Wuolah Free Cost Accounting Class Notes 3

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bheva
Cost Accounting
1º Grado en Administración de Empresas
Facultad de Ciencias Humanas, Sociales y de Comunicación

IE Universidad
Reservados todos los derechos.

No se permite la explotación económica ni la transformación de esta obra. Queda permitida la impresión en su totalidad.
CHAPTER 1: THE MANAGER AND MANAGEMENT ACCOUNTING
Management accounting: measures, analyzes and reports financial and nonfinancial
information related to costs of acquiring or using resources in an organization, that helps
managers make decisions to fulfill organizational goals. → Management accounting does
NOT need to follow GAAP (generally accepted accounting principles).
Managers use managerial accounting information to:
- Develop, communicate and implement strategies.
- Coordinate product design, production and marketing decisions and evaluate a
company’s performance.
example of nonfinancial information:

- Amount of hours, kilos, etc. → these are related to the costs of using resources.
Main differences between cost/management accounting and financial accounting
Management Accounting Financial Accounting
Purpose of Help managers make decisions Communicate the financial position

information → fulfill organization's goals. of the organization to external
parties.
Primary users Managers External users
Focus and emphasis Future oriented Past oriented
Rules of Based on cost-benefit analyses, Must follow GAAP

measurement and doesn’t need to follow GAAP
reporting
Time span and type Varies Annual and quarterly

of reports
Behavioral Designed to influence the Primarily reports economic events.

implications behavior of managers and other
employees.
Strategic Decisions and the Management Accountant

Strategy: how an organization matches its own capabilities with the opportunities in the
marketplace.
- Cost leadership strategy
- Product differentiation strategy
Management accounting information helps managers formulate strategy.
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Reservados todos los derechos. No se permite la explotación económica ni la transformación de esta obra. Queda permitida la impresión en su totalidad.
Value-chain and Supply-chain Analysis and Key Successful Factors
Creating value is an important part of planning and implementing strategy.
Value: the usefulness a customer gains from a company’s product or service.
Value chain: the sequence of business functions by which a product is made progressively
more useful to customers. It consists of the following:
- Research and Development
- Design of Products and Processes
- Production
- Marketing (including sales)
- Distribution
- Customer Service
Customer Relationship Management (CRM)

CRM: a strategy that integrates people and technology in all business functions to deepen
relationships with customers, partners and distributors.
→ Coordinate all customer-facing activities and design and production activities
necessary to get products to customers.
Supply-chain Analysis
Supply chain: production and distribution, which are the parts of the value chain associated
with producing and delivering a product or service.
- It describes the flow of goods, services and information from the initial sources of
materials, services and information to their delivery, regardless of whether the
activities occur in one organization or multiple organizations.
Key Success Factors

- Cost and Efficiency
- Quality
- Time
- Innovation
- Sustainability
Decision-Making, Planning and Control: The Five-Step Decision-Making Process

1. Identify the problem / 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.
Planning and Control Systems → Management accountants work
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Planning consists of:
- Selecting an organization’s goals and strategies.
- Predicting results under various alternative ways of achieving those goals.
- Deciding how to attain the desired goals.
- Communicating the goals and how to achieve them to the entire organization.
Control comprises:
- Taking actions that implement the planning decisions.
- Evaluating past performance.
- Providing feedback and learning to help future decision making.
Budget: the quantitative expression of a proposed plan of action by management and is an

aid to coordinating what needs to be done to execute the plan. → The most important
planning tool.
Management Accounting Guidelines

1. Cost-benefit approach → compares the benefits of an action/purchase to the costs.
Generally, of course, the benefits should exceed costs.
2. Behavioral and technical considerations → recognize, among other things, that
management is primarily a human activity that focus on encouraging individuals to do
their jobs better.
3. Managers use alternative ways to compare costs in different decision-making
situations because there are different costs for different purposes.
Line and Staff Relationships

- Line management → directly responsible for achieving goals of the organization.
- Staff management → provides advice, support, and assistance to line management.
- Here is where cost accountants are. They are typically under the
responsibility of the Chief Financial Officer (CFO).
Three types of inventory for manufacturing companies:

- Inventory of raw materials / dated materials.
- Inventory of working products → unfinished goods.
- Inventory of finished goods.
Cost accountants are the ones identifying the value of the finished goods.
Management Accounting Beyond the Numbers

Successful management accountants possess several of the following skills and
characteristics:
- Work well in cross-functional teams.
- Promote fact-based analysis and make tough-minded, critical judgements without
being adversarial.
- Lead and motivate people to change and be innovative.
- Communicate clearly, openly and candidly.
- Have high integrity.
CHAPTER 2: AN INTRODUCTION TO COST TERMS AND PURPOSES
Cost: a specific or forgone resource to achieve a specific goal objective.

Actual cost: a cost that has occurred.
Budget cost: a predicted cost. → in respect to the future.
Cost object: anything for which a cost measurement is desired. → not necessarily
something tangible.
- Product - Customer
- Service - Activity
- Project - Department
Cost accumulation: the collection of cost data in an organized way by means of an
accounting system.
Cost Assignment: a general term that encompasses the gathering of accumulated costs to
a cost object in two ways:
- Tracing costs with a direct relationship to the cost object.
- Allocating accumulated costs with an indirect relationship to a cost object.
Operating income = revenues - operating costs. → Before taxes and insurance expenses.
Direct and Indirect Costs

Direct costs → can be conveniently and economically traced (tracked) to a cost object. →
they can be connected to a specific product.
Indirect costs → cannot be conveniently and economically traced (tracked) to a cost
object.
- These costs are allocated to a cost object in a rational and systematic manner.
In the case of IE:

DIRECT COSTS INDIRECT COSTS
(they are not only related to BBA degree for example)
- Direct labor. → teachers - Electricity.

- Material - Cleaner services.
- Depreciation → of PPE assets, such as desks.
- Salary of the security services.
Cost Behavior Patterns: Variable Costs and Fixed Costs

Variable costs → change, in total, in proportion to changes in the related level of activity or
volume of output produced. → They are constant on a per-unit basis.
Fixed costs → remain unchanged, in total, for a given time period, despite changes in the
related level of activity or volume of output produced. → cost per unit changes inversely with
the level of production.
Costs are fixed or variable for a specific activity and/or for a given time period.
Mixed costs: costs that have variable and fixed components.
The objective of any company is to minimize the fixed costs per unit.
Other Cost Concepts

Cost driver: a variable cost, such as the level of activity or volume, that casually affects
costs over the given time span.
Relevant range: the band or range of normal activity level (or volume) in which there is a
specific relationship between the level of activity (or volume) and the cost in question.
- Fixed costs are considered fixed only within the relevant range.
Example of Multiple Classifications of Costs
The Three Different Sectors of the Economy
1. Manufacturing sector: companies purchase materials and components and convert
them into various finished goods.
2. Merchandising sector: companies purchase and then sell tangible products without
changing the basic form.
3. Service sector: companies provide services (intangible products) like legal advice or
audits.
Types of Inventory in Manufacturing

Direct materials: resources in-stock and available for use.
Work-in-process (WIP): goods partially worked on but not yet completed.
Finished goods: goods completed but not yet sold.
→ merchandising sector companies hold only merchandise inventory → retailers
Commonly Used Classifications of Manufacturing Costs/ Inventoriable costs

Inventoriable cost: cost of manufacturing a product. Types:
- Direct materials → acquisition costs of all material that will become part of the cost
object.
- Direct labor → compensation of all manufacturing labor that can be traced to the
cost object.
- Indirect manufacturing → all manufacturing costs that are related to the cost object
but cannot be traced to that cost object in an economically feasible way.
Inventoriable costs → all costs of a product that are considered assets in a company’s
balance sheet when the costs are incurred, and that are expensed as cost of goods sold
when the product is sold.
For manufacturing costs companies → all manufacturing costs are inventoriable
costs.
Period costs: all costs in the income statement other than cost of goods sold. They are
treated as expenses of the accounting period in which they are incurred. → eg: advertising
costs, depreciation. → these costs are NOT included in the inventory.
Need to be able to distinguish between manufacturing costs and not manufacturing costs.
Cost Flows
The cost of goods manufactured and the cost of goods sold on the income statement
are accounting representations of the actual flow of costs through a production system.
FLOW OF REVENUE AND COSTS FOR A MANUFACTURING-SECTOR COMPANY
Total manufacturing cost = direct material used + direct manufacturing labor +
other indirect manufacturing costs
It is the same as: direct material used + conversion cost
Direct material used = beginning inventory + direct material purchases - ending

inventory of direct materials
Cost of goods manufactured = total manufacturing costs + beginning inventory (of

work-in-process inventory) - ending inventory (of work-in-process inventory)
Cost of goods available for sale = beginning inventory (of finished goods) + cost of
goods manufactured
Cost of Goods Sold (COGS): Cost of goods sold available for sale - Ending inventory
of finished goods
Gross margin = revenues - cost of goods sold

(sometimes expressed as a percentage of the revenues to make comparison over time with
competitors) → gross margin/sales
Operating income = gross margin - period costs
Might also be expressed as a percentage revenues →
operating income margin = operating income/revenues
FLOW OF REVENUE AND COSTS FOR A MERCHANDISING-SECTOR COMPANY
Cost of goods purchased = beginning inventory of merchandise + purchases of

merchandise
COGS = beginning inventory of merchandise + merchandise purchases - ending

inventory of merchandise
Gross margin = Revenues - COGS

(sometimes expressed as a percentage of the revenues to make comparison over time with
competitors) → gross margin/sales
Operating income = gross margin - period costs

Might also be expressed as a percentage revenues →
operating income margin = operating income/revenues
Other Cost Considerations

Prime cost: the sum of all direct material and direct labor → all direct manufacturing costs.
Conversion cost: direct labor + indirect manufacturing costs.
- Overtime premium labor costs are considered part of indirect overhead costs.
- Idle time: wages paid for unproductive time caused by lack of orders, machine or
computer breakdown, work delays, poor scheduling, etc.
Different Product Costs for Different Purposes
CHAPTER 9: INVENTORY COSTING AND CAPACITY ANALYSIS
Inventory Costing Choices

- Variable costing: a method of inventory costing in which all variable manufacturing
costs (direct and indirect) are included as inventoriable costs.
→ EI (finished goods) = ALL Variable manufacturing cost
- Absorption costing: a method of inventory costing in which all variable and fixed
manufacturing costs are included as inventoriable costs. You can say that inventory
absorbs all manufacturing costs.
→ EI (finished goods) = ALL Variable manufacturing cost + fixed
manufacturing costs
- Throughput costing: a method of inventory costing in which only direct materials
are included as inventoriable costs. All other costs are expensed. → EI (finished
goods) = direct materials only
𝐹𝑖𝑥𝑒𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠

Fixed manufacturing costs per unit = 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦
Differences in income
- Operating income will differ between absorption and variable costing if inventory
levels change because of the difference in accounting for fixed and manufacturing
costs.
- The amount of the difference represents the amount of fixed manufacturing costs
capitalized as inventory under absorption costing and expensed as a period cost
under variable costing.
1. Variable manufacturing costs =
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 * 𝑢𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑
2. Cost of goods available for sale= variable manufacturing costs + beginning
inventory
3. Deduct inventory =
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 * 𝑢𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑛𝑜𝑡 𝑠𝑜𝑙𝑑
4. Variable marketing costs = 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑚𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 * 𝑢𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑
5. Contribution margin = Revenues - variable COGS - Variable marketing costs
6. Operating income = Contribution margin - fixed manufacturing costs - fixed
marketing costs
1. Allocated fixed manufacturing costs = fixed manufacturing cost per unit * units
produced
𝐹𝑖𝑥𝑒𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠
Fixed manufacturing costs per unit = 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦
2. Cost of goods Available for sale = beginning inventory + variable manufacturing

costs + allocated fixed manufacturing costs.
3. The adjustment of the production-volume variance is the portion of the
fixed cost which is not allocated to production.
Adjustment of the production-volume variance = total Fixed
manufacturing cost - allocated fixed manufacturing cost.
Allocated fixed manufacturing costs = fixed manufacturing cost per
unit * units produced
4. Deducting ending inventory (IN ABSORPTION) = (variable manufacturing cost per
unit + fixed manufacturing cost per unit) * amount produced NOT sold. .
5. Cost of goods sold = cost of goods available for sale - deducting ending inventory.
6. Gross margin = revenue - COGS
7. Operating income = Contribution margin - fixed manufacturing costs - fixed
marketing costs
VARIABLE COSTING
ABSORPTION COSTING
Explain the difference in operating income in the different inventory costing strategies
The only difference is the way the ending inventory is valued. So:
Operating income (absorption) - Operating income (variable)
=
Deduct ending inventory (absorption) - Deduct ending inventory (variable)
The difference in operating income is explained by the different way the ending inventory is
valued in each strategy.
The difference between variable and absorption costing is the way you value the ending
inventory.
In the short run, absorption costing is better, as you show a higher operating income, even if
the value of ending inventory is higher. However, in the long run, variable costing is better as
the ending inventory of last year will become beginning inventory of the new year, and as in
variable costing, ending inventory is valued lower, the beginning inventory of next year will
also be lower, and therefore the profit will be higher (relative to absorption costing).
Absorption costing and Performance Measurement

Absorption costing is the required inventory method for external financial reporting in most
countries. Absorption costing is preferred for several reasons:
- It is cost-effective and less confusing.
- It can help prevent managers from taking actions that make their performance
measure look good but that hurt the income they report to shareholders.
- It measures the cost of all manufacturing resources (variable or fixed) necessary to
produce inventory.
Extreme Variable costing
Throughput costing (super-variable costing): is a method of inventory costing in which only
direct materials costs are included as inventory costs. All other product costs are treated as
period expenses.
- Throughput margin = revenues - all direct cost of the goods sold.
Capacity Levels
Four different capacity levels can be used as the denominator to compute the budget fixed
manufacturing cost rate:
1. THEORETICAL CAPACITY
- The level of capacity based on producing at full efficiency all the time.
- It doesn’t allow for any slowdowns due to plant maintenance,
shutdown periods, or interruptions because of downtime on the
assembly lines.
- Theoretical capacity levels, in the real world, are unattainable, but they
represent the ideal goal of capacity utilization a company can aspire
to.
- Based on producing at full efficiency ALL the time → no stops. Ideal goal,
but unattainable.
2. PRACTICAL CAPACITY
- The level of capacity that reduces theoretical capacity by considering
unavoidable operating interruptions like scheduled maintenance time and
shutdowns for holidays. → has to do with the ability to produce → how many
units can my machines manufacture?
- Both theoretical capacity and practical capacity measure capacity
levels in terms of what a plant can supply.
- Our next two levels measure capacity levels in terms of demand.
- Reduces theoretical capacity by considering unavoidable operating
interruptions.
3. NORMAL CAPACITY UTILIZATION
- The level of capacity utilization that satisfies average customer demand
over a period that is long enough to consider seasonal, cyclical, and trend
factors. → The expected number of units planned to be sold over a long
period of time considering ups and downs. Made by an average of the last
years.
-
4. MASTER-BUDGET CAPACITY UTILIZATION
- The level of capacity utilization that managers expect for the current
budget period, which is typically one year. → The expected number of units
planned to be sold over the next four months. → how many units are my
clients willing to purchase?
- High prices when demand is low.
- Indicated the price at which all costs could be recovered to generate
profit.
Effects of Capacity Levels on Budget Fixed Manufacturing Cost Rate

The choice of capacity level can have a huge impact on budget fixed manufacturing cost per
unit. It is possible and even likely that budget demand will be below production capacity
levels.
𝐹𝑖𝑥𝑒𝑑 𝑚𝑎𝑛𝑢𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑

% of denominator level = 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑓𝑖𝑥𝑒𝑑 𝑚𝑎𝑛𝑢𝑓. 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑
Throughput margin = revenues - all direct costs of the goods sold
CHAPTER 3: COST VOLUME PROFIT ANALYSIS (CVP)
Basic CPV equations

1. Contribution margin (1) = Total Revenue - Total Variable Costs.
- Contribution margin per unit = selling price - variable cost per unit.
= Total revenue / number of units sold.
2. Contribution margin (2) = contribution margin per unit * units sold.
- Contribution margin (ratio %) = contribution margin / revenues.
3. Operating income = Contribution margin - Fixed Costs
Manipulation of the basic equations yields an extremely important and powerful tool called
contribution margin.
- = revenue - variable costs.
- Contribution margin per unit = unit selling price - unit variable costs.
= contribution margin / units sold.
CM (contribution margin) method:

Operating Income = [(Selling price * quantity) - (variable costs * quantity)] - fixed costs
EXAMPLE:
60,000 - 20,000 - 35,000 =

5000
If OI = 0, we’ll get the break even point.

Break even point: number of units which will make the operating income = 0.
- How many units the company will need to sell to not have losses.
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
Break even point in bundles: 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑖𝑛 𝑏𝑢𝑛𝑑𝑙𝑒𝑠
CPV and Income Taxes

Net income = Operating Income * (1 - tax rate)
→ What is left after the company has paid taxes on the operating income.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
Operating income = .
(1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒)
*ALWAYS ROUND UP.
Units sold - 125

Revenues - 75,000
Variable costs - 43,750
Fixed costs - 25,000
OPERATING INCOME = 6,250
Margin of Safety (MOS)

Measures the distance between budgeted sales and break even (BE) sales:
MOS = budgeted sales - BE sales.
MOS in $ = budgeted/actual revenue - break even revenue
- The MOS ratio removes the firm’s size from the output and expresses itself in the
form of a percentage
- MOS ratio = MOS / Budgeted sales
Cost structure
The relationship between variable and fixed costs.
- Managers make strategic decisions that affect the cost structure of the company.
- We can use CVP based sensitivity analysis to highlight the risks and returns as fixed
costs are substituted for variable costs in a company’s structure.
- The higher the % of fixed costs, the most risky the company is. → more volatility.
Cost-volume-profit analysis (CVP) examines the behavior of total revenues, total costs and
operating income as changes occur in the units sold, selling price, variable costs, or fixed
costs of a product.
Operating leverage = contribution margin / operating income.

→ This describes the effect that FC have on changes in OI
as changes occur in units sold, hence CM.
Sales mix: Relative proportion of sales of one product relative to the sales of another
product.
𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 1
= 𝑆𝑎𝑙𝑒𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 2 (in units)
Fixed costs are a risk.
CHAPTER 14: PRICING DECISIONS AND COST MANAGEMENT
How companies price a product or service ultimately depends on the demand and supply for
it. Demand and supply have three influences: 3C’s:
- Customers → customers influence price through their effect on the demand for a
product or service. (product features or quality)
- Competitors → competitors influence price through their technologies, plant
capacities and operating strategies that affect their costs.
- Costs → costs influence prices because they affect supply. The lower the cost of
producing a product, the greater the quantity a firm is willing to supply.
- Generally, there is an inverse relationship between costs and supply.
Short-run pricing decisions have a time horizon of less than one year:
- Pricing on-time-only special order with no long-run implications.
- Adjusting product mix and output volume in a competitive market.
Long-run pricing builds relationships with customers based on stable and predictable
prices. → Managers prefer a stable price because it reduces the need for continuous
monitoring of prices, improves planning, and builds long-term buyer-seller relationships.
Cost Allocation
Since prices are driven by costs, costs have to be allocated.
Indirect costs (of a particular object): costs that are related to that cost object but cannot be
traced in an economically cost-effective way.
- They often comprise a large percentage of the overall costs assigned to cost objects.
Cost allocations and product profitability analysis affect the products promoted by the
company. To increase profits, managers focus on high-margin products.
Purposes of cost allocation
- To provide information for economic decisions. → (eg: To decide on the selling price
for a product, or to decide whether to add a new product feature.)
- To motivate managers and other employees. → (eg: To encourage the design of
products that are simpler to manufacture or less costly to service.)
- To justify costs or compute reimbursement amounts. → (eg: TO cost product at a “fair
price”, or to compute reimbursement of the cost savings resulting from the
implementation of its recommendations.)
- To measure income and assets → (eg: To cost inventories for reporting to external
parties, or for reporting to tax authorities.)
Alternative Long-Run Pricing Approaches

Two different approaches for pricing decisions:
1. The market-based approach: based consumer’s willingness to buy for a product
and competitors. → “Given what our customers want and how competitors will react
to what we do, what price should be charged?
2. The cost-based approach: “Given what it costs us to make this product, what price
should we charge that will recoup our costs and achieve a target return on
investment (profit), also called cost-plus.
Market-based approach → Target pricing
Before setting prices under any approach, managers need to understand customers and
competitors for three reasons:
- Lower-cost competitors continually restrain prices.
- Products have shorter lives, which leaves companies less time and opportunity to
recover from pricing mistakes,
- Customers are more knowledgeable because they have easy access to price and
other information online and demand high-quality products at low prices.
It starts with a target price which is the estimated price for a product that potential customers
are willing to pay. The target price is estimated based on:
1. An understanding of customers’ perceived value for a product or service
2. How competitors will price competing products or services.
Four steps in developing a target prices and target costs:
1. Develop a product that satisfies the needs of potential customers.
2. Choose a target price.
3. Derive a target cost per unit: Target price - Target operating income = Target cost
4. Perform value engineering to achieve target cost.
Value Engineering
- Is a systematic evaluation of all aspects of the value chain, with the objective of
reducing costs and achieving a quality level that satisfies customers.
- It entails improvements in product designs, changes in materials specifications, and
modifications in process methods. To implement value engineering, managers must
distinguish between:
- Value-added costs: costs that, if eliminated, would reduce the actual or
perceived value or utility (usefulness) customers experience from using the
product or service.
- Non-value-added costs: costs that do not add value to the product, and
clients are not willing to pay for them → companies don’t have to invest in
these, they would rather try to lower these costs.
- Costs that if eliminated, would not reduce the actual or perceived
value or utility of the product.
- Cost incurrence: describes when a resource is consumed (or benefit foregone) to
meet a specific objective → eg: manufacturing
- Locked in costs (designed costs): costs that have not yet been incurred but will be
incurred in the future based on decisions that have already been made.
- The best opportunity to manage costs is before they are locked in.
A graphical view of cost incurrence and locked-in costs.
- The bottom curve plots the cumulative cost per unit incurred in different
business functions of the value chain.
- The top curve plots cumulative locked-in costs.
- Total cumulative cost per unit for both curves is $900, but there is wide
divergence between the locked-in costs and costs incurred.
The KEY steps in value engineering are:

1. Understand customer requirements and value-added and non-value-added
costs.
2. Anticipate how costs are locked in before they are incurred.
3. Use cross-functional teams to redesign products and processes to reduce
costs while meeting customer needs.
Possible Undesirable Effects of Value Engineering and Target Costing

1. Employees may feel frustrated if they fail to attain targets.
2. The cross-functional team may add too many features just to accommodate the
different wishes of team members.
3. A product may be in development for a long time as the team repeatedly evaluates
alternative designs.
4. Organizational conflicts may develop as the burden of cutting costs falls unequally on
different business functions in the company’s value chain.
Cost-Plus Pricing
Instead of using the market-based approach for long-run pricing decisions, managers
sometimes use a cost-based approach.
- The general formula for setting a cost-based selling price adds a markup component
to the cost base.
- Usually, it is only a starting point in the price setting process.
- Makeup is somewhat flexible, based partially on customers and competitors.
- Because a mark-up is added, cost-based pricing is often called cost-plus pricing,
where the plus refers to the markup component.
Cost-plus pricing can be determined in several ways:
- Choose a markup to earn a target rate of return on investment, which is the target
annual operating income divided by invested capital.
- Compute the specific amount of capital invested in a product, which is challenging
because it requires difficult and arbitrary allocations of investments in equipment and
buildings to individual products.
Because computing the specific amount of capital invested in a product is challenging,

sometimes managers use alternate cost bases to set prospective selling prices:
- Variable manufacturing cost
- Variable cost
- Manufacturing cost
- Full cost
Many managers use full cost for their cost-based pricing decisions:
- It allows for full recovery of all costs of the product.
- It allows for price stability.
- It is a simple approach.
Comparison between the two pricing systems

- The selling prices computed under cost-plus pricing are prospective prices.
- The target-pricing approach reduces the need to go back and forth among
prospective cost-plus prices, customer reactions, and design modifications.
- Target-pricing first determines product characteristics and target price on the basis of
customer preferences and expected competitor responses and then computes a
target cost.
Life-Cycle Product Budgeting and Costing

- Managers sometimes need to consider target prices and target costs over a
multiple-year product life cycle.
- Product life cycles span the time from initial R&D to when customer service and
support are no longer offered.
- In life-cycle budgeting, managers estimate the revenues and business function costs
across the entire value-chain, from its initial R&D to its final customer service and
support.
- Life-cycle costing tracks and accumulates business function costs across the entire
value chain, from a product’s initial R&D to its final customer service and support.
- Life-cycle budgeting and life-cycle costing span several years.
Managing Environmental and Sustainability Costs
Managing environmental costs is a critical area where managers apply life-cycle costing and
value engineering.
Environmental costs that are incurred over several years of the product’s life cycle are often
locked in at the product- and process-design stage.
A new organization, the Sustainability Accounting Standards Board (S A S B) has begun
defining standards for environmental, social, and governance (E S G) performance for
different industries. When measured over multiple periods, companies that have higher
relevant E S G ratings, have higher future profitability and financial performance, perhaps
because of customer loyalty and satisfaction, employee engagement, or brand and
reputation.
Customer Life-Cycle Costing
Customer life-cycle costs focus on the total costs incurred by a customer to acquire, use,
maintain, and dispose of a product or service.
These costs influence the prices a company can charge for its products.
- Eg: Maytag can charge higher prices for appliances that save electricity and have low
maintenance costs.
Non-cost Factors in Pricing Decisions
1. Predatory pricing—when a company deliberately prices below its costs in an effort
to drive competitors out of the market to restrict supply and then recoups its losses
by raising prices or enlarging demand
2. Collusive pricing—when companies in an industry conspire in their pricing and
production decisions to achieve a price above the competitive price and so restrain
trade
Both types of pricing violate the U.S. Antitrust Laws and are illegal.
3. Price discrimination is the practice of charging different customers different prices
for the same product or service.
- Price discrimination is permissible if differences in prices can be justified by
differences in costs.
- Price discrimination is illegal only if the intent is to lessen or prevent
competition.
4. Peak-load pricing is the practice of charging a higher price for the same product or
service when demand approaches the physical limit of the capacity to produce that
product or service.
5. International pricing is a form of price discrimination where prices charged in
different countries may vary much more than the costs of delivering the product
because of differences in customers’ purchasing power in those different countries.
FORMULAS
Target operating income = Return on capital in dollars = total capital investment * % of
target return.
- This is the same as operating income.
Variable costs = all variable costs per unit * units sold.
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
Selling price = 𝑈𝑛𝑖𝑡𝑠 𝑆𝑜𝑙𝑑
= $ per unit.
Markup % on full cost:

Full cost = OI + FC
Unit cost = full cost / units sold
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 − 𝑢𝑛𝑖𝑡 𝑐𝑜𝑠𝑡
Markup% on full cost = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒
* 100 = %
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
Return on Investment (ROI) = 𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
CHAPTER 12: DECISION-MAKING AND RELEVANT INFORMATION
Decision model: a formal method of making a choice that often involves both quantitative
and qualitative analysis.
- Management accountants analyze and represent relevant data to guide managers’
decisions.
- Managers use the five step decision making process to make decisions:
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.
The Concept of Relevance

- Relevant information has two characteristics:
- It occurs in the future.
- It differs among the alternative courses of action
- Relevant costs are expected future costs.
- Relevant revenues are expected future revenues.
- Past costs (historical costs) are NEVER relevant and are also called sunk costs.
Qualitative and Quantitative Relevant Information

Managers divide the outcomes of decisions into two broad categories: quantitative and
qualitative.
- Quantitative factors: outcomes that are measured in numerical terms.
- Qualitative factors: outcomes that are difficult to measure accurately in numerical
terms, such as satisfaction.
Although quantitative non-financial factors and qualitative factors are difficult to measure in
financial terms, they are important for managers to consider. → Qualitative factors are as
important as quantitative factors.
Sunk costs: costs that have already occurred and cannot be changed. They are excluded
because they cannot be changed by future actions → they are NOT RELEVANT
Terminology
Incremental cost: the additional total cost incurred for an activity.
Differential cost: the difference in total cost between two alternatives.
Incremental revenue: the additional total revenue from the activity.
Differential revenue: the difference in total revenue between two alternatives.
Types of decisions needed to be made

- One-time-only special orders
- Short-run pricing decisions
- Insourcing vs. outsourcing → making or buying
- Outsourcing and idle facilities.
- Strategic and qualitative factors.
- International outsourcing.
- The total alternatives approach.
- The opportunity cost approach.
- Carrying costs of inventory.
- Product-mix decisions with capacity constraints.
- Managers make decisions about which products to sell and what quantities.
These decisions usually have only a short-run focus because they typically
arise in the context of capacity constraints that can be relaxed in the long run.
- Bottlenecks, theory of constraints and throughput-margin analysis.
- Customer profitability and relevant costs
- Managers must make decisions about adding or dropping a product line or
business segment, but if the cost object is a customer, managers must decide
about adding or dropping customers.
- Brach / segment: adding or discontinuing
- Equipment replacement.
ONE-TIME-ONLY SPECIAL ORDERS

Decision: to accept or reject special orders when there is idle production capacity and
the special orders have no long-run implications.
- Idle production capacity: the time spent in the manufacturing plant where no
production occurs.
If the special order generates a positive operating income → ACCEPT
If the special order does NOT generates a positive operating income → REJECT
Compares relevant revenues and relevant costs to determine profitability
Potential problems in relevant-cost analysis:
- Avoid incorrect general assumptions such as “all variable costs are relevant, and all
fixed costs are irrelevant”.
- Be aware that unit-fixed-cost data can potentially mislead managers in two ways:
1. Fixed unit costs might include irrelevant costs, costs that will not change
whether or not the one-time only order is accepted or not.
2. If using the same unit fixed costs at different output levels, managers may
reach erroneous conclusions. Total fixed costs should be used.
Any price above incremental costs will improve operating income, however, consideration
must be given to capacity constraints, current marketing conditions, customer demand,
competition, etc.
SHORT-RUN PRICING DECISIONS

A special order decision is, in many aspects, a short-run pricing decision. Sometimes, the
decision is simply about setting an acceptable price.
- Any price above incremental costs will improve operating income; however,
consideration must be given to capacity constraints, current market conditions,
customer demand, competition, etc.
INSOURCING vs OUTSOURCING → make or buy decisions
- Outsourcing: purchasing goods and services from outside vendors.
- Insourcing: producing the good or providing the service within the
organization.
Decisions about whether to insource or outsource are called → make-or-buy
decisions.
Opportunity cost: the contribution to operating income forgone by not using a
limited resource in its next-best alternative use.
Outsourcing and Idle Facilities

- To make a good decision, managers must consider the difference in relevant
costs between the alternatives, including the cost of idle capacity and related
costs.
Strategic and qualitative factors
- Outsourcing decisions invariably have a long-run horizon in which the
financial costs and benefits of outsourcing become more uncertain. Almost
always, strategic and qualitative factors became important determinants of the
outsourcing decision. Weighing all these factors requires considerable
managerial judgment and care.
International Outsourcing
- International outsourcing requires managers to evaluate manufacturing and
transportation costs, exchange-rate risks, and other strategic and qualitative
factors, such as quality, reliability, and efficiency of the supply chain.
The Total Alternatives Approach
- Managers should consider future costs and revenues for all products. If, for
example, one decision will create idle capacity but that idle capacity can be
used for manufacture of another product, that should be considered in the
overall decision.
The opportunity cost approach
- Deciding to use a resource one way means a manager must forgo the
opportunity to use the resource in any other way. Managers must consider
that cost in their decision-making.
Carrying Cost of Inventory
- Recall that under the opportunity-cost approach, the relevant cost of any
alternative is (1) the incremental cost of the alternative plus (2) the opportunity
cost of the profit forgone from choosing that alternative. The opportunity cost
of holding inventory is the income forgone by tying up money in inventory and
not investing it elsewhere.
PRODUCT-MIX DECISIONS WITH CAPACITY CONSTRAINTS
Product-mix decisions are decisions managers make about which products to sell
and in what quantities.
Decision rule (with a constraint):
- Choose the product that produces the highest contribution margin per unit of
the constraining resource (not the highest contribution margin per unit of the
product).
BOTTLENECKS
Bottleneck: a phenomenon where the performance or capacity of an entire system
is limited by a single or limited number of components or resources.
- By increasing the width of the bottleneck, one can increase the rate at which the
water flows out of the neck at different frequencies.
- Such limiting components of a system are sometimes referred to as bottleneck
points.
- Limited amount of output due to the nature of your production process.
THEORY OF CONSTRAINTS
The theory of constraints (TOC) describes methods to maximize income when faced with
some bottleneck operations. To implement TOC we use three measures:
1. Throughput margin
2. Investments = sum of materials, R&D costs and capital costs of equipment and
buildings.
3. Operating costs = costs of operations (other than direct materials)
The objective of TOC is to increase throughput margin while decreasing investments and
operating costs. TOC focuses on managing bottleneck operations. Managing bottleneck
operations has 4 steps:
1. Recognize that bottleneck operations determine the contribution margin of the entire
system.
2. Identify the bottleneck operations.
3. Keep the bottleneck operations busy and subordinate all non-bottleneck operations
to the bottleneck operation.
4. Take actions to increase efficiency and capacity of the bottleneck operation.
Customer Profitability ad Relevant Costs

ADDING OR DROPPING A CUSTOMER
- When the cost object is a customer, managers must decide about adding or
dropping the customer.
- Decision rule: Does adding or dropping a customer add operating income to
the firm?
- YES → add or don’t drop.
- NO → drop or don’t add.
- Decision is based on incremental income of the customer, not how much
revenue the customer generates.
When a customer doesn’t produce positive operating income, managers should
attempt to determine why. Some possible reasons might be:
- Low-margin products ordered.
- High sales order costs.
- High delivery-processing and other handling costs.
- High marketing costs.
Once identified, managers could work with the customer to reduce costs so the
customer becomes profitable.
- At least one critical distinction exists between the relevant costs of adding
versus dropping a customer.
Items NOT relevant:
- Cost, accumulated depreciation, and book value of existing equipment.
- Any potential gain or loss on the transaction, a financial accounting phenomenon
only.
- Sunk costs (past costs) are unavoidable, cannot be changed no matter what action is
taken, and are not relevant.
Items that MAY BE relevant:
- Current disposal value of old machine and cost of the new machine.
CLOSING OR ADDING BRANCH OFFICES OR BUSINESS DIVISIONS

Sometimes companies must decide about closing, adding branch offices or business
divisions. The analysis is similar to the decision process of adding or closing a customer with
a notable exception:
- Often, branches or divisions are allocated a share of corporate-office costs. If a
branch or division is closed, these costs may be allocated differently but they may not
actually change.
CHAPTER 4: JOB COSTING
Basic costing terminology:
Cost objects: anything for which a cost measurement is desired.
Direct costs (of a cost object): are costs that can be traced to that cost object in an
economically feasible way. → eg: manufacturing a car: direct materials used, direct labor
Indirect costs (of a cost object): costs that cannot be traced in an economically feasible
way. → eg: manufacturing a car: rent of the plant (when it’s related to a firm that
manufactures more than one type of product in that plant), electricity
Cost pool: a grouping of individual indirect cost items. Cost pools simplify the allocation of
indirect costs because the costing system does not have to allocate each cost individually.
Cost-allocation base: a systematic way to link an indirect cost or group of indirect costs to
cost objects.
Cost driver = cost allocation base
Cost assignment
Costing Systems
- Job Costing System: the cost object is a unit or multiple units of a distinct product
or service which we call a job. Each job generally uses different amounts of
resources. → every single unit is different from the previous one, and any of these
units is called a job. → products or services are personalized to the specific client. →
unic products → eg: lawyers, accountants
- This one will give more problems.
- Process Costing System: the cost object includes masses of identical or similar
units of a product or service. In this type of system, we divide the total cost of
producing an identical or similar product or service by the total number of units
produced to obtain a per-unit cost. → masses of identical products.
Costing Approaches
- Actual costing: allocates indirect costs based on the actual indirect cost rates
times the actual quantities of the cost allocation base. → in respect to the costs you
have HAD at the END of providing the service.
- Normal costing: allocates indirect costs based on the budgeted indirect cost rates
times the actual quantities of the cost allocation base. → in respect to the costs you
EXPECT to incur. → Companies choose this approach because they prefer to have a
rational forecast on the product to be able to set a price for the customers.
Both methods allocate direct costs to a cost object the same way by using actual direct cost
rates times actual consumption.
7-Step Approach to Job Costing Using Normal Costing

1. Identify the job that is the chosen cost object.
2. Identify the direct costs of the job.
3. Select the cost-allocation base(s) to use for allocating indirect costs to the job.
4. Identify the indirect costs associated with each cost-allocation base (determine the
appropriate cost pools that are necessary).
5. Compute the rate per unit of each cost-allocation base used to allocate indirect costs
to the job.
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐶𝑜𝑠𝑡𝑠
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 (𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡) = 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑇𝑜𝑡𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝐶𝑜𝑠𝑡 − 𝐴𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝐵𝑎𝑠𝑒
6. Compute the indirect costs allocated to the job.

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑅𝑎𝑡𝑒 * 𝐴𝑐𝑡𝑢𝑎𝑙 𝐵𝑎𝑠𝑒 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑓𝑜𝑟 𝑡ℎ𝑒 𝐽𝑜𝑏
7. Compute total job costs by adding all indirect and direct costs together.
EXAMPLE EXERCISE
Actual costing, normal costing, accounting for indirect costs. PG is a very famous
tailor/designer who designs tailor-made tuxedos for sophisticated clients. It uses a
job-costing system to calculate the cost of a particular tuxedo. To design, cut, and eventually
complete every given tuxedo, PG uses materials (i.e. fabrics) and labor which are direct in
nature, and indirect costs allocated to different tuxedos using direct labor costs (i.e. more
labor time needed for a given tuxedo => more electricity is needed => and more sewing
machine usage/time is needed).
PG provides the following information:
Budget for 2018 Actual Results for 2018
PRIME COSTS
Direct material costs € 275,000 € 300,000
Direct labor costs 183,000 225,000
Indirect costs 329,400 378,000
Prime costs = direct materials used + direct manufacturing labor = all manufacturing
costs except manufacturing overhead (all manufacturing costs except indirect costs)
Required:
1. Compute the actual and budgeted indirect costs rates for 2018.
𝐴𝐶𝑇𝑈𝐴𝐿 𝑇𝑂𝑇𝐴𝐿 𝐼𝑁𝐷𝐼𝑅𝐸𝐶𝑇 𝐶𝑂𝑆𝑇𝑆
ACTUAL INDIRECT COSTS RATE = 𝐴𝐶𝑇𝑈𝐴𝐿 𝑇𝑂𝑇𝐴𝐿 𝐶𝑂𝑆𝑇 𝐴𝐿𝐿𝑂𝐶𝐴𝑇𝐼𝑂𝑁 𝐵𝐴𝑆𝐸
→ actual indirect costs
378,000
Actual indirect costs rate = 225,000 = 1.68 → For every single € of labor, at the
end of the year 1.68€ of electricity have been incurred.
𝐵𝑈𝐷𝐺𝐸𝑇𝐸𝐷 𝑇𝑂𝑇𝐴𝐿 𝐼𝑁𝐷𝐼𝑅𝐸𝐶𝑇 𝐶𝑂𝑆𝑇𝑆
BUDGET (or NORMAL) INDIRECT COST RATE = 𝐵𝑈𝐷𝐺𝐸𝑇𝐸𝐷 𝑇𝑂𝑇𝐴𝐿 𝐶𝑂𝑆𝑇 𝐴𝐿𝐿𝑂𝐶𝐴𝑇𝐼𝑂𝑁 𝐵𝐴𝑆𝐸
→
allocated indirect costs
329,000
Budgeted total cost-allocation base = 183,000
= 1.8 →
2. In February 2018, PG completed tuxedo15 for which it collected the following

information:
Direct materials used € 8,000
Direct labor costs € 5,000
Compute the cost of tuxedo15 using (a) actual costing and (b) normal costing.
a)
Cost of tuxedo15 based on ACTUAL COSTING = DIRECT COSTS +
INDIRECT COSTS = 8,000 + 5,000 + indirect costs = 13,000 + 1.68 * 5,000
= 21,400€
b)
Cost of tuxedo15 based on NORMAL COSTING = DIRECT COSTS +
INDIRECT COSTS = 8,000 + 5,000 + indirect costs = 13,000 + 1.8 * 5000 =
22,000€
3. At the end of 2018, compute the under- or overallocated indirect costs under normal
costing.
Actual indirect costs in 2018 = €378,000
Allocated indirect costs 2018 based on normal costing = 1.8 per € of labor.
= 1.8 * 225,000 = 405,000
Indirect costs were overallocated.
Calculation of overallocation of indirect costs = 405,000 - 378,000 = 27,000€
overallocated indirect costs
Contrasting Actual and Normal Costing

The only difference between costing a job with normal costing and actual costing is that
normal costing uses budgeted indirect costs rates where actual costing uses actual indirect
cost rates calculated annually at the end of the year.
Graphical representation of the cost components of a cost object.
Generally, actual and allocated indirect costs are different. So:
1. Allocated indirect costs > actual indirect costs → overallocation of indirect costs
2. Allocated indirect costs < actual indirect costs → underallocation of indirect costs.
What do companies do? → Reconciliation
OPTION 1
- Restart using actual numbers
OPTION 2
- Whatever difference will be linked to de COGS.
- Overallocation → reduce COGS.
- Underallocation → increase COGS
OPTION 3
- Break the under or overallocation under the following 3 accounts: → Spreading the
under or overallocation.
- Work in Progress control
- Finished goods control
- COGS
CHAPTER 5: ACTIVITY-BASED COSTING (ABC) AND ACTIVITY-BASED
MANAGEMENT
Simple methodologies: simple costing systems (eg: average) → inaccurate results

Complex methodologies: different cost allocation basis looking at different cost drivers →
more accurate. → ABC
Example: company consisting of departments A and B, with overhead costs pof $300,000
and $450,000, respectively.
Department A → Direct labor hours
Department B → Machine hours
Allocation rate Department A = 300,000 / 8,000 = $37.50

Allocation rate Department B = 450,000 / 1,200 = $375
Overcosting: when the cost measurement system reports a cost for a product that is above
the cost of the resources the product consumes.
Undercosting: when the cost measurement system reports a cost for a product that is
below the cost of the resources the product consumes.
→ Since pricing is more likely driven by costs, if costs are over or under allocated, prices
may be influenced by that. This is why it is important to calculate the costs in the most
accurate way.
Product Cost Cross-Subsidization

- If a company undercosts one of its products, it will overcost at least one of its other
products.
- The overcosted product absorbs too much cost, making it seem less
profitable than it really is.
- The undercosted product is left with too little costing, making it seem more
profitable than it really is.
Cost hierarchy: categorizes various activity cost pools on the basis of the different types of
cost drivers, cost-allocation bases, or different degrees of difficulty in determining
cause-and-effect relationships.
- ABC systems commonly use hierarchy with four levels to identify cost-allocation
bases that are cost drivers of the activity cost pools.
Activity-Based Costing (ABC)

Allocate indirect costs across different products / segments / departments
- Provide a more accurate assessment of the cost of a particular activity.
- More time consuming, more level of attention.
Refines a costing system by identifying individual activities as the fundamental source of
indirect costs.
Activity: an event, task or unit of work with a specified purpose.
Levels of the cost hierarchy
1. Output unit-level costs → related to the individual units of a product or service.
2. Batch-level costs → related to a group of units.
3. Product (or service) sustaining costs → related to support a particular product or
service without regard to the number of units or batches.
4. Facility - sustaining costs → related to costs of activities that cannot be traced to
individual products or services.
ABC vs. Simple Costing

- ABC is time and resource consuming → more expensive for the company
+ ABC is more accurate than simple costing. However it does not guarantee that it is
always correct. → Using ABC does not guarantee more accurate costs.
Activity-Based Management
A method of management decision-making that uses ABC information to improve customer
satisfaction and profitability.
Formulas
𝐵𝑢𝑑𝑔𝑒𝑡 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 𝑖𝑛 𝑖𝑛𝑑𝑖𝑟𝑒𝑐𝑡 𝑐𝑜𝑠𝑡 𝑝𝑜𝑜𝑙
Budget overhead rate (simple costing system) = 𝐵𝑢𝑑𝑔𝑒𝑡 𝑡𝑜𝑡𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑐𝑜𝑠𝑡 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

ABC allocation rate = 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑐𝑜𝑠𝑡 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦

Activity rate (cost driver rate) = 𝑇𝑜𝑡𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑐𝑜𝑠𝑡 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒
Gross margin = revenues - COGS
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
Operating income margin = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
𝐺𝑟𝑜𝑠𝑠 𝑚𝑎𝑟𝑔𝑖𝑛
Gross margin % = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠

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Cost-Accounting-class-notes-3.

1º Grado en Administración de Empresas

Facultad de Ciencias Humanas, Sociales y de Comunicación

Reservados todos los derechos.

example of nonfinancial information:

Main differences between cost/management accounting and financial accounting

Management Accounting Financial Accounting

Purpose of Help managers make decisions Communicate the financial position

Primary users Managers External users

Focus and emphasis Future oriented Past oriented

Rules of Based on cost-benefit analyses, Must follow GAAP

Time span and type Varies Annual and quarterly

Behavioral Designed to influence the Primarily reports economic events.

Strategic Decisions and the Management Accountant

Customer Relationship Management (CRM)

Key Success Factors

Decision-Making, Planning and Control: The Five-Step Decision-Making Process

Planning and Control Systems → Management accountants work

Budget: the quantitative expression of a proposed plan of action by management and is an

Management Accounting Guidelines

Line and Staff Relationships

Three types of inventory for manufacturing companies:

Management Accounting Beyond the Numbers

Cost: a specific or forgone resource to achieve a specific goal objective.

Direct and Indirect Costs

In the case of IE:

- Direct labor. → teachers - Electricity.

Cost Behavior Patterns: Variable Costs and Fixed Costs

Other Cost Concepts

Example of Multiple Classifications of Costs

Types of Inventory in Manufacturing

Commonly Used Classifications of Manufacturing Costs/ Inventoriable costs

FLOW OF REVENUE AND COSTS FOR A MANUFACTURING-SECTOR COMPANY

Direct material used = beginning inventory + direct material purchases - ending

Cost of goods manufactured = total manufacturing costs + beginning inventory (of

Gross margin = revenues - cost of goods sold

Cost of goods purchased = beginning inventory of merchandise + purchases of

COGS = beginning inventory of merchandise + merchandise purchases - ending

Gross margin = Revenues - COGS

Operating income = gross margin - period costs

Other Cost Considerations

Inventory Costing Choices

𝐹𝑖𝑥𝑒𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠

2. Cost of goods Available for sale = beginning inventory + variable manufacturing

Absorption costing and Performance Measurement

Effects of Capacity Levels on Budget Fixed Manufacturing Cost Rate

𝐹𝑖𝑥𝑒𝑑 𝑚𝑎𝑛𝑢𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑

Throughput margin = revenues - all direct costs of the goods sold

Basic CPV equations

CM (contribution margin) method:

60,000 - 20,000 - 35,000 =

If OI = 0, we’ll get the break even point.

CPV and Income Taxes

Units sold - 125

Margin of Safety (MOS)

Operating leverage = contribution margin / operating income.

Fixed costs are a risk.

Alternative Long-Run Pricing Approaches

Market-based approach → Target pricing