Engineering Cost Analysis

Code: IENG 403

Chapter 4

Job Order Costing

4-1
 • Quiz
• A person buy and sell a product which sells for 15.00 m.u. each. The cost for
purchase the product is 3.00 m.u. In order to trade he requires premises and
equipment which, in total, represent a fixed cost to of 25,000 m.u. Total planned
volume for the year of the product is 4,000 units.
1- How many units do he needs to sell to break-even?
2- How many units do he needs to sell to make 1,000 m.u. profit?
3- Would it be worth the introduction of advertising at a cost of 6,000 m.u. to
increase sales to 4,450?
4- What impact would a 10% drop in selling price have on the break-even volume?

3-2
 Learning Objectives

1) Describe the building-block concepts of costing systems.

2) Describe Cost-allocation base for overhead cost
3) Distinguish between job costing and process costing.
4) Outline a seven-step approach to job costing.
5) Describe how to collect data for job costing
6) Distinguish actual costing from normal costing

4-3
 Learning Objective 1

Describe the building-block concepts

of costing systems.

4-4
 Building-Block Concepts
of Costing Systems

Cost object

Direct costs
of a cost object
Indirect costs
of a cost object
4-5
Building-Block Concepts
of Costing Systems

Cost Assignment

Direct Tracing
Costs
Cost
Cost Object
Indirect Allocation
Costs

4-6
Cost assignment is a general term for assigning costs, whether
direct or indirect, to a cost object.
Cost tracing is a specific term for assigning direct costs;
Cost allocation refers to assigning indirect costs.
The relationship among these three concepts can be graphically
represented in the last figure

4-7
Building-Block Concepts
of Costing Systems

Cost pool

Cost allocation base

4-8
1.Cost object—
anything for which a measurement of costs is
desired—for example, a product, such as ABC-
computer, or a service, such as the cost of repairing A
car.

4-9
2. Direct costs of a cost object
costs related to a particular cost object that can be
traced to that cost object in an economically feasible (cost-effective) way.
—for example the cost of purchasing the computer board or the cost of
parts used to make or assembly the ABC-computer.

4 - 10
3. Indirect costs of a cost object
costs related to a particular cost object that cannot be traced to that cost
object in an economically feasible (cost-effective) way.
—for example,
the costs of supervisors who oversee multiple products, one of which is
the ABC-computer, or the rent paid for the repair facility that repairs
many different Apple computer products besides the ABS-computer.
Indirect costs are allocated to the cost object using a cost allocation
method. 4 - 11
4. Cost pool.
A cost pool
• is a grouping of individual indirect cost items.
• Cost pools can range from broad, such as all manufacturing-plant costs, to
narrow, such as the costs of operating metal-cutting machines.
• Cost pools are often organized in conjunction with cost-allocation bases.

4 - 12
 Learning Objective 2

Describe Cost-allocation base for Manufacturing overhead

4 - 13
5. Cost-allocation base.

How should a company allocate costs to operate one product “X” among

different products?

One way to allocate costs is based on the number of machine-hours used to

produce different products.

4 - 14
5. Cost-allocation base.
The cost-allocation base (number of machine-hours)
is a systematic way to link an indirect cost or group of
indirect costs (operating costs of all metal-cutting
machines) to cost objects (different products).

4 - 15
5. Cost-allocation base.
For example,
if indirect costs of operating metal-cutting machines is $500,000
based on running these machines for 10,000 hours, the cost
allocation rate is $500,000 ÷ 10,000 hours = $50 per machine-
hour,
where machine-hours is the cost allocation base.

4 - 16
5. Cost-allocation base.
If a product uses 800 machine-hours, it will be allocated
$40,000,
$50 per machine-hour * 800 machine-hours.

A cost-allocation base can be either financial (such as direct labor

costs) or nonfinancial (such as the number of machine-hours).
When the cost object is a job, product, or customer, the cost-allocation
base is also called a cost-application base.
4 - 17
 Job Order Cost Flow
Manufacturing Overhead Costs
Using assumed data, the summary entry for manufacturing overhead in
Wallace Manufacturing Company is:

Example of manufacturing overhead

Jan. 31 Manufacturing Overhead 13,800

• Utilities ‫ مرافق‬Payable 4,800

• Prepaid Insurance 2,000

• Accounts Payable (for repairs) 2,600

• Accumulated Depreciation 3,000

• Property Taxes Payable ‫ضرائب ملكية واجبة الدفع‬ 1,400

 Job Order Cost
Predetermined Overhead Rate
◆ Established at the beginning of the year.

◆ May use a single, company-wide predetermined rate.

◆ May use a different rate for each department and each department
may have a different activity base.

◆ Formula for computing the predetermined rate overhead rate is

 Job Order Cost
Manufacturing Overhead Costs

Assigned to Work in Process during the period to get timely

information about the cost of a completed job. Illustration 16-10
 Job Order Cost
Manufacturing Overhead Costs

Illustration: Wallace uses direct labor cost as the activity base. Assuming that the
company expects annual overhead costs to be $280,000 and direct labor costs for the
year to be $350,000, compute the overhead rate.

$280,000 $350,000 = 0.8

This means that for every dollar of direct labor, Wallace will assign
80 cents of manufacturing overhead to a job.
_______
 Job Order Cost

Manufacturing Overhead Costs

Illustration: Wallace applies manufacturing overhead to work in process when it assigns
direct labor costs. Calculate the amount of applied overhead assuming direct labor costs
were $28,000.

$28,000 x 0.8= $22,400

The following entry records this application.

Jan. 31 Work in Process Inventory 22,400

Manufacturing Overhead 22,400
 Job Order Cost Flow

Manufacturing Overhead
Costs
The sum of the manufacturing
overhead columns of the job cost
sheets should equal the
manufacturing overhead debited
(i.e., applied) to Work in Process
Inventory.
 Job Order Cost

Manufacturing Overhead Costs

At the End of Each Month:

The balance in the Work in Process Inventory should equal the sum of the
costs shown on the job cost sheets of unfinished jobs.
Illustration 16-12
 Learning Objective 3

Distinguish between job costing and process costing.

4 - 25
 Job-Costing and
Process-Costing Systems

Job-costing Process-costing
system system

Distinct units Masses of identical

of a product or similar units of
or service a product or service

4 - 26
 Job Order Cost Systems

◆ Costs are assigned to each job or batch.

◆ Key feature: Each job or batch has its own distinguishing

characteristics.

◆ Objective: Compute the cost per job.

◆ Measures costs for each job completed – not for set time periods.
 Job Order Cost Systems
Some of the companies that use job-order costing include:

• Accounting, consulting and legal firms

• Architects

• Manufacturers of ships and airplanes

• Book publishers

• Movie producers
 Cost Accounting Systems
Process Cost System

◆ Used when a large volume of similar products are manufactured - (cereal,

refining of petroleum, production of ice cream).

◆ Costs are accumulated for a time period – (week or month).

◆ Costs are assigned to departments or processes for a specified period of time.

Learning Objective 4

Outline a seven-step
approach to job costing.

4 - 30
 Seven-Step Approach to Job Costing
1) Identify the chosen cost object.
2) Identify the direct costs of the job.
3) Select the cost-allocation bases.
4) Identify the indirect costs.
5) Compute the rate per unit.
6) Compute the indirect costs.
7) Compute the total cost of the job.
4 - 31
 General Approach to Job Costing
A manufacturing company is planning to sell a batch of 25
special machines (Job 650) to a retailer for $114,800.
It is required to compute the cost of this job from the following information
Direct materials used in the job = $50,000, the job used Direct manufacturing labor with
total of$19,000. The cost allocation base is machine-hours. the job used 500 machine-hours.
A total of 2,480 machine-hours were used by all jobs.
Total Manufacturing overhead costs were $65,100.

4 - 32
 General Approach to Job Costing
A manufacturing company is planning to sell a batch of 25
special machines (Job 650) to a retailer for $114,800.
It is required to compute the cost of this job from the given information
Step 1: The cost object is Job 650.
Step 2: Direct costs are: Direct materials = $50,000
Direct manufacturing labor = $19,000
Step 3: The cost allocation base is machine-hours.
Job 650 used 500 machine-hours.
2,480 machine-hours were used by all jobs.
Step 4: Manufacturing overhead costs were $65,100.
Step 5: Actual indirect cost rate is
$65,100 ÷ 2,480 = $26.25 per machine-hour.
Step 6: Factory overhead= $26.25 per machine-hour × 500 hours = $13,125
4 - 33
 General Approach to Job Costing

Step 7:total cost for the job 650 is:

Direct materials $50,000
Direct labor 19,000
Factory overhead 13,125
Total $82,125

4 - 34
 General Approach to Job Costing
What is the gross margin of this job?

Revenues $114,800
Cost of goods sold 82,125
Gross margin $ 32,675

What is the gross margin percentage?

$32,675 ÷ $114,800 = 28.5%

4 - 35
 Learning Objective 5

Describe how to collect data for job costing

4 - 36
 Source Documents

Job cost record

Materials requisition record

Labor time record

4 - 37
Job Order Cost Flow
Job Order Cost Flow
 Job Order Cost Flow

Factory Labor Costs

◆ Assigned to jobs on the basis of time tickets

◆ Time tickets are prepared when the work is performed

◆ Time tickets indicate

► Employee

► Hours worked

► Account and job charged

► Total labor cost

Job Order Cost Flow
 Job Order Cost Flow

Factory Labor Costs

Illustration: The time tickets are later sent to the payroll department, which applies the
employee’s hourly wage rate and computes the total labor cost. If the $32,000 total factory
labor cost consists of $28,000 of direct labor and $4,000 of indirect labor, the entry is:

Jan. 31 Work in Process Inventory 28,000

Manufacturing Overhead 4,000
Factory Labor 32,000
 Job Order Cost Flow
Factory Labor Costs
Jan. 31 Work in Process Inventory 28,000
Manufacturing Overhead 4,000
Factory Labor 32,000

LO 3
Job Order Cost Flow

Job Cost Sheets – Direct

Labor
The sum of the direct labor columns
of the job cost sheets should equal
the direct labor debited to Work in
Process Inventory.

LO 3
 Learning Objective 6

Distinguish actual costing from normal costing.

4 - 45
 Costing Systems

Actual costing is a system that uses actual costs to determine the cost of individual jobs.

It allocates indirect costs based on the actual indirect-cost rate(s) times the
actual quantity of the cost-allocation base(s).

4 - 46
 Costing Systems
Normal costing is a method that allocates indirect costs based on the budgeted
indirect-cost rate(s) times the actual quantity of the cost allocation base(s).

4 - 47
 Normal Costing

Assume that the manufacturing company budgets $60,000 for total manufacturing
overhead costs and 2,400 machine-hours.
What is the budgeted indirect-cost rate‫؟‬
$60,000 ÷ 2,400 = $25 per hour
How much indirect cost was allocated to Job 650?

Factory overhead= $ 25 per machine-hour × 500 hours = $12500

4 - 48
 Normal Costing

What is the cost of Job 650 under normal costing?

Direct materials used in the job = $50,000, the job used Direct manufacturing labor with
total of$19,000. The cost allocation base is machine-hours. the job used 500 machine-hours.

Direct materials $50,000

Direct labor 19,000
Factory overhead 12,500
Total $81,500 4 - 49
 Learning Objective 7

Track the flow of costs in a job-costing system.

4 - 50
 Job Order Cost Flow

The cost flow parallels the physical flow of the materials as they are converted into
finished goods

◆ Manufacturing costs are assigned to Work in Process (WIP).

◆ Cost of completed jobs is transferred to Finished Goods.

◆ When units are sold, the cost is transferred to Cost of Goods Sold.
 Transactions
Purchase of materials and other manufacturing inputs

Conversion into work in process inventory

Conversion into finished goods inventory

Sale of finished goods 4 - 52

T Accounts?
The T Account is a visual representation of individual accounts that looks like a
“T”, making it so that all additions and subtractions (debits and credits) to the
account can be easily tracked and represented visually.

4 - 53
 Transactions
$80,000 worth of materials (direct and indirect) were purchased on credit.

Materials Accounts Payable

Control Control

1. 80,000 1. 80,000

4 - 54
 Transactions
Materials costing $75,000 were sent to the manufacturing plant floor.
$50,000 were issued to Job No. 650 and $10,000 to Job 651.
$15,000 of indirect materials were issued.
What is the journal entry?
Work in Process Control:
Job No. 650 50,000
Job No. 651 10,000
Factory Overhead Control 15,000
Materials Control 75,000
4 - 55
 Transactions

Materials
Control Work in Process
1. 80,000 2. 75,000 Control
2. 60,000

Manufacturing
Overhead Job 650

Control 2. 50,000
2. 15,000
4 - 56
 Transactions
Total manufacturing payroll ‫ رواتب تصنيع‬for the period was $27,000.
Job No. 650 incurred direct labor costs of $19,000 and Job No. 651 incurred
direct labor costs of $3,000. $5,000 of indirect labor was also incurred.
What is the journal entry?

Work in Process Control:

Job No. 650 19,000
Job No. 651 3,000
Manufacturing Overhead Control 5,000
Wages Payable ‫اجور مستحقة الدفع‬ 27,000
4 - 57
 Transactions

Wages Payable Work in Process

Control Control

3. 27,000 2. 60,000
3. 22,000
Manufacturing
Overhead
Control Job 650
2. 15,000 2. 50,000
3. 5,000 3. 19,000 4 - 58
 Transactions
Wages payable were paid.

Wages Payable Control 27,000

Cash Control 27,000

Wages Payable
Cash
Control
Control
4. 27,000 3. 27,000
4. 27,000

4 - 59
 Transactions

Assume that depreciation for the period is $26,000.

Other manufacturing overhead incurred amounted to $19,100.
What is the journal entry?

4 - 60
 Transactions
Manufacturing Overhead Control 45,100
Accumulated Depreciation
Control 26,000
Various Accounts 19,100
What is the balance of the Manufacturing Overhead Control account?

4 - 61
 Transactions

$62,000 of overhead was allocated to the various jobs of

which $12,500 went to Job 650.
Work in Process Control 62,000
Manufacturing Overhead Control 62,000
What are the balances of the control accounts?

4 - 62
 Transactions

Manufacturing Overhead Work in Process

Control Control
2. 15,000 6. 62,000 2. 60,000
3. 5,000 3. 22,000
5. 45,100 6. 62,000
Bal. 3,100 Bal. 144,000

4 - 63
 Transactions

The cost of Job 650 is:

Job 650
2. 50,000
3. 19,000
6. 12,500
Bal.81,500

4 - 64
 Transactions
Jobs costing $104,000 were completed and transferred to finished
goods, including Job 650.
What effect does this have on the control accounts?

4 - 65
 Transactions
Finished Goods
Work in Process
Control
Control
2. 60,000 7. 104,000
7. 104,000
3. 22,000
6. 62,000
Bal. 40,000

4 - 66
 Transactions
Job 650 was sold for $114,800.
What is the journal entry?

Accounts Receivable Control 114,800

Revenues 114,800
Cost of Goods Sold 81,500
Finished Goods Control 81,500

4 - 67
 Transactions

What is the balance in the Finished Goods Control account?

$104,000 – $81,500 = $22,500
Assume that marketing and administrative
salaries were $9,000 and $10,000
What is the journal entry?

4 - 68
 Transactions
Marketing and Administrative Costs 19,000
Salaries Payable Control 19,000

4 - 69
 Transactions
Direct Materials Used $60,000+
Direct Labor and Overhead $84,000-
Cost of Goods Manufactured $104,000
=Ending WIP Inventory $40,000

4 - 70
 Transactions
Cost of Goods Manufactured$104,000

– Ending Finished Goods Inventory $22,500

= Cost of Goods Sold $81,500

4 - 71
The General Ledger

4 - 72
4 - 73
End of Chapter 4

4 - 74
1-1

ENGINEERING COST ANALYSIS

CODE: IENG 403

CHAPTER 2

AN INTRODUCTION TO COST
TERMS AND PURPOSES
2-2
LEARNING OBJECTIVE 1

Define and illustrate a cost object.

 2-3
COST AND COST TERMINOLOGY

▪ Cost is a resource sacrificed ‫التضحية‬or forgone‫ التخلى عنه‬to achieve

▪ a specific objective.
▪ An actual cost is the cost incurred ‫( تحملها‬a historical cost)as
distinguished from budgeted costs.
▪ A cost object is anything for which a separate measurement of
costs is desired.
2-4
COST AND COST TERMINOLOGY

Cost Object
Cost
Accumulation Cost Object

Cost Object
Cost Tracing
Assignment
Allocating
2-5
LEARNING OBJECTIVE 2

Distinguish between direct costs

and indirect costs.
2-6
DIRECT AND INDIRECT COSTS

COST OBJECT
Direct Costs
Example: Paper on which
Example: Sports
Sports Illustrated magazine
Illustrated magazine
is printed
Indirect Costs
Example: Lease cost for
Time-Warner building
housing the senior editors
of its magazine
 DIRECT AND INDIRECT COSTS EXAMPLE
2-7

Direct Costs:
Maintenance Department $40,000
Personnel Department $20,600
Assembly Department $75,000
Finishing Department $55,000
Assume that Maintenance Department costs are
allocated equally among the production departments.
How much is allocated to each department?
 DIRECT AND INDIRECT COSTS EXAMPLE
2-8

Maintenance
$40,000

Assembly Finishing
Direct Costs Direct Costs
$75,000 $55,000

$20,000 Allocated $20,000

 LEARNING OBJECTIVE 3
2-9

Explain variable costs and fixed costs.

 COST BEHAVIOR PATTERNS EXAMPLE
2 - 10

▪ Bicycles by the Sea buys a handlebar at $52 for each of its bicycles.

▪ What is the total handlebar cost when 1,000 bicycles are assembled?
 COST BEHAVIOR PATTERNS EXAMPLE
2 - 11

1,000 units × $52 = $52,000

What is the total handlebar cost

when 3,500 bicycles are assembled?

3,500 units × $52 = $182,000

 COST BEHAVIOR PATTERNS EXAMPLE
2 - 12

▪ Bicycles by the Sea incurred $94,500 in a given year for the

leasing of its plant.
▪ This is an example of fixed costs with respect to the number
of bicycles assembled
 COST BEHAVIOR PATTERNS EXAMPLE
2 - 13

▪ What is the leasing (fixed) cost per bicycle when Bicycles

▪ assembles 1,000 bicycles?
▪ $94,500 ÷ 1,000 = $94.50
• What is the leasing (fixed) cost per bicycle when Bicycles
assembles 3,500 bicycles?
$94,500 ÷ 3,500 = $27
 COST DRIVERS
2 - 14

▪ The cost driver of variable costs is the level of activity or volume

whose change causes the (variable) costs to change proportionately.

▪ The number of bicycles assembled is a cost driver of the cost of

handlebars.
 RELEVANT RANGE EXAMPLE
2 - 15

▪ Assume that fixed (leasing) costs are $94,500 for a year and that
they remain the same for a certain volume range
(1,000 to 5,000 bicycles).
▪ 1,000 to 5,000 bicycles is the relevant range.
 RELEVANT RANGE EXAMPLE
2 - 16

120000
100000
Fixed Costs

80000
60000
40000
$94,500
20000
0
0 1000 2000 3000 4000 5000 6000
Volume
 RELATIONSHIPS OF TYPES OF COSTS
2 - 17

Direct

Variable Fixed

Indirect
 LEARNING OBJECTIVE 4
2 - 18

Interpret unit costs cautiously.

 TOTAL COSTS AND UNIT COSTS EXAMPLE
2 - 19

▪ What is the unit cost (leasing and handlebars) when Bicycles

assembles 1,000 bicycles?
Total fixed cost $94,500
+ Total variable cost $52,000 = $146,500

$146,500 ÷ 1,000 = $146.50

 TOTAL COSTS AND UNIT COSTS EXAMPLE
2 - 20

$146,500
200000

150000
Total Costs

100000 $94,500

50000

0
0 500 1000 1500
Volume
 USE UNIT COSTS CAUTIOUSLY
2 - 21

▪ Assume that Bicycles management uses

a unit cost of $146.50 (leasing and wheels).
▪ Management is budgeting costs for
different levels of production.
▪ What is their budgeted cost for an estimated
production of 600 bicycles?

600 × $146.50 = $87,900

 USE UNIT COSTS CAUTIOUSLY
2 - 22

▪ What is their budgeted cost for an estimated

production of 3,500 bicycles?
= 3,500 × $146.50 = $512,750
▪ What should the budgeted cost be for an
estimated production of 600 bicycles?
 USE UNIT COSTS CAUTIOUSLY
2 - 23

Total fixed cost $ 94,5 00

Total variable cost ($52 × 600) 31,200
Total $125,700
$125,700 ÷ 600 = $209.50
Using a cost of $146.50 per unit would underestimate actual
total costs if output is below 1,000 units.
 USE UNIT COSTS CAUTIOUSLY
2 - 24

• What should the budgeted cost be for an estimated production

• of 3,500 bicycles?

Total fixed cost $ 94,500

Total variable cost (52 × 3,500) 182,000
Total $276,500

$276,500 ÷ 3,500 = $79.00

 LEARNING OBJECTIVE 5
2 - 25

Distinguish among manufacturing companies,

merchandising companies, and service-sector companies.

 MANUFACTURING
2 - 26

Manufacturing companies
purchase materials and components and
convert them into finished goods.

A manufacturing company must also develop,

design, market, and distribute its products.

 MERCHANDISING
2 - 27

Merchandising companies
purchase and then sell tangible products
without changing their basic form.
 MERCHANDISING
2 - 28

Service companies
provide services or intangible
products to their customers.

Labor is the most significant cost category.

 LEARNING OBJECTIVE 6
2 - 29

Differentiate between inventoriable costs

and period costs.

 TYPES OF INVENTORY
2 - 30

▪ Manufacturing-sector companies typically have one or more of the

following three types of inventories:
1) Direct materials inventory
2) Work in process inventory (work in progress)
3) Finished goods inventory
 TYPES OF INVENTORY
2 - 31

Merchandising-sector companies hold only one type of inventory

– the product in its original purchased form.
▪ Service-sector companies do not hold inventories
of tangible products.
 CLASSIFICATION OF MANUFACTURING
2 - 32 COSTS

Direct materials costs

Direct manufacturing labor costs

Indirect manufacturing costs

 LEARNING OBJECTIVE 7
2 - 33

Describe the three categories of inventories

commonly found in manufacturing companies.
 INVENTORIABLE COSTS
2 - 34

Inventoriable costs (assets)…

become cost of goods sold…

after a sale takes place.

 PERIOD COSTS
2 - 35

Period costs are all costs in the income

statement other than cost of goods sold.
Period costs are recorded as expenses of the
accounting period in which they are incurred.
 FLOW OF COSTS EXAMPLE
2 - 36

Bicycles by the Sea had $50,000 of direct

materials inventory at the beginning of the period.
Purchases during the period amounted to
$180,000 and ending inventory was $30,000.
How much direct materials were used?
$50,000 + $180,000 – $30,000 = $200,000
 FLOW OF COSTS EXAMPLE
2 - 37

Direct labor costs incurred were $105,500.

Indirect manufacturing costs were $194,500.
What are the total manufacturing costs incurred?
Direct materials used $200,000
Direct labor 105,500
Indirect manufacturing costs 194,500
Total manufacturing costs $500,000
 FLOW OF COSTS EXAMPLE
2 - 38

Assume that the work in process inventory

at the beginning of the period was $30,000,
and $35,000 at the end of the period.
What is the cost of goods manufactured?
Beginning work in process $ 30,000
Total manufacturing costs 500,000
Ending work in process 35,000
Cost of goods manufactured $495,000
 FLOW OF COSTS EXAMPLE
2 - 39

Assume that the finished goods inventory

at the beginning of the period was $10,000,
and $15,000 at the end of the period.
What is the cost of goods sold?
Beginning finished goods $ 10,000
Cost of goods manufactured 495,000
Ending finished goods 15,000
Cost of goods sold $490,000
 FLOW OF COSTS EXAMPLE
2 - 40

Work in Process
Beg. Balance 30,000 495,000
Direct mtls. used 200,000
Direct labor 105,500
Indirect mfg. costs 194,500
Ending Balance 35,000
 FLOW OF COSTS EXAMPLE
2 - 41

Work in Process
495,000 Finished Goods
10,000 490,000
495,000
15,000

Cost of Goods Sold

490,000
 MANUFACTURING COMPANY
2 - 42

BALANCE SHEET INCOME STATEMENT

Inventoriable
Costs Revenues
when deduct
Finished sales
Materials occur Cost of
Goods
Inventory Goods Sold
Inventory
Equals Gross Margin
deduct
Work in Period
Process Costs
Inventory
Equals Operating Income
 MERCHANDISING COMPANY
2 - 43

BALANCE SHEET INCOME STATEMENT

Inventoriable
Costs Revenues
when deduct
sales
Merchandise occur Cost of
Inventory
Purchases Goods Sold
Equals Gross Margin
deduct
Period
Costs
Equals Operating Income
 PRIME COSTS
2 - 44

Direct Direct Prime

Materials + Labor = Costs
 PRIME COSTS
2 - 45

What are the prime costs for Bicycles by the Sea?

Direct materials used $200,000
+ Direct labor 105,500
= $305,000
 CONVERSION COSTS
2 - 46

Direct Manufacturing Conversion

Labor + Overhead = Costs

Indirect Indirect
Labor Materials Other
 CONVERSION COSTS
2 - 47

What are the conversion costs for

Bicycles by the Sea?
Direct labor $105,500
+ Indirect manufacturing costs 194,500
= $300,000
 MEASURING COSTS REQUIRES JUDGMENT
2 - 48

Manufacturing labor-cost classifications vary among companies.

The following distinctions are generally found:

Direct manufacturing labor

Manufacturing overhead
 MEASURING COSTS REQUIRES JUDGMENT
2 - 49

Manufacturing overhead

Indirect labor Managers’ salaries Payroll fringe costs

Forklift truck operators (internal handling of materials)
Janitors Rework labor
Overtime premium Idle time
 MEASURING COSTS REQUIRES JUDGMENT
2 - 50

❑ Overtime premium is usually considered part of overhead.

❑ Assume that a worker gets $18/hour for straight time and gets
time and one-half for overtime.
 MEASURING COSTS REQUIRES JUDGMENT
2 - 51

How much is the overtime premium?

$18 × 50% = $9 per overtime hour

If this worker works 44 hours on a given
week, how much are his gross earnings?
Direct labor 44 hours × $18 = $792
Overtime premium 4 hours × $ 9 = 36
Total gross earnings $828
 LEARNING OBJECTIVE 8
2 - 52

Explain why product costs are computed in

different ways for different purposes.
 MANY MEANINGS OF PRODUCT COST
2 - 53

❑ A product cost is the sum of the costs assigned to a product

for a specific purpose.
1. Pricing and product emphasis decisions
2. Contracting with government agencies
3. Preparing financial statements for external reporting under generally
accepted accounting principles
 LEARNING OBJECTIVE 9
2 - 54

Present key features of cost accounting and

cost management.
 A FRAMEWORK FOR COST MANAGEMENT
2 - 55

Three features of cost accounting and cost management:

1. Calculating the costs of products
2. Obtaining information
3. Analyzing information
 CHAPTER 3

COST-VOLUME-PROFIT ANALYSIS

3-1
In Chapter 2, we discussed total revenues, total costs, and income.
Cost-volume-profit (CVP) analysis studies the behavior and
relationship among these elements as changes occur in the units sold,
the selling price, the variable cost per unit, or the fixed costs of a
product.

3-2
 LEARNING OBJECTIVE 1

Understand the assumptions underlying cost-volume-profit

(CVP) analysis.

3-3
 COST-VOLUME-PROFIT ASSUMPTIONS
AND TERMINOLOGY

1. Changes in the level of revenues and costs arise only because of changes in the
number of product (or service) units produced and sold.

2. Total costs can be divided into a fixed component and a component that is
variable with respect to the level of output.

3-4
 COST-VOLUME-PROFIT ASSUMPTIONS
AND TERMINOLOGY

3. When graphed, the behavior of total revenues and total costs is linear (straight-line)
in relation to output units within the relevant range (and time period).

4. The unit selling price, unit variable costs, and

fixed costs are known and constant.

3-5
 COST-VOLUME-PROFIT ASSUMPTIONS
AND TERMINOLOGY

5. The analysis either covers a single product orassumes that the sales mix when multiple
products are sold will remain constant as the level of total units sold changes.

6. All revenues and costs can be added and compared without taking into account
the time value of money.

3-6
 COST-VOLUME-PROFIT ASSUMPTIONS
AND TERMINOLOGY

Operating income
= Total revenues from operations – Cost of goods sold and operating costs
(excluding income taxes)

Net income = Operating income – Income taxes

3-7
LEARNING OBJECTIVE 2

Explain the feature of CVP analysis.

3-8
 ESSENTIALS OF COST-VOLUME-PROFIT
(CVP) ANALYSIS EXAMPLE
Assume that the Pants Shop can purchase pants for $32 from a local factory;
other variable costs amount to $10 per unit.
The local factory allows the Pants Shop to return all unsold pants and receive a full $32
refund per pair of pants within one year.

The average selling price per pair of pants is $70 and total fixed costs amount to $84,000.

3-9
 ESSENTIALS OF COST-VOLUME-PROFIT
(CVP) ANALYSIS EXAMPLE

How much revenue will the business receive if 2,500 units are sold?

2,500 × $70 = $175,000

How much variable costs will the business incur?

Variable cost= 2,500 × $42 = $105,000

fixed costs=$84,000.

Revenue=$175,000 – 105,000 – 84,000 = ($14,000) 3 - 10

 ESSENTIALS OF COST-VOLUME-PROFIT
(CVP) ANALYSIS EXAMPLE

What is the contribution margin per unit?

$70 – $42 = $28 contribution margin per unit

What is the total contribution margin when 2,500 pairs of pants are sold?

2,500 × $28 = $70,000

3 - 11
 ESSENTIALS OF COST-VOLUME-PROFIT
(CVP) ANALYSIS EXAMPLE

Contribution margin percentage (contribution margin ratio) is the contribution margin

Per unit divided by the selling price.
What is the contribution margin percentage?
$28 ÷ $70 = 40%

3 - 12
 ESSENTIALS OF COST-VOLUME-PROFIT
(CVP) ANALYSIS EXAMPLE

If the business sells 3,000 pairs of pants,

revenues will be $210,000 and contribution
margin would equal 40% × $210,000 = $84,000. F E D ER A L RE SE R V E N O TE

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3 - 13
 LEARNING OBJECTIVE 3

Determine the breakeven point and output level needed to achieve

a target operating income using the equation, contribution margin,
and graph methods.

3 - 14
 BREAKEVEN POINT

Variable
Sales – = Fixed
expenses
expenses

Total revenues = Total costs

3 - 15
 ABBREVIATIONS
SP = Selling price
VCU = Variable cost per unit
CMU = Contribution margin per unit
CM% = Contribution margin percentage
FC = Fixed costs
• Q = Quantity of output units sold (and manufactured)
• OI = Operating income
• TOI = Target operating income
• TNI = Target net income

3 - 16
 EQUATION METHOD
(Selling price × Quantity sold) – (Variable unit cost
× Quantity sold) – Fixed costs = Operating income
Let Q = number of units to be sold to break even
$70Q – $42Q – $84,000 = 0
$28Q = $84,000
Q = $84,000 ÷ $28 = 3,000 units

CONTRIBUTION MARGIN METHOD

Breakeven point =$84,000 ÷ $28 = 3,000 units

Revenue= $84,000 ÷ 40% = $210,000
3 - 17
 GRAPH METHOD

378
336 Breakeven
294
252
$(000)

210
168
126
84
42 Fixed costs
0
0 1000 2000 3000 4000 5000
Units
3 - 18
 TARGET OPERATING INCOME

No of units solid Q to make a required Target operating income=

(Fixed costs + Target operating income)divided by Contribution margin per unit

dollar sales needed to achieve a required Target operating income=

(Fixed costs + Target operating income)divided by Contribution margin per unit

3 - 19
 TARGET OPERATING INCOME

Assume that management wants to have an operating income of $14,000.

No. of units to solid =($84,000 + $14,000) ÷ $28 = 3,500
What dollar sales are needed to achieve this income?
($84,000 + $14,000) ÷ 40% = $245,000

3 - 20
 LEARNING OBJECTIVE 4

Understand how income taxes affect CVP analysis.

3 - 21
 TARGET NET INCOME
AND INCOME TAXES EXAMPLE

Management would like to earn an after tax income of $35,711.

The tax rate is 30%.
What is the target operating income?
Target operating income
= Target net income ÷ (1 – tax rate)
TOI = $35,711 ÷ (1 – 0.30) = $51,016

3 - 22
 TARGET NET INCOME
AND INCOME TAXES EXAMPLE

How many units must be sold?

Revenues – Variable costs – Fixed costs
= Target net income ÷ (1 – tax rate)
$70Q – $42Q – $84,000 = $35,711 ÷ 0.70
$28Q = $51,016 + $84,000
Q = $135,016 ÷ $28 = 4,822 pairs of pants

3 - 23
 TARGET NET INCOME
AND INCOME TAXES EXAMPLE

Proof:
Revenues: 4,822 × $70 $337,540
Variable costs: 4,822 × $42 202,524
Contribution margin $135,016
Fixed costs 84,000
Operating income 51,016
Income taxes: $51,016 × 30% 15,305
Net income $ 35,711

3 - 24
 LEARNING OBJECTIVE 5

Explain CVP analysis in decision making and

how sensitivity analysis helps managers cope with uncertainty.

3 - 25
 USING CVP ANALYSIS EXAMPLE

Suppose the management anticipates selling 3,200 pairs of pants.

Management is considering an advertising campaign that would cost $10,000.
It is anticipated that the advertising will increase sales to 4,000 units. Should the
business advertise?

3 - 26
 USING CVP ANALYSIS EXAMPLE

3,200 pairs of pants sold with no advertising:

Contribution margin = 28 X 3200 = $ 89,600
Fixed costs 84,000
Operating income =89600-84000= $ 5,600
4,000 pairs of pants sold with advertising:
Contribution margin = 4000 X 28 = $ 112,000
Fixed costs = 94,000
Operating income =112000-94000= $ 18000
Operating income $ 18,000
3 - 27
Diction is to make an advertising
 USING CVP ANALYSIS EXAMPLE

Instead of advertising, management is considering reducing the selling

price to $61 per pair of pants.
It is anticipated that this will increase sales to 4,500 units.
Should management decrease the selling price per pair of pants to $61?

3 - 28
 USING CVP ANALYSIS EXAMPLE

3,200 pairs of pants sold with no change in the selling price:

Operating income = $5,600
4,500 pairs of pants sold at a reduced selling price:
Contribution margin: (4,500 × $19) $85,500
Fixed costs 84,000
Operating income $ 1,500

Diction is Not to Change selling price to $ 61

3 - 29
 SENSITIVITY ANALYSIS AND
UNCERTAINTY EXAMPLE

Assume that the Pants Shop can sell 4,000 pairs of pants.
Fixed costs are $84,000
Contribution margin ratio is 40%.
At the present time the business cannot handle more than 3,500 pairs of pants.
To satisfy a demand for 4,000 pairs, management must acquire additional
space for $6,000. Should the additional space be acquired?

3 - 30
 SENSITIVITY ANALYSIS AND
UNCERTAINTY EXAMPLE

Revenues at breakeven with existing space are

$84,000 ÷ .40 = $210,000.
Revenues at breakeven with additional space are
$90,000 ÷ .40 = $225,000

3 - 31
 SENSITIVITY ANALYSIS AND
UNCERTAINTY EXAMPLE
First Alternative ( existing space) Operating income at $280,000 revenues with
Operating income at $245,000 revenues with additional space =
existing space = ($280,000 × .40) – $90,000 = $22,000.
($245,000 × .40)– $84,000 = $14,000. Or
(3,500 pairs of pants × $28) – $84,000 (4,000 unit× $28 )– $90,000
= $14,000 = $22,000

3 - 32
LEARNING OBJECTIVE 6

Use CVP analysis to plan

fixed and variable costs.

3 - 33
 ALTERNATIVE FIXED/VARIABLE COST
STRUCTURES EXAMPLE

Suppose that the factory the Pants Shop is using to obtain the merchandise offers
the following:
Decrease the price they charge from $32 to $25 and
charge an annual administrative fee of $30,000.
What is the new contribution margin?

3 - 34
 ALTERNATIVE FIXED/VARIABLE COST
STRUCTURES EXAMPLE

$70 – ($25 + $10) = $35 Variable cost per unit =

Contribution margin increases from $28 to $35. ($ 25 selling price+
What is the contribution margin percentage? $ 10 other expenses
$35 ÷ $70 = 50% Fixed cost =
What are the new fixed costs? $ 84000+
$84,000 + $30,000 = $114,000 $ 30000 administrative fees

3 - 35
 ALTERNATIVE FIXED/VARIABLE COST
STRUCTURES EXAMPLE

Management questions what sales volume would yield an identical operating income
regardless of the arrangement.
28x – 84,000 = 35x – 114,000
114,000 – 84,000 = 35x – 28x
7x = 30,000
x = 4,286 pairs of pants

3 - 36
 ALTERNATIVE FIXED/VARIABLE COST
STRUCTURES EXAMPLE

Total Cost with existing arrangement

X is the total revenue in $
= Total Cost with new arrangement
0.60x + 84,000 = 0.50x + 114,000
0.1 x = $30,000  x = $300,000
Operating income existing=
($300,000 × .40) – $ 84,000 = $36,000
Operating income new=
($300,000 × .50) – $114,000 = $36,000
3 - 37
 OPERATING LEVERAGE

Operating leverage describes the effects that fixed costs have on changes in operating
income as changes occur in units sold. Organizations with a high proportion of fixed
costs have high operating leverage.

3 - 38
 OPERATING LEVERAGE EXAMPLE
Degree of operating leverage = Contribution margin ÷ Operating income
What is the degree of operating leverage of the Pants Shop at the 3,500 sales level
under both arrangements?
Existing arrangement: New arrangement:
fixed costs= $84,000 fixed costs = $114,000
contribution margin=3,500 × $28 = $98,000 contribution margin=3,500 × $35 = $122,500
operating income =$98,000– $84,000 = $14,000 operating income =$122,500– $114,000 = $8,500
Degree of operating leverage=$98,000 ÷ $14,000 = 7.0 Degree of operating leverage=$122,500 ÷ $8,500
= 14.4

The degree of operating leverage at a given level of sales helps managers

calculate the effect offluctuations in sales on operating income.
3 - 39
LEARNING OBJECTIVE 7

Apply CVP analysis to a company

producing different products.

3 - 40
 EFFECTS OF SALES MIX ON INCOME
Pants Shop Example Management expects to sell 2 shirts at $20 each for every
pair of pants it sells. This will not require any additional fixed costs.
Shirt variable cost per unit = $9

3 - 41
 EFFECTS OF SALES MIX ON INCOME
Contribution margin per shirt: $20 – $9 = $11
What is the contribution margin of the mix?
contribution margin =$28 + (2 × $11) = $28 + $22 = $50

3 - 42
 EFFECTS OF SALES MIX ON INCOME
Brake even = $84,000 fixed costs ÷ $50 = 1,680 packages
No of units of shirts=1,680 × 2 = 3,360 shirts
No. of units for pants= 1,680 × 1 = 1,680 pairs of pants
Total units = 5,040

3 - 43
 EFFECTS OF SALES MIX ON INCOME

What is the breakeven in dollars?

3,360 shirts × $20 = $ 67,200
1,680 pairs of pants × $70 = 117,600
$184,800

3 - 44
 LEARNING OBJECTIVE 8

Adapt CVP analysis to situations

in which a product has more than one cost driver.

3 - 45
 MULTIPLE COST DRIVERS EXAMPLE

Suppose that the business will incur an additional

cost of $10 for preparing documents associated
with the sale of pants to various customers.
Assume that the business sells 3,500
pants to 100 different customers.
What is the operating income from this sale?

3 - 46
 MULTIPLE COST DRIVERS EXAMPLE
Revenues: 3,500 × $70 $245,000
Variable costs:
Pants: 3,500 × $42 147,000
Documents: 100 × $10 1,000
Total 148,000
Contribution margin 97,000
Fixed costs 84,000
Operating income $ 13,000
3 - 47
 MULTIPLE COST DRIVERS
Would the operating income of the Pants Shop
be lower or higher if the business sells pants
to more customers?
The cost structure depends on two cost drivers:

1. Number of units

2. Number of customers

3 - 48
 • Quiz
• A person buy and sell a product which sells for 15.00 m.u. each. The cost
for purchase the product is 3.00 m.u. In order to trade he requires
premises and equipment which, in total, represent a fixed cost to of 25,000
m.u. Total planned volume for the year of the product is 4,000 units.
1- How many units do he needs to sell to break-even?
2- How many units do he needs to sell to make 1,000 m.u. profit?
3- Would it be worth the introduction of advertising at a cost of 6,000
m.u. to increase sales to 4,450?
4- What impact would a 10% drop in selling price have on the break-even
volume?
3 - 49
Engineering Cost Analysis
Code: IENG 403
Prof. Dr. Mohamed Fahmy
Chapter 1
Mob. 01096970945-Whatsup
Mail: [email protected]

1-1
 COURSE OBJECTIVES

•Enhance cost awareness and its relationship with strategy

•How to add value to the bottom line
•Describe specific cost analysis and performance measurement techniques
•Learning how to get from cost to strategy then to performance measurement
•Broadening the management accounting knowledge
•Deliver more timely and useful information to decision makers
•Identify and manage key financial and non-financial indicators for the business

1-2
 COST ACCOUNTING
No of
Course Contents Weeks
Contact hours

Introduction : Definition & meaning of cost accounting, cost terminology,

3 9
classification of costs and calculation of various cost.

Job Costing: Concept, Job costing systems, Job costing in manufacturing, actual v/s
2 6
normal costing, job costing systems in manufacturing.

Activity Based Costing: Simple v/s Activity based costing system, cost hierarchy, 3 9
cost products or services using activity based costing, ABC v/s ABM

Process Costing: Process Costing methods, job order costing and spoilage, job
4 12
costing & rework and accounting for scrap.

Cost Allocation Techiques : Joint Products v/s By Products, approaches to 2 6

allocating joint costs and accounting for by-products.
Total 14 42
Grading Scheme
• Mid Term 20 %
• Final 30 %
• Assignment 15
• Att. And participation 10 %
• Projects 15 %
• Quizzes 10 %

1-4
 Chapter 1

The Accountant’s Role

in the Organization

1-5
 Learning Objectives

1) Describe how cost accounting supports management accounting and financial accounting.
2) Understand how management accountants affect strategic decisions.
3) Distinguish between the planning and control decisions of managers of management accountants.

4) Distinguish among ,the problem- solving, scorekeeping, and attention-directing roles

5) Identify four themes managers need to consider for attaining success.

6) Describe the set of business functions in the value chain.

7) Describe three ways management accountants support managers

8) Understand how cost management accounting fits into an organization’s structure.

9) Understand what professional ethics mean to management accountants.

1-6
 Learning Objective 1

Describe how cost accounting supports

management accounting and financial accounting.

1-7
 Accounting Discipline Overview
Managerial Accounting – measures, analyzes and reports financial and nonfinancial

information to help managers make decisions to fulfill organizational goals.

Managerial accounting need not be GAAP compliant.

Financial Accounting – focus on reporting to external users including investors,

creditors, and governmental agencies. Financial statements must be based on

GAAP.

Generally Accepted Accounting Principles (GAAP)

 Management Accounting

It measures and reports financial and nonfinancial information that

helps make decisions to fulfill the goals of an organization.

1-9
 Financial Accounting

Its focus is on reporting to external parties.

It measures and records business transactions.
It provides financial statements based on generally
accepted accounting principles (GAAP).

1 - 10
 Customers Employees
Management

Suppliers

Creditors
Stakeholders
Government

Banks

Shareholders
Environment Local community

1 - 11
 External Stakeholders
Customers Employees
Management

Suppliers

Creditors
Stakeholders
Government

Banks

Shareholders
Environment Local community

1 - 12
 Enternal Stakeholders

Customers Employees
Management

Suppliers

Creditors
Stakeholders
Government

Banks

Shareholders
Environment Local community

1 - 13
 Cost Accounting

It provides information for both management

accounting and financial accounting.
It measures and reports financial and nonfinancial data.

1 - 14
 Cost Management

It describes the activities of managers in planning and

control of costs.
It includes the continuous reduction of costs.
It is a key part of general management strategies and their
implementation.

1 - 15
 Help managers in

Accounting

Information

System

1 - 16
 Major Differences Between
Financial & Managerial Accounting
Managerial Accounting Financial Accounting
Communicate financial position to
Purpose Decision making
outsiders
Primary Users Internal managers External users

Focus/Emphasis Future-oriented Past-oriented

Do not have to follow GAAP; cost vs.
Rules GAAP compliant; -CPA audited
benefit

Time Span Ultra current to very long time horizons Historical monthly, quarterly reports

Behavioral Issues Designed to influence employee behavior Indirect effects on employee behavior

Certified Public Accountant, is a trusted financial advisor who helps individuals, businesses, and other
organizations plan and reach their financial goals
S.N Cost Accounting Management Accounting
o.
1 The main objective of cost The primary objective of management accounting is
accounting is to assist the to provide necessary information to the management
management in cost control in the process of its planning, controlling, and
and decision-making. performance evaluation, and decision-making.
2 Cost accounting system Management accounting uses both quantitative and
uses quantitative cost data qualitative data. It also uses those data that cannot
that can be measured in be measured in terms of money.
monitory terms.
3 Determination of cost and Efficient and effective performance of a concern is
cost control are the primary the primary role of management accounting.
roles of cost accounting.
S.N Cost Accounting Management Accounting
o.
4 Success of cost accounting does not Success of management accounting depends
depend upon management on sound financial accounting system and
accounting system. cost accounting systems of a concern.
5 Cost-related data as obtained from Management accounting is based on the
financial accounting is the base of data as received from financial accounting
cost accounting. and cost accounting.
6 Provides future cost-related Provides historical and predictive
decisions based on the historical information for future decision-making.
cost information.
7 Cost accounting reports are useful Management accounting prepares reports
to the management as well as the exclusively meant for the management.
shareholders and creditors of a
concern.
S.N Cost Accounting Management Accounting
o.
8 Only cost accounting principles Principals of cost accounting and
are used in it. financial accounting are used in
management accounting.
9 Statutory audit of cost No statutory requirement of audit for
accounting reports are necessary reports.
in some cases, especially big
business houses.
10 Cost accounting is restricted to Management accounting uses financial
cost-related data. accounting data as well as cost
accounting data.
 Learning Objective 2

Understand how management accountants affect

strategic decisions.

1 - 21
 Strategic Cost Management

Developing strategy

Building resources and capabilities

Implementing strategy

1 - 22
 Strategic Cost Management

Building resources and capabilities

Long-Term
Current Intangible
Productive
Assets Assets
Assets

1 - 23
 Strategy & Management
Accounting

Strategy – specifies how an organization matches its own capabilities with

the opportunities in the marketplace to accomplish its objectives

Strategic Cost Management – focuses specifically on the cost dimension

within a firm’s overall strategy

 Strategy & Management
Accounting
Business follow one of two main strategies:

A quality product with minimum cost

They have been profitable and have grown over the years on the basis of
providing quality products or services at low prices by judiciously
managing their costs.
A unique product with higher cost
Management accountants work closely with managers in formulating
strategy by providing information about the sources of competitive
advantage
 Strategy & Management
Accounting
Management accounting helps answer important questions such as:
Who are our most important customers, and how do we deliver value to
them?

What substitute products exist in the marketplace, and how do they differ
from our own?

What is our critical capability?

Will we have enough cash to support our strategy or will we need to seek
additional sources?
 Management Accounting and Value

▪ Creating value is an important part of planning and implementing strategy

▪ Value is the usefulness a customer gains from a company’s product or

service
 Management Accounting and Value
Value Chain is the sequence of business functions in which customer usefulness is
added to products or services

The Value-Chain consists of:

1. Research & Development

2. Design
3. Production
4. Marketing
5. Distribution
6. Customer Service
 Learning Objective 3

Distinguish between the

planning and control decisions of managers.

1 - 29
 Planning and Controlling

Management Decision Management Accounting System

Planning Budgets
Feedback

Accounting
Control System

Performance Performance
Reports
Evaluation

1 - 30
 Planning and Controlling

What is planning?

Setting Predicting Deciding how

goals results to attain goals

1 - 31
 Planning and Controlling

What is control?

Deciding and Deciding on performance

Taking actions Evaluation and feedback

1 - 32
 Planning and Controlling

What are budgets?

• They are quantitative expressions of a proposed plan of action.

• They aid in the coordination and implementation of the plan

1 - 33
 Planning and Controlling

What are performance reports?

reports that compare actual results with budgeted amounts.

1 - 34
 Performance Report Example

Boone Shop, July 2003

Budget Actual Variance
Revenues $59,000 $60,000 $1,000 F
Cost of goods sold 42,000 43,400 1,400 U
Wages 6,700 7,000 300 U
General 1,300 900 400 F
Fixed costs 5,000 5,000 0
Operating income$ 4,000 $ 3,700 $ 300 U

1 - 35
 Performance Report Example

Actual cost of goods sold were

72% of revenues instead of the budgeted 71%.

Budget % Actual %
Revenues $59,000 100 $60,000 100
Cost of goods sold 42,000 71 43,400 72
Gross margin $17,000 29 $16,600 28

1 - 36
 Feedback

This involves managers examining past performance

and systematically exploring alternative ways to make
better informed decisions in the future.

1 - 37
How Accounting Aids Decision Making, Planning, and Control
at the Daily News 1 - 38
 Learning Objective 4

Distinguish among
▪ the problem- solving,
▪ scorekeeping, and
▪ attention-directing
roles of management accountants.

1 - 39
 Problem Solving

▪ This involves comparative analysis for decision making.

▪ This role asks: Of the several alternatives available, which is the best?

1 - 40
 Explain the five-step decision-making process
1- . . . identify the problem and uncertainties,
2- obtain information,
3- make predictions about the future,
4- make decisions by choosing among alternatives,
5- implement the decision, evaluate performance, and learn
and its role in Management Accounting
. . . planning and control of operations and activities

1 - 41
 Scorekeeping

▪ This involves accumulating data and reporting reliable results to

all levels of management.

▪ This role asks: How is the business doing?

1 - 42
 Attention Directing

This involves helping managers properly focus their attention.

This role asks: Which opportunities and problems should
be emphasized first.
Attention directing should focus on all opportunities to
add value to an organization, not just cost-reduction opportunities.

1 - 43
 Learning Objective 5

Identify four themes managers need to consider for

attaining success.

1 - 44
 Key Themes in Management
Decision Making

Customer Focus

Value Chain Key Success Factors: Continuous

and Cost and Efficiency, Improvement
Time, Quality,
Supply Chain And Benchmarking
Innovation
Analysis

1 - 45
 Customer Focus

The challenge facing managers is to continue investing

sufficient (but not excessive)resources in customer
satisfaction such that profitable customers are attracted
and retained.

1 - 46
 Value Chain and
Supply Chain Analysis

This theme has two related aspects:

1. Treat each of the business functions in the value

chain as an essential and valued contributor.

2. Integrate and coordinate the efforts of all business

functions in addition to developing the capabilities
of each individual business function.
1 - 47
 Value Chain and
Supply Chain Analysis

Supply chain
describes the flow of goods, services, and information from cradle to
grave, regardless of whether those activities occur in the same
organization or other organizations.

1 - 48
 Key Success Factors
These are operational factors that directly affect the
economic viability of the organization.

Quality – customers are expecting higher levels of quality.

Cost – organizations are under continuous pressure to reduce costs.

1 - 49
 Key Success Factors

Time – organizations are under pressure to complete activities faster and to meet
promised delivery dates more reliably.

Innovation – there is now heightened recognition that a continuing flow of

innovative products or services is a prerequisite to the ongoing success of most
organizations.

1 - 50
 Continuous Improvement
and Benchmarking

Continuous improvement by competitors creates a never-ending search

for higher levels of performance within many organizations.

1 - 51
 Learning Objective 6

Describe the set of business functions in the value chain.

1 - 52
 Value Chain

The term “value chain” refers to the sequence of

business functions in which usefulness is added
to the products or services of an organization.

The term “value” is used because as the usefulness

of the product or service is increased, so is its value
to the customer.

1 - 53
 Value Chain Functions
Management accountants provide decision support for managers in the
following six business functions:

R&D Design Production

Management Accounting

Marketing Distribution Service

1 - 54
 Value Chain Functions
1- Research and Development
It is the process that is conducted to generate and experiment with ideas
related to new products, services, or processes.
2- Design
It is the detailed planning and engineering
of products, services, or processes.

1 - 55
 Value Chain Functions
3- Production
It is the acquisition, coordination, and assembly of resources to produce a product
or deliver a service.

4- Marketing
It is the manner by which companiespromote and sell their products or services
to customers or prospective customers.

1 - 56
 Value Chain Functions

5-Distribution
It is the delivery of products or services to the customer.
6-Service
It is the after-sale support activities provided to customers.

1 - 57
 Learning Objective 7

Describe three ways management accountants support managers.

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 Key Guidelines

1. Cost-benefit approach

2. Full recognition of behavioral as well as technical considerations

3. Using different costs for different purposes

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 Cost-Benefit Approach

A cost-benefit approach should be used in order

to spend resources if they promote decision
making that better attains organization goals
in relation to the costs of those resources.

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 Behavioral and Technical Considerations

A management accounting system should have two simultaneous

missions for providing information:

1. To help managers make wise economic decisions

2. To help managers and other employees to aim and strive for goals
of the organization

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 Different Costs for Different Purposes

A cost concept used for the external reporting purpose need not
be the appropriate concept for the purpose of internal routine
Reporting to managers.

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 Learning Objective 8

Understand how cost management accounting fits into

an organization’s structure.

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 Line and Staff Relationships

Line management
is directly responsible for attaining the objectives
of the organization.
Staff management
Provide advice and assistance to line management.

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 Line and Staff Relationships
Board of Directors

Chairman
Chief Executive Officer (CEO)

President
Chief Operating Officer (COO)

Chief Financial Officer (CFO)

Controller Audit Tax Treasury Risk Investor

Management Relations

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 Line and Staff Relationships
Controller

Examples of Functions

• Global Financial Planning/Budgeting • Royalties

• Operations Administration • General Ledger
• Profitability Reporting • Accounts Payable and Receivable
• Inventory • Subsidiary and Liaison Accounting
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 Learning Objective 9

Understand what professional ethics mean to management accountants.

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Professional Ethics

Competence Integrity

Confidentiality Objectivity

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 Ethical Guidelines

The Institute of Management Accountants (IMA)

is the largest association of management
The IMAaccountants in the
has issued United States.
a Standards of Ethical
Conduct for Management Accountant.

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Process Costing
1. Identify the situation in which process-costing systems are appropriate

2. Understand the basic concepts of process-costing and compute average unit

costs
3. Describe the five steps in process costing and calculate equivalent units

4. Use the weighted-average method and first-in, first-out (FIFO) method of

process costing
5. Apply process-costing methods to situations with transferred-in costs
6. Understand the need for hybrid-costing systems such as operation-costing
Prof. Dr. Mohamed Fahmy
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 Process-Costing Systems
Job-Costing Systems Masses of identical
Distinct, identifiable
or similar units of a
units of a product or service
Examples: Custom-made machines,
product or service
houses Examples: Food,
chemical processing

Prof. Dr. Mohamed Fahmy

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Process costing is a system where the unit cost of a product or service
is obtained by assigning total costs to many identical or similar units
of output.
Unit costs are computed by dividing total costs incurred by the
number of units of output from the production process.
Each unit receives the same or similar amounts of direct materials
costs, direct labor costs, and manufacturing overhead.

Prof. Dr. Mohamed Fahmy

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In a job-costing system, individual jobs use different quantities of
resources, so it would be incorrect to cost each job at the same average
production cost.
In contrast, when identical or similar units of products or services are
mass-produced, process costing is used to calculate an average production
cost for all units produced.

Prof. Dr. Mohamed Fahmy

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Process-costing systems separate costs into cost categories according
to when costs are introduced into the process.
1. Direct materials are usually added at the beginning of the
production process, or at the start of work in a subsequent department
down the assembly line.
2. Conversion costs are generally added equally along the production
process.
Prof. Dr. Mohamed Fahmy
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Let’s look at the process-costing process three ways:
1. No beginning or ending work-in-process inventories.

2. No beginning work-in-process inventory and some ending work-in-

process inventory.
3. Both beginning and ending work-in-process inventories are present.

Prof. Dr. Mohamed Fahmy

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When using process costing without any beginning or ending
work-in-process inventory, all costs that were introduced to the
process during the period will be assigned to the finished units
leaving work-in-process inventory at the end of the period.

Prof. Dr. Mohamed Fahmy

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1. Summarize the flow of physical units of output.

2. Compute output in terms of equivalent units.

3. Summarize total costs to account for.

4. Compute cost per equivalent unit.

5. Assign total costs to units completed and to units in ending

work-in-process.

Prof. Dr. Mohamed Fahmy

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 A derived amount of output units that:
1. Takes the quantity of each input in units completed and in unfinished units of
work in process and
2. Converts the quantity of input into the amount of completed output units that
could be produced with that quantity of input.
 Are calculated separately for each input. (direct materials and conversion cost)
 When calculating equivalent units in step 2, focus on quantities and disregard
dollar amounts until after the equivalent units are computed.

Prof. Dr. Mohamed Fahmy

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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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Process costing can be accomplished using the weighted-average
method or the FIFO method. We’ll look first at weighted-average.
Calculates cost per equivalent unit of all work done to date. (regardless
of the accounting period in which it was done)
Assigns this cost to equivalent units completed and transferred out of
the process, and to equivalent units in ending work-in-process
inventory.
Prof. Dr. Mohamed Fahmy
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The Weighted-average cost is the total of all costs entering the work-in-
process account divided by the total equivalent units of work done to date.
The beginning balance of the work-in-process account (work done in a
prior period) is blended in with current period costs.
Let’s look at Case 3 (with both beginning and ending work-in-process
inventory using the Weighted Average method.)

Prof. Dr. Mohamed Fahmy

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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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 Two critical figures arise out of step 5 of the cost allocation process:
1. The amount of the journal entry transferring the allocated cost of units
completed and sent from work-in-process inventory to finished goods
inventory
2. The ending balance of the work-in-process inventory account that will
appear on the balance sheet.

Prof. Dr. Mohamed Fahmy

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Assigns the cost of the previous accounting period’s equivalent units in
beginning work-in-process inventory to the first units completed and
transferred out of the process.
Assigns the cost of equivalent units worked on during the current period
first to complete beginning inventory, next to started and completed new
units, and finally to units in ending work-in-process inventory.

Prof. Dr. Mohamed Fahmy

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A distinctive feature of FIFO process-costing method is that work done
on beginning inventory is kept separate from work done in the current
period.
There is no blending of costs as we saw with the weighted-average
method.

Prof. Dr. Mohamed Fahmy

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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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 Two critical figures arise out of step 5 of the cost-allocation
process:
1. The amount of the journal entry transferring the allocated
cost of units completed and sent from work-in-process
inventory to finished goods inventory.
2. The ending balance of the work-in-process inventory
account that will appear on the balance sheet.
Prof. Dr. Mohamed Fahmy
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FIFO assumes that all the higher-cost units (from our example) from
the previous period in beginning wip are the first to be completed and
transferred out and that ending wip consists of only the lower-cost
current-period units.
The weighted-average method smooths out the cost per equivalent
unit by assuming that more lower-cost units are transferred out and
some higher-cost remain in ending wip.

Prof. Dr. Mohamed Fahmy

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Managers use information from process-costing systems to make
pricing and product-mix decisions and understand how well a firm’s
processes are performing.
FIFO provides managers with information about changes in the costs
per unit from one period to the next.
In a period of rising prices, the weighted-average method will decrease
taxes because cost of goods sold will be higher and operating income
lower.
Prof. Dr. Mohamed Fahmy
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 Are costs incurred in previous departments that are
carried forward as the product’s cost when it moves to a
subsequent process in the production cycle.
Are also called previous department costs.
Journal entries are made to mirror the progress in
production from department to department.
Transferred-in costs are treated as if they are a separate
type of direct material added at the beginning of the
Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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Prof. Dr. Mohamed Fahmy
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1. Be sure to include the transferred-in costs from previous departments

in your calculations.
2. When calculating the costs to be transferred using the FIFO method, do

not overlook costs that were in beginning wip which may now be part
of the units transferred.
3. Unit costs may fluctuate between periods so transferred units may

contain batches accumulated at different costs (using FIFO).

Prof. Dr. Mohamed Fahmy

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4. Those unit costs discussed in item #3 on the prior slide will be
transferred to the next department at ONE AVERAGE UNIT cost.
5. Units may be measured in different denominations in different
departments (feet in one department and yards in another or kilos vs.
liters). In this case, measurements must be converted to the correct
measure.

Prof. Dr. Mohamed Fahmy

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Product-costing systems do not always fall neatly into
either job-costing or process-costing categories.
A Hybrid-costing system blends characteristics from both
job-costing and process-costing systems.
Many actual production systems are in fact hybrids.
Examples include manufacturers of televisions,
dishwashers, and washing machines, and shoes who tend to
use hybrid-costing systems.
Prof. Dr. Mohamed Fahmy
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The hybrid-costing systems use process costing to account for the
conversion costs and job costing for the material and customizable
components.
One specific type of hybrid-costing system is known as the
Operation-Costing System

Prof. Dr. Mohamed Fahmy

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An operation is a standardized method or technique that is performed repetitively
resulting in different finished goods.
An operation-costing system is a hybrid-costing system applied to batches of similar,
but not identical, products.
Within each operation, all product units are treated exactly alike, using identical
amounts of the operation’s resources.
Managers find operation costing useful in cost management because operation
costing focuses on control of physical processes or operations of a given production
system.
Prof. Dr. Mohamed Fahmy
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