Lecture 4 Flashcards
Income-shifting
Moving income or expenses from one period to another. Earning management one period will come back to bite you the next!
Materiality Approach :
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.
Joint Products:
are products that are produced together. Producing one always gives you the other.
Joint Costs :
are the shared costs of the joint products – costs that occur before the split-off point.
Split-Off Point:
is the point when the products become separately identifiable.
Separate Costs:
are costs that can be attributed to an individual product.
4 types of joint cost allocation methods
Physical
Measures,
Relative Sales Value,
Net Realizable Value (NRV),
Constant Gross Margin
Physical Measures
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
Relative Sales Value
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
Net Realizable Value (NRV)
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
Constant Gross Margin
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)
By-Products:
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
Waste:
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
If the by-products have a negative NPV:
Add the negative NPV to the joint cost that is allocated to the main products
If the by-products have a positive but small NPV you have three options:
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!
Marginal revenue
Marginal revenue = Price - price of origin product
Marginal cost
Marginal cost = Cost per product
Marginal benefit
= 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)
Unit Costs:
Truly variable costs. Additional cost incurred for each additional unit produced.
Batch Cost:
Batch Cost: Cost incurred anytime we start a new batch, but fixed for any additional units within the batch.
Product-Level Costs:
Costs associated with maintaining a product line. Adding new product lines adds more costs, but fixed for any additional units within the product line.
Facility Costs:
Costs associated with having any operations running at all. Will occur regardless of how many products/batches/units we produced.
Whats the Problem with the old approach: Over/Under-costing
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
Average Cost
= Total Costs / Units Produced
Marginal Cost
= Cost of making 1 more unit. Usually equal to the variable cost, as long as its within an existing batch.
ABC vs. Simple Costing
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!
When to Implement ABC:
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
IN WACC cost added is
started units * cost allocation
