management accounting reviewer

7/21/2019 Management Accounting Reviewer

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ACCTBA3 FINALS REVIEWER

I. CHAPTER 1: MANAGERIAL ACCOUNTING AND THE BUSINESS ENVIRONMENT

Globalization

The marketplace is becoming increasingly globalo Reductions in barriers to free trade (tariffs,

quotas, etc)o

Improvements in global transportationo

Expansion of the Interneto

Increasing sophistication in internationalmarkets

Effects of globalizationo

Greater and wider competitiono Greater access to new markets, customers and

workerso

More variety of goods and services forconsumers

The Internet and globalizationo

The internet provides companies with greateraccess to geographically dispersed customers,employees and suppliers

However, 78% of the population wasstill not connected to the Internet.

Strategy

A “game plan” that enables a company to attractcustomers by distinguishing itself from competitors

Customer Value Propositionso

Customer Intimacy Understand and respond to individual

customer needso Operational Excellence Strategy

Deliver products and services faster,more conveniently, and at lower prices

o

Product Leadership Strategy Offer higher quality products

Organizational Structure

Decentralizationo Delegation of decision-making authority

throughout an organization Can be done by giving managers the

authority to make decisions relating totheir area of responsibility

Corporate Organization Charto

Shows how responsibility is divided (chain ofcommand)

o Depicts the line and staff positions in anorganization

Line positions: directly related to theachievement of the basic objectives oan organization

Example: productionsupervisors in amanufacturing plant

Staff positions: support and assist linepositions

Example: cost accountants inthe manufacturing plant

o

Chief Financial Officer Provides timely and relevant data to

support planning and controllingactivities

Prepares financial statements foexternal users

Process Management

Business Process o A series of steps that are followed in order to

carry out some task in a business

Value Chain o Consists of the major business functions tha

add value to a company’s products and services Business functions making up the value chain

RandD

ProductDesign

Manufacturing

Marketing

Distribution

Customer

Service

Three approaches to improving business processes o

Lean Production o

Theory of Constraints o

Six Sigma

Traditional “push” manufacturing company

Lean Production o Lean thinking model

Five-step management approach

Results in a “pull” manufacturingsystem that reduces inventories and

wasted effort, decreases defects, andshortens customer response times

Board of Directors

President

Puchasing Personnel Vice President

OperationsChief Financial

Officer

Treasurer Controller

Forecast sales

Order components

Store inventoryProduce goods in

anticipation ofsales

Store inventory

Make sales fromfinished goods

inventoy

1. Identify value inspecific

products/services

2. Identify businessprocess that delivers

value

3. Organize work

arangements

4. Create a pullsystem

5. Continuouslypursue perfection

in business process



o

Lean thinking can be used to improve businessprocesses that link companies together

o Supply Chain Management Coordination of business processes

across companies to better serve endconsumers

Theory of Constraints o

Based on the observation that effectivelymanaging the constraint is the key to success

Constraint (bottleneck): anything thatprevents you from getting more of

what you want. Determined by the step that has the

smallest capacity

Six Sigma

o

Relies on customer feedback and fact-based datagathering and analysis techniques to driveprocess improvement

o Refers to a process that generates no more than3.4 defects per million opportunities

o Sometimes associated with the term zero defects . o DMAIC Framework

Stage Goals

Define Establish scope and purpose

Diagram the flow

Establish customer’s requirements Measure Gather baseline performance data

Narrow the scope of the project to the most

important problems A nalyze Identify root cause(s) of the problems Improve Develop, evaluate and implement solutions Control Ensure problems remain fixed

Seek to improve the new methods over time

IMA’s Code of Conduct for Management Accountants

IMA Guidelines for Ethical Behavioro Competence

Recognize and communicateprofessional limitations

Follow applicable laws

Provide accurate, clear, concise, andtimely decision support information

o

Confidentiality Do not disclose (and ensure

subordinates do not discloseconfidential information unless legallyobligated

Do not use confidential informationfor unethical or illegal advantage

o Integrity

Mitigate conflicts of interest and adviseothers of potential conflicts

Abstain from activities that mighdiscredit the profession

Refrain from conduct that wouldprejudice carrying out duties ethically

o Credibility Communicate information fairly Disclose delays or deficiencies Disclose all relevant information tha

could influence a user’s understandingof reports and recommendations

IMA Guidelines for Resolution of an Ethical Conflict

o

Follow employer’s established policies o For an unresolved ethical conflict:

Discuss conflict with immediatesupervisor or next highest uninvolvedmanager

If immediate is CEOconsider BoD or the audicommittee

Contact with levels above theimmediate supervisor should only bedone with the supervisor’s knowledge

Except where legally prescribedmaintain confidentiality

Clarify issues in a confidentiadiscussion with an objective advisor

Consult an attorney as to legaobligations

Why have ethical standards? o These are essential for a smooth functioning

economy o Without ethical standards will lead to a lowe

quality of life with less desirable goods andservices at higher prices

Corporate Governance

The system by which a company is directed andcontrolled

Boards of directors provide incentives and monitoringfor top management to pursue objectives ostockholders.

Enterprise Risk Management

Process used by a company to proactively identify andmanage risk

Once a company identifies its risks, specific controls maybe implemented to reduce these risks

Corporate Social Responsibility

Customer places anorder

Create productionorder

Generatecomponent

requirements

Components areordered

Production beginsas parts arrive

Goods delivered when needed

1. Identify the weakest link

2. Allow the weakest link to set

the tempo

3. Focus onimproving the weakest link

4. Recognize thatthe weakest link is

no longer so



Concept whereby organizations consider the needs of allstakeholders when making decisions

Extends beyond legal compliance to include voluntaryactions that satisfy stakeholder expectations

II. CHAPTER 2: MANAGERIAL ACCOUNTING ANDCOST CONCEPTS

Work of Management

Planning

Directing and Motivatingo

Involves managing day-to-day activities to keepthe organization running smoothly

Controllingo

Ensuring that plans are being followedo Feedback in the form of performance reports

that compare actual results with the budget arean essential part of the control function

Planning and Control Cycle

Comparison of Financial and Managerial Accounting

Financial ManagerialUsers External persons who

make financialdecisions

Managers who plan forand control anorganization

Time focus Historical perspective Future emphasis Verifiability vs. relevance

Verifiability Relevance for planningand control

Precision vs.timeliness

Precision Timeliness

Subject Focus is on the wholeorganization

Focuses on segments ofan organization

GAAP Required Not requiredRequirement Mandatory for external

reports

Optional

Manufacturing Costs (PRODUCT COSTS)

Direct Materials (Direct Cost) o Raw materials that can be conveniently traced

directly to the finished product

Direct Labor (Direct Cost) o Labor costs that can be easily traced to

individual units of product

Manufacturing Overhead (Indirect Cost) o

Cannot be traced directly to the specific unitsproduced (indirect materials and indirect labor;support)

Prime Cost = Direct Labor + Direct Material

Conversion Cost = Direct Labor + ManufacturingOverhead

Nonmanufacturing Costs (PERIOD COSTS)

Selling costso Necessary to secure the order and deliver the

product

Administrative costso

Executive, organizational and clerical costs

Income Statement

Format for Merchandising

Format for Manufacturing

Schedule of Cost of Goods Manufactured

Cost Behavior

How a cost will react to changes in the level of activity within the relevant range

Identifyalternatives

Selectalternative

Developbudgets to

guideprogress

Formulatinglong- and short-

term plans

Implementingplans

Measuringperformance

Comparing actual toplanned

performance

DecisionMaking



Variable Costs vs. Fixed CostsBehavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable costchanges as activity level

changes

Variable cost per unitremains the same over wide ranges of activity

Fixed Total fixed costremains the same even

when activity levelchanges

Average fixed cost perunit goes down as

activity level goes up

Differential Cost and Revenue

Costs and revenues that differ among alternatives

Opportunity Cost

Potential benefit that is given up when one alternative isselected over another

Sunk Costs

Costs that have already been incurred and cannot bechanged now or in the future

These costs should be ignored when making decisions

Summary of the Types of Cost Classifications

Financial reporting

Predicting cost behavior (variable/fixed)

Assigning costs to cost objects (direct/indirect)

Making business decisions

III. CHAPTER 3: SYSTEMS DESIGN: JOB-ORDERCOSTING

Types of Product Costing Systems

Process Costingo

Production of many units of a single,

homogenous producto

The identical nature of each unit of productenables assigning the same average cost per unit

o Basic formula for process costing:

Job-Order Costingo

Usually used in service-oriented industrieso

Many different products are produced eachperiod

o Manufactured to ordero

The unique nature of each order requires tracing

or allocating costs to each job, and maintainingcost records for each job.

Comparison Job-Order Process

Number of jobs worked Many Single ProductCost accumulated by Job Department

Average cost computed by Job Department

Job Order Costing Overview

Direct materials and direct labor costs are charged to eachjob as work is performed

Manufacturing overhead, including indirect materials andindirect labor, are allocated rather than directly traced toeach job

Job Cost Sheet

Applying Manufacturing Overhead

An allocation base (a measure such as direct labor-houror machine-hours that is used to assign overhead costs toproducts and services) is used because:

o

It is impossible/difficult to trace overhead costto particular jobs

o

Manufacturing overhead consists of manydifferent items

o Many times of manufacturing overhead costs arefixed in spite of output fluctuation

Predetermined overhead rateo Determined before the period beginso

Enables estimation of total job costs sooner, asactual overhead is not known until the end ofthe period

o Formula:

Applied Manufacturing Overhead

Note: we use Applied MOH for the COGM schedule.

Manufacturing

Overhead

Direct Labor

Direct Materials Job 1

Job 2

Job 3



Job-Order Costing Document Flow Summary

*Note: Indirect materials and indirect labor are first included in themanufacturing overhead account before the job cost sheet

Flow of Costs and Applying Manufacturing Overhead

T-account format ; Journal Entries

Raw MaterialsMaterialPurchases

DMIM

Work In Process(Job Cost Sheet)DMDLOverhead

Applied

Salaries and WagesPayable

DLIL

Mfg. Overhead Actual Applied

IMILOthers

OHapplied to

WIP

Accounting for Nonmanufacturing Cost

These costs are not assigned to individual jobs, ratherthey are expensed in the period incurred.

Debit expense, credit asset/liability

Transferring Completed Units

T-account format ; Journal Entries Work In Process(Job Cost Sheet)

DMDLOverhead

Applied

COGM

Finished GoodsCOGM COGS

Cost of Goods SoldCOGS

Overhead Application Problems

Underapplied overheado Actual MOH > Applied MOH

Overapplied overheado Actual MOH < Applied MOH

Allocation of under/overapplied OH

If MOH is: ALTERNATIVE 1Close to COGS

ALTERNATIVE 2 Allocation

Underapplied

Increase

COGS

Increase

WIPFinished GoodsCOGS

OveappliedDecrease

COGS

Decrease WIP

Finished GoodsCOGS

New format used for COGM and COGS!

Sales OrderProduction

OrderMaterials

requisitionform*

Employeetime ticket*

ProductionOrder

Job costsheet



IV. CHAPTER 5: COST BEHAVIOR: ANALYSIS ANDUSE

Variable Costs

Cost drivero A measure of what causes the incurrence of a

variable cost Units produced Machine hours Labor hours Miles driven, etc.

Examples of variable costs

Merchandising ManufacturingMerchandising

AndManufacturing

Service

>Cost of

goods sold

>Direct

materials>Direct labor>Variableoverhead

>Commissions

>Shippingcosts>Clerical costs

>Supply

>Travel>Clerical

True variable costo Total variable cost is directly proportional to the

activity levelo Variable cost per unit is constant

Step-variable costo

Cost of a resource that is obtained in largechunks and that increases or decreases only in

response to fairly wide changes in activity

The Linearity Assumption and the Relevant Range

Fixed Costs

A cost whose total dollar amount remains constant as theactivity level changes

Average fixed cost per unit decrease as the activity leve

increases

Types of fixed costso

Committed: long-term, cannot be significantlyreduced in the short term

Depreciation, real estate taxeso Discretionary: may be altered in the short-term

by current managerial decisions Advertising, research and development

Fixed Costs and the Relevant Rangeo

The relevant range of activity for a fixed cost isthe range of activity over which the graph of thecost is flat

o Concludes that discretionary and committedfixed costs are really just step-variable costs

In the long run, almost all costs can beadjusted

o

Difference with step-variable costs Step-variable costs can often be

adjusted quickly as conditions change

Activity Level Activity Level

TotalCost

CostPerUnit

Activity Level

Cost

Small changes in production are unlikely tohave any effect on the number of workersemployed

Only wide changes in activitylevel will cause a change inthe number of workersemployed

We assume a strictlylinear relationship

between cost and volume Relevant Range

o

Range of activity within which theassumptions arereasonably valid

Activity Level Activity Level

TotalCost

CostPerUnit



Relevant

Range

Width of the steps in step-variablecosts is much narrower

Summary of Cost Behavior Patterns

Cost In Total Per Unit

Variable Total variable cost is

proportional to theactivity level within the

relevant range

Variable cost per unitremains the same over

ranges of activity

Fixed Total fixed costs remainthe same even when the

activity level changes within the relevant range

Average fixed costs perunit decrease as the

activity level increases

Mixed Costs (semivariable costs)

Contains both variable and fixed cost elements Can be expressed as an equation

o Y = total mixed costo a = Total fixed costo b = Variable cost per unit of activity (slope)

Can be obtained with the formula:

o

X = The level of activity

Analysis of Mixed Costso

Account analysis Each account is classified as either

variable or fixed based on the analyst’sknowledge of how the account behaves

o

Engineering approach Classifies costs based upon an

industrial engineer’s evaluation ofproduct methods, and material, laborand overhead requirements

High-Low Methodo Steps:

Find b (variable cost per unit) with theformula:

Find a (fixed cost) with the (derived)formula:

Use both the “highs” and“lows” to ensure that the

value of a is constant Substitute the values of b and a in the

general formula

Least-Squares Regression Methodo Method used to analyze mixed costs if a

scattergraph plot reveals an approximately linearelationship between X and Y variables

o

Uses all of the data points to estimate the fixedand variable cost components of a mixed cost

o Provides a statistic called R 2, which is a measureof the goodness of fit of the regression line tothe data points.

o

Goal: to fit a straight line to the data thaminimizes the sum of the squared errors

Contribution Format

The contribution margin format emphasizes cosbehavior. Contribution margin covers fixed costs andprovides for income.

Used primarily by management

Volume

Cost

Activity Level

TotalCost

Intercept = totalfixed cost

Mixed CostSlope = variablecost/unit

Fixed cost element

Variable cost element



V. COST-VOLUME-PROFIT RELATIONSHIPS

CVP Relationships in Equation Form

Profit formula

Unit CM formula

CVP Graph

Contribution Margin Ratio

Application

Variable Expense Ratio

Formula

Application

Break-Even Analysis

Target Profit

Margin of Safety The excess of budgeted (or actual) sales over the break

even volume of sales

Fixed expense



Cost Structure and Profit Stability

Cost structure refers to the relative proportion of fixedand variable costs in an organization.High fixed cost (or low variable cost) structures

Advantage Disadvantage

> Income will be higher ingood years compared tocompanies with lowerproportion of fixed costs

> Income will be lower in badyears compared to companies

with lower proportion of fixedcosts

Companies with low fixed cost structures enjoy greaterstability in income across good and bad years.

Operating Leverage

Measure of how sensitive net operating income is topercentage changes in sales

Concept of Sales Mix

Sales mix – the relative proportion in which a company’sproducts are sold

Different products = different selling prices, coststructures and contribution margin

Key Assumptions of CVP Analysis

Selling price is constant

Costs are linear and can be accurately divided into variable (constant per unit) and fixed (constant in total)elements

In multiproduct companies, the sales mix is constant.

In manufacturing companies, inventories do not change.

VI. CHAPTER 11: STANDARD COSTS AND OPERATINGPERFORMANCE MEASURES

Standard Costs Standards: benchmarks or “norms” for measuring

performanceo

Quantity standards: specify how much of aninput should be used to make a product orprovide a service

o

Price standards: specify how much should bepaid for each unit of input

Management by exception: practice in which deviationsfrom standards deemed significant are brought to theattention of management

Variance Analysis Cycle

Setting Standard Costs

Accountants, engineers, purchasing agents, andproduction managers combine efforts to set standardsthat encourage efficient future operations

Setting Direct Material Standards

Price Standards: final, delivered cost of materials, net ofdiscounts

Quantity Standards: summarized in a Bill of Materials

Setting Direct Labor Standards

Rate Standards: often a single rate is used that reflects themix of wages earned

Time standards: use time and motion studies for eachlabor operation

Setting Manufacturing Overhead Standards

Rate Standards: the rate is the variable portion of thepredetermined overhead rate

Quantity Standards: the quantity is the activity in theallocation base for predetermined overhead

Standard Cost Card

Price and Quantity Standards

Determined separately for the following reasons:o The purchasing manager is responsible for raw

material purchase prices; the production

manager is responsible for the quantity of rawmaterials used

o Buying and using activities occur at differentimes. Raw material purchases may be held ininventory for a period of time before using.

General Model for Variance Analysis

1. Prepare standardcost performance

report

2. Analyze variances

3. Identifyquestions

4. Receiveexplanations

5. Take correctiveactions

6. Conduct nextperiod's

operations

Variance Analysis

Price Variance

Differencebetween

actual priceand

standardprice

Materials PV

Labor RatePV

VOH Rate variance

Quantity Variance

Differencebetweenactual

quantity andstandardquantity

Materials QV

Labor efficiency variance

VOH efficiency variance

A A x B

Standard Standard Standard

Quantity Price Cost

Inputs or Hours or Rate per Unit

Direct materials 3.0 lbs. 4.00$ per lb. 12.00$

Direct labor 2.5 hours 14.00 per hour 35.00

Variable mfg. overhead 2.5 hours 3.00 per hour 7.50

Total standard unit cost 54.50$

B



FORMULAS (Shortcut, as taught by Sir Drex )

Responsibility for Material Variance

Materials Quantity Variance: Production Manager

Materials Price Variance: Purchasing Managero The standard price is used to compute the

quantity variance so that the productionmanager is not held responsible for thepurchasing manager’s performance

Responsibility for Labor Variances Production managers are usually held accountable, for

they can influence:o

Mix of skill levels assigned to work taskso Level of employee motivationo Quality of production supervisiono Quality of training provided to employees

Variance Analysis and Management by Exception

Larger variances are investigated first

Plotting variance analysis data on a statistical control chartis helpful in investigation decisions

Advantages of Standard Costs

Management by exception Promotes economy and efficiency

Enhances responsibility accounting

Simplified bookkeeping

Potential Problems with Standard Costs

Emphasizing standards may exclude other importantobjectives

Standard cost reports may not be timely

Invalid assumptions about the relationship between laborcost and output

Favorable variances may be misinterpreted

Emphasis on negative may impact morale

Continuous improvement may be more important thanmeeting standards

Examples

Standard example

In which materials purchased ≠ materials used



Backtracking

VII. CHAPTER 12: SEGMENT REPORTINGDECENTRALIZATION AND THE BALANCEDSCORECARD

Decentralization

Benefitso

Top management can concentrate on strategyo Lower-level managers gain experience in

decision-makingo

Decision-making authority leads to job

satisfactiono

Lower-level decisions often based on betterinformation

o Lower level managers can respond quickly tocustomers

Disadvantageso May be a lack of coordination among

autonomous managerso

Lower-level managers may make decisions without seeing the “big picture”

o Lower-level manager’s objective may not bethose of the organization

o May be difficult to spread innovative ideas in the

organization

Responsibility Center

Cost Centero

Segment whose manager has control over costsbut not over revenues or investment funds

Profit centero

Segment whose manage has control over bothcosts and revenues, but not investment funds

Investment centero

Segment whose manager has control over costsrevenues, and investments in operating assets

Decentralization and Segment Reporting Segment: any part or activity of an organization about

which manager seeks cost, revenue or profit data

Segmented Income Statements

Two keys to building:o Contribution format should be used because i

separates fixed from variable costs, and enablescalculation of contribution margin

o

Traceable fixed costs should be separated fromcommon fixed costs to enable the calculation ofa segment margin

o Common costs should not be allocated to thedivisions, as these would remain even if one othe divisions were eliminated



Identifying Traceable Fixed Costs Traceable costs arise because of the existence of a

particular segment and would disappear over time if thesegment itself disappeared.

Common costs arise because of the overall operation ofthe company, and would not disappear if any particularsegment were eliminated.

Segment Margin

Computed by subtracting the traceable fixed costs fromits contribution margin

Best gauge of the long-run profitability of a segment

Return on Investment Measures net operating income earned relative to the

investment in average operating assets

Formulas

Increasing ROIo

Increase saleso

Reduce expenseso Reduce assets

Net book value: used by most companies to calculateaverage operating assets

Residual Income

Another measure of performance

Measures net operating income earned less the minimum

required return on average operating assets Encourages managers to make profitable investments that

would be rejected by managers using ROI

Disadvantage: Cannot be used to compare theperformance of divisions of different sizes

Formula

Examples

Standard

Backtracking

Income Statement

Company Television Computer

Sales 500,000$ 300,000$ 200,000$

Variable costs 230,000 150,000 80,000

CM 270,000 150,000 120,000

Traceable FC 170,000 90,000 80,000

Division margin 100,000 60,000$ 40,000$

Common costs 25,000

Net operating

income 75,000$



With Analysis

VIII. APPENDIX 12-A – TRANSFER PRICING

Key Concepts

Transfer price: price charged when one segment of acompany provides goods or services to another segment

Objective: motivate managers to act in the best interests

of the overall company Three approaches

o

Negotiated transfer priceso

Transfers at the cost to the selling divisiono Transfers at market price

Negotiated Transfer Prices

Results from discussions between the selling and buyingdivisions

Advantages:o Preserve the autonomy of divisions – consistent

with decentralizationo Managers are likely to have better information

about potential costs and benefits

Range of Acceptable Transfer Priceso Upper limit: buying divisiono

Lower limit: selling division

Formulas (Sir Drex’s formulas )o

Selling Division (Lower limit, LL )

o Buying Division (Upper limit, UL )

Evaluationo If an intracompany would result in higher

profits, there is always a range of transfer price within which both the selling and buyingdivisions would have higher profits should theyagree to the transfer

o If managers are pitted against each other ratherthan against their past performances, a nocooperative atmosphere is almost guaranteed

o

Given disputes that accompany the negotiation

process, most rely on other means of settingtransfer prices.

Transfers at the Cost to the Selling Division

Many companies set transfer prices at either the variablecost or full (absorption) cost incurred by the sellingdivision

Drawbackso Using full cost can lead to suboptimizationo Selling division will never show a profit on any

internal transfero

Cost-based transfer prices do not provideincentives to control costs

Transfers at Market Price

Market price (price charged for an item on the openmarket) : often regarded as the best approach to thetransfer pricing problem

Works best when the product or service is sold in itpresent for to outside customers and the selling divisionhas no idle capacity

Does not work well when the selling division has idlecapacity

Divisional Autonomy and Suboptimization

Managers should be granted autonomy to set transfe

prices and decide whether to sell internally or externallyeven if it may result in suboptimal decisions



Example

IX. CHAPTER 13: RELEVANT COSTS FOR DECISION

MAKING

Relevant Cost: cost that differs between alternatives

Types of relevant costso Avoidable costs

Types of irrelevant costso

Unavoidable costso

Sunk costso Future costs that do not differ between

alternatives

Costs that are relevant in one situation may not berelevant in another context. The manager must examine

the data at hand and isolate the relevant costs in eachsituation.

Relevant Cost Analysis

Step 1: Eliminate costs and benefits that do not diffebetween alternatives

Step 2: Use the remaining costs (avoidable costs) andbenefits to make a decision.

Total and Differential Cost Approaches

Only rarely will enough information be available toprepare detailed income statements for both alternatives

Mingling irrelevant costs with relevant costs may causeconfusion and distract attention from critical information

“General Formula” for Differential Cost

Adding or Dropping Segments

Formula

Make or Buy Analysis

When a company is involved in more than one activity inthe entire value chain, it is vertically integrated

o Advantages Smoother flow of parts and materials Better quality control Realize profits

o

Disadvantage Companies may fail to take advantage

of supplies who can create economiesof scale advantage by pooling demand

A company must be careful to retaincontrol over activities that are essentia

to maintaining its competitive position Formula

Whichever is lower should be accepted.

Opportunity Cost: benefit that is forgone as a result ofpursuing some course of action

o

Not actual cash outlays and not recorded in theformal accounts of an organization

Special Orders Special Order: one-time order that is not considered par

of the company’s normal ongoing business

Only incremental costs and benefits are relevant

Since manufacturing overhead costs would not beaffected by the order, they are not relevant.

Formula



Examples

Dropping Segments Make or Buy Analysis

Special Orders



Total Cost

Differential Cost

Constrained Resources

Constraint: limited resource of some type restricts acompany’s ability to satisfy demand

Bottleneck: machine or process that limits overall output Utilization

o Fixed costs are usually unaffected, so theproduct mix that maximizes the company’s totalcontribution margin should be selected

o A company should not necessarily promotethose products with highest unit CM

o Total CM will be maximized by promotingproducts or accepting orders that provide thehighest CM in relation to the constraint

General formula

Several Methods on Managing Constraints

Working overtime on the bottleneck

Subcontracting some of the processing

Investing in additional machines

Shifting workers to the bottleneck

Focusing business process improvement efforts on thebottleneck

Reducing defective units processed

Joint Costs

Two or more products produced from a common input

Traditionally allocated among different products at thesplit-off point

o Split-off point: point in the manufacturingprocess where each joint product can berecognized as a separate product

o

Typical approach: allocated joint costs accordingto relative sales value of the end products

Can be dangerous for decision making

Sell or Process Further

Joint costs are considered irrelevant here

It is profitable to continue processing a joint producafter the split-off point so long as the incrementarevenue from such processing exceeds the incrementaprocessing costs incurred after the split-off point

General formula

If there is profit, process further. If loss, sell at split-ofpoint.

Examples

Managing Constraints

Decrease in direct labor costs (5,000 units @ $3 per unit) 15,000$

Increase in fixed rental expenses (3,000)

Ne t annua l cost saving from renting the new machine 12,000$

Net Advantage to Renting the New Machine

Current

Situation

Situation

With New

Machine

Differential

Costs and

Benefits

Sales (5,000 units @ $40 per unit) 200,000$ 200,000$ -

Less variable expenses:

Di rect materials (5,000 uni ts @ $14 per unit) 70,000 70,000 -

Direct labor (5,000 units @ $8 and $5 per unit) 40,000 25,000 15,000

Variable overhead (5,000 units @ $2 per unit) 10,000 10,000 -

Total variable expenses 120,000 105,000 -

Contribution margin 80,000 95,000 15,000

Less fixed e xpense:

Other 62,000 62,000 -

Rent on new machine - 3,000 (3,000) Total fixed expenses 62,000 65,000 (3,000)

Net operating income 18,000$ 30,000$ 12,000



Sell or Process Further

o

In this case, the lumber should be processedfurther and the sawdust should be sold at split-off point.

REMINDERS:

Do not forget to bring the ff:o

CALCULATORo

Rulero

Assignment notebook

Please don’t rely on this reviewer alone! This is just asummarized version of the PPTs STUDY WELL! Andbest of luck!

Analysis of Sell or Process Further

Per Log

Lumber Sawdust

Sales value after further processing 270$ 50$

Sales value at the split-off point 140 40

Incremental revenue 130 10

Cost of further processing 50 20 Profit (loss) from further processing 80$ (10)$

Per Log

Lumber Sawdust

Sales value at the split-off point 140$ 40$

Sales value after further processing 270 50

Allocated joint product costs 176 24

Cost of further processing 50 20

management accounting reviewer

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