F2- MANAGEMENT ACCOUNTING KHOA KẾ TOÁN VÀ KIỂM TOÁN TRƯỜNG ĐẠI HỌC NGOẠI THƯƠNG Bộ môn Kế toán quản trị Part B: Cost accounting techniques 01 Material cost 02 Labor cost 03 Overheads cost 04 Marginal and absorption costing 05 Job, batch and service costing 06 Process costing 07 Alternative costing techniques Part B-1 MATERIAL COST Ordering and accounting for inventory Re-order quantities and re-order levels Ordering and accounting for inventory ❑ Inventory ❑ Accounting procedures for ordering and issuing inventory ❑ Recording of Inventory ❑ Physical inventory and book inventory Inventory ❑ Types of inventory: RM (raw materials), FGs (finished goods), WIP (work in progress), consumables/tools & supplies ❑ Control over inventory: ➢ Ordering ➢ Purchasing ➢ Receipt ➢ Storage ➢ Issue ➢ Maintenance of Inventory at the most appropriate level Accounting procedures for ordering and issuing inventory ❑ Inventory ordering: • Departments requires new material by sending Purchase request to Purchasing department Ordering • < authorized purchase request> • Purchasing department send Purchase Order (PO) to: • Suppliers Purchase • Accounting department order • Good receiving departments (stores) • Suppliers receive POs → Quotation → Contract → prepare to deliver goods • Suppliers deliver goods with Goods Delivery Notes (GDNs) Goods • Goods receiving department (store) will check the goods received with GDN and PO. Good Receipt delivery Notes (GRNs) are updated and then the copies are sent to Purchasing and Accounting departments • Purchasing department will monitor GRNs with PO to supervise the PO status • Invoice sent from suppliers directly to Accounting department for payment Invoices • Invoice, GRN and PO are matched (3-way match) at Accounting dept. to ensure proper quantity and price. Accounting procedures for ordering and issuing inventory ❑ Inventory issuing: Material requisition notes •Authorize store keepers to release RM •To update store records Material returned notes Material transfer notes •Record unused RM returned to stores •To update store records •Transfer materials from one department to another •To update store records Recording for inventory ❑ Debit Inventory a/c: Purchase, Return to stores ❑ Credit Inventory a/c: Issuing, Return to suppliers Inventory valuation: FIFO, WAC, LIFO ➢ FIFO: assumes that materials are issued to out of stock in the order in which they were delivered into inventory. ➢ WAC: values all items of inventory and issues at an average price. The average price is calculated after each receipt of goods. ➢ LIFO: assumes that materials are issued out of inventory in the reverse order to which they were delivered into inventory. Recording for inventory ❑ The following transactions occur during May 2017 related to item A: Opening balance + Purchasing = Issuing +Closing balance Quantity units Unit cost £ Total cost £ Opening balance, 1 May Receipts, 7 May 100 400 2.00 2.10 200 840 => Closing at 7 May Issues, 11 May 500 200 =(200+840)/500=2.08 2.08 1.040 416 => Closing @ 11 May 300 2.08 624 Receipts, 16 May 300 2.12 636 => Closing @ 16 May Issues, 21 May 600 400 =1,260/600=2.1 2.1 =624+636=1,260 840 Closing balance, 31 May Total 200 2.1 420 1676 Recording for inventory ❑ FIFO method- the cost of issues and closing inventory value would be: Quantity unit cost Total cost units $ $ Issues, 11 May 200 Issues, 21 May Closing balance, 31 May 400 100 at $2 100 at $2.1 300 at $2.1 100 at $2.12 200 200 at $2.12 $410 $842 $424 1676 Recording for inventory ❑ LIFO method- the cost of issues and closing inventory value would be: Quantity unit cost Total cost units £ £ Issues, 11 May 200 $420 Issues, 21 May Closing balance, 31 May 400 200 at $2.1 300 at $2.12 100 at $2.1 100 at $2.1 100 at $2.0 200 $846 $410 1676 Recording for inventory ❑ WAC method- the cost of issues and closing inventory value would be: Quantity unit cost Total cost Inventory balance units $ $ units $ Issues, 11 May 200 $1040/500= $2.08 416 300 624 Issues, 21 May Closing balance, 31 May 400 $(624+636)/600= $2.1 840 200 420 200 $2.1 420 200 420 1676 Inventory balance Physical inventory and book inventory Perpetual inventory vs. Periodic inventory ❑ Perpetual inventory: Inventory is continuously updated. It is the recording as they occur of receipts, issues and the resulting balances of individual items of inventory in ether quantity or quantity and value ➢ Inventory records are updated using stores ledger cards and bin cards, which show the records of receipts, issues and balances of the quantity (bin cards) and value (stored ledger cards). ❑ Periodic inventory: Inventory is counted at the end of period and then recorded accordingly. It records inventory purchase or sale in "Purchases/sales" account. ➢ “Sales, Purchases" accounts are updated continuously ➢ Inventory subsidiary ledger is not updated after each purchase or sale of inventory. Inventory quantities are updated on a periodic basis. Physical inventory and book inventory Stock taking ❑ Definition: Stocktaking process involves: checking the physical quantity of inventory held on a certain date and check this balance against the balances on the store ledger cards or bin cards. ❑ Method: ➢ Period stocktaking: count every item of inventory at the same date (usually at the balance sheet date) ➢ Continuous stock taking: count selected items of inventory on a rotating basis. Each item is checked at least once a year with a valuable items being checked more frequently Order quantities and reorder level ❑ Costs of maintaining inventory ❑ Economic order quantity ❑ Gradual replenishment of inventory ❑ Inventory control levels Inventory costs ❑ Types of inventory costs ➢ Holding costs ➢ Ordering/procurement costs ➢ Stock-out costs ❑ Reasons of maintaining inventory Reasons of maintaining inventory Sufficient goods available to meet expected demand Avoid future shortages Prevent hold-ups in the production process Take advantage of bulk purchases discounts Inventory costs Holding costs ❑ Costs associated with holding inventory are known as holding costs ❑ Holding cost included: ➢ Interest on capital tied up in inventory ➢ Cost of storage space ➢ Cost of insurance ➢ Out of date costs ➢ Deterioration: disposal cost for unusable inventory ❑ Holding cost can be distinguished between fixed holding costs and variable holding costs ❑ It is often stated as being valued at a certain percentage of the average inventory held. Inventory costs Ordering/procurement costs ❑ Ordering/procurement costs: are the costs associated with placing orders. They include: ➢ Administrative costs: are usually a fixed cost per order. The total admin costs of placing orders will increase in proportion to the number of orders placed. >>> Variable costs ➢ Delivery costs: are usually a fixed charge per delivery (order). The total delivery costs will also increase in direct proportion to the number of deliveries in the period. >>> Variable cost Inventory costs Stock-out costs Stock-out costs The costs are associated with running out of inventory and they include loss of sales, loss of customers and reduced profit Inventory costs ❑ Stock control and inventory costs ➢ Low inventory level: decrease holding cost vs. increase ordering costs + increase risk of stock-out. ➢ High inventory level: decrease ordering costs + decrease risk of stock-out vs. increase holding cost ➢ So, it should maintain inventory at a level (optimum level) where the total of holding costs, ordering costs and stock-out costs are at minimum. This is the main objective of stock/ inventory control. Economic order quantity ❑ EOQ is the re-order quantity which minimizes the total costs associated with holding and ordering stock = holding cost + ordering costs are at a minimum at the EOQ ❑ Graph: ➢ TAC reach minimum at point: Holding cost= ordering cost EOQ= √(2CoD/Ch) • D= demand during time period (per annum) • Co= cost of placing one order from supplier • Ch= cost of holding one unit for one time period ( one year) • EOQ= Economic Order quantity Economic order quantity ❑ EOQ assumptions: ➢ Average inventory= Q/2 ➢ Total annual holding cost= Q/2*Ch ➢ The number of orders in a year= D/Q ➢ Total annual ordering cost = D/Q*Co → Total average costs TAC= D/Q* CO + Q/2*Ch Economic order quantity Economic order quantity ❑ EOQ with discount ➢ Discount for bulk orders ➢ Effect of quantity discount: ✓ The annual purchase price will decrease ✓ The annual holding cost will increase ✓ The annual ordering cost will decrease ➢ To establish whether the discount should be accepted or not: ✓ Calculate the TAC with the discount (including the purchase cost) ✓ Compare with the annual costs without the discount at EOQ point ➢ Steps: ➢ Calculate pre-discount (EOQ) level ➢ Calculate the total cost for the EOQ = the annual holding costs+ ordering costs + purchasing costs (at price pre-discount for bulk purchase) ➢ Calculate the total cost for a bulk purchase = TAC of the bulk quantity ➢ Compare the total costs in the two above cases → Select the min cost alternative. EBQ – Economic batch quantity ❑ EBQ: inventory to be replenished gradually instead of instantaneous by manufacturing their own products. EBQ is used to determine the quantity of units that can be produced at minimum average costs in a given batch or production run. ❑ Setup cost replaces ordering cost of EOQ ❑ Formula: EBQ = √(2CoD/[Ch(1-D/R)] ➢ EBQ= Economic Batch quantity (batch size) ➢ D= Demand of production per time period ➢ Ch= cost of holding one unit for one time period ➢ Co= cost of setting up a batch ready to be produced ➢ R= production rate per time period (replenishment rate) Gradual replenishment of inventory ❑ Producing large batches at long interval will lead to low machine setup costs (as fewer machines setups will be needed) and high holding costs ❑ Producing small batches at short interval will lead to high machine setup costs (as more machine setups will be needed) and low holding costs Inventory control level Inventory control level Max Min Average Free Reorder inventory inventory inventory inventory level level level level level Inventory control level ❑ Reorder level (RL): when inventory reaches the reorder level, a replenishment order should be placed ➢ RL= usage*lead-time (when demand in the lead time is constant) ➢ RL= max usage* max lead time (when demand in the lead time is not constant) ❑ Lead time= this is the time expected to elapse between placing an order and receiving an order for inventory ❑ Reorder quantity: when the reorder level is reached, the quantity of inventory to be ordered is known as the EOQ ❑ Demand: this is the rate at which the inventory is being used up = inventory usage Inventory control level ❑ Max inventory level: this is a warning level when inventory are dangerously high. Max inventory level = reorder level + reorder quantity – min usage*min lead time ❑ Min inventory level: this is a warning level when inventory are dangerously low and that stock-outs are potential threats. It is known as buffer inventory/safety inventory Min inventory level = reorder level – average usage*average lead time ❑ Average inventory = Reorder quantity/2+ min inventory ❑ Free inventory = physical inventory + inventory on order- inventory requisitioned (not yet issued) Part B-2 LABOR COST Direct and indirect labor cost Recording, calculating and accounting for Labor cost Remuneration method Labor turnover and Measuring labor activity Direct and Indirect labor cost Direct A part of the prime cost of a product Include basic pay of direct workers <Pay to employees who are directly involved in making a product> Indirect A part of overheads Include basic pay of indirect workers <Pay to employees who are not directly involved in making products> Bonus payment Idle time: workers are paid but not making any products Sick pay Pay for time spent by direct workers doing indirect jobs Recording, calculating and accounting for Labor cost Recording and calculating Labor cost ❑ Recording time spent doing jobs ➢ Time records: for payment, determining cost to be charged ✓ E.g.: Attendance record- show days absent or attend. ✓ E.g.: Time cards (gate or lock cards)- record time of arrival and departure. To be used in manufacturing industry ➢ Activity time record: ✓ Period related timesheets: commonly used in service industries, cover days/weeks/longer period ✓ Task related activity time records (job sheets, operation charts, piecework tickets) Recording, calculating and accounting for Labor cost Accounting for labor cost ❑ Direct labor: Dr WIP account Cr Wages control account ❑ Indirect labor: Dr Production overhead account Cr Wages control account ❑ Wages payment: Dr wage control account Cr Bank account Remuneration method Remuneration methods (1) Time work (2) Piecework scheme (3) Bonus/incentive scheme Wages = Hours worked x rate of pay per hour Wages = Units produced x rate of pay per unit (a) High day rate system (b) Individual/discretionary bonus schemes (c) Time saved bonus scheme (d) Group bonus schemes (e) Profit sharing schemes (f) Incentive schemes involving shares (g) Value added incentive schemes Labor turnover and measuring labor activity Labor turnover ❑ To measure proportion of people leaving relatively to the average number of people employed ❑ Causes: ➢ Avoidable causes: poor remuneration/working conditions, lack of training opportunities/promotion prospect ➢ Unavoidable causes: retirement, illness, death, family reasons Labor turnover and measuring labor activity Labor turnover ❑ Costs of labor turnover: ➢ Replacement costs: advertisement, selection, training costs, efficiency decreases ➢ Lower the performance of current employees ➢ Preventative costs: incurred to minimized Labor turnover, associated with escaping the avoidable causes: ✓ Increase wages ✓ Improve working conditions ✓ Increase training programs ✓ Promotion scheme ✓ Investigate high LT rate Labor turnover and measuring labor activity Measuring labor activity Production volume ratio = efficiency ratio x capacity ratio ❑ Efficiency ratio (Productivity ratio)= (Expected hours to make output)/(Actual hour taken) x 100% ➢ If the ratio > 100%: productivity is greater than expectation ➢ If the ratio < 100%: less than expectation, inefficient labor ❑ Capacity ratio= (actual hours taken)/(budgeted hours) x 100% ➢ If the ratio >100%: work above capacity ➢ If the ratio <100%: work below capacity ❑ Production volume ratio OR Activity ratio = (Expected hours to make output)/(Budgeted hours) x 100% ➢ If the ratio >100%: produce more than budget ➢ If the ratio <100%: produce less than budget Part B-3 OVERHEADS Overheads and cost categories review Absorption costing Under and over absorption of overheads Accounting entries Non-production overheads Overheads and cost categories review ❑ Overheads (OH) is the cost incurred in the course of making product, providing a service or running a department but cannot be traced directly and in full to the product/service/department ❑ Categories: Indirect Materials + Indirect labor + Indirect expenses ❑ Production OH: can be fixed or variable ❑ Non production OH include: ➢ Administration OH ➢ Selling OH ➢ Distribution OH ➢ Finance OH Overheads and cost categories review Why should OH be included in the total cost of product? Absorption costing ❑ Stock valuations •Include Fixed production OH in cost of product Marginal costing ➢ Closing stock figure in the balance sheet ➢ Cost of sales figure in the P&L account ❑ Pricing decisions ➢ If companies follow “full cost plus pricing” strategy. ❑ Establishing the profitability of different products. •Exclude fixed production OH in cost of product Absorption costing ❑ It is a method of sharing overheads between a number of different products on a fair basis. ❑ Objective: to include in the total cost of a product (unit or job) an appropriate share of the organization’s total overhead ➢ By an appropriate share, an amount that reflects the amount of time and efforts has gone into producing a unit or completing a job ➢ Closing stock in the balance sheet and the COGS in the P&L must be valued at full in PRODUCTION COST Absorption costing Stage 1: Allocation Stage 2: Apportionment Stage 3: Absorption Absorption costing Stage 1: Allocation ❑ Allocation is the process by which whole cost items are charged direct to a cost unit or a cost centre. Indirect materials, Indirect labors, Security guard, Depreciation, Rent, etc. Canteen Maintenance Machining Assembly Absorption costing Stage 2: Apportionment ❑ Apportionment is a process whereby indirect costs are spread fairly between cost centers. 2 stages: Apportionment Reapportionment Absorption costing Stage 2: Apportionment ❑ Basic of apportionment: apportion OH to Cost centers (production + service cost centers) Overheads Rent, rates, heating and light, repairs and depreciation of buildings Depreciation, insurance of equipment Personnel office, canteen, welfare, wages and cost office Heating and cooling Basic of apportionment Floor area occupied by each cost center Cost of book value of equipment Number of employees or labor hours worked in each cost center Volume of space occupied by each cost center Absorption costing Stage 2: Apportionment ❑ Basic of reapportionment: apportioning service cost centers’ overheads to the production cost center using appropriate bases Service departments Stores Maintenance Production planning Basic of apportionment Number of cost/value of material requisitions Hours of maintenance work done for each cost center Direct labor hours worked in each production cost center Absorption costing Stage 2: Apportionment ❑ Service cost centre costs may be apportioned to production cost centers by using one of the following methods: ➢ Direct method IGNORE reciprocal services (if any) Apportion service department costs only to production departments ➢ Step (down) method Services that do most work for other service departments are allocated first Reciprocal services (if any) are then ignored ➢ Reciprocal methods Give full recognition to reciprocal services Two methods ▪ continuous re-apportionment ▪ algebraic method Absorption costing Stage 3: Absorption ❑ Overhead absorption is the process whereby overhead costs allocated and apportioned to production cost centers are added to cost units, jobs or process costs using an appropriate basis ❑ A product cost can now be determined: Direct materials + Direct labor + Absorbed overhead Product cost Absorption costing Stage 3: Absorption OH absorption rate = Total budgeted overhead costs Total budgeted act. level ❑ Step 1: Estimate OH likely to be incurred during the period. ❑ Step 2: Estimate budgeted activity level for the period. (DLH, MH, …) ❑ Step 3: Divide the estimated OH by the budgeted activity level --> the OH absorption rate. ❑ Step 4: Absorb the OH into the cost unit by applying the calculated absorption rate. Overhead absorbed = OAR x Actual level of activity Absorption costing Stage 3: Absorption ❑ 3 methods of Absorbing Overhead Costs: Overhead can be absorbed into cost units in one of three ways Blanket absorption rate (Single factory rate) Separate absorption rates (Separate Departmental rates) Activity-based costing (later) Absorption costing Under/Over absorption of overheads ❑ Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates. Overhead is over absorbed Actual overhead costs incurred Overhead absorbed to Work in Process (OAR × Activity) Over absorption means that the OHs charged to the cost of sales are greater than the OH actually incurred. Actual OH 1000 Absorbed OH (1200) Over absorbed OH 200 Absorption costing Under/Over absorption of overheads ❑ Adjusting of Over absorbed and Under absorbed Overhead: --->Adjusting Cost of sales for under absorbed or over absorbed overhead Overhead is: Cost of sales is: Adjustment will: Actual overhead > Underabsorbed overhead absorbed Actual overhead < Overabsorbed overhead absorbed Too low Increase Cost of sales Too high Decrease Cost of sales Accounting entries ❑ Occurrence of overhead ➢ Dr Production overhead account ➢ Cr Inventory/ Wages control /Cash/Creditor accounts ❑ Absorption of overhead ➢ Dr WIP account ➢ Cr Production overhead account ❑ Over-absorption of overhead ➢ Dr Production overhead account ➢ Cr under/over absorbed overhead (P&L) ❑ Under-absorption of overhead ➢ Dr under/over absorbed overhead (P&L) ➢ Cr Production overhead account Part B-4 Marginal and absorption costing Recap of absorption costing Marginal costing definition and principles Absorption costing vs. Marginal costing Reconciling the profit figures given by 2 methods Recap of absorption costing Absorption costing (Full costing): ❑ The cost of a unit of product consists of: ➢ Direct materials ➢ Direct labor ➢ Manufacturing overheads Marginal costing definition and principles ❑ Marginal cost is the variable cost of one unit of product or service → would be avoided if that unit were not produced or provided. ❑ The cost of a unit consists of only variable (marginal) manufacturing costs: ➢Direct materials ➢Direct labor ➢Variable manufacturing overhead ❑ Contribution = sales revenue – variable costs of sales ❑ Fixed costs are treated as period costs and are charged in full to the PL account of the accounting period in which they are incurred. ❑ No distribution of fixed cost to cost of a unit is required. Marginal costing definition and principles ❑ No extra fixed cost incurred when output is increased ❑ By selling an extra item of product or service, the following will happen: ➢ Revenue will increase by the sale value of item sold ➢ Costs will increase by the variable cost per unit ➢ Profit will increase by the amount of contribution earned from the extra item Absorption Costing Marginal Costing Direct Materials Product Costs Direct Labor Product Costs Variable Manufacturing Overhead Fixed Manufacturing Overhead Period Costs Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Period Costs Absorption costing vs. Marginal costing Costs Material Purchases Balance Sheet Inventories Raw Materials Income Statement Expenses Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Selling and Administrative Work in Process Finished Goods Cost of Goods Sold Period cost Period Costs Reconciling the profit figures given by 2 methods Effect on profit of changing inventory levels ❑ Inventory values: AC > MC (always!) due to inclusion of fixed production costs ❑ Profit may be more or less or same under AC as for MC depending on change in inventory level ❑ A rule for exam purposes Inventory levels Effect on profit Closing = opening AC = MC Closing < opening AC < MC Closing > opening AC > MC Reconciling the profit figures given by 2 methods Difference in profits = change in inventory level * Fixed overhead AR per unit $ MC profit X Add: Fixed overhead in closing inventory (closing inventory units × fixed overhead per unit) X Less: Fixed overhead in opening inventory (opening inventory units × fixed overhead per unit) (X) AC profit ––– X ––– Reconciling the profit figures given by 2 methods Step 1 2 3 4 5 Absorption costing Calculate: OAR per unit = Budgeted OH/Budgeted units Calculate: Total cost per unit = variable cost + fixed production cost Calculate: Closing inventory in units = opening inventory + production - sales Calculate: Under/Over absorption of OH = Actual OH – Absorbed OH Produce income statement Marginal Costing Calculate: Total cost per unit = variable cost Calculate: Closing inventory in units = opening inventory + production - sales Produce income statement Part B-5 Job, batch, service costing Overview of costing techniques Job costing Batch costing Service costing Overview of costing techniques Costs: materials, labor, overheads Distribute OH to production cost per unit •Absorption costing •Marginal costing •ABC costing WIP Finish goods (FG) Capture cost to production cost per unit •Job costing •Batch costing •Service costing •Process costing Cost of goods sold (COGS) Job costing ❑ Is a form of specific order costing and it is used when a customer orders a specific job to be done ❑ Each job is price separately, often used cost plus pricing ❑ A wide range of “unique” products/jobs requiring different amounts of resource inputs ❑ Often requires highly skilled labor, creativity, advanced technology… Job costing ❑ Each order is costed separately using a “job card”/“job cost sheet” ❑ Direct costs: ➢ materials purchases (GRNs/suppliers’ invoices) ➢ materials issued by stores ➢ direct wages from time sheets ➢ other direct expenses from invoices ❑ Indirect cost (factory overhead) – usually at pre-determined overhead absorption rate ❑ Abnormal costs (e.g. rectification) are charged depending on cause ➢ to a job (e.g. change in customer specification) or ➢ to a separate account (e.g. a “write-off”) ❑ Potential problem Clerically expensive Batch (“Operation”) Costing ❑ Is a form of specific order costing which is very similar to job costing ❑ Each batch include a number of identical units but each batch will be different from each other ❑ Cost per unit in a batch = Total production cost of batch Number of units in batch ❑ Example: Engineering components industry, footwear and clothing manufacturing industry, etc. Service costing ❑ Used by a company operating in service industry or by company wishing to establish the cost of services carried out by some of their departments. ❑ Specific characteristics of service ➢ Simultaneity: cannot be divided ➢ Heterogeneity: quality varies each time ➢ Intangibility: no substance exists ➢ Perishability: cannot be stored ❑ Purpose of internal service’s calculation: ➢ Subsidize or not? How much? ➢ Use internal service or outsource? ➢ Control cost of both service department and using department Service costing ❑ Using a composite cost unit to measure service provided Service Road, rail and air transportation Hotels Education Hospital Catering establishment ❑ Cost per service unit = Cost unit Passenger/mile or km Occupied bed night Full time student Patient Meal served Total costs for period Number of service units in the period Part B-6 Process costing Process costing terms Normal and Abnormal gains/losses WIP/ equivalent units Joint costs & By products Framework to deal with process costing Process costing terms ❑ Used when mass production of many identical and indistinguishable products taken place. ❑ Output of one process forms the input of another process Process 1 Process 2 Process 3 ❑ Framework: 4 steps to deal with process costing ➢ ➢ ➢ ➢ Step 1: Determine output and losses Step 2: Calculate cost per unit of output, losses and WIP Step 3: Calculate total cost of output, losses and WIP Step 4: Complete account Normal and abnormal gains/ losses Normal losses ❑ Is the loss that is expected in a process and often expressed as a % of the materials input ❑ Average cost per unit = Total costs of inputs – Scrap value per unit * normal loss units Units inputs – Normal loss units ❑ If normal losses have no scrap value, it is recorded in Process a/c as nil. ❑ If normal losses have scrap value, it is recorded as a credit entry in Process a/c Normal and abnormal gains/ losses Abnormal gains/losses ❑ Actual loss> Normal loss → Abnormal losses ❑ Actual loss< Normal loss → Abnormal gain ❑ Abnormal losses/gains are not absorbed into the cost of output, but shown as credit/debit entry in Process account ❑ Abnormal losses/gains = abnormal loss/gain units* cost per good unit → they are valued at the cost of good product Normal and abnormal gains/ losses Normal Abnormal • Only losses (“inherent”) • Losses or gains • “Expected” under efficient (normal) operating conditions • Not expected • Uncontrollable/ unavoidable • Controllable/avoidable • Cannot be eliminated • Possible to eliminate • Part of normal cost of production • Not included in product cost • Therefore absorbed in product cost • Therefore reported separately (for investigation) Normal and abnormal gains/ losses Process a/c Units Costs incurred Materials Labour Overhead Abnormal gain $ X X X X X X ___ ___ X X ___ ___ Units Normal loss X Actual output X Abnormal loss X $ X X X ___ ___ X ___ X ___ Abnormal gains/losses must be costed at normal CPU (i.e. of good production) Normal and abnormal gains/ losses ❑ Separate a/cs are not required for normal/abnormal losses/gains ❑ Balancing figure on quantity/units is abnormal ❑ Only actual loss has actual value ❑ Each unit of gain represents a cost saving of difference between normal CPU and normal loss proceeds per unit Losses a/c a/c Losses Units Units $$ Units Units Scrapproceeds proceeds Normal loss Scrap (@ scrap value) value) X X foractual actualloss loss X X for XX Abnormal Loss written off (al) Gains (al)loss X Abnormal gains (@ normal CPU) X X (income statement) (income statement) (@ normal CPU) X ––– ––– ––– ––– ––– ––– X X X X XX ––– ––– ––– ––– ––– ––– $$ XX XX ––– ––– XX ––– ––– WIP and equivalent unit ❑ WIPs are units entered a production process but the process has not been completed ❑ EUs – partly processed units can be expressed as a proportion of a fully-completed unit Inputs Process 1 Inputs Transfer from previous process Process 2 ❑ Average cost per EU= Material cost incurred + Equivalent units of material Conversion cost incurred Equivalent units of conversion cost WIP and equivalent unit Number of EU: ❑ No opening WIP: EU = finished units + unfinished units * % completed (completed percentage of material and conversion cost may be different) ❑ Opening WIP: ➢ FIFO method: EU = OB unfinished units * % incomplete + fully worked units + CB unfinished units * % completed ➢ WAC method: EU = (OB unfinished units + fully worked units) + CB unfinished units * % completed Joint costs & By products Product A Joint cost Product B By Product C Split off point Joint products Joint costs & By products ❑ Accounting treatment of joint products ➢ Joint process costs are apportioned between joint products only at the split off point. ➢ The basis for apportionment can be: ▪ Sales value of production (market value) ▪ Production units (= Physical measurement) ❑ Accounting treatment of by-product ➢ The sale value of by-product at the split off point is treated as reduction in production costs OR increase in sales value. ➢ The net income of by-product after further processing is treated as a reduction in production costs Part B-7 Alternative costing techniques Activity based costing Life cycle costing Target costing Total quality management Activity based costing ❑ ABC firstly assigns costs to the activity that are real cause of the OH. It then assigns the cost of those activities only to the products that are actually demanding the activities. ❑ Major ideas under ABC Cost Activity Product Activity based costing The reasons for the development of ABC ❑ Manufacturing OHs have increased significantly ❑ Manufacturing OHs no longer correlate with direct labor hours or machine hours ❑ The diversity of products and customer’s demand ❑ Some products are made in large batch, while others in smaller ones Activity based costing Calculation of ABC •Identify an organization’s major activities Step 1 Step 2 •Identify the cost driver – factors which determine the size of the costs of an activity (Ordering – No. of orders; material handling – No. of prdn runs…) Step 3 •Collect the costs of each activity into cost pools (equivalent to cost center under the traditional costing methods) Activity based costing Calculation of ABC ABC Absorption costing Focus on OH related to activity in each cost Focus on OH incurred in each cost center pool Trace the cost of product unit Allocate costs to product unit A modern costing approach assume that A traditional method to assign costs directly product consumed activities, and activities to product or service. consumed resources Not accepted in publishing FSs Allowed by GAAP Improve the quality of management accounting information Remains suitable for small firms Life cycle costing ❑ Life cycle costing is Sum of all recurring and one-time costs over the full life span of a product. Market introduction stage Growth stage Maturity stage Saturation and decline stage Life cycle costing PRODUCT LIFE CYCLE CURVE Target costing ❑ Target cost is an estimate of a product cost which is determined by subtracting a desired profit margin from a competitive market price. ❑ This target cost may be lower than the initial production cost but is expected to be reached at the maturity stage of the product’s life cycle. → Force the business to perform in a more effective way Target costing Step in the implementation of the target costing process Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Step 7 Step 8 Determine a product specification of which an adequate sales volume is estimated Set a selling price to achieve desired market share Estimate required profit margin Target cost = Target selling price – target profit Compile an estimated cost based on the anticipated design specification and current cost level Calculate cost gap = estimated cost – target cost Make effort to close the gap Negotiate with customer/management before going ahead with the project Total quality management ❑ Total quality management is a process of applying a zero defect philosophy to the management of all resources and sustaining a culture of continuous improvement which focuses on meeting customers’ expectation. ❑ Basic principles: ➢ Get it first right at the first time ➢ Always possible to improve ➢ Performance measurement applied in all activities of the organization Summary ❑ Cost classification ❑ Closer look at Material, Labor, and OH expenses ❑ Absorption costing ❑ Marginal vs. absorption costing ❑ Job, batch, service, and process costing ❑ Other costing techniques (life cycle, target, TQM) Thank You !
