Week 8 Flashcards
Three types of costs
- Direct labour - the labour for a product that was for that product only
- Direct material - the material for a product that was for that product only
- Overhead costs - all costs other than direct labour and direct materials (e.g. rent, maintenance)
How do we assign overhead costs?
- Direct labour and direct materials can be assigned directly to a product - for example, an hour worked to paint a picture is direct labour and the cost can be directly assigned to the picture
- Overhead costs are harder to link to the product that required the cost. For example - the cost of rent for an artist’s studio cannot be assigned to just one picture if the artist works on many pictures during the rental period.
What is Activity-Based Costing (ABC)?
ABC assigns overhead cost to a product as the sum of the costs of the activities that occur to make the product.
What is Activity-Based Management? (ABM)
- ABM refers to the actions that a manager takes based on the cost information from ABC.
- For instance, a manager may want to produce more of a product after using ABC to identify its cost because ABC shows that the product’s cost is low, the manager knows that the product can be sold at a high price.
How do you apply overhead costs using traditional costing?
Apply total overhead to each product using a single cost allocation base, such as direct labour or direct material for the product.
How do you apply overhead costs using Activity Based Costing (ABC)?
First divide overhead into cost pools, and then apply each cost pool to each product using a cost driver.
Steps for traiditonal cost allocation
- Choose a cost allocation base. Such as direct labour or direct material
- Calculate the cost allocation rate. To do this, divide the total overhead by the total quantity of the cost allocation base.
- Apply the overhead to each product. To do this, for each product, multiply the cost allocation rate by the product’s quantity of the cost allocation base.
ABC Cost Allocation Steps
- Divide overhead cost into cost pools. Each cost pool is a group of costs incurred in the same manner. For example, shipping could be a cost pool.
- Choose a cost driver for each cost pool A cost driver for shipping could be shipments.
- Calculate a cost driver rate for each cost driver. To do this, divide the total dollar amount of each cost pool by the total quantity of each cost driver.
- Apply the overhead from each cost pool to each product. To do this, for each product, multiply the cost driver rate by the quantity of the cost driver.
What is variance analysis?
An analysis of the difference between planned figures and those that actually occurred. This can be conducted for revenues, costs, or both.
Why do we conduct variance analysis?
- Identify the causes of difference from planned profits.
- If the difference from planned profit was favourable (unfavourable), that does not necessarily mean the manager did well (poorly) since the causes could be outside of the managers control.
Variables used in analysis
SQ =
SP =
SW =
SH =
AQ =
AP =
AW =
AH =
SQ = Standard Quantity
SP = Standard Price
SW = Standard wage per hour
SH = standard hours worked
AQ = actual quantity
AP = actual price
AW = actual wage per hour
AH =actual hours worked
What is material cost variance?
The difference between actual and planned direct material costs.
Material cost variance can be divided into 2 pieces
- material quantity variance
- material price variance
Equation for material quantity variance
(AQ - SQ) x SP
What does material quantity variance show?
This shows us how different our material costs were from planned given that we used a different quantity of inputs than planned.
Equation for material price variance
(AP - SP) x AQ
What does material price variance show?
The cost of the difference in price from what was planned
What is the material cost variance?
Material Quantity Variance + Material price variance
What is labor cost variance?
The difference between actual and planned direct labour costs.
Labour cost variance can be divided into two pieces
- Labor efficiency variance
- Labor price variance
Labor efficiency variance equation
(AH-SH) x SW
What does the labor efficiency variance show?
This shows us how different out labour costs were from planned given that labour hours were different from what was planned.
Labour rate variance equation
(AW - SW) x AH
What does the labor rate variance show?
The effect on cost of the difference in wages
How do you calculate the labor cost variance?
Labor efficiency variance + labor price variance
Sales volume variance equation
(AQ-SQ) x Std contribution margin per unit
What is sales volume variance?
The difference in profit due to the difference between actual sales volume and planned sales volume.
What is the sales price variance equation?
(AP-SP) x AQ
What does sales price variance show?”
The effect on profit of the change in price
What is static variance analysis?
SQ and SH are calculated using the standard input per unit of output multiplied by the planned output.
What is the problem with static variance analysis?
Static variance analysis can make us look like we are not keeping our costs under control when our business grows.
To avoid this problem - use flexible budgets
What is flexible variance analysis?
SQ and SH are calculated using the standard input per unit of output multiplied by the actual ouput.
What is the advantage of flexible variance analysis?
When we “flex” the budget by accounting for the increased production, we are able to judge ourselves on the efficiency of the process (amount used per unit of ouput) rather than on whether we produced more or less output than we planned.
What are financial responsibility centers?
Centers responsible for a subset of financial results within the organization
What are management processes?
Setting expectations and then evaluating success toward those expectations (planning and budgeting, followed by performance review)
