Part 1 Study Unit 5. Cost Accumulations Systems Jim Clemons, CMA Ronald Schmidt, CMA, CFM

Transcription

1 Part 1 Study Unit 5 Cost Accumulations Systems Jim Clemons, CMA Ronald Schmidt, CMA, CFM 1

2 Overview Cost accounting systems record manufacturing activities using a perpetual inventory system, which continuously update records for cost of materials, goods in process and finished goods inventory. Cost accounting systems accumulate cost and then assign them to products and services. The two basic types of cost accounting systems are job order cost accounting and process cost accounting. 2

3 SU Job Costing When companies produce customized products that are separately manufactured, the production is called job order productions or job order manufacturing (also called customized production, which is the production of products in response to special orders). Production activities for a customized product represent a job, which can apply to manufacturing or service companies. 3

4 SU Job Costing A major aim of a job order cost accounting system is to determine the cost of producing each job or job lot, the system also aims to compute the cost per unit Required: Separate records for each job to accomplish this. 4

5 SU Job Costing Steps in Job-Order Costing Receipt of a sales order Predict the cost to complete the job depends on product design Negotiate price and decide whether to pursue the job Cost-plus contracts Customer pays the mfg. for cost incurred on the job plus a negotiated amount or rate of profit Market factor prices Target cost Sales order is approved and production order is issued Cost are recorded by classification Direct Material Direct Labor Manufacturing Overhead Charged is charged using an estimated rate. Remember overhead costs support production of more than one job, and include depreciation, factory supplies, supervision, maintenance, cleaning and utilities. See journal entries on page 145 & 146 5

6 SU Job Costing Target Costing: Many producers determine a target cost for their jobs. Target cost is determined as follows: Expected selling price Desired profit = Target Cost If the projected target cost of the job as determined by job costing is too high, the producer can apply value engineering, which is a method of determining ways to reduce job cost until the target cost is met. 6

7 SU Job Costing Job Cost Sheet General ledger accounts usually do not provide the accounting information that managers of job order operations need to plan and control production activities. Subsidiary records store information about raw materials, overhead costs, jobs in process, finished goods, and other items. Jobs cost sheets are separate records maintained for each job. It identifies: Customer Job Number Product Key Dates Continued 7

8 SU Job Costing Any costs incurred on the job are immediately recorded on this sheet. When each job is complete, the supervisor enters the date of completion and records any remarks. Factory overhead is also allocated (also termed applied, assigned or charged). Factory overhead consists of cost (other than direct materials and direct labor) that ensure the production activities are carried out. 8

9 SU Job Costing As a job is being produced, its accumulated cost are kept in Good in Process Inventory. The summation of all cost sheets makes up a subsidiary ledger controlled by the Goods in Process Inventory account in the general ledger. 9

10 SU Job Costing Cost Flows: During Production While a job is being produced, its accumulated costs are kept in Goods in Processed Inventory. The collection of job cost sheets for all jobs in process makes up a subsidiary ledger controlled by the Goods in Process Inventory account in the general ledger. Managers use job cost sheets to monitor costs incurred to date and to predict and control cost for each job. Cost Flow: Job completion When a job is finished, its job cost sheet is completed and moved from the jobs in process file to the jobs file. This latter file acts as a subsidiary ledger controlled by the Finished Goods Inventory Account. Cost Flows: Job Delivery When a finished job is delivered to a customer, the job cost sheet is moved to a permanent file supporting the total cost of goods sold. This permanent file contains records from both current and prior periods. 10

11 SU Job Costing Material Ledger Cards (files) are perpetual records that are updated each time units are purchased and each time units are issued for use in production. When materials are needed in production, a production manager prepares a material requisition and sends it to the materials manager. 11

12 SU Job Costing Labor cost from Factory Payroll account flow to the subsidiary records of the job order cost accounting system. Factory Payroll and Factory Overhead should be considered temporary accounts, which hold various expenses until they are allocated to balance sheep or income statements accounts. 12

13 SU Job Costing Factory overhead includes all production costs other than direct materials and direct labor, such as indirect material and indirect labor. They are recorded to the Factory Overhead Control account, and ultimately to the job cost sheets via an allocations. 13

14 SU Job Costing Overhead Allocation Bases Usually based on factors of productions like direct labor or machine hours. Correct allocation is important and affects accuracy. Overhead Allocation Rates Predetermined Overhead rate or predetermined overhead allocation (or application) rate. The predetermined overhead rate is computed at the start of the period and is used throughout the period to allocate overhead to jobs. 14

15 SU Job Costing Overhead cost are applied to (or absorbed by) each job based on a predetermined overhead application rate for the year. Three step process: 1. Estimate total overhead for the year 2. Divide total overhead by allocation base 3. Apply based on number of allocation base units used per job 15

16 SU Job Costing At the end of the period, the overhead control and applied accounts are netted. If the results (balance) in the overhead control account is a credit, then overhead was overapplied. Actual overhead < applied = Overapplied Continued 16

17 SU Job Costing If the results (balance) in the overhead control account is a debit, the overhead was underapplied. Actual overhead > applied = Underapplied overhead The closer a estimate is to actuals in absolute terms the better the estimates was 17

18 SU Job Costing If the variance is immaterial (with respect to the company), it can be closed (charged off to) cost of goods sold. If the variance is material, it should be allocated based on the relative weights of work in process, finished goods and cost of goods sold. It is important that you and understand the meaning of over/under applied with respect to net income and actual job cost. 18

19 SU Job Costing See Job-Order Cost Flow Diagram on page

20 SU Job Costing Spoilage Output that does not meet the quality standards for salability is considered spoilage. That amount that is expected is considered normal spoilage in which case it is included as product costs. Spoilage that is over or above normal is considered abnormal and treated as period cost. 20

21 SU Job Costing Remember! You are expected to understand the proper accounting for normal and abnormal spoilage under both joborder and process costing: In job-order costing, normal spoilage is treated as a product cost while abnormal spoilage is treated as a period cost. Consider what: System is being used, and Whether the product can be sold or not 21

22 SU Job Costing Question 1 Question 1 - CMA1 Study Unit 2: Cost Accumulation Systems Lucy Sportswear manufactures a specialty line of T-shirts Cusing a job-order costing system. During March, the A. $6.50 following costs were incurred in completing job ICU2: direct materials, $13,700; direct labor, $4,800; administrative, $1,400; and selling, $5,600. Overhead was applied at the rate of $25 per machine hour, and job ICU2 required 800 machine hours. If job ICU2 resulted in 7,000 B. $6.30 good shirts, the cost of goods sold per unit would be C. $5.70 D. D. $

23 Question 1 Answer Correct Answer: D Cost of goods sold is based on the manufacturing costs incurred in production but does not include selling or general and administrative expenses. Manufacturing costs equal $38,500 [$13,700 DM + $4,800 DL + (800 hours $25) OH]. Thus, per-unit cost is $5.50 ($38,500 7,000 units). 23

24 SU Job Costing Question 2 Question 2 - CMA1 Study Unit 2: Cost Accumulation Systems Kepler Optics makes lenses for telescopes. Because Kepler will only sell lenses of the highest quality, the normal spoilage during a reporting period is 1,000 units. At the beginning of the current reporting period, Kepler had 2,200 units in inventory, and during the period, production was started and completed on 4,000 units. Units in inventory at the end of the current reporting period were 1,500, and the units transferred out were 3,000. During this period, the abnormal spoilage for Kepler s lens production was A. 700 units. B. 1,000 units. C. 1,700 units. D. 3,200 units. 24

25 Question 2 Answer Correct Answer: A Kepler s abnormal spoilage for the period can be calculated as follows: Beginning work-in-process 2,200 Add: started and completed 4,000 Less: transferred out -3,000 Less: ending work-in-process -1,500 Total spoilage for period 1,700 Less: normal spoilage -1,000 Abnormal spoilage for period

26 SU Job Costing Question 3 Question 3 - CMA1 Study Unit 2: Cost Accumulation Systems What is the journal entry to record the purchase of materials on account? A. Raw materials inventory Accounts payable B. Accounts payable Raw materials inventory C. Accounts receivable Accounts payable D. Raw materials inventory Cash XX XX XX XX XX XX XX XX 26

27 Question 3 Answer Correct Answer: A The correct entry to record a purchase of materials on account is to increase the appropriate asset and liability accounts. Materials are charged to an inventory; the corresponding liability is accounts payable. The asset account(s) could be stores control and/or supplies or a number of other accounts. Also, subsidiary ledgers may be used to account for various individual items (a perpetual inventory system). The term control implies that a subsidiary ledger is being used. 27

28 5.2 Activity-Based Costing Activity-based costing (ABC) is a response to the significant increase in the incurrence of indirect costs resulting from the rapid advance of technology ABC may be used by manufacturing, service, or retailing entities. 28

29 5.2 Activity-based costing Under traditional costing system: OH is simply dumped into a single cost pool Under ABC, indirect costs are attached to activities and then rationally allocated ABC may be used by manufacturing service or retailing 29

30 Traditional Costing System Peanut-butter costing = product-cost cross-subsidization è inaccurate allocation of indirect costs over products or service units DL + DM are traced to products/services A single pool of indirect costs is allocated based on a single rate (overhead) Indirect costs from the pool are assigned using an allocative (rather than a tracing) procedure, such as using a single overhead rate for an entire department. How much resources did I use to product X? 30

31 Example See example given on page 147 of the book. 31

32 Volume-Based vs. Activity Based Systems See drawing on the top of page 148, which shows OH Allocations of volume-based organizations. Appropriate when direct cost were the bulk of manufacturing costs. Contemporary organization have a larger percentage overhead due to automation. 32

33 Steps in ABC process 1) Activity Analysis: understand the different steps and process from DM to Finished Goods 2) Assign Resource Costs to Activities: firststage allocation. Identify resource costs: a separate Accounting System may be necessary to track resource costs separately from the GL. Then we need to define resource drivers to allocate it. 3) Allocate Activity Cost Pools to Cost Objects: allocating the activity cost pools to final cost objects = second-stage allocation è What are my activity drivers? 33

34 Cost Drivers Cause-&-effect relationship Cost object may be a job, product, process, activity, service or anything else for which a cost measure is desired Process value analysis: Organization flow Value-adding Vs. Non Value-adding Product costing / continuous improvement See examples on page 150 and 151 ABC used to obtain full-absorption cost (US GAAP) 34

35 ABC Advantages/Disadvantages Product costing is improved, better decision making Process value analysis (non-value adding activities can be removed) More cost assignment of OH Better cost control and more efficient operations Maintain a separate Accounting System to capture resource costs Design and implement drivers and cost pools ABC-derived costs of products or services may not conform with GAAP Cost of implementing an ABC system 35

36 Organizational Benefits Significant variance in volume, diversity of activities, complexity of operations, relatively high OH costs ABC difficult for service organizations: high facility-level costs hard to assign to service DL as a base for allocating OH No benefit for a single product and average regular volume of activity Real benefits for high level of FC + wide variety of products and level of production 36

37 ABC - Question 1 Question 1 - CMA1 Study Unit 2: Cost Accumulation Systems The use of activity-based costing (ABC) normally results in A. Substantially greater unit costs for low-volume products than is reported by traditional product costing. B. Substantially lower unit costs for low-volume products than is reported by traditional product costing. C. Decreased setup costs being charged to low-volume products. D. Equalizing setup costs for all product lines. 37

38 Question 1 - Answer Correct Answer: A ABC differs from traditional product costing because it uses multiple allocation bases and therefore allocates overhead more accurately. The result is that ABC often charges low-volume products with more overhead than a traditional system. For example, the cost of machine setup may be the same for production runs of widely varying sizes. This relationship is reflected in an ABC system that allocates setup costs on the basis of the number of setups. However, a traditional system using an allocation base such as machine hours may underallocate setup costs to low-volume products. Many companies adopting ABC have found that they have been losing money on low-volume products because costs were actually higher than originally thought. 38

39 ABC - Question 2 Question 2 - CMA1 Study Unit 2: Cost Accumulation Systems Multiple or departmental overhead rates are considered preferable to a single or plantwide overhead rate when A. Manufacturing is limited to a single product flowing through identical departments in a fixed sequence. B. Various products are manufactured that do not pass through the same departments or use the same manufacturing techniques. C. Cost drivers, such as direct labor, are the same over all processes. D. Individual cost drivers cannot accurately be determined with respect to cause-and-effect 39

40 Question 2 - Answer Correct Answer: B Multiple rates are appropriate when a process differs substantially among departments or when products do not go through all departments or all processes. The trend in cost accounting is toward activity-based costing, which divides production into numerous activities and identifies the cost driver(s) most relevant to each. The result is a more accurate tracing of costs. 40

41 ABC - Question 3 Question 3 - CMA1 Study Unit 2: Cost Accumulation Systems New-Rage Cosmetics has used a traditional cost accounting system to apply quality control costs uniformly to all products at a rate of 14.5% of direct labor cost. Monthly direct labor cost for Satin Sheen makeup is $27,500. In an attempt to distribute quality control costs more equitably, New-Rage is considering activity-based costing. The monthly data shown in the chart below have been gathered for Satin Sheen makeup. 41

42 ABC - Question 3 (CONTINUED) The monthly quality control cost assigned to Satin Sheen makeup using activity-based costing (ABC) is Quantity for Activity Cost Driver Cost Rates Satin Sheen Incoming material inspection Type of material $11.50 per type 12 types In-process inspection Number of units $0.14 per unit 17,500 units Product certification Per order $77 per order 25 orders A. $88.64 per order. B. $ lower than the cost using the traditional system. C. $8, D. $ higher than the cost using the traditional system. 42

43 Question 3 - Answer Correct Answer: D ABC identifies the causal relationship between the incurrence of cost and activities, determines the drivers of the activities, establishes cost pools related to the drivers and activities, and assigns costs to ultimate cost objects on the basis of the demands (resources or drivers consumed) placed on the activities by those cost objects. Hence, ABC assigns overhead costs based on multiple allocation bases or cost drivers. Under the traditional, single-base system, the amount allocated is $3, ($27, %). Under ABC, the amount allocated is $4,513 [(12 $11.50) + (17,500 $.14) + (25 $77)], or $ more than under the traditional system. 43

44 SU Process Costing Process costing is used in Process Operations, also called process manufacturing or process production, is the mass production of products in a continuous flow of steps. Products pass through a series of sequential processes Can you think of any examples? 44

45 SU Process Costing Process operations can also extend to services, i.e. mail sorting. Common feature of Process Operations is that it is sequential using a series of standardized processes. Series of processes = series of steps 45

46 SU Process Costing Understanding processes for companies with process operations is crucial for measuring their costs. Job order costing system the focus is on the individual job or batch. In process costing system focus is on the process itself and the standardized units produced. 46

47 SU Process Costing In process operations, each process is identified as a separate production department, workstation, or work center. Every subsequent department, workstation, etc. receives the output of the previous step (and is cumulative of all preceding) 47

48 SU Process Costing Additional cost added at each step can be Direct Material Direct Labor Overhead (labor, material and other) The last step produces the finished goods Output of one department becomes the input of another department, as is the case with sequential processing costs transfer with those units from the prior step 48

49 SU Process Costing Remember! Job order cost accounting systems assign direct material, direct labor, and overhead to a job. The total job is then divided by the number of units to compute a cost pre unit for that job. Process cost accounting systems assign direct material, direct labor, and overhead to specific processes (or departments). The total costs associated with each process are the divided by the number of units passing through that process to determine the cost per equivalent unit (EU) for that process. 49

50 SU Process Costing In a process operation, the direct labor of a production department includes all labor used exclusively by that department. This is the case if the labor is not applied to the product itself. If a production department in a process operations, for instance, has a full-time manager and a full-time maintenance work, their salaries are direct labor costs of that process and are not factory overhead. A department's indirect labor cost might include an allocated portion of the salary of a manager who supervises two or more departments. 50

51 SU Process Costing Because of the machine-intensive nature of process costing, direct labor tends to form a smaller proportion of overall costs than under job-order costing. Cost accounting under process costing sometimes combines direct labor and manufacturing overhead and treats them as conversion costs. 51

52 SU Process Costing See journal entries on page

53 SU Process Costing Process Cost Factory Overhead Cost The time it takes to process (cycle) products through a process is sometimes used to allocate costs. With increasing automation, companies with process operations are more likely to use machine hours to allocate overhead. 53

54 SU Process Costing Consider the Ethics You are working to identify the direct and indirect costs of a new processing department that has several machines. This department's manager instructs you to classify a majority of the costs as indirect to take advantage of the direct labor-based overhead allocation so it will be charged a lower amount of overhead (because of its small labor cost). This would penalize other departments with higher allocations. It also will cause the performance ratings of managers in these other departments to suffer. What actions would you take? 54

55 See cost flow on page 156 SU Process Costing 55

56 SU Process Costing Equivalent Units! If a process has no beginning and no ending goods in process inventory, then the unit cost of goods transferred out of a process is: Total cost assigned to the process (direct material, direct labor, and overhead) Total number of units started and finished in the period 56

57 SU Process Costing If a process has a beginning or ending inventory of partially processed units (or both), then the total cost assigned to the process must be allocated to all completed and incomplete units worked on during the period. Therefore, the denominator must measure the entire production activity of the process for the period, called equivalent units of production (or EUP). EUP = the number of units that could have started and completed given the cost incurred during a period. 57

58 SU Process Costing The goal is to compute the cost per equivalent unit and to assign costs to finished goods and goods in process inventory. What complicates calculations is that material, labor and overhead sometimes are added in unequal increments over the process steps. Remember: First equivalent units are determined and then per-unit cost are calculated. 58

59 SU Process Costing Two methods of calculating EUP (both are tested on the exam!) Weighted-average method units in beginning work-in-process inventory are treated as if they were started and completed during the current period. First-in, first-out method units in beginning work-in-process inventory are part of the EUP calculation. The calculation is thus more complex than weighted-average but tends to be more accurate. 59

60 SU Process Costing See Process Costing Extended Example (Pages ) 60

61 SU Process Costing Spoilage in Process Costing Same as Job order Normal left in COGS Abnormal recognized separately as a loss Multi-step process 61

62 SU Process Costing Question 1 Question 1 - CMA1 Study Unit 2: Cost Accumulation Systems Levittown Company employs a process cost system for its manufacturing operations. All direct materials are added at the beginning of the process and conversion costs are added proportionately. Levittown s production quantity schedule for November is reproduced in the next column. 62

63 SU Process Costing Question 1 (continued) Work-in-process November 1 (60% complete as to conversion costs) 1,000 Units started during November 5,000 Total units to account for 6,000 Units completed and transferred out from beginning inventory Units started and completed during November Work-in-process on November 30 1,000 3,000 (20% complete as to conversion costs) 2,000 63

64 SU Process Costing Question 1 (continued) Using the FIFO method, Levittown s equivalent units for direct materials for November are A. 5,000 units. B. 6,000 units. C. 4,400 units. D. 3,800 units. 64

65 SU Process Costing Question 1 Answer Correct Answer: A The computation of equivalent units for a period using the FIFO method of process costing includes only the conversion costs and material added to the product in that period and excludes any work done in previous periods. Accordingly, FIFO equivalent units include work and material to complete BWIP, plus work and material to complete units started this period, minus work and material needed to complete EWIP. Given that all materials are added at the beginning of the process, only those units started during November would have received materials in that month. Because 5,000 units were started, the equivalent units for direct materials equal 5,

66 SU Process Costing Question 2 Question 2 - CMA1 Study Unit 2: Cost Accumulation Systems Superb Hancock Company uses a process costing system in which all materials are added at the beginning of the first process. Conversion costs are added evenly throughout the process. During the past month, 10,000 units were started in production, and 8,000 were completed and transferred to the next department. There were no beginning inventories. The ending inventories were 70% complete at the end of the month. The company uses a weighted-average method for inventory valuation. If Superb Hancock s materials used in production cost $15,000 and its conversion costs incurred were $25,000, what amount of inventory (rounded) was transferred to the next department? A. $32,000 B. $33,280 C. $36,280 D. $40,000 66

67 SU Process Costing Question 2 Answer Correct Answer: B The equivalent units of materials equal 10,000 because all materials are added at the beginning of the process, and 10,000 units were started. The equivalent units of conversion costs equal 9,400 [8,000 units completed + (2,000 units in ending inventory 70%)]. The unit cost of materials is $1.50 ($15,000 10,000 EU). The unit cost of conversion is $2.66 ($25,000 9,400 EU). Thus, the cost of goods transferred was $33,280 [8,000 units ($ $2.66)]. 67

68 SU Process Costing Question 3 Question 3 - CMA1 Study Unit 2: Cost Accumulation Systems Superb Hancock Company uses a process costing system in which all materials are added at the beginning of the first process. Conversion costs are added evenly throughout the process. During the past month, 10,000 units were started in production, and 8,000 were completed and transferred to the next department. There were no beginning inventories. The ending inventories were 70% complete at the end of the month. The company uses a weighted-average method for inventory valuation. Assume that Superb Hancock uses first-in, first-out (FIFO) for inventory costing instead of the weighted-average inventory valuation. If materials used in production cost $15,000 and conversion costs incurred were 25,000, what amount of inventory (rounded) was transferred to the next department under FIFO? A. $32,000 B. $33,280 C. $36,280 D. $40,000 68

69 SU Process Costing Question 3 Answer Correct Answer: B The only difference between weighted average and FIFO relates to the beginning inventories. Because there were no beginning inventories in this problem, the two valuation methods produce the same results. The equivalent units of materials equal 10,000 because all materials are added at the beginning of the process, and 10,000 units were started. The equivalent units of conversion costs equal 9,400 [8,000 units completed + (2,000 units in ending inventory 70%)]. The unit cost of materials is $1.50 ($15,000 10,000 EU). The unit cost of conversion is $2.66 ($25,000 9,400 EU). Therefore, the cost of goods transferred using the FIFO method for inventory costing is $33,280 [8,000 units ($ $2.66)]. 69

70 SU Life-cycle costing Estimate revenues & expenses Over the entire sales life cycle Upstream costs (R&D, Design) Manufacturing Downstream costs (Mktg & Distribution, Customer Service) è Great value for Pricing Decision 70

71 SU Life-cycle costing Potential Benefits Relationships among costs incurred at different value-chain stages Incurring costs vs. locking in costs (SUNK) Focus on cost control Vs. cost reduction After-purchase costs (operating, support, repair, disposal ) Life-cycle and whole-life cycle è target costing Value engineering: minimize cost without reducing customer satisfaction 71

72 SU Life-cycle costing Life-Cycle vs. Other Costing Methods Traditional approaches: Focus on cost control as opposed cost reduction. Treat pre- and postproduction costs as period costs largely ignored in determining profitability. After purchase costs are ignored. Continued 72

73 SU Life-cycle costing Life-Cycle vs. Other Costing Methods Whole-life is closely associated with life-cycle costing. Life-cycle and whole-life are associated with target costing and pricing. Value engineering is not lessening the quality, it focuses on value-added and non-value added. 73

74 SU Life-cycle costing Internal & External Reporting For external financial statement purposes, costs during the upstream phase must be expensed in the period incurred IFRS allows development costs to be capitalized For internal purposes, the costs (R&D) must be capitalized in a life-cycle costing Organizations must develop an accounting system consistent with GAAP 74

75 SU Life-cycle costing Advantage Better measure for evaluating the performance of Product Managers Life-cycle costing combines all costs and revenues for all periods to provide a better view of a product s overall performance 75

76 SU Life-cycle Costing - Question 1 Question 1 - CMA1 Study Unit 2: Cost Accumulation Systems Life-cycle costing A. Is sometimes used as a basis for cost planning and product pricing. B. Includes only manufacturing costs incurred over the life of the product. C. Includes only manufacturing cost, selling expense, and distribution expense. D. Emphasizes cost savings opportunities during the manufacturing cycle. 76

77 SU Life-cycle Costing Question 1 - Answer Correct Answer: A Life-cycle costing estimates a product s revenues and expenses over its expected life cycle. This approach is especially useful when revenues and related costs do not occur in the same periods. It emphasizes the need to price products to cover all costs, not just those for production. Hence, costs are determined for all value-chain categories: upstream (R&D, design), manufacturing, and downstream (marketing, distribution, and customer service). The result is to highlight upstream and downstream costs in the cost planning process that often receive insufficient attention. 77

78 SU Life-cycle Costing Question 2 Question 2 - CMA1 Study Unit 2: Cost Accumulation Systems Target pricing A. Is more effective when applied to mature, long-established products. B. Considers short-term variable costs and excludes fixed costs. C. Is often used when costs are difficult to control. D. Is a pricing strategy used to create competitive advantage. 78

79 SU Life-cycle Costing Question 2 - Answer Correct Answer: D Target pricing and costing may result in a competitive advantage because it is a customer-oriented approach that focuses on what products can be sold at what prices. It is also advantageous because it emphasizes control of costs prior to their being locked in during the early links in the value chain. The company sets a target price for a potential product reflecting what it believes consumers will pay and competitors will do. After subtracting the desired profit margin, the long-run target cost is known. If current costs are too high to allow an acceptable profit, cost-cutting measures are implemented or the product is abandoned. The assumption is that the target price is a constraint. 79

80 SU Life-cycle Costing Question 3 Question 3 - CMA1 Study Unit 2: Cost Accumulation Systems Claremont Company has been asked to evaluate the profitability of a product that it manufactured and sold from Year 7 through Year 10. The product had a one-year warranty from date of sale. The following information appears in the financial records. Research, development, and design cost Manufacturing and distribution costs Warranty costs Warranty cost Yr 5 & Yr 6 Yr 7 - Yr 10 Yr 7 - Yr 10 Yr 11 $5,000,000 $7,000,000 $200,000 $100,000 80

81 SU Life-cycle Costing Question 3 The life-cycle cost for this product is A. $10,000,000 B. $12,000,000 C. $12,200,000 D. $12,300,000 81

82 Correct Answer: D SU Life-cycle Costing Question 3 - Answer Life-cycle costing takes into account costs incurred at all stages of the value-chain, not just manufacturing. The life-cycle cost for this product is thus $12,300,000 ($5,000,000 + $7,000,000 + $200,000 + $100,000). 82