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Chapter 1 Cost Concepts 1. Categorize costs by role • Manufacturing costs vs Nonmanufacturing costs Manufacturing costs are all costs that incur inside the factory affiliated with transforming raw materials into finished products Three aspects • Direct Materials • Direct labors • Manufacturing overhead Total manufacturing costs= Direct Materials + Direct Labor + ManDon't forget about the age old question of State the 2 ways to display distribution.
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ufacturing overhead Nonmanufacturing costs include a company’s other costs • Selling costs • Administrative costs Manufacturing Costs • Direct materials- Are a physical part of the finished product and their costs can be independently and conveniently traced to the finished product Example: Hard drive in a computer • Direct Labor- the labor that can be directly traced to the goods or services being produced. The most common direct labor is the wages of chefs in a restaurant • Manufacturing overhead- includes all manufacturing costs that are not direct materials and direct labor, includes: • Indirect materials- glue, oil, and nails • Indirect labor- wages of a manager, janitor, and supervisor • Warehouse utilities, Warehouse rent, and Warehouse insurance • Depreciation on Warehouse Nonmanufacturing costs • Selling costs- costs needed to market, distribute, and service a product or service. Examples: Salaries and commissions of sales people, Advertising • Administrative costs- costs affiliated with the general management of the company. Examples: General Accounting, Top Executive salaries Among Manufacturing Costs Prime cost = Direct Materials + Direct Labor Conversion Cost= Direct Labor + Manufacturing overhead (cost of converting raw materials into a finished product) Product Costs vs Period Costs Product costs include: Direct Materials, Direct Labor, and Manufacturing overhead (Also Manufacturing costs) Period cost include all selling and administrative costs (Nonmanufacturing costs) 2. Categorize costs by behavior Variable vs Fixed Costs Variable costs • Total variable costs change in direct proportion to changes in activity level • Variable cost per unit does not change as activity level increases Fixed costs • Total fixed costs remain the same, regardless of activity level • Fixed cost per unit decreases as activity level increases Total Cost and Average Cost Total cost = Total fixed cost + Total variable cost = Total fixed cost + (Variable cost per unit x Number of units) Average Cost = Total cost/Number of units Example: Fixed costs = $30,000 Variable cost per unit = $60 per unit Number of units = 150 What is the total cost? Total cost = $30,000 + (60 x 150) = $39,000 What is the average cost? Average cost =$39,000/150 units = $260 per unit 3. Categorize costs in relation to cost objects Direct Costs vs. Indirect Costs Cost object- any item for which costs are measured and assigned • Examples: Costumers, Departments, Regions Direct Costs- costs that can be easily and accurately traced to a cost object (Direct Materials, Direct Labor) Indirect Costs- costs that cannot be easily to a cost object (Manufacturing overhead). 4. Categorize costs for Decision Making Differential cost and Revenue- costs and revenues that differ among alternatives Example: You have a job where you live where you can earn $3,000 a month. You also have a job in a city an hour away that pays $3,400 a month, however commuting cost to that city is $200 a month. Differential Revenue is: $3,400- $3,000= $400 Differential cost is $200 Opportunity cost- the potential benefit is given up when one choice is selected over the other Example: Choosing to attend college instead of working Sunk cost- costs that have already incurred and can’t be changed in the present or future. Ignore these costs when making decisions Example: You buy a computer for $1,000 but now it is on sale for $800. Should you wait until the computer is sold out or sale is over before selling it? You probably would even though the $1,000 purchase is a sunk cost. Chapter 2: Job Order Costing What companies use Job-Order Costing? • Products that are manufactured to order • Various products that are produced each other • The distinct nature of each order requires tracing or allocating costs to each job, and marinating cost records for each job. • Companies who use Job-order costing: Bechtel International, Walt Disney Studios, and Boeing Manufacturing Overhead: Cannot trace: Allocate/Apply • In addition to DM and DL, manufacturing overhead costs also occur during production • Managers use an allocation base, such as direct labor hours, direct labor dollars, or machine hours, to assign manufacturing overhead to individual jobs Manufacturing Overhead Application: Three-Step Procedure 1. Select a cost allocation base, example: direct labor hours, direct labor dollars, or machine hours. Ideally, the allocation base is a cost driver that causes overhead. 2. Compute the POHR (predetermined overhead rate) POHR = Estimated total manufacturing cost for the coming period/Estimated total units in the allocation base for the coming period. (Determined before the period occurs) 3. Apply MOH to jobs. MOH applied = POHR x Actual Activity About Applying MOH using POHR • Pro: Using a predetermined rate makes it possible to estimate total job costs sooner. Actual overhead for the period is not known until the end of the period. • Con: Creates complication: Actual MOH does not equal applied MOH. Need to do end of period adjustment for underapplied or overapplied MOH. End of Period Adjustment for Under or Overapplied Overhead • When using POHR to apply to MOH products, actual overhead will probably not equal to overhead applied to products • MOH applied vs MOH actual. If MOH applied > MOH actual, then MOH was overapplied. If MOH applied < MOH actual, then MOH was underapplied. Chapter 3: Activity Based Costing Assigning Overhead Costs to Products: Job-Order Costing uses a Plantwide Overhead Rate- A single overhead rate used throughout an entire factory.Machining Department, Assembly Department, Shipping Department This may not be proper since the allocation base depends on the nature of the work performed in each department. In the machining department, overhead may be based on machine-hours, but in the assembly department, overhead may be based on labor-hours • Plantwide overhead rate was used when cost systems were developed in thew 1800s, because back then the emphasis was on simplicity • Costs and activity data had to be collected by hand and all calculations were done with paper and pencil. Direct labor information was already being recorded. Computers make more records available • Most companies produced a limited variety of similar products, so there was little difference in the overhead costs consumed by each product. Complexity of products and production has increased • Managers believed direct labor and overhead costs were highly correlated. Many MOH costs have been found to not correlate with direct labor • Direct labor was a large component of product costs. DL costs have decreased as percentage of total costs; MOH costs have increased • Using a single plantwide overhead rate is no longer suitable for MOH allocation in today’s business environment • Need a more refined allocation system to better match the overhead resources with the products that consume those resources, and avoid cost distortion Activity Based Costing (ABC)• ABC uses multiple allocation bases which we call activities to assign cots to products these activities are the real cause of the overhead. • Activity- an event that causes the consumption of overhead resources • Activity Cost Pool- A “cost bucket” in which costs related to a particular activity are accumulated • Activity Measure- Expresses how much of the activity is carried out and is used as the allocation base for applying overhead costs • Activity Rate- A predetermined overhead rate for each activity cost pool. Steps for Designing an ABC system 1. Identify and define activities 2. Accumulate costs to activity costs pools 3. Calculate activity rates 4. Assign MOH to products 5. Prepare management reports Benefits of ABC • Improves accuracy of product costing • Increasing the number of cost pools used to accumulate overhead costs • Using activity cost pools that are more homogenous than departmental cost pools • Assigning overhead costs using activity measures that cause those costs, rather than relying solely on direct labor hours. Limitations of ABC: costly! Chapter 4: Process Costing Process Costing • A company that produces many units of a single product • One unit of product is indstinguishable from other units of product • The identical nature of each unit enables assigning the same average cost per unit • Companies who use process costing: Coca-Cola, Reynolds Aluminum, and Weyerhaeuser Similarities and Differences between Job-Order and Process Costing Similarities: • Both systems assign material, labor, and overhead costs to products and they provide a mechanism for computing unit product costs • Both systems use the same manufacturing accounts, including Manufacturing Overhead, Raw materials, Work in Process, and Finished Goods • The Flow of costs through the manufacturing accounts is basically the same in both systems Differences: • Process costing is used when a single product us produced on a continuing basis. Job-Order costing used when many different jobs having different production requirements are worked on • Process costing accumulates costs by departments. Job-Order costing accumulates costs by individual jobs • Process costing computes unit costs by department. Job-order costing system computes unit cots by job on the cost sheet Processing Departments Any unit in an organization where materials, labor or overhead are added to the product • The activities performed in a processing department are performed uniformly on all units of production. The output of a processing department are homogenous. Products flow in a sequence from department to another Complication: Partially Completed Units • A department usually has some partially completed units in its beginning and ending inventory • Complicate the determination of a department’s output for a given period, and the unit cost that should be assigned to that departments output Equivalent Units Two half-completed products are equivalent to one compete product Equivalent units = # of partially completed units X percentage completion of those units Equivalent units of production for a department = the # of units completed and transferred out + the equivalent units in ending work in process inventory Chapter 6: Variable Costing • Only those manufacturing costs that vary with output are treated as product costs: Direct materials, Direct labor, Variable portion of manufacturing overhead • Fixed MOH is not treated as a product costs, but as a period cost • The unit product cost in inventory or COG under variable costing does not contain any fixed MOH cost Key Formulas • Absorption unit product cost = (DM + DL + VOH) per unit + FMOH/units produced • Variable unit product cost = (DM + DL + VOH) per unit • COGS = unit product cost x unites sold • Gross Margin = Sales - Absorption COGS • Contribution Margin = Sales - Variable COGS - VSA Expenses • Sales = units sold x price per unit • Absorption period cost = Total SA expenses + Variable SA + Fixed SA • Variable period cost = Total SA expenses + FMOH • Absorption NOI = Gross Margin - Total SA expenses • Variable NOI = Contribution margin - FMOH - Fixed SA expenses