7 Cost Accounting System Collecting costs by some“natural” classificationsuch as materials or laborCostAccumulationCostAllocationTracing costs to one ormore cost objectives
8 Cost Accounting System RAW MATERIALCOSTS (METALSCost AccumulationCost Allocationto Cost Objects:1. Departments2. Activities3. ProductsMACHININGDEPARTMENTACTIVITY ACTIVITYFINISHINGDEPARTMENTACTIVITY ACTIVITYCABINETSCABINETSDESKSDESKSTABLESTABLES
9 CostA cost may be defined as a sacrifice or giving up of resources for a particular purpose.Costs are frequently measured by the monetary units that must be paid for goods and services.
10 Cost Objective What is a cost object or cost objective? It is anything for which a separate measurementof costs is desired.
11 Learning Objective 3Distinguish among direct,indirect, and unallocated costs.
12 Direct Costs What are direct costs? Direct costs can be identified specificallyand exclusively with a given costobjective in an economicallyfeasible way.
13 Indirect Costs What are indirect costs? Indirect costs cannot be identifiedspecifically and exclusively with agiven cost objective in an economicallyfeasible way.
14 What Distinguishes Direct and Indirect Costs? Managers prefer to classify costs as direct rather than indirect whenever it is “economically feasible” or “cost effective.”Other factors also influence whether a cost is considered direct or indirect.The key is the particular cost objective.
15 Categories of Manufacturing Costs Any raw material, labor, or other inputused by any organization could,in theory, be identified as adirect or indirect costdepending on thecost objective.
16 Categories of Manufacturing Costs All costs which are eventually allocated to products are classified as either…direct materials,direct labor, orindirect manufacturing.
17 Direct Material Costs...include the acquisition costs of all materials that are physically identified as a part of the manufactured goods and that may be traced to the manufactured goods in an economically feasible way.
18 Direct Labor Costs...include the wages of all labor that can be traced specifically and exclusively to the manufactured goods in an economically feasible way.
19 Indirect Manufacturing Costs... or factory overhead, include all costs associated with the manufacturing process that cannot be traced to the manufactured goods in an economically feasible way.
20 Product Costs...are costs identified with goods produced or purchased for resale.Product costs are initially identified as part of the inventory on hand.These costs, inventoriable costs, become expenses (in the form of cost of goods sold) only when the inventory is sold.
21 Period Costs...are costs that are deducted as expenses during the current period without going through an inventory stage.
22 Period or Product Costs In merchandising accounting, insurance, depreciation, and wages are period costs (expenses of the current period).In manufacturing accounting, many of these items are related to production activities and thus, as indirect manufacturing, are product costs.
23 Period Costs – Merchandising and Manufacturing In both merchandising and manufacturing accounting, selling and general administrative costs are period costs.
24 Learning Objective 4Explain how the financialstatements of merchandisersand manufacturers differbecause of the types of goodsthey sell.
25 Financial Statement Presentation – Merchandising Companies Balance SheetIncome StatementSales–MerchandiseInventoryExpirationCost of Goods Sold(an expense)Equals Gross Margin–Selling andAdministrativeExpensesPeriodCostsEquals Operating Income
26 Financial Statement Presentation – Manufacturing Companies Balance SheetIncome StatementSales–DirectMaterialInventoryExpirationCost of Goods Sold(an expense)Equals Gross Margin–Work-in-ProcessInventoryFinishedGoodsInventorySelling andAdministrativeExpensesPeriodCostsEquals Operating Income
27 Costs and Income Statements On income statements, the detailed reporting of selling and administrative expenses is typically the same for manufacturing and merchandising organizations, but the cost of goods sold is different.
28 Cost of Goods Sold for a Manufacturer The manufacturer’s cost of goods produced and then sold is usually composed of the three major categories of cost:Direct materialsDirect laborIndirect manufacturing
29 Cost of Goods Sold for a Retailer or Wholesaler The merchandiser’s cost of goods sold is usually composed of the purchase cost of items, including freight-in, that are acquired and then resold.
30 Learning Objective 5Understand the maindifferences between traditionaland activity-based costingsystems and why ABC systemsprovide value to managers.
31 Traditional Cost System DirectMaterialResourceDirectLaborResourceAllIndirectResourcesAllUnallocatedValue ChainCostsDirectTraceDirectTraceCostDriverProductsUnallocated
32 Two-Stage Activity-Based Cost System DirectMaterialResourceDirectLaborResourceOtherDirectResourcesIndirectResourceAIndirectResourceZAllUnallocatedValue ChainCosts%%%%DirectTraceDirectTraceActivity1Activity10CostDriverCostDriverProductsUnallocated
33 Activity-Based Costing Understanding the relationships among activities, resources, costs, and cost drivers is the key to understanding ABC and how ABC facilitates managers’ understanding of operations.
34 Activity-Based Costing Example of Activities and Cost Drivers:Activities:Account billingBill verificationAccount iniquityCorrespondenceCost Drivers:No. of linesNo. of accountsNo. of labor hoursNo. of letters
35 Learning Objective 6Identify the steps involved in thedesign and implementationof an activity-basedcosting system.
36 Designing and Implementing an Activity-Based Costing System Step 1Step 2Determine cost ofactivities, resources,and related costdrivers.Develop a process-basedmap representing the flowof activities, resources, andtheir interrelationships.
37 Designing and Implementing an Activity-Based Costing System Step 3Collect relevant data concerning costsand the physical flow of the cost-driverunits among resources and activities.
38 Designing and Implementing an Activity-Based Costing System Step 4Calculate and interpret the newactivity-based information.Using an activity-based costing system toimprove the operations of an organizationis activity-based management (ABM).
39 Activity-Based Management Activity-based management aims to improve the value received by customers and to improve profits by identifying opportunities for improvements in strategy and operations.
40 Activity-Based Management A value-added cost is the cost of an activity that cannot be eliminated without affecting a product’s value to the customer.In contrast, non-value-added costs are costs that can be eliminated without affecting a product’s value to the customer.
41 Learning Objective 7Use activity-based costinformation to improve theoperations of an organization.
42 Using ABC Information Activity-based management… provides costs of value-added andnon-value-added activities.improves managers’ understanding of operations.
43 Learning Objective 8Understand cost accounting’srole in a company’simprovement efforts acrossthe value chain.
44 Cost Accounting and the Value Chain A good cost accounting system is critical toall value-chain functions from research anddevelopment through customer service.
46 Activity-Based Management (ABM) Activity-based management (ABM) is a systemwide, integrated approach that focuses management’s attention on activities with the objective of improving customer value and the profit achieved by providing this value.Activity-based management encompasses both product costing and process value analysis.
47 Activity-Based Management Model Cost DimensionResourcesProcess DimensionDriver AnalysisActivitiesPerformance MeasuresWhy? What? How Well?Products andCustomers
48 Process Value Analysis Process value analysis is fundamental to activity-based responsibility accounting, focuses on accountability for activities rather than costs, and emphasizes the maximization of systemwide performance instead of individual performance.Process value analysis is concerned with:Driver analysisActivity analysisPerformance measurement
49 Activity Analysis Activity analysis should produce four outcomes: What activities are performed?How many people perform the activities?The time and resources required to perform the activities.An assessment of the value of the activities to the organization, including a recommendation to select and keep only those that add value.
50 Value-Added Activities A discretionary activity is classified as value-added provided it simultaneously satisfies three conditions:The activity produces a change of state.The change of state was not achievable by preceding activities.The activity enables other activities to be performed.
51 Nonvalue-Added Activities Nonvalue-Added Activities are activities that add cost and impedeperformance.SchedulingMovingWaitingInspectingStoringExamples
52 Activity Analysis Activity elimination Activity selection Activity Analysis Can Reduce Costs in Four Ways:Activity eliminationActivity selectionActivity reductionActivity sharing
53 Activity Performance Measurement Three Dimensions of Activity PerformanceEfficiencyQualityTime
54 Measures of Activity Performance Financial measures of activity efficiency include:Value and nonvalue-added activity cost reportsTrends in activity cost reportsKaizen standard settingBenchmarking
55 Economic Order Quantity, JIT, and the Theory of Contraints INVENTORY MANAGEMENTEconomic Order Quantity, JIT, and the Theory of Contraints1
56 Learning ObjectivesDescribe the traditional inventory management model.Describe JIT inventory management.Explain the basic concepts of constrained optimization.Describe the theory of constraints, and explain how it can be used to manage inventory.
57 Managing Inventories Inventory 60 Inventory, thousands of bricks 30 Average InventoryWeeks
58 The Appropriate Inventory Policy Two Basic Questions Must be AddressedHow much should be ordered or produced?When should the order be placed or the setup be performed?
59 InventoriesAs the firm increases its order size, the number of orders falls and therefore the order costs decline. However, an increase in order size also increases the average amount in inventory, so that the carrying cost of inventory rises. The trick is to strike a balance between these two costs.22
60 Basics of Traditional Inventory Management Inventory CostsOrdering or Setup CostsCarrying CostsStockout Costs3
61 Inventory CostsOrdering Costs: The costs of placing and receiving an orderExamples: clerical costs, documents, insurance for shipment, and unloading.Carrying Costs: The costs of carrying inventoryExamples: insurance, inventory taxes, obsolescence, opportunity cost of capital tied up in inventory, and storage.
62 Inventory Costs (continued) 3. Stock-Out Costs: The costs of not having sufficient inventoryExamples: lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of interrupted production.4. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or componentExamples: setup labor, lost income (from idled facilities), and test runs. When a firm produces the goods internally, ordering costs are replaced by setup costs.
63 Traditional Reasons for Carrying Inventory 1. To balance ordering or setup costs and carrying costs2. To satisfy customer demand (e.g., meet delivery dates)3. To avoid shutting down manufacturing facilities because of:a. machine failureb. defective partsc. unavailable partsd. late delivery of parts
64 Traditional Reasons for Carrying Inventory (continued) 4. Unreliable production processes5. To take advantage of discounts6. To hedge against future price increases
65 Inventories Determination of optimal order size Total costs Carrying costsInventory costs, dollarsTotal order costsOrder sizeOptimalorder size24
66 An Inventory Model Total Costs = Ordering costs + Carrying cost TC = PD/Q + CQ/2where TC = The total ordering (or setup) and carrying costP = The cost of placing and receiving an order (or the costof setting up a production run)Q = The number of units ordered each time an order isplaced (or the lot size for production)D = The known annual demandC = The cost of carrying one unit of stock for one yearEconomic order quantity (EOQ) = 2PD/C7
67 InventoriesEconomic Order Quantity - Order size that minimizes total inventory costs.23
68 Economic-Order-Quantity Decision Model The formula for the EOQ model is:EOQ =D = Demand in units for a specified time periodP = Relevant ordering costs per purchase orderC = Relevant carrying costs of one unit instock for the time period used for D
69 An EOQ Illustration EOQ = 2PD/C D = 1,000 units Q = 500 units P = $200 per orderC = $40 per unitEOQ = (2 x 200 x 10,000) / 40EOQ = 10,000EOQ = 100 units8
70 Economic-Order-Quantity Decision Model What are the relevant total costs?The formula for relevant total costs (RTC) is: RTC = Annual relevant ordering costs + Annual relevant carrying costs RTC = ( ) × P + ( ) × C =Q can be any order quantity, not just EOQ.QC2DQQ 2DP Q
71 Economic-Order-Quantity Decision Model 10,0008,000Annual relevant total costsRelevant Total Costs (Dollars)6,0005,434Annual relevant ordering costs4,000Annual relevant carrying costs2,000600988EOQ1,2001,8002,400Order Quantity (Units)
72 Considerations in Obtaining Estimates of Relevant Costs Obtaining accurate estimates of the cost parameters used in the EOQ decision model is a challenging task.What are the relevant incremental costs of carrying inventory?Only those costs of the purchasing company that change with the quantity of inventory held
73 Considerations in Obtaining Estimates of Relevant Costs What is the relevant opportunity cost of capital?It is the return forgone by investing capital in inventory rather than elsewhere.It is calculated as the required rate of return multiplied by those costs per unit that vary with the number of units purchased and that are incurred at the time the units are received.
74 Costs Associated with Goods for Sale Five categories of costs associated with goods for sale are:. Purchasing costs. Ordering costs. Carrying costs. Stockout costs. Quality costs
75 Reorder Point When Demand is Certain Reorder point = Rate of usage x Lead timeExample: Assume that the average rate of usage is 4 units per day for a component. Assume also that the time required to place and receive an order is 10 days. What is the reorder point?Reorder point = 4 x 10 = 40 unitsThus, an order should be placed when inventory drops to 40 units.
76 Reorder Point When Demand is Uncertain Reorder point = (Ave. rate of usage x Lead time) +Safety stockwhere:Safety stock = (Maximum usage - Average usage) xLead time
77 Reorder Point (continued) Example:Suppose that the maximum usage is 6 units per day and the average usage is 4 units per day. The lead time is 10 days.What is the reorder point?Safety stock = (6 - 4) x 10 = 20 unitsReorder point = (4 x 10) + 20 = 60 units
78 Reorder Point 988 Reorder Point Reorder Point 494 Weeks 1 2 3 4 5 6 7 Lead Time2 weeks
79 Reorder Point (no safety stock) Reorder point = Rate of usage x Lead time10080604020ROPTime9
80 Safety StockSafety stock is inventory held at all times regardless of the quantity of inventory ordered using the EOQ model.Safety stock is used as a buffer against unexpected increases in demand or lead time and unavailability of stock from suppliers.
81 Evaluating Managers and Goal-Congruence Issues Goal-congruence issues can arise when there is an inconsistency between the EOQ decision model and the model used to evaluate the performance of the manager implementing the inventory management decisions.
82 Traditional versus JIT Inventory Procedures Inventory ControlSystemTraditional SystemsJIT Systems1. Balance setup and carrying costs2. Satisfy customer demand3. Avoid manufacturing shutdowns4. Take advantage of discounts5. Hedge against future price increases1. Drive setup and carrying costs to zero2. Use due-date performance*3. Total preventive maintenance*4. Total quality control*5. The Kanban system*Rather than holding inventories as a hedge against plant-shutdowns,JIT attacks the plant-shutdown problem by addressing these issues.11
83 Just-In-Time Production Systems Just-in-time (JIT) production systems take a “demand pull” approach in which goods are only manufactured to satisfy customer orders.Demand triggers each step of the production process, starting with customer demand for a finished product at the end of the process, to the demand for direct materials at the beginning of the process.
84 Materials Requirement Planning (MRP) Materials requirements planning (MRP) systems take a “push-through” approach that manufactures finished goods for inventory on the basis of demand forecasts.MRP predetermines the necessary outputs at each stage of production.Inventory management is a key challenge in an MRP system.
85 JIT And Inventory Management Setup and Carrying Costs: The JIT Approach JIT reduces the costs of acquiring inventory to insignificant levels by:1. Drastically reducing setup time2. Using long-term contracts for outside purchasesCarrying costs are reduced to insignificant levels by reducing inventories to insignificant levels
86 JIT And Inventory Management Due-Date Performance: The JIT Solution Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand.Lead times are reduced by:reducing setup timesimproving qualityusing cellular manufacturing
87 JIT And Inventory Management Avoidance of Shutdown: The JIT Approach Total preventive maintenance to reduce machine failuresTotal quality control to reduce defective partsCultivation of supplier relationships to ensure availability of quality raw materials and subassembliesThe use of the Kanban system is also essential
88 JIT And Inventory Management Discounts and Price Increases: JIT Purchasing Versus Holding InventoriesCareful vendor selectionLong-term contracts with vendorsPrices are stipulated (usually producing a significant savings)Quality is stipulatedThe number of orders placed are reduced
89 Major Features of a JIT System The five major features of a JIT system are:Organizing production in manufacturing cellsHiring and retaining multi-skilled workersEmphasizing total quality managementReducing manufacturing lead time and setup TimeBuilding strong supplier relationships
90 Benefits of JIT Systems Benefits of JIT production:Lower carrying costs of inventoryEliminating the root causes of rework, scrap, waste, and manufacturing lead time.
91 Performance Measures and Control in JIT Production To manage and reduce inventories, the management accountant must design performance measures to control and evaluate JIT production.What information may management accountants use?Personal observation by production line workers and managersFinancial performance measures, such as inventory turnover ratios
92 Performance Measures and Control in JIT Production What are nonfinancial performance measures of time, inventory, and quality?Manufacturing lead timeUnits produced per hourDays’ inventory on handTotal setup time for machines/Total manufacturing timeNumber of units requiring rework or scrap/Total number of units started and completed
93 Backflush CostingA unique production system such as JIT often leads to its own unique costing system.Organizing manufacturing in cells, reducing defects and manufacturing lead time, and ensuring timely delivery of materials enables purchasing, production, and sales to occur in quick succession with minimal inventories.
94 Backflush CostingWhere journal entries for one or more stages in the cycle are omitted, the journal entries for a subsequent stage use normal or standard costs to work backward to flush out the costs in the cycle for which journal entries were not made.
95 Trigger Points Stage A: Purchase of direct materials Stage B: Production resulting in work in processStage C: Completion of a good finished unit orproductStage D: Sale of finished goods
96 Trigger Points Assume trigger points A, C, and D. This company would have two inventory accounts:Type Account Title Combined materials Inventory: Material and materials in work-in- and In-Process process inventory Control2. Finished goods Finished Goods Control
97 Trigger Points Assume trigger points A and D. This company would have one inventory account:Type Account Title Combines direct materials Inventory inventory and any direct Control materials in work-in-process and finished goods inventories
98 Special Considerations in Backflush Costing Backflush costing does not necessarily comply with GAAPHowever, inventory levels may be immaterial, negating the necessity for complianceBackflush costing does not leave a good audit trail – the ability of the accounting system to pinpoint the uses of resources at each step of the production process
99 What is the Kanban System? A Card System is used to monitor work-in-processA withdrawal KanbanA production KanbanA vendor Kanban12
100 The Withdrawal Kanban Item No. TVD-114 Preceding Process Item Name LCD Screen Computer AssemblyComputer Type Compaq 4/25Box Capacity Subsequent ProcessBox Type AD Final Assembly13
101 The Production Kanban Item No. TVD-114 Process Item Name LCD Screen Computer AssemblyComputer Type Compaq 4/25Box CapacityBox Type ___AD-194214
102 The Vendor Kanban Item No. TVD-114 Name of Receiving Company Item Name Computer Chassis Type Black PlasticBox Capacity 12Box Type Cardboard--Type Receiving Gate North Receiving GateTime to Deliver :30 A.M., 12:30 P.M., 2:30 P.M.Name of Vendor Hovey Supply Company15
103 The Kanban Process (7) Withdrawal (1) Store Lot with P-Kanban LCD Assembly(5) AttachW-Kanban(1) RemoveW-KanbanAttach toPost(6) SignalRemove(4) P-KanbanAttach toPostLCD ScreenWithdrawal(2), (3)Withdrawal PostProductionOrdering PostFinal Assembly16
104 Multiple Constrained Resource To the Thurman Company example for a one constrained resource, add the following additional constraint: the market limits sales of the economy disk player to 3,000 units.Formulate the linear programming problem and solve using the graphical method Let X1 = deluxe models and X2 = economy modelsFormulation: Max CM = 40X X2Subject to: 4X + 2X2 < 20,000X2 < 3,000
106 Multiple Constrained Resource (continued) Corner Point X1 X2 CM = 40X X2A 0 0 0B 5,000 0 $200,000C* 3,500 3,000 $215,000D 0 3,000 $75,000* Point C is optimalThe X1 value of point c is found by substituting the second equation into the first one like so:$X (3,000) = 20,0004X1 + 6,000 = 20,0004X1 =14,000X1 = 3,500
107 Theory of Constraints Three Measures of Systems Performance Throughput InventoryOperating expenses17
108 The Theory of Constraints (continued) Five steps to improve 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.18
109 Restrictions or barriers that impede progress toward an objective Theory of ConstraintsA sequential process of identifying and removing constraints in a system.Restrictions or barriers that impede progress toward an objective
110 Theory of ConstraintsThe theory of constraints emphasizes the management of bottlenecks as the key to improving the performance of the production system as a whole.
111 Methods to Relieve Bottlenecks Eliminate idle time at the bottleneck operationProcess only those parts or products that increase throughput contribution, not parts or products that will remain in finished goods or spare parts inventoriesShift products that do not have to be made on the bottleneck operation to nonbottleneck processes, or to outside processing facilities
112 Methods to Relieve Bottlenecks Reduce setup time and processing time at bottleneck operationsImprove the quality of parts or products manufactured at the bottleneck operation
113 Theory of ConstraintsThe objective of TOC is to increase throughput contribution while decreasing investments and operating costs.TOC considers a short-run time horizon and assumes operating costs to be fixed costs.
114 The Drum-Buffer-Rope System Raw MaterialsInitial ProcessProcess CRopeProcess AFinal ProcessProcess BFinished GoodsTime BufferDrummer Process19
115 The Management of Capacity Managers can reduce capacity-based fixed costs by measuring and managing unused capacityUnused Capacity is the amount of productive capacity available over and above the productive capacity employed to meet consumer demand in the current period
116 Analysis of Unused Capacity Two Important Features:Engineered Costs result from a cause-and-effect relationship between output and the resources used to produce that outputDiscretionary Costs have two parts:They arise from periodic (annual) decisions regarding the maximum amount to be incurredThey have no measurable cause-and-effect relationship between output and resources used
117 Managing Unused Capacity Downsizing (Rightsizing) is an integrated approach of configuring processes, products, and people to match costs to the activities that need to be performed to operate effectively and efficiently in the present and futureBecause identifying unused capacity for discretionary costs is difficult, downsizing, or otherwise managing this unused capacity, is also difficult.
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