Cost Accounting for Managers
Cost Accounting for Managers ACCT 310
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Chapter 48 Notes Page 1 Support Departments l This Appendix continues our discussion of different methods that companies use to allocate their Manufacturing Overhead to their products or services We have already discussed dividing a firm s operations by Production Departments also known as Operating or Producing Departments and using Departmental Application Rates A refinement to that approach is to include Support Departments also known as Service Departments in this division By dividing its Manufacturing Overhead into multiple Support and Production Departments a company is attempting to better match its overhead to the products that generated it When the departments are labeled cost centers then Support Departments are referred to as Intermediate Cost Centers and Producing Departments are referred to as Final Cost Centers In a manufacturing context Production Departments are the departments that actually produce the product being manufactured eg assembly department mixing department bottling department andor packaging department In service industries Production Departments deliver services directly to their clients eg an accounting firm s auditing department tax department andor consulting department Support Departments do not actually produce the products or services provided to customers Instead they provide support services eg security department maintenance department word processing department legal department andor computer service 7 department that help the Production Departments to provide the products or services to their customers Manufacturing Overhead support that cannot be identified with a department is placed in a general Department overhead department Support Departments are part of the Manufacturing Overhead of the factory and their cost represents part of the overhead of the Production Departments The cost of the Support Departments will be allocated to the Production Departments When the Production Departments receive the allocated Support Departments costs these costs i become part of the overhead cost of the Production Departments and ii are allocated to the goods or services produced by the Production Departments along with the other overhead costs of the Production Departments Each Support Department should choose the Cost Driver that gives the most accurate reflection of how its services are consumed They are free to use different Cost Drivers Please Send Comments and Corrections to me at mconstascsulbedu Chapter 48 Notes Page 2 Example Consider the Firm a prominent Memphis law firm The Firm divides its lawyers into two Production Departments i the Corporate Department and ii the Litigation Department The Firm also has Support Departments One of those Support Departments the Word Processing Department provides word processing services to the Corporate and Litigation Departments Word Processing 200000 100 Hours 50 Hours Corporate Law 40 Hours Litgation Law The 200000 cost of the Word Processing Department is really part of the overhead cost of the Corporate Department and the Litigation Department It you allocate the cost of the Word Processing Department based upon the hours worked for each department Cost Driver then the Corporate Department will be allocated 60 of the cost of the Word Processing Department Also the Litigation Department will be allocated 40 of the cost of the Word Processing Department mum rmmuu THE FIRM Interactions Between Support Departments It you have multiple Support Departments that provide services to each other then you have to consider how to deal with this interaction between the Support Departments Assume that the Firm has two Support departments Word Processing and Recruiting 10 Hours Recruiting Word Processing 200000 200000 60 Hours 50 Hours 50 Hours Litrgatron Department Corporate Department Please Send Comments and Corrections to me at mconstascsulbedu Chapter 48 Notes Page 3 A small portion 909 of the 200000 Word Processing cost is a Recruiting cost and a small portion 476 of the 200000 Recruiting cost is a Word Processing cost each Support Department gives part of its cost to the other Support Department then each Support Department would have new costs that need to be allocated to all of the Departments to whom it provides services including the other Support Department These allocations would go back and forth between the Support Departments at a diminishing rate because most of the allocated cost would go to the Production Departments This can be seen in the diagrams appearing below circuitous Allocation Word Processm m an 91 mama I 479X g Dann so 51 359523 St 1518 52 V 4 75 X 9 05 N 30 31y 55 E 311565 an 55 W V l 75 X 905 J W57 30913 Seam mu I95 24 545 24 Word circuitous Allocation Recruntlng Processmg Litigation Companies give varying degrees of recognition to the interaction between Support Departments by using three alternate methods to allocate Support Department costs to the Production Departments i the Direct Method ii the StepDown Method and iii the Reciprocal Method A firm selects the method that provides it with an acceptable level of accuracy at an acceptable cost 364 476 9 m a g a m S a m 3 n 2 c u 9 r E E a 2 2 a E 3 m S 2 O u E 3 D 3 9 m o a O m Total Allocated I Direct Method I With the Direct Method you allocate the cost of the Support Departments to the Production Departments without any recognition of the services that the Support Departments provide to each other Applying the Direct Method to the Firm39s two Support Departments you would allocate the cost 0 the Support Departments to the two Production Departments ignoring i the 10 hours of work done by Word Processing for Recruiting and ii the 5 hours of work done by Recruiting forWord Processing Please Send Comments and Corrections to me at mconstascsulbedu Chapter 48 Notes Page 4 Corporate Litigation W d P 39 60100 X 200000 40100 X 200000 582 053 95539 9 120000 80000 Recru in 50100 x 200000 50100 x 200000 200 0009 100 000 100 000 Allocated Costs 220 000 180 000 Note that we allocated all of the cost of the Support Departments 200000 200000 400000 to the Production Departments 220000 180000 400000 The purpose of each of these three methods is to allocate the aggregate amount of Support Department costs to the Production Departments If you do not allocate all of the Support Department costs to the Production Departments then you have made a mistake StepDown Method s1gtszsaP1ampP2 The next method that we will discuss is called 52235151122 the StepDown method It is also called the Step Method or the Sequential Method Under the StepDown method you allow one Support Department to allocate its costs to the other departments both Support and Production to whom it provides services Once the first Support Department allocates its costs it drops out of the process and it does not receive an allocation of cost from the other Support Departments After the first Support Department allocates its costs then a second Support Department allocates its costs to the departments Producing and Support to whom it provides its services other than the first Support Department and then the Second Support Department drops out of the process This procedure is followed until all of the Support Departments have allocated their costs and have dropped out of the process The allocation procedure goes down the steps not up This is a oneway allocation of Support Department costs The oneway nature of the StepDown Method means that it only partially recognizes the interaction between the Support Departments How do you decide the order in which the Support Departments allocate their costs Your book notes that it is common to base the order on the dollar amount of costs that each Support Department has to allocate largest goes first While this is a simple rule to implement it does not provide the most accurate allocation Most authorities recommend that you should start with the Support Department that does the highest percentage of its work for the other Support Departments In the above example Word Processing does 909 10110 of its work for Recruiting On the other hand Recruiting does 476 5105 of its work for Word Processing Thus on a percentage basis Word Processing does more work for Recruiting than Recruiting does for Word Processing Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4B Notes Page 5 Recruiting Corporate Litigation Word processing 10110x200000 60110x200000 40110x200000 200 000 18182 109091 72727 Recruiting 50100 x 218182 50100 x 218182 218182 200000 18182 109 091 109 091 Allocated Costs 18182 218182 181 818 Note that we have again allocated 400000 of Support Department costs to the Production Departments 218182 181818 400000 Remember that if you have not allocated the aggregate original cost of the Support Departments to the Production Departments then you have made a mistake Often managers are uncomfortable with the fact that we are allocating more than 400000 in the rows of the allocation table 200000 218182 418182 You have to remember that Word Processing has said Here Recruiting you take 18182 of my cost and give it to the Production Departmentsquot Although this amount 18182 appears twice in the rows of the table it is given to the Production Departments only m by Recruiting As noted above we allocated only 400000 to the Production Departments If i there are more than two Support Departments and ii the order in which the Support Departments allocate their cost is based upon the percentage of work that the Support Departments do for each other how do you decide the order by which the remaining Support Department allocate their costs after the first allocation by a Support Department You would still compare percentages of work done for other Support Departments however there would be a new calculation of this percentage after each allocation by a Support Department In making these later percentage calculations you would disregard any work that the remaining Support Departments did for the Support Departments that have already allocated their costs eg the first Support Department and select the Support Department that does the highest percentage of its work for the remaining Support Departments that have not yet allocated their costs For example assume that there are three Support Departments S1 S2 amp SS that perform the following services for the other Support Departments and the two Production Departments P1 amp P2 Departments Receiving Allocation Support Department Making Allocation g g g E Q Total S1 20 20 30 30 100 S2 25 5 40 30 100 83 25 25 30 20 100 In this example SS would allocate its costs first because it performs 50 of its services for the other Support Departments S1 does 40 and S2 does 30 Despite the fact that S1 does more of its work for the other Support Departments than does S2 S2 Please Send Comments and Corrections to me at mconstascsulbedu Chapter 48 Notes Page 6 would allocate its cost next because you do not count the work done for the Support Department that has already allocated its cost SS Without counting the work done for SS S1 performs a higher percentage of its work for the remaining Support Department 25 than S1 does 20 Reciprocal Method We will now discuss the Reciprocal Method which is also known as the Simultaneous Method and the Reciprocal Allocation Method Under the Reciprocal Method you fully recognize the services that the Support Departments provide to each other The Support Departments allocate their costs to all of the departments to whom they provide services including the Other Support Departments As noted above this allocation could initiate multiple rounds of circuitous allocations As noted above in the Firm example six rounds of allocations would result in Word Processing allocating total costs of 21043480 and Recruiting allocating total costs of 21912040 To avoid the need to actually make these six rounds of allocations we can calculate the amounts that each Support Department will ultimately allocate after all these circuitous allocations are completed We can then have each Support Department make one allocation of this final amount in our allocation table In order to calculate the total amount that will be allocated by each Support Department you would first set up a cost function for each Support Department Using the Firm example R 200000 10110xWP Recruiting will allocate its original 200000 of costs plus the share of Word Processing s cost that it receives from Word Processing Recruiting receives 909 101 10 of Word Processing s cost WP 200000 5105 R Word Processing will allocate its original 200000 of costs plus the share of Recruiting s cost that it receives from Recruiting Word Processing receives 476 5105 of Recruiting s cost You now solve these equations for the two unknown variables WP amp R Start with the Recruiting cost equation R R 200000 10110 x WP The Word Processing WP cost equation gives you the amount of cost that the Word Processing Department ultimately allocates to all of the departments which is the WP variable that appears in the Recruiting R cost equation above Since they are equal we can replace the WP variable in the R cost equation by the right hand side of the WP cost equation R 200000 10110 x 200000 5105 x R Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4B Notes Page 7 Now you have one equation with one unknown variable R You now solve for R 200000 181818 00433R 2181818 004329R 2181818 2181818 2181818995671 21913042 R 004329 995671 333333 You now know that Recruiting will ultimately allocate 21913042 to all the departments You now substitute this value for the R variable in the WP equation WP 2000005105xR WP 2000005105x21913042 WP 2000001043478 WP 21043478 You now know that Word Processing will ultimately allocate 21043478 to all of the departments Note that 21913042 Word Processing and 21043478 Recruiting are the same amounts that we calculated earlier by making the six rounds of allocations If you had more than two Support Departments you would have needed to use Matrix Algebra in order to solve for the multiple unknowns You will not be given a problem in this class that requires the use of Matrix Algebra Each Support Department allocates the total cost that we just calculated Because a Support Department does not allocate any of its cost to itself we will place an X in the cells of the table where a Support Department would allocate a cost to itself Word Processing Recruiting Corporate Litigation Word Proc 10110 x21043478 60110x21043478 40110 x21043478 210 43478 X 1913043 11478261 7652174 200000 1043478 Recruiting 5105x21913042 50105x21913042 50105x21913042 21913042 10 43478 x 104 34782 104 34782 200000 1913043 Allocated Costs 1043478 1913043 219 13043 180 86956 Note that except for a small rounding error we allocated 400000 of Support Department costs to the Production Departments If this is not true then you made a mistake Support Department Costs Are Allocated To The Production Departments Word Processing Recruiting Corporate Litigation 200000 200000 21913043 18086956 400000 39999999 Please Send Comments and Corrections to me at mconstascsulbedu Chapter 48 Notes Page 8 Also note that each Support Department only allocated its original cost plus the cost that it received from the other Support Department Word Processing Recruiting Original Cost 20000000 20000000 Received From Other Dept 10 43478 19 13043 Total To Be Allocated 210 43478 219 13043 If this is not true then you have made a mistake Please Send Comments and Corrections to me at mconstascsulbedu Chapter 131 Notes Page 1 j Constraints j l Constrained Optimization j We will now consider how to maximize Sales Revenue amp Contribution Margin or minimize costs when dealing with limited resources constraints We will first discuss using the graphical approach to solving these constrained optimization problems Then we will discuss how to use Excel to solve these problems The first thing you need to do is to state your Objective Function This is your goal the object of your analysis The Objective Function should state your goal eg maximize or minimize something along with a mathematical formula for the item that you are maximizing or minimizing eg Revenue Contribution Margin or Cost The Objective Function Variables should be your alternative courses of action eg the number of each type of product that you will produce For example assume that Karloff Bolt Company makes two types of bolts Bolt A and Bolt B Bolt A has a Unit Contribution Margin of 10 and the Contribution Margin per Unit for Bolt B is 12 You want to know how many units of each bolt Karloff should produce in order to maximize its total Contribution Margin The Objective Function is Maximize 10A and 12B where A is the number of A Bolts that you will produce and B is the number of B Bolts that you should produce A and B are the Objective Function Variables Without more information Karloff would produce an infinite number of each type of bolt and thereby make an infinite total Contribution Margin In reality there is a limit to the number of bolts that can be produced Please send comments and corrections to me at mconstascsulbedu Chap er 1371 No es Page 2 Le us assurne ha eaon boH mum oass Hrough ne VoHowmg o nree machmes and ne urne reourreo on eaon rnaonrne omers as snown rn ne ab e e ow Machine Machine Machine Iquot A BOH 1mm 1mm mm B BOH 1mm 4mm 5mm n a day Were are 240 720 and 150 mmu es avaHab e on Maonrne M Maonrne H and Maonrne m respecuve y K non waan 0 know now rnany 0V eaon type 0V boHs n Shou d produce m a day We now have 0 add hese cons ram s 0 our Objecuve Funcuon Des roblem ans rs ne oorecuve Funcuon Max mm 12 Tnese are me cons rarn s subre H You omy nave 240 mmmes avaHab e on Machme A B s 2 0 A AB 5 720 You omy nave 5 es You can manmac ure a negauve nurnoer 0V boHs nave 0 graon ne area 039 orooucuon na mee s 3H 039 hese cons rawms ne Tne gra n Shou d consrs ov a 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1he po1h1 where 1he 11he crosses 1he Arax1s has zero as 1he B cooro1ha1e so we rep1ace B w11h zero 1h 1he equauoh aho so1ve or 1A 1B 240 1A 10 240 1A 240 A 2401 A 2400 s e know 1ha1 1he 11he crosses 1he Araxm a1 2400 0 We how wah11o see where he 11he crosses 1he Bram We know 1ha1 A 1s ze o a1 ahy po1h1 oh 1he 873x18 ThereVore 1he po1h1 where 1he 11he crosses 1he Bram has zero as 1he A cooro1ha1e 80 we rep1ace A w11h zero 1h 1he equauoh aho so1ve1or B 1A 1B 240 110 1B 240 1B 240 B 2401 B 24m 80 we know 1ha11he 11he crosses 1he Bram a1 0 24m W11h1hese 1wo po1h1s you cah how gr ph1he11he we a zouu MID we A Wease Send commems and correcuons 0 me a moons asgcsu b edu Chap er 1371 No es Page 4 Now we need 0 orck ne srde or We Mme na sausvres W8 rneouamy Tne easres way 0 do W8 rs 0 es one pow on one srde or me hne You em a pow by subsmuung ne coordma es mo ne rneouamy Vormu a and check 0 see u coordma es produce a varue ha sausvres ne nequah perm on ne sarne srde 0V ne We as ne perm es ed wm sausry We rneouamy n rs easres 0 use We ongrn 0 0 0 es whemer ne rneouamy rs rue because you are deahng wun zeros as ne vanaores 80 orug ne ongrn mo ne rneouamy and see u ne rneouamy rs rue vor na perm A 15 240 nequahiy 10 10 o s 240 True S a emem So we know ha ne Feasrore Regron vor ne Wm cons rarm rncrudes ne srde 0V ne me ha comams ne ongrn Tne Feasrore Regron ha sausvres ne mm and as cons rarm comma or ne voHowrng we a zouu MID we A To graon ne second cons rarm 1AAB 720 we wam 0 graon ne Mne 1A 4572 We know ha W8 hne crosses ne Araxrs a 0 72m P ease Send commems and correcuons 0 me a moons asgcsu b edu Chap er 1371 No es Page 5 We know 073 MS hne crosses We Brews a 1800 U By esung me ongm we see ha me srde ma comams me ongrn saushes me rnequamy A AB 720 nequahly 10 40 720 Tes We Ongrn o s 720 True S a emem or we know ha We Feasrore Regron or We second cons rarm rncwoes me sroe or me hne ma comams me ongrn The Feasrore Regron ma sausvres We W8 second and as cons rarms consrs s 0V me voHowrng we a zouu mu zouu 72mm we A To graoh me mrrd cons rarm 1A SB s 150 we wam 0 graph me Mne 1A 5515 We know ma W8 hne crosses me Anaws a 0 1 00 1A SB 150 1A 50 150 1A so A 1501 A 15cm P ease Send commems and correcuons 0 me a moons asgcsu b edu Chap er 1371 No es Page 5 We know ma ms hne crosses me Bram a 22m 1A B 150 may B 150 5B 150 B 1505 B 320 By esung me ongm we see ha me swde ma comams me ongm sausnes me mequamy A 585180 nequahiy 10 50150 Tes me Ongm 0 5180 True S a emem 80 we know ha me Feaswb e Regwon vor me mo cons rawm nc udes me swde 0V me me ha comams me ongm The Feaswb e Regwon ha sausnes aH 0V me cons ram s 8 me voHowmg we a zouu am am mu 72mm Yype A The Vac men We Feas b e Reg on no onger ouches We hnes Vor We WS and Second cons ram s eHS you men We WS and Second cons ram s are no bmdmg The me on Once you have demmed me area mm sausnes aH 0V me cons rawms you have 0 oeooe wmoh poms wnhm me Feaswb e Regwon maxwrmze your oomnouuon Margm The comers poms ov me Feaswb e Regwon are me mom ex reme pom s and hereVore mey represem me producuon eve s ma produce me mos ex reme Comnbuuon Margms e g y me mghes and owes oomnouuon Margms P ease Send commems and correcuons 0 me a moons asgcsu b edu Chapter 131 Notes Page 7 In order to find the highest Contribution Margin you plug each of these corner points into the original Objective Function 10A12B and check to see which corner point produces the highest Contribution Margin Corner 10A12B Contribution Margin 16000 1 1600120 1600 16000 0 320 1 0 12 320 0 384 3840 00 1 0120 00 0 The firm will generate the highest Contribution Margin by producing 1600 A Bolts and no B Bolts Using Excel To Solve Constrained Optimization Problems We can solve these Constrained Optimization Problems using Excel You need to have one cell on your Excel spreadsheet represent the value of each of your two Objective Function Variables number of A Bolts and number of B Bolts Excel will place the optimal value in these cells after it solves the problem For now give A Bolts a value of 10quot and give B Bolts a value of 20quot so that you can tell if your other formulas are correct Cell Label Cell Contents A Bolts 10 B Bolts 20 You also need to have another cell represent the value of the Objection Function formula using the values in your Objective Function Variable cells Cell Label Cell Contents Objective Function 1A Bolt Cell12B Bolt Cell For your constraints you need to have a separate cell for each constraint The cell will contain the value of the side of the constraint inequality formula that uses the Objective Function Variables eg the time on each machine uses the number of each type of bolt produced The side of the constraint inequality formula containing the fixed value will be supplied later M m Time on Machine 1A Bolt Cell1B Bolt Cell Time on Machine ll 1A Bolt Cell4B Bolt Cell Time on Machine lll 1A Bolt Cell5B Bolt Cell Please send comments and corrections to me at mconstascsulbedu Chapter 131 Notes Page 8 Your spreadsheet should look something like the following A B C Objective Function 1BA12 BS No of A Bolts 10 No of B Bolts 20 Time on Machine 1 B41BS BA4 BS Time on Machine ll Time on Machine lll 1BA5 BS 10 Now select Tools on the Menu Bar and then click on Solver If you do not see Solver select AddIns and then select Solver Addln Once you select Solver the following dialogue box will open Solver Parameters jn 1 0 Mn 0 1m nF For Set Target Cell click on the cell that contains the Objective Function For Equal To click whether you want to maximize the Objective Function or minimize it For By Changing Cells highlight the two cells that contain the Objective Function Variables For Subject to the Constraints click on Add and the following dialogue box will open Add Constraint Cell Bafevance39 gcnstralnt 7l Add For each constraint i the left box should name the cell that contains the portion of the constraint inequality that contains the Objective Function Variables ii the middle box Please send comments and corrections to me at mconstascsulbedu Chapter 131 Notes Page 9 should give the proper inequality symbol and iii the right box should contain the fixed value portion of the constraint inequality For each nonnegative constraint eg AZO i the left box should name the cell that contains the Objective Function Variable ii the middle box should have gt as the inequality symbol and iii the right box should contain 0 as the fixed amount In our example we have the following constraints Subject to the Constraints B4 gt 0 B5 1 U 153 lt 240 BB lt r20 B9 lt 160 Once you have entered all of this information click on Solve Excel will change the values in the Objective Function Variable cells to reflect their optimal value You can see that Excel gives the same answer that we got using the graphical method produce 1600 A Bolts and zero B Bolts IObjective Function 160 Solver Results 5 l n all mnstvaints and avhmalilY No of A Bolts 1600 No of B Bolts Time on Machine 160 Time on Machine 160 Time on Machine I 160 A Solver Results dialogue box will open Leave Keep Solver Solution checked Also under Reports click on Answer and Sensitivity When you click OK two new worksheets will be created on your spreadsheet the Answer Report 1 sheet and the Sensitivity Report 1 sheet The Answer Report 1 sheet contains a description of your constraints and indicates which ones were binding Answer Report 1 indicates that the constraints involving Machines and II are not binding We noted the same thing when we used the graphical approach Notice that Please send comments and corrections to me at mconstascsulbedu ChapterH No1es Pagem Exoe1 says m1 vesmotmg me a ao11s1o a nonrnegawe answev was bmdmg Ms move A Eons Fov examp ey 1 a oouu be 11 men you oou1o obtam an em 30 seconds on Maohme 111 Ms wou1o aHow you 1o pvoduoe 5 move A Eons and s1ay wmhm the oonsuam 1Ae5a 11aoo 51 111305 5171 negatwe one a EON wouu oos1 you 12o a neganye Comnouuon Mavgm ou1 me A ao11swou1d pvoduoe an addn1ona100nmbut1on Mavgm o1 50 Thus 11 you oou1o go negawey me n neganye a EON wou p1 uoe a maygma1 mom o1 ago Ms po1en11a1 1s vepon pon 1 1 The 11ye ed asme Reduoed Gvad1emquot on Sensmyuy Re Au us1ab1e 0e11s F39ml Reduced Cell Name Value Gm 1 m4 Nu u1AEu11 1 s 1 m5 Nu uvaams EDD n n in aannnnm Cunsnsms r ml Lagrange a M er Cell Name v Iue M7 Tyne un Mam 1 151 1 ma my rm Marhm n my Tyne un Macmne 111 151 1 The Lagvange Mumphev 1sthe 8hadow Pnoequot o1 a mmu1e on Maohme 111 111eponsma1 e w1H1ng 1o pay up 1o 51 1o1an exua mmme on Maohme 111 Vou can s e owma1 each A EON 1akes 1 mmu1e on Maohme 111 1 pvoduoe 10 A Eons W101 an em mmme on Maohme anh A Eon pvoduoes a Comnouuon Mavgm o11oo Thus an em mmme on Maohme 111 wmoh aHows us1o pvoduoe 10 A Bo11s1swonh 1 10ox101o us P1ease send oommen1s and ooneo11ons1o me a1 moon a osmb edu Chapter 13 Notes Page 1 Relevant Costing In making decisions the following steps are taken Define the problem Identify the feasible alternatives Identify the costs of each feasible alternative Compare the relevant costs and benefits and Select the alternative with the greatest net benefit The key part of this analysis is to consider only the information that is relevant to the decision being made Relevant Costs amp Benefits Relevant costs and benefits are costs and benefits that are different between the alternatives being considered Costs that are the same regardless of which alternative is chosen have no impact on the decision making process How can they Their impact on each alternative is exactly the same For example assume that you rent a boat for 1000 a month Also assume that you can operate either a harbor tour business or a fishing business using that boat The following revenues and costs would be generated from the alternative uses of the boat Fishing Tour Difference Revenue 8000 10000 2000 Expenses 1000 4000 3000 Rent 1 000 1 000 0 Profit 6 000 5 000 1 000 You will generate 1000 more profit if you choose the Fishing Business alternative Your decision to operate a Fishing business would remain unchanged if you had not considered the rent Fishing Tour Difference Revenue 8000 10000 2000 Expenses 1 000 4 000 3 000 Profit 7 000 6 000 1 000 With either calculation the Fishing business produces a profit that is 1 000 higher than the Tour business If a particular cost is the same under both alternatives eg rent that cost is not relevant to the decision of which alternative to choose Including such a cost in your analysis might cause you to make the wrong decision The purpose of this analysis is to make a decision as to which alternative to choose The bottom line profitcost that appears in the table is not important to our analysis and it does not have Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 2 to reflect all of the revenues and costs associated with each alternative The difference between the two columns is the key to this analysis eg Fishing produces 1000 more in Operating Profits Another term used for relevant costs is differential costs and this subject matter is often referred to as Relevant Costing or Differential Costing Relevant costs do not include sunk or historical costs Sunk costs are costs that we have already spent and t at no r ver Because ey are alread spent sunk costs are the same not different for each alternative In order to be relevant costs and benefits must be future costs and benefits For example assume that you bought an original oil 7 painting by Leroy Neiman f r Sunk Cost painting is huge and filled an entire wall of your living room At the time you paid 10000 for the painting You are now downsizing your lifestyle and living accommodations and the painting is too large to be appropriately displa ed in your new trailer park accommo ations ou h ecided to sell e painting but the only offer that you have received is 800 The fact that you originally paid 10000 for the painting is not relevant to whether you should accept or reject this offer The original price that you paid for the painting is a sunk cost Although you may not like the idea of selling the painting for less than you paid for it you should be attempting to liquidate your investment in the painting in a manner that will produce the highest net benefit to you This could involve selling the painting at a loss if that is the best deal that you can obtain Other revenue generating operations that are available if only one of the alternatives is selected is relevant to our decision These are Opportuni Costs For exam le assume that you have rented retail space and you are tIying to decide whether to use it to operate a CD store or a ComI Bo r Assume that If you elect to operate a Comic B ok sto then you Will also be able to sublease part of y r space to endIng machIne operators for an addItIonal 200 a re Is not suffIcIent space to permIt such a sublease I you choose to operate a CD store The os revenue from e vending machines 200 is viewed as an Opportunity Cost if the CD store alternative is chosen and it is added to the other costs of the CD store Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 3 CD Store Comic Book Store Difference Revenue 10000 7000 3000 Expenses 5000 2000 3000 Sublease 0 200 Profit 4800 5000 200 In this chapter we will focus on a quantitative analysis but qualitative factors are also relevant For example assume you are trying to decide whether you should produce a product internally or outsource its production While we will focus on which alternative provides you with the maximum economic net benefit in real life qualitative factors would play an important role in your decision For example you would be concerned with such qualitative factors as the reliability of the supplier your ability to control the quality of the outsourced products the impact on the morale of your workforce if you downsize your manufacturing operations whether you decision would change with a change in circumstances and the ability for you to resume production of the product if circumstances change Another factor that is very relevant to decision making is the timevalue of money For simplicity we will not consider it in this chapter I Relevant Cost Example Assume that Titanic lnc owns a ship that takes passengers on daylong cruises from Long Beach to Catalina and back again The ship was purchased for 4000000 and has a 20year life The ship is depreciated using the straightline method over its useful life with no salvage value This produces a depreciation expense of 200000 a year Only half of the ship is used for the Catalina cruises Titanic is very pleased with its cruise business which generates an Operating Profit of 500000 each year Titanic is also on the verge of signing a contract with the Boy Scouts in which Titanic will be engaged to transport the Scouts on a regular basis to Catalina for camping trips This contract is expected to bring in an additional net profit of 15000 each year Titanic is considering two alternate uses of the unused portion of the ship The first alternative is to carry freight to Catalina Titanic estimates that it a freight business would produce an annual revenue of 70000 and annual expenses of 10000 not including the depreciation attributable to the half of the ship used for the freight which would be 100000 Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 4 The second alternative is to rent the space to a company that will use the space to operate a floating disco Titanic projects that a disco rental will generate annual rents of 90000 but it will also increase expenses by 20000 not including the 100000 depreciation expense The Boy Scouts have told Titanic however that they will not patronize a ship that is used as a disco We would analyze the two alternatives in the following manner Freight Disco Difference Revenue 70000 90000 20000 Cash Expenses 10000 20000 10000 Opportunity Cost 15 000 15 000 Operating Profit 60 000 55 000 5 000 The Operating Profit from the cruise operation is irrelevant to our decision We will operate the cruise regardless of which alternative we choose It is not different between our alternatives The depreciation on the ship is also irrelevant The depreciation expense is based on the original cost of the ship and it represents a sunk cost The loss ticket sales to the Boy Scouts are an Opportunity Cost for the Disco alternative I Special Orders Special Orders are a classic area in which Relevant Costing is used In these problems you have a business that is approached by a potential customer The customer is in an area that your business does not normally serve The potential customer offers to buy your product or service at a price below the cost to provide the product or service the special order The caveat about the area not normally served is often put into these problems to avoid the issue of whether the special order will result in any cannibalization of your existing sales when existing customers demand the same low price The caveat in effect states that the special order has no relationship to or impact on our regular business The caveat is also included because price discrimination between similar customers is illegal under antitrust laws In these problems the overall cost to provide the product or service is irrelevant You are already in the business You are trying to decide if accepting the special order will increase your Operating Profit Your focus should be on whether the incremental revenue produced by the special order is higher than the added expenses and costs incurred by the special order We know from our discussion of cost behavior that the increased production to meet a special order will increase our Variable Costs We also need to examine whether we can produce the units needed for the special order with our existing capacity Fixed Costs or whether additional capacity will be needed Please send comments and corrections to me at mconstascsulbedu Chap er 13 No es Rage 5 For examp e assurne You norrnauy nave Revenue 0V A and ne specrar order wru produce addmonar Revenue 039 Kia You normaHy nave Vanaore 308 s 0V 05 and ne specrar order wru produce addmonar Vanaore 308 s 0V 0o You normaHy nave Rxed 308 s 0V 00 and whemer ne specrar order wru reourre addmonar capacuy a a 008 ct 0 nas 0 be de ermmed Don t Take Special Order Take Special Order Dillerence A Revenue A a a Vanaore 308 s VB ram 7o Rxed 308 s 70 7 30 c0 ncremema Rrom A 7 50 AarBcCc ammo Because A By amp c are ne sarne vor bow ahemauves you can rgnore hem and Vocus omy on ne moremema revenue and 008 s vrorn ne specrar order Tne Rxed 308 s do no cnange 0 you nave Summem excess capacuy 0 do ne specrar order You a o ave 0 be carevur abomwhe her sorne Vanaore 308 s wru be dmerem wnen producrng ne specrar order For examp e rnayoe you wm no need 0 pay a sares cornrnrssron or 0er be a reduced sares cornrnrss on Assurne ha you run a srnau arnrne ha akes passengers 0 a reson rsrand wnrcn nas a deruxe comerence cemer Annougn ouns s go 0 W8 s and hey And your ra e 0V 700 per passenger 00 mgh and hey prerer 0 ake ne 4 nour verry nde 0 ne rsrand wnrcn omy 008 s 50 per passenger Your cheme e are ousrness peop e wno anend rneeun s a ne comerence cemer Tne ousrness peopre are wrurng 0 pay your ra es m order 0 ge 0 ne rsrand n 20 mmu es A onerway mp oVrom ne rsrand 008 s you 300 and your Je can carry en pas ngers m heretore 008 s you 200 per passenger 0 opera e your ousrness On a yprca pr you seu a seam and 4 See s remam emp y Mo e 8V2 oners 0 purcnase on a S andrby basrs any unsord ucke s on your Je Tney agree ha ne noke s wm omy be resord 0 mew cus omers wno are ouns s Tne ousrness rave ers may a ne uxury ho e a ne comerence cemer no ne Mo e 5 2 Tne rnanager 0V ne Mo e 8V2 oners 0 pay you 100 a ncke Tne Vac na 0 008 s you 200 per passenger 0 My 0 ne rsrand rs rre evam You are arreadyrn ne arnrne ousrness and you make on average 1200 on eacn thm 4200 P ease Send commems and correcuons 0 me a moons asgcsu b edu Chapter 13 Notes Page 6 3000 You should be considering whether the sale of the tickets to the tourists will hurt your existing airline business Assuming that it will not you should then ask whether the accepting the special order will increase your Operating Profits Take Don t Take Special Order Special Order Difference 400 Incremental Revenue 0 00 Incremental Expenses 0 g g Marginal Profit 400 SQ 400 Accepting the special order will increase your Operating Profits by 400 per trip Per Unit Fixed Manufacturing Overhead Application Rates Managers often complain that despite the fact that i they have excess capacity and ii their Fixed Manufacturing Overhead will not increase if they accept a special order their firm will still charge the special order for Fixed Manufacturing Overhead These managers are forgetting to include the Fixed Manufacturing Overhead Variance in their analysis of the situation An overhead variance is ultimately used to adjust the amount of overhead applied to the units produced to the actual overhead cost incurred If your overhead is overapplied then adding additional overhead to the special order will just increase the amount that the overhead is overapplied The amount by which the overhead is overapplied will ultimately be credited to Cost of Goods Sold thereby reducing the amount of overhead in Cost of Goods Sold to the actual overhead cost and canceling out that application of overhead to the special order Assume Overapplied OH100000 amp Special Order OH 10000 Don t Accept Accept Added to Special Order 10000 Added to COGS at Year End 100 000 110 000 Net Affect 100 000 100 000 If your overhead is underapplied then the Cost of Goods Sold will be increased by the amount that the overhead is underapplied at the end of the year If you apply more overhead to the special order you will also reduce the amount that Cost of Goods Sold will be increased at the end of the year by that same amount You would have added that overhead to the Cost of Goods Sold anyway you just shifted it to the special order away from the end of the year adjustment Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 7 Operating Profits will not be affected by the overhead applied to the special order Assume Underapplied OH100000 amp Special Order OH 10000 Don t Ac 9 Acceg Added to Special Order 10000 Added to COGS at Year End 100 000 90 000 Net Affect 100 000 100 000 hen the year end variance adjustment to Cost of Goods Sold is considered the Fixed Manufacturing Overhead applied to a special order ultimately does not lower your Operating Profits Dropping A Division or Product Another area in which Relevant Costing is used is whether to drop a division or product Companies often prepare income statements for th i divisions or products These income statements include all of the Some Fixed Costs however are not relevant to this decision and their inclusion can mis ea manager en deciding whether to discontinue a division or product In this area the only relevant Fixed Costs are the costs that will disappear if the product or division is discontinued Fixed osts o not disappear then they are not product Lineup different and thereby not relevant o o 3 tn 9 5 m 399 c 9 tn m 5 a Q S 2 o 5 tn Consider Green Toys a prominent toy manufacturer whose lineup of toys includes three action figures Gumb Barbie and GI Joe Green releases internal inc m statements that show that Green is losing money on the Gumby action figure Based on these financial statements Green is considering discontinuing production of the Gumby action figure Barbie GI Joe Gumby Total 600000 350000 250000 1200000 Variable Costs 200000 100000 150000 450000 Fixed Costs 300 000 200 000 150 000 650 000 Operating Profit 100000 50000 50000 The presentation of this income statement leads the reader to assume that Green39s Operating Profit will increase by 50000 if the 50000 loss on the Gumby sales can be eliminated by discontinuing the action figure This conclusion however may not be accurate Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 8 We know that the revenue produced by sale of the action figure will disappear if Gumby is discontinued We also know that the Gumby Variable Costs by definition will drop to zero if the product is dropped Without knowing more we cannot be sure that the Fixed Costs attributable to the Gumby action figure will disappear if the action figure is discontinued Some Fixed Costs disappear if a product is dropped These Fixed Costs are tied to the product They are called Direct Fixed Costs An example of a Direct Fixed Cost would be the salary of the product manager who will be laid off if the product is discontinued If the Gumby action figure is dropped the salary paid to the product manager will drop to zero On the other hand some Fixed Costs are not tied to the product but are generated by the factory or company as a whole These are called Common Fixed Costs Common Fixed Costs are allocated to a product but they are not reduced if you drop the product to which they are assigned Instead they are reassigned to another product An example of a Common Fixed Cost would be the factory rent allocated to the Gumby action figure It is likely that the rent on the factory will not be decreased if we drop the Gumby action figure Instead it will be reassigned to the Gumby and Pokey action figures Assume that the factory rent is 450000 and it is allocated to the three action figures based on the factory floor space dedicated to their respective production lines The remaining Fixed Costs are the salaries of the product managers who will be laid off if their product is discontinued Barbie GI Joe Gumby Total Revenue 600000 350000 250000 1200000 Variable Costs 200000 100000 150000 450000 Manager Salary 100000 50000 50000 200000 Rent 200000 150000 100000 450000 Operating Profit 100000 50000 50000 100 000 Now that the rent has been separated from the product managers salaries we can analyze the situation Don t Drop Gumby Drop Gumby Difference Revenue 250000 0 250000 Variable Costs 150000 0 150000 Manager Salary 50 000 g 50 000 Operating Profit 50 000 Si 50 000 The factory rent will not change if you drop the Gumby action figure It is not a relevant cost Green will make 50000 more if it does not drop the Gumby action figure rather than dropping the figure There is nothing wrong with allocating rent to the Gumby Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 9 action figure Green is in fact losing 50000 on the Gumby action figure The profitability of the Gumby action figure is not the issue The issue is whether Green s Operating Profit will be higher or lower if it drops the action figure Assume that Green dropped the Gumby action figure and that all other revenue and costs remain unchanged other than reassigning the factory rent to the remaining products Revising Green s income statement to reflect the discontinuance of the Gumby action figure shows that Green s Operating Profit will go down by 50000 as predicted above Barbie GI Joe Total Revenue 600000 350000 950000 Variable Costs 200000 100000 300000 Fixed Costs 100000 50000 150000 Rent 257143 192857 450000 Operating Profit 42857 7143 50 000 You can prepare an income statement that treats Common Fixed Costs in a manner that will not mislead managers into making the wrong decision regarding whether to retain or drop a product or division With this format the Common Fixed Costs such as rent are shown under a total column and not allocated to an individual product Barbie GI Joe Gumby m Revenue 600000 350000 250000 1200000 Variable Costs 200000 100000 150000 450000 Manager Salary 100 000 50 000 50 000 200000 Product Profit 300000 200000 50000 Rent 450 000 Operating Profit 100 000 With this format it is clear that the sales of the Gumby action figure contribute 50000 to Green s Operating Profits We will discuss this area more fully when we discuss Variable Costing Make or Buy Relevant Costing is also very useful in when deciding whether you should outsource a product In these problems you can either make an item that you use in your business or you can purchase it from an outside supplier When calculating the cost of each alternative you have to be careful to accurately reflect what manufacturing costs will disappear if you purchase a product rather than manufacturing it Also Opportunity Costs often appear in this area Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 10 Assume that the National Parks Service runs a restaurant on Liberty Island that offers a limited gourmet menu to discriminating tourists visiting the Statue of Liberty The meals that are served at the restaurant are prepared by the National Parks Service at a nearby kitchen facility located in the New York City not on Liberty Island The meals are then delivered to the restaurant During a month the National Parks Service prepares 12000 meals The National Parks Service is not interested in relinquishing control of its restaurant It is interested however in subcontracting the preparation of the meals that are served at the restaurant McDonald s Corporation wishes to enter the gourmet catering market and offers to cater the meals served at the Liberty lsland restaurant Each meal costs the National Parks Service 35 as shown below Direct Materials Direct Labor Variable Overhead Fixed Overhead 6quot 0 LL OIU39IOU39IU I McDonald s Corporation has offered to provide each meal for 37 If the National Parks Service accepts the offer its kitchen facility can be rented out for 40000 However 3 of the Fixed Manufacturing Overhead currently being applied to each meal would have to be reassigned to the restaurant operation It represents a portion of the salaries of the restaurant personnel who will continue to work at the restaurant The National Parks Service would consider the following Relevant Costs of each alternative Direct Materials Direct Labor Variable Overhead Fixed Overhead Opportunity Cost Purchase Price Total Cost W W M 0 60000 5x12000 60000 0 180000 15x12000 180000 0 120000 10x12000 120000 36000 3x12000 60000 5x12000 24000 0 40000 40000 444000 37x12000 444000 480000 460000 20000 It is cheaper for the National Parks Service to continue to make the meals served at the restaurant Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 11 Most books treat the 40000 rental as an Opportunity Cost as shown above You could also place it in the Buy column as a reduction of cost Regardless of how you treat these items the 20000 difference in cost will remain iii WM M w Direct Materials 60000 5x121000 60000 Direct Labor39 180000 15X121000 180000 Variable Overhead 120000 10X121000 120000 Fixed Overhead 36000 3X121000 60000 5X121000 24000 Sublease 40000 0 40000 Purchase Price 444 000 37x121000 0 444 000 Total Cost 440 000 420 000 amp I Sell or Process Further Another area in which Relevant Costing is traditionally used is when you produce a product in a raw or semifinished state There is a market for your raw product but you could process the product further and sell the processed product at a higher price For example assume that you own oil wells You could either sell the crude oil to a refiner or refine it yourself Assume that Bond Inc owns a diamond mine It produces two grades of diamonds Grade A and Grade B Currently Bond sells its diamonds to DeBeers DeBeers pays 700 a carat for Grade A diamonds and 500 a carat for Grade B diamonds Alternatively Bond could process the Grade A andor Grade B diamonds further and then sell them directly to American jewelers for 900 and 1200 respectively Additional processing and marketing costs of 100 for Grade A diamonds and 750 for Grade B diamonds would be incurred in the event of a direct sale to American jewelers You would analyze the situation as follows Grade A Diamonds USA Sale DeBeers Sale Difference evenue 00 Additional Marketing Costs 7 Operating Profit amp E 100 Bond makes 100 more in profits if it processes the Grade A Diamonds and then sells them directly to American jewelers Please send comments and corrections to me at mconstascsulbedu Chapter 13 Notes Page 12 Grade B Diamonds DeBeers Sale USA Sale Difference Revenue 500 1 200 700 Additional Marketing Costs E Operating Profit m 450 50 Bond makes 50 more in profits if it sells the Grade B diamonds to DeBeers Please send comments and corrections to me at mconstascsubedu CHAPTER 13 Utilization of a Constrained Resource Pages 594597 2 Constrained OQtimization We want to either Maximize profitsCM or Minimize costs This is easy you make either infinity units to maximize profitsCM or zero units to minimize costs Problem have a constraint Limited Capacity 9 Max profitsCM Need to achieve goals 9 Min costs 3 If there is only one constraint this is easy Max 9Find profitCM per unit of constraint for each alternative Pick highest Min 9 Find cost per unit of constraint for each alternative Pick lowest 4 Eg CM is 4 for Product A amp 9 for Product B You can make 3 Product As in 1 hour You can make 1 Product B in 1 hour Only 100 hours are available 15 Calculate the CM tor1 hourwith each Product CM of 12 per hour for ProductA CM of 9 per hour for Product B Only make Product A 5 How do you Maximize Sales RevenueCM or Minimize costs When dealing with multiple constraints We will discuss 2 ways to solve these problems Graphical approach Excel 6 Graphical Approach 15 state your goal 39 Eg Maximize CM Minimize cost Mathematical formula for item being maximized or minimized Called Objective Function OB Variables in CB are your alternative courses of action 9 What you can change Eg of each type of product that you will produce 7 Assume Co can make 2 types of bolts Bolt A or Bolt B Bolt A has CMU 10 Bolt B has CMU 12 Co wants to know of each type of bolt to produce to maximize CM Maximize 10A 12B Where A 94 of A Bolts produced B 94 of B Bolts produced 8 Without more information Go would produce of every bolt Withthis production Co would have CM In reality there is limit to of bolts that Co can produce 9 Assume each bolt must pass through following machines amptime required on each machine differs as shown below Machinel Machine Machine Iquot ABolt 1 min 1 min 1 min B Bolt 1 min 4 min 5 min n1 day there are 240 720 amp160 minutes available on Machine Machine II and Machine I respectively How many of each type of bolts should Co produce in 1 day 1O Add constraints to OB Description Problem OB Max 10A 12B Constraints subject to Only 240 mins available on Machine 1A 18 S 240 Only 720 mins available on Machine ll 1A 48 S 720 Only 160 mins available on Machine I 1A SB 5 160 Can39t manufacture negative of bolts A B 2 0 Next graph production area that meets all of constraints Feasible Region Graph consists of Cartesian axis with the OB Variables as xaxis amp yaxis Eg Last constraint alone means you are dealing with top right quarter of Cartesian axis 12 Now graph other constraints which are inequalities either 2 or s Area covered by such an inequality consists of 1 line that divides Cartesian plane amp1 side of that me Formula of line is inequality formula with substituted for s or 2 To graph inequality 9 graph line that divides the Car esian plane amp chose side of line that satisfies inequality To graph 151 constraint 1A1B s 240 Graph ine 1A1B 240 Easiest way to graph line is identify points where ine crosses each axis We know that B0 on any point on Aaxis Therefore point where ine crosses Aaxis has 0 as B coordIn So we replace B with 0 in equation amp solve for A 1A 1 B 240 1A10 240 1A 240 A 2401 A 2400 So ine crosses Aaxis at 2400 0 1 3 Where does ine cross Baxis We knowt at A0 at any point on Baxis Therefore point where ine crosses Baxis has 0 as A coordinate So we replace Awith 0 in equation and solve for B 1A1B 24o 101B 240 1B 240 B 2401 B 2400 So ine crosses Baxis at 0 2400 15 With these 2 points you can now graph the line type a zoom MID type A 1 6 Now we need to pick side of line that satisfies inequality Easiestway to do this is to test 1point on 1 side of line 7 Vou test point by Substituting coordinates into inequality lormula amp check ll coordinates produce a value that satrslres inequality If point tested satis es inequality then ever point on same side of line will satisfy inequality Easiest point to test is origin 00 because you are dealing wi zeros as varia les So plug origin into inequality 8t see if inequality is true 1A 1 B S 240 Inequality 1 0 10 5 240 Testthe Origin 0 S 240 True Statement 17 So Feasible Region for 13 constraint includes side of line that contains origin Feasible Region that satisfies 13 amp last constraint consists of rvpe a zoom MID rvpe A 18 To graph 2nd constraint 1A4B S 720 Graph line 1A4B 720 We Know that line crosses Aaxis at 7200 0 1A 48 720 1A 4o 720 1A 720 A 7201 A 7200 19 Line crosses Baxis at 01800 1A4B 720 1O4B 720 48 720 B 7204 B 1800 20 By testing origin we see that side that contains origin satisfies inequality 1A 48 s 720 Inequality 10 40 5 720 Test the Origin 0 s 720 True Statement 21 Feasible Region for 2nd constraint includes side of line that contains origin Feasible Region that satisfies 15 2nd amp last constraints consists of following M22 5 zouu mun mu mm W A 22 To graph 3 constraint 1ASB s 160 Graph line 1ASB 160 Line crosses Aaxis at 1600 0 1ASB 160 1A50 160 1A 160 A 1601 A 1600 23 Line crosses Baxis at 0 320 1ASB 160 10SB 160 58 160 B 1605 B 320 24 By testing origin we see side that contains origin satisfies inequality 1A SB 5 160 Inequality 10 50 5 160 Test the Origin 0 S 160 True Statement 25 Feasible Region for 3d constraint includes side of line that contains origi Feasible Region that satisfies all of constraints is M22 5 zouu mun sun mu 72 M22 A 26 The factthat Feasible Region no longer touches lines for 15 amp 2nd constraints tells you that 15 amp 2nd constraints are no binding Time on Machines and II could be unlimited and it would not affect our production possibilities 27 Once you have identified Feasible Region that satisfies all constraints You have to decide which points within Feasible Region maximize CM Corners points of Feasible Region are most extreme points Therefore corner points represent production levels that produce most extreme CM Eg highest amp lowest CM To find highest CM Plug each corner points into original OB 10A12B Co generates highest CM by producing 1600A Bolts and O B Bolts Check to see which point produces highest CM Corner 10A12B m 16000 1 1600120 1600 16000 0 320 1 0 12 320 0384 3840 00 10120 00 0 28 29 We can solve Constrlained Optimization e problems using Exc Have each of your 2 QB Variables ofABoltsampofBBolts Excel will place optimal value in these cells after it solves problem For now 3 alue of ec are corr t Cell Label Cell Contents A Bolts 1 0 B Bolts 20 one cell on spreadsheet represent value of ive A Bolts a value of 1 0quot amp give B Bolts a 0quot so that you can tell if your other formulas 3O You also need to have another cell represent value of CB formula using values in your OB Variable cells Cell Label Ce Contents OB 1A Bolt Cell12B Bolt Cell 31 For your constraints you need a separate cell for each constraint Cell will contain value of side of constraint inequality formula that uses OB Variables Eg time on each machine This uses of each type of bolt produced Side of constraint inequality formula containing fixed value will be supplied later Cell Label Cell Contents Time on Machine 1A Bolt Cell1B Bolt Cell Time on Machine ll 1A Bolt Cell4B Bolt Cell Time on Machine lll 1A Bolt Cell5B Bolt Cell 32 Your spreadsheet should look something like the following l l A B l c L A Objective Function 1BA12quotBS 3 i o ofA Bolts 10 i o of B Bolts 20 Time on Machine 1quot39B41B5 Time on Machine ll 1BA4B5 Time on Machine lll 1B45quotB5 33 Select Tools on Menu Bar Click on Solver If you do not see Solver Select Add Ins amp select Solver Add In Once you select Solver the following dialogue box will open Solver Parameters g T Equalla max OMB mam u l sumac m the WW 7 U Solver Parameters oyatear wit E m For Set Target Cell Click on cell that contains OB For Equal To Click whether you want to maximizeminimize OB For By Changing Cells Highlight 2 cells that contain OB Variables 35 For Subject to the Constraints Click on Add and the following dialogue box will open Add Constraint Cell Reference For each constraint Left box should name cell that contains portion of constraint inequality formula that contains OB Variables Middle box should give inequality symbol Right box should contain fixed value portion of constraint inequality For each nonnegative constraint eg A 2 O Left box should name cell that contains OB Variable Middle box should have gt as inequality symbol Right box should contain 0 as fixed amount Subject to the Constraints iB4 gt 0 i 1B5 gt 0 1B lt 240 iBB lt 720 i39 lt160 i 36 37 Once you have entered all of this information click Solve Excel will change values in OB Variable cells to reflect optimal value Excel gives same answer we got using graphical method Produce 1600 A Bolts and zero B Bolts Objective Function 160 Solver Results Salve lutian nu constraints and apmaltv No ofA Bolts 1600 No of B Bolts 0 m Time on Machine 160 Time on Machine 160 Time on Machine I 160 A Solver Results dialogue box will open Leave Keep Solver Solution checked Under Reports click on Answer amp Sensitivity When you click OK 2 new worksheets will be created Answer Report 1quot sheet Sensitivity Report 1quot sheet 39 Answer Report1 sheet contains description of constraints amp indicates which are binding Answer Report 1 indicates that constraints involving Machines land II a not binding We noted same thing with graphical approach Notice Excel says restricting B Bolts to non negatlve answer w In lng Without this constraint Excel would have given n e u or o uce A negative B Bolt value would allow you to produce more A Bolts v E g ll B could be 71 then you could obtaln an extra so seconds on Machlne lll Tnls would allow you to produce 5 more A Bolts and slay wlthln the conslrarnl 1 ASB s 160 Constraint 1 1600 50 160 Optimal Value 11605 51 160 Allowing Bto be 1 41 The 1 B Bolt would cost you 12 a negative M but the 5 A Bolts would produce an additional CM of 50 Thus if you could go negative the next negative B Bolt would produce a marginal profit of 38 This potential is reported as Reduced Gradient on Sensitivity Report 1 A ustable Cells Final Reduced Name Value Grnlien1 er4 Nu ogAEolls 180D q 185 No 111132 is u 70 380000213 42 The Lagra e Multiplier is the Shadow Pricequot of 1 minute on achine lll You wou Id be willing to pay up to 1 for an extra minute on Machine lll You can calculate this you self 7 We know that eacn Bolttakes l rnlnule on Macnlne lll r EachA Boll produces a CM 0110 7 Thus an extra mlnule on Machlne lll wnrcn allows us to produce lOABolts ls worth 110 X10 to us Cunstlalnts Lag Ige Cell I r m7 n J Machl ll mu m E9 Tlme ml Mach rrre lll 1EEI l Chapler4 Noles Page l Process Cos n and Control Process ooslrhg rs used wheh lhe good servrces oerhg produced are lhe same or uhrlorrh For example he lelevrsroh sels lhal Sony sells l0 Krlvlarl are he same as lhe lelevrsroh sels sold l0 Walllam or Targel Slmllarly lhe galloh ol gas lhalARco sells l0 you rs lhe same as he galloh lhal ARGO sells l0 your herghoor These are lyplcally assemblyrllne operalrohs You cah also have process cosls rh servrce lnduslrles e g check processrhg rh a oahla checklng baggage al ah alrporl washrhg ahd rrohrhg shrrls ahd dorhg a oasrc eslale plah Because he producls are lhe Same lheh lhe gueslroh ahd lreal lhe average as he aclual cosl ol each uhrl For example ll Sony makes 200love lelevrsroh sels al a cosl ol oe ooo m lheh each lelevrsroh cosls 20 l0 malmaln Cost Allocation Recall lhal lhere are lhree corhpohehls ol cosl Dlrecl Malerlalsl Dlrecl Laborl ahd Manulaclurlng Overhead lh Process Cosllng you calculale a separale average cosl lor each ol lhese corhpohehls The reasoh lhal you calculale a separale average cosl lor each corhpohehl ol cosl rs oecause lhe corhpohehls may be rhcurred dllleremly ll lhe corhpohehls ol cosl are lhcurred lh lhe sarhe rhahher e g lhey ave l e sarhe osl Drlver lheh you cah corhorhe lherh ahd lreal lherh as ohe cosl pool For example ll you apply Manulaclurlng Overhead usrhg Dlrecl Labor Hours as us oosl Drlver lheh you cah oorhorhe Manulaclurlng Overhead ahd Dlrecl Labor ahd lreal lhe oohversroh oosls as ohe cosl Thrs rs because he sarhe drlver Dlrecl Labor hours rs oerhg used l0 rheasure bolh corhpohehls Please Send Commenls and Correcllons l0 me all moonslas csulb edu Chapter 4 Notes Page 2 I Grouping Of Units As noted above in Process Costing we calculate average costs for each component of cost for a given period of time For example we would calculate the average cost for this month as follows Cost Incurred This Month Work Done During This Month This average cost calculation can become more complicated if you are dealing with units that were only partially made during this month In this case the numerator would only include the cost incurred on those units during this month and the denominator would include only the work done on those units during this month When calculating average costs we divide the units that passed through Work In Process during this month into three groups of similarly situated units Name MM Beginning Inventory Units left over from the prior period and completed during this period Started and Completed Units that were started during this period and completed during this period Ending Inventory Units that were started during this period but not finished These groups have the following characteristics Units Started This Period Units Finished This Period Beginning Inventory NO Started Last Period V quot Started and Completed a i Ending Inventory NO Not Yet Finished The units that are finished this month consist of Beginning Inventory and Started amp Completed The units that are started this month consist of Started amp Completed and Ending Inventory Units Started Units Finished Started and Completed Ending Inventory Beginning Inventory Started and Completed Knowing these relationships can help you calculate the number of units that are in each of the three groups of units Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 3 For example if you know that i 10000 units were started ii 6000 units were completed and iii 2000 units were in Beginning Inventory then you can compute the following Group Number of Units Beginning Inventory 2000 Given Started and Completed 4000 Units Finished Beginning Inventory 60002000 Ending Inventory 67000 Units Started Started amp Completed 10000 4000 You are told that Beginning Inventory consists of 2000 units and that you finished 6000 units Since you know that the units finished consist of Beginning Inventory and Started amp Completed then you can calculate the number of units in Started amp Completed by taking the units finished 6000 and subtracting the Beginning Inventory 2000 The remaining 4000 units are in Started and Completed Similarly you are told that you started work on 10000 units Since you know that the units started consist of Started amp Completed and Ending Inventory then you can calculate the number of units in Ending Inventory by taking the units started 10000 and subtracting the number of units in Started amp Completed 4000 The remaining 6000 units are in Ending Inventory I Percentage Compete In this area you will often see Beginning and Ending Inventories described as being a certain percentage complete eg Ending Inventory is 40 complete This notation is not stating that 40 of the units in Ending Inventory are complete If any unit were complete it would not be in Ending Inventory By definition none of the units in Ending Inventory are completed This notation is stating that we have done 40 of the work that needs to be done in order to complete the Ending Inventory and 60 of the work on those units still needs to be done In real life the units in either Beginning Inventory or Ending Inventory are probably not all at the same stage of completion This notation is stating that on average the Ending Inventory is 40 complete The use of the average rate of completion in these calculations is a common convention in this area I Cost Behavior In real life the average amount of work done is known eg you would know that the Beginning Inventory is 55 complete as to Direct Materials and 75 complete as to Conversion Costs Sometimes problems in this area do not provide you with the actual percentage completed for each group Instead the problem describes the behavior of the cost and it asks you to calculate the appropriate percentage For this reason we will discuss two types of costs Initial Costs and Uniform Costs Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 4 Initial Costs Consider the following example Clampett Co makes baseball bats by whittling carving the bats into shape from a piece of wood Clampett Co hires Jed to whittle the baseball bats During this period Clampett Co paid 20 for wood and Jed started work on 20 bats He completed 10 baseball bats and 0 He did half of the work on 10 more baseball bats How much did Clampett Co spend on the cost of wood for each baseball bat As soon as Jed starts work on a baseball bat he uses all the wood that he is ever going to use on that bat This is because he is adding all of a bat39s wood cost at the start of the manufacturing process This is sometimes referred to as an Initial Cost Initial Costs are added at the beginning of the process Because the bats have the same wood cost whether or not they are completed you treat completed and partially completed bats exactly the same when calculating the average cost of wood in a bat This is true of all Initial Costs Thus the wood cost is calculated as follows 20 total wood cost 20 baseball bats 1 per bat Each bat cost 1 regardless of whether it was finished If Clampett Co had five bats left over from last month it would not affect our calculation These 5 bats in Clampett Co s Beginning Inventory would have received all of the wood that they were going to receive when Jed started work on them last month The 20 in our calculation is the amount that Clampett Co spent on wood this month and this month39s wood cost has nothing to do with the Beginning Inventory Beginning Inventory is not included in the denominator when calculating the average wood cost for m month Uniform Costs Another way that costs can behave is that they can be added evenly throughout the manufacturing process This is the way we often think of costs For example assume that you hire a student to paint your house and you estimate that the work will take 20 hours at a cost of 10 an hour When half of the house is painted we would expect that the labor cost incurred up to that point would be 100 10 hours at 10 an hour Our expectation is due to the fact that we assume that the student works at an even or uniform rate These costs are often called Uniform Costs Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 5 Continuing the Clampett Co example assume that Jed s labor cost is added evenly throughout the process and Clampett Co paid Jed 30 for his labor in making this month s bats 10 completed baseball bats and 10 halfcompleted baseball bats The amount of labor in a halfcompleted baseball bat is half of the amount of labor in a completed bat Let the variable quotXquot represent the labor cost of a completed bat and sz represent the labor cost to complete half of one bat You can solve for the labor cost of a completed bat as follows Labor Cost of 10 Whole Bats Labor Cost of 10 HalfBats Total Labor Cost 10x 10 12x 30 10x 5x 30 15X 30 X 3015 X 2 Each completed bat has a labor cost of 2 and each halfcompleted bat has a labor cost of 1 so far Eguivalent Units When calculating the average labor cost of each baseball bat our denominator of 15 was arrived at by converting the 10 halfcompleted bats into 5 completed bats We call this process calculating Equivalent Units In other words the amount of labor needed to do 10 halfcompleted bats is the same as equivalent toquot the amount of labor that is needed to make 5 completed bats Similarly the decision to treat half completed bats the same as equivalent toquot whole bats when calculating the wood cost of each baseball bat is an example of calculating Equivalent Units The calculation of the Equivalent Units provides the denominator used in the calculation of average costs We are going to discuss two methods of calculating costs when using Process Costing We will first focus on the FIFO First In First Out Costing Method AftenNards we will discuss the Weighted Average Costing Method Under the FIFO Costing Method Equivalent Units for Uniform Costs are calculated by multiplying i the number of units involved by ii the percentage of work done this period eg 10 X 50 Equivalent Units for Initial Costs are zero for Beginning Inventory and 100 of the units for Started amp Completed and Ending lnventory When using the Weighted Average Costing Method the Equivalent Units are slightly different Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 6 Other Cost Behavior Patterns Initial and Uniform Costs are not the only two ways that costs can behave NonUniform Costs can behave a number of different ways Initial and Uniform Costs merely provide discussion scenarios These problems may not describe the cost behavior Instead they may just give the percentage of work done during the time period If the problem gives you that percentage then use the percentage given and do not worry about whether you are dealing with Initial andor Uniform Costs The sole purpose of talking about whether a cost is an Initial or Uniform Cost is to give you those percentages Process Costing Steps When calculating the cost of units using Process Costing you do the following Step 1 Physical Flow Analysis You calculate the number of units in each of the following three groups of units Beginning Inventory Started amp Completed and Ending Inventory Step 2 Calculation of Equivalent Units You calculate the number of units to include in the denominator of the average cost calculation eg 20 bats for wood cost and 15 bats for labor cosh Step 3 Computation of Unit Cost You calculate the average cost for each component of cost cost per Equivalent Unit Step 4 Valuation of Inventories You calculate the cost of each of the three groups of units Step 5 Cost Reconciliation You make sure that you have allocated all of your costs to the three groups of units FIFO Example Assume that Paul Inc uses Process Costing to calculate the cost to produce its salad dressing Direct Materials are added at the beginning of the process and Direct Labor and Manufacturing Overhead are added evenly throughout the process Paul had the following cost data Beginning Inventory May 1 42360 Operating costs for May Direct Materials 360000 Direct Labor 211200 Manufacturing Overhead 316 800 888 000 39 Total Costs 930 360 An quot0quot CHARITY Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 7 Beginning Inventory consisted of 20000 gallons 30 complete During May 180000 gallons were started On May 31 the Ending lnventory consisted of 30000 gallons 40 complete Step 1 Physical Flow Analysis First we need to calculate the number of units that are in each of the three groups of units described above You know that Beginning lnventory consists of 20000 gallons because it is given You also know that Ending lnventory consists of 30000 gallons because it is also given In addition you are also told that Paul started work on 180000 gallons Using the fact that the units started consist of Ending Inventory and Started amp Completed you can calculate the number of units that were Started and Completed Units Started Ending lnventory Started amp Completed 180000 30000 Started amp Completed 180000 Started amp Completed 180000 30000 Started amp Completed 150000 Let us start a table to calculate the average cost of the units that Paul produces and include this information about the units Units Beg lnv 20000 S amp C 150000 End lnv 30000 Step 2 Calculation of Eguivalent Units ln FIFO our average cost calculation involves only this month s costs and the work done this month We therefore need to know the percentage work done this month in order to calculate the number of units in the denominator of an average cost calculation The summary of the Beginning lnventory describes the Beginning lnventory as it existed at the start of the month At the beginning of the month the Beginning lnventory was 30 complete Therefore Paul had to complete the remaining 70 of the Beginning lnventory this month in order to finish those units The summary of Ending lnventory describes those units as they existed at the end of the month At the end of the month the Ending lnventory was 40 complete Thus Paul did 40 of those units this month The Started and Completed units were started this month and finished this month So Paul did 100 of those units this month Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 8 Put the information regarding the percentage of work done this month in our table This Month s Units Beg lnv 20000 70 S amp C 150000 100 End lnv 30000 40 Paul spent 360000 on Direct Materials this month This is the numerator of our average cost calculation We are told that the Direct Materials were added at the beginning of the process an Initial Cost If you wish you can note that Direct Materials is an Initial Cost by adding I to the column heading Include this information in our table MIKE S DirMat Units 3GOKI Beg lnv 20000 70 S amp C 150000 100 End lnv 30000 40 Next consider the Equivalent Units for the Direct Materials cost calculation Remember that the Equivalent Units are the denominator of our average cost calculation Because i the Beginning lnventory was started last month and ii Direct Materials is an Initial Cost added at the start of the manufacturing process then Paul did not add any additional Direct Materials to its Beginning lnventory this month in order to finish the Beginning lnventory Thus Beginning lnventory has no share of this month s Direct Materials cost lts Equivalent Units for Direct Materials cost are zero MIKE S DirMat Units 360K I Beg lnv 20000 70 0 S amp C 150000 100 End lnv 30000 40 The Ending lnventory was started this month and all the Direct Materials that were needed to complete the Ending lnventory were added at the beginning of the manufacturing process Therefore each unit of Ending lnventory has the same amount of Direct Materials Cost as a unit that was completely manufactured this month So in the denominator of the average cost calculation we should treat incomplete units the same as completed units as was the case for the wood cost in the Clampett Co example In our calculation we will include 30000 units in the denominator for the Ending lnventory We include all of the Started and Completed units in the denominator because all of the work done on those units occurred this month Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 9 Thus Direct Materials will have 180000 Equivalent Units as the denominator of its average cost calculation MIKE S DirMat Units 360K I Beg lnv 20000 70 0 S amp C 150000 100 150K End lnv 30000 40 180K Next consider the Direct Labor 211200 and Manufacturing Overhead 316800 They are both added evenly throughout the processquot Because they are both Uniform Costs we can add them together and treat the Conversion Costs 528000 as one cost This is the numerator of the average cost calculation Beginning lnventory was 70 done this month That means that each of the Beginning lnventory units has 70 of the Conversion Costs for this month that are contained in each of the Started and Completed units So convert Beginning lnventory s 20000 710 hScompleted units into 14000 20000 X 70 completed units Equivalent Units just like we did for Clampett Co s labor cost Similarly you convert Ending lnventory s 30000 410 hScompleted units into 12000 30000 X 40 completed units Equivalent Units Again you include all of the Started and Completed units in the denominator Thus Conversion Costs will have 176000 Equivalent Units as the denominator in its average cost calculation for Conversion Costs If you wish you can note that Conversion Costs are a Uniform Cost by adding a U to the column heading This Month s DIrMat Conv Units 360K I 528K U Beg lnv 20000 70 0 14K S amp C 150000 100 150K 150K End lnv 30000 40 M g 180K 176K Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 10 Step 3 Computation of Unit Cost Next we calculate cost per Equivalent Unit for each component of cost We divide the numerator the Cost by the denominator Equivalent Units for each component of cost This Month s DIrMat Conv Units 3GOK1 528KU Beg lnv 20000 70 0 14K SampC 150000 100 150K 150K End 30000 40 M g lnv Equivalent Units 180K 176K Calculation 360K 528K Cost 180K 176K Equivalent Units Cost Per Equivalent Unit 200 300 Step 4 Valuation of Inventories Now we figure out how much each group of units cost to make The Beginning lnventory s total cost will include the 42360 that was incurred last month This was the cost to make 30 of these units last month This month Paul spent nothing on Direct Materials for the Beginning Inventory Thus we add nothing to the 42360 on account of Direct Materials for this month The amount of Conversion Cost work done this month on the Beginning Inventory is equivalent to the amount of work that would have been needed in order to do 14000 full units Equivalent Units and the cost of this work is 3 per Equivalent Unit So we add 42000 3 X 14000 for Conversion Cost to the 42360 from last month in order to get the total cost of the Beginning Inventory 84360 Mimi s DirMat Conv Units 360K I1 528K U1 ME Beg lnv 20000 70 0 14K 423603X14Kll 84360 SampC 150000 100 150K 150K End lnv 30000 40 M g Equivalent Units 180K 176K Calculation 360K 528K 180K 176K Cost Per Equivalent Unit 200 300 The Started and Completed units were completely done this month and the cost to make a unit this month is 5 per unit 2 per unit for Direct Materials amp 3 per unit for Conversion Costs Since Started amp Completed consists of 150000 units produced at a cost of 5 per unit the total cost to make these units is 750000 150000 X 5 Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 1 1 Beginning Inventory and Started and Completed represent all of the units that we completed and sent to Finished Goods The total cost of these units is referred to Transferred Out This Month s DirMat Conv M 360K 1 528K U1 Cost of Group Beg Inv 20000 70 0 14K 423603x14Kli 84360 880 150000 100 150K 150K 150K23 750 000 End Inv 30000 40 M g TransferredOut 834 360 Equivalent Units 180K 176K Calculation 360K 528K 180K 176K Cost Per Equivalent Unit 200 300 Paul spent 60000 2X30000 on Direct Materials for the Ending Inventory It also spent 36000 3X12000 on Conversion Costs for the Ending Inventory Thus Paul spent 96000 to complete 40 of the Ending Inventory This Month s DIrMat Conv Units 360K 1 528K U1 Cost of Group Beg Inv 20000 70 0 14K 423603X14KII 84360 SampC 150000 100 150K 150K 150K23 750000 End Inv 30000 40 M g Transferred Our 834 360 Equivalent Units 180K 176K 2x30K3x12K 96000 Calculation 360K 528K T013C S fUniiS 930 360 180K 176K Cost Per Equivalent Unit 200 300 Step 5 Cost Reconciliation In this step we confirm that we took all of Paul s costs and applied them to the units that Paul produced Costs Incurred Cost of Units Last Month s Cost 42360 Direct Materials 360000 Beginning Inventory 84360 Direct Labor 211200 Started amp Completed 750000 Manufacturing Overhead 316 800 Ending Inventory 96 000 Total 930 360 Total 930 360 Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 12 PRODUCTION COST REPORT All of this information is then summarized in an internal report Production Cost Report You are not responsible for knowing how to construct such a report but you are required to know how to get the numbers used in that report as we did above Production Cost Report Unit Information physical Equivalent Units Flow of Production Units Direct Material Conversion Costs Work In Process Beginning 20000 Started During Current Period 180 000 To Account For 200 000 Completed amp Transferred Out From Beginning Work In Process 20000 0 14000 Started amp Completed 150000 150000 150000 Work In Process Ending 30 000 30 000 12 000 Accounted For 200 000 Work Done In Current Period Only 180 000 176 000 Cost Information Production Direct Conversion Costs Material Costs Work In Process Beginning 42360 Work Done In Prior Period Costs Added In Current Period 888 000 360000 528000 Divide By Equivalent Units This Period 180 000 176 000 Costs Per Equivalent Unit 200 300 Total Costs To Account For 930 360 Costs Accounted For Goods Transferred Out Beginning Work In Process 42360 Direct Materials Current Period 0 x 200 Conversion Costs Current Period 42 000 14000 x 300 Total From Beginning Inventory 84360 Started amp Completed 750 000 150000 x 200 150000 x 300 Total Cost of Units Transferred Out 834 360 Work In Process Ending Direct Materials 60000 30000 x 200 Conversion Costs 36 000 12000 x 3000 Total Work In Process Ending 96 000 Total Costs Accounted For 930 360 Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 13 Use of Calculations You can see how these calculations are used in the accounting process by considering the Work In Process taccount WORK IN PROCESS 42360 Beginning Balance 84360 Beginning Inventory 211200 Direct Labor 750000 Started amp Completed 316800 Manufacturing Overhead 360000 Direct Materials 96000 Ending Balance I Weighted Average Costing Method With the Weighted Average Costing Method we want to take the costs incurred on the Beginning Inventory during last month add those costs to the costs incurred this month and calculate an average cost for the work done over the last two months on all of the units in Work In Process With the FIFO Costing Method we calculated the average cost for the current month by including this month s costs in the numerator and dividing them by the number of Equivalent Units made this month the denominator Other the other hand with the Weighted Average Costing Method we will calculate the average cost for the last two months by including the last two months costs in the numerator and dividing their total by the Equivalent Units produced over the last two months the denominator You can calculate the cost of units using the Weighted Average Costing Method by making the following changes to the FIFO Costing Method that we discussed above Add the costs of the Beginning Inventory from last month to the costs for the current month numerator The percentage of work done on the Beginning Inventory becomes 100 regardless of whether you are dealing with an Initial or Uniform Cost For an Initial Cost the question that we ask when we determine whether to include a unit in Equivalent Units is Were the units started during the last two monthsquot With FIFO the question was Were the units started this monthquot For a Uniform Cost the question that we ask when we determine whether to include a unit in Equivalent Units is How much work was done during the last two monthsquot With FIFO the question was Was the work was done this monthquot Do not add the Beginning Inventory cost from last month back to the cost of the Beginning Inventory in the calculation of the cost of Beginning Inventory This cost is already reflected in the average cost per Equivalent Unit and Beginning Inventory was given a full share 100 of those costs Complete the remainder of the table in the same way as you did before Please Send Comments and Corrections to me at mconstascsubedu Chapter 4 Notes Page 14 Weighted Average Example Take the Paul Inc example that we did above and add the following information regarding the 42360 that was spent on the Beginning Inventory last month Cost Direct Materials in Beginning Inventory 35000 Conversion Costs in Beginning Inventory 7 360 Total Cost From Last Month 42 360 You can now calculate the cost of the units using the Weighted Average Costing Method The changes from FIFO are shaded in the following table Keep in mind that The Direct Materials Cost to be allocated becomes 395000 35000 last month 360000 this month The Conversion Cost to be allocated become 535360 7360 last month 528000this month The Direct Materials percentage becomes 100 and Do not add the 42360 to the cost of the Beginning Inventory Weighted Average Costing Method M DMat ConvU M 5 K m Cost of Group Beg Inv 20000 u m 98340 8 amp C 150000 100 150K 150K 150K198 294 737 550 End Inv 30000 40 M g TranSfBWEd Out 835 890 Equivalent Units 200K 182K 1 98x30K294x12K 94 554 Calculation 395K 535 360 Total C051 0f UNIS 930 444 200K 182K Cost Per Equivalent Unit 1975 2942 includes rounded numbers Compare this calculation with our FIFO Costing Method calculation This Month s DIrMat Conv Units 360K 1 528K U1 Cost of Group Beg Inv 20000 70 0 14K 423603x14KH 84360 SampC 150000 100 150K 150K 150K23 750 000 End Inv 30000 40 TranSfermd Out 834 360 Equivalent Units 180K 176K 2x30K3x12K 96 000 Calculation 360K 528K TOtHICOStofUnitS 930360 180K 176K Cost Per Equivalent Unit 200 300 Please Send Comments and Corrections to me at mconstascsulbedu Chapter 4 Notes Page 15 The per unit costs from last month were lower than the per unit costs for the current month Under FIFO these cheaper costs were allocated solely to the Beginning Inventory With Weighted Average the cheaper costs are allocated to all of the units in Work In Process this month As a result Beginning Inventory replaced these cheaper costs with higher costs from the current month and the cost of Beginning Inventory has increased On the other hand Ending Inventory and Started amp Completed have replaced this month s higher costs with last month s lower costs thereby reducing their costs Two Group Approad With the Weighted Average Method the BI is treated the same as SampC They are both always 100 Because of this you can treat them as the same group Units Finished El is treated the same Using the foregoing example Weighted Average Costing Method 2Month s DMat CnU Units Cost of Group Units V Finished 170000 N n m 1 835 890 End Inv 30000 40 m g Transferred Our 835 890 Equivalent Units 200K 182K 198x30K294x12K 94 554 Calculation 395K 535 360 T013C S fUniS 930 444 200K 182K Cost Per Equivalent Unit 1975 2942 includes rounded numbers Please Send Comments and Corrections to me at mconstascsulbedu CHAPTER 13 Utilization of a Constrained Resource Pages 594597 2 Constrained Optimization We want to either Maximize profitsCM or Minimize costs This is easy you make either infinity units to maximize profitsCM or zero units to minimize costs Problem have a constraint Limited Capacity 9 Max profitsCM Need to achieve goals 9 Min costs 3 If there is only one constraint this is easy Max 9Find profitCM per unit of constraint for each alternative Pick highest Min 9 Find cost per unit of constraint for each alternative Pick lowest 4 Eg CM is 4 for Product A amp 9 for Product B You can make 3 Product As in 1 hour You can make 1 Product B in 1 hour Only 100 hours are available 15 Calculate the CM tor1 hourwith each Product CM of 12 per hour for ProductA CM of 9 per hour for Product B Only make Product A 5 How do you Maximize Sales RevenueCM or Minimize costs When dealing with multiple constraints We will discuss 2 ways to solve these problems Graphical approach Excel 6 Graphical Approach 15 state your goal 39 Eg Maximize CM Minimize cost Mathematica formula for item being maximized or minimized Called Objective Function OB Variables in CB are your alternative courses of action 9 What you can change Eg of each type of product that you will produce 7 Assume Co can make 2 types of bolts Bolt A or Bolt B BoltA has CMU 10 Bolt B has CMU 12 Co wants to know of each type of bolt to produce to maximize CM B Maximize 1OA 12B Where A 9 of A Bolts produced B 9 of B Bolts produced 8 Without more information Go would produce e0 of every bolt With this production Co would have e0 CM In reality there is limit to of bolts that Co can produce 9 Assume each bolt must ass throu h p g Add constraints to OB followmg machines amp time required on each machine differs as shown below Descrimion pr bem OB Max 10A 12B Machinel Machine ll Machine Ill Constraints subject to A Bolt 1 min 1 min 1 min Only 240 mins available on Machine I 1A 1B s 240 B Bolt 1 min 4 min 5 min Only 720 mins available on Machine ll 1A 4B 5 720 OI 160 39 39l bl M h39 I 1A SBS160 In 1 day there are 240 720 amp160 minutes available on mt mms aval a e on ac me gt Machine Machine II and Machine I respectively Can t manUfacmre negat39ve 0f bons39 A39 B 0 How many of each type of bolts should Co produce in 1 day Next graph production area that meets all of constraints 1 2 Feasible Region I I Graph consists of Cartesian axis with the OB Nowv glltaiph Other nStra39ntSv Wh39Ch are Variables as xaxis amp yaxis meals 39Qes lt Eg ei eror Last constraint alone means you are dealing with top right quarter of Cartesian axis wine a Feasible Regiqri Area covered by such an inequality consists of 1 line that divides Cartesian plane amp1 side of that me Formula of line is inequality formula with substituted for s or 2 To raph inequality 9 graph line that divides the Car esian plane amp chose side of line that satisfies inequality To graph 13 constraint 1A1 B S 240 Graph line 1A1B 240 line crosses eac We Know that B0 on any point on Aaxis as B coor inate 1A1B 240 1A10 240 240 A 2401 A 2400 So line crosses Aaxis at 2400 0 Easiest way to graph line is identify points where XIS Therefore point where line crosses Aaxis has 0 So we replace B with 0 in equation amp solve for A Where does line cross Baxis We know that A0 at any point on Baxis Therefore point where line crosses Baxis has 0 as A Cool nate So we replace Awith 0 in equation and solve for B 1A1B 24o 101B 240 18 240 B 2401 B 2400 So line crosses Baxis at 0 2400 15 With these 2 points you can now graph the line was 24mm was A 16 Now we need to pick side of line that satisfies inequality Easiestway to do this is to test 1point on 1 side of line 7 you test point by Substituting coordinates ll ilo li iequailly lormula amp l s roduce avalue that checkilcoordii iae p saiisiies li iequailly If point tested satisfies inequality then every point on same side of line will satisfy inequality Easiest point to test is origin 00 because you are ealing wi zeros as variables So plug origin into inequality 8t see if inequality is true 1A 1 B S 240 Inequality 10 1 0 S 240 Test the Origin 0 S 240 True Statement 17 So Feasible Region for 13 constraint includes side of line that contains origin Feasible Region that satisfies 13 amp last constraint consists of wine a zouu MID M22 A 18 To graph 2nd constraint 1A4B S 720 Graph line 1A4B 720 We know that line crosses Aaxis at 7200 0 1A4B 720 1A40 720 1A 720 A 7201 A 7200 19 Line crosses Baxis at 01800 1A4B 720 1O4B 720 48 720 B 7204 B 1800 20 By testing origin we see that side that contains origin satisfies inequality 1A 48 s 720 Inequality 10 40 5 720 Test the Origin 0 s 720 True Statement 21 Feasible Region for 2nd constraint includes side of line that contains origin Feasible Region that satisfies 15 2nd amp last constraints consists of following M22 5 zouu mun mu mm W A 22 To graph 3rd constraint 1ABB s 160 Graph line 1ASB 160 Line crosses Aaxis at 1600 0 1A5B 160 1A5O 160 1A 160 A 1601 A 1600 23 Line crosses Baxis at 0 320 1A 58 160 105B 160 58 160 B 1605 B320 24 By testing origin we see side that contains origin satisfies inequality 1A 58 s 160 Inequality 10 50 5 160 Testthe Origin 0 s 160 True Statement Feasible Region for 3d constraint includes side of line that contains origin Feasible Region that satisfies all of constraints is wise 2mm 1am 1am mu 72mm me A 26 The fact that Feasible Region no longer touches lines for 15 amp 2nd constraints tells you that 15 amp 2nd constraints are not binding Time on Machines and II could be unlimited and it would not affect our production possibilities 27 nce you have identified Feasible Region that satisfies all constraints You have to decide which points within Feasible Region maximize CM Corners points of Feasible Region are most extreme points Therefore corner points represent production levels that produce most extreme CM Eg highest amp lowest CM To find highest CM 28 Plug each corner points into original OB 10A12B Check to see which point produces highest CM Corner 10A12B m 1600 0 1 1600 12 0 1600 16000 0 320 1 0 12 320 0384 3840 00 10120 00 0 Co generates highest CM by producing 1600A Bolts and 0 B Bolts 29 We can solve Constrained Optimization problems using Excel Have one cell on spreadsheet represent value of each of your 2 QB ariables of A Bolts amp of B Bolts Excel will place optimal value in these cells after it solves pro em For now ive A Bolts a value of 1 10quot amp give B Bolts a value of 0quot so that you can tell Ifyour other formulas are correct Cell Label A Bolts B Bolts 20 Cell Contents 3O You also need to have another cell represent value of OB formula using values in your OB Variable cells Cell Label Cell Contents OB 1A Bolt Cell12B Bolt Cell 31 For your constraints you need a separate cell for each constraint Cell will contain value of side of constraint inequality formula that uses OB Variables 32 Your spreadsheet should look something like the following Eg time on each machine 1 A 7 7 B 9 This uses of each type of bolt produced I 7k Side of constraint inequality formula containing fixed 2 Objecme Funcmn39 1 B4 12 B5 value will be supplied later No of A Bolts 10 Cell Label Cell Contents 757 No of B Bolts 20 Time on Machine 1A Bolt Cell1B Bolt Cell 7 T M h I 1 B4 1 BS Ime on ac Ine T M h ll 1 BltCll 4BBltCll fme on ac fne A o e o e 8 Time on Machine II 1B44B 5 Time on Machine lll 1A Bolt Cell5B Bolt Cell 9 Time on Machine I 1tB4 5435 10 33 34 Select Tools on Menu Bar Click on Solver If you do not see Solver E S lect Add lns amp select Solver Add In e 39 Once you select Solver the following dialogue box will open Solver Parameters Sgt target cell i W 771 W l Max 0 Mo 0 value af Ev Changing Cells guess IEEHl I For Set Target Cell Click on cell that contains OB For Equal To Click whether you want to maximizeminimize OB For By Changing Cells Highlight 2 cells that contain OB Variables 35 For Subject to the Constraints Click on Add and the following dialogue box will open Add Constraint Cell Beference gonstraint ll For each constraint Left box should name cell that contains portion of constraint inequality formulathat contains OB Variables Middle box should give inequality symbol Right box should contain fixed value portion of constraint inequality For each nonnegative constraint eg A 2 O Left box should name cell that contains OB Variable Middle box should have gt as inequality symbol Right box should contain 0 as fixed amount Subject to the Constraints lB4 gt 0 B9 lt 150 l 36 37 once you have entered all of this information click Solve Excel will change values in OB Variable cells to reflect optimal value Excel gives same answer we got using graphical method Produce 1600 A Bolts and zero B Bolts Objective Function 160 Solver Results No ofA Bolts 1600 No of B Bolts 0 Time on Machine 160 Time on Machine 160 Time on Machine I 160 39 Answer Report1 sheet contains description of constraints amp indicates which are binding 38 A Solver Results dialogue box will open Leave Keep Solver Solution checked Under Reports click on Answer amp Sensitivity When you click OK 2 new worksheets will be created Answer Report 1quot sheet Sensitivity Report 1quot sheet Answer Re ortl1 indicates that constraints involvmg achines l and II are not binding We noted same thing with graphical approach Notice Excel says restricting B Bolts to non negative answer was binding Without this constraint Excel would have given negative number for ii of B Bolts produced A negative B Bolt value would allow you to produce more A Bolts Eg if B could be 1 then you could obtain an extra 30 seconds on Machine I This would allow you to produce 5 more A Bolts and stay within the constraint 1ASB S 160 Constraint 11600 50 160 Optimal Value 11605 51 160 Allowing B to be 1 41 The 1 B Bolt would cost you 12 a negative CM but the 5 A Bolts would produce an additional CM of 50 Thus if you could go negative the next negative B Bolt would produce a marginal profit of 38 This potential is reported as Reduced Gradientquot on Sensitivity Report 1 Adjustable Cells Final Reduced Cell Name Value Gradient E4 No ofAElolts 1500 0 E5 No ofB Bolts 0 0380000249 42 The Lagran e Multiplier is the Shadow Price of 1 minute on achine You would be willing to pay up to 1 for an extra minute on Machine I You can calculate this yourself We know that each A Bolt takes 1 minute on Machine I You can therefore produce 10 A Bolts with an extra minute on Machine lll Each A Bolt produces a GM of 10 Thus an extra minute on Machine III which allows us to produce 10A Bolts is worth 1 10 x 10 to us Constraints Final Lagrange Cell Name Value Multiplier E7 Time on Machine l 180 0 EB Time on Machine ll 160 0 ER Time on Machine lll 160 l CHAPTER 6 CostVolumeProfit Analysis Firms study relationship between their CVP levels Part of planning process Answers common questions 4 How many units does Firm have to produce amp sell in orderto BE Can Firm obtain this level of production amp sales 5 How many units does Firm have to sell to produce a target income If Firm increases its sales volume by 50 what will be the impact on my OP BreakEven Point 7 P Selling Price Per Unit X Units Produced and Sold V Variable Cost Per Unit F Total Fixed Costs OP Operating ProfitsBefore Tax t Tax rate 8 Sales Revenue Px Total Costs Vx F When Firm Breaks Even BE Sales Revenue Total Costs 0 9 Revenue Total Costs Px Vx F Px Vx F xP V F X L P V FORMULA quot quot 10 Denominator called CMU L x CMU FORMULA A 11 Eg Assume Firm has following costs revenues and tax rates P 200 V 120 F 2000 Tax Rate t 40 X 25 units 13 This is common sense Firm makes 80 every time it sells a unit 2 000 X L50 25 units F Formula A 0 X H PV FORMULA quot3quot 15 Denominator called CMR PX CMR FORMULA B What is CMR 16 CMR gives of Sales Price that goes to pay off FC amp generates profits after you pay VC P VP PP VP 1 part of price that pays VC 17 PX FP VP 2000 PX 200 120 200 PX 2000 40 PX 5000 18 Why do we need Formula B 19 Eg What is BE Point for 00 Revenue 100K PX Less VCs 3OK VX CM 70K PX VX Less FCs 50K F OP 20K PXVX F 20 What is BE We do not know the of units sold We do not know P or VC per unit We cannot use Formula A 21 We can calculate the CMR So we can use Formula B m PX VX Revenue PX PVX PV PX P 22 The CMR is 70 70000100000 The BE Point in Sales Revenue is PX FCMR 5000070 7142857 23 Revenue 100K Less VCs 3OK CM 70K Less FCs 50K OP 20K 24 OLD REVISED Rev 100K PX 71 4K VC30 30K VX 214K CM 70K 50K FC 50K 50K OP 20K 0 25 Targeted Operating Profits 26 OP Revenue Costs OP PX VX F PX VX F OP 27 PX VX F OP PXVX FOP XPV FOP x 1F OP miter P V X F OP CMU P v PX F OPP P V PX ML 3217 B P V P PX F OP CMR X 1FOPi 28 Same Eg 29 Assume Co wants Target OP of 40K 2000 40000 200 120 42000 80 X 525 units x Again this is common sense Firm makes 80 for every unit Needs to sell 25 units to BE 200080 Needs to sell 500 units to generate OP of 40K 4000080 Needs to sell 525 units 4200080i 30 31 OP do not include tax expense OP Tax Expense NI What if given Targeted NI 32 Eg Given target NI aftertax of 50K amp tax rate of 40 Convert 50K NI into OP OP Taxes NI OP 4 OP 50000 6 OP 50000 OP 500006 OP 33334 33 You can checkthis OP 83334 Taxes 40 33334 NI 50000 34 What If Target OP Is given as of revenue PX FOPPVP PX 2000 1 PX200 120200 PX 20001PX40 4 PX 20001PX 3 PX 2000 PX 20003 PX 6667 35 Revenue 6667 Less VCs 60 4000 CM 2667 Less FCs 2000 OP 667 36 Multiple Products 37 Firm has gt1 product Same analysis but use composite CMU Formula A or CMR Formula B 38 If using CMR Formula B Need to calculate CMR for entire Company CMR CMSales 39 If using composite CMU Basket Package Method Weighted Average CM Method 40 Need to assume sales mix product mix doesn t change 4 1 Eg Co sells 3 Bananas for each Orange that it sells 75 vs 25 Bananas Oranges Price 2 4 VC per Unit 1 2 CMU 1 2 Common Fixed Costs 2000 42 Basket Method 7525 Basket 9 3 Bs amp1 Or CMB 3 CMban 1CMor CMB 311 2 CMB 5 43 Now plug CMB into BE formula Gives you BE Point in Baskets Baskets FCMB Baskets 20005 Baskets 400 Baskets 44 Bananas 3 X 400 Baskets 1200 Oranges 1 X 400 Baskets 400 45 Weighted Average Method CMWA 75 CMban 25 CMor CMWA 75 125 2 CMWA 75 5 125 46 The BE Point in units is X FCMWA X 2000 125 X 1600 units 47 Bananas 75 1600 1200 Oranges 25 1600 400 48 Margin of Safety 49 Margin Of Safety 9 Amount that actual sales dollars or units exceed BE Point lf BE Point is 25 units or 5000 amp Co actually sells 40 units 8000 Margin Of Safety is 15 units or 3000 50 Operating Leverage 51 Operating Leverage OL Divide CM by OP OL is a multiplier If you multiply Co s OL by quot0 increase in Co s Sales 9 You get quot0 increase in Co s OP 52 Eg Revenue 8000 200x40 PX VCs 4 800 120x40 VX CM 3200 FCs 2 000 OP 1 200 53 Operating Leverage 54 Common to ask 9 If we increase our sales by so much what will be our new OP OL gives you the answer quickly 55 If Sales increases by 50 OL X Sales1 OPT 267 X 50 133 OP of 1200 will increase by 1600 133 X 1200 New OP 9 2800 56 Q Rev 8000 200 X 40 units VCs 4800 120 X 40 units CM 3200 80 x 40 units FCs 2000 OP 1200 increase in x m Rev 12000 VCs 7200 CM 4800 FCs 2000 OP 2800 57 The increase in Rev is assumed to be due to 200 X 60 units 120 X 60 units 80 x 60 units CHAPTER 8 USE OF 1 PLANTWIDE PREDETERMINED OH RATE 3 In Chapter 3 we assumed 1 Predetermined OH Rate 4 1 PlantWide Application Rate may not be very accurate Eg goods are different If you apply MOH inaccurately 9 Inaccurate costing 5 Consequences of inaccurate costing May go after wrong business Inaccurate pricing Wrong product line Having gt 1 cost pool might increase accuracy Allows you to differentiate between products Departmental MOH Application Rates Each department can have a different Predetermined OH rate Each department can have a different cost driver 9 Example Company Makes Standard amp Custom Trophies 2 production departments Design Department Manufacturing Department 10 OH Costs Design Manufacturing Total Rent 20K 80K 100K Depreciation 200K 200K Supervisors 50K 50K 100K Maintenance amp 100K Total 90K 41 OK 500K 1 1 DeQartment Direct Labor Hours Design 10K Manufacturing Total 100K 12 Job 1 9 unique product design 20 DLHs in Design 20 DLHs in Manufacturing Job 2 9 standard model No Design services 20 DLHs in Manufacturing 13 PlantWide Application Rate 500000 100000 5DLH Job 140 hours X 5 200 Job 2 20 hours X 5 100 14 Job 1 Job 2 Direct Materials 200 200 Direct Labor 400 200 MOH amp m Total Cost 800 500 Profit m m Price Bid 960 600 15 Job 2 bid rejected by client Said we charged too much Job 1 bid accepted Said we had best prices in town 16 Departmental Application Rates 90K10K 9DLH 410K90K 455DLH 17 Job 1 Job 2 20X9 180 Man 20x455 20x455 Total 271 91 18 Job 1 Job 2 DM 20000 20000 DL 40000 20000 MOH 27100 9100 Total 87100 49100 Profit 17420 9820 Bid 105520 58920 PlantWide Rate 96000 60000 Departmental Rates 105520 58920 Difference 9520 1080 20 PlantWide Rate 500 Design Rate 900 Manufacturing Rate 455 21 ACTIVITY BASED COSTING 22 ActivityBased Costing ABC Cost pools based on activities Activities are not subdivisions of departments Possible manufacturing activities Pen orm Engineering Work Pan Production Purchase Materials Receive and Handle Materials Manage Production Setup Machinery Store Final Product amp Ship Final Product 23 24 With ABC Calculate separate application rate for each activity Use appropriate cost drivers for each activity Apply MOH by activity 25 Disadvantage of ABC More record keeping Institutional resistance 26 Advantage of ABC 9 Accurate cost information Provides insight into cost control ActivityBased Management ABM 27 DLCs can be included in ABC DL and MOH are combined Called Conversion Costsquot 28 ABC Example 29 Example Company produces three products Quaity Superior amp Superb Currently applies Conversion Costs using 1 PlantWide Application Rate DLHs as Driver Considering using ABC 30 Activity Area Budget Cost Driver Mat Handling 2584K parts Prod Scheduling 114K prod orders Setups 160K prod setups Mach Maint 3510K Machine hours Finishing 1092K DLHs Packg amp Shipng orders shipped Total 53244K Cost Driver Q pr pb Units planned 10K 5K 800 of parts per unit 30 50 120 Production orders 300 70 200 Production setups 100 50 50 MHs per unit 7 7 15 DLHs per unit 2 5 12 Orders shipped 1K 2K 800 Estimates it will have 54600 DLHs next year Material Handling 40 part 32 25840030 x1000050 x 5000120x 800 Production Scheduling 200 production order 114000 300 70 200 Setups 800 production setup 160000 100 50 50 Machinery 30 machine hour 35100007 x 100007 x 500015800 Finishing 20 DLH 10920002 x 100005 x 500012 x 800 Packing amp Shipping 50l order shipped 190 000 1 nnma nnnmnni 33 1 PlantWide Application Rate using DLHs Est Conversion Cost 5 324 400 9752 Estimated DLHs 54600 rounded 34 Activity Quality Mat Hand 30x10000 x 40120000 Prod Sch 300 X 200 60000 Setups 100 X 800 80000 Machinery 7 X 10000 X 30 2100K Finishing 2 X 10000 X 20 400000 Pck amp Shp 1000 X 50 M Ttl Conv 2 810 000 ConvUnit 281000010000 28100 35 Activity Superior Mat Hand 50x5000x 40 100000 Prod Sch 70 X 200 14000 Setups 50 X 800 40000 Machinery 7 X 5000 X 30 1050000 Finishing 5 X 5000 X 20 500000 Pck amp Shp 2000 X 50 100 000 Ttl Conv 1 804 000 ConvUnit 1 804000 5000 36080 36 Activity Superb Mat Hand 120 x 800 x 40 38400 Prod Sch 200 X 200 40000 Setups 50 X 800 40000 Machinery 15 X 800 X 30 360000 Finishing 12 X 800 X 20 192000 Pck amp Shp 800 x 50 40 000 Ttl Conv 710 400 ConvUnit 71 0400 800 88800 37 Quality Superior Sugerb PlantWide 19504 48760 1 17024 2 x 9752 5 x 9752 12 x 9752 ABC 28100 36080 88800 Difference 8596 12680 28224 38 REAL LIFE ABC EXAMPLES 39 Lagorte Industries Ltd Produced cleaning chemicals Sales force focus Big customers lgnored small customers OH allocation system Big customers were more profitable ABC allocated OH accurately Profit margins higher for smaller customer Smaller customers did not generate OH costs Placed orders by telephone Required little contact with sales force 40 41 Larger customers generated high OH costs Constant contact with sales force 24hourtechnical support Loans of equipment at no charge Other concessions 42 After ABC New cost structure Change in sales mixes amp prices bid Operating Profits increased 43 ExxonMobil Lubricants Division ABC Accuracy in Costing Understood Cost Behavior ABC resulted in Cut of products Cut of suppliers Profit increased 44 The Boeing Company Boeing tested ABM in two operations at its Wichita plant 45 ABC analysis showed Boeing outsourced when it shouldn t This is Relevant Costing 46 ABC analysis showed No standard for when rework required Estabished rework standard Cut costs by 20 CHAPTER 13 Joint Products Pages 597599 Joint Products 3 Joint Costs JC Egs Dairy Slaughter house Petroeum refinery SplitOff Point 4 Joint Products JP vs ByProducts BP Assume JCS not allocated to BPs We will discuss BPs later Methods of Allocation 7 Methods Used to Allocate JCs Some Two Methods that use FMV rSales Value at SplitrOff rNet Realizable Value Based on FM 8 Sometimes FMV is Suspect 7E S Can Use Another Method rPhysical nits 9 10 Physical Units Method Z39jws uglggjm Nuts 3le m3n Nut Places to lbs ttu 11 NutPiecesasJP 12 quotquot5 5 Uquotquot Notice same unit cost for JPs Diem 2 215 X60 3 4 m a a xseo z W 4 rNot realIstIc amp causes Pieces amp 1015 gtlteo 40 4 problems 1 Nut Pieces as BP Cost Unit Diem 2 25 24 12 Nut 35 36 12 13 14 Nut Pieces as JP Unit Price FMV Cost Prem 2 30 60 60100 x60 36 Sales Value At SplitOff Method Nuts 3 10 30 30100 X3360 18 Pieces m 1 m 10100 x60 6 15 100 Cost per unit Premium 18Ib Nut 6Ib Pieces 60 llb 15 Nut Pieces as BP 16 Unit Price FMV Cost Prem 2 30 60 6090 X60 40 Net Realizable Value Method Nuts a 10 m 3090 x60 20 5 90 Cost Per Unit Premium20Ib Nuts 667Ib 17 18 Chemical A mu gallans mu Chemical c an gallans 2lgal Chemical 5 2m gallans Unknawn Value Chemical B 9 No FMV Work backwards 9 approximate FMV Value of Chemical C 50 x 2 Value of Chemical D 50 x 3 Total Value of Chemical C amp D Less Further Costs Net Flealizable Value of B Unit Value of B 240200 100 250 w 240 1 20unit Using NRV for Chemical B Units Price Value Costs A 100 3 300 300540 x300 167 B a 12 m 240540 x300 133 300 540 Cost per unit A 167 B 67 21 ByProducts 23 Two basic way to handle BPS 1St way 9Net proceeds treated as Other Revenue 2ncl way 9 Deduct net proceeds from JCs Then do allocation of new JC 20 M Price Value 30 C 50 2 100 100250 x143 5720 D Q 3 m 150250 x143 8580 100 250 Cost Per Unit C 114 D 172 22 1St thing to remember is that you are dealing with net sales proceeds from the sale of the BP Sales price less further processing costs 24 Chemical A 100 gallons 3lgal Process One Joint C051 Chemical C Chemical B 200 gallons Unknown Value Process Two Joint Cost 10 Chemical D m o in 9 ca w 3Igal By Product Net Proceeds 20 2nd way 9 JC are 280 300 20 I Chapter 7 Demonstration Problem Solutions Page 1 I Demo 71 ANSWER A E Q Q Total Sales 1 000 2000 1 000 1000 Variable Costs 660 1 200 800 400 Contribution Margin 340 800 200 600 Direct Fixed Costs 120 240 120 120 Division Profit 220 560 80 480 1340 Common Fixed Costs 900 Operating Profit 440 Each division has a positive Operating Profit If you drop Division C in the first year A a 2 m Sales 1000 2000 1000 Variable Costs 660 1200 400 Fixed Costs Operating Profit 4 110 Si amp If you drop Division A in the second year a 2 m Sales 2000 1 000 Variable Costs 1200 400 Fixed Costs Operating Profit amp m If you drop Division B in the third year 2 M Sales 1 000 Variable Costs 400 Fixed Costs 1 020 Operating Profit 420 420 If you drop Division D in the fourth year then there is no fifth year Please send comments and corrections to me at mconstascsulbedu No division should be dropped Chapter 7 Demonstration Problem Solutions Page 2 I Demo 72 ANSWER 1 When you produce more inventory than you are selling then fix costs are being treated as assets and not being expensed 2 1995 1996 1997 Sales 30000 32000 34000 Less Var COGS 15 000 10 X150K 16 800 105X160K 18 700 11 X170K Contrib Margin 15000 15200 15300 Less Fixed Costs Fixed Manufacturing OH 15000 15000 15000 Fixed SampA Expense 3 000 3 600 3 800 Operating Profit 3 000 3 400 3 500 3 The difference in income between fullabsorption costing method and the variable costing method is due to the different treatment of the fixed factory overhead attributable to unsold units 1995 75 X 50000 3750 1996 60 X 90000 5400 1997 50 X 130000 6500 4 On the balance sheet check the of inventory to sales I Demo 73 ANSWER 1 a Absorption manufacturing cost per unit Direct Materials 400 2 lbs 2 Direct Labor 1050 1 5 hrs 7 Variable Manufacturing Overhead 300 1 5 hrs 2 Fixed Manufacturing Overhead 450 1 5 hrs 3 Total 2200 b Variable manufacturing cost per unit Direct Materials 400 2 lbs 2 Direct Labor 1050 1 5 hrs 7 Variable Manufacturing Overhead 300 1 5 hrs 2 Total 1750 Please send comments and corrections to me at mconstascsulbedu Chapter 7 Demonstration Problem Solutions 2 Absorption Costing Income Statement Revenue Page 3 800000 20000 x 40 Less Cost of Goods Sold 455 000 20000 X 22 10000 5000 Gross Margin 345000 Less Selling amp Administrative Expenses 280 000 200000 1 X 800000 Operating Profit 65 000 3 Variable Costing Income Statement Revenue 800000 20000 x 40 Less Variable Costs Variable Cost of Goods Sold 355000 20000 X 1750 5000 Variable Selling and Administrative Expenses 80 000 800000 X 1 Contribution Margin 365000 Less Fixed Costs Fixed Selling and Administrative Expenses 200000 Fixed Manufacturing Overhead 122 500 25000 X 45 10000 Operating Profit 42 500 4 Unsold Units x Fixed Manufacturing Overhead per Unit 5000 x 45 22500 Demo 74 ANSWER A Sales 1500 Less Variable Costs 1 000 Contribution Margin 500 Less Fixed Costs 100 Operating Profit 400 E 9 2800 1050 2 200 1 550 600 500 500 150 100 650 Product C has a negative contribution margin so the firm should drop C Please send comments and corrections to me at mconstascsulbedu Chapter 7 Demonstration Problem Solutions Page 4 If D replaces C then 15000 units of D would be produced and sold 2 Sales 1050 Less Variable Costs 450 Contrib Margin 600 Less Fixed Costs 640 Product Margin 40 D has a positive contribution margin however the fixed costs are higher than the contribution margin These are direct fixed costs and the firm can save the 640 if it doesn t make product D It would be betterjust to drop C If product D replaced product B then D would sell more units and can cover its direct fixed costs 2 Sales 1400 Less Variable Costs 600 Contrib Margin 800 Less Fixed Costs 640 Product Margin 160 Product D could make 60 more than product B So the firm would be best to drop C and replace B with D Please send comments and corrections to me at mconstascsulbedu CHAPTER 5 COST DRIVERS 3 Drivers cause a cost to change of Baseball Bats drives wood cost 4 Assume for this discussion only Units In reality Many cost drivers FIXED COSTS Behavior of Fixed Costs Tuiai Casi Number n1 Ums This graph is simplistic 10 Tuizi Casi W RE WWW a ma Wmmm imam Equation of FC Graph F 11 12 VARIABLE COSTS Behavior of Variable Costs VC rmai Casts Number m units 14 This graph is simplistic 15 16 Total Casts REIEVEHTREHEE Equation of VC Graph Numbar at UM y Vx 17 18 TOTAL COSTS Total Costs Variable Fixed Costs C Vx F To FC VC Total FC 9 F VC per Unit 9 V Total V08 9 Vx 20 Equation of line 23 T V y mX b 2 D S X Total cost function Fixedcurds F VX F 21 22 ou vmngm ESTIMATING COSTS 0 FROM PAST DATA 35 0 o 23 24 HIGH LOW METHOD 0 mmme 23 0 o 0 o O O Luwes AEWW Lem Numbev m unns 25 Example High Activity 40000 bats 500000 cost Low Activity 20000 bats 300000 cost 26 Remember the equation of a slope of a line VC per unit is the slope of the TC function VC per Unit m 27 500000 300000 40000 20000 200000 20000 V 10 per bat V TC 10XF 28 Using the High Point Total Cost 10X F 500000 1040000 F 500000 400000 F 500000400000 F 100000 F Cost Fn TC 10X 100000 29 Using the Low Point Total Cost 10X F 300000 10 20000 F 300000 200000 F 300000 200000 F 100000 F Cost Fn TC 10X 100000 30 OLS REGRESSION 31 32 least squares 5 least squares 4 3 Y 2 otal Square Area 1 1 U 1 2 X 339 4 5 1 33 34 TC 381x 219385 hours OUTPUT Terminology Dependent Variable squareRSquare 33333353233 I Error 6620693738 Independent Variable Simple Regression 39 lVlUltlple Regresslon 10 4383358557 4383358557 35 TC 1802x 379985 Units 36 TC 386x1 25x2 217230 OUTPUT Square 0984378363 Square 099071704 R Square 0982816199 R Square 0988654161 Error 8588100946 Error 6978399654 73755477813 7375547786 4332825555 4369805173 Variable1 3865355522 1559236807 2479004795 003504862 37 Excel can be used to do a Regression Example 38 Elmaquotan Excel 7 Regressinn rChaplel 5 5311 Fl e can yew Insert mm Innis Data mm Lela WPEaQuestlanfmhelp s x 41 E glljil fi la 1117 la2wzlll ezmmvay gm lsw ml llt A A c l D l E l F l G l Month Hours Units OH Costs January 100000 12000 600000 February 95000 11000 580000 March 89000 10000 570000 April 84000 9000 545000 May 80000 8000 523000 June 76000 7000 499000 July 69000 6000 475000 August 64000 5000 464000 September 60 000 4 000 444 000 October 56 000 3 000 430 000 November 51000 2000 423000 December 50000 1000 413000 455545 A 0 TN Haws X Unll JEWHDUV5 X1J SltQ l gt 2gt19113 llt gt T y 39 0 Go to Tools 0 Select Data Analysis This is an AddIn 0 Select Regression 40 Data Analysis analysis Tools OK Exponential Smoothing FTest TwoSample for l ariances 7 Fourier Analysis Histogram Moving Fwerage Random Number Generation Rank and Percentile F ression 7 Samplin t Test Paired Two Sample For Means gt l 41 Z Input OK Input 3 Range D2D13 Input a Range Hel D Labels 1 Constant is gem D Con dence Level We Output options O gutput Range 1 New 39 l C New workbook Residuals El Residuals El Residual Plots El Standardized Residuals El Line Fit Plots Normal Probabilit El Normal Probability Plots icrnsn Excel gtRegressinn hapler 5 le Edi ew Insert Fgmlat Iouls Qata Mnduw elp 391 15a ganja311 1 an Jim we 2 21 acme may l lnla1ulE 0 v0 tau 1 i as 7 w M A1 1 SUMMARY OUTPUT AlacolelFlslHllJlKlLlMleol UNWl HY UUlPUI Regression Slatlellcs Multiple R 0995347 RSquare 0950715 Adjusted F 13939733 Standard E 5520594 servaliu 12 ANOVA df MS F i zlhbarlceF Regresslnl 1455910453510 113157112 175711 Residual 11 means 43833586 Total 11 472E1U Coef ci nts andard Err 1 Sta P value Lower 95 U er 95 ower 95094 er 95 0 lnlercept 219335 3 0715 545 2517144 2 24E1D 199985 E 235805 159985 E 235805 X Vallable 3 813932 0116753 3288589 17E 11 3 55379 4074074 3755379 4074074 gt lNHDuvsiUoitix BulhHDylsXDampUnlt X2 X hgelunag It CHAPTER 13 Decision Making 3 Steps in decision making Define problem ldentify alternatives ldentify costs benefits of alternatives Compare relevant costs benefits Select alternative with Greatest benefit Lowest cost Focus only on relevant costs amp benefits Everything else is irrelevant Relevant Costs amp Benefits 6 Relevant costs amp benefits are different between alternatives 7 Assume you rent boat for 1000month Harbor tour business vs fishing business Fishing M Difference 8 Rent is same for both alternatives You get same result if you ignore Rent Fishing Tour Difference Revenue 8000 10000 2000 39 1 000 4 000 3 000 Profit 7 000 6 000 1 000 Rent is not relevant Revenue 8000 10000 2000 Expenses 1000 4000 3000 Rent 1000 1000 0 Profit 6 000 5 000 1 000 9 No need to consider costs benefits that are same May mislead you Also 9 Relevant costs amp benefits are future costs amp benefits Not sunk or historical costs 10 Eg Assume you own large painting for home Paid 10000 Moving amp no room Only offer is 8000 Fact that you originally paid 10000 is irrelevant Original price is sunk cost Opportunity Costs 12 Opportunity Costs Other revenue Only available if one of alternatives is selected Treated as cost of alternative that closes off additional revenue 13 Eg Assume you rented retail space Choice CD store vs Comic Book store With Comic Book store only Can sublease part of space to vending machine operators Additional 200 a month This sublease not available with CD store alternative 14 Lost revenue from vending machine sublease 200 Opportunity Cost of CD store Added to other costs of CD store 15 Lost sublease rent shown as cost for CD Store Alternative Opportunity Cost Q Comic Difference m M Revenue 10000 7000 3000 Expenses 5000 2000 3000 Sublease 0 200 Profit 4 800 5 000 200 16 Can also show Opportunity as additional revenue D Comic m Store Book Store Revenue 10000 7000 3000 Expenses 5000 2000 3000 Sublease 200 200 Profit 5 000 5 200 200 Other Important Factors 18 We focus on quantitative Qualitative factors Eg Should we outsource Supplier reliability Quality control Workforce morale Robustness Ability to resume production 19 Timevalue of money relevant Ignore for now 21 Assume you own Catalina cruise ship Original Cost 9 4000000 20 year life SL Depreciation Depreciation 200000year Operating Profit of 500000year 2 of ship not used for cruise business Potential contract 9 transport Scouts to Catalina for camping trips Additional 15000 20 General Example 2 alternate uses for unused 12 of ship Figures exclude depreciation 100K Freight business Annual revenue 70000 Annual expenses 10000 Floating disco Annual rents 90000 Annual expenses 20000 Boy Scouts 9 will not patronize ship 23 Freight m Difference Revenue 70K 90K 20K Cash Expenses 10K 20K 10K Opportunity Cost 3 Operating Profit 60K 55K 6K Cruise net profit irrelevant Depreciation is irrelevant Loss Boy Scout contract 9 Opportunity Cost for Disco used as disco 22 24 Freight m Difference Revenue 70K 90K 20K Cash Expenses 10K 20K 10K Opportunity Cost A5K Operating Profit 75K 70K 6K Boy Scout contract 9 Additional Revenue for Freight 25 Special Orders Overall cost is irrelevant 27 Aready In business Focus on effect of special order on OP Don t Take M Difference Rev A A a a VCs B Bb b FCs C Ccl c Profit A BC AaBbCc a bc A B amp C 9 irrelevant FC don t change if sufficient capacity VC could be different 29 Passengers cost you 300person Trip costs you 3000 Jet can carry 10 passengers Typical trip 9 sell 6 seats 4 seats empty Motel offers to buy empty seats for 100 Purchase on Stand By basis Won t affect your current business 26 Special Orders Approached by potential customer ln area not normally served Avoids cannibalization Avoids price discrimination Offers to buy productservice at price below your cost 28 n Assume small airline takes passengers to resort island with deluxe conference center amp hotel Normal tourists take ferry for 50passenger Conference attendees take your jet amp pay 700passenger 30 300passenger cost irrelevant Make 1 200 on each flight 4200 3000 Wi special order hurt OP Accept if OP increases Take Don tTake Difference Fteven ue 400 0 400 Expenses 0 Q Q Profit 400 g 400 31 With special orders pay attention to capacity If you have excess capacity taking special order does not cost you extra If you don t have enough current capacity can you buy some extra capacity That cost is a relevant cost Eg Assume 33 Every unit has variable costs of 10 per unit and fixed costs of 3 per unit You have no excess capacity You currently sell units for 20 and you get special order for 1000 units at 15 If you take the special order your costs are the same you are trading sales prices Costs are irrelevant Only difference is 1000 units x 20 20000 and 1000 units x 15 15000 You lose 5000 32 If you don t have enough current capacity and you can t buy extra capacity Then you have to give up a current sale in order to take special order If you do this your costs are the same whether you take the special order but your revenue is different You are trading the current sales revenue for the lower special order sales revenue 34 Keep or Drop 35 Keep or drop divisionproduct Firms prepare income statements nclude all costs of products divisions But some FCs are not relevant They don t change 36 Barbie GlJoe Gumby Total Revenue 600K 350K 250K 1 200K VCS 200K 100K 150K 450K FCs 300K 200K 150K 650K Profit 100K 50K 50K 100K Looks like dropping Gumby will save 50K What are FCs 37 Rent is Common FC Manager salary is Direct FC 38 Rent is not relevant Will make 50K more if you don t drop Gumby Barbie GI Joe Gumby Total Revenue 600K 350K 250K 1 200K VCs 200K 100K 150K 450K Salary 100K 50K 50K 200K Rent M M M M Profit 100K 50K 50K 100K 39 Operating Profit drops from 100K to 50K if you drop Gumby Don t Drop m Difference Revenue 250K 0 250K VCs 150K 0 150K Salary Profit m E m 40 With following set up 9 not misleading Can see Gumby produces 50K Rent shown under Total because common FC Barbie GI Joe Gumby Total Revenue 600K 350K 250K 1 200K VCs 200K 100K 150K 450K Salary M 200K Profit 300K 200K 50K Rent Profit 100K Barbie GI Joe Total Revenue 600000 350000 950000 VCs 200000 100000 300000 Salary 100000 50000 150000 Rent 257 143 192 857 450 000 Profit 42857 7143 50 000 41 Make or Buy Make or Buy 9 outsourcing decisions Assume National Parks Service runs restaurant at Statue of Liberty Meals are prepared by Service at nearby kitchen facility During month Service prepares 12000 meals Receive offerfrom business willing to cater meals Each inhouse meal costs Service 35 Direct Materials 5 Direct Labor 15 Variable Overhead 10 Fixed Overhead 5 43 Outsider offers to provide each meal for 33 Fixed OH is part of supervisors salaries Supervisors will stay on payroll They still supervise the Statue s operations 44 FOH is irrelevant It won t go away 45 Sell or Process Further Buy Meals Make Meals Difference DM 0 60K 5x12K 60K DL 0 180K 15x12K 180K VOH 0 120K 10x12K 120K Price 33x12K 396K Total 396K 360K m 46 Sell or Process Further If you produce raw or intermediate good You could Sell good or Process it further amp sell 47 Own diamond mine Produces 2 grades of diamonds A amp B You sell diamonds to DeBeers 700carat for Grade A 500carat for Grade B You could process diamonds further amp sell them directly to jewelers 900carat for Grade A Additional processing amp marketing costs 100 for Grade A 1 200carat for Grade B Additional processing amp marketing costs 750 for Grade Eg oil wells 48 Grade A Jewelers DeBeers Difference Revenue 900 Additional Costs 100 100 Operating Profit 800 700 100 Grade B Jewelers DeBeers Difference Revenue 1 200 500 700 Additional Costs 750 750 Operating Profit 450 500 50 You should sell Grade A directly to jewelers You should sell Grade Bto DeBeers CHAPTER 7 4 Absorption Costing All we have used so far Cost of units All factory costs Factory costs expensed when inventory sold COGS 5 Absorption Costing Inventory costs DL DM MOH Both FOH amp VOH Required by GAAP 2 Variable Costing Vs Absorption Costing 3 Two systems are used to produce lSs Absorption Costing Variable Costing 6 Variable Costing Alternative to Absorption Costing Not GAAP Separates VCs amp FCs 7 Variable Costing Problem with COGS Both FC amp vc Need to change Inventory cost DL DM VOH Not FOH 1O Different IS formats 8 FOH Variable Costing Not inventory cost product cost Expensed period cost COGS is now a VG Different IS Formats ABSORPTION VARIABLE Sales Sales COGS GM CM SGampA OP OP Assume39Units Produced 10K 11 Units Sold 10K Price Per Unit 25 DM 50K DL 30K VOH 20K FOH 50K Variable SGampA 30K Fixed SGampA 30K 12 With These Problems 1st calculate cost of 1 unit ALWAYS 13 Absorption Costing 1st 9 Calculate cost of 1 unit DM 50K DL 30K VOH 20K FOH W Total Costs 150K Units Produced 10K Cost Per Unit 15 14 Variable Costing 1St 9 Calculate Cost of 1 unit DM DL VOH Total Costs Units Produced Cost Per Unit 50K 30K 29K 100K 10K 10 15 Difference in cost Absorption Costing 15 Variable Costing Method 10 9 FOH per unit 50K10K units 5 16 Absorption Costing IS Sales 250K 25X10K COGS 105X10K GM 100K SGampA 30K30K OP 40K 17 Variable Costing Is Sales 250K 25X10K Less VC v coes 100K 10x10K v SGampA CM 120K Less FC FOH 50K F SGampA OP 40K 18 OP was same for both methods units sold units produced OP will be different if units sold at units produced Same eg but assume 5K units sold 12 of production 22 Difference due to FOH Variable Costing 9 FOH Cost expensed 50K Absorption Costing 9 FOH divided into per unit cost 5 Part of cost of each unit Expensed when unit sold 12 of units sold 9 12 of FOH expensed 25K 23 Difference in OP 5K 20K 25K Due to difference in treatment of FOH of unsold units FOH Per Unit X Unsold Units 5 X 5K 25K 19 Absorption Costing IS Sales 125K 25X5K COGS 105X5K GM 50K SGampA 30K 12 30K OP 5K 20 Variable Costing IS Sales 125K 25X5K Less VC V COGS 50K 10x5K V SGampA 12 30K CM 60K Less FC FOH 50K F SGampA OP 20K 21 Reason For Different OP Absorption Costing 24 nventory Cost 15 per unit Cost of 5K unsold units is 75K Variable Costing nventory Cost 10 per unit Cost of the 5K unsold units is 50K Cost not expensed9 added to lnv Nothing disappears 25 Cooking The Books 26 Let s Review Cost Behavior 28 FC per unit drops as you produce more units FC per unitiFxT Total FC stays the same Total units goes up FC per unit drops Spreading FC over greater of units 29 Because of these relationships You can artificially inflate GAAP 27 VC per unit doesn t change as production increases VVXTXT Total VC go up Total units go up VC per unit V stays the same 30 With Absorption Costing 9 If you produce more units FC per unit drops Cost of each unit drops You end up with Lower COGS Higher OP You can artificially inflate OP 31 0 Production 10K units Produce 50K Units amp Sell 10K Units 34 Assume Produce amp Sell 10K Units 07 5K 1unit produced Sales 19K 190X10K Sales Price 1 90 COGS 15K 150x10K GM 4K 32 35 0 15K 7 5K 1x10K ales 19K 190X10K 7 Unit cost 7 1 50 coes 11K 110x10K r Prolit 4Munil 1 90 7 1 50 GM 3K 33 36 0 Production 50Ku its TC 55K 7 5K 1x50K 7 Unit cost 110 7 Prolit unil 1 90 7 1 10 0 Co doubled its OP 7 without selling more units 0 Co made 40 ol cost disappear 7 10K units F0 per unit 51m 5KtoK units 7 50K units F0 Dev 1mm 5K50K units 40 37 40 The 5K F0 is still there I I I But only 1 K was expensed with 39 W39th Var39able COSt39ng 9 10K units sold Co has 4K of OP regardless 4K is part of cost of unsold units 0f 0f un39ts prOduced It is part of the cost of the unsold Inventory It is an asset Not an expense 38 41 Manipulation of OP is not W possible with Variable Costing Sales 19K 1 90X10K All FOH is expensed VCOGs 10K 1X10K currently CM 9K Cost of Inventory 9 solely FOH VCS OP39 K Can t shift FOH cost to Inv 39 4 39 42 Production 10K units TC 10K 1 X 10K Produce 50K Units amp Sell 10K Units 31128 12 m x Production 50K units CM 9K Unit cost 1 Op 4K 43 Both Methods give same OP when Units produced Units sold 44 That is why we like Variable Costing OP Tells you what Absorption Costing OP would have been if no overproduction It exposes OP manipulation by making unneeded units 46 If units sold gt units produced Variable Costing OP gt Absorption Costing OP 47 Continue with same Eg Units Produced Sold 1st Year 50K 10K 2nd Year 10K 50K Cost Fn 5000 1unit Produced Absorption Variable 15 Year 50K 110unit 1unit 2ndYear 10K 150unit 1unit 45 Overproduction may improve Absorption OP But it is detrimental to Co 48 1St Year Absorption Costing Sales 19K 190X10K COGS 11K 110X10K OP 8K 80 X10K 52 2nd Year Variable Costing Sales 95K 1 90X50K VCOGS 1X50K CM 45K FOH OP 40K 49 1St Year Variable Costing Revenue 19K 190X10K VCOGS 10K 1X10K CM 9K FOH OP 4K 50 Difference in OP FOHUnit X Unsold Units Difference 10 X 40000 4000 FOH unit 10 500050000 53 What happened 15 Year 9 Shifted 4K of FC into Inventory 2nd Year 9 Sold all the units produced in 2 d Year This included all of F0 for 2 d Year Sold unsold units from 13 Year This included 4K of F0 from 13 Year There is an extra 4K of FC in COGS In 2nd Year 51 2nd Year Absorption Costing Sales 95K 1 9X50K cogs 59K 11OX4OK15 x10K OP 36K 54 1St Year Units produced gt Units sold Absorption OP gt Variable OP 4K of FC put into lnv 2nd Year Units produced lt Units sold Absorption OP lt Variable OP Extra 4K of FC in COGS 55 In 2nd year 9 Difference in Methods 58 Absorption Costing COGMunit DM 20K 2x10K DL 10K 1x10K VOH 10K 1x10K FOH Total Cost 100K Units Produced Cost Per Unit 10 FOHUnit X Unsold Units Difference 10 X 40000 4000 56 Another Example 57 Price 15 VC DL 1 unit produced DM 2 unit produced VOH 1 unit produced V SGA 2 unit sold FC FOH 60000 F SGA 40000 10K Units Made amp Sold 59 Variable Costing COGM DM 20K 2x10K DL 10K 1x10K VOH 1x10K Total Cost 40K Units Produced Cost Per Unit 4 FOH per unit is 6 6000010000 units 10 4 6 60 of units made of units sold ABSORPTION COSTING Sales 150K 15X10K COGS M 10X10K GM 50K SGA M 40K2X10K OP M 61 VARIABLE COSTING Sales 150K 15X10K VCOGS 40K 4x10K VSGA 2x10K CM 90K FOH 60K FSGA OP 62 Make 20K units ampse 10K units COGM Absorption Costing DM 40K 2x20K DL 20K 1x20K VOH 20K 1x20K FOH Total Cost 140K Units Produced Cost Per Unit 7 Was 10 9 now 7 FOH 9 Changed from 6 to 3 53 COGM Variable Costing DM is 40K 2x20K DL 20K 1x20K VOH 1x20K Total Cost 80K Units Produced Cost Per Unit 4 The cost of unit did not change There is no FOH in COGM 64 ABSORPTION COSTING Sales 150K 15X1OK COGS 70K 7x10K GM 80K SGA 60K 4OK2X1OK OP 20K 65 VARIABLE COSTING Sales 150K 15X1OK VCOGS 4OK 4x10K VSGA 20K 2x1 OK CM 90K FOH 60K FSGA 4OK OP 66 Difference in Methods FMOH Per Unit X Unsold Units 3 X 10K 30K Variable Costing Tells U59 lf Co had only produced 10K units Instead of 20K Co would have lost 10K CHAPTER 4 PROCESS COSTING 3 4 Uniform goodsservices I I I I I Used In Similar Products 9 Similar Costs Manufacturing Operations use Average COSt Service Industries 5 6 Example Calculate average cost for 300I000 TVS 6I000I000 each of cost component Each TV costs 20 DMS 6000000300000 DL Less expensive to maintain MOH 7 8 If different behavior Example Separate average cost MOH uses DLHs as driver calculation Combine MOH amp DLC If same cost driver Treat them as 1 cost pool Can combine cost components Caed Conversion Costs Average for combined cost 9 10 Average Cost per component When you make partial units Numerator9this month s cost Denominator this month s work Round to whole numbers Cost Incurred This Month Units Manufactured This Month 12 FLOW OF UNITS Three Groups of Units Beginning Inventory Bl Started amp Completed 8amp0 Ending Inventory El This month s EI is next month s BI 10000 units started 6000 units finished 2000 units in Bl 13 Started This Period Finished This Period Bl NO YES SampC YES YES El YES NO Units Started SampC El Units Finished Bl SampC 15 Groug No of Units Bl 2000 Given 8amp0 4000 Units Finished Bl 60002000 El 6000 Units Started 8amp0 10000 4000 Partial Units 17 Real life You know of units completed Your Book Assumes you know s Some Problems Often don t provide s Use code words for cost behavior CODE WORDS In Test Bank Questions 19 Initial Cost Not in Book Example baseball bats 20 for wood work done on 20 bats 1 0 bats 9 completed 10 bats 9 12 done 20 How much spent on wood for each bat This is called Initial Cost Cost added quotat the beginning of the processquot 21 Bats have same wood cost whether or not completed Treat half amp whole bats the same way 22 What if there were also 5 eXtra bats were left overfrom last month Bl The 20 spent on wood this month has nothing to do with Bl 23 Uniform Costs In Test Bank Questions Costs added quotevenly throughout the manufacturing processquot 24 Example Assume baseball bat labor is added evenly throughout the process You pay 30 for labor to make 1 0 completed bats amp 1 0 12completed bats 25 Let quotXquot represent labor cost of completed bat Let quot12Xquot represent labor cost to complete 12 bat Labor Cost of 10 Bats Labor Cost of 10 12Bats Total Labor Cost 27 Equivalent Units EU is denominator in average cost calculation For DL9 EU 15 ForDM9EU20 26 1000 10 12x 30 10X 5X 30 15x 30 x 3015 X 2 gtgt1 bat 9 labor cost of 2 gtgt12bat 9 labor cost of 1 28 Initial amp Uniform Costs are not the only ways costs behave If problem gives you quot0 9 Use quot0 given Do not worry about whether Initial or Uniform Costs This is what Book assumes 29 When you are given quot0 9 Multiply quot0 by units to get EUs Treat everything like a uniform cost Still 1 o for BI 30 FIFO METHOD 31 Two Process Costing methods FIFO In appendix Weighted Average In Chapter 32 Process Costing Steps Step 1 Physical Flow Analysis Step 2 Calculation of EUs Step 3 Computation of Unit Cost Step 4 Valuation of Inventories Step 5 Cost Reconciliation 33 Example DM 9 initial cost DL amp MOH 9 uniform cost BI 9 20000 gals 30 complete 30CC amp100 DM During May 9 180000 gals started 40 o CC amp100 o DM May 31 El 9 30000 gals 40 complete 34 BI May 1 42360 May Costs DM 360000 DL 211200 MOH 316800 888000 Total Costs 930360 Given 35 BI 20000 gallons E 30000 gallons Units started 180000 gallons Units EISampC 180K Started 30KSampC 180K SampC 180K30K SampC 150K 36 m BI 20000 sac 150000 E I 30000 38 FIFO uses this month s costs amp this month s work This month s DM cost 360K Numerator of average cost This month s units is Denominator of average cost 37 Units DM00 BI 20K 0 70 8amp0 150K 100 100 E 30K 100 40 39 m m 360K BI 20K 070 8amp0 150K 100100 E 30K 10040 41 DM Units 360K BI 20K 070 0 8amp0 150K 100100 150K E 30K 10040 30K EUs 180K 40 DM Units 360K BI 20K 070 0 8amp0 150K 100100 E 30K 10040 42 DL 9 211200 MOH 9 316800 Both are Uniform Costs Treat Conversion Costs 528000 as one cost Cost Reconciliation Costs Incurred Cost of Units 44 DM I CC U m 360K 528K BI OK 070 0 14K 8 amp C 150K 100100 150K 150K E 30K 10040 g EUs 180K 176K Calculation 360K 528K 180K 176K Cost Per EU 200 300 46 43 DM CC Units 360K 528K BI 20K 070 o 0 14K SampC 150K 100100 150K 150K E 30K 10040 30K 12K EUS 180K 176K 45 mm com Units 360K 528K BI 20K 070 0 14K 8 amp C 150K 100100 150K 150K El 30K 1004017o M g 180K 176K Calculation 360K 528K 180K 176K Cost Per EU 200 300 BI 423603X14K 84360 S amp C 150K23 750 000 Transferred Out 834360 El 2X30K3X12K 96000 47 WORK IN PROCESS 84360 Beg Inv 750000 8 amp C 42360 Beg Bal 211 200 DL 316800 MOH 360000 DM 96000 End Bal Last Month 42360 DM 360000 BI 84360 DL 211200 S amp C 750000 MOH 316 800 El 96 000 Total 930360 Total 930360 48 WEIGHTED AVERAGE METHOD 49 Weighted Average Average cost calculation CostsNVork from last 2 months Bl s costwork from last month added to calculation 51 Weighted Average Same as FIFO BUT Add Bl s costs from last month to numerator Bl s quot0 now becomes 100 Do not add last month s Bl cost to cost of Bi Group 53 Add Last Month39s Costs to Numerator DM to be allocated 9 395000 35000 360000 CC to be allocated 9 535360 7360 528000 50 With FIFO Average cost current month With Weighted Average Average cost last 2 months 52 Redo Prior Example Beg Bal of WlP 0st DM in Bl 35000 CO in Bl 7360 Total Beg Bal 42360 54 FIFO WA DM I 00 U DMI CCU 360K 528K 395K 535 360 B1 sampc EI Calci Avert E o 56 FIFO WA DM I 00 U DM CCU 360K 528K 395K 535360 B1 0 14K 20K 20K 3amp0 150K 150K 150K 150K E1 amp EU 180K 176K 200K 182K Cale 360K 528K 395K 535360 180K 176K 200K 182K Aver 200 300 1975 2942 58 With WA BI is nowjust like SampC They are both always 100 No need for three groups Reallyjust Units Finished amp El Units o Bl 20000 070 o S amp C 150000 100100 o El 30000 10040 o WA Units Bl 20000 100100 o S amp C 150000 100100 o El 30000 10040 o 57 BI 423603X14K 84360 sampc 150K23 750 000 FIFO Transferred Out 834 360 E1 2X3OK3X12K 96 000 Total Cost 930360 BI 20K198294 93340 WA sampc 150K198 294 737 550 Transferred Out 835 890 E1 1 93x30K294x12K 94 554 Total Cost 930444 WA 29rps Units o Units Finished 170000 100100 o El 30 000 10040 o WA Units Bl 20000 100100 o S amp C 150000 100100 o 59 El 30000 10040 o 60 WA Zgrps WA DM I CC U DM CCU 360K 528K 395K 535360 Units 20K 20K Finished 170K 170K 150K 150K EI EU 200K 182K 200K 182K Cale 359K 535 360K 395K 535 360 200K 182K 200K 182K Aver 1975 2942 1975 2942 61 Units FinA 17OK198 294 835 890 WA392 Transferred Out 835 890 E1 1 98x30K294x12K 94 554 Total Cost 930444 BI 20K198294 98340 WA sampc 150K198 294 737 550 Transferred Out 835 890 E1 1 98x30K294x12K 94 554 Total Cost 930444 Chapter 3 Notes Page 1 JobOrder System There are basically two approaches to assign manufacturing costs to products produced or services rendered Job Order Costing and Process Costing The approach that you use depends upon the character of your production operations In Columbo Goes To College two students get caught cheating Naturally they respond by killing their professor Unfortunately for them Lt Columbo is the guest lecturer that night and he solves the murder DON T EVEN THINK ABOUT IT Products and services are often produced according to a customer s order Because every job is different the cost of each product or service will be different Because of this difference in cost you have to keep track of the cost of every job separately This is what occurs with Job Order Costing also called Job Costing Companies that typically use Job Order Costing include print shops law firms accounting firms doctors construction television series The cost of these products differed greatly 12 million vs 600000 per episode Process Costing is used in assembly line operations or where the products are standard Because all of the products are the same they should all cost the same to make Therefore with Process Costing you treat the average cost to produce the products as the cost of each unit You do not keep track of the cost to make each unit separately Not all operations are clearly Job Order Costing or Process Costing Think of a Nissan Sentra They all have basic common features that cost the same to produce eg the body Different models however have different engines seat fabrics andor sound systems To the extent that all the Sentras produced have the same common features Nissan can use Process Costing To the extent that different models have different features then they can use Job Order Costing to keep track of the costs of the different features by model This is called Operation Costing also called Hybrid Costing A recent survey found that 511 manufacturing firms used Job Order Costing 142 manufacturing firms used Process Costing 106 manufacturing firms used Operation Costing and 241 manufacturing firms used Standard Costing Please send comments and corrections to me at mconstascsulbedu Chapter 3 Notes Page 2 With Standard Costing you use the estimated cost to make a unit as the cost of that unit There is no need to determine the actual cost to produce your units We will discuss Standard Costing in a later chapter I Components of Cost If you purchased your inventory retail business then all of the costs incurred in order to get the inventory to your place of business and have it ready to sell are included in the cost of the inventory The same approach is applied when you make your own inventory Because you need to run the factory in order to make your inventory then all of the costs to run the factory are treated as the cost of the inventory produced and they are not typically expensed when incurred All of the costs to run the factory can be divided into three components of the cost of the inventory that you produce Direct Labor Direct Materials and Manufacturing Overhead Materials that become part of the product being made are Direct Materials eg wood for furniture Materials that are used in the manufacturing process but do not become part of the product itself eg sandpaper used to make furniture lubricants for equipment cleaning solvents for plant personnel amp premises and other factory supplies are lndirect Materials Labor costs incurred by workers who actually make the products eg assemblyline workers or finishing labor are Direct Labor Factory labor costs of workers who do not make the products eg security maintenance janitorial and supervisory personnel are lndirect Labor Manufacturing Overhead consists of all of the costs of the factory that are not Direct Materials and Direct Labor Manufacturing Overhead includes such things as lndirect Materials lndirect Labor depreciation on factory assets factory utility cost factory property taxes factory insurance and factory landscaping Manufacturing Overhead is also referred to as Indirect Costs Overhead and Factory Overhead Please send comments and corrections to me at mconstascsulbedu Chapter 3 Notes Page 3 Record Keeping Job Number 2347 Department Milling Item Special order coupling JOB COST SHEET Date Initiated L Date Completed M Units Completed 2 For Stock Directed Materials Direct Labor Manufacturing Overhead ReqNo Amount Ticket Hours Amount Hours Rate Amount 14873 660 843 5 45 27 8DLH m 14875 506 846 8 60 14912 238 850 4 21 1404 851 m j 27 M Cost Summary 1800 2 units 900 per unit Units Shipped Materials Requisition Number 14873 Date march 2 Job Number to be Charged 2347 Department Milling Description Quantity Unit Cost Total Cost M46 Housing 2 124 248 G7 Connector 4 103 412 8660 Authorized Signature BI wife Time Ticket No 343 Date March 3 Employee wary Homequot Station 4 Time Started Ended Completed Rate Amount Job Number 700 1200 50 9 45 2347 1230 230 20 9 18 2350 230 330 10 9 9 Maintenance Totals 80 72 SupewisorM With JobOrder Costing every job order has a record of costs called a Job Cost Sheet also called a Job Cost Record Card or File where the costs to make the products are recorded At any given time the cost of each job can be found on the Job Cost Sheet The Job Cost Sheets serve as the subsidiary ledger for the Work In Process account You can determine the amount in Work In Process by adding up the balances on all of the Job Cost Sheets for jobs in process The same is true for Finished Goods Some books add the word quotControlquot to the name of an account to remind you of this When materials are needed for a job the workers or supervisors fill out a Materials Requisition Form The Materials Requisition Form is then sent to the accounting office which notes the materials cost on the Job Cost Sheet Factory workers fill out Time Sheets or Time Tickets noting on what orders or jobs they worked for a given day or managers fill out Labor Requisition Forms when they use labor on a job or order These records are sent to the accounting office which notes the labor costs on the Job Cost Sheet The accounting office adds Manufacturing Overhead to the Job Cost Sheet using the selected Cost Driver Please send comments and corrections to me at mconstascsulbedu Chap er 3 No es Page 4 Flow 01 Costs 308 s How mrough me aocouhuhg sys em as Ho ed be ow m Cast aF Guads D t Manufacture Matema s hamz Matema s Journal Entries wuh Vew exceouohs Vac ory 008 s are HO expehsed As Ho ed above hey are rea ed as We 008 ct me mvemory oehg produced wmoh s ah asse H s OH y when he mvemory s So d ma We 008 s expehseo as Com 0V Goods So dquot Wheh oohg We journa emHeS vorvahous Vac ory oos s s ar wuh me journa eh ry ma Dhec Ma e a s aho Dhec abor or Manmac urwg Overhead Vor 001 Memory 008 For examp e conswder me journa ehhy tor depreoauoh ha you eamed h mroduc ory accouhuhg Dr Depreoauoh Exoehse xxx Cr Accumu a ed Depreoauoh gtltgtOlt The depreoauoh oh Vac ory equ pmem wou d HO be ewensed s ead n wou d be Dr Manmac u g xxx r Accumu a ed Depreoauoh gtltgtOlt Keep h mm mm H you are HO oeahhg wnh a 008 ct We Vac ory He We journa ehhy s We same as you eamed w your mroduc ory accouhuhg mass The oeou cah be ah ex ehse h rhho ma wheh purd asmg raw ma erwa S you are acouhhg ah asse HO hourhhg wha wou d omerwwse be ah expensequot Thus mere 8 ho heed 0 modHy W8 journa ehhy P ease Send commems and correcuons 0 me a moons asgcsu b edu Chapter 3 Notes Page 5 The General Journal entries for typical manufacturing operations include the following a The purchase of raw materials on credit Dr Materials Inventory XXX Cr Accounts Payable XXX Materials Inventory is also called Raw Materials and Raw Materials Inventory b The requisition of Direct Materials from the warehouse for Job 301 Dr Work In Process Job 301 XXX Cr Materials Inventory XXX c The requisition of Indirect Materials from the warehouse Dr Manufacturing Overhead XXX Cr Materials Inventory XXX Sometimes problems combine Direct Materials and Indirect Materials in one 39ournal entry d Incur Direct Labor Costs in working on Job 301 Dr Work In Process Job 301 XXX Cr Wages Payable XXX introductory accounting course Note that the credit does not change but the This is similar to the general journal entry for wages that you learned in your debit is no longer wage Expense e Incur Indirect Labor costs Dr Manufacturing Overhead XXX Cr Wages Payable XXX Some problems combine Indirect Labor Costs and Direct Labor Costs in one journal entry Please send comments and corrections to me at mconstascsulbedu Chapter 3 Notes Page 6 f lncur depreciation on factory equipment Dr Manufacturing Overhead XXX Cr Accumulated Depreciation XXX your introductory accounting course Note that the credit has not changed but As noted above this is similar to the depreciation journal entry you learned in that the debit is no longer depreciation expense g lncur factory utility cost Dr Manufacturing Overhead XXX Cr Utilities Payable XXX accounting course Note that the credit has not changed but that the debit is no This is similar to the utility journal entry you learned in you introductory longer utij expense h Assume that the firm has prepaid the factory rent for a year One month has gone by Dr Manufacturing Overhead XXX Cr Prepaid Rent XXX accounting course Note that the credit has not changed but that the debit is no This is similar to the prepaid rent journal entry you learned in you introductory longer rent expense i Apply Manufacturing Overhead to Job 301 Dr Work in Process Job 301 XXX Cr Manufacturing Overhead XXX Manufacturing Overhead is a clearing account The debits are all the Manufacturing Overhead Costs that the firm has incurred The credits are all the Manufacturing Overhead Costs that the firm applies to the orders By applying Manufacturing Overhead Costs the firm is in effect taking the costs that you added to Manufacturing Overhead and putting those costs into Work In Process Please send comments and corrections to me at mconstascsulbedu Chapter 3 Notes Page 7 Some books use two accounts for Manufacturing Overhead not just one All the debits go into Manufacturing Overhead and all the credits go into Manufacturing Overhead Applied j The factory completes Job 301 Dr Finished Goods Job 301 XXX Cr Work in Process Job 301 XXX The cost of all of the goods completed and sent from Work In Process to Finished Goods is called Cost of Goods Manufactured Job 301 is delivered to the customer Dr Cost of Goods Sold XXX Cr Finished Goods Inventory Job 301 XXX This only covers the cost side of the sale don t forget there is also the revenue side of the transaction Dr Accounts Receivable or Cash XXX Cr Sales Revenue XXX Predetermined Overhead Rate While you can measure how much Direct Labor and Direct Materials are used to produce an order it is difficult to measure how much Manufacturing Overhead is used for each job or order As a result firms use a measurable proxy for Manufacturing Overhead This is the Cost Driver Typical Manufacturing Overhead Cost Drivers include Direct Labor Hours Direct Labor Cost units or machine hours A recent survey found that more than 60 of the largest companies in America use Direct Labor Hours or Direct Labor Cost as the Cost Driver for Manufacturing Overhead In the Manufacturing Overhead area it is difficult to assign actual costs to a product For example some Manufacturing Overhead Costs are not known until after the goods are delivered to the customer Also seasonal variations in production and Manufacturing Overhead Costs can cause per unit Manufacturing Overhead Costs to vary widely Please send comments and corrections to me at mconstascsulbedu Chapter 3 Notes Page 8 For example assume that you own a toy factory that is located in the New York City Your production will vary because the greatest demand for your toys is at Christmas Moreover the weather in New York varies greatly depending upon the season of the year This variation causes you to experience high air conditioning bills during the summer high heating bills during the winter and lower utility costs in WE if if the spring and fall Assume that you have the following Manufacturing Overhead Costs and productions ApLil y January Actual Manufacturing Overhead 50000 70000 60000 Production in Units 40000 80000 20000 Per Unit Manufacturing Overhead Costs 125 88 300 If you use actual costs you firm39s profits would fluctuate widely depending upon the month in which the units sold were produced Most firms want to avoid such fluctuation so they normalize these costs With normalized costs in applying Manufacturing Overhead a Predetermined Overhead Rate is determined at the beginning of the year as follows Estimated Manufacturing Overhead for the Year Estimated Cost Driver for the Year Application Rate For example if the firm estimates that it will have Manufacturing Overhead of 300000 for the year and 100000 Direct Labor Hours for the year then Manufacturing Overhead is applied at the rate of 300 per Direct Labor Hour 80 if a job has 10 Direct Labor Hours then the job will be allocated 30 of Manufacturing Overhead While Predetermined Application Rates can be created for Direct Labor and Direct Materials this is usually not done because these costs are easily traced to the goods manufactured regardless of the method being used Actual Costing refers to using only actual costs in calculating the cost of your units The use of a Predetermined Overhead Rate but actual costs for Direct Labor and Direct Materials is called Normal Costing The use of Predetermined Application Rates for Direct Labor Direct Materials and Manufacturing Overhead is called Budgeted Costing Please send comments and corrections to me at mconstascsulbedu Chapter 3 Notes Page 9 UnderApplied and OverApplied Overhead Biumur Datum 1 25 Walker Amnur H lllimms Maryland 252m August 14 1995 Kelvin D Eaggetz 2128 Lake 0111593 5 El Patio TX 799353808 Dear Me lvm ur psycnac tarmac and I are very concerned about you at this critacal time 1 your 11139s h vendorful stroke of good luck could be on your horlznn u these is a naturism factor You must 51m our What to do u that Quad fortune may not com your way With Normal Costing the Manufacturing Overhead is applied to production based upon the Predetermined Overhead Rate This rate is based on estimates and it is highly unlikely that the amount of Manufacturing Overhead applied will be equal to actual amount of Manufacturing Overhead incurred during the year unless you employ a psychic to calculate your application rates At the end of the year it is likely that there will be either a debit or a credit balance in the Manufacturing Overhead account If the debits in Manufacturing Overhead are greater than the credits then you did not apply enough Manufacturing Overhead to the units produced You have a debit balance The Manufacturing Overhead is under applied If the credits in Manufacturing Overhead are greater than the debits then you applied too much Manufacturing Overhead to the units produced You have a credit balance The Manufacturing Overhead is over applied The amount that is under applied or over applied is called the Manufacturing Overhead Variance Manufacturing Overhead Manufacturing Overhead 100000 90000 90000 100000 Actual Cost Applied to WIP Actual Cost Applied to WIP 10000 10000 Under Applied Over Applied In order to see what we should do with the Manufacturing Overhead Variance consider the flow chart that appears below Assume that the Manufacturing Overhead applied was 10 too low This results in the amount in Work in Process being 10 too low Assuming that all of the units in Work in Process were completed the 10 variance moves with the units to Finished Goods and the amount in Finished Goods becomes 10 too low Assuming that all of the units in Finished Goods were sold then the 10 variance moves with the units to Cost of Goods Sold and the amount in Cost of Goods Sold becomes 10 too low Thus ultimately the mistake caused by over applying or under applying Manufacturing Overhead ends up in the Cost of Goods Sold Please send comments and corrections to me at mconstascsubedu Chap er 3 No es Page 10 Cast aF Gauds Manufacture b Thrs rs why your book says ha you shourd dose om me Mahuvac urrhg Overhead accoum We varrahce 0 me 308 ct Goods Sord accoum Thr r We approp a e rea mem wheh aH 0V We uhns produced have oeeh comp e ed ahd sord H 3 0V me uhus have HO oeeh comp e ed ah so d Ms rea mem rs suH approp a e provrded ha you are deahng wnh ah mma ena Manmac urmg Overhead Varrahce We wm drscuss Ms shor y Dwect Matema s n Manufacturmg Overhead ham Labar Matema s hvemrv ham Matema s H We Manmac urmg Overhead was underrapphed he me geherar journa ehvy used 0 dose me Manmac urmg Overhead accoum rs as voHows Dr 308 ct Goods Sord c Manmac urmg Overhead x x you are how rhcreasrhg me 008 ct mose uhus 0 re ec mew rue 008 s H We Mahuvac urrhg Overhead was overrapphed He We geherar journa eh ry used 0 dose me Mahuvac urrhg Overhead accoum rs as voHows Dr Manmac urmg Overhead x xxx Or 308 ct Goods Sord x xxx You added 00 rhuch Manmac urmg Overhead 0 me 008 ct me uhns produced ahd you are how decreasrhg me 008 or hose uhns 0 re ec mew rue 008 s I Malerial Overhead Variance Prevrous y we saw ma n Manmac unng Overhead was overrapphed or underrapphed He We Manmac unng Overhead Varrahce umma e y ehds up rh 308 ct Goods Sord Thus wheh aH 0V me oods produced by a corhpahy have oeeh corh e ed ahd so d He aH 0V We varrahoe shourd be added 0 308 or Goods ord m however you have uhus mm are uhhhrshed rh Work rh Process ahdor uhsord h Prhrshed Goods a me ehd or me penod he me rhrsapphcauoh 0V Manmac urmg Overhead ma rs evrdehced by me varrahce a ec s We uhus rh Work h Process ahd Prhrshed Goods as We as P ease Send commems and correcuons 0 me a moons asgcsu b edu cnab1e1 a No1es Page 11 cos1 o1 Goods sou Pvewousw we b1aced 1ne en1ne Manmacmnng Ovemead Vanance 1n cos1 o1 Goods 3010 even 11 some o11ne un11s weve no1comb1e1ed 01 so1d Tn1s11ea1rnen11syus1111ed undenneconcem01Ma1ena111y As you W111 vecaH 1mm yom 1n1mduc1ory accounnng dass GenevaHy Acceb1ed Accounung Pv1nc1p1es GAAP momde 1ne conceb1o1 Ma1ena111y Ma1ena111y auows you 10 use an 1nconeo1accounung11ea1rnen1b10y1ded1na11ne1mbmbev1vea1rnen1wou1d n01 an 01 e s de1s1 n examp e 11 1s common 10 cons1de1 me e anyon c 0 makmg F01 Manmacmnng Ovemead Vanance 10 be 1mma1ena1 wnen 1ne 1mp10pev 11ea1rnen1 cnanges Ne1 moome by1ess1nan1 012 11 me Manmacmvmg Cnemead Vanance 1s ma1ena1 1nen 1ne vanance snomd be b101a1ed1a11oca1ea among 1ne un11s 1n cos1 o1 Goods 3011 F1n1sned Goods and WOW 1n oncess Tn1s a11oca11on o11neyanance can be aeoornbnsned a numbev 01 ways F01 examme on can a bomon 1ne vanance be1ween 1ne1n1ee aeooun1s 1 usmg 1ne 1e1a11ye end1ng ba1ances o11ne1n1ee 1ne vanance 01111 Tne e11ec1on Ne1 moome 1s o11en so smaH 1na11ne Manmacmnng Ovemead Vav1ance1s 00ns1deved nnrna1ena1 and 11 1s dosed 1o cos1 o1 Goods 3010 Tn1s 1s because mos 0 me un11s1na1a1e s1a11ed ave11n1ac11cornb b at A Mawrlallw Glrl began weve comb1e1e a o1ne1 10 ave s1111 1n WovK 1n oncess and01 F1n1shed Goods As n ed a Cnemead Vanance among WovK n P10 d by men 1e1a11ye endmg ba ances 0 00 51001000 Tnus on1y 1000 w s Tne 101000nnb10be11ncvease1n cos1 o1 Goods 3010 nas1ne e11ec1 o1 decveasmg Ne1 moome by 100001 wnbn 1s 1 01 Madonna s Ne1 moome Tn1s 1s bmbab1y 1mma1ena1 P1ease send commems and coneb11ons10 me a1 moons1assu1b edu Chapter 3 Notes Page 12 Assuming that there is a material variance where Manufacturing Overhead is under applied then the general journal entry used to close the Manufacturing Overhead account is as follows Dr Cost of Goods Sold XXX Finished Goods XXX Work In Process XXX Cr Manufacturing Overhead XXX Assuming that there is a material variance where Manufacturing Overhead is over applied then the general journal entry used to close the Manufacturing Overhead account is as follows Dr Manufacturing Overhead XXX Cr Cost of Goods Sold XXX Finished Goods XXX Work In Process XXX Please send comments and corrections to me at mconstascsulbedu Chapters 10 amp 11 Demonstration Problem Solutions Page 1 Demo 10111 ANSWER Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 490 X 4200 520 X 4200 520 X 4000 20580 21840 20800 Material Price Variance 1260 F Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 930 X 5700 950 X 5700 950 X 6000 53010 54150 57000 Labor Rate Variance 1140 F Demo 10112 ANSWER Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 400 X 7500 400 X 7200 2x3600 31500 30000 28800 I Variable Overhead Spending Variance 1500 U Actual Cost Fixed Overhead Static Budget Standard AP X AQ SP X 0 700 X 7200 2 x 3600 51600 56000 50400 Fixed Overhead Budget Variance 4400 F Please send comments and corrections to me at moonstascsulbedu Chapters 10 amp 11 Demonstration Problem Solutions Page 2 Demo 10113 ANSWER a Direct Materials variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 200 X 38000 220 X 38000 220 X 36000 4x9000 76000 83600 79200 Material Price Variance 7600 F b Direct Labor variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 1130 X 18500 1100 X 18500 1100 X 18000 2x9000 209050 203500 198000 Labor Rate Variance 5550 U c Variable Manufacturing Overhead variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 300 X 18500 300 X 18000 2 x 9000 54900 55500 I Variable Overhead Spending Variance 600 F Please send comments and corrections to me at mconstascsulbedu Chapters 10 amp 11 Demonstration Problem Solutions Page 3 d Fixed Manufacturing Overhead variances Actual Cost Fixed Overhead Static Budget Standard AP X AQ SP X 0 250 X 18000 2 x 9000 52000 50000 I Fixed Overhead Budget Variance 2000 U Demo 10114 ANSWER a Direct Materials variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 940 X 3000 900 X 3000 900 X 2700 6x4500 28200 27000 24300 Material Price Variance 1200 U b Direct Labor variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 1250 X 3800 1280 X 3800 1280 X 3600 8x4500 47500 48640 46080 Labor Rate Variance 1140 F Please send comments and corrections to me at mconstascsulbedu Chapters 10 amp 11 Demonstration Problem Solutions Page 4 c Variable Manufacturing Overhead variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 750 X 3800 750 X 3600 8 x 4500 30100 28500 27000 I Variable Overhead Spending Variance 1600 U d Fixed Manufacturing Overhead variances Actual Cost Fixed Overhead Static Budget Standard AP X AQ SP X 0 2250 X 3600 8 x 4500 88700 90000 81000 Fixed Overhead Budget Variance 1300 F Demo 10115 ANSWER a Direct Material variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 220 X 6400 200 X 6400 200 X 6000 3x2000 14080 12800 12000 Material Price Variance 1280 U Please send comments and corrections to me at mconstascsulbedu Chapters 10 amp 11 Demonstration Problem Solutions Page 5 b Direct Labor variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 1370 X 950 1400 X 950 1400 X 1000 5x2000 13015 13300 14000 Labor Rate Variance 285 F c Variable Manufacturing Overhead variances Actual Cost Mixed Flexible Budget APXAQ SPXAQ SPXSQ 400 X 950 400 X 1000 5 x 2000 4300 3800 4000 Variable Overhead Spending Variance 500 U d Fixed Manufacturing Overhead variances Actual Cost Fixed Overhead Static Budget Standard AP X AQ SP X 0 600 X 1000 5 x 2000 6820 6600 6000 I Fixed Overhead Budget Variance 220 U Please send comments and corrections to me at mconstascsulbedu Chapter 9 Notes Page 1 Budgeting In this chapter we discuss the process of budgeting A business needs to plan for future contingencies and it needs to make sure that it can handle them A budget is an expression of a business plans and goals using dollar amounts You begin by forecasting sales in dollars and units and from there you calculate i the expenses that you will need in order to support your sales forecast ii the capital expenditures that you will need to make to support your operations and iii the cash inflows and outflows that your anticipated sales expenses and expenditures will generate By engaging in this process you can help make sure that you have the resources that your business will need in the future The budget process is also a tool that can be used in evaluating a business personnel lf sales are estimated to be a set amount and fewer sales are generated then you can ask the personnel responsible for sales to explain why the sales fell short of expectations Similarly if expenses or expenditures are higher than anticipated you can ask the personnel responsible for those outlays to explain why they were above expectations Please Send Comments and Corrections to me at mconstascsulbedu Chapter 9 Notes Page 2 I The Master Budget The master budget is a comprehensive financial plan for a business It is made up of the Operating and Financial budgets which are in turn made up of supporting schedules budgets I The Operating Budget The Operating Budget is a Budgeted Income Statement and all supporting schedules As an example you would do the following in order to construct a rough operating budget for a manufacturing operation You plan on how many units you will sell I will sell 100000 units this year 9 Where will those units come from How many units do I already have Will I need any more units for inventory purposes You plan on how many units you will produce this year 9 From this you calculate the cost to produce the units that you will need this year You plan on how many salesman you will need and the other marketing expenses you will need to incur this year in order to sell the units that you want to sell 9 This tells you how much you will spend on marketing this year You plan on how many administrative support people you will need at this level of operation 9 This tells you how much you will spend on administrative expenses From all of these numbers you can create a Budgeted Income Statement which is also called a Pro Forma Income statement You can break these numbers down by month or quarter in order to produce a quarterly Pro Forma Income Statement Please Send Comments and Corrections to me at mconstascsulbedu Chapter 9 Notes Page 3 MATERIALS BU DGET ALES PRODUCTION LABOR BUDGEr quot39 390 BUDGET 390 BUDGET 9 9 l i 7 6 6 FACTORY 53221 x OVERHEAD BU DGET Operating Budget for a Manufacturing Enterprise For a manufacturing operation an Operating Budget will begin with a Sales Budget A Sales Budget outlines the expected sales for each product in units and dollars SHEHADEH MOVIE SCREENS Sales Budget For the Year Ending December 31 20x9 l 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter M MD Estimated units 2100 1500 3000 2400 9000 XPerunit sales price 175 S 175 5 175 5 20000 51575000 Total estimated sales 5 You would then prepare a Production Budget The Production Budget describes how many units must be produced in order to meet your sales needs and satisfy ending inventory requirements Please Send Comments and Corrections to me at mconstascsulbedu Chap er 9 No es Page 4 SHEHADEH MOVIE SCREENS Pm union Budget Furlhe Year Ending December31ZDX9 Nmzs m guaner 1nd gunner 1m guaner n Quads Estrmatea unnssnm 2 no man quotWW5 55 25v m wunwmg Qua erssa u Dssrrsnsnmng mshsngnnns mu m eg E XZS39 r 75 Tom mm neeaen 3 on r533 L525 Schs me Dru udmn 2 sun 2 we A er me proddcuon budge rs prepared you can prepare budge s from drrec ma errars drrec abor and overhead The Drrec Ma errars Budge Hes me proddcuon 0 me Drrec Ma errars ma WrH need 0 be purchased m order 0 produce me esnma ed drms Direct Mal ials Budget Furlhe VeerEnding December 3120x9 Nuts 51 gumer 2m gunner 1m gunner n Qumer g39 Schedme vrmudrnn 95a ms zxsn 2an 93975 quot 7 quot Wquot quotquot39quotEi gtlt Raw meme Der MM sq m 35 35 35 35 35 We 3952 D3 WESquot mm raw materra neens M m 221525 2m anHnwmgquners was We Targetanmng raw muener 195W reg ss szsxznvlaznzs Tumunnsnms Ls m sear 25 L235 waeueg raw muener Massn r 27 I175 m cm or raw Haterm nurchasas 5 579n5 Prease Send Commems and Correcuons 0 me a moons ascsdb edd Chapter 9 Notes Page 5 The Direct Labor Budget ties the production to the direct labor hours needed to produce the estimated units SHEHADEH MOVIE SCREENS Direct Lahor Dudger For the Veer Ending December 31 mm ltnles ls gunner zne gunner 3rd aunner 4m nunner Sch ut uroductmn Win 1275 2252 zsca 9w quot 739 Mm 5quotquot Dwecllahnrnnu39sairums 3 z 3 3 Ehuursnsrscren Ynlal Direct lannr ham 5 ran 5525 39 ta irirtlstornwr 5 Hull 5 mm s Cnslntdiriclabcr 5 stream s 7375 5 The Overhead Budget shows the expected cost ot all indirect manulacturing items SHEHADEH MOVIE SCREENS 39FactDry Overhead Budget Enrthe Year Ending December 31 zuxs Nate m gunner 1m gunner 1m gunner n gunner 22 Drizct lalmr nrue 5 n5r 5525 a55r 15w 27525 quotWMquot 22 XVariablslactUHnverhea rne s 5 m1 5 5m 5 5 m1 Tntalvariablslactnrynvsrhn 5 zez5n 5 25125 5 427En 5 3mm 5131625 les lactm39werh a sansn 53nn 57n5n mm mm anniien emery nvirhsa rate 51 re haw Tntallactnrynverhea 5 man s m 15 s 533ml 5 eessn s 357325 5357 52y275257 Lsss anrzciatinn strum mum nnnn mum cnennnurrrrnnowruemenn s warm 5 sv55r 5 337325 The Ending Finished Goods Inventory Budget supplies inlormation needed tor the budgeted balance sheet and also serves as an important input tor the preparation ot the cost ot goods budget Please Send Comments and Corrections to me at mconsta csulb edu Chap er 9 No es Page a SHEHADEH MOVIE SCREENS Ending39nnleneu Goods Invenlory Fm he Yea Ending Decelnhel 31V 20x9 Cosl Corn ower Ulws m m Mmaenu 5 M a s 9 nmum Emmy a New um mm 3 19 x 5 en Mm mm mummm m am Wow we Enmng ms e gwu s memry You esnma e 3H 01 your seng genera and admmvanve expenses m one Seng Genera and Adrmms ranve Budge SHEHADEH MOVIE SCREENS 1 Selling GeneraIand dm alive Budget Farme Year Ending ueeemner1zox9 Annum m gumer 2m gunner 3m gunner n gumer Rm smmnunnmm 2mm sun mm H xverunnvanamesew s 5 man 5 15mm 5 mm mm mm 56M MW 1 5m 5 12mm 5 mu 5 12mm 5 3mm mmm P ease Send Commems and Correcnons 0 me a moons as csmb edu Chap er 9 No es Page 7 The nan al Bud The rernamrng budge s ha appear rn me Mas er Budge make up we Fmancra Budge The Fmancra Budge ypreauy consws s 01 me Cash Budge me Budge ed Ba ance Sheen and he Budge ed ncome S a emem From me prrpr supporung budge s you can men produce me Budge ed ncome S a emem SHEHADEH MOVIE SCREENS U n r Fanhe Year Ending December 31 20x9 Nmes Sam 5 sum quotWm 3m Ens M gm am Eegmmng mahsa gnn s 5 3325 hm39bawancasnsw me39nrndudmn39 arrest 9 175 UNIS gtlt cmmmsmammuraa Vrnm msha gnn s shze ts13 Derun Less Enmng mshza gunnsvwzmnry Mann quotW39WEV S D n s 37 52 W mm rawssn snea Mme new mm m s 199 an ramcar up m M NEW in hexane shs Chap er 9 News Page 8 The Cash Budge shows am of me cash n ows and oumows ma we me me numbers ndwca ed m We Fmancwa Budge n addmon H shows omer n ows and oumows nc udmg cash n ows and oumows from nancmg acuvmes SHEHADEH MOVIE SCREENS Furlhe Vear Ending December31ZDX9 3 m gumer 2m gunner 3m Qua el n gua er quot M Reba Begmmngcash mam 5 BMW 5 5 ems 5 n ma m summer renews 45 m7 Vrnm39sa zs snbel Ava amscazh 5 355mm 5 mm 5 ummgm 5 mm 5 mum 5 23252 m mmmunea Ever 31 En ms Mgan WWW w Purimwarhan mun mus mm mm umwmmnnsm 56M Asnnn mun sauna he Taxes snnn mm 2nnnn Eqmnmzmnurchasa 7 15mm nmnmmmm 5 m 52 5 32 5 52 152 casnswwmencm 5 mm 5 my 5 mm anmm P annan Enrrawmg 7 15mm mm gymquot 7 r 75 nun mm an renaymsn 7 way Enmnqcashba am e 32 AK 5 ms 5 554 P ease Send Commems and Correcuons 0 me a moons asgqcsmb edu Chapter 9 Notes Page 9 From all ol L 39 you Can u n m n y L Please Send Comments and Corrections to me at moonstascsulb edu Chap erQNo es Page 0 static vs Mos Mas er Budge s smver vrom me mm mm mey are s anc budge s A s anc budge assumes ma one eve ov acnvny s acmeved n probamy wou d be more bene cwa vor 3 budge eve s H w 008 s Flex ble Product n Budget In thousands Vnhbk Om Rang ofl mduclion units pct Unit 2401 3000 3600 l mdumun mm m ublc Duutrmlcnnlx sun 5 cu 5 7m 5 van a 17 m m 132 um 72 an um mm M 2m 52 on M w 739 391qu mm mm so 0 suuu 13m lem m crhcnd Suwmmm beganmum Rent Tun 1 ed mm 39Iunl pruluimn mm Chap er 9 No es Page H I uuagel variances u re mpor am 0 compare me budge ed perrorrnance wnh me ousrnesa ac ua perror The re done by carcuraung budge varrances The re me oprc 0V me nex Iwo chap ers le Performance Report n Costs n thou Actual versus Fle Qua rly Produc sands Actual Blldykd Vnrianw L39nm menuu 3000 3an mdmuun 0 Hunt mman x quot1 3 5 mm mm U 3000 360 u o o hum mm melv m nrllcm Su Ins Indunz leur Pu er 1m umbh unn Flk39d m crhrJd upxn39mnn 5 11m 0 s m o F mymumrn a 0 km 10 I U 391 our mm man u o 5127 1 U Tum pmnrmon xsn n W become evroem ha oeoore are usmg unreahsuc budge numbers because arge budge vanances er be consrs em y genera ed Budge varranoes are arso usevur m evaruaung me oerrorrnance 0V depanmems and personner H your ac ua expenonure rs omerem Vrom your budge ed 008 ct ma ena s you Mr wam 0 mvesuga e me reason why You may wam 0 encourage me be avror ha caused me budge varrance or you may wrsh 0 dracourage n H rs mpor an however ha you use budge varranoes ror comroHaore 008 s when usmg mern ror oerrorrnance evaruauon P ease Send Commems and Correcuons 0 me a moons as cswb edu Chapter 6 Notes Page 1 CostVolume Profit Analysis Understanding the relationship between a firm s costs profits and its volume levels is very important for strategic planning When you are considering undertaking a new project you will probably ask yourself How many units do l have to produce and sell in order to Break Even The feasibility of obtaining the level of production and sales indicated by that answer is very important in deciding whether or not to move forward on the project in question j Similarly before undertaking a new project you have to assure yourself that you can generate sufficient profits in order to meet the 4 l profit targets set by your firm Thus you might ask yourself How Baking Even many units do l have to sell in order to produce a target income You could also ask If I increase my sales volume by 50 what will be the impact on my profits This area is called Cost Volume Profit CVP Analysis In this discussion we will assume that the following variables have the meanings given below P Selling Price Per Unit X Units Produced and Sold V Variable Cost Per Unit F Total Fixed Costs Op Operating Profits Before Tax Profits t Tax rate BreakEven Point Your Sales Revenue is equal to the number of units sold times the price you get for each unit sold Sales Revenue Px Assume that you have a linear cost function and your total costs equal the sum of your Variable Costs and Fixed Costs Total Costs Vx F When you Break Even your Sales Revenue minus your Total Costs are zero Sales Revenue Total Costs 0 Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 2 This is the Operating Income Approachquot described in your book If you move your Total Costs to the other side of the equation you see that your Sales Revenue equals your Total Costs when you Break Even Sales Revenue Total Costs Now solve for the number of units produced and sold X that satisfies this relationship Revenue Total Costs Px Vx F Px Vx F xP V F F u u x P V FORMULA A Formula quotAquot is the Contribution Margin Approachquot that is described in your book You can see that both approaches are related and produce the same result BreakEven Example Assume Bullock Net Co is an Internet Service Provider Bullock offers its customers various products and services related to the Internet Bullock is considering selling router packages for its DSL customers For this project Bullock would have the following costs revenues and tax rates P 200 V 120 F 2000 Tax Rate t 40 Using Formula A we can compute the BreakEven Point in units 2 000 x 200 120 x 2 000 80 X 25 units Sometimes you see the PV replaced by the term quotContribution Margin Per Unitquot CMU WFU FORMULA quotAquot Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 3 This is way that your textbook presents Formula This makes sense if you think about it Every time that you sell a unit you earn the Contribution Margin per unit The Contribution Margin per unit is the portion of the Sales Price that is left after paying the Variable Cost per unit It is available to pay the Fixed Costs If every time you sell a unit you earn 80 to help pay your Fixed Costs of 2000 how many units do you need to sell in order to pay off the 2000 completely BreakEven Point In Sales Dollars Taking Formula quotAquot you can multiply both sides of the equation by P F X Pv FxP PX W Recall what you do when you have a fraction in the denominator of a fraction i a x c bc 39 b This works backwards as well alxgc i b bc We can rewrite this equation L PX PVl FORMULA quotBquot P Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 4 Formula B gives you the Sales Revenue that you need in order to Break Even The Denominator PVP is referred to as the Contribution Margin Ratioquot It tells you what percentage of every dollar of Sales Revenue goes to help pay off the Fixed Costs You can see this if you break up the Contribution Margin Ratio PVP PP VP 1 VP VP gives you the percentage of the Sales Price that goes to pay off the Variable Costs the Variable Cost Ratio or Variable Margin Thus one minus the Variable Cost Ratio gives you the percentage of the Sales Price that is available to help pay the Fixed Costs Sometimes Formula B is rewritten by replacing PVP with the Contribution Margin Ratio CMR Px FORMULA quot3quot L CMR This is the way Formula B is presented in your book I BreakEven Point In Sales Dollars Examples Let us continue using the Bullock example Using Formula B we can compute the BreakEven Point in Sales Revenue 2000 200 120 PX 200 Px 2 000 40 Px 5000 80 what is the big deal We already knew that Bullock needed to sell 25 units to Break Even by using Formula We also know that each unit sells for 200 We therefore know that selling the 25 units will produce Sales Revenue of 5000 Why do we need a separate formula We have the two formulas because sometimes you might not have enough information to use Formula A but you will have enough information to use Formula B Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 5 For eXample Cuba Radio Co produces portable sports radios It has released the following Variable Costing Income Statement This is the only financial information that we have regarding the Cuba s operations Sales Revenue 100000 PX Less Variable Costs 30 000 VX Contribution Margin 70000 PX VX Less Fixed Costs 50 000 F Operating Profit 20 000 PX VX F What is the BreakEven point for Cuba We do not know the number of units that Cuba sells in a year We do not know the Price or the Variable Cost per unit For all we know Cuba sells one radio for 100000 each or 100000 radios for 1 each So we cannot use Formula Alt ou h you do not know the price or the Variable Cost per unit you are still able to calculate the Contribution Margin Ratio Contribution Margin PX VX PV X PV Sales Revenue PX PX P us we can use Formula B The Contribution Margin Ratio is 70 70000100000 and the BreakEven Point in Sales Revenue is PX FCMR 5000070 7142857 Keep in mind that the reason that Cuba s Sales Revenue is lower than it was before is because Cuba sold fewer units Cuba s price and Variable Cost per unit remained unchanged Let39s check if Cuba Breaks Even at this Sales Revenue figure Sales Revenue 7142857 P7142857old unit volume Less Variable Costs 30 21 42857 V 7142857 old unit volume Contribution Margin 50000 7142857 old Contribution Margin Less FiXed Costs 50 000 Operating Profit Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 6 I Profit Targets You can use this same analysis to figure out how many units you need to sell in order to generate a target beforetax profit Operating Profits Operating Profits are determined as follows Operating Profits Op Revenue Costs Px Vx F If you move the costs to the other side of the equation you end up with PX VX F Op If you solve for X you will see how many units you need to produce and sell in order to generate your target Operating Profits PX VX F Op Px Vx F Op xP V F Op F o X Modified Formula A P v or X will CMU As was true with Formula B we can multiply both sides of Modified Formula A by price to produce the formula that gives the Sales Revenue that is necessary to produce the target Operating Profits X P39V F omp P V Px mom L Modified Formula B Px Or PX 1FOpl CMR Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 7 I Profit Target Example I Assume that Bullock Net Co has established a target Operating Profits figure of 40000 Using Modified Formula A you can determine the number of units that Bullock will need to sell in order to generate this target 2 000 40 000 X 200 120 42 000 X 80 X 525 units If you think about it it makes sense to add the Fixed Costs and the Target Operating Profits together and then divide by the Contribution Margin If you make 80 every time you sell a unit then you have to sell 25 units to Break Even 200080 After you Break Even you make 80 of profits every time that you sell a unit and you have to sell 500 units in order to generate Operating Profits of 40000 4000080 Using Modified Formula B you can determine the Sales Revenue that Bullock will need in order to generate Operating Profits of 40000 2 000 40 000 X 200 120 200 42 000 X 4 X 105000 AfterTax Profit Targets The Operating Profits to which we have been referring do not include tax expense Once you subtract your tax expense from your Operating Profits you have your Net Income If you want to know how many units that you need to produce and sell in order to generate a target Net Income or aftertax profit just convert the aftertax number into a beforetax number You can then substitute the beforetax profit figure in the above formulas Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 8 For example if you are told that you want to generate a Net Income aftertax of 50000 and your tax rate is 40 then you can convert the 50000 aftertax Net Income into the beforetax Operating Profits that you need in order to produce Net Income of 50000 Operating Profits Taxes Net Income Op 4 Op 50000 6 Op 50000 Op 50000 6 Op 83334 You can check this Operating Profits 83334 Taxes 40 33 334 Net Income 50000 Targeted Income As A Percent Of Sales Revenue What if you are given a before tax target income which is equal to a percentage of Sales Revenue Just plug a formula for the target eg 1Px for 10 of Sales Revenue into the formula in place of quotOpquot instead of a dollar figure For example assume that Bullock Net Co desires a target Operating Profits that are equal to 10 of its Sales Revenue Px 20001Px200120200 Px 20001Px40 4Px 20001Px 3 Px 2000 Px 20003 Px 6667 MultipleProduct Analysis What if you are interested in performing a CVP analysis but you have more than one product You can perform this analysis in the same manner as we described above if you assume that your sales mix is fixed The quotsales mixquot or product mixquot is the percentage of total sales in units of the company composed of the products sold eg 60 of units sold is product quotAquot and 40 is product quot8quot You use the same formulas that are described above but you substitute a composite Contribution Margin for the entire product line in place of the Contribution Margin for one product that we used above When using a version of Formula B you need to calculate the Contribution Margin for all of your products We did this above when we talked about the need for Formula B Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 9 Remember the following example Sales Revenue 100000 Px Less Variable Costs 30 Vx Contribution Margin 70000 Px Vx Less Fixed Costs 50 000 F Operating Profit 20 000 Px Vx F Remember that we calculated that the Contribution Margin Ratio is 70 70000100000 and that the BreakEven Point in Sales Revenue is PX FCMR 5000070 7142857 If you use a version of Formula you have to come up with composite Contribution Margin per Unit that represents the entire product line There are two methods that are commonly used to develop the needed composite variables i Basket Package Method and ii Weighted Average Contribution Margin Method A major competitor of Carmen s Banana Business Inc is Woody s Bananas Ltd Competition between Woody and Carmen has become so fierce on the Banana front that Woody has been suspected of engaging in gueria tactics This suspicion could just be based on the CEO s strange fashion statements Unlike Carmen who specializes in various banana products Woody only sells raw fruit Woody s main emphasis is Bananas but it also sells Oranges Woody sells 3 Bananas for each Orange that it sells 75 vs 25 Bananas Oranges 2 4 Price Variable Cost per Unit 1 2 Contribution Margin per Unit 1 2 Common Fixed Costs 2000 With the Basket Method you create a Basket that reflects Woody s sales mix 7525 Assume that is the Contribution Margin of that Basket CMbaskei 3 CMbanana 1CMorange CMbaskei 3 1 1 2 CMbaskei 3 2 CMbaskei 5 Now you plug the Contribution Margin for the Basket into the Formula that you wish to use The BreakEven point in Baskets is Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 10 Baskets FCMbasket Baskets 2000 5 Baskets 400 Baskets You now describe the units of fruit contained in the Baskets Bananas There are 3 Bananas in every Basket so we need to sell 3 X 400 Baskets 1200 Bananas in order to BreakEven Oranges There is one Orange in every Basket so we need to sell 400 Oranges in order to BreakEven With the Weighted Average Contribution Margin Method we calculate the Weighted Average Contribution Margin for one unit of fruit using the given sales mix CMwa 75 CMbanana 25 CMorange CMwa 75 1 25 2 CMwa 75 5 125 The BreakEven Point in units is x FCMwa x 2000 125 X 1600 units Since we know that the total units of fruit sold should be 1600 and we know the sales mix is 7525 Bananas 75 1600 1200 Bananas Oranges 25 1600 400 Oranges I Margin of Safety The quotMargin Of Safetyquot is the amount of sales in dollars or units by which the actual sales of the company exceeds the BreakEven Point We know that Bullock s Break Even Point is 25 units or 5000 If Bullock really sells 40 units Sales Revenue of 8000 then its Margin Of Safety is 15 units 4025 or 3000 8000 5000 Operating Leverage If you take the total Contribution Margin and divide it by the Operating Profits this gives you the Operating Leverage or degree of Operating Leverage For example if Bullock Net Co had actual sales of 40 units its Operating Profits would be calculated as follows Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 1 1 Revenue 8000 200x40 Variable Costs 4 800 120x40 Contribution Margin 3200 Fixed Costs 2 000 Operating Profits 1 200 The Operating Leverage is calculated as follows Contribution Margin 3 200 2 67 Operating Profits 17200 Please send comments and corrections to me at mconstascsulbedu Chapter 6 Notes Page 12 The Operating Leverage of 267 indicates that if Bullock can increase its sales by 50 then its Operating Profits will increase by 267 X 50 or 133 Thus the Operating Profits of 1200 will increase by 1600 133 X 1200 to 2800 This calculation assumes that the Price Variable Cost per Unit and the Fixed Costs do not change You are assuming that the increase in sales is caused by a 50 increase in the number of units sold X E NEW Revenue 8000 200X40 12000 200 X 60 Variable Costs 4 800 120X40 7 200 120 X 60 Contribution Margin 3200 4800 80 X 60 Fixed Costs 2 000 2 000 Operating Profit 1 200 2 800 Please send comments and corrections to me at mconstascsulbedu Chapter 8 Notes Page 1 ActivityBased Costing I Cost Pools As we mentioned in Chapter 3 in a manufacturing situation there are three components to cost Direct Labor Direct Materials and Manufacturing Overhead As noted previously it is relatively easy to allocate Direct Labor and Direct Materials to the products produced but it is difficult to allocate Manufacturing Overhead costs Because of this we have Normal Costing and the allocation of Manufacturing Overhead using Predetermined Overhead Rates In Chapter 3 we used a single Predetermined Overhead Rate to allocate the Manufacturing Overhead costs to the products being produced If all of the products are similar this approach may produce a fairly accurate allocation of Manufacturing Overhead On the other hand if you have widely diversified product lines and production operations then a PlantWide Application Rate may not be very accurate You may find that some products are being undercosted and others are being overcosted In this case you might obtain more accuracy in the allocation of Manufacturing Overhead to the units that generated it by using more than one overhead cost pools The number of cost pools to use always involves a costbenefit analysis because of the additional record keeping involved Why should you care whether your products being overcosted or undercosted Having more accurate cost information can lead to an improvement in your bidding process If you base your customer bid prices on your costs you could charge the wrong amounts If you charge more than your competitors then you will lose business If you charge less than your competitors you will get more business but your profits will be less than you expected because you are not charging your customers enough Having more accurate cost information could improve a firm s product mix Even if your prices are not based on your costs eg set by the free market you still may have problems For example you may not actively go after certain business because you don t think it is very profitable when that business actually is profitable Similarly you may go after other business that you believe is very profitable when it is not profitable or less profitable than you believe Another way that overcosting or undercosting can affect a business is in the decision whether to offer a product or discontinue a product Having misinformation on the Please send comments and corrections to me at mconstascsulbedu Chapter 8 Notes Page 2 profitability of a product may cause a product to be improperly discontinued or retained when it should be discontinued For example a firm may incorrectly outsource the manufacture of a part or product because it wrongly believes that it is cheaper to purchase the part or product rather than manufacture it Department Allocations of Overhead A simple way to have multiple cost pools is to pool Manufacturing Overhead costs separately by production department This is especially true if the departments are very different eg one is labor intensive and the other is automated You calculate a separate Predetermined Overhead Rate for each department s Manufacturing Overhead When using Departmental Application Rates it is possible to use different Cost Drivers for different departments Departmental Application Rate Example Ajax Inc produces standard model trophies as well as custom designed trophies Ajax s plant has two production departments i the Design Department and ii the Manufacturing Department The standard model trophies are made in the Manufacturing Department without any Design Department services Custom designed trophies are designed in the Design Department and then manufactured in the Manufacturing Department The Design Department uses 10000 Direct Labor Hours and the Manufacturing Department uses 90000 Direct Labor Hours Ajax currently allocates its Manufacturing Overhead using one Plant Wide Application Rate using Direct Labor Hours as the Cost Driver The Manufacturing Overhead for the plant is as follows Indirect Costs Design Manufacturing Total Rent 20000 80000 100000 Depreciation 200000 200000 Supervisors 50000 50000 100000 Maintenance 20 000 80 000 100 000 Total 90 000 410 000 500 000 Recently Ajax bid on two different jobs Job 1 involves a unique product design and it requires 20 Direct Labor Hours of Design services and 20 Direct Labor Hours of Manufacturing services Job 2 involves a standard model and it involves no Design services Job 2 only requires 20 Direct Labor Hours of Manufacturing services Both jobs require 200 of Direct Materials and the Direct Labor Cost is 5 per Direct Labor Hour Ajax prices its products using a cost plus 20 profit margin method Please send comments and corrections to me at mconstascsulbedu
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