f2- management accounting part b class
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F2 ACCA Phi Thanh Tu
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F2- Management accounting
F2 ACCA Phi Thanh Tu
Syllabus
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Cost card- – Cost statement of total cost of 1 unit of product
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Direct labour
Direct material
Direct expense
PRIME COST Production cost
Variable production overheads
MARGINAL PRODUCTION COST
Fixed production overheads
TOTAL PRODUCTION COST
Non production overheads
Admin cost
Selling cost Non-production cost
Distribution cost
Finance cost
TOTAL COST
Profit (marked up 10%)
Selling price
30
20
10
60
10
70
30
100
10
10
10
20
150
15
165
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Part BCost accounting techniques
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I. Material costII. Labor costIII. OverheadsIV. Marginal and absorption costingV. Job, batch and service costingVI. Process costingVII. Alternative costing techniques
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Part B-1- Material cost
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I. Ordering and accounting for inventoryII. Order quantities and reorder levels
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I. Ordering and accounting for inventory
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1. Inventory2. Accounting procedures for ordering and
issuing inventory3. Recording of Inventory4. Physical inventory and book inventory
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1. Inventory
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Types of inventory: RM, FGs, WIP, consumables/tools & supplies
Control over inventory: OrderingPurchasingReceiptStorageIssue Maintenance of Inventory at the most
appropriate level
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2. Accounting procedures for ordering and issuing inventory
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Ordering
•Departments requires new material by sending Purchase request to Purchasing department
•< authorized purchase request>
Purchase order
•Purchasing department send PO to:•Suppliers•Accounti
ng department
•Good receiving departments (stores)
Goods delivery
•Suppliers receive Pos to prepare to deliver goods
•Suppliers deliver the Goods with Delivery Notes
•Goods receiving department will check the Goods received with Delivery notes and PO. Good receipt Notes are updated and then the copies are sent to Purchasing and accounting departments
•Purchasing department will monitor GRNs with PO to supervise the PO status
Invoices
•Invoice sent from suppliers directly to accounting department for payment
•Invoice, GRN and PO are matched (3-way match) to ensure proper quantity and price
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2. Accounting procedures for ordering and issuing inventory
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Inventory issuing:
Material requisition
notes• Authorize
store keepers to release RM
• To update store records
Material returned notes
• Record unused RM returned to stores
• To update store records
Material transfer notes
• Transfer materials from one department to another
• To update store records
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3. Recording for inventory
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Debit Inventory a/c: Purchase, Return to storesCredit Inventory a/c: Issuing, Return to suppliers
Inventory valuation: FIFO, WAC, LIFOFIFO: assumes that materials are issued to out of
stock in the order in which they were delivered into inventory
WAC: values all items of inventory and issues at an average price. The average price is calculated after each receipt of goods.
LIFO: assumes that materials are issued out of inventory in the reverse order to which they were delivered into inventory
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3. Recording for inventory
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The following transactions occur during May 2008 related to item A: Opening balance + Purchasing = Issuing +Closing
Quantity unit cost Total cost
units £ £Opening balance, 1 May 100 2.00 200
Receipts, 7 May 400 2.10 840
Issues, 11 May 200Receipts, 16 May 300 2.12 636
Issues, 21 May 400Closing balance, 31 May 200
Total 1676
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3. Recording for inventory
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FIFO method- the cost of issues and closing inventory value would be:
Quantity unit cost Total cost
units $ $
Issues, 11 May 200100 at $2
100 at $2.1 $410
Issues, 21 May 400300 at $2.1100 at $2.12 $842
Closing balance, 31 May 200 200 at $2.12 $424
1676
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3. Recording for inventory
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LIFO method- the cost of issues and closing inventory value would be:
Quantity unit cost Total cost
units £ £
Issues, 11 May200 200 at $2.1 $420
Issues, 21 May400300 at $2.12100 at $2.1 $846
Closing balance, 31 May 200
100 at $2.1100 at $2.0 $410
1676
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3. Recording for inventory
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WAC method- the cost of issues and closing inventory value would be:
Quantity unit cost
Total cost
Inventory balance
Inventory balance
units $ $ units $
Issues, 11 May 200
$1040/500= $2.08 416 300 624
Issues, 21 May 400
$(624+636)/600= $2.1 840 200 420
Closing balance, 31
May 200 $2.1 420 200 420
1676
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3. Recording for inventory
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Exercise Exercise\FIFO WAC LIFO.docx
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4. Physical inventory and book inventory
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4.1. Perpetual inventory vs. Periodic inventory
Perpetual inventory: Inventory is continuously updated. It is the recording as they occur of receipts, issues and the resulting balances of individual items of inventory in ether quantity or quantity and valueInventory records are updated using stores ledger cards and bin cards, which show the records of receipts, issues and balances of the quantity (bin cards) and value (stored ledger cards).
Periodic inventory: Inventory is counted at the end of period and then recorded accordingly. It records inventory purchase or sale in "Purchases/sales" account.
“Sales, Purchases" accounts are updated continuously Inventory subsidiary ledger is not updated after each purchase or sale of inventory. Inventory quantities are updated on a periodic basis.
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4. Physical inventory and book inventory
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4.2. Stock taking
Definition: Stocktaking process involves: checking the physical quantity of inventory held on a certain date and check this balance against the balances on the store ledger (record) cards or bin cards.
Method:Period stocktaking: count every item of inventory at the same date (usually at the balance sheet date)Continuous stock taking: count selected items of inventory on a rotating basis. Each item is checked at least once a year with a valuable items being checked more frequently
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4. Physical inventory and book inventory
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4.2. Stock taking
Physical count
•Stock count is carried out
Inventory discrepancies
•It is the difference between book inventory vs. physical inventory
•<bin cards/ store ledger cards vs. inventory count>
Adjust book inventory
•Investigate the inventory discrepancies
•Adjust store ledger cards/bin cards to reflect the true physical inventory count
Slow
moving and obsolete items
•Identifying “slow moving” and obsolete item to bring attention to management•Slow
moving: items take long time to use up
•Obsolete: out of date, no longer required
•Management solutions on the slow moving and obsolete items
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4. Physical inventory and book inventory
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4.3. Control procedures to minimize discrepancies and loss of inventory
Problems control proceduresOrdering goods at inflated prices(higher/unreasonable)
use standard costs for Purchase quotation (for special items)
Fictitious purchase
Segregation of ordering and purchasingPhysical controls over materials receipt, usage and inventory
Shortage on receiptsCheck in all goods inwards at gatesDelivery signature
Losses from inventoryRegular stock takingPhysical security procedures
Writing off obsolete or damaged inventory which is good
control of responsible officers over all written-offs
Losses after issue to production department
Record all issuesStandard usage allowance
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II. Order quantities and reorder level
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1. Costs of holding inventory2. Economic order quantity3. Gradual replenishment of inventory4. Inventory control levels
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1. Cost of holding inventory
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1.1. Reasons of holding inventory Sufficient goods available to meet expected
demand Prevent hold-ups in the production process Meet future shortages Take advantage of bulk purchases discounts
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1. Cost of holding inventory
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1.2. Holding costsCosts associated with holding inventory are known as
holding costsHolding cost included:
Interest on capital tied up in inventoryCost of storage spaceCost of insuranceRisk of obsolesceDeterioration: disposal cost for unusable inventory
Holding cost can be distinguished between fixed holding costs and variable holding costs
It is often stated as being valued at a certain percentage of the average inventory held
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1. Cost of holding inventory
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1.3. Ordering/procurement costsOrdering/procurement costs: are the costs associated with placing orders. They include:
Administrative costs: are usually a fixed cost per order. The total admin costs of placing orders will increase in proportion to the number of orders placed. >>> Variable costs
Delivery costs: are usually a fixed charge per delivery (order). The total delivery costs will also increase in direct proportion to the number of deliveries in the period. >>> Variable cost
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1. Cost of holding inventory
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1.4. Stock out costsStock-out costs: are the costs associated
with running out of inventory and they include loss of sales, loss of customers and reduced profit
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1. Cost of holding inventory
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1.5. Stock control and inventory holding costIf inventory level is too low, there is a danger
that the number of stock-outs will increase, and there will increase in the number of order placed
An increase in the number of order placed will cause a corresponding increase in ordering costs
So, it should maintain inventory at a level (optimum level) where the total of holding costs, ordering costs and stock-out costs are at minimum. This is the main objective of stock control
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2. Economic order quantity
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EOQ is the reorder quantity which minimizes the total costs associated with holding and ordering stock = holding cost + ordering costs are at a minimum at the EOQ
Graph:Holding cost= ordering cost
EOQ= √(2CoD/Ch)D= demand per annumCo= cost of placing one orderCh= cost of holding one unit for one yearQ= Reorder quantity
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2. Economic order quantity
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2. Economic order quantity
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EOQ assumptions:Average inventory= EOQ/2The number of orders in a year= expected
annual demand/EOQTotal annual holding cost= EOQ/2*holding cost
per unit of inventoryTotal annual ordering cost = number of
orders*cost of placing an orderTAC= CO * D/Q + ChQ/2
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2. Economic order quantity
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EOQ with discountDiscount for bulk ordersEffect of quantity discount:
The annual purchase price will decreaseThe annual holding cost will increaseThe annual ordering cost will decrease
To establish whether the discount should be accepted or not:Calculate the TAC with the discount (including the purchase cost)Compare with the annual costs without the discount at EOQ point
Steps:Calculate EOQ ignoring discount If EOQ< min purchase quantity to obtain bulk discount, calculate the
total cost for the EOQ (= the annual stockholding costs+ stock ordering costs + stock purchasing costs)
Recalculate the total cost for a purchase order size that is only just large enough to qualify for the bulk discount = TAC of the bulk quantity
Compare the total costs when the order quantity is the EOQ with the total costs when the order quantity is just large enough to obtain the discount. Select the min cost alternative
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EOQ: inventory to be replenished immediately when organization buy inventory from suppliers
EBQ: inventory to be replenished gradually by manufacturing their own products internally
Setup cost replaces ordering cost of EOQ Average inventory held in EOQ is greater than average held
in EBQ for the same size of batch EBQ = √(2CoD/[Ch(1-D/R)]
Q= batch sizeD= Demand per annumCh= cost of holding one unit for one yearCo= cost of setting up a batch ready to be producedR= annual replenishment rate
3. Gradual replenishment of inventory
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Producing large batches at long interval will lead to low machine setup costs (as fewer machines setups will be needed) and high holding costs (as more inventory)
Producing small batches at short interval will lead to high machine setup costs (as more machine setups will be needed) and low holding costs (low average inventory levels as less inventory held)
3. Gradual replenishment of inventory
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Reorder level: when inventory reaches the reorder level, a replenishment order should be placed
RL= usage*lead-time (when demand in the lead time is constant)
RL= max usage* max lead time (when demand in the lead time is not constant)
o Lead time= this is the time expected to elapse between placing an order and receiving an order for inventory
o Reorder quantity: when the reorder level is reached, the quantity of inventory to be ordered is known as the EOQ
o Demand: this is the rate at which the inventory is being used up = inventory usage
4. Inventory control level
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Max inventory- this is a warning level when inventory are dangerously high.
Max inventory level = reorder level + reorder quantity – min usage*min lead time
Min inventory- this is a warning level when inventory are dangerously low and that stock-outs are potential threat. It is know as buffer inventory/safety inventory
Min inventory level = reorder level – average usage*average lead-time
Average inventory= Reorder quantity/2+ min inventory
Free inventory= physical inventory + inventory on order- inventory requisitioned (not yet issued)
4. Inventory control level
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Part B-2- Labor cost
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1. Direct and indirect labor cost2. Recording, calculating and accounting for
Labor cost3. Remuneration method4. Labor turnover and Measuring labor activity
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1. Direct and Indirect labor cost
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Direct Indirect
Make up part of the prime cost of a product
Make up part of overheads
Include basic pay of direct workers Include basic pay of indirect workers
<Pay to employees who are directly involved in making a product>
<Pay to employees who are not directly involved in making products>
Bonus payment
Idle time: workers are paid but not making any products
Sick pay
Pay for time spent by direct workers doing indirect jobs
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1. Direct and Indirect labor cost
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Overtime and overtime premium of direct employees
Overtime paid = basic element + overtime premium
Direct cost Indirect cost
Overtime premiums are treated as direct labor cost if it is at the specific request of a customer.
Shift allowance/premium >>>> similar to overtime premium
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2. Recording, calculating and accounting for Labor cost
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2.1. Recording and calculating Labor cost Recording time spent doing jobs
Time records: for payment, determining cost to be charged
E.g.: Attendance record- show days absent or attend. E.g.: Time cards (gate or lock cards)- record time of
arrival and departure. To be used in manufacturing industry
Activity time record: Period related timesheets: commonly used in service
industries, cover days/weeks/longer period Task related activity time records (job sheets,
operation charts, piecework tickets)
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2. Recording, calculating and accounting for Labor cost
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2.1. Recording and calculating Labor cost Organization for controlling and measuring labor cost:
Personnel department Production planning department Time keeping department Wages department Cost accounting
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2. Recording, calculating and accounting for Labor cost
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2.2. Accounting for labor cost
Wages payment: Dr wage control account
Cr Bank account
Direct labor: Dr WIP account
Cr Wages control account
Indirect labor: Dr Production overhead account
Cr Wages control account
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3. Remuneration method
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Remuneration methods
(1) Time work (2) Piecework scheme
(3) Bonus/incentive scheme
Wages = Hours worked x rate of pay per hour
Wages = Units produced x rate of pay per unit
(a) High day rate system
(b) Individual/discretionary bonus schemes
(c) Time saved bonus scheme
(d) Group bonus schemes
(e) Profit sharing schemes
(f) Incentive schemes involving shares
(g) Value added incentive schemes
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3. Remuneration method
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(3) Bonus/ incentive schemes (a) High day rate system is a system where employees are paid a high hourly rate in the expectation that they will work more efficiently than similar employees on a lower hourly rate in different company.
(b) Individual bonus schemesIndividual employees can qualify for a bonus on top of their basic wage, which each person's bonus being calculated separately.The bonus is unique to the individual. It is not a share of a group bonusThe individual earns a bigger bonus with the greater his efficiency. quality safeguard.
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3. Remuneration method
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(3) Bonus/ incentive schemes
(c) Time saved bonus schemes:Employees are paid for the time saved in completing the job The bonus encourage employees to do work at a faster rate.
(d) Group bonus schemes is an incentive plan which is related to the output performance of an
entire group of workers, a department, or even the whole factory. (e) Profit sharing schemes is a scheme in which employees receive a certain proportion of their
company year-end profits. Possible criteria of this scheme: position of employees and employment time.
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3. Remuneration
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(3) Bonus/ incentive schemes
(f) Incentive schemes involving shares A share option scheme is a scheme in which gives its members the right to buy shares in the company for which they work at a set date in the future and at a price usually determined when the scheme is set up. (g) Value added incentive scheme It is an alternative to profit as a business performance measureValue added = Sales - cost of brought-in materials and servicesTarget value added should be set, some of any excess value added earned would be paid out as bonus.
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4. Labor turnover and measuring labor activity
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4.1. Labor turnover To measure proportion of people leaving relatively to the
average number of people employed Causes:
Avoidable causes: poor remuneration/working conditions, lack of training opportunities/promotion prospect
Unavoidable causes: retirement, illness, death, family reasons
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4. Labor turnover and measuring labor activity
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4.1. Labor turnover Costs of labor turnover:
Replacement costs: advertisement, selection, training costs, efficiency decreases
Lower the performance of current employeesPreventative costs: incurred to minimized Labor
turnover, associated with escaping the avoidable causes:Increase wagesImprove working conditionsIncrease training programsPromotion schemeInvestigate high LT rate
Labor turnover rate = Number of leavers who require replacement / average number of employees
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4. Labor turnover and measuring labor activity
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4.2. Measuring labor activity Efficiency ratio (Productivity ratio)=
(Expected hours to make output)/(Actual hour taken) x 100%If the ratio > 100%: productivity is greater than expectationIf the ratio < 100%: less than expectation, inefficient labor
Capacity ratio= (actual hours taken)/(budgeted hours) x 100%If the ratio >100%: work above capacityIf the ratio <100%: work below capacity
Production volume ratio/ Activity ratio = (Expected hours to make output)/(Budgeted hours) x 100%
Production volume ratio = efficiency ratio x capacity ratioIf the ratio >100%: produce more than budgetIf the ratio <100%: produce less than budget
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Part B-3- Overheads
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1. Overheads and cost categories review2. Absorption costing3. Under and over absorption of overheads4. Accounting entries5. Non-production overheads
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1. Overheads and cost categories review
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Overheads is the cost incurred in the course of making product, providing a service or running a department but cannot be traced directly and in full to the product/service/department Categories: Indirect Materials + Indirect labor + Indirect expense:
Production OH: can be fixed or variableAdministration OHSelling & distribution OH
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1. Overheads and cost categories review
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Why should OH be included in the total cost of product?
Stock valuationsClosing stock figure in the balance sheetCost of sales figure in the P&L account
Pricing decisionsIf companies follow “full cost plus pricing” strategy.
Establishing the profitability of different products.
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2. Absorption costing
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2.1. What is absorption costing? It is a method of sharing overheads between a number of different products an a fair basis. Objective: to include in the total cost of a product (unit or job) an appropriate share of the organization’s total overhead
By an appropriate share, an amount that reflects the amount of time and efforts has gone into producing a unit or completing a job Closing stock in the balance sheet and the COGS in the P&L a/c must be valued at full in PRODUCTION COST
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2. Absorption costing
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2.2. Absorption costing procedures
Stage 1: Allocation
Stage 2: Apportionment
Stage 3: Absorption
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 1: Allocation
Allocation is the process by which whole cost items are charged direct to a cost unit or a cost centre.
Indirect materials, Indirect labors, Security guard, Depreciation, Rent, etc.
Canteen Maintenance
AssemblyMachining
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: ApportionmentApportionment is a process whereby indirect costs are spread fairly between cost centers. 2 stages:
Apportionment Re-apportionment
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: ApportionmentBasic of apportionment: apportion OH to Cost centers (production+service cost centers)
Overheads Basic of apportionment
Rent, rates, heating and light, repairs and depreciation of buildings
Floor area occupied by each cost center
Depreciation, insurance of equipment
Cost of book value of equipment
Personnel office, canteen, welfare, wages and cost office
Number of employees or labor hours worked in each cost center
Heating and cooling Volume of space occupied by each cost center
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: ApportionmentBasic of re-apportionment- apportioning service cost centers’ overheads to the production cost center using appropriate bases
Service departments Basic of apportionment
Stores Number of cost/value of material requisitions
Maintenance Hours of maintenance work done for each cost centers
Production planning Direct labor hours worked in each production cost center
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: Apportionment- reapportionmentService cost centre costs may be apportioned to production cost centers by using one of the following methods:
Direct methodReciprocal methodStep method
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: Apportionment- Direct method Costs of each service costs centre are apportioned only
to production cost centers
Service Department
(Canteen)
Service Department
(Maintenance)
Operating Department
(Machining)
Operating Department
(Assembly)
Interactionsbetween service departments areignored and all costs are apportioned directly to operating (Production)departments.
DIRECT METHOD
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: Apportionment- Step method Costs apportionment are performed in a step-down
fashion, using predetermined ranking procedures (e.g., degree of support)
Once a servicedepartment’s costsare apportioned,
other servicedepartment costsare not apportionedback to it.
Service Department
(Canteen)
Service Department
(Maintenance)
Operating Department
(Machining)
Operating Department
(Assembly)
STEP METHOD
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 2: Apportionment- Reciprocal method Recognizes interactions of service costs centers prior to
apportion to production cost centers Costs of each service costs centre are apportioned not
only to production cost centers, but also to other service cost centers which make use of its services.
The results of the reciprocal method may also be obtained using algebra and simultaneous equations.
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2. Absorption costing
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2.2. Absorption costing proceduresSTAGE 2: Apportionment- Reciprocal method
Interdepartmentalservices are givenfull recognitionrather than partialrecognition as withthe step method.
Service Departmen
t
(Canteen)
Service Department
(Maintenance)
Operating Departmen
t
(Machining)
Operating Departmen
t
(Assembly)
RECIPROCAL METHOD
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 3- Absorption Overhead absorption is the process whereby overhead costs
allocated and apportioned to production cost centers are added to cost units, jobs or process costs using an appropriate basis
A product cost can now be determined:
Direct materials
+ Direct labor
+ Absorbed overhead
Product cost
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 3- Absorption OH are usually added to cost units using a predetermined
overhead absorption rate.Step 1: Estimate the OH likely to be incurred during the
coming period.Step 2: Estimate the activity level for the period. This
could be total hours, units, or direct costs of whatever it is upon which the OH absorption rates are to be based.
Step 3: Divide the estimated OH by the budgeted activity level --> the OH absorption rate.
Step 4: Absorb the OH into the cost unit by applying the calculated absorption rate.
Overhead absorbed = predetermined OAR x Actual level of activity
OH absorption rate
=Total budgeted overhead costs
Total budgeted act. level
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2. Absorption costing
63
2.2. Absorption costing procedures
STAGE 3- Absorption Possible bases of absorption rate:
Rate per unitRate per machine hourRate per direct labor hourPercentage of direct material costPercentage of direct labor costPercentage of total direct costPercentage of factor cost (for admin overhead)Percentage of sales or factory cost (for selling and distribution overhead)
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2. Absorption costing
64
2.2. Absorption costing procedures
STAGE 3- Absorption3 methods of Absorbing Overhead Costs:
Overhead can be absorbed into cost units in one of three ways:
Blanket absorption rate (Single plant-wide
rate)
Separate absorption
rates (Departmenta
l overhead rates)
Activity-based
costing (later)
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2. Absorption costing
65
2.2. Absorption costing procedures
STAGE 3- Absorption3 methods of Absorbing Overhead Costs- Method 1- Blanket absorption rate
Overhead CostIndirect
Costs
Cost
Absorption
Base
Blanket absorption rate
Cost
ObjectsProduct
1Product
2Product
3
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2. Absorption costing
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2.2. Absorption costing procedures
STAGE 3- Absorption3 methods of Absorbing Overhead Costs- Method 2- Separate absorption rate
Overhead Cost
First
Stage
Second
Stage
Department A
Indirect
Costs
Cost
Objects
Absorption Base
Cost
Objects
Department A
Overhead Rate
Department
B
Department B
Overhead Rate
Product 1
Product 2
Product 3
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3. Under/Over absorption of overheads
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Normal costing involves using the predetermined absorption rate in order to establish the actual cost of
production.
Direct materials xxx
Direct labour xxx
Overheads xxx
(based on the predetermined absorption rate)
Actual cost of production xxx
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3. Under/Over absorption of overheads
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Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.
.Overhead is
over absorbed
Overhead is over
absorbed
Overheadabsorbed to
Work in Process
(OAR × Activity)
Actualoverhead
costsincurred
Over absorption means that the OHs charged to the cost of sales are greater than the OH actually incurred.
Actual OH 1000
Absorbed OH (1200)
Over absorbed OH 200
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3. Under/Over absorption of overheads
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Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.
. Overhead is under
absorbed
Overhead is under
absorbed
Actualoverhead
costsincurred
Overheadabsorbed to
Work in Process
(OAR × Activity)
Under absorption means that inssufficient OHs have been included in the cost of sales.
Actual OH 1000
Absorbed OH (900)
Under absorbed OH 100
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3. Under/Over absorption of overheads
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Adjusting of Over absorbed and Under absorbed Overhead:--->Adjusting Cost of sales for under absorbed or over absorbed overhead
Overhead is:
Cost of salesis:
Adjustment will:
Actual overhead > absorbed overhead
Under-absorbed Too low Increase Cost
of sales
Actual overhead < absorbed overhead
Over-absorbed Too high Decrease Cost
of sales
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4. Accounting entries
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Occurrence of overheadDr Production overhead accountCr Inventory/ Wages control /Cash/Creditor accounts
Absorption of overheadDr WIP accountCr Production overhead account
Over-absorption of overheadDr Production overhead accountCr under/over absorbed overhead (P&L)
Under-absorption of overheadDr under/over absorbed overhead (P&L)Cr Production overhead account
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5. Non-production overheads
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Method 1: Choose a basic for the overhead absorption rate which most closely matches the non production overhead. E.g.: direct labor hours, direct machine hours and so on.
Method 2: Allocate non-production overheads on the ability of the products to bear such cost. One possible approach is to use the production cost.
OAR=
Estimated non production overheads
Estimated production costs
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5. Non-production overheads
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Other bases for absorbing overheads
Types of overheads Possible absorption rate
Selling and marketing Sales value
Research and development Consumer cost (= pro.cost – cost of direct materials)
Distribution Sales value
Administration Consumer cost
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Part B-4- Marginal and absorption costing
74
1. Recap of absorption costing2. Marginal costing definition and principles3. Absorption costing vs. Marginal costing4. Reconciling the profit figures given by 2
methods
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1. Recap of absorption costing
75
Absorption costing (Full costing):The cost of a unit of product consists of:
Direct materialsDirect laborManufacturing overheads
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2. Marginal costing definition and principles
76
Marginal cost is the variable cost of one unit of product or service >>>> would be avoided if that unit were not produced or provided
The cost of a unit of product consists of only variable (marginal) manufacturing costs:
Direct materials Direct labor Variable manufacturing overhead
Contribution = sales revenue – variable costs of sales Fixed costs are treated as period costs and are charged
in full to the PL account of the accounting period in which they are incurred
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2. Marginal costing definition and principles
77
No extra fixed cost incurred when output is increased By selling an extra item of product or service, the
following will happen: Revenue will increase by the sale value of item sold Costs will increase by the variable cost per unit Profit will increase by the amount of contribution
earned from the extra item
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3. Absorption costing vs. Marginal costing
78
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
Variable
Costing
AbsorptionCosting
Product
Costs
PeriodCosts
Product
Costs
PeriodCosts
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3. Absorption costing vs. Marginal costing
79
Manufacturing Cost Flows
Variable costing
Income StatementExpenses
Cost of GoodsSold
Selling andAdministrativePeriod Costs
Work in Process
FinishedGoods
Raw Materials
VariableManufacturing
Overhead
Material Purchases
Direct Labor
Selling andAdministrative
FixedManufacturing
Overhead
Absorptio
n costing
Balance Sheet
InventoriesCosts
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4. Reconciling the profit figures given by 2 methods
80
The difference is due to the difference stock valuation method used
Relation between production and
salesEffect on inventory
Relation between marginal and
absorption profit
Production > Sales
Inventory increases
Absorption > marginal
Production < Sales
Inventory decreases
Absorption < Marginal
Production = Sales
No change
Absorption = marginal
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4. Reconciling the profit figures given by 2 methods
81
$'000 $'000 $'000 $'000Sales X XLess COS+ Opening inventory X X+ Add production cost X X-Less Closing inventory (X) (X)Subtotal COS (X) (X)Add/less Under/Over absorbed O/H XLess other variable costs (X)Contribution XGross profit XLessFixed production O/H (X) NILFixed selling O/H (X) (X)Net profit X X
Marginal costing Absorption costingIncome statements
Phi Thanh, Tu (EXT-Other - VN/ Hanoi):At variable production cost
Phi Thanh, Tu (EXT-Other - VN/ Hanoi):At full production cost
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Part B-5- Job, batch and service costing
82
1. Job costing2. Batch costing3. Service costing
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Costing system
83
Specific order costing
• Work done by an organization consists of separately identifiable jobs or batches
• Job, batch costing
Continuous operation costing
• Goods or services are produced as a direct result of a sequence of continuous operation or processes
• Process costing
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1. Job costing
84
JobCosting
Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.
Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.
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1. Job costing
85
Work in Progress
Cost of SalesLabor
Materials
Indirect
Indirect
FinishedGoods
FactoryOverhead
Direct
Direct
Apportion
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1. Job costing
86
Receive order from customers
Predict cost to complete job
Negotiate a sales price and decide whether to
pursue the job.
Schedule the job
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2. Batch costing
87
BatchCosting
Similar to Job costingWithin each batch are number of identical units but each batch will be differentCost per unit in batch =
Similar to Job costingWithin each batch are number of identical units but each batch will be differentCost per unit in batch =
Total production cost of batch
Number of units in batch
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2. Batch costing
88
Total production cost of batch
Number of units in batch
JOB
&
BATCH
The units of a particular
job/batch are easy to identify.
Individual goods or services have
very different characteristics
and costs.
Value of WIP at the year end is the sum of the
costs incurred on incomplete job/batch.
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3. Pricing the Job/Batch
89
Pricing the Job
Cost plus method
Mark-up
%Cost of job 100+ Profit 25
= Selling price 125
Profit Mark-up: 25% on job cost
Margin
%Cost of job 100+ Profit 25
= Selling price 125
Profit Margin: 20% on selling price
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4. Service costing
90
Different characteristics of services: Simultaneity, Heterogeneity, Intangibility, Perishability
Difficulty in defining cost units. It is usually a composite cost unit
E.g.: tones-miles for haulage companiespatient days for hospitalguest days for hotel services
passenger miles for public transport companies
Direct materials will be relatively small compared to labor & OH.
However, service costing techniques are quite similar to job/batch costing:
Cost per service unit
Total costs for period
Number of service units in the period
= -----------------------------------------
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Part B-6- Process costing
91
1. Process costing2. Losses in process costing3. Dealing with scrap value4. Losses with a disposal cost5. Valuing WIP6. Joint products & By-products
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1. Process costing
92
A form of continuous operation costing To be used in mass production of many identical
products Output of process 1 forms the materials input of the next
process Average cost per unit is calculated for each process
Average cost per unit
Costs of production
Expected or normal output
= -----------------------------------------
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1. Process costing
93
Differences Between Job-Order and Process Costing
Job order costingMany jobs are worked during the period.
Costs are accumulated by individual jobs.Job cost sheet is the key document.Unit costs are computed by job
Process costingA single product is produced for a long period of time/ and/or going through different processes.Costs are accumulated by departments. Department production report is key document. Unit costs are computed by department (each process)
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1. Process costing
94
Direct labor and manu. OH are often combined into one
product cost called conversion.
DirectMaterial
s
Type of Product Cost
Dollar Amount
DirectLabor
Overhead
DirectMaterial
s
Type of Product Cost
Dollar Amount
Conversion
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2. Losses in process costing
95
Framework for dealing with process costing
Step 2: Calculate cost per unit of output, losses & WIP
Step 1: Determine output & losses
Step 3: Calculate total cost of output, losses & WIP
Step 4: Complete accounts
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2. Losses in process costing
96
Step 1: Determine output & losses Normal loss:
The loss is expected in a processExpressed as a % of material input to the processIf Normal loss does not have a scrap value, It is valued
in the process account as NILIf Normal loss has a scrap value, it is valued in the
process account at this value. Revenue from scrap value is used to reduce the input cost of the process
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2. Losses in process costing
97
Step 1: Determine output & losses Abnormal loss and gains
If the actual loss/gain in the process is different to what we are expecting, it is an abnormal loss or an abnormal gain
Actual loss > normal loss = Abnormal lossActual loss < normal loss = Abnormal gainCost of abnormal loss and gain:
not absorbed into the cost of good outputShown as loss and gain in the process accountValue is the same as cost of unit of good output
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2. Losses in process costing
98
Step 1: Determine output & losses
Input: 1000 units Production Process
Normal loss rate: 10%
Output: 860 units
Normal loss: 100 units
(10% x 1000 units)
Abnormal loss: 40 units
(140 units - 100 units)
Actual Losses: 140 units
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2. Losses in process costing
99
Step 1: Determine output & losses
Input: 1000 units Production Process
Normal loss rate: 10%
Output: 960 units
Normal loss: 100 units
(10% x 1000 units)
Abnormal gain: 60 units
(100 units - 40 units)
Actual Losses: 40 units
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2. Losses in process costing
100
Step 2: Calculate cost per unit
Rule: Unit cost of output is calculated based on expected output
Example:
For both case 1 & 2 above, if total costs of input is $4,500,
Cost per unit of output is:
$4,500/ 900 units = $5 per unit
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2. Losses in process costing
101
Step 3: Calculate total cost of output and losses Rule:
Normal loss: No cost
Abnormal loss: given a cost (equal to unit cost of out put)
Abnormal gain: given a negative cost (equal to unit cost of out put)
Case 1Normal loss: NILAbnormal loss= 40units x $5 = $200Output = 860units x $5 = $4300
Case 2Normal loss: NILAbnormal gain= 60units x $5 = $300Output = 960units x $5 = $4800
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2. Losses in process costing
102
Step 4: Complete accounts Case 1:
INPUT Units $ OUPUT Units $Cost incurred 1000 4500 Normal loss 100 0
Output 860 4300Abnormal loss 40 200
PROCESS ACCOUNT
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2. Losses in process costing
103
Step 4: Complete accounts Case 1:
Units $ Units $Process account 40 200 Income statement
ABNORMAL LOSS ACCOUNT
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2. Losses in process costing
104
Step 4: Complete accounts Case 2:
INPUT Units $ OUPUT Units $Cost incurred 1000 4500 Normal loss 100 0Abnormal gain 60 300 Output 960 4800
PROCESS ACCOUNT
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2. Losses in process costing
105
Step 4: Complete accounts Case 2:
Units $ Units $Income statement Abnormal gain 60 300
ABNORMAL GAIN ACCOUNT
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3. Dealing with scrap value
106
Losses or spoilage may have scrap value.
Basic rule:
Revenue from scrap is not treated as an addition to sales
revenue, but as a reduction in costs.Scrap value
Normal loss/gain Abnormal loss/gain
Deduct from cost of process Deduct from cost
of abnormal loss
Deduct from value of abnormal gain
Dr Scrap a/c
Cr Process a/cDr Scrap a/c
Cr Abnormal loss a/c
Dr Abnormal gain a/c Cr Scrap a/c
LOSS GAIN
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3. Dealing with scrap value
107
Example:
JJ has a factory which operates two production processes, cutting and pasting. Normal loss in each process is 10%. Scrapped units out of the cutting process sell for $3 per unit whereas scrapped units out of the pasting process sell for $5. Output from the cutting process is transferred to the pasting process: output from the pasting process is finished output ready for sale.
Relevant information about costs for control period 7 are as follows:
Pls prepare accounts for the cutting/pasting process, abnormal loss, abnormal gain and scrap.
Cutting process Pasting process
Units $ Units $
Input materials 18,000 54,000
Transferred to pasting process
16,000
Material from cutting process 16,000
Added materials 14,000 70,000
Labor and overheads 32,400 135,000
Output to FGs 28,000
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4. Losses with a disposal cost
108
Disposal cost
Normal loss Abnormal loss/gain
Add to cost of process
Add to cost of abnormal loss
Add to value of abnormal gain
Dr Process a/c
Cr Disposal cost a/c
Dr Abnormal loss a/c
Cr Disposal cost a/c
Dr Disposal cost a/c
Cr Abnormal gain a/c
LOSS GAIN
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5. Valuing WIP
109
Equivalent units are partially complete and are part of work in process inventory. Partially completed products are expressed in terms of a smaller number of fully completed units- as a proportion of completed units.
Calculating and Using Equivalent Units of Production
Different degree of completion for each cost element:MaterialsConversion costs = labor + overheads
Cost perequivalent
unit
= Costs for the period
Equivalent units of production for the period
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5. Valuing WIP
110
Example 1:
For process 1 in ABC Co, the following is relevant for the latest period:
Period cost: $4440
Input: 800 units
Output: 600 fully-worked units and 200 units only 70% complete.
There were no process losses
Prepare statement of Eus and Process 1 account.
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5. Valuing WIP
111
Example 1:Statements of EUs
Output % Eus
FGs 600 100% 600
Closing WIP 200 70% 140
Total 800 740
Costs $4440
Cost per EU $6
Process 1 A/c
Units $ Units $
Input 800 4440
Transferred to next process
600 3600 (600*6)
WIP 200 840 (140*6)
Total 800 4440
800 4440
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5. Valuing WIP
112
How to value WIP if there is WIP at the beginning of the period?
Valuing Opening WIP
FIFO method Weighted Average method
Cost during period
Work done during period
Cost till date
Work done till date
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5. Valuing WIP
113
Assumption in FIFO Assumption in WAC
WIP at the beginning of the period must be completed, and transferred out first.
Makes no distinction between work done in prior and current period
Closing WIP includes the most recently incurred costs
Blends together units and costs from prior period and current period.
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5. Valuing WIP
114
Work in process, May 1: 200 units Materials: 55% complete. $ 9,600Conversion: 30% complete. $ 5,575
Production started during May: 5,000 unitsProduction completed during May: 4,800 unitsCosts added to production in May
Materials cost $ 368,600Conversion cost $ 350,900
Work in process, May 31: 400 unitsMaterials 40% complete.Conversion 25% complete.
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5. Valuing WIP
115
Prepare the process account for May 2008- FIFO
Beginning WIP200 Units
55% Complete
Ending WIP400 Units
40% Complete
5,000 Units Started
4,600 Units Startedand Completed
MaterialsMaterials
90 Equivalent Units4,600 Units Completed160 Equivalent Units
400 × 40%
4,850 Equivalent units of Materials
200 x 45%
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5. Valuing WIP
116
Prepare the process account for May 2008- FIFO
5,000 Units Started
4,600 Units Startedand Completed
400 × 25%
4,840 Equivalent units of Conversion
Beginning WIP200 Units
30% Complete
Ending WIP400 Units
25% Complete
ConversionConversion
140 Equivalent Units 4600 Units completed 100 Equivalent Units
200 x 70%
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5. Valuing WIP
117
Prepare the process account for May 2008- WAC
Beginning WIP200 Units
55% Complete
Ending WIP400 Units
40% Complete
5,000 Units Started
4,600 Units Startedand Completed
MaterialsMaterials
4800 Units Completed160 Equivalent Units
400 × 40%
4,960 Equivalent units of Materials
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5. Valuing WIP
118
Prepare the process account for May 2008- WAC
5,000 Units Started
4,600 Units Startedand Completed
400 × 25%
4,900 Equivalent units of Conversions
Beginning WIP200 Units
30% Complete
Ending WIP400 Units
25% Complete
ConversionConversion
4800 Units completed 100 Equivalent Units
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6. Joint and by products
119
6.1. Joint products Joint products are two or more products produced
simultaneously by the same process up to a “split-off” point. Each is important and can have a significant sales
value. Each should therefore be valued separately. e.g..,
seafood processing, oil refining,... Cost incurred up to this point are called common costs
or joint costs. The split-off point is the point at which the joint
products become separate and identifiable. Should be treated as normal output from the process
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6. Joint and by products
120
6.1. Joint products Joint Cost Apportionment Methods
Physical units: production units Sales value at split-off point: the sales value of the total
output from the particular processes concerned. Net realizable value: final sales value – further processing
cost
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6. Joint and by products
121
6.2. By products What are the differences between a joint and a
by- product?
•The distinction between joint and by-products rests solely on the relative importance of their sales value.
•A by-product is a secondary product recovered in the course of manufacturing a primary product.
Characteristics of By-products:Relatively low in sales value Small in quantity produced Sold in bulks
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6. Joint and by products
122
6.2. By products Accounting for by-products: Similar to Normal
LossCost of By-product: Generally NO cost is
apportioned to the by-products.Income of By-product: 4 methods
added to sales of main products. treated as a separate, incidental source of income. deducted from the cost of production of the main
product. Net realizable value (NRV) of the by-product is
deducted from the cost of production in the period. ***** the most common method.
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Part B-7- Alternative costing
123
1. Activity based costing2. Calculation of ABC3. Absorption costing vs. ABC4. Advantages and disadvantages of ABC5. Total Quality Management6. Life cycle costing7. Target costing
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1. Activity base costing (ABC)
124
Costs are firstly assigned to the activities which are the real causes of the overheadThen costs of those activities are assigned to the products which are actually demanding those activities
Overheads
Activity 1
Activity 2
Activity 3
Product 1
Product 2
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1. Activity base costing (ABC)
125
Activities cause costs: the special engineering, special testing, machine setups, etc—(they cause the company to consume resources).The reasons for the development of ABC:
(1) manufacturing overhead costs have increased significantly,
(2) the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours,
(3) the diversity of products and the diversity in customers' demands have grown, and
(4) some products are produced in large batches, while others are produced in small batches.
2. Calculation of ABC
F2 ACCA Phi Thanh Tu126
Step1
•Identify an organization's major activities
Step 2
•Identify the cost drivers- factors which determine the size of the costs of an activity (cause the costs of an activity)
Step 3
•Collect the costs of each activity into cost pools (equivalent to cost centers under the traditional costing methods) (each activity)
Step 4
•Charge support overheads to products on the basis of their usage of the activity- number of the activity’s cost driver it generates
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1. Activity base costing (ACB)
127
Activity Cost drivers
Ordering Number of orders
Materials handling Number of production runs
Production scheduling Number of production runs
Dispatching Number of dispatches
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2. Calculation of ACB- Example
128
We will assume that a company has annual manufacturing overhead costs of $2,000,000—of which $200,000 is directly involved in setting up the production machines. During the year the company expects to perform 400 machine setups. Let’s also assume that the batch sizes vary considerably, but the setup efforts for each machine are similar.
For simplicity, let’s assume that the remaining $1,800,000 of
manufacturing overhead is caused by the production activities that correlate with the company’s 100,000 machine hours.
Assume that a company manufactures a batch of 5,000 units and it
produces 50 units per machine hour, calculate the cost assigned to the units with activity based costing and without activity based costing compares.
If a company manufactures a batch of 50,000 units and produces 50 units
per machine hour, show how the cost assigned to the units with ABC and without ABC compares.
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2. Calculation of ACB- Example
129
With ABC Without ABC
Mfg overhead costs assigned to setups
$200,000 $–0–
Number of setups 400 Not applicable
Mfg overhead cost per setup
$500 $–0–
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2. Calculation of ACB- Example
130
With ABC Without ABC
Total manufacturing overhead costs
$2,000,000 $2,000,000
Less: Cost traced to machine setups
200,000 –0–
Mfg O/H costs allocated on machine hours
$1,800,000 $2,000,000
Machine hours (MH) 100,000 100,000
Mfg overhead costs per MH
$18 $20
Mfg Overhead Cost Allocations
$500 setup cost per batch + $18
per MH$20 per MH
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2. Calculation of ACB- Example
131
With ABC Without ABC
Mfg overhead for setting up machine
$500 $–0–
No. of units in batch
5,000 Not applicable
Mfg O/H caused by Setup – Per Unit
$0.10 Not applicable
If the company manufactures a batch of 5,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:
F2 ACCA Phi Thanh Tu
2. Calculation of ACB- Example
132
With ABC Without ABC
Mfg overhead costs per machine hour
$18 $20
No. of units produced per machine hour
50 50
Mfg O/H caused by Production – Per Unit
$0.36 $0.40
Total Mfg O/H Allocated – Per Unit
$0.46 $0.40
F2 ACCA Phi Thanh Tu
2. Calculation of ACB- Example
133
With ABC Without ABC
Mfg overhead for setting up machine
$500 $–0–
No. of units in batch
50,000 Not applicable
Mfg O/H caused by Setup – Per Unit
$0.01 Not applicable
If the company manufactures a batch of 50,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:
F2 ACCA Phi Thanh Tu
2. Calculation of ACB- Example
134
With ABC Without ABC
Mfg overhead costs per machine hour
$18 $20
No. of units produced per machine hour
50 50
Mfg O/H caused by Production – Per Unit
$0.36 $0.40
Total Mfg O/H Allocated – Per Unit
$0.37 $0.40
F2 ACCA Phi Thanh Tu
2. Calculation of ACB- Example
135
As the tables above illustrate: with activity based costing the cost per unit decreases from $0.46 to
$0.37 because the cost of the setup activity is spread over 50,000 units instead of 5,000 units.
Without ABC, the cost per unit is $0.40 regardless of the number of units in each batch.
If companies base their selling prices on costs, a company not using an ABC approach might lose the large batch work to a competitor who bids a lower price based on the lower, more accurate overhead cost of $0.37.
It’s also possible that a company not using ABC may find itself being the low bidder for manufacturing small batches of product, since its $0.40 is lower than the ABC model of $0.46 for a batch size of 5,000 units. With its bid price based on manufacturing overhead of $0.40—but a true cost of $0.46—the company may end up doing lots of production for little or no profit.
F2 ACCA Phi Thanh Tu
3. Absorption costing vs. ACB
136
ACB Absorption costing
ABC ascertains the purpose of each activity or service and assigns the cost of such activity or service to the product or service unit that demands such activity.
Cost of a product unit under absorption costing = cost of direct materials + direct labor + variable manufacturing overheads + (fixed manufacturing overhead costs/units produced).
Traces the costs of product units. (define activity >>> allocate COST)
Allocates costs to product units. (allocate all production cost)
ABC presumes that products or services consume activities, and activities consume resources. It thus, works to convert indirect costs into direct costs.
It works under the simple approach of assigning resources to products or services directly.
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3. Absorption costing vs. ABC
137
ABC Absorption costing
Identifies the actual proportion of fixed overheads costs incurred by the product unit.
Divides equally the fixed overhead costs with the number of product units
Price fixation in ABC bases calculations to derive the actual overheads incurred on a unit, and does not vary with change in inventory levels.
Price fixation in absorption costing depends on the inventory. The higher the inventory, the lower the product cost and lower the inventory; or the higher per-product cost
Not allowed by GAAP. Allowed by GAAP
Improves the quality of management accounting information, especially in large and multi-product operations
Remains more suitable for small firms and enterprises with homogeneous products or services.
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4. Advantages and disadvantages of ABC
138
Advantages Disadvantages
Estimate cost precisely The method is complex, time consuming and costly
Provide quantifiable figure for planning and estimates
Not accept by GAAP
Facilitate the determination of selling price
Difficult to identify/analyze/quantify cost in the activity
Help to identify inefficient/ non-profitable products/activities
Help to allocate resources to profitable items
Etc Etc
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5. Total quality management
139
TQM is a process of applying a zero defect philosophy to the management of all resources and relationships within an organization as a means of developing and sustaining a culture of continuous improvement which focuses on meeting customer expectation. Quality combines the criteria:
How well made a product is/ how well performed if it is a serviceHow well it serves its purposeHow it measures up against its rival
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5. Total quality management
140
Basic principles of TQM:Get it right, first time: basic principal of TQM- the cost of
preventing mistakes is less than the cost of correcting them.Continuous improvement: always possible to improvePerformance measures for TQM must embrace every activity
of the organizationThe requirement of quality: 8 requirements of quality
according to Mark Lee Inman
Customer Customer-supplier relationship
Preventing the cause of the defect in the 1st place
Employees must be personally responsible for defect free production
Any level of defects is unacceptable
All departments are involved
Quality certification Emphasize cost of poor quality
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6. Life cycle costing
141
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5. Life Cycle costing
142
Market introduction
Growth Maturity Decline
Demand/sales
-Demand needs to be created-Sales is slow to start
- Public awareness increases- Sales volumes increase significantly
Sales peaks - Decline
Price Targeted price Begin to decrease due to competition
Tends to drop
Diminish
Cost Very high Reduced due to economics of scale
Lower Counter-optimal
Competition Little or no Begin to increase with a few players
Increase Increase/ Peaks
Profitability Make no money Begin to rise Go down Diminish
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7. Target costing
143
Target cost is an estimate of a product cost which is determined by subtracting a desired profit margin from a competitive market price.
This target cost may be less than the planned initial product cost but it is expected to be achieved by the time the product reaches the maturity stage of the product life cycle
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7. Target costing
144
Step 1
•Determine a product specification of which an adequate sales volume is estimated
Step 2
•Set a selling price at which the organization will be able to achieve a desired market share
Step 3
•Estimate the required profit based on return on sales or return on investment
Step 4
•Calculate the target cost = target selling price- target profit
Step 5
•Compile an estimated cost for the product based on the anticipated design specification an d current cost level
Step 6
•Calculate cost gap = estimated cost - target cost
Step 7
•Make efforts to close the gap (at design phase)
Step 8
•Negotiate with the customer before making the decision about whether to go ahead with the project