MANAGERIAL ACCOUNTING COST BEHAVIORS, SYSTEMS, AND ANALYSIS with Gary Hecht
Costing Systems 1: Elements and Design
Financial Perspective and Costing System Approaches
Lesson Objectives
LESSON 2-1 OBJECTIVES
You will understand: The purpose of costing systems inside organizations How to identify different types of costing systems
Flow of Costs Through Financial Statements
FUNDAMENTALS
Financial perspective Product costing according to generally accepted accounting principles Matching principle “Inventoriable� costs versus period costs
Costs versus expenses
DIFFERENT PERSPECTIVES OF COSTS: MANUFACTURING SETTING PRODUCT COSTS = INVENTORIABLE COSTS
DIRECT PRODUCT COSTS
PERIOD COSTS = SELLING & ADMIN
INDIRECT PRODUCT COSTS = MFG OVERHEAD
FLOW OF COSTS THROUGH FINANCIAL STATEMENTS Direct Materials Direct Labor Mfg Overhead
Work in Process Inventory
Finished Goods Inventory
Cost of Goods Sold
Two Traditional Systems
COST SYSTEMS BY COST OBJECT TYPE Many types of costing systems - one distinction relates to cost object type Job Costing Cost object is a unit or multiple units of a distinct product or service Process Costing Cost object is masses of identical or similar units of product or service
Often, a continuum . . .
EXAMPLES Job costing Law firms Consulting Planes, yachts
Process costing Computers Food products Mail, express delivery
JOB COSTING VS. PROCESS COSTING Job Costing: Accumulates Costs by Individual Job
Work-inProcess Inventory Job 1 Direct Material Direct Labor Manufacturing Overhead
Job 2 Job 3
FinishedGoods Inventory
Cost of Goods Sold
JOB COSTING VS. PROCESS COSTING Process Costing: Accumulates Costs by Production Department Direct Material Direct Labor Manufacturing Overhead
Work-in-Process Inventory: Production Department A
Work-in-Process Inventory: Production Department B
Finished-Goods Inventory
Cost of Goods Sold
Extension – Overhead Costs
OVERHEAD CONSIDERATIONS
Consulting firm setting Accounting for costs Pricing decision
Two general types of costs Labor Overhead
OVERHEAD TIMING
Beginning of the Period
Decisions
Budgeted
End of the Period
Applied
Actual
APPLYING OVERHEAD
A simple formula: Predetermined OH Rate = Budgeted Overhead (Total) Total Volume of Driver
Use this rate to allocate overhead.
EXAMPLE Step 1: Calculate Rate Predetermined OH Rate = Budgeted Overhead (Total) Total Volume of Driver Predetermined OH Rate =
$1,500,000 30,000 Labor Hours
=
$50 per hour
EXAMPLE
Step 2: Apply Overhead Suppose a consulting engagement used 350 labor hours. $50 per hour x 350 hours = $17,500
CORRECTING ESTIMATES The predetermined OH rate is based on budgeted information. However, estimates from the beginning of the year likely do not match actual overhead at the end of the year. An adjustment is usually made to reflect this difference in the costing system.
VIDEO 2-1.6
What We’ve Learned What We’ve Learned
WHAT WE’VE LEARNED IN LESSON 2-1 Financial perspective of costs How costs flow through financial statements Production costs remain in inventory (i.e., as an asset) until sold
Various types of costing systems Adopted by organizations according to nature of business and product
The Problem of Fixed Costs
Lesson Objectives
LESSON 2-2 OBJECTIVES
You will understand: How to account for costs using absorption costing, which is required for financial reporting purposes The problems associated with fixed costs for decision making
Example Scenario
MANUFACTURING SETTING Financial Accounting Revenue -
Direct Material (V)
-
Direct Labor (V)
-
Overhead (V & F)
=
Gross Margin
-
Other Expenses (V & F)
=
Profit
EXAMPLE Keith Adventures, Inc. manufactures and sells a variety of boats and jet skis. The following information is available for its main line of boats. Selling price (per unit) $ 21,000 Variable costs (per unit) Materials 5,000 Labor 3,000 Selling 2,000 Fixed costs (total) Manufacturing 1,500,000 Selling 450,000
Month 1 Beginning inventory 0 ProducFon 400 Sales 300 Ending inventory 100
Month 2 100 350
400 50
CREATING THE INCOME STATEMENT What is Keith’s revenue from boats for Month 1? $21,000 per unit x 300 units sold = $6,300,000
What are Keith’s variable manufacturing costs? Direct materials + Direct labor = $5,000 + $3,000 = $8,000 per unit Total = $8,000 per unit x 400 units = $3,200,000
Where are the variable manufacturing costs reported? Income statement (COGS): $8,000 x 300 units sold = $2,400,000 Balance sheet (Inventory): $8,000 x 100 units in inventory = $800,000
CREATING THE INCOME STATEMENT (CONT)
What are Keith’s fixed manufacturing costs for Month 1? Given as $1,500,000
Where are the fixed manufacturing costs reported? How much fixed cost is allocated per unit? $1,500,000 / 400 units produced = $3,750 per unit Income statement (COGS): $3,750 x 300 units sold = $1,125,000 Balance sheet (Inventory): $3,750 x 100 units in inventory = $375,000
CREATING THE INCOME STATEMENT (CONT)
What are Keith’s other costs? Variable selling and admin: $2,000 per unit x 300 units sold = $600,000 Fixed selling and admin: $450,000
Where are these costs reported? All on the income statement, as they are not inventoriable costs
INCOME STATEMENT – MONTH 1
Revenues
$6,300,000
Cost of goods sold
3,525,000
Gross margin
2,775,000
Total Selling & Admin
1,050,000
Operating income
1,725,000
2,400,000 + 1,125,000
600,000 + 450,000
The Manager Did What?
AN ALTERNATIVE VERSION Let’s envision a different version of Month 1 . . . That is, suppose that Keith manufactured 800 units (instead of the 400 units in our original scenario).
ALTERNATIVE VERSION What is Keith’s revenue from boats for Month 1? $21,000 per unit x 300 units sold = $6,300,000
What are Keith’s variable manufacturing costs? Direct materials + Direct labor = $5,000 + $3,000 = $8,000 per unit Total = $8,000 per unit x 800 units = $6,400,000
Where are the variable manufacturing costs reported? Income statement (COGS): $8,000 x 300 units sold = $2,400,000 Balance sheet (Inventory): $8,000 x 500 units in inventory = $4,000,000
ALTERNATIVE VERSION (CONT)
What are Keith’s fixed manufacturing costs for Month 1? Given as $1,500,000
Where are the fixed manufacturing costs reported? How much fixed cost is allocated per unit? $1,500,000 / 800 units produced = $1,875 per unit Income statement (COGS): $1,875 x 300 units sold = $562,500 Balance sheet (Inventory): $1,875 x 500 units in inventory = $937,500
COMPARISON
400 units
800 units
$6,300,000
$6,300,000
Cost of goods sold
3,525,000
2,962,500
Gross margin
2,775,000
3,337,500
Total Selling & Admin
1,050,000
1,050,000
Operating income
1,725,000
2,287,500
Revenues
INCENTIVE IMPLICATIONS Assume the boating business unit manager’s evaluation and compensation is determined by operating income . . . Certainly, the manager is aligned with the organization. However, the “accounting” story might induce inventory build-up!
WHAT IS THE ROOT OF THE PROBLEM? Accounting for fixed costs is complicated. Absorption costing (required for financial accounting purposes) treats fixed costs as product costs. Financial accounting information may not be the best for internal decision-making.
POTENTIAL FIX? For internal purposes, firms can account for costs however they like. Variable costing is one such method. Separate costs according to behavior, and account for variable costs on a per unit basis, and leave fixed costs in aggregate.
What We’ve Learned
WHAT WE’VE LEARNED IN LESSON 2-2 Challenges of accounting for fixed costs Misleading information Dysfunctional behavior
Customization of information according to decision
WHAT WE’VE LEARNED IN MODULE 2 The purpose of costing systems How to differentiate the financial and managerial perspectives of costing systems Different types of costing systems The problems associated with accounting for fixed costs