Accountancy 302

1
Accountancy 302

• Course Recap

2
Agenda

• Product costs and cost behavior
• Costs and decision making
• Budgeting and variances
• Performance evaluation
• Uncertainty

3
Product costs and cost behavior

• Before market, manufacturing, and after market.
• GAAP product costs manufacturing costs
• Variable and fixed
• Direct and indirect
• The flow of costs through a manufacturers
  accounts
• Standard costs

4
Standard Product Costs

• Direct material (standard input cost, standard
  input quantity)
• Direct labor (standard labor rate, standard input
  quantity)
• Manufacturing overhead (fixed and variable,
  predetermined rate)

5
Flow of product costs.

• Material, labor and overhead go into
  Work-in-process inventory.
• All at standard cost.
• Flexible budget amounts.
• Cost of goods manufactured comes out of WIP and
  goes into FG.
• Cost of goods sold comes out of FG and goes into
  COGS.

6
Cost of goods sold

• Cost of goods sold is
• Goods sold x Standard material, plus
• Goods sold x Standard labor, plus
• Goods sold x Predetermined overhead rate.
• Cost of goods manufactured is
• Goods manufactured x Standard material, plus
• Goods manufactured x Standard labor, plus
• Goods manufactured x Predetermined overhead rate

7
Costs for decision making

• Cost-volume-profit model
• Example
• Prestige Telephone
• Cost estimation
• Lincoln Community Hospital (analyzing costs for
  decision making)
• Burd Fletcher (forecasting overhead costs)
• Relevant cost analysis (cost, capacity, and
  profitability
• Hanson Manufacturing
• Schulze Waxed Containers

8
Cost-Volume-Profit
The Rapid Meal has two restaurants that are open
24 hoursper day. Fixed costs for the two
restaurants together total 450,000 per year.
Service varies from a cup of coffee to full
meals. The average sales check for each customer
is 8. The average cost of food and other
variable costs for each customer is 3.20. The
income tax rate is 30. Target net income is
105,000.
What level of unit sales will achieve the target
income?
9
Rapid Meal Example C-V-P
SP 8.00 VC 3.20 FC 450,000
Tax rate 30
What level of sales will achieve the target
income?
Profit Revenues - Costs
If Q units sold, Revenues SPQ, and
Variable costs Unit
variable cost (VC) Q
Costs Variable costs Fixed costs (FC) Taxes
Taxes Tax rate (t) x profit before taxes
Therefore, Profit SPQ - VCQ - FC - t(SPQ -
VCQ - FC)
105,000 8Q - 3.20Q - 450,000 - .3(8Q -
3.20Q-450,000)
SOLVE THIS FOR Q!
125,000 units
10
C-V-P Example
Lorocettes Sandwich Shop produces two
products,6-inch and12-inch sandwiches with the
followingcharacteristics 6-inch
12-inch Selling price per unit
4 6 Variable cost per unit
2 3.50 Expected
sales (units) 10,000 15,000The
total fixed costs for the company are 34,500.
23,000
What is expected profit?
11
C-V-P Example
FC34,500 6-inch 12-inch Selling
price per unit 4 6
Variable cost per unit 2
3.50 Expected sales (units)
10,000 15,000
Assuming that the product mix is the same at
thebreak-even point, compute the break-even
point.
WACM 2.30
BE 34,500/2.3 15,000
12
C-V-P Example
FC 34,500 6-inch 12-inch Selling
price per unit 4 6
Variable cost per unit 2
3.50 Expected sales (units)
10,000 15,000
If the product sales mix were to change to four
6-inchsandwiches for each 12-inbch sandwich,
what wouldbe the new break-even volume for each
of the products?
WACM 2.10
BE 34,500/2.10 16,429
4/5(16,429) 13,143 6-inch sandwiches.
13
Relevant Costs
Identifying relevant costs means identifying
thecosts that are relevant to the decision at
hand.Relevant costs are the ones that differ
across decision alternatives.
New equipment
Make or buy
Dropping or adding a product lline
Special order
14
Standard costs, budgets, and variances

• Purposes of budgeting planning, motivation,
  control
• Variable cost variances
• Overhead variances (Example)
• Sales variances
• price, sales activity, sales volume, sales mix,
  price recovery
• market size, market share (Example)

15
Overhead variances Example

Variable Fixed Actual
costs incurred 11,900
6,000 Applied to products
9,000 4,500 Flexible budget
9,000
5,000 Actual input x budgeted rate
10,000 5,000

Variable Fixed
Spending/Budget variance?
1,900
1,000
1,000
NA
Efficiency variance?
NA
500
PVV?
1,000
2,900
Flexible budget variance?
Over- or underapplied overhead?
1,500
2,900
16
Sales variances
Computer Horizons derived its total unit sales
budget for 1996 from an internal management
estimate of 20 market share and an industry
sales forecast by Micro-Information Services of
5,000,000 units. At the end of 1996,
Micro-Information reported actual industry sales
of 6,875,000 units. Computer Horizons actual
sales were 1,100,000 units and its
budgetedcontribution margin is 780.
292,500,000
F
What was the market size variance?
214,500,000
U
What was the market share variance?
78,000,000
F
What was the sales volume variance?
17
Decentralization and performance evaluation

• Why decentralize? (motivation, evaluation and
  risk)
• Responsibility centers
• ROI
• Residual income
• Profit performance measures
• Transfer pricing (General Appliance)
• General rule TP VC OC (OC opportunity
  cost)
• Example
• Setting budget targets (HCC Industries)
• Company vision, goals, and strategy, as well as
  long- and short-term motivation and evaluation
  Provigo

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Transfer pricing example
Allison-Chambers Corp. is a decentralized tractor
manufacturer. Divisions A and C are operated as
profit centers. Division C has always purchased
tractor engines from A, but A increased its
selling price to 150 to recover the cost of new
specialized equipment. Cs manager decided to
purchase the engine from outside suppliers at
135.
As manager appealed to A-Cs top management for
resolution
Data Cs annual purchases of engines 1,000
units As variable costs per unit
120 As fixed costs per unit 20
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Transfer pricing example
Data Cs annual purchases of engines 1,000
units As variable costs per unit
120 As fixed costs per unit 20 Cs
outside price 135 As asking price 150
If there is no alterntive use for As facilities,
does the company want C to purchase the engine
externally?
If there is an alternative use for As facilities
that saves 18,000 in operating costs annually,
does the company want C to purchase externally?
If there is no alternative use for As
facilities, and the outside price drops to 115
per units, does the company want C to purchase
engines externally?
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Uncertainty

• All of the above, plus . . .
• Assessing and using probability
• Probability revision (Bayes Rule) Example
• Decision trees
• Structured decision representation Example
• Warren Agency.
• Rosetta Stone
• Charles River Jazz Festival.

21
Probability revision Example
A large textile mill is faced with the problem of
extending 100,000 in credit to a new customer, a
dress manufacturer. The mill classifies typical
customers into the categories poor, average,
and good risk. Their experience indicates that
20 percent of similar customers are poor risks,
50 percent are average risks, and 30 percent are
good risks. If credit is extended, the expected
profit for poor risks is 15,000, for average
risks it is 10,000, and for good risks is
20,000. If credit is not extended, the customer
will turn to another mill.
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Probability revision Example
Priors .2 poor, .5 average, .3 good. Payoffs
15,000 poor, 10,000 average, 20,000 good
The mill is able to consult with a credit-rating
agency for a fee of 2,000. Their experience
with the credit-rating agency is summarized in
the following frequency table
ACTUAL
Poor
Average
Good
50
40
20
Poor
110
REPORT
40
40
50
Average
130
10
10
40
Good
60
300
100
100
100
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Probability revision Example
Priors .2 poor, .5 average, .3 good. Payoffs
15,000 poor, 10,000 average, 20,000 good
What is the probability (likelihood) of a poor
report given a good credit risk?
What is the probability of an average report
given an average credit risk?
What is the probability (posterior) of a good
credit risk given a poor credit report?
What is the marginal probability of a good credit
risk?
What is the prior probability of a good credit
risk?
ACTUAL
Poor
Average
Good
50
40
20
Poor
110
REPORT
40
40
50
Average
130
10
10
40
Good
60
300
100
100
100
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Probability revision Example
Joint probability table
ACTUAL
Poor
Average
Good
50
40
20
Poor
110
.167
.133
.067
.367
REPORT
40
.167
.133
40
50
Average
130
.133
.433
.033
.133
10
10
40
Good
60
.033
.20
300
100
100
100
1
.333
.333
.333
25
Decision trees Example
What should the mill do?
good
20
.667
Good
.167
average
10
poor
.2
15
17,500
.167
good
20
.308
Buy report
.
.384
Average
433
average
10
poor
.308
15
14,600
good
20
15,000 - 2,000 13,000
.182
.364
average
Poor
.367
10
poor
.454
15
14,100
Dont buy . . .
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Decision trees Example
good
20,000
.3
Dont buy
.5
average
10,000
.2
14,000
poor
15,000
Dont buy the report.
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Decision trees Another example
If I build a large hotel (cost 5,000,000) and
tourismis high (P(high) 2/3), I will make
15,000,000 in revenue, but if it is low, I will
make 2,000,000.
If I build a small hotel (cost 3,000,000) and
tourismis high, I will make 5,000,000, but if
tourism is low, I will make 2,000,000.
I can also choose to do nothing.
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I can expand after one year for 3,000,000 if I
initially chose to build small. The probability
of high demand in year 2 given high in year 1 is
.75 the probability of low demand in year 2
given high in year 1 is .5.
16,387,500
.5
-1,000,000
5,500,000
14,000,000
Expand
1,000,000
10,750,000
7,000,000
Dont
.67
9,182,500
4,000,000
10,750,000
6,250,000
14,000,000
-2,000,000
6,000,000
4,000,000
.33
1,000,000
2,500,000
6,000,000