with four product/service attributes:
Price
Quality
Sales service
Delivery time
43

Internal Business Perspective
“At what business processes must we excel to satisfy customer and financial objectives?”
Three factors:
Innovation
Operations
Post-sales support
44

Learning and Growth Perspective
“Can we continue to improve and create value?”
Three factors:
Employee capabilities
Information system capabilities
Company’s “climate for action”
45

Sustainability and Performance Evaluation
Sustainability-related KPIs
Fifth perspective – “Sustainability”
Sixth perspective – “Community”
46

End of Chapter 10
47

 Topic: Examples of managerial accounting helping managers with decision making

 Deadline: 03/18/2013

 1 – 4 people in one group

 12 to 14 pages double space

 You can apply whatever you have learned so far to real life. For example, you can give suggestions on how to improve the company’s current costing method or analyzing why the current costing method is suitable for the company. Other topics include CVP analysis, cost behavior, value chain, budget, performance evaluation, and so on.

 Please use real companies as examples. You can search data from internet (you can financial statements on

www.sec.gov

, search company filings) or data of the company you work for. Note that financial statements are for external users, so they don’t have information such as cost behavior. You can make up some numbers or do a what-if analysis.

PS: I will send you the powerpoint you need with the tools you need to use. So you can apply them the same way they are applied in the PPT.

Here attached are the PPT

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