part 1 cram session

Part 1Cram Session

Financial Planning, Performance, and Control

Exam format• 3 hrs - 100 multiple choice questions = approx. 1.5 minutes per question (on average).

– Find ways to “bank” time– Look for short-cuts– You will find that you most question do not seem “easy”, don’t get discouraged– You “earn” points for each question answered correctly– Some questions are “test” questions that carry no point value. You will not know which ones they

are– Extra time can be carried forward to the Essay portion

• 1 hr - 2 Essay questions with up to 8 sub-parts– You can’t go back to multiple-choice part once you enter this portion of the exam– Whatever you have typed on the screen will be saved as your answer, irrespective if the timer

runs out on you

Exam formatPart 1 – Financial Planning, Performance and Control 4 hours, 100 multiple-choice questions and two 30-minute essay scenarios • Planning, budgeting, and forecasting (30%) • Performance measurement (25%) • Cost management (25%) • Internal controls (15%) • Professional ethics (5%)

If you find you have weaknesses in any topic ref. Appendix A for ref. the appropriate sub –units

Exam Structure & Feedback • Exam structure

– 3 hours of multiple choice questions ~ 75% of score – 1 hour of essay questions ~ 25% of score

• Must earn at least 50% on multiple choice section in order to advance to essay section

• Cannot return to the multiple choice section once you’ve advanced to the essay section of the exam

Exam Strategy• To pass the exam, you need: • Knowledge • Confidence • Effective Time Management • Commitment!

Last minute prep for the exam• Focus on what you don’t know• Realize that you will be more proficient in some topics more than others• Practice the Essay questions – use the Gleim Essay Wizard• Create short mock multiple choice exams (say no more than 50 questions) to

condition for the longer 100 question exam, or take the Gleim online CMA Practice Exam that came with your Gleim study material. It is a 4 hour exam.

• You can also read the question and only the correct answer of questions at the end of each SU. It is a fast way of covering a lot of ground.

• Make sure your financial calculator has a fresh battery, and that it is not the first time you used it.

Day of the Exam• Do not study up to the exam day/time• Give yourself plenty of time to get to the testing center. Make sure you have

identified exact location prior• Make sure you are well rested (probably not a good idea to take exam after a long

day of work, for example• It is a four hour exam, make sure you are prepared for the duration (eat, etc.)• Dress in layers. You can always shed layers when you are there, they have lockers• Don’t wear a watch into the testing center• You can bring your own foam earplugs, so long that they are in a plastic bag

Day of the Exam• Take a copy of the type of calculators that are permitted with you.

Ref. the ones listed on the IMA Website• You realistically should not plan on any breaks outside of bathroom

breaks. Note the timer keeps running if you do take a break.• Be optimistic. At this point there is nothing else you can do, and

being stressed or discouraged will not help your test results.

Relax - “NO ONE HAS DIED FROM FAILING THE CMA EXAM”, there is life beyond and we will help you pass it!!!!

Exam• Budget your time, know your “time hacks”• See how many Essay sub-questions you will be given. There are two

parts with different amounts of sub-parts• Answer the questions in consecutive order, and limit the number you

want to come back to no more than say 10, but make sure you answer it before going on to the next.

• Never leave a question unanswered, score is based on number of correct answers.

• Do not allow the answer choices to affect your reading of the question

Most common reasons for missing questions

1. Misreading the requirement (stem) – Read the question first2. Not understanding what is required3. Making a math error – Try to not do calculations of paper first,

with the idea of “transferring” to the exam later. If you know how to use your memory button(s) well on your calculator, use it (i.e. save sub-calculations in your calculator).

4. Applying the wrong rule or concept5. Being distracted by one or more of the answers – the most

common wrong answers are the incorrect alternatives

Most common reasons for missing questions

6. Incorrectly eliminating answers from considerations – read all answers first, some are more correct or complete then others

7. Not having any knowledge of the topic tested – don’t agonize over it. If possible try to make an educated guess by eliminating obvious wrong answers. If you guess, use the same letter each time.

8. Employing bad intuition when guessing

The essays• Remember, 2 essay questions with 3 to 6 parts each!

• This section provides a great opportunity to earn partial credit – Be sure to show your work and assumptions – You can scroll between questions and scenarios within the

essay section of the exam • Helps to determine how much time you will need for responses

Essay Questions • Pay close attention to verbs

– E.g., if it says compare or contrast, don’t define something

• Read the entire question to understand all requirements – You may have more than one requirement, for example:

“Define abc and interpret its applicability to xyz.”

• Grammar and writing skills – Focus is on use of standard English, organization and clarity – Graders are looking for effective writing skills

Essay Questions • Be brief and to the point

– It’s ok to use bullet points!!!

• Do not leave a questions blank – If short on time, at least write an outline of your main points

• Graders are looking to give you points, not take them away – Make it as easy as possible for graders to give you points!

Essay Questions • Type your responses into a text box – Similar to MS Word, but with more simple

functionality – Effective January 2013, the spreadsheet tool is no

longer being used on the CMA exam

• Be sure to use all of the time available to you

Essay• There is a sample grading rubric for essay portion enclosed in slide presentation. This is

interesting because this shows that the graders only give points for correct answers. They don't deduct for wrong answers. Notice on rubric for the second sample essay, there are multiple points that could be earned for each question, but the total points for each question is less than the sum for all the possible answers. This means that there is more than one correct answer. Once you get the maximum points for this part, the grader moves on. You don't get more points for embellishing.

• Don't embellish. Be direct. Be simple. Use bullet points. Show your work, including calculations. Use proper grammar and English. Then move on to the next question.

• Practice answering essays online. This will get you used to how to type calculations and make bullet points.

• Use ALL the time you have on your essay questions, even if you pull time from your multiple choice section.

• The more you study, the better you will do. It is as simple as that.

Sample Essay Question #1 A City owns and operates a community swimming pool. The pool is open each year for 90 days during the summer months of June, July, and August. A daily admission is charged to patrons of the pool. By law, 10% of all recreational and sporting fees must be remitted to a state tourism promotion fund. The City Manager has set a goal that pool admission revenue, after subtracting the state fee and variable costs, must be sufficient to cover the fixed costs. Variable costs are assumed to be 15% of gross revenue. Fixed costs for the three-month period total $33,000. The following budget for the pool has been prepared for the current year.

Adult admissions: 30 per day x 90 days x $5.00 $ 13,500 Student admissions: 120 per day x 90 days x $2.50 27,000

Total revenue 40,500 State tourism fee 4,050

Net revenue 36,450 Variable costs 6,075 Fixed costs 33,000

Expected deficit $ (2,625) The City Manager is trying to determine what admission mix is necessary to break even and what actions could be taken to eliminate the expected deficit.

Essay Requirements (partial)

1. Given the anticipated mix of adult and student admissions, how many total admissions must the pool have in order to break even for the season?

2. Regardless of the admissions mix, what is the highest number of admissions that would be necessary to break even for the season?

Sample Essay Response Question 1: Given the anticipated mix of adult and student admissions, how many total admissions must the pool have in order to break even for the season? Sample Response: The contribution margin is 75% or $3.75 per adult admission, and $1.875 per student admission. The mix is 20% adult (30 ÷ 150) and 80% student (120 ÷ 150).

– Calculate the weighted average contribution margin (WACM) – WACM = 0.20 ($3.75) + 0.80 ($1.875) = $2.25 – The breakeven point in units is calculated as follows: – Fixed costs ÷ WACM

• Fixed costs = $33,000 • WACM = $2.25 • $33,000 ÷ $2.25 = 14,667 admissions per season

Sample Essay Response Question 2: Regardless of the admissions mix, what is the highest number of admissions that would be necessary to break even for the season? Sample Response: To calculate the highest number of admissions to break even, you would assume that all admissions are students. That’s because the student admission price is the lowest of all admission prices. – The breakeven point in units is calculated as follows:

• Fixed costs ÷ Contribution margin for students – Fixed costs = $33,000 – Contribution margin for students = $1.875 – $33,000 ÷ $1.875 = 17,600 admissions per season

City Pool Question Item Description Maximum % Score

Points CorrectQuestion 1 8 CM% = 1-10%-15% (75%) 1 0Adult = 75% x $5 ($3.75) 1 0

Student = 75% x $2.50 ($1.875) 1 0 Mix = 30/150 adult (20%) / 120/150 students (80%) 1 0

WACM = 20% x $3.75 + 80% x$1.875 ($2.25) 1 0 Break-even point = fixed costs $33,000 1 0 divided by CM ($2.25) (14,667) 1 0 14,667 1 0

0 Subtotal 0.00

Question 2 2 Uses students 1/2 0 $33,000/$1.875 (17,600) 1 0 =17,600 1/2 0 TOTAL FOR ALL QUESTIONS: 10 0.00

Essay Question #2 SmallParts is a manufacturer of metal washers, screws, and other parts required in the manufacture of various handmade craft and novelty items. The firm has the ability to custom make virtually any small part, provided the client is able to provide SmallParts with the dimensions and tolerance required of the product. Because of its niche in the market, SmallParts has over 1,000 clients. Unfortunately, many of its small business clients eventually merge or cease operations. One of the company’s biggest challenges is the return of shipped product. Usually, this is because the small business client has ceased operations. While most of the product is custom made, SmallParts has found that much of it can be sold to other clients for adapted use. The company’s accountant is reviewing the company’s internal controls and financial accounting procedures, in particular, with respect to inventory.

Essay Question #2Currently, SmallParts has one salesperson responsible for marketing returned product. This salesperson has exclusive and total control over the returned product including arranging of sales terms, billing, and collection. The salesperson receives the returned product and attempts to find a client who may be able to adapt the product for the client’s use. The inventory of returned product is not entered in the accounting records, under the logic that the cost is sunk. Revenue generated from its sale is classified as other revenue on the SmallParts income statement.

Sample Essay Requirements (partial) 1. Identify and describe the three objectives of a system of internal control. 2. Identify and explain three ways that the procedure for handling returned product

violates the internal control system of segregation of duties. 3. Identify and describe three ways that SmallParts can provide for better internal

control over its inventory of returned product. 4. The company accountant is concerned about SmallParts’ current procedure for

accounting for returned product and has turned to IMA’s Statement of Ethical Professional Practice for guidance. Assume the company’s accountant identifies a possible conflict of interest on the part of the salesperson responsible for the returned product.

a)Identify the ethical principles that should guide the work of a management accountant. b)Identify and describe the standards that relate to this situation and explain how they apply.

Sample Essay Response Question 1: Identify and describe the three objectives of a system of internal control.

Sample Response: A good system of internal control is designed to provide reasonable assurance regarding achievement of an entity’s objectives involving effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations.

Sample Essay Response Question 2: Identify and explain three ways that the procedure for handling returned product violates the internal control system of segregation of duties.

Sample Response: Segregation of duties requires that no one person have control over the physical custody of an asset and the accounting for it. There is no evidence to suggest SmallParts makes any effort to account for the value of returned product, which may indeed be significant. The one salesperson seems to be in charge of all aspects related to returned product, including authorizing the returns, crediting the customers, receiving the returns, handling the physical custody, finding new customers, concluding sales, shipping, billing, and collecting. Most of these rules should be separated.

Sample Essay Question #2 Information relative to answering #2 of Question 2 has been circled in red.

SmallParts is a manufacturer of metal washers, screws, and other parts required in the manufacture of various handmade craft and novelty items. The firm has the ability to custom make virtually any small part, provided the client is able to provide SmallParts with the dimensions and tolerance required of the product. Because of its niche in the market, SmallParts has over 1,000 clients. Unfortunately, many of its small business clients eventually merge or cease operations. One of the company’s biggest challenges is the return of shipped product. Usually, this is because the small business client has ceased operations. While most of the product is custom made, SmallParts has found that much of it can be sold to other clients for adapted use. The company’s accountant is reviewing the company’s internal controls and financial accounting procedures, in particular, with respect to inventory.

Currently, SmallParts has one salesperson responsible for marketing returned product. This salesperson has exclusive and total control over the returned product including arranging of sales terms, billing, and collection. The salesperson receives the returned product and attempts to find a client who may be able to adapt the product for the client’s use. The inventory of returned product is not entered in the accounting records, under the logic that the cost is sunk. Revenue generated from its sale is classified as other revenue on the SmallParts income statement.

Sample Essay Response Question 3: Identify and describe three ways that SmallParts can provide for better internal control over its inventory of returned product.

Sample Response: Separate responsibilities and duties. While the salesman may be assigned to work with customers who return products, and find other customers for these products, other staff should post credits to customer accounts following written policy. The products should be received, inventoried, booked and shipped just like regular products.

Sample Essay Response Question 4: (Summarized)

a) Identify the ethical principles that should guide the work of a management accountant. b) Identify and describe the standards that relate to this situation and explain how they apply.

Sample Response: a)The Statement lists the following four ethical principles: – Honesty, Fairness, Objectivity, Responsibility

b)Several standards from the Statement apply. – Credibility: “Each practitioner has a responsibility to disclose deficiencies in internal controls.” – Competence: duty to maintain an appropriate level of professional expertise relative to standard

procedure commonly used in the accounting of firms dealing with returned product – Confidentiality: refrain from using this confidential information for unethical advantage, by not

informing firms of the lax controls and availability of steep discounts on returned product – Integrity: mitigating any conflict of interest.

Small Parts Question Item Description Maximum % Score

Points CorrectQuestion 1 2 Reasonable Assurance 1/2 0Effectiveness of operations 1/2 0 Efficiency of operationsi 1/2 0 Reliability of financial reporting 1/2 0 Other 1/2 0

Subtotal 0.00

Question 2 2 1 person should not control custody& acctg. 1/2 0 Salesperson in charge of everything 1/2 0 No accounting for returned product 1/2 0 No tracking or returned product 1/2 0 Other 1/2 0

Subtotal 0.00

Small Parts Question (continued)Item Description Maximum % Score

Points CorrectQuestion 3 2 Separate resp./segregation of duties 1/2 04 different ind. for ret. Prod. duties 1/2 0 Authority, recording, custody, reco. 1/2 0 Other 1/2 0

Subtotal 0.00

SmallParts Question (continued) Item Description Maximum Points % correct Score Question #4 6 a. Principles: max = 1 Honesty, Fairness, Objectivity, Responsibility Two correct identifications 1/2 0Four correct identifications 1 0 b. Standards max = 5 Competence 1/2 0 maintain appropriate level of prof competence 1/2 0 prepare complete & clear reports 1/2 0 perform in accord with laws, regs & tech stds 1/2 0 Confidentiality 1/2 0 refrain from disclosing confidential info 1/2 0 refrain from using info unethically 1 0 Integrity 1/2 0 refrain from activity discrediting the profession 1 0 avoid actual or apparent conflicts of interest 1 0 refrain fr activity prejudice ability to carry out duties 1/2 0 refrain fr activity subverting attn of org objectives 1/2 0 Credibility/Objectivity 1/2 0 communicate info fairly and objectively 1/2 0 disclose fully all relevant info 1/2 0other 1/2 TOTAL FOR ALL QUESTIONS: 12 0.00

Remember!• The CMA exam uses essays to reflect a more "real-world" environment in which candidates

must apply the knowledge they have acquired. Essays are graded on both writing skills and subject matter. Partial credit IS available for essays that have some correct and some incorrect points. Finally, it is important to remember that essays are not intended to test typing ability, so the time you allocated for essay response is adequate to complete the questions even if you do not have the best typing skills.

• Answering multiple-choice questions is an effective method to study the material for both the multiple-choice and essay sections of the exam. They are an excellent diagnostic tool that will allow you to quickly identify your weak areas. Also, think about what your answer would be if the question were not multiple-choice. When reviewing the correct and incorrect answer explanations, your "essay answers" should be somewhat equivalent to the detailed answer explanations.

Essay• Roughly 75% of points come from multiple choice. Essay only accounts for 25% of

points.• There are two essay questions for each section of the CMA exam. Each question

will have 3-6 parts that must be answered.• Be sure you skim all essay parts before begin answering. This will help you survey

how much time to spend on each question from the beginning. Some will be easy, just asking for a definition. Some will require calculations. Show all your work. Even if your answer is wrong, showing your work will give you partial credit.

• Be sure to answer the question correctly. If the question asks you to compare or contrast something, don't define it. That is not what they are looking for.

Ethics• Ethics is tested from:

– Individual Perspective – Part 1– Organizational Perspective – Part 2

• Questions could be either Multiple Choice or Essay• Make sure you study the IMA Framework on Ethics, ref. the IMA website, or

following URL: http://www.imanet.org/PDFs/Public/Press_Releases/STATEMENT%20OF%20ETHICAL%20PROFESSIONAL%20PRACTICE_2.2.12.pdf

http://www.imanet.org/resources_and_publications/ethics_center_helpline.aspx – Have it “conceptually” memorized.– Similar to the AICPA version– You will then be able to answer any question from there– Stay “within” an objective view, and don’t get side-tracked in emotional distractors

http://www.imanet.org/PDFs/Public/Press_Releases/STATEMENT%20OF%20ETHICAL%20PROFESSIONAL%20PRACTICE_2.2.12.pdf



EthicsIMA’s Statement of Ethical Professional Practicea. The Statement contains four overaching principles, which can be remembered with the

mnemonic HFOR.1. Honesty2. Fairness3. Objectivity4. Responsibility

b. The Statement also contains four specific standards, which be remembered with the mnemonic CCIC.

1. Competence2. Confidentiality3. Integrity4. Credibility

Conflict of Interest

One of the provisions of the IMA Statement enjoins members to mitigate actual, and to avoid apparent, conflicts of interest.

Budgeting• Overview– A Formal Plan - A budget is a formal statement of an

organization’s plan for a period of time expressed in quantitative terms. It is used to guide an entity toward reaching its operational goals and is, therefore, an important element of overall planning and control. Financial and qualitative issues must be considered along with the quantitative data to ensure that all aspects of company operations are included in profit planning.

Budgeting• Budgeting is part of an effective planning

process.– Hierarchy of Planning

• Mission and strategic plans• Strategic objectives and plans• Tactical objectives and plans• Operational objectives and plans• Contingency Plans

Budgeting• Budgeting is part of an effective control

system, which has:– Measurement of Progress– Corrective Actions– Adaptation to change

Budgeting• Different types of controls include:– Preliminary (Feedforward) Controls– Screening (Concurrent) Controls– Post-Action (Feedback) Controls

• Budgeting is also used for/with Benchmarking– “A point of reference from which measurements can be

made.”

Budgeting– Used for communication and coordination– Evaluation tool – Budget Report• Budget/Variance Report• Motivation

– Top management commitment– Essential Planning Element

Budgeting• Roles of Budgeting – Each company may use budgets for

different purposes. Remember PREMECC– Planning– Ritual– Evaluation– Motivation– Education– Coordination– Communication

Budgeting• Environments include:

– Economic– Organization– Behavior

• Budgets include– Annual– Project

• Level of detail– Line items– Programs

Budgeting• Estimates for budgets include:

– Incremental– Zero-based

• Process includes:– Authoritarian/Top-down/Imposed– Participative/Bottom-up

• Types of budgets include:– Kaizen budgeting– Continuous/Rolling Budgets– Contingency Budgeting– Activity-based Budgeting

Budgeting• See examples on page 73

Cost Classifications• Controllable VS. Noncontrollable• Avoidable Vs. Committed• Incremental vs. Differential• Engineered s. Discretionary• Outlays vs. Opportunity• Relevant vs. Sunk

Cost Classifications• Joined vs. Separable• Normal vs. Abnormal Spoilage• Rework, Scrap, and Waste• Other

– Carrying costs– Transferred-in costs– Value-adding costs

• Manufacturing Capacity– Normal capacity– Practical capacity– Theoretical (ideal) capacity

Costing Techniques• Absorption vs. Variable Costing

– Need to understand: • Under absorption costing, which costs are considered product costs and

which are considered period costs?

• Under variable costing, which costs are considered products and which are considered period costs?

• When is income under variable costing higher than income under absorption costing?

• What formula can be used to calculate the difference between income under variable costing and income under absorption costing?

• What managerial behavior does variable costing render ineffective?

Costing Techniques (cont.) • Absorption costing

– Also called full costing treats all manufacturing costs as product costs.

– Inventoried cost of the product thus includes all prodcution costs, fixed and variable. Required by GAAP.

– Gross Margin (gross profit) = Sales revenue and absorption cost of COGS, and covers S, G & A.

Costing Techniques (cont.) • Absorption vs. Variable Costing (continued)

• Variable costing – Also called direct costing considers only variable manufacturing cost as

product cost.

– Fixed cost are period costs and expensed as incurred.

– Simple and easy to calculate. First consideration in determining whether product should be manufactured (does it cover variable production costs).

– Contribution margin = net sales revenue minus all variable costs (mfg. & S, G & A). “Contributions toward covering fixed costs”.

SU 1.6 - Practice Question 1Which one of the following considers the impact of fixed overhead costs?

A Full absorption costing.

B Marginal costing.

C Direct costing.

D Variable costing.

SU 1.6 - Practice Question 1 Answer

Correct Answer: A

Full absorption costing treats fixed factory overhead costs as product costs. Thus, inventory and cost of goods sold include (absorb) fixed factory overhead.

SU 1.6 - Practice Question 2An accounting system that collects financial and operating data on the basis of the underlying nature and extent of the cost drivers is

A Direct costing.

B Activity-based costing.

C Cycle-time costing.

D Variable costing.


Correct Answer: B

An activity-based costing (ABC) system identifies the causal relationship between the incurrence of cost and the underlying activities that cause those costs. Under an ABC system, costs are applied to products on the basis of resources consumed (drivers).

SU 1.6 - Practice Question 3

Consider the cost of goods sold calculation shown below.

Beginning inventory $ 100,000Plus cost of goods manufactured 2,500,000Less ending inventory -125,000

Plus variable overhead efficiency variance 10,000

Cost of goods sold $2,485,000


Correct Answer: D

In both normal and standard costing, immaterial efficiency variances are accounted for as an addition to cost of goods sold.

Learning Curve• This method involves applying a mathematical formula to

estimate future time to produce units. Learning curves were first developed in the aircraft industry before World War II. Analyst discovered that the direct labor input per airplane declined as more airplanes were produced. Surveys of manufacturers showed that the direct labor for the eight unit was only 80% of the direct labor required for the fourth unit, and the direct labor for the twelfth unit was only 80% of the labor for the sixth unit.

Learning Curve• Learning curves enable the manager to

protect the manufacturing cost per unit.– Application – Firms that emphasize low price and

large volumes must move down the learning cost to reduce cost per unit.

– Product changes can disrupt the learning curve model.

Learning Curve• Assumptions– Increasing efficiency– Decrease will decline– Exponential curve

Learning Curve• Example – A company has a learning curve of

80 percent, and the first 50 units took 1,000 hours to make. How long will the next order of 150 units take?

Learning Curve• Answer: 50 units @ 1000 hours = 20 hours per unit,

therefore on the first doubling to 100 units the cumulative average is 16 hours (20 hours X.80) per unit. The second doubling to 200 units produces a cumulative average of 12.8 hours (16 hours X .80) per unit.

200 units X 12.8 hours per unit 2,560 total hoursSubtract the hours for the first 50 units (1,000) hoursHours to make another 150 units 1,560 hours

Cost Accumulations MethodsJob Costing

• As a job is being produced, its accumulated cost are kept in Good in Process Inventory.

• The summation of all cost sheets makes up a subsidiary ledger controlled by the Goods in Process Inventory account in the general ledger.

• Cost Flows: During Production – While a job is being produced, its accumulated costs are kept in Goods in Processed Inventory. The collection of job cost sheets for all jobs in process makes up a subsidiary ledger controlled by the Goods in Process Inventory account in the general ledger. Managers use job cost sheets to monitor costs incurred to date and to predict and control cost for each job.


• Cost Flow: Job completion – When a job is finished, its job cost sheet is completed and moved from the jobs in process file to the jobs file. This latter file acts as a subsidiary ledger controlled by the Finished Goods Inventory Account.

• Cost Flows: Job Delivery – When a finished job is delivered to a customer, the job cost sheet is moved to a permanent file supporting the total cost of goods sold. This permanent file contains records from both current and prior periods.


• Factory overhead includes all production costs other than direct materials and direct labor, such as indirect material and indirect labor.

• They are recorded to the Factory Overhead Control account, and ultimately to the job cost sheets via an allocations.

• Overhead Allocation Bases– Usually based on factors of productions like direct labor or machine hours.– Correct allocation is important and affects accuracy.

• Overhead Allocation Rates– Predetermined Overhead rate or predetermined overhead allocation (or application) rate.

The predetermined overhead rate is computed at the start of the period and is used throughout the period to allocate overhead to jobs.


• Adjusting Factory Overhead– Actual overhead < applied = Underapplied overhead– Actual overhead > applied = Overapplied– The closer a estimate is to actuals in absolute terms

the better the estimates was

Understand the effects on the Financials statements when this occurs


• Spoilage– Output that does not meet the quality standards

for salability is considered spoilage.• That amount that is expected is considered normal

spoilage in which case it is included as product costs.• Spoilage that is over or above normal is considered

abnormal and treated as period cost.

Cost Accumulations MethodsProcess Costing

Process costing is used in Process Operations, also called process manufacturing or process production, is the mass production of products in

a continuous flow of steps.

“Products pass through a series of sequential processes”

• Common feature of Process Operations is that it is sequential using a series of standardized processes.

• Series of processes = series of steps


• Understanding processes for companies with process operations is crucial for measuring their costs.

• In process costing system focus is on the process itself and the standardized units produced.

• In process operations, each process is identified as a separate production department, workstation, or work center.

• Every subsequent department, workstation, etc. receives the output of the previous “step” (and is cumulative of all preceding)


• Additional cost added at each “step” can be– Direct Material– Direct Labor– Overhead (labor, material and other)– The last “step” produces the finished goods

– Output of one department becomes the input of another department, as is the case with sequential processing – costs transfer with those units from the prior “step”

Remember!Process cost accounting systems assign direct material, direct labor, and overhead to specific processes (or departments). The total costs associated with each process are the divided by the number of units passing through that process to determine the cost per equivalent unit (EU) for that process.


• Process Cost Factory Overhead Cost– The time it takes to process (cycle) products

through a process is sometimes used to allocate costs.

– With increasing automation, companies with process operations are more likely to use machine hours to allocate overhead.


Equivalent Units!

If a process has no beginning and no ending goods in process inventory, then the unit cost of goods transferred out of a process is:

Total cost assigned to the process (direct material, direct labor, and overhead)Total number of units started and finished in the period


The goal is to compute the cost per equivalent unit and to assign costs to finished goods and goods in process inventory.

• What complicates calculations is that material, labor and overhead sometimes are added in unequal increments over the process “steps”.

• Remember:– First equivalent units are determined and then per-unit cost are calculated.


• Two methods of calculating EUP (both are tested on the exam!)– Weighted-average method – units in beginning work-in-process

inventory are treated as if they were started and completed during the current period.

– First-in, first-out method – units in beginning work-in-process inventory are part of the EUP calculation. The calculation is thus more complex than weighted-average but tends to be more accurate.


• See Process costing handout

SU 2.2 Practice Question 1In a process-costing system, the cost of abnormal spoilage should be

A Prorated between units transferred out and ending inventory.

B Included in the cost of units transferred out.

C Treated as a loss in the period incurred.

D Ignored.

SU 2.2 Practice Question 1Correct Answer: C

Abnormal spoilage is spoilage that is not expected to occur under normal, efficient operating conditions. Because of its unusual nature, abnormal spoilage is typically treated as a loss in the period in which it is incurred.

SU 2.2 Practice Question 2Fact pattern: Superb Hancock Company uses a process costing system in which all materials are added at the beginning of the first process. Conversion costs are added evenly throughout the process. During the past month, 10,000 units were started in production, and 8,000 were completed and transferred to the next department. There were no beginning inventories. The ending inventories were 70% complete at the end of the month. The company uses a weighted-average method for inventory valuation.

If Superb Hancock’s materials used in production cost $15,000 and its conversion costs incurred were $25,000, what amount of inventory (rounded) was transferred to the next department?A $32,000B $33,280C $36,280D $40,000

SU 2.2 Practice Question 2 AnswerCorrect Answer: B

The equivalent units of materials equal 10,000 because all materials are added at the beginning of the process, and 10,000 units were started. The equivalent units of conversion costs equal 9,400 [8,000 units completed + (2,000 units in ending inventory × 70%)]. The unit cost of materials is $1.50 ($15,000 ÷ 10,000 EU). The unit cost of conversion is $2.66 ($25,000 ÷ 9,400 EU). Thus, the cost of goods transferred was $33,280 [8,000 units × ($1.50 + $2.66)].


If Superb Hancock’s materials used in production cost $15,000 and its conversion costs incurred were $25,000, what is the value (rounded) of the ending work-in-process inventory in the first processing department?

A $6,720B $8,000C $3,720D $0

SU 2.2 Practice Question 3 AnswerCorrect Answer: B

The equivalent units of materials equal 10,000 because all materials are added at the beginning of the process, and 10,000 units were started. The equivalent units of conversion costs equal 9,400 [8,000 units completed + (2,000 units in ending inventory × 70%)]. The unit cost of materials is $1.50 ($15,000 ÷ 10,000 EU). The unit cost of conversion is $2.66 ($25,000 ÷ 9,400 EU). Thus, the cost of goods transferred was $33,280 [8,000 units × ($1.50 + $2.66)].


If Superb Hancock’s materials used in production cost $15,000 and its conversion costs incurred were $25,000, what is the value (rounded) of the ending work-in-process inventory in the first processing department?

A $6,720B $8,000C $3,720D $0

SU 2.2 Practice Question 4 AnswerCorrect Answer: A

The cost transferred out was $33,280. Hence, the ending inventory must equal the production costs for the month (given no beginning inventories), minus costs transferred out, or $6,720 [($15,000 materials + $25,000 conversion cost) – $33,280].


Assume that Superb Hancock uses first-in, first-out (FIFO) for inventory costing instead of the weighted-average inventory valuation. If materials used in production cost $15,000 and conversion costs incurred were 25,000, what amount of inventory (rounded) was transferred to the next department under FIFO?

A $32,000B $33,280C $36,280D $40,000

SU 2.2 Practice Question 5Correct Answer: B

The only difference between weighted average and FIFO relates to the beginning inventories. Because there were no beginning inventories in this problem, the two valuation methods produce the same results. The equivalent units of materials equal 10,000 because all materials are added at the beginning of the process, and 10,000 units were started. The equivalent units of conversion costs equal 9,400 [8,000 units completed + (2,000 units in ending inventory × 70%)]. The unit cost of materials is $1.50 ($15,000 ÷ 10,000 EU). The unit cost of conversion is $2.66 ($25,000 ÷ 9,400 EU). Therefore, the cost of goods transferred using the FIFO method for inventory costing is $33,280 [8,000 units × ($1.50 + $2.66)].

Cost Accumulations MethodsActivity–based Costing

1) Activity Analysis: understand the different steps and process from DM to Finished Goods

2) Assign Resource Costs to Activities: first-stage allocation. Identify resource costs: a separate Accounting System may be necessary to track resource costs separately from the GL. Then we need to define resource drivers to allocate it.

3) Allocate Activity Cost Pools to Cost Objects: allocating the activity cost pools to final cost objects = second-stage allocation What are my activity drivers?


• Cause-&-effect relationship• Cost object may be a job, product, process, activity, service

or anything else for which a cost measure is desired• Process value analysis: Organization flow

– Value-adding Vs. Non Value-adding– Product costing / continuous improvement

ABC used to obtain full-absorption cost (US GAAP)


ABC Advantages/Disadvantages• Product costing is improved, better decision making• Process value analysis (non-value adding activities can be removed)• More cost assignment of OH• Better cost control and more efficient operations

• Maintain a separate Accounting System to capture resource costs• Design and implement drivers and cost pools• ABC-derived costs of products or services may not conform with GAAP• Cost of implementing an ABC system


Organizational Benefits• Significant variance in volume, diversity of activities, complexity of

operations, relatively high OH costs…• ABC difficult for service organizations: high facility-level costs hard to

assign to service• DL as a base for allocating OH• No benefit for a single product and average regular volume of activity• Real benefits for high level of FC + wide variety of products and level

of production

Cost Accumulations MethodsLife-cycle Costing

• Estimate revenues & expenses• Over the entire sales life cycle• Upstream costs (R&D, Design)• Manufacturing• Downstream costs (Mktg & Distribution, Customer Service)

Great value for Pricing Decision

Cost Accumulations MethodsLife-cycle Costing

• Relationships among costs incurred at different value-chain stages

• Incurring costs vs. locking in costs (SUNK)• Focus on cost control Vs. cost reduction• After-purchase costs (operating, support, repair, disposal…)• Life-cycle and whole-life cycle target costing• Value engineering: minimize cost without reducing customer

satisfaction

Cost Allocations TechniquesAbsorption vs. Variable Costing

• You need to be able to answer the following:

– Under absorption costing, which cost are considered product cost? Which costs are considered period cost?

– In the variable costing, which costs are considered product cost? Which costs are considered period cost?

– What income statement format is appropriate for variable cost?– When is income of the variable costing higher than income and absorption costing?– What format can be used to calculate the difference between income under

variable costing and income and absorption costing? – What managerial behavior does variable costs were render ineffective?


Product cost consist of all the costs incurred the production of a product: direct materials, direct labor, and manufacturing overhead. The process to classified all these costs as part of product costs is referred to as absorption costing (or full costing).

Absorption costing is the cost accumulation method required by generally accepted accounting principles (GAAP) for external reporting, and by regulatory body such as the Internal Revenue Service.

In variable costing, fixed manufacturing overhead is treated as a period expense rather than product cost, meaning it is expensed in the period in which it is incurred.

Absorption Costing

Sales- Product Costs (incl. fixed and variable)

= Gross Margin- Total S, G & A (fixed and Variable)

Variable CostingSales

- Product Cost (only variable cost)= Contribution Margin (portion available to cover fixed costs

- Fixed Costs (both mfg. and S, G & A)

- Under variable costing, fixed overhead is considered a cost of maintaining capacity, not a cost of producing a product.

- Contribution margin will tell you if you are covering at least the direct product costs


• Impact on Operating Income– Produced = Sold = no difference in income

– Produced > Sold > income• When production exceeds sales, fewer fixed cost are expensed under the absorption

basis, and operating income always increases.

• A production manager can thus increase absorption-based operating income by increasing production, whether there is any customer demand for the additional product or not.

• This practice, called producing for inventory, can be effectively discouraged by using variable costing for performance reporting and consequent bonus calculation.


– Produced < Sold < income

• Variable costing will show a higher income in periods when inventories decline because absorption method forces the subtraction of all of the current fixed costs, plus some fixed costs incurred (and capitalized) in prior periods.

• Most importantly, in using variable costing, profits always move in the same direction as sales volume. Profits reported on absorption costing behave erratically and sometimes move in the opposite direction from sales trends

Variable Costing Practical Exercise Solutions


• Other benefits of variable costing:– Variable costing is better suited for management's needs which requires a

knowledge of cost behavior under various operating conditions. For planning and control, management is more concerned with treating fixed and variable costs separately than with calculating full cost.

– Full costs are usually dubious value because they contain arbitrary allocation of fixed cost.

– The production manager cannot manipulate income levels over overproducing.


– The cost data for profit planning and decision-making are readily available from accounting records and statements under variable costing. For example cost profit relationships and the effects of changes in sales volume on that income can easily be computed from income statement prepared under the variable costing concept, but not from the conventional absorption costing income statement based on the same data.

– Absorption cost income statements may show decreases in profits from sales and rising and increases in profits from sales or decreasing, which may be confusing to management.

– A favorable margin in the variable costing justifies a higher production level.– Variable costing is also preferred over absorption costing for studies of relative

profitability of products, territories, and other segments of a business. A concentrate on the contribution of each segment makes to the recovery of fixed costs that will not be altered by decisions to make and sell.

continued


• Inventory changes have no effect on the breakeven computation.

• Disinvestment decisions are facilitated because were their product or department is recouping its variable cost can be determined. If the variable costs are being covered operating a department at apparent loss may be profitable.

• Cost figures are guided by the sales figures. Under variable costing cost of goods sold very directly with sales volume, and the influence of production of gross profit is avoided.

• There will costing also eliminates a possible difficulties have explain over and under applied factory overhead to higher management.

Normal CostingNormal costing is used to derive the cost of a product. It includes the following components:Actual cost of materialsActual cost of laborA standard overhead rate that is applied using the product's actual usage of whatever allocation base is being used (such as direct labor hours or machine time)If there is a difference between the standard overhead cost and the actual overhead cost, then you can either charge the difference to the cost of goods sold (for smaller variances) or prorate the difference between the cost of goods sold and inventory.Normal costing is designed to yield product costs that do not contain the sudden cost spikes that can occur when you use actual overhead costs; instead, it uses a smoother long-term estimated overhead rate.It is acceptable under generally accepted accounting principles and international financial reporting standards to use normal costing to derive the cost of a product.Normal costing varies from standard costing, in that standard costing uses entirely predetermined costs for all aspects of a product, while normal costing uses actual costs for the materials and labor components.

http://www.accountingtools.com/definition-cost

http://www.accountingtools.com/definition-direct-material-cos

http://www.accountingtools.com/definition-direct-labor

http://www.accountingtools.com/overhead-definition

http://www.accountingtools.com/questions-and-answers/what-is-an-allocation-base.html

http://www.accountingtools.com/definition-cost-of-goods-sold

http://www.accountingtools.com/dictionary-inventory

http://www.accountingtools.com/definition-gaap

http://www.accountingtools.com/definition-ifrs

http://www.accountingtools.com/standard-costing

Normal CostingNormal costing uses a predetermined annual overhead rate to assign manufacturing overhead to products. In other words, the overhead rate under normal costing is based on the expected overhead costs for the entire accounting year and the expected production volume for the entire year.Under actual costing each month’s actual costs and each month’s actual production volume are used to assign overhead costs. Since most companies will experience month to month fluctuations in activity, the actual monthly overhead rates will likely vary from month to month.Normal costing will result in an overhead rate that is more uniform and realistic for all of the units manufactured during an accounting year.

Normal CostingManufacturing overhead (also referred to as factory overhead, factory burden, and manufacturing support costs) refers to indirect factory-related costs that are incurred when a product is manufactured. Along with costs such as direct material and direct labor, the cost of manufacturing overhead must be assigned to each unit produced so that Inventory and Cost of Goods Sold are valued and reported according to generally accepted accounting principles (GAAP).

Manufacturing overhead includes such things as the electricity used to operate the factory equipment, depreciation on the factory equipment and building, factory supplies and factory personnel (other than direct labor). How these costs are assigned to products has an impact on the measurement of an individual product's profitability.

Nonmanufacturing costs (sometimes referred to as “administrative overhead”) represent a manufacturer’s expenses that occur apart from the actual manufacturing function. In accounting and financial terminology, the nonmanufacturing costs include Selling, General and Administrative (SG&A) expenses, and Interest Expense. Since accounting principles do not consider these expenses as product costs, they are not assigned to inventory or to the cost of goods sold. Instead, nonmanufacturing costs are simply reported as expenses on the income statement at the time they are incurred.

http://www.accountingcoach.com/terms/I/inventory.html

http://www.accountingcoach.com/terms/C/cost-of-goods-sold.html

http://www.accountingcoach.com/terms/G/generally-accepted-accounting-principles.html

http://www.accountingcoach.com/terms/S/selling-general-and-administrative-expenses.html

http://www.accountingcoach.com/terms/I/interest-expense.html

http://www.accountingcoach.com/terms/I/incurred.html

Normal CostingOn financial statements, each product must include the costs of the following: • Direct material • Direct labor • Manufacturing (or factory) overhead

According to generally accepted accounting principles (GAAP), manufacturing overhead must be included in the cost of Work in Process Inventory and Finished Goods Inventory on a manufacturer’s balance sheet, as well as in the Cost of Goods Sold on its income statement.

As their names indicate, direct material and direct labor costs are directly traceable to the products being manufactured. Manufacturing overhead, however, consists of indirect factory-related costs and as such must be divided up and allocated to each unit produced. For example, the property tax on a factory building is part of manufacturing overhead. Although the property tax covers an entire year and appears as one large amount on just one tax bill, GAAP requires that a portion of this amount be allocated or assigned to each product manufactured during that year.

http://www.accountingcoach.com/terms/I/inventory-work-in-process.html

http://www.accountingcoach.com/terms/I/inventory-finished-goods.html

MOH VariancesRemember!

• If variance is immaterial: directly allocated to COGS

• If variance is material: allocated based on relative values of WIP, Finished goods, COGS

Service Department Costs• Direct Method• Step-Down Method• Reciprocal Method

• Service Depart. = OH = not traced to cost object = must be allocated to operating Departs.

• Cause-&-effect relationship and/or benefits received

See example in SU 3

part 1 cram session

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