acct 1b week 2, chap 2 - cabrillo.edumbooth/acct1b/week2_chap2 acct_1b spring 16...fixed costs costs...
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Acct 1B
Week 2, Chap 2Managerial Accounting and Cost
Concepts
Instructor: Michael Booth
Cabrillo College
Product Costing
Product Costing
Managers need to know the cost of
their products and services.
Cost Plus Pricing
A common business practice.
Product Costs in Solar Panel
Manufacturing Companies
Materials Labor Overhead
Manufacturing Costs
Direct Material
Raw Material Traceable to product
Direct Labor
Cost of salaries, wages, and fringe benefits of personnel
that work directly on the manufactured products
Manufacturing overhead
All other costs: indirect material, indirect labor, and other
manufacturing costs
Other manufacturing costs; all other manufacturing costs that
are neither material or labor costs i.e. maintenance of
production equipment
Transformation of Cash into
Inventory
$2,490 finished goods
Variance=$210
Direct Material= $1,369
Direct labor= $833
Overhead= $ 288
Cash= $2,700
Costs Can Be Assets or
Expenses
Period Cost
Expense
COGSAssetProduct
Cost
Cost vs Expense Cost
A sacrifice made, measured by resources given up, to achieve a specific purpose
Direct Cost
Traced to specific department or product
Indirect Cost
A Cost that cannot be applied to specific product or department
Expense
Is a cost incurred when an asset is used up
Period Costs All costs that are not product costs
Identified and recognized in the period when incurred rather than with units of production
Research & Development Include all development costs of new products and
services Running a lab, building prototypes, test products
Salary, benefits, ovhd expense of R & D personnel
Selling Costs Include salaries, commissions, travel costs, advertising,
promotional costs
Administrative Costs Costs for running the organization; management,
accounting, legal, public relations
Product Costs Inventory cost
Is a product cost because it is stored as the cost of inventory until the goods are sold
Cost of Goods Sold Product costs are recognized in the period of sale as an
expense COGS (cost of goods sold)
Merchandise Inventory Consists of purchase cost of the inventory plus shipping
and handling
Manufactured Inventory Consists of direct Material, direct labor, and manufacturing
overhead
Cost vs Expense flow
Product Costs•Direct Material
•Direct Labor
•Mfg Overhead
Finished Goods
Ending Inventory
COGS
Selling, General &
Administrative•Salaries
•Commissions
•Travel Costs
•Cost of Advertising
SG & A Expense
Cost Classification Balance Sheet Income Statement
Manufacturing Costs
(Product Costs or
Inventoriable Costs)
Direct Materials Direct LaborManufacturing
Overhead
Prime Cost Conversion
Cost
WIP WIP
Stage 1 Assembly
Process Cost Flow
Product
costs
Materials
Labor
Overhead
Income
statement
Cost of
goods
sold
Finished
goods
inventory
Materials
Labor
Overhead
Transferred-
in costs
Materials
Labor
Overhead Cost of
goods
available
for sale
Overhead Costs: A Closer
Look
Indirect Costs
DepreciationSupervisor’s
SalaryUtilities
Learning Objective
To identify and describe
fixed, variable, and mixed
cost behavior
Types of Costs Fixed Costs
Costs which do not change as production or sales change
within a relevant range
Variable Costs
Directly proportional to sales or production volumes
Mixed Costs
Components of fixed and variable that can be identified and
divided
Fixed Cost Behavior
Increases Decreases
Total Fixed Cost Remains constant Remains Constant
Fixed Cost Per Unit Decreases Increases
When activity . . . .
Fixed Cost Behavior(Solar
Panel Production)
Solar Panels Produce 2,700 3,000 3,300
Per Month Lease Cost 52,000$ 52,000$ 52,000$
Per Solar Panel unit Cost 19.26$ 17.33$ 15.76$
Operating Leverage
When all costs are fixed, every additional sales dollar contributes
one dollar to gross profit.
22% RevenueIncrease
50% GrossProfit Increase
Types of Costs Fixed Costs
Costs which do not change as production or sales change
within a relevant range
Variable Costs
Directly proportional to sales or production volumes
Mixed Costs
Components of fixed and variable that can be identified and
divided
The total variable cost increases in directproportion to the number of Solar Panels sold.
Variable unit cost per ticket remains at$498 regardless of the number of Solar Panels sold.
Variable Cost Behavior (Solar
Panel)
Variable Cost Behavior
Increases Decreases
Total Variable
Cost
Increases
Proportionately
Decreases
Proportionately
Variable Cost
Per UnitRemains Constant Remains Constant
When activity . . .
Shifting the cost structure from fixed to variable not only reduces
risk but also the potential for profits.
Risk and Reward
Assessment22% Revenue
Increase
22% GrossProfit Increase
Fixed Cost Structure
Fixed CostProfit
Loss
Revenue $
Unit Volume
Effect of Cost Structure
on Profit StabilityS
ale
s
$
Co
st
Variable Cost Structure
VariableCost
Revenue$
Effect of Cost Structure
on Profit Stability
Unit Volume
Sale
s
$
Co
st
VariableCosts
FixedCosts
Do companieswith higher levels of
fixed costs experiencemore earnings
volatility?
Effect of Cost Structure
on Profit Stability
MixedCosts
Units are all the same, but costs are shifted between fixed,
variable or mixed
Effect of Cost Structure
on Profit Stability
Effect of Cost Structure
on Profit Stability for Solar Panels
The income increase is greaterin the All Fixed Company.
If sales decrease,will the income
decrease be greaterin the All Fixed
Company?
Effect of Cost Structure
on Profit Stability
VariableCosts
FixedCosts
MixedCosts
Effect of Cost Structure
on Profit Stability for Solar Panels
Net Income decrease is greaterin the All Fixed Company.
Level of
Fixed Cost
Earnings
Volatility
High High
Low Low
Effect of Cost Structure
on Profit Stability
VariableCosts
FixedCosts
MixedCosts
Learning Objective
To prepare an income
statement using the
contribution margin
approach
An Income Statement under the
Contribution Margin Approach
Total Unit
Sales Revenue 1,650,000$ 825$
Less: Variable Costs 348,000 174
Contribution Margin 1,302,000$ 651$
Less: Fixed Costs 648,000
Gross Margin 654,000$
The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs
and provides for income.
Consider the following two scenarios:
What happens if each company cuts the service revenueto $35 per hour in order to increase the amount of business, as an offset to
the Fed Tax Credit Expiration?
Using Fixed Cost to Provide a
Competitive Operating Advantage
Using Fixed Cost to Provide a
Competitive Operating Advantage
Advantage of the all fixed cost.
Using Fixed Cost to Provide a
Competitive Operating
Advantage
Fixed vs. Variable cost comparison
Fixed costs will earn more profits as volume increases
Variable cost structure is better in periods of declining
business volume
Cost Behavior SummarizedYour monthly basic telephone bill is probably fixed and does
not change when you make more local calls.
Number of Local Calls
Mo
nth
ly B
asic
T
ele
ph
on
e B
ill
Total Fixed Cost
Cost Behavior SummarizedThe fixed cost per local call decreases
as more local calls are made.
Number of Local CallsMo
nth
ly B
asic
Te
lep
ho
ne
B
ill
pe
r Lo
ca
l C
all
Cost Behavior SummarizedYour total long distance telephone bill is based on how
many minutes you talk.
Minutes Talked
To
tal
Lo
ng
Dis
tan
ce
Te
lep
ho
ne
Bil
l
Cost Behavior SummarizedThe cost per minute talked is constant.
For example, 10 cents per minute.
Minutes Talked
Pe
r M
inu
teT
ele
ph
on
e C
ha
rge
Variable Cost Per Unit
Total Cost Cost Per Unit
Fixed CostsRemains
Constant
Changes
Inversely
Variable CostsChanges in
Direct Proportion
Remains
Constant
Cost Behavior Summarized
When activity level changes . . .
Learning Objective
How the relevant range and
decision context affect cost
behavior
Relevant Range
Span of activity over which a certain cost behavior
holds true.
High risk to extrapolate
Example: fixed costs will not change only for a specified
range of volume of activity
beyond specific volume, fixed costs are not constant
volume range in which the behavior of variable costs,
fixed costs, and selling prices can be predicted with
reasonable accuracy.
Copyright © 2005, 2000, 1995, 1987 by Barron's Educational Series, Inc., Reprinted by arrangement with Publisher.
The Relevant Range
Example:
Office space is available at a fixed rental rate of $30,000 per year/ 1,000 sq ft
increments of 1,000 square feet can be added
as the business grows more space is rented, increasing the total cost.
Re
nt
Co
st
in
Th
ou
sa
nd
s o
f D
oll
ars
0 1,000 2,000 3,000 Rented Area (Square Feet)
0
30
60
The Relevant Range
90
Relevant
Range
Total fixed cost doesn’t change for a range of activity,
and then jumps to a new higher cost for
the next higher range of activity.
Activity
To
tal
Co
st
RelevantRange
The Relevant Range
Variable cost assumption
(constant unit variable cost)
applies within the relevant range.
Possible VariableCost Behavior
VariableCost Assumption
Expected volume
Learning Objective
Mixed cost
Mixed Costs
A mixed cost
has both fixed
and variable
components.Electric utilities
Fixed Monthly
Utility Charge
Variable
Utility Charge
Activity (Kilowatt Hours)
To
tal
Uti
lity
Co
st
Mixed Costs
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed costs remain the
same even when the activity Average fixed costs per unit
Fixed level changes within the decrease as the activity
relevant range. level increases.
Average fixed costs per unit decrease as the
activity level increases.
Types of Cost Behavior
Patterns – Fixed
Examples
Advertising and Research and Development
Examples
Depreciation on Buildings and Equipment and Real
Estate Taxes
Types of Fixed Costs
Discretionary
May be altered in the short-term by current managerial decisions
Committed
Long-term, cannot be significantly reduced in
the short term.
Quick Check Which of the following statements about
cost behavior are true?a. Fixed costs per unit vary with the level of
activity.
b. Variable costs per unit are constant within the relevant range.
c. Total fixed costs are constant within the relevant range.
d. Total variable costs are constant within the relevant range.
Which of the following statements about
cost behavior are true?
a. Fixed costs per unit vary with the level of
activity.
b. Variable costs per unit are constant within the
relevant range.
c. Total fixed costs are constant within the
relevant range.
d. Total variable costs are constant within the
relevant range.
Quick Check
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Tota
l U
tilit
y C
ost
X
Y
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
Mixed Costs (also called
semivariable costs)
Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX
Where: Y = The total mixed cost.
a = The total fixed cost (the
vertical intercept of the line).
b = The variable cost per unit of
activity (the slope of the line).
X = The level of activity.
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Tota
l U
tilit
y C
ost
X
Y
Mixed Costs – An ExampleIf your fixed monthly utility charge is $40, your
variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
Use a scattergraph plot to
diagnose cost behavior.
Plot the data points on a graph
(Total Cost Y vs. Activity X).
0 1 2 3 4
*
Ma
inte
na
nce
Co
st
1,0
00’s o
f D
olla
rs
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
The Scattergraph Method
The Scattergraph Method
Draw a line through the data points with about an
equal numbers of points above and below the line.
0 1 2 3 4
*
Ma
inte
na
nce
Co
st
1,0
00’s o
f D
olla
rs
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
The Scattergraph MethodUse one data point to estimate the total level of activity
and the total cost.
Intercept = Fixed cost: $10,000
0 1 2 3 4
*
Main
tena
nce C
ost
1,0
00’s o
f D
olla
rs
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
Patient days = 800
Total maintenance cost = $11,000
The Scattergraph Method
Make a quick estimate of variable cost per unit and
determine the cost equation.
Variable cost per unit = $1,000
800= $1.25/patient-day
Y = $10,000 + $1.25X
Total maintenance at 800 patients 11,000$
Less: Fixed cost 10,000
Estimated total variable cost for 800 patients 1,000$
Total maintenance cost Number of patient days
Analyze a mixed cost
using the high-low
method.
The High-Low Method – An
ExampleAssume the following hours of maintenance work and the total maintenance costs for six months.
MONTH Hrs of
Maintenance
Total
Maintenance
Cost
January 625 $ 7,950
February 450 7,400
March 700 8,275
April 550 7,625
May 775 9,100
June 850 9,800
The High-Low Method – An
ExampleThe variable cost
per hour of
maintenance is
equal to the change
in cost divided by
the change in hours.
= $6.00/hour$2,400
400
MONTH Hrs of
Maintenance
Total
Maintenance
Cost
January 625 $ 7,950
February 450 7,400
March 700 8,275
April 550 7,625
May 775 9,100
June 850 9,800
High 850 9,800
Low 450 7,400
Change 400 2,400
MONTH Hrs of
Maintenance
Total
Maintenance
Cost
High 850 9,800
Low 450 7,400
Change 400 2,400
The High-Low Method – An
Example
Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700
The High-Low Method – An
Example
Y = $4,700 + $6.00X
The Cost Equation for Maintenance
MONTH Hrs of
Maintenance
Total
Maintenance
Cost
High 850 9,800
Low 450 7,400
Change 400 2,400
Quick Check Sales salaries and commissions are $10,000 when 80,000
units are sold, and $14,000 when 120,000 units are sold.
Using the high-low method, what is the variable portion of
sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is the
variable portion of sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
Quick Check
$4,000 ÷ 40,000 units
= $0.10 per unit
Quick Check Sales salaries and commissions are $10,000 when 80,000
units are sold, and $14,000 when 120,000 units are sold.
Using the high-low method, what is the fixed portion of
sales salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is
the fixed portion of sales salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
Quick Check
Total cost = Total fixed cost +
Total variable cost
$14,000 = Total fixed cost +
($0.10 × 120,000 units)
Total fixed cost = $14,000 - $12,000
Total fixed cost = $2,000
Least-Squares Regression
MethodA method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the
data points to estimate
the fixed and variable
cost components of a
mixed cost.The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.
Least-Squares Regression
Method
Software can be used to fit a
regression line through the
data points.
The cost analysis objective is
the same: Y = a + bX
Least-squares regression also provides a statistic, called
the R2, which is a measure of the goodness
of fit of the regression line to the data points.
Least-Squares Regression
Method
0 1 2 3 4
Tota
l C
ost
10
20
0
Activity
*
***
**
****
R2 is the percentage of the variation in the dependent
variable (total cost) that is explained by variation in the
independent variable (activity).
R2 varies from 0% to 100%, and
the higher the percentage the better.
X
Y
Comparing Results From the
Three Methods
The three methods provide slightly different
estimates of the fixed and variable cost
components of the mixed cost.
Least-squares regression provides the most
accurate estimate because it uses all the data
points.
An Income Statement under the
Contribution Margin Approach
Total Unit
Sales Revenue 1,650,000$ 825$
Less: Variable Costs 348,000 174
Contribution Margin 1,302,000$ 651$
Less: Fixed Costs 648,000
Gross Margin 654,000$
The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs
and provides for income.
Consider the following two scenarios:
What happens if each company cuts the service revenueto $35 per hour in order to increase the amount of business, as an offset to
the Fed Tax Credit Expiration?
Using Fixed Cost to Provide a
Competitive Operating Advantage
Using Fixed Cost to Provide a
Competitive Operating Advantage
Advantage of the all fixed cost.
Using Fixed Cost to Provide
a Competitive Operating
Advantage
Fixed vs. Variable cost comparison
Fixed costs will earn more profits as volume increases
Variable cost structure is better in periods of declining
business volume
Income statement using
the contribution format.
The Contribution FormatTotal Unit
Sales Revenue 100,000$ 50$
Less: Variable costs 60,000 30
Contribution margin 40,000$ 20$
Less: Fixed costs 30,000
Net operating income 10,000$
The contribution margin format emphasizes cost
behavior. Contribution margin covers fixed costs
and provides for income.
Uses of the Contribution
Format
The contribution income statement format is used
as an internal planning and decision-making tool.
We will use this approach for:
1.Cost-volume-profit analysis (Chapter 5).
2.Budgeting (Chapter 8).
3.Special decisions such as pricing and make-or-
buy analysis (Chapter 12).
The Contribution Format
Used primarily for
external reporting.
Used primarily by
management.
The Contribution Format
Used primarily for
external reporting.
Used primarily by
management.
Cost of Quality
Six Sigma
A process improvement method relying on customer
feedback and fact-based data gathering and analysis
techniques to drive process improvement.
Refers to a process that
generates no more
than 3.4 defects per million
opportunities.
Sometimes
associated
with the term zero
defects.
1-84
Minimizing Total Quality Costs
Total Quality cost
Percent of Products without Defects
Cost
per
Unit (
$)
Voluntary costs
(Prevention and
Appraisal)
Failure cost
0 100
Cost of QUALITY
is minimized
Six Sigma
Stage Goals
Define ● Establish the scope and purpose of the project.
● Diagram the flow of the current process.
● Establish the customer's requirements for the
process.
Measure ● Gather baseline performance data related to
the existing process.
● Narrow the scope of the project to the most
important problems.
Analyze ● Identify the root cause(s) of the problems
identified in the Measure stage.
Improve ● Develop, evaluate, and implement solutions
to the problems.
Control ● Ensure that problems remain fixed.
● Seek to improve the new methods over time.
The Six Sigma DMAIC Framework
1-86
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