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Managerial Cost ConceptsManagerial Cost Concepts
1.1. Direct materialsDirect materials: raw materials physically associated with the final product
2.2. Direct laborDirect labor: employees physically and directly associated with the final product
3.3. OverheadOverhead: costs indirectly associated with the final product
More ConceptsMore Concepts1.1. Period costsPeriod costs: costs matched with revenue for
a specific time period. (i.e., net income for a specific period (i.e., quarterly, annual).
2.2. Product costsProduct costs: costs associated with producing the final product. Not considered an expense until the product is sold.
3.3. Total costsTotal costs: equals direct materials, direct labor and manufacturing overhead plus indirect costs (selling and administrative expenses).
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
Selling and AdministrativeExpense Budget
Selling and AdministrativeExpense Budget
Budgeted IncomeStatement
Budgeted IncomeStatement
Budgeted Cash Flow Statement
Budgeted Cash Flow Statement
BudgetedBalance Sheet
BudgetedBalance Sheet
Pro Forma Financial StatementsPro Forma Financial Statements
Capital expenditures
Capital expendituresCash BudgetCash Budget
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Sales BudgetSales Budget
Production BudgetProduction Budget
Direct MaterialsBudget
Direct MaterialsBudget
Direct LaborBudget
Direct LaborBudget
OverheadBudget
OverheadBudget
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Enterprise #n•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Enterprise #1•Unit sales and expected price•Unit production and inventory•Direct materials used•Direct labor used•Manufacturing overhead
Examples of direct materials:•Purchase of corn.•Purchase of natural gas.•Purchase of other inputs used in the production process.
Examples of manufacturing overhead:•Other expenses directly related to production of a specific product.•Examples include property taxes, rent and depreciation
The Master Budget and Pro Forma Financial StatementsThe Master Budget and Pro Forma Financial Statements
Indirect expenses are those expenses not associated with manufacturing a product or providing a service. Some examples include:
Marketing and selling expenses Transportation expenses outside the factory Management salaries and other administrative expenses
Total CostsTotal Costs
Production CostsManufacturing Costs
Direct Direct MaterialsMaterials
Direct Direct MaterialsMaterials
Period CostsNon-manufacturing Costs
Total CostsTotal Costs
Production CostsManufacturing Costs
Direct Direct MaterialsMaterials
Direct Direct MaterialsMaterials
Period CostsNon-manufacturing Costs
Direct Direct LaborLabor
Direct Direct LaborLabor
Total CostsTotal Costs
Production CostsManufacturing Costs
Direct Direct MaterialsMaterials
Direct Direct MaterialsMaterials
Period CostsNon-manufacturing Costs
Direct Direct LaborLabor
Direct Direct LaborLabor
Manufacturing Manufacturing OverheadOverhead
Manufacturing Manufacturing OverheadOverhead
Total CostsTotal Costs
Production CostsManufacturing Costs
Direct Direct MaterialsMaterials
Direct Direct MaterialsMaterials
SellingSellingExpensesExpenses
SellingSellingExpensesExpenses
Period CostsNon-manufacturing Costs
Direct Direct LaborLabor
Direct Direct LaborLabor
Manufacturing Manufacturing OverheadOverhead
Manufacturing Manufacturing OverheadOverhead
Total CostsTotal Costs
Production CostsManufacturing Costs
Direct Direct MaterialsMaterials
Direct Direct MaterialsMaterials
SellingSellingExpensesExpenses
SellingSellingExpensesExpenses
Period CostsNon-manufacturing Costs
Direct Direct LaborLabor
Direct Direct LaborLabor
AdministrativeAdministrativeExpensesExpenses
AdministrativeAdministrativeExpensesExpenses
Manufacturing Manufacturing OverheadOverhead
Manufacturing Manufacturing OverheadOverhead
Total CostsTotal Costs
Production CostsManufacturing Costs
Direct Direct MaterialsMaterials
Direct Direct MaterialsMaterials
SellingSellingExpensesExpenses
SellingSellingExpensesExpenses
Period CostsNon-manufacturing Costs
Direct Direct LaborLabor
Direct Direct LaborLabor
AdministrativeAdministrativeExpensesExpenses
AdministrativeAdministrativeExpensesExpenses
Manufacturing Manufacturing OverheadOverhead
Manufacturing Manufacturing OverheadOverhead
Other IndirectOther IndirectExpensesExpenses
Other IndirectOther IndirectExpensesExpenses
Three Cost Accounting ConceptsThree Cost Accounting Concepts
1.1. ProcessProcess cost accounting cost accounting
2.2. Job orderJob order cost accounting cost accounting
3.3. Activity basedActivity based cost cost accountingaccounting
1. Process Cost Accounting1. Process Cost Accounting
Tracking costs associated with a specific a specific processprocess
Direct materials and labor associated with the specific process
Manufacturing overhead costs associated with the specific process
Assigning costs to finished goods
Direct MaterialsDirect Labor
Variable Overhead
Direct MaterialsDirect Labor
Variable Overhead
MixingDepartment
MixingDepartment
BakingDepartment
BakingDepartment
Production CostReport
Production CostReport
PackagingDepartment
PackagingDepartment
FinishedGoods
FinishedGoods
WIP WIP WIP
Example: Process Costs in Making Bread
Direct MaterialsDirect Labor
Variable Overhead
Direct MaterialsDirect Labor
Variable Overhead
MixingDepartment
MixingDepartment
BakingDepartment
BakingDepartment
Production CostReport
Production CostReport
PackagingDepartment
PackagingDepartment
FinishedGoods
FinishedGoods
WIP WIP WIP
Production CostReport
Production CostReport
Example: Process Costs in Making Bread
Direct MaterialsDirect Labor
Variable Overhead
Direct MaterialsDirect Labor
Variable Overhead
MixingDepartment
MixingDepartment
BakingDepartment
BakingDepartment
Production CostReport
Production CostReport
PackagingDepartment
PackagingDepartment
FinishedGoods
FinishedGoods
WIP WIP WIP
Production CostReport
Production CostReport
Production CostReport
Production CostReport
Example: Process Costs in Making Bread
Comparison of Cost SystemsComparison of Cost Systems
Features
Process Cost System
Work in process accounts
Multiple work in process accounts
Documents used Production cost reports
Determination of total manf. costs
Each period
Unit-cost computations
Total manf. costs/ units produced
during the period
2. Job Order Cost Accounting2. Job Order Cost Accounting
Tracking costs associated with a specific specific order or joborder or job
Direct materials and labor associated with a specific order or job
Manufacturing overhead costs associated with a specific order or job
Assigning costs to finished goods
Comparison of Cost SystemsComparison of Cost Systems
Features
Process Cost System
Job Order Cost System
Work in process accounts
Multiple work in process accounts
One work in process account
Documents used Production cost reports
Job cost sheets
Determination of total manf. costs
Each period Each job
Unit-cost computations
Total manf. costs/ units produced
during the period
Cost of each job/ units produced for
the job
3. Activity Based Cost Accounting3. Activity Based Cost Accounting
An approach for allocating overhead.An activity is any event, action, transaction or
work sequence that incurs when producing a product or providing a service.
An activity cost pool is a distinct type of activity (e.g., ordering materials).
A cost driver is any factor or activity that has a direct cause-effect relationship with resources consumed (e.g., machine hours).
Steps in ABC AccountingSteps in ABC Accounting
1. Identify and classify activities and allocate overhead to cost pools.
2. Identify cost drivers – correlation between driver and use.
3. Compute overhead rates – ABC rate.4. Assign overhead costs to products – use
of cost drivers.5. Comparison of unit costs across
products.
Overhead Costs
Overhead Costs
Orderingand
ReceivingMaterialsCost Pool
Orderingand
ReceivingMaterialsCost Pool
Setting Up
MachinesCostPool
Setting Up
MachinesCostPool
MachiningCostPool
MachiningCostPool
# ofPurchase
orders
# ofPurchase
orders
AssemblyCostPool
AssemblyCostPool
Inspectingand
TestingCostPool
Inspectingand
TestingCostPool
PaintingCostPool
PaintingCostPool
# ofSetups
# ofSetups
# ofMachine
hours
# ofMachine
hours
# ofParts
# ofParts
# ofTests
# ofTests
# ofDirecthours
# ofDirecthours
Products
Products
Activity cost pools:Activity cost pools:
Cost drivers: Cost drivers:
Activity Based Cost AllocationActivity Based Cost Allocation
Example of ABC AccountingExample of ABC AccountingABC Overhead rate = Overhead per activity ABC Overhead rate = Overhead per activity ÷ Cost driver per activity÷ Cost driver per activityInitial status:Initial status:Activity Cost Pool Process Driver AB overhead overhead activity rateSetting up machines $300,000 1,500 setups $200/setupMachining $500,000 50,000 hours $10/hourInspecting $100,000 2,000 inspection $50/inspection Total $900,000
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
500/1,500 x $300,000 or 500 units x $200/setup500/1,500 x $300,000 or 500 units x $200/setup
Example of ABC AccountingExample of ABC Accounting
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
1,000/1,500 x $300,000 or 1,000 x $200/setup1,000/1,500 x $300,000 or 1,000 x $200/setup
Example of ABC AccountingExample of ABC Accounting
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
30,000/50,000 x $500,000 or 30,000 x $10/hour30,000/50,000 x $500,000 or 30,000 x $10/hour
Example of ABC AccountingExample of ABC Accounting
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
20,000/50,000 x $500,000 or 20,000 x $10/hour20,000/50,000 x $500,000 or 20,000 x $10/hour
Example of ABC AccountingExample of ABC Accounting
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
500/2,000 x $100,000 or 500 x $50/inspection500/2,000 x $100,000 or 500 x $50/inspection
Example of ABC AccountingExample of ABC Accounting
Step 1: Assigning overhead driver activity to products:Step 1: Assigning overhead driver activity to products:Activity Cost Pool Cost driver Driver Product 1 Product 2
activitySetting up machines # setups 1,500 500 1,000Machining Hours 50,000 30,000 20,000Inspecting # inspections 2,000 500 1,500
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2___Setting up machines $300,000 (33%) $100,000 (67%) $200,000Machining $500,000 (60%) $300,000 (40%) $200,000Inspecting $100,000 (25%) $25,000 (75%) $75,000
1,500/2,000 x $100,000 or 1,500 x $50/inspection1,500/2,000 x $100,000 or 1,500 x $50/inspection
Example of ABC AccountingExample of ABC Accounting
Step 2: Partitioning of process overhead:Step 2: Partitioning of process overhead: Overhead Product 1 Product 2Setting up machines $300,000 $100,000 $200,000Machining $500,000 $300,000 $200,000Inspecting $100,000 $25,000 $75,000 Total $900,000 $425,000 $475,000Step 3: Process overhead costs per unit:Step 3: Process overhead costs per unit:Units produced 25,000 5,000 Process overhead cost per unit $17 $95
Traditional process overhead cost per unit* $30 $30
* $900,000 divided by 30,000 units
Avoids overstating profitability of some enterprises and
understating profitability of others
Avoids overstating profitability of some enterprises and
understating profitability of others
Example of ABC AccountingExample of ABC Accounting
Product 1 Product 2COP unit costs with COP unit costs with ABC costingABC costing::Direct materials $40 $30Direct labor $12 $12ABC overhead $17 $95 Total unit costs $69 $137
COP unit costs with COP unit costs with traditional costingtraditional costing::Direct materials $40 $30Direct labor $12 $12Traditional overhead * $30 $30 Total unit costs $82 $72
* $900,000 divided by 30,000 unitsTraditional overhead costing
suggests that Product 2 is cheaper to produce than
Product 1, which is not true!
Traditional overhead costing suggests that Product 2 is cheaper to produce than
Product 1, which is not true!
Example of ABC AccountingExample of ABC Accounting
LOC and the Master BudgetLOC and the Master Budget
Identifying monthly cash flow surpluses and deficits
Determining the required LOC – summation of monthly draws less monthly repayments
Role of the Master Budget; LOC is derived from the cash budget.