Transcript Study Unit 2 - CMAPrepCourse

Part 1
Cram Session
Financial Planning, Performance,
and Control
Exam format
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3 hrs - 100 multiple choice questions = approx. 1.5 minutes per question (on
average).
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Find ways to “bank” time
Look for short-cuts
You will find that you most question do not seem “easy”, don’t get discouraged
You “earn” points for each question answered correctly
Some questions are “test” questions that carry no point value. You will not know which ones
they are
– Extra time can be carried forward to the Essay portion
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1 hr - 2 Essay questions with up to 8 sub-parts
– You can’t go back to multiple-choice part once you enter this portion of the exam
– Whatever you have typed on the screen will be saved as your answer, irrespective if the timer
runs out on you
Exam format
Part 1 – Financial Planning, Performance and Control
4 hours, 100 multiple-choice questions and two 30-minute essay scenarios
• Planning, budgeting, and forecasting (30%)
• Performance measurement (25%)
• Cost management (25%)
• Internal controls (15%)
• Professional ethics (5%)
If you find you have weaknesses in any topic ref. Appendix A for ref. the
appropriate sub –units
Exam Structure & Feedback
• Exam structure
– 3 hours of multiple choice questions ~ 75% of score
– 1 hour of essay questions ~ 25% of score
• Must earn at least 50% on multiple choice section in order
to advance to essay section
• Cannot return to the multiple choice section once you’ve
advanced to the essay section of the exam
Exam Strategy
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To pass the exam, you need:
Knowledge
Confidence
Effective Time Management
Commitment!
Last minute prep for the exam
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Focus on what you don’t know
Realize that you will be more proficient in some topics more than others
Practice the Essay questions – use the Gleim Essay Wizard
Create short mock multiple choice exams (say no more than 50 questions)
to condition for the longer 100 question exam, or take the Gleim online
CMA Practice Exam that came with your Gleim study material. It is a 4
hour exam.
• You can also read the question and only the correct answer of questions at
the end of each SU. It is a fast way of covering a lot of ground.
• Make sure your financial calculator has a fresh battery, and that it is not
the first time you used it.
Day of the Exam
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Do not study up to the exam day/time
Give yourself plenty of time to get to the testing center. Make sure you have
identified exact location prior
Make sure you are well rested (probably not a good idea to take exam after a long
day of work, for example
It is a four hour exam, make sure you are prepared for the duration (eat, etc.)
Dress in layers. You can always shed layers when you are there, they have lockers
Don’t wear a watch into the testing center
You can bring your own foam earplugs, so long that they are in a plastic bag
Day of the Exam
• Take a copy of the type of calculators that are permitted with you.
Ref. the ones listed on the IMA Website
• You realistically should not plan on any breaks outside of bathroom
breaks. Note the timer keeps running if you do take a break.
• Be optimistic. At this point there is nothing else you can do, and
being stressed or discouraged will not help your test results.
Relax - “NO ONE HAS DIED FROM FAILING THE CMA EXAM”, there is
life beyond and we will help you pass it!!!!
Exam
• Budget your time, know your “time hacks”
• See how many Essay sub-questions you will be given. There are
two parts with different amounts of sub-parts
• Answer the questions in consecutive order, and limit the number
you want to come back to no more than say 10, but make sure you
answer it before going on to the next.
• Never leave a question unanswered, score is based on number of
correct answers.
• Do not allow the answer choices to affect your reading of the
question
Most common reasons for missing
questions
1. Misreading the requirement (stem) – Read the question first
2. Not understanding what is required
3. Making a math error – Try to not do calculations of paper first,
with the idea of “transferring” to the exam later. If you know how
to use your memory button(s) well on your calculator, use it (i.e.
save sub-calculations in your calculator).
4. Applying the wrong rule or concept
5. Being distracted by one or more of the answers – the most
common wrong answers are the incorrect alternatives
Most common reasons for missing
questions
6. Incorrectly eliminating answers from considerations – read
all answers first, some are more correct or complete then
others
7. Not having any knowledge of the topic tested – don’t
agonize over it. If possible try to make an educated guess by
eliminating obvious wrong answers. If you guess, use the
same letter each time.
8. Employing bad intuition when guessing
The essays
• Remember, 2 essay questions with 3 to 6 parts each!
• This section provides a great opportunity to earn
partial credit
– Be sure to show your work and assumptions
– You can scroll between questions and scenarios within the
essay section of the exam
• Helps to determine how much time you will need for responses
Essay Questions
• Pay close attention to verbs
– E.g., if it says compare or contrast, don’t define something
• Read the entire question to understand all requirements
– You may have more than one requirement, for example:
“Define abc and interpret its applicability to xyz.”
• Grammar and writing skills
– Focus is on use of standard English, organization and clarity
– Graders are looking for effective writing skills
Essay Questions
• Be brief and to the point
– It’s ok to use bullet points!!!
• Do not leave a questions blank
– If short on time, at least write an outline of your main points
• Graders are looking to give you points, not take them away
– Make it as easy as possible for graders to give you points!
Essay Questions
• Type your responses into a text box
– Similar to MS Word, but with more simple
functionality
– Effective January 2013, the spreadsheet tool is no
longer being used on the CMA exam
• Be sure to use all of the time available to you
Essay
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There is a sample grading rubric for essay portion enclosed in slide presentation. This is
interesting because this shows that the graders only give points for correct answers. They
don't deduct for wrong answers. Notice on rubric for the second sample essay, there are
multiple points that could be earned for each question, but the total points for each question
is less than the sum for all the possible answers. This means that there is more than one
correct answer. Once you get the maximum points for this part, the grader moves on. You
don't get more points for embellishing.
Don't embellish. Be direct. Be simple. Use bullet points. Show your work, including
calculations. Use proper grammar and English. Then move on to the next question.
Practice answering essays online. This will get you used to how to type calculations and make
bullet points.
Use ALL the time you have on your essay questions, even if you pull time from your multiple
choice section.
The more you study, the better you will do. It is as simple as that.
Sample Essay Question #1
A City owns and operates a community swimming pool. The pool is open each year for 90 days during
the summer months of June, July, and August. A daily admission is charged to patrons of the pool. By
law, 10% of all recreational and sporting fees must be remitted to a state tourism promotion fund. The
City Manager has set a goal that pool admission revenue, after subtracting the state fee and variable
costs, must be sufficient to cover the fixed costs. Variable costs are assumed to be 15% of gross
revenue. Fixed costs for the three-month period total $33,000. The following budget for the pool has
been prepared for the current year.
Adult admissions: 30 per day x 90 days x $5.00
$ 13,500
Student admissions: 120 per day x 90 days x $2.50
27,000
Total revenue
40,500
State tourism fee
4,050
Net revenue
36,450
Variable costs
6,075
Fixed costs
33,000
Expected deficit $
(2,625)
The City Manager is trying to determine what admission mix is necessary to break even and what
actions could be taken to eliminate the expected deficit.
Essay Requirements (partial)
1. Given the anticipated mix of adult and student
admissions, how many total admissions must
the pool have in order to break even for the
season?
2. Regardless of the admissions mix, what is the
highest number of admissions that would be
necessary to break even for the season?
Sample Essay Response
Question 1:
Given the anticipated mix of adult and student admissions, how many total
admissions must the pool have in order to break even for the season?
Sample Response:
The contribution margin is 75% or $3.75 per adult admission, and $1.875 per student
admission. The mix is 20% adult (30 ÷ 150) and 80% student (120 ÷ 150).
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Calculate the weighted average contribution margin (WACM)
WACM = 0.20 ($3.75) + 0.80 ($1.875) = $2.25
The breakeven point in units is calculated as follows:
Fixed costs ÷ WACM
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Fixed costs = $33,000
WACM = $2.25
$33,000 ÷ $2.25 = 14,667 admissions per season
Sample Essay Response
Question 2:
Regardless of the admissions mix, what is the highest number of
admissions that would be necessary to break even for the season?
Sample Response:
To calculate the highest number of admissions to break even, you
would assume that all admissions are students. That’s because the
student admission price is the lowest of all admission prices.
– The breakeven point in units is calculated as follows:
• Fixed costs ÷ Contribution margin for students
– Fixed costs = $33,000
– Contribution margin for students = $1.875
– $33,000 ÷ $1.875 = 17,600 admissions per season
City Pool Question
Item Description
Question 1
CM% = 1-10%-15% (75%)
Adult = 75% x $5 ($3.75)
Student = 75% x $2.50 ($1.875)
Mix = 30/150 adult (20%) / 120/150
students (80%)
WACM = 20% x $3.75 + 80% x$1.875
($2.25)
Break-even point = fixed costs $33,000
divided by CM ($2.25) (14,667)
14,667
Subtotal
Question 2
Uses students
$33,000/$1.875 (17,600)
=17,600
TOTAL FOR ALL QUESTIONS:
Maximum
Points
8
1
1
1
%
Correct
Score
0
0
0
1
0
1
1
1
1
0
0
0
0
0
0.00
2
1/2
1
1/2
10
0
0
0
0.00
Essay Question #2
SmallParts is a manufacturer of metal washers, screws, and other parts
required in the manufacture of various handmade craft and novelty
items. The firm has the ability to custom make virtually any small part,
provided the client is able to provide SmallParts with the dimensions
and tolerance required of the product. Because of its niche in the
market, SmallParts has over 1,000 clients. Unfortunately, many of its
small business clients eventually merge or cease operations. One of
the company’s biggest challenges is the return of shipped product.
Usually, this is because the small business client has ceased
operations. While most of the product is custom made, SmallParts has
found that much of it can be sold to other clients for adapted use. The
company’s accountant is reviewing the company’s internal controls
and financial accounting procedures, in particular, with respect to
inventory.
Essay Question #2
Currently, SmallParts has one salesperson responsible for
marketing returned product. This salesperson has exclusive
and total control over the returned product including
arranging of sales terms, billing, and collection. The
salesperson receives the returned product and attempts to
find a client who may be able to adapt the product for the
client’s use. The inventory of returned product is not entered
in the accounting records, under the logic that the cost is
sunk. Revenue generated from its sale is classified as other
revenue on the SmallParts income statement.
Sample Essay Requirements (partial)
1.
2.
3.
4.
Identify and describe the three objectives of a system of internal control.
Identify and explain three ways that the procedure for handling returned
product violates the internal control system of segregation of duties.
Identify and describe three ways that SmallParts can provide for better internal
control over its inventory of returned product.
The company accountant is concerned about SmallParts’ current procedure for
accounting for returned product and has turned to IMA’s Statement of Ethical
Professional Practice for guidance. Assume the company’s accountant identifies
a possible conflict of interest on the part of the salesperson responsible for the
returned product.
a)Identify the ethical principles that should guide the work of a management
accountant.
b)Identify and describe the standards that relate to this situation and explain
how they apply.
Sample Essay Response
Question 1: Identify and describe the three objectives of
a system of internal control.
Sample Response:
A good system of internal control is designed to provide
reasonable assurance regarding achievement of an
entity’s objectives involving effectiveness and efficiency
of operations, reliability of financial reporting, and
compliance with applicable laws and regulations.
Sample Essay Response
Question 2: Identify and explain three ways that the procedure for handling returned
product violates the internal control system of segregation of duties.
Sample Response:
Segregation of duties requires that no one person have control over the physical
custody of an asset and the accounting for it. There is no evidence to suggest
SmallParts makes any effort to account for the value of returned product, which may
indeed be significant. The one salesperson seems to be in charge of all aspects
related to returned product, including authorizing the returns, crediting the
customers, receiving the returns, handling the physical custody, finding new
customers, concluding sales, shipping, billing, and collecting. Most of these rules
should be separated.
Sample Essay Question #2 Information relative to answering #2 of
Question 2 has been circled in red.
SmallParts is a manufacturer of metal washers, screws, and other parts required in the manufacture of
various handmade craft and novelty items. The firm has the ability to custom make virtually any small
part, provided the client is able to provide SmallParts with the dimensions and tolerance required of
the product. Because of its niche in the market, SmallParts has over 1,000 clients. Unfortunately, many
of its small business clients eventually merge or cease operations. One of the company’s biggest
challenges is the return of shipped product. Usually, this is because the small business client has
ceased operations. While most of the product is custom made, SmallParts has found that much of it
can be sold to other clients for adapted use. The company’s accountant is reviewing the company’s
internal controls and financial accounting procedures, in particular, with respect to inventory.
Currently, SmallParts has one salesperson responsible for marketing returned product. This
salesperson has exclusive and total control over the returned product including arranging of sales
terms, billing, and collection. The salesperson receives the returned product and attempts to find a
client who may be able to adapt the product for the client’s use. The inventory of returned product is
not entered in the accounting records, under the logic that the cost is sunk. Revenue generated from
its sale is classified as other revenue on the SmallParts income statement.
Sample Essay Response
Question 3: Identify and describe three ways that SmallParts can
provide for better internal control over its inventory of returned
product.
Sample Response:
Separate responsibilities and duties. While the salesman may be
assigned to work with customers who return products, and find other
customers for these products, other staff should post credits to
customer accounts following written policy. The products should be
received, inventoried, booked and shipped just like regular products.
Sample Essay Response
Question 4: (Summarized)
a) Identify the ethical principles that should guide the work of a management accountant.
b) Identify and describe the standards that relate to this situation and explain how they apply.
Sample Response:
a)The Statement lists the following four ethical principles:
– Honesty, Fairness, Objectivity, Responsibility
b)Several standards from the Statement apply.
– Credibility: “Each practitioner has a responsibility to disclose deficiencies in internal controls.”
– Competence: duty to maintain an appropriate level of professional expertise relative to
standard procedure commonly used in the accounting of firms dealing with returned product
– Confidentiality: refrain from using this confidential information for unethical advantage, by
not informing firms of the lax controls and availability of steep discounts on returned product
– Integrity: mitigating any conflict of interest.
Small Parts Question
Item Description
Question 1
Reasonable Assurance
Effectiveness of operations
Efficiency of operationsi
Reliability of financial reporting
Other
Subtotal
Question 2
1 person should not control custody
& acctg.
Salesperson in charge of everything
No accounting for returned product
No tracking or returned product
Other
Subtotal
Maximum
Points
2
1/2
1/2
1/2
1/2
1/2
%
Correct
Score
0
0
0
0
0
0.00
2
1/2
1/2
1/2
1/2
1/2
0
0
0
0
0
0.00
Small Parts Question (continued)
Item Description
Question 3
Separate resp./segregation of duties
4 different ind. for ret. Prod. duties
Authority, recording, custody, reco.
Other
Subtotal
Maximum
Points
2
1/2
1/2
1/2
1/2
%
Correct
Score
0
0
0
0
0.00
SmallParts Question (continued)
Item Description
Question #4
a. Principles: max = 1
Honesty, Fairness, Objectivity, Responsibility
Two correct identifications
Four correct identifications
b. Standards max = 5
Competence
maintain appropriate level of prof competence
prepare complete & clear reports
perform in accord with laws, regs & tech stds
Confidentiality
refrain from disclosing confidential info
refrain from using info unethically
Integrity
refrain from activity discrediting the profession
avoid actual or apparent conflicts of interest
refrain fr activity prejudice ability to carry out duties
refrain fr activity subverting attn of org objectives
Credibility/Objectivity
communicate info fairly and objectively
disclose fully all relevant info
other
TOTAL FOR ALL QUESTIONS:
Maximum Points
6
% correct
Score
1/2
1
0
0
1/2
1/2
1/2
1/2
1/2
1/2
1
1/2
1
1
1/2
1/2
1/2
1/2
1/2
1/2
12
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0.00
Remember!
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The CMA exam uses essays to reflect a more "real-world" environment in which candidates must
apply the knowledge they have acquired. Essays are graded on both writing skills and subject
matter. Partial credit IS available for essays that have some correct and some incorrect points.
Finally, it is important to remember that essays are not intended to test typing ability, so the time
you allocated for essay response is adequate to complete the questions even if you do not have the
best typing skills.
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Answering multiple-choice questions is an effective method to study the material for both the
multiple-choice and essay sections of the exam. They are an excellent diagnostic tool that will allow
you to quickly identify your weak areas. Also, think about what your answer would be if the
question were not multiple-choice. When reviewing the correct and incorrect answer explanations,
your "essay answers" should be somewhat equivalent to the detailed answer explanations.
Essay
• Roughly 75% of points come from multiple choice. Essay only accounts for
25% of points.
• There are two essay questions for each section of the CMA exam. Each
question will have 3-6 parts that must be answered.
• Be sure you skim all essay parts before begin answering. This will help you
survey how much time to spend on each question from the beginning.
Some will be easy, just asking for a definition. Some will require
calculations. Show all your work. Even if your answer is wrong, showing
your work will give you partial credit.
• Be sure to answer the question correctly. If the question asks you to
compare or contrast something, don't define it. That is not what they are
looking for.
Ethics
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Ethics is tested from:
– Individual Perspective – Part 1
– Organizational Perspective – Part 2
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Questions could be either Multiple Choice or Essay
Make sure you study the IMA Framework on Ethics, ref. the IMA website, or
following URL:
http://www.imanet.org/PDFs/Public/Press_Releases/STATEMENT%20OF%20ETHICAL%20PROFESSIONAL%20PRACTICE_2.2.12.pdf
http://www.imanet.org/resources_and_publications/ethics_center_helpline.aspx
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Have it “conceptually” memorized.
Similar to the AICPA version
You will then be able to answer any question from there
Stay “within” an objective view, and don’t get side-tracked in emotional distractors
Ethics
IMA’s Statement of Ethical Professional Practice
a. The Statement contains four overaching principles, which can be remembered
with the mnemonic HFOR.
1. Honesty
2. Fairness
3. Objectivity
4. Responsibility
b.
The Statement also contains four specific standards, which be remembered with
the mnemonic CCIC.
1. Competence
2. Confidentiality
3. Integrity
4. Credibility
Conflict of Interest
One of the provisions of the IMA Statement
enjoins members to mitigate actual, and to
avoid apparent, conflicts of interest.
Budgeting
• Overview
– A Formal Plan - A budget is a formal statement of an
organization’s plan for a period of time expressed in
quantitative terms. It is used to guide an entity
toward reaching its operational goals and is,
therefore, an important element of overall planning
and control. Financial and qualitative issues must be
considered along with the quantitative data to ensure
that all aspects of company operations are included in
profit planning.
Budgeting
• Budgeting is part of an effective planning process.
– Hierarchy of Planning
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Mission and strategic plans
Strategic objectives and plans
Tactical objectives and plans
Operational objectives and plans
Contingency Plans
Budgeting
• Budgeting is part of an effective control
system, which has:
– Measurement of Progress
– Corrective Actions
– Adaptation to change
Budgeting
• Different types of controls include:
– Preliminary (Feedforward) Controls
– Screening (Concurrent) Controls
– Post-Action (Feedback) Controls
• Budgeting is also used for/with Benchmarking
– “A point of reference from which measurements can
be made.”
Budgeting
– Used for communication and coordination
– Evaluation tool – Budget Report
• Budget/Variance Report
• Motivation
– Top management commitment
– Essential Planning Element
Budgeting
• Roles of Budgeting – Each company may use budgets
for different purposes. Remember PREMECC
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Planning
Ritual
Evaluation
Motivation
Education
Coordination
Communication
Budgeting
• Environments include:
– Economic
– Organization
– Behavior
• Budgets include
– Annual
– Project
• Level of detail
– Line items
– Programs
Budgeting
• Estimates for budgets include:
– Incremental
– Zero-based
• Process includes:
– Authoritarian/Top-down/Imposed
– Participative/Bottom-up
• Types of budgets include:
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Kaizen budgeting
Continuous/Rolling Budgets
Contingency Budgeting
Activity-based Budgeting
Budgeting
• See examples on page 73
Cost Classifications
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Controllable VS. Noncontrollable
Avoidable Vs. Committed
Incremental vs. Differential
Engineered s. Discretionary
Outlays vs. Opportunity
Relevant vs. Sunk
Cost Classifications
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Joined vs. Separable
Normal vs. Abnormal Spoilage
Rework, Scrap, and Waste
Other
– Carrying costs
– Transferred-in costs
– Value-adding costs
Manufacturing Capacity
– Normal capacity
– Practical capacity
– Theoretical (ideal) capacity
Costing Techniques
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Absorption vs. Variable Costing
– Need to understand:
• Under absorption costing, which costs are considered product
costs and which are considered period costs?
• Under variable costing, which costs are considered products and
which are considered period costs?
• When is income under variable costing higher than income under
absorption costing?
• What formula can be used to calculate the difference between
income under variable costing and income under absorption
costing?
• What managerial behavior does variable costing render ineffective?
Costing Techniques (cont.)
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Absorption costing
– Also called full costing treats all manufacturing costs as
product costs.
– Inventoried cost of the product thus includes all prodcution
costs, fixed and variable. Required by GAAP.
– Gross Margin (gross profit) = Sales revenue and absorption
cost of COGS, and covers S, G & A.
Costing Techniques (cont.)
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Absorption vs. Variable Costing (continued)
•
Variable costing
– Also called direct costing considers only variable manufacturing cost as
product cost.
– Fixed cost are period costs and expensed as incurred.
– Simple and easy to calculate. First consideration in determining whether
product should be manufactured (does it cover variable production costs).
– Contribution margin = net sales revenue minus all variable costs (mfg. & S,
G & A). “Contributions toward covering fixed costs”.
SU 1.6 - Practice Question 1
Which one of the following considers the impact of fixed
overhead costs?
A
Full absorption costing.
B
Marginal costing.
C
Direct costing.
D
Variable costing.
SU 1.6 - Practice Question 1 Answer
Correct Answer: A
Full absorption costing treats fixed factory
overhead costs as product costs. Thus, inventory
and cost of goods sold include (absorb) fixed
factory overhead.
SU 1.6 - Practice Question 2
An accounting system that collects financial and operating data on the basis
of the underlying nature and extent of the cost drivers is
A
Direct costing.
B
Activity-based costing.
C
Cycle-time costing.
D
Variable costing.
SU 1.6 - Practice Question 2 Answer
Correct Answer: B
An activity-based costing (ABC) system identifies the causal
relationship between the incurrence of cost and the underlying
activities that cause those costs. Under an ABC system, costs are
applied to products on the basis of resources consumed
(drivers).
SU 1.6 - Practice Question 3
Consider the cost of goods sold calculation shown below.
Beginning inventory
Plus cost of goods manufactured
Less ending inventory
Plus variable overhead efficiency variance
Cost of goods sold
$ 100,000
2,500,000
-125,000
10,000
$2,485,000
SU 1.6 - Practice Question 3 Answer
Correct Answer: D
In both normal and standard costing, immaterial
efficiency variances are accounted for as an
addition to cost of goods sold.
Learning Curve
• This method involves applying a mathematical formula
to estimate future time to produce units. Learning
curves were first developed in the aircraft industry
before World War II. Analyst discovered that the direct
labor input per airplane declined as more airplanes
were produced. Surveys of manufacturers showed that
the direct labor for the eight unit was only 80% of the
direct labor required for the fourth unit, and the direct
labor for the twelfth unit was only 80% of the labor for
the sixth unit.
Learning Curve
• Learning curves enable the manager to
protect the manufacturing cost per unit.
– Application – Firms that emphasize low price and
large volumes must move down the learning cost
to reduce cost per unit.
– Product changes can disrupt the learning curve
model.
Learning Curve
• Assumptions
– Increasing efficiency
– Decrease will decline
– Exponential curve
Learning Curve
• Example – A company has a learning curve of
80 percent, and the first 50 units took 1,000
hours to make. How long will the next order
of 150 units take?
Learning Curve
• Answer: 50 units @ 1000 hours = 20 hours per
unit, therefore on the first doubling to 100 units
the cumulative average is 16 hours (20 hours
X.80) per unit. The second doubling to 200 units
produces a cumulative average of 12.8 hours (16
hours X .80) per unit.
200 units X 12.8 hours per unit
Subtract the hours for the first 50 units
Hours to make another 150 units
2,560 total hours
(1,000) hours
1,560 hours
Cost Accumulations Methods
Job Costing
• As a job is being produced, its accumulated cost are kept in Good in
Process Inventory.
• The summation of all cost sheets makes up a subsidiary ledger controlled
by the Goods in Process Inventory account in the general ledger.
• Cost Flows: During Production – While a job is being produced, its
accumulated costs are kept in Goods in Processed Inventory. The
collection of job cost sheets for all jobs in process makes up a subsidiary
ledger controlled by the Goods in Process Inventory account in the general
ledger. Managers use job cost sheets to monitor costs incurred to date and
to predict and control cost for each job.
Cost Accumulations Methods
Job Costing
• Cost Flow: Job completion – When a job is finished, its job
cost sheet is completed and moved from the jobs in
process file to the jobs file. This latter file acts as a
subsidiary ledger controlled by the Finished Goods
Inventory Account.
• Cost Flows: Job Delivery – When a finished job is delivered
to a customer, the job cost sheet is moved to a permanent
file supporting the total cost of goods sold. This permanent
file contains records from both current and prior periods.
Cost Accumulations Methods
Job Costing
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•
•
Factory overhead includes all production costs other than direct materials and
direct labor, such as indirect material and indirect labor.
They are recorded to the Factory Overhead Control account, and ultimately to the
job cost sheets via an allocations.
Overhead Allocation Bases
– Usually based on factors of productions like direct labor or machine hours.
– Correct allocation is important and affects accuracy.
•
Overhead Allocation Rates
– Predetermined Overhead rate or predetermined overhead allocation (or application) rate.
The predetermined overhead rate is computed at the start of the period and is used
throughout the period to allocate overhead to jobs.
Cost Accumulations Methods
Job Costing
• Adjusting Factory Overhead
– Actual overhead < applied = Underapplied overhead
– Actual overhead > applied = Overapplied
– The closer a estimate is to actuals in absolute terms
the better the estimates was
Understand the effects on the Financials
statements when this occurs
Cost Accumulations Methods
Job Costing
• Spoilage
– Output that does not meet the quality standards
for salability is considered spoilage.
• That amount that is expected is considered normal
spoilage in which case it is included as product costs.
• Spoilage that is over or above normal is considered
abnormal and treated as period cost.
Cost Accumulations Methods
Process Costing
Process costing is used in Process Operations, also called process
manufacturing or process production, is the mass production of
products in a continuous flow of steps.
“Products pass through a series of sequential processes”
• Common feature of Process Operations is that it is sequential using
a series of standardized processes.
• Series of processes = series of steps
Cost Accumulations Methods
Process Costing
• Understanding processes for companies with process operations is crucial
for measuring their costs.
• In process costing system focus is on the process itself and the
standardized units produced.
• In process operations, each process is identified as a separate production
department, workstation, or work center.
• Every subsequent department, workstation, etc. receives the output of the
previous “step” (and is cumulative of all preceding)
Cost Accumulations Methods
Process Costing
•
Additional cost added at each “step” can be
– Direct Material
– Direct Labor
– Overhead (labor, material and other)
– The last “step” produces the finished goods
– Output of one department becomes the input of another department, as is the case
with sequential processing – costs transfer with those units from the prior “step”
Remember!
Process cost accounting systems assign direct material, direct labor, and overhead to specific
processes (or departments). The total costs associated with each process are the divided by the
number of units passing through that process to determine the cost per equivalent unit (EU) for
that process.
Cost Accumulations Methods
Process Costing
• Process Cost Factory Overhead Cost
– The time it takes to process (cycle) products
through a process is sometimes used to allocate
costs.
– With increasing automation, companies with
process operations are more likely to use machine
hours to allocate overhead.
Cost Accumulations Methods
Process Costing
Equivalent Units!
If a process has no beginning and no ending goods
in process inventory, then the unit cost of goods
transferred out of a process is:
Total cost assigned to the process (direct material, direct labor, and overhead)
Total number of units started and finished in the period
Cost Accumulations Methods
Process Costing
The goal is to compute the cost per equivalent unit and to assign costs
to finished goods and goods in process inventory.
• What complicates calculations is that material, labor and overhead
sometimes are added in unequal increments over the process
“steps”.
• Remember:
– First equivalent units are determined and then per-unit cost are
calculated.
Cost Accumulations Methods
Process Costing
• Two methods of calculating EUP (both are tested on
the exam!)
– Weighted-average method – units in beginning work-inprocess inventory are treated as if they were started and
completed during the current period.
– First-in, first-out method – units in beginning work-inprocess inventory are part of the EUP calculation. The
calculation is thus more complex than weighted-average
but tends to be more accurate.
Cost Accumulations Methods
Process Costing
• See Process costing handout
SU 2.2 Practice Question 1
In a process-costing system, the cost of abnormal spoilage should be
A
Prorated between units transferred
out and ending inventory.
B
Included in the cost of units
transferred out.
C
Treated as a loss in the period
incurred.
D
Ignored.
SU 2.2 Practice Question 1
Correct Answer: C
Abnormal spoilage is spoilage that is not
expected to occur under normal, efficient
operating conditions. Because of its unusual
nature, abnormal spoilage is typically treated as
a loss in the period in which it is incurred.
SU 2.2 Practice Question 2
Fact pattern: Superb Hancock Company uses a process costing system in which all
materials are added at the beginning of the first process. Conversion costs are added
evenly throughout the process. During the past month, 10,000 units were started in
production, and 8,000 were completed and transferred to the next department. There
were no beginning inventories. The ending inventories were 70% complete at the end of
the month. The company uses a weighted-average method for inventory valuation.
If Superb Hancock’s materials used in production cost $15,000 and its conversion costs
incurred were $25,000, what amount of inventory (rounded) was transferred to the next
department?
A
$32,000
B
$33,280
C
$36,280
D
$40,000
SU 2.2 Practice Question 2 Answer
Correct Answer: B
The equivalent units of materials equal 10,000 because all
materials are added at the beginning of the process, and
10,000 units were started. The equivalent units of conversion
costs equal 9,400 [8,000 units completed + (2,000 units in
ending inventory × 70%)]. The unit cost of materials is $1.50
($15,000 ÷ 10,000 EU). The unit cost of conversion is $2.66
($25,000 ÷ 9,400 EU). Thus, the cost of goods transferred was
$33,280 [8,000 units × ($1.50 + $2.66)].
SU 2.2 Practice Question 3
Fact pattern: Superb Hancock Company uses a process costing system in which all
materials are added at the beginning of the first process. Conversion costs are added
evenly throughout the process. During the past month, 10,000 units were started in
production, and 8,000 were completed and transferred to the next department. There
were no beginning inventories. The ending inventories were 70% complete at the end
of the month. The company uses a weighted-average method for inventory valuation.
If Superb Hancock’s materials used in production cost $15,000 and its conversion
costs incurred were $25,000, what is the value (rounded) of the ending work-inprocess inventory in the first processing department?
A
$6,720
B
$8,000
C
$3,720
D
$0
SU 2.2 Practice Question 3 Answer
Correct Answer: B
The equivalent units of materials equal 10,000 because all
materials are added at the beginning of the process, and
10,000 units were started. The equivalent units of conversion
costs equal 9,400 [8,000 units completed + (2,000 units in
ending inventory × 70%)]. The unit cost of materials is $1.50
($15,000 ÷ 10,000 EU). The unit cost of conversion is $2.66
($25,000 ÷ 9,400 EU). Thus, the cost of goods transferred was
$33,280 [8,000 units × ($1.50 + $2.66)].
SU 2.2 Practice Question 4
Fact pattern: Superb Hancock Company uses a process costing system in which all
materials are added at the beginning of the first process. Conversion costs are added
evenly throughout the process. During the past month, 10,000 units were started in
production, and 8,000 were completed and transferred to the next department. There
were no beginning inventories. The ending inventories were 70% complete at the end of
the month. The company uses a weighted-average method for inventory valuation.
If Superb Hancock’s materials used in production cost $15,000 and its conversion costs
incurred were $25,000, what is the value (rounded) of the ending work-in-process
inventory in the first processing department?
A
$6,720
B
$8,000
C
$3,720
D
$0
SU 2.2 Practice Question 4 Answer
Correct Answer: A
The cost transferred out was $33,280. Hence, the
ending inventory must equal the production costs
for the month (given no beginning inventories),
minus costs transferred out, or $6,720 [($15,000
materials + $25,000 conversion cost) – $33,280].
SU 2.2 Practice Question 5
Fact pattern: Superb Hancock Company uses a process costing system in which all materials are
added at the beginning of the first process. Conversion costs are added evenly throughout the
process. During the past month, 10,000 units were started in production, and 8,000 were completed
and transferred to the next department. There were no beginning inventories. The ending
inventories were 70% complete at the end of the month. The company uses a weighted-average
method for inventory valuation.
Assume that Superb Hancock uses first-in, first-out (FIFO) for inventory costing instead of the
weighted-average inventory valuation. If materials used in production cost $15,000 and conversion
costs incurred were 25,000, what amount of inventory (rounded) was transferred to the next
department under FIFO?
A
$32,000
B
$33,280
C
$36,280
D
$40,000
SU 2.2 Practice Question 5
Correct Answer: B
The only difference between weighted average and FIFO relates to the
beginning inventories. Because there were no beginning inventories in this
problem, the two valuation methods produce the same results. The
equivalent units of materials equal 10,000 because all materials are added at
the beginning of the process, and 10,000 units were started. The equivalent
units of conversion costs equal 9,400 [8,000 units completed + (2,000 units in
ending inventory × 70%)]. The unit cost of materials is $1.50 ($15,000 ÷
10,000 EU). The unit cost of conversion is $2.66 ($25,000 ÷ 9,400 EU).
Therefore, the cost of goods transferred using the FIFO method for inventory
costing is $33,280 [8,000 units × ($1.50 + $2.66)].
Cost Accumulations Methods
Activity–based Costing
1) Activity Analysis: understand the different steps and process from
DM to Finished Goods
2) Assign Resource Costs to Activities: first-stage allocation. Identify
resource costs: a separate Accounting System may be necessary
to track resource costs separately from the GL. Then we need to
define resource drivers to allocate it.
3) Allocate Activity Cost Pools to Cost Objects: allocating the activity
cost pools to final cost objects = second-stage allocation
 What are my activity drivers?
Cost Accumulations Methods
Activity–based Costing
• Cause-&-effect relationship
• Cost object may be a job, product, process, activity,
service or anything else for which a cost measure is
desired
• Process value analysis: Organization flow
– Value-adding Vs. Non Value-adding
– Product costing / continuous improvement
ABC used to obtain full-absorption cost (US GAAP)
Cost Accumulations Methods
Activity–based Costing
ABC Advantages/Disadvantages
• Product costing is improved, better decision making
• Process value analysis (non-value adding activities can be removed)
• More cost assignment of OH
• Better cost control and more efficient operations
•
•
•
•
Maintain a separate Accounting System to capture resource costs
Design and implement drivers and cost pools
ABC-derived costs of products or services may not conform with GAAP
Cost of implementing an ABC system
Cost Accumulations Methods
Activity–based Costing
Organizational Benefits
• Significant variance in volume, diversity of activities, complexity of
operations, relatively high OH costs…
• ABC difficult for service organizations: high facility-level costs hard
to assign to service
• DL as a base for allocating OH
• No benefit for a single product and average regular volume of
activity
• Real benefits for high level of FC + wide variety of products and
level of production
Cost Accumulations Methods
Life-cycle Costing
•
•
•
•
•
Estimate revenues & expenses
Over the entire sales life cycle
Upstream costs (R&D, Design)
Manufacturing
Downstream costs (Mktg & Distribution, Customer
Service)
 Great value for Pricing Decision
Cost Accumulations Methods
Life-cycle Costing
• Relationships among costs incurred at different value-chain
stages
• Incurring costs vs. locking in costs (SUNK)
• Focus on cost control Vs. cost reduction
• After-purchase costs (operating, support, repair, disposal…)
• Life-cycle and whole-life cycle  target costing
• Value engineering: minimize cost without reducing
customer satisfaction
Cost Allocations Techniques
Absorption vs. Variable Costing
• You need to be able to answer the following:
– Under absorption costing, which cost are considered product cost? Which
costs are considered period cost?
– In the variable costing, which costs are considered product cost? Which costs
are considered period cost?
– What income statement format is appropriate for variable cost?
– When is income of the variable costing higher than income and absorption
costing?
– What format can be used to calculate the difference between income under
variable costing and income and absorption costing?
– What managerial behavior does variable costs were render ineffective?
Cost Allocations Techniques
Absorption vs. Variable Costing
Product cost consist of all the costs incurred the production of a product: direct
materials, direct labor, and manufacturing overhead.
The process to classified all these costs as part of product costs is referred to as
absorption costing (or full costing).
Absorption costing is the cost accumulation method required by generally
accepted accounting principles (GAAP) for external reporting, and by regulatory
body such as the Internal Revenue Service.
In variable costing, fixed manufacturing overhead is treated as a period expense
rather than product cost, meaning it is expensed in the period in which it is
incurred.
Absorption Costing
Sales
- Product Costs (incl. fixed and variable)
= Gross Margin
- Total S, G & A (fixed and Variable)
Variable Costing
Sales
- Product Cost (only variable cost)
= Contribution Margin (portion available to cover fixed costs
- Fixed Costs (both mfg. and S, G & A)
- Under variable costing, fixed overhead is considered a cost
of maintaining capacity, not a cost of producing a product.
- Contribution margin will tell you if you are covering at least
the direct product costs
Cost Allocations Techniques
Absorption vs. Variable Costing
• Impact on Operating Income
– Produced = Sold = no difference in income
– Produced > Sold > income
• When production exceeds sales, fewer fixed cost are expensed under the absorption
basis, and operating income always increases.
• A production manager can thus increase absorption-based operating income by
increasing production, whether there is any customer demand for the additional product
or not.
• This practice, called producing for inventory, can be effectively discouraged by using
variable costing for performance reporting and consequent bonus calculation.
Cost Allocations Techniques
Absorption vs. Variable Costing
– Produced < Sold < income
• Variable costing will show a higher income in periods when
inventories decline because absorption method forces the
subtraction of all of the current fixed costs, plus some fixed costs
incurred (and capitalized) in prior periods.
• Most importantly, in using variable costing, profits always move in
the same direction as sales volume. Profits reported on absorption
costing behave erratically and sometimes move in the opposite
direction from sales trends
Cost Allocations Techniques
Absorption vs. Variable Costing
Variable Costing Practical Exercise Solutions
Cost Allocations Techniques
Absorption vs. Variable Costing
• Other benefits of variable costing:
– Variable costing is better suited for management's needs which requires a
knowledge of cost behavior under various operating conditions. For
planning and control, management is more concerned with treating fixed
and variable costs separately than with calculating full cost.
– Full costs are usually dubious value because they contain arbitrary
allocation of fixed cost.
– The production manager cannot manipulate income levels over
overproducing.
Cost Allocations Techniques
Absorption vs. Variable Costing
–
–
–
–
The cost data for profit planning and decision-making are readily available from
accounting records and statements under variable costing. For example cost profit
relationships and the effects of changes in sales volume on that income can easily be
computed from income statement prepared under the variable costing concept, but not
from the conventional absorption costing income statement based on the same data.
Absorption cost income statements may show decreases in profits from sales and rising
and increases in profits from sales or decreasing, which may be confusing to
management.
A favorable margin in the variable costing justifies a higher production level.
Variable costing is also preferred over absorption costing for studies of relative
profitability of products, territories, and other segments of a business. A concentrate on
the contribution of each segment makes to the recovery of fixed costs that will not be
altered by decisions to make and sell.
continued
Cost Allocations Techniques
Absorption vs. Variable Costing
•
Inventory changes have no effect on the breakeven computation.
•
Disinvestment decisions are facilitated because were their product or department
is recouping its variable cost can be determined. If the variable costs are being
covered operating a department at apparent loss may be profitable.
•
Cost figures are guided by the sales figures. Under variable costing cost of goods
sold very directly with sales volume, and the influence of production of gross profit
is avoided.
•
There will costing also eliminates a possible difficulties have explain over and
under applied factory overhead to higher management.
Normal Costing
Normal costing is used to derive the cost of a product. It includes the following components:
Actual cost of materials
Actual cost of labor
A standard overhead rate that is applied using the product's actual usage of whatever allocation
base is being used (such as direct labor hours or machine time)
If there is a difference between the standard overhead cost and the actual overhead cost, then
you can either charge the difference to the cost of goods sold (for smaller variances) or prorate
the difference between the cost of goods sold and inventory.
Normal costing is designed to yield product costs that do not contain the sudden cost spikes that
can occur when you use actual overhead costs; instead, it uses a smoother long-term estimated
overhead rate.
It is acceptable under generally accepted accounting principles and international financial
reporting standards to use normal costing to derive the cost of a product.
Normal costing varies from standard costing, in that standard costing uses entirely
predetermined costs for all aspects of a product, while normal costing uses actual costs for the
materials and labor components.
Normal Costing
Normal costing uses a predetermined annual overhead rate to assign
manufacturing overhead to products. In other words, the overhead rate
under normal costing is based on the expected overhead costs for the entire
accounting year and the expected production volume for the entire year.
Under actual costing each month’s actual costs and each month’s actual
production volume are used to assign overhead costs. Since most companies
will experience month to month fluctuations in activity, the actual monthly
overhead rates will likely vary from month to month.
Normal costing will result in an overhead rate that is more uniform and
realistic for all of the units manufactured during an accounting year.
Normal Costing
Manufacturing overhead (also referred to as factory overhead, factory burden, and manufacturing
support costs) refers to indirect factory-related costs that are incurred when a product is
manufactured. Along with costs such as direct material and direct labor, the cost of manufacturing
overhead must be assigned to each unit produced so that Inventory and Cost of Goods Sold are valued
and reported according to generally accepted accounting principles (GAAP).
Manufacturing overhead includes such things as the electricity used to operate the factory equipment,
depreciation on the factory equipment and building, factory supplies and factory personnel (other than
direct labor). How these costs are assigned to products has an impact on the measurement of an
individual product's profitability.
Nonmanufacturing costs (sometimes referred to as “administrative overhead”) represent a
manufacturer’s expenses that occur apart from the actual manufacturing function. In accounting and
financial terminology, the nonmanufacturing costs include Selling, General and Administrative (SG&A)
expenses, and Interest Expense. Since accounting principles do not consider these expenses as product
costs, they are not assigned to inventory or to the cost of goods sold. Instead, nonmanufacturing costs
are simply reported as expenses on the income statement at the time they are incurred.
Normal Costing
On financial statements, each product must include the costs of the following:
•
Direct material
•
Direct labor
•
Manufacturing (or factory) overhead
According to generally accepted accounting principles (GAAP), manufacturing overhead must be included in the cost
of Work in Process Inventory and Finished Goods Inventory on a manufacturer’s balance sheet, as well as in the Cost
of Goods Sold on its income statement.
As their names indicate, direct material and direct labor costs are directly traceable to the products being
manufactured. Manufacturing overhead, however, consists of indirect factory-related costs and as such must be
divided up and allocated to each unit produced. For example, the property tax on a factory building is part of
manufacturing overhead. Although the property tax covers an entire year and appears as one large amount on just
one tax bill, GAAP requires that a portion of this amount be allocated or assigned to each product manufactured
during that year.
MOH Variances
Remember!
• If variance is immaterial: directly allocated to
COGS
• If variance is material: allocated based on
relative values of WIP, Finished goods, COGS
Service Department Costs
• Direct Method
• Step-Down Method
• Reciprocal Method
• Service Depart. = OH = not traced to cost object = must be
allocated to operating Departs.
• Cause-&-effect relationship and/or benefits received
See example in SU 3