Copyright 2006 John Wiley & Sons, Inc. Inventory Management.
2013 John Wiley Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 1.
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Transcript of 2013 John Wiley Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 1.
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 1
CHAPTER 11
AccountingDecisions
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 2
Learning Objectives How do I distinguish between various types of costs,
including product, period, direct, indirect, prime, conversion, and overhead costs?
What risks are present when arbitrary methods of overhead allocation are used?
How does activity-based costing create more accurate product costs?
What is the difference between absorption and variable costing?
What are two methods of writing off an overallocation or underallocation of overhead?
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 3
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 4
Product and Period Costs Period costs relate to the accounting period (year,
month) in which a cost was incurred Product costs relate to the cost of goods or services
produced The calculation of profit is based on the separation
of product and period costs Revenues - Cost of goods sold = Gross profit
– Selling and Administrative costs and other period costs = Operating profit
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 5
Product and Period Costs Cost of goods sold (product cost)
The cost of providing a service The cost of buying goods sold by a retailer The cost of raw materials and production costs
for a manufacturer For a retailer
Cost of goods sold = Opening inventory + Purchases - Closing inventory
For a manufacturer Cost of goods sold = Opening inventory + Cost of
production - Closing inventory
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 6
Calculation of Operating Profit
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 7
Direct and Indirect Costs Production costs
Direct Indirect
Direct costs Traceable to product/ services
Direct materials or labour Other direct costs
Indirect costs (Overhead costs) Necessary, but not readily traceable to particular
product/ services Indirect materials Indirect labour Other indirect costs
Other Cost Terms Prime cost refers to the total of all direct costs
Includes the total of direct materials and direct labour. Production overhead is all production costs
other than direct costs The total of all indirect material, indirect labour, and
other indirect costs Conversion costs are the production costs, other
than direct materials, used to make a product or provide a service. Includes direct labour and production overhead
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 8
Calculating Product/Service Costs Company-wide overhead rate
An overhead rate calculated using the total of the overhead costs for the company, divided by the total of the allocation base for the overhead
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 9
Calculating Product/Service Costs Divisional-based overhead rate
Calculates the overhead for each division within the company and then uses an allocation base to assign the divisional overhead to jobs
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 10
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 11
Activity-Based Costing (ABC)
Uses cost pools to accumulate the indirect costs of significant business activities and then assigns the costs from the cost pools to products based on cost drivers , which measure each product’s demand for activities
Cost Pools Cost pools accumulate the indirect cost of
business processes Business process
A sales order from customer to delivery and invoicing
A purchase order on a supplier to receipt of goods and payment
Collects the purchasing costs in all of the departments into a cost pool
12© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11
Cost Drivers The most significant cause of activity in a
cost pool, e.g. Enable the cost of activities to be assigned
from cost pools to cost objects
13© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 14
Activity-Based Costing (ABC) Three stage process
Trace costs for business processes to cost pools Identify cost drivers for each cost pool Determine number of activities for each cost
driver Transaction, frequency, intensity
Cost driver rateCost pool / Number of cost drivers Apply cost driver rate to product/services based
on number of cost drivers for each business process
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 15
Activity-Based Costing (ABC) In order to identify a cost driver, categorize
costs as follows Unit-level activities Batch-related activities Product-sustaining activities Customer-sustaining activities Facility-sustaining activities
Example of ABC
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 16
Accumulated overhead costs
Cost drivers identified
Example of ABC
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 17
Calculation of Cost per Activity
Allocation of Overhead to Products
Example of ABC
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 18
Overhead per Product Based on ABC
Total Product Cost under ABC
Difference between Traditional Approach and ABC
19© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11
Total Product Cost under Traditional Approach
Difference between Traditional Approach and ABC
Absorption and Variable Costing Variable costing
A method of reporting in which only variable costs are treated as inventoriable
Direct materials, direct labour, and variable overhead costs are assigned to each product made during the period
Fixed overhead costs are treated as period expenses
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 20
Absorption and Variable Costing Absorption costing
A system where all production overhead costs (fixed and variable) are inventoriable
Variable costs (direct materials, direct labour, and variable overhead) are assigned directly to each unit made
Fixed overhead costs are assigned to each product/service based on an allocation base
Fixed production overhead is estimated and divided by the allocation base to calculate a budgeted overhead rate
Each and every product that is made at the plant is then assigned fixed production overhead costs based on this budgeted overhead rate
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 21
Absorption and Variable Costing Budgeted fixed overhead rate
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 22
Absorption and Variable Costing Compared
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 23
Company Data
Absorption and Variable Costing Compared
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 24
Overallocation or Underallocationof Overhead
The overhead rate is normally established prior to the production year
At the end of the year when actual cost and actual activity volumes are known, there is going to be a difference between the actual overhead and the budgeted overhead that was allocated throughout the period
This is underallocation or overallocation of overhead
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 25
In order to adjust the records of the company, two approaches can be used
1. Assign overallocation or underallocation to cost of goods sold
2. Prorate overallocation or underallocation to cost of goods sold, work in progress inventory, and finished goods inventory
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 26
Overallocation or Underallocationof Overhead
Conclusions Cost terminology
Product/period Direct/indirect Other costs Activity-based costing Variable costing Absorption costing Comparison of approaches Overallocation or underallocation of overhead
© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 11 27