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Traditional Allocation Systems Plant- wide and departmental approaches, have advantages. They meet financial reporting requirements for determining the costs assign the inventory as product cost. Simple, information is easy to obtain, May result in relatively accurate estimates of products cost that accurately capture the cost of manufacturing those products.

Using these approaches to allocate overhead makes a couple of inherent assumptions. Overhead costs change with changes in the allocation base. - over time overhead costs either at the plant-wide level or the departmental level, depending on which traditional system used such as direct labor costs. if overhead is comprised primarily of costs associated with supervision and human resource management and administration, that assumption may be a valid one. it's likely that as a company has more direct labor cost over time, it probably does end up having more supervisory and human resource and administrative costs. Direct labor costs likely do drive those types of overhead costs. Products that use more direct labor probably do cause more of these overhead costs to be incurred. If overhead cost are comprised primarily of costs associated with processing customers orders, setting up the equipment to produce a new batch of products associated with those orders, and shipping the resulting orders of products made, then that the assumption may not be as valid. As the company accepts more and more orders as it grows, those overhead costs will probably be larger. So the number of orders likely drives those type of overhead costs and would be more appropriate allocation base. All products are equally responsible for the overhead costs that are incurred (they use overhead in the same proportions.) - may not valid Noting that over time the composition of costs, particularly in manufacturing organizations, has changed. Decades or more ago, manufacturing processes were very labor intensive. with little automation, little computerization, little technology. Indirect costs were a very small proportion of total manufacturing costs. the bottom line was that the choices about overhead allocation didn't really affect the overall estimated product cost too much. Recent times, increasingly more automation, and indirect costs now represent a much higher proportion of total costs. Choices in how to allocate overhead can change dramatically the estimated cost of a product. It can be harder to get accurate estimates of the cost of our products. Competition has became more global, intense not having accurate estimates of the cost to make your product or offer your service. important to design good cost systems.

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Designing Cost Allocation Systems Four steps of allocation overhead. The first two steps, determining the pools of overhead costs and the allocation base, involved choices that management makes. The last two steps are mathematical calculations that result form the choices made in the first two steps. There are two choices we must make in designing a cost system, pool and base. It's important to make good choices about cost pools and about allocation bases, because the estimated product or service cost that result from those choices in the cost system we will design, will be used in making management decisions. Choices, traditionally manufacturing organizations that must allocate manufacturing overhead to products in compliance with financial accounting requirements, have used relatively simple allocation systems. Two common traditional choices are allocating overhead with a plantwide allocation rate, and then allocating overhead with a departmental allocation base. With a plantwide approach, you have just one cost pool that contains all the manufacturing overhead cost. and it's allocated using a relatively simple, volume-driven allocation base like direct labor or machine hours. Like in the example all manufacturing overhead cost were placed into that one cost pool and allocated to the products direct labor costs. A departmental approach, you have cost pool for each department that contains all the overhead costs in that department. Overhead in each department is allocated separately, but again, using a relatively simply allocation base. For companies that have more than one department in which overhead is consumed in different ways, this approach often leads to product costs that more accurately reflect the manufacturing process to make those products. Allocation of overhead costs- 4 step process Step 1 Determine amount of costs in the "cost pool" Step 2 Choose an "allocation base" Step 3 Calculate an allocation rate Step 4 Use allocation rate to allocate OH to cost object based on object's use of the base

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Allocating Overhead Costs When needing to allocate overhead cost objects, like products, it might be helpful to think of that process in 4 steps. Step 1. Divide the total mount of overhead cost into several cost pools to be treated separately. Step 2. Choose a basis for allocating those overhead costs. Step 3. Calculate an overhead rate that will be used to allocate the overhead. That rate is calculated as the relation between overhead to be allocated and the allocation base. Step 4. use that overhead rate to allocate overhead as products are being made.

Step 3, Calculating that allocation rate. determining this overhead allocation rate, organizations typically use budgeted information. The beginning of the period, like a year, and the organization has an estimate or budget of the overhead costs that it expects to incur during the upcoming year. And then here, we have the end of the period. It's only at that time that we know how much actual overhead has been incurred. Managers need to make good management decisions during this timeframe. Typically allocate overhead based on estimates by using information form the budget. There'll be some differences between the actual amount and the budgeted amount. For financial accounting purposes, once we know the actuals, correct for the difference between actuals and estimates in the books. Step 1. Determine amount of cost in the "cost pool" Step 2. Choose an "allocation base" Step 3. Calculate a allocation rate Budgeted OH allocation rate = Budgeted overhead Budgeted allocation base Step 4. Use allocation rate to allocate OH to cost object based on object's use of the base. Company H Using direct labor costs as it overhead allocation base. $26,000 Amount of overhead cost that need to be allocated. $26,000 overhead/ $26,000 direct labor Estimated 10,000 units x $2 direct labor per unit basic model 2000 units x 3 direct labor per unit deluxe model = $26,000 direct labor cost dividing the $26,000 in overhead by the $26,000 in direct labor cost, overhead rate of 100%, for every $1 in direct labor for product, it will be allocated $1 in overhead. Basic Deluxe Direct material $4 $5 Direct labor 2 3 Overhead 2 3 Total cost $8 $11

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Cost systems System that assigns costs to products, or services; Cost object, anything that we want to determine the cost of. - Product - Service - Department - Customer process ect.

Companies are rarely required to determine the cost of any specific cost object but doing so can enhance management's ability to make better decisions. One situation in a company is required for financial accounting purposes to do this. Manufacturing companies are required to ensure that all manufacturing, or product costs are assigned to the units of product that are in inventory and eventually sold. How do they? How do these cost systems work? Ex. Company G makes three products, using cost system terminology these three products are the cost object. Lots of costs that we can trace easily to each of these products. Direct cost, Direct material and direct labor. Each product has it own direct material, and it's own direct labor traced directly to it. Cost we cannot easily trace, indirect costs or overhead. Cost system terminology, Cost pool- A group or a pool of costs. This group or pool of indirect costs, we can't easily trace to any individual cost objects. We really need to know what products those indirect costs are associated with. Why? A manufacturing company, we have to find a way to associate the indirect manufacturing cost with each product, so that we can include it in inventory as part of the inventories cost on the balance sheet. From a managerial perspective, we need to find a way to determine how much indirect costs, maybe both manufacturing and non-manufacturing, are associated with each product so that we can make good management decisions about each product that we make. Making sure to set a price on each product that's greater than all the costs that product causes us to incur. this can only be done by know how much costs the product causes us to incur. Exp. Company H makes two different types of products, Basic model and deluxe model. The cost objects, the basic model and deluxe model. We can easily trace the direct cost materials and labor to make the products. $26,000 in additional manufacturing costs, managers need to know how much of the indirect manufacturing costs are associated with each type of product. Find a way to allocate that $26,000 to those products. how? One thing could be to allocate or assign the exact same amount of overhead to each individual model. Company H's $26,000 of overhead, and in making 12,000 models. Simply allocate each model, 2.17 an overhead. Doing so, this results in an estimated cost of 8.17 for the basic model and 10.17 for deluxe model. Why don't we just do that? Because it's unlikely that a basic model and a deluxe model both cause the company to incur the same amount of overhead costs. Chances are the manufacturing process is somewhat different. That those two product would likely use overhead resources differently. The company could make better management decisions if the product cost estimates reflected those differences.

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The Flow of Cost

What type of costs are incurred in making and selling products and services, and how are these costs treated for financial accounting purposes?

Organization that provides services, - Wages for office personnel -Equipment - Sales effort - Administrative items - Salaries for consultants - Managers and partners Merchandising company - Inventory - Wages for store employees - Rent - Equipment - Cash registers and computers - Administrate items -Salaries for managers Manufacturing company - Material - Wages for workers - Rent - Equipment - Sales efforts - Administrative items - Salaries for managers How are all these costs treated for financial accounting purposes? How does the cost flow through the company's financial statements the a prepaid according to the appropriate accounting standards? - Product costs are the costs associated with make the product , and are also the called manufacturing costs. Period costs are the costs not associated with making the product, non-manufacturing costs. - Service organization is not making product , it has no product cost and inventory. All of it cost are period costs, and they're recorded as expenses on the income statement, as they are incurred. - Merchandising organization, they are not making the product, but the the cost of the product that it purchases to resell is included in inventory on the balance sheet when it's purchased. It stays there until it's sold to customer, and at that time those costs move to the income statement as cost of goods sold. Merchandising organization also incurs other costs, like rent on the store, the administrative costs, and so on. And those costs are period costs and recorded on the income statement as they are incurred. - Manufacturing organization, incurs the cost of material, labor, and other costs to make the product. those costs are product or manufacturing costs, and they're included on the balance sheet in inventory as the product is being made. Once the product is sold to the customer, those costs move to the statement, As cost of goods sold expense. the other costs that it incurs, but these are costs not incurred to make the product. They include things like selling and administration, are they're treated as period costs and recorded on the income statement as expenses as they incurred. They're not included in inventory. For financial statement purposes, Product costs are accumulated in inventory on the balance sheet and expended on the income statement when the product is sold and period costs are expended on the income statement as incurred.

Manufacturing companies have an inventory account on their balance sheet, Inventory account is comprised of three different types of inventory. - Raw materials inventory , contains materials that have not yet been put into the production process. - Work-in-process inventory, contains inventory that has been partially but not fully completed. The cost of labor that has been used thus far in the process and overhead or indirect costs that has been incurred to get the inventory to it current state. - finished goods inventory, It contains the cost of all inventory that's been completed but not yet sold. Cost flow through the financial statement for a manufacturing company, there are two types of costing systems. - Job costing system, track these costs by job and determine the cost of an individual unit after the job is completed by dividing the cost of the job by the number of units in the job. - Process costing system, tracks these cost by process or department and determines the cost of an individual unit at the end of a time period by dividing the cost of the departments by number of units completed during that time period. Both job costing and process costing track direct materials, direct labor and manufacturing overhead, and the objective in both systems is to determine the cost of an individual unit of product or service. Ex. Companies that might use a job costing system include companies that make teams uniforms that feature specific team's logo or accounting firm that performs audits for different clients or manufacturer if it make different designed for a specific race or company. These product are usually customized or each job is designed to meet specific customers needs. Ex.Companies using process costing systems include making beverages, cereals or pharmaceuticals and others. These products are made using standardized production processes that made up large quantities of identical products though a continuous flow of processes. Flow of costs through the financial statements under each of these systems, general flow is the same. - Direct material - Direct labor - Manufacturing overhead All product or manufacturing costs are included in inventory, and then moved to the income statement as cost of goods sold once the product is sold to a customer. The primary difference - job costing system, costs are accumulated in work-in-process inventory to finished goods inventory. - process costing system, costs are accumulated in work-in-process inventory by department as units of products are completed, and then they move from the last department in work-in-process inventory to finished goods inventory.

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CVP Analysis with Multiple Products

Sales mix is the relative proportion of sales units or dollars that comes from each product. Using the tool when there are multiple products or services, requires the assumption that the sales mix remains constant. Using the average contribution margin across all units, rather than the contribution margin of a single product analysis.

Product 1 Price VC/unit CM/unit

Product 2 Price VC/unit CM/unit

Total FC Sales mix (number of each product) Avg. CM/unit (CM)(sales mx) + (CM)(sales mx) (Sales mx) = Avg.CM/unit

Company E sells a product in two models. The basic model has a price per unit of $100 and a variable costs per unit of $60. The deluxe model has a price per unit of $120 and variable costs per unit of $100. It's typical sales mix is 75% basic models and 25% deluxe models. total fixed costs for the year are $105,000. How many basic and deluxe units must Company E sell to breakeven?

product 1 Product 2 Price $100 Price $120 VC $60 VC$100 CM $40 CM $20

FC 105,000 Sale mix Product 1 (75%) to Product 2 (25% )

Avg CM/unit= 75%(40) + 25% (20) = 30+ 5

Avg CM/unit = 35

(Price)(units)- (VC/unit)(unit) - FC = Profit

Product 1 CM(unit) -FC 35xunit -105,000

Q= 105,000/$35 =3000 units

75% x 3000 units= $2,250 product 2 25% x 3000 units= $750

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Beyond Breakeven: profit

Setting a target profit

Revenues- variable costs - fixed costs = profit

Price

VC/unit

Number of units

Total FC

Target profit

(Price)(units)- (VC/unit)(unit) - FC = Profit

(Price -VC/unit)(units) - FC = Profit

(CM/unit)(units) - FC =Profit

Units = FC + Profit

CM/unit

Company a sells s product whose price per unit is $100, Variable costs per unit are $60, and total fixed costs for the year are 100,00. How many units must Company A sell to make a $300,000 Profit?

($100)(units)- ($60/unit)(unit) - 100,000= $300,000

(Price -VC/unit)(units) - FC = Profit

(100-60)(x) -$400,000

(CM/unit)(units) - FC =Profit

(40)(x) /$400,00 =10,000

Units = FC + Profit 10,000= $100,000+ $300,000

CM/unit $ 40

price $100

VC $60

FC $100,000

Profit 300,000

units 10,000

Company B sells a product whose price per unit is $90, variable costs per unit are $50, and total fixed costs for the year are $100,000. How many units must Company B sell to make a $80,000 profit?

($90)(units)- ($50)(unit) - $100,000 = $80,000

(Price -VC/unit)(units) - FC = Profit

$40 (unit) - $100,000 = $80,000

(CM/unit)(units) - FC =Profit $40(unit) / $180,000

Units = FC + Profit 4500 = $100,000 + $80,000

CM/unit $40

Price $90

VC $50

FC $100,000

Profit $80,000

Units 4500

Company C sells a product whose variable costs per unit are $30. Total fixed costs for the year are $40,000. The company anticipates selling 2,000 units. What price must Company C charge to make a profit of $60,000?

(Price)(units)- ($30)(2,000) - $40,000 = $60,000

(Price -VC/unit)(units) - FC = Profit $60,00+$40,000+60,000 $160,000/2000units =$80

(CM/unit)(units) - FC =Profit

Units = FC + Profit

CM/unit

VC $30 FC $40,000 Units 2,000 Profit $60,000 Price $80

Company D sells a product whose variable costs per unit are $50. Total fixed costs for the year are $200,000. The company anticipates selling 5,000 units. What price must Company D charge to make a profit of 150,000?

(Price)(units)- ($50)(5,000) - $200,000 = $150,000

(Price -VC/unit)(units) - FC = Profit 250,000+200,000+150,000= $600,000 5000/600,000 = $120

(CM/unit)(units) - FC =Profit

Units = FC + Profit CM/unit

Price $ 120 VC $50 FC $200,000 Units 5,000 Profit $150,000

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Breakeven Analysis

When profit is exactly equal to zero or its revenues exactly equal it's costs.

Revenues minus variable costs are equal to zero.

Profit=0 or revenues= total Costs

Handy profit formula: Revenues - Variable Costs - Fixed Costs =0

Breakeven analysis: determining the breakeven quantity or number of units that a company needs to sell to breakeven or have profit exactly to zero and then determining the breakeven price or the price at which the company wants price it products or services to breakeven.

Breakeven point or breakeven quantity in an important concept to managers. Sales levels below that point, the organization incurs loss and only when sales increase beyond that level is reported profit.

Variable cost per unit and total fixed costs, determine how many units the company needs to sell to breakeven.

Revenues - Variable Costs - Fixed Costs =0

(price)(units) - (VC/unit)(Units) - FC =0

(Price - VC/unit)(units) - FC = 0

(CM/unit)(units) = 0

BE units = FC

CM/unit

Contribution margin per unit

The price of a product or service less it's variable costs

Represents the incremental profit for each unit sold

Total contribution margin

Contribution margin per unit x number of units sold

Amount available to cover the organization's fixed costs and then generate a profit

Looking for a price that is sufficient to cover all the costs. Total fixed costs plus the total variable cost.

price 1000

vc/unit 600

FC 1000000

(1000xQ)-(600xQ)- 1000000= 0

(1000-600)xQ=1000000

Q=1000000 / $400

Q=2500 units

When the total price in unavailable

VC unit 30

FC 30000

2000 units

(2000 xP) -(2000x $30)- 30000=0

2000x P= $30000 + 60000

P 90000 / 2000

P= $45 /unit

Company D sells a product whose variable costs per unit are $40. Total fixed cost for the year are $400,000. The company Anticipates selling 10,000 units. What price must Company D charge to breakeven? Revenues- VC -FC=0

unit cost (VC)$40

FC $400,000

10,000 Units

(10,000xP)-(10,000x$40)-400,000=0

10000 xp = 400,000 +400,000

10,000 /800,000

price= $809

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Functional Versus Contribution Margin Income Statement

Income Statement prepare for financial accounting purposes

Starts with revenues, subtracts cost of goods sold (COGS) or manufacturing cost for a manufacturer to get gross margin and then subtract selling general and administrative expenses, non-manufacturing costs to get profit.

"functional" income statement

(Financial Accounting)

Revenues

COGS (Manufacturing costs)- Variable and Fixed

Gross Margin

SG&A (Non-manufacturing costs)Variable and fixed

Profit

The cost are grouped according to function, manufacturing varsus non-manufacturing. Income statements can be using to make managerial or decision-oriented. When costs are not grouped according to function but according to behavior.

Starting format revenues, subtracts variable cost to get Contribution margin and then subtracts fixed cost to get a profit.

"Contribution Margin" income statement

(Management Accounting)

Revenues

Variable costs- Manufacturing and Non-manufacturing

Contribution Margin

Fixed costs -Manufacting and Non-manufacturing

Profit

Functional income statement, cost of goods sold which are manufacturing cost will include both variable and fixed manufacturing cost and as GNA - non-manufacturing costs will include both variable and fixed non-manufacturing cost.

Finanacial accounting or functional income statement, costs are organized by function, and on the managerial or contribution margin income statement costs are rearranged and organized by behavior.

As manager using the organization's financial income statement and rearrange in contribution margin format, helpful in making decisions.

Contribution margin for one unit of a product or service equals it price minus its variable cost per unit. Incremental profit of selling one more unit. Price - VC per unit= CM per unit.

We can also think about total contribution margin rather than contribution margin per unit. Total contribution margin is a contribution margin per unit multiplied by the number of units sold. CM per unit x number of units.

The total contribution margin is the total amount of dollars available after paying for the variable cost of course to cover the organization's fixed cost and then generate a profit.

Income statement format - Handy profit formula

Revenues minus our variable cost, minus our fixed costs, is equal to our profit.

revenues minus variable cost equals the contribution margin.

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Week 2

Cost volume profit analysis.

It is applied to the concept of breaking even, asking questions "how many unit's does the organization need to sell to break even?" "What prices does the organization need to set to break even?" taking cost volume profit analysis beyond break even, moving in to profit planning to ask questions "How many units does the organization need to sell to achieve a specific target profit?

The relationship among components of the profit equation, price, volume, cost structure and profit to assess the financial impact of alternative management decisions. CVP questions, "How many units does the company need to sell to generate a profit of 10000?" "How much does the company need to reduce cost to achieve a profit of 20000?" "How many units of a new product does the company need to sell to cover costs?" "What is the impact on profit of a decease in variable cost per unit of 10%?"

CVP analysis requires several assumptions.

all costs can either be represented as fixed or variable.

The price per unit, the variable cost per unit, the total fixed cost are constant within some relevant range.

Cost function is linear within relevant range

Only one cost driver- sales volume (units)

Production or purchases is equal to sales, so there is no beginning or ending inventory

if company sells more than one product or service, the sales mix remains constant

While CVP analysis can be a good place to start in the profit planning process, simplifying assumptions do suggest that additional analysis be conducted before finalizing.

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Managerial Accounting Fundamentals

Important caveats

Careful about when making decisions that depend on understanding costs behavior,Costs that behave one way for one organization might behave another way for another organization.

When an employee is paid based on productivity (paid a certain amount based on labor) the labor costs are variable costs. Cost function that we derive is valid only for a certain range of activity. Using past data about cost and activity for different levels of activity, for an organization's typical activity level make up our estimate. so you estimate is valid only with in that range of activity. this range is something call the relevant range.

When it exceeds what the organization typically sees or if it falls below the typical activity level, out costs predictions may not be accurate. The organization's fixed cost changes.

reasonably or reliably estimate or predict costs for activity levels outside of that relevant range with the equations.

Cost that are fixed in short term, may be variable in the long term. Many fixed cost may appear fixed based on the past data that is used to assess them, data may be based on relatively short time.

Longer term, managers have to open them more options than they do in the short term.

unit per cost- Total fixed cost stay the same as number of units increases, but notice that the fixed cost per unit decreases as the number of units increases. it happens because we're dividing a constant amount a fixed cost, by an increasing number of units. using two by two matrix, as the number of units increase, the variable costs increase in total, but they stay the same per unit. As the number of units increase, fixed costs stay the same in total, but they decrease per unit.

Making decisions using unitized or per unit cost can sometime lead to poor decisions because using united fixed costs, treats those costs as if they were variable. Careful not to assume that fixed cost per unit and total cost per unit stay the same across different levels of activity. when decision that involve choosing between alternatives that have different levels of activity, don't unitize the fixed cost in your analysis. Cost my also very based on something other than cost.

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Choose a book and documentary by Thích Nhất Hạnh.

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cost equation

y=mx+b

To calculate the variable cost's estimate the slope of the line by picking two points along the. calculate the change by dividing the change in costs by the change units. b is where the line intercept on the y axis. which is 200000 at this time.

m is solved by using to points on the graph, with different unit amounts, first by dividing the variable cost by the unit amount second subtract the amounts.

500000 - 700000 = 200000

5000 units - 10000 units = 5000

then divided

200000/5000= 40$ per unit

y=40x+200000

High-low method

step 1: identify typical high and low activity observations

step2: Estimate the variable cost per unit.

Total costs hi - Total costs lo

Units hi - Units lo

step 3: Estimate fixed costs by subtracting total variable costs form the total costs at either activity level.

Total costs hi - (VC per unit)(Units hi) = toal FC

low $950000, 10000 -high $2,975,000; 55000

2,025000/45000

45$/vc per unit

950000tc lo- (45vc)(10000 unit lo)=

- 450000= $500000

y=mx+b

y=45x+ 500000

lo $310,000 : 2000unit - hi 805,000 :11000unit

495,000 / 9000 = 55$ vc per unit

805,000- 55$(11000)= 200,000total fc (fixed cost)

y=55x+200,000

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5-17

Type tester

"It' easy to make a buck it's harder to make a difference."

Tom brokaw

“Perfection is not attainable, but if we chase perfection we can catch excellence.”

Vince Lombardi.