Chapter 1 Info Systems and Relevant info in Management Decision Making

Transcription

1 Chapter 1 Info Systems and Relevant info in Management Decision Making Cost accounting: involves the process of tracking, recording, analyzing and determining the cost of an organization s project, process or activity - Helps managers understand the costs of operating a business so that they can use the info to make sound business decisions, mainly to reduce the company s costs and to improve its profitability and productivity Management accounting: the process of gathering, summarizing, and reporting financial and nonfinancial info used internally by managers to make decisions - Since the info is mainly for internal users, it doesn t follow IFRS or ASPE - Helps managers plan, control, and measure performance - Future oriented and concerned with reporting on a segment of an organization Financial accounting: the process of preparing and reporting financial info that is used most frequently by decision makers outside the organization, such as shareholders and creditors - Since the info is for external users, must follower IFRS or ASPE Relevant info: helps decision makers evaluate and choose among alternative courses of action concerns the future and varies with the action taken Irrelevant info: doesn t vary with the action taken and isn t useful for decision making Relevant cash flows are incremental cash flows: they occur under one course of action or decision alternatives but not under another - Also called avoidable cash flows b/c they are avoided if the course of action or decision alternative is not taken Irrelevant cash flows are unavoidable cash flows: occur regardless of which course of action or decision alternative is chosen - They are irrelevant b/c they don t help managers choose among alternatives Product costs: the total manufacturing costs of units that are sold during the period usually called costs of goods sold - Example: direct materials, direct labour, manufacturing overhead Period costs: other operating costs like marketing, advertising, and administration Biases: systematic distortions in judgment 1) Information bias: errors in judgement caused by data that are consistently overestimated, underestimated, or misrepresented 2) Cognitive bias: errors in judgement caused by the way people s minds process info 3) Predisposition bias: errors in judgement caused by preferences, attitudes, or emotions that prevent objective analysis

2 Chapter 2: Cost Concepts, Behaviour, and Estimation Costs are classified by: Relevance relevant cost vs. irrelevant cost Behaviour fixed cost vs. variable cost Traceability direct cost vs. indirect cost Function manufacturing cost (product cost) vs. nonmanufacturing cost (period cost) Controllability controllable cost vs. uncontrollable cost Relevant revenues and costs: the revenues and costs that differentiate between alternatives that will occur in the future - Opportunity cost is a relevant cost b/c it s the potential benefit given up by not taking one alternative over another o It s the benefits we forgo when we choose one alternative over the next best alternative Irrelevant revenues and costs: don t make a difference to either alternative, and have no bearing on the decision - Sunk cost is an irrelevant cost b/c the cost had already been incurred and can t now be avoided o They are expenditures made in the past Fixed cost: the total cost won t chance within a certain range of activity the relevant range Variable cost: varies in proportion to the production level Mixed costs: partly fixed and partly variable Cost object: a thing or activity for which we measure costs - Include things such as individual products, product lines, projects, customers, departments, and the entire company Direct cost: a cost that can be directly traced to a cost object and is incurred for the benefit of a particular cost object - A clear cause-and-effect relationship generally exists between the cost object and the cost Indirect cost: incurred for the benefit of more than one cost object and can t be easily and economically traced to a particular cost object - Relate to multiple products or services Manufacturing costs: direct materials, direct labour, manufacturing overhead costs - Prime costs: direct materials and direct labour - Conversion costs: direct labour and manufacturing overhead Relevant range: a span of activity for a given cost object, where total fixed costs remain constant and variable costs per unit of activity remain constant

3 Marginal cost: the incremental cost of an activity, such as producing a unit of goods or services - Within the relevant range, variable costs approximates marginal cost, so variable cost is usually a measure of marginal cost - Marginal cost is often relevant in decision making Cost behaviour: the variation in costs relative to the variation in an organization s activities such as production, merchandise sales, and services Cost function: an algebraic representation of the total cost of a cost object over a relevant range of activity - We assume that within a relevant range of activity, the total fixed costs remain fixed and the variable cost per unit remains constant TC = VQ + FC - Piecewise linear cost function: when the slope of a variable function changes at some point but remains linear after the change, - Stepwise linear cost function: when a fixed cost function changes at some point but remains constant after the change Cost driver: some input or activity that causes changes in total cost for a cost object Discretionary costs: reflect periodic (usually annual) decisions about the maximum amount that will be spent on costs for activities such as advertising, executive travel, or research and development - They are managed FC or managed VC, b/c managers decide the amount to spend on them Two-point method: uses any two sets of data points for cost and a cost drive to calculate a mixed cost function Change in cost driver / change in the cost driver $ / units = VC - After finding VC, find FC by using any point and then create the cost function TC = V(Q) + F High-low method: uses the highest and lowest data points of the cost driver Regression: - Regression analysis provides the best estimate of the cost function in cases with a strong positive linear relationship between the cost and the cost driver - R squared reflects an estimate of the percentage of variation in the cost that is explained by the cost driver

4 Chapter 3: Cost-Volume-Profit (CVP) Analysis Cost-volume profit (CVP) analysis: a technique that examines changes in profits in response to changes in sales volumes, costs, and prices - Often perform CVP analysis to plan future levels of operating activity and provide info about: o Which products/services to emphasize o The volume of sales needed to achieve a targeted level of profit o The amount of revenue required to avoid losses o Whether to increase fixed costs o How much to budget for discretionary expenditures o Whether fixed costs expose the organization to an unacceptable level of risk Profit = Total Revenue Total Costs Profit = Total Revenue Total Variable Costs Total Fixed Costs Contribution margin: the total revenue the total variable costs Contribution margin per unit: the selling price per unit the variable cost per unit - Tells us how much revenue from each unit sold can be applied toward fixed costs or contributed over to them - Once enough units have been sold to cover all fixed costs, the CM per unit from all remaining sales becomes profit EBT = SQ VQ FC Solving for Q: F + EBT = quantity (units) required to obtain target profit (S-VC) Contribution Margin Ratio (CMR): the % by which the selling price (or revenue) per unit exceeds the variable cost per unit CMR = CM SP To get CVP in terms of total revenue instead of units, we use CMR instead of CM Sales Revenue = F + EBT CMR Breakeven Point: where revenues cover all fixed and variable costs, resulting in zero profit - The CM is the same as FC, which leaves no profit - Sales Revenue = F + EBT CMR or CM A CVP Graph: shows the relationship between total revenues and total costs, it illustrates how an organization s profits are expected to change under different volumes of activity

5 CVP with Income Taxes EAT = EBT x (1 Tax Rate) To know the pre-tax earnings needed to achieve a target level of after-tax earnings: EBT = EAT (1- Tax) CVP with Variable Amount of Earning - Managers may want to set an earning amount as a variable amount of sales - Before-tax earnings of % of sales o EBT = SQ VQ FC = x%s - After-tax earnings of % of sales o EBT = EAT / (1-Tax) X%S = y%s / (1-Tax) EBT (S) = SQ Sales Mix: the proportion of different products or services that an organization sells. - When performing CVP computations for sales mix, assume that the products a company sells are in a constant ratio - Sales Revenue = FC / CM = composite units - To determine the number of units to be sold to BE, multiply the number of composite units by the sales mix Planning, Monitoring and Motivating with CVP - CVP analyses are useful for planning and monitoring operations and for motivating employee performance - Results can be compared to identify differences in revenue levels and cost functions - When the owner analyzes the reasons for differences in profitability, emphasis can be placed on increasing revenues, reducing costs, or both - The owner can also hold managers accountable for performance, which should motivate their work efforts toward the owner s goals Assumptions and Limitations of CVP pg. 109 CVP for Not-for-Profit Organizations - Not-for-profit organizations often receive grants and donations and are usually offset against FC - They may be included in revenues or subtracted from VC - The treatment depends on the nature of the grant or donation

6 Margin of Safety: the excess of an organization s expected future sales (in either revenue or units) above the breakeven point - It indicates the amount by which sales could drop before profits reach the breakeven point - MOS (#) = Actual or estimated units of activity units at breakeven point - MOS ($) = Actual or estimated revenue revenue at breakeven point - To evaluate future risk when planning, use estimated sales - To evaluate actual risk when monitoring operations, use actual sales - If MOS is small, managers may put more emphasis on reducing costs and increasing sales to avoid potential losses - Larger MOS gives managers greater confidence in making plans such as incurring additional fixed costs - Margin of safety %: indicates the extent to which sales can decline before profits become zero o MOS% (#) = MOS in units / Actual or estimated units o MOS% ($) = MOS in revenue / Actual or estimated revenue Degree of operating leverage: the extent to which the cost function is made up of fixed costs - Organizations with high operating leverage incur more risk of loss when sales decline - When operating leverage is high, an increase in sales (After fixed costs are covered) quickly contributes to profit - DOL in terms of CM = CM / EBT - DOL in terms of FC = F/EBT Managers use DOL to gauge the risk associated with their cost function and to explicitly calculate the sensitivity of profits to changes in sales (units or revenues): o % Change in profit = % change in sales x DOL - DOL and MOS are reciprocals o MOS % = 1/DOL o DOL = 1/MOS% o If MOS% is small then DOL is large o As the level of operating activity increases above the breakeven point, MOS increases, DOL decreases Indifference point: the level of activity at which equal cost or profit occurs across multiple alternatives - Set two cost functions equal to each other and solve for Q CM = Sales VC Gross Margin = Sales COGS CM Format Revenue VC CM FC EBT GM Format Revenue COGS manufacturing expenses GM Nonmanufacturing expenses EBT

7 Chapter 4 Relevant Info for Decision Making Identifying Relevant Info Quantitative info: is numerical info that is available for addressing a problem - To be relevant, cash flows must (1) arise in the future and (2) vary with the action taken - We identify cash flows by first analyzing the decision alternatives and then selecting cash flows that are unique to each alternative - We ignore irrelevant (unavoidable) cash flows those that don t differ among alternatives ex. Sunk costs (costs that were incurred in the past) are always irrelevant Qualitative info: factors that are not valued in numerical terms is vital to good decision making - Can be difficult to identify, b/c no formula assures us that we have considered the important info - Might be identified from experience with similar past decisions, through research into business risks and other factors that might affect the outcomes of a decision, or of discussions with managers or other personnel - Ex. Outsourcing ability of the outside vendor to provide a good or service at the same level of quality and in a timely manner Product Line and Business Segment (Keep or Drop) Decisions - The general rule is that we want to be at least as well off after we discontinue a product or business segment as we were before we dropped it - Usually, this means that we discontinue a product or segment when the incremental profit from keeping it is negative - The decision rule is to drop if: CM < relevant FC + Opportunity cost - Consider whether the cost is avoidable if we drop the product or segment or unavoidable whether we do or not - VC are often avoidable and relevant to the decision, FC usually include both avoidable and unavoidable costs Customer Profitability - Customers are increasingly demanding additional services, such as timely delivery of small amounts of inventory or large amounts of support. Sometimes the seller s cost to maintain these relationships are larger than the benefits. - A customer should be dropped if: Customer CM < Relevant FC + Opp. Cost - Relevant cash flows include the revenues that will be forgone if the customer is dropped along with the costs to maintain the customer and deliver products or services - Relevant costs include: o Avoidable costs of products manufactured or services provided o Marketing, sales-order, and delivery costs o Cost for equipment or other assets devoted to particular customers o Product technical support, warranty costs, and product return handling o Inventory carrying costs (material handling, warehousing, and insurance) o Avoidable admin costs for labour, facility, or other resources needed to satisfy customer demands o Alternative uses for capacity devoted to customers

8 Costs of Carrying Inventory - Costs of carrying inventory are avoidable if a firm drops a customer or product - These costs can be relevant to keep or drop decisions - Are separate from general overhead costs - These costs include: o Costs to process purchase orders o Avoidable costs invested in the inventory (FM, FL, VOH, FOH) o Inventory shrinkage o Opp. Cost of forgone sales from inventory shortages Keep or Drop Summary: Insource or Outsource (Make or Buy) Decisions Outsourcing: the practice of finding outside vendors to supply products and services has become increasingly common Insourcing: the practice of providing a good or service from internal resources - For manufacturers, outsourcing decisions are often called make or buy decisions should the company make the product or provide the service internally, or should the company buy it from the outside? - The general rule for insource or outsource decisions is to choose the option with the lowest relevant cost o The decision rule is to outsource (buy) if: Cost to outsource < cost to insource OR Cost to outsource < relevant VC + relevant FC + Opp. Cost - VC are usually relevant, existing FC are relevant only if they can be avoided through outsourcing - The costs for insourcing also include opp. Costs sometimes extra space or capacity from outsourcing can be converted to other uses, another product could be manufactured or the space rented out so the forgone benefits (CM from the new product or rent payments) are an opportunity cost for insourcing

9 Special Orders - Managers need to determine whether to accept a customer s special order one that is not part of the organization s normal operations - This type of decision has no long-term strategic impact, b/c it involves a one-time sale of a specified quantity of good or services, often at a reduced price - We want to be as well off after accepting the order as we were before we accepted it o The decision rule to accept the special order is if: Price >= relevant VC + relevant FC + Opp. Cost - VC of delivering the product or service are usually relevant, V selling C such as commissions are irrelevant if the company requesting special orders places it directly - Most FC like rent and depreciation on plant and equipment are unavoidable, making them irrelevant - Some FC like the lease cost for a piece of equipment needed for the special order, are relevant b/c they are unique to the special order - Labour costs are relevant if the special order causes them to change - If the other replaces regular business, ten the opp. Cost is also relevant - If idle capacity is available, the special order is acceptable if the organization at least breaks even Summary: Special Orders and Pricing Policies - Managers are willing to accept a special order as long as the selling price is at least equal to incremental costs as long as the incremental CM is zero, or positive - If excess capacity exists, the minimum acceptable selling price is the sum of the per-unit relevant variable and FC - A special order isn t apart of the organization s normal operations. If excess capacity exists, and if the price on a special order will not affect prices on regular business, then the organization is better off accepting special orders that generate at least some incremental profit

10 Theory of Constraints and Constrained Resources Theory of Constraints: managers will always face a constraint in their operations Constraints: resource limitations and can be shortages of DM or DL, or bottlenecks in the manufacturing process Bottleneck: any resource or process that limits overall capacity - Internal constraints include limits in capacity, materials, or labour o Ex. The company could face a shortage of DM, or a direct materials constraint. A shortage of labour to run machines or to load books into packaging creates would be a labour constraint. A shortage or machines to bind the covers onto the books would be a capacity constraint. - Relax the constraint by: o Purchasing g&s from an outside supplier o Increasing the speed and constancy of bottlenecks by operating them during breaks and meals o Increasing internal capacity by using overtime (increase available resources), outsourced labour or processes, and buying new equipment o Redesigning products and processes to use existing capacity more efficiently o Offloading some products that use high-technology bottleneck resources to older, less-efficient equipment that performs the same task General Rule for Choosing the Product Mix When Resources are Constrained - When resources are constrained we have to emphasize products and services that maximize the CM per unit of constrained resource General Rule for Relaxing Constraints for One or Two Products - The general rule for relaxing a short-term constraint for DM, DL, or capacity is that mangers should be willing to pay not only what they are already paying but also some or the entire CM per unit of constrained resource - Their goal is to acquire capacity, thereby eliminating the constraint - As the VC/unit (including new cost of materials or labour) approaches the selling price of the product or service, managers become indifferent to purchasing more of the constrained resource for continued production o The general rule is valid under these assumptions: The organization will forgo sales if the resource constraint Is not relaxed Fixed costs are unaffected by short-term decisions made to relax constraints The managers want to maximize profits in the short term Sales of one product don t affect sales of other products - Capacity constraints are time constraints; meaning we have limited time available for processing products b/c one or more bottlenecks slow production o Any process, part, or machine that limits overall capacity is a bottleneck o To maximize use of bottleneck resources, we emphasize products that have the highest CM per bottleneck hour o We calculate the relevant CM in terms of time needed at the bottleneck resource

11 Chapter 5 Job Costing Product Costs and Cost Flows - Product costs: are those involved in either making or purchasing a project, and they are called manufacturing or inventoriable costs - Period costs: are the operating costs that are not part of making or purchasing a product, such as sales and administrative expenses - Manufacturing companies purchase raw materials and components and process them, making them into finished goods, so they may have leftover inventories in the raw materials account, the WIP (partially finished products) account, and the FG account at the end of an accounting period o Need to prepare an income statement, schedule of COGS and COGM o They consider 3 main components to a product: Direct materials that become a part of a product (cost object) Direct labour that includes the wages paid to the operator or assembly workers Manufacturing overhead, which includes all indirect expenses of making the product such as utilities, machine amortization, plant insurance, maintenance and repair, indirect materials, indirect labour, etc. - Prime costs: DM and DL - Conversion costs: DL and MOH COGS = Beginning Inventory + Purchases Ending Inventory COGS = Beginning FG Inventory + COGM Ending FG Inventory Schedule of COGM Direct materials used: Beginning raw material inventory + Purchases Raw materials available for use - Ending inventory Direct materials used in production Direct Labour Manufacturing OH Indirect labour Machine amortization Utilities Plant insurance Total MOH Manufacturing costs incurred + Beg. WIP inventory Total Manufacturing costs inventory - Ending WIP inventory COGM

12 Schedule of COGS Beg FG + COGM Good available for sale - Ending FG COGS Product costs: direct and indirect costs of product g/s and overhead costs related to production - Exclude the costs of operating activities that aren t directly related to production ex. Sales & Admin Process costing: allocates both direct and overhead costs to continuous-flow processing lines; it s generally used for mass-produced products - Direct and indirect costs are traced and allocated to production departments and then allocated to units A job: when a customer with specific product or service requirements places an order Job costing: used when goods/services are customized so that costs are easily traced to individual products - The process of assigning costs to custom products or services - DM and DL are traced to individual jobs, and production OH is allocated Source documents: manual or electronic records created to capture and provide info about transactions or events Job cost record: the cost and activity info gathered from source documents is used to record costs in a subsidiary ledge for each new job. This record contains all the costs traced and assigned to a specific job Allocating Overhead - Overhead includes all production costs - Allocating OH to individual products is a two-stage process 1) A variety of OH costs re collected in an OH cost pool, a group of individual costs that are accumulated for a particular purpose 2) Costs are allocated from the cost pool to individual jobs Steps in Allocating OH: 1) Identify the relevant cost object - In a job costing system, the cost object is a job. Sometimes a job consists of an individual product, and sometimes it consist of a batch of products 2) Identify one or more OH cost pools and allocation bases - FOH includes costs such as production management salaries and space rental. VOH includes any cost that varies with activity levels, such as supplies, and sometimes electricity - For each OH cost pool, an allocation base is chosen to assign OH costs to cost objects - Allocate OH by DL hours, DL costs or Machine Hours

13 3) For each OH cost pool, calculate an OH allocation rate Allocation rate: a dollar amount per unit of allocation base used to allocate OH to each cost object Actual OH allocation rate = actual OH cost / actual quantity of allocation base Estimated allocation rate = estimated OH cost / estimated quantity of allocation base 4) For each OH cost pool, allocate costs to the cost object - Allocate OH costs by multiplying the OH allocation ate by the quantity of the allocation base used by each job Actual and Normal Costing Actual costing, OH is allocated using the actual volume of the allocation base multiplied by the actual allocation rate - Since managers need cost info before total actual cost and resource use info is available at the end of the period, estimates are typically used to allocate OH - Normal costing: when the estimated allocation rate and actual quantity of the allocation base are used to allocate OH Process costing vs. job costing - Hospital uses a job costing system instead of a process costing system b/c process costing allocates both direct and OH costs together, but job costing assigns costs to each custom product or service. DM and DL are traced to each job and OH is allocated. Using job costing allows hospitals to trace exactly what costs are incurred to each patient Overapplied and Underapplied OH - Under normal costing, periodic adjustments need to be made to reconcile the actual OH cost with the amount of OH that has been allocated to jobs - When we determine the OH allocation rate, we estimate both the cost of OH (numerator) and the volume of the allocation base (denominator) - At the end of the period, the amounts of OH in the inventory accounts (WIP, FG, COGS) are either too little or too much so adjustments need to be made - Overapplied OH: occurs when actual costs are less than the total amount of OH allocated to inventory accounts - Underapplied OH: occurs when actual costs are more than the amount of OH allocated actual under OH allocated over If overapplied this is journal entry: OH COGS (Overapplied x cost in account / cost in all 3 accounts) FGI (Overapplied x cost in account / cost in all 3 accounts) WIP (Overapplied x cost in account / cost in all 3 accounts) - Do opposite for underapplied

14 - If the amount is immaterial (less than 10%), it is simply assigned to COGS o Over/Underapplied OH o DR COGS CR Mnfg. OH - Normal capacity: the range of production volumes that is expected to occur under ordinary circumstances Spoilage, Rework and Scrap in Job Costing - Spoiling: refers to units of product that are unacceptable and are discarded, reworked, or sold at a reduced price - Normal spoilage: consist of defective units that arise as part of regular operations o If normal spoilage arises from the requirements of a specific job, the cost of the spoiled units is charged to the job o Also occurs periodically as a regular part of all jobs, the loss has nothing to do with any specific order, it s a normal part of operations o The cost of normal spoilage common to all jobs is charged to OH and is allocated with other OH costs to all jobs - Abnormal spoilage: spoilage that isn t part of everyday operations it occurs for reasons like: out-of-control manufacturing processes, unusual machine breakdowns, unexpected electrical outages that result in a number of spoiled units o Some abnormal spoilage is considered avoidable, if managers monitor processes and maintain machinery appropriately, little spoilage will occur o Abnormal spoilage is recorded in a loss from abnormal spoilage account in the general ledger and is not included in the job costing inventory accounts (WIP, FG, COGS) - Rework: consists of spoiled units that are repaired and sold as if they were originally produced correctly o If the cost of the rework is tracked, it is recorded in the same manner as spoilage; normal rework is charged to OH or to a specific job, and abnormal rework is recorded as a line item loss o Rework costs are often not tracked o Sometimes sold at regular price, sometimes at a reduced price o Costs and benefits are analyzed to decided whether to rework a spoiled unit

15 - Scrap: consists of the bits of DM left over from normal manufacturing processes o Sometimes it has value and can be sold, and sometimes its discarded o Some manufacturers track scrap to measure whether resources are being used efficiently o Scrap is also tracked if it has value and could be stolen o Often it is recorded in physical terms ex. The weight of jewellery o If scrap is sold, the revenue is recoded either at the time its produced or at the time its sold, when the value of it is immaterial, its simply recorded as part of other revenues in the I/S o Scrap sometimes arises as part of specific jobs, if we can trace it to individual jobs; revenue from the scrap is credited to the specific job in WIP. Scrap revenues reduce the cost of the job with which its associated. If scrap is common to all jobs, or if it is not worth tracing to individual jobs, the scrap revenue offsets OH cost for the period. This entry reduces OH costs for all jobs produced Spoilage Opportunity Costs - Forgone profit an organization forgoes the normal profit from resources that are used to product spoiled units o When capacity limits are involved, the organization forgoes the profit on resources employed as well as the CM from good units that might have been produced o As the number of spoiled units increases, a larger number of spoiled units will inevitably be sold to customers - The sale of these defective units leads to loss of market share b/c consumers switch brands o The company eventually loses its reputation for quality products, leading to further erosion of market share, including customers who never had direct quality problems