MACTbookCaplan2

5/21/2018 MACTbookCaplan2

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Management Accounting Concepts and Techniques

Dennis Caplan, Oregon State University

capland@busoregonstateedu

http!""denniscaplan#atco$com"TOChtm

Table o# Contents

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/art %! 0ntroduction

Management accounting de#ined, described, and compared to #inancial accounting

1elevant concepts #rom management and operations management, and a brie# history o# management

accounting/art &! Microeconomic #oundations o# management accounting

1elevant cost analysis

Cost behavior

Cost2volume2pro#it

3le4ible budgeting

Cost variances #or direct materials and labor

/art '! /roduct costing and cost allocations

/roduct costing

5ormal costing

Standard costing

Activity2based costing

Allocation o# service department costsThe role o# cost in setting prices

/art (! Determining the cost o# inventory

6or72in2process

Alternative inventory valuation methods

3i4ed manu#acturing overhead

Cost variances #or variable and #i4ed overhead

8oint products

/art )! /lanning tools and per#ormance measures #or pro9ects and divisions

Capital budgeting

Operating budgets

:udgetary incentive schemesDivisional per#ormance measures

Trans#er pricing

Corporate social responsibility

3ive2page summary o# 7ey concepts

;lossary

This site is maintained by Dennis Caplan, University at Albany (State University of New York) !rofessor Caplan maybe "onta"ted at d"aplan#$amailalbanyed$ Sol$tions to the end%of%"hapter materials will be sent via email to anyinstr$"tor listed in &ames 'asselba"ks A""o$ntin *a"$lty Dire"tory

+anaement A""o$ntin Con"epts and Te"hni$es Copyriht- .//0 +ost re"ent $pdate- November .//1

C


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two equivalent units in work-in-process (hat does it mean for a unit of inventory to be #'$ complete? %t means that #'$ of theinputs required to make the unit have been incurred

%n some manufacturing environments, materials enter the production process early, while labor and other inputs are incurred moreevenly throughout the process !or example, an apparel manufacturer cuts all of the fabric for the batch at the beginning of the

production process, while sewing operator labor is incurred more-or-less evenly from the time the fabric is cut until the garmentsare completed %n this situation, companies frequently calculate equivalent units separately for materials and conversion costs)labor and overhead* %n fact, companies can calculate equivalent units separately for as many different types of inputs as desired,

breaking materials and labor into subcategories However, the additional accuracy of the cost accounting information thus

obtained seldom +ustifies the additional costs to track itThe following nine examples illustrate how equivalent units are used to calculate the cost of work-in-process, beginning with asimple setting and progressing to more complicated scenarios Each example involves a company that assembles personalcomputers from purchased components s shown in some of these examples, the companys assumption about inventory flow isrelevant

=4ample %!

:eginning 0nventory

Activity during the $ee7

=nding

0nventory

Units '.' units made and shipped out )ie, sold*

'

Costsincurred

/'01aterials23onversion costs2

/.,4''45'

0 Throughout these examples, the box for 6costs incurred7beginning inventory8 reports the beginning balance in the (%9account for the week>uestion!(hat is the cost per unit for each unit made and sold?

Ans$er!

Total costs2 /.,4'' : /45' ; /",


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incurred 3onversion costs2 45'

>uestions!(hat is cost of goods sold? (hat is the cost of ending work-in-process?Ans$er!

Total costs2 /.,4'' : /45' ; /",uestions!(hat is cost of goods sold? (hat is the ending balance in finished goods inventory?

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Ans$er!lthough total costs to account for is easily calculated )/A'' : /.,4'' : /45' ; /A,.5'*, it is impossible to determinethe break-out between cost of goods sold and finished goods inventory without knowing the companys inventory flowassumption=4ample *!Bata and questions are the same as in Example # ssume the company uses the !%!C )first in, first out* inventoryflow assumptionAns$er! The cost per unit for production this week is /"


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3ost per equivalent unit2Ending work-in-process23ost of goods sold2

/",44' = .." equivalent units ; /"@@4@/"@@4@ per unit x . unit "'$ complete ; /#AA4/"@@4@ x .. units ; /"4A@#@

5ote!Cne might think that the calculation of equivalent units needs to include the beginning inventory that is #'$ completeHowever, we would be double-counting if we did so, because the unit that is #'$ complete in beginning inventory is one of the

.. units identified as finished during the period in the equivalent unit calculation %n the schedule below, the costs to account forare highlighted in green, and the physical units to account for are highlighted in yellow

:eginning

0nventory

Activity during the $ee7

=nding

0nventory

Units . unit #'$ complete withrespect to both materialsand conversion costs

The %unit coming into the period iscompleted %.units are started andcompleted . unit is started but notcompleted

%unit &.?complete withrespect to both materialsand conversion costs

Costs

incurred

%).beginning balance in(%9

1aterials23onversion costs2

%,-..

-(.

=4ercises and /roblems!

%(2%!%n applying the weighted-average method for equivalent unit cost calculations, which of the following information do younot need to know?

)* 9roduction costs incurred during the period)* The equivalent units in beginning work-in-process inventory)3* The cost of beginning work-in-process inventory

)B* ll of the above must be known, in order to calculate the cost per equivalent unit%(2&!

A&ix units were in beginning work-in-process )(%9* at the beginning of 1ay These units were .''$ complete with respect todirect materials, and #'$ complete with respect to conversion costs Buring the period, these six units were completed, andanother eight units were started t the end of the period, four of these eight units were completed, and the other four units were.''$ finished with respect to direct materials, and F#$ complete with respect to conversion costs !ollowing is pertinent costinformation2

eginning (%9 3osts added in 1ay Birect 1aterials /@'' /A,@'' 3onversion costs /@'' /","''3alculate the cost per equivalent unit, using the weighted-average method

: "#' units were in beginning work-in-process at the beginning of &eptember These units were .''$ complete with respect todirect materials, and #'$ complete with respect to conversion costs t the end of &eptember, .'' units were in ending work-in-

process These units were ero units of finished goods inventory Thecompany starts and completes production of nine units The company starts a tenth unit, but it is not complete by the end of theweek %t is @'$ complete with respect to both materials and conversion costs /.,4'' in materials was transferred during the weekfrom raw materials inventory to work-in-process inventory /45' in conversion costs was incurred and debited to work-in-processinventory during the week 3alculate the cost per equivalent unit for units transferred from (%9 to finished goods inventory

: company starts the week with >ero units of work-in-process inventory and >ero units of finished goods inventory The

company starts and completes production of nine units The company starts a tenth unit, but it is not complete at the end of theweek %t is .''$ complete with respect to materials and #'$ with respect to conversion costs /.,4'' in materials was transferredduring the week from raw materials inventory to work-in-process inventory /45' in conversion costs was incurred and debited to

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work-in-process inventory during the week 3alculate the cost per equivalent unit for units transferred from (%9 to finished goodsinventory

C The company starts the week with >ero units in finished goods inventory, and one unit in work-in-process The one unit in (%9is @'$ complete with respect to both materials and conversion costs, and it is carried at a cost of /.#' Buring the week, thecompany completes this one unit, starts and completes ten more units, and starts production of yet another unit, but this last unit isonly A'$ complete with respect to both materials and conversion costs at the end of the week The company incurred /",ero beginning inventory, starts and completes 5'' units, and starts production of another "'' units, butthese "'' units are not finished at the end of the period These "'' units are #'$ complete with respect to materials, and A'$complete with respect to labor and overhead Buring the period, the factory spent /.',''' on materials and /5,@'' on labor and

overhead 3alculate the cost per equivalent unit using the weighted-average method

%(2+! ent 9lastics began the period with #' units that were .''$ complete with respect to materials and #'$ complete withrespect to conversion costs Buring the period, ent began production of another .'' units t the end of the period, there were @'units, .''$ complete with respect to materials and #'$ complete with respect to conversion costs 3alculate the equivalent units

producedduring the period with respect to conversion costs ) 5ote2 This is notthe denominator in the weighted-average methodfor determining the cost of production Iather, it is a measure of the level of production activity during the period*

%(2! @' units were in beginning (%9 These units were #'$ complete with respect to materials and conversion costs #' unitswere in ending (%9 These units were also #'$ complete with respect to materials and conversion costs Buring the period, 4'units were transferred from (%9 to !inished Goods How many units were started during the period?%(2-! JH% company started "''A with .'' units in beginning work-in-process )(%9* that were .''$ complete with respect to

materials and #'$ complete with respect to conversion costs The cost of this beginning (%9 was /#,''' for materials and /A,'''for conversion costs Buring "''A, JH% complete these .'' units, and started another .'' units t the end of "''A, JH% had #'

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units in ending (%9 that were .''$ with respect to materials and .'$ complete with respect to conversion costs JH% incurredmaterials costs of /5,''' and conversion costs of /.,#'' in "''A 3ompute the cost per equivalent unit using the weighted-average method

%(2%.! The factory has >ero beginning inventory, starts and completes .'' units, and starts production of another "'' units, butthese "'' units are not finished at the end of the period These "'' units are .''$ complete with respect to materials, but only#'$ complete with respect to labor and overhead Buring the period, the factory spent /A,''' on materials and /


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costs/ but t'e$ all agree t'at non-manu"acturing costs s'ould not be debited as part o" t'e cost o"

in(entor$0

or e!ternal nancial reporting under #enerall$ Accepted Accounting %rinciples/ as .ell as "or ta!

reporting/ companies are re)uired to use absorption costing also called "ull costin70 8ence/ t'ere is

no c'oice "rom t'e abo(e table "or e!ternal nancial reporting0

or internal reporting purposes/ sur(e$ data suggests t'at appro!imatel$ 'al" o" manu"acturing

companies use absorption costing and appro!imatel$ 'al" use (ariable costing0 &'roug'put costing is arelati(el$ recent p'enomenon/ and does not seem to be used e!tensi(el$ $et0

Absorption Costin:

&'e t'eoretical ustication "or absorption costing is to 'onor t'e matc'ing principle "or all

manu"acturing costs0 i!ed manu"acturing o(er'ead costs are onl$ incurred .it' t'e e!pectation t'at

t'e resources represented b$ t'ese costs .ill be used in t'e production o" in(entor$0 8ence/ t'ese costs

s'ould be matc'ed against t'e re(enue generated "rom t'e sale o" t'at in(entor$0

Absorption costing re)uires computing an o(er'ead rate "or appl$ing all manu"acturing o(er'ead to

units produced during t'e period or else t.o o(er'ead rates/ one "or (ariable manu"acturing o(er'ead

and one "or !ed manu"acturing o(er'ead: or else multiple o(er'ead rates i" t'e compan$ uses acti(it$-based costing70 &'ere are important issues related to c'oosing t'e denominator in t'e o(er'ead rate

"or !ed manu"acturing o(er'ead/ .'ic' are discussed in t'e ne!t c'apter o" t'is boo;0

Variable Costin:

&'e t'eoretical ustication "or (ariable costing is t'at !ed manu"acturing o(er'ead (ariable costing? is per'aps less t'an ideal/ because not all (ariable costs are capitali,ed* non-

manu"acturing costs are not capitali,ed as part o" t'e cost o" in(entor$ under an$ circumstances0

@nder (ariable costing/ t'e cost o" ending in(entor$ consists o" direct manu"acturing costs usuall$

materials and labor7 and (ariable manu"acturing o(er'ead0 8ence/ t'ese are t'e costs "or .'ic'

(ariable costing 'onors t'e matc'ing principle/ and not'ing else is capitali,ed as part o" t'e cost o"

in(entor$0

Absorption Costin and Variable Costin Co#pared:

&'e only dierence bet.een absorption costing and (ariable costing is t'e treatment o" !edmanu"acturing o(er'ead


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- I" beginning and ending in(entor$ le(els are ,ero/ absorption costing and (ariable

costing .ill al.a$s result in t'e same income0

- I" beginning in(entor$ is ,ero and ending in(entor$ is positi(e/ absorption costing

.ill al.a$s result in 'ig'er income t'an (ariable costing/ and a 'ig'er (aluation "or

ending in(entor$0

- I" beginning in(entor$ is positi(e and ending in(entor$ is ,ero/ absorption costing

.ill al.a$s result in lo.er income t'an (ariable costing/ and a 'ig'er (aluation "or

beginning in(entor$0

- +'en in(entor$ le(els are increasing "rom period-end to period-end/ as .ould bee!pected .'en t'e compan$ is gro.ing/ absorption costing will generallyresult in 'ig'er

ending in(entor$ (aluations t'an (ariable costing/ and also 'ig'er income in eac' period0

&'e reason is t'at absorption costing postpones recogni,ing e(er-increasing amounts o"

!ed manu"acturing o(er'ead on t'e income statement/ because increasing amounts o"

!ed manu"acturing o(er'ead are capitali,ed as ending in(entor$0

=(er t'e li"e o" t'e compan$ or "rom an$ point in time at .'ic' t'ere is ,ero in(entor$ to an$ ot'er

point in time at .'ic' t'ere is ,ero in(entor$7/ t'e sum o" income o(er all periods must be e)ual under

t'e t.o met'ods0 &'e dierence bet.een absorption costing and (ariable costing is onl$ a timing

dierence* t'e )uestion o" .'en !ed manu"acturing o(er'ead is ta;en to t'e income statement0

Inco#e $tate#ent Presentation:

Absorption costing/ (ariable costing and t'roug'put costing are eac' associated .it' an income

statement "ormat*

Absorption costing uses a ross #arin inco#e state#ent/ .'ic' starts .it' re(enues and

subtracts cost o" goods sold to deri(e gross margin/ t'en subtracts non-manu"acturing costs to

deri(e operating income0 Virtuall$ e(er$ income statement presented in connection .it'

e!ternal nancial reporting uses a gross margin "ormat0 #ross margin income statements

separate manu"acturing costs "rom non-manu"acturing costs/ .'ic' is 'elp"ul "or certain t$pes o"

anal$ses0

Variable costing uses a contribution #arin inco#e state#ent/ .'ic' starts .it' re(enues

and subtracts (ariable costs (ariable manu"acturing costs related to units sold/ plus all (ariable

non-manu"acturing costs7 to deri(e contribution margin/ t'en subtracts all !ed costs

manu"acturing and non-manu"acturing7 to deri(e operating income0 Contribution margin

income statements "acilitate cost-(olume-prot anal$sis0 It s'ould be emp'asi,ed t'at under

(ariable costing/ not all (ariable costs appear on t'e income statement in t'e period incurred0

Variable manu"acturing costs t'at 'a(e been incurred to ma;e in(entor$ t'at 'asnBt been sold

$et appear on t'e balance s'eet as part o" t'e cost o" nis'ed goods in(entor$0

&'roug'put costing starts .it' re(enues and subtracts direct material costs associated .it'

units sold to deri(e throuhput #arin/ t'en subtracts all ot'er costs0

&'ese income statement "ormats do not dene t'e costing met'ods0 &'e costing met'ods are dened

b$ .'ic' manu"acturing costs are capitali,ed/ as indicated in t'e table at t'e beginning o" t'is c'apter0

It is possible/ "or e!ample/ to cost in(entor$ and determine income using t'e rules o" absorption

costing/ but to t'en present t'e data in a contribution margin "ormat b$ ma;ing certain

reclassications0

%u#erical E&a#ple o" Absorption Costin and Variable Costin:

ollo.ing is in"ormation about t'e operations o" @ltimate NA/ Inc0/ "or t'e $ear ended ecember 31/

260

irect materials used in production D3/

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irect labor costs incurred

Variable manu"acturing o(er'ead costs incurred

Variable non-manu"acturing costs incurred

i!ed manu"acturing o(er'ead costs incurred

i!ed non-manu"acturing costs incurred

D1/

D 5/

D 4/

D /

D 2/

&'ere .as no beginning in(entor$0 1 units .ere produced/ and 5 units .ere sold at a price o"

D2/ per unit0 &'e (ariable non-manu"acturing costs consist o" t.o items* a sales commission paid

"or units sold/ and a transportation cost to s'ip nis'ed product "rom t'e "actor$ to (arious .are'ouses.'ere product is stored until it is sold0

Re'uired: %repare a Contribution


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Re'uired: Calculate t'e cost o" ending in(entor$ under Variable Costing0

D4/5 per unit ! 5 units G D225/

=nl$ (ariable manu"acturing costs are capitali,ed0 All ot'er costs are e!pensed as incurred0

1equired!3alculate the cost of ending inventory under bsorption 3osting?

/#,A'' per unit x #' units ; /"@#,'''

Cnly manufacturing costs )fixed and variable* are capitali>ed ll non-manufacturing costs are expensed as incurrednder both Jariable and bsorption 3osting, all non-manufacturing costs are expensed as incurred !or example, the variablenon-manufacturing costs include a sales commission for units sold, and a transportation cost incurred for all units shortly afterthey are manufactured Even though the transportation cost includes shipping costs for units in the warehouse and not yet sold,this cost cannot be capitali>ed as part of the cost of inventory, because the transportation cost is not a manufacturing cost, andinventory is ready for sale at the time it leaves the factory

Absorption Costin and (enerally Accepted Accountin Principles:

In 24/ t'e inancial Accounting Standards oard issued Statement o" inancial Accounting Standards

SAS7 No0 151/ to amend and clari"$ generall$ accepted accounting principles "or t'e calculation o"

in(entories under absorption costing0 &'e oardBs stated purpose "or issuing t'e ne. standard .as to

impro(e t'e comparabilit$ o" cross-border nancial reporting/ b$ aligning @0S0 #AA% .it' t'e

International Accounting Standards oardBs Statement No0 20

SAS No0 151 .as t'e rst ne. pronouncement on absorption costing issued b$ a @0S0 accounting

standard-setting bod$ in "t$ $ears0 @ntil SAS No0 151/ neit'er t'e inancial Accounting Standards

oard nor its predecessor/ t'e Accounting %rinciples oard/ 'ad specicall$ addressed absorption

costing in a broad-based .a$0 Jat'er/ eac' board 'ad incorporated #AA% t'at e!isted at t'e time t'e

board .as "ounded0 @sing t'is genealog$/ prior to SAS No0 151/ #AA% "or absorption costing could be

traced to Accounting Jesearc' ulletin AJ7 No0 43/ issued in 1953 b$ t'e Committee on Accounting

%rocedure t'e predecessor to t'e Accounting %rinciples oard70

Ke$ pro(isions o" AJ No0 43/ C'apter 4 on in(entor$ pricing/ included t'e "ollo.ing*

A maor obecti(e o" accounting "or in(entories is t'e proper determination

o" income t'roug' t'e process o" matc'ing appropriate costs against

re(enues0

- AJ No0 43/ C'apter 4/

Statement No0 2

As applied to in(entories/ cost means in principle t'e sum o" t'e applicable

e!penditures and c'arges directl$ or indirectl$ incurred in bringing an

article to its e!isting condition and location0

- AJ No0 43/ C'apter 4/

Statement No0 3

&'e denition o" cost as applied to in(entories is understood to mean

ac)uisition and production cost/ and its determination in(ol(es man$

problems0 L @nder some circumstances/ items suc' as idle "acilit$

e!pense/ e!cessi(e spoilage/ double "reig't/ and re'andling costs ma$ be

so abnormal as to re)uire treatment as current period c'arges rat'er t'an

as a portion o" t'e in(entor$ cost0

- AJ No0 43/ C'apter 4iscussion o" Statement No0 3

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SAS No0 151 amends AJ No0 43 b$ eliminating t'e >so abnormal? criterion in t'is last paragrap'0

8ence/ items suc' as idle "acilit$ e!pense and e!cessi(e spoilage must no. be recogni,ed as current-

period c'arges0

+it' respect to idle "acilit$ e!pense/ SAS No0 151 re)uires !ed production o(er'ead to be allocated to

in(entor$ based on t'e >normal capacit$? o" t'e production "acilit$0 &'e Statement denes normal

capacit$* >normal capacit$ re"ers to a range o" production le(els/ and is t'e production le(el e!pected

to be ac'ie(ed o(er a number o" periods or seasons under normal circumstances/ ta;ing into accountt'e loss o" capacit$ resulting "rom planned maintenance0? &'e Statement notes t'at some (ariation in

production le(els "rom period to period is e!pected/ t'at normal capacit$ .ill (ar$ based on business-

specic and industr$-specic "actors/ and t'at t'ese (ariations .ill establis' t'e range o" normal

capacit$0 i!ed manu"acturing o(er'ead can be allocated based on t'e actual le(el o" production .'en

actual production appro!imates normal capacit$0 &'e Statement obser(es t'at udgment is re)uired to

determine .'en a production le(el is abnormall$ lo. i0e0/ outside t'e range o" t'e e!pected (ariation

in production70 !amples o" "actors t'at mig't cause an abnormall$ lo. production le(el include

signicantl$-reduced customer demand/ labor and materials s'ortages/ and unplanned "acilit$ or

e)uipment do.ntime0

Alt'oug' SAS No0 151 con(e$s t'e (ie. o" t'e inancial Accounting Standards oard t'at t'e ne.pronouncement .ould not lead to signicant c'anges in in(entor$ accounting practice/ some

companiesB nancial statements ma$ be aected0 &'ere is some e(idence t'at prior to SAS No0 151/

companies did not appl$ absorption costing in t'e same manner0 &'e (agueness in t'e .ording o" AJ

No0 43 seemed to permit alternati(e treatments0 urt'ermore/ because AJ No0 43 did not re)uire

companies to disclose 'o. t'e$ applied absorption costing/ in"ormation .as generall$ not a(ailable

about t'e e!tent to .'ic' t'ese alternati(e treatments .ere emplo$ed0

Sur(e$ data on t'is issue .as pro(ided in t.o articles t'at appeared in Management Accountingb$


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Customer ser(ice

or man$ industries/ manu"acturing costs constitute t'e maorit$ o" costs incurred in t'e (alue c'ain0

or companies in t'ese industries/ t'e decision to capitali,e most or all manu"acturing costs as

in(entor$/ and to run t'ese costs t'roug' t'e income statement .'en t'e related in(entor$ is sold/

pro(ides t'e benets o" t'e matc'ing principle t'at are discussed in introductor$ nancial accounting

courses0

8o.e(er/ t'ere are some industries in .'ic' manu"acturing costs are small relati(e to one or more o"t'e ot'er acti(ities in t'e (alue c'ain0 or e!ample/ p'armaceutical companies incur large researc' and

de(elopment JO7 costs0 @nder all t'ree costing met'ods t'at are discussed in t'is c'apter/ JO does

not become a part o" t'e cost o" in(entor$0 In most situations/ JO is e!pensed .'en incurred "or

nancial reporting purposes/ .'ic' clearl$ "ails to 'onor t'e matc'ing principle in a signicant .a$0

Marge e!penditures are incurred and ta;en to t'e income statement "or man$ $ears be"ore an$ re(enue

is reali,ed "or t'at drug/ and t'en a"ter t'e drug is appro(ed b$ t'e ood and rug Administration/

re(enue is generated "or man$ $ears .it' no directl$-related osetting JO e!penditures0 &'e actual

manu"acturing cost o" t'e drug can be )uite small relati(e to t'e JO e!penditures t'at .ere incurred

to bring t'e drug to mar;et0 =" course/ t'e situation is some.'at more complicated "or large

p'armaceutical companies/ because t'ere are numerous drugs at (arious stages in t'eir li"ec$cles/ so

t'at JO on some proects oset re(enue "rom drugs "or .'ic' t'e JO is alread$ complete/ and also/t'ere are man$ JO proects t'at ne(er result in a saleable product0

Anot'er industr$ in .'ic' manu"acturing costs are small relati(e to some o" t'e ot'er acti(ities in t'e

(alue c'ain is t'e so"t drin; industr$0 &'e ingredients and processes used in t'e manu"acture o" so"t

drin;s are "airl$ ine!pensi(e/ and t'ere are "e. barriers to entr$0 Conse)uentl$/ so"t drin; companies

spend large amounts on mar;eting and ad(ertising0 &'ese mar;eting eorts are anticipated to pro(ide

long-term benets b$ turning consumers into li"e-long Coca-ColaPor %epsiPdrin;ers0 8o.e(er/ t'ese

costs are not capitali,ed as part o" t'e cost o" in(entor$ or as an$ ot'er t$pe o" asset: rat'er/ t'e$ are

e!pensed .'en incurred subect to t'e usual accrual accounting practices70

Throuhput Costin:Also called super*variable costin/ t'roug'put costing is a relati(el$ ne. de(elopment0 &'roug'put

costing treats all costs as period e!penses e!cept "or direct materials0 In ot'er .ords/ t'e matc'ing

principle is 'onored onl$ "or direct materials0

A compan$ s'ould probabl$ meet t.o criteria be"ore it c'ooses t'roug'put costing0 &'e rst criterion

relates to t'e nature o" t'e manu"acturing process0 &'roug'put costing onl$ ma;es sense "or

companies engaged in a manu"acturing process in .'ic' most labor and o(er'ead are !ed costs0

Assembl$-line and continuous processes t'at are 'ig'l$ automated are most li;el$ to meet t'is

criterion0 or e!ample/ t'irt$ "actor$ emplo$ees mig't be re)uired to .or; a gi(en s'i"t/ regardless o"

.'et'er t'e mac'iner$ is set at "ull capacit$ or less0 &'e second criterion is t'at management pre"ers

cost accounting in"ormation t'at is 'elp"ul "or s'ort-term/ incremental anal$sis/ suc' as .'et'er t'ecompan$ s'ould accept a one-time special sales order at a reduced sales price0 In t'is respect/ a

compan$Bs c'oice o" t'roug'put costing is a logical e!tension o" t'e compan$Bs c'oice o" (ariable

costing o(er absorption costing0

li$a'u #oldratt/ .'o de(eloped t'e t'eor$ o" constraints/ ad(ocates t'roug'put costing in 'is popular

business no(el The Goal0 Alt'oug' t'roug'put costing 'as not gained .ide acceptance/ #oldrattBs

support "or it 'as been inQuential0

E&ercises and Proble#s:

15*1: +'ic' o" t'e "ollo.ing items account "or t'e dierence in income bet.een Variable Costing andAbsorption Costing .'en in(entor$ le(els are c'anging C'ec; all t'at appl$07

13


14/91

A7 i!ed manu"acturing costs

7 i!ed non-manu"acturing costs

C7 Variable manu"acturing costs

7 Variable non-manu"acturing costs

15*+: At a production le(el o" 1 units/ t'e per unit cost under Absorption Costing is D/ .'ic'

consists o" D2 o" direct materials/ D2 o" direct labor/ D2 o" (ariable manu"acturing o(er'ead/ and D2 o"

!ed manu"acturing o(er'ead0 Calculate t'e Absorption Costing per unit cost assuming t'e productionle(el is increased to 2 units

15*,: 8an;Bs 8ot og actor$ manu"actures 'ot dogs0 &'e "actor$Bs cost structure is as "ollo.s* !ed

manu"acturing costs per mont' are D/0 Variable manu"acturing costs are D04 per 'ot dog0 i!ed

non-manu"acturing costs are D/ per mont'0 Variable non-manu"acturing costs consist o" a D02

sales commission "or e(er$ 'ot dog sold0 &'e sales price per 'ot dog is D2020

Re'uired: I" t'e compan$ begins t'e mont' .it' ,ero in(entor$/ ma;es 1/ 'ot dogs/ and sells

/ 'ot dogs/ .'at is t'e total cost o" in(entor$ on t'e alance S'eet at t'e end o" t'e mont' under

Variable Costing +'at is income loss7 "or t'e mont' under Variable Costing

%)2(!The Esquimau 9ie 3ompany makes and sells the famous Esquimau 9ie ice cream bar The companys cost structure is asfollows2 fixed manufacturing overhead is /#,''' monthly Jariable manufacturing costs are /.5' for each Esquimau 9ie !ixednon-manufacturing costs are /A,''' monthly There are no variable non-manufacturing costs The company begins the month withno inventory, makes ",''' Esquimau 9ies, and sells .,''' Esquimau 9ies for /.' per pieA (hat is the cost of ending inventory under bsorption 3osting?

: (hat is the cost of ending inventory under Jariable 3osting?C (hat is income under bsorption 3osting?

D (hat is income under Jariable 3osting?

15*5:&'e Impatients-&o-#o Sil; lo.er Compan$ began operations on anuar$ 1/ 240 +'ic' o" t'e

"ollo.ing circumstances ensures t'at t'e compan$Bs net income .ill be t'e same under Absorption

Costing as under Variable Costing "or 25/ its second $ear o" operations

I7 &'e compan$ 'as no in(entor$ on anuar$ 1/ 25/ and no in(entor$ on ecember 31/

250

II7 &'e compan$ incurred no !ed manu"acturing o(er'ead in 25/ and 'as no in(entor$

on ecember 31/ 250

III7 &'e compan$ incurred no !ed manu"acturing o(er'ead in 24/ and 'as no in(entor$ onecember 31/ 250

A7 I onl$

7 I and II are eac' suRcient

C7 I and III are eac' suRcient

7 I/ II and III are eac' suRcient

%)2*! The !oster 3ompany has variable and fixed manufacturing costs, and also some variable and fixed non-manufacturing costs!or the year "''#, the company has >ero beginning inventory, and positive ending inventory (hich statement is true?

14


15/91

)* %ncome in "''# is the same under both bsorption 3osting and Jariable 3osting

)* %ncome in "''# is higher under bsorption 3osting than under Jariable 3osting)3* %ncome in "''# is lower under bsorption 3osting than under Jariable 3osting)B* nable to determine, from the information given, whether income is higher or lower under bsorption 3osting

than under Jariable 3osting

%)2+! Crien and Hwang started "''@ with >ero inventory, produced .'' units of product, and sold 4' units They incurred thefollowing costs2 variable manufacturing costs of /.' per unitK fixed manufacturing costs of /",'''K variable non-manufacturingcosts of a /" sales commission per unit soldK and fixed non-manufacturing costs of /F''

A(hat will the "''@ year-end balance sheet show for ending inventory if the company uses Jariable 3osting?:3alculate net income for "''@ under Jariable 3osting The sales price is /#' per unit

15*-:o'n Smit' o.ned a Qour mill0 8e started 13 .it' no in(entor$/ produced 5 tons o" Qour/ and

ended t'e $ear .it' (e tons o" Qour0 Sales .ere D22/50 8e 'ad no (ariable manu"acturing o(er'ead0

8is onl$ direct cost .as grain/ "or .'ic' 'e paid D/0 Non-manu"acturing (ariable costs .ere D5//

non-manu"acturing !ed costs .ere D4// and manu"acturing !ed costs .ere D6/0

A. +'at .as Smit'Bs contribution margin "or 13

A7 D9/5

7 D1/3

C7 D1/

7 &'e ans.er depends on .'et'er Smit' uses Absorption Costing or Variable Costing

/.+'at .as operating income "or 13 under Variable Costing

A7 Moss o" D5

7 Income o" D

C7 Income o" D9

7 Income o" D3

%)2-!The following information pertains to oo> udio, a manufacturer of high-end speakers for home audio systems Each6nit8 is actually two speakers )ie, a pair of speakers* The sales price per unit is /.,#'' in both years eginning inventory in

"''5 was >ero

&..(

nits manufacturednits soldBirect manufacturing costs )materials and labor*Jariable manufacturing overhead!ixed manufacturing overheadJariable non-manufacturing overhead!ixed non-manufacturing overhead

#,'''5,#''

/",''','''#'','''

.,''','''#','''

.'','''

&..)

nits manufacturednits soldBirect manufacturing costs )materials and labor*

5,'''5,.''

/.,@'','''

15


16/91

Jariable manufacturing overhead!ixed manufacturing overheadJariable non-manufacturing overhead!ixed non-manufacturing overhead

5'','''.,''','''

5','''.'','''

1equired!

A 9repare a contribution margin income statement for "''#, using variable costing, assuming the company uses !%!C

: 9repare a gross margin income statement for "''#, using absorption costing, assuming the company uses !%!C

C 3ompute cost-of-goods-sold for "''#, using absorption costing, assuming the company uses D%!C%)2%.! The rcata icycle 3ompany began operations on Lanuary ., "''' with no inventory The company makes one product, atouring bike !ollowing is information for production and sales for rcatas first two years of operations

)or the year +000 )or the year +001

@nits produced

@nits sold

Selling price per unit

irect materials per unit

irect labor per unit

Sales commission per unit

1

5

D2/

D1

D6

D2

1

D2/

D9

D6

D2

%n each year, total variable manufacturing overhead was /#','''K total fixed manufacturing overhead was /@','''K and total fixednon-manufacturing overhead was /"',''' There were no variable non-manufacturing costs other than sales commissions

A. 8o. man$ units are in ending in(entor$ at t'e end o" 21

/. @sing I= irst-in irst-out7 and Absorption Costing/ .'at is t'e cost o" ending in(entor$ on t'ealance S'eet at t'e end o" 21

C. @sing Variable Costing and MI=/ .'at is income "or 21

15*11: =nen Corporation ma;es ust one product* a '$draulic pump t'at sells "or D1/ per unit0 In


17/91

/ortable Standard Delu4e

&ales price1aximum sales demandeginning inventory%nputs2Birect materialsBirect labor1etal-working time!ixed manufacturing overhead

/5'' per unit.,''' units>ero/ing product mix? ssuming that the company uses this product mix, show an income statementfor each product produced

C (ithout regard to your answers to parts and , assume that the company decides to produce only the portable heaterHalfway through the year, the metal-working machine breaks down, in+uring the machine operator, and prompting the

labor union to call a strike The machine cannot be repaired or replaced for the rest of the year, and in any case, theworkers remain on strike Buring the first six months, the company produced #'' portable heaters, and by the end of theyear, the company sold 5'', leaving .'' units in ending finished goods inventory Jalue this ending inventory forfinancial reporting purposes, in accordance with &!& .#.

%)2%'!M!N &candinavia is a new affiliate of M!N %nternational M!N &candinavia manufactures bell-bottom +eans in a singlemanufacturing facility !ollowing is pertinent data for "''#, its first year of operations )hence, there is no beginning inventory*

actor$ capacit$* 25/ eans per $ear

@nits manu"actured in 25* 192/ eans

Variable manu"acturing costs* D1 per ean

i!ed manu"acturing o(er'ead costs* D1/344/

S0 #0 O A0 e!penses* D2 per ean t'is is a sales commission7Sales* 15/ eans at D25 per ean

Sales demand/ sales price/ and (ariable costs are all e!pected to remain unc'anged in 26 "rom

250 i!ed manu"acturing o(er'ead costs are e!pected to increase b$ 10

Re'uired:

Calculate 25 income and proected 26 income under Absorption Costing/ under eac' o" t'e

"ollo.ing sets o" assumptions*

A. &'e compan$ accounts "or in(entor$ using I=/ allocates !ed manu"acturing

o(er'ead costs based on units produced/ manu"actures enoug' units in 26 toplan "or 6/ units in ending in(entor$ at t'e end o" t'e $ear0

1


18/91

/. &'e compan$ accounts "or in(entor$ using I=/ allocates !ed manu"acturing

o(er'ead costs based on units produced/ manu"actures at capacit$ in 260

C. &'e compan$ accounts "or in(entor$ using MI=/ allocates !ed manu"acturing

o(er'ead costs based on units produced/ manu"actures enoug' units in 26 to

plan "or 6/ units in ending in(entor$ at t'e end o" t'e $ear0

. &'e compan$ accounts "or in(entor$ using MI=/ allocates !ed manu"acturingo(er'ead costs based on units produced/ manu"actures at capacit$ in 260

Calculate 25 income and proected 26 income under Variable Costing/ under I=/ assuming t'e

compan$ manu"actures enoug' units in 26 to plan "or 6/ units in ending in(entor$ at t'e end o"

t'e $ear0

%)2%(!>tech %ndustries makes only one product %n "''., the company started the year with >ero beginning inventory Thecompany reported the following results for "''# and "''@2

&..) &..*

nits madenits soldverage unit sales priceJariable manufacturing costs!ixed overhead manufacturing costsJariable non-manufacturing costs!ixed non-manufacturing costs

"'.uestion %*2%!

The Taos &ki and Tennis Iesort has a &ummer manager and a (inter manager These managers receive a substantial portion oftheir income in the form of a bonus based on profitability They constantly argue about how certain costs should be allocatedacross the two seasons !or example, they both wanted a new espresso bar constructed, and they convinced the owner to build it

by agreeing to have the construction cost depreciated over the life of the building, and to have each years depreciation expenseallocated between the &ummer season and the (inter season for purposes of calculating each managers profits This convincedthe owner that the managers really believed the espresso bar would cover its costs However, although the two managers agreedthat these fixed costs should be allocated, and although they believe that the incremental revenue will more than cover the costs,including the cost to build the espresso bar, they cant agree on how to allocate depreciation expense between the two seasons Thesummer manager suggests splitting depreciation expense #'#', since the number of visitors is about the same for each seasonThe (inter manager suggests splitting depreciation expense F'A' )F'$ to &ummer*, since this roughly represents the length )in

days* of each season

The best way for the owner to resolve this dispute is to

)* Not allocate depreciation expense at all, since the cost of the building was relevant before it was built, but isirrelevant now that it is a sunk cost

)* llocate depreciation #'#', since all else equal, this will not favor either manager)3* llocate depreciation F'A', because this method is consistent with depreciating the entire cost of the building

over its useful life)B* llocate the cost based on actual espresso bar revenues, since this allocates costs on an 6ability to bear8 basis, and

recogni>es the fact that guests are more likely to buy coffee when the weather is cooler, so that the &ummermanager is not penali>ed

Discussion >uestion %*2&!

The ernalillo Tortilla !actory manufactures a variety of packaged 1exican food products in a large factory in Northern New1exico %n general, each product has its own equipment, factory personnel, and product manager 1any of these products arecurrently very popular, and in the short-term, there is not enough space in the factory to meet consumer demand (hich of thefollow statements are true?

)* llocating fixed manufacturing overhead to production will encourage product managers to set sales prices onindividual products that will help achieve the companys overall profitability goals

)* llocating fixed manufacturing overhead to production using factory square feet as the allocation base will assist

management in determining the most profitable product mix)3* llocating fixed manufacturing overhead to production during the year will provide product cost information that

is more consistent with the companys year-end financial statements )prepared in accordance with Generallyaccepted ccounting 9rinciples* than would treating fixed manufacturing overhead as a period expense

)B* !ixed manufacturing overhead costs are sunk in the short-run, and hence, are independent of the level of

production Therefore, there is no purpose in allocating these costs to production%*2'! 1ilwood 1ills makes decorative woodcut prints Each design is run in a single batch once during the year 1ilwood 1illsallocates machine set-up costs using set-up hours as the allocation base !ollowing is budgeted information for next year for twoof the companys numerous designs2Bull and MatadorandDogs Playing Poker

ull Bogs

112


23/91

Number of woodcutsBirect materials costBirect labor cost

Number of machine set-up hours9ounds of materialilowatt hours

#,'''/"#,'''/.5,'''

."'#,'''",'''

.#,'''/AA,'''/.@,'''

.#'.','''

A,'''A (hat is the anticipated effect of making the #,''' 6ull8 woodcuts in two batches instead of one, holding all else constant, ifmachine set-up costs are variable, in a linear fashion, in the number of setups?

)* The unit cost of 6ull8 will increase, and the unit cost of 6Bogs8 will decrease)* The unit cost of 6ull8 will increase, and the unit cost of 6Bogs8 will remain unchanged)3* The unit cost of 6ull8 will decrease, and the unit cost of 6Bogs8 will remain unchanged)B* The unit cost of both 6ull U 1atador8 and 6Bogs8 will remain unchanged

: (hat is the anticipated effect of making the #,''' woodcuts of 6ull8 in two batches instead of one, holding all else constant,if machine set-up costs include both fixed and variable components?

)* The unit cost of 6ull8 will increase, and the unit cost of 6Bogs8 will decrease

)* The unit cost of 6ull8 will increase, and the unit cost of 6Bogs8 will remain unchanged)3* The unit cost of 6ull8 will decrease, and the unit cost of 6Bogs8 will remain unchanged)B* The unit cost of both 6ull U 1atador8 and 6Bogs8 will remain unchanged

%*2(!The not-for-profit health clinic &hots-V-s provides various types of vaccinations and other shots, especially flu shots, tothe public for free or for a nominal fee The clinic is funded by several local governmental agencies as well as by a number ofcharitable organi>ations &ince different donors wish to fund different types of shots, the clinic determines the full cost of eachtype of shot, by adding overhead to the direct costs, and then provides this information to current and prospective donors

!ollowing are actual and budgeted costs for &hots-V-s for "''A2

Actual :udgeted

Number of patient visitsNumber of shots administered!ixed overhead2 salaries, rent for the facility, insurance,depreciationJariable overhead2 nursing staff hoursly wages, utilities,disposable supplies

3ost of hypodermics )a direct cost*3ost of medications )a direct cost*

#,'''@,'''

/45,'''

/@@,'''

/.,'''

/A','''

5,'''5,#''

/..','''

/5',#''

/F#'

/"','''

ssume the clinic allocates fixed overhead separately from variable overhead, and allocates fixed overhead using the number ofshots as the allocation base 3linic management believes that the facility could deliver as many as F,''' shots per year (hich ofthe following overhead rates will result in underallocated fixed overhead for the year?

% ctual level of activity in the denominator, and actual costs in the numerator%% udgeted level of activity in the denominator, and budgeted costs in the numerator%%% 9ractical capacity in the denominator, and budgeted costs in the numerator

)* %%% only

113


24/91

)* %% and %%% only

)3* %% only

)B* % only

)E* neither %, %%, nor %%%

%*2)! The 3arl-3arlson 3orporation uses bsorption 3osting, begins the year with >ero inventory, and has both fixed and variablemanufacturing costs Ielative to the benchmark in which the company produces the same number of units that it sells, which ofthe following statements is true?

)* y producing above its sales level, the company will increase the total cost of ending inventory on the balancesheet, and will also increase net income

)* y producing above its sales level, the company will increase the total cost of ending inventory on the balance

sheet, but will not affect net income)3* y producing above its sales level, the company will increase the total cost of ending inventory on the balance

sheet, but will decrease net income

)B* None of the above statements can be made with certainty, unless the actual costs and unit volumes are known

%*2*! !or the year "''5 )his first year of operations*, Harvey 1udd sold F,#'' units at /A#' per unit, and produced .',''' units,of his sole product, a combination espresso machine and rug steamer !actory capacity is .#,''' units Cther information for theyear included the following2

Birect manufacturing laborJariable manufacturing overheadBirect materialsJariable selling expense )a sales commission*!ixed non-manufacturing expenses!ixed manufacturing overhead

/F#','''5'','''@'','''5'','''5'','''


25/91

Birect labor per unitJariable non-manufacturing costs2 &ales commission per unit

/F'

/5'

/F'

/5#

!actory capacity is "'' units per year %n "''#, total variable manufacturing overhead was /


26/91

Rcienc$ (ariance G EVG $P! A4T $47

+'ere AP is t'e actual o(er'ead rate used to allocate (ariable o(er'ead/ and $P is t'e budgeted

o(er'ead rate0 &'e >4s? re"er to t'e )uantit$ o" t'e allocation base used to allocate (ariable o(er'ead/

so t'at A4is t'e actual )uantit$ o" t'e allocation base used during t'e period/ and $4is t'e standard

)uantit$ o" t'e allocation base0 &'e standard )uantit$ o" t'e allocation base is t'e amount o" t'e

allocation base t'at s'ould 'a(e been used i0e0/ .ould 'a(e been budgeted7 "or t'e actual output units

produced0

#i(en t'e use o" t'e allocation base in t'ese "ormulas "or t'e cost (ariances "or (ariable o(er'ead/ t'e

meaning o" t'ese (ariances diers "undamentall$ "rom t'e interpretation o" t'e (ariances "or direct

materials and direct labor0 Consider a compan$ t'at allocates electricit$ using direct labor as t'e

allocation base0 A negati(e (ariable o(er'ead eRcienc$ (ariance does not necessaril$ mean t'at t'e

"actor$ used more electricit$ t'an t'e Qe!ible budget )uantit$ o" ;ilo.att 'ours "or t'e actual outputs

produced0 Jat'er/ t'e negati(e (ariance literall$ means t'at t'e "actor$ used more direct labor t'an

t'e Qe!ible budget )uantit$ "or direct labor0 I" t'ere is a cause-and-eect relations'ip bet.een t'e

allocation base and t'e (ariable o(er'ead cost categor$ i0e0/ i" more direct labor 'ours implies more

electricit$ used7/ t'en t'e negati(e eRcienc$ (ariance suggests t'at more electricit$ .as used t'an t'e

Qe!ible budget )uantit$/ but t'e eRcienc$ (ariance does not measure ;ilo.atts directl$0

Similarl$/ a negati(e spending (ariance "or (ariable o(er'ead does not necessaril$ mean t'at t'e cost

per ;ilo.att-'our .as 'ig'er t'an budgeted0 Jat'er/ a negati(e spending (ariance "or (ariable

o(er'ead literall$ states t'at t'e actual o(er'ead rate .as 'ig'er t'an t'e budgeted o(er'ead rate/

.'ic' could be due eitherto a 'ig'er cost per ;ilo.att-'our/ or more kilowatt hours used per unit of

the allocation base0 8ence/ .'at one mig't t'in; s'ould be included in t'e eRcienc$ (ariance ;ilo.att

'ours re)uired per direct-labor-'our being 'ig'er or lo.er t'an budgeted7 actuall$ gets included as part

o" t'e spending (ariance0

Cost Variances "or )i&ed 3verhead:

+'ereas t'e cost (ariances "or direct materials/ direct labor/ and (ariable o(er'ead all use t'e same

t.o "ormulas/ t'e cost (ariances "or !ed o(er'ead are dierent/ and do not use t'ese "ormulas at all0

Also/ .'ereas cost (ariances "or direct materials/ direct labor/ and (ariable o(er'ead can be calculated

"or indi(idual products in a multi-product "actor$/ cost (ariances "or !ed o(er'ead can onl$ be

calculated "or t'e "actor$ or "acilit$ as a .'ole0


27/91

17 budgeted production

27 "actor$ capacit$

&'e interpretation o" t'e (olume (ariance depends on .'ic' o" t'ese t.o denominators are used/ but in

eit'er case/ t'e production (olume (ariance is t'e dierence bet.een budgeted !ed o(er'ead a lump

sum7/ and t'e amount o" !ed o(er'ead t'at .ould be allocated to production under a standard costing

s$stem using t'is !ed o(er'ead rate0

The volu#e variance 6ith budeted production in the deno#inator o" the overhead rate:

irst .e use budgeted production to calculate t'e (olume (ariance0 In t'is case*

(olume

(arianc

e

G

budgeted !ed o(er'ead

!

units produced

7

budgeted !ed

o(er'eadbudeted production

&'e term in parent'esis e)uals t'e amount o" !ed o(er'ead t'at .ould be allocated to production

under a standard costing s$stem/ .'en budgeted production is t'e denominator-le(el concept0

Since

budgeted !ed o(er'ead H budgeted production G budgeted o(er'ead rate

t'e abo(e e!pression "or t'e (olume (ariance is algebraicall$ e)ui(alent to t'e "ollo.ing "ormula*

(olume (ariance G units produced budgeted production7 ! budgeted o(er'ead rate

&'is "ormula "or t'e (olume (ariance illustrates t'e statement abo(e: t'at t'e (olume (ariance

attac'es a dollar amount to t'e dierence bet.een t.o production le(els0 In t'is case/ t'e t.oproduction le(els are actual production and budgeted production0 &'e interpretation o" t'e (olume

(ariance/ .'en budgeted production is used in t'e denominator o" t'e o(er'ead rate/ is t'e "ollo.ing0

+'en actual production is less t'an budgeted production/ t'e (olume (ariance represents t'e !ed

o(er'ead costs t'at are not allocated to product because actual production is belo. budget0 In t'is

case/ t'e (olume (ariance is unfavorable0 +'en actual production is greater t'an budgeted

production/ t'en t'e (olume (ariance represents t'e additional !ed o(er'ead costs t'at are allocated

to product because actual production e!ceeds budget0 In t'is case/ t'e (olume (ariance is favorable0

&'e intuition "or .'en t'e (olume (ariance is "a(orable and .'en it is un"a(orable is t'e "ollo.ing0 I"

t'e compan$ can produce more units o" output using t'e same !ed assets i0e0/ t'e resources t'at

comprise !ed o(er'ead7/ t'en assuming t'ose additional units can be sold/ t'e compan$ is more

protable0 +'en !ed o(er'ead is allocated to production/ t'is greater protabilit$ is reQected in a

lo.er per-unit production cost/ because t'e same amount o" total !ed o(er'ead is spread o(er more

units0 =n t'e ot'er 'and/ i" "e.er units are produced t'an planned/ t'en t'e same !ed o(er'ead is

spread o(er "e.er units/ t'e per-unit production cost is 'ig'er/ and t'e compan$ is less protable0 &'is

'ig'er or lo.er protabilit$ t'at arises "rom c'anges in production le(els is not an arti"act o" t'e

accounting s$stem0 (en i" t'e compan$ uses Variable Costing/ and e!penses !ed o(er'ead as a

lump-sum period cost/ .'en t'e compan$ ma;es and sells "e.er units t'an planned using t'e same

!ed o(er'ead resources/ it reall$ is less protable t'an .as budgeted/ and .'en t'e compan$ ma;es

and sells more units t'an planned using t'e same !ed o(er'ead resources/ it reall$ is more protable

t'an .as budgeted0

The volu#e variance 6ith "actory capacity in the deno#inator o" the 37H rate:

Ne!t .e use "actor$ capacit$ to calculate t'e (olume (ariance0 In t'is case*

11


28/91

(olume

(arianc

e

G

budgeted !ed o(er'ead

!

units produced

7

budgeted !ed

o(er'ead"actory capacity

Since

budgeted !ed o(er'ead H "actor$ capacit$ G budgeted o(er'ead rate

t'e abo(e e!pression "or t'e (olume (ariance is algebraicall$ e)ui(alent to t'e "ollo.ing "ormula*

(olume (ariance G units produced "actor$ capacit$7 ! budgeted o(er'ead rate

&'e interpretation o" t'e (olume (ariance/ .'en "actor$ capacit$ is used in t'e denominator o" t'e

o(er'ead rate/ is t'e "ollo.ing0 Actual production is almost al.a$s belo. capacit$0 &'e (olume (ariance

represents t'e !ed o(er'ead costs t'at are not allocated to product because actual production is

belo. capacit$0 8ence t'e (olume (ariance represents t'e cost o" idle capacit$/ and t'is (ariance is

t$picall$ unfavorable0 or t'is reason/ t'is (olume (ariance is sometimes called t'e idle capacity

variance0 In t'e unli;el$ e(ent t'at t'e "actor$ produces abo(e capacit$ .'ic' can occur i" t'e

concept o" practical capacit$ is used/ and actual do.n-time "or routine maintenance/ etc0/ is less t'ane!pected7/ t'en t'e (olume (ariance represents t'e additional !ed o(er'ead costs t'at are allocated

to product because actual production e!ceeds capacit$0 In t'is case/ t'e (olume (ariance is favorable0

Additional Issues Related to the Volu#e Variance:

@nder .'at circumstances .ould a compan$ calculate t'e (olume (ariance using budgeted production

as t'e denominator-le(el concept/ and under .'at circumstances .ould a compan$ use "actor$

capacit$ as t'e denominator-le(el concept

&'e use o" budgeted production in t'e calculation o" t'e (olume (ariance attac'es a lump sum benet

or cost to actual production le(els t'at e!ceed or "all s'ort o" budgeted production le(els0 or t'is

reason/ man$ companies consider t'is calculation o" t'e (olume (ariance to be an importantper"ormance measure "or t'e "actor$ manager and mar;eting managers responsible "or ma;ing and

mar;eting t'e product0

&'e use o" "actor$ capacit$ in t'e calculation o" t'e (olume (ariance pro(ides an indication o" 'o. lo.

t'e per-unit cost can go/ i" demand e)uals or e!ceeds "actor$ capacit$0 I" senior management .ould li;e

product managers to ma;e pricing and operating decisions based on a long-term e!pectation t'at

demand "or t'e product .ill e)ual or e!ceed "actor$ capacit$/ e(en t'oug' current or s'ort-term

demand is belo. capacit$/ calculating t'e per-unit cost in t'is manner .ill encourage product

managers to ta;e t'is long-run perspecti(e0 or e!ample/ consider t'e launc' o" a ne. product line in a

ne. "actor$0 I" !ed o(er'ead is allocated based on budgeted production/ t'en product managers mig't

"eel pressured to set sales prices t'at .ill co(er "ull product costs at initiall$-lo. production le(els/ but

t'ese sales prices mig't be too 'ig' to generate suRcient initial consumer interest in t'e product "or a

success"ul product launc'0

Anot'er reason to use "actor$ capacit$ in t'e denominator o" t'e !ed o(er'ead rate/ and in t'e

calculation o" t'e (olume (ariance/ is t'at doing so isolates t'e cost o" idle capacit$0 ="ten/ t'e decision

to build a "actor$ t'at is larger t'an current demand .arrants is a strategic decision made at 'ig' le(els

.it'in t'e organi,ation0 I" t'e !ed o(er'ead associated .it' t'is "actor$ is allocated based on

budgeted or actual production/ t'e per-unit cost o" e(er$ unit manu"actured includes a small portion o"

t'e cost o" t'is strategic decision/ and t'e cost reports o" "actor$ managers and t'e product protabilit$

statements o" product managers are negati(el$ aected b$ t'is unused capacit$0 Some companies

pre"er to isolate t'e cost associated .it' t'is strategic decision/ and to eit'er s'o. t'e cost o" idle

capacit$ as separate line-items on t'e cost reports and prot statements o" t'e "actor$ manager and

11


29/91

product managers/ or remo(e t'is cost entirel$ "rom t'ese per"ormance reports/ and report it onl$ at

t'e corporate le(el0

Allocating !ed o(er'ead using actual production can pro(ide managers s'ort-run incenti(es to

o(erproduce/ because as production increases/ t'e per-unit cost decreases0 Similarl$/ calculating t'e

(olume (ariance using budgeted production in t'e denominator o" t'e o(er'ead rate can pro(ide

managers s'ort-run incenti(es to o(erproduce/ because as production e!ceeds budget/ t'e (olume

(ariance becomes increasingl$ "a(orable0 or t'is reason/ some companies c'oose not to allocate !ed

o(er'ead at all0 8o.e(er/ t'e use o" "actor$ capacit$ in t'e denominator o" t'e !ed o(er'ead rateaccomplis'es t'e same obecti(e/ because it isolates t'e (olume (ariance suc' t'at t'e per"ormance

reports o" t'ese managers need not be aected b$ it0

+e 'a(e assumed/ t'roug'out t'is section/ t'at !ed o(er'ead is allocated based on units o" output0

8o.e(er/ .e sa. in t'e c'apter on acti(it$-based costing t'at units o" production is o"ten a poor c'oice

o" allocation base in a multi-product "actor$/ and man$ companies t'at use standard costing s$stems

use allocation bases t'at are more sop'isticated/ suc' as direct labor 'ours or direct materials dollars0

&'e )uestion mig't arise/ 'o. does t'e use o" a dierent allocation base/ suc' as direct labor 'ours/

aect t'e calculation o" t'e (olume (ariance &'e ans.er is* Not at all.ecause o" t'e .a$ in .'ic'

standard costing s$stems .or;/ t'e amount o" !ed o(er'ead t'at .ill be allocated to product does not

depend on t'e c'oice o" allocation base0

or e!ample/ assume t'at a one-product compan$ budgets t.o direct labor 'ours to ma;e eac' unit/

and assume t'at i" !ed o(er'ead is allocated based on output units/ t'e budgeted !ed o(er'ead rate

is D1 per unit0 &'en using direct labor 'ours as t'e allocation base/ t'e budgeted !ed o(er'ead rate

is D5 per direct labor 'our0 ecause o" t'e mec'anics o" standard costing s$stems/ no matter .'et'er

t'e D1-per-unit rate is used/ or t'e D5-per-direct-labor-'our rate is used/ D1 o" !ed o(er'ead .ill be

allocated to e(er$ unit produced/ no matter 'o. man$ direct labor 'ours are actuall$ used per unit0 I"

t'is "act is not ob(ious to $ou/ re"er bac; to C'apter 1 on standard costing07 &'ere"ore/ "or t'e purpose

o" calculating t'e (olume (ariance/ .e mig't as .ell use t'e easiest allocation base/ .'ic' is units-o"-

output0

It is important to recogni,e t'at e(en t'oug' most manu"acturing companies use a standard costing

s$stem/ and e(en t'oug' t'e calculation o" t'e !ed o(er'ead (olume (ariance relies on t'e concept o"

standard costing/ companies can calculate t'e (olume (ariance e(en i" t'e$ do not use a standard

costing s$stem0 In t'is case/ t'e calculation is identical to t'e discussion abo(e/ but t'e compan$ .ill

not be able to obtain t'e re)uired in"ormation "rom t'e cost accounting s$stem itsel"/ but rat'er/ .ill

need to ma;e a separate calculation0

Co#prehensive E&a#ple o" )i&ed 3verhead Variances:

&'e Coac'man Compan$ ma;es pencils0 &'e pencils are sold b$ t'e bo!0 ollo.ing is in"ormation about

t'e compan$Bs onl$ "actor$*

/udet Actual Capacity

Number o" bo!es

irect labor 'ours


30/91

Ne!t .e calculate a !ed o(er'ead rate using budgeted costs/ and budgeted output units as t'e

denominator-le(el concept*

D4/ H 1/ bo!es G D40 per bo!0

Ne!t .e calculate a !ed o(er'ead rate using budgeted costs/ and "actor$ capacit$ as t'e

denominator-le(el concept e!pressed in terms o" output units70

D4/ H 2/ bo!es G D20 per bo!0

&'e ad(antage o" using capacit$ in t'e denominator is t'at t'is denominator-le(el concept s'o.s 'o.

lo. t'e !ed cost per unit can go/ and 'ence/ 'o. lo. t'e total cost per unit can go/ as production

increases0

&'e !ed o(er'ead spending (ariance is calculated as "ollo.s*

D42/ actual D4/ budgeted G D2/ un"a(orable0

Ne!t/ .e calculate t'e (olume (ariance using capacit$ as t'e denominator-le(el concept*

(olume (ariance G D20 per bo! ! 12/ bo!es7 D4/ G D16/ un"a(orable

or e)ui(alentl$*

(olume (ariance G D20 per bo! ! 12/ bo!es 2/ bo!es7 G D16/ un"a(orable

I" t'e compan$ uses a standard costing s$stem/ t'e amount o" o(erallocated or underallocated !ed

o(er'ead is t'e dierence bet.een actual !ed o(er'ead incurred/ and !ed o(er'ead allocated to

product/ calculated as "ollo.s*

actual !ed o(er'ead !ed o(er'ead allocated

D42/ D20 per bo! ! 12/ bo!es7

G D42/ D24/ G D1/ underallocated

&'is D1/ o" underallocated !ed o(er'ead is e)ual to t'e sum o" t'e D2/ un"a(orable !ed

o(er'ead spending (ariance and t'e D16/ un"a(orable (olume (ariance0

Ne!t/ .e calculate t'e (olume (ariance using budgeted production as t'e denominator-le(el concept*

(olume (ariance G D40 per bo! ! 12/ bo!es7 D4/ G D/ "a(orable

or e)ui(alentl$*

(olume (ariance G D40 per bo! ! 12/ bo!es 1/ bo!es7 G D/ "a(orable

I" t'e compan$ uses a standard costing s$stem/ t'e amount o" o(erallocated or underallocated !ed

o(er'ead is t'e dierence bet.een actual !ed o(er'ead incurred/ and !ed o(er'ead allocated to

product/ calculated as "ollo.s*

actual !ed o(er'ead !ed o(er'ead allocated

12


31/91

D42/ D40 per bo! ! 12/ bo!es7

G D42/ D4/ G D6/ o(erallocated

&'is D6/ o" o(erallocated !ed o(er'ead is e)ual to t'e sum o" t'e D2/ un"a(orable !ed

o(er'ead spending (ariance .'ic' did not c'ange .'en .e c'anged t'e denominator-le(el concept

"rom capacit$ to budgeted production7 and t'e D/ "a(orable (olume (ariance0

&o illustrate t'at t'e c'oice o" allocation base does not aect t'e calculation o" t'e (olume (ariance/ .e

recalculate t'e (olume (ariance assuming t'e compan$ allocates o(er'ead using mac'ine 'ours as t'e

allocation base and budgeted production as t'e denominator-le(el concept0 &'e budgeted o(er'ead

rate is no.

D4/ H 5 mac'ine 'ours G D per mac'ine 'our0

Since t'e standard "or mac'ine time is one 'our "or e(er$ t.ent$ bo!es deri(ed "rom t'e budget

column in t'e bo! at t'e beginning o" t'e e!ample7/ t'e standard costing s$stem .ill allocate !ed

o(er'ead as "ollo.s*

/udetedo(er'ead rate ! standard inputs allo6ed"or actual outputs ac'ie(ed7

G D per mac'ine 'our ! 12/ bo!es H 2 bo!es per mac'ine 'our7

G D per mac'ine 'our ! 6 mac'ine 'ours G D4/

And t'e (olume (ariance is

!ed o(er'ead allocated to product budgeted !ed o(er'ead

G D4/D4/ G D/ "a(orable/ as be"ore0

E&ercises and Proble#s:

%+2%! !ollowing is selected information about the Hopi 9opcorn company ll information represents total amounts, not per unitamounts

Static :udget Actual 1esults

nits made and soldBirect materials costsBirect materials used in production!ixed overhead

.''/#,'''

.,''' pounds/A,'''

#'/",F''

5#' pounds/5,'''

Hopi had no beginning or ending inventory of either finished product or raw materials Hopi allocates fixed overhead using unitsof output as the allocation base, and a budgeted overhead rate with budgeted production in the denominator1equired!3alculate the fixed overhead volume variance

12*+: order Construction Compan$ is a road-pa(ing compan$0 Suc' companies are c'aracteri,ed b$

'ig' !ed costs in plant and e)uipment0 &'e compan$ allocates !ed o(er'ead to its obs based on

miles o" road pa(ed0 &'e compan$ 'as an un"a(orable !ed o(er'ead spending (ariance/ and

o(erallocated !ed o(er'ead0 &'is set o" "acts is consistent .it'

8A. @ne!pected capital e!penditures and t'e use o" practical capacit$ in t'e

denominator o" t'e !ed o(er'ead rate0

121


32/91

8/. An une!pected decrease in !ed o(er'ead costs/ t'e use o" budgeted acti(it$ in

t'e denominator o" t'e !ed o(er'ead rate/ and an une!pected increase in business0

8C. An une!pected increase in appropriations b$ t'e State Megislature "or road .or;/

resulting in more business "or t'e compan$/ and une!pected capital e!penditures0

8. &'e use o" actual miles in t'e denominator o" t'e !ed o(er'ead rate/ actual

!ed o(er'ead costs in t'e numerator/ and signicant une!pected capital e!penditures0

12*,: Assume t'e "ollo.ing in"ormation "or t'e Center(ille 2 plant o" %ol$par/ .'ic' manu"actures onl$

but$l0

udgeted !ed o(er'ead

%lant production capacit$

udgeted but$l production

Actual but$l production

D12//

1// tons o" but$l

5/ tons o" but$l

6/ tons o" but$l

Re'uired:

A. @sing budgeted but$l production in t'e denominator o" t'e !ed o(er'ead rate/ calculate t'e!ed o(er'ead (olume (ariance0

/. @sing plant capacit$ in t'e denominator o" t'e !ed o(er'ead rate/ calculate t'e !ed o(er'ead

(olume (ariance0

C. In one or t.o sentences/ interpret .'at eac' o" t'ese (ariances represents0

%+2(! Xellow 3ompany budgeted fixed manufacturing overhead of /.,''',''', but actually incurred fixed manufacturingoverhead of /.,"'',''' The company expected to produce .'',''' units of product, but actually produced


33/91

7 I7 and II7 onl$

12*9: ollo.ing is in"ormation about ecember production at t'e oorstop ruitca;e Compan$/ and t'e

principal ingredient used in t'e manu"acture o" "ruitca;es* Qour0 All Qour purc'ased during t'e mont'

.as used in production0 &'ere .as no Qour on 'and at t'e beginning o" t'e mont'0 i!ed manu"acturing

o(er'ead .as budgeted at D9// but .as actuall$ D1/0 i!ed manu"acturing o(er'ead is

allocated using pounds o" Qour as t'e allocation base0 &'e "actor$ e!pects to be operating at capacit$

in ecember0

o" ruitca;es produced

%ounds o" Qour used

Cost o" Qour

Actual

udget

1/15

1/2

5/9

6/

D2/405

D3/0

I" t'e compan$ allocates (ariable o(er'ead based on pounds o" Qour/ t'e (ariable o(er'ead eRcienc$

(ariance .ill be

A7 Wero

7 @n"a(orable

C7 a(orable

7 @nable to determine "rom t'e in"ormation pro(ided

12*2: +'ic' o" t'e "ollo.ing scenarios mig't not result in an un"a(orable production (olume (ariance

I0 Actual production is belo. practical capacit$/ .'en budgeted production is used in t'e

denominator to calculate t'e o(er'ead rate0

II0 Actual production is belo. practical capacit$/ .'en practical capacit$ is used in t'e

denominator to calculate t'e o(er'ead rate0

III0 Actual production is belo. budget/ .'en budgeted production is used in t'e denominator

to calculate t'e o(er'ead rate0

IV0 Actual production is abo(e budget/ .'en practical capacit$ is used in t'e denominator to

calculate t'e o(er'ead rate0

)* % and %J

)* % only

)3* %, %%, %%% and %J

)B* % and %%%

12*-: Assume t'e "ollo.ing in"ormation "or t'e %ittseld "actor$ o" Carnegie Steel0

udgeted !ed o(er'ead

%roduction capacit$

udgeted production

D12//

1// tons

5/ tons

123


34/91

A. Assume .e are at t'e beginning o" t'e $ear0 I" t'e (olume (ariance .ill be calculated using

plant capacit$ in t'e denominator o" t'e !ed o(er'ead rate/ .'at .ould t'e plant manager

'a(e to do to ensure t'at t'e production (olume (ariance .ill be ,ero

/. Again/ assume .e are at t'e beginning o" t'e $ear0 I" t'e (olume (ariance .ill be calculated

using budgeted production in t'e denominator o" t'e !ed o(er'ead rate/ .'at .ould t'e plant

manager 'a(e to do to ensure t'at t'e production (olume (ariance .ill be "a(orable

C. Assume t'at .e are at t'e beginning o" t'e $ear/ and t'at t'e "actor$ manager is told t'at t'eproduction (olume (ariance/ "a(orable or un"a(orable/ .ill be recorded at t'e corporate le(el/

and not on t'e "actor$ income statement t'at "orms t'e basis "or t'e managerBs per"ormance

re(ie.0 Assume also t'at t'e "actor$ manager is gi(en t'e c'oice o" t'e denominator-le(el

concept "or calculating t'e (olume (ariance actual/ budget/ or practical capacit$7/ but t'at t'e

manager must ma;e t'e c'oice at t'e beginning o" t'e $ear/ ;no.ing onl$ t'e in"ormation in

t'e table at t'e start o" t'is )uestion/ but not ;no.ing actual production or actual !ed

o(er'ead costs0 +'at denominator-le(el concept do $ou t'in; t'e "actor$ manager .ill c'oose/

and .'$ +ould $our ans.er c'ange i"/ instead o" budgeting production o" 5/ tons/

production .as budgeted "or "actor$ practical capacit$ o" 1// tons

12*: I" a "actor$ is on a Standard Costing S$stem/ and 'as o(erallocated !ed o(er'ead/ .'ic' o" t'e"ollo.ing statements is certainl$ true

A7 &'e "actor$ made more units t'an planned0

7 &'e "actor$ 'as a "a(orable spending (ariance0

C7 &'e "actor$ 'as a "a(orable production (olume (ariance0

7 &'e actuall$ amount spent "or !ed o(er'ead .as less t'an t'e amount o" !ed

o(er'ead allocated to in(entor$0

12*10:&'e Marge and !pensi(e +idget Compan$ allocates o(er'ead based on direct labor 'ours0 I"

t'e compan$ uses more total direct labor 'ours t'an planned/ but t'e actual labor .age rate is t'e

same as t'e budgeted labor .age rate/ .'ic' o" t'e "ollo.ing statements mig't not be true

A7 &'ere .ill be an un"a(orable static budget (ariance "or labor0

7 &'e labor .age rate (ariance .ill be ,ero0

C7 &'ere .ill be an un"a(orable labor eRcienc$ (ariance0

7 &'e labor eRcienc$ and o(er'ead eRcienc$ (ariances .ill be in t'e same direction i0e0/eit'er bot' (ariances .ill be "a(orable/ t'e$ .ill bot' be un"a(orable/ or t'e$ .ill bot' be

e)ual to ,ero70

12*11:


35/91

Number of shirtsBirect 1aterials3ost per yard of fabricXards of fabric per shirtBirect laborBirect labor cost for all of the shirtsHours of direct labor for all of the shirts

Jariable Cverhead!ixed Cverhead

.,"''

/5#'"''

/"F,'''A,'''

/.


36/91

: The variable overhead efficiency variance is /4.F favorable )rounded to the nearest dollar* Iecalculate the variable overheadefficiency variance assuming the company allocates overhead based on machine hours instead of labor hoursC 3alculate the variable overhead spending variance assuming the company allocates variable overhead based on machine hoursinstead of labor hoursD 3alculate the fixed overhead spending variance %s it favorable or unfavorable?

= How much of the fixed overhead spending variance is due to the fact that production was higher than planned?

3 3alculate the fixed overhead volume variance

; How much of the fixed overhead volume variance is due to the fact that production was higher than planned?


37/91

&otal =(er'ead

actual

budget

D2/565/

D2/46/

5otes!

% The company uses a Normal 3osting &ystem& Total square feet refers to the square feet of factory floor space used in the production of each model of product %t is

expressed as total square feet for that model, not square feet per unit' Jariable manufacturing overhead is divided into two cost pools, one for labor support and one for materials supportA ssume that the Dabor &upport overhead cost pool is allocated based on direct labor hours )labor hours is the allocation base*,that the 1aterials &upport overhead cost pool is allocated based on number of parts )parts is the allocation base*, and that the!ixed Cverhead cost pool is allocated based on square feet 3alculate the cost per unit for each 1odel

:Now assume that the Jariable Cverhead Dabor &upport cost pool is allocated to product based on direct labor dollars 3alculatethe variable overhead spending and efficiency variances for this overhead cost pool category

C 3alculate the fixed overhead production volume and spending variances, assuming that fixed overhead is allocated usingoutput units as the allocation base, and budgeted production as the denominator-level concept

12*15: Sil(erstream Compan$ ma;es tra(el trailers0 &'e "ollo.ing in"ormation pertains to t'e

compan$Bs ='io i(ision/ .'ic' manu"actures and mar;ets onl$ one model o" trailer* t'e 32-"oot

Ambassador trailer0 ollo.ing is budgeted and actual in"ormation "or t'e ='io i(ision "or 24*

/udeted Actual

&railers manu"actured in 24&railers sold in 24Sales price per trailerirect materials costs all (ariable

costs7* Aluminum

Steel =t'er &otal materials costsirect labor costs all (ariable costs7Variable o(er'ead manu"acturing costsi!ed o(er'ead costs*


38/91

A. &'e Qe!ible budget (ariance "or (ariable manu"acturing o(er'ead0/. &'e (ariable manu"acturing o(er'ead spending (ariance0C. &'e (ariable manu"acturing o(er'ead eRcienc$ (ariance0. Jecalculate t'e (ariable manu"acturing o(er'ead rate/ assuming t'e compan$ applies (ariable

o(er'ead based on pounds o" aluminum/ instead o" direct labor 'ours0

E. @sing t'e o(er'ead rate calculated in part 7/ recalculate t'e (ariable manu"acturing o(er'eadspending (ariance0

). @sing t'e o(er'ead rate calculated in part 7/ recalculate t'e (ariable manu"acturing o(er'ead

eRcienc$ (ariance0(. @sing t'e o(er'ead rate calculated in part 7/ recalculate t'e (ariable manu"acturing o(er'ead

Qe!ible budget (ariance0H. &'e !ed manu"acturing o(er'ead spending or budget (ariance0I. &'e Qe!ible budget (ariance "or !ed manu"acturing o(er'ead0

. &'e amount o" o(erapplied or underapplied !ed manu"acturing o(er'ead/ i" t'e compan$

applies o(er'ead based on budgeted production0

Ced by the amount of milkfat &ome of these products then constitute raw materials in

the manufacture of other products such as butter and cheese

!ollowing are some important terms2Common costs!These costs cannot be identified with a particular +oint product y definition, +oint products incur common costsuntil they reach the split-off point

Split2o## point!t this stage, the +oint products acquire separate identities 3osts incurred prior to this point are common costs,and any costs incurred after this point are separable costsSeparable costs!These costs can be identified with a particular +oint product These costs are incurred for a specific product, afterthe split-off point

The characteristic feature of +oint products is that all costs incurred prior to the split-off point are common costs, and cannot beidentified with individual products that are derived at split-off !urthermore, the costs incurred by the dairy farmer to feed andcare for the cows do not significantly affect the relative amounts of cream and skim obtained, and the costs incurred by the lumber

12


39/91

company to maintain and harvest the second-growth timber do not significantly affect the relative quantities of lumber of variousgrades that are obtained

1easons #or Allocating Common Costs!

Given the lack of a cause-and-effect relationship between the incurrence of common costs and the relative quantities of +ointproducts obtained, any allocation of these common costs to the +oint products is arbitrary 3onsequently, there is no managementaccounting purpose served by the allocation of these common costs Diterally, there is no managerial decision that becomes betterinformed by such an allocation 3onsider the possibilities2

. 3an the allocation of common costs prompt the manager to favor some +oint products over other +oint products and totherefore change the production process, and hence the quantities of +oint products obtained?

5oy definition, the relative quantities obtained from the +oint process are inherent in the production process itself, andcannot be managed %n fact, the manager probably does have strong preferences for some +oint products over others)high-grade lumber over low-grade lumberK cream over skim milk*, but the managers preferences are irrelevant

" 3an the allocation of common costs prompt the manager to change the sales prices for the +oint products, or to changedecisions about whether to incur separable costs to process one or more of the +oint products further?

5oThe decision to sell a +oint product at split-off or to process it further depends only on the incrementalcosts andrevenues of the additional processing, not on the common costs %n fact, the common costs can be considered sunk at thetime the additional processing decision is made s for pricing, most +oint products are commodities, and producers are

generally price-takers To the extent that the producer faces a downward sloping demand curve, determining the optimalcombination of price and production level depends on the variable cost of production, but this calculation would have to

be done simultaneously for all +oint products, in which case no allocation of common costs would be necessaryA 3an the allocation of common costs inform the manager that the entire production process is unprofitable and should be

terminated? !or example, does this allocation tell the dairy farmer whether the farmer should sell the herd and get out ofthe dairy business?

5o&uch an allocation is unnecessary for the decision of whether to terminate the +oint production process !or thisdecision, the producer can look at the operation in its entirety )total revenues from all +oint products less total commoncosts and total separable costs*

Xet despite the fact that allocating common costs to +oint products serves no decision-making purpose, it is required for external

financial reporting %t is necessary for product costing if we wish to honor the matching principle for common costs, because thesecommon costs are manufacturing costs !or example, if the dairy sells lowfat milk shortly after split-off, but processes highmilkfat product into cheese that requires an aging process, the allocation of common costs is necessary for the valuation of endinginventory )work-in-process for cheese* and the determination of cost-of-goods sold )lowfat milk*

Alternative Methods #or Allocating Common Costs!

Here are four methods of allocating common costs2

. /hysical measure!sing this method, some common physical measure is identified to describe the quantity ofeach product obtained at split-off !or example2 the weight of the +oint products, or the volume 3ommon costs arethen allocated in proportion to this physical measure This method presumes that the quantities of all +oint productscan be expressed using a common measure, which is not always the case !or example, crude oil is a liquid, whilenatural gas is, naturally, a gas, and volumes of liquids and gasses are not normally measured in the same units

" Sales value at split2o##!%f a market price can be established for the products that are obtained at split-off,

common costs can be allocated in proportion to the sales value of the products at split-off The sales value of each+oint product is derived by multiplying the price per unit by the number of units obtained !or example, if the dairyfarmer obtains "' gallons of cream, and if cream can be sold for /A per gallon, then the sales value for cream is /@'%f the farmer also obtains 5' gallons of skim milk that sells for /" per gallon, then the sales value of skim milk is/


40/91

split-off, as in the previous method nder the net reali>able value method of common cost allocation, common costsare allocated in proportion to their net reali>able values s with the previous method, the allocation is based on thetotal value of all quantities of each +oint product obtained )the net reali>able value per unit, multiplied by the numberof units of each +oint product*

5 Constant ;ross Margin /ercentage!This method allocates common costs such that the overall gross marginpercentage is identical for each +oint product The gross margin percentage is calculated as follows2

Gross 1argin 9ercentage ; )&ales Z 3ost of Goods &old* = &ales

3ost of Goods &old for each product includes common costs and possibly some separable costs The application ofthe 3onstant Gross 1argin 9ercentage requires solving for the allocation of common costs that equates the Gross1argin 9ercentage across all +oint products

Conclusion!

The choice of method for allocating common costs should depend on the ease of application, the perceived quality of informationreported to external parties, and the perceived fairness of the allocation when multiple product managers are responsible for +oint

products However, as discussed above, the allocation of common costs is arbitrary, and no method is conceptually preferable toany other method ll methods of allocating common costs across +oint products are generally useless for operational, marketing,and product pricing decisions=4ercises and /roblems!

%2%! Her> 3orporation processes soybeans into soybean oil and other products in a +oint process The common costs allocated tosoybean oil are /"'' per gallon The soybean oil can either be sold for /.4' or processed into margarine The cost to process onegallon of soybean oil into margarine is /."' Each gallon of soybean oil yields A pounds of margarine, which sells for /'


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A (hat common costs will be allocated to each unit of 9roduct using the relative sales value at split-off as the allocationmethod?

: (hich products should be processed further?C (hat common costs will be allocated to each unit of 9roduct using the net reali>able value method of +oint cost

allocation )and assuming that NIJ is calculated based on the profit-maximi>ing production choice*%2(! 1ichael Hearns is a commercial fisherman and he has +ust returned from a trip off the coast of laska 1ichael has

calculated the cost of his trip at /F",''' This entire amount represents +oint costs with respect to the different types of fish that1ichael caught 1ichaels nets yielded a catch of .,''' pounds of salmon, .,''' pounds of halibut, and ",''' pounds of flounder&almon sells for /5 per pound, halibut for /A per pound, and !lounder for /. per pound1equired! llocate the +oint costs to the three types of fish based on their relative sales value

%2)! %n harvesting maple syrup, two grades of maple syrup are obtained from a +oint process (e will call these two grades ofsyrup Grade syrup and Grade M syrup The common costs are /#' to obtain .' gallons of Grade syrup and .# gallons ofGrade M syrup Grade can be sold at the split-off point for /" per gallon, or alternatively, /. of additional processing costs can

be incurred per gallon and Grade can then be sold for /@#' per gallon Grade M can be sold at split-off for /. per gallon, oralternatively, /'#' of additional processing costs can be incurred per gallon, and Grade M can then be sold for /A#' per gallon

A 3alculate the common costs allocated to all .# gallons of Grade M syrup, allocating common costs based on physical

quantities

: 3alculate the common costs allocated to each gallon of Grade syrup using the net reali>able value method of +oint costallocation

%2*! The Tara Bairy incurs +oint costs of /..' per day in order to obtain #' gallons of raw milk This raw milk is then separatedto obtain "' gallons of cream and A' gallons of skim milk The dairy allocates +oint costs based on physical quantities 3alculatethe +oint costs that would be allocated to cream

%2+!Loint costs are /F"' Loint products are .'' feet of product , .'' feet of product , and "'' feet of product 3 9roduct sells for /5 per foot at the split off point, but for /. of additional processing costs, can be sold for /@ per foot 9roduct sells for/A per foot, but for /" of additional processing costs, can be sold for /5 per foot 9roduct 3 sells for /. per foot, and cannot be

processed further

1equired!llocate the +oint costs to the three products based on Net Ieali>able Jalue

C


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characteristic feature of capital pro+ects is that the bulk of the cash outflows precede the cash inflows lthough a capital pro+ectmay involve cash outflows that occur over time, and cash inflows that vary from year to year, our discussion will often assume atypical scenario in which there is a single cash outflow for the acquisition of the asset that occurs at the beginning of year one)called 6time >ero8*, followed by a series of equal cash inflows that occur at the end of each year for the life of the pro+ect Thisseries of cash inflows is called an annuity

Time Ealue o# Money!

dollar today is worth more than a dollar one year from now The reason for this appreciation is that cash is an asset, and like anyasset, it can be invested to earn a return over time The discount rateis a measure of the time value of moneyK it measures how

much more a dollar is worth today than a dollar one year from now !or example, if you are indifferent between receiving /.''today and /."' one year from now, your discount rate is "'$ The time value of money has nothing to do with inflation, whichworks in the opposite direction %nflation refers to the declining purchasing power of the dollar that occurs when prices of goodsand services rise over time&oftware spreadsheet applications and financial calculators include present value functions that calculate the present value of anyamount received )or paid* at any time in the future These tools also provide the future value, for any point in time in the future, ofany amount received )or paid* today efore these electronic resources were commonplace, tables were widely available thatallowed one to easily calculate present values and future values for frequently-used discount rates and time periods lthough suchtables are unnecessary in practice today, we will use them in this chapter, because they visually illustrate the relevant concepts

Table . at the end of this chapter is a present value table %t provides present value factors for selected dis

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