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Traditional Cost Management Systems. Chapter 3. Cost Management Systems. Cost management systems have a wide variety of uses Two cost management systems have been used traditionally to cost products and services Job order costing Process costing

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Traditional Cost Management Systems


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    1. TraditionalCost ManagementSystems Chapter 3

    2. Cost Management Systems • Cost management systems have a wide variety of uses • Two cost management systems have been used traditionally to cost products and services • Job order costing • Process costing • Many companies continue to use these two systems

    3. Cost Management Systems • All cost systems work in essentially the same way: • Expense categories are developed and then expenses are mapped to service departments, production centers, or activities • Expenses are then attached to cost objects • The way these links are made and the activities defined is what differentiates systems

    4. Manufacturing costs • The costs of producing a product can be broken down into two broad categories: • Direct cost – cost of a resource or activity that is acquired or used by a single cost object • Indirect cost – cost of a resource that was acquired to be used by more than one cost object

    5. Direct and Indirect Costs • Direct costs can be easily traced to a cost object • Indirect costs cannot easily be traced to a cost object so they must be allocated or assigned to the cost object

    6. Job Order v. Process Costing Systems • A job order costing system estimates the costs of manufacturing products for different jobs required for specific customer orders • A process costing system is applicable when all units produced during a specified time frame are treated as one unit of output

    7. Need for Job Order Costing • Products may differ • Materials content • Hours of labor required • Machine time required • Demand placed on support activity resources (i.e., manufacturing overhead) • Special customer needs that require customized production • With such variety, managers need to understand the costs of individual products so that they can assess product and customer profitability

    8. The Cost Flow Model • The cost flow model essentially uses an inventory concept to track costs • Raw materials inventory • Work-in-process (WIP) inventory • Raw materials are transformed by labor and support resources • Costs of the resources for each job not yet completed • Finished goods inventory • When the goods are sold, they are accounted for in the expense category Cost of Goods Sold

    9. Bidding Using Job Order Costing • Firms are sometimes required to bid on jobs before customers decide to place an order with them • Costs need to be estimated for each job in order to prepare a bid • Job order costing systems provide the means to estimate these costs • A job bid sheet provides a format for recording the estimated costs

    10. Job Bid Sheet • Panel 1 identifies the customer, the product, and the number of units required Bid Number: J4369 Date: July 6, 2006 Customer: Michigan Motors Product: Automobile engine valves (Valve #L181) Engineering Design Number: JDR-103 Number of Units: 1,500

    11. Job Bid Sheet • Panel 2lists all the materials required to complete the job MaterialsQuantity Price Amount Bar steel stock 3” 3,600 lbs $11.30 $40,680 Subassembly 1,500 39.00 58,500 Total direct materials $99,180

    12. Job Bid Sheet • Panel 3lists the amount of direct labor required for the job Labor HoursRateAmount Lathe operators 480 $26.00 $12,480 Assembly workers 900 18.00 16,200 Total direct labor 1,380 $28,680

    13. Job Bid Sheet • Panel 4contains estimates for cost driver costs Support Costs Amount 600 machine-hours @ $40/hour $24,000 1,380 direct labor hours @$36/hour 49,680 Total support costs $73,680

    14. Job Bid Sheet • Panel 5summarizes the total costs estimated for the job Direct material $ 99,180 Direct labor 28,680 Support costs 73,680 Total costs $201,540

    15. Job Bid Sheet • A markup rate is applied to translate the estimated cost into a bid price Total costs $201,540 Add 25% markup 50,385 Bid price $251,925 Unit cost $134.36 Unit price $167.95

    16. Job Costs And Markup • Markup rate – percent by which job costs are marked up • The markup rate depends on a variety of factors: • The amount of support costs excluded from the cost driver rate • The target rate of return desired by the corporation • Competitive intensity • Past bidding strategies adopted by key competitors • Demand conditions • Overall product-market strategies

    17. Determination Of Cost Driver Rates • Determining realistic cost driver rates has become increasingly important with the increase in support costs as a percentage of total cost • Firms now recognize that several different factors may be driving support costs rather than one or even two factors, such as direct labor or machine hours

    18. Cost Driver Rates • All costs associated with a cost driver, such as setup hours, are accumulated separately in a cost pool • Each cost pool has a separate cost driver rate • The cost driver rate is the ratio of the cost of a support activity accumulated in the cost pool to the level of the cost driver for the activity Activity cost driver rate = Cost of support activity / Level of cost driver

    19. Stable Cost Driver Rates • The cost of the support activity is the cost of the resources committed to the particular activity • The level of the activity cost driver is the long-term capacity made available by the amount of resources committed to a support activity • The cost of a support activity excludes fluctuations in costs caused by short-term adjustments such as overtime payments • The level of the support activity cost driver also excludes short-term variations in demand as reflected in overtime or idle time

    20. Stable Cost Driver Rates • The ratio shown is based on costs and cost driver levels, the rate remains stable over time: • Rate does not fluctuate as activity levels change in the short run • Rate does not change simply because of short-run changes in external factors that do not affect the efficiency or price of the activity resources

    21. Fluctuating Rates • If the rate for machine costs is based on quarterly cost driver levels instead of the normal levels: • The rate increases as the demand for the machine activity falls • The rate decreases as the demand increases • If the cost driver rate is based on costs and activity levels remains fixed throughout the year • Costs depend on the machine capacity made available and not on the season

    22. Problems With Fluctuating Rates • Determination of cost driver rates based on short-term usage results in higher rates during periods of lower demand • Job costs appear to be higher during time periods when demand is lower • Bid prices based on estimated job costs are likely to be higher during periods of low demand when they probably should be lower • The higher bid price can further decrease demand, which in turn leads to higher cost driver rates and even higher prices

    23. Number of Cost Pools • The number of cost pools can vary • The general principle is to use separate cost pools if the cost or productivity of resources is different and if the pattern of demand varies across resources • The increase in measurement costs required by a more detailed cost system must be traded off against the benefit of increased accuracy in estimating product costs

    24. Recording Actual Job Costs • Job order cost accounting systems record costs actually incurred on individual jobs as they are produced • Copies of all materials requisition notes and worker time cards are forwarded to the accounting department, which then posts them on a job cost sheet • The system calculates total costs for the portion of the job completed

    25. Multi-stage Process Costing • Continuous processing - production flows continuously, semi-continuously, or in large batches from one process stage to the next • At each successive process stage, there is further progress toward converting the raw materials into the finished product • In continuous processing it is necessary first to determine costs for each stage of the process and then to assign their costs to individual products

    26. Multistage Process Costing Systems • The design of product costing systems in such process-oriented plants allows measurement of the costs of converting the raw materials during a time period to be made separately for each process stage • The conversion costs are applied to products as they pass through successive process stages • This system for determining product costs, known as a multistage process costing system, is common in process-oriented industries

    27. Process-Oriented Industries • Multistage process costing systems are found in plants engaged in continuous processing, such as those in the chemicals, basic metals, pharmaceuticals, grain milling and processing, and electric utilities industries • Also found in some discrete-parts manufacturing plants such as those producing automobile components, small appliances, and electronic instruments and computers • Common feature in these settings is that the products manufactured are relatively homogeneous

    28. Comparison With Job Order Costing • Both systems have the same objective: • Assign material, labor, and manufacturing support activity costs to product • Process costing systems differ in that they: • Do not maintain separate cost records for individual jobs • Measure costs only for process stages • Determine cost variances only at the level of the process stages instead of at the level of individual jobs

    29. Job Order and Multistage Process Costing • In job order costing production is carried out in different jobs • In multistage process costing, production is carried out continuously, semi- continuously, or in large batches

    30. Job Order and Multistage Process Costing • In job order costing, productionrequirements are different for each individual job • In multistage process costing, productionrequirements are homogeneous across products or jobs

    31. Job Order and Multistage Process Costing • In job order costing, variances between actual and estimated direct material and direct labor costs are determined for each individual jobs • In multistage process costing, variances between actual and estimated costs are determined for individual process stages

    32. Equivalent Units of Production • Process costing issue: units in production that are not complete at the end of a production period • These partially completed units are converted mathematically into equivalent units of production (EUPs)

    33. EUPs • Equivalent units = Number of partially completed units Percentage completion • Weighted-average method: EUP = units transferred out to the next dept. + Equivalent units in ending WIP

    34. Service DepartmentCost Allocations Appendix 3-1

    35. Operating Expense Allocations • Traditional cost accounting systems assign operating expenses to products with a two-stage procedure: • Expenses are assigned to production departments • Production department expenses are assigned to the products • Departmental structure influences the first-stage allocation process

    36. Effect Of Departmental Structure • Departments that have direct responsibility for converting raw materials into finished products are called production departments • Service departments perform activities that support production, such as: • Machine maintenance • Production engineering • Machine setup • Production scheduling • All service department costs are indirect support activity costs because they do not arise from direct production activities

    37. Two-Stage Cost Allocation Conventional product costing systems assign indirect costs to jobs or products in two stages • In the first stage: • System identifies indirect costs with various production and service departments • Service department costs are then allocated to production departments • The system assigns the accumulated indirect costs for the production departments to individual jobs or products based on predetermined departmental cost driver rates

    38. Two-Stage Cost Allocation (2 of 2)

    39. Allocating Service Department Costs To Production Departments • There are three ways that companies allocate service department costs to production departments: • Direct allocation • Sequential allocation • Reciprocal allocation • The last two are used when service departments consume services provided by other departments

    40. PATIENTAID EXAMPLE Step 1 of Stage 1 cost allocations (given)

    41. Direct Allocation Method • The direct allocation method is a simple method that allocates the service department costs directly to the production departments • Allocations to production departments are based on each production department’s relative use of the applicable cost driver • Possibility that some of the activities of a service department may benefit other service departments as well as production departments is ignored

    42. Allocation Bases Values

    43. Allocation Ratios Based on relative allocation basis value 300,000 / 1,200,000 = 0.250

    44. Allocation ofService Department Costs • Multiply service department cost by the allocation ratios $160,000 x 0.250 = $40,000

    45. Stage 2 Cost Allocations • Stage 2 allocations • Require the identification of appropriate cost drivers for each production department • Assign production department costs to jobs and products while they are worked on in the departments • Conventional cost accounting systems use unit-related cost drivers • Dividing the indirect costs accumulated in each production department by the total number of units of the corresponding cost driver results in cost driver rates for each department

    46. PATIENTAID Stage 2 • The Casting Department allocates its indirect costs to jobs based on machine hours, with total capacity for Casting equaling 6,000 machine hours • Total indirect costs for Casting, after the allocation from service departments in Step 2 of Stage 1 was $216,000 • As a result, Casting allocates indirect costs to jobs at a rate of $36.00 per machine hour • $216,000/6,000 hours

    47. PATIENTAID Stage 2 • If Job J189-4 uses 40 machine hours while in the Casting Department, Casting will allocate $1,440 of its indirect costs to Job J189-4 • 40 hours x $36.00 per hour • Each department will allocate indirect costs to Job J189-4 in a similar manner, and Casting will allocate some costs to all jobs in a similar manner • To determine the total cost of Job J198-4, add the Direct Material and Direct Labor cost assigned in each department and the indirect cost allocated from each department • To determine the cost per unit, divide the total cost by the number of units in Job J189-4

    48. Cost Distortions inA Two-Stage Allocation • The two-stage allocation can cause some products to be overcosted and others undercosted if allocations are based on unit measures but the units of different products have different relative consumption ratios

    49. Cost Distortions inA Two-Stage Allocation (2 of 2) • Cost distortions are greater when the difference between the relative proportion of the cost driver for the activity and the relative proportion of the basis for second-stage assignment of support costs is greater • Such distortions could be eliminated if the costing system used the actual cost driver for each support activity to assign costs directly to the products

    50. Sequential and ReciprocalAllocation Methods • Sequential and reciprocal allocation methods are used when service departments consume services provided by other service departments • The sequential allocation method allocates service department costs to one service department at a time in sequential order • The reciprocal allocation method determines service department cost allocations simultaneously