Overview of managerial accounting issues

Introduction To Cost Accounting Accounting Outline ¾ Overview of managerial accounting issues ƒ Brief discussion of performance evaluation ¾ Cost accounting terminology ¾ Cost behavior ¾ Product costing: traditional method ¾ Product costing: activity based costing (ABC) Managerial Accounting What are the Goals? Performance Evaluation (Control) Budgeting Variance Analysis Profit and Cost Centers Costing Decision Making Pricing Financial Reporting Production Product Mix Make or Buy Change Methods Discontinue A few words about Performance Evaluation ¾“You get what you pay for” ¾Strongly recommended reading: “On the folly of rewarding A, while hoping for B” ƒ Doctors and litigation – penalty for type II errors. † † Where else is this evident? Auditors Litigation risk induced conservatism ƒ Insurance company – reward for attendance but hoping for performance. ƒ Financial markets – focus on quarterly earnings while hoping for long-term growth in profitability Basic Cost Terms: Cost Objects and Drivers Cost ¾ A sacrifice of resources. Distinguish from “expense.” Cost Object ¾ Any activity or item for which a separate measurement of costs is desired. Cost Driver e.g. Processing Sales Order $ Cost Driver ¾ Any factor whose change “causes” a change in the total cost of a related cost object. Note: Cost drivers can be factors other than volume Cost Object e.g., Product Basic Cost Terms: Direct and Indirect Costs Direct Costs ¾ Costs that can be traced to a given cost object (product, department, etc.) in an economically feasible way. Direct Cost A Indirect Cost C Indirect Costs ¾ Costs that cannot be traced to a given cost object in an economically feasible way. These costs are also known as “overhead”. Cost Assignment ¾ Direct costs are traced to a cost object. ¾ Indirect costs are allocated or assigned to a cost object. Direct Cost B Object X Object Y Basic Cost Terms: Product and Period Costs Product Costs ¾ Costs that “attach” to the units that are produced (i.e., manufacturing costs) and are not reported as expenses until the goods are sold. Product Costs Direct Cost Period costs ¾ Costs that must be charged against income in the period incurred and cannot be inventoried (e.g., selling and administrative expenses). Period Cost Indirect Cost Product X Inventory Unit Costs ¾ Total cost of units divided by units produced. Sale Income Statement Basic Cost Terms: Cost Behavior Variable Costs ¾ Costs that change directly in proportion to changes in the related cost driver Fixed Costs ¾ Costs that remain unchanged for a given time period regardless of changes in the related cost driver. Other Common Functions for Cost Behavior ¾ Semi-variable costs (part variable and part fixed) ¾ Step costs (aka semi-fixed costs) Main Assumptions Needed to Define Fixed and Variable Costs ¾ Cost object, Time span, Linear functional form ¾ Relevant range- the band of cost driver activity in which a specific relationship between a cost and a driver holds. Basic Cost Terms ¾Product costs can be Direct or Indirect (Overhead) ¾Not all Direct costs are variable ƒ The depreciation of a special piece of equipment bought to manufacture a single product line. ¾Not all Overheads are fixed ƒ Processing of raw material purchase orders ƒ Electricity used in operating production equipment. The “Ins” of Inventory Accounting ¾ What costs are assigned to inventory as products are manufactured? ¾ GAAP requires Full Absorption Costing: the products fully absorb all manufacturing costs, including: ƒ Variable manufacturing costs. e.g., direct material ƒ Fixed manufacturing costs. e.g., building depreciation ¾ Results in unitizing fixed costs: convert total fixed costs (TFC) to a unit cost by allocating TFC to the units produced. The “Ins” and “Outs” of Inventory Accounting Raw Materials Direct Labor Raw Materials Inventory Work-in-process Inventory Finished Goods Inventory Transportation, Set-up, etc Indirect labor, Indirect materials, Depreciation Cost of Goods Sold Non-manufacturing (period) costs I/S, Retained Earnings Examples of Product Costing ¾ Electron, Inc. produces 10,000 calculators in one month. ¾ Variable manufacturing costs are : ƒ $6/unit for material, ƒ $1/unit for direct labor, and ƒ $1/unit for variable overhead. ¾ Fixed manufacturing overhead is $50,000/month. ¾ Unit costs are $8 (variable) + $50,000/10,000 (fixed) or $13/unit. ¾ How do these costs flow through Inventory Accounts? Product Costing Events 11/ 1: Purchase and receive $60,000 of material (Nov. supply) 11/ 2: Requisition ½ of materials to the factory floor ($30,000) 11/ 5: Apply labor to the materials ($5,000) 11/ 7: Recognize depreciation expense for the month ($50,000) 11/ 8: Apply variable OH to the materials ($5,000) 11/ 9: Transfer 5,000 completed calculators from WIP to FG Inventory 11/10: Ship 2,000 completed calculators to customer How do Costs Flow through Inventory Accounts? Cash RM Inv WIP Inv FG Inv Net Wages PPE = Payable RE Buy Materials Requisition ½ Of materials Apply labor Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units How do Costs Flow through Inventory Accounts? Buy Materials Requisition ½ Of materials Apply labor Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units Cash –60 RM Inv 60 WIP Inv FG Inv Net Wages PPE = Payable RE How do Costs Flow through Inventory Accounts? Buy Materials Cash –60 Requisition ½ Of materials Apply labor RM Inv 60 WIP Inv –30 30 FG Inv Net Wages PPE = Payable RE Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units How do Costs Flow through Inventory Accounts? Buy Materials Cash –60 Requisition ½ Of materials Apply labor RM Inv 60 WIP Inv –30 30 FG Inv Net Wages PPE = Payable 5 RE 5 Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units How do Costs Flow through Inventory Accounts? Buy Materials Requisition ½ Of materials Apply labor Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units Cash –60 RM Inv 60 WIP Inv –30 30 FG Inv Net Wages PPE = Payable 5 50 5 –50 RE How do Costs Flow through Inventory Accounts? Buy Materials Cash –60 Requisition ½ Of materials Apply labor Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units RM Inv 60 WIP Inv –30 30 FG Inv Net Wages PPE = Payable 5 5 50 –5 RE –50 5 How do Costs Flow through Inventory Accounts? Buy Materials Cash –60 Requisition ½ Of materials Apply labor Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units RM Inv 60 WIP Inv –30 30 FG Inv Net Wages PPE = Payable 5 5 50 –5 RE –50 5 –65 65 How do Costs Flow through Inventory Accounts? Buy Materials Cash –60 Requisition ½ Of materials Apply labor Apply fixed OH (Depreciation) Apply variable OH Transfer to FG Inv Sell 2000 units RM Inv 60 WIP Inv –30 30 FG Inv Net Wages PPE = Payable 5 5 50 –5 RE –50 5 –65 65 –26 –26 Cost Flow Through Inventories ¾ In particular, note the following ¾ On direct labor, the accounting entry is 5 ƒ Dr WIP ƒ Cr Wages Payable ¾ Not 5 ƒ Dr Salaries Expense ƒ Cr Wages Payable ¾ Similarly, on depreciation for manufacturing facility ƒ Dr WIP 50 ƒ Cr Accumulated Depreciation ¾ Not ƒ Dr Depreciation Expense 50 ƒ Cr Accumulated Depreciation 5 5 50 50 Traditional Costing System Direct Costs Direct Labor Direct Materials Traced directly Product Costs Overhead Costs Indirect Labor Indirect Materials Depreciation Traced using allocation base eg direct labor hrs, machine hrs Examples of Overhead Activities ¾Purchase order processing ¾Receiving/Inventorying materials ¾Inspecting materials ¾Processing accounts payable ¾Facility maintenance ¾Scheduling production ¾Customer complaints ¾Quality inspection/testing Activity-Based Costing System Direct Costs Direct Labor Direct Materials Overhead Costs Indirect Labor Indirect Materials Depreciation Activities that drive overhd Product Costs Typical Activity Cost Drivers ¾ Number of alteration notices per product ¾ Units produced ¾ Number of receipts for materials/parts ¾ Stockroom transfers ¾ Direct labor hours ¾ Set-up hours ¾ Inspection hours ¾ Facility hours ¾ Number of customer complaints Cost Allocation Example Dialglow Corporation manufactures travel clocks and watches. Overhead costs are currently allocated using direct labor hours, but the controller has recommended an activity-based costing system using the following data: Activity Production Setup Cost Cost Driver $120,000 No. of setups Material Handling & Requisition 30,000 No. of parts Packaging & Shipping 60,000 #Units Shipped Total Overhead Direct labor hours Clocks 10 Watches 15 18 36 45,000 75,000 35,000 105,000 $210,000 140,000 Using Traditional Costing System Allocate Total OH based on labor hours (35,000 hours for travel clocks; 105,000 hours for watches.) OH Rate: $210,000 / 140,000 hours = $1.50/hour OH cost per Travel Clock: ($1.50/hr * 35,000 hrs) / 45,000 units = $1.167 OH cost per Watch: ($1.50/hr * 105,000 hrs) / 75,000 units = $2.10 Using ABC Allocation of : Production Setup Costs: $120,000 / (10+15) setups = $4,800/setup Material Handl’g Costs: $30,000 / (18+36) part numbers = $555.56/part Packing/shipping Costs: $60,000 / (45,000+75,000) units = $0.50/unit shipped Product Costs using ABC: Production Setup Material Handling Packing/Shipping Activity Level Clocks Activity Level Watches Total Per Unit Using ABC Allocation of : Production Setup Costs: $120,000 / (10+15) setups = $4,800/setup Material Handl’g Costs: $30,000 / (18+36) part numbers = $555.56/part Packing/shipping Costs: $60,000 / (45,000+75,000) units = $0.50/unit shipped Product Costs using ABC: Production Setup Material Handling Packing/Shipping Total Per Unit Activity Level 10 Clocks $48,000 Activity Level 15 Watches $72,000 Using ABC Allocation of : Production Setup Costs: $120,000 / (10+15) setups = $4,800/setup Material Handl’g Costs: $30,000 / (18+36) part numbers = $555.56/part Packing/shipping Costs: $60,000 / (45,000+75,000) units = $0.50/unit shipped Product Costs using ABC: Production Setup Material Handling Packing/Shipping Activity Level 10 18 Clocks $48,000 10,000 Activity Level 15 36 Watches $72,000 20,000 Total Per Unit Using ABC Allocation of : Production Setup Costs: $120,000 / (10+15) setups = $4,800/setup Material Handl’g Costs: $30,000 / (18+36) part numbers = $555.56/part Packing/shipping Costs: $60,000 / (45,000+75,000) units = $0.50/unit shipped Product Costs using ABC: Production Setup Material Handling Packing/Shipping Activity Level 10 18 45000 Clocks $48,000 10,000 22,500 Activity Level 15 36 75000 Watches $72,000 20,000 37,500 Total Per Unit Using ABC Allocation of : Production Setup Costs: $120,000 / (10+15) setups = $4,800/setup Material Handl’g Costs: $30,000 / (18+36) part numbers = $555.56/part Packing/shipping Costs: $60,000 / (45,000+75,000) units = $0.50/unit shipped Product Costs using ABC: Production Setup Material Handling Packing/Shipping Total Per Unit Activity Level 10 18 45000 Clocks $48,000 10,000 22,500 $80,500 Activity Level 15 36 75000 Watches $72,000 20,000 37,500 $129,500 Using ABC Allocation of : Production Setup Costs: $120,000 / (10+15) setups = $4,800/setup Material Handl’g Costs: $30,000 / (18+36) part numbers = $555.56/part Packing/shipping Costs: $60,000 / (45,000+75,000) units = $0.50/unit shipped Product Costs using ABC: Production Setup Material Handling Packing/Shipping Total Per Unit Activity Level 10 18 45000 Clocks $48,000 10,000 22,500 Activity Level 15 36 75000 Watches $72,000 20,000 37,500 $80,500 $129,500 $1.79 $1.73 Summary ¾ Managerial accounting focuses on decision making and control: ƒ Decision making: initiating and implementing decisions. ƒ Control: ratifying and monitoring decisions. ƒ Important: Organizational structure of firm should separate both functions. ¾ Characteristics of good internal accounting system: ƒ Provide information necessary to identify most profitable products. ƒ Provide information necessary to identify production inefficiencies to ensure production at minimum cost. ƒ Combine measurement of performance with evaluation of performance to create incentives for managers that maximize firm value.