Cost Management Measuring, Monitoring, and Motivating Performance Chapter 8 Measuring and Assigning Support Department Costs © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 8: Measuring and Assigning Support Department Costs Learning objectives • • • • • • • Q1: What are support departments, and why are their costs allocated to other departments? Q2: What process is used to allocate support department costs? Q3: How is the direct method used to allocate support costs to operating departments? Q4: How is the step-down method used to allocate support costs to operating departments? Q5: How is the reciprocal method used to allocate support costs to operating departments? Q6: What is the difference between single- and dual-rate allocations? Q7: How do support cost allocations affect decisions and managerial incentives? © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Support versus Operating Departments • The operating departments of an organization produce products or services that generate revenue. • The support departments of an organization produce products or provide services to the operating and other support departments. • The support department costs are common costs that are shared between two or more other departments. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Reasons for Allocating Support Department Costs • External reporting • Motivation • appropriate consumption of support department resources • efficiency of support department • monitor consumption of support department services • Decision making • product pricing • make or buy decisions © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q1: Support Department Allocation Process © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q2: Process for Allocating Support Department Costs 1. Clarify allocation purpose 2. Identify cost pools 3. Assign costs to cost pools 4. Choose allocation bases for each cost pool 5. Choose allocation method; allocate support department costs 6. Allocate updated operating department costs to units of goods or services, if relevant © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 6 Q2: Process for Allocating Support Department Costs 1. Clarify allocation purpose • if the purpose is to motivate the use of the services of a newly formed department, perhaps no costs should be allocated • if the purpose is to discourage operating department managers from over-use of the services of support departments, then a rate per unit of service might be large and not based on actual costs • if the purpose is to determine the full cost of products or services for long-term pricing decisions, then all support costs should be allocated © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 7 Q2: Process for Allocating Support Department Costs 2. Identify cost pools • the purpose will determine whether both fixed and variable support department costs should be allocated • the purpose will determine which costs should be allocated © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2: Process for Allocating Support Department Costs 3. Assign costs to cost pools • some costs will be direct to the cost pool (e.g. toner cartridge costs would be direct to the “variable copying costs” cost pool) • some costs will be indirect to the cost pool (e.g. rent costs for an entire facility would be indirect to the “information technology costs” cost pool) © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 9 Q2: Process for Allocating Support Department Costs 4. Choose allocation bases for each cost pool • an allocation base with a good cause-andeffect relationship with the cost pool provides a reasonable allocation rate • users of support department services will carefully monitor their consumption of the allocation base © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 10 Q2: Process for Allocating Support Department Costs 5. Choose allocation method and allocate support department costs • in this chapter we cover three allocation methods • each of these three methods could be implemented using • a single- or dual-rate approach (covered later) • actual or budgeted costs and allocation bases (covered later) © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Process for Allocating Support Department Costs 6. Allocate updated operating department costs to units of goods or services, if relevant • for some decisions, this may not be relevant • for long-term pricing decisions, this is likely to be relevant © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 12 Q3: The Direct Method of Allocating Support Department Costs • The direct method ignores the fact that support departments use each others’ services. • Each support department’s costs are allocated only to operating departments. • This method is the easiest computationally and the easiest to explain. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 13 Q3: The Direct Method Example Philco Toys makes metal and plastic toys in separate departments. It has two support departments, Accounting and Information Systems. Philco has decided to allocate Accounting department costs based on the number of employees in each department and Information Systems costs based on the number of computers in each department. Given the information below, use the direct method to allocate support department costs. Support Dep’ts Total department costs Number of employees Number of computers Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting (48,000) Information Systems Totals © John Wiley & Sons, 2011 (72,000) $0 $0 27,789 20,211 $0 36,000 36,000 $0 $449,789 $238,211 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q3: The Direct Method Example Plastic Products is allocated Plastic and Metal Product share 22/(22+16) of Accounting Info Systems costs equally department costs, and Metal because they have the same Products is allocated number of computers in each 16/(22+16). Notice that the department. Notice that the number of employees in the number of computers in the support departments is ignored departments is ignored Support Dep’ts support Operating Departments under the direct method. under the direct method. Total department costs Number of employees Number of computers AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting (48,000) Information Systems Totals © John Wiley & Sons, 2011 (72,000) $0 $0 27,789 20,211 $0 36,000 36,000 $0 $449,789 $238,211 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 15 Q4: The Step-Down Method of Allocating Support Department Costs • The step-down method allocates some (but not all) support department costs to other support departments. • The first support department’s costs are allocated to all operating and support departments that use its services. • Each subsequent support department’s costs are allocated to all operating and support departments that use its services, except any support department whose costs were already allocated. • Allocation order must be determined. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 16 Q4: The Step-Down Method Example Given the information for Philco, use the step-down method to allocate support department costs. Allocate the costs of the support department that provides the largest percentage of its services to the other support department first. First determine allocation order: Accounting provided 4/(4+22+16) = 4/42 = 9.5% of its services to Info Systems. Information Systems provided 4/(4+3+3) = 4/10 = 40% of its services to Accounting, so Information Systems goes first. Support Dep’ts Total department costs Number of employees Number of computers © John Wiley & Sons, 2011 Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q4: The Step-Down Method Example Given the information for Philco, use the step-down method to allocate support department costs. Now perform the allocation: Support Dep’ts Total department costs Number of employees Number of computers Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 (76,800) (48,000) 28,800 $0 (72,000) $0 44,463 27,789 32,337 20,211 $0 $0 21,600 21,600 21,600 $0 $0 $435,389 $452,063 $223,811 $235,937 $659,200 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q4: The Step-Down Method Example Info Systems costs are allocated to Accounting, Plastic, & Metal based on each department’s number of computers compared to total non-Info Systems Support Dep’ts computers: 4+3+3=10. Total department costs Number of employees Number of computers Accounting costs are allocated only to Plastic & Metal based on each department’s number of employees compared to total non-Accounting and non-Info Operatingemployees: Departments Systems 22+16=38 AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting Information Systems Totals (76,800) 28,800 $0 (72,000) $0 44,463 32,337 $0 21,600 21,600 $0 $452,063 $235,937 $688,000 Total costs allocated out of Accounting are now higher because of the Info Systems costs allocated to Accounting. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q4: The Step-Down Method Example (22/38) x $76,800 (4/10) x $72,000 (16/38) x $76,800 (3/10) x $72,000 Support Dep’ts Total department costs Number of employees Number of computers (3/10) x $72,000 Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 (76,800) 28,800 $0 (72,000) $0 44,463 32,337 $0 21,600 21,600 $0 $452,063 $235,937 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q5: The Reciprocal Method of Allocating Support Department Costs • The reciprocal method allocates all support department costs to other support departments. • The first step is to compute the total costs of each support department when its usage of other support department services is taken into consideration. • Support department costs are then allocated to all other operating and support departments that consume its services. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q5: The Reciprocal Method Example Given the information for Philco, use the reciprocal method to allocate support department costs. First determine total costs for each support department by writing an equation for its costs (use A and IS as abbreviations). A = $48,000 + [4/(4+3+3)] x IS; IS = $72,000 + [4/(4+22+16)] x A Then solve: A = $48,000 + (4/10) x [$72,000 + (4/42) x A] A = $48,000 + $28,800 + (16/420) x A] (404/420) x A = $76,800 A = $76,800 x (420/404) = $79,842 IS = $72,000 + (4/42) x $79,842 = $79,604 Support Dep’ts Total department costs Number of employees Number of computers © John Wiley & Sons, 2011 Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 22 Q5: The Reciprocal Method Example Given the information for Philco, use the reciprocal method to allocate support department costs. Now perform the allocation: Support Dep’ts Total department costs Number of employees Number of computers Operating Departments Metal Plastic Info AccTotal Products ounting Systems Products $48,000 $72,000 $386,000 $182,000 $688,000 45 16 22 4 3 16 3 3 6 4 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 41,822 7,604 (79,842) (79,842) 7,604 41,822 23,881 (79,604) 31,842 (79,604) 31,842 23,881 $451,703 $0 $451,703 $0 $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e 30,416 30,416 23,881 23,881 $0 $0 $236,297 $236,297 $688,000 Slide # 23 Q5: The Reciprocal Method Example These numbers are the solutions to the simultaneous equations. (4/42) x $79,842 (22/42) x $79,842 (16/42) x $79,842 Support Dep’ts Total department costs Number of employees Number of computers Operating Departments Metal Plastic Info AccTotal Products ounting Systems Products $48,000 $72,000 $386,000 $182,000 $688,000 45 16 22 4 3 16 3 3 6 4 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 41,822 7,604 (79,842) (79,842) 7,604 41,822 23,881 (79,604) 31,842 (79,604) 31,842 23,881 $451,703 $0 $451,703 $0 $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e 30,416 30,416 23,881 23,881 $0 $0 $236,297 $236,297 $688,000 Slide # 24 Q5: The Reciprocal Method Example (4/10) x $79,604 (3/10) x $79,604 (3/10) x $79,604 Support Dep’ts Total department costs Number of employees Number of computers Operating Departments Metal Plastic Info AccTotal Products ounting Systems Products $48,000 $72,000 $386,000 $182,000 $688,000 45 16 22 4 3 16 3 3 6 4 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 41,822 7,604 (79,842) (79,842) 7,604 41,822 23,881 (79,604) 31,842 (79,604) 31,842 23,881 $451,703 $0 $451,703 $0 $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e 30,416 30,416 23,881 23,881 $0 $0 $236,297 $236,297 $688,000 Slide # 25 Q6: Single- versus Dual-Rate Allocation • In single-rate allocation, each cost pool includes fixed and variable costs. • In dual-rate allocation, fixed and variable costs are in separate cost pools. • Both methods can be employed with the direct, step-down, or reciprocal methods. • The prior three examples used the singlerate allocation method. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 26 Q6: Single- versus Dual-Rate Example Philco has decided to use the direct method and allocate variable Accounting costs based on the number of transactions and fixed Accounting costs based on the number of employees. The Info Systems variable costs will be allocated based on the number of service requests and fixed costs will be allocated based on the number of computers. The required information is presented below. Support Dep’ts Total department variable costs Total department fixed costs Number of transactions Number of employees Number of service requests Number of computers Operating Departments AccInfo Plastic Metal ounting Systems Products Products $20,000 $22,000 $186,000 $100,000 $28,000 $50,000 $200,000 $82,000 20 32 140 86 3 4 22 16 18 5 12 8 4 6 3 3 Now perform the allocation… © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 27 Q6: Single- versus Dual-Rate Example Total department variable costs Total department fixed costs Number of transactions Number of employees Number of service requests Number of computers Support Accounting $20,000 $28,000 20 3 18 4 Dep’ts Operating Departments Info Plastic Metal Systems Products Products $22,000 $186,000 $100,000 $50,000 $200,000 $82,000 32 140 86 4 22 16 5 12 8 6 3 3 (20,000) 12,389 7,611 13,200 8,800 $211,589 $116,411 16,211 25,000 $241,211 11,789 25,000 $118,789 $452,800 $235,200 Allocate variable costs: Accounting Information Systems Total variable costs Allocate fixed costs: Accounting Information Systems Total fixed costs Total fixed and variable costs © John Wiley & Sons, 2011 (22,000) $0 $0 (28,000) $0 $0 (50,000) $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 28 Q7: Decision Making with Support Costs • Support costs need to be considered when evaluating decisions such as make/buy, keep/drop, special order, and constrained resource • Necessary to isolate relevant support costs – This may not be the same as the allocated support costs – For example, outsourcing an operating department may not result in a reduction in support department costs © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 29 Q7: Establishing Transfer Prices for Support Departments • Transfer prices should be set to motivate efficient use of the support department resources – If transfer price is set too high, user departments may outsource the service – If transfer price is set too low, user departments may utilize the support department inefficiently • The best transfer pricing approach is the Opportunity Cost approach – Each department is charged an amount that reflects the value of any opportunities forgone by not using the service for its next best alternative use. – This is often difficult in practice so most companies use a cost based or market based transfer pricing policy © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 30 Q7: Estimated versus Actual Support Costs and Rates A department’s allocation of support department costs = the allocation rate x the department’s consumption of the allocation base Either of these could be estimated or actual. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 31 Q7: Estimated versus Actual Support Costs and Rates the allocation rate x the department’s consumption of the allocation base Using actual rates and actual consumption provides the best measure of the cost of support services; it is the most accurate but the least timely. The purpose of the cost allocation will determine whether actual or estimated rates, and actual or estimated consumption, should be used. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 32 Q7: Estimated versus Actual Support Costs and Rates • Actual rates and consumption may be required for some types of government contracts. • Most federal grants to educational institutions allow the use of estimates. • Using an actual rate means that support service users are affected by • inefficiencies of support department managers • changes in the consumption of support services by other users © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 33 Q7: Other Common Cost Allocation Methods • Other cost allocation purposes may require the allocation to • be perceived as “fair” • be based on the user’s “ability to bear” the cost • Under the stand-alone method, a common cost is allocated based on information about the users’ consumption of the cost. • Under the incremental cost allocation method, a “primary user” is allocated the bulk of the common cost and the secondary user is allocated only the increment in cost that it caused. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 34 Q7: Stand-Alone versus Incremental Cost Allocation Methods Example Leslie has a job interview with Big Co. next month in New York City. Her plane ticket cost $300, and she will need to spend $125/night for 2 nights in a hotel. She estimates that she will spend $50 in cab fares and $50 for food. Big Co. has promised to reimburse her actual costs. After this trip was arranged, Small Co., also located in New York City, called her for an interview. If she interviews with Small Co. while she’s there, she will spend an additional $125 for another night at a hotel, and another estimated $40 in cab fares and food. Think of at least two ways to allocate Leslie’s travel costs using the stand-alone method. Discuss the merits of each. 1. Compute the total cost of the trip and divide it by 2, since there are 2 interviews. 2. Compute the total cost of the trip and allocate 2/3 of it to Big Co. and 1/3 to Small Co. since she is spending 2 of the 3 nights in NYC for the Big Co. interview. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 35 Q7: Stand-Alone versus Incremental Cost Allocation Methods Example Perform the calculations for your two versions of the cost allocation under the stand-alone method. Then allocate the travel costs using the incremental cost allocation method. Which is more appropriate? Why? Estimated total costs: Plane ticket Hotel Cab fares & food Total If shared equally, then this is $300 $407.50 for each company; if 375 Big Co. is allocated 2/3 of the 140 cost then $543.33 is allocated $815 to Big Co. and $271.67 is allocated to Small Co. Under the incremental cost allocation method, Big Co. is most likely to be considered the primary user. Since Leslie’s budgeted travel costs were $300 + $250 + $50 + $50 = $650 before she was offered the Small Co. interview, Big Co. is allocated $650 and Small Co. is allocated $815 – $650 = $165. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 36 Q7: Fixed Price versus Cost-Based Contracts • Under fixed price contracts, vendors provide products or services for a specified price. • Under cost-based contracts, the price is computed based on the actual cost of the products or services. • may be necessary for research & new product development • vendors are not motivated to control costs • vendors may be motivated to inappropriately allocate common costs © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 37 Appendix 8A: Excel Solver and the Reciprocal Method • Solving the simultaneous equations required for the reciprocal method can be tedious when there are 3 or more support departments. • Excel Solver can be used to solve these equations. • Refer to Appendix 4A for help with using Excel Solver. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 38 Appendix 8A: Excel Solver and the Reciprocal Method • Set up a “change cell” for each support department’s total costs. • The target function is the sum of the change cells. • The simultaneous equations are entered as constraints; one constraint per equation. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 39 Cost Management Measuring, Monitoring, and Motivating Performance Chapter 9 JOINT PRODUCT AND BY-PRODUCT COSTING © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 9: Joint Product and By-Product Costing Learning objectives • Q1: What is a joint process, and what is the difference between a by-product and a main product? • Q2: How are joint costs allocated? • Q3: What factors are considered in choosing a joint cost allocation method? • Q4: What information is relevant for deciding whether to process a joint product beyond the split-off point? • Q5: What methods are used to account for the sale of byproducts? • Q6: How does a sales mix affect joint cost allocation? • Q7: How do joint cost allocations affect decisions and managerial incentives? © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Joint Processes and Costs • A process that yields one or more products is called a joint process. • The products are called joint products. • The costs of the process are called joint costs. • The split-off point is the stage in the joint process where the separate products become identifiable. • Joints costs are incurred prior to the split-off point. • Costs incurred past split-off are separable costs. • Joint products that have minimal sales value compared to the main product are called byproducts. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Joint Processes and Costs Sawdust Bark Joint costs include DM, DL & Overhead. © John Wiley & Sons, 2011 Planks If sawdust sells for a relatively minimal amount, it is a byproduct. The costs of processing planks further are separable costs. Wall paneling Joint products Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q2: Methods of Allocating Joint Costs • Physical output methods • Can be used only when joint products are measured the same way (e.g. pounds or feet). • Market-based methods • Sales value at split-off method • Often used when all products sold at split-off. • Net realizable value (NRV) method • NRV = Final selling price – Separable costs. • Constant gross margin (GM) NRV method • The two NRV methods can be used when some products are processed past split-off. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q2: Physical Volume Method Example Pleasing Peaches grows peaches and processes three different peach products that are sold to a canning company. The pounds produced for each product, and the selling price per pound, is given below. The joint costs of processing the 280,000 pounds of products were $70,000. Allocate the joint costs to each product using the physical volume method. Selling Total Sales Pounds Price per Value at Product Produced Pound Split-Off Peach halves 160,000 $0.50 $80,000 Peach slices 80,000 $0.40 $32,000 Peach purée 40,000 $0.30 $12,000 280,000 $124,000 © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Relative Allocated Weight Joint Costs 57.1% $40,000 28.6% $20,000 14.3% $10,000 100.0% $70,000 Slide # 6 Q2: Sales Value at Split-Off Method Example Allocate the joint costs of $70,000 to each of Pleasing Peaches products using the sales value at split-off method. Product Peach halves Peach slices Peach purée © John Wiley & Sons, 2011 Pounds Produced 160,000 80,000 40,000 280,000 Selling Total Sales Price per Value at Pound Split-Off $0.50 $0.40 $0.30 $80,000 $32,000 $12,000 $124,000 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Relative Sales Allocated Value Joint Costs 64.5% 25.8% 9.7% 100.0% $45,161 $18,065 $6,774 $70,000 Slide # 7 Q2, 6: Compare the Physical Volume and Sales Value at Split-Off Methods Compute the gross margin for each product for each of the two allocation methods. Discuss the differences between the two methods. Total Sales Value at Product Split-Off Peach halves $80,000 Peach slices $32,000 Peach purée $12,000 $124,000 © John Wiley & Sons, 2011 Allocated Joint Costs Sales Physical Value at Volume Split-Off Method Method $40,000 $45,161 $20,000 $18,065 $10,000 $6,774 $70,000 $70,000 Gross Margin Sales Physical Value at Volume Split-Off Method Method $40,000 $34,839 $12,000 $13,935 $2,000 $5,226 $54,000 $54,000 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2, 6: Compare the Physical Volume and Sales Value at Split-Off Methods Compute the gross margin ratio (GM/Sales) for each product under both of the methods and discuss. Product Peach halves Peach slices Peach purée © John Wiley & Sons, 2011 Total Sales Value at Split-Off $80,000 $32,000 $12,000 $124,000 Gross Margin Sales Physical Value at Volume Split-Off Method Method $40,000 $34,839 $12,000 $13,935 $2,000 $5,226 $54,000 $54,000 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Gross Margin Ratio Sales Physical Value at Volume Split-Off Method Method 50.0% 43.5% 37.5% 43.5% 16.7% 43.5% 43.5% 43.5% Slide # 9 Q2: Net Realizable Value (NRV) Method Example Pleasing Peaches could process each of its three products beyond split off. It could can the peach halves itself, make the peach slices into frozen peach pie, and make juice out of the peach purée. The retail value of the new products and the separable costs for the additional processing are given below. Compute the joint costs allocated to each of the products using the NRV method. Final Sales Separable Relative Product Value Costs NRV NRV Canned peaches $180,000 $60,000 $120,000 64.2% Peach pie $120,000 $70,000 $50,000 26.7% Peach juice $50,000 $33,000 $17,000 9.1% $350,000 $163,000 $187,000 100.0% © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Allocated Joint Costs $44,920 $18,717 $6,364 $70,000 Slide # 10 Q2: Constant GM NRV Method • Under the constant GM NRV method, all products are allocated joint costs to achieve the same gross margin ratio (GM%). • First compute overall gross margin and GM%: GM = Revenue – Joint costs – Separable costs GM% = GM/Sales • Then compute the GM for each product: GM = Final sales value x GM% • All products end up with the same gross margin ratio; for each product solve for allocated joint costs: Final sales value – joint costs – separable costs = GM © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Constant GM NRV Method Example Compute the joint costs that Pleasing Peaches would allocate to each of the products using the constant GM NRV method. First compute the overall GM and GM ratio: GM = $350,000 – $163,000 – $70,000 = $117,000 GM% = $117,000/$350,000 = 33.43% Allocated Final Sales Separable Joint Gross Product Value Costs Costs Margin Canned peaches $180,000 $60,000 $59,829 $60,171 Peach pie $120,000 $70,000 $9,886 $40,114 Peach juice $50,000 $33,000 $286 $16,714 $350,000 $163,000 $70,000 $117,000 Gross Margin Ratio 33.4% 33.4% 33.4% Values are rounded as appropriate. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 12 Q2, 6: Compare the NRV and Constant GM NRV Methods Compute the gross margin (GM) and the gross margin ratio (GM%) for each product under NRV method. Compare this to the results of the constant GM NRV method and discuss. Product Peach halves Peach slices Peach purée Final Sales Value $180,000 $120,000 $50,000 $350,000 Gross Margin Gross Margin Ratio Constant Constant NRV GM NRV NRV GM NRV Method Method Method Method $75,080 $60,171 41.7% 33.4% $31,283 $40,114 26.1% 33.4% $10,636 $16,714 21.3% 33.4% 33.4% $117,000 $117,000 33.4% Values are rounded as appropriate. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 13 Q3: Choosing a Joint Cost Allocation Method • Allocated joint costs should not be used in decision making. • Still, avoid a method that shows one product to be unprofitable. • Under the physical volume method, the product with the greatest relative physical volume is allocated the most joint costs, regardless of product’s sales value. • Both of the NRV methods allocate joint costs based on the products’ “ability to bear the cost”. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q4: Sell or Process Further Decisions • Companies often can choose to sell a product at the split-off point or to process it further. • Compare the incremental revenue of processing further to the product’s separable costs. • Incremental revenue of processing further = Final sales value – Sales value at split-off • Process further only when the incremental revenue exceeds the separable costs. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 15 Q4: Sell or Process Further Example Peg’s Plastic Products makes the molded plastic parts for three model car kits, A, B & C from a joint production process. The joint costs of this process are $150,000. In each case, Peg could decide to make the entire kit rather than just the plastic parts. Information about the sales values and separable costs for each kit is given below. Determine which kits Peg should sell at the split-off point and which she should process further. Kit A B C Final Sales SepIncreSales Value at arable mental Value Split-Off Costs Revenue $200,000 $180,000 $25,000 $20,000 $120,000 $60,000 $40,000 $60,000 $80,000 $40,000 $10,000 $40,000 © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Incremental Profit if Process Further ($5,000) $20,000 $30,000 Sell at Split-Off or Process Further? Sell Process Process Slide # 16 Q5: Accounting for By-Products • When by-products have no sales value, there is no reason to account for them. • Otherwise, there are two accounting methods available: • Recognize by-product value at time of production • Recognize by-product value at time of by-product sale © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q5: Recognize By-Product Value at Time of Production • This method is also known as the offset approach or the NRV approach. • Joint cost of the main products is reduced by the NRV of the by-products, even if by-products are not yet sold. • NRV of the by-products is kept in ending inventory until sold. • At sale of by-product, ending inventory is reduced; there is no gain/loss on sale. • This method allows managers to control by-products. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q5: By-Product Value Recognized at Time of Production Example SJ Enterprises produces a main product and one by-product in a joint process. The joint costs totaled $480,000. The main product sells for $10/unit and the by-product sells for $1/unit. Information about the production and sales of the 2 products is given below. Use the NRV method to compute the production cost per unit for the main product. Information in Units of Each Product Beginning ProdEnding Inventory uction Sales Inventory Main product 0 100,000 95,000 5,000 By-product 0 10,000 3,000 7,000 Production costs $480,000 Less: NRV of by-product 10,000 Net joint product cost $470,000 Net product cost per unit © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $4.70 Slide # 19 Q5: By-Product Value Recognized at Time of Production Example Prepare an income statement for SJ Enterprises and compute the costs attached to ending inventory using the NRV method, assuming that nonmanufacturing costs totaled $250,000. Revenue: 95,000 units at $10/unit $950,000 Cost of goods sold: 95,000 units at $4.70/unit 446,500 Gross margin 503,500 Less: nonmanufacturing expenses 250,000 Operating income $253,500 Ending inventory: Main product: 5,000 units at $4.70 By-product: 7,000 units at $1 Value of ending inventory for balance sheet © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $23,500 7,000 $30,500 Slide # 20 Q5: Recognize By-Product Value at Time of Sale • This method is also known as the Realized Value Approach or the RV Approach. • Joint cost of the main products is not reduced by the NRV of the by-products, regardless if byproducts are sold. • NRV of the by-products is not kept in ending inventory. • At sale of by-product, either Other Income is recorded or Cost of Goods Sold is reduced. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q5: By-Product Value Recognized at Time of Sale Example SJ Enterprises produces a main product and one by-product in a joint process. The joint costs totaled $480,000. The main product sells for $10/unit and the by-product sells for $1/unit. Information about the production and sales of the 2 products is given below. Use the RV method to compute the production cost per unit for the main product. Information in Units of Each Product Beginning ProdEnding Inventory uction Sales Inventory Main product 0 100,000 95,000 5,000 By-product 0 10,000 3,000 7,000 Production costs Net product cost per unit © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $480,000 $4.80 Slide # 22 Q5: By-Product Value Recognized at Time of Sale Example Prepare an income statement for SJ Enterprises and compute the costs attached to ending inventory using the RV method, assuming that nonmanufacturing costs totaled $250,000. By-product sales is recorded as other income. Revenue: 95,000 units at $10/unit $950,000 By-product sales: 3,000 units at $1/unit 3,000 Total revenue 953,000 Cost of goods sold: 95,000 units at $4.80/unit 456,000 Gross margin 497,000 Less: nonmanufacturing expenses 250,000 Operating income $247,000 Ending inventory: Main product: 5,000 units at $4.80 © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $24,000 Slide # 23 Q7: Decision Making & Joint Cost • Joint cost information is required for financial statement & tax return preparation when production does not equal sales (inventory and cost of goods sold). • Allocated joint costs are irrelevant for most decisions, especially regarding individual products • Joint cost information should not be used to make product mix decisions. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 24 Cost Management Measuring, Monitoring, and Motivating Performance Chapter 10 Static and Flexible Budgets © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 10: Static and Flexible Budgets Learning objectives • Q1: How do budgets contribute to the strategic management process? • Q2: What is a master budget and how is it prepared? • Q3: What are flexible budgets and how can they be used for sensitivity analysis? • Q4: How are budget variances calculated and used as performance measures? • Q5: How do behavioral tensions influence the budgeting process? • Q6: What approaches exist for addressing the problems of traditional budgeting? © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Budgets & Strategic Management Process • A budget is • • • • A formalized financial plan. A translation of an organization’s strategies. A method of communicating. A way to define areas of responsibility and decision rights. • The budget cycle is the series of sequential steps followed to create and use budgets. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Budgets & Strategic Management Process • Budgeting process begins with the organizational vision, core competencies, and risk appetite • Organizational strategies designed to achieve the vision will drive the capital expenditures and long term financing plans • Operating plans are then created in line with the organizational strategies • Actual results must be monitored, measured, and analyzed compared to budgeted plans © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q1: Budgets & Levers of Control Belief Systems • Communicates organizational strategies and goals • Motivates managers to plan in advance and coordinate activities © John Wiley & Sons, 2011 Boundary Systems • Authorizes employees to engage in planned activities and spend within budget limits • Ensures sufficient cash flow for financial viability Interactive Control Systems Diagnostic Control Systems • Utilize variances to identify opportunities and threats to the business • Revaluate strategies and operating plans as conditions changes • Assign responsibility and reward employees for achieving budget targets • Motivate managers to provide good estimates and use resources appropriately Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q2: Master Budgets • A master budget is • A comprehensive plan for the upcoming accounting period. • Usually prepared for a one-year period. • Is based on a series of budget assumptions. • The master budget consists of several subsidiary budgets, in two categories: • Operating budgets. • Financial budgets. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 6 Q2: Operating Budgets © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 7 Q2: Operating Budgets The operating budget is created by preparing the following individual budgets, in this order: • • • • • • • • Revenue budget Production budget Direct materials budget Direct labor budget Manufacturing overhead budget Inventory and cost of goods sold budget Support department budgets Budgeted income statement © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2: Financial Budgets The financial budget is created by preparing the following individual budgets, in this order: • • • • • Capital budget Long-term financing budget Cash budget Budgeted balance sheet Budgeted statement of cash flows © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 9 Q2: Operating Budget Example Stanley J, Inc., makes a tool used by auto mechanics that sells for $68/unit. It expects to sell 6,000 units in April and 7,000 units in May. Stanley J prefers to end each period with a finished goods inventory equal to 10% of the next period’s sales in units and a direct materials inventory equal to 20% of the direct materials required for the next period’s production. The company never has any beginning or ending work-in-process inventories. There were 400 units in finished goods inventory on April 1. Prepare the revenue and production budgets for April. Revenue budget Budgeted sales in units in April 6,000 Budgeted selling price per unit $68.00 Budgeted revenues $408,000 © John Wiley & Sons, 2011 Production budget Budgeted sales in units in April Desired ending FG inventory Total units required Less: beginning FG inventory Required production in units Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e 6,000 700 6,700 (400) 6,300 Slide # 10 Q2: Operating Budget Example Stanley J’s product uses 0.3 pounds of direct material per unit, at a cost of $4/lb. There were 220 lbs. of direct material on hand on April 1. Assume that budgeted production for May is 6,500 units. Prepare the direct materials purchases and usage budget for April. Direct materials budget Required production in units DM required per unit, in pounds Total DM required, in pounds Less: Beginning DM inventory Plus: Desired ending DM inventory Required DM purchases in pounds Budgeted DM cost per pound Budgeted cost of DM 6,300 0.3 1,890 (220) 390 2,060 $4.00 $8,240 Usage Budget = 1,890 pounds * $4 per pound = $7,560 © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Operating Budget Example Stanley J’s product uses 0.2 hours of direct labor at a cost of $12/hr. Prepare the direct labor budget for April. Direct labor budget Required production in units DL required per unit, in hours Total DL hours required Budgeted cost per DL hour Budgeted cost of DL © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e 6,300 0.2 1,260 $12.00 $15,120 Slide # 12 Q2: Operating Budget Example Stanley J’s budgeted fixed manufacturing overhead for April is $167,000, and variable manufacturing overhead is budgeted at $6 per direct labor hour. Prepare the manufacturing overhead budget for April. Manufacturing overhead budget Total DL hours required Budgeted variable overhead per DL hour Total budgeted variable overhead Budgeted fixed overhead Total budgeted overhead © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e 1,260 $6.00 $7,560 $167,000 $174,560 Slide # 13 Q2: Operating Budget Example Assume that Stanley J’s April 1 direct materials inventory had a cost of $1,560. Prepare the April ending inventories budget for direct materials. Ending inventories budgets Budgeted cost of DM purchases $8,240 Beginning DM inventory $854 DM available for use $9,094 Budgeted cost of desired ending DM inventory: [6,500 units x 0.3 lbs/unit] x 20% x $4/lb $1,560 Budgeted cost of DM to be used $7,534 © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q2: Operating Budget Example Prepare the April ending inventories budget for finished goods. Budgeted cost of DM to be used Budgeted cost of DL Total budgeted overhead Total budgeted manufacturing costs Required production in units Budgeted manufacturing cost per unit Budgeted ending FG inventory in units Budgeted cost of ending FG inventory © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e $7,534 $15,120 $174,560 $197,214 6,300 $31.3037 700 $21,913 Slide # 15 Q2: Operating Budget Example Assume that Stanley J’s April 1 finished goods inventory had a cost of $12,146. Prepare the cost of goods sold budget for April. Cost of goods sold budget Beginning FG inventory Total budgeted manufacturing costs Cost of goods available for sale Less: budgeted ending FG inventory Budgeted cost of goods sold © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e $12,146 $197,214 $209,359 $21,913 $187,447 Slide # 16 Q2: Operating Budget Example Stanley J’s budget for April includes $22,000 for administrative costs, $34,000 for fixed distribution costs, $18,000 for research and development, and $13,000 for fixed marketing costs. Additionally, the budgeted variable costs for distribution are $0.75/unit sold and the budgeted variable costs for marketing are 4% of sales revenue. Prepare the support department budget for April. Support department budget Administration $22,000 Distribution: Fixed costs $34,000 Variable costs $4,500 $38,500 Research & development $18,000 Marketing: Fixed costs $13,000 Variable costs $16,320 $29,320 Total budgeted support department costs $107,820 © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q2: Operating Budget Example Suppose that Stanley J’s income tax rate is 28%. Prepare the budgeted income statement for April. Budgeted income statement Sales revenue Cost of goods sold Gross margin Operating costs: Administration Distribution Research & development Marketing Net income before taxes Income taxes Net income © John Wiley & Sons, 2011 $408,000 $187,447 $220,553 $22,000 $38,500 $18,000 $29,320 $107,820 $112,733 $31,565 $81,168 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q4: Budget Variances • Managers compare actual results to budgeted results in order to • Monitor operations, and • Motivate appropriate performance. • Differences between budgeted and actual results are called budget variances. • Variances are stated in absolute value terms, and labeled as Favorable or Unfavorable. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q4: Budget Variances • Reasons for budget variances are investigated. • The investigation may find: • Inefficiencies in actual operations that can be corrected. • Efficiencies in actual operations that can be replicated in other areas of the organization. • Uncontrollable outside factors that require changes to the budgeting process. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q3: Static Budgets • A budget prepared for a single level of sales volume is called a static budget. • Static budgets are prepared at the beginning of the year. • Differences between actual results and the static budget are called static budget variances. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q3: Flexible Budgets • A budget prepared for a multiple levels of sales volume is called a flexible budget. • Flexible budgets are prepared at the beginning of the year for planning purposes and at the end of the year for performance evaluation. • Flexible budgets are also used for sensitivity analysis and to manage risk due to uncertainty. • Differences between actual results and the flexible budget are called flexible budget variances. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 22 Q3, Q4: Flexible Budget Example Tina’s Trinkets is preparing a budget for 2006. The budgeted selling price per unit is $10, and total fixed costs for 2006 are estimated to be $5,000. Variable costs are budgeted at $3/unit. Prepare a flexible budget for the volume levels 1,000, 1,100, and 1,200 units. Sales in units Revenues Variable costs Contribution margin Fixed costs Operating income © John Wiley & Sons, 2011 Volume Levels 1,000 1,100 1,200 $10,000 $11,000 $12,000 $3,000 $3,300 $3,600 $7,000 $7,700 $8,400 $5,000 $5,000 $5,000 $2,000 $2,700 $3,400 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 23 Q3, Q4: Static Budget Variances Example Suppose that Tina’s 2006 static budget was for 1,100 units of sales. The actual results are given below. Compute the static budget variances for each row and discuss. Static Budget Sales in units 1,100 Revenues $11,000 Variable costs $3,300 Contribution margin $7,700 Fixed costs $5,000 Operating income $2,700 © John Wiley & Sons, 2011 Static Actual Budget Results Variance 980 $9,604 $1,396 $2,989 $311 $6,615 $1,085 $4,520 $480 $2,095 $605 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Unfavorable Favorable Unfavorable Favorable Unfavorable Slide # 24 Q3, Q4: Flexible Budget Variances Example Compute the flexible budget variances for Tina and discuss the results. Compare the flexible budget variances to the static budget variances on the prior page. Year-end Flexible Budget Sales in units 980 Revenues $9,800 Variable costs $2,940 Contribution margin $6,860 Fixed costs $5,000 Operating income $1,860 © John Wiley & Sons, 2011 Flexible Actual Budget Results Variance 980 $9,604 $196 $2,989 $49 $6,615 $245 $4,520 $480 $2,095 $235 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Unfavorable Unfavorable Unfavorable Favorable Unfavorable Slide # 25 Q3, Q4: Performance Evaluation • A static budget variance includes effects from output volume. • A flexible budget variance removes these output volume effects. • Other adjustments to the year-end flexible budget may be made for a fair performance evaluation, such as • Input price changes outside the control of the manager under evaluation • Fixed cost increases outside the control of the manager under evaluation © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 26 Q5: Behavior Tensions in Budgeting • Budgets used to evaluate performance and compensation can create behavioral tension • Participative budgeting – when managers who are responsible for the budgets prepare the budget forecasts – Can result in budgetary slack – when managers set targets so low that goals can be met easily (and bonuses achieved) • Budget ratcheting – when top managers set targets – If targets unachievable, this can result in employees having little motivation to meet targets • Organizations must watch for budget manipulation © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 27 Q6: Other Budgeting Approaches • Zero based budgets are prepared without using past information as justification. • Rolling budgets are prepared frequently for overlapping time periods and actual results may be used to update the budget for the next period. • Kaizen budgets plan cost reductions over time. • Activity based budgets use more cost pools and cost drivers. • GPK and RCA budgets identify fixed and variable cost functions at the resource center level. • Beyond budgeting uses external benchmarks to evaluate managers’ performance © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 28

Do you have a similar assignment and would want someone to complete it for you? Click on
the ORDER NOW option to get instant services . We assure you of a well
written and plagiarism free papers delivered within your specified deadline.

,

Cost Management Measuring, Monitoring, and Motivating Performance Chapter 8 Measuring and Assigning Support Department Costs © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 8: Measuring and Assigning Support Department Costs Learning objectives • • • • • • • Q1: What are support departments, and why are their costs allocated to other departments? Q2: What process is used to allocate support department costs? Q3: How is the direct method used to allocate support costs to operating departments? Q4: How is the step-down method used to allocate support costs to operating departments? Q5: How is the reciprocal method used to allocate support costs to operating departments? Q6: What is the difference between single- and dual-rate allocations? Q7: How do support cost allocations affect decisions and managerial incentives? © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Support versus Operating Departments • The operating departments of an organization produce products or services that generate revenue. • The support departments of an organization produce products or provide services to the operating and other support departments. • The support department costs are common costs that are shared between two or more other departments. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Reasons for Allocating Support Department Costs • External reporting • Motivation • appropriate consumption of support department resources • efficiency of support department • monitor consumption of support department services • Decision making • product pricing • make or buy decisions © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q1: Support Department Allocation Process © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q2: Process for Allocating Support Department Costs 1. Clarify allocation purpose 2. Identify cost pools 3. Assign costs to cost pools 4. Choose allocation bases for each cost pool 5. Choose allocation method; allocate support department costs 6. Allocate updated operating department costs to units of goods or services, if relevant © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 6 Q2: Process for Allocating Support Department Costs 1. Clarify allocation purpose • if the purpose is to motivate the use of the services of a newly formed department, perhaps no costs should be allocated • if the purpose is to discourage operating department managers from over-use of the services of support departments, then a rate per unit of service might be large and not based on actual costs • if the purpose is to determine the full cost of products or services for long-term pricing decisions, then all support costs should be allocated © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 7 Q2: Process for Allocating Support Department Costs 2. Identify cost pools • the purpose will determine whether both fixed and variable support department costs should be allocated • the purpose will determine which costs should be allocated © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2: Process for Allocating Support Department Costs 3. Assign costs to cost pools • some costs will be direct to the cost pool (e.g. toner cartridge costs would be direct to the “variable copying costs” cost pool) • some costs will be indirect to the cost pool (e.g. rent costs for an entire facility would be indirect to the “information technology costs” cost pool) © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 9 Q2: Process for Allocating Support Department Costs 4. Choose allocation bases for each cost pool • an allocation base with a good cause-andeffect relationship with the cost pool provides a reasonable allocation rate • users of support department services will carefully monitor their consumption of the allocation base © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 10 Q2: Process for Allocating Support Department Costs 5. Choose allocation method and allocate support department costs • in this chapter we cover three allocation methods • each of these three methods could be implemented using • a single- or dual-rate approach (covered later) • actual or budgeted costs and allocation bases (covered later) © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Process for Allocating Support Department Costs 6. Allocate updated operating department costs to units of goods or services, if relevant • for some decisions, this may not be relevant • for long-term pricing decisions, this is likely to be relevant © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 12 Q3: The Direct Method of Allocating Support Department Costs • The direct method ignores the fact that support departments use each others’ services. • Each support department’s costs are allocated only to operating departments. • This method is the easiest computationally and the easiest to explain. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 13 Q3: The Direct Method Example Philco Toys makes metal and plastic toys in separate departments. It has two support departments, Accounting and Information Systems. Philco has decided to allocate Accounting department costs based on the number of employees in each department and Information Systems costs based on the number of computers in each department. Given the information below, use the direct method to allocate support department costs. Support Dep’ts Total department costs Number of employees Number of computers Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting (48,000) Information Systems Totals © John Wiley & Sons, 2011 (72,000) $0 $0 27,789 20,211 $0 36,000 36,000 $0 $449,789 $238,211 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q3: The Direct Method Example Plastic Products is allocated Plastic and Metal Product share 22/(22+16) of Accounting Info Systems costs equally department costs, and Metal because they have the same Products is allocated number of computers in each 16/(22+16). Notice that the department. Notice that the number of employees in the number of computers in the support departments is ignored departments is ignored Support Dep’ts support Operating Departments under the direct method. under the direct method. Total department costs Number of employees Number of computers AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting (48,000) Information Systems Totals © John Wiley & Sons, 2011 (72,000) $0 $0 27,789 20,211 $0 36,000 36,000 $0 $449,789 $238,211 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 15 Q4: The Step-Down Method of Allocating Support Department Costs • The step-down method allocates some (but not all) support department costs to other support departments. • The first support department’s costs are allocated to all operating and support departments that use its services. • Each subsequent support department’s costs are allocated to all operating and support departments that use its services, except any support department whose costs were already allocated. • Allocation order must be determined. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 16 Q4: The Step-Down Method Example Given the information for Philco, use the step-down method to allocate support department costs. Allocate the costs of the support department that provides the largest percentage of its services to the other support department first. First determine allocation order: Accounting provided 4/(4+22+16) = 4/42 = 9.5% of its services to Info Systems. Information Systems provided 4/(4+3+3) = 4/10 = 40% of its services to Accounting, so Information Systems goes first. Support Dep’ts Total department costs Number of employees Number of computers © John Wiley & Sons, 2011 Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q4: The Step-Down Method Example Given the information for Philco, use the step-down method to allocate support department costs. Now perform the allocation: Support Dep’ts Total department costs Number of employees Number of computers Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 (76,800) (48,000) 28,800 $0 (72,000) $0 44,463 27,789 32,337 20,211 $0 $0 21,600 21,600 21,600 $0 $0 $435,389 $452,063 $223,811 $235,937 $659,200 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q4: The Step-Down Method Example Info Systems costs are allocated to Accounting, Plastic, & Metal based on each department’s number of computers compared to total non-Info Systems Support Dep’ts computers: 4+3+3=10. Total department costs Number of employees Number of computers Accounting costs are allocated only to Plastic & Metal based on each department’s number of employees compared to total non-Accounting and non-Info Operatingemployees: Departments Systems 22+16=38 AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting Information Systems Totals (76,800) 28,800 $0 (72,000) $0 44,463 32,337 $0 21,600 21,600 $0 $452,063 $235,937 $688,000 Total costs allocated out of Accounting are now higher because of the Info Systems costs allocated to Accounting. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q4: The Step-Down Method Example (22/38) x $76,800 (4/10) x $72,000 (16/38) x $76,800 (3/10) x $72,000 Support Dep’ts Total department costs Number of employees Number of computers (3/10) x $72,000 Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 (76,800) 28,800 $0 (72,000) $0 44,463 32,337 $0 21,600 21,600 $0 $452,063 $235,937 $688,000 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q5: The Reciprocal Method of Allocating Support Department Costs • The reciprocal method allocates all support department costs to other support departments. • The first step is to compute the total costs of each support department when its usage of other support department services is taken into consideration. • Support department costs are then allocated to all other operating and support departments that consume its services. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q5: The Reciprocal Method Example Given the information for Philco, use the reciprocal method to allocate support department costs. First determine total costs for each support department by writing an equation for its costs (use A and IS as abbreviations). A = $48,000 + [4/(4+3+3)] x IS; IS = $72,000 + [4/(4+22+16)] x A Then solve: A = $48,000 + (4/10) x [$72,000 + (4/42) x A] A = $48,000 + $28,800 + (16/420) x A] (404/420) x A = $76,800 A = $76,800 x (420/404) = $79,842 IS = $72,000 + (4/42) x $79,842 = $79,604 Support Dep’ts Total department costs Number of employees Number of computers © John Wiley & Sons, 2011 Operating Departments AccInfo Plastic Metal ounting Systems Products Products Total $48,000 $72,000 $386,000 $182,000 $688,000 3 4 22 16 45 4 6 3 3 16 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 22 Q5: The Reciprocal Method Example Given the information for Philco, use the reciprocal method to allocate support department costs. Now perform the allocation: Support Dep’ts Total department costs Number of employees Number of computers Operating Departments Metal Plastic Info AccTotal Products ounting Systems Products $48,000 $72,000 $386,000 $182,000 $688,000 45 16 22 4 3 16 3 3 6 4 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 41,822 7,604 (79,842) (79,842) 7,604 41,822 23,881 (79,604) 31,842 (79,604) 31,842 23,881 $451,703 $0 $451,703 $0 $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e 30,416 30,416 23,881 23,881 $0 $0 $236,297 $236,297 $688,000 Slide # 23 Q5: The Reciprocal Method Example These numbers are the solutions to the simultaneous equations. (4/42) x $79,842 (22/42) x $79,842 (16/42) x $79,842 Support Dep’ts Total department costs Number of employees Number of computers Operating Departments Metal Plastic Info AccTotal Products ounting Systems Products $48,000 $72,000 $386,000 $182,000 $688,000 45 16 22 4 3 16 3 3 6 4 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 41,822 7,604 (79,842) (79,842) 7,604 41,822 23,881 (79,604) 31,842 (79,604) 31,842 23,881 $451,703 $0 $451,703 $0 $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e 30,416 30,416 23,881 23,881 $0 $0 $236,297 $236,297 $688,000 Slide # 24 Q5: The Reciprocal Method Example (4/10) x $79,604 (3/10) x $79,604 (3/10) x $79,604 Support Dep’ts Total department costs Number of employees Number of computers Operating Departments Metal Plastic Info AccTotal Products ounting Systems Products $48,000 $72,000 $386,000 $182,000 $688,000 45 16 22 4 3 16 3 3 6 4 Allocate costs: Accounting Information Systems Totals © John Wiley & Sons, 2011 41,822 7,604 (79,842) (79,842) 7,604 41,822 23,881 (79,604) 31,842 (79,604) 31,842 23,881 $451,703 $0 $451,703 $0 $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e 30,416 30,416 23,881 23,881 $0 $0 $236,297 $236,297 $688,000 Slide # 25 Q6: Single- versus Dual-Rate Allocation • In single-rate allocation, each cost pool includes fixed and variable costs. • In dual-rate allocation, fixed and variable costs are in separate cost pools. • Both methods can be employed with the direct, step-down, or reciprocal methods. • The prior three examples used the singlerate allocation method. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 26 Q6: Single- versus Dual-Rate Example Philco has decided to use the direct method and allocate variable Accounting costs based on the number of transactions and fixed Accounting costs based on the number of employees. The Info Systems variable costs will be allocated based on the number of service requests and fixed costs will be allocated based on the number of computers. The required information is presented below. Support Dep’ts Total department variable costs Total department fixed costs Number of transactions Number of employees Number of service requests Number of computers Operating Departments AccInfo Plastic Metal ounting Systems Products Products $20,000 $22,000 $186,000 $100,000 $28,000 $50,000 $200,000 $82,000 20 32 140 86 3 4 22 16 18 5 12 8 4 6 3 3 Now perform the allocation… © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 27 Q6: Single- versus Dual-Rate Example Total department variable costs Total department fixed costs Number of transactions Number of employees Number of service requests Number of computers Support Accounting $20,000 $28,000 20 3 18 4 Dep’ts Operating Departments Info Plastic Metal Systems Products Products $22,000 $186,000 $100,000 $50,000 $200,000 $82,000 32 140 86 4 22 16 5 12 8 6 3 3 (20,000) 12,389 7,611 13,200 8,800 $211,589 $116,411 16,211 25,000 $241,211 11,789 25,000 $118,789 $452,800 $235,200 Allocate variable costs: Accounting Information Systems Total variable costs Allocate fixed costs: Accounting Information Systems Total fixed costs Total fixed and variable costs © John Wiley & Sons, 2011 (22,000) $0 $0 (28,000) $0 $0 (50,000) $0 $0 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 28 Q7: Decision Making with Support Costs • Support costs need to be considered when evaluating decisions such as make/buy, keep/drop, special order, and constrained resource • Necessary to isolate relevant support costs – This may not be the same as the allocated support costs – For example, outsourcing an operating department may not result in a reduction in support department costs © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 29 Q7: Establishing Transfer Prices for Support Departments • Transfer prices should be set to motivate efficient use of the support department resources – If transfer price is set too high, user departments may outsource the service – If transfer price is set too low, user departments may utilize the support department inefficiently • The best transfer pricing approach is the Opportunity Cost approach – Each department is charged an amount that reflects the value of any opportunities forgone by not using the service for its next best alternative use. – This is often difficult in practice so most companies use a cost based or market based transfer pricing policy © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 30 Q7: Estimated versus Actual Support Costs and Rates A department’s allocation of support department costs = the allocation rate x the department’s consumption of the allocation base Either of these could be estimated or actual. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 31 Q7: Estimated versus Actual Support Costs and Rates the allocation rate x the department’s consumption of the allocation base Using actual rates and actual consumption provides the best measure of the cost of support services; it is the most accurate but the least timely. The purpose of the cost allocation will determine whether actual or estimated rates, and actual or estimated consumption, should be used. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 32 Q7: Estimated versus Actual Support Costs and Rates • Actual rates and consumption may be required for some types of government contracts. • Most federal grants to educational institutions allow the use of estimates. • Using an actual rate means that support service users are affected by • inefficiencies of support department managers • changes in the consumption of support services by other users © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 33 Q7: Other Common Cost Allocation Methods • Other cost allocation purposes may require the allocation to • be perceived as “fair” • be based on the user’s “ability to bear” the cost • Under the stand-alone method, a common cost is allocated based on information about the users’ consumption of the cost. • Under the incremental cost allocation method, a “primary user” is allocated the bulk of the common cost and the secondary user is allocated only the increment in cost that it caused. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 34 Q7: Stand-Alone versus Incremental Cost Allocation Methods Example Leslie has a job interview with Big Co. next month in New York City. Her plane ticket cost $300, and she will need to spend $125/night for 2 nights in a hotel. She estimates that she will spend $50 in cab fares and $50 for food. Big Co. has promised to reimburse her actual costs. After this trip was arranged, Small Co., also located in New York City, called her for an interview. If she interviews with Small Co. while she’s there, she will spend an additional $125 for another night at a hotel, and another estimated $40 in cab fares and food. Think of at least two ways to allocate Leslie’s travel costs using the stand-alone method. Discuss the merits of each. 1. Compute the total cost of the trip and divide it by 2, since there are 2 interviews. 2. Compute the total cost of the trip and allocate 2/3 of it to Big Co. and 1/3 to Small Co. since she is spending 2 of the 3 nights in NYC for the Big Co. interview. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 35 Q7: Stand-Alone versus Incremental Cost Allocation Methods Example Perform the calculations for your two versions of the cost allocation under the stand-alone method. Then allocate the travel costs using the incremental cost allocation method. Which is more appropriate? Why? Estimated total costs: Plane ticket Hotel Cab fares & food Total If shared equally, then this is $300 $407.50 for each company; if 375 Big Co. is allocated 2/3 of the 140 cost then $543.33 is allocated $815 to Big Co. and $271.67 is allocated to Small Co. Under the incremental cost allocation method, Big Co. is most likely to be considered the primary user. Since Leslie’s budgeted travel costs were $300 + $250 + $50 + $50 = $650 before she was offered the Small Co. interview, Big Co. is allocated $650 and Small Co. is allocated $815 – $650 = $165. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 36 Q7: Fixed Price versus Cost-Based Contracts • Under fixed price contracts, vendors provide products or services for a specified price. • Under cost-based contracts, the price is computed based on the actual cost of the products or services. • may be necessary for research & new product development • vendors are not motivated to control costs • vendors may be motivated to inappropriately allocate common costs © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 37 Appendix 8A: Excel Solver and the Reciprocal Method • Solving the simultaneous equations required for the reciprocal method can be tedious when there are 3 or more support departments. • Excel Solver can be used to solve these equations. • Refer to Appendix 4A for help with using Excel Solver. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 38 Appendix 8A: Excel Solver and the Reciprocal Method • Set up a “change cell” for each support department’s total costs. • The target function is the sum of the change cells. • The simultaneous equations are entered as constraints; one constraint per equation. © John Wiley & Sons, 2011 Chapter 8: Measuring and Assigning Support Department Costs Eldenburg & Wolcott’s Cost Management, 2e Slide # 39 Cost Management Measuring, Monitoring, and Motivating Performance Chapter 9 JOINT PRODUCT AND BY-PRODUCT COSTING © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 9: Joint Product and By-Product Costing Learning objectives • Q1: What is a joint process, and what is the difference between a by-product and a main product? • Q2: How are joint costs allocated? • Q3: What factors are considered in choosing a joint cost allocation method? • Q4: What information is relevant for deciding whether to process a joint product beyond the split-off point? • Q5: What methods are used to account for the sale of byproducts? • Q6: How does a sales mix affect joint cost allocation? • Q7: How do joint cost allocations affect decisions and managerial incentives? © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Joint Processes and Costs • A process that yields one or more products is called a joint process. • The products are called joint products. • The costs of the process are called joint costs. • The split-off point is the stage in the joint process where the separate products become identifiable. • Joints costs are incurred prior to the split-off point. • Costs incurred past split-off are separable costs. • Joint products that have minimal sales value compared to the main product are called byproducts. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Joint Processes and Costs Sawdust Bark Joint costs include DM, DL & Overhead. © John Wiley & Sons, 2011 Planks If sawdust sells for a relatively minimal amount, it is a byproduct. The costs of processing planks further are separable costs. Wall paneling Joint products Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q2: Methods of Allocating Joint Costs • Physical output methods • Can be used only when joint products are measured the same way (e.g. pounds or feet). • Market-based methods • Sales value at split-off method • Often used when all products sold at split-off. • Net realizable value (NRV) method • NRV = Final selling price – Separable costs. • Constant gross margin (GM) NRV method • The two NRV methods can be used when some products are processed past split-off. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q2: Physical Volume Method Example Pleasing Peaches grows peaches and processes three different peach products that are sold to a canning company. The pounds produced for each product, and the selling price per pound, is given below. The joint costs of processing the 280,000 pounds of products were $70,000. Allocate the joint costs to each product using the physical volume method. Selling Total Sales Pounds Price per Value at Product Produced Pound Split-Off Peach halves 160,000 $0.50 $80,000 Peach slices 80,000 $0.40 $32,000 Peach purée 40,000 $0.30 $12,000 280,000 $124,000 © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Relative Allocated Weight Joint Costs 57.1% $40,000 28.6% $20,000 14.3% $10,000 100.0% $70,000 Slide # 6 Q2: Sales Value at Split-Off Method Example Allocate the joint costs of $70,000 to each of Pleasing Peaches products using the sales value at split-off method. Product Peach halves Peach slices Peach purée © John Wiley & Sons, 2011 Pounds Produced 160,000 80,000 40,000 280,000 Selling Total Sales Price per Value at Pound Split-Off $0.50 $0.40 $0.30 $80,000 $32,000 $12,000 $124,000 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Relative Sales Allocated Value Joint Costs 64.5% 25.8% 9.7% 100.0% $45,161 $18,065 $6,774 $70,000 Slide # 7 Q2, 6: Compare the Physical Volume and Sales Value at Split-Off Methods Compute the gross margin for each product for each of the two allocation methods. Discuss the differences between the two methods. Total Sales Value at Product Split-Off Peach halves $80,000 Peach slices $32,000 Peach purée $12,000 $124,000 © John Wiley & Sons, 2011 Allocated Joint Costs Sales Physical Value at Volume Split-Off Method Method $40,000 $45,161 $20,000 $18,065 $10,000 $6,774 $70,000 $70,000 Gross Margin Sales Physical Value at Volume Split-Off Method Method $40,000 $34,839 $12,000 $13,935 $2,000 $5,226 $54,000 $54,000 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2, 6: Compare the Physical Volume and Sales Value at Split-Off Methods Compute the gross margin ratio (GM/Sales) for each product under both of the methods and discuss. Product Peach halves Peach slices Peach purée © John Wiley & Sons, 2011 Total Sales Value at Split-Off $80,000 $32,000 $12,000 $124,000 Gross Margin Sales Physical Value at Volume Split-Off Method Method $40,000 $34,839 $12,000 $13,935 $2,000 $5,226 $54,000 $54,000 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Gross Margin Ratio Sales Physical Value at Volume Split-Off Method Method 50.0% 43.5% 37.5% 43.5% 16.7% 43.5% 43.5% 43.5% Slide # 9 Q2: Net Realizable Value (NRV) Method Example Pleasing Peaches could process each of its three products beyond split off. It could can the peach halves itself, make the peach slices into frozen peach pie, and make juice out of the peach purée. The retail value of the new products and the separable costs for the additional processing are given below. Compute the joint costs allocated to each of the products using the NRV method. Final Sales Separable Relative Product Value Costs NRV NRV Canned peaches $180,000 $60,000 $120,000 64.2% Peach pie $120,000 $70,000 $50,000 26.7% Peach juice $50,000 $33,000 $17,000 9.1% $350,000 $163,000 $187,000 100.0% © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Allocated Joint Costs $44,920 $18,717 $6,364 $70,000 Slide # 10 Q2: Constant GM NRV Method • Under the constant GM NRV method, all products are allocated joint costs to achieve the same gross margin ratio (GM%). • First compute overall gross margin and GM%: GM = Revenue – Joint costs – Separable costs GM% = GM/Sales • Then compute the GM for each product: GM = Final sales value x GM% • All products end up with the same gross margin ratio; for each product solve for allocated joint costs: Final sales value – joint costs – separable costs = GM © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Constant GM NRV Method Example Compute the joint costs that Pleasing Peaches would allocate to each of the products using the constant GM NRV method. First compute the overall GM and GM ratio: GM = $350,000 – $163,000 – $70,000 = $117,000 GM% = $117,000/$350,000 = 33.43% Allocated Final Sales Separable Joint Gross Product Value Costs Costs Margin Canned peaches $180,000 $60,000 $59,829 $60,171 Peach pie $120,000 $70,000 $9,886 $40,114 Peach juice $50,000 $33,000 $286 $16,714 $350,000 $163,000 $70,000 $117,000 Gross Margin Ratio 33.4% 33.4% 33.4% Values are rounded as appropriate. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 12 Q2, 6: Compare the NRV and Constant GM NRV Methods Compute the gross margin (GM) and the gross margin ratio (GM%) for each product under NRV method. Compare this to the results of the constant GM NRV method and discuss. Product Peach halves Peach slices Peach purée Final Sales Value $180,000 $120,000 $50,000 $350,000 Gross Margin Gross Margin Ratio Constant Constant NRV GM NRV NRV GM NRV Method Method Method Method $75,080 $60,171 41.7% 33.4% $31,283 $40,114 26.1% 33.4% $10,636 $16,714 21.3% 33.4% 33.4% $117,000 $117,000 33.4% Values are rounded as appropriate. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 13 Q3: Choosing a Joint Cost Allocation Method • Allocated joint costs should not be used in decision making. • Still, avoid a method that shows one product to be unprofitable. • Under the physical volume method, the product with the greatest relative physical volume is allocated the most joint costs, regardless of product’s sales value. • Both of the NRV methods allocate joint costs based on the products’ “ability to bear the cost”. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q4: Sell or Process Further Decisions • Companies often can choose to sell a product at the split-off point or to process it further. • Compare the incremental revenue of processing further to the product’s separable costs. • Incremental revenue of processing further = Final sales value – Sales value at split-off • Process further only when the incremental revenue exceeds the separable costs. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 15 Q4: Sell or Process Further Example Peg’s Plastic Products makes the molded plastic parts for three model car kits, A, B & C from a joint production process. The joint costs of this process are $150,000. In each case, Peg could decide to make the entire kit rather than just the plastic parts. Information about the sales values and separable costs for each kit is given below. Determine which kits Peg should sell at the split-off point and which she should process further. Kit A B C Final Sales SepIncreSales Value at arable mental Value Split-Off Costs Revenue $200,000 $180,000 $25,000 $20,000 $120,000 $60,000 $40,000 $60,000 $80,000 $40,000 $10,000 $40,000 © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Incremental Profit if Process Further ($5,000) $20,000 $30,000 Sell at Split-Off or Process Further? Sell Process Process Slide # 16 Q5: Accounting for By-Products • When by-products have no sales value, there is no reason to account for them. • Otherwise, there are two accounting methods available: • Recognize by-product value at time of production • Recognize by-product value at time of by-product sale © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q5: Recognize By-Product Value at Time of Production • This method is also known as the offset approach or the NRV approach. • Joint cost of the main products is reduced by the NRV of the by-products, even if by-products are not yet sold. • NRV of the by-products is kept in ending inventory until sold. • At sale of by-product, ending inventory is reduced; there is no gain/loss on sale. • This method allows managers to control by-products. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q5: By-Product Value Recognized at Time of Production Example SJ Enterprises produces a main product and one by-product in a joint process. The joint costs totaled $480,000. The main product sells for $10/unit and the by-product sells for $1/unit. Information about the production and sales of the 2 products is given below. Use the NRV method to compute the production cost per unit for the main product. Information in Units of Each Product Beginning ProdEnding Inventory uction Sales Inventory Main product 0 100,000 95,000 5,000 By-product 0 10,000 3,000 7,000 Production costs $480,000 Less: NRV of by-product 10,000 Net joint product cost $470,000 Net product cost per unit © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $4.70 Slide # 19 Q5: By-Product Value Recognized at Time of Production Example Prepare an income statement for SJ Enterprises and compute the costs attached to ending inventory using the NRV method, assuming that nonmanufacturing costs totaled $250,000. Revenue: 95,000 units at $10/unit $950,000 Cost of goods sold: 95,000 units at $4.70/unit 446,500 Gross margin 503,500 Less: nonmanufacturing expenses 250,000 Operating income $253,500 Ending inventory: Main product: 5,000 units at $4.70 By-product: 7,000 units at $1 Value of ending inventory for balance sheet © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $23,500 7,000 $30,500 Slide # 20 Q5: Recognize By-Product Value at Time of Sale • This method is also known as the Realized Value Approach or the RV Approach. • Joint cost of the main products is not reduced by the NRV of the by-products, regardless if byproducts are sold. • NRV of the by-products is not kept in ending inventory. • At sale of by-product, either Other Income is recorded or Cost of Goods Sold is reduced. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q5: By-Product Value Recognized at Time of Sale Example SJ Enterprises produces a main product and one by-product in a joint process. The joint costs totaled $480,000. The main product sells for $10/unit and the by-product sells for $1/unit. Information about the production and sales of the 2 products is given below. Use the RV method to compute the production cost per unit for the main product. Information in Units of Each Product Beginning ProdEnding Inventory uction Sales Inventory Main product 0 100,000 95,000 5,000 By-product 0 10,000 3,000 7,000 Production costs Net product cost per unit © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $480,000 $4.80 Slide # 22 Q5: By-Product Value Recognized at Time of Sale Example Prepare an income statement for SJ Enterprises and compute the costs attached to ending inventory using the RV method, assuming that nonmanufacturing costs totaled $250,000. By-product sales is recorded as other income. Revenue: 95,000 units at $10/unit $950,000 By-product sales: 3,000 units at $1/unit 3,000 Total revenue 953,000 Cost of goods sold: 95,000 units at $4.80/unit 456,000 Gross margin 497,000 Less: nonmanufacturing expenses 250,000 Operating income $247,000 Ending inventory: Main product: 5,000 units at $4.80 © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e $24,000 Slide # 23 Q7: Decision Making & Joint Cost • Joint cost information is required for financial statement & tax return preparation when production does not equal sales (inventory and cost of goods sold). • Allocated joint costs are irrelevant for most decisions, especially regarding individual products • Joint cost information should not be used to make product mix decisions. © John Wiley & Sons, 2011 Chapter 9: Joint Product and By-Product Costing Eldenburg & Wolcott’s Cost Management, 2e Slide # 24 Cost Management Measuring, Monitoring, and Motivating Performance Chapter 10 Static and Flexible Budgets © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 10: Static and Flexible Budgets Learning objectives • Q1: How do budgets contribute to the strategic management process? • Q2: What is a master budget and how is it prepared? • Q3: What are flexible budgets and how can they be used for sensitivity analysis? • Q4: How are budget variances calculated and used as performance measures? • Q5: How do behavioral tensions influence the budgeting process? • Q6: What approaches exist for addressing the problems of traditional budgeting? © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Budgets & Strategic Management Process • A budget is • • • • A formalized financial plan. A translation of an organization’s strategies. A method of communicating. A way to define areas of responsibility and decision rights. • The budget cycle is the series of sequential steps followed to create and use budgets. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Budgets & Strategic Management Process • Budgeting process begins with the organizational vision, core competencies, and risk appetite • Organizational strategies designed to achieve the vision will drive the capital expenditures and long term financing plans • Operating plans are then created in line with the organizational strategies • Actual results must be monitored, measured, and analyzed compared to budgeted plans © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q1: Budgets & Levers of Control Belief Systems • Communicates organizational strategies and goals • Motivates managers to plan in advance and coordinate activities © John Wiley & Sons, 2011 Boundary Systems • Authorizes employees to engage in planned activities and spend within budget limits • Ensures sufficient cash flow for financial viability Interactive Control Systems Diagnostic Control Systems • Utilize variances to identify opportunities and threats to the business • Revaluate strategies and operating plans as conditions changes • Assign responsibility and reward employees for achieving budget targets • Motivate managers to provide good estimates and use resources appropriately Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q2: Master Budgets • A master budget is • A comprehensive plan for the upcoming accounting period. • Usually prepared for a one-year period. • Is based on a series of budget assumptions. • The master budget consists of several subsidiary budgets, in two categories: • Operating budgets. • Financial budgets. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 6 Q2: Operating Budgets © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 7 Q2: Operating Budgets The operating budget is created by preparing the following individual budgets, in this order: • • • • • • • • Revenue budget Production budget Direct materials budget Direct labor budget Manufacturing overhead budget Inventory and cost of goods sold budget Support department budgets Budgeted income statement © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2: Financial Budgets The financial budget is created by preparing the following individual budgets, in this order: • • • • • Capital budget Long-term financing budget Cash budget Budgeted balance sheet Budgeted statement of cash flows © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 9 Q2: Operating Budget Example Stanley J, Inc., makes a tool used by auto mechanics that sells for $68/unit. It expects to sell 6,000 units in April and 7,000 units in May. Stanley J prefers to end each period with a finished goods inventory equal to 10% of the next period’s sales in units and a direct materials inventory equal to 20% of the direct materials required for the next period’s production. The company never has any beginning or ending work-in-process inventories. There were 400 units in finished goods inventory on April 1. Prepare the revenue and production budgets for April. Revenue budget Budgeted sales in units in April 6,000 Budgeted selling price per unit $68.00 Budgeted revenues $408,000 © John Wiley & Sons, 2011 Production budget Budgeted sales in units in April Desired ending FG inventory Total units required Less: beginning FG inventory Required production in units Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e 6,000 700 6,700 (400) 6,300 Slide # 10 Q2: Operating Budget Example Stanley J’s product uses 0.3 pounds of direct material per unit, at a cost of $4/lb. There were 220 lbs. of direct material on hand on April 1. Assume that budgeted production for May is 6,500 units. Prepare the direct materials purchases and usage budget for April. Direct materials budget Required production in units DM required per unit, in pounds Total DM required, in pounds Less: Beginning DM inventory Plus: Desired ending DM inventory Required DM purchases in pounds Budgeted DM cost per pound Budgeted cost of DM 6,300 0.3 1,890 (220) 390 2,060 $4.00 $8,240 Usage Budget = 1,890 pounds * $4 per pound = $7,560 © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Operating Budget Example Stanley J’s product uses 0.2 hours of direct labor at a cost of $12/hr. Prepare the direct labor budget for April. Direct labor budget Required production in units DL required per unit, in hours Total DL hours required Budgeted cost per DL hour Budgeted cost of DL © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e 6,300 0.2 1,260 $12.00 $15,120 Slide # 12 Q2: Operating Budget Example Stanley J’s budgeted fixed manufacturing overhead for April is $167,000, and variable manufacturing overhead is budgeted at $6 per direct labor hour. Prepare the manufacturing overhead budget for April. Manufacturing overhead budget Total DL hours required Budgeted variable overhead per DL hour Total budgeted variable overhead Budgeted fixed overhead Total budgeted overhead © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e 1,260 $6.00 $7,560 $167,000 $174,560 Slide # 13 Q2: Operating Budget Example Assume that Stanley J’s April 1 direct materials inventory had a cost of $1,560. Prepare the April ending inventories budget for direct materials. Ending inventories budgets Budgeted cost of DM purchases $8,240 Beginning DM inventory $854 DM available for use $9,094 Budgeted cost of desired ending DM inventory: [6,500 units x 0.3 lbs/unit] x 20% x $4/lb $1,560 Budgeted cost of DM to be used $7,534 © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q2: Operating Budget Example Prepare the April ending inventories budget for finished goods. Budgeted cost of DM to be used Budgeted cost of DL Total budgeted overhead Total budgeted manufacturing costs Required production in units Budgeted manufacturing cost per unit Budgeted ending FG inventory in units Budgeted cost of ending FG inventory © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e $7,534 $15,120 $174,560 $197,214 6,300 $31.3037 700 $21,913 Slide # 15 Q2: Operating Budget Example Assume that Stanley J’s April 1 finished goods inventory had a cost of $12,146. Prepare the cost of goods sold budget for April. Cost of goods sold budget Beginning FG inventory Total budgeted manufacturing costs Cost of goods available for sale Less: budgeted ending FG inventory Budgeted cost of goods sold © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e $12,146 $197,214 $209,359 $21,913 $187,447 Slide # 16 Q2: Operating Budget Example Stanley J’s budget for April includes $22,000 for administrative costs, $34,000 for fixed distribution costs, $18,000 for research and development, and $13,000 for fixed marketing costs. Additionally, the budgeted variable costs for distribution are $0.75/unit sold and the budgeted variable costs for marketing are 4% of sales revenue. Prepare the support department budget for April. Support department budget Administration $22,000 Distribution: Fixed costs $34,000 Variable costs $4,500 $38,500 Research & development $18,000 Marketing: Fixed costs $13,000 Variable costs $16,320 $29,320 Total budgeted support department costs $107,820 © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q2: Operating Budget Example Suppose that Stanley J’s income tax rate is 28%. Prepare the budgeted income statement for April. Budgeted income statement Sales revenue Cost of goods sold Gross margin Operating costs: Administration Distribution Research & development Marketing Net income before taxes Income taxes Net income © John Wiley & Sons, 2011 $408,000 $187,447 $220,553 $22,000 $38,500 $18,000 $29,320 $107,820 $112,733 $31,565 $81,168 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q4: Budget Variances • Managers compare actual results to budgeted results in order to • Monitor operations, and • Motivate appropriate performance. • Differences between budgeted and actual results are called budget variances. • Variances are stated in absolute value terms, and labeled as Favorable or Unfavorable. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q4: Budget Variances • Reasons for budget variances are investigated. • The investigation may find: • Inefficiencies in actual operations that can be corrected. • Efficiencies in actual operations that can be replicated in other areas of the organization. • Uncontrollable outside factors that require changes to the budgeting process. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q3: Static Budgets • A budget prepared for a single level of sales volume is called a static budget. • Static budgets are prepared at the beginning of the year. • Differences between actual results and the static budget are called static budget variances. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q3: Flexible Budgets • A budget prepared for a multiple levels of sales volume is called a flexible budget. • Flexible budgets are prepared at the beginning of the year for planning purposes and at the end of the year for performance evaluation. • Flexible budgets are also used for sensitivity analysis and to manage risk due to uncertainty. • Differences between actual results and the flexible budget are called flexible budget variances. © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 22 Q3, Q4: Flexible Budget Example Tina’s Trinkets is preparing a budget for 2006. The budgeted selling price per unit is $10, and total fixed costs for 2006 are estimated to be $5,000. Variable costs are budgeted at $3/unit. Prepare a flexible budget for the volume levels 1,000, 1,100, and 1,200 units. Sales in units Revenues Variable costs Contribution margin Fixed costs Operating income © John Wiley & Sons, 2011 Volume Levels 1,000 1,100 1,200 $10,000 $11,000 $12,000 $3,000 $3,300 $3,600 $7,000 $7,700 $8,400 $5,000 $5,000 $5,000 $2,000 $2,700 $3,400 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 23 Q3, Q4: Static Budget Variances Example Suppose that Tina’s 2006 static budget was for 1,100 units of sales. The actual results are given below. Compute the static budget variances for each row and discuss. Static Budget Sales in units 1,100 Revenues $11,000 Variable costs $3,300 Contribution margin $7,700 Fixed costs $5,000 Operating income $2,700 © John Wiley & Sons, 2011 Static Actual Budget Results Variance 980 $9,604 $1,396 $2,989 $311 $6,615 $1,085 $4,520 $480 $2,095 $605 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Unfavorable Favorable Unfavorable Favorable Unfavorable Slide # 24 Q3, Q4: Flexible Budget Variances Example Compute the flexible budget variances for Tina and discuss the results. Compare the flexible budget variances to the static budget variances on the prior page. Year-end Flexible Budget Sales in units 980 Revenues $9,800 Variable costs $2,940 Contribution margin $6,860 Fixed costs $5,000 Operating income $1,860 © John Wiley & Sons, 2011 Flexible Actual Budget Results Variance 980 $9,604 $196 $2,989 $49 $6,615 $245 $4,520 $480 $2,095 $235 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Unfavorable Unfavorable Unfavorable Favorable Unfavorable Slide # 25 Q3, Q4: Performance Evaluation • A static budget variance includes effects from output volume. • A flexible budget variance removes these output volume effects. • Other adjustments to the year-end flexible budget may be made for a fair performance evaluation, such as • Input price changes outside the control of the manager under evaluation • Fixed cost increases outside the control of the manager under evaluation © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 26 Q5: Behavior Tensions in Budgeting • Budgets used to evaluate performance and compensation can create behavioral tension • Participative budgeting – when managers who are responsible for the budgets prepare the budget forecasts – Can result in budgetary slack – when managers set targets so low that goals can be met easily (and bonuses achieved) • Budget ratcheting – when top managers set targets – If targets unachievable, this can result in employees having little motivation to meet targets • Organizations must watch for budget manipulation © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 27 Q6: Other Budgeting Approaches • Zero based budgets are prepared without using past information as justification. • Rolling budgets are prepared frequently for overlapping time periods and actual results may be used to update the budget for the next period. • Kaizen budgets plan cost reductions over time. • Activity based budgets use more cost pools and cost drivers. • GPK and RCA budgets identify fixed and variable cost functions at the resource center level. • Beyond budgeting uses external benchmarks to evaluate managers’ performance © John Wiley & Sons, 2011 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcott’s Cost Management, 2e Slide # 28

Do you have a similar assignment and would want someone to complete it for you? Click on
the ORDER NOW option to get instant services . We assure you of a well
written and plagiarism free papers delivered within your specified deadline.

QUALITY: 100% ORIGINAL – NO PLAGIARISM

(USA, AUS, UK & CA PhD. Writers)

CLICK HERE TO GET A PROFESSIONAL WRITER TO WORK ON THIS PAPER AND OTHER SIMILAR PAPERS

The Best Custom Essay Writing Service

About Our Service

We are an online academic writing company that connects talented freelance writers with students in need of their services. Unlike other writing companies, our team is made up of native English speakers from countries such as the USA, UK, Canada, Australia, Ireland, and New Zealand.

Qualified Writers

Our Guarantees:

CLICK TO SUBMIT YOUR ORDER