compiled by nut khorn -page 2 · pdf filechapter 9 activity-based costing chapter 10...

Compiled By Nut Khorn -


Table of Contents 1. Course Description: .......................................................................................... 6

Learning Objectives: ............................................................................................ 6

2. Course objectives .............................................................................................. 6

3. Course content ............................................................................................... 7

4. Learning Resources: ......................................................................................... 8

Additional Reading ......................................................................................... 8

5. Course requirement ......................................................................................... 8

6. Evaluation of the student performance .......................................................... 8 Internet Web for these Courses: ......................................................................... 10 7-HOME WORK AND ASSIGNMENT .......................................................... 10

Research the Manufacturing Companies in Pursat Province and prepare the financial statements. ......................................................................................... 10

Course Outline for Fundamentals of Cost Accounting ................................ 11

Chapter 01: Cost Accounting: Information for Decision Making ................. 12 Learning Objectives ..................................................................................... 12

What Does Cost Accounting Mean? .................................................................. 13 Cost accounting .................................................................................................... 13 Classical cost elements are: ............................................................................... 13

Origins ................................................................................................................. 14 Elements of cost .................................................................................................. 14

Classification of costs ......................................................................................... 15

Value Chain ......................................................................................................... 15 The Value Chain Components .......................................................................... 15 Accounting Systems ............................................................................................ 16

Managerial Decisions ......................................................................................... 16

Trends in Cost Accounting ................................................................................ 16

Enterprise Resource Planning ........................................................................... 16 Ethical Issues for Accountants .......................................................................... 17 Sarbanes-Oxley Act of 2002 ............................................................................... 17

Institute of Management Accountants’ (IMA) Code of Ethics: Standards 18

Chapter Summary .............................................................................................. 18

Glossary ............................................................................................................... 19 Chapter 2: Cost Concepts and Behavior .......................................................... 23

In this chapter, the following learning objectives will be covered: .............. 24

Subtopics .............................................................................................................. 24 Objectives ............................................................................................................ 24 1.General cost classification ............................................................................... 25

Manufacturing costs ........................................................................................... 25

Nonmanufacturing cost ...................................................................................... 25

a. Marketing or selling costs. ............................................................................ 25 b .Administrative costs. ................................................................................. 26

2. Product cost versus period costs ............................................................... 26 2.1 Product costs .......................................................................................... 26

Period cost ........................................................................................................... 26 Cost Flow ............................................................................................................. 27 3. Cost classification on financial statements ................................................... 28

The balance sheet ................................................................................................ 28

The income statement ........................................................................................ 28

Schedule of Cost of Goods Manufactured ........................................................ 29


Cost classifications .............................................................................................. 31

For predicting cost behavior ......................................................................... 31

A. Variable cost ................................................................................................ 31 B. Fixed cost ........................................................................................................ 31

For assigning costs to cost objectives ................................................................. 32 A. Direct cost .............................................................................................. 32

B. Indirect cost .................................................................................................... 32

For decision making ........................................................................................... 32

A. Opportunity cost .......................................................................................... 32 B. Sunk cost ...................................................................................................... 32

Income Statement ................................................................................................ 33

1) Formula of Direct Materials .......................................................................... 33 Key Terms ............................................................................................................ 35

Problems ....................................................................................................... 37 Chapter 03: Fundamentals of Cost-Volume-Profit Analysis (CVP) .............. 46

GOALS ............................................................................................................ 46 DISCUSSION .................................................................................................. 46

COST BEHAVIOR ........................................................................................ 46

VARIABLE COSTS: ......................................................................................... 47

FIXED COSTS: .................................................................................................... 47 BUSINESS IMPLICATIONS OF THE FIXED COST STRUCTURE: ....... 48 ECONOMIES OF SCALE: .................................................................................. 49

RELEVANT RANGE: ......................................................................................... 49

DIALING IN YOUR BUSINESS MODEL: ........................................................ 50

COST BEHAVIOR ANALYSIS ....................................................................... 51 MIXED COSTS: .................................................................................................. 52 HIGH-LOW METHOD: ...................................................................................... 53

METHOD OF LEAST SQUARES: ..................................................................... 54

BREAK-EVEN AND TARGET INCOME ...................................................... 56 Assumptions ........................................................................................................ 57

CONTRIBUTION MARGIN: ........................................................................... 57 CONTRIBUTION MARGIN: ........................................................................... 58 Aggregated, per unit, or ratio? .............................................................................. 58 GRAPHIC PRESENTATION:............................................................................. 59

BREAK-EVEN CALCULATIONS: ................................................................. 59 TARGET INCOME CALCULATIONS: ......................................................... 60 CRITICAL THINKING ABOUT CVP: .......................................................... 61 The Margin of Safety ......................................................................................... 62

Operating Leverage ............................................................................................ 63

Summary Formulas of CVP .............................................................................. 64

Key Terms ........................................................................................................... 65 Solved Problems ........................................................................................... 66

Chapter 4 Cost Estimation ......................................................................... 71 Learning Objectives ......................................................................................... 71

Mixed Costs ......................................................................................................... 72 Mixed Costs Example ......................................................................................... 72

Analysis of Mixed Costs ..................................................................................... 72

Use a scatter graph plot to diagnose cost behavior. ........................................ 73

Analyze a mixed cost using the high-low method. ........................................... 74

Least-Squares Regression Method .................................................................... 76


Chapter Summary .............................................................................................. 80

Glossary ............................................................................................................... 81 Solved Problems ................................................................................................. 82


SYLLABUS FOR

Cost Accounting

By Nut Khorn

(Course Facilitator) For BBA students

1. Course Description: The course provides an introduction to cost accounting, a field of business

which develops the financial and non-financial information necessary to effectively manage the firm or organization. Managerial Accounting is a company’s internal language, and is used for decision making, production management, product design and pricing, performance evaluation, and motivating employees. The central focus of this course is on how cost accounting helps managers make better decisions. Understanding managerial accounting is essential for developing a thorough understanding of a company’s internal operations. What you learn in this course will help you understand your future employer and enable you to be more successful at your job. Upon completion of the course students should be able to:

Learning Objectives: 1. Identify and evaluate ethical issues faced by management accountants.

2. Explain and analyze cost behavior.

3. Explain cost-volume-profit relationships, perform breakeven analysis and interpret results.

4. Identify relevant costs and demonstrate their use in the decision making process.

5. Explain the importance of cost allocations, and demonstrate their impact on product costing, transfer pricing, and performance measurement

6. Explain the concept of standard costs and perform variance analysis.

7. Prepare master budget and flexible budgets.

8. Be able to calculate product cost, prime cost, conversion cost, the cost of goods sold and income of a manufacturing, service, or merchandising firm.

9. Use measures including ROI, residual income, and economic value added to evaluate performance.

10. Build basic Excel models.

2. Course objectives Cost accounting is concerned with the internal generation, communication and interpretation of information for both operational and strategic decision-making purposes. Note that this definition and this course both focus on information internal to the firm. We will not be directly concerned here with published or external financial statements or the impact of accounting information in the broader market place. Note also that information is relevant for two types of internal decision-making: operational decision-making, which


can include all aspects of planning and controlling an organization’s day-to-day operations; and strategic decision-making, which relates information to the planning and control of an organization’s strategy. The objective of ACCT 6205 is to develop your ability to create and use accounting information and tools to facilitate and influence decision-making. The course will explore, at an introductory level, theories that underpin the discipline of managerial accounting.

By the end of this course you should be able to:

• Distinguish between product costs and period costs in preparing financial statements.

• Understand how product costs flow through the inventory accounts of a manufacturing firm and are reported in the financial statements.

• Use both one-stage and two-stage allocation methods to allocate indirect costs to cost objects.

• Distinguish between variable and fixed costs, and use cost-volume-profit analysis to determine the impact of changes in prices, costs, and volumes on profits.

• Identify relevant costs in short-term and long-term settings and apply relevant cost analysis to managerial decisions.

Unless you understand managerial accounting, you cannot have a thorough understanding of a company’s internal operations. What you learn in this course will help you understand the operations of your future employer, and help you understand other companies you encounter in your role as competitor, consultant, auditor or investor. 3. Course content

Introduction and Overview

Chapter 1 Cost Accounting: Information for Decision Making Chapter 2 Cost Concepts and Behavior

Cost Analysis and Estimation

Chapter 3 Fundamentals of Cost-Volume-Profit Analysis Chapter 4 Fundamentals of Cost Analysis for Decision Making Chapter 5 Cost Estimation

Cost Management Systems

Chapter 6 Fundamentals of Product and Service Costing Chapter 7 Job Costing Chapter 8 Process Costing Chapter 9 Activity-Based Costing Chapter 10 Fundamentals of Cost Management Chapter 11 Service Department and Joint Cost Allocation


Management Control Systems

Chapter 12 Fundamentals of Management Control Systems Chapter 13 Planning and Budgeting Chapter 14 Business Unit Performance Measurement Chapter 15 Transfer Pricing Chapter 16 Fundamentals of Variance Analysis Chapter 17 Additional Topics in Variance Analysis Chapter 18 Nonfinancial and Multiple Measures of Performance Appendix Capital Investment Decisions: An Overview

4. Learning Resources: Required textbook • Lanen, Anderson, and Maher Fundamentals of Cost Accounting, 2nd edition is

available at the SMU book store.

Charles T. Horngren, Srikant M.Datar, George Foster. 2003. Cost Accounting. 11. s.l. : Prentice Hall , 2003. 0-13-099619-x. Ray H. Garrison. , Eric W. Noreen, and Peter C. Brewer (2005) Introduction to Managerial Accounting, 2nd international Edition, McGraw. Hill (USA)

Additional Reading

Instructors can choose any of the following textbooks to accompany this course:

• Hilton, Ronald W. Managerial Accounting: Creating Value in a Dynamic Business Environment, 6th edition, McGraw-Hill/Irwin, 2005, ISBN: 978-0-07-250287-9.

• Garrison, Ray H., Eric W. Noreen, and Peter C. Brewer. Managerial Accounting, 11th edition, McGraw-Hill/Irwin, 2006, ISBN: 978-0-07-283494-9.

• Hilton, Ronald W. Managerial Accounting: Creating Value in a Dynamic Business Environment, 7th edition, McGraw-Hill/Irwin, 2008, ISBN: 978-0-07-302285-7.

• Garrison, Ray H., Eric W. Noreen, and Peter C. Brewer. Managerial Accounting, 12th edition, McGraw-Hill/Irwin, 2008, ISBN: 978-0-07-352670-6.

5. Course requirement Student should have basic knowledge of Business mathematics, financial accounting, Merchandising Company and manufacturing company and so on. 6. Evaluation of the student performance Course assessment: Attendance and participation…………………………...10% Quizzes, Homework Problems, Assignments………… 50% Mid-term Exam…………………… 20% Final Examination ………….. 20%


Total: ………….. 100%

Suggested Course Evaluation Criteria

Grade Points Point Range % Interpretation

A 4.0 93-100 Excellent

A- 3.7 90-92

B+ 3.3 87-89

B 3.0 83-86 Above Average

B- 2.7 80-82

C+ 2.3 77-79

C 2.0 73-76 Average

C- 1.7 70-72

D+ 1.3 66-69

D 1.0 60-65 Below average

F 0.0 59 & below Failure

I 0.0 Incomplete

Work Requirement for a Cost Accounting Major under Mr. Nut Khorn

• I will apply the international standard when I teach all managerial accounting courses I will require that you do all the assigned work before class:

Read your textbook (slide presentation is not complete) Read the power point materials Do the assignments Prepare for all examinations. Internet research work.

• To perform well in my courses, you need to spend about a minimum of 15 hours per week for this class. If you do not want to make this commitment, then do not take my courses.

• You should be present in all my classes. If you do not show up for my

lectures, I will consider you as absent (no need to give excuses).

• If you fail any of my courses (I hope you won’t), you must retake a new written examination plus an oral examination to prove that you know the subjects.


Internet Web for these Courses: www.mhhe.com/lanen3e When you search the web you will get power point presentation (Slide), quizzes, multiple choices, excel template, and so on. Other webs to supporting of your course. www.mhhe.com (General subjects) www.mhhe.com/williams_basis14e (Financial & Managerial Accounting) www.mhhe.com/garrison12e (Managerial Accounting)

www.wiley.com (General Subjects) www.wiley.com/college/weygandt (Accounting Principles, Financial

Accounting, Hospital Accounting, and Managerial Accounting) General Research: www.en.wikipedia.org www.mhhe.com/wild www.mhhe.com/hm www.nutkhorn.wordpress.com

�� Note: When you research the entire web above you should enter the STUDENT CENTER OR STUDENT COMPONION.

7-HOME WORK AND ASSIGNMENT Students MUST COMPLY STRICTLY with the following instructions in writing their Home Work, Individual Assignments, Group Case-study and Group Case-Study Presentation. 1. The student(s) is expected to do his/her own research in order to write up individual assignments and home work. 2. All Individual Assignments/Home work and Group Case-Study MUST be type written on A-4 sized paper with adequate margins. You should include a TITLE PAGE and a LIST OF CONTENTS. 3. Use headings and sub-headings to organize your report, including supporting material(s) as attachments. 4. All reference books/published materials you refer to should be properly referenced (arrange in this order: name of author(s), year, and title of the book, publisher, and the country the book was published) and this must be included in a bibliography at the end of the assignment. 5. Use text referencing when you cite somebody else’s work from your references. Citation may mean direct quoting, or paraphrasing, or summarizing, or simply to make a statement of that author's view of finding. An example of text referencing: Beamer and Varner (2001), suggested that culture is not something we are born with, but rather it is learned. 6. Number all pages sequentially and securely staple and/or bind all sheets together.

Date Chapter Topic Class Preparation and Home

work Assignments

16.Aug.2010

Ch01 Research the Manufacturing Companies in Pursat Province and prepare the financial statements.

Accounting data depend on your requirements. Group Assignments


17.Aug.2010

Ch02 P2-2; P2-10, P2-11 Home Work

20.Aug.2010

Ch03 P3-4; P3-133TB Home Work

26Aug.2010

Ch04 P4-1; Home Work

Course Outline for Fundamentals of Cost Accounting

Teaching Weeks Chapters Topics Due Dates Time Allowed

Week 1 Ch 01 Cost Accounting: Information for Decision Making

16 Aug.2010 3 Hrs

Week 2 Ch 02

Cost Concepts and Behavior

17 Aug.2010 10 Hrs

Mid-Term Exam

Week 3 Ch03 Fundamentals of Cost-Volume-Profit Analysis (CVP)

20 Aug.2010 10 Hrs

Week 4 Ch04 Cost Estimation 25 Aug.2010 10 Hrs Week 5 Ch 05 Job-Order Costing 30 Aug.2010 15 Hrs

Final Exam


Chapter 01: Cost Accounting: Information for Decision Making

Learning Objectives

After reading this chapter, you should be able to:

• Describe the way managers use accounting information to create value in organizations.

• Distinguish between the uses and users of cost accounting and financial accounting information.

• Explain how cost accounting information is used for decision making and performance evaluation in organizations.

• Identify current trends in cost accounting. • Understand ethical issues faced by accountants and ways to deal with

ethical problems that you face in your career.


We start the study of the Fundamentals of Cost Accounting with a review and overview of information necessary for decision making. What Does Cost Accounting Mean? A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step of production as well as fixed costs such as depreciation of capital equipment. Cost accounting will first measure and record these costs individually, then compare input results to output or actual results to aid company management in measuring financial performance. While cost accounting is often used within a company to aid in decision making, financial accounting is what the outside investor community typically sees. Financial accounting is a different representation of costs and financial performance that includes a company's assets and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost control programs, which can improve net margins for the company in the future.

Cost accounting

In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not to follow standards such as GAAP, because its primary use is for internal managers, rather than outside users, and what to compute is instead decided pragmatically.

Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the supply chain (the series of events in the production process that, in concert, result in a product) into financial values.

There are various managerial accounting approaches:

• standardized or standard cost accounting • lean accounting • activity-based costing • resource consumption accounting • throughput accounting • marginal costing/cost-volume-profit analysis

Classical cost elements are:

1. raw materials 2. labor 3. indirect expenses/overhead


Origins

Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions.

In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes.

Some costs tend to remain the same even during busy periods, unlike variable costs, which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing.

For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.

Elements of cost

• 1. Material(Material is a very important part of business) o A. Direct material o B. Indirect material

• 2. Labor o A. Direct labor o B. Indirect labor

• 3. Overhead o A. Indirect material o B. Indirect labor


(In some companies, machine cost is segregated form overhead and reported as a separate element)

They are grouped further based on their functions as,

• 1. Production or works overheads • 2. Administration overheads • 3. Selling overheads • 4. Distribution overheads

Classification of costs

Classification of cost means, the grouping of costs according to their common characteristics. The important ways of classification of costs are:

• By nature or element: materials, labor, expenses • By functions: production, selling, distribution, administration, R&D,

development, • As direct and indirect • By variability: fixed, variable, semi-variable • By controllability: controllable, uncontrollable • By normality: normal, abnormal

Value Chain The value chain describes the set of activities that increase the value of an organization’s products or services. Value-added activities are activities that customers perceive as valuable because the activity adds utility to the goods or services they purchase. In other words, customers define value.

• The Value Chain describes a set of activities that transforms raw materials and resources into the goods and services end users purchase and consume.

• – Value added activities • – Non value added activities •

The Value Chain Components All products start with research and development. Is research and development (creating and developing ideas related to a new product) value-added or nonvalue-added? Once we have the idea for a new product, the product must be developed and engineered. Does this add value? The purchasing department is responsible for acquiring all of the necessary components and supplies in order to produce the product. Does this add value? We must produce the product or deliver the service in order for the product or service to have value to a customer. We need to inform potential customers about the attributes of our product or service. Delivering the product or service to the customer adds value. If the customer does not have the product or service, it has no value.


Finally, chances are you have experienced the value of customer service. Have you ever called the technical support line for a software application you installed on your computer? If so, I hope the support added value to your product.

Research and Development

Design Purchasing

Production

Marketing Distribution Customer Services

Accounting Systems Financial accounting information is designed for decision makers who are not directly involved in the daily management of the firm. Cost accounting information is designed for managers.

Managerial Decisions The key question is: What adds value to the firm? Let’s look at how cost information adds value to the organization. Cost information adds value to the organization if that information improves managers’ decisions.

• Individuals make decisions. • Decisions determine the performance of the organization • Managers use information from the accounting system to make decisions. • Owners evaluate organizational and managerial performance with

accounting information. Trends in Cost Accounting Cost accounting continues to experience dramatic changes. Developments in information technology (IT) have nearly eliminated manual bookkeeping. Emphasis on cost control is increasing in all types of organizations. Enterprise Resource Planning

Enterprise resource planning (ERP) uses information technology to link the various processes of the enterprise into a single comprehensive information system. Because all the company’s processes are integrated, ERP has significant potential for providing information on the cost of products and services. However, implementation problems are keeping many companies from realizing this potential

Financial Accounting

Financial Position and Income

Cost Accounting Information about

Costs

Reports

Reports


Ethical Issues for Accountants • The design of the cost accounting system has the potential to be misused

to defraud customers, employees, or shareholders. • Accountants report information that can have a substantial impact on the

careers of managers who are generally held accountable for achieving financial performance targets. Failure to achieve a target can have serious negative consequences for a manager. Therefore, accountants may find themselves under pressure by management to make accounting choices that improve performance reports rather than accurately reflect performance. As a professional accountant, manager, or business owner, you will face ethical situations on an everyday basis.

Sarbanes-Oxley Act of 2002 When there is a public perception of widespread ethical problems, the result is often legislation making certain conduct is not only unethical, but also illegal. Congress passed the Sarbanes-Oxley Act of 2002 to address some of the more serious problems of corporate governance that surfaced in the late 1990s and early 2000s.

Technology

Purchasing

Human Resources

Marketing

Production

Finance


Institute of Management Accountants’ (IMA) Code of Ethics: Standards

1. Competence 2. Confidentiality 3. Integrity 4. Credibility

Chapter Summary This chapter discusses the use of cost accounting in its two primary managerial uses: decision making and performance evaluation. The following summarizes key ideas tied to the chapter's learning objectives. For example, L.O. 1 refers to the first learning objective in the chapter. L.O. 1. Describe the way managers use accounting information to create value in organizations. Managers make decisions to increase the value of the organization using information from the accounting system. Cost information helps identify value-increasing alternatives and activities that do not add value to the product or service. L.O. 2. Distinguish between the uses and users of cost accounting and financial accounting information. Financial accounting information provides information to users (decision makers) who are not involved in the operations and strategy of the firm. These users are often external to the firm. While cost accounting information is often used in the financial accounting system, its primary role is to aid managers inside the firm in making operational and strategic decisions. L.O. 3. Explain how cost accounting information is used for decision making and performance evaluation in organizations. Cost accounting information can be used for decision making by assessing differential costs associated with alternative courses of action. Accounting information also can be used to evaluate performance by comparing budget amounts to actual results. L.O. 4. Identify current trends in cost accounting. Cost accounting changes with changes in information technology and the adoption of new operational techniques. L.O. 5. Understand ethical issues faced by accountants and ways to deal with ethical problems that you face in your career. Ethical standards exist for management accountants. These standards are related to competence, confidentiality, integrity, and objectivity.

What is the intent? Address problem of corporate governance

Accounting firms and Corporations

Who is impacted?

How are corporations impacted?

Corporate Responsibility

Compiled By Nut Khorn

Glossary

activity-based costing (ABC)

benchmarking

budget

cost accounting

cost-benefit analysis

cost driver

cost of quality (COQ)

customer relationship management (CRM)

differential costs

differential revenues

distribution chain

enterprise resource planning (ERP)

financial accounting

generally accepted accounting principles (GAAP)

just-in-time (JIT) method

nonvalue-added activities

outsourcing


based costing Use of activity analysis to make decisions and manage costs.

Continuous process of measuring products, services, or activities against competitors' performance.

Financial plan of the resources needed to carry out activities and meet financial goals.

Field of accounting that measures, records, and reports information about costs.

benefit analysis Process of comparing benefits (often measured in savings or increased profits) with costs associated with a proposed change within an organization.

Factor that causes, or "drives," costs.

of quality (COQ) System that identifies the costs of producing low quality items, including rework, returns, and lost sales.

customer relationship management (CRM)

System that allows firms to target profitable customers by assessing customer revenues and costs.

With two or more alternatives, costs that differ among or between alternatives.

differential revenues Revenues that change in response to a particular course of action.

Set of firms and individuals that buys and distributes goods and services from the firm.

Information technology that links the various systems of the enterprise into a single comprehensive information system.

financial accounting Field of accounting that reports financial position and income according to accounting rules.

accounting principles Rules, standards, and conventions that guide the preparation of financial accounting statements for shareholders.

In production or purchasing, each unit is purchased or produced just in time for its use.

Activities that do not add value to the good or service.

Having one or more of the firm's activities performed by another firm or individual in the supply or distribution chain.

Use of activity analysis to make decisions and

Continuous process of measuring products, services, against competitors' performance.

Financial plan of the resources needed to carry out

Field of accounting that measures, records, and

Process of comparing benefits (often measured in savings or increased profits) with costs associated with a proposed change within an organization.

System that identifies the costs of producing low quality items, including rework, returns, and lost

System that allows firms to target profitable revenues and costs.

With two or more alternatives, costs that differ

Revenues that change in response to a particular

Set of firms and individuals that buys and distributes

Information technology that links the various systems of the enterprise into a single comprehensive

Field of accounting that reports financial position and

Rules, standards, and conventions that guide the of financial accounting statements for

In production or purchasing, each unit is purchased or

the good or

Having one or more of the firm's activities performed by another firm or individual in the supply or


performance measure

responsibility center

supply chain

total quality management (TQM)

value-added activities

value chain

Budget

Business process

Chief Financial Officer (CFO)

Constraint

Control

Controller

Controlling

Corporate governance

Decentralization

Directing and motivating


performance measure Metric that indicates how well an individual, business unit, product, firm, and so on, is working.

responsibility center Specific unit of an organization assigned to a manager who is held accountable for its operations and resources.

Linked set of firms that exchange goods combination to provide a final product or service to the consumer.

total quality management Management method by which the organization seeks to excel on all dimensions, with the customer ultimately defining quality.

added activities Those activities that customers perceive as adding utility to the goods or services they purchase.

Linked set of activities that increases the usefulness (or value) of the goods or services of an

A detailed plan for the future, usually expressed in formal quantitative terms. A series of steps that are followed to carry out some task in a business. The member of the top management team who is responsible for providing timely and relevant data to support planning and control activities and for preparing financial statements for external users. Anything that prevents an organization or individual from getting more of what it wants. The process of instituting procedures and then obtaining feedback to ensure that all parts of the organization are functioning effectively and moving toward overall company goals. The member of the top management team who is responsible for providing relevant and timely data to managers and for preparing financial statements for external users. The controller reports to the CFO.Ensuring that the plan is actually carried out and is appropriately modified as circumstances change.

The system by which a company is directed and controlled. If properly implemented it should provide incentives for top management to pursue objectives that are in the interests of the company and it should effectively monitor performance. The delegation of decision-making authority throughout an organization by providing managers with the authority to make decisions relating to their area of responsibility.Mobilizing people to carry out plans and run routine operations.

Metric that indicates how well an individual, business unit, product, firm, and so on, is working.

Specific unit of an organization assigned to a manager who is held accountable for its operations

Linked set of firms that exchange goods or services in combination to provide a final product or service to

Management method by which the organization seeks to excel on all dimensions, with the customer

Those activities that customers perceive as adding utility to the goods or services they purchase.

Linked set of activities that increases the usefulness (or value) of the goods or services of an organization.

A detailed plan for the future, usually expressed in formal

A series of steps that are followed to carry out some task in

management team who is responsible for providing timely and relevant data to support planning and control activities and for preparing

Anything that prevents an organization or individual from

The process of instituting procedures and then obtaining feedback to ensure that all parts of the organization are functioning effectively and moving toward overall

ment team who is responsible for providing relevant and timely data to managers and for preparing financial statements for external users. The controller reports to the CFO. Ensuring that the plan is actually carried out and is

modified as circumstances change.

The system by which a company is directed and controlled. If properly implemented it should provide incentives for top management to pursue objectives that are in the

and it should effectively monitor

making authority throughout an organization by providing managers with the authority to make decisions relating to their area of responsibility. Mobilizing people to carry out plans and run routine


Enterprise system A software system that integrates data from across an organization into a single centralized database that enables all employees to access a common set of data.

Enterprise risk management

A process used by a company to help identify the risks that it faces and to develop responses to those risks that enable the company to be reasonably assured of meeting its goals.

Feedback Accounting and other reports that help managers monitor performance and focus on problems and/or opportunities that might otherwise go unnoticed.

Financial accounting

The phase of accounting concerned with providing information to stockholders, creditors, and others outside the organization.

Finished goods Units of product that have been completed but have not yet been sold to customers.

Just-in-time (JIT) A production and inventory control system in which materials are purchased and units are produced only as needed to meet actual customer demand.

Lean thinking model

A five-step management approach that organizes resources around the flow of business processes and that pulls units through these processes in response to customer orders.

Line A position in an organization that is directly related to the achievement of the organization's basic objectives.

Managerial accounting

The phase of accounting concerned with providing information to managers for use inside the organization.

Non-value-added activities

An activity that consumes resources but that does not add value for which customers are willing to pay.

Organization chart A diagram of a company's organizational structure that depicts formal lines of reporting, communication, and responsibility between managers.

Performance report

A detailed report comparing budgeted data to actual data.

Planning Selecting a course of action and specifying how the action will be implemented.

Planning and control cycle

The flow of management activities through planning, directing and motivating, and controlling, and then back to planning again.

Raw materials Materials that are used to make a product. Sarbanes-Oxley Act of 2002

Legislation enacted to protect the interests of stockholders who invest in publicly traded companies by improving the reliability and accuracy of the disclosures provided to them.

Segment Any part of an organization that can be evaluated independently of other parts and about which the manager seeks financial data. Examples include a product line, a sales territory, a division, or a department.

Six Sigma A method that relies on customer feedback and objective data gathering and analysis techniques to drive process improvement.

Staff A position in an organization that is only indirectly related to the achievement of the organization's basic objectives. Such positions provide service or assistance to line


positions or to other staff positions. Strategy A "game plan" that enables a company to attract customers

by distinguishing itself from competitors. Supply chain management

A management approach that coordinates business processes across companies to better serve end consumers.

Theory of Constraints (TOC)

A management approach that emphasizes the importance of managing constraints.

Value chain The major business functions that add value to a company's products and services such as research and development, product design, manufacturing, marketing, distribution, and customer service.

Work in process Units of product that are only partially complete and will require further work before they are ready for sale to a customer.

End of Chapter 01


Chapter 2: Cost Concepts and Behavior

In this chapter, we have looked at some of the ways in which managers classify costs. How the costs will be used—for preparing external reports, predicting cost behavior, assigning costs to cost objects, or decision making—will dictate how the costs are classified.

For purposes of valuing inventories and determining expenses for the balance sheet and income statement, costs are classified as either product costs or period costs. Product costs are assigned to inventories and are considered assets until the products are sold. At the point of sale, product costs become cost of goods sold on the income statement. In contrast, period costs are taken directly to the income statement as expenses in the period in which they are incurred.

In a merchandising company, product cost is whatever the company paid for its merchandise. For external financial reports in a manufacturing company, product costs consist of all manufacturing costs. In both kinds of companies, selling and administrative costs are considered to be period costs and are expensed as incurred.

For purposes of predicting how costs will react to changes in activity, costs are classified into two categories—variable and fixed. Variable costs, in total, are strictly proportional to activity. The variable cost per unit is constant. Fixed costs, in total, remain at the same level for changes in activity that occur within the relevant range. The average fixed cost per unit decreases as the number of units increases.

For purposes of assigning costs to cost objects such as products or departments, costs are classified as direct or indirect. Direct costs can be conveniently traced to cost objects. Indirect costs cannot be conveniently traced to cost objects.

For purposes of making decisions, the concepts of differential cost and revenue, opportunity cost and sunk cost are vitally important. Differential costs and revenues are the costs and revenues that differ between alternatives. Opportunity cost is the benefit that is forgone when one alternative is selected over another. Sunk cost is a cost that occurred in the past and cannot be altered. Differential costs and opportunity costs should be carefully considered in decisions. Sunk costs are always irrelevant in decisions and should be ignored.

These various cost classifications are different ways of looking at costs. A particular cost, such as the cost of cheese in a taco served at Taco Bell, could be a manufacturing cost, a product cost, a variable cost, a direct cost, and a differential cost—all at the same time. Taco Bell is a manufacturer of fast food. The cost of the cheese in a taco is a manufacturing cost and, as such, it would be a product cost as well. In addition, the cost of cheese is variable with respect to the number of tacos served and it is a direct cost of serving tacos. Finally, the cost of the cheese in a taco is a differential cost of making and serving the taco.


In this chapter, the following learning objectives will be covered: Identify and give examples of each of the three basic manufacturing costcategories. Distinguish between product costs and period costs and give examples of each. Prepare an income statement including calculation of the cost of goods sold. Prepare a schedule of cost of goods manufactured. Understand the differences between variable costs and fixed costs. Understand the differences between direct and indirect costs. Define and give examples of cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs. (Appendix 2A) Properly account for labor costs associated with idle time, overtime, and fringe benefits. (Appendix 2B) Identify the four types of quality costs and explain how they interact. (Appendix 2B) Prepare and interpret a quality cost report. Subtopics

• Cost Concepts: An Overview • General Cost Classifications • Cost Classifications on Financial Statements • Cost Classifications for Different Purposes

Objectives

• Define cost and distinguish between product costs and period costs. • Analyze the fundamental manufacturing cost categories and diagram the

flow of product costs in a manufacturing operation. • Analyze the cost components on financial statements and prepare an

income statement and a schedule of cost of goods manufactured for a manufacturer.

• Compare direct and indirect costs and distinguish between variable and fixed costs.


1.General cost classification Costs are associated with all types of organizations – business, nonbusiness, manufacturing, retail, and service. Generally, the kind of costs that are incurred and the way in which these costs are classified depend on the type of organization involved. Manufacturing costs Most manufacturing companies divide manufacturing costs into three broad categories: direct materials, direct labor, and manufacturing overhead

a- Direct materials

The materials that go into the final product are called raw materials. Actually, raw materials refer to any materials that are used in final product; and the finished product of one company can be the raw materials of another company. Direct materials are those materials that become an integral part of the finished product and that can be physically and conveniently traced to it. b- Direct labor The term direct labor is served for those labor costs that can be easily traced to individual unit of product. Direct labor is sometimes called touch labor, since direct labor workers typically touch the product while it is being made. c- Manufacturing overhead

Manufacturing overhead, the third element of manufacturing cost, included all cost of manufacturing except direct materials and direct labor. Manufacturing overhead includes items such as indirect materials; indirect labor; maintenance and repair production equipment; property taxes; depreciation, and insurance on manufacturing facilities... Various names are used for manufacturing overhead, such as indirect manufacturing cost, factory overhead, and factory burden. all these terms are synonymous of manufacturing overhead.

Nonmanufacturing cost Generally, nonmanufacturing costs are subclassified into two categories:

a. Marketing or selling costs. Include all costs necessary to secure customer orders and get the finished product or service into the hands of customer. These costs are often called order-getting and order-filling costs. Example of marketing costs include


advertising, shipping, sales travel, sales commission, sales salaries, and cost of finished goods warehouses.

b .Administrative costs. Include all executive, organizational, and clerical costs associated with the general management of an organization rather than with manufacturing, marketing or selling. Examples of administrative costs include general accounting, secretarial, public relation...

2. Product cost versus period costs In addition to the distinction between manufacturing and nonmanufacturing costs, there are two other ways to look at costs. For instant, they can also be classified as either product costs or period costs. 2.1 Product costs For financial accounting purpose, product costs include all the costs there are involved in acquiring or making a product Period cost Period cost is all cost that is not included in product costs. These cost are expense on the income statement in the period in which they are incurred. A suggested above, all selling and administrative expenses are considered to be period cost. Exhibit 2 – 1 Summary of cost terms � Manufacturing costs or product costs

� Direct materials Prime cost

� Direct labor Conversion cost

� Manufacturing overhead

� Nonmanufacturing costs or period costs

� Marketing or selling costs � Administrative costs


Cost Flow


3. Cost classification on financial statements The financial statements prepared by manufacturing company are more complex than the statements are prepared by a merchandising company. The balance sheet The balance sheet or statement of financial position, of a manufacturing company is similar to that of a merchandising company has only one class of inventory – goods purchased from suppliers that are awaiting resale to customer. By contrast, manufacturing companies have three classes of inventories – raw materials, work in process, and finished goods.

Graham Manufacturing Company

Inventory Account

Beginning Ending Balance balance $ $ Raw materials................ 60,000 50,000 Work in process............... 90,000 60,000 Finished goods................125,000 175,000 In contrast, the inventory account at Reston Bookstore consist entirely of the cost of books the company has purchased from publisher for resale to the public

Reston Bookstore Inventory account

Beg. Bal Ending Bal $ $ Merchandise inventory........ 100,000 150,000 The income statement Exhibit 2 – 2 compares the income statements of Reston Bookstore and Graham Manufacturing. For purpose of illustration, these statements contain more detail about cost of goods sold than you will generally find and published financial statements. Exhibit 2 – 2 Comparative income statements: Merchandise and manufacturing companies:

Merchandise Company Reston Bookstore

____________________________

$ $ Sales.................................................. 1,000,000 Cost of goods sold: Beginning merchandise inventory.... 100,000


Add: purchases................................ 650,000 Goods available for sale.................... 750,000 Deduct: ending merch. Inventory....... 150,000 600,000 Gross margin...................................... 400,000 Less: operating expenses: Selling expense.................................. 100,000 Administrative expense...................... 200,000 300,000 Net income.......................................... 100,000

Manufacturing Company Graham Manufacturing

___________________________

$ $ Sales................................................. 1,500,000 Cost of goods sold: Beginning finished goods inventory.. 125,000 Add: cost of goods manufactured...... 850,000 Goods available for sale.................... 975,000 Deduct: ending finis. Goods inventory..... 175,000 800,000 Gross margin..................................... 700,000 Less: operating expenses: Selling expense................................ 125,000 Administrative expense.................... 300,000 550,000 Net income........................................ 150,000 To determine the cost of goods sold in merchandising company like Reston Bookstore, we only need to know the opening and closing balance in the Merchandise Inventory account and purchases. To determine the cost of goods sold in manufacturing company like Graham Manufacturing, we need to know the cost of goods manufactured and the opening and closing balance of Finished Goods Inventory account. The cost of goods manufactured consists of the manufacturing costs associated with goods that were finished during the period. Schedule of Cost of Goods Manufactured The cost of goods manufactured contains the three elements of product costs that we discussed earlier – direct materials, direct labor, and manufacturing overhead. Exhibit 2 – 3 Schedule of cost of goods manufactured Direct materials: Opening raw materials inventory................. $ 60,000


Add: purchases of raw materials.................. 400,000 Raw materials available for use.................... 460,000 Deduct: closing raw materials inventory....... 50,000 Raw materials used in production................ 410,000 Direct labor.......................................................... 60,000 Manufacturing overhead: Insurance factory........................................ 6,000 Indirect labor.............................................. 100,000 Machine rental............................................ 50,000 Utilities, factory........................................... 75,000 Supplies...................................................... 21,000 Depreciation, factory................................... 90,000 Property taxes, factory................................ 8,000 Total overhead cost............................ 350,000 Total manufacturing costs……….... 820,000 Add: opening work in process inventory............ 90,000 910,000 Deduct: closing work in process inventory........ 60,000 Cost of goods manufactured................................ $850,000


Cost classifications For predicting cost behaviorCost behavior means how a cost will react or respond to changes in the level of business activity. As the activity level rises and falls, a particular cost may rise and fall as well. A. Variable cost A variable cost is a cost that level of activity. The activity can be expressed in many ways, such as units produced, units sold, miles driven, hours worked. The cost of direct materials used during a period will varies, in total, units that are produced. It is importance to note that when we speak of a cost as being variable, we mean the total cost rises and falls as the activity level rises and falls.B. Fixed cost A fixed cost is a cost thatlevel of activity. Fixed costs are not affected by changes in the activity. Consequence, as the activity level rises and falls


predicting cost behavior

means how a cost will react or respond to changes in the level of business activity. As the activity level rises and falls, a particular cost may rise

is a cost that varies, in total, in direct proportion to change in the level of activity. The activity can be expressed in many ways, such as units produced, units sold, miles driven, hours worked. The cost of direct materials used during a period will varies, in total, in direct proportion to the number of units that are produced.

It is importance to note that when we speak of a cost as being variable, we mean the total cost rises and falls as the activity level rises and falls.

is a cost that remains constant, in total, regardless of changes in the level of activity. Fixed costs are not affected by changes in the activity. Consequence, as the activity level rises and falls.

means how a cost will react or respond to changes in the level of business activity. As the activity level rises and falls, a particular cost may rise

varies, in total, in direct proportion to change in the level of activity. The activity can be expressed in many ways, such as units produced, units sold, miles driven, hours worked. The cost of direct materials

in direct proportion to the number of

It is importance to note that when we speak of a cost as being variable, we mean

remains constant, in total, regardless of changes in the level of activity. Fixed costs are not affected by changes in the activity.


UnitsTotalCostsTotal

CostUnit =

For assigning costs to cost objectives Costs are assigned to objectives for a variety of purpose including pricing, profitability studies, and control of spending. A cost objective is anything for which cost data are desired – including products, customer, jobs, and organization. A. Direct cost A direct cost is a cost that can be easily and conveniently traced to the particular cost object under consideration. Direct Materials and Direct labor. B. Indirect cost An indirect cost is a cost that can not be easily and conveniently traced to the particular cost object under consideration. For decision making A. Opportunity cost Opportunity cost is the potential benefit that is given up when one alternative is selected over another. B. Sunk cost A sunk cost is a cost that has already been incurred and that can not be changed by any decision made now or in the future.


Income Statement

./

arg/

LossincomeNet

ExpenseOperating

inmprofitGross

COGS

SalesNet

=−=−

sincome/LosNet

ExpensesAdmin and Selling-

Margin

=

=−

Gross

COGS

SalesNet

1) Formula of Direct Materials

productionin used Materials Raw

Materials Raw Ending-

usefor available Materials Raw

Materials Raw of Purchases

Materials Beg.Raw

=

=+

2)

Costs ingManufactur Total

(MOH) Overhead ingManufactur

(DL)Labor Direct

(DM) MaterialsDirect

=++

3)


edManufactur Goods ofCost

WIPEnding-

WIPofCost Total

(WIP) processin Beg.Work

Costs ingManufactur Total

=

=+

4)

(COGS)Sold Goods ofCost

Goods Finished Ending-

Salefor Available Goods

edManufactur Goods ofCost

Goods Finished Beg.

=

=+


Key Terms Administrative costs

All executive, organizational, and clerical costs associated with the general with manufacturing or selling.

Common cost A cost that is incurred to support a number of cost objects but that cannot be traced to them individually. For example, the wage cost of the pilot of a 747 airliner isof all of the passengers on the aircraft. Without the pilot, there would be no flight and no passengers. But no part of the pilot's wage is caused by any one passenger taking the flight.

Conversion cost Direct labor cost plus manufacturinCost behavior The way in which a cost reacts to changes in the level of

activity.Cost object Anything for which cost data are desired. Examples of cost

objects are products, customers, jobs, and parts of the organization such as dep

Cost of goods manufactured

The manufacturing costs associated with the goods that were finished during the period.

Differential cost A difference in cost between two alternatives. Also see Incremental cost

Differential revenue

The difference in revenue between two alternatives.

Direct cost A cost that can be easily and conveniently traced to a specified cost object.

Direct labor Factory labor costs that can be easily traced to individual units of product. Also called

Direct materials Materials that become an integral part of a finished product and whose costs can be conveniently traced to it.

Finished goods Units of product that have been completed but not yet sold to customers.

Fixed cost A cost in the level of activity within the relevant range. If a fixed cost is expressed on a per unit basis, it varies inversely with the level of activity.

Incremental cost An increase in cost between twoDifferential cost

Indirect cost A cost that cannot be easily and conveniently traced to a specified cost object.

Indirect labor The labor costs of janitors, supervisors, materials handlers, and other factory workers that cannto particular products.

Indirect materials

Small items of material such as glue and nails that may be an integral part of a finished product, but whose costs cannot be easily or conveniently traced to it.

Inventoriable costs

Synonym for

Manufacturing All manufacturing costs except direct materials and direct


All executive, organizational, and clerical costs associated with the general management of an organization rather than with manufacturing or selling. A cost that is incurred to support a number of cost objects but that cannot be traced to them individually. For example, the wage cost of the pilot of a 747 airliner is a common cost of all of the passengers on the aircraft. Without the pilot, there would be no flight and no passengers. But no part of the pilot's wage is caused by any one passenger taking the flight. Direct labor cost plus manufacturing overhead cost.The way in which a cost reacts to changes in the level of activity. Anything for which cost data are desired. Examples of cost objects are products, customers, jobs, and parts of the organization such as departments or divisions.The manufacturing costs associated with the goods that were finished during the period. A difference in cost between two alternatives. Also see Incremental cost. The difference in revenue between two alternatives.

A cost that can be easily and conveniently traced to a specified cost object. Factory labor costs that can be easily traced to individual units of product. Also called touch labor. Materials that become an integral part of a finished product and whose costs can be conveniently traced to it.Units of product that have been completed but not yet sold to customers. A cost that remains constant, in total, regardless of changes in the level of activity within the relevant range. If a fixed cost is expressed on a per unit basis, it varies inversely with the level of activity. An increase in cost between two alternatives. Also see Differential cost. A cost that cannot be easily and conveniently traced to a specified cost object. The labor costs of janitors, supervisors, materials handlers, and other factory workers that cannot be conveniently traced to particular products.

Small items of material such as glue and nails that may be an integral part of a finished product, but whose costs cannot be easily or conveniently traced to it. Synonym for product costs.

All manufacturing costs except direct materials and direct

All executive, organizational, and clerical costs associated management of an organization rather than

A cost that is incurred to support a number of cost objects but that cannot be traced to them individually. For example,

a common cost of all of the passengers on the aircraft. Without the pilot, there would be no flight and no passengers. But no part of the pilot's wage is caused by any one passenger taking the

g overhead cost. The way in which a cost reacts to changes in the level of

Anything for which cost data are desired. Examples of cost objects are products, customers, jobs, and parts of the

artments or divisions. The manufacturing costs associated with the goods that were

A difference in cost between two alternatives. Also see

The difference in revenue between two alternatives.

A cost that can be easily and conveniently traced to a

Factory labor costs that can be easily traced to individual

Materials that become an integral part of a finished product and whose costs can be conveniently traced to it. Units of product that have been completed but not yet sold to

that remains constant, in total, regardless of changes in the level of activity within the relevant range. If a fixed cost is expressed on a per unit basis, it varies inversely with

alternatives. Also see

A cost that cannot be easily and conveniently traced to a

The labor costs of janitors, supervisors, materials handlers, ot be conveniently traced

Small items of material such as glue and nails that may be an integral part of a finished product, but whose costs cannot be

All manufacturing costs except direct materials and direct


overhead labor. Opportunity cost The potential benefit that is given up when one alternative is

selected over another. Period costs Costs that are taken directly to the income statement as

expenses in the period in which they are incurred or accrued. Prime cost Direct materials cost plus direct labor cost. Product costs All costs that are involved in acquiring or making a product.

In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Also see Inventoriable costs.

Raw materials Any materials that go into the final product. Relevant range The range of activity within which assumptions about

variable and fixed cost behavior are valid. Schedule of cost of goods manufactured

A schedule showing the direct materials, direct labor, and manufacturing overhead costs incurred during a period and the portion of those costs that are assigned to Work in Process and Finished Goods.

Selling costs All costs that are incurred to secure customer orders and get the finished product or service into the hands of the customer.

Sunk cost A cost that has already been incurred and that cannot be changed by any decision made now or in the future.

Variable cost A cost that varies, in total, in direct proportion to changes in the level of activity. A variable cost is constant per unit.

Work in process Units of product that are only partially complete.


Problems P2-1) The following data (in thousands of dollars) have been taken from the accounting

records of Kovach Corporation for the just completed year.

Raw materials inventory, beginning $ 80

Raw materials inventory, ending 140

Work in process inventory, beginning 140

Work in process inventory, ending 100

Finished goods inventory, beginning 240

Finished goods inventory, ending 320

Administrative expenses 300

Direct labor 400

Manufacturing overhead 460

Purchases of raw materials 240

Sales 1,980

Selling expenses 280

Part (a) what was the cost of the raw materials used in production during the year (in thousands of dollars)? Part (b) what was the cost of goods manufactured (finished) for the year (in thousands of dollars)? Part (c) What was the cost of goods sold for the year (in thousands of dollars)? Part (d) what was the net income for the year (in thousands of dollars)? P2-2 The following information is taken from the December 31, 2005, adjusted trial balance and other records of OTW Company before the calendar year-end closing entries are recorded:


Advertising expense $ 14,000 Direct labor 700,000 Depreciation expense — Office equipment 5,100 Income taxes expense 212,000 Depreciation expense — Selling equipment 8,560 Indirect labor 75,070 Depreciation expense — Factory equipmen 32,420 Miscellaneous production costs 16,125 Factory supervision 98,100 Office salaries expense 57,000 Factory supplies used 18,400 Raw materials purchases 805,000 Factory utilities 25,000 Rent expense — Office space 11,000 Inventories Rent expense — Selling space 31,800 Raw materials, December 31, 2004 112,350 Rent expense — Factory building 46,790 Raw materials, December 31, 2005 212,000 Maintenance — Factory equipment 34,500 Goods in process, December 31, 2004 13,300 Sales 4,579,000 Goods in process, December 31, 2005 17,080 Sales discounts 42,500 Finished goods, December 31, 2004 122,500 Sales salaries expense 382,160 Finished goods, December 31, 2005 156,000

Required 1. Prepare the 2005 schedule of cost of goods manufactured for the company. 2. Prepare the 2005 income statement for the company that reports separate categories for: (a) selling expenses, (b) general and administrative expenses, and, (3) income tax expense.


P2-3 Tommi Corporation incurred the following costs while manufacturing its product Work-in-process inventory was $10,000 at January 1 and $14,000 at December 31. Finished goods inventory was $60,500 at January 1 and $50,600 at December 31.

Instructions(a) Compute cost of goods manufactured.(b) Compute cost of goods sold.P2-4) Data are provided below Required: Supply the missing data in the following cases.

Schedule of Cost of Goods ManufacturedDirect materials ................................Direct labor ................................Manufacturing overhead ............................Total manufacturing costsBeginning work in process inventoryEnding work in process inventoryCost of goods manufactured Income Statement Sales ................................Beginning finished goods inventoryCost of goods manufacturedGoods available for sale ............................Ending finished goods inventoryCost of goods sold ................................Gross margin ................................Selling and administrative expensesNet operating income ................................


Tommi Corporation incurred the following costs while manufacturing its product

inventory was $10,000 at January 1 and $14,000 at December goods inventory was $60,500 at January 1 and $50,600 at December

Instructions (a) Compute cost of goods manufactured. (b) Compute cost of goods sold.

Data are provided below for four cases. Each case is independent of the others.

Supply the missing data in the following cases.

Case

1 2 3 Schedule of Cost of Goods Manufactured

......................................... $ 7,200 $ 4,500 $ 8,000 ................................................ ? 3,900 7,000

............................ 5,500 4,000 ? Total manufacturing costs ......................... 18,700 ? 19,500 Beginning work in process inventory ........ 1,000 ? 2,500 Ending work in process inventory ............. ? 1,000 3,000 Cost of goods manufactured ...................... $17,700 $13,400 $ ?

.......................................................... $35,000 $40,000 $15,000 Beginning finished goods inventory .......... 2,500 3,000 ? Cost of goods manufactured ...................... ? ? ?

............................ ? ? ? Ending finished goods inventory ............... ? 1,200 12,000

..................................... 17,200 ? 10,000 ............................................. 17,800 ? 5,000

Selling and administrative expenses .......... ? 9,200 ? ................................ $15,800 $ ? $ 3,000

Tommi Corporation incurred the following costs while manufacturing its product

inventory was $10,000 at January 1 and $14,000 at December goods inventory was $60,500 at January 1 and $50,600 at December

for four cases. Each case is independent of the others.

4 $7,500 6,000 4,900 ? ? 2,000 $ ? $38,000 4,000 19,300 ? 2,000 ? ? ? $11,100


P2-5 Selected account balances for the year ended December 31 are provided below for Rolling Company: Selling and administrative salaries .......... $150,000 Insurance, factory .................................... $7,500 Utilities, factory ...................................... $30,000 Purchases of raw materials ...................... $165,000 Indirect labor ........................................... $45,000 Direct labor ............................................. ? Advertising expense ................................ $76,000 Cleaning supplies, factory ....................... $4,900 Sales commissions .................................. $54,000 Rent, factory building ............................. $110,000 Maintenance, factory ............................... $22,500 Inventory balances at the beginning and end of the year were as follows: Beginning of End of the Year the Year Raw materials............ $35,000 $20,000 Work in process ........ ? $27,500 Finished goods .......... $45,000 ? The total manufacturing costs for the year were $479,000; the goods available for sale totaled $520,000; and the cost of goods sold totaled $500,000. Required: 1. Prepare a schedule of cost of goods manufactured and the cost of goods sold section of the

company’s income statement for the year. 2. The company produced the equivalent of 10,000 units during the year. Compute the average

cost per unit for direct materials used and the average cost per unit for rent on the factory building.

3. In the following year the company expects to produce 20,000 units. What average cost per unit and total cost would you expect to be incurred for direct materials? For rent on the factory building? (Assume that direct materials is a variable cost and that rent is a fixed cost.)

4. Explain to the president the reason for any difference in the average cost per unit between (2) and (3) above.

[CHECK FIGURE (1) Cost of goods manufactured: $475,000] P2-6) Various cost and sales data for Jaskot Company for the just completed year follow: Finished goods inventory, beginning ........ $22,000 Finished goods inventory, ending ............. $18,000 Depreciation, factory ................................. $24,000 Administrative expenses ........................... $36,000 Utilities, factory ........................................ $15,000 Maintenance, factory ................................. $12,000 Supplies, factory ....................................... $6,000 Insurance, factory ...................................... $5,000 Purchases of raw materials ........................ $102,500


Raw materials inventory, beginning ......... $8,000 Raw materials inventory, ending ............... $10,000 Direct labor ............................................... $60,000 Indirect labor ............................................. $18,000 Work in process inventory, beginning ...... $10,000 Work in process inventory, ending ........... $12,000 Sales .......................................................... $400,000 Selling expenses ........................................ $63,000 Required: 1. Prepare a schedule of cost of goods manufactured. 2. Prepare an income statement. 3. The company produced the equivalent of 10,000 units of product during the year just

completed. What was the average cost per unit for direct materials? What was the average cost per unit for factory depreciation?

4. The company expects to produce 12,000 units of product during the coming year. What average cost per unit and what total cost would you expect the company to incur for direct materials at this level of activity? For factory depreciation? (In preparing your answer, assume that direct materials is a variable cost and that depreciation is a fixed cost that is computed on a straight-line basis.)

5. Explain to the president any difference in the average cost per unit between (3) and (4) above.

[CHECK FIGURE (1) Cost of goods manufactured: $238,500] P2-7 CHECK FIGURE (1) Cost of goods manufactured: $512,270 Madlinx Company was organized on April 1 of the current year. After five months of start-up losses, management had expected to earn a profit during September, the most recent month. Management was disappointed, however, when the income statement for September also showed a loss. September’s income statement follows: Madlinx Company

Income Statement For the Month Ended September 30

Sales .................................................... $725,000 Less operating expenses: Indirect labor cost ............................ $ 22,000 Utilities ............................................ 23,000 Direct labor cost .............................. 115,000 Depreciation, factory equipment ..... 32,000 Raw materials purchased ................. 275,000 Depreciation, sales equipment ......... 28,000 Insurance ......................................... 6,800 Rent on facilities .............................. 85,000 Selling and administrative salaries .. 51,000 Advertising ...................................... 100,000 737,800 Net operating loss ............................... $(12,800) After seeing the $12,800 loss for September, Madlinx’s president stated, “I was sure we’d be profitable within six months, but our six months are up and this loss for September is even worse than August’s. I think it’s time to start looking for someone to buy out the company’s assets—if we don’t, within a few


months there won’t be any assets to sell. By the way, I don’t see any reason to look for a new controller. We’ll just limp along with Harry for the time being.” The company’s controller resigned a month ago. Harry, a new inexperienced assistant in the controller’s office, prepared the income statement above. Additional information about the company follows:

a. Some 75% of the utilities cost and 65% of the insurance apply to factory operations. The remaining amounts apply to selling and administrative activities.

b. Inventory balances at the beginning and end of September were:

September 1 September 30 Raw materials .......... $12,000 $17,900 Work in process ....... 31,000 38,000 Finished goods ......... 35,000 59,000

c. Only 70% of the rent on facilities applies to factory operations; the remainder applies to selling and administrative activities.

The president has asked you to check over the income statement and make a recommendation as to whether the company should look for a buyer for its assets. Required: 1. As one step in gathering data for a recommendation to the president, prepare a schedule of

cost of goods manufactured for September. 2. As a second step, prepare a new income statement for September. 3. Based on your statements prepared in (1) and (2) above, would you recommend that the

company look for a buyer? P2-8 Selected account balances for the year ended December 31 are provided below for Rolling Company:

Selling and administrative salaries $55,000

Insurance, factory………………………. $6,000

Utilities, factory………………………….. $10,000

Purchases of raw materials……….. $76,000

Indirect labor………………………………. $3,000

Direct labor……………………………… ?

Advertising expense…………………. $26,000

Cleaning supplies, factory………….. $4,000

Sales commissions…………………….. $33,000

Rent, factory building……………… $49,000

Maintenance, factory………………… $15,000

Inventory balances at the beginning and end of the year were as follows: Beginning of the year End of the year Raw materials………..$3,000 $9,000


Work in process……….? 13,000 Finished goods……….25,000 ? The total manufacturing costs for the year were $242,000; the goods available for sale totaled $269,000; and the cost of goods sold totaled $229,000. Required: 1. Prepare a schedule of cost of goods manufacturing in good form and the cost of goods sold section of the company’s income statement for the year. 2. The company produced the equivalent of 7,000 units during the year. Compute the average cost per unit for direct materials used and the average per unit for rent on the factory building. P2-9 The cost of goods manufactured schedule shows each of the cost elements. Complete the following schedule for Lanier

Manufacturing Company:

LANIER MANUFACTURING COMPANY

Cost of Goods Manufactured Schedule For the Year Ended December 31, 2010

Work in process (1/1)……………………………………………….$200,000 Direct materials

Raw materials inventory (1/1)………$? Add: raw material purchases………158,000

Less: raw material purchases………… 6,500 Direct material used…………………………………………… $190,000

Direct labor…………………………………………………………………………? Manufacturing overhead

Indirect labor ……………………….$18,000 Factory depreciation……………….36,000

Factory utilities ……………………….68,000

Total overhead ………………………………………….. 122,000 Total manufacturing costs……………………………………………… ?

Total cost work in process………………………………………………..$ ? Less: work in process (12/31)………………………………………87,000

Cost of goods manufactured………………………………… $560,000 P2-10 Hawkinson Company is manufacturer of toys. Its controller, Al

Duryea, resigned on August 2010. An inexperience assistant accountant has prepared the following income statement for the

month of August 2010. HAWKINSOM COMAPANY

Income Statement For the Month Ended August31, 2010

Sales (net) $670,000

Less: Operating expenses


Raw materials purchased

Direct labor cost

Advertising expense

Selling and administrating salaries

Rent on factory facilities

Depreciation on sales equipment

Depreciation on factory equipment

Indirect labor cost

Factory utilities

Factory insurance

Net loss

Prior to August 2010 the company has been profitable every month. The company’s president is concerned about the

accuracy of the income statement above. As a friend of the president, you have been asked to review the income statement

and make necessary cormanufacturing cost data, you have required additional

information as follows: 1. Inventory balance at the beginning and end of August

were:

Raw materials ………..$18,000

Work in proce Finished goods …………..40,000

2. Only 70% of the utilities expense and 80% of the insurance expense apply to factory operations; the

remaining amounts should be charged to selling and administrative activities.

Instructions: (a) Prepare a cost of goods manufactured

schedule for August 2010.(b) Prepare a correct income statement for August

2010. P2-11) Manufacturing cost data for Natasha Company are presented below


Raw materials purchased $200,000

Direct labor cost $150,000

Advertising expense $80,000

Selling and administrating salaries $70,000

Rent on factory facilities $60,000

Depreciation on sales equipment $55,000

Depreciation on factory equipment $40,000

Indirect labor cost $20,000

Factory utilities $10,000

Factory insurance $5,000



and make necessary corrections. After examining other manufacturing cost data, you have required additional

information as follows: Inventory balance at the beginning and end of August

August 1

Raw materials ………..$18,000

Work in process………… 25,000 Finished goods …………..40,000

Only 70% of the utilities expense and 80% of the insurance expense apply to factory operations; the

remaining amounts should be charged to selling and administrative activities.

Prepare a cost of goods manufactured

schedule for August 2010. Prepare a correct income statement for August

2010.

Manufacturing cost data for Natasha Company are presented below

$690,000

$(20,000)



rections. After examining other manufacturing cost data, you have required additional

Inventory balance at the beginning and end of August

August 31

$33,000

21,000 62,000

Only 70% of the utilities expense and 80% of the insurance expense apply to factory operations; the

remaining amounts should be charged to selling and

Prepare a cost of goods manufactured

Prepare a correct income statement for August

Manufacturing cost data for Natasha Company are presented below.


Instructions Indicate the missing amount for each letter (a) P2-12) Incomplete manufacturing cost data for Heintz Company for 2011 are presentedas follows for four different situations. Instructions

(a) Indicate the missing amount for each letter.(b) Prepare a condensed cost of goods

situation (1) for the P2-13 Tart Corporation has the following cost records for June 2011. Instructions

(a) Prepare a cost of goods manufactured schedule for June 2011.(b) Prepare an income

assuming net sales


Indicate the missing amount for each letter (a) through (i).

Incomplete manufacturing cost data for Heintz Company for 2011 are presentedas follows for four different situations.

(a) Indicate the missing amount for each letter. (b) Prepare a condensed cost of goods manufactured schedule for

situation (1) for the year ended December 31, 2011.

Tart Corporation has the following cost records for June 2011.

a) Prepare a cost of goods manufactured schedule for June 2011.(b) Prepare an income statement through gross profit for June 2011

assuming net sales are $85,100.

The End of Chapter 02

Incomplete manufacturing cost data for Heintz Company for 2011 are presented

edule for

a) Prepare a cost of goods manufactured schedule for June 2011. statement through gross profit for June 2011


Chapter 03: Fundamentals of Cost-Volume-Profit Analysis (CVP) GOALS

Your goals for this "cost-volume-profit analysis" chapter are to learn about:

• Cost behavior patterns and implications for managing business growth. • Methods of cost behavior analysis. • Break-even and target income analysis • Cost and profit sensitivity analysis. • Cost-volume-profit analysis for multiproduct scenarios. • Critical assumptions of cost-volume-profit modeling.

DISCUSSION

COST BEHAVIOR

"Profitability is just around the corner." This is a common expression in the business world; you may have heard or said this yourself. But, the reality is that many businesses don't make it! Business is tough, profits are illusive, and competition has a habit of moving into areas where profits are available. And, sometimes, business owners become frustrated because revenue growth only seems to bring on waves of additional expenses, even to the point of going backwards.

How does one realistically assess the viability of a business? This is perhaps the most critical business assessment a manager must make. Most of us are taught from an early age to do our best and not give up, even in the face of adversity. And, there are countless stories of businesses that struggled to survive their infancy, but went on to become highly successful firms. But, it is equally important to note that some business models will not work. You likely have heard the tongue-in-cheek story about the car dealer who said he loses money on every sale but makes it up on volume. Of course, the math just won't work.

A good manager must learn to use information to make informed decisions about which business prospects to pursue. Managerial accounting methods provide techniques for evaluating the viability and ability to grow or "scale" a business. These techniques are called cost-volume-profit analysis (CVP).

THE NATURE OF COSTS: Before one can begin to understand how a business is going to perform over time and with shifts in volume, it is imperative to first consider the cost structure of the business. This requires drilling down into the specific types of costs that are to be incurred and trying to understand their unique attributes.


VARIABLE COSTS:

Variable costs will vary in direct proportion to changes in the level of an activity. For example, direct material, direct labor, sales commissions, fuel cost for a trucking company, and so on, may be expected to increase with each additional unit of output.

Assume that GoSound produces portable digital music players. Each unit produced requires a printed circuit board (PCB) that costs $11. At right is a spreadsheet that reveals rising PCB costs with increases in unit production. For example, $1,650,000 is spent when 150,000 units are produced (150,000 X $11 = $1,650,000). The data are plotted on the graphs. The top graph reveals that total variable cost increases in a linear fashion as total production rises. The slope of the line is constant. Of course, when plotted on a "per unit" basis (the bottom graph), the variable cost is constant at $11 per unit. Increases in volume do not change the per unit cost. In summary, every additional unit produced brings another incremental unit of variable cost.

The activity base is the item or event that causes the incurrence of a variable cost. It is easy to think of the activity base in terms of units produced, but it can be more than that. Activity can relate to labor hours worked, units sold, customers processed, or other such "cost drivers." For instance, a dentist will uses a new pair of disposable gloves for each patient seen, no matter how many teeth are being filled. Therefore, disposable gloves are variable and key on patient count. But, the material used for fillings is a variable that is tied to the number of decayed teeth that are repaired. Some patients have none, some have one, and others have many. So, each variable cost must be considered independently and with careful attention to what activity drives the cost.

FIXED COSTS:


The opposite of variable costs are fixed costs. Fixed costs do not fluctuate with changes in the level of activity. Assume that GoSound leases the manufacturing facility where the portable digital music players are assembled. Assume that rent is $1,200,000 no matter the level of production. The rent is said to be a "fixed" cost, because total rent will not change as output rises and falls. The following spreadsheet reveals the factory rent incurred at different levels of production and the resulting "per unit" rent amount. Observe that the fixed cost per unit will decline with increases in production. This attribute of fixed costs is important to consider in assessing the scalability of a business proposition. There are numerous types of fixed costs. Examples include administrative salaries, rents, property taxes, security, networking infrastructure support, and so forth.

BUSINESS IMPLICATIONS OF THE FIXED COST STRUCTURE:

The nature of a specific business will have a lot to do with defining its inherent fixed cost structure. Airlines have historically been burdened with high fixed costs related to gates, maintenance, contractual labor agreements, computer reservation systems, aircraft, and the like. As you are aware, airlines have struggled during lean years because they are unable to cover fixed costs. During boom years, these same companies have been extremely profitable, because costs do not rise (much) with increases in volume. Basically, there is not much cost difference in flying a plane empty or full! Software companies have a big investment in product development, but very little cost in reproducing multiple electronic copies of the finished product. Their variable costs are low.


Other businesses have attempted to avoid fixed costs so that they can maintain a more stable stream of income relative to sales. For example, a computer company might outsource its tech support. Rather than having a fixed staff that is either idle or overloaded at any point in time, they pay an independent support company a per-call fee. The effect is to transform the organization's fixed costs to variable, and better insulate the bottom line from fluctuations brought about by the related ability to cover or not cover the fixed costs of operations.

Every business is unique, and a savvy business person will be careful to understand their cost structure. For a long time, the trend for many businesses was toward increased fixed costs. Some of this was the result of increased investment in robotics and technology. However, those components have become more affordable. And, we are now seeing more outsourcing, elimination of health insurance, conversion of pension plans, and so forth. These activities suggest attempts to structure businesses with a definitive margin

(revenues minus variable costs) that scales up and down with changes in the level of business activity. No matter the specific example, a manager must understand their cost structure.

ECONOMIES OF SCALE:

Economists speak of the concept of economies of scale. This means that certain efficiencies are achieved as production levels rise. This can take many forms. For starters, fixed costs can be spread over larger production runs, and this causes a decrease in the per unit fixed cost. In addition, enhanced buying power results (e.g., quantity discounts) as volume goes up, and this can reduce the per unit variable cost. These are valid considerations. The accountant is not blind to these issues and must take them into consideration in any business evaluation.

However, care must also be exercised to limit one's analysis to a "relevant range" of activity.

RELEVANT RANGE:

At right is an excerpt from an online catalog (Digi-Key Corporation). This is a pricing table for surface mount Zener Diodes. Notice that they are $0.44 each, or $3.00 for ten units, or $20.80 for 100 units, or $92.00 per thousand. The bottom


line here is that they range from $0.44 down to $0.092 each, depending on the quantity purchased. This is quite a remarkable spread.

Despite the wild spread in pricing, if your business needed about 150 of these diodes in your production process, you would study the above table and determine that the best quantity for you to order would be priced at $20.80 per hundred. As a result, your per unit variable cost would be $0.208. The "relevant range" is the anticipated activity level at which you will perform. Any pricing data outside of this range is irrelevant and need not be considered. This enhanced concept of variable cost is portrayed in the following graphic:

The relevant range comes into play when considering fixed costs as well. Many fixed costs are only fixed for a certain level of production. For example, a machine or manufacturing plant can reach capacity. To increase production beyond a certain level, additional machinery (or a new plant, additional supervisors, etc.) must be deployed. This will cause a major step upward in the fixed cost. Fixed costs that behave in this fashion are also called step costs. These costs are illustrated by the following diagram. The key conceptual point is to note that fixed costs are only fixed over some particular range of activity, and moving outside that range can significantly alter the cost structure.

DIALING IN YOUR BUSINESS MODEL:


After grasping the concepts of variable and fixed costs, it is important to understand their full implications in managing a business. Let's first give added thought to fixed cost concepts. In an ideal setting, you would try to produce at the right-most edge of a fixed-cost step. This squeezes maximum productive output from a given level of expenditure. For a machine, it is as simple as running at full capacity. However, for a business with many fixed costs, it is more challenging to orchestrate operations so that each component is fully utilized.

Some fixed costs are committed fixed costs arising from an organization's commitment to engage in operations. These elements include such items as depreciation, rent, insurance, property taxes, and the like. These costs are not easily adjusted with changes in business activity. On the other hand, discretionary fixed costs originate from top management's yearly spending decisions; proper planning can result in avoidance of these costs if cutbacks become necessary or desirable. Examples of discretionary fixed costs include advertising, employee training, and so forth. Committed fixed costs relate to the desired long-run positioning of the firm; whereas, discretionary fixed costs have a short-term orientation. Committed fixed costs are important because they cannot be avoided in lean times; discretionary fixed costs can be altered with proper planning. Of course, a company should be careful to avoid incurring excessive committed fixed costs.

Variable costs are also subject to adjustment. In the Digi-Key Corporation example, it was illustrated how such costs can vary based on quantities ordered. Perhaps it occurred to you that one might order and store large quantities of the diodes for use in future periods (after all, 1200 units at $.208 each > 3000 units at $0.08 each). In a subsequent chapter, you will learn how to calculate economic order quantities that take into account carrying and ordering costs in balancing these important considerations. Even direct labor cost can be subject to adjustment for overtime premiums, based on whether or not overtime is worked. It may or may not make sense to meet customer demand by ramping up production when overtime premiums kick in. Later in this book, you will learn how to perform incremental analysis for such decision tasks.

The interplay between all of the different costs emphasizes the importance of good planning. The trick is to synchronize operations so that the benefits of each fixed cost are maximized, and variable cost patterns are established in the most economic position. All of this must be weighed against revenue opportunities; you must be able to sell what you produce. Some advanced managerial accounting courses present sophisticated linear programming models that take into account constraints and opportunities and project the ideal firm positioning. Those models are beyond the scope of an introductory class, but a number of simpler tools are available, and will be covered next.

COST BEHAVIOR ANALYSIS

Good managers must not only be able to understand the conceptual underpinnings of cost behavior, but they must also be able to apply those concepts to real world data that do not always behave in the expected manner.


Cost data are impacted by complex interactions. Consider for instance the costs of operating a vehicle. Conceptually, fuel usage is a variable cost that is driven by miles. But, the efficiency of fuel usage can fluctuate based on highway miles versus city miles. Beyond that, tires wear faster at higher speeds; brakes suffer more from city driving, and on and on. Vehicle insurance is seen as a fixed cost; but some portions are required (liability coverage) and some portions are not (collision coverage). Furthermore, if you have a wreck or get a ticket, your cost of coverage can rise. Now, the point is that assessing the actual character of cost behavior can be more daunting than you might first suspect. Nevertheless, management must understand cost behavior, and this sometimes takes a bit of forensic accounting work. Let's begin by considering the case of "mixed costs."

MIXED COSTS:

Many costs contain both variable and fixed components. These costs are called mixed or semi-variable. If you have a cell phone, you probably know more than you wish about such items. Cell phone agreements usually provide for a monthly fee plus usage charges for excess minutes, text messages, and so forth. With a mixed cost, there is some fixed amount plus a variable component tied to an activity. Mixed costs are harder to evaluate, because they change in response to fluctuations in volume. But, the fixed cost element means the overall change is not directly proportional to the change in activity.

To illustrate, assume that Butler's Car Wash has a contract for its water supply that provides for a flat monthly meter charge of $1,000, plus $3 per thousand gallons of usage. This is a classic example of a mixed cost. Below is a graphic portraying Butler's potential water bill, keyed to gallons used:

Look closely at the data in the spreadsheet, and notice that the "variable" portion of the water cost is $3 per thousand gallons. For example, spreadsheet cell B12 is $2,100 (700 thousand gallons at $3 per thousand); observe the formula for cell B12 in the upper bar of the spreadsheet (= (A12/1000)*3). In addition, the "fixed" cost is $1,000, regardless of the gallons used. The total in column D is


the summation of columns B and C. The cost components are mapped in the diagram at the right.

Hopefully, the preceding illustration is clear enough. But, what if you were not given the "formula" by which the water bill is calculated? Instead, all you had was the information from a handful of past water bills. How hard would it be to to sort it out? Could you estimate how much the water bill should be for a particular level of usage? This type of problem is frequently encountered in business, as many expenses (individually and by category) contain both fixed and variable components.

HIGH-LOW METHOD:

One approach to sorting out mixed costs is the high-low method. It is perhaps the simplest technique for separating a mixed cost into fixed and variable portions. However, beware that it can return an imprecise answer if the data set under analysis has a number of rogue data points. But, it will work fine in other cases, as with the water bills for Butler's Car Wash. Information from Butler's actual water bills is shown at left. Butler is curious to know how much the August water bill will be if 650,000 gallons are used. Assume that the only data available are from the aforementioned four water bills.

With the high-low technique, the highest and lowest levels of activity are identified for a period of time. The highest water bill is $3,550, and the lowest is $2,020. The difference in cost between the highest and lowest level of activity represents the variable cost ($3,550 - $2,020 = $1,530) associated with the change in activity (850,000 gallons on the high end and 340,000 gallons on the low end yields a 510,000 gallon difference). The cost difference is divided by the activity difference to determine the variable cost for each additional unit of activity ($1,530/510 thousand gallons = $3 per thousand). The fixed cost can be calculated by subtracting variable cost (per-unit variable cost multiplied by the activity level) from total cost. The table at right reveals the application of the high-low method.

An electronic spreadsheet can be used to simplify the high-low calculations. Click this link to open a separate browser window revealing an illustrative spreadsheet for Butler.


METHOD OF LEAST SQUARES:

As cautioned, the high-low method can be quite misleading. The reason is that cost data are rarely as linear as presented in the preceding illustration, and inferences are based on only two observations (either of which could be a statistical anomaly or "outlier"). For most cases, a more precise analysis tool should be used. If you have studied statistical methods, recall "regression analysis" or the "method of least squares." This tool is ideally suited to cost behavior analysis. This method appears to be imposingly complex, but it is not nearly so complex as it seems. Let's start by considering the objective of this calculation.

The goal of least squares is to define a line so that it fits through a set of points on a graph, where the cumulative sum of the squared distances between the points and the line is minimized (hence, the name "least squares"). Simply, if you were laying out a straight train track between a lot of cities, least squares would define a straight-line route between all of the cities, so that the cumulative distances (squared) from each city to the track is minimized.

Let's dissect this method, beginning with the definition of a line. A line on a graph can be defined by its intercept with the vertical (Y) axis and the slope along the horizontal (X) axis. In the following diagram, observe a red line starting on the Y axis (at the value of "2"), and rising gently upward as it moves out along the X axis. The rate of rise is called the slope of the line; in this case, the slope is 0.8, because the line "rises" 8 units on the Y axis for every 10 units of "run" along the X axis.

In general, a straight line can be defined by this formula: Y = a + bX Where: a = the intercept on the Y axis b = the slope of the line X = the position on the X axis For the line drawn above, the formula would be:

Y =2 +0.8X


And, if you wished to know the value of Y, when X is 5 (see the red circle on the line), you perform the following calculation: Y = 2 + (0.8 * 5) = 6 Now, lets move on to fitting a line through a set of points. Below is a table of data showing monthly unit production and the associated cost (sorted from low to high). These data are plotted on the graph to the right. Through the middle of the data points is drawn a line and the line has a formula of:

Y = $138,533 + $10.34X

This formula suggests that fixed costs are $138,533, and variable costs are $10.34 per unit. For example, how much would it cost to produce about 110,000 units? The answer is about $1,275,000 ($138,533 + ($10.34 * 110,000)).

How was the formula derived? One approach would be to simply "eyeball the points" and draw a line through them. You would then estimate the slope of the line and the Y intercept. This approach is known as the scatter graph method, but it would not be precise. A more accurate approach, and the one used to derive the above formula, would be the least squares technique. With least squares, the vertical distance between each point and resulting line (e.g., as illustrated by an arrow at the $1,500,000 point) is squared, and all of the squared values are summed. Importantly, the defined line is the one that minimizes the summed squared values! This line is deemed to be the best fit line, hopefully giving the clearest indication of the fixed portion (the intercept) and the variable portion (the slope) of the observed data.

One can always fit a line to data, but how reliable or accurate is that resulting line? The R-Square value is a statistical calculation that characterizes how well a particular line fits a set of data. For the illustration, note (in cell B21) an R2 of .798; meaning that almost 80% of the variation in cost can be explained by volume fluctuations. As a general rule, the closer R2 is to 1.00 the better; as this would represent a perfect fit where every point fell exactly on the resulting line.


The R-Square method is good in theory. But, how does one go about finding the line that results in a minimization of the cumulative squared distances from the points to the line? One way is to utilize built-in tools in spreadsheet programs, as illustrated above. Notice that the formula for cell B21 (as noted at the top of spreadsheet) contains the function RSQ(C5:C16,B5:B16). This tells the spreadsheet to calculate the R2 value for the data in the indicated ranges. Likewise, cell B20 is based on the function SLOPE(C5:C16,B5:B16). Cell B19 is INTERCEPT(C5:C16,B5:B16). Most spreadsheets provide intuitive pop-up windows with prompts for setting up these statistical functions.

Spreadsheets have not always been available. You may be curious to know the underlying mechanics for the least squares method. If so, you can check out this link.

RECAP: Before moving on, let's review a few key points. A good manager must understand an organization's cost structure. This requires careful consideration of variable and fixed cost components. However, it is sometimes difficult to discern the exact cost structure. As a result, various methods can be employed to analyze cost behavior. Once an organization's cost structure is understood, it then becomes possible to perform important diagnostic calculations which are the subject of the next sections of this chapter.

BREAK-EVEN AND TARGET INCOME

COST-VOLUME-PROFIT (CVP): CVP analysis is imperative for management. It is used to build an understanding of the relationship between costs, business volume, and profitability. The analysis focuses on the interplay of pricing, volume, variable and fixed costs, and product mix. This analysis will drive decisions about what products to offer, how to price them, and how to


manage an organization's cost structure. CVP is at the heart of techniques that are useful for calculating the break-even point, volume levels necessary to achieve targeted income levels, and similar computations. The starting point for these calculations is to consider the contribution margin.

Cost-Volume-profit (CVP), in managerial economics is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions. Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analysis. Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are: The behavior of both costs and revenues is linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.) Costs can be classified accurately as either fixed or variable. Changes in activity are the only factors that affect costs. All units produced are sold (there is no ending finished goods inventory). When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant. The components of Cost-Volume-Profit Analysis are:

• Level or volume of activity • Unit Selling Prices • Variable cost per unit • Total fixed costs • Sales mix

Assumptions CVP assumes the following:

• Constant sales price; • Constant variable cost per unit; • Constant total fixed cost; • Constant sales mix; • Units sold equal units produced.

These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear and the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful. CONTRIBUTION MARGIN:

The contribution margin is revenues minus variable expenses. Do not confuse the contribution margin with gross profit as discussed in the previous chapter (revenues minus cost of sales). Gross profit would be calculated after deducting all manufacturing costs associated with sold units, whether fixed or variable. Instead, the contribution margin is a conceptual number reflecting the amount available from each sale, after deducting all variable costs associated with the units sold. Some of these variable costs are product costs, and some are selling


and administrative in nature. The contribution margin is generally a number calculated for internal use and analysis; it does not ordinarily become a part of the externally reported data set.

CONTRIBUTION MARGIN: Aggregated, per unit, or ratio?

When speaking of the contribution margin, one might be referring to aggregated data, per unit data, or ratios. This point is illustrated below for Leyland Sports, a manufacturer of score board signs. The production cost is $500 per sign, and Leyland pays its sales representatives $300 per sign sold. Thus, variable costs are $800 per sign. Each signs sells for $2,000. Leyland's contribution margin is $1,200 ($2,000 - ($500 + $300)) per sign. In addition, assume that Leyland incurs $1,200,000 of fixed costs, regardless of the level of activity. Below is a schedule with contribution margin information, assuming 1,000 units are produced and sold:

What would happen if Leyland sold 2,000 units?

What would happen if Leyland sold only 500 units?

Notice that changes in volume only impact certain amounts within the "total column." Volume changes did not impact fixed costs, or change the per unit or ratio calculations. By reviewing the above data, also note that 1,000 units achieved breakeven net income. At 2,000 units, Leyland managed to achieve a $1,200,000 net income. Conversely, 500 units resulted in a $600,000 loss.


GRAPHIC PRESENTATION:

Leyland's management would find the following chart handy. Dollars are represented on the vertical axis and units on the horizontal:

Be sure to examine this chart, taking note of the following items:

• The total sales line starts at "0" and raises $2,000 for each additional unit. • The total cost line starts at $1,200,000 (reflecting the fixed cost), and rises

$800 for each additional unit (reflecting the addition of variable cost). • "Break-even" results where sales equal total costs. • At any given point, the width of the loss area (in red) or profit area (in

green) is the difference between sales and total costs.

BREAK-EVEN CALCULATIONS:

As they say, a picture is worth a thousand words, and that is certainly true for the CVP graphic just presented. However, everyone is not an artist, and you may find it more precise to do a little algebra to calculate the break-even point. Consider that:

Break-even results when:

Sales = Total Variable Costs + Total Fixed Costs

For Leyland, the math turns out this way:

(Units X $2,000) = (Units X $800) + $1,200,000


Solving:

Step

a:

(Units X

$2,000)

= (Units X $800) + $1,200,000

Step

b:

(Units X

$1,200)

= $1,200,000

Step

c:

Units = 1,000

Now, it is possible to "jump to step b" above by dividing the fixed costs by the contribution margin per unit. Thus, a break-even short cut is:

Break-Even Point in Units = Total Fixed Costs / Contribution Margin per Unit

1,000 Units = $1,200,000 / $1,200

Sometimes, you may want to know the break-even point in dollars of sales (rather than units). This approach is especially useful for companies with more than one product, where those products all have a similar contribution margin ratio:

Break-Even Point in Sales = Total Fixed Costs / Contribution Margin Ratio

$2,000,000 = $1,200,000 / 0.60

TARGET INCOME CALCULATIONS:

Breaking even is not a bad thing, but hardly a satisfactory outcome for most businesses. Instead, a manager may be more interested in learning the necessary sales level to achieve a targeted profit. The approach to solving this problem is to treat the "target income" like an added increment of fixed costs. In other words, the margin must cover the fixed costs and the desired profit:

Target Income results when:

Sales = Total Variable Costs + Total Fixed Costs + Target Income

Assume Leyland wants to know the level of sales to reach a $600,000 income:

(Units X $2,000) = (Units X $800) + $1,200,000 + $600,000

Solving:

Step

a:

(Units X

$2,000)

= (Units X $800) + $1,200,000 + $600,000


Step

b:

(Units X

$1,200)

= $1,800,000

Step

c:

Units = 1,500

Again, it is possible to "jump to step b" by dividing the fixed costs and target income by the per unit contribution margin:

Units to Achieve a Target Income = (Total Fixed Costs + Target Income) / Contribution Margin per Unit

1,500 Units = $1,800,000 / $1,200

If you want to know the dollar level of sales to achieve a target net income:

Sales to Achieve a Target Income = (Total Fixed Costs + Target Income) / Contribution Margin Ratio

$3,000,000 = $1,800,000 / 0.60

CRITICAL THINKING ABOUT CVP:

CVP is more than just a mathematical tool to calculate values like the break-even point. It can be used for critical evaluations about business viability.

For instance, a manager should be aware of the "margin of safety." The margin of safety is the degree to which sales exceed the break-even point. For Leyland, the degree to which sales exceed $2,000,000 (its break-even point) is the margin of safety. This will give a manager valuable information as they plan for inevitable business cycles.

A manager should also understand the scalability of the business. This refers to the ability to grow profits with increases in volume. Compare the income analysis for Leaping Lemming Corporation and Leaping Leopard Corporation:

Both companies "broke even" in 20X1. Which company would you rather own? If you knew that each company was growing rapidly and expected to double sales


each year (without any change in cost structure), which company would you prefer? With the added information, you would expect the following outcomes for 20X2:

This analysis reveals that Leopard has a more scalable business model. Its contribution margin is high and once it clears its fixed cost hurdle, it will turn very profitable. Lemming is fighting a never ending battle; sales increases are met with significant increases in variable costs. Be aware that scalability can be a double-edged sword. Pull backs in volume can be devastating to companies like Leopard because the fixed cost burden can be consuming. Whatever the situation, managers need to be fully cognizant of the effects of changes in scale on the bottom-line performance.

The Margin of Safety The margin of safety is the excess of budgeted (or actual) sales over the break-even volume of sales. The margin of safety helps management assess how far above or below the break-even point the company is currently operating. To calculate the margin of safety, we take total current sales and subtract break-even sales.

Margin of safety = Total sales - Break-even sales Let’s calculate the margin of safety for RBC. If we assume that Racing Bicycle Company has actual sales of $250,000, given that we have already determined the break-even sales to be $200,000, the margin of safety is $50,000 as shown. We can express the margin of safety as a percent of sales.

Break-even sales

400 unitsActual sales

500 unitsSales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net operating income -$ 20,000$

Break-even sales

400 unitsActual sales

500 unitsSales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net operating income -$ 20,000$


sales actual)(or budgeted Totaldollarsin safety ofMargin

percentagesafety ofMargin =

In the case of RBC, the margin of safety is 20% ($50,000 divided by $250,000). The margin of safety can be expressed in terms of the number of units sold. The margin of safety at Racing is $50,000, and each bike sells for $500.

bikes 100 $500

$50,000 unitsin safety ofMargin ==

Operating Leverage A measure of how sensitive net operating income is to percentage changes in sales. The degree of operating leverage is a measure, at any given level of sales, of how a percentage change in sales volume will affect profits. It is computed by dividing contribution margin by net operating income.

income operatingNet Margin on Contributi

leverage operating of Degree =

Let’s look at Racing Bicycle. At Racing, the degree of operating leverage is 5.

5000,20$0000,100$ =

With an operating leverage of 5, if Racing increases its sales by 10%, net operating income would increase by 50%. If Racing is able to increase sales by 10%, net income will increase by 50%. We multiply the percentage increase in sales by the degree of operating leverage. Let’s verify the 50% increase in profit.

Actual sales 500 Bikes

Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 80,000 Net income 20,000$

Actual sales 500 Bikes

Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 80,000 Net income 20,000$

Percent increase in sales 10%

Degree of operating leverage × 5

Percent increase in profits 50%


A 10% increase in sales would increase bike sales from the current level of 500 to 550. Look at the contribution margin income statement and notice that income increased from $20,000 to $30,000. That $10,000 increase in net income is a 50% increase. So it is true that a 10% increase in sales results in a 50% in net income. This is powerful information for a manager to have. Summary Formulas of CVP Total Revenue (TR) = Price (P) x Units of output produced and sold (X) TR = PX Total cost (TC) = [variable cost per unit (V) x Units of output(X)] + Fixed Cost (FC) TC = VCX +FC π = TR-TC = PX – (VCX+F) = (P-VC) X +FC Contribution Margin The difference between price and variable cost. It is what is leftover to cover fixed costs and then add to operating profit. Contribution Margin per Unit: Price per unit – Variable cost per unit = CM per unit CMunit = Punit – VCunit

price sellingUnit

marginSales

margin)1

oncontributiUnitratioCM

onContributiratioCM

=

=

Break-even: The point at which profits equal zero. At break-even, all fixed costs are covered, but the firm is not producing any operating profit. Equation:

π =TR –TC TR = TC + π PX = VCX + FC + π PX –VCX = FC + π

Actual sales (500)

Increased sales (550)

Sales 250,000$ 275,000$ Less variable expenses 150,000 165,000 Contribution margin 100,000 110,000 Less fixed expenses 80,000 80,000 Net operating income 20,000$ 30,000$


X (P-VC) = F

VCP

FCX

−Π+=

Break-even point in Units

VCP

FCX

−=

Break-even point in Dollars

ratioCM

FC=

Target Profit Analysis

VolumeTarget )2

Volume(Target )1

Key Terms

Break-even point The level of sales at which profit is zero. The breakpoint can also be defined as the point where total sales equals total expenses or as the point where total contribution margin equals total fixed expenses.

Contribution margin method

A method of computing the breakfixed expenses are divided by the contribution margin per unit.

Contribution margin ratio (CM ratio)

A ratio computed by dividing contribution margin by dollar sales.

Cost-volume-profit (CVP) graph

A graphical representation of the relationships between an organization's revenues, costs, and profits on the one hand and its sales volume on the other hand.

Degree of operating leverage

A measure, at a given change in sales will affect profits. The degree of operating leverage is computed by dividing contribution margin by net operating income.


= FC + π

VC

Π Break –even is where π =0

even point in Units

unitCM

FC

VC=

even point in Dollars

ratio

Target Profit Analysis

ratio CM

FC Dollars) (sales Volume

CMUnit FC

units) Volume(

Π+=

Π+=

The level of sales at which profit is zero. The breakpoint can also be defined as the point where total sales equals total expenses or as the point where total contribution margin equals total fixed expenses.

A method of computing the break-even point in which the fixed expenses are divided by the contribution margin per unit.

A ratio computed by dividing contribution margin by dollar sales.

A graphical representation of the relationships between an organization's revenues, costs, and profits on the one hand and its sales volume on the other hand.

A measure, at a given level of sales, of how a percentage change in sales will affect profits. The degree of operating leverage is computed by dividing contribution margin by net operating income.

The level of sales at which profit is zero. The break-even point can also be defined as the point where total sales equals total expenses or as the point where total contribution

even point in which the fixed expenses are divided by the contribution margin per

A ratio computed by dividing contribution margin by dollar

A graphical representation of the relationships between an organization's revenues, costs, and profits on the one hand

level of sales, of how a percentage change in sales will affect profits. The degree of operating leverage is computed by dividing contribution margin by net


Equation method A method of computing the breakthe equation Sales = Variable expenses + Fixed expenses + Profits.

Incremental analysis

An analytical approach that focuses only on those costs and revenues that change as a result of a decision.

Margin of safety The break

Operating leverage

A measure of how sensitive net operating income is to a given percentage change in dollar sales.

Sales mix The relative proportions in sold. Sales mix is computed by expressing the sales of each product as a percentage of total sales.

Variable expense ratio

A ratio computed by dividing variable expenses by dollar sales.

P3-1Q). Which one of the following is the format of a CVP income statement?A. Sales – Variable costs = Fixed costs + Net income.B. Sales – Fixed costs C. Sales – Cost of goods sold D. Sales – Variable costs

P3-3Q.) Which one of the following describes the breakA. It is the point where sales total equals total variable plus total fixed costs.B. It is the point where the contribution margC. It is the point where total variable costs equal total fixed costs.D. It is the point where sales total equals total fixed costs.

P3-4Q) . The following information is available for Chap Company.Sales…………………………. $350,000Cost of good sold……………… $120,000Total fixed expenses…………… $60,000Total variable expenses………… $100,000

Which amount would you find on Chap's CVP income statement?A. Contribution margin of $250,000.B. Contribution margin of $190,000.C. Gross profit of $230,000.D. Gross profit of $190,000.

P3-5Q. Gabriel Corporation has fixed costs of $180,000 and variable costs of $8.50 per unit. It has a target income $268,000. How many units must it sell at $12 per unit to achieve its target net income?

A. 51,429 units.B. 128,000 units.C. 76,571 units.D. 21,176 units.

P3-1 ST ) . The format of a CVP Income statement is Sales Operating expenses = Net Income.

A. True B. False

P3-2ST) . Contribution margin ratio is contribution margin divided by sales.


A method of computing the break-even point that the equation Sales = Variable expenses + Fixed expenses + Profits.


The excess of budgeted (or actual) dollar sales over the break-even dollar sales.

A measure of how sensitive net operating income is to a given percentage change in dollar sales.

The relative proportions in which a company's products are sold. Sales mix is computed by expressing the sales of each product as a percentage of total sales.

A ratio computed by dividing variable expenses by dollar sales.

Solved Problems Which one of the following is the format of a CVP income statement?

Variable costs = Fixed costs + Net income. Fixed costs – Variable costs – Operating expenses = Net income.Cost of goods sold – Operating expenses =Net income.Variable costs – Fixed costs = Net income.

Which one of the following describes the break-even point?It is the point where sales total equals total variable plus total fixed costs.It is the point where the contribution margin equals zero. It is the point where total variable costs equal total fixed costs.It is the point where sales total equals total fixed costs.

The following information is available for Chap Company. Sales…………………………. $350,000

good sold……………… $120,000 Total fixed expenses…………… $60,000 Total variable expenses………… $100,000

Which amount would you find on Chap's CVP income statement? Contribution margin of $250,000. Contribution margin of $190,000. Gross profit of $230,000. Gross profit of $190,000.

Gabriel Corporation has fixed costs of $180,000 and variable costs of $8.50 per unit. It has a target income $268,000. How many units must it sell at $12 per unit to achieve its target net income?

51,429 units. 8,000 units.

76,571 units. 21,176 units. The format of a CVP Income statement is Sales – Cost of goods sold

Operating expenses = Net Income.

Contribution margin ratio is contribution margin divided by sales.

even point that relies on the equation Sales = Variable expenses + Fixed expenses +


excess of budgeted (or actual) dollar sales over the

A measure of how sensitive net operating income is to a

which a company's products are sold. Sales mix is computed by expressing the sales of each

A ratio computed by dividing variable expenses by dollar

Which one of the following is the format of a CVP income statement?

Operating expenses = Net income. ome.

even point? It is the point where sales total equals total variable plus total fixed costs.

It is the point where total variable costs equal total fixed costs.

Gabriel Corporation has fixed costs of $180,000 and variable costs of $8.50 per unit. It has a target income $268,000. How many units must it sell at $12 per unit

Cost of goods sold –

Contribution margin ratio is contribution margin divided by sales.


A. True B. False

P3-11ST). ______ is the amount of revenue that remains after deducting variable costs in a CVP income statement.

A. Net income. B. Contribution margin. C. Fixed income. D. Gross income.

P3-12ST) . Given the following information, what is the contribution margin ratio? Sales…………………………….. $900,000 Variable expenses………………... 400,000 Fixed Expenses………………….. 300,000 Net Income………………………. 200,000 A. 44% B. 22% C. 33% D. 56%

P3-1) Cambridge, Inc. is considering the introduction of a new calculator with the following price and cost characteristics:

Sales price . . . . . . . . . . . . . . $ 18 each Variable costs . . . . . . . . . . . ..10 each Fixed costs . . . . . . . . . . . . . . 20,000 per month

Required a. What number must Cambridge sell per month to break even? b. What number must Cambridge sell to make an operating profit t of $16,000 for the month? P3-2) Balance, Inc. is considering the introduction of a new energy snack with the following price and cost characteristics:

Sales price . . . . . . . . . . . $ 1.00 per unit Variable costs . . . . . . . . . 0.20 per unit Fixed costs . . . . . . . . . . . 400,000 per month

Required a. What number must Balance sell per month to break even? b. What number must Balance sell per month to make an operating profit of $100,000? P3-1Brew) Bird Shelters, Inc. distributes a high-quality wooden birdhouse that sells for $15.00 per unit. Variable costs are $4.50 per unit, and fixed costs total $135,000 per year. Required: Answer the following independent questions: 1. What is the product’s CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. Due to an increase in demand, the company estimates that sales will increase by $56,250 during the next year. By how much should net operating income increase (or net operating loss decrease), assuming that fixed costs do not change?


P3- Solu-Gari) Voltar Company manufactured and sells a telephone answering machine. The company’s contribution format income statement for the most recent year is given below:

Total Per Unit Percent of SalesSales (20,000 units ………. 1,200,000$ 60$ 100%Less variable expenses….. 900,000 45 ?Contribution margin………. 300,000 15$ ? %Less fixed expenses……… 240,000 Net operating income…….. 60,000$

Management is anxious to improve the company’s profit performance and has asked for an analysis of a number of items.

Required: 1- Compute the company’s CM ratio and variable expense ratio. 2- Compute the company’s break-even point in both units and sales dollars. Use

the equation method. 3- Assume that sales increase by $400,000 next year. If cost behavior patterns

remain unchanged, by how much will be company’s net operating income increase? Use the CM ratio to determine your answer.

4- Refer to the original data. Assume that next year management wants the company to earn a minimum profit of $90,000. How many units will have to be sold to meet this target profit figure?

5- Refer to the original data. Compute the company’s margin of safety in both dollar and percentage form.

6- a. Compute the company’s degree of operating leverage at the present level of sales. b.Assume that through a more intense effort by the sales of staff the company’s sales increase by 8% next year. By what percentage would you expect next operating income to increase? Use the operating leverage concept to obtain your answer.

c.Verify your answer to (b) by preparing a new income statement showing an 8% increase in sales.

7- In an effort to increase sales and profits, management is considering the use of a higher quality speaker. The higher quality speaker would increase variable costs by $3 per unit, but management could eliminate one quality inspector who is paid a salary of $30,000 per year. The sale manager estimates that the higher quality speaker would increase annual sales by at least 20%. a) Assume that changes are made as described above; prepare a projected income statement for next year. Show data on a total per unit, and percentage basis. b) Compute the company’s new break-even point in both units and dollars of sales. Use the contribution margin method. c) Would you recommend that the changes be made?

P3-3) Chen & Chen Furniture Inc. sells a small hand-crafted table for $30 per unit. The variable costs related to the table, including product and shipping costs, are $18


per unit. Total fixed costs for the company are $60,000. Prepare a CVP graph to approximate the break-even point in dollars and units. P3-4) Barnard Ltd. sells a single product. The product has a selling price of $100

per unit, variable expenses of 80% of sales, and its fixed expenses total $150,000 per year. Part (a) What is the company’s contribution margin ratio? Part (b) What is its break-even point? (Give answer in dollars and in units.) Part (c) Draw the CVP graph and show the graph.

P3-5) Dahlia Manufacturing Company reported $4,000,000 of sales during the month and incurred variable expenses totaling $2,800,000 and fixed expenses of $720,000. A total of 80,000 units were produced and sold last month. The company has no beginning or ending inventories.

Part (a) what is the company’s total contribution margin and contribution margin per unit? Part (b) how many units would the company have to sell to achieve a desired target profit of $600,000? Part (c) What is the company’s break-even point in sales dollars? Part (d) What is the company’s margin of safety? Part (e) What is the company's degree of operating leverage?

P3-132TB)1 . Delphi Company has developed a new product that will be marketed for the first time during the next fiscal year. Although the Marketing Department estimates that 35,000 units could be sold at $36 per unit, Delphi's management has allocated only enough manufacturing capacity to produce a maximum of 25,000 units of the new product annually. The fixed expenses associated with the new product are budgeted at $450,000 for the year. The variable expenses of the new product are $16 per unit.

Required: a. How many units of the new product must Delphi sell during the next fiscal year in order to break even on the product? b. What is the profit Delphi would earn on the new product if all of the manufacturing capacity allocated by management is used and the product is sold for $36 per unit? c. What is the degree of operating leverage for the new product if 25,000 units are sold for $36 per unit? d. The Marketing Department would like more manufacturing capacity to be devoted to the new product. What would be the percentage increase in net operating income for the new product if its unit sales could be expanded by 10% without any increase in fixed expenses and without any change in the unit selling price and unit variable expense? e. Delphi's management has stipulated that the new product must earn a profit of at least $125,000 in the next fiscal year. What unit selling price would achieve this target profit if all of the manufacturing capacity allocated by management is used and all of the output can be sold at that selling price? P3-133TB). 1 Managerial Accounting _Edition_12_Garrison_Noreen_Brewer_Test _Bank


Parkins Company produces and sells a single product. The company's income statement for the most recent month is given below:

Sales (6,000 units at $40 per unit) ............. …………………. $240,000 Less manufacturing costs:

Direct materials...................................... $48,000 Direct labor (variable) ............................ 60,000 Variable factory overhead ...................... 12,000 Fixed factory overhead ........................... 30,000…….. 150,000 Gross margin................................................................. 90,000

Less selling and other expenses: Variable selling and other expenses ....... 24,000 Fixed selling and other expenses ............ 42,000…….. 66,000

Net operating income ................................ …………………..$ 24,000 There are no beginning or ending inventories. Required: a. Compute the company's monthly break-even point in units of product. b. What would the company's monthly net operating income be if sales increased by 25% and there is no change in total fixed expenses? c. What dollar sales must the company achieve in order to earn a net operating income of $50,000 per month?

End of chapter 03


Chapter 4 Cost Estimation

Learning Objectives

Managers who understand how costs behave are better able to predict costs and make decisions under various circumstances. This chapter explores the meaning of variable, fixed, and mixed costs (the relative proportions of which define an organization’s cost structure). It also introduces a new income statement called the contribution approach. Understand how fixed and variable costs behave and how to use them to predict costs We discussed this table in an earlier chapter. Let’s concentrate on variable costs in total. Recall that total variable cost is proportional to the activity level within the relevant range. As activity increases, total variable cost increases, and as activity decreases, total variable cost decreases. Types of Cost Behavior Patterns

After reading this chapter, you should be able to:

• Understand the reasons for estimating fixed and variable costs. • Estimate costs using engineering estimates. • Estimate costs using account analysis. • Estimate costs using statistical analysis. • Interpret the results of regression output. • Identify potential problems with regression data. • Evaluate the advantages and disadvantages of alternative cost

estimation methods. • (Appendix A) Use Microsoft Excel to perform a regression analysis. • (Appendix B) Understand the mathematical relationship describing

the learning phenomenon.

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Variable Total variable cost is Variable cost per uni t remainsproportional to the activity the same over wide rang es

level within the relevant range. of activity.

Total fixed cost remains thesame even when the activity Fixed cost per unit goes

Fixed level changes within the down as activity level goes up. relevant range.


Mixed Costs A mixed cost has both a fixed and variable element. If you pay your utility bill, you know that a portion of your total bill is fixed. This is the standard monthly utility charge. The variable portion of your utility costs depends upon the number of kilowatt hours you consume. In other words, your total utility bill has both a fixed and variable element. The graph demonstrates the nature of a normal utility bill. The total mixed cost line can be expressed

as an equation: Y= aX +b or Y = a +bX Where: Y = the total mixed cost b = the total fixed cost (the

vertical intercept of the line) a = the variable cost per unit of activity (the slope of the line) X = the level of activity

The mixed cost line can be expressed with the equation Y = A + B*X. This equation should look familiar, from your algebra and statistics classes. In the equation, Y is the total mixed cost; A is the total fixed cost (or the vertical intercept of the line); B is the variable cost per unit of activity (or the slope of the line), and X is the actual level of activity. In our utility example, Y is the total mixed cost; A is the total fixed monthly utility charge; B is the cost per kilowatt hour consumed, and X is the number of kilowatt hours consumed. Mixed Costs Example If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill? Y = aX +b = $0.03*2,000 +$40 =$100. Analysis of Mixed Costs


We can analyze mixed costs by looking at each account and classifying the cost as variable, fixed or mixed based on the cost behaA more sophisticated way to analyze the nature of a cost is to ask our engineers to evaluate each cost in terms of production methods, material requirements, labor usage and overhead.

• Account Analysis and the Engineering Approach• Each account is classified as either

analyst’s knowledge of how the account behaves.• Cost estimates are based on an evaluation of production methods, and

material, labor and overhead requirements.

Use a scatter graph plot to diagnose A scatter graph plot is a quick and easy way to isolate the fixed and variable components of a mixed cost. The first step is to identify the cost, which is referred to as the variable, and plot it on the variable, is plotted on the If the plotted dots do not appear to be linear, do not analyze the data any further. If there does appear to be a linear relationship between the level of activity and cost, we will continue our analysis.

Next, we draw a straight line where, roughly speaking, an equal number of points reside above and below the line. Make sure that the straight line goes through at least one data point on the scattergraph. Draw a line through the data points with about an and below the line.


We can analyze mixed costs by looking at each account and classifying the cost as variable, fixed or mixed based on the cost behavior over time. A more sophisticated way to analyze the nature of a cost is to ask our engineers to evaluate each cost in terms of production methods, material requirements, labor usage and overhead.

Account Analysis and the Engineering Approach nt is classified as either variable or fixed based on the

knowledge of how the account behaves. Cost estimates are based on an evaluation of production methods, and material, labor and overhead requirements.

Use a scatter graph plot to diagnose cost behavior. graph plot is a quick and easy way to isolate the fixed and variable

components of a mixed cost.

The first step is to identify the cost, which is referred to as the dependent , and plot it on the Y axis. The activity, referred to as the independent , is plotted on the X axis.

If the plotted dots do not appear to be linear, do not analyze the data any further. If there does appear to be a linear relationship between the level of activity and ost, we will continue our analysis.

Next, we draw a straight line where, roughly speaking, an equal number of points reside above and below the line. Make sure that the straight line goes through at least one data point on the scattergraph.

h the data points with about an equal numbers of points above

We can analyze mixed costs by looking at each account and classifying the cost

A more sophisticated way to analyze the nature of a cost is to ask our engineers to evaluate each cost in terms of production methods, material requirements,

r fixed based on the

Cost estimates are based on an evaluation of production methods, and

graph plot is a quick and easy way to isolate the fixed and variable

dependent independent

If the plotted dots do not appear to be linear, do not analyze the data any further. If there does appear to be a linear relationship between the level of activity and

Next, we draw a straight line where, roughly speaking, an equal number of points reside above and below the line. Make sure that the straight line goes through at

equal numbers of points above


Part I Where the straight line crosses the Y axis determines the estimate of total fixed costs. In this case, the fixed costs are $10,000. Part II Next, select one data point to estimate the variable cost per patient day. In our example, we used the first data point that was on the straight line. From this point, we estimate the total number of patient days and the total maintenance cost. Part III Our estimate of the total number of patient days at this data point is 800, and the estimate of the total maintenance cost is $11,000. We will use this information to estimate the variable cost per patient day. Make a quick estimate of variable cost per unit and determine the cost equation. Variable cost per unit = $1,000/ 800= $1.25/ patient –day Y = $10,000 +$1.25X Where Y = Total maintenance cost X= Number of patient days Analyze a mixed cost using the high-low method. The high-low method can be used to analyze mixed costs, if a scattergraph plot reveals an approximately linear relationship between the X and Y variables. We will use the data shown in the Excel spreadsheet to determine the fixed and variable portions of maintenance costs. We have collected data about the number of hours of maintenance and total cost incurred. Let’s see how the high-low method works. Assume the following hours of maintenance work and the total maintenance costs for six months.

Month Hours of maintenance Total maintenance cost Jan 625 $7,950Feb 500 $7,400Mar 700 $8,275Apr 550 $7,625May 775 $9,100Jun 800 $9,800

Part I The first step in the process is to identify the high level of activity and its related total cost and the low level of activity with its related total cost. You can see that the high level of activity is 800 hours with a cost of $9,800 dollars. The low level of activity is 500 hours with a related total cost of $7,400. Part II

Total maintenance at 800 patients 11,000$ Less: Fixed cost 10,000 Estimated total variable cost for 800 patients 1,000$

Total maintenance at 800 patients 11,000$ Less: Fixed cost 10,000 Estimated total variable cost for 800 patients 1,000$


Now, we subtract the low level of activity from the high level and do the same for the costs we have identified. In our case, the change in level of activity and cost is 300 hours and $2,400, respectively. The variable cost per unit of activity is determined by dividing the change in total cost by the change in activity. For our maintenance example, we divide $2,400 by 300 and determine that the variable cost per hour of maintenance is $8.00.

Month Hours of maintenance Total maintenance cost Jan 625 $7,950Feb 500 $7,400Mar 700 $8,275Apr 550 $7,625May 775 $9,100Jun 800 $9,800

High 800 $9,800Low 500 $7,400Change 300 $2,400

The variable cost per hour of maintenance is equal to the change in cost divided by the change in hours.

hour/00.8$300

$2,400hour per cost variable ==

Total Fixed Cost = Total Cost – Total Variable Cost Total Fixed Cost = $9,800 – ($8/hour × 800 hours) Total Fixed Cost = $9,800 – $6,400 = $3,400

The Cost Equation for Maintenance Y = $3,400 + $8.00X

Quick Check �� Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000


Least-Squares Regression Method The least-squares regression method is a more sophisticated approach to isolating the fixed and variable portion of a mixed cost. This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost. This method is superior to the scattergraph plot method that relies upon only one data point and the high-low method that uses only two data points to estimate the fixed and variable cost components of a mixed cost. The basic goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors. The regression errors are the vertical deviations from the data points to the regression line. The formulas that are used for least-squares regression are complex. Fortunately, computer software can perform the calculations, quickly. The observed values of the X and Y variables are entered into the computer program and all necessary calculations are made. In the appendix to this chapter, we show you how to use Microsoft Excel to complete a least-squares regression analysis. Output from the regression analysis can be used to create the equation that enables us to estimate total costs at any activity level. The key statistic to examine when evaluating regression results is called R squared, which is a measure of the goodness of fit.

bXaYbaXY +=+= ;

The “Best” Regression Line bnaÞt;rIeRhÁsin RbesIrbMput smIkarmanrag baxy += Edl ( )∑

∑ ∑ ∑

∑−

−=

xxn

yxxyna

22

( )∑

∑ ∑ ∑ ∑

∑−

−=

xxx

n

xyxyb

22

2

b¤ ( )∑ ∑−= xayn

b1

emKuNéntMErtMrglIenEG‘ (r)

( ) ( )∑∑

∑ ∑ ∑

∑−−∑−

−=

yyxx nn

yxxynr

2222

tMé;l r GacERbRbÜlkñúgcenøaH 11 ≤≤− r


625 $7,950 $4,968,750 390,625 63,202,500 500 $7,400 $3,700,000 250,000 54,760,000 700 $8,275 $5,792,500 490,000 68,475,625 550 $7,625 $4,193,750 302,500 58,140,625 775 $9,100 $7,052,500 600,625 82,810,000 800 $9,800 $7,840,000 640,000 96,040,000 3950 50,150$ $33,547,500 2,673,750 423,428,750 15,602,500 2,515,022,500

a 7.26$ b 3,581.68$ r 0.95

Y = $3,581.68+ 7.26X Fortunately, computers are adept at carrying out the computations required by the least-squares regression formulas. Use Microsoft Excel 2003 or 2007. � Find a : = slope(known_y’s, known_x’s) � Find b : = intercept(known_y’s, known_x’s) � Find r : =rsq(known_y’s, known_x’s)

Step 1:

Step 2:


Step 3

Note: Use the regression method in Microsoft Excel 2003 or 2007 Data > Data Analysis

Data > Data Analysis > Regression > ok


Chapter Summary

Accurate cost estimation is important to most organizations for decision-making purposes. Although no estimation method is completely accurate, some are better than others. The usefulness of a cost estimation method depends highly on the user's knowledge of the business and the costs being analyzed.

The following summarizes the key ideas tied to the chapter's learning objectives.

L.O. 1. Understand the reasons for estimating fixed and variable costs. The behavior of costs, not the accounting classification, is the important distinction for decision making. Cost estimation focuses on identifying (estimating) the fixed and variable components of costs.

L.O. 2. Estimate costs using engineering estimates. Cost estimates can be developed by identifying all activities and resources required to make a product or provide a service. An engineering cost estimate applies unit costs to the estimate of the physical resources required to accomplish a task.

L.O. 3. Estimate costs using account analysis. Reviewing historical accounting data to determine the behavior of costs requires analyzing the accounts. Because these estimates are based on actual results, they include factors such as downtime for maintenance and absenteeism that could be missed by an engineering estimate.

L.O. 4. Estimate costs using statistical analysis. Statistical analysis of data allows estimates of costs to be based on many periods of operation. Statistical estimates average out fluctuations in the relation between costs and activities. Scattergraphs provide a visual representation of the relation and are useful to see how closely costs and activities are related. High-low analysis uses two observations to estimate the slope of the line (an estimate of the unit variable cost) and the intercept (an estimate of the fixed costs). Regression analysis uses all data and can be accomplished easily with a spreadsheet program. Using regression analysis avoids the problem of selecting observations in the high-low method that might not be representative.

L.O. 5. Interpret the results of regression output. Using regression analysis requires care because the estimates depend on certain assumptions. At a minimum, you should look at a scattergraph to determine whether the relation appears to be representative for your data. You should also check the coefficient of determination (R2) to determine how closely the estimates fit the observed data.

L.O. 6. Identify potential problems with regression data. Regression methods rely on certain assumptions. The relation between cost and activity is assumed to be


Glossary

account analysis Cost estimation method that calls for a review of each account making up the total cost being analyzed.

adjusted R-squared (R2)

Correlation coefficient squared and adjusted for the number of independent variables used to make the estimate.

coefficient of determination

Square of the correlation coefficient, interpreted as the proportion of the variation in the dependent variable explained by the independent variable(s).

correlation coefficient

Measure of the linear relation between two or more variables, such as cost and some measure of activity.

dependent variable

Y term or the left-hand side of a regression equation.

engineering estimate

Cost estimate based on measurement and pricing of the work involved in a task.

high-low cost estimation

Method to estimate costs based on two cost observations, usually at the highest and lowest activity levels.

independent variable

X term, or predictor, on the righthand side of a regression equation.

learning phenomenon

Systematic relationship between the amount of experience in performing a task and the time required to perform it.

regression Statistical procedure to determine the relation between variables.

relevant range Activity levels within which a cost estimate is valid; in particular the range within which a given fixed or unit variable cost will be unchanged even though volume changes.

linear, but this might not be the case, especially outside the relevant range. In using data from actual operations, it is important to ensure that each observation is representative and that there have been no special circumstances (strikes, weather disasters, etc.) for the period. Also, it is important to guard against spurious relations that are masked by a good statistical fit.

L.O. 7. Evaluate the advantages and disadvantages of alternative cost estimation methods. Each method has its advantages and disadvantages. Using two, three, or four of the methods together can indicate whether you should be confident of the estimates (if all the methods give similar results) or invest in more analysis.

L.O. 8. (Appendix A) Use Microsoft Excel to perform a regression analysis. Microsoft Excel or many other statistical software programs can be used to perform a regression analysis.

L.O. 9. (Appendix B) Understand the mathematical relationship describing the learning phenomenon.


scattergraph Graph that plots costs against activity levels.

t-statistic t is the value of estimated coefficient, b, divided by its standard error.

Solved Problems

Brief Exercise 4-1: Fixed and Variable Cost Behavior (LO1) Coffee Express operations a number of espresso coffee stands in busy suburban mails. The fixed weekly expense of a coffee stand is $1,100 and the variable cost per cup of coffee served is $0.26. Required:

1- Fill in the following table with your estimates total costs and cost per cup of coffee at the indicated levels of activity for a coffee stand. Round off the cost of a cup of coffee to the nearest tenth of a cent.

Cups of Coffee Served in a Week 1,800 1,900 2,000 Fixed cost…………………………… ? ? ? Variable cost………………………… ? ? ? Total cost……………………………. ? ? ? Cost per cup of coffee served………... ? ? ?

2- Does the cost per cup of coffee served increase, decrease, or remain the

same as the number of cups of coffee served in a week increases? Explain.

Brief Exercise 4-2: Scattergraph Analysis (LO2) The data below have been taken from the cost records of the Atlanta Processing Company. The data relate to the cost of operating one of the company’s processing facilities at various levels of activities:

Month Units Processed Total Cost January…………………….. 8,000 $14,000 February…………………… 4,500 $10,000 March……………………… 7,000 $12,500 April……………………….. 9,000 $15,500 May………………………… 3,750 $10,000 June………………………… 6,000 $12,500 July………………………… 3,000 $8,500 August……………………… 5,000 $11,500

Required:

1- Prepare a scattegraph by plotting the above data on a graph. Plot cost on the vertical axis and activity on the horizontal axis. Fit a line to your plotted points using a ruler.

2- Using the quick-and-dirty method, what is the approximate monthly fixed cost? The approximate variable cost per unit processes? Show your computations.


Brief Exercise 4-3: High-Low Method (LO3) The Edelweiss Hotel in Vail, Colorado, has accumulated records of the total electrical costs of the hotel and the number of occupancy-days over the last year. An occupancy-day represents a room rented out for one day. The hotel’s business is highly seasonal, with peaks occurring during the ski season and in the summer.

Month Occupancy-Day Electrical Costs January…………………….. 2,604 $6,257 February…………………… 2,856 $6,550 March……………………… 3,534 $7,986 April……………………….. 1,440 $4,022 May………………………… 540 $2,289 June………………………… 1,116 $3,591 July………………………… 3,162 $7,264 August……………………… 3,608 $8,111 September………………….. 1,260 $3,707 October…………………….. 186 $1,712 November………………….. 1,080 $3,321 December………………….. 2,046 $5,196

Required:

1- Using the high-low estimate the fixed cost of electricity per month and the variable cost of electricity per occupancy-day. Round off the fixed cost to the nearest whole dollar and the variable cost to the nearest whole cent.

2- What other factors other than occupancy-days are likely to a affect the variation in electrical costs from month to month?

Brief Exercise 4-4: Contribution Income Statement (LO4) Haaki Shop, Inc., is a large retailer or water sports equipment. An income statement for the company’s surfboard department for a recent quarter is presented below:

Sales……………………………….. 800,000$

Less cost of goods sold……………. 300,000

Gross margin………………………. 500,000

Less operating expenses: Selling expense………………… 250,000$

Administrative expenses………. 160,000 410000

Net operating income………………………… 90,000$

THE HAAKI SHOP, INC.Income Statement-Surfboard Department

For the Quarter Ended May 31

The surfboards sell, on the average, for $400 each. The department’s

variable selling expenses are $50 per surfboard sold. The remaining selling expenses are fixed. The administrative expenses are 25% variable and 75% fixed. The company purchases its surfboards from a supplier at a cost of $150 per surfboard. Required:


1- Prepare an income statement for the quarter using the contribution approach.

2- What was the contribution toward fixed expenses and profits from each surfboard sold during the quarter? (State this as a dollar amount per surfboard).

Brief Exercise 4-5: High-Low Method; Predicting Cost (LO1, LO3) The number of X-rays taken and X-ray cost over the last nine months in Beverly Hospital are given below:

Month X-Rays Taken X-Ray Costs

January 6,250 28,000$

February 7,000 29,000$

March 5,000 23,000$

April 4,250 20,000$

May 45,000 22,000$

June 3,000 17,000$

July 3,750 18,000$

August 5,500 24,000$

September 5,750 26,000$ Required:

1- Using the high-low method, estimate the cost formula for X-ray costs. 2- Using the cost formula you derived above, what X-ray costs would you

expect to be incurred during a month in which 4,600 X-rays are taken? Brief Exercise 4-6: Scattergraph Analysis; High-Low Method (LO2, LO3) Refer to the data in Exercise 4-5 Required:

1- Prepare a scattergraph using the data from Exercise 4-5. Plot cost on the vertical axis and activity on the horizontal axis. Using a ruler fit a line to your plotted points.

2- Using the quick-and-dirty method, what is the approximate monthly fixed cost for X-rays? The approximate variable cost per X-ray taken?

3- scattergraph cost formula in this situation.

P4_111TB .Rapid Delivery, Inc., operates a parcel delivery service across the nation. The company keeps detailed records relating to operating costs of trucks, and has found that if a truck is driven 150,000 miles per year the average operating cost is 10 cents per mile. This cost increases to 11 cents per mile if a truck is driven only 100,000 miles per year. Assume that all of the activity levels mentioned in this problem are within the relevant range. Required: a. Using the high-low method, derive the cost formula for truck operating costs. b. Using the cost formula you derived above, what total cost would you expect the company to incur in connection with the truck if it is driven 130,000 miles in a year?


P4-112TB) . Butler Sales Company is a distributor that has an exclusive franchise to sell a particular product made by another company. Butler Sales Company's income statements for the last two years are given below:

This Year Last Year Units sold ................................................... 200,000 ……………….160, 000 Sales revenue ............................................. $1,000,000……………. $800,000 Less cost of goods sold .............................. 700,000……………….. 560,000 Gross margin ............................................. 300,000…………………. 240,000 Less operating expenses ............................ 210,000………………….198, 000 Net operating income................................ $ 90,000…………………$ 42,000 Operating expenses are a mixture of fixed costs and variable and mixed costs that vary with respect to the number of units sold. Required: a. Estimate the company's variable operating expenses per unit, and its total fixed operating expenses per year. b. Compute the company's contribution margin for this year. P4-113TB) . SomethingNew is a small one-person company that provides elaborate and imaginative wedding cakes to order for very large wedding receptions. The owner of the company would like to understand the cost structure of the company and has compiled the following records of activity and costs incurred. The owner believes that the number of weddings catered is the best measure of activity.

Month Weddings Costs Incurred January 3 $3,800 February 2 $3,600 March 6 $4,000 April 9 $4,300 May 12 $4,500 June 20 $5,200

Required: a. Using the high-low method, estimate the variable cost per wedding and the total fixed cost per month. (Round off the variable cost per wedding to the nearest cent and the total fixed cost to the nearest dollar.) b. Using the least-squares regression method, estimate the variable cost per wedding and the total fixed cost per month. (Round off the variable cost per wedding to the nearest cent and the total fixed cost to the nearest dollar.)

P4-1) CHECK FIGURE (1) $1,200 per month plus $24.00 per scan Northern Province Hospital of British Columbia has just hired a new chief administrator who is anxious to employ sound management and planning techniques in the business affairs of the hospital. Accordingly, she has directed her assistant to summarize the cost structure of the various departments so that data will be available for planning purposes. The assistant is unsure how to classify the utilities costs in the Radiology Department since these costs do not exhibit either strictly variable or fixed cost behavior. Utilities costs are very high in the department due to a CAT scanner that draws a large amount of power and that is kept running at all times. The


scanner can’t be turned off due to the long warm-up period required for its use. When the scanner is used to scan a patient, it consumes an additional burst of power. The assistant has accumulated the following data on utilities costs and use of the scanner since the first of the year.

Month

Number of Scans

Utilities Cost

January ... 60 $2,640 February . 70 $3,120 March ..... 90 $3,480 April ....... 120 $3,960 May ......... 100 $3,600 June ......... 130 $4,320 July ......... 150 $4,800 August .... 140 $4,320 September 110 $3,720 October ................................80 $3,000 The chief administrator has informed her assistant that the utilities cost is probably a mixed cost that will have to be broken down into its variable and fixed cost elements by use of a scattergraph. The assistant feels, however, that if an analysis of this type is necessary, then the high-low method should be used, since it is easier and quicker. The controller has suggested that there may be a better approach. Required: 1. using the high-low method, estimate a cost formula for utilities. Express the

formula in the form Y = a + bX. (The variable rate should be stated in terms of cost per scan.)

2. Prepare a scattergraph by using the data above. (The number of scans should be placed on the horizontal axis, and utilities cost should be placed on the vertical axis.) Fit a straight line to the plotted points using a ruler and estimate a cost formula for utilities using the quick-and-dirty method.

3. using the regression method, estimate a cost formula for utilities. P4-3A3Horngren) Martina Fernandez, the president of Fernandez Tool Co., has asked for information about the cost behavior of manufacturing support costs. Specially, she wants to know how much support cost is fixed and how much is variable. The following data are the only records available: Month Machine Hours Support Costs May 850 9,000$ June 1400 12,500$ July 1000 7,900$ August 1250 11,000$ September 1750 13,500$ Required:


1. Find monthly fixed support cost and the variable support cost per machine hour by the high-low method.

2. A least-squares regression analysis gave the following output: Regression equation: Y = $2,728 +$6.77X

What recommendation would you give the president based on these analyses?

End of Chapter 04

compiled by nut khorn -page 2 · pdf filechapter 9 activity-based costing chapter 10...

Documents