AC 222 Class Notes (Whole Semester)
AC 222 Class Notes (Whole Semester) AC 222
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Date Created: 01/13/16
Chapter 1 A=L+E Inventories are assets Merchandising/retail: only ONE inventory – that which they buy and resell Manufacturing comps buy: Raw materials – don’t like to keep too many in inventory – speed cash flow Work in progress (WIP) – partially done products/services Where costs are developed/come together This is difference between merch. and manuf. Service industry ex: patient during surgery Finished goods These are PRODUCT COSTS – costs incurred to make a product Inventorial costs Period costs (never on balance sheet) - incurred to distribute, market and sell product OR operate company Selling expense: sales, marketing, distribution Admin expense: not concerned with product – corp officers, HR, accounting, facility management Manufacturing costs - added to WIP in current period Direct costs: easily traced to product Direct materials Direct labor Indirect costs or Manufacturing overhead: needed to make the product but not easily traced to units of product/not easily traced economically (per unit of product) Supervisors Building Machines Cost behavior: how a cost will respond to changes in ACTIVITY Activity (volume): units of product we make, number of clients treated, number of students enrolled Variable costs change directly and proportionally when volume changes Constant per unit within relevant range Fixed costs do not change with volume within the period we’re measuring – the RELEVANT RANGE (time period or # of units) Mixed costs – part variable part fixed Ex: electricity bill – has fixed portion and kilowatt/hour portion Will be separated with a formula to keep functions simple Variable costs Direct materials Direct labor Constant of ONE UNIT of a variable cost Fixed costs Remains constant in total Fixed cost per unit decreases as volume increases Economies of sale Building cost Salary Chapter 2 Variable costs: Ex: direct materials, direct labor Remains constant at PER UNIT cost, but varies as TOTAL COST On graph: VC drawn as increasing equation of a line (x axis - $ / y axis - volume) Fixed costs: Remains constant IN TOTAL Per unit DECREASES as volume INCREASES o Rapidly at first and then slowly Ex: building cost, supervisory salary On graph: straight horizontal line Mixed costs: Variable and fixed elements o Ex: electricity - fixed month charge + rate per kwh used o On graph: has a y-intercept higher than 0, then increases as linear equation TMC increases and volume increases o To predict: separate fixed/variable portion High-low Method: separates mixed cost into variable and fixed parts Y = a + bX o Equation of a line o Y= total cost o "a= total fixed portion o "b= variable cost per unit (slope) o X= volume, total units of activity Only reason more cost at 6 than at 2 is because of variable portion o If just fixed cost, would stay the same o Variable cost causes the cost to change when moving from one unit to another o Can approx. variable cost with rise over run equation, use 2 point on graph Why do this? To separate fixed and variable pieces of mixed costs Traditional format Income Statement: what we've used so far - for external use o Sales o -COGS o =Gross margin o -selling/admin costs o =Net Operation Income Contribution format: for internal managers to make decisions o Traditional IS has no way to differentiate fixed/mixed costs o Emphasizes cost behavior o Not always exact but need a little 'hand-waving' - need to pick which to call it o Sales o -all variable costs (manufacturing, selling, admin) o =contribution margin: what every sale actually contributes to the company recovering the fixed costs and finally getting profit o -all fixed costs (manufacturing, selling, admin) o =net operation income - profit o Differential cost: one that will change depending on choice made o Sunk cost: past cost, cannot be changed not matter what choice is made o Opportunity cost: income you give up if you make one choice over another Chapter 3 Flow of costs through manufacturing - begins with raw materials o o COGM: cost of goods completed during the period May include costs from earlier periods o Manufacturing costs just include added costs from THIS period o Statement of COGM - stays internal Beginning Raw Materials Inventory + purchases = Materials available for use -Ending Raw Materials Inventory = Materials used in production (DM) Assumes wasted materials is part of DM + Beginning WIP Inventory = Goods in production for the period -Ending WIP Inventory = COGM o Income Statement, including COGS (traditional format) Sales Less COGS Beginning finished goods + COGM -Ending FD = COGS Gross margin -selling/admin expenses = Net income o Job order costing: Assumes company makes multiple products/performs multiple service and they are different Assumes company builds them in batched - governed by demand Organize WIP - break it into departments (process costing) or jobs (job order costing) so that we know which product costs belong to Process costing: opposite of job order costing Organized by department Assumes continuous production Assumes uniform product Produced to inventory not to orders - large-scale production quantities Ex: coca cola bottling factory - produces continuously Job order costing: Job = each batch of a product/service, for a specific order When materials are taken out of raw materials/WIP, not just charged to raw materials/WIP, but to that specific job WIP contains many jobs, all being worked on at the same time Job completed --> product moved to FG Job's cost consists of material, labor, overhead used to complete particular batch These costs --> FG account Overhead: indirect costs of making a product/performing service o o Right side of overhead T-account: charge products for the costs of overhead Allocation: estimate overhead then charge to cost objects based on estimated spending rate Cost objects: products made/services performed 2 estimates are made: What will overhead costs be next year (must be estimated ahead of time) How many units of cost driver will we use? (denominator of activity) What causes overhead - not products but it's support to labor --> cause of overhead is DIRECT LABOR Ultimate driver is product but need to make more specific than that Labor hours or dollars Estimated OH costs / Estimated units of cost driver = Predetermined Overhead Rate POR: Rate at which appear to spend overhead per unit of cost driver Over applied or under applied: Have to adjust at the end of the year Close it out to COGS As long it's not material it's not a big deal What causes wrong estimate: how much cost driver was used or variable portion spent in proportion to cost driver could be off Overhead primarily fixed - easier to estimate The Three OH Numbers Your Going to Encounter o Total estimated overhead Calculated before year beings What company THINKS overhead WILL be next year Used ONLY to calculate POR Estimated OH cost / estimated cost driver units o Actual overhead expenses These expenses - actual OH spending - are summarized on LEFT (debit) of OH control T-account (temporary account) See yellow handout for costs found in OH o The Predetermined RATE *Multiplied by ACTUAL units of cost drives = OB applied to WIP Accumulated on RIGHT (credit) side of OH control T-account o Under/Over applied OH Different between ACTUAL OH costs (left side) and OH applied at POR (right side) Under applied= more expense than applied Actual>applied --> subtract from COGS Over applied= more applied than actual expense Actual<applied --> add to COGS ***OVERHEAD o In Overhead T account - need actual/estimated at end of year before adjustment: Actual= given from table Estimated= ACTUAL units of cost driver X POR o Complete Overhead account with adjustment: If under applied: ending balance is on left (DEBIT) and on left side (DEBIT) of COGS If over applied: ending balance is on right (CREDIT) and on right (CREDIT) of COGS Chapter 5 CVP Assumptions Occurs within relevant range Costs are linear Sales price/sales mix remains constant Sales mix =percentage that each product sold accounts for company's sales/revenues Units produced = units sold o No CHANGE in inventories - sell the same amount as they produce so dollar amount of inventory stays same ***CVP calculations always done using pretax amounts o Taxes are neither fixed nor variable Contribution Margin (CM) Format Sales -variable costs =Contribution margin -fixed costs = net operating income Why CVP: understand how sales, VC, volume and profits relate to each other How changes in cost (caused by changes in volume) affect net income Cost structure: ratio of fixed to variable costs, employed in making product/service Important because particular behavior of these costs Contribution ratio*** CM/sales (sales-variable cost)/sales Break-even equations How much needed to sell (in units/$) to just cover all our costs - to make profit of $0 Unit break even = FC/CM per unit $ break even = FC/CM ratio Target profit analysis: how much do we need to sell to achieve profit figure in mind Unit sales to achieve target profit (TP) = (FC+TP) / CM per unit $ sales to achieve target profit (TP) = (FC+TP) / CM ratio *relevant range - how much capacity your FC give you Margin of Safety: how secure are we in terms of net income Sell BELOW break even --> incur loss - how far ABOVE break even are our sales? Unit = current unit sales - BE unit sales Dollars = current $ sales - BE$ sales % = (current sales - BE sales) / current sales Operating Leverage: quick estimate of effect on income of % change in sales CM / NI = OL factor OL * % change in sales = % change in income Key is fixed costs* - gap between NI and FC will change as sales change o Represent risk A measure of risk in our cost structure o Small increase in sales --> income UP by a lot o BUT small decrease in sales --> income DOWN by a lot o High OL is good because it allows for rapid growth BUT risky because it can lead to rapid loss When sales change --> OL changes Chapter 6 Concepts needed for Chapter 6: Cost flow Cost behavior (VC, FC, MC) Traditional vs. CM IS Fixed OH (as cost of capacity):ability to produce OH in general is MIXED cost despite allocation o Allocation makes it look like a VC Variable vs Absorption Costing Variable Costing: o Assumes only variable manufacturing costs (DM, DL, VOH) are to be considered product costs Considers fixed cost to be a period cost o Uses CM Income Statement format Absorption costing: o Assumes ALL manufacturing costs (VC and FC) are product costs o Uses traditional/gross margin IS format o MUST be used for external financial reporting Selling/Admin expenses: ALWAYS period costs Decentralization: delegation of responsibility Segments of organization Managers of each segment Why decentralize: o Upper management can focus on long-term strategy o Empower/motivate lower management o Trains managers for higher responsibility o Quick response time Risks: o Lower managers don't have "big picture" o Lack of coordination o Lack of goal congruence between lower management and organizational goals o Communication/innovation may decrease Segment Reporting Segment: any piece of your organization who manager wants cost, revenue or profit data Types of segments (responsibility center) o Cost center: manager controls costs, but not revenue or investments Provide goods/services at a cost that is attractive to the business o Profit center: manager controls revenues and costs, but not investments Expected to earn a profit o Investment center: manager controls costs, revenues and investments in assets Profit should have return >/= return they would receive if they had passive investments Segment report: o Contribution format o Two categories of FC: Traceable to the segment: disappear if segment were eliminated Common to company: support > one segment, not traceable to any one o Segment margin: Sales - VC - traceable fixed costs Best indicator of long-term profitability CM used in decision relating to use of existing capacity and short-term changes in volume o Common fixed costs: NEVER ALLOCATE to segments, because they are NOT AVOIDED if segments are eliminated Allocation can cause flawed decision-making o Break even Segments can break even BUT company as a whole may still suffer a loss because of common fixed costs Common FC were not allocated to segments, but COMPNY still incurs them Must be recovered by segment margins Notes from Problem 6-20 Always assume units produced = units sold…what if they don’t? o Be aware of effect of FC on income statement Beginning of plant's operations --> no beginning inventory o Usually refers to FG inventory *Selling/admin costs DO NOT CHANGE between costing methods COGS (tradition) vs. Variable COGS: why are they different? o Because of FOH o Absorption: includes $10/unit of FOH into product cost/unit --> $40/unit o Variable: FOH is separated from product costs --> $30/unit FOH: how much FOH did Absorption vs. Variable out on IS? o Absorption: $10/unit of FOH x 8000 units produced = $80,000 o Variable: Used total amount of FOH for the month (period cost) = $100,000 o Variable has $20,000 more FOH than absorption Why is NOI lower in Variable costing? o Because incurs ALL FOH on IS which is an extra $20,000 while Absorption only includes direct FOH in relation to units produced o *Difference in ($) income = different in ($) inventory o ** Difference in income ALWAYS = change in inventory (in units) x FOH/unit** If inventory INCREASES --> absorption NOI is HIGHER If inventory DECREASES --> variable NOI is HIGHER Chapter 6 Reminders: Variable vs. absorption costs Inventories: raw materials, WIP, finished goods Fixed OH is key* Absorption costing: FOH charged to PRODUCTS in WIP --> o FOH on products sols goes to income statement o FOH on unsold units is in FG inventory Variable costing: FOH is PERIOD cost --> o All FOH is charged to income statement Different in end FG or NOI = FOH/unit x CHANGE in inventory (units) o Inventory increases --> absorption costing has higher NOI o Inventory decreases --> variable costing has high NOI Both expense selling/admin costs Chapter 7 Activity-based costing answers question: what if misallocation of departmentalized OH affects product costing? OH: indirect cost of making product/doing service 1 Budget: Total overhead expenses (by line item) - total estimated (budgeted) OH cost Overhead base (cost driver) units OH is variable AND fixed 1 POR Calculation: estimated OH expense / estimated OH cost driver a POR x ACTUAL units of cost driver used by product or service = OH APPLIED 2 Calculate Cost of product/service ('allocating OH) a Direct material b + Direct labor c + OH APPLIED to actual units of cost driver at POR 2 Different Types of OH a Single - plant-wide: one OH cost pool for whole company b Departmental: each department has its own OH rate c Activity-based: activities cross department lines; each production activity has its own - more cost pools than traditional (plant-wide/departmental) systems Activity: ID different steps we perform to make, market, distribute products and run the company Costs of the Steps: o ID costs that are caused - resources used - by each step Every cost in OH is a RESOURCE: something the company says for the will help it do what it needs to do Steps are activities o Each step - each ACTIVITY - is ideally homogenous pool: all costs in it serve single purpose In reality, this doesn’t really occur, but little extra left over don't account for much OH Rate: calculations are the same but ABC makes more of them o Each activity has its own rate*** Issues with ABC: o More work and expense to track al activities o Doesn’t always conform to GAAP Leaves out some OH costs (organization-sustaining) Common costs Includes some selling/admin costs That's why called activity rather than OH rates - because include allocation of some selling/admin costs Benefit: ABC is more accurate if diversity exists* o Product diversity: more than one (truly different) product o Process diversity: number of production processes, not all products use them equally o Volume diversity: great differences in product volume *Activity levels - how often you do an activity relative to units of product you're producing o Unit: done individually for each product o Batch: done once for group of products Size of batch determined by product o Product: done for a product line (sets up/makes a product line) then can make as many units/batches as in demand o Customer: customer-orientated cost, different for each customer not each product o Organization sustaining: costs not allocated in traditional ABC Modified ABC for GAAP, must be allocated into unit activity level (?) Unit-based cost driver (used in plant-wide and departmental rates) won't accurately capture the way products capture the way products use non-unit-level activities Steps: o ID OH costs o Define OH activities and assign OH costs to activities o Select cost driver for each activity o Determine # units of each cost driver company will use during the year o Calculate a rate to each activity: total costs of activity / total units of cost driver (for the COMPANY) o Apply OH to products using activity (OH) rate x actual units of cost driver Green cost: can be reduced easily and is automatically reduced when __ Yellow cost: can be reduced but requires management decision Red cost: difficult to reduce without affected company's ability to make products o Ex: machines - if try to get rid of machine to reduce # inspections --> won't be able to do other inspections necessary and will reduce profit **ABC Costing changes way allocate indirect cost - it doesn’t change indirect costs or pricing but can help make decisions about cost drivers and allocation rates and pricing Chapter 12 Relevant Costs - short-term decisions Relevant (for short-term decisions): future costs AND differ between alternatives All costs are relevant but for short-term decisions, ignore some costs because they are capacity costs which have nothing to do with this situation Can be fixed/variable costs Why not use all costs? Take focus away from critical items o May focus attention on items that are not affected by the decisions, causing incorrect decisions May not know all the costs Types of decisions: Add/drop segment o Watch out for fixed costs: only consider fixed costs that are traceable/avoidable; not common costs o Compare lost CM with saved fixed cost Make/buy a components (outsourcing) o Opportunity cost Will cost of buying them < making them Will buying them free up time/money to make more tables Incremental cost (including opportunity cost) to make item Special order o Is incremental cost of making extra < contribution generated at lower selling price company wants (for buying in bulk) Constrained resources o Along line of making product have a shortage o CM per unit of scarce resource Joint costs o Sell /process further - have a product you COULD sell now Sell as is or put in more work and sell it for more $ Compare incremental revenue vs. incremental cost How much more could we sell a product with more work into it and how much would it cost us Differential: costs that will be different between two alternatives Incremental: increase in cost between two alternatives Avoidable cost: eliminated by ceasing to perform some activity Opportunity cost: value of alternative you give up $ you WON'T bring in because you didn't choose an alternative Sunk cost: past cost, cannot be changed Chapter 8 The Budgeting Process Planning process Allocation of resources Communication document o Communicates company plans o Long range perspective (and short term) Coordination/integration Control - benchmarking Factors leading to reduced effectiveness: Lack of well-defined strategy Lack of clear links between strategy and operational plans Lack of individual accountability for results o Not about blame - means every person is responsible for something in the budget Lack of meaningful performance measures Who does all the work Effectiveness of budgeting process depends on environment, people, business, etc. Top down: management dictates, lower management follows Bottom up: managers at all levels prepare budgets based on company guidelines o A self-imposed or participative budget process Where do you begin Sales budget o Cash sales o Collections on account o *understand difference between cash and accrual schedules Then, something to sell… Production budget vs. Merchandise purchases budget For production, you need… Raw materials purchases budget (often done in units, then converted to $ in final answer Then pay for what you buy Cash disbursements for merchandise purchases or DM purchases …people to make the goods Production budget: o Direct labor budget o OH budget to support production Retail - would not need these The "staff" departments Selling and admin expenses budget - operation expenses - for ANY type of company Then, put it all together Cash budget (usually prepared monthly) o Collections - from customers/misc. sources o Disbursements: Inventory Labor and OH (if manufacturing) Selling & admin Equipment/assets Dividends o Financing: Assumption: in couple of months, when budgeting goes other way - will repay $ This is for short term financing Borrowing if necessary, or repayments (if don't meet disbursements) Allowance for minimum cash balance And finally Budgeted financial statements o IS and BS (haven't happened yet, all budgeted number) Note: cash budget is similar to statement of cash flows, without the headings the statement requires o Cash budget is set up as statement of cash flows in different format Chapter 9 What flexible budget does: Find out what budget should be based on budget formula - if sales are y instead of x Then can compare actual results to realistic numbers Recognizes costs that change when volume changes => variable costs Static Budget One level of activity o One level for each period Master budget; "planning" budget Suitable for planning, but not for control o For comparing actual results - need to adjust budget --> that's flexible Flexible budget How costs change at different volumes o Budgeted costs for actual level of output (sales) achieved o IMPORTANT: CM format to distinguish VC from FC Output volume First step in converting master budget --> flexible budget: o Actual volume achieved o Master budget is volume you EXPECTED to achieve Actual volume = denominator volume or flexible budget volume o Basis for flexible budget On the other hand: If segment is cost center/service department (no sales), then volume may be measured in INPUTS rather than OUTPUTS o Ex: machine hours Cost Formula: budgeted cost per unit (this is for VC, not for FC) Master budget / # unit in master budget Fixed costs: Flexible budgets for fixed costs = master budget (Since volume should not affect level of FC) Variances: Activity variance: actual activity differs from budgeted activity, and causes more/less income o If you sold more units, this SHOULD affect both revenues and SOME costs o Concerned with top level activities like selling more or less Not really looking at this to control it Revenue variance: actual revenue vs. flexible budget revenue o Budgeted revenue/unit x actual activity Spending variance: line items of actual expense compared to flexible budget amount for each item o Variable: budget cost/unit x actual volume o Fixed: budgeted FC Doesn't mean there won't be variances in FC, just means they won't be caused by volume, because (at least in short term, FC not affected by volume) o Manager look at closely because these are the ones managers can control Favorable vs. Unfavorable: effect variance will have Favorable doesn't always mean good/best Favorable: more NOI Unfavorable: less NOI Variances interact with each other Chapter 10 Standard Costs and Variances Standard: Norm, benchmark, used to measure performance Standard Cost System: inventory accounts kept at standard instead of actual costs What do you do with differences (Variances) between standard and actual? o Charge against income in the period incurred - go to COGS Normal Cost System: o Standard Cost System: o Standard: what you based your budget on o Standard input for actual output: flexible budget for that input Variance Analysis - how costs vary from standard Two types of variances: o Quantity: how much of input was used compared to standard allowed o Price: what was paid for the input, compared to standard price Standard Cost Card: Quantity and price of each INPUT o DM o DL o VMOH o FOH o = Total Standard Cost of One Unit of Output DM Price Variance: actual cost of materials purchased compared to ACTUAL QUANTITY purchased at STANDARD PRICE Measures what you actually paid for materials compared to what budget says the price should have been DM Quantity Variance: actual quantity used at standard price compared to standard quantity allowed (from standard cost card) for ACTUAL OUTPUT at STANDARD price How much material did you use, compared to the budgeted amount? Measures at standard price because you already have eliminated the price variance from standard DL Rate Variance: actual amount paid for actual DLH used compared to ACTUAL DLH used at STANDARD rate Like material price variance What did DL cost, compare to budgeted rated for ACTUAL hours used DL Efficiency Variance: actual DLH used at standard rate compared to standard DLH allowed for ACTUAL output at STANDARD rate Did labor use the number of hours budgeted to do the work accomplished VOH Spending Variance: actual VOH expenses compare to ACTUAL units of cost driver used time PVOR (which is VOH standard) Variable OH rate based on budgeted VOH, and budgeted nits of cost driver o Did you actually spend at this average rate? VOH Efficiency Variance: POR times ACTUAL units of cost driver used compared to PVOR times STANDARD units of cost driver allowed for ACTUAL output Not VOH variance, it's a cost driver variance o How much extra/less OH would be caused by the difference between actual and standard DLH How much cost driver (dlh, mh, etc.) was used, compared to standard Measures efficiency of the cost driver FOH Budget Variance: actual FOH spent compared to budgeted FOH FOH Volume Variance: FOH budget compared to FOH applied to standard inputs for ACTUAL output Reflects over/under applied FOH caused by more/less OUTPUT compared to budget FOH is FIXED, so no more /less would be spent if you produced/sold greater/smaller # units of output o Merely have over applied/under applied FOH Model for Variance Calc: Practical vs. Ideal Standard Practical: allows for unavoidable waste/inefficiency *Standard and variances are calculated ASAP Materials Price Variance - almost always FIRST variance calculated
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