MANAGERIAL ACCOUNTING GARRISON 11TH EDITION PDF

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For example, Motorola, Allied Signal, and many other companies now measure defects in terms of the number of defects per million units of product.

The main benefits of JIT ine the relationship between financial include: Funds that were tied up in inventories can be used elsewhere. Evidence on the Extent and Origins 2. Accounting Review, January , pp. Throughput time is reduced, resulting in greater potential output and quicker re- sponse to customers.

Defect rates are reduced, resulting in less waste and greater customer satisfaction. As a result of benefits such as those cited above, more companies are embracing JIT each year. Most companies find, however, that simply reducing inventories is not enough. To remain competitive in an ever changing and increasingly competitive business envi- ronment, companies must strive for continuous improvement. A production line can quickly come to a halt if essential parts are unavailable. Toyota, the developer of JIT, found this out the hard way.

By Tuesday, Toyota had to close down all of its Japanese assembly lines. A variety of specific tools are available to aid teams in their problem solving. One of these tools, benchmarking, involves studying organiza- tions that are among the best in the world at performing a particular task. For example, General Mills studied NASCAR pit crews in action to figure out how to cut the time to change a production line from one product to another from 4.

Kent Bowen couraging the use of science in decision-making and discouraging counter-productive de- explain how Toyota uses the scien- fensive behavior. As this list il- lustrates, TQM is international in scope and is not confined to manufacturing. Instead of tweaking the existing system in a series of incremental improvements, in Process Reengineering a business process is diagrammed in detail, questioned, and then com- pletely redesigned to eliminate unnecessary steps, to reduce opportunities for errors, and to reduce costs.

A business process is any series of steps that are followed to carry out Suggested Reading some task in a business. The steps followed by reengineering in a Harvard your bank when you deposit a check are a business process. While Process Reengineer- Business Review article. His more ing is similar in some respects to TQM, its proponents view it as a more sweeping ap- recent thinking with respect to proach to change. Business Review, November , Process Reengineering focuses on simplification and elimination of wasted effort.

Activities that do not add value to a product or ser- Business Review, September , vice that customers are not willing to pay for are known as non-value-added activities. For example, moving large batches of work in process from one workstation to another is a non-value-added activity. Rotab Khan provides a good TQM. These management approaches often overlap. There are only two ways to increase profits—decrease costs or Process Reengineering of an Air increase sales.

However, employees quickly get the message that process improvements lead to job losses and they will understandably re- sist further improvement efforts. If improvement is to be ongoing, employees must be convinced that the end result of improvement will be more secure rather than less secure jobs. This can only happen if management uses business process improvements to gener- ate more business rather than to cut the workforce.

Every in- dividual and every organization faces at least one constraint, so it is not difficult to find examples of constraints. You may not have enough time to study thoroughly for every subject and to go out with your friends on the weekend, so time is your constraint.

Mabin and Steven J. Vail Resorts has only a limited amount of land to develop Balderstone analyze quantitative as homesites and commercial lots at its ski areas, so its constraint is land. As an example, long waiting periods for surgery are a mance of the Theory of Constraints chronic problem in the National Health Service NHS , the government-funded provider Methodology: Analysis and Discus- of health care in the United Kingdom.

The number of patients who can be processed through each step in a day is indi- Production Management 23, no. For example, appointments for outpatient visits can be made for up , pp. Their results to referrals from general practitioners in a day. The total number of patients processed through result of applying the TOC.

No matter how hard managers, doctors, and nurses try to improve Suggested Reading the processing rate elsewhere in the system, they will never succeed in driving down wait To compare JIT production methods lists until the capacity of surgery is increased.

In fact, improvements elsewhere in the with the TOC approach to produc- system—particularly before the constraint—are likely to result in even longer waiting tion scheduling, see Patricia Huff, times and more frustrated patients and health care providers.

If you want to increase the strength of a chain, Quarterly, Winter , pp. Should you concentrate your efforts on strengthening the strongest link, all the links, or the weakest link? Explain to students that the theory of Continuing with this analogy, the procedure to follow to strengthen the chain is clear.

Ask students whether they would be on the system than the weakest link can handle—if you do, the chain will break. In the case better off spending their available of the NHS, waiting lists become unacceptably long. Third, concentrate improvement ef- time studying for a course in which forts on strengthening the weakest link. Find ways to increase the number of surgeries that they have an A average or one in can be performed in a day.

Fourth, if the improvement efforts are successful, eventually the which they have a C average. At that point, the new weakest link i. This simple sequential process provides a powerful strat- egy for continuous improvement. The TOC approach is a perfect complement to other im- provement tools such as TQM and process reengineering—it focuses improvement efforts where they are likely to be most effective.

It turned out, after investigation, that the constraint was not the emergency room itself; it was the housekeeping staff. To cut costs, managers at the hospital had laid off housekeeping workers. This created a bot- tleneck in the emergency room because rooms were not being cleaned as quickly as the emergency room staff could process new patients. Thus, laying off some of the lowest paid workers at the hos- pital had the effect of forcing the hospital to idle some of its most highly paid staff and most ex- pensive equipment!

Manage- ment of the plant is acutely aware of the necessity to actively manage its constraints. For example, when materials are a constraint, management may go to a secondary vendor and download materi- als at a higher cost than normal.

When a machine is the constraint, a weekend shift is often added on the machine. If a particular machine is chronically the constraint and management has exhausted the possibilities of using it more effectively, then additional capacity is downloadd.

For example, when the constraint was the plastic extruding machines, a new extruding machine was ordered. However, even before the machine arrived, management had determined that the constraint would shift to the blenders once the new extruding capacity was added.

Therefore, a new blender was al- ready being planned. International Competition Over the last several decades, competition has become worldwide in many industries.

This has been caused by reductions in tariffs, quotas, and other barriers to free trade; im- provements in global transportation systems; and increasing sophistication in interna- tional markets. These factors work together to reduce the costs of conducting international trade and make it possible for foreign companies to compete on a more equal footing with local companies.

Reductions in trade barriers have made it easier for agile and aggressive companies to expand outside of their home markets. As a result, very few companies can afford to be complacent. A company may be very successful today in its local market relative to its lo- cal competitors, but tomorrow the competition may come from halfway around the globe. As a matter of survival, even companies that are presently doing very well in their home markets must become world-class competitors.

On the bright side, the freer international movement of goods and services presents tremendous export opportunities for those com- panies that can transform themselves into world-class competitors. And, from the stand- point of consumers, heightened competition promises an even greater variety of goods, at higher quality and lower prices.

It would be very difficult for a company to become world-class if it plans, directs, and controls its operations and makes decisions using a second-class management accounting system. An excellent management accounting system will not by itself guarantee success, but a poor management accounting system can stymie the best efforts of people in an organization to make the company truly competitive.

It is noteworthy that ele- ments of well-designed management accounting systems have originated in many countries. More and more, managerial accounting has become a worldwide discipline. For example, Spain, Italy, and Greece have relied on less formal management accounting systems than other European countries. According to Professor Norman B. Spain also followed this pattern and relied more on personal relationships and oral inquisitions than on hard data for control. In the case of France, these were codified in law.

In England, management accounting practice was influenced by economists, who emphasized the use of accounting data in decision making. The Nordic countries tended to import management accounting ideas from both Germany and England. A number of factors have been acting in recent years to make management accounting prac- tices more similar within Europe and around the world. These forces include: E-Commerce Suggested Reading Widespread use of the Internet is a fairly new phenomenon, and the impact it will even- While the internet is reshaping how tually have on business is far from settled.

For a few brief months, it looked like dot. But, of course, the bubble burst and few of the startups are now in busi- For example, D. Keith Denton dis- ness. With the benefit of hindsight, it is now clear that the managers of the dot.

And , pp. At the time of this writing, it is still not clear if a successful business model will emerge for Internet-based companies. It is generally believed that site. The Internet has important advan- Review, March , pp. The financial institution does not have to tie up staff filling out forms—that can be done directly by the consumer over the Internet.

However, it is unlikely that a successful blockbuster business will ever be built around the concept of selling low-value, low-margin, and bulky items like groceries over the Internet.

The managers and companies involved in these scandals have suffered mightily—from huge fines to jail terms and financial collapse. And the recognition that ethical behavior is absolutely es- Reinforcing Problems sential for the functioning of our economy has led to numerous regulatory changes and Learning Objective 4 calls for new legislation.

But why is ethical behavior so important? This is not a matter Exercise 1—3 Basic 15 min. Problem 1—5 Basic 20 min.

Without that lubricant, the economy would operate much less efficiently—less would be Problem 1—7 Medium 20 min. As James Problem 1—8 Medium 30 min.

Surowiecki writes: Suggested Reading [F]lourishing economies require a healthy level of trust in the reliability and fairness For a brief discussion of how large of everyday transactions. If you assumed every potential deal was a rip-off or that the frauds and bankruptcies, such as products you were downloading were probably going to be lemons, then very little business WorldCom, affect other stakehold- ers, see Joseph Bower and Stuart would get done.

For an Review, December , pp.

Suppose that unethical farmers, distributors, and grocers knowingly tried to sell wormy apples as good apples and that grocers refused to take back wormy apples. What would you do? Go to another grocer? But what if all grocers acted in this way? What would you do then? You would probably either stop downloading apples or you would spend a lot of time inspecting apples before downloading them.

So would everyone else. Now notice what has happened. Because farmers, distributors, and grocers cannot be trusted, sales of apples would plummet and those who did download apples would waste a lot of time meticulously inspecting them. Everyone loses. Farmers, distributors, and gro- ceries make less money, consumers enjoy fewer apples, and consumers waste time look- ing for worms.

One commentator argues that integrity is particularly critical in companies whose as- sets are largely intangible: In the new, digital, trust-based economy, the stakes are extraordinarily high. Experience shows that this asset is built slowly and painfully but can be lost in an eye blink, and in losing it, you lose everything. But the firm also had legitimate businesses and actual assets. There is no room for fudging on this because the consequences of not having the electricity when consumers switch on their lights are dire.

This means that the firms with whom Enron was trading electricity. And trust Enron they did, to the tune of billions of dollars of trades every year. As everyone recognizes, the announcement caused investors to lower their valuations of the firm. Less understood, however, was the more important impact of the announcement; by revealing some of its reported earnings to be a house of cards, Enron sabotaged its reputation.

The effect was to undermine even its legitimate and previously prof- itable operations that relied on its trustworthiness. This is why Enron melted down so fast. When that reputation was wounded, energy traders took their business elsewhere. Energy traders lost their faith in Enron, but what if no other company could be trusted to deliver on Suggested Reading its commitments to provide electricity as contracted? In that case, energy traders would have For an overview of the parties that nowhere to turn.

As a direct result, energy producers with surplus generating capacity would be un- must all function properly for corpo- rate governance to be credible, see able to sell their surplus power. So a general , pp. Jonathan M. Even though the standards were specifically developed for management accountants, they have much broader application. All rights reserved. The standards have two ing Number 1C, Standards of Ethical parts. The first part provides general guidelines for ethical behavior.

In a nutshell, a man- Conduct for Practitioners of Manage- ment Accounting and Financial Man- agement accountant has ethical responsibilities in four broad areas: First, to maintain a agement issued by the Institute of high level of professional competence; second, to treat sensitive matters with confiden- Management Accountants, Mont- tiality; third, to maintain personal integrity; and fourth, to be objective in all disclosures.

We recommend that you stop at this point and read the stan- and the management accounting dards in Exhibit 1—5. EXHIBIT 1—5 Practitioners of management accounting and financial management have an obligation Standards of Ethical Conduct for to the public, their profession, the organization they serve, and themselves, to maintain Practitioners of Management the highest standards of ethical conduct. In recognition of this obligation, the Institute of Accounting and Financial Management Accountants has promulgated the following standards of ethical conduct Management for practitioners of management accounting and financial management.

Adherence to these standards, both domestically and internationally, is integral to achieving the Objectives of Management Accounting.

Practitioners of management accounting and financial management shall not commit acts contrary to these standards nor shall they condone the commission of such acts by others within their organizations. Practitioners of management accounting and financial management have a responsibility to: Practitioners of management accounting and financial management concluded have a responsibility to: Resolution of Ethical Conflict.

In applying the standards of ethical conduct, practi- tioners of management accounting and financial management may encounter prob- lems in identifying unethical behavior or in resolving an ethical conflict. When faced with significant ethical issues, practitioners of management accounting and financial management should follow the established policies of the organization bearing on the resolution of such conflict.

If these policies do not resolve the ethical conflict, such practitioner should consider the following courses of action: If a satisfactory resolution cannot be achieved when the problem is initially presented, submit the issues to the next higher managerial level. Except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate.

After resignation, depending on the nature of the ethical conflict, it may also be appropriate to notify other parties. Objectives of Management Accounting, Statement No.

The ethical standards provide sound, practical advice for management accountants Suggested Reading and managers. Most of the rules in the ethical standards are motivated by a very practical See Otto B. Consider the following specific examples of the consequences Management Accounting Quarterly, of not abiding by the standards: Fall , pp. Then top showing links between the impor- managers would be reluctant to distribute such information within the company and, tance placed by individuals on elements of the IMA code of ethics as a result, decisions would be based on incomplete information and operations and their own ethical judgments in would deteriorate.

Then contracts would tend to go to suppliers who pay the highest bribes rather than to the most competent suppliers. Would you like to fly in aircraft whose wings were made by the subcontractor who paid the highest bribe?

Would you fly as often? What would happen to the airline in- dustry if its safety record deteriorated due to shoddy workmanship on contracted parts and assemblies? Felo and nancial statements, they would have little basis for making informed decisions. Steven A. Implications of Sar- panies and may not be willing to invest at all.

As these examples suggest, if ethical standards were not generally adhered to, everyone would suffer—businesses as well as consumers. Essentially, abandoning ethical standards would lead to a lower standard of living with lower-quality goods and services, less to choose from, and higher prices. In short, following ethical rules such as those in the Stan- dards of Ethical Conduct for Practitioners of Management Accounting and Financial Management is absolutely essential for the smooth functioning of an advanced market economy.

Research 9, , pp. A man- dealing with fairness and ethics. They were the truth-tellers. Instead, CFOs became corporate spokesmen, guiding stock analysts in their quarterly earnings estimates— and then making sure that those earnings estimates were beaten using whatever was necessary, in- cluding accounting tricks and in some cases outright fraud.

CFOs at companies like Enron who allegedly became entangled in such corrupt practices found themselves under arrest and in hand- cuffs. What is needed? Greater personal integrity and less emphasis on meeting quarterly earnings estimates. Instead, they give broad Suggested Reading guidelines. For an interesting discussion of Unfortunately, the single-minded emphasis placed on short-term profits in some com- the negative effects of overempha- panies may make it seem like the only way to get ahead is to act unethically.

McCuddy, Karl E. Fact or Fiction? Management Accounting, April , pp. He is known to have proudly declared: For one of the chandising, and service. Man- petitive environment, see Robert S. Therefore, an understanding of costs in a manufac- Business Review, July— August turing company can be very helpful in understanding costs in other types of organizations. In this chapter, we develop cost concepts that apply to diverse organizations.

The exact PLUS terms used in these industries may not be the same as those used in manufacturing, but the 2—1 same basic concepts apply. With some slight modifications, these basic concepts also ap- ply to merchandising companies such as Wal-Mart, The Gap, 7-Eleven, Nordstrom, and Tower Records that resell finished goods acquired from manufacturers and other sources.

With that in mind, let us begin our discussion of manufacturing costs. Identify and give examples of direct materials, direct labor, and manufacturing overhead. A discussion of each of these each of the three basic categories follows. Direct Materials The materials that go into the final product are called raw materi- als. Actually, raw materials refer to any materials that Reinforcing Problems are used in the final product; and the finished product of one company can become the Learning Objective 1 raw materials of another company.

For example, the plastics produced by Du Pont are a Exercise 2—1 Basic 15 min. Exercise 2—10 Basic 30 min. One study of 37 man- Problem 2—14 Basic 30 min. Direct materials are those materials that become an integral part of the finished prod- Problem 2—24 Medium 60 min. This would include, for exam- Problem 2—26 Medium 60 min.

Also Problem 2—27 Medium 60 min. Problem 2—28 Difficult 60 min. Use something in the classroom Materials such as solder and glue are called indirect materials and are included as part such as a chair to illustrate manufac- of manufacturing overhead, which is discussed later in this section. Center discus- sion on the materials classified as Direct Labor The term direct labor is reserved for those labor costs that can be eas- direct materials and as manufactur- ily i. Direct labor is ing overhead; labor costs classified sometimes called touch labor, since direct labor workers typically touch the product while as direct labor and as manufacturing it is being made.

The labor costs of assembly-line workers, for example, would be direct overhead; and other costs incurred labor costs, as would the labor costs of carpenters, bricklayers, and machine operators. Indirect labor includes the la- More details about direct materials, bor costs of janitors, supervisors, materials handlers, and night security guards. Although direct labor, and manufacturing the efforts of these workers are essential to production, it would be either impractical or overhead costs can be found in impossible to accurately trace their costs to specific units of product.

Hence, such labor the following Statements on Man- costs are treated as indirect labor. So- the Institute of Management Ac- countants, Montvale, New Jersey phisticated automated equipment, run and maintained by skilled indirect workers, is in- www.

Statement Num- creasingly replacing direct labor. Indeed, in the study cited above of 37 manufacturing ber 4C: In a few companies, di- of Direct Labor Cost, Statement rect labor has become such a minor element of cost that it has disappeared altogether as a Number 4E: Definition and Measure- separate cost category. More is said in later chapters about this trend and about the impact ment of Direct Material Cost, and it is having on cost systems.

However, the vast majority of manufacturing and service com- Statement Number 4G: Accounting panies throughout the world continue to recognize direct labor as a separate cost category. Manufacturing Overhead Manufacturing overhead, the third element of manu- facturing cost, includes all costs of manufacturing except direct materials and direct labor.

Manufacturing overhead includes items such as indirect materials; indirect labor; mainte- nance and repairs on production equipment; and heat and light, property taxes, deprecia- tion, and insurance on manufacturing facilities.

A company also incurs costs for heat and light, property taxes, insurance, depreciation, and so forth, associated with its selling and administrative functions, but these costs are not included as part of manufacturing over- head. Only those costs associated with operating the factory are included in the manu- facturing overhead category. All of these terms are synonyms for manu- facturing overhead. Manufacturing overhead combined with direct labor is called conversion cost or sometimes value-added cost.

Miller, A. DeMeyer, and J. Richard D. Irwin, , Chapter 2. The Boer and Jeter article cited above contains a similar finding con- cerning the magnitude of manufacturing overhead. Direct labor com- bined with direct materials is called prime cost. Nonmanufacturing Costs Generally, nonmanufacturing costs are subclassified into two categories: Marketing or selling costs.

Administrative costs. Marketing or selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are often called order- getting and order-filling costs. Examples of marketing costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses. Administrative costs include all executive, organizational, and clerical costs associ- ated with the general management of an organization rather than with manufacturing, marketing, or selling.

Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the organization as a whole. Do you ever wonder why tuition costs are so high?

Administrative costs can be crushing. Forbes magazine reports that an average of 2. The worst case is Mississippi, which has four adminis- trators for every teacher. For instance, they can also be classified as either product costs costs and period costs and or period costs. To understand the difference between product costs and period costs, we give examples of each.

Generally, costs are recognized as expenses on the income statement in the period that benefits from the cost. For example, if a company pays for liability insurance in ad- vance for two years, the entire amount is not considered an expense of the year in which the payment is made.

Instead, one-half of the cost would be recognized as an expense each year. The reason is that both years—not just the first year—benefit from the insur- ance payment. The unexpensed portion of the insurance payment is carried on the balance sheet as an asset called prepaid insurance. You should be familiar with this type of accrual from your financial accounting coursework. The matching principle is based on the accrual concept and states that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized.

This means that if a cost is incurred to acquire or make something that will eventually be sold, then the cost should be recognized as an expense only when the sale takes place—that is, when the benefit occurs. Such costs are called product costs. Product Costs For financial accounting purposes, product costs include all the costs that are involved in acquiring or making a product. So initially, product costs are Exercise 2—2 Basic 15 min. Exercise 2—11 Basic 15 min. When the goods are sold, the costs Exercise 2—12 Basic 30 min.

Since product costs are initially assigned to inventories, they are Problem 2—15 Basic 30 min. Problem 2—19 Medium 30 min. We want to emphasize that product costs are not necessarily treated as expenses in the Problem 2—20 Medium 15 min. Rather, as explained above, they are treated as expenses Problem 2—23 Medium 30 min.

This means that a product cost such Problem 2—24 Medium 60 min. Problem 2—26 Medium 60 min. Problem 2—27 Medium 60 min.

Period Costs Case 2—31 Difficult 60 min. Period costs are all the costs that are not included in product costs. Period costs tion between product costs and are not included as part of the cost of either downloadd or manufactured goods. Sales com- period costs.

Ask students if raw missions and office rent are good examples of period costs. Neither commissions nor of- materials downloads are inventoried fice rent are included as part of the cost of downloadd or manufactured goods. Thus, they are said to be period costs. As suggested above, all selling and administrative expenses are considered to be pe- riod costs. Advertising, executive salaries, sales commissions, public relations, and other nonmanufacturing costs discussed earlier would all be period costs.

They will appear on the income statement as expenses in the period in which they are incurred. Exhibit 2—1 page 40 contains a summary of the cost terms that we have introduced so far. Most companies are involved in only one or two of these activities. Looking at this company allows us to see how costs are distributed across the entire value chain. A recent income statement from the company contained the following data: Millions of Percent of Euros Revenues Revenue.

Payroll and related cost. One U. Direct labor as indirect materials, indirect is sometimes called touch labor. Jon E. The re- ports you studied were probably those of merchandising companies, such as retail stores, PLUS which simply download goods from suppliers for resale to customers. In this section, we fo- cus our attention on how this accounting is carried out in the balance sheet and income statement. The Balance Sheet The balance sheet, or statement of financial position, of a manufacturing company is sim- ilar to that of a merchandising company.

However, the inventory accounts differ between the two types of companies. A merchandising company has only one class of inventory— goods downloadd from suppliers that are awaiting resale to customers. In contrast, manu- facturing companies have three classes of inventories—raw materials, work in process, and finished goods. Raw materials are the materials that are used to make a product. Work in process consists of units of product that are only partially complete and will re- quire further work before they are ready for sale to a customer.

Finished goods consist of units of product that have been completed but have not yet been sold to customers. The overall inventory figure is usually broken down into these three classes of inventories in a footnote to the financial statements.

We will use two companies—Graham Manufacturing and Reston Bookstore—to il- lustrate the concepts discussed in this section. Graham Manufacturing is located in Portsmouth, New Hampshire, and makes precision brass fittings for yachts.

Reston Book- store is a small bookstore in Reston, Virginia, specializing in books about the Civil War. The work in process inventory consists of partially completed brass fit- tings. The finished goods inventory consists of brass fittings that are ready to be sold to customers. In contrast, the inventory account at Reston Bookstore consists entirely of the costs of books the company has downloadd from publishers for resale to the public.

In mer- chandising companies like Reston, these inventories may be called merchandise inven- tory. The beginning and ending balances in this account appear as follows: For purposes of illustration, these statements contain more detail about cost of of goods sold.

Reinforcing Problems At first glance, the income statements of merchandising and manufacturing compa- Learning Objective 3 nies like Reston Bookstore and Graham Manufacturing are very similar. The only appar- Exercise 2—3 Basic 15 min.

In the exhibit, the computation of cost of goods sold relies on the following Exercise 2—12 Basic 30 min. Problem 2—24 Medium 60 min. Case 2—30 Difficult 60 min. The logic underlying this equation, which applies to any inventory account, is illus- Case 2—31 Difficult 60 min. Ending merchandise inventory. Selling expense. Cost of goods manufactured. See Exhibit Goods available for sale.

Ending finished goods inventory. The sum of the beginning balance and the additions to the account is the total Since three inventory accounts often amount of inventory available. During the period, withdrawals are made from inventory. They start out company like Reston Bookstore as follows: Total downloads can be easily determined in a merchandising company by simply adding together all downloads from suppliers. The cost of goods sold for a manufacturing company like Graham Manufacturing is determined as follows: The cost of goods manufactured consists of the manufacturing costs associated with goods that were finished during the period.

The cost of goods manufactured figure for Graham Manufacturing is derived in Exhibit 2—4, which contains a schedule of cost of goods manufactured. However, it is all quite logical. downloads of raw materials. Ending raw materials inventory. Insurance, factory. Beginning work in process inventory. Ending work in process inventory. Using a Supplies account for indirect materials is a common practice among companies. In Chapter 3, we discuss the procedure to be followed if both direct and indirect materials are carried in a single account.

Reinforcing Problems of cost of goods manufactured contains the three elements of product costs that we dis- Learning Objective 4 cussed earlier—direct materials, direct labor, and manufacturing overhead. The direct ma- Exercise 2—4 Basic 15 min. The downloads of raw materials are added to the be- Problem 2—24 Medium 60 min.

The ending materi- Problem 2—26 Medium 60 min. The sum of the three cost elements—materials, direct labor, and manufacturing Problem 2—29 Difficult 45 min. This is not the same thing, however, as the cost Case 2—30 Difficult 60 min. The subtle distinction between the total manufactur- Case 2—31 Difficult 60 min. Some of the materials, di- rect labor, and manufacturing overhead costs incurred during the period relate to goods that are not yet completed. As stated above, the cost of goods manufactured consists of the man- ufacturing costs associated with the goods that were finished during the period.

Conse- quently, adjustments need to be made to the total manufacturing cost of the period for the partially completed goods that were in process at the beginning and at the end of the period.

The costs that relate to goods that are not yet completed are shown in the work in process inventory figures at the bottom of the schedule. Note that the beginning work in process in- ventory must be added to the manufacturing costs of the period, and the ending work in process inventory must be deducted, to arrive at the cost of goods manufactured. For manufactured goods, these costs consist of direct ma- terials, direct labor, and manufacturing overhead. It will be helpful at this point to look briefly at the flow of costs in a manufacturing company.

This will help us understand how product costs move through the various accounts and how they affect the balance sheet and the income statement. Exhibit 2—5 illustrates the flow of costs in a manufacturing company.

Raw materials downloads are recorded in the Raw Materials inventory account. When raw materials are used in production, their costs are transferred to the Work in Process inventory account as direct materials. Notice that direct labor cost and manufacturing overhead cost are added directly to Work in Process. Work in Process can be viewed most simply as products on an assembly line. The direct materials, direct labor, and manufacturing overhead costs added to Work in Process in Exhibit 2—5 are the costs needed to complete these products as they move along this assembly line.

Notice from the exhibit that as goods are completed, their costs are transferred from Work in Process to Finished Goods. Here the goods await sale to customers. At this point the various material, labor, and overhead costs required to make the product are finally recorded as expenses. Until that point, these costs are in inventory accounts on the balance sheet. Inventoriable Costs As stated earlier, product costs are often called inventoriable costs.

The reason is that these costs go directly into inventory accounts as they are incurred first into Work in Process and then into Finished Goods , rather than going into expense accounts. Thus, they are termed inventoriable costs. This is a key concept since such costs can end up on the balance sheet as assets if goods are only partially completed or are unsold at the end of a period. To illustrate this point, refer again to Exhibit 2—5. As explained earlier, these costs will not become expenses until later when the goods are completed and sold.

Selling and administrative expenses are not involved in making a product. For this reason, they are not treated as product costs but rather as period costs that are expensed as they are incurred, as shown in Exhibit 2—5.

Thus far, we have been mainly concerned with classifications of manufacturing costs for the purpose of determining inventory valuations on the balance sheet and cost of goods sold on the income statement of external financial reports. However, costs are used for many other purposes, and each purpose requires a different classification of costs. These purposes and the corresponding cost classifications are summarized in Exhibit 2—7. To help keep the big picture in mind, we suggest that you refer back to this exhibit frequently as you progress through the rest of this chapter.

My problem basically is that my boss, the division general manager, wants me to put costs into inventory that I know should be expensed.

Have you expressed your doubts to your boss? Yes, but he is basically a salesman and claims he knows nothing about GAAP. Also, he asks if I am ready to make the entries that I think are im- proper.

It seems he wants to make it look like my idea all along. What does he say when you tell him these matters need resolution? He just says we need a meeting, but the meetings never solve anything.

Does your company have an ethics hot-line? Yes, but my boss would view use of the hot-line as snitching or even whistle-blowing. If you might face reprisals for using the hot-line, perhaps you should evaluate whether or not you really want to work for a company whose ethical climate is one you are un- comfortable in.

Curtis C. Cost behavior refers to how a cost will react to changes in the level of activity. As the activity level rises and falls, a particu- lar cost may rise and fall as well—or it may remain constant. For planning purposes, a manager must be able to anticipate which of these will happen; and if a cost can be ex- pected to change, the manager must be able to estimate how much it will change.

To help make such distinctions, costs are often categorized as variable or fixed. Variable Cost Exercise 2—11 Basic 15 min. Problem 2—14 Basic 30 min. A variable cost is a cost that varies, in total, in direct proportion to changes in the level Problem 2—15 Basic 30 min. The activity can be expressed in many ways, such as units produced, units Problem 2—16 Basic 30 min.

A good ex- Problem 2—19 Medium 30 min. The cost of direct materials used during a pe- Problem 2—21 Medium 15 min. To Problem 2—24 Medium 60 min. Each auto requires one battery. Problem 2—25 Medium 45 min. As the output of autos increases and decreases, the number of batteries used will increase Problem 2—27 Medium 60 min. The concept of a variable cost is shown in graphic form in Exhibit 2—8.

It is important to note that when we speak of a cost as being variable, we mean the to- tal cost rises and falls as the activity level rises and falls. In economics, a variable cost There are many examples of costs that are variable with respect to the products and is a cost that can be modified in the services provided by a company.

In a manufacturing company, variable costs include short term. A fixed cost is a cost that items such as direct materials and some elements of manufacturing overhead such as lu- cannot be modified in the short term. For the present, we will also assume that Economists do not assume that vari- direct labor is a variable cost, although as we shall see in Chapter 5, direct labor may act able costs are proportional to activ- more like a fixed cost in many situations.

In a merchandising company, variable costs in- ity. On the contrary, economists clude items such as cost of goods sold, commissions to salespersons, and billing costs.

In usually assume that costs are a a hospital, the variable costs of providing health care services to patients would include nonlinear function of activity.

However, costs can be vari- vidual has in mind when using the able with respect to other things. For example, the wages paid to employees at a Block- terms. Nevertheless, when we say that a cost is variable, Lippman in The Wall Street Journal, we ordinarily mean it is variable with respect to the amount of goods and services pro- Thursday, February 18, , duced.

This could be how many Jeep Cherokees are produced, how many videos are p. News Corp. Fixed Cost A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity.

Unlike variable costs, fixed costs are not affected by changes in activity. Rent is a good example of a fixed for the cost of a large pizza. Then cost. What would be the cost per ples for the presence of leukemia cells. The concept of pizza? What if four people download the a fixed cost is shown in graphic form in Exhibit 2—8. This makes it clear why fixed Very few costs are completely fixed.

Most will change if there is a large enough costs change on a per unit basis. To change in activity. For example, suppose that the capacity of the leukemia diagnostic ma- illustrate variable costs, add that a chine at the Mayo Clinic is 2, tests per month. So if two people were eating the would cause a jump in the fixed costs. When we say a cost is fixed, we mean it is fixed pizza, the total beverage bill would within some relevant range.

This is be- beverage. In the Mayo Clinic, for example, the average cost per test will fall as the number of tests performed increases. This concept is illus- trated in the table below: Fixed cost Total fixed cost is not affected Fixed cost per unit decreases by changes in the activity level as the activity level rises and within the relevant range.

More will be said later about the problems created for both the accountant and the manager by this variation in unit costs. Examples of fixed costs include straight-line depreciation, insurance, property taxes, rent, supervisory salaries, administrative salaries, and advertising. A summary of both variable and fixed cost behavior is presented in Exhibit 2—9. It now costs more to bill for the call than to provide it. In short, they have extremely high fixed costs for equip- ment, buildings, and personnel.

The prices the telephone companies charge to consumers must cover these fixed costs as well as the relatively small variable costs of completing a particular call for a customer. A cost object is anything for which cost data are desired— between direct and indirect including products, product lines, customers, jobs, and organizational subunits. For pur- costs.

A direct cost is a cost that can be easily and conveniently traced to the particular cost ob- Problem 2—15 Basic 30 min. The concept of direct cost extends beyond just direct materials Problem 2—16 Basic 30 min. For example, if Reebok is assigning costs to its various regional and na- Problem 2—21 Medium 15 min.

Indirect Cost An indirect cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration. For example, a Campbell Soup factory may produce dozens of varieties of canned soups.

To be traced to a cost object such as a partic- Suggested Reading ular product, the cost must be caused by the cost object. Gordon and Martin P.

A common cost is a type of indirect cost. In the first case, the cost ob- Summer , pp. In the second case, the cost object is the entire manufacturing division. Decisions involve choosing between alternatives. In business decisions, each alternative will have costs and benefits that must be compared to the costs and benefits of the other Reinforcing Problems available alternatives.

A difference in costs between any two alternatives is known as a Learning Objective 7 Exercise 2—7 Basic 15 min. A difference in revenues between any two alternatives is known as dif- Problem 2—14 Basic 30 min.

A differential cost is also known as an incremental cost, although technically an in- cremental cost should refer only to an increase in cost from one alternative to another; de- creases in cost should be referred to as decremental costs. Differential cost is a broader term, encompassing both cost increases incremental costs and cost decreases decre- mental costs between alternatives.

In speaking of changes in cost and revenue, the economist employs the terms marginal cost and marginal revenue. The revenue that can be obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is called marginal cost. Differential costs can be either fixed or variable.

To illustrate, assume that Nature Way Cosmetics, Inc. Present costs and revenues are compared to projected costs and revenues in the following table: The decision of whether Nature Way Cosmetics should stay with the present retail distribution or switch to door-to-door direct selling could be made on the basis of the net operating incomes of the two alternatives.

In general, only the differences between alternatives are relevant in decisions. Those items that are the same under all alternatives and that are not affected by the decision can be ignored. This is an extremely important prin- ciple in management accounting that we will return to in later chapters.

Flying on a commercial airline can be an expensive and grueling experience for these patients. Taking the initiative, she founded Corporate Angel Net- work www. Since its founding, Corporate Angel Network has provided over 16, free flights.

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To illustrate this important concept, consider the following examples: She would like to spend a week at the beach during spring break, and her employer has Their opportunity cost is the value agreed to give her the time off, but without pay. Rather than invest the funds in land, the company could invest the funds in high-grade securities.

If the land is acquired, the opportunity cost will be the investment income that could have been realized if the secu- rities had been downloadd instead.

He is thinking about leaving the company and returning to school. Virtually every alternative has some opportunity cost attached to it. In example 3 above, for instance, if Steve decides to stay at his job, the higher income that could be re- alized in future years as a result of returning to school is an opportunity cost. Should you special-purpose machine. Even though in hindsight the download of the machine may before selling it?

They could go on only one of the ski trips and would have to throw away the unused ticket. The larger cost mattered more to the students than having more fun.

However, the sunk costs of the tickets should have been totally irrelevant in this decision. And since this cost does not differ between the alternatives, it should be ignored.

Like these students, most people have a great deal of difficulty ignoring sunk costs when making decisions. Summary Summary In this chapter, we have looked at some of the ways in which managers classify costs. How the costs will be used—for preparing external reports, predicting cost behavior, assigning costs to cost objects, or decision making—will dictate how the costs are classified. For purposes of valuing inventories and determining expenses for the balance sheet and in- come statement, costs are classified as either product costs or period costs.

Product costs are as- signed to inventories and are considered assets until the products are sold. At the point of sale, product costs become cost of goods sold on the income statement. In contrast, following the usual accrual practices, period costs are taken directly to the income statement as expenses in the period in which they are incurred.

In a merchandising company, product cost is whatever the company paid for its merchandise. For external financial reports in a manufacturing company, product costs consist of all manufac- turing costs. In both kinds of companies, selling and administrative costs are considered to be pe- riod costs and are expensed as incurred. For purposes of predicting cost behavior—how costs will react to changes in activity— managers commonly classify costs into two categories—variable and fixed.

Variable costs, in total, are strictly proportional to activity. The variable cost per unit is constant. The average fixed cost per unit decreases as the number of units increases. For purposes of assigning costs to cost objects such as products or departments, costs are clas- sified as direct or indirect. Direct costs can be conveniently traced to cost objects. Indirect costs cannot be conveniently traced to cost objects. It seems he wants to make it look like my idea all along.

What does he say when you tell him these matters need resolution? He just says we need a meeting, but the meetings never solve anything. Does your company have an ethics hot-line? Yes, but my boss would view use of the hot-line as snitching or even whistle-blowing. If you might face reprisals for using the hot-line, perhaps you should evaluate whether or not you really want to work for a company whose ethical climate is one you are un- comfortable in.

Curtis C. Cost behavior refers to how a cost will react to changes in the level of activity. As the activity level rises and falls, a particu- lar cost may rise and fall as well—or it may remain constant. For planning purposes, a manager must be able to anticipate which of these will happen; and if a cost can be ex- pected to change, the manager must be able to estimate how much it will change. To help make such distinctions, costs are often categorized as variable or fixed.

Variable Cost Exercise 2—11 Basic 15 min. Problem 2—14 Basic 30 min. A variable cost is a cost that varies, in total, in direct proportion to changes in the level Problem 2—15 Basic 30 min. The activity can be expressed in many ways, such as units produced, units Problem 2—16 Basic 30 min. A good ex- Problem 2—19 Medium 30 min. The cost of direct materials used during a pe- Problem 2—21 Medium 15 min. To Problem 2—24 Medium 60 min. Each auto requires one battery. Problem 2—25 Medium 45 min. As the output of autos increases and decreases, the number of batteries used will increase Problem 2—27 Medium 60 min.

The concept of a variable cost is shown in graphic form in Exhibit 2—8. It is important to note that when we speak of a cost as being variable, we mean the to- tal cost rises and falls as the activity level rises and falls. In economics, a variable cost There are many examples of costs that are variable with respect to the products and is a cost that can be modified in the services provided by a company.

In a manufacturing company, variable costs include short term. A fixed cost is a cost that items such as direct materials and some elements of manufacturing overhead such as lu- cannot be modified in the short term. For the present, we will also assume that Economists do not assume that vari- direct labor is a variable cost, although as we shall see in Chapter 5, direct labor may act able costs are proportional to activ- more like a fixed cost in many situations. In a merchandising company, variable costs in- ity.

On the contrary, economists clude items such as cost of goods sold, commissions to salespersons, and billing costs. In usually assume that costs are a a hospital, the variable costs of providing health care services to patients would include nonlinear function of activity.

However, costs can be vari- vidual has in mind when using the able with respect to other things. For example, the wages paid to employees at a Block- terms. Nevertheless, when we say that a cost is variable, Lippman in The Wall Street Journal, we ordinarily mean it is variable with respect to the amount of goods and services pro- Thursday, February 18, , duced. This could be how many Jeep Cherokees are produced, how many videos are p.

News Corp. Fixed Cost A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity. Unlike variable costs, fixed costs are not affected by changes in activity. Rent is a good example of a fixed for the cost of a large pizza.

Then cost. What would be the cost per ples for the presence of leukemia cells. The concept of pizza? What if four people download the a fixed cost is shown in graphic form in Exhibit 2—8.

This makes it clear why fixed Very few costs are completely fixed. Most will change if there is a large enough costs change on a per unit basis. To change in activity. For example, suppose that the capacity of the leukemia diagnostic ma- illustrate variable costs, add that a chine at the Mayo Clinic is 2, tests per month. So if two people were eating the would cause a jump in the fixed costs. When we say a cost is fixed, we mean it is fixed pizza, the total beverage bill would within some relevant range.

This is be- beverage. In the Mayo Clinic, for example, the average cost per test will fall as the number of tests performed increases. This concept is illus- trated in the table below: Fixed cost Total fixed cost is not affected Fixed cost per unit decreases by changes in the activity level as the activity level rises and within the relevant range.

More will be said later about the problems created for both the accountant and the manager by this variation in unit costs. Examples of fixed costs include straight-line depreciation, insurance, property taxes, rent, supervisory salaries, administrative salaries, and advertising.

A summary of both variable and fixed cost behavior is presented in Exhibit 2—9. It now costs more to bill for the call than to provide it. In short, they have extremely high fixed costs for equip- ment, buildings, and personnel. The prices the telephone companies charge to consumers must cover these fixed costs as well as the relatively small variable costs of completing a particular call for a customer.

A cost object is anything for which cost data are desired— between direct and indirect including products, product lines, customers, jobs, and organizational subunits.

For pur- costs. A direct cost is a cost that can be easily and conveniently traced to the particular cost ob- Problem 2—15 Basic 30 min.

The concept of direct cost extends beyond just direct materials Problem 2—16 Basic 30 min. For example, if Reebok is assigning costs to its various regional and na- Problem 2—21 Medium 15 min. Indirect Cost An indirect cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration.

For example, a Campbell Soup factory may produce dozens of varieties of canned soups. To be traced to a cost object such as a partic- Suggested Reading ular product, the cost must be caused by the cost object. Gordon and Martin P. A common cost is a type of indirect cost. In the first case, the cost ob- Summer , pp. In the second case, the cost object is the entire manufacturing division. Decisions involve choosing between alternatives. In business decisions, each alternative will have costs and benefits that must be compared to the costs and benefits of the other Reinforcing Problems available alternatives.

A difference in costs between any two alternatives is known as a Learning Objective 7 Exercise 2—7 Basic 15 min. A difference in revenues between any two alternatives is known as dif- Problem 2—14 Basic 30 min. A differential cost is also known as an incremental cost, although technically an in- cremental cost should refer only to an increase in cost from one alternative to another; de- creases in cost should be referred to as decremental costs.

Differential cost is a broader term, encompassing both cost increases incremental costs and cost decreases decre- mental costs between alternatives. In speaking of changes in cost and revenue, the economist employs the terms marginal cost and marginal revenue. The revenue that can be obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is called marginal cost. Differential costs can be either fixed or variable.

To illustrate, assume that Nature Way Cosmetics, Inc. Present costs and revenues are compared to projected costs and revenues in the following table: The decision of whether Nature Way Cosmetics should stay with the present retail distribution or switch to door-to-door direct selling could be made on the basis of the net operating incomes of the two alternatives.

In general, only the differences between alternatives are relevant in decisions. Those items that are the same under all alternatives and that are not affected by the decision can be ignored. This is an extremely important prin- ciple in management accounting that we will return to in later chapters. Flying on a commercial airline can be an expensive and grueling experience for these patients.

Taking the initiative, she founded Corporate Angel Net- work www. Since its founding, Corporate Angel Network has provided over 16, free flights.

To illustrate this important concept, consider the following examples: She would like to spend a week at the beach during spring break, and her employer has Their opportunity cost is the value agreed to give her the time off, but without pay.

Rather than invest the funds in land, the company could invest the funds in high-grade securities. If the land is acquired, the opportunity cost will be the investment income that could have been realized if the secu- rities had been downloadd instead.

He is thinking about leaving the company and returning to school. Virtually every alternative has some opportunity cost attached to it. In example 3 above, for instance, if Steve decides to stay at his job, the higher income that could be re- alized in future years as a result of returning to school is an opportunity cost. Should you special-purpose machine. Even though in hindsight the download of the machine may before selling it?

They could go on only one of the ski trips and would have to throw away the unused ticket. The larger cost mattered more to the students than having more fun. However, the sunk costs of the tickets should have been totally irrelevant in this decision. And since this cost does not differ between the alternatives, it should be ignored. Like these students, most people have a great deal of difficulty ignoring sunk costs when making decisions. Summary Summary In this chapter, we have looked at some of the ways in which managers classify costs.

How the costs will be used—for preparing external reports, predicting cost behavior, assigning costs to cost objects, or decision making—will dictate how the costs are classified. For purposes of valuing inventories and determining expenses for the balance sheet and in- come statement, costs are classified as either product costs or period costs.

Product costs are as- signed to inventories and are considered assets until the products are sold. At the point of sale, product costs become cost of goods sold on the income statement. In contrast, following the usual accrual practices, period costs are taken directly to the income statement as expenses in the period in which they are incurred.

In a merchandising company, product cost is whatever the company paid for its merchandise. For external financial reports in a manufacturing company, product costs consist of all manufac- turing costs. In both kinds of companies, selling and administrative costs are considered to be pe- riod costs and are expensed as incurred. For purposes of predicting cost behavior—how costs will react to changes in activity— managers commonly classify costs into two categories—variable and fixed.

Variable costs, in total, are strictly proportional to activity. The variable cost per unit is constant. The average fixed cost per unit decreases as the number of units increases.

For purposes of assigning costs to cost objects such as products or departments, costs are clas- sified as direct or indirect. Direct costs can be conveniently traced to cost objects. Indirect costs cannot be conveniently traced to cost objects.

For purposes of making decisions, the concepts of differential cost and revenue, opportunity cost, and sunk cost are of vital importance. Differential costs and revenues are the costs and rev- enues that differ between alternatives. Opportunity cost is the benefit that is forgone when one al- ternative is selected over another.

Sunk cost is a cost that occurred in the past and cannot be altered. Differential costs and opportunity costs should be carefully considered in decisions.

Sunk costs are always irrelevant in decisions and should be ignored. These various cost classifications are different ways of looking at costs. A particular cost, such as the cost of cheese in a taco served at Taco Bell, could be a manufacturing cost, a product cost, a variable cost, a direct cost, and a differential cost—all at the same time. Taco Bell can be consid- ered to be a manufacturer of fast food.

The cost of the cheese in a taco would be considered a man- ufacturing cost and, as such, it would be a product cost as well. In addition, the cost of cheese would be considered variable with respect to the number of tacos served and would be a direct cost of serving tacos.

Finally, the cost of the cheese in a taco would be considered a differential cost of making and serving the taco. Review Problem 1: CostReview Terms Problem 1: Cost Terms Many new cost terms have been introduced in this chapter. It will take you some time to learn what each term means and how to properly classify costs in an organization. Consider the following ex- ample: Porter Company manufactures furniture, including tables. Selected costs are given below: Four machine-hours are required to produce a table.

The ma- chines have no resale value and do not wear out through use. Classify these costs according to the various cost terms used in the chapter. Carefully study the classification of each cost. The terms variable cost and fixed cost refer to how costs behave with respect to the number of tables produced in a year.

Rental income forgone on factory space. To avoid possible confusion with other costs, we will not attempt to classify this cost in any other way except as an opportunity cost. Review Problem 2: Schedule Review Problemof2: Selling expenses. Prepare a schedule of cost of goods manufactured as in Exhibit 2—4. Compute the cost of goods sold. Using data as needed from 1 and 2 above, prepare an income statement. Solution to Review Problem 2 1. Raw materials inventory, January 1.

Raw materials inventory, December Utilities, factory. Work in process inventory, January 1. Work in process inventory, December The cost of goods sold would be computed as follows: Finished goods inventory, January 1.

Finished goods inventory, December For example, the wage cost of the pilot of a airliner is a common cost of all of the passengers on the aircraft. Without the pilot, there would be no flight and no passengers. Examples of possible cost objects are prod- ucts, product lines, customers, jobs, and organizational subunits such as departments or divi- sions of a company.

Also see Incremental cost. Also called touch labor. If a fixed cost is expressed on a per unit basis, it varies inversely with the level of activity. Also see Differential cost. These items may become an in- tegral part of a finished product, but their costs cannot be easily or conveniently traced to it.

In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Also see Inventoriable costs. A variable cost is constant per unit. Are these costs a part of the costs of direct la- costs associated with idle time, bor or are they something else?

Reinforcing Problems Idle Time Learning Objective 8 Machine breakdowns, materials shortages, power failures, and the like result in idle time. Exercise 2—8 Basic 15 min. The labor costs incurred during idle time may be treated as a manufacturing overhead cost Exercise 2—13 Basic 15 min.

Problem 2—17 Basic 30 min. This approach spreads such costs over all the production of a period rather than just the jobs that happen to be in process when breakdowns or Suggested Reading other disruptions occur. Statement on Management Account- To give an example of how the cost of idle time may be handled, assume that a press ing Number 4C: If the press operator is paid for a normal hour workweek surement of Direct Labor Cost, but is idle for 3 hours during a given week due to breakdowns, labor cost would be allo- issued by the Institute of Manage- cated as follows: Overtime Premium The overtime premium paid to all factory workers direct labor as well as indirect labor is usually considered to be part of manufacturing overhead and is not assigned to any par- ticular order.

At first glance this may seem strange, since overtime is always spent work- ing on some particular order. Why not charge that order for the overtime cost? The reason is that it would be considered unfair and arbitrary to charge an overtime premium against a particular order simply because the order happened to fall on the tail end of the daily production schedule. To illustrate, assume that two batches of goods, order A and order B, each take three hours to complete.

By the time the run on order B is completed, two hours of overtime have been logged. The necessity to work overtime was a result of the fact that total production exceeded the regular time available. Order B was no more responsible for the overtime than was order A. Therefore, managers feel that all production should share in the premium charge that resulted. She is paid time and a half for overtime time in excess of 40 hours a week. During a given week, she works 45 hours and has no idle time.

Her labor cost for the week would be allocated as follows: Many companies treat all such costs as indirect labor by adding them to manufactur- ing overhead. Other companies treat the portion of fringe benefits that relates to direct la- bor as additional direct labor cost. This approach is conceptually superior, since the fringe benefits provided to direct labor workers clearly represent an added cost of their services.

Appendix 2B: Cost of Quality Appendix 2B: Cost of Quality A company may have a product with a high-quality design that uses high-quality compo- nents, but if the product is poorly assembled or has other defects, the company will have high warranty repair costs and dissatisfied customers.

People who are dissatisfied with a product are unlikely to download the product again. They are also likely to tell others about their bad experiences. To pre- vent such problems, companies have been expending a great deal of effort to reduce de- fects. The objective is to have high quality of conformance.

Note Identify the four types of quality that if an economy car is free of defects, it can have a quality of conformance that is just costs and explain how they as high as a defect-free luxury car. The downloadrs of economy cars cannot expect their interact. Reinforcing Problems Preventing, detecting, and dealing with defects causes costs that are called quality Learning Objective 9 costs or the cost of quality.

The use of the term quality cost is confusing to some people. Exercise 2—9 Basic 15 min. It does not refer to costs such as using a higher-grade leather to make a wallet or using Problem 2—18 Basic 60 min.

Instead, the term quality cost refers to all of the costs that are incurred to prevent defects or that result from defects in products. Individuals selected to be Black Belts undergo intensive training for four months in statistical process control and other quality-control techniques. William M. A1 and A6. Hart, James L. Heskett, and W. Earl Sasser, Jr. Two of these groups— many of the ideas in this appendix. The other two groups of ant gritty ice crystals in its ice costs—known as internal failure costs and external failure costs—are incurred because cream.

Ask students for examples defects are produced despite efforts to prevent them. Examples of specific costs involved of internal and external failure costs in each of these four groups are given in Exhibit 2B—1.

Internal Several things should be noted about the quality costs shown in the exhibit. Second, the ice crystals. External failure costs number of costs associated with quality is very large; total quality cost can be quite high could result from customers return- unless management gives this area special attention. Finally, the costs in the four groupings ing defective ice cream or downloading are quite different.

We will now look at each of these groupings more closely. One ap- first place. It is much less costly to prevent a problem from ever happening than it is to proach would be to investigate the find and correct the problem after it has occurred.

Prevention costs support activities manufacturing process. Perhaps the whose purpose is to reduce the number of defects. Companies employ many techniques gritty ice crystals are caused by to prevent defects including statistical process control, quality engineering, training, and temperature variations in the freezer.

Controlled experiments could be a variety of tools from Total Quality Management. If this is the circles and statistical process control. Quality circles consist of small groups of employ- cause, the variation in temperature ees that meet on a regular basis to discuss ways to improve quality. Both management could be decreased or the ingredi- and workers are included in these circles. Quality circles are widely used and can be ents changed so they would be less found in manufacturing companies, utilities, health care organizations, banks, and many sensitive to temperature changes.

An out-of-control process results in defective units and may be caused For an excellent case study of a by a miscalibrated machine or some other factor. In statistical process control, workers quality improvement program, see George Foster and Leif Sjoblom, use charts to monitor the quality of units that pass through their workstations. Problems can be immediately corrected and further defects prevented rather than Management Accounting Research waiting for an inspector to catch the defects later.

Note also from the list of prevention costs in Exhibit 2B—1 that some companies pro- Lawrence P. Carr describes Xe- vide technical support to their suppliers as a way of preventing defects. If a defective part is received from a supplier, the part pp. Hence, every part received from a supplier must be free of defects. Consequently, companies that use JIT often require that their suppliers use sophisticated quality control programs such as statistical process control and that their suppliers certify that they will deliver parts and materials that are free of defects.

Yamada Electric had a per- sistent problem assembling a simple push-button switch. The switch has two buttons, an on button and an off button, with a small spring under each button.

Assembly is very simple. A worker inserts the small springs in the device and then installs the buttons. However, the worker sometimes forgets to put in one of the springs. After each such incident, workers are urged to be more careful, and for a while quality im- proves. But eventually, someone forgets to put in a spring, and Yamada gets into trouble with the customer again. This chronic problem was very embarrassing to Yamada.

Shigeo Shingo, an expert on quality control, suggested a very simple solution. A small dish was placed next to the assembly station. At the beginning of each operation, two of the small springs are taken out of a parts box containing hundreds of springs and placed in the dish.

The worker then as- sembles the switch.

Managerial Accounting Garrison 11th Edition Solutions

If a spring remains on the dish after assembling the switch, the worker imme- diately realizes a spring has been left out, and the switch is reassembled.

This simple change in procedures completely eliminated the problem. Shigeo Shingo and Dr. Productivity Press , pp. Appraisal costs, which are sometimes called inspection costs, are incurred to Continuing the ice cream example, identify defective products before the products are shipped to customers. For proach to quality control. We have 40 quality control inspectors in the random in a small but important factory.

Or the ice tory. So now the trick is to run a factory without any quality control inspectors; each em- crystals could only be detected by ployee is his or her own quality control person.

This approach, along with designing products to be easy to manufacture properly, allows quality to be built into products rather than relying on inspection to get the de- fects out. Internal Failure Costs Failure costs are incurred when a product fails to conform to its design specifications.

Failure costs can be either internal or external. Internal failure costs result from identi- fying defects before they are shipped to customers. These costs include scrap, rejected products, reworking of defective units, and downtime caused by quality problems.

This is the price that is paid to avoid incurring external fail- ure costs, which can be devastating. As Often it is cheaper to prevent defects shown in Exhibit 2B—1, external failure costs include warranty repairs and replacements, than to inspect them out or put up product recalls, liability arising from legal action against a company, and lost sales aris- with the costs of internal or external ing from a reputation for poor quality.

Such costs can decimate profits. It could even share and profits. Quality costs for U. Carr and Lawrence A. How Ponemon provide empirical evi- does a company reduce its total quality cost? The answer lies in how the quality costs are dence from pulp and paper mills distributed.

Refer to the graph in Exhibit 2B—2, which shows total quality costs as a func- concerning the trade-offs among tion of the quality of conformance.

However, as a company spends more and more on agement, Summer , pp.

This results in lower internal and external failure costs. Ordi- ing quality are discussed in Alahas- narily, total quality cost drops rapidly as the quality of conformance increases. Thus, a sane Diallo, Zafar U. Khan, and company can reduce its total quality cost by focusing its efforts on prevention and ap- Curtis F. Management Accounting, August The graph in Exhibit 2B—2 has been drawn so that the total quality cost is minimized , pp.

Indeed, many companies have found that the total quality costs seem to Costs: Appraisal can only find defects, whereas prevention can eliminate them. The best way to prevent defects from happening is to design processes that reduce the likeli- hood of defects and to continually monitor processes using statistical process control methods.

A quality cost report details the prevention costs, appraisal costs, cost report. Managers are often shocked by the magnitude of these costs. A typical Reinforcing Problems quality cost report is shown in Exhibit 2B—3 page Learning Objective 10 Several things should be noted from the data in the exhibit. The external failure costs are particularly high in Year 1 in comparison to other costs.

Second, note that the company increased its spending on prevention and appraisal activities in Year 2. Because of the increase in appraisal activity in Year 2, more defects were caught inside the company before they were shipped to customers.

This resulted in more cost for scrap, rework, and so forth, but saved huge amounts in warranty repairs, warranty replacements, and other external fail- ure costs. Third, note that as a result of greater emphasis on prevention and appraisal, total quality cost decreased in Year 2. As continued emphasis is placed on prevention and ap- praisal in future years, total quality cost should continue to decrease. Systems development.

Net cost of scrap. Warranty repairs. Moreover, appraisal costs should also decrease as more effort is placed in prevention. Companies that sell products that rely on soft- ware know this, and fighting these particular defects can consume enormous resources. For exam- ple, it was once estimated that the cost of quality i. Lead in Software?

Venky Nagar and Madhav V.This means that a product cost such Problem 2—24 Medium 60 min. Such costs are called product costs. A few months later, the accounting ploys Dunlap had been using to bolster earnings came unraveled, leading to a dramatic boardroom ouster.

Disposal of defective products. Do you need a variable cost, do you need a fully burdened cost, do you need overhead applied, are you just talking about discretionary cost? One study of 37 man- Problem 2—14 Basic 30 min. Cost of the new color laser printer. The United States has experienced over years of unprecedented economic prosperity in large part because innovators like Henry Ford applied these economic principles with a vengeance.

In applying the standards of ethical conduct, practi- tioners of management accounting and financial management may encounter prob- lems in identifying unethical behavior or in resolving an ethical conflict.

Suresh S.

BETTYE from Amarillo
See my other articles. I take pleasure in sea kayaking. I do fancy queerly.
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