Princess Nourah Bint Abdul Rahman University Cost Accounting Questions

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Cost Accounting Sixteenth Edition, Global Edition Chapter 5 Activity-Based Costing And Activity-Based Management Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Learning Objectives (1 of 2) 5.1 Explain how broad averaging undercosts and overcosts products or services 5.2 Present three guidelines for refining a costing system 5.3 Distinguish between simple and activity-based costing systems 5.4 Describe a four-part cost hierarchy 5.5 Cost products or services using activity-based costing Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Learning Objectives (2 of 2) 5.6 Evaluate the benefits and costs of implementing activity-based costing systems 5.7 Explain how managers use activity-based costing systems in activity-based management 5.8 Compare activity-based costing systems and department costing systems Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Undercosting and Overcosting Example Jose, Roberta, and Nancy order separate items for lunch. Jose’s order amounts to $14 Roberta consumed 30 Nancy’s order is 16 Total $60 What is the average cost per lunch? Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. $60 ÷ 3 = $20 Jose and Nancy are overcosted. Roberta is undercosted. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Background Recall that plant overhead is applied to production in a rational systematic manner, using some type of averaging. There are a variety of methods to accomplish this goal. These methods often involve trade-offs between simplicity and realism. Simple Methods Can be Inaccurate ↔ Complex Methods Usually more accurate Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Plantwide Overhead Calculations Plantwide Overhead Rate: Total Estimated Overhead ** / Total Estimated Base *** ** Obtain total of all overhead costs to be allocated. *** Determine the best “base” – direct labor hours, machine hours, etc. This rate is used to allocate overhead costs to all products Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Broad Averaging • Historically, firms produced a limited variety of goods and at the same time, their indirect costs were relatively small. • Allocating overhead costs was simple: use broad averages to allocate costs uniformly regardless of how they are actually incurred. – Generally known as “Peanut-butter costing” (perhaps because it is spread evenly??) • The end-result: – Products using fewer resources are overcosted and products using more resources are undercosted. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Over And Undercosting - Defined • OVERCOSTING occurs when a product consumes a low level of resources but is allocated high costs per unit. • UNDERCOSTING occurs when a product consumes a high level of resources but is allocated low costs per unit. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Product Cost Cross-Subsidization (1 of 4) • If a company undercosts one of its products, it will overcost at least one of its other products. • The overcosted product absorbs too much cost, making it seem less profitable than it really is. • The undercosted product is left with too little cost, making it seem more profitable than it really is. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Product Cost Cross-Subsidization (2 of 4) CONSIDER THIS: • If you were using cost to determine price, what effect would this have? • If you were looking at product profitability to determine marketing focus, what result? • Managers use product costs everyday to make decisions. If the cost is wrong, so will be the decision. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. An Example: Plastim EXHIBIT 5.1 Overview of Plastim’s Simple Costing System Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Plastim And Simple Costing EXHIBIT 5.2 Plastim’s Product Costs Using the Simple Costing System Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Reasons For Refining A Costing System Three principal reasons have accelerated the demand for refinements to the costing system. 1. Increase in product diversity 2. Increase in indirect costs with different cost drivers 3. Competition in product markets Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Guidelines For Refining A Costing System There are three main guidelines for refining a costing system: 1. Direct-cost tracing 2. Indirect-cost pools 3. Cost-allocation bases Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Cost Hierarchies (1 of 2) A cost hierarchy categorizes various activity cost pools on the basis of the different types of cost drivers, cost-allocation bases, or different degrees of difficulty in determining cause-and-effect relationships. ABC systems commonly use a cost hierarchy with four levels to identify cost-allocation bases that are cost drivers of the activity cost pools. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Cost Hierarchies (2 of 2) The four levels in the cost hierarchy are: Output unit-level costs (related to the individual units of a product or service) Batch-level costs (related to a group of units) Product (or service)-sustaining costs (related to support a particular product or service without regard to the number of units or batches) Facility-sustaining costs (related to costs of activities that cannot be traced to individual products or services) Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Plastim and ABC Illustrated EXHIBT 5.3 Overview of Plastim’s Activity-Based Costing System Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Plastim And ABC Rate Calculation EXHIBIT 5.4 Activity-Cost Rates for Indirect-Cost Pools Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Plastim and ABC Product Costs EXHIBIT 5.5 Plastim’s Product Costs Using Activity-Based Costing System Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Plastim: Simple and ABC Compared EXHIBIT 5.6 Comparing Alternative Costing Systems Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Conclusions • Each method is mathematically correct • Each method is acceptable • Each method yields a different cost figure, which will lead to different Gross Margin calculations • Only Overhead is involved. Total Costs for the entire firm remain the same – they are just allocated to different cost objects within the firm • Selection of the appropriate method and drivers should be based on experience, industry practices, as well as a costbenefit analysis of each option under consideration Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. ABC Vs. Simple Costing (1 of 2) • ABC is generally perceived to produce superior costing figures due to the use of multiple drivers across multiple levels. • ABC is only as good as the drivers selected, and their actual relationship to costs. Poorly chosen drivers will produce inaccurate costs, even with ABC. • Using ABC does not guarantee more accurate costs! Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. ABC Vs. Simple Costing (2 of 2) • ABC is an alternate way to allocate costs. It is generally considered to be more accurate and more costly to implement. • A company should consider refining their cost system when evidence begins to suggest that their existing system is flawed. For Plastim, that occurred when they were in danger of losing business due to their higher price. • Because a number of critical decisions, such as pricing, whether or not one product should be “pushed” over another, whether or not a product should be dropped, etc. will be made using cost information, best efforts should be used to arrive at a cost that is fair and reasonable for each product. The goal isn’t to attain a cost that serves the current purposes. • This is an imprecise science and differences of opinion are likely to occur. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Signals that suggest that ABC Implementation could help a Firm: (1 of 2) 1. Significant amounts of indirect costs are allocated using only one or two cost pools. 2. All or most indirect costs are identified as output unit-level costs. 3. Products make diverse demands on resources because of volume, process steps, batch size or complexity. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Signals that suggest that ABC Implementation could help a Firm: (2 of 2) 4. Products that a company is well-suited to make show small profits whereas products that a company is less suited to make show large profits. 5. Operations staff has substantial disagreement with the reported costs of manufacturing and marketing products or services Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Activity-based Management A method of management decision-making that uses ABC information to improve customer satisfaction and profitability. We define ABM broadly to include decisions about pricing and product mix, cost reduction, process improvement and product and process design. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. ABC and Service/Merchandising Firms ABC implementation is widespread in a variety of applications outside manufacturing, including: • Health Care • Banking • Telecommunications • Retailing • Transportation Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Terms to Learn (1 of 2) TERMS TO LEARN PAGE NUMBER REFERENCE Activity 178 Activity Based Costing (ABC) 178 Activity Based Management (ABM) 189 Batch-level costs 181 Cost Hierarchy 181 Facility-Sustaining Costs 181 Output Unit-Level Costs 181 Product-Cost Cross-Subsidization 172 Product overcosting 172 Product-sustaining costs 181 Product undercosting 172 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Terms to Learn (2 of 2) TERMS TO LEARN PAGE NUMBER REFERENCE Refined Costing System 177 Service-Sustaining Costs 181 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Cost Accounting Sixteenth Edition, Global Edition Chapter 6 Master Budget and Responsibility Accounting Copyright © 2015 Pearson Education 6-1 LEARNING OBJECTIVES 1. Describe the master budget and explain its benefits 2. Describe the advantages of budgets 3. Prepare the operating budget and its supporting schedules 4. Use computer-based financial planning models for sensitivity analysis 5. Describe responsibility centers and responsibility accounting Copyright © 2015 Pearson Education 6-2 Chapter 6 learning objectives, concluded 6. Recognize the human aspects of budgeting 7. Appreciate the special challenges of budgeting in multinational companies Copyright © 2015 Pearson Education 6-3 Budget Defined • A budget is the quantitative expression of a proposed plan of action by management for a specified period. • A budget is an aid to coordinating what needs to be done to implement that plan. A budget generally includes both the plan’s financial and nonfinancial aspects and serves as a blueprint for the company to follow in an upcoming period. Copyright © 2015 Pearson Education 6-4 Budgets help managers…. • Communicate directions and goals to different departments of a company to help them coordinate the actions they must pursue to satisfy customers and succeed in the marketplace. • Judge performance by measuring financial results against planned objectives, activities, and timelines to learn about potential problems. • Motivate employees to achieve their goals. Copyright © 2015 Pearson Education 6-5 Strategic plans and operating plans To develop successful strategies, managers must consider questions such as the following: 1.What are our objectives? 2.How do we create value for our customers while distinguishing ourselves from our competitors? 3.Are the markets for our products local, regional, national or global? 4.What trends affect our markets? 5.What organizational and financial structures serve us best? 6.What are risks and opportunities of alternative strategies and what are our contingency plans if our preferred plan fails? Copyright © 2015 Pearson Education 6-6 Budgeting cycle: 1. Before the start of a fiscal year, managers at all levels take into account past performance, market feedback, anticipated future changes and other indicators to initiate plans for the next period. 2. Senior managers give subordinate managers a frame of reference against which they will compare actual results. 3. Managers and management accountants investigate any deviations from the plan. Copyright © 2015 Pearson Education 6-7 Working document: Master Budget The master budget is at the core of the budgeting process. It expresses management’s operating and financial plans for a specified period: • Operating decisions deal with how to best use the limited resources of an organization. (the operating budget) • Financial decisions deal with how to obtain the funds to acquire those resources. (the financial budget) Copyright © 2015 Pearson Education 6-8 Advantages of Budgets • Promotes coordination and communication among subunits within the company. • Provides a framework for judging performance and facilitating learning. • Motivates managers and other employees. Copyright © 2015 Pearson Education 6-9 Challenges in administering a budget • Top managers want lower-level managers to participate in the budgeting process because they have more specialized knowledge of day-to-day management, however… • The budgeting process is time-consuming, and • Upper-level management’s support is crucial Copyright © 2015 Pearson Education 6-10 Time coverage of budgets The timeline for a budget is dependent on the motive for creating the budget. The most frequently used budget period is 1 year. Businesses may also use a rolling budget. This budget is always available for a specified future period, by continually adding a month, quarter, or year to the period just ended. Copyright © 2015 Pearson Education 6-11 The master budget Sales budget Closing stock budget Production budget Selling and administrative budget Direct materials budget Direct labour budget Manufacturing overhead budget Cash budget Copyright © 2015 Pearson Education The sales budget Detailed schedule showing expected sales for the coming periods expressed in units and monetary value. Copyright © 2015 Pearson Education Budgeting example Royal Company is preparing budgets for the quarter ending June 30. Budgeted sales for the next five months are: April May June July August 20,000 units 50,000 units 30,000 units 25,000 units 15,000 units. The selling price is £10 per unit. Copyright © 2015 Pearson Education The sales budget April Budgeted sales (units) 20,000 Selling price per unit £ 10 Total sales £ 200,000 May June 50,000 30,000 100,000 £ 10 £ 500,000 £ 10 £ 300,000 £ 10 £ 1,000,000 Copyright © 2015 Pearson Education Quarter Use this as a template for all sales budgets The production budget Sales Budget Production Budget Production must be adequate to meet budgeted sales and provide for sufficient ending stock. Copyright © 2015 Pearson Education The production budget Royal Company wants closing stock to be equal to 20% of the following month’s budgeted sales in units. On March 31st, 4,000 units were on hand. Let’s prepare the production budget. Copyright © 2015 Pearson Education The production budget Budgeted sales Add desired closing stock Total needed Less opening stock Required production April 20,000 10,000 30,000 4,000 26,000 Use this as a template for all production budgets May 50,000 June 30,000 Budgeted May sales Desired percent Desired stock Copyright © 2015 Pearson Education Quarter 100,000 50,000 20% 10,000 The production budget April 20,000 May 50,000 Add desired closing stock Total needed Less opening stock 10,000 30,000 4,000 6,000 56,000 Required production 26,000 Budgeted sales Copyright © 2015 Pearson Education June 30,000 Quarter 100,000 The production budget April 20,000 May 50,000 Add desired closing stock Total needed Less opening stock 10,000 30,000 4,000 6,000 56,000 10,000 Required production 26,000 46,000 Budgeted sales Copyright © 2015 Pearson Education June 30,000 Quarter 100,000 The production budget Be careful with your total column April 20,000 May 50,000 June 30,000 Quarter 100,000 Add desired closing stock Total needed Less opening stock 10,000 30,000 4,000 6,000 56,000 10,000 5,000 35,000 6,000 5,000 105,000 4,000 Required production 26,000 46,000 29,000 101,000 Budgeted sales 20% of July sales 25,000 Copyright © 2015 Pearson Education The direct materials budget • At Royal Company, 5 lbs of material are required per unit of product. • Management wants materials on hand at the end of each month equal to 10% of the following month’s production. • On March 31st, 13,000 lbs of material are on hand. Materials cost £0.40 per pound. • Let’s prepare the direct materials budget…. … Copyright © 2015 Pearson Education The direct materials budget Production Materials per unit Production needs April 26,000 May 46,000 June 29,000 Quarter 101,000 Add desired closing stock Total needed Less opening stock Materials to be purchased Use this as a template for all raw mat purch budgets Copyright © 2015 Pearson Education Starting point - from production budget The direct materials budget Production Materials per unit Production needs April 26,000 5 130,000 May 46,000 5 230,000 Add desired closing stock Total needed Less opening stock Materials to be purchased Copyright © 2015 Pearson Education June 29,000 5 145,000 Quarter 101,000 5 505,000 The direct materials budget Production Materials per unit Production needs Add desired closing stock Total needed Less opening stock Materials to be purchased April 26,000 5 130,000 May 46,000 5 230,000 23,000 153,000 10% of the following month’s production Copyright © 2015 Pearson Education June 29,000 5 145,000 Quarter 101,000 5 505,000 The direct materials budget Production Materials per unit Production needs Add desired closing stock Total needed Less opening stock Materials to be purchased April 26,000 5 130,000 May 46,000 5 230,000 23,000 153,000 13,000 140,000 March 31 stock Copyright © 2015 Pearson Education June 29,000 5 145,000 Quarter 101,000 5 505,000 The direct materials budget Production Materials per unit Production needs Add desired closing stock Total needed Less opening stock Materials to be purchased April 26,000 5 130,000 May 46,000 5 230,000 June 29,000 5 145,000 Quarter 101,000 5 505,000 23,000 153,000 14,500 244,500 11,500 156,500 11,500 516,500 13,000 23,000 14,500 13,000 140,000 221,500 142,000 503,500 Copyright © 2015 Pearson Education The direct materials budget Production Materials per unit Production needs April 26,000 5 130,000 May 46,000 5 230,000 Add desired ending stock 23,000 14,500 Total needed 153,000 244,500 July Production and Stock Less beginning Sales in units 25,000 inventory 13,000 23,000 Add desired ending stock 3,000 Materials to be Total units needed 28,000 purchased 140,000 221,500 Less beginning stock 5,000 Production in units 23,000 Pounds per unit 5 Total pounds 115,000 Desired percent 10% Desired ending stock Copyright © 2015 Pearson 11,500 Education June 29,000 5 145,000 Quarter 101,000 5 505,000 11,500 156,500 11,500 516,500 14,500 13,000 142,000 503,500 The direct materials budget April Production May June Be careful with your total column Quarter 26,000 46,000 29,000 101,000 Materials per unit 5 5 5 5 Production needs 130,000 230,000 145,000 505,000 23,000 14,500 11,500 11,500 153,000 244,500 156,500 516,500 13,000 23,000 14,500 13,000 140,000 221,500 142,000 503,500 $0.4 $0.4 $0.4 $88,600 $56,800 $201,400 Add desired ending stock Total needed Less beginning inventory Materials to be purchased cost per pounds of Direct Material total Cost of Direct material $0.4 $56,000 Copyright © 2015 Pearson Education 29 The direct labour budget • At Royal, each unit of product requires 0.05 hours of direct labour. • The company has a ‘no layoff’ policy so all 10 employees will be paid for 37.5 hours of work each week (Assume each month has 4 weeks) • In exchange for the ‘no layoff’ policy, workers agreed to a wage rate of £10 per hour regardless of the hours worked (no overtime pay). Copyright © 2015 Pearson Education The direct labour budget Production Direct labour hours Labour hours required April 26,000 May 46,000 June 29,000 Quarter 101,000 Guaranteed labour hours Labour hours paid Wage rate Total direct labour cost Starting point - from production Copyright © 2015 Pearson Education budget The direct labour budget Production Direct labour hours Labour hours required April 26,000 0.05 1,300 May 46,000 0.05 2,300 Guaranteed labour hours Labour hours paid Wage rate Total direct labour cost Copyright © 2015 Pearson Education June 29,000 0.05 1,450 Quarter 101,000 0.05 5,050 The direct labour budget Production Direct labour hours Labour hours required Guaranteed labour hours Labour hours paid Wage rate Total direct labour cost 37.5 x 10 x 4 April 26,000 0.05 1,300 May 46,000 0.05 2,300 June 29,000 0.05 1,450 Quarter 101,000 0.05 5,050 1,500 1,500 1,500 2,300 1,500 1,500 5,300 Higher of labour hours required or labour hours guaranteed. Copyright © 2015 Pearson Education The direct labour budget April 26,000 0.05 1,300 May 46,000 0.05 2,300 June 29,000 0.05 1,450 Quarter 101,000 0.05 5,050 Guaranteed labour hours 1,500 Labour hours paid 1,500 Wage rate £ 10 Total direct labour cost £ 15,000 1,500 2,300 £ 10 £ 23,000 1,500 1,500 £ 10 £ 15,000 5,300 £ 10 £ 53,000 Production Direct labour hours Labour hours required Copyright © 2015 Pearson Education Manufacturing overhead budget Royal Company uses a variable manufacturing overhead rate of £1 per unit produced. Fixed manufacturing overhead is £50,000 per month and includes £20,000 of non cash costs (primarily depreciation of plant assets). Let’s prepare the manufacturing overhead budget… Copyright © 2015 Pearson Education Manufacturing overhead budget April Production in units 26,000 Variable mfg. OH rate £ 1 Variable mfg. OH costs £ 26,000 Fixed mfg. OH costs Total mfg. OH costs Less noncash costs May 46,000 £ 1 £ 46,000 June 29,000 £ 1 £ 29,000 Quarter 101,000 £ 1 £ 101,000 Cash disbursements for manufacturing OH Starting point - from production budget Copyright © 2015 Pearson Education Manufacturing overhead budget April Production in units 26,000 Variable mfg. OH rate £ 1 Variable mfg. OH costs £ 26,000 Fixed mfg. OH costs 50,000 Total mfg. OH costs 76,000 May 46,000 £ 1 £ 46,000 50,000 96,000 Copyright © 2015 Pearson Education June 29,000 £ 1 £ 29,000 50,000 79,000 Quarter 101,000 £ 1 £ 101,000 150,000 251,000 Adj as workings for cash budget April Production in units 26,000 Variable mfg. OH rate £ 1 Variable mfg. OH costs £ 26,000 Fixed mfg. OH costs 50,000 Total mfg. OH costs 76,000 Less noncash costs May 46,000 £ 1 £ 46,000 50,000 96,000 Cash disbursements for manufacturing OH Copyright © 2015 Pearson Education June 29,000 £ 1 £ 29,000 50,000 79,000 Quarter 101,000 £ 1 £ 101,000 150,000 251,000 Manufacturing overhead budget April Production in units 26,000 Variable mfg. OH rate £ 1 Variable mfg. OH costs £ 26,000 Fixed mfg. OH costs 50,000 Total mfg. OH costs 76,000 Less non-cash costs 20,000 May 46,000 £ 1 £ 46,000 50,000 96,000 20,000 June 29,000 £ 1 £ 29,000 50,000 79,000 20,000 Quarter 101,000 £ 1 £ 101,000 150,000 251,000 60,000 Cash disbursements for manufacturing OH £ 56,000 £ 76,000 £ 59,000 £ 191,000 Depreciation is a non-cash charge. Copyright © 2015 Pearson Education Selling and administrative expense budget • At Royal, variable selling and administrative expenses are £0.50 per unit sold. • Fixed selling and administrative expenses are £70,000 per month. • The fixed selling and administrative expenses include £10,000 in costs – primarily depreciation – that are not cash outflows of the current month. Let’s prepare the company’s selling and administrative expense budget… Copyright © 2015 Pearson Education Selling and administrative expense budget April 20,000 Budgeted sales Variable selling and admin. rate £ 0.50 Variable expense £ 10,000 Fixed selling and admin. expense 70,000 Total expense 80,000 May 50,000 June 30,000 Quarter 100,000 £ 0.50 £ 25,000 £ 0.50 £ 15,000 £ 0.50 £ 50,000 70,000 95,000 70,000 85,000 210,000 260,000 Copyright © 2015 Pearson Education Selling and administrative expense budget April 20,000 Adj for cash budget workings – take off depreciation - it’s not a cash flow Budgeted sales Variable selling and admin. rate £ 0.50 Variable expense £ 10,000 Fixed selling and admin. expense 70,000 Total expense 80,000 Less non-cash expenses Cash disbursements for selling & admin. May 50,000 June 30,000 Quarter 100,000 £ 0.50 £ 25,000 £ 0.50 £ 15,000 £ 0.50 £ 50,000 70,000 95,000 70,000 85,000 210,000 260,000 Copyright © 2015 Pearson Education Selling and administrative expense budget April 20,000 Budgeted sales Variable selling and admin. rate £ 0.50 Variable expense £ 10,000 Fixed selling and admin. expense 70,000 Total expense 80,000 Less non-cash expenses 10,000 Cash disbursements for selling & admin. £ 70,000 May 50,000 June 30,000 Quarter 100,000 £ 0.50 £ 25,000 £ 0.50 £ 15,000 £ 0.50 £ 50,000 70,000 95,000 70,000 85,000 210,000 260,000 10,000 10,000 30,000 £ 85,000 £ 75,000 £ 230,000 Copyright © 2015 Pearson Education Cash Budget • Finally everything thing pulls together into an overall cash budget • First, get the template for the cash budget straight in your head……… • Then complete the workings for the different elements of the cash budget • Expected cash collections • From sales • Expected cash payments • For raw materials, direct labour, production o/h, selling & admin expenses, perhaps some capital purchases • Remember the depreciation adjustment on the o/h budgets Copyright © 2015 Pearson Education The Cash budget Opening Cash Bal Month Month Month Total €/SAR €/SAR €/SAR €/SAR - Cash Receipts Total cash receipts - - - - Cash payments/ disbursements Total cash disbursements- - - - Net Cashflow - - - - Closing Cash balance - - - - Copyright © 2015 Pearson Education Use as a template… Expected cash collections • All sales are on account. • Royal’s collection pattern is: 70% collected in the month of sale 25% collected in the month following sale 5% is uncollectible • The March 31 debtors/receivables balance of £30,000 will be collected in full in April. Copyright © 2015 Pearson Education Expected cash collections Accounts rec. - 3/31 April £ 30,000 Total cash collections Copyright © 2015 Pearson Education May June Quarter £ 30,000 Expected cash collections Remember you’re getting this £200,000 from your sales budget Accounts rec. - 3/31 April sales 70% x £200,000 25% x £200,000 April £ 30,000 May 140,000 £ 50,000 Total cash collections £ 170,000 Copyright © 2015 Pearson Education June Quarter £ 30,000 140,000 50,000 Expected cash collections Accounts rec. - 3/31 April sales 70% x £200,000 25% x £200,000 May sales 70% x £500,000 25% x £500,000 April £ 30,000 May June 140,000 Total cash collections £ 170,000 140,000 50,000 £ 50,000 350,000 £ 125,000 £ 400,000 Copyright © 2015 Pearson Education Quarter £ 30,000 350,000 125,000 Expected cash collections April £ 30,000 Accounts rec. - 3/31 April sales 70% x £200,000 140,000 25% x £200,000 May sales 70% x £500,000 25% x £500,000 June sales 70% x £300,000 Total cash collections £ 170,000 May June 140,000 50,000 £ 50,000 350,000 £ 400,000 Copyright © 2015 Pearson Education Quarter £ 30,000 £ 125,000 350,000 125,000 210,000 £ 335,000 210,000 £ 905,000 Expected cash payments for materials • Royal pays £0.40 per pound for its materials. • One half of a month’s purchases are paid for in the month of purchase; the other half is paid in the following month. • The March 31 creditors/payables balance is £12,000. Let’s calculate expected cash disbursements… Copyright © 2015 Pearson Education Expected cash payments for materials Accounts pay. 3/31 April purchases April £ 12,000 May May purchases June purchases Total cash disbursements Copyright © 2015 Pearson Education June Quarter £ 12,000 Expected cash payments for materials Accounts pay. 3/31 April purchases 50% x £56,000 50% x £56,000 May purchases April £ 12,000 May 28,000 £ 28,000 June purchases Total cash disbursements £ 40,000 140,000kgs × £.40/kg = £56,000 Copyright © 2015 Pearson Education June Quarter £ 12,000 28,000 28,000 Expected cash payments for materials Accounts pay. 3/31 April purchases 50% x £56,000 50% x £56,000 May purchases 50% x £88,600 50% x £88,600 June purchases Total cash disbursements April £ 12,000 May June 28,000 28,000 28,000 £ 28,000 44,300 £ 44,300 £ 40,000 £ 72,300 Copyright © 2015 Pearson Education Quarter £ 12,000 44,300 44,300 Expected cash payments for materials Accounts pay. 3/31 April purchases 50% x £56,000 50% x £56,000 May purchases 50% x £88,600 50% x £88,600 June purchases 50% x £56,800 Total cash disbursements April £ 12,000 May June 28,000 28,000 28,000 £ 28,000 44,300 £ 40,000 £ 72,300 Copyright © 2015 Pearson Education Quarter £ 12,000 £ 44,300 44,300 44,300 28,400 28,400 £ 72,700 £ 185,000 The cash budget This means that every month the co is free to borrow whatever it needs in order to ensure that it has a closing cash balance of 30k per month Royal: • maintains a 16% (interest rate) open line of credit for £75,000. • Maintains a minimum cash balance of £30,000. • borrows on the first day of the month and repays loans on the last day of the month. • pays a cash dividend of £49,000 in April. • purchases £143,700 of equipment in May and £48,300 in June- paid in cash. • has an April 1 cash balance of £40,000. Of course they must pay that back and you must build this into Copyright © 2015 Pearson Education your cash budget The cash budget April £ 40,000 170,000 210,000 May June Quarter Beginning cash balance Add cash collections Total cash available Less disbursements Materials 40,000 Direct labour Mfg. overhead Schedule of expected Selling and admin. cash disbursements Equipment purchase Dividends Total disbursements Schedule of expected Excess (deficiency) of cash collections cash available over disbursements Copyright © 2015 Pearson Education The cash budget Beginning cash balance Add cash collections Total cash available Less disbursements Materials Direct labour Mfg. overhead Selling and admin. Equipment purchase Dividends Total disbursements Excess (deficiency) of cash available over disbursements April £ 40,000 170,000 210,000 May June Quarter Direct labour budget 40,000 15,000 56,000 70,000 Manufacturing overhead budget Selling and administrative expense budget Copyright © 2015 Pearson Education The cash budget Beginning cash balance Add cash collections Total cash available Less disbursements Materials Direct labour Mfg. overhead Selling and admin. Equipment purchase Dividends Total disbursements Excess (deficiency) of cash available over disbursements April £ 40,000 170,000 210,000 40,000 15,000 56,000 70,000 49,000 230,000 May June Quarter Because Royal maintains a cash balance of £30,000, the company must borrow on its line-of-credit -£ 20,000 Copyright © 2015 Pearson Education Financing and repayment April Excess (deficiency) of cash available over disbursements -£ 20,000 Financing: Borrowing 50,000 Repayments Interest Total financing 50,000 Ending cash balance £ 30,000 May £ 30,000 Ending cash balance for April is the beginning May balance. Copyright © 2015 Pearson Education June £ Quarter - £ - The cash budget April £ 40,000 170,000 210,000 Beginning cash balance Add cash collections Total cash available Less disbursements Materials 40,000 Direct labour 15,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 49,000 Total disbursements 230,000 Excess (deficiency) of cash available over disbursements -£ 20,000 Copyright © 2015 Pearson Education May £ 30,000 400,000 430,000 72,300 23,000 76,000 85,000 143,700 400,000 £ 30,000 June Quarter Financing and repayment April Excess (deficiency) of cash available over disbursements -£ 20,000 Financing: Borrowing 50,000 Repayments Interest Total financing 50,000 Ending cash balance £ 30,000 May £ 30,000 £ 30,000 June Because the ending cash balance is exactly £30,000, Royal will not repay the loan this month. Copyright © 2015 Pearson Education Quarter The cash budget April £ 40,000 170,000 210,000 Beginning cash balance Add cash collections Total cash available Less disbursements Materials 40,000 Direct labour 15,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 49,000 Total disbursements 230,000 Excess (deficiency) of cash available over disbursements -£ 20,000 May £ 30,000 400,000 430,000 June £ 30,000 335,000 365,000 Quarter £ 40,000 905,000 945,000 72,300 23,000 76,000 85,000 143,700 400,000 72,700 15,000 59,000 75,000 48,300 270,000 185,000 53,000 191,000 230,000 192,000 49,000 900,000 £ 30,000 £ 95,000 £ 45,000 + 50,000 loan Copyright © 2015 Pearson Education no loan needed The cash budget April £ 40,000 170,000 210,000 May £ 30,000 400,000 430,000 June £ 30,000 335,000 365,000 Quarter £ 40,000 905,000 945,000 Beginning cash balance Add cash collections Total cash available Less disbursements Materials 40,000 72,300 72,700 185,000 Direct labour 15,000 23,000 15,000 53,000 Mfg. overhead 56,000 76,000 59,000 191,000 Selling and admin. 70,000 85,000 75,000 230,000 At the end of June, Royal has enough cash Equipment purchase 143,700 48,300 192,000 to repay49,000 the £50,000 loan plus interest at49,000 16%. Dividends Total disbursements 230,000 400,000 270,000 900,000 Excess (deficiency) of cash available over disbursements -£ 20,000 £ 30,000 £ 95,000 £ 45,000 Copyright © 2015 Pearson Education Financing and repayment April Excess (deficiency) of cash available over disbursements -£ 20,000 Financing: Borrowing 50,000 Repayments Interest Total financing 50,000 Ending cash balance £ 30,000 May £ 30,000 £ 30,000 £50,000 × 16% × 3/12 = £2,000 Borrowings on April 1 and repayment of June 30. Copyright © 2015 Pearson Education June £ 95,000 £ (50,000) (2,000) (52,000) 43,000 Quarter £ 45,000 £ 50,000 (50,000) (2,000) (2,000) 43,000 Budgeted profit statement Cash budget Budgeted profit Statement and balance sheet After we complete the cash budget, it is possible to go on and prepare the budgeted profit statement and budgeted balance sheet for Royal Copyright © 2015 Pearson Education Cost Accounting Sixteenth Edition, Global Edition Chapter 7 Flexible Budgets, Direct-Cost Variances, and Management Control Copyright © 2015 Pearson Education Chapter 7 learning objectives 1. Understand static budgets and static-budget variances 2. Examine the concept of a flexible budget and learn how to develop it 3. Calculate flexible-budget variances and salesvolume variances 4. Explain why standard costs are often used in variance analysis Copyright © 2015 Pearson Education 7-2 Chapter 7 learning objectives, concluded 5. Compute price variances and efficiency variances for direct-cost categories. 6. Understand how managers use variances 7. Describe benchmarking and explain its role in cost management Copyright © 2015 Pearson Education 7-3 Basic Concepts • Variance—difference between actual results and expected (budgeted) performance. • Management by exception—the practice of focusing attention on areas not operating as expected (budgeted). • Static (master) budget is based on the output planned at the start of the budget period. Copyright © 2015 Pearson Education 7-4 Basic Concepts • Static-budget variance—the difference between the actual result and the corresponding static budget amount • Favorable variance (F)—has the effect of increasing operating income relative to the budget amount (actual revenues >budgeted revenues actual costs < budgeted costs ) • Unfavorable variance (U)—has the effect of decreasing operating income relative to the budget amount (actual revenues < budgeted revenues actual costs > budgeted costs ) Copyright © 2015 Pearson Education 7-5 Copyright © 2015 Pearson Education 7-6 Assume that Pasadena Co. manufactures and sells dress suits. Budgeted variable costs per suit are as follows: Direct materials cost $ 65 Direct manufacturing labor 26 Variable manufacturing overhead 24 Total variable costs $115 Copyright © 2015 Pearson Education 7-7 Static Budget Example Budgeted selling price is $155 per suit. Fixed manufacturing costs are expected to be $286,000 within a relevant range between 9,000 and 13,500 suits. Variable and fixed period costs are ignored. The static budget for year 2018 is based on selling 13,000 suits. What is the static-budget operating income? Copyright © 2015 Pearson Education 7-8 Static Budget Example Revenues (13,000 × $155) Less Expenses: Variable (13,000 × $115) Fixed Budgeted operating income $2,015,000 1,495,000 286,000 $ 234,000 Assume that Pasadena Co. produced and sold 10,000 suits at $160 each with actual variable costs of $120 per suit and fixed manufacturing costs of $300,000. Copyright © 2015 Pearson Education 7-9 Static Budget Example What was the actual operating income? Revenues (10,000 × $160) Less Expenses: Variable (10,000 × $120) Fixed Actual operating income $1,600,000 1,200,000 300,000 $ 100,000 Copyright © 2015 Pearson Education 7-10 Static-Budget Variance Example What is the static-budget variance of operating income? Actual operating income Budgeted operating income Static-budget variance of operating income $100,000 234,000 Copyright © 2015 Pearson Education $134,000 U 7-11 Static-Budget Variance Example Static-Budget Based Variance Analysis in (000) Static Budget Suits Actual 13 10 $2,015 $1,600 Variable costs 1,495 1,200 Contribution margin $520 $400 286 300 $234 $ 100 Revenue Fixed costs Operating income Copyright © 2015 Pearson Education 7-12 Static-Budget Variance Example Static-Budget Based Variance Analysis in (000) Suits Revenue Variable costs Contribution margin Fixed costs Operating income Static Budget 13 $2,015 1,495 $ 520 286 $ 234 Copyright © 2015 Pearson Education Actual 10 $1,600 1,200 $ 400 300 $ 100 Variance 3U $415 U 296 F $120 U 14 U $134 U 7-13 Static Budgets and Performance Reports • The relevant question is . . . “How much of the favourable cost variance is due to lower activity, and how much is due to good cost control?” • To answer the question, we must the budget to the actual level of activity. Copyright © 2015 Pearson Education 7-14 Flexible Budgets Show revenues and expenses that should have occurred at the actual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation. Copyright © 2015 Pearson Education 7-15 Flexible Budgets Central Concept If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been. Copyright © 2015 Pearson Education 7-16 Step 1: Determine budgeted selling price, variable cost per unit, and budgeted fixed cost. Budgeted selling price is $155, variable cost is $115 per suit, and the budgeted fixed cost is $286,000. Copyright © 2015 Pearson Education 7-17 Step 2: Determine the actual quantity of output. In the year 2018: 10,000 suits were produced and sold. Step 3: Determine the flexible budget for revenues. $155 × 10,000 = $1,550,000 Copyright © 2015 Pearson Education 7-18 Step 4: Determine the flexible budget for costs. Variable costs: 10,000 × $115 = $1,150,000 Fixed costs 286,000 Total costs $1,436,000 Copyright © 2015 Pearson Education 7-19 Flexible-Budget Variance in (000) Suits Revenue Variable cost Contribution margin Fixed costs Operating income Flexible Budget 10 $1,550 1,150 $ 400 286 $ 114 Copyright © 2015 Pearson Education Actual 10 $1,600 1,200 $ 400 300 $ 100 7-20 Flexible-Budget Variance in (000) Suits Revenue Variable costs Contribution margin Fixed costs Operating income Flexible Budget 10 $1,550 1,150 $ 400 286 $ 114 Actual Variance 10 0 $1,600 $ 50 F 1,200 50 U $ 400 $ 0 300 14 U $ 100 $ 14 U Copyright © 2015 Pearson Education 7-21 Flexible Budget Variance What causes the variable cost variance? There are two primary reasons for unfavorable variable cost variance 1. Spending too much for resources. 2. Using the resources inefficiently. Copyright © 2015 Pearson Education 7-22 Sales-Volume Variance in (000) Suits Revenue Variable costs Contr. margin Fixed costs Operating income Flexible Budget 10 $1,550 1,150 $ 400 286 $ 114 Static Budget 13 $2,015 1,495 $ 520 286 $ 234 Copyright © 2015 Pearson Education Sales-Volume Variance 3U $465 U 295 F $120 U 0 $120 U 7-23 VARIANCES, ANALYSIS Some possible reasons we might incur an unfavorable Sales-Volume Variance include: 1. Failure to execute the sales plan 2. Weaker than anticipated demand 3. Aggressive competitors taking market share 4. Unanticipated market preference away from the product 5. Quality problems Copyright © 2015 Pearson Education 7-24 Flexible Budget Variances Level 3 variances provide even more information than we get from level 2. All product costs can have Level 3 variances. Direct materials and direct labor will be discussed next. Overhead variances are discussed in detail in a later chapter. • Level 3 variances provide details of our level 2 flexible budget variances. Instead of simply identifying the difference between actual Material costs and (flexible) budgeted costs, we can break that variance down into a price variance component and an efficiency component. Copyright © 2015 Pearson Education 7-25 Price and Efficiency variances • Direct materials and direct labor both have price and efficiency variances, and their formulae are the same. Copyright © 2015 Pearson Education 7-26 Variances • Price variance formula: Price Variance = { Actual Price Of Input - Budgeted Price Of Input } X Actual Quantity Of Input • Efficiency variance formula: Efficiency Variance = { Actual Quantity Of Input Used - Budgeted Quantity of Input Allowed for Actual Output }X Budgeted Price Of Input Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 7-27 Actual Data Direct materials purchased and used: 42,500 square yards at $15.95 Cost of direct materials = $677,875 Labor hours: 21,500 at $12.90 Cost of direct manufacturing labor = $277,350 Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 28 Budgeted Data Direct materials purchase and use: 40,000 square yards at $16.25 Cost of direct materials = $650, 000 Labor hours: 20,000 at $13.00 Cost of direct manufacturing labor = $260,000 Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 29 Price Variance Example Direct-material price variance = = Actual price – Budgeted price × Actual quantity ($15.95 – $16.25) × 42,500 = $12,750 F Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 30 Price Variance Example Direct-labor price variance = = Actual price – Budgeted price × Actual quantity ($12.90 – $13.00) × 21,500 = $2,150 F Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 31 Efficiency Variance Example Direct-material efficiency variance = = Actual quantity – budgeted quantity × Budgeted price (42,500 – 40,000) × $16.25 = $40,625 U Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 32 Efficiency Variance Example Direct-labor efficiency variance = = Actual quantity – Budgeted quantity × Budgeted price (21,500 – 20,000) × $13.00 = $19,500 U Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 33 Obtaining budgeted input prices and input quantities Budgeted input prices and budgeted input quantities can be obtained from a number of sources including actual input data from past periods, data from other companies that have similar processes and standards developed by the firm itself. A standard is a carefully determined price, cost or quantity that is used as a benchmark for judging performance. Copyright © 2015 Pearson Education 7-34 Standard Costing • Targets or standards are established for direct material and direct labor. • The standard costs are recorded in the accounting system. • Actual price and usage amounts are compared to the standard and variances are recorded. Copyright © 2015 Pearson Education 7-35 Standard Costs can be a Useful Tool • Price and efficiency variances provide feedback to initiate corrective actions. • Standards are used to control costs. • Managers use variance analysis to evaluate performance after decisions are implemented. • Part of a continuous improvement program. Copyright © 2015 Pearson Education 7-36 Benchmarking and Variances Benchmarking refers to the continuous process of measuring products, services, and activities against the best levels of performance. Variances can be extended to include comparison to other entities Copyright © 2015 Pearson Education 7-37 Cost Accounting Sixteenth Edition, Global Edition Flexible Budgets, Overhead Cost Variances, and Management Control Copyright © 2015 Pearson Education Copyright © 2015 Pearson Education Chapter 8 learning objectives 1. Explain the similarities and differences in planning variable and fixed overhead costs 2. Develop budgeted variable and fixed overhead cost rates 3. Compute the variable overhead flexible-budget variance, the variable overhead efficiency variance and the variable overhead spending variance 4. Compute the fixed overhead flexible-budget variance, the fixed overhead spending variance and the fixed overhead production-volume variance Copyright © 2015 Pearson Education 8-2 Chapter 8 learning objectives, concluded 5. Show how the 4-variance analysis approach reconciles the actual overhead incurred with the overhead amounts allocated during the period 6. Calculate variances in activity-based costing 7. Examine the use of overhead variances in nonmanufacturing settings Copyright © 2015 Pearson Education 8-3 Planning fixed and variable Overhead • To effectively plan variable overhead costs, managers should focus on activities that add value and eliminate those that do not. • Fixed overhead planning is similar ~ plan only for essential activities and plan to be as efficient as possible. Copyright © 2015 Pearson Education 8-4 Standard Costing …is a costing system that Traces direct costs to output by multiplying the standard prices or rate by the standard quantities of inputs allowed for actual outputs produced. Allocates overhead costs on the basis of the standard overhead-cost rates times the standard quantities of the allocation bases allowed for the actual outputs produced. Copyright © 2015 Pearson Education 8-5 Developing Budgeted Variable Overhead Cost Rates 1. Choose the period to be used for the budget. 2. Select the cost-allocation bases to use in allocating variable overhead costs to output produced. 3. Identify the variable overhead costs associated with each cost-allocation base. 4. Compute the rate per unit of each costallocation base used to allocate variable overhead costs to output produced. Copyright © 2015 Pearson Education 8-6 The Details: Variable OH Variances VARIABLE OVERHEAD FLEXIBLE-BUDGET VARIANCE • Variable overhead flexible-budget variance measures the difference between actual variable overhead costs incurred and flexible-budget variable overhead amounts. Variable Overhead flexible-budget variance = Actual Costs Incurred - Flexible-budget amount This variance can be further broken down into the Variable Overhead Efficiency Variance and the Variable Overhead Spending Variance. 8-7 Copyright © 2015 Pearson Education, Inc. All Rights Reserved The Details: Variable OH Variances VARIABLE OVERHEAD EFFICIENCY VARIANCE Variable overhead efficiency variance is the difference between the actual quantity of the variable overhead costallocation base used and the budgeted quantity of the variable overhead cost-allocation base allowed for the actual output X the budgeted variable overhead cost per unit of the cost-allocation base. Variable Overhead Efficiency Variance = { Actual quantity of variable overhead cost-allocation base used for actual output - Budgeted quantity of variable overhead costallocation base allowed for actual output }X Budgeted variable overhead cost per unit of cost-allocation base 8-8 Copyright © 2015 Pearson Education, Inc. All Rights Reserved The Details: Variable OH Variances VARIABLE OVERHEAD SPENDING VARIANCE • Variable overhead spending variance is the difference between actual and budgeted variable overhead cost per unit of the cost-allocation base, multiplied by the actual quantity of variable overhead cost-allocation base used. = { Actual variable overhead cost per unit of cost-allocation base - Budgeted variable overhead cost per unit of cost-allocation base }X Actual quantity of variable overhead cost-allocation base used 8-9 Copyright © 2015 Pearson Education, Inc. All Rights Reserved EXAMPLE • If the cost-allocation base were machine hours Budgeted Data: variable overhead cost per machine hour $30 Machine hours per unit 0.40hr/unit production 12000 units Actual Data machine hours 4500 variable overhead cost per machine hour $29 Production 10,000 units 10 Copyright © 2015 Pearson Education, Inc. All Rights Reserved What is the variable overhead efficiency variance? = (4500 x $30 ) – ( 0.4 x10,000x 30) = 135,000 – 120,000 = 15,000 U What is the variable overhead spending variance? (29 – 30) x 4500 = $4500 F What is the Flexible budget variance? (4500 x29)-(.40 x10,000x 30) = 130,500-120,000= 10,500 U 11 Copyright © 2015 Pearson Education, Inc. All Rights Reserved Developing budgeted fixed overhead rates-intro Fixed overhead costs are, by definition, a lump sum of costs that remain unchanged for a given period despite potentially wide changes in activity within the relevant range. These costs are fixed in the sense that, unlike variable costs, fixed costs do not automatically increase or decrease with the level of activity within the relevant range. Copyright © 2015 Pearson Education 8-12 Developing Budgeted Fixed Overhead Cost Rates 1. Choose the period to be used for the budget. 2. Select the cost-allocation bases to use in allocating fixed overhead costs to output produced. 3. Identify the fixed overhead costs associated with each cost-allocation base. 4. Compute the rate per unit of each costallocation base used to allocate fixed overhead costs to output produced. Copyright © 2015 Pearson Education 8-13 The Details: Fixed OH Variances fixed overhead flexible-budget variance & fixed overhead spending variance Fixed overhead flexible-budget variance is the difference between actual fixed overhead costs and fixed overhead costs in the flexible budget. The fixed overhead spending variance is the same variance as the Fixed Overhead Flexible-Budget Variance Fixed Overhead flexible-budget variance = Actual Costs Incurred - Flexible-budget amount 8-14 Copyright © 2015 Pearson Education, Inc. All Rights Reserved The Details: Fixed OH Variances production-volume variance • Production-volume variance is the difference between budgeted fixed overhead and fixed overhead allocated on the basis of actual output produced. Production-Volume Variance = Budgeted Fixed Overhead - Fixed Overhead allocated for actual output units produced 8-15 Copyright © 2015 Pearson Education, Inc. All Rights Reserved Production-Volume Variance • Interpretation of this variance is difficult due to the nature of the costs involved and how they are budgeted. • Fixed costs are by definition somewhat inflexible. While market conditions may cause production to flex up or down, the associated fixed costs remain the same. • Fixed costs may be set years in advance, and may be difficult to change quickly. • Contradiction: Despite this, examination of the fixed overhead budget formulae reveals that it is budgeted similar to a variable cost. Copyright © 2015 Pearson Education 8-16 EXAMPLE • Budgeted Data : fixed overhead Fixed overhead per unit production $276,000 $23 12000 units • Actual results: fixed overhead Production $285,000 10,000 units Copyright © 2015 Pearson Education 8-17 What is the Fixed cost spending variance? $285,000- $276,000 = $9,000 U ❖ remember spending variance is the same variance as the Fixed Overhead Flexible-Budget Variance What is the production -Volume variance ? = $276,000 – ($23/unit x 10000) = $276,000 – 230,000= $46,000 U Copyright © 2015 Pearson Education 8-18 4-variance analysis 4-VARIANCE ANALYSIS SPENDING VARIANCE EFFICIENCY VARIANCE PRODUCTIONVOLUME VARIANCE VARIABLE OVERHEAD YES YES NEVER A VARIANCE FIXED OVERHEAD YES NEVER A VARIANCE YES Copyright © 2015 Pearson Education 8-19 Variance analysis and activity based costing • Activity-based costing systems focus on individual activities as the fundamental cost objects. • Variances are calculated for each activity Copyright © 2015 Pearson Education 8-20 Overhead variances in nonmanufacturing settings • Nonmanufacturing companies can benefit from overhead variances just as manufacturing companies can. • Variance analysis can be used to examine overhead costs and make decisions about pricing, managing costs and the mix of products. • Output measures will be different and can be passenger-miles flown, patient days provided, rooms-days occupied, ton-miles of freight hauled, etc. Copyright © 2015 Pearson Education 8-21 Financial and Nonfinancial Performance Measures The overhead variances discussed in this chapter are examples of financial performance measures. Nonfinancial measures such as those related to capacity utilization and physical measures of input usage also provide useful information. Both financial and nonfinancial performance measures are used to evaluate the performance of managers. Copyright © 2015 Pearson Education 8-22 Cost Accounting Sixteenth Edition, Global Edition Chapter 9 Inventory Costing and Capacity Analysis Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Learning Objectives (1 of 2) 9.1 Identify what distinguishes variable costing from absorption costing. 9.2 Compute income under absorption costing and variable costing and explain the difference in income. 9.3 Understand how absorption costing can provide undesirable incentives for managers to build up inventory. 9.4 Differentiate throughput costing from variable costing and absorption costing. 9.5 Describe the various capacity concepts that firms can use in absorption costing. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Learning Objectives (2 of 2) ‪ 9.6 Examine the key factors managers use to choose a ‪ capacity level to compute the budgeted fixed ‪ manufacturing cost rate. ‪ 9.7 Understand other issues that play an important role in ‪ capacity planning and control. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Chapter Overview INVENTORY COSTING The two most common methods of costing inventory in manufacturing companies are VARIABLE costing and ABSORPTION costing. The choice determines which manufacturing costs are treated as inventoriable costs. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Inventory Costing Choices: Overview • Variable costing is a method of inventory costing in which all variable manufacturing costs (direct and indirect) are included as inventoriable costs. • Absorption costing is a method of inventory costing in which all variable and fixed manufacturing costs are included as inventoriable‪costs.‪‪You‪can‪say‪that‪inventory‪“absorbs”‪all‪ manufacturing costs. • Throughput costing is a method of inventory costing in which only direct materials are included as inventoriable costs. All other costs are expensed. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Inventory Costing: Differences in Income 1. Operating income will differ between absorption and variable costing if inventory levels change because of the difference in accounting for fixed manufacturing costs. 2. The amount of the difference represents the amount of fixed manufacturing costs capitalized as inventory under absorption costing and expensed as a period cost under variable costing. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. EXAMPLE units Beginning inventory 0 Production 8,000 Sales 6,000 Ending inventory 2,000 Selling price $1,000 Variable manufacturing cost per unit: DM per unit $ 110 DL per unit $ 40 MOH per unit $ 50 Total variable manufacturing cost per unit = $ 200 Variable marketing costs per unit sold $185 Fixed MOH costs $ 1,080,000 Fixed marketing costs $ 1,380,000 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Comparative Income Statements Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. 2017 Budgeted production 2018 2019 8,000 8,000 8,000 0 2,000 500 Actual production 8,000 5,000 10,000 Sales 6,000 6,500 7,500 Ending inventory 2,000 500 3,000 Example cont. Beginning inventory 9-9 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Comparing income Statements for Multiple Years EXHIBIT 9.2 Comparison of Variable Costing and Absorption Costing for Stassen Company: Telescope Product-Line Income Statements for 2017 and 2018 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. 9-11 Comparative Income Effects Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. 9-12 Comparative Income Effects Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Absorption Costing and Performance Measurement (1 of 2) Absorption costing is the required inventory method for external financial reporting in most countries. Also preferred because: • It is cost-effective and less confusing. • It can help prevent managers from taking actions that make their performance measure look good but that hurt the income they report to shareholders. • It measures the cost of all manufacturing resources (variable or fixed) necessary to produce inventory. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Absorption Costing and Performance Measurement (2 of 2) • An important attribute of absorption costing is that it enables a manager to increase margins and operating income by producing more ending inventory. • Producing‪for‪inventory‪is‪justified‪when‪a‪firm’s‪managers‪ anticipate rapid growth in demand and want to produce and store additional units to deal with possible production shortages in the next year. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Proposals for Revising Performance Evaluation • To reduce the undesirable effects of absorption costing, management can: • Focus on careful budgeting and inventory planning. • Incorporate an internal carrying charge for inventory • Change (lengthen) the period used to evaluate performance. • Include nonfinancial as well as financial variables in the measures to evaluate performance. (compare ratio of ending/beginning inventory to ratio of units produced/sold) Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Extreme Variable Costing: Throughput Costing • Throughput costing (super-variable costing) is a method of inventory costing in which only direct material costs are included as inventory costs. All other product costs are treated as period expenses. • Throughput margin equals revenues minus all direct material cost of the goods sold. Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Throughput Costing, Illustrated EXHIBIT 9.5 Throughput Costing for Stassen Company: Telescope Product-Line Income Statements for 2017 and 2018 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Costing Systems Compared Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. Terms to Learn TERMS TO LEARN PAGE NUMBER REFERENCE Absorption costing 350 Direct costing 350 Downward demand spiral 367 Master-budget capacity utilization 364 Normal capacity utilization 364 Practical capacity 364 Super-variable costing 361 Theoretical capacity 364 Throughput costing 361 Variable costing 350 Copyright © 2018, 2016, 2015 Pearson Education, Ltd. All Rights Reserved. 5-21 Plant-wide, department, and ABC indirect cost rates. Automotive Products (AP) designs and produces automotive parts. In 2017, actual variable manufacturing overhead is $308,600. AP’s simple costing system allocates variable manufacturing overhead to its three customers based on machine-hours and prices its contracts based on full costs. One of its customers has regularly complained of being charged noncompetitive prices, so AP’s controller Devon Smith realizes that it is time to examine the consumption of overhead resources more closely. He knows that there are three main departments that consume overhead resources: design, production, and engineering. Interviews with the department personnel and examination of time records yield the following detailed information: Required: 1. Compute the manufacturing overhead allocated to each customer in 2014 using the simple costing system that uses machine-hours as the allocation base. 2. Compute the manufacturing overhead allocated to each customer in 2014 using department-based manufacturing overhead rates. 3. Comment on your answers in requirements 1 and 2. Which customer do you think was complaining about being overcharged in the simple system? If the new department-based rates are used to price contracts, which customer(s) will be unhappy? How would you respond to these concerns? SOLUTION: Plant wide, department, and ABC indirect cost rates. Actual plant wide variable MOH rate based on machine hours: $308,600 ÷ 4,000 = $77.15 per machine hour Simple costing system 1. United Motors Variable manufacturing overhead, allocated based on machine hours Holden Motors ($77.15× 120) $9,258 Leland Auto ($77.15 × 2,800) $216,020 Total ($77.15 × 1,080) $83,322 $308,600 Department-based manufacturing overhead rates (...…) 2. Department MOH in 2014 Total Driver Units Rate Design Production Engineering $39,000 29,600 240,000 390 370 4,000 $100 $ 80 $ 60 Design-related overhead, allocated on CAD-design hours Production-related overhead, allocated on engineering hours Engineering-related overhead, allocated on machine hours Total per CAD-design hour per engineering hour per machine hour United Motors Holden Motors Leland Auto 110 × $100 200 × $100 80 × $100 $11,000 $ 20,000 $ 8,000 70 × $80 60 × $80 240 × $80 5,600 4,800 19,200 120 × $60 2,800 × $60 1,080 × $60 7,200 $23,800 168,000 $192,800 64,800 $92,000 Total $ 39,000 29,600 240,000 $308,600 3. United Motors Holden Motors Leland Auto a.Department rates(Requirement 2) $23,800 $192,800 $92,000 b. Plant wide rate(Requirement 1) $ 9,258 $216,020 $83,322 Ratio of (a) ÷ (b) 2.57 0.89 1.10 The manufacturing overhead allocated to United Motors increases by 157% under the department rates, the overhead allocated to Holden decreases by about 11%, and the overhead allocated to Leland increases by about 10%. Holden Motors was probably complaining under the use of the simple system because its contract was being over costed relative to its consumption of MOH resources. United and Leland, on the other hand, were having their contracts undercoated and underpriced by the simple system. 5-26 Activity-based costing, manufacturing. Decorative Doors, Inc., produces two types of doors, interior and exterior. The company’s simple costing system has two direct-cost categories (materials and labor) and one indirect-cost pool. The simple costing system allocates indirect costs on the basis of machine-hours. Recently, the owners of Decorative Doors have been concerned about a decline in the market share for their interior doors, usually their biggest seller. Information related to Decorative Doors production for the most recent year follows: The owners have heard of other companies in the industry that are now using an activity-based costing system and are curious how an ABC system would affect their product costing decisions. After analyzing the indirect-cost pool for Decorative Doors, the owners identify six activities as generating indirect costs: production scheduling, material handling, machine setup, assembly, inspection, and marketing. Decorative Doors collected the following data related to the indirectcost activities: Marketing costs were determined to be 3% of the sales revenue for each type of door. Required 1. Calculate the cost of an interior door and an exterior door under the existing simple costing system. 2. Calculate the cost of an interior door and an exterior door under an activity-based costing system. 3. Compare the costs of the doors in requirements 1 and 2. Why do the simple and activity-based costing systems differ in the cost of an interior door and an exterior door? 4. How might Decorative Doors, Inc., use the new cost information from its activity-based costing system to address the declining market share for interior doors? SOLUTION (30 min.) Activity-based costing, manufacturing. 1. Simple costing system: Total indirect costs = $95,000 + $45,000 + $25,000 + $60,000 + $8,000 + 3 %[($125  3,200) + ($200  1,800)] = $255,800 Total machine-hours = 5,500 + 4,500 = 10,000 Indirect cost rate per machine-hour = $255,800  10,000 = $25.58 per machine-hour Simple Costing System Direct materialsa Direct manufacturing laborb Interior $ 96,000 76,800 Exterior $ 81,000 64,800 ($25.58 × 5,500) Indirect cost allocated to each job (machine hours) Total costs 140,690 a b 115,110 $313,490 ($313,490  3,200) Total cost per unit ($25.58 × 4,500) $ $260,910 $260,910  1,800 97.97 ($30 × 3,200 units =$96,000);( $45  1,800 units =$81,000) ($16 × 1.5 × 3,200 units =76,800 ); ($16  2.25  1,800 units =64,800) $ 144.95 2. Activity-based costing system Total Cost of Activity (2) Activity (1) Product scheduling Material handling Machine setup Assembly Inspection Marketing c $95,000 $45,000 $25,000 $60,000 $ 8,000 40 + 85 = 125; d Cost Driver Quantity (4) Cost Driver (3) 125c $760.00 240d $187.50 e 200 $125.00 10,000 $ 6.00 400f $ 20.00 3% Or $0.03 Production runs Material moves Machine setups Machine hours Inspections Percentage of revenues 72 + 168 = 240; e f 45 + 155 = 200; ABC System Direct materials Direct manufacturing labor Indirect costs allocated: Production scheduling Allocation Rate (5) = (2)  (4) per production run per material move per setup per machine hour per inspection per dollar of sales 250 + 150 = 400 Interior $ 96,000 76,800 ($760 per run Exterior $ 81,000 64,800  40) ($760 per run 30,400 Material handling ( $187.50per move  72) ( $125 per setup  45 ) ( $125 per setup ($6 per MH × 5,500) ($6 per MH × 4,500) 27,000 ($20 per inspection × 250) ($20 per inspection × 150) 5,000 Marketing Total costs Total cost per unit  ( $125  12,000 $272,325 3% $272,325 ÷ 3,200 units  155) 19,375 33,000 Inspection 168) 31,500 5,625 Assembly 85)  ( $187.50 per move 13,500 Machine setup  64,600 3,000  ( $200  10,800 $302,075 3,200) 3% $302,075 ÷ 1,800 units $ 85.10 1,800) $ 167.82 3. Cost per unit Simple Costing System Activity-based Costing System Difference (Simple – ABC) Interior $97.97 $85.10 $12.87 Exterior $144.95 $167.82 $ (22.87) Relative to the ABC system, the simple costing system overcosts interior doors and undercosts exterior doors. Cost Accounting: A Managerial Emphasis, 16e (Horngren) Chapter 5 Activity-Based Costing and Activity-Based Management 5.1 Objective 5.1 1) Which of the following statements is true of a peanut-butter costing system? A) A peanut-butter costing system typically has more-homogeneous indirect cost pools. B) A peanut-butter costing system broadly averages or spreads the cost of resources uniformly to cost objects. C) A peanut-butter costing system assumes that all costs are variable. D) In a peanut-butter costing system, costs of activities are used to assign costs to other cost objects such as products or services based on the activities the products or services consume. Answer: B Diff: 2 Objective: 1 AACSB: Analytical thinking 2) Overcosting a particular product may result in: A) pricing the product too high B) pricing the product too low C) operating efficiencies D) understating total product costs Answer: A Diff: 2 Objective: 1 AACSB: Analytical thinking 3) For a company with diverse products, undercosting overhead of a product will lead to product-cross subsidization which means that: A) direct labor costs of the product are misallocated B) direct material costs of the product are misallocated C) indirect costs of another product are misallocated D) direct costs of another product are misallocated Answer: C Diff: 2 Objective: 1 AACSB: Analytical thinking 1 Copyright © 2018 Pearson Education, Inc. 4) Aqua Company produces two products–Alpha and Beta. Alpha has a high market share and is produced in bulk. Production of Beta is based on customer orders and is custom designed. Also, 55% of Beta's cost is shared between design and setup costs, while Alpha's major portions of costs are direct costs. Alpha is using a single cost pool to allocate indirect costs. Which of the following statements is true of Aqua? A) Aqua will overcost Beta's direct costs as it is using a single cost pool to allocate indirect costs. B) Aqua will undercost Alpha's indirect costs because alpha has high direct costs. C) Aqua will overcost Alpha's indirect costs as it is using a single cost pool to allocate indirect costs. D) Aqua will overcost Beta's indirect costs because beta has high indirect costs. Answer: C Diff: 2 Objective: 1 AACSB: Analytical thinking 5) Product-cost cross-subsidization means that: A) when one product is overcosted, it results in more than one other product being overcosted B) when a company undercosts more than one of its products, it will overcost more than one of its other products C) when a company undercosts one of its products, it will overcost at least one of its other products D) when one product is overcosted it results in all other products being overcosted Answer: C Diff: 2 Objective: 1 AACSB: Analytical thinking 6) Which of the following has accelerated need for refined cost systems? A) global monopolies B) rising prices C) intense competition D) a shift toward increased direct costs Answer: C Diff: 2 Objective: 1 AACSB: Analytical thinking 7) Uniformly assigning the costs of resources to cost objects when those resources are actually used in a nonuniform way is called activity based costing. Answer: FALSE Explanation: Peanut butter costing occurs when costs are assigned uniformly amount multiple products using average costs that do not take into account the nonuniform way the resources are consumed to produce the different products. Diff: 1 Objective: 1 AACSB: Analytical thinking 2 Copyright © 2018 Pearson Education, Inc. 8) Product-cost cross-subsidization is very common when costs are uniformly spread across various products. Answer: TRUE Diff: 2 Objective: 1 AACSB: Analytical thinking 9) Companies that overcost products risk becoming less effective on pricing and losing market share when competition utilizes more accurate cost systems. Answer: TRUE Diff: 1 Objective: 1 AACSB: Analytical thinking 10) If companies increase market share in a given product line because their reported costs are less than their actual costs, they will become more profitable in the long run. Answer: FALSE Explanation: The actual costs will increase because of the additional sales and the other product lines (which are subsidizing the undercosting of the growing product line) will suffer. The net result will be the company having a lower operating income than it could have had. Diff: 2 Objective: 1 AACSB: Analytical thinking 11) As product diversity and indirect costs increase, it is usually best to switch away from a broad averaging system to an activity-based cost system. Answer: TRUE Diff: 1 Objective: 1 AACSB: Analytical thinking 12) The risk of peanut-butter costing rises when broad averages are used across multiple products without managers considering the true amounts of resources consumed in the making of each product. Answer: TRUE Diff: 2 Objective: 1 AACSB: Analytical thinking 13) Explain how a top-selling product may actually result in losses for the company. Answer: If indirect costs are not properly allocated to the products, a product may appear to cost less than it actually does cost to produce. If the selling price is based on these lower costs, the selling price may actually be lower than the costs needed to produce the product resulting in losses for the company. This would make undercosted products appear more profitable and therefore making marketing efforts to promote the undercosted product counter productive. Diff: 2 Objective: 1 AACSB: Analytical thinking 3 Copyright © 2018 Pearson Education, Inc. 5.2 Objective 5.2 1) Refining a cost system involves which of the following? A) classifying as many costs as indirect costs as is feasible B) creating as many cost pools as possible to capture all costs C) identifying the activities involved in a process and understanding how those activities consume resources D) Seeking an easier and more cost effective way to calculate average costs Answer: C Diff: 1 Objective: 2 AACSB: Analytical thinking 2) Which of the following is true of refinement of a costing system? A) While refining a costing system, companies should identify as many indirect costs as is economically feasible. B) A homogeneous cost pool will use multiple cost drivers to allocate costs. C) It reduces the use of broad averages for assigning the cost of resources to cost objects. D) It is likely to yield the most decision-making benefits when direct costs are a high percentage of total costs. Answer: C Diff: 2 Objective: 2 AACSB: Analytical thinking 3) Which of the following is a reason that has accelerated the demand for refinements to the costing system? A) The declining demand for customized products has led managers to decrease the variety of products and services their companies offer. B) The use of product and process technology has led to an increase in indirect costs and a decrease in direct costs. C) The increased of automated processes has led to the increase in direct manufacturing cost leading to a decrease in break even point. D) The increasing competition in product markets has led to an increase in contribution margin resulting in a decrease of break even point. Answer: B Diff: 3 Objective: 2 AACSB: Analytical thinking 4) Demand for refinements to the costing system has accelerated due to ________. A) increase in direct costs B) decrease in product diversity C) decrease in indirect costs D) competition in product markets Answer: D Diff: 1 Objective: 2 AACSB: Analytical thinking 4 Copyright © 2018 Pearson Education, Inc. 5) Johnson Superior Products Inc. produces hospital equipment and the setup requirements vary from product to product. Johnson produces its products based on customer orders and uses ABC costing. In one of its indirect cost pools, setup costs and distribution costs are pooled together. Costs in this pool are allocated using number of customer orders for the easiness of costing operations. Based on the information provided, which of the following arguments is valid? A) Johnson has clearly failed to identify as many direct costs as is economically feasible. B) All costs in a homogeneous cost pool have the same or a similar cause-and-effect relationship with the single cost driver that is used as the cost-allocation base for Johnson. C) Johnson has unnecessarily wasted resources by classifying setup and distribution costs as they could have been considered as direct costs. D) Johnson has failed to use the correct cost driver as the cost-allocation base for setup costs. Answer: D Diff: 1 Objective: 2 AACSB: Application of knowledge 6) Increased used of automation, computer integrated manufacturing, and utilization of robots have lead to an increase in indirect costs relative to direct costs. Answer: TRUE Diff: 2 Objective: 2 AACSB: Analytical thinking 7) Modern manufacturing practices have helped reduce overhead costs relative to direct costs as the reliance on support resources such as scheduling, design, and engineering has diminished. Answer: FALSE Explanation: Managing complex technology and producing diverse products require additional support functions such as production scheduling, product and process design, and engineering. Diff: 1 Objective: 2 AACSB: Analytical thinking 8) Indirect labor and distribution costs would most likely be in the same activity-cost pool. Answer: FALSE Explanation: Indirect labor and distribution costs would not be in the same activity-cost pool because their cost drivers are very dissimilar. A cost driver of indirect labor would include direct labor hours, while a cost driver of distribution costs would include, for example, cubic feet of cargo moved. Diff: 2 Objective: 2 AACSB: Analytical thinking 9) Managers should look for evidence of cause-and-effect when choosing a cost driver with the driver being the cause and the effect being the cost incurred. Answer: TRUE Diff: 1 Objective: 2 AACSB: Analytical thinking 5 Copyright © 2018 Pearson Education, Inc. 10) Identification of a cost-allocation base is not a critical element when using a strategy that will refine a costing system. Answer: FALSE Explanation: Managers refine their cost systems by looking for effective cost=allocation basis (cost driver) and seek evidence of cause-and-effect when choosing a cost driver with the driver being the cause and the effect being the cost incurred. Diff: 1 Objective: 2 AACSB: Analytical thinking 11) What are the factors that are causing many companies to refine their costing systems to obtain more accurate measures of the costs of their products? Answer: The first cause is increasing product diversity. Companies are producing many more products than they used to, placing strains on more simple, older cost systems. A second cause is the overall increased in indirect costs and the relative decline of direct costs. The indirect nature of these costs requires allocation, and any inaccuracies in allocation of these costs become magnified as these indirect costs increase. A third cause would be advances in information technology that makes complex allocation of indirect costs less burdensome. Finally, increased competition from both national and international competitors has resulted in more pressure to reduce costs, as well as increasing the need for and value of information to support responses to these new threats. Diff: 2 Objective: 2 AACSB: Analytical thinking 5.3 Objective 5.3 1) ABC systems create ________. A) one large cost pool B) homogeneous activity-related cost pools C) activity-cost pools with a broad focus D) activity-cost pools containing many direct costs Answer: B Diff: 1 Objective: 3 AACSB: Analytical thinking 2) Activity based costing system differs from traditional costing systems in the treatment of ________. A) direct labor costs B) direct material costs C) prime costs D) indirect costs Answer: D Diff: 1 Objective: 3 AACSB: Analytical thinking 6 Copyright © 2018 Pearson Education, Inc. 3) The fundamental cost objects of ABC are ________. A) activities B) cost drivers C) products D) services Answer: A Diff: 2 Objective: 3 AACSB: Analytical thinking 4) Which of the following statements is true of activity-based costing? A) In activity-based costing, direct labor-hours is always the best allocation base to allocate all nonmanufacturing indirect costs. B) Activity based costing is more suited to companies with high product diversity than companies with single product line. C) Activity based costing broadly averages or spreads the cost of resources uniformly to cost objects such as products or services. D) The main advantage of activity-based costing over peanut-butter costing is the accurate distribution of all direct costs to the products. Answer: B Diff: 2 Objective: 3 AACSB: Analytical thinking 5) A single indirect-cost rate distorts product costs because ________. A) there is an assumption that all support activities affect all products in a uniform way B) it recognizes specific activities that are required to produce a product C) competitive pricing is ignored D) it assumes all costs are product costs Answer: A Diff: 2 Objective: 3 AACSB: Analytical thinking 7 Copyright © 2018 Pearson Education, Inc. 6) Extracts from cost information of Hebar Corp.: Simple L3 Pack Setup cost allocated using direct labor-hours $19,250 Setup cost allocated using setup-hours $13,400 Total Complex L7 Pack $5,750 $25,000 $11,600 $25,000 Assuming that setup-hours is considered a more effective cost drive for allocating setup costs than direct labor-hours. Which of the following statements is true of Hebar's setup costs under traditional costing? A) L3 pack is undercosted by $5,850 B) L7 pack is undercosted by $5,750 C) L3 pack is overcosted by $5,850 D) L7 pack is overcosted by $5,850 Answer: C Explanation: Setup cost allocated using direct labor-hours - Setup cost allocated using setup-hours = $19,250 − $13,400 = $5,850 Diff: 2 Objective: 3 AACSB: Application of knowledge 7) Which of the following is true with activity based cost accounting? A) Activity-based costing ignores the allocation of marketing and distribution costs. B) Activity-based costing is more likely to result in major differences from traditional costing systems if the firm manufactures only one product rather than multiple products. C) The focus is on activities that account for a sizable fraction of indirect costs . D) Chances of product-cost cross-subsidization are higher in activity-based costing compared to traditional costing systems. Answer: C Diff: 2 Objective: 3 AACSB: Analytical thinking 8) Activity-based costing (ABC) can eliminate cost distortions because ABC systems ________. A) establish a cause-and-effect relationship with the activities performed B) use single cost pool for all overhead costs, thereby enabling simplicity C) use a broad average to allocate all overhead costs D) never consider interactions between different departments in assigning support costs Answer: A Diff: 2 Objective: 3 AACSB: Analytical thinking 8 Copyright © 2018 Pearson Education, Inc. 9) When "available time" (i.e., setup-hours) is used to calculate a cost of a resource and to allocate costs to cost objects , the system is called: A) job costing B) process costing C) hybrid costing D) time-driven activity based costing Answer: D Diff: 2 Objective: 3 AACSB: Analytical thinking 10) Extreme Manufacturing Company provides the following ABC costing information: Activities Account inquiry Account billing Account verification accounts Correspondence letters Total costs Total Costs $320,000 $200,000 $173,250 $24,000 $717,250 Activity-cost drivers 16,000 hours 4,000,000 lines 70,000 accounts 4,000 letters The above activities are used by Departments A and B as follows: Account inquiry hours Account billing lines Account verification accounts Correspondence letters Department A 2,700 hours 900,000 lines 8,000 accounts 1,400 letters Department B 4,200 hours 750,000 lines 6,000 accounts 1,800 letters How much of the account inquiry cost will be assigned to Department A? A) $54,000 B) $320,000 C) $160,000 D) $84,000 Answer: A Explanation: Account inquiry costs - Department A = ($320,000 ÷ 16,000) × 2,700 = $54,000 Diff: 2 Objective: 3 AACSB: Application of knowledge 9 Copyright © 2018 Pearson Education, Inc. 11) Extreme Manufacturing Company provides the following ABC costing information: Activities Account inquiry Account billing Account verification accounts Correspondence letters Total costs Total Costs $320,000 $220,000 $182,000 $25,000 $747,000 Activity-cost drivers 16,000 hours 4,000,000 lines 80,000 accounts 4,000 letters The above activities are used by Departments A and B as follows: Account inquiry hours Account billing lines Account verification accounts Correspondence letters Department A 2,200 hours 600,000 lines 5,000 accounts 1,000 letters Department B 3,700 hours 450,000 lines 3,000 accounts 1,400 letters How much of the account billing cost will be assigned to Department B? A) $220,000 B) $110,000 C) $24,750 D) $33,000 Answer: C Explanation: Billing costs - Department B = ($220,000 ÷ 4,000,000) × 450,000 = $24,750 Diff: 2 Objective: 3 AACSB: Application of knowledge 10 Copyright © 2018 Pearson Education, Inc. 12) Extreme Manufacturing Company provides the following ABC costing information: Activities Account inquiry Account billing Account verification accounts Correspondence letters Total costs Total Costs $420,000 $225,000 $95,000 $46,000 $786,000 Activity-cost drivers 14,000 hours 5,000,000 lines 40,000 accounts 8,000 letters The above activities are used by Departments A and B as follows: Account inquiry hours Account billing lines Account verification accounts Correspondence letters Department A 2,900 hours 600,000 lines 12,000 accounts 1,800 letters Department B 4,400 hours 450,000 lines 10,000 accounts 2,200 letters How much of account verification costs will be assigned to Department A? A) $23,750 B) $28,500 C) $95,000 D) $47,500 Answer: B Explanation: Account verification costs - Department A = ($95,000/ 40,000) × 12,000 = $28,500 Diff: 2 Objective: 3 AACSB: Analytical thinking 11 Copyright © 2018 Pearson Education, Inc. 13) Extreme Manufacturing Company provides the following ABC costing information: Activities Account inquiry Account billing Account verification accounts Correspondence letters Total costs Total Costs $390,000 $275,000 $130,500 $22,000 $817,500 Activity-cost drivers 13,000 hours 5,000,000 lines 60,000 accounts 4,000 letters The above activities are used by Departments A and B as follows: Account inquiry hours Account billing lines Account verification accounts Correspondence letters Department A 2,500 hours 800,000 lines 9,000 accounts 2,000 letters Department B 4,000 hours 650,000 lines 7,000 accounts 2,400 letters How much of correspondence costs will be assigned to Department A? A) $22,000 B) $49,500 C) $11,000 D) $11,242 Answer: C Explanation: Correspondence costs - Department A = ($22,000 ÷ 4,000) × 2,000 = $11,000 Diff: 2 Objective: 3 AACSB: Application of knowledge 12 Copyright © 2018 Pearson Education, Inc. 14) Extreme Manufacturing Company provides the following ABC costing information: Activities Account inquiry Account billing Account verification accounts Correspondence letters Total costs Total Costs $280,000 $350,000 $93,750 $29,000 $752,750 Activity-cost drivers 14,000 hours 7,000,000 lines 50,000 accounts 4,000 letters The above activities are used by Departments A and B as follows: Account inquiry hours Account billing lines Account verification accounts Correspondence letters Department A 2,100 hours 500,000 lines 7,000 accounts 1,200 letters Department B 3,600 hours 350,000 lines 5,000 accounts 1,600 letters How much of the total costs will be assigned to Department A? A) $88,825 B) $118,825 C) $120,000 D) $85,075 Answer: A Explanation: Account inquiry costs = ($280,000 ÷ 14,000) × 2,100 Billing costs = ($350,000 ÷ 7,000,000) × 500,000 = $25,000 Account verification costs = ($93,750 ÷ 50,000) × 7,000 Correspondence costs = ($29,000 ÷ 4,000) × 1,200 = $8,700 $88,825 Diff: 3 Objective: 3 AACSB: Application of knowledge 13 Copyright © 2018 Pearson Education, Inc. = $42,000 = $13,125 15) Extreme Manufacturing Company provides the following ABC costing information: Activities Account inquiry Account billing Account verification accounts Correspondence letters Total costs Total Costs $750,000 $250,000 $173,250 $42,000 $1,215,250 Activity-cost drivers 15,000 hours 5,000,000 lines 70,000 accounts 7,000 letters The above activities are used by Departments A and B as follows: Account inquiry hours Account billing lines Account verification accounts Correspondence letters Department A 2,000 hours 900,000 lines 9,000 accounts 1,200 letters Department B 3,500 hours 750,000 lines 7,000 accounts 1,600 letters How much of the total costs will be assigned to Department B? A) $282,460 B) $246,925 C) $239,425 D) $256,825 Answer: C Explanation: Account inquiry costs = ($750,000 ÷ 15,000) × 3,500 Billing costs = ($250,000 ÷ 5,000,000) × 750,000 = $37,500 Account verification costs = ($173,250 ÷ 70,000) × 7,000 = $17,325 Correspondence costs = ($42,000 ÷ 7,000) × 1,600 = $9,600 $239,425 = $175,000 Diff: 3 Objective: 3 AACSB: Application of knowledge 16) Dalrymple Company produces a special spray nozzle. The budgeted indirect total cost of inserting the spray nozzle is $68,750. The budgeted number of nozzles to be inserted is 11,000. What is the budgeted indirect cost allocation rate for this activity? A) $0.16 B) $0.32 C) $1.16 D) $6.25 Answer: D Explanation: $68,750 / 11,000 = $6.25 Diff: 2 Objective: 3 AACSB: Application of knowledge 14 Copyright © 2018 Pearson Education, Inc. 17) Activity-based costing is most likely to yield benefits for companies ________. A) with complex product design processes that vary significantly from product to product B) with operations that remain fairly consistent across product lines C) in a monopolistic market D) having nominal percentage of indirect costs Answer: A Diff: 1 Objective: 3 AACSB: Analytical thinking 18) Which of the following statements is true of ABC systems? A) ABC systems are time-driven cost systems. B) ABC systems classify some direct costs as indirect costs and some indirect costs as direct costs. C) ABC systems provide valuable information to managers beyond accurate product costs. D) ABC systems assume all costs are variable costs. Answer: C Diff: 2 Objective: 2 AACSB: Analytical thinking 19) Columbus Company provides the following ABC costing information: Activities Labor Gas Invoices Total costs Total Costs $392,000 $30,000 $180,000 $602,000 Activity-cost drivers 8,000 hours 5,000 gallons 7,500 invoices The above activities used by their three departments are: Labor Gas Invoices Lawn Department 2,600 hours 1,800 gallons 1,600 invoices Bush Department 1,300 hours 1,000 gallons 100 invoices How much of the labor cost will be assigned to the Bush Department? A) $127,400 B) $63,700 C) $200,900 D) $97,825 Answer: B Explanation: Labor cost assigned = ($392,000 ÷ 8,000) × 1,300 = $63,700 Diff: 2 Objective: 3 AACSB: Analytical thinking 15 Copyright © 2018 Pearson Education, Inc. Plowing Department 4,100 hours 2,200 gallons 5,800 invoices 20) Columbus Company provides the following ABC costing information: Activities Labor Gas Invoices Total costs Total Costs $336,000 $84,000 $180,000 $600,000 Activity-cost drivers 8,000 hours 7,000 gallons 7,500 invoices The above activities used by their three departments are: Labor Gas Invoices Lawn Department 3,100 hours 1,900 gallons 1,300 invoices Bush Department 1,500 hours 900 gallons 400 invoices Plowing Department 3,400 hours 4,200 gallons 5,800 invoices If labor hours are used to allocate the non-labor, overhead costs, what is the overhead allocation rate? A) $75.00 per hour B) $26.67 per hour C) $42.00 per hour D) $33.00 per hour Answer: D Explanation: Overhead allocation rate = ($84,000 + $180,000) ÷ 8,000 = $33.00 Diff: 2 Objective: 3 AACSB: Application of knowledge 16 Copyright © 2018 Pearson Education, Inc. 21) Columbus Company provides the following ABC costing information: Activities Labor Gas Invoices Total costs Total Costs $384,000 $36,000 $180,000 $600,000 Activity-cost drivers 8,000 hours 6,000 gallons 7,500 invoices The above activities used by their three departments are: Labor Gas Invoices Lawn Department 2,500 hours 1,800 gallons 1,300 invoices Bush Department 1,400 hours 1,000 gallons 300 invoices How much of invoice cost will be assigned to the Bush Department? A) $7,200 B) $141,600 C) $31,200 D) $180,000 Answer: A Explanation: ($180,000 / 7,500 invoices) × 300 invoices = $7,200 Diff: 2 Objective: 3 AACSB: Application of knowledge 17 Copyright © 2018 Pearson Education, Inc. Plowing Department 4,100 hours 3,200 gallons 5,900 invoices 22) Columbus Company provides the following ABC costing information: Activities Labor Gas Invoices Total costs Total Costs $352,000 $8,000 $110,000 $470,000 Activity-cost drivers 8,000 hours 4,000 gallons 5,500 invoices The above activities used by their three departments are: Labor Gas Invoices Lawn Department 3,200 hours 1,900 gallons 1,500 invoices Bush Department 1,200 hours 900 gallons 300 invoices How much of the gas cost will be assigned to the Lawn Department? A) $1,800 B) $3,800 C) $2,400 D) $8,000 Answer: B Explanation: Gas cost = ($8,000 ÷ 4,000 gallons) × 1,900 gallons = $3,800 Diff: 2 Objective: 3 AACSB: Application of knowledge 18 Copyright © 2018 Pearson Education, Inc. Plowing Department 3,600 hours 1,200 gallons 3,700 invoices 23) Columbus Company provides the following ABC costing information: Activities Labor Gas Invoices Total costs Total Costs $490,000 $18,000 $56,000 $564,000 Activity-cost drivers 10,000 hours 3,000 gallons 3,500 invoices The above activities used by their three departments are: Labor Gas Invoices Lawn Department 2,800 hours 1,800 gallons 1,600 invoices Bush Department 1,400 hours 900 gallons 300 invoices How much of the total cost will be assigned to the Plowing Department? A) $564,000 B) $311,600 C) $188,000 D) $173,600 Answer: B Explanation: ($490,000 / 10,000) × 5,800 = $284,200 ($18,000 / 3,000) × 300 = $1,800 ($56,000 / 3,500) × 1,600 = $25,600 $311,600 Diff: 3 Objective: 3 AACSB: Application of knowledge 19 Copyright © 2018 Pearson Education, Inc. Plowing Department 5,800 hours 300 gallons 1,600 invoices 24) Columbus Company provides the following ABC costing information: Activities Labor Gas Invoices Total costs Total Costs $384,000 $40,000 $40,000 $464,000 Activity-cost drivers 8,000 hours 4,000 gallons 2,500 invoices The above activities used by their three departments are: Labor Gas Invoices Lawn Department 2,800 hours 1,800 gallons 1,400 invoices Bush Department 1,500 hours 900 gallons 300 invoices How much of the total costs will be assigned to the Lawn Department? A) $192,000 B) $464,000 C) $174,800 D) $154,667 Answer: C Diff: 3 Objective: 3 AACSB: Application of knowledge 20 Copyright © 2018 Pearson Education, Inc. Plowing Department 3,700 hours 1,300 gallons 800 invoices 25) Milan Manufacturing Company has identified three cost pools to allocate overhead costs. The following estimates are provided for the coming year: Cost Pool Supervision of direct labor Machine maintenance Facility rent Total overhead costs Overhead Costs $539,000 $120,000 $215,000 $874,000 Cost driver Direct labor-hours Machine-hours Square feet of area Activity level 920,000 1,000,000 160,000 The accounting records show the Mossman Job consumed the following resources: Cost driver Direct labor-hours Machine-hours Square feet of area Actual level 300 1,675 70 If direct labor-hours are considered the only overhead cost driver, what is the single cost driver rate for Milan? A) $1.05 per direct labor-hour B) $0.59 per direct labor-hour C) $0.95 per direct labor-hour D) $1.71 per direct labor-hour Answer: C Explanation: Cost driver rate = $874,000 ÷ 920,000 = 0.95 per dlh Diff: 2 Objective: 3 AACSB: Application of knowledge 21 Copyright © 2018 Pearson Education, Inc. 26) Milan Company has identified three cost pools to allocate overhead costs. The following estimates are provided for the coming year: Cost Pool Supervision of direct labor Machine maintenance Facility rent Total overhead costs Overhead Costs $624,000 $100,000 $216,000 $940,000 Cost driver Direct labor-hours Machine-hours Square feet of area Activity level 940,000 840,000 140,000 The accounting records show the Mossman Job consumed the following resources: Cost driver Direct labor-hours Machine-hours Square feet of area Actual level 290 1,681.68 50 Under activity-based costing, what is the amount of machine maintenance costs allocated to the Mossman Job? (Do not round any intermediary calculations.) A) $1,881.88 B) $200.20 C) $1,681.68 D) $210.45 Answer: B Explanation: Machine maintenance costs = 1,681.68 mh × ($100,000 ÷ 840,000) = $200.20 Diff: 2 Objective: 3 AACSB: Application of knowledge 22 Copyright © 2018 Pearson Education, Inc. 27) Velshi Printers has contracts to complete weekly supplements required by forty-six customers. For the year 2018, manufacturing overhead cost estimates total $1,500,000 for an annual production capacity of 10 million pages. For 2018 Velshi Printers has decided to evaluate the use of additional cost pools. After analyzing manufacturing overhead costs, it was determined that number of design changes, setups, and inspections are the primary manufacturing overhead cost drivers. The following information was gathered during the analysis: Cost pool Manufacturing overhead costs Design changes $100,000 Setups 1,300,000 Inspections 100,000 Total manufacturing overhead costs $1,500,000 Activity level 400 design changes 3,000 setups 10,000 inspections During 2018, two customers, Money Managers and Hospita...
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Explanation & Answer

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QUESTION 1:
a). The amount of material handling and machine maintenance cost allocated to the customer A
Material handling=$540,000/(60,000 +30,000) x 60,000
Material handling=$540,000/90,000 x 60,000
Material handling=$6 x 60,000
Material handling allocated to Customer A=$360,000
Machine maintenance=$90,000/(10,000 +5,000) x 10,000
Machine maintenance=$90,000/15,000 x 10,000
Machine maintenance allocated to customer A=$6 x 10,000
Machine maintenance allocated to customer A=$60,000
b). The amount of material handling and machine maintenance cost allocated to the customer B
Material handling=$540,000/(60,000 +30,000) x 30,000
Material handling=$540,000/90,000 x 30,000
Material handling=$6 x 30,000
Material handling allocated to Customer A=$180,000
Machine maintenance=$90,000/(10,000 +5,000) x 5,000
Machine maintenance=$90,000/15,000 x 5,000
Machine maintenance allocat...


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