Accounting assignment that contains 4 questions I uplthe subject book and the assignment fileAll answers should be clear and well presented with clear examples Please post your answers in the same file Avoid plagiarism so I don’t lose marks There must be at least two references All answers must be typed using Time new roman( size12, double-spaced)
College of Administration and Finance Sciences
Assignment (2)
Deadline: Saturday 11/11/2023 @ 23:59
Course Name: Cost Accounting
Student’s Name:
Course Code: ACCT 301
Student’s ID Number:
Semester: 1st
CRN:
Academic Year: 1445 H
For Instructor’s Use only
Instructor’s Name:
Students’ Grade:
/15
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the cover
page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students or
other resources without proper referencing will result in ZERO marks. No exceptions.
• All answers must be typed using Times New Roman (size 12, double-spaced) font.
No pictures containing text will be accepted and will be considered plagiarism.
• Submissions without this cover page will NOT be accepted.
College of Administration and Finance Sciences
Assignment Question(s):
(Marks 15)
Q1. Discuss with suitable examples why activity-based costing (ABC) is better than the
traditional costing system. Provide a suitable numerical example of ABC in the manufacturing
sector and show all the necessary calculations required under the ABC system.
(3 Marks)
Note: Your answer must include suitable numerical examples showing all the calculations of the
ABC system. You are required to assume values of numerical examples of your own and they should
not be copied from any sources.
(Chapter 7)
Answer:
Q2. “A non-routine decision is one that is taken in response to a non-repetitive, operational
scenario.” Comment on this statement and explain with suitable examples the various types of
non-routine operating decisions that a company makes under such a scenario. Support your
answer with numerical examples along with qualitative considerations involved in making such
decisions.
(4 Marks)
Note: Your answer must include suitable numerical examples for various types of non-routine
operating decisions. You are required to assume values of numerical examples of your own and they
should not be copied from any sources.
Answer:
(Chapter 4)
College of Administration and Finance Sciences
Q3. ADLG Company has two support departments, SS1 and SS2, and two operating
departments, OD1 and OD2. The company has decided to use the direct method and allocate
variable SS1 dept. costs based on the number of transactions and fixed SS1 dept. costs based on
the number of employees. SS2 dept. variable costs will be allocated based on the number of
service requests and fixed costs will be allocated based on the number of computers. The
following values have been extracted for the allocation:
(4 Marks)
Support Departments
Operating Departments
SS1
SS2
OD1
OD2
Total Department variable costs
16,000
19,000
105,000
68,000
Total department fixed costs
19,500
34,000
120,000
55,000
Number of transactions
50
55
250
140
Number of employees
18
24
47
38
Number of service requests
37
22
26
32
Number of computers
20
25
31
37
You are required to allocate variable and fixed costs.
(Chapter 8)
Answer:
Q4. JKL Company processes a direct material and produces three products: P1, P2, and P3. The
joint costs of the three products in 2018 were SAR 120,000. The total number of units for each
product and the selling price per unit is given below:
(4 Marks)
Product
Units
Selling Price per unit
P1
55,000
SAR 70
College of Administration and Finance Sciences
P2
34,500
SAR 58
P3
10,500
SAR 44
You are required to use the physical volume method and sales value at the split-off method to
allocate the joint costs to each product.
Answer:
(Chapter 9)
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 4
Relevant Information for Decision Making
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 4: Relevant Costs for Nonroutine
Operating Decisions
Learning objectives
•
•
•
•
•
•
Q1: What is the process for identifying and using relevant
information in decision making?
Q2: How is relevant quantitative and qualitative information used
in special order decisions?
Q3: How is relevant quantitative and qualitative information used
in keep or drop decisions?
Q4: How is relevant quantitative and qualitative information used in
outsourcing (make or buy) decisions?
Q5: How is relevant quantitative and qualitative information used in
product emphasis and constrained resource decisions?
Q6: What factors affect the quality of operating decisions?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Nonroutine Operating Decisions
• Routine operating decisions are those made on a
regular schedule. Examples include:
• annual budgets and resource allocation decisions
• monthly production planning
• weekly work scheduling issues
• Nonroutine operating decisions are not made on a
regular schedule. Examples include:
• accept or reject a customer’s special order
• keep or drop business segments
• insource or outsource a business activity
• constrained (scarce) resource allocation issues
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Nonroutine Operating Decisions
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Process for Making Nonroutine
Operating Decisions
1. Identify the type of decision to be made.
2. Identify the relevant quantitative analysis technique
(s).
3. Identify and analyze the qualitative factors.
4. Perform quantitative and/or qualitative analyses
5. Prioritize issues and arrive at a decision.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Identify the Type of Decision
•
•
Special order decisions
•
determine the pricing
•
accept or reject a customer’s proposal for order quantity
and pricing
•
identify if there is sufficient available capacity
Keep or drop business segment decisions
•
examples of business segments include product lines,
divisions, services, geographic regions, or other distinct
segments of the business
•
eliminating segments with operating losses will not
always improve profits
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q1: Identify the Type of Decision
•
•
•
Outsourcing decisions
•
make or buy production components
•
perform business activities “in-house” or pay another
business to perform the activity
Constrained resource allocation decisions
•
determine which products (or business segments)
should receive allocations of scarce resources
•
examples include allocating scarce machine hours or
limited supplies of materials to products
Other decisions may use similar analyses
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q1: Identify and Apply the Relevant
Quantitative Analysis Technique(s)
•
•
Regression, CVP, and linear programming are
examples of quantitative analysis techniques.
Analysis techniques require input data.
•
Data for some input variables will be known and for
other input variables estimates will be required.
•
Many nonroutine decisions have a general
decision rule to apply to the data.
•
The results of the general rule need to be
interpreted.
•
The quality of the information used must be considered
when interpreting the results of the general rule.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2-Q5 : Identify and Analyze Qualitative Factors
•
Qualitative information cannot easily be valued in
dollars.
•
•
•
can be difficult to identify
can be every bit as important as the quantitative
information
Examples of qualitative information that may be
relevant in some nonroutine decisions include:
•
quality of inputs available from a supplier
•
effects of decision on regular customers
•
effects of decision on employee morale
•
effects of production on the environment or the
community
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q1: Consider All Information and Make a Decision
•
Before making a decision:
•
Consider all quantitative and qualitative information.
• Judgment is required when interpreting the effects of
qualitative information.
•
Consider the quality of the information.
• Judgment is also required when user lower-quality
information.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Special Order Decisions
•
•
A new customer (or an existing customer) may
sometimes request a special order with a lower
selling price per unit.
The general rule for special order decisions is:
•
•
accept the order if incremental revenues exceed
incremental costs,
subject to qualitative considerations.
Price >= Relevant
Variable Costs +
•
Relevant
Fixed Costs +
Opportunity
Cost
If the special order replaces a portion of normal
operations, then the opportunity cost of accepting
the order must be included in incremental costs.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Special Order Decisions
RobotBits, Inc. makes sensory input devices for robot manufacturers.
The normal selling price is $38.00 per unit. RobotBits was approached
by a large robot manufacturer, U.S. Robots, Inc. USR wants to buy
8,000 units at $24, and USR will pay the shipping costs. The per-unit
costs traceable to the product (based on normal capacity of 94,000
units) are listed below. Which costs are relevant to this decision?
yes
yes
yes
no
yes
no
no
no
© John Wiley & Sons, 2011
Relevant?
Relevant?
Relevant?
Relevant?
Relevant?
Relevant?
Relevant?
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
$20.00
Slide # 12
Q2: Special Order Decisions
Suppose that the capacity of RobotBits is 107,000 units and projected
sales to regular customers this year total 94,000 units. Does the
quantitative analysis suggest that the company should accept the
special order?
First determine if there is sufficient idle capacity to accept this
order without disrupting normal operations:
Projected sales to regular customers
Special order 8,000 units
102,000
units
94,000 units
RobotBits still has 5,000 units of idle capacity if the order is
accepted. Compare incremental revenue to incremental cost:
Incremental profit if accept special order =
($24 selling price – $20 relevant costs) x 8,000 units = $32,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q2: Qualitative Factors in
Special Order Decisions
What qualitative issues, in general, might RobotBits consider before
finalizing its decision?
• Will USR expect the same selling price per unit on future
orders?
• Will other regular customers be upset if they discover the
lower selling price to one of their competitors?
• Will employee productivity change with the increase in
production?
• Given the increase in production, will the incremental costs
remain as predicted for this special order?
• Are materials available from its supplier to meet the increase
in production?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q2: Special Order Decisions and Capacity Issues
Suppose instead that the capacity of RobotBits is 100,000 units and
projected sales to regular customers this year totals 94,000 units.
Should the company accept the special order?
Here the company does not have enough idle
capacity to accept the order:
Projected sales to regular customers
Special order 8,000 units
102,000
units
94,000 units
If USR will not agree to a reduction of the order to 6,000
units, then the offer can only be accepted by denying sales
of 2,000 units to regular customers.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q2: Special Order Decisions and Capacity Issues
Suppose instead that the capacity of RobotBits is 100,000 units and
projected sales to regular customers this year total 94,000 units. Does
the quantitative analysis suggest that the company should accept the
special order?
Variable cost/unit for
regular sales = $22.50.
CM/unit on regular sales
= $38.00 – $22.50 = $15.50.
The opportunity cost of accepting this
order is the lost contribution margin on
2,000 units of regular sales.
Incremental profit if accept special order =
$32,000 incremental profit under idle capacity – opportunity cost =
$32,000 – $15.50 x 2,000 = $1,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q2: Qualitative Factors in
Special Order Decisions
What additional qualitative issues, in this case of a capacity constraint,
might RobotBits consider before finalizing its decision?
• What will be the effect on the regular customer(s) that do not
receive their order(s) of 2,000 units?
• What is the effect on the company’s reputation of leaving
orders from regular customers of 2,000 units unfilled?
• Will any of the projected costs change if the company
operates at 100% capacity?
• Are there any methods to increase capacity? What effects do
these methods have on employees and on the community?
• Notice that the small incremental profit of $1,000 will probably
be outweighed by the qualitative considerations.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q3: Keep or Drop Decisions
•
Managers must determine whether to keep or
eliminate business segments that appear to be
unprofitable.
•
The general rule for keep or drop decisions is:
•
•
keep the business segment if its contribution margin
covers its avoidable fixed costs,
subject to qualitative considerations.
Drop if: Contribution < Relevant
Margin
Fixed Costs +
•
Opportunity
Cost
If the business segment’s elimination will affect
continuing operations, the opportunity costs of its
discontinuation must be included in the analysis.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q3: Keep or Drop Decisions
Starz, Inc. has 3 divisions. The Gibson and Quaid Divisions have recently
been operating at a loss. Management is considering the elimination of these
divisions. Divisional income statements (in 1000s of dollars) are given below.
According to the quantitative analysis, should Starz eliminate Gibson or
Quaid or both?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q3: Keep or Drop Decisions
Use the general rule
to determine if Gibson
and/or Quaid should
be eliminated.
The general rule shows that we should keep Quaid and drop Gibson.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q3: Keep or Drop Decisions
Using the general rule is easier
than recasting the income
statements:
Quaid &
Russell
only
Profits increase by $11 when Gibson is eliminated.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q3: Keep or Drop Decisions
Suppose that the Gibson & Quaid Divisions use the same supplier for a
particular production input. If the Gibson Division is dropped, the decrease in
purchases from this supplier means that Quaid will no longer receive volume
discounts on this input. This will increase the costs of production for Quaid by
$14,000 per year. In this scenario, should Starz still eliminate the Gibson
Division?
Profits decrease by $3 when Gibson is eliminated.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q3: Qualitative Factors in
Keep or Drop Decisions
What qualitative issues should Starz consider before finalizing its
decision?
• What will be the effect on the customers of Gibson if it
is eliminated? What is the effect on the company’s
reputation?
• What will be the effect on the employees of Gibson?
Can any of them be reassigned to other divisions?
• What will be the effect on the community where Gibson
is located if the decision is made to drop Gibson?
• What will be the effect on the morale of the employees
of the remaining divisions?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
•
Q4: Insource or Outsource
(Make or Buy) Decisions
Managers often must determine whether to
•
•
•
The general rule for make or buy decisions is:
•
•
make or buy a production input
keep a business activity in house or outsource the activity
choose the alternative with the lowest relevant
(incremental cost), subject to qualitative considerations
If the decision will affect other aspects of
operations, these costs (or lost revenues) must be
included in the analysis.
Outsource if: Cost to Outsource < Cost to Insource
Where:
© John Wiley & Sons, 2011
Cost to
Relevant Relevant Opportunity
Insource =
FC
+
VC
+
Cost
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q4: Make or Buy Decisions
Graham Co. currently of our main product manufactures a part called a
gasker used in the manufacture of its main product. Graham makes and
uses 60,000 gaskers per year. The production costs are detailed below.
An outside supplier has offered to supply Graham 60,000 gaskers per
year at $1.55 each. Fixed production costs of $30,000 associated with
the gaskers are unavoidable. Should Graham make or buy the gaskers?
The production costs per unit for manufacturing a gasker are:
yes
Relevant?
Direct materials
$0.65
Relevant?
yes
Direct labor 0.45
Variable manufacturing overhead yes 0.40 Relevant?
no
Relevant?
Fixed manufacturing overhead* 0.50
$2.00
*$30,000/60,000 units = $0.50/unit
$1.50
Advantage of “make” over “buy” = [$1.55 - $1.50] x 60,000 = $3,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q4: Qualitative Factors in
Make or Buy Decisions
The quantitative analysis indicates that Graham should continue to
make the component. What qualitative issues should Graham
consider before finalizing its decision?
• Is the quality of the manufactured component superior
to the quality of the purchased component?
• Will purchasing the component result in more timely
availability of the component?
• Would a relationship with the potential supplier benefit
the company in any way?
• Are there any worker productivity issues that affect this
decision?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q3: Make or Buy Decisions
Suppose the potential supplier of the gasker offers Graham a discount for a
different sub-unit required to manufacture Graham’s main product if Graham
purchases 60,000 gaskers annually. This discount is expected to save
Graham $15,000 per year. Should Graham consider purchasing the
gaskers?
Advantage of “make” over “buy”
before considering discount (slide 23)
$3,000
Discount
15,000
Advantage of “buy” over “make” $12,000
Profits increase by $12,000 when the gasker is purchased
instead of manufactured.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q5: Constrained Resource
(Product Emphasis) Decisions
•
Managers often face constraints such as
•
•
production capacity constraints such as machine hours
or limits on availability of material inputs
limits on the quantities of outputs that customers
demand
•
Managers need to determine which products
should first be allocated the scarce resources.
•
The general rule for constrained resource
allocation decisions with only one constraint is:
•
allocate scarce resources to products with the highest
contribution margin per unit of the constrained resource,
•
subject to qualitative considerations.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
Urban’s Umbrellas makes two types of patio umbrellas, regular and deluxe.
Suppose there is unlimited customer demand for each product. The selling
prices and variable costs of each product are listed below.
Regular
Deluxe
Selling price per unit
$40
$110
Variable cost per unit
20
44
Contribution margin per unit
$20
$ 66
Contribution margin ratio
50%
Required machine hours/unit
0.4
60%
2.0
Urban has only 160,000 machine hours available per year.
Write Urban’s machine hour constraint as an inequality.
0.4R + 2D ≤ 160,000 machine hours
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 29
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
Suppose that Urban decides to make all Regular umbrellas. What is the total
contribution margin? Recall that the CM/unit for R is $20.
The machine hour constraint is: 0.4R + 2D ≤ 160,000 machine hours
If D=0, this constraint becomes 0.4R ≤ 160,000 machine hours,
or R ≤ 400,000 units
Total contribution margin = $20*400,000 = $8 million
Suppose that Urban decides to make all Deluxe umbrellas. What is the total
contribution margin? Recall that the CM/unit for D is $66.
If R=0, this constraint becomes 2D ≤ 160,000 machine hours, or
D ≤ 80,000 units
Total contribution margin = $66*80,000 = $5.28 million
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 30
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
If the choice is between all Ds or all Rs, then clearly making all Rs
is better. But how do we know that some combination of Rs and Ds
won’t yield an even higher contribution margin?
make all Ds; get
$5.28 million
make all Rs; get
$8 million
In a one constraint problem, a combination of Rs and Ds will yield
a contribution margin between $5.28 and $8 million. Therefore,
Urban will only make one product, and clearly R is the best choice.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 31
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
The general rule for constrained resource decisions with one scarce
resource is to first make only the product with the highest
contribution margin per unit of the constrained resource.
In Urban’s case, the sole scarce resource was machine hours,
so Urban should make only the product with the highest
contribution margin per machine hour.
R: CM/mach hr = $20/0.4mach hrs = $50/mach hr
D: CM/mach hr = $66/2mach hrs = $33/mach hr
Notice that the total contribution margin from making all Rs
is $50/mach hr x 160,000 machine hours to be used
producing Rs = $8 million.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 32
Q5: Constrained Resource Decisions
(Multiple Scarce Resources)
•
Usually managers face more than one constraint.
•
Multiple constraints are easiest to analyze using a
quantitative analysis technique known as linear
programming.
•
A problem formulated as a linear programming
problem contains
•
an algebraic expression of the company’s goal, known
as the objective function
• for example “maximize total contribution margin” or “minimize
total costs”
•
a list of the constraints written as inequalities
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 33
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
Suppose Urban also need 2 and 6 hours of direct labor per unit of R
and D, respectively. There are only 120,000 direct labor hours available
per year. Formulate this as a linear programming problem.
Max 20R + 66D
R,D
subject to:
0.4R+2D ≤ 160,000 mach hr constraint
2R+6D ≤ 120,000 DL hr constraint
nonnegativity constraints
R≥0
(can’t make a negative
D≥0
amount of R or D)
objective function
R, D are the
choice variables
constraints
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 34
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
Draw a graph showing the possible production plans for Urban.
Every R, D ordered pair
To determine this, graph the
is a production plan.
constraints as inequalities.
But which ones are feasible,
0.4R+2D ≤ 160,000 mach hr constraint
given the constraints?
When D=0, R=400,000
D
When R=0, D=80,000
2R+6D ≤ 120,000 DL hr constraint
When D=0, R=60,000
When R=0, D=20,000
80,000
20,000
60,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 35
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
There are not enough machine hours or enough
direct labor hours to produce this production plan.
There are enough machine hours, but
not enough direct labor hours, to
produce this production plan.
This production plan is feasible;
there are enough machine hours
and enough direct labor hours for
this plan.
D
80,000
The feasible set is the area where all the
production constraints are satisfied.
20,000
60,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 36
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
The graph helped us realize an important aspect of this
problem – we thought there were 2 constrained resources but
in fact there is only one.
For every feasible production plan, Urban will never
run out of machine hours.
D
The machine hour constraint is non-binding, or slack,
but the direct labor hour constraint is binding.
80,000
We are back to a one-scarceresource problem.
20,000
60,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 37
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
Here direct labor hours is the sole scarce resource.
We can use the general rule for one-constraint problems.
R: CM/DL hr = $20/2DL hrs = $10/DL hr
D: CM/DL hr = $66/6DL hrs = $11/DL hr
D
Urban should make all deluxe umbrellas.
80,000
Optimal plan is R=0, D=20,000.
Total contribution margin = $66 x
20,000 = $1,320,000
20,000
60,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 38
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
Suppose Urban has been able to train a new workforce and now there
are 600,000 direct labor hours available per year. Formulate this as a
linear programming problem, graph it, and find the feasible set.
Max 20R + 66D
R,D
subject to:
0.4R+2D ≤ 160,000 mach hr constraint
2R+6D ≤ 600,000
DL hr constraint
R≥0
D≥0
The formulation of the problem is the same as before; the
only change is that the right hand side (RHS) of the DL
hour constraint is larger.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 39
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
The machine hour constraint is the same as before.
0.4R+2D ≤ 160,000 mach hr constraint
D
100,000
2R+6D ≤ 600,000 DL hr constraint
When D=0, R=300,000
When R=0, D=100,000
80,000
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 40
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
There are not enough machine hours or enough
direct labor hours for this production plan.
There are enough direct labor hours, but not
enough machine hours, for this production plan.
D
100,000
There are enough machine hours, but not
enough direct labor hours, for this production
plan.
This production plan is feasible; there
are enough machine hours and enough
direct labor hours for this plan.
80,000
The feasible set is the area where all the
production constraints are satisfied.
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 41
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
How do we know which of the feasible plans is optimal?
We can’t use the general rule for one-constraint problems.
We can graph the total contribution margin line, because its slope
will help us determine the optimal production plan.
D
100,000
80,000
The objective “maximize total
contribution margin” means that we
. . . this would be the
choose a production plan so that the
optimal production plan.
contribution margin is a large as
possible, without leaving the feasible
set. If the slope of the total contribution
margin line is lower (in absolute value
terms) than the slope of the machine
hour constraint, then. . .
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 42
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
What if the slope of the total contribution margin line is higher (in
absolute value terms) than the slope of the direct labor hour
constraint?
If the total CM line had this steep slope, . .
D
100,000
. . then this would
be the optimal
production plan.
80,000
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 43
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
What if the slope of the total contribution margin line is between
the slopes of the two constraints?
If the total CM line had this slope, . .
D
100,000
. . then this would
be the optimal
production plan.
80,000
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 44
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
The last 3 slides showed that the optimal production plan is always
at a corner of the feasible set. This gives us an easy way to solve
2 product, 2 or more scarce resource problems.
D
100,000
R=0, D=80,000
The total contribution margin here is
0 x $20 + 80,000 x $66 = $5,280,000.
R=?, D=?
Find the intersection of the 2 constraints.
80,000
R=300,000, D=0
The total contribution margin here is
300,000 x $20 + 0 x $66 = $6,000,000.
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 45
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
To find the intersection of the 2 constraints, use substitution or
subtract one constraint from the other.
multiply each side by 5
Total CM = $5,280,000.
D
100,000
80,000
0.4R+2D = 160,000 2R+10D = 800,000
2R+6D = 600,000
2R+6D = 600,000
subtract 0R+4D = 200,000
D = 50,000
Total CM = $20 x 150,000 +
2R+6(50,000) = 600,000
$66 x 50,000 = $6,300,000.
2R = 300,000
R = 150,000
Total CM = $6,000,000.
300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 46
Q5: Constrained Resource Decisions
(Two Products; Two Scarce Resources)
By checking the total contribution margin at each corner
of the feasible set (ignoring the origin), we can see that
the optimal production plan is R=150,000, D=50,000.
Total CM = $5,280,000.
D
100,000
80,000
Knowing how to graph and solve 2
product, 2 scarce resource problems is
good for understanding the nature of a
linear programming problem (but
difficult in more complex problems).
Total CM = $6,300,000.
50,000
Total CM = $6,000,000.
150,000 300,000
© John Wiley & Sons, 2011
400,000
R
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 47
Q5: Qualitative Factors in
Scarce Resource Allocation Decisions
The quantitative analysis indicates that Urban should produce 150,000
regular umbrellas and 50,000 deluxe umbrellas. What qualitative
issues should Urban consider before finalizing its decision?
• The assumption that customer demand is unlimited is
unlikely; can this be investigated further?
• Are there any long-term strategic implications of
minimizing production of the deluxe umbrellas?
• What would be the effects of attempting to relax the
machine hour or DL hour constraints?
• Are there any worker productivity issues that affect this
decision?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 48
Q5: Constrained Resource Decisions
(Multiple Products; Multiple Constraints)
• Problems with multiple products, one scarce resource,
and one constraint on customer demand for each
product are easy to solve.
• The general rule is to make the product with the highest
contribution margin per unit of the scarce resource:
– until its customer demand is satisfied
– then move to the product with the next highest contribution margin
per unit of the scarce resource, etc.
• Problems with multiple products and multiple scarce
resources are too cumbersome to solve by hand – Excel
solver is a useful tool here.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 49
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
Urban’s Umbrellas makes two types of patio umbrellas, regular and deluxe.
Suppose customer demand for regular umbrellas is 300,000 units and for
deluxe umbrellas customer demand is limited to 60,000. Urban has only
160,000 machine hours available per year. What is his optimal production
plan? How much would he pay (above his normal costs) for an extra
machine hour?
Regular
Deluxe
Selling price per unit
$40
$110
Variable cost per unit
20
44
Contribution margin per unit
$20
$ 66
Required machine hours/unit
0.4
CM/machine hour
$33
$50
2.0
Urban should first concentrate on making Rs. He can make enough to satisfy
customer demand for Rs: 300,000 Rs x 0.4 mach hr/R = 120,000 mach hrs.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 50
Q5: Constrained Resource Decisions
(Two Products; One Scarce Resource)
Regular
Deluxe
Selling price per unit
$40
$110
Variable cost per unit
20
44
Contribution margin per unit
$20
$ 66
Required machine hours/unit
0.4
CM/machine hour
$33
$50
2.0
The 40,000
remaining hours
will make 20,000
Ds.
The optimal plan is 300,000 Rs and 20,000 Ds. The CM/mach hr shows
how much Urban would be willing to pay, above his normal costs, for an
additional machine hour.
Here Urban will be producing Ds when he runs out of machine hours so he’
d be willing to pay up to $33 for an additional machine hour.
If customer demand for Rs exceeded 400,000 units, Urban would be willing
to pay up to an additional $50 for a machine hour.
If customer demand for Rs and Ds could be satisfied with the 160,000
available machine hours, then Urban would not be willing to pay anything to
acquire an additional machine hour.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 51
Q5: Constrained Resource Decisions
Using Excel Solver
To obtain the
solver dialog box,
choose “Solver”
from the Tools
pull-down menu.
The “target cell” will
contain the maximized
value for the objective
(or “target”) function.
Choose “max” for the
types of problems in this
chapter.
Add constraint
formulas by clicking
“add”.
© John Wiley & Sons, 2011
Choose one cell for
each choice variable
(product). It’s helpful
to “name” these cells.
Click “solve” to obtain the
next dialog box.
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 52
Q5: Constrained Resource Decisions
Using Excel Solver
Cell B2 was
named
“Regular” and
cell C2 was
named Deluxe.
=20*Regular
+ 66*Deluxe
=0.
4*Regular+2*
Deluxe
=2*Regular+
6*Deluxe
=Regular (cell B2)
=Deluxe (cell C2)
Then click “solve” and choose all 3 reports.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 53
Q5: Excel Solver Answer Report
Refer to the problem on Slide #50.
The total contribution margin for
the optimal plan was $6.3 million.
The optimal production plan was
150,000 Rs and 50,000 Ds.
The machine and DL hour
constraints are binding – the plan
uses all available machine and DL
hours.
The nonnegativity
constraints for R and D
are not binding; the slack
is 50,000 and 150,000
units respectively.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 54
Q5: Excel Solver Sensitivity Report
Refer to the problem on Slide #50.
This shows
how much the
slope of the
total CM line
can change
before the
optimal
production
plan will
change.
The CM per unit for Regular can drop to $13.20 or increase to $22 (all else equal)
before the optimal plan will change. The CM per unit for Deluxe can drop to $60 or
increase to $100 (all else equal) before the optimal plan will change.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 55
Q5: Excel Solver Sensitivity Report
Refer to the problem on Slide #50.
This shows
how much the
RHS of each
constraint can
change
before the
shadow price
will change.
The available DL hours could decrease to 480,000 or increase to 800,000 (all
else equal) before the shadow price for DL would change. The available
machine hours could decrease to 120,000 or increase to 200,000 (all else
equal) before the shadow price for machine hours would change.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 56
Q5: Excel Solver Sensitivity Report
Refer to the problem on Slide #50.
The shadow
price shows
how much a
one unit
increase in
the RHS of a
constraint will
improve the
total
contribution
margin.
Urban would be willing to pay up to $8.50 to obtain one more DL hour and up
to $7.50 to obtain one more machine hour.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 57
Q7: Impacts to Quality of
Nonroutine Operating Decisions
• The quality of the information used in nonroutine
operating decisions must be assessed.
• There may be more information quality issues (and more
uncertainty) in nonroutine decisions because of the
irregularity of the decisions.
• Three aspects of the quality of information available
can affect decision quality.
• Business risk (changes in economic condition, consumer
demand, regulation, competitors, etc.)
• Information timeliness
• Assumptions in the quantitative and qualitative analyses
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 58
Q7: Impacts to Quality of
Nonroutine Operating Decisions
• Short term decision must align to company’s overall
strategic plans
• Must watch for decision maker bias
– Predisposition for specific outcome
– Preference for one type of analysis without considering
other options
• Opportunity costs are often overlooked
• Performing sensitivity analysis can help assess and
minimize business risk
• Established control system incentives (performance
bonuses, etc.) can encourage sub-obtimal decision
making
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 59
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 6
Process Costing
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 6: Process Costing
Learning objectives
•
Q1: How are costs assigned to mass-produced products?
•
Q2: What are equivalent units & how do they relate to the
production process?
•
Q3: How is the weighted average method used in process
costing?
•
Q4: How is the FIFO method used in process costing?
•
Q5: What alternative methods are used for mass production?
•
Q6: How is process costing performed for multiple production
departments?
•
Q7: How are spoilage costs handled in process costing?
•
Q8: How does process costing information affect managers’
incentives and decisions?
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Job Order versus Process Costing
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Job Order versus Process Costing
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Introduction to Process Costing
Process costing is a method of averaging costs over the units
of production. This is necessary to determine the cost of the
units transferred out of a department, as well as the cost of the
department’s ending WIP inventory.
WIP Inventory - Units
This
information
is all known
BI
Units started
Units completed
& transferred out
EI
WIP Inventory - $
BI
DM
CC
Units completed
& transferred out
Unlike job
costing,
there are
no job cost
records to
give us this
information
EI
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Process Costing with all Units Completed
Riker Co. had June costs for Department 1 as follows:
DM$60,000
CC 30,000
$90,000
There were no units in beginning or ending WIP inventory in June.
During June Department 1 started 45,000 units, and all 45,000
were completed in June. What is the manufacturing cost/unit?
WIP Inventory - Units
0
45,000
45,000
0
WIP Inventory - $
0
90,000
90,000
0
The manufacturing cost/unit is $90,000/45,000 units = $2/unit.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q2: The Concept of Equivalent Units
In order to value partially complete units of inventory, we
measure units in equivalent whole units rather than actual units.
Suppose that 30,000 units were completed in June, and the units in
ending WIP were 1/3 complete. What is the manufacturing cost/unit?
WIP Inventory - Units
0
45,000
30,000
15,000
WIP Inventory - $
0
90,000
The 15,000 units taken to 1/3 completion are counted as 5,000
equivalent whole units, or 5,000 equivalent units of production (EUP).
The manufacturing cost/unit =
$90,000/[30,000 + 5,000]EUP = $2.57143/EUP.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: The Concept of Equivalent Units
Using the cost/EUP of $2.57143 from the prior slide, compute the costs
attached to the 30,000 completed units and the costs attached to the
15,000 units in ending WIP inventory.
WIP Inventory - Units
0
30,000
45,000
WIP Inventory - $
0
77,143
90,000
15,000
12,857
5,000 EUP x
$2.57143
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
30,000 units x
$2.57143
Slide # 8
Q2-Q4: Equivalent Units &
Process Costing Methods
• The prior slide simplified the computation of EUP.
• 15,000 units taken to 1/3 completion is equivalent to 5,000
whole units only if costs are incurred evenly.
• We will return to this later.
• The prior slide ignored the different methods of
computing EUP.
• The weighted average and FIFO methods compute EUP
differently.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q2-Q4: Three Categories of Units
In process costing we categorize units according to the time
period(s) they were produced.
Prior months
Current month
BI units: The units in
beginning Work in process
inventory were worked on
in prior months and (we
assume) they will be
completed in the current
month.
© John Wiley & Sons, 2011
Next month
EI units: The units in
ending Work in process
inventory are started (we
assume) in the current
month and (we assume)
they will be completed in
the current month.
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2-Q4: Three Categories of Units
In process costing we categorize units according to the time
period(s) they were produced.
Prior months
Current month
Next month
S&C units: Any units that are started in the current
month and are totally complete by month end are
called started & completed units.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2-Q4: Summarizing the
Physical Flow of Production
The number of S&C units can be computed as the number of
units transferred out less the number of BI units.
For example, suppose a department had 5,000 units in
beginning WIP and started 50,000 units this month. If 35,000
units were completed, what is the number of S&C units?
WIP Inventory - Units
5,000
35,000
50,000
20,000
© John Wiley & Sons, 2011
BI units 5,000
S&C units30,000
Completed units 35,000
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q2-Q4: Two Process Costing Methods
The weighted average and FIFO methods of process costing
methods compute EUP differently.
Prior months
Current month
The weighted average
(WA) method gives credit
for work performed in the
current & prior months.
© John Wiley & Sons, 2011
Next month
This means that under the
WA method, the EUP for
BI units and S&C units is
the same as the physical
number of units in each
category.
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q2-Q4: Two Process Costing Methods
The weighted average and FIFO methods of process costing
methods compute EUP differently.
Prior months
Current month
The weighted average
(WA) method gives credit
for work performed in the
current & prior months.
© John Wiley & Sons, 2011
Next month
The EUP for EI units and
is based on the stage of
completion of the EI units
– only the portion of the
work done in the current
month is included.
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q2-Q4: Two Process Costing Methods
The weighted average and FIFO methods of process costing
methods compute EUP differently.
Prior months
Current month
Next month
The FIFO method gives credit only for work
performed in the current month.
This means that the EUP for BI
units is based on the
completion of these units
during the current month.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q2-Q4: Two Process Costing Methods
The weighted average and FIFO methods of process costing
methods compute EUP differently.
Prior months
Current month
Next month
The FIFO method gives credit only for work
performed in the current month.
The EUP for EI units and is based on
the stage of completion of the EI units
– only the portion of the work done in
the current month is included.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q2-Q4: Equivalent Units of Production Example
In July, Rita Corp. had 30,000 units in beginning WIP that were 60%
complete and 20,000 units in ending WIP that were 80% complete. There
were 100,000 units completed and transferred to FG inventory. Compute
EUP for July using both the weighted average and FIFO methods.
First, summarize the physical flow of the units and compute S&C.
WIP Inventory - Units
30,000
90,000 100,000
20,000
© John Wiley & Sons, 2011
BI units
30,000
S&C units 70,000
Completed units
100,000
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q2-Q4: Equivalent Units of Production Example
In July, Rita Corp. had 30,000 units in beginning WIP that were 60%
complete and 20,000 units in ending WIP that were 80% complete. There
were 100,000 units completed and transferred to FG inventory. Compute
EUP for July using both the weighted average and FIFO methods.
Then, convert the physical units to EUP.
WIP Inventory Units
30,00
90,0000 100,000
BI units 30,000
S&C units
70,000
Completed units
100,000
20,000
© John Wiley & Sons, 2011
Slide # 18
Q2-Q4: Equivalent Units of Production Example
In July, Rita Corp. had 30,000 units in beginning WIP that were 60%
complete and 20,000 units in ending WIP that were 80% complete. There
were 100,000 units completed and transferred to FG inventory. Compute
EUP for July using both the weighted average and FIFO methods.
Then, convert the physical units to EUP.
WIP Inventory Units
30,00
90,0000 100,000
BI units 30,000
S&C units
70,000
Completed units
100,000
(1-60%)
20,000
© John Wiley & Sons, 2011
Slide # 19
Q2-Q4: Equivalent Units &
Process Costing Methods
• The prior slides simplified the computation of EUP
• 20,000 units started and taken to 80% completion is
equivalent to 16,000 whole units only if costs are incurred
evenly.
• We usually assume that conversion costs are incurred
evenly throughout production, but direct materials costs
may not be incurred evenly.
• Direct materials costs may be incurred at the beginning of
processing or in some other uneven manner.
• Because costs are incurred at different times, separate
EUP computations are done for DM & CC.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q2-Q4: Separate EUP for DM & CC
You are given the information below about the physical flow of the units in
Department 1. The BI units were 25% complete and the EI units were 40%
complete. Compute EUP for DM and CC if DM costs are incurred at the
beginning of production.
WIP Inventory Units
5,000
20,00 17,000
8,0000
© John Wiley & Sons, 2011
BI units 5,000
S&C units
12,000
Completed units 17,000
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
(1-25%)
Slide # 21
Q2-Q4: Separate EUP for DM & CC
Use the same information from the prior slide; recall that the BI units were
25% complete and the EI units were 40% complete. Compute EUP for DM
and CC if 20% of DM costs are incurred at the beginning of processing and
the rest of the DM costs are incurred when the units pass the 60% stage of
completion.
No
Change
(1-20%)
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q2-Q4: Cost per Equivalent Unit
• The EUP calculations provide the denominator in
the cost per EUP computation.
• A cost per EUP is computed for each cost category.
• The WA and FIFO methods use different
numerators in the cost per EUP computation.
• The numerator for the WA cost per EUP includes total
costs (current costs plus the BI costs).
• The numerator for the FIFO cost per EUP includes only
current costs.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q3&4: Process Costing Example, no BI
You are given the information below about May’s production and costs
for Slocik Co. The units in ending WIP were 1/3 complete. Direct
materials are added at the beginning of processing. What is the
manufacturing cost per EUP under both methods?
WIP Inventory - Units
0
30,000
45,000
WIP Inventory - $
0
DM65,250
CC 28,000
15,000
First, compute the EUP for DM & CC.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q3&4: Process Costing Example, no BI
WIP Inventory - Units
0
30,000
45,000
WIP Inventory - $
0
DM65,250
CC 28,000
15,000
When there is no BI, WA and FIFO have the same
EUP, and hence the same costs/EUP.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q3&4: Process Costing Example, no BI
WIP Inventory - Units
0
30,000
45,000
WIP Inventory - $
0
DM65,250
CC 28,000
15,000
Now, compute the costs/EUP for DM & CC.
DM cost/EUP = $65,250/45,000 EUP = $1.45/EUP
CC/EUP = $28,000/35,000 EUP = 0.80/EUP
Total manufacturing cost/EUP $2.25/EUP
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q3&4: Process Costing Example, no BI
The last step is a process cost report that breaks the “total
costs to account for” into:
• the portion that is assigned to the completed units, and
• the portion that is assigned to the units in ending
WIP inventory
total costs to account
for = $93,250
WIP Inventory - Units
0
30,000
45,000
15,000
total units to account
for = 45,000
© John Wiley & Sons, 2011
WIP Inventory - $
0
$ assigned to
DM65,250
completed units
CC 28,000
$ assigned
to EI units
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q3&4: Process Costing Example, no BI
The journal entry to record the costs transferred out is:
FG inventory 67,500
WIP inventory
67,500
30,000 x $2.25
15,000 x $1.45
5,000 x $0.80
0
30,000
30,000
15,000
45,000
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
0
67,500
67,500
21,750
4,000
25,750
93,250
Slide # 28
Q3&4: Process Costing Example, with BI
Colors R Us, Inc. uses a process costing system for its sole processing
department. There were 6,200 units in beginning WIP inventory for
February and 57,500 units were started in February. The beginning WIP
units were 60% complete and the 5,000 units in ending WIP were 45%
complete. All materials are added at the start of processing. Compute the
EUP for DM and CC using both methods.
First, compute the # of units started & completed:
WIP Inventory - Units
6,200
57,500
5,000
© John Wiley & Sons, 2011
58,700
BI units
6,200
S&C units 52,500
Completed units
58,700
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 29
Q3&4: Process Costing Example, with BI
WIP Inventory - Units
6,200
BI units
6,200
S&C units 52,500
57,500 58,700
Completed units
58,700
5,000
Now, compute the EUP for DM & CC (recall that BI & EI were 60% & 45%
complete, respectively, and all DM are added at the start of processing).
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 30
Q3&4: Process Costing Example, with BI
Beginning WIP inventory was valued at $42,896 [DM costs of $12,850
plus CC of $30,046]. During February Colors incurred DM costs of
$178,250, and CC of $274,704. Compute the cost of the goods
transferred out the the costs assigned to ending WIP inventory for
February, using both methods.
WIP Inventory - $
BI 42,896
DM178,250
CC 274,704
The EUP from the prior slide:
Under FIFO, the numerator includes only current costs:
DM cost/EUP = $178,250/57,500 EUP =
$3.10
/EUP
CC/EUP = $274,704/57,230 EUP = 4.80/EUP
Total manufacturing cost/EUP $7.90/EUP
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 31
Q3&4: Process Costing Example, with BI
Beginning WIP inventory was valued at $42,896 [DM costs of $12,850
plus CC of $30,046]. During February Colors incurred DM costs of
$178,250, and CC of $274,704. Compute the cost of the goods
transferred out the the costs assigned to ending WIP inventory for
February, using both methods.
WIP Inventory - $
BI 42,896
DM178,250
CC 274,704
The EUP from the prior slide:
Under WA, the numerator includes BI and current costs:
DM cost/EUP = $191,100/63,700 EUP =
$3.00
/EUP
CC/EUP = $307,750/60,950 EUP = 5.00/EUP
Total manufacturing cost/EUP $8.00/EUP
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management,2e
Slide # 32
Q3&4: Process Costing Example, with BI
The last step is a process cost report that breaks the “total
costs to account for” into:
• the portion that is assigned to the completed units, and
• the portion that is assigned to the units in ending
WIP inventory
total costs to account
for = $495,850
WIP Inventory - Units
6,2
00
58,700
57,
5,00
total units to0500
account
for = 63,700
© John Wiley & Sons, 2011
WIP Inventory - $
42,896
$ assigned to
DM178,250
completed units
CC 274,704
$ assigned
to EI units
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 33
Q3&4: WA Process Costing Example, with BI
Under the WA method, there is no
distinction between the 6,200 BI
units and the 52,500 S&C units.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 34
Q3&4: FIFO Process Costing Example, with BI
Under the FIFO method, the cost
assigned to the 6,200 BI units is
computed separately from the cost
of the 52,500 S&C units.
= 2,480 * $4.80
= 52,500 * $7.90
= 5,000 * $3.10
= 2,250 * $4.80
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 35
Q6: Accounting for Transferred-in Costs
• “Transferred-in costs” (TI) is merely another cost
category like DM or CC
• All processing departments except the first will
account for TI costs
• When preparing a process cost report for a
department with TI costs:
• Compute EUP for TI costs; all TI costs are incurred at the
start of processing
• Compute cost/EUP for TI costs
• Assign TI costs to EI units
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 36
Q6: Process Costing Example, with TI Costs
Crusher Drugs manufactures a pain medication in a two-process cycle. In
Department 2, direct materials are added as follows: 20% are added at the
beginning of processing, and the rest at the 60% stage. There were 5,000
units in Dep’t 2’s beginning WIP inventory that were 40% complete, and
20,000 units were transferred in to Dep’t 2 in May. The Dep’t 2 ending WIP
inventory of 6,000 units was 55% complete. Compute the May EUP for all
cost categories for Department 2 using both methods.
First, compute the # of units started & completed:
Dep’t 2 WIP Inventory - Units
5,000
BI units
5,000
S&C units 14,000
20,000
19,000
Completed units
19,000
6,000
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 37
Q6: Process Costing Example, with TI Costs
Dep’t 2WIP Inventory - Units
5,000
BI units
5,000
S&C units 14,000
20,000 19,000
Completed units
19,000
6,000
Now, compute the EUP for DM & CC (recall that BI & EI were 40% &
55% complete, respectively; 20% of DM costs are incurred at the start of
processing, and the rest are incurred at the 60% stage).
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 38
Q6: Process Costing Example, with TI Costs
You are given the cost information below. Compute the cost per EUP
under both methods.
Under WA, the numerator includes BI and current costs:
DM cost/EUP = $79,537.50/20,200 EUP = $3.9375/EUP
CC/EUP = $35,122.50/22,300 EUP =
1.5750/EUP
TI cost/EUP = $131,250/25,000 EUP = 5.2500/EUP
Total manufacturing cost/EUP
© John Wiley & Sons, 2011
$10.7625/EUP
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 39
Q6: Process Costing Example, with TI Costs
You are given the cost information below. Compute the cost per EUP
under both methods.
Under FIFO, the numerator includes only current costs:
DM cost/EUP = $72,240/19,200 EUP = $3.7625/EUP
CC/EUP = $31,262/20,300 EUP = 1.5400/EUP
TI cost/EUP = $112,000/20,000 EUP = 5.6000/EUP
Total manufacturing cost/EUP
$10.9025/EUP
Next, complete the process cost report using both methods….
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 40
Q6: Process Costing Example, with TI Costs
4,000 *
3,000 *
14,000 *
1,200 * $3.7625 =
3,300 * $1.5400 =
6,000 * $5.6000 =
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Given $
* 19,000
1,200 * $3.9375 =
3,300 * $1.5750 =
6,000 * $5.2500 =
Slide # 41
Q5: What Alternative Methods are Used for Mass
Production?
• Adaptations to Traditional Process Costing
– Match equivalent units calculations more closely to actual
production processes
– Separate conversion costs into multiple pools
• Standard costs simplify the accounting
• Just-in-time production
• Hybrid costing, or operation costing
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 42
Q7: Accounting for Spoilage in Process Costing
• Costs of normal spoilage are absorbed by
the good units transferred out.
• Costs of abnormal spoilage are charged to a
Loss from abnormal spoilage account.
• Costs attach to spoilage depending on when
spoilage is detected.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 43
Q7: Process Costing & Spoilage Example
Hollidaze makes molded plastic party decorations. In June, there were 800
units in beginning WIP inventory that were 40% complete and the 500 units in
ending WIP were 30% complete. The company completed 3,000 units in
June, but 200 of these were defective and were discarded. The defective
units are located upon inspection before transfer to finished goods. It was
determined that 50 of these defective units should be considered normal
spoilage. The remaining spoilage occurred because of a rare machine
malfunction and should be considered abnormal spoilage. All direct materials
are added at the beginning of processing.
Compute the June EUP for DM and CC using both methods.
First, compute the # of units started & completed:
WIP Inventory - Units
800
BI units
800
S&C units 2,200
3,000
2,700
Completed units 3,000
500
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
this
includes
200
defective
units
Slide # 44
Q7: Process Costing & Spoilage Example
WIP Inventory - Units
800
2,700 3,000
500
© John Wiley & Sons, 2011
BI units 800
S&C units 2,200
Completed units
3,000
Now, compute the EUP for DM &
CC (recall that BI & EI were 40%
& 30% complete, respectively;
DM costs are incurred at the start
of processing).
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 45
Q7: Process Costing & Spoilage Example
You are given the cost information below. Compute the cost per EUP
under both methods.
Under WA, the numerator includes BI and current costs:
DM cost/EUP = $11,375/3,500 EUP = $3.25/EUP
CC/EUP = $7,245/3,150 EUP = 2.30/EUP
Total manufacturing cost/EUP
© John Wiley & Sons, 2011
$5.55/EUP
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 46
Q7: Process Costing & Spoilage Example
You are given the cost information below. Compute the cost per EUP
under both methods.
Under FIFO, the numerator includes only current costs:
DM cost/EUP = $8,640/2,700 EUP = $3.20/EUP
CC/EUP = $5,943/2,830 EUP = 2.10/EUP
Total manufacturing cost/EUP
$5.30/EUP
Next, complete the process cost report using both methods….
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 47
Q7: WA Process Costing & Spoilage Example
The WA journal entry to record the costs transferred out is:
FG inventory 15,81.50
Loss from abnormal spoilage 832.50
WIP inventory
16,650.00
Note the total good
units accounted for is
the total units to
account for less the
spoiled units.
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Q7: FIFO Process Costing & Spoilage Example
The FIFO journal entry to record the costs
transferred out is:
FG inventory
15,910
Loss from abnormal
spoilage
795
WIP inventory
16,705
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 49
Q8: Process Costing Uses for Decision Making
• Used to determine valuation for inventory and cost of
goods sold at the end of each period
• Required for financial statements and income tax
returns
• Helps managers evaluate if the production processes
are operating as expected
• Compare actual results to budget, standards, or
prior periods
• Identify areas for process improvements
• Analyze benefits of quality improvements
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management 2e
Slide # 50
Q8: Process Costing Limitations & Impacts on
Managers’ Decision Making
• Process cost information is generally not useful for
many short-term decisions because unavoidable
fixed costs are allocated to the products.
• Need to determine incremental or marginal costs
• Separating conversion costs into fixed and
variable pools would help
• Requires use of estimates:
• The point of the production process when DM
costs or CC are incurred.
• Stage of completion for all units in beginning and
ending WIP inventories
© John Wiley & Sons, 2011
Chapter 6: Process Costing
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 51
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 7
Activity-Based Costing and
Management
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 7: Activity-Based Costing and Management
Learning objectives
•
Q1: What is activity-based costing (ABC)?
•
Q2: What are activities and how are they identified?
•
Q3: What process is used to assign costs in an ABC system?
•
Q4: What is activity-based management?
•
Q5: What are GPK and RCA?
•
Q6: How does information from ABC, GPK, and RCA affect
managers’ incentives and decisions?
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Activity-Based Costing (ABC)
• ABC is a method of cost system refinement.
• Indirect costs are divided into “sub-pools” of
costs of activities.
• Activity costs are then allocated to the final cost
objects using a cost allocation base (more
commonly called cost drivers in ABC).
• Activities are measurable, making it more likely
that cost drivers can be found so that a final cost
object will absorb indirect costs in proportion to
its use of the activity.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Traditional Costing vs. ABC
Traditional costing systems:
Indirect
Costs
Indirect costs are
grouped into one (or a
small number) of cost
pools; a cost allocation
base assigns costs to
the individual products
© John Wiley & Sons, 2011
Product A
Direct Costs
Product B
Direct Costs
Product C
Direct Costs
The individual
products are
the final cost
objects.
Direct costs are
traced to the
individual
products.
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Traditional Costing Systems
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Traditional Costing vs. ABC
Activity-based costing systems:
Activity 1
Indirect
Costs
Activity 2
Activity 3
Indirect costs are
assigned (traced &
allocated) to various
pools of activity costs.
© John Wiley & Sons, 2011
Product A
Direct Costs
Product B
Direct Costs
Product C
Direct Costs
Activity costs are
allocated to
products
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
The individual products
are the final cost objects
& direct costs are traced
to the individual products.
Slide # 6
Q1: ABC Costing Systems
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: What are Activities and How are They
Identified?
The ABC cost hierarchy includes the following activities:
• organization-sustaining – associated with overall
organization
• facility-sustaining – associated with single manufacturing
plant or service facility
• customer-sustaining – associated with a single customer
• product-sustaining – associated with product lien or
single product
• batch-level – associated with each batch of product
• unit-level – associated with each unit produced
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: ABC Cost Hierarchy Example
Some of the costs incurred by the Dewey Chargem law firm are listed
below. This firm specializes in immigration issues and family law. For each
cost, identify whether the cost most likely relates to a(n) (1) organiz-ationsustaining, (2) facility-sustaining, (3) customer-sustaining, (4) productsustaining, (5) batch-level, or (6) unit-level activity and explain your choice.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q3: What Process is Used to Assign Costs in an
ABC system?
1. Identify the relevant cost object.
2. Identify activities and group homogeneous
activities.
3. Assign costs to the activity cost pools.
4. Choose a cost driver for each activity cost
pool.
5. Calculate an allocation rate for each
activity cost pool.
6. Allocate activity costs to the final cost
object.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q3: How Are Cost Drivers Selected for
Activities?
• For each activity, determine its place
in the ABC cost hierarchy.
• Look for drivers that have a good
cause-and-effect relationship with the
activities’ costs.
• Use a reasonable driver when there is
no cause-and-effect relationship.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q3: ABC in Manufacturing Example
Alphabet Co. makes products A & B. Product A is a low-volume
specialty item and B is a high-volume item. Estimated factory- wide
overhead is $800,000, and the number of DL hours for the year is
estimated to be 50,000 hours. DL costs are $10/hour. Each product
uses 2 DL hours. Compute the traditional cost of each product if
Products A & B use $25 and $10 in direct materials, respectively.
First, compute the estimated overhead rate:
Estimated overhead rate = $800,000/50,000 hours = $16/hour.
Product A Product B
Direct materials
$25
Direct labor (2hrs @ $10)
Overhead (2 hrs @ $16)
$77
$62
© John Wiley & Sons, 2011
$10
20
32
20
32
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q3: ABC in Manufacturing Example
Alphabet Co. is implementing an ABC system. It estimated the costs
and activity levels for the upcoming year shown below.
First, compute the estimated overhead rate for each activity:
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q3: ABC in Manufacturing Example
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q3: ABC in Manufacturing Example
Alphabet recently completed a batch of 100 As and a batch of 100 Bs.
Direct material and labor costs were as budgeted. Information about each
batch’s use of the cost drivers is given below. Compute the overhead
allocated to each unit of A and B.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q3: ABC in Manufacturing Example
Compute the total cost of each product and compare it to the costs
computed under traditional costing.
Traditional costing
assigned $77 to a unit of
Product A and $62 to a
unit of Product B.
• The only difference between the two costing systems is that
Product A is assigned more overhead costs under ABC.
• The additional overhead assigned to Product A reflects Product
A’s consumption of resources.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q4: Activity-Based Management (ABM)
• ABM is the process of using ABC information to
evaluate opportunities for improvements in an
organization.
• Examples include managing & monitoring
• customer profitability
• product and process design
• environmental costs
• quality
• constrained resources
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q4: ABM & Customer Profitability
• Activities can be defined so that different costs of
servicing customers are accumulated.
• Examples include
• analyzing the types of bank transactions used
by various categories of customers
• comparing the costs of servicing insurance
contracts sold to married versus single
individuals
• comparing the costs of different distribution
channels
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: ABM & Product/Process Improvements
• Activities can be defined so that the costs of stages
of production or of a business process are
accumulated.
• Examples include
• determining the costs of non-value-added
activities so the most costly can be reduced or
eliminated
• changing the steps in the accounts payable
function to reduce the number of personnel
• determining the most costly stages of product
development so that the time to market is
reduced
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: ABM & Environmental Costs
• Activities can be defined so that types of
environmental costs are accumulated.
• Examples include
• capturing the costs of contingent liabilities for
waste disposal site remediation
• comparing the cost of recycling packaging to the
cost of disposal
• computing the costs of treating different kinds of
emissions
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q4: ABM & Quality Costs
• Activities can be defined so that categories of costs
of managing quality are accumulated.
• Common categories of quality costs are
• costs of prevention activities
• costs of appraisal activities
• costs of production activities
• costs of postsales activities
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q5: What are GPK and RCA?
• Costing approaches similar to ABC because they
involve multiple pools and multiple drivers
• GPK can be described as marginal planning and
cost accounting
– Each cost is traced to a cost center (smaller than a
department) which performs a single repetitive activity,
and is the responsibility of one manager)
– Output measures tracks the volume of resource use
– Costs are segregated into proportional (change with
volume in resource use) and fixed
– Practical capacity is used for estimated allocation rate
volumes
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q5: Capacity Definitions
• Theoretical capacity – maximum assuming
continuous, uninterrupted operations 365 days/year
• Practical capacity – typical operating conditions
• Budgeted capacity – expected volume for the
upcoming time period
• Idle/excess capacity – difference between activity
capacity used and one of the above measures of
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q5: What are GPK and RCA?
• Resource Consumption Accounting (RCA)
• Builds on GPK and ABC principles
• Each cost is assigned to a resource cost pool
– Labor and machinery are often placed in different cost
pools since they are different types of resources
– RCA involves a significantly larger number of cost pools
than traditional accounting
– Like GPK, segregates proportional and fixed costs
– Utilizes theoretical rather than practical capacity for
allocating fixed costs
• More likely to focus manager attention on reducing idle and nonproductive resource time
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q5: Benefits/Drawbacks to GPK/RCA
• Benefits
– Generates multi-level internal income statements useful
for short terms decisions because it focuses on marginal
cost
– Increases cause & effect awareness among managers
– Categorizes costs (and generates profit margin) at the
product, product group, division, and company level
– Avoids arbitrary allocations of fixed costs
• Drawbacks
– Can be costly to implement
– Can result in a large number of variances to analyze
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q5: Comparison of ABC, GPK, and RCA
ABC
GPK
RCA
Character of cost
accounting system
Full costing
Marginal costing
Full and marginal
costing
Location of data
Database separate
from general ledger
Comprehensive
accounting system
Comprehensive
accounting system
Primary decision
relevance
Mid- to long-term
Short-term
Short-, Mid-, and
Long term
Allocation of
overhead based on
Activities
Cost Centers
Resources and/or
activities
Cost Drivers
Activity –Based
Resource Output
related
Resource output or
activity related
Fixed cost
allocation rate
denominator
Actual, budgeted,
or practical
capacity
Budgeted or
practical capacity
Theoretical
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q6: Decision Making with ABC, GPK, and RCA
• Benefits
• more accurate and relevant product cost information
• employees focus attention on activities
• measurement of the costs of activities and business
processes
• identify non-value-added activities and reduce costs
• Costs
• systems can be difficult to design and maintain
• more information must be captured
• decision makers may not use the information
appropriately
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Uncertainties in ABC and ABM Implementation
• Judgment is required when determining
activities.
• Judgment is required when selecting cost
drivers.
• Denominator levels for cost drivers are
estimates.
• ABC information includes unitized fixed
costs, so decision makers must use ABC
information correctly.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 8
Measuring and Assigning Support
Department Costs
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 8: Measuring and Assigning Support
Department Costs
Learning objectives
•
•
•
•
•
•
•
Q1: What are support departments, and why are their costs
allocated to other departments?
Q2: What process is used to allocate support department costs?
Q3: How is the direct method used to allocate support costs to
operating departments?
Q4: How is the step-down method used to allocate support costs
to operating departments?
Q5: How is the reciprocal method used to allocate support costs to
operating departments?
Q6: What is the difference between single- and dual-rate
allocations?
Q7: How do support cost allocations affect decisions and
managerial incentives?
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Support versus Operating Departments
• The operating departments of an organization
produce products or services that generate
revenue.
• The support departments of an organization
produce products or provide services to the
operating and other support departments.
• The support department costs are common
costs that are shared between two or more
other departments.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Reasons for Allocating Support
Department Costs
• External reporting
• Motivation
• appropriate consumption of support
department resources
• efficiency of support department
• monitor consumption of support
department services
• Decision making
• product pricing
• make or buy decisions
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Support Department Allocation Process
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q2: Process for Allocating Support
Department Costs
1. Clarify allocation purpose
2. Identify cost pools
3. Assign costs to cost pools
4. Choose allocation bases for each cost pool
5. Choose allocation method; allocate support
department costs
6. Allocate updated operating department costs to
units of goods or services, if relevant
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q2: Process for Allocating Support
Department Costs
1. Clarify allocation purpose
•
if the purpose is to motivate the use of the services
of a newly formed department, perhaps no costs
should be allocated
•
if the purpose is to discourage operating department
managers from over-use of the services of support
departments, then a rate per unit of service might be
large and not based on actual costs
•
if the purpose is to determine the full cost of products
or services for long-term pricing decisions, then all
support costs should be allocated
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: Process for Allocating Support
Department Costs
2. Identify cost pools
• the purpose will determine whether both fixed
and variable support department costs
should be allocated
• the purpose will determine which costs
should be allocated
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: Process for Allocating Support
Department Costs
3. Assign costs to cost pools
• some costs will be direct to the cost pool (e.g.
toner cartridge costs would be direct to the
“variable copying costs” cost pool)
• some costs will be indirect to the cost pool (e.
g. rent costs for an entire facility would be
indirect to the “information technology costs”
cost pool)
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q2: Process for Allocating Support
Department Costs
4. Choose allocation bases for each cost pool
• an allocation base with a good cause-andeffect relationship with the cost pool provides
a reasonable allocation rate
• users of support department services will
carefully monitor their consumption of the
allocation base
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Process for Allocating Support
Department Costs
5. Choose allocation method and allocate support
department costs
• in this chapter we cover three allocation
methods
• each of these three methods could be
implemented using
• a single- or dual-rate approach (covered later)
• actual or budgeted costs and allocation bases
(covered later)
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Process for Allocating Support
Department Costs
6. Allocate updated operating department costs to
units of goods or services, if relevant
• for some decisions, this may not be relevant
• for long-term pricing decisions, this is likely to
be relevant
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 12
Q3: The Direct Method of Allocating
Support Department Costs
• The direct method ignores the fact that
support departments use each others’
services.
• Each support department’s costs are
allocated only to operating departments.
• This method is the easiest
computationally and the easiest to
explain.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q3: The Direct Method Example
Philco Toys makes metal and plastic toys in separate departments. It has
two support departments, Accounting and Information Systems. Philco has
decided to allocate Accounting department costs based on the number of
employees in each department and Information Systems costs based on
the number of computers in each department. Given the information below,
use the direct method to allocate support department costs.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q3: The Direct Method Example
Plastic Products is allocated 22/
(22+16) of Accounting
department costs, and Metal
Products is allocated 16/
(22+16). Notice that the number
of employees in the support
departments is ignored under
the direct method.
© John Wiley & Sons, 2011
Plastic and Metal Product share
Info Systems costs equally
because they have the same
number of computers in each
department. Notice that the
number of computers in the
support departments is ignored
under the direct method.
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q4: The Step-Down Method of Allocating
Support Department Costs
• The step-down method allocates some (but not all)
support department costs to other support
departments.
• The first support department’s costs are allocated
to all operating and support departments that use
its services.
• Each subsequent support department’s costs are
allocated to all operating and support departments
that use its services, except any support
department whose costs were already allocated.
• Allocation order must be determined.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q4: The Step-Down Method Example
Given the information for Philco, use the step-down method to allocate
support department costs. Allocate the costs of the support department that
provides the largest percentage of its services to the other support
department first.
First determine
allocation order:
Accounting provided 4/(4+22+16) = 4/42
= 9.5% of its services to Info Systems.
Information Systems provided 4/(4+3+3) = 4/10 = 40% of its
services to Accounting, so Information Systems goes first.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q4: The Step-Down Method Example
Given the information for Philco, use the step-down method to allocate
support department costs.
Now perform the allocation:
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: The Step-Down Method Example
Info Systems costs are allocated
to Accounting, Plastic, & Metal
based on each department’s
number of computers compared
to total non-Info Systems
computers: 4+3+3=10.
Accounting costs are allocated
only to Plastic & Metal based on
each department’s number of
employees compared to total
non-Accounting and non-Info
Systems employees: 22+16=38
Total costs allocated out of Accounting are now higher because of
the Info Systems costs allocated to Accounting.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: The Step-Down Method Example
(22/38) x $76,800
(4/10) x $72,000
© John Wiley & Sons, 2011
(16/38) x $76,800
(3/10) x $72,000
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
(3/10) x $72,000
Slide # 20
Q5: The Reciprocal Method of Allocating
Support Department Costs
• The reciprocal method allocates all support
department costs to other support
departments.
• The first step is to compute the total costs of
each support department when its usage of
other support department services is taken
into consideration.
• Support department costs are then allocated
to all other operating and support
departments that consume its services.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q5: The Reciprocal Method Example
Given the information for Philco, use the reciprocal method to allocate
support department costs.
First determine total costs for each support department by writing an equation for its
costs (use A and IS as abbreviations).
A = $48,000 + [4/(4+3+3)] x IS; IS = $72,000 + [4/(4+22+16)] x A
Then solve: A = $48,000 + (4/10) x [$72,000 + (4/42) x A]
A = $48,000 + $28,800 + (16/420) x A]
(404/420) x A = $76,800
A = $76,800 x (420/404) = $79,842
IS = $72,000 + (4/42) x $79,842 = $79,604
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q5: The Reciprocal Method Example
Given the information for Philco, use the reciprocal method to allocate
support department costs.
Now perform the allocation:
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q5: The Reciprocal Method Example
These numbers are the
solutions to the
simultaneous equations.
(4/42) x $79,842
(22/42) x $79,842
(16/42) x $79,842
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q5: The Reciprocal Method Example
(4/10) x $79,604
(3/10) x $79,604
(3/10) x $79,604
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q6: Single- versus Dual-Rate Allocation
• In single-rate allocation, each cost pool
includes fixed and variable costs.
• In dual-rate allocation, fixed and variable
costs are in separate cost pools.
• Both methods can be employed with the
direct, step-down, or reciprocal methods.
• The prior three examples used the singlerate allocation method.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q6: Single- versus Dual-Rate Example
Philco has decided to use the direct method and allocate variable
Accounting costs based on the number of transactions and fixed
Accounting costs based on the number of employees. The Info Systems
variable costs will be allocated based on the number of service requests
and fixed costs will be allocated based on the number of computers. The
required information is presented below.
Now perform the allocation…
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Single- versus Dual-Rate Example
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Q7: Decision Making with Support Costs
• Support costs need to be considered when
evaluating decisions such as make/buy, keep/drop,
special order, and constrained resource
• Necessary to isolate relevant support costs
– This may not be the same as the allocated support costs
– For example, outsourcing an operating department may
not result in a reduction in support department costs
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 29
Q7: Establishing Transfer Prices for
Support Departments
• Transfer prices should be set to motivate efficient
use of the support department resources
– If transfer price is set too high, user departments may
outsource the service
– If transfer price is set too low, user departments may
utilize the support department inefficiently
• The best transfer pricing approach is the
Opportunity Cost approach
– Each department is charged an amount that reflects the
value of any opportunities forgone by not using the
service for its next best alternative use.
– This is often difficult in practice so most companies use a
cost based or market based transfer pricing policy
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 30
Q7: Estimated versus Actual
Support Costs and Rates
A department’s allocation
of support department costs
=
the allocation
rate
x
the department’s
consumption
of the allocation base
Either of these could be estimated or actual.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 31
Q7: Estimated versus Actual
Support Costs and Rates
the allocation
rate
x
the department’s
consumption
of the allocation base
Using actual rates and actual consumption provides the
best measure of the cost of support services; it is the
most accurate but the least timely.
The purpose of the cost allocation will determine
whether actual or estimated rates, and actual or
estimated consumption, should be used.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 32
Q7: Estimated versus Actual
Support Costs and Rates
• Actual rates and consumption may be
required for some types of government
contracts.
• Most federal grants to educational institutions
allow the use of estimates.
• Using an actual rate means that support
service users are affected by
• inefficiencies of support department managers
• changes in the consumption of support services by other
users
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 33
Q7: Other Common Cost Allocation Methods
• Other cost allocation purposes may require the
allocation to
• be perceived as “fair”
• be based on the user’s “ability to bear” the cost
• Under the stand-alone method, a common cost is
allocated based on information about the users’
consumption of the cost.
• Under the incremental cost allocation method, a
“primary user” is allocated the bulk of the common
cost and the secondary user is allocated only the
increment in cost that it caused.
© John Wiley & Sons, 2011
Chapter 8: Measuring and Assigning Support Department Costs
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 34
Q7: Stand-Alone versus Incremental Cost
Allocation Methods Example
Leslie has a job interview with Big Co. next month in New York City. Her
plane ticket cost $300, and she will need to spend $125/night for 2 nights in
a hotel. She estimates that she will spend $50 in cab fares and $50 for
food. Big Co. has promised to reimburse her actual costs. After this trip
was arranged, Small Co., also located in New York City, called her for an
interview. If she interviews with Small Co. while she’s there, she will spend
an additional $125 for another night at a hotel, and another estimated $40
in cab fares and food. Think of at least two ways to allocate Leslie’s travel
costs using the stand-alone method. Discuss the merits of each.
1. Compute the total cost of the trip and divide it by 2, since
there are 2 interviews.
2. Compute the total cost of the trip and allocate 2/3 of it to
Big Co. and 1/3 to Small Co. sin...
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