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Flashcards in BEC 1 Operations management Deck (102):

Financial performance measures

1. Profit
2. Return on investment
3. Variance analysis
4. Balance scorecard


Nonfinancial measures

1. External benchmarking - Productivity measures
a. total productivity ratios
b. partial productivity ratios
2. Internal benchmarking - Techniques to find and analyze problems
a. Control charts
b. Pareto diagrams
c. Cause and effect Fishbone diagram


Characteristics of effective performance measures

- relate to the goals of the organization
- balance long and short term issues
- reflect mgt of key activities sometimes referred to as critical success factors in the balanced scorecard
- are under the control or influence of the employee
- are understood by employee
- are used to evaluate and reward the employee or influence behavior
- objective and easily measured
- used consistently


Marketing practices and methods

1. Transaction marketing
2. Interaction based relationship marketing
3. Database marketing
4. E-marketing
5. Network marketing - referrals



1. Marketing methods are aligned with products
2. Performance and performance incentives


Incentive compensation

1. Fixed salary
2. Bonuses - based on profit or stock performance
3. Other perks


Design choices for management compensation

1. Time horizon
2. Fixed and variable bonuses
3. Stock vs accounting based performance evaluation
4. Local vs company wide performance
5. Cooperative vs competitive incentive plans


Total productivity ratios

Total productivity ratios reflect the value of all output relative to the value of all input.


Partial productivity ratios

Partial productivity ratios reflect the value of all outputs as compared to the value of major categories of input.


Effective performance measure

- balances both long and short term issues
- relates to the goals of organization
- be objective and easily measured
- under the control of the employee
- understood by the employee


Cost objects

Cost objects are defined as resources or activities that serve as the basis for management decisions. They require separate cost measurement and may be products, product line, departments, geographic territories or any other classification that aids in decision making.


Focus of cost objectives

integration of product costing with cost control measurement and assignment objectives maximizes the effectiveness of management accounting systems. Cost measurement and assignment may focus on valuation of product or inventory or cost control.


Product costs

All costs related to the manufacturing of the product.
1. Inventory and cost of goods manufactured and sold
2. Components


Inventory and cost of goods manufactured and sold

Product costs are inventoriable and attached to units of output



Consist of direct materials, direct labor, and manufacturing overhead applied


Period costs

Expensed in the period in which they are incurred and are NOT inventoriable.
1. Expenses - selling and administrative expenses, interest expenses.
2. Components - selling the product and administering and managing the operations of the firm.


Manufacturing costs

Treated as product costs.
Include costs associated with the manufacture of a product:
- Inventory and cost of goods manufactured and sold
- components- direct and indirect costs


Nonmanufactuing costs

Treated as period costs.
Costs not related to the manufacturing of a product. These costs are expensed in the period incurred.


Costs accounting systems measure costs objects

1. Product costing - inventory and cost of goods manufactured and sold
2. Efficiency measurements - comparisons to standards
3. Income determination - profitability


Direct costs

A. Directs costs - easily traced to a cost pool or object
1. Direct raw materials = used in production + freight-in - discounts + scrap
2. Direct labor = used in production + service + expected "down town" (training, set up)


Indirect Cost

Incurred to benefit two or more cost pools or objects. The specific benefit each cost gives to the cost pool or object cant be determined without making some sort of reasonable estimate or suing an allocation methodology.
1. Indirect materials
2. Indirect labor
3. other indirect costs


Indirect materials

Not used specifically or could not be traced to the completed product with ease


Indirect labor

Not easily traceable to a specific product, service etc


Other indirect costs

indirect costs other than materials or labor


Prime cost

Direct cost + Direct material


Conversion cost

Direct labor + Manufacturing overhead


Overhead allocation using cost drivers

Indirect costs are allocated to benefiting cost pools or cost objectives using cost drivers that are considered to have a strong relationship to the incurrence of these costs.


Allocation bases

The cost drivers that are used to allocate indirect costs.


Accounting for overhead

When traditional costing is used, all indirect costs are allocated to a single cost pool called "overhead" and allocated as a single pool. Overhead may also be allocated using activity based costing.


Traditional costing

Step 1: Calculated overhead rate = budgeted overhead costs / Estimated cost driver
Step 2: Applied overhead = Actual cost driver x Overhead rate


Cost behavior

Fixed (indirect cost may be both) or variable (direct material and direct labor)


Variable cost

1. Behavior - a variable cost changes proportionally with the cost driver
2. Amount - constant per unit, total varies- variable costs change in total, but they remain constant per unit. As production volume increases or decreases the total variable cost will increase or decrease, but the variable cost per unit will always remain the same.
3. Long- run characteristics - the short run and long run impacts of variable costs are the same within relevant ranges.


Fixed cost

1. Behavior - in the short term and within a relevant range, a fixed cost does not change when the cost driver changes.
2. Amount - varies per unit, total remains constant- fixed costs remain constant in total but they vary per unit. As production volume increases or decreases, fixed costs remain the same, but the cost per unit will decrease or increase respectively.
3. Long run characteristics - given enough time, any cost can be considered variable.


Semi-variable costs

Mixed costs.
Costs contain both fixed and variable components. A cost that includes components that remain constant over the relevant range and includes components that fluctuate in direct relation to production are termed semi-variable.


Relevant range

The range for which the assumptions of the cost driver are valid. When the cost driver activity is no longer within the relevant range, the variable and fixed cost assumptions for that cost driver cant be used to allocate costs to cost objects.


Cost accumulation system

The manner in which the accounting system assigns costs to products. The system used is driven by the cost object involved. If the cost object is a custom order, job costing is used. If the cost object is a mass produced homogeneous product process costing is used.


Cost of goods manufactured and sold

Production costs may be summarized in the form of:
- "cost of goods manufactured statements" and
- a "cost of goods sold statement"
These statements may be prepared separately or combined as a "cost of goods manufactured and sold statements".
A. Cost of goods manufactured
B. Cost of goods sold


Cost of goods manufactured

manufacturing costs of the products completed during the period: direct material, direct labor and manufacturing overhead costs


Cost of goods sold

statement similar to retail statement, except cost of goods manufactured is used in place of purchases


Raw materials used
How to calculate Direct material used for a statement of Cost of goods manufactured

Beginning Raw Materials
+ Net purchases
Material available
- Ending Raw Material
Raw Materials used


Cost of goods manufactured

Work in process inventory BB
+ Direct material used
+ Direct labor
+ Manufacturing overhead applied
Total manufacturing costs incurred
Total manufacturing costs available
- Work in progress inventory
Cost of goods manufactured


Cost of Goods Sold

Finished goods inventory, BB
+ Cost of goods manufactured
Cost of goods available for sale
- Finished goods inventory, EB
Cost of goods sold


Job order costing

Method of product costing that identifies the job as the cost objective and is used when there are relatively few units pro ducted and then each unit is unique or easily identifiable.


Cost objective is the job or unit

Cost is allocated to a specific job as it moves through the manufacturing process. Record-keeping for job costing emphasizes the job as the cost objective.


Job cost records

Maintained for each product, service or batch of products, and they serve as the primary records used to accumulate all costs for the job. Job cost records accumulate data from the following docs:
1. Materials requisitions
2. Labor Time Tickets
3. Overview of job order costing


Manufacturing overhead

Debit balance
Actual costs incurred:
Indirect labor
Indirect materials
Depreciation on buildings and equipment
Taxes (payroll, property)
Fire insurance
Other indirect costs
Debit balance - underapplied overhead 

Credit balance
Overhead applied = Rate x actual hours or $
Credit balance - overapplied overhead
One way variance


Process costing

Process costing is a method of product costing that averages costs and applies the to a large number of homogeneous items.


Computation of how each segment of the process should compute cost of goods transferred out and the cost of goods remaining in work in process is the central product costing issue in process costing environments.

1. Summarize the flow of physical units (beginning with the production report)
2. Calculate "equivalent unit" output
3. Accumulate the total costs to be accounted for (Production Report)
4. Calculate the unit costs based on total costs and equivalent units.
5. Apply the average costs to the units completed and the units remaining in ending work in process inventory.


Units and costs collected on a Production Report.

Costs incurred for a period and all units produced during that period are accumulated on a production report that accounts for the physical flow of units.
The report includes:
- the beginning inventory,
- the number of units started,
- the number of units completed,
- the number of units remaining in inventory.


Unit (Quantity) Accounting

The number of units accounted for must equal the number of units charged to the department or separate process.


Cost accounting

The amount of costs accounted for must also equal the amount of costs charged to the department or separate process.


Inventory: Raw Material

Beginning inventory of raw materials
Add: Purchases of raw materials
Raw materials available for use
Subtract: Raw materials used
Ending inventory of raw materials


Inventory Work in Process

Beginning inventory of work in process
Add: Raw materials used plus direct labor and overhead used
Work in process inventory available to be finished
Subtract: Inventory transferred to finished goods
Ending inventory of work in process


Inventory Finished goods

Beginning inventory of finished goods
Add: Inventory transferred from work in process
Finished goods inventory available for sale
Subtract: Cost of goods sold
Ending inventory of finished goods


Equivalent units

Costs must be attached to the completed units as well as to the units that are partially complete at the end of each period.


Equivalent unit defined

An equivalent of direct material, direct labor or conversion costs (direct labor plus factory overhead) is equal to the amount of direct material, direct labor, or conversion costs necessary to complete one unit of production.


Process costing assumptions

a. Transfers in are 100% complete
b. Timing of addition of direct material
- addition at the beginning or during a process
- addition at the end of a process


Costing issues

Calculations of average units costs
- averaging of costs from prior months's WIP
- cost flow assumptions - cost averaging computations depend on FIFO and/or weighted average cost flow assumptions.


Specific Cost Flow Assumptions FIFO

Calculation using FIFO
a. Equivalent unit components
- completion of units on hand at the beginning of the period
- units started and completed during the period
- units partially complete at the end of the period
b. Cost components - current costs incurred during the period are allocated to the equivalent units produced during the period.


Specific Cost Flow Assumptions Weighted Average

Calculation using Weighted Average
a. Equivalent unit components
- units completed during the month
- units partially complete at the end of the period
b. Cost components - total costs include both the costs of beginning inventory and current costs are allocated to equivalent units to arrive at a weighted average unit cost.


Comparison of FIFO and Weighted average

a. Unit components
-FIFO - equivalent unit calculation under FIFO consists of 3 elements representing curent period production,
- Weighted average - the calculation under the weighted- average method consists of 2 elements that embrace units completed and are available in beginning inventory.
b. Cost components
- FIFO - costs incurred in the current period
- WA - curent period units + prior period units


Equivalent units WA

Weighted average
1. Units completed
2. Ending WIP x % completed
= Equivalent units


Equivalent units FIFO

1. Beginning WIP x % to be completed
2. Units completed - Beginning WIP
3. Ending WIP x % completed
= Equivalent units


Cost per equivalent unit is computed:

1. Weighted average = (Beginning cost + Current cost) / Equivalent units
2. FIFO = Current cost only / Equivalent units


Spoilage or shrinkage

Spoilage or shrinkage is usually taken care of because the equivalent units added for the month are generally less than the actual units added during the month due to problems with the production process.


Normal spoilage

Happens under regular operating conditions and is included in the standard cost of the manufactured product.
a. Computation - for normal spoilage or shrinkage per unit cost is automatically increased as a result of spoilage because actual costs are spread over fewer equivalent good units rather than actual units produced.
b. Accounting treatment - normal spoilage is capitalized as part of inventory cost. Normal spoilage costs, if accounted for separately, are allocated to good units produced.


Abnormal spoilage

Period expense.
Should occur under normal operating conditions and is not included in the standard cost of a manufactured product.
a. Computation - for abnormal spoilage, the unit cost is based on actual units. Equivalent units of production include spoiled units.
b. Accounting treatment - the cost of abnormal spoilage is normally expensed separately on the income statement as a period expense. Abnormal spoilage is charged against income of the period as a separate component of cost of goods sold.


Activity based costing
Types of operational cost drivers

1. Volume based
2. Activity based


Volume based cost drivers

Traditional costing systems assign overhead as a single cost pool with a single plant-wide overhead application rate using a single allocation base.
These rates use volume-based cost drivers like direct labor hours or machine hours. Assigning overhead costs based on volume can distort the amount of costs assigned to various product lines since all overhead costs do not fluctuate with volume.


Activity based cost drivers

Activity based costing refines traditional costing methods and assumes that the resource-consuming activities with specific purposes causes costs. ABC assumes that the best way to assign indirect costs to products is based on the product's demand for resource-consuming activities. Application of activity based costing techniques attempts to improve cost allocation by emphasizing long-term product analysis.



- any work performed inside a firm
- identified for ABC



an element that is used to perform an activity


Cost drivers

activity bases that are closely correlated with the incurrence of manufacturing overhead costs in an activity center, and they are often used as allocation bases for applying overhead costs to cot objects.


Resource cost driver

the amount of resources that will be used by an activity


Activity cost driver

the amount of activity that a cost object will use, and it is used to assign the costs to the cost objects


Activity centers

an operation necessary to produce a product


Cost pool

a group of costs or a specially identified cost center in which costs are grouped, assigned or collected


Characteristics of ABC

- applies a more focused and detailed approach that using a department or plant as the level for gathering costs
- focuses on multiple causes and effects and then assigns costs to them
- the cost of activities is used to build up the engineered cost of products using increased cost pools and allocations
- ABC can be part of a job order system or a process cost system
- ABC can be used for manufacturing or service businesses
- takes a long term viewpoint and treats production costs as variable
- the cost driver is often a nonfinancial variable
- may be used for internal but not for external purposes


Transaction-based costing

Activity based costing ABC is also called "transaction based costing". The cost driver is the number of transactions involved in a particular activity.


Focuses on Cost/Benefit of Activities

ABC focuses management on the cost/benefit actives. Value added activities increase the product value or service.
a. Value chain - value added activities - a series of activities in which customer usefulness is added to the product. Support activities directly support value added activities.
b. Non-value added activities - do not increase product value or service and are targeted for elimination.


Basic operation of activity based costing

1. Analysis of cost drivers
2. Accumulate the costs in cost pools
3. Trace indirect costs to activity centers
4. Allocate remaining indirect cost pools
5. Divide assigned costs by level of activity for the cost center
6. Cost the Product


Effects of Activity based costing

An ABC system will apply high amounts of overhead to a product that places high demands on expensive resources.
If a product places few demands on expensive resources, the system will assign little of that cost to the product. This will remove much of the cost distortion caused by traditional, volume-based overhead system.


ABC and standard cost systems

a natural extension of activity based costing. Standards are set at activity levels based on cost drivers. Useful variances are calculated by comparing actual and standard costs that consider levels of activity. These variances can be due to price, usage etc.
1. Normal and abnormal scrap or spoilage is estimated for activity levels.
2. Standards may be difficult to set on a per unit basis.
a. per unit costs are often inversely proportionate to volume
b. assumption of a relevant range may be necessary to set a per unit standard


Traditional cost accounting system for the application of overhead to the products.

1. Total overhead for activity center / Total direct labor hours = overhead application rate
2. Overhead application rate x direct labor hours for each segment


The overhead application rate under an activity-based costing system using each activity as a cost pool

1. Each activity center overhead is divided by total amount of activity level
2. Each activity level is multiplied by results from #1


Joint product costing and by product costing

Allocating the cost of a single process among several final products if two or more final products are produced from the same raw material or input.


Common (joint) costs

relate to more than one product and cant be separately identified. Common costs must be allocated



minor products of relatively small value that incidentally result from the manufacture of the main product


Split off point

the point in the production process where the joint products can be recognized as individual products.


Joint product costs

costs incurred in producing products up to the split off point.


Separable costs

costs incurred on a product after the split off point


Joint products

outputs of significant value that are the object of a manufacturing process. Cost drivers in the manufacturing process cant be distinguished for each product, so common costs must be allocated by some arbitrary means


Relative Net Realizable Values at Split off Point

Net realizable value = sales value - cost of completion and disposal
Relative sales value at split off point is used purely for inventory costing and is of little use for cost planning and control purposes


Sales price quotations available at split off

The relative sales value at split off point can be used to allocate joint costs if sales price quotations are known or can be determined. The relative sales value approach assigns costs to the separate joint products in relation to their market values


Sales values not available at split off

1. Work backwards and estimate net realizable values at the split off point
2. Separable costs - identifiable costs incurred after the split off point (separable costs) must be subtracted from the final selling price to arrive at the net realizable value at split off.


By products

- minor value
- low sale values
- revenue accounting can take one of common costs:
Applied to main product - reduction of common costs for joint product costing
Misc income - credit to misc income


Mixed costs

both fixed and variable


Carrying costs

costs of carrying inventory


Sunk costs

past and unavoidable costs


Committed costs

future and unavoidable costs


Net sales value at split off

Sales price less cost to complete


Changing the accounting from by product to joint product

- changes the computation of gross margin,
- by product method - selling expense is netted against the selling price to arrive at the deduction from cost of goods sold
- joint product method - the selling cost is a selling expense, which is not included in calculating of gross margin. Selling expenses are deducted from gross margin to arrive at net income