1. Welcome Back Atef Abuelaish1

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3. Purpose of Managerial Accounting 3 C 1

4. Nature of Managerial Accounting 4 C 1

5. Activity Cost Activity Cost Types of Cost Classifications Classification by Behavior 5 Cost behavior refers to how a cost will react to changes in the level of business activity. Total fixed costs do not change when activity changes. Total variable costs change in proportion to activity changes. C 2

6. Direct costs Costs traceable to a single cost object. Examples: material and labor cost for a product. Indirect costs Costs that cannot be traced to a single cost object. Example: A maintenance expenditure benefiting two or more departments. Types of Cost Classifications Classification by Traceability 6 C 2

7. Comparing Product and Period Costs Comparing Product and Period Costs 7

8. Product Types of Cost Classifications Classification by Function 8 Direct Labor Direct Material Manufacturing Overhead Period costs are expenses not attached to the product. Administrative costs are non-manufacturing costs of staff support and administrative functions. Selling costs are incurred to obtain orders and to deliver finished goods to customers. C 3

9. Period and Product Costs in Financial Statements 9 C 3

10. Manufacturer’s Costs 10 C 3

11. Direct Material Direct Labor Manufacturing Overhead Prime Cost Conversion Cost Manufacturing costs are often combined as follows: Prime and Conversion Costs 11 C 3

12. Summarizes the types and amounts of costs incurred in a company’s manufacturing process. Schedule of Cost of Good Manufactured 12 Direct Materials Used +Direct Labor +Factory Overhead =Total Manufacturing Costs +Beginning Work in Process – Ending Work in Process =Cost of Goods Manufactured P 2

13. Important Stuff  Raw materials Inventory turnover = Raw materials used / Average materials inventory  Manufacturers cost of Goods Sold (COGS) = Beg. Inventory + Purchases Costs – End. Inventory = COGS  Merchandisers Cost of Goods Sold = Beg. Inventory + Cost of Goods Manufactured – End. Inventory = COGS  Cost of Goods Manufactured = Direct Materials + Direct Labors + Factory Overhead = Total Manufacturing Costs + Beg. Work in Progress - End. Work in Progress = Cost of Goods Manufactured Atef Abuelaish13

14. Process Costing Job Costing  Used for production of large, unique, or high-cost items.  Built to order rather than mass produced.  Many costs can be directly traced to each job.  Used for production of large, unique, or high-cost items.  Built to order rather than mass produced.  Many costs can be directly traced to each job. Cost Accounting Systems 14 Chapter 7 C 1

15. Summary of Cost Flows P 3 15

16. Summary of Cost Flows P 3 16

17. Comparing Job Order and Process Operations 17 Job Order Systems  Custom orders  Heterogeneous products  Low production volume  High product flexibility  Low to medium standardization Process Systems  Repetitive operations  Homogeneous products  High production volume  Low product flexibility  High standardization A 1

18. Comparing Job Order and Process Operations 18 A 1

19. Assigning Overhead Costs Goods in Process Cost of Goods Sold Labor Materials Indirect Finished Goods Factory Overhead Direct Allocate 19 C 1

20. Assigning Overhead Costs Overhead can be assigned to production in one of three ways: Single plant- wide overhead rate Departmental overhead rates Activity-based - costing 20 C 1

21. Plantwide Overhead Rate Method (Exhibit 4.2) Overhead Cost Indirect Costs Cost Allocation Base Single Plantwide Overhead Rate Cost Objects Product 1Product 2 Product 3 21 P 1

22. Plantwide Overhead Rate Method Illustration Plantwide overhead rate = Total budgeted overhead costs Total budgeted DLH 22 P 1

23. Departmental Overhead Rate Method (exhibit 4.5) Overhead Cost Department A Indirect Costs Cost Pools Cost Allocation Base Cost Objects Department A Overhead Rate Department B Department B Overhead Rate Product 1Product 2 Product 3 23 P 2

24. Departmental Overhead Rate Method: First Step Overhead Cost $4,800,000 Machining Dept. $4,200,000 Assembly Dept. $600,000 24 P 2

25. Departmental Overhead Rate Method: Second Step Product 1 Product 2 Product 3 25 Machining Dept. Overhead Rate based on machine hours (MH) Assembly Dept. Overhead Rate based on direct labor hours (DLH) P 2

26. Departmental Overhead Rate Method: Third Step (Exhibit 4.6) Departmental Overhead Rate = Total budgeted departmental overhead costs Total amount of departmental allocation base 26 P 2

27. Cost Flows Under Activity-Based Costing Method (Exhibit 4.9) Overhead Cost Activity Cost Pool X Activity Cost Pool Y Activity Cost Pool Z Activity Overhead rate Activity Overhead rate Activity Overhead rate Product 1Product 2Product 3 Indirect Costs Cost Pools Cost Objects Cost Allocation Base 27 C 2

28. Applying Activity-Based Costing 4 STEPS: 1.Identify activities and the costs they cause. 2.Trace overhead costs to cost pools. 3.Determine activity rates. 4.Assign overhead costs to cost objects (products). 28 P 3

29. Step One: Identify Activities and the Costs They Cause Machine setup Machine repair Factory maintenance Engineer salaries Assembly line power Heating and lighting P 3 29

30. Step Two: Trace Overhead Costs to Cost Pools Overhead Cost Activity Cost Pool (Craftsmanship) Activity Cost Pool (Setup) Activity Cost Pool (Design Modification) 30 Activity Cost Pool (Plant Services) P 3

31. Step Three: Determine Activity Rates Step 3 is to compute the activity rates used to assign overhead costs to final cost objects such as products. Activity Overhead rate ? Activity Overhead Rate ? Activity Overhead rate ? 31 Activity Cost Pool (Craftsmanship) Activity Cost Pool (Setup) Activity Cost Pool (Design Modification) Activity Cost Pool (Plant Services) Activity Overhead rate ? P 3

32. Step Three: Determine Activity Rates Proper identification of the factor that drives the cost Proper measures of activities Proper determination of activity rates depends on: and 32 P 3

33. Step Three: Determine Activity Rates For example: Craftsmanship cost pool activity rate= $600,000 / 30,000 DLH = $20 per DLH Cost Pool Activity Rate = Overhead costs assigned to pool Expected activity level 33 P 3

34. Step Four: Assign Overhead Costs to Cost Objects Step 4 is to assign overhead costs in each activity cost pool to final cost objects using activity rates. Activity Overhead rate Activity Overhead rate Activity Overhead rate Product 1Product 2Product 3 34 P 3

35. Step Four: Assign Overhead Costs to Cost Objects To illustrate, the overhead costs in the craftsmanship pool are allocated to standard go-karts as follows : Overhead allocated from craftsmanship pool to standard go-kart = Activities consumed X Activity rate 25,000 DLH x $20 per DLH = $500,000 35 P 3

36. Identifying Cost Behavior Cost-Volume-Profit analysis is used to answer questions such as: o How much does income increase if we install a new machine to reduce labor costs? o What is the change in income if selling prices decline and sales volume increases? o How will income change if we change the sales mix of our products or services? o What sales volume is needed to earn a target income? 36 C 1

37. Fixed Costs 37 C 1

38. Variable Costs 38 C 1

39. Mixed Costs 39 C 1

40. Step-Wise Costs 40 Total cost increases to a new higher cost for the next higher range of activity, but remains constant within a range of activity. C 1

41. Curvilinear Costs 41 Costs that increase when activity increases, but in a nonlinear manner. C 1

42. Measuring Cost Behavior 42 The objective is to classify all costs as either fixed or variable. We will look at three methods: 1.Scatter diagrams. 2.The high-low method. 3.Least–squares regression. A scatter diagram is a plot of cost data points on a graph. It is almost always helpful to plot cost data to be able to observe a visual picture of the relationship between cost and activity. P 1

43. Scatter Diagrams 43 P 1

44. The High-Low Method The following relationships between units produced and total cost are observed: Using these two levels of activity, compute:  the variable cost per unit.  the total fixed cost. 44 P 1

45. The High-Low Method 45 Total cost = $17,525 + $0.17 per unit produced P 1

46. The objective of the cost analysis remains the same: determination of total fixed cost and the variable unit cost. Least-Squares Regression 46 Least-squares regression is usually covered in advanced cost accounting courses. It is commonly used with spreadsheet programs or calculators. P 1

47. Absorption Costing & Variable Costing Absorption costing (also called full costing), assumes that products absorb all costs incurred to produce them. While widely used for financial reporting (GAAP), this costing method can result in misleading product cost information for managers’ business decisions. Absorption costing (also called full costing), assumes that products absorb all costs incurred to produce them. While widely used for financial reporting (GAAP), this costing method can result in misleading product cost information for managers’ business decisions. 47 P 1

48. Absorption Costing & Variable Costing Under variable costing, only costs that change in total with changes in production level are included in product costs. 48 P 1

49. Distinguishing between Absorption Costing and Variable Costing: Absorption Costing Absorption Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product Cost 49 P 1

50. Distinguishing between Absorption Costing and Variable Costing: Variable Costing Distinguishing between Absorption Costing and Variable Costing: Variable Costing Variable Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product CostPeriod Cost 50 P 1

51. 5) Communicates management plans throughout the organization. 4) Provides a benchmark for evaluating performance. 2) Promotes analysis and a focus on the future. 3) Converts long-term strategic plans into short-term financial plans. 1) Motivates employees through participation in the budgeting process and the establishment of attainable goals. Enhances coordination so that activities of all units contribute to meeting the company’s overall goals. Benefits of Budgeting C 1 51 WARNING: If not properly applied, budgets can have a negative effect on a company…so make sure that budgets are realistic!

52. Master Budget Process for a Manufacturer 52 C 2

53. Budgetary Control and Reporting 53  Revise objectives and prepare a new budget. Management uses budgets to monitor and control operations.  Develop the budget from planned objectives.  Compare actual to budget and analyze any differences.  Take corrective and strategic actions. Budgets are an important cost control tool. Actual results are compared with budgets and differences are investigated and analyzed.

54. U = Unfavorable variance Actual cost is greater than budgeted cost. F = Favorable variance Actual revenue and income are greater than budgeted revenue and income. If unit sales are higher, should we expect costs to be higher? How much of the higher costs are because of higher unit sales? Fixed Budget Performance Report 54 A fixed budget, also called a static budget, is based on a single predicted amount of sales or other activity measure.

55. Improve performance evaluation. May be prepared for any activity level in the relevant range. Show revenues and expenses that should have occurred at the actual level of activity. Reveal variances due to good cost control or lack of cost control. Purpose of Flexible Budgets 55

56. Preparation of Flexible Budgets 56 To a budget for different activity levels, we must know how costs behave with changes in activity levels. o Total variable costs change in direct proportion to changes in activity. o Total fixed costs remain unchanged within the relevant range. Fixed Variable P 1

57. Benchmarks for measuring performance. The expected level of performance. Based on carefully predetermined amounts. Used for planning materials, labor, and overhead requirements. Standard costs are Standard Costs 57 C 1 Standard costs can be used in a flexible budgeting system to enable management to better understand the reasons for variances

58. Setting Standard Costs 58 Quantity Standards Price Standards Direct Materials Time Standards Rate Standards Direct Labor Activity Standards Rate Standards Variable Overhead C 1

59. A standard cost variance is the amount by which an actual cost differs from the standard cost. Cost Variances 59 Manufacturing Overhead Direct Materials Direct Labor Standard cost Type of Product Cost $ Amount F This variance is favorable (F) because the actual cost is less than the standard cost. U This variance is unfavorable (U) because the actual cost exceeds the standard cost. C 2

60. Cost Variance Computation 60 C 2 Management needs information about the factors causing a cost variance, but first it must properly compute the variance. In its most simple form, a cost variance (CV) is computed as: Cost Variance (CV) = Actual Cost (AC) - Standard Cost (SC) Actual Cost (AC) = Actual Quantity (AQ) x Actual Price (AP) Standard Cost (SC) = Standard Quantity (SQ) x Standard Price (SP) Actual quantity (AQ) is the input (material or labor) used to manufacture the quantity of output. Standard quantity (SQ) is the standard input for the quantity of output. where: Actual price (AP) is the actual amount paid to acquire the input (material or labor). Standard price (SP) is the standard price.

61. Cost Variance Computation 61 Cost Variance Quantity VariancePrice Variance The difference between the actual price and the standard price. The difference between the actual quantity and the standard quantity. C 2 Two main factors cause a cost variance: To assess the impacts of these two factors in a cost variance, let’s look at the model on the next slide.

62. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity Variance Cost Variance Computation 62 used Standard quantity is the quantity that should have been used for the actual good output. paid Standard price is the amount that should have been paid for the resources acquired. C 2

63. (AP - SP) x AQ (AQ - SQ) x SP AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceQuantity Variance Cost Variance Computation 63 C 2 Actual CostStandard Cost

64. Overhead Standards and Variances Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): 64 Estimated total overhead costs Estimated activity POHR = Assigned Overhead = POHR × Standard Activity P 3

65. Standard Overhead Rate variable Contains a variable unit rate which stays constant at all levels of activity. fixed Contains a fixed overhead rate which declines as activity level increases. Function of activity level chosen to determine rate. Setting Overhead Standards 65 various levels of activity Flexible budgets, showing budgeted amount of overhead for various levels of activity, are used to analyze overhead costs. Standard overhead costs are the overhead amounts expected to occur at a certain activity level. To allocate overhead costs to products or services, management needs to establish the standard overhead cost rate.

66. Computing Overhead Cost Variances 66 Overhead Cost Variance (OCV) Actual Overhead Incurred (AOI) Standard Overhead Applied (SOA) =– Ex: During May, G-Max produced 3,500 club heads working 3,400 hours. G-Max budgeted for 4,000 units (80%). Actual variable overhead was $3,650 and actual fixed overhead was $4,000. P 3 When standard costs are used, a company applies overhead to the units produced using the predetermined standard overhead rate. applied actually The difference between the total overhead cost applied to products and the total overhead cost actually incurred is called an overhead cost variance. It’s defined as:

67. By Geography By Product line Common ways to decentralize organizations Decentralization 67

68. Advantages of Decentralization 68 Providing lower-level managers with decision-making authority offers several advantages. Timely access to information Enables top-level managers to focus on long-term strategy Good training for employees Boosts employee morale and retention

69. Disadvantages of Decentralization 69 Decentralization has potential disadvantages which organizations should consider: Department managers are too focused on own department Decisions of individual departments might conflict with one another Departments might duplicate certain activities

70. Performance Evaluation 70 The accounting system provides information about resources used and outputs achieved. Managers use this information to control operations, appraise performance, allocate resources, and plan strategy. The type of accounting information provided depends on whether the department is a... control costs Evaluated on ability to control costs. Cost center revenues Evaluated on ability to generate revenues in excess of expenses. Profit center return on investment Evaluated on ability to generate return on investment in assets. Investment center

71. Controllable versus Uncontrollable Costs 71 A cost is controllable if a manager has the power to determine or at least significantly affect the amount incurred. Uncontrollable costs are not within the manager’s control or influence. The department manager’s own salary Supplies used in the manager’s department

72. An accounting system that provides information... Responsibility Accounting System 72 Relating to the responsibilities of individual managers. To evaluate managers on controllable items. P 1

73. Amount of detail varies according to the level in the organization. A department manager receives detailed reports. A store manager receives summarized information from each department. Responsibility Accounting Performance Reports 73 P 1

74. Departmental Income Statements 74 Let’s prepare departmental income statements using the following steps: 1.Accumulating revenues and direct expenses by department. 2.Allocating indirect expenses across departments. 3.Allocating service department expenses to operating departments. 4.Preparing departmental income statements. P 3

75. 1) Raw Materials Inventory Turnover 75 A1 Raw materials Inventory turnover = Raw materials used Average materials inventory

76. 2) Investment Center Return on Assets Invested (ROI) 76 ROI ROI = Investment Center Net Income Investment Center Average Invested Assets LCD Division earned more dollars of income, but it was less efficient in using its assets to generate income compared to S-Phone Division. A 1

77. Residual Income Investment Center Net Income Target Investment Center Net Income =– Investment Center Residual Income 77 A 1

78. Investment Center Profit Margin and Investment Turnover 78 Return on investment (ROI) = Profit Margin Investment turnover × Investment center sales Investment center average assets Investment center income Investment center sales Media Networks ROI = 23.78% Parks and Resorts ROI= 10.4% A 2

79. Innovation/Learning Innovation/Learning How can we continually improve and create value? Internal Processes In which activities must we excel? Balanced Scorecard Collects information on several key performance indicators within each of the four perspectives. 79 Performance Indicators Financial Perspective How do we look to the firm’s owners? Customer Perspective How do our customers see us? A 3

80. Process time is the time spent producing the product and it is the only value-added time! Order Received Production Started Goods Shipped Manufacturing Cycle Time Cycle Time and Cycle Efficiency A metric that measures the time involved in manufacturing a product. 80 Total Time Process Time + Inspection Time + Move Time + Wait Time A 4

81. Cycle Efficiency Value-added time Cycle time = Cycle Time and Cycle Efficiency 81 Process Time + Inspection Time + Move Time + Wait Time Order Received Production Started Goods Shipped Manufacturing Cycle Time Total Time A 4

82. Homework assignment 10Relevant Costing for Managerial DecisionsPrepare for Chapter 10 “ Relevant Costing for Managerial Decisions.” Prepare chapters 7. 8, and 9 for EXAM # 3. Happiness is having all homework up to date Atef Abuelaish82

83. Thank you and See You Thursday at the Same Time, Take Care Thank you and See You Thursday at the Same Time, Take Care Atef Abuelaish83