Cost Accounting Techniques

FACTS Famous accountants

• Kenny G (U of Washington)

• John Grisham (Mississippi State)

• Cost to produce a Model T

– 1908 = $700, 1914 = $475

Profit per car 1909 was $220, 1912 $99, lower selling price from $850 to $575, dropped the price and gained 48% market share by increasing sales

What Does My Product Cost

Why is it important:

• Pricing decisions (margin expectation)

• Product mix decision (make more profitable items)

• Make vs buy decisions (outsource some items)

• Capacity decisions (add capacity vs cut product)

• Cost control decisions (reduce labor)

Challenges to Costing

• Technology

– Quality/robust system

– Excel

• Competency of staff

• Purpose

GAAP vs. Internal GAAP

• LCM

• Full Absorption

• All costs related to inventory on-hand at reporting date

Internal

• Managerial Decisions – Cost control

– Variance analysis

Traditional Costing - Where do we stumble Materials:

• Generally easy to track to product – set accurate inputs

• G/L “trued up” with physical/cycle count • Actual vs Standard? (how often do we adjust)

Labor: • Time consuming to track to product • Time sheet vs swipe/scan • Actual vs Standard • Do we care about variance analysis • G/L how much is actually in inventory at report date

Traditional Costing - Where do we stumble

Overhead:

• Overhead is dumped into single cost pool and spread evenly across all end products

• Product-cost cross-subsidization

• Single pool of indirect costs – single OH rate (e.g., factor of DL)

Traditional Costing - Overhead

XYZ Manufacturing

OVERHEAD ABSORPTION

ACCOUNT AMOUNT

Indirect Wages (Supervision, Quality,

Purchasing, Engineering) 600,000$

Fringe Benefits 210,000

Rent 60,000

Maintenance 80,000

Depreciation 50,000

All Other 100,000

Total Indirect Costs 1,100,000$

Budgeted DL Hrs (30 ee X (2,080 hrs X 80%) 49,920

Standard Overhead Rate 22.04$

Traditional Costing Job Order Costing

• Custom builds

• Produce to customer orders/spec

• Track costs to shop/work order

Process Costing:

• Mass produced homogeneous products

• Continuous production, build to stock

Traditional Costing Advantage:

• Simple

• GAAP

• Variance analysis

Disadvantage:

• Assumes inputs/costs are consumed evenly across products

• Limited managerial information (true costs)

• Time consuming to maintain (all inputs)

Activity Based Costing • Can be used by manufacturing or service companies

• Indirect costs are attached to activities & rationally allocated to end products

• Each activity has a cost pool, which are assigned based on cost driver

• Identifying activities that constitute overhead

• Assigning the costs of resources consumed by the activities

• Assigning costs based on activity (driver)

• Two stage allocation

Activity Based Costing

Activity Based Costing Advantages:

• Improved product costing (more accurate cost assignments, better cost control)

• More useful when overhead costs are high

Disadvantages:

• Increased time & effort (implement drivers & cost pools)

Variable/Direct Costing • Not applicable for external reporting

• Product costs = only variable manufacturing costs

• Fixed manufacturing costs are expensed – incurred regardless of production

• Contribution Margin = Sales less all variable costs (mfg. and sga), represents the margin to cover fixed costs

Variable Costing Effects on Income and Ending Inventory:

• Inventory will be lower since fixed costs are excluded

• Lower income when produce more than sell, all fixed costs are subtracted on income statement, under absorption some are capitalized

• Higher income when sell more than produce, only current fixed costs are expensed

• Under VC, income moves in same direction as sales volume

Contribution Margin XYZ Manufacturing

VARIABLE COSTING

Assume sell 80 units, produce 100 units

Absorption Variable

ACCOUNT Costing Costing

Sales 8,000$ 8,000$

Beg Inventory -$ -$

Plus: Variable Production Costs 4,500 4,500

Plus: Fixed Production Costs 3,000 -

Less: Ending Inventory (1,500) (900)

Cost of Sales 6,000 3,600

Less: Variable SG&A - 200

Gross Margin/Contribution Margin 2,000 4,200

Less: Fixed Production Costs - 3,000

Less: Variable SG&A 200 -

Less: Fixed SG&A 600 600

Operating Income 1,200$ 600$

Contribution Margin

XYZ Manufacturing

PER UNIT

Assume sell 80 units, produce 100 units

Absorption Variable

Costing Costing

Gross Margin/Contribution Margin 25$ 53$

Profit Margin 15$ 8$

Fixed Costs 3,600$

Break-Even Units 69

Variable/Direct Costing Advantages:

• Fully loaded costs usually contain arbitrary allocations of fixed costs

• Income is related to sales volume, not production

• Fewer manufacturing variances – less confusing

• Fixed costs are not buried on the balance sheet

• Better managerial tool – break even analysis, make vs buy, pricing decisions

Throughput Costing Theory of Constraints:

• Constraint sets the pace for the entire process

• Identify the constraint (bottleneck)

• Determine the most profitable product mix given the constraint

• Maximize the flow through the constraint

• Increase capacity at the constraint

• Redesign manufacturing process for greater flexibility & speed

Throughput Margin (Sales – Direct Material):

• Only direct materials are variable, DL & OH are fixed costs

• Calculate TM per unit of time spent at constraint

• Profit maximized by keeping bottleneck busy with highest TM

• Prioritize production in order of highest TM item, based on demand

Make vs Buy Qualitative – Produce Internally: • Specialized design (“made in America”) • Specialized designs and mfg skills • Fits within the firm’s core competencies Quantitative: • Fully loaded costs inflates internal cost of production • Only incremental costs should be considered • Fixed and unavoidable costs should be excluded If at 100% Capacity – Decide between Multiple Parts: • Determine capacity of factory • Calculate incremental cost of each item • Choose to produce the items with the greatest incremental

savings over purchase until plant capacity if filled, outsource the remaining

Make vs Buy Favor manufacturing in-house:

• Less expensive to make the part

• Use of excess plant capacity

• Control over quality

• Control of lead time

• Greater assurance of continual supply

Favor purchasing externally:

• Higher quality from supplier

• Less expensive

• Insufficient capacity

• Item not essential to the firm's strategy

Contact Information

Joe Mocciaro, CPA

Bowers & Company CPAs PLLC

1200 AXA Tower I – 100 Madison St.

Syracuse, New York 13202

Phone: 315-234-1179

jmm@bcpllc.com

www.bcpllc.com