Managerial Accounting 1 (Cost Accounting)

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    Introduction toManagerial Accounting

    Chapter One

    Prepared and Taught by Lecturer: YIN SOKHENG,Master in Finance

    E-mail: [email protected]

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    Managerial accounting provides infor-mation formanagers of an organization whodirect and control its operations.

    Financial accounting provides infor-

    mation for stockholders, creditors and otherswho are outside the organization.

    Lecturer YIN SOKHENG, Master in Finance 2

    I. Definition of Managerial Accounting

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    Financial Accounting Managerial Accounting

    1. Users External persons who

    make financial decisions

    Managers who plans for

    and control an

    organization

    2. Time focus Historical perspective Future emphasis

    3. Verifiabilityversus relevance

    Emphasis onverifiability

    Emphasis on relevancefor planning and control

    4. Precision versus

    timeliness

    Emphasis on

    precision

    Emphasis on

    timeliness

    5. Subject Primary focus is on

    the whole organization

    Focuses on segments of

    an organization

    6. G.A.A.P Must follow GAAP

    and prescribed formats

    Need not follow GAAP

    or any prescribed format

    7. Requirement Mandatory for

    external reports

    Not mandatory

    Differences Between Financial and Managerial Accounting

    Lecturer YIN SOKHENG, Master in Finance 3

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    Lecturer YIN SOKHENG, Master in Finance 4

    Controlling

    Directing

    and

    Motivating

    Planning

    II. Work of Management

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    Select a best

    alternative

    Planning

    Lecturer YIN SOKHENG, Master in Finance

    Develop budgets

    Identify

    alternatives

    5

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    Directing and motivating involves managing day-to-dayactivities to keep the organization running smoothly.

    Employee work assignments.

    Routine problem solving.

    Conflict resolution.

    Effective communications.

    Directing and Motivating

    Lecturer YIN SOKHENG, Master in Finance 6

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    Feedback in the form of performance reports

    that compare actual result with the budgets

    are an essential part of the control function.

    The control function ensures

    that plans are being followed.

    Controlling

    Lecturer YIN SOKHENG, Master in Finance 7

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    Planning and Control Cycle

    Lecturer YIN SOKHENG, Master in Finance 8

    BeingFormulating long and

    short term plans

    (Planning)

    Comparing actual

    to planed performance

    (Controlling)

    Measuring

    performance

    (Controlling)

    Implementing plans(Directing and

    Motivating)

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    Corporate Organization Chart

    Organization Structure

    Lecturer YIN SOKHENG, Master in Finance

    Board of Directors

    President/CEO

    Purchasing Personnel Vice presidentoperations Chief FinancialOfficer (CFO)

    Treasurer Controller

    9

    Decentralization is the delegation of

    decision-making authority throughout anorganization

    Manager Manager

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    Staff positions supportand assist line positions.Example: Cost

    accountants.

    Line position aredirectly related toachievement of the

    basic objectives of anorganization.Example: Productionsupervisors .

    Line and Staff Relationships

    Lecturer YIN SOKHENG, Master in Finance 10

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    The Chief Financial Officer (CFO)

    A member of the top manager team (CFO) responsiblefor:

    Providing the timely and relevant data to

    support planning and control activities. Preparing financial statement for external

    users.

    The treasurer is responsible for:

    handing cash flows,managing capital expenditures decisions, and

    making financial plans.

    1-11Lecturer YIN SOKHENG, Master in Finance

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    A just-in-time manufacturer produces goods toship to customers rather than producing goods forinventory.

    Production is initiated by a customer order, asystem referred to as "demand pull," rather than adesire to build inventory for potential orders.

    When applied in a manufacturing company, JITsystems minimize raw materials, work in process,and finished goods inventories.

    Lecturer YIN SOKHENG, Master in Finance 13

    III. Just-in-Time (JIT) System

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    The Steps in JIT System processing

    Lecturer YIN SOKHENG, Master in Finance14

    Receivecustomer

    orders.

    Scheduleproduction.

    Complete partsjust-in-time for

    assembly into products.

    Receive materialsjust-in-time for

    production.

    Complete productsjust-in-time to

    ship customers.

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    Key Elements for a Successful JIT System

    Lecturer YIN SOKHENG, Master in Finance 15

    Improvedplant layout

    Reducedsetup time

    Zero productionDefects

    Flexibleworkforce

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    Cost Terms, Concepts, and

    Classifications

    Chapter Two

    E-mail: [email protected]

    Prepared and Taught by Lecturer: YIN SOKHENG,Master in Finance

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    Classifying CostsBy Behavior

    - Variable Costs

    - Fixed Costs

    By Traceability/ Cost Objects

    - Direct Costs

    - Indirect Costs

    By Function- Product Costs

    - Period Costs

    Lecturer YIN SOKHENG, Master in Finance 2

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    I. Cost Classifications by BehaviorCost Behavior: How a cost will react to changes in

    the level of business activity.

    Variable Costs:

    - Total variable costs change when the level ofactivity changes.

    - The variable cost per unit remains the same

    over wide ranges of activity . Example: direct materials cost, direct labour

    cost, sale commissions, cost of goods sold

    Lecturer YIN SOKHENG, Master in Finance 3

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    Total Variable Cost

    Your telephone bill is based on how many minutesyou talk.

    Lecturer YIN SOKHENG, Master in Finance 4

    A variable cost is one that change in total inproportion to change in the volume of activity

    TotalTelephoneBill

    Minutes Talked

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    Variable Cost Per Unit

    The cost per minute talked is constant.

    For example, 10 cents per minute.

    Lecturer YIN SOKHENG, Master in Finance 5

    On a per unit basis, a variable cost remainconstant over a wide range of activity

    PerM

    inute

    Telephon

    eCharge

    Minutes Talked

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    Cost Classifications by Behavior Fixed Costs:

    - Total fixed costs remain unchanged when thelevel of activity changes.

    - The fixed cost per unit goes down as activitylevel goes up.

    Example: depreciation, supervisory salaries, and

    rent

    Lecturer YIN SOKHENG, Master in Finance 6

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    Fixed Cost Per Unit

    The average cost per local call decreases as morelocal calls are made.

    Lecturer YIN SOKHENG, Master in Finance 8

    On a per unit basis, a fixed cost changesas the volume of activity changes

    Month

    lybasic

    Telephon

    eCharge

    perLocalCall

    Number of Local Calls

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    II. Cost Classifications by Traceability

    Direct Costs:

    Costs that can easily and conveniently traced to aunit of product or other cost objective.

    Examples: Direct materials cost, Direct labour cost.

    Indirect labour Costs:

    Costs that cant easily and conveniently traced to a

    unit of product or other cost objective.Example: Manufacturing overhead

    Lecturer YIN SOKHENG, Master in Finance 9

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    III. Cost Classifications by Function:

    Lecturer YIN SOKHENG, Master in Finance 10

    Manufacturing Costs/Product Costs Direct MaterialDirect labour Overhead

    NonmanufacturingCosts/ Period Costs Selling & marketing

    expenses General and

    administrativeexpenses

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    Classification of Manufacturing Costs/

    Product CostsManufacturing costs are often classified as follows:

    Lecturer YIN SOKHENG, Master in Finance 11

    Manufacturing

    Costs

    Direct Labor

    ConversionCost

    Prime Cost

    DirectMaterial

    ManufacturingOverhead

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    Manufacturing Costs

    Lecturer YIN SOKHENG, Master in Finance 12

    DirectMaterial

    DirectLabour

    ManufacturingOverhead

    Product Costs

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    Direct Materials Direct materials are raw materials that become an

    integral part of the finished product and that can bephysically and conveniently traced directly to it.

    Lecturer YIN SOKHENG, Master in Finance 13

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    Non-manufacturing Costs/ Period Costs

    Lecturer YIN SOKHENG, Master in Finance 16

    Marketing orSelling Costs

    AdministrativeCosts

    All executive ,organizational,and clerical costs.

    Costs necessary toget the order anddeliver product.

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    Comparing Merchandising and Manufacturing

    Activities

    Lecturer YIN SOKHENG, Master in Finance 18

    Merchandisers- Buy finished goods- Sell finished goods

    Manufacturing- Buy raw materials- Produce and sell

    finished goods

    LUCKY GOODS

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    IV. Cost Classifications on

    Financial Statement

    Lecturer YIN SOKHENG, Master in Finance 19

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    Partial Balance Sheet

    Lecturer YIN SOKHENG, Master in Finance 20

    MerchandiserCurrent assets:

    Cash

    ReceivablePrepaid expenseMerchandiseInventory

    ManufacturerCurrent assets:

    Cash

    ReceivablePrepaid expenseInventories- Raw Materials- Work in Process

    - Finished Goods

    Fully completed productsawaiting sale.

    Partially completeproducts-somematerial, labour, oroverhead has been

    added.

    Materials waitingto be processed.

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    Income Statement

    Lecturer YIN SOKHENG, Master in Finance 21

    Merchandiser CompanyCost of goods sold:

    Beg. merchandiseinventory $14,200

    +Purchase 234,150Goods available

    for sale $248,350-Ending

    merchandise

    inventory (12,100)

    =Cost of goods sold $236,250

    Manufacturing CompanyCost of goods sold:

    Beg. Finishedgoods invent. $ 14,200

    +Cost of goodsmanufactured 234,150Goods available

    for sale $248,350-Ending

    finished goodsinventory (12,100)

    =Cost of goods sold $236,250

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    Lecturer YIN SOKHENG, Master in Finance 22

    Beginningbalance

    Basic Equation for Inventory Accounts

    + = +Additionsto inventory

    Endingbalance

    Withdrawalsfrom inventory

    Inventory Flows

    Available WithdrawalsEndingbalance

    Beginningbalance

    AvailableAdditions+ =

    =-

    Or

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    Merchandising Company

    Lecturer YIN SOKHENG, Master in Finance 23

    Beginningmerchandise

    inventory

    Cost of Goods Sold

    + = +Purchased

    Endingmerchandise

    inventory

    Cost of goodssold

    Beginning

    merchandiseinventory

    Cost of Goods Sold

    = + -Purchased

    Ending

    merchandiseinventory

    Cost of goodssold

    or

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    Manufacturing Company

    Lecturer YIN SOKHENG, Master in Finance 24

    Beginningfinished goods

    inventory

    Cost of Goods Sold

    + = +Ending finished

    goods inventory

    Cost ofgoods sold

    Cost of Goods Sold

    = + -

    or

    Cost of goodsmanufactured

    Cost of

    goods sold

    Beginning

    finished goodsinventory

    Cost of goodsmanufactured

    Ending finished

    goods inventory

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    Schedule of Cost of Goods

    Manufactured It calculates the cost of raw material, direct

    labor and manufacturing overhead used in

    production. It also calculates the manufacturing costs

    associated with goods that were finished

    during the period.

    Lecturer YIN SOKHENG, Master in Finance 25

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    Product Costs

    Lecturer YIN SOKHENG, Master in Finance 27

    Finished GoodsWork inProcess

    Total manufacturingcosts

    + Beginning work inprocess inventory

    = Total work inprocess

    - Ending work inprocess inventory

    = Cost of goodsmanufactured

    Beginning finishedgoods inventory

    +Cost of goodsmanufactured

    = Cost of goodsavailable for sale

    - Ending finishedgoods inventory

    = Cost ofgoods sold

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    The Schedule of Costs of Goods Manufactured

    Lecturer YIN SOKHENG, Master in Finance 28

    Raw MaterialsBeginning raw material inventory xx+ Raw materials purchased xx= Raw materials available for use xx- Ending raw materials inventory (xx)

    = Direct materials use in product xx+ Direct labour xx+ Manufacturing OH xx= Total manufacturing costs xx

    + Beginning work in process inventory xx= Total work in process xx-Ending work in process inventory (xx)= Cost of goods manufactured xx

    Finished Goods

    Beginning finishedgoods inventory

    +Cost of goodsmanufactured

    = Cost of goodsavailable for sale

    - Ending finishedgoods inventory

    = Cost ofgoods sold

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    Beginning raw materials inventory is the inventorycarried over from the prior period.

    As items are removed from raw materials inventoryand placed in to the production process, thy are celleddirect materials.

    Conversion costs ( direct labour + MOH/ FOH) are

    costs incurred the convert the direct material in to afinished product.

    Total manufacturing costs are all manufacturing costsincurred during the period and added to the

    beginning balance of work in process. Cost of goods manufactured: Costs associated with the

    goods that are completed during the period aretransferred to finished goods inventory.

    Lecturer YIN SOKHENG, Master in Finance 29

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    Lecturer YIN SOKHENG, Master in Finance 30

    Manufacturing Cost Flows

    Balance SheetInventories

    IncomeStatementExpensesCosts

    Materials Purchases

    Direct Labour

    ManufacturingOverhead

    Work inProcess

    Finished

    Goods

    Cost of

    Goods Sold

    Selling andAdministrative

    Expenses

    Selling andAdministrative

    Raw Materials

    PeriodCosts

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    V. Cost Classifications for

    Decision Making Every decision involves a choice between at least

    two alternatives.

    The goal of making decisions is to identify thosecosts that are either relevant or irrelevant to thedecision.

    Costs and benefits that differ between alternatives

    are relevant in a decision. All other costs andbenefits are irrelevant and can and should beignored.

    Lecturer YIN SOKHENG, Master in Finance 31

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    Differential costs and Revenues Differential costs (or incremental costs) is a difference in

    cost between any two alternatives. Differential costs can beeither fixed or variable.

    A difference in revenue between two alternatives is called

    differential revenue. For example, assume you have a job paying $1,500 per

    month in your hometown. You have a job offer in aneighboring city that pays $2,000 per month. The

    commuting cost to the city is $300 per month.- Differential revenue is : $2,000 $1,500 = $500- Differential cost: $ 300

    Lecturer YIN SOKHENG, Master in Finance 32

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    RetailerDistribution

    (present)

    Direct SaleDistribution(proposed)

    DifferentialCosts andRevenue

    Revenue (variable) $ 700,000 $ 800,000 $ 100,000

    Cost of goods sold (variable) 350,000 400,000 50,000

    Advertising (fixed) 80,000 45,000 (35,000)

    Commissions (variable) 0 40,000 40,000

    Warehouse depreciation (fixed) 50,000 80,000 30,000

    Other expenses (fixed) 60,000 60,000 0Total 540,000 625,000 85,000

    Net operating income $ 160,000 $ 175,000 $ 15,000

    Lecturer YIN SOKHENG, Master in Finance 33

    Differential costs and Revenues

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    Opportunity cost Opportunity cost is the potential benefit that is

    given up when one alternative is selected overanother.

    These costs are not usually entered into theaccounting records of an organization, but mustbe explicitly considered in all decisions.

    Example: If you were not attending college, you

    could be earning $ 15,000 per year. Youropportunity cost of attending collage for one yearis $ 15,000.

    Lecturer YIN SOKHENG, Master in Finance 34

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    Sunk costs Sunk cost have already been incurred and that

    cannot be changed by any decision made now or inthe future.

    Since sunk costs cannot be changed and therefore

    cannot be differential costs, they should beignored in decision making.

    Example: If you bought an automobile that cost$10,000 two year a go. The $10,000 cost is sunkbecause whether you drive it, park it, trade it, orsell it, you cant change the $10,000 cost.

    Lecturer YIN SOKHENG, Master in Finance 35

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    Idle Time

    Lecturer YIN SOKHENG, Master in Finance 36

    The labor costs incurred during idletime are ordinarily treated as

    manufacturing overhead

    Machinebreakdowns

    Powerfailures

    Materialshortages

    Direct labour ($12 per hour x 37 hours) .............$ 444Manufacturing overhead (idle time: $12 per hour x 3 hours). 36Total cost for the week $ 480

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    Overtime The overtime premiums for all factory workers are

    usually considered to be part of manufacturingoverhead.

    This is done to avoid penalizing particular products orcustomer orders simply because they happen to fall onthe tail end of the daily production schedule.

    Lecturer YIN SOKHENG, Master in Finance 37

    Direct labour($12 per hour x 45 hours)...$ 540

    Manufacturing overhead(overtime premium : $6 per hour x 5 hours).. 30

    Total cost for the week ...$ 570

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    Job Order Costing System

    Chapter Three

    E-mail: [email protected]

    Prepared and Taught by Lecturer: YIN SOKHENG,

    Master in Finance

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    I. Types of Product Costing System

    Lecturer YIN SOKHENG, Master in Finance 2

    There are several methods that can be used toaccumulate manufacturing costs and determine

    unit product cost. One of these methods is

    known as a job- order cost system.

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    A process cost system

    A companies that produce many units of a singleproduct

    One unit of product is indistinguishable from any

    other unit of product.The identical nature of each unit of product

    enables assigning the same average cost per unit.

    Example:

    - Weyerhaeuser (paper manufacturing)

    - Coca-Cola

    Lecturer YIN SOKHENG, Master in Finance 3

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    A job order costing system Many different products are produced each period.

    The products are usually manufactured to customers'order

    The unique nature of each order requires tracing orallocating costs to each job, and maintaining costrecords for each job.

    Example companies:

    - Boeing (aircraft manufacturing)

    - Bechtel International (large scale construction)

    - Walt Disney Studios (movies production)

    Also used in the service industry- Hospitals- Law firms.

    Lecturer YIN SOKHENG, Master in Finance 4

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    ComparingProcess and Job-Order Costing System

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    Job-Order ProcessNumber of jobs worked Many Single product

    Cost accumulated by Job Department

    Average cost computed by Job Department

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    II. Measuring the Job-Order costing

    system

    Lecturer YIN SOKHENG, Master in Finance 6

    Direct Manufacturing Costs

    Direct Materials

    Direct Labour

    ManufacturingOverhead

    Charge directmaterials anddirect labour

    costs to eachjob as work is

    performed

    Job NO. 1

    Job NO. 2

    Job NO. 3

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    Lecturer YIN SOKHENG, Master in Finance 7

    Indirect Manufacturing Costs

    Direct Materials

    Direct Labour

    Manufacturing

    Overhead

    Manufacturingoverhead,includingindirect

    materials andindirect labour,

    are allocated to

    jobs ratherthan directlytraced to each

    job.

    Job NO. 1

    Job NO. 2

    Job NO. 3

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    Materials Requisition Form

    The materials requisition form is a detailed sourcedocument that (1) specifies the type and quantity ofmaterials to be drawn from the storeroom, and (2)identifies the job to which the costs of the materials

    are to be charged. The form is used to control the flow of materials

    into production and also for making entries in theaccounting records.

    Production managers use materials requisitionforms to request materials for manufacturing.

    Lecturer YIN SOKHENG, Master in Finance 8

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    Materials Requisition Form

    Materials Requisition Number 0017 Job Number to Be charge d 2B77Department Milling

    Date March 2, 20x2

    Description Quantity Unit Cost Total Cost

    M46 Housing 150 $ 1.64 $ 246G7 Connector 300 1.38 414

    $ 660

    Authorized

    Signature Bill White

    Lecturer YIN SOKHENG, Master in Finance 9

    Total cost is transferred to job cost sheet for job 2B77

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    Employee Time Ticket

    A worker uses a time ticket to record the time

    spent on each job (or overhead activity).

    A completed time ticket is an hour-by-hour

    summary of the employees activities throughoutthe day.

    This source document determines the amount of

    direct labour that is charged to a job (or the amount

    of indirect labour that is charged to overhead).

    Lecturer YIN SOKHENG, Master in Finance 10

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    Employee Time Ticket

    Time Ticket No 016 Date March 3, 20x2Employee Marry Holden Station 2

    Started EndedTime

    Completed Rate Amount Job Number

    7:00 12:00 5.0 $9 $ 45 2B77

    12:00 2:30 2.0 9 18 2B88

    2:30 3:30 1.0 9 9 Maintenance

    Total 8.0 $ 72

    Supervisor McMalen

    Lecturer YIN SOKHENG, Master in Finance 11

    Information is transferred to job cost sheet for job 2B77

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    Application of Manufacturing Overhead

    It is usually easy to assign materials and labourcosts to products and services. Why?

    It is difficult, however, to assign overhead costs to

    products and services. Why? There are threereasons for this:

    1. Manufacturing overhead is an indirect cost.

    2. Manufacturing overhead consists of many

    different items.3. Output may fluctuate due to seasonal or

    other factors.

    Lecturer YIN SOKHENG, Master in Finance 12

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    Application of Manufacturing Overhead

    The only way to assign overhead costs to productsis use an allocation (allocation base) process.

    An allocation base is a measure such as direct

    labour-hours (DLH) or machine-hours (MH) that isused to assign overhead costs to products andservices.

    The allocation base is used to compute the

    predetermined overhead rate. So, a predeterminedoverhead rate is used to assign overhead costs toproducts and services.

    Lecturer YIN SOKHENG, Master in Finance 13

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    Application of Manufacturing Overhead Apredetermined overhead rateis used to assign overhead

    costs to products and services. It is:

    Based on estimated data.

    Established before the period begins.

    Why Use Estimated Data?

    1. Waiting until the year is over to determineactual overhead costs would be too late.Managers need to cost jobs immediately.

    2. Overhead rates, if based on actual costs andactivity, would vary substantially from month tomonth. Much of this variation would be due torandom changes in activity.

    Lecturer YIN SOKHENG, Master in Finance 14

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    Application of Manufacturing Overhead

    Predetermined overhead rate =

    The process of assigning overhead cost to job ( job cost sheet) is calledoverhead application (overhead applied).

    Lecturer YIN SOKHENG, Master in Finance 15

    Estimated total manufacturing overhead cost

    Estimated total units in the allocation base(DLH, MH, etc.)

    Overhead applied

    to a particular job

    Predetermined

    overhead rate

    Amount of allocation

    base incurred by the job(actual DLH, MH, etc.)X=

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    Application of Manufacturing OverheadExample: Assume that company allocates overhead costs to

    job (and therefore to products) on the basis of direct labour

    hours. For the coming year the company estimates that it

    will incur $600,000 in manufacturing overhead costs and

    work 75,000 direct labour hours. The companys predeter-

    mined overhead rate would be:

    Predetermined overhead rate =

    Lecturer YIN SOKHENG, Master in Finance 16

    $ 600,00075,000 DLH

    = $ 8/ DHL

    Overhead applied $ 8 per DLH 27 DLHsX=

    = $216 0f overhead applied to job (job cost sheet) 2B77

    Ticket NO 016 = 5 DLHsTicket NO 072 = 8 DLHsTicket NO 088 = 4 DLH sTicket NO 099 = 10 DLHsTotal = 27 DLHs

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    Job Cost Sheet

    After being notified that the production order has

    been issued, the Accounting Department prepares

    ajob cost sheet. A job cost sheet is a form prepared for each

    separate job that records the direct materials, direct

    labour, and overhead (overhead applied) costs

    charged to the job.

    Lecturer YIN SOKHENG, Master in Finance 17

    JOB COST SHEET

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    Job Number 2B77 Date Initiated March 2

    Date Completed March 8

    Department Milling

    Item Special order coupling Units Completed 2For Stock

    Direct Materials Direct Labor Manufacturing Overhead

    Req. NO. Amount Ticket Hours Amount Hours Rate Amount

    0017 $ 660 016 5 $ 45 27 $8/DLH $ 216

    0025 506 072 8 60

    0036 238 088 4 21

    099 10 54

    27 $ 180

    Cost Summary Units ShippedDirect Materials $ 1,404 Date Number Balance

    Direct Labor $ 180 March 8 - 2

    Manufacturing Overhead $ 216

    Total Cost $ 1,800

    Unit Product Cost $ 900 18

    LecturerYINSOK

    HENG,MasterinFinance

    THE FLOW OF DOCUMENTS IN A JOB ORDER

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    THE FLOW OF DOCUMENTS IN A JOB-ORDER

    COSTING SYSTEM

    Lecturer YIN SOKHENG, Master in Finance 19

    Sales Order

    Product Order

    Direct Labor Time TicketMaterials Requisition

    Job Cost Sheet

    Predetermined OH Rates

    The various costs of production are accumulated on a form,prepared by the accounting department, known as a

    The job costs sheet forms the basis for computing unit coststhat are used to cost ending inventories and cost of goods sold.

    A sales order is prepared as basis for issuing a

    A product order initiates work on a job,whereby costs are charged through

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    III. Entry to record the Cost Flows in a Job-OrderCosting System

    Under perpetual system.

    The Steps of Accounting Processing Cycle.

    Entry to record cost flows of : materials

    labour

    application of overhead

    transfer to finished goods

    sales of goods to customer

    operating

    Lecturer YIN SOKHENG, Master in Finance 20

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    Job-Order Costing Flow of Materials Costs

    Lecturer YIN SOKHENG, Master in Finance 21

    Indirect

    Materials

    MaterialsRequisition

    Record on each JobOrder Cost Sheetand add to Work

    in Process Account

    DirectMaterials

    Record inManufacturing

    Overhead Account

    Materials usedmay be either

    direct orindirect.

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    Job-Order Costing Flow of Labour Costs

    Lecturer YIN SOKHENG, Master in Finance 22

    Indirect

    Labour

    EmployeeTime Ticket

    Record on each JobOrder Cost Sheetand add to Work

    in Process Account

    DirectLabour

    Record inManufacturing

    Overhead Account

    An employeestime may be eitherdirect or indirect.

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    Entry to record the Cost Flows Materials Purchases

    Raw materials purchased are recorded in aninventory account.

    Lecturer YIN SOKHENG, Master in Finance 24

    General Journal Page 3

    Date Account Titles P.R Debit Credit

    Raw Materials XX,XXX

    Account Payable XX,XXX

    Raw Materials Account Payable

    XX,XXX XX,XXX

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    Entry to record the Cost Flows Use of Materials Direct materials issued to a job increase the work in process

    account and decrease raw materials account. Indirect materials that are used in the factory increase the

    manufacturing overhead account and decrease raw

    materials account.

    Lecturer YIN SOKHENG, Master in Finance 25

    General Journal Page 3

    Date Account Titles P.R Debit Credit

    Work in Process XX,XXX

    Manufacturing Overhead XX,XXX

    Raw Materials XX,XXX

    Raw Materials Work in Process Manuf. OH

    XX,XXX XX,XXX XX,XXX

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    Entry to record the Cost Flows Labour The cost of direct labour incurred increases the work in process

    account and increases the salaries and wage payable account.

    The cost of indirect labour incurred increases the manufacturing

    overhead account and increses the salaries and wage payable

    account.

    Lecturer YIN SOKHENG, Master in Finance 26

    General Journal Page 3

    Date Account Titles P.R Debit CreditWork in Process XX,XXX

    Manufacturing Overhead XX,XXX

    Salaries and Wage Payable XX,XXX

    Salariesand Wage Payable Work in Process Manuf. OH

    XX,XXX XX,XXX XX,XXX

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    Entry to record the Cost Flows Actual Overhead In addition to indirect materials and indirect labour, other

    manufacturing overhead costs are charged (or added) to the

    manufacturing overhead account as they are incurred.

    Lecturer YIN SOKHENG, Master in Finance 27

    General Journal Page 3

    Date Account Titles P.R Debit Credit

    Manufacturing Overhead XX,XXX

    Account Payable XX,XXX

    Property Taxes Payable XX,XXX

    Prepaid Insurance XX,XXX

    Accumulated Dep., factory XX,XXX

    AccountPayable

    Property TaxesPayable

    PrepaidInsurance

    AccumulatedDep., factory Manuf. OH

    XX,XXX XX,XXX XX,XXX XX,XXX XX,XXX

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    Entry to record the Cost Flows Application of Overhead The work in process account is increased the and the

    manufacturing overhead account is decreased when overhead is

    applied (or allocated) to jobs.

    Lecturer YIN SOKHENG, Master in Finance 28

    General Journal Page 3

    Date Account Titles P.R Debit Credit

    Work in Process XX,XXX Manufacturing Overhead XX,XXX

    Manuf. OH Work in Process

    XX,XXX XX,XXX

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    Entry to record the Cost Flows Transfer to Finished Goods

    As a job is completed, the cost of goods that were

    completed for that job is transferred from the work inprocess account to finished goods account.

    Lecturer YIN SOKHENG, Master in Finance 29

    General Journal Page 3

    Date Account Titles P.R Debit Credit

    Finished Goods XX,XXX

    Work in Process XX,XXX

    Work in Process Finished Goods

    XX,XXX XX,XXX

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    Entry to record the Cost Flows Sales of Job to Customer

    When a job is sold to a customer on account:

    1. The sale is recorded; and2. The cost of the job is transferred from the finished goods account

    to the cost of goods sold account.

    Lecturer YIN SOKHENG, Master in Finance 30

    General Journal Page 3

    Date Account Titles P.R Debit CreditAccount Receivable XX,XXX

    Sales XX,XXX

    Cost of Goods Sold XX,XXX

    Finished Goods XX,XXX

    Finished GoodsCost of

    Goods SoldAccount

    Receivable Sales

    XX,XXX XX,XXX XX,XXX XX,XXX

    Summary of Cost Flows in a Job-Order Costing System

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    Raw Materials

    Debit for thecost ofmaterials

    purchased

    Credit for directmaterials added towork in process

    Work in ProcessCredit for indirectmaterials addedto MOH

    Debit for directmaterials, directlabor, and MOHapplied

    Credit for thecost of goodsmanufactured

    Salaries and Wages Payable

    Credit for directlabor added to WIP

    Credit for indirectlabor added toMOH

    MOH/ FOH Finished Goods

    Debit for actualOH costsincurred

    Credit for OH costapplied to WIP Debit for thecost of goodsmanufactured

    Credit for thecost of goods sold

    UnderappliedOH cost

    Overapplied OHcost

    Cost of Goods SoldDebit for the costof goods sold

    LecturerYINSOK

    HENG,MasterinFinanc

    e

    31

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    Disposition of the Amount ofOverapplied and Underapplied OH

    Lecturer YIN SOKHENG, Master in Finance 32

    If balance is materials

    The amount isallocated to these

    accounts:

    Work inProcess

    FinishedGoods

    Cost ofGoods Sold

    If balance is not materials

    The amount maybe closed directlyto cost of goods

    sold.

    Cost ofGoods Sold

    OR

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    Closed Out to Cost of Goods Sold

    Lecturer YIN SOKHENG, Master in Finance 33

    Assuming balance is not material

    General Journal Page 4

    Date Account Titles P.R Debit Credit

    Manufacturing Overhead 3,000

    Cost of Goods Sold 3,000

    MOH/ FOH Cost of Goods SoldActual OH costs

    $ 497,000OH applied to job

    $ 500,000Unadjusted balance $ 3,000

    $ 3,000 $ 3,000Overapplied

    Adjustedbalance

    $ 0 Income Statement

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    Allocated between accounts

    Lecturer YIN SOKHENG, Master in Finance 34

    Allocation of under- or overapplied overhead betweenWork in Process, Finished Goods, and Cost of GoodsSold is more accurate than closing the entries balanceinto Cost of Goods Sold.

    Assume that:- Total overhead applied $ 90,000

    - MOH account has a debit balance $ 5,000

    - Overhead applied in WIP inventory, ending $ 30,000- Overhead applied in FG inventory, ending 15,000

    - Overhead applied in COGS inventory, ending 45,000

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    Allocated between accounts

    Lecturer YIN SOKHENG, Master in Finance 35

    Overhead applied in WIP inventory, ending $ 30,000 33.33%

    Overhead applied in FG inventory, ending 15,000 16.67%

    Overhead applied in COGS inventory, ending 45,000 50.00%

    Total overhead applied $ 90,000 100.00%

    Based on the above percentages, the underappliedoverhead would be allocated as shown in the following

    journal entry:

    WIP (33.33% X $ 5,000) 1,666.50

    FG (16.67% X $5,000) 833.50COGS (50.00% X $ 5,000) 2,500.00

    Manufacturing Overhead 5,000.00

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    Summary Overapplied and Underapplied OH

    Lecturer YIN SOKHENG, Master in Finance 36

    If overhead is: Assuming not material:

    UNDERAPPLIED(Applied OH is less than

    actual OH)

    INCREASECost of Goods Sold

    OVERAPPLIED(Applied OH is greater than

    actual OH)

    DECREASECost of Goods Sold

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    Summary of Overhead Concepts

    Lecturer YIN SOKHENG, Master in Finance 37

    At the beginning of the period:Estimated total

    manufacturing overheadcost

    Estimatedtotal units in theallocation base

    =Predeterminedoverhead rate

    During the period:

    Predeterminedoverhead rate X

    Actual total units of theallocation base incurred

    during the year=

    Totalmanufacturing

    overhead applied

    At the of the period:

    Actual totalmanufacturingoverhead cost

    Total manufacturing

    overhead applied =Underapplied(oveerapplied)

    overhead

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    Lecturer YIN SOKHENG, Master in Finance 38

    GeneralJournal

    GeneralLedger

    After-closingtrial balance

    UnadjustedTrial balance

    Adjusted trialbalance

    Financial

    statementanddisclosure

    1. Record businesstransactions

    4. Make end of periodadjustments

    7. Make closingentries

    2. Post(alltypesof

    entries)

    8. Prepare

    5. Prepare3. Prepare

    6. Prepare

    The Steps of Accounting Processing Cycle

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    The Steps of Accounting Processing Cycle

    Lecturer YIN SOKHENG, Master in Finance 39

    1. Joumnalize (record) transactions

    2. Post to ledger accounts

    3. Prepare a trial balance ( unadjusted trial balance)

    4. Make end of period adjustments in the general journaland post to ledger accounts

    5. Prepare an adjusted trial balance

    6. Prepare financial statement and and appropriate disclosures

    7. Journalize and post the closing entries to ledger accounts

    8. Prepare an after-closing trial balance

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    Process Costing System

    Chapter Four

    E-mail: [email protected]

    Prepared and Taught by Lecturer: YIN SOKHENG,

    Master in Finance

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    Product Costing System

    Lecturer YIN SOKHENG, Master in Finance 2

    In this chapter we look at an alternative known asprocess costing .

    A process costing is most commonly used in

    industries that produce essentially homogenous(uniform) products on a continuous basis, such as

    bricks, cornflakes, or paper.

    A form of process costing may also be used in

    utilities that produce gas, water, and electricity.

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    I. Comparison of Job-Order and Process Costing

    1. Similarities Between Job-Order and Process

    Costing

    Both system assign material, labor, and overhead

    costs to products and they provide a mechanism forcomputing unit product cost.

    Both system 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 system.

    Lecturer YIN SOKHENG, Master in Finance 3

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    2. Difference Between Job-Order and Process

    Costing Process costing is used when a single product is

    produced on the continuing basis or for a longperiod of time. Job-order costing is used when many

    different jobs are worked on each period. Process costing systems accumulate costs by

    department. Job-order costing systems accumulatedcosts by individual jobs.

    Process costing systems use department productionreports to accumulate costs. Job-order costingsystems use job cost sheets to accumulate costs.

    Lecturer YIN SOKHENG, Master in Finance 4

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    II. Perspective of Process Cost Flows

    1. Processing Department

    What is a processing department?

    Any location in an organization where materials,

    labour or overhead are added to product.

    The activities performed in a processing

    department are performed uniformly on all units or

    production. Furthermore, the output of a processingdepartment must be homogeneous.

    Lecturer YIN SOKHENG, Master in Finance 5

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    2. Comparing Job-Order and Process Costing

    Lecturer YIN SOKHENG, Master in Finance 6

    DirectMaterials

    Direct Labour

    Manufacturing

    Overhead

    Work inProcess

    FinishedGoods

    Cost ofGoods Sold

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    Job-Order Costing System

    Lecturer YIN SOKHENG, Master in Finance 7

    DirectMaterials

    Direct Labour

    ManufacturingOverhead

    JobsFinishedGoods

    Cost ofGoods Sold

    Costs are traced andapplied to individualjobs in a job-order

    costing system.

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    Proces Costing System

    Lecturer YIN SOKHENG, Master in Finance 8

    DirectMaterials

    Direct Labour

    ManufacturingOverhead

    ProcessingDepartment

    FinishedGoods

    Cost ofGoods Sold

    Costs are traced andapplied to departments

    in a process costingsystem.

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    III. Entry to Record Cost Flows in a Process Costing

    System

    Lecturer YIN SOKHENG, Master in Finance 9

    For purposes of this example,

    assume there are two processing

    department Department A and B.

    We will use journal entries andT.accounts.

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    Process Cost Flows (in journal entry form)

    The requisition of direct materials for use in processdepartment.

    Lecturer YIN SOKHENG, Master in Finance 10

    General Journal Page 4

    Date Account Titles P.R Debit Credit

    Work in Process A XX,XXX

    Work in Process B XX,XXX

    Raw Materials XX,XXX

    To record the use of direct materials

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    Process Cost Flows (in journal entry form)

    Direct Labour Cost

    Lecturer YIN SOKHENG, Master in Finance 12

    General Journal Page 4

    Date Account Titles P.R Debit Credit

    Work in Process A XX,XXX

    Work in Process B XX,XXX

    Salaries and Wages Payable XX,XXX

    To record direct labour cost

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    Process Cost Flows (in journal entry form)

    Applied Overhead to Work in Process

    Lecturer YIN SOKHENG, Master in Finance 14

    General Journal Page 4

    Date Account Titles P.R Debit Credit

    Work in Process A XX,XXX

    Work in Process B XX,XXX

    Manufacturing Overhead XX,XXX

    To apply overhead to department.

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    Work in ProcessDepartment A

    . Directmaterials

    ManufacturingOverhead

    . DirectLabour

    . ActualOverhead

    . OverheadApplied to

    Work inProcess

    . AppliedOverhead

    Work in ProcessDepartment B

    . Directmaterials

    . DirectLabour

    . AppliedOverhead

    Lecturer YIN SOKHENG, Master in Finance

    15

    Process Cost Flows

    (in T-account form)

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    Process Cost Flows (in journal entry form)

    Transfer the Cost ( Partially Completed)

    Lecturer YIN SOKHENG, Master in Finance 16

    General Journal Page 4

    Date Account Titles P.R Debit Credit

    Work in Process Department B XX,XXX

    Work in Process Department A XX,XXX

    To record the transfer of goods fromDepartment A to Department B.

    P C Fl

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    Work in ProcessDepartment A

    Work in ProcessDepartment B

    . Directmaterials

    . Transferredto Dept. B

    . Directmaterials

    . DirectLabour

    . DirectLabour

    . AppliedOverhead

    . AppliedOverhead

    . Transferredfrom Dept. A

    Lecturer YIN SOKHENG, Master in Finance

    17

    Process Cost Flows

    (in T-account form)

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    Process Cost Flows (in journal entry form)

    Finished Goods ( Fully Completed)

    Lecturer YIN SOKHENG, Master in Finance 18

    General Journal Page 4

    Date Account Titles P.R Debit Credit

    Finished Goods XX,XXX

    Work in Process Department B XX,XXX To record the completion of goods andtheir transfer from Department B to

    finished inventory.

    P C Fl

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    Work in ProcessDepartment B Finished Goods

    . Directmaterials

    . Cost ofGoods

    Manufactured

    . Cost ofGoods

    Manufactured

    . DirectLabour

    . AppliedOverhead

    . Transferred

    from Dept. A

    Lecturer YIN SOKHENG, Master in Finance

    19

    Process Cost Flows

    (in T-account form)

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    P C Fl

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    Work in ProcessDepartment B Finished Goods

    . Directmaterials

    . Cost ofGoods

    Manufactured

    . Cost ofGoods

    Manufactured

    . Cost ofGoodsSold

    . DirectLabour

    . AppliedOverhead

    . Transferredfrom Dept. A

    Cost of Goods Sold. Cost of Goods

    Sold

    Lecturer YIN SOKHENG, Master in Finance

    21

    Process Cost Flows

    (in T-account form)

    III Computing Cost / Accumulation of Cost

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    III. Computing Cost / Accumulation of Cost

    Equivalent Units of Production Equivalent units are the product of the number of

    partially completed units and percentage

    completion of those units.

    Two half completed product are equivalent to one

    completed product. So, 10,000 units 70% complete

    are equivalent to 7,000 complete units.

    We need to calculate equivalent units because adepartment usually has some partially completed

    units in its beginning and ending inventory.

    Lecturer YIN SOKHENG, Master in Finance 22

    Calculating Equivalent Units

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    g q Equivalent units can be calculated two ways:

    1. The Weighted Average Method2. The First-In, First-Out (FIFO) Method

    The production report is divided into three parts:

    Lecturer YIN SOKHENG, Master in Finance 23

    1: A quantity schedule showing

    the flow of units and the

    computation of equivalent units.

    2: A computation of cost per

    equivalent unit.3: Cost Reconciliation section

    show the reconciliation of all cost

    flow into and out of the department

    during the period.

    Production Report

    Section

    Section

    Section

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    Process Costing and Direct Labour

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    Process Costing and Direct Labour

    Lecturer YIN SOKHENG, Master in Finance 25

    Direct labour costsmay be small incomparison to other

    product costs in

    process costsystems.

    DirectMaterials

    DirectLabour

    MOH

    DollarAm

    ount

    Type of Product Cost

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    The Weighted Average Example

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    The Weighted Average Example

    Smith Company reported the following activity inDepartment A for the month of June:

    Lecturer YIN SOKHENG, Master in Finance 27

    Percent Completed

    Units Materials Conversion

    Work in process, June 1 300 40% 20%

    Units started into production in June 6,000

    Units completed and transferred out of

    Department A during June

    5,400

    Work in process, June 30 900 60% 30%

    E i l t it f d ti l l

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    Equivalent units of production always equal=

    Units completed and transferred

    + Equivalent units remaining in work in process

    Lecturer YIN SOKHENG, Master in Finance 28

    Materials Conversion

    Units completed and transferred out ofDepartment A during June

    5,400 5,400

    Work in process, June 30:

    900 units x 60% 540

    900 units x 30% 270

    Equivalent units of production inDepartment A during June 5,940 5,670

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    Materials

    Lecturer YIN SOKHENG, Master in Finance 29

    Beginning work inprocess 300 units

    40% complete

    5,100 units started andcompleted

    Ending work inprocess 900 units

    60% complete

    5,400 Units Completed540 Equivalent Units

    5,940 Equivalent UnitsOf Production

    6,000 Units Started

    900 x 60%

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    Conversion

    Lecturer YIN SOKHENG, Master in Finance 30

    Beginning work inprocess 300 units

    20% complete

    5,100 units started andcompleted

    Ending work inprocess 900 units

    30% complete

    5,400 Units Completed270 Equivalent Units

    5,670 Equivalent UnitsOf Production

    6,000 Units Started

    900 x 30%

    Example: Assume that Double Diamond Skis use theProduction Report Example

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    Example: Assume that Double Diamond Skis use the

    weighted-average method of process costing to determine

    unit costs in it Shaping and Milling Department.

    Lecturer YIN SOKHENG, Master in Finance 31

    Work in process, May 1 200 units

    Materials: 55% complete $ 9,600

    Conversion: 30% complete $ 5,575

    Production started during May 5,000 units

    Production completed during May 4,800 units

    Costs added to production in May:

    Materials cost $ 368,600

    Conversion cost $ 350,900Work in process, 31 400 units

    Materials: 40% complete

    Conversion: 25% complete

    Production ReportStep 1: Prepare Quantity Schedule with Equivalent Units

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    Lecturer YIN SOKHENG, Master in Finance 32

    QUANTITY

    Units to be accounted for:

    Work in process, May 1 200

    Started into production 5,000

    Total units 5,200

    Equivalent units

    Materials Conversion

    Units accounted for as follows:

    Completed and transferred 4,800 4,800 4,800

    Work in process, May 31 400

    Materials 40% complete 160Conversion 25% compl. 100

    Total units 5,200 4,960 4,900

    Step 1: Prepare Quantity Schedule with Equivalent Units

    Step 2: Cost per Equivalent Unit

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    To calculate the cost per equivalent unit forthe period:

    Cost per equivalent

    unit

    Lecturer YIN SOKHENG, Master in Finance 33

    Step 2: Cost per Equivalent Unit

    =Cost for the period

    Equivalent unit of production

    of the period

    Step 2: Cost per Equivalent Unit

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    Lecturer YIN SOKHENG, Master in Finance 34

    COT TO BE ACCOUNTED FOR

    Total cost Materials Conversion

    Units to be accounted for:

    Work in process, May 1 $ 15,175 $ 9,600 $ 5,575

    Costs added in the Shippingand Milling Department 719,500 368,600 350,900

    Total cost $ 734,675 $ 368,600 $ 350,900

    Equivalent units 4,960 4,900

    Cost per equivalent unit $ 76.25 $ 72.75Total cost per equivalent unit($ 76.25 + 72.75) $ 149

    Step 2: Cost per Equivalent Unit

    S 3 C R ili i

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    Lecturer YIN SOKHENG, Master in Finance 35

    COT ACCOUNTED FOR

    Total cost Equivalent Units

    Materials Conversion

    Cost accounted for as follows:

    Transferred during the period $ 715, 200 4,800 4,800Work in process, May 31:

    Materials (160 x $76.25) 12,200 160

    Conversion (100 x $ 72.75) 7,275 100

    Total work in process, May 31 $ 19,475Total cost accounted for $ 734,675 4,960 4,900

    Step 3: Cost Reconciliation

    2. The First-In, First-Out Method

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    2. The First In, First Out Method

    The FIFO method (generally considered moreaccurate that the weighted-average method) differs

    from the weighted average method in two ways:

    1. The computation of equivalent units.

    2.The way in which the costs of beginning

    inventory are treated in the cost reconciliation

    report.

    Lecturer YIN SOKHENG, Master in Finance 36

    Equivalent units FIFO Method

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    Equivalent units FIFO Method

    Smith Company reported the following activity inDepartment A for the month of June:

    Lecturer YIN SOKHENG, Master in Finance 37

    Percent Completed

    Units Materials Conversion

    Work in process, June 1 300 40% 20%

    Units started into production in June 6,000

    Units completed and transferred out of

    Department A during June

    5,400

    Work in process, June 30 900 60% 30%

    M i l C i

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    Lecturer YIN SOKHENG, Master in Finance 38

    Materials Conversion

    Units completed and transferred out of

    Department A during June

    5,400 5,400

    Work in process, June 30:

    900 units x 60% 540

    900 units x 30% 270

    Equivalent units in Department A duringJune 5,940 5,670

    Equivalent units in beginning inventory

    300 units x 40% 120

    300 units x 20% 60Units completed and transferred out ofDepartment A during June 5,820 5,610

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    Materials

    Lecturer YIN SOKHENG, Master in Finance 39

    Beginning work inprocess 300 units

    40% complete

    5,100 units started andcompleted

    Ending work inprocess 900 units

    60% complete

    Units completed & transferred out 5,400Equivalent units in ending WIP invent. 540Equivalent units in beg. WIP invent. (120)

    Equivalent Units of Production 5,820

    6,000 Units Started

    900x60%

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    Example: Assume that Double Diamond Skis use the

    i h d h d f i d i

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    weighted-average method of process costing to determine

    unit costs in it Shaping and Milling Department.

    Lecturer YIN SOKHENG, Master in Finance 41

    Work in process, May 1 200 units

    Materials: 55% complete $ 9,600

    Conversion: 30% complete $ 5,575

    $ 15,175

    Production started during May 5,000 units

    Production completed during May 4,800 units

    Costs added to production in May:

    Materials cost $ 368,600

    Conversion cost $ 350,900Work in process, 31 400 units

    Materials: 40% complete

    Conversion: 25% complete

    Production ReportStep 1: Prepare Quantity Schedule with Equivalent Units

    QUANTITY

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    LecturerYINSOKHENG,MasterinFinance

    42

    Units to be accounted for:

    Work in process, May 1 200

    Started into production 5,000

    Total units 5,200

    Equivalent units

    Materials Conversion

    Units accounted for as follows:

    Beginning inventory 200

    Materials 200 units x 45% 90

    Conversion 200 units x 70% 140

    Units started & completed 4,600 4,600 4,600

    Work in process, May 31 400

    Materials 40% complete 160

    Conversion 25% compl. 100

    Total units 5,200 4,960 4,900

    Step 2: Cost per Equivalent Unit

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    Lecturer YIN SOKHENG, Master in Finance 43

    COT TO BE ACCOUNTED FOR

    Total cost Materials Conversion

    Units to be accounted for:

    Work in process, May 1 $ 15,175

    Costs added in the Shipping

    and Milling Department 719,500 368,600 350,900

    Total cost $ 734,675 $ 368,600 $ 350,900

    Equivalent units 4,850 4,840

    Cost per equivalent unit $ 76.00 $ 72.50

    Total cost per equivalent unit($ 76.00 + 72.50) $ 148.50

    p p q

    COT ACCOUNTED FOR

    Step 3: Cost Reconciliation

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    Lecturer YIN SOKHENG, Master in Finance 44

    Total cost Equivalent Units

    Materials Conversion

    Work in process, May 1 $ 15,175

    Materials (90 x $76.00) 6,840 90

    Conversion (140 x $ 72.50) 10,150 140

    Total $ 32,165

    Started and completed in May 683,100 4,600 4,600

    Total transferred during the period $ 715, 265

    Work in process, May 31:

    Materials (160 x $76.00) 12,160 160

    Conversion (100 x $ 72.50) 7,250 100Total $ 19,410

    Total cost accounted for $ 734,675 4,850 4,840

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    Cost Behavior Analysis

    Chapter Five

    E-mail: [email protected]

    Prepared and Taught by Lecturer: YIN SOKHENG,

    Master in Finance

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    Types of Cost Behavior PatternsVariable Cost

    Fixed Cost

    Mixed Cost

    Lecturer YIN SOKHENG, Master in Finance 2

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    The Variable Cost Total variable cost is proportional to the activity level

    within the relevant range.

    As activity increases total variable cost increases, and

    as activity decreases total variable cost decreases.

    Lecturer YIN SOKHENG, Master in Finance 3

    The Activity Base

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    Unitsproduced

    A measure of what

    causes theincurrence of avariable cost

    Labour

    hours

    Miles

    driven

    Machinehours

    The Activity Base

    Lecturer YIN SOKHENG, Master in Finance 4

    Total Variable Cost

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    Your telephone bill is based on how many minutesyou talk.

    Lecturer YIN SOKHENG, Master in Finance 5

    A variable cost is one that change in total in

    proportion to change in the volume of activity

    TotalTe

    lephoneBill

    Minutes Talked

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    Extent of Variable Costs The proportion of variable costs differs across

    organizations.

    1. Merchandising companies cost of goods sold.

    2. Manufacturing companies direct materials, directlabour, and variable overhead.

    3. Merchandising companies and Manufacturingcompanies commission, shipping costs, and clerical

    costs such as invoicing.

    4. Service companies supplies, travel, and clerical.

    Lecturer YIN SOKHENG, Master in Finance 7

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    True Variable Cost The variable costs vary in direct proportion to the level

    of production activity during a period.

    Example: direct material

    Lecturer YIN SOKHENG, Master in Finance 8

    Cost

    Volume

    Step Variable Cost

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    Step-Variable Cost

    Lecturer YIN SOKHENG, Master in Finance 9

    C

    ost

    Activity

    Total cost increases to anew higher cost for thenext higher range of

    activity.

    Total cost remainsconstant within a arrow

    range of activity.

    Step-Variable Cost

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    Step Variable Cost

    Lecturer YIN SOKHENG, Master in Finance 10

    C

    ost

    Volume

    Small changes in the level of production are not likelyto have any effect on the number of maintenance

    workers employed.

    Only fairly wide changesin the activity level willcause a change in the

    number of maintenanceworkers employed.

    Fixed Cost

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    Fixed Cost

    - Total fixed costs remain unchanged when thelevel of activity changes.

    - The fixed cost per unit goes down as activity levelgoes up.

    Example: depreciation, supervisory salaries, andrent

    Lecturer YIN SOKHENG, Master in Finance 11

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    Fixed Cost Per Unit

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    Fixed Cost Per Unit

    The average cost per local call decreases as morelocal calls are made.

    Lecturer YIN SOKHENG, Master in Finance 13

    On a per unit basis, a fixed cost changesas the volume of activity changes

    Mon

    thlybasic

    Teleph

    oneCharge

    perLocalCall

    Number of Local Calls

    Types of Fixed Costs

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    Lecturer YIN SOKHENG, Master in Finance 14

    CommittedLong term cannot be

    significantly reduced inthe short term.

    DiscretionaryMay be altered in the short-term by current managerial

    decisions.

    ExamplesAdvertising and

    research and

    development

    ExamplesDepreciation on

    equipment and real

    estate taxes

    Fixed Cost and Relevant Range

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    Lecturer YIN SOKHENG, Master in Finance 15

    Relevant

    Range

    Cost

    Rented Area (Square Feet)

    0

    30

    60

    90

    1,000 2,000 3,000

    Total cost doesnt

    change for a widerange of activity,

    and then jumps to anew higher cost for

    the next higherrange of activity.

    The companysnormal operating range

    Example: Office space is available at rental rate of

    $30,000 per year in increments of 1,000 square feet.

    Variable and Fixed Cost Behavior

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    Avariable costchanges in direct

    proportion to changes

    in the cost-driver level.

    Afixed costisnot immediately

    affected by changes

    in the cost-driver.

    Think of variable

    costs on a per-unit basis.

    The per-unit variable

    cost remains unchanged

    regardless of changes in

    the cost-driver.

    Think of fixed costs

    on a total-cost basis.

    Total fixed costs remainunchanged regardless of

    changes in the cost-driver.

    16Lecturer YIN SOKHENG, Master in Finance

    Mixed CostsA mixed cost has both fixed and variable components

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    The total mixed cost line can expressed as anequation: Y = a + bx

    Where: Y = the total mixed costa = the total fixed cost

    b = the variable cost per unitX = the level of activity

    Lecturer YIN SOKHENG, Master in Finance 17

    A mixed cost has both fixed and variable components.Consider the example of utility cost.

    TotalU

    tilityCost

    Activity (Kilowatt Hours)

    Fixed MonthlyUtility Charge

    Variable Costper KW

    Y

    X

    Analysis of Mixed Costs

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    Analysis of Mixed Costs

    Each account and classifying the cost as variable, fixedor mixed based on the cost behavior over time.

    Cost estimates are based on an evaluation of

    production method, and material, labour, andoverhead requirements.

    Lecturer YIN SOKHENG, Master in Finance 18

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    Lecturer YIN SOKHENG, Master in Finance 19

    Understanding relationships between costsand their cost drivers allows managers to...

    evaluate strategic plans andoperational improvement programs.

    make short- and long-run decisions.

    plan or budget the effects of future activities.

    Cost Drivers and Cost Behavior

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    Traditional View of Cost Behavior Activity-Based View of Cost Behavior

    Resource ACost Driver =Units ofResourceOutput

    Resource BCost Driver =Units ofResourceOutput

    Activity ACost Driver =Units ofActivity Output

    Activity BCost Driver =Units ofActivity Output

    Resource BCost Driver =Units ofResourceOutput

    Resource ACost Driver =Units ofResourceOutput

    Product or Service

    Cost Driver = Units of Final

    Product or Service

    Product or Service

    Cost Driver = Output of Final

    Product or Service

    20Lecturer YIN SOKHENG, Master in Finance

    Cost Drivers and Cost Behavior

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    Cost behavior is how the activities

    of an organization affect its costs.

    Any output measure that causes

    the use of costly resources

    is a cost driver.

    21Lecturer YIN SOKHENG, Master in Finance

    Value Chain Functions, Costs, and Cost Drivers

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    Value Chain Function and Example Costs Example Cost DriversResearch and developmentSalaries marketing research personnel Number of new product proposals

    costs of market surveysSalaries of product and process engineers Complexity of proposed productsDesign of products, services, and processesSalaries of product and process engineers Number of engineering hoursCost of computer-aided design equipment Number of parts per productCost to develop prototype of product

    for testing

    22Lecturer YIN SOKHENG, Master in Finance

    Value Chain Functions, Costs, and Cost Drivers

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    Value Chain Function and Example Costs Example Cost DriversProductionLabor wages Labor hoursSupervisory salaries Number of people supervisedMaintenance wages Number of mechanic hoursDepreciation of plant and machinery Number of machine hourssuppliesEnergy cost Kilowatt hoursMarketingCost of advertisements Number of advertisementsSalaries of marketing personnel, Sales dollars

    travel costs, entertainment costs23Lecturer YIN SOKHENG, Master in Finance

    Value Chain Functions, Costs, and Cost Drivers

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    C , C , d C

    Value chain function and Example costs Example Cost Drivers

    DistributionWages of shipping personnel Labor hoursTransportation costs including Weight of items delivered

    depreciation of vehicles and fuelCustomer serviceSalaries of service personnel Hours spent servicingproductsCosts of supplies, travel Number of service calls

    24Lecturer YIN SOKHENG, Master in Finance

    Methods of Measuring

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    g

    Mixed Costs

    Lecturer YIN SOKHENG, Master in Finance 25

    1. The Scattergraph Method 2. The High-low Method

    3. Least-squares regression Method

    The Scattergraph Method

    Use one data point to estimate the total level of activity

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    Lecturer YIN SOKHENG, Master in Finance 26

    Use one data point to estimate the total level of activityand the total cost.

    M

    aintenancecos

    t

    1,000sofdollars

    Patient-days in 1,000s

    Total maintenance cost = $11,000Y

    X

    Intercept = Fixed cost = $10,000

    4321

    Patient-days = 800

    0

    10

    20

    The Scattergraph MethodM k i k ti t f i bl t it

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    Total maintenance at 800 patients $ 11,000

    Less: Fixed cost 10,000

    Estimated total variable cost for 800 patient $ 1,000

    Lecturer YIN SOKHENG, Master in Finance 27

    Make a quick estimate of variable cost per unit

    and determine the cost equation.

    Variable cost per unit =$ 1,000

    800= $ 1.25 /patient-day

    Y = $10,000 + $1.25X

    Total maintenance cost Number of patient days

    High Low Method

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    High-Low Method

    Lecturer YIN SOKHENG, Master in Finance 28

    The focus of this method is normally onthe highest- and lowest-activity points.

    The first step if to plot the historicaldata points on a graph.

    High-Low Method Example

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    Lecturer YIN SOKHENG, Master in Finance 29

    High month: AprilMaintenance cost: $47,000

    Number of patient-days: 4,900

    Low month: SeptemberMaintenance cost: $17,000

    Number of patient-days: 1,200

    What is the variable cost (per unit)?

    High-Low Method Example

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    Lecturer YIN SOKHENG, Master in Finance 30

    ($47,000 $17,000) (4,900 1,200)

    = $30,000 3,700 = $8.1081

    What is the fixed cost?

    Unit variable cost = Change in costChange in unit

    High Low Method Example

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    High-Low Method Example

    Lecturer YIN SOKHENG, Master in Finance 31

    $47,000 = Fixed cost + ($8.1081 4,900)$47,000 $39,730 = $7,270

    $17,000 = Fixed cost + ($8.1081 1,200)$17,000 $9,730 = $7,270

    Least-Squares Regression Method

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    Lecturer YIN SOKHENG, Master in Finance 32

    This method use all of the data pointsto estimate the fixed and variable costcomponents of a mixed cost.

    Regression analysis measurescost behavior more reliably than

    other cost measurement methods.

    The cost analysis objective is the same:Y = a + bX

    Coefficient of Determination

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    Coefficient of Determination

    Lecturer YIN SOKHENG, Master in Finance 33

    One measure of reliability,or goodness of fit, is the

    coefficient of determination,

    R (or R-squared).

    The coefficient of determination

    measures how much of thefluctuation of a cost is explainedby changes in the cost driver.

    Least-Squares Regression Method

    http://d/SOKHENG%20Personal/SOKHENG%20Lesson/Managerial%20Accounting%20I/Slides/Scattergraph.xlsxhttp://d/SOKHENG%20Personal/SOKHENG%20Lesson/Managerial%20Accounting%20I/Slides/Scattergraph.xlsx
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    Lecturer YIN SOKHENG, Master in Finance 34

    Totalcost

    Activity

    R2 is the percentage of the variation in totalcost explained by the activity.

    Y

    X

    R2varies from 0% to 100%, and thehigher the percentage the better.

    43210

    10

    20

    q g

    The Contribution Format

    http://d/SOKHENG%20Personal/SOKHENG%20Lesson/Managerial%20Accounting%20I/Slides/Scattergraph.xlsxhttp://d/SOKHENG%20Personal/SOKHENG%20Lesson/Managerial%20Accounting%20I/Slides/Scattergraph.xlsx
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    Lecturer YIN SOKHENG, Master in Finance 35

    Racing Bicycle Company

    Contribution Income StatementFor the month of June

    Sales (500 bicycles) $ 250,000

    Less: Variable expenses 150,000

    Contribution margin $ 100,000Less: Fixed expenses 80,000

    Net income $ 20,000

    The contribution Margin (CM) emphasizes cost behavior.Contribution margin covers fixed costs and provides for income.

    The Contribution Format

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    Comparison of the Contribution Income Statement

    With the Traditional Income Statement

    Traditional Approach(costs organized by function)

    Contribution Approach(costs organized by behavior)

    Sales (500 bicycles) $ 250,000 Sales (500 bicycles) $ 250,000

    Less: Cost of goods sold 150,000 Less: Variable expenses 150,000

    Gross margin $ 100,000 Contribution margin $ 100,000

    Less: Operating expenses 80,000 Less: Fixed expenses 80,000

    Net income $ 20,000 Net income $ 20,000

    Lecturer YIN SOKHENG, Master in Finance 36

    Used primarily bymanagement

    Used primarily forexternal reporting

    The End

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    End of Chapter 5

    The End

    37Lecturer YIN SOKHENG, Master in Finance

    Thank You

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    thank you all for yourattention.