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LESSON 1: INTRODUCTION TO ACCOUNTINGA STRATEGIC CONTEXT
DECISION PROCESS FOR MANAGERS
1. Identify problem:describethesituation,focus on key problemto besolved2. Perform quantitative & qualitativeanalysis:analysethedata relatedto the problem3. Identifyalternativesolutions:determine or createfeasibleactionalternatives4. Evaluatealternativesolutions:consider likelyconsequences ofactionalternatives5. Make recommendations:choosethe bestalternative6. Implement recommendations:implementthechosenalternative
CHARACTERISTICS OF SERVICE ORGANISATIONS
y Labour intensive; often,highest proportionateexpenses = salaries & wagesy Outputs & inputscant bestored;servicemust beconsumed whenitis provided;no inventory ofintangiblesy Inconsistencyinservice provisioning; output variesfromindividual to individual
NOT-FOR-PROFIT ORGANISATIONS
y E.g. clinics,hospitals,schools,healthmaintenance,nursing & retirementhomesy Traditionallyfew pressures w/managementcontrol b/cacceptableto expend resourcesto maintainhuman life;
also,humanserviceareas = difficultymeasuring outputs
y Now sever resource limitationsPERFORMANCE IN HEALTH CARE ORGANISATIONS
y Key variable = critical factor believedto beadirectcause oftheachievement or non-achievement oforganisationgoals & objectives;can beexternal or internal
o Traditionallyservicesdelivered;now whereservices will havegreatestimpacty Output = healthcareservicedeliveredto patient;outcome = resultinghealthstatus ofpatient
CHAPTER 1: THE STRATEGIC CONTEXT
MANAGEMENT ACCOUNTING DEFINED
y Management accounting = gathering & application ofinformationusedto plan,makedecisions,evaluateperformance, & control an organisation
o Gathersinformationfrom other unitso Providesinformationto other units
y Financial accounting = generation ofaccountinginformationfor external reportingFinancial Management
Primary users External Internal
Primary organisational focus Whole (aggregation) Parts (segmentation)
Information characteristics * Historical,accurate
* Quantitative
* Monetary
* Forecasted,timely & reasonable
* Quantitative or qualitative
* Monetary or non-monetary
Overriding criteria * GAAP
* Consistency
* Verifiability & objectivity
* Situational relevance
* Benefits > costs
* Flexibility
Recordkeeping Formal Formal & informal
y Cost accounting = tools & methodsappliedto determinethecost ofmaking products or performingservicesMANAGEMENT ACCOUNTING: A COMPONENT OF MANAGEMENT CONTROL
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y Control = exertion ofmanagerial influence on operationsso thatthey will conformto planso Needed b/c (1)employeesmaynotunderstandexpectationsdueto lack ofability,training, or information
(2)employeesmay lack goal congruence w/organisation
o Examples:financial accounting,managementinformationsystems,employee & manager evaluationsystems,organisational culture (set ofbasicassumptionsabout organisation,itsgoals, & its business
practices;describes organisationsnormsininternal & external,formal & informal transactions)
y Managementaccounting = organisational controlo Specifyappropriateactivitieso Specifyappropriate resultso Recruit & develop appropriate personnel
MANAGEMENT ACCOUNTING: IMPLEMENTING STRATEGY
y Strategy = long-termdynamic planthatfulfils organisational goals & objectivesthroughsatisfaction ofcustomerneeds & wants withinthecompanysacknowledged operatingmarkets
y Mission statements = firststage ofstrategyformulation;shouldo Clearlystate what organisation wantsto accomplisho Expresshow that organisationmeetsitstargetedcustomersneeds
y Strategyistheart ofcreating value. It providestheintellectual frameworks,conceptual models,andgoverningideasthatallow an organisationsmanagersto identify opportunitiesfor bringing valueto customersandfor
delivering valueata profit. Inthis respect,strategyisthe wayacompanydefinesits businessand linkstogetherwiththe onlytwo resourcesthat reallymatter intodayseconomy: knowledgeand relationships or an
organisationscompetenciesanditscustomers.
y Business model = description ofa businesssdistinguishing operations or mechanisms,functions,and revenues &expenses
o Matchesstrategy w/internal skills & external environment opportunitieso Unitstrategiesshouldflow from overall strategyto ensureeffective & efficient resourceallocationsare
made, overridingcorporatecultureisdeveloped, & organisational directionisenhanced
y Managementaccountinghelpsmanagersdesign,implement, & evaluate organisationsstrategy by providinginformationaboutexpectations ofwhatastrategy will accomplish & cost, & strategysactual past performance
y Organisational structure = the wayin whichauthority & responsibilityfor makingdecisionsisdistributedinanorganisation
o Designedto implement organisationsstrategyo Organisation = people, resources, & commitments,acquired & arrangedto achieve resultsspecified bythe
strategy viagoals & objectives
o Goals = desired results or conditionsthatareexpressedin qualitativeterms; oftenformulatedforstakeholders (shareholders,customers,employees,suppliers)
o Objectives = quantitativelyexpressed resultsthatcan beachievedduringa pre-established period or byaspecifieddate;should logicallymeasure progressinachievinggoals
o Authority = the right (usually by virtue ofposition or rank)to use resourcesto accomplishatask or achievan objective;can bedelegated or assignedto others
o Responsibility = obligationto accomplishtask/achieve objective;cant bedelegatedto othersy Line positions = directly relatedto theachievement oforganisations basicstrategies;e.g. production,sales,
professorsy Staff positions = indirectlyassociated w/achievement oforganisations basicstrategies; providesupport or
assistanceto line & other staffpositions;e.g. managementaccountant
y Centralisation = organisational structurein whichtop managementmakesmostdecisions & control smostactivities oforganisational unitsfromcentral headquarters;difficultydiversifying operations b/ctop management
may lack necessaryindustry-specific knowledge
y Decentralisation = downwarddelegation bytop management ofauthority & decisionmakingto theindividuals whareclosestto internal processes & customers;to besuccessful,musthaveemployeeempowerment (practices
designedto give workerstraining,authority, & responsibilitytheyneedto managetheir own jobs & makedecision
abouttheir work);uses responsibilityaccounting
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y Core competency = anycritical function or activityin which one organisationhasahigher proficiencythanitscompetitors; roots ofcompetitiveness & competitiveadvantage
o E.g. technological innovation,engineering, productdevelopment,after-saleservicey Differentiation strategy = organisationdistinguishesits products or servicesfromthose ofcompetitors byadding
enough value (incl. quality & features)thatcustomersare willingto payahigher price;can be based on product,
deliverysystem,marketingapproach,etc.
y Cost leadership strategy = organisation becomesthe low-cost producer/provider &@ableto charge low pricesthatemphasisecostefficiencies
y Environmental constraint = any limitation onstrategycaused byexternal cultural,fiscal (e.g. taxation), legal,regulatory, or political situations or bycompetitivemarketstructures;tendsto have long run rather thanshort run
effects
y Managementaccountinginformationfor formulating,implementing, & evaluatingstrategieso Formulating:information on prospectivecustomers (e.g. numbers, locations,spending patterns,
profitability) basisfor forecasts & plans
y Managementaccountingfinancial & non-financial/operational datafor designing,implementing, & assessingstrategies
CONTRIBUTION OF MANAGEMENT ACCOUNTING TO THE VALUE CREATION CHAIN
y Strategicmanagementinvolves organisational planningfor deployment ofresources (e.g. fixedassets,employees,workingcapital)to create valuefor customers & shareholders;cannot bemeasured byfinancial accounting(monetary)
o How to deploy resourcesto supportstrategieso How resourcesareusedin, or recoveredfrom,change processeso How customer value & shareholder value will serveasguidesto theeffectiveuse ofresourceso How resourcesareto bedeployed & re-deployed over time
y Value creation chain (VCC) = set ofprocesses & activitiesthatconvertinputsinto products & servicesthataddvalueto the organisationscustomers;foundation ofstrategicmanagement ofresources
o Includessuppliers,internal processes, & customerso Can beused bymanagersto determine whichactivitiescreatecustomer valueas reflectedin
product/service prices &@ revenuesearned
ySuccessful organisationsmustcooperate w/everyoneinthe valuecreationchain b/ctodayscompetition = b/wvaluechains,not businesses
y VCC:sourcingenhancingaggregatingdisseminatinginteractingo Sourcing: obtaining raw or crudely producedmaterialsin order to add value latero Enhancing:making basic productsfrom raw materialso Aggregating: puttingtogether variousenhanced productsto produceacomplex producto Disseminating:distributing products/servicesto customers;incl. wholesale & retailo Interacting:conducted byconsumer;activitiesundertaken bycustomer in obtaininggood/service being
produced by valuecreationchain;e.g. driveto storeto buymilk
y Organisations requiremanagementaccountinginformationto manageactivities;e.g. customer information =necessaryto determine which products/servicesaredesired & how manyunits ofeachshould be produced,to
projectdemand levelsfor existing & future products/services
y Vertical integration = extentto which VCC resides withinasinglefirm (high VI = low number oflinksto other firmslow VI = highdependence onsuppliers,etc.)
y Strategic alliance = agreementinvolving 2+ firms w/complementarycorecompetenciesto contribute jointlyto VCRECENT DEVELOPMENTS AND THEIR IMPACT ON MANAGEMENT ACCOUNTING
y Informationtechnologyo Helpedautomateaccountingsystems:manual enterprise resource planning (ERP):fullyintegrated,full-
servicesuite ofsoftware w/commondatabasethatcan beusedto plan & control resourcesacrossanentir
organisation
o Shiftto manageatactivity level rather thanatfinancial transactions level (possible via ERP)
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y Crisis ofconfidenceo Ethical standards = normsthat represent beliefsaboutmoral & immoral behaviours;normsfor individuals
conductinmakingdecisions & engagingin businesstransactions
LESSON 2: COST BEHAVIOUR AND ANALYSISINTRODUCTION
KEY TERMS
y Cost accumulation: process ofcollectingcostsusingsomenatural classification,e.g. materials or laboury Cost allocation: tracking & allocatingindirectcoststo one or more objectivesy Cost assignment:tracking & assigningdirectcoststo one or move objectivesy Overhead costs:anycosts, other thandirectmaterials & labour,thatareassociated w/primary product ofan
organisation;e.g. inhealthcare, overheadcosts = facilitiesmanagement,accounting, HR
BASIC COST CONCEPTS
y Cost drivers = activitiesthataffectcostsy Variable cost = costthat indirect proportionto inthecostdrivery Fixed cost = fixedin relationto agiven period oftime & range ofactivity (relevant range)
o Relevant range= limit ofcost-driver activity within whichaspecific relationship b/w costs & costdriver isvalid
COST-VOLUME-PROFIT RELATIONSHIPS
1. Equation methoda. Profits = revenues per unitxunits (variablecosts per unitxunits + fixedcosts)
2. Graphical method3. Contribution margin method
a. Units = (fixedcosts + desired profit) contributionmargin per uniti. Contributionmargin = revenues variablecosts
COST-VOLUME-REVENUE ANALYSIS (appropriatetermfor breakevenanalysisinnot-for-profit organisations)
y Fixed revenues = revenuesthat,intotal, will remainataconstant level intheshort run (funding period) regardlessofvariationsinthe level ofactivity
y Variable revenues = revenuesthat varyindirect proportionto activity levels (e.g. clinical fees)y Fixed revenue fixedcosts = (variable revenue/unit variablecosts/unit)xservice volume
o Iffixed revenuesexceedfixedcostsnetfixedsurpluso Iffixed revenuesare lessthanfixedcostsnetfixeddeficito Contributionmargin per unit = variable revenue per unit variablecost per unit
y Netfixedsurplus or deficit = contributionmargin per unitxservice volumeUSING ACTIVITY ANALYSIS TO EXAMINE COST BEHAVIOUR
y Activityanalysis = importantfor measuring & predictingcosts wherecostdrivers obviousy Previouslyhiddenactivities,e.g. supervision & administration,caninfluencecost behaviour
MANAGEMENTS INFLUENCE ON COST BEHAVIOUR
y Product or servicedecisions (e.g. productmix,design, quality,marketing,etc.)y Capacitydecisions
o Capacity costs:fixedcosts relatedto achievingadesired level ofproduction or service;ineconomicdownturn,fixedcapacitycostscant be recovered
o Committed fixed costs:costs offacilities,equipment, & basic organisationcosts whichcompanyisobligatedto incur;e.g. lease payments,mortgage payments,insurancecosts, propertytaxes,salaries
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o Discretionary fixed costs:incurredto achieve organisational goals;no relationship to output levels, butdetermined via periodic budget planning;e.g. R&D,advertising,employeetraining
y Technologydecisions (e.g. machine vs. labour-intensivemanufacturing)y Costcontrol incentives (e.g. costexpectationsfor employees & providing rewardsifexpectationsaremet)
CHAPTER 2: COST TERMINOLOGY AND COST FLOWS
COMPONENTS OF PRODUCT COST
y Cost: amonetarymeasure ofthe resourcegivenup to acquireagood or servicey Cost object: anythingto whichcostsattach or are related;can be product or service,department,division,territor
etc.;ascost object ,so do direct & indirectcostallocations
y Direct cost: acostthatisclearly,conveniently, & economicallytraceableto a particular cost objecty Indirect cost:acostthatcant beclearlytracedto a particular cost object;akacommoncost;must beallocated
(assignindirect or overheadcosts based ontheuse ofacostdriver,a predictor, or anarbitrarymethod)
y Period cost:acostthatisincurredduringanaccounting periodto supporttheactivities ofthecompany (incurrednon-productionarea);cost ofresourcesconsumedduringthe period; relatedto businessfunctions likeselling,
administration,etc.
y Product cost:acostassociated w/making or acquiring/producinginventory or providingaservice;either direct orindirectto particular cost object;akainventoriablecosts;incl. costs ofdirectmaterial,direct labour,manufacturin
overhead (set ofindirectcosts)y Direct material:a readilyidentifiable, physical part ofa productthatisclearly,conveniently, & economically
traceableto that product;may be purchased raw materials or manufacturedcomponents (shouldtheoretically
includeall materialsusedin product)
o Whencosts = too expensiveto allocateto each product (e.g. saltfor sauce)indirecto Whencosts = too expensiveto allocateto eachservice provided (e.g. pencilsfor adcampaigndesigns)
indirectthesecosts significant
y Direct labour: timespent byindividuals who work specifically onmanufacturinga product or performingaservice& whoseefforts = conveniently & economicallytraceableto that product/service;direct labour time;directlyadds
valueto final product/service;consists ofwages/salaries, often: basiccompensation, productionefficiency bonuse
employersshare ofemploymenttaxes (whencosts = stable,shouldincl. employer-paidinsurancecosts,holiday &
vacation pay, pension, retirement benefits)o Sometimes,somecostsgetallocatedto indirect labour costs, b/c (1)inefficientto trace labour costs (e.g.
fringe benefitsin volatile low-payindustrydifficultto predict,notuseful), (2)erroneousinformation (e.g
overtime pay/shift premiums = overheadcosts)
o However,substance > forme.g. servicescheduledduringnon-work hours (overtime)direct labour costallocatedto specificservice revenues/expenses (not result ofscheduling)
y Overhead: expenses ofa businesssuchas rent,insurance,utilitiesconsumedin production ofproduct or insupplying ofservice;consideredindirect;majority ofcompaniesexpenses (direct labour costsq)
o Anyindirectmanufacturing or productioncost;excl. directmaterials & labour costso Evenmanufacturingindustry 2/3 ofcosts = overhead
y Total product cost:directmaterials + direct labour + overhead;inventoriableuntil productssold/written offy Production processing/conversion (also primaryaccounts;commondatabasefor accountingsystems)
o Work notstarted Costincurred reflects prices paidfor raw materials & supplies
o Work in process (raw materials + supplies + direct labour + manufacturing overhead) Costs relatedto conversion = accumulated & accrued;incl. wages, overhead
o Finished work (product readyfor sale;incl. all productioncosts)y Service organisations: work notstarted = cost ofnecessarysupplies (inventorieduntil needed)y Prime cost: total cost ofdirectmaterials & direct labour (mostconvincinglyassociated w/ & mosttraceableto a
specific product)
y Conversion cost:sum ofdirect labour & manufacturing overheadthatisdirectly or indirectlynecessaryfortransformingdirect (raw)materials & purchased partsinto saleablefinished product
o NB:direct labour includedin both,@ primecost + conversioncost total productcost
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COST BEHAVIOUR
y Cost behaviour: manner in whichacost respondsto a ina related level ofactivity;two types: variable & fixedo Relevant range: specified range ofactivity over whicha variablecost remainsconstant per unit & afixed
cost remainsfixedintotal;generally = operatingcycle or oneyear
y Cost driver: factor (activity/occurrence)thathasadirectcauseeffect relationship to acost;e.g. production volumdirecteffect ontotal cost ofraw materialsused;usuallynot obvious (costs = affected bymultiplefactors)e.g.
qualityassurancecostsaffected by volume ofproduction + quality ofmaterialsused + skill level ofworkers + level
ofautomation
y Predictor:activitymeasurethatisaccompanied byaconsistent, observable inacostitem;doesnotnecessarilycause in relateditem (reflects possible relationship or random related occurrence)
y Variable cost:costthat variesintotal indirect proportionto inactivityy Fixed cost:costthat remainsconstantintotal withinaspecified range ofactivity
o Incl. depreciation, propertytaxes,insuranceTotal cost Unit cost
Variable cost Variesindirect proportionto inactivity Isconstantthroughoutthe relevant range
Fixed costRemainsconstantthroughoutthe relevant
range
Variesinversely with inactivitythroughoutthe
relevant range
y Lean production = emphasis on wasteelimination,highinventoryturnover, & low inventory levelsy Companies oftenswitch variable & fixedcosts (e.g. automation, outsourcing, wagestructure,depreciationmethod
suchasunits-of-production v. straight-line, rent v. propertytaxes
y Mixed cost: costthathas both variable & fixedcomponents;doesntfluctuateindirect proportion or remainconstant w/ inactivity;e.g. electricity (flatcharge + per-usagecharge)
y Step cost: variable or fixedcostthatshiftsupward or downward whenactivity byacertaininterval or step (e.g.volumediscounts)must bedivided byfixed & variablecomponents over predicted range/usage (approximate
reality & allowsstability)
y Straight-line cost formula: y = a + bx, wherey = total cost,a = fixed portion, b = variable portion,x = activitybase/costdriver to whichyis being related
Methods for separating mixed costs into variable & fixed elements
y High-low method: costestimationtechniquefor separatingmixedcoststhatusesactual observations ofatotal coatthehighest & lowest levels ofactivity & calculates in bothactivity & cost; levelschosenmust be within relevan
activity range (activitiesinfluencecosts,not vice versa)
o Outlier:non-representative pointthatfalls outside ofrelevant range ofactivity, or thatisadistortion ofnormal costs within relevant range;should bedisregardedunder high-low method
o Independent variable: variablethat, when , will causeconsistent, observable inanother variable;variableusedasthe basis ofpredictingthe value ofdependent variable
o Dependent variable:unknown variablethatisto be predicted byuse ofone or moreindependent variableo Total mixedcostoor qw/ inactivities; incost = inactivityxunit variablecosto @ b = difference b/w costsathighest & lowestactivity levels difference b/w highest & lowestactivitylevels,i.e. intotal cost inactivity level
Representsunit variablecost per measure ofactivityy Scatter graph method: graphic representation ofrelationship b/w variables withina populationachieved by
plottingeachmagnitude or itemagainstcoordinates provided
o Cost v. activityo (1) Plot points ondiagramdatashouldcover range ofvolume wideenoughto incl. both lowest & highest
volumes likelyto happeninnear future,usuallymonthly, (2)draw straight linethrough pointsto represen
atrendseparatesfixed & variablecosts
y Regression analysis: statistical procedureusedto determine & measurea predictive relationship b/w onedependent variable & 1+ other variables
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o Better estimate ofcostformulathanhigh-low method;usesall data pointsy All areestimationtechniques only;appropriateness ofcostformuladepends on validity ofactivitymeasurechosen
(activity baseselectedshould be relatedto incurrence ofoverheadcost,should reflectsignificantcorrelation
statistical measure ofstrength ofrelationship b/w two variables); bewaresignificant inindustry (historical data
reliable)
DEVELOPING AND USING PREDETERMINED OVERHEAD RATES
Variable overhead rate(VOH): proportionatelyintotal w/somemeasure ofvolume or activity
y Predetermined overhead rate: budgetedconstantcharge per unit ofactivityusedto assign overheadcoststoproduction or services;should becomputedfor each VOH pool relevant rangeischosen,total costfor each pool
level ofactivity on whichestimate was based = per unitcost ofactivity
o Since VOH = constant per unitatall activity levels within relevant range,activity level chosenfor estimatintotal variablecost important
o Activitymeasureselectedshould logically relatemeasure & overheadcostincurrenceo Predetermined VOH rate = estimated VOH cost estimated outputo Alwayscalculatedinadvance ofyear ofapplication
y Homogeneity (uniformcommonattributecommonto all costsinagivencost pool)underliesall costallocation,e.gdirect labour hours,direct labour dollars,machinehours, production orders, production-related physical measures
(e.g. kg,L)
y Typical costsystem: overhead = assignedto Work in Processinventoryusing predetermined ratexactual quantityofactivity base
y Recording overhead: (a)separateaccountsfor actual & applied, (b)general ledgery Recordingmanufacturing overhead: (a)single overheadaccount, (b)separateaccountsfor variable & fixed
components (@mustseparatemixedcosts)
Fixed overhead rate (FOH): portion oftotal overheadthat remainsconstantintotal w/ inactivity within relevant range
y For productcosting:all fixedmanufacturing overheadcostsmust beestimated & assignedto appropriatecost pooto calculatenumerator ofpredeterminedfixedmanufacturing overhead rate
oSincefixed overhead = constantintotal,it variesinversely on per-unit basis w/ inactivity
@
specificactivity level must bechosenfor denominator
o Level ofactivityselected = firmsexpectedactivity Expected annual capacity: short-runconcept representinganticipated level ofactivityfor upcomin
year
y Capacity:measure ofproduction volume or ofsome other costdriver relatedto plantproductioncapabilityduringa period
y Ifactual results = closeto expected results ($ & volume)measure ofcapacityshould resuin productcoststhatmostclosely reflectactual costs
o Predetermined FOH rate = estimatedtotal fixedcosts estimated outputy Maychooseactivity level other thanexpectedannual capacity,e.g. ideal/theoretical capacity, practical capacity, &
normal capacity
o Theoretical capacity: estimatedabsolutemaximum potential productionactivitythatcould occur inproductionfacilityduringspecifictimeframe w/perfect operationcycle
o Practical capacity:activity level thatcould beachievedduringnormal workinghoursduringunusedcapaci& ongoing, regular operatinginterruptions,e.g. holidays,downtime,start-up time,etc.;takesinto account
unused resources
o Normal capacity:firms long runaverageactivity (5-10 years) whichgiveseffectto historical & estimatedfuture production levels & to cyclical andseasonal fluctuations
OVERHEAD APPLICATION
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y Applied overhead: amount ofoverheadassignedto Work in Processinventoryasa result ofoccurrence oftheactivitythat wasusedto develop theapplication rate; result ofmultiplyingthe quantity ofactual activity by
predetermined rate
o DRWork in Processinventory CR Variablemanufacturing overhead (variablecost per unitx output) CR Fixedmanufacturing overhead (fixedcost per timeunitxtime)
y Under-applied overhead: actual overhead applied overheadincurredfor the period;ending balance = debity Over-applied overhead: applied overhead actual overheadincurredfor the period;ending balance = credity Manufacturing overheadaccountsusedfor recordingactual & applied overheadamounts = temporary, balances
must beclosedatyear-end
y Typical costingsystem:actual overheadcosts = debitedto variable & fixed overheadgeneral ledger accounts,creditedto varioussources ofoverheadcosts;applied overheadcosts = debitedto Work in Processinventory via
predetermined rates & actual levels ofactivity,creditedto variable & fixed overheadgeneral ledger accounts
o Applied overhead = addedto actual directmaterials & direct labour costs whencalculatingcost ofgoodsmanufactured
o End-of-period balanceineach overheadgeneral ledger account = under-applied (debit) or over-applied(credit) overhead
y Closingimmaterial amounts ofover-applied variable overheado DR Variablemanufacturing overhead
CR Cost ofgoodssoldy Ifunder-/over-applied overhead = significant,allocateamongaccountscontainingapplied overhead (i.e. Work in
Process, FinishedGoods, Cost ofGoods Sold/ServicesRendered)
COMBINED OVERHEAD RATES
y Combined overhead rates = used b/c (1)clerical ease, (2)clerical costsavings, (3)absence offormal requirementsseparate overheadcosts bycost behaviour
o Only onetype ofactivitycan beselectedfor thecost pool (rather than variable & fixed)y Overheadapplication ratecan be relatedto particular cost pool (e.g. machine-related overhead) or to overhead
costsingeneral
y Blurscauseeffect relationshipsinabilityto reducecosts,improve productivity,discover causes ofunder-/over-applied overhead
hindersabilityto plan operations,control costs,makedecisions
ACCUMULATION OF PRODUCT COSTS Journal entries (p. 67), T-accounts (p. 68)
y Productcosts = accumulatedfor inventory purposes & expensedto Cost ofGoods Sold (flow via Work in Process,FinishedGoods, & ultimately Cost ofGoods Sold)
y Perpetual inventorycontrol system = continuously providescurrentinventory & cost ofgoodssoldinformationforfinancial statement preparation & inventory planning,costcontrol,decision-making
COST OF GOODS MANUFACTURED AND SOLD
y Cost ofgoodssold (CGS) = beginningmerchandiseinventory + purchases endingmerchandiseinventory;toosimplistic
y Cost of goods manufactured (CGM): total manufacturingcostsattachedto units producedduringanaccountingperiod
y Cost of goods manufactured statement:total cost ofgoodsthat werecompleted & transferredto FinishedGoodsinventoryduringthe period;internal statement only
o Preliminarystep to present CGSo Doesntincludecost ofwork still in processatend ofperiodo Allowsto see relationship b/w various productioncosts & know results ofcostflows viainventoryaccount
y Cost of goods sold: cost ofproducts/servicessoldduringthe periodo To calculate: CGM + beginning balance ofFinishedGoods (= cost ofgoodsavailablefor sale) ending
balance ofFinishedGoods
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LEAST-SQUARES REGRESSION ANALYSIS (Appendix 2A)
y Least-squares regression analysis: statistical techniquefor mathematicallydeterminingthecost line ofamixedcothat bestfitsthedataset byconsideringall representativedata points;allowstheuser to investigatethe
relationship b/w dependent & independent variables
y Simple regression analysis: regressionanalysisusing only oneindependent variableto predictthedependentvariable
y Multiple regression analysis: regressionanalysisusing 2+ independent variablesy Regression line: linethat representsthecostformulafor aset ofcost observationsfitto those observationsina
mathematicallydeterminedmanner
CHAPTER 3: COSTVOLUMEPROFIT ANALYSIS
THE BREAKEVEN POINT Short-term only
y Breakeven point (BEP): level ofactivity,inunits or dollars,at whichtotal revenue = total costsy Basicassumptionsaboutcost behaviour for BEP calculation
o Relevant range:company operates within relevant range ofactivityo Revenue: revenue per unit remainsconstanto Variablecosts: on per-unit basis,assumedto beconstant (production = directmaterials,direct labour, &
variable overhead;selling = commission,shipping;administrative,etc.)o Fixedcosts: remainconstant within relevant range (manufacturing overhead,fixedselling & administrative
etc.)
o Mixedcosts:must beseparatedinto variable & fixedelements (viaanymethod,e.g. high-low, regression,etc.)
y Contribution margin (CM): selling price per unit all variable production,selling, & administrativecosts per unit,i.e. CM = R VC; CM per unit = constant,total CM = fluctuates
y Breakeven pointformula:R(X) VC(X) FC = PBTy @ X = FC (R VC),@ X = FC CMy Contribution margin ratio (CM%): contributionmargindivided by revenue;indicates what proportion ofselling
price remainsafter variablecostshave beencovered
yCM% = (
R VC)
R,@
X($) = FC CM%y Variable cost ratio (VC%): 100% CM%; represents variablecost proportion ofeach revenuedollar
USING COSTVOLUMEPROFIT ANALYSIS
y Costvolumeprofit analysis (CVP analysis): process ofexamining relationshipsamong revenues,costs, & profitsfor a relevant range ofactivity & for a particular time period
Fixed amount of profit before tax
y Set PBTdesiredy X = (FC + PBT) CM or R(X) = (FC + PBT) CM%
Fixed amount of profit after tax
y PBTxTR = taxexpensey PAT = PBT (PBT)(TR) = PBT(1 TR)y PBT = PAT (1 TR)y X = (FC + PBT) CM or R(X) = (FC + PBT) CM%
Variable amount of profit before tax (specified variableamount ofsales)
y R(X) VC(X) FC = PuBT(X), where PuBT = profit per unit beforeincometax
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y X = FC (CM - PuBT)Variable amount of profit after tax
y PuBT(X)xTR = taxexpensey PuBT(X) = PuAT(X) (1 TR)y X = FC (CM - PuBT)
THE INCOME STATEMENT APPROACH
y Incomestatementapproachto CVP analysisallows preparation ofpro formastatementsy Sinceformula & incomestatementapproaches = based onthesame relationships,eachshould beableto proveth
other
y See p. 123 for proofofcomputations viaincomestatementapproachto CVPINCREMENTAL ANALYSIS FOR SHORT-RUN CHANGES
y BEP oifFC o, VC o,selling price per unitq, or CM% qy CM% (unit)qifVC oand/or selling priceqy Incremental analysis: techniqueusedindecisionanalysisthatcomparesalternatives byfocusing ondifferencesin
their projected revenues & costso In CVP analysis = based on occurringin revenues,costs,and/or volume
y Breakeven graph: graphical depiction ofrelationships b/w revenues, VC, FC, & profts/losseso X-axis: volume,y-axis:dollars;comparetotal revenue line & total VC line CM areao CM = created byexcess ofrevenues over VC;ifVC > revenues,no quantity ofvolume profito Total CM = total FC + profit or losso Before profitcan begenerated, CM must > FC
y Profitvolume (PV) graph: graphical presentation ofprofit or lossassociated w/each level ofsaleso X-axis:salesunits,y-axis: profit/lossindollars; profit lineaty = 0 BEP; profit lineatx = 0 FC
COSTVOLUMEPROFT ANALYSIS IN A MULTIPRODUCT ENVIRONMENT
y Mustuse weighted-average CM% (dueto assumption ofconstantsalesmix)o Pre-productsum ofsalesmix % (relativeto salesdollars)x CM ratio
y Companiescanalso bundle productsto increasesales (e.g. valuemeals)UNDERLYING ASSUMPTIONS OF COSTVOLUMEPROFT ANALYSIS
y All VC & revenue behaviour patterns = constant per unit & linear within relevant rangey Total CM (i.e. total revenue total VC) = linear within relevant range & oproportionately w/outputy Total FC = constantamount within relevant rangey Mixedcostscan beaccuratelyseparatedinto fixed & variableelements (estimatescan bedeveloped viahigh-low,
regression,etc. analyses)
y Sales & production = equal,@no material fluctuationininventory levels (needed b/c ofallocation ofFC toinventoryat potentiallydifferent rateseachyear)y No capacityadditionsduring periodunder consideration (FC/VC cant )y Inmultiproductfirm,salesmix = remainconstanty No inflation, or inflationaffectsall costfactorsequally; or iffactors affectedequally,appropriateeffects
incorporatedinto CVP figures
y Labour productivity, productiontechnology, & marketconditions will not (ifany occurred,costs would correspondingly, possiblethatselling prices would invalidatefirstthreeassumptions)
MARGIN OF SAFETY AND OPERATING LEVERAGE
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y Margin of safety: excess ofestimated (budgeted) or actual sales ofacompany over its breakeven point;can becalculatedinunits or dollars, or asa percentage
o Inunits:estimated (actual)units breakevenunitso Indollars:estimated (actual)salesdollars breakevensalesdollarso As percentage:margin ofsafetyinunits or dollars estimated (actual)salesinunits or dollars
y Operating leverage: factor that reflectsthe relationship ofacompanys variable & fixedcosts;measures in profiexpectedto resultfromaspecified percentage insales
y o VC &q FC (e.g. labour-intensive organisations)q operating leverage & q BEPy q VC &o FC (e.g. capital-intensive organisations)o operating leverage & o BEP
o o operating leverageo CM%;i.e. eachunitsoldafter BEP (i.e. after o FC covered) = o profitsy Degree of operating leverage (DOL): measure ofhow a percentage insales will affect profits;calculatedata
specifiedsales level ascontributionmargindivided byincome beforetax
o DOL = CM PBT;assumesthat FC do noto whensalesoy DOLqascompanymovesfurther awayfrom BEPy qmargin ofsafetyoDOL;at BEP,DOL = (anyofrom 0 %)
ABSORPTION AND VARIABLE COSTING (Appendix 3A)
y Absorption costing: mostcommonapproachto productcosting;costaccumulationmethodthattreatscosts ofallmanufacturingcomponents (directmaterials & labour, variable & fixed overhead)asinventoriable or productcost
akafull costing;approved by CICA (re:matching)o Productcosts work in processfinishedgoodscost ofgoodssoldo Periodcostsselling/administrative/other expenseso Incomestatement: revenue cost ofgoodssold (= grossmargin) other expenses = PBTo Functional classification: grouping ofcostsincurredfor thesame basic purpose
y Variable costing: costaccumulationmethodthatincludes only variable productioncosts (directmaterials & labouvariablemanufacturing overhead)as product or inventoriablecosts & treatsfixedmanufacturing overheadasa
periodcost;akadirectcosting
o Product contribution margin (PCM): revenue variablecost ofgoodssoldo Total contribution margin (TCM): revenue all variablecosts regardless ofarea ofincurrence (production
or non-production)
Also,TCM = PCM non-productioncostso Incomestatement: revenue variablecost ofgoodssold (= PCM) variablenon-manufacturingexpenses,
e.g. selling/administrative/other (= TCM) total fixedexpenses,e.g.
manufacturing/selling/administrative/other = PBT
y Cost behaviour (relativeto inactivity)cant be observedfromabsorptioncostingincomestatementy @althoughmandated by regulation,absorptioncostingshouldnt beusedinternallyy Differences b/w absorption & variablecostingmethods
o Absorptioncosting FOH = productcost; variablecosting FOH = periodcosto Absorptioncostingclassifiesexpenses byfunction; variablecostingclassifiesexpenses by behaviour,
then byfunctionifnecessary
y Similarities b/w absorption & variablecostingmethodso
Same basiccostinformationo Sametreatment ofdirectmaterials & labour, VOH (always productcosts)
ABSORPTION COSTING VARIABLE COSTING
Composition of product cost
Manufacturing FOH = attached,inseparateamounts,to
units produced;iffirmsellsall inventory producedin period
+ onhandat beginning ofperiod previouslyincurred
manufacturing FOH incomestatementas part ofCOGS.
Manufacturing FOH = periodcost (expense) whenincurred
notattachedinseparateamountsto units produced;each
period,all manufacturing FOH incurredincomestateme
asexpense, butnot via COGS
Structure of the chart of accounts
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o Selling & administrativeexpenses = periodcostso No differences b/w accounts other than Work in Process, FinishedGoods, & expenseaccounts
LESSON 3: COST MANAGEMENT SYSTEMS INTRODUCTION
CONTROLLING COSTS OR COST DRIVERS
y Cost ofsetupscontrolled via (1) volume-related,mass-productionsolution ofhavinga limitednumber ofproduction runs ofmanyitemsso that onlyafew productionsetupsareneeded (long production runsavoidcostly
changeovers), or (2) lower setup costs,e.g. just-in-time (JIT) or total qualitymanagement (TQM)simplifying &
redesigningmachinery,@ production runscan beshorter,easier to produceto demand
ABC PROVIDES MORE ACCURATE COSTING
y Activity-based costing (ABC): two-step allocationsystemthat (1)accumulatescoststhathavethesamecostdriveinto cost pools, (2)usesanactivitydriver to assigncoststo products & services
y Triesto treat overheadcostsas variablecostso proportion ofoverheadcostsallocated w/ABC,oaccuracy (restmust beallocated viatraditional methods)
y Eliminates productcross-subsidies;inaccurate productcostinginaccurate product pricingy Tracesnon-manufacturingcosts,e.g. marketing,customer service,engineering, & administrative,to products &
servicesusingadditional cost pools & activitymeasures (advantageous b/csome products & servicesmayusemor
than others better product pricing, planning,design, & distribution)
COST SYSTEM PHILOSOPHY
y Organisationsdecisionto adoptABC changesemphasis ofcostaccumulationfromcost objects (e.g. departmentto activities
y Combined w/broader objectiveto reduce/eliminatenon-value-addedcosts & improve product & process qualityABC helpso profitability,efficiency, & effectiveness
o Calledcost management systemo Activity-based management: activityanalysis + activity-basedcosting
HOW ENTERPRISE RESOURCE PLANNING BENEFITS ABC
y ChallengeinimplementingABC = finding rightactivitycostdriver to useinattributingcost ofactivityto products oother cost objects
o Usuallynumber ofsales orders,material moves,engineeringchangenotice per type,etc.y Enterprise resource planning (ERP)systemsoavailability & reliability ofABC information
o Use relational databaseto integratefinancial accounting,managerial accounting,costaccounting,production planning,materialsmanagement,sales & distribution,human resourcemanagement, quality
management, & customer service
o Permitsdifferentfunctional areasto shareinformation w/o re-entering/duplicatingdatain variousdatabasesin organisation
o Provides reliableactivitycostdriver information byintegrating production planning,materialsmanagement, & costandmanagementaccounting (ABC = usedto oaccuracy ofproduct-costinformation
to develop activity-based budgets)
Costs = classifiedaccordingto functional categories,e.g.
production,selling,administrative.
Costs = classifiedaccordingto cost behaviour & functional
categories (manufacturing/non-m);mixedcosts = separate
Process of accumulating costs
All manufacturingcosts = productcosts;all non-
manufacturingcosts = periodcosts
Classified & accumulated bycost behaviour;manufacturin
VC = productcosts;manufacturing/non-m FC = periodcos
Format of the income statement
Costsincomestatement byfunctional categoriesGM
highlighted;doesntincl. cost behaviour;non-m period
costs = deductedfromGM income beforetaxes
Costsincomestatement bycost behaviour CM
highlighted; FC = deductedfrom CM income beforetaxe
costsmay befurther categorised byfunctions
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o BeforeABC,materialshanding/other managementcostsallocatedto products based on % ofdirectmaterial costsassociated w/each product (based on relationship b/w budgetedmaterialsmanagement
costs & expectedtotal cost ofdirectmaterials)
CHAPTER 4: COSTING SYSTEMS
JOB ORDER COSTING SYSTEM
y Productcosting: (1)costidentification, (2)costmanagement, (3) productcostassignmenty Job order costing system: productcostingmethodused byentitiesthat produce limited quantities ofcustom-mad
goods or servicesthatconformto specificationsdesignated bythe purchaser
o Costs = accumulatedindividually byjob (singleunit or group oflikeunitsidentifiableas being producedtodistinctcustomer specifications)
y Costs ofdifferent jobs = maintainedinseparatesubsidiary ledger accounts & notaddedtogethery Typical job order inventoryaccount:actual directmaterials & labour,combined w/predetermined overhead rates
actual costdriver (e.g. direct labour hours,cost/quantity ofmaterialsused,materials requisitionsunits,etc.)
normal costing method (used b/cactuals = easyto identify)
y Overheadcosts = allocatedto productionJOB ORDER COSTING: DETAILS AND DOCUMENTS
y Basicstages ofproduction (re: production lifecycle)o (1)Agreed-upon butnotyetstarted, (2) Jobsin process, (3) Completed jobs
y Materials requisition form: sourcedocumentthatindicatesthetypes & quantities ofmaterialsto be placedintoproduction or usedin performingaservice;causesmaterials & their coststo be releasedfromthe raw materials
warehouse & sentto Work in Processinventory
o DRWork in Processinventory (directmaterials)o DRManufacturing overhead (indirectmaterials)
CRRaw material inventoryy Job order cost sheet:sourcedocumentthat provides virtuallyall financial informationabouta particular job;the
set ofall job order costsheetscomposes Work in Processinventorysubsidiary ledger
o Top portion ofjob order costsheet: job number,description oftask,customer identification, variousschedulinginformation,deliveryinstructions,contract price
o Rest ofform:actual costsfor materials & labour,applied overheadcosts;sometimesestimatesy Employee time sheet (time ticket): sourcedocumentthatindicates,for eachemployee, what jobs were worked o
duringtheday & for whatamounts oftime
o DRWork in Processinventory (direct labour)o DRManufacturing overhead (indirect labour)
CR Wages payabley Cost-plus job: a job being billedatcost plusspecified profitmarginy Actual overheadincurredduring production = incl. in overheadcontrol account
o Ifactual overhead = appliedto jobs,costaccountant = waituntil end ofperiod & divideactual overheadincurred bysome relatedmeasure ofactivity or costdriver
o Actual overhead would beappliedto jobs bymultiplyingactual overhead rate byactual measure ofactivityassociated w/each job
o Overheadappliedatearliest of: (a)completion ofjob, or (b)end ofperiod DR Work in Processinventory CR Manufacturing overhead
y Completion ofproductiono DR FinishedGoodsinventory
CR Work in Processinventoryo DR Cost ofgoodssold
FinishedGoodsinventory
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INTRODUCTION TO PROCESS COSTING
y Process costing:method ofaccumulating & assigningcoststo units ofproductionincompaniesthatmake largequantities ofhomogeneous products,i.e. mass-producing
o Ifproducts homogeneous joint processingcosts:allocation ofprocesscoststo 2+ productsy Calculating productunitcostin processcostingsystem: weightedaverage & FIFO
o Major difference:treatment ofbeginning Work in Processinventoryy Process costing system: productcostingsystemused bycompaniesthat produce largeamounts ofhomogeneous
productsthroughacontinuous productionflow
o Costs = accumulated bycostcomponentineach productiondepartment (similar to job order)y Differences between job order & processcosting
o Job order costing:accumulateddepartmental costsassignedto specific jobs; processcosting:accumulateddepartmental costsassignedto all unitsthatflowedthroughdepartmentduringthe period
Valuationmethod (actual,normal,standard)affectscoststo beincl. ininventoryo Quantity ofproductionfor whichcostsare beingaccumulatedatany onetime (specific v. mass-produced)o Cost objectto whichcostsareassigned (specific v. batch)
y Similar to job order costing,directmaterial & labour components ofproductcost = determined viasamemethodso Processcosting:costsassignedatend ofperiodfromdepartmentsto units produced; overheadmust be
allocatedto units
y Processcostingassignscoststo bothfully & partiallycompletedunits byconverting partiallycompletedunits(Work in Processinventory)to equivalent wholeunits/units ofproduction
y Equivalent units of production (EUP): approximation ofnumber ofwholeunits ofoutputthatcouldhave beenproducedduringa periodfromactual effortexpendedduringthat period
o Actual units being producedx % ofcompletionatend ofperiodo Use ofEUP recognisesthat: (1)unitsin beginning Work in Processinventory will becompletedduring
current period, (2) partiallycompletedunitsinending Work in Process werestartedincurrent period but
will not becompleteduntil next period
INTRODUCTION TO WEIGHTED AVERAGE AND FIFO PROCESS COSTING
y Weighted average method: method ofprocesscostingthatcomputesaveragecost per equivalentunit ofproduction;combines beginninginventoryunits w/current production & beginninginventorycosts w/currentcost
to computetheaverage
y FIFO method:method ofprocesscostingthatcomputesaveragecost per equivalentunit ofproductionusing onlycurrent production & currentcostinformation;units & costsin beginninginventory = accountedfor separately
EUP calculation & cost assignment Formula Comments
1. Calculate physical unitsto accountfor BWIP + startedincurrent period Determineunitsthatarein process
2. Calculate physical unitsaccountedfor Completed & transferred out + EWIPIdentifygroups ofunitsto becosted
(beginning & ending WIP,completed
Verify that (2) = (1)
3. Determine EUP Weightedaverage or FIFOIdentify relatedeffortincurredfor
eachunitgroup bycostcomponent4. Determinetotal costto accountfor BWIP cost + currentcosts Determinecostsalreadyincurred
5. Calculatecost per EUP Weightedaverage or FIFOCalculate EUP costto beassigned pe
costcomponent
6. Assigncoststo inventoriesTransferred out (FG or next
department) & EWIP
Calculatetotal costto beassignedto
eachgroup ofunits worked onduring
period
Verify that total costs transferred out
+ costs in ending inventory = (4)
y Weightedaveragemethod = focuses onunitscompletedincurrent period & unitsthat remainin EWIP
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o Units started & completed (S&C): total unitscompletedduring period BWIP; or,unitsstarted EWIPy Cost per EUP = (BWIP + current periodcost) total weightedaverage EUPy Cost of production report: documentusedin processcostingsystem;detailsall manufacturing quantities & costs,
showscomputation ofcost per EUP, & indicatescostassignmentto goods producedduring period
y FIFO (3): only work performed on BWIP duringcurrent period = part ofEUP,i.e. BWIP x (1 - % work done prior)y FIFO (5):cost per EUP = current periodcost FIFO EUP (3)y Spoilage (spoiled unit, defective unit): unit ofproduct w/imperfectionsthatcant beeconomicallycorrectedy Normal spoilage: units lostdueto nature ofmanufacturing process;unavoidable; productcosty Abnormal spoilage:units lostin productiondueto eventsnotinherentinmanufacturing process; periodcostsy Continuous loss: reductionsthat occur uniformlyduring processingy Method of neglect:method oftreatingspoiledunitsinschedulecalculatingequivalentunits
CHAPTER 6: ACTIVITYBASED MANAGEMENT AND COSTING
THE ABC SYSTEM (NB: German cost accounting similarities, p. 370)
y Activitybased costing (ABC): accountinginformationsystemthatidentifies variousactivities performedinanorganisation & collectscosts onthe basis ofunderlyingnature & extent ofthoseactivities
y 3 strategies objectives: (1) reportaccuratecoststhatcan beusedto identifysource offirm profits; (2)identifycostofactivitiesidentifymoreefficient waysto performthem or producetheir outputs; (3)identifyfutureneedfor
resourcesacquirethemmoreefficientlyy Model the way resources = consumed,notacquired
DEVELOPING PRODUCT/SERVICE COST INFORMATION
y Product/servicecosts = developedto (1)haveinformationfor financial & regulatory reporting, (2)helpmanagementmake product pricing & produce lineexpansion/contractiondecisions, (3)allow managementto
monitor & control operations
y Ifbestestimate results when largestnumbers ofcosts = traceddirectly,then bestestimate will also be obtainedwhenfewestcosts = assignedarbitrarily
o Overheadcant bedirectlytraced,@must beattached via validcost predictor (driver) or arbitrarilyACTIVITY ANALYSIS
y Activitybased management (ABM): disciplinethatfocuses onhow activities performedduringproduction/performance processcanimprove value received bycustomer & profitachieved by providing value
o Process & activityanalysis,costdriver analysis,activitybasedcosting,strategic planning,integration w/comanagementsystem,continuousimprovement, operational control, performanceevaluation, business
processengineering
y Activity: repetitiveaction,movement, or work sequence, performedto fulfil a businessfunctiony Process map:flowchart or diagramthatindicateseverystep inmakinga product or providingaservicey Value chart: visual representation ofthe value-addedandnon-value-addedactivities & thetimespentinall of
theseactivitiesfrom beginningto end ofthe process
y Value-added activity (VA): activitythatoworth ofproduct/serviceto customer,for whichcustomer = willingto pao E.g. packaging,compounding
y Value-added processing time: timeittakesto performall necessarymanufacturingfunctionsfor acustomery Value-added service time: timeittakesto performall necessaryservicefunctionsfor acustomery Non-value-added activity (NVA): activitythatotimespent on product/service butdoesntoits value/worth
o E.g. materials receiving, qualitycontrol,storage,machinesetup,shipping betweenfacilitieso Transfer time: timeittakesto move products/componentsfrom one placeto another;movetimeo Idle time:storagetime & timespent waitingat production operationsfor processingo Inspection time:timetakento perform qualitycontrolo Can beattributedto systemic, physical, & humanfactors
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y Business value-added activity (BVA): activitythatisnecessaryfor operation ofbusiness butfor whichcustomer willingto pay,e.g. auditingcosts
y Cycle time:timefrom whencustomer places order to time when product/service = delivered,OR, viafull life-cycleapproach:timefromconceptualisation ofproduct/serviceto time product/service = deliveredto market/consume
o Cycletime = value-added processingtime + total non-value-addedtimeo Retail:timefrom whenitem = orderedto time whenitem = soldto customero Service:timefrom whenservice order = placedto time whenservice = completed
y Manufacturing cycleefficiency (MCE): value-added processingtime total cycletime;shows productionefficiencyy Activityimprovementmeasures:changeflows & processes,schedule,train,simplify,combinefragmentedactivitie
automate,standardise,eliminateduplication,eliminatecause ofrework
y ocostdriversanalysedoaccuracymayocosts;@costs v. benefitsmust beconsidered (costbenefitanalysis)y ABC abilityto moredirectly observe where,how, & whycosts = incurred, byfocusing onactual activitiesdirectly
associated w/providing product
ACTIVITYBASED COSTING
y Underlyingelements ofABC: (1)gatheringcostsinto relatedcost pools, (2) recognisingthat variousactivity & costlevelsexist, (3)usingmultiplecostdriversto assigncoststo products & services
y Overhead = accumulatedinto one or two cost pools (total overhead, or variable & fixed overhead)y Levels ofcostincurrence
CLASSIFICATION LEVEL DEFINITION TYPE OF COSTS NECESSITY OF COST
Unit-level cost
Cost created by productionor acquisition of a single unitof production or delivery of asingle unit of service
* Direct material* Direct labour* Some machine costs, if traceable
Once for each unitproduced
Batch-level cost
Cost created by group ofsimilar things made, handled,or processed at a single time
* Purchase orders* Setup* Inspection* Movement* Scrap, if related to batch
Once for each batchproduced
Product- or process-
level cost
Cost created by need toimplement or supportspecific product
* Engineering change orders* Equipment maintenance* Product development* Scrap, if related to product design
Supports a producttype or a process
Organisational- or
facility-level cost
Cost incurred to supportongoing operations, which inturn provide availablefacilities
* Building depreciation* Plant or division managers salary* Organisational advertising
Supports overallproduction or servicprocess
y Batch-, product-/process-, & organisational-/facility-level costs = traditionally regardedasfixed;however,can beseenas long-term variable
y Long-term variable cost: costthathastraditionally been viewedasfixed butthat will actually reactto somesignificantchangeinactivity;akastep fixedcosty Activity centre:segment ofproduction or service processfor whichmanagement wantsaseparate report ofcosts
ofactivities performed;consider geographical proximity ofequipment,definedcentres ofmanagerial responsibilit
magnitude ofproductcosts,needto maintainmanageablenumber ofactivitycentres
o Past: overheadaccumulatedusing vertical or functional approach;e.g. departmental costseparationo Now:since production & serviceactivities = horizontal,should begatheredin pools reflectingsamecost
drivers
y Activity cost centre: measure ofdemands placed onactivities &@ resourcesconsumed by products & services;oftenindicatesactivitys output
y Determining product profitability & company profits:
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o Total product revenue = productunitselling pricex productunit volumeo Total productcost = total productcost per unitx productunit volumeo Net productmargin = total product revenue total productcosto Total margins provided by products = net productmargin all other net productmarginso Company profit or loss = total margins provided by products organisational-/facility-level costs (i.e.
corporate/divisional administration,facilitydepreciation)
y ActivitydriversACTIVITY CENTRE ACTIVITY COST DRIVERS
Accounting Reports requested; dollars expended
Personnel Job change actions; hiring actions; training hours; counselling hours
Data processing Reports requested; transactions processed; programming hours; program change requests
Production engineeringHours spend in each shop; job specification changes requested; product change noticesprocessed
Quality control Hours spent in each shop; defects discovered; samples analysed
Plant services Preventative maintenance cycles; hours spent in each shop; repair maintenance actions
Material servicesDollar value of requisitions; numbers of transactions processed; number of personnel indirect support
Utilities Direct usage (metered to shop); space occupied
Production shopsFixed per-job charge; setups made; direct labour; machine hours; number of moves;material applied
y ABC requiresinvestigation ofeachdepartmentto determine (a)how muchtime personnel actuallyspend oneachproduct, (b) whatfactor drivescostsinthatdepartment
y ABC v. traditional costing:ABC = forward-looking,@yields better informationfor settingappropriate prices &determiningcost & profitimpact ofdifferent productmixes;traditional costing = companymayinappropriately
assumethata particular productiscontributingmore profitthatitactuallyis (e.g. dueto inaccurate breakdown of
associatedcosts,esp. overhead)
y Assume: 10% costdifference b/w ABC & traditional costingtrigger to switchto ABC;not less b/cevenABC incl.arbitraryallocation ofoverheadcosts,@at overheadcosts of15%+ oftotal cost = ABC moreaccurate,at
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y Arenon-standard partsusedin products purchased byimportantcustomers who are willinto paya premium pricefor products?
o May be worthit, but wouldcustomers beequallysatisfiedifmorecommon partswereused & product price were reduced?
Partscomplexityis onlyacceptable whencustomer findsit value-addedo Simultaneous (concurrent) engineering: integratedapproachin whichall primaryfunctions & personnel
contributingto products origination & production = involvedcontinuouslyfrom beginning ofproject
Multifunctional teams = usedto design product byconsideringcustomer expectations, vendorcapabilities, partscommonality, & production processcompatibility
y Design-for-manufacturabilityapproacho Business process re-engineering: processinnovation & redesignaimedatfinding & implementing radical
changesinhow thingsaremade or how tasksare performedto achievesubstantial cost,service, or time
reductions
Needed b/ceven whensimultaneousengineeringisusedin processdevelopment, processesmaydevelop complexity over time
Appropriatefor 70% offirms;alternative = new productdesign (expensive,maynot benecessary)y Thereisa lack ofcommonalityincreation & use ofoverhead
o E.g. some products requiresubstantiallymoreadvertising,usehigher costdistributionchannels,necessitause ofhigh-technologymachinery; when output volumesdiffer among products & servicesadditional
overheadcostsunfair overheaddistributionamong products & services
y Thereare problems w/currentcostallocationso Manycompaniesautomated production processesq labour costs,o overheadcostso Traditional costallocation = assigns productcosts (i.e. directmaterials & labour,manufacturing overhead)
to products & expensemajority ofperiodcosts whenincurred;ABC some periodcostscan beassociated
w/products & should beallocatedappropriately
y Therehas beensignificantchangeinenvironmentin which organisation operateso ocompetitionmay occur b/c
Other companies recognised profit potential ofa particular product/service Product/service becamecost-feasibleto make or perform Industry becamederegulated
o Changesinmanagementstrategy,e.g. eliminatingNVAactivitiesABC helpsidentifythemy Comparedto processcostinginformation, job-order costsystem better reflects productcostdifferencesinvolving
material & labour b/cit recognisesthattwo different productsmayhavedifferentcosts;however,italso assumes
that overheadcosts = relatedto amount ofdirect labour incurred
y Process & job-order costing = systemsfor allocatingcosts;ABC = optionfor allocating overhead, & alternativetotraditional method ofallocating w/volumedrivers,e.g. labour,machinehours;@ABC worksinconjunction
w/process & job-order costing,notasanalternative
OPERATIONAL AND STRATEGIC PLANNING AND CONTROL USING ABC
y Traditional accountingsystemsconcentrate oncontrollingcostincurrence, whileABC focuses oncontrollingcauseofcostincurrencemoreeffectivecost reductions
y Reasons whyABC implementationmayfailo Software wasnotITintegratedo ABC &ABM applications integratedinto organisationmeasurement & managementsystems;asABC was
deployedas retrospectivemodellinganalysis,managers werenot requiredto useitfor planning purposes
o Applicationsare poorlyimplemented;no standardsfor development & deployment ofABCCRITICISMS OF AND CONCLUSIONS ABOUT ABC
y Individual barriersto ABC adoption: (1)fear ofunknown or shiftinstatus quo, (2) possible loss ofstatus, (3)needtlearnnew skills
y Organisational barriers:territorial,hierarchical,corporate-cultureissues
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y Environmental barriers:unions, regulatoryagencies, other stakeholdersy ABC doesntconform withGAAP (p. 380)
o Traditionallydesignated periodcosts (e.g. R&D,servicedepartmentcosts)allocatedto products viaABCo Traditionallydesignated productcosts (e.g. buildingdepreciation)notallocatedto products viaABC
y ABC doesnot promotetotal qualitymanagement & continuousimprovement (p. 380)o But,ABC helpsto identify & monitor significanttechnologycosts;tracemanytechnologycostsdirectlyto
products; promoteachievement or marketshare viause oftargetcosting;identifycostdriversthatcreate
or influencecost;identifyactivitiesthatdontcontributeto perceivedcustomer value,understandimpact
ofnew technologies onall elements ofperformance;translatecompanygoalsinto activitygoals;analyse
performance ofactivitiesacross businessfunctions;analyse performance problems; promotestandards of
excellence
y W/ERP systems,ABC = fullyintegrated w/all other subsystems,e.g. processcosting,financial statements,fixedassets
o Fixedassetcosts or depreciationcostsautomatically recordedincost pools & thenthesecosts = allocateto activities & thento products & services;thoseallocatedcosts = transferredto inventoryand/or cost of
goodssold, & to thefinancial statements, whichcan be producedupondemand