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Cost accounting systems provide information to help managers make better decisions. Cost a sacrifice of resources. The price of each item measures the sacrifice we must make to acquire it. Expense a cost charged against revenue in an accounting period. The focus on cost accounting is on costs, not expenses. Two Major categories of costs outlay costs and opportunity costs Outlay costs a past, present, or future cash flow. Opportunity cost forgone benefit that could have been realized from the best forgone alternative use of a resource. Operating profit excess of operating revenues over the operating costs necessary to generate those revenues. Three types of income statements where the organization sell (what we focus on) Service, Product that it acquires from anther organization (retailer), A product that it builds using materials from other organization (manufacturer) Service Organizations provides customers an intangible product. While retail and wholesale companies sell but do not make intangible products, also they have additional information which is cost of goods sold. Cost of goods sold expense assigned to products sold during a period. Product costs costs assigned to the manufacture of products and recognized for financial reporting when sold. Period costs costs recognized for financial reporting when incurred. Two types of product costs direct manufacturing costs and indirect manufacturing costs Direct manufacturing costs product costs that can be feasibly identified with units of production. Indirect manufacturing costs all product costs except direct costs. Direct costs are classified further into direct materials cost and direct labor costs: Direct materials materials that can be identified directly with the product at reasonable cost Direct labor labor that can be identified directly with the product at reasonable cost Manufacturing overhead all production costs except those for direct labor and direct materials. Such as indirect labor, indirect materials and other manufacturing costs Two categories of cost in manufacturing prime and conversion costs Prime costs sum of direct materials and direct labor Conversion costs sum of direct labor and manufacturing overhead Two elements of nonmanufacturing costs marketing costs and administrative costs Marketing costs costs required to obtain customer orders and provide customers with finished products, including advertising, sales commissions, and shipping costs Administrative costs costs required to manage the organization and provide staff support, including executive salaries, costs of data processing and legal costs Nonmanufacturing costs are expensed periodically Cost allocation process of assigning indirect costs to products, services, people, business units, etc Cost object any end to which a cost is assigned Cost pool collection of costs to be assigned in the cost objects Cost allocation rule method used to assign costs in the cost pool to the cost objects Cost flow diagram diagram or flowchart illustrating the cost allocation process. Direct costs any cost that can be directly (unambiguously) related to a cost object at reasonable cost. Indirect costs any cost that cannot be directly related to a cost object. Work in process product in the production process but not yet complete Finished goods product fully completed but not yet sold. Inventoriable costs costs added to inventory accounts. Fixed costs costs that are unchanged as volume changes within the relevant range of activity Variable costs costs that change in direct proportion with a change in volume within the relevant range of activity Relevant range activity levels within which a given total fixed cost or unit variable cost will be unchanged Semi variable cost cost that has both fixed and variable components; also called mixed costs. Step cost cost that increases with volume in steps; also called semi fixed costs Full cost sum of all costs of manufacturing and selling a unit of product (includes both fixed and variable costs) Full absorption cost all variable and fixed manufacturing costs; used to compute a product's inventory value under GAAP Gross margin revenue minus cost of goods sold on income statements. Per unit, the gross margin equals sales price minus full absorption cost per unit. Contribution margin sales price minus variable costs per unit How to make cost information more useful for managers full absorption costing, variable costing, and managerial costing Full absorption costing all fixed and variable costs are product costs, all others are period costs Variable costing only variable manufacturing costs are product costs, others are period costs Managerial costing assumes that management determines which costs are associated with the product and should be considered product costs Cost management system system to provide information about the costs of process, products, and services used and produced by an organization. The following three points relate to designing a new cost system for managerial purposes Cost systems should have a decision focus, Different cost information is used for different purposes and Cost information for managerial purposes must meet the cost benefit test Basic Cost Flow Model (basic inventory equation) Beginning Balance + Transfers In - Transfers Out = Ending Balance Predetermined Overhead Rate cost per unit of the allocation base used to charge overhead to products. Predetermined Overhead Rate equals Estimated Overhead / Estimated Allocation Base Two Stage Cost Allocation process of first allocating costs to intermediate cost pools and then to the individual cost objects using different allocation bases Job unit of a product that is easily distinguishable from another units Job costing accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods. Process costing accounting system used when identical units are produced through a series of uniform production steps Continuous flow processing system that mass produces a single, homogeneous output in a continuing process Operation costing hybrid costing system often used in manufacturing goods that have some common characteristics plus some individual characteristics Operation standardized method or technique that is repetitively performed Job unit of a product that is easily distinguishable from other units Job shop firm that produces jobs Job cost sheet record of the cost of the job kept in the accounting system Subsidiary ledger account account that records financial transactions for a specific customer, vendor or job Control account account in the general ledger that summarizes a set of subsidiary ledger accounts Underapplied overhead excess of actual overhead costs incurred over applied overhead costs Overapplied overhead excess of applied overhead costs incurred over actual overhead during a period. Normal cost cost of job determined by actual direct material and labor cost plus overhead applied using a predetermined rate and an actual allocation base Actual cost cost of job determined by actual direct material and labor cost plus overhead applied using an actual overhead rate and an actual allocation base Standard cost cost of job determined by standard (budgeted) direct material and labor cost plus overhead applied using a predetermined overhead rate and a standard (budgeted) allocation base. Project complex job that often takes months or years to complete and requires the work of many different departments, divisions or subcontractors equivalent units number of complete physical units to which units in inventories are equal in terms of work done to date. A number of physical units multiplied by the estimated percentage that an "average" unit in inventory is "complete" with respect to the individual resource. Five Steps to determining equivalent units 1) measure the physical flow of resources, 2) compute the equivalent unit of production, 3) identify the product costs for which to account, 4) compute the costs per equivalent unit: weighted average, 5) assign product cost to batches of work (Weighted Average Process Costing Inventory Equation Beginning WIP inventory + Units Started = Units Transferred Out + Ending WIP weighted-average process costing inventory method that for product costing purposes combines costs and equivalent units of a period with the costs and the equivalent units in the beginning inventory. first in, first out (FIFO) process costing inventory method whereby the first goods received are the first one charged out when sold or transferred. keeps the costs and the work separate and, in effect, computes separate unit costs for the two periods production cost report report that summarizes production and cost results for a period; generally used by managers to monitor production and cost flows. Assigning Costs Using First-in, First-Out (FIFO) Process Costing A disadvantage of weighted average costing is that it mixes current period costs with the costs of product in beginning inventory, making it impossible for managers to know how much it cost to make a product THIS PERIOD. T-Accounts purpose of presenting the T-accounts is to give you an overview of the cost flows associated with the process costing computations. Determining Which is Better: FIFO or Weighted Average Either methods are acceptable for assigning costs to inventories and cost of goods sold. Weighted average has been criticized for masking current period costs. If computational and record keeping costs are about the same under both FIFO and weighted average, FIFO costing generally offers greater decision making benefits Prior Department costs manufacturing costs incurred in one department and transferred to a subsequent department in the manufacturing process Job costing costs are collected for each unit produced. Process costing accumulates costs in a department for an accounting period and then spreads them evenly, or on an average basis, over all units produced that period. process costing assumes that each unit produced is relatively uniform. Process costing has less detailed recordkeeping, so it is cheaper than job costing. But still does not provide as much information as job costing does. Job costing records the cost of each unit produced. the choice of process versus job costing system involves a comparison of the costs and benefits of each system as well as the production process being utilized. operation costing hybrid costing system used in manufacturing goods that have some common characteristics and some individual characteristics operation standardized method of making a product that is repeatedly performed. operation costing is used in manufacturing goods that have some common characteristics plus some individual characteristics. The key difference between operation costing and the two methods is that for each work order or batch passing through a particular operation, direct materials are different but conversion costs (direct labor and manufacturing overhead) are the same. Operation costing system assigns materials cost to the specific products for which the underlying materials are used. death spiral process that begins by attempting to increase price to meet reported product costs, losing demand, reporting still higher costs, and so on until the firm is out of business. Can begin in many ways, but easy to avoid. Two-Stage Cost Allocation the basic approach in product costing is to allocate costs in the cost pool to the individual cost objects, which are the products or services of interest. we assign, or allocate, these costs to the individual cost objects by using appropriate cost allocation bases or cost drivers. plantwide allocation method allocation method that uses one cost pool for the entire plant by using one overhead allocation rate, or one set of rates, for all of a plant's departments Department Allocation Method allocation method that has a separate cost pool for each department, which has its own overhead allocation rate or set of rates A Cost-Benefit Decision the choice of whether to use a plantwide rate or departmental rates depends on the products and the production process. If the company manufactures products that are quite similar and that use the same set of resources, the plantwide rate is probably sufficient. if multiple products use the manufacturing facilities in many different ways, departmental rates provide a better picture of the use of manufacturing resources by the different products. Activity based costing (ABC) costing method that first assigns costs to activities and then assigns them to products based on the products' consumption of activities. cost driver factor that causes, or "drives" an activity's costs Activity based costing involves the following four steps 1)identify the activities 2)identify the cost drivers associated with each activity 3)compute a cost rate per driver unit or transaction 4)assign costs to products by multiplying the cost driver rate by the volume of cost driver units consumed by the product. cost hierarchy classification of cost drivers into general levels of activity, such as volume, batch, or product Master budget is the first step in the budgetary planning and control cycle. The budgeting process provides a means to coordinate activities among units of the organization, to communicate the organization's goals to individual units, and to ensure that adequate resources are available to carry out the planned activities. Master budget is typically set up before the beginning of the accounting period, common to be revised during. operating budgets budgeted income statement, production budget, budgeted cost of goods sold, and supporting budgets. financial budgets budgets of financial resources, such as the cash budget and the budgeted balance sheet. Two parts of master budget are operating and financial budgets Variance difference between planned result and actual outcome. Uses this difference to evaluate the performance of individuals and business units and identify possible sources of deviations between budgeted and actual performance. favorable variance variance that, taken alone, results in an addition to operating profit unfavorable variance variance that, taken alone, reduces the operating profit. static budget budget for a single activity level; usually the master budget flexible budget budget that indicates revenues, costs, and profits for different levels of activity, including the ex post actual activity level flexible budget line expected monthly costs at different output levels. sales activity variance difference between operating profit in the master budget and operating profit in the flexible budget that arises because the actual number of units sold is different from the budgeted number; also known as sales volume variance Profit Variance Analysis as a Key Tool For Managers profit variance analysis analysis of the causes of differences between budgeted profits and the actual profits earned. sales price variance difference between the actual revenue and actual units sold multiplied by budgeted selling price. Fixed costs are treated as period costs, should not be affected by activity levels within a relevant range. That is why fixed costs is always the same in the master and flexible budgets Marketing and Administrative costs are treated like production costs. Variable costs are expected to change as activity changes. standard cost sheet form providing standard quantities of inputs used to produce a unit of output and the standard prices for the inputs. cost variance analysis comparison of actual input amounts and prices with standard input amounts and prices price variance difference between actual costs and budgeted costs arising from changes in the cost of inputs to a production process or other activity efficiency variance difference between budgeted and actual results arising from differences between the inputs that were budgeted per unit of output and the inputs actually used. total cost variance difference between budgeted and actual results (equal to the sum of the price and efficiency variances) flexible production budget standard input price times standard quantity of input allowed for actual good output The direct labor price variance is caused by the difference between actual and standard labor costs per hour. LABOR EFFICIENCY VARIANCE is a measure of labor productivity. it is one of the closely watched variances because production managers usually can control it. spending (budget) variance price variance for fixed overhead production volume variance variance that arises because the volume used to apply fixed overhead differs from the estimated volume used to estimate fixed costs per unit. also called "capacity variance", "idle capacity" or a "denominator variance" standard costing an accounting method that assigns costs to cost objects at predetermined amounts Cost volume profit (CVP) analysis study of the relations among revenue, cost, and volume and their effect on profit. Profit equation operating profit equals total revenue less total costs Unit contribution margin difference between revenues per unit (price) and variable cost per unit Total contribution margin difference between revenues and total variable costs Break-even point volume level at which profits equal zero Contribution margin ratio contribution margin as a percentage of sales revenue Profit volume analysis version of CVP analysis using a single profit line Cost structure proportion of an organization's fixed and variable costs to its total costs Operating leverage extent to which an organization's cost structure is made of fixed costs Margin of safety the excess of projected or actual sales over the break even volume Margin of safety percentage the excess of projected or actual sales over the break even volume expressed as a percentage of actual sales volume Differential analysis process of estimating revenues and costs of alternative actions available to decision makers and of comparing these estimates to the status quo Short run period of time over which capacity will be unchanged, usually one year Differential costs with two or more alternatives, costs that differ among or between alternatives Sunk costs costs incurred in the past that cannot be changed by present or future decisions Full cost sum of all fixed and variable costs of manufacturing and selling an unit Special order order that will not affect other sales and is usually a short run occurrences Product life cycle time from initial research and development to the time that support to the customer ends Target price price based on customers' perceived value for the product and the price that competitors charge Target cost equals the target price minus the desired profit margin Predatory pricing practice of setting price below cost with the intent to drive competitors out of business Dumping exporting a product to another country at a price below domestic cost Price discrimination practice of selling identical goods to different customers at different prices Peak load pricing practice of setting prices highest when the quantity demanded for the product approaches capacity Price fixing agreement among business competitors to set prices at a particular level Make or buy decisions decision concerning whether to make needed goods internally or purchase them from outside sources Constraint activity, resource, or policy that limits or bounds the attainment of an objective Contribution margin per unit of scarce resource contribution margin per unit of a particular input with limited availability Theory of constraints (TOC) focuses on revenue and cost management when faced with bottlenecks Bottlenecks operation where the work required limits production Throughout contribution sales dollars minus direct materials costs and variables such as energy and piecework labor Engineering estimate cost estimate based on measurement and pricing of the work involved in a task Account analysis cost estimation method that calls for a review of each account making up the total cost being analyzed Relevant range limits within which a cost estimate may be valid Scatter-graph graph that plots costs against activity levels High low cost estimation method to estimate costs based on two cost observations, usually at the highest and lowest activity levels Regression statistical procedure to determine the relation between variables Independent variable x term, or predictor, on the right hand side of a regression equation Dependent variable y term, or the left handed side of a regression equation Correlation coefficient measure of the linear relation between two or more variables, such as cost and some measure of activity Coefficient of determination square of the correlation coefficient, interpreted as the proportion of the variation in the dependent variable explained by the independent variables T statistic t is the value of the estimated coefficient, b, divided by its standard error Adjusted R squared correlation coefficient squared and adjusted for the number of independent variables used to make the estimate Learning phenomenon the systematic relationship between the amount of experience in performing a task and the time required to perform it