Ba 115
Ba 115
Ba 115
Reports to external users (owners, creditors, Reports to managers inside the organization
tax authorities, regulators) for planning, controlling, decision making
Precision Timeliness
1.1. Cost Objects - can be products, customers, jobs, and organizational subunits
1.2. Direct Costs - can be traced to specific cost objects; caused by the cost object
1.3. Indirect Costs
● Common cost - incurred to support a number of cost objects but can’t be traced
individually
Manufacturing Costs/Inventoriable Costs
1. Selling costs/order-getting and order-filling costs - secure customer orders and get the
finished product to the customer; advertising, shipping, sales travel, sales commissions, sales
salaries, costs of finished goods warehouses, and depreciation of delivery equipment
2. Administrative costs - executive compensation, general accounting, secretarial, public
relations, depreciation of office buildings and equipment, etc.; can be direct or indirect cost
1. Cost behavior - how the cost will react to changes in the level of activity
1.1. Variable Cost - varies in total, in direct proportion to the changes in the level of activity;
constant per unit
● Activity Base/Cost driver - what causes the incurrence of variable costs
1.2. Fixed Cost - remains constant in total; averaged fixed cost varies inversely with changes in
activity; rent, insurance, salary
● Committed Fixed Costs - fixed over the period of time; insurance expenses → every
year we incur the same insurance cost
● Discretionary Fixed Costs - cost that arise from decisions of management
1.1.1 Relevant range - range of activity within which the assumptions made about cost
behavior are valid (applies to both fixed and variable costs); for fixed cost, the graph of the cost
is flat within the relevant range
1.3. Mixed cost/Semi-variable cost - cost that contains both variable and fixed elements;
example utility bills, laundry sa KnL
● Account analysis - based on analyst’s prior knowledge
● Engineering Approach - based upon industrial engineer’s evaluation
1.4 Cost structure - relative proportion of each type of cost in an organization
1. Traditional Approach - separates product costs from selling and administrative expenses; it
does not focus on cost behavior; for external users
● Sales - COGS (Product Costs) = Gross Margin
● Gross Margin - Selling & Administrative Costs (Period Costs) = Net Operating Income
2. Contribution Approach - separates costs into fixed and variable categories; for internal
users
● Sales - Variable Costs = Contribution Margin
● Contribution Margin - Fixed Costs = Net Operating Income
Cost Classification for Decision Making
1. Differential Cost - difference in costs between any two alternative (there is also differential
revenue); encompasses incremental costs (increase in cost from one alternative to another) and
decremental cost; only differential costs are relevant in decision making
2. Opportunity Cost - potential benefit that is given up when we choose one alternative over
the other; every alternative has an opportunity cost
3. Sunk Cost - costs that occurred in the past and cannot be altered
Cost of Quality/Quality Cost - cost incurred to prevent defects or incurred due to defects
Quality of conformance:
● Exceeds design specifications
● Free of defects/problems that degrade the product’s performance
A. Cost incurred to prevent selling of defective products (high quality conformance = high
prevention/appraisal costs)
1. Prevention Costs - for activities whose purpose is to reduce/eliminate defects
a. Quality circles - small groups of employees that meet on a regular basis to
discuss ways to improve quality
b. Statistical Process Control - detect whether the process is in or out of control
i. Out-of-control process - results in defective units (e.g. caused by a
miscalibrated machine)
2. Appraisal Costs/Inspection Costs - incurred to identify defective products before the
products are shipped to the customers
B. Cost incurred due to defects despite efforts to prevent them (low quality conformance = high
failure costs)
1. Internal Failure Costs - result from identifying defects before they are shipped to
customers (e.g. scrap, rejected products, reworking of defective units, downtime)
● Effect appraisal activities = high internal failure costs (but less external failure
costs)
2. External Failure Costs - result when a defective product is delivered to a customer (e.g.
warranty repairs, replacements, product recalls, liability arising from legal action against
a company, lost of sales arising from a reputation for poor quality)
Quality Cost Report - compilation of prevention, appraisal, internal, and external failure costs
related to company’s current quality control efforts (as a percentage of total sales)
Absorption Costing - costing method that includes all manufacturing costs in unit product costs
Job-order costing - used in situations where the organization offers many different products or
services, such as in furniture manufacturing, hospitals, and legal firms
● Direct materials, direct labor, and manufacturing overhead are assigned to jobs
● Costs of the job are divided by the number of units in the job → average cost per unit
(unit product cost)
Job Cost Sheet - records the materials, labor, and manufacturing overhead costs charged to a
job
Measuring Direct Labor Cost
● Time ticket - document used to record the amount of time an employee spends on
various activities
Main Idea:
1. A customer order triggers a number of activities
2. Performing the activities consumes resources
3. The consumption of resources incurs costs
Hierarchy of Activities:
1. Unit level activities
2. Batch-level activities (setting up equipment, shipping customer orders)
3. Product-level activity
4. Facility-level activity
Activity level:
Theoretical capacity - max level of activity that can be used under perfect conditions
Actual capacity -
Process Costing - single product is produced on a continuing basis for a long period of time
● Accumulates cost by department and assigns them uniformly for all the products
produced during the period
● Unit cost by department
Job-order Costing - many different products having production requirements are worked on
each period
● Unit cost by job cost sheet
EUP = Units transferred to the next department or to finished goods + Equivalent units in
ending inventory
Units in beginning WIP + Units started into production/transferred in = Units in ending
inventory + Units completed and transferred out
Cost Per Equivalent Unit = (Cost of Beginning WIP + Cost Added During the Period) /
Equivalent Units of Production
Ending Inventory EUP x Cost per Equivalent Unit per Cost Category per Processing
Department
Units Completed and Transferred Out x Cost Per Equivalent Unit Per Cost Category Per
Department
4. Reconciliation Report
Cost of Beg. WIP + Cost Added during the Period = Cost of Ending WIP + Cost of Units
Transferred Out
Cost-Volume-Profit (CVP) Analysis - estimate how profits are affected by the following factors:
1. Selling prices
2. Sales volume
3. Unit variable costs
4. Total fixed costs
5. Mix of products sold
Assumptions in CVP:
1. Price of a product or service will not change as volume changes
2. Variable costs are constant per unit; TOTAL fixed costs is constant
3. Mix of products sold remains constant
Contribution Margin - amount remaining from sales revenue after variable expenses have
been deducted → amount available to cover fixed expenses and then provide profits for the
period
Break-even Point - levels of sales at which profit is zero → once reached net operating income
will increase by the amount of the unit contribution margin for each additional unit sold.
Cost-Volume-Profit Graph or Break-even Chart: Unit Volume (X) and & Money (Y)
1. Line parallel to the volume axis to represent the total fixed expense
2. Choose a volume of unit sales and plot the point representing total expense (fixed and
variable); Draw a line through the point back to the point where the fixed expense line
intersects with the Y axis
3. Choose a volume of units sales; plot the point representing the total revenue at the
selected activity level; draw a line through this point back to the origin
Variable Expense Ratio = Variable Expense / Sales = Var Expense per Unit / Unit Selling Price
NOTE: CM Ratio is valuable in situations where dollar sales of one product must be traded off
against dollar sales of another product → products that yield the greatest CM Ratio should be
emphasized
Incremental Analysis - consider only the costs and revenues that will change if the new program
is implemented
Target Profit Analysis - We estimate what sales volume that is needed to achieve a specific
target profit
Margin of Safety - amount by which sales can drop before losses are incurred; excess of actual
sales over the break-even volume sales; higher margin of safety = lower risk of incurring a loss
Degree of Operating Leverage (at a given level of sales): greatest at sales levels near the
break-even point and decreases as sales and profits rise → might explain why management will
often work very hard for only a small increase in sales volume
Sales Mix - relative proportion in which a company’s products are sold → profits will be greater
if high-margin rather than low-margin items make up a relatively large portion of total sales
Break-even for Sales Mix: Profit = (Overall CM Ratio x Total Sales) - Fixed Expenses
Topic: Differential Analysis (Choosing between alternatives based on their differential costs and
benefits)
Make or Buy Decisions: decision to carry out one of the activities in the value chain internally,
rather than to buy externally from a supplier
● Value Chain - all activities from development, to production, to after-sales service
○ Separate companies may carry out each of the activities in the value chain or a
single company may carry out several
○ Vertically integrated - company involved in more than one activity in the entire
value chain
NOTE: Assume that allocated common costs are irrelevant to the decision unless you are
explicitly told otherwise. If explicitly told that a portion of allocated common costs can be
avoided by choosing one alternative over another, treat the explicitly identified avoidable costs
as relevant costs.
Special Order Decisions: Decision on whether a special order should be accepted, and if the
order is accepted, the price that should be priced
● Special order - one-time order that is not considered part of the company’s normal
ongoing business
● A special order should be accepted if the incremental revenue from the special order
exceeds the incremental costs of the order
○ Important: Make sure that there is indeed idle capacity and that the special order
does not cut into normal unit sales or undercut prices on normal sales
Volume Trade-off Decisions: When companies do not have enough capacity to produce all of
the products and sales volume demanded by their customers; companies must trade off, or
sacrifice production of some products in favor of others in an effort to maximize profits (which
products should they sell and which sales opportunities should they bypass?)
● Fixed costs remain the same regardless of how a constrained resource is used,
managers should ignore them when making volume trade-off decisions; focus the
attention on identifying the mix of products that maximizes the total contribution margin
● Constraint or Bottleneck - step that limits total output because it has the smallest
capacity
● Favor the products that provide the highest contribution margin per unit of the
constrained resource: (Product’s CM per unit) / (Amount of constrained resource
required to make a unit of that product)
● Managers can also increase profits by increasing the capacity of the bottleneck
operation
● Relaxing (or Elevating) the Constraint - when managers increases the capacity of the
bottleneck
Joint Product Costs and Sell or Process Further Decisions: Should a joint product be sold
at the split-off point or processed further?
● Joint products - two or more products produced from a single raw material input (terms:
intermediate products and end products)
● Split-off point - point in a manufacturing process where joint products can be
recognized as separate products
● Procedure:
○ Always ignore all joint costs (all costs incurred up to the split-off point)
○ Determine the incremental revenue that is earned by further processing the joint
product (revenue earned after further processing the joint product - revenue that
could be earned by selling the joint product at the split off point)
○ Incremental Revenue - Incremental Costs (costs associated with processing the
joint product beyond the split-off point)
Master Budgeting
Budget - detailed plan for the future that is usually expressed in formal quantitative terms
Responsibility Accounting - a manager should be held responsible for those items, and only
those items, that the manager can actually control to a significant extent; each line of item (i.e.
revenue or cost) in the budget is the responsibility of a manager who is held responsible for
subsequent deviations between budgeted goals and actual results; someone must be held
responsible for each cost or else no one will be responsible and the cost will grow inevitably out
of control
Continuous or Perpetual Budget - 12 month budget that rolls forward one month (or quarter)
as the current month (quarter) is completed; one month (quarter) is added to the end of the
budget as each month (or quarter) comes to a close
Self-imposed or Participative Budget - budget that is prepared with the full cooperation and
participation of managers at all levels
● Limitations:
○ Lower-level managers may make suboptimal budgeting recommendations if they
lack the broad strategic perspective possessed by top managers
○ Self-imposed budgeting may allow lower-level managers to create too much
budgetary slack
Master Budget - a number of separate interdependent budgets that formally lay out the
company’s sales, production, and financial goals
Procedure:
1. Beginning Balance Sheet
2. Budgeting Assumptions
3. Sales Budget - detailed schedule showing the expected sales for the budget period;
based on the company’s sales forecast, which may require the use of sophisticated
mathematical models and statistical tools
● With schedule of expected cash collections
4. Production Budget/Merchandise Purchases Budget - lists the number of units that
must be produced to satisfy sales needs and to provide for the desired ending finished
goods inventory
5. Direct Materials Budget - details the raw materials that must be purchased to fulfill the
production budget and to provide for adequate inventories
● With schedule of expected cash disbursements for purchases of materials
6. Direct Labor Budget - shows the direct labor hours required to satisfy the production
7. Manufacturing Overhead Budget - lists all costs of production other than direct
materials and direct labor
● With cash disbursements for manufacturing overhead
8. Ending Finished Goods Inventory Budget - shows the cost of unsold units
9. Selling and administrative Expenses Budget - lists the budgeted expenses for areas
other than manufacturing
● With cash disbursements for selling and administrative expenses
10. Cash Budget - detailed plan showing how cash resources will be acquired and used
● Cash receipts section - lists all of the cash inflows, except from financing,
expected during the budgeting period
● Cash disbursement section - summarizes all cash payments that are planned
for the budget period
● Cash excess or deficiency section
○ Cash deficiency or cash less than the minimum required cash balance -
the company will need to borrow money
○ Cash excess greater than the minimum required cash balance - the
company can invest the excess funds or repay principal and interest to
lenders
12. Budgeted Balance Sheet - estimates the company’s assets, liabilities, and
stockholders’ equity at the end of the budget period
→ Dividends paid are deducted from retained earnings
Flexible Budgets and Performance Analysis
Planning Budget
- Prepared before the period begins
- Static; Valid for only the planned level of activity
- Inappropriate for evaluating how well costs are controlled; If the actual level of activity
differs from what was planned, it would be misleading to compare actual costs to the
static, unchanged planned budget
Flexible Budget
- Estimate of what revenue and costs should have been, given the actual level of activity
for the period
- Take into account how changes in activity affect costs
Activity Variances - differences between the actual level of activity (flexible budget) and the
level of activity in the planning budget from the beginning period.
Revenue and Spending Variances - difference between actual total revenue (expenses) and
what the total revenue (expenses) should have been, given the actual level of activity for the
period.
● While fixed costs do not depend on the level of activity, the actual amount of a fixed cost
can differ from the estimated amount included in a flexible budget
Standard quantity per unit - amount of direct material that should be used for each unit of
finished product, including an allowance for normal inefficiencies, such as scrap and spoilage
Standard price per unit - price that should be paid for each unit of direct materials; should
reflect the final, delivered cost of the materials
>>> When faced with rising raw material costs, companies can:
1. Maintain existing selling price and consequently operate with lower margins
2. Pass the cost increases along to customers in the form of higher prices
3. Lower their raw material costs (e.g. hedging contracts)
Standard hours per unit - amount of direct labor-hours that should be used to produce one unit
of finished goods → via time and motion study → consider reasonable allowances for breaks,
personal needs of employees, cleanup, and machine breakdown
Standard rate per hour - expected direct labor wage rate per hour, including employment taxes
and fringe benefits; reflects expected “mix” of workers, even though the actual hourly wage
rates may vary somewhat from individual to individual
Standard rate per unit - variable portion of the predetermined overhead rate
Standard cost card - shows the standard quantity (or hours) and standard price (or rate) of the
inputs required to produce a unit of a specific product
Q: Was the high direct material cost due to higher than expected prices for materials? Or was it
due to too much material being used?
Price Variance - difference between the actual amount paid for an input and the standard
amount that should have been paid
Quantity Variance - difference between how much of an input was actually used and how much
should have been used for the actual level of output (stated in dollar terms using the standard
price for the input)
>>> Positive difference == unfavorable; negative difference == favorable
Volume Variance = Budgeted fixed overhead - Fixed overhead applied to WIP (Standard fixed
overhead cost X Standard quantity of allocation base allowed)
PERFORMANCE MEASUREMENT IN DECENTRALIZED ORGANIZATIONS
>>> When a company’s owners (e.g. stockholders) delegate decision-making authority to top
managers → Corporate Governance Systems → provide incentives and feedback
mechanisms to help ensure that a company’s board of directors and top managers pursue goals
that align with the owner’s interests
Advantages of Decentralization:
1. Top-level managers can concentrate on bigger issues
2. Puts the decision-making in the hands of those who tend to have the most detailed and
up-to-date information about day-to-day operations
3. Can respond more quickly to customers and other changes in the operating environment
4. Trains lower-level managers for higher-level positions
5. Increase motivation and job satisfaction
Disadvantages of Decentralization:
1. Lower-level managers may make decisions without fully understanding the company’s
overall strategy
2. Coordination may be lacking
3. Lower-level managers may have objectives that clash with the objectives of the entire
organization
4. Spreading innovative ideas may be difficult
Responsibility Accounting
Responsibility Centers
>>> Return on Investment (ROI): The higher the business segment’s ROI, the greater the
profit earned per dollar invested in the segment’s operating assets
Residual Income/Economic Value Added (EVA) - net operating income that an investment
center earns above the minimum required return on its operating assets
>>> When comparing investment centers, it is probably better to focus on the percentage
change in residual income from year to year rather than on the absolute amount of the residual
income
>>> Throughput (Manufacturing Cycle) Time - elapsed time from when production is started
until finished goods are shipped to customers
>>> Delivery Cycle Time - elapsed time from when a customer order is received until finished
goods are shipped
→ Wait time - elapsed time from when a customer order is received until production of order is
started; non-value added activity
Balanced Scorecard - integrated set of performance measures that are derived from and
support a company’s strategy
>>> Top management translates its strategy into performance measures that employees can
understand and influence.
>>> Strategy - how to achieve the organization’s goals