ACCG200 Lectures 2-11 Handout

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Product costing system

Welcome to ACCG200 Week 5
Types of product costing systems (procedures)

Base on the nature of production environment Job costing system the cost object is a distinct product (distinct batch) called a job. E.g., construction jobs (house, buildings, roads) and air craft building.
A system that accumulates product-related costs and uses a series of procedures to assign them to the organization's final products Why product costing: - Pricing - Performance evaluation - Planning and controlling costs
Job Costing
Chapter 4
Dr. Ranjith Appuhami
Process costing system A mass of an identical product is produced over many periods. E.g., production of beverage (Coca-Cola), Mobile phones and Books (Week 6 lecture)
Department of Accounting and Corporate Governance
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Types of product costing systems (procedures)
Lecture example 1
In each of the following situations, determine whether job costing or process costing would be more appropriate
Different product costs for different purposes

Valuation of inventory for external reporting -
manufacturing costs AASB 102
Short-term decisions variable manufacturing and downstream costs / relevant costs Long-term decisions total costs (both manufacturing and nonmanufacturing costs) associated with the product
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General approach to job costing
Manufacturing Cost Categories of a Job

Direct Labou r Direct Material s Manufacturin g Overhead
1. Trace the direct costs of the job

- Direct materials - Direct labour
Assignment of Manufacturing Costs to Jobs Source Documents

used to Assign Direct Costs to Jobs Direct Material s Direct Labou r Material Requisiti o n Form
2. Apply manufacturing overhead costs to the Job

Apply overhead costs to products at the predetermined overhead rate:
Predetermined Overhead Rate

:
Budgeted T otal Manufacturing Overhead Cost
Budgeted activity level in the Allocation Base
Ideally , the allocation base is a cost driver that causes overhead.
Job Cost Labo ur Time Ticket Allocation Base is used to Assign Indirect Costs to Jobs Manufacturing Cost Driver/ Predetermined Overhead Allocation Overhead Rate Base
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Materials Requisition Form
Direct Labour Time Tickets
Predetermined Overhead Rates

Manufacturing overhead is applied to jobs that are in process. An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign manufacturing overhead to individual jobs.
We use an allocation base to apply budgeted manufacturing overhead because: 1.It is impossible or difficult to trace overhead costs to particular jobs. 2. Manufacturing overhead consists of many different items ranging from the grease used in machines to a production manager s salary .
$700 charged to Job #2719
$300 charged to Job #3335
3.
Actual overhead for the period may not be known until the end of the period.
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The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins using estimates.
Predetermined Overhead Rate Estimated T otal Manufacturing Overhead Cost
Example 2 - Predetermined Overhead Rates

Because home building is a labour intensive business, T oll Brothers uses direct labor hours as the overhead allocation base. T oll Brothers estimates the total manufacturing overhead cost for the year to be $750,000, while direct labour hours are estimated to be 10,000. What is T oll Brothers predetermined overhead rate? Pre.MOH Rate = $750,000 10,000 direct labor hours (DLH)

Based on estimates, and determined before the period begins.
Predetermined Overhead Rate
Actual V alue of the Allocation Base for Each Job
Overhead Applied to an Individual Job
Estimated Units in the Allocation Base
Pre.MOH Rate = $75.00 per DLH

Ideally , the allocation base is a cost driver that causes overhead.
For each direct labour hour worked on a job, $75.00 of manufacturing overhead will be applied to the job.
Actual amount of the cost driver such as units produced, direct labor hours, or machine hours incurred during the period.
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Lecture example 3 - Job costing

Ranjith construction builds residential houses. It uses job-costing system with one indirect cost pool (building support or manufacturing overhead). Direct labour-hours is the allocation base for building support costs. Direct labour-hours $8 800 000
Lecture example 3 Job costing

Required 1. Compute predetermined overhead rate 2. What are the job costs of L model house and M model house?
Lecture example 3 solutions

1. Predetermined overhead rate =Budgeted OH Costs/ Budgeted direct labour hours = 8800,000/160,000 = $55/DLH Applied overhead allocated for the job =Predetermined overhead rate X Actual direct labour hours For L house: Applied MOH = 55 X 900=49500 For M house: Applied MOH= 55 X 1010=55550
Actual results for 2011
Two builds were started and Direct material costs Direct labour costs Direct labour-hours
$7 380 000 160 000 164 000 com leted durin 2011
L Model house
$106 450 $ 36 276 900
M Model house
$ 127 604 $ 41 410 1010
Adapted: Horngren eta/., 2011
MACQUARIE UNIVERSITY
Y JI"
A\t,
FACULTY OF BUSINESSAND ECONOMICS
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Lecture example 3 Job costing

2. Job costs of two houses
Cost of each model = DM + DL + MOH
Recording the Flow of Costs in Job Order Costing

Raw Material Purchases Direct Labor
Recording the Purchase and Issue of Materials

T oll Brothers purchased $150,000 in raw materials on account. T oll Brothers withdraws $150,000 worth of materials from inventory , $100,000 for Job #2719 (Simpson home), $40,000 for Job #3335 (Flintstone Home) and $10,000 for supplies.
Raw Materials Inventory Purchases 150,000 Issued to production 150,000
Raw Direct Materials Materials Inventory A/C
Work in Process A/C

Job 101 Job 102 Job 103
Finished Goods Inventory a/c
Cost of Goods Sold a/c
Indirect Materials Indirect Labor

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Manufacturing Overhead a/c Actual Costs Incurred Applied To WIP

2-20
Manufacturing Overhead 10,000
Work in Process Inventory 140,000

Job 2719 Direct Materials $100,000
Direct Materials
Indirect Materials
Equipment Depreciation
Job 3335 Direct Materials $40,000
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Recording Labour Costs

T oll Brothers incurs $55,000 in labour costs, $30,000 for Job #2719 (Simpson home), $20,000 for Job #3335 (Flintstone Home) and $5,000 for indirect labour.
W ages payable 55,000
Recording Actual Manufacturing Overhead

In addition to indirect materials and indirect labor, T oll Brothers incurs other manufacturing overhead costs including: Salary paid to construction site supervisor, $12,000. Salary owed to a construction engineer, $8,000. Property taxes owed but not yet paid, $6,000. Expired insurance premium for construction, $4,000. Depreciation on construction equipment, $18,000.
Manufacturing Overhead Actual Applied Indirect materials 10,000 Indirect labor 5,000 Supervisor salary 12,000 Engineer salary 8,000 Property taxes 6,000 Insurance expense 4,000 Depreciation 18,000
Recording Applied Manufacturing Overhead

T oll Brothers applies manufacturing overhead to jobs using a predetermined overhead rate of $75 per direct labuor hour. Time tickets for the month show a total of 800 direct labor hours, 600 hours for Job #2719 (Simpson home) and 200 hours for Job #3335 (Flintstone Home).
Applied MOH = Pre.MOH rate x actual direct labour hours
Direct Overhead Applied Labor Hrs Rate Overhead Job # Simpson home 2719 600 $ 75 $ 45,000 Flintstone home 3335 200 75 15,000 Total direct labor hours 800 $ 60,000
Labour Costs Indirect Labor Direc t Wo ra kb in L oP r rocess Inventory

50,000
Manufacturing Overhead 5,000
Job 2719 Direct Labor $30,000
Job 3335 Direct Labor $20,000
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Recording Actual and Applied Manufacturing Overhead

Manufacturing Overhead Actual Applied 60,000 Indirect materials 10,000 Applied OH
Under-applied or over-applied overhead

Under-applied/ (Over- applied) = Actual overhead - Overhead applied overhead
Disposing of Overapplied and Underapplied Overhead

The most common method for disposing of the balance in Manufacturing Overhead is to make a direct adjustment to Cost of Goods Sold.
Overapplied Manufacturin g Overhead Underapplie d Manufacturin g Overhead
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Work in Process Inventory 60,000
Under-applied = Actual overhead > Overhead applied

Job 2719 Manufacturing OH $45,000 Job 3335 Manufacturing OH $15,000
Over-applied = Actual overhead < Overhead applied
Decreases Cost of Goods Sold Increases Cost of Goods Sold
Actual Applied MOH = MOH The difference is closed to cost of goods sold.
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Calculating Overapplied and Underapplied Overhead

Actual Applied Indirect materials 10,000 Applied OH 60,000 ndirect labor 5,000 Supervisor salary 12,000 8,000 COGS 3000 Engineer salary Property 6,000 taxes Insurance expense 4,000 Depreciation 18,000
Transferring Costs to Finished Goods Inventory and Cost of Goods Sold

Work in Porcess Inventory 140,000 Job 2719 completed
Transferring Costs to Finished Goods Inventory and Cost of Goods Sold

Assume Job 2719, the Simpson home was sold.
Finished Goods Inventory Cost of goods completed 175,000 When job is sold 175,000
Direct material
175,000
After all costs are recorded .
Finished Goods Inventory Cost of goods completed 175,000
Job 2719 sold
Cost of Goods Sold 175,000
Underapplied Manufacturing Overhead
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Summary of Recorded Manufacturing Costs

Raw Materials
Issued Purchased $150,000 $150,000
Job costing: journal entries and T- accounts

1. Purchase of materials (assuming materials are purchased on credit) Dr Cr Raw material inventory xxxx Account payable xxxx 2. Transferring direct material to WIP Work in process inventory xxxx Raw material inventory

4. MOH applied Work in process inventory Manufacturing overhead 5. MOH actually incurred Manufacturing overhead Various accounts Dr xxxx Cr xxxx
Work in Process
Direct Materials $140,000 Direct Labor Applied Mfg. OH 50,000 60,000 When Job is Completed $175,000
Finished Goods
Cost of Goods Manufactured $175,000 When Job is Sold $175,000
xxxx xxxx
xxxx 6. Completion of production Finished goods inventory Work in process inventory xxxx xxxx xxxx
Balance $ 75,000
Cost of Goods Sold

$175,000 $3,000 $178,000
Manufacturing Overhead
Actual Indirect Materials $10,000 Indirect Labor Other Mfg. OH Underapplied 5,000 48,000 $3,000 Applied Applied Overhead $60,000 $3,000 Adjusted to COGS
3. Charging direct labour costs Work in process inventory Wages payable
xxxx
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7. Sale of goods Cost of goods sold Finished goods inventory Accounts receivable Sales revenue 8. Adjust underapplied overhead Cost of goods sold Manufacturing overhead Dr xxxx Cr xxxx xxxx xxxx
Lecture example 4
The following information is provided in relation to Shanker Corporation for January . (1) Opening balances: Raw materials inventory $10,000 Work in process inventory $24,000 Finished goods inventory $53,000 (2) Closing balances: Work in process inventory $32,000 Finished goods inventory $26,000 (3) (4) (5) (6) Raw materials were purchased for $63,000. Direct labour costs of $75,000 were incurred at a rate of $15 per hour. Manufacturing overhead was applied at a rate of $13.20 per direct labour hour. Actual manufacturing overhead costs incurred during January were $71,000 (including $50000 indirect labour and $21000 office supplies inventory). (7) Jobs were sold during the month for $345,000. The cost of goods sold during the month was $222,000. Complete the relevant T- accounts (provided on next page) to show the flow of costs and prepare relevant journal entries.
Lecture example 4 solutions Raw Materials

O/B 10000 RM used 62000 C/B 11000 Purchases 63000 Acc payable
Work in Progress
O/B 24000 RM 62000 DL 75000 FGs 195000 O/B WIP C/B 32000
Finished Goods
53000 COGS 222000 195000 C/B 26000
MOH 66000*
COGS
FGs 222000 MOH(Adjustment) 5000
Manufacturing OH
Wages P . 50000 WIP 66000* Office sup. 21000 COGS(Adjustment) 5000
Account Receivable
Sales 345000
xxxx xxxx
Wages Payable
WIP 75000 MOH 50000
Accounts payable
RM Purchases 63000
Sales Revenue
AR 345000
Office supplies
MOH 21000
(Or the reverse entry if overhead is overapplied)
*T otal DL hours = 75000/15=5000 hrs MOH=$13.2*5000=66000

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1. Purchase of materials Dr Raw material inventory Cr Account payable 63 000 63 000

5. Completion of production
Dr Finished goods inventory 195 000 Cr Work in process inventory 6. Sale of goods 195 000
Additional Example
Abbotsford Ltd has supplied the following information to its new management accountant for the month of March.
Account Raw materials WIP Opening balances $12, 000 $12,500 $65,000 Closing Balances $18,000 $26,800 $32,000
2. Transferring direct material to jobs Dr Work in process inventory 62 000 Cr Raw material inventory 3. Charging direct labour to jobs Dr Work in process inventory 75 000 Cr Wages payable 4. Application of manufacturing overhead Dr Work in process inventory 66 000 Cr Manufacturing overhead
62 000
Dr Accounts receivable Cr Sales revenue Dr Cost of goods sold Cr Finished goods inventory
345 000 345 000 222 000 222 000
Finished Goods
75 000
7. MOH actually incurred 71 000 50 000 Dr Manufacturing overhead Cr Wage payable 8.inventory Adjust underapplied overhead Cr Office supplies 21 000 Dr Cost of goods sold Cr Manufacturing overhead
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66 000
1. Overhead is applied on the basis of $6 per direct labour hour (8000 DL hours incurred) 2. Jobs during the period were sold for $250,000. 3. The cost of goods sold during the month was $200,000. 4. Indirect materials worth $1,500 were issued (from RM account) to production during the month. 5. Regular hourly rate is $10. A total of 7,500 labour hours were worked during normal working hours. Employees also worked an additional 500 hours of overtime during the month. Overtime is paid at a rate of 150% of the normal hourly rate. 6.Sundry manufacturing overhead costs incurred during the month were $38,000. 5000 5000
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Required: Complete the T-accounts provided and prepare relevant journal entries.
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solutions Raw Materials

O/B 12 000 RM used 53 300 O/B MOH 1500 C/B 18 000 Purchases 60800 Ac Payable
Solutions
Finished Goods
O/B 65000 COGS 200000 WIP 167000 C/B 32000
Work in Progress
12500 FGs 167000 C/B 26800 RM 53 300 DL 80 000*
1. Purchase of materials Dr Raw material inventory Cr 60 800 60 800 2. Transferring direct material to jobs Dr Work in process inventory 533 000 Cr Raw material inventory 3. Charging direct labour to jobs Dr Work in process inventory 80 000 Cr Wages payable 4. Application of manufacturing overhead Dr Work in process inventory 48 000 Cr Manufacturing overhead
Account payable
Solutions
5. Completion of production Dr Finished goods inventory Cr Work in process inventory 6. Sale of goods Dr Accounts receivable Cr Sales revenue Dr Cost of goods sold Cr Finished goods inventory 167 000 167 000
MOH 48 000
COGS
FGs 200000
Manufacturing OH
Credit to Miscellaneous account
533 000
250 000 250 000 200 000 200 000
MOH 6000
Sundry 38000 A/P RM 2500** 1500
WIP
48000
COGS 6000
80 000
Wages Payable
WIP 80000* MOH 2500**
Accounts payable
RM Purchases 60800
Sales Revenue
A/R 250 000
48 000
*DL = $10*8000hrs= 80000 **MOH for overtime premium=$5*500 = 2500

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Solutions
7. MOH actually incurred Dr Manufacturing overhead Cr Wage payable Cr Raw material inventory Cr Miscellaneous account 8. Adjust overapplied overhead Dr Manufacturing overhead Cr Cost of goods sold 42 000 2 500 1 500 38 000
From lecture 2: Types of product costing systems

Welcome to ACCG200 Lecture 3
Base on the nature of production environment Job costing system a costing system that assigns manufacturing (or product-related) costs to individual jobs.
6 000 6 000
Process Costing
Process costing system a costing system that assigns all production costs to processes or departments, and averages them across all units produced
Dr. Ranjith Appuhami Department of Accounting and Corporate Governance

Note: Many businesses use a combination of job and process costing, which is called hybrid costing
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Quick Check Process costing is used for products that are:

a. Different and produced continuously . b. Similar and produced continuously . c. Individual units produced to customer specifications. d. Purchased from vendors.
Similarities Between Job-Order and Process Costing

Both systems assign material, labour, and manufacturing
Flow of Costs in Process Costing
overhead costs to products and they provide a mechanism for computing unit product costs.
Both systems use the same manufacturing accounts,
including Manufacturing Overhead, Raw Materials, Work in Process, and Finished Goods.
The flow of costs through the manufacturing accounts is
basically the same in both systems.
Direct Labor and Manufacturing Overhead (Conversion Costs)
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T-Account and Journal Entry Views of Process Cost Flows
Process Cost Flows: The Flow of Raw Materials (in T-account form)
Raw Materials
Direct Materials
For purposes of this example, assume there are two processing departments Departments A and B. We will use T-accounts and journal entries.
Work in Process Department A

Direct Materials
Process Cost Flows: The Flow of Raw Materials (in journal entry form)
Work in Process - Department A Work in Process - Department B Raw Materials XXXXX XXXXX XXXXX
Work in Process Department B

Direct Materials
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Process Cost Flows: The Flow of Labour Costs (in T-account form)
Salaries and Wages Payable
Direct Labour
Process Costing: The Flow of Labour Costs (in journal entry form)
Process Cost Flows: The Flow of Manufacturing Overhead Costs (in Taccount form)

Direct Materials Direct Labour
Work in Process - Department A Work in Process - Department B Salaries and Wages Payable
XXXXX XXXXX XXXXX
Actual Overhead Overhead Applied to Work in Process

Direct Materials Direct Labour
Direct Materials Direct Labou r Applied Overhead

Direct Materials Direct Labour Applied
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Process Cost Flows: The Flow of Manufacturing Overhead Costs (in journal entry form)
Process Cost Flows: Transfers from WIPDept. A to WIP-Dept. B (in Taccount form)
Work in Process Department A Direct Transferred Materials to Dept. B Direct Labor Applied Overhead Work in Process Department B Direct Materials Direct Labor Applied Overhead Transferred from Dept. A
Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in journal entry form)
Work in Process - Department XXXX B X Work in Process Department A
Work in Process - Department A Work in Process - Department B Manufacturing Overhead
XXXX X XXXX X XXXX X
XXXX X
Department A
Department B
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Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (in Taccount form)
Work in Process Department B Direct Cost of Materials Goods Direct Manufactured Labor Applied Overhead Transferred from Dept. A Finished Goods Cost of Goods Manufactured
Process Cost Flows: Transfers from WIP-Dept. B to Finished Goods (in journal entry form)
Finished Goods Work in Process Department B XXXX X XXXX X
Process Cost Flows: Transfers from Finished Goods to COGS (in Taccount form)
Work in Process Department B Finished Goods
Direct Cost of Cost of Cost of Materials Goods Goods Goods Direct Manufactured Manufactured Sold Labor Applied Overhead Transferred Cost of Goods Sold from Dept. A Cost of Goods Sold
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Process Cost Flows: Transfers from Finished Goods to COGS (in journal entry form)
Cost of Goods Sold Finished Goods XXXX X XXXX X
Process costing: calculation of product costs

Process costing system accumulates the cost of each process then average these costs across all units produced.
.
Process costing with no beginning and ending WIP inventory

Two main steps to calculate product costs 1. Accumulates total costs of the production processes
Cost in each production process = DM +DL+MOH; T otal manufacturing costs = costs from all production processes. 2.Calculate the average cost per unit by dividing total costs of the processes by the number of units produced
Product cost/unit = T otal manufacturing costs / T otal no. of units produced
Two scenarios: 1) Process costing with zero beginning and ending WIP inventory; 2) Process costing with some beginning and ending WIP inventory
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Lecture Example 1
Pencil Ltd produced 60 000 pencils in August, with the following manufacturing costs incurred. There is no beginning and ending WIP . Direct labour Direct materials Manufacturing OH Total manufacturing cost $1 000 $1 800 $2 600 $5 400
Lecture Example 2
Stanmore Chemicals Ltd produces chemical called Super Clean, in two- litre containers. In July the company produced 140 000 liters of Super Clean mixture, which was packed into 70 000 containers. Production takes place in two departments: Mixing and Packing. The manufacturing costs for each department for July were provided in the table. There is no beginning and ending WIP inventory. Cost item Direct Materials Direct Labour Manufacturing Overhead Mixing $50 000 24 000 14 400 Packing $10 000 8 000 4 800

1. Calculate the cost per container Step1: cost in mixing department = 50000 + 24000 +14400=88400 cost in packing department = 10000 +8000+4800=22800
Total manufacturing cost = 88400+22800=111200
Calculate the cost per pencil produced in August:
= $ 5400/60000 = $0.09 ( 9 cents each)
Required: 1. What is the cost per container for Super Clean? 2. Complete the T-accounts provided and prepare journal entries to record the production costs for July
Step 2: Average cost per unit = total cost/ total units produced =1 1 1200/70000 = $1.59/container
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2. T-accounts
WIP Mixing Department DM DL MOH 50 000 24 000 14 400
to Packing department 88 400 T ransferred from Mixing 88 400

2. Journal entries
a). Usage of raw materials, direct labour and overhead in Mixing dept.

c). Usage of raw materials, direct labour and overhead in Packing dept
WIP Packing Department DM 10 000

Transf 8 000 erred
Finished Goods
M D LOH 4 800
FGs 111 200
WIP 111200
COGS 111200
b). Completion and transfer of super clean mixture from Mixing to Packing Dept.
d). Completion and transfer of completed Super Clean from Packing Dept to Finished Goods.
Cost of Goods Sold

FGs 111200
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Process costing with some beginning and ending WIP inventories

When there are partially completed units on hand at the beginning or end of the period, product costs will relate to units that are: Units started in the previous period (beginning WIP) and completed in the current period; Units started and completed during the period; Units that are incomplete at the end of the period (ending WIP).
Key concept: Equivalent units

Definition: the number of whole units that could have been completed if all the work during the period had been used to produce whole units. For example, two units that are 50% complete are the equivalent of one unit of fully completed.
Quick Check
For the current period, Jones started 15,000 units and completed 10,000 units, leaving 5,000 units in process 30 percent complete. How many equivalent units of production did Jones have for the period? a. 10,000 10,000 units + (5,000 units 0.30) b. 11,500 = 11,500 equivalent units c. 13,500 d. 15,000
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No. units 150 1000
% of completion 30% 80%
Equivalent units 45 800
Partially completed goods at the beginning or end of the period need to be converted to equivalent units.
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Treatment of Direct Labour

Direct Materials Direct Labour Manufacturing Overhead
Treatment of Direct Labour

Direct Materials Dollar Amount Conversion
Direct Labour
Assumptions
1. Direct materials are added at the beginning of the process. So, once a unit is started, it will have 100% of the required direct materials. 2. Conversion costs are incurred uniformly in the process.
Direct labour costs may be small in comparison to other product costs in process cost systems.
Direct Labour T ype of Product Cost
T ype of Product Cost
Direct labour and manufacturing overhead may be combined into one classification of product cost called conversion costs.
Dollar Amount
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Lecture example 3
During January 10 000 cameras are placed into production. Only 9000 cameras are fully completed and transferred out at the end of the month. Percentage of completion of remaining 1000 cameras is: Direct material (DM) cost - 100% and conversion cost 50%. What are the total equivalent units for DM and conversion cost?

Item Physical units 9000 1000 % of completion DM 100% 100% Equivalent units Conversion 9000 500 9500 Conversion DM 100% 50% 9000 1000 10000
Weighted average method to calculate product costs

Weighted average method averages the cost of opening WIP inventory with current production costs to determine the cost of completed production and closing WIP Four steps: Step one: analyse the physical flow of units
Physical units in beginning WIP
Completed units Ending WIP
Total equivalent units
Physical units started
Physical units completed and transferred out
Physical units in ending WIP
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Step two: calculate the equivalent units
The equivalent units in beginning WIP are not identified separately; this is a key feature of the weighted average cost method

Step three: calculate the unit costs
Lecture example 4
ABC Ltd produces toys with the following information relating to activities in March: Beginning WIP: 4000 units (Degree of completion: DM 100% and conversion cost-75%). Costs include: DM $220,000; Conversion cost $66,000. Production started: 25,000 units Production completed and transferred out: 24000 units Ending WIP inventory: DM- 100% completed and conversion cost 40% completed. During March DM used $1404,000; Conversion cost incurred: $506,000. The company uses weighted average cost to allocate costs to production. Determine the cost of goods completed during the month and cost of the WIP inventory on 31March.
The cost per equivalent unit for direct material is the total direct material costs divided by the total equivalent units for direct material; The cost per equivalent unit for conversion cost is the total conversion cost divided by the total equivalent units for conversion.
Equivalent units completed and transferred out
Equivalent units in ending WIP
Note: Under the weighted average method the cost per equivalent unit is based on the total costs incurred including the cost of beginning WIP
T otal equivalent units
Step four: Analyse the total costs

DM? Conversion? i) cost of goods completed and transferred out; ii) cost of ending WIP
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Lecture example 4
Step 1: analyse the physical flow of units
Lecture example 4
Lecture example 4
Step 4: analyse the total costs
Cost of goods completed and transferred during the month
DM Conversion $66,000 506,000 572,000 26000 $22 Total
Physical units started
= =
Step 3: Calculate the unit costs

WIP inventory, 1 March Costs incurred during the month Total costs accounted for Equivalent units Cost per equivalent unit $220,000 1404,000 1624,000 29000 $56
4000
+ 25000
24000
5000
Step 2: calculate the equivalent units

T otal equivalent units
= 24000 units $56 +24000 units $22 = $1872,000 or 24000 units $78 = $1872, 000 Cost of WIP inventory on 31 March = DM cost + Conversion cost = 5000 units $56 + 2000 units $22 = $324,000
equivalent units completed and transferred out
Equivalent units in ending WIP Equivalent units
physical units Units completed & transferred out during month Ending WIP units Total equivalent units 24000 5000
% of DM completion 100% 100%
% of conversion completion 100% 40%
DM
Conversion
$78
24000 5000 29000
24000 2000 26000
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Lecture example 5
Smith T oys Ltd manufactures wooden toys. The following information relate to its production activities in May. WIP on 1 May: 225 units (DM 100% completed; Conversion costs 60% completed); Costs include: DM $1800, Conversion cost $810. Production started: 275 units Production completed and transferred out: 400 units Ending WIP inventory: DM 100% completed; Conversion costs 50% completed. During May DM used $1980; Conversion costs incurred $1638; Required: Determine the cost of goods completed during the month and cost of the WIP inventory on 31st May.

Step 1: analyse the physical flow of units

=
+ Physical units
started
Step 3: Calculate the unit costs

DM Conversion $ 810 1 638 2448 450 $5.44 Total WIP inventory, 1 May Costs incurred during the month Total costs accounted for Equivalent units Cost per equivalent unit $1800 1980 3780 500 $7.56
225
275
400
= 100
Step 2: calculate the equivalent units

Equivalent units % of DM physical % of units completion conversion completion 100% 400 100% 100% 100 50% DM Conversion
$13
Units completed during month WIP units,31 May Total equivalent units
400 100 500
400 50 450
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Step 4: analyse the total costs
Cost of goods completed and transferred during the month = 400 units $13 = $5 200 Cost of WIP inventory on 31 March = DM cost + Conversion cost = 100 units $7.56 + 50 units $5.44 = $1028
What are Service Organisations?
ACCG200 Lecture 4
SERVICE COSTING Chapter 6
Organisations that deliver help, utility or care; provide an experience, information or other intellectual content; and the majority of the value is intangible rather than residing in any physical products Examples include legal firms; accountants; banks; hotels; hairdressers; etc.
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Relevance of service costing

Differences between Service and Manufacturing Businesses

Service Manufacturing
Most service outputs are intangible Most products are tangible Service outputs are often heterogeneous Services are consumed as they are produced; and cannot be stored Products are either homogeneous or heterogeneous Products are stored as inventory until they are sold
The value chain in service firms
Assess service profitability Decide which service to produce (short-term decisions) Set service prices (fees) Plan and control costs
*Please note that merchandisers such as retail and wholesale businesses are also part of the service sector while they do not fit comfortably with the definition and distinguishing features of service organizations.
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Purpose of service costing system and cost of service 1) Internal reporting (management decision making) All
upstream and downstream costs and production costs
2)
Types of service organizations and costing systems
Types of service costing systems (procedures)

Base on the nature of service production environment Job costing system the cost object is a distinct service called a job. E.g., advertising campaign, audit engagements, legal cases Professional services
External reporting (financial accounting)

No inventory to value, so the influence of external reporting requirements is not relevant Individual service costs are usually not accumulated separately in the general ledger Costs are hidden in operating expenses, not in cost of goods sold (COGS) in income statements
Process costing system A mass of an identical service is produced over many periods. E.g., postal delivery by Australian Post and Deposit processing at Westpac Mass services Both Job costing + process costing (Hybrid) produce both a mass of identical service and distinct service - Service shops
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Lecture example 1
Determine the types of service organizations and the most appropriate costing system for each of the following firms:
Name An accounting firm An advertising agency An electricity supplier A law firm A management consulting firm A telecommunication company An automotive repair shop Airline ticketing counter Service type Professional service Professional service Mass service Professional service Professional service Mass service Service shop Mass service costing system Job costing Job costing Process costing Job costing Job costing Process costing Hybrid costing Process costing
Job costing for professional services

1.
Lecture example 2
T aylor & Associates, a consulting firm, has the following condensed budget for 2010. The firm has a single direct cost category (professional labour) and a single indirect-cost pool (client support). Indirect costs are allocated to jobs on the basis of professional labour costs.
Trace direct costs of the job (service) - Direct labour professional labour costs
Direct materials are relatively insignificant and be treated as indirect material under overhead
2.
Apply overhead costs to the Job (service)
using a predetermined (budgeted) overhead rate;
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Lecture example 2 (Cont.)

The firm provides a consulting job for Red Rooster, a fast-food chain specialising in chicken. The breakdown of professional labour on the job is as follows:
Profession labour category Director Partner Associate Assistant Hourly rate $200 100 50 30 Hours consumed 6 12 60 150

1. Predetermined overhead rate = Budgeted Indirect Costs/ Budgeted direct Labour costs = $13,000,000 $5,000,000 = 260% of professional labour costs 2. Direct costs: Director, $200 6 Partner, $100 12

3) How much will the firm charge for the job if it is to earn its 40 per cent profit margin to total cost. Service fees charged = total cost + 40% profit margin = 35640 + 40% 35640 = $49896
Required: 1) Compute the 2010 budgeted indirect-cost rate/predetermined overhead rate for the firm; 2) Compute the cost of the Red Rooster job; 3) How much will the firm charge for the job if it is to earn its 40 per cent profit margin to total cost.
$ 1,200 1,200 Associate, $50 60 3,000 4,500 Assistant, $30 150 Indirect/OH costs: Consulting support, 260% $9,900 T otal costs $ 9,900 25,740 $35,640
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Lecture example 3
Based on the information in lecture example 2, if the firm uses a chargeout rate of $180/professional labour hour and 260 professional labour hours were actually worked on this job. How much will the firm charge the job? Explain the key differences between the method used in example 2 and example 3. Service fees charged = 180 260 = $46800 Key difference between the method used in example 2 and 3.
In example 2 a costing system is applied. Service fees charged are determined based on the total cost plus a target profit margin. In example 3 a billing system is applied. The billing system estimates fees based on a chargeout rate per billable hour. This rate is then multiplied by the actual hours worked on the service. The chargeout rate is set to cover the cost of labour and overheads, and a profit margin.
MCQ example
If the engineer worked for 20 hours on a job, Z, and the overhead is 125 per cent on direct labour cost and the direct labour rate was $25 per hour, what is the total cost of the job?
A.$500 B.$625 C.$1000 D.$1125
Accounting for under/over applied overhead. For the purpose of preparing income statements,
under/over applied overhead must be adjusted to income statement at the of accounting period. For the purpose of making management decisions (e.g., pricing and controlling), there will be no requirement to adjust the service costs for under/over applied overhead. Service costs are shown as line item operating expenses, not COGS, in income statements.
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Process costing systems for mass services

Two main steps Accumulates total cost of delivering services
Lecture example 4
ATS is a major provider of texts and stationary to secondary schools throughout South Australia. Students orders to ATS go through 3 stages: a)Order is received from the school and entered into the ATS inventory order system. b)Books and stationary required to fill the order are drawn from inventory, packed and dispatched to the student. c) Payment is received from the student and processed
Lecture example 4 cont.

The costs of these 3 processes in the year just ended are listed below. During the year ATS processed 22000 student orders.
Calculate the average cost per service by dividing the total cost of the process by the number of services delivered.
Required: 1) Calculate the total cost per order 2) Does the total cost per order provide a reliable estimate of the costs incurred to process each order?
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1.Calculating cost per order and total costs T otal costs = $564 500 + $520 000 + $396 000 = $1480 500 T otal cost per order = 1480 500 / 22000 = $67.30 2.Does the total cost per order provide a reliable estimate of the costs incurred to process each order?
No. Because the greatest variation is likely to occur in the content of each order. For instance, the weight of each package of books dispatched and the distance that they are freighted could be significantly different amongst different orders.
When should firms estimate their service costs?

No external reporting requirements to estimate individual service costs Service costing systems will be implemented where benefits exceed costs Cost and benefits are influenced by Complexity of the costing system Accuracy of the service cost information Relevance of service cost information to managing resources and creating value
A CLOSER LOOK A T OVERHEAD COSTS
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A closer look at overhead cost aT ll o c to is o n h re ea p s ible approaches
A Plantwide Rate
A plantwide rate is a single overhead rate that is calculated for the entire production plant Three steps:
1. Identify the overhead cost driver/allocation base 2. Calculate the overhead rate per unit of cost driver:
Pre. MOH rate= T otal budgeted MOH/budgeted level of cost driver
Lecture example 1
Grand stands Ltd manufactures sheet music stands in two separate departments: Cutting and Welding. The following data relate to the year just ended:
A plantwide rate Departmental rates Activity-based costing (6 lecture)
3. Apply the manufacturing overhead cost to the product

Applied MOH= Pre. MOH rate actual level of cost driver consumed
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The following information is related to the production of one unit product A and B.
Lecture Example 1 Solutions

a) Based on direct labour hours
Predetermined plantwide rate
= budgeted MOH cost / budgeted level of cost driver = $120 000 / 30 000 direct labour hour = $4 per labour hour

b) Based on machine hours
Predetermined MOH rate
= budgeted MOH / budgeted machine hours = $120 000 / 80 000 = $ 1.5 per machine hour
Amount of overhead cost allocated/applied

= Pre. MOH rate x Actual direct labour hours consumed by the product Required: Calculate manufacturing overhead cost of the product A and B using: a) Predetermined plantwide rate based on direct labour hours b) Predetermined plantwide rate based on machine hours Product A = 4 X 5 = $20 Product B = 4 X 6 = $24
Amount of overhead cost allocated

= Pre. MOH rate x actual machine hours consumed by the product Product A = 1.5 X 6.5 = $ 9.75 Product B = 1.5 X 9 = $ 13.5
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Departmental overhead rates

Departmental overhead rates recognise that overheads in each department may be driven by different cost drivers. Two-stage cost allocation for departmental overhead rates:
Stage one - MOH costs are assigned to production departments:
Step 1. All manufacturing costs are distributed to each department, including
both production and support departments. Step 2. Support department costs are reassigned to the production departments
Departmental overhead rates

Stage two: Allocation of MOH costs from production departments to product.
Pre.MOH rate for each department For each product MOH costs applied in each department Actual cost driver = Pre. MOH rate consumed in the depart. for the depart.
Budgeted MOH costs of the department
Lecture example 2
Using the information given in lecture example 1, calculate overhead costs for Product A and Product B using departmental rates based on: Direct labour hours for Cutting department and Machine hours for Welding department.
Budgeted level of cost driver of the department
Stage two - MOH accumulated in production departments are applied to products
T otal MOH cost applied to the product = Applied MOH from all departments
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The following information is related to the production of one unit product A and B.
Lecture Example 2 solutions

Pre. MOH rate Cutting dept
Budgeted MOH costs in the cutting department

For product A: MOH costs applied in Cutting = $2 4 labour hours = $8 MOH costs applied in Welding = $1.25 4 machine hours = $ 5 T otal applied MOH costs for product A = 8 + 5 = $13 For product B: MOH costs applied in Cutting = $2 4.5 labour hours = $9 MOH costs applied in Welding = $1.25 6 machine hours = $7.5 T otal applied MOH costs for product B = 9 + 7.5 = $16.5
Budgeted labour hours in the cutting department
= 40,000/ 20,000
= $2 per labour hour
Budgeted MOH costs in the Welding department Pre. MOH rate Welding dept= Budgeted machine hours in the Welding department
= $80,000 / 64,000
= $1.25 per machine hour
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Allocating support department costs to production departments (Stage 1 step 2)

This process informs production departments managers of the cost of the services provided by support departments, and assists them to plan and control their use of services. Allocation methods include
ST AG E ONE
O ve r h e a d cost s a r e assig n ed to p ro d u c tio n d e p a rt m e n ts
Step2
Lecture example 3
Quality Cont r ol D _e _ _ a_ p rt _ m _ e_ n_ t _ _.
S u p p o r t depar t m ent s
r
/
Step 1 M an u fac tu rin g o ve r h e a d d i s t r i b u t i o n (General m anuf ac t ur ing ov er head c o s t s are dis t r ibut ed t o a// depar t m ent s )
Material H andl i n g D -e _p _a _ r t_ m _e_ n_ t
E qui pm ent Maint enanc e D _ e _ p _artm _e _ _t n
1
1
Su p p o rt d e p a rtm e n t c o s t al l ocati on (S uppor t depar t m ent c o s t s are alloc ated t o t h e pr oduc t i on depar t m ent s .)
The Smith Company has 4 departments in its factory . Two Service Dep: Plant maintenance (S1) and Information system (S2 ), Two Production Dep: Machining ( P1) and Assembly (P2). The budgeted overhead costs incurred in each dep. are given as follows: S1 S2 P1 P2 $84,000 $96,000 $100,000 $150,000 The following table provides the usage of the two support departments output Service Service Provided to: provided by: S S P P
1 2 1 2
-
P r oduc t i on depar t m ent s B endi ng D epar t m ent W elding D epar t m ent
Direct: support department costs are allocated directly to production departments Step-down: partially recognises the services provided by one support department to another Reciprocal services: fully recognises the provision of services between support departments
I
-
S1 S2
20%
30% -
30% 60%
40% 20%
ST AG E TW O
O ve r h e a d co sts are applied t o p ro d u c ts
Ov e r h e a d application (All c o s t s a c c u m u l a t e d in t he pr oduc t i on depar t m ent s are appl i ed t o p r o d u c t s .)*
. 1 . P r od uct s p a ss t hrough product i on d e p ar t m ent s l
>
Required: Allocate the budgeted OH costs from support dep. (S1 and S2) to production dep. (P1 and P2), using the direct method, step-down method and reciprocal method
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Example 3 Solutions- Direct method

Service provided by: S1 $84,000 Allocate S1 ($84,000) Service Provided to: S2 $96,000 30% P1 $100,000 30% (x3/7) 36,000 60% (6/8) 72,000 $208,000 P2 $150,000 40% (x 4/7) 48,000 20% (2/8) 24,000 $222,000
Step-down method
Example 3 Solutions-Step-down method

Service provided by: S1 $84,000 Allocate S2 20% 19,200 Allocate S1 (103,200) Total OH costs of production dep. 30% Service Provided to: S2 $96,000 (96,000) P1 $100,000 60% 57,600 30% (x3/7) 44,229 $201,829 P2 $150,000 20% 19,200 40% (x 4/7) 58,971 $228,171
Rule 1: Firstly allocate the support department that provides services to the largest number of other su d epp ao rtr m t ents. A
B C
Allocate S2
20%
($96,000)
Rule 2: If they are equal, allocate the support department with the largest overhead costs first.
A = $56,000 B= $83,000
Total OH costs of production dep.
Note: Once a support departments costs have been allocated you do not allocate costs back to that support department.
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Example 3 Solutions - Reciprocal method

Service provided by: S1 $84,000 Allocate S1 Allocate S2 20% Service Provided to: S2 $96,000 30% P1 $100,000 30% 60% P2 $150,000 40% 20%

Step 2: solve the simultaneous equations:
S1 = 84,000 + 0.2 S2 - equation (1) S2 = 96,000 + 0.3 S1 - equation (2) Substitute equation (1) into equation (2): S2 = 96,000 + 0.3 [ 84,000 + 0.2S2] S2 = 96,000 + 25,200 + 0.06S2 0.94S2 = 121,200 S2 = $128,936.17 Substitute into equation (1) to find S1 S1 = 84,000 + 0.2 x 128,936.17 = $109,787.23

Step 3: allocate total OH costs (new S1 and S2 from Step 2) from support departments to production departments
Service provided by: Service Provided to: S1 $84,000 (109,787.23) (0.20) 25,787.24 0 S2 $96,000 (0.30) 32936.17 (128,936.17 ) 0 P1 $100,000 (0.30) 32936.17 (0.60) 77,361.7 $210,298 P2 $150,000 (0.40) 43914.89 (0.20) 25,787.24 $219, 702
Allocate S1 Allocate S2 Total OH costs of production dep.
Step 1: specify a set of equations that express the relationships between the departments ( 1 equation for 1 support department)
S1= 84000 + 20%S2 S2= 96000 + 30%S1
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Comparison of the three methods

Which allocation method is best? And why?
The reciprocal method is the best approach from a conceptual viewpoint. Reasons: Direct method fully ignores services provided between support departments. Step-down method partially recognizes the provision of services between support departments. Reciprocal method fully recognizes the provision of services between support departments.
Lecture example 4
The Dexter Manufacturing Company has two production departments (P1 and P2) and two service departments (S1 and S2). The usage of the two service departments is as follows:
Service provided by: S1 $90,000 Allocate S1 Allocate S2 20% Service Provided to: S2 $50,000 10% P1 $200,000 60% 40% P2 $250,000 30% 40%
Example 4 Solutions- Direct method

Service provided by: S1 $90,000 Allocate S1 ($90,000) Service Provided to: S2 $50,000 10% P1 $200,000 60% (x6/9) 60,000 40% (x4/8) 25,000 Total OH costs of production dep. $285,000 P2 $250,000 30% (x 3/9) 30,000 40% (x4/8) 25,000 $305,000
Allocate S2
20%
($50,000)
Required: Allocate the overhead costs from support dep. (S1 and S2) to production dep. (P1 and P2), using the direct method and step-down method.
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Example 4 Solutions - Step-down method

Service provided by: S1 $90,000 Allocate S1 (90,000) Service Provided to: S2 $50,000 10% 9,000 Allocate S2 20% (59,000) P1 $200,000 60% 54,000 40% (x4/8) 29,500 $283,500 P2 $250,000 30% 27,000 40% (x 4/8) 29,500 $306,500
Reminder
The 1st Excel assignment will be due by 6pm on Monday 6th of January 2014
Activity-based costing (ABC)

Chapter 8
Total OH costs of production dep.
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Features of Conventional product costing systems
Problems with conventional product costing systems

Conventional product costing systems are likely to result in inaccurate product costs when: the proportion of manufacturing overhead costs not related directly to production volume increases; non-manufacturing costs that are product-related become substantial; product diversity increases.
Conventional product costing systems

Assume that T oyota Motor Manufacturing in Australia produces three types of automobiles, with the following cost and production information:
Avalon Per Unit Cost Information Direct Materials Direct Labour Manufacturing Overhead Annual Production Information Units Produced (in thousands) Direct Labour Hours Per Unit Camry Camry Hybrid Total
Direct material & direct labour costs are traced to products; MOH costs are allocated to products using a predetermined overhead rate: a plantwide rate or department overhead rates; Predermined overhead rate is calculated using a volume- based cost driver; Non-manufacturing costs are not assigned to products.
8,000 2,800 ?
7,000 2,400 ?
6,500 2,400 ?
500 100 350 50 35 30 30 15,500 Total Direct Labor Hours (in thousands) 3,500 10,500 method 1,500is to a ssign the The purpose of the cost allocation
indirect or manufacturing overhead costs to each product.

2 3
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4-7

The total manufacturing overhead cost for Australian plant is estimated at $3,720,000 (in thousands) per year. In our example, this cost will be assigned to the three products on the basis of direct labour hours. The first step is to calculate the predetermined overhead rate. Estimated T otal Predetermined Manufacturing Overhead Cost = MOH Estimated Units in the Rate Allocation Base
Predetermined MOH Rate

T o assign manufacturing overhead costs to the individual products, we multiply the $240 overhead rate by the number of direct labor hours required for each product.
Avalon Annual Production Information Direct Labor Hours Per Unit Predetermined Overhead Rate Manufacturing Overhead Per Unit Number of Units Produced (thousan Total Manufacturing Overhead 35 $ 240 $ 8,400 100 $ 840,000 Camry 30 $ 240 $ 7,200 350 $ 2,520,000 Camry Hybrid 30 240 7,200 50 360,000 Total $ 3,720,000 $ $ $
Calculate Total Manufacturing Cost and Profitability

T o compute total manufacturing cost, we need to add the manufacturing overhead cost to the direct material and direct labour cost, which were provided earlier on a per unit basis.
Avalon Per Unit Cost Information Direct Materials $ 8,000 Direct Labour 2,800 Manufacturing Overhead 8,400 Total Manufacturing Cost Per Unit $ 19,200 Camry $ 7,000 2,400 7,200 $ 16,600 $ Camry Hybrid 6,500 2,400 7,200
$ 16,100
The Camry receives the most total manufacturing overhead cost because it is the
$3,720,000 = $240 per direct labor $15,500 hour
highest volume product and thus requires the most total direct labor hours.
This analysis shows that the Avalon is the most costly of the three models on a per unit basis. The Camry is the next most costly model, followed by the Camry-Hybrid.
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4-8
Calculate Total Manufacturing Cost and Profitability

If we subtract the total manufacturing cost per unit from the unit sales price, we get the gross margin for each product. Remember that gross margin only takes into account the manufacturing cost of the product, before selling and administrative costs such as distribution fees, advertising, dealer costs and profit, and corporate administration charges have been deducted.
Assumed Selling Price to the Consumer Less: Total Manufacturing Cost Per Unit Gross Profit Per Unit Gross Profit Margin (% of Sales) Avalon 28,000 19,200 $ 8,800 $ 31% Camry $ 18,000 16,600 $ 1,400 8% Camry Hybrid $ 35,000 16,100 $ 18,900 54%

ABC is a method of assigning indirect costs/overhead costs to products and services based on the activities they require.:
ABC is designed to provide managers with cost information for strategic and other decisions.
ABC is a good supplement to our traditional cost system
I agree!
Implementing ABC model
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4-12

Each

Recall that the total manufacturing overhead cost in our T oyota example was $3,720,000 (in thousands). Now we must assign this total cost to one of the four activity cost pools.
Select an Activity Cost Driver for Each Cost Pool

Machine hours will be used as the driver for the machining and installation activity . Number of set-ups will be used as the activity driver for the set-up activity . Engineering hours will be used as the driver to assign engineering and design costs. Inspection time will be used to assign quality control costs.
major activity has its own activity cost pool to which overhead costs are assigned;
Each
activity cost pool has its own cost driver (i.e. volume driven or non-volume driven);
A predetermined
overhead rate is computed for each activity cost
pool;
The
predetermined rates are used to apply overhead costs to products.
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Calculating activity rates

Activities Total activity costs $825 000 $795 000 $1 200 000 Cost driver Total activity level Activity rate
$55 per hour $795 per setup $200 per hour
Products consumption of activities

Avalon Machine Hours No. set-ups Engineering hours Inspection time/hour 3,000 400 1,200 2,700 Camry 10,500 350 600 18,00 Camry Hybrid 1,500 250 4,200 4,500 Total 15,000 1,000 6,000 9,000
Assign Activity Costs to Individual Products

T o complete the Stage 2 ABC allocations, we need to add up the cost of all four activities for each product line.
Avalon Machining and Installation Machine Set-Up Engineering and Product Design Quality Control Total Manufacturing Overhead Cost $ 165,000 318,000 240,000 270,000 $ 993,000 Camry $ 577,500 278,250 120,000 180,000 $ 1,155,750 Camry Hybrid 82,500 198,750 840,000 450,000 $ 1,571,250 Total $ 825,000 795,000 1,200,000 900,000 $ 3,720,000
Machining & installation Machine setups Engineering and Product Design Quality Control Total cost
Machine hours 15000 hours No. of set-ups Engineering hours Inspection time/hours
1000 set-ups 6000 hours
900 000 $3 720 000
9000 hours
$100 per hour
$55
x 3000 hours
$795
$200 $100
x 1200 hours
$825 000
15000 = $55
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x 400 set-ups
x 2700 hours
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4-18
Assign Activity Costs to Individual Products

T o calculate the cost per unit, we need to divide the total manufacturing overhead by the number of units of each product.
Avalon Camry Camry Hybrid Total 00
Comparison of conventional and ActivityBased Cost Systems

Traditional vs. ABC Costing Method
$35,000 $30,000
4-19
Calculate Total Manufacturing Cost and Gross Margin

The ABC analysis shows that the T oyota Camry is the most profitable product, with a 29.4% gross margin, compared to 26% for the Avalon and negative 15.2% for the Camry-Hybrid.
Avalon Direct Materials Direct Labor Manufacturing Overhead Total Manufacturing Cost Unit Selling Price to Customer Gross Profit Per Unit Gross Profit Margin (% of Sales) $ 8,000 2,800 9,930 20,730 28,000 $ 7,270 26.0% Camry $ 7,000 2,400 3,302 12,702 18,000 $ 5,298 29.4% Camry Hybrid $ 6,500 2,400 31,425 40,325 35,000 $ (5,325) -15.2%
$25,000
M anufacturing Overhead Cost Per Unit
$20,000
$15,000
$10,000
$5,000
$Traditional ABC
Avalon $8,400 $9,930
Camry $7,200 $3,302
Camry-Hybrid $7,200 $31,425
$28,000 - $20,730 = $7,270
$5,298 $18,000 = 29.4%
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Lecture example 1
Kestral manufacturing Ltd has estimated the following activity costs and activity drivers for the current period. Activities Machine set up Materials handling Product design Inspection Total cost Total activity costs $40 000 160 000 100 000 260 000 $560 000 Cost driver No. of set-ups No. of material removals Design hours No. of inspections Total activity level
400 set-ups 16000 removals 2000 hours 13000 inspections

Information for a particular job (job no. 42) completed during the period is as follows:
Direct materials Direct labour Units completed No. of set-ups No. of material removals No. of inspections No. of design hours $10 000 $4 000 200 2 60 40 20

1) Calculate cost per unit of activity driver for each of the four activities:
Activity Activity driver Total costs Total activity Cost per unit of level activity driver $40 000 400 $100/set-up 160 000 100 000 260 000 16000 2000 13000 10/material removal 50/design hour 20/inspection
Machine set up No. of set-ups Materials No. of material handling removal Prodcut design Design hours Inspection No. of inspections
Required: 1)Calculate the cost per unit of activity driver for each of the four manufacturing activities; 2)Calculate the total costs for job 42; 3)Calculate the cost per unit for job 42.
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2) Calculate the total costs for job 42: DM: 10 000 DL: 4 000 MOH: Costs for set-ups Costs for material removals Costs for inspections Costs for product design Total MOH T otal costs for job 42:
Lecture example 2- Past final exam question

Pitney Corporation manufactures two types of transponders (i.e. No. 156 and No. 157) and applies manufacturing overhead to all units at the rate of $76.50 per machine hour. Production information follows. The firm's total overhead is subdivided as follows: manufacturing setups, $260,000; machine processing, $2,400,000; and product shipping, $400,000.
Required: A.Compute the overhead rates that would be used for manufacturing setups, machine processing, and product shipping in an ABC system; B.Assuming using ABC, compute the unit overhead costs for No.156 and 157 if the expected manufacturing volume is attained; C. Assuming using ABC, compute the total cost per unit of product No. 156; D.f the company's selling price is based heavily on cost, would a switch to ABC from the current traditional system result in a price increase or decrease for product No. 156? Show computations.
2$100= 200 60$10=600 40$20=800 20$50=1000 $2600

Unit Unit
10000+4000+2600=16600
The controller, who is studying the use of activity-based costing, has determined that the firm's overhead can be identified with three activities: manufacturing setups, machine processing, and product shipping. Data on the number of setups, machine hours worked, and outgoing shipments, the activities' three respective cost drivers, follow.
3) Cost per unit in job no. 42 = 16600/200 = $83/unit

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A) Compute Overhead rate for each activity Manufacturing setups: $260,000 /100 setups = $2,600 per setup; Machine processing: $2,400,000 /40,000 Mhs = $60 per Mh; Product shipping: $400,000 /200 shipments = $2,000 per shipment. B) Compute the unit overhead costs for No.156 and 157 T otal overhead costs for No. 156 = $260060 + $60 15000 + $2000 120 = $1296,000 Unit overhead costs for No. 156 = 1296000/6000= $216 T otal overhead costs for No. 157 = $260040 + $60 25000 + $2000 80 = $1764,000 Unit overhead costs for No. 157 = 1764000/14000= $126

C) Compute the total cost per unit of product No. 156 Unit product cost for No. 156 = $40 + $25 + $216 = $281 D) For product No. 156 under conventional costing system, Unit overhead costs = Overhead rate/ Mhr Mhrs/ unit = $76.5 (15000 6000) = $191.25 Unit product costs = $40 + $25 + $191.25 = $256.25 Product No.156 is currently undercosted ($256.25 vs. $281.00), so a switch to activity-based costing will likely result in a price hike.
Activity-Based Costing and External Reporting

Most companies do not use ABC for external reporting because . . .
1. External reports are less detailed than internal reports. 2. It may be difficult to make changes to the companys accounting system. 3. ABC does not conform to GAAP . 4. Auditors may be suspect of the subjective allocation process based on interviews with employees.
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The benefits of ABC are the greatest when:

ABC Limitations
Substantial resources required to implement and maintain. Desire to fully allocate all costs to products. Resistance to change.
Overhead costs are a significant proportion of total cost; A large part of overhead is not directly related to production volume; The business has a diverse product range; Proportion of non-manufacturing costs is increasing relative to manufacturing costs; There are likely to be high costs associated with making inappropriate decisions, based on inaccurate product costs; The cost of designing, implementing and maintaining the ABC system is relatively low due to sophisticated IT support
Potential misinterpretation of unfamiliar numbers.
Cost Volume Profit Analysis Chapter 18

29
Does not conform to GAAP . Two costing systems may be needed.
1 Week 2 - Session 1, 2013
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Cost volume profit (CVP) analysis

It is a technique used to determine the effects of changes in an organisations sales volume on:

Assumptions underlying CVP analysis

Key concepts/tools

Costs Revenue Profit (Revenue Costs)
Aim: T o assist managers in making decisions to improve PROFITABILITY and increase shareholder value
The behaviour of total revenue is linear The behaviour of total costs is linear For both variable and fixed costs, sales volume is the only cost driver The sales mix remains constant In manufacturing firms, the levels of inventory at the beginning and end of the period are the same Thus, the number of units produced and sold during a period are equal
Contribution margin Breakeven Point (in sales units) Breakeven Point (in dollars) Safety margin Weighted average contribution margin (WACM)
Week 2 - Session 1, 2013
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Contribution margin
Unit contribution margin (UCM) = Unit sales price Unit variable costs Total contribution margin (TCM) =T otal sales revenues T otal variable costs Or = UCM No. of units sold Contribution margin ratio (CMR) = Unit contribution margin / unit sales price Contribution margin percentage (CMP) = Contribution margin ratio 100
Lecture example 1
ABC Ltd sold 6000 handbags at the price of $100. The costs to produce one handbag include: Direct materials worth $28 Direct labour of 1.5 hours @ $14 per hour Variable MOH of $16. T otal fixed costs are $48,000 Calculate: 1 The contribution margin per handbag 2 The Contribution margin ratio. 3 Contribution margin percentage 4 The total contribution margin.

1. The contribution margin per handbag = Unit sales price Unit variable costs = 100 (DM + DL+ Variable MOH) = 100 (28+ 1.514 + 16) = 100 65 = $35 2. The contribution margin ratio = UCM / Unit sales price = 35 / 100 = 0.35
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3. Contribution margin percentage = CMR 100 = 0.35 100 = 35% 4. The total contribution margin =T otal sales revenues T otal variable costs = 100 6000 65 6000 = $210,000 Or = UCM No. of units sold = 356000 = $210,000
Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the CM Ratio for Coffee Klatch? a. 1.319 CM Ratio = Unit contribution margin b. 0.758 Unit selling price c. 0.242 ($1.49 - $0.36) = d. 4.139 $1.49
= $1.13 = 0.758 $1.49
Breakeven point (BEP)

The point at which the volume of sales will result in:
T otal revenues T otal costs = 0 Two types of costs to consider: Variable costs Fixed costs T o breakeven we must sell enough units to cover both variable and fixed costs
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Breakeven point
Step 1: Calculate the Unit contribution margin (UCM)
The CVP Graph

$350,000
Quick Check
Profit Area
UCM = Unit sales price Unit variable costs

Step 2: Calculate breakeven point by using:
Break-even point
$300,000
$250,000
Breakeven point (in units) =
Fixed costs UCM Fixed costs
$200,000
Sales Total expenses

$150,000
Fixed expenses
Breakeven point (in dollars) = CM Ratio
$100,000
$50,000
$0
100
200
300
400
500
600
Loss Area
Units
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the break-even sales dollars? a. $1,300 b. $1,715 c. $1,788 d.
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Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the break-even sales dollars? a. $1,300 Break-even Fixed expenses = b. sales CM Ratio $1,300 $1,715 c. = 0.758 $1,788 = $1,715 d.
Lecture example 2
The promoters of The Voice want to know how many tickets they need to sell for the final concert to breakeven on all the costs associated with the production. The information you have been given is: Selling price = $100 per ticket T otal Fixed costs = $ 750 000 Variable costs = $25 per ticket How many tickets need to be sold to cover all the costs? And how much revenues must be generated to breakeven?

1. Breakeven point (in units) = Fixed costs UCM = 750 000 / (100 - 25)
= 750 000 / 75 = 10 000 units Fixed costs 2. Breakeven point (in dollars) = CM Ratio = 750 000 / (UCMUnit sales price) = 750 000 / (75100) = $1000 000
$3,129
Week 2 - Session 1, 2013 Week 2 - Session 1, 2013 Week 2 - Session 1, 2013
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Safety margin
Difference between the budgeted/actual sales revenue and breakeven sales revenue
E.g. To breakeven The Voice team must generate $100,000 revenues, while the budgeted sales revenues are $150,000. What is the safety margin? Safety margin = budgeted sales revenue breakeven sales revenue = 150,000 100,000 = $50,000
Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the margin of safety expressed in cups? a. 3,250 cups b. 950 cups c. 1,150 cups d. 2,100 cups
Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the margin of safety expressed in cups? a. 3,250 cups b. 950 cups cups c d. 1 2,15 00 ups Margin of safety = T otal sales Break-even sales = 2,100 cups 1,150 cups = 950 cups
Indicates the extent to which sales can decline before profits become zero
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Lecture example 3
A small theatre company (330 seats) has planned for 30 performances. On average 65% of seats will be sold. The sales price per ticket is $80 and variable costs per ticket are $30. Fixed costs are $320 000 in total. Calculate:
a. b. c.

a.
Target net profit

A desired profit level determined by management. The break-even formula can be used to determine the sales volume required to achieve a target profit:
The breakeven point in sales dollars = Fixed costs/ CM ratio = 320 000 / (UCM Unit sales price) = 320 000 / (50 80 = 0.625) = $512 000
b.
The breakeven point in sales dollars The safety margin for this production Calculate profit/loss using safety margin
The safety margin for this production Budgeted revenue = $80 x (330 seats x 0.65 x 30 performances) = $514 800 Safety margin = Budgeted revenue breakeven revenue = $514 800 - $512 000 = $2800
C
T arget sales volume (in units)= T arget sales volume (in dollars)=
Fixed costs + T arget profit UCM Fixed costs+ T arget profit CM Ratio
. Profit = Safety margin x CM ratio

= 2800 X 0.625 = 1750
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Lecture example 4
The promoters of The Voice want to know how many tickets they need to sell for the final concert to breakeven on all the costs associated with the production. The information you have been given is: Sales price = $100 per ticket T otal Fixed costs = $ 750 000 Variable costs = $25 per ticket How many tickets need to be sold to make a profit of $250 000? And how much revenues must be generated to achieve a profit of $250 000?

1.Target sales volume (in units)= Fixed costs + Target profit UCM
Including income taxes in CVP analysis

Sales volume (in units) required to earn target net profit after tax
= (750 000 + 250 000) / (100 - 25) = 1000 000 / 75 = 13333.3 = 13334 units (round up to the next integer) arget profit 2.Target sales volume (in dollars)= Fixed costs + T CM Ratio = 1000 000 /(75100) = $1333 333.3 = $1333 334
FC + T arget net profit before tax Unit contribution margin before tax ratio
Sales volume (in dollars) required to FC + T arget net profit = earn target net profit after tax Contribution margin
T arget net profit before tax = T arget net profit after tax / (1- tax rate)
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Lecture example 5 Quick Check

Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. Determine how many cups of coffee would have to be sold to attain target profits of $2,500 per month. a. 3,363 cups b. 2,212 cups c. 1,150 cups d. 4,200 cups
Quick Check
Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is sales $0.36. T he Unit average fixed expense per + month $1,300. T arget profit Fixed is expenses to attain = determine how rmula method to Use the o f Unitmany CM cups of target profit coffee w ould have to be sold to attain target profits of $2,500 + $1,300 $2,500 p er month. = $1.49 - $0.36 a. 3,363 cups b. 2,212 cups $3,800 = $1.13 c. 1,150 cups d. 4,200 cups = 3,363 cups
Information for ABC Ltd is provided below:

Selling price $ 10
Selling price Variable cost per unit: V ariable cost per unit: Manufacturing cost per unit Manufacturing cost per unit Selling cost per unit
Annual Fixed costs Annual Fixed costs Selling Selling Administration
$5 10 $ $ 1.40 5 $
$ 240 000
Selling cost per unit
$ 1.40
Administration
$ 380 240000 000 $ $ 380 000 $ 126 000

30% 30% $ 126 000
After tax net profit target
After tax profit target
Tax rate T ax rate
Required: Calculate number of units that need to be sold in 201 1 to achieve the target net profit after tax
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Sales volume (in units) required to = earn target net profit after tax
CVP analysis with multiple products
FC + target net profit before tax Unit contribution margin
Key terms:
Lecture Example 6
Healthylife Ltd produces three different frozen meals: Beef, Pork and Chicken meals.
Beef Sales mix 30% $8 $3 Pork 50% $7 $2.5 Chicken 20% $6 $2
Sales mix
Fixed costs = 240 000 + 380 000 = $ 620 000 T arget net Profit before tax = Net profit after tax / (1- tax rate) = 126 000 / (1 30%) = $180 000 Unit contribution margin = Unit sales price Unit variable costs = 10 (5 + 1.4) = $3.6 Sales volume required = 620 000 + 180 000 = 222 223 units 3.6
The relative proportions of each type of product sold by the organisation

Selling price/unit Variable costs
Weighted average unit contribution margin
The average of the products unit contribution margins, weighted by the sales mix.
e.g. The sales mix for Product A and B are 40% and 60% respectively. UCM = $10 for A and $15 for B Weighted average UCM = 40%10 + 60%15 = $13
Calculate the weighted average unit contribution margin
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TIPS: to calculate the weighted average UCM, you should always calculate the UCM for each product first, then take the sales mix into account.
Breakeven point with multiple products

Step 1:
Fixed costs Breakeven point (in units) = Weighted average UCM*
* to calculate the weighted average UCM, you should always calculate the UCM for each product first, then take the sales mix into account.
Lecture example 7
The Opera House has decided to offer seats at two different prices: VIP Seats: $700 per ticket with only 250 seats available Normal Seats: $270 per ticket with 2250 seats. Variable cost per unit is $100. Fixed costs are $310 000 Required: Calculate breakeven point in seats. Specifically, how many of each seat we need to sell to breakeven?
UCM (beef) = 8 3 = $5 UCM (pork) = 7 2.5 = $ 4.5 UCM (chicken) = 6 2 = $ 4 Weighted average UCM = 30%5 + 50%4.5 +20%4 = $4.55
Step 2: Breakeven point for each product (in units): The total breakeven units needs to be broken up in proportion to the expected sales mix.
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Calculate Weighted average UCM:
i) UCM of each product UCM of VIP seats = $700 100 = $600 UCM of Normal seats = $270 - $100 = $170 ii) Calculate Sales Mix T otal seats available = 2500 VIP seats = 250/2500 = 10% Normal seats = 2250/2500 = 90% iii) eighted average UCM = 600 10% + 17090% = $213

Calculate the breakeven point (in No. of seats) = Fixed costs / Weighted average UCM = 310 000 / 213 = 1456 tickets To break up the total breakeven tickets into: No. of VIP seats = 145610% =145.6 = 146 No. of Normal seats = 145690% = 1310.4 = 1311 (Note: Adds to 1457 seats due to rounding and needs to breakeven)
Limitations of CVP analysis

CVP analysis is merely a simplified model; The usefulness of CVP analysis may be greater in less complex smaller firms, or stand-alone projects; For larger firms, CVP analysis can be valuable as a decision tool for the planning stages of new projects and ventures; CVP analysis is based on several assumptions which limits its usefulness for decision making.
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Summary of the week

How to calculate the breakeven point (in units and in dollars); How to calculate safety margin; How to calculate the sales volume required to achieve a targeted profit (with or without taxes); How to calculate the breakeven point for multiple products.
Previous final exam question

Speed Bicycle Shop sells 10-speed bicycles. For purposes of a CVP analysis the shop owner has divided sales into two categories as follows: Product type High quality Medium quality Sales price $ 100 60 Invoice cost $ 55 27 Sales commission $ 5 3
Solutions
1. UCM for High quality = 100 (55+5) = $40 UCM for medium quality = 60 (27+3) = $30 2.Weighted average UCM= 4025% + 3075% = $32.5 3. BEP (in units) = 13000/32.5 =400 units High quality products: 40025% = 100 units Medium quality products: 40075% = 300 units Hence, sales revenues from high quality products= 100$100= $10 000 sales revenues from medium quality products= 300$60=$18 000 4. Sales volume required = (13000+6500)/32.5 = 600 units High quality products: 60025% = 150 units Medium quality products: 60075% = 450 units
Three-quarters of the shops sales are medium quality bikes. The shops annual fixed expenses are $13,000. (In the following requirements, ignore income taxes.) REQUIRED: (a)Calculate the UCM for each product type. (1 mark) (b) Calculate the weighted average UCM, assuming a constant sales mix. (2 marks) (c) What is the shops break even sales volume in dollars? Assume a constant sales mix. (3 marks) (d)How many bicycles of each type must be sold to earn a target net profit of $6,500? Assume a constant sales mix. (2 marks)
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Two methods of costing inventories in manufacturing companies
Variable MOH and fixed MOH
Absorption costing: all manufacturing costs are assigned to products: direct material, direct labour, variable and fixed manufacturing overhead;
Variable MOH: Indirect manufacturing costs that vary in proportion to the level of production
(e.g. Indirect labour and materials; electricity)
Variable and Absorption Costing Chapter 7 pp.316-321
Variable costing: only variable costs are assigned to products: direct material, direct labour and variable manufacturing overhead.
Fixed MOH: indirect manufacturing costs that DO NOT vary in proportion to the level of production (i.e. factory manager s salary; factory rent)
AASB 102 inventories requires inventory to be valued at absorption costing for external reporting
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Variable and Absorption Costing

Inventory / product costs include:
Absorption Costing Direct materials Direct labour Variable MOH Fixed MOH* Variable Costing Direct materials Direct labour Variable MOH
Treatment of Fixed MOH

Variable costing: Fixed MOH is expensed immediately as it is incurred Period cost Absorption costing: Fixed MOH is inventoried until the manufactured goods are sold
Variable and absorption costing

Copyright 2012 McGraw-Hill Australia (A) Variable costi ng
Direct material Direct labour V ariable manufacturing overhead
when costs are incurred
W ork in Process Inventory on Balance Sheet
when goods are finished
Finished Goods Inventory on Balance Sheet
when good s are sold
Expense on Income Statement
Fixed manufacturing overhead
when costs are incurred -
- - - - - -
(B) Absorption costi ng
The difference between the two methods is? the treatment of Fixed MOH
Direct material Direct labour All manufacturing overhead
when costs are incurred
W ork in Process Inventory on Balance Sheet
when goods are finished
..
Finished Goods Inventory on Balance Sheet
when good s are sold
Y JI"
A\t,
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Lecture example 1
Company X produces ipods which include the following costs per unit: Direct materials $12 Direct labour $10 MOH $ 8 The MOH includes fixed MOH of $3 per unit and variable MOH of $5 per unit. At the end of the accounting period a stocktake is undertaken and the company has 4000 units on hand (beginning balance is 0).

a)

b)
Under absorption: Under variable:
Product costing under the two methods:

Absorption product Cost Variable product Cost 12 10 5 $27
Value of inventory (4000 units)

$ 30 4000 units = $120,000 $27 4000 units = $108,000
Direct material Direct labour Variable MOH Fixed MOH Unit product cost
12 10 5 3 $30
c) Difference = 120 000 108 000 = $12,000 Discuss why? Because under Absorption costing the total fixed MOH in regard to the 4000 units ($3 4000 units = $12,000) are inventoried, while under Variable Costing the total fixed MOH in regard to the 4000 units are recorded as expenses.
Required:
(a) (b) (c)
Calculate the unit product cost under absorption and variable costing; Calculate the value of inventory under both methods; Compare and discuss the difference in total inventory values under both methods.
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Calculating profit under variable and absorption costing

Absorption costing Total revenue Less: cost of goods sold
(unit product cost units sold)
Lecture example 2
Austimber Ltd produced and sold 50000 meters of timber in 2009, with the following operating information given:
Actual and budgeted fixed manufacturing overhead Variable manufacturing cost per meter (DM+DL+VMOH) Fixed manufacturing overhead per meter Actual fixed selling and administration expenses (S&A) Actual variable S&A expenses per meter Selling price per unit/per meter $60 000 $7 $1.2 $50 000 $1 $15

Absorption Costing
Revenue Less: Cost of goods sold * * unit product cost ($8.2) 50000 units sold Gross margin Less: total non-manufacturing expenses Variable selling & admin. costs Fixed selling & admin. costs 50 000 50 000 (100 000) 240 000 340 000 $ 750 000 ( 410 000)
Variable costing Total revenue Less: total variable cost including:

1. manufacturing variable cost (i.e. unit product cost units sold); 2. all other variable costs.
Gross margin/ gross profit Less: total nonmanufacturing costs Operating profit
Contribution margin Less: total fixed costs Operating profit
Required: compute operating profits in 2009 using both absorption and variable costing.
10 11
Operating profit
12
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Variable costing
Revenue Less: Variable manufacturing cost/variable COGS Variable S& A expenses Contribution margin Less: Fixed manufacturing overhead Fixed S & A expenses Operating profit $ 750 000 ( 350 000) (50 000) 350 000 (60 000) (50 000) 240 000
Lecture example 3
Using the cost data given in the example 2, compute the operating profit of Austimber Ltd for both 2010 and 2011 with additional information provided below.
2009 (in units) Beginning inventory finished goods Actual production Sales Ending inventory of finished goods 0 50 000 50 000 0 2010 (in units) 0 50 000 45 000 5 000 2011 (in units) 5000 50 000 55 000 0

Absorption Costing
Revenue Less: Cost of goods sold Gross margin Less: Non-manufacturing expenses Fixed S&A Variable S&A Operating profit (50 000) (45 000) 211 000 (50 000) (55 000) 269 000
2010
$ 675 000 ( 369 000) 306 000
2011
$ 825 000 (451 000) 374 000
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14
15
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Variable costing
Revenue Less: Variable cost of goods sold Variable S& A expenses Contribution margin Less: Fixed manufacturing overhead Fixed S & A expenses Operating profit
2010
$ 675 000 ( 315 000) (45 000) 315 000 (60 000) (50 000) 205 000
Comparison of variable and absorption costing

2011
2009 $ 825 000 (385 000) (55 000) 385 000 3. Difference in profit (60 000) (50 000) 275 000 4. Absorption costing Fixed Manufacturing cost expensed 4. Variable costing Fixed Manufacturing cost expensed 4. Level of inventory 5. Difference b/w production and sales
16
A short cut to reconciling profit under variable and absorption costing

Difference in profit under absorption and variable costing Difference in fixed change in predetermine = MOH cost expensed = inventory x d fixed under absorption and (in units) manufacturing variable costing overhead rate per unit
2010 $211 000 205 000 6000 $54,000 $60,000 Beg < End
2011 $269 000 275 000 (6000) $66,000 $60,000 Beg > End
1. Absorption costing operating profit 2. Variable costing operating profit
$240 000 240 000 0 $60,000 $60,000 Beg = End Pro = Sales
Pro > Sales Pro < Sales
17
18
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Lecture example 4
Based on the information from example 3, apply the short cut method to reconcile profit under variable and absorption costing.
Year Change in inventory Predetermined fixed Manu overhead rate X 1.20 X 1.20 Difference in fixed overhead expensed =0 = 6000 = 6000 Absorption costing profit minus variable costing =0 = + 6000 = - 6000
Comparative Income Effects

Variable costing Absorption costing
How do changes in unit inventory cost affect operating income if?
Lecture example 5
Osawa Ltd planned and actually manufactured 200 000 units of its single product in 2011, its first year of operation. Variable manufacturing cost was $20 per unit produced. Variable non-manufacturing cost was $10 per unit sold. Planned and actual fixed manufacturing costs were $600 000. Planned and actual fixed non-manufacturing costs were totalled $400 000. Osawa sold 120 000 units of product at $40 per unit.
1. 2.
2009 2010 2011
0 (Production = sales ) 5000 (increase)

(production > sales) (50000 > 45000)
Production = sales Production > sales Production < sales
Equal Lower Higher
Equal Higher Lower
5000 (decrease) X 1.20

(production < sales) (50000<55000
Compute Osawas 2011 operating profit using variable costing Compute Osawas 2011 operating profit using absorption costing
19
20
21
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Variable costing
Revenue Less: Variable cost of goods sold Variable non-manufacturing cost Contribution margin Less: Fixed manufacturing overhead Fixed non-manufacturing cost Operating profit $ 4800,000 (2400,000) (1200,000) 1200,000 (600,000) (400,000) 200,000

Absorption Costing
Revenue Less: Cost of goods sold ($20+ FOH/unit) * No. of units sold (20 + 600,000/200,000) * 120,000 Gross margin Less: non-manufacturing cost Variable Fixed Operating profit $10*120,000 (1200,000) (400,000) 440,000 (2760,000) 2040,000 $ 4800,000
Absorption versus Variable costing
AASB 102 Inventories requires that for external financial reporting, absorption costing is used to value inventory. Variable costing provides managers information that is useful for planning costs and tactical decision making. Note absorption costing is more useful for longterm decision making
22
23
24
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Lecture example 6 MCQ 1

Classix Products reported $28 000 in net profit for the year using variable costing. The company had no units in beginning inventory, planned and actual production was 30 000 units, and sales were 25 000 units during the year. Variable manufacturing costs were $15 per unit and total budgeted fixed manufacturing overhead was $150 000. There was no underapplied or overapplied overhead reported during the year. Determine the net profit under absorption costing. A. B.
00
MCQ 2
Gallison Company's net profit under absorption costing was $15 000 higher than under variable costing. During the year, the company planned and produced 20 000 units for total variable production costs of $80 000. If fixed manufacturing overhead was $40 000, how many units were sold? A. B. C.
0 00
Which of the two methods (i.e. absorption and variable) would a manager prefer to use if their bonus was tied to profits? Answer: Absorption costing. Reasons:
Managers
20 000 units 12 500 units 10 000 units 7500 units
FMOH rate = $40000 / 20000 units = 2

Profit difference = change in Inventory X FMOH rate
can manipulate profits by simply building inventories (i.e. producing more units than the actual demand).
This
$28 000 $30 000 $53 000 $58 000
FMOH rate = $150000 / 30000 units = 5 Profit difference = 5000 units X 5 = $25 Absorption costing profit = $28 000 + $25
15000 = change in Inventory X 2

change in Inventory = 15000/2 = 7500 units
D.
will result in more fixed costs being capitalised as inventory rather than expensed in the current period.
Units sold = 20000 - 7500 = 12 500 units - B
Profit increases and potentially so does a manager s bonus
C.
0
D.
= $53 000 - C
25
26
27
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Reminder
The 2nd Excel assignment will be due by 6pm Wednesday 15th of January 2014
The management accountants role in decision making

T o provide relevant information to managers and teams who make the decisions
T actical decisions/ short-term decisions

Decision Making I Information for tactical decisions
Do not require significant or permanent resource commitments Can be changed or reversed quickly
Chapter 19
Long-term decisions

May involve increases or decreases in capacity-related resources More difficult to reverse and effects may extend over longer time periods
28 Week 3 Session 1, 2013
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Characteristics of relevant information

Relevant information must satisfy the following criteria:
Information for decisions -- terminology
Information for decisions terminology (cont.)
Incremental revenues
The additional revenue that will be gained as a result of choosing one course of action over another. e.g., 2 alternative products A and B. Revenues from product A = $15,000 Revenues from product B = ($10,000)
Sunk costs

Different under competing courses of action

Costs and benefits that are the same across all available courses of action need not be considered.
2 alternative products A and B. Raw material cost of product A Raw material cost of product B Raw material cost is irrelevant . = $3,000 = $3,000
Incremental revenue from choosing product A
= $5,000
Costs that have already been incurred Irrelevant to any future decisions
Incremental costs The additional costs that arise from choosing one course of action over another
2 alternative products A and B. Manufacturing cost of product A Manufacturing cost of product B
Opportunity costs
= $8,000 = ($5,000) = $3,000
Relates to the future
Incremental cost choosing product A
The potential benefit given up when the choice of one action precludes a different action
= $8,000 = $5,000 = $5,000
Avoidable costs
Costs that have already been incurred cannot be changed and are irrelevant
Timeliness versus accuracy
As accuracy increases, timeliness may decrease

3
Costs that will not be incurred in the future if a particular decision is made Unavoidable costs Costs that will continue to be incurred no matter which decision alternative is chosen Irrelevant to the decision

2 alternative products A and B. Contribution margin from product A Contribution margin from product B Opportunity cost, if you choose product A
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Tactical decision making

Accept or reject a special order

A special order is a one-time order that is not considered part of the companys normal ongoing business. Whether or not to supply a customer with a single, one-off order for goods or services, at a special price When analyzing a special order, only the incremental costs and benefits are relevant.
Accept or reject a special order

Decision rule: does the special order generate additional operating profit? - incremental revenues are greater than incremental costs Y es accept No reject
Accept or reject a special order Make or buy a product Add or delete a product or department Joint products: sell or process further
19-8
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Accept or reject a special order (cont.)
Lecture Example 1:
Waugh Ltd has a plant capacity of 30,000 units per month. Unit cost includes: Direct labour Variable overhead Fixed overhead Fixed selling expenses Variable selling expenses $1.60 $1.00 $0.90 $1.80 $1.50
Lecture Example 1 - Solutions
If there is idle (spare) production capacity

Spare capacity occurs where equipment, labour or other inputs to
production are not being utilised and, hence, are available for other purposes
Increase in Revenue Increase in costs: Direct materials Direct labour Variable overhead Total increase in profit
1000 x $5 1000 x $ 1.20 = 1200 1000 x $ 1.60 = 1600
5000
Allocated fixed costs should not be included
If there is no spare capacity
Currently monthly sales are 29,000 units at $5.30 per unit. Border Ltd has contacted Waugh Ltd about purchasing 1000 units at $5 each. Current sales would not be affected by the order.
The analysis should take account of opportunity costs with the use of the limited capacity
associated
Special order also requires 1000 Kg of raw materials. Firm has sufficient inventory of raw materials at book value of $1 per Kg. However, if the order is accepted, the firm will be forced to restock at a predicted cost of $1.2 per Kg. Assumption: variable selling cost is not affected by the special order.
Required If the order is accepted what is the change in Waughs profit for the month?
1000 x $1.00 = 1000
3800 1 200
Long term strategic issues:
whether the decision to accept the special order will impact on the business reputation or relationships with existing customers
19-9
10
11
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7-14
Lecture example 2
Crystal Lattice (CL) produces mats for use in fitness centers. Production capacity is 20000 mats per year. Due to a chain of fitness centers closing, CL now has spare capacity of 2000 mats per year. An international hotel chain, Resteasy, has recently contacted CL to place a one-off order for 3000 mats. The hotel chain has recently remodelled a number of its hotels to incorporate fitness centers for guests.
Budgeted cost for 20 000 mats Variable manufacturing costs Fixed manufacturing costs $ 800 000 $ 900 000

If accepts the special order:
Relevant revenue Relevant costs : Variable costs of embossing machine Opportunity cost Profit/ loss $90 3000 = $270 000 $40 3000 = $120 000 $20 000 (100-40) 1000 = $60 000 $70 000 profit
Make-or-Buy Decisions
A decision to make a part or provide a service internally rather than to buy externally from a supplier is called a make-or-buy decision.
Make-or-buy decisions are also called insourcing versus outsourcing decisions.
CL normally sells mats for $100/mat, and Resteasy has offered to pay $90 per mat. Resteasy has also requested that each mat be embossed with its company logo. An embossing machine costing $20 000 would therefore need to be purchased by CL. The machine could not be used for other products. Questions: 1) From a financial perspective, should CL accept the special order? 2) What other factors should be considered before accepting the order?
12
V ariable cost/unit = 800000/20000=$40/unit

13
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7-16
7-17
Make or buy a product

Decision rule: Choose the option with the lowest relevant cost. Consider avoidable versus unavoidable costs Opportunity costs are often relevant
Example
Mattel Ltd is trying to decide whether to continue packaging the American Girl doll in-house or outsource the packaging process to an external supplier. Mattels packaging costs for the dolls are:
Inter nal C ost of Packaging 200,000 Amer ican G ir l D olls Annual C ost Packaging Materials Packaging D ir ect Labour Indir ect Mater ials Packaging Super vision O ther Fixed Manu O ver head Total Packaging C ost $ 300,000 90,000 60,000 50,000 200,000 700,000 $ U nit C ost 1.50 0.45 0.30 0.25 1 .0 0 3 .5 0
Example cont.,
The agreement with the outside supplier includes a 3-year contract
for a minimum of 200,000 units per year.
All costs directly related to the packaging activities, including all direct and indirect materials, labour, and supervision, would be avoided if the packaging is outsourced. Other total fixed manufacturing overhead costs would remain unchanged. The factory space that is now used for packaging could be used to expand production of a popular product line. The expansion would generate an additional $150,000 in profit per year.
Strategic issues may include:

Quality of the purchased product Delivery responsiveness, technical capabilities, labour relations and financial stability of the supplier Ability of the supplier to respect confidential information
19-15
The outside supplier bid $3.00 per doll for the packaging work. Should Mattel outsource the packaging?
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7-18
7-19
Incremental Analysis
Relevant Costs of Packaging 200,000 Units per Year Internal Costs $ 300,000 90,000 60,000 50,000 $ 500,000 Outsourced Costs $ 600,000
Qualitative Analysis
What is the supplier s level of quality and reliability? What happens if demand for the product drops below 200,000 units or rises significantly higher than 200,000? Does the supplier have the capacity to meet the increased demand? Will the price be higher or lower for any additional or fewer units? What happens in three years? Will the price of packaging increase significantly? Returning to internal packaging will be difficult after the space is converted to another use. What if the predicted profit to be generated by expanding the other product line has been substantially over- or underestimated? Does outsourcing the packaging create any additional risks, such as loss of sensitive information to the supplier that could result in a competitive disadvantage for Mattel?
Lecture example 3
Spa Company produces plunge pools. Currently, the company uses internally manufactured pumps to power jets. Spa Co. has found that 40 % of the pumps have failed within their 12-month warranty period, causing huge warranty costs. Because of the companys inability to manufacture high-quality pumps, management is considering buying pumps from a reputable outside supplier who will also bear any related warranty costs. Spa Companys unit cost of manufacturing pumps is $83.75 per unit, including $17.25 of allocated fixed overhead. Also, the company has spent an average of $22 repairing each pump returned. Spa company can purchase pumps for $92.50 per pump. During 2011, Spa Co. plans to sell 12 800 plunge pools (each pool requires one pump). Required: Determine whether Spa Company should make or buy the pumps?
Supplier's Price ($3.00 per unit) Packaging Materials ($1.50 per unit) Packaging Direct Labor ($0.45 per unit) Indirect Materials ($0.30 per unit) Packaging Supervisor Profit from Expanding Another Product Line Total cost
(150,000) 450,000
Outsourcing is $50,000 less.

Note that fixed costs are excluded because they are irrelevant to the decision. Mattel should outsource the packaging.
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7-22

Option1- Make pumps Manufacturing cost (83.75-17.25 = 66.50/pump) Warranty cost ($22/pump returned) Total Relevant cost 66.5 12800=$851200 22 (12800 40%)=$112640 $963 840
Add or delete a product, service or department
Add or delete a product, service or department
Decision Rule: Discontinue a product, service or business segment when its total contribution margin does not cover avoidable fixed costs. Strategic issues: If we delete a product, will this affect sales of other products? Will we loose customers? Will it impact capacity? Deleting a department may impact on employee morale
Option 2- Buy pumps Purchase price ($92.5/pump) Total Relevant cost 92.5 12800 = $1184 000
One of the most important decisions managers make is whether to continue or eliminate a business segment, such as a product or a store. A segment is a candidate for elimination if its revenues are less than its relevant (avoidable) expenses.
If pumps are purchased, Spa Company will reduce its profits by $220 160 (1 184000 963840). Thus, Spa should make pumps.
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Lecture Example 4
Burt Ltd has three divisions which are in competition with each other, selling slightly different products. Annual results appear below:
Division A Sales in units Selling price/unit Variable costs/unit Fixed costs 8 000 $22 $10 $15 000 Division B 9 000 $18 $8 $36 000 Division C 12 000 $15 $9 $25 000
Lecture Example 4 - solutions

If division B is closed: Lost contribution margin: Reduced avoidable fixed costs: Lost divisional profit Effect on other divisions Increased CM in Division A: Increased CM in Division C: T otal increased CM (18-8) 9000 = $90 000 $24 000 $66 000 (22-10) 4000=$48 000 (15-9) 2000 = $12 000 $ 60 000
Joint products: sell or process further
Joint products

In the process of making one product, one or more other products are created. Cannot be separated prior to split-off All manufacturing costs incurred in the production of joint products
Joint cost
The company believes that if it drops Division B, sales of Division A will increase by 4000 units and sales of Division C will increase by 2000 units. Analysis reveals that $24000 of fixed costs relating to Division B are avoidable for the company if Division B is closed.
Should the division B be closed?

24
Hence, overall loss by closing Division B is $6000. Close division B ? NO

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Joint Products
Joint costs are incurred up to the split-off point
Lecture Example 5
Lecture Example 5 Data about Sawmills joint products includes:

Lumbe r $ 140 270 176 50 Pe r Log Saw dust $ 40 50 24 20
Oil
Separate Processing
Final Sale
crude oil
Common Production Process
Gasoline
Chemicals
Fina l Sal e Separate Processing
Sawmill, Inc. cuts logs from which unfinished lumber and sawdust are the immediate joint products. Unfinished lumber is sold as is or processed further into finished lumber. Sawdust can also be sold as is to gardening wholesalers or processed further into presto-logs.
Sa le s va lue a t the split-off point Sa le s va lue a fte r furthe r proce ssing Allocate d joint product costs Cost of furthe r proce ssing
Final Sale Unfinished Lumber Sawdust
Split-Off Point
Separate Product Costs
Required: 1. What are the relevant costs/revenues in making a decision to process further? 2. Should the company sell products at split-off point or process them further?
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Lecture Example 5 solution

An a l ysi s o f S e l l o r P ro c e ss F u rth e r P e r Log
Lu m b e r S a w du s t
Summary
Summary (cont.)
S a l e s va l u e a fte r fu rth e r p ro c e ssi n g S a l e s va l u e a t th e sp l i to ff p o i n t I n c re m e n ta l re ve n u e C o st o f fu rth e r p ro c e ssi n g P ro fi t (l o ss) fro m fu rth e r p ro c e ssi n g
270 140 130 50 80
50 40 10 20 (10 )
The lumber should be processed further and the sawdust should be sold at the split-off point.
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T actical decisions do not require significant changes in capacity and can be changed if better opportunities arise Relevant information will include quantitative and qualitative information, as well as strategic issues In decision analysis, incremental revenues and costs are usually the focus, and in some cases so are avoidable costs Identifying whether there is spare capacity is important in special orders and make or buy decisions, as opportunity costs become relevant where there is no spare capacity
Adding or deleting a product/department involves consideration of avoidable and unavoidable costs Processing joint products further requires consideration of incremental revenue and costs Management incentives can sometimes distort the collection and analysis of information in decisions
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Product mix decisions Welcome to ACCG200 Lecture 10

Product mix decisions
T actical product mix decisions with limited resources Determining the optimum product mix to maximize profits .
When a limited resource of some type restricts the companys ability to satisfy demand, the company is said to have a constraint that is referred to as a bottleneck.
Single limited resource: compare the contribution margin per unit of the scarce resource (not contribution margin per unit) to determine the profitability of each product. Multiple limited resources: linear programming
Joint cost allocation and product mix decisions

Chapter 19 Appendix (pp.928-931) Chapter 20 pp. 967-978
To maximize profits in the short run, a company with a bottleneck must prioritize its products or services so as to maximize contribution margin per unit of the constrained resource.
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Lecture example 1
Company A provides the following information for product P and Q. The company has limited machine hours.
Product P Selling price/unit Total variable costs/unit Contribution margin/unit Machine hrs/unit Contribution margin/ mhr $80 $50 $30/unit 2hrs $15/mhr Product Q $120 $70 $50/unit 5 hrs $10/mhr
Lecture example 2
Power T ool manufactures engines for commercial and consumer products. It assembles two engines: engine A and B. Following is information for each product line:
Engine A Selling price Variable cost per unit Contribution margin per unit Contribution margin ratio $ 800 560 240 30% Engine B $ 1000 625 375 37.5%
Lecture example 2 solution

1) How many engine A and B should be produced to maximize the profit
Engine A Contribution per unit Machine hours per unit CM per hour Rank 1 $240 2 hrs 240/2 = $120/hr Engine B $375 5 hrs 375/5 = $ 75/hr 2
With the limited machine hrs, which product should be produced first so as to maximize the total profits? P or Q? Answer: Product P .
Engine A require 2 machine hrs each and engine B require 5 machine hrs each. Only 600 machine hours are available each day for assembling engines. Additional capacity cannot be obtained in the short run. Power tools only has demand for 200 engine A but can sell as many engine B as it produces. Required: 1) How many of each type of engine should be produced to maximize the total contribution margin? 2) Calculate the contribution margin at the optimal solution.
Total available hours = 600 hrs Engine type A B Production units 200 units 40 units Mhrs / unit 2hr/unit 5hr/unit Total Mhrs 400 hrs 200 hrs
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2) Calculate the contribution margin with the optimal product mix
Contribution margin with the optimal product mix Engine type A B Total Production units CM per unit 200 units 40 units $240/unit $375/unit Total CM $48 000 $15 000 $63 000
Multiple limited resources: linear programming
Linear programming
Five steps in determining the optimal solution: Identify the decision variables ( products involved) 1.
2.
Involves identifying linear relationships between the decision variables to determine the optimal solution, given a number of constraints Represents the solution of two simultaneous equations either algebraically or graphically
Determine the objective function: refers to the sum of the contribution margin for each product. Determine the constraints based on the limited resources available. Graph the constraints: the space between the axes and the constraints form an area known as the feasible region. Determine the optimal point by calculating the contribution margin that can be obtained at the extreme points in the feasible region.
3.
4.
5.
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Lecture example 3
Company A produces two products X and Y with contribution margins of $30 and $25 respectively. The company has a maximum of 1200 machine hours and 3000 labour hours per month. Product X requires 1 machine hour per unit while product Y requires 2 machine hours per unit. Product X requires 3 direct labour hours per unit while product Y requires 2 direct labour hours per unit. Determine the number of product X and Y to be produced to maximise the companys profits/contribution each month?

Step 1: Identify the decision variables:
X = number of X product to produce each month Y = number of Y product to produce each month
Graphical Solution
Solution to lecture example 3
Step 4: Graph the constraints
maximisation.
Step 2: Determine Objective function = Contribution margin

Maximise Z = 30X + 25Y Where Z = total contribution margin
1X + 2Y = 1200 .equation(1) (machine hours) Let X = 0 then Y = 600 =(1200/2) (point B) Let Y = 0 then X = 1200 =(1200/1) (point F) Graph this line using these two end points 3X + 2Y = 3000equation (2) (labour hours) Let X = 0 then Y = 1500 =(3000/2) (point E) Let Y = 0 then X = 1000 =(3000/3) (point D) Graph this line using these two end points
Step 3: Determine the constraints based on the limited resources available. Machine hours: 1X + 2Y 1200 Labour hours: 3X + 2Y 3000 Both X, Y 0
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Graphical Solution
Represents the Labour hours constraint
Graphical Solution
Step 5: Determine the optimal point by calculating the contribution margin that can be obtained at the extreme points in the feasible region.
Extreme points in the feasible region Objective function value (Z= 30X + 25Y) Z=0 Z = 0 + 25600 = 15 000 Z = 301000 + 0 = 30 000 Z = 30x 900+ 25x 150=30 750
Lecture example 3- solution

Determining the intersection point: Use simultaneous equations Equation 1: 1X + 2Y = 1200 Equation 2: 3X + 2Y = 3000 T o work out the value for X and Y , subtract Equation 1 from Equation 2: 2X = 1800 X = 900 We then substitute the value for X (900) into Equation1 (or Equation 2) to find the value for Y . 1 900 +2 Y = 1200, 2Y =1200- 900= 300 Y =150 Hence, the intersection point is (X=900, Y=150), Z= $30900 + $25150= $30 750
1600 1400 1200

Product Y
(900,150)
Series1
Point A: X= 0, Y= 0 Point B: X=0, Y=600 Point D: X=1000, Y=0 Point C: Intersection point of the two lines (X=? Y=?)
1000 800 600 400 200 0 0A 200 400 600 800
B
Feasible region
C F D 1000
1200 1400 Product X
The optimal point should be the point with the maximum objective function value: 900 units of product X and 150 units of product Y
Represents the Machine hours constraint

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Lecture example 4
A firms two products are both produced on a single machine. Product X requires 3 machine hours per unit while Product Y requires 6 machine hours per unit. There is a maximum of 24000 machine hours available. There is also a limit of 12000 hours of supervision time available, with both products requiring 2 hours of supervision per unit. Details concerning the unit selling price and unit costs of each product are shown below: Product Selling price Variable costs X $30 $24 Y $35 $27

Step 1: Identify the decision variables:
X = number of X product to produce each month Y = number of Y product to produce each month

Step 4: Graph the constraints 3X + 6Y = 24 000 .equation(1) (machine hours) Let X = 0 then Y = 4 000 =(24000/4) (point B) Let Y = 0 then X = 8 000=(24000/3) (point F) Graph this line using these two end points 2X + 2Y = 12 000equation (2) (supervision hours) Let X = 0 then Y = 6 000=(12000/2)(point E) Let Y = 0 then X = 6 000 =(12000/2) (point D) Graph this line using these two end points
Step 2: Determine the objective function: Contribution margin maximisation. Maximise Z = 6X + 8Y Where Z = total contribution margin
Step 3: Determine the constraints based on the limited resources available.

3 X + 6 Y 24000 (Machine hour constraint) 2 X + 2 Y 12000 (Supervision constraint) Both X, Y 0
How many units of each product should be produced and sold?
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Graphical Solution

Step 5: Determine the optimal point by calculating the contribution margin that can be obtained at the extreme points in the feasible region. Extreme points in the feasible region Objective function value (Z= 6 X + 8 Y) Z=0 Z = 0 + 84000 = 32 000 Z = 66000 + 0 = 36 000 Z = 6x4000+ 8x2000= 40 000

Determining the intersection point: Use simultaneous equations Equation 1: 3X + 6Y = 24 000 Equation 2: 2X + 2Y = 12 000 T o work out the value for X and Y , We could multiple Equation 2 by 3: Equation 3: 6X + 6Y = 36000 and then subtract Equation 1 from Equation 3: 3 X = 12000 X = 4000 Then substitute the value for X (4000) into Equation 1 (or Equation 2) to find the value for Y: 3 4000 +6 Y = 24000 Y = 2,000 Hence, the intersection point is (X=4 000, Y=2 000), Z= 64000 + 82000= 40 000
10000 8000 Product Y 6000 4000 2000 0

A0 E
Supervision constraint
X=4000 Y=2000
Point A: X= 0, Y= 0 Point B: X=0, Y=4000 Point D: X=6000, Y=0 Point C: X=4000, Y=2000
B Feasible region
C F
2000
4000
6000
8000
10000
Product X
Machine hours constraint
The optimal point should be the point with the maximum objective function value: 4000 units of product A and 2000 units of product B
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Joint cost allocation
Joint cost allocation

Methods of allocating joint costs
Constant gross margin (GM) method

Three steps:
1. GM % for the entire production = total GM* /total sales * total GM=total sales- total production costs 2. Required GM ($) for each product = sales revenues GM% 3. Joint costs allocated to each product = sale revenues required GM separable processing cost
Joint cost
All manufacturing costs incurred in the production of joint products
Physical units method: allocate joint costs to joint products in proportion to their physical units at the split-off point; Relative sales value method: allocating joint cost to joint products in proportion to their sales value at the split-off point Net realisable value (NRV) method: allocate joint cost to joint products in proportion to their final NRV values (NRV = final sales value separable further processing costs) Constant gross margin method: allocate joint costs to joint products so that the gross margin (%) for each product is identical
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Lecture Example 5
Mount Franks manufacturers 2 drinking products from a joint water process. The two products are Still Water and Mineral Water. A standard production run incurs joint costs of $40 000 and results in 60 000 litres of still water and 90 000 litres of mineral water. Each still water litre sells for $1.50, and each mineral litre sells for $3.00. Required: Calculate the amount of joint costs allocated to pure water and mineral water using the physical units method and relative sales value method

1 Calculate the amount of joint costs allocated to pure
water and mineral water on a physical units basis
Joint Cost $40 000 Joint Products Still Mineral Total QTY at Split-off 60 000 90 000 150 000 Relative Proportion Allocation of joint cost 16 000 24 000 40 000

Calculate the amount of joint cost allocated to the still water on a relative sales value basis
Joint Cost $40 000 Joint Products Still Mineral Total Sales value at Split-off 90 000 270 000 360 000 Relative Proportion Allocation of joint cost 10 000 30 000 40 000
60 000/150 000 = 40% 90 000/150 000 = 60%
90 000 / 360 000 = 25% 270 000 / 360 000 = 75%
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Lecture Example 6
In addition to the data given in the example 5, assume that the still water can be processed further for $60000 to produce fruit flavoured water. This can then be sold for $3.00 per litre. While the mineral water can be processed at a cost of $80000 to produce sparkling mineral water that can be sold for $4.00 per litre. Using the net realisable value method and gross margin method calculate the joint cost assigned to each product?

a). Net realisable value method
Joint Cost Joint Products Sales value of final product 180 000 360 000 540 000 Further processing cost 60 000 80 000 NRV Relative Allocation Proportion of joint cost 30% 70% 12 000 28 000 40 000

b) Constant gross margin (GM) method
T otal sales= $540 000 total costs= 40 000+60 000+80 000 =$180 000 GM % = (540 000 180 000) /540 000 = 66.6667%
Joint Cost Joint Product Gross margin (%) 66.6667% 66.6667% Sales revenue Required Separable gross cost of margin ($) processing 120 000 240 000 $60 000 $80 000 Allocation of joint cost 0 40 000 40 000
$40 000 Total
Still Mineral
120 000 280 000 400 000
$40 000
Still Mineral
180 000 360 000
Sales value of final product:

Still (fruit flavoured) = 60000 x $3 = $180 000 Sparkling mineral = 90000 x $4 = $360 000
Total
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A Budget Welcome to ACCG200 Lecture 11

A detailed plan that shows the financial consequences of an organisations operating activities for a specific future time period.
The annual budget: a planning tool
The annual budget (or master budget) is a comprehensive set of budgets that covers all aspects of a firms activities Consists of several interdependent budgets Operating budgets:
Sales budget; cost budget
Purposes of budgeting:
Budgeting systems
Chapters 9 and 11 pp.514-519
1. 2. 3. 4. 5.
Planning Facilitating communication and coordination Allocating resources Controlling profits and operations Evaluating performance and providing incentives
Financial budgets:
Cash budget; budgeted balance sheet; budgeted income statement; capital expenditure budget
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The annual budget: a planning tool
The operating budgets
The operating budgets (cont.)

The cost budgets
The sales budget A detailed summary of the estimated sales units and revenues from the organisation's products for the budget year
Manufacturing firms A production budget, which has cost budgets for direct materials, direct labour and overheads Budgets for selling and administrative expenses Retailers and wholesalers A purchasing budget will be used to determine the quantity and cost of goods purchased for resale Service firms A set of budgets that show how demand for services will be met
Based on the sales forecast, which involves estimating which products will be sold and in what quantities Market research may be used
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Operating budgets for manufacturing firms
Lecture example 1
Suzuki Ltd has a division that manufactures twowheel motorcycles. Its budgeted sales for Model G in 2012 is 450 000 units. Suzukis target ending inventory is 40 000 units and its beginning inventory is 50000 units. The companys budgeted selling price to distributors and dealers is $4000 per motorcycle. Suziki buys all its wheels from an outside supplier. No defective wheels are accepted. The companys target ending inventory is 30 000 wheels and its beginning inventory is 25 000 wheels. The purchase price is $160 per wheel. Required: Prepare sales budget, production budget (in units) and wheel purchase budget (in units and dollars)
Lecture example 1
T otal sales Units 450 000 Selling price per unit 4000 1,800,000,000
Production budget for the year ended 31st December 2012 (in units) Sales + Target ending Inventory Total required units - Beginning Inventory Production to be completed 450,000 40,000 490,000 (50,000) 440,000
Source: Horngren et al., 201 1)

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Wheel Purchase budget for the year ended 31st December 2012 Units Wheels required for production +T arget ending inventory Total requirement - Beginning inventory Wheels to be purchased
*880 000=440 0002
Lecture example 2
Summer furniture Ltd produces two different table sets, A and B. The company predicts a sales volume of 2000 sets for A and 2300 sets for B. The beginning inventory includes 1000 sets of A and 1200 sets of B, and the desired ending inventory will consist of 900 sets of A and 800 sets of B. T o produce a set of A it requires 2 hrs in Assembly and 0.2 hr in Packing. T o produce a set of B it requires 3 hrs in Assembly and 0.3 hr in Packing. The direct labour rate is $30/hr for assembly, and $10/hr for packing. Information regarding the use of direct material are provided as follows (NB. No change incurred in costs from last period to this period).
Direct material Cost/meter Wood $75 Fibreglass $42 Required for A 2 meters/set 1 meters/set Required for B 3 meters/set 2 meters/set

a) Production budget (in no. of sets):
A 2 000 900 2 900 (1 000) 1 900 B 2 300 800 3 100 (1 200) 1 900
880 000* 30 000 910 000 (25 000) 885 000
Sales Add Desired ending inventory Total required units Deduct Beginning Inventory Production to be completed
Wheels to be purchased in dollars = $160*885 000=$141,600,000
Required: Prepare the production (in no. of sets), direct material (in meters and in dollars) and direct labour (in dollars for A only) budgets.
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Lecture example 2 solutions cont.

b) Direct material budget ( in meters and in dollars)
Wood: 2 1900 + 31900 = 9500 meters 9500 $75 = $712 500 Fibreglass: 11900 + 21900 = 5700 meters 5700 $42 = $ 239 400
Flexible budgets
Static budget:
A budget prepared for one specific planned level of activity.
Benefits of Flexible Budgets over Static budgets

It allows comparisons to be made between actual costs incurred at the actual level of activity and the budgeted costs that should have been incurred at the actual level of activity. It makes the budget more responsive to changes in activity levels;
Flexible budget:
A detailed budget prepared for a range of levels of activities.
c) Direct labour budget for A (in dollars):

Assembly: $30/hr 2 hrs 1900 units = $114 000 Packing: $10/hr 0.2 hr 1900 units = $ 3 800 T otal labour costs $117 800
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Lecture example 3
Jones Ltd budgeted to produce 350 photocopy machines in March. The number of machine hours budgeted to produce one photocopy machine is 2.5 hours. Budgeted overhead (electricity) was expected to be $35 000. In March Jones Ltd produced 300 photocopy machines. The firm incurred electricity costs of $32 000.

(i) Predetermined OH rate = budgeted total overhead costs/budgeted total machine hrs = $35000/(3502.5) = $40 per machine hour Actual electricity costs = $32 000 Budgeted electricity costs = $35 000 Difference = $3 000 Comments: Jones Ltd performs well since actual electricity costs consumed are less than the budgeted amount.

(iii) Flexible Budget Approach
Actual electricity costs = $32 000 Budgeted electricity costs = $40 machines allowed for actual output = $40 (300 2.5 hours per unit) = $30 000 Difference = 2000 Comments: Jones Ltd does not perform well since actual electricity costs consumed are greater than the budgeted amount.
Required:
Calculate the predetermined overhead rate for electricity costs based on machine hours. Calculate the difference between actual electricity costs and budgeted ii. electricity costs. Comment on Jones Ltds performance in relation to electricity usage in March. Calculate the difference between actual electricity costs and budgeted iii. electricity costs if a flexible budget is applied . Comment on Jones Ltds performance in relation to electricity usage in March.
i.
(ii)
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A flexible budget report
Lecture example 4
The chief accountant for Northern Suburbs Hospital estimates that the hospital uses 40 kilowatt hours of electricity per patient-day, and that the cost of electricity will be $0.16 per kilowatt hour. The hospital also pays a fixed monthly charge of $800 to the electricity to rent emergency back-up electricity generation. Required: Construct a flexible budget for the hospitals electricity costs using each of the following techniques:
a)A formula b)Using i. ii.

a) A formula flexible budget The budgeted variable cost rate per patient-day = 40 kwh per patient day x $0.16 per kwh = $6.4/patient day Total budgeted monthly electricity cost = (6.4 x number of patient days) + 800
Flexible budget report: shows flexible overhead budgets at various levels of activity Formula flexible budget: shows overhead costs at various levels of activity using the following formula
flexible budget
your flexible budget calculate the budgeted electricity costs for: April when it is expected that there will be 50 000 patient days July when it is expected that there will be 80 000 patient days
c)A report
form flexible budget for 30 000, 40 000 and 50 000 patient-days of activity. List variable and fixed electricity costs separately.
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b) (i) T otal budgeted monthly electricity costs for April = 6.4 x 50000 + 800 = $320800 (ii) T otal budgeted monthly electricity costs for July = 6.4 x 80000 + 800 = $512 800
C)
Behavioural consequences of budgeting
A budget affects virtually all staff in an organisation those who prepare the budget those who use the budget for decision making those whose performance is evaluated using the budget Three main behavioural issues Participative budgeting Budgetary slack Budget difficulty
Participative budgeting Allows managers at all levels of the firm to develop their own initial estimates for budgeted sales, costs, etc. T op-down budgeting is where senior managers impose budget targets on more junior managers Bottom-up budgeting is where people at the lower managerial and operations levels play an active part in setting their own budgets
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Budget difficulty
Budgetary slack: Is the difference between the estimated revenue or cost projection that a person provides and a realistic estimate of that revenue or cost
Reasons for budgetary slack Performance can look better if you can beat the budget; A way of coping with uncertainty
Budget acceptance is more likely when T argets are developed with employee participation T argets are considered achievable There is frequent feedback on performance Employees are held responsible for activities that are within their control Achievement of targets is accompanied by rewards that are valued Budgets must be set at a level that provides challenge and stretch, but is not too difficult to achieve
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ACCG200 Lectures 2-11 Handout

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21/01/2014

Product costing system

Types of product costing systems (procedures)

Department of Accounting and Corporate Governance

Types of product costing systems (procedures)

Different product costs for different purposes

manufacturing costs AASB 102

General approach to job costing

Manufacturing Cost Categories of a Job

1. Trace the direct costs of the job

Assignment of Manufacturing Costs to Jobs Source Documents

2. Apply manufacturing overhead costs to the Job

Predetermined Overhead Rate

Budgeted T otal Manufacturing Overhead Cost

Budgeted activity level in the Allocation Base

Ideally , the allocation base is a cost driver that causes overhead.

Materials Requisition Form

Direct Labour Time Tickets

Predetermined Overhead Rates

$700 charged to Job #2719

$300 charged to Job #3335

Predetermined Overhead Rates

Example 2 - Predetermined Overhead Rates

Predetermined Overhead Rates

Actual V alue of the Allocation Base for Each Job

Overhead Applied to an Individual Job

Estimated Units in the Allocation Base

Pre.MOH Rate = $75.00 per DLH

Lecture example 3 - Job costing

Lecture example 3 Job costing

Lecture example 3 solutions

Actual results for 2011

Adapted: Horngren eta/., 2011

FACULTY OF BUSINESSAND ECONOMICS

Lecture example 3 Job costing

Recording the Flow of Costs in Job Order Costing

Recording the Purchase and Issue of Materials

Raw Direct Materials Materials Inventory A/C

Work in Process A/C

Finished Goods Inventory a/c

Cost of Goods Sold a/c

Indirect Materials Indirect Labor

Manufacturing Overhead a/c Actual Costs Incurred Applied To WIP

Manufacturing Overhead 10,000

Work in Process Inventory 140,000

Job 3335 Direct Materials $40,000

Recording Labour Costs

Recording Actual Manufacturing Overhead

Recording Applied Manufacturing Overhead

Labour Costs Indirect Labor Direc t Wo ra kb in L oP r rocess Inventory

Manufacturing Overhead 5,000

Job 2719 Direct Labor $30,000

Job 3335 Direct Labor $20,000

Recording Actual and Applied Manufacturing Overhead

Under-applied or over-applied overhead

Disposing of Overapplied and Underapplied Overhead

Work in Process Inventory 60,000

Under-applied = Actual overhead > Overhead applied

Over-applied = Actual overhead < Overhead applied

Decreases Cost of Goods Sold Increases Cost of Goods Sold

Calculating Overapplied and Underapplied Overhead

Transferring Costs to Finished Goods Inventory and Cost of Goods Sold

Transferring Costs to Finished Goods Inventory and Cost of Goods Sold

After all costs are recorded .

T otal DL hours = 75000/15=5000 hrs MOH=$13.25000=66000

DL = $108000hrs= 80000 **MOH for overtime premium=$5*500 = 2500