Management accounting Flashcards
Product Costs
For financial accountants, product cost includes only the cost of manufacturing or acquiring a product.
Management accountants will start with the financial accountants’ definition of product cost and add the cost of promoting, selling, distributing and servicing the product in the customer’s hands if the cost can reasonably be traced to the product.
Period Costs
Period costs are costs accountants, financial or management do not count as product costs.
Financial accountants treat all non-manufacturing costs such as selling, administrative and research and development as period costs.
Direct Cost
A direct cost is a product cost that can be uniquely and unambiguously associated with a cost object.
A material cost uniquely associated with a cost object is called a direct materials cost.
Labour uniquely associated with a cost object is called a direct labour cost.
Indirect Cost
Any product cost that fails the direct cost test (If the resource to which the cost relates did not exist, or be consumed if the cost object did not exist, and if the cost is material relative to the total direct cost of the product, then the cost is a direct cost) is treated as an indirect cost. The salary of a sales manager is an indirect cost of all products the sales manager handles.
Schedule of costs of goods manufactured
Since it summarizes manufacturing costs, it is
a summary of work-in-process activities. The sum of direct materials, direct labour and various overhead items equals the amount of manufacturing costs incurred this period.
These costs are added to the opening balance of work-in-process and ending inventory is deducted to yield the cost of the work-in-process completed and transferred to finished goods.
Direct materials Beginning direct materials inventory Add: purchases of direct materials \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Raw materials available for sale Deduct: ending direct materials inventory \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Direct materials transferred to work-in-process
Direct labour xxx
Manufacturing overhead Indirect labour xxx Supervisory labour Consumables (lubricants, drill bits, etc.) Utilities (heat and power) 1,125,000 Depreciation of factory equipment Taxes on factory property \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Total manufacturing costs Add: beginning work-in-process inventor Deduct: ending work-in-process inventory \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Cost of goods manufactured
goods inventory this period
Statement of Costs of Goods Sold
Finished inventory Beginning finished goods inventory inventory xxxx Add: cost of goods manufactured xxxxx \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Goods available for sale
Deduct: ending finished goods inventory
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Cost of goods sold
Actual costing vs Normal costing
When organizations charge actual costs to work-inprocess, they are said to use actual costing.
When organizations simplify the statement of cost of goods manufactured by charging overhead to work-in-process, they are using a predetermined rate, an
approach called normal costing.
Opportunity Cost:
An opportunity cost is the benefit forgone when a resource is used for some purpose.
A resource should always be allocated to the opportunity that has the lowest opportunity cost,
If there is more capacity of a resource than there are
productive opportunities, the opportunity cost of the resource is zero.
Sunk Cost
A sunk cost is a previous cost incurred for some
resource.
Sunk costs are important because they cannot be changed by any decision subsequent to the acquisition.
Job order costing steps
To summarize, the steps in job order costing include:
1. Identify the cost object. The cost object will be a unique order or service.
2. Assign the direct materials and direct labour costs to the cost object.
3. Allocate manufacturing or service related overhead to the cost object either by using a separate rate or including a component for overhead in the cost of materials or labour.
The idea in job order costing is to estimate the actual cost of completing a unique job to provide a basis for setting the price or to compare the revenue received for a job with the job’s estimated cost.
Manufacturing overhead rate
The manufacturing overhead costs are allocated to cost objects using some rate.
Manufacturing overhead rate = budgeted manufacturing overhead costs/denominator activity(cost driver).
The amount of manufacturing overhead charged to a job will equal = the manufacturing overhead rate * the denominator activity for the job.
Using actual values in the numerator and denominator results in a rate that management accountants call an actual rate. Any other combination of numerator and denominator results in what is called a normal or normalized rate.
Fixed cost
Management accountants call a cost that does not change over the contemplated range of activity, a fixed cost.
Variable Cost
A variable cost increases in constant proportion with changes in activity level. The formula for a variable cost is:
Variable cost = variable cost per unit of activity * number of units of activity
Management accountants call the “number of units of activity” the cost driver.
Committed Cost
A committed cost is cost that is unavoidable for a certain period for time. A contractual lease payment is an example of a committed cost as is depreciation on buildings and equipment. By their nature, decisions creating committed costs create organization risk
since they cannot be avoided in periods of financial distress.
Direct vs indirect labour
Direct labour can be directly traced to a cost object such as a product or service This is accomplished through a source document, such as a time ticket or through
automated tracking systems such as touch screens or bar code scanners at a work station.
Indirect labour cannot be easily traced to a particular product or service (or management chooses not to trace directly because of the cost involved in attempting
direct tracing and/or the insignificance of the labour cost involved). Often, indirect labour is a common cost applicable to many products.
Non-productive labour: direct vs indirect
Direct : Some types of non-productive labour are normal, unavoidable and/or required by law. Examples include break and bathroom times. Thus, the amount of time budgeted (and must be paid for) as direct labour includes productive time directly working on a
product or service plus an allocation of this non-productive time.
Indirect: Other types of labour time, such as down and training time, are classified as indirect
labour costs because these activities are (potentially) avoidable and not attributable to
an individual product.
Job order costing
A job order costing system is used to accumulate the
cost of a custom made product.
In a service environment, the service provider will
accumulate the costs of the engagement, which are primarily labour related costs, as part of the invoice submitted to the client.
Job order costing systems are used for two purposes:
1. To provide documentation to serve as a basis for charging the customer.
2. To compare the costs of a fixed price contract with the revenues received from the customer in order to evaluate the efficiency in executing the contract.
Cost driver activity levels
There are four common choices for the cost driver activity level:
1. The actual activity level of the cost driver
- The estimated activity level of the cost driver
- The argument- it intends to allocate the total estimated manufacturing overhead to all jobs. The problem with this approach is it leads to the counter-intuitive idea that costs go up as demand goes down (recall that most manufacturing overhead costs are fixed). Decreased demand causes the price to increase if pricing is cost based that causes the demand to fall further. - The average activity of the cost driver (across different accounting periods), also called the normal activity level
-The argument for using the average value of the cost driver activity level is that this is likely the amount used in the capital budgeting exercise supporting the acquisition of total capacity. The problem with this approach is it does not reflect periodic demand and
supply conditions. - The practical capacity of the cost driver (this is the theoretical capacity level less ordinary losses due to breaks and maintenance and an allowance for breakdowns)
- The argument for using the practical capacity is that manufacturing overhead cost is primarily fixed and, therefore, the cost driver for fixed costs is the amount of capacity required and not the amount of capacity used. While this approach provides a constant cost estimate, it does not provide a basis for the expected recovery of fixed costs if pricing is cost based.
Actual vs normal overhead rate
If the intended overhead rate is an actual rate, the
management accountant will use the actual activity level of the cost driver and the actual level of overhead cost. Using actual values in the numerator and denominator results in a rate that management accountants call an actual rate. Any other combination of numerator and denominator results in what is called a normal or normalized rate.
Designing of overhead cost pools
The cost allocations should, to the extent possible, reflect cause and effect relationships between the cost objects and manufacturing overhead.
This insight leads to two principles that management accountants seek to apply when designing the system of overhead cost pools.
- To the extent possible, avoid mixing manufacturing overhead costs that have different cost drivers in the same cost pool.
- Use the activity base thought to explain the long-term behaviour of costs in the cost pool as the cost driver to allocate the costs in that pool to cost objects.
Over/under allocated MOH
Management accountants have two approaches for dealing with over- or under-applied overhead for financial reporting purposes.
-If the amount is material relative to total
overhead costs the over- or under-applied overhead is prorated among work-in-process, finished goods inventory and cost of goods sold in an attempt to estimate the actual manufacturing costs incurred during the period.
-Otherwise, of the amount of over- or under-applied overhead is immaterial, it is simply charged to cost of goods sold. Under or over-applied overhead will increase (decrease) the reported cost of goods sold.
There are the three approaches the management accountant might follow to handle the over-applied
overhead.
Method 1 – direct charge to cost of goods sold
if the entity is IFRS compliant, this is the only method
that is acceptable for financial reporting purposes.
Method 2 – proration based on ending balances
Prorated between WIP, finished goods and cost of goods sold based on their ending balances.
Method 3 – adjustment of applied manufacturing overhead
This approach traces the distribution of applied manufacturing overhead and bases the proration on the balance of applied manufacturing overhead in the three accounts. So the key in this approach is to follow the applied manufacturing overhead.
Process costing
Process costing is a costing system suitable for costing the mass production of identical products.
It focuses on identifying the cost of each of the steps
(processes) needed to produce the final product.
Process Costing Steps
Step 1:
The first step in process costing is to identify the physical flow.
Step 2
The second step in process costing is to identify the equivalent units of production for each of the cost elements such as materials and conversion costs.
Step 3:
In this step, the management accountant introduces costs into the process costing calculation and computes the cost per equivalent unit.
Step 4:
In step 4, the final step the management accountant allocates the total costs to account for to ending work-in-process and work completed and transferred out.
HIgh low method
Slope = cost associated with the highest level of cost driver - cost associated with the lowest level of cost
driver / highest value of cost driver - lowest value of cost driver
Substitute the slope value in either pair of observations to find the fixed cost estimate.
Opportunity cost of faulty cost information
Examples of opportunity costs caused by bad cost
information include the losses caused by:
1. Continuing to make a product that appears to be profitable, but is not.
2. Inappropriate pricing in cost plus environments, such as contract pricing.
3. Failing to recognize opportunities for process improvement.
4. Inappropriate budget projections creating cash flow problems
5. Inappropriate product mix choices when allocating constrained capacity.
Need for a new costing system
You know you need a new costing system when:
Vendor bids are lower than expected
Functional managers want to drop seemingly
profitable lines
Profit margins are hard to explain
Hard-to-make products show big profits
Departments have their own cost systems
You have a high-margin niche all to yourself
Competitors’ prices are unrealistically low
Customers don’t mind price increases
The results of bids are hard to explain
ABC Cost Hierarchy
• Unit level (costs that vary directly with the level of production such as factory
supplies, commonly called variable manufacturing costs)
• Batch level (examples include setting up machines for a production run and shipping a truckload of products)
• Product sustaining (examples include advertising to support a product and developing and implementing a product design change)
• Facility sustaining (examples include plant depreciation and the factory manager’s salary). These costs are not usually allocated, since there is no apparent cause and
effect relationship with activity levels.
• Customer sustaining (examples include the cost of the sales representative visiting the customer and special customer shipping requirements)
• Organization sustaining (examples include the fees paid to the Board of Directors and depreciation on the administrative office suite). These costs are not usually allocated, since there is no apparent cause and effect relationship with activity levels.
Activity based cosing
Activity based costing tries to model the cause and effect relationship between activities undertaken to produce a good or service and the cost of those activities. The objective is to provide improved cost information for decision making. However, these ABC costing systems are expensive to design and maintain so organizations must decide whether the costs of these systems are justified against the benefits provided by improved decisions resulting from the ABC costs.
Activity based costing focuses on activities as the fundamental cost objects and uses the costs of these activities as building blocks for compiling the costs
of other cost objects. The final product costs are built up from the costs of the specific activities undergone in manufacturing the product. Because of the
many activity areas, indirect costs are accumulated in many indirect cost pools.
Traditional product based costing is much simpler and more general in that costs are accumulated in only one or a few cost pools. Costs may be allocated
based on cost drivers, such as direct labour hours or machine hours, or a cost application base could be financial, such as direct labour costs or direct
material costs.
Service organizations most likely to benefit from activity based costing have operating personnel with little faith in the accuracy of existing cost information, a widely diverse set of operating activities and many changes in
activities over time, among other characteristics.
