Managerial Accounting ACCT 2521
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This 12 page Class Notes was uploaded by Christa Glover on Sunday October 11, 2015. The Class Notes belongs to ACCT 2521 at East Carolina University taught by Michele Reisch in Fall. Since its upload, it has received 42 views. For similar materials see /class/221355/acct-2521-east-carolina-university in Accounting at East Carolina University.
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Date Created: 10/11/15
Chapter 5amp6 1 What is the relevant range and the assumptions that follow relevant range that range of activity within which the assumptions made about cost behavior are reasonably valid managers should always keep in mind that assumptions made about cost behavior may be invalid if the activity falls outside of the relevant range except in the case of step Variable costs we ordinarily assume a strictly linear relationship between cost and volume Economists correctly point out that many costs that the accountant classifies as variable actually behave in a curvilinear fashion that is the relation between cost and activity is a curve although many costs are not strictly linear a curvilinear cost can be satisfactorily approximated with a straight line within a narrow band of activity known as the relevant range 2 Know the cost behaviors of fixed and variable costs Fixed total fixed costs remain constant within the relevant range ofactivity because fixed costs remain constant in total the average fixed cost per unit becomes progressively smaller as the level ofactivity increases it is necessary in some contexts to express fixed costs on an average per unit basis however to avoid confusion in internal reporting and decision making situations fixed costs should be expressed in total rather than on a per unit basis Variable Variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level If the activity level doubles the total variable cost also doubles a variable cost remains constant if expressed on a per unit bassis a variable cost is constant per unit but varies in total with activity 3 What is the difference between discretionary and committed FC committed fixed costs investments in facilities equipment and basic organizational structure that can t be significantly reduced even for short periods of time without making fundamental changes discretionary fixed costs those fixed costs that arise from annual decisions by management to spend on certain fixed cost items such as advertising and research 4 Know how to calculate mixed costs given missing elements a mixed cost contains both variable and fixed cost elements Mixed costs are also known as semivariable costs YA BX the equation for a straight line can be used to express the relationship between a mixed cost and the level of activity Ythe total mixed cost athe total fixed cost bthe variable cost per unit of activity and xthe level of activity the steeper the slope of the line the higher the variable cost per unit mixed costs are very common the fixed portion ofa mixed cost represents the minimum cost of having a service ready and available for use The variable portion represents the cost incurred for actual consumption of the service this it varies in proportion to the amount of service actually consumed the most common methods used to estimate the fixed and variable components ofa mixed cost are the account analysis approach and the engineering approach in the account analysis approach an account is classified as either variable or fixed based on the analyst s prior knowledge ofhow the cost in the account behaves the engineering approach to cost analysis involves a detailed analysis ofwhat cost behavior should be based on an industrial engineers evaluation of the production methods to be used the materials specifications labor requirements equipment usage production efficiency power consumption and so on The engineering approach must be used in those situations where no past experience is available concerning activity and costs In addition it is sometimes used together with other methods to improve the accuracy of cost analysis 5 Hilo method for finding mixed costs using the cost formula assuming that the scattergraph plot indicates a linear relation between cost and activity the fixed and variable cost elements ofa mixed cost can be estimated using the highlow method or the leastsquares regression method The highlow method is based on the rise over run formula for the slope ofa straight line variable cost per unit slope ofthe line m run 312311 x2 x1 to analyze mixed costs with the highlow method begin by identifying the period with the lowest level of activity and the period with the highest level ofactivity The period with the lowest level ofactivity is selected as the first point in the above formula and the period with the highest activity is selected as the second point Consequently the formula becomes variable cost yZyl x2x1 cost at the high activitv levelcost at the low activitv level high activity levellow activity level variable cost change in cost change in activity therefore when the high low method is used the variable cost is estimated by dividing the difference in cost between the high and low levels of activity by the change in activity between those two points the costs at the highest and lowest levels ofactivity are always used to analyze a mixed cost under the high low method because the analyst would like to use data that re ect the greatest possible variation in activity the high low method is very simple to apply but it suffers from a major defect it utilizes only two data points 6 Traditional vs Contribution format income statement you may have to calculate Gross Margin Contribution Margin or Net income Traditional an income statement prepared using the traditional approach is organized in a functional format emphasizing the functions of production administration and sales No attempt is made to distinguish between fixed and variable costs although an income statement prepared in the functional format may be useful for external reporting purposes it has serious limitations when used for internal purposes Internally managers need cost data organized in a format that will faciliate planning controlling and decision making Contribution the crucial distinction between fixed and variable costs is at the heart of the contribution approach to constructing income statements the unique thing about the contribution approach is that it provides managers with an income statement that clearly distinguishes between fixed and variable costs and therefore facilitates planning control and decision making the contribution approach seperates costs into fixed and variable categories first deducting variable expenses from sales to obtain the contribution margin The contribution margin is the amount remaining from sales revenue after variable expenses have been deducted This amount contributes toward covering fixed expenses and then toward profits for the period Traditional Approach Contribution Approach costs organized by behavior Sales 12000 Variable administrative 7 know the breakeven concepts 8 Know the Unit Contribution MarginContribution Margin concepts impact of each additional unit sold the breakeven point is the level of sales at which profit is zero once the breakeven point as been reached net operating income will increase by the amount of the unit contribution margin for each additional unit sold to estimate the profit at any sales volume above the breakeven point simply multiply the number of units sold in excess of the breakeven point by the unit contribution margin The result represents the anticipated profits for the period to estimate the effect of a planned increase in sales on profits simply multiply the increase in units sold by the unit contribution margin 9 Know the breakeven formulas what we call breakeven analysis is really just a special case of target profit analysis in which the target profit is zero Breakeven in Unit Sales to compute the unit sales to breakeven all we have to do is to set the target profit to zero in the equation as follows unit sales to break even 0 fixed expenses unit CM Breakeven in Sales Dollars we can find the breakeven point in sales dollars using several methods first we could solve for the breakeven point in unit sales using the equation method or formula method and then multiply the result by the selling price we can also use an equation Dollar sales to break even fixed expense CM ratio 10 CVP analysis changing selling price volume or cost info costvolume profit analysis is a powerful tool that helps managers understand the relationships among cost volume and profit CVP analysis focuses on how profits are affected by the following 5 factors 1 Selling prices 2 Sales Volume 3 Unit variable costs 4Total fixed costs 5 Mix ofproducts sold the contribution margin ratio can be used in costvolume calculations the contribution margin as a percentage of sales is referred to as the contribution margin ration CM ratio This ratio is computed as follows CM ratio ontributon margin Sales the CM ratio can also be computer on a per unit basis as follows CM ratio W Unit selling price the CM ratio shows how the contribution margin will be affected by a change in the total sales for example a CM ratio of40 means that for each dollar increase in sales total contribution margin will increase by 40 cents the impact on new operating income of any given dollar change in total sales can be computed by simply applying the CM ratio to the dollar change the relation between profit and the CM ratio can also be expressed using the following equation Profit CM ratio x sales Fixed expenses the variable expense ratio is the ratio of variable expenses to sales It can be computer by dividing the total variable expenses by the total sales or in a single product analysis it can be computed by dividing the variable expenses per unit by the unit selling price 11 Know the Target Profit Formulas in target profit analysis we estimate what sales volume is needed to achieve a specific target profit To do this we either use the equation method or the formula method the equation method we can use a basic profit equation to find the sales volume required to attain a target profit Profit Unit CM X Q Fixed Expense Qactivity level formula method the formula method is a shortcut version of the equation method In general in a singleproduct situation we can compute the sales volume required to attain a specific target profit using the following formula Unit Sales to attain the target profit target profit fixed expenses unit contribution margin instead of unit sales we may want to know what dollar sales are needed to attain a target profit Dollar sales to reach a target profit target profit fixed expenses CM ratio 12 Know margin of safety the margin of safety is the excess ofbudgeted or actual sales dollars over the break even volume of sales dollars It is the amount by which sale can drop before losses are incurred The higher the margin of safety the lower the risk ofnot breaking even and incurring a loss the formula for the margin of safety is Margin of safety in dollars total budgeted or actual sales break even sales the margin of safety can also be expressed in percentage form by dividing the margin of safety in dollars by total dollar sales margin of safety percentage margin of safety in dollars total budgeted or actual sales in dollars Chapter 11 1 Know relevant costs avoidable sunk costs opportunity costs avoidable cost a cost that can be eliminated in whole or in part by choosing alternative over another in a decision This term is synonymous with relevant cost and differential cost sunk cost any cost that has already been incurred and that cannot be changed by any decision made now or in the future differential cost any cost that differs between alternatives in a decision making situation This term is synonymous with avoidable cost and relevant cost relevant cost a cost that differs between alternatives in a decision opportunity costs represent economic benefits that are forgone as a result of pursuing some course of action opportunity costs are not recorded in the organization s ledger because they do not represent actual dollar outlays to identify the costs that are avoidable in a particular situation and are therefore relevant these steps should be followed 1 eliminate costs and benefits that do not differ between alternatives 2 use the remaining costs and benefits that do not differ between alternatives in making the decision only those costs that differ in total between alternatives are relevant in decision making avoidable costs relevant unavoidable costs not relevant two broad categories of costs are never relevant in decision making these are 1 Sunk costs and 2 Future costs that do not differ between alternatives 2 Know how to calculate newold 3 Know how to calculate make buy a decision to carry out one of the activities in the value chain internally rather than to buy externally from a supplier is called a make or buy decision quite often these decisions involve whether to buy a particular part of make it interanally 4 know how to calculate special order managers must often evaluate whether a special order should be accepted and if the order is accepted the price that should be charged a special order is a onetime order that is not considered part of the company s normal ongoing business 1 Know the difference between financial and managerial accounting Financial Accounting Reports to those outside the organization owners creditors tax authorities regulators Managerial Accountng Reports to those inside the organization for planning directing and motivating controlling performance evaluation Emphasizes financial consequences of past activities Emphasizes decisions affecting the future Emphasizes objectivity and verifiability Emphasizes summary data concerning the entire organization Emphasizes relevance Emphasizes timeliness Emphasizes precision Emphasizes detailed segment reports about departments products and customers Must follow GAAP Need not follow GAAP Mandatory for external reports N ot mandatory 2 Know the difference between product and period costs Pro duct Costs Product costs include all costs involved in acquiring or making a product In the case of manufactured goods these costs consist ofdirect materials direct labor and manufacturing overhead Product costs quotattachquot to units ofproduct as the goods are purchased or manufactured and they remain attached as the goods go into inventory awaiting sale Product costs are initially assigned to an inventory account on the balance sheet When the goods are sold the costs are released from inventory as expenses typically called cost of goods sold and matched against sales revenue Because product costs are initially assigned to inventories they are also known as inventoriable costs Product costs are no necessarily treated as expense in the period in which they are incurred Rather they are treated as expenses in the period in whch the related products are sold This means that a product cost such as direct materials or direct labor might be incurred during one period but no recorded as an expense until a following period or when the completed product is sold Period Costs Period costs are all the costs that are not product costs For example sales commissions and the rental costs ofadministrative offices are period costs Period costs are not included as part of the cost of either purchased or manufactured goods instead period costs are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting Keep in mind that the period in which a cost is incurred is not necessarily the period in which cash changes hands For example the cost ofliability insurance are spread across periods that benefit from the insurance regardless of the period in which they are incurred All selling and administrative expenses are considered to be period costs Advertising executive salaries sales commissions public relations and other nonmanufacturing costs are all examples ofperiod costs They will appear on the income statement as expenses in the period in which they are incurred Know what Direct Materials Direct Labor and Manufacturing Overhead are and examples Direct Materials The materials that go into the final product are called raw materials Raw materials don t just refer to unprocessed natural resources they are any materials that are used in the final product and the finished product of one company can be the raw materials of another Raw materials may include both direct and indirect materials Direct materials are those materials that become an integral part of the finished products and whose costs can be easily traced to the finished product This would include for example the seats that Airbus purchases from subcontractors to install in its commercial aircrafts and the tiny electric motor that Panasonic uses in its DVD players DJ Direct Labor Direct labor consists oflabor costs that can be easily traced to individual units ofproduct Direct labor is sometimes called touch labor because direct labor workers typically touch the product while it is being made Examples of direct labor include assemblyline workers at Toyota carpenters at the home builder Kaufman and Broad and the electricians who install equipment on aircrafs at Bombardier Learjet Manufacturing Overhead Manufacturing overhead includes all manufacturing costs besides direct labor and direct materials Manufacturing overhead includes such items such as indirect materials and indirect labor maintenance and repairs on production equipment head and light property taxes depreciation and insurance on manufacturing facilities Only those costs associated with operating the factory are included in manufacturing overhead Various names are used for manufacturing overhead such as indirect manufacturing factory overhead and factory burden Other materials such as solder and glue are called indirect materials and are included as part of manufacturing overhead Labor costs that cannot be physically traced to particular products or that can be traced only at great cost and inconvenince are termed indirect labor Indirect labor is part of manufacturing overhead Indirect labor consists of the labor costs ofjanitors supervisors material handlers and night security guards 4 Know prime cost vs conversion cost Prime Cost Prime cost is the sum of direct materials cost and direct labor cost Conversion Cost Conversion cost is the sum of direct labor cost and manufacturing overhead cost The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished roduct 39 7 Know the difference between joborder costing and process costing and examples of companies that might use each job Order Costing ob order costing is used in situations where many different products are produced each period For example Levi clothing factory would typically make many different types ofjeans for both men and women during the month A typical order might consist of 1000 stonewashed men s blue denim jeans style number 2793 8 This order of 1000 jeans is called a job In a job order costing system costs are traced and allocated to jobs and then the costs of the job are divided by the number of units in the job to arrive at an average cost per unit Other examples of situations where joborder costing would be used include large scale construction projects commercial aircrafts greeting cards airline meals ob order costing is also used extensively in the service industry For example hospitals law firms movie studios accounting firms advertising agencies and repair shops all use a variation ofjob order costing Process Costing Process costing is used in companies that produce many units of a single product for long periods Examples include producing paper refining aluminum ingots mixing and bottling beverages at Cocacola and making wieners at oscar meyer These are all homogenous products that ow through the production process on a continual basis Process costing systems accumulate costs in a particular operation or department for an entire period and then divide this total by the number of units produced during the period The basic formula is unit product cost total manufacturing costtotal units produced Because one unit is indistinguishable from any other unit ofproduct each unit produced during the period is assigned the same average cost This costing technique results in a broad average unit cost figure that applies to homogenous 9 Predetermined Manufacturing Overhead Rate what is it Predetermined Manufacturing Overhead Rate Manufacturing overhead is applied to products using a predetermined manufacturing overhead rate The predetermined overhead rate is computed by dividing the total estimated manufacturing overhead cost for the period by the estimated total amount of the allocation base Allocation is accomplished by selecting an allocation base that is common to all of the company s products or services An allocation base is a measure such as direct laborhours or direct machinehours that is used to assign overhead cost to products and services 10 why is it used Instead ofusing a predetermined rate based on estimates why not base the overhead rate on the actual total manufacturing overhead cost and the actual total amount of the allocation base incurred on a monthly quarterly or annual basis If an actual rate is computed monthly or quarterly seasonal factors in overhead costs or in the allocation base can produce uctuations in the overhead rate To avoid such uctuations actual overhead rates could be computed on an annual or lessfrequent basis However if the overhead rate is computed annually based on the actual costs and activity for the year the manufacturing overhead assigned to any particular job would not be known until the end of the year For these reasons most companies use predetermined overhead rates rather than actual overhead rates in their cost accounting systems 11 calculate the rate Predetermined overhead rate estimated total manufacturing overhead costestimated total amount of allocation base the predetermined overhead rate is computed before the period begins The first step is to estimate the amount of the allocation base that will be required to support operations in the upcoming period The second step is to estimate the total manufacturing cost at that level of activity The third step is to compute the predetermined overhead rate 12 calculate applied MOH The predetermined overhead rate is used to apply overhead cost to jobs throughout the period The process ofassigning overhead costs to jobs is called overhead application The formula for determining the amount of overhead to apply to a particular job is overhead applied to a particular job predetermined overhead rate X amount of the allocation base incurred by the job Manufacturing overhead costs are entered directly into the manufacturing overhead account as they are incurred by debiting manufacturing overhead and crediting cash or accounts payable Manufacturing overhead costs are then applied to the Work in Process account by means of the predetermined overhead rate the predetermined overhead rate is applied to a job by multiplying the rate by the amount of allocation base used on the job this amount is then debited to work in process and credited to manufacturing overhead the manufacturing overhead account acts as a clearing account Actual factory overhead costs are debited to the account as they are incurred throughout the year When a job is completed overhead cost is applied to the job using the predetermined overhead rate and Work in Process is debited and Manufacturing Overhead is credited The cost ofa completed job consists of the actual direct materials of the job the actual direct labor of the job and the manufacturing overhead cost applied to the job Pay close attention to the following point actual overhead costs are not charged to jobs actual overhead costs do not appear on the job cost sheet nor do they appear in the Workin Process account Only the applied overhead cost based on the predetermined overhead rate appears on the job cost sheet and in the Work in Process account 1 3 determine over under The predetermined overhead rate is based entirely on estimates ofwhat the level of activity and overhead costs are expected to be and it is established before the year begins As a result the overhead cost applied during a year will almost certainly turn out to be more or less than the actual overhead cost incurred because the predetermined overhead rate is established before the period begins and is based entirely on estimated data the overhead cost applied to work in progress will generally differ from the amount of overhead cost actually incurred The difference between the overhead cost applied to Work in Progress and the actual overhead costs ofa period is called either underapplied or overapplied overhead What is the cause of underapplied or overapplied overhead The causes can be complex The basic problem is that the method of applying overhead to jobs using a predetermined overhead rate assumes that actual overhead costs will be proportional to the actual amount of the allocation base incurred during the period There are at least two reasons why this may not be true First much of the overhead often consists of fixed costs that do not change as the number of machinehours incurred goes up or down Second spending on overhead items may or may not be under control Debit entries to the manufacturing overhead account represent actual overhead costs incurred whereas credit entries represent overhead costs applied to jobs If the actual overhead costs incur red exceeded the overhead costs applied to the jobs there will be a debit balance If the actual overhead costs incurred is less than the overhead costs applied then there will be a debit balance If there is a debit balance in the Manufacturing Overhead account ofX dollars then the overhead is underapplied by X dollars On the other hand if there is a credit balance in the Manufacturing Overhead account on dollars then the overhead is overapplied by Y dollars 14 close out MOH What happens to any underapplied or overapplied balance in the Manufacturing Overhead account The simplest method is to close out the balance to Cost of Goods Sold If the overhead is underapplied debit balance then to close out you debit cost of goods sold and credit manufacturing overhead If the overhead is overapplied credit balance then to close out you debit manufacturing overhead and credit cost of goods sold 15 effect on NI When overhead is overapplied the balance in the Manufacturing overhead account is credited to Cost of goods sold debit manufacturing overhead credit cost of goods sold This has the effect of decreasing Cost of Goods sold and increasing net income When overhead is underapplied the balance in the manufacturing overhead account is debited to Cost ofGoods Sold This has the effect ofincreasing Cost of Goods sold and decreasing net income 17Calculate Net Income given sales and cost information use product cost to calculate CGS and value ending inventory
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