Manufacturing Costs and Allocation

• Barry Roberts is the new plant manager at Jackson Gears
• Roberts was hired to improve company operations and cut costs.
• Roberts wants insight into Jackson Gears' costing terminology

Higher Transportation Costs

• Many manufacturing companies moved production overseas for lower manufacturing costs.
• Due to higher transportation costs, increased prices, and higher wages in other countries, companies are moving production back to the U.S.
• Claude Hayes (DESA LLC president, retail heating division) reports shipping costs increased 15% since January to $5,300, with expected increases to $5,600
• DESA LLC moved most of its production from China to Bowling Green, Kentucky

Cost Accounting Systems

• These systems help managers make informed decisions.
• Managers must comprehend the cost terms used inside their organizations.
• Cost accounting systems can differ depending on the business and its consumers.
• Managers must know how financial statements show information. The impact of managerial choices are reflected in published financial statements

What is Cost?

• Cost represents a sacrifice of resources.
• It is measured by the price of an item that one gives up to acquire it, which can be paid in cash or credit.

Costs vs Expenses

• Expense is a cost charged against revenue, therefore, expenses are deducted from revenue
• Costs happen when resources are sacrificed, regardless of accounting.
• Costs recorded as assets become expenses when consumed, which would only be applied to external financial reports.
• Managers must be aware of outlay costs and opportunity costs

Outlay Costs

• Represent past, present, or future cash outflows.
• For example, these include tuition, books, and fees for higher education

Opportunity costs

• Missed benefits come from using resources in their next best alternative.
• For example, forgone income to attend college.

Examples of Opportunity Costs

• Forgone interest comes from a bank certificate of deposit
• Forgone income comes from spending spring break in Mexico
• Forgone pleasure comes from taking a temporary job during spring break
• Of course, no one can ever know all possible opportunities at any moment
• Accounting systems mainly track outlay costs, leading to missed opportunity costs

Financial statements

• These are the statements that summarize the financial transactions of businesses
• They are not always helpful for managing businesses.
• Cost and financial accounting serve different purposes, but they are not completely separate.
• External financial statements use data from the cost accounting system.
• Cost accounting tracks the organization's use of resources.
• A chapter summary highlights key cost concepts for review

Operating Profit

• This is the excess of operating revenues over related costs.
• It differs from net income; the operating profit balances interest, income taxes, extraordinary items, and GAAP regulations

Income Statements

• These statements can be prepared for firms, divisions, or products
• It is important to seek the "best" information and understanding of this data, while recognizing the cost of preparing useful information.
• Basic statements are improved with better detail for more informative purposes.
• The generic income statement summarizes both revenues and the costs of a unit.
• The basic form of the income statement is standard, however, cost details vary.

Service organizations

• These organizations provide intangible products such as information services
• Labor costs are normally the most important because managers need information to properly manage their time.

Cost of Service Sold

• This includes billable hours and costs of items that are billed to clients

Retail and Wholesale organizations

• They sell goods, but dont necessarily make them.
• Income statements include revenue and a cost of goods sold category which are the cost of goods they buy.
• Example expenses include paper products and computer accessories

Cost of goods sold statement

• Beginning inventory represents the cost of salable items at the start of the year.
• Total costs for purchases includes transportation costs
• Total Cost of goods shows how much cost has been put into the creation of each product

Cost of Goods Available for Sale

• This is a firm’s total saleable amount

• The cost of goods helps firms to get their products into the market, or be otherwise available for sale.

• Managers realize an average for every dollar helps to cover administrative costs.

• Cost of goods only counts costs paid for the good sold, and excludes salaries for marketing or administrative costs

Manufacturing Companies

• They have more complex income statements for financial reporting
• Financial accounting usually has retail firms as examples.
• This is due to the focus being on the process of preparing and presenting statements.
• Retail units are known because it was purchased from a third party.
• It must also know costs associated with making them.

Product Costs

• Costs assigned to units of production expensed when sold

Period Costs

• Nonmanufacturing costs expensed when incurred

Direct Manufacturing Costs

• Costs identified with units or batches at low cost.

Indirect Manufacturing Costs

• All product costs except direct costs

Product Cost categories

• Direct materials, direct labor, manufacturing overhead

Direct Materials

• Feasibly identified directly at low cost
• For example, purchased parts
• These are items that make up direct materials
  • Raw/indirect

Direct labor

• Labor that is identified directly at a reasonable cost
• Direct laborers convert raw materials into finished products.

Manufacturing Overhead

• All other transformation costs
  • Indirect labor: Supervisors/maintenance
  • Indirect materials: Lubricants/cleaning
  • Other manufacturing costs: Depreciation/taxes/insurance/utilities

Synonyms for manufacturing overhead

• These are other words with similar meaning
  • Factory burden
  • Factory overhead
  • Burden
  • Factory Expense
  • Overhead

Prime costs

• Direct costs namely direct materials and labor
• In some companies, this is 80-90% of costs

Conversion Costs

• Converts direct materials to final product: direct labor and manufacturing overhead

Nonmanufacturing Costs

• Marketing costs: Obtain customer orders/provide products: advertising/sales/shipping
• Administrative costs: Manage organization/provide support: executive salaries/data processing/legal

Cost Allocation

• This is the method devised for assigning a share of the costs to each user
• This process assigns costs and discuss it in more detail throughout the book.
• First, it needs some definitions.

Key Terms:

• Cost object: End to which a cost is assigned: unit of product/service/department/customer
• Managers make decisions at the level of the cost object
• Cost pool: A cost to assign to the cost objects: department/rental/travel
• Cost allocation rule: assigns a cost pool to a cost object

Cost flow diagram

• This is a diagram or flowchart that illustrated the cost allocation

Cost Categories

• These are based on how it flows through the system based on if a cost is direct or indirect

Direct Cost

• Unambiguously related to a cost object at reasonable cost

Indirect Cost

• Cost that cannot be directly related to a cost object
• Should quickly identify Direct/Indirect with what cost

Steps of Manufacturing Cost Flow

• Three steps: metal is delivered, metal is transported to an assembly line, and the gear is completed and ready
• There are typically four or even five steps

Cost Accounting System

• Three stages that each have unique inventory accounts that map to physical flows
  • Direct Materials Inventory
  • Work-in-Process Inventory
  • Finished Goods Inventory

Inventory Accounts

• Account is likely to have a beginning inventory amount, additions/withdrawals during the period, ending inventory is based on what remains.
• Costs added to inventory accounts are called inventoriable costs.

Production process

• This process is carried-out using Jackson Gears' process flow.
• Metal arrives --> checked by the department to assure quality
• JIT: Metals, plastics are transferred to machining line immediately if JIT
• Not JIT: Metal/plastic transferred to materials warehouse until needed
• Direct material inventory if not yet transferred to a manufacturing department
• Machines create parts --> creates transformations --> gears are cut
• Not complete part of Work-In-Progress inventory
• Gears inspected/moved to holding while awaiting shipment
• Products finished/not sold included in Finished Goods Inventory.

Cost Flow example

• This will numerically determine how to report Jackson Gears' revenues & costs
• Income statement: Jackson Gears, $20.45MM in revenue, $13.1MM cost of goods sold, $3.85MM in administrative costs

Components of costs of manufactured good?

• Demonstrate how derive the cost of good amount
• Jackson Gears uses the cost of goods manufactured and sold stated on a company's activities
• The amounts can be easily traces with the example.

Direct materials

• Total direct materials
• Total cost of work in process is the labor and costs divided by labor force. Inventory and machine usage.

Finished Goods Inventory

• Has amount completed for production
• Finished inventory had the original inventory sold, plus whats available.

Cost Of Goods Manufactured And Sold Statement

• The cost of goods manufactured an sold statemen is frequently used in an internal repoorting system
• Not published externally
• They show how things are calculated

Cost Behavior Overview

• Concerned with behaviors & how costs are analyzed for decisions.
• Managerial decisions create (or destroy) value in an org
• This helps determine activities that occur in a business

Cost Driver Overview

• The basic idea is cost behavior

• Factors causes, or “drives” that influence costs. Lumber (Activity) and Board feet, Square Feet (Cost Driver)

• Need to know behavior for decision making, performance, evaluation and planning

• Classification: fixed, variable, semivariable/step, next

Variable vs Fixed

• An operations manager, at United: How much lower if flights reduced
• Manager at US Post Office: how much if saturday deliveries eliminated
• B-School Dean: How much costs if increase class increased.

Fixed Costs

• Total costs, at which one can stay the same
• Costs that do not change and dont directly propotion to the volume of ativity.
• These include non-changeable salaries

Variable costs

• Change with activity at which volume changes

Activity

If activity is producing units, variable manufacturing costs typically:

• Direct materials
• certain manufacturing overhead
• Direct labor in case of temporary workers.

Non-manufacturing overhead

• Distribution
• Sales commissions

Activity-based costs

• Volume is placed on the horizontal axis, and the total cost on the vertical axis.
• Total variable costs directly to changes in volume. item b --> level, does not increase

The Relevant Range

• The relevant range is valid only in a certain range of activity.
• The range in which total fixed costs and unit variable costs do not change.
• The identification of total/unit variable costs is valid inside relevant range.

Example of an exception

• An exception could be a Utility cost - the costs are semivariable.
• Volume increases with steps that can be referred to as step costs
• A semivariable cost has the aspects of both those costs

Cost behavior classifications

• Classifications will depend on measure used.

Cost Data

• Eastern Transmissions requests a modification and price quot
• Jessica Martinez preps some basic data for sandy ventura to determine some costs regarding direct materials
• All these combined make the direct labor costs

Semivariable costs

• For example, in a machine, they can work to almost perfection, to certain number.
• the same for the amount to the labor amount that it will cost.

Component of Product Costs

• Now we will have cost of certain system.

Cost Categories

• Some determined by financial accounting rules
• Managerial decision making is more useful in others

Full Cost

• Total costs of manufacturing and selling
• Unit of production to sell

Full-Absorpotion Cost

• GAAP amount of inventoriable cost
• Full absorption means manufacturing fixed and variable costs

Exhibit 2.11 includes unit fixed costs only at one volume or for Jackson Gears, The Volume is 2000

• Fixed costs total and does not change with volume.
• change in volume = a change in unit fixed cost.

Misleading decision making

• Costs has been recorded as only vol.

• Fixed costs have been allocated.

• When allocating fixed costs to each unit, the records give impression of the cost when thats all thats left.

• Example - allocating some of factory rent to each unit results in rent or "unit cost"

• Cost has many effects and not simple!

Marketing Managers

• Manager believed should be accepted long as unit price exceeds man.
• Marketing manager decided to do something to earn the inventory.

Income Statement analysis

• 2.12 and 2.13-
• Revenue, minus COGS = gross, we recall
• Cost of goods = full absorption
• Exhibis 2.12 and 2.13 are designed to clarify definitions gross contribution = operating profit
• per unit = fixed.

Self-Study Question

What are examples of changes and their impacts

• Exhibit 2.13 Shows the contribution margin per unit that can effect the costs based on how what happens. -contribution margin - fixed.
• the change.

Marketing managers are aware of products with greater margin, and if changes are worth it

• They analyze a bunch of different aspects before they fully commit too the product.
• Marketing managers analyze a bunch of products for more clarity

How to Make Cost Information More Useful for Managers

As discussed earlier, cost accountants divide costs into product or period categories.

Different approaches

• Full absorption costing fixed. Under the approach, all fixed costs are accounted for here.
• Variable costing income . With this only variable factors , all other costs period

Explore indirect vs direct manufacturing costs. Learn about allocation methods like revenue-based allocation. Discover the challenges of allocating central IS costs.