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OLEMISS / Accounting / ACCT 202 / which of the following budgets needs to be prepared prior to preparing

which of the following budgets needs to be prepared prior to preparing

which of the following budgets needs to be prepared prior to preparing

Description

School: University of Mississippi
Department: Accounting
Course: Introduction to Accounting Principles II
Professor: Barton
Term: Fall 2016
Tags:
Cost: 50
Name: ACCY202, Exam 3 Study Guide
Description: These notes cover all of chapters 20 (MASTER BUDGETS), 21 (FLEXIBLE BUDGETS & STANDARD COSTS), 22 (PERFORMANCE MEASUREMENT), and 23 (RELEVANT COSTING & DECISION-MAKING). I included notes from the textbook, from my notes, and from the powerpoints in class. I also attempted working the practice problems she gave us. :)
Uploaded: 11/11/2016
23 Pages 8 Views 14 Unlocks
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Chapter 20 – Master Budgets


What is based on a single prediction of sales or production?



ACCY202

EXAM 3  

Chapter 20-23  

• Static (Fixed) Budget – the purpose of a budget is to coordinate the  activities of all departments to meet the company’s overall goal; this  chapter is about fixed budgets, which means they’re based on a single  prediction of sales or production volume

• Types of Budgets/Parts of a Master Budget:

o Operating Budgets – include…

▪ Sales budgets –

• Based on expected sales volume and expected dollars  from these sales (budgeted sales in units x  

SALES  BUDGET


What is the importance of Budgeting?



BUDGETED  SALES


Who are in charge of explaining price variances?



We also discuss several other topics like kevin, marketing manager of the north american bowling league, has decided to televise major bowling competitions to viewers in multiple countries rather than only in canada and the u.s. which of the following goals would this most likely help kevin accom

(IN UNITS)

SELLING  PRICE PER  UNIT Don't forget about the age old question of rhonda brownbill

• This is the first step in preparing the master budget,  because plans from most departments are dependent  on this budget

▪ Production and manufacturing cost budgets – • Applies only to manufacturing companies

• Shows the number of units to be produced in a period  and is based on the unit sales projected in the sales  budget, along with inventory consideration

o Safety stock – a quantity of inventory that  

provides protection against lost sales caused by  unfulfilled demands from customers or delays in  shipments from suppliers

• These budgets NEVER show costs, only units of product

ACCY202

EXAM 3  

Chapter 20-23  

• Production cost budget formula:

Budgeted  Ending  

Inventory  (units of Safety  If you want to learn more check out comm 223

stock)

Budgeted  

Sales Units  for the period  (from the  

sales budget)

Required  units  

needed for  the period

Number of  units in  beginning  inventory Don't forget about the age old question of hhs 231

Total units to  be produced  in the period

▪ Merchandise Purchase Budgets –

• Applies only to merchandising companies

• Expressed in both dollars and units of production o If the formula is expressed in units (and if only one  product is involved) we can compute the number  of dollars of inventory by multiplying the units to  be purchased by the cost per unit

• Merchandise purchase budget formula:

BUDGETED ENDING  MERCHANDISE  

INVENTORY

(next month’s budgeted  sales (units) x Ratio to  Inventory to Future  Sales

BUDGETED  SALES FOR  THE PERIOD

BUDGETED  BEGINNING  MERCHANDISE  INVENTORY Don't forget about the age old question of unr anthropology

MERCHANDISE  INVENTORY  TO BE  

PURCHASED

ACCY202

EXAM 3  

Chapter 20-23  

• Example of a Purchase Budget for a Merchandiser:

COMPANY

PURCHASES BUDGET

     Next Month’s Budgeted Sales (in units)

(given)

x  Ratio of Inventory to Future Sales

(given)

=  Budgeted Ending Inventory (in units)

(Next Month’s Budgeted Sales x Ratio)

+  Budgeted Sales

(given)

=  Required Units of Available Merch

(Budgeted Ending Inventory +  Budgeted Sales)

-   Beginning Inventory (in units)

(given)

=  Units to be Purchased

(Required Units of Available Merch – Beginning Inventory)

▪ Selling expense budgets –

• An estimate of the types and amounts of selling  

expenses expected during the budget period

• Based on the sales budget, plus a fixed amount of sales  

manager salaries  

• Line items on this budget include advertising, delivery  

expenses, and marketing expenses

BUDGETED  SALES

SALES  

COMMISSION  PERCENT

SALES

COMMISSIONS

FIXED SALES  MANAGER  SALARY

TOTAL SELLING  EXPENSES

ACCY202

EXAM 3  

Chapter 20-23  

▪ General and administrative expense budgets –

• Predict the operating expenses not included in the  selling expense budget Don't forget about the age old question of in which region did european values and structures penetrate least during colonialism?

• Line items on this budget include insurance, taxes, and  depreciation on nonmanufacturing assets

o Capital Expenditures Budgets – shows the dollar amounts  estimated to be spent to purchase additional plant assets the  company will use to carry out its budgeted business activities, as  well as any amounts expected to be received from plant asset  disposals, as companies replace old assets with new ones

▪ Important for a company because the content involves large  monetary commitments, affects predicted cash flows, and  impacts future debt and equity financing

o Financial Budgets – include…

▪ Cash Budgets –

• This is prepared after developing budgets for sales,  manufacturing costs, expenses, and capital  

expenditures

• Shows the expected cash inflows (receipts – added) and  outflows (disbursements – deducted) during the budget  period  

• Helps the company maintain a cash balance necessary  to meet ongoing obligations

o If a cash balance is too high, that is undesirable  

because it earns a relatively low (if any) return

• Cash Budget formula:

REPAY LOANS,  

BUY SECURITIES

BEGINNING  

CASH  

BALANCE

BUDGETED  CASH  

RECEIPTS

BUDGETED  CASH  

DISBURSE MENTS

PRELIMINARY  CASH  

BALANCE

(with adequate cash  balance)

INCREASE SHORT  TERM LOANS

(with low cash  

balance)

ACCY202

EXAM 3  

Chapter 20-23  

• Preparing a Cash Budget:

MONTH

      Beginning Cash Balance

(end of last month’s cash balance)

+   Cash receipts from customers

(budgeted sales for current month x % of  sales in cash) + (ending A/R from prior  month if applicable x % of sales on credit)

=   Total Cash Available

(Beg. Cash Bal. + Cash Receipts)

-          Purchases of Merchandise

(prior month purchases x % paid from prior  month purchases) + (current month  purchases x % paid to current month  purchases)  

-          Sales Commissions

(commission % x current month sales)

-          Salaries Expense

(given)

- General & Admin (other)  Expenses

(given)

-            Interest on Bank Loan

(loan interest % (given) x loan payable (given))

=  Total Cash Disbursement

(Purchases of Merch + Sales Commissions +  Salaries Expense + other expenses + Interest on  Bank Loan)

=   Preliminary Cash Balance

(Total Cash Avail. – Total Cash Disburs.)

+      Additional Loan from Bank

(Minimum year-end Cash Balance (given) – Preliminary Cash Balance))

=  Ending Cash Balance

(Preliminary Cash Bal. + Additional Loan)

=   Loan Balance at end of month

(Loan payable (given) + additional loan  from bank (OR) – repayment of loan to  bank)

ACCY202

EXAM 3  

Chapter 20-23  

▪ Budgeted Income Statements –

• A managerial accounting report showing predicted  

amounts of sales and expenses for the budget period

• Summarizes the income effects of the budgeted  

activities

• Comes after the Cash Budgets in the Master Budget

▪ Budgeted Balance Sheets –

• Shows predicted amounts for the company’s assets,  

liabilities, and equity at the end of the budgeted period

• Benefits of Budgeting

o Focuses on the future opportunities and threats to the  organization, making planning an explicit management  

responsibility

o Acts as a monitoring/control system, since management is  required to compare the benchmark operations to the company,  economy, and industrial norms

o Ensures that every department of a company is contributing to  the company’s overall goals

o Effectively communicates specific action plans to all employees o An be used to motivate employees, because it shows attainable  goals; incentives are offered by some companies

• Effects of Budgeting on Human Behavior

o A budget must seem realistic or else employees will be  discouraged, which will lead to a negative impact on performance o Also, pressure to meet budgets can lead employees to engage in  unethical behavior or commit fraud

o However, a well-applied budget can be a positive motivating force  on an organization’s employees

ACCY202

EXAM 3  

Chapter 20-23  

• Timing of Budgets –

o Most companies at least have an annual budget, but many have  monthly/quarterly budgets that allow them to periodically  

evaluate performance and take corrective action

o Continuous Budgeting –

▪ Used by most companies

▪ Means that, when a budget period has lapsed, these  

companies revise their entire set of budgets for the  

months remaining, as well as add new monthly/quarterly  budgets accordingly, (aka, a rolling budget)

CHAPTER 20 – PRACTICE QUESTION!

Dexter Morgan sells knives. His private business must maintain $50,000 cash at  year end, so he has a revolving loan agreement with Miami Metro Bank to borrow  cash when the preliminary cash balance a the end of the month falls below  $50,000, and to repay the loan when the balance exceeds $50,000 to the extent of  either (a) the loan balance, or (b) the amount of excess cash, whichever is smaller.  Cash interest is due to the bank at 1% of the beginning of the month loan balance,  if any. The following information relates to Dexter’s business in the month of May:

o Sales are 30% cash and 70%credit. Credit sales are collected the month  following the sale. April sales were $80,000 and May sales are budgeted at  $125,000.

o Knife inventory is purchased on credit, and credit purchases are paid 85% in  the month of purchase and 15% the month following the purchase. April  purchases were $50,000 and budgeted May purchases are $85,000. o Cash at April 30 was $50,000.

o Loan Payable at April 30 was $135,000.

o Salaries Expense of $18,000 will be paid in May.

o Sales Commissions of 6% of sales will be paid in May.  

o Other cash expenses in the amount of $1,800 will be paid in May.  Prepare the cash budget for Dexter Morgan as of May 31.

ACCY202

EXAM 3  

Chapter 20-23

DEXTER MORGAN

CASH BUDGET

May

Beginning Cash Balance

$50,000

Cash receipts from customers        30% x 125,000 = 37,500

       70% x 80,000 = 56,000

                                    = 93,500

93,500

Total Cash Available

143,500

        Purchases of Merchandise                     85% x 85,000 = 72,250                     15% x 50,000 = 7,500                                                 = 79,750

79,750

        Sales Commissions

                    6% x 125,000 = 7,500

7,500

        Salaries Expense

18,000

         General & Admin (other)          Expenses

1,800

         Interest on Bank Loan

                1% x 135,000 = 1,350

1,350

Total Cash Disbursement

108,400

Preliminary Cash Balance

35,100

Additional Loan from Bank

50,000 – 35,100 = 14,900

14,900

Ending Cash Balance

50,000

Loan Balance at end of month       135,000 + 14,900 = 149,900

149,900

ACCY202

EXAM 3  

Chapter 20-23  

Chapter 21 – Flexible Budgets/Standard Costs • Standard Costs – preset costs for delivering a product or service under  normal conditions; helps managers assess the reasonableness of actual  costs incurred for producing the product or providing the service, when  

the standard/anticipated costs are compared to the actual costs  incurred

• Fixed vs. Flexible Budgets –

o Fixed (static) Budget – based on a single predicted amount of sales  or other activity measure

▪ Fixed Budget Performance Report – compares actual results  with the results with the results expected under a fixed  

budget, to show the variances

o Flexible (variable) Budget – based on several different amounts of  sales; more useful than a fixed budget when actual sales activity is  different than what was predicted

▪ Flexible Budget Performance Report – compares actual  performance and budgeted performance based on actual  

sales volume (or other activity level), to show the variances

• Performance Reports – make it easy for managers to see the variances  between budgeted amounts and actual amounts

o The effects of these variances are measured with an F or a U ▪ F – Favorable Variance – when compared to a budget, the  actual cost or revenue contributes to a higher income; i.e.  

actual revenue is higher than standard revenue; i.e. actual  cost is lower than standard cost

▪ U – Unfavorable Variance – when compared to a budget,  the actual cost or revenue contributes to a lower income; i.e.  actual revenue is lower than standard revenue; i.e. actual  cost is higher than standard cost

• Direct Materials (price/quantity) Variance –

ACCY202

EXAM 3  

Chapter 20-23  

o Purchasing managers are in charge of explaining price variances,  especially if a price higher than the standard caused the  unfavorable variance.

▪ Cheaper prices – though favorable – may indicate a decline in  product quality.

o Production managers are responsible for explaining why  production processes used more than the standard amount of  materials, which would result in an unfavorable variance.  

▪ Cheaper than standard materials – though favorable – may  not meet the specifications of production, which can lead to  excessive waste.  

AQ x AP

(actual quantity  x actual price)

AQ x SP

(actual quantity  x standard price)

SQ x SP

(standard quantity x standard price)

PRICE VARIANCE (AQ x AP) – (AQ x SP)

QUANTITY VARIANCE (AQ x SP) – (SQ x SP)

TOTAL DIRECT MATERIALS VARIANCE

U or F?

• Direct Labor (rate/efficiency) Variance –

o Production managers or personnel administrators are in charge  of explaining why wage rate is higher than expected

(unfavorable).  

▪ Lower wage rates – though favorable – can mean that  workers/employees are less skilled and are producing poorer  quality products.  

ACCY202

EXAM 3  

Chapter 20-23  

▪ Higher than standard wage rates – though unfavorable – can  indicate that there are more skilled workers working the  production line.  

o Production managers should also be able to explain an unfavorable number of labor hours that’s higher than the  standard.  

▪ Using more than the standard labor hours (unfavorable) can  indicate that your employees are less-skilled or are not  working together efficiently.  

▪ Using less than the standard labor hours (favorable) can  indicate that highly-skilled employees are working the  production line, or workers are becoming careless.

AH x AR

(actual hours x actual rate)

AH x SR

(actual hours x  standard rate)

SH x SR

(standard hours x standard rate)

RATE VARIANCE (AH x AR) – (AH x SR)

EFFICIENCY VARIANCE

(AH x SR) – (SH x SR)

TOTAL DIRECT LABOR VARIANCE U or F?

ACCY202

EXAM 3  

Chapter 20-23  

• Factory Overhead Variances –

o Overhead Controllable Variance –

OVERHEAD

CONTROLLABLE VARIANCE

ACTUAL TOTAL  OVERHEAD

INCURRED

BUDGETED TOTAL

OVERHEAD

▪ Types of Overhead Controllable Variances –

• Spending Variance – occurs when management pays  an amount different from the standard price to acquire  an item; i.e. Supervisor Salaries were higher or lower  than expected.

• Efficiency Variance – occurs when standard direct  labor hours (the allocation base) expected for  

production differ from the actual direct labor hours  

used

o Overhead Volume Variance –

OVERHEAD VOLUME VARIANCE

BUDGETED FIXED

OVERHEAD

APPLIED FIXED

OVERHEAD

▪ An unfavorable OH Volume Variance (meaning that the  company didn’t reach its predicted operating level), can  indicate that customer demand was low, which is not a  company employee’s fault.  

ACCY202

EXAM 3  

Chapter 20-23  

• Management By Exception – means that managers focus their  attention on the most significant differences between actual costs and  standard costs and give less attention to areas where production is  reasonably close to the standard; it’s especially useful when directed at  controllable items, enabling top management to affect the actions of  lower-level managers responsible for the company’s revenues and costs.  

CHAPTER 21 – PRACTICE QUESTION!

The following information is available for Merritt’s Winery:  

MERRITT’S WINERY

STANDARD COST CARD

PRODUCTION Direct Materials Direct Labor Overhead

COST FACTOR 

0.5 gal @ $15 per gal 1 hr @ $18 per hr 1.5 hrs @ $9 per hr

TOTAL $7.50 $18.00 $13.50 $39.00

Direct materials used for production 9,000 gallons

Actual cost per gallon of direct material $14.50 per gallon

Direct labor used for production 18,000 hours

Actual cost per hour of direct labor $18.50 per hour

Units produced 18,400 bottles

A) Compute the direct materials price variance, quantity variance, and total  variance, indicating whether each variance is favorable or unfavorable.  

AQ x AP

= 9,000 x $14.50 = $130,500

AQ x SP  

= 9,000 x $15  = $135,000

SQ x SP  

= 9,200 x $15  = $138,000

PRICE VARIANCE = 130,500 – 135,000 = 4,500

FAVORABLE

QUANTITY VARIANCE = 135,000 – 138,000 = 3,000  

FAVORABLE

TOTAL VARIANCE $7,500

FAVORABLE

ACCY202

EXAM 3  

Chapter 20-23  

B) Compute the direct labor rate variance, efficiency variance, and total  variance, indicating whether each variance is favorable or unfavorable.  

AH x AR

= 18,000 x $18.50 = 333,000

AH x SR

= 18,000 x $18 = 324,000

SH x SR

= 18,400 x $18 = 331,200

RATE VARIANCE = 9,000

UNFAVORABLE

EFFICIENCY VARIANCE

= 7,200

FAVORABLE

TOTAL VARIANCE

1,800

UNFAVORABLE

Chapter 22 – Performance Measurement • Decentralization – when a company’s decisions are made by  managers throughout the organization, instead of by a few top executives; these top executives, however, need a system to evaluate  the managers’ performances

o Financial information used to evaluate a department depends on  whether it is evaluated as a cost center, profit center, or  

investment center

▪ Cost center – incurs costs without directly generating  revenue; i.e. manufacturing department, accounting  

department, advertising department, purchasing  

department

▪ Profit center – generates revenues and incurs costs; i.e.  production lines (Kraft’s Capri Sun and Kool-Aid) and selling  departments  

▪ Investment center – generates revenues and incurs costs (like profit centers), except their managers are responsible  for the investments made in operating assets; i.e. manager  

ACCY202

EXAM 3  

Chapter 20-23  

of Kraft’s beverage division has the authority to make  

decisions such as build a new manufacturing plant

• Responsibility Accounting System – ensures that costs are controlled  and managers are being evaluated, by assigning costs to the managers responsible for controlling them; some costs, however, are out of the  managers’ hands, so we do not evaluate them on those costs ▪ Uncontrollable Costs – costs that managers have no  

influence on; i.e. depreciation expenses, because the  

manager has no control of the amount of equipment  

assigned to their department

▪ Controllable Costs – costs that managers have the power to  determine – or at least significantly affect – the amount  

incurred; i.e. the costs of supplies, because some managers  are in charge of ordering  

o Responsibility accounting budgets - based on the flexible budget  approach, which is based on several different amounts/types of  sales

o Direct Expenses – can be traced back to a specific department and  are incurred for the sole benefit of that department; i.e. the  salary of a supervisor in one department is a direct expense of that  one department

▪ Doesn’t require and allocation across departments

▪ Direct Expenses are often, but not always, controllable costs o Indirect Expenses – costs that are incurred for the joint benefit  of more than one department, and cannot be traced back to only  one department; i.e. service departments that provide payroll,  human resources for multiple departments, etc.

▪ Allocated across the departments that are benefitting from  them

ACCY202

EXAM 3  

Chapter 20-23  

• Departmental Income Statements – includes direct expenses and the  department’s share of indirect expenses  

COMPANY

DEPARTMENTAL INCOME STATEMENT

Department 1

Department 2

   Sales

(given)

(given)

- Cost of Goods Sold

(given)

(given)

= Gross Profit

(sales - COGS)

(sales - COGS)

Direct Expenses:

-       Salaries

(given)

(given)

-       Advertising

(given)

(given)

  -      Utilities

(given)

(given)

  -      Depreciation

(given)

(given)

   -     Maintenance

(given)

(given)

= Total Direct Expenses

(salaries + advertising + utilities +  depreciation + maintenance)

(salaries + advertising + utilities +  depreciation + maintenance)

Departmental Contribution  to Overhead

(gross profit – total direct  expenses)

(gross profit – total direct  expenses)

Indirect Expense Allocations: (determined by allocation bases given in problem)

  -       Salaries

(Salaries Indirect Cost (given) x %  allocated by allocation base)

(Salaries Indirect Cost (given) x %  allocated by allocation base)

  -       Advertising

(Advertising Indirect Cost x %  allocated by allocation base)

(Advertising Indirect Cost x %  allocated by allocation base)

  -       Utilities

(Utilities Indirect Cost x % allocated  by allocation base)

(Utilities Indirect Cost x % allocated  by allocation base)

  -       Depreciation

(Depreciation Indirect Cost x %  allocated by allocation base)

(Depreciation Indirect Cost x %  allocated by allocation base)

  -       Maintenance

(Maintenance Indirect Cost x %  allocated by allocation base)

(Maintenance Indirect Cost x %  allocated by allocation base)

  -       Human Resources

(HR Indirect Cost x % allocated by  allocation base)

(HR Indirect Cost x % allocated by  allocation base)

= Total Indirect Expenses

(salaries + advertising + utilities +  depreciation + maintenance +  human resources)

(salaries + advertising + utilities +  depreciation + maintenance +  human resources)

Net Income (loss)

(departmental contribution to  overhead – total indirect expenses)

(departmental contribution to  overhead – total indirect expenses)

ACCY202

EXAM 3  

Chapter 20-23  

• Return on Investment (ROI) – a ratio of the amount invested to the  amount received as a result; a method used to evaluate division  performance within investment centers  

o ROI Formula: (income ÷ avg invested assets)

RETURN ON  INVESTMENT

INVESTMENT CENTER INCOME INVESTMENT CENTER AVERAGE INVESTED ASSETS

• Residual Income – the excess of income from operations over the  minimum acceptable income; another method used to evaluate  division performance in investment centers

o Residual Income Formula: (actual income – target income)

RESIDUAL INCOME

INVESTMENT CENTER

INCOME

TARGET

INVESTMENT CENTER INCOME

CHAPTER 22 – PRACTICE QUESTION!  

ACCY202

EXAM 3  

Chapter 20-23  

Faye Co. has two operating (production) departments supported by a number  of service departments. The following information was collected for a recent  period:  

Direct Costs

Salaries

Advertising

Utilities

Depreciation

Maintenance

Human Resources Cost of Goods Sold

Paint

Dept

117,150 14,950 18,650 15,450 1,750

322,350

Welding Dept

80,450 5,750

8,650

6,250

550

115,950  

Indirect  Costs

31,450 25,250 3,250

8,550

24,150 65,850

Indirect costs are allocated as follows: advertising on the basis of sales,  human resources on the basis of the number of employees, and all other costs  on the basis of square footage. Additional information about the production  departments follows:

Square Footage

# of  

Employees

Paint Dept Welding Dept

10,200            65 3,000               48

Sales for the Paint Department are $650,000 and sales for the Welding  Department are $300,000. Determine the departmental contribution to  overhead and the departmental net income for each production department  by preparing the departmental income statement. Round to the nearest  whole dollar or percent where applicable.  

ACCY202

EXAM 3  

Chapter 20-23

FAYE CO.  

DEPARTMENTAL INCOME STATEMENT

Paint Dept

Welding Dept

   Sales

650,000

300,000

- Cost of Goods Sold

322,350

115,950

= Gross Profit

327,650

184,050

Direct Expenses:

-       Salaries

117,150

80,450

-       Advertising

14,950

5,750

  -      Utilities

18,650

8,650

  -      Depreciation

15,450

6,250

   -     Maintenance

1,750

550

= Total Direct Expenses

167,950

101,650

Departmental Contribution  to Overhead

159,700

82,400

Indirect Expense Allocations: (determined by allocation bases given in problem)

-       Salaries (sq. ft)

31,450 x 77% =  

24,216.50

31,450 x 23% =  

7,233.50

  -       Advertising (sales)

25,250 x 4% =  

1,010

25,250 x 8% =  

2,020

  -       Utilities (sq. ft)

3,250 x 77% =  

2,502.50

3,250 x 23% =  

747.50

-       Depreciation

              (sq. ft)

8,550 x 77% =  

6,583.50

8,550 x 23% =  

1,966.50

-       Maintenance

            (sq. ft)

24,150 x 77% =  

18,595.50

24,150 x 23% =  

5,554.50

-       Human Resources            (# of employees)

65,850 x 58% =  

38,193

65,850 x 42% =  

27,657

= Total Indirect Expenses

91,101

45,179

Net Income (loss)

68,599

39,021

ACCY202

EXAM 3  

Chapter 20-23  

Chapter 23–Relevant Costing/Decision-Making • A company’s managers use relevant costing to make informed  decisions within the company; it includes many types of costs: o Incremental (Relevant) Costs – future costs that will differ  among different courses of action; will make a difference in  decision-making

o Sunk Costs – come from past decisions and can’t be avoided or  changed; are irrelevant to future decisions

• i.e. the cost incurred to purchase new computer  

equipment two years ago is not relevant to the decision  

of whether to replace the computer equipment

o Other important Types of costs in Relevant Costing:  

▪ Out-of-Pocket Costs – require a future outlay of cash;  

relevant for current and future decision-making; determined  primarily by management

• i.e. future purchases of computer equipment involve  

relevant out-of-pocket costs when deciding whether to  

replace the computer equipment or not

▪ Opportunity Costs – the potential benefit lost by taking a  specific action when alternative actions are available;  

(selling price – incremental costs)

• i.e. when a student is determining how much summer  

intercession will cost her, she must factor in the amount  

of work she will have to take off (and the amount of  

money lost) in order to do so

ACCY202

EXAM 3  

Chapter 20-23  

• i.e. a single-product manufacturing company is  approached by a client and is asked to create a special  product. The company can’t just think about the  potential profit (opportunity cost); they must factor in  the time and resources that would be used and  compare them to those of other potential projects

ACCY202

EXAM 3  

Chapter 20-23  

• Managerial Decision-Making Scenarios:

o Additional Business –

▪ Management must not blindly use historical costs,  

especially allocated overhead costs; they must focus on the  incremental costs to be incurred if the additional business  is accepted

SALES VARIABLE  

CONTRIBUTION  

DIRECT  

MATERIALS

DIRECT  LABOR

SELLING EXPENSES

OVERHEAD

MARGIN

(PER UNIT AND ANNUAL TOTAL)

CONTRIBUTION MARGIN

FIXED  

OVERHEAD

ADMINISTRATIVE  EXPENSES

INCREMENTAL  OPERATING  INCOME

(PER UNIT AND ANNUAL TOTAL) o Make or Buy –

DIRECT  

MATERIALS (per unit)

DIRECT  LABOR

(per unit)

OVERHEAD COSTS  (USING GIVEN  RATE per unit)

TOTAL  

MANUFACTURING  COSTS

(IN COMPARISON TO) TOTAL PURCHASE PRICE

ACCY202

EXAM 3  

Chapter 20-23  

o Scrap or Rework –

FULL SELLING  PRICE (per unit) x

# OF UNITS  

REWORKED

OUT-OF-POCKET  COSTS TO

REWORK (per unit) x

# OF UNITS  

REWORKED

OPPORTUNITY COSTS  OF NOT MAKING NEW UNITS (per unit)

x

# OF UNITS  

REWORKED  

INCREMENTAL  NET INCOME  (per unit)

x

# OF UNITS  REWORKED

(IN COMPARISON TO)

INCREMENTAL  

INCOME TO SCRAP  

(per unit)

x

# OF UNITS  

REWORKED

o Keep or Replace Equipment –

VARIABLE  

TOTAL  

CASH RECEIVED  TO TRADE IN  OLD MACHINE

COST TO BUY  NEW MACHINE

MANUFACTURING  COST SAVINGS  x  

LIFE OF  

EQUIPMENT

INCREASE  

(OR DECREASE)  IN NET INCOME

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