MANAGEMENT ACCOUNTING

Matrikulasi
Kelas Maksi
 TOPICS
1. Cost Concept
2. Cost Objective and Measurement
3. Cost Accumulation
4. Overhead Allocation
5. Decision Making and Relevant cost
6. Cost management & Management strategic
 TOPICS : Cost Concept
1. Review of Cost Management
Factor affecting to Cost Management, The Role
of Cost and Management Accountant
2. Cost Behaviour
Fixed Cost, Variable Cost, Mixed cost,
3. Cost Management
Characteristic of Cost Management, Strategic
Decision Making, The Value Chain
Accounting Information System

Financial accounting system

follows established rules and conventions to provide
information (financial statements) to external users
such as investors, government agencies, and banks.
Cost management system
identifies, collects, measures, classifies, and reports
information that is useful to managers in costing
(determining what something costs), planning,
controlling, and decision making.
Factors Affecting - Cost Management
Global Competition
 Vastly imported transportation and communication has led to a
global market for many manufacturing and service firms.
 The new competitive environment has increased the demand
not only for more cost information but also for more accurate
information.

Growth of the Service Industry

 As manufacturing industries has declined in importance, the service
sector of the economy has increased in importance.
 Deregulation of many services has increased competition in the service
industry
Factors Affecting - Cost Management
Global Competition
 Vastly imported transportation and communication has led to
a global market for many manufacturing and service firms.
 The new competitive environment has increased the demand
not only for more cost information but also for more accurate
information.

Growth of the Service Industry

 As manufacturing industries has declined in importance, the service
sector of the economy has increased in importance.
 Deregulation of many services has increased competition in the
service industry
Factors Affecting - Cost Management
Advances in Information Technology
 Computers are used to continuously monitor and control system-wide
operations.
 Increased ability to accurately cost products because of advances in
available tools.
 Emergence of electronic commerce

Advances in Management Environment

 Theory Of Constraints is used to continuously improve manufacturing
activities and nonmanufacturing activities.
 Just-in-Time Manufacturing is a demand-pull system that strives to produce a
product only when it is needed and only in the quantities demanded by
customers.
Factors Affecting - Cost Management

Computer-Integrated Manufacturing
 Can produce a competitive advantage for a firm
 Typically follows JIT as a response to increased needs for quality and
shorter response time

Consumer Orientation
 Value chain is the set of activities required to design, develop,
produce, market, and deliver products and services to customers
 Firms compete not only in terms of technology and manufacturing, but
in the speed of delivery and response to deliver value to the customer
 Factors Affecting - Cost Management
New Product Development
 Management recognizes that a high proportion of production costs are
committed during the development and design stage of a new product.
 The requirement to control cost encourages the use of target costing
and activity-based management.

Total Quality Management

 Continual improvement and elimination of waste are the two foundation
principles that govern a state of manufacturing excellence.
 A philosophy of total quality management, in which managers strive to create an
environment that will enable organizations to manufacture perfect products, has
replaced the acceptable quality attitudes of the past.
Factors Affecting - Cost Management

Time as a Competitive Element

 Time is the crucial element in all phases of the value chain.
 Decreasing non-value-added time appears to go hand-in-hand with
increasing quality.

Efficiency
 While quality and time are important, improving these dimensions
without corresponding improvements in financial performance may be
futile, if not fatal.
The Role of Cost and Management
Accountant
 Responsible for generating financial information
required by the firm for
 Internal reporting
 External reporting

 Accounting system information is used by management

to
 Plan
 Control
 Make decisions
The Role of Cost and Management
Accountant
Planning
 Detailed formulation of future actions to achieve a particular end.
 Requires setting objectives and identifying methods to achieve those
objectives.

Controlling
 The managerial activity of monitoring a plan’s implementation and
taking corrective action as needed.
 Feedback is information that can be used to evaluate or correct the
steps being taken to implement a plan.
 Performance reports compare budgeted and actual data
The Role of Cost and Management
Accountant
Continuous Improvement
 Required in a dynamic environment if a firm is to remain
competitive or to establish a competitive advantage.
 Searching for ways to increase overall efficiency through
 Reduction of waste
 Quality improvement
 Cost reduction

Decision Making
 The process of choosing among competing alternatives.
 Decisions are based on information provided by the accounting
system
 Fixed Cost

Fixed costs are costs that in total are constant within the
relevant range as the level of the activity driver varies

Two production lines can process 10,000 computers per year each.
The workers on each line are supervised by a production-line manager who is
paid $24,000 per year.
For production up to 10,000 units, only one supervisor is needed.
When production is between 10,001 and 20,000 units, two supervisors are
required.
 Fixed Cost
Days Computers, Inc. Days Computers, Inc.
Computers Computers
Supervision Processed Supervision Processed Unit Cost
$54,000 4,000 $54,000 4,000 $13.50
54,000 8,000 54,000 8,000 6.75
54,000 10,000 54,000 10,000 5.40
108,000 12,000 108,000 12,000 9.00
108,000 16,000 108,000 16,000 6.75
108,000 20,000 108,000 20,000 5.40
 Variable Cost
Variable costs are costs that in total vary in direct
proportion to changes in an activity driver.

A CD-ROM disk drive is added to each computer at a cost

of $30 per computer.
The total cost of disk drives for each level of production
varies.
 Variable Cost

Days Computers, Inc. Days Computers, Inc.

Number of Number of
Total Cost of Computers Total Cost of Computers Unit Cost of
CD-ROMs Processed CD-ROMs Processed CD-ROMs
$120,000 4,000 $120,000 4,000 $30.00
240,000 8,000 240,000 8,000 30.00
360,000 12,000 360,000 12,000 30.00
480,000 16,000 480,000 16,000 30.00
600,000 20,000 600,000 20,000 30.00
 Mixed Costs
Mixed costs are costs that have both a fixed and a
variable component

Ten sales representatives each earn an annual salary of

$30,000 plus a commission of $50 per computer sold.
10,000 computers are sold.
 Mised Costs
Y = Fixed cost + Total variable cost
Y = F + VX
where
Y = Total cost

For Days Computer, the selling cost is:

Y = $300,000 + $50X
 Mixed Costs

Days Computers, Inc.

Variable
Fixed Cost of Cost of Computers Selling Cost
Selling Selling Total Cost Sold per Unit
$300,000 $200,000 $500,000 4,000 $125.00
300,000 400,000 700,000 8,000 87.50
300,000 600,000 900,000 12,000 75.00
300,000 800,000 1,100,000 16,000 68.75
300,000 1,000,000 1,300,000 20,000 65.00
 Characteristic of Cost Management
 What is Cost Management ?
In addition to measuring and reporting costs, it is a
philosophy, an attitude, and a set of techniques to
create more customer value at a lower cost.
 Characteristics of Cost-
Management Analysts
Cost analysts use cost
accounting and other data to:

Improve Improve Improve

products resource use services

Support Reduce
strategies costs
Characteristics of Cost-Management
Analysts
• Integrity
• Broad knowledge of the business
• Ability to work in cross-functional teams
 Strategic Decision Making
Strategy

An organization’s overall plan

or policy to achieve its goals.

Key
questions

Where
Wheredodowe
wewant
want How
Howdodowewewant
wantto
to
to
togo?
go? get
getthere?
there?
Where do We Want to Go? – Strategic Missions
• New market potential
• Be early entrant
• Achieve growth
• Capture market share Build
High
• Continuing market
• Maintain growth
• Be a major player
Hold • Protect market share
REWARDS

• Continuing market
Medium • Maintain cash flow
• Maintain volume
Harvest • Cut costs
• Declining market
• Exit at lowest cost
• Minimize losses
Divest • Find a buyer quickly
Low

Low Medium High

RISK
How Do We Want to Get There?
Managers
Managersarearemore
moresuccessful
successful
in
inattaining
attainingobjectives
objectivesififthey:
they:

Understand
Understandsources
sources Use
Useeffective
effective
and
andthreats
threatsto
to decision
decisionmaking
making
competitive
competitiveadvantages.
advantages. techniques.
techniques.

Competitive
Competitiveadvantages
advantagesexist
existin
inaavalue
valuechain
chain
that
thatenables
enablesananorganization
organizationtotoprovide
provide
more
morevalue
valueat
ataalower
lowercost
costthan
thanits
itscompetitors.
competitors.
 Value chain
Where
Wheredo
dowe
wewant
wanttotogo?
go?
How
Howdo
dowe
wewant
wantto
toget
getthere?
there?

Physical
Physical Human
Human
resources
resources resources
resources
Support
Supportservices
services
••Accounting
Accounting
••Human
Humanresources
resources
••Legal
Legalservices
services
••Information
Informationsystems
systems
••Telecommunications
Telecommunications

Value
Valueofof
R& Distri- Customer products
products
Design Supply Production
Marketing
D bution service and
and 27
services
services
 Value Chain
Focus
Focusresources
resourceson onparts
partsof
of Outsource
Outsourcethose
thosevalue
value
the
thevalue
valuechain
chainthat
thatare
are chain
chainprocesses
processesthat
thatcan
can
most
mostimportant
importantto tocompany
company be
bedone
donemore
moreefficiently
efficiently
goals.
goals. by
byothers.
others.

What
Whatisismost
mostlikely
likely
to
tobe
beoutsourced?
outsourced?
Information
Informationservices,
services, Potential problem
legal,
legal,logistics,
logistics,human
human Loss of control
resources, payroll,
resources, payroll, and
accounting,
accounting,tax.
tax. internal expertise.
Cost Objective and Measurement
TOPICS : Cost Objective and Measurement

1. Cost assigment
Definition of Cost Assignment,
2. Product Cost vs non product cost
 Meaning of Cost, Product Cost, Non-Product
Cost
3. Cost Flow
Stages of Production and the Flow of Costs,
Stages of Production and the Flow of Costs
Cost Assignment

Cost assignment is allocation of consumed resources to

the consumer activities or cost object.
An activity is a basic unit of work performed within an
organization.
A cost object is any item, such as products, customers,
departments, projects, activities, and so on, for which
costs are measured and assigned.

31
Cost Assignment

 Traceability means that costs can be assigned easily

and accurately, using a causal relationship.

 Methods of tracing:
 Direct tracing: relies on physical observance of causal
relationships to assign costs to cost objects.
 Driver tracing: relies on drivers as causal factors to
assign costs to cost objects.

32
Cost Assignment Methods

Cost of Resources

Resources
Driver

Direct Direct
Tracking Allocation
Tracing

Physical Causal Convenience

Assumed
Observation Factor Lingkage

Cost Objective
Meaning of Cost

The
Thesacrifice
sacrificemade,
made,
usually
usuallymeasured
measured
by
bythe
theresources
resources
given
givenup,
up,to
toachieve
achieve
aaparticular
particular
purpose.
purpose.
Product
ProductCosts
Costs Period
PeriodCosts
Costs
The
Thecost
cost Costs
Coststhat
thatare
are
assigned
assignedtoto identified
identifiedwith
with
goods
goodsthat
that the
theperiod
periodinin
were
wereeither
either which
whichthey
theyare
are
purchased
purchasedor or incurred
incurred
manufactured
manufactured instead
insteadofofunits
units
for
forresale.
resale. produced.
produced. 34
Manufacturing Cost

There
There are
are 33 major
major categories
categories of
of
manufacturing
manufacturing costs:
costs:

Manufacturing
Manufacturing
Direct
DirectLabor
Labor Overhead
Direct
DirectMaterials
Materials Overhead
The
Thecost
costofof
Raw
Rawmaterial,
material, Indirect
paying
paying Indirect
parts,
parts,and
and material
employees
employeeswhowho material
components
componentsthatthat convert
convertdirect
direct Indirect
can be observed
can be observed Indirectlabor
labor
materials
materialsinto
into
being
beingused
usedtotomake
make Other
Other
finished
finished
aaspecific
specificproduct.
product. overhead
product.
product. overhead
Manufacturing Cost
 Direct materials: those materials directly traceable
to the goods or services being produced.
 Example: The cost of wood in furniture.
 Direct labor: labor that is directly traceable to the
goods or services being produced.
 Example: Wages of assembly-line workers.
 Overhead: all other manufacturing costs.
 Example: Plant depreciation, utilities, property
taxes, indirect materials, indirect labor, etc.
36
Manufacturing Cost

Prime
Prime Costs
Costs include:
include:

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Manufacturin
Manufacturin
ggOverhead
Overhead

Conversion
Conversion Costs
Costs include:
include:

Direct
DirectMaterials
Materials Direct
DirectLabor
Labor Manufacturing
Manufacturing
Overhead
Overhead
 Non-Product Cost
• Amount and timing of benefit cannot be reasonably
estimated
• Period costs
– Not inventoried
– Expensed as incurred
• Examples
– Research and development
– Marketing costs
– Administrative costs
Production and Nonproduction Costs

Production or Nonproduction
Manufacturing or
Costs Operating
Costs

Direct Material R&D

Prime
Expenses
Costs
Marketing (Selling)
Direct Labor Expenses
Conversion
Costs

Overhead Aministrative
Expenses
Stages of Production and the Flow of Costs

Stages of Production and the Flow of Costs

Stages of Production and the Flow of Costs - Example

Axel
AxelElectronics
Electronicsmakes
makestoasters.
toasters.
On
OnFebruary
February1,1,Axel
Axelhas
has$15,000
$15,000
of
ofraw
rawmaterial
materialon
onhand.
hand. Axel’s
Axel’s
purchases
purchasesand
andtransfers
transfersto
tothe
the
production
productionfloor
floorare
areindicated
indicated
below.
below.

What
WhatisisEnding
Ending
Inventory
Inventoryinin
February?
February?
Stages of Production and the Flow of Costs - Example

Axel
AxelElectronics
Electronicsmakes
makestoasters.
toasters.
On
OnFebruary
February1,1,Axel
Axelhas
has$15,000
$15,000
of
ofraw
rawmaterial
materialon
onhand.
hand. Axel’s
Axel’s
purchase
purchaseandandtransfers
transferstotothe
the
production
productionfloor
floorare
areindicated
indicated
below.
below.

Now
Nowlet’s
let’slook
lookat
at
Work-in-Process.
Work-in-Process.
Stages of Production and the Flow of Costs
- Example
On
OnFebruary
February1,1,Axel Axel
had
hadWIP WIPofof$30,000
$30,000
on
onthethefactory
factoryfloor.
floor.
During
DuringFebruary,
February,Axel Axel
paid
paid$92,000
$92,000inindirect
direct
labor
laborwages.
wages.
Overhead
Overheadisisapplied
applied
atat150%
150%ofofdirect
direct
What labor.
labor.On
On2/28,
Whatisisthe
the 2/28,
amount $22,000
$22,000isisstill
stillininWIP.
amountof ofcost
cost WIP.
transferred
transferredto
to
Finished
FinishedGoods
Goodsinin
February?
February?
Stages of Production and the Flow of Costs - Example

150 % of $92,000

On
OnFebruary
February1,1,Axel Axel
had
hadWIP WIPofof$30,000
$30,000
on
onthethefactory
factoryfloor.
floor.
Now
Nowlet’s
let’s During
DuringFebruary,
February,Axel Axel
look
lookat
at paid
paid$92,000
$92,000inindirect
direct
Finished
Finished labor
laborwages.
wages.
Transferred
Goods.
Goods. Overhead
Overheadisisapplied
applied
to Finished
atat150%
150%ofofdirect
direct
Goods
labor.
labor.On
On2/28,
2/28,
$22,000
$22,000isisstill
stillininWIP.
WIP.
Stages of Production and the Flow of Costs - Example

On
OnFebruary
February1,1,Axel
Axelhad
hadFinished
FinishedGoods
Goodsof of$125,000
$125,000ononhand.
hand.
At the end of February, a physical inventory count revealed
At the end of February, a physical inventory count revealed
$96,000
$96,000ininFinished
FinishedGoods
Goodsstill
stillon
onhand.
hand.
What
WhatwaswasCost
CostofofGoods
GoodsSold
Soldfor
forFebruary?
February?
Stages of Production and the Flow of Costs - Example

On
OnFebruary
February1,1,Axel
AxelhadhadFinished
FinishedGoods
Goodsof of$125,000
$125,000on
onhand.
hand. At
At
the
theend
endof
ofFebruary,
February,aaphysical
physicalinventory
inventorycount
countrevealed
revealed$96,000
$96,000
ininFinished Goods still on hand.
Finished Goods still on hand.
What
Whatwas wasCost
CostofofGoods
GoodsSold
Soldfor
forFebruary?
February?
 TOPICS : Cost Accumulation
1. Job Order & Batch Costing
Definition of Cost Assignment,
2. Process Costing
 Meaning of Cost, Product Cost, Non-Product
Cost
3. Activity Based-Costing
Evaluating Major Types of Product-Costing Systems

Job Process
Costing vs Costing

Distinct
Distinctunits
unitsof
of Homogeneous
Homogeneous
output.
output. units.
units.
High
Highvalue
valueunits.
units. Low
Lowvalue
valueunits.
units.
Feasible
Feasibleto
totrace
trace Not
Notfeasible
feasibleto
to
costs
coststo
to trace
tracecosts
coststo
to
individual
individualunits.
units. individual
individualunits.
units.
Evaluating Major Types of Product-Costing Systems

Job Process
Costing vs Costing

Each
Eachindividual
individual Costs
Costsare
aretraced
traced
job
jobtreated
treatedas asaa Operation
OperationCosting
Costingisisaa to
tothe
theprocess
process
separate
separateunitunitof
of hybrid
hybridoften
oftenused
usedfor
for and
andthen
thendivided
divided
output. Costs
output. Costs batches of similar
batches of similar by units
by units
are
aretraced
tracedor or products
productswith
withdifferent
different produced
producedto to
assigned
assignedto toeach
each types
typesof
ofmaterials.
materials. obtain
obtainan an
job.
job. average
averageunitunit
cost.
cost.
Costing System

 Job-Costing: system accounting for distinct cost

objects called Jobs. Each job may be different from
the next, and consumes different resources
 Wedding announcements, aircraft, advertising
 Process-Costing: system accounting for mass
production of identical or similar products
 Oil refining, orange juice, soda pop
Job Order And Batch Costing

Basic Job Cost Flow

Job-cost
Job-costaccounting
accountingsystems
systemsrecord
record
cost flows systematically.
cost flows systematically.

Transactions
are journalized.
Info is posted to
ledger accounts.
Job Order And Batch Costing
Basic Job Cost Flow

Accounts
Accountsrelated
relatedto
toJobs
Jobsare
areposted
posted
to various Job WIP accounts.
to various Job WIP accounts.
Job Order And Batch Costing

Assigning Overhead to Jobs

We
Wecan
candetermine
determineDirect
Direct
Materials
MaterialsCost
Costand
andDirect
Direct
Labor
LaborCost
Costfor
foraaJob
Jobas
aswe
wedodo
the
thework.
work.

But we won’t know actual Overhead

Cost until the end of the accounting
period, so we apply overhead to the job
using a Predetermined Overhead Rate.
Job Order And Batch Costing
Use of Predetermined Overhead Rates.
Identify the items to be included as indirect
overhead costs.
Estimate the costs for each of the indirect overhead
items.
Select the cost-driver.
Estimate the amount of the cost-driver rate.
Compute the predetermined overhead rate (POHR).
÷
Job Order And Batch Costing

The
The predetermined
predeterminedoverhead
overheadrate
rate (POHR)
(POHR) used
usedto
to apply
applyoverhead
overhead
to
tojobs
jobsisisdetermined
determinedbefore
before the
the period
periodbegins.
begins.

Budgeted total manufacturing

POHR =
overhead cost for the coming year
Budgeted total units in the
allocation base for the coming period

Ideally, the allocation base

is a cost driver that causes
overhead.
Job Order And Batch Costing
Based on estimates,
and determined
before the period
begins.

Overhead applied = POHR × Actual activity

Actual amount of the cost

driver such as units
produced, direct labor
hours, or machine hours
incurred during the period.
 Job Order And Batch Costing
Use of Predetermined Overhead Rates
Using a predetermined rate makes it possible to estimate total job costs
sooner.
Actual overhead for the period is not known until the end of the period.

Glass Creations applies overhead based on direct labor hours. Total

estimated overhead for the year is $360,000. Total estimated labor hours
are 12,000.
What is Glass Creations’ predetermined overhead rate per hour?
Job Order And Batch Costing
Budgeted total manufacturing
POHR =
overhead cost for the coming period
Budgeted total units in the
allocation base for the coming period

$360,000
POHR =
12,000 direct labor hours (DLH)

POHR = $30.00 per DLH

For each direct labor hour

worked on a job, $30.00 of
manufacturing overhead will be
applied to the job.
Job Order And Batch Costing
Overhead Variance

Actual > Applied

We
Wecompare
compare Overhead is
UNDERAPPLIED
the
theActual
Actual
Overhead
Overheadto to
Applied
Applied
Overhead.
Overhead.
Actual < Applied
Overhead is
OVERAPPLIED
Job Order And Batch Costing
Assume
Assume Glass
Glass Creations’
Creations’ actual
actual overhead
overhead for for the
the
year
year was
was $370,000
$370,000 forfor aa total
total of
of 13,000
13,000 direct
direct labor
labor
hours.
hours.
How
How much
much total
total overhead
overhead was was applied
applied to
to jobs
jobs
during
during the
the year?
year? Use
Use Glass
Glass Creations’
Creations’
predetermined
predetermined overhead
overhead raterate of
of $30.00
$30.00 per
per direct
direct
labor
labor hour.
hour.

SOLUTION
SOLUTION
Applied
Applied Overhead
Overhead == POHR
POHR ×× Actual
Actual Direct
Direct Labor
Labor
Hours
Hours
Applied
Applied Overhead
Overhead == $30.00
$30.00 per
per DLH
DLH ×× 13,000
13,000 DLH
DLH ==
$390,000
$390,000
Job Order And Batch Costing
Assume
Assume Glass
GlassCreations’
Creations’ actual
actual overhead
overheadfor forthe
the year
year was
was
$370,000
$370,000for
for aa total
total of
of 13,000
13,000 direct
direct labor
labor hours.
hours.
How
Howmuch
muchtotal
total overhead
overheadwas
was applied
applied to
to jobs
jobsduring
duringthe
the year?
year? UseUse Glass
Glass
Creations’
Creations’ predetermined
predetermined overhead
overheadraterate ofof $30.00
$30.00 per
per direct
direct labor
laborhour.
hour.

Overhead is overapplied
for the year by
$20,000. What will
Glass Creations do?
SOLUTION
SOLUTION
Applied
Applied Overhead
Overhead == POHR
POHR××Actual
ActualDirect
DirectLabor
LaborHours
Hours
Applied
Applied Overhead
Overhead == $30.00
$30.00 per
perDLH
DLH××13,000
13,000DLH
DLH== $390,000
$390,000
Job Order And Batch Costing
Glass Creations’ Method

$20,000 $20,000 may be

may be allocated closed directly to
to these accounts. cost of goods sold.

OR
Work in Finished
Process Goods

Cost of Cost of
Goods Sold Goods Sold
 Process Costing
Production environment
 Homogenous units
 Mass produced
 Automated
 Continuous flow

Costing procedure
 Costs are recorded for a department.
 Department costs are assigned equally to units produced.
 Process Costing
Comparing Job Costing and Process Costing
Job costing
 Costs accumulated by the
job.
 Work in process has a job
cost record for each job.
 Many unique, high cost
jobs.
 Jobs built to customer
order.
Process costing
 Costs accumulated by
department or process.
 Work in process has a
production report for each
batch of products.
 A few identical, low cost
products.
 Units continuously
produced for inventory in
automated process.
 Process Costing
Job Order
Work in process contains
individual jobs in a
job cost system.
Direct Materials

Finished
Direct Labor Jobs Goods

ManufacturingO Cost of
verhead Goods
Sold
 Process Costing
Process Costing
Work in process contains
homogenous products in a
process cost system.
Direct Materials

Direct Labor Finished

& Overhead Products Goods
(Conversion)

Cost of
Goods
Sold
 Process Costing
Department With No Beginning or Ending WIP Inventory
No beginning or ending
Work in Process Inventory

Common when a company is

successful at just-in-time production

Cost per Manufacturing costs for a period

=
unit Units produced for the period
 Process Costing
Spirit Beverages produces a sport drink. During October, the
Blending Department had the following manufacturing costs:

Direct materials $16,000

Conversion costs 5,600
Total costs to be assigned $21,600
Spirit started and completed 8,000 four-bottle packages during
October. Spirit had no beginning work in process inventory.
Compute the manufacturing unit costs for October.

Direct materials $16,000 ÷ 8,000 units = $ 2.00

Conversion costs 5,600 ÷ 8,000 units = $ 0.70
Mfg. cost per completed unit $21,600 ÷ 8,000 units = $ 2.70
 Process Costing
Department With No Beginning But Have Ending WIP Inventory

No beginning Work in Process

Inventory

Ending Work in Process Inventory consists

of incomplete units at the end of the
period.

We must now deal with the concept

of equivalent units.
 Process Costing
Department With No Beginning But Have Ending WIP Inventory

We must now deal with the concept

of equivalent units.

Equivalent units is a concept expressing

partially complete units as a smaller number
of fully complete units.

Cost per
Manufacturing costs for a period
equivalent =
Equivalent units for the period
unit
 Process Costing
• Equivalent
Unit Two one-half filled cups are
equivalent to one full cup.

+ =
So, 10,000 units 70 percent complete
are equivalent to 7,000 complete units.
 Process Costing
Assigning Costs to Products – The Five-Step Process
Summarize the flow of physical units (number of units
completed and number of units remaining in process).
Compute the number of equivalent units produced.
Summarize the total costs to be accounted for (costs in
beginning work in process inventory and the costs incurred in the
current period).
Compute costs per equivalent unit.
Assign unit costs from  to units completed and to units in
ending work-in-process inventory
 Process Costing
Sample :
Spirit incurred the following manufacturing costs in October (same data as
before):

Direct materials $16,000

Conversion costs 5,600
Total costs to be assigned $21,600
Spirit started 8,000 units and completed 6,000 units in October. Spirit had
no beginning work in process inventory. All direct materials had been added
to each unit still in process, but only 20 percent of conversion costs had been
incurred for the 2,000 units still in process.
Complete the five-step process to assign
costs to units produced in October.
 Department With Ending WIP
Inventory – Equivalent Units

Step 1 Step 2
Physical Equivalent Units
Flow of Units in October Units Material Conversion
Units to account for
Beginning work in process inventory 0
Units started this period 8,000
Total units to account for 8,000
Units accounted for
Completed and transferred out 6,000 ? ?
Ending work in process inventory 2,000 ? ?
Total units accounted for 8,000 ? ?
 Department With Ending WIP Inventory –
Equivalent Units
Step 1 Step 2
Physical Equivalent Units
Flow of Units in October Units Material Conversion
Units to account for
Beginning work in process inventory 0
Units started this period 8,000
Total units to account for 8,000
Units accounted for
Completed and transferred out 6,000 6,000 6,000
Ending work in process inventory 2,000 ? ?
Total units accounted for 8,000 ? ?

Units completed and transferred are 100%

complete for both material and conversion.
 Department With Ending WIP Inventory –
Equivalent Units

Step 1 Step 2
Physical Equivalent Units
Flow of Units in October Units Material Conversion
Units to account for
Beginning work in process inventory 0
Units started this period 8,000
Total units to account for 8,000
Units accounted for
Completed and transferred out 6,000 6,000 6,000
Ending work in process inventory 2,000 2,000 ?
Total units accounted for 8,000 8,000 ?

All material had been added to

units remaining in process.
 Department With Ending WIP Inventory –
Equivalent Units
Flow of Costs in October Material Conversion Total
Costs to account for (Step 3)
Costs in beginning work in process inventory $ 0 $ 0 $ 0
Current period costs 16,000 5,600 21,600
Total costs to account for $ 16,000 $ 5,600 $ 21,600

Equivalent Units 8,000 6,400

Costs per equivalent unit (Step 4) ? ? ?

Costs accounted for (Step 5)

Costs transferred ? ? ?
Cost of ending work in process inventory ? ? ?
Total costs accounted for ? ? ?
 Department With Ending WIP Inventory –
Equivalent Units
Step 1 Step 2
Physical Equivalent Units
Flow of Units in October Units Material Conversion
Units to account for
Beginning work in process inventory 0
Units started this period 8,000
Total units to account for 8,000
Units accounted for
Completed and transferred out 6,000 6,000 6,000
Ending work in process inventory 2,000 2,000 400
Total units accounted for 8,000 8,000 6,400

20% of 2,000 units

 Department With Ending WIP Inventory –
Equivalent Units
Flow of Costs in October Material Conversion Total
Costs to account for (Step 3)
Costs in beginning work in process inventory $ 0 $ 0 $ 0
Current period costs 16,000 5,600 21,600
Total costs to account for $ 16,000 $ 5,600 $ 21,600

Equivalent Units 8,000 6,400

Costs per equivalent unit (Step 4) $ 2.00 $ 0.875 $ 2.875

Costs accounted for (Step 5)

Costs transferred ? ? ?
Cost of ending work in process inventory ? ? ?
Total costs accounted for ? ? ?

$16,000 ÷ 8,000 equivalent units $5,600 ÷ 6,400 equivalent units

 Department With Ending WIP Inventory –
Equivalent Units
Flow of Costs in October Material Conversion Total
Costs to account for (Step 3)
Costs in beginning work in process inventory $ 0 $ 0 $ 0
Current period costs 16,000 5,600 21,600
Total costs to account for $ 16,000 $ 5,600 $ 21,600

Equivalent Units 8,000 6,400

Costs per equivalent unit (Step 4) $ 2.00 $ 0.875 $ 2.875

Costs accounted for (Step 5)

Costs transferred $ 12,000 $ 5,250 $ 17,250
Cost of ending work in process inventory ? ? ?
Total costs accounted for ? ? ?

6,000 equivalent units @ $2.00 6,000 equivalent units @ $0.875

 Department With Ending WIP Inventory –
Equivalent Units
Flow of Costs in October Material Conversion Total
Costs to account for (Step 3)
Costs in beginning work in process inventory $ 0 $ 0 $ 0
Current period costs 16,000 5,600 21,600
Total costs to account for $ 16,000 $ 5,600 $ 21,600

Equivalent Units 8,000 6,400

Costs per equivalent unit (Step 4) $ 2.00 $ 0.875 $ 2.875

Costs accounted for (Step 5)

Costs transferred $ 12,000 $ 5,250 $ 17,250
Cost of ending work in process inventory 4,000 350 4,350
Total costs accounted for $ 16,000 $ 5,600 $ 21,600

2,000 equivalent units @ $2.00 400 equivalent units @ $0.875

 Activity Based Costing
Traditional Costing Systems
Traditional cost systems were created when manufacturing
processes were labor intensive
A single company-wide overhead rate, based on direct labor hours,
may be used to allocate overhead to products in these labor
intensive processes
For Example : Overhead is allocated to jobs using direct labor
hours. If overhead is $120, how much overhead is allocated to each
job? The allocationhours for jobs as follows :
 Activity Based Costing
Overhead Rate = $120 ÷ 8 direct labor hours
Overhead Rate = $15 per direct labor hour
Job 1 = 2 hours × $15 per hour = $30
Job 2 = 6 hours × $15 per hour = $90

Automation increases overhead from $120 to $420 and reduces the Job 2
labor hours from 6 to 1. Allocate the $420 overhead to the two jobs using
direct labor.

Overhead Rate = $420 ÷ 3 direct labor hours

Overhead Rate = $140 per direct labor hour
Job 1 = 2 hours × $140 per hour = $280
Job 2 = 1 hour × $140 per hour = $140

Is this reasonable?
Automation benefited Job 2, but Job 1 is allocated more overhead. Clearly,
we need
another cost driver to allocate overhead.
 Activity Based Costing
• Activity Based-Costing is a costing method that
first assigns costs to activities, then assigns costs
to products based on their use of the activities

Products Activities
Require Consume
Activities Resources

People
Manage
Activities
 Activity Based Costing
Traditional Activity-Based
Costing Costing
Resource Costs Resource Costs

Directly Directly
traced traced
or allocated or allocated

Cost Pools: Cost Pools:

Plants or Activities or
Departments Activity Centers

Predetermin Cost
ed driver
overhead rates for
rate each
activity
Cost Objects Cost Objects
Activities that cause costs to be incurred
are called COST DRIVERS
Cost Driver Examples
Activity Cost Driver
Machining operations Machine hours
Setup Setup hours
Production scheduling Manufacturing orders
Inspection Pieces inspected
Purchasing Purchase orders
Shop order handling Shop orders
Valve assembly support CustomerRequisitions
 Activity Based Costing
 An Activity Cost Pool is a “container” in which costs are
accumulated that relate to a single activity in the ABC system
 Four Steps in the ABC Process
 Identify and classify the activities related to the company’s
products or services.
 Estimate the cost of each activity identified in .
 Calculate a cost-driver rate for each activity.
 Assign activity costs to products using the cost-driver rate.
 Activity Based Costing
1. Identify and Classify Activities
UNIT-LEVEL ACTIVITES
Resources acquired and activities performed for individual units.

BATCH-LEVEL ACTIVITES
Resources acquired and activities performed for a group or
batch of similar products or services.
PRODUCT-LEVEL ACTIVITES
Resources acquired and activities performed to produce and
sell a specific product or service.

CUSTOMER-LEVEL ACTIVITES
Resources acquired and activities performed to serve specific
FACILITY-LEVEL ACTIVITIEScustomers.
Resources acquired and activities performed to provide general
capacity to produce goods or services.
 Activity Based Costing
2. Estimate the Cost of Activities

The ABC teams should gather data on the costs of all the
activities identified in Step 1.

Examine
Examine Ask
Askemployees
employees
accounting
accounting to
to indicatehow
indicate how
records
recordsfor
for much time
much time
recorded
recordedcost
cost they
theywork
workon on
information.
information. various
various
activities.
activities.
 Activity Based Costing

3. Calculate Cost-Driver Rates for Activities

Two
Twopieces
piecesof
of
information
informationareare
required
requiredto tocompute
compute
the
thecost-driver
cost-driverrate:
rate:
••Activity
ActivityCost
Cost
••Activity
ActivityVolume
Volume

MAY
MAYCompany
Companyhas has44employees
employeesininits
itsQuality
QualityControl
Control
Department.
Department.Salaries
Salariesand
andcosts
costsfor
forthe
thedepartment
departmenttotal
total
$360,000
$360,000per
peryear.
year. MAY
MAYproduces
produces500,000
500,000units
unitsof
ofproduct
productaa
year.
year. What
Whatisisthe
thecost-driver
cost-driverrate
rateper
perunit?
unit?
$360,000
$360,000÷÷500,000
500,000units
units==$.72
$.72per
perunit
unit
 Activity Based Costing
 MAY has a customer service center where customers can call to ask
questions. Customers pay a fixed fee for each call they make to the
service center. It costs MAY $1,260,000 a year to operate the center.
The center receives 120,000 calls per year. The center handles
1,000,000 minutes of calls.What is the appropriate cost driver; total
minutes for all calls or number of calls? What is the cost-driver rate?
 Since customers are charged “per call”, the proper activity in this
case is the number of calls handled by the center.
The cost-driver rate would be:
$1,260,000 ÷ 120,000 calls = $10.50 per call
 Activity Based Costing

4. Assign Activity Costs to Products

1.Identify all the activities related to a given product or
service.
2.Determine how many units of each activity are used per
unit of product
3.Assign costs to products using the cost-driver rates for each
activity.
 Activity Based Costing
Exsample
Example: Yazz, Inc. produces 130,000 units of Product A and 400,000
units for Product B. Using the following cost information, how much
overhead should be allocated to Product A?
Activity Based Costing
 Activity Based Costing
Product A Product B
Volume 5,000 25,000
ABC Sales Price $ 195.00 $ 156.00

Costing Sales Revenue

Direct Material $ 40.00
$ 975,000
200,000 $ 29.00
$ 3,900,000
725,000
Conversion 217.50 1,087,500 49.50 1,237,500
Gross Margin $ (62.50) $ (312,500) $ 77.50 $ 1,937,500
Customer Service Costs 200,000 300,000
Product operating income $ (512,500) $ 1,637,500

Product A Product B
Volume 5,000 25,000
Sales Price $ 195.00 $ 156.00

Sales Revenue $ 975,000 $ 3,900,000

Direct Material
Direct Labor
$ 40.00
30.00
200,000
150,000
$ 29.00
25.00
725,000
625,000
Traditional
Overhead 60.00 300,000 50.00 1,250,000 Costing
Gross Margin $ 65.00 $ 325,000 $ 52.00 $ 1,300,000
Customer Service Costs 100,000 400,000
Product operating income $ 225,000 $ 900,000
 Activity Based Costing
When Should a Company Use ABC?
Indirect costs are significant in proportion to direct costs.
Goods are complex, requiring many inputs and processes.
Complex, low-volume products are profitable while standard, high-volume
products are not.
Different departments believe costs are assigned inaccurately.
The company loses bids it thought were low, and wins bids it thought
were high.
Operations have changed significantly, but the costing system has not
changed.
Introduction of new models result in higher sales, apparent profits per
unit, but an overall income decline.
 TOPICS : Overhead Allocation
1. Allocating Support Department Costs to Producing
Departments
 Direct method, Sequential (Step) Method,
Reciprocal Method
2. Choosing a Support Department Cost Allocation
Method
3. Accounting for Joint Production Processes & cost
allocation
 Allocating Support Department Costs to
Producing Departments
Allocating One Department’s Costs to Another Department
• The costs of a support department are often
allocated through the use of a charging rate.
• Major factors of rate selection:
– Choice of single or dual rate
– Use of budgeted or actual support department
costs.
 Allocating Support Department
Costs to Producing Departments
 Single-rate method – allocates costs in each cost pool
(service department) to cost objects (production
departments) using the same rate per unit of a single
allocation base
 No distinction is made between fixed and variable
costs in this method
 Single-Rate method is simple to implement, but
treats fixed costs in a manner similar to variable
costs
Allocating Support Department Costs to
Producing Departments
 Dual-Rate method – segregates costs within each
cost pool into two segments: a variable-cost pool
and a fixed-cost pool.
 Each pool uses a different cost-allocation base
 Dual-Rate method treats fixed and variable
costs more realistically, but is more complex to
implement
Allocating Support Department Costs to Producing
Departments

Single = Fixed costs + estimated variable costs

rate estimated usage

Dual rate: Fixed rate and a variable rate

 Developing a fixed rate
 Determine budgeted fixed costs
 Compute allocation ratio
 Allocate
 Developing the variable rate
 Depends on the costs that change as the activity driver
changes
Allocating Support Department Costs to Producing
Departments
Single Rate Method
Department No of Copies X Total Rate = Allocated Cost

Audit 94.500 $ 0.12 $ 11.340

Tax 67.500 0.12 8.100
MAS 108.000 0.12 12.960
Total 270.000 $ 32.400

Dual Rate Method

Department No of Copies X Variable + Fixed = Allocated Cost
Rate Allocation
Audit 94.500 $ 0.0.23 $ 9.167 $ 11.340
Tax 67.500 0.0.23 6.548 8.100
MAS 108.000 0.0.23 10.476 12.960
Total 270.000 $ 32.400
Allocating Support Department Costs to Producing
Departments
Methods of Allocating Support Costs to Production Departments :
Direct method
 Costs are allocated only to producing departments
Sequential (step) method
 Costs allocations are performed in a step-down fashion, using
predetermined ranking procedures (e.g., degree of support)
Reciprocal method
 Recognizes interactions of support departments prior to
allocation to producing departments
Allocating Support Department Costs to Producing
Departments

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000

Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied
Allocating Support Department Costs to Producing
Departments
Allocation base: Square feet occupied

25,000
$90,000 = $30,000
× 25,000 + 50,000

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 0 144,000 216,000
Custodial allocation 0 (90,000) 30,000 60,000
Total after allocation $ 0 $ 0 $ 574,000 $ 976,000

20 30
$360,000 = $144,000 $360,00 = $216,000
× 20 + 20 +
0×
30 30
Allocation base: Number of employees
Allocating Support Department Costs to Producing
Departments

• Sequential (Step) Method

Service department Service Production
Department Department
costs are allocated (Cafeteria) (Machining)
to other service
departments and
to production
departments, usually
starting with the
service department Service Production
that provides the Department Department
greatest amount of (Custodial) (Assembly)
service to other
departments.
Allocating Support Department Costs to Producing
Departments

• Sequential (Step) Method

Service Production
Department Department
(Cafeteria) (Machining)
Once a service
department’s costs
are allocated,
other service
department costs
are not allocated Service Production
back to it. Department Department
(Custodial) (Assembly)

107
Allocating Support Department Costs to Producing
Departments

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000

Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied
Allocating Support Department Costs to Producing
Departments

 Sequential (Step) Method

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation ? ? ? ?
Custodial allocation ? ? ? ?
Total after allocation ? ? ? ?
Allocating Support Department Costs to Producing
Departments
Service Departments Production Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation ? ? ? ?
Total after allocation ? ? ? ?

10 20 30
$360,000 x 10 + 20 + = $60,000 $360,000 × 10 + 20 + = $120,000 $360,000 × = $180,000
10 20+30
30 30

Allocation base: Number of employees

Allocating Support Department Costs to Producing
Departments

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation ? (150,000) ? ?
Total after allocation ? $ 0 ? ?

New total = $90,000 original custodial cost

plus $60,000 allocated from the cafeteria.
Allocating Support Department Costs to Producing
Departments

Service Departments Production Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation 0 (150,000) 50,000 ?
Total after allocation $ 0 $ 0 $ 570,000 ?

25,000
$150,000 × = $50,000
25,000 + 50,000

Allocation base: Square feet occupied

 Choosing a Support Department Cost
Allocation Method
Support Departments Production Departments
Reciprocal Method

•Allocates support department costs to

Information Systems

Manufacturing
operating departments by fully
recognizing the mutual services provided
among all support departments

Packaging
•Full Two-Way Interaction between
Support Departments prior to allocation
Accounting

113
Choosing a Support Department Cost
Allocation Method
Recirpocal Method - Example
 Choosing a Support Department Cost
Allocation Method
• Reciprocal is the most precise
• The Reciprocal Method is more thorough in considering
interactions among service departments
• Direct and Step-Down are simple to compute and understand
• The Step Method considers some interactionsamong service
departments.
• Direct Method is widely used
• The Direct Method does not consider interactions among service
departments
Accounting for Joint Production Processes
& cost allocation
 Joint products are two or more products produced
simultaneously by the same process up to a “split-off” point.
 The split-off point is the point at which the joint products
become separate and identifiable.
 Separable costs are easily traced to individual products and
offer no particular problem.

Condernsed

Cow Milk

Chese
Accounting for Joint Production Processes
& cost allocation
 The distinction between joint and by-products rests solely on the
relative importance of their sales value.
 A by-product is a secondary product recovered in the course of
manufacturing a primary product.
 Joint costs are not typically allocated
 Sales revenue is classified as “other income”
 Post-split-off processing costs are deducted from sales revenue
Accounting for Joint Production Processes
& cost allocation
Joint Cost Allocation Methods
Physical Units Method
 Presumes that each unit of the final product costs as much to produce as
any other
Weighted Average Method
 Applies weight factors to reflect differing materials, complexity, time, etc.
Physical Units Method
 Presumes that each unit of the final product costs as much to produce as
any other
Weighted Average Method
 Applies weight factors to reflect differing materials, complexity, time, etc.
Accounting for Joint Production Processes
& cost allocation
A sawmill processes logs into four grades of
lumber and incurs total joint costs of $186,000

Percent Joint Cost

Grades Board Feet of Units Allocation
First and second 450,000 15.00% $ 27,900
No. 1 common 1,200,000 40.00% 74,400
No. 2 common 600,000 20.00% 37,200
No. 3 common 750,000 25.00% 46,500
3,000,000 $ 186,000
Accounting for Joint Production Processes
& cost allocation
A peach canning factory purchases $5,000 of peaches and
grades and cans them by quality.

Weighted Joint
Number Weight Number Cost
Grades of Cases Factor of Cases Percent Allocation
Fancy 100 1.30 130 21.67% $ 1,083
Choice 120 1.10 132 22.00% 1,100
Standard 303 1.00 303 50.50% 2,525
Pie 70 0.50 35 5.83% 292
600 $ 5,000
Accounting for Joint Production Processes
& cost allocation
Join Cost Allocation Method

Sales-Value-at-Split-Off-Method
 Allocates joint cost based on each product’s proportionate
share of sales value at split-off
Net Realizable Value Method
 Allocates joint cost based on hypothetical market price
(eventual market value minus processing costs beyond
split-off)
Constant Gross Margin Percentage Method
 Allocates joint costs such that the gross margin is the
same for each
Accounting for Joint Production Processes
& cost allocation
Sales-Value-at-Split-Off Method

A sawmill processes logs into four grades of lumber and incurs

total joint costs of $186,000:
Price at
Split-Off
(per 1,000 Sales Value Joint Cost
Grades Board Feet board ft.) at Split-Off Percent Allocation
First and second 450,000 $ 300 135,000 26.99% $ 50,201
No. 1 common 1,200,000 200 240,000 47.99% 89,261
No. 2 common 600,000 121 72,600 14.52% 27,007
No. 3 common 750,000 70 52,500 10.50% 19,530
3,000,000 500,100 $ 185,999
does not sum to $186,000 due to rounding
Accounting for Joint Production Processes
& cost allocation
Net Realizable Value Method
A company manufactures two products, Alpha and Beta, from a
joint process. One production run costs $5,750 and results in
1,000 gallons of Alpha and 3,000 gallons of Beta. The separable
cost for Alpha is $1 per gallon and for Beta is $2 per gallon.

Further
Market Processing Hypothetical Number Hypothetical Allocated
Price Cost Market Price of Units Market Value Percent Joint Cost
Alpha $5 $1 $4 1,000 $ 4,000 40.0% $ 2,300
Beta 4 2 2 3,000 6,000 60.0% 3,450
$ 10,000 $ 5,750
Accounting for Joint Production Processes
& cost allocation
• Constant Gross Margin Method
Revenue:
Alpha ($5 × 1,000) $ 5,000
Beta ($4 × 3,000) 12,000 $ 17,000 100%
Costs
Alpha ($1 × 1,000) $ 1,000 .
Beta ($2 × 3,000) 6,000
Joint costs 5,750 12,750 75% Determine gross margin
Gross Margin $ 4,250 25% percentage
Alpha Beta
Eventual market value $ 5,000 $ 12,000
Less: Gross margin at 25% (1,250) (3,000)
Joint cost Cost of goods sold $ 3,750 $ 9,000
allocation Less: seperable costs (1,000) (6,000)
Allocated joint costs $ 2,750 $ 3,000
 TOPICS : Decision Making and
Relevant cost
1. Relevant vs irrelevant cost
2. type of decision
 One-Time-Only Special Orders
 Make or Buy
 Continue or Drop
 Replacement Equipment
The Meaning of Relevance

 Relevant Information has two characteristics:

 It occurs in the future
 It differs among the alternative courses of action
 Relevant Costs – expected future costs
 Relevant Revenues – expected future revenues

Relevant costs and relevant revenues are expected future

costs and revenues that differ among alternative
courses of action.
 Irrelevant Cost

• Historical costs are past costs that are irrelevant

to decision making
– Also called Sunk Costs
 Types of Decisions
• One-Time-Only Special Orders
• Make or Buy
• Product-Mix
• Customer Profitability
• Branch / Segment: Adding or Discontinuing
• Equipment Replacement
 One-Time-Only Special Orders
• Accepting or rejecting special orders when there is
idle production capacity and the special orders has
no long-run implications
• Decision Rule: does the special order generate
additional operating income?
– Yes – accept
– No – reject
• Compares relevant revenues and relevant costs to
determine profitability
 One-Time-Only Special Orders

Ex-sample
Variable Fixed
The Bismark Co. manufacturing plant has a Costs Costs
production capacity of 44,000 towels each Per Unit Per Unit
month. Current monthly production is 30,000 Direct materials $6.50 $ -0-
Direct labor .50 1.50
towels. Costs can be classified as either variable Manufacturing costs 1.50 3.50
or fixed with respect to units of output. Total $8.50 $5.00

• Total fixed direct manufacturing labor is

$45,000.
• Total fixed direct manufacturing labor is Variable ($8.50 + $5.00): $13.50
$45,000. Fixed: : 7.00
Total : $20.50
• Marketing costs per unit are $7 ($5 of which is
variable).
• What is the full cost per towel?
 One-Time-Only Special Orders

A hotel in San Juan has offered to buy 5,000 towels

from Bismark Co. at $11.50/towel for a total of
$57,500. Take it or no.

What are the relevant costs of making the towels ?

incremental costs  $8.50 × 5,000 = $42,500
What are the incremental revenues ?
$57,500 – $42,500 = $15,000
 RELEVANT VS. IRRELEVANT COSTS
Cost Not to Differential
Cost to Make Make Cost
Direct labor $ 150,000 --- $ 150,000
Depreciation 125,000 $ 125,000 ---
Allocated lease 12,000 12,000 ---
$ 287,000 $ 137,000 $150,000

Direct labor is the relevant cost because it differs

between alternatives.
 Make or Buy
Example
• Thor Co. manufactures 20,000 of part 457 that is currently used in
one of its products. The costs to make this part are:

Direct materials/unit $ 9.00 Direct

Directmaterials
materials $$ 9.00
9.00
Direct
Directlabor
labor 5.00
5.00
Direct labor/unit 5.00
Variable
Variableoverhead
overhead 1.00
1.00
Variable overhead/unit 1.00 Fixed
Fixedoverhead
overhead($180,000
($180,000÷÷20,000)
20,000) 9.00
9.00
Fixed overhead 180,000 Common
Commoncosts
costs($100,000
($100,000÷÷20,000)
20,000) 5.00
5.00
Allocated common costs 100,000 Unit
Unitcost
cost $$29.00
29.00

Fixed manufacturing overhead is the cost of leasing and

operating the equipment necessary to produce part 457.
 Make or Buy
Common costs are allocated on the basis of direct labor hours.
Total unit cost of $29 is based on 20,000 parts produced each
year. An outside supplier has offered to provide the 20,000
parts at a cost of $25 per part. Should we accept the supplier’s
offer?
 Make or Buy
20,000 × $25
purchase price

The common costs

20,000 × $29 remain unchanged.
per unit

Should we make or buy

part 457?
 Make or Buy

• If Thor could use the space currently being used to

make Part 457 for another purpose, resulting in a cost
savings of $45,000, would you change your decision?
 Yes. The cost savings (opportunity cost) of $45,000
overcomes the $20,000 disadvantage of buying.
Now there is a $25,000 advantage to buying.

• Key : The real issue is the most profitable use of the

space.
 Continue or Drop
Segment Income Statement
Digital Watches
Sales $ 500,000
Less: variable expenses
Variable mfg. costs $ 120,000
Variable shipping costs 5,000
Commissions 75,000 200,000
Contribution margin $ 300,000
Less: fixed expenses
General factory overhead $ 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Advertising - direct 100,000
Rent - factory space 70,000
General admin. expenses 30,000 400,000
Net loss $ (100,000)

If the digital watch line is dropped, the fixed general factory

overhead and general administrative expenses will be
allocated to other product lines.
 Continue or Drop

The equipment used to manufacture digital watches has no

resale value or alternative use.
Should Market retain or drop the digital watch line?
Market Company
Solution
Contribution margin lost if digital
watches are dropped $ (300,000)

Less fixed costs that can be avoided

Salary of the line manager $ 90,000
Advertising - direct 100,000
Rent - factory space 70,000 260,000
Net disadvantage $ (40,000)
 Continue or Drop
Differential Analysis
Solution • Keeping the Digital Watch product
Keep Drop line may have an opportunity cost
Digital Digital
Watches Watches Difference that we have not yet considered.
Sales $ 500,000 $ - $ (500,000)
Less variable expenses: -
• The opportunity cost of retaining
Mfg. expenses 120,000 - 120,000 the digital watch line is measured
Freight out 5,000 - 5,000 by the differential profits given up
Commissions 75,000 - 75,000
Total variable expenses 200,000 - 200,000 if the next best use of the
Contribution margin 300,000 - (300,000) production facilities is rejected.
Less fixed expenses:
General factory overhead 60,000 60,000 - • Example: If the idled facilities can
Salary of line manager 90,000 - 90,000 be used to make a product
Depreciation 50,000 50,000 -
Advertising - direct 100,000 - 100,000 generating $350,000 per year in
Rent - factory space 70,000 - 70,000 contribution margin, with no
General admin. expenses 30,000 30,000 -
Total fixed expenses 400,000 140,000 260,000
other change in fixed costs, might
Net loss $ (100,000) $ (140,000) $ (40,000) this change your decision?
 Replacement Equipment
 Old machine cost $5,400 when purchased.
 Old machine has a book value of $1,500.
 Purchase price of a new machine is $10,000.
 New machine will reduce labor from $12.00 to $11.00 per unit.
 New machine is expected to last two years.
 Repairs to old machine would be $4,600 and would allow two more years
of productivity.
 Power for either machine is expected to be $2.50 per unit.
 Expected level of output: 1,000 units per year.

Which costs are relevant to the decision to replace an old machine

with a new machine
 Replacement Equipment
Which costs are relevant to the decision to replace an
old machine with a new machine?
 Old
Oldmachine
machinecostcost$5,400
$5,400when
whenpurchased.
purchased.
 Old
Oldmachine
machinehas hasaabook
bookvalue
valueofof$1,500.
$1,500.
 Purchase
Purchaseprice
priceofofaanew
newmachine
machineisis$10,000.
$10,000.
 New
Newmachine
machinewillwillreduce
reducelabor
laborfrom
from$12.00
$12.00toto
Relevant
$11.00
$11.00per
perunit.
unit.
because
 New
Newmachine
machineisisexpected
expectedto tolast
lasttwo
twoyears.
years.
of labor  Repairs
Repairsto
toold
oldmachine
machinewould
wouldbe be$4,600
$4,600and
and
savings would
wouldallow
allowtwo
twomore
moreyears
yearsof ofproductivity.
productivity.
over the  Power
Powerfor
foreither
eithermachine
machineisisexpected
expectedto tobe
be
2-year life. $2.50
$2.50per
perunit.
unit.
 Expected
Expectedlevel
levelofofoutput:
output: 1,000
1,000units
unitsper
peryear
year
 Replacement Equipment
1,000 units @ $12.00 for 2 years

1,000 units @ $11.00 for 2 years

Keep Old Replace old

Cost Machine Machine
Labor $ 24,000 $ 22,000
Repair cost 4,600
Purchase cost 10,000
Total $ 28,600 $ 32,000

Conclusion: keep old machine.

 TOPICS : Cost management &
Management strategic
1. Value Chain
2. Lean Manufacturing
3. Just In Time
4. Theory of Constraint.
 Value Chain

• Value Chain is the sequence of business functions

in which customer usefulness is added to products
or services
• The Value-Chain consists of:
1. Research & Development
2. Design
3. Production
4. Marketing
5. Distribution
6. Customer Service
Value Chain
Value Chain

Key Success Factors

 The dimensions of performance that customers expect, and that
are key to the success of a company include:
 Cost and efficiency
 Quality
 Time
 Innovation
Lean Manufacturing

• An operating approach designed to eliminate waste

and maximize customer value.
• Characterized by delivering
– The right product…
– In the right quantity…
– With the right quality (zero-defect)…
– At the exact time the customer needs it…
– At the lowest possible cost.
 Lean Manufacturing
• Principles of Lean Thinking:
– Precisely specify value by each particular
product.
– Identify the “value stream.”
– Make value flow without interruption.
– Let the customer pull value from the
producer.
– Pursue perfection.
Value by Product
 Value is determined by the customer
 The value of a product to customer is the difference between
realization and sacrifice
 Realization is what a customer receives.
 Sacrifice is what the customer gives up for the basic and
special product features, quality, brand name, and
reputation.
 Lean Manufacturing
Value Stream
 The value stream is made up of all activities, both value-added and non-
value-added, required to bring a product group or service from its starting
point to a finished product in the hands of the customer.
 Non-value-added activities are the source of waste
 Activities avoidable in the short run
 Activities unavoidable in the short run due to current technology or
production methods.
 Types of value streams
 Order fulfillment
 New product value stream
 Sales and marketing value stream
 Lean Manufacturing
Identifying value streams
 Two-dimensional matrix
 Activities/processes on one dimension
 Products on the second dimension

Value flow
 Reduced setup/changeover times
 Reduces waste due to move time and wait time
 Enables production of smaller batches in greater variety
 Lean Manufacturing

Pull Value
• Lean manufacturing uses a demand-pull system, where
the production is triggered by the customer order
• Eliminates waste by producing a product only when it
is needed and only in the quantities demanded by
customers
– No production takes place until a signal from a succeeding
process indicates a need to produce
 Lean Manufacturing

Pull Value (con’t)

• Customer demand extends back through the
value chain
• Affects how a manufacturer deals with suppliers
– JIT purchasing requires suppliers to deliver parts and
materials just in time to be used in production
– Supply of parts must be linked to production, which is
linked to demand.
 Lean Manufacturing

Pull Value (con’t)

• Customer demand extends back through the value
chain
• Affects how a manufacturer deals with suppliers
– JIT purchasing requires suppliers to deliver parts and
materials just in time to be used in production
– Supply of parts must be linked to production, which is
linked to demand.
 Lean Manufacturing
Pull Value (con’t)
 JIT purchasing exploits supplier linkages
 Negotiate long-term contracts with a few chosen suppliers
located as close to the production facility as possible
 Establish more extensive supplier involvement
 Vendor selection
 Not on the basis of price alone
 The quality of the component, the ability to deliver as needed,
and the commitment to JIT purchasing are vital considerations
 Establish a partners-in-profits relationship with suppliers
 Lean Manufacturing

Pursue Perfection
• Identify and eliminate sources of waste
• Employee empowerment
• Total quality control
• Inventory management
• Activity-based management
 Lean Accounting

• Accounting practice should closely follow changes in

the operation of a business
• Traditional cost management systems may not work
well in the lean environment. Changes in structural
and procedural activities for lean manufacturing
change
– Product-costing
– Operational control
 Lean Accounting
• Accounting practice should closely follow changes in
the operation of a business
• Traditional cost management systems may not work
well in the lean environment. Changes in structural
and procedural activities for lean manufacturing
change
– Product-costing
– Operational control
 Lean Accounting
Traceability of Overhead Costs
 In a lean environment, many overhead costs
assigned to products using either driver tracing or
allocation are now directly traceable to products.
 Increasing directly traceable costs yields increased
accuracy of product costing
 Lean Accounting
Multiple Products (con’t)
• Product costs for value streams are calculated
using an actual average cost
• Average costs are usually calculated weekly and
are based on actual costs
 Lean Accounting
Traceability of Overhead Costs
 In a lean environment, many overhead costs
assigned to products using either driver tracing
or allocation are now directly traceable to
products.
 Increasing directly traceable costs yields
increased accuracy of product costing
 Lean Accounting
Traceability of Overhead Costs
 In a lean environment, many overhead costs
assigned to products using either driver tracing
or allocation are now directly traceable to
products.
 Increasing directly traceable costs yields
increased accuracy of product costing
 Just In Time
Ordering Costs: The costs of placing and receiving an
order.
Examples: Clerical costs, documents, insurance for shipment,
and unloading.

Setup Costs: The costs of preparing equipment and

facilities so they can be used to produce a particular
product or component.
Examples: Setup labor, lost income (from idled facilities), and
test runs.
 Just In Time
Stock-Out Costs: The costs of not having sufficient
inventory.
Examples: Lost sales, costs of expediting (extra setup,
transportation, etc.) and the costs of interrupted production.
Carrying Costs: The costs of carrying inventory.
Examples: Insurance, inventory taxes, obsolescence,
opportunity cost of capital tied up in inventory, and storage.
 Just In Time
Just in Time Management
JIT reduces the costs of acquiring inventory to
insignificant levels by
 Drastically reducing setup time
 Using long-term contracts for outside purchases
Carrying costs are reduced to insignificant levels by
reducing inventories to insignificant levels.
 Just In Time
Avoidance of Shutdown: the JIT approach
 Total preventive maintenance
 to reduce machine failures
 Total quality control
 To reduce defective parts
 The Kanban system (The Kanban system is
responsible for ensuring that the necessary products
are produced in the necessary quantities at the
necessary time.)
 To control production
 Theory of Constraint
• The theory of constraints (TOC) is a management paradigm
that views any manageable system as being limited in
achieving more of its goals by a very small number of
constraints. There is always at least one constraint, and TOC
uses a focusing process to identify the constraint and
restructure the rest of the organization around it. TOC adopts
the common idiom "a chain is no stronger than its weakest
link." This means that processes, organizations, etc., are
vulnerable because the weakest person or part can always
damage or break them or at least adversely affect the
outcome.
 Theory of Constraint
Measures of Systems Performance
– Throughput*
• The rate at which an organization generates money
through sales
– Inventory
• The money the organization spends in turning
materials into throughput
– Operating expenses
• The money the organization spends in turning
inventories into throughput

*Throughput =

Sales - Unit-level
Rev Var Exp 
Time
 Theory of Constraint

Five-Step Method for Improving Performance

1. Identify an organization’s constraints.
2. Exploit the binding constraints.
3. Subordinate everything else to the decisions made in Step 2.
4. Elevate the organization’s binding constraints.
5. Repeat the process as a new constraint emerges to limit output.