202 Appendix S08 S

202 Appendix S08 S - ACC 202 Intro to Management Accounting...

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Unformatted text preview: ACC 202 Intro to Management Accounting Appendix A: Pricing Products and Services Appendix 4B & 12B: Service Department Costing: An Activity Approach obj 1 Appendix A: Learning Objectives Understand the economic concept of price elasticity. Calculate a selling price using cost plus pricing based on absorption costing product cost. Compute the target cost for a new product using the target costing process. Terminology Markup is the difference between the selling price and the cost of a product or service. Markup is usually expressed as a percentage of cost. Costplus pricing applies a predetermined markup to a cost base to determine the selling price. Economic Approach to Pricing Elasticity of Demand Price elasticity measures the degree to which unit sales of a product or service is affected by a change in price. Change Change in versus in Unit Price Sales Price Elasticity of Demand Demand for a product is inelastic if a change in price has little effect on the number of units sold. Example The demand for designer perfumes sold at cosmetic counters in department stores is relatively inelastic. Price Elasticity of Demand Demand for a product is elastic if a change in price has a substantial effect on the number of units sold. Example The demand for gasoline is relatively elastic because if a gas station raises its price, unit sales will drop as customers seek lower prices elsewhere. Price Elasticity of Demand As a manager, you usually set: higher markups over cost when demand is inelastic lower markups lower markups over cost when demand is elastic Accounting Approach to Pricing Selling prices are set using cost-plus pricing. The "cost base" in the calculation is the per unit product cost under absorption costing. This method is also known as the "absorption costing approach". Setting a Selling Price - Example Information for Ritter Company Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Variable S & A expenses Fixed S & A expenses Per Unit $ 6 4 3 2 60,000 Total $ 70,000 Determine the per unit cost if Ritter: 1) produces & sells 10,000 units of the new product, & 2) uses a 50 percent markup percentage. Setting a Selling Price - Example Step 1: Calculate the per unit product cost under absorption costing. Per Unit $ 6 4 3 7 $ 20 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Unit product cost ($70,000 10,000 units = $7 per unit) Setting a Selling Price - Example Step 2: Apply the markup % to the unit product cost to calculate the target selling price. The markup covers selling, general, & admin expenses and contributes to profit. Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Unit product cost 50% markup ($20 * 50% = $10) Target selling price Per Unit $ 6 4 3 7 $ 20 10 $ 30 Determining the Markup % The markup % can be based on: industry "rule of thumb," company tradition, or an explicit calculation. To calculate the markup %: Markup % = (Required ROI Investment) + SG&A expenses Unit sales Unit product cost Determining the Markup % Calculate the markup % if Ritter: invests $100,000 in the product markets 10,000 units of product requires a 20 % ROI on all investments Determining the Markup % Markup % = (20% $100,000) + ($2 10,000 + $60,000) 10,000 $20 Total fixed SG&A Variable SG&A per unit Markup % = ($20,000 + $80,000) $200,000 = 50% Absorption Costing Approach Weaknesses The absorption costing approach assumes customers: need the forecasted unit sales, & will pay whatever price the company charges. This logic is flawed because customers have a choice. Absorption Costing Approach Weaknesses Here's the result if Ritter produces and sells only 7,000 units at $30 each, instead of the forecasted 10,000 units. RITTER COMPANY Income Statement For the Year Ended December 31, 2005 Sales (7,000 units $30) Cost of goods sold (7,000 units $23) Gross margin SG&A expenses Net operating loss ROI = $ $ $ $ 210,000 161,000 49,000 74,000 (25,000) (25,000) = 100,000 -25% Absorption Costing Approach Weaknesses Here's the result if Ritter produces and sells only 7,000 units at $30 each, instead of the forecasted 10,000 units. The pricing is a safe approach only if customers choose Sales (7,000 units $30) $ 210,000 Cost to goods sold least asmany units as of buy at (7,000 units $23) 161,000 Gross margin 49,000 managers forecasted they would buy. SG&A expenses Net operating loss $ ROI = $ $ 74,000 (25,000) (25,000) = 100,000 RITTER COMPANY Income Statement absorption costing approach to For the Year Ended December 31, 2005 -25% Target Costing Process First determine the maximum allowable cost for a new product. Then develop a prototype that can be made for that maximum target cost figure. Here's the equation for determining the target price: Target cost = Anticipated selling price Desired profit Reasons for Using Target Costing 1. Market supply and demand determines price. 2. Most of the cost of a product is determined in the design stage. Target costing focuses a company's cost reduction efforts in the product design stage of production. Target Costing - Example Handy Appliance feels there is a niche for a hand mixer with certain features. The Marketing Department has determined: a selling price of $30 is appropriate approximately 40,000 mixers could be sold an investment of $2,000,000 is needed the company requires a 15 % ROI Let see how we determine the target cost. Target Costing - Example Projected sales (40,000 units $30) Desired profit ($2,000,000 15% ) Target cost for 40K mixers Target cost per mixer ($900,000 40,000) $ 1,200,000 300,000 $ 900,000 $ 22.50 Each functional area within Handy Appliance would be responsible for keeping its actual costs within the target established for that area. Appendix 4B & 12B: Learning Objectives Allocate service department costs to other departments using: The direct method The stepdown method Allocation by behavior Operating Departments Types of Departments Service Departments Carry out the central purposes of the organization Surgery department, marketing department, production department Provide services or assistance to the operating departments Cafeteria, internal auditing, human resources, cost accounting, purchasing Reasons for Allocating Service Department Costs To encourage operating departments to wisely use service department resources. To help measure the profitability of operating departments. To value inventory for external financial reporting purposes. To provide operating departments with more complete cost data for making decisions. To create incentive for service departments to operate efficiently. To include all overhead in the cost base when cost-plus pricing is used. Selecting Allocation Bases The allocation bases used should "drive" the cost being allocated. For example, when allocating costs of the employee cafeteria, the number of meals served would be a good choice for the allocation base. Service Departments $ Operating Departments Exh. 15-1 Examples of Allocation Bases Service Department Laundry Airport Ground Services Cafeteria Medical Facilities Materials Handling Information Technology Custodial Services Cost Accounting Power Human Resources Receiving, Shipping, and Stores Factory Administration Maintenance Allocation Bases Pounds of laundry Number of flights Number of meals Cases handled; number of employees; hours worked Hours of service; volume handled Number of personal computers; applications installed Square footage occupied Labor hours; customers served KWH used; capacity of machines Number of employees; training hours Units handled; number of requisitions; space occupied Total labor hours Machine hours Interdepartmental Services Problem Allocating costs when service departments provide services to each other Solutions Direct Method Step-down Method Reciprocal Method Direct Method Interactions between service departments are ignored and all costs are allocated directly to operating departments. Service Department (Cafeteria) Operating Department (Machining) Service Department (Custodial) Operating Department (Assembly) Direct Method Example Service Departments Cafeteria Departmental costs before allocation Number of employees Square feet occupied $ 360,000 15 5,000 Custodial $ 90,000 10 2,000 Operating Departments Machining $ 400,000 20 25,000 Assembly $ 700,000 30 50,000 Service Department Cafeteria Custodial Allocation Base Number of employees Square feet occupied Direct Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation ? $ 360,000 ? ? ? Custodial $ 90,000 Operating Departments Machining $ 400,000 ? ? ? Assembly $ 700,000 ? ? ? Direct Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) ? ? Custodial $ 90,000 Operating Departments Machining $ 400,000 144,000 ? ? Assembly $ 700,000 ? ? ? 20 $360,000 = $144,000 20 + 30 Allocation base: Number of employees Direct Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) ? ? Custodial $ 90,000 Operating Departments Machining $ 400,000 144,000 ? ? Assembly $ 700,000 216,000 ? ? $360,000 30 = $216,000 20 + 30 Allocation base: Number of employees Direct Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ $ 360,000 (360,000) (90,000) 0 Custodial $ 90,000 Operating Departments Machining $ 400,000 144,000 30,000 $ 574,000 Assembly $ 700,000 216,000 ? ? 25,000 $90,000 25,000 + 50,000 = $30,000 Allocation base: Square feet occupied Direct Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ $ 360,000 (360,000) (90,000) 0 Custodial $ 90,000 Operating Departments Machining $ 400,000 144,000 30,000 $ 574,000 Assembly $ 700,000 216,000 60,000 $ 976,000 50,000 $90,000 25,000 + 50,000 = $60,000 Allocation base: Square feet occupied Step-down Method Once a service department's costs are allocated, other service department costs are not allocated back to it. Service Department (Cafeteria) Operating Department (Machining) Service Department (Custodial) Operating Department (Assembly) Step-down Method Example Use the same data used in the direct method example. Service Departments Cafeteria Departmental costs before allocation Number of employees Square feet occupied $ 360,000 15 5,000 Custodial $ 90,000 10 2,000 Operating Departments Machining $ 400,000 20 25,000 Assembly $ 700,000 30 50,000 Service Department Cafeteria Custodial Allocation Base Number of employees Square feet occupied Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation ? $ 360,000 ? Custodial $ 90,000 ? ? ? Operating Departments Machining $ 400,000 ? ? ? Assembly $ 700,000 ? ? ? Allocate Cafeteria costs first since it provides more service than Custodial. Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 ? ? Operating Departments Machining $ 400,000 ? ? ? Assembly $ 700,000 ? ? ? 10 $360,000 10 + 20 + 30 = $60,000 Allocation base: Number of employees Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 ? ? Operating Departments Machining $ 400,000 120,000 ? ? Assembly $ 700,000 ? ? ? 20 $360,000 10 + 20 + 30 = $120,000 Allocation base: Number of employees Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 ? ? Operating Departments Machining $ 400,000 120,000 ? ? Assembly $ 700,000 180,000 ? ? 30 $360,000 10 + 20 + 30 = $180,000 Allocation base: Number of employees Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 (150,000) $ 0 Operating Departments Machining $ 400,000 120,000 ? ? Assembly $ 700,000 180,000 ? ? New total = $90,000 original Custodial cost plus $60,000 allocated from the Cafeteria. Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 (150,000) $ 0 Operating Departments Machining $ 400,000 120,000 50,000 $ 570,000 Assembly $ 700,000 180,000 ? ? 25,000 $150,000 25,000 + 50,000 = $50,000 Allocation base: Square feet occupied Step-down Method Example Service Departments Cafeteria Departmental costs before allocation Cafeteria allocation Custodial allocation Total after allocation $ 0 $ 360,000 (360,000) Custodial $ 90,000 60,000 (150,000) $ 0 Operating Departments Machining $ 400,000 120,000 50,000 $ 570,000 Assembly $ 700,000 180,000 100,000 $ 980,000 50,000 $150,000 25,000 + 50,000 = $100,000 Allocation base: Square feet occupied Revenue Producing Service Departments If a service department generates revenue, such as a cafeteria that charges for the service it provides, the revenue generated should be offset against the costs incurred. Only the remaining net amount of costs should be allocated to other departments. Allocating Costs by Behavior When possible, variable and fixed service department costs should be allocated separately. Allocating Costs by Behavior Variable service department costs should be allocated to consuming departments according to the activity causing incurrence of the cost. Allocating Costs by Behavior Allocate fixed service department costs to consuming departments in predetermined lump-sum amounts that are based on the consuming departments' peak or long-run average needs. Fixed cost allocations: Are based on amounts of capacity each consuming department requires. Should not vary from period to period. Allocating Costs by Behavior Budgeted variable and fixed service department costs should be allocated to operating departments. Allocating Costs by Behavior Variances over budgeted costs are not allocated. Service departments are responsible for these variances. Once explained, the variances are closed at year-end. Allocation Example Ono, Inc. Ono, Inc. has a maintenance department and two operating departments: cutting and assembly. Variable maintenance costs are budgeted at $0.60 per machine hour. Fixed maintenance costs are budgeted at $200,000 per year. Data relating to the current year are: Percent of Peak-Period Capacity Required 60% 40% 100% Operating Departments Cutting Assembly Total hours Hours Planned 75,000 50,000 125,000 Hours Used 80,000 40,000 120,000 Allocate maintenance costs to the two operating departments. Ono, Inc. - Beginning of the Year Hours planned Cutting Department Variable cost allocation: $0.60 75,000 hours $0.60 50,000 hours Fixed cost allocation: $ 45,000 $ 30,000 Assembly Department Total allocated cost Ono, Inc. - Beginning of the Year Hours planned Cutting Department Variable cost allocation: $0.60 75,000 hours $0.60 50,000 hours Fixed cost allocation: 60% of $200,000 40% of $200,000 Total allocated cost $ 45,000 $ 120,000 $ 165,000 $ 80,000 110,000 30,000 Assembly Department Percent of peak-period capacity. Ono, Inc. - End of the Year Hours used Cutting Department Variable cost allocation: $0.60 80,000 hours $0.60 40,000 hours Fixed cost allocation: $ 48,000 $ 24,000 Assembly Department Total allocated cost Ono, Inc. - End of the Year Hours used Cutting Department Variable cost allocation: $0.60 80,000 hours $0.60 40,000 hours Fixed cost allocation: 60% of $200,000 40% of $200,000 Total allocated cost $ 48,000 $ 120,000 $ 168,000 $ 80,000 104,000 24,000 Assembly Department Percent of peak-period capacity. Quick Check Foster City has an ambulance service that is used by the two public hospitals in the city. Variable ambulance costs are budgeted at $4.20 per mile. Fixed ambulance costs are budgeted at $120,000 per year. Data relating to the current year are: Percent of Peak-Period Capacity Required 45% 55% 100% Hospitals Mercy Northside Total Miles Planned 15,000 17,000 32,000 Miles Used 16,000 17,500 33,500 Quick Check How much ambulance service cost will be allocated to Mercy Hospital at the beginning of the year? a. $117,000 b. $254,400 c. $114,480 d. $119,250 End of ACC 202 Material ! ...
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This note was uploaded on 08/25/2008 for the course ACC 202 taught by Professor Woollen during the Spring '08 term at Hawaii.

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