Download Review of key topics

Review of Basic Cost Accounting
Key Topics
Today we will briefly review:
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Cost Terms and Purposes
Job & Process Costing
Standard Costing
Activity Based Costing
Alternative Income Calculations
COST TERMS & PURPOSES
Types of Cost Classification
Classification
Example
Object of Expenditure
Heat, light, xerox paper, salaries, etc.
(Common in state budgets. Says nothing about
purpose; hard to evaluate!)
Functional
Sales, administration, Cost of Goods Sold
(used under GAAP. shows purpose.)
Behavior as volume of activity changes
variable, fixed (useful internally for decisions.)
Others: Not really “classifications” since
they are so situation-specific.
Controllable /noncontrollable (useful concept in
budgeting)
Direct (traceable to cost object) or Indirect
(can’t trace)
Cost Object [or Objective]: "any activity or
item for which a separate measurement of cost
is desired."
Example: a product, a department a
customer [all are activities?]
Purpose: to help in decisions or to prepare
financial reports
Phases of assigning cost to objectives
(1) Accumulation by some "natural" classification (labor, material, etc.)
(2) Assignment to the objectives by either…
--Tracing
--Allocating
E.g.: Material costs are accumulated as material is purchased, then
typically traced to units of product as they are manufactured.
Indirect manufacturing costs (overhead) are allocated to units of
product.
Direct vs. indirect costs: can they be traced to the cost objective in an
economically feasible way? [cost-benefit.]
-A matter of judgment
Direct/Indirect Examples for Discussion
For a sales office as the cost object......
The office space?
A receptionist?
The sales manager's salary?
The company president's salary?
Insurance against fire and casualty?
Electricity
For a manufactured circuit board......
Transistors, integrated circuits, etc., mounted on the boards?
Solder used to make the connections?
Insulating varnish used to coat it?
Labor of the assembly line worker?
Supervisor's salary?
Cost Behavior: Fixed vs. Variable
Cost Driver: Any underlying factor that causes or
changes total costs.
Example: Cost of an audit engagement?
- Client new?
- No. of transactions the client has had
- Whether and how computerized
- Number of branch offices
- Volume (units made, sold)
Purpose is Prediction:
Would we predict based on a driver?
e.g. -The plant manager's salary is "fixed" -- does not depend on
volume.
Volume
But the manager might be laid off at very low volume or a second
shift manager hired at very high volume. Many fixed costs are discretionary.
Fixed does not mean Unchangeable
Cost Reaction to Changes in Activity
Need four perspectives!
Unit
Fixed Cost:
$
Total
$
Volume
Variable Cost: $
Volume
$
Volume
Within the relevant range
Volume
Separate Dichotomies
Think of Examples in a _______________ setting.
Cost object is a _____________
Direct/Indirect means it can be traced to the object.
Fixed/Variable concerns whether it increases with volume of activity (define).
Direct
Fixed
Variable
Indirect
Inventoriable ("Product") Costs vs. Period Costs
[Expensed when product sold]
[Expensed Immediately]
– Selling expenses
– General and Administrative
All costs to obtain the
merchandise:
– Dir. Material
"Prime"costs
– Dir. Labor
– Factory Overhead "Conversion" costs
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Different Definitions of Costs
for Different Applications
Activity-Based Costing and
Activity-Based Management
Undercosting and Overcosting
Product undercosting:
Occurs when a product consumes a relatively
high level of resources but is reported to have a
relatively low total cost.
Product overcosting:
A product consumes a relatively low level of
resources but is reported to have a relatively
high total cost.
Undercosting and Overcosting
Irene, Roberta, and Nancy are three bank customers.
They require different activities from the bank:
– Irene banks exclusively at the ATM or online.
– Roberta visits the teller daily to make deposits, withdrawals
– Nancy deposits foreign currency as well as calling the branch
frequently to ask currency rates.
Undercosting and Overcosting
Traditional allocation bases might apply branch
overhead to accounts based on account
balances or equal amounts per account.
Irene (who never makes any demands on the
branch) will be overcosted and appear less
profitable than she should.
Roberta and Nancy may be undercosted and
appear more profitable than they are.
Refining a Costing System
Guidelines for refining a costing system:
Direct-cost tracing – Classify as many of the total
costs as direct costs as is economically feasible.
Indirect-cost pools – Expand the number of cost
pools until each of these pools is homogeneous.
Cost-allocation basis – Identify the preferred
cost-allocation base for each indirect-cost pool.
Activity-Based Costing System
ABC calculates the costs of individual activities
and assigns costs to cost objects such as
products, services, or customers based on the
activities used to produce a product or service,
serve a customer, etc.
Activities of a
Milk Truck Delivery Person
Activity
Driving
Shelving
Paperwork
Waiting
Cost Driver
Time; miles; area of town
Time; number of packages;
categories of products
Time; types of customer
Type of customer?
Cost Hierarchies
1
2
3
4
Different cost pools basis on of the different types of
cost drivers (used as the cost-allocation bases)
ABC systems commonly use a four-part cost hierarchy
to identify cost-allocation bases:
Output unit-level cost
Batch level costs
Product-sustaining costs
Facility-sustaining costs
Output Unit-Level Costs...
are resources consumed for activities
performed as a function of individual units of
product or service.
– Energy
– Machine maintenance, repairs (depreciation?)
– Labor
Batch-Level Costs...
are resources used on activities that are related
to a group of units of product or service
– Setup hours to run a batch
– Procurement costs of placing an order
Product-Sustaining...
or service-sustaining, costs are incurred on
activities to support individual products or
services.
– Design costs
– Engineering costs
– Equipment dedicated to the product or service
Facility-Sustaining Costs...
are resources used on activities that cannot be
traced to individual products or services but
support the organization as a whole.
– General administration
– Rent or depreciation for headquarters, etc.
– Building security
Usefulness of Cost Hierarchies
Different levels of cost drivers:
Level
Output-unit
Batch
Useful for Decisions Such As…
Shall we increase production, and at what price?
How often should we produce batches?
What base amount must we charge to set up a “run,”
regardless of the number a customer wants made?
Product/Service-Sustaining Should we continue to offer this service/product?
Facility-Sustaining
Shall we continue in business or dissolve it?
Activity-based Management
Supervisors & managers typically oversee
activities rather than products.
ABC pinpoints opportunities for cost
reduction.
Improved information technology facilitates
ABC.
Activity-Based Management
ABM describes management decisions that use
activity-based costing information to satisfy
customers and improve profits.
– Product pricing and mix decisions
– Cost reduction and process improvement
decisions
– Design decisions
Product Pricing and Mix Decisions
ABC gives management insight into the cost
structures for making and selling diverse
products.
It provides more accurate product cost
information and more detailed information on
costs of activities and the drivers of those costs.
Cost Reduction and Process Improvement
Decisions
Manufacturing and distribution personnel use
ABC systems to focus on cost reduction efforts.
Managers set cost-reduction targets in terms of
reducing the cost per unit of the cost-allocation
base.
Design Decisions
Management can identify and evaluate new
designs to improve performance by evaluating
how product and process designs affect
activities and costs.
Companies can work with their customers to
evaluate the costs and prices of alternative
design choices.
Major Differences,
Traditional Costing vs. ABC
Typical System
One or a few indirect
cost pools
Application base may
be a true cost driver
Application base often
financial (direct labor cost,
direct material cost, etc)
ABC
Many pools
Base more likely a
true cost driver
Bases likely to be
non-financial (# of parts,
number of operations,
hours of testing, etc.)
Indicators of Need for ABC Systems...
significant amounts of indirect costs are now
allocated using only one or two cost pools.
all or most costs are identified as output unitlevel costs.
products make diverse demands on resources
because of differences in volume, process steps,
batch size, or complexity.
Indicators of Need for ABC Systems...
products that a company is well-suited to make and sell
report small profits while products for which a company
is less suited report large profits.
complex products appear to be very profitable and
simple products appear to be losing money.
operations staff have significant disagreements with the
accounting staff about the costs.
Limitations of ABC Systems
The main limitations of ABC are the effort &
measurements necessary to implement the
system.
ABC systems require management to estimate
costs of activity pools and to identify and
measure cost drivers for these pools.
Limitations of ABC Systems
Activity-cost rates also need to be updated
regularly.
Very detailed ABC systems are costly to operate
and difficult to understand.
Standard Costing
Basic Concept: Only the standard cost will be
applied to the product for inventory valuation and
income determination.
– Any difference from std. is called a "variance.“
– Variances are calculated and investigated (if large).
– Management by exception
Standard Cost Variances
Variable OH: Like DM, DL
Fixed OH: Prod’n volume,
Spending components
Criticisms of Standard Costing
A static target?
– Can avoid this
Emphasis on efficiency
– Encourages buildup of inventory, keeping workers &
machines busy
Emphasis on price of inputs
– Can undermine quality
Alternative Income Calculations
Absorption Costing
Sales
- CGS
=Gross Margin
- Selling Expenses
- Gen & Admin Expns
=Operating Income
Variable Costing
Sales
-Variable Mfg. Costs
[= Manufacturing Margin possible subtotal]
-Variable Selling & Admin
= Contribution Margin
-Fixed Costs:
Manufacturing
Selling
Administrative
=Operating Income
Differences in Reported Income
Change in Effect on FC
Inventory Expensed
Effect on
Incomes
Increase
Some FC deferred under Absorption that ACI higher than VCI
would be expensed under Variable
Decrease
Some FC carried forward from last year;
this year’s FC also expensed
ACI less than VCI
No Change
Amounts expensed are the same
ACI = VCI
If fixed OH/unit is not constant across time, we must trace the difference in
fixed overhead that gets expensed (or the amount that gets carried forward –
the same difference in amounts).