managerial accounting series 2

MANAGERIAL ACCOUNTING COST BEHAVIORS, SYSTEMS, AND ANALYSIS

with Gary Hecht

Costing Systems 1: Elements and Design

Financial Perspective and Costing System Approaches

Lesson Objectives

LESSON 2-1 OBJECTIVES

You will understand:

The purpose of costing systems inside organizations

How to identify different types of costing systems

Flow of Costs Through Financial Statements

FUNDAMENTALS

Financial perspective Product costing according to generally accepted accounting principles

Matching principle

“Inventoriable” costs versus period costs

Costs versus expenses

DIFFERENT PERSPECTIVES OF COSTS: MANUFACTURING SETTING

PRODUCT COSTS =

INVENTORIABLE COSTS

PERIOD COSTS =

SELLING & ADMIN

DIRECT PRODUCT

COSTS

INDIRECT PRODUCT COSTS

= MFG OVERHEAD

Direct    Materials  

FLOW OF COSTS THROUGH FINANCIAL STATEMENTS

Direct    Labor  

Mfg  Overhead  

Work  in  Process  Inventory  

Finished  Goods  

Inventory    

Cost  of  Goods  Sold  

Two Traditional Systems

COST SYSTEMS BY COST OBJECT TYPE

Many types of costing systems - one distinction relates to cost object type

Job Costing

Cost object is a unit or multiple units of a distinct product or service

Process Costing

Cost object is masses of identical or similar units of product or service

Often, a continuum . . .

EXAMPLES

Job costing Law firms Consulting Planes, yachts

Process costing Computers Food products Mail, express delivery

JOB COSTING VS. PROCESS COSTING

Finished-Goods Inventory

Cost of Goods Sold

Work-in-Process Inventory

Direct Material Direct Labor Manufacturing Overhead

Job 1

Job 2

Job 3

Job Costing: Accumulates Costs by Individual Job

JOB COSTING VS. PROCESS COSTING

Work-in-Process Inventory: Production Department A

Direct Material Direct Labor Manufacturing Overhead

Process Costing: Accumulates Costs by Production Department

Work-in-Process Inventory: Production Department B

Cost of Goods Sold

Finished-Goods Inventory

Extension – Overhead Costs

OVERHEAD CONSIDERATIONS

Consulting firm setting Accounting for costs Pricing decision

Two general types of costs Labor Overhead

OVERHEAD TIMING

Beginning  of  the  Period  

End    of  the  Period  

Budgeted    

Actual    

Decisions    

Applied    

APPLYING OVERHEAD

A simple formula:

Predetermined OH Rate = Budgeted Overhead (Total)

Total Volume of Driver

Use this rate to allocate overhead.

EXAMPLE

Step 1: Calculate Rate

Predetermined OH Rate = Budgeted Overhead (Total)

Total Volume of Driver

Predetermined OH Rate = $1,500,000 = $50 per hour

30,000 Labor Hours

EXAMPLE

Step 2: Apply Overhead

Suppose a consulting engagement used 350 labor hours.

$50 per hour x 350 hours = $17,500

CORRECTING ESTIMATES

The predetermined OH rate is based on budgeted information.

However, estimates from the beginning of the year likely do not match actual overhead at the end of the year.

An adjustment is usually made to reflect this difference in the costing system.

VIDEO 2-1.6

What We’ve Learned

What We’ve Learned

WHAT WE’VE LEARNED IN LESSON 2-1

Financial perspective of costs How costs flow through financial statements Production costs remain in inventory (i.e., as an asset) until sold

Various types of costing systems Adopted by organizations according to nature of business and product

The Problem of Fixed Costs

Lesson Objectives

LESSON 2-2 OBJECTIVES

You will understand:

How to account for costs using absorption costing, which is required for financial reporting purposes

The problems associated with fixed costs for decision making

Example Scenario

MANUFACTURING SETTING

Financial Accounting Revenue

- Direct Material (V) - Direct Labor (V) - Overhead (V & F) = Gross Margin - Other Expenses (V & F) = Profit

EXAMPLE Keith Adventures, Inc. manufactures and sells a variety of boats and jet skis. The following information is available for its main line of boats.

Selling  price  (per  unit)    Variable  costs  (per  unit)      Materials      Labor      Selling    Fixed  costs  (total)      Manufacturing      Selling    

$  21,000      

5,000  3,000  2,000  

1,500,000  450,000  

 Beginning  inventory    ProducFon    Sales    Ending  inventory  

Month  1      0        

400    

300    

100  

Month  2      

100    

350    

400    

50  

CREATING THE INCOME STATEMENT

What is Keith’s revenue from boats for Month 1? $21,000 per unit x 300 units sold = $6,300,000

What are Keith’s variable manufacturing costs? Direct materials + Direct labor = $5,000 + $3,000 = $8,000 per unit Total = $8,000 per unit x 400 units = $3,200,000

Where are the variable manufacturing costs reported?

Income statement (COGS): $8,000 x 300 units sold = $2,400,000 Balance sheet (Inventory): $8,000 x 100 units in inventory = $800,000

CREATING THE INCOME STATEMENT (CONT)

What are Keith’s fixed manufacturing costs for Month 1? Given as $1,500,000

Where are the fixed manufacturing costs reported? How much fixed cost is allocated per unit? $1,500,000 / 400 units produced = $3,750 per unit Income statement (COGS): $3,750 x 300 units sold = $1,125,000 Balance sheet (Inventory): $3,750 x 100 units in inventory = $375,000

CREATING THE INCOME STATEMENT (CONT)

What are Keith’s other costs? Variable selling and admin: $2,000 per unit x 300 units sold = $600,000 Fixed selling and admin: $450,000

Where are these costs reported?

All on the income statement, as they are not inventoriable costs

2,400,000 + 1,125,000

600,000 + 450,000

Revenues Cost of goods sold Gross margin Total Selling & Admin Operating income

$6,300,000 3,525,000 2,775,000 1,050,000 1,725,000

INCOME STATEMENT – MONTH 1

The Manager Did What?

AN ALTERNATIVE VERSION

Let’s envision a different version of Month 1 . . .

That is, suppose that Keith manufactured 800 units (instead of the 400 units in our original scenario).

ALTERNATIVE VERSION

What is Keith’s revenue from boats for Month 1? $21,000 per unit x 300 units sold = $6,300,000

What are Keith’s variable manufacturing costs? Direct materials + Direct labor = $5,000 + $3,000 = $8,000 per unit Total = $8,000 per unit x 800 units = $6,400,000

Where are the variable manufacturing costs reported?

Income statement (COGS): $8,000 x 300 units sold = $2,400,000 Balance sheet (Inventory): $8,000 x 500 units in inventory = $4,000,000

ALTERNATIVE VERSION (CONT)

What are Keith’s fixed manufacturing costs for Month 1? Given as $1,500,000

Where are the fixed manufacturing costs reported? How much fixed cost is allocated per unit? $1,500,000 / 800 units produced = $1,875 per unit Income statement (COGS): $1,875 x 300 units sold = $562,500 Balance sheet (Inventory): $1,875 x 500 units in inventory = $937,500

Revenues Cost of goods sold Gross margin Total Selling & Admin Operating income

400 units $6,300,000 3,525,000 2,775,000 1,050,000 1,725,000

800 units $6,300,000 2,962,500 3,337,500 1,050,000 2,287,500

COMPARISON

INCENTIVE IMPLICATIONS

Assume the boating business unit manager’s evaluation and compensation is determined by operating income . . .

Certainly, the manager is aligned with the organization.

However, the “accounting” story might induce inventory build-up!

WHAT IS THE ROOT OF THE PROBLEM?

Accounting for fixed costs is complicated.

Absorption costing (required for financial accounting purposes) treats fixed costs as product costs.

Financial accounting information may not be the best for internal decision-making.

POTENTIAL FIX?

For internal purposes, firms can account for costs however they like. Variable costing is one such method.

Separate costs according to behavior, and account for variable costs on a per unit basis, and leave fixed costs in aggregate.

What We’ve Learned

WHAT WE’VE LEARNED IN LESSON 2-2

Challenges of accounting for fixed costs

Misleading information

Dysfunctional behavior

Customization of information according to decision

WHAT WE’VE LEARNED IN MODULE 2

The purpose of costing systems

How to differentiate the financial and managerial perspectives of costing systems

Different types of costing systems

The problems associated with accounting for fixed costs