Pricing and Costing Lesson 1-3

COST CONTROL

is the identification of business expenses and taking steps to reduce them.

• Look for a lower-cost vendor

• Outsource certain functions

• Take corrective action

If actual costs exceed the budget, management may:

Planning

Employee’s role

Monitoring

Assessment

Taking Decisions

FIVE STEPS OF COST CONTROL

 PLANNING

___establishes what the organization expects to achieve.

• Be informed about the plans

• Understand their responsibilities

• Know how their roles contribute to cost control

Employees role in cost control

• Record actual costs

• Collect relevant information

• Evaluate actual performance

Management should monitor

Actual Results

Projected Results

what results should be compared in assessment

Precise Responsibility Centers

Different Cost Standards

Relevance of Controllable Costs

Prescribed Authority

Cost Reduction

Cost Reporting

CHARACTERISTICS OF GOOD COST CONTROL

Precise Responsibility Centers

Responsibility for costs should be clearly assigned.

Different Cost Standards

Standards should be established for evaluating performance.

 Relevance of Controllable Costs

The system should focus on costs that responsible managers can influence.

Prescribed Authority

Employees/managers should have clearly defined authority.

Cost Reduction

The system should help identify ways to reduce unnecessary costs.

Cost Reporting

Cost information should be properly reported for evaluation and action.

COST STANDARDS

provide a basis for evaluating performance.

EXTERNAL STANDARDS

INTERNAL STANDARDS

2 TYPES OF COST STANDARDS

EXTERNAL STANDARDS

Performance is compared with outside organizations or companies in the same industry.

INTERNAL STANDARDS

Performance is compared within the organization.

BUDGETARY CONTROL

 involves the creation and use of budgets to plan, execute, and regulate operations.

• Plan operations

• Execute operations

• Regulate operations

• Monitor expenses

• Compare estimated and actual costs

• Identify differences

• Take corrective action

PURPOSES OF BUDGETARY CONTROL

Planning

Distribution

Information Sharing

Day-to-Day Record Keeping

Control

STEPS IN BUDGETARY CONTROL

STANDARD COSTING

uses predetermined costs or standards under certain working conditions.

• Establish expected levels of performance

• Measure actual performance

• Compare actual performance with standards

• Identify variances

• Determine the causes of variances

• Take corrective action

PURPOSE OF STANDARD COSTING

Performance Measurement System

Comparison Tool

REQUIREMENTS OF STANDARD COSTING

Sales − Fixed Costs − Variable Costs = Target Net Income

Target Net Income Formula

Provides a Yardstick for Performance

Allows Comparison

Decreases Debt

Reduces Replacement and Repair Costs

Frees Money for Other Avenues

Provides Competitive Advantage

ADVANTAGES OF COST CONTROL

Cost Analysis

• is the process of examining the relationship between cost and output.

TOP-DOWN ANALYSIS
BOTTOM-UP ANALYSIS

2 APPROACHES TO ANALYZE COSTS 

TOP-DOWN ANALYSIS

starts with the organization's overall financial information and works downward toward specific programs, units, locations, and expenses.

BOTTOM-UP ANALYSIS

starts with the organization's actual activities and operations and works upward to understand the costs.

Surplus/deficit analysis 

examines whether a particular cost object is generating a surplus or deficit after considering its costs.

SERVICE COST

To determine whether a service is breaking even, it is necessary to determine the cost of providing that service.

DIRECT COST

a cost that is directly associated with and feasibly traceable to a specific activity or service.

INDIRECT COST

a cost that:

• Is shared among several activities, or

• Cannot be feasibly traced to one specific activity.

OVERHEAD

is a variable term generally referring to costs that support activities but are not directly assigned to a specific activity.

LUMPY COSTS

do not increase smoothly. They behave more like a step function.

Unit costs may decline as volume increases until capacity is reached. When additional fixed capacity is required, total cost can suddenly increase.

FULL COST METHOD

It is used to determine the average cost per unit or service.

• Direct costs

• An allocated portion of indirect/overhead costs

The full cost method includes:

INCREMENTAL COST METHOD

a cost method that requires more detailed analysis and judgment.

INCREMENTAL COST METHOD

a cost method that examines:

• Cost structure

• Cost drivers

• Additional costs resulting from decisions or changes

INCREMENTAL COST

additional cost caused by a change or decision.

MANAGERIAL ACCOUNTING

is primarily focused on the internal needs of management.

• Planning

• Control

• Decision-making

Managerial accounting provides information used for:

FINANCIAL ACCOUNTING

focuses on providing information through periodic financial statements.

FINANCIAL ACCOUNTING

It is primarily concerned with reporting past performance and providing information for external users.

Direct

Indirect

Fixed

Variable

Product cost

Period Cost

BASIC COST CLASSIFICATIONS

Opportunity Cost

The value of an alternative that is given up.

Business Cost

Cost incurred in carrying out business activities.

Full Cost

Includes direct costs plus allocated indirect/overhead costs.

Explicit Cost

A cost involving an actual monetary payment.

Implicit Cost

A cost associated with using resources without a direct monetary payment.

Out-of-Pocket Cost

An actual cash expenditure.

Book Cost

A cost recorded in the accounting records.

Fixed Cost

Cost that remains constant within a relevant range.

Variable Cost

Cost that changes with the level of activity.

Total Cost

The total amount of costs incurred.

Average Cost

Cost per unit.

Marginal Cost

The additional cost of producing one more unit.

Short-Run Cost

Cost when some factors of production are fixed.

Long-Run Cost

Cost when factors can generally be changed.

Sunk Cost

Cost already incurred that cannot be recovered.

Historical Cost

Original cost of an asset/resource.

Replacement Cost

Cost of replacing an asset/resource.

Private Cost

Cost borne by an individual or business.

Social Cost

Cost imposed on society as a whole.

• LIFO

• FIFO

• Specific Identification

• Weighted Average

COST ASSIGNMENT METHODS

Last-in, first-out

LIFO MEANING

First-In, First-Out

FIFO MEANING

JOB COSTING

involves the accumulation of the costs of:

• Materials

• Labor

• Overhead

JOB COSTING

it accumulate costs for each specific job.

MATERIALS

The cost of components is accumulated and assigned to a product or project when the components are used.

LABOR

Employees charge their time to specific jobs.

OVERHEAD

are accumulated into cost pools and then allocated to jobs.

MONITORING LONG-TERM JOBS

Job Costing → Track costs → Compare with budget → Detect overruns → Take action

Cost-plus contract

The customer pays:

All Costs Incurred + Profit

Materials → Warehouse → Picked from stock → Issued to specific job

JOB COSTING ALLOCATION OF MATERIALS

• charged to an overhead cost pool for later allocation

If spoilage or scrap occurs in Normal amounts

charged directly to Cost of Goods Sold (COGS)

If spoilage or scrap occurs in abormal amounts

Work-in-Process Inventory → Finished Goods Inventory

When the job is completed:

Finished Goods Inventory → Cost of Goods Sold

When the goods are sold:

Direct Labor

Labor that can be directly traced to an individual job.

Indirect Labor

Manufacturing-related labor that cannot be directly traced to a specific job.

Standard Overhead Rate × Units of Activity = Overhead Allocated

STANDARD OVERHEAD COST ALLOCATION FORMULA

Charge to cost of goods sold

Allocate the Variance

Charge to Jobs

3 DISPOSAL METHOD OF THE REMAINING OVERHEAD VARIANCE

• Finished Goods

• Work-in-Process

• Cost of Goods Sold

where to allocate the remaining overhead variance based on the 2nd method of disposal of the remaining overhead variance

associated with a specific job.

The allocation of an overhead cost pool is inherently inaccurate because the underlying costs cannot be directly ____

ACTIVITY-BASED MANAGEMENT

ABM MEANING

ACTIVITY-BASED MANAGEMENT

is a way of analyzing and evaluating a company's business activities through:

• Activity-Based Costing (ABC)

• Value-chain analysis

ACTIVITY-BASED MANAGEMENT

analyzes the cost of an activity in relation to the value added by the activity.

Identification and Analysis

Evaluation and Value-Chain Analysis

Identifying Opportunities to Improve

Process of Activity-Based Management

Cost Drivers

is a factor that causes the cost of an activity to vary.

EVALUATION AND VALUE-CHAIN ANALYSIS

A process where the manager calculates the cost of each activity by considering the direct and indirect costs related to that activity.

Identification and Analysis

A process where the company finds and list a company's significant business activities.

VALUE-CHAIN ANALYSIS

By identifying the value generated by each activity, it allows management to compare:

Cost of Activity ↔ Value Generated

VALUE-CHAIN

value generated by each activity

OPERATIONAL ABM

focuses on improving operational efficiency.

• Enhancing value-generating activities

• Eliminating unnecessary costs

• Eliminating non-value-generating activities

• Identifying anomalies in the costing process

• Investigating unusual results

Using operational abm helps in:

STRATEGIC ABM

uses activity-based costing to analyze the profitability of an activity.

• Improve the economic efficiency of operations

• Support strategic decision-making

• Enhance value-generating activities

• Potentially improve customer experience

• Increase profitability in the long run

• Provide costing information useful for forecasting

• Help determine financial information for future fiscal years

• Support more accurate budgeting

ABM — ADVANTAGES