Lecture Notes for Chapter 4

Lecture Notes for Chapter 4 - Chapter 4 Notes Page 1 IV....

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Chapter 4 Notes Page 1 Please send comments and corrections to me at [email protected] IV. Activity-Based Costing In this chapter we will focus on the application of Manufacturing Overhead to a firm’s products and services. In particular, we will see that dividing your Manufacturing Overhead into separate cost pools can lead to a more accurate application of Manufacturing Overhead. We will discuss the possibility of separating a firm into different production departments and applying Manufacturing Overhead separately by department. Alternatively, we will discuss dividing a firm’s operations into different activities, and applying the Manufacturing Overhead associated with each activity separately. Manufacturing Overhead Variance In Chapter 5, we saw that if Manufacturing Overhead was over-applied or under- applied, then the Manufacturing Overhead Variance ultimately ends up in Cost of Goods Sold. Thus, when all of the goods produced by a company have been completed and sold, then all of the variance should be added to Cost of Goods Sold. If, however, you have units that are unfinished (in Work in Process) and/or unsold (in Finished Goods) at the end of the period, then the misapplication of Manufacturing Overhead (that is evidenced by the variance) affects the units in Work In Process and Finished Goods, as well as, Cost of Goods Sold. In Chapter 5, we placed the entire Manufacturing Overhead Variance in Cost of Goods Sold even if some of the units were not completed or sold. This treatment is justified under the concept of Materiality. As you will recall from your introductory accounting class, Generally Accepted Accounting Principles (GAAP) include the concept of Materiality. Materiality allows you to use an incorrect accounting treatment provided that the improper treatment would not affect anyone’s decision making. For example, it is common to consider the Manufacturing Overhead Variance to be immaterial when the improper treatment changes Net Income by less than 1% or 2%. If the Manufacturing Overhead Variance is material, then the variance should be prorated (allocated) among the units in Cost of Goods Sold, Finished Goods and Work in Process. This allocation of the variance can be accomplished a number of ways. For example, you can apportion the variance between the three accounts: (i) using the relative ending balances of the three accounts (before allocating the variance) or (ii) using the relative amount of Manufacturing Overhead that is retained in each account. The effect on Net Income is often so small that the Manufacturing Overhead Variance is considered immaterial, and it is closed to Cost of Goods Sold. This is because most of the units that are started are, in fact, completed and sold during the current period.
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Chapter 4 Notes Page 2 Please send comments and corrections to me at [email protected] For example, assume that Madonna, Inc. had a Net Income of $1,000,000 and a
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This note was uploaded on 07/14/2008 for the course MGMT 122 taught by Professor Saouma during the Spring '08 term at UCLA.

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Lecture Notes for Chapter 4 - Chapter 4 Notes Page 1 IV....

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