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Transcript of Part 3 C – 1 V3.0 THE IIA’S CIA LEARNING SYSTEM TM Section Topics 1.Cost concepts 2.Capital...
Part 3 C – 1V3.0
THE IIA’S CIA LEARNING SYSTEMTM
www.LearnCia.com
Section Topics
1. Cost concepts
2. Capital budgeting
3. Operating budget
4. Transfer pricing
5. Cost-volume-profit analysis
6. Relevant cost
7. Costing systems
8. Responsibility accounting
Part 3, Section C
Part 3 C – 2V3.0
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Purpose of Managerial Accounting
To support management activities
Decision making
Planning
Continuous improvement
Evaluating
Controlling
Part 3, Section C, Introduction
Part 3 C – 3V3.0
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Cost Concepts:Fill in the blanks
Concept/Term Description
Any resource that must be given up to obtain some objective; can be money paid for a good or service, a new liability, or giving up an asset.
Any object that can have a cost applied to it and can be used to determine how much a particular thing or activity costs; includes products, services, customers, projects, departments, and activities.
Any factor that has a cause-and-effect relationship with costs, such as a rise in sales volume that affects a rise in sales commissions.
The historical cost paid for goods and services.
Cost
Cost driver
Actual costs
Cost object
Part 3, Section C, Topic 1
Part 3 C – 4V3.0
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Cost Concepts:Fill in the blanks
Concept/Term Description
Any costs that can be easily and accurately traced to an object (usually direct labor and direct materials).
Any costs that are related to a cost object but cannot be easily traced to the product (such as overhead).
The difference in costs between any two alternatives.
The potential benefits given up when one alternative is selected over another.
Any costs that have already been incurred and that cannot be changed by any decision made now or in the future.
Direct costs
Differential costs
Opportunity costs
Indirect costs
Sunk costs
Part 3, Section C, Topic 1
Part 3 C – 5V3.0
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Product vs. Period Costs
Product Costs
Also called inventoriable or manufacturing costs. When products are sold, product costs become cost of goods sold. Product costs include:
• Direct materials.
• Direct labor.
• Manufacturing overhead.
Categorized as prime or conversion costs.
Also called operating expenses and nonmanufacturing costs. These items are expensed in the period in which they occur. Period costs include:
• Marketing or selling costs such asadvertising, shipping, and storagecosts in shipping warehouses.
• Administrative costs, including allexecutive, organizational, andclerical costs of the organization(such as PR and secretarial costs).
Period Costs
Part 3, Section C, Topic 1
Part 3 C – 6V3.0
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Cost Behavior
Variable Costs Mixed CostsFixed Costs
Costs that rise and fall as afirm’s output level rises andfalls.• Manufacturing: direct labor,
raw materials, utilities, waste disposal
• Merchandising: cost of goods sold, sales commissions, billing costs
• Service (hospital): supplies, drugs, meals
Portions of total costs thatremain constant regardlessof changes in activitylevels over a relevantrange. Examples of fixedcosts: • Rent, depreciation• Insurance, property taxes• Supervisory and
administrative salaries
Costs that are a combination of fixed and variable costs.
The time horizon often determines cost behavior as costs can change in the long and short term.
All three cost patterns are found in most organizations.
Part 3, Section C, Topic 1
Part 3 C – 7V3.0
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Which of the following is NOT true of absorption costing?
A. It is required for external reporting.
B. It deducts fixed manufacturing costs.
C. It defers fixed manufacturing costs.
D. It uses a gross margin format.
Answer: B. It defers fixed costs in ending inventory to future periods.
Discussion Question
Part 3, Section C, Topic 1
Part 3 C – 8V3.0
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Classification of Costs Under Absorptionand Variable Costing
Absorption Costing Variable Costing
Product costs • Direct materials
• Direct labor
• Variable overhead
• Fixed overhead
• Direct materials
• Direct labor
• Variable overhead
Period costs • Selling expenses
• Administrative expenses
• Fixed overhead
• Selling expenses
• Administrative expenses
Part 3, Section C, Topic 1
Part 3 C – 9V3.0
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Master Budget
A summary of an organization’s plans that sets specific targets for sales, production, distribution, and financing activities.
Master Budget Components
Operating Budget
Capital Budget
Financial Budget
Part 3, Section C, Topic 2
Part 3 C – 10V3.0
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Capital Budgeting Process
Identify, understand, and define projects
and boundaries.
Select projects and analyze
revenues, costs, and cash flows.
Monitor and review projects and modify as
necessary.
Part 3, Section C, Topic 2
Part 3 C – 11V3.0
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Investment Evaluation Analysis
Typical capital budgeting decisions include:
Cost reduction. (Should new equipment be purchased to reduce costs?)
Expansion. (Should a new plant or warehouse be acquired to increase capacity and sales?)
Equipment selection. (Which machine would be the most cost-effective to buy?)
Lease or buy. (Should new equipment be leased or purchased?)
Equipment replacement. (Should old equipment be replaced now or later?)
Part 3, Section C, Topic 2
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• Compares present value of a project’s cash inflows to present value of a project’s cash outflows.
• The difference, the net present value, determines whether the project is an acceptable investment.
Discounting Models:Net Present Value (NPV) Method
Where: i = interest raten = number of periods
n
1 1PVa = 1
i 1 + i
Part 3, Section C, Topic 2
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• Most widely used capital investment technique. IRR is the rate of return or “yield” promised by a project over its lifetime.
• Find discount rate that equates present value of project’s cash outflows with present value of project’s cash inflows. IRR is the discount rate that causes the net present value of a project to be equal to zero.
• Computed IRR is compared to firm’s required rate of return. Greater or equal IRR means project may be acceptable.
Discounting Models:Internal Rate of Return (IRR) Method
Investment US $XXXX = = x.xxxx
Annuity US $XXXX
Part 3, Section C, Topic 2
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Which of the following is true of the NPV decision model in relation to the IRR?
A. It is more complicated.
B. It makes more realistic assumptions.
C. It favors larger investments.
D. It is less accurate.
Answer: B. NPV makes more realistic assumptions about the rate of return that can be earned on cash flows from a project.
Discussion Question
Part 3, Section C, Topic 2
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• Focuses on the payback period, the time required for an organization to recover its original investment.
• Some organizations set a maximum payback period for all projects and reject any that exceed that level. This provides a rough measure of risk and provides information about controlling risks of obsolescence and uncertainty of cash flows.
Nondiscounting Models: Payback Method
(if cash flows are equal amount each period)
Original InvestmentPayback Period =
Annual Cash Flow
Part 3, Section C, Topic 2
Part 3 C – 16V3.0
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• Also called simple rate of return. Unlike other methods, it measures the return on a project in terms of net operating income instead of cash flow.
• Estimated revenues generated by a project are deducted from the projected operating expenses; this figure is then related to the initial investment.
Nondiscounting Models:Accounting Rate of Return (ARR) Method
Increase in Expected Average Annual Operating IncomeARR =
Initial Required Investment
Part 3, Section C, Topic 2
Part 3 C – 17V3.0
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• ARR method does not consider a project’s profitability; however, it can ensure that new investments don’t adversely affect financial accounting ratios.
• Critical deficiency is that both methods ignore the time value of money.
• Used less frequently than discounting models; however, still commonly used as screening measures.
• Payback method can help identify proposals managers should consider further.
Payback and ARR Compared
Part 3, Section C, Topic 2
Part 3 C – 18V3.0
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• Residual income calculation to help determine whether the money an organization makes is more than the money it takes to make it.
• Value is created if after-tax operating income is greater than cost of capital.
• Key point is emphasis on after-tax operating profit and the actual cost of capital.
Economic Value Added (EVA)
EVA = After-Tax Operating Income – (Actual Percentage Cost of Capital x Average Capital Employed)
Part 3, Section C, Topic 2
Part 3 C – 19V3.0
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Capital Budgeting Models: Fill in the blanks
Method Strengths Weaknesses
Considers time value of money and uses realistic discount rate for reinvestment.
Not useful for comparing projects requiring different amounts of investment.
Considers time value of money and easy to compare projects with different amounts.
Complex to compute, and reinvestment rate of return might be unrealistic.
Simple, measures liquidity, and allows for risk tolerance.
Ignores time value of money and cash flows beyond payback period.
Data readily available, consistent with other financial measures.
Ignores time value of money, uses accounting numbers rather than cash flow.
Emphasizes after-tax operating profit.
Not able to compare investments among different-sized divisions.
NPV
IRR
Payback
ARR
EVA
Part 3, Section C, Topic 2
Part 3 C – 20V3.0
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• Are the basis for evaluating a manager’s performance.
• Assign responsibilities to managers, authorize budget amounts, and set performance expectations.
• Help coordinate activities of several parts of an organization.
• Fine-tune an organization’s strategic plan.
• Typically cover a one-year period and state revenues and expense planning.
• Identify resources (and sources) to support organization’s daily activities.
Operating Budgets
Part 3, Section C, Topic 3
• Are tools for short-term planning and control.
• Are used in conjunction to develop overall operating budget.
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Sales BudgetBasis for all other budgets. Defines capacity needed throughout organization, including production, selling, and administrative costs.
Steel, Inc., Sales Budget
Q1 Q2 Q3 Q4 Year 6
Steel girders 256 266 282 294 1,098
Price per girder (USD)
$5,000 $5,000 $5,500 $5,500
Rebar, short tons
70 78 88 96 332
Price per ton (rebar) (USD)
$4,000 $4,000 $4,400 $4,400
Total sales(USD)
$1,560,000 $1,642,000 $1,938,200 $2,039,400 $7,179,600
Part 3, Section C, Topic 3
Part 3 C – 22V3.0
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Production BudgetPlan for acquiring resources, meeting sales goals, and maintaining a specific level of inventory.
Steel, Inc., Production Budget
Q1 Q2 Q3 Q4 Year 6(G = girders, R = rebar) G R G R G R G R G R
Budgeted sales 256 70 266 78 282 88 294 96 1,098 332
Plus ending inventory
26 7 27 8 28 9 29 10 29 10
Units needed 282 77 293 86 310 97 323 106 1,127 342
Minus beginning inventory
20 9 26 7 27 8 28 9 20 9
Budgeted production
262 68 267 79 283 89 295 97 1,107 333
Part 3, Section C, Topic 3
Part 3 C – 23V3.0
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Direct Materials BudgetDetermines required materials and quality of materials used to meet production. Often broken down into usage and purchase budgets.
Steel, Inc., Purchase BudgetDirect Materials (DM)
Q1 Q2 Q3 Q4 Year 6(R = rebar) R R R R R
Total DM needed 68 79 89 97 333
Plus target ending inventory 5 6 5 7 7
Total DM required 73 85 94 104 340
Minus DM beginning inventory 4 5 6 5 4
DM purchases 69 80 88 99 336
Purchase price (USD) $1,000 $1,000 $1,000 $1,000
Total cost for DM purchases (USD)
69K 80k 88K 99K 336K
Part 3, Section C, Topic 3
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Direct Labor BudgetSteel, Inc., Direct Labor Budget
Q1 Q2 Q3 Q4 Year 6(G = girders;
R = rebar)G R G R G R G R G R
Budgeted production
262 68 267 79 283 89 295 97 1,107 333
DLH per unit 20 40 20 40 20 40 20 40
DLH needed 5,240 2,720 5,340 3,160 5,660 3,560 5,900 3,800 22,140 13,320
Hourly wage 20 20 20 20 20 20 20 20
Total wages 104.8k 54.4k 106.8k 63.2k 113.2k 71.2k 118k 77.6k 442.8k 266.4k
Total labor $159,200 $170,000 $184,400 $195,600 $709, 200
(All figures in USD)
Part 3, Section C, Topic 3
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Overhead BudgetAll production costs other than direct materials and direct labor. Includes fixed and variable costs such as rent, insurance, utilities, etc.
Steel, Inc., Overhead Budget
Rate/DLH
Q1 Q2 Q3 Q4 Year 6
Total DLH 7,960 8,500 9,220 9,780 35,460
Total variable overhead
$38.50 $306,460 $327,250 $354,970 $376.530 $1,365,210
Total fixed overhead
$53,190 $53,190 $53,190 $53,190 $212,760
Total overhead $359,650 $380,440 $408,160 $429,720 $1,577,970
(All figures in USD)
Part 3, Section C, Topic 3
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Cost of Goods Sold BudgetTotal and per unit production cost budgeted for a period.
Steel, Inc., Cost of Goods Sold Budget
Q1 Q2 Q3 Q4 Year 6
Direct materials $854,000 $880,000 $938,000 $1,036,000 $3,708,000
Direct labor $159,200 $170,000 $184,400 $195,600 $709,200
Overhead $359,650 $380,440 $408,160 $429,720 $1,577,970
COGS manufactured
$1,372,850 $1,430,440 $1,530,560 $1,661,320 $5,995,170
+ Beginning inventory
$113, 460 $131,800 $139,310 $152,420 $113,460
COGS available $1,486,310 $1,562,240 $1,669,870 $1,813,740 $6,108,630
− Ending inventory
$131,800 $139,310 $152,420 $160,130 $160,130
COGS $1,354,510 $1,422,930 $1,517,450 $1,653,610 $5,948,500(All figures in USD)
Part 3, Section C, Topic 3
Part 3 C – 27V3.0
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Selling and Administrative Expenses Budget
Nonmanufacturing expenses and sales expenses make up this budget.
Steel, Inc., Selling and Administrative Expenses Budget
Q1 Q2 Q3 Q4 Year 6
Variable selling expenses
$35,000 $36,000 $40,000 $43,000 $154,000
Fixed selling expenses
$64,000 $64,000 $64,000 $64,000 $256,000
Administrative expenses
$46,000 $46,000 $46,000 $46,000 $184,000
Total selling and administrative expenses
$145,000 $146,000 $150,000 $153,000 $594,000
(All figures in USD)
Part 3, Section C, Topic 3
Part 3 C – 28V3.0
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Alternative Budget Approaches
Project budgeting
Activity-based
budgeting
Zero-based
budgeting
Kaizen budgeting
Part 3, Section C, Topic 3
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ABB vs. Traditional Budgeting
Activity-based Budgeting Traditional Budgeting
• Emphasizes value-added activities and activity costs
• Encourages teamwork, continuous improvement, customer satisfaction
• Eliminates wasteful activities and encourages cost reduction
• Identifies value-added vs. non-value-added activities
• Coordinates and synchronizes activities of entire organization
• Emphasizes input resources and functional areas
• Encourages increasing management performance
• Relies on past budgets without taking into account cost-effectiveness
• Minimizes variances and maximizes individual responsibility unit performances
Part 3, Section C, Topic 3
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Zero-based Budgeting
• Creates lean, efficient organization.
• Forces constant cost justification.
• Encourages annual reviews.
• Managers exhaust resources unnecessarily.
• Can encourage waste through budget slack.
• Annual reviews are expensive.
• Omitting prior budgets can lead to ignoring lessons learned from prior years.
Pros Cons
Part 3, Section C, Topic 3
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Reinforcing Activity 3-8Part 3, Section C, Topic 3
Operating Budget
Part 3, Section C, Topic 3
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Transfer pricing is a system for pricing products or services transferred from one responsibility center to another.
Decentralized Organization
Responsibility Unit A
ResponsibilityUnit B
Unit A “sells” a product to Unit B.
Unit B “pays” a transfer price to Unit A.
Transfer Pricing
Part 3, Section C, Topic 4
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• Control– Used to provide incentives and performance measures– Ensures that costs are assigned to correct responsibility
center
• Decentralized planning decisions– Purchasing decisions are consistent with organization’s
goals– Considers effect on selling and buying units’ incentives
• International issues– Minimize tax liability, expropriation risks, taxes, and tariffs– Incorporate alternative performance measures if necessary– Comply with all national laws and regulations
Transfer Pricing Issues
Part 3, Section C, Topic 4
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The overriding reason for using transfer pricing is to
A. motivate managers to make decisionsconsistent with organizational goals.
B. hold managers responsible for problems.
C. generate tax savings.
D. improve economic performance.
Answer: A. Transfer pricing also affects B, C, and D, but the primary reason for using it is A.
Discussion Question
Part 3, Section C, Topic 4
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• Market price: A true arm’s-length model that sets the internal transfer price at the going market price.
• Full cost (absorption): Starts with seller’s variable cost for an item and then allocates fixed costs to the prices.
• Variable cost: Sets transfer prices at the unit’s variable cost, or the actual cost to produce the good or service less all fixed costs.
• Negotiated price: Sets the transfer price through negotiation between buyer and seller.
Transfer Pricing Models
Part 3, Section C, Topic 4
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Transfer Pricing Models:Fill in the blanks
Model Advantages Disadvantages
• Helps preserve unit autonomy• Incentive for selling unit• Arm’s-length standard
• Intermediate products have no market price
• Must be adjusted for cost savings
• Easy to implement• Intuitive, easily understood• Preferred by tax authorities
• Overstates opportunity cost if excess capacity exists
• Irrelevance of fixed cost in decisions
• Causes buyer to act as desired
• Unfair to seller if seller is a profit or investment business unit
• Practical when conflict exists • Arbitration procedure reduces autonomy
• Potential tax problems
Market price
Full cost
Variable cost
Negotiated price
Part 3, Section C, Topic 4
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Which of the following in NOT a key factor in transfer pricing?
A. The seller’s variable cost vs. market price
B. If selling unit is operating at full capacity
C. If there’s an outside supplier
D. Organization’s market share
Answer: D. Other factors are more important.
Discussion Question
Part 3, Section C, Topic 4
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• Helps managers understand interrelationships among cost, volume, and profit by focusing on interactions among:
CVP Analysis
— Prices of products. — Volume or level of activity.— Per unit variable costs.
— Total fixed costs.— Mix of products sold.
• Decision-making applications include:— Setting prices.— Product introductions.— Replacing equipment.
— Make or buy decisions.— “What-if” analyses.
Part 3, Section C, Topic 5
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Tracks how costs, revenues, and profits change in a predictable way as the volume of activity changes.
Profit = Revenues – Total Costs
or
Revenues = Fixed Costs + Variable Costs + Profit
CVP Model
Part 3, Section C, Topic 5
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Break-even Analysis
• Determinant of CVP analysis used to assess how “what-if” decision alternatives will affect operating income.
• Break-even point is output level at which total revenues and total costs are equal.
At break-even, operating income is zero.0
Above break-even, operating income levels are profitable.
Below break-even, there is a loss.
+
–
Part 3, Section C, Topic 5
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Break-even Analysis—Equation Method
Revenues – Variable Costs – Fixed Costs = Operating Income
or
USP × Q – UVC × Q – FC + OI
Where:
• USP is the unit selling price.
• Q is the quantity sold.
• UVC is the unit variable costs.
• FC is the fixed costs.
• OI is the operating income.
Part 3, Section C, Topic 5
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Break-even Analysis—Contribution Margin Method
Algebraic adaptation of the equation method
USP × Q UVC × Q FC = OI
USP UVC × Q = FC + OI
UCM × Q = FC + OI
FC + OIQ =
UCM
Where:
• USP is the unit selling price.
• Q is the quantity sold.
• UVC is the unit variable costs.
• FC is the fixed costs.
• OI is the operating income.
• UCM is the unit contribution margin (USP − UVC).
Part 3, Section C, Topic 5
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Break-even Analysis—Graph Method
CVP graph (or break-even chart) shows interrelationships among cost, volume, and profit graphically.
Units Sold
Dollars
Total revenues
Loss
Fixed costs
Operating income
Variable costsTotal costs
Profit
Part 3, Section C, Topic 5
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Relevant vs. Irrelevant Costs
• Are yet to be incurred (future costs).
• Differ for each option.
• Are avoidable.
• Are focused on short-term decisions.
• Have already been incurred.
• Have already been committed.
• Will be the same regardless of alternative chosen.
• Can be ignored.
Irrelevant Costs:Relevant Costs:
Part 3, Section C, Topic 6
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Which of the following BEST describes a relevant cost?
A. A cost that is the same for both choices
B. A cost that has already been incurred
C. A cost yet to be incurred
D. A cost that is unavoidable
Answer: C. Costs that have already been incurred (sunk costs) are irrelevant.
Discussion Question
Part 3, Section C, Topic 6
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Relevant Cost Analysis Applications
Make or buy
decisions
Special order
decisions
Sell or process further
decisions
Keep or drop
decisions
Part 3, Section C, Topic 6
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Relevant Cost Analysis:Fill in the blanks
Decision Considerations Conclusion
Compare relevant cost of making product internally vs. buying product externally.
If relevant cost is less than purchase price, make product internally.
Evaluate profitability based on relevant and opportunity costs and capacity.
Accept order if there is excess capacity and unit costs are less than price offered.
Analyze relevant costs; ignore joint costs as they are irrelevant.
Process further if incremental revenue exceeds incremental processing costs incurred.
Identify avoidable costs and determine contribution margin.
Drop product if avoidable fixed costs saved are greater than contribution margin amount lost.
Make or buy
Special order
Keep or drop
Sell or process further
Part 3, Section C, Topic 6
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Product Costing Systems
Product costing is the process of accumulating, classifying, and assigning direct materials, direct labor, and factory overhead costs to products and services.
Types of Product Costing Systems:
Cost measurement (allocation) systems
Cost accumulation systems
Part 3, Section C, Topic 7
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Actual CostingRecords actual costs incurred for direct materials, direct labor, and overhead (by allocating actual amounts).
Steel, Inc., Period Costs
P1 P2 P3
Direct materials
256 266 282
Direct labor
$5,000 $5,000 $5,500
Overhead 70 258 175
Total costs
$5,326 $5,524 $5,957
Limitations of actual costing:
• Cannot provide accurate unit cost information on a timely basis.
• Difficult to assign overhead items to unit cost without direct relationship.
• Can distort period costs due to irregular overhead items.
Part 3, Section C, Topic 7
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Normal CostingMost widely used costing method; applies actual costs for direct materials and direct labor to a job, process, or other cost center and uses a predetermined rate to assign overhead to cost centers.
Steel, Inc., Period Costs
P1 P2
Direct materials 256 266
Direct labor $5,000 $5,000
Overhead (pre-determined rate)
150 150
Total costs $5,406 $5,416
Advantages of normal costing:
• Actual overhead costs are not readily available.
• Helps keep product costs current by allowing for immediate cost calculation using standard overhead rate.
• Helps smooth out or “normalize” factory overhead rate fluctuations.
Part 3, Section C, Topic 7
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Which of the following is a disadvantage of a standard costing system?
A. It does not improve planning and control.
B. Unreasonable standards might be set.
C. It can complicate product costing.
D. It is not easily adapted to new data.
Answer: B. Standards might be authoritarian, inflexible, or secretive.
Discussion Question
Part 3, Section C, Topic 7
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Cost Assignment in Measurement Systems:Fill in the blanks
System Direct Materials Direct Labor Overhead
Actual cost Actual cost Actual cost
Actual cost Actual cost Budgeted overhead cost using predetermined rate
Standard cost Standard cost Standard cost
Actual Costing
Normal Costing
Standard Costing
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Job Costing (Job-Order Costing)
Assigns costs to a specific job (a distinct unit, batch, or lot of a product or service).
• Used where many different products are produced each period and each unique job uses a different amount of resources.
Costs assigned to each product • Can accommodate multiple
costing methods, such as actual, normal, and standard costing.
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Process Costing
Accumulates costs by process or department and assigns them to a large number of nearly identical products.
• Appropriate for highly automated, repetitive processes where cost of one unit is identical to another.
• Common among manufacturers mass-producing similar goods.
• Total assigned costs are divided by total number of units produced.
Costs assigned to many identical products
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Key Differences BetweenJob Costing and Process Costing
Job Costing Process Costing• Used with a wide variety of distinct
products or services.
• Total job costs are actual direct materials and direct labor and predetermined overhead rates.
• Costs accumulate by individual job and are tracked separately.
• Unit cost is computed by dividing total job costs by units produced.
• Used with similar or identical products with continuous flow.
• Costs are assigned uniformly to all units passing through a department during a specific period.
• Costs accumulate by process or department.
• Unit cost is computed by dividing total process costs of the period by the units produced.
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• How is unit cost for a product or service computed given that some units produced in a period are complete and some are incomplete?
• Should costs and work of beginning WIP be counted with current period’s work and costs or be treated separately?
Process Costing—WIP InventoriesAccounting for work-in-process (WIP) inventories is a major concern in process costing, particularly in manufacturing.
Primary issues
Units started and completed in current
period (Period 2)
Units started in prior period, completed in this period
(Period 1 WIP)
Period 2 WIP inventories
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Equivalent Units (EUs)
Amount of work done on partially completed units expressed in terms of how many complete units could have been created with the same amount of work in the same period.
Equivalent Units = Number of Partially Completed Units % Completion
Units started in prior period, completed in this period
(Period 1 WIP)
Period 2 WIP inventories
and/or
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Methods to Calculate Equivalent Units
Weighted Average MethodCosts and work carried over from the prior period are counted as if they belong to the current period.
Equivalent Units = Units Transferred to Next Department or Finished Goods + Equivalent Units in Ending Work-in-Process Inventory
Equivalent units =
(Computed for current accounting period)
Units transferred to department or finished goods
Department’s ending WIP
inventories (EUs)
+
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Methods to Calculate Equivalent Units
FIFO MethodCalculates unit cost using only costs incurred and work performed during current accounting period.
Equivalent Units = Equivalent Units to Complete Beginning Inventory + Units Started and Completed During the Period + Equivalent Units in
Ending Work-in-Process Inventory
EUs to complete beginning inventory
Department’s ending WIP
inventories (EUs)+
Equivalent units =
(Computed for current accounting period)
Units started and
completed+
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Key Differences Between Weighted Average and FIFO Methods
Weighted Average FIFO• Blends work and costs from prior
period with those in current period.
• Easier to use, simpler calculations.
• Suited for stable inventories and manufacturing costs.
• Less accurate in computing unit costs for current period output and for units in beginning work in process.
• EUs and unit costs relate only to work done in the current period.
• Separates prior and current periods.
• Produces more current unit cost if prices change in manufacturing inputs.
• More closely linked to continuous improvement efforts and gives greater control over costs and performance evaluation.
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ABC Traditional• Uses activity- and volume-based cost
drivers.
• Assigns overhead to activities and then to products or services.
• Focuses on processes and costing issues that cross departments.
• Nonmanufacturing and manufacturing costs may be assigned to products.
• Uses up to three volume-based cost drivers.
• Assigns overhead to departments and then to products or services.
• Focuses on processes and costing improvement issues within departments.
• Only manufacturing costs are assigned to products.
Differences Between ABC and Traditional Costing
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Steps to Implementing an ABC System
Step 1. Identify activities and resource costs.
Step 3. Assign activity costs to cost objects.
Step 2. Assign resource costs to activities.
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• Reduces distortions caused by traditional allocation methods
• Gives managers access to relevant costs
• Measures activity-driving costs, easier to assess how overall cost and value are affected
• Results in greater unit costs for low-volume products
• Requires many hours to implement and use
• Does not relate all overhead costs to a particular cost driver
• Generates much data that may lead to confusion
• Reports do not conform to GAAP, may not be used for external reporting
Benefits and Limitations of ABC
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Reinforcing Activity 3-9Part 3, Section C, Topic 7
Cost Concepts and Costing Systems
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Managers of different responsibility centers are held responsible only for those revenues or costs they can actually control.
Decentralized Organization
Profit/revenue Center
Cost CenterInvestment
CenterProfit/Revenue
Center
Responsibility Accounting
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Centers ResponsibilitiesCost (data processing, HR, accounting, customer service)
• Fewest responsibilities; must control costs through efficient use of resources.
• Rewarded for minimizing costs without sacrificing quality.
• Compensation tied to favorable cost variances.
Profit/revenue (restaurants, retail shops)
• Responsible for generating revenues, controlling costs, and cost and pricing of products.
• Decides types, quality, and marketing of products.
• Performance based on profit, quality, customer satisfaction.
Investment (profit centers focused on internal or external investment)
• Responsible for long- and short-term investments, costs, and revenues.
• Can request more funds to increase capacity.
• Evaluated on successful investments, strategy.
Responsibility Centers and Manager Responsibilities
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Questions?
End of Section C
Part 3, Section C