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LESSON 1: INTRODUCTION TO ACCOUNTINGA STRATEGIC CONTEXT

DECISION PROCESS FOR MANAGERS

1. Identify problem:describethesituation,focus on key problemto besolved2. Perform quantitative & qualitativeanalysis:analysethedata relatedto the problem3. Identifyalternativesolutions:determine or createfeasibleactionalternatives4. Evaluatealternativesolutions:consider likelyconsequences ofactionalternatives5. Make recommendations:choosethe bestalternative6. Implement recommendations:implementthechosenalternative

CHARACTERISTICS OF SERVICE ORGANISATIONS

y Labour intensive; often,highest proportionateexpenses = salaries & wagesy Outputs & inputscant bestored;servicemust beconsumed whenitis provided;no inventory ofintangiblesy Inconsistencyinservice provisioning; output variesfromindividual to individual

NOT-FOR-PROFIT ORGANISATIONS

y E.g. clinics,hospitals,schools,healthmaintenance,nursing & retirementhomesy Traditionallyfew pressures w/managementcontrol b/cacceptableto expend resourcesto maintainhuman life;

also,humanserviceareas = difficultymeasuring outputs

y Now sever resource limitationsPERFORMANCE IN HEALTH CARE ORGANISATIONS

y Key variable = critical factor believedto beadirectcause oftheachievement or non-achievement oforganisationgoals & objectives;can beexternal or internal

o Traditionallyservicesdelivered;now whereservices will havegreatestimpacty Output = healthcareservicedeliveredto patient;outcome = resultinghealthstatus ofpatient

CHAPTER 1: THE STRATEGIC CONTEXT

MANAGEMENT ACCOUNTING DEFINED

y Management accounting = gathering & application ofinformationusedto plan,makedecisions,evaluateperformance, & control an organisation

o Gathersinformationfrom other unitso Providesinformationto other units

y Financial accounting = generation ofaccountinginformationfor external reportingFinancial Management

Primary users External Internal

Primary organisational focus Whole (aggregation) Parts (segmentation)

Information characteristics * Historical,accurate

* Quantitative

* Monetary

* Forecasted,timely & reasonable

* Quantitative or qualitative

* Monetary or non-monetary

Overriding criteria * GAAP

* Consistency

* Verifiability & objectivity

* Situational relevance

* Benefits > costs

* Flexibility

Recordkeeping Formal Formal & informal

y Cost accounting = tools & methodsappliedto determinethecost ofmaking products or performingservicesMANAGEMENT ACCOUNTING: A COMPONENT OF MANAGEMENT CONTROL

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y Control = exertion ofmanagerial influence on operationsso thatthey will conformto planso Needed b/c (1)employeesmaynotunderstandexpectationsdueto lack ofability,training, or information

(2)employeesmay lack goal congruence w/organisation

o Examples:financial accounting,managementinformationsystems,employee & manager evaluationsystems,organisational culture (set ofbasicassumptionsabout organisation,itsgoals, & its business

practices;describes organisationsnormsininternal & external,formal & informal transactions)

y Managementaccounting = organisational controlo Specifyappropriateactivitieso Specifyappropriate resultso Recruit & develop appropriate personnel

MANAGEMENT ACCOUNTING: IMPLEMENTING STRATEGY

y Strategy = long-termdynamic planthatfulfils organisational goals & objectivesthroughsatisfaction ofcustomerneeds & wants withinthecompanysacknowledged operatingmarkets

y Mission statements = firststage ofstrategyformulation;shouldo Clearlystate what organisation wantsto accomplisho Expresshow that organisationmeetsitstargetedcustomersneeds

y Strategyistheart ofcreating value. It providestheintellectual frameworks,conceptual models,andgoverningideasthatallow an organisationsmanagersto identify opportunitiesfor bringing valueto customersandfor

delivering valueata profit. Inthis respect,strategyisthe wayacompanydefinesits businessand linkstogetherwiththe onlytwo resourcesthat reallymatter intodayseconomy: knowledgeand relationships or an

organisationscompetenciesanditscustomers.

y Business model = description ofa businesssdistinguishing operations or mechanisms,functions,and revenues &expenses

o Matchesstrategy w/internal skills & external environment opportunitieso Unitstrategiesshouldflow from overall strategyto ensureeffective & efficient resourceallocationsare

made, overridingcorporatecultureisdeveloped, & organisational directionisenhanced

y Managementaccountinghelpsmanagersdesign,implement, & evaluate organisationsstrategy by providinginformationaboutexpectations ofwhatastrategy will accomplish & cost, & strategysactual past performance

y Organisational structure = the wayin whichauthority & responsibilityfor makingdecisionsisdistributedinanorganisation

o Designedto implement organisationsstrategyo Organisation = people, resources, & commitments,acquired & arrangedto achieve resultsspecified bythe

strategy viagoals & objectives

o Goals = desired results or conditionsthatareexpressedin qualitativeterms; oftenformulatedforstakeholders (shareholders,customers,employees,suppliers)

o Objectives = quantitativelyexpressed resultsthatcan beachievedduringa pre-established period or byaspecifieddate;should logicallymeasure progressinachievinggoals

o Authority = the right (usually by virtue ofposition or rank)to use resourcesto accomplishatask or achievan objective;can bedelegated or assignedto others

o Responsibility = obligationto accomplishtask/achieve objective;cant bedelegatedto othersy Line positions = directly relatedto theachievement oforganisations basicstrategies;e.g. production,sales,

professorsy Staff positions = indirectlyassociated w/achievement oforganisations basicstrategies; providesupport or

assistanceto line & other staffpositions;e.g. managementaccountant

y Centralisation = organisational structurein whichtop managementmakesmostdecisions & control smostactivities oforganisational unitsfromcentral headquarters;difficultydiversifying operations b/ctop management

may lack necessaryindustry-specific knowledge

y Decentralisation = downwarddelegation bytop management ofauthority & decisionmakingto theindividuals whareclosestto internal processes & customers;to besuccessful,musthaveemployeeempowerment (practices

designedto give workerstraining,authority, & responsibilitytheyneedto managetheir own jobs & makedecision

abouttheir work);uses responsibilityaccounting

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y Core competency = anycritical function or activityin which one organisationhasahigher proficiencythanitscompetitors; roots ofcompetitiveness & competitiveadvantage

o E.g. technological innovation,engineering, productdevelopment,after-saleservicey Differentiation strategy = organisationdistinguishesits products or servicesfromthose ofcompetitors byadding

enough value (incl. quality & features)thatcustomersare willingto payahigher price;can be based on product,

deliverysystem,marketingapproach,etc.

y Cost leadership strategy = organisation becomesthe low-cost producer/provider &@ableto charge low pricesthatemphasisecostefficiencies

y Environmental constraint = any limitation onstrategycaused byexternal cultural,fiscal (e.g. taxation), legal,regulatory, or political situations or bycompetitivemarketstructures;tendsto have long run rather thanshort run

effects

y Managementaccountinginformationfor formulating,implementing, & evaluatingstrategieso Formulating:information on prospectivecustomers (e.g. numbers, locations,spending patterns,

profitability) basisfor forecasts & plans

y Managementaccountingfinancial & non-financial/operational datafor designing,implementing, & assessingstrategies

CONTRIBUTION OF MANAGEMENT ACCOUNTING TO THE VALUE CREATION CHAIN

y Strategicmanagementinvolves organisational planningfor deployment ofresources (e.g. fixedassets,employees,workingcapital)to create valuefor customers & shareholders;cannot bemeasured byfinancial accounting(monetary)

o How to deploy resourcesto supportstrategieso How resourcesareusedin, or recoveredfrom,change processeso How customer value & shareholder value will serveasguidesto theeffectiveuse ofresourceso How resourcesareto bedeployed & re-deployed over time

y Value creation chain (VCC) = set ofprocesses & activitiesthatconvertinputsinto products & servicesthataddvalueto the organisationscustomers;foundation ofstrategicmanagement ofresources

o Includessuppliers,internal processes, & customerso Can beused bymanagersto determine whichactivitiescreatecustomer valueas reflectedin

product/service prices &@ revenuesearned

ySuccessful organisationsmustcooperate w/everyoneinthe valuecreationchain b/ctodayscompetition = b/wvaluechains,not businesses

y VCC:sourcingenhancingaggregatingdisseminatinginteractingo Sourcing: obtaining raw or crudely producedmaterialsin order to add value latero Enhancing:making basic productsfrom raw materialso Aggregating: puttingtogether variousenhanced productsto produceacomplex producto Disseminating:distributing products/servicesto customers;incl. wholesale & retailo Interacting:conducted byconsumer;activitiesundertaken bycustomer in obtaininggood/service being

produced by valuecreationchain;e.g. driveto storeto buymilk

y Organisations requiremanagementaccountinginformationto manageactivities;e.g. customer information =necessaryto determine which products/servicesaredesired & how manyunits ofeachshould be produced,to

projectdemand levelsfor existing & future products/services

y Vertical integration = extentto which VCC resides withinasinglefirm (high VI = low number oflinksto other firmslow VI = highdependence onsuppliers,etc.)

y Strategic alliance = agreementinvolving 2+ firms w/complementarycorecompetenciesto contribute jointlyto VCRECENT DEVELOPMENTS AND THEIR IMPACT ON MANAGEMENT ACCOUNTING

y Informationtechnologyo Helpedautomateaccountingsystems:manual enterprise resource planning (ERP):fullyintegrated,full-

servicesuite ofsoftware w/commondatabasethatcan beusedto plan & control resourcesacrossanentir

organisation

o Shiftto manageatactivity level rather thanatfinancial transactions level (possible via ERP)

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y Crisis ofconfidenceo Ethical standards = normsthat represent beliefsaboutmoral & immoral behaviours;normsfor individuals

conductinmakingdecisions & engagingin businesstransactions

LESSON 2: COST BEHAVIOUR AND ANALYSISINTRODUCTION

KEY TERMS

y Cost accumulation: process ofcollectingcostsusingsomenatural classification,e.g. materials or laboury Cost allocation: tracking & allocatingindirectcoststo one or more objectivesy Cost assignment:tracking & assigningdirectcoststo one or move objectivesy Overhead costs:anycosts, other thandirectmaterials & labour,thatareassociated w/primary product ofan

organisation;e.g. inhealthcare, overheadcosts = facilitiesmanagement,accounting, HR

BASIC COST CONCEPTS

y Cost drivers = activitiesthataffectcostsy Variable cost = costthat indirect proportionto inthecostdrivery Fixed cost = fixedin relationto agiven period oftime & range ofactivity (relevant range)

o Relevant range= limit ofcost-driver activity within whichaspecific relationship b/w costs & costdriver isvalid

COST-VOLUME-PROFIT RELATIONSHIPS

1. Equation methoda. Profits = revenues per unitxunits (variablecosts per unitxunits + fixedcosts)

2. Graphical method3. Contribution margin method

a. Units = (fixedcosts + desired profit) contributionmargin per uniti. Contributionmargin = revenues variablecosts

COST-VOLUME-REVENUE ANALYSIS (appropriatetermfor breakevenanalysisinnot-for-profit organisations)

y Fixed revenues = revenuesthat,intotal, will remainataconstant level intheshort run (funding period) regardlessofvariationsinthe level ofactivity

y Variable revenues = revenuesthat varyindirect proportionto activity levels (e.g. clinical fees)y Fixed revenue fixedcosts = (variable revenue/unit variablecosts/unit)xservice volume

o Iffixed revenuesexceedfixedcostsnetfixedsurpluso Iffixed revenuesare lessthanfixedcostsnetfixeddeficito Contributionmargin per unit = variable revenue per unit variablecost per unit

y Netfixedsurplus or deficit = contributionmargin per unitxservice volumeUSING ACTIVITY ANALYSIS TO EXAMINE COST BEHAVIOUR

y Activityanalysis = importantfor measuring & predictingcosts wherecostdrivers obviousy Previouslyhiddenactivities,e.g. supervision & administration,caninfluencecost behaviour

MANAGEMENTS INFLUENCE ON COST BEHAVIOUR

y Product or servicedecisions (e.g. productmix,design, quality,marketing,etc.)y Capacitydecisions

o Capacity costs:fixedcosts relatedto achievingadesired level ofproduction or service;ineconomicdownturn,fixedcapacitycostscant be recovered

o Committed fixed costs:costs offacilities,equipment, & basic organisationcosts whichcompanyisobligatedto incur;e.g. lease payments,mortgage payments,insurancecosts, propertytaxes,salaries

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o Discretionary fixed costs:incurredto achieve organisational goals;no relationship to output levels, butdetermined via periodic budget planning;e.g. R&D,advertising,employeetraining

y Technologydecisions (e.g. machine vs. labour-intensivemanufacturing)y Costcontrol incentives (e.g. costexpectationsfor employees & providing rewardsifexpectationsaremet)

CHAPTER 2: COST TERMINOLOGY AND COST FLOWS

COMPONENTS OF PRODUCT COST

y Cost: amonetarymeasure ofthe resourcegivenup to acquireagood or servicey Cost object: anythingto whichcostsattach or are related;can be product or service,department,division,territor

etc.;ascost object ,so do direct & indirectcostallocations

y Direct cost: acostthatisclearly,conveniently, & economicallytraceableto a particular cost objecty Indirect cost:acostthatcant beclearlytracedto a particular cost object;akacommoncost;must beallocated

(assignindirect or overheadcosts based ontheuse ofacostdriver,a predictor, or anarbitrarymethod)

y Period cost:acostthatisincurredduringanaccounting periodto supporttheactivities ofthecompany (incurrednon-productionarea);cost ofresourcesconsumedduringthe period; relatedto businessfunctions likeselling,

administration,etc.

y Product cost:acostassociated w/making or acquiring/producinginventory or providingaservice;either direct orindirectto particular cost object;akainventoriablecosts;incl. costs ofdirectmaterial,direct labour,manufacturin

overhead (set ofindirectcosts)y Direct material:a readilyidentifiable, physical part ofa productthatisclearly,conveniently, & economically

traceableto that product;may be purchased raw materials or manufacturedcomponents (shouldtheoretically

includeall materialsusedin product)

o Whencosts = too expensiveto allocateto each product (e.g. saltfor sauce)indirecto Whencosts = too expensiveto allocateto eachservice provided (e.g. pencilsfor adcampaigndesigns)

indirectthesecosts significant

y Direct labour: timespent byindividuals who work specifically onmanufacturinga product or performingaservice& whoseefforts = conveniently & economicallytraceableto that product/service;direct labour time;directlyadds

valueto final product/service;consists ofwages/salaries, often: basiccompensation, productionefficiency bonuse

employersshare ofemploymenttaxes (whencosts = stable,shouldincl. employer-paidinsurancecosts,holiday &

vacation pay, pension, retirement benefits)o Sometimes,somecostsgetallocatedto indirect labour costs, b/c (1)inefficientto trace labour costs (e.g.

fringe benefitsin volatile low-payindustrydifficultto predict,notuseful), (2)erroneousinformation (e.g

overtime pay/shift premiums = overheadcosts)

o However,substance > forme.g. servicescheduledduringnon-work hours (overtime)direct labour costallocatedto specificservice revenues/expenses (not result ofscheduling)

y Overhead: expenses ofa businesssuchas rent,insurance,utilitiesconsumedin production ofproduct or insupplying ofservice;consideredindirect;majority ofcompaniesexpenses (direct labour costsq)

o Anyindirectmanufacturing or productioncost;excl. directmaterials & labour costso Evenmanufacturingindustry 2/3 ofcosts = overhead

y Total product cost:directmaterials + direct labour + overhead;inventoriableuntil productssold/written offy Production processing/conversion (also primaryaccounts;commondatabasefor accountingsystems)

o Work notstarted Costincurred reflects prices paidfor raw materials & supplies

o Work in process (raw materials + supplies + direct labour + manufacturing overhead) Costs relatedto conversion = accumulated & accrued;incl. wages, overhead

o Finished work (product readyfor sale;incl. all productioncosts)y Service organisations: work notstarted = cost ofnecessarysupplies (inventorieduntil needed)y Prime cost: total cost ofdirectmaterials & direct labour (mostconvincinglyassociated w/ & mosttraceableto a

specific product)

y Conversion cost:sum ofdirect labour & manufacturing overheadthatisdirectly or indirectlynecessaryfortransformingdirect (raw)materials & purchased partsinto saleablefinished product

o NB:direct labour includedin both,@ primecost + conversioncost total productcost

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COST BEHAVIOUR

y Cost behaviour: manner in whichacost respondsto a ina related level ofactivity;two types: variable & fixedo Relevant range: specified range ofactivity over whicha variablecost remainsconstant per unit & afixed

cost remainsfixedintotal;generally = operatingcycle or oneyear

y Cost driver: factor (activity/occurrence)thathasadirectcauseeffect relationship to acost;e.g. production volumdirecteffect ontotal cost ofraw materialsused;usuallynot obvious (costs = affected bymultiplefactors)e.g.

qualityassurancecostsaffected by volume ofproduction + quality ofmaterialsused + skill level ofworkers + level

ofautomation

y Predictor:activitymeasurethatisaccompanied byaconsistent, observable inacostitem;doesnotnecessarilycause in relateditem (reflects possible relationship or random related occurrence)

y Variable cost:costthat variesintotal indirect proportionto inactivityy Fixed cost:costthat remainsconstantintotal withinaspecified range ofactivity

o Incl. depreciation, propertytaxes,insuranceTotal cost Unit cost

Variable cost Variesindirect proportionto inactivity Isconstantthroughoutthe relevant range

Fixed costRemainsconstantthroughoutthe relevant

range

Variesinversely with inactivitythroughoutthe

relevant range

y Lean production = emphasis on wasteelimination,highinventoryturnover, & low inventory levelsy Companies oftenswitch variable & fixedcosts (e.g. automation, outsourcing, wagestructure,depreciationmethod

suchasunits-of-production v. straight-line, rent v. propertytaxes

y Mixed cost: costthathas both variable & fixedcomponents;doesntfluctuateindirect proportion or remainconstant w/ inactivity;e.g. electricity (flatcharge + per-usagecharge)

y Step cost: variable or fixedcostthatshiftsupward or downward whenactivity byacertaininterval or step (e.g.volumediscounts)must bedivided byfixed & variablecomponents over predicted range/usage (approximate

reality & allowsstability)

y Straight-line cost formula: y = a + bx, wherey = total cost,a = fixed portion, b = variable portion,x = activitybase/costdriver to whichyis being related

Methods for separating mixed costs into variable & fixed elements

y High-low method: costestimationtechniquefor separatingmixedcoststhatusesactual observations ofatotal coatthehighest & lowest levels ofactivity & calculates in bothactivity & cost; levelschosenmust be within relevan

activity range (activitiesinfluencecosts,not vice versa)

o Outlier:non-representative pointthatfalls outside ofrelevant range ofactivity, or thatisadistortion ofnormal costs within relevant range;should bedisregardedunder high-low method

o Independent variable: variablethat, when , will causeconsistent, observable inanother variable;variableusedasthe basis ofpredictingthe value ofdependent variable

o Dependent variable:unknown variablethatisto be predicted byuse ofone or moreindependent variableo Total mixedcostoor qw/ inactivities; incost = inactivityxunit variablecosto @ b = difference b/w costsathighest & lowestactivity levels difference b/w highest & lowestactivitylevels,i.e. intotal cost inactivity level

Representsunit variablecost per measure ofactivityy Scatter graph method: graphic representation ofrelationship b/w variables withina populationachieved by

plottingeachmagnitude or itemagainstcoordinates provided

o Cost v. activityo (1) Plot points ondiagramdatashouldcover range ofvolume wideenoughto incl. both lowest & highest

volumes likelyto happeninnear future,usuallymonthly, (2)draw straight linethrough pointsto represen

atrendseparatesfixed & variablecosts

y Regression analysis: statistical procedureusedto determine & measurea predictive relationship b/w onedependent variable & 1+ other variables

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o Better estimate ofcostformulathanhigh-low method;usesall data pointsy All areestimationtechniques only;appropriateness ofcostformuladepends on validity ofactivitymeasurechosen

(activity baseselectedshould be relatedto incurrence ofoverheadcost,should reflectsignificantcorrelation

statistical measure ofstrength ofrelationship b/w two variables); bewaresignificant inindustry (historical data

reliable)

DEVELOPING AND USING PREDETERMINED OVERHEAD RATES

Variable overhead rate(VOH): proportionatelyintotal w/somemeasure ofvolume or activity

y Predetermined overhead rate: budgetedconstantcharge per unit ofactivityusedto assign overheadcoststoproduction or services;should becomputedfor each VOH pool relevant rangeischosen,total costfor each pool

level ofactivity on whichestimate was based = per unitcost ofactivity

o Since VOH = constant per unitatall activity levels within relevant range,activity level chosenfor estimatintotal variablecost important

o Activitymeasureselectedshould logically relatemeasure & overheadcostincurrenceo Predetermined VOH rate = estimated VOH cost estimated outputo Alwayscalculatedinadvance ofyear ofapplication

y Homogeneity (uniformcommonattributecommonto all costsinagivencost pool)underliesall costallocation,e.gdirect labour hours,direct labour dollars,machinehours, production orders, production-related physical measures

(e.g. kg,L)

y Typical costsystem: overhead = assignedto Work in Processinventoryusing predetermined ratexactual quantityofactivity base

y Recording overhead: (a)separateaccountsfor actual & applied, (b)general ledgery Recordingmanufacturing overhead: (a)single overheadaccount, (b)separateaccountsfor variable & fixed

components (@mustseparatemixedcosts)

Fixed overhead rate (FOH): portion oftotal overheadthat remainsconstantintotal w/ inactivity within relevant range

y For productcosting:all fixedmanufacturing overheadcostsmust beestimated & assignedto appropriatecost pooto calculatenumerator ofpredeterminedfixedmanufacturing overhead rate

oSincefixed overhead = constantintotal,it variesinversely on per-unit basis w/ inactivity

@

specificactivity level must bechosenfor denominator

o Level ofactivityselected = firmsexpectedactivity Expected annual capacity: short-runconcept representinganticipated level ofactivityfor upcomin

year

y Capacity:measure ofproduction volume or ofsome other costdriver relatedto plantproductioncapabilityduringa period

y Ifactual results = closeto expected results ($ & volume)measure ofcapacityshould resuin productcoststhatmostclosely reflectactual costs

o Predetermined FOH rate = estimatedtotal fixedcosts estimated outputy Maychooseactivity level other thanexpectedannual capacity,e.g. ideal/theoretical capacity, practical capacity, &

normal capacity

o Theoretical capacity: estimatedabsolutemaximum potential productionactivitythatcould occur inproductionfacilityduringspecifictimeframe w/perfect operationcycle

o Practical capacity:activity level thatcould beachievedduringnormal workinghoursduringunusedcapaci& ongoing, regular operatinginterruptions,e.g. holidays,downtime,start-up time,etc.;takesinto account

unused resources

o Normal capacity:firms long runaverageactivity (5-10 years) whichgiveseffectto historical & estimatedfuture production levels & to cyclical andseasonal fluctuations

OVERHEAD APPLICATION

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y Applied overhead: amount ofoverheadassignedto Work in Processinventoryasa result ofoccurrence oftheactivitythat wasusedto develop theapplication rate; result ofmultiplyingthe quantity ofactual activity by

predetermined rate

o DRWork in Processinventory CR Variablemanufacturing overhead (variablecost per unitx output) CR Fixedmanufacturing overhead (fixedcost per timeunitxtime)

y Under-applied overhead: actual overhead applied overheadincurredfor the period;ending balance = debity Over-applied overhead: applied overhead actual overheadincurredfor the period;ending balance = credity Manufacturing overheadaccountsusedfor recordingactual & applied overheadamounts = temporary, balances

must beclosedatyear-end

y Typical costingsystem:actual overheadcosts = debitedto variable & fixed overheadgeneral ledger accounts,creditedto varioussources ofoverheadcosts;applied overheadcosts = debitedto Work in Processinventory via

predetermined rates & actual levels ofactivity,creditedto variable & fixed overheadgeneral ledger accounts

o Applied overhead = addedto actual directmaterials & direct labour costs whencalculatingcost ofgoodsmanufactured

o End-of-period balanceineach overheadgeneral ledger account = under-applied (debit) or over-applied(credit) overhead

y Closingimmaterial amounts ofover-applied variable overheado DR Variablemanufacturing overhead

CR Cost ofgoodssoldy Ifunder-/over-applied overhead = significant,allocateamongaccountscontainingapplied overhead (i.e. Work in

Process, FinishedGoods, Cost ofGoods Sold/ServicesRendered)

COMBINED OVERHEAD RATES

y Combined overhead rates = used b/c (1)clerical ease, (2)clerical costsavings, (3)absence offormal requirementsseparate overheadcosts bycost behaviour

o Only onetype ofactivitycan beselectedfor thecost pool (rather than variable & fixed)y Overheadapplication ratecan be relatedto particular cost pool (e.g. machine-related overhead) or to overhead

costsingeneral

y Blurscauseeffect relationshipsinabilityto reducecosts,improve productivity,discover causes ofunder-/over-applied overhead

hindersabilityto plan operations,control costs,makedecisions

ACCUMULATION OF PRODUCT COSTS Journal entries (p. 67), T-accounts (p. 68)

y Productcosts = accumulatedfor inventory purposes & expensedto Cost ofGoods Sold (flow via Work in Process,FinishedGoods, & ultimately Cost ofGoods Sold)

y Perpetual inventorycontrol system = continuously providescurrentinventory & cost ofgoodssoldinformationforfinancial statement preparation & inventory planning,costcontrol,decision-making

COST OF GOODS MANUFACTURED AND SOLD

y Cost ofgoodssold (CGS) = beginningmerchandiseinventory + purchases endingmerchandiseinventory;toosimplistic

y Cost of goods manufactured (CGM): total manufacturingcostsattachedto units producedduringanaccountingperiod

y Cost of goods manufactured statement:total cost ofgoodsthat werecompleted & transferredto FinishedGoodsinventoryduringthe period;internal statement only

o Preliminarystep to present CGSo Doesntincludecost ofwork still in processatend ofperiodo Allowsto see relationship b/w various productioncosts & know results ofcostflows viainventoryaccount

y Cost of goods sold: cost ofproducts/servicessoldduringthe periodo To calculate: CGM + beginning balance ofFinishedGoods (= cost ofgoodsavailablefor sale) ending

balance ofFinishedGoods

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LEAST-SQUARES REGRESSION ANALYSIS (Appendix 2A)

y Least-squares regression analysis: statistical techniquefor mathematicallydeterminingthecost line ofamixedcothat bestfitsthedataset byconsideringall representativedata points;allowstheuser to investigatethe

relationship b/w dependent & independent variables

y Simple regression analysis: regressionanalysisusing only oneindependent variableto predictthedependentvariable

y Multiple regression analysis: regressionanalysisusing 2+ independent variablesy Regression line: linethat representsthecostformulafor aset ofcost observationsfitto those observationsina

mathematicallydeterminedmanner

CHAPTER 3: COSTVOLUMEPROFIT ANALYSIS

THE BREAKEVEN POINT Short-term only

y Breakeven point (BEP): level ofactivity,inunits or dollars,at whichtotal revenue = total costsy Basicassumptionsaboutcost behaviour for BEP calculation

o Relevant range:company operates within relevant range ofactivityo Revenue: revenue per unit remainsconstanto Variablecosts: on per-unit basis,assumedto beconstant (production = directmaterials,direct labour, &

variable overhead;selling = commission,shipping;administrative,etc.)o Fixedcosts: remainconstant within relevant range (manufacturing overhead,fixedselling & administrative

etc.)

o Mixedcosts:must beseparatedinto variable & fixedelements (viaanymethod,e.g. high-low, regression,etc.)

y Contribution margin (CM): selling price per unit all variable production,selling, & administrativecosts per unit,i.e. CM = R VC; CM per unit = constant,total CM = fluctuates

y Breakeven pointformula:R(X) VC(X) FC = PBTy @ X = FC (R VC),@ X = FC CMy Contribution margin ratio (CM%): contributionmargindivided by revenue;indicates what proportion ofselling

price remainsafter variablecostshave beencovered

yCM% = (

R VC)

R,@

X($) = FC CM%y Variable cost ratio (VC%): 100% CM%; represents variablecost proportion ofeach revenuedollar

USING COSTVOLUMEPROFIT ANALYSIS

y Costvolumeprofit analysis (CVP analysis): process ofexamining relationshipsamong revenues,costs, & profitsfor a relevant range ofactivity & for a particular time period

Fixed amount of profit before tax

y Set PBTdesiredy X = (FC + PBT) CM or R(X) = (FC + PBT) CM%

Fixed amount of profit after tax

y PBTxTR = taxexpensey PAT = PBT (PBT)(TR) = PBT(1 TR)y PBT = PAT (1 TR)y X = (FC + PBT) CM or R(X) = (FC + PBT) CM%

Variable amount of profit before tax (specified variableamount ofsales)

y R(X) VC(X) FC = PuBT(X), where PuBT = profit per unit beforeincometax

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y X = FC (CM - PuBT)Variable amount of profit after tax

y PuBT(X)xTR = taxexpensey PuBT(X) = PuAT(X) (1 TR)y X = FC (CM - PuBT)

THE INCOME STATEMENT APPROACH

y Incomestatementapproachto CVP analysisallows preparation ofpro formastatementsy Sinceformula & incomestatementapproaches = based onthesame relationships,eachshould beableto proveth

other

y See p. 123 for proofofcomputations viaincomestatementapproachto CVPINCREMENTAL ANALYSIS FOR SHORT-RUN CHANGES

y BEP oifFC o, VC o,selling price per unitq, or CM% qy CM% (unit)qifVC oand/or selling priceqy Incremental analysis: techniqueusedindecisionanalysisthatcomparesalternatives byfocusing ondifferencesin

their projected revenues & costso In CVP analysis = based on occurringin revenues,costs,and/or volume

y Breakeven graph: graphical depiction ofrelationships b/w revenues, VC, FC, & profts/losseso X-axis: volume,y-axis:dollars;comparetotal revenue line & total VC line CM areao CM = created byexcess ofrevenues over VC;ifVC > revenues,no quantity ofvolume profito Total CM = total FC + profit or losso Before profitcan begenerated, CM must > FC

y Profitvolume (PV) graph: graphical presentation ofprofit or lossassociated w/each level ofsaleso X-axis:salesunits,y-axis: profit/lossindollars; profit lineaty = 0 BEP; profit lineatx = 0 FC

COSTVOLUMEPROFT ANALYSIS IN A MULTIPRODUCT ENVIRONMENT

y Mustuse weighted-average CM% (dueto assumption ofconstantsalesmix)o Pre-productsum ofsalesmix % (relativeto salesdollars)x CM ratio

y Companiescanalso bundle productsto increasesales (e.g. valuemeals)UNDERLYING ASSUMPTIONS OF COSTVOLUMEPROFT ANALYSIS

y All VC & revenue behaviour patterns = constant per unit & linear within relevant rangey Total CM (i.e. total revenue total VC) = linear within relevant range & oproportionately w/outputy Total FC = constantamount within relevant rangey Mixedcostscan beaccuratelyseparatedinto fixed & variableelements (estimatescan bedeveloped viahigh-low,

regression,etc. analyses)

y Sales & production = equal,@no material fluctuationininventory levels (needed b/c ofallocation ofFC toinventoryat potentiallydifferent rateseachyear)y No capacityadditionsduring periodunder consideration (FC/VC cant )y Inmultiproductfirm,salesmix = remainconstanty No inflation, or inflationaffectsall costfactorsequally; or iffactors affectedequally,appropriateeffects

incorporatedinto CVP figures

y Labour productivity, productiontechnology, & marketconditions will not (ifany occurred,costs would correspondingly, possiblethatselling prices would invalidatefirstthreeassumptions)

MARGIN OF SAFETY AND OPERATING LEVERAGE

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y Margin of safety: excess ofestimated (budgeted) or actual sales ofacompany over its breakeven point;can becalculatedinunits or dollars, or asa percentage

o Inunits:estimated (actual)units breakevenunitso Indollars:estimated (actual)salesdollars breakevensalesdollarso As percentage:margin ofsafetyinunits or dollars estimated (actual)salesinunits or dollars

y Operating leverage: factor that reflectsthe relationship ofacompanys variable & fixedcosts;measures in profiexpectedto resultfromaspecified percentage insales

y o VC &q FC (e.g. labour-intensive organisations)q operating leverage & q BEPy q VC &o FC (e.g. capital-intensive organisations)o operating leverage & o BEP

o o operating leverageo CM%;i.e. eachunitsoldafter BEP (i.e. after o FC covered) = o profitsy Degree of operating leverage (DOL): measure ofhow a percentage insales will affect profits;calculatedata

specifiedsales level ascontributionmargindivided byincome beforetax

o DOL = CM PBT;assumesthat FC do noto whensalesoy DOLqascompanymovesfurther awayfrom BEPy qmargin ofsafetyoDOL;at BEP,DOL = (anyofrom 0 %)

ABSORPTION AND VARIABLE COSTING (Appendix 3A)

y Absorption costing: mostcommonapproachto productcosting;costaccumulationmethodthattreatscosts ofallmanufacturingcomponents (directmaterials & labour, variable & fixed overhead)asinventoriable or productcost

akafull costing;approved by CICA (re:matching)o Productcosts work in processfinishedgoodscost ofgoodssoldo Periodcostsselling/administrative/other expenseso Incomestatement: revenue cost ofgoodssold (= grossmargin) other expenses = PBTo Functional classification: grouping ofcostsincurredfor thesame basic purpose

y Variable costing: costaccumulationmethodthatincludes only variable productioncosts (directmaterials & labouvariablemanufacturing overhead)as product or inventoriablecosts & treatsfixedmanufacturing overheadasa

periodcost;akadirectcosting

o Product contribution margin (PCM): revenue variablecost ofgoodssoldo Total contribution margin (TCM): revenue all variablecosts regardless ofarea ofincurrence (production

or non-production)

Also,TCM = PCM non-productioncostso Incomestatement: revenue variablecost ofgoodssold (= PCM) variablenon-manufacturingexpenses,

e.g. selling/administrative/other (= TCM) total fixedexpenses,e.g.

manufacturing/selling/administrative/other = PBT

y Cost behaviour (relativeto inactivity)cant be observedfromabsorptioncostingincomestatementy @althoughmandated by regulation,absorptioncostingshouldnt beusedinternallyy Differences b/w absorption & variablecostingmethods

o Absorptioncosting FOH = productcost; variablecosting FOH = periodcosto Absorptioncostingclassifiesexpenses byfunction; variablecostingclassifiesexpenses by behaviour,

then byfunctionifnecessary

y Similarities b/w absorption & variablecostingmethodso

Same basiccostinformationo Sametreatment ofdirectmaterials & labour, VOH (always productcosts)

ABSORPTION COSTING VARIABLE COSTING

Composition of product cost

Manufacturing FOH = attached,inseparateamounts,to

units produced;iffirmsellsall inventory producedin period

+ onhandat beginning ofperiod previouslyincurred

manufacturing FOH incomestatementas part ofCOGS.

Manufacturing FOH = periodcost (expense) whenincurred

notattachedinseparateamountsto units produced;each

period,all manufacturing FOH incurredincomestateme

asexpense, butnot via COGS

Structure of the chart of accounts

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o Selling & administrativeexpenses = periodcostso No differences b/w accounts other than Work in Process, FinishedGoods, & expenseaccounts

LESSON 3: COST MANAGEMENT SYSTEMS INTRODUCTION

CONTROLLING COSTS OR COST DRIVERS

y Cost ofsetupscontrolled via (1) volume-related,mass-productionsolution ofhavinga limitednumber ofproduction runs ofmanyitemsso that onlyafew productionsetupsareneeded (long production runsavoidcostly

changeovers), or (2) lower setup costs,e.g. just-in-time (JIT) or total qualitymanagement (TQM)simplifying &

redesigningmachinery,@ production runscan beshorter,easier to produceto demand

ABC PROVIDES MORE ACCURATE COSTING

y Activity-based costing (ABC): two-step allocationsystemthat (1)accumulatescoststhathavethesamecostdriveinto cost pools, (2)usesanactivitydriver to assigncoststo products & services

y Triesto treat overheadcostsas variablecostso proportion ofoverheadcostsallocated w/ABC,oaccuracy (restmust beallocated viatraditional methods)

y Eliminates productcross-subsidies;inaccurate productcostinginaccurate product pricingy Tracesnon-manufacturingcosts,e.g. marketing,customer service,engineering, & administrative,to products &

servicesusingadditional cost pools & activitymeasures (advantageous b/csome products & servicesmayusemor

than others better product pricing, planning,design, & distribution)

COST SYSTEM PHILOSOPHY

y Organisationsdecisionto adoptABC changesemphasis ofcostaccumulationfromcost objects (e.g. departmentto activities

y Combined w/broader objectiveto reduce/eliminatenon-value-addedcosts & improve product & process qualityABC helpso profitability,efficiency, & effectiveness

o Calledcost management systemo Activity-based management: activityanalysis + activity-basedcosting

HOW ENTERPRISE RESOURCE PLANNING BENEFITS ABC

y ChallengeinimplementingABC = finding rightactivitycostdriver to useinattributingcost ofactivityto products oother cost objects

o Usuallynumber ofsales orders,material moves,engineeringchangenotice per type,etc.y Enterprise resource planning (ERP)systemsoavailability & reliability ofABC information

o Use relational databaseto integratefinancial accounting,managerial accounting,costaccounting,production planning,materialsmanagement,sales & distribution,human resourcemanagement, quality

management, & customer service

o Permitsdifferentfunctional areasto shareinformation w/o re-entering/duplicatingdatain variousdatabasesin organisation

o Provides reliableactivitycostdriver information byintegrating production planning,materialsmanagement, & costandmanagementaccounting (ABC = usedto oaccuracy ofproduct-costinformation

to develop activity-based budgets)

Costs = classifiedaccordingto functional categories,e.g.

production,selling,administrative.

Costs = classifiedaccordingto cost behaviour & functional

categories (manufacturing/non-m);mixedcosts = separate

Process of accumulating costs

All manufacturingcosts = productcosts;all non-

manufacturingcosts = periodcosts

Classified & accumulated bycost behaviour;manufacturin

VC = productcosts;manufacturing/non-m FC = periodcos

Format of the income statement

Costsincomestatement byfunctional categoriesGM

highlighted;doesntincl. cost behaviour;non-m period

costs = deductedfromGM income beforetaxes

Costsincomestatement bycost behaviour CM

highlighted; FC = deductedfrom CM income beforetaxe

costsmay befurther categorised byfunctions

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o BeforeABC,materialshanding/other managementcostsallocatedto products based on % ofdirectmaterial costsassociated w/each product (based on relationship b/w budgetedmaterialsmanagement

costs & expectedtotal cost ofdirectmaterials)

CHAPTER 4: COSTING SYSTEMS

JOB ORDER COSTING SYSTEM

y Productcosting: (1)costidentification, (2)costmanagement, (3) productcostassignmenty Job order costing system: productcostingmethodused byentitiesthat produce limited quantities ofcustom-mad

goods or servicesthatconformto specificationsdesignated bythe purchaser

o Costs = accumulatedindividually byjob (singleunit or group oflikeunitsidentifiableas being producedtodistinctcustomer specifications)

y Costs ofdifferent jobs = maintainedinseparatesubsidiary ledger accounts & notaddedtogethery Typical job order inventoryaccount:actual directmaterials & labour,combined w/predetermined overhead rates

actual costdriver (e.g. direct labour hours,cost/quantity ofmaterialsused,materials requisitionsunits,etc.)

normal costing method (used b/cactuals = easyto identify)

y Overheadcosts = allocatedto productionJOB ORDER COSTING: DETAILS AND DOCUMENTS

y Basicstages ofproduction (re: production lifecycle)o (1)Agreed-upon butnotyetstarted, (2) Jobsin process, (3) Completed jobs

y Materials requisition form: sourcedocumentthatindicatesthetypes & quantities ofmaterialsto be placedintoproduction or usedin performingaservice;causesmaterials & their coststo be releasedfromthe raw materials

warehouse & sentto Work in Processinventory

o DRWork in Processinventory (directmaterials)o DRManufacturing overhead (indirectmaterials)

CRRaw material inventoryy Job order cost sheet:sourcedocumentthat provides virtuallyall financial informationabouta particular job;the

set ofall job order costsheetscomposes Work in Processinventorysubsidiary ledger

o Top portion ofjob order costsheet: job number,description oftask,customer identification, variousschedulinginformation,deliveryinstructions,contract price

o Rest ofform:actual costsfor materials & labour,applied overheadcosts;sometimesestimatesy Employee time sheet (time ticket): sourcedocumentthatindicates,for eachemployee, what jobs were worked o

duringtheday & for whatamounts oftime

o DRWork in Processinventory (direct labour)o DRManufacturing overhead (indirect labour)

CR Wages payabley Cost-plus job: a job being billedatcost plusspecified profitmarginy Actual overheadincurredduring production = incl. in overheadcontrol account

o Ifactual overhead = appliedto jobs,costaccountant = waituntil end ofperiod & divideactual overheadincurred bysome relatedmeasure ofactivity or costdriver

o Actual overhead would beappliedto jobs bymultiplyingactual overhead rate byactual measure ofactivityassociated w/each job

o Overheadappliedatearliest of: (a)completion ofjob, or (b)end ofperiod DR Work in Processinventory CR Manufacturing overhead

y Completion ofproductiono DR FinishedGoodsinventory

CR Work in Processinventoryo DR Cost ofgoodssold

FinishedGoodsinventory

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INTRODUCTION TO PROCESS COSTING

y Process costing:method ofaccumulating & assigningcoststo units ofproductionincompaniesthatmake largequantities ofhomogeneous products,i.e. mass-producing

o Ifproducts homogeneous joint processingcosts:allocation ofprocesscoststo 2+ productsy Calculating productunitcostin processcostingsystem: weightedaverage & FIFO

o Major difference:treatment ofbeginning Work in Processinventoryy Process costing system: productcostingsystemused bycompaniesthat produce largeamounts ofhomogeneous

productsthroughacontinuous productionflow

o Costs = accumulated bycostcomponentineach productiondepartment (similar to job order)y Differences between job order & processcosting

o Job order costing:accumulateddepartmental costsassignedto specific jobs; processcosting:accumulateddepartmental costsassignedto all unitsthatflowedthroughdepartmentduringthe period

Valuationmethod (actual,normal,standard)affectscoststo beincl. ininventoryo Quantity ofproductionfor whichcostsare beingaccumulatedatany onetime (specific v. mass-produced)o Cost objectto whichcostsareassigned (specific v. batch)

y Similar to job order costing,directmaterial & labour components ofproductcost = determined viasamemethodso Processcosting:costsassignedatend ofperiodfromdepartmentsto units produced; overheadmust be

allocatedto units

y Processcostingassignscoststo bothfully & partiallycompletedunits byconverting partiallycompletedunits(Work in Processinventory)to equivalent wholeunits/units ofproduction

y Equivalent units of production (EUP): approximation ofnumber ofwholeunits ofoutputthatcouldhave beenproducedduringa periodfromactual effortexpendedduringthat period

o Actual units being producedx % ofcompletionatend ofperiodo Use ofEUP recognisesthat: (1)unitsin beginning Work in Processinventory will becompletedduring

current period, (2) partiallycompletedunitsinending Work in Process werestartedincurrent period but

will not becompleteduntil next period

INTRODUCTION TO WEIGHTED AVERAGE AND FIFO PROCESS COSTING

y Weighted average method: method ofprocesscostingthatcomputesaveragecost per equivalentunit ofproduction;combines beginninginventoryunits w/current production & beginninginventorycosts w/currentcost

to computetheaverage

y FIFO method:method ofprocesscostingthatcomputesaveragecost per equivalentunit ofproductionusing onlycurrent production & currentcostinformation;units & costsin beginninginventory = accountedfor separately

EUP calculation & cost assignment Formula Comments

1. Calculate physical unitsto accountfor BWIP + startedincurrent period Determineunitsthatarein process

2. Calculate physical unitsaccountedfor Completed & transferred out + EWIPIdentifygroups ofunitsto becosted

(beginning & ending WIP,completed

Verify that (2) = (1)

3. Determine EUP Weightedaverage or FIFOIdentify relatedeffortincurredfor

eachunitgroup bycostcomponent4. Determinetotal costto accountfor BWIP cost + currentcosts Determinecostsalreadyincurred

5. Calculatecost per EUP Weightedaverage or FIFOCalculate EUP costto beassigned pe

costcomponent

6. Assigncoststo inventoriesTransferred out (FG or next

department) & EWIP

Calculatetotal costto beassignedto

eachgroup ofunits worked onduring

period

Verify that total costs transferred out

+ costs in ending inventory = (4)

y Weightedaveragemethod = focuses onunitscompletedincurrent period & unitsthat remainin EWIP

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o Units started & completed (S&C): total unitscompletedduring period BWIP; or,unitsstarted EWIPy Cost per EUP = (BWIP + current periodcost) total weightedaverage EUPy Cost of production report: documentusedin processcostingsystem;detailsall manufacturing quantities & costs,

showscomputation ofcost per EUP, & indicatescostassignmentto goods producedduring period

y FIFO (3): only work performed on BWIP duringcurrent period = part ofEUP,i.e. BWIP x (1 - % work done prior)y FIFO (5):cost per EUP = current periodcost FIFO EUP (3)y Spoilage (spoiled unit, defective unit): unit ofproduct w/imperfectionsthatcant beeconomicallycorrectedy Normal spoilage: units lostdueto nature ofmanufacturing process;unavoidable; productcosty Abnormal spoilage:units lostin productiondueto eventsnotinherentinmanufacturing process; periodcostsy Continuous loss: reductionsthat occur uniformlyduring processingy Method of neglect:method oftreatingspoiledunitsinschedulecalculatingequivalentunits

CHAPTER 6: ACTIVITYBASED MANAGEMENT AND COSTING

THE ABC SYSTEM (NB: German cost accounting similarities, p. 370)

y Activitybased costing (ABC): accountinginformationsystemthatidentifies variousactivities performedinanorganisation & collectscosts onthe basis ofunderlyingnature & extent ofthoseactivities

y 3 strategies objectives: (1) reportaccuratecoststhatcan beusedto identifysource offirm profits; (2)identifycostofactivitiesidentifymoreefficient waysto performthem or producetheir outputs; (3)identifyfutureneedfor

resourcesacquirethemmoreefficientlyy Model the way resources = consumed,notacquired

DEVELOPING PRODUCT/SERVICE COST INFORMATION

y Product/servicecosts = developedto (1)haveinformationfor financial & regulatory reporting, (2)helpmanagementmake product pricing & produce lineexpansion/contractiondecisions, (3)allow managementto

monitor & control operations

y Ifbestestimate results when largestnumbers ofcosts = traceddirectly,then bestestimate will also be obtainedwhenfewestcosts = assignedarbitrarily

o Overheadcant bedirectlytraced,@must beattached via validcost predictor (driver) or arbitrarilyACTIVITY ANALYSIS

y Activitybased management (ABM): disciplinethatfocuses onhow activities performedduringproduction/performance processcanimprove value received bycustomer & profitachieved by providing value

o Process & activityanalysis,costdriver analysis,activitybasedcosting,strategic planning,integration w/comanagementsystem,continuousimprovement, operational control, performanceevaluation, business

processengineering

y Activity: repetitiveaction,movement, or work sequence, performedto fulfil a businessfunctiony Process map:flowchart or diagramthatindicateseverystep inmakinga product or providingaservicey Value chart: visual representation ofthe value-addedandnon-value-addedactivities & thetimespentinall of

theseactivitiesfrom beginningto end ofthe process

y Value-added activity (VA): activitythatoworth ofproduct/serviceto customer,for whichcustomer = willingto pao E.g. packaging,compounding

y Value-added processing time: timeittakesto performall necessarymanufacturingfunctionsfor acustomery Value-added service time: timeittakesto performall necessaryservicefunctionsfor acustomery Non-value-added activity (NVA): activitythatotimespent on product/service butdoesntoits value/worth

o E.g. materials receiving, qualitycontrol,storage,machinesetup,shipping betweenfacilitieso Transfer time: timeittakesto move products/componentsfrom one placeto another;movetimeo Idle time:storagetime & timespent waitingat production operationsfor processingo Inspection time:timetakento perform qualitycontrolo Can beattributedto systemic, physical, & humanfactors

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y Business value-added activity (BVA): activitythatisnecessaryfor operation ofbusiness butfor whichcustomer willingto pay,e.g. auditingcosts

y Cycle time:timefrom whencustomer places order to time when product/service = delivered,OR, viafull life-cycleapproach:timefromconceptualisation ofproduct/serviceto time product/service = deliveredto market/consume

o Cycletime = value-added processingtime + total non-value-addedtimeo Retail:timefrom whenitem = orderedto time whenitem = soldto customero Service:timefrom whenservice order = placedto time whenservice = completed

y Manufacturing cycleefficiency (MCE): value-added processingtime total cycletime;shows productionefficiencyy Activityimprovementmeasures:changeflows & processes,schedule,train,simplify,combinefragmentedactivitie

automate,standardise,eliminateduplication,eliminatecause ofrework

y ocostdriversanalysedoaccuracymayocosts;@costs v. benefitsmust beconsidered (costbenefitanalysis)y ABC abilityto moredirectly observe where,how, & whycosts = incurred, byfocusing onactual activitiesdirectly

associated w/providing product

ACTIVITYBASED COSTING

y Underlyingelements ofABC: (1)gatheringcostsinto relatedcost pools, (2) recognisingthat variousactivity & costlevelsexist, (3)usingmultiplecostdriversto assigncoststo products & services

y Overhead = accumulatedinto one or two cost pools (total overhead, or variable & fixed overhead)y Levels ofcostincurrence

CLASSIFICATION LEVEL DEFINITION TYPE OF COSTS NECESSITY OF COST

Unit-level cost

Cost created by productionor acquisition of a single unitof production or delivery of asingle unit of service

* Direct material* Direct labour* Some machine costs, if traceable

Once for each unitproduced

Batch-level cost

Cost created by group ofsimilar things made, handled,or processed at a single time

* Purchase orders* Setup* Inspection* Movement* Scrap, if related to batch

Once for each batchproduced

Product- or process-

level cost

Cost created by need toimplement or supportspecific product

* Engineering change orders* Equipment maintenance* Product development* Scrap, if related to product design

Supports a producttype or a process

Organisational- or

facility-level cost

Cost incurred to supportongoing operations, which inturn provide availablefacilities

* Building depreciation* Plant or division managers salary* Organisational advertising

Supports overallproduction or servicprocess

y Batch-, product-/process-, & organisational-/facility-level costs = traditionally regardedasfixed;however,can beseenas long-term variable

y Long-term variable cost: costthathastraditionally been viewedasfixed butthat will actually reactto somesignificantchangeinactivity;akastep fixedcosty Activity centre:segment ofproduction or service processfor whichmanagement wantsaseparate report ofcosts

ofactivities performed;consider geographical proximity ofequipment,definedcentres ofmanagerial responsibilit

magnitude ofproductcosts,needto maintainmanageablenumber ofactivitycentres

o Past: overheadaccumulatedusing vertical or functional approach;e.g. departmental costseparationo Now:since production & serviceactivities = horizontal,should begatheredin pools reflectingsamecost

drivers

y Activity cost centre: measure ofdemands placed onactivities &@ resourcesconsumed by products & services;oftenindicatesactivitys output

y Determining product profitability & company profits:

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o Total product revenue = productunitselling pricex productunit volumeo Total productcost = total productcost per unitx productunit volumeo Net productmargin = total product revenue total productcosto Total margins provided by products = net productmargin all other net productmarginso Company profit or loss = total margins provided by products organisational-/facility-level costs (i.e.

corporate/divisional administration,facilitydepreciation)

y ActivitydriversACTIVITY CENTRE ACTIVITY COST DRIVERS

Accounting Reports requested; dollars expended

Personnel Job change actions; hiring actions; training hours; counselling hours

Data processing Reports requested; transactions processed; programming hours; program change requests

Production engineeringHours spend in each shop; job specification changes requested; product change noticesprocessed

Quality control Hours spent in each shop; defects discovered; samples analysed

Plant services Preventative maintenance cycles; hours spent in each shop; repair maintenance actions

Material servicesDollar value of requisitions; numbers of transactions processed; number of personnel indirect support

Utilities Direct usage (metered to shop); space occupied

Production shopsFixed per-job charge; setups made; direct labour; machine hours; number of moves;material applied

y ABC requiresinvestigation ofeachdepartmentto determine (a)how muchtime personnel actuallyspend oneachproduct, (b) whatfactor drivescostsinthatdepartment

y ABC v. traditional costing:ABC = forward-looking,@yields better informationfor settingappropriate prices &determiningcost & profitimpact ofdifferent productmixes;traditional costing = companymayinappropriately

assumethata particular productiscontributingmore profitthatitactuallyis (e.g. dueto inaccurate breakdown of

associatedcosts,esp. overhead)

y Assume: 10% costdifference b/w ABC & traditional costingtrigger to switchto ABC;not less b/cevenABC incl.arbitraryallocation ofoverheadcosts,@at overheadcosts of15%+ oftotal cost = ABC moreaccurate,at

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y Arenon-standard partsusedin products purchased byimportantcustomers who are willinto paya premium pricefor products?

o May be worthit, but wouldcustomers beequallysatisfiedifmorecommon partswereused & product price were reduced?

Partscomplexityis onlyacceptable whencustomer findsit value-addedo Simultaneous (concurrent) engineering: integratedapproachin whichall primaryfunctions & personnel

contributingto products origination & production = involvedcontinuouslyfrom beginning ofproject

Multifunctional teams = usedto design product byconsideringcustomer expectations, vendorcapabilities, partscommonality, & production processcompatibility

y Design-for-manufacturabilityapproacho Business process re-engineering: processinnovation & redesignaimedatfinding & implementing radical

changesinhow thingsaremade or how tasksare performedto achievesubstantial cost,service, or time

reductions

Needed b/ceven whensimultaneousengineeringisusedin processdevelopment, processesmaydevelop complexity over time

Appropriatefor 70% offirms;alternative = new productdesign (expensive,maynot benecessary)y Thereisa lack ofcommonalityincreation & use ofoverhead

o E.g. some products requiresubstantiallymoreadvertising,usehigher costdistributionchannels,necessitause ofhigh-technologymachinery; when output volumesdiffer among products & servicesadditional

overheadcostsunfair overheaddistributionamong products & services

y Thereare problems w/currentcostallocationso Manycompaniesautomated production processesq labour costs,o overheadcostso Traditional costallocation = assigns productcosts (i.e. directmaterials & labour,manufacturing overhead)

to products & expensemajority ofperiodcosts whenincurred;ABC some periodcostscan beassociated

w/products & should beallocatedappropriately

y Therehas beensignificantchangeinenvironmentin which organisation operateso ocompetitionmay occur b/c

Other companies recognised profit potential ofa particular product/service Product/service becamecost-feasibleto make or perform Industry becamederegulated

o Changesinmanagementstrategy,e.g. eliminatingNVAactivitiesABC helpsidentifythemy Comparedto processcostinginformation, job-order costsystem better reflects productcostdifferencesinvolving

material & labour b/cit recognisesthattwo different productsmayhavedifferentcosts;however,italso assumes

that overheadcosts = relatedto amount ofdirect labour incurred

y Process & job-order costing = systemsfor allocatingcosts;ABC = optionfor allocating overhead, & alternativetotraditional method ofallocating w/volumedrivers,e.g. labour,machinehours;@ABC worksinconjunction

w/process & job-order costing,notasanalternative

OPERATIONAL AND STRATEGIC PLANNING AND CONTROL USING ABC

y Traditional accountingsystemsconcentrate oncontrollingcostincurrence, whileABC focuses oncontrollingcauseofcostincurrencemoreeffectivecost reductions

y Reasons whyABC implementationmayfailo Software wasnotITintegratedo ABC &ABM applications integratedinto organisationmeasurement & managementsystems;asABC was

deployedas retrospectivemodellinganalysis,managers werenot requiredto useitfor planning purposes

o Applicationsare poorlyimplemented;no standardsfor development & deployment ofABCCRITICISMS OF AND CONCLUSIONS ABOUT ABC

y Individual barriersto ABC adoption: (1)fear ofunknown or shiftinstatus quo, (2) possible loss ofstatus, (3)needtlearnnew skills

y Organisational barriers:territorial,hierarchical,corporate-cultureissues

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y Environmental barriers:unions, regulatoryagencies, other stakeholdersy ABC doesntconform withGAAP (p. 380)

o Traditionallydesignated periodcosts (e.g. R&D,servicedepartmentcosts)allocatedto products viaABCo Traditionallydesignated productcosts (e.g. buildingdepreciation)notallocatedto products viaABC

y ABC doesnot promotetotal qualitymanagement & continuousimprovement (p. 380)o But,ABC helpsto identify & monitor significanttechnologycosts;tracemanytechnologycostsdirectlyto

products; promoteachievement or marketshare viause oftargetcosting;identifycostdriversthatcreate

or influencecost;identifyactivitiesthatdontcontributeto perceivedcustomer value,understandimpact

ofnew technologies onall elements ofperformance;translatecompanygoalsinto activitygoals;analyse

performance ofactivitiesacross businessfunctions;analyse performance problems; promotestandards of

excellence

y W/ERP systems,ABC = fullyintegrated w/all other subsystems,e.g. processcosting,financial statements,fixedassets

o Fixedassetcosts or depreciationcostsautomatically recordedincost pools & thenthesecosts = allocateto activities & thento products & services;thoseallocatedcosts = transferredto inventoryand/or cost of

goodssold, & to thefinancial statements, whichcan be producedupondemand