C. Cost Management

Question 1

Topic 1 - Measurement Concepts

What is the “relevant range” in terms of cost behavior and cost objects?

Answer 1

The range in which fixed costs and variable costs are defined and constrained. FC and VC are defined with respect to cost drivers for a specific duration of time. Change any quantity by a large enough degree and the fixed costs will no longer remain fixed (ex. If “Q = 0”, all FC will end as well as the product. FC will change when “Q” goes above certain levels because new factories may need to be produced, etc.)

Question 2

Topic 1 - Measurement Concepts

What is a “variable cost”?

Answer 2

Includes changes in total for a cost object in proportion to each change in the quantity of a cost driver over a relevant range.

VC on a per unit basis will remain constant over a relevant range.

Examples: Direct material, direct labor

Question 3

Topic 1 - Measurement Concepts

What is a “fixed cost”? What is the difference between “discretionary” and “committed” fixed costs?

Answer 3

The portion of total costs that do not change when the quantity of a cost driver changes over a relevant range and duration.

Fixed costs on a per unit basis will decline as quantities increase.

Can be further classified into:

(1) Discretionary costs (aka “managed” or “budgeted” fixed costs): can be included/excluded from budget at the discretion of management (ex. advertising, training, internships, etc)
(2) Committed costs: costs that CANNOT be omitted due to strategic or operational properties in the short run (ex. depreciation on equipment previously purchased). Tend be facilities related.

Question 4

Topic 1 - Measurement Concepts

What are “step costs”?

Answer 4

Fixed costs with VERY NARROW relevant ranges. Tend to be considered fixed costs in the short-run, but variable costs over the long-run.

Can be “step fixed” or “step variable”.

(a) Step-fixed: Increase in equal-size chunks over an equal number of cost drivers (ex. plant OH increasing by $100K for each plant added)
(b) Step-variable: Go up to a higher constant cost in either increasingly larger/smaller amounts of a cost driver (ex. if one worker can produce 0.5 units, then two workers can produce 1.0 units, and so forth)

Question 5

Topic 1 - Measurement Concepts

What are “mixed costs”?

Answer 5

The sum of all fixed costs and variable costs.

Mixed Costs = FC + VC

Question 6

Topic 1 - Measurement Concepts

What is “capacity” in terms of cost type relationships? What is the difference between “practical” and “theoretical” capacity?

Answer 6

Measures the constraints or bottlenecks keeping a system from expanding in output or some other measure. (ex. Manufacturing capacity can be increased by adding additional plants, employees, or equipment)

Relates to relevant range because capacities tend to be reached at the upper limit of a relevant range.

“Practical” capacity = the highest output level of a resource such as a plant can achieve without increasing its costs due to bottlenecks

“Theoretical capacity” = the upper limit on output assuming that nothing goes wrong, everything operates at full speed, and no holidays or other scheduling conflicts are included; the ideal state

Question 7

Topic 1 - Measurement Concepts

Name and briefly describe the four (4) types of cost drivers.

Answer 7

1. Activity-based cost drivers: focus on operations that involve manufacturing or service activities (ex. machine setup, etc)
2. Volume-based cost drivers: focus on output, which involves aggregate measures (ex. units produced, labor hours)
3. Structural cost drivers: focus on company strategy, which involves long-term plans for scale, complexity, amount of experience in an area, or level of technical expertise.
4. Executional cost drivers: focus on short-term operations, which involve reducing costs through concern with workforce commitment and involvement, production design, and supplier relationships

Question 8

Topic 1 - Measurement Concepts

What are “activity-based” cost drivers? What is a benefit of using activity based cost drivers?

Answer 8

Developed by analyzing and detailing the different activities within the firm, which form the basis for the activity-based cost driver. The descriptions are then broken down into steps and each step in the description becomes different cost drivers. Intent is to determine how changing the steps will change the overall cost of the operation. The cost of each step or activity can also be determined. This detailed breakdown can help firms determine which activities add value for customers and which do not. Furthermore, when an activity costs more than it’s expected, activity-based cost drivers will highlight this discrepancy.

Benefits:
Can help firms determine which activities add value for customers and which do not. Furthermore, when an activity costs more than its expected to cost, an activity-based cost driver will highlight this discrepancy.

Ex. (Activity / Cost Driver)

• Accepting Cash / Number of Cash Transactions
• Processing a Credit Card / Number of Credit Transactions
• Training / Number of Stores
• Maintenance of Computer Equipment / Number of Computer Terminals

Question 9

Topic 1 - Measurement Concepts

What are “volume-based” cost drivers? Describe the cost behavior of volume-based cost drivers along/within the relevant range?

Answer 9

Aggregations of activities based on volume of use. DM and DL cost drivers are inherently volume-based.

Cost Behavior: When volume-based cost drivers are very low, factors such as learning curves and efficient use of resources will cause costs to increase more slowly as production numbers increase (called the “increasing marginal productivity”). At a certain level this behavior will level-off, and a rise in production volume will have a proportional rise in cost within the relevant range, until a certain point at which the capacity of the persons or equipment will reach the limit. As the volume increases toward the limit, the costs will rise dramatically because of increased needs for repairs, more overtime, and other similar factors. This is called the “law of diminishing marginal capacity”. This is why the relevant range is an important element of cost drivers.

Question 10

Topic 1 - Measurement Concepts

What are “structural” cost drivers? What are the four (4) types of structural cost drivers?

Answer 10

Long-term cost drivers based on the overall strategy of the company.

Four types:

(1) Scale - the scale of a project or speed at which a company grows will affect all of the costs of the company overall
(2) Experience level - the strategic level of a company for a particular strategic initiative will affect the overall cost of achieving that goal
(3) Technology - changing the level of technology for a process can make that process more efficient and therefore less costly
(4) Complexity - the more complex a firm becomes (more products, more hierarchy, etc) the more it costs to sustain that complexity

Question 11

Topic 1 - Measurement Concepts

What are “executional” cost drivers?

Answer 11

The short-term decisions that can be made to reduce operational costs.

Three types:

(1) Workforce involvement - the greater the commitment of the workforce, the lower the labor costs will be in proportion to the amount of work that gets done
(2) Production process design - production costs can be reduced by analyzing and redesigning production processes and incorporating software applications to streamline workflow
(3) Supplier relationships - close relationships with suppliers can reduce overall costs, especially inventory costs (electronic data interchanges allow suppliers to see the firm’s inventory levels and ship inventory as needed, which increases efficiency)

Question 12

Topic 1 - Measurement Concepts

What is “actual”, “normal”, and “standard” costing?

Answer 12

Types of cost allocation methods. Terms “actual” and “normal” refer to means of applying/allocating overhead costs to cost objects. All three are types of job order costing in which costs are accumulated in inventory accounts (ex. WIP or Finished Goods) and recorded on the income statement as COGS.

Actual Costing: Uses actual cost amounts for DL, DM, and OH

Normal Costing: Uses actual cost amounts for DL and DM, but uses a predetermined overhead rate for OH.

Standard Costing: Uses a predetermined standard (aka “should”) cost for DL, DM, and OH.

Question 13

Topic 1 - Measurement Concepts

What is “actual costing” in terms of what is used for DM, DL, and OH (actual vs. predetermined rate allocation)? What are its benefits/limitations?

Answer 13

Uses actual costs incurred for ALL costs (i.e. DM, DL, and OH).

Costs can only be determined by waiting until the end of the accounting period.

Benefits: More accurate than other costing systems.

Cons: Delay in information because must wait until all invoices are received, which may not occur until the end of the fiscal year or later

Question 14

Topic 1 - Measurement Concepts

What is “normal costing” and how are DM, DL, and OH determined (actual vs. allocated amount)? What is its benefit in relation to “actual costing”?

Answer 14

Applies actual costs for direct materials and direct labor for a job, but uses a predetermined OH rate to assign to the cost object.

Allows current calculation of product costs.

Steps for determining the predetermined OH factory rate:

(1) Create a budget for overhead costs
(2) Chose the cost drivers (usually activity or volume) for charging overhead
(3) Estimate the total annual amount/volume of the selected cost driver for the total OH cost pools or each cost pool
(4) Divide the budgeted factory OH costs by the estimated cost driver activity level

Formula:
Predetermined Factory OH Rate = (Budgeted Factory OH Costs / Est. Cost Driver Activity Level)

Question 15

Topic 1 - Measurement Concepts

What is “standard costing” and what figures of DM, DL, and OH are used to allocate costs to cost objects (actual vs. predetermined rate)? What are the two parts of a standard cost?

Answer 15

Applies all product costs (DM, DL, and OH) using a predetermined (standard) rate. Standard costs are expected / targeted costs for an operation. They are designed to point out where variances occur so that the company can achieve a better operating result.

Two Parts of a Standard Cost:

(1) Standard # of units of a cost driver adjusted for actual unit production (ex. labor hours divided by units produced, such as 40,000 labor hours divided by 80,000 units produced = 0.5 labor hours per unit)
(2) Standard rate per unit of the cost driver (ex. $20 per labor hour)

Knowing these two parts allows one to calculate the standard cost of DM and DL. They can then be compared to actual DM and DL for analysis purposes. (ex. In an actual month with the same 80,000 units produced, actual labor hours totaled 42,000 at an actual rate of $18 per hour). These differences lead to budget variances.

Advantages:

• Less likely to incorporate past inefficiencies
• Can be adapted as new data to indicate expected changes during the budget period

Disadvantages:
- Unreasonable standards can potentially be set

Question 16

Topic 1 - Measurement Concepts

Describe “absorption” (aka “full”) costing and “variable” (aka “direct”) costing.

Answer 16

Types of inventory costing systems. Both systems expense all nonmanufacturing costs (variable and fixed) in the period in which they occur. The two methods only differ in how they account for fixed manufacturing costs (Absorption costing includes fixed manufacturing costs; variable costing excludes it).

Absorption (full) costing (REQUIRED for external reporting):

• Inventory costing system that includes both variable and fixed manufacturing costs. Inventory absorbs all costs of manufacturing (PRIMARY DIFFERERENCE)
• Income statement prepared using the “gross margin” format, which highlights the difference between manufacturing and nonmanufacturing costs

Variable (direct) costing:

• Inventory costing system that includes only variable manufacturing costs. Fixed manufacturing costs are expensed in the period during which they were incurred. (PRIMARY DIFFERENCE)
• Income statement prepared using “contribution margin” approach, which highlights differences between fixed and variable costs

Question 17

Topic 1 - Measurement Concepts

What are “joint products” and “by-products” from a costing system standpoint? What is the “split-off” point? How are costs allocated to joint products in relation to the split-off point and cost amounts used?

Answer 17

“Joint products”:
- Products that share a portion of the production process and have relatively the same sales values (ex. The oil industry uses joint products. Crude oil is refined into joint products such as diesel, gasoline, motor oil, and plastic).

“By-products”:
- Products that share the same production process with a product or joint product but have relatively minor value in comparison to the main product (ex. Lumber mills may have finished boards and the sawdust–a by-product–is used in other products).

Split-off Point: Point at which products diverge and become separately identifiable. This isn’t necessarily the point in which products become finished goods.

Costing for “Joint” and “By”-Products:

• Includes all manufacturing costs incurred before and after the split-off point.
• **For financial reporting purposes, joint costs incurred prior to the split-off point are allocated among the joint products.

Two Basis Approaches for Allocating Joint Costs to Joint Products:

(1) Using Market Data (ex. sales value at split-off point, gross profit method, NRV method)
(2) Using Physical Measures Data

Question 18

Topic 1 - Measurement Concepts

What are the three (3) “market-based approaches” for allocating joint costs to joint products?

Answer 18

Includes three methods of allocating costs:

(1) Sales value at split-off method
- Widely used because its simple
- Can only be used when the sales values are available at split-off
- Allocates joint costs to joint products using their proportional sales value at the split-off point

(2) Gross profit method
- Allocates joint costs so as to provide the same gross margin percentage of profit for each product

(3) NRV Method
- Used when the market price for one or more of the joint products is unknown at the split-off point; usually because additional processes are needed
- Formula: NRV = Final Sales Value - Additional Processing Costs
- Allocate using ratios of newly determined values at split-off

Question 19

Topic 1 - Measurement Concepts

What is the “physical measures method” for allocating joint costs to joint products?

Answer 19

Uses a physical measurement to allocate joint costs to joint products. Physical measures include weight, number, and volume. Measures can be input or output measures.

Steps:

(1) Calculate Avg. Cost per Unit = (Total Joint Costs / Total Lbs.)
(2) Multiply the avg. cost per unit by the total number of units to determine the amount to allocate to each joint product

Question 20

Topic 2 - Costing Systems

From beginning to end, describe how costs flow in a manufacturing organization?

Answer 20

Certain inputs are fed into the cost of the product to determine the product’s total cost.

Cost Flow Diagram:
[DM + DL + OH] > WIP Inventory > Finished Goods Inventory > COGS

Question 21

Topic 2 - Costing Systems

What are “job order costing” and “process costing” systems? Please provide brief definitions of both systems.

Answer 21

Two types of costing systems that companies typically use to assign costs to products / services.

Job Order Costing:

• Assigns costs to a specific job (a distinct unit, batch, or lot of a product or service)
• Used when the product/service has costs that can be, and often need to be, tracked and assigned to a specific job or service (ex. Construction of buildings or ships, advertising campaigns, research and development, etc)
• Costs are accumulated by job, not department

Process Costing:

• Accumulates product or service costs by process or department and then assigns them to a large number of nearly identical products by dividing the total costs by the total number of units produced
• Used for multiple, nearly identical units that can be organized into a flow (ex. newspapers, books, soft drinks, check processing, postal delivery, magazine subscription receipts)
• Products tend to be homogenous in nature and therefore it is not necessary to track costs to specific unit of product/service
• Costs are accumulated by department, not job

Both “job costing” and “process costing” utilize the same DM, DL, OH, WIP, Finished Goods, and COGS accounts.

Question 22

Topic 2 - Costing Systems

What are the six (6) basic steps in assigning costs to a job when using a “job costing” system?

Answer 22

(1) ID the job with a unique reference
(2) Trace the direct costs for the job (DM, DL)
(3) ID indirect cost pools associated with the job (OH)
(4) Select the cost allocation base (cost driver) to be used in allocating indirect cost pools to the job
(5) Calculate the target rate per unit of each cost allocation base. Actual Indirect Cost Rate = [Actual Total Cost in Indirect Cost Pool / Actual Total Quantity of Cost Driver]
(6) Assign cost to the cost object by adding up all the direct (DL and DM) and indirect costs (OH)

Question 23

Topic 2 - Costing Systems

What is “spoilage”, “rework”, and “scrap”? How are they treated in “job order” costing systems?

Answer 23

Spoilage - UNACCEPTABLE & SOLD FOR DISPOSAL VALUE

• Definition: Any material/good that is considered unacceptable and is discarded or sold for its disposal value
• “Normal” = Any spoilage is any unit of production that is deemed unacceptable during the normal production process, assuming efficient operations. Considered part of the cost of operations and therefore is included in COGS. Can be a direct cost to a job reduced by any salvage value or an indirect cost to production in general (allocated to factory OH)
• “Abnormal” = Any unacceptable product that should not normally exist under efficient and normal operating conditions. Any spoilage over the amount considered “normal” is allocated to a loss from abnormal spoilage account
• “Total Spoilage” = Beginning Inventory + Units Started - Units Completed and Transferred Out - Ending Inventory

Rework - REQUIRES ADDITIONAL WORK

• Any finished product that must have additional work performed on it before it can be sold
• Three types: (a) Normal defective units for a specific job. Charged to specific job’s WIP account, which increases costs and reduces profits; (b) Normal defective units common for all jobs. Charged to factory OH; (c) Abnormal defective units. Charged to “loss from abnormal rework account”

Scrap - NO ECONOMIC VALUE

• A portion of a product or leftover material that has no economic value.
• Can be categorized as related to a specific job (charged to specific job’s WIP account) or is common to all jobs (charged to factory OH)
• If sold, the aforementioned accounts will be credited

Question 24

Topic 2 - Costing Systems

What is “process costing”? What are “equivalent units” and how do you calculate them? Describe the process costing flow.

Answer 24

Recommended for companies with large mass production processes or nearly identical products. Such companies track their quantities and costs on a departmental production cost report and calculate the unit cost at the end of the period by dividing the total cost of an operation or department by the total units produced

Equivalent Units in Process Costing:

• Unlike job order costs, which automatically assigns costs to partially completed units, process costing cannot easily determine values for partially completed units because the accounting highlights costs for processes/departments rather than specific jobs.
• Process costing must find the combined cost for all units, including all partially complete at the beginning and end of the accounting period (i.e. items still in WIP)
• Product costs are calculated by determining the cost per unit in each department and therefore partially completed units must be factored into these calculations
• Process costing accounts for any WIP as “equivalent units”
• “Equivalent unit” = measure of the amount of work done on partially completed units expressed in terms of how many complete units could be have been created with the same amount of work
• Completed separately for DL, DM, and OH
• “Beginning Inventory” was accounted for in the last period. Therefore, the reciprocal of “beginning inventory” needs to be accounted for in this period (ex. if beg. inventory is 30% complete then the remaining 70% complete used to calculate EUs)

EUs = [Beg Inv Units x (100% - % Complete Beg Inv)] + Units Started and Completed During the Period + EUs in Ending WIP

“Conversion Costs”:

• Equals the sum of DL and OH
• Some companies combine DL and OH when DL is not a significant portion of the costs due to the highly automated process

Process Costing Flow:

• Costs flow through processes and departments
• Departments must have their own WIP accounts
• When departments complete their portion of work on a product, all of the costs are transferred to the next department’s WIP by debiting a “transferred-in costs” account on the next department’s books

Question 25

Topic 2 - Costing Systems

What are the (5) steps in preparing a “production cost report” relating to a process costing system?

Answer 25

Steps completed separately for DM, DL, and OH:

(1) Determine the flow of physical units (Input = Output)
a. Input units
- Beginning WIP inventory
- Units entered into production
b. Output Units
- Units completed and transferred out to Finished Goods
- Ending WIP Inventory
(2) Determine the EUs:
- EUs = [Units in Beg WIP x (100% - % Complete) + Units Completed and Transferred Out + (Units in End WIP x % Complete)
(3) Calculate the manufacturing costs
- Includes any costs in WIP and any current costs
(4) Calculate unit costs:
- Used to determine product costing and income for a period
- Calculated for overall costs, as well as DM, DL, and OH
(5) Assign total manufacturing costs to units (cost assignment):
- Units completed and transferred out and units remaining in WIP inventory receive the period’s manufacturing costs

Question 26

What are the two (2) ways that spoilage can be handled in a process costing system?

Answer 26

1st Method’s Steps:

• Counts the number of spoiled units
• Separately computes the cost per unit
• Allocate the cost per unit to the spoiled units

2nd Method’s Steps:

• Spoilage cost is included in the total manufacturing costs
• i.e. Omits spoiled units in the totals so that the cost per unit does not include any spoiled units

Question 27

What is “activity-based costing” (ABC) and what is the two-stage approach it uses to allocate costs to cost objects?

Answer 27

A method of assigning costs to customers, services, and products based on an activity’s consumption of resources.

Two-Stage Approach to Allocate Costs:

• Resource cost assignment of OH costs to activity cost pools or activity centers using pertinent resource cost drivers
• Activity cost assignment of activity costs to cost objects using pertinent activity cost drivers (to measure a cost object’s drain on an activity)

Key Term Definitions:
“Activity” = any type of action, work, or movement performed within the entity

“Activity center” = a logical grouping of activities, actions, movements, or sequences of work

“Resource” = an element with economic value that is consumed or applied when performing an activity

“Resource Cost Driver”:

• Measures the amount of resources consumed by an activity.
• Resource costs used in an activity are assigned to a cost pool using a resource cost driver
• Ex. rubber required to make a batch of tennis balls, number of hours used by an engineer to design, build, and maintain a project schedule, etc

“Activity Cost Driver”:

• Measurement of the amount of an activity used by a cost object.
• Assign costs in cost pools to cost objects

Question 28

Name the three (3) “key” steps in ABC systems.

Answer 28

STEP 1: Identify Activities and Resource Costs:

a) Activity Analysis: ID’s resource costs of performing particular activities by determining the work performed for each activity. The project team makes detailed lists of activities and organizes them into activity centers as well as into these activity levels:
- Unit-level: performed for each unit produced (ex. DM, DL, etc)
- Batch-level: performed for each batch of units (ex. machine setup, purchase orders, etc)
- Product-sustaining: support production process (ex. product design, expediting, etc)
- Facility-sustaining: support production for an entire facility (ex. security, plant management, property taxes, insurance, etc)
- Customer-level: support customer needs

STEP 2: Assign Resource Costs to Activities

a) Resource costs are assigned to activities using “resource cost drivers”. Cause-and-effect relationships must be established between the driver and the activity
b) Example resource cost drivers and related activity often used include:
- Number of employees : Personnel activities
- Time worked : Personnel activities
- Setup hours : Setup/Machine activities
- Meters : Utilities
- Machine Hours : Machine-running activities
- Number of orders : Production orders
- Square feet : Cleaning activities
- Amount of value added : General and administrative

STEP 3: Assign Activity Costs to Cost Objects

• After determining the activity costs, the activity cost per unit are measured using an appropriate cost driver, which should show a cause-and-effect relationship
• Activity cost drivers determine the proportion of a cost to allocate to each product or service using a formula
• Formula: “Rate” = (Cost Pool / Driver)

Question 29

Topic 4 - Operational Efficiency

What is the main concept of the “materials requirements planning” (MRP) system of production? What are the premises underlying an MRP system? What are its major benefits / limitations?

Answer 29

• Essentially “push-through” systems.
• Taking a product from raw material through delivery often is treated as a series of discrete events.
• The concept is to “push” the product through production to reach a market.
• Once the scheduled production run begins, departments push output through a system, regardless of whether that output is needed.

Premises:

(a) Demand forecasts
(b) A materials order specifying materials, components, and subunit tasks needed to produce a final product
(c) A production order specifying the quantities of materials, components, subunits, and product inventories needed to meet the demand forecast

Benefits:

• Less coordination required between functional areas
• Scheduling improvements
• Predictable raw material needs
• More efficient inventory control
• Additional “emergency” inventory on-hand should the product become damaged
• Quick response to new customer demand
• Better manufacturing process control

Disadvantages:
- Potential inventory accumulation / backup / bottlenecks

Question 30

Topic 4 - Operational Efficiency

What is the main concept of the “just-in-time” (JIT) system of production? What are the major characteristics of a JIT system? What is “kanban”? What are its major benefits / limitations?

Answer 30

• A comprehensive production and inventory control methodology in which materials arrive exactly as they are needed for each stage in the production process
• GOAL = To create “lean” manufacturing
• Need is created by market’s “demand”, which “pulls” a replacement product from the last position of the production system. Demand triggers EVERY step.

Major Characteristics:

• Production organized into manufacturing work cells
• Multiskilled workers to maintain “smooth” production flow
• Reduced setup times
• Reduced manufacturing lead times
• Reliable suppliers

“Kanban”:

• A visual record / card that is used to signal the need for a specified quantity of materials or parts to move from one work cell operation to another
• Workers respond only after receiving a “kanban”

Benefits:

• No overproduction occurrences
• Easier inventory control / lower inventory investments
• Strong supplier relationships

Limitations:

• No buffer inventory
• Reliance on suppliers
• Potential overtime for unanticipated orders

Question 31

Topic 4 - Operational Efficiency

What is the main concept of “outsourcing” one’s system of production? What are its major benefits / limitations?

Answer 31

• A company’s decision to purchase a product or service from an outside supplier rather than producing it in house

Benefits:

• Allows management to focus on core competencies / strategy
• Gaining outside expertise or scale
• Access to current technologies at a reasonable cost without the risk of obsolescence
• Gaining capabilities without incurring overhead costs
• Improve quality

Disadvantages:

• May cost more
• Potential loss of in-house expertise / capabilities
• Reduces process and quality controls
• Potentially lead to less flexibility and personalized service
• Privacy and confidentiality issues
• Employee morale and loyalty issues

Question 32

Topic 4 - Operational Efficiency

What is the “theory of constraints” (TOC)? What is its main goal?

Answer 32

• An overall management philosophy with a basis in the manufacturing environment
• GOAL: Improve speed in the manufacturing process by optimizing throughput rather than simply measuring output
• Main Premise: Every system is pursuing a goal and that every goal is constrained by a limit.
• Focuses on “constraint management”, which is the process of identifying process barriers, gaining an understanding of the barriers, and finally removing the barriers to reduce cycle time
• TOC focuses on fixing the constraint and temporarily ignoring the lesser / nonconstraints
• When one constraint is mitigated, a new constraint emerges that the TOC focuses on

Question 33

Topic 4 - Operational Efficiency

What are the basic principles underlying TOC?

Answer 33

(a) Inventory:
- All the money the system invests in purchasing items it intends to resell
(b) Operating Expenses:
- All the money the system spends to convert inventory into throughput; employees are responsible for doing this
- Ex. direct/indirect labor, supplies, outside contractors, interest payments, depreciation, etc
(c) Throughput Contribution:
- Measure of product profitability
- The rate at which the entire system generates money through product and/or service sales
- Formula: Throughput Contribution = Sales Revenue - DM (includes purchased components and material handling costs)
- TOC assumes labor is a “fixed cost”
(d) Drum-Buffer-Rope System:
- Method to balance the flow of production through the constraint
- “Drum” = the constraint
- “Rope” = the sequence of processes prior to and including the constraint
- “Buffer” = the minimum amount of WIP input needed to keep the drum busy
- GOAL: Keep the process flow running smoothly through the constraint by careful timing and scheduling of the processes in the rope leading up to the constraint

Question 34

Topic 4 - Operational Efficiency

What are the five (5) steps of TOC?

Answer 34

(1) Identify the system constraint
(2) Decide how to exploit the constraint (utilizing every bit of the constraining component without committing to costly upgrades)
(3) Subordinate everything else (with step #2 plan in place, org. adjusts the rest of the system to enable the constraint to operate at maximum efficiency and evaluates the results; proceed to step #4 if still isn’t sufficient)
(4) Elevate the constraint (steps #2 and #3 failed; now must take whatever action is necessary to eliminate the constraint, including major changes, if necessary)
(5) Return to Step #1, but beware of inertia

Question 35

Topic 4 - Operational Efficiency

What is “theoretical capacity” and “practical capacity”? Which is better when it comes to allocating overhead costs?

Answer 35

Terms used to calculate overhead allocations (determines the denominator of the cost allocation rate formula).

“Theoretical capacity”:

• The level of capacity that can be achieved under ideal conditions
• Represents the largest volume of output possible
• Unrealistic and unattainable
• Uses the largest denominator value possible, resulting in lower OH allocation to individual products (and thus unrealistic)

“Practical capacity”:

• The highest level of capacity that can be achieved while allowing for unavoidable losses of production time (ex. machine breakdowns, etc)
• Can be realistically achieved

Practical capacity is a better choice to use as the denominator activity level for allocating overhead because it is MORE REALISTIC and will generate product costs that accurately reflect the cost of the product

Question 36

Topic 1 - Measurement Concepts

How is overapplied / underapplied OH dealt with in a “normal” costing system at the end of every accounting period?

Answer 36

There are two ways to handle over/underapplied OH:
(1) Adjusting the COGS account
- Ex. Actual = $1,530,000; OH-Allocated = $1,490,000
- Underapplied by $40,000
- Increase COGS by $40,000 using the following J/E:
- DR: COGS $ 40,000
DR: Factory OH Applied $1,490,000
CR: Factory OH $1,530,000

(2) Prorating the net difference between the current period’s applied overhead balances in the WIP inventory, finished goods inventory, and COGS accounts.

Question 37

Topic 2 - Costing Systems

What are the two ways in which a “production cost report” can be prepared in a “process costing” system?

Answer 37

(1) First-In, First-Out (FIFO) Method
- Calculates the unit costs using only costs incurred and work performed during the CURRENT period.
- Keeps the beginning WIP inventory separated from the inventory that begins and ends during the current period
- Assumes the beginning WIP inventory is the first inventory to be completed in the period and therefore must be complete at the end of the period (hence, “FIFO” method)
- Requires two categories of completed units to correctly cost all inventory: (a) Beginning WIP Units, and (b) Units Started & Completed During the Period
- Five-Step Process:
a) Determine physical flow of units (input units = output units); also known as the “units to be accounted for”
b) Determine the EUs (“units accounted for”)
c) Calculate total manufacturing costs (using work done in the current period only)
d) Calculate unit costs (beginning WIP + current period-costs; “costs to be accounted for”)
e) Assign total manufacturing costs to units (cost assignment; “costs accounted for”)
e)