INTR MANAGERIAL ACTG
INTR MANAGERIAL ACTG ACG 2071
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ACG 2071 Final Study Guide Ch 1 1 uestion39 Conce tual 0 Financial Accounting vs lVIanagerial Accounting 0 Managerial I Internal Users I NonGAAP I Divisionaldepartmental reporting as needed I Future oriented I Reports prepared as needed 0 Financial I External Users I Complies with GAAP I Companywide reporting I Historical I Reports prepared at the end of the accounting period Ch2 3 uestions 1Conce tual Cost Behavior The way a cost reacts to changes in activity levels 0 Cost Drivers The activity levels that cause costs to change 0 4 types of behavior Variable Fixed Step lVIixed Variable Cost Any total cost that varies in proportion to a business activity As the level of activity increases decreases the total cost increases decreases o Constant on a per unit basis 0 Varies in tota Fixed Cost Cost that remains constant in total as the cost driver activity changes 0 Varies on a per unit basis 0 Constant in total 0 Discretionary Fixed Costs Fixed costs that can be changed over the short run 0 Committed Fixed Costs Fixed costs that cannot change in the short run Step Cost Cost that remains constant for a small range of activity but then changes abruptly once outside of that range of activity Mixed Cost Cost that has both a fixed component and a variable component Cost Estimation Goal is to separate the mixed costs in to the variable and xed components 0 3 methods Visual t Regression Analysis HighLow Method only one on the test 0 Cost function I y mx b I y total cost I m variable cost per unit I x activity level of units I b total xed cost HighLow Method 0 Identify the highest and lowest levels of activity 0 Compute the variable cost per unit the slope of the line angle in total cost I Variable cost per unit Change 111 actlmty 0 Calculate the xed cost using either the high point or the low point I Fixed Costs Total Cost Variable Cost 0 Complete the cost equation by showing that I Variable cost per unit gtlt Units Fixed Cost Total Cost 0 Relevant Range Normal level of operating activity 0 Cost behavior only works within this range 0 Contribution Margin vs Gross Margin 0 Operating Income Sales Revenue Total Expenses 0 Gross Margin Sales Revenue COGS 0 Contribution Margin Difference between sales revenue and variable expenses In other words it is the amount that remains to cover xed expenses and provide a pro t Contribution Margin Sales Revenue Total Variable Expenses Q 0 Contribution Margin per unit Sales Price per unit Variable Cost per unit Contribution Mar in Contribution Mar in er unit 0 Contribution Margin Ration g g p Sales Revenue Sales Price per unit Ch3 3 uestions 1Conce tual Breakeven Analysis 0 Breakeven Point Sales revenue is exactly equal to total expenses There is no pro t or loss 0 3 ways to calculate Equation method contribution margin technique contribution margin ration technique 0 Equation Method 0 Sales Variable Expenses Fixed Expenses Operating Income 0 SPx VCx FC 0 I Use this when solving for units Operating Income is set to 0 when using equation method I SP Sales Price I VC Variable Cost I FC Fixed Cost I X units 0 When solving for dollars use ratios I Ex 5 65 4000 0 0 S Sales in dollars 0 Variable expenses are 60 of sales 0 Fixed expenses are 4000 0 Contribution Margin Technique Fixed Expenses Breakeven Point in Units Contribution Margin per unit 0 Contribution Margin Ratio Technique Fixed Expenses m Breakeven Paint in Dollars o Margin of Safety 0 Current Sales Breakeven Sales Margin of Safety CostVolumeProfit Analysis CV P o CVP Helps managers assess the impact of various business decisions on company pro ts 0 Target Operating Income 0 3 ways to calculate Equation Contribution Margin Contribution Margin Ratio 0 Equation Method 0 Sales Variable Expenses Fixed Expenses Operating Income 0 SPx VCx FC Target Operating Income I Use this when solving for units I Plug in target operating income I SP Sales Price I VC Variable Cost I FC Fixed Cost I X units 0 When solving for dollars use ratios I Ex 5 65 4000 20000 o S Sales in dollars 0 Variable expenses are 60 of sales 0 Fixed expenses are 4000 0 20000 is the target operating income 0 Contribution Margin Technique Fixe Ema arth in ating 1nwme Sales in units to reach target 01 Contribution Margin per unit 0 Contribution Margin Ratio Technique Fixed Expenses Target Operating Income Sales in dollarsto reach target 0 Contribution Margin Ratio Ch 4 11 Question Applying Overhead o Predetermined Overhead Rate 0 Application Base A measure that is correlated with overhead costs I Common application bases 0 Direct labor hours 0 Machine hours 0 Direct labor costs 0 Units of production Budgeted total manufacturing overhead cost o Predetermined Overhead Rate Budget ed total level of application base 0 Applied Overhead Predetermined Overhead gtlt Actual Amount of Application Base Underapplied Overhead Not enough overhead cost was charged to products as they were made 0 If there is a debit balance in the overhead account more overhead was incurred than was recorded in the Work in Process Inventory account 0 The inventory cost is too low and needs to be increased 0 To adjust for underapplied overhead Cost of Goods Sold xxx Manufacturing Overhead xxx 0 Overapplied Overhead Too much overhead cost was charged to products as they were made o If there is a credit balance in the overhead account more overhead was recorded in the Work in Process Inventory account than was incurred o The inventory cost is too high and needs to be decreased 0 To adjust for overapplied overhead Manufacturing Overhead XXX Cost of Goods Sold XXX 0 Prorating Underapplied and Overapplied Overhead o This is done when the amount of underoverapplied overhead is large 0 Prorate the accounts that contain overhead work in process nished goods COGS 0 Steps I Add together the ending balances of work in process nished goods and COGS I Calculate the percentage of the total represented by each of the accounts I Multiply each percentage by the underoverapplied amount to determine how much overhead should be charged to each account Ch 7 11 Question Activity Based Costing Activity Based Costing A costing technique that assigns costs to cost objects such as products or customers based on the activities those cost objects require 0 Activity based costing matches resources consumed with the products that consumed them Activity An event that consumes resources Activity Allocation Rate Method Total Activity Cost Total Activity Cost Driver Activity Proportion Method 0 Activity Proportion 0 Activity Rate Activity Cost Driver for each Product Total Activity Cost Driver Allocate Costs to Products or Services 0 Allocated Cost Activity Rate gtlt Activity Driver Consumption Ch 8 15 Questions Relevant Information Meets two criteria 0 Differs between the alternatives 0 Occurs in the future Avoidable Costs Costs that are incurred under one alternative but are not incurred under the other Avoidable costs are relevant Unavoidable Costs Costs that are incurred under all alternatives Irrelevant Sunk Costs Costs that have already been incurred in the past Irrelevant Decision Making 0 Opportunity Cost The contribution margin of the nextbest alternative use of the facilities Special Order Pricing A customer offers to purchase a large quantity of the company s product but wants to pay an amount less than the regular sales price Company decides whether to accept or reject the order 0 If a special order returns a positive increase in income take the order Outsourcing Moving the production of goods or the delivery of services from Within the organization to a provider outside the organization 0 Decisions involving whether to manufacture a good within the company or to have someone else do it are also called makeorbuy decisions 0 Watch out for avoidable xed costs 0 If the purchase price is less than the avoidable costs to produce outsource Allocating Constrained Resources 0 Constrained Resource Anything that limits a company s ability to produce products or provide services 0 Bottleneck The most constrained resource that limits the business ability to produce products or provide services 0 Contribution Margin per Constrained Resource I CM per constrained resource W constrained resouce per unit 0 Make as much of the most pro table product highest CM per constrained resource as you can up to the quantity demanded by customers Then make the 2quotd most pro table then 3r etc 0 Keeping or Eliminating Operations 0 Segment Margin Contribution margin of a particular segment less any direct xed costs 0 Direct Fixed Costs Fixed costs that can be attributed to one speci c segment These are avoidable costs 0 Common Fixed Costs Fixed costs that are shared by all segments Will continue to be incurred even if a segment is eliminated AKA allocated or assigned xed costs 0 Decide to keep or eliminate an operation 0 If segment margin is positive keep the segment 0 Sell or Process Further 0 Some products can be sold as is or processed further into a different product that can be sold for a higher amount with higher costs 0 Decide whether to sell the product as is or process further 0 If the processed product returns a positive increase in income make the decision to process further Ch 5 14 Questions The Cash Budget 0 Cash Budget Summarizes all budgeted cash receipts and disbursements for the period 0 Cash Available to Spend Cash Disbursements Cash Excess or Deficit 0 Cash Excess or Deficit Short Term Financing Ending Cash Balance Cash Available to Spend Beginning Cash Balance Cash Received Cash Receipts Budget Shows when and how much cash is expected to be collected from the sale of products or services 0 The company must review its past collections history in order estimate its collection patter and bad debt percentage this is given to us 0 The company then applies the pattern to the sales budget to determine the budgeted cash receipts from customers Cash Payments Budget Details when payments for material purchases will occur 0 Company must review its cash payments history and credit terms to develop a cash disbursements pattern given Apply the cash disbursements pattern to budgeted materials purchases to estimate when cash payments will be made Only cash payments should show up on the cash budget Noncash expenses do not result in a cash payment and do not affect the cash budget Financing Needs 0 To nd the cash excess cash de cit I Subtract the total cash disbursements from the total cash available to spend to determine whether the cash available to spend is enough to cover the budgeted cash disbursements for the period Subtract the minimum desired cash balance from the result in step 1 to determine the cash excess or cash needed Cash Excess Deficit Cash Available to Spend Cash Disbursements Minimum Desired Cash Balance 0 If a shortage of cash exists shortterm nancing will be needed I Ending Cash Balance Cash Available to Spend Cash Disbursements Short Term Financing 0 O ProForma Balance Sheet 0 Accounts Receivable Balance comes from the amount of uncollected credit sales on the cash receipts budget 0 Accounts Payable Balance comes from the unpaid purchases in the cash payments budget Ch 6 13 Questions 0 Variance The difference between the actual results and budgeted results 0 If actual sales gt budgeted sales the variance is favorable o If actual costs gt budgeted costs the variance is unfavorable Flexible Budgets 0 Flexible Budget Budget based on the actual sales volume achieved during the period Shows the revenues and expenses the company should have achieved based on the actual sales level during the period 0 Flexible Budget Variance Difference between the actual results and the exible budget Direct Materials Variances 0 Two causes for the exible budget variance in direct materials 0 Actual price paid for direct materials differed from the budgeted standard price 0 Actual quantity of materials used differed from the budgeted standard quantity allowed for the units produced 0 Direct Materials Price Variance 0 DM Price Variance ATQPWCl gtlt AP SP I ATQPWC h Actual quantity of materials purchased I AP Actual price paid per unit of material I SP Standard Price allowed per unit of material 0 Alternate Equation I DM Price Variance ATQPWCl X AP ATQPWCl gtlt SP 0 Favorable if the number is negative 0 Unfavorable if the number is positive 0 Direct Materials Quantity Variance 0 DM Quantity Variance lATQUSed STQI X SP I ATQUSGd Actual total quantity of direct materials used I STQ Standard total quantity of direct materials allowed for the units produced I SP Standard price per unit of direct material 0 Alternate Equation I DM Quantity Variance ATQUSed gtlt SP STQ gtlt SP 0 Favorable if the number is negative 0 Unfavorable if the number is positive Direct Labor Variances 0 Two causes for the exible budget variance in direct labor 0 Actual wage rate paid per hour of direct labor differed from the budgeted rate 0 Actual quantity of direct labor hours differed from the budgeted quantity allowed for the units produced 0 Direct Labor Rate Variance 0 DL Rate Variance AP SP gtlt ATQ I AP Actual rate per direct labor hour I SP Standard rate per direct labor hour I ATQ Actual total hours of direct labor 0 Alternate Equation I DL Rate Variance ATQ gtlt AP ATQ gtlt SP 0 Favorable if the number is negative 0 Unfavorable if the number is positive 0 Direct Labor Efficiency Variance 0 DL Efficiency Variance IATQ STQI gtlt SP I STQ Standard total hours of direct labor allowed for the units produced 0 Alternate Equation I ATQ gtlt SP STQ gtlt SP 0 Favorable if the number is negative o Unfavorable if the number is positive Ch 9 17 Questions 2 Conceptual Capital Budgeting Decisions 0 Capital Budgeting The process of evaluating an organization s investment in longterm assets capital assets 0 Screening Decisions Comparing a proposed project to a performance benchmark to determine whether the project should be considered further 0 Preference Decisions Determining which projects will receive funding by ranking the projects based on both financial and non nancial criteria 0 Most decisions focus on cash ows Time Value of Money 0 Present Value The current value of an amount of money to be received in the future 0 Present value is always smaller than the future value 0 PV Future Value gtlt Present Value Factor 0 Discounting Process of determining how much an amount of money to be received in the future is worth today 0 Discount Rate Interest rate used to discount cash ows to their present value 0 PV Tables 0 Use the PV of 1 to discount a single cash ow 0 Use the PV of an Annuity to discount a series of cash ows I The cash ows must consist of equal amounts occurring over equal amounts of time 0 Need to know the period of time and the discount rate I Use these to get the present value factor Net Present Value NPV 0 Net Present Value Discounted cash ow technique that discounts all future cash ows to their present value and then sums all of those present values 0 Calculating NPV 0 Identify the amount and timing of each cash ow 0 Determine the appropriate discount rate 0 Calculate the present value of each cash ow 0 Sum all of the present values 0 NPV 2 0 the project is acceptable 0 NPVlt 0 the project is unacceptable Internal Rate of Return IRR 0 Internal Rate of Retum Actual return expected to be earned by the project The rate of return where NPV equals zero 0 NPV gt 0 IRR gt Discount Rate 0 NPV lt 0 IRR lt Discount Rate 0 NPV 0 IRR Discount Rate 0 Calculate IRR o PVinflowsx PVoutflows 0 o PVinflowsx PVoutflows PVoutflows o x PVinflows o x PV factor I If x is not on the PV table use the rates it is between 0 Ex Ifthe PV factor falls between 16 and 18 then the IRR is between 16 and 18 0 When the annual cash ows are a different amount each year the IRR must be calculated by performing a series of NPV calculations until by trial and error the discount rate that yields a 0 NPV is found Profitability Index Compares the present value of the project s cash ows to the net initial investment PV of future cash flows Net initial investment 0 Profitability Index Payback Period 0 Payback Period The time it takes in years for an investment to return the original amount of invested capital Initial Investment Annual Net Cash Flow I For projects with even cash ows 0 Uneven cash ows I Investment to be recouped Annual net cash flow Investment remaining I Subtract net cash ow each year until the year s cash ow exceeds the investment remaining 0 Ex 5 years paid cash ow exceeds invest remaining in year 6 I You now know that this will be the final payment I To determine when in the final year the investment is paid off 0 Divide the amount of remaining cash ow by the cash ow in the final year 0 This will tell you what fraction of the year it took to pay off the investment 0 Ex 022 years 9 26 months I Add this additional payback period to the rest of the payback period 0 Ex 5 years 26 months 0 Payback Period 0 Limitations 0 Ignores time value of money 0 Ignores cash ows that occur after the payback period Accounting Rate of Return ARR 0 Accounting Rate of Retum Return generated by an investment based on its net operating income 0 Includes noncash expenses Annual 0 eratin Income 0 ARR 5 Net Intial Investment Ch 10 17 Questions 4 Conceptual Centralized Vs Decentralized Organizations 0 Centralization The organizational structure in which decisionmaking authority for the entire organization rests in the hands of one person or a small group of people in a single location 0 Decentralization Decision making authority is dispersed throughout the organization 0 Advantages I Lower level managers have the best information to make the daytoday operating decisions that affect their divisions Lower level managers gain decision making expertise and other management skills I Top managers can focus on more strategic longterm issues 0 Disadvantages I Potential for errors in decision making I Duplication of work efforts across the different divisions may occur I Lack of communication and sharing of ideas may occur 0 Responsibility Accounting Evaluation of managerial performance based only on those items over which the manager has control 0 Cost Center Division whose manger is responsible only for the costs incurred in the division Pro t Center Division whose manager is responsible for both the revenues and the costs incurred in producing a product or providing a service Investment Center Manager is expected to invest in assets that generate pro ts 0 Segment Any part of the organization that management wishes to evaluate 0 Segment Margin Income Statement An income statement that emphasizes those items that are under the segment manager s control 0 0 Performance M easures 0 Return on Investment ROI Measures the rate of return generated by an investment in assets 0 R0 Operating Income Segment Margin 01quot Average Operating Assets Average Operating Assets Beginning Asset Balance Ending Asset Balance 0 Average Operating Assets 2 o ROI can be improved by I Increase Sales Revenue I Decrease Expenses I Decrease Operating Assets 0 Residual Income Income that is earned above a speci ed minimum level of return 0 Residual Income Operating Income Average Assets gtlt Required Minimum Rate of Return 0 Segment Margin can be substituted for operating income 0 ROI vs Residual Income 0 Goal of ROI is to maximize the return a percentage 0 Goal of residual income is to maximize the return a dollar amount o ROI does not always lead to investment decisions that are in the best interest of the organization as a whole 0 Economic Value Added EVA A variation of residual income that measures economic pro t 0 EVA Net Operating Profit Invested Capital gtlt Weighted Avg Cost of Capital 0 Net Operating Profit Operating Income Income Taxes 0 Invested Capital Total Assets Current Liabilities o Weighted Average Cost of Capital WACC Combined rate of return required by all capital providers I Calculate WACC 0 Need to know the relative percentage of capital provided by each source as well as the required rate of return Multiply the cost of invested capital for debt by its share of invested capital Multiply the cost of invested capital for equity by its share of invested capital 0 Add those two numbers together to get the WACC I EX Source of Cost of Invested Share of WACC A X B Invested Capital Capital A Invested Capital B Debt 6 40 24 Equity 12 60 72 96 Transfer Pricing 0 Transfer Price The price at which the exchange between divisions takes place 0 3 approaches to determining the transfer price I MarketBased Price I Costbased and costplusbased price I Negotiated price 0 Market Based Price 0 Determined by monitoring similar trades that occur in the marketplace between unrelated parties 0 Highest price the buying division would pay 0 If the selling division is at full capacity this is the lowest price the selling division would accept o CostBased and CostplusBased Price 0 Costbased price The cost to produce the product 0 Costplusbased price Some markup is added to the product s cost I EX there is a 20 markup o The product costs 10 to produce 0 The transfer price would be 12unit 10 X 12 o If the selling division has excess capacity the lowest acceptable transfer price is the variable cost 0 Negotiated Price 0 Price that is agreed to by both the buying and the selling division 0 Should fall somewhere between the variable coast and the market price l N w P 5 m l 9 1 2 3 4 5 Managerial Accounting 1981 The process of identification measurement accumulation analysis preparation interpretation and communication of financial information used by management to plan evaluate and control within an organization and to assure appropriate use of and accountability for its resources Managerial Accounting 2008 A profession that involves partnering in management decision making devising planning and performance management systems and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization39s strategy Managerial Accounting the generation and analysis of relevant information to support managers39 strategic decision making activities Adds value by helping managers do theirjobs more efficiently and effectively Managerial accounting benefits internal users Information provided by managerial accountants isnot released to the public Managerial accounting has reporting rules ie quotGAAPquot Completely optional Because most managerial decisions are made at an operatingsegment level managerial accounting must focus on similar units ofthe company I Managerial accounting is historical in nature but helps make decisions that will affect the future I Precision is sacrificed fortimeliness I Someone with authority must take responsibility for decisions and directing the manager Managerial accounting is designed to assist managers with 4 activities 1 Planning 2 Controlling 3 Evaluating 4 Decision Making Managers participate in both shortterm and longterm planning activities 1 Lon term lannin Strate ic establishes the direction in which an organization wishes to go 2 Shortterm planning Operational translatesthe longterm strategy into a shortterm plan to be completed within the next year Controlling requires monitoring operations to identify problems requiring corrective action I Ex monitor operations to ensure smooth operations I Frequency depends on consequences I Faster corrected better results Evaluating once operations have been completed managers review the info and compare actual results to planned results may lead to changes Decision Making the forefront of managerial activity I Managerial accounting information can be provided by a controller a plant accountant a cost accountant a financial analyst a budget or cost analyst a general accountant or a chief financial officer I Notjust quotnumbercrunchersquot but decision makers A company MUST have goals Monitoring different strategies requires different accounting information Product differentiation will lookfor innovation ie quality design or service Lowcost production will set itself apart by offering a lower sales price A company that focuses on production differentiation must monitor product costs because if too much money is spent on quality the sales price will be too high to be competitive There are 4 strategiesthat can be classified based on a firm39s approach to market share 1 Build I Company aims to increase its market share and competitive position relative to others in the industry even at the expense of shortterm earnings and cash flows 2 Hold I Company seeks to maintain its current market share and generate a reasonable return on investment l 399 H 53 H H I Information needed Percentage of sales from repeat customers market share return on investment and gross margin 3 Harvest I Company focuses on shortterm profits and cash even at the expense of market share I Information needed Gross margin and cash sales 4 Divest I Appropriate when a company desires to exit a particular market I Companiesthat want to build market share need information about sales volumes sales growth market share growth sales from new customers and customer satisfaction Balanced Scorecard developed in the early 1990s by David Norton and Robert Kaplan a collection of performance measures that track an organization39s progress toward achieving its goals I The selections of performance measures to be included on the scorecard is driven by the organization39s strategy I Used to communicate the corporate strategy throughout the organization I Places equal emphasis on financial and nonfinancial performance measures Le financial customer internal business processes and learning and growth Managers should NOT be limited to what financial results or projections imply Supply Chain a network of facilitiesthat procure raw materials transform them into intermediate goods and then into final products and deliver the final products to customers through a distribution system I An interdependent system of suppliers and customersthat organizations operate within I Goal is to get the right product to the right location in the right quantities and the right time at the right cost I Supply chain management systems are for economic or strategic advantage Justintime Inventory JIT an inventory strategy that focuses on reducing waste and inefficiency by ordering inventory items so that they arrivejust when they are nee e I Eliminated extra inventory and it39s added costs I JIT inventory management results in a shorter production cycle and reduced financial investment in inventory I Must rearrange equipment for efficiency in some cases and quality is a MUST due to no extras in stock Enterprise Resource Planning ERP system such as SAP and Oracle to accumulate data and provide information to decision akers integrates all data from the company39s many business processes into a single information system l N w Jgt Sarbanes Oxley Act dictates rules for ethics code Managers must act ethicallyjust like employees I quotWalkthe walkquot Top unethical behaviors company resource abuse abusive or intimidating behavior lying to employees and email or internet abuse I Usually observed by mergers Commitment to ethicality experience better financial performance according to research l 0 Cost Behavior refers to the way in which total costs change in response to changes in the level of activity Va 39 ble Cost and total cost that varies in proportion to a business activity I ie 1 per minute I Activity any repetitive event that serves as a measure of output or usage such as units sold units produced minutes talked or miles driven Variable costs are two main characteristics 1 The total cost varies in proportion to changes in the level of activity The cost per unit remains constant regardless ofthe level of activity Fixed Cost does not change with activity level I Fixed costs have two characteristics 1 The total cost remains fixed regardless of changes in the level of activity 2 The cost per unit varies inversely with changes in the level of activity I One important distinction between different types of fixed costs is the period over which they can be changed I Discretionapy Fixed Costs fixed coststhat can be changed overthe shortrun I Committed Fixed Costs cannot be changed overthe short run 5 5 l N w 5 5 m l 8 H N w 5 I Companies should be careful about reducing their discretionary fixed costs during times of falling profits Step Costs fixed only over a small range of activity I Once that level of activity has been exceeded total cost increases and remains constant over another small range of activity Some costs have bother a fixed and a variable component I Referred to as mixed costs I Both the TOTAL cost and the M cost will vary with changes in the level of activity A large part of analyzing a business decision is predictingthe level of cost that will be incurred Total cost39 a combination of fixed and variable costs m variable cost per unit x level of activity b total fixed costs I y total cost Scatter graph a graph that shows total costs in relation to volume or activity level I Simplest method for estimatingthe fixed and variable components of a mixed cost HighLow Method requires only two data points the lowest point of activity and the highest point of activity I To estimate total cost using the highlow method 1 Identify highest and lowest point 2 Compute the variable cost per unit the slope of the line 2 v q 4 V n 1 3 Calculate the fixed cost using eitherthe high point or the low point 1 H quation by showing that 4 Complete the cost w w I May not truly represent the cost relationship because it only uses TWO points I Outliers GREATLY skew cost estimate More precise approach to separating a mixed cost is regression analysis a statistical technique that identifiesthe line of best fit for the points plotted in a scatter graph Cost behaviors and estimates are only valid when they are within the relevant range the normal level of operating activity Beyond the relevant range cost relationships are likely to change and with them cost estimates Estimation techniques based on a linear relationship are valid but ONLY OVER THE RELEVANT RANGE If an organization wants to make a profit it must generate more sales revenuesthan expenses I m m l m r39 Co tribution margin the difference between sales revenue and variable expenses The amount that remains to cover fixed expenses and provide a profit 3 v r i Co tribution Margin Rati the ratio ofthe contribution margin to sales iv ri II Cont 39bu I Does NOT change incomejust rearranges components 5 Variable Cost Ratio variable amounts divided by sales 1 ltnowingthe breakeven point helps managers evaluate the desirability and profitability of various business opportunities 2 Breakeven Point when sales revenue is exactly equal to total expenses and there is no profit or loss I Only one level of sales at which this is true I Set operating income equal to ZERO l Sales revenue and varIable expenses must be In a per unIt basIs h 39 a L w Pam 3 i39 1 3 Breakeven Graph illustratesthe relationship between sales revenue and expenses allowing managers to view a range of results at a single glance I The point at which the total sales revenue line and the total expense line intersect isthe breakeven point I Left Loss Right Income 4 When expenses go down operating profit goes up 5 Margin of Safety the difference between current sales and breakeven sales represents the volume of sales that can be lost before the company begins to lose money and can be measured in units or sales dollars l v r 1 CostVolumeProfit Analysis CVP helps managers assessthe impact of various business decisions on company profits I Helps find out how they can generate a PROFIT I Use same formula as breakeven but plug in for 0 I Adjusted formula 2 3 4 earn same profit 2 w ilt i w H leili iii1t i luguer u m 1 l in ml i 5 WHAT IF raise price by unknown amount because expenses have increased same profit igumwi Vin u 2 im xiii PH 1 I I w 6 The predictions provided bythe costvolumeprofit CVP analysis are only as good asthe data they are based on 7 When using CVP analysis you make the following assumptions I All costs can be easily and accurately separated into fixed and variable categories I A linear relationship exists between total variable expenses and sales activity overthe relevant range or interest I Total fixed expenses and variable costs per unit remain constant across all sales levels I Inventory is sold duringthe same period it is purchased or produced 8 To some degree overtime firms can control the relative size of variable and fixed costs in orderto establish a particular cost structure Lo H o H H H WNH P 5 m l l N w 5 Companies that carry a high level of fixed costs relative to variable costs are considered to have a greater level of variable costs relative to fixed costs Operating Leverage directly affected by the company39s cost structure the change in operating income relative to a change in sales I A company with high operating leverage will experience a large percentage change in operating income as a result of small percentage change in sales Degree of Operating Leverage a way to compute the expected change in operating income due to a change in sales volume at a given level of sales Degree of Operating Leverage contribution margin net operating income I Firms can manage their degree of operating leverage by converting variable costs to fixed costs and vice versa I With more fixed and fewer variable costs the cost structure creates a higher degree or operating leverage and thus a higher degree of risk I The payoff is bigger when sales increase and the downside is bigger when sales decrease As operating leverage rises more product must be sold to break even Sales Mix the sales of each product relative to total sales I Companiesthat sell multiple products need to know what results are required for the company not individual oducts to achieve certain targets Price and demand are inversely related quotPrice Takersquot when production and sales decisions of not affect the price of a product To justify a higher price a company must differentiate its product or service from that of competitors so that customers believe it is different enough to warrant the higher price CostPlus Pricing adds and amount to the cost of the product or service to cover the company39s operating costs and contribute to its profit Iliquot c391gtl i Markup the difference between the selling price and cost of product ost base expends fewer l I L quot I FLAWS I Price a customer will pay reflects value a markup is not a value to a customer I Impliesthat the cost of the seller39s operational inefficiencies should be borne bythe customers and customers don39t care Target Costing starts with the price customers are willing to pay computes that desired markup and maximum cost the company can incurto deliver a product or service at the market price 241liiil ul l 397 Period Costs costs related to the selling and administrative functions I Costs in a manufacturing business are factored into inventory cost Product Costs Manufacturing Costs any costs that a company incurs to acquire raw materials and convert them to finished goods ready for sale I 3 Categories direct materials direct labor and manufacturing overhead Direct Labor the wages and possibly benefits paid to the workers who transform direct materials into a finished product I To be considered direct worker must have physically come in contact with the product while it was being made Direct Labor Hours time spend working by direct labor workers Overhead the indirect product coststhat arise in the manufacturing process and that cannot easily be traced to a unit of product I AKA manufacturing overhead factory overhead manufacturing support factory support manufacturing burden orfactory burden Cost incurred to support factory but isn39t direct labor or direct material 6 Indirect Materials the supplies used in supporting the production process may or may not be part of the final product I ie cleaning supplies to keep a clean factory electricity water etc 7 Indirect Labor the labor cost of all the workers who support the production process I ie janitors supervisors guards etc 8 Period Costs Nonmanufacturing Cost any cost that is not a product cost I Associated with the selling of products and the administration ofthe business I Expensed the same period they are incurred 9 Selling costs costs that are associated with the storage sale and delivery of finished goods I ie rents salaries advertising etc 10 General and Administrative Costs all costs associated with the general management ofthe company that benefit the company as a whole 1 Raw Materials Inventopy includesthe cost of purchased items used to make products 2 Supp es Inventory materials used indirectly to produce a finished product I Rubber bands cleaning supplies etc 3 WorkinProcess Inventory records the costs of all productsthat have been started but not completed I Labor and manufacturing overhead are reported in this account as incurred 4 Finished Goods Inventopy records all the production costs of completed products I Final Inventory account Costs are transferred between accounts as product moves in stages 5 Cost of Goods Manufactured the total cost of all the food unites completed during the accounting period I The cost of everythingthat is finished duringthe period whether or not it was started during the period 6 Gross profit includes all product costs regardless of behavior 7 Contribution margin includes all variables regardless of function 8 I 39 39 7 41 I 1 Job Order Costing System products are manufactured in batches orjobs and product costs are accumulated for each batch orjob When thejob is completed the total costs accumulated for thejob are divided bythe number of units produced to determine the average cost per unit 2 Job Cost Sheet accumulates and summarizes all the costs incurred during thejob 3 Materials Reguisition Slip releases direct materials from the storeroom to the factory floor 4 Bill of Materials each product has their own lists all the materials required to make a single unit ofthe product A quotrecipequot 5 Time Ticket records start and end times ofjobs along with employee name date andjob number I Clocking in and out 6 Due to lack of traceability manufacturing overhead must be divided among the different jobs or products a company makes 7 Overhead Application dividing or allocating overhead to variousjobs 8 Applied Overhead he amount of manufacturing overhead allocated to eachjob THREE reasons to allocate overhead Lo 10 Predetermined l N w P Unlike direct materials and labor costs the amount of manufacturing overhead actually incurred by the company may not be known at the time a job is being worked on ie property tax Some overhead costs are seasonal ie cost of electricity Fixed manufacturing overhead costs are not always related to the number of units produced ie ent Overhead Rate based on an application base and the budgeted manufacturing overhead costs the total overhead costs the company expects to incur during the year 2 I I Application Base a measure that is correlated with overhead costs I Common ones are direct labor hours DLH machine hours MH direct labor costs DL and units of production At the end of the accounting period the actual overhead incurred during the period will equalthe applied overhead for the perio I The manufacturing overhead control account will show a balance I Te p rary account Under Applied Overhead not enough overhead cost was charged to products as they were made I When manufacturing overhead control account has a DEBIT balance Over Applied Overhead more overhead was recorded in the Work in Process Inventory account than was actually incurred duringthe period When manufacturing overhead control account has a CREDIT balance If the amount of under applied or over applied manufacturing overhead is relatively large the more appropriate treatment is to prorate the amount to all the accountsthat contain applied overhead gt work in process inventory finished goods inventory and cost of goods sold I T proration should be based on the relative size ofthe ending balance in each account STEP 1 ADD ending balances of Work in Process Inventory Finished Goods Inventory and COGS accounts STEP 2 Find PERCENTAGES of total STEP 3 MULTIPLY percentage by the OVER APPLIED or UNDER APPLIED amount l N w P Activity Based Costing ABC a costing technique that assigns costs to cost objects such as products or customers based on the activitiesthose cost objects require Activity an event that consumes resources I Ordering materials processing purchase orders setting up machines etc With ActivityBased Costing ABC the goal is to allocate a cost in a manner that reflects the amount of each resource consumed by the activities performed to produce a specific product Indicatorsthat an activitybased costing analysis may be appropriate include I Complex bids accepted simple bids rejected I Highvolumejobs bring in lowto no profit lowvolumejobs bring in good to high profit I Bids for quotspecialquot jobs are always accepted I Some manufacturing departments run at capacity whereas others have minimal operations Including nonproduct costs in the activitybased costing analysis means that the resulting costs can M be used for GAAPbased financial reporting of inventory or cost of goods sold FIVE categories of Activities Unitlevel Activities performed for each individual unit of production Batchlevel Activities performed all at once or in groups batches I Batch consumes the same amount of resources whether its 1 or 100 Productlevel Activities AKA productsustaining activities activities that support the products or services a company provides I Performed for entire product line regardless of unit number 4 Customerlevel Activities performed for specific customers I Sales calls Organizationlevel Activities required to provide productive capacity and to keep the business in operation I Renting factory space managing the organization 2 5 5 STEPS TO IMPLEMENT AN ACTIVITVBASED COSTING SVSTEM 1 Identify activities performed how much time to spend performing each activity I Activities from different categories should not be combined 2 Develop activity cost pools and combine I Activity Cost Pools groups based on cost drivers I Once activity pools have been determined manufacturing overhead costs can be assigned I FirstStage Allocation assigning manufacturing overhead costs to activity pools 3 Calculate activity cost pool rates by calculating an activity rate 4 r r Lin r m2 4 Allocated costs to products or services 1 ActivityBased Management the process of using activitybased costing information to manage a business39s activities Used for product costing and cost control and to make decisions regarding pricing customer profitability distribution channel profitability and process improvement 2 Nonvalueadded Activities activities that consume resources but do not contribute to the value of the product 3 Valueadded Act39 s activities that create the product the customer wants to uy I As nonvalue added activities and their associated resources are eliminated a company39s costs will decrease 4 Process Improvement the examination of business processes to identify incremental changesthat may reduce operating costs 5 Business Process Reengineering BDR a managerial tool that focuses on improving the efficiency and effectiveness of an organization39s business processesthrough radical change 6 A company that is interested in maximizing profits will instruct its sales force to emphasize its most profitable products m r r 7 ActivityBased Budgeting he practice of using activitybased costing information and knowledge about activities and resource consumption to prepare an organization39s budget I Based on the activities that will be performed to support the planned level of production