Cost pools, cost objects, cost driver (allocation basis), and allocation volume (denominator volume). 3. 12 Determine the allocation rate (overhead rate), and allocate the cost. 3. 13 They are equal. Discussion Questions 14. For long-term software and consultancy projects, typically one of two methods is followed. The first is the completed contract method. Ender this method, the company accumulates the expenses incurred in the project in an Winters” account, and states this inventory at cost in the balance sheet as Of the balance sheet date. In the year in Which the project is completed, this cost is then charged to the income statement against the revenues earned from the project (like cost Of goods sold for a manufacturing firm). The second method is the percentage completion method. Under this method, expenses for each period are charged directly to the income statement each year, and a proportional amount of the total project revenue is also recognized as income in that year.
In this case, there is no inventory account for the project. 15. Yes, a restaurant would typically be classified as a service firm because the benefit from the “product” is not received by the customer over a period of mime in the future. There is no transfer of ownership to an “asset’ as it were. Restaurant patrons receive the benefit of the eating experience while being served at the restaurant site-?this benefit cannot be bought and stored tort future use (the exception of course is “take-outs,” but we are not considering take-outs here). 16.
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We would classify U-Haul as a service firm as well for the same reason we consider restaurants and hotels as service Customers are essentially purchasing the right to use the U-Haul truck for a specific period of time. This benefit is not storable and used at some future point in time. As mentioned in the text, the products service firms offer are not tangible or storable like they are for merchandising and manufacturing firms. U-Haul is a good example. 17. Merchandising firms hold inventories for the following reasons: ; Tomato products readily available whenever customers need them and shop for them.
If an item is not in stock, ordering, receiving and delivering it to the customer takes time, and the product may reach the customer too late (think of grocery store items such as milk, vegetables, and meat). ; Some items are available only in retain seasons, but there is demand throughout the year. By stocking up when supply is available, merchandising firms can meet the demand at other times. Often ordering and receiving in hulk quantities is a lot more cost effective for merchandising firms than ordering in small quantities. Planning, handling and transportation activities are a lot easier.
For this reason, many suppliers offer bulk discounts to induce merchandising firms to buy in large quantities and maintain inventories at their own sites. 18, Yes, inventory is an asset, and the cost of an asset includes not just the arches price but all other expenses incurred to ready the asset for its intended purpose Inventories are no exception. Thus, the cost of inventory must include the cost of receiving and stocking goods. However, including the cost of receiving and stocking goods poses an allocation problem for merchandising firms because these firms often purchase many different products in large quantities from the same vendor.
Any reasonable and equitable allocation procedure is acceptable. Lag. Some merchandising firms have very fast moving inventories because Of the nature of the business and the products involved. Grocery stores are a good example because they sell numerous products With very short shelf lives. Allocating transportation and receiving costs to individual products if done properly may result in accurate cost numbers for each product, but for such firms, charging these costs directly to cost of goods sold is not likely to result in material distortions. 20.
Research development expenditures typically provide benefits to companies at some future in point in time. They are not part of the costs incurred to produce units in the inventory. Hence they are not included in inventories costs. In general, G?AP requires that the costs of research and development activities be expensed in the period in which they are incurred. The logic is that it is difficult to ascertain future benefits that these expenditures may generate. So GAP advocates a “conservative” approach by advocating expensing of all research and development costs, and not allowing any recognition of expected benefits. 1 Generally speaking, operating cash flows and income differ from each other because of Nan-cash flows charges to income. One such non-cash item is depreciation. Depreciation is significant in magnitude for manufacturing firms cause these firms are capital incentive With property, plant and equipment accounting for a major percentage of total assets. On the other hand, service firms such as consulting firms, software and IT firms, are far more dependent on human resources. As we know, human resources are not reported as assets under GAP; the costs of human resources are expensed as period costs in the periods in which they are incurred.
Consequently, the depreciation charge is much lower for service firms compared to manufacturing firms, and income and cash flows tend to be closer to each other, 2, A noticeable trend in the last fifty years is the increase in the level of automation in almost every sector of manufacturing. The direct labor content has decreased appreciably, This trend has dramatically increased manufacturing overhead as a percentage total costs because much tooth costs to automation get reflected in the increase in depreciation associated with property, plant and equipment; and depreciation is included in the manufacturing overhead.
Later, in Chapter 10, we will learn that machine and equipments costs are better viewed as direct costs rather than overhead from a decision making perspective. 3. Ship building and custom boat building require significant labor input. Another example would be custom home building. Automobile manufacturing – once an extremely labor intensive operation – is now highly automated, with very little labor content. Motorcycle manufacturing, Harley-Davidson in particular, is highly automated. 24.
In general, any two drivers would yield the same allocations if they are perfectly correlated With one another. Gore example, suppose a company is producing two products, A and B. Product A requires two hours of labor per unit, and one hour Of machining per unit. Product B requires four hours Of labor per unit, and two hours of machining per unit. Let us say that the company expects to produce 200 units of A and 100 units of B in a month, requiring 800 hours of labor and 400 hours of machine time. Assume that the expected overhead costs are $8,000.
If we use labor hour as the cost driver, the overhead rate is $10 per labor hour (= 58,000/ 800 labor hours), and we would charge $20 of overhead to a unit of A, and $40 to a unit of 8. Suppose instead that we use machine hour as the cost driver. In this case, the overhead rate is $20 (z machine hours). Notice that the overhead charged per unit of A is again $20, and the overhead charged per unit of g is $40, The reason we get the same allocations is that both products use labor and machine time in the same proportion (two to one). 25, Yes, depreciation is a cost allocation procedure that allocates the purchase price of an asset (e. . , a machine) over its life. The cost pool is the depreciation cost If the objective of the allocation is to compute product costs (either for inventory valuation or for decision making), the cost object would be the product that the asset helps produce. The cost driver is time, and allocation volume would be the useful life of the asset measured in number of years or number of hours. 26. The most important resource for a professional services firm such as a consultancy firm is human resource in the form of the professional or the consultant providing the service.
A reasonable basis for allocating a consultant’s cost to a project or a job is to measure the amount of the time individual spends on the job, and allocate his/her cost (e. G. , salary, direct support and overhead costs) in proportion to the time spend. For example, if a consultant is aid $400,000 in annual salary, and works, on average, 2,000 hours a year, the application rate will be $200 per hour. Therefore, if this individual spends 20 hours on an assignment, that assignment will be charged $4,000. 27.
Sometimes, situations do arise when revenues have to be allocated to different components to a product offering that a company makes. Often, companies bundle products and services in order to increase demand. Xerox is known to bundle sales of copiers with service agreements it offers to maintain the copiers at the customers’ sites, Yet, from an organizational perspective, making copiers and revering them maybe be viewed as two distinct sets of activities for Xerox. It is important for the company to know how profitable copiers themselves are, and how profitable is servicing the copiers.
Therefore, revenues from bundling these two aspects have to be allocated in a reasonable way to help Xerox plan and manage their operations well. Exercises 3. 28 The following table provides the required classifications (with product costs listed first, followed by period costs). I Salary paid to consultants of providing the service. L I Travel to client site I Product cost. This is a cost I Product cost. This is a cost of providing the service. L Cost of general purpose software Product}period cost. This is an ambiguous item.
We can I I llama a stronger case for product cost if it pertains to a specific service. A general purpose software Microsoft Office probably would be a period cost, I Fee for attending training seminar to the firm’s expenses for I much like recruiting new I I Salary to office administrator Period cost, This is part I maintaining skill, consultants. I Period cost. Pertains to administration, Administrative support. I I Corporate office rent I Period cost. As this problem illustrates, we can classic’ many costs unambiguously as being product or period costs.
However, there is no bright line test. Some costs could be classified either way, with the specifics determining the actual bucket. 3. 29 The following is the GAP margin statement for Boyd Associates. Revenues Cost Of delivering service I , OASIS Gross margin 450,000 Marketing & administration 174600 Profit before taxes 275,400 We can readily obtain the answers by noting that revenue – cost of services – gross margin and gross margin – marketing and administration costs profit before taxes. . 30 The following is the gross margin statement for Kooks Consulting.
Revenues 9,000 hours x SO/hour Cost of delivering service 9,000 hours x $300/hour Gross m argil SO, COO Marketing & administration Plug figure 220,000 Profit before taxes Given $230,000 We can readily obtain the answers by noting that revenue -? cost of services gross margin and gross margin – marketing and administration costs = profit before taxes. Notice that we ignored the reimbursement of actual costs in this statement. If we included the amounts, it would increase revenue and costs by identically. 331 a. I Brad Timberline Income Statement Detail person 328,125 700,000 I I Gross margin Office administrator expenses taxes b.
I Item I Cost of supplies of persons seminars Amount I Seminar Revenue 135 seminars 125 persons x 5400 per 135 seminars 125 persons x $75 per Set up costs per seminar 135 seminars x $20,000 per seminar 721,875 50,000 tether | 250,000 | I Profit before 1$421,875 I Classification unit level Rationale Proportional to the number attending Brad’s I Set up costs per seminar thatch level Proportional to the number of seminars only Office administrator Product level I Facility level This amount is traceable to the seminar Product.
This classification makes more senses I life Brad also offers other products such as Books, video tapes, and DVD’s- I Other expenses I This amount is independent of the number of I persons per seminar or the number of Seminars. C. By inspection, it appears that unit- and batch-level costs make up product costs, while product and facility level costs comprise period costs. However, this equivalence is not usually true. For instance, the cost of a dedicated machine is a product level cost. The cost dedicatory rental is a facility level cost. However, both sots are product costs as they are manufacturing costs.
Likewise, sales commissions are unit level costs, and the cost transporting items to the customer’s site is a batch level costs, Both of these selling expenses are period costs. In sum, there is no obvious correspondence between costs per the cost hierarchy and product / period costs. These cost classifications are useful for different purposes, underscoring the maxim, “different costs for different purposes. ” 3. 32 The following table provides the required classifications (with product costs listed first, followed by period costs). Cost of merchandise sold cost Of getting the goods sale. I Transportation in Product cost.
This is a ready for Product cost. Required for getting goods ready for I Cost of display cases ambiguous item. We can I for product cost if it pertains I I I I Stocking goods on shelves firm’s expenses for I I Store rental I [Store managers salary Productivities cost. This is an I make a stronger case to a specific I Period cost. This is part of the I maintaining its facilities. I Period cost. Pertains to administration. Period cost. Administrative support. As this problem illustrates, we can classify many costs unambiguously as being e classified either way, with the specifics determining the actual bucket the cost falls into. . 33 The following is the GAP income statement for Megavolt Mart, We learn that profit before taxes for the year is $644,691 Megavolt Mart I Purchases GAP Income Statement I I Revenues I I Beginning inventory, 1/1 | $245,600 I ‘Ending | 260,400 Transportation in inventory, 12/31 g, 775 Store rent 1134. 675 102,500 Sales commissions I I Other administration | 437,064 I Store utilities 1879,345 Profit before taxes 15644,691 Notice that all costs related to getting the goods ready for sale go above the line for gross margin. All period costs such as selling and administration expenses appear below the line. . 34 The following is the GAP income statement for Sweets & Treats. We first fill in COGS and then use the inventory equation to fill in purchases, We learn that purchases total $1,598,645 and that costs of sales and administration were $435,500. Sweets & Treats Statement I GAP Income I elite I Amount I Revenues 1$ ‘Beginning inventory, 1/1 125,000 Purchases 12,131 II 12,400 I Gross margin l- Ending inventory, Cost of goods sold Sales and administration I s 203,555 | 435,500 639,055 Profit before taxes for gross margin.
All selling and administration expenses appear below the line. 3. 35 The following table provides the required classifications. I Comments I I Connectors used to make a product Direct materials items form a part to the product and vary with the These Volume of production. Components Direct labor because the workers I I I Labor to machine product I Some refer to this as "touch labor physically I Steel used to make components touch the product. Direct materials varies I I The steel becomes an integral part of the product and Twit the volume of production.
I I Drill bits, saw blades, and other I Variable manufacturing overhead These items are used to make many units of the product and/or I Tools tools. I many products. We would classify their cost as variable, as I making more units would require more I Salary paid to the factory manager Fixed manufacturing overhead I This item is a fixed cost: it is not directly traceable to I limits Of any product. Factory I Partly fixed manufacturing I Some items, such as maintenance costs the salary to the maintenance manager, levelheaded and partly variable large fixed.
Other items, such as the supplies used to maintain] I I manufacturing overhead the number of units I equipment, might vary with usage and I made. Depreciation on materials handling Fixed manufacturing overhead I The amount does not vary with any obvious volume-related costs alignment I driver. Paid to assembly Direct labor/ variable labor cost. Some firms include I Rockers. I ‘Holiday pay This item likely varies with manufacturing overhead lit as a part of direct labor. Others treat the item as I variable overhead, allocating it by using labor hours or I I I labor cost as the allocation basis.
The following table provides the required classification (with variable, product costs listed first, followed by fixed, product costs, variable, period costs and fixed, erred costs) Fixed Variable Variable I Variable I Fixed ‘Variable Product / Period I Product components I Direct manufacturing labor Variable / Product Supplies used in manufacturing Production supervisor I Factory rent I I Plant manager salary I Sales commissions I Distribution costs I Mixed (has both variable & fixed I portions) I Sales manager salary I Corporate office expenses Product Period I Period I period As the classification indicates, product/period costs correspond to business function, All manufacturing costs are product costs while Nan-manufacturing costs are period costs. This classification is useful for financial reporting. Product costs flow through the firm’s inventory accounts, In contrast, we expense period costs during the accounting period. Variability does not relate to function but is a cost characteristic. Thus, both manufacturing and Nan-manufacturing costs could be variable or fixed. 337 a.
Inventories costs are another term for product cost. As you know, only manufacturing costs can be inventoried. Thus, we have: Direct materials cost Direct labor cost 720. 000 Factory overhead (140% x $720,000 labor cost) Total costs 4, 128,000 Number of units 120,000 cost per unit 94. 40 120,000) b. No. We have to consider all controllable costs, regardless to business donation, when evaluating a produces profit. We need to do this because changing a product’s volume will change other costs. For example, we need to consider sales commission when evaluating profitability. The product/period cost classification (which leads to inventories costs) is useful from a financial accounting purpose.
But it often is NOT useful from a decision making perspective. 338 a. We can express cost flows through the materials inventory account using the following accounting equation: Ending balance Beginning balance Purchases -? Issued out to Plugging in the numbers, we find: 525,000 = 524,000 582,000 – Issued out to WIPE Issued out to WIPE ,OHO. B. We can express cost flows through the work-in-process account using the following accounting equation: Ending balance = Beginning balance -e Costs charged to operations – Cost of goods manufactured. We can, therefore, compute cost of goods manufactured as: $180,000 – $220,000 + $800,000 – cost of goods manufactured Cost of goods manufactured = $840,000. C.