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Financial Accounting
-Reports to those outside the organization: Owners Lenders Tax Authorities Regulators -Emphasizes financial consequences of past activities -Emphasizes objectivity and verifiability -Emphasizes precision -Emphasizes summary data concerning the entire organization -Must follow GAAP -Mandatory for external reports
Managerial Accounting
-Reports to those inside the organization: Planning Directing and Motivating Controlling Performance Evaluation -Emphasizes decisions affecting the future -Emphasizes relevance -Emphasizes timeliness -Emphasizes detailed segment reports about departments, products, customers, and employees -Need not follow GAAP -Not mandatory
What are the 4 steps in the planning and control cycle?
1. Planning Formulating long- and short-term plans 2. Directing & Motivating Implements Plans 3. Controlling Measuring Performance 4. Performance Evaluation Comparing actual to planned performance
What are the 3 major elements of product costs in a manufacturing company?
1. Direct Materials Materials that become an integral part of the finished product and whose cost can be conveniently traced to the finished product. Example: Seats purchased for a bus 2. Direct Labor Labor costs that can be easily traced to individual units of product. Example: Assembly-line workers for Toyota 3. Manufacturing Overhead All costs of manufacture except direct materials and direct labor. Includes items such as indirect materials, indirect labor, maintenance and repairs on production equipment; heat and light, property taxes, depreciation, and insurance on manufacturing facilities. Examples: Glue used to assemble a chair; labor costs of janitors
Product Cost
All costs involved in acquiring or making a product; direct materials, direct labor, and manufacturing overhead
Period Cost
costs involved that are nonmanufacturing costs: selling & administrative costs.
Merchandising Company’s Income Statement:
Sales Cost of Goods Sold: Beginning Merchandise Inventory Add: Purchases Goods Available for Sale Deduct: Ending Merchandise Inventory Gross Margin Selling and Administrative Expenses: Selling Expense Administrative Expense Net Operating Income
Manufacturing Company’s Income Statement
Sales Cost of Goods Sold: Beginning Finished Goods Inventory Add: Cost of Goods Manufactured Goods Available for Sale Deduct: Ending Finished Goods Inventory Gross Margin Selling and Administrative Expenses: Selling Expense Administrative Expense Net Operating Income
the schedule of Cost of Goods Manufactured
Direct Materials: Beginning raw materials inventory Add: Purchases of Raw Materials Raw Materials Available for Use Direct Labor Manufacturing Overhead Insurance, factory Indirect labor Machine Rental Utilities, factory Supplies Depreciation, factory Property taxes, factory Total Manufacturing Overhead Cost Total Manufacturing Cost Add: Begging work in process inventory Deduct: Ending work in process inventory Cost of Good Manufactured
Know why costs are classified as variable, fixed, direct, indirect, differential, sunk and opportunity cost
Predicting cost behavior in response to changed in activity- Variable Cost: (proportional to activity) Fixed Cost: (constant in total) Assigning costs to cost objects such as departments or products- Direct Cost: (can be easily traced) Indirect Cost: (cannot be easily traced) Making Decisions Differential Cost: (differs between alternatives) Sunk Cost: (past cost not affected by decision) Opportunity Cost: (forgone benefit)
The tables are made of wood that cost $100 per table.
(Variable Cost, Direct Materials)
The tables are assembled by workers, at a wage cost of $40 per table.
(Variable Cost, Direct Labor)
Workers making the tables are supervised by a factory supervisor who is paid $38,000 per year.
(Fixed Cost, Manufacturing Overhead)
Electrical costs are $2 per machine-hour. Four machine-hours are required to produce a table.
(Variable Cost, Manufacturing Overhead)
The depreciation on the machines used to make the table totals $10,000 per year. The machines have no resale value and do not wear out through use.
(Fixed Cost, Manufacturing Overhead, Sunk Cost)
The salary of the president of the company is $100,000 per year.
(Fixed Cost, Period Cost)
The company spends $250,000 per year to advertise its products.
(Fixed Cost, Period Cost)
Salespersons are paid a commission of $30 for each table sold.
(Fixed Cost, Period Cost)
Salespersons are paid a commission of $30 for each table sold
(Fixed Cost, Period Cost)
9.) Instead of producing the tables, the company could rent its factory space for $50,000 per year.
(Opportunity Cost)
Job Order Costing
used in situations where many different products are produced each period Example: Levi Strauss clothing factory would typically make many different types of jeans for both men and women during a month; Hallmark designs and prints different greeting cards during a month
Process Costing
used in situations where the company produces many units of a single product for long periods Example: Mixing and bottling beverages at Coca Cola; Making wieners at Oscar Mayer
How is a job cost sheet used and what is typically entered on it?
form that records the materials, labor, and overhead costs charged to the job.
How is the predetermined overhead rate applied?
Overhead applied to a particular job = predetermined overhead rate X amount of the allocation based incurred by the job
How is an allocation base selected?
The allocation base used in the predetermined overhead rate should drive the overhead cost. A cost driver is a factor, such as machine-hours, beds occupied, computer time, or flight-hours that causes overhead costs.
Raw Materials Purchased
(Debit: Raw Materials; Credit: Accounts Payable)
Direct and Indirect Materials issued to Production
(Debit: Work in Process & Manufacturing Overhead; Credit: Raw Materials)
Direct and indirect factory labor cost incurred
(Debit: Work in Process & Manufacturing Overhead; Credit: Salaries and Wages Payable)
Utilities and other factory costs incurred
(Debit: Manufacturing Overhead; Credit: Accounts Payable)
Depreciation recorded on factory assets
(Debit: Manufacturing Overhead; Credit: Accumulated Depreciation)
Overhead cost applied to Work in Process
(Debit: Work in Process; Credit: Manufacturing Overhead)
Administrative salaries expense incurred
(Debit: Salaries Expense; Credit: Salaries & Wages Payable)
Cost of goods manufactured transferred into finished goods
(Debit: Finished Goods; Credit: Work in Process)
Sale of Job A recorded
(Debit: Accounts Receivable; Credit: Sales)
Cost of goods sold recorded for Job A
(Debit: Cost of Goods Sold; Credit: Finished Goods)
Underapplied Overhead
(+)when the overhead cost applied to Work in Process is less than the actual overhead costs of a period Debit: Cost of Goods Sold Credit: Manufacturing Overhead
Overapplied Overhead
(-)when the overhead cost applied to Work in Process is greater than the actual overhead costs of a period Debit: Manufacturing Overhead Credit: Cost of Goods Sold
Why is estimated overhead cost used rather than actual?
1.) They would like to know the accounting system’s valuation of completed jobs before the end of the account period. 2.) If actual overhead rates are computed frequently, seasonal factors in overhead cost or in the allocation base can produce fluctuations in overhead rates. 3.) The use of predetermined overhead rate simplifies record keeping.
Predetermined Overhead Rate
(Estimated Total Manufacturing Overhead Cost)/(Estimated Total Amount of the Allocation Base)
Activity based costing (ABC)
a technique that attempts to assign overhead costs most accurately to products than the simpler methods. Each major activity has its own overhead cost pool (also known as activity cost pool), its own activity measure, and its own predetermines overhead rate (also known as an activity rate). An activity cost pool is a “cost bucket” in which cost related to a particular activity measure are accumulated. The activity measure expressed how much of the activity is carried out and it is use, as the allocation base for applying overhead costs to products and services. An activity rate is a predetermined overhead rate in an activity-based costing system.
Plantwide overhead rate
Single overhead rate for an entire factory. ---Conditions have since changed
Unit Level
Processing units on machines (machine-hours) Processing units by hand (direct labor-hours) Consuming factory supplies (units produced)
Batch Level
Processing purchase orders (purchase orders processed) Processing production orders (production orders processed) Setting up equipment (number of setup; setup hours) Handling material (pounds of material handled; number of times material moved)
Product Level
Testing new products (hours of testing time) Administering parts inventories (number of part types) Designing products (hours of design time)
Facility Level
General factory administration (direct labor hours) Plant building and grounds (direct labor hours)
Activity Rate
(Estimated Overhead Cost)/(Total Expected Activity)
Overhead Cost per Unit
(Total Overhead Costs Assigned)/(Number of Units Produced)
Note why overhead rates may shift from high-volume to low-volume products with activity based costing
When a company implements activity-based costing, overhead cost often shifts from high-volume products to low-volume products, with a higher unit product cost resulting for the low-volume products. An increase in unit product cost can result from batch-level and product-level costs, which can shift from the high-volume product to the low-volume product
Know the three ways activity based costing can improve costing products
1.) Activity-based costing usually increases the number of cost pools use to accumulate overhead costs. Rather than accumulating all overhead costs in a single, plantwide pool, or accumulating them in departmental pools, the company accumulates costs for each major activity. 2.) The activity cost pools are more standardized than departmental cost pools. All of the costs in an activity cost pool pertain to a single activity. 3.) Activity-based costing uses a variety of activity measures to assign overhead costs to products, some of which are correlate with volume and some of which are not.
What are the limitations of ABC costing?
Relies on a number of critical assumptions -Assumes the cost in each activity cost pool is strictly proportion to its activity measure -According to economists, as activity increases, the average cost drops -Using ABC method will overstate product costs
Cost Structure
the relative proportion of each type of cost present in an organization Example: An organization might have many fixed cost but few variable costs. Alternatively, it might have many fixed costs but few variable or mixed costs.
Variable costs
a cost whose total dollar amount varies in direct proportion to changes in the activity level Variable In total Change Per Unit Constant **If the activity level increase by only 10%, then the total variable cost increase by 10% as well. Examples: cost of goods sold, direct materials, direct labor
Activity Base
a measure of whatever causes the incurrence of variable cost (also known as a cost driver) Examples: -direct labor-hours, machine-hours, units produced, and units sold -number of miles driven by a salesperson, the number of pounds of laundry cleaned by a hotel, the number of calls by technical support staff at a software company, and the number of beds occupied in a hospital
Relevant Range
range of activity within which the assumptions made about cost behavior are reasonably valid
Fixed Costs
a cost whose total dollar amount remains constant even when there are changes in the activity level Fixed In total Constant Per Unit Change ** The cost per unit becomes smaller as the level of activity increases . Examples: property taxes, rent
Mixed Costs
contains both variable and fixed cost elements (also known as semivariable costs) Example: Nooksack Company must pay a license fee of $25,000 per year plus $3 per rafting party to the state’s Department of Natural Resources
Analysis of Mixed Cost
The fixed portion of a mixed cost represents the minimum cost of having a service ready and available for use. The variable portion represents the cost incurred for actual consumption of the service, thus it varies in proportion to the amount of service actually consumed. Account Analysis: an account is classified as either variable or fixed based on the analyst’s prior knowledge of how the cost in the account behaves. Engineering Approach: a detailed analysis of what cost behavior should be, based on an industrials engineer’s evaluation of the production methods used, the materials specifications, labor requirements, equipment usage, production efficiency, power consumption, etc.
General formula for a mixed cost
Y = a + bX Where Y = the total mixed cost a = the total fixed cost (the vertical intercept of the line) b = the variable cost per unit of activity (the slope of the line) X = the level of activity
reveal what is called linear cost behavior whenever a straight line reasonable approximates the relation between cost and activity (the dependent and independent variables)
Quick & Dirty Method
drawing a straight line through one of the data points helps make a quick estimate of variable and fixed costs. Estimated Fixed Cost = Vertical intercept where the straight line crosses the Y axis Estimated Variable Cost = Total cost at the point lying on the straight line – Estimated fixed cost
High-Low method
drawing a straight line through two of the data points (highest & lowest levels of activity) Variable cost = Slope of the line = Rise/Run = (Y_(2-) Y_1)/(X_2-X_1 ) = (Cost at the high activity level-Cost at the low activity level)/(High Activity Level-Low Activity Level) Fixed cost = Total cost – Variable cost (Slope x High Activity Level) Total cost = Fixed Cost + Variable cost (Slope x High Activity Level)
Drawback to High-Low Method
It utilized only two data points. A cost formula that is estimated solely using data from these two unusual periods may misrepresent the trust cost behavior during normal periods. **Only works if a linear relation between cost and activity exists**
Least-Squares regression Method
uses all the data points to separate a mixed cost into its fixed and variable components. A regression line of the form Y = a + bX is fitted to the data. The regression line minimizes the sum of these squared errors. (Distance away from linear regression line and data point). ** Most accurate method**
Contribution income statement
distinguishes between fixed and variable costs and therefore facilitates planning, control, and decision making
Calculate Contribution Margin
Contribution Margin = Sales – Variable Costs *shows what contributes toward covering fixed costs and then toward profits for the period
Cost-Volume Profit (CVP)
a powerful tool that helps managers understand the relationships among cost, volume, and profit. It focuses on how changes in the following will affect the contribution margin: 1.) Selling Prices 2.) Sales Volume 3.) Unit Variable Costs 4.) Total Fixed Costs 5.) Mix of Products Sold
What is meant by the contribution ratio?
Contribution Ratio = (Contribution Margin)/Sales or (Total Contribution Margin)/(Total Sales) or (Unit Contribution Margin)/(Unit Selling Price) It is the percentage (%) increase in profits for every $1 increase in sales.
Explain the process of incremental analysis..Consider only those items that will change
Incremental Analysis: A shorter, simpler approach to determine increased net operating income that does not depend on knowledge of previous sales, nor does it need a prepared income statement. It is more direct and focuses attention on the specific changes that would occur as a result of the decision. Considered items: only revenue, cost, and volume will change if the new program is implements
When one company’s costs consist of more fixed costs than another’s what will happen to profits when sales increase which company’s profits will tend to rise faster after fixed costs are covered?
Profits will increase when sales increase.
The Equation Method
Profits = (Sales – Variable Expenses) – Fixed Expenses Or Sales = Variable Expenses + Fixed Expenses + Profits Example: $250Q = $150Q + $35,000 + 0 **Profits must equal 0 for break-even point
Break-even point in units sold
(Fixed Expenses)/(Unit Contribution Margin)
Break-even point in total sales dollars
(Fixed Expenses)/(Contribution Ratio)
Target profit analysis input desired profit into equation
Sales = Variable Expenses + Fixed Expenses + Targeted Profit Example: $250Q = $150Q + 35,000 + 40,000 $100Q = $75,000 Q = 750 units
Sales Mix
the relative proportion in which a company’s products are sold. The idea is to achieve the combination, or mix, that will yield the greatest amount of profits. Most companies have many products, and often these products are not equally profitable.
Relevant costs
costs that differ between alternatives. Irrelevant costs can be ignored, saving decision makers tremendous amounts of time and effort and bad decision can easily result for erroneously decision making.
When are variable costs not relevant?
They are irrelevant when the variable costs do not differ between alternatives.
In assessing alternate courses of action explain the significance of relevant costs, sunk costs, opportunity costs , variable costs, avoidable costs, fixed costs, future costs, differential costs⬦
Relevant Cost: (see above) Sunk Cost: a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do. They are always the same no matter what alternatives are being considered; therefore, they are irrelevant and should be ignored when making decision. (irrelevant) Opportunity Cost: the potential benefit that is given up when one alternative is selected over another (relevant) Variable Cost: a cost whose total dollar amount varies in direct proportion to changes in the activity level Avoidable Cost: a cost that can be eliminated in whole or part by choosing one alternative over the other. (relevant) Fixed Cost: a cost whose total dollar amount remains constant even when there are changes in the activity level (irrelevant) Future Cost: a cost that has not yet been incurred (irrelevant if it doesn’t different between alternatives) Differential Cost: a difference in revenue between any two alternatives (relevant)
What are the relevant factors to consider when determining whether to drop a product line or discontinue part of an operation? P.459 How do allocated common fixed costs figure into the decision?
Relevant Factors: many qualitative & quantitative factors must be considered. The biggest factor is the impact the decision will have on net operating income. To assess the impact, cost must be carefully analyzed. 1.) An Illustration of Cost Analysis 2.) A comparative Format 3.) Beware of Allocated Fixed Costs Allocated Common Fixed Costs: can make a product line look less profitable than it really is. Dropping some product lines would result in a decrease in the company’s overall net operating income.
What is the significance of a constraint?
It is a limited resource of some type restricts the ability to satisfy demand. Manager must decide how products or services should be cut back since the company cannot fully satisfy demand.

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