C. Cost Management Flashcards
(37 cards)
Topic 1 - Measurement Concepts
What is the “relevant range” in terms of cost behavior and cost objects?
The range in which fixed costs and variable costs are defined and constrained. FC and VC are defined with respect to cost drivers for a specific duration of time. Change any quantity by a large enough degree and the fixed costs will no longer remain fixed (ex. If “Q = 0”, all FC will end as well as the product. FC will change when “Q” goes above certain levels because new factories may need to be produced, etc.)
Topic 1 - Measurement Concepts
What is a “variable cost”?
Includes changes in total for a cost object in proportion to each change in the quantity of a cost driver over a relevant range.
VC on a per unit basis will remain constant over a relevant range.
Examples: Direct material, direct labor
Topic 1 - Measurement Concepts
What is a “fixed cost”? What is the difference between “discretionary” and “committed” fixed costs?
The portion of total costs that do not change when the quantity of a cost driver changes over a relevant range and duration.
Fixed costs on a per unit basis will decline as quantities increase.
Can be further classified into:
(1) Discretionary costs (aka “managed” or “budgeted” fixed costs): can be included/excluded from budget at the discretion of management (ex. advertising, training, internships, etc)
(2) Committed costs: costs that CANNOT be omitted due to strategic or operational properties in the short run (ex. depreciation on equipment previously purchased). Tend be facilities related.
Topic 1 - Measurement Concepts
What are “step costs”?
Fixed costs with VERY NARROW relevant ranges. Tend to be considered fixed costs in the short-run, but variable costs over the long-run.
Can be “step fixed” or “step variable”.
(a) Step-fixed: Increase in equal-size chunks over an equal number of cost drivers (ex. plant OH increasing by $100K for each plant added)
(b) Step-variable: Go up to a higher constant cost in either increasingly larger/smaller amounts of a cost driver (ex. if one worker can produce 0.5 units, then two workers can produce 1.0 units, and so forth)
Topic 1 - Measurement Concepts
What are “mixed costs”?
The sum of all fixed costs and variable costs.
Mixed Costs = FC + VC
Topic 1 - Measurement Concepts
What is “capacity” in terms of cost type relationships? What is the difference between “practical” and “theoretical” capacity?
Measures the constraints or bottlenecks keeping a system from expanding in output or some other measure. (ex. Manufacturing capacity can be increased by adding additional plants, employees, or equipment)
Relates to relevant range because capacities tend to be reached at the upper limit of a relevant range.
“Practical” capacity = the highest output level of a resource such as a plant can achieve without increasing its costs due to bottlenecks
“Theoretical capacity” = the upper limit on output assuming that nothing goes wrong, everything operates at full speed, and no holidays or other scheduling conflicts are included; the ideal state
Topic 1 - Measurement Concepts
Name and briefly describe the four (4) types of cost drivers.
- Activity-based cost drivers: focus on operations that involve manufacturing or service activities (ex. machine setup, etc)
- Volume-based cost drivers: focus on output, which involves aggregate measures (ex. units produced, labor hours)
- Structural cost drivers: focus on company strategy, which involves long-term plans for scale, complexity, amount of experience in an area, or level of technical expertise.
- Executional cost drivers: focus on short-term operations, which involve reducing costs through concern with workforce commitment and involvement, production design, and supplier relationships
Topic 1 - Measurement Concepts
What are “activity-based” cost drivers? What is a benefit of using activity based cost drivers?
Developed by analyzing and detailing the different activities within the firm, which form the basis for the activity-based cost driver. The descriptions are then broken down into steps and each step in the description becomes different cost drivers. Intent is to determine how changing the steps will change the overall cost of the operation. The cost of each step or activity can also be determined. This detailed breakdown can help firms determine which activities add value for customers and which do not. Furthermore, when an activity costs more than it’s expected, activity-based cost drivers will highlight this discrepancy.
Benefits:
Can help firms determine which activities add value for customers and which do not. Furthermore, when an activity costs more than its expected to cost, an activity-based cost driver will highlight this discrepancy.
Ex. (Activity / Cost Driver)
- Accepting Cash / Number of Cash Transactions
- Processing a Credit Card / Number of Credit Transactions
- Training / Number of Stores
- Maintenance of Computer Equipment / Number of Computer Terminals
Topic 1 - Measurement Concepts
What are “volume-based” cost drivers? Describe the cost behavior of volume-based cost drivers along/within the relevant range?
Aggregations of activities based on volume of use. DM and DL cost drivers are inherently volume-based.
Cost Behavior: When volume-based cost drivers are very low, factors such as learning curves and efficient use of resources will cause costs to increase more slowly as production numbers increase (called the “increasing marginal productivity”). At a certain level this behavior will level-off, and a rise in production volume will have a proportional rise in cost within the relevant range, until a certain point at which the capacity of the persons or equipment will reach the limit. As the volume increases toward the limit, the costs will rise dramatically because of increased needs for repairs, more overtime, and other similar factors. This is called the “law of diminishing marginal capacity”. This is why the relevant range is an important element of cost drivers.
Topic 1 - Measurement Concepts
What are “structural” cost drivers? What are the four (4) types of structural cost drivers?
Long-term cost drivers based on the overall strategy of the company.
Four types:
(1) Scale - the scale of a project or speed at which a company grows will affect all of the costs of the company overall
(2) Experience level - the strategic level of a company for a particular strategic initiative will affect the overall cost of achieving that goal
(3) Technology - changing the level of technology for a process can make that process more efficient and therefore less costly
(4) Complexity - the more complex a firm becomes (more products, more hierarchy, etc) the more it costs to sustain that complexity
Topic 1 - Measurement Concepts
What are “executional” cost drivers?
The short-term decisions that can be made to reduce operational costs.
Three types:
(1) Workforce involvement - the greater the commitment of the workforce, the lower the labor costs will be in proportion to the amount of work that gets done
(2) Production process design - production costs can be reduced by analyzing and redesigning production processes and incorporating software applications to streamline workflow
(3) Supplier relationships - close relationships with suppliers can reduce overall costs, especially inventory costs (electronic data interchanges allow suppliers to see the firm’s inventory levels and ship inventory as needed, which increases efficiency)
Topic 1 - Measurement Concepts
What is “actual”, “normal”, and “standard” costing?
Types of cost allocation methods. Terms “actual” and “normal” refer to means of applying/allocating overhead costs to cost objects. All three are types of job order costing in which costs are accumulated in inventory accounts (ex. WIP or Finished Goods) and recorded on the income statement as COGS.
Actual Costing: Uses actual cost amounts for DL, DM, and OH
Normal Costing: Uses actual cost amounts for DL and DM, but uses a predetermined overhead rate for OH.
Standard Costing: Uses a predetermined standard (aka “should”) cost for DL, DM, and OH.
Topic 1 - Measurement Concepts
What is “actual costing” in terms of what is used for DM, DL, and OH (actual vs. predetermined rate allocation)? What are its benefits/limitations?
Uses actual costs incurred for ALL costs (i.e. DM, DL, and OH).
Costs can only be determined by waiting until the end of the accounting period.
Benefits: More accurate than other costing systems.
Cons: Delay in information because must wait until all invoices are received, which may not occur until the end of the fiscal year or later
Topic 1 - Measurement Concepts
What is “normal costing” and how are DM, DL, and OH determined (actual vs. allocated amount)? What is its benefit in relation to “actual costing”?
Applies actual costs for direct materials and direct labor for a job, but uses a predetermined OH rate to assign to the cost object.
Allows current calculation of product costs.
Steps for determining the predetermined OH factory rate:
(1) Create a budget for overhead costs
(2) Chose the cost drivers (usually activity or volume) for charging overhead
(3) Estimate the total annual amount/volume of the selected cost driver for the total OH cost pools or each cost pool
(4) Divide the budgeted factory OH costs by the estimated cost driver activity level
Formula:
Predetermined Factory OH Rate = (Budgeted Factory OH Costs / Est. Cost Driver Activity Level)
Topic 1 - Measurement Concepts
What is “standard costing” and what figures of DM, DL, and OH are used to allocate costs to cost objects (actual vs. predetermined rate)? What are the two parts of a standard cost?
Applies all product costs (DM, DL, and OH) using a predetermined (standard) rate. Standard costs are expected / targeted costs for an operation. They are designed to point out where variances occur so that the company can achieve a better operating result.
Two Parts of a Standard Cost:
(1) Standard # of units of a cost driver adjusted for actual unit production (ex. labor hours divided by units produced, such as 40,000 labor hours divided by 80,000 units produced = 0.5 labor hours per unit)
(2) Standard rate per unit of the cost driver (ex. $20 per labor hour)
Knowing these two parts allows one to calculate the standard cost of DM and DL. They can then be compared to actual DM and DL for analysis purposes. (ex. In an actual month with the same 80,000 units produced, actual labor hours totaled 42,000 at an actual rate of $18 per hour). These differences lead to budget variances.
Advantages:
- Less likely to incorporate past inefficiencies
- Can be adapted as new data to indicate expected changes during the budget period
Disadvantages:
- Unreasonable standards can potentially be set
Topic 1 - Measurement Concepts
Describe “absorption” (aka “full”) costing and “variable” (aka “direct”) costing.
Types of inventory costing systems. Both systems expense all nonmanufacturing costs (variable and fixed) in the period in which they occur. The two methods only differ in how they account for fixed manufacturing costs (Absorption costing includes fixed manufacturing costs; variable costing excludes it).
Absorption (full) costing (REQUIRED for external reporting):
- Inventory costing system that includes both variable and fixed manufacturing costs. Inventory absorbs all costs of manufacturing (PRIMARY DIFFERERENCE)
- Income statement prepared using the “gross margin” format, which highlights the difference between manufacturing and nonmanufacturing costs
Variable (direct) costing:
- Inventory costing system that includes only variable manufacturing costs. Fixed manufacturing costs are expensed in the period during which they were incurred. (PRIMARY DIFFERENCE)
- Income statement prepared using “contribution margin” approach, which highlights differences between fixed and variable costs
Topic 1 - Measurement Concepts
What are “joint products” and “by-products” from a costing system standpoint? What is the “split-off” point? How are costs allocated to joint products in relation to the split-off point and cost amounts used?
“Joint products”:
- Products that share a portion of the production process and have relatively the same sales values (ex. The oil industry uses joint products. Crude oil is refined into joint products such as diesel, gasoline, motor oil, and plastic).
“By-products”:
- Products that share the same production process with a product or joint product but have relatively minor value in comparison to the main product (ex. Lumber mills may have finished boards and the sawdust–a by-product–is used in other products).
Split-off Point: Point at which products diverge and become separately identifiable. This isn’t necessarily the point in which products become finished goods.
Costing for “Joint” and “By”-Products:
- Includes all manufacturing costs incurred before and after the split-off point.
- **For financial reporting purposes, joint costs incurred prior to the split-off point are allocated among the joint products.
Two Basis Approaches for Allocating Joint Costs to Joint Products:
(1) Using Market Data (ex. sales value at split-off point, gross profit method, NRV method)
(2) Using Physical Measures Data
Topic 1 - Measurement Concepts
What are the three (3) “market-based approaches” for allocating joint costs to joint products?
Includes three methods of allocating costs:
(1) Sales value at split-off method
- Widely used because its simple
- Can only be used when the sales values are available at split-off
- Allocates joint costs to joint products using their proportional sales value at the split-off point
(2) Gross profit method
- Allocates joint costs so as to provide the same gross margin percentage of profit for each product
(3) NRV Method
- Used when the market price for one or more of the joint products is unknown at the split-off point; usually because additional processes are needed
- Formula: NRV = Final Sales Value - Additional Processing Costs
- Allocate using ratios of newly determined values at split-off
Topic 1 - Measurement Concepts
What is the “physical measures method” for allocating joint costs to joint products?
Uses a physical measurement to allocate joint costs to joint products. Physical measures include weight, number, and volume. Measures can be input or output measures.
Steps:
(1) Calculate Avg. Cost per Unit = (Total Joint Costs / Total Lbs.)
(2) Multiply the avg. cost per unit by the total number of units to determine the amount to allocate to each joint product
Topic 2 - Costing Systems
From beginning to end, describe how costs flow in a manufacturing organization?
Certain inputs are fed into the cost of the product to determine the product’s total cost.
Cost Flow Diagram:
[DM + DL + OH] > WIP Inventory > Finished Goods Inventory > COGS
Topic 2 - Costing Systems
What are “job order costing” and “process costing” systems? Please provide brief definitions of both systems.
Two types of costing systems that companies typically use to assign costs to products / services.
Job Order Costing:
- Assigns costs to a specific job (a distinct unit, batch, or lot of a product or service)
- Used when the product/service has costs that can be, and often need to be, tracked and assigned to a specific job or service (ex. Construction of buildings or ships, advertising campaigns, research and development, etc)
- Costs are accumulated by job, not department
Process Costing:
- Accumulates product or service costs by process or department and then assigns them to a large number of nearly identical products by dividing the total costs by the total number of units produced
- Used for multiple, nearly identical units that can be organized into a flow (ex. newspapers, books, soft drinks, check processing, postal delivery, magazine subscription receipts)
- Products tend to be homogenous in nature and therefore it is not necessary to track costs to specific unit of product/service
- Costs are accumulated by department, not job
Both “job costing” and “process costing” utilize the same DM, DL, OH, WIP, Finished Goods, and COGS accounts.
Topic 2 - Costing Systems
What are the six (6) basic steps in assigning costs to a job when using a “job costing” system?
(1) ID the job with a unique reference
(2) Trace the direct costs for the job (DM, DL)
(3) ID indirect cost pools associated with the job (OH)
(4) Select the cost allocation base (cost driver) to be used in allocating indirect cost pools to the job
(5) Calculate the target rate per unit of each cost allocation base. Actual Indirect Cost Rate = [Actual Total Cost in Indirect Cost Pool / Actual Total Quantity of Cost Driver]
(6) Assign cost to the cost object by adding up all the direct (DL and DM) and indirect costs (OH)
Topic 2 - Costing Systems
What is “spoilage”, “rework”, and “scrap”? How are they treated in “job order” costing systems?
Spoilage - UNACCEPTABLE & SOLD FOR DISPOSAL VALUE
- Definition: Any material/good that is considered unacceptable and is discarded or sold for its disposal value
- “Normal” = Any spoilage is any unit of production that is deemed unacceptable during the normal production process, assuming efficient operations. Considered part of the cost of operations and therefore is included in COGS. Can be a direct cost to a job reduced by any salvage value or an indirect cost to production in general (allocated to factory OH)
- “Abnormal” = Any unacceptable product that should not normally exist under efficient and normal operating conditions. Any spoilage over the amount considered “normal” is allocated to a loss from abnormal spoilage account
- “Total Spoilage” = Beginning Inventory + Units Started - Units Completed and Transferred Out - Ending Inventory
Rework - REQUIRES ADDITIONAL WORK
- Any finished product that must have additional work performed on it before it can be sold
- Three types: (a) Normal defective units for a specific job. Charged to specific job’s WIP account, which increases costs and reduces profits; (b) Normal defective units common for all jobs. Charged to factory OH; (c) Abnormal defective units. Charged to “loss from abnormal rework account”
Scrap - NO ECONOMIC VALUE
- A portion of a product or leftover material that has no economic value.
- Can be categorized as related to a specific job (charged to specific job’s WIP account) or is common to all jobs (charged to factory OH)
- If sold, the aforementioned accounts will be credited
Topic 2 - Costing Systems
What is “process costing”? What are “equivalent units” and how do you calculate them? Describe the process costing flow.
Recommended for companies with large mass production processes or nearly identical products. Such companies track their quantities and costs on a departmental production cost report and calculate the unit cost at the end of the period by dividing the total cost of an operation or department by the total units produced
Equivalent Units in Process Costing:
- Unlike job order costs, which automatically assigns costs to partially completed units, process costing cannot easily determine values for partially completed units because the accounting highlights costs for processes/departments rather than specific jobs.
- Process costing must find the combined cost for all units, including all partially complete at the beginning and end of the accounting period (i.e. items still in WIP)
- Product costs are calculated by determining the cost per unit in each department and therefore partially completed units must be factored into these calculations
- Process costing accounts for any WIP as “equivalent units”
- “Equivalent unit” = measure of the amount of work done on partially completed units expressed in terms of how many complete units could be have been created with the same amount of work
- Completed separately for DL, DM, and OH
- “Beginning Inventory” was accounted for in the last period. Therefore, the reciprocal of “beginning inventory” needs to be accounted for in this period (ex. if beg. inventory is 30% complete then the remaining 70% complete used to calculate EUs)
EUs = [Beg Inv Units x (100% - % Complete Beg Inv)] + Units Started and Completed During the Period + EUs in Ending WIP
“Conversion Costs”:
- Equals the sum of DL and OH
- Some companies combine DL and OH when DL is not a significant portion of the costs due to the highly automated process
Process Costing Flow:
- Costs flow through processes and departments
- Departments must have their own WIP accounts
- When departments complete their portion of work on a product, all of the costs are transferred to the next department’s WIP by debiting a “transferred-in costs” account on the next department’s books
