Professional Documents
Culture Documents
Decision making
A framework
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Benefit received
Materials, labor, commissions, travel, advertising
Function supported
Manufacturing, marketing, research
Product versus period costs
Used in financial reporting
Helps figure out gross margin
Variable versus fixed costs
Helps understand how costs change with decisions
Computes contribution margin
Direct versus indirect costs
Helps attach costs to different units of analysis
Associated term is segment margin
Phelps Industries
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Examples
Product or Why?
Period cost?
Raw materials
Factory rent
Sales commissions
Separate handout (in LMS) has the detail for each kind of firm
Review on your own (also in Chapter 3 of book)
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Capacity * Depreciation
Asset
(Machines) (part of mfg. overhead)
Period costs
Commissions
Period costs
Distribution
Administration
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Points to note
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COGS
Inventory 14
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Spend
$675,000 on
COGS: $630,000 Inventory: $45,000
materials and
= 14,000 units * $45/unit = 1,000 units * $45/unit
labor
Spend
$448,750 on COGS: $418,833
capacity costs Inventory = $29,917
= 14,000 units * 1,000 units * $29.916/
(fixed) $29.916/unit unit
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Labor
Labor
control Cost of Goods
sold (COGS)
Capacity * Depreciation
Asset
(Buildings) (overhead)
Commissions
Period costs
Distribution
Administration
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The key is to recognize that some costs will change and others
will not with volume
Usual classification
Variable costs change proportionately with volume
Fixed costs do not change as volume changes
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Activity
Activity (units)
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Classifying costs
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Variable COGS
Inventory value
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Units
produced Units sold Units into inventory
=15,000 = 14,000 = 1,000
Spend
$791,250 on COGS: $738,500 Inventory = $52,750
materials, = 14,000 units * $52.75 = 1,000 units * $52.75
labor and VOH per unit per unit
Spend
$332,500 on Expensed $332,500 in
capacity costs Inventory = 0
income statement Not allocated to units
(fixed) (below CM line)
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Gross margin (GM) of gears has gone up because we are now spreading the
(same amount of) fixed overhead over a larger base
Same idea as when we increased the volume of operations
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More on relevance
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Examples
Product or Direct or Indirect to a
Period cost? product?
Raw materials
Product
Factory rent
Product
Sales commissions
Period
Forklift used in distribution
center Period
Travel expenses for plant
manager Depends
Cost of freight in
Product
Overtime premium for direct Product
labor
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Segment reporting
Gears Sprockets Total
(30,000 hrs.) (18,000 hours)
Revenue $1,800,000 $876,000 2,676,000
Variable Mfg. costs 791,250 750,000 1,541,250
Variable SGA costs 66,000 41,250 107,520
Contribution margin $942,750 $84,480 $1,027,230
Traceable fixed costs 85,000 67,500 152,500
Segment margin $857,750 $ 16,980 $ 874,730
Common fixed costs (Mfg.) 247,500
Common fixed costs (SGA) 280,000
Profit margin $ 347,230
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No!
Cannot restrict all decisions to contribution or segment margins
This focus is appropriate only for short-term decisions
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Types of decisions
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Short-term
Capacity costs are not controllable. Not relevant for decisions
Long-term
Capacity costs are controllable. Relevant for decisions.
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Transforming data
Short-run decisions
Period over which we cannot change capacity
The opportunity cost of capacity is still relevant
The link between historical and opportunity cost is broken
Historical capacity costs are not relevant for decision making
Decisions require that we strip out historical costs and put in opportunity
costs
Long-term decisions
Period over which we can change capacity
OC of capacity is relevant for decision making
We use accounting data on allocated costs to estimate OC
There is a link between historical and opportunity cost
But, the validity of this link is not always strong
Decisions require that we validate the link and, even then, use the data with
caution
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C = Chapter
Howdowematchthe Areweusing
supplyanddemandfor C11 resources
Long
Long resources?Class4,5 effectively?Class9,10
term (C9,C10) (C12,C13)
term
Planning Control
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A detour
Service Industries
Billing in consulting
JLR Enterprises provides the following data re its budget, the % of each cost traceable
to clients directly, and the detail for one client. The firm desires a total profit of
$640,000 before tax. The firm allocates overhead based on direct costs and tacks on a
markup for profit. (See last sheet in handout for problem)
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Example: JLR Enterprises
JLR Enterprises provides consulting services throughout California and uses job-order
costing system to accumulate the cost of client projects. In contrast, other costs incurred
by JLT, but not identifiable with specific clients are charged to jobs using a
predetermined overhead application rate. Clients are billed directly for chargeable costs,
overhead, and a markup. JLRs director of cost management, Brent Dean, anticipates the
following costs for the upcoming year:
Percentage of cost
Directly Traceable to
Cost Clients
Professional staff salaries $2,500,000 80%
Administrative support
staff 300,000 60%
Travel 250,000 90%
Photocopying 50,000 90%
Other operating costs 100,000 50%
Total $3,200,000
The firm desires to make a $640,000 profit for the firm and adds a percentage markup on
total cost to achieve that figure.
During the year, JLR received a proposal from Martin Inc. for a project. The following
costs are expected for this project: professional staff salaries, $41,000; administrative
support staff, $2,600; travel, $4,500; photocopying, $500; and other operating costs,
$1,400.
Required:
1. Determine JLRs total traceable costs for the upcoming year and the firms total
anticipated overhead
2. Calculate the predetermined overhead rate. The rate is based on total costs
traceable to client jobs.
3. What percentage of cost will JLR add to each job to achieve its profit target?
4. Determine the total cost of the Martin project. How much would Martin be quoted
for the project for the company?