Chapter 5: Activity-Based Costing (cost hierachy) • The Manufacturing Cost Per Unit is not used to allocate costs residual

facturing Cost Per Unit is not used to allocate costs residual after the price and the profit margin. Cost control becomes key to success
ABC Versus Traditional Costing o Unit direct material cost used to allocate total Direct Materials Cost Other Costing Methods: Firm price maker. Price is set by firm and not market. Price is the residual after
• Traditional Costing Systems allocate overhead using a single predetermined rate. • For direct material and conversion, Total costs = BWIP + Cost Added the cost structure and the profit margin. In a competitive market price maker methods no longer effective
• Tra.costing assumes all overhead costs are caused or driven by a single activity or driver => DM cost per unit OR CC per unit = Total DM cost OR Total CC/EU of DM OR CC Target Costing Steps
o Job order costing: e.g., direct labour cost was assumed to be the relevant activity base. - Total Manufacturing Cost per Unit = DM Cost per Unit + Conversion Costs per Unit 1. Find market niche: Select segment to compete in, example, luxury goods or economy goods
o Process costing: e.g., machine hours was assumed to be the relevant activity base. Step 4: Prepare a Cost Reconciliation Schedule (cost/unit x EU) 2. Find the target price: Price the company believes will place it in the best position for its target audience;
• A traditional one-stage costing system: DL hours or dollars is often the appropriate basis for assigning • Determines cost of goods transferred to the next department based on market research
overhead costs if DL is a significant component of the end product or service • Assigns total costs to units completed and transferred out and to ending WIP inventory 3. Determine target cost: Difference between target price and desired profit. Includes all product and
Traditional Costing: Volume-based; overhead costs driven solely by volume. Regardless of the activities • Shows that total costs accounted for equal total costs to be accounted for period costs necessary to make and market the product
or tasks needed to complete a unit, overhead is allocated with a single POR Equivalent Units In A Sequential Process Setting 4. Assemble expert team to design and develop a product that meets quality specifications while not
ABC: Activity-based; each unit has different activities (tasks) need to complete them. Each activity uses • Requires an additional cost component called Transferred In. exceeding target cost. Includes production, operations, marketing, finance.
resources at different rates/quantities. Overhead allocated at a POR per activity o Percentage of completion factor is always 100%. Treated the same as any other cost component in the Total Cost-Plus Pricing:
- You start by firgure out all activites company does & organize them by cost pool. Each pool has a bunch calculation of equivalent units and cost per equivalent unit of production Appropriate pricing
of similiar activites with the same cost driver - Beginning WIP + Transfer In = Transferred Out + EWIP strategy when there is little
ABC: An overhead cost allocation system that allocates overhead to multiple activity cost pools. Assigns FIFO Method: calculation of equivalent units is done on a first- in, first-out basis. or no competition
the activity cost pools to products or services by means of cost drivers that represent the activities used. Treats beginning WIP separately, only considers work needed to complete it this period. • Price is a function of
- Activity: Any event, action, transaction, or work sequence that incurs costs when producing a product or Input (unit to account for) = Output (units accounted for) product cost and target ROI
performing a service. - Activity cost pool: Overhead cost attributed to a distinct activity (for example, Units (BB) + Unit Started = Unit C&TO + Unit (EB) - ROI= Net Operating
ordering materials or setting up machines). - Cost driver: Any factor or activity that has a direct cause– Units C&TO = units completed and transferred out. Includes started in prior period and completed in this Income/Average
effect relationship with the resources consumed. (e.g., DL) period (BB), and started and completed fully this period (S & C). Operating Assets
Repairs & maintenance: square feet, or number of students, or number of class hours,.. Step 1: Work done to finish the units from beginning work in process inventory • A higher ROI means the
HR services: total salaries of employees in faculty or number of employees in faculty o 500 units in beginning work in process inventory = 40% complete company is generating more profit from its assets, which is desirable.
General service of registrar: students each faculty/class hours of programs each faculty => 60% of work & resources was consumed to complete = 500 × 60% = 300 equivalent units 1. Establish a cost base 2. Add a markup based on desired operating income or return on investment (ROI)
EX: The POR is $30/DLH (Estimated OH $900,000÷30,000 direct labour hours) • Always assume units in beg inventory have completed in current period => first units out - Total Unit Cost + Markup % × Total unit Cost = Target Selling Price = Cost + Desired ROI/unit
=> Overhead cost: 1DLH x $30/direct labour hour = $30 MOH Equivalent units to complete Beginning Work in Process = Units in beginning WIP x (100% - - Desired ROI per unit = (Desired ROI % * Amount Invested) / Units Produced
o Traditional costing systems Percentage completion of beginning WIP) - Markup % = Desired ROI per unit / Total unot cost
can lead to some products Step 2: Work done to complete the units started and completed during the period • Advantage: Easy to calculate
being over or under costed Started & Completed unit = units completed&transferred out - units beg WIP invento • Disadvantages: Does not consider demand side; Customer pay the price?; Fixed cost per unit changes
- A high degree of correlation = units started – units ending WIP inventory with change in volume; At lower sales volume, company must charge a higher price to meet desired ROI
must exist between the cost Step 3: Work done to the units in ending work in process inventory. Absorption Cost-Plus
drive and the actual • 400 units in ending inventory were 75% complete = 400 × 75% = 300 equivalent units Pricing Cost base includes
consumption of overhead costs Equivalent Units under FIFO Method (separately for DM and Conversion costs) = only manufacturing costs –
in cost pool Equivalent units to complete Beginning Work in Process * + Units started and completed during both fixed and variable
- Activity-based OH rate = period + Equivalent units in Ending WIP inventory • The markup must cover

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Estimated OH cost per act / 3 & 4. Cost per equivalent unit (separately for DM and Conversion costs): the selling and
Estimated Cost Driver Use per Activity = $/cost driver unit administrative costs plus
- Total Overhead Cost Assigned to a Product = Activity-Based OH Rate × Expected Use of Cost 5. Assign costs to (1) EU to complete from Beg WIP; (2) units completed and (3) EU in Ending WIP: the target ROI • All selling and administrative costs excluded from the cost base.
Drivers per Product - Profit margin = OI/Revenue (1) Cost per EU x EU in Beg WIP (2) Cost per EU x Units completed - Desired ROI/unit + Selling&administrative expense/unit = Markup percentage * mfg cost per unit
(3) Cost per EU x EU in End WIP For (1) &(3), need to separately for DM and CC. - Mfg cost per unit + (markup % * mfg cost per unit) = Target selling price
Process Costing Method Comparison Variable Cost-Plus Pricing Cost
Weighted Average: • Simple to understand and apply • Where prices do not change much, produces base includes all variable costs
results similar to FIFO • Because fixed costs are not
FIFO: • Conceptually superior to weighted average: o Current performance is measured as only current included, markup covers all fixed
Classification of Activity Level costs are considered o Helps to set pricing strategies costs (manufacturing and selling and
1. Unit-level activities are performed for each unit of production. cell phones is a unit-level activity bc Chapter 8: Alternative Inventory Costing Methods: A Decision-Making Perspective administrative) plus the target ROI.
assembly company performs increases with each additional cell phone assembled. Absorption Costing versus Variable Costing • Best suited for make short term decisions bc it considers variable&fixed behaviour patterns separately
2. Batch-level activities are performed every time a company produces another batch of a product. set up Full or Absorption Costing • All varia&fix mfg costs are product costs • Required for external reporting - Desired ROI/unit + (Fix mfg OH + fix S&A expense/unit) = Markup %* variable cost per unit
its ice cream machines. The amount of time spent setting up machine increases with the number of • Production levels will impact cost of inventory & COGS • OI can”manipulated” by adjusting production - Variable cost per unit + (markup % * variable cost per unit) = Target selling price
batches produced, not with the number of units produced. Variable Costing: • Only variable mfg costs (FMOH=period cost). Only for internal reporting purposes Advantage o By using only variable costs as the cost base, aid to management decision makers
3. Product-level activities are performed every time a company produces a new type of product. Time • Variable costing does not defer fixed manufacturing overhead to the future - i.e., they are not inventoried o Variable cost per unit stays the same regardless of volume – reduces need for price changes
spent on testing activities inc with number of products company produces. • Since product costs under Absorption Costing are made up of four costs and those under Variable • Disadvantages: o Price may be set too low o Requires higher markup % to cover all FC plus the ROI
4. Facility-level activities are required to support or sustain an entire production process. The hospital Costing are made up of three costs, then the cost of one unit under Absorption Costing is always greater Time-and-Material Pricing • A cost-plus pricing variation with two pricing rates:
building must be insured and heated, property taxes must be paid, no matter how many patients. These than the cost of one unit under Variable Costing. o One for the labour used on a job: Includes actual labour cost and all benefits
costs not vary as a function of the number of units, batches, products. • In Absorption Costing, Income is a function of Production and Sales. o One for the material used: Includes actual material cost plus any handling cost
Activity flowcharts used to identify value-added and non-value- added activities Inc in invento: • Widely used in service industries, especially professional firms
production>sales Step 1: Determine a
• Absorption-costing net charge for labour time
income greater than • Express as a rate per
variable-costing hour of labour; rate
Use ABC When One or More of the Following Exist: • With absorption costing, includes: o Direct labour
• Product lines differ greatly in volume and manufacturing complexity • Products lines are numerous, a portion of the period's cost of employees and
diverse and require different degrees of support services • Overhead costs are a significant portion of total fixed manufacturing benefit costs
costs • Significant change in manufacturing process or number overhead remains on the o Selling, administrative,
of products • Managers ignore data existing system and instead use “bootleg” costing data balance sheet in inventory. and similar overhead costs o Allowance for desired profit (ROI) per labour hour
Major difficulty in implementing ABC (services): A larger proportion of overhead costs are company- Decrease in inventory: • Labour rate for Lake Holiday Marina for 2022 based on:
wide costs that cannot be directly traced to specific services (e.g., it would be difficult to define precise sales > production Step 2: Calculate the
drivers for company-wide costs) • Under absorptioncosting, Material Loading
Chapter 4: Process Cost Accounting units manufactured in the Charge
Nature of Process Cost Systems: Process Costing for Manufacturing prior period are sold, • Added to materials
• Used to apply costs to similar products are mass (homo) produced in a continuous fashion resulting in an amount invoice price to establish
• An average cost is calculated for all units of a product produced in a specific time period greater than the current materials price
• Examples include the production of cereal, paint, and soft drinks period's fixed mfg • Must cover cost of
• Each unit goes through at least two identifiable production processes, with each unit consuming the overhead flowing through purchasing, receiving,
same amount of direct materials, direct labour and overhead. to COGS. handling, storing and
Nature of Process Cost Systems: Similarities/Differences Between Systems Which NOT be desired materials profit margin on
• Same manufacturing cost considered a period cost • Expressed as a percentage of estimated annual parts and materials cost:
elements: DM, Direct Labour, on an absorption costing (Estimated purchasing, receiving,handing, storing costs + Desired profit margin on materials)/
Manufacturing Overhead (MO) income statement? Estimated costs of parts/materials
• Similar accumulation of costs: A. Both variable and - bill: Rate charge per hour of labour * hours + part costing + part costing * material loading %
Debit raw materials purchases to fixed manufacturing overhead costs B. Fixed marketing and sales costs Transfer Pricing for Internal Sales price used to record the transfer between two divisions of a company
RMaterials Inventory; Debit C. Administration costs D. Variable marketing and sales costs • Vertically integrated companies – grow in the direction of their customers or supplies
factory labour costs to Factory - COGS = Beg inventory + Production – Ending inventory • Frequently transfer goods to other divisions as well as outside customers: o Divisions will ‘purchase’
Labour; De mfg overhead costs - |Change in Net Income| = |Change in Inventory| x FMOH per unit from another division rather than purchase from an outside source o Keeps company’s labour force
Mfg Overhead account <=> |NIAC – NIVC| = |Units in Ending -Invento – Units in Beginning Inventory| x FMOH per unit productive o Utilizes any available or spare capacity o Ensures in-house quality control
• Same flow of costs: WIP Inventory, Finished Goods Inventory, and Cost of Goods Sold OR |NIAC – NIVC| = |Units Produced – Units Sold| x FMOH per unit OR A firm’s transfer price policy should accomplish three objectives:
Operations Costing: A combination of a process costing and a job-order cost system = |FMOH in Ending Inventory – FMOH in Beginning Inventory| • Promote goal congruence – promote maximization of company’s earnings as a whole plus allow each
Flow and Assignment of Manufacturing Costs: - FMOH per unit = Total FMOH /Total Units Produced manager to make decisions that maximize division earnings
- Direct Material Costs: Process costing system requires fewer raw material requisitions than a job order Firms must prepare income statements and balance sheets in accordance with financial accounting • Maintain divisional autonomy. • Provide accurate performance evaluation
cost system. o Direct materials are used for processes not specific jobs standards that require the use of: absorption costing • Formula provides the minimum acceptable transfer price for the ‘selling’ division
o Requisitions are for larger quantities of direct materials Normal-Absorption Costing • The maximum acceptable transfer price for the ‘purchasing’ division is the external price (if available)
- Factory Labour Costs: Time tickets used in both systems o In process costing DL time and cost is not • Method for allocating overhead costs using an estimated allocation rate and actual quantity of the • Available capacity plays a role in determining the transfer price.
separated by job, rather by the time spent in a department or process allocation base. o Normal-absorption costing uses an estimated, rather than an actual, denominator level No Excess Capacity: the transfer would ‘take away’ the contribution margin (CM) earned from any
- Manufacturing Overhead Costs: Objective of assigning overhead – allocate overhead to departments for the overhead cost allocation base. o If an actual denominator level is used, information is not timely. lost external sales. The lost CM is the opportunity cost of the transfer & becomes part of the transfer price
on an objective and equitable basis o Use the activity that “drives” or causes the costs o Machine time - Direct Materials = Actual quantity used × Actual cost There is Excess Capacity: there is no opportunity cost, as there are no lost external sales
used – primary driver in continuous mfg operations; widely used. - Direct Labour = Actual quantity used × Actual cost
Equivalent Units: measure of work done during period, expressed in fully completed units - Manufacturing Overhead = Actual quantity of cost driver used (# unit produced) × POR
o Allows for partially completed units to be considered - Predetermined overhead rate POR = Budgeted overhead cost/Budgeted cost driver units
• Used to determine the cost per unit of the completed product Production Volume Variance actual production deviates from budgeted production level
• Key difference between the two methods is how beginning work in process units are treate o Happens only when absorption costing is used
Equivalent Units: Weighted-Average Method • Typically written off to cost of goods sold
• Considers the degree of completion (weighting) of units completed and transferred out and units in • Actual production > budgeted production variance will be favourable => Variance will reduce COGS Three approaches to
ending work in process inventory • Actual production < budgeted production variance will unfavourable => Variance will incr COGS determine a transfer price:
• Beginning work in process inventory is not part of the calculation of equivalent units. Throughput Costing (super-variable costing) • Negotiated transfer price
• Weighted average considers only the work completed in the current period • Only direct materials are determined by agreement of
▪ Direct materials and Conversion considered separately product (inventoriable) costs division managers when no
• Conversion costs – sum of direct labour costs and manufacturing overhead costs (DL and all mfgoverhead are external market price
- Equivalent Units of Production = Units Completed & Transferred Out + Equivalent Units of period costs) • Conceptually - a negotiated transfer price is best
Ending in WIP (nhớ x %) • 2 criteria should met b4 • Due to practical considerations, the other two methods are more widely used
- Beginning WIP + Units Started = Transferred Out + EWIP implementing Negotiated Transfer Price
Assign costs to (1) units completed and (2) EU in Ending WIP: 1. Companies engaged in a No excess capacity: Minimum transfer price = $18 = 11+7
(1) Cost/EU x Units completed (2) Cost/EU x EU in End WIP (separately for DM&CC) mfg process in which Maximum price Boot will accept = current external purchase price of $17
Production Cost Report: Management report to understand department activities. Prepared for each conversion costs such as • Minimum price is greater than maximum price. Transfer not take place as firm will be worse off.
department and shows: Production quantity; Cost data direct labour and mfg Excess capacity: Minimum transfer price = $11 + 0 = 11
Step 1: Calculate Physical Unit Flow overhead are fixed costs and Maximum price Boot will accept = current external purchase price of $17
• Physical units: Actual units to be accounted during a period, regardless of work performed do not vary proportionately • Minimum price is less than the maximum price. Transfer should take place as firm will be better off.
• Total units to be accounted for: Units started (or transferred) into production during period + with the units of production. • Negotiate a transfer price between $11 and $17
units in production at beginning of period Assembly-line and continuous processes that are highly automated are most likely to meet this criterion. The minimum transfer pricing formula can still be used – just use the internal variable costs
• Total units accounted for: Units completed & transferred out during period + units in 2. Management needs cost information for short-term, incremental analysis decisions Opportunity cost if units sold are unequal to units forgone:
production at end • Throughput costing income statements used for internal purposes only. o Gross profit and contribution
- ((Selling Price – variable cost) * units forgone) / units transfer internally = opportunity cost
of period margin replaced with Throughput Margin (or Throughput Contribution Margin) Potential problems with negotiated approach: o Market price information may not be available
Step 2: Calculate Produced > sale => Variable cost > Throughput costing o Lack of trust between the two divisions o Different pricing strategies between divisions
Equivalent Units of Chapter 9: Pricing
• Companies may then use cost or market-based information to develop transfer prices
Production Target Costing: cost that yields the desired profit when the seller does not control the product’s price Cost-Based Transfer
Step 3: Calculate • Traditionally price was set at: Price = Cost + Profit Margin Prices* Uses costs
Unit Production Costs • In a highly competitive market, price is largely determined by supply and demand incurred by the
• Costs expressed in terms of equivalent units of production • When equivalent units of production are Market Price − Desired Profit = Target Cost division producing the
different for direct materials and for conversion costs, three separate unit costs are calculated: o Direct Target Costing Comparison goods as the cost base
Materials o Conversion o Total Manufacturing Target Costing: Firm becomes a price taker. Price is set by the market, not by the firm. Cost is the • May be based on
variable costs or variable plus fixed costs and Markup. • Can result in improper transfer prices causing: o Financial Budgets o Capital Expenditure Budget o Budgeted Balance Sheet BUT, RI encourages managers to accept any project that earns more than the cost of capital and helps
Loss of profitability for company o Unfair evaluation of division performance o Cash Budget: Considered the most important budget as no business is sustainable without cash. Often avoid short-sighted decision-making based on protecting ROI percentages
If the transfer price is based on variable cost and there is no excess capacity the most overlooked budget - Controllable Margin – (Minimum Rate of Return * Average Operating Assets) = Residual Income
• Sole Division – no profit on transfer of 10,000 soles and loses profit of $70,000 ($7 CM per unit sold Cash Budget Reports anticipated cash flows Chapter 12: Standard Costs and Balanced Scorecard
externally x 10,000 units) on external sales. • Prepared at least monthly to assist in overall cash manage: Help plan short financing needs or repayment The Need for Standards: standard costs are predetermined unit costs that used measures of performance
• Boot Division increases contribution margin by $6 per sole ($60,000 total). • Contains three sections: 1. Cash receipts 2. Cash disbursements 3. Financing • Standards: o Used in business settings to establish consistent practices o E.g.: quality control standards;
• company lost $70,000 CM in Sole Division, but only gained $60,000 from Boot Division. • Includes beginning and ending cash balances • Standard costs: o A predetermined unit cost ▪ Example: company determines widget produced cost $6.23
Sole Division has excess capacity: Cash receipts section • Includes expected receipts from principal sources of revenue – cash sales and Distinguishing Between Standards and Budgets
• Sole division continues to report a zero profit on these 10,000 units but does not lose the $7 per unit collections on credit sales • Includes any other expected cash inflows: o interest and dividend receipts • Standards and budgets are both: o Pre-determined costs o Play a role in management planning, control
(because it had excess capacity). o proceeds from planned sales of investments, plant assets, and share capital • A standard is a per unit amount where a budget is a total amount
• The boot division gains $6. So overall, the company is better off by $60,000 (10,000 × $6). Cash disbursements section • Includes expected cash payments for: o Direct material purchase (typically • Standard costs may be incorporated into a cost accounting system
• However, with a cost-based system, the sole division continues to report a 0 profit on these 10,000 units. accounts payable payments) o Direct and indirect labour costs, fixed and variable overhead costs o All o E.g. standard cost for each unit produced is recorded as the inventoriable cost regardless of actual cost
• Advantages o Simple to understand o Easy to use due to availability of information o Market other period expenses o All other non expense disbursements including income tax instalments, dividends,Setting Standard Costs o Requires input from all persons who have responsibility for
information often not available plant assets acquisitions, investment purchases costs and quantities o Standards costs need to be current and should be under continuous review
• Disadvantages o Does not reflect a division’s true profitability o Does not provide an incentive to Financing section • Shows expected borrowings and repayments of borrowed funds plus interest o Funds • Two levels of standard costs: 1. Ideal standards: optimum level of performance under perfect operating
control costs which are passed on to the next division will need to be borrowed when there is a cash deficiency or when the cash balance below management’s conditions. Can be demotivating. 2. Normal standards: efficient levels of performance attainable under
Market-Based Transfer Prices Based on actual market prices of competing products minimum required balance o Borrowed funds can be repaid when there is a cash surplus, or the cash expected operating conditions (rigorous but attainable). Usually used.
• Often considered best approach because: o Objective o Economic incentives balance is greater than the minimum required cash balance Direct Materials Price Standard cost per unit of direct materials that should be incurred
• Indifferent between selling internally and externally if the market price is used Which one of the following items would NEVER appear on a cash budget? Depreciation expense • Based on the purchasing department’s best estimate of the cost of raw materials
• Can lead to bad decisions if there is excess capacity bc No opportunity cost. Financial Budgets Budgeted Balance Sheet a financial statement that provides a snapshot of a o When actual cost is known and is significantly and permanently different from the best estimate the
Transfers between divisions located in countries with different tax rates: a. simplify the determination of company's financial position at a specific point in time. It shows what a company owns (assets), what it standard should be reviewed
the appropriate transfer price. b. are decreasing in number as more companies "localize" operations. owes (liabilities), and the owners' equity (the residual interest in the assets after liabilities are deducted). • Includes related costs such as receiving, storing, and handling
c. encourage companies to report more income in countries with low tax rates • Developed from the budgeted balance sheet for the preceding year and the budgets for the current year • Quantity standard is amount direct materials that should be used per unit of finished product or service
Chapter 10: Budgetary Planning o Net income from the Budgeted Income Statement is added to the beginning balances for RE • Includes allowances for unavoidable waste and normal spoilage
Budgeting Basics and the Master Budget o Finished Goods Inventory is taken from the Production Budget - Standard DM Price (SP) × Standard DM Quantity (SQ) = Standard Direct Materials Cost
• A budget is a formal written statement of management’s plans for a specified future time period, o Building and equipment accounts are updated using information from the Capital Expenditure Budget Direct Labour Price Standard • Rate per hour that should be incurred for direct labour • Based on
expressed in financial terms; is a primary way to communicate agreed-upon objectives to all parts of the Assets= Liabilities + Shareholders’ Equity current wage rates adjusted for anticipated changes, such as cost of living adjustments
company; Tool management may use to promote efficiency and discourage waste; is an important basis Shareholders’ Equity: net worth of the company, showing what remains for shareholders if all liabilities • Includes employer payroll taxes (income tax, CPP, EI), benefits: holidays, paid vacation, and insurance
for performance evaluation once adopted; Historical accounting data on revenuesresponsibility were paid off. Captures both external investments and internally accumulated value • Quantity Standard: Time should required to make one unit of product under normal operating conditions
• Budgeting benefits: Requires all management levels to plan ahead and formalize goals on a recurring Retained earnings: cumulative amount of the company’s profit that management projects will remain in • Standard quantity should include allowances for: o Normal rest periods (e.g. coffee breaks)
basis; Provides definite objectives for evaluating performance at each level of responsibility; Creates an the business at the end of the budget period (rather than being distributed to shareholders as dividends) o Cleanup and regular maintenance o Machine setup and downtime
early warning system for potential problem; Facilitates coordination of activities within the business; Budgeting for Merchandisers • Sales Budget: starting point and key factor in developing master budget • Critical in labour-intensive industries
Results in greater management awareness of the entity’s overall operations and the impact of external • Use a purchases budget instead of a production budget • Does not use the manufacturing budgets (direct - Standard Direct Labour Rate (SP) × Standard Direct Labour Hours (SQ) = Standard DL Cost
factors; Motivates personnel throughout organization to meet planned objectives materials, direct labour, and manufacturing overhead) • To determine budgeted merchandise purchases: Manufacturing Overhead Standard a standard
•A budget is an aid to management not a substitute for management Budgeted COGS + Desired End Mer. Inven – Beg Merchandise Inven = Required Mer. Purchases predetermined overhead rate is used
• May be prepared for any period of Chapter 11: Budgetary Control and Responsibility Accounting
time: Most common - one year; Static Budget Reports • Projection of budget data at a single given level of activity => litmitation
Supplement with monthly and o Typically uses the activity level from the master budget o Ignores data for different levels of
quarterly budgets; Different budgets activity
may cover different time periods • Compares actual results with budget data from the static or master budget o The predetermined rate =
• Long enough to provide an o A variance is considered unfavourable if the difference between actual and budgeted reduces OI budgeted overhead
attainable goal and minimize o A variance is considered favourable if the difference between actual and budgeted inc or adds to OI costs/expected standard
seasonal or cyclical fluctuations • Appropriate for evaluating a manager’s effectiveness in controlling costs when: activity index (normal capa
• Short enough for reliable estimates o Actual level of activity closely approximates the master budget activity level ▪ Activity index based on normal capacity: The average activity output the company expects to experience
• Continuous twelve-month budget: Drop the month just ended and add a future month; Keeps o Behaviour of the costs is fixed in response to changes in activity over the long-term
management planning a full year ahea • Appropriate for fixed manufacturing and SG&A costs o Examples: Standard direct labour hours and standard machine hours.
Participative Budgeting (bottom-up) • Difficult to evaluate performance when reporting variable costs • Activity-based costing (ABC) can be used with standard costing
• Overall goal: produce a budget considered fair & achievable by managers while meeting corporate goals Flexible Budgets budget data for various levels of activity (a series of static budgets at dif activity levels) Analyzing and Reporting Variances from Standards
• Risk of unreliable budgets greater when they are “top-down”: No real buy-in from lower-level managers • Budgetary process more useful if it is adaptable to changes in operating conditions - Materials Variance + Labor Variance + Overhead Variance = Total Variance
Advantages:• More accurate budget estimates: lower-level managers have more detailed knowledge of • Can be prepared for each type of budget in the master budget • Direct labour variance is made up of a Rate Variance and a Quantity Variance
their area. Tendency to perceive the overall process as fair due to involvement of lower-level management • Assists management is analyzing and controlling variable costs Actual Quantity is the standard quantity allowed for the actual output.
Disadvantages: • time consuming&costly; • Foster budgetary “gaming” through budgetary slack: When Note the actual volume compared to budgeted volume o With higher volume one expects higher costs Direct material Variances
managers intentionally underestimate revenues or overestimate expenses => budget goals easier to meet o Only a flexible budget can show where costs have been saved, or not Total variance analyzed to determine amount that is attributable to price (costs) and to quantities (usage)
The Master Budget A set of interrelated budgets that constitute a plan of action for a specified time 1. Identify the activity index and the relevant range: - Total Actual Quantities (AQ) × Actual Price (AP) − Total Standard Quantities Allowed (SQ) ×
period • Contains two categories of budgets: o Activity index: direct labour hours o Relevant range: 8,000 – 12,000 direct labour hours per month Standard Price (SP) = Total Direct Materials Budget Variance (TDMBV)
o Operating budgets: Individual budgets that result in the preparation of the budgeted income statement 2. Identify the VC and determine the budgeted variable cost per unit of activity for each cost The total budget variance is a combination of the Price Variance and the Quantity Variance
o Financial budgets: Budgets that focus primarily on cash needs to fund operations and capital Variable cost per unit = Budgeted Cost/Budgeted Units - Total Actual Quantities (AQ) × Actual Price (AP) − Total Actual Quantities (AQ) × Standard Price
expenditure; Uses information from the operating budgets; Final budget prepared is the balance sheet Tính từng cost per unit cho từng line bằng ct trên xong nhân cho số lượng đề yêu cầu để ra chi phí (SP) = Materials Price Variance (MPV) = TAQ x (AP – SP)
Preparing the Sales, Production, and Direct Materials Budgets cho mỗi line cost => cộng lại hết với fix cost rồi chia với units yêu cầu => total cost per DLH - Total Actual Quantities (AQ) × Standard Price (SP) − Total Standard Quantities Allowed (SQ) ×
• Sales budget: Management’s best estimate of sales revenue for the budget period; Prepared by 3. Identify the fixed costs and determine the budgeted amount for each cost (chia 12 tháng) Standard Price (SP) = Materials Quantity Variance (MQV) = (AQ – SQ) x SP
multiplying expected unit sales volume for each product and anticipated unit selling price 4. Prepare the budget for selected increments of activity within the relevant range: Causes of Materials Variances: May be caused by a variety of factors, both internal and external factors
• Budgeted sales revenue dollars used in the Budgeted Income Statement and Cash Budget The Responsibility Accounting Concept • Investigating materials price variances begins in purchasing department (prices rise faster than expected)
• Budgeted unit sales used in the Production budget – which drives all other operating budgets • Involves accumulating and reporting costs on the basis of the manager who has the authority to make • Investigating materials quantity variance begins in the production department (E.g. faulty machinery,
Operating Budgets: Production day-to-day decisions about the cost items newer labour force unfamiliar with process)
Budget • A manager's performance is evaluated on the matters directly under the manager's control Direct Labour Variances QUANTITY=HOUR
• Shows the units that must be • May extend from the lowest levels of management to the top strata of management - Total Actual Hours (AH) × Actual Rate (AR) − Total Standard Hours Allowed (SQ) × Standard
produced in order to meet • Responsibility accounting useful at each level of management so long as the following exist: o Costs Rate (SR) = Total Direct Labour Budget Variance (TDLBV)
budgeted sales and invent targets and revenues can be directly associated with the specific level of management responsibility o - Total Actual Hours (AH) × Actual Rate (AR) − Total Actual Hours (AH) × Standard Rate (SR) =
• Production budget drives the controllable at the level of responsibility with which they are associated o Budget data can be developed Labour Price Variance (LPV) = AH x (AR – SP)
materials, direct labour and for evaluating the manager's effectiveness in controlling the costs and revenues - Total Actual Hours (AH) × Standard Rate (SR) − Total Standard Hours Allowed (SH) × Standard
manufacturing overhead budgets • Responsibility accounting especially valuable in a decentralized company where control is delegated to Rate (SR) = Labour Quantity Variance (LQV) = (AH – SH) x SR
• Production budget does not managers throughout the organization Causes Of Labour Variances: • Labour price variances usually result from either: Pay workers higher
include dollar values – only units • Key dif between responsibility accounting&budget reporting: o Responsibility accounting distinguishes than expected, or Misallocating workers (for ex., using skilled workers in place of unskilled workers)
- Expected Sales Units + Desired Ending Finished Goods Units – Beg Finished Goods Units = controllable and noncontrollable costs and revenues o Responsibility accounting reports only those items • Labour quantity variances relate to the efficiency of workers and are usually related to the production
Required Production Units under a manager’s specific control; where budget reports all items for that department or product department: Other causes include quality of the materials used; condition of equipment used, newly hired
Operating Budgets: Direct • Applies to both profit and not-for-profit entities: employees are not properly trained; Poor scheduling and carelessness on the part of management.
Materials Budget reports o Profit entities: maximize net income o Not-for-profit: minimize cost of providing services Total Overhead Variance: The dif between actual overhead costs incurred and overhead applied based
three key pieces of information Controllable versus Noncontrollable Revenues and Costs • All costs and revenues can be controlled: on standard cost drivers units (i.e. labour or machine hours) allowed for the amount of units produced
o Units DM needed to meet Someone at some level is responsible for making decisions about each revenue and cost item - Actual Overhead − Overhead Applied (Total Standard Hours Allowed (SH)* × Standard Rate
production&inven needs: • As one moves down the levels of management, control diminishes (SR)) = Total Overhead Variance (TOHV)
Target ending inventory for • Controllable costs – costs incurred directly by a responsibility level and are controllable at that level Variable - Actual Variable Overhead − Variable Overhead Applied (Total Standard Hours Allowed
DM key component to the DM • Noncontrollable costs – costs indirectly incurred and allocated to a responsibility level, where manager (SH)* × Standard Rate (SR)) = Total Variable Overhead Budget Variance (TVOHBV)
budget o DM to be purchased has no decision over the allocation - Actual Variable Overhead − Total Actual Hours at Standard Variable Overhead Rate (AH) × (SR)
o Cost of the direct materials Principles of Performance Evaluation = Variable Overhead Spending (Price) Variance (VOHSPV)
to be purchased which is also part of the Cash Flow Budget Management by Exception - Total Actual Hours at Standard Variable Overhead Rate (AH) × (SR) − Total Standard Hours
- Units to Be Produced × Direct Materials per Unit Produced = DM Units Required for Production • Investigate only material and controllable differences: o Materiality often expressed as a certain Allowed at Standard Variable Overhead Rate (SH) × (SR) = Variable Overhead Efficiency Variance
- Direct Materials Units Required for Production + Desired Ending Direct Materials Units – percentage difference from budget o Controllability relates to those items controllable by the manager • The TVOHBV shows if variable overhead costs are being effectively controlled. Does not however
Beginning Direct Materials Units = Direct Materials Units to Be Purchased Performance reports should: 1. Contain only data controllable by the responsibility show the source of the variance
- DM Units to Be Purchased × Cost per Direct Materials Unit = Cost of Direct Materials Purchase centre manager in the report 2. Provide accurate and reliable budget data 3. Highlight material dif • Separating TVOHBV into a spending (price) variance and an efficiency (quantity) variance will show if:
Preparing the Direct Labour, Manufacturing Overhead, and S&A Expense Budgets between budget and actual 4. Be tailor-made for the intended evaluation 5. Be prepared at reasonable o More, or less, overhead costs were incurred than budgeted (spending variance); or
• DL and mfg overhead intervals o More, or less, activity base was used than standard allowed for the output achieved (efficiency variance)
budgets are based on the Types of Responsibility Centres • Variable overhead Spending variance = |Actual Rate – Standard Rate| x Actual Quantity of
production budget: No 1. Cost centres - Responsible for Costs/Expenses: o No decision-making authority for any revenue or cost driver
inventories to account for sales related items o Example: Production centre or service department (indirect M, indirect L, utilities,..) • Variable overhead Efficiency variance = |Actual Quantity of cost driver – Standard Quantity of
• Manufacturing overhead: • Based on a manager’s ability to meet budgeted goals for controllable costs cost driver| x Standard Rate
distinguishes between fixed • Results in responsibility reports which compare actual controllable costs with flexible budget data: Fix Fixed overhead standard budget = Budgeted fixed overhead = PFOHR × Normal Capacity
and variable overhead costs o Include only controllable costs in reports o No distinction between variable and fixed costs Hours (for period of interest). essentially the fixed overhead we budgeted for before the period.
o Applies whether traditional 2. Profit centres - Responsible for Revenue and Costs/Expenses: o No decision-making authority for • Applied Fixed Overhead (to WIP) = fixed overhead budgeted for standard hours allowed: PFOHR
or activity-based costing capital or investment decisions o Example: Individual retail store, bank branch × Standard Activity allowed for actual output (depends on actual production).
methods are applied • Based on detailed information from both controllable revenues and controllable costs - Actual Fixed Overhead − Fixed Overhead Applied (Total Standard Hours Allowed (SH) x
• Sales and administrative • Manager controls operating revenues earned, such as sales: Sales authority may include such things as Standard Rate (SR)) = Total Fixed Overhead Variance (TFOHV)
(S&A) expense budget not price, quantity, and customer - Actual Fixed Overhead Costs − Fixed Overhead Master Budget (Static Budget) (Normal Capacity
directly based on production • Manager controls all variable costs (and expenses) incurred by the centre because they vary with sales: Hours x Standard Fixed Overhead Rate (NCH) × (SR)) = Fixed Overhead Spending Variance
budget May include fixed costs if the manager has decision making authority - Fixed Overhead Master Budget (Static Budget) (Normal Capacity Hours at Standard Fixed
Operating Budgets: Direct • Reports only controllable budgeted and actual revenues and costs Overhead Rate (NCH) × (SR)) − Fixed Overhead Applied: (Total Standard Hours Allowed at
Labour • Prepared using the cost-volume-profit (CVP) income statement format: Standard Fixed Overhead Rate (SH) × (SR)) = Fixed Overhead Volume Variance (produced more)
- Units to Be Produced × o Controllable contribution margin = Controllable revenues - variable costs • Spending or Budget Variance = |Actual Fixed OH – Budgeted Fixed OH |
DL Hours per Unit × DL o Controllable margin = Contribution margin - controllable fixed costs • Volume Variance = | Budgeted Fixed OH – Applied Fixed OH | = |(PFOHR × Normal capacity
Cost per Hour = Total ▪ Provides the best measure of manager’s performance in controlling revenues and costs activity (for period of interest)) – (PFOHR × Standard Activity allowed (depends on actual
Direct Labour Cost o Noncontrollable fixed costs are not reported (Allocated head office costs and manager’s production)) | = | Normal
salary) capacity activity – Standard
3. Investment centres - Responsible for: Revenue, Expenses and Return on Investment o Have Activity allowed| × PFOHR
decision-making authority for investm, fixed asset acquisitions/disposals o Example: Subsidiary Manufacturing overhead
company costs are applied to work in
Operating Budgets: Budgeted Income Statement Controllable (operating) Margin  Average Operating Assets = Return on Investment (ROI) process based on: actual
- Cost of goods sold = units sold*unit cost (DM + DL + mfg OH) (nhớ nhân quantity cho unit cost) = Profit Margin => Operating Income/Sales × Investment Turnover => Sales/Operating Assets hours worked.
Expenses typically not on S&A budget: interest expense; income taxes; miscellaneous or other revenue Alternative Measures of ROI Inputs Expected sale + desired
• Valuation of operating assets: o May be valued at acquisition cost, book value, appraised ending for Inv – Beg for Inv =
value, or market value o Whichever valuation is chosen should be used consistently from year to year Reuired production units
• Margin (income) measure: o May be controllable margin, income from operations, or net income o Best
option is controllable margin; the other two will include noncontrollable revenues and costs
Residual Income Compared to ROI (Purpose: To evaluate management performance)
• Use the residual income approach to evaluate performance using the minimum rate of return
• Residual Income: The income that remains after subtracting from controllable margin the minimum rate
of return on average operating assets
Managers are often evaluated and rewarded based on how high their division’s ROI is. But this creates a
perverse incentive: A manager might reject a profitable investment just because it would lower their
division’s ROI, even if it would increase the company’s total profit.