ACC 230 Exam #3

Characteristics of Job-costing systems:

Distinct, identifiable units of a product or service

• Examples:

– Custom-made machines, houses

Characteristics of Process-costing systems

Masses of identical or similar units of a product or service

• Examples:

– Food, chemical processing

Process-costing system Definition

• Process costing is a system where the unit cost of a product or service is obtained by assigning total costs to many identical or similar units of output.

• Unit costs are calculated by dividing total costs incurred by the number of units of output from the production process.

• Each unit receives the same or similar amounts of direct materials costs, direct manufacturing labor costs, and indirect manufacturing costs (manufacturing overhead).

Job-costing systems Definition

• In a job-costing system, individual jobs use different quantities of resources, so it would be incorrect to cost each job at the same average production cost.

• In contrast, when identical or similar units of products or services are mass-produced, process costing is used to calculate an average production cost for all units produced.

• The main difference between process costing and job costing is the extent of averaging used to compute the unit costs of products or services.

Process-costing systems separate costs into cost categories according to when costs are introduced into the process:

1. Direct materials are usually added at the beginning of the production process, or at the start of work in a subsequent department down the assembly line.

2. Conversion costs are generally added equally along the production process (Direct Labor and Overhead).

Equivalent Units:

• A derived amount of output units that

- takes the quantity of each input in units completed and in unfinished units of work in process and

– converts the quantity of input into the amount of

completed output units that could be produced with that

quantity of input.

They are calculated separately for each input (direct

materials and conversion cost).

• When calculating equivalent units in step 2, focus on

quantities and disregard dollar amounts until after the

equivalent units are computed.

Five-Step Process-Costing Allocation:

1. Summarize the flow of physical units of output.

2. Compute output in terms of equivalent units.

3. Summarize total costs to account for.

4. Compute cost per equivalent unit.

5. Assign total costs to units completed and to units in ending work-in-process.

Weighted-Average Method: Part One

• Calculates cost per equivalent unit of all work done to date (regardless of the accounting period in which it was done)

• Assigns this cost to equivalent units completed and transferred out of the process and to equivalent units in ending work-in-process inventory

Weighted-Average Method: Part Two

• The weighted-average cost is the total of all costs entering the work-in-process account divided by the total equivalent units of work done to date.

• The beginning balance of the work-in-process account (work done in a prior period) is blended in with current period costs.

Two critical figures arise out of step 5 of the cost allocation process:

1. The amount of the journal entry transferring the allocated cost of units completed and sent from work-in-process inventory to finished goods inventory

2. The ending balance of the work-in-process inventory account that will appear on the balance sheet

First-In, First-Out (FIFO) Process-Costing Method: Part One

• Assigns the cost of the previous accounting period’s equivalent units in beginning work-in-process inventory to the first units completed and transferred out of the process

• Assigns the cost of equivalent units worked on during the current period first to complete beginning inventory, next to started and completed new units, and finally to units in ending work-in-process inventory

First-In, First-Out (FIFO) Process-Costing Method: Part Two

• A distinctive feature of FIFO process-costing method is that work done on the beginning inventory before the current period is kept separate from work done in the current period.

• The costs incurred and units produced in the current period are used to calculate the cost per equivalent unit of work done in the current period.

• In contrast, the equivalent-unit and cost per equivalent unit calculations under the weighted-average method MERGE the units and costs in beginning inventory with the units and costs of work done in the current period.

Comparing Weighted-Average and FIFO Methods: Part One

• FIFO assumes that all the units from the previous period (higher cost units in our example) in beginning WIP are the first to be completed and transferred out and that ending WIP consists of only the lower cost current-period units.

• The weighted-average method smooths out the cost per equivalent unit by assuming that more lower cost units are transferred out and some higher cost remain in ending WIP.

Comparing Weighted-Average and FIFO Methods: Part Two

• Managers use information from process-costing systems to make pricing and product-mix decisions and understand how well a firm’s processes are performing.

• FIFO provides managers with information about changes in the costs per unit from one period to the next.

• In a period of rising prices, the weighted-average method will decrease taxes because cost of goods sold will be higher and operating income lower.

Transferred-In Costs Defintion:

• Transferred-in costs are costs incurred in previous departments that are carried forward as the product’s cost when it moves to a subsequent process in the production cycle.

• They are also called previous department costs.

• Journal entries are made to mirror the progress in production from department to department.

• Transferred-in costs are treated as if they are a separate type of direct material added at the beginning of the process.

Hybrid Costing Systems: Part One

• Product-costing systems do not always fall neatly into either job-costing or process-costing categories.

• A hybrid-costing system blends characteristics from both job-costing and process-costing systems.

• Many actual production systems are in fact hybrids.

• Manufacturers who tend to use hybrid-costing systems include producers of televisions, dishwashers, washing machines, and shoes.

Hybrid Costing Systems: Part Two

• The hybrid-costing systems use process costing to account for the conversion costs and job costing for the material and customizable components.

• One specific type of hybrid-costing system is known as the operation costing system.

Operation Costing System Definition:

• An operation is a standardized method or technique often performed repetitively on different material resulting in different finished goods.

• An operation-costing system is a hybrid-costing system applied to batches of similar, but not identical, products.

• Within each operation, all product units are treated exactly alike, using identical amounts of the operation’s resources.

• Managers find operation costing useful in cost management because operation costing focuses on control of physical processes or operations of a given production system.

Information and the Decision Process Definition:

Managers usually follow a decision model for choosing among different courses of action.

• A decision model is a formal method of making a choice that often involves both quantitative and qualitative analyses.

• Management accountants analyze and present relevant data to guide managers’ decisions.

The Concept of Relevance:

Relevant information has two characteristics:

– It occurs in the future.

– It differs among the alternative courses of action.

• Relevant costs are expected future costs.

• Relevant revenues are expected future revenues.

Sunk Costs Are Irrelevant in Decision-Making:

• Sunk costs are costs that have already occurred (historical costs) and cannot be changed.

• Sunk costs are excluded because they cannot be changed by future actions.

Potential Problems in Relevant-Cost Analysis:

Managers should avoid two potential problems in relevant–cost analysis:

1. Avoid incorrect general assumptions such as “All variable costs are relevant, and all fixed costs are irrelevant.” Even in our simple example, we had irrelevant, variable marketing costs.

2. Be aware that unit-fixed-cost data can potentially mislead managers in two ways.

Incremental cost definition

The additional total cost incurred for an activity

Differential cost definition

The difference in total cost between two alternatives

Incremental revenue definiton

The additional total revenue from an activity

Differential revenue definition

the difference in total revenue between two alternatives

Outsourcing definition

Outsourcing is purchasing goods and services from outside vendors.

Insourcing definition

Insourcing means you’ll produce the good (or provide the service) within the organization.

Opportunity costs definition

Opportunity costs are the contribution to operating income forgone by not using a limited resource in its next-best alternative use.

International outsourcing definition

International outsourcing requires managers to evaluate manufacturing and transportation costs, exchange-rate risks, and other strategic and qualitative factors, such as quality, reliability, and efficiency of the supply chain.

The Total Alternatives Approach:

This approach simply means that managers should consider future costs and revenues for all products. If, for example, one decision will create idle capacity but that idle capacity can be used for manufacture of another product, that should be considered in the overall decision.

The Opportunity-Cost Approach:

Opportunity cost is the contribution to operating income that is forgone by not using a limited resource in its next-best alternative use. Deciding to use a resource one way means a manager must forgo the opportunity to use the resource in any other way. Managers must consider that cost in their decision-making.

Carrying Costs of Inventory:

Recall that under the opportunity-cost approach, the relevant cost of any alternative is (1) the incremental cost of the alternative plus (2) the opportunity cost of the profit forgone from choosing that alternative. The opportunity cost of holding inventory is the income forgone by tying up money in inventory and not investing it elsewhere.

Product-Mix Decisions with Capacity Constraints:

Product-mix decisions are decisions managers make about which products to sell and in what quantities.

• Decision rule (with a constraint):

– Choose the product that produces the highest contribution margin per unit of the constraining resource (not the highest contribution margin per unit of the product).

Bottleneck definition:

A bottleneck is a phenomenon where the performance or capacity of an entire system is limited by a single or limited number of components or resources.

The theory of constraints (TOC) definition:

The theory of constraints (TO C) is designed to maximize operating income when faced with some bottleneck and some non-bottleneck operations.

• Throughput margin – Contribution Margin in terms of the constraint

The objective of TOC is to increase throughput margin while decreasing investments and operating costs. TOC focuses on managing bottleneck operations.

Managing bottleneck operations has four steps:

1. Recognize that bottleneck operations determine the contribution margin of the entire system.

2. Identify the bottleneck operations.

3. Keep the bottleneck operation busy and subordinate all non-bottleneck operations to the bottleneck operation.

4. Take actions to increase the efficiency and capacity of the bottleneck operation.

Why doesn’t depreciation cost matter when deciding whether to drop a customer?

Depreciation cost is irrelevant in deciding whether to drop a customer because depreciation on equipment that has already been purchased is a past (sunk) cost

Some items of cost are NOT relevant:

• Cost, accumulated depreciation, and book value of existing equipment

• Any potential gain or loss on the transaction, a financial accounting phenomenon only

• Sunk costs (past costs) are unavoidable, cannot be changed no matter what action is taken, and are not relevant.

Some items of cost MAY BE relevant:

Current disposal value of old machine and cost of new machine

Joint costs definition:

The costs of a production process that yields multiple products simultaneously

Split off point definition:

The juncture in a joint production process when two or more products become separately identifiable

Separable costs definition:

All costs (manufacturing, marketing, distribution, and so on) incurred beyond the split off point that are assignable to each of the specific products identified at the split off point

Categories of joint process outputs:

1. Outputs with a positive sales value

2. Outputs with a zero sales value

Main product definition:

Output of a joint production process that yields one product with a high sales value compared to the sales values of the other outputs

Joint products definition:

Outputs of a joint production process that yields two or more products with a high sales value compared to the sales values of any other outputs

Byproducts definition:

Outputs of a joint production process that have low sales values compared to the sales values of the other outputs

Two Approaches to Allocating Joint Costs:

1. Market-based—allocate using market-derived data (dollars)

– Sales value at splitoff method

– Net realizable value (NRV) method

– Constant gross-margin percentage NRV method

2. Physical measures—allocate using tangible attributes of the products, such as weight, quantity, or volume of the joint products

Net Realizable Value Method:

• Allocates joint costs to joint products produced during the accounting period on the basis of relative NRV.

• NRV = Final Sales Value – Separable Costs.

Physical-Measure Method:

The physical-measure method allocates joint costs to joint products produced during the accounting period on the basis of a comparable physical measure, such as the relative weight, quantity, or volume at the split off point.

The constant gross margin percentage NRV method can be broken down into three steps:

1. Compute the overall gross margin percentage.

2. Compute the total production costs for each product.

3. Compute the allocated joint costs.

Joint costs are what type of costs?

Sunk costs

In sell-or-process further decisions, what costs are irrelevant?

Joint cost

Capital budgeting definition

• Capital budgeting is the process of making long-run planning decisions for investments in projects.

• In much of accounting, income is calculated on a period-by-period basis.

• In choosing investments, managers make selections among multiple projects, each of which may span several periods.

Four Capital Budgeting Analysis Methods:

1. Net present value (NPV)

2. Internal rate of return (IRR)

3. Payback period

4. Accrual accounting rate of return (AAR R)

Discounted cash flow (DCF) methods definition:

Discounted cash flow (DCF) methods measure all expected future cash inflows and outflows of a project discounted back to the present point in time.

What is the key feature of DCF?

The key feature of DCF methods is the time value of money, which means that a dollar received today is worth more than a dollar received at any future time.

What does the NPV method calculate?

The NPV method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time, using the Required Rate of Return (RRR).

What does the IRR method calculate?

The IRR method calculates the discount rate at which an investment’s present value of all expected cash inflows equals the present value of its expected cash outflows.

Payback method definition

The payback method measures the time it will take to recoup, in the form of expected future cash flows, the net initial investment in a project.

Why is IRR is more prone than NPV to indicate erroneous decisions?

• IRR implicitly assumes that project cash flows can be reinvested at the project’s rate of return.

• NPV accurately assumes that project cash flows can only be reinvested at the company’s required rate of return.

Why do managers still use the IRR method, even though it makes more errors than the
NPV method?

Managers find the percentage return computed under the IRR method easy to understand and compare.

Two weaknesses for the payback method:

1. Fails to recognize the time value of money

2. Doesn’t consider cash flow beyond the payback point

Payback method equation:

Net initial investments / Uniform increase inannual future cash flows

AAR R methd equation:

Average annual [accrual accounting] income of a project / a measure of the investment in it

Accrual Accounting Rate of Return equation:

Increase in Expected Average Annual After - Tax Operating Income / Net Initial Investment

Two components of cash flow from operations:

1. Annual after-tax cash flow from operations (excluding the depreciation effect)

2. Income tax cash savings from annual depreciation deductions

Post-investment audit definition:

A post-investment audit provides managers with feedback about the performance of a project so that they can compare the actual results to the costs and benefits expected at the time the project was selected.