Managerial Accounting Change Methods Make or Buy Product Mix Production Pricing Decision Making Financial Reporting Costing Profit and Cost Centers Variance Analysis Budgeting Discontinue (Control) Performance Evaluation What are the Goals? 15.514 Summer 2003BASIC COST TERMS Cost A sacrifice of resources. Distinguish from “expense” Cost Object Any activity or item for which a separate measurement of costs is desired. Cost objects are the “something” in the statement: “We need the cost of ‘something’”! Cost Driver Any factor whose change “causes” a change in the total cost of a related cost object. Note: Cost drivers can be factors other than volume 15.514 Summer 2003BASIC COST TERMS (contd.) Direct Costs Costs that can be traced to a given cost object (product, department, etc.) in an economically feasible way. Indirect Costs Costs that cannot be traced to a given cost object in an economically feasible way. These costs are also known as “overhead” or “burden.” Cost Assignment Direct costs are traced to a cost object. Indirect costs are allocated or assigned to a cost object. Product Costs All costs that “attach” to the units that are produced and are not reported as expenses until the goods are sold (e.g., direct materials, direct labor, applied overhead). 15.514 Summer 2003BASIC COST TERMS (contd.) Period costs Costs that must be charged against income in the period incurred and cannot be inventoried (e.g., selling and administrative expenses). Manufacturing Costs The sum of direct materials, direct labor, and indirect manufacturing costs Unit Costs Total cost of units divided by units produced. Controllable Costs Any cost that is primarily subject to the influence of a given manager of a given responsibility center for a given time period. 15.514 Summer 2003COST BEHAVIOR Variable Costs Costs that change directly in proportion to changes in the related cost driver Fixed Costs Costs that remain unchanged for a given time period regardless of changes in the related cost driver. Other Common Functions for Cost Behavior •Semivariable Costs (part variable and part fixed) •Step costs Major Assumptions Needed to Define Fixed and Variable Costs •Cost object, Time span, Linear functional form •Relevant range- the band of cost driver activity in which a specific relationship between a cost and a driver holds. 15.514 Summer 2003The “Ins” of Inventory Accounting What costs are assigned to inventory as products are manufactured? GAAP requires Full Absorption Costing: the products fully absorb all manufacturing costs, including: Variable manufacturing Costs: Material, Labor Fixed manufacturing Costs: Overhead Results in unitizing fixed costs: convert total fixed costs (TFC) to a unit cost by allocating TFC to the units produced. 15.514 Summer 2003Traditional Costing System Product Costs Traced directly Traced using machine hrs Direct Costs Direct Labor Direct Materials Overhead Costs Indirect Labor Indirect Materials Depreciation allocation base eg direct labor hrs, 15.514 Summer 2003Example of Product Costing Electron, Inc. produces 10,000 units in one month. •Variable manufacturing costs are: • $6/unit for material, • $1/unit for direct labor, and • $1/unit for variable overhead. •Fixed mfg overhead is $50,000/month. •Unit costs are $8 (variable) + $50,000/10,000 (fixed) or $13/unit. •How do these costs flow through Inventory Accounts? 15.514 Summer 2003Product Costing Events First half of November: 11/ 1: Purchase and receive $60,000 of material (Nov. supply) 11/ 2: Requisition half of the materials to the factory floor ($30,000) 11/ 5: Apply labor to the materials ($5,000) 11/ 7: Recognize depreciation expense for the month ($50,000) 11/ 8: Apply variable OH to the materials ($5,000) 11/ 9: Transfer 5,000 completed calculators from WIP to FG Inventory 11/10: Ship 2,000 completed calculators to customer 15.514 Summer 2003How do Costs Flow through Inventory Accounts? Cash Mat's Inv Raw WIP Inv Inv Goods Fin PP&E Net = Payable Wages RE Buy Materials -60 60 = maerials to factory Requisition half of -30 30 = Apply labor 5 = 5 depreciation) (PP&E Apply fixed OH 50 -50 = Apply variable OH -5 5 = inventory Transfer to FG -65 65 = Sell 2,000 units -26 = -26 15.514 Summer 2003Key Strategic Management Decisions ! Pricing ! Dropping unprofitable products ! Re-engineering/restructuring ! Making new investments ! Mergers & acquisitions ! Targeting customer groups 15.514 Summer 2003Cost Information for Strategic Decisions ! Product Costs – Pricing – Dropping unprofitable products ! Process/Business Costs – Re-engineering/restructuring – Making new investments – Mergers & acquisitions ! Customer Costs – Targeting customer groups 15.514 Summer 2003Activity-Based Costing System Product CostsActivities that drive overhd Direct Costs Direct Labor Direct Materials Overhead Costs Indirect Labor Indirect Materials Depreciation 15.514 Summer 2003Examples of Overhead Activities ! Purchase order processing ! Receiving/Inventorying materials ! Inspecting materials ! Processing accounts payable ! Facility maintenance ! Scheduling production ! Customer complaints ! Quality inspection/testing 15.514 Summer 2003Typical Activity Cost Drivers ! Number of alteration notices per product ! Units produced ! Number of receipts for materials/parts ! Stockroom transfers ! Direct labor hours ! Set-up hours ! Inspection hours ! Facility hours ! Number of customer complaints 15.514 Summer 2003ABC Example Dialglow Corporation manufactures travel clocks and watches. Overhead costs are currently allocated using direct labor hours, but the controller has recommended an activity-based costing system using the following data: Activity Level Activity Cost Driver Cost Clocks Watches Production Setup No. of Setups $120,000 10 15 Material Handling & Requisition No. of Parts 30,000 18 36 Packaging & Shipping #Units Shipped 60,000 45,000 75,000 Total Overhead $210,000 15.514 Summer 2003ABC Example, contd. Existing Cost System: Allocate Total OH based on labor hours (35,000 hours for travel clocks; 105,000 hours for watches.) OH Rate: $210,000/140,000 hours = $1.50/hour OH cost per Travel Clock: ($1.50/hr * 35,000 hrs) / 45,000 units = $1.167 OH cost per Watch: ($1.50/hr * 105,000 hrs) / 75,000 units = $2.10 15.514 Summer 2003ABC Example, contd. Allocation of : Production Setup Costs: $120,000/(10+15) setups =