Accounting Question

accounting question and need the explanation and answer to help me learn.

Hello,
please find attached assignment 01 for Cost Accounting, do the needful as per instructed in the cover page. No plagiarism please, thank you. I have attached the required chapters for help.
Requirements:
Assignment (1)
Deadline: Saturday 29/04/2023 @ 23:59
For Instructor’s Use only
Instructions – PLEASE READ THEM CAREFULLY
The Assignment must be submitted on Blackboard (WORD format only) via allocated folder.
Assignments submitted through email will not be accepted.
Students are advised to make their work clear and well presented, marks may be reduced for poor presentation. This includes filling your information on the cover page.
Students must mention question number clearly in their answer.
Late submission will NOT be accepted.
Avoid plagiarism, the work should be in your own words, copying from students or other resources without proper referencing will result in ZERO marks. No exceptions.
All answers must be typed using Times New Roman (size 12, double-spaced) font. No pictures containing text will be accepted and will be considered plagiarism.
Submissions without this cover page will NOT be accepted.
Assignment Question(s): (Marks 15)
Q1. Differentiate with suitable examples the relevant cash flows and irrelevant cash flows. What relevant role do these cash flows provide in management decision-making? Provide a suitable example in context to an organization to support your answer. (3 Marks)
                                         
Note: Your answer must include suitable examples of relevant and irrelevant cash flows for management decision-making. (Week 2, Chapter 1)
Answer:
Q2. What are the various methods of estimating cost functions? Explain each method with suitable numerical examples. (4 Marks)
Note: You are required to assume values for numerical examples of your own, and they should not be copied from any sources. (Week 3, Chapter 2)
Answer:
Q3. ALC ltd. manufactures a product ‘X’ for which the selling price per unit, variables cost per unit, and fixed costs are as follows: (4 Marks)

Answer the following questions using cost volume profit analysis:
Determine the break-even point in units.
Determine the break-even point in sales SAR.
What will be the pretax profit if the company sells 1,400 units of the product?
How many units the company will be required to sell to reach a target pretax profit of SAR 200,000?
The margin of safety in units if the company’s estimated next year budgeted sales are 1,500 units. (Week 4, Chapter 3)
Answer:
Q4. KCC Ltd. uses a process costing system for its sole processing department. There were 35,000 units in the beginning WIP inventory for June and 325,000 units were started in June. The beginning WIP units were 50% complete and the 30,000 units in the ending WIP were 40% complete. All materials are added at the start of processing. (4 Marks)
You are required to:
a) Compute the no. of units started & completed.
b) Compute the EUP for DM and CC using FIFO and WA methods.
c) Calculate total manufacturing cost/EUP under both methods with the following details:
(Week 5, Chapter 6)
Answer:
© John Wiley & Sons, 2011Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 1Cost ManagementMeasuring, Monitoring, and Motivating PerformanceChapter 1The Role of Accounting Information in Management Decision Making
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 2Chapter 1: The Role of Accounting Information in Management Decision MakingLearning objectivesQ1-What is the process of strategic management and decision making?Q2-What types of control systems do managers use?Q3-What is the role of accounting information in strategic management?Q4-What information is relevant for decision making?Q5-How does business risk affect management decision making?Q6-How do biases affect management decision making?Q7-How can managers make higher-quality decisions?Q8-What is ethical decision making, and why is it important?© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 3Q1: Organizational Vision and Core Competencies•The organizational visionis the core purpose and ideology of the organization.•Determining the organizational vision precedes all other management decision making.•Management must also isolate the organization’s core competencies–its strengths relative to competitors.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 4Q1: Organizational Vision and Core CompetenciesOrganizational VisionCore CompetenciesThe organizational vision and the core competencies are closely related.The organization’s strengths should help shape the vision.The vision should help locate the organization’s strengths.If you were starting an accounting practice, what would be your organizational vision? What do you think would be your core competencies?© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 5Q1: Organizational StrategiesOrganizational Vision & Core CompetenciesOrganizational StrategiesOrganizational strategiesare the tactics that managers use to work toward the organizational vision while taking advantage of the core competencies.These strategies are long-termin nature.Examples include organization structure, financial structure, and long-term resource allocation strategies.If you were starting an accounting practice, what would be some of your organizational strategies? How do these work toward your organizational vision?How do they take advantage of your core competencies?© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 6Q1: Operating PlansOrganizational StrategiesOperating PlansOperating plansare the short-termimplementations of the organizational strategies.Operating plans usually include budgeted goals for revenues and expenses.Examples include schedules for employees and procedures for daily relationship management decisions with suppliers.If you were starting an accounting practice, what would be some of your operating plans? How do these relate to your organizational strategies?© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 7Q1: Actual OperationsOperating PlansActual OperationsActual operationsare the actions taken and the results achieved.The organization’s information system measures the results of actual operations.Examples include number of units sold, advertising expense, and the wage expense for the period.If you had an accounting practice, what would information would you want to collect about the results of your actual operations?© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 8Q1: Monitoring and Motivating PerformanceOrganizational Vision & Core CompetenciesActual OperationsManagers use the results of actual operations to monitor performance and ensure that it is in line with the organizational vision.Managers may find that the results of actual operations make them re-think the organizational vision or their view of the organization’s core competencies.If you had an accounting practice, can you think of an example of a measure of actual operations and how you would use it to motivate performance? Can you think of an example of a measure of actual operations that might make you redefine your organizational vision or your view of your core competencies?© John Wiley & Sons, 2011
Q2: Management Control Systems•Belief Systems–Vision, Mission, Core Values Statements•Boundary Systems–Code of Conduct, Procedure Manuals, Compliance Actions•Diagnostic Control Systems–Measure, monitor, and motivate employees against preset goals•Interactive Control Systems–Recurring information and reports to evaluate performance and direct actionsChapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 9© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 10Q3: Financial, Managerial, and Cost AccountingFinancial accountingprepares reports most frequently used by decision makers externalto the organization.Managerial accountingprepares reports most frequently used by decision makers internalto the organization.Cost accountingincludes both financial and nonfinancial information and is used for both financial and managerial accounting.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 11Q3: Strategic Cost Managementand the Balanced Scorecard•Strategic cost managementis an approach to reducing costs while strengthening the organization’s strategic position.•The balanced scorecardcan be used to formalize strategic cost management efforts by detailing financial and nonfinancial benchmarks for all segments of the organization.•Examples of such benchmarks include:•Personnel can reduce costs by completing all hiring within 20 days of initial interview.•Production can reduce costs and improve quality if Engineering can reduce the number of processes in the production process.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 12Q4: What Information is Relevantfor Decision Making?•Information is relevantif:•Differsacross the alternatives, and•Is about the future.•Relevant information can be quantitative or qualitative•Information is irrelevant if:•Does not vary with the option chosen or action takenIrrelevant information is NOT useful in decision making!© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 13Q4: Relevant Cash Flows•Relevant cash flows are future cash flows that differ across the alternatives.•also called incremental cash flows•also called avoidablecash flows•Irrelevant cash flows are:•non-incrementaland unavoidable cash flows•do not vary among alternatives•Must look at the cash flow relevance to the decision being made•Electricity costs are relevant to the decision to open a business or not•Electricity costs are not relevant in the decision to lease or buy a building for your business© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 14Q4: What Information is Relevantfor Decision Making?You have a small computer repair company and are deciding whether to replace your old copy machine or repair it. In the list of information below, identify which data are relevant to this decision and which are irrelevant.•The purchase price of the copy machine was $1200.•The repair costs are $320.•The copy machine can make 20 copies per minute.•If you repair it, the machine will use less toner than it does now.•You make approximately 1000 copies per month.•The repair won’t fix the broken stapler.•The repair carries a one-year warranty.•The copy machine was a gift from your spouse.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 15Q4: Relevance of Income Statement Information•Income Statements include:–Period costs–Product costs (recorded as cost of goods sold)•Many business decisions require the incremental cost to produce a unit•Cost per unit on the income statement includes both fixed and variable costs•Including fixed costs does not represent the true incremental cost of a unit© John Wiley & Sons, 2011
Q5: Impact of Business Risk on Decision Making•Business Riskis the possibility an event will occur and interfere with the organization’s strategic goals•The existence of business risk can cloud management’s decision making processChapter 1: The Role of Accounting Information in Management Decision MakingEldenburg & Wolcott’s Cost Management, 2eSlide # 16Economic & FinancialPeople, Legal & HealthPolitical and SocialReputationWeatherCriminal and TerroristInformational & OperationalEnvironment & Man Made© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 17Q6: Uncertainties, Biases, and Decision Quality•Uncertainties are issues and information about which there is doubt.•Biasesare preconceived notions adopted without careful thought.•Both uncertainty and bias reduce decision quality.•Decision qualityrefers to the characteristics of a decision that affect the likelihood of achieving a positive outcome.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 18Q6: Uncertainties and Biases in Information•Uncertainties come from many sources and can be exogenous or endogenous.•Biases can come from many sources.•The future is always uncertain.•Managers may be uncertain that the right information was captured in a report.•The decision maker may be biased towards or against a particular alternative (predisposition bias)•The methods used to collect information could have introduced bias (information bias)•The decision maker may exercise an error in judgment or processing information (cognitive bias)© John Wiley & Sons, 2011
Q6: Motorola’s Iridium Project•How did uncertaintiesand biaseffect Motorola’s decision making process?Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg & Wolcott’s Cost Management, 2eSlide # 19© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 20Q6: Uncertainties, Biases, and Decision QualityLori loves to sew and has always made her own clothes. People often tell her that she is the best-dressed person they’ve ever met. She can design and sew a lovely outfit in under 2 days. She is considering opening a store that could sell her home-made fashions. Then she could combine her work with her hobby.Can you identify some of the uncertainties Lori faces? Can you think of any way she can reduce some of these uncertainties?Can you identify any possible personal biases that Lori may have? How could these affect her decision making process?© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 21Q7: Characteristics of Higher-Quality DecisionsHigher quality decisions come from a higher quality decision making process. Such a process is thorough, unbiased, focused, strategic, creative, and visionary.This process requires reportsthat are relevant, understandable, and available.These reports must contain informationthat is more certain, complete, relevant, timely and valuable.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 22Q8: Components of Ethical Decision MakingIdentify ethical problems as they ariseConsider the well being of others and societyClarify and apply ethical valuesContinuously improve your personal ethics© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 23Q8: The IMA’s Code of Ethics•The Institute of Management Accountants (IMA) has a Code of Ethics that states that IMA members have a responsibility to:•maintain an appropriate level of professional competence and perform their professional duties in accordance with laws, regulations, and standards;•refrain from disclosing confidential information (unless legally obligated), or using (or even appearing to use) confidential information to illegal advantage;•avoid actual and apparent conflicts of interest; and•communicate information fairly and objectively, and disclose all relevant information to decision makers.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 24Q8: Ethical Decision MakingSuppose you work for the Lee K. Fawcett Plumbing Company as Mr. Fawcett’s administrative assistant. Recently Mr. Fawcett asked you to type some financial statements from his hand-written notes so that he can take them to the bank as part of a loan application.This exercise seems odd to you because the company’s CPA recently delivered the monthly financial statements that she prepares.While typing the financial statements you notice that the building the company rents is listed as an asset. Also, you write checks each month for the monthly payments on two car loans, and these are not listed as liabilities.Do you have an ethical dilemma? Discuss your approach to handling this situation. © John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg & Wolcott’s Cost Management, 1eSlide # 25Appendix: Steps for Better ThinkingSource: (c) 2002. C. L. Lynch, S. K. Wolcott, and G. E. Huber, “Steps for Better Thinking: A Developmental Problem-Solving Process” (August 5, 2002).Steps for Better Thinking is a process to help address open-endedquestions.Open-ended questions have no single correct solution; managers must seek the bestsolution.© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 26Appendix: Steps for Better Thinking –Foundation (Knowing)•Foundation level skills include a knowledge of the terminology and basic concepts that are relevant to the decision at hand.•An individual with Foundation level skills can:•perform calculations to arrive at correct answer•define terms in his/her own words•describe a concept•list the elements contained in a concept or process© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 27Appendix: Steps for Better Thinking -Identifying•Step 1 skills include the ability to identify relevant information and uncertainties.•An individual with Step 1 skills can:•create a list of issues related to the decision•sort information that is relevant•identify the reasons for the underlying uncertainties•perform research to obtain input into the decision© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 28Appendix: Steps for Better Thinking -Exploring•Step 2 skills include the ability to explore interpretations of the information and connections between alternative solutions approaches.•An individual with Step 2 skills can:•recognize and control for his/her own biases•articulate assumptions and reasoning associated with alternative points of view•organize information in meaningful ways to encompass problem complexities•compare and contrast different approaches to a problem’s solutions© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 29Appendix: Steps for Better Thinking -Prioritizing•Step 3 skills include the ability to prioritize alternatives, come to a decision, and implement the decision.•An individual with Step 3 skills can:•develop guidelines for prioritizing alternatives•prioritize alternatives after objective analysis•communicate findings in a manner appropriate to the audience•describe how the solution or decision might change if priorities change© John Wiley & Sons, 2011
Chapter 1: The Role of Accounting Information in Management Decision MakingEldenburg& Wolcott’s Cost Management, 2eSlide # 30Appendix: Steps for Better Thinking -Envisioning•Step 4 skills include the ability to monitor the decision and innovate new strategies to modify the decision when circumstances change.•An individual with Step 4 skills can:•explain the limitations of the decision made•establish a plan for monitoring the performance of the decision•explain how conditions may change in the future and how this may change the decision© John Wiley & Sons, 2011
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 1Cost ManagementMeasuring, Monitoring, and Motivating PerformanceChapter 2The Cost Function
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 2Chapter 2: The Cost FunctionLearning objectives•Q1: What are the different ways to describe cost behavior?•Q2: What process is used to estimate future costs?•Q3: How are engineered estimates, account analysis, and two-point methods used to estimate cost functions?•Q4: How does a scatter plot assist with categorizing a cost?•Q5: How is regression analysis used to estimate a cost function?•Q6: How are cost estimates used in decision making?
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 3Q1: Different Ways to Describe Costs•Costs can be defined by how they relate to a cost object, which is defined as any thing or activity for which we measure costs.•Costs can also be categorized as to how they are used in decision making.•Costs can also be distinguished by the way they change as activity or volume levels change.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 4Q1: Assigning Costs to a Cost ObjectDirect costsare easily tracedto the cost object.Determining the costs that should attach to a cost object is called cost assignment.Cost AssignmentIndirectCostsCostObjectDirectCostsIndirect costsare not easily traced to the cost object, and must be allocated.cost tracingcost allocation
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 5Q1: Direct and Indirect Costs•In manufacturing: •all labor costs that are easily traced to the product are called direct laborcosts•all materials costs that are easily traced to the product are called direct material costs•all other production costs are called overheadcosts•Whether or not a cost is a direct cost depends upon:•the technology available to capture cost information•the definition of the cost object•whether the benefits of tracking the cost as direct exceed the resources expended to track the cost•the precision of the bookkeeping system that tracks costs•the nature of the operations that produce the product or service
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 6Q1: Linear Cost Behavior Terminology•Total fixed costsare costs that do not change (in total) as activity levels change.•Total variable costsare costs that increase (in total) in proportion to the increase in activity levels.•The relevant rangeis the span of activity levels for which the cost behavior patterns hold.•A cost driveris a measure of activity or volume level; increases in a cost driver cause total costs to increase.•Total costsequal total fixed costs plus total variable costs.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 7Q1:Behavior of Total (Linear) CostsTotal Fixed Costs$Cost Driver$Cost DriverTotal CostsIf costs are linear, then total costs graphically look like this. Total fixed costs do not change as the cost driver increases. Higher total fixed costs are higher above the x axis.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 8Q1:Behavior of Total (Linear) CostsTotal Variable Costs$Cost Driver$Cost DriverTotal CostsIf costs are linear, then total costs graphically look like this. Total variable costs increase as the cost driver increases.A steeper slope represents higher variable costs per unit of the cost driver.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 9Q1:Total Versus Per-unit (Average) Cost BehaviorIf total variable costs look like this . . . . . . then variable costs per unit look like this.$Cost DriverTotal Variable Costs$/unitCost DriverPer-Unit Variable Costsmslope = $m/unit
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 10Q1:Total Versus Per-Unit (Average) Cost BehaviorIf total fixed costs look like this . . . . . . then fixed costs per unit look like this.$Cost DriverTotal Fixed Costs$/unitCost DriverPer-Unit Fixed Costs
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 11Lari’s Leather produces customized motorcycle jackets. The leather for one jacket costs $50, and Lari rents a shop for $450/month. Compute the total costs per month and the average cost per jacket if she made only one jacket per month. What if she made 10 jackets per month?$50$450$500$50$450$500$500$450$950$50$45$95Q1:Total Versus Per-Unit (Average) Cost BehaviorTotal variable costs go upTotal fixed costs are constantAverage variable costs are constantAverage fixed costs go down
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 12When costs are linear, the cost function is:TC = F+ Vx Q, whereF= total fixed cost, V= variable cost per unit of the cost driver, and Q= the quantity of the cost driver.Q1:The Cost Function$Cost DriverTotal CostsFslope = $V/unit of cost driverThe intercept is the total fixed cost.The slope is the variable cost per unit of the cost driver.A cost that includes a fixed cost element and a variable cost element is known as a mixed cost.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 13Sometimes nonlinear costs exhibit linear cost behavior over a range of the cost driver. This is the relevant rangeof activity.Q1:Nonlinear Cost BehaviorCost DriverTotalCostsRelevant Rangeslope = variable cost per unit of cost driverintercept = total fixed costs
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 14Some costs are fixed at one level for one range of activity and fixed at another level for another range of activity. These are known as stepwise linear costs.Q1:Stepwise Linear Cost BehaviorTotal Supervisor Salaries Cost in $1000sNumber of units produced, in 1000s1004020080300120Example: A production supervisor makes $40,000 per year and the factory can produce 100,000 units annually for each 8-hour shift it operates.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 15Some variable costs per unit are constant at one level for one range of activity and constant at another level for another range of activity. These are known as piecewise linear costs.Q1:Piecewise Linear Cost BehaviorGallons purchasedTotal Materials Costs10002000Example: A supplier sells us raw materials at $9/gallon for the first 1000 gallons, $8/gallon for the second 1000 gallons, and at $7.50/gallon for all gallons purchased over 2000 gallons. slope=$9/gallonslope=$8/gallonslope=$7.50/gallon
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 16Q1: Cost Terms for Decision Making•In Chapter 1 we learned the distinction between relevant and irrelevant cash flows.•Opportunity costsare the benefits of an alternative one gives up when that alternative is not chosen.•Sunk costsare costs that were incurred in the past.•Opportunity costs are difficult to measure because they are associated with something that did not occur.•Opportunity costs are always relevant in decision making.•Sunk costs are never relevant for decision making.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 17Q1: Cost Terms for Decision Making•Discretionary costsare periodic costs incurred for activities that management may or may not determine are worthwhile.•These costs may be variable or fixed costs.•Discretionary costs are relevant for decision making only if they vary across the alternatives under consideration.•Marginal costis the incremental cost of producing the next unit.•When costs are linear and the level of activity is within the relevant range, marginal cost is the same as variable cost per unit.•Marginal costs are often relevant in decision making.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 18Past costs are often used to estimate future, non-discretionary, costs. In these instances, one must also consider: Q2:What Process is Used to Estimate Future Costs?•whether the past costs are relevant to the decision at hand•whether the future cost behavior is likely to mimic the past cost behavior•whether the past fixed and variable cost estimates are likely to hold in the future
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 19•Use accountants, engineers, employees, and/or consultants to analyze the resources used in the activities required to complete a product, service, or process.Q3:Engineered Estimates of Cost Functions•For example, a company making inflatable rubber kayaks would estimate some of the following:•the amount and cost of the rubber required•the amount and cost of labor required in the cutting department•the amount and cost of labor required in the assembly department•the distribution costs •the selling costs, including commissions and advertising•overhead costs and the best cost allocation base to use
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 20•Review past costs in the general ledger and past activity levels to determine each cost’s past behavior.Q3:Account Analysis Method ofEstimating a Cost Function•For example, a company producing clay wine goblets might review its records and find: •the cost of clay is piecewise linear with respect to the number of pounds of clay purchased•skilled production labor is variable with respect to the number of goblets produced•unskilled production labor is mixed, and the variable portion varies with respect to the number of times the kiln is operated•production supervisors’ salary costs are stepwise linear•distribution costs are mixed, with the variable portion dependent upon the number of retailers ordering goblets
ExpenseAmountVariableFixedDirect Materials$500,000Direct Labor300,000Rent25,000Insurance15,000Commissions200,000Property Tax20,000Telephone10,000Depreciation85,000Power & Light30,000Admin Salaries100,000Total1,285,000•The table on the right contains the expenditures for Scott Manufacturing during the last year.•100,000 units were produced and sold•$500,000 of sales revenue was recordedRequired:1.Determine the cost function using units produced as the driver2.Repeat using sales dollars as the driver© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 21Q3: Example-Account Analysis Method ofEstimating a Cost Function
•Steps in estimating a cost function using account analysis–Separate fixed and variable costs–Total the fixed costs–Total the variable costs–Calculate a variable cost per driver–Write out the cost function© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 22Q3: Example-Account Analysis Method ofEstimating a Cost Function
ExpenseAmountVariableFixedDirect Materials$500,000500,000Direct Labor300,000300,000Rent25,00025,000Insurance15,00015,000Commissions200,000200,000Property Tax20,00020,000Telephone10,00010,000Depreciation85,00085,000Power & Light30,00030,000Admin Salaries100,000100,000Total1,285,0001,000,000285,000© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 23Q3: Solution -Account Analysis Method ofEstimating a Cost FunctionCost Function on Units:TC = FC + VC/Unit * QtyTC = $285,000 + ($10/unit) * QtyCost Function on Dollars:TC = FC + VC/Sales $ * Sales $TC = $285,000 + ($0.20) * Sales $
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 24Q3:Two-Point Method ofEstimating a Cost Function•Use the information contained in two past observations of cost and activity to separate mixed and variable costs.•It is much easier and less costly to use than the account analysis or engineered estimate of cost methods, but:•it estimates only mixed cost functions,•it is not very accurate, and•it can grossly misrepresent costs if the data points come from different relevant ranges of activity
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 25Units$$58,0006,200$40,0003,200Q3:Example -Two-Point Method ofEstimating a Cost FunctionIn July the Gibson Co. incurred total overhead costs of $58,000 and made 6,200 units. In December it produced 3,200 units and total overhead costs were $40,000. What are the total fixed factory costs per month and average variable factory costs?We first need to determine V, using the equation for the slope of a line.rise/run = $58,000 -$40,0006,200 –3,200 units= $18,000/3,000 unitsThen, using TC = F+ Vx Q, and one of the data points, determine F. = $6/unit$58,000 = F+ $6/unit x 6,200 units$58,000 = F+ $37,200$20,800 = F$20,800
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 26•The high-low method is a two-point method•the two data points used to estimate costs are observations with the highest and the lowest activity levelsQ3:High-Low Method ofEstimating a Cost Function•The extreme points for activity levels may not be representative of costs in the relevant range•this method may underestimate total fixed costs and overestimate variable costs per unit, •or vice versa.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 27•A scatterplotshows cost observations plotted against levels of a possible cost driver.Q4:How Does a ScatterplotAssist with Categorizing a Cost?•A scatterplot can assist in determining:•which cost driver might be the best for analyzing total costs, and•the cost behavior of the cost against the potential cost driver.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 28Q4:Which Cost Driver Has the BestCause & Effect Relationship with Total Cost?# units sold$8 observations of total selling expenses plotted against 3 potential cost drivers# customers$# salespersons$The number of salespersons appears to be the best cost driver of the 3.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 29Q4:What is the Underlying Cost Behavior?# units sold$# units sold$This cost is probably linear and fixed.This cost is probably linear and variable.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 30Q4:What is the Underlying Cost Behavior?# units sold$# units sold$This cost is probably linear and mixed.This is likely a stepwise linear cost.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 31Q4:What is the Underlying Cost Behavior?# units sold$# units sold$This cost may be piecewise linear.This cost appears to have a nonlinear relationship with units sold.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 32Q5:How is Regression Analysis Used toEstimate a Mixed Cost Function?•Regression analysis estimates the parameters for a linear relationship between a dependent variable and one or more independent (explanatory) variables.•When there is only one independent variable, it is called simple regression.•When there is more than one independent variable, it is called multiple regression.Y = α+βX + independent variabledependent variableαandβare the parameters; is the error term (or residual)
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 33Q5:How is Regression Analysis Used toEstimate a Mixed Cost Function?We can use regression to separate the fixed and variable components of a mixed cost.Yi= α+βXi+ ithe slope term is the variable cost per unitthe intercept term is total fixed costsiisthe difference between the predicted total cost for Xiand the actual total cost for observation iYiis the actual total costs for data point i Xiis the actual quantity of the cost driver for data point i
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 34•Goodness of fitQ5:Regression Output Terminology:Adjusted R-Square•How well does the line from the regression output fit the actual data points?•The adjusted R-squarestatistic shows the percentage of variation in the Y variable that is explained by the regression equation.•The next slide has an illustration of how a regression equation can explain the variation in a Y variable.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 35Q5:Regression Output Terminology:Adjusted R-Square•We have 29 observations of a Y variable, and the average of the Y variables is 56,700. •If we plot them in order of the observation number, there is no discernable pattern. •We have no explanation as to why the observations vary about the average of 56,700.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 36Q5:Regression Output Terminology:Adjusted R-SquareIf each Y value had an associated X value, then we could reorder the Y observations along the X axis according to the value of the associated X.Now we can measure how the Y observations vary from the “line of best fit” instead of from the average of the Y observations. Adjusted R-Square measures the portion of Y’s variation about its mean that is explained by Y’s relationship to X.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 37•Statistical significanceof regression coefficientsQ5:Regression Output Terminology:p-value and t-statistic.•When running a regression we are concerned about whether the “true” (unknown) coefficients are non-zero.•Did we get a non-zero intercept (or slope coefficient) in the regression output only because of the particular data set we used?
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 38Q5:Regression Output Terminology:p-value and t-statistic.•In general, if the t-statistic for the intercept (slope) term > 2, we can be about 95% confident (at least) that the true intercept (slope) term is not zero.•The t-statisticand the p-valueboth measure our confidence that the true coefficient is non-zero.•The p-value is more precise•it tells us the probability that the true coefficient being estimated is zero•if the p-value is less than 5%, we are more than 95% confident that the true coefficient is non-zero.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 39Q5:Interpreting Regression OutputThe coefficients give you the parameters of the estimated cost function.Predicted total costs =$2,937+($5.215/mach hr)x (# of mach hrs)Suppose we had 16 observations of total costs and activity levels (measured in machine hours) for each total cost. If we regressed the total costs against the machine hours, we would get . . . Total fixed costs are estimated at $2,937.Variable costs per machine hour are estimated at $5.215.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 40Q5:Interpreting Regression OutputThe regression line explains 76.8% of the variation in the total cost observations.The high t-statistics . . .. . . and the low p-values on both of the regression parameters tell us that the intercept and the slope coefficient are “statistically significant”.(5.26E-06 means 5.26 x 10-6, or 0.00000526)
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 41Carole’s Coffee asked you to help determine its cost function for its chain of coffee shops. Carole gave you 16 observations of total monthly costs and the number of customers served in the month. The data is presented below, and the a portion of the output from the regression you ran is presented on the next slide. Help Carole interpret this output.Q5:Regression Interpretation Example
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 42Q5:Regression Interpretation ExampleWhat is Carole’s estimated cost function? In a store that serves 10,000 customers, what would you predict for the store’s total monthly costs?Predicted total costs =$4,634+ ($1.388/customer)x (# of customers)Predicted totalcosts at 10,000 customers$4,634+ ($1.388/customer) x 10,000 customers=$18,514=
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 43Q5:Regression Interpretation ExampleWhat is the explanatory power of this model? Are the coefficients statistically significant or not? What does this mean about the cost function?The model explains 81.58% of the variation in total costs, which is pretty good.The slope coefficient is significantly different from zero. This means we can be pretty sure that the true cost function includes nonzero variable costs per customer. The intercept is not significantly different from zero. There’s a 9.8% probability that the true fixed costs are zero*.*(Some would say the intercept is significant as long as the p-value is less than 10%, rather than 5%.)
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 44Q6: Considerations When UsingEstimates of Future Costs•The future is always unknown, so there are uncertainties when estimating future costs.•The estimated cost function may have mis-specified the cost behavior.•Future cost behavior may not mimic past cost behavior.•Future costs may be different from past costs.•The cost function may be using an incorrect cost driver.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 45Q6: Considerations When UsingEstimates of Future Costs•The data used to estimate past costs may not be of high-quality.•The accounting system may aggregate costs in a way that mis-specifies cost behavior.•The true cost function may not be in agreement with the cost function assumptions.•For example, if variable costs per unit of the cost driver are not constant over any reasonable range of activity, the linearity of total cost assumption is violated.•Information from outside the accounting system may not be accurate.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 46Appendix 2A: Multiple Regression ExampleWe have 10 observations of total project cost, the number of machine hours used by the projects, and the number of machine set-ups the projects used.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 47Appendix 2A: Multiple Regression ExampleRegress total costs on the number of set-ups to get the following output and estimated cost function:Predicted project costs =$2,926+ ($1,225/set-up)x (# set-ups)The explanatory power is 57.4%. The # of set-ups is significant, but the intercept is not significant if we use a 5% limit for the p-value.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 48Appendix 2A: Multiple Regression ExampleRegress total costs on the number of machine hours to get the following output and estimated cost function:Predicted project costs =-$173+ ($113/mach hr)x (# mach hrs)The explanatory power is 62.1%. The intercept shows up negative, which is impossible as total fixed costs can not be negative. However, the p-value on the intercept tells us that there is a 93% probability that the true intercept is zero. The # of machine hours is significant.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 49Appendix 2A: Multiple Regression ExampleRegress total costs on the # of set ups andthe # of machine hours to get the following:The explanatory power is now 89.6%. The p-values on both slope coefficients show that both are significant. Since the intercept is not significant, project costs can be estimated based on the project’s usage of set-ups and machine hours.Predictedprojectcosts=-$1,132+ ($82/mach hr)x (# mach hrs)+ ($857/set-up)x (# set-ups)
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 50A learning curveis •the rate at which labor hours per unit decrease as the volume of activity increases•the relationship between cumulative average hours per unit and the cumulative number of units produced. Appendix 2B:What is a Learning Curve?A learning curve can be represented mathematically as:Y= αXr,whereX= cumulative number of units produced,r= an index for learning = ln(% learning)/ln(2), andY= cumulative average labor hours,α= time required for the first unit,ln is the natural logarithmic function.
© John Wiley & Sons, 2011Chapter 2: The Cost FunctionEldenburg& Wolcott’s Cost Management, 2eSlide # 51Appendix 2B:Learning Curve ExampleFirst compute r:Deanna’s Designer Desks just designed a new solid wood desk for executives. The first desk took her workforce 55 labor hours to make, but she estimates that each desk will require 75% of the time of the prior desk (i.e. “% learning” = 75%). Compute the cumulative average time to make 7 desks, and draw a learning curve.r= ln(75%)/ln(2) = -0.2877/0.693 = -0.4152Then compute the cumulative average time for 7 desks:Y= 55×7(-0.4152)= 25.42 hrsIn order to draw a learning curve, you must compute the value of Yfor all Xvalues from 1 to 7. . . .
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 1Cost ManagementMeasuring, Monitoring, and Motivating PerformanceChapter 3Cost-Volume-Profit Analysis
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 2Chapter 3: Cost-Volume-Profit AnalysisLearning objectives•Q1: What is cost-volume-profit (CVP) analysis, and how is it used for decision making? •Q2: How are CVP calculations performed for a single product?•Q3: How are CVP calculations performed for multiple products?•Q4: What assumptions and limitations should managers consider when using CVP analysis?•Q5: How are the margin of safety and operating leverage used to assess operational risk?
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 3units$Total Costs (TC)Total Revenue (TR)Q1: CVP Analysis and the Breakeven Point•The breakeven point(BEP) is where total revenue equal total costs.•CVP analysis looks at the relationship between selling prices, sales volumes, costs, and profits.BEP in unitsBEP insales $
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 4Q2: How is CVP Analysis Used?•CVP analysis can determine, both in units and in sales dollars:•the volume required to break even•the volume required to achieve target profit levels•the effects of discretionary expenditures•the selling price or costs required to achieve target volume levels•CVP analysis helps analyze the sensitivity of profits to changes in selling prices, costs, volume and sales mix.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 5Q2: CVP Calculations for a Single ProductTo find the breakeven point in units, set Profit = 0.Units required to achieve targetpretax profit whereF= total fixed costsP= selling price per unitV= variable cost per unitP -V= contribution marginper unit
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 6Q2: CVP Calculations for a Single ProductTo find the breakeven point in sales $, set Profit = 0.Sales $ requiredto achieve targetpretax profit whereF= total fixed costsCMR= contribution margin ratio= (P-V)/PNote that CMRcan also be computed as
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 7Bill’s Briefcases makes high quality cases for laptops that sell for $200. The variable costs per briefcase are $80, and the total fixed costs are $360,000. Find the BEP in units and in sales $ for this company.Q2: Breakeven Point CalculationsBEP in unitsBEP in sales $
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 8units$1000sTCTR3000$600Q2: CVP GraphDraw a CVP graph for Bill’s Briefcases. What is the pretax profit if Bill sells 4100 briefcases? If he sells 2200 briefcases? Recall that P= $200, V= $80, and F= $360,000.$36041002200Profit at 4100 units = $120 x 4100 -$360,000.$132,000-$96,000Profit at 2200 units = $120 x 2200 -$360,000.More easily: 4100 units is 1100 units past BEP, so profit = $120 x 1100 units; 2200 units is 800 units before BEP, so loss = $120 x 800 units.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 9How many briefcases does Bill need to sell to reach a target pretax profit of $240,000? What level of sales revenue is this? Recall that P= $200, V= $80, and F= $360,000.Q2: CVP CalculationsUnits needed to reach target pretax profit Sales $ required to reach target pretax profitOf course, 5,000 units x $200/unit = $1,000,000, too.But sometimes you only know the CMR and not the selling price per unit, so this is still a valuable formula.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 10How many briefcases does Bill need to sell to reach a target after-tax profit of $319,200 if the tax rate is 30%? What level of sales revenue is this? Recall that P= $200, V= $80, and F= $360,000.Q2: CVP CalculationsFirst convert the target after-tax profit to its target pretax profit:Units needed to reach target pretax profit Sales $ needed to reach target pretax profit
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 11Suppose that Bill’s marketing department says that he can sell 6,000 briefcases if the selling price is reduced to $170. Bill’s target pretax profit is $210,000. Determine the highest level that his variable costs can so that he can make his target. Recall that F= $360,000.Q1,2: Using CVP to Determine Target Cost LevelsUse the CVP formula for units, but solve for V:Q = 6,000 unitsIf Bill can reduce his variable costs to $75/unit, he can meet his goal.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 12Q4: Business Risk in Bill’s Decision•After this analysis, Bill needs to consider several issues before deciding to lower his price to $170/unit.•How reliable are his marketing department’s estimates?•Is a $5/unit decrease in variable costs feasible?•Will this decrease in variable costs affect product quality?•If 6,000 briefcases is within his plant’s capacity but lower than his current sales level, will the increased production affect employee morale or productivity?
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 13Q1: Using CVP to Compare Alternatives•CVP analysis can compare alternative cost structures or selling prices. •high salary/low commission vs. lower salary/higher commission for sales persons•highly automated production process with low variable costs per unit vs. lower technology process with higher variable costs per unit and lower fixed costs.•The indifferencepointbetween alternatives is the level of sales (in units or sales $) where the profits of the alternatives are equal. •broad advertising campaign with higher selling prices vs. minimal advertising and lower selling prices
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 14Currently Bill’s salespersons have salaries totaling $80,000 (included in F of $360,000) and earn a 5% commission on each unit ($10 per briefcase). He is considering an alternative compensation arrangement where the salaries are decreased to $35,000 and the commission is increased to 20% ($40 per briefcase). Compute the BEP in units under the proposed alternative. Recall that P= $200 and V= $80 currently.Q1,2: Using CVP to Compare AlternativesFirst compute Fand Vunder the proposed plan:F= $360,000 -$45,000 decrease in salaries= $315,000V= $80 + $30 increase in commission= $110Then compute Qunder the proposed plan:Units needed to breakeven
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 15Q1: Determining the Indifference Point Compute the volume of sales, in units, for which Bill is indifferent between the two alternatives.The indifference point in units is the Qfor which the profit equations of the two alternatives are equal.Current PlanProposed PlanContribution margin per unit$120$90Total fixed costs$360,000$315,000Profit (current plan) = $120Q-$360,000Profit (proposed plan) = $90Q-$315,000$120Q-$360,000 = $90Q-$315,000$30Q= $45,000Q= 1,500 units
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 16Q1,2: CVP Graphs of the Indifference PointDraw a CVP graph for Bill’s that displays the costs under both alternatives. Notice that the total revenue line for both alternatives is the same, but the total cost lines are different.TC-current planTRunits$1000s3000$600$3603500$315TC-proposed plan1500BEP for the current planBEP for the proposed planindifference point between the plans
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 17TC-current planTRunits$1000s3000$600Q1,2: Comparing Alternatives$3603500$315TC-proposed plan1500The current plan breaks even before the proposed plan.At 1500 units, the plans have the same total cost.Each unit sold provides a larger contribution to profits under the current plan.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 18Q4: Business Risk in Bill’s Decision•Hopefully Bill is currently selling more than 1500 briefcases, because profits are negative under BOTH plans at this point.•Therefore, it seems the current plan is preferable to the proposed plan.However, . . .•The total costs of the current plan are less than the those of the proposed plan at sales levels past 1500 briefcases.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 19Q5: Business Risk in Bill’s Decision. . . this may not be true because the level of future sales is always uncertain. •What if the briefcases were a new product line? •The plans may create different estimates of the likelihood of various sales levels.•Estimates of sales levels may be highly uncertain.•The lower fixed costs of the proposed plan may be safer.•Salespersons may have an incentive to sell more units under the proposed plan.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 20Q3: CVP Analysis for Multiple ProductsWhen a company sells more than one product the CVP calculations must be adjusted for the sales mix. The sales mix should be stated as a proportion •of total units sold when performing CVP calculations for in units.•of total revenues when performing CVP calculations in sales $.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 21Q3: Sales Mix Computations•The weighted average contribution margin is the weighted sum of the products’ contribution margins: where λiis product i’s % of total sales in units, CMiis product i’s contribution margin, and n= the number of products.where iis product i’s % of total sales revenues, CMRiis product i’s contribution margin ratio, and n= the number of products.•The weighted average contribution margin ratio is the weighted sum of the products’ contribution margin ratios:
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 22Peggy’s Kitchen Wares sells three sizes of frying pans. Next year she hopes to sell a total of 10,000 pans. Peggy’s total fixed costs are $40,800. Each product’s selling price and variable costs is given below. Find the BEP in units for this company.Q3: Multiple Product Breakeven PointFirst note the sales mix in units is 20%:50%:30%, respectively; then compute the weighted average contribution margin:
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 23Q3: Multiple Product Breakeven PointBut 6,000 units is not really the BEP in units; the BEP is only 6,000 units ifthe sales mix remains the same.Next, compute the BEP in terms of total units:Total units needed to breakeven The BEP should be stated in terms of how many of each unit must be sold:
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 24Find the BEP in sales $ for Peggy’s Kitchen Wares. The total revenue and total variable cost information below is based on the expected sales mix.Q3: Multiple Product Breakeven PointFirst compute the weighted average contribution margin ratio:
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 25Q3: Multiple Product Breakeven PointNext compute the BEP in sales $:. . . = 45.6%, of course! Depending on how the given information is structured, it may be easier to compute the CMR as Total contribution margin/Total revenue.BEP in sales $** If you sum the number of units of each size pan required at breakeven times its selling price you get $89,400. The extra $74 in the answer above comes from rounding the contribution margin ratio to three decimals.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 26Q4: Assumptions in CVP AnalysisCVP analysis assumes that costs and revenues are linear within a relevant range of activity.•Linear total revenues means that selling prices per unit are constant and the sales mix does not change.•If volume discounts are received from suppliers, then variable costs per unit are not constant.•Offering volume discounts to customers violates this assumption.•Linear total costs means total fixed costs are constant and variable costs per unit are constant.•If worker productivity changes as activity levels change, then variable costs per unit are not constant.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 27Q4: Assumptions in CVP Analysis•These assumptions may induce a small relevant range.•Results of CVP calculations must be checked to see if they fall within the relevant range.•Nonlinear analysis techniques are available.•Linear CVP analysis may be inappropriate if the linearity assumptions hold only over small ranges of activity.•For example, regression analysis, along with nonlinear transformations of the data, can be used to estimate nonlinear cost and revenue functions.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 28Q5: Margin of SafetyThe margin of safetyis a measure of how far past the breakeven point a company is operating, or plans to operate. It can be measured 3 ways.margin ofsafety in unitsactual or estimated units of activity –BEP in units=margin ofsafety in $actual or estimated sales $ –BEP in sales $=margin ofsafety percentage=
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 29Suppose that Bill’s Briefcases has budgeted next year’s sales at 5,000 units. Compute all three measures of the margin of safety for Bill. Recall that P= $200, V= $80, F= $360,000, the BEP in units = 3,000, and the BEP in sales $ = $600,000.Q5: Margin of Safetymargin of safety in units = 5,000 units –3,000 units = 2,000 unitsmargin of safety in $ = $200 x 5,000 -$600,000 = $400,000margin of safety percentageThe margin of safety tells Bill how far sales can decrease before profits go to zero.
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 30Q5: Degree of Operating Leverage•The degree of operating leveragemeasures the extent to which the cost function is comprised of fixed costs.•A high degree of operating leverage indicates a high proportion of fixed costs.•Businesses operating at a high degree of operating leverage•but enjoy profits that rise more quickly when sales increase.•face higher risk of loss when sales decrease,
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 31Q5: Degree of Operating LeverageThe degree of operating leverage can be computed 3 ways.degree ofoperating =leverage
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 32Suppose that Bill’s Briefcases has budgeted next year’s sales at 5,000 units. Compute Bill’s degree of operating leverage. Recall that P= $200, V= $80, F= $360,000, and the margin of safety percentage at 5,000 units is 40%.Q5: Degree of Operating LeverageFirst, compute contribution margin and profit at 5,000 units:Profit = $600,000 -$360,000 = $240,000Contribution margin = ($200 -$80) x 5,000 = $600,000
© John Wiley & Sons, 2011Chapter 3: Cost-Volume-Profit AnalysisEldenburg& Wolcott’s Cost Management, 2eSlide # 33Q5: Using the Degree of Operating Leverage•The degree of operating leverage shows the sensitivity of profits to changes in sales.•On the prior slide Bill’s degree of operating leverage was 2.5 and profits were $240,000.* $240,000 x 1.5 = $360,000•If expected sales were to increase to 6,000 units, a 20% increase, then profits would increase by 2.5 x 20%, or 50%, to $360,000.*•If expected sales were to decrease to 4,500 units, a 10% decrease, then profits would decrease by 2.5 x 10%, or 25%, to $180,000.**** $240,000 x 0.75 = $180,000
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 1Cost ManagementMeasuring, Monitoring, and Motivating PerformanceChapter 5Job Costing
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 2Chapter 5: Job CostingLearning objectives•Q1: How are costs assigned to customized goods and services? •Q2: How is overhead allocated to individual jobs?•Q3: How does job costing information affect managers’ incentives and decisions?•Q4: How are spoilage, rework, and scrap handled in job costing?•Q5: What are the quality and behavioral implications of spoilage?
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 3Q1: Job Costing versus Process Costing•Used when products can be distinguished from one anotherJob Costing•Used when similar products are mass producedProcess Costing•Includes characteristics of both job and process costingHybrid Costing
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 4Q1: Job Costing versus Process Costing
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 5Q1: Assigning Costs to JobsCostAssign-mentIndirectCostsCost TracingCostObject(Job)DirectCostsCost Allocation
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 6Q1: Job Cost RecordsEach job’s costs are maintained on a job cost record.The job cost records form the subsidiary ledgerfor Work in process inventory.This information comes from Materials Requisition FormsThis information comes from Labor Time ReportsOverhead costs must be allocated to each job
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 7Q2: Allocating Overhead Costs to Jobs•Direct costs are traced to the individual jobs using source documents.•Overhead costs are indirect and cannot be traced to individual jobs; they must be allocated.•An overhead allocation base must be chosen.•The overhead allocation base should be some measure of activity; it should be a reasonably good cost driver for overhead costs.
1.Identify the relevant cost object.2.Identify one or more overhead cost pools and allocation bases.3.For each overhead cost pool, calculate an overhead allocation rate.4.For each overhead cost pool, allocate costs to the cost object.© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 8Q2: Steps in Allocating Overhead
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 9Q2: Overhead Allocation Rates•Companies may use an actual or an estimated overhead allocation rate.•The actual allocation rate cannot be computed until the accounting period is over.•The estimated allocation rate can be computed at the beginning of the accounting period (normal costing).
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 10Chausse Manufacturing makes road paving equipment. At the beginning of the year, overhead costs were estimated to be $450,000. However, actual overhead was $504,000. Chausse uses direct labor hours as the cost allocation base. At the beginning of the year, total direct labor hours were estimated at 10,000 hours, but actual direct labor hours for the year totaled 12,000 hours. Compute the actual overhead rate and the estimated overhead rate.Q2: Overhead Allocation Rates
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 11Q2: Actual and Normal CostingIn normal costing, annual budgeted rates are used•smoothing effect on numerator•smoothing effect on denominator
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 12Serena-Sturm is an architectural firm with a professional staff of 5 architects and a support staff of 7. Some projects are done for a fixed fee, while others are billed for the actual hours spent on the project. You are given the following information for Serena-Sturm (SS) for 2005. What is the estimated indirect cost rate if # of projects is used as the cost allocation base? Is this a good choice for the cost allocation base?Q2: Job Costing Example (Service Sector)Estimated indirect cost rate = $450,000/1,000 projects =$450/projectTerrible choice for a cost allocation base; ignores resource consumption of the projects.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 13SS has a costing system with a single direct cost pool. If SS uses a single indirect cost pool, determine both the estimated and actual indirect cost rates using (a) number of professional labor hours and (b) number of blueprints prepared as cost allocation bases.Q2: Job Costing Example (Service Sector)$450,00010,000 hrs= $45/hr$504,0004,000 bpts= $126/bpt$504,00012,000 hrs= $42/hr$450,0003,600 bpts= $125/bpt
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 14SS was asked to prepare a fixed fee bid for an out-of-town project called The Culebra Complex. The budgeted professional hours for this project was 400, and the job is expected to require the preparation of 7 blueprints. Compute the budgeted project cost using (a) professional labor hours and (b) number of blue prints prepared as a cost driver for indirect costs.Q2: Job Costing Example (Service Sector)$40/hr x 400 hrs = $16,000$40/hr x 400 hrs = $16,000$45/hr x 400 hrs = $18,000$125/bpt x 7 bpts = $875$34,000$16,875
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 15Why do the different cost allocation bases yield vastly different project costs?Q2: Why Are Costs so Different?If professional labor hours is a good measure of activity, then this project is expected to be 400 hrs/10,000 hrs, or 4% of the year’s activity.If # of blueprints is a good measure of activity, then this project is expected to be 7 bpts/3,600 bpts, or less than 0.2% of the year’s activity.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 16Shipping & ReceivingQ2: Job Costing in ManufacturingLogo lamps makes desk lamps stamped with the customer’s logo. MaterialsStorageSheet Metal StampingPaintingAreaFinished GoodsStorageInspection & PackingAssemblyArea
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 17Q2: Journal Entries in Job Costing•Flow of costs matches flow of the goods through the factory•debit Overhead cost control for actual overhead costs•credit Overhead cost control when overhead allocated to WIP•Source documents used to update accounts for direct costs•Normal costing is used, so overhead is charged to jobs based on estimated overhead rates•Overhead cost controlis a temporary account used in normal costing
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 18Shipping & ReceivingQ2: Flow of Costs in Job CostingMaterialsStorageSheet Metal StampingPaintingAreaFinished GoodsStorageInspection & PackingAssemblyAreaWhen raw materials are received, costs are debited to raw materials inventory; no distinction between direct and indirect materials is made at this stage.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 19Shipping & ReceivingQ2: Flow of Costs in Job CostingMaterialsStorageSheet Metal StampingPaintingAreaFinished GoodsStorageInspection & PackingAssemblyAreaWhen raw materials are sent to the factory floor, direct materials costs (per materials requisition forms)are debited to Work in process inventory.Indirect materials costs are debited to Overhead cost control.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 20Shipping & ReceivingQ2: Flow of Costs in Job CostingMaterialsStorageSheet Metal StampingPaintingAreaFinished GoodsStorageInspection & PackingAssemblyAreaWhen labor costs are incurred, direct labor costs (per time records)are debited to Work in process inventory.Indirect labor costs are debited to Overhead cost control.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 21Shipping & ReceivingQ2: Flow of Costs in Job CostingMaterialsStorageSheet Metal StampingPaintingAreaFinished GoodsStorageInspection & PackingAssemblyAreaWhen a job is completed, costs are removed from WIP inventory and transferred to FG inventory.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 22Shipping & ReceivingQ2: Flow of Costs in Job CostingMaterialsStorageSheet Metal StampingPaintingAreaFinished GoodsStorageInspection & PackingAssemblyAreaWhen a job is shipped to a customer, costs are removed from FG inventory and transferred to CGS; The revenue and the receivable are also recorded.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 23Q2: Journal Entries in Job CostingThe materials storeroom receives a shipment of direct and indirect materials that cost $12,500. Prepare the journal entry.Materials are sent to the stamping and assembly areas. The cost of the direct materials is $1,400 and the cost of the indirect materials is $800. Prepare the journal entry.Raw materials inventory12,500Accounts payable12,500Overhead cost control800Raw materials inventory 2,200Work in process inventory1,400
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 24Q2: Journal Entries in Job CostingWages totaling $2,000 are accrued; 75% of these costs are direct labor and 25% are indirect labor. Prepare the journal entry.Overhead costs are allocated to work in process using an allocation rate of 200% of direct labor costs. Prepare the journal entry.Work in process inventory3,000Overhead cost control 3,000Overhead cost control500Wages Payable 2,000Work in process inventory1,500
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 25Q2: Journal Entries in Job CostingJob #1208, with a total cost of $2,200 is completed. Prepare the journal entry.Job #1208 is shipped to the customer, who is billed for $4,000. Prepare the journal entry.Cost of goods sold2,200Finished goods inventory 2,200Work in process inventory 2,200Finished goods inventory2,200Accounts receivable4,000Sales 4,000
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 26•Under normal costing, actual overhead is different from allocated overhead.•Misallocated overheadis the difference between actual and allocated overhead.•At the end of the year, the Overhead cost control account is closed out to WIP, FG & CGS.•Misallocated overhead (if material) is prorated to the 3 accounts based on a ratio of their account balances; if immaterial it is closed to CGS.Q2: Disposition of Misallocated Overhead
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 27Suppose budgeted overhead was $100,000 fixed overhead plus variable overhead of $10/DL hour. Expected DL hours were 50,00, so that the estimated overhead rate was $12/DL hour. Actual DL hours totaled 40,000 for the year and actual overhead was $550,000. At the end of the year, WIP, FG & CGS had the account balances shown below. Prepare the year-end entry to close the Overhead cost control account.Overhead cost control 70,000Q2: Disposition of Misallocated OverheadWIP $ 100,000FG 200,000CGS1,700,000$2,000,000Cost of goods sold59,500Finished goods inventory7,000Work in process inventory3,0005%10%85%Overhead cost control$550,000$480,000 ($12/DL hr x 40,000 DL hrs)$70,000
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 28Q3: Uses & Limitations of Job Costing Information•Job cost information is used for•Financial statement preparation•Income tax returns•Bidding for jobs•Comparing expected to actual costs (diagnostic control)•Job cost information may not be useful for non-routine short term decision making as allocated fixed costs may not be relevant•Accountant’s judgment is used to determine:•Direct vs. allocated costs•Type and number of overhead pools•Type of cost driver
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 29•Spoilage–unacceptable units that are discarded or sold for disposal costsQ4: Job Costing and Spoilage -Terminology•Reworked units-unacceptable units that are reprocessed and sold•Scrap–left over direct materials that are discarded or sold for a minimal amount–Normal spoilagearises under efficient operating conditions & is treated as an inventoriable cost–Abormal spoilageis not part of normal operations & is treated as a period cost
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 30Q4: Job Costing and SpoilageIn job costing, spoilage could be normal spoilage that coincidentally occurred on this job, but was not due to any demanding aspects of this job–spoilage costs removed from Work in process inventory–spoilage costs are debited to Overhead cost control–in this case a job without spoilage has the same manufacturing cost per unit as a job where spoilage occurred
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 31Q4: Job Costing and SpoilageIn job costing, spoilage could be abnormal spoilage that coincidentally occurred on this job, but was not due to any demanding aspects of this job–spoilage costs removed from Work in process inventory–spoilage costs are debited to Loss from abnormal spoilage–in this case a job without spoilage has the same manufacturing cost per unit as a job where spoilage occurred
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 32Q4: Job Costing and SpoilageIn job costing, spoilage could be spoilage that occurred on this job due to the job’s demanding specifications–spoilage costs are not removed from Work in process inventory–in this case a job without spoilage has a lower manufacturing cost per unit than a job where this type of spoilage occurred
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 33On January 1 LeiaCorp. budgeted the following factory overhead:Factory rent$40,000Leiaexpected to use 28,000 DL hours this Utilities10,000 year; overhead is allocated to WIP usingNormal spoilage6,000DL hours. Job #3 shows total costs of $56,000$12,200. An inspection reveals that 20% of Job #3 must be scrapped and sold for $100. Prepare the journal entry to record the spoilage and the sale of the scrap if the spoilage is considered normal and is not due to the demanding specifications of Job #3. If Job #3 was originally a batch of 10,000 units, what is the manufacturing cost per unit for the good units in Job #3?Work in process inventory2,440(20% x $12,200)Cash100Overhead cost control2,340Q4: Job Costing and Spoilage ExampleMfg cost/unit = ($12,200 -$2,440)/8,000 good units = $1.22/unit.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 34On January 1 Leia Corp. budgeted the following factory overhead:Factory rent$40,000Leia expected to use 28,000 DL hours this Utilities10,000 year; overhead is allocated to WIP usingNormal spoilage6,000DL hours. Job #3 shows total costs of $56,000$12,200. An inspection reveals that 20% of Job #3 must be scrapped and sold for $100. Prepare the journal entry to record the spoilage and the sale of the scrap if the spoilage is considered abnormal. If Job #3 was originally a batch of 10,000 units, what is the manufacturing cost per unit for the good units in Job #3?Work in process inventory2,440(20% x $12,200)Cash100Loss from abnormal spoilage2,340Q4: Job Costing and Spoilage ExampleMfg cost/unit = ($12,200 -$2,440)/8,000 good units = $1.22/unit.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 35On January 1 Leia Corp. budgeted the following factory overhead:Factory rent$40,000Leia expected to use 28,000 DL hours this Utilities10,000 year; overhead is allocated to WIP usingNormal spoilage6,000DL hours. Job #3 shows total costs of $56,000$12,200. An inspection reveals that 20% of Job #3 must be scrapped and sold for $100. Prepare the journal entry to record the spoilage and the sale of the scrap if the spoilage occurred to the demanding specifications of Job #3. If Job #3 was originally a batch of 10,000 units, what is the manufacturing cost per unit for the good units in Job #3?Work in process inventory100Cash100Q4: Job Costing and Spoilage ExampleMfg cost/unit = ($12,200 -$100)/8,000 good units = $1.5125/unit.
© John Wiley & Sons, 2011Chapter 5: Job CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 36Q5: Effect of Spoilage Accountingon Manager Behavior•If spoilage costs are ignored, there is no incentive for managers to control these costs.•If company has a zero defect policy, all spoilage is considered abnormal; the loss on the income statement may force managers to control spoilage.•If rework costs are not accounted for separately, managers may rework units that should be scrapped.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 1Cost ManagementMeasuring, Monitoring, and Motivating PerformanceChapter 6Process Costing
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 2Chapter 6: Process CostingLearning objectives•Q1: How are costs assigned to mass-produced products? •Q2: What are equivalent units & how do they relate to the production process?•Q3: How is the weighted average method used in process costing?•Q4: How is the FIFO method used in process costing?•Q5: What alternative methods are used for mass production?•Q7: How are spoilage costs handled in process costing?•Q8: How does process costing information affect managers’ incentives and decisions?•Q6: How is process costing performed for multiple production departments?
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 3Q1: Job Order versus Process Costing
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 4Q1: Job Order versus Process Costing
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 5WIP Inventory -UnitsBIUnits startedEIUnits completed& transferred outWIP Inventory -$BIDMCCEIUnits completed& transferred outQ1: Introduction to Process CostingProcess costing is a method of averaging costs over the units of production. This is necessary to determine the cost of the units transferred out of a department, as well as the cost of the department’s ending WIP inventory.This information is all knownUnlike job costing, there are no job cost records to give us this information
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 6Riker Co. had June costs for Department 1 as follows:DM$60,000CC30,000$90,000There were no units in beginning or ending WIP inventory in June. During June Department 1 started 45,000 units, and all 45,000 were completed in June. What is the manufacturing cost/unit? Q1: Process Costing with all Units CompletedWIP Inventory -Units045,000045,000WIP Inventory -$090,000090,000The manufacturing cost/unit is $90,000/45,000 units = $2/unit.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 7Suppose that 30,000 units were completed in June, and the units in ending WIP were 1/3 complete. What is the manufacturing cost/unit? The 15,000 units taken to 1/3 completion are counted as 5,000 equivalent whole units, or 5,000 equivalent units of production (EUP).Q2:The Concept of Equivalent UnitsIn order to value partially complete units of inventory, we measure units in equivalent whole units rather than actual units.The manufacturing cost/unit = $90,000/[30,000 + 5,000]EUP = $2.57143/EUP.WIP Inventory -Units045,00015,00030,000WIP Inventory -$090,000
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 8Using the cost/EUP of $2.57143 from the prior slide, compute the costs attached to the 30,000 completed units and the costs attached to the 15,000 units in ending WIP inventory.Q2:The Concept of Equivalent Units30,000 units x $2.5714377,14312,8575,000 EUP x $2.57143WIP Inventory -Units045,00030,000WIP Inventory -$090,00015,000
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 9•The prior slide simplified the computation of EUP.Q2-Q4:Equivalent Units &Process Costing Methods•15,000 units taken to 1/3 completion is equivalent to 5,000 whole units only if costs are incurred evenly.•We will return to this later.•The prior slide ignored the different methods of computing EUP.•The weighted average and FIFO methods compute EUP differently.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 10Q2-Q4: Three Categories of UnitsIn process costing we categorize units according to the time period(s) they were produced.Prior monthsCurrent monthNext monthBI units: The units in beginning Work in process inventory were worked on in prior months and (we assume) they will be completed in the current month.EI units: The units in ending Work in process inventory are started (we assume) in the current month and (we assume) they will be completed in the current month.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 11Q2-Q4: Three Categories of UnitsIn process costing we categorize units according to the time period(s) they were produced.Prior monthsCurrent monthNext monthS&C units: Any units that are started in the current month and are totally complete by month end are called started & completedunits.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 12Q2-Q4: Summarizing thePhysical Flow of ProductionThe number of S&C units can be computed as the number of units transferred out less the number of BI units.For example, suppose a department had 5,000 units in beginning WIP and started 50,000 units this month. If 35,000 units were completed, what is the number of S&C units?WIP Inventory -Units5,00050,00035,00020,000BI units5,000S&C units30,000Completed units35,000
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 13Q2-Q4: Two Process Costing MethodsThe weighted average and FIFO methods of process costing methods compute EUP differently.Prior monthsCurrent monthNext monthThe weighted average (WA) method gives credit for work performed in the current & prior months.This means that under the WA method, the EUP for BI units and S&C units is the same as the physical number of units in each category.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 14Q2-Q4: Two Process Costing MethodsThe weighted average and FIFO methods of process costing methods compute EUP differently.Prior monthsCurrent monthNext monthThe weighted average (WA) method gives credit for work performed in the current & prior months.The EUP for EI units and is based on the stage of completion of the EI units –only the portion of the work done in the current month is included.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 15Q2-Q4: Two Process Costing MethodsThe weighted average and FIFO methods of process costing methods compute EUP differently.Prior monthsCurrent monthNext monthThe FIFO method gives credit onlyfor work performed in the current month.This means that the EUP for BI units is based on the completion of these units during the current month.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 16Q2-Q4: Two Process Costing MethodsThe weighted average and FIFO methods of process costing methods compute EUP differently.Prior monthsCurrent monthNext monthThe FIFO method gives credit onlyfor work performed in the current month.The EUP for EI units and is based on the stage of completion of the EI units –only the portion of the work done in the current month is included.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 17Q2-Q4: Equivalent Units of Production ExampleIn July, Rita Corp. had 30,000 units in beginning WIP that were 60% complete and 20,000 units in ending WIP that were 80% complete. There were 100,000 units completed and transferred to FG inventory. Compute EUP for July using both the weighted average and FIFO methods.WIP Inventory -Units30,000100,00020,000BI units30,000S&C units70,000Completed units100,00090,000First, summarize the physical flow of the units and compute S&C.
© John Wiley & Sons, 2011Slide # 18Q2-Q4: Equivalent Units of Production ExampleIn July, Rita Corp. had 30,000 units in beginning WIP that were 60% complete and 20,000 units in ending WIP that were 80% complete. There were 100,000 units completed and transferred to FG inventory. Compute EUP for July using both the weighted average and FIFO methods.BI units30,000S&C units70,000Completed units100,000WIP Inventory -Units30,000100,00020,00090,000Then, convert the physical units to EUP.
© John Wiley & Sons, 2011Slide # 19Q2-Q4: Equivalent Units of Production ExampleIn July, Rita Corp. had 30,000 units in beginning WIP that were 60% complete and 20,000 units in ending WIP that were 80% complete. There were 100,000 units completed and transferred to FG inventory. Compute EUP for July using both the weighted average and FIFO methods.BI units30,000S&C units70,000Completed units100,000WIP Inventory -Units30,000100,00020,00090,000Then, convert the physical units to EUP.(1-60%)
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 20•The prior slides simplified the computation of EUPQ2-Q4:Equivalent Units &Process Costing Methods•20,000 units started and taken to 80% completion is equivalent to 16,000 whole units only if costs are incurred evenly.•We usually assume that conversion costs are incurred evenly throughout production, but direct materials costs may not be incurred evenly.•Direct materials costs may be incurred at the beginning of processing or in some other uneven manner.•Because costs are incurred at different times, separate EUP computations are done for DM & CC.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 21Q2-Q4: Separate EUP for DM & CCYou are given the information below about the physical flow of the units in Department 1. The BI units were 25% complete and the EI units were 40% complete. Compute EUP for DM and CC if DM costs are incurred at the beginning of production.WIP Inventory -Units5,00020,00017,0008,000BI units5,000S&C units12,000Completed units17,000(1-25%)
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 22Q2-Q4: Separate EUP for DM & CCUse the same information from the prior slide; recall that the BI units were 25% complete and the EI units were 40% complete. Compute EUP for DM and CC if 20% of DM costs are incurred at the beginning of processing and the rest of the DM costs are incurred when the units pass the 60% stage of completion.(1-20%)No Change
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 23•The EUP calculations provide the denominator in the cost per EUP computation.Q2-Q4:Cost per Equivalent Unit•The numerator for the WA cost per EUP includes totalcosts(current costs plus the BI costs).•The numerator for the FIFO cost per EUP includes only current costs.•A cost per EUP is computed for each cost category.•The WA and FIFO methods use different numerators in the cost per EUP computation.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 24You are given the information below about May’s production and costs for Slocik Co. The units in ending WIP were 1/3 complete. Direct materials are added at the beginning of processing. What is the manufacturing cost per EUP under both methods? 045,000WIP Inventory -Units30,00015,0000DM65,250CC28,000WIP Inventory -$Q3&4: Process Costing Example, no BIFirst, compute the EUP for DM & CC.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 25045,000WIP Inventory -Units30,00015,0000DM65,250CC28,000WIP Inventory -$Q3&4: Process Costing Example, no BIWhen there is no BI, WA and FIFO have the same EUP, and hence the same costs/EUP.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 26045,000WIP Inventory -Units30,00015,0000DM65,250CC28,000WIP Inventory -$Q3&4: Process Costing Example, no BINow, compute the costs/EUP for DM & CC.DM cost/EUP = $65,250/45,000 EUP = $1.45/EUPCC/EUP = $28,000/35,000 EUP = 0.80/EUPTotal manufacturing cost/EUP $2.25/EUP
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 27045,000WIP Inventory -Units30,00015,0000DM65,250CC28,000WIP Inventory -$Q3&4: Process Costing Example, no BIThe last step is a process cost report that breaks the “total costs to account for” into:total units to account for = 45,000total costs to account for = $93,250$ assigned to completed units$ assigned to EI units•the portion that is assigned to the units in ending WIP inventory•the portion that is assigned to the completed units, and
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 28Q3&4: Process Costing Example, no BI0030,000 x $2.2567,50030,00067,50030,00045,00093,25015,00021,7504,00025,75015,000 x $1.455,000 x $0.80The journal entry to record the costs transferred out is:FG inventory67,500WIP inventory67,500
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 29Colors R Us, Inc. uses a process costing system for its sole processing department. There were 6,200 units in beginning WIP inventory for February and 57,500 units were started in February. The beginning WIP units were 60% complete and the 5,000 units in ending WIP were 45% complete. All materials are added at the start of processing. Compute the EUP for DM and CC using both methods.58,700Q3&4: Process Costing Example, with BIFirst, compute the # of units started & completed:6,200WIP Inventory -Units5,00057,500BI units6,200S&C units52,500Completed units58,700
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 30Q3&4: Process Costing Example, with BI58,7006,200WIP Inventory -Units5,00057,500BI units6,200S&C units52,500Completed units58,700Now, compute the EUP for DM & CC (recall that BI & EI were 60% & 45% complete, respectively, and all DM are added at the start of processing).
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 31Beginning WIP inventory was valued at $42,896 [DM costs of $12,850 plus CC of $30,046]. During February Colors incurred DM costs of $178,250, and CC of $274,704. Compute the cost of the goods transferred out the the costs assigned to ending WIP inventory for February, using both methods. BI 42,896DM178,250CC274,704WIP Inventory -$Q3&4: Process Costing Example, with BIUnder FIFO, the numerator includes only current costs:The EUP from the prior slide:DM cost/EUP = $178,250/57,500 EUP = $3.10/EUPCC/EUP = $274,704/57,230 EUP = 4.80/EUPTotal manufacturing cost/EUP $7.90/EUP
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management,2eSlide # 32Beginning WIP inventory was valued at $42,896 [DM costs of $12,850 plus CC of $30,046]. During February Colors incurred DM costs of $178,250, and CC of $274,704. Compute the cost of the goods transferred out the thecosts assigned to ending WIP inventory for February, using both methods. BI 42,896DM178,250CC274,704WIP Inventory -$Q3&4: Process Costing Example, with BIUnder WA, the numerator includes BI andcurrent costs:The EUP from the prior slide:DM cost/EUP = $191,100/63,700 EUP = $3.00/EUPCC/EUP = $307,750/60,950 EUP = 5.00/EUPTotal manufacturing cost/EUP $8.00/EUP
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 336,20057,500WIP Inventory -Units58,7005,00042,896DM178,250CC274,704WIP Inventory -$Q3&4: Process Costing Example, with BIThe last step is a process cost report that breaks the “total costs to account for” into:total units to account for = 63,700total costs to account for = $495,850$ assigned to completed units$ assigned to EI units•the portion that is assigned to the units in ending WIP inventory•the portion that is assigned to the completed units, and
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 34Q3&4: WA Process Costing Example, with BIUnder the WA method, there is no distinction between the 6,200 BI units and the 52,500 S&C units.
Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 35Q3&4: FIFO Process Costing Example, with BIUnder the FIFO method, the cost assigned to the 6,200 BI units is computed separately from the cost of the 52,500 S&C units.= 2,480 * $4.80= 52,500 * $7.90= 5,000 * $3.10= 2,250 * $4.80
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 36Q6: Accounting for Transferred-in Costs•“Transferred-in costs” (TI) is merely another cost category like DM or CC•When preparing a process cost report for a department with TI costs: •All processing departments except the first will account for TI costs•Compute EUP for TI costs; all TI costs are incurred at the start of processing•Compute cost/EUP for TI costs•Assign TI costs to EI units
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 37Crusher Drugs manufactures a pain medication in a two-process cycle. In Department 2, direct materials are added as follows: 20% are added at the beginning of processing, and the rest at the 60% stage. There were 5,000 units in Dep’t 2’s beginning WIP inventory that were 40% complete, and 20,000 units were transferred in to Dep’t 2 in May. The Dep’t 2 ending WIP inventory of 6,000 units was 55% complete. Compute the May EUP for all cost categories for Department 2 using both methods.Q6: Process Costing Example, with TI CostsFirst, compute the # of units started & completed:5,000Dep’t 2 WIP Inventory -Units6,00020,000BI units5,000S&C units14,000Completed units19,00019,000
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 38Q6: Process Costing Example, with TI Costs19,0005,000Dep’t 2WIP Inventory -Units6,00020,000BI units5,000S&C units14,000Completed units19,000Now, compute the EUP for DM & CC (recall that BI & EI were 40% & 55% complete, respectively; 20% of DM costs are incurred at the start of processing, and the rest are incurred at the 60% stage).
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 39You are given the cost information below. Compute the cost per EUP under both methods. Under WA, the numerator includes BI and current costs:Q6: Process Costing Example, with TI CostsDM cost/EUP = $79,537.50/20,200 EUP =$3.9375/EUPCC/EUP = $35,122.50/22,300 EUP = 1.5750/EUPTotal manufacturing cost/EUP $10.7625/EUPTI cost/EUP = $131,250/25,000 EUP = 5.2500/EUP
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 40You are given the cost information below. Compute the cost per EUP under both methods. Under FIFO, the numerator includes only current costs:Q6: Process Costing Example, with TI CostsDM cost/EUP = $72,240/19,200 EUP =$3.7625/EUPCC/EUP = $31,262/20,300 EUP = 1.5400/EUPTotal manufacturing cost/EUP $10.9025/EUPTI cost/EUP = $112,000/20,000 EUP = 5.6000/EUPNext, complete the process cost report using both methods….
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 41Q6: Process Costing Example, with TI CostsGiven $4,000 * 3,000 *14,000 ** 19,0001,200 * $3.7625 = 3,300 * $1.5400 = 6,000 * $5.6000 = 1,200 * $3.9375 = 3,300 * $1.5750 = 6,000 * $5.2500 =
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 42Q5: What Alternative Methods are Used for Mass Production?•Adaptations to Traditional Process Costing–Match equivalent units calculations more closely to actual production processes–Separate conversion costs into multiple pools•Standard costs simplify the accounting•Just-in-time production•Hybrid costing, or operation costing
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 43Q7: Accounting for Spoilage in Process Costing•Costs of normal spoilage are absorbed by the good units transferred out.•Costs of abnormal spoilage are charged to a Loss from abnormal spoilage account.•Costs attach to spoilage depending on when spoilage is detected.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 44Hollidazemakes molded plastic party decorations. In June, there were 800 units in beginning WIP inventory that were 40% complete and the 500 units in ending WIP were 30% complete. The company completed 3,000 units in June, but 200 of these were defective and were discarded. The defective units are located upon inspection before transfer to finished goods. It was determined that 50 of these defective units should be considered normal spoilage. The remaining spoilage occurred because of a rare machine malfunction and should be considered abnormal spoilage. All direct materials are added at the beginning of processing. Compute the June EUP for DM and CC using both methods.Q7: Process Costing & Spoilage ExampleFirst, compute the # of units started & completed:2,700BI units800S&C units2,200Completed units3,000800WIP Inventory -Units5003,000this includes 200 defective units
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 45Q7: Process Costing & Spoilage ExampleNow, compute the EUP for DM & CC (recall that BI & EI were 40% & 30% complete, respectively; DM costs are incurred at the start of processing).BI units800S&C units2,200Completed units3,0002,700800WIP Inventory -Units5003,000
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 46You are given the cost information below. Compute the cost per EUP under both methods. Under WA, the numerator includes BI and current costs:Q7: Process Costing & Spoilage ExampleDM cost/EUP = $11,375/3,500 EUP =$3.25/EUPCC/EUP = $7,245/3,150 EUP = 2.30/EUPTotal manufacturing cost/EUP $5.55/EUP
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 47You are given the cost information below. Compute the cost per EUP under both methods. Q7: Process Costing & Spoilage ExampleDM cost/EUP = $8,640/2,700 EUP =$3.20/EUPCC/EUP = $5,943/2,830 EUP = 2.10/EUPTotal manufacturing cost/EUP $5.30/EUPUnder FIFO, the numerator includes only current costs:Next, complete the process cost report using both methods….
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eQ7: WAProcess Costing & Spoilage ExampleThe WA journal entry to record the costs transferred out is:FG inventory15,81.50Loss from abnormal spoilage832.50WIP inventory16,650.00Note the total good units accounted for is the total units to account for less the spoiled units.
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg& Wolcott’s Cost Management, 2eSlide # 49Q7: FIFOProcess Costing & Spoilage ExampleThe FIFO journal entry to record the costs transferred out is:FG inventory15,910Loss from abnormalspoilage795WIP inventory16,705
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management 2eSlide # 50Q8: Process Costing Uses for Decision Making•Used to determine valuation for inventory and cost of goods sold at the end of each period•Required for financial statements and income tax returns•Helps managers evaluateif the production processesare operating as expected •Compare actual results to budget, standards, or prior periods•Identify areas for process improvements •Analyze benefits of quality improvements
© John Wiley & Sons, 2011Chapter 6: Process CostingEldenburg & Wolcott’s Cost Management, 2eSlide # 51Q8: Process Costing Limitations & Impacts on Managers’ Decision Making•Process cost information is generally not useful for many short-term decisions because unavoidable fixed costs are allocated to the products.•Need to determine incremental or marginal costs•Separating conversion costs into fixed and variable pools would help•Requires use of estimates:•The point of the production process when DM costs or CC are incurred.•Stage of completion for all units in beginning and ending WIP inventories