Chapter 4 (Process Costing) Management Accounting Tutorial...

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McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Management Accounting Tutorial 16 (Chapter 4, 7, 8, 9, and 11)

Module Review

Bangor University Transfer Abroad Programme


Chapter 4 (Process Costing) TM 4-1

© The McGraw-Hill Companies, Inc., 2008. All rights reserved.

AGENDA: PROCESS COSTING

A. Differences between job-order and process costing.

B. Overview of cost flows in process costing.

C. The concept of equivalent (whole) units for partially completed units.

D. The weighted-average method for determining costs.

E. (FIFO Supplement) The FIFO method for determining costs.

F. (FIFO Supplement) Comparison of weighted-average and FIFO methods.




OVERVIEW OF PROCESS COSTING

A. In process costing, costs are accumulated in processing departments.

B. A separate departmental production report is compiled for each processing department. This report provides the details of how costs are assigned to units that pass through the department.

C. Costs to be accounted for in each processing department consist of:

1. Costs of the beginning work in process inventory in the department.

2. Costs added during the period.

a. Costs of units transferred in from a preceding department.

b. Costs added in the department itself.

Materials + Labor + Overhead

Conversion Costs

D. Costs are accounted for by assigning them to:

1. Ending work in process inventory in the department.

2. Units transferred out to the next department (or to finished goods).




OVERVIEW OF PROCESS COSTING (continued)

E. In process costing, each unit is assigned the average cost of units processed through the department.

F. Two things must be known to compute the average cost per unit in a department:

1. The total cost.

2. The total number of units processed.

G. Partially completed units are converted to equivalent (whole) units.

For example, 200 units in ending inventory are 25% complete with respect to conversion costs.

Equivalent Number of partially Percentage = × units completed units completion

= 200 × 50% = 50 EUs

H. The two common methods of computing average costs per unit are the weighted-average method and the FIFO method. The FIFO method is discussed in FIFO Supplement.




WEIGHTED-AVERAGE METHOD

• The weighted-average method averages together the beginning work in process inventories with the units started during the current period.

• For each category of cost in each processing department the following calculations are made:

Equivalent Units Equivalent unitsunits of = transferred + in ending WIP

production out inventory

Units transferred out of the department are 100% complete with respect to the work done in the department.

Cost of beginning Cost added+work in process inventory during the periodCost per = equivalent unit Equivalent units of production

Cost of units Cost per Units = × transferred out equivalent unit transferred out

Cost of units in Cost per Equivalent units in = × ending WIP inventory equivalent unit ending WIP inventory




FIFO METHOD (FIFO Supplement)

• The FIFO method separates the costs of beginning inventory from the costs incurred during the current period. (The weighted-average method combines them.)

• FIFO assumes the beginning inventory is completed before any new units are started.

Equivalent Equivalent units Units started Equivalent unitsunits of = to complete beginning + and completed + in ending

production WIP inventory during the period WIP inventory

Units in beginning inventory × (100% − Percentage completion of beginning WIP inventory)

Cost added during the periodCost per = equivalent unit Equivalent units of production

Cost of units Cost in Cost to complete Cost of units startedtransferred = beginning WIP+ units in beginning + and completed

out inventory WIP inventory this period

Equivalent units to complete beginning WIP inventory × Cost per equivalent unit

Units started and completed this period× Cost per equivalent unit

Cost of units in Cost per Equivalent units in = × ending WIP inventory equivalent unit ending WIP inventory

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Chapter 4 (Process Costing - Comparison) TM 4-13


COMPARISON OF EQUIVALENT UNITS

Beginning Work in Process: 15,000 Units 80% Complete

Started and Completed: 160,000 Units

Ending Work in Process: 20,000 Units 30% Complete

Weighted-Average Method

180,000 Units Started

Units transferred to next department: Work in process, ending: 20,000 units x 30% Equivalent units of production

175,000

6,000 181,000

FIFO Method

Work in process, beginning: 15,000 units x (100% - 80%) Units started and completed: Work in process, ending: 20,000 units x 30% Equivalent units of production

3,000 160,000

6,000 169,000






Chapter 4 (Process Costing - Comparison)

TM 4-13


COMPARISON OF EQUIVALENT UNITS




Weighted-Average Method


Units transferred to next department: Work in process, ending: 20,000 units x 30% Equivalent units of production

175,000

6,000 181,000

FIFO Method

Work in process, beginning: 15,000 units x (100% - 80%) Units started and completed: Work in process, ending: 20,000 units x 30% Equivalent units of production

3,000 160,000

6,000 169,000






Chapter 7 (Profit Planning) TM 7-1


AGENDA: PROFIT PLANNING (BUDGETING)

A. Purposes and overview of budgeting.

B. Building a master budget.

1. Sales budget

2. Production budget

3. Direct materials budget

4. Direct labor budget

5. Manufacturing overhead budget

6. Ending finished goods inventory budget

7. Selling and administrative expenses budget

8. Cash budget

9. Budgeted income statement

10. Budgeted balance sheet


Chapter 7 (Profit Planning) TM 7-2


OVERVIEW OF BUDGETING

A budget is a detailed plan for acquiring and using financial and other resources over a specified period. Budgeting involves two stages:

• Planning: Developing objectives and preparing various detailed budgets to achieve those objectives.

• Control: The steps taken by management to attain the objectives set down at the planning stage.

PURPOSES OF BUDGETING

• Budgets communicate management’s plans throughout the organization.

• Budgeting forces managers to give planning top priority.

• Budgets provide a means of allocating resources to their most effective uses.

• Budgeting uncovers potential bottlenecks.

• Budgeting coordinates the activities of the entire organization.

• Budgeting provides goals that serve as benchmarks for evaluating subsequent performance.


Balanced Score Card Vision and Strategy (Four Perspectives)

Using the Balanced Scorecard as a Strategic Management System

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harvard business review • managing for the long term • july–august 2007 page 4

Translating Vision and Strategy: Four Perspectives

Managing Strategy: Four Processes McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Balanced Score Card

Using the Balanced Scorecard as a Strategic Management System

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harvard business review • managing for the long term • july–august 2007 page 12

date, and modify the hypotheses embeddedin a business unit’s strategy. By establishingshort-term goals, or milestones, within thebusiness-planning process, executives areforecasting the relationship between changesin performance drivers and the associatedchanges in one or more specified goals. Forexample, executives at Metro Bank estimatedthe amount of time it would take for improve-ments in training and in the availability ofinformation systems before employees couldsell multiple financial products effectivelyto existing and new customers. They also esti-mated how great the effect of that selling

capability would be.Another organization attempted to validate

its hypothesized cause-and-effect relation-ships in the balanced scorecard by measuringthe strength of the linkages among measuresin the different perspectives. (See the exhibit“How One Company Linked Measures fromthe Four Perspectives.”) The company foundsignificant correlations between employees’morale, a measure in the learning-and-growthperspective, and customer satisfaction, animportant customer perspective measure.Customer satisfaction, in turn, was correlatedwith faster payment of invoices—a relation-ship that led to a substantial reduction inaccounts receivable and hence a higher returnon capital employed. The company also foundcorrelations between employees’ morale andthe number of suggestions made by employ-ees (two learning-and-growth measures) aswell as between an increased number ofsuggestions and lower rework (an internal-business-process measure). Evidence of suchstrong correlations help to confirm the orga-nization’s business strategy. If, however, theexpected correlations are not found overtime, it should be an indication to executivesthat the theory underlying the unit’s strategymay not be working as they had anticipated.

Especially in large organizations, accumu-lating sufficient data to document significantcorrelations and causation among balancedscorecard measures can take a long time—months or years. Over the short term, manag-ers’ assessment of strategic impact may haveto rest on subjective and qualitative judg-ments. Eventually, however, as more evidenceaccumulates, organizations may be able toprovide more objectively grounded estimatesof cause-and-effect relationships. But just get-ting managers to think systematically aboutthe assumptions underlying their strategyis an improvement over the current practiceof making decisions based on short-termoperational results.

Third, the scorecard facilitates the strategyreview that is essential to strategic learning.Traditionally, companies use the monthly orquarterly meetings between corporate anddivision executives to analyze the most recentperiod’s financial results. Discussions focus onpast performance and on explanations of whyfinancial objectives were not achieved. Thebalanced scorecard, with its specification of

How One Company Linked Measures from the Four Perspectives

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Chapter 8 (Standard Costs)

TM 8-1


AGENDA: STANDARD COSTS AND THE BALANCED SCORECARD

A. Setting standard costs

1. Ideal versus practical standards

2. Direct materials standards

3. Direct labor standards

4. Variable manufacturing overhead standards

B. Standard cost card

C. Computing variances

1. The general variance model

2. Direct materials variances

3. Direct labor variances

4. Variable manufacturing overhead variances

D. (Appendix) Journal entries for variances

E. Potential problems with standard costs McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 8 (Standard Costs) TM 8-2


SETTING STANDARD COSTS

• A standard is a benchmark or “norm” for measuring performance.

• Price standard: How much an input should cost.

• Quantity standard: How much of a given input should be used to make a unit of output.

IDEAL VERSUS PRACTICAL STANDARDS

Ideal standards allow for no machine breakdowns or work interruptions, and can be attained only by working at peak effort 100% of the time. Such standards:

• often discourage workers.

• shouldn’t be used for decision making.

Practical standards allow for “normal” down time, employee rest periods, and the like. Such standards:

• are felt to motivate employees, since the standards are “tight but attainable.”

• are useful for decision-making purposes, since variances from standard will contain only “abnormal” elements.




VARIABLE OVERHEAD STANDARDS

There may be standards for variable overhead, as well as for direct materials and direct labor. The standards are typically expressed in terms of a “rate” and “hours,” much like direct labor.

• The “rate” is the variable portion of the predetermined overhead rate.

• The “hours” represent whatever base is used to apply overhead cost to products. Ordinarily, this would be direct labor-hours or machine-hours.

EXAMPLE: Speeds, Inc. applies overhead cost to products on the basis of direct labor-hours. The variable portion of the predetermined overhead rate is $4 per direct labor-hour. Using this rate, the standard cost of variable overhead for one unit of product is:

2.0 hours per jogging suit × $4 per hour = $8 per jogging suit.

TM 8-8


STANDARD COST CARD

After standards have been set for materials, labor, and overhead, a standard cost card is prepared. The standard cost card indicates what the cost should be for a completed unit of product.

EXAMPLE: Referring back to the standard costs computed for materials, labor, and overhead, the standard cost for one jogging suit would be:

Standard Cost Card for Jogging Suits

(1 ) Standard Quantity or Hours

(2) Standard

Price or Rate

(1) × (2)

Standard Cost

Direct materials .................. 3.5 yards $6 per yard $21 Direct labor ........................ 2.0 hours $18 per hour 36 Variable manufacturing

overhead ......................... 2.0 hours $4 per hour 8 Total standard cost per suit . $65




POTENTIAL PROBLEMS WITH STANDARD COSTS

• Variances are often reported too late to be useful.

• If used as a tool for punishing people, standards can undermine morale.

• Labor efficiency standards encourage high output. This may lead to excessive work in process if a workstation is not a bottleneck.

• A favorable quantity variance may be worse than an unfavorable quantity variance.

• Quality may suffer if undue emphasis is placed on just meeting the standards.

• Just meeting standards may not be sufficient; continual improvement is often necessary.


Chapter 9 (Budgets and Overhead Analysis) TM 9-1


AGENDA: FLEXIBLE BUDGETS AND OVERHEAD ANALYSIS

A. Flexible budgets and performance reports

1. Static budgets

2. Flexible budgets

3. Flexible budget overhead performance report

B. Further analysis of variable overhead

1. The choice of activity measure

2. Variable overhead spending variance

3. Variable overhead efficiency variance

C. Overhead application in a standard cost system

1. Predetermined overhead rate

2. Applying overhead

D. Fixed overhead variances

1. Budget variance

2. Volume variance

E. Overhead under- and overapplied and standard cost variances McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.



FLEXIBLE BUDGETS

• A flexible budget is geared toward all levels of activity within a range, rather than toward only one level of activity.

• A flexible budget is dynamic rather than static; it can be tailored for any level of activity within the relevant range.

EXAMPLE: Refer to the data for Larch Corporation. A flexible budget for manufacturing overhead is provided below for three different levels of activity ranging from 5,000 to 15,000 units.

Larch Corporation Flexible Budget for Overhead

Cost Formula Units Per Unit 5,000 10,000 15,000

Variable overhead costs: Maintenance ................. $0.60 $ 3,000 $ 6,000 $ 9,000 Indirect materials .......... 1.40 7,000 14,000 21,000 Utilities ......................... 1.00 5,000 10,000 15,000

Total variable overhead .... $3.00 15,000 30,000 45,000

Fixed overhead costs: Depreciation ................. 40,000 40,000 40,000 Supervision ................... 50,000 50,000 50,000 Insurance ..................... 10,000 10,000 10,000

Total fixed overhead ........ 100,000 100,000 100,000

Total overhead cost ......... $115,000 $130,000 $145,000

TM 9-5


OVERHEAD PERFORMANCE REPORT

In a performance report focused on cost control, actual costs should be compared to the flexible budget for the actual level of activity—not the budget for the planned level of activity.

EXAMPLE: Since Larch Corporation produced and sold only 8,000 units instead of the 10,000 units that had been planned, we would expect spending on variable overhead items to be less than had been planned.

Larch Corporation Overhead Performance Report

Actual Budget Costs Based Cost Incurred on Spending Formula 8,000 8,000 & Budget Per Unit Units Units Variances

Variable overhead costs: Maintenance ................. $0.60 $ 4,500 $ 4,800 $ 300 F Indirect materials .......... 1.40 12,000 11,200 800 U Utilities ......................... 1.00 9,500 8,000 1,500 U

Total variable overhead .... $3.00 26,000 24,000 2,000 U

Fixed overhead costs: Depreciation .................. 40,000 40,000 0 Supervision ................... 49,000 50,000 1,000 F Insurance ..................... 10,000 10,000 0

Total fixed overhead ......... 99,000 100,000 1,000 F

Total overhead cost .......... $125,000 $124,000 $1,000 U

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Chapter 9 (Budgets and Overhead Analysis)

TM 9-6


THE MEASURE OF ACTIVITY

• Most companies use a measure of activity such as labor-hours or machine-hours as the activity base for manufacturing overhead. This is particularly true in multi-product firms where hours often serve as a common denominator for diverse products.

• Should actual hours or standard hours allowed for the actual output be used in constructing budget allowances for the performance report? There are two approaches:

1. The budget allowance is based solely on the actual hours. Then only a spending variance for variable overhead is computed. (See Exhibit 9-6 in the text for an example.)

2. Budget allowances are based on both the actual hours and the standard hours allowed for the actual output. Then both spending and efficiency variances are computed for variable overhead. (See Exhibit 9-7 in the text for an example.)




OVERHEAD VARIANCE ANALYSIS

The flexible budget for manufacturing overhead provides information to:

• Compute predetermined overhead rates.

• Complete the standard cost card.

• Apply overhead cost to products.

• Prepare overhead variance reports.

EXAMPLE: Swift Corporation manufactures a single product. Standard cost data for the product follow:

(1) (2) Standard Standard Standard Quantity Price Cost or Hours or Rate (1) × (2)

Direct materials .... 3.5 feet $12 per foot $42 Direct labor .......... 2.0 hours $16 per hour $32

Overhead is assigned to the product on the basis of standard direct labor-hours. Swift Corporation’s flexible budget for overhead (in condensed form) is given below:

Cost Direct Labor-Hours Per DLH 10,000 15,000 20,000

Variable costs .. $5 $ 50,000 $ 75,000 $100,000 Fixed costs ...... 300,000 300,000 300,000 Total cost ........ $350,000 $375,000 $400,000

TM 9-10


PREDETERMINED OVERHEAD RATE

• In a standard cost system, the predetermined overhead rate is computed as follows:

Flexible budget for overhead atthe denominator level of activityPredetermined = overhead rate Denominator level of activity

EXAMPLE: The predetermined overhead rate at Swift Corporation is computed below for two levels of activity:

Denominator activity: 10,000 DLHs

Variable element: ($50,000 ÷ 10,000 DLHs) ... $ 5 per DLH Fixed element: ($300,000 ÷ 10,000 DLHs) ..... 30 per DLH Predetermined overhead rate ........................ $35 per DLH

Denominator activity: 15,000 DLHs

Variable element: ($75,000 ÷ 15,000 DLHs) ... $ 5 per DLH Fixed element: ($300,000 ÷ 15,000 DLHs) ..... 20 per DLH Predetermined overhead rate ........................ $25 per DLH

Note that the difference between the predetermined overhead rates at the two levels of activity is entirely due to fixed overhead being spread over different amounts of activity.




GRAPHIC ANALYSIS OF VOLUME VARIANCE

13 14 15 16 17 18

320,000

300,000Volume variance

20,000 F

Denominatorhours

Standardhours

allowed

Fixed overhead costapplied at $20 per

standard hour

Standard direct labor hours (000)

Budgetedfixed

overhead

Appliedfixed

overhead




SUMMARY OF VARIANCES

• In a standard costing system, under or overapplied overhead equals the sum of:

• Variable overhead spending variance

• Variable overhead efficiency variance

• Fixed overhead budget variance

• Fixed overhead spending variance

• Underapplied overhead is equivalent to a net unfavorable variance.

• Overapplied overhead is equivalent to a net favorable variance.

Thus, Swift Corporation’s $14,000 overapplied overhead can be explained as follows:

Variable overhead: Spending variance ................ $ 9,000 F Efficiency variance ................ 10,000 U

Fixed overhead: Budget variance ................... 5,000 U Volume variance .................. 20,000 F

Overapplied overhead ............. $14,000 F


Chapter 11 (Relevant Costs for Decision Making) TM 11-1


AGENDA: RELEVANT COSTS FOR DECISION MAKING

A. Identification of relevant costs.

B. Drop or retain a segment.

C. Make or buy decision.

D. Utilization of constrained resources.

E. Special order.




RELEVANT COSTS

Every decision involves a choice from among at least two alternatives.

A relevant cost or benefit is a cost or benefit that differs, in total, between the alternatives. Any cost or benefit that does not differ between the alternatives is irrelevant and can be ignored. Relevant costs and benefits are also known as differential costs and benefits.

Avoidable costs are those costs that can be eliminated in whole or in part by choosing one alternative over another. Avoidable costs are relevant costs.

Two broad categories of costs are never relevant in decisions:

1. Sunk costs

2. Future costs that do not differ between alternatives.

To make a decision:

1. Eliminate costs and benefits that do not differ, in total, between alternatives.

2. Base the decision on the remaining costs and benefits.

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UTILIZATION OF CONSTRAINED RESOURCES

• Anything that prevents an organization from getting more of what it wants (e.g., profits) is a constraint.

• A particular machine may not have enough capacity to satisfy current demand.

• Supplies of a critical part may not be sufficient to satisfy current demand.

• When the constraint is a machine or a work center, it is called a bottleneck.

• When capacity is not sufficient to satisfy demand, something must be cut back. Which products should be cut back and by how much?

• Fixed costs are not usually affected by the decision of which products should be emphasized in the short run. All of the machines and other fixed assets are in place—it is just a question of how they should be used.

• When fixed costs are unaffected by the choice of which product to emphasize, maximizing the total contribution margin will also maximize total profits.

• The total contribution margin is maximized by emphasizing the products with the greatest contribution margin per unit of the constrained resource.




UTILIZATION OF CONSTRAINED RESOURCES (cont’d)

MANAGING CONSTRAINTS

Processing more good units through the bottleneck that customers actually want is a key to increased profits:

• Produce only what can be sold.

• Pay workers overtime to keep the bottleneck running after normal working hours.

• Shift workers from non-bottleneck areas to the bottleneck.

• Hire more workers or acquire more machines for the bottleneck.

• Subcontract some of the production that would use the bottleneck.

• Focus business process improvement efforts such as Six Sigma on the bottleneck.

• Reduce defects.

The potential payoff to effectively managing the constraint can be enormous.

EXAMPLE: Suppose the available time on Machine N34 can be increased by paying the machine’s operator to work overtime. Would this be worthwhile?

ANSWER: Since the additional time would be used to make more of Product X, each minute of overtime is worth $24 to the company and hence each hour is worth $1,440 (60 minutes × $24 per minute)!


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