Lecture 4

Question 1

Income-shifting

Answer 1

Moving income or expenses from one period to another. Earning management one period will come back to bite you the next!

Question 2

Materiality Approach :

Answer 2

The Materiality Approach is when managers ignore partially completed units. They say that the effect is immaterial relative to the whole, so we just ignore them.

Question 3

Joint Products:

Answer 3

are products that are produced together. Producing one always gives you the other.

Question 4

Joint Costs :

Answer 4

are the shared costs of the joint products – costs that occur before the split-off point.

Question 5

Split-Off Point:

Answer 5

is the point when the products become separately identifiable.

Question 6

Separate Costs:

Answer 6

are costs that can be attributed to an individual product.

Question 7

4 types of joint cost allocation methods

Answer 7

Physical
Measures,
Relative Sales Value,
Net Realizable Value (NRV),
Constant Gross Margin

Question 8

Physical
Measures

Answer 8

Joint costs are allocated based on physical measure (weight, volume) of products at the split-off point

-> X units / (x + y units) * Joint costs
-> Y units / (x + y units) * Joint costs

Question 9

Relative Sales Value

Answer 9

Joint costs are allocated based on the relative sales value of the two products

-> X revenue / (x + y revenues) * Joint costs
-> Y revenue / (x + y revenues) * Joint costs

Question 10

Net Realizable Value (NRV)

Answer 10

Joint costs are allocated based on the values of the products after additional processing

[X’s NRV = X revenue-x additional costs]
[Y’s NRV = Y revenue-y additional costs]

-> X NRV / (x + y NRVs) * Joint costs
-> Y NRV / (x + y NRVs) * Joint costs

Question 11

Constant Gross Margin

Answer 11

Joint costs are allocated based on the gross margin of products after additional processing

Overall Gross Margin profit = Revenue – Joint Cost – Separate Cost

Gross margin % = Overall Gross profit/overall Sales revenue

Sales value (x) * Gross margin %
Sales value (y) * Gross margin %

X = Sales value (x) - [Sales value (x) * Gross margin %]

Y = Sales value (y) - [Sales value (y) * Gross margin %]

X - Seperate costs (x)
Y - Seperate costs (y)

Question 12

By-Products:

Answer 12

By-Products: has little or no value relative to the main product.
Scrap technically has sales value, but it’s very small compared to the main product.

For example:
Scratched/dented products
Bruised/defective fruit

Question 13

Waste:

Answer 13

Waste: is stuff that has a negative NPV. You have to pay to get rid of it! For

example:
Milk from sick cows that were treated with anti-biotics (this milk cannot be sold for food)
Rotten fruit
Chemical waste

Question 14

If the by-products have a negative NPV:

Answer 14

Add the negative NPV to the joint cost that is allocated to the main products

Question 15

If the by-products have a positive but small NPV you have three options:

Answer 15

1) Treat the by-product as though it were a main product and allocate a small amount of joint costs to it.

2) Don’t allocate any joint costs to it. Just take the small NPV as extra earnings.

3)Deduct the NPV from the joint cost allocated to the other products (i.e., treat the by-product not as its own product line, but more like a negative expense)
Usually, it doesn’t matter which option you choose. It’s a by-product, so the NPV is very small!

Question 16

Marginal revenue

Answer 16

Marginal revenue = Price - price of origin product

Question 17

Marginal cost

Answer 17

Marginal cost = Cost per product

Question 18

Marginal benefit

Answer 18

= Marginal revenue - Marginal cost

-> (if positive good also x amount we get is the same as what we would get if we actually did change)

Question 19

Unit Costs:

Answer 19

Truly variable costs. Additional cost incurred for each additional unit produced.

Question 20

Batch Cost:

Answer 20

Batch Cost: Cost incurred anytime we start a new batch, but fixed for any additional units within the batch.

Question 21

Product-Level Costs:

Answer 21

Costs associated with maintaining a product line. Adding new product lines adds more costs, but fixed for any additional units within the product line.

Question 22

Facility Costs:

Answer 22

Costs associated with having any operations running at all. Will occur regardless of how many products/batches/units we produced.

Question 23

Whats the Problem with the old approach: Over/Under-costing

Answer 23

1) Overcosting: a product consumes a low level of resources but is allocated high costs per unit

2) Undercosting: a product consumes a high level of resources but is allocated low costs per unit

3) Cross-subsidization: One product “subsidises” another

->The over-costed product absorbs too much cost making it seem less profitable than it really is

->The under-costed product is left with too little cost making it seem more profitable than it really is

Question 24

Average Cost

Answer 24

= Total Costs / Units Produced

Question 25

Marginal Cost

Answer 25

= Cost of making 1 more unit. Usually equal to the variable cost, as long as its within an existing batch.

Question 26

ABC vs. Simple Costing

Answer 26

ABC is more complicated

ABC is usually more accurate

ABC is only as good as the drivers selected

• Are changes in the driver closely related to changes in costs in that pool?
• Poorly chosen drivers will produce inaccurate costs, even with ABC!

Question 27

When to Implement ABC:

Answer 27

1) Lots of overhead

2) Products of different complexity

3)Different volume levels

4) Production does not happen “one unit at a time”
- E.g. Production in batches

5) Low reported profits on main products, high reported profits on low-volume products

• This could be a sign of under/over-costing of products

Question 28

IN WACC cost added is

Answer 28

started units * cost allocation