Lecture Notes, Lectures 2,3,5,7,9,10,11,14 PDF

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ACC 312 – Spring 2015 Fundamentals of Managerial Accounting Instructor – Brian Lendecky, MPA, CPA (copyright 2015 © Brian Lendecky) Monday, January 26, 2015 Chapter 2 – Costs in Organizations

To use accounting information to help make decisions, managers must often classify costs in different ways. Depending on the information needed, costs are categorized by: 1. Timing - when the cost appears on the Income Statement. Does the cost go straight to the Income Statement as an expense or through the Inventory account (which is on the Balance Sheet) first? 2. Assignment - how do you assign the manufacturing cost to the cost object? Is it nice and easy (aka not debatable) or do you have to allocate it somehow? 3. Behavior - how the cost behaves when more or less units are produced. Is the cost variable or fixed? (We will group costs by behavior during our next class on September 8/9 when we cover Chapter 6.)

Timing of expenses – Product or Period Cost - the sacrifice made, usually measured by the resources given up, to achieve a particular purpose. Expense – the cost incurred when an asset is used up or sold for the purpose of generating revenue. These two words are NOT synonyms!!! A cost can be capitalized or expensed. Capitalized= turned into an asset Two terms are used to describe the timing with which expenses are recognized on the Income Statement. 1. Product Cost (aka Inventoriable Cost) –costs that are part of inventory “capitalized” until the inventory is sold. They are eventually expensed via COGS. Product costs are the costs of the actual raw materials plus direct labor and manufacturing overhead.

2. Period Cost – All other costs. These costs do not go into inventory. They are expensed in the period they are incurred. (All expenses on the income statement other than the COGS)

What is a merchandising organization? An organization that buys goods from suppliers and resells substantially the same products to customers. Product costs are the costs of the actual merchandise inventory plus all costs incurred in bringing a unit to usable or salable condition and location.

Merchandise Purchased

Merchandise Inventory

Cost of Goods Sold

What is a manufacturing organization? An organization that uses labor and equipment to transform inputs such as raw materials and components into outputs. Laymen’s terms – they make something

Direct Labor Raw Materials Direct Materials Inventory Manuf. Overhead

Work-in-Process Inventory

Finished Goods Inventory

Cost of Goods Sold

“Cost of Goods Manufactured” (COGM)

Every box on flow chart is an account. Direct materials is not an account just a term when a raw material is on the production floor. Cost of Goods manufactured : number when moved from work in process to finished goods Product costs for a manufacturing firm are: Raw (Direct) Materials – All materials that eventually become part of the product Raw materials is a debit inventory account on the balance sheet Direct labor – The compensation of employees who work directly on the products being manufactured “people actually touching the good”, direct labor is added into work into in process inventory Manufacturing overhead – All other manufacturing costs that are related to the product but cannot be traced in an economically feasible way

a. Indirect Materials – materials used in the production process that do not end up in the product. “ Rolled into the price of your car”

b. Indirect Labor – examples – Machine maintenance staff, product supervisor c. Other Manufacturing Overhead – examples – electricity for the plant, rent for the plant, overtime premiums, idle time All other costs are period costs. Raw Materials Inventory

WIP Inventory

FG Inventory

Beginning Balance + Purchases - Direct Materials Ending Balance

Beginning Balance + Direct Materials + Direct Labor + MOH - COGM (amt to FG) Ending Balance

Beginning Balance + COGM (amt from WIP) Cost of goods avail for sale - COGS Ending Balance

0 + amount sold Ending Balance

RM Inventory Beg. Bal. Purchases DM End. Bal.

WIP Inventory Beg. Bal. DM DL MOH COGM End. Bal.

FG Inventory Beg. Bal. COGM COGS End. Bal.

COGS 0 COGS End. Bal.

COGS

Journal Entries 1. When raw materials are purchased DB Raw Materials XX CR Cash XX 2. When raw materials are put into the manufacturing process (aka become direct materials) DB WIP Inventory CR Raw Materials

XX XX

3. When direct labor is used in the manufacturing process DB WIP Inventory CR Cash (Wages Payable)

XX XX

4. When manufacturing overhead is used in the manufacturing process DB WIP Inventory XX CR Cash (Wages Payable) XX

5. When the product is completed and ready for sale DB FG Inventory XX CR WIP Inventory XX

6. When the product is sold DB Cost Of Goods Sold Cash CR FG Inventory CR Revenue

XX XX XX XX

Let’s do some examples. State whether each cost below for Michael Angelo’s Gourmet Foods is a product or period cost and if it is a product cost whether it is raw materials, direct labor, or manufacturing overhead. Tomatoes RM Product Cost Cheese RM Product Cost Worker placing cheese on the lasagna DL Product Cost Production Line Supervisor MO Product Cost Electricity in factory MO Product Cost Electricity in accounting office Period Cost Machine Maintenance staff wages MO Product Cost CFO’s salary Period Cost VP of Sales’s salary Period Cost AKA Administrative Cost Receptionist’s wages Period Cost

Some other vocabulary…. Prime Costs = Direct Materials and Direct Labor Conversion Costs = Direct Labor and Manufacturing Overhead

Assignment of costs to Cost Object - Direct or Indirect What are the two most basic questions every business needs to answer? How much can I sell my product or service for? How much does it cost me to make my product or provide my service?

In the long run, the answer to the first question better be greater than the answer to the second question!

Cost Object – an Entity ( a specific product, service department) to which a cost is assigned. Basically what you want to know the cost of? Can be a product, machine, service, process, department, customer, etc.) Direct Cost – A cost that can be easily traced to a cost object. “ it cant be debatable” Indirect Cost – A cost that cannot be easily trace to a cost object. Indirect costs have to be allocated to cost objects. Whether a cost is direct or indirect, depends on the cost object! Example 1 - Direct or Indirect Cost? – Dean Gilligan’s salary If the Cost Object = Campus (UT-Austin, UT-Arlington, UT-San Antonio, etc) Direct If the Cost Object = School (School of Education, Architecture School, Business School, Engineering School, etc.) Direct If the Cost Object = Department (Accounting, Finance, Marketing , etc.) Indirect

Example 2 – Please categorize each of the following costs for the Toyota plant in San Antonio as a direct cost or indirect cost. The cost object at the San Antonio plant is type of car, example Corolla, Camry, Highlander, etc. Tires = Direct Steering Wheels = Direct Labor = Direct Extra information – people clock in and clock out at the different lines as they move during the day. Electricity = Indirect Rent = Indirect

So every cost (pasta, tomato sauce, salary of production supervisor, salary of accountant, rent, electricity, advertising campaign, gas, copier paper) is a: Product and Period

(Timing of expense on Income Statement)

AND Direct Cost or Indirect Cost

(Assignment of cost to cost object)

AND Variable Cost or Fixed Cost

(Behavior of cost – we will discuss this on Mon/Tues)

Relevant Costs and Revenues In addition to accounting cost classifications (such as product and period costs, direct and indirect costs, variable and fixed costs), managerial accountants also find themselves using economic concepts in classifying costs. Such concepts are often useful in helping managerial accountants decide what cost information is relevant to the decision faced by the organization’s managers.

When making a decision managers need to determine which revenues and costs are relevant and which are irrelevant. In order for a cost or benefit/revenue to be relevant it must meet two criteria: 1. Bearing on the Future Sunk Costs – Past cots that have already been incurred. They are irrelevant in decision making because the amounts cannot be changed by any of the alternatives

Key note… Relevant information must involve costs and benefits to be realized in the future. Therefore past/historical/sunk costs may be helpful as a basis for making predictions, however past costs themselves are always irrelevant when making decisions. http://www.youtube.com/watch?v=hTNgPMuldTM

2. Opportunity Costs – cost or benefit of a forgone alternative. Very relevant! Ex – the wages forgone when you decided to attend college rather than be employed full-time.

Some other ways managerial accountants classify costs… Controllable cost – a manager can control or heavily influence the level of a cost. Uncontrollable cost – costs that a manager cannot influence significantly. Out-of-pocket cost – a cost that requires a cash outlay. Incremental Cost – the increase in cost from one alternative to another. Marginal Cost – the extra cost incurred when one additional unit is produced. This is usually equal to the variable cost per unit. (Again, we will talk more about variable and fixed costs in our next class.) To end our notes on this topic, let’s see if you understand the flow of product costs. Try to answer the following two questions: Question 1 Raw Materials Inventory, 1/1/14 Raw Materials Inventory, 12/31/14 WIP Inventory, 1/1/14 WIP Inventory, 12/31/14 FG Inventory, 1/1/14 FG Inventory, 12/31/14

$11 $8 $6 $7 $22 $27

Direct Labor in 2014 Raw Materials Purchases in 2014 Indirect Manufacturing Labor Manufacturing Supplies Electricity in plant Depreciation – plant building Depreciation – plant equipment Other Manufacturing Overhead Depreciation – sales and marketing office Electricity in sales and marketing office Revenue

$9 $73 $7 $2 $5 $2 $3 $1 $45 $25 $210

What is Net Income??

RW Spent 76 9 7 2 5 2 3 1 6 - x= 7 x=28 COGS 23 + 76 = 99 41 = NI

Question 2 How much are Raw Material purchases and Direct Labor for the period if: Beginning Raw Materials Ending Raw Materials Direct Materials Manufacturing Overhead Beginning Work in Process Ending Work in Process Beginning Finished Goods Ending Finished Goods COGS

$10 30 80 45 5 15 35 40 140

BRW + PRW - DM = ERW 10 + X – 80 = 30 X= 100 Raw material Purchases = 100 BWIP + MO + DL + DM - COGM = EWIP 5+ 45 + X + 80 – 145= 15 DL = 30 BFG + COGM - COGS = EFG 35 + X – 140 = 40 COGM = 145

ACC 312 – Spring 2015 Fundamentals of Managerial Accounting Instructor – Brian Lendecky, MPA, CPA (copyright 2015 © Brian Lendecky) Wednesday January 28 and Monday February 2, 2015 Chapter 6 – Cost Behavior, Cost Estimation, and Cost Prediction Chapter 6 – Summary of Part I (Wednesday January 28) and Part II (Monday February 2) The three general topics discussed in Chapter 6 are: Cost Behavior (Part I) – The relationship between cost and activity Cost Estimation (Part II) – how does a cost act relative to some cost driver? Cost Prediction (Part II) – using the analysis of cost behavior to predict future costs

Cost Behavior Cost Driver – any event or activity that causes costs to be incurred

Variable Costs – Increases or decrease in total in direct proportion to a change in activity of the cost driver. The cost per unit remains constant.

Example 1 – the total cost of steering wheels for a Mercedes plant varies with the number of Mercedes (cost driver) made. However, the steering wheel cost per Mercedes will NOT vary depending on the amount of Mercedes made. Example 2 – the paper cost of tests will vary with the number of students each professor has in their class.

The cost driver of a variable cost is the level of activity or volume whose change causes proportionate changes in the variable cost.

Fixed Costs – remains constant in total as the level of activity changes within a given relevant range. Cost per unit increases or decreases due to changes in activity.

Example 1 – the salary of the Mercedes SUV line manager is fixed no matter how many SUVs are made. However, the salary cost per SUV will vary depending on the amount of SUVs made.

Example 2 – My salary. My salary is fixed no matter how many of you are enrolled in this class. However, my salary cost per student will vary depending on class size. Example - Blue Bell sells each half-gallon carton of ice cream (from Blue Bell to grocery chain, delivered) for $2.50 each. In December, Blue Bell produced and sold 80,000 cartons at an average cost of $2.00 per carton. (FYI - Total variable costs equaled $120,000, total fixed costs equaled $40,000). What was Blue Bell profit in December? 40,000 This coming June, Blue Bell plans to sell 120,000 cartons. How much profit will they have? 120,000 * 2.5-2 = 60,000 NOOOOOOOOOOOOOOO 1.50 cost per carton 180000+40000= 220,000 120,000* 2.5 = 300,000 80,000

The above Blue Bell example is a good example of the pitfalls of using unit costs instead of total costs.

Generally, the decision maker should think in terms of total costs rather than unit costs. But, decision makers need to also consider activity levels, so managerial accounting reports often report costs per unit. Unit costs are very important, but be VERY careful when computing and analyzing. Units costs for predicting the future are only good when production levels stay the same! Why? Because of fixed costs (FYI – missed exam or quiz questions often are the result of students not being careful when analyzing unit costs!!)

Step-variable costs – Are nearly variable. Step-variable cost increases in small steps rather than in direct proportion (continuously) to cost-driver changes. Example – Wait staff at a restaurant Step-fixed costs – are fixed within a wide range of activity but will change outside that range. Can anyone think of an example?

Mixed cost (or semi-variable) – contains both fixed and variable components. Example – Most salespeople are compensated with a salary and a sales commission.

Curvilinear cost – function that cannot be represented with a straight line but instead is represented with a curve that reflects either increasing or decreasing marginal costs.

Big Picture - Why is understanding cost behavior important? To plan – make budgets To control – you better figure out quickly what is going on if costs are not behaving as expected. To make decisions – should we offer a new product? add a new store? close down a plant? How can you make a decision about your business if you don’t know how your costs behave? For every decision a company makes, it has to know how much revenue will be earned and what costs will be incurred from making that decision.

Some other Cost Categories Engineered Cost – cost that bears a definite physical relationship to the cost driver. Example – the food cost of a restaurant, as it is impossible to serve more meals without incurring additional food cost. Committed costs vs. Discretionary costs Committed costs – Result from an organization ownership or use of facilities and its basic organizational structure. Committed costs can change only through relatively major decisions that have long-term implications. Examples – property taxes, facility rent, top management salaries

Discretionary costs – exist as the result of a management decision to spend a particular amount of money for some purpose. In comparison with committed costs, these costs can be changed in the short run much more easily.

(Doesn’t mean discretionary costs are unimportant, just means the company can change them easier.) How do you estimate costs? Cost Estimation Methods 1. Account-classification method (also called account analysis) Examining an account in the general ledger and using personal judgment to determine future cost behavior (whether fixed or variable). Advantage a. Can provide very accurate estimates because it requires examination of each cost account in detail

Disadvantages b. Extremely time consuming for large organizations. c. Classifications frequently require considerable knowledge and experience d. Subject can be arbitrary, based on the person performing the task

2. Visual-Fit Method Using a scatter diagram, plot recent observations of the cost or costs at various activity levels. The scatter diagram helps the analyst visualize the relationship between cost and the level of activity (or cost driver). Let’s go back to our handouts.

Wherever the line intercepts the Y-axis is the estimate of the fixed portion of the cost or costs. To determine the variable costs, subtract the fixed cost from the total cost at any activity level Advantages a. Easy to use and easy to explain to others b. Easy to spot outliers

Disadvantage a. very subjective. Ten different people would probably draw 10 different lines

3. High-low method Considers only two points of data, the highest and lowest for activity, within the relevant range. The points selected should be representative of normal behavior (aka not an outlier). From these two points we estimate unit variable cost and total fixed costs. This estimation of unit variable cost and total fixed costs is performed using the cost equation: total variable costs + total fixed costs = total costs (unit variable cost)(volume of activity) + total fixed costs = total costs

cost equation

The high-low method first focuses on cost changes, allowing an analyst to determine the presence of any variable cost. This is done by computing the slope of the line. The slope is the variable cost per unit: “rise over run” = (Difference in costs) / (Difference in activity level) Next, fixed costs are determined by subtracting variable cost from the total cost at either of the two data points (it doesn’t matter which one).

Let’s take a look at a sample data series for estimating cost behavior…

Year 1, Quarter 1 Year 1, Quarter 2 Year 1, Quarter 3 Year 1, Quarter 4 Year 2, Quarter 1 Year 2, Quarter 2 Year 2, Quarter 3 Year 2, Quarter 4 Year 3, Quarter 1 Year 3, Quarter 2 Year 3, Quarter 3 Year 3, Quarter 4 Year 4, Quarter 1 Year 4, Quarter 2 Year 4, Quarter 3 Year 4, Quarter 4 Year 5, Quarter 1 Year 5, Quarter 2 Year 5, Quarter 3

Units 37,090 44,801 43,995 40,470 37,186 45,368 45,369 41,297 38,329 46,396 46,763 41,316 38,376 47,576 48,926 42,085 40,880 50,572 50,735

Total Cost $793,407 $831,863 $831,243 $808,547 $824,088 $863,332 $861,573 $839,794 $852,608 $895,335 $894,507 $868,742 $895,219 $941,834 $942,572 $913,464 $939,565 $987,518 $1,037,037

Year 5, Quarter 4

43,575

$956,824

High-Low Analysis… Variable Cost per unit =

$ at High - $ at Low Activity at High – Activity at Low

“rise” “run”

17.85$ Fixed Cost at High = 131,317.25

Fixed Cost at Low = $131,350.5

High-Low Result =

$ at High – (variable cost per unit)(activity at High)

$ at Low – (variable cost per unit)(activity at Low)

Total Costs = 17.85X + 131,333

(this is the cost equation)

Advantages 1. not subjective like the account- classification method or visual fit

2. easy to do. Does not require classification of individual cost items like account-classification method.

3. only need total ...