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Cost Measurement and Cost Measurement Concepts
Cost measurement concepts is associated with managerial accounting and internal reporting.
- Future orientation and usefulness characterize managerial accounting
- Meant for internal users
Cost drivers (a factor that has the ability to change total costs) may be based on
- Volume (output)
- Activity (value added)
- other
Cost objects - resources or activities that serve as the basis for management decisions. Cost objects require
separate cost measurement and may be products, product lines, departments, geographic locations, or any other
classification that aids in decision making.
A single cost object can have more than one measurement. Inventory (product) costs for financial statements
are usually different than costs reported for tax purposes. These costs differ than the inventory (product) costs
that management uses to make decisions
Product costs = DM + DL + Mfg OH applied. These costs are not expensed until the product is sold
(inventoriable)
Period costs = non mfg costs (SG&A). Are expensed in the period they are incurred and are not inventoriable.
Cost accounting systems are designed to meet the goal of measuring cost objects or objectives. The most
frequent objectives include:
- Product costing (inventory and COGS)
- Efficiency measurements (comparisons to standards)
- Income determination (profitability)
Examples of indirect costs - not easily traceable to a cost pool or cost object (B5-7)
Indirect costs are allocated to a single cost pool called overhead, i.e. manufacturing overhead
Indirect costs in mfg OH consist of both fixed and variable components (such as rent and indirect materials).
Total overhead cost is a mixed cost because it includes both fixed and variable costs
Depreciation is a fixed cost
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BEC - Notes Chapter 5
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In a standard costing system, standard costs are used for all mfg costs (DM, DL, mfg OH)
Joint product costs - costs incurred in production up to the split-off point. Only allocated to the main products.
By-products do not receive an allocation of joint costs.
Method 2: Net realizable value (value at split-off point), used for inventory costing only
(Sales value of product A at split-off ÷ Total sales value at split-off) * joint costs = portion of product A
joint costs
Method 3: Sales value not available at split-off, subtract separable costs from final selling price to find net
realizable value at split-off
Final sales value of product A - Separable costs = sales value of product A at split-off
(Sales value of product A at split-off ÷ Total sales value at split-off) * joint costs = portion of product A
joint costs
*subtract value of byproduct from joint costs when allocating. Because proceeds from by-product reduce costs.
The lowest unit price acceptable is the variable cost of the product (DL + DM + Var mfg OH) plus the
contribution margin of the alternative use for the production capacity.
Beg WIP + total mfg costs [DL + DM used + mfg OH applied] - ending WIP = COGM
Application of overhead
Overhead rate = Budgeted overhead costs ÷ Estimated cost driver [such as labor hrs or costs, machine hrs]
Overhead applied = Actual cost driver * overhead rate
[based on actual production]
Overhead applied consists of both variable overhead and fixed overhead. The calculation is as follows (with
direct labour hours as the cost driver):
Variable overhead rate = budgeted variable mfg OH / budgeted direct labor hours
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BEC - Notes Chapter 5
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Fixed overhead rate = Budgeted fixed mfg OH / budgeted direct labor hours
Total overhead rate = Variable overhead rate + Fixed overhead rate
Overhead applied to the job = Total overhead rate x actual direct labor hours = $5,625
Normal spoilage is an inventory cost and is included in the standard cost of the manufactured product
Abnormal normal spoilage is a period expense and is charged against income of the period as separate
component of cost of goods sold.
Activity based costing (ABC) uses multiple OH rates to assign indirect costs to products (cost objects) based on
the resources a product consumes.
An ABC system will apply high amounts of overhead to a product that places high demands on expensive
resources
Variable costing and absorption costing are the same except that all fixed mfg costs are treated as period costs
Under the contribution approach (variable costing), all fixed mfg OH is treated as a period cost and expensed
immediately. i.e. COGS includes only variable mfg costs. Not GAAP
Under the absorption approach (absorption costing), all fixed mfg OH is treated as a product cost and included
in inventory values. i.e. COGS includes both fixed and variable costs. GAAP
Target costing - the selling price of the product determines the production costs allowed
Economic value added (EVA) - measures the excess of income after taxes earned by an investment over the
return rate defined by the company's cost of capital.
Investment * cost of capital = required rate of return
Income after taxes - required return = economic value added
When considering alternatives, such as discontinuation of a product line, management should consider relevant costs.
Relevant costs are those costs that will change under different alternatives.
Learning curve analysis - used to determine increases in efficiency or production as experience is gained. Both
products have long production runs, making learning curve analysis the best method for estimating the cost of
the competitive bid.
Authoritative standards are set exclusively by management, while participative standards are set by both
managers and employees
A flexible budget - a series of budgets based on different activity levels within the relevant range.
The production budget - begins with sales budget and then adds in the effect of any changes in inventory levels
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BEC - Notes Chapter 5
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Standard costs usually means that a flexible budget is being used. Standard costs per unit can be used to adjust
the flexible budget to the actual volume.
Sales volume variance = (actual units sold - budgeted unit sales) * standard contribution margin per unit
Sales mix variance = (actual product sales mix ratio - budgeted product sales mix ratio) * actual sold units *
budgeted contribution margin per unit of that product
Sales quantity variance = (actual units sold - budgeted unit sales) * budgeted sales mix ratio * budgeted
contribution margin per unit
Market size variance = (actual market size in units - expected market size in units) * budgeted market share *
budgeted contribution margin per unit weighted avg
Market share variance (actual market share - budgeted market share) * actual industry units * budgeted
contribution margin per unit weighted avg
Selling price variance = (actual SP per unit - budgeted selling price per unit) * actual units sold
Variable overhead efficiency variance - computed as budgeted variable overhead based on standard hours
minus budgeted variable overhead based on actual hours.
Budgeted variable OH = standard direct labor hours allowed x standard variable overhead rate
Budgeted variable OH = actual direct labor hours x standard variable overhead rate
Production volume variance component for overhead variances is computed as applied overhead minus
budgeted overhead based on standard hours
Applied Overhead
(Std Var OH Rate x Std DLH Allowed) + (Std Fixed OH Rate x Actual Production)
Budgeted overhead based on standard hours
(Std Var OH Rate x Std DLH Allowed) + (Std Fixed OH Rate x Standard Production)
The fixed overhead rate is $5 per machine hour [$1,200,000 / 240,000 = $5].
• The amount of FIXED manufacturing overhead planned for November is $100,000.
• Therefore, the standard production for FIXED overhead is 20,000 machine hours [$100,000/$5 = 20,000.]
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BEC - Notes Chapter 5
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Critical success factors to accomplish a firm strategy are FICA:
- Financial
- Internal business processes
- Customer Satisfaction
- Advancement of innovation and human resource development