bec week 1 slides

Kaplan CPA ReviewBusiness Environment and ConceptsCost, Volume , Profit Analysis, and

Variance Analysis

Kaplan CPA ReviewBusiness Environment and ConceptsCost, Volume , Profit Analysis, and

Variance Analysis

BEC Exam Content: Valid Through December 31, 2010

• Structures, partnerships, and corporations 17–23%

• Economics—micro and macro 8–12%

• Financial management 17–23%

• Information technology 22–28%

• Planning and measurement* 22–28%

• BEC exam consists of multiple choice questions only—2.5 hour exam (shortest of all four parts)

• *Tonight’s class falls within planning and measurement

3

Approach

• Try to learn something about every topic rather than try to know everything about a few topics

4

How Many Hours Should You Study?

• No two candidates are alike—little credit is given for time spent; credit is given only for results. A good rule would be to try to study for ten minutes the first day rather than three hours and then gradually build that up to 60 minutes. It is easier to go from one hour to two hours, but hard to study for two hours having never studied for ten minutes.

5

Are Weekends Enough?

• I would rather see a candidate study one hour a day, six days out of seven, than try to save it all for the weekend

6

Exam Rules

• Candidates can take one section of the exam at a time—that’s the good news. Start with the BEC, pass the BEC, and then must pass the other three sections in 18 months. The 18 months begins on the date you pass your first section.

7

Registering for the Exam

• Your State Board of Accountancy will advise you of what you need to do to sit for the exam, including education requirements, more credit hours, or a MBA. You must know what your state requires.

8

NASBA

• The National Association of State Boards of Accountancy’s Website, www.nasba.org, has prepared a comparison of state board requirements. Can you take the New Jersey exam if you live in New York? What about reciprocity? See the Kaplan Schweser Website for more details.

9

Apply to Sit Early

• A frequent problem that candidates have is failing to apply by the deadline. Have someone else review your completed application before mailing it to the state board.

10

How Do You Know the State Board Received Everything?

• Once you have been cleared to take the exam by the applicable state board, you will receive by mail a notice to schedule, NTS, and then schedule to sit for one or more sections

11

Exam Window

• The CPA Exam may be taken only during the open periods of:

• January–February

• April–May

• July–August

• October–November

12

When Should You Start Studying?

• Your exam preparation should begin at least two months prior to the date you plan to schedule your seating for an exam section

13

Where Do You Actually Take the Exam?

• A test center locator and scheduler application is available at Prometric’s Website, www.prometric.com/cpa. Prometric is the company that was hired by the AICPA to administer the CPA exam by computer. Candidates should schedule with Prometric at least 45 days in advance. Choose a convenient location near your home and familiarize yourself with it.

14

Outline of Steps Discussed

1. Choose your sections and prepare to pass those sections

2. Apply and obtain acceptance from your state board

3. Schedule your test location and time

15

Common Myth

• Most candidates believe that they pass the exam on the day of the exam and that’s not really the case. You only take the exam that day; you actually pass the exam every day you prepare.

16

External Reporting by a Company: GAAP

• Focus on historical performance

• Sales

• Less: Cost of goods sold

• Gross profit

• Less: Operating expenses

• Net income

• Known as absorption costing

• Appropriate under US generally accepted accounting principles (GAAP)—FAR exam

17

Internal Decision Making

• When a company is faced with a decision, such as raising the sale price of its items or changing the mix of expenses, possible future net income needs to be estimated

• Instead of using absorption costing, companies normally use direct costing (sometimes called variable costing) to anticipate net income because management is not always comfortable with GAAP reporting when it comes to making internal decisions

• Direct costing is not allowed according to US GAAP, but it is widely used internally to evaluate proposed decisions—for the BEC exam, you must know direct costing

18

2009 Release Question

Which of the following topics is the focus of managerial accounting?

A. Financial statements and other financial reports

B. Historical cost principles

C. The needs of creditors

D. The needs of the organization's internal parties

Source: 2009 AICPA Release Questions

19

Question – Answer

• Answer is D

• The purpose of managerial accounting is to provide internal decision makers with information to make better decisions

• Answer A is incorrect because financial statements and other financial reports are prepared for external users in accordance with GAAP

20

Question – Answer (continued)

• Answer B is incorrect because the focus of managerial accounting is on current performance, not on historical cost.

• Answer C is incorrect because the needs of creditors are met with absorption costing

21

Direct Costing: Computing Net Income

• In direct costing, net income is computed as follows:

• Sales – Variable costs – Fixed costs = Net income

• Allows management to make internal decisions

• GAAP doesn’t distinguish between fixed and variable costs, so management needs direct costing for internal decision making

• GAAP only cares about product cost versus period cost

22

Question

Which of the following is CORRECT?

I. Managerial accounting often departs from GAAP since the users of the information are internal rather than external.

II.Direct costing is widely used in managerial accounting to anticipate net income.

23

Question (continued)

Correct answer is:

A. I only.

B. II only.

C. Both I and II.

D. Neither I nor II.

Source: AICPA 2008 Release Questions 24

Question – Answer

• Answer is C

• Managerial accounting often departs from GAAP since the users of the information are internal rather than external

• Direct costing is widely used in managerial accounting to anticipate net income

25

Question

In managerial accounting, which of the following terms is synonymous with direct costing?

I. Absorption costing.

II. Variable costing.

26


Best answer is:

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Source: AICPA 2008 Release Questions

27

Question – Answer

• Answer is B

• In managerial accounting, direct costing or variable costing is used to anticipate net income. Direct costing does not follow GAAP rules but are allowed for internal decision making purposes. Absorption costing is GAAP and is required for (external) financial statement purposes.

28

Absorption Versus Direct Costing

• The difference in operating income under absorption and variable costing is attributable to the handling of fixed manufacturing costs. Examples of fixed costs include rent, depreciation, and property taxes. These costs are inventoried under absorption costing and expensed under variable costing.

29

Question

In which of the following methods of accounting would fixed manufacturing costs be inventoried and not expensed?

I. Variable or direct costing.

II. Absorption costing.

30


Best answer is:

A. I only.

B. II only.

C. Both I and II.



31

Question – Answer

• Answer is B

• The difference in operating income under absorption and variable costing is attributable to the handling of fixed manufacturing costs. These fixed manufacturing costs are inventoried under absorption accounting and expensed under variable costing.

32

Direct Costing Formula

• Remember, in direct costing, net income is computed as follows:

• Sales – variable costs – fixed costs = net income

33

Variable Costs

• A variable cost is any cost that stays the same per unit but changes in total as production or sales change

• Examples: direct materials, direct labor, electricity, and sales commissions. If a company doesn’t sell anything, there are no sales commissions

• In direct costing, variable costs are stated as a percentage of sales or as a cost per unit

• The more produced or sold, the more variable cost there is. Total variable cost changes with production.

• If the plant has to shut down, all the costs saved are variable costs 34

Fixed Costs

• A fixed cost is any cost that does not change as production or sales change. Examples of fixed costs include rent, depreciation, and property taxes.

• In direct costing, fixed costs are usually stated as a set dollar amount. For example, fixed costs for a company might be $60,000 per year.

35

Relevant Range

• Variable costs and fixed costs are said to hold their particular cost pattern only within a relevant range

• For example, if a company has to produce an especially high number of units, it may have to rent more space and buy more equipment. Then, a new fixed cost amount would be established at that new level.

36

Question – Part 1

• Adrian Co. incurred the following costs:

• Direct materials and direct labor $600,000

• Variable factory overhead $80,000

• Straight line depreciation:

• Production machinery $70,000

• Factory building $50,000

• Under direct costing, what are the inventoriable costs?

37

Question – Part 1 (continued)

Answer is:

A. $680,000.

B. $730,000.

C. $750,000.

D. $800,000.

38

Question – Answer

• Answer is A

• $600,000 + $80,000 = $680,000

• Only variable manufacturing costs are inventoriable under the direct costing method. Depreciation would be expensed under direct costing.

39

Question – Part 2

• Delvin Co. incurred the following costs:



• Straight line depreciation:

• Production machinery $70,000

• Factory building $50,000

• Under absorption costing, the inventoriable costs are?

40


Determine the best answer:

A. $680,000.

B. $730,000.

C. $750,000.

D. $800,000.

41

Question – Answer

• Answer is D

• $600,000 + $80,000 + depreciation of production machinery of $70,000 + depreciation of factory machinery $50,000 = $800,000

• Full absorption costing considers all those costs to be manufacturing costs

42


Which of the following costs would decreaseif production levels were increased within the relevant range?

A. Total fixed costs.

B. Variable costs per unit.

C. Total variable costs.

D. Fixed costs per unit


43

Question – Answer

• Answer is D

• Because total fixed costs remain the same within a relevant range, the fixed costs per unit will decrease as production increases

• Answer A is incorrect because total fixed costs will remain the same within a relevant range

• Answer B is incorrect because variable costs per unit remain the same within a relevant range

• Answer C is incorrect because total variable costs will increase as production levels increase

44

2008 Release Question• Selected information concerning the operations of the

Drudge Company for the year ending December 31 is as follows:

• Units produced 20,000

• Units sold 18,000

• Direct materials used $80,000

• Direct labor incurred $40,000

• Fixed factory overhead $50,000


• Fixed selling and administrative expenses $60,000

• Variable selling and administrative expenses $9,000


45

2008 Question – Part 1

Work-in-process inventories at the beginning and end of the year were zero. Under the direct costing method, how much of DrudgeCo. costs are inventoriable?

A. $239,000.

B. $194,000.

C. $170,000.

D. $144,000.

46

Question – Answer

• Answer is D• Inventory is calculated differently under the

variable (direct) costing method than with the absorption method. Fixed manufacturing costs are not inventoriable under the variable costing method. Therefore, in this problem, the only inventoriable costs are direct materials, direct labor, and variable factory overhead ($80,000 + $40,000 + $24,000 = $144,000). The variable selling and administrative expenses are

expensed.

47

Release Question – Part 2

Work-in-process inventories at the beginning and end of the year were zero. What was the Drudgecompany's finished goods inventory cost at December 31 under the variable (direct) costing method based on the 2000 units remaining?

A. $23,900.

B. $19,400.

C. $17,000.

D. $14,400.


Question – Answer

• Answer is D• Inventory is calculated differently under the

variable (direct) costing method than with the absorption method. Fixed manufacturing costs are not inventoriable under the variable costing method. Therefore, in this problem, the only inventoriable costs are direct materials, direct labor, and variable factory overhead ($80,000 + $40,000 + $24,000 =

$144,000).

49


• Because there is a zero balance in the work-in-process inventory at the beginning and ending of the year, all of these costs ($144,000) have been recorded in finished goods inventory. However, the costs associated with the goods sold (18,000 units sold) have been moved out of finished goods inventory and into cost of goods sold. Therefore, the finished goods inventory cost is only for the 2,000 units still in finished goods.

50

• 2,000 units out of 20,000 units = 10%; therefore, the correct answer would be 10% of $144,000, or $14,400

OR

• $144,000 / 20,000 units = $7.20 per unit; therefore, 2,000 × $7.20 = $14,400


51

Terminology

• In working with direct costing, knowledge of certain terms is important:

• Contribution margin is sales revenue minus variable costs

• Breakeven point is the amount of sales needed to make neither a profit nor a loss

• Margin of safety is the amount of sales in excess of the sales needed to break even

52

Vocabulary: Exam Hint

• The terms “contribution margin,” “breakeven point,” and “margin of safety” are of great internal importance. They will only appear, however, on an income statement prepared for internal purposes using the direct or variable costing method. The terms “contribution margin,”“breakeven point,” and “margin of safety” would not appear on an income statement using the absorption costing method. The exam loves to test this.

53

Question

Which of the following methods are allowed for internal reporting?

I. Direct or variable costing.

II. Full absorption costing.

54


Correct answer is:

A. I only.

B. II only.

C. Both I and II.


55

Question – Answer

• Answer is C

• Absorption costing is used for external reporting, and is allowed for internal reporting as well. Variable or direct costing is allowed only for internal use and is not allowed for external reporting. The absorption costing method is the one allowed by GAAP.

56

Question

In an income statement prepared as an internal report using the absorption costing method, which of the following terms should appear?

I. Contribution margin.

II. Gross profit (margin).

57


Best answer is:

A. I only.

B. II only.

C. Both I and II.


58

Question – Answer

• Answer is B

• Contribution margin is a term associated with variable costing. However, it is not applicable to absorption costing. Contribution margin is sales less all variable costs and it’s from this amount that all fixed costs (manufacturing, selling, and administrative) are deducted to determine operating income. Under absorption costing, cost of goods sold includes both variable and fixed manufacturing costs and sales less cost of goods sold is referred to as gross profit or gross margin.

• Absorption costing is used for external reporting and is allowed for internal reporting as well. Variable or direct costing is allowed only for internal use and is not allowed for external reporting

59

Question

In an income statement prepared as an internal report using the variable costingmethod, which of the following terms should appear?

I. Gross profit (margin).

II. Operating income.

60


Best answer is:

A. I only.

B. II only.

C. Both I and II.


61

Question – Answer

• Answer is B

• Gross profit is a term associated with absorption costing. However, it is not applicable to variable costing. Under direct costing, the cost of goods sold includes only the variable costs associated with the inventory sold and sales less variable cost of goods sold is referred to as contribution margin-manufacturing, not gross profit. Operating income applies to both variable and absorption costing.

62

Direct Costing: Computing Net Income

• In direct costing, net income is computed as follows:

sales – variable costs – fixed costs = net income

63

Question

• Last year, a company had sales of $100,000, variable costs of $60,000, and fixed costs of $30,000, so that net income was $10,000

• This year, the cost patterns are expected to stay the same except that fixed costs will go up to $40,000

64


1. How much revenue does the company have to generate to have the same net income this year?

2. How much revenue does the company have to generate this year just to break even?

65

Question – Answer

• Variable cost is 60% of revenue ($60,000 / $100,000)

• Fixed cost is now $40,000

• Desired net income is the same as last year’s $10,000 figure

66

Question – Answer

• Formula—income of $10,000

Sales – Variable costs – Fixed costs = Net income

• Variable costs $60,000 / Sales $100,000 = .6

• Sales – 0.60 Sales – $40,000 = $10,000

• 0.40 Sales = $50,000

• Sales = $125,000

67

Question – Answer

• Formula—breakeven point

Sales – Variable costs – Fixed costs = Net income

• Sales – 0.60 Sales – $40,000 = 0

• 0.40 Sales = $40,000

• Breakeven sales = $100,000

68

Question

•The following information pertains to Beta Corp.

• Sales $400,000

• Variable costs $80,000

• Fixed costs $20,000

Beta’s breakeven point in sales dollars is

A.$20,000

B.$25,000

C.$80,000

D.100,000

69

Question – Answer

• Answer is B

• Breakeven point in dollar sales equals fixed costs/contribution margin percent

• Sales $400,000

• Less variable costs 80,000

• Contribution margin $320,000

• $320,000 / $400,000 = 80% contribution margin

• Fixed costs $20,000 / 80% contribution margin = $25,000

70

Question – Part 1

• The following information pertains to April Corp.

• Sales (50,000 units) $1,000,000


• Factory overhead:

• Variable $40,000

• Fixed $70,000

• Selling and general expenses:

• Variable $10,000

• Fixed $60,000

71


Assuming direct labor is a variable cost, how much was April’s contribution margin?

A. $650,000.

B. $700,000.

C. $660,000.

D. $950,000.

72

Question – Answer

• Answer is A

• Fixed costs are $70,000 + $60,000 = $130,000. Variable costs are $350,000 ($300,000 + $40,000 + $10,000).

• Direct materials and direct labor are both variable costs

• Sales of $1,000,000 less variable costs of $350,000 equals a contribution margin of $650,000

• Note that even the variable selling and administrative expense of $10,000 is included in the calculation of contribution margin

73

Question – Part 2

Assuming direct labor is a variable cost, how much was April’s breakeven point in number of units?

A. 10,000.

B. 18,571.

C. 26,000.

D. 9,848.

74

Question – Answer

• Answer is A

• Fixed costs are $70,000 + $60,000 = $130,000. Variable costs are $350,000 ($300,000 + $40,000 plus $10,000).

• Direct materials and direct labor are both variable costs

• Sales of $1,000,000 less variable costs of $350,000 equals a contribution margin of $650,000. Per unit, the contribution margin is $650,000 / 50,000 units, or $13.00.

• Breakeven in units is fixed cost / contribution margin per unit, so $130,000 / $13 = 10,000 units

75

Question

Using the variable costing method, which of the following costs are assigned to inventory?

I. Variable selling and administrative costs.

II. Variable factory overhead costs.

76


Best answer is:

A. I only.

B. II only.

C.Both I and II.

D.Neither I nor II.

77

Question – Answer

• Answer is B

• Under direct or variable costing, product costs, or inventoriable costs, include only variable manufacturing costs (direct material, direct labor, and variable overhead). Variable selling costs are used in the calculation of contribution margin; however, they are not a product cost.

78

Question

In direct costing, variable selling costs are:

I. used in the calculation of contribution margin.

II. expensed rather than included as an inventoriable cost.

79


Correct answer is:

A. I only.

B. II only.

C. Both I and II.


80

Question – Answer

• Answer is C

• In direct costing, variable selling costs are used in the calculation of contribution margin; however, they are NOT an inventoriable cost

81

Question

In an income statement prepared as an internal report using the direct (variable) costing method, which of the following would be included in the computation of contribution margin?

I. Fixed selling and administrative expenses.

II. Variable selling and administrative expenses.

82


Best answer is:

A. I only.

B. II only.

C. Both I and II.


83

Question – Answer

• Answer is B

• Under the direct or variable costing method, variable costs are deducted from revenue to determine the contribution margin and all fixed costs are then deducted to obtain net income or income from operations. The contribution margin is calculated in two steps:

1.Revenue less variable cost of goods sold = contribution margin – manufacturing

2.Contribution margin – manufacturing less other variable costs (selling general and administrative) = contribution margin final

84

Question

If Curry Inc. is preparing an income statement using the variable costing method, fixed factory overhead would:

A. not be used.

B. be used in the computation of the contribution margin.

C. be used in the computation of operating income but not in the computation of the contribution margin.

D. be treated the same as variable factory overhead.

85

Question – Answer

• Answer is C

• Under the direct costing method, variable costs are deducted from sales revenue to determine the contribution margin and all fixed costs are then deducted to obtain net income or income from operations. The contribution margin is calculated in two steps:

1.Revenue less variable cost of goods sold = contribution margin – manufacturing

2.Contribution margin – manufacturing less other variable costs (selling general and administrative) = contribution margin final

86

Standard Cost Accounting and Variance Analysis

• In manufacturing companies, a standard cost is normally determined for each item being produced based on what the company believes should be expended

• Variance analysis is then used to isolate differences that occur between actual results and the standard so that possible remedial action can be taken. The CPA exam gets involved here because business failure is often the result of not understanding costs.

87

Direct Labor and Direct Material

• The most important variances that are computed deal with direct labor and direct material

• Direct labor is the cost of any employee who actually works in the manufacturing process

• Direct material is the cost of any materials that are traceable to the product being manufactured

88

Direct Labor Variances

• Two separate direct labor variances are computed: understanding the difference between what the company paid employees and what the company expected to pay them

• A direct labor rate variance measures whether the employees are being paid more or less than the standard rate

• A direct labor efficiency variance measures whether employees take longer or less time to produce items than the standard time

89

Direct Labor Rate Variance

Actual hours × (actual rate – standard sate)

• The total actual hours worked multiplied by the actual pay rate gives the actual amount paid to employees

• The total actual hours worked multiplied by the standard pay rate shows what the company expected to pay

×

90

Direct Labor Rate Variance: Favorable or Unfavorable

• The difference between these two computations is the direct labor rate variance

• If the actual rate was higher, the variance is unfavorable; if the actual rate was lower than the standard, the variance is favorable

91

Question

A company plans to produce 1000 units and expects the process to take four hours of direct labor for each unit (4,000 hours expected). The standard cost of labor is set at $11.00 per hour. The company actually uses 4,100 hours of labor this period to produce 1,100 units. The labor had a cost of $10.70 per hour. How much is the labor rate variance?

92


Answer is:

A. $1,230 favorable.

B. $1,230 unfavorable.

C. $1,200 favorable.

D. $1,200 unfavorable.

93

Question – Answer

• Answer is A

• The company saved 30 cents per hour on its labor charge. Because it paid 4,100 hours at this reduced rate, the labor rate variance is $1,230 ($4,100 × .30). It is favorable because the company paid less than expected.

94

Direct Labor Efficiency (Usage) Variance

• Standard rate × (actual hours – standard hours)

• The total actual hours worked multiplied by the standard pay rate is computed

• Also, the standard number of hours that should have been worked is multiplied by the standard pay rate to determine the standard labor cost for the period

95

Standard Hours Worked

• The difference in the two computations is the direct labor efficiency variance. It is favorable or unfavorable depending on whether the employees required more or less hours than the standard

• The standard number of hours is based on the actual level of production for the period

96

Question

• A company plans to produce 1,000 units and expects the process to take 4 hours of direct labor for each unit. The standard cost of labor is $11.00 per hour. The company actually uses 4,500 hours of labor this period to produce 1,100 units. The company had to pay a cost of $11.10 to get workers. How much is the labor efficiency variance?

97


Best answer is:



C. $1,110 favorable.


98

Question – Answer

• Answer is B

• Since the company produces 1,100 units, it would have expected to utilize 4,400 hours of labor (based on the standard of four hours per unit). The company actually had to pay for 4,500 hours, so that 100 extra hours were required.

• Efficiency variances are valued based on the standard cost. Because the standard cost here is $11.00 per hour, the labor efficiency variance for these 100 hours is $1,100 unfavorable

99


The difference between standard hours at standard wage rates and actual hours at standard wage rates is referred to as which of the following types of variances?

A. Labor rate.

B. Labor (efficiency) usage.

C. Direct labor spending.

D. Indirect labor spending.


Question – Answer

• Answer is B

• This question is asking for the variance associated with the actual amount of time needed to complete the job compared to the expected, or standard, amount of time needed to complete the job. This is determined by comparing standard hours to actual hours and measuring that difference by applying the standard wage rate. Choices C and D are not viable answers.

101

Direct Material Variances

• Two separate direct material variances are also computed:

• A direct material price variance measures whether the company paid more or less than the standard rate for materials this period

• A direct usage (or quantity) variancemeasures whether the company used more or less material than the standard amount to produce items this period

102

Direct Material Price Variance• Actual quantity purchased × (actual price –

standard price)

• Similar to labor rate variance

• The actual quantity of materials bought multiplied by the actual purchase price gives the actual amount paid for materials

• The actual quantity of materials bought multiplied by the standard purchase price shows what the company expected to pay for these materials purchased

103

Direct Material Price Variance: Favorable or Unfavorable

• The difference in these two computations is the direct material price variance

• If the actual rate was higher, the variance is unfavorable; if the actual rate was lower than the standard, the variance is favorable

104

2008 Release QuestionFor the current period production levels, Woodwork Co. budgeted 11,000 board feet of production and purchased 15,000 board feet. The material cost was budgeted at $7 per foot. The actual cost for the period was $8.50 per foot. What was Woodwork's material price variance for the period?

A. $6,000 unfavorable.


C. $19,500 unfavorable.



105

Question – Answer

• Answer is D

• The direct materials price variance is calculated by finding the difference between the standard price and the actual price ($8.50 – $7), and measuring the difference by the actual quantity purchased (15,000)

• ($8.50 – $7) × 15,000 = $22,500

• Because the price paid is greater than the standard price, the variance is unfavorable

106

Question

• A company plans to produce 1,000 units and expects to use 2 pounds of material in each unit. The standard cost of the material is $3.00 per pound. The company actually buys 2,700 pounds of material but only uses 2,090 pounds this period to produce 1,100 units. The material had a cost of $3.20 per pound. How much is the material price variance?

107


Answer is:

A. $540 unfavorable.

B. $540 favorable.

C. $418 favorable.

D. $418 unfavorable.

108

Question – Answer

• Answer is A

• The company paid 20 cents more than expected in buying 2,700 pounds of material. Thus, the material price variance is $540 unfavorable. A material price variance is computed based on the amount of materials purchased, rather than the amount actually used in production during the period.

109


• Relevant information for material A follows:

• Quantity purchased 6,500 lbs.

• Standard quantity allowed 6,000 lbs.

• Actual price $3.80

• Standard price $4.00



What was the direct material price variance for material A?


B. $1,200 favorable.

C. $1,200 unfavorable.



111

Question – Answer

• Answer is A

• The direct material price variance is calculated by comparing the actual price paid ($3.80) to the standard price ($4.00). This difference is then multiplied by the quantity purchased (6,500).

• ($4.00 – $3.80) × 6,500 = $1,300

• This variance is favorable because the price paid is less than the standard price

112

Direct Material Usage Variance

• Standard price × (actual quantity – standard quantity)

• Similar to labor efficiency variation

• Multiply the actual quantity of materials used in the period by the standard purchase price

• Multiply the standard quantity of material that should have been used by the standard purchase price to determine the standard for the period

• The difference is the direct material usage variance

113

Question

• A company plans to produce 1,000 units and expects to use 2 pounds of material in each unit. The standard cost of the material is $4.00 per pound. The company actually buys 2,500 pounds of material and uses 2,110 pounds of material to produce 1,100 units. The material had a cost of only $3.90 per pound. How much is the material usage variance?

114



A. $360 unfavorable.

B. $351 favorable.

C.$351 unfavorable.

D.$360 favorable.

115

Question – Answer

• Answer is D

• To produce 1,100 units, the company would have expected to use 2,200 pounds of material based on the standard of two pounds per unit. However, the company only used 2,110 pounds, so that 90 pounds were saved. Quantity variances (90 pounds) are valued at the standard price (4.00 per pound). The company has a $360 favorable material quantity variance.

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Kaplan CPA ReviewBusiness Environment and Concepts

Cost Accounting

118

Direct Materials and Direct Labor

• In manufacturing, there are several different types of costs

• Direct materials: Cost of any materials traceable to the product being manufactured

• Direct labor: Cost of labor used in the manufacturing process

119

Factory Overhead

• Building a table: four legs and the tabletop are considered material costs, the person assembling is direct labor, but you also need glue, bolts, screws—they are purchased in large quantity and are considered indirect material. The supervisor’s salary is an example of indirect labor and would be considered factory overhead rather than direct labor.

120

Question

• Fortis Co. manufactures textiles. Among Fortis’s manufacturing costs were the following salaries and wages

• Loom operators $120,000

• Factory foremen $45,000

• Machine mechanics $30,000

• What was the amount of direct labor?

121



A. $195,000.

B. $165,000.

C. $150,000.

D. $120,000.

122

Question – Answer

• Answer is D

• A loom operator’s salary or wages would be classified as direct labor since the loom operator works directly on the manufacture of the product. The salary or wages of factory foremen and machine mechanics are indirect labor costs and appropriately classified as overhead.

123

Indirect Costs

• Indirect costs are part of the product cost also but they are difficult to associate with any one unit

• Must calculate an allocation for those product costs that are difficult to associate with any given product and we do that by using a factory overhead account where we will accumulate these costs and then estimate an allocation to each product so we can ultimately sell the product for a price that covers these costs

124

Prime Costs Versus Conversion Costs

• Factory overhead: Any manufacturing cost other than direct material or direct labor, such as rent on the buildings and equipment, electricity, and property taxes

• Direct labor and factory overhead are sometimes combined and referred to as conversion costs

• Direct labor and direct materials are sometimes combined and referred to as prime costs

• Note that direct labor is both a prime cost and a conversion cost

125

Question

Which of the following are conversion costs?

I. Factory overhead.

II. Direct material.

III. Direct labor.

126


Choose the best answer.

A. I and II.

B. II and III.

C. I and III.

D. III only.

127

Question – Answer

• Answer is C



128

Question

Which of the following are considered both prime costs and conversion costs?

I. Indirect labor.

II. Direct labor.

III. Factory overhead.

129


Best answer is:

A. I and II.

B. II only.

C. II and III.

D. I and III.

130

Question – Answer

• Answer is B



131

Question

Which of the following are considered factory overhead?

I. Indirect materials.

II. Prime costs.

III. Indirect labor.

132


Correct answer is:

A. I and II.

B. II and III.

C. I and III.

D. I only.

133

Question – Answer

• Answer is C

• Factory overhead includes indirect materials and indirect labor.

• Prime costs are direct materials and direct labor and are not part of factory overhead.

134

Question

Which of the following is considered factory overhead?

I. Rent paid on the factory.

II. Salaries and commissions of the salespeople

135


Answer is:

A. I only.

B. II only.

C. Both I and II.


136

Question – Answer

• Answer is A

• Rent paid on the factory is considered factory overhead. Sales salaries and commissions are expensed as incurred.

137

Flow of Costs in Manufacturing

• Materials to be used in production are acquired and recorded as raw materials. A manufacturing company has three inventory accounts.

Raw materials

Cash

Work-in-process inventory

Raw materials

Finished goods

Work-in-process

• Materials are moved into production and labor and overhead are added. Cost is then monitored in a work-in-process account. Often, a separate work-in-process account is used as goods move from one department to another. Each department may have its own work-in-process account.

138

Job Order Costing

• Job order costing would be appropriate when you have a product that is different every time you make it, like custom cabinets.

• In job order costing, direct labor is proportionately larger relative to total product costs because it generally uses more highly skilled labor, which is paid more. It also takes more labor per unit to produce compared to mass production.

• The job cost will be different every time. The emphasis in job order costing is on direct labor and direct material which are called prime costs.

• When units are complete, cost is transferred to finished goods. When sold, cost is transferred to cost of goods sold.

139

Question

In job order costing:

I. mass production is usually involved in making homogeneous or identical units.

II. the emphasis is on prime costs.

140


Best answer is:

A. I only.

B. II only.

C. Both I and II.


141

Question – Answer

• Answer is B

• Job order costing would be appropriate when you have a product that is different every time you make it, like custom cabinets.

• In job order costing, direct labor is proportionately larger relative to total product costs because it generally uses more highly skilled labor, which is paid more. It also takes more labor per unit to produce compared to mass production.

• The job cost will be different every time. The emphasis in job order costing is on direct labor and direct material which are called prime costs.

142

Question

Which is CORRECT regarding job order costing?

I. Job order costing often involves highly skilled labor

II. Costs of the units sold are treated as cost of sales with other costs remaining in ending inventor

143


Correct answer is:

A. I only.

B. II only.

C. Both I and II.


144

Question – Answer

• Answer is C

• Job order costing often involves highly skilled labor. Costs of the units sold are treated as cost of sales with costs of unsold units remaining in ending inventory.

145

Process Costing

• For process costing, the emphasis is on direct material. Direct labor and factory overhead are generally combined and called conversion costs.

• The accountant must determine the cost per unit to transfer from work-in-process to finished goods

• Example: how much did it cost to produce 10,000 gallons of vanilla ice cream? We need to transfer those identical buckets of ice cream from work in process to finished goods.

146

Accumulating Costs

• In process costing, separate costs are frequently accumulated by department: direct material and conversion costs (or separately as direct labor and factory overhead). Also, in every department after the first, costs transferred in from earlier departments must be monitored.

• Thus, each department will keep up with two, three, or four different categories of costs

147

Cost Per Unit

• In transferring cost into finished goods, a separate cost per unit is calculated for each cost category (such as direct materials). A cost figure is determined and an equivalent unit of work figure is then calculated for each separate cost.

• The calculation of the cost per unit is calculated using the weighted-average or FIFO method. If we are the second department, it will have a cost already associated with it.

148

Beginning Work-in-Process

• The primary difference between the weighted-average and FIFO methods is how we handle the beginning work-in-process

• The weighted-average method includes these earlier costs and units of work donewithin the current cost per unit computation

• FIFO omits them in determining cost per unit. FIFO focuses on the current period.

149


Weighted-average and first-in, first-out (FIFO) equivalent units would be the same in a period when which of the following occurs?

A. No beginning inventory exists.

B. No ending inventory exists.

C. Beginning inventory units equal ending inventory units.

D. Both a beginning and an ending inventory exist but are not necessarily equal.

Source: 2009 AICPA Release Questions150

Question – Answer

• Answer is A

• The only difference between the weighted average and FIFO methods is how beginning inventory is handled. If there is no beginning inventory, the two methods would yield the same result.

• The weighted average method includes beginning inventory in the calculation of per unit costs. The FIFO method excludes beginning inventory in the per unit cost calculation.

151

Equivalent Units of Work

• In determining a cost per unit, the term unit refers to an equivalent unit of work

• Therefore, one unit that is completed is one unit of work; whereas two units that are 70% complete is 1.4 units of work, and three units that are 40% complete is 1.2 units of work. We need both total cost numbers and equivalent unit numbers to calculate cost per unit.

152

Cost Per Unit

• Total cost:

• Equivalent units = cost per unit

• Exam wants you to know two methods: weighted average and FIFO

153

Equivalent Units of Work: Weighted Average

• In a process cost accounting system using the weighted average method, the number of completed units for the period is added to the equivalent units of work in ending work-in-process.

• If 20,000 units are completed this month and 10,000 remain in process, with 30% completed, the equivalent units of work is 20,000 plus 3,000, or 23,000 units (23,000 units would be the denominator).

• To get the numerator, total cost, see the next slide154

Total Cost (Numerator)

• At the start of the current year, a company has work-in-process in Department Number Two with a direct material cost of $13,000. During the period, additional direct material costs of $70,000 are incurred in this department. The company is using the weighted average system. In computing cost per unit, $83,000 will be used as the cost of the direct materials.

• $83,000

• 23,000 units (previous slide) = $3.61 (the direct material cost per unit)

155

Question

• A company begins the current period with 10,000 units in process. These units are 60 percent complete as to direct labor. During the period, an additional 40,000 units are started. By the end of the period, 35,000 units are completed and the remaining 15,000 units are 80 percent complete. If a weighted-average system is being used, how many equivalent units have been completed?

156


Answer is:

A. $47,000.

B. $50,000.

C. $42,000.

D. $35,000.

157

Question – Answer

• Answer is A

• In a weighted average system, all work done by the end of the period is included in determining the number of equivalent units of direct labor. The 35,000 units are 100 percent complete with respect to direct labor. The 15,000 units in ending inventory are 80 percent complete for 12,000 equivalent units of direct labor. By the end of the period, 47,000 equivalent units of work have been completed (35,000 + 12,000) and that figure is used in computing the cost per unit.

158

Question

• A company starts the year with 20,000 units in process, 80 percent complete as to direct labor. During the year, 50,000 more units are started. By the end of the year, 10,000 units are left in ending work-in-process, 40 percent complete. The remaining 60,000 units have been finished and sent to the company’s warehouse. Beginning work-in-process had a direct labor cost of $8,000. For the year, the direct labor costs incurred were $120,000. According to a weighted average system, what was the direct labor cost per unit?

159


Best answer is:

A. $2.50 per unit.

B. $2.00 per unit.

C. $2.25 per unit.

D. $2.35 per unit.

160

Question – Answer

• Answer is B

• In a weighted average system, all costs are included, current plus prior, so that the direct labor cost will total $128,000. The equivalent units of direct labor is based on the total output by the end of the period. The 60,000 units have been completed and the 10,000 units are 40% complete, indicating 4000 units more of direct labor.

• The total direct labor cost of $128,000 / 64,000 equivalent units of direct labor = $2 per unit in direct labor cost

161

Equivalent Units of Work: FIFO

• In FIFO, the number of completed units for the period is added to the equivalent units of work in ending work-in-process but, then, the equivalent units of work in beginning work-in-process is subtracted

• Removing beginning work-in-process leaves the amount of work done during the current period

162

FIFO Units: Illustration

• To illustrate FIFO, assume that the beginning work-in-process is 5,000 units that are 40% complete. If 20,000 units are completed this month and 10,000 remain in process at the end that are 30% done, the total equivalent units of work is 20,000 plus 3,000, or 23,000. By subtracting out 2,000 units for the beginning work-in-process (5,000 units 40% completed), the company is left with 21,000 units of work performed in the current period.

163

Question

• At the start of the current year, a company has a beginning work-in-process with a direct labor cost of $19,000. During the period, additional direct labor costs of $60,000 are incurred in this department. This company has adopted a FIFO system. In computing cost per unit, how much will be used for direct labor?

164


Answer is:

A. $60,000.

B. $19,000.

C. $79,000.

D. $41,000.

165

Question – Answer

• Answer is A

• According to FIFO, only the costs actually incurred during the current period are included in computing the cost per unit. Thus, the $60,000 expended in the period will be used for this calculation.

166

Question

• A company starts the year with 10,000 units in process, 60 percent complete as to direct labor. During the year, 50,000 more units are started. By the end of the year, 20,000 units are left in ending work-in-process, 50 percent complete. The remaining 40,000 units have been finished and sent to the company’s warehouse. Beginning work-in-process had a direct labor cost of $8,800. For the year, direct labor costs incurred were $220,000. According to a FIFO system, how much was the direct labor cost per unit?

167


Best answer is:

A. $5.20.

B. $5.00.

C. $4.72.

D. $4.00.

168

Question – Answer

• Answer is B

• In a FIFO system, only the cost of the current period ($220,000) is used in computing cost per unit. The equivalent units of direct labor are the completed units (40,000) plus ending work-in-process (20,000 units that are 50 percent complete or 10,000 units) less the beginning work-in-process (10,000 units 60 percent complete or 6,000 units). The appropriate number of units is 44,000 (40,000 + 10,000 –6,000). $220,000 / 44,000 = 5.00 per unit, according to FIFO.

169

Question

• Corn company has a process costing system using the FIFO method. All materials are introduced at the beginning of the process in Department One. The following information is available for the month of January:

170


Work in process, 1/1 500 units

(40% complete as to conversion costs)

Started in January 2,000 units

Transferred to Dept. 2

During January 2,100 units

Work in process 1/31

(25% complete as to

conversion costs) 400 units

171


Corn’s equivalent units of production for the month of January are:

Materials Conversion

A. $2,500 $2,200

B. $2,500 $1,900

C. $2,000 $2,000

D. $2,000 $2,200

172

Question – Answer

• Answer is C

Materials Conversion

Finished unit 2,100 2,100

Ending Inventory:

400 units × 100% 400

400 units × 25% 100

Less:

Beginning inventory

500 units × 100% (500)

500 units × 40% (200)

EFU FIFO 2,000 2,000

173

Percentage of Work Completed

• One of the key elements with either of these methods is being able to assess the degree of completion of goods currently in process

• Conversion costs (direct labor and factory overhead): the degree of completion for in-process items must be given in the problem

174

Direct Materials and Transferred-In Costs

• Direct materials: Depends on when materials are added to the process. If added at the beginning, all in-process items are 100% complete as to materials; if added at the end, in-process items are 0% complete as to materials.

• Transferred-in costs: Because items in one department must have successfully completed previous departments, these units are 100% complete as to transferred-in costs

175

Question One

• Department 3 starts the current month with 1,000 tables 20% complete as to conversion costs. During the month, 9,000 new tables are transferred in from Department 2. By the end of the month, 8,000 tables have been completed and the remaining 2,000 are 60% complete as to conversion costs. In this department, direct materials are added at the end of production.

176

Question One (continued)

• The beginning work-in-process had a cost of $6,200 transferred in from Department 2 and $2,900 as the conversion cost. During the month, another $37,800 was transferred in while $56,000 was spent for direct materials and $89,100 for conversion costs. If the weighted-average method is used, what is the cost for one completed unit?

• Total costs/total equivalent units. We have to solve this equation three times: once for transferred in costs, once for direct material costs, and once for conversion costs. The denominator is different for all three.

177

Question One – Answer

• In using the weighted-average method, all costs are included: Beginning work-in-process plus the current amount incurred

• Thus, costs should be:

• Transferred-in costs $6,200 + $37,800 = $44,000

• Direct materials0 + $56,000 = $56,000

• Conversion costs $2,900 + $89,100 = $92,000

178

Question One – Answer (continued)

• In applying the weighted-average method, all units as of the end of the year are included: 8,000 were completed and 2,000 remain

• Transferred-in costs: 8,000 + 2,000 = 10,000 (work-in-process is always 100% complete as far as the prior departments)

179

Question One – Answer (continued)

• Direct materials: 8,000 + 0 = 8,000 (direct materials are added at the end of the department so that none are included in the ending work-in-process)

• Conversion costs: 8,000 + 1,200 = 9,200 (ending work-in-process is 60% finished)

180

Question One – Answer(continued)

• Transferred-in costs

• $44,000 / 10,000 units or $4.40

• Direct materials

• $56,000 / 8,000 units or $7.00

• Conversion costs

• $92,000 / 9,200 units or $10.00

• Total cost per unit is $21.40

181

Question Two

• Department 3 starts the current month with 1,000 tables 20% complete as to conversion costs. During the month, 9,000 new tables are transferred in from Department 2. By the end of the month, 8,000 tables have been completed and the remaining 2,000 tables are 60% complete as to conversion costs. In this department, direct materials are added at the end of production.

182

Question Two (continued)

• The beginning work-in-process had a cost of $6,200 transferred in from Department 2 and $2,900 as conversion cost. During the month, another $37,800 was transferred in while $56,000 was spent for direct materials and $89,100 for conversion costs.

• If FIFO is used, what is the cost for one completed unit?

183

Question Two – Answer

• In using FIFO, only current costs are included. Beginning work-in-process is omitted. Thus, costs should be:

• Transferred-in costs $37,800

• Direct materials $56,000

• Conversion costs $89,100

184

Question Two – Answer(continued)

• In applying FIFO, the total work done is determined (same as weighted average) and then beginning work-in-process units are removed:

• Transferred-in costs: 10,000 – 1,000 = 9,000 units (work-in-process is always 100% complete as far as prior departments)

185

Question Two – Answer (continued)

• Direct materials: 8,000 – 0 = 8,000 units (direct materials are added at the end of the department so that none are included in ending work-in-process)

• Conversion costs: 9,200 – 200 units = 9,000 units (beginning work-in-process was 20% finished)

186


• Transferred-in costs

• $37,800 / 9,000 units or $4.20

• Direct materials

• $56,000 / 8,000 units or $7.00

• Conversion costs

• $89,100 / 9,000 units or $9.90

• Total cost per unit is $21.10




Cost Accounting

Practice Problems

189

Question One

• In Department 1, for this month, a company started 20,000 new units and completed 16,000. The other 4,000 were 100% finished as far as direct materials, but only 20% finished as far as conversion costs. No other units were in process this period.

• How will the computation of cost per unit differ between the weighted-average method and FIFO?

190

Question One – Answer

• In this situation, there will be no difference between weighted average and FIFO

• The only difference is in the handling of the units and cost of any beginning work-in-process. There was no beginning work-in-process for this department; therefore, both methods would be handled in exactly the same manner.

191

Question Two• A company starts the new year with 8,000

units in process. During the year, 20,000 additional units are started for a total of 28,000. Of these, 24,000 are completed and the other 4,000 are still in process. The beginning inventory was 90% complete as to conversion costs while the ending units were only 30% complete.

192

Question Two (continued)

• If the company uses the weighted-average method, what should be the equivalent units of work for conversion costs?

• If the company uses FIFO, what should be the equivalent units of work for conversion costs?

193

Question Two – Answer

• For weighted average, the accountant looks at all that has been accomplished by the end of the period:

• Completed units 24,000 × 100% = 24,000 units of work

• Ending work-in-process4,000 × 30% = 1,200 units of work

• Total units of work done: 25,200

194


• For FIFO, the accountant looks at what has been accomplished during the current period by subtracting out any work done in the previous period:

• Completed = units 24,000 × 100% = 24,000 units of work

• Ending work-in-process 4,000 × 30% = 1,200 units of work

• Less beginning work-in-process 8,000 × 90% = (7,200) units of work

• Total units of work done in current period: 18,000




Cost Accounting: Other Areas

197

Joint Product Costs

• In many production processes, a single cost will be used in manufacturing multiple products. For example, crude oil can be purchased and then turned into jet fuel, gasoline, kerosene, heating oil, and a host of other products.

198

Allocation of Joint Product Costs

• The accountant must determine how a joint cost will be allocated to the various products

• Any assignment system can be used as long as it is reasonable and logical. Thus, on the exam, the candidate must read carefully to determine the method being utilized.

199


Which of the following is not a basic approach to allocating costs for costing inventory in joint-cost situations?

A. Sales value at split-off.

B. Flexible budget amounts.

C. Physical measures such as weights or volume.

D. Constant gross margin percentage net realizable value method.

Source: 2009 AICPA Release Questions 200

Question – Answer

• Answer is B

• Any assignment system can be used if it is reasonable and logical. The most common methods are the methods given in answers A, C, and D which are allocate joint cost in a reasonable and logical manner.

201

Relative Sales Value at Split-Off

• One common method of allocating joint product costs is the relative sales value at split-off approach

• On the day that multiple products emerge as a result of a single cost, the individual sales values at that point in time are determined and used for the allocation.

202

Relative Sales Value at Split-Off: Illustrated

• Assume Products A and Z are created through the expenditure of $80,000. At that time, the amount of A that results is worth $70,000 and Z is worth $30,000. Their total sales value is $100,000, 70% coming from A and 30% from Z.

• Therefore, $56,000 of the joint cost (70%) is assigned to Product A and $24,000 (30%) to Product Z

203

Question

• Eastern Corp. manufactures liquid chemicals A and B from a joint process. Joint costs are allocated on the basis of relative sales value at split off. It costs $4,560 to process 500 gallons of Product A and 1,000 gallons of product B to the split off point. The sales value at split-off is $10 per gallon for product A and $14 for Product B. Product B requires an additional process beyond split-off at a cost of $1 per gallon before it can be sold. What is Eastern’s cost to produce 1,000 gallons of product B?

204



A. $3,360.

B. $3,660.

C. $4,040.

D. $4,360.

205

Question – Answer

• Answer is D

• Sales value at split off

• A. 500 gallons × $10 = $5,000

• B. 1,000 gallons × $14 = $14,000

• Total: $19,000

• Joint costs allocated to B:

• $4560 total cost × 14,000 / 19,000 = $3,360

• Cost of subsequent processing:

• 1,000 gallons × $1 = $1,000

• Total cost of 1,000 gallons of B: $4,360206

Net Realizable Value

• Use of the relative sales value at split-off may not be possible because sales values are not always known at that point in the process

• An alternative allocation process uses each product’s eventual sales value and then subtracts all costs necessary to get each item from the split-off point to eventual sale. This is a net realizable value (NRV) approach.

207

Net Realizable Value Method: Illustrated

• Assume that $80,000 is spent to create Products A and Z. There is no sales value at that time but if $30,000 more is spent on A, it can be sold for $150,000; if $20,000 more is spent on Z, it can be sold for $100,000. The NRV of A when split off is $120,000 ($150,000 – $30,000) and the NRV of Z is $80,000 ($100,000 – $20,000).

208

Net Realizable Value Method: Illustrated (continued)

• The total of the two net realizable values is $200,000

• A is assigned 60% ($120,000 / $200,000) of the joint cost (or $48,000) and Z is assigned the remaining 40% ($80,000 / $200,000) of the joint cost (or $32,000)

209

Question

• A processing department produces joint products Alex and Boniguen, each of which incurs separable production costs after split off. Information concerning a batch produced at a $60,000 joint cost before split off follows:

210


Product Separable Costs Sales Value

Alex $8,000 $80,000

Boniguen $22,000 $40,000

Total $30,000 $120,000

• What is the joint cost assigned to Alex if costs are assigned using the relative net realizable value?

211


Correct answer is:

A. $16,000.

B. $40,000.

C. $48,000.

D. $52,000.

212

Question – Answer

• Answer is C

• Sales value – Separable cost = NRV

Alex: $80,000 – $8,000 = $72,000

Boniguen: $40,000 – $22,000 = $18,000 $90,000

• Alex = $72,000 / 90,000 = 80% × 60,000 before split off = $48,000

• Joint products require us to allocate that joint cost, the cost incurred while they are still a single product, to the multiple products

213

Byproducts

• In some manufacturing operations, a single cost will be used to create a number of products. However, one or more of these items may have such a small sales value that it can be viewed as a byproduct of the process rather than as a joint product. In such cases, the byproduct can be handled by the accountant differently than the joint products. Once again, the method used for such items is up to the company as long as it is reasonable and logical.

214

Byproduct: No Allocation

• One method for handling a byproduct is to assign no cost at all to the item

• If the byproduct is eventually sold, the cash received can be recorded as a miscellaneous revenue or as a reduction to cost of goods sold. Use this method if there isn’t much byproduct to sell.

215

Some Allocation of Cost

• A portion of the joint cost incurred, though, can be assigned to a byproduct

• The allocation is often the estimated net realizable value. The exam will say how much the byproduct can be sold for.

216

Allocation of Cost: Illustrated

• Assume that $80,000 is spent to manufacture Products A and Z as well as Byproduct X. Assume that X is believed to have a net realizable value of only $6,000. One possibility is that this cost can be assigned to Product X with the remaining $74,000 to be split between A and Z in some logical way.

217

Question

• A company spends $200,000 to produce Bain and Yin, each of which has an equal sales value of $130,000. In this process, 1,000 pounds of a by-product (Mu) is also created. Mu can be sold for $3 per pound after spending $1 per pound for processing. None of the joint costs will be assigned to this by-product and its sales revenue will be reported as miscellaneous income. How much is the profit on the product Yin?

218


Best answer is:

A. $25,000.

B. $30,000.

C. $32,000.

D. $34,000.

219

Question – Answer

• Answer is B

• Since no part of the joint cost is assigned to Mu, the $200,000 is assigned evenly (based on sales value) to Bain and Yin. Each is assigned $100,000. If Yin is sold for $130,000, the profit recognized on that product is $30,000.

220

Question

• The Central Company produces three products Arc, Bag, and Cab from one process costing $300,000. Arc and Bag can be immediately sold for $200,000 and Cab can be immediately sold for $20,000. Cab is held to be a by-product and an amount of the joint cost equal to its sales value is assigned to it. How much profit will be recognized on the sale of Arc?

221


Correct answer is:

A. $50,000.

B. $40,000.

C. $60,000.

D. $20,000.

222

Question – Answer

• Answer is C

• By-products can be accounted for in a number of ways. In this case, a portion of the joint cost equal to the sales value of the by-product is assigned to it so that no profit is recognized when the sale eventually occurs. However, the joint cost has been reduced to $280,000. Based on equal sales value, each of the two joint products is assigned $140,000. If the sales price is $200,000, a profit of $60,000

would be anticipated on each.

223

Question

Which of the following best describes a by-product?

I. A product that usually produces a small amount of revenue when compared to the main product revenue.

II. A product of relatively small value which is obtained during production of the main product.

224


Correct answer is:

A. I only.

B. II only.

C. Both I and II.


225

Question – Answer

• Answer is C

• A by-product usually produces a small amount of revenue when compared to the main product revenue

• A by-product is obtained during production of the main product

226

Factory Overhead

• Factory overhead refers to any manufacturing cost other than direct material and direct labor

• In most manufacturing companies, there is a wide range of possible costs that qualify as factory overhead: heating oil, electricity, depreciation on the factory, insurance, etc.

227

Application of Factory Overhead

• Because of the need for cost figures to be determined in a timely fashion, factory overhead poses a special problem. Many of these costs may not be known precisely until a much later date.

• For this reason, it is common for overhead costs to be applied to the work-in-process account based on an estimation. We estimate our total factory overhead and then we estimate our total cost-driver formula

Estimated total factory overheadEstimated total cost driver

228

Application Rates and Cost Drivers

• To include an appropriate amount of factory overhead in a product’s cost, most companies tie in the recording of factory overhead to some other production factor that is viewed as the primary creator of factory overhead: machine hours, direct labor costs, number of units produced, etc.

229

Factory Overhead Terminology

• That other factor is often known as a cost driver

• The cost relationship is known as the application or allocation rate

• The goal is to come up with an allocation of factory overhead like factory overhead per man hours, etc.

230

Question

Dayton Inc. is developing a factory overhead application rate for use in a process costing system. Which of the following could be used in the numerator?

A. Actual direct labor hours.

B. Estimated direct labor hours.

C. Actual factory overhead costs.

D. Estimated factory overhead costs.

231

Question – Answer

• Answer is D

• Predetermined rate =

Estimated total factory overhead

Estimated total cost driver

232


• Merry Co. has two major categories of factory overhead: material handling and quality control. The costs expected for these categories for the coming year are as follows:

• Material handling $120,000

• Quality inspection $200,000


233

2009 Release Question (continued)

• The plant currently applies overhead based on direct labor hours. The estimated direct labor hours are 80,000 per year. The plant manager is asked to submit a bid and assembles the following data on a proposed job:

• Direct materials $4,000

• Direct labor (2,000 hours) $6,000

Source: 2009 AICPA Release Questions234

2009 Release Question (continued)

What amount is the estimated product cost on the proposed job?

A. $ 8,000

B. $10,000

C.$14,000

D.$18,000


235

Question – Answer

• Answer is D

• Product costs include direct material, direct labor, and factory overhead costs. In this problem, direct material and direct labor costs are given and total $10,000.

• Factory overhead costs are to be allocated according to direct labor hours. The allocation rate is calculated as: ($120,000 + $200,000) / 80,000 hours = $4 per direct labor hour.

• 2,000 hours × $4 = $8,000 factory overhead cost

• Total cost = $10,000 + $8,000 = $18,000236

Factory Overhead T

• Important to understand the T account for factory overhead—see the next slide

237

Factory Overhead

Actual indirect product costs

Allocation of factory

overhead to finished goods

inventory

238

Application Process: Illustration

• Assume that a company believes that direct labor cost is the primary cost driver for factory overhead. Last year, direct labor cost was $400,000 and factory overhead was $200,000. This year, direct labor cost turns out to be $440,000. At the end of the current year, factory overhead turned out to be exactly $225,000.

• How is the factory overhead reported?

239

Application Process: Illustration – Answer

• Based on last year’s figures, factory overhead appears to be 50% of its cost driver (direct labor cost)

• Therefore, during the current year, $220,000 should be added to work-in-process (50% of the $440,000 labor cost)

240

Factory Overhead

Actual indirect product costs

$225,000

Balance $5,000

Allocation of factory

overhead to finished goods

inventory

$220,000

241

Application Process: Illustration – Answer

• The actual cost turns out to be $225,000, or $5,000 different than the applied amount

• Unless such differences are a large amount, they are simply used to adjust cost of goods sold. If the difference is viewed as large, it is allocated among cost of goods sold, finished goods, and work-in-process. If the $5,000 is considered insignificant, then make the following journal entry as it would all get allocated to cost of goods sold.

• Cost of goods sold $5,000

• Factory overhead $5,000242

If Balance of Overhead Is Significant

• If significant, based on pro-rata

Work in process

Cost of goods sold

Finished goods

Factory overhead

243

Allocation of Overhead by Department

• Historically, the application of overhead costs has been done on a department-by-department basis

• One department might use direct material units as a cost driver, while the next department uses machine hours

244

Need for PreciseAllocation of Overhead

• With automation and the increased prevalence of service organizations, managing overhead costs have become more important for many companies than managing direct material or direct labor costs

• Companies have seen the need for better allocations of overhead costs which has led to significant interest in activity-based costing

245

Activity-Based Costing (ABC)

• Activity-based costing focuses on determining a very accurate allocation of all factory overhead for each and every product

• There are several characteristics normally associated with activity-based costing that have made it popular in recent years

246

ABC Characteristics

• Overhead is applied throughout the creation process and not just during production

• From inception of the idea to completion of the units, the process is divided into separate activities. One department might have 12 different activities.

• A cost driver would then be determined for each activity to provide an accurate allocation rate for overhead

• Any activity that does not add value to the final product can be limited or removed entirely, if possible

• Summary—activity-based costing is not by department but by activities.

247

ABC Illustrated

• One department in a company’s production process might consist of a sawing activity, an assembly activity, and a painting activity

• Under traditional cost accounting, one application rate for the entire department would be used to apply overhead

• In activity-based costing, three different cost drivers could be determined—one for each separate activity. In that way, a more precise allocation of costs would be made.

248

Cost Pools

• In some companies, the number of activities and cost drivers can get large and become difficult to implement

• Consequently, it is not unusual for a company to group all of the activities that use the same cost driver into cost pools to facilitate the application process

249

Question

Which is CORRECT regarding activity-based costing?

I. Activity-based costing is especially appropriate for service activities or where factory overhead makes up a significant amount of a products cost.

II. Activity-based costing identifies every separate activity that occurs from inception to completion of an output.

250

Question

Correct answer is:

A. I only.

B. II only.

C. Both I and II.


251

Question – Answer

• Answer is C

• Activity-based costing is especially appropriate for service activities or where factory overhead makes up a significant amount of a products cost. Activity-based costing identifies every separate activity that occurs from inception to completion of an output. The result is more accurate cost assignments.

252

Question

Which is CORRECT regarding activity-based costing?

I. In activity-based costing, factory overhead is assigned to activities based on a multiple of cause and effect relationships, also known as cost drivers

II. In activity-based costing, all activities are identified as either value adding or non-value adding

253


Correct answer is:

A. I only.

B. II only.

C. Both I and II.


254

Question – Answer

• Answer is C

• In activity-based costing, factory overhead is assigned to activities based on a multiple of cause and effect relationships also known as cost drivers. In activity-based costing, all activities are identified as either value adding or non-value adding. For example, adding cheese to pizza is value adding whereas storing the pizza until the customer arrives is non-value adding.

255

Question

• Payroll Service Co. uses the activity-based costing approach for cost allocation and product purposes. Printing, stamping, and perforating, make up the manufacturing process. Machinery and equipment are arranged in operating cells that produce a complete product starting with raw materials. Which of the following are characteristics of Payroll Co’s cost-based approach?

256


I. Costs are accumulated by department or function for purposes of product costing.

II. Activities that do not add value to the product are identified and reduced to the extent possible.

III. Cost drivers are used for a basis of cost allocation.

257


Answer is:

A. II and III.

B. I and II.

C. I and III.

D. II only.

258

Question – Answer

• Answer is A

• Activity-based costing assigns cost to products based upon the product’s use of activities (cost drivers) that caused the cost to be incurred. Costs are accumulated by activities rather than by departments or function as in more traditional costing systems. Non-value added items are eliminated or minimized without adversely affecting the product or service.

259

Question

• Adam Co.’s cost allocation and product costing procedures follow activity-based costing principles. Activities have been identified and classified as being either value adding or non-value adding as to each product. Which of the following activities, used in Adam’s production process, is non-value adding?

260


Correct answer is:

A. design engineering activity.

B. heat treatment activity.

C. raw materials storage activity.

D. drill press activity.

261

Question – Answer

• Answer is C

• In the production process, storing raw materials until they are needed represents a non-value added step, whereas engineering heat treatment, or drilling represents improving the product

262

Spoilage

• Normal spoilage versus abnormal spoilage

• Normal spoilage is expected—inventory gets damaged etc. The cost of normal spoilage is a product cost which should be absorbed by the good units produced and included in the recorded cost of both work in process and finished goods inventory.

• Abnormal spoilage is a period cost and should be expensed as incurred

263

Question

• In manufacturing its products for the month of July, Matthews Inc. incurred normal spoilage of $5,000 and abnormal spoilage of $9,000. How much spoilage should Matthews charge as a period cost for the month of July?

264


Correct answer is:

A. $0.

B. $5,000.

C.$9,000.

D.$14,000.

265

Question – Answer

• Answer is C

• The cost of normal spoilage is a product cost which should be absorbed by the good units produced and included in the recorded cost of both work in process and finished goods inventory. $5,000 would be the product cost for normal spoilage.

• Abnormal spoilage is a period cost and should be expensed as incurred—$9,000 is the period cost

266

Question

Direct labor cost is a:

I. conversion cost.

II. prime cost.

A. I only.

B. II only.

C.Both I and II.

D.Neither I nor II.

267

Question – Answer

• Answer is C

• Direct labor is both a prime cost and a conversion cost

268

Question

• Following are Milford co’s production costs for June:

Factory overhead $4,000

Direct Materials $100,000

Direct Labor $90,000

What amount of costs can be traced to specific products in the production process?

269


Best answer is:

A. $194,000.

B. $190,000.

C. $100,000.

D. $90,000.

270

Question – Answer

• Answer is B

• Only direct manufacturing costs, direct materials, and direct labor can be traced to specific products. The other manufacturing costs, called indirect costs, should be allocated based upon activity cost drivers which only approximates the amount of cost incurred.

271

Question

Which of the following is CORRECT regarding the differences between job-order costing and process costing?

I. Process costing involves the use of equivalent units, and equivalent units are based on estimates of the state of completion.

II. In a job-order costing system, the cost of direct materials and direct labor can be directly traced to the job without estimation.

272

Question

Correct answer is:

A. I only.

B. II only.

C. Both I and II.


273

Question – Answer

• Answer is C

• Process costing involves the use of equivalent units and equivalent units depend upon estimates of the stage of completion, which is certainly not an exact science. It is difficult, even for an auditor, to walk on the floor of a manufacturing plant and view 50 machines at different stages of production. Whereas in a job-order costing system, the cost of direct materials and direct labor can be directly traced to the job without estimation.



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