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lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna 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 applicaon results in a dier...
lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna 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 applicaon results in a dierent 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 accounng 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 acvies that it performs, it is employing an approach called acvity-based cosng. Acvity-based cosng is an alternave approach to developing mulple predetermined overhead rates. Managers use acvity-based cosng systems to more accurately measure the demands that jobs, products, customers, and other cost objects make on overhead resources. Learning Objecve 5: Use job cost sheets to calculate ending inventories and cost of goods sold JOB COST SHEETS Job-order cosng systems are oen used to create a balance sheet and income statement for external pares. All of a company’s job cost sheets collecvely form a subsidiary ledger. The job costs sheets provide an underlying set of nancial records that explain what specic 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 specic 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 dier from the actual amount of overhead costs incurred during the period. 1. When a company applies less overhead to producon than it actually incurs, it creates what is known as underapplied overhead 2. When it applies more overhead to producon 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 reect underapplied or overapplied overhead. 1. The adjustment for underapplied overhead increases cost of goods sold and decreases net operang income 2. The adjustment for overapplied overhead decreases cost of goods sold and increases net operang income JOB-ORDER COSTING IN SERVICE COMPANIES Although our aenon has focused on manufacturing applicaons, it bears re-emphasizing that job-order cosng is also used in service industries. Job-order cosng is also used in many dierent types of service companies. For example, law rms, accounng rms, and medical treatment. QUICK RECAP 20 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna 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 synchronizaon, we extend our me horizon to 1 year and at the beginning of the period we esmate both component of the predetermined overhead rate, that is the numerator (total manufacturing overhead) and the denominator (allocaon base based on which we would like to allocate the overhead). So, we esmate 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 allocaon rate mulplied the allocaon base (actual). So, these allocated applied overhead to each job, and then cumulavely in the whole year, it’s a combinaon of a predetermined rate, which is established at the beginning of the period, and an actual ulizaon of the allocaon 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 transacon we have seen in nancial accounng. 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 esmated 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 lile (applied manufacturing overhead < actual manufacturing overhead). The problem is the following: – – When we look at the cost of product if we have an over applicaon of manufacturing overhead, the cost of product is overstated When we look at the cost of product if we have an under applicaon of manufacturing overhead, the cost of product is understated Since normally this account needs to be cleared (set to zero) for the following accounng 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 underesmated or overesmated. VARIABLE COSTING AND SEGMENT REPORTING: TOOLS FOR MANAGEMENT Learning Objecve 1: Explain how variable cosng diers from absorpon cosng and compute unit product costs under each method THREE SIMPLIFYING ASSUMPTIONS 1. This chapter uses actual cosng rather than the normal cosng approach that was used in the job order cosng chapters. 2. This chapter always uses the actual number of units produced as the allocaon base for assigning actual xed manufacturing overhead costs to products. 21 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna 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 cosng has something to do with the cost classicaon regarding variable to xed costs and it means the ulizaon of only variable costs to compute the cost of product. Absorpon cosng, which is the contrary of variable cosng, means cosng the product by including both the xed component and the variable component. So, we are compung the cost of product and we apply the cost classicaon variable versus xed: – In one case, variable cosng, we associate to the cost of product only variable costs (it doesn’t maer whether they are direct or indirect) – In the other case, absorpon cosng, 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 cosng, 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 absorpon cosng, not only direct and indirect variable costs, but also xed manufacturing overhead is product costs, while the rest is period costs. Therefore, the dierence between variable cosng and absorpon cosng 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 accounng ow product costs dier 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 lile dierence can create dierences in the value of income under certain condions. UNIT COST COMPUTATIONS Harvey Company produces a single product with the following informaon available: Unit product cost is determined as follows: Absorpon Cosng Variable cosng 22 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna 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 absorpon cosng, all producon costs, variable and xed, are included when determining unit product cost. Under variable cosng, only the variable producon costs are included in product costs. Learning Objecve 2: Prepare income statements using both variable and absorpon cosng VARIABLE AND ABSORPTION COSTING INCOME STATEMENTS – Let’s assume the following addional informaon 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 operang income using both absorpon and variable cosng. 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 Objecve 3: Reconcile variable cosng and absorpon cosng net operang incomes and explain why the two amounts dier COMPARING THE TWO METHODS 23 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi We can reconcile the dierence between absorpon and variable income as follows: Variable cosng net operang income Add: Fixed mfg. Overhead costs deferred in inventory (5,000 units x $6 per unit) Absorpon cosng net operang income $ 90.000 $ $ 30.000 120.000 EXTENDED COMPARISONS OF INCOME DATA HARVEY COMPANY – YEAR TWO UNIT COST COMPUTATIONS Absorpon Cosng Direct materials, direct labor, and variable mfg. overhead Fixed mfg. Overhead ($150,000 ÷ 25,000 units) Unit product cost Variable cosng $ 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 computaons 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 Accounng | Marna 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 dierence between absorpon and variable income as follows: Variable cosng net operang income $ Add: Fixed mfg. Overhead costs deferred in inventory (5,000 units x $6 per unit) Absorpon cosng net operang income 260.000 $ $ 30.000 230.000 SUMMARY OF KEY INSIGHTS Relaon between producon and sales Units produced = Units sold Units produced > Units sold Units produced < Units sold ENABLING CVP ANALYSIS Eect on inventory No change in inventory Inventory increases Inventory decreases Relaon between producon and sales Absorpon = Variable Absorpon > Variable Absorpon < Variable 25 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Variable cosng 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 contribuon margin, which is the change of the overall income due to in the volume of the overall acvity). Because absorpon cosng assigns xed manufacturing overhead costs to units produced ($6 per unit for Harvey Company), a poron of xed manufacturing overhead resides in inventory when units remain unsold. The potenal result is posive operang income when the number of units sold is less than the breakeven point. Explaining Changes in Net Operang Income Variable cosng income is only aected by changes in unit sales; it is not aected by the number of units produced. As a general rule, when sales go up, net operang income goes up, and vice versa. Absorpon cosng income is inuenced by changes in unit sales and units of producon; net operang income can be increased simply by producing more units even if those units are not sold. By using absorpon cosng we would not be able to run the break-even analysis or the cost-volume-prot analysis because we have a distoron of the xed manufacturing overhead, which under absorpon cosng are considered variable, but are not variable, they are in fact xed. SUPPORTING DECISION MAKING Variable cosng correctly idenes the addional variable costs incurred to make one more unit ($10 per unit for Harvey Company). It also emphasizes the impact of total xed costs on prots. Because absorpon cosng 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 disconnuaon decisions. Learning Objecve 4: Prepare a segmented income statement that dierenates traceable xed costs from common xed costs and use it to make decisions DECENTRALIZATION AND SEGMENT REPORTING Decentralizaon means that there is an organizaon with a number of units, which implies deciding how to segment the overall acvity into small acvies (segments). Managerial accounng provides informaon by unit, by segment, that is why segmental reporng is associated to decentralizaon. A segment is any part or acvity of an organizaon about which a manager seeks cost, revenue, or prot data: An Individual Store A Sales Territory A Service Center and these segments need to have a relevance which is both strategic and organizaonal (there needs to be a segmentaon that makes sense in strategic terms and in organizaonal terms). KEYS TO SEGMENTED INCOME STATEMENTS There are two keys to building segmented income statements: – A contribuon format should be used because it separates xed from variable costs, and it enables the calculaon of a contribuon margin – Traceable xed costs should be separated from common xed costs to enable the calculaon of a segment margin IDENTIFYING FIXED COSTS There is a disncon regarding xed costs: – Traceable xed costs arise because of the existence of a parcular 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 operaon of the company and would not disappear if any parcular segment were eliminated (indirect costs) Traceable direct costs and common indirect costs depend on the denion 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 parcular 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 Accounng | Marna Marazzi The segment margin, which is computed by subtracng the traceable xed costs of a segment from its contribuon margin, is the best gauge of the long-run protability 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 reporng uses the contribuon format Cost of goods sold consists of variable manufacturing costs Contribuon margin is computed by taking sales minus variable costs Fixed and variable costs are listed in separate secons Segment margin is Television’s contribuon to prots 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 combinaon of the two (company level). ACTIVITY-BASED COSTING: A TOOL TO AID DECISION MAKING Acvity Based Cosng is a cosng method designed to provide managers with cost informaon for strategic and other decisions that potenally aect 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 cosng system. 27 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Before the Acvity Based Cosng system was discovered, the only problem was volume (how many) and that driver, allocaon 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 dierenaon. Learning Objecve 1: Understand acvity-based cosng and how it diers from a tradional cosng system HOW COSTS ARE TREATED UNDER ACTIVITY–BASED COSTING In Acvity Based Cosng, nonmanufacturing as well as manufacturing costs may be assigned to products, but only on a cause-and-eect basis: Acvity-based cosng systems can assign sales commissions, shipping costs, and warranty repair costs to specic products. Some manufacturing costs may be excluded from product costs: Acvity-based cosng excludes organizaon-sustaining costs and idle capacity costs from product cost. Acvity-based cosng diers from tradional cost accounng because numerous overhead cost pools are used (much more complex allocaon scheme). From a company point of view this means reviewing all the cosng system. Each ABC cost pool has its own unique measure of acvity, while tradional 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 quanty 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 scruny since, on an economy-wide basis, direct labor and overhead costs have been moving in opposite direcons and the variety of products produced by companies has increased. KEY DEFINITIONS AND CONCEPTS – Acvity: an event that causes the consumpon of overhead resources – Acvity Cost Pool: a “cost bucket” in which costs related to a single acvity measure are accumulated – Acvity Measure: an allocaon base in an acvity-based cosng system • the term cost driver is also used to refer to an acvity measure Two common types of acvity measures: Transacon driver Simple count of the number of mes an acvity occurs Duraon driver A measure of the amount of me needed for an acvity 28 Downloaded by Chiara Davoli ([email protected]) lOMoARcPSD|11350337 Financial Statement Analysis and Managerial Accounng | Marna Marazzi Tradional cost systems rely exclusively on allocaon bases that are driven by the volume of producon. Dierently, Acvity-based cosng denes ve levels of acvity 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 movated to embrace the need to change – Linked to how people are evaluated and rewarded If employees connue to be evaluated and rewarded using tradional (non-ABC) cost data, they will quickly get the message that ABC is not important, and they will abandon it – Cross-funconal teams should be created Cross-funconal employees possess inmate knowledge of operaons that is necessary for designing an eecve ABC system THE FIVE STEPS FOR IMPLEMENTING ABC The company makes two types of automobile baeries—SureStart (a standard baery) and LongLife (a deluxe baery). 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 Relaons - assigned all costs associated with maintaining relaons with customers. Other - assigned all organizaon-sustaining costs and _______________________________________________unused capacity costs. Learning Objecve 2: Assign costs to cost pools using a rst-stage allocaon 29 Downloaded by Chiara Davoli ([email protected])
