ACCT210 Study Guide Test 1
ACCT210 Study Guide Test 1 ACCT210
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Accounting 210 Test #1 Study Guide: Ch.1,2,4,& 5 Chapter 1: - Managerial Accounting: provides economic and financial information for managers and other internal users. - Comparing Managerial and Financial Accounting: - Major Management Functions: o Planning: maximize short term profit and market share, commit to environmental protection and social programs, and add value to the business o Directing: coordinate diverse activities and human resources, implement planned objectives, provide incentives to motivate employees, hire and train employees, and produce a smooth running operation. o Controlling: keeping activities on track, determine whether goals are met, decide changes needed to get back on track, and may use an informal or formal system of evaluations. - Organizational Charts: show the interrelationships of activities and the delegation of authority and responsibility within the company. - True or False? o Managerial accountants have a single role within an organization, collection and reporting costs to management? ▯ FALSE o Financial accounting reports are general-purpose and intended for external users? ▯ TRUE o Managerial accounting reports are special-purpose and issued as frequently as needed? ▯ TRUE o Managers’ activities and responsibilities can be classified into three broad functions: cost accounting, budgeting, and internal control? ▯ FALSE (refer to three major management functions above) o Managerial accounting reports must now comply with generally accounting principles (GAAP). ▯ FALSE - Managers should ask questions such as the following: o What costs are involved in making a product or providing a service? o If we decrease production volume, will costs decrease? o What impact will automation have on total costs? o How can we best control costs? - Manufacturing costs: o Manufacturing consists of activities and processes that convert raw materials into finished goods. ▯ Direct Materials, Direct Labor, Manufacturing Overhead o Direct Materials ▯ Raw Materials: Basic materials and parts used in the manufacturing process ▯ Direct Materials: Raw materials that can be physically and directly associated with the finished product during the manufacturing process. o Indirect Materials: Not physically part of the finished product or they are and impractical to trace to the finished product because their physical association with the finished product is too small in terms of cost. ▯ Considered part of the manufacturing overhead. o Direct Labor: Work of factory employees that can be physically and directly associated with converting raw materials into finished goods. o Indirect Labor: Work of factory employees that has no physical association with the finished product or for which it is impractical to trace costs to the finished goods produced. o Manufacturing Overhead: ▯ Costs that are indirectly associated with manufacturing the finished product. ▯ Includes all manufacturing cost except direct materials and direct labor. ▯ Also called factory overhead, indirect manufacturing costs, or burden. - Product Verses Period Costs: o Product Costs: ▯ Components include direct materials, direct labor, and manufacturing overhead. ▯ Costs that are an integral part of producing the product. ▯ Recorded in “inventory” account. ▯ Not an expense (COGS) until the goods are sold. o Period Costs: ▯ Charged to expense as incurred. ▯ Non-manufacturing costs. ▯ Includes all selling and administrative expenses. o Example: Direct Materials include tires, spokes, and handlebars. Direct Labor includes salaries of employees who put tires on the wheels. Overhead includes factory depreciation, lubricants, factory manager salary, and factory maintenance employees’ salary. - Income Statement: o Under a periodic inventory system, the income statements of a merchandiser and a manufacturer differ in the cost of goods sold section. Costs of good sold is shown by the acronym “COGS”. - Review Question: o For the year, Red Company has cost of goods manufactured of $600,000, beginning finished goods inventory of $200,000, and ending finished goods inventory of $250,000. The COGS is: ▯ Beginning Finished Goods Inventory+ Cost of Goods Manufactured= Costs of Goods Available for Sale- Ending Finished Goods Inventory= COGS ▯ 200,000+600,000= $800,000 ▯ 800,000-250,000= $550,000 • Answer: $550,000 - Cost of Goods Manufactured: o Total Manufacturing Costs: sum of direct material costs, direct labor costs, and manufacturing overhead in the current year. o Total Work in Process: (1) cost of beginning work in process and (2) total manufacturing costs for the current period. ▯ Example: Starting with this information: End with this statement: - Balance Sheet: o Inventory accounts for a manufacturer. ▯ Raw Materials Inventory: Shows the cost of raw materials on hand. ▯ Work in Process Inventory: Shows the cost applicable to units that have been started into production but are only partially completed. ▯ Finished Goods Inventory: Shows the cost of completed goods on hand. o The balance sheet for a merchandising company shows just one category of inventory. ▯ Example of current assets section of merchandising and manufacturing balance sheets: - Service Industries: o Much of the U.S. economy has shifted toward an emphasis on providing services rather than goods. o Over 50% of U.S workers are now employed by service companies. o Most of the techniques learned for manufacturing firms are applicable to service companies. - Focus on the Value Chain o Refers to all business processes associated with providing a product or service. ▯ For a manufacturing firm these include: research and development and product design -> acquisition of raw materials -> production -> sales and marketing -> delivery -> customer relations and subsequent services. o Just-In-Time (JIT) Inventory Methods: ▯ Inventory system in which goods are manufactured or purchased just in time for sale. o Total Quality Management (TQM): ▯ Reduce defects in finished products, with the goal of zero defects. o Theory of Constraints: ▯ Constraints (“bottlenecks”) limit the company’s potential profitability. ▯ A specific approach to identify and manage these constraints in order to achieve company goals. o Enterprise Resource Planning (ERP) ▯ Software programs designed to manage all major business processes. o Activity-Based Costing (ABC): ▯ Allocates overhead based on use of activities. ▯ Results in more accurate product costing and scrutiny of all activities in the value chain. - Balanced Scorecard: o Evaluates operations in an integrated fashion. o Uses both financial and non-financial measures. o Links performance to overall company objectives. - Business Ethics: o All employees are expected to act ethically. o Many organizations have codes of business ethics. o Past financial frauds: ▯ Enron, Global Crossing, WorldCom o Creating Proper Incentives: ▯ Systems and controls sometimes create incentives for managers to take unethical actions. ▯ Controls need to be effective and realistic. o Code of Ethical Standards: ▯ Sarbanes-Oxley Act (SOX) • Clarifies managements’ responsibilities. • Requires certifications by CEO and CFO. • Selection criteria for Board of Directors and Audit Committee. • Substantially increased penalties for misconduct. - Corporate Social Responsibility: o Considers a company’s efforts to employ sustainable business practices with regard to its employees, society, & the environment. o Is sometimes referred to as the triple bottom line because it evaluates a company’s performance regarding people, planet, and profit. o Recent reports indicate that over 50% of the 500 largest U.S. companies provide sustainability reports. - REVIEW Definitions: o Value Chain: All activities associated with providing a product or performing service. o Activity based costing: A method of allocating overhead based on each product’s use of activities in making the product. o Total Quality Management (TQM): Systems implemented to reduce defects in finished products with the goal of achieving zero defects. o Balanced Scorecard: A performance-measurement approach that uses financial and non-financial measures, tied to company objectives, to evaluate a company’s operations in an integrated fashion. o Just-in-time (JIT) Inventory: Inventory system in which goods are manufactured or purchased just as they are needed for use. o Corporate social responsibility: A company’s efforts to employ sustainable business practices with regards to its employees, society and the environment. o Statement of Ethical Professional Practice: Inventory system in which goods are manufactured or purchased just as they are needed for use. Chapter 2: - Cost accounting involves measuring, recording, and reporting product costs. o Accounts are fully integrated into the general ledger. o Perpetual inventory system provides immediate, up-to-date information on the cost of a product. o Two basic types: (1) a process order cost system and (2) a job order cost system. - Process Cost System: o Used when a large volume of similar products are manufactured- (cereal, refining of petroleum, production of ice cream). o Costs are accumulated for a time period – (week or month). o Costs are assigned to departments or processes for a specified period of time. - Job Order Cost System: o Costs are assigned to each job or batch. o Important feature: Each job or batch has its own distinguishing characteristics. o Objective is to compute the cost per job. o Measures costs for each job completed, not for set time periods. o Example: Producing an animated film is comparable in cost to producing an action film; the costs just come from different places. - Job Order Cost Flow: o The flow of costs parallels the physical flow of the materials as they are converted into finished goods ▯ Manufacturing costs are assigned to the work in process (WIP) account. ▯ Cost of completed jobs is transferred to the finished goods inventory account. ▯ When units are sold, the cost is transferred to the cost of goods sold account. ▯ Basic overview of the flow of costs in a manufacturing setting for production of a fire truck. - Accumulating Manufacturing Costs: o Raw Materials Costs ▯ Example: Wallace Company purchases 2,000 lithium batteries (Stock No. AA2746) at $5 per unit ($10,000) and 800 electronic modules (Stock No. AA2850) at $40 per unit ($32,000) for a total cost of $42,000 ($10,000 + $32,000). The entry to record this purchase on January 4 is: Jan. 4 Dr. Raw Materials Inventory 42,000 Cr. Accounts Payable 42,000 o Factory Labor Costs ▯ Consists of three costs: 1.Gross earnings of factory workers(anyone involved in manufacturing process. 2. Employer payroll taxes on these earnings. 3. Fringe benefits (such as sick pay, pensions, and vacation pay) incurred by the employer. ▯ Example: Wallace incurs $32,000 of factory labor costs. Of that amount, $27,000 relates to wages payable and $5,000 relates to payroll taxes payable in February. The entry to record factory labor for the month is: Jan. 31 Dr. Factory Labor 32,000 Cr. Wages Payable 27,000 Cr. Payroll Taxes 5,000 o Manufacturing Overhead Costs ▯ Many types of overhead costs for example: property taxes, depreciation, insurance, and repairs related to the manufacturing process. ▯ Costs unrelated to manufacturing process are expensed. ▯ Costs related to manufacturing process are accumulated in the Manufacturing Overhead account. • Manufacturing overhead subsequently assigned to work in process. o DO IT! During the current month, KRT Company incurs the following manufacturing costs: a. Raw material purchases of $4,200 on account. (Direct Materials) b. Factory labor of $18,000. Of that amount, $15,000 relates to wages payable and $3,000 relates to payroll taxes payable. (Direct Labor) c. Factory utilities of $2,200 are payable, prepaid factory insurance of $1,800 has expired, and depreciation on the factory building is $3,500. (Manufacturing Overhead) Prepare the journal entries for each type of manufacturing cost: a) Raw material purchases of $4,200 on account. Dr. Raw Materials Inventory 4,200 Cr. Accumulated Depreciation 4,200 b) Factory labor of $18,000. Of that amount, $15,000 relates to wages payable and $3,000 relates to payroll taxes payable. Dr. Factory Labor 18,000 Cr. Wages Payable 15,000 Cr. Payroll Taxes Payable 3,000 c) Factory utilities of $2,200 are payable, prepaid factory insurance of $1,800 has expired, and depreciation on the factory building is $3,500. Dr. Manufacturing Overhead 7,500 Cr. Utilities Payable 2,200 Cr. Prepaid Insurance 1,800 Cr. Accumulated Depreciation 3,500 o Assigning manufacturing costs to work in process results in the following entries ▯ Debits made to work in process inventory. ▯ Credits made to raw materials inventory, factory labor, and manufacturing overhead. - Job Cost Sheet: o Used to record costs chargeable to specific jobs. o Constitutes the subsidiary ledger for the work in process account. o Each entry to Work in Process Inventory must be accompanied by a corresponding posting to one or more job cost sheets. ▯ Example of Job Cost Sheet: - Raw Material Costs: o Assigned to a job when materials are issued in response to requests. o Materials requisition slip: ▯ Written authorization for issuing raw materials. ▯ May be directly issued to use on a job - direct materials (charged to Work in Process Inventory). ▯ May be considered indirect materials – charged to Manufacturing Overhead. • Example of Materials Requisition Slip: o Example: Wallace uses $24,000 of direct materials and $6,000 of indirect materials in January, the entry is: Jan. 31 Dr. Work in Process 24,000 Dr. Manufacturing Overhead 6,000 Cr. Raw Materials Inventory 30,000 o The sum of the direct materials columns of the job cost sheets should equal the direct materials debited to Work in Process Inventory account. - Factory Labor Costs: o Assigned to jobs on the basis of time tickets. o Time tickets are prepared when the work is performed. o Time tickets indicate: employee, hours worked, account and job charged, and total labor cost. ▯ Example of Time Ticket: o Example: The time tickets are later sent to the payroll department, which applies the employee’s hourly wage rate and computes the total labor cost. If the $32,000 total factory labor cost consists of $28,000 of direct labor and $4,000 of indirect labor, the entry is: Jan. 31 Dr. Work in Process 28,000 Dr. Manufacturing Overhead 4,000 Cr. Factory Labor 32,000 o The sum of the direct labor columns of the job cost sheets should equal the direct labor debited to Work in Process Inventory. o DO IT! Danielle Company is working on two job orders. The job cost sheets show the following: Direct materials—Job 120 $6,000; Job 121 $3,600= $9,600 Direct labor—Job 120 $4,000; Job 121 $2,000= $6,000 Manufacturing overhead—Job 120 $5,000; Job 121 $2,500=$7,500 Prepare the three summary entries to record the assignment of costs to Work in Process from the data on the job cost sheets. 1.) Dr. Work in Process $9,600 Cr. Raw Materials Inventory $9,600 2.) Dr. Work in Process $6,000 Cr. Factory labor $6,000 3.) Dr. Work in Process $7,500 Cr. Manufacturing Overhead $7,500 - Manufacturing Overhead Costs: o Relates to production operations as a whole. o Cannot be assigned to specific jobs based on actual costs incurred. o Companies assign to work in process and to specific jobs on an estimated basis through the use of a predetermined overhead rate. - Predetermined Overhead Rate: o Based on the relationship between estimated annual overhead costs and expected annual operating activity. o Expressed in terms of an activity base such as: ▯ Direct labor costs ▯ Direct labor hours ▯ Machine hours ▯ Any other measure that will provide an equitable basis for applying overhead costs to jobs. o Established at the beginning of the year. o Small companies often use a single, company-wide predetermined rate. o Large companies often use a different rate for each department and each department may have a different activity base. o Formula for computing the predetermined rate overhead rate is: o Manufacturing overhead costs are assigned to Work in Process during the period to get timely information about the cost of a completed job. o Example: Wallace Company uses direct labor cost as the activity base. Assuming that the company expects annual overhead costs to be $280,000 and direct labor costs for the year to be $350,000, compute the overhead rate. ▯ This means that for every dollar of direct labor, Wallace will assign 80 cents of manufacturing overhead to a job. o Example: Wallace applies manufacturing overhead to work in process when it assigns direct labor costs. Calculate the amount of applied overhead assuming direct labor costs were $28,000. $28,000 x 80% = $22,400 Jan. 31 Dr. Work in Process $22,400 Cr. Manufacturing Overhead $22,400 o The sum of the manufacturing overhead columns of the job cost sheets should equal the manufacturing overhead debited (i.e., applied) to Work in Process Inventory. o At the end of each month: The balance in the Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfinished jobs. - DO IT! Stanley Company produces specialized safety devices. For the year, manufacturing overhead costs are expected to be $160,000. Expected machine usage is 40,000 hours. The company assigns overhead based on machine hours. Job No. 302 used 2,000 machine hours. Compute the predetermined overhead rate, determine the amount of overhead to allocate to Job No. 302., AND prepare the entry to assign overhead to Job No. 302 on March 31. - Assigning Costs to Finished Goods: o When a job is completed, Wallace Company summarizes the costs and completes the lower portion of the applicable job cost sheet. o Example: When a job is completed, Wallace makes an entry to transfer its total cost to finished goods inventory. Jan 31. Dr. Finished Goods Inventory 39,000 Cr. Work in Process 39,000 o Example: On January 31 Wallace Manufacturing sells on account Job 101. The job cost $39,000, and it sold for $50,000. Entries to record the sale and recognize cost of goods sold are: Jan. 31. Dr. Accounts Receivable $50,000 Cr. Sales Revenue $50,000 Dr. COGS $39,000 Cr. Finished Goods Inventory $39,000 - Summary of Job Order Cost Flows - Job Order Costing for Service Companies: o While service companies do not have inventory, the techniques of job order costing are still quite useful in many service-industry environments. o Consider, for example, the Mayo Clinic (health care), PricewaterhouseCoopers (accounting), and Goldman Sachs (investment banking). o These companies need to keep track of the cost of jobs performed for specific customers to evaluate the profitability of medical treatments, audits, or investment banking engagements. ▯ Advantages: • More precise in assignment of costs to projects than process costing. • Provides more useful information for determining the profitability of particular projects and for estimating costs when preparing bids on future jobs. ▯ Disadvantages: • Requires a significant amount of data entry. o DO IT! During the current month, Onyx Corporation completed Job 109 and Job 112. Job 109 cost $19,000 and Job 112 costs $27,000. Job 112 was sold on account for $42,000. Journalize the entries for the completion of the two jobs and the sale of Job 112. - Distinguishing between under and over applied manufacturing overhead: o Shows manufacturing overhead applied rather than actual overhead costs. o Applied overhead is added to direct materials and direct labor to determine total manufacturing costs o A debit balance in manufacturing overhead means that overhead is under-applied. o A credit balance in manufacturing overhead means that overhead is over-applied. o Any Year-End Balance in manufacturing overhead is eliminated by adjusting cost of goods sold. ▯ Under-applied overhead is debited to COGS ▯ Over-applied overhead is credited to COGS o Example: Wallace has a $2,500 credit balance in Manufacturing Overhead at December 31. The adjusting entry for the over-applied overhead is: Jan. 31 Dr. Manufacturing Overhead $2,500 Cr. COGS $2,500 o DO IT! For Karr Company, the predetermined overhead rate is 140% of direct labor cost. During the month, Karr incurred $90,000 of factory labor costs, of which $80,000 is direct labor and $10,000 is indirect labor. Actual overhead incurred was $119,000. Compute the amount of manufacturing overhead applied during the month. Determine the amount of under- or over-applied manufacturing overhead. Chapter 4: - Tradition Costing Systems: o Allocates overhead using a predetermined rate. o Job order costing: direct labor cost may be the relevant activity base. o Process costing: machine hours may be the relevant activity base. o Illustration: Atlas Company produces two abdominal fitness products—the Ab Bench and the Ab Coaster. The direct materials cost per unit is $40 for the Ab Bench and $30 for the Ab Coaster. The direct labor cost is $12 per unit for each product. Both products require one direct labor hour per unit; both products are allocated overhead cost of $30 per unit. - The Need for a New Approach: o Tremendous change in manufacturing and service industries. o Decrease in amount of direct labor usage. o Significant increase in total overhead costs. o Inappropriate to use plantwide predetermined overhead rates when a lack of correlation exists. o Complex manufacturing processes may require multiple allocation bases; this approach is called activity-based costing (ABC). - Activity-Based Costing o An approach for allocating overhead costs. ▯ Allocates overhead to multiple activity cost pools. ▯ Assigns the activity cost pools to products or services by means of cost drivers. - Four Steps of Activity-Based Costing: o 1. Identify and classify the activities involved in the manufacture of specific products and assign overhead to cost pools. ▯ Overhead costs are assigned directly to the appropriate activity cost pool. o 2. Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool. ▯ Cost driver must accurately measure the actual consumption of the activity by the various products. o 3. Compute the activity-based overhead rate for each cost pool. ▯ Next, the company computes an activity-based overhead rate per cost driver. o 4. Allocate overhead cost to products using the overhead rates determined for each cost pool. ▯ In allocating overhead costs, it is necessary to know the expected use of cost drivers for each product. Because of its low volume and higher number of components, the Ab Coaster requires more setups and purchase orders than the Ab Bench. - Activity-Based Costing Cont.: o ABC allocates overhead in a two-stage process: ▯ Stage 1: Overhead costs are assigned to activity cost pools (Step 1). ▯ Stage 2: Allocates overhead assigned to the activity cost pools to products, using cost drivers (Steps 2-4). • The more complex a product’s manufacturing operation, the more activities and cost drivers are likely to be present. - DO IT! Indicate if the following are TRUE or FALSE: o 1. A traditional costing system allocates overhead by means of multiple overhead rates. false o 2. Activity-based costing allocates overhead costs in a two-stage process. true o 3. Direct material and direct labor costs are easier to trace to products than overhead. true o 4. As manufacturing processes have become more automated, more companies have chosen to allocate overhead on the basis of direct labor costs. false o 5. In activity-based costing, an activity is any event, action, transaction, or work sequence that incurs cost when producing a product. true - Comparing Unit Costs: o Likely consequence of differences in assigning overhead. ▯ Overpricing the Ab Bench and possibly losing market share to competitors. ▯ Sacrificing profitability by under-pricing the Ab Coaster. - DO IT! Casey Company has five activity cost pools and two products. It expects to produce 200,000 units of its automobile scissors jack and 80,000 units of its truck hydraulic jack. Having identified its activity cost pools and the cost drivers for each cost pool, Casey Company accumulated the following data relative to those activity cost pools and cost drivers. Using the data below,1.) prepare a schedule showing the computations of the activity-based overhead rates per cost driver, 2.) prepare a schedule assigning each activity’s overhead cost to the two products. 1. 2. o ABC has three primary benefits: ▯ 1.) More cost pools, therefore more accurate product costing. ▯ 2.) Enhanced control over overhead costs. ▯ 3.) Better management decisions. - The Advantage of Multiple Cost Pools: o Multiple cost pools: ▯ Used instead of one plantwide pool and a single cost driver. ▯ Numerous activity cost pools with more relevant cost drivers. • Costs allocated on basis of cost drivers used to produce each product. o Classification of activity levels: ▯ Unit Level • Performed for each unit of production. • Example: Assembly of cell phones ▯ Batch Level • Performed every time a company produces another batch of a product. • Example: Batch of ice cream ▯ Product Level • Performed every time a company produces a new type of product. • Example: Time spent testing a new drug by a pharmaceutical company. ▯ Facility Level • Required to support or sustain an entire production process. • Example: A hospital - The Advancement of Enhanced Cost Control: o Value Added Activities: Increase the perceived value of a product or service to costumers, such as: ▯ Manufacturing Company: Engineering design, Machining services, Assembly, Painting ▯ Service Company: Performing surgery, Legal research, Delivering packages o Non Value Added Activities: Adds cost to, or increases the time spent on, a product/ service without increasing its perceived value, such as: ▯ Manufacturing Company: Storage of inventory, Moving of inventory, Inspections, Fixing defective goods, set up machines ▯ Service Company: Taking appointments, Reception, Bookkeeping and billing, Traveling, Ordering supplies, Advertising - Advantage of Better Management Decisions: o Activity-based management (ABM), a management tool that focuses on reducing costs and improving processes and decision- making. o Managers use ABC via ABM: for both strategic and operational decisions or perspectives, to help managers evaluate employees, departments, and business units, and to establish performance standards, as well as benchmark against other companies. - Limitations and Knowing When to Use ABC: o Limitations: ▯ Expensive to use ▯ Arbitrary allocations remain o When to use: ▯ Product lines differ in volume and manufacturing complexity. ▯ Product lines are numerous and diverse. ▯ Overhead costs constitute a significant portion of total costs. ▯ Manufacturing process or the number of products has changed significantly. ▯ Production or marketing managers are ignoring data. - DO IT! Classify Activity Levels: Morgan Toy Company manufactures six primary product lines in its Morganville plant. As a result of an activity analysis, the accounting department has identified eight activity cost pools. Each of the toy products is produced in large batches, with the whole plant devoted to one product at a time. Classify each of the following activities as either unit-level, batch-level, product-level, or facility- level: o a. Engineering design o b. Machine setup o c. Toy design o d. Interviews of prospective employees o e. Inspections after each setup o f. Polishing parts o g. Assembling parts o h. Health and safety - Apply Activity-Based Costing to Service Industries: o Overall objective: Identify key activities that generate costs and keep track of how many of those activities are completed for each service performed. ▯ General approach is to identify activities, cost pools, and cost drivers. ▯ Labeling of activities as value-added or non-value-added. ▯ Sometimes, a larger proportion of overhead costs are company-wide costs that cannot be directly traced to specific services provided by the company. - Traditional Costing Example: o The public accounting firm of Check and Doublecheck prepares the following condensed annual budget. o Assume that Check and Doublecheck records $140,000 of actual direct professional labor cost during its audit of Plano Molding Company, which was billed an audit fee of $260,000. Under traditional costing, using 50% as the rate for applying overhead to the job, Check and Doublecheck would compute applied overhead and operating income as shown in Illustration 4-16. - Activity Based Costing Example: o Check and Doublecheck distributes its estimated annual overhead costs of $600,000 to three activity cost pools. o Assigning overhead in a service industry: o Under activity-based costing, Check and Doublecheck assigns overhead costs of $57,200 as compared to $70,000 under traditional costing. - Appendix 4A: Explain Just in Time (JIT) Processing: o JIT manufacturing is dedicated to having the right amount of materials, parts, or products just as they are needed. o Objectives of JIT Processing: ▯ To eliminate all manufacturing inventories. o Elements of JIT Processing: ▯ Dependable suppliers. ▯ Multi-skilled work force. ▯ Total quality control system. o Benefits of JIT Processing: ▯ Significant reduction or elimination of manufacturing inventories. ▯ Enhanced product quality. ▯ Reduction or elimination of rework costs and inventory storage costs. ▯ Production cost savings from the improved flow of goods through the processes. Chapter 5: - Cost Behavior Analysis is the study of how specific costs respond to changes in the level of business activity. o Some costs change; others remain the same. o Helps management plan operations and decide between alternative courses of action. o Applies to all types of businesses and entities. o Starting point is measuring key business activities. o Activity levels may be expressed in terms of: ▯ Sales dollars (in a retail company) ▯ Miles driven (in a trucking company) ▯ Room occupancy (in a hotel) ▯ Dance classes taught (by a dance studio) o Many companies use more than one measurement base. o Changes in the level or volume of activity should be correlated with changes in costs. o Activity level selected is called activity or volume index. ▯ Identifies the activity that causes changes in the behavior of costs. ▯ Allows costs to be classified as variable, fixed, or mixed. - Variable Costs: o Costs that vary in total directly and proportionately with changes in the activity level. ▯ Example: If the activity level increases 10 percent, total variable costs increase 10 percent. ▯ Example: If the activity level decreases by 25 percent, total variable costs decrease by 25 percent. o Variable costs remain the same per unit at every level of activity. o Illustration: Damon Company manufactures tablet computers that contain a $10 camera. The activity index is the number of tablets produced. As Damon manufactures each tablet, the total cost of the cameras used increases by $10. As part (b) of Illustration 5-1 shows, the unit cost of $10 for the camera is the same whether Damon produces 2,000 or 10,000 tablets. - Fixed Costs: o Costs that remain the same in total regardless of changes in the activity level within a relevant range. o Fixed cost per unit varies inversely with activity: As volume increases, unit cost declines, and vice versa o Examples: ▯ Property taxes ▯ Insurance ▯ Rent ▯ Depreciation on buildings and equipment o Illustration: Damon Company leases its productive facilities at a cost of $10,000 per month. Total fixed costs of the facilities will remain constant at every level of activity, as part (a) of Illustration 5- 2 shows. - Relevant Range: o Throughout the range of possible levels of activity, a straight- line relationship usually does not exist for either variable costs or fixed costs. o Relationship between variable costs and changes in activity level is often curvilinear. o For fixed costs, the relationship is also nonlinear – some fixed costs will not change over the entire range of activities, while other fixed costs may change. ▯ Range of activity over which a company expects to operate during a year. - Mixed Costs: o Costs that have both a variable element and a fixed element. o Change in total but not proportionately with changes in activity level. - High Low Method: o High-Low Method uses the total costs incurred at the high and the low levels of activity to classify mixed costs into fixed and variable components. o The difference in costs between the high and low levels represents variable costs, since only variable-cost element can change as activity levels change. ▯ Step 1: Determine variable cost per unit. • (Change in Costs)/ (High minus Low) = (variable cost per unit) • $63,000-$30,000/50,000-20,000= $33,000/30,000= $1.10 per mile ▯ STEP 2: Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level. ▯ Maintenance costs are therefore $8,000 per month of fixed costs plus $1.10 per mile of variable costs. This is represented by the following formula: • Maintenance costs = $8,000 + ($1.10 x Miles driven) • Example: At 45,000 miles, estimated maintenance costs would be: o DO IT! High Low Method: Byrnes Company accumulates the following data concerning a mixed cost, using units produced as the activity level. ▯ (a) Compute the variable- and fixed-cost elements using the high-low method. • Variable: $14,740-$11,100/9,000-7,000= $3,640/2,800= $1.30 per unit • Fixed: $11,100-($1.30 x 7,000)= %11,100-9,100= $2,000 ▯ (b) Estimate the total cost if the company produces 8,000 units. • $2,000+$1.30 x 8,000)= $2,000+$10,400= $12,400 - Cost Volume Profit (CVP) Analysis: o The study of the effects of changes in costs and volume on a company’s profits. o Important in profit planning. o Critical factor in management decisions as ▯ Setting selling prices, ▯ Determining product mix, and ▯ Maximizing use of production facilities. o Basic Components: ▯ Behavior of both costs and revenues is linear throughout the relevant range of the activity index. ▯ Costs can be classified accurately as either variable or fixed. ▯ Changes in activity are the only factors that affect costs. ▯ All units produced are sold. ▯ When more than one type of product is sold, the sales mix will remain constant. o CVP Income Statement: ▯ A statement for internal use. ▯ Classifies costs and expenses as fixed or variable. ▯ Reports contribution margin in the body of the statement. • Contribution margin – amount of revenue remaining after deducting variable costs. ▯ Reports the same net income as a traditional income statement. o Unit Contribution Margin: ▯ Contribution margin is available to cover fixed costs and to contribute to income. ▯ Formula for contribution margin per unit and the computation for Vargo Video are: ▯ Vargo’s CVP income statement assuming a zero net income. ▯ Assume that Vargo sold one more camcorder, for a total of 1,001 camcorders sold. o Contribution Margin Ratio: ▯ Shows the percentage of each sales dollar available to apply toward fixed costs and profits. ▯ Formula for contribution margin ratio and the computation for Vargo Video are: ▯ Assume Vargo Video’s current sales are $500,000 and it wants to know the effect of a $100,000 (200-unit) increase in sales. o DO IT! Ampco Industries produces and sells a cell phone-operated thermostat. Information regarding the costs and sales of thermostats during September 2017 are provided below. Unit selling price of thermostat $85 Unit variable costs $32 Total monthly fixed costs $190,000 Units sold 4,000 Prepare a CVP income statement for Ampco Industries for the month of September. Provide per unit values and total values: - Break-Even Analysis: o Process of finding the break-even point level of activity at which total revenues equal total costs (both fixed and variable). o Can be computed or derived ▯ From a mathematical equation, ▯ By using contribution margin, or ▯ From a cost-volume profit (CVP) graph. o Expressed either in sales units or in sales dollars. o Mathematical Equation: Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero. o Contribution Margin Technique: ▯ At the break-even point, contribution margin must equal total fixed costs (CM = total revenues – variable costs) ▯ Break-even point can be computed using either contribution margin per unit or contribution margin ratio. o Contribution Margin in Units: ▯ When the break-even-point in units is desired, contribution margin per unit is used in the following formula which shows the computation for Vargo Video: o Contribution Margin Ratio: ▯ When the break-even-point in dollars is desired, contribution margin ratio is used in the following formula which shows the computation for Vargo Video: ▯ o DO IT! Lombardi Company has a unit-selling price of $400, variable costs per unit of $240, and fixed costs of $180,000. Compute the break-even point in units using (a) a mathematical equation and (b) contribution margin per unit. ▯ (a) ▯ (b) - Target New Income: o Level of sales necessary to achieve a specified income. o Can be determined from each of the approaches used to determine break-even sales/units: ▯ ►from a mathematical equation, ▯ ►by using contribution margin technique, or ▯ ►from a cost-volume profit (CVP) graph. o Expressed either in sales units or in sales dollars. o Mathematical Equation: ▯ Using the formula for the break-even point, simply include the desired net income as a factor. o Contribution Margin Technique: ▯ To determine the required sales in units for Vargo Video: ▯ To determine the required sales in dollars for Vargo Video: - Margin of Safety: o Difference between actual or expected sales and sales at the breakeven point. o Measures the “cushion” that a particular level of sales provides. o May be expressed in dollars or as a percentage of sales. o Assuming actual/expected sales are $750,000: o Computed by dividing the margin of safety in dollars by the actual (or expected) sales. o Assuming actual/expected sales are $750,000: o The higher the dollars or percentage, the greater the margin of safety. o DO IT! Zootsuit Inc. makes travel bags that sell for $56 each. For the coming year, management expects fixed costs to total $320,000 and variable costs to be $42 per unit. Compute the following: ▯ (a.) Compute break-even point in dollars using the contribution margin (CM) ratio: ▯ (b.) Compute the margin of safety and margin of safety ratio assuming actual sales are $1,382,400:
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