REMEMEBER MY TEXT BOOK IS:
Horngren, C. T., Datar, S. M., &Rajan, M. V. (2015). Cost accounting: A managerial emphasis (15th ed.). Boston: Pearson
1). Using this week's lecture, discuss the concept of equivalent units and how that concept relates to management decision making. Be sure to include information in your discussion about the weighted-average method in comparison to the FIFO method of accounting for work residing in work-in-process units.
WEEK LECTURE:
Process costing deals with batches of like products. For example, paint is produced in large quantities and you can't tell one gallon of white paint from another gallon of white paint. A barrel of oil would be another example. The essence of this costing method is that costs are accumulated by process rather than by job. Accounting is very definitive, so process costing becomes a little out of the comfort zone for many accountants because we don't have anything that is exact. At month end under job costing, we know how much in materials have been charged to a specific job. However, under process costing we only know that a certain quantity of materials has been entered into the process. As a result, we have to estimate how far along we are in the process for direct materials and direct labor. To do this we introduce the concept of equivalent units. Equivalent units is just fancy terminology for how far along we are in the process. Since accountants like to think of completed units for costing purposes, we estimate, based on where we are in the process, how many equivalent units of completed materials we would have if we combined all the partially completed units into a smaller number of completed units. For example, we might estimate that 200 units ½ complete would be equivalent to 100 fully completed units. See, that wasn't so bad.
Here is a short video on the basics: Process Costing Part 1 - Managerial Accounting
Journal entries under process costing are also a little different than under job order costing. Materials are issued to a process, rather than a job, so materials requisitioned would be debited to WIP (some department) and credited to Materials Inventory. There are a series of five steps we use for this type of costing:
1. Measure the physical flow of resources
2. Compute the equivalent units of production
3. Identify the product costs to be accounted for
4. Compute the cost per equivalent unit: weighted average
5. Assign product cost to batches of wor
Here's a problem that will demonstrate this process: Process Costing Part 2 - Managerial Accounting
One other concept that bears some additional discussion is called an Economic Order Quantity (EOQ). The idea behind the EOQ is that there is some specific quantity of materials that should be orderedeach time an order is placed in order to minimize inventory holding costs and inventory ordering costs. This concept dovetails nicely with our ABC discussion in an earlier week actually.
The formula for the EOQ is:
EOQ = the square root of (2DS/H) where D=annual quantity demanded, S=flat fixed cost per order and H is the annual holding cost.
There are several assumptions that underlie this formula. First, the order cost is constant per order. Next, demand is known and is evenly distributed throughout the period. Third, the lead time for the order is fixed.
2). Using this week's lecture, answer the following:
• What is an (EOQ)?
• How is EQQ calculated and what are the underlying assumptions associated with the use of this tool?
• From a management perspective, why might the EOQ conflict with a manager's performance evaluation goals?
3). Capital budgeting is an integral part of the strategic planning and budgeting process of most firms. Explain and provide a numerical example of the use of the internal rate-of-return method and the Net Present Value (NPV) method of analyzing capital budget projects. Which one is a better indicator for management decision-making related to capital acquisition decisions? Why?
4). Using this week's lecture, explain what a transfer price is, what the criteria should be for evaluating potential transfer price, and provide an example of transfer pricing in action assuming: a) excess capacity and b) no excess capacity. Review the Forbes article: Transfer Pricing as Tax Avoidance and explain how transfer pricing might be used for tax avoidance.
WEEKS LECTURE:
Coming down the home stretch this week we take a look at combining all these activities and concepts into a management tool we call a budget, or plan. It has been said that if we don't know where we are going, then it doesn't really matter how we get there. A budget not only tells us where we are heading (in financial terms) but also gives us measures of performance along the way to help managers stay on track. Think about this in terms of your own personal situation. If you did not know how much money you were going to make this month, how would you know what to buy and what not to buy, right? So this budget becomes a tool to manage performance.
Since a budget causes us to think about our operations in broad terms, we can call this strategic management. In the perfect world a company establishes its long-term strategic objectives in terms of financial profitability and then budgets are prepared that indicate how each manager/department will perform in order to help the company reach those goals. So, we need a process that will lead us to our end result, which is a master budget. To get to this, we start with a sales forecast of units expected to be sold. Once we have this figured out, then we can figure out the revenue those sales will generate. To meet that sales demand, we figure out how much needs to be produced, then we break this down into the main components, direct materials, direct labor and manufacturing overhead. Once we have these figures, then we can put dollar values to them and create a budget for each. A budget must also be prepared for administrative overhead and for capital spending (machinery and so on), and from this, we create a cash flow budget (inflows and outflows). The end result of this activity will be a budgeted (forecasted) income statement, balance sheet, and statement of cash flows.
This short video will summarize this process: Responsibility Accounting: Master Budget - Managerial Accounting Video
Our final topic is transfer pricing. Let's suppose we have a sister plant that makes a part for a widget that we need to produce our widgets. Presently we are purchasing that part from an outside supplier. If we were to switch and buy that part internally from our sister plant, what price should be charged to us that would make us willing to purchase the part internally and would also make our sister plant happy to do business with us? That price is the subject of much debate among plant managers, but the "fair" price is actually dependent on the level of capacity the producing plant has available. Ingeneral terms, the transfer price should be the sum of the outlay costs (usually variable costs to produce) plus the opportunity cost of the resource at the transfer point.
Take a look at a quick example: Pricing - 6: Transfer Pricing.