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AC 222 Book Notes (Whole Semester)

by: Frankie Fucci

AC 222 Book Notes (Whole Semester) AC 222

Marketplace > Boston University > Accounting > AC 222 > AC 222 Book Notes Whole Semester
Frankie Fucci
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These notes cover book chapters 1,2,3,5,6,7,8,9,10,12 for Professor Doherty's AC 222 Fall 2015 semester class.
Managerial Accounting I
Patricia Doherty
Accounting, notes, Book notes, AC 222
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This 32 page Bundle was uploaded by Frankie Fucci on Wednesday January 13, 2016. The Bundle belongs to AC 222 at Boston University taught by Patricia Doherty in Spring 2016. Since its upload, it has received 76 views. For similar materials see Managerial Accounting I in Accounting at Boston University.


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Date Created: 01/13/16
Chapter 1  Managerial Accounting: provides information to managers for use within the organization  Used for planning, controlling and decision-making  Emphasis on decisions affecting the future  Emphasizes relevance, timeliness, segment reports  Doesn't need to follow GAAP/IFRS Not mandatory   Planning: establishing goals and specifying how to achieve them  First step - establish a goal  Second step - answer questions to determine how to achieve the goal  Controlling: gathering feedback to ensure plans are properly executed/modified as needed  Gather, evaluate and respond to feedback in order to make future decisions more effective  Decision making: selecting a course of action from competing alternatives  Code of Conduct for Management Accountants  Statement of Ethical Professional Practice: ethical code adopted by the Institute of Management Accountants (IMA) o Describes the ethical responsibilities of management accountants o First part: general guidelines for ethical behavior  Responsibilities in 4 broad areas:  Maintain high level of professional competence  Treat sensitive matters with confidentiality  Maintain personal integrity  Disclose information with credibility o Second part: what should be done if evidence of ethical misconduct is found  Strategic Management Perspective  Strategy: "game plan" that enables companies to attract customers by setting itself apart  Companies must give target customer a reason to choose it over a competitor o Customer value propositions: essence of strategy; three broad categories  Customer intimacy: product/service customized to fit individual needs  Operational excellence: needs met faster, cheaper and more convenient  Product leadership: high quality products/services  Enterprise Risk Management: process used to identify risks in strategies/decisions and develop responses to them to try and meet company goals  Help company proactively manage their risks  Ex: Inaccurate budget estimates --> implement rigorous budget review process  Corporate Social Responsibility Perspective: company has a responsibility to serve other stakeholders who interests are ties to the company's performance  Process Management Perspective  Business process: series of steps that are followed in order to carry out some task in a business; steps span departments  Value chain: consist of major business functions that add value to a company's products and services o Used to describe how an org's functional departments interact with one another  Lean Production/Thinking (aka just-in-time (JIT) production): management approach that organizes resources around the flow of business processes and that only produces units in response to customer orders o Leads to # of units produced being close to # units sold --> minimal inventory o Fewer defects, less wasted effort, quicker customer response times  Leadership Perspective - organizational leaders must focus employees around two common themes: pursuing strategic goals and making optimal decisions To do this, must understand how certain factor affect human behavior   Intrinsic Motivation: motivation that comes from within; org will prosper if people want to help the company succeed o ^ manager credibility and respect --> ^ employee motivation to pursue strategic goals  3 attributes to be perceives as credible:  Technical competence, integrity, strong communication skills  3 attributes to be perceived as respectful of employee values:  Strong mentoring skills/listening skills and personal humility  Extrinsic Incentives: used to highlight important goals and motivate employees o Challenge: create financial compensation system that encourages positive behavior rather than negative  Cognitive Bias: distorted though processes o Can adversely affect planning, controlling and decisions making  Corporate Governance: system by which a company is directed and controlled  Sarbanes-Oxley Act of 2002: protect the interest of those who invest in publicly traded companies by improving the reliability and accuracy of corporate financial reports/reduce fraudulent financial reporting o CEO and CFO must certify in writing that the financial statement and reports fairly represent the results of operations o Public Company Accounting Oversight Board must provide additional oversight over the audit profession o Audit committee of the BOD has the power to hire, compensate and terminate the public accounting firm that audit's a company's reports o Accounting firm cannot provide a wide variety of nonauditing services to a client to limit conflict of interest o Annual report must contain an internal control report: provide assurance to investors that the financial disclosures are reliable o Severe penalties for altering/destroying docs that may eventually be used in court  Internal Control: process designed to provide assurance that objectives are being achieved o Company uses internal controls to provide assurance financial reports are reliable o Preventive control: deters undesirable events from occurring  Ex: authorizations, segregations of duties, physical safeguards, information systems security o Detective control: detects undesirable events that have already occurred  Ex: reconciliations, performance reviews, maintaining records, information systems security Chapter 2  Cost Classifications for Assigning Cost to Cost Objects  Costs are assigned to cost objects for a variety of purposes (pricing, preparation of profitability studies and controlling spending  Cost object: anything for which cost data is desired; classified as direct/indirect  Direct cost: cost that can be easily and conveniently traces to a specific cost object  Indirect cost: cannot be easily traced to a specific cost object  To be traced to a cost object - such as a particular product - the cost must be caused by the cost object  Common cost: incurred to support # of cost objects but cannot be traced to one individ. o Type of indirect cost  Cost Classifications for Manufacturing Companies  Manufacturing Costs  Direct materials: materials that become integral part of the finished product and whose costs can be traced to the finished product  Indirect materials: not work tracing to end product, included in manufacturing overhead  Direct Labor (touch labor): labor costs that can be easily traced to individual units of product  Indirect labor: cannot/hard to trace to particular products and included in overhead  Manufacturing overhead: all manufacturing costs except direct materials/labor o Does not included costs related to selling/administrative functions o Aka: indirect manufacturing costs, factory overhead, factory burden  Nonmanufacturing Costs  Selling costs: all costs incurred to secure customer orders and get product to customer o Aka: order-getting/order-filling costs o Can be direct/indirect  Administrative costs: associated with general management o Can be direct/indirect  Cost Classifications for preparing Financial Statements  Product Costs (Inventorial Costs): all costs involved in acquiring/making a product Direct materials + direct labor + manufacturing overhead  Period Costs: All costs that are not product costs  Selling + admin expenses  Prime Cost: sum of direct materials/labor costs  Conversion cost: sum of direct labor and manufacturing overhead  Cost Classifications for Predicting Cost Behavior  Cost behavior: how a cost reacts to changes in level of activity  Cost structure: relative proportion of each type of cost in an organization  Variable cost: varies, in total, in direct proportion to changes in level of activity o Must be variable with respect to something Activity base (cost driver): measure of whatever causes  the incurrence of variable cost o *A variable cost is constant if expressed on a "per unit" basis  Fixed cost: remains constant, in total, regardless of changes in level of activity o Committed fixed costs: organizational investments with multiyear planning horizon o Discretionary foxed costs (managed fixed costs): annual decisions by management to spend on certain fixed costs items  Linearity Assumption & Relevant Range?  Relevant range: range of activity within which the assumption that cost behavior is strictly linear is reasonably valid o  Behavior of cost within relevant range: o Variable cost (in total): increases/decreases with change in activity  Per unit: constant o Fixed cost (in total): not affected by changes in activity  Per unit: decreases as activity rises/increases as activity falls  Mixed Costs (Semivariable costs): both variable and fixed cost elements?  Relationship between mixed cost and the level of activity: Y=a+bX o Y=total mixed cost o a=total fixed cost (vertical intercept of the line) o b=variable cost per unit of activity (slope) o X=level of activity o Steeper the slope --> higher the variable cost per unit  Analysis of Mixed Cost?  High-Low Method: ID the period with the lowest level of activity and the period with highest level  Variable cost= Change in cost / Change in activity o Cost at high level - low level / high activity level - low activity level  Fixed cost element= Total cost - Variable cost element  Traditional and Contribution Format Income Statements  Traditional - mainly for external reporting use  Contribution Format Income Statement: provides managers with an income statement that clearly distinguished between fixed and variable costs --> aids in planning, controlling and decision making o Separate costs into fixed and variable categories o Contribution margin: amount remaining from sales revenue after variable expenses have been deducted  deduct variable expenses from sales  Cost Classifications for Decision Making  Differential Cost and Revenue?  Differential cost: difference in cost between two alternatives o Aka: incremental/decremental cost - depending on increase/decrease  Differential revenue: difference in revenues (usually sales) between any two alternatives  Marginal revenue: revenue obtained from selling one more unit of product  Opportunity cost: potential benefit that is given up when one alternative is selected  Sunk cost: cost that's already incurred and cannot be changed by any further decisions made  Not differential cost because cannot be changed --> only differential costs are relevant in decision making --> sunk costs always ignored  Cost of Quality  Quality of conformance: high quality of conformance is obtained when a product meets/exceeds design specs/free from defects that degrade its performance  Quality costs/costs of quality: costs of preventing, detecting and dealing with defects o Prevention/appraisal costs: incurred by keeping defective products from reaching the customer o Internal failure/external failure costs: incurred because defects occur despite prevention efforts  Prevention costs: actions taken to reduce # defects o Most effective way to manage quality cost prevention - proactive measures o Quality circles: small groups that meet regularly to discuss quality improvement o Statistical process control: technique used to detect if a process is in/out of control  Charts used to monitor the quality of units that pass through workstations  Allow workers to quickly spot out of control processes causing issues  Appraisal costs (inspection costs): ID defective parts/products before they go to customers o Group of inspectors - costly --> employees must self quality- check o Design product to be easily manufactures properly  Internal failure costs: ID defects before they go out o incurred when products don't conform to design specs  External failure cost: incurred when defective product goes out to customer o Ex: warranty repairs/replacements, recalls, legal actions, etc. Chapter 3  Managerial costing systems provide cost data to help managers plan, control and make decisions  Absorption costing: all manufacturing costs, fixed/variable, assigned to units of product o Used to determine product costs o Units are said to fully absorb manufacturing costs  Job Costing Overview  Under absorption costing, product costs include all manufacturing costs o Easy for direct costs because they can be directly traced to individual units o Harder for indirect costs because cannot be traced to units  Assigned to products/services by averaging time across products  Influenced by type of production process  Job-order costing: used when many different products with unique features are produced each period o Ex: large-scale construction projects, commercial aircrafts, greeting cards, etc.  All characterized by diverse outputs o Used a lot in service industries: advertising agencies, repair shops, hospitals, etc. o One "order" is called a job o Average cost per unit: costs are traced/allocated to jobs then costs of the job are divided by # units in the job o Job Costing Info  Measuring Direct Materials Cost o Manufacturing costs: direct materials, direct labor, manufacturing overhead o Bill of materials: doc lists type/quantity of each type of direct material needed to complete a unit of product o Production order: issued when an agreement with the customer is reached concerning quantities, prices and shipment date for the order o Materials requisition form: doc specifies type/quantity of materials to be drawn from storeroom/IDs the job that will be charged for the cost of materials  Controls the flow of materials into production/for entries in accounting records o Job Cost Sheet: records materials, labor and manufacturing overhead costs charged to job  Measuring Direct Labor Cost o Indirect labor costs (maintenance, supervision, etc.) - part of manufacturing overhead o Time ticket: hour-by-hour summary of employee's activity throughout the day  Computing Predetermined Overhead Rates (POR): o Allocation used to assign overhead costs  Allocation base: measure used to assign overhead costs to products/services  Predetermined overhead rate= estimated total manufacturing overhead cost Estimated total amount of allocation base  Y=a + bX  Y= est. total manufacturing overhead cost  A= est. total fixed manufacturing overhead cost  B= est. variable manufacturing overhead cost/unit of allocation base  X= est. total amount of allocation base  Applying Manufacturing Overhead: o Predetermined overhead rate is computed BEFORE period begins  Overhead applied to job= POR x amount of allocation base incurred by job  Job-Order Costing - The Flow of Costs  Purchase/Issues of Materials o Raw Materials………………..60,000  Accounts Payable……..………60,000  *Raw materials is asset account - initially recorded as asset, not expense  Issue of Direct/Indirect Materials: raw materials (direct/indirect) taken from storeroom for use o Work in Process………………50,000 o Manufacturing Overhead….2,000  Raw Materials…………..……..52,000 o *WIP= direct materials, manufacturing overhead= indirect costs part of that  Labor Cost: time tickets recorded direct/indirect labor o Work in Process………………60,000 o Manufacturing Overhead…15,000  Salaries/Wages Payable…..75,000  Manufacturing Overhead Costs: anything that's not direct materials/labor; entered in as incurred o Manufacturing Overhead……  Accounts Payable………  Cost of Goods Manufactured: once goods finished --> finished goods warehouse o Job already charged with direct materials/labor and manufacturing overhead thru POR  Finished goods…….158000  Work in process……158000  Costs are transferred out of Work in Process -- Finished Goods  Cost of Goods Sold (COGS): as FG shipped to customers, costs are transferred FG --> COGS o Accounts Receivable…….225,000  Sales…………………………...225,000 o COGS…………………………..118,500  Finished Goods…..………..118,500 o Usually, portion of units in job are immediately sold --> unit product cost must be used to determine how much product cost should be removed from FG  Schedule of Cost of Goods Manufactures and COGS  Schedule of COGM: 3 elements of product costs: direct materials/labor/manufacturing overhead, and summarizes the portions of those costs that remain in WIP inventory and in FG o 3 equations:  Raw materials used in production= beginning raw materials inventory + purchase of raw materials - ending raw materials inventory  Total manufacturing costs= direct materials + direct labor + manufacturing overhead applied in WIP  COGM= total manufacturing costs + beginning WIP inventory - ending WIP inventory  Schedule of COGS: 3 elements of product costs: direct materials/labor/manufacturing overhead, summarizes portions of those costs that remain in ending FG inventory and in COGS o Unadjusted COGS = beginning FG inventory + COGM - Ending FG inventory  COG available for sale= beginning FG inventory + COGM  Underapplied/Overapplied Overhead  Computing Underapplied/Overapplied Overhead o Overhead costs applied to WIP will usually differ from overhead cost actually incurred o Underapplied/Overapplied overhead: difference between overhead cost applied to WIP and actual overhead costs of a period o *debit balance in Manufacturing Overhead --> overhead is underapplied o *credit balance --> overhead is overapplied  Appendix 3A: Activity-Based Absorption Costing  Activity-based absorption costing: assigns all manufacturing overhead costs to products based on activities performed to make those products  Activity: event that causes consumption of manufacturing overhead resources o Activity cost pools (ACP): used to accumulate each activity's overhead cost; bucket in which costs are accumulated that relate to a single activity  Activity measure: allocation base that is used as the denominator for an activity cost pool o Each ACP has one  Activity rate: cost accumulated in numerator of ACP / quantity of activity measured in denominator o Used to assign costs from ACP to products  Differs from traditional absorption costing: some activities don't relate to volume of units produced o Batch-level activity: performed each time a batch is handled/processed, regardless of # units Ex: placing purchase orders, setting up equipment,  transporting component parts  Costs at batch-level depend on # batched processed rather than # units produced o Product-level activity: related to specific product; carried out regardless of # batches/units  Ex: designing product, engineering design changes  Costs at product-level depend on # products supported rather than # batches/units  Appendix 3B: Predetermined Overhead Rate (POR) and Capacity  Companies base POR on estimated/budgeted amount of the allocation base for upcoming period o Criticism: too much fixed manufacturing overhead cost is applied to products  Two assumptions: o We will consider only fixed manufacturing overhead o Assume that actual fixed manufacturing overhead at end of period is the same as estimated/budgeted fixed manufacturing overhead at beginning of period  Other criticism: products are charged for resources they don't use o Fixed costs of capacity spread over est. activity, units produced gain cost of unused capacity  Reason applied overhead cost/unit increases as level of activity falls o Argument: products should be charged only for capacity they use  Base predetermined overhead rate on capacity rather than allocation base  *estimated total manufacturing overhead cost at capacity will be larger than estimated total manufacturing overhead cost at estimated level of activity Chapter 5 Cost-Volume Profit Relationships  Cost-volume-profit (CVP analysis) helps managers make important decisions  Primary purpose is to estimate how profits are affected by: o Selling prices o Sales volume o Units variable cost o Total fixed costs o Mix of products sold  Simplify CVP calculations - managers have certain assumptions of these factors: o Selling price is constant: price of product/service stays the same as volume changes o Costs and linear/can be accurately divided into variable/fixed costs: variable element is constant per unit, fixed element is constant in total over relevant range o In multiproduct companies, mix of products sold remains constant Basics of CVP Analysis   Contribution income statement: emphasizes behavior of costs o Helpful in judging the impact on profits of changes in selling price, cost or volume o *Sales/variable expense/contribution margin expressed as per unit and in total  Contribution Margin: amount remaining from sales revenue after variable expenses have been deducted o Amount available to cover fixed expenses then to provide profit for period  If contribution margin not enough to cover fixed expenses --> net loss o Break-even point: level of sales at which profit is zero  *once break-even point is reached, net operating income increases by amount of unit contribution margin for each additional unit sold  CVP Relationships in Equation Form o Profit= (Sales - Variable expenses) - Fixes expenses  Profit stands for net operating income in equations o If one product:  Sales= Selling price per unit X Quantity sold= P X Q  Variable expenses= Variable expenses per unit X Quantity sold= V X Q  Profit= (P X Q - V X Q) - Fixed expenses  Useful to express in terms of unit contribution margin (Unit CM):  Unit CM= Selling price per unit - Variable expense per unit= P - V  Profit= Unit CM X Q - Fixed Expenses  CVP Relationships in Graphic Form o AKA Break-even chart o Highlights CVP relationships over wide range of activity o X-axis = unit volume / y-axis = $ o Draw line parallel to volume axis = total fixed expense o Choose some volume of unit sales, plot point representing total expense (fixed/variable) at the sales volume you selected  Draw line to point where fixed expense line intersects $ axis o Choose some sales volume, plot point representing total sales dollars at activity selected  Draw line through this point back to origin o Profit/loss at any given level of sales measured by vertical distance between total revenue line (sales) and total expense line (variable+fixed expense) o  Contribution Margin Ratio (CM Ratio) o Contribution margin as percentage of sales  CM Ratio = Contribution margin Sales o Company with only one product:  CM Ratio = unit contribution margin Unit selling price o CM ratio shows how contribution margin is affected by change in total sales  Ex: CM ratio of 40% = for each dollar ^ in sales, total CM ^ $.40 o Effect of change in sales on CM:  Change in CM = CM ratio X Change in sales o Relationship between profit and CM ratio:  Profit= CM ratio X Sales - Fixed Expenses^2 ????????  Changes in profit= CM ratio X Change in sales - Change in fixed expenses^2  Applications of CVP Concepts o Variable expense ratio: ratio of variable expenses to sales  Variable expense ratio = Variable expenses Sales o CM ratio = Sales - Variable expenses Sales o CM ratio = 1 - Variable expense ratio  Break-Even and Target Profit Analysis  Break-Even Analysis o Calculate break-even point (in unit sales) through two approaches  Equation Method - solve for Q  Profit = Unit CM X Q - Fixed expense  Formula Method  Unit sales to break even = Fixed expenses^3 Unit CM o Break-Even in Dollar Sales  Use equations above then multiply by selling price  Equation Method - solve for Sales  Profit = CM ratio X Sales - Fixed expenses  Formula Method:  Dollar sales to break-even = Fixed expenses^4 CM ratio  Target Profit Analysis o Estimate what sales volume is needed to achieve specific target profit  Equation Method - solve for Q  Profit = Unit CM X Q - Fixed expense  Formula Method (single product situation)  Unit sales to attain target profit = Target profit + Fixed expenses Unit CM o Target Profit in Terms of Dollar Sales  Solve for units needed (above) and multiply by selling price  Equation Method - solve for Sales  Profit = CM ratio X Sales - Fixed expenses o Formula Method:  Dollar sales to attain a target profit = Target profit + Fixed expenses CM ratio  Margin of Safety: excess of budgeted/actual sales $ over break-even volume of sales $ o Amount by which sales can drop before losses are incurred o High margin of safety --> lower risk of not breaking even and incurring loss o Margin of safety (MOS) dollars = Total budgeted/actual sales - break-even sales o MOS percentage = Margin of safety in dollars Total budgeted/actual sales in dollars o Ex: $12,500/12.5% = 12.5% at current level of sales/w/in company's current price/cost structure, reduction in sales of $12,500/12.5% would result in just breaking even CVP Considerations in Choosing a Cost Structure   Cost structure and Profit Stability o Cost structure: relative proportion of fixed/variable costs in organizations  Operating Leverage: measure of how sensitive net operating income is to given % change in $ sales o Operating leverage is high --> small % increase in sales can produce much larger % increase in net operating income o Degree of operating leverage (at given level of sales) = Contribution margin Net operating income  Measure-at given level of sales-how % change in sales volume affects profit  Sales Mix o Relative proportion in which company's products are sold o Achieve combination (mix) that yields greatest profit o Sales Mix and Break-Even Analysis o Companies with more than one product --> more complex break- even analysis Chapter 6 Variable and Absorption Costing:  Variable costing: o only manufacturing costs that vary with output are treated as product costs  DM, DL, variable MOH o Period cost: FOH, selling/admin expenses o Cost of a unit of product in inventory/COGS with variable costing doesn't contain any FOH costs o Mostly used for internal decision-making - uses contribution margin  Absorption costing (full cost method): o All manufacturing costs are product costs regardless of variable or fixed o DM, DL and fixed/variable MOH o Required by GAAP/IFRS - uses gross margin  Selling and Admin Expenses: NEVER treated as product costs*** o Variable and fixed selling/admin are period costs and expensed as incurred  Variable vs. Absorption o Difference = how fixed MOH is accounted for***  Everything else is the same o Variable: FMOH=period cost --> taken immediately to IS as period expense o Absorption: Fixed MOH included as post of WIP inventories  Once completed --> costs transferred to FG  Only once sold do costs flow through to IS as part of COGS o Segmented Income Statement and Contribution Approach  Segment: part or activity of an organization about which managers would like cost, revenue, or profit data  Traceable fixed cost: fixed cost incurred due to existence of the segment o If segment didn't exist, neither would that particular fixed cost  Common fixed cost: supports operations of more than one segment o Is not traceable in whole or in part to any one segment o Even if a segment were elimination, there would be no change in true common FC  Segmented Income Statement: o Sales (of segment) o -VC (of segment) o =Segment contribution margin  helpful in making short-run decisions about changes in volume o -Traceable fixed cost (of segment) o =Segment Margin: margin left over after segment has covered all its costs  *best gauge of long-run profitability of a segment  only includes costs caused by the segment  Helps to decide whether or not to keep/drop a segment  ID Traceable FC o Traceable cost = only costs that would disappear over time if segment disappeared o *allocation of fixed cost to segments reduces value of segment margin as measure of long-term segment profitability/performance o FC traceable to one segment may be common costs to another segment Chapter 7 Activity-Based Costing (ABC) - A Tool to Aid Decision Making  ABC: costing method designed to provide managers with cost info for strategic/other decisions that can affect capacity and therefore "fixed" as well as variable costs o Used as supplement to company's usual costing system o Used for internal decisions making/managing activities  Activity-Based Costing  Different from traditional absorption costing: o Nonmanufacturing as well as manufacturing costs may be assigned to products, but only on cause-and-effect basis o Some manufacturing costs may be excluded from product costs o Many OH pools are used, each is allocated to products/other cost objects using its own measure of activity  Nonmanufacturing costs and ABC o Traditional absorption costing assigned manufacturing costs but not non manufacturing costs to products o Different for ABC: many nonmanufacturing costs relate to selling, distributing, and servicing SPECIFIC PRODUCTS  Ex: sales commissions, shipping, warranty repair, etc. o ABC allocates indirect nonmanufacturing costs to products whenever the products have presumably CAUSED the costs to be incurred  Expands definition of OH - includes all indirect costs (manufacturing and nonmanufacturing) o ABC product cost calculations => all direct costs traced to products and all indirect costs caused by product  Manufacturing costs and ABC o Traditional absorption costing assigns all manufacturing costs to product  MOH costs assigned to products even though they're unaffected by which products are made during a period  Organization-sustaining costs: MOH not directly to product o Different for ABC: those costs are period costs rather than product costs o Traditional absorption costing assigns costs of unused/idle capacity costs  Results in high product cost and low product margin o Different for ABC: products only charge for costs of capacity they use  Provides more stable unit product costs/consistent with goal of assigning to products only costs of resources they use  Cost Pools, Allocation Bases, and ABC o In ABC - activity: any event that causes consumption of OH resources o Activity cost pool: "bucket" in which costs are accumulated that relate to single activity measure in ABC system  amount of costs accumulated for single activity o Activity measure: allocation base in ABC system  Aka cost driver - activity measure should drive cost being allocated  Two most common types of activity measures:  Transaction drivers: simple counts of # times activity occurs  Often used more often  Duration drivers: amount of time required to perform activity  Usually more accurate, but take more effort to record o In traditional cost systems use allocation bases driven by volume of prod. o Different for ABC: defines 5 levels of activity that do not relate (with exception of unit) to volume of units produced  Unit-level activities: performed each time a unit is produced; cost should be proportional to # unit produced  Batch-level activities: performed each time a batch is handled or processed, regardless of # units in each batch  Ex: purchase orders, equipment setup, shipments, etc.  Product-level activities: relate to specific products/typically must be carried out regardless of # batches/units produced/sold  Ex: designing/advertising product, product manager, etc.  Customer-level activities: relate to specific customers  Ex: sales calls, catalog mailings, general technical support, etc.  Organization-sustaining activities: carried out regardless of any above categories  Ex: heating factory, IT help, annual reports, etc.  Designing ABC System  ABC Model o Cost objects --> activities --> consumption of resources --> cost  Steps for implementing ABC: o Define activities, activity cost pools/measures o Assign OH costs to activity cost pools  Divide typed of OH costs among activity cost pools  First-stage allocation: assign functionally organized OH costs derive from company's ledger to activity cost pools o Calculate activity rates  Used to assign OH cost to products/customers  Activity rate = total cost for each activity / total activity o Assign OH costs to cost objects using activity rates/measures  Second-stage allocation: activity rates used to apply OH costs  ABC cost = activity rate x activity o Prepare management reports  Traditional vs. ABC Product Costs  Traditional cost system overcosts/undercosts some products --> reports artificially low/high product margin for products o Assigned idle/organization/sustaining costs to products --> high product cost and low product margin o ABC view --> increases product margin of undercosted in traditional, etc.  3 reasons why traditional and ABC systems report different product margins o Traditional allocated all MOH to product o Allocated all MOH using one allocation base even if that may not be the dominant cost driver for a certain department/activity o ABC system assigns nonmanufacturing OH caused to products of cause-and-effect basis  Traditional systems disregard these as period costs  Why ABC Not Used for External Reporting  External reports not as detailed as internal reports  Difficult to change company's accounting system  Does not conform with GAAP Chapter 12 Differential Analysis: The Key to Decision Making  Every decision involves choosing from at least two alternatives o Cost/benefits of one option must be compared to the other  Key to making comparisons is differential analysis - focusing on the costs/benefits that DIFFER between the alternatives  Differential cost: different in cost between any two alternatives  Differential revenue (benefit): difference in revenue between two alternatives  Costs that do not differ between two alternatives are irrelevant  Cost Concepts for Decision Making  Identifying Relevant Costs/Benefits o Avoidable cost: can be eliminated by choosing one alternative over another  Avoidable => relevant cost  Unavoidable => irrelevant cost o Two broad categories of costs are never relevant:  Sunk cost: had already been incurred and cannot be avoided regardless of what manager decides to do  Depreciation is irrelevant it is a noncash item that simply spreads the cost of the truck over its useful life  Sunk costs are always the same no matter what alternatives are being considered => irrelevant  Future cost that do not differ between the alternatives o Opportunity cost: potential benefit that is GIVEN UP when one alternative is selected over another o *Only costs/benefits that different between alternatives are relevant in a decision o Differential costs = relevant costs/avoidable costs o *Key to decision making: focus on relevant costs/benefits and opportunity costs while ignoring sunk/future costs/benefits that do not differ between the alternatives  Different Costs for Different Purposes o Fundamental concept : costs that are relevant in one decision may not be relevant in another o Means: managers need different costs for different purposes o Basic concept of managerial accounting  Why Isolate Relevant Costs? o Two methods of analyzing alternatives:  Consider all costs - relevant and irrelevant  Consider only relevant costs o Why both separating relevant from irrelevant at all if get same answer?  Rarely will enough info be provided to make a full IS  Mingling irrelevant costs with relevant costs may cause confusion and distract attention from critical information --> incorrect decisions o Relevant costs combined with the contribution IS => powerful tool for making decisions  Adding/Dropping Product Lines/Other Segments  Final decision based on the impact on net operating income  Ex: If you drop a product line --> lose that CM but may make up that loss by saving on FC that can be avoided because traceable to that line  If avoided FC > lost CM --> overall NOI up --> drop line  Fixed Avoidable: o Salaries of people working directly on product o Advertising expense specific to a product line o Insurance specific to a product line  Fixed Unavoidable: o Utilities expense allocated to product based on space occupies o Depreciation expense (if no resale value) o General admin salaries  The Make or Buy Decision  Value chain: all steps a business takes to take in revenue - from development --> production --> after-sales service  Vertically integrated: company is involved in more than one activity in entire value chain  Some would rather integrate on smaller scale by purchasing many of the parts/materials that go into finished product  Make or buy decision: decision to carry out one of the activities in value chain internally rather than to buy externally from supplier  Benefits of Vertical Integration: o Less dependent on suppliers  Ensure smoother flow of parts/material for products o Control quality better o Realizes profit from parts and materials it "makes" rather than "buys"  Benefits of External Suppliers: o Economies of scale --> higher quality and lower costs  Opportunity Costs  Outsourcing if: space remains idle vs. used for something else o Make vs. buy  Total annual cost  Opportunity cost of potential new product line  Different (in favor of which)  Special Order: one-time order not considered part of normal ongoing business o Managers must evaluate whether special order should be accepted and at what price  Utilization of a Constrained Resource  Constraint: anything that prevents you from getting more of what you want  Constraints (or bottlenecks) in the system is determined by the step that limits total output because it has the smallest capacity  CM/unit of Constrained Resource o Mangers have to decide how constrained resources are going to be  Must decide which products make the best use of constrained resources  **FC usually unaffected --> course of action that will maximize total contribution margin should be selected  Managing Constraints o Capacity of bottleneck can be effective increased by:  Working overtime on bottleneck  Subcontracting some of processing that would normally be done at bottleneck  Investing in additional machines at bottleneck  Shifting workers from processes that are not bottlenecks to the bottleneck process  Focus business process improvement efforts on bottleneck  Reduce defective unit - each unit that is processed through bottleneck and the scrapped takes the place of a good unit that could have been sold  Joint Product Costs and Contribution Approach  Joint products: products produced from common input  Split-off point: point in manufacturing process at which joint products can be recognized as separate products  Joint cost: costs incurred up to the split-off point  Sell of Process Further Decisions o Joint costs are irrelevant regarding what to do with a product from split-off point forward o Joint costs are not avoidable by disposing of any one of the products that come from split-off point --> none of joint costs are attributable to any of intermediate/end products  They are common costs of all intermediate/end products --> should not be allocated o Sell or process further decisions:  Profitable to continue processing joint product after split- off point SO LONG AS incremental revenue from such processing exceeds incremental processing cost incurred after split-off point  ABC and Relevant Costs  ABC helps ID potential relevant costs for decision-making o Improves traceability of costs by focusing on costs caused by a product or other segment o *DON'T assume traceable => avoidable Chapter 8  Master Budgeting o Budget: detailed plan for future usually expressed in formal terms  Quantitative plan for acquiring/using resources over specified time o Budgets used for two distinct purposes:  Planning: develop goals/prepare various budgets to achieve goals  Control: gathering feedback to ensure plan is being properly executed/modified as circumstances change o Advantages of Budgeting  Communicates management's plans throughout firm  Forces managers to think about/plan for future  Without it, managers would spend all time on daily emergencies  Provides means of allocating resources to parts of firm where they will be used most effectively  Uncover potential bottlenecks before they occur  Coordinates activities of entire org. by integrating plan of many depts.  Ensures everyone is pulling in the same direction  Define goals/objectives that can serve as benchmarks for evaluating subsequent performance o Responsibility Accounting: managers should be held responsible for those items - and ONLY those items - that they can actually control to a significant extent  Each line item (rev/cost)in budget is responsibility of manager who is held responsible for subsequent deviations between budgeted goals/results  Personalizes accounting info by holding individuals responsible for revenues/costs  Concept is central to any effective planning/control system o Choosing Budget Period  Operating budgets cover one-year period  Usually divided in four quarters, can further be divided into months  Continuous/Perpetual budget: 12-month budget that rolls forward one month/quarter as current month/quarter is completed  One month/quarter is added to end of budget as each month/quarter comes to a close  Keeps managers focused at least one year ahead so they don't get too narrowly focused on short-term goals/results o Self-Imposed Budget  Success of budget program largely determined by its development  Many times, budget is imposed from above w/ little participation by lower-level managers  Can generate resentment in employees who are penalized for not meeting expectations imposed on them from above  Self-imposed/Participative budget: budget prepared with full cooperation/participation of managers at all levels  Some feel this is most effective method  Advantages:  People at all levels feel valued  Estimates often more accurate/reliable when made by front-line managers rather than guesses from above  Motivation is higher --> creates commitment  Puts accountability on managers to meet the goals they made  Limitations:  LL management may make suboptimal budgeting recommendations if lack broad strategic perspectives  May allow LL managers to create too much budgetary slack  May submit a budget that is easy to attain o Human Factors in Budgeting  Success of budget depends on way its used by top managers  Rather than being a weapon of blame, budget should be used as positive instrument to assist in:  Establishing goals  Measuring operating results  Isolating areas that need attention  Master Budget: An Overview o Master budget: consists of number of separate but interdependent budgets that formally lay our company's sales,/production/financial goals  Culminates in cash budget, budgeted IS and budgeted BS o Overview of various parts of master budget/how they relate o o First step - preparation of sales budget: detailed schedule showing expected sales for budget period  Key to entire budgeting process: accurate sales budget  All other budgets come from sale budget  Based on company's sales forecast (required mathematical tools)  Influences variable portion of selling/admin expense budget  Feeds into production budget: defines # units need produced in period  Production budget used to determine DM, DL, OH cost budgets  These three manufacturing costs budgets --> prepare FG inventory budget  Preparing Master Budget o Sales Budget: mostly derived from cell references o Production budget: lists number of units that must be produced to satisfy sales need and to provide for desired ending FG inventory o Inventory purchases - merchandising company  Prepare inventory purchases budget: shows amount of goods to be purchases from suppliers during period o Direct Materials Budget  Prepared after production reqs have been computed  DM budget: details RM that must be purchased to fulfill production budget and provide for adequate inventories  Calculate raw materials to be purchased: need beginning inventory of RM and RM required per unit o Direct labor Budget  DL budget: shows DL hours required to satisfy production budget  Knowing labor time needed in advance --> can develop plans to adjust labor force as situation requires  First line in DL budget consists of required production for each qtr. o Manufacturing Overhead Budget  MOH budget: lists all costs of production other than DL/DL  Separated into variable and fixed components  Most common significant noncash MOH cost=depreciation  FC and budgeting:  FC: costs of supplying capacity to make products, process purchase orders, handle customer calls, etc.  Amount of capacity that will be required depends on expected level of activity for the period  Expected level>current capacity => FC may have to increase  Expected level<current capacity => may want to decrease FC  Once level of FC determined --> FC ARE FIXED o Ending Finished Goods Inventory Budget  Complete schedules 1-5 --> can compute unit product cost for units made  Needed for 2 reasons:  Help determine COGS on budgeted IS  To value ending inventories on budgeted BS  Cost of unsold units is computed on ending FG inventory budget o Selling and Administrative Expense Budget  S&A expense budget: lists budgeted expenses for areas other than manufacturing  Large firms: compilation of many smaller, individual budgets submitted by dept. heads/people responsible for S&A expenses  Dividing into variable and fixed cost components o The Cash Budget - composed of four major sections:  Receipts section: lists all cash inflows - expect from financing - expected during period  Majority from sales  Disbursements section: summarizes all cash payments that ae planned for budget period  Include RW purchases, DL payments, MOH costs, other cash disbursements such as equipment purchases and dividends, etc.  Cash excess or deficiency section: if cash deficiency exists in period/cash excess that is less than minimum required cash balance --> borrow money  Financing section: details borrowings/principal and interest repayments projected to take place during budget period  This chapter - always assume all borrowings take place on first day of borrowing period and all repayments take place on last day of final period included in cash budget  Calculate borrowings/interest payments, watch firm's desired minimum cash balance and terms of company's loan agreement  Calculate required borrowings on cash budget= add desired ending cash balance t amount of cash deficiency o Budgeted Income Statement: one of key schedules in budget process  Shows company's planned profit  Serves as benchmark against which firm performance is measured o Budgeted Balance Sheet  Developed using data from the beginning of the budget period and data contained in various schedules Chapter 9  Flexible Budgets:  Planning budget: prepared before period begins; valid for only planned level of activity o NOT for control o If actual level of activity differs from planned --> misleading to compare actual cost to static budget  Ex: if activity higher than expected => VC should be higher  If activity lower => VC should be lower than expected  Flexible budget: estimate of what revenues/costs SHOULD HAVE BEEN given the ACTUAL level of activity for the period o takes into account how changes in activity affect costs o Used for performance evaluation: ACTUAL costs compared to what costs SHOULD HAVE BEEN for actual level of activity during period RATHER THAN static planning budget said  How it works: o Shows what revenues and costs should have been given actual level of activity o Uses cost formula for each cost to estimate what cost should have been for the actual level of activity  Flexible Budget Variances: discrepancies between budgeted/actual costs  Activity variances: differences between budgeted/actual profit because actual level of activity differed from what was expected o When activity level increases by % --> NOI increases by more than that %  DUE TO FIXED COSTS  Revenue variance: difference between actual total revenue and what total revenue should have been, given actual level of activity o Actual revenue > what revenue should have been => favorable o Actual revenue < what revenue should have been => unfavorable  Spending variance: difference between actual amount of cost and how much cost should have been, given actual level of activity o Actual cost > what cost should have been => unfavorable o Actual cost < what cost should have been => favorable  Unfavorable variance: less NOI  Favorable variance: more NOI  Performance Report: combines activity variances w/ revenue/spending variances o Easier to interpret what happened o Format:


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