Final MA Bible 2 PDF

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Cost classification for preparing financial statements (Pg 27)

CHAPTER 2: COST CONCEPTS Cost classification for assigning costs to cost objects (Pg 24) Direct cost (pg 24)

Indirect cost (pg 25)

A cost that can be easily and conveniently traced to a specified cost object. - E.g. ingredients of a F&B bakery A cost that cannot be easily (no economically feasible) and conveniently traced to a specified cost object. - To be traced to a cost object, the cost must be caused by the cost object - E.g. factory manager’s salary (it is incurred for running the entire factory) o Common cost: incurred to support a number of cost objects but cannot be traced to them individually.

Cost classification for manufacturing companies (Pg 25) Manufacturing Costs Materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product. - E.g. Flour used in making a cake Direct Materials But note that the finished product of one company, can become the raw material of another (pg 25) company. - E.g Plastic produced by company A are raw material used by company B in its personal computers. Relatively insignificant materials to end products and it is not worth the effort to trace these Indirect cost. Materials - Treated as Manufacturing Overhead (pg 25) - E.g. glue and solder used Labor costs that can be physically and conveniently traced to individual units of product Direct Labor - E.g. Assembly line workers (pg 25) Labour costs that cannot be physically traced to particular products, or can only be traced at a great cost and inconvenience Indirect Labor (pg 26) - Treated as Manufacturing Overhead - E.g. janitors, night security guard All manufacturing costs except direct materials and direct labour - Indirect materials, indirect labour, maintenance and repairs on production equipment, Manufacturing Overhead heat and light, property taxes, depreciation, insurance on manufacturing facilities, glue, (pg 26) factory rental (if the whole factory is used to produce one product, then the entire rental is direct cost to this product) Nonmanufacturing Costs (pg 26) Costs incurred to secure customer orders and get the finished product to the customer. - E.g. advertising, shipping, sales travel, sales commissions, sales salaries, cost of finished Selling Costs goods warehouse - Can be direct or indirect Costs that are associated with the general management of an organization - E.g. Executive compensation, general accounting, public relations, HR provides supports Administrative to other departments, so the cost incurs in HR department will be charged to other Costs departments as well - Can be direct or indirect Production cost (material + labour + others) is not the same as manufacturing cost. It depends on the accounting period that is being tabulated. E.g if the product is being made in 2 months, the manufacturing cost is $300 for Jan and $200 for Feb. The production cost is $500.

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Recall: Matching Principle - Based on accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized. - E.g. cost to make a product should only be incurred when the product is sold All costs that are involved in acquiring or making a product - “Attach” to units of products as the goods are purchased or manufactured, and when they go into inventory awaiting sale Product - Initially: Assigns to inventory account Cost (pg 27) - When goods are sold: release from inventory account as expenses (COGS) and matched against sales revenue on income statement All costs that are not product cost - All selling and administrative expenses are treated as period cost Period cost - Not included as part of the cost of purchase or manufactured goods (pg 27) - Expensed in income statement in the period which they are incurred (not necessarily the period in which cash changes) SUMMARY Product Cost = DM + DL + applied acMOH Period Cost = Selling expenses + Admin expenses Conversion Cost = DL + MOH Prime Cost = DM + DL

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Cost classification for predicting cost behaviors (Pg 29)

Variable Cost (pg 29)

Fixed Cost (pg 30)

Mixed Cost (pg 33)

Step Variable

Linear assumption and Relevant Range

Account Analysis (pg 35)

Engineering Approach (pg 35)

Based on rise-over-run formula for the slope of a straight line

Varies in direct proportion to changes in the level of activity. - E.g. COGS, direct materials, direct labor, indirect materials, supplies - Must be “in respect to something” → Cost driver o A measure of whatever causes the incurrence of a variable cost o E.g. Direct labor hours, Machine hours, material - Constant when expressed on per unit basis Remains constant, in total, regardless of changes in the level of activity. - E.g. straight line depreciation, insurance, property taxes, rent - Total fixed costs remains constant unless influenced by outside force - Average Fixed Cost per unit ↓ as level of activity ↑ o Creates a false impression that fixed costs are like variable costs in internal reports

-

Variable Cost =

𝒀𝟐−𝒀𝟏 𝑿𝟐−𝑿𝟏

=

𝑪𝒐𝒔𝒕 𝒂𝒕 𝒕𝒉𝒆 𝒉𝒊𝒈𝒉 𝒂𝒄𝒕𝒊𝒗𝒊𝒕𝒚 𝒍𝒆𝒗𝒆𝒍 − 𝒄𝒐𝒔𝒕 𝒂𝒕 𝒕𝒉𝒆 𝒍𝒐𝒘 𝒂𝒄𝒕𝒊𝒗𝒊𝒕𝒚 𝒍𝒆𝒗𝒆𝒍 𝑯𝒊𝒈𝒉 𝒂𝒄𝒕𝒊𝒗𝒊𝒕𝒚 𝒍𝒆𝒗𝒆𝒍 − 𝑳𝒐𝒘 𝒂𝒄𝒕𝒊𝒗𝒊𝒕𝒚 𝒍𝒆𝒗𝒆𝒍

Or 𝑪𝒉𝒂𝒏𝒈𝒆𝒔 𝒊𝒏 𝒄𝒐𝒔𝒕

-

Variable Cost =

-

High-Low method is simple to apply but it only utilizes 2 data points

𝑪𝒉𝒂𝒏𝒈𝒆𝒔 𝒊𝒏 𝒂𝒄𝒕𝒊𝒗𝒊𝒕𝒚

1. Committed Fixed Costs Organizational investments with a multiyear planning horizon that cannot be significantly reduced even for short periods of time without making fundamental changes. - E.g. real estate taxes, investments in facilities and equipment, depreciation on buildings 2. Discretionary Fixed Costs (Managed Fixed Cost) Arise from annual decisions by management to spend on certain fixed cost items - Can be cut for short period of time with minimal damage to the long-run goals of the organization - E.g. Advertising, research, public relations Both variable and fixed cost - Also known as semivariable cost - Y = a + bx - Y = Total Mixed Cost - a = the total fixed cost (vertical intercept of the line) - b = the variable cost per unit of activity (the slope of the line) - X = the level of activity A step variable cost is a cost that generally varies with the level of activity, but which tends to be incurred at certain discrete points and to involve large changes in amounts when such a point is reached. Conversely, a truly variable cost will vary continually and directly in concert with the level of activity.

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High- Low Method (pg 36)

Step-variable costs are costs that stay fixed over a range of activity and then change after this range is overcome. In other words, these costs change in increments. Analysis of Mixed Cost A straight line closely approximate a curillinear variable cost line within the relevant range. - Outside the relevant range, o a fixed cost may no longer be strictly fixed. o a variable may not be strictly variable. - For e.g Suppose the capacity of the leukemia diagnostic machine is 3000 test per month. The assumption that the rent for the diagnostic machine is $20,000 per month is only valid within the relevant range of 0 – 3000 test per month. If the Clinic needed to test 5000 blood samples per month, then it would need to rent another machine for additional $20,000 per month. An account is classified as either variable or fixed based on the analyst’s prior knowledge of how the cost in the account behaves. - E.g. direct materials as variable costs and building lease cost as fixed due to the nature of those costs. Detailed analysis of what cost behavior should be, based on an industrial engineer’s evaluation of the production methods to be used, the materials specifications, labor requirements -

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2 data points are not enough to produce accurate results Additionally, the periods with the highest and lowest activity tend to be unusual

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-

May misrepresent the true cost behavior during normal periods Therefore, least squares regression will be more accurate

LeastSquares Regression Method (pg 38)

Uses all of the data to separate a mixed cost into its fixed and variable components, minimise sum of squared errors - A regression line is form (Y = a + bx) - Rsquare = measure of goodness of fit - V6 ques 25

Traditional and Contribution Format Income Statement (pg40) Traditional Format Income Statement (pg40)

Prepared for external reporting purposes - Cost of goods sold reports the product costs attached to the merchandise sold - Selling and administrative expenses report all period costs that has been expensed - COGS = Beg Merchandise Inventory + Purchases – Ending Merchandise Inventory

Traditional Format

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Contribution Format

Sales COGS Gross Margin

xxx xxx xxx

Selling and Admin Expense Net Operating Income

xxx xxx

Sales Variable Expenses: COGS Variable Selling Variable Admin Contribution Margin Fixed Expenses: Fixed Selling Fixed Admin Net Operating Income

xxx xxx xxx xxx

xxx xxx

xxx xxx

xxx xxx

Provides managers with an income statement that clearly distinguishes between fixed and variable costs - Helps in planning, controlling, and decision making Contribution Approach (pg41)

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Used as an internal planning and decision-making tools - Emphasis on cost behavior aids CVP, management performance appraisals - Helps managers to organize data pertinent to numerous decisions such as product-line analysis, pricing, use of scare resources

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Cost Classification for Decision Making (pg 41)

Differential Cost (pg 41)

Differential Revenue (pg 41)

CHAPTER 4: JOB ORDER COSTING

In business decisions, each alternative will have costs and benefits that must be compared to the costs and benefits of the other available alternatives. - A difference in costs between any 2 alternatives - Also known as incremental cost - Differential cost: broader term, encompassing both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives A difference in revenues (usually just sales) between any two alternatives

To determine Product Cost (pg 118) Absorption Costing (pg 118)

All manufacturing costs , both fixed and variable, are assigned to units of products - Units are said to fully absorb manufacturing costs (DM + DL + VMOH+ FMOH) Only Var Manu cost →Units (DM+DL+VMOH)

Variable Costing Differential cost and revenue

Opportunity Cost (pg 42)

Sunk Cost (pg 42)

differential revenue is $100,000 and the differential costs total $85,000, leaving a positive differential net operating income of $15,000 Potential benefit that is given up when one alternative is selected over another - Not found in accounting records - Costs that must be explicitly considered in every decision a manager makes Cost that has already been incurred and cannot be changed by any decisions made now or in the future - Not differential cost - Only differential costs are relevant in a decision - Sunk costs should always be ignored E.g Depreciation is a sunk cost because of the outlay for the equipment made in a previous period.

Example: Assume that a company paid $50,000 several years ago for a special-purpose machine. The machine was used to make a product that is now obsolete and is no longer being sold. Even though in hindsight purchasing the machine may have been unwise, the $50,000 cost has already been incurred and cannot be undone. And it would be folly to continue making the obsolete product in a misguided attempt to “recover” the original cost of the machine. In short, the $50,000 originally paid for the machine is a sunk cost that should be ignored in current decisions.

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Difference between Variable and Absorption

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Predetermined Overhead Rates (pg 122) Difficulties to assign manufacturing overhead to a specific job: 1. MOH is an indirect cost o Impossible or difficult to trace these costs to a particular product or job. 2. MOH consists of many different type of cost o Some are variable, some are fixed 3. Total MOH tend to remain relatively constant from one period to the next even though number of units can fluctuate widely. Consequently, average cost per unit will vary from one period to the next. o Due to the presence of fixed cost in MOH Therefore given these issues, we will use Predetermined Overhead Rate to assign manufacturing overhead to products. *Allocation base: is a measure such as Direct Labour Hours, Machine Hours that is used to assign overhead costs to products and services - Common to all of the company’s products and services - Should drive overhead costs (if not product cost will be distorted)

Hybrid Costing

Adv of variable costing: Explains the changes in Net operating income, supports decision makingte A hybrid costing system is a cost accounting system that includes features of both a job costing and process costing system. A consideration when using a hybrid system is the added cost of using essentially two different cost tracking systems, rather than a single cost tracking concept for all operations.

In the past most companies use DLH as the allocation base, but the situation has changed due to: 1. Automated equipment replacing work that are performed by direct labour workers • Overhead ↑, direct labour ↓ (because equipment is OH) 2. Products becoming more sophisticated and complex and are modified more frequently • Increases the need for highly skilled indirect workers such as engineers • Overhead ↑, direct labour ↓ (indirect labour is OH) *POHR (Ttl estimated MOH/ Ttl lest allocation base) are estimated and not actual so it is not accurate*

Job Order Costing (pg 118) Used in situations where many different products, each with individual and unique features, are produced each period. Know how much it cost to produce, For(Price to set, financial reports) - Costs are traced and allocated to jobs -

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑗𝑜𝑏 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑗𝑜𝑏

= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑠𝑡 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡

From notes: - Accumulate costs by jobs - Normally low volume - Labour intensive (due to the unique features), different product lines use different materials/labour Bill of materials Document that lists the type and quantity of each type of direct material needed to complete a unit of product. Measuring Direct Materials Cost Materials Requisition Form (pg 120) Document that specifies the type and quantity of materials to be drawn from the store room and identifies the job that will be charged for the cost of the materials. - Use to control the flow of materials into production - Making entries in the accounting records Job Cost Sheet Records the materials, labour and manufacturing overhead costs charged to that job. (pg 120) Time ticket Measuring Direct Hour-by-hour summary of the employee’s activities throughout the day Labour Cost (pg - Uses bar code to capture data, as each employee and each job have a unique bar 122) code.

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Step 1

Step 2

Computing Predetermined Overhead Rate (pg 123) – before the period begins Estimate total amount of allocation base (denominator) that will be required for next period’s estimated level of production Estimate: 1. Total fixed manufacturing overhead cost for the coming period 2. Variable manufacturing overhead cost per unit of the allocation base

Estimate total manufacturing overhead cost (numerator) for the coming period: Y = a + bX Step 3

In the quality control area, number of defects may provide the best allocation base. Thus, because homogeneity is more likely within a department than among departments, separate departmental rates are generally thought to provide managers more useful information than plant-wide rates. The Cutting and Mounting Department is highly automated and, therefore, uses machine hours as its overhead cost driver. In contrast, the Packing Department is more labor intensive and uses DLHs.

Computation of Unit Cost (pg 126) Only compute when the job is completed (transfer to finished goods account) Find the Total Product Cost Step 1 Total Product Cost = DM + DL + MOH

Y = Estimated total manufacturing overhead cost a = Estimated total fixed manufacturing overhead cost b = Estimated variable manufacturing overhead cost per unit of the allocation base X = Estimated total amount of the allocation base Compute the Predetermined Overhead Rate:

Find the Unit Product Cost Step 2

𝑈𝑛𝑖𝑡 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑐𝑜𝑠𝑡 =

𝑃𝑟𝑒𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒 =

Step 4

𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒

Notes:

Why not use Actual total MOH and Actual total allocation base? (pg 124) - Seasonal factors in overhead cost/allocation base can produce fluctuations in the overhead rate - Such fluctuations serve no useful purpose - To avoid such fluctuations, actual rates are computed annually/less frequent basis o Meant that MOH assigned to jobs will not be known till the end of the year Therefore, companies prefer to use predetermined rather than actual rates - E.g. cost of heating and cooling a factory will be highest in winter and summer, lowest in spring and fall. o Results in two jobs that are completed in different season to assigned with different MOH cost. Applying Manufacturing Overhead (pg 123) Determining the amount of overhead cost to apply to a particular job:

Applied Overhead Look at pg 124 for examples of computations**

Need for Predetermined Rates

Choice of Allocation base for Overhead Cost Plantwide versus departmental predetermined rates

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𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝐶𝑜𝑠𝑡 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑈𝑛𝑖𝑡𝑠

It is an average cost, should not be interpreted as the cost that would be incurred if another unit was produced o Incremental cost of an additional unit will decrease o Due to the presence of fixed OH that cause the actual OH cost to not vary much Used for valuing unsold units in ending inventory and determining COGS Raw Materials: materials that goes into the final product Work in process: consist of units of product that are only partially complete and will require further work before they are ready for sale to the customer Finished goods: completed units of product that have not been sold to the customers Cost of good m: manufacturing cost associated with the goods that were finished during the period

Flow of Costs (pg 127) – refer to T-account that prof taught in class

*Note that predetermined overhead rate is computed before the period begins*

Overhead applied to a particular job

Predetermined overhead x rate

=

Amount of the allocation base incurred by the job (Actual)

Why does company not consider actual overhead rate and actual total amount of the allocation base incurred on monthly, quarterly, or annual basis than predetermined rate? - Because it causes fluctuations in the produce rate which serve no useful purposes. Therefore, to avoid fluctuations actual overhead rate could be computed on an annual or less-frequent basis. Cost driver: is a factor such as machine hours, beds occupied, computer time, or flight hours that causes overhead costs. If the base in the predetermined rate does not “drive” overhead cost, product cost will be distorted. - E.g if direct-labour hours (DLH) is used to allocate overhead, but in reality overhead has little to do with DLH, then prod...