MGT 212 Exam 2 Cram

Learning objectives

1. Develop and use departmental overhead rates to allocate indirect costs

2. Develop and use activity-based costing (ABC) to allocate indirect costs

3. Understand the benefits and limitations of ABC/ABM systems

4. Describe lean operations

5. Describe and use the costs of quality framework

6. Describe the data cleaning process needed before using activity cost pool and driver data

This chapter introduces:

• Refined costing systems

• Lean operations

• Total equity management and the cost of quality

Cost distortion

Overcosting some products while undercosting other products.

Why is it important to understand that simple cost allocation systems can lead to cost distortion?

With better cost information, managers are able to make more profitable decisions. One company reported triple sales and a fivefold increase in profits after it implemented a refined costing system. By using better cost information for quoting jobs, management was able to generate a more profitable mix of job contracts. Also by using simple cost allocation, people can be paying more than they actually need to as cited in the example in the textbook with the three roomates.

pmohr

Estimated total overhead costs of year / total allocation base (can be labor cost or hours)

Plantwide overhead rate

When overhead is allocated to every product using the same manufacturing overhead rate.

Activity based costing

Focusing on activities as the fundamental cost objects. The costs of those activities become building blocks for compiling the indirect costs of products, services, and customers.

Step 1 of activity based costing

The company identifies activities and then estimates the total manufacturing overhead costs associated with each activity. These are known as activity cost pools.

Step 2 of Activity Based Costing

The company selects an allocation base for each activity and estimates the total amount that will be used during the year.

Step 3 of activity based costing

The company calculates its activity cost allocation rates using the information estimated in Steps 1 and 2.

Activity cost allocation rate formula

Total estimated activity cost pool / total estimated activity allocation base

Step 4 of allocation base costing

The company allocates some manufacturing overhead from each activity to the individual jobs that use the activities.

Moh allocated to job formula (activity based costing)

Activity cost allocation rate x Actual amount of activity allocation base used by job

If a company refines its costing system using departmental overhead rates or ABC, will manufacturing overhead still be overallocated or underallocated by the end of the year? ( as saw in chapter 3)

Yes. The use of any predetermined allocation rate will result in the over- or under-allocation of manufacturing overhead. That's because predetermined rates are developed using estimated data before the actual manufacturing overhead costs and actual cost driver activity for the year are known. Refined costing systems decrease cost distortion between products but do not eliminate the issue of over- or underallocating total manufacturing overhead. As described in Chapter 3, the Cost of Goods Sold account will need to be adjusted at year-end for the total amount by which manufacturing overhead has been over- or underallocated.

The cost hierarchy

1. Facility level activities

2. Product level activities

3. Batch level activities

4. Unit level activities

Unit level activities

Activities and costs incurred for every unit produced.

Batch level activities

Activities and costs incurred for every batch regardless of the number of units in the batch.

Product level activities

Activities and costs incurred for a particular product regardless of the number of units or batches of the product produced.

Facility level activities

activities and costs incurred no matter how many units, batches, or products that are produced in the plant

Do the journal entries used to record job costing differ if a manufacturer uses a refined cost allocation system (departmental overhead rates or ABC) rather than a single, plantwide overhead rate?

The journal entries used for a refined costing system are essentially the same as those described in Chapter 3 for a traditional job costing system. The only difference is that the company will typically use several MOH accounts (one for each department or activity cost pool) rather than one MOH account. By using several MOH accounts, the manufacturer obtains more detailed information on each cost pool. This information may help managers make better estimates when calculating allocation rates the next year.

Activity based management

Using activity-based cost information to make decisions that increase profits while satisfying customers' needs.

Value added activities

Activities for which the customer is willing to pay because these activities add value to the final product or service.

Non value added activities

Activities that neither enhance the customer's image of the product or service nor provide a competitive advantage; also known as waste activities.

Can governmental agencies use ABC/ABM to run their operations more efficiently?

Yes. ABC/ABM is not just for private-sector companies. The City of Indianapolis was able to save its taxpayers millions of dollars after using ABC to study the cost of providing city services (activities) to local citizens. Once the city determined the cost of its activities, it was able to obtain competitive bids for those same services from private businesses. As a result, the city outsourced many activities to private-sector firms for a lower cost.

How can a refined costing system support environmental sustainability?

By creating separate cost pools for environmental related costs, managers are better able to identify those activities and products with larger environmental footprints.

What types of decisions would benefit from the use of ABC?

Managers use ABC data in ABM to make the following decisions:

• Pricing and product mix

• Cost cutting

• Routine planning and control

What are the main benefits of ABC?

• More accurate product cost information.

• More detailed information on costs of activities and associated cost drivers help managers control costs and eliminate non-value added activities.

When is ABC most likely to pass the cost-benefit test?

• The company is in a competitive environment and needs accurate product costs.

• The company makes different products that use different amounts of resources.

• The company has high indirect costs.

• The company produces high volumes of some products and lower volumes of other products.

• The company has accounting and information technology expertise to implement the system.

How do we tell when a cost system needs to be refined?

• Managers lose bids they expected to win and win bids they expected to lose.

• Competitors earn profits despite pricing high-volume products below the company's costs.

• Employees do not believe cost numbers.

• The company has diversified the products it manufactures.

• The company has reengineered the production process but not the accounting system.

Lean thinking

A philosophy and business strategy of operating without waste.

Kaizen

A Japanese word meaning “change for the better.”

Customer response time

The time that elapses between receipt of a customer order and delivery of the product or service.

DOWNTIME Acronym

D - defects

O- overproduction

W- waiting

N- not utilizing people to full potential

T- transportation

I- inventory

M- movement

E- excess processing

Eight wastes

Defects, overproduction, waiting, not utilizing people to their full potential, transportation, inventory, movement, excess processing.

Defects

Costs time and money. The product will either need to be repaired, at additional cost, or disposed of. In either case, resources are wasted. The final section of this chapter is devoted to discussing the various costs associated with poor quality of product or service.

Overproduction

means that the company is making more product than needed or making product sooner than it is needed. Traditional manufacturers often make products in large batches because of long and costly machine setup times and to protect themselves against higher than expected demand for the product. Also, traditional manufacturers often make extra work in process inventory so that each department will have something to continue working on in the event production stops or slows in earlier departments.

Waiting

Employees must often wait for parts, materials, information, or machine repairs before they can proceed with their tasks. In addition, because of overproduction and large batches, work in process inventory often waits in a queue for the next production process to begin. Whether it refers to people or product, wait time is wasted time. The company's customer response time could be much shorter if wait time were eliminated.

Not utilizing people to their full potential

By assuming that managers always know best, traditional companies have often underutilized their employees. In contrast, one of the key mantras of lean thinking is employee empowerment at all levels of the organization. Employees usually have excellent ideas on how their jobs could be done more efficiently and with less frustration.

Transportation

While movement of parts, inventory, and paperwork is necessary to some extent, any excess transportation is simply wasteful because of the equipment, manpower, energy, and time it requires. Excess transportation is often caused by poor plant layout, large centralized storage cribs, large batches, and long lead times that require product to be moved elsewhere until the next production process is ready to begin.

Inventory

Typically, traditional manufacturers buy more raw materials than they need "just in case" any of the materials are defective or the supplier is late with the next delivery. As noted earlier, they produce extra work in process inventory "just in case" something goes wrong in the production process. Also, they produce extra finished goods inventory "just in case" demand is higher than expected. In other words, large inventories are essentially a response to uncertainty. Uncertainty is a valid reason for keeping large inventories.

Movement

In contrast to the waste of transportation, which refers to moving products and materials, the waste of movement refers to excess human motion, such as excess bending, reaching, turning, and walking. This waste is often caused by cluttered or unorganized work areas (where employees must search for the needed tools and supplies), poorly designed facilities (where employees must walk from one area of the building to another), and poorly designed workstations and work methods (where employees must continually crouch, stretch, bend, and turn to do their tasks). Not only does excess movement take time, but also it can signal unsafe work conditions that can decrease employee morale and increase the company's exposure to workers' compensation claims.

Excess processing

This waste refers to performing additional production steps or adding features the customer doesn't care about. Often, this waste is caused when customer requirements are not clearly defined, when engineering changes are made without simultaneous process changes, or when additional steps are performed to make up for shortfalls in earlier production steps. For example, to keep its price point relatively low, IKEA flat packs all of its furniture and lets the customer perform the final assembly. By eliminating the final assembly process, IKEA gives customers what they want at a price that is affordable. Also, IKEA saves on related transportation and warehousing costs that would be incurred on bulkier, fully assembled furniture.

Just in time (JIT)

An inventory management philosophy that focuses on purchasing raw materials just in time for production and completing finished goods just in time for delivery to customers.

5s

A workplace organization system composed of the following steps: sort, set in order, shine, standardize, and sustain.

Point of use storage

A storage system used to reduce the waste of transportation and movement in which tools, materials, and equipment are stored in proximity to where they will be used most frequently.

Back flush costing

A simplified accounting system in which production costs are not assigned to the units until they are finished or even sold, thereby saving the bookkeeping steps of moving the product through the various inventory accounts.

Total quality management

A management philosophy of delighting customers with superior products and services by continually setting higher goals and improving the performance of every business function.

Costs of quality reports

A report that lists the costs incurred by the company related to quality.

The costs are categorized as prevention costs, appraisal costs, internal failure costs, and external tailure costs.

Prevention costs

Costs incurred to avoid poor-quality goods or services.

Appraisal costs

Costs incurred to detect poor-quality goods or services.

Internal failure costs

Costs incurred when the company detects and corrects poor-quality goods or services before making delivery to customers.

External failure costs

Costs incurred when the company does not detect poor-quality goods or services until after delivery is made to customers.

Conformance costs

The combination of prevention and appraisal costs; the costs incurred to make sure a product or service is not defective and therefore conforms to its intended design.

Nonconformance costs

The combination of internal failure and external failure costs; the costs incurred when a product is defective and therefore does not conform to its intended design.

Conversion costs formula

Direct labor + moh

Number of equivalent units formula

Number of physical units X percentage of completion

Weighted average method of process costing

A process costing method that combines any beginning inventory units (and costs) with the current period’s units (and costs) to get a weighted average cost.

5 step process costing procedure

1. Summarize the flow of physical units

2. Calculate output in terms of equivalent units

3. Summarize total costs to account for

4. Calculate the cost per equivalent unit

5. Assign total costs to units completed and units in ending Work in process inventory

In step one what two lines must be equal?

Total physical units to account for

Transferred in costs

Costs incurred in a previous process that are carried forward as part of the product’s cost when it moves to the next process.

Production cost report

Summarizes a processing department’s operations for a period

Equivalent units

Express the amount of work done during a period in terms of fully completed units of output.

Two basic job costing systems

• Job costing

• Process costing

Job costing

• unique goods, small batches

• Service companies

Process costing

• series of steps to produce large quantities of identical unitsj

• Jelly belly

• Shell oil

Process costing analogy

Process costing is like rolling a snowball into a snowman. The product (snowball) keeps picking up cost (snow) as it rolls through each production process. Thus, the cost assigned to the product (snowball) keeps getting larger and larger as costs from each department are progressively added to it through the transfer of costs.

Why is process costing in the first production department important?

"Most food and consumer products are mass-produced. Managers need to know (1) the cost of each manufacturing process, to make each one as cost-efficient as possible; and (2) the cost of each unit, to aid in pricing and other business decisions."

Step 1: Summarize the Flow of physical units

You have to make sure the units accounted for are equal!!!!

Step 2: Calculate output in terms of equivalent units

Everything finished isn’t getting anymore DM. DM is equal to units accounted for.

Step 3: summarize total costs to account for

Total costs to account for must ALWAYS equal total costs accounted for in step 5!!! This is the total cost of the WIP inventory account.

Step 4: Compute the cost per equivalent unit

This is the average cost of making one unit in this department.

Step 5: assign total costs to units complete and to units in ending WIP inventory

• costs assigned to units completed are transferred out TOTAL must be transferred out of the department to go with the units that were transferred out.

• Total costs accounted for must ALWAYS equal total costs to account for (step 3)

Journal entry: During October, $140,000 of direct materials was requisitioned for use by the Shaping Department. In the following journal entry, notice how these costs are recorded specifically to the Shaping Department's Work in Process Inventory account. In process costing, each processing department maintains a separate Work in Process Inventory account.

Debit WIP inventory 140,000

Credit Raw Materials inventory 140,000

(To record dm used by the shaping department in October)

Journal entry: Labor time records show that $21,250 of direct labor was used in the Shaping Department during October, resulting in the following journal entry:

Debut WIP inventory— shaping 21,250

Credit Wages Payable 21,250

(To record dl used in the shaping department in October)

Journal entry: Manufacturing overhead (MOH) is allocated to the Shaping Department using the company's predetermined overhead rate(s). Recall from Chapters 3 and 4 that companies can use a plantwide rate, departmental rates, or ABC to allocate MOH. Since SeaView is already segmented into departments, using departmental rates makes the most sense. For example, let's say that the Shaping Department's overhead rate is $50 per machine hour and the department used 935 machine hours during the month. That means $46,470 ($50 x 935) of MOH should bé allocated to the Shaping Department during October:

Debit WIP inventory— shaping 46,750

Credit MOH 46,750

(To record moh allocated to the shaping department in October)

Learning objectives

1. Describe key characteristics and graphs of various cost behaviors

2. Use cost equations to express and predict costs

3. Use account analysis and scatterplots to analyze cost behavior

4. Use the high-low method to analyze cost behavior

5. Use regression analysis to analyze cost behavior

6. Describe variable costing and prepare a contribution margin income statement

7. Contrast linear regression with multiple regression when used to analyze and predict costs

Variable costs

Costs incurred for every unit of activity. As a result, total variable costs change in direct proportion to changes in volume.

Cost behavior

A behavior that describes how costs change as volume changes

Total variable cost formula (y)

Variable cost per unit of activity (v) x volume of activity (x)

Why is cost behavior important?

"Cost behavior is a key component of most planning and operating decisions. Without a thorough understanding of cost behavior, managers are apt to make less profitable decisions."

Why are cost equations important?

"cost equations help managers predict total costs at different operating volumes so that they can better plan for the future."

Key characteristics of variable costs

• Total variable costs change in direct proportion to changes in volume

• The variable cost per unit of activity (v) remains constant and is the slope of the variable cost line

• Total variable cost graphs always begin at the origin (if volume is zero,

total variable costs are zero)

• Total variable costs can be expressed as follows:

y=vx

where,

y= total variable cost

v= variable cost per unit of activity

x= volume of activity

Fixed costs

Costs that do not change in total despite wide changes in volume.

Example of fixed costs in a hotel

• Property taxes and insurance

• Straight-line depreciation and maintenance on parking ramp, hotel, and furnishings

• Lease payments on fitness room equipment

• Cable TV and wireless Internet access for all rooms

• Salaries of hotel department managers (housekeeping, food service, special events, etc.)

Committed fixed costs

Fixed costs that are locked in because of previous management decisions; management has little or no control over these costs in the short run.

Discretionary fixed costs

Fixed costs that are a result of annual management decisions; fixed costs that are controllable in the short run.

Variable cost graph

• graphs always begin at origin

• Slope represents the variable cost per unit of activity

Graph of fixed costs

Flat line that intersects y-axis

Fixed cost equation

total fixed cost per month (y) = fixed cost over a given period of time (f)

Key characteristics of fixed costs

• Total fixed costs stay constant over a wide range of volume

• Fixed costs per unit of activity vary inversely in proportion to changes in volume:

- Fixed cost per unit of activity increases when volume decreases (If volume is cut in half, the fixed cost per unit will double)

- Fixed cost per unit of activity decreases when volume increases (If volume doubles, the fixed cost per unit will be cut in half)

• Total fixed cost graphs are always flat lines with no slope that intersect the y-axis at a level equal to total fixed costs

• Total fixed costs can be expressed as y = f

where,

y = total fixed cost

f = fixed cost over a given period of time

Mixed costs

Costs that change but not in direct proportion to changes in volume. Mixed costs have both variable cost and fixed cost components.

Mixed cost graph

• Increases with volume

• Does not start at origin

Mixed cost equation

Total mixed costs (y)= variable cost component (vx) + fixed cost component (f)

Key characteristics of mixed costs

• Total mixed costs increase as volume increases because of the variable cost component

• Mixed costs per unit decrease as volume increases because of the fixed cost component

• Total mixed costs graphs slope upward but do not begin at the origin— they intersect the y-axis at the level of fixed costs

• Total mixed costs can be expressed as a combination of the variable and fixed cost equations:

Total mixed costs= variable cost component + fixed cost component

y=vx+f

where,

y = total mixed costs

v = variable cost per unit of activity (slope)

x = volume of activity

f = fixed cost over a given period of time (vertical intercept)

Relevant range

The band of volume where total fixed costs remain constant at a certain level and where the variable cost per unit remains constant at a certain level.

Step costs

A cost behavior that is fixed over a small range of activity and then jumps to a different fixed level with moderate changes in volume.

How can you tell if a total cost is variable, mixed, or fixed?

• Total variable costs increase in direct proportion to increases in volume.

• Total fixed costs stay constant over a wide range of volumes.

• Total mixed costs increase but not in direct proportion to increases in volume.

How can you tell if a per unit cost is variable, mixed, or fixed?

• On a per-unit basis, variable costs stay constant.

• On a per-unit basis, fixed costs decrease in proportion to increases in volume (that is to say, they are inversely proportional).

• On a per-unit basis, mixed costs decrease but not in direct proportion to increases in volume.

How can you tell by looking at a graph if a cost is variable, fixed or mixed?

• Variable cost lines slope upward and begin at the origin.

• Fixed cost lines are flat (no slope) and intersect the y-axis at a level equal to total fixed costs (this is known as the vertical intercept).

• Mixed cost lines slope upward but do not begin at the origin. They intersect the y-axis at a level equal to their fixed cost component.

Account analysis

A method for determining cost behavior that is based on a manager's judgment in classifying each general ledger account as a variable, fixed, or mixed cost.