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CHAPTER 1 Decentralization - Delegation of decision-making authority throughout an organization by giving managers the authority to make decisions relating to their

area of responsibility. Line positions Staff positions - Directly related to achievement of the basic - Support and assist line positions objectives of an organization. Process Management The push approach - Production first before orders - Results in large inventories of raw materials, work in process, and finished goods. Lean Thinking Model Identify the value to customers in specific products and services. Identify the business process that delivers this value. Organize work arrangements around the flow of the business process through a manufacturing cell.

Create a pull system where production is not initiated until a customer has ordered a product, also known as just-in-time (JIT) production. Pursue perfection in the business process.

Supply chain management - Refers to the coordination of business processes across companies to better serve end consumers. Theory of Constraints - A constraint or bottleneck is anything that prevents you from getting more of what you want. - The constraint in a system is determined by the step that has the least capacity. - Based on the insight that effectively managing the constraint is the key to success. - Manage the constraint with the intent of generating more business rather than cutting the workforce. The Theory of Constraints approach to process improvement involves four steps: Identify the weakest link in the chain which is the Concentrate improvement efforts on strengthening the constraint. weakest link. Do not place a greater strain on the system than the If the improvement efforts are successful, the weakest weakest link can handle if you do, the chain will break. link will improve to the point that it is no longer the weakest link. Process starts all over again. Six Sigma (zero defects) - A process improvement method that relies on customer feedback and fact-based data gathering and analysis techniques to drive process improvement. Ethics in Business IMA Guidelines for Ethical Behavior Management accountants must: Competence Maintain professional competence. Follow applicable laws, regulations, and standards. Provide accurate, clear, concise, and timely decision support information. Recognize and communicate professional limitations that preclude responsible judgment. Confidentiality Not disclose confidential information unless legally obligated to do so. Ensure that subordinates do not disclose confidential information. Not use confidential information for unethical or illegal advantage. Integrity Mitigate conflicts of interest and advise others of potential conflicts.

Refrain from conduct that would prejudice carrying out duties ethically. Abstain from activities that might discredit the profession. Credibility Communicate information fairly and objectively. Disclose all relevant information that could influence a users understanding of reports and recommendations. Disclose delays or deficiencies in information timeliness, processing, or internal controls. IMA Guidelines for Resolution of an Ethical Conflict Follow employers established policies. For an unresolved ethical conflict: Discuss the conflict with next highest uninvolved manager. If immediate supervisor is the CEO, consider the board of directors or the audit committee. Contact with levels above the immediate supervisor should only be initiated with the supervisors knowledge, assuming the supervisor is not involved. Except where legally prescribed, maintain confidentiality. Clarify issues in a confidential discussion with an objective advisor. Consult an attorney as to legal obligations. Why have ethical standards? - If the standards are not followed in business, then the economy, and all of us, would suffer. - Abandoning ethical standards would lead to a lower standard of living with lower-quality goods and services, less to choose from, and higher prices. The Code of Ethics for Professional Accountants - Issued by the International Federation of Accountants (IFAC) governs the activities of all professional accountants throughout the world. - IFACs code also outlines the accountants ethical responsibilities in matters relating to: Taxes, Advertising and solicitation, Independence, Handling of monies Fees and commissions, Cross-border activities. Corporate governance - System by which a company is directed and controlled. - Provide incentives for the board of directors and top management to pursue objectives that are in the interests of the company. - Provide effective monitoring of performance. The Sarbanes-Oxley Act of 2002 - Was intended to protect the interests of those who invest in publicly traded companies by improving the reliability and accuracy of corporate financial reports and disclosures. - Six key aspects of the legislation: CEO and CFO should certify in writing that their The public companys independent auditor should issue companys financial statements and disclosures fairly an opinion on the effectiveness of the companys internal represent the results of operations. control over financial reporting to accompany Public Company Accounting Oversight Board will managements assessment, and both are included in the provide additional oversight of the audit profession. companys annual report. The power to hire, compensate, and terminate public The Act establishes severe penalties for certain accounting firms is in the hands of the audit committee. behaviors, such as: The Act places restrictions on audit firms, such as Altering or destroying any documents that may prohibiting public accounting firms from providing a variety eventually be used in an official proceeding. of non-audit services to an audit client. Retaliating against a whistle blower. Enterprise risk management - Process used by a company to proactively identify the risks that it faces and manage those risks.

- Most common tactic is to reduce risks by implementing specific controls. Corporate social responsibility (CSR) A concept whereby organizations consider the needs of all stakeholders when making decisions. - CSR extends beyond legal compliance to include voluntary actions that satisfy stakeholder expectations. Certified Management Accountant (CMA) - A management accountant who has the necessary qualifications and who passes a rigorous professional exam. CHAPTER 2 Work of Management Planning - Identify alternatives - Select best alternatives to further objectives Directing and Motivating - Day-to-day activities - Employee work assignments, effective communications, etc. Controlling - Ensures plans are followed - Feedback through performance reports Comparison of Financial and Managerial Accounting Financial Managerial External persons Users Managers Historical Time Focus Future Verifiability VS Relevance Precision VS Timeliness Whole org Subject Segments of org Mandatory Requirement Not mandatory Manufacturing Costs Direct Materials - Raw materials that become an integral part of the product and that can be conveniently traced directly to it Direct Labor - Those labor costs can be easily traced to individual units of the product Product Costs Versus Period Costs Product costs - Include direct materials, direct labor and manufacturing overhead. Classification of Costs Direct Material s Prime Cost Direct Labor Manufacturing Overhead

Develop budgets achieve selected alternative Formulate long and short-term plans Implement plans

Measure performance Comparing actuality to plans

Manufacturing Overhead - Manufacturing costs that cannot be traced directly to specific units produced Nonmanufacturing Costs - Selling Costs: Costs necessary to secure the order and deliver the product - Administrative Costs: All executive, organizational and clerical costs Period costs - Include all selling costs and administrative costs.

Balance Sheet Merchandiser Current Assets Cash Receivables Merchandise Inventory

Conversion Cost

Manufacturer Current Assets Cash Receivables Inventories Raw Materials Work in Process Finished Goods

Raw materials are the materials used to make the product. Work in process consists of units of product that are partially complete, but will require further work to be saleable to customers. Finished goods consist of units of product that have been completed, but not yet sold to customers. Income Statement Basic Equation for Inventory Accounts Beginning + Additions = Ending + Withdrawals Balance to inventory Balance from inventory

Cost of Goods Sold Beg Finished + Cost of goods = End finished + Cost of Goods inventory manufactured goods inventory goods sold

Cost Classifications for Predicting Cost Behavior Cost Behavior - How a cost will react to changes in the level of activity within the relevant range Cost In Total Per Unit Variable In proportion Constant Fixed Constant Inversely

Cost Classifications for Assigning Cost to Cost Objects Direct Costs Costs that can be easily and conveniently traced to a unit of product or other cost object. Ex: Direct materials and direct labor Indirect Costs Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Ex: Manufacturing overhead

Cost Classifications Used in Making Decisions Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored. Differential costs (or incremental costs) - Difference in cost between any two alternatives. - Can be either fixed or variable. - A difference in revenue between two alternatives is called differential revenue. Opportunity cost - Potential benefit that is given up when one alternative is selected over another. Sunk cost - A cost that has already been incurred and that cannot be changed by any decision made now or in the future. - Cannot be differential costs, therefore ignored in decision making. CHAPTER 3 Cost Systems Process Costing - Best used by companies producing many units of a single product - One unit of output is indistinguishable from any other unit of output. Job-order Costing - Many different products are produced each period. - The products are usually manufactured to customers specifications and are unique in nature. Documents used: Measuring Direct Materials Cost - Bill of materials: document that lists the type and quantity of each type of direct material needed to complete a product. - Materials requisite form: specifies the type and quantity of materials to be drawn from the storeroom and identifies the job that will be charged for the cost of materials. Job Cost Sheet - Records the materials, labor and manufacturing overhead costs charged to the job. Measuring Direct Labor Cost - Time ticket: an hour-by-hour summary of the employees activities throughout the day.

Predetermined manufacturing overhead rate Manufacturing overhead - Applied to all jobs that are in process. We apply overhead using a base we believe causes overhead costs to be incurred. We must use an allocation base because: - It is difficult, if not impossible, to actually trace overhead costs to a particular job. - Manufacturing overhead also includes a number of different costs and it would be very difficult to gather all of them together in time to charge them to a particular job. - Many types of overhead are fixed in nature even though output fluctuates during the period. Predetermined overhead rate (POHR) - Used to apply overhead to jobs; determined before the period begins Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period

POHR

Overhead applied = POHR x Actual activity Normal cost system - Applies overhead to jobs by multiplying a POHR by the actual amount of the allocation base incurred by the jobs. Cost driver - A factor, such as machine-hours, flight hours, that causes overhead costs. Cost of Goods Manufactured Schedule Direct Materials Beginning raw materials inventory Add: Purchases of raw materials Raw materials available for use Deduct: Ending raw materials inventory Raw materials used in production Direct Labor Manufacturing Overhead Total Manufacturing cost Add: Beginning work in process inventory Deduct: Ending work in process inventory Cost of goods manufactured Cost of Goods Sold Schedule Finished goods inventory, beginning Add: Cost of goods manufactured Goods available for sale Deduct: Finished goods, inventory ending Unadjusted cost of goods sold Add: Underapplied (or Deduct: Overapplied) overhead Adjusted cost of goods sold Functional-form Income Statement Sales Cost of goods sold Gross margin Selling and Administrative expenses: Salaries expense Depreciation expense Advertising expense Other expense Net operating income

Underapplied or overapplied overhead - Difference between the overhead cost applied to Work in Process and the actual overhead costs Summary of Overhead Concept At the beginning of the period: Estimated total Estimated total manufacturing / amount of the overhead cost allocation base

Predetermined overhead rate

During the period: Predetermined Actual amount of Total overhead rate X the allocation base = manufacturing incurred during the overhead period applied At the end of the period: Actual total Total Underapplied manufacturing _ manufacturing = (overhead) overhead cost overhead applied overhead CHAPTER 5 Cost Behavior and Analysis Activity base (cost driver) - A measure of what causes the incurrence of variable costs. - As the level of the activity base increases, the total variable cost increases proportionally. Variable Costs - Total amount varies in direct proportion to changes in activity level - Remains constant in a per unit basis - The proportion of variable costs differs across organizations True Variable Cost - Amount used during the period that varies in direct proportion to the activity level. Step-Variable Cost - A resource that is obtainable only in large chucks. - Changes only in response to fairly wide changes in activity. Linearity Assumption - Economists correctly point out that many costs which accountants classify as variable costs actually behave in a curvilinear fashion. - Nonetheless, within a narrow band of activity known as the relevant range, a curvilinear cost can be suitably approximated by a straight line. Relevant range - Range of activity within which the assumptions made about cost behavior are valid. Fixed Cost - Total amount remains constant within the relevant range - Decreases on a per unit basis as the activity level increases - The trend in many industries is toward greater fixed costs relative to variable costs. Types of Fixed Costs Committed - Long-term, cannot be significantly reduced in the short term.

Discretionary - May be altered in the short-term by current managerial decisions - Arise from annual decisions by management

Fixed Costs and the Relevant Range - The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat. - Step fashion Differences from Step-Variable - First, step-variable costs can often be adjusted quickly as conditions change, whereas fixed costs cannot be changed easily. - The second difference is that the width of the steps for fixed costs is wider than the width of the steps for stepvariable costs.

Mixed costs (also called semivariable costs) - Contain both variable and fixed cost elements. - Fixed portion is constant regardless of kilowatt hours consumed. This cost represents the minimum cost that is incurred to have the service ready and available for use. - Variable portion varies in direct proportion to the activity. Y = a + bX. Y = the total mixed cost a = the total fixed cost (vertical intercept of the line) b = the variable cost per unit of activity (slope of the line) X = the actual level of activity. Analysis of Mixed Costs Account analysis - An account is classified as variable and fixed based on the analysts prior knowledge about how costs behave. Engineering approach - Classifies costs based upon an industrial engineers evaluation of production methods, materials specifications, labor requirements, equipment usage, power consumption, and so on. High-Low Method 1. Choose the data points pertaining to the highest and lowest activity levels. 2. Determine the total costs associated with the two chosen points. 3. Calculate change in cost between the two data points. 4. Take the total cost at either activity level. Total Fixed Cost = Total Cost Total Variable Cost 5. Construct an equation that can be used to estimate the total cost at any activity level. Y = Total Fixed Cost + Variable Cost per Unit(X) Contribution Format Income Statement Sales Less: Variable expenses Contribution margin Less: Fixed expenses Net operating income CHAPTER 6 Contribution income statement - Helpful to managers in judging the impact on profits of changes in selling price, cost, or volume. Contribution margin - Defined as the amount remaining from sales revenue after variable expenses have been deducted. - Used to cover fixed expenses. - Remaining CM contributes to net operating income. CVP in Equation Form Profit = (Sales Variable expenses) Fixed expenses Unit CM = Selling price/unit Variable expenses/unit Profit = (P Q V Q) Fixed expenses Profit = (P V) Q Fixed expenses Profit = Unit CM Q Fixed expenses CVP in Graphic Form - Unit volume is usually represented on the X-axis and dollars on the Y-axis. Break-even point - Where the total revenue and total expenses lines intersect. Least Squares Regression Method - A method used to analyze mixed costs if a scatter graph plot reveals an approximately linear relationship between the X and Y variables. - This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost. - The cost analysis objective is: Y = a + bX 2 - R is the percentage of the variation in the dependent variable (total cost) that is explained by variation in the independent variable (activity).

Contribution margin ratio CM Ratio = Total CM Total Sales

CM Ratio = CM per unit SP per unit

Target Profit Analysis - We estimate what sales volume is needed to achieve a specific target profit Equation Method Formula Method Unit Sales Unit sales to attain target profit = Target profit + Fixed expenses Profit = Unit CM Q Fixed expenses Unit CM Dollar Sales Dollar sales to attain target profit = Target profit + Fixed expenses Profit = CM ratio x Sales Fixed expenses CM Ratio

Break-even Analysis Unit sales to break even = Fixed expenses Unit CM Dollar sales to break even = Fixed expenses CM Ratio

Operating Leverage - Operating leverage is a measure of how sensitive net operating income is to percentage changes in sales. Degree of operating leverage = Contribution Margin Net operating income

Margin of Safety - Amount by which sales can drop before losses are incurred. Margin of safety = Total sales - Break-even sales Margin of safety percentage = Margin of safety in dollars Total actual sales in dollars Sales mix - The relative proportion in which a companys products are sold. CHAPTER 11 Standard Costing Standard - Benchmark or norm for measuring performance Quality standards - How much of an input should be used to make a product or provide a service. Price standards - How much should be paid for each input of the unit. Management by exception - Managers investigate the discrepancy to find the cause of the problem and eliminate it. Standard cost card - Shows the standard quantities and costs of the inputs required to produce a unit of a specific product. Ideal standards Attained under best circumstances No machine breakdowns, or any work interruptions Most skilled employees working 100% of the time Practical standards tight but attainable Allow normal machine downtime, rest periods Reasonable though efficient efforts by average workers

Direct materials standards Standard price per unit - Should reflect final, delivered out cost of the materials, net of any discounts taken

Standard quantity per unit - Should reflect the amount of material required for each unit of finished product as well as an allowance for unavoidable waste

Direct labor standards Standard rate per hour - Includes wages, employment taxes, and fringe benefits. Direct materials variances Materials price variance = AQ (AP SP) Materials quantity variance = SP (AQ SQ) Variable manufacturing overhead variances Variable overhead rate variance = AH (AR SR) Variable overhead efficiency variance = SR (AH SH) CHAPTER 12

Standard hours per unit - Direct labor time needed to complete a product

Direct labor variances Labor rate variance = AH (AR SR) Labor efficiency variance = SR (AH SH)

Responsibility Center - Any part of an organization whose manager has control over cost, profit and investment centers. Cost Center - Has control over costs, but not over revenue or use of investment funds. Profit Center - Has control over both costs and revenues, but no control or investment funds. Investment Center - Has control over costs, revenue and investments in operating assets. Segment Reporting Segment - Any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Segment margin - Computed by subtracting the traceable fixed costs of a segment from its contribution margin. - best gauge of the long-run profitability of a segment Traceable costs Common costs - Arise because of the existence of a particular - Arise because of the overall operation of company; segment and would disappear over time if the would not disappear if any segment were eliminated. segment itself disappeared. - May make a profitable business segment appear to be unprofitable. Return on Investment (ROI) ROI = Net operating income Average operating assets Turnover = Sales Average operating assets

Margin = Net operating income Sales Ways to increase ROI: - Increase sales - Reduce operating expenses - Reduce operating assets

ROI = Margin x Turnover

Residual Income - Net operating income earned above minimum required return on its operating assets Residual Income Net operating income Average operating assets Minimum required rate of return

Transfer pricing Transfer price - The price charged when one segment of a company provides goods or services to another segment of the company. Transfer Variable cost + Total contribution margin on lost sales Price per unit Number of units transferred Transfer Price Cost of buying from outside supplier CHAPTER 13 Cost Concepts for Decision Making Relevant Costs - Differ between alternatives - Avoidable Cost: eliminated in choosing alternatives - Also called differential or incremental cost

Irrelevant Costs (Unavoidable Costs) - Sunk Costs: already incurred and cannot be avoided - Future costs that do not differ between alternatives

Relevant Cost Analysis: Two-Step Process 1. Eliminate costs that do not differ between alternatives 2. Use the costs that differ between alternatives in making the decision. Drop or continue a product line or segment Contribution margin approach: Solution: CM lost if product line is dropped Less fixed costs that can be avoided Net advantage/disadvantage Make or buy analysis Make or buy - A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier. Opportunity cost - The benefit that is foregone as a result of pursuing some course of action. Utilization of constrained resource When a constraint exists, a company should select a product mix that maximizes the total contribution margin earned since fixed costs usually remain unchanged. A company should not necessarily promote those products that have the highest unit contribution margin. Rather, it should promote those products that earn the highest contribution margin in relation to the constraining resource.

Accept or reject a special order Special order - A one-time order that is not considered part of the companys normal ongoing business. - Incremental costs and benefits are relevant. Sell as is or process further Two or more products produced from a common input are called joint products. The point in the manufacturing process where each joint product can be recognized as a separate product is called the split-off point.

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