Financial Statement Analysis and Managerial Accounting PDF

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This document discusses financial statement analysis and managerial accounting, including topics like job-order costing, overhead, and variable costing. It explains various concepts in detail and provides examples. The document is geared towards students learning about managerial accounting.

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lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi STEP 5 – CALCULATE THE SELLING PRICE FOR JOB 407 The selling price of Job 407 assuming a 75% markup: It is important to emphasize that using a departmental approach to overhead applicaon results in a dier...

lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi STEP 5 – CALCULATE THE SELLING PRICE FOR JOB 407 The selling price of Job 407 assuming a 75% markup: It is important to emphasize that using a departmental approach to overhead applicaon results in a dierent selling price for Job 407 than would have been derived using a Plantwide overhead rate based on either direct labor-hours or machine-hours. The appeal of using predetermined departmental overhead rates is that they presumably provide a more accurate accounng of the costs caused by jobs, which in turn, should enhance management planning and decision making. MULTIPLE PREDETERMINED OVERHEAD RATES – AN ACTIVITY-BASED APPROACH When a company creates overhead rates based on the acvies that it performs, it is employing an approach called acvity-based cosng. Acvity-based cosng is an alternave approach to developing mulple predetermined overhead rates. Managers use acvity-based cosng systems to more accurately measure the demands that jobs, products, customers, and other cost objects make on overhead resources. Learning Objecve 5: Use job cost sheets to calculate ending inventories and cost of goods sold JOB COST SHEETS Job-order cosng systems are oen used to create a balance sheet and income statement for external pares. All of a company’s job cost sheets collecvely form a subsidiary ledger. The job costs sheets provide an underlying set of nancial records that explain what specic jobs comprise the amounts reported in Work-in-Process and Finished Goods on the Balance Sheet. The job costs sheets provide an underlying set of nancial records that explain what specic jobs comprise the amounts reported in Cost of Goods Sold on the income statement. JOB-ORDER COSTING FOR FINANCIAL STATEMENTS TO EXTERNAL PARTIES The amount of overhead applied to all jobs during a period will dier from the actual amount of overhead costs incurred during the period. 1. When a company applies less overhead to producon than it actually incurs, it creates what is known as underapplied overhead 2. When it applies more overhead to producon than it actually incurs, it results in overapplied overhead FINANCIAL ADJUST FOR OVERHEAD APPLIED The cost of goods sold reported on a company’s Income Statement must be adjusted to reect underapplied or overapplied overhead. 1. The adjustment for underapplied overhead increases cost of goods sold and decreases net operang income 2. The adjustment for overapplied overhead decreases cost of goods sold and increases net operang income JOB-ORDER COSTING IN SERVICE COMPANIES Although our aenon has focused on manufacturing applicaons, it bears re-emphasizing that job-order cosng is also used in service industries. Job-order cosng is also used in many dierent types of service companies. For example, law rms, accounng rms, and medical treatment. QUICK RECAP 20 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi In order to cost a job, we need to trace costs: some are more directly traceable, like labor and material, while others are indirectly traceable, like all the manufacturing overhead, which includes xed manufacturing overhead and variable manufacturing overhead. In order to trace these manufacturing overhead we need to determine the so called predetermined overhead rate, which is predetermined because we compute it at the beginning of every period because the accrual of the manufacturing overhead is not synchronized with the manufacturing of the job, so because we lack this synchronizaon, we extend our me horizon to 1 year and at the beginning of the period we esmate both component of the predetermined overhead rate, that is the numerator (total manufacturing overhead) and the denominator (allocaon base based on which we would like to allocate the overhead). So, we esmate and then we start producing, and from me to me we complete the jobs; every me we complete the job we apply the overhead, based on the predetermined allocaon rate mulplied the allocaon base (actual). So, these allocated applied overhead to each job, and then cumulavely in the whole year, it’s a combinaon of a predetermined rate, which is established at the beginning of the period, and an actual ulizaon of the allocaon base as we go. What can happen at the end of the period? At the end of the period, we have two numbers: an applied overhead (all the applied overhead to each individual job) and the actual overhead. So, we have to gather, measure and record which is the actual amount of overhead, so basically whatever is recorded in the transacon we have seen in nancial accounng. These values equate or not? It depends: if the two are the same it means that the cost of product (which is a product cost, so can be inventoried) that is associated to the nished good inventory is corrected esmated and computed, but it can happen that we apply too much (applied manufacturing overhead > actual manufacturing overhead) or it can happen that we apply too lile (applied manufacturing overhead < actual manufacturing overhead). The problem is the following: – – When we look at the cost of product if we have an over applicaon of manufacturing overhead, the cost of product is overstated When we look at the cost of product if we have an under applicaon of manufacturing overhead, the cost of product is understated Since normally this account needs to be cleared (set to zero) for the following accounng period, what can happen that in order to close it we should write o whatever remains in one side or in the other side and adjust it in the cost of goods sold (because sooner or later these nished goods will be sold), in order to take into account that the cost of product may be underesmated or overesmated. VARIABLE COSTING AND SEGMENT REPORTING: TOOLS FOR MANAGEMENT Learning Objecve 1: Explain how variable cosng diers from absorpon cosng and compute unit product costs under each method THREE SIMPLIFYING ASSUMPTIONS 1. This chapter uses actual cosng rather than the normal cosng approach that was used in the job order cosng chapters. 2. This chapter always uses the actual number of units produced as the allocaon base for assigning actual xed manufacturing overhead costs to products. 21 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi 3. This chapter always assumes that the variable manufacturing costs per unit and the total xed manufacturing overhead cost per period remain constant. Variable cosng has something to do with the cost classicaon regarding variable to xed costs and it means the ulizaon of only variable costs to compute the cost of product. Absorpon cosng, which is the contrary of variable cosng, means cosng the product by including both the xed component and the variable component. So, we are compung the cost of product and we apply the cost classicaon variable versus xed: – In one case, variable cosng, we associate to the cost of product only variable costs (it doesn’t maer whether they are direct or indirect) – In the other case, absorpon cosng, we associate to the cost of product costs that are both variable and xed OVERVIEW OF VARIABLE AND ABSORPTION COSTING In the case of variable cosng, only the direct and indirect, as long as they are variable costs, are product costs, while the rest is period costs. In the case of absorpon cosng, not only direct and indirect variable costs, but also xed manufacturing overhead is product costs, while the rest is period costs. Therefore, the dierence between variable cosng and absorpon cosng is this component of xed manufacturing overhead, that in one case are cost of product and in the other case are costs of period. Just to remember, in the accounng ow product costs dier from period costs because product costs can be associated to the inventory and if sold, they will impact on the cost of goods sold, but they are capitalized in inventory. This lile dierence can create dierences in the value of income under certain condions. UNIT COST COMPUTATIONS Harvey Company produces a single product with the following informaon available: Unit product cost is determined as follows: Absorpon Cosng Variable cosng 22 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Direct materials, direct labor, and variable mfg. overhead Fixed mfg. Overhead ($150,000 ÷ 25,000 units) Unit product cost $ 10,00 $ 10,00 $ $ 6,00 16,00 $ $ 10,00 Under absorpon cosng, all producon costs, variable and xed, are included when determining unit product cost. Under variable cosng, only the variable producon costs are included in product costs. Learning Objecve 2: Prepare income statements using both variable and absorpon cosng VARIABLE AND ABSORPTION COSTING INCOME STATEMENTS – Let’s assume the following addional informaon for Harvey Company. – 20,000 units were sold during the year at a price of $30 each. There is no beginning inventory. Now, let’s compute net operang income using both absorpon and variable cosng. VARIABLE COSTING CONTRIBUTION FORMAT INCOME STATEMENT Variable manufacturing Variable manufacturing costs only costs only ABSORPTION COSTING INCOME STATEMENT Unit product cost Fixed manufacturing overhead deferred in inventory is 5,000 units × $6 = $30,000. Learning Objecve 3: Reconcile variable cosng and absorpon cosng net operang incomes and explain why the two amounts dier COMPARING THE TWO METHODS 23 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi We can reconcile the dierence between absorpon and variable income as follows: Variable cosng net operang income Add: Fixed mfg. Overhead costs deferred in inventory (5,000 units x $6 per unit) Absorpon cosng net operang income $ 90.000 $ $ 30.000 120.000 EXTENDED COMPARISONS OF INCOME DATA HARVEY COMPANY – YEAR TWO UNIT COST COMPUTATIONS Absorpon Cosng Direct materials, direct labor, and variable mfg. overhead Fixed mfg. Overhead ($150,000 ÷ 25,000 units) Unit product cost Variable cosng $ 10,00 $ 10,00 $ $ 6,00 16,00 $ $ 10,00 Since the variable costs per unit, total xed costs, and the number of units produced remained unchanged, the unit cost computaons also remain unchanged. VARIABLE COSTING Variable manufacturing costs only All xed manufacturing overhead is expensed 24 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi ABSORPTION COSTING Unit product cost Fixed manufacturing overhead released from inventory is 5,000 units × $6 = $30,000. RECONCILING THE DIFFERENCE We can reconcile the dierence between absorpon and variable income as follows: Variable cosng net operang income $ Add: Fixed mfg. Overhead costs deferred in inventory (5,000 units x $6 per unit) Absorpon cosng net operang income 260.000 $ $ 30.000 230.000 SUMMARY OF KEY INSIGHTS Relaon between producon and sales Units produced = Units sold Units produced > Units sold Units produced < Units sold ENABLING CVP ANALYSIS Eect on inventory No change in inventory Inventory increases Inventory decreases Relaon between producon and sales Absorpon = Variable Absorpon > Variable Absorpon < Variable 25 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Variable cosng categorizes costs as variable and xed, so it is much easier to use this income statement format for CVP analysis (to have an highlight of the contribuon margin, which is the change of the overall income due to in the volume of the overall acvity). Because absorpon cosng assigns xed manufacturing overhead costs to units produced ($6 per unit for Harvey Company), a poron of xed manufacturing overhead resides in inventory when units remain unsold. The potenal result is posive operang income when the number of units sold is less than the breakeven point. Explaining Changes in Net Operang Income Variable cosng income is only aected by changes in unit sales; it is not aected by the number of units produced. As a general rule, when sales go up, net operang income goes up, and vice versa. Absorpon cosng income is inuenced by changes in unit sales and units of producon; net operang income can be increased simply by producing more units even if those units are not sold. By using absorpon cosng we would not be able to run the break-even analysis or the cost-volume-prot analysis because we have a distoron of the xed manufacturing overhead, which under absorpon cosng are considered variable, but are not variable, they are in fact xed. SUPPORTING DECISION MAKING Variable cosng correctly idenes the addional variable costs incurred to make one more unit ($10 per unit for Harvey Company). It also emphasizes the impact of total xed costs on prots. Because absorpon cosng assigns xed manufacturing overhead costs to units produced ($6 per unit for Harvey Company), it gives the impression that xed manufacturing overhead is variable with respect to the number of units produced, but it is not. The result can be inappropriate pricing decisions and product disconnuaon decisions. Learning Objecve 4: Prepare a segmented income statement that dierenates traceable xed costs from common xed costs and use it to make decisions DECENTRALIZATION AND SEGMENT REPORTING Decentralizaon means that there is an organizaon with a number of units, which implies deciding how to segment the overall acvity into small acvies (segments). Managerial accounng provides informaon by unit, by segment, that is why segmental reporng is associated to decentralizaon. A segment is any part or acvity of an organizaon about which a manager seeks cost, revenue, or prot data: An Individual Store A Sales Territory A Service Center and these segments need to have a relevance which is both strategic and organizaonal (there needs to be a segmentaon that makes sense in strategic terms and in organizaonal terms). KEYS TO SEGMENTED INCOME STATEMENTS There are two keys to building segmented income statements: – A contribuon format should be used because it separates xed from variable costs, and it enables the calculaon of a contribuon margin – Traceable xed costs should be separated from common xed costs to enable the calculaon of a segment margin IDENTIFYING FIXED COSTS There is a disncon regarding xed costs: – Traceable xed costs arise because of the existence of a parcular segment and would disappear over me if the segment itself disappeared (direct costs), so if the company eliminates the segment, it also eliminates the xed cost – Common xed costs arise because of the overall operaon of the company and would not disappear if any parcular segment were eliminated (indirect costs) Traceable direct costs and common indirect costs depend on the denion of cost object. The cost object in this case is not the single unit of a product anymore, but something wider (more observable). It is important to realize that the traceable xed costs of one segment may be a common xed cost of another segment. For example, the landing fee paid to land an airplane at an airport is traceable to the parcular ight, but it is not traceable to rst class, business-class, and economy-class passengers. SEGMENT MARGIN 26 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi The segment margin, which is computed by subtracng the traceable xed costs of a segment from its contribuon margin, is the best gauge of the long-run protability of a segment. TRACEABLE AND COMMON COSTS The methodology, as a result, is to not allocate common costs to segment since it distorts decision making. LEVELS OF SEGMENTED STATEMENTS Webber, Inc. has two divisions: Our approach to segment reporng uses the contribuon format Cost of goods sold consists of variable manufacturing costs Contribuon margin is computed by taking sales minus variable costs Fixed and variable costs are listed in separate secons Segment margin is Television’s contribuon to prots Common costs should not be allocated to the divisions. These costs would remain even if one of the divisions were eliminated At which level do we have to compute the break-even analysis? For each product and for the combinaon of the two (company level). ACTIVITY-BASED COSTING: A TOOL TO AID DECISION MAKING Acvity Based Cosng is a cosng method designed to provide managers with cost informaon for strategic and other decisions that potenally aect capacity and, therefore, “xed” as well as variable costs. It is ordinarily used as a supplement to, rather than as a replacement for, the company’s usual cosng system. 27 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Before the Acvity Based Cosng system was discovered, the only problem was volume (how many) and that driver, allocaon base, was driving the cost, nowadays, with this new system, the problem is not only the volume, it is the complexity and the complexity means the product dierenaon. Learning Objecve 1: Understand acvity-based cosng and how it diers from a tradional cosng system HOW COSTS ARE TREATED UNDER ACTIVITY–BASED COSTING In Acvity Based Cosng, nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause-and-eect basis: Acvity-based cosng systems can assign sales commissions, shipping costs, and warranty repair costs to specic products. Some manufacturing costs may be excluded from product costs: Acvity-based cosng excludes organizaon-sustaining costs and idle capacity costs from product cost. Acvity-based cosng diers from tradional cost accounng because numerous overhead cost pools are used (much more complex allocaon scheme). From a company point of view this means reviewing all the cosng system. Each ABC cost pool has its own unique measure of acvity, while tradional cost systems usually rely on direct labor hours and/or machine hours to allocate all overhead costs to products. Direct labor and machine hours work correctly when changes in the quanty of the base are correlated with changes in the overhead costs being assigned using the base. Relying exclusively on direct labor hours and/or machine hours to assign overhead costs to products has come under increased scruny since, on an economy-wide basis, direct labor and overhead costs have been moving in opposite direcons and the variety of products produced by companies has increased. KEY DEFINITIONS AND CONCEPTS – Acvity: an event that causes the consumpon of overhead resources – Acvity Cost Pool: a “cost bucket” in which costs related to a single acvity measure are accumulated – Acvity Measure: an allocaon base in an acvity-based cosng system • the term cost driver is also used to refer to an acvity measure Two common types of acvity measures: Transacon driver Simple count of the number of mes an acvity occurs Duraon driver A measure of the amount of me needed for an acvity 28 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Tradional cost systems rely exclusively on allocaon bases that are driven by the volume of producon. Dierently, Acvity-based cosng denes ve levels of acvity that largely do not relate to the volume of units produced. CHARACTERISTICS OF A SUCCESSFUL ABC IMPLEMENTATION – Strong top management support Without leadership from top management, some managers may not be movated to embrace the need to change – Linked to how people are evaluated and rewarded If employees connue to be evaluated and rewarded using tradional (non-ABC) cost data, they will quickly get the message that ABC is not important, and they will abandon it – Cross-funconal teams should be created Cross-funconal employees possess inmate knowledge of operaons that is necessary for designing an eecve ABC system THE FIVE STEPS FOR IMPLEMENTING ABC The company makes two types of automobile baeries—SureStart (a standard baery) and LongLife (a deluxe baery). Baxter reported its rst loss ever. DEFINE ACTIVITIES, ACTIVITY COST POOS, AND ACTIVITY MEASURES Customer Orders - assigned all costs of resources that are consumed by taking and processing customer orders. Design Changes - assigned all costs of resources consumed by customer requested design changes. Order Size - assigned all costs of resources consumed as a consequence of the number of units produced. Customer Relaons - assigned all costs associated with maintaining relaons with customers. Other - assigned all organizaon-sustaining costs and _______________________________________________unused capacity costs. Learning Objecve 2: Assign costs to cost pools using a rst-stage allocaon 29 Downloaded by Chiara Davoli ([email protected])

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