Professional Documents
Culture Documents
• Theory of Constraints
▫ Emphasizes the importance of managing the
organization’s constraints or barriers that hinder
or impede progress toward an objective
• Target Costing
▫ involves the determination of the desired cost for a
product or the basis of a given competitive price so
that the product will earn a desired profit
Management Accounting
• Continuous Improvement and Benchmarking
▫ Continuous improvement targets are often set by
benchmarking in measuring the quality of the
products, services and activities of the company
against the best levels of performance found in
competing companies
Cost Concepts and Classification
Costs
• Value forgone for the purpose of achieving some
economic benefit which will promote the profit-
making ability of the firm
Cost Pools
• Costs collected into meaningful groups
▫ By type of cost
▫ By source
▫ By responsibility
▫ etc
Cost Objects
• Any product, service or organizational unit to
which costs are assigned for some management
purpose
Manufacturing
Department
Product Service
Cost Drivers
• Any factor that has the effect of changing the
level of total cost
Cost Classification
Nature of Mgt Manufacturing Costs
Function Non Manufacturing Costs
Raw Materials
Work-in-Process
Finished Goods
Income Statement
Merchandising Manufacturing
y = a + bx
y = total mixed cost
a = total fixed cost
b = variable cost per unit of activity
x = level of activity
Cost Estimation for Mixed Cost
1. Account Analysis
- Uses experience and judgement of managers and
accountants who are familiar with company
operations and the way costs react to changes in
activity level
- Step1: Review each cost account used to record
the costs that are of interest. Each cost is
identified as either fixed or variable depending
on the relationship between the cost and some
activity.
Step2: Each major class of manufacturing OH or
other mixed cost is itemized. Each cost is then
divided into its estimated variable and fixed
components. This is done on the basis of the
experience and judgement of accounting and other
personnel.
Advantage: involves detailed examination of the data
base by accountants and managers who are familiar
with it
Disadvantage: subjective, judgemental approach
2. High-Low Method
- Based on costs observed at both the high and low
levels of activity within the relevant range
- Step1: Select the highest pair and lowest pair (cost
and activity level)
- Step2: Compute the variable rate, b, by using the
formula
- VC = (difference in cost y)/(difference in activity x)
- Step3: Compute the fixed cost portion as
- FC portion = total mixed cost – variable cost
- Advantage: simple and easy
- Disadvantage: uses only 2 data points (may not be
representative of normal conditions)
3. Least-Squares Method
- a statistical technique which is often used in separating
mixed costs into their fixed and variable components
- a line of regression is determined by solving two
simultaneous linear equations which are based on the
condition that the sum of deviations above the line
equals the sum of deviations below the line
- includes all the observed data and attempts to find a
line of best fit
- advantage: uses all data
easy to use with computers and
sophisticated calculators
a measure of goodness of fit of the line is
provided
- disadvantage: requires that several relatively strict
assumptions be satisfied for results to be valid
4. Scatter Graph or Visual Fit
- rough guide for cost estimation which plot the cost against
past activity levels (fitted regression line by visual inspection)
-Step1: plot actual costs (on y-axis) during the period under
study against the volume levels (x-axis)
-Step2: draw line of best fit by visual inspection
-Step3: FC is estimated by extending the left end of the line
-Step4: Variable cost rate or slope of the cost line is
determined by dividing the difference between any two costs
by the difference of the corresponding level of activities
-Advantage: uses all observations of cost data
relatively easy to understand and apply
-Disadvantage: fitting of line is subjective
difficult where several independent variables are to be used
The Contribution Approach to the IS
Traditional Approach
- shows functional classification of costs
(manufacturing vs non manufacturing)
Sales $ 15,000
Less: COGS 7,000
Gross Margin 8,000
Less: OpEx
Selling (2,100)
Admin (1,500)
4,400
Contribution Approach
- looks at cost behavior
- provides data useful for managerial planning
and decision making
- highlights the concept of contribution margin
Sales $15,000
Less: Variable Expense
Mfg (4,000)
Selling (1,600)
Admin (500)
Contribution Margin 8,900
Less: Fixed Expense
Mfg (3,000)
Selling (500)
Admin (1,000)
Net Income 4,400
Variable Costing
Variable Costing
• Also known as Direct Costing
• Only variable manufacturing costs are included
in product costs
• Income statement under this approach
highlights the contribution margin of the
product
• Preferred by managers for cost-volume-profit
anaylsis
Advantages:
• Shows costs that can be traced and controlled by
each strategic business unit
• Appraisal of performance of product line or
other segments of the business can be facilitated
without the need for allocations of fixed cost
• Analysis of costs relevant to pricing is likewise
simplified and enhanced
Disadvantages:
• Tends to give the impression that variable costs
are recovered first, that fixed costs are recovered
later and finally profits are realized
• Not acceptable for external reporting and tax
purpose
Comparison between Variable Costing
and Absorption Costing (Traditional)
Required:
a. Income statement for 2005 and 2006 under variable costing and absorption
costing.
b. A reconciliation of the difference in net income for 2005 and 2006 and the two
years as a whole.
Systems Design and Costing
Flow of Cost in a Merchandising
Company
Costs Balance Sheet Income Statement
Finished Goods
Period Expense
Selling and
Selling and Admin.
Admin.
Manufacturing Cost Accounting System
4 Decisions:
1. Will the system use historical costs or
standard costs?
2. Job order or Process costing?
3. Full absorption or direct costing of inventory?
4. What system will be used to assign OH costs
or products? Plant-wide or Activity-based
predetermined OH rates? How many cost
drivers?
Job Order Costing System
• Costs are assigned by jobs, contracts, or orders
• DM and DL are traced to a particular job
• FOH applied to individual jobs using
predetermined OH rate
• Uses job sheet which records various production
costs for WiP inventory (summarizes all
manufacturing costs)
Accounting Procedures Using Job Order
Costing to a Manufacturing Company
1. Record the purchase and issue of materials
with journal entries.
2. Record Labor Costs with journal entries.
3. Calculate predetermined OH and use it to
assign OH costs to a job.
4. Record applied manufacturing OH costs with
journal entries.
5. Complete a job cost sheet and calculate the
average cost per unit of a job.
6. Record actual MOH costs with journal entries.
7. Compute over and under applied OH.
-any differences are closed to COGS
under applied = applied < actual
over applied = applied > actual
Required:
1. Prepare journal entries
2. Post the journal entries from above to T-accounts. The balance in the
Processing Dept’s WiP account on April 1 was P15,000; the balance in the
Finishing Dept’s WiP account was P7,000
3. Prepare a production report for the Processing Department for April. The
following additional information is available regarding production in the
Processing Department during April:
Production Data
Cost Data
Work in Process Inventory, April 1:
Materials P 9,200
Cost Added During April Labor 2,100
Materials P85,100 Overhead 3,700
Labor 33,000 Total P15,000
Overhead 66,500
total P184,600
Illustrative Problem
Camia Co. manufactures a product that goes
through three departments, A, B, and C.
Information relating to activity in department A
during October is given below:
Percent Completed
Units Materials Conversion
WiP, Oct 1 50,000 90 60
Started into Production 390,000
Completed and transferred to Dept B 410,000
WiP, Oct 31 30,000 70 50
Compute the equivalent units for October using Average Method and FIFO.
Cost-Volume-Profit Analysis
Answers the questions:
D W
Unit selling price P 10 P5
Unit variable cost 6 3
Total Fixed Cost P 420,000
Target Income Volume
Sales (units) = (Total FC + Desired Profit)
CM per unit
Req’d:
Budgeted sales volume in units
Margin of safety in pesos and percentage
• Operating Leverage
▫ the ratio of the contribution margin to profit
▫ Measures the potential effect of the risk that sales
will fall short of planned levels as influenced by
the relative proportion of fixed to variable
manufacturing costs
Req’d:
1. Operating leverage for each company. If sales increase, which
company benefits more?
2. Assume sales rise 10% in the next year. Calculate the percentage
increase in profit for each company.
Responsibility Accounting
Responsibility Accounting
• is the system for collecting and reporting
revenue and cost information by areas of
responsibility
• also called profitability accounting and activity
accounting
• Objective: Managers will be compelled to set
managerial targets and formulate strategies to
attain the firm’s overall objectives. Control
mechanism will be provided which will serve as
the basis in evaluating actual results or
performance.
Advantages
1. It facilitates delegation of decision making.
2. It helps management promote the concept of
management by objective wherein managers agree on
a set of goals and their performance is then evaluated
based on his or her attainment of these goals.
3. It provides a guide to the evaluation of performance
and helps to establish standards of performance which
are then used for comparison purposes.
4. It permits effective use of the concept of management
by exception, which means that the manager’s
attention is concentrated on the important deviations
from standards and budgets.
Basic Conditions for an Effective
Responsibility Accounting System
1. The organization structure must be well defined.
2. Standards of performance in revenues, costs, and
investments must be properly determined and well
defined.
3. The responsibility accounting reports (or
performance reports) should include only the
items that are controllable by the manager of the
responsibility center. Also, they should highlight
items that call for managerial attention.
responsibility center is defined as a unit in the
organization which has control over costs,
revenues, and/or investment funds
Req’d:
1. Compute the direct materials, labor and
variable mfg overhead price and efficiency
variances
2. Compute the fixed mfg overhead price variance
Relevant Costs for
Decision Making
Types of Decisions
• Make or Buy
• Add or Drop a Product or Other Segments
• Sell Now or Process Further
• Special Sales Pricing
• Utilization of Scarce Resources
• Shut-down or Continue Operations
• Pricing
Relevant Costs
• Any cost that is avoidable (cost that can be
eliminated, in whole or in part) as a result of
choosing one alternative over another
• Expected future costs
• Incremental or differential costs
• All costs are considered relevant, except:
▫ Sunk costs
▫ Future costs that do not differ between alternatives
Approaches in Analyzing Alternatives
• Incremental or Differential Analysis Approach
▫ Compares differential revenues, costs and
contribution margins
▫ Shows only relevant amounts
▫ Steps:
Gather all costs associated with each alternative.
Drop the sunk costs and non-differential costs.
Select the best alternative based on the remaining
cost data.
• Total Project Analysis Approach
▫ Aka Comparative Statement Approach
▫ Shows all items of revenue and cost data and
compares net income result
▫ Prepared in Contribution Format
• Opportunity Cost Approach
▫ Opportunity cost – net revenue lost by rejecting
some alternative course of action
▫ More effective when there are excessive
alternatives available
Illustration
A company owns a milling machine that was purchased three
years ago for $25,000. Its present book value is $17,500. The
company is contemplating replacing this machine with a new
one which will cost $50,000 and have a five-year useful life.
The new machine will generate the same amount of revenue
as the old one but will cut down substantially on variable
operating costs. Annual sales and operating costs of the
present machine and the proposed replacement are based on
normal sales volume of 20,000 units and are estimated as
follows:
Present Machine New Machine
Sales $60,000 $60,000
Variable Cost 35,000 20,000
Fixed Cost:
Depreciation 2,500 10,000
Taxes, Ins, Etc 4,000 4,000
Net Income $18,500 $26,000
Make or Buy
• Point of indifference cost volume
▫ Total cost to make = total cost to buy
Adding or Dropping Products/Segments
Sell Now or Process Further
• Joint product cost
▫ All manufacturing costs incurred prior to the point
where the joint products are identified as
individual products
• Split-off Point
▫ Point in the manufacturing process at which joint
product can be recognized as separate products
Special Sales Pricing
• Considered if:
▫ Operating in a distress situation
▫ There is idle capacity
▫ When faced with sharp competition or in a
competitive bidding situation
Utilization of Scarce Resources
• Constraint – when capacity becomes pressed
because of scarce resource
• Fixed costs are usually not affected, therefore
apply contribution margin per unit of scarce
resource used
Shut Down or Continue Operations
Pricing
• Cost-Plus Pricing
▫ Price of product or service should cover all costs
▫ Target Selling Price = [ Cost + (Markup % x Cost) ]
▫ Either by Absorption Approach or Contribution
Approach
• Target Costing
▫ Target Cost = Anticipated Selling Price – Desired Profit