3 components of product cost
(1) materials, (2) labor, (3) and overhead
period costs
costs normally expensed in the period in which they are incurred; ex: Selling, General, and Administrative Costs (SG&A)
indirect costs
costs that cannot be traced to products and services in a cost-effective manner
manufacturing overhead
the indirect costs incurred to make products; includes indirect materials, indirect labor, factory utilities, rent of manufacturing facilities, and depreciation on manufacturing assets
cost allocation
the process of dividing a total cost into parts and assigning the parts to relevant cost objects
upstream costs
costs like R&D that occur before the manufacturing process begins
downstream costs
costs like advertising that occur after the manufacturing process is complete
just in time (JIT) inventory
making products available just in time for customer consumption to lower costs and increase customer satisfaction
fraud triangle components
opportunity, pressure, rationalization
cost behavior
how costs behave relative to the level of business activity
operating leverage
using fixed costs to magnify small changes in revenue into dramatic changes in profitability
contribution margin
revenue - variable costs
magnitude of operating leverage
(contribution margin)/(net income)
how does magnitude of operating leverage affect change in profitability?
% change in revenue x operating leverage = % change in profitability
mixed (semi variable) costs
include both fixed and variable components
relevant range
the range of activity over which the definitions of fixed and variable costs are valid
high-low method of estimating fixed and variable costs
(1) select high and low points in the data set (sales volume and cost history)
(2) determine the estimated variable cost per unit: (difference in total costs)/(difference in total volume)
(3) determine the estimated total fixed cost: fixed cost + variable
find breakeven point in units
(fixed costs + profit)/(contribution margin per unit)
find breakeven point in sales
(fixed costs + profit)/(contribution margin ratio)
contribution margin ratio
(contribution margin per unit)/(sales price per unit) OR (contribution margin in dollars)/(sales in dollars)
cost-volume-profit graph
margin of safety
(budgeted sales - break-even sales)/(budgeted sales)
cost driver (aka allocation base)
has a cause-and-effect relationship with a cost object
common costs
support multiple cost objects but cannot be directly traced to any specific object
controllable costs
costs that can be influenced by a manager's decisions and actions
allocation rate
(total costs to be allocated)/(allocation base)
find allocation per cost object
allocation rate x weight of the costs driver
cost pool
accumulation of many individual costs; the total is then allocated to the cost objects
three volume-based cost drivers
(1) units, (2) labor hours, (3) direct material dollars
predetermined overhead rate
overhead allocation rate determined before actual cost and volume data are available
direct method
simplest allocation approach; allocates service department costs directly to operating department cost pools
step method
unlike the direct method, considers the fact that service departments render assistance to other service departments`
companywide allocation rate
all overhead costs are allocated using a single labor-basel company-wide overhead rate
activity-based cost drivers
cost drivers based on activities rather than on volume
activity-based costing (ABC)
first stage: costs are assigned to pools based on the activities that cause the costs to be incurred
second stage: costs in the pools are allocated to products using a variety of cost drivers
4 categories of activities
(1) unit-level activities, (2) batch-level activities, (3) product-level activities, and (4) facility-level activities
unit-level activities
occur each time a unit of product is made; ex; inspection costs, machine-related utility costs, and costs for production supplies
batch-level activities
relate to producing groups of products; fixed regardless of the number of units produced in a single batch; ex: costs of setting up machinery and cost of a first-item batch test
production-level activities
support specific products or product lines; ex: raw materials inventory holding costs, engineering development costs, and legal fees for patents, copyrights, trademarks, and brand names
facility-level activities
benefit the production process as a whole and are not related to any specific product, batch, or unit of production; ex: insurance, security, general utilities, property taxes
4 categories of costs companies incur to ensure quality conformance
(1) prevention, (2) appraisal, (3) internal failure, and (4) external failure
prevention costs
costs to avoid nonconforming products
appraisal costs
costs to identify nonconforming products produced in spite of prevention cost expenditures
failure costs
costs that result from correcting defects in nonconforming products produced
internal failure costs
costs that pertain to correcting defects before goods reach customers
external failure costs
costs that result from delivering defective goods to reach customers
sunk costs
costs incurred in past transactions; cannot be changed; not relevant for making current decisions
opportunity cost
the sacrifice that is incurred in order to obtain an alternative opportunity
differential revenue
the relevant revenue that differs among the alternatives
avoidable costs
costs managers can eliminate by making specific choices
5 types of special decisions
(1) special order, (2) outsourcing, (3) segment elimination, (4) asset replacement, and (5) scarce resource allocation
special order decision
decision a company must make about whether they will accept an offer to sell its goods at a price significantly below its normal selling price
steps for quantitative analysis of special order decision
(1) determine the amount of relevant revenue and cost the company will earn/incur by accepting the offer
(2) accept the special offer if the relevant revenue exceeds the relevant cost
outsourcing
buying goods and services from other companies rather than producing them internally
steps for quantitative analysis of outsourcing decision
(1) determine the production costs the company can avoid if it outsources production
(2) compare the relevant (avoidable) production costs with the cost of buying the product and select the lower-cost option
segment elimination
getting rid of a subcomponent of a company
steps for quantitative analysis of segment elimination decision
(1) determine the amount of relevant revenue and cost that pertains to eliminating the division/segment
(2) if the relevant revenue is less than the avoidable cost, eliminate the segment; if not, continue to operate it
steps for quantitative analysis of equipment replacement decision
(1) determine what relevant costs/revenue the company will incur if it keeps the old machine (market value opportunity cost, salvage value, operating expenses)
(2) determine what relevant costs/revenue will be incurred if the company purchases and uses th
strategic planning
involves making long-term decisions such as defining the scope of the business, determining which products to develop or discontinue, and identifying the most profitable market niche
capital budgeting
focuses on intermediate range planning; involves such decisions as whether to buy or lease equipment, whether to stimulate sales, or whether to increase the company's asset base
operations budgeting
concentrates on short-term plans; a key component is the master budget
master budget
a group of detailed budgets and schedules representing the company's operating and financial plans for a future accounting period
budgets that master budget includes
(1) operating budgets, (2) capital budgets, and (3) pro forma financial statements
operating budgets
focus on detailed operating activities; include (1) sales budget, (2) an inventory purchases budget, (3) a selling and administrative expense budget, and (4) a cash budget
pro forma financial statements
based on projected rather than historical information
two sections of the sales budget
(1) projected sales for each month, and (2) a schedule of the cash receipts for the projected sales
two sections of the inventory purchases budget
(1) projected purchases, and (2) schedule of cash payments for inventory purchases
items under projected purchases section of inventory purchases budget
budgeting costs of goods sold
plus desired ending inventory
total inventory needed
less beginning inventory
required purchases (on account)
items under schedule of cash payments section of inventory purchases budget
pay % if current month accounts payable
pay % of prior month accounts payable
total budgeted disbursements for inventory
two sections of the selling and administrative expense budget
(1) projected S&A expenses, and (2) schedule of cash payments for S&A expenses
items under projected S&A expenses section of S&A expense budget
salary expense
sales commissions
supplies expense
utilities expense
depreciation expense
rent expense
miscellaneous expense
total S&A expenses before interest
items under schedule of cash payments section for S&A expense budget
salary expense
% of current and/or prior month sales commissions
supplies expense
% of prior month utilities expense
rent expense
miscellaneous expense
total payments for S&A expenses
3 major sections of cash budget
(1) cash receipts section, (2) cash payments section, and (3) financing section
items under cash receipts section of cash budget
beginning cash balance
add cash receipts
total cash available
items under cash payments section of cash budget
all expenses (don't forget interest expense)
items under financing activities section of cash budget
surplus (shortage)
financing balance
borrowing (repayment)
ending cash balance
pro forma balance sheet items
assets
cash
accounts receivable
inventory
total assets
liabilities
accounts payable
sales commissions payable
utilities payable
line of credit borrowings
equity
retained earnings
total liabilities and equity
pro forma income statement items
sales revenue
cost of goods sold
gross margin
SG&A expenses
operating income
interest expense
net income
pro forma statement of cash flows items
cash flow from operating activities
receipts
payments
net cash flow for operating activities
cash flow from investing activities
cash flow from financing activities
net change in cash
plus beginning cash balance
ending cash balance
flexible budget
an extension of the master budget; shows expected revenues and costs at a variety of volume levels
variances
differences between the standard and actual amounts
sales volume variance
difference between the static budget and flexible budget based on actual volume
variable cost volume variance
difference between the static and flexible budget amounts of variable costs
flexible budget variances
differences between the flexible budget figures and the actual results
price variance
(actual cost per unit - standard cost per unit) x actual units
usage variance
(actual usage rate -standard usage rate) x actual units produced x standard price
variance dividing data
standard price x actual units x actual quantity per unit
actual cost
actual price x actual units x actual quantity per unit
standard cost
standard price x standard quantity per unit x actual units
capital investments
purchases of long-term operational assets
time value of money
the present value of a dollar received in the future is less than a dollar
net present value decision rule
if the net present value is equal to or greater than zero, accept the investment opportunity