accg200 lectures 2-11 handout

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Welcome to ACCG200

Week 5

1

Job Costing

Chapter 4

Dr. Ranjith Appuhami

Department of Accounting and Corporate Governance

Product costing system

2

A system that accumulates product-related costs and

uses a series of procedures to assign them to the

organization's final products

Why product costing:

- Pricing

- Performance evaluation

- Planning and controlling costs

Types of product costing

systems (procedures)

3

Base on the nature of production environment

Job costing system – the cost object is a distinct

product (distinct batch) called a job. E.g., construction

jobs (house, buildings, roads) and air craft building.

Process costing system – A mass of an identical

product is produced over many periods. E.g.,

production of beverage (Coca-Cola), Mobile phones

and Books (Week 6 lecture)

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Types of product costing


4

Lecture example 1

In each of the following situations, determine whether job

costing or process costing would be more appropriate

5

Different product costs for different

purposes

Valuation of inventory for external reporting - manufacturing costs – AASB 102

Short-term decisions – variable manufacturing and downstream costs / relevant costs

Long-term decisions – total costs (both manufacturing and non- manufacturing costs) associated with the product

6

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Manufacturing Cost Categories of a Job

Direct

Material

s

Direct

Labou

r Manufacturin

g Overhead

General approach to job costing

1. Trace the direct costs of the job

- Direct materials

- Direct labour

2. Apply manufacturing overhead costs to the Job Apply overhead costs to products at the predetermined overhead rate:

:

8

Predetermined

Overhead

Rate

Budgeted Total Manufacturing Overhead Cost

Budgeted activity level in the Allocation Base

Ideally, the allocation base is a

cost driver that causes

overhead.

=

Assignment of Manufacturing Costs to

Jobs

Material

Requisiti

o n Form Job Cost

Direct

Labou

r

Direct

Material

s

Manufacturing

Overhead

Labo

u r

Time

Ticket

Predetermined

Overhead Rate

Cost Driver/

Allocation

Base

Source Documents used to Assign

Direct Costs to Jobs

Allocation Base is used to Assign Indirect Costs to Jobs

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Materials Requisition Form Direct Labour Time Tickets

$300 charged to Job #3335

$700 charged to Job #2719

Manufacturing overhead is applied to jobs that

are in process. An allocation base, such as

direct labor hours, direct labor dollars, or

machine hours, is used to assign

manufacturing overhead to individual jobs.

We use an allocation base to apply budgeted manufacturing overhead

because:

1.It is impossible or difficult to trace overhead costs to particular

jobs.

2. Manufacturing overhead consists of many different items ranging

from the grease used in machines to a production manager ’s salary.

3. Actual overhead for the period may not be known until the end of

the period.

Predetermined Overhead Rates

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The predetermined overhead rate (POHR)

used to apply overhead to jobs is

determined before the period begins

using estimates.

Predetermined

Overhead

Rate

Estimated Total Manufacturing Overhead Cost

Estimated Units in the Allocation Base

Ideally, the allocation base is a

cost driver that causes overhead.

=

Example 2 - Predetermined Overhead

Rates

Because home building is a labour intensive business, Toll

Brothers uses direct labor hours as the overhead allocation

base. Toll Brothers estimates the total manufacturing overhead

cost for the year to be $750,000, while direct labour hours are

estimated to be 10,000. What is Toll Brothers predetermined

overhead rate?

10,000 direct labor hours (DLH)

Pre.MOH Rate = $75.00 per DLH

For each direct labour hour worked on a job, $75.00 of

manufacturing overhead will be applied to the job.

$750,000 Pre.MOH Rate =

Actual amount of the cost driver such as units

produced, direct labor hours, or machine

hours incurred during the period.


Based on estimates, and

determined before the

period begins.

= × Overhead Applied

to an Individual Job

Predetermined

Overhead

Rate

Actual Value of the

Allocation Base for

Each Job

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Lecture example 3 - Job costing

MACQUARIE A\t, UNIVERSITY YJI"

FACULTY OF

BUSINESSAND ECONOMICS

Adapted: Horngren eta/., 2011

16

Ranjith construction builds residential houses. It uses job-costing system with

one indirect cost pool (building support or manufacturing overhead). Direct

labour-hours is the allocation base for building support costs.

Direct labour-hours $8 800 000 Actual results for 2011

$7 380 000

160 000 164 000

Two builds were started com leted durin 2011

and

L Model house M Model house

Direct material costs $106 450 $ 127 604

Direct labour costs $ 36 276 $ 41 410

Direct labour-hours 900 1010

Lecture example 3– Job costing

17

Required

1. Compute predetermined overhead rate

2. What are the job costs of L model house

and M model house?

Lecture example 3 solutions

18

1. Predetermined overhead rate

=Budgeted OH Costs/ Budgeted direct labour hours

= 8800,000/160,000

= $55/DLH

Applied overhead allocated for the job

=Predetermined overhead rate X Actual direct labour hours

For L house: Applied MOH = 55 X 900=49500

For M house: Applied MOH= 55 X 1010=55550

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Lecture example 3– Job costing

2. Job costs of two houses

Cost of each model = DM + DL + MOH

19 2-20

Cost of

Goods

Sold a/c

Raw

Materials

Inventory A/C

Finished

Goods

Inventory

a/c

Direct Labor

Direct

Materials

Recording the Flow of Costs in Job

Order Costing

Work in

Process A/C

Job 101

Job Job 102 103

Raw Material

Purchases

Indirect

Materials

Indirect

Labor

Equipment

Depreciation

Manufacturing Overhead a/c

Actual

Costs

Incurred

Applied

To

WIP

Toll Brothers purchased $150,000 in raw materials on account.

Toll Brothers withdraws $150,000 worth of materials from

inventory, $100,000 for Job #2719 (Simpson home), $40,000 for

Job #3335 (Flintstone Home) and $10,000 for supplies.

Raw Materials Inventory

Purchases 150,000 Issued to production 150,000

Direct

Materials

10,000

Indirect

Manufacturing Overhead 140,000

Work in Process Inventory

Recording the Purchase and Issue of

Materials

Materials Job 2719

Direct Materials

Job 3335

Direct Materials

$100,000 $40,000

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Recording Labour Costs

Labour Costs

Manufacturing Overhead

5,000 WoLrakbinoPr rocess Inventory

50,000

Direc

t

Indirect

Labor

Job 2719

Direct Labor

Job 3335

Direct Labor

Toll Brothers incurs $55,000 in labour costs, $30,000 for Job

#2719 (Simpson home), $20,000 for Job #3335 (Flintstone

Home) and $5,000 for indirect labour.

W ages payable

55,000

$20,000 $30,000

Recording Actual Manufacturing

Overhead

In addition to indirect materials and indirect labor, Toll Brothers

incurs other manufacturing overhead costs including:

• Salary paid to construction site supervisor, $12,000.

•Salary owed to a construction engineer, $8,000.

•Property taxes owed but not yet paid, $6,000.

•Expired insurance premium for construction, $4,000. •Depreciation on construction equipment, $18,000.


Actual Applied

Indirect materials 10,000

Indirect labor 5,000

Supervisor salary 12,000

Engineer salary 8,000

Property taxes 6,000

Insurance expense 4,000

Depreciation 18,000

Recording Applied Manufacturing

Overhead

Direct

Labor Hrs

Overhead

Rate

Applied

Overhead Job # Simpson home

Flintstone home 2719

3335

600 $

200

75 $ 45,000

75 15,000

Total direct labor hours 800 $ 60,000

Toll Brothers applies manufacturing overhead to jobs using

a predetermined overhead rate of $75 per direct labuor

hour. Time tickets for the month show a total of 800 direct

labor hours, 600 hours for Job #2719 (Simpson home) and

200 hours for Job #3335 (Flintstone Home).

Applied MOH = Pre.MOH rate x actual direct labour hours

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Recording Actual and Applied



The difference is closed to cost of goods sold.

Actual MOH

Applied MOH =/

Actual Applied

60,000

Work in Process Inventory

Job 2719

Manufacturing OH

$45,000

Job 3335

Manufacturing OH

$15,000

60,000 Indirect materials 10,000 Applied OH

Under-applied or over-applied

overhead

Under-applied/ (Over- applied) = Actual overhead - Overhead applied

overhead

Under-applied = Actual overhead > Overhead applied

Over-applied = Actual overhead < Overhead applied

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Disposing of Overapplied and

Underapplied Overhead

The most common method for disposing of the

balance in Manufacturing Overhead is to make

a direct adjustment to Cost of Goods Sold.

Overapplied

Manufacturin

g Overhead

Underapplie

d

Manufacturin

g Overhead

Decreases

Cost of Goods

Sold

Increases

Cost of Goods

Sold

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Calculating Overapplied and

Underapplied Overhead

Underapplied


Actual Applied

Indirect materials 10,000 Applied OH 60,000

ndirect labor 5,000

Supervisor salary 12,000

Engineer

salary Property

taxes

8,000 COGS

6,000

3000

Insurance expense 4,000

Depreciation 18,000

Transferring Costs to Finished Goods

Inventory and Cost of Goods Sold

After all

costs are

recorded

.

Work in Porcess Inventory

Cost of goods completed 175,000

Finished Goods Inventory

175,000 Direct material 140,000 Job 2719 completed

Transferring Costs to Finished Goods

Inventory and Cost of Goods Sold

Cost of goods completed 175,000 When job is sold 175,000

Job 2719 sold 175,000

Cost of Goods Sold

Assume Job 2719, the Simpson home was sold.

Finished Goods Inventory

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2-31

Summary of Recorded Manufacturing

Costs

Actual

Indirect Materials

Applied

Applied Overhead

$60,000

$10,000

5,000 Indirect Labor


Raw Materials Work in Process Finished Goods

Purchased

$150,000

Issued

$150,000

Balance $ 75,000

Direct

Materials $140,000

Direct

Labor

Applied

Mfg. OH

50,000

60,000

When Job is

Completed

$175,000

Cost of Goods

Cost of Goods Sold

Manufactured

$175,000

When Job

is Sold

$175,000

$175,000

$3,000

$178,000

Other Mfg. OH 48,000

Underapplied $3,000 $3,000 Adjusted

to COGS

Job costing: journal entries and T- accounts

32

1. Purchase of materials (assuming materials are purchased on credit)

2. Transferring direct material to WIP

Work in process inventory xxxx

Raw material inventory xxxx

3. Charging direct labour costs

Work in process inventory

Wages payable

xxxx

xxxx

x

Dr Cr

Raw material inventory xxxx

Account payable xxx


33

5. MOH actually incurred

Manufacturing overhead

Various accounts

xxxx

xxxx

6. Completion of production

Finished goods inventory

Work in process inventory

xxxx

xxxx

x

4. MOH applied Dr Cr

Work in process inventory xxxx

Manufacturing overhead xxx

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34

Accounts receivable

Sales revenue xxxx

xxxx

8. Adjust underapplied overhead

Cost of goods sold

Manufacturing overhead

xxxx

xxxx

(Or the reverse entry if overhead is overapplied)

7. Sale of goods Dr Cr

Cost of goods sold xxxx

Finished goods inventory xxxx

Lecture example 4

35

The following information is provided in relation to Shanker Corporation for January.

(1) Opening balances:

Raw materials inventory $10,000

Work in process inventory $24,000

Finished goods inventory $53,000

(2) Closing balances:

Work in process inventory $32,000

Finished goods inventory $26,000

(3) Raw materials were purchased for $63,000.

(4) Direct labour costs of $75,000 were incurred at a rate of $15 per hour.

(5) Manufacturing overhead was applied at a rate of $13.20 per direct labour hour.

(6) Actual manufacturing overhead costs incurred during January were $71,000 (including

$50000 indirect labour and $21000 office supplies inventory).

(7) Jobs were sold during the month for $345,000. The cost of goods sold during the month

was $222,000.

Complete the relevant T- accounts (provided on next page) to show the flow of

costs and prepare relevant journal entries. *Total DL hours = 75000/15=5000 hrs

MOH=$13.2*5000=66000

36

Manufacturing OH

Wages Payable Accounts payable

Raw Materials Work in Progress O/B 24000 FGs 195000

Finished Goods

COGS

Sales Revenue

AR 345000

Office supplies

O/B 10000

Purchases 63000

Acc payable

RM used 62000

C/B 11000

MOH 66000*

O/B 53000 COGS 222000

C/B 26000

FGs 222000

MOH(Adjustment) 5000

Wages P. 50000

Office sup. 21000

WIP

COGS(Adjustment)

66000*

WIP 75000

MOH 50000

RM Purchases

63000

5000


Account Receivable

Sales 345000

MOH 21000

RM 62000 C/B 32000 WIP 195000

DL 75000

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37

1. Purchase of materials

Dr Raw material inventory 63 000

Cr Account payable 63 000

2. Transferring direct material to jobs

Dr Work in process inventory 62 000

Cr Raw material inventory 62 000

3. Charging direct labour to jobs

Dr Work in process inventory

Cr Wages payable

75 000

75 000

4. Application of manufacturing overhead


Cr Manufacturing overhead 66 000


38


Dr Finished goods inventory 195 000

Cr Work in process inventory 195 000

Dr Cost of goods sold 222 000

222 000 Cr Finished goods inventory

8. Adjust underapplied overhead Dr Cost of goods sold

Cr Manufacturing overhead

5000

5000

6. Sale of goods

Dr Accounts receivable 345 000

Cr Sales revenue 345 000


Dr Manufacturing

overhead Cr Wage

payable

71 000 50 000

Cr Office supplies inventory 21 000

Additional Example Abbotsford Ltd has supplied the following information to its new management

accountant for the month of March.

Closing Balances

$18,000

$26,800

$32,000

1. Overhead is applied on the basis of $6 per direct labour hour (8000 DL hours incurred)

2. Jobs during the period were sold for $250,000.

3. The cost of goods sold during the month was $200,000.

4. Indirect materials worth $1,500 were issued (from RM account) to production during the month.

5. Regular hourly rate is $10. A total of 7,500 labour hours were worked during normal

working hours. Employees also worked an additional 500 hours of overtime during the

month. Overtime is paid at a rate of 150% of the normal hourly rate.

6.Sundry manufacturing overhead costs incurred during the month were $38,000.

Required: Complete the T-accounts provided and prepare relevant

journal entries.

Account Opening balances

Raw materials $12, 000

WIP $12,500

Finished Goods $65,000

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*DL = $10*8000hrs= 80000

**MOH for overtime premium=$5*500 = 2500

40

Raw Materials Work in Progress Finished Goods

COGS Manufacturing OH

Wages Payable Accounts payable Sales Revenue

O/B 12 000

Purchases 60800

Ac Payable

RM used 53 300

MOH 1500

C/B 18 000

O/B 12500

RM 53 300

DL 80 000*

MOH 48 000

FGs 167000

C/B 26800

O/B 65000

WIP 167000

COGS 200000

C/B 32000

FGs 200000 Sundry 38000

A/P 2500**

RM 1500

COGS 6000

WIP 48000

WIP 80000*

MOH 2500**

RM Purchases

60800

A/R 250 000

MOH 6000

solutions

Credit to “Miscellaneous account”

Solutions

41

1. Purchase of materials Dr Raw material inventory Cr

60 800

60 800

Account payable

2. Transferring direct material to jobs


Cr Raw material inventory

3. Charging direct labour to jobs

Dr Work in process inventory

Cr Wages payable

4. Application of manufacturing overhead


Cr Manufacturing overhead

533 000

80 000

80 000

48 000

Solutions

42


Dr Finished goods inventory

Cr Work in process inventory

167 000

167 000

6. Sale of goods

Dr Accounts receivable

Cr Sales revenue

250 000

250 000

Dr Cost of goods sold 200 000

Cr Finished goods inventory 200 000

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Solutions

43

8. Adjust overapplied overhead

Dr Manufacturing overhead

Cr Cost of goods sold

6 000

6 000


Dr Manufacturing overhead

Cr Wage payable

42 000 2 500

Cr Raw material inventory 1 500

Cr Miscellaneous account 38 000

Welcome to ACCG200

Lecture 3

1

Process Costing



From lecture 2:

Types of product costing systems

Base on the nature of production environment

Job costing system – a costing system that assigns

manufacturing (or product-related) costs to individual jobs.

Process costing system – a costing system that assigns

all production costs to processes or departments, and

averages them across all units produced

2

Note: Many businesses use a combination of job and process costing, which is called

hybrid costing

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Process costing is used for products

that are:

a. Different and produced continuously.

b. Similar and produced continuously.

c. Individual units produced to customer specifications.

d. Purchased from vendors.

Quick Check Similarities Between Job-Order and

Process Costing

Both systems assign material, labour, and manufacturing

overhead costs to products and they provide a

mechanism for computing unit product costs.

Both systems use the same manufacturing accounts,

including Manufacturing Overhead, Raw Materials, Work in

Process, and Finished Goods.

The flow of costs through the manufacturing accounts is

basically the same in both systems.

Flow of Costs in Process Costing

Direct Labor and Manufacturing Overhead (Conversion Costs)

3-5

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T-Account and Journal Entry Views of

Process Cost Flows

For purposes of this example, assume

there are two processing departments –

Departments A and B.

We will use T-accounts and journal

entries.

Process Cost Flows: The Flow of Raw

Materials (in T-account form)

Raw Materials •Direct

Materials

Work in Process Department B

•Direct Materials

Work in Process Department A

•Direct Materials

Process Cost Flows: The Flow of

Raw Materials (in journal entry

form)

Work in Process - Department A XXXXX

Work in Process - Department B XXXXX

Raw Materials XXXXX

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Labour Costs (in T-account form)


•Direct Materials •Direct Labour


•Direct Materials

•Direct Labour

Salaries and

Wages Payable

•Direct Labour

Process Costing: The Flow of Labour

Costs (in journal entry form)

Work in Process - Department A XXXXX

Work in Process - Department B XXXXX

Salaries and Wages Payable XXXXX


Manufacturing Overhead Costs (in T-

account form)


•Direct Materials •Direct Labou

r •Applied

Overhead


•Direct Materials

•Direct Labour

•Applied


•Overhead Applied to

Work in Process

•Actual

Overhead

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Manufacturing Overhead Costs (in

journal entry form)

Work in Process - Department

A

XXXX

X


B

XXXX

X

Manufacturing Overhead XXXX

X

Process Cost Flows: Transfers from WIP-Dept. A to WIP-Dept. B (in T-

account form)


•Direct

Materials

•Direct

Labor •Applied

Overhead

•Transferred

from Dept. A

Department

B


•Direct

Materials

•Direct

Labor •Applied

Overhead

Transferred

to Dept. B

Department

A

Process Cost Flows: Transfers from

WIP-Dept. A to WIP-Dept. B (in journal

entry form)


B

XXXX

X

Work in Process -

Department A

XXXX

X

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Finished Goods

•Cost of

Goods

Manufactured


WIP-Dept. B to Finished Goods (in T-

account form)


•Cost of

Goods

Manufactured

•Direct

Materials

•Direct

Labor •Applied

Overhead •Transferred

from Dept. A


WIP-Dept. B to Finished Goods (in

journal entry form)

Finished Goods XXXX

X

Work in Process -

Department B

XXXX

X

Finished Goods

Cost of Goods Sold

Process Cost Flows: Transfers from Finished Goods to COGS (in T-

account form)


•Cost of

Goods

Manufactured

•Direct

Materials

•Direct

Labor •Applied

Overhead •Transferred

from Dept. A

•Cost of

Goods

Sold

•Cost of

Goods

Sold

•Cost of

Goods

Manufactured

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Finished Goods to COGS (in journal

entry form)

Cost of Goods Sold XXXX

X

Finished Goods XXXX

X

Process costing: calculation of product costs

19

Process costing system accumulates the cost of each

process then average these costs across all units produced. .

Two scenarios:

1) Process costing with zero beginning and ending WIP

inventory;

2) Process costing with some beginning and ending WIP

inventory

Process costing with no beginning and

ending WIP inventory

20

Two main steps to calculate product costs

1. Accumulates total costs of the production processes

Cost in each production process = DM +DL+MOH;

Total manufacturing costs = costs from all production processes.

2.Calculate the average cost per unit by dividing total costs of the

processes by the number of units produced

Product cost/unit = Total manufacturing costs / Total no. of units produced

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Lecture Example 1

21

Pencil Ltd produced 60 000 pencils in August, with the following

manufacturing costs incurred. There is no beginning and ending WIP.

Calculate the cost per pencil produced in August:

= $ 5400/60000 = $0.09 ( 9 cents each)

Direct labour $1 000

Direct materials $1 800

Manufacturing OH $2 600

Total manufacturing cost $5 400

Lecture Example 2

22

Stanmore Chemicals Ltd produces chemical called Super Clean, in two- litre

containers. In July the company produced 140 000 liters of Super Clean mixture,

which was packed into 70 000 containers. Production takes place in two

departments: Mixing and Packing. The manufacturing costs for each department for

July were provided in the table. There is no beginning and ending WIP inventory.

Required:

1. What is the cost per container for Super Clean?

2. Complete the T-accounts provided and prepare journal entries to record the

production costs for July

Cost item Mixing Packing

Direct Materials $50 000 $10 000

Direct Labour 24 000 8 000

Manufacturing Overhead 14 400 4 800


23

1. Calculate the cost per container

Step1: cost in mixing department

= 50000 + 24000 +14400=88400

cost in packing department

= 10000 +8000+4800=22800

Total manufacturing cost = 88400+22800=111200

Step 2: Average cost per unit = total cost/ total units produced

= 111200/70000

= $1.59/container

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MOH 14 400

24

erred

DMLOH 4 800 to Packing

department

88 400

Transferred

from Mixing

88 400

Cost of Goods Sold

FGs 111200

WIP Packing Department WIP Mixing Department

2. T-accounts

FGs 111 200

Finished Goods

WIP 111200

COGS 111200

DM 50 000 DM 10 000

DL 24 000 Transf 8 000


2. Journal entries

a). Usage of raw materials, direct labour and overhead in Mixing dept.

25

b). Completion and transfer of super clean mixture from Mixing to Packing Dept.


c). Usage of raw materials, direct labour and overhead in Packing dept

26

d). Completion and transfer of completed Super Clean from Packing Dept to

Finished Goods.

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Process costing with some beginning and

ending WIP inventories

27

When there are partially completed units on hand at the

beginning or end of the period, product costs will relate to units

that are:

Units started in the previous period (beginning WIP)

and completed in the current period;

Units started and completed during the period;

Units that are incomplete at the end of the period (ending WIP).

Key concept: Equivalent units

Definition: the number of whole units that could have been completed if

all the work during the period had been used to produce whole units.

For example, two units that are 50% complete are the equivalent of one

unit of fully completed.

Partially completed goods at the beginning or end of the period need to

be converted to equivalent units.

28

No. units % of completion Equivalent units

150 30% 45

1000 80% 800

For the current period, Jones started 15,000

units and completed 10,000 units, leaving 5,000

units in process 30 percent complete. How

many equivalent units of production did Jones

have for the period?

10,000 units + (5,000 units × 0.30)

= 11,500 equivalent units

Quick Check

a. 10,000

b. 11,500

c. 13,500

d. 15,000

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Treatment of Direct Labour

Type of Product Cost

Direct labour

costs

may be small

in comparison to

other product

costs in process

cost systems. Do

llar A

mo

un

t

Direct Materials


Direct Labour

Treatment of Direct Labour

Do

lla

r A

mo

un

t

Conversion Direct labour and

manufacturing

overhead may be

combined into

one classification

of product

cost called

Direct Materials

Direct Labour

Direct

conversion costs. Type of Product Cost

Labour


Assumptions

32

1. Direct materials are added at the beginning of

the process. So, once a unit is started, it will

have 100% of the required direct materials.

2. Conversion costs are incurred uniformly in the

process.

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Lecture example 3

33

During January 10 000 cameras are placed into production.

Only 9000 cameras are fully completed and transferred out at

the end of the month. Percentage of completion of remaining

1000 cameras is: Direct material (DM) cost - 100% and

conversion cost – 50%.

What are the total equivalent units for DM and conversion

cost?


34

Item Physical

units

% of completion Equivalent units

DM Conversion DM Conversion

Completed

units

9000 100% 100% 9000 9000

Ending WIP 1000 100% 50% 1000 500

Total equivalent units 10000 9500

Weighted average method to calculate

product costs

35

Weighted average method – averages the cost of opening

WIP inventory with current production costs to determine the

cost of completed production and closing WIP

Four steps:

Step one: analyse the physical flow of units

Physical units in beginning WIP +

Physical units started

– Physical units completed and transferred out

= Physical units in

ending WIP

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product costs

Step two: calculate the equivalent units

The equivalent units in beginning WIP are not identified separately;

this is a key feature of the weighted average cost method

Equivalent units completed and transferred out

+ Equivalent units in

ending WIP = Total equivalent units

DM?

36

Conversion?


product costs

37

Step three: calculate the unit costs

The cost per equivalent unit for direct material is the total direct

material costs divided by the total equivalent units for direct material;

The cost per equivalent unit for conversion cost is the total

conversion cost divided by the total equivalent units for conversion.

Note: Under the weighted average method the cost per equivalent unit is based on the total costs incurred including the cost of beginning WIP

Step four: Analyse the total costs

i) cost of goods completed and transferred out;

ii) cost of ending WIP

Lecture example 4

38

ABC Ltd produces toys with the following information relating to activities

in March:

Beginning WIP: 4000 units (Degree of completion: DM – 100% and

conversion cost-75%). Costs include: DM $220,000; Conversion cost

$66,000.

Production started: 25,000 units

Production completed and transferred out: 24000 units

Ending WIP inventory: DM- 100% completed and conversion cost 40%

completed.

During March DM used $1404,000; Conversion cost incurred: $506,000.

The company uses weighted average cost to allocate costs to

production.

Determine the cost of goods completed during the

month and cost of the WIP inventory on 31March.

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Lecture example 4 Step 1: analyse the physical flow of units

4000 25000 24000 5000

Step 2: calculate the equivalent units

equivalent units completed and

39

Physical units in

beginning WIP +

+

Physical units

started –

–

Physical units completed and

transferred out = Physical units in

ending WIP

=

Total equivalent units = transferred out

+ Equivalent units in ending WIP

Equivalent units

physical units

% of DM completion

% of

conversion

completion

DM Conversion

Units completed & transferred out

during month 24000 100% 100% 24000 24000

Ending WIP units 5000 100% 40% 5000 2000


Lecture example 4

40

Step 3: Calculate the unit costs

DM Conversion Total

WIP inventory, 1 March $220,000 $66,000

Costs incurred during the month 1404,000 506,000

Total costs accounted for 1624,000 572,000

Equivalent units 29000 26000

Cost per equivalent unit $56 $22 $78

Lecture example 4

41

Step 4: analyse the total costs

Cost of goods completed and transferred during the month

= 24000 units × $56 +24000 units × $22 = $1872,000

or 24000 units × $78 = $1872, 000

Cost of WIP inventory on 31 March

= DM cost + Conversion cost

= 5000 units × $56 + 2000 units × $22

= $324,000

21/01/2014

29

Lecture example 5

42

Smith Toys Ltd manufactures wooden toys. The following information

relate to its production activities in May.

WIP on 1 May: 225 units (DM 100% completed; Conversion costs 60%

completed); Costs include: DM $1800, Conversion cost $810.

Production started: 275 units

Production completed and transferred out: 400 units

Ending WIP inventory: DM 100% completed; Conversion costs 50%

completed.

During May DM used $1980; Conversion costs incurred $1638;

Required: Determine the cost of goods completed during the month and

cost of the WIP inventory on 31st May.


Step 1: analyse the physical flow of units

Physical units

225 + 275 –

Physical units– completed and = transferred out

400 100

Step 2: calculate the equivalent units

43

Physical units in beginning WIP

+ started

Physical units in ending WIP

=

Equivalent units

physical units

% of DM completion

% of conversion

completion

DM Conversion

Units completed during month 400 100% 100% 400 400

WIP units,31 May 100 100% 50% 100 50



44

Step 3: Calculate the unit costs

DM Conversion Total

WIP inventory, 1 May $1800 $ 810

Costs incurred during the month 1980 1 638

Total costs accounted for 3780 2448

Equivalent units 500 450

Cost per equivalent unit $7.56 $5.44 $13

21/01/2014

30


45

Step 4: analyse the total costs

Cost of goods completed and transferred during the month

= 400 units × $13 = $5 200

Cost of WIP inventory on 31 March

= DM cost + Conversion cost

= 100 units × $7.56 + 50 units × $5.44

= $1028

ACCG200 – Lecture 4

1

SERVICE COSTING

Chapter 6



What are Service Organisations?

2

Organisations that deliver help, utility or care; provide an

experience, information or other intellectual content; and

the majority of the value is intangible rather than

residing in any physical products

Examples include

legal firms; accountants; banks; hotels; hairdressers; etc.

21/01/2014

31

Relevance of service costing

3

Assess service profitability

Decide which service to produce (short-term

decisions)

Set service prices (fees)

Plan and control costs

Differences between Service and

Manufacturing Businesses

4

*Please note that merchandisers such as retail and wholesale businesses are also part of

the service sector while they do not fit comfortably with the definition and distinguishing

features of service organizations.

Service Manufacturing

Most service outputs are intangible Most products are tangible

Service outputs are often

heterogeneous

Products are either homogeneous or

heterogeneous

Services are consumed as they

are produced; and cannot be

stored

Products are stored as inventory until

they are sold

The value chain in service firms

21/01/2014

32

Purpose of service costing

system and cost of

service

6

1) Internal reporting (management decision making) – All

upstream and downstream costs and production costs

2) External reporting (financial accounting) – No inventory to value, so the influence of external reporting requirements is

not relevant

Individual service costs are usually not accumulated separately in the general

ledger

Costs are ‘hidden’ in operating expenses, not in cost of goods sold (COGS) in

income statements

Types of service organizations and

costing systems

7

Types of service costing


8

Base on the nature of service production environment

Job costing system – the cost object is a distinct service called a

job. E.g., advertising campaign, audit engagements, legal cases –

Professional services

Process costing system – A mass of an identical service is

produced over many periods. E.g., postal delivery by Australian Post

and Deposit processing at Westpac – Mass services

Both Job costing + process costing (Hybrid) – produce both a

mass of identical service and distinct service - Service shops

21/01/2014

33

Lecture example 1

9

Determine the types of service organizations and the most appropriate costing system for each of the following firms:

Name Service type costing system

An accounting firm Professional service Job costing

An advertising agency Professional service Job costing

An electricity supplier Mass service Process costing

A law firm Professional service Job costing

A management consulting firm Professional service Job costing

A telecommunication company

Mass service Process costing

An automotive repair shop Service shop Hybrid costing

Airline ticketing counter Mass service Process costing

Job costing for professional services

10

1. Trace direct costs of the job (service)

- Direct labour – professional labour costs

Direct materials are relatively insignificant and be treated as

indirect material under overhead

2. Apply overhead costs to the Job (service)

using a predetermined (budgeted) overhead rate;

Lecture example 2

Taylor & Associates, a consulting firm, has the following condensed

budget for 2010. The firm has a single direct cost category

(professional labour) and a single indirect-cost pool (client support).

Indirect costs are allocated to jobs on the basis of professional

labour costs.

11

21/01/2014

34

Lecture example 2 (Cont.)

12

The firm provides a consulting job for Red Rooster, a fast-food chain specialising

in chicken. The breakdown of professional labour on the job is as follows:

Required:

1) Compute the 2010 budgeted indirect-cost rate/predetermined overhead

the firm;

2) Compute the cost of the Red Rooster job;

rate for

3) How much will the firm charge for the job if it is to earn its 40 per cent profit

margin to total cost.

Profession labour category Hourly rate Hours consumed

Director $200 6

Partner 100 12

Associate 50 60

Assistant 30 150


1. Predetermined overhead rate

= Budgeted Indirect Costs/ Budgeted direct Labour costs

= $13,000,000 ÷ $5,000,000

= 260% of professional labour costs

2. Direct costs:

Director, $200 × 6

Partner, $100 × 12

$ 1,200

1,200

Consulting support, 260% × $9,900

Total costs

25,740

$35,640

13

Associate, $50 × 60 3,000

Assistant, $30 × 150

Indirect/OH costs:

4,500 $ 9,900


14

3) How much will the firm charge for the job if it is to earn its 40 per

cent profit margin to total cost.

Service fees charged = total cost + 40% profit margin

= 35640 + 40% × 35640

= $49896

21/01/2014

35

Lecture example 3

15

Based on the information in lecture example 2, if the firm uses a

chargeout rate of $180/professional labour hour and 260 professional

labour hours were actually worked on this job. How much will the firm

charge the job? Explain the key differences between the method used

in example 2 and example 3.

Service fees charged = 180 × 260 = $46800

Key difference between the method used in example 2 and 3.

In example 2 a costing system is applied. Service fees charged are determined

based on the total cost plus a target profit margin.

In example 3 a billing system is applied. The billing system estimates fees based

on a chargeout rate per billable hour. This rate is then multiplied by the actual

hours worked on the service. The chargeout rate is set to cover the cost of labour

and overheads, and a profit margin.

MCQ example

If the engineer worked for 20 hours on a job, Z, and the

overhead is 125 per cent on direct labour cost and the

direct labour rate was $25 per hour, what is the total cost of

the job?

A.$500

B.$625

C.$1000

D.$1125

16

Accounting for

under/over applied

overhead.

17

For the purpose of preparing income statements,

under/over applied overhead must be adjusted to income

statement at the of accounting period.

For the purpose of making management decisions (e.g.,

pricing and controlling), there will be no requirement to

adjust the service costs for under/over applied overhead.

Service costs are shown as line item operating expenses,

not COGS, in income statements.

21/01/2014

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Process costing systems for mass

services

18

Two main steps

Accumulates total cost of delivering services

Calculate the average cost per service by dividing

the total cost of the process by the number of services

delivered.

Lecture example 4

19

ATS is a major provider of texts and stationary to secondary

schools throughout South Australia. Students’ orders to ATS

go through 3 stages:

a)Order is received from the school and entered into the ATS

inventory order system.

b)Books and stationary required to fill the order are drawn

from inventory, packed and dispatched to the student.

c) Payment is received from the student and processed

Lecture example 4 cont. The costs of these 3 processes in the year just ended are listed below.

During the year ATS processed 22000 student orders.

Required:

1)

2)

Calculate the total cost per order

Does the total cost per order provide a reliable estimate of the

costs incurred to process each order?

20

21/01/2014

37


21

1.Calculating cost per order and total costs

Total costs = $564 500 + $520 000 + $396 000

= $1480 500

Total cost per order = 1480 500 / 22000

= $67.30

2.Does the total cost per order provide a reliable estimate of the costs

incurred to process each order?

No. Because the greatest variation is likely to occur in the content of each order.

For instance, the weight of each package of books dispatched and the distance

that they are freighted could be significantly different amongst different orders.

When should firms estimate their

service costs?

22

No external reporting requirements to estimate individual

service costs

Service costing systems will be implemented

where benefits exceed costs

Cost and benefits are influenced by

Complexity of the costing system

Accuracy of the service cost information

Relevance of service cost information to

managing resources and creating value

Welcome to ACCG200

Lecture 5

1

A CLOSER LOOK AT OVERHEAD COSTS

21/01/2014

38

A closer look at

overhead cost

2

aTllhoreceaptoisosnible approaches

A plantwide rate

Departmental rates

Activity-based costing (6 lecture)

A Plantwide Rate

3

A plantwide rate is a single overhead rate that is

calculated for the entire production plant

Three steps:

1. Identify the overhead cost driver/allocation base

2. Calculate the overhead rate per unit of cost driver:

Pre. MOH rate= Total budgeted MOH/budgeted level of cost driver

3. Apply the manufacturing overhead cost to the product

Applied MOH= Pre. MOH rate× actual level of cost driver

consumed

Lecture example 1

Grand stands Ltd manufactures sheet music stands in two separate

departments: Cutting and Welding. The following data relate to the year

just ended:

4

21/01/2014

39

Lecture example 1 cont.

The following information is related to the production of one unit product A

and B.

Required:

Calculate manufacturing overhead cost of the product A and B using:

a) Predetermined plantwide rate based on direct labour hours

b) Predetermined plantwide rate based on machine hours

5

a) Based on direct labour hours

Predetermined plantwide rate

= budgeted MOH cost / budgeted level of cost driver

= $120 000 / 30 000 direct labour hour

= $4 per labour hour

Amount of overhead cost allocated/applied

= Pre. MOH rate x Actual direct labour hours consumed by the product

Product A = 4 X 5 = $20

Product B = 4 X 6 = $24

6

Lecture Example 1 Solutions

b) Based on machine hours

Predetermined MOH rate

= budgeted MOH / budgeted machine hours

= $120 000 / 80 000

= $ 1.5 per machine hour

Amount of overhead cost allocated

= Pre. MOH rate x actual machine hours consumed by the product

Product A = 1.5 X 6.5 = $ 9.75

Product B = 1.5 X 9 = $ 13.5

7


21/01/2014

40

Departmental overhead rates

8

Departmental overhead rates recognise that overheads in

each department may be driven by different cost drivers.

Two-stage cost allocation for departmental overhead rates:

Stage one - MOH costs are assigned to production departments:

Step 1. All manufacturing costs are distributed to each department, including

both production and support departments.

Step 2. Support department costs are reassigned to the production

departments

Stage two - MOH accumulated in production departments

are applied to products

Departmental overhead rates

Stage two: Allocation of MOH costs from production

departments to product.

9

For each product

Pre.MOH rate for each department =

Budgeted MOH costs of the department

Budgeted level of cost driver of the department

MOH costs applied in each department =

Pre. MOH rate for the depart.

× Actual cost driver

consumed in the depart.

Total MOH cost applied to the product = Applied MOH from all departments

Lecture example 2

Using the information given in lecture example 1, calculate overhead

costs for Product A and Product B using departmental rates based on:

Direct labour hours for Cutting department and Machine hours for

Welding department.

10

21/01/2014

41

Lecture example 2 cont. The following information is related to the production of one unit

product A and B.

11

Lecture Example 2 solutions

12

Pre. MOH rate – Cutting dept = Budgeted labour hours in the cutting department

= 40,000/ 20,000

= $2 per labour hour

Budgeted MOH costs in the cutting department

Pre. MOH rate – Welding dept= Budgeted machine hours in the Welding

Budgeted MOH costs in the Welding department

department

= $80,000 / 64,000

= $1.25 per machine hour


13

For product A:

MOH costs applied in Cutting = $2 × 4 labour hours = $8

MOH costs applied in Welding = $1.25 × 4 machine hours = $ 5

Total applied MOH costs for product A = 8 + 5 = $13

For product B:

MOH costs applied in Cutting = $2 × 4.5 labour hours = $9

MOH costs applied in Welding = $1.25 × 6 machine hours = $7.5

Total applied MOH costs for product B = 9 + 7.5 = $16.5

21/01/2014

42

Allocating support department costs to

production departments (Stage 1 step 2)

14

This process informs production departments’ managers of

the cost of the services provided by support departments,

and assists them to plan and control their use of services.

Allocation methods include

Direct: support department costs are allocated directly to

production departments

Step-down: partially recognises the services provided by one

support department to another

Reciprocal services: fully recognises the provision of services

between support departments

ST AG E

O NE

O v e r h e a d

co st s a r e

a s s i g n e d t o

p r o d u c t i o n

d e p a r t m e n t s

S t e p 2

S uppor t depar t m ent s

r Material

H andl i n g

E qui pm ent

Maint enanc e

Qual i ty

Cont r ol

/ _ D-e_p_a_r t_m_e_n_t D_e_p_artm_e_n_t D_e_p_a_rt_m_ e_n_t _ _.

S t e p 1

M a n u f a c t u r i n g o v e r h e a d

d i s t r i bu t i on (General

m anuf ac t ur ing ov er head

c o s t s are dis t r ibut ed

to a// depar t m ent s )

-

[

ST AG E

TW O

O v e r h e a d

c o s t s a r e

a pp l i e d t o

p r o d u c t s

S u p p o r t d e p a r t m e n t c o s t a l l o cat i o n

(S uppor t depar t m ent c o s t s are al located

to t he pr oduc t i on depar t m ent s .) 1 P r oduc t i on depar t m ent s

B endi ng

D epar t m ent W elding

D epar t m ent

I 1 - · -

O v e r h e a d a pp l i c a t i on (All c o s t s ac c um u la t ed in t he

pr oduc t i on depar t m ent s are

appl i ed to p r oduc t s .)*

1 P r od uct s pass t hrough product i on depar t m ent s > l. .

MACQUARIE UNIVERSITY

FACULTY OF


The Smith Company has 4 departments in its factory.

Two Service Dep: Plant maintenance (S1) and Information system (S2 ),

Two Production Dep: Machining ( P1) and Assembly (P2).

The budgeted overhead costs incurred in each dep. are given as follows:

00

The following table provides the usage of the two support departments’ output

16

Required: Allocate the budgeted OH costs from support dep. (S1 and S2) to

production dep. (P1 and P2), using the direct method, step-down method

and reciprocal method

Lecture example 3

Service

provided by:

Service Provided to:

S1 S2 P1 P2

S1 - 30% 30% 40%

S2 20% - 60% 20%

S1 S2 P1 P2

$84,000 $96,000 $100,000 $150,0

21/01/2014

43

Example 3 Solutions- Direct method

17

Service provided

by:


S1

$84,000

S2

$96,000

P1

$100,000

P2

$150,000

Allocate S1 ($84,000) 30% 30%

(x3/7)

36,000

40%

(x 4/7)

48,000

Allocate S2 20% ($96,000) 60%

(6/8)

72,000

20%

(2/8)

24,000

Total OH costs of

production dep.

- - $208,000 $222,000

Rule 1: Firstly allocate the support department that

provides services to the largest number of other

sdueppaortrmt ents. A

B

C

Rule 2: If they are equal, allocate the support department

with the largest overhead costs first.

A = $56,000

B= $83,000

Note: Once a support departments costs have been allocated

you do not allocate costs back to that support department.

Step-down method

18

Example 3 Solutions-Step-down method

19

Service provided

by:


S1

$84,000

S2

$96,000

P1

$100,000

P2

$150,000

Allocate S2 20% (96,000) 60% 20%

19,200 57,600 19,200

Allocate S1 - 30% 30% 40%

(103,200) (x3/7) (x 4/7)

44,229 58,971

Total OH costs of

production dep.

- - $201,829 $228,171

21/01/2014

44

Example 3 Solutions - Reciprocal method

20

Step 1: specify a set of equations that express the relationships

between the departments ( 1 equation for 1 support department)

S1= 84000 + 20%S2

S2= 96000 + 30%S1

Service

provided by:


S1

$84,000

S2

$96,000

P1

$100,000

P2

$150,000

Allocate S1 - 30% 30% 40%

Allocate S2 20% - 60% 20%

Step 2: solve the simultaneous equations:

21

S1 = 84,000 + 0.2 S2

S2 = 96,000 + 0.3 S1

- equation (1)

- equation (2)

Substitute equation (1) into equation (2):

S2 = 96,000 + 0.3 [ 84,000 + 0.2S2]

S2 = 96,000 + 25,200 + 0.06S2

0.94S2 = 121,200

S2 = $128,936.17

Substitute into equation (1) to find S1

S1 = 84,000 + 0.2 x 128,936.17 = $109,787.23

Example 3 Solutions - Reciprocal method Example 3 Solutions - Reciprocal method

22

Step 3: allocate total OH costs (new S1 and S2 from Step 2)

from support departments to production departments

Service provided

by:


S1

$84,000

S2

$96,000

P1

$100,000

P2

$150,000

Allocate S1 (109,787.23) (0.30) (0.30) (0.40)

32936.17 32936.17 43914.89

Allocate S2 (0.20) (128,936.17 ) (0.60) (0.20)

25,787.24 77,361.7 25,787.24

Total OH costs of

production dep.

0 0 $210,298 $219, 702

21/01/2014

45

Comparison of the three methods

23

Which allocation method is best? And why?

The reciprocal method is the best approach from a

conceptual viewpoint.

Reasons:

Direct method fully ignores services provided

between support departments.

Step-down method partially recognizes the provision of

services between support departments.

Reciprocal method fully recognizes the provision

of services between support departments.

Lecture example 4

24

The Dexter Manufacturing Company has two production departments

(P1 and P2) and two service departments (S1 and S2). The usage of

the two service departments is as follows:

Required:

Allocate the overhead costs from support dep. (S1 and S2) to

production dep. (P1 and P2), using the direct method and step-down

method.

Service

provided by:


S1

$90,000

S2

$50,000

P1

$200,000

P2

$250,000

Allocate S1 - 10% 60% 30%

Allocate S2 20% - 40% 40%

Example 4 Solutions- Direct method

25

Service provided

by:


S1

$90,000

S2

$50,000

P1

$200,000

P2

$250,000

Allocate S1 ($90,000) 10% 60% 30%

(x6/9) (x 3/9)

60,000 30,000

Allocate S2 20% ($50,000) 40% 40%

(x4/8) (x4/8)

25,000 25,000

Total OH costs of

production dep.

- - $285,000 $305,000

21/01/2014

46

Example 4 Solutions - Step-down method

26

Service provided

by:


S1

$90,000

S2

$50,000

P1

$200,000

P2

$250,000

Allocate S1 (90,000) 10% 60% 30%

9,000 54,000 27,000

Allocate S2 20% (59,000) 40% 40%

(x4/8) (x 4/8)

29,500 29,500

Total OH costs of

production dep.

- - $283,500 $306,500

Reminder

27

The 1st Excel assignment will be due by 6pm

on Monday 6th of January 2014

Welcome to ACCG200

Lecture 6

1

Activity-based costing

(ABC)

Chapter 8

21/01/2014

47

Features of Conventional product

costing systems

2

Direct material & direct labour costs are traced to products;

MOH costs are allocated to products using a predetermined overhead rate: a plantwide rate or department overhead rates;

Predermined overhead rate is calculated using a volume- based cost driver;

Non-manufacturing costs are not assigned to products.

Problems with conventional product

costing systems

3

Conventional product costing systems are likely to result in

inaccurate product costs when:

the proportion of manufacturing overhead costs not

related directly to production volume increases;

non-manufacturing costs that are product-related

become substantial;

product diversity increases.

Conventional product costing

systems Assume that Toyota Motor Manufacturing in Australia

produces three types of automobiles, with the following cost

and production information:

The purpose of the cost allocation method is to a ssign the

indirect or manufacturing overhead costs to each product.

Camry

Avalon Camry Hybrid

Per Unit Cost Information

Direct Materials $ 8,000 $ 7,000 $ 6,500

Direct Labour 2,800 2,400 2,400

Manufacturing Overhead ? ? ?

Annual Production Information

Units Produced (in thousands) 100 350 50

Direct Labour Hours Per Unit 35 30 30

Total Direct Labor Hours (in thousands)

3,500 10,500 1,500

Total

500

15,500

21/01/2014

48


systems

Predetermined

MOH

Rate

Manufacturing Overhead Cost

Estimated Units in the

Allocation Base

The total manufacturing overhead cost for Australian plant is

estimated at $3,720,000 (in thousands) per year. In our

example, this cost will be assigned to the three products on

the basis of direct labour hours. The first step is to calculate

the predetermined overhead rate.

Estimated Total

=

Predetermined

MOH

Rate =

$3,720,000

$15,500 = $240 per direct labor

hour


systems

To assign manufacturing overhead costs to the individual

products, we multiply the $240 overhead rate by the

number of direct labor hours required for each product.

The Camry receives the most total manufacturing overhead cost because it is the

highest volume product and thus requires the most total direct labor hours.

Camry

Avalon Camry Hybrid

Annual Production Information

Direct Labor Hours Per Unit 35 30 30

× Predetermined Overhead Rate $ 240 $ 240 $ 240

Manufacturing Overhead Per Unit $ 8,400 $ 7,200 $ 7,200

× Number of Units Produced (thousan 100 350 50

Total Manufacturing Overhead $ 840,000 $ 2,520,000 $ 360,000

Total

$ 3,720,000

Calculate Total Manufacturing

Cost and Profitability

To compute total manufacturing cost, we need to add the

manufacturing overhead cost to the direct material and direct

labour cost, which were provided earlier on a per unit basis.

This analysis shows that the Avalon is the most costly of the three

models on a per unit basis. The Camry is the next most costly

model, followed by the Camry-Hybrid.

4-7

Avalon Camry

Per Unit Cost Information

Direct Materials $ 8,000 $ 7,000 Direct Labour 2,800 2,400

Manufacturing Overhead 8,400 7,200

Total Manufacturing Cost Per Unit $ 19,200 $ 16,600

Camry

Hybrid

$ 6,500

2,400

7,200

$ 16,100

21/01/2014

49


Cost and Profitability

If we subtract the total manufacturing cost per unit from the

unit sales price, we get the gross margin for each product.

Remember that gross margin only takes into account the

manufacturing cost of the product, before selling and

administrative costs such as distribution fees, advertising,

dealer costs and profit, and corporate administration

charges have been deducted.

4-8

Avalon Camry

Assumed Selling Price to the Consumer $ 28,000 $ 18,000

Less: Total Manufacturing Cost Per Unit 19,200 16,600

Gross Profit Per Unit $ 8,800 $ 1,400

Gross Profit Margin (% of Sales) 31% 8%

Camry

Hybrid

$ 35,000

16,100

$ 18,900

54%

Activity-based costing (ABC)

ABC is a method of assigning indirect costs/overhead costs

to products and services based on the activities they require.:

ABC is designed to provide managers with cost information for

strategic and other decisions.

ABC is a good supplement to

our traditional cost

system

9

I agree!

Implementing ABC model

10

21/01/2014

50


11

Each major activity has its own activity cost pool to which overhead costs are assigned;

Each activity cost pool has its own cost driver (i.e. volume driven or non-volume driven);

A predetermined overhead rate is computed for each activity cost pool;

The predetermined rates are used to apply overhead costs to products.


Recall that the total manufacturing overhead cost in our Toyota

example was $3,720,000 (in thousands). Now we must assign

this total cost to one of the four activity cost pools.

4-12

Select an Activity Cost Driver

for Each Cost Pool Machine hours will be used as the driver for the machining and

installation activity. Number of set-ups will be used as the activity

driver for the set-up activity. Engineering hours will be used as

the driver to assign engineering and design costs. Inspection

time will be used to assign quality control costs.

21/01/2014

51

14

$825 000 ÷ 15000 = $55

Calculating activity rates

Activities Total activity

costs

Cost driver Total

activity

level

Activity

rate

Machining &

installation

$825 000 Machine hours 15000 hours $55 per hour

Machine set-

ups

$795 000 No. of set-ups 1000 set-ups $795 per set-

up

Engineering

and Product

Design

$1 200 000 Engineering

hours

6000 hours $200 per hour

Quality

Control

900 000 Inspection

time/hours

9000 hours $100 per hour

Total cost $3 720 000

Products’ consumption of

activities

Avalon Camry Camry

Hybrid

Total

Machine Hours 3,000 10,500 1,500 15,000

No. set-ups 400 350 250 1,000

Engineering hours 1,200 600 4,200 6,000

Inspection time/hour 2,700 18,00 4,500 9,000

Assign Activity Costs to

Individual Products

To complete the Stage 2 ABC allocations, we need to add up the cost of all four activities for each product line.

$55 x 3000 hours

$795 x 400 set-ups

$200 x 1200 hours

$100 x 2700 hours

Avalon Camry Camry

Hybrid

Total

Machining and Installation $ 165,000 $ 577,500 $ 82,500 $ 825,000

Machine Set-Up 318,000 278,250 198,750 795,000

Engineering and Product Design 240,000 120,000 840,000 1,200,000

Quality Control 270,000 180,000 450,000 900,000

Total Manufacturing Overhead Cost $ 993,000 $ 1,155,750 $ 1,571,250 $ 3,720,000

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52

Assign Activity Costs to

Individual Products

To calculate the cost per unit, we need to divide the

total manufacturing overhead by the number of

units of each product.

4-17

Total

00

Avalon Camry Camry

Hybrid

Comparison of conventional and Activity-Based Cost Systems

Avalon Camry Camry-Hybrid

Traditional $8,400 $7,200 $7,200

ABC $9,930 $3,302 $31,425

$-

Traditional vs. ABC Costing Method

$35,000 $30,000 $25,000 $20,000 $15,000 $10,000

$5,000

Ma

nu

fac

turin

g

Ov

erh

ea

d

Co

st P

er U

nit

4-18


Cost and Gross Margin

The ABC analysis shows that the Toyota Camry is the most

profitable product, with a 29.4% gross margin, compared to

26% for the Avalon and negative 15.2% for the Camry-Hybrid.

Gross Profit Margin (% of Sales) 26.0% 29.4% -15.2%

$28,000 - $20,730 = $7,270 $5,298 ÷ $18,000 = 29.4%

4-19

Avalon Camry Camry

Hybrid

Direct Materials $ 8,000 $ 7,000 $ 6,500

Direct Labor 2,800 2,400 2,400

Manufacturing Overhead 9,930 3,302 31,425 Total Manufacturing Cost 20,730 12,702 40,325

Unit Selling Price to Customer 28,000 18,000 35,000

Gross Profit Per Unit $ 7,270 $ 5,298 $ (5,325)

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Lecture example 1

20

Kestral manufacturing Ltd has estimated the following activity costs and

activity drivers for the current period.

Activities Total activity costs Cost driver Total activity

level

Machine set up $40 000 No. of set-ups 400 set-ups

Materials

handling

160 000 No. of material

removals

16000 removals

Product design 100 000 Design hours 2000 hours

Inspection 260 000 No. of inspections 13000 inspections

Total cost $560 000


Information for a particular job (job no. 42) completed during the period

is as follows:

21

Required:

1)Calculate the cost per unit of activity driver for each of the four

manufacturing activities;

2)Calculate the total costs for job 42;

3)Calculate the cost per unit for job 42.

Direct materials $10 000

Direct labour $4 000

Units completed 200

No. of set-ups 2

No. of material removals 60

No. of inspections 40

No. of design hours 20


22

1) Calculate cost per unit of activity driver for each of the four

activities:

Activity Activity driver Total costs Total activity level

Cost per unit of activity driver

Machine set up No. of set-ups $40 000 400 $100/set-up

Materials handling

No. of material removal

160 000 16000 10/material removal

Prodcut design Design hours 100 000 2000 50/design hour

Inspection No. of inspections 260 000 13000 20/inspection

21/01/2014

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23

2) Calculate the total costs for job 42:

DM: 10 000

DL: 4 000

MOH:

Total costs for job 42: 10000+4000+2600=16600

3) Cost per unit in job no. 42 = 16600/200

= $83/unit

Costs for set-ups 2×$100= 200

Costs for material removals 60×$10=600

Costs for inspections 40×$20=800

Costs for product design 20×$50=1000

Total MOH $2600

Lecture example 2- Past final exam question

Pitney Corporation manufactures two types of transponders (i.e. No.

156 and No. 157) and applies manufacturing overhead to all units at

the rate of $76.50 per machine hour. Production information follows.

Unit

Unit

The controller, who is studying the use of activity-based costing, has

determined that the firm's overhead can be identified with three

activities: manufacturing setups, machine processing, and product

shipping. Data on the number of setups, machine hours worked, and

outgoing shipments, the activities' three respective cost drivers, follow.

24

The firm's total overhead is subdivided as follows: manufacturing setups,

$260,000; machine processing, $2,400,000; and product shipping, $400,000.

25

Required:

A.Compute the overhead rates that would be used for manufacturing setups, machine

processing, and product shipping in an ABC system;

B.Assuming using ABC, compute the unit overhead costs for No.156 and 157 if the

expected manufacturing volume is attained;

C. Assuming using ABC, compute the total cost per unit of product No. 156;

D.f the company's selling price is based heavily on cost, would a switch to ABC from

the current traditional system result in a price increase or decrease for product No.

156? Show computations.

21/01/2014

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26

A) Compute Overhead rate for each activity

Manufacturing setups:

Machine processing:

$260,000 /100 setups = $2,600 per setup;

$2,400,000 /40,000 Mhs = $60 per Mh;

Product shipping: $400,000 /200 shipments = $2,000 per shipment.

B) Compute the unit overhead costs for No.156 and 157

Total overhead costs for No. 156

= $2600×60 + $60 × 15000 + $2000 × 120 = $1296,000

Unit overhead costs for No. 156 = 1296000/6000= $216

Total overhead costs for No. 157

= $2600×40 + $60 × 25000 + $2000 × 80 = $1764,000

Unit overhead costs for No. 157 = 1764000/14000= $126


27

C) Compute the total cost per unit of product No. 156

Unit product cost for No. 156

= $40 + $25 + $216 = $281

D) For product No. 156 under conventional costing system,

Unit overhead costs = Overhead rate/ Mhr × Mhrs/ unit

= $76.5 × (15000÷ 6000)

= $191.25

Unit product costs = $40 + $25 + $191.25 = $256.25

Product No.156 is currently undercosted ($256.25 vs. $281.00), so a

switch to activity-based costing will likely result in a price hike.

Activity-Based Costing and

External Reporting

Most companies do not use ABC

for external reporting because . . .

1. External reports are less detailed than internal

reports.

2. It may be difficult to make changes to the company’s

accounting system.

3. ABC does not conform to GAAP.

4. Auditors may be suspect of the subjective allocation

process based on interviews with employees.

21/01/2014

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29

The benefits of ABC are the greatest

when:

Overhead costs are a significant proportion of total cost;

A large part of overhead is not directly related to production volume;

The business has a diverse product range;

Proportion of non-manufacturing costs is increasing relative to manufacturing costs;

There are likely to be high costs associated with making inappropriate decisions, based on inaccurate product costs;

The cost of designing, implementing and maintaining the ABC system is relatively low due to sophisticated IT support

ABC Limitations

Substantial resources

required to

implement and

maintain.

Resistance to

change.

Desire to fully

allocate all costs

to products.

Potential

misinterpretation of

unfamiliar

numbers.

Does not conform to

GAAP. Two costing

systems may be

needed.

Welcome to ACCG200

Week 2 - Session 1, 2013

Lecture 7

Cost Volume Profit Analysis

Chapter 18



1

21/01/2014

57

Cost volume profit (CVP) analysis


It is a technique used to determine the

effects of changes in an organisation’s sales

volume on:

Costs

Revenue

Profit (Revenue – Costs)

Aim: To assist managers in making decisions to

improve PROFITABILITY and increase

shareholder value

Assumptions underlying CVP

analysis


The behaviour of total revenue is linear

The behaviour of total costs is linear

For both variable and fixed costs, sales volume is the

only cost driver

The sales mix remains constant

In manufacturing firms, the levels of inventory at the

beginning and end of the period are the same

Thus, the number of units produced and sold during a

period are equal

Key concepts/tools


Contribution margin

Breakeven Point (in sales units)

Breakeven Point (in dollars)

Safety margin

Weighted average contribution margin

(WACM)

21/01/2014

58

Contribution margin


Unit contribution margin (UCM)

= Unit sales price – Unit variable costs

Total contribution margin (TCM)

= Total sales revenues – Total variable costs

Or = UCM ×No. of units sold

Contribution margin ratio (CMR)

= Unit contribution margin / unit sales price

Contribution margin percentage (CMP)

= Contribution margin ratio ×100

Lecture example 1


ABC Ltd sold 6000 handbags at the price of $100. The costs to

produce one handbag include:

Direct materials worth $28

Direct labour of 1.5 hours @ $14 per hour

Variable MOH of $16.

Total fixed costs are $48,000

Calculate:

1 The contribution margin per handbag

2 The Contribution margin ratio.

3 Contribution margin percentage

4 The total contribution margin.



1. The contribution margin per handbag

= Unit sales price – Unit variable costs

= 100 – (DM + DL+ Variable MOH)

= 100 – (28+ 1.5×14 + 16)

= 100 – 65

= $35

2. The contribution margin ratio

= UCM / Unit sales price

= 35 / 100

= 0.35

21/01/2014

59



3. Contribution margin percentage

= CMR ×100

= 0.35 ×100

= 35%

4. The total contribution margin

=Total sales revenues – Total variable costs

= 100 ×6000 – 65 ×6000

= $210,000

Or = UCM ×No. of units sold = 35×6000 = $210,000

5-9

Coffee Klatch is an espresso stand in a downtown

office building. The average selling price of a cup of

coffee is $1.49 and the average variable expense per

cup is $0.36. The average fixed expense per month is

$1,300. An average of 2,100 cups are sold each

month. What is the CM Ratio for Coffee Klatch?

a. 1.319

b. 0.758

c. 0.242

d. 4.139

Quick Check

CM Ratio = Unit contribution margin

Unit selling price

= ($1.49 - $0.36)

$1.49

= $1.13

$1.49 = 0.758

Breakeven point (BEP)


The point at which the volume of sales will

result in:

Total revenues – Total costs = 0

Two types of costs to consider:

Variable costs

Fixed costs

To breakeven we must sell enough units to cover both

variable and fixed costs

21/01/2014

60

Breakeven point

Step 1: Calculate the Unit contribution margin (UCM)

UCM = Unit sales price – Unit variable costs

Step 2: Calculate breakeven point by using: Fixed costs

Breakeven point (in units) =

Fixed costs

Breakeven point (in dollars) = CM Ratio


UCM

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

0 100 200 300 400 500 600

Sales

Total expenses

Fixed expenses

The CVP Graph Break-even point

Units Loss Area

Profit Area


Quick Check



coffee is $1.49 and the average variable expense per

cup is $0.36. The average fixed expense per month is

$1,300. An average of 2,100 cups are sold each

month. What is the break-even sales dollars?

a.

$1,300

b.

$1,715 c.

$1,788

d. Week 2 - Session 1, 2013

21/01/2014

61



coffee is $1.49 and the average variable expense

per cup is $0.36. The average fixed expense per

month is $1,300. An average of 2,100 cups are sold

each month. What is the break-even sales dollars?

a. $1,300

b.

$1,715 c.

$1,788

d.

$3,129

Quick Check

Break-even Fixed expenses

sales CM Ratio $1,300

0.758

= $1,715

=


=

Lecture example 2


The promoters of The Voice want to know how many tickets they need

to sell for the final concert to breakeven on all the costs associated with

the production. The information you have been given is:

Selling price = $100 per ticket

Total Fixed costs = $ 750 000

Variable costs = $25 per ticket

How many tickets need to be sold to cover all the costs? And

how much revenues must be generated to breakeven?


1. Breakeven point (in units) =

= 750 000 / (100 - 25)

= 750 000 / 75

= 10 000 units

Fixed costs 2. Breakeven point (in dollars) = CM Ratio

= 750 000 / (UCM÷Unit sales price)

= 750 000 / (75÷100)

= $1000 000

Fixed costs UCM


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62

Safety margin


Difference between the budgeted/actual sales

revenue and breakeven sales revenue

E.g. To breakeven “The Voice” team must generate $100,000

revenues, while the budgeted sales revenues are $150,000. What is

the safety margin?

Safety margin = budgeted sales revenue – breakeven sales revenue

= 150,000 – 100,000 = $50,000

Indicates the extent to which sales can decline

before profits become zero

Quick Check

Coffee Klatch is an espresso stand in a downtown office

building. The average selling price of a cup of coffee is

$1.49 and the average variable expense per cup

is

$0.36. The average fixed expense per month is $1,300.

An average of 2,100 cups are sold each month. What is

the margin of safety expressed in cups?

a. 3,250 cups

b. 950

cups

c. 1,150 cups

d. 2,100 cups




$1.49 and the average variable expense per cup is

$0.36. The average fixed expense per month is $1,300.

An

average of 2,100 cups are sold each month. What is the

margin of safety expressed in cups?

a. 3,250 cups

b. 950 cups

dc. 12,1 Margin of safety = Total sales – Break-even sales = 2,100 cups – 1,150 cups

= 950 cups

500 ccupsups

Quick Check


21/01/2014

63

Lecture example 3


A small theatre company (330 seats) has planned for 30

performances. On average 65% of seats will be sold.

The sales price per ticket is $80 and variable costs per

ticket are $30. Fixed costs are $320 000 in total.

Calculate:

a. The breakeven point in sales dollars

b. The safety margin for this production

c. Calculate profit/loss using safety margin



a. The breakeven point in sales dollars

= Fixed costs/ CM ratio

= 320 000 / (UCM ÷ Unit sales price)

= 320 000 / (50 ÷80 = 0.625)

= $512 000

b. The safety margin for this production

Budgeted revenue = $80 x (330 seats x 0.65 x 30 performances)

= $514 800

Safety margin = Budgeted revenue – breakeven revenue

= $514 800 - $512 000 = $2800

C. Profit = Safety margin x CM ratio

= 2800 X 0.625 = 1750

Target net profit

A desired profit level determined by management.

The break-even formula can be used to determine the sales volume

required to achieve a target profit:

Target sales volume (in units)=

Target sales volume (in dollars)=

Fixed costs + Target profit UCM

Fixed costs+ Target profit

CM Ratio


21/01/2014

64

Lecture example 4


The promoters of The Voice want to know how many tickets they need

to sell for the final concert to breakeven on all the costs associated with

the production. The information you have been given is:

Sales price = $100 per ticket

Total Fixed costs = $ 750 000

Variable costs = $25 per ticket

How many tickets need to be sold to make a profit of $250 000?

And how much revenues must be generated to achieve a profit

of $250 000?


1.Target sales volume (in units)=

= (750 000 + 250 000) / (100 - 25)

= 1000 000 / 75

= 13333.3

= 13334 units (round up to the next integer)

2.Target sales volume (in dollars)= Fixed costs + Target profit

CM Ratio

= 1000 000 /(75÷100)

= $1333 333.3

= $1333 334

Fixed costs + Target profit

UCM


Including income taxes in CVP analysis

Target net profit before tax = Target net profit after tax / (1- tax rate)

Sales volume (in units) required to

earn target net profit after tax

FC + Target net profit before tax

Unit contribution margin =

Sales volume (in dollars) required to

earn target net profit after tax = FC + Target net profit before tax

Contribution margin ratio


21/01/2014

65

Quick Check



$1.49 and the average variable expense per cup is $0.36.

The average fixed expense per month is $1,300.

Determine

how many cups of coffee would have to be sold to attain

target profits of $2,500 per month.

a. 3,363 cups

b. 2,212 cups

c. 1,150 cups

d. 4,200 cups




$1.49 and the average variable expense per cup is

$0.36. T he average fixed expense per month is $1,300.

rmula method to determine how many cups of

ould have to be sold to attain target profits of

er month.

cups

cups

cups

cups

Use the of

coffee w

$2,500 p

a. 3,363

b. 2,212

c. 1,150

d. 4,200

Quick Check

Target profit + Fixed expenses

Unit CM

Unit sales

to attain

target profit

= 3,363 cups

=

$2,500 + $1,300

$1.49 - $0.36

$3,800

$1.13


=

=

Lecture example 5


Selling price

Variable cost per unit:

Manufacturing cost per unit

Selling cost per unit

$ 10

$ 5

$ 1.40

Annual Fixed costs

Selling

Administration

$ 240 000

$ 380 000

After tax profit target $ 126 000

Tax rate 30%

Information for ABC Ltd is provided below:

Required: Calculate number of units that need to be sold in 2011

to achieve the target net profit after tax

Selling price $ 10

Variable cost per unit: $ 5

Manufacturing cost per unit

Selling cost per unit $ 1.40

Annual Fixed costs $ 240 000

Selling

Administration $ 380 000

After tax net profit target $ 126 000

Tax rate 30%

21/01/2014

66


Fixed costs = 240 000 + 380 000 = $ 620 000

Target net Profit before tax = Net profit after tax / (1- tax rate)

= 126 000 / (1 – 30%)

= $180 000

Unit contribution margin = Unit sales price – Unit variable costs

= 10 – (5 + 1.4)

= $3.6

Sales volume required = = 222 223 units

Sales volume (in units) required to = earn target net profit after tax


FC + target net profit before tax

Unit contribution margin

620 000 + 180 000

3.6

CVP analysis with multiple products


Key terms:

Sales mix

The relative proportions of each type of product

sold by the organisation

Weighted average unit contribution margin

The average of the products’ unit contribution

margins, weighted by the sales mix.

e.g. The sales mix for Product A and B are 40% and 60%

respectively. UCM = $10 for A and $15 for B →

Weighted average UCM = 40%×10 + 60%×15 = $13

Lecture Example 6


Healthylife Ltd produces three different frozen

meals: Beef, Pork and Chicken meals.

Calculate the weighted average unit contribution margin

Beef Pork Chicken

Sales mix 30% 50% 20%

Selling price/unit $8 $7 $6

Variable costs $3 $2.5 $2

21/01/2014

67

Lecture example 6 solutions TIPS: to calculate the weighted average UCM, you should always calculate

the UCM for each product first, then take the sales mix into account.


UCM (beef) = 8 – 3 = $5

UCM (pork) = 7 – 2.5 = $ 4.5

UCM (chicken) = 6 – 2 = $ 4

Weighted average UCM

= 30%×5 + 50%×4.5 +20%×4

= $4.55

Breakeven point with multiple products

Step 1:

Breakeven point (in units) =

* to calculate the weighted average UCM, you should always calculate the

UCM for each product first, then take the sales mix into account.

Step 2:

Breakeven point for each product (in units):

The total breakeven units needs to be broken up

in proportion to the expected sales mix.

Fixed costs Weighted average UCM*


Lecture example 7


The Opera House has decided to offer seats at two different prices:

VIP Seats: $700 per ticket with only 250 seats available

Normal Seats: $270 per ticket with 2250 seats.

Variable cost per unit is $100.

Fixed costs are $310 000

Required:

Calculate breakeven point in seats. Specifically, how many of each

seat we need to sell to breakeven?

21/01/2014

68



Calculate Weighted average UCM:

i) UCM of each product

UCM of VIP seats = $700 – 100 = $600

UCM of Normal seats = $270 - $100 = $170

ii) Calculate Sales Mix

Total seats available = 2500

VIP seats = 250/2500 = 10%

Normal seats = 2250/2500 = 90%

iii) eighted average UCM = 600 ×10% + 170×90% = $213



Calculate the breakeven point (in No. of seats)

= Fixed costs / Weighted average UCM

= 310 000 / 213

= 1456 tickets

To break up the total breakeven tickets into:

No. of VIP seats = 1456×10% =145.6 = 146

No. of Normal seats = 1456×90% = 1310.4 = 1311

(Note: Adds to 1457 seats due to rounding and needs to breakeven)

Limitations of CVP analysis


CVP analysis is merely a simplified model;

The usefulness of CVP analysis may be greater in

less complex smaller firms, or stand-alone projects;

For larger firms, CVP analysis can be valuable as a

decision tool for the planning stages of new

projects and ventures;

CVP analysis is based on several assumptions which

limits its usefulness for decision making.

21/01/2014

69

Summary of the week

How to calculate the breakeven point (in units

and in dollars);


How to calculate safety margin;

How to calculate the sales volume required to

achieve a targeted profit (with or without taxes);

How to calculate the breakeven point for

multiple products.

Previous final exam question


Speed Bicycle Shop sells 10-speed bicycles. For purposes of a CVP analysis the shop owner has divided sales into two categories as follows:

Three-quarters of the shop’s sales are medium quality bikes. The shop’s annual fixed expenses are $13,000. (In the following requirements, ignore income taxes.)

REQUIRED:

(a)Calculate the UCM for each product type. (1 mark)

(b) Calculate the weighted average UCM, assuming a constant sales mix. (2 marks)

(c) What is the shop’s break even sales volume in dollars? Assume a constant sales mix.

(3 marks)

(d)How many bicycles of each type must be sold to earn a target net profit of $6,500?

Assume a constant sales mix. (2 marks)

Product type Sales price $ Invoice cost $ Sales commission $

High quality 100 55 5

Medium quality 60 27 3

Solutions


1. UCM for High quality = 100 –(55+5) = $40

UCM for medium quality = 60 – (27+3) = $30

2.Weighted average UCM= 40×25% + 30×75% = $32.5

3. BEP (in units) = 13000/32.5 =400 units

High quality products: 400×25% = 100 units

Medium quality products: 400×75% = 300 units

Hence, sales revenues from high quality products= 100×$100= $10 000

sales revenues from medium quality products= 300×$60=$18 000

4. Sales volume required = (13000+6500)/32.5 = 600

units High quality products: 600×25% = 150 units

Medium quality products: 600×75% = 450 units

21/01/2014

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Welcome to ACCG200

1

Lecture 8

Variable and Absorption Costing

Chapter 7 pp.316-321

Two methods of costing inventories

in manufacturing companies

2

Absorption costing: all manufacturing costs are

assigned to products: direct material, direct labour,

variable and fixed manufacturing overhead;

Variable costing: only variable costs are assigned to

products: direct material, direct labour and variable

manufacturing overhead.

AASB 102 inventories requires inventory to be valued at absorption

costing for external reporting

Variable MOH and fixed MOH

3

Variable MOH: Indirect manufacturing costs

that vary in proportion to the level of production (e.g. Indirect labour and materials; electricity)

Fixed MOH: indirect manufacturing costs that

DO NOT vary in proportion to the level of

production (i.e. factory manager ’s salary; factory rent)

21/01/2014

71

Variable and Absorption Costing

Inventory / product costs include:

The difference between the two methods is?

the treatment of Fixed MOH

Absorption Costing Variable Costing

Direct materials Direct materials

Direct labour Direct labour

Variable MOH Variable MOH

Fixed MOH*

Treatment of Fixed MOH

Variable costing:

Fixed MOH is expensed immediately as it is

incurred → Period cost

Absorption costing:

Fixed MOH is inventoried until the manufactured

goods are sold

5

Variable and absorption costing Copyright © 2012 McGraw-Hill Australia

(A) Variable costing

Direct material

Direct labour Variable

manufacturing overhead

when

costs are

incurred

Work in

Process Inventory

on Balance

Sheet

when

goods are

finished

Finished

Goods Inventory

on Balance

Sheet

when

good s are

sold

• • • Expense

on Income

Statement

Expense

on

Income Statement

Fixed

manufacturing overhead

when costs are incurred - - - - - - - •

(B) Absorption costing

Direct material

Direct labour All manufacturing

overhead

when

costs are

incurred

Work in

Process Inventory

on Balance

Sheet

when

goods

are finished

Finished

Goods Inventory

on Balance

Sheet

when

good s are

sold

Expense

on • .. • Income

Statement

MACQUARIE A\t, UNIVERSITY YJI"

FACULTY OF


21/01/2014

72

Lecture example 1

7

Company X produces ipods which include the following costs per unit:

The MOH includes fixed MOH of $3 per unit and variable MOH of $5 per

unit. At the end of the accounting period a stocktake is undertaken and

the company has 4000 units on hand (beginning balance is 0).

Required: (a) Calculate the unit product cost under absorption and variable costing;

(b) Calculate the value of inventory under both methods;

(c) Compare and discuss the difference in total inventory values under both

methods.

Direct materials $12

Direct labour $10

MOH $ 8


8

a) Product costing under the two methods:

Absorption product Cost Variable product Cost

Direct material 12 12

Direct labour 10 10

Variable MOH 5 5

Fixed MOH 3 -

Unit product cost $30 $27


9

b) Under absorption:

Under variable:

Value of inventory (4000 units)

$ 30 × 4000 units = $120,000

$27 × 4000 units = $108,000

c) Difference = 120 000 – 108 000 = $12,000

Discuss why?

Because under Absorption costing the total fixed MOH in regard to the

4000 units ($3 × 4000 units = $12,000) are inventoried, while under

Variable Costing the total fixed MOH in regard to the 4000 units are

recorded as expenses.

21/01/2014

73

Calculating profit under variable and

absorption costing

10

Absorption costing Variable costing

Total revenue Total revenue

Less: cost of goods sold (unit product cost × units sold)

Less: total variable cost including:

1. manufacturing variable cost

(i.e. unit product cost × units sold);

2. all other variable costs.

Gross margin/ gross profit Contribution margin

Less: total non-

manufacturing costs

Less: total fixed costs

Operating profit Operating profit

Lecture example 2

Austimber Ltd produced and sold 50000 meters of timber in 2009, with the

following operating information given:

11

Required: compute operating profits in 2009 using both absorption

and variable costing.

Actual and budgeted fixed manufacturing overhead $60 000

Variable manufacturing cost per meter (DM+DL+VMOH) $7

Fixed manufacturing overhead per meter $1.2

Actual fixed selling and administration expenses (S&A) $50 000

Actual variable S&A expenses per meter $1

Selling price per unit/per meter $15


12

Absorption Costing

Revenue $ 750 000

Less: Cost of goods sold * ( 410 000)

* unit product cost ($8.2) × 50000 units sold

Gross margin 340 000

Less: total non-manufacturing expenses

Variable selling & admin. costs 50 000

Fixed selling & admin. costs 50 000 (100 000)

Operating profit 240 000

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13

Variable costing

Revenue $ 750 000

Less: Variable manufacturing cost/variable COGS ( 350 000)

Variable S& A expenses (50 000)

Contribution margin 350 000

Less: Fixed manufacturing overhead (60 000)

Fixed S & A expenses (50 000)

Operating profit 240 000

Lecture example 3

14

Using the cost data given in the example 2, compute the

operating profit of Austimber Ltd for both 2010 and 2011 with

additional information provided below.

2009 (in units) 2010 (in units) 2011 (in units)

Beginning inventory

finished goods

0 0 5000

Actual production 50 000 50 000 50 000

Sales 50 000 45 000 55 000

Ending inventory of

finished goods

0 5 000 0


15

Absorption Costing 2010 2011

Revenue $ 675 000 $ 825 000

Less: Cost of goods sold ( 369 000) (451 000)

Gross margin 306 000 374 000

Less: Non-manufacturing expenses

Fixed S&A (50 000) (50 000)

Variable S&A (45 000) (55 000)

Operating profit 211 000 269 000

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16

Variable costing 2010 2011

Revenue $ 675 000 $ 825 000

Less: Variable cost of goods sold ( 315 000) (385 000)

Variable S& A expenses (45 000) (55 000)

Contribution margin 315 000 385 000

Less: Fixed manufacturing overhead (60 000) (60 000)

Fixed S & A expenses (50 000) (50 000)

Operating profit 205 000 275 000

Comparison of variable and absorption

costing

2009 2010 2011

1. Absorption costing operating profit $240 000 $211 000 $269 000

2. Variable costing operating profit 240 000 205 000 275 000

3. Difference in profit 0 6000 (6000)

4. Absorption costing –Fixed

Manufacturing cost expensed

$60,000 $54,000 $66,000

4. Variable costing –Fixed

Manufacturing cost expensed

$60,000 $60,000 $60,000

4. Level of inventory Beg = End Beg < End Beg > End

5. Difference b/w production and sales Pro = Sales Pro > Sales Pro < Sales 17

A short cut to reconciling profit under

variable and absorption costing

18

Difference in fixed

MOH cost expensed= inventory under absorption and

variable costing

change in

(in units)

predetermine

d fixed

manufacturing

overhead rate

per unit

x

Difference in

profit under

absorption and

variable costing

=

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Lecture example 4 Based on the information from example 3, apply the short cut

method to reconcile profit under variable and absorption

costing.

Year

19

Change in

inventory

Predetermined

fixed Manu

overhead rate

Difference in

fixed

overhead

expensed

Absorption

costing profit

minus variable

costing

2009 0

(Production = sales )

X 1.20 = 0 = 0

2010 5000 (increase) (production > sales)

(50000 > 45000)

X 1.20 = 6000 = + 6000

2011 5000 (decrease) (production < sales)

(50000<55000

X 1.20 = 6000 = - 6000

Comparative Income Effects

20

Variable costing Absorption costing

How do changes in unit

inventory cost affect

operating income if…?

Production = sales Equal Equal

Production > sales Lower Higher

Production < sales Higher Lower

Lecture example 5

21

Osawa Ltd planned and actually manufactured 200 000 units of its

single product in 2011, its first year of operation.

Variable manufacturing cost was $20 per unit produced.

Variable non-manufacturing cost was $10 per unit sold.

Planned and actual fixed manufacturing costs were $600 000.

Planned and actual fixed non-manufacturing costs were totalled $400

000.

Osawa sold 120 000 units of product at $40 per unit.

1. Compute Osawa’s 2011 operating profit using variable costing

2. Compute Osawa’s 2011 operating profit using absorption costing

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22

Variable costing

Revenue $ 4800,000

Less: Variable cost of goods sold (2400,000)

Variable non-manufacturing cost (1200,000)

Contribution margin 1200,000

Less: Fixed manufacturing overhead (600,000)

Fixed non-manufacturing cost (400,000)

Operating profit 200,000


23

Absorption Costing

Revenue $ 4800,000

Less: Cost of goods sold

($20+ FOH/unit) * No. of units sold

(20 + 600,000/200,000) * 120,000

(2760,000)

Gross margin 2040,000

Less: non-manufacturing cost

Variable $10*120,000 (1200,000)

Fixed (400,000)

Operating profit 440,000

Absorption versus Variable costing

24

AASB 102 Inventories requires that for external financial

reporting, absorption costing is used to value inventory.

Variable costing provides managers information that is

useful for planning costs and tactical decision making.

Note absorption costing is more useful for long-

term decision making

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MCQ 1

25

Classix Products reported $28 000 in net profit for the year using variable

costing. The company had no units in beginning inventory, planned and actual

production was 30 000 units, and sales were 25 000 units during the year.

Variable manufacturing costs were $15 per unit and total budgeted fixed

manufacturing overhead was $150 000. There was no underapplied or

overapplied overhead reported during the year. Determine the net profit under

absorption costing.

0

00

A. $28 000 FMOH rate = $150000 / 30000 units = 5

B. $30 000 Profit difference = 5000 units X 5 = $25

00

C. $53 000 Absorption costing profit = $28 000 + $25

0

D. $58 000 = $53 000 - C

MCQ 2

26

Gallison Company's net profit under absorption costing was $15 000 higher than

under variable costing. During the year, the company planned and produced 20 000

units for total variable production costs of $80 000. If fixed manufacturing overhead

was $40 000, how many units were sold?

Units sold = 20000 - 7500 = 12 500 units - B

rate

A. 20 000 units FMOH rate = $40000 / 20000 units = 2

B. 12 500 units Profit difference = change in Inventory X FMOH

C. 10 000 units 15000 = change in Inventory X 2

D. 7500 units change in Inventory = 15000/2 = 7500 units

Lecture example 6

27

Which of the two methods (i.e. absorption and variable)

would a manager prefer to use if their bonus was tied to

profits?

Answer: Absorption costing.

Reasons:

Managers can manipulate profits by simply building inventories (i.e. producing more units than the actual demand).

This will result in more fixed costs being capitalised as inventory rather than expensed in the current period.

Profit increases and potentially so does a manager ’s bonus

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Reminder

28

The 2nd Excel assignment will be due by

6pm Wednesday 15th of January 2014

.

Week 3 – Session 1, 2013

Welcome to ACCG200

Lecture 9

Decision Making I

Information for tactical decisions

Chapter 19


The management accountant’s role in

decision making

2

To provide relevant information to managers and teams

who make the decisions

Tactical decisions/ short-term decisions

Do not require significant or permanent resource commitments

Can be changed or reversed quickly

Long-term decisions

May involve increases or decreases in capacity-related resources

More difficult to reverse and effects may extend over longer time

periods

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Characteristics of relevant information

3

Relevant information must satisfy the following criteria:

Different under competing courses of action

Costs and benefits that are the same across all available courses of

action need not be considered. 2 alternative products – A and B.

Raw material cost of product A

Raw material cost of product B

Raw material cost is irrelevant .

= $3,000

= $3,000

Relates to the future

Costs that have already been incurred cannot be changed and

are irrelevant

Timeliness versus accuracy

As accuracy increases, timeliness may decrease

Information for decisions -- terminology

4

Incremental revenues

The additional revenue that will be gained as a result of choosing one course of action over

another. e.g., 2 alternative products – A and B.

The additional costs that arise from choosing one course of action over another 2 alternative products – A and B.

Costs that will not be incurred in the future if a particular decision is made

Unavoidable costs

Costs that will continue to be incurred no matter which decision alternative is

chosen

Irrelevant to the decision

Revenues from product A

Revenues from product B

Incremental revenue from choosing product A

Incremental costs

= $15,000

= ($10,000)

= $5,000

Manufacturing cost of product A

Manufacturing cost of product B

Incremental cost choosing product A

Avoidable costs

= $8,000

= ($5,000)

= $3,000

Information for decisions – terminology

(cont.)

5

Sunk costs

Costs that have already been incurred

Irrelevant to any future decisions

Opportunity costs

The potential benefit given up when the choice of one action

precludes a different action 2 alternative products – A and B. Contribution margin from product A

Contribution margin from product B

Opportunity cost, if you choose product A

= $8,000

= $5,000

= $5,000

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Tactical decision making

6

Accept or reject a special order

Make or buy a product

Add or delete a product or department

Joint products: sell or process further

A special order is a one-time

order that is not considered

part of the company’s normal

ongoing business.

Whether or not to supply a customer

with a single, one-off order for goods

or services, at a special price

When analyzing a special

order, only the incremental

costs and benefits are

relevant.

Accept or reject a special order Accept or reject a special order

19-8

Decision rule: does the special order generate

additional operating profit? - incremental revenues are

greater than incremental costs

Yes – accept

No – reject

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Accept or reject a special order (cont.)

19-9

If there is idle (spare) production capacity

Spare capacity occurs where equipment, labour or other inputs to

production are not being utilised and, hence, are available for other

purposes

Allocated fixed costs should not be included

If there is no spare capacity

The analysis should take account of opportunity costs

with the use of the limited capacity

associated

Long term strategic issues:

whether the decision to accept the special order will impact on the

business’ reputation or relationships with existing customers

Lecture Example 1:

10

Waugh Ltd has a plant capacity of 30,000 units per month. Unit cost includes:

Currently monthly sales are 29,000 units at $5.30 per unit. Border Ltd has contacted Waugh Ltd about purchasing 1000 units at $5 each. Current sales would not be affected by the order.

Special order also requires 1000 Kg of raw materials. Firm has sufficient inventory of raw materials at book value of $1 per Kg. However, if the order is accepted, the firm will be forced to restock at a predicted cost of $1.2 per Kg.

Assumption: variable selling cost is not affected by the special order.

Required

If the order is accepted what is the change in Waugh’s profit for the month?

Direct labour $1.60

Variable overhead $1.00

Fixed overhead $0.90

Fixed selling expenses $1.80

Variable selling expenses $1.50

Lecture Example 1 - Solutions

11

Increase in Revenue 1000 x $5 5000

Increase in costs:

Direct materials

Direct labour

1000 x $ 1.20 = 1200

1000 x $ 1.60 = 1600

Variable overhead 1000 x $1.00 = 1000 3800

Total increase in profit 1 200

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Lecture example 2

Crystal Lattice (CL) produces mats for use in fitness centers. Production capacity is

20000 mats per year. Due to a chain of fitness centers closing, CL now has spare

capacity of 2000 mats per year. An international hotel chain, Resteasy, has recently

contacted CL to place a one-off order for 3000 mats. The hotel chain has recently

remodelled a number of its hotels to incorporate fitness centers for guests.

12

CL normally sells mats for $100/mat, and Resteasy has offered to pay $90 per mat.

Resteasy has also requested that each mat be embossed with its company logo. An

embossing machine costing $20 000 would therefore need to be purchased by CL.

The machine could not be used for other products.

Questions:

1) From a financial perspective, should CL accept the special order?

2) What other factors should be considered before accepting the order?

Budgeted cost for 20 000 mats

Variable manufacturing costs $ 800 000

Fixed manufacturing costs $ 900 000

Lecture example 2 – solutions

13

Variable cost/unit = 800000/20000=$40/unit

If accepts the special order:

Relevant revenue $90 ͯ 3000 = $270 000

Relevant costs :

Variable $40 ͯ 3000 = $120 000

costs of embossing machine $20 000

Opportunity cost (100-40) ͯ 1000 = $60 000

Profit/ loss $70 000 profit

A decision to make a part or provide a service

internally rather than to buy externally from a

supplier is called a “make-or-buy” decision.

Make-or-buy decisions are also called insourcing

versus outsourcing decisions.

Make-or-Buy Decisions

7-14

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Make or buy a product

Decision rule: Choose the option with the lowest relevant cost.

Consider avoidable versus unavoidable costs

Opportunity costs are often relevant

Strategic issues may include:

Quality of the purchased product

Delivery responsiveness, technical capabilities, labour relations and

financial stability of the supplier

Ability of the supplier to respect confidential information

19-15

Annual

C ost

U nit

C ost

Packaging Materials

Packaging D irect Labour

Indirect Mater ials

Packaging Supervision

O ther Fixed Manu O verhead

Total Packaging C ost

$ 300,000

90,000

60,000

1.50

0.45

0.30

$

Mattel Ltd is trying to decide whether to continue packaging the

American Girl doll “in-house” or outsource the packaging process to

an external supplier. Mattel’s packaging costs for the dolls are:

Internal C ost of Packaging

200,000 American G ir l D olls

The outside supplier bid $3.00 per doll for the packaging work.

Should Mattel outsource the packaging?

Example

7-16

50,000 0.25

200, 000 1 .0 0

$ 700, 000 $ 3 .5 0

Example cont.,

• The agreement with the outside supplier includes a 3-year contract

for a minimum of 200,000 units per year.

• All costs directly related to the packaging activities, including all

direct and indirect materials, labour, and supervision, would be

avoided if the packaging is outsourced.

• Other total fixed manufacturing overhead costs would remain

unchanged.

• The factory space that is now used for packaging could be used

to expand production of a popular product line. The expansion

would generate an additional $150,000 in profit per year.

7-17

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85

Internal

Costs

-

Outsourced

Costs

$ 600,000 Supplier's Price ($3.00 per unit)

Packaging Materials ($1.50 per unit)

Packaging Direct Labor ($0.45 per unit)

Indirect Materials ($0.30 per unit)

Packaging Supervisor

Profit from Expanding Another Product Line Total cost

Relevant Costs of Packaging 200,000 Units per Year

Incremental Analysis

Outsourcing is $50,000 less.

Note that fixed costs are excluded because they are irrelevant

to the decision. Mattel should outsource the packaging.

7-18

$ 300,000

90,000

60,000

50,000

-

$ 500,000

(150,000)

$ 450,000

Qualitative Analysis

• What is the supplier ’s level of quality and reliability?

• What happens if demand for the product drops below 200,000

units or rises significantly higher than 200,000? Does the

supplier have the capacity to meet the increased demand? Will

the price be higher or lower for any additional or fewer units?

• What happens in three years? Will the price of packaging

increase significantly? Returning to internal packaging will be

difficult after the space is converted to another use.

• What if the predicted profit to be generated by expanding the

other product line has been substantially over- or

underestimated?

• Does outsourcing the packaging create any additional risks,

such as loss of sensitive information to the supplier that could

result in a competitive disadvantage for Mattel?

7-19

Lecture example 3

20

Spa Company produces plunge pools. Currently, the company uses internally

manufactured pumps to power jets. Spa Co. has found that 40 % of the pumps have

failed within their 12-month warranty period, causing huge warranty costs.

Because of the company’s inability to manufacture high-quality pumps, management

is considering buying pumps from a reputable outside supplier who will also bear any

related warranty costs.

Spa Company’s unit cost of manufacturing pumps is $83.75 per unit, including $17.25

of allocated fixed overhead. Also, the company has spent an average of $22 repairing

each pump returned. Spa company can purchase pumps for $92.50 per pump. During

2011, Spa Co. plans to sell 12 800 plunge pools (each pool requires one pump).

Required:

Determine whether Spa Company should make or buy the pumps?

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Lecture example 3 – solutions

21

If pumps are purchased, Spa Company will reduce its profits by $220

160 (1184000 – 963840). Thus, Spa should make pumps.

Option1- Make pumps

Manufacturing cost

(83.75-17.25 = 66.50/pump)

66.5 ͯ 12800=$851200

Warranty cost ($22/pump returned) 22 ͯ (12800 ͯ 40%)=$112640

Total Relevant cost $963 840

Option 2- Buy pumps

Purchase price ($92.5/pump)

Total Relevant cost 92.5 ͯ 12800 = $1184 000

One of the most important decisions managers make is whether to continue or eliminate a business segment, such as a product or a store.

A segment is a candidate for elimination if its revenues are less than its relevant (avoidable) expenses.

Add or delete a product, service or

department

7-22

Add or delete a product, service or

department

Decision Rule: Discontinue a product, service or business

segment when its total contribution margin does not

cover avoidable fixed costs.

Strategic issues:

If we delete a product, will this affect sales of other

products? Will we loose customers? Will it impact

capacity?

Deleting a department may impact on employee morale

23

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Lecture Example 4

Burt Ltd has three divisions which are in competition with each other,

selling slightly different products. Annual results appear below:

The company believes that if it drops Division B, sales of Division A will

increase by 4000 units and sales of Division C will increase by 2000

units. Analysis reveals that $24000 of fixed costs relating to Division B

are avoidable for the company if Division B is closed.

Should the division B be closed?

24

Division A Division B Division C

Sales in units 8 000 9 000 12 000

Selling price/unit $22 $18 $15

Variable costs/unit $10 $8 $9

Fixed costs $15 000 $36 000 $25 000

Lecture Example 4 - solutions

If division B is closed:

Lost contribution margin:

Reduced avoidable fixed

costs: Lost divisional profit

Effect on other divisions

Increased CM in Division A:

Increased CM in Division

C: Total increased CM

(18-8) ͯ 9000 = $90 000

$24 000

$66 000

(22-10) ͯ 4000=$48 000

(15-9) ͯ 2000 = $12 000

$ 60 000

Hence, overall loss by closing Division B is $6000.

Close division B ? NO

25

Joint products: sell or process further Joint products

In the process of making one product, one or more other products are created.

Cannot be separated prior to split-off

Joint cost All manufacturing costs incurred in the production of joint products

19-26

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12-27

Joint Products

Separate

Processing

Separate

Processing

Final

Sale

Final

Sale

Fina

l

Sal

e

Separate

Product

Costs

crude oil Common

Production

Process

Split-Off

Point

Oil

Gasoline

Chemicals

Joint costs

are incurred

up to the

split-off point

Lecture Example 5

Sawmill, Inc. cuts logs from which unfinished lumber

and sawdust are the immediate joint products.

Unfinished lumber is sold “as is” or processed

further into finished lumber.

Sawdust can also be sold “as is” to gardening

wholesalers or processed further into “presto-logs.”

Unfinished Lumber Sawdust

Lecture Example 5

Data about Sawmill’s joint products includes:

Pe r Log

Lumbe r

$ 140

270

176

50

Saw dust

$ 40

50

24

20

Sa le s va lue a t the split-off point

Sa le s va lue a fte r furthe r proce ssing

Allocate d joint product costs

Cost of furthe r proce ssing

Required:

1. What are the relevant costs/revenues in making a

decision to process further?

2. Should the company sell products at split-off point or

process them further?

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Lecture Example 5 – solution

The lumber should be processed

further and the sawdust should

be sold at the split-off point.

An a l ysi s o f S e l l o r P ro c e ss F u rth e r

P e r L o g

Lu m b e r

$ 270

140

130 10

50 20

$ 80 $ (10 )

S a w du s t

$ 50

40

S a l e s va l u e a fte r fu rth e r

p ro c e ssi ng S a l e s va l u e a t th e sp l i t-

o ff p o i n t I n c re m e n ta l re ve n u e

C o st o f fu rth e r p ro c e ssi ng

P ro fi t (l o ss) fro m fu rth e r p ro c e ssi ng

Summary

19-31

Tactical decisions do not require significant changes in

capacity and can be changed if better opportunities

arise

Relevant information will include quantitative and

qualitative information, as well as strategic issues

In decision analysis, incremental revenues and costs

are usually the focus, and in some cases so are

avoidable costs

Identifying whether there is spare capacity is important

in special orders and make or buy decisions, as

opportunity costs become relevant where there is no

spare capacity

Summary (cont.)

19-32

Adding or deleting a product/department involves

consideration of avoidable and unavoidable costs

Processing joint products further requires consideration of

incremental revenue and costs

Management incentives can sometimes distort the collection and analysis of information in decisions

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Welcome to ACCG200

Lecture 10

Joint cost allocation and product mix

decisions Chapter 19 Appendix (pp.928-931)

Chapter 20 pp. 967-978


Product mix decisions

Tactical product mix decisions with limited resources

Determining the optimum product mix to maximize profits .

When a limited resource of some type

restricts the company’s ability to satisfy

demand, the company is said to have a

constraint that is referred to as a

bottleneck.

To maximize profits in the short

run, a company with a

bottleneck must prioritize its

products or services so as to

maximize contribution margin

per unit of the constrained

resource.

2

Product mix decisions

3

Single limited resource: compare the contribution margin per unit of

the scarce resource (not contribution margin per unit) to determine

the profitability of each product.

Multiple limited resources: linear programming

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Lecture example 1

4

Company A provides the following information for product P and Q. The

company has limited machine hours.

With the limited machine hrs, which product should be produced first so

as to maximize the total profits? P or Q?

Answer: Product P.

Product P Product Q

Selling price/unit $80 $120

Total variable costs/unit $50 $70

Contribution margin/unit $30/unit $50/unit

Machine hrs/unit 2hrs 5 hrs

Contribution margin/ mhr $15/mhr $10/mhr

Lecture example 2

5

Power Tool manufactures engines for commercial and consumer products. It

assembles two engines: engine A and B. Following is information for each product

line:

Engine A require 2 machine hrs each and engine B require 5 machine hrs each.

Only 600 machine hours are available each day for assembling engines. Additional

capacity cannot be obtained in the short run. Power tools only has demand for 200

engine A but can sell as many engine B as it produces.

Required: 1) How many of each type of engine should be produced to maximize

the total contribution margin?

2) Calculate the contribution margin at the optimal solution.

Engine A Engine B

Selling price $ 800 $ 1000

Variable cost per unit 560 625

Contribution margin per unit 240 375

Contribution margin ratio 30% 37.5%

Lecture example 2 solution

6

1) How many engine A and B should be produced to maximize the profit

Engine A Engine B

Contribution per unit $240 $375

Machine hours per unit 2 hrs 5 hrs

CM per hour 240/2 = $120/hr 375/5 = $ 75/hr

Rank 1 2

Total available hours = 600 hrs

Engine type Production units Mhrs / unit Total Mhrs

A 200 units 2hr/unit 400 hrs

B 40 units 5hr/unit 200 hrs

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7

2) Calculate the contribution margin with the optimal product mix

Contribution margin with the optimal product mix

Engine type Production units CM per unit Total CM

A 200 units $240/unit $48 000

B 40 units $375/unit $15 000

Total $63 000

Multiple limited resources: linear

programming

8

Involves identifying linear relationships between the

decision variables to determine the optimal

solution, given a number of constraints

Represents the solution of two simultaneous

equations either algebraically or graphically

Linear programming

9

Five steps in determining the optimal solution:

1. Identify the decision variables ( products involved)

2. Determine the objective function: refers to the sum of the contribution margin for each product.

3. Determine the constraints based on the limited resources available.

4. Graph the constraints: the space between the axes and the constraints form an area known as the feasible region.

5. Determine the optimal point by calculating the contribution margin that can be obtained at the extreme points in the feasible region.

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Lecture example 3

10

Company A produces two products X and Y with contribution margins

of $30 and $25 respectively. The company has a maximum of 1200

machine hours and 3000 labour hours per month.

Product X requires 1 machine hour per unit while product Y requires 2

machine hours per unit. Product X requires 3 direct labour hours per

unit while product Y requires 2 direct labour hours per unit.

Determine the number of product X and Y to be produced to

maximise the company’s profits/contribution each month?


11

Step 1: Identify the decision variables: X = number of X product to produce each month

Y = number of Y product to produce each month

Step 2: Determine Objective function = Contribution margin

Maximise Z = 30X + 25Y

Where Z = total contribution margin

maximisation.

Step 3: Determine the constraints based on the limited

resources available.

Machine hours: 1X + 2Y ≤ 1200

Labour hours: 3X + 2Y ≤ 3000

Both X, Y ≥ 0

Graphical Solution Solution to lecture example 3

12

Step 4: Graph the constraints

1X + 2Y = 1200 ……….equation(1) (machine hours)

Let X = 0 then Y = 600 =(1200/2) (point B)

Let Y = 0 then X = 1200 =(1200/1) (point F)

Graph this line using these two end points

3X + 2Y = 3000………equation (2) (labour hours)

Let X = 0 then Y = 1500 =(3000/2) (point E)

Let Y = 0 then X = 1000 =(3000/3) (point D)


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600

400

200

0

800

1600

1400

1200

1000

0 A 200 400 600 800 D 1000 1200 1400

Pro

du

ct Y

Product X

Represents the Machine hours

constraint

Series1

(900,150)

Graphical Solution Solution to lecture example 3

Represents the Labour hours constraint

Feasible region

B

C

E

F

13

Graphical Solution

14

Solution to lecture example 3 Step 5: Determine the optimal point by calculating the contribution

margin that can be obtained at the extreme points in the feasible

region.

The optimal point should be the point with the maximum objective

function value: 900 units of product X and 150 units of product Y

Extreme points in the feasible region Objective function value

(Z= 30X + 25Y)

Point A: X= 0, Y= 0 Z = 0

Point B: X=0, Y=600 Z = 0 + 25×600 = 15 000

Point D: X=1000, Y=0 Z = 30×1000 + 0 = 30 000

Point C: Intersection point of the two lines

(X=? Y=?)

Z = 30x 900+ 25x 150=30 750

Lecture example 3- solution Determining the intersection point:

Use simultaneous equations

Equation 1: 1X + 2Y = 1200

Equation 2: 3X + 2Y = 3000

To work out the value for X and Y, subtract Equation 1 from Equation 2:

2X = 1800

X = 900

We then substitute the value for X (900) into Equation1 (or Equation 2) to find the value for Y.

1 × 900 +2 Y = 1200,

2Y =1200- 900= 300

Y =150

Hence, the intersection point is (X=900, Y=150),

Z= $30×900 + $25×150= $30 750

15

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Lecture example 4

A firm’s two products are both produced on a single machine. Product X

requires 3 machine hours per unit while Product Y requires 6 machine

hours per unit. There is a maximum of 24000 machine hours available.

There is also a limit of 12000 hours of supervision time available, with

both products requiring 2 hours of supervision per unit. Details concerning

the unit selling price and unit costs of each product are shown below:

16

5

7

How many units of each product should be produced and sold?

Product X Y

Selling price $30 $3

Variable costs $24 $2


17

Step 1: Identify the decision variables: X = number of X product to produce each month

Y = number of Y product to produce each month

Step 2: Determine the objective function: Contribution margin maximisation.

Maximise Z = 6X + 8Y

Where Z = total contribution margin

Step 3: Determine the constraints based on the limited

resources available.

3 X + 6 Y ≤ 24000 (Machine hour constraint)

2 X + 2 Y ≤ 12000 (Supervision constraint)

Both X, Y ≥ 0


18

Step 4: Graph the constraints

3X + 6Y = 24 000 ……….equation(1) (machine hours)

Let X = 0 then Y = 4 000 =(24000/4) (point B)

Let Y = 0 then X = 8 000=(24000/3) (point F)


2X + 2Y = 12 000………equation (2) (supervision hours)

Let X = 0 then Y = 6 000=(12000/2)(point E)

Let Y = 0 then X = 6 000 =(12000/2) (point D)


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10000

8000

6000

4000

2000

0 8000 10000

Pro

du

ct

Y

A 0 2000 D

4000 6000

Product X

Graphical Solution

B

F

E

C Feasible

region

X=4000 Y=2000 Supervision

constraint

Machine hours

constraint

19


20

Step 5: Determine the optimal point by calculating the contribution margin that can be obtained at the extreme points in the feasible region.

The optimal point should be the point with the maximum objective

function value: 4000 units of product A and 2000 units of product B

Extreme points in the feasible region Objective function value

(Z= 6 X + 8 Y)

Point A: X= 0, Y= 0 Z = 0

Point B: X=0, Y=4000 Z = 0 + 8×4000 = 32 000

Point D: X=6000, Y=0 Z = 6×6000 + 0 = 36 000

Point C: X=4000, Y=2000 Z = 6x4000+ 8x2000= 40 000

Lecture example 4 solution Determining the intersection point:

Use simultaneous equations

Equation 1: 3X + 6Y = 24 000

Equation 2: 2X + 2Y = 12 000

To work out the value for X and Y, We could multiple Equation 2 by 3:

Equation 3: 6X + 6Y = 36000

and then subtract Equation 1 from Equation 3:

3 X = 12000

X = 4000

Then substitute the value for X (4000) into Equation 1 (or Equation 2) to find the value for Y:

3 × 4000 +6 Y = 24000

Y = 2,000

Hence, the intersection point is (X=4 000, Y=2 000),

Z= 6×4000 + 8×2000= 40 000

21

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Joint cost allocation

Joint cost All manufacturing costs incurred in the production of joint products

22

Joint cost allocation

23

Methods of allocating joint costs Physical units method: allocate joint costs to joint products in

proportion to their physical units at the split-off point;

Relative sales value method: allocating joint cost to joint products in proportion to their sales value at the split-off point

Net realisable value (NRV) method: allocate joint cost to joint products in proportion to their final NRV values

(NRV = final sales value – separable further processing costs)

Constant gross margin method: allocate joint costs to joint products so that the gross margin (%) for each product is identical

Constant gross margin (GM) method

24

Three steps:

1. GM % for the entire production = total GM* /total sales

* total GM=total sales- total production costs

2. Required GM ($) for each product

= sales revenues ͯ GM%

3. Joint costs allocated to each product

= sale revenues – required GM – separable processing cost

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Lecture Example 5

25

Mount Franks manufacturers 2 drinking products from a joint

water process. The two products are Still Water and Mineral

Water. A standard production run incurs joint costs of $40

000 and results in 60 000 litres of still water and 90 000 litres

of mineral water. Each still water litre sells for $1.50, and

each mineral litre sells for $3.00.

Required:

Calculate the amount of joint costs allocated to “pure

water” and “mineral water” using the physical units method

and relative sales value method


26

1 Calculate the amount of joint costs allocated to “pure

water” and “mineral water” on a physical units basis

Joint

Cost

Joint

Products

QTY at

Split-off

Relative Proportion Allocation

of joint cost

$40 000 Still 60 000 60 000/150 000 = 40% 16 000

Mineral 90 000 90 000/150 000 = 60% 24 000

Total 150 000 40 000

Calculate the amount of joint cost allocated to the

“still water” on a relative sales value basis

27


Joint

Cost

Joint

Products

Sales

value at

Split-off

Relative Proportion Allocation

of joint cost

$40 000 Still 90 000 90 000 / 360 000 = 25% 10 000

Mineral 270 000 270 000 / 360 000 = 75% 30 000

Total 360 000 40 000

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In addition to the data given in the example 5, assume that

the still water can be processed further for $60000 to

produce fruit flavoured water. This can then be sold for

$3.00 per litre. While the mineral water can be processed

at a cost of $80000 to produce sparkling mineral water that

can be sold for $4.00 per litre.

Using the net realisable value method and gross

margin method calculate the joint cost assigned to

each product?

28

Lecture Example 6 Lecture example 6 solution

29

a). Net realisable value method

Sales value of final product:

Still (fruit flavoured) = 60000 x $3 = $180 000

Sparkling mineral = 90000 x $4 = $360 000

Joint

Cost

Joint

Products

Sales

value of

final

product

Further

processing

cost

NRV Relative

Proportion

Allocation

of joint

cost

$40 000 Still 180 000 60 000 120 000 30% 12 000

Mineral 360 000 80 000 280 000 70% 28 000

Total 540 000 400 000 40 000


30

b) Constant gross margin (GM) method

Total sales= $540 000

total costs= 40 000+60 000+80 000 =$180 000

GM % = (540 000 – 180 000) /540 000 = 66.6667%

Joint

Cost

Joint

Product

Gross

margin

(%)

Sales

revenue

Required

gross

margin ($)

Separable

cost of

processing

Allocation

of joint

cost

$40 000 Still 66.6667% 180 000 120 000 $60 000 0

Mineral 66.6667% 360 000 240 000 $80 000 40 000

Total 40 000

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Welcome to ACCG200

1

Lecture 11

Budgeting systems

Chapters 9 and 11 pp.514-519

A Budget

2

A detailed plan that shows the financial consequences of an

organisation’s operating activities for a specific future time

period.

Purposes of budgeting:

1. Planning

2. Facilitating communication and coordination

3. Allocating resources

4. Controlling profits and operations

5. Evaluating performance and providing incentives

The annual budget: a planning tool

3

The annual budget (or master budget) is a

comprehensive set of budgets that covers all aspects of a

firm’s activities

Consists of several interdependent budgets

Operating budgets:

Sales budget; cost budget

Financial budgets:

Cash budget; budgeted balance sheet; budgeted income statement;

capital expenditure budget

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The annual budget: a planning tool

4

The operating budgets

5

The sales budget

A detailed summary of the estimated sales units and

revenues from the organisation's products for the

budget year

Based on the sales forecast, which involves

estimating which products will be sold and in

what quantities

Market research may be used

The operating budgets (cont.)

6

The cost budgets

Manufacturing firms

A production budget, which has cost budgets for direct

materials, direct labour and overheads

Budgets for selling and administrative expenses

Retailers and wholesalers

A purchasing budget will be used to determine the quantity

and cost of goods purchased for resale

Service firms

A set of budgets that show how demand for services will be

met

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Operating budgets for manufacturing

firms

7

Lecture example 1

8

Suzuki Ltd has a division that manufactures two–wheel motorcycles. Its

budgeted sales for Model G in 2012 is 450 000 units. Suzuki’s target

ending inventory is 40 000 units and its beginning inventory is 50000

units. The company’s budgeted selling price to distributors and dealers

is $4000 per motorcycle.

Suziki buys all its wheels from an outside supplier. No defective wheels

are accepted. The company’s target ending inventory is 30 000 wheels

and its beginning inventory is 25 000 wheels. The purchase price is

$160 per wheel.

Required: Prepare sales budget, production budget (in units) and

wheel purchase budget (in units and dollars)

Source: Horngren et al., 2011)

Lecture example 1

1,800,000,000 450 000 4000

9

Total sales

Units Selling price per unit

Production budget for the year ended 31st December 2012 (in units)

Sales

+ Target ending Inventory

Total required units

- Beginning Inventory

Production to be completed

450,000

40,000

490,000

(50,000)

440,000

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*880 000=440 000×2

Wheels to be purchased in dollars = $160*885 000=$141,600,000

Wheel Purchase budget for the year ended 31st December

2012

Units

10

Wheels required for production 880 000*

+ Target ending inventory 30 000

Total requirement 910 000

- Beginning inventory (25 000)

Wheels to be purchased 885 000

Lecture example 2

11

Summer furniture Ltd produces two different table sets, A and B. The company

predicts a sales volume of 2000 sets for A and 2300 sets for B. The beginning

inventory includes 1000 sets of A and 1200 sets of B, and the desired ending

inventory will consist of 900 sets of A and 800 sets of B. To produce a set of A it

requires 2 hrs in Assembly and 0.2 hr in Packing. To produce a set of B it requires

3 hrs in Assembly and 0.3 hr in Packing. The direct labour rate is $30/hr for

assembly, and $10/hr for packing. Information regarding the use of direct material

are provided as follows (NB. No change incurred in costs from last period to this

period).

Required: Prepare the production (in no. of sets), direct material (in meters and in

dollars) and direct labour (in dollars for A only) budgets.

Direct material Cost/meter Required for A Required for B

Wood $75 2 meters/set 3 meters/set

Fibreglass $42 1 meters/set 2 meters/set


12

a) Production budget (in no. of sets):

A B

Sales 2 000 2 300

Add Desired ending inventory 900 800

Total required units 2 900 3 100

Deduct Beginning Inventory (1 000) (1 200)

Production to be completed 1 900 1 900

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Lecture example 2 solutions cont.

13

b) Direct material budget ( in meters and in dollars)

Wood: 2 ×1900 + 3×1900 = 9500 meters

9500 ×$75 = $712 500

Fibreglass: 1×1900 + 2×1900 = 5700 meters

5700 × $42 = $ 239 400

c) Direct labour budget for A (in dollars):

Assembly:

Packing:

$30/hr ×2 hrs × 1900 units = $114 000

$10/hr ×0.2 hr × 1900 units = $ 3 800

$117 800 Total labour costs

Flexible budgets

Static budget:

A budget prepared for one specific planned level of activity.

Flexible budget:

A detailed budget prepared for a range of levels of activities.

14

Benefits of Flexible Budgets over

Static budgets

15

It allows comparisons to be made between

actual costs incurred at the actual level of activity

and the budgeted costs that should have been

incurred at the actual level of activity.

It makes the budget more responsive to changes

in activity levels;

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Lecture example 3

16

Jones Ltd budgeted to produce 350 photocopy machines in March. The number of machine hours budgeted to produce one photocopy machine is 2.5 hours. Budgeted overhead (electricity) was expected to be $35 000.

In March Jones Ltd produced 300 photocopy machines. The firm incurred electricity costs of $32 000.

Required:

i. Calculate the predetermined overhead rate for electricity costs based on machine hours.

ii. Calculate the difference between actual electricity costs and budgeted electricity costs. Comment on Jones Ltd’s performance in relation to electricity usage in March.

iii. Calculate the difference between actual electricity costs and budgeted electricity costs if a flexible budget is applied . Comment on Jones Ltd’s

performance in relation to electricity usage in March.


17

(i) Predetermined OH rate

= budgeted total overhead costs/budgeted total machine hrs

= $35000/(350×2.5)

= $40 per machine hour

Actual electricity costs = $32 000

Budgeted electricity costs = $35 000

Difference = $3 000

Comments:

Jones Ltd performs well since actual electricity costs

consumed are less than the budgeted amount.

(ii)


18

(iii) Flexible Budget Approach

Actual electricity costs = $32 000

Budgeted electricity costs

= $40 × machines allowed for actual output

= $40 × (300 × 2.5 hours per unit)

= $30 000

Difference = 2000

Comments:

Jones Ltd does not perform well since actual electricity costs consumed are greater than the budgeted amount.

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A flexible budget report

Flexible budget report: shows flexible overhead

budgets at various levels of activity

Formula flexible budget: shows overhead costs at

various levels of activity using the following

formula

19

Lecture example 4

20

The chief accountant for Northern Suburbs Hospital estimates that the hospital uses 40 kilowatt hours of electricity per patient-day, and that the cost of electricity will be $0.16 per kilowatt hour. The hospital also pays a fixed monthly charge of $800 to the electricity to rent emergency back-up electricity generation.

Required: Construct a flexible budget for the hospital’s electricity costs using each of the following techniques:

a)A formula flexible budget

b)Using your flexible budget calculate the budgeted electricity costs for:

i.

ii.

April when it is expected that there will be 50 000 patient days

July when it is expected that there will be 80 000 patient days

c)A report form flexible budget for 30 000, 40 000 and 50 000 patient-days of activity. List variable and fixed electricity costs separately.


21

a) A formula flexible budget

The budgeted variable cost rate per patient-day

= 40 kwh per patient day x $0.16 per kwh

= $6.4/patient day

Total budgeted monthly electricity cost

= (6.4 x number of patient days) + 800

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b)

(i) Total budgeted monthly electricity costs for April

= 6.4 x 50000 + 800 = $320800

(ii) Total budgeted monthly electricity costs for July

= 6.4 x 80000 + 800 = $512 800

C)

22

Behavioural consequences of budgeting

23

A budget affects virtually all staff in an organisation

those who prepare the budget

those who use the budget for decision making

those whose performance is evaluated using

the budget

Three main behavioural issues

Participative budgeting

Budgetary slack

Budget difficulty


24

Participative budgeting

Allows managers at all levels of the firm to develop

their own initial estimates for budgeted sales, costs,

etc.

Top-down budgeting is where senior managers

impose budget targets on more junior

managers

Bottom-up budgeting is where people at the lower

managerial and operations levels play an active

part in setting their own budgets

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25

Budgetary slack:

Is the difference between the estimated revenue or cost

projection that a person provides and a realistic

estimate of that revenue or cost

Reasons for budgetary slack

Performance can look better if you can ‘beat the budget’;

A way of coping with uncertainty


26

Budget difficulty

Budget acceptance is more likely when

Targets are developed with employee participation

Targets are considered achievable

There is frequent feedback on performance

Employees are held responsible for activities that are within

their control

Achievement of targets is accompanied by rewards that are

valued

Budgets must be set at a level that provides challenge and

stretch, but is not too difficult to achieve

accg200 lectures 2-11 handout

Documents

manufacturing overhead

actual overhead

predetermined overhead

different product costs

productrelated costs

jobs allocation base

indirect costs

manufacturing cost categories