Core 2 - Unit 1 Management Accounting PDF

Core 2 - Unit 1 Management Accounting: uates and applies cost management techniques appropriate for specific costing decisions Learning outcomes: Differentiate between product costs and period costs incurred by a manufacturing business. Describe fixed, variable, and mixed costs in the manufactur...

Core 2 - Unit 1 Management Accounting: uates and applies cost management techniques appropriate for specific costing decisions Learning outcomes: Differentiate between product costs and period costs incurred by a manufacturing business. Describe fixed, variable, and mixed costs in the manufacturing process. Explain how the relevant range of costs affects cost behaviour. 5.1 Types of costs in a manufacturing system 5.1.1 Product costs Product costs, which were defined as all costs associated with the purchase or production of a good, form the cost of inventory, and include direct labour, direct materials, and an allocated amount for manufacturing overhead. uates and applies cost management techniques appropriate for specific costing decisions Learning outcomes: Differentiate between product costs and period costs incurred by a manufacturing business. Describe fixed, variable, and mixed costs in the manufacturing process. Explain how the relevant range of costs affects cost behaviour. 5.1 Types of costs in a manufacturing system 5.1.1 Product costs Product costs, which were defined as all costs associated with the purchase or production of a good, form the cost of inventory, and include direct labour, direct materials, and an allocated amount for manufacturing overhead..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses..1.1.2 Conversion costs Accountants refer to all manufacturing costs other than direct materials costs as conversion costs, because these costs are required to transform direct materials into the final product. Conversion costs include direct labour costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs. Figure 5c: Conversion costs Note that direct labour is both a prime cost and a conversion cost. These classifications are not mutually exclusive, but rather a way to refer to groupings of costs. Direct labour is a prime cost because it is a direct cost that is easily tied to a product. Direct labour is also a conversion cost because it is a cost of converting the raw materials into the finished good. 5.1.2 Period costs Period costs are costs that accountants (financial or management) do not count as product costs. Financial accountants treat all non-manufacturing costs, such as selling, administrative, and research and development costs, as period costs. Therefore, inventory costs consist only of manufacturing costs, and never include period costs. Period costs are expensed as incurred. Management accountants have some flexibility when classifying costs, and where possible, they attempt to allocate costs using the cost drivers and tracing costs to the cost object in a way that will assist in assessing those costs when making decisions. For example, a management accountant might treat advertising designed to promote a company’s name as a period cost but treat advertising designed to promote a specific product as a product cost. Period costs can be referred to by other terms, such as non-manufacturing costs, upstream or downstream costs, or operating expenses. 8.4 Spoilage in a job costing system When goods are produced, not all direct materials end up as finished goods. It may be that a good being produced is defective, the material purchased needs to be trimmed and so there is waste, or the set up for each new job creates waste until the process is calibrated correctly. This is referred to as spoilage, which must be accounted for in a job costing system, either as an additional cost of jobs or as a separate cost (process). The treatment depends on whether spoilage is classified as normal spoilage or abnormal spoilage. Normal spoilage occurs as a regular part of operations and is difficult to avoid. Consider a burrito manufacturer that uses fresh tomatoes in its recipes. A small number of tomatoes will be spoiled and unusable because they are being transported fresh, which the manufacturer understands and considers a normal part of producing burritos. Accordingly, the cost of normal spoilage is viewed as part of OH, even when the amount of spoilage is significant. However, with that being said, when assigning costs, job costing systems generally distinguish normal spoilage attributable to a specific job from normal spoilage common to all jobs. Abnormal spoilage occurs under atypical and abnormal circumstances. Consider the burrito manufacturer from above that had a new employee improperly freeze one batch of burritos. This is not normal or expected, and occurred because of an error. If abnormal spoilage occurs, then the cost should be removed from inventory and recorded as a period expense. It will then be highlighted for further analysis, with the ultimate goal of preventing it from occurring again the future. If abnormal spoilage arises from problems that are unique to a particular job, then the cost is part of the job cost. Normal spoilage Charge to OH Spoilage cost is removed from WIP inventory and assigned to a relevant manufacturing OH cost control account Increases the cost of all jobs and units  Attention is not drawn to the cost; does not encourage quality improvements Ignores opportunity costs of spoilage Normal spoilage specific to a particular job Cost remains in the specific job and not charged to OH Increases the cost of the specific job impact and provides more reliable figures Draws attention to the cost; encourages investigation and quality improvements Ignores the opportunity cost of spoilage Abnormal spoilage Abnormal spoilage Charge to the period Spoilage cost is removed from WIP inventory and assigned to a loss account Draws attention to the cost; encourages investigation and quality improvements Ignores opportunity costs of spoilage specific to a particular job Charge to the job Spoilage cost remains in WIP inventory for the job If desired, allocate the cost across good units for the job Attention might or might not be drawn to the cost Ignores opportunity costs of spoilag 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 9.1 Introduction to cost-volume-profit analysis Cost-volume-profit (CVP) analysis is a tool that assists managers in understanding the relationship between revenues and costs and the effect of a change in either of these variables on profit. Through isolating specific variables (price, volume, variable costs per unit, fixed costs, and product mix), management accountants can understand how profit moves in relation to a change in any of these items. With the assistance of effective CVP analysis, managers can then make decisions regarding what product or mix of products to produce and what selling price and cost structure to use. CVP analysis can be used in many areas, including the following: determining a break-even point establishing a target profit estimating the impact on profit as variables change While CVP is a useful tool, it is important that management is mindful of the assumptions that are involved in using CVP. These will be addressed in Section 9.1.2. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. 0.1 How do managers make decisions? Managers make decisions in an organization every day, as the process of decision-making facilitates the main functions of management discussed in the Management Accounting Today chapter. Not all decisions are the same; some decisions must be made quickly and without extensive planning, while other decisions are made over a very long period of time, using research, collaboration, and evidence. Short-term decisions are those that address temporary situations or the immediate needs of an organization. Long-term decisions are those that address more permanent situations and attempt to meet the strategic goals of an organization. For a management accountant, distinguishing between short-and long-term decisions is important, as they are fundamentally different types of decisions and require different analyses, with different relevant costs. Consider the decision to accept a one-time special order from a new customer. In the short term, the organization must consider its capacity because it only has so many labour hours, machine hours, direct materials, and so on. However, in the long term, the organization has the ability to increase its capacity and thus allow it to take additional special orders. e outsourcing decision (also called a make-or-buy decision) considers whether an organization should make an intermediate good or service or purchase it from an outside supplier. This decision is influenced by cost as well as by qualitative factors such as the required level of quality, the predictability of delivery, and the degree of integration required. In the event that an organization has sufficient capacity, expertise, and a reliable supply of material and labour, it is reasonable that, with costs being the same, the organization would prefer to keep things internal. In doing so, the organization will be able to control quality, cost, delivery performance, and integration. An organization will benefit from outsourcing when one or more of the following circumstances are present: A lack of productive and/or logistics capacity exists in the long run. The product or service being outsourced is not a core competency of the organization, or another organization excels at the manufacture and supply of the product or service. There is a lack of supply of the necessary raw material and/or labour. The cost as a percentage of the total manufacturing cost is small. Successful outsourcing results in a seamless e outsourcing decision (also called a make-or-buy decision) considers whether an organization should make an intermediate good or service or purchase it from an outside supplier. This decision is influenced by cost as well as by qualitative factors such as the required level of quality, the predictability of delivery, and the degree of integration required. In the event that an organization has sufficient capacity, expertise, and a reliable supply of material and labour, it is reasonable that, with costs being the same, the organization would prefer to keep things internal. In doing so, the organization will be able to control quality, cost, delivery performance, and integration. An organization will benefit from outsourcing when one or more of the following circumstances are present: A lack of productive and/or logistics capacity exists in the long run. The product or service being outsourced is not a core competency of the organization, or another organization excels at the manufacture and supply of the product or service. There is a lack of supply of the necessary raw material and/or labour. The cost as a percentage of the total manufacturing cost is small. Successful outsourcing results in a seamless e outsourcing decision (also called a make-or-buy decision) considers whether an organization should make an intermediate good or service or purchase it from an outside supplier. This decision is influenced by cost as well as by qualitative factors such as the required level of quality, the predictability of delivery, and the degree of integration required. In the event that an organization has sufficient capacity, expertise, and a reliable supply of material and labour, it is reasonable that, with costs being the same, the organization would prefer to keep things internal. In doing so, the organization will be able to control quality, cost, delivery performance, and integration. An organization will benefit from outsourcing when one or more of the following circumstances are present: A lack of productive and/or logistics capacity exists in the long run. The product or service being outsourced is not a core competency of the organization, or another organization excels at the manufacture and supply of the product or service. There is a lack of supply of the necessary raw material and/or labour. The cost as a percentage of the total manufacturing cost is small. Successful outsourcing results in a seamless e outsourcing decision (also called a make-or-buy decision) considers whether an organization should make an intermediate good or service or purchase it from an outside supplier. This decision is influenced by cost as well as by qualitative factors such as the required level of quality, the predictability of delivery, and the degree of integration required. In the event that an organization has sufficient capacity, expertise, and a reliable supply of material and labour, it is reasonable that, with costs being the same, the organization would prefer to keep things internal. In doing so, the organization will be able to control quality, cost, delivery performance, and integration. An organization will benefit from outsourcing when one or more of the following circumstances are present: A lack of productive and/or logistics capacity exists in the long run. The product or service being outsourced is not a core competency of the organization, or another organization excels at the manufacture and supply of the product or service. There is a lack of supply of the necessary raw material and/or labour. The cost as a percentage of the total manufacturing cost is small. Successful outsourcing results in a seamless  addition to quantitative considerations, the following are some qualitative considerations for a scarce resource analysis: whether improvements in quality can be made to focus capacity on producing only good units (and thus reducing spoilage) whether outsourcing allows for a constraint to be eliminated addition to quantitative considerations, the following are some qualitative considerations for a scarce resource analysis: whether improvements in quality can be made to focus capacity on producing only good units (and thus reducing spoilage) whether outsourcing allows for a constraint to be eliminated 10.7 Theory of constraints Organizations all have constraints that limit their profitability, called bottlenecks. The theory of constraints explains methods to achieve the goal of maximizing operating income by identifying and managing these constraints, or bottlenecks, within its operations. Three measurements are used in the theory of constraints: throughput contribution: the difference between sales revenue and direct materials (the contribution when finished goods are sold) investments: costs required to convert raw inventory into finished goods, such as materials costs for raw material and work-in-process, and costs of finished goods inventory, the plant and equipment used, and research and development to bring an idea to production operating costs: all operating costs outside of direct materials, including both product and period costs, incurred to achieve throughput contribution Throughput costing is the generation of money through sales and is calculated as sales minus direct materials cost. Product that is not sold is considered an increase in investment and is recorded only at the cost of its direct materials. The idea is that only direct materials add value to the product, and the goal is to increase throughput and decrease investment and operating costs. Hence, all conversion costs are omitted from the product cost and are treated as period costs. Instead of focusing on product costs, the theory of constraints seeks to increase throughput contribution and decrease both investment and operating costs through managing bottlenecks in the production process. This is a short-term issue, because when each bottleneck is solved, the organization moves on to the next bottleneck. The focus is on short-run maximization of the throughput contribution, not on how to efficiently manage operating costs. As discussed previously, the ability to change fixed or operating costs can happen, but over a longer time frame. The following steps are taken to maximize throughput contribution: 1. Identify the bottleneck in the operation. 2. Identify options for exploiting the bottleneck that is limiting capacity. 3. Subordinate all other processes without constraints in favour of the bottlenecked part of the process, using the bottleneck to set the production needs for the overall plant. 4. Work to remove the bottleneck in order to increase the throughput contribution less the incremental costs related to the improvements. 5. Repeat the process with the next bottleneck The following are some methods that can be used to improve the bottleneck situation: Improve the quality of the parts or products manufactured at the bottleneck. Reduce setup and processing time at the bottleneck. Outsource bottlenecked activities or move them to other areas of the process with capacity. Process on a just-in-time basis for items that increase throughput contribution (rather than increasing inventory levels). Reduce or eliminate idle time at the bottlen Dimensions of quality information Relevance Ease of use Integrity Timeliness Information is applicable to the situation. Information can support decision-making as is, without a lot of effort. Information is accurate, consistent, and reliable. Information is available in time to make an effective decision. Methods of communicating uncertainty Probability distributions A function that shows the probability as a percentage of different outcomes for an event. Payoff tables A way to present the expected payoff of the alternative actions by showing the actions an organization may take against the events that cannot be controlled. Graphs A visual representation of uncertainty that can show data as a range or error bar, rather than as a point. 25.1 Uncertainty defined Uncertainty occurs when an action can have more than one outcome and the outcome that will occur is unknown. For example, when someone tosses a coin, there are two possible outcomes: heads up or heads down. For an organization, uncertainty means that it is not possible to know the exact outcome of its actions on future performance. Risk is the potential for uncertainty to impair an organization’s ability to achieve its objectives. When a gambler tosses a coin and places a wager on whether the coin will land heads up or heads down, the gambler is facing risk. Similarly, an organization faces many risks that may impede its ability to meet its strategic and operational objectives, such as its ability to raise sufficient capital or future changes in customer preferences. Most important decisions made in organizations involve actions in the face of uncertainty and, therefore, risk. The management accountant often identifies risks and their possible effects on decision-making to management. This chapter introduces the basics of decision-making under uncertainty. 25.1.1 Decision-making under uncertainty The following probability definitions are important to the idea of decision-making under uncertainty: Objective criterion This is a function expressing the objective, such as maximizing income or minimizing cost. A set of possible actions A set of possible events This is the set of alternative actions the decision maker can undertake to meet the objective. In the case of tossing a coin, there are two wagers (actions): wager the coin will fall heads up or wager it will fall heads down. This is the set of possible events that occur after actions have been taken that affect the outcome, over which the decision-maker has little or no control. These events are beyond the control of the decision maker and are often called states of nature. In the case of the coin tossing, the possible events are that the coin will fall heads up or heads down. Other possibilities, such as the coin landing on its edge, are excluded. A set of probabilities that defines the chance of each event occurring A set of possible outcomes In the case of tossing a fair coin, the chance of the coin landing heads up is believed to be half and the chance of it landing heads down is believed to be half. The sum of the probabilities of all possible events must equal one. Outcomes measure the consequence to the decision maker of each action-event pairing. Decision makers often express the set of outcomes in an outcomes table. The following table for the coin-toss example assumes that the gambler is betting $1 on the coin toss: Gambler bets heads up Gambler bets heads down Coin lands heads up Win $1 Lose $1 Coin lands heads down Lose $1 Win $1 Each of these elements has 25.1 Uncertainty defined Uncertainty occurs when an action can have more than one outcome and the outcome that will occur is unknown. For example, when someone tosses a coin, there are two possible outcomes: heads up or heads down. For an organization, uncertainty means that it is not possible to know the exact outcome of its actions on future performance. Risk is the potential for uncertainty to impair an organization’s ability to achieve its objectives. When a gambler tosses a coin and places a wager on whether the coin will land heads up or heads down, the gambler is facing risk. Similarly, an organization faces many risks that may impede its ability to meet its strategic and operational objectives, such as its ability to raise sufficient capital or future changes in customer preferences. Most important decisions made in organizations involve actions in the face of uncertainty and, therefore, risk. The management accountant often identifies risks and their possible effects on decision-making to management. This chapter introduces the basics of decision-making under uncertainty. 25.1.1 Decision-making under uncertainty The following probability definitions are important to the idea of decision-making under uncertainty: Objective criterion This is a function expressing the objective, such as maximizing income or minimizing cost. A set of possible actions A set of possible events This is the set of alternative actions the decision maker can undertake to meet the objective. In the case of tossing a coin, there are two wagers (actions): wager the coin will fall heads up or wager it will fall heads down. This is the set of possible events that occur after actions have been taken that affect the outcome, over which the decision-maker has little or no control. These events are beyond the control of the decision maker and are often called states of nature. In the case of the coin tossing, the possible events are that the coin will fall heads up or heads down. Other possibilities, such as the coin landing on its edge, are excluded. A set of probabilities that defines the chance of each event occurring A set of possible outcomes In the case of tossing a fair coin, the chance of the coin landing heads up is believed to be half and the chance of it landing heads down is believed to be half. The sum of the probabilities of all possible events must equal one. Outcomes measure the consequence to the decision maker of each action-event pairing. Decision makers often express the set of outcomes in an outcomes table. The following table for the coin-toss example assumes that the gambler is betting $1 on the coin toss: Gambler bets heads up Gambler bets heads down Coin lands heads up Win $1 Lose $1 Coin lands heads down Lose $1 Win $1 Each of these elements has 5.2 Quality of information When dealing with uncertainty, the quality of information becomes a key consideration for the management accountant. There are four basic dimensions of quality information: relevance, ease of use, integrity, and timeliness. Relevance Ease of use Integrity Timeliness Information is applicable to the situation. Information can support decision-making as is, without a lot of effort. Information is accurate, consistent, and reliable. Information is available in time to make an effective decision. The following sources were used: raw data of all sales in the Canadian real estate market for the last five years provided by the Canadian Real Estate Association  several real estate blogs written by local bloggers quarterly forecasts provided by local and provincial real estate associations a paper on the real estate market written by a provincial economist two years ago The dimensions of information quality can be considered for each source of information: Raw sales data Relevance Maybe Ease of use No Integrity Timeliness Maybe Yes Past raw sales data is somewhat relevant to future sales, but the data is not in a form that is easy to use because it is raw data, for the entire country. As it comes from the Canadian Real Estate Association, the information is likely to have integrity. Blogs Yes Yes Maybe Maybe Blogs that discuss possible future economic conditions for real estate are likely relevant and easy to use/read, but the information may not have integrity because it is difficult know if it is accurate or reliable. Quarterly forecasts Yes Yes Yes Yes Forecasts of future sales are relevant to the local real estate market and are likely to have integrity because they come from local and provincial real estate associations. This information is also timely, because forecasts are prepared each quarter. Economist paper No Yes Yes No The paper on the real estate market is likely has high integrity, because it is written by an economist. However, it is not timely, because the paper is two years old, and therefore is unlikely to be relevant to the future real estate market. 25.2.1 Professional skepticism regarding data The concept of professional skepticism is most commonly applied in auditing, but it can also be applied to the management accountant when considering data. When completing their work, a management accountant must demonstrate professional values, which means maintaining skepticism and critically assessing information that will be used. For example, when selecting data to be used to forecast future revenues, data should not be “hand-picked” to show the best possible result for the organization, but instead should be selected without preconceived ideas and so that any conclusion reached from the data can be relied on. Where data has not been skeptically considered before its use, decisions based on this data may lead to outcomes that are not in the best interests of the organization. Consider a report with the average revenue per customer that only includes the top 20 customers being used to project future revenues for capacity planning. The end result would be poor decision-making, such as expanding facilities faster than needed, because the decisions were made on misleading information. 25.2b Let’s look at an example Safety Co. is a manufacturer of smoke alarms that is testing out a new product — a fire extinguisher. After seeing that the extinguisher is getting better customer reviews on its website than all of its other products, which are smoke alarms, Robert, Safety’s management accountant, suggests that the organization stop manufacturing smoke alarms and exclusively make fire extinguishers. If professional skepticism had been used, Robert would have considered that the website reviews may not have information integrity. It is possible the fire extinguisher is experiencing a bump in sales due to being new, and that with more reviews, its rating will decrease. It is also possible that the products complement in each other, and that sales of fire extinguishers will be lower if smoke alarms are no longer sold. More information could be gathered from other sources, such as market research, discussions with salespeople, sales analysis, or customer surveys, to determine which products should be manufactured 25.3 Communicating uncertainty Management accountants have a variety of tools at their disposal that can be used to communicate uncertainty to management and other parties. This section discusses three such tools: probability distributions, payoff tables, and graphs. 25.3.1 Probability distributions for event uncertainty Decision makers assess event uncertainty, which is uncertainty regarding whether a future event will occur or at what value, using probability distributions. In a discrete probability distribution, each of a finite number of events is assigned a probability of occurring. The result of a coin toss is modelled as a discrete distribution as follows: Event: coin lands heads up Event: coin lands heads down Probability: 50% Probability: 50% The discrete probability distribution can be further analyzed using expected value, which is the sum of each risk-weighted option when there is event uncertainty. It builds on the discrete probability distribution by arriving at a single expected value to assist with planning. To compute the expected value of sales in the above distribution, each sales amount (outcome) is multiplied by its probability and all of the weights are summed. For a coin toss, the probability of one flip landing heads up is 50%. If the coin was flipped 500 times, the expected value of landing heads up would be 250 times (500 flips × 50% probability of heads up). This does not mean there will be exactly 250 heads up flips in 500 flips total; instead, the expected value represents an amount that is most likely given the probability of each flip being heads. 25.3.2 Payoff tables In decision analysis, the decision maker is facing uncertain acts of nature, where the outcome of the decision is determined either by random acts of nature or by the actions of competitors. Decision makers use payoff tables to set the actions they may take against the events they cannot control to estimate the expected payoff of the alternative actions. Consider an entertainment company that is holding an outdoor concert. Based on prior concerts, it is expected that between 10,000 and 12,000 tickets will be sold. If weather is poor on the date of the concert, revenue from concessions will be significantly lower compared to that of clear weather. The uncertainty in the expected revenue from the concert can be presented as follows: Clear weather 10,000 tickets sold 12,000 tickets sold $750,000 $1,000,000 Poor weather $550,000 $800,000 25.3.3 Graphs Graphs are a useful tool to present uncertainty because they provide a visual representation to management or other users of the possible range of outcomes. Each point on the graph is represented by both an x-value and a y-value. If there is uncertainty in the value, either the x-value or y-value may be a range, rather than a point, called an error bar. An error bar shows the range of each possible value so that users of the graph can visually see the uncertainty in the data. Errors lines can also be presented on a graph that highlight the high and low estimates. Consider a glass manufacturer that is thinking about replacing an aging furnace to reduce its electricity costs. Comparing electricity costs of running the old furnace to electricity costs of a new furnace involves uncertainty because the organization’s electricity usage varies and the cost of electricity may change. A graph can be used to show the range of possible electricity costs using error bars, rather than points, and error lines can be used to present the high and low cost estimates, as follows Summary Problem Required a) Differentiate between risk and uncertainty. Provide an example of uncertainty and risk in the decision-making process. b) Identify the four basic dimensions of information quality. c) An organization is forecasting its revenue for the next year and would like to communicate uncertainty in the calculations. Describe how probability distributions, payoff tables, and graphs could be used to present uncertainty in its revenue forecast. Solution a) An organization is operating in uncertainty when more than one outcome may occur in the future and the outcome is unknown. Risk occurs when uncertainty may prevent an or