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Chapter 1:

Accounting
• Financial (GB201)
• Users of information are external
• Managerial (GB202)"Cost Accounting"
• Users of information are internal

Cost for production


• 3 components
• Direct Materials
• Direct Labor
• Manufacturing Overhead
 (indirect costs)
• Indirect Materials
• Indirect Labor
Prime Costs
• Direct Materials + Direct Labor
Conversion Cost
• Direct Labor + Manufacturing Overhead
• How we convert raw materials into finished product
Upstream costs
• Incur before production
• Research and Development, attorney fees, licensing, ect.
Production Costs
• 3 components
Downstream costs
• Incur after production
• Marketing, Delivery, ect

Period Costs
• General, Selling, and Administration costs (G, S, & A)
• All costs outside of Production Costs

We need to know Product cost to determine the Selling Price

Value Chain
• Research and Development
• Obtain Materials
• Manufacturing
• Marketing
• Delivery
Value-added activities
• Includes steps involved in the actual processing of goods or services

Production Cost
• If not sold then it is an inventory and is an Asset
• If it is sold it is a Cost of goods sold and is an Expense

Fixed Cost
• Set costs that do not change with quantity
• Higher the quantity = less cost per unit
• i.e Rent

Chapter 2:

Cost Behavior
• Fixed Cost
• Total
 Will remain the same depending on quantity
• Per Unit
 Changes inversely as output changes
 Inverse relationship
• Operation Leverage
• How managers magnify small changes in revenue into dramatic
changes in profitability
 Uses fixed cost as a lever
• (alternative measure - base measure) / base measure = % change
• Variable Cost
• Total
 Varies with level of output
 Changes proportionally as output changes
• As sales increase there is no magnification in profitability only a
direct correlation
• Contribution margin
 Subtract variable costs from revenue
 Represents the amount available to cover fixed expenses and
thereafter to provide company profits
Operation leverage using contribution margin
• Magnitude of operating leverage = contribution margin / net income
• Shows percent change in revenue as profitability increases
• Operating Leverage x change in sales = change in net income

• Mixed Cost
• Includes both fixed and variable components
• Total cost = fixed cost + (variable cost per unit x number of units)
Relevant range
• Range of activity over fixed and variable costs are valid
High-low method
• How to separate mixed cost from variable cost
• Assemble sales volume and cost history for an existing store
• Select the high and low points in the data set
• Determine the estimated variable cost per unit
• Variable cost per unit = difference in total cost / difference in volume
• Determine the estimated total fixed cost
• Fixed cost + Variable cost = total cost

R2 statistic
• Represents the percentage of change in the dependent variable (total
cost) that is explained by a change in the independent variable (units
sold).

Chapter 3:

Break-even point
• where profit equals zero (= fixed costs/ Contribution margin per unit)
• Multiply by sales price per unit to obtain the dollar amount
• Total fixed cost + total variable cots = break even point
Contribution Margin Ratio
• Contribution margin / revenue
Equation Method (most important approach)
• Fixed Cost / Contribution Margin Ratio
• Sales revenue- Variable costs - Fixed costs = Profit (Net Income)

Contribution margin per unit


• (sales price per unit) - (variable cost per unit)
Target Profit
• (Fixed Cost + Target Profit)/ Contribution Margin per Unit
• To find the additional units
• Minus Break Even Units from Target Units
• To find target profit
• FC+TP/ contribution Ratio
 Minus break even point to find Profit

Pricing Strategies
• Cost plus pricing - sets the selling price at cost plus a markup equal
to a percentage of the cost
• Prestige pricing - sets the selling price at a premium under the
assumption that customers will pay more because of its prestigious
brand name, media attention, etc
• Target pricing - sets the selling price by determining the price at
which a product that will satisfy market demands will sell and then
developing that product at a cost that results in a profit
Cost-Volume-Profit (CVP) Graph - break even chart

Margin of Safety - measures the cushion between budgeted sales and the break
even point
• Margin of Safety= (budgeted sales -break even sales)/budgeted sales

Sensitivity analysis - Spreadsheet tool used to answer "what if" questions to assess
the sensitivity of profits to simultaneous changes in fixed cost, variable cost, and
sales volume

GB202 (Behavior)

Sales Revenue xxx


Variable costs of COGS xxx
Variable cost of GS&A xxx
Total VC (xxx)
Contribution Margin xxx
Fixed cost of COGS xxx
Fixed cost of GSA xxx
Total FC (xxx)
Net Income xxx
Contribution margin
• Contribution margin = Fixed cost is the break even point
• Contribution margin > FC is Profit
• The contribution margin is how much money is able to pay for fixed costs
Cost-Volume-Profit Analysis
1. Break-even analysis
i. Break even in units
i. Break even in dollars
1. Target Profit
1. Sensitivity Analysis(what if situation)

Chapter 4:

Cost accumulation
• Cost of product
• Cost of advertising and promotion
• Cost of labor
Cost objects
• Primary cost object is cost of promotion
Cost driver
• How many units
• How many advertisements
• How many labor hours
Cost tracing
• Assigning costs to the departments(cost objects)

Direct Costs
• Can be traced to cost objects in a cost-effective manner
• Direct Materials
• Receipts, statements can tell us how much raw materials were purchased
• Direct Labor
• Payroll can tell us how much people worked and how much they will be
paid
Indirect Costs
• Cannot be traced to objects in a cost-effective manner
• Cannot be accurate until end of the production cycle
• Must ESTIMATE

When a cost is incurred to the company it is classified as an indirect cots


• When a cost is incurred to a department it is a direct cost

Common costs
• Support multiple cost objects, but cannot be directly traced to any specific
objects

Controllable costs
• Costs that can be influenced by a manager's decisions and actions
Cost allocation
• Dividing a total cost into parts and assigning the parts to designated cost
objects

Number of sales transactions is more accurate as a cost driver


• Unless number of sales transactions per department are kept, we must used
total sales volume

Volume measures are good cost drivers for allocating variable costs
• Supplies such as glue, staples (variable costs) depend on how many desks
there are
• The most accurate allocations of indirect costs may actually require using
multiple cost drivers
• Such as units, labor hours, direct material costs

Predetermined overhead rate


• Overhead allocation rate is determined before actual cost and volume data are
available
Cost pool
• When a company groups individual costs into a single cost
• i.e utilities
• Limited to costs with common drivers
Joint costs
• Common costs incurred in the process of making two or more joint products
• i.e raw milk into cream, 2%, 1%, fat free
• Include not only material costs but labor and overhead costs
• Point where product become separate and identifiable called split off point

In class

Cost accumulation and allocation


Step 1
• Predetermined overhead rate (POHR)
Step 2
• Allocate the cost to the department or products being produced
Cost accumulation
• Cost of product
• Cost of advertising and promotion
• Cost of labor
Cost objects
• Primary cost object is cost of promotion
Cost driver
• How many units
• How many advertisements
• How many labor hours
Cost tracing
• Assigning costs to the departments(cost objects)

Direct Costs
• Can be traced to cost objects in a cost-effective manner
• Direct Materials
• Receipts, statements can tell us how much raw materials were
purchased
• Direct Labor
• Payroll can tell us how much people worked and how much they will
be paid
Indirect Costs
• Cannot be traced to objects in a cost-effective manner
• Cannot be accurate until end of the production cycle
• Must ESTIMATE

When a cost is incurred to the company it is classified as an indirect cots


• When a cost is incurred to a department it is a direct cost

Common costs
• Support multiple cost objects, but cannot be directly traced to any specific
objects

Controllable costs
• Costs that can be influenced by a manager's decisions and actions
Cost allocation
• Dividing a total cost into parts and assigning the parts to designated cost
objects

Number of sales transactions is more accurate as a cost driver


• Unless number of sales transactions per department are kept, we must
used total sales volume

Volume measures are good cost drivers for allocating variable costs
• Supplies such as glue, staples (variable costs) depend on how many desks
there are
• The most accurate allocations of indirect costs may actually require using
multiple cost drivers
• Such as units, labor hours, direct material costs

Predetermined overhead rate


• Overhead allocation rate is determined before actual cost and volume
data are available
Cost pool
• When a company groups individual costs into a single cost
• i.e utilities
• Limited to costs with common drivers
Joint costs
• Common costs incurred in the process of making two or more joint
products
• i.e raw milk into cream, 2%, 1%, fat free
• Include not only material costs but labor and overhead costs
• Point where product become separate and identifiable called split off
point
Utility bill of $120
• Can split it up by appliances, hours used, time spend
Appliance Method
Roommate 1- 5 50% $60
Roommate 2 - 2 20% $24
Roommate 3 -3 30% $36
Step 1. POHR = total estimated overhead / Total estimated activity
Step 2. Allocation = rate x weight (number of units)
We want to allocate costs to determine
• Pricing
• Performance evaluation
• Contracts (out sourcing)

Mixed Cost to Allocate


• Go back to Overhead costs and group similar costs
• Machinery cost ---machine hours
• Workers costs ----- labor hours

Chapter 5:

Relevant Cost for Decision-Making


• Cost must be avoidable (Overhead Cost)
• Has to be future oriented
• Differs among the alternative
• Cannot be the same
Sunk Cost
• Past costs
• Not relevant costs

Types of decisions
• Special offers
• Outsourcing ( Make or Buy Decisions)
• How reliable is the supplier
• Opportunity costs for vacancy
• Questionable quality of the product
• Old vs. New Equipment
• Continuing to use the equipment
 may cause resale value will decrease
 Longer we keep the equipment more repairs
• Operating costs will increase
• Buying new equipment
 Salvage value will be higher
 Decrease in operating costs
• Segment Elimination
• If we eliminate a product line
 The contribution margin will be lost
 Then fixed costs will be distributed among other projects
Cost hierarchy for Avoidable costs
• Unit-Level Costs
• Avoiding costs of materials and labor
• A product that is produced one at a time
• Batch-Level Costs
• Setup Costs
• Inspection costs
• Product-Level Costs
• Legal costs
 Ie to publish a book
• Engineering costs
• Facility-Level Costs
• Depreciation of factories machines
• utilities
• Not relevant for decision making
• Very difficult to get rid of
• i.e. shutting down the company

Chapter 7:

Planning for Profit and Cost Control

Planning and Control

Planning cycle

Plan ->Do -> Check against your plan -> Act (performance review)

3 Categories of Planning
• Strategic Planning
○ Long-term decisions such as defining the scope of the business,
determining which products to develop or discontinue, and identifying the
most profitable market niche
○ Top level management budgeting
○ Long term planning (more then a year)
○ Participative Budgeting
• When you start from the bottom
 These employees know the costs better then top level
management
○ Top level management might create an Ideal Budget
• Realistic Budget
 When the employees set a budget that is suitable for the job
• Slack Budget
 When the company puts the budget too high and it is easy for
employees
 Employees will take breaks and be non productive
• Capital Budgeting
○ Pay-Back Period
• Analyse each project and determine how long they will earn their
capital back
• Pick the project that will pay back the fastest (Bird in Hand theory)
○ Net Present Value
• Discount all future cash in flows to "today's money"
• Highest npv is the one that the company will pick
○ Accounting Rate of Return
• Accounting analysis
• Looking for highest net income
○ Profitability Index

○ Capital Asset Pricing Model


• Operational Budgeting
○ Direct firms activity in the short range
○ One year or less

Advantages of Budgeting
• Planning
• Goals of the company
• Budgeting formalizes and documents managerial plans in order to
clearly communicate objectives to superiors and subordinates.
• Coordination
• Different departments cooperate to promote overall good
• Budgeting process forcers coordination among departments to
promote decisions in the best interests of the company as a whole
• Enhances Performance Measurements
• Comparing budgeted expectations to actual performance
• Enhance Corrective Actions
• Provides advance notice of potential shortages, bottlenecks, or other
weaknesses in operating plans
• Advises managers of potential problems in time for them to carefully
devise effective solutions

Perpetual (continuous) budgeting


• Covers a 12-month reporting period
• Advantage of keeping management constantly focused on thinking ahead
to the next 12 months

Consideration for the Human Factor


• Involving employees in budgeting process
• Achieve better production
Participative budgeting
• Participation in the budget process by personnel at all levels of the
organization, not just upper-level managers
• Information flows from both bottom to top and top to bottom
• Can help set more realistic targets
Master Budget
• Compilation of various budgets
• Group of detailed budges and schedules representing the company's
operating and financial plans for a future accounting period
• Includes
• Operating budgets
• Capital budgets
 Describes the company's intermediate-range plans for
investments in facilities, equipment, new products, store outlets,
and lines of business
• Pro forma financial statements
 Uses operating budgets to prepare
 Projected rather then historical information
 Balance sheet, income statement, cash flows

Order for a manufacturing budget


• Sales Budget- we need to know what quantity we will need to sell
• Purchase of Raw Materials Budget - we know how much product we need
• Production- we know how much each will cost
• Selling and Administration Budget
• Cash Budget

Purchases Budget
Budgeted Sales (COGS) xxx
+Desired Ending Inventory xxx
Total inventory Needed xxx
-Beginning Inventory (xxx)
Required Purchases XXX

Cash Budget
• Alerts management to anticipated cash shortages or excess cash balances
• Divided into three sections
• Cash receipts section
 Beginning cash balance
 Add cash receipts (sales budget)
• Cash payments section
 Cash payments from inventory purchases
 For S&A expense
 For interest Expense
 For purches of store fixtures
• Financing section
 Surplus (shortage)
 Borrowing (Repayment)

Chapter 8:
Flexible budget
• Extension of the master budget discussed previously
• Show expected revenues and costs at a variety of volume levels
Variances
• Difference between standard and actual amounts
• Can be favorable or unfavorable
• Actual sales revenue is greater then expected sales revenue = favorable
• Actual sales revenue is less then expected sales revenue = unfavorable
• Actual costs exceed standard costs = unfavorable
• Actual costs are less than standard costs = favorable
Sales volume variance
• Difference between the static budget and a flexible budget based on actual
volume
Variable cost volume variances
• Differences between the static and flexible budget amounts
Spending variances
• Differences between budgeted fixed costs and actual fixed costs
• i.e. an unexpected raise
Fixed cost volume variance
• Used to monitor the effects of volume on fixed cost per unit
Flexible budget variances
• Differences between the flexible budget figures and the actual results
Management by exception
• Managers should concentrate on areas not performing as expected
• Management should attend to the exceptions
• Using standard costing shows differences between actual and standard costs
• Focus attention on the items that show significant variances
Standard
• Represents the amount that a price, cost, or quantity should be under certain
anticipated circumstances
• Uses historical data is a good start to establish standards
Ideal standards
• Represent flawless performances
• What costs should be under the best possible circumstances
• Do not allow for normal materials waste and spoilage or ordinary labor
inefficiencies caused by machine downtime, cleanups, breaks, or personal
needs
• Meeting these standards are beyond the capabilities of most, if not all,
employees
• Can help strive for better performance or discourage
Practical standards
• Reasonable effort; they are attainable for most employees
• Allows for normal levels of inefficiency in materials and labor usage
• Promotes a feeling of accomplishment and produces meaningful variances
Lax standards
• Easily attainable goals
• Achieve with minimal effort
• Do not motivate; can lead to boredom and lackluster performance
• Variances lose meaning
Material variances
• Could influence management decisions
• Establish materiality guidelines for selecting variances to analyze
• Frequency
• Frequent and large variations
• Capacity to control
• Whether management action can influence the variance
• Concentrate on controllable variances
• characteristics
• Closely analyzed
• Can invite management abuse
 I.e. delays for maintenance
Budget slack
• Difference between inflated and realistic standards
• When management tries to gain praise by manipulating the standard budget
Price Variance = |actual price - standard price| x actual quantity
Usage Variance = |actual quantity - standard quantity| x standard price

Fixed manufacturing overhead cost spending variance


• Differences between the actual fixed costs and the budgeted fixed costs
Budgeted fixed manufacturing overhead cost / planned volume of
production
• Predetermined overhead rate

Performance Evaluation

Static Budget
• Master Budget
• Based on one level of activity

Flexible Budget
• Based on more then one level of activity

Use Budgets to evaluate performance of managers


• Profit based

• Cost based

Must give managers Planning and Control


• Managers and employees know costs better then upper-management

Budget vs. Actual


• When there are differences these are called variances
• Can be two choices
• Favorable
• Unfavorable
Variances
• Materials
• Material Quantity Variances
• Material Price Variances
• Labor
• Labor Efficiency Variances (efficiency of hours used)
• Labor rate Variance (rate of pay)
• Overhead
• Overhead Volume Variance (cost that is allocated)
• Overhead Spending Variance

See favorable and unfavorable budgets