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UT / Accounting / AIM 200 / What is the difference between manufacturing businesses and merchandis

What is the difference between manufacturing businesses and merchandis

What is the difference between manufacturing businesses and merchandis

Description

School: University of Tennessee - Knoxville
Department: Accounting
Course: Foundations of Accounting
Professor: Ellen anderson
Term: Spring 2016
Tags: Accounting
Cost: 50
Name: Acc 200, Exam 3 Study Guide
Description: This study guide covers everything that will be on our next and final exam
Uploaded: 05/01/2016
26 Pages 66 Views 4 Unlocks
Reviews


ACCOUNTING 200 EXAM 3 STUDY GUIDE  


What is the difference between manufacturing businesses and merchandising businesses?



Merchandising Businesses

∙ Both buyers and sellers of goods

∙ Buy from manufacturers

∙ Sell to consumers

∙ 3 types of expenses

 #1 expense

∙ Buying and selling of goods

o This is what merchandisers do for a living

o When buying, cost of purchase is recorded  

on balance sheet as the current asset  

Inventory until sold

o When selling, cost of good sold is removed  

from Inventory and recorded on income  

statement as expense

 #2 expense

∙ Selling expense and administrative expense


How do manufacturers accumulate product costs?



 #3 expense

∙ Other income and other expenses

o Other income

 Interest revenue

 Rent revenue

o Other expense

 Sales tax expense

 Interest expense

∙ Multi-step income statement separates expenses

∙ First part

 Revenue

∙ 3 steps

o Sales (gross sales)

o Sales returns and allowances

 Contra revenue, subtracted

o Sales discounts

 Contra revenue, subtracted

∙ Second part

 Expenses

∙ Cost of goods/merchandise sold expense


What are the two methods of budgeting?



o #1 expense

∙ Selling and administrative expenses If you want to learn more check out Give an example of error.

o #2 expense

 Selling expenses

∙ Store utilities, rent, salaries, etc.

 Administrative expenses

∙ Office

∙ Third part

 Others

∙ Don’t have to do with normal operations of  

business

∙ Other income

o Rent

o Interest if business loaned money to  

someone

∙ Other expense

o #3 expense

o Income taxes

o Interest if business borrows

∙ 12 step process

1. Add Sales

2. Subtract Sales Returns & Allowances

3. Subtract Sales Discounts

4. equals Net Sales

5. subtract Cost of Merchandise Sold expense

6. equals Gross Profit

7. subtract Selling Expense

8. subtract Administrative Expense

9. equals Income from Operating Activities

10.add Other Income

11.subtract Other Expense

12.equals Net Income

∙ Gross profit percentage

o Gross profit divided by net sales

 Profit per dollar of sales Don't forget about the age old question of How was the interstate highway system paid for?

∙ Net income percentage

o Net income divided by net sales

 Often around 3%

 Gets split between retained earnings and dividends

 Sometimes called margin

∙ Businesses are usually run on very thin margins

∙ Returns and Allowances

o Sales returns and allowances

 Contra revenue that reduces sales revenue of the seller  for the period

∙ Seller receives the return and puts it back in  

inventory

∙ Up on sales returns and allowances, down on cost  

of goods sold

o Purchase returns and allowances

 Reduce buyer’s cost of inventory

∙ Down on inventory

o Journal Entry If you want to learn more check out Why reflect meaning?

 Seller

∙ Reverse the sale

o Down accounts receivable

o Up Sales Returns and Allowances

o Up Merchandise Inventory

o Down Cost of Merchandise Sold Expense

 Buyer

∙ Down accounts payable

∙ Down merchandise inventory

∙ Discounts

o Seller

 Gives discount

∙ Increases Discounts

o Contra revenue

o Decreases revenue

o Buyer

 Receives discount

∙ Reduces cost of merchandise inventory

o Decreases merchandise inventory

o Typical discount terms

 Written into purchase-sale contract

 2/10, n/30

∙ 2% off price of goods if payment is made within 10  

days, otherwise whole amount is due within 30  

days

 n/30

∙ no discount, full amount is due within 30 days

 The seller sets the discount, and they can decide on  We also discuss several other topics like What is the technique used in saint dorothy?

whatever terms they want

∙ Seller can’t record anything about the discount until

the buyer either pays or passes it up

o Discount still applies if paid on the final day  

of the discount period

o Discounts are off PRICE of goods

 Never includes freight

 If there is a return and the buyer pays within discount  period, discount is calculated based on cost of unreturned goods

∙ If discount is 3% and $10000 of goods are shipped,

but then $2000 are returned, discount will be 3% of

$8000

∙ Freight cost

o Cost of transportation (shipping) of goods

o 2 kinds

 FOB shipping point

∙ Buyer owns goods during transit

o From the minute they leave the seller’s dock,

the buyer owns them

o Buyer pays shipping cost Don't forget about the age old question of What are the verbal and nonverbal cues which helped you make your inference?
Don't forget about the age old question of At which age do infants start showing gains in attention?

 Up Merchandise Inventory

 FOB destination

∙ Seller owns goods during transit

o Up until the minutes goods are dropped off  

at the buyer’s dock, the seller still owns  

them

o Seller pays shipping cost

 Up Transportation Out Expense

∙ Selling Expense (#2 operating  

expense)

o Common for sellers to prepay freight costs even when it falls on  buyer because freight companies often demand payment before  transport

o Journal entry

 Seller

∙ Down cash

∙ Up transportation out expense

o #2 operating expense

∙ Receipt of Payment

o Journal entries

 Seller

∙ Up cash

∙ Down accounts receivable

∙ Up Sales Discounts if within discount period

 Buyer

∙ Down cash

∙ Down accounts payable

∙ Down merchandise inventory if within discount  

period

Business Activity Differences

∙ Differences between manufacturing businesses and merchandising  businesses

o Balance sheet

 Merchandising businesses report only one kind of  

inventory because all products are actually finished when  

they have them

 Manufacturers have 3 types of inventory

∙ Raw Materials Inventory

o Just materials

o Production has not begun yet

∙ Work in Process Inventory

o Production has begun but has not yet  

finished

 Began before the period ended but did

not get completed in time

∙ Finished Goods Inventory

o Goods that have been completed

o Biggest difference between merchandisers and manufacturers is how expenditures are classified

 2 ways  

∙ Asset on the balance sheet

o Product costs

 3 kinds

∙ Direct Materials Cost

∙ Direct Labor Cost

o Can be people or  

machines

∙ Factory Overhead Cost

o Everything takes  

overhead and labor to  

create

∙ Expense on the income statement

o Period costs

 Product Costs

∙ Combination of Direct Materials Cost, Direct Labor  Cost, and Factory Overhead Cost

o Equals Total Manufacturing Cost

∙ Will be on Balance Sheet as current asset until  

products are sold

o Becomes Cost of Goods Sold Expense once  

sold

 #1 expense

∙ 3 sections

o Direct Materials

 Big

 Cost of materials that are

∙ Significant portion of total cost

∙ Easily traced to final product

∙ Integral to product

o Only the stuff you really  

need to make the  

ACTUAL product, like  

wood for a desk

o Direct Labor

 Big

 Cost of labor that is  

∙ Significant portion of total cost

∙ Easily traced to final product

∙ Integral to product

o Making of actual product

 Wages of  

production line  

employees

o Factory Overhead

 3 parts

∙ Indirect Materials

o Small but necessary

o Not significant portion of  

total cost

o Not easily traced to final  

product

∙ Indirect labor

o Not significant portion of  

total cost

o Not easily traceable to  

final product

 E.g. guy sweeping  

sawdust at factory

∙ Other costs of operating factory

o Utilities, rent,  

depreciation, insurance,  

supplies, taxes

 Only on stuff within

the factory

o Research and  

development costs are  

product costs

∙ The word “factory” is automatically indicative of a  

product cost

 Period Costs

∙ Selling expense and administrative expense

o #2 operating expense

∙ The word “office” is automatically indicative of a  

period cost

o How do manufacturers accumulate product costs

 Why

∙ To help set a price that will generate profit

∙ To evaluate profitability

o Control operations

 Compare actual costs by departments  

or processes with budgeted costs’

∙ To develop financial statements

o Cost of ending inventory on Balance Sheet

o Cost of Goods Sold on Income Statement

∙ Manufacturing (Product) Cost Flow

o Inside business

 Asset on Balance Sheet

∙ Warehouse

o When materials are purchased

∙ Production Floor

o When work has begun on product

∙ Showroom

o When product is complete

o Outside of business

 #1 expense on income statement

∙ No longer here

o When product is sold

∙ Inventories

o Raw Materials Inventory

 Increases when you buy original materials

 Decreases when materials are issued to production

 Beginning balance + purchases + issuances = ending  balance

o Work in Process Inventory

 Start creating goods

 Materials have been issued to production and transferred  to WIP inventory

∙ Journal entry

o Up WIP Inventory (direct materials)

o Up Factory Overhead (Indirect Materials)

o Down Raw Materials Inventory

 Cost of labor

∙ Journal entry

o Up WIP Inventory (direct labor)

o Up Factory Overhead (Indirect Labor)

o Up Wages Payable

 Cost of Other Factory Overhead

∙ Journal entry

o Up Factory Overhead (other)

o Up expenses

o Up accounts payable

 Application of Factory Overhead

∙ Applied means “sent costs to production”

o Journal entry

 Up WIP Inventory

 Down Factory Overhead

∙ Factory Overhead always has a  

balance of 0 at the beginning  

and end of the period

o It only exists to gather  

indirect material, indirect  

labor, and other costs

o Finished Goods Inventory

 When work is completed

∙ Journal entry

o Up Finished Goods Inventory

o Down WIP Inventory

 Cost of Goods Manufactured

∙ Makes WIP inventory go down

∙ “Transferred from WIP to  

Finished Goods”

 WIP inventory can have a beginning  

balance

∙ Will be whatever job/s didn’t get

finished

 When goods are sold

∙ Every manufacturer becomes a merchandiser when

they sell junk

o Journal entry

 Up Sales Revenue

 Up Accounts Receivable

 Up Cost of Goods Sold expense

 Down Finished Goods Inventory

∙ Product Cost Flow relationship

o Sequential order of costs

 Income statement and inventory balance

 Raw Materials Inventory

∙ Beginning balance

∙ + purchases

∙ - issuances

∙ = ending balance

 WIP Inventory

∙ Beginning balance

∙ + Total Manufacturing Costs

o Direct Materials

o + Direct Labor

o + Factory Overhead

∙ - Cost of Goods Manufactured

∙ = ending balance

 Finished Goods Inventory

∙ Beginning balance

∙ + Cost of Goods Manufactured

∙ - Cost of Goods Sold

∙ = ending balance

 Expense on Income Statement

∙ - Cost of Goods Sold

o Ending balances for inventories are just things that haven’t  moved yet

∙ Job Order Cost Systems

o Accumulate product costs in total AND by job

 Individual product & product type

 Needs to be done this way

∙ Splits up costs by job so you can get an accurate  

cost per unit and decide on a profitable selling price

Budgeting

∙ Budget

o Financial plan written in advance of operation period

 Game plan for what we’re going to do

o Master budget

 Plan for all facets of operation

∙ Budgeted income statement, budgeted balance  

sheet, etc.

o Continuous budgeting

 Budget projected 12 months into the future at all times ∙ When current month finishes, we add on another  

month to the end of the budget

o After May of this year is over, we create the  

budget for May of next year

o Budget formats

 There are 2

∙ Static

o Budget for only one activity level

 Probably stupid

o One size fits all

o Ineffective when actual level of activity is  

different from budgeted level of activity

∙ Flexible

o Side-by-side comparative budgets for  

multiple activity levels

 Smarter

o Budget for actual units produced

o Flex budget by applying costs to actual hours

o 3 objectives of Budgeting

 Planning

∙ Write budget BEFORE year begins

∙ Takes the longest because everybody has to agree

 Directing

∙ Execute budget DURING the year

 Controlling

∙ Observe deviation from the budget at the END of  

the year

o Variance

∙ 2 methods of budgeting

o Incremental budgeting

 Stupid

 Budgets based on revenue and expense levels of past  periods with projected increases

∙ Never think they can do with less money than they  

had in past periods

 Fosters budgetary slack

∙ Fosters overspending

o Excess funds at the end that we need to  

either spend or lose

o Zero-based budgeting

 Start with $0 in the budget

 New figures every period

∙ Managers must justify all budget requests

o Last period’s funds are not a given

∙ Variance

o Difference between actual and standard costs

 Standard

∙ Budgeted, planned, expected, etc.

∙ What the company thought they were going to pay  

for things

o Standard price

 Amount company planned to pay to  

produce product

o Standard quantity

 Amount of materials, etc. company  

planned to use

o Standard cost

 Standard price multiplied by standard  

quantity

 Actual

∙ What the company actually did end up using

o As opposed to what they planned for

o Budget performance report

 Actual Cost – Standard Cost = Variance

∙ 2 types of variance

o Favorable

 Under budget

 When number is negative

o Unfavorable

 Over budget

∙ We paid too much

 When number is positive

o Both are bad

o Price Variance and Quantity Variance

 Material cost variance

∙ Price Variance

o (Actual Price – Standard Price) x Actual  

Quantity

∙ Quantity Variance

o (Actual Quantity – Standard Quantity) x  

Standard Price

∙ Amounts must be turned into dollars

o Off budget is off budget

 Labor Cost Variance

∙ Rate Variance

o (Actual Rate – Standard Rate) x Actual Time

∙ Time Variance

o (Actual Time – Standard Time) x Standard  

Rate

 When multiplying by price outside of parentheses, use  standard

 When multiplying by quantity outside of parentheses, use  actual

Cost Behavior & Sales-cost-volume-profit analysis

∙ Sales-Cost-Volume-Profit Analysis

o Sales

 Selling price per unit

o Cost

 Total cost per unit

o Volume

 Number of units

o Profit

 FAT STACK$

∙ Cost behavior

o How a cost changes when business activity (volume)  changes over relevant range

 Relevant range

∙ Normal range for number of units produced  

and sold

o 3 types of costs

 Variable cost

∙ Constant cost per unit

∙ Total cost increases as volume increases and  

decreases as volume decreases

 Fixed cost

∙ Constant total cost

∙ Cost per unit will decrease as volume  

increases and increase as volume decreases

 Mixed cost

∙ Neither total cost nor per unit cost is  

constant

∙ Contains part fixed cost and part variable  

cost

∙ Have to be split into separate parts to be  

able to create a cost formula and predict  

costs

o High-low method

 Find variable cost first

 Variable cost per unit = (highest

total cost – lowest total cost)/

(highest volume – lowest  

volume)

 Total cost = (Variable Cost per  

Unit x Number of Units) – Fixed  

Cost

∙ Contribution Income Statement

o Traditional income statements are required by GAAP  These don’t help with predicting future costs at all ∙ We need the contribution income statement  

to do that

o Sales Revenue – Variable Costs =  

Contribution Margin

o Contribution Margin – Fixed Costs =  

Income from Operations

 Fixed costs

∙ Unchangeable lump

o Important Ratios

 Contribution Margin Ratio

∙ Divide Contribution Margin by Total Sales to  

get Contribution Margin Ratio

o Number of cents each dollar of sales  

contributes to profit

 Unit Contribution Margin

∙ Divide total sales by number of units, then  

subtract cost of production for 1 unit to get  

Unit Contribution Margin

o Amount of profit garnered from the  

sale of one unit

 Helps managers predict future costs, revenues, and profits

∙ CM ratio x Change in Sales = Change in  

Profits

∙ Unit CM x Change in Units = Change in  

Profits

 Break-even point

∙ Number of units business must sell for profit  

to equal 0

o Total revenue = total expenses

o Contribution margin = fixed costs

o Calculation

 (Total Fixed Costs)/(Unit CM) =  

Break-even number of units

∙ Helps managers plan for future

o Margin of safety

 How far sales can fall before we  

start losing money

∙ Current Units – Break

even Units

o Bottom Line

 How far can selling price per  

unit fall before we start losing  

money?

∙ 4 things to do to improve  

bottom line

o Sell more

o Increase price

o Decrease variable  

cost

o Decrease fixed  

cost

 Target Profit

∙ Number of units business must sell to garner  a specific profit

o Exactly like break-even, but target  

profit in break-even is 0

o Calculation

 (Total Fixed Costs + Target  

Profit)/Unit CM = Target Profit  

Units

 Sales Mix

∙ For companies and businesses that sell more than 1 product

o Most of them do

∙ Break-even point is slightly different

o Formula is the same, but if you have  

more than one fixed cost, there is  

more than one Unit CM

o You have to construct a weighted CM

 Multiply the percentage of total  

sales each product makes up by

its Unit CM and add those up  

together to get the weighted  

unit CM

 Break-even units = (Total Fixed  

Costs)/Weighted Unit CM

 To find the number of units of  

each product that must be sold,  

multiply percentage of total  

sales each product makes up by

the calculated number of units

ACCOUNTING 200 EXAM 3 STUDY GUIDE  

Merchandising Businesses

∙ Both buyers and sellers of goods

∙ Buy from manufacturers

∙ Sell to consumers

∙ 3 types of expenses

 #1 expense

∙ Buying and selling of goods

o This is what merchandisers do for a living

o When buying, cost of purchase is recorded  

on balance sheet as the current asset  

Inventory until sold

o When selling, cost of good sold is removed  

from Inventory and recorded on income  

statement as expense

 #2 expense

∙ Selling expense and administrative expense

 #3 expense

∙ Other income and other expenses

o Other income

 Interest revenue

 Rent revenue

o Other expense

 Sales tax expense

 Interest expense

∙ Multi-step income statement separates expenses

∙ First part

 Revenue

∙ 3 steps

o Sales (gross sales)

o Sales returns and allowances

 Contra revenue, subtracted

o Sales discounts

 Contra revenue, subtracted

∙ Second part

 Expenses

∙ Cost of goods/merchandise sold expense

o #1 expense

∙ Selling and administrative expenses

o #2 expense

 Selling expenses

∙ Store utilities, rent, salaries, etc.

 Administrative expenses

∙ Office

∙ Third part

 Others

∙ Don’t have to do with normal operations of  

business

∙ Other income

o Rent

o Interest if business loaned money to  

someone

∙ Other expense

o #3 expense

o Income taxes

o Interest if business borrows

∙ 12 step process

1. Add Sales

2. Subtract Sales Returns & Allowances

3. Subtract Sales Discounts

4. equals Net Sales

5. subtract Cost of Merchandise Sold expense

6. equals Gross Profit

7. subtract Selling Expense

8. subtract Administrative Expense

9. equals Income from Operating Activities

10.add Other Income

11.subtract Other Expense

12.equals Net Income

∙ Gross profit percentage

o Gross profit divided by net sales

 Profit per dollar of sales

∙ Net income percentage

o Net income divided by net sales

 Often around 3%

 Gets split between retained earnings and dividends

 Sometimes called margin

∙ Businesses are usually run on very thin margins

∙ Returns and Allowances

o Sales returns and allowances

 Contra revenue that reduces sales revenue of the seller  for the period

∙ Seller receives the return and puts it back in  

inventory

∙ Up on sales returns and allowances, down on cost  

of goods sold

o Purchase returns and allowances

 Reduce buyer’s cost of inventory

∙ Down on inventory

o Journal Entry

 Seller

∙ Reverse the sale

o Down accounts receivable

o Up Sales Returns and Allowances

o Up Merchandise Inventory

o Down Cost of Merchandise Sold Expense

 Buyer

∙ Down accounts payable

∙ Down merchandise inventory

∙ Discounts

o Seller

 Gives discount

∙ Increases Discounts

o Contra revenue

o Decreases revenue

o Buyer

 Receives discount

∙ Reduces cost of merchandise inventory

o Decreases merchandise inventory

o Typical discount terms

 Written into purchase-sale contract

 2/10, n/30

∙ 2% off price of goods if payment is made within 10  

days, otherwise whole amount is due within 30  

days

 n/30

∙ no discount, full amount is due within 30 days

 The seller sets the discount, and they can decide on  

whatever terms they want

∙ Seller can’t record anything about the discount until

the buyer either pays or passes it up

o Discount still applies if paid on the final day  

of the discount period

o Discounts are off PRICE of goods

 Never includes freight

 If there is a return and the buyer pays within discount  period, discount is calculated based on cost of unreturned goods

∙ If discount is 3% and $10000 of goods are shipped,

but then $2000 are returned, discount will be 3% of

$8000

∙ Freight cost

o Cost of transportation (shipping) of goods

o 2 kinds

 FOB shipping point

∙ Buyer owns goods during transit

o From the minute they leave the seller’s dock,

the buyer owns them

o Buyer pays shipping cost

 Up Merchandise Inventory

 FOB destination

∙ Seller owns goods during transit

o Up until the minutes goods are dropped off  

at the buyer’s dock, the seller still owns  

them

o Seller pays shipping cost

 Up Transportation Out Expense

∙ Selling Expense (#2 operating  

expense)

o Common for sellers to prepay freight costs even when it falls on  buyer because freight companies often demand payment before  transport

o Journal entry

 Seller

∙ Down cash

∙ Up transportation out expense

o #2 operating expense

∙ Receipt of Payment

o Journal entries

 Seller

∙ Up cash

∙ Down accounts receivable

∙ Up Sales Discounts if within discount period

 Buyer

∙ Down cash

∙ Down accounts payable

∙ Down merchandise inventory if within discount  

period

Business Activity Differences

∙ Differences between manufacturing businesses and merchandising  businesses

o Balance sheet

 Merchandising businesses report only one kind of  

inventory because all products are actually finished when  

they have them

 Manufacturers have 3 types of inventory

∙ Raw Materials Inventory

o Just materials

o Production has not begun yet

∙ Work in Process Inventory

o Production has begun but has not yet  

finished

 Began before the period ended but did

not get completed in time

∙ Finished Goods Inventory

o Goods that have been completed

o Biggest difference between merchandisers and manufacturers is how expenditures are classified

 2 ways  

∙ Asset on the balance sheet

o Product costs

 3 kinds

∙ Direct Materials Cost

∙ Direct Labor Cost

o Can be people or  

machines

∙ Factory Overhead Cost

o Everything takes  

overhead and labor to  

create

∙ Expense on the income statement

o Period costs

 Product Costs

∙ Combination of Direct Materials Cost, Direct Labor  Cost, and Factory Overhead Cost

o Equals Total Manufacturing Cost

∙ Will be on Balance Sheet as current asset until  

products are sold

o Becomes Cost of Goods Sold Expense once  

sold

 #1 expense

∙ 3 sections

o Direct Materials

 Big

 Cost of materials that are

∙ Significant portion of total cost

∙ Easily traced to final product

∙ Integral to product

o Only the stuff you really  

need to make the  

ACTUAL product, like  

wood for a desk

o Direct Labor

 Big

 Cost of labor that is  

∙ Significant portion of total cost

∙ Easily traced to final product

∙ Integral to product

o Making of actual product

 Wages of  

production line  

employees

o Factory Overhead

 3 parts

∙ Indirect Materials

o Small but necessary

o Not significant portion of  

total cost

o Not easily traced to final  

product

∙ Indirect labor

o Not significant portion of  

total cost

o Not easily traceable to  

final product

 E.g. guy sweeping  

sawdust at factory

∙ Other costs of operating factory

o Utilities, rent,  

depreciation, insurance,  

supplies, taxes

 Only on stuff within

the factory

o Research and  

development costs are  

product costs

∙ The word “factory” is automatically indicative of a  

product cost

 Period Costs

∙ Selling expense and administrative expense

o #2 operating expense

∙ The word “office” is automatically indicative of a  

period cost

o How do manufacturers accumulate product costs

 Why

∙ To help set a price that will generate profit

∙ To evaluate profitability

o Control operations

 Compare actual costs by departments  

or processes with budgeted costs’

∙ To develop financial statements

o Cost of ending inventory on Balance Sheet

o Cost of Goods Sold on Income Statement

∙ Manufacturing (Product) Cost Flow

o Inside business

 Asset on Balance Sheet

∙ Warehouse

o When materials are purchased

∙ Production Floor

o When work has begun on product

∙ Showroom

o When product is complete

o Outside of business

 #1 expense on income statement

∙ No longer here

o When product is sold

∙ Inventories

o Raw Materials Inventory

 Increases when you buy original materials

 Decreases when materials are issued to production

 Beginning balance + purchases + issuances = ending  balance

o Work in Process Inventory

 Start creating goods

 Materials have been issued to production and transferred  to WIP inventory

∙ Journal entry

o Up WIP Inventory (direct materials)

o Up Factory Overhead (Indirect Materials)

o Down Raw Materials Inventory

 Cost of labor

∙ Journal entry

o Up WIP Inventory (direct labor)

o Up Factory Overhead (Indirect Labor)

o Up Wages Payable

 Cost of Other Factory Overhead

∙ Journal entry

o Up Factory Overhead (other)

o Up expenses

o Up accounts payable

 Application of Factory Overhead

∙ Applied means “sent costs to production”

o Journal entry

 Up WIP Inventory

 Down Factory Overhead

∙ Factory Overhead always has a  

balance of 0 at the beginning  

and end of the period

o It only exists to gather  

indirect material, indirect  

labor, and other costs

o Finished Goods Inventory

 When work is completed

∙ Journal entry

o Up Finished Goods Inventory

o Down WIP Inventory

 Cost of Goods Manufactured

∙ Makes WIP inventory go down

∙ “Transferred from WIP to  

Finished Goods”

 WIP inventory can have a beginning  

balance

∙ Will be whatever job/s didn’t get

finished

 When goods are sold

∙ Every manufacturer becomes a merchandiser when

they sell junk

o Journal entry

 Up Sales Revenue

 Up Accounts Receivable

 Up Cost of Goods Sold expense

 Down Finished Goods Inventory

∙ Product Cost Flow relationship

o Sequential order of costs

 Income statement and inventory balance

 Raw Materials Inventory

∙ Beginning balance

∙ + purchases

∙ - issuances

∙ = ending balance

 WIP Inventory

∙ Beginning balance

∙ + Total Manufacturing Costs

o Direct Materials

o + Direct Labor

o + Factory Overhead

∙ - Cost of Goods Manufactured

∙ = ending balance

 Finished Goods Inventory

∙ Beginning balance

∙ + Cost of Goods Manufactured

∙ - Cost of Goods Sold

∙ = ending balance

 Expense on Income Statement

∙ - Cost of Goods Sold

o Ending balances for inventories are just things that haven’t  moved yet

∙ Job Order Cost Systems

o Accumulate product costs in total AND by job

 Individual product & product type

 Needs to be done this way

∙ Splits up costs by job so you can get an accurate  

cost per unit and decide on a profitable selling price

Budgeting

∙ Budget

o Financial plan written in advance of operation period

 Game plan for what we’re going to do

o Master budget

 Plan for all facets of operation

∙ Budgeted income statement, budgeted balance  

sheet, etc.

o Continuous budgeting

 Budget projected 12 months into the future at all times ∙ When current month finishes, we add on another  

month to the end of the budget

o After May of this year is over, we create the  

budget for May of next year

o Budget formats

 There are 2

∙ Static

o Budget for only one activity level

 Probably stupid

o One size fits all

o Ineffective when actual level of activity is  

different from budgeted level of activity

∙ Flexible

o Side-by-side comparative budgets for  

multiple activity levels

 Smarter

o Budget for actual units produced

o Flex budget by applying costs to actual hours

o 3 objectives of Budgeting

 Planning

∙ Write budget BEFORE year begins

∙ Takes the longest because everybody has to agree

 Directing

∙ Execute budget DURING the year

 Controlling

∙ Observe deviation from the budget at the END of  

the year

o Variance

∙ 2 methods of budgeting

o Incremental budgeting

 Stupid

 Budgets based on revenue and expense levels of past  periods with projected increases

∙ Never think they can do with less money than they  

had in past periods

 Fosters budgetary slack

∙ Fosters overspending

o Excess funds at the end that we need to  

either spend or lose

o Zero-based budgeting

 Start with $0 in the budget

 New figures every period

∙ Managers must justify all budget requests

o Last period’s funds are not a given

∙ Variance

o Difference between actual and standard costs

 Standard

∙ Budgeted, planned, expected, etc.

∙ What the company thought they were going to pay  

for things

o Standard price

 Amount company planned to pay to  

produce product

o Standard quantity

 Amount of materials, etc. company  

planned to use

o Standard cost

 Standard price multiplied by standard  

quantity

 Actual

∙ What the company actually did end up using

o As opposed to what they planned for

o Budget performance report

 Actual Cost – Standard Cost = Variance

∙ 2 types of variance

o Favorable

 Under budget

 When number is negative

o Unfavorable

 Over budget

∙ We paid too much

 When number is positive

o Both are bad

o Price Variance and Quantity Variance

 Material cost variance

∙ Price Variance

o (Actual Price – Standard Price) x Actual  

Quantity

∙ Quantity Variance

o (Actual Quantity – Standard Quantity) x  

Standard Price

∙ Amounts must be turned into dollars

o Off budget is off budget

 Labor Cost Variance

∙ Rate Variance

o (Actual Rate – Standard Rate) x Actual Time

∙ Time Variance

o (Actual Time – Standard Time) x Standard  

Rate

 When multiplying by price outside of parentheses, use  standard

 When multiplying by quantity outside of parentheses, use  actual

Cost Behavior & Sales-cost-volume-profit analysis

∙ Sales-Cost-Volume-Profit Analysis

o Sales

 Selling price per unit

o Cost

 Total cost per unit

o Volume

 Number of units

o Profit

 FAT STACK$

∙ Cost behavior

o How a cost changes when business activity (volume)  changes over relevant range

 Relevant range

∙ Normal range for number of units produced  

and sold

o 3 types of costs

 Variable cost

∙ Constant cost per unit

∙ Total cost increases as volume increases and  

decreases as volume decreases

 Fixed cost

∙ Constant total cost

∙ Cost per unit will decrease as volume  

increases and increase as volume decreases

 Mixed cost

∙ Neither total cost nor per unit cost is  

constant

∙ Contains part fixed cost and part variable  

cost

∙ Have to be split into separate parts to be  

able to create a cost formula and predict  

costs

o High-low method

 Find variable cost first

 Variable cost per unit = (highest

total cost – lowest total cost)/

(highest volume – lowest  

volume)

 Total cost = (Variable Cost per  

Unit x Number of Units) – Fixed  

Cost

∙ Contribution Income Statement

o Traditional income statements are required by GAAP  These don’t help with predicting future costs at all ∙ We need the contribution income statement  

to do that

o Sales Revenue – Variable Costs =  

Contribution Margin

o Contribution Margin – Fixed Costs =  

Income from Operations

 Fixed costs

∙ Unchangeable lump

o Important Ratios

 Contribution Margin Ratio

∙ Divide Contribution Margin by Total Sales to  

get Contribution Margin Ratio

o Number of cents each dollar of sales  

contributes to profit

 Unit Contribution Margin

∙ Divide total sales by number of units, then  

subtract cost of production for 1 unit to get  

Unit Contribution Margin

o Amount of profit garnered from the  

sale of one unit

 Helps managers predict future costs, revenues, and profits

∙ CM ratio x Change in Sales = Change in  

Profits

∙ Unit CM x Change in Units = Change in  

Profits

 Break-even point

∙ Number of units business must sell for profit  

to equal 0

o Total revenue = total expenses

o Contribution margin = fixed costs

o Calculation

 (Total Fixed Costs)/(Unit CM) =  

Break-even number of units

∙ Helps managers plan for future

o Margin of safety

 How far sales can fall before we  

start losing money

∙ Current Units – Break

even Units

o Bottom Line

 How far can selling price per  

unit fall before we start losing  

money?

∙ 4 things to do to improve  

bottom line

o Sell more

o Increase price

o Decrease variable  

cost

o Decrease fixed  

cost

 Target Profit

∙ Number of units business must sell to garner  a specific profit

o Exactly like break-even, but target  

profit in break-even is 0

o Calculation

 (Total Fixed Costs + Target  

Profit)/Unit CM = Target Profit  

Units

 Sales Mix

∙ For companies and businesses that sell more than 1 product

o Most of them do

∙ Break-even point is slightly different

o Formula is the same, but if you have  

more than one fixed cost, there is  

more than one Unit CM

o You have to construct a weighted CM

 Multiply the percentage of total  

sales each product makes up by

its Unit CM and add those up  

together to get the weighted  

unit CM

 Break-even units = (Total Fixed  

Costs)/Weighted Unit CM

 To find the number of units of  

each product that must be sold,  

multiply percentage of total  

sales each product makes up by

the calculated number of units

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