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© Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse.

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Presentation on theme: "© Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse."— Presentation transcript:

1 © Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

2 3-2 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Measuring and analysing product costs (Planning) Chapter 3

3 3-3 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Objectives Identify activities of the organization related to the different products and services of the organization Teat products as cost objects for the purpose of making product-mix and pricing decisions Estimate the direct costs of a product or service Identify different levels of indirect product costs Trace indirect costs using a cost driver Use activity-based costing to estimate the cost of a product or service Recognize costs and benefits of using activity-based costing Estimate product costs using a single cost driver

4 3-4 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activities and Product Costs Products require activities Activities consume resources Resources have costs

5 3-5 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Estimating Product Costs For Planning Decisions Planning decisions are improved with better estimates of product costs The costs and benefits of different decisions must be estimated The item to be costed is called the cost objective – the primary cost objects are the products or services provided by an organization The cost of using resources to provide a product or service is called the product or service cost

6 3-6 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse The Product-mix Decision The benefits of the product The costs of providing the product In order to decide the product-mix it is necessary to balance If the benefits exceed the costs a product is included in the product -mix The choice of what products and services to offer is known as the product-mix decision

7 3-7 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Pricing Decision Customers Competition Product Costs Prices are affected by If a price is too high the result will be low customer demand If a price is too low the result will reduce organizational value

8 3-8 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Pricing Decision Activities supporting only one product generate direct product costs Activities supporting multiple products generate indirect product costs

9 3-9 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Direct Product Costs Direct costs are easily traced to a given product Production costs include both direct and indirect costs Direct costs include direct materials and direct labour Direct costs include direct materials and direct labour

10 3-10 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Indirect Product Costs Numerical Example Ben’s Deli uses the following estimates to determine the direct cost of making a sandwich ItemQuantity per sandwich Purchase PriceCost (Quantity per Sandwich x Purchase price) Meat100 grams£4.00/kg£0.40 Roll1£1.20/dozen0.10 Mustard15 grams£0.04/30g0.02 Pickles15 grams£0.06/30g0.03 Labour1 minute£6/hour0.10 Total Direct cost/sandwich£0.65

11 3-11 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Indirect Product Costs Indirect Costs cannot be traced directly to individual products Unit-Level Costs Batch-Level Costs Facility-Level Costs Product- Level Costs Indirect Costs Indirect costs are also called overhead costs

12 3-12 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Indirect Product Costs Unit-Level Costs Costs that vary with the number of units produced Batch- Level Costs Costs associated with production of multiple units of the same product that are produced together Product- Level Costs Fixed with respect to the number of units and batches produced, but vary with the number of products Facility- Level Costs Fixed with respect to the number of units, batches, and products or services produced

13 3-13 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Indirect Product Costs Numerical Example The indirect costs of Bended Knee Skateboards are as follows Support FunctionLevelAmount (£) AdministrativeFacility90,000 PurchasingBatch50,000 Production: WarehousingBatch18,000 CuttingUnit50,000 GluingUnit10,000 Setting up mouldsBatch55,000 PaintingUnit35,000 AssemblyUnit42,000 MarketingProduct100,000 Total450,000 Splitting the indirect costs among the flat and moulded skateboards should recognize each of these levels of indirect costs

14 3-14 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Tracing indirect costs to different products can be very costly Tracing Indirect Costs Tracing indirect costs to products is difficult One method of estimating the indirect costs of a product is to choose some characteristic of the different products that causes the indirect costs The characteristic is called a cost driver The relationship between indirect costs and products is not always clear

15 3-15 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Tracing Indirect Costs using a Cost Driver 1.Identify activities that generate indirect product costs 2.Estimate costs of the activities 3.Select a cost driver for each activity 4.Estimate the cost-driver usage by all of the products 5.Calculate a cost-driver application rate 6.Trace activity costs to each product 1.Identify activities that generate indirect product costs 2.Estimate costs of the activities 3.Select a cost driver for each activity 4.Estimate the cost-driver usage by all of the products 5.Calculate a cost-driver application rate 6.Trace activity costs to each product Causes the costs of an activity Estimated cost of each activity Estimated usage of activity cost driver Actual cost-driver usage by each product x Cost-driver application rate

16 3-16 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Tracing Indirect Costs using a Cost Driver Numerical Example A sunglass company manufactures three different products that use the same assembly line To change production from one product to another the machines must be reset. The activity of resetting the machines is estimated to cost €400,000 during the year. The number of resets is the cost driver. Trace costs to each product A sunglass company manufactures three different products that use the same assembly line To change production from one product to another the machines must be reset. The activity of resetting the machines is estimated to cost €400,000 during the year. The number of resets is the cost driver. Trace costs to each product Estimated cost driver usage is 50+200+150 = 400 Resets Cost driver application rate €400,000/400 = €1,000/reset Estimated cost driver usage is 50+200+150 = 400 Resets Cost driver application rate €400,000/400 = €1,000/reset ProductEstimated resetsApplication Rate (€) Traced costs (€) Euro501,000/reset50,000 Aussie2001,000/reset200,000 Salsa1501,000/reset150,000 Total4001,000/reset400,000

17 3-17 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activity-Based Costing (ABC) ABC is a procedure that attempts to trace the costs of different activities to products ABC is a procedure that attempts to trace the costs of different activities to products

18 3-18 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activity-Based Costing (ABC) Numerical Example A tree nursery is considering a change of product mix in its inventory The manager wants to estimate the product cost of different types of tree. There are no activities that lead to direct costs. Indirect costs are identified for watering, repotting and administration A tree nursery is considering a change of product mix in its inventory The manager wants to estimate the product cost of different types of tree. There are no activities that lead to direct costs. Indirect costs are identified for watering, repotting and administration Calculate the Application rate for each activity Identify the level of each activity Trace indirect costs to 10 royal oaks each of which requiring one repotting each year Calculate the Application rate for each activity Identify the level of each activity Trace indirect costs to 10 royal oaks each of which requiring one repotting each year ActivityEstimated costs (£) Cost driverEstimated usage of cost driver Watering50,000Number of trees500,000 Repotting100,000Number of repots200,000 Administration75,000Number of different types of trees500

19 3-19 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activity-Based Costing (ABC) Numerical Example Calculate the Application rate for each activity ActivityApplication Rate Watering50,000/500,000£0.10/tree Repotting100,000/200,000£0.50/repot Administration75,000/500£150/type of tree

20 3-20 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activity-Based Costing (ABC) Numerical Example Identify the level of each activity Watering and Repotting are unit level activities as their cost drivers vary with the number of units Administration is a product-level activity as each product receives the same amount of indirect costs

21 3-21 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activity-Based Costing (ABC) Numerical Example Trace indirect costs to 10 royal oaks each of which requiring one repotting each year ActivityApplication rateUsageCosts (£) Watering£0.10/tree10010.00 Repotting£0.50/repot10050.00 Administration£150/type of tree1150.00 Total annual indirect costs210.00 The estimated cost per royal oak is £210/100 royal oaks (£2.10 each tree)

22 3-22 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Advantages of ABC ABC is most beneficial in estimating accurate product costs for organizations with multiple products and services ABC is more beneficial in firms where products and services use overhead activities in different ways ABC is especially useful to organizations with a high percentage of indirect product costs ABC seeks to improve the tracing of indirect costs to products by recognizing the different levels of activities that lead to indirect product costs

23 3-23 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse ABC does not always achieve a n accurate estimate of the cost of making a product ABC ignores the difference between the fixed and variable costs of an activity ABC is more costly to implement because additional measurements and observations must be made Problems With ABC

24 3-24 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse If planning decisions are not sensitive to the accuracy of the estimate of indirect product costs Then using a single cost driver to trace all indirect product costs is often sufficient Tracing Indirect Product Costs Using a Single Cost Driver

25 3-25 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Tracing Indirect Product Costs Using a Single Cost Driver A four step process 1. Identify and estimate all of the indirect product costs 2. Identify a cost driver to apply 3. Calculate the application rate 4. Apply indirect costs to the various products and services A four step process 1. Identify and estimate all of the indirect product costs 2. Identify a cost driver to apply 3. Calculate the application rate 4. Apply indirect costs to the various products and services

26 3-26 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Cascade Cleaning Service cleans 3 different buildings Tracing Indirect Product Costs Using a Single Cost Driver Numerical Example m2m2 Estimated hours of cleaning time Anderson Office Building100,0008,000 Carla’s Pizza10,0006,000 Town Hall90,0006,000 Total200,00020,000 The company has the following indirect costs £ Supplies50,000 Administration50,000 Total100,000

27 3-27 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Apply the indirect costs to the different buildings using square meters (application rate £100,000/200,000m 2) Tracing Indirect Product Costs Using a Single Cost Driver Numerical Example m2m2 Application rateEstimated indirect costs (£) Anderson Office Building100,0000.5050,000 Carla’s Pizza10,0000.505,000 Town Hall90,0000.5045,000 Total applied costs100,000

28 3-28 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Apply the indirect costs to the different buildings using estimated hours (application rate £100,000/20,000hours) Apply the indirect costs to the different buildings using estimated hours (application rate £100,000/20,000hours) Tracing Indirect Product Costs Using a Single Cost Driver Numerical Example Estimated Hours Application rate (£) Estimated indirect costs (£) Anderson Office Building8,0005.0040,000 Carla’s Pizza6,0005.0030,000 Town Hall6,0005.0030,000 Total applied costs100,000

29 3-29 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Compare the costs of the two methods Tracing Indirect Product Costs Using a Single Cost Driver Numerical Example M2M2 Estimated indirect costs (£) Anderson Office Building 50,000 Carla’s Pizza5,000 Town Hall45,000 Total100,000 You can see how different allocation methods might lead to making different management decisions Estimated HoursEstimated indirect costs (£) Anderson Office Building 40,000 Carla’s Pizza30,000 Town Hall30,000 Total100,000

30 3-30 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse MANAGEMENT ACCOUNTING Measuring and analysing product costs (Planning) End of Chapter 3


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