3 Activity Based Costing Costs per service or activity.Costs are allocated to a service or activityExamples:Cost per sales enquiryCosts per warranty claimCosts per credit check
4 Cost Drivers There are two main types of cost driver: A resource driver, which refers to the contribution of the quantity of resources used to the cost of an activity.An activity driver, which refers to the costs incurred by the activities required to complete a particular task or project.
5 Activity-Based Costing A way to allocate as many costs as possible to a productFocuses on activities and cost of activitiesEach activity has its own cost driverUses a separate allocation rate for each activityActivity based costing is a way to allocate indirect costs (overhead) to production. The focus is on activities and the cost of performing those activities. Each activity has its own cost driver and uses a separate allocation rate.5
7 Job CostingMeasures individual costs of production or service to each sales unit.Example: A builder will charge to a job all the materials and labour so as to identify the results of that particular job.
8 Processing CostingTraces all direct an indirect costs of manufacturing often on a batch process. They eventually divide these costs up to calculate a per unit cost.
10 Equivalent UnitsWhen valuing ending inventories of WIP, there may well be many partly completed units.These have to be equated into completed units.Example: At the month end a cycle manufacture has 500 half completed cycles. That would equate to 250 equivalent units.
12 The principles of variable/marginal costing For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the ‘relevant range’). Therefore, selling an extra item of product or service:Revenue will increase by the sales volume of the item soldCosts will increase by the variable cost per unitProfit will increase by the amount of contribution earned from the extra item
13 Cost-volume-profit analysis Systematic method of examining the relationship between changes in activity and changes in total sales revenue, expenses and net profitCVP analysis is subject to a number of underlying assumptions and limitationsThe objective of CVP analysis is to establish what will happen to the financial results if a specified level of activity or volume fluctuates
14 CVP analysis assumptions All other variables remain constantA single product or constant sales mixTotal costs and total revenue are linear functions of outputThe analysis applies to the relevant range onlyCosts can be accurately divided into their fixed and variable elementsThe analysis applies only to a short-time horizonComplexity-related fixed costs do not changeCVP analysis model simplifies the real-world conditions that firm faces. That’s why the analysis is subject to a number of underlying assumptions and limitationsAll other variables remain constant means that volume of production is the only factor which will cause the costs and revenue to change throughout the analysis. (changes in other variables such as production efficiency, sales mix, price level and production methods have an important influence on sales revenue and costs, so if it is significant the CVP analysis will be incorrect).A single product or constant sales mix means that either a single product is sold or, if range of products is sold that sales will be in accordance with a predetermined sales mix. If the sales mix is used than then volume of sales can be depicted in a graph of CVP-analysis measured using standard batch sizeTotal costs and total revenue are linear functions of output means that unit variables and selling price are constantThe analysis applies to the relevant range only means that the CVP-analysis is valid only for decision taken within the relevant production range (outside this range the unit selling price and the variable cost are no longer constant per unit)Costs can be accurately divided into their fixed and variable elementsThe analysis applies only to a short-time horizon. In short-time the costs of providing a firm’s operating capacity, such as property taxes and the salaries are likely to be fixed in relation to changes in activity and unaffected by changes in volume whereas other costs will vary with changes of production. In the short-run volume is he most important variable influencing total revenue, cost and profit.Complexity-related fixed costs do not change means that the changes in complexity-related costs arising from changes in the range of items produced are not captured
16 CVP diagram Horizontal axis – unit of production Vertical axis – total cost and revenueFixed costs (FC) are plotted as a single horizontal line at the one level. Variable costs (VC) are added to the fixed costs to enable the total cost to be plotted. For plotting total cost line there are need to be two points. At zero sales volume total cost will be equal to the fixed costs and at particular volume of production total costs will be sum of fixed costs and variable costs (VC per unit * number of units). The relevant range consisting of 2 horizontal lines are added to the graph: beyond these lines we have assurance that the CVP analysis is valid.This graph helps us estimate the proper volume of production. Break-even point is the point at which the total sales revenue line cuts the total cost line (the point where the production makes neither profit nor loss). The area between the total sales revenue line and the total cost line at a volume below the break-even point represents losses that will occur for various sales below break-even point. And the similar if the company operates at a sales volume above the break-even point, the difference between the total revenue and the total cost lines represents the profit that results from the sales level above break-even point.
17 Margin of safetyThe extent that the revenue exceeds total costs, is called the margin of safety.Indicates by how much sales may decrease before a loss occurs
18 Break Even Analysis Remember: A higher price or lower price does not mean that break even will never be reached!The break even point depends on the number of sales needed to generate revenue to cover costs – the break even chart is NOT time related!
22 BudgetsEstimates of the income and expenditure of a business or a part of a business over a time periodUsed extensively in planningHelps establish efficient use of resourcesHelp monitor cash flow and identify departures from plansMaintains a focus and discipline for those involved
23 BudgetsFlexible Budgets – budgets that take account of changing business conditionsStatic Budget – Based on pre determined level of activity
25 Acct 311 - Prof. Teresa Gordon 3/25/2017Flexible BudgetThis is the budget we would have prepared HAD WE ONLY KNOWN the number of units that would be sold or produced2525
26 What is needed to do a flexible budget Acct Prof. Teresa Gordon3/25/2017What is needed to do a flexible budgetTo do a flexible budget we need to know the assumptions used to create the original budgetUnits expected to be soldExpected selling price per unitVariable cost per unitFixed costs (in total)2626
31 Actual Vs Budget Actual Budget Variance Sales 540,000 520,000 20,000 F Purchases 350, , ,000 UBecause it is a positive variance the it is marked with a F. Unfavourable is marked with a U
32 BudgetsVariance – the difference between planned values and actual valuesPositive or Favourable variance – actual figures less than plannedNegative Unfavourable variance – actual figures above planned
34 Revenue or Cost Variance Analysis Standard variancesPrice varianceQuantity varianceThe difference between the actual price and the standard priceThe difference between the actual quantity and the standard quantity
35 Easier than formulas? Sales volume variance Sales price variance Acct Prof. Teresa Gordon3/25/2017Easier than formulas?Sales volume variance(actual units – planned units) * planned selling price per unitSales price variance(actual unit price – budgeted unit price) * units soldNote: Some companies use contribution margin per unit instead of selling price to compute these variances.3535
36 Acct 311 - Prof. Teresa Gordon 3/25/2017Drilling down further . . .Sales volume variance can be further analyzedAre sales more or less than expected because we sold a different mix of products than we planned?The selling price for each product might also be different than we planned3636
37 Production Variances Direct materials Price variance Quantity variance Acct Prof. Teresa Gordon3/25/2017Production VariancesDirect materialsPrice varianceQuantity varianceThe computations are similar to what we illustrated for sales. You change one element at a time and, from the difference, determine the impact on costs (instead of sales)3737
43 Performance ReportsReport financial performance of responsibility centersCost centerDifference between actual results and budgetChanges in labour dollars or hoursChanges in purchased price vs. quantity discountRevenue centerVariance due to selling more or less units than expectedVariance due to price changesProfit centerFocus on both revenue and cost variancesResponsibility accounting performance reports capture the financial performance of cost, revenue, and profit centers. Responsibility accounting performance reports compare actual results with budgeted amounts and display a variance, or difference, between the two amounts. Because cost centers are only responsible for controlling costs, their performance reports only include information on actual versus budgeted costs. Cost center performance reports typically focus on the flexible budget variance—the difference between actual results and the flexible budget.Likewise, performance reports for revenue centers only contain actual versus budgeted revenue. Revenue center performance reports often highlight both the flexible budget variance and the sales volume variance. The sales volume variance is due strictly to volume differences—selling more or fewer units than originally planned. The flexible budget variance, however, is due strictly to differences in the sales price—selling units for a higher or lower price than originally planned. Both the sales volume variance and the flexible budget variance help revenue center managers understand why they have exceeded or fallen short of budgeted revenue.However, profit centers are responsible for both controlling costs and generating revenue. Therefore, their performance reports contain actual and budgeted information on both their revenues and costs.Copyright (c) 2009 Prentice Hall. All rights reserved.43
44 Performance Reports Management by exception Only material variances are investigatedShould focus on information, not blameSome variances are uncontrollableExamples: increase in costs due to a natural disaster or macro economic issuesManagers use management by exception to determine which variances in the performance report are worth investigating. For example, management may only investigate variances that exceed a certain dollar amount (for example, over $1,000) or a certain percentage of the budgeted figure (for example, over 10%). Smaller variances signal that operations are close to target and do not require management’s immediate attention.Regardless of the type of responsibility center, performance reports should focus on information, not blame. Analyzing budget variances helps managers understand the underlying reasons for the unit’s performance. Once management understands these reasons, it may be able to take corrective actions.But some variances are uncontrollable. Managers should not be held accountable for conditions they cannot control. Responsibility accounting can help management identify the causes of variances, thereby allowing them to determine what was controllable, and what was not.Copyright (c) 2009 Prentice Hall. All rights reserved.44
45 Question 1 Activity Based Costing requires: Answer: Costs to be allocated to an activityEnables management to evaluate its services to customersEnables variances to be created on customer focused tasks.All of the aboveAnswer:d. All of the above
46 Question 2 Job Costing is where: Answer: d. Costs are assigned to a particular jobOften used by Accountants & Lawyers to charge their clientsEnables accurate control of each job.All the above are correctAnswer:d.
47 Question 3 Process costing is: Answer: c. Suitable for controlling costs in a manufacturing environmentUsually allocates costs by batch then divides them up to get a per unit costBoth a and b are correctAnswer:c.
48 Question 4 Equivalent Units: Answer: c. Are a method of assessing ending inventoriesAre calculated by establishing the extent that WIP is completed in terms of finished goods.A and B are correctAnswer:c.
49 Question 5 CVP enables evaluation of: Answer: c The number of units to be sold to break evenThe relationship that total costs have to total revenuesBoth a and b are correctAnswer:c
50 Question 6 Margin of Safety is: Answer: d. The extent that revenues exceed total costsIs the extent that profits are above Break EvenRepresent the level of activity that can be lost before losses are sustainedAll above are correctAnswer:d.
51 Question 7 A flexible budget is: Answer: c. A static budget adjusted for volume activityIs prepared for several levels of expected activity.Both A and B are correctAnswer:c.
52 Question 8 A variance is: Answer: d. The extent that actual has departed from forecastIs either Favourable or UnfavourableEnables management by exceptionAll above are correctAnswer:d.
53 Question 9 A Sales variance can be: Answer: a. Both because of price and quantityCan only be a price varianceCan only be a quantity varianceAnswer:a.recast
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