Exercise in Cost Accounting:
De Niro, Scorsese and Pesci, Inc.
DSP, Inc. is a home maintenance services operation,
started by three men, De Niro, Scorsese and Pesci.
Services offered: Plumbing, Window Cleaning, Gutter
Guard Installation, and Landscaping.
There is ample demand for these services. However,
there is also a shortage of qualified workers in the area.
DSP has had a motto: “Teach Your Children Well,” ever
since their younger days. They have employed their
children, 5 high-school graduates, to run operations.
1
DSP, Inc.: Labor Costs
Monthly wage per employee = $2,000 including benefits
Hours budgeted per employee per month = 200 hours
Monthly capacity with 5 employees = 1,000 hours
Total Direct Labor cost per month = $10,000
Direct labor rate = $10,000/1,000 = $10 per hour
2
DSP, Inc.: Revenue & Cost Data
Plumbing
Window
Cleaning
Gutter
Guards
Landscaping
Current Monthly
Output
90 jobs
70 jobs
80 jobs
60 jobs
Labor Hours/job
2 hours
4 hours
3 hours
5 hours
Revenue/job
$130
$170
$200
$250
Material Cost
$30
$10
$70
$75
Labor Cost
$20
$40
$30
$50
Job Type
Note:
Total number of jobs per month
= 90 + 70 + 80 + 60 = 300 jobs.
At current output level, capacity used
= 90 x 2 + 70 x 4 + 80 x 3 + 60 x 5
= 1,000 hours per month
3
DSP, Inc.: Overheads
In standard cost accounting, indirect costs are allocated to the
product based on the volume of the cost driver they have
consumed. There may be more than one single cost driver. The
cost driver could be other than labor cost based on the nature of
the business. Here it is # of Jobs.
Monthly Administrative Overhead (Salaries) = $18,000.
Monthly Non-Administrative Overhead (Rent, Truck Fleet
Maintenance, Marketing, Depreciation) = $9,000.
Overhead is currently allocated to products based on production
volume. Current volume is 300 jobs per month.
Administrative Overhead per job $18,000/300 = $60.
Non-Administrative Overhead per job = $9,000/300 = $30.
4
DSP, Inc.: Summary Cost Table
`
Market
Current Output
Revenue /Job
Material Cost /Job
Labour Hours/Job
Labor Cost /Job
Administrative /Job
Non Administrative /Job
Profit /Job
Window
Plumbing Cleaning
250
160
90
70
130
170
30
10
2
4
20
40
60
60
Gutter Landscap
Guards
ing
145
120
80
60
200
250
70
75
3
5
30
50
60
60
30
30
30
30
-10
30
10
35
300
18000
9000
5
DSP, Inc.
CSN is using all its labor capacity, and is absorbing all
overheads. So there is no labor variance or overhead
absorption variance to worry about.
Therefore, the total profit is:
90 x (-$10) + 70 x $30 + 80 x $10 + 60 x $35 =
$4,100 per month.
6
DSP, Inc., Demand for Services
Suppose the monthly demand for these services is:
Plumbing:
250 jobs
Window cleaning:
160 jobs
Gutter guard installs:
145 jobs
Landscaping:
120 jobs
Suppose, too, that CSN, Inc., can choose which
products to go after.
What is the best product offering for CSN, Inc., that
will maximize its profit?
7
DSP, Inc.: Summary Cost Table
Plumbing
Window
Cleaning
Gutter
Guards
Landscaping
Current Output
90/250
70/160
80/145
60/120
Labor Hours/job
2 hours
4*100= 400
3 hours
5*120 = 600
Revenue/job
$130
$170
$200
$250
Material Cost
$30
$10
$70
$75
Labor Cost
$20
$40
$30
$50
Administrative
Overhead Allocation
$60
$60
$60
$60
Non-Administrative
Overhead Allocation
$30
$30
$30
$30
-$10
$30
$10
$35
Job Type
Profit
8
DSP, Inc.
We may think the Total Profit is:
120*35=4200
100*30 =3000
4200+3000= 7200 Profit
9
DSP, Inc.: Summary Cost Table
Job Type
Window
Cleaning
Landscaping
Current Output
100/160
120/120
Labor Hours
4*100= 400
5*120 = 600
Revenue/job
(170*100)
17000
$47000
(250*120)
30000
Material Cost
(10*100)
1000
$10000
(75*120)
9000
Labor Cost
10000
Administrative
Overhead Allocation
18000
Non-Administrative
Overhead Allocation
9000
Instead of 7200 Profit, We have 0 Profit, While with original plan we had 4100
Profit
10
DSP, Inc.: Summary Cost Table
Job Type
Window
Cleaning
Landscaping
Current Output
100/160
120/120
Labor Hours
4*100 = 400
5*120 = 600
Revenue/job
170
250
Material Cost
10
75
Labor Cost
40
50
Administrative
Overhead Allocation
(18000/220)
81.82
(18000/220)
81.82
Non-Administrative
Overhead Allocation
(9000/220)
40.1
(9000/220)
40.1
11
DSP, Inc.: Activity-Based Costing
CSN, Inc. wants to use a better method to allocate the
overheads (using Activity-Based Costing).
To accurately allocate Administrative Overhead, CSN
gathers data on the time the administrators, Cromby,
Steele and Nash, devote to the four products, each
month. The data reveals the following breakdown on
the time administration spends on the 4 products:
Plumbing: 30%; Window Cleaning: 35%
Gutter Guards: 20%; Landscaping: 15%
12
DSP, Inc.: Administrative
Overhead Allocation using ABC
Administrative Overhead to be allocated = $18,000
Job Type
Plumbing
Window
Cleaning
Gutter
Guards
Landscaping
30%
35%
20%
15%
Admin O/H Allocated =
%age effort x $18,000
$5,400
$6,300
$3,600
$2,700
Number of Jobs
90 jobs
70 jobs
80 jobs
60 jobs
$60
$90
$45
$45
Percentage Effort
Administrative O/H
Allocation per job
13
DSP, Inc.: Non-Administrative
Overhead Allocation using ABC
Non-Administrative Overhead to be allocated = $9,000.
The allocation is made based on labor hours.
Total labor hours = 1,000. So,
Non-Admin. O/H rate = $9,000/1,000 = $9.00 per labor hour.
Since Plumbing takes 2 hours, the Non-Admin. Overhead
allocated to a Plumbing job is = $9 x 2 = $18.
Thus the Non-Administrative Overhead allocation per job is:
Plumbing (2 hours): $18; W. Cleaning (4 hours): $36
G. Guards (3 hours): $27;Landscaping (5 hours): $45
14
DSP, Inc.: Improved Allocation with ABC
Plumbing
Window
Cleaning
Gutter
Guards
Landscaping
Current Output
90 jobs
70 jobs
80 jobs
60 jobs
Labor Hrs./job
2 hours
4 hours
3 hours
5 hours
Revenue/job
$130
$170
$200
$250
Material Cost
$30
$10
$70
$75
Labor Cost
$20
$40
$30
$50
Administrative
Overhead Allocation
$60
$90
$45
$45
Non-Administrative
Overhead Allocation
$18
$36
$27
$45
Profit
$2
-$6
$28
$35
Profit
-$10
$30
$10
$35
Job Type
15
DSP, Inc., Demand for Services
Suppose the monthly demand for these services is:
Plumbing:
250 jobs
Window cleaning:
160 jobs
Gutter guard installs:
145 jobs
Landscaping:
120 jobs
Suppose, too, that CSN, Inc., can choose which
products to go after.
What is the best product offering for CSN, Inc., that
will maximize its profit?
16
DSP, Inc.
Can CSN do better? Let’s use ABC cost figures.
Which is the most profitable product? Landscaping
Compute profits if they first complete meeting the
demand for the most profitable product, then focus
on the next most profitable product, and so on. Use
the following pages for your calculations.
17
DSP, Inc.
First complete demand for 120 Landscaping jobs.
That uses up 600 hours, leaving 400 hours of capacity.
Next work on Gutter Guards. Each job takes 3 hours.
Can complete 400/3 =133 jobs.
(1 hour of labor unused.)
With this product mix, the apparent profit seems to be:
120 x $35 + 133 x $28 = $7,924.
Not the true profit. Why?
Answer: Unabsorbed overheads.
18
DSP, Inc.: Reconciling Variances
120 Landscaping and 133 Gutter Guard jobs will each
recover $45 of Administrative Overhead, that is:
$45 x 120 + $45 x 133 = $11,385.
Admin. Overhead Variance = $18,000 - $11,385 = $6,615.
The 1 hour of unused labor gives a Labor Usage Variance
of $10 and Non-Admin. Overhead Variance of $9.
So, the total of all the Variances is: $6,634.
Actual profit with ABC is thus: $7924 - $6,634 = $1,290.
So, “optimal” profit is less than earlier profit! Why?
19
DSP, Inc.: A Better Approach
a) Consider only the variable costs in the profit equation –
use marginal profits.
b) Focus on the constraint. Evaluate rate at which marginal
profits are generated at the constraint (Throughput). Best
product is the one with the highest Throughput.
Complete demand on this product, move to next most
profitable product, and so on, till you run out of capacity
at constraint.
c) Find total marginal profit, and subtract out fixed costs to
get total net profit.
20
DSP, Inc.
Capacity at the constraint (total labor hours) = 1,000 hours.
Product
Plumbing
Demand for product
250 jobs
Marginal Profit (Rev.
– Var. Cost)
$130-$30
= $100
W. Clean
160 jobs
G. Guard
Landscape
145 jobs
120 jobs
$170-$10 = $200-$70 $250-$75 =
$160
= $130
$175
# of hours needed
per job
2 hours
4 hours
3 hours
5 hours
Profit Generation
Rate (Throughput)
$50.00 per
hour
$40.00 per
hour
$43.33
per hour
$35.00 per
hour
Fixed costs are: Labor + Administrative O/H + Non-Admin. Overhead
= $10,000 + $18,000 + $9,000 = $37,000.
21
DSP, Inc.
Do 250 plumbing jobs first (250 x 2 = 500 hours).
Next, do 145 gutter guards (145 x 3 = 435 hours).
With the remaining 65 hours, you can complete 65/4
= 16 window cleaning jobs (64 hours)
Net Marginal Profit = 250*$100 + 145*$130 +
16*$160 = $46,410.
Net Marginal Profit = 250*$100 + 144*$130 +
17*$160 = $46,440.
$46,440 - $37,000 = $9,440.
22
DSP, Inc.: Summary
Summary:
“Optimal profit” with Standard Costing : $0
“Optimal profit” with ABC: $1,290
Profit with arbitrary product mix: $4,100
Optimal profit with Throughput Accounting: $9,410
23
Traditional Decision
Making
Inventory Valuation and Cost
Accounting
2008,
M. Srinivasan
24
An Inventory Conundrum
Raw Material cost per unit:
WIP value per unit:
Finished Goods value per unit:
Sale Price per unit:
$10
$20
$35
$50
Other Operating Expenses: $4 Million in 2006; $3.75 Million in 2007
2006
2007
Beginning WIP Inventory (1000 units)
50
50
Beginning FG Inventory (1000 units)
Raw Material (1000 units)
Sales (1000 units)
Ending WIP Inventory (1000 units)
Ending FG Inventory (1000 units)
40
400
400
50
40
40
330
400
10
10
25
An Inventory Conundrum: The
Income Statement
2002
2007
Sales (1000 $)
Beginning WIP Inventory (1000 $)
Beginning FG Inventory (1000 $)
Raw Material Purchase (1000 $)
Other Expenses (1000 $)
Ending WIP Inventory (1000 $)
Ending FG Inventory (1000 $)
Cost of Goods Sold (1000 $)
20,000
1,000
1,400
4,000
4,000
1,000
1,400
20,000
1,000
1,400
3,300
3,750
200
350
8,000
8,900
Profit (1000 $)
12,000
11,100
26
Traditional Decision Making:
Product Costs

How can we calculate a company’s profit?
Net Profit = Sp Revenuep - Sc Expensec.
But how do we use this information to, say,
decide on launching a new product?
 Allocate! If we allocate overhead costs correctly:
Net Profitp = Revenuep - Expensep, and so,
Net Profit = Sp Net Profitp
27
Obtaining Accurate Product Costs

How do we allocate overhead costs
properly so that product costs are
accurate?


Standard Costing
Activity Based Costing (ABC)
28