MANAGEMENT ACCOUNTING

1. MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

2. Measuring and analysing product costs (Planning) Chapter 3

3. Objectives • Identify activities of the organization related to the different products and services of the organization • Teat products as cost objects for the purpose of making product-mix and pricing decisions • Estimate the direct costs of a product or service • Identify different levels of indirect product costs • Trace indirect costs using a cost driver • Use activity-based costing to estimate the cost of a product or service • Recognize costs and benefits of using activity-based costing • Estimate product costs using a single cost driver

4. Activities and Product Costs Products requireactivities Activities consumeresources Resources havecosts

5. Estimating Product CostsFor Planning Decisions Planning decisions are improved with better estimates of product costs The costs and benefits of different decisions must be estimated The item to be costed is called the cost objective – the primary cost objects are the products or services provided by an organization The cost of using resources to provide a product or service is called the product or service cost

6. The Product-mix Decision The choice of what products and services to offer is known as the product-mix decision In order to decide the product-mix it is necessary to balance The benefits of the product The costs of providing the product If the benefits exceed the costs a product is included in the product -mix

7. Pricing Decision Prices are affected by Competition Customers ProductCosts If a price is too high the result will be low customer demand If a price is too low the result will reduce organizational value

8. Pricing Decision Activities supporting only one product generate direct product costs Activities supporting multipleproducts generate indirect product costs

9. Direct Product Costs Production costs include both direct and indirect costs Direct costsare easily traced toa given product Direct costs include direct materials and direct labour

10. Indirect Product CostsNumerical Example Ben’s Deli uses the following estimates to determine the direct cost of making a sandwich

11. Indirect Product Costs Indirect Costs cannot be traced directly to individual products Facility-Level Costs Unit-Level Costs Indirect costs are also calledoverhead costs Indirect Costs Product-Level Costs Batch-Level Costs

12. Indirect Product Costs Unit-Level Costs Costs that vary with the number of units produced • Batch-Level Costs Costs associated with production of multiple units of the same product that are produced together • Product-Level Costs Fixed with respect to the number of units and batches produced, but vary with the number of products • Facility-Level Costs Fixed with respect to the number of units, batches, and products or services produced

13. Indirect Product CostsNumerical Example The indirect costs of Bended Knee Skateboardsare as follows Splitting the indirect costs among the flat and moulded skateboards should recognize each of these levels of indirect costs

14. Tracing Indirect Costs Tracing indirect costs to products is difficult The relationship between indirect costs and products is not always clear Tracing indirect costs to different products can be very costly One method of estimating the indirect costs of a product is to choose some characteristic of the different products that causes the indirect costs The characteristic is called a cost driver

15. Tracing Indirect Costs using a Cost Driver Causes thecosts of anactivity • Identify activities that generate indirectproduct costs • Estimate costs of the activities • Select a cost driver for each activity • Estimate the cost-driver usage by all of the products • Calculate a cost-driver application rate • Trace activity costs to each product Estimated cost of each activityEstimated usage of activity cost driver Actualcost-driver usage by each product xCost-driver application rate

16. Tracing Indirect Costs using a Cost DriverNumerical Example A sunglass company manufactures three different products that use the same assembly line To change production from one product to another the machines must be reset. The activity of resetting the machines is estimated to cost €400,000 during the year. The number of resets is the cost driver. Trace costs to each product Estimated cost driver usage is 50+200+150 = 400 Resets Cost driver application rate €400,000/400 = €1,000/reset

17. Activity-Based Costing (ABC) ABC is a procedure that attempts to trace the costs of different activities to products

18. Activity-Based Costing (ABC)Numerical Example A tree nursery is considering a change of product mix in its inventory The manager wants to estimate the product cost of different types of tree. There are no activities that lead to direct costs. Indirect costs are identified for watering, repotting and administration Calculate the Application rate for each activity Identify the level of each activity Trace indirect costs to 10 royal oaks each of which requiring one repotting each year

19. Activity-Based Costing (ABC)Numerical Example Calculate the Application rate for each activity

20. Activity-Based Costing (ABC)Numerical Example Identify the level of each activity Watering and Repotting are unit level activities as their cost drivers vary with the number of units Administration is a product-level activity as each product receives the same amount of indirect costs

21. Activity-Based Costing (ABC)Numerical Example Trace indirect costs to 10 royal oaks each of which requiring one repotting each year The estimated cost per royal oak is £210/100 royal oaks (£2.10 each tree)

22. Advantages of ABC ABC seeks to improve the tracing of indirect costs to products by recognizing the different levels of activities that lead to indirect product costs ABC is most beneficial in estimating accurate product costs for organizations with multiple products and services ABC is more beneficial in firms where products and services use overhead activities in different ways ABC is especially useful to organizations with a high percentage of indirect product costs

23. Problems With ABC ABC does not always achieve a n accurate estimate of the cost of making a product ABC ignores the difference between the fixed and variable costs of an activity ABC is more costly to implement because additional measurements and observations must be made

24. Tracing Indirect Product CostsUsing a Single Cost Driver If planning decisions are not sensitive to the accuracy of the estimate of indirect product costs Then using a single cost driver to trace all indirect product costs is often sufficient

25. Tracing Indirect Product CostsUsing a Single Cost Driver A four step process • Identify and estimate all of the indirect product costs • Identify a cost driver to apply • Calculate the application rate • Apply indirect costs to the various products and services

26. Tracing Indirect Product CostsUsing a Single Cost DriverNumerical Example Cascade Cleaning Service cleans 3 different buildings The company has the following indirect costs

27. Tracing Indirect Product CostsUsing a Single Cost DriverNumerical Example Apply the indirect costs to the different buildings using square meters (application rate £100,000/200,000m2)

28. Tracing Indirect Product CostsUsing a Single Cost DriverNumerical Example Apply the indirect costs to the different buildings using estimated hours (application rate £100,000/20,000hours)

29. Tracing Indirect Product CostsUsing a Single Cost DriverNumerical Example Compare the costs of the two methods You can see how different allocation methods might lead to making different management decisions

30. MANAGEMENT ACCOUNTING Measuring and analysingproduct costs (Planning) End of Chapter 3