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FIU / English / ENG 3301 / What is job costing?

# What is job costing? Description

##### Description: These notes cover chapter 5-8
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CHAPTER 5: “ PROCESS COSTING”

## What is job costing?

Process Costing: used by companies that produce extremely large numbers of identical units through a series of uniform production steps or processes. Because each unit is identical, in theory, each unit should cost the same  to make

∙ Each process has its own separate Work in Process Inventory.

∙ Direct materials, direct labor, and manufacturing overhead are assigned to each processing department’s  Work in Process Inventory account based on the manufacturing costs incurred by that process ∙ The manufacturing costs assigned to the product must always follow the physical movement of the  product

Job Costing: a system for assigning costs to products or services that differ in the amount of materials, labor,  and overhead required. Typically used by manufacturers that produce unique, or custom­ordered products in  small batches; and also used by professional service firms

## What refers to the cost to convert direct materials into new finished products?

Conversion Cost: cost to convert direct materials into new finished products ConversionCost=Direct Labor+ ManufacturingOverhead

Equivalent Units: express the amount of work done during a period in terms of fully  completed units of output

EquivalentUnits=Number of Physical Units× %of Compeltion

Inventory Flow Assumptions: uses Weighted-Average-Method of Process Costing,  which combines any beginning inventory units and costs with the current period’s units  and costs to get a weighted-average cost

Five-Step Process Costing Procedure:

∙ Summarize the Flow of Physical Units

## What is the five-step process costing procedure?

∙ Compute Output in Terms of Equivalent Units

∙ Summarize Total Costs to Account for

∙ Compute the Cost per Equivalent Unit We also discuss several other topics like What is leonardo’s influence on raphael?

∙ Assign total costs to units completed and to units in ending Work in Process  Inventory

Waste Audit or Trash Audit or Waste Sort: studying the contents of a company’s  trash in order to identify solid waste and scraps that could potentially be recycled,  repurposed, or sold to create a new revenue stream

Journal Entries are Needed in a Process Costing System:

∙ To record direct materials used by the XX department

o Work In Process Inventory-- XX (debit)

 Raw Materials Inventory (Credit)

∙ To record direct labor used in the XX Department

o Work in Process Inventory -- XX (debit)

 Wages Payable (credit)

∙ To record manufacturing overhead allocated to the XX Department o Work in Process Inventory -- XX (debit) If you want to learn more check out What convinced jackson to run for president in 1824 how did he fair in that election?

∙ To record transfer of cost out of the XX department into the YY department o Work in Process Inventory -- YY (debit)

 Work in Process Inventory -- XX (credit)

Transferred-In Costs: costs incurred in a previous process that are carried forward as  part of the product’s cost when it moves to the next process

Gross Profit

Gross Profit=Sales Revenue−Cost of Goods Sold

Production Cost Report: summarizes the entire five-step process on one schedule.  Summarizes a processing department’s operations for a period

Journal Entries in a Second Processing Department

∙ To record manufacturing costs incurred in the YY department

o Work in Process Inventory -- YY (debit)

 Raw Materials Inventory (Credit)

 Wages Payable (credit)

∙ To record the transfer cost out of the XX department and into the YY department o Work in process Inventory -- YY (debit)

 Work in Process Inventory -- XX (credit)

∙ To record transfer of cost out of the YY Department and into Finished Goods  Inventory We also discuss several other topics like Does paleolithic mean old stone?

o Finished Goods Inventory (debit)

o Work in Process Inventory -- YY (Credit)

CHAPTER 6: “COST BEHAVIOR”

Cost Behavior: how costs change as volume changes

∙ Variable Costs: costs that are incurred for every unit of volume

o Cost Equation: mathematical equation for a straight line that expresses how a cost behaves

∙ Fixed Costs: costs that do not change in total despite wide changes in volume o Committed Fixed Costs: fixed costs that are locked because of previous  management decision; management have little or no control over these  costs in the short run If you want to learn more check out What is the relationship between savings and investment spending?

 Property Taxes and Insurance

o Discretionary Fixed Costs: result of annual management decisions; fixed  costs that are controllable in the short run

∙ Mixed Costs: cost that change, but not in direct proportion to changes in volume. It decreases as volume increases. Contain both Variable and Fixed Cost components. Total Mixed Costs= Total Variable Cost + Total Fixed Costs

∙ Relevant Range: the band of volume where the total fixed costs and variable cost  per unit remain constant at a certain level

∙ Step Costs: cost behavior that is fixed over a small range of activity and then jump  up to a next fixed level with moderately small changes in volume. Resembles stair  steps.

∙ Curvilinear Costs: do not fit into any neat pattern. Uses Straight Line  Approximations

Determine Cost Behavior

∙ Account Analysis: managers classify each general ledger account as a variable,  fixed, or mixed cost.

∙ Scatter Plots: graphs the historical cost data and volume data, helps managers  visualize the relationship between the cost and the volume of activity o Outliers or Abnormal Data Points: data points that do not fall in the same  general pattern as the other data points We also discuss several other topics like Why is supply inelastic in the short run?

∙ High-Low Method: estimate the variable and fixed cost components of a mixed  cost. It fits a mixed cost line through the highest and lowest volume data points. o Step 1: find the slope of the mixed cost line that connects the data points.  the slope is the variable cost per unit of activity.

o Step 2: find the vertical intercept, the place where the line connecting the  data points intersects the y-axis. this is the fixed cost component of the  mixed cost

o Step 3: Using the variable cost per unit of activity (slope) and the fixed cost  component, write the equation representing the costs’ behavior.

∙ Regression Analysis or “Line of Best Fit”: statistical procedure for determining the  line, and associated cost equation, that best fits all of the data points in the data  set, by using all of the historical data points, not just the high and low data points We also discuss several other topics like What do you call the theory of knight?

∙ Data Concerns: cost equations are only as good as the data on which they are  based.

Absorption Costing and Variable Costing

∙ Absorption Costing: all manufacturing-related costs, whether fixed or variable, are  “absorbed” into the cost of the product. All direct materials, direct labor, and  manufacturing overhead (MOH) costs are treated as inventoriable product costs.  Products “absorb” both fixed and variable manufacturing costs

∙ Variable Costing or Direct Costing: only variable manufacturing costs are treated as inventoriable product costs. Treats all fixed MOH costs as operating expenses in  the period incurred, rather than treating fixed MOH as an inventoriable product

cost. can only be used for internal management purposes. Is often better for  decision making than absorption costing because it clearly shows managers the  additional cost of making one more unit of product. Is often better for performance  evaluation than absorption costing because it gives managers no incentive to build unnecessary inventory

Contribution Margin Income Statement

∙ Contribution Margin: show managers how much profit has been made on sales  before considering fixed costs

Contribution Margin=Sales Revenue−Variable Expenses

VariableExpenses=VariableCOGS +VariableOperatin g Expenses

∙ Contribution Margin Income Statement: is organized by cost behavior; first all  variable expenses are deducted from sales revenue to arrive at the company’s  contribution margin; next, all fixed expenses are deducted from the contribution  margin to arrive at operating income. Is often more useful than a traditional  income statement for planning and decision making because it clearly  distinguishes the costs that will be affected by changes in volume (variable costs)  from the costs that will be unaffected (fixed costs). Only for internal management  purposes.

Operating Income: Variable Vs. Absorption Costing

∙ Scenario 1: Inventory levels remain constant: if units produced equal units sold,  then inventory levels remain constant, and absorption income equal variable  costing income

∙ Scenario 2: Inventory levels increase: if more units are produced than the ones  sold, then the inventory levels increase, and absorption income is bigger than the  variable costing income

∙ Scenario 3: Inventory levels decrease: if the units produced are less than the units  sold, then the inventory levels decrease, and the absorption income is less than  the variable costing income

Reconciling Operating Income Between the Two Costing Systems Difference∈Operating Income=(Change∈inventory level ,∈units)×(¿ MOH per unit)

CHAPTER 7: “COST-VOLUME-PROFIT ANALYSIS”

Cost-Volume-Profit Analysis (CVP Analysis): expresses the relationships among  costs, volume, and the company’s profit. It helps managers determine the sales volume  that will be needed just to breakeven, or cover costs.

∙ Components:

o Sales Price

o Volume

o Variable Costs

o Fixed Costs

o Profit or Loss

∙ Assumptions:

o A change in volume is the only factor that affects costs

o Managers can classify each cost (or the components of mixed costs) as  either variable or fixed. These costs are linear throughout the relevant range  of volume

o Revenues are linear throughout the relevant range of volume

o Inventory levels will not change

o The sales mix of products will not change.

 Sales mix: combinations of products that make up total sales

The Unit Contribution Margin or Contribution Margin per Unit: excess of the  selling price per unit over the variable cost of obtaining and selling each unit. Contribution Margin Ratio: ratio of contribution margin to sales revenue Contribution Margin Ratio=Contirbution Margin

SalesRevenue (Price)

Breakeven Point: sales level at which operating income is zero. Sales below the  breakeven point result in a loss, and above result in a profit

∙ Approaches:

o The Income Statement Approach

Operating Income=Sales Revenue−Variable Expenses−¿Expenses=0

Operating Income=( SalesPrice per Unit×Units Sod )−(Variable cost per unit ×Units Sold )−¿Costs o The Shortcut Approach using the Unit Contribution Margin

Operating Income=Sales Revenue−Variabl e Expenses−¿Expenses=0

Operating Income=Contribution Margin−¿ Expenses=0

Contribution MarginUnits Sold=Operating Income+¿ Expenses

Sales∈Units=Operating Income+¿ Expenses

Contribution Margin per Unit

o The Shortcut Approach using the Contribution Margin Ratio

Sales∈Dollars=Operating Income+¿ Expenses

Contribution Margin Ratio

Graphing CVP Relationships

∙ Step 1: choose a sales volume

∙ Step 2: draw the fixed expense line, a horizontal line that intersects the y-axis ∙ Step 3: draw the total expense line

∙ Step 4: identify the breakeven point

∙ Step 5: mark the operating income and the operating loss areas on the graph Sensitivity Analysis: “what-if” technique that asks what results will be if actual prices  or costs change or if an underlying assumption changes

Margin of Safety: excess of actual or expected sales over breakeven sales; the drop in  sales a company can absorb without incurring an operating loss

Margin of Safety∈Units=Expected Sales∈Units−Breakeven Sales∈Units

Margin of Safety∈Dollars=Expected Sales∈Dollars−Breakeven Sales∈Dollars

Margin of Safetyas a ∈units=Margin of Safety∈Units

Expected Sales∈Units

Margin of Safety as a ∈dollars=Margin of Safety∈Dollars

Expected Sales∈Dollars

Operating Leverage: relative amount of fixed and variable costs that make up its total  costs

∙ Operating Leverage Factor: indicates the percentage change in operating income  that will occur from a 1% change in sales volume

Operating Leverage Factor=Contribution Margin

Operating Income

Choosing a Cost Structure

∙ Indifference Point: the volume of sales at which a company would be indifferent  between alternative cost structures because they would result in the same total  cost

Cost under Option1=Cost under Option2

CHAPTER 8: “RELEVANT COSTS FOR SHORT-TERM DECISIONS” Relevant Information: expected future data that differs among alternatives Sunk Costs: costs that were incurred in the past and cannot be changed regardless of  which future action is taken.

Relevant Nonfinancial Information: qualitative factors that play a role in managers’  decisions

Keys to Making Short-Term Special Decisions:

∙ Focus on relevant revenues, costs, and profits

∙ Use a contribution margin approach that separates variable costs from fixed costs Special Order And Regular Pricing Decisions:

∙ Special Order Decision: occurs when a customer requests a one-time order at a  reduced sales price.

o Considerations

 Available capacity

 Special reduced sales price is high enough to cover the incremental  costs of filling the order

 Fixed Costs

 If special order will affect regular sales in the long run

∙ Regular Pricing Decisions:

o Target Costing: use by price-takers. It starts with the market price of the  product (the price customers are willing to pay) and subtracts the company’s desired profit to determine the product’s target total cost, the total cost to  develop, design, produce, market deliver, and service the product

Target TotalCost=Revenueat Market Price−Desired Profit

Target ¿Cost=Total TargetCost−Current VariableCost

Target TotalVariableC ost=Total TargetCost−Current ¿Cost

Target VariableCost per Unit=Total Target VariableCost

Number of Units

o Cost-Plus Pricing: it used by price-setter. It starts with the product’s total  costs and adds its desired profit to determine a cost-plus price

Cost−Plus Price=TotalCost+Desired Profit

Current TotalCosts=Current VariableCost +Current ¿Costs

Target Revenue=Current TotalCost+Desired Profit

Cost−Plus Price per Unit=Target Revenue

Number of Units

Decisions to Discontinue Products, Departments, or Stores: managers often must decide whether to discontinue products, departments, stores, or territories that are not  as profitable as desired

∙ Product Line Income Statement: shows the operating income of each product line,  as well as the company as a whole

∙ Consider the Product’s Contribution Margin and Avoidable Fixed Costs o If the Contribution Margin is negative, management would either need to  raise the price of the product, if possible, cut variable costs, or discontinue  the line

 Avoidable Fixed Costs: any fixed costs that can be eliminated as a

result of discontinuing the product

 Unavoidable Fixed costs: those fixed costs that will continue to be

incurred even if the product line is discontinued

o Freed Capacity: if a product line, department, or store is discontinued,  management needs to consider what it would do with the newly freed

capacity

o Some products or departments stores would be hurt through discontinuing a  particular product or department store

∙ Pitfall to Avoid on Discontinuation Decisions: base decision on a product line  income statement that contains an allocation of common fixed expenses o Common Fixed Expenses: those expenses that cannot be traced directly to a  product line

o Segment Margin Income Statement: contain no allocation of common fixed  costs. Only direct fixed costs that can be traced to specific product lines are  subtracted from the product line’s contribution margin. All common fixed  costs remain unallocated, and are shown only under the company total

 Segment Margin: resulting operating income or loss for each individual  product line. Income resulting from subtracting only the direct fixed

costs of a product line from its contribution margin. It contain no

allocation of common fixed costs

Product Mix Decisions when Resources are Constrained

∙ Constraints: factor that restricts production or sale of a product

o Changing Assumptions: Product Mix when Demand is Limited: companies  must always consider companion products, which are products that

customers typically purchase together

∙ Outsourcing: contracting an outside company to produce a product or performed a  service

ExtraVariableCost per Unit ¿Outsource=VariableCost per Unit of Outsourcing−VariableCoste per Unit of Making ExtraVariableCost ¿Outsource=ExtraVariableCost per Unit ¿Outsource× Number of Units Needed Net ExtraCost ¿Outsource=ExtraVariableCost ¿Outsource−Savings on ¿ costsif Outsourcing o Determining an Acceptable Outsourcing Price:

Indifference Point=Costsof Making=Cost of Outsourcing

o Alternative Use of Freed Capacity:

 Opportunity Cost: benefit foregone by choosing a particular course of  action

o Potential Drawbacks of Outsourcing: when a company outsources, it gives  up control of the production process

∙ Offshoring: having work performed overseas. Can be performed by the company  itself or by outsourcing the work to another company

∙ Contract Manufacturers: manufacturers that only make products for other  companies, not for themselves

Decisions to Sell As Is or Process Further

∙ Considerations:

o How much revenue will we receive if we sell the product as is? o How much revenue will we receive if we sell the product after processing it  further?

o How much will it cost to process the product further?

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