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Midterm 1 Review.docx

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Aadil Merali Juma

Midterm 1 Review Chapter One: overview of managerial accounting  Accounting To provide stakeholders with useful information about a business enterprise Financial accounting To provide external users with useful financial information in order to make investment and credit decisions Management accounting To provide internal user with financial information and non-financial information as to achieve the goals of the organization Managerial Accounting Planning: Establishing goals and objectives, predicting results, and drawing a detailed plan of who will do what, when and how to achieve the desired goals. Implementing the plan and decision making: Directing, Motivating and measuring performance Controlling and performance evaluation: Keeping the firm's activities on track and ensuring that the plan has been followed in the implementation process. Agency theory: decision maker does not think about the company but only for themselves Similarities and Differences between Financial and Managerial accounting There are both similarities and differences between managerial and financial accounting. o Both fields of accounting deal with the economic events of a business and require that the results of that company's economic events be quantified and communicated to interested parties. o The two fields differ along several diminutions including: primary users of reports, types and frequency of reports, purpose of reports, content of reports, and verification process. Perspective  Financial Accounting Managerial Accounting Primary Users External users: Investors, Internal users: Managers of a creditors, tax authorities. firm at all levels Time Orientation (focus) Past Current &Future Purpose of reports General Purpose to help Special-purpose for a external users make particular user for a specific investment & credit decisions. decision Frequency of reporting Periodic (e.g. quarterly) As frequent as needed Level of aggregation Aggregate Very detailed Rules &Regulation of Regulated. Must follow GAAP No GAAP. Uses Cost--- Reporting Benefit concept Guideline for judging Focus on Reliability Focus is on Relevance usefulness of information Verification process Independent Audit Internal Audit Chapter Two: Intro to cost terms and purposes  Cost the value of economic resources (e.g., money) sacrificed or used up to achieve a particular objective (e.g., produce a product or perform a service). Cost object A cost object is anything for which a separate measurement of cost is desired or needed (e.g., cost of a product, a machine, a service, or a process). The cost can be identified Cost Driver A cost driver is any activity (e.g., production volume) or factor (e.g., time) that causes the total amount spent on a particular cost object to change. This influences cost behaviour Cost behaviour For the purposes of planning, control, and decision making, managers need to understand how the TOTAL amount spent on a particular cost object reacts to changes in a cost driver as measured, for example, by production or sales volume. Cost Estimation Cost estimation is defined as the development of a well-defined relationship between a cost object and its cost drivers, for the purpose of identifying cost behavior and predicting future costs. Cost assignment Cost assignment is the process of measuring the amount of costs consumed by a particular cost object from the costs incurred 1. Cost accumulation: collection of cost data in some organized means in an accounting system. a. The cost incurred example the wood for furniture 2. Cost assignment/classification: is a general term that describes the process of assigning (charging) costs incurred to a cost object. a. Direct costs of a cost object are those costs that can be traced easily to a cost object in an accurate and economically feasible (cost-effective) way. E.g.: Direct materials costs , Direct labor , can be traced directly to cost objects b. Indirect costs of a cost object are related to the particular cost object but cannot be traced to that cost object in an economically feasible (cost-effective) way. Indirect costs, therefore, should be allocated to the cost objects using an allocation BASE factor. E.g. depreciation of machines, maintenance cost, rent of the factory, and salary of supervisors, MOH Note the following: 1. The classification of costs into direct and indirect are defined with reference to a specific cost object. A particular cost can be classified as direct with respect to a certain cost object and indirect with respect to another cost object. 2. A cost would be considered indirect for one of two reasons: either it is impractical or it is impossible to trace the cost to the cost object. For example, it could be possible to measure the precise amount of nails or the amount of glue used on each table produced at a furniture plant, but it wouldn’t be worth the effort. Instead, cost of nails and glue would typically be considered an indirect material and would be included in overhead. Uses of cost information 1. Product Costing: Product costing means calculating the cost of production for the purpose of determining the Cost of Goods Sold (CGS) for income determination and cost of Ending Inventory to prepare the balance sheet. 2. Decision Making. Mangers need to make different types of decisions to run the company. Each decision requires different information. P-Costs a. Product Costs: Product costs are the costs charged to the units produced as they are incurred. They become part of the cost of goods manufactured and treated as inventory (i.e., asset) until they are sold. At this point, they become cost of goods sold and charged to the income statement at the end of the period. Balance sheet items, the assets b. Period Costs. Period costs are expensed in the time period in which they are incurred. All selling and administrative costs are typically considered to be period costs. Income statement items, the expenses Manufacturing costs 1.Direct Material 2.Direct Labor 3.Indirect (overhead): indirect material, indirect labour and other manufacturing overhead TMC=DM+DL+MOH Direct cost=DM+DL Conversion cost=DL+MOH T- Accounts and who they connect Some issue related to the cost of labour (MOH costs): Idle time: represents the wages of direct labour workers who are idle due to machine breakdowns, material shortages, power failures, and the like. Although the cost of the idle time can be traced to direct labor, it should be treated as indirect labor added to overhead, units are not being produced Overtime premium: the wage rate paid to workers (for both direct labor and indirect labor) in excess of their straight-time wage rates. Any overtime premium paid to factory workers (direct as well as indirect labor) is usually considered to be part of manufacturing overhead. However, if the customer is responsible for causing the overtime, then the overtime premium paid to direct workers will be treated as direct labor. Note that this case has to be explicitly stated, otherwise it should be treated indirect labor. Usually calculated with time and a half Reasons for overtime: -idle time causes overtime (overhead cost) -customers may ask for overtime periods for quicker service, in this case it is direct -bad scheduling (regular time is direct, overtime is indirect) Labour fringe benefits: made up of employment related costs paid by the employer. These costs are handled in two different ways by companies: 1. Many firms treat all such costs as indirect labor and add them to manufacturing overhead. 2. Other firms treat the fringe benefits that relate to direct labor as additional direct labor cost and those relate to indirect labor as FOH. Classifying cost for decision making Variable cost: a cost that changes (increases and decreases) in total in direct proportion to changes in the related level of activity or volume. Total variable costs for a given situation are equal to the number of units multiplied by the variable cost per unit….each unit is fixed -TVC is y-axis -units produced is x- axis -positive and always beginning at the origin Fixed cost: is a cost that remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume. As production increases, total fixed costs stay the same within the relevant range, but since we are dividing a constant numerator [total fixed costs] by a progressively larger denominator [total production or sales], the resulting costs per unit become smaller and smaller. Each unit is variable -TFC is the y-axis -units produced is x –axis “Relevant Range” is the range activity during which the relationship between the cost and cost driver remain valid. Mixed Cost: have characteristics of both fixed and variable cost Step function: Another example of mixed cost. An example of such cost behavior would be the total salary expense for shift supervisors. If the factory runs one shift, only one shift supervisor is required. In order for the factory to produce above the maximum capacity of a single shift, the factory must add a second shift and hire a second shift supervisor, so that total shift supervisor salary expense doubles. If the factory runs three shifts, three shift supervisors are required. -Total cost is y-axis - units produced is x-axis Chapter 10: Cost Estimation Cost estimation the process of developing a well-defined functional relationship between a cost object and its cost driver(s) in order to understand the cost behavior. The purposes of cost estimation are: (1) to identify the key cost drivers for each cost object to help managers control costs (2) to measure the variable and/or fixed components of the cost item so as to help managers make correct decisions, and (3) to predict its value in the future so as to help managers correctly plan for the future. Cost behaviours 1. The total cost may stay unchanged (fixed cost) 2. The total cost may change proportionately in response to the change on the activity level (variable cost) 3. It may partially change proportionately and partially remain constant (mixed cost) How to estimate cost function: There are six steps in the cost estimation process 1. Define the Cost item to be estimated. 2. Determine the Cost Drivers. 3. Collect Consistent and Accurate Data. 4. Plot (Graph) the Data. 5. Select and Employ the Estimation Method. 6. Assess the Accuracy of the Cost Estimation Linear Methods of cost estimation Basic assumptions (1) Changes in total costs can be explained by changes in the level of a single cost driver. (2) Cost behavior can adequately be approximated by a linear function of the activity level within the relevant range Basic Linear Function: straight line equation as follows: y = a + b(x) y = Total costs a = fixed cost component b = slope coefficient (variable cost rate) x = the volume (quantity) of the cost driver Note that: 1. If the estimated value of a = 0 and b > 0 then we can conclude that the cost behavior is Variable. 2. If the estimated value of b = 0 and a > 0 then we can conclude that the cost behavior is Fixed. 3. If the estimated values of both a & b > 0 then we can conclude that the cost behavior is Mixed. High-Low (HL) Method Assumption: only use one cost driver for hi-lo method relationship between cost drivers are linear 1. Identify the highest value of volume (X) and its associated value of cost (Y) 2. Identify the Lowest value of volume (X) and its associated value of cost (Y) 3. Use the above two points to estimate the parameter b (variable cost per unit) in the following cost function: b = UVC= Slope = Change in cost (y) (Hy – Ly) Change in volume (x) (Hx – Lx) 4. Estimate the Fixed component a as follows: Substitute the value of b into the basic equation along with actual values of Y and X at either the highest point or the lowest point into the following equation; then solve for the intercept a: y = a + b(x) Total Cost (lowest cost driver level) = a + b(x at lowest quantity of cost driver) Using the highest cost-quantity pair will give the same answer for the intercept. 5. Use the estimated cost function to predict future costs. Major Weakness of High-Low Method: 1. H-L method uses only two data points and ignores the rest of the data. 2. H-L method could provide biased estimates if the two data points are outliers. 3. H-L method does not provide information to evaluate how good the estimated function in representing the cost behavior or how accurate it is in predicting future costs. 4. It allows only one independent variable to explain the behavior of cost. Regression Analysis A statistical method for obtaining the unique cost-estimating equation that best fits a set of data points. Regression analysis fits the data by
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