Cost Accounting Fundamentals

5th Edition

Steven M. Bragg

Table of Contents

Chapter 1 – Overview of Cost Accounting ...... 1 Learning Objectives ...... 1 Introduction ...... 1 Financial Reporting ...... 1 Management Reporting ...... 1 Problem Resolution ...... 3 Price Setting ...... 3 Cost Investigation ...... 4 Budget Formulation ...... 5 Constraint Analysis ...... 5 Cost Accumulation Systems ...... 5 Summary ...... 6 Review Questions...... 7 Review Answers ...... 8

Chapter 2 – The Cost Accountant Job Description...... 9 Learning Objectives ...... 9 Introduction ...... 9 To Whom Does the Cost Accountant Report? ...... 9 What Are the Principal Accountabilities of the Cost Accountant? ...... 9 What Are the Qualifications of a Cost Accountant? ...... 11 Who Does the Cost Accountant Supervise? ...... 11 Summary ...... 11 Review Questions...... 12 Review Answers ...... 13

Chapter 3 – Types of Costs ...... 15 Learning Objectives ...... 15 Introduction ...... 15 Actual Costs ...... 15 Avoidable Costs ...... 15 Committed Costs ...... 15 Conversion Costs ...... 16 Deferred Costs ...... 16 Differential Costs ...... 17 Direct Costs ...... 17 Discretionary Costs ...... 18 Expired Costs ...... 18 Fixed Costs ...... 18 Historical Costs ...... 18 Indirect Costs ...... 19 Irrelevant Costs ...... 19 Marginal Costs ...... 19 Normal Costs...... 20 Period Costs ...... 20 Replacement Costs ...... 20 Semi-Fixed Costs ...... 21 Step Costs...... 21 Sunk Costs ...... 21 Traceable Costs ...... 21 Variable Costs ...... 22 Summary ...... 22 Review Questions...... 23 Review Answers ...... 24 Table of Contents

Chapter 4 – Inventory Valuation ...... 25 Learning Objectives ...... 25 Introduction ...... 25 Valuation Step 1: The Quantity of Inventory on Hand ...... 25 The Periodic Inventory System ...... 25 The Perpetual Inventory System ...... 26 The Gross Profit Method ...... 27 Valuation Step 2a: Inventory Costing ...... 28 The First In, First Out Method ...... 28 The Last In, First Out Method ...... 29 The Dollar-Value LIFO Method ...... 31 The Link-Chain Method ...... 32 The Weighted Average Method ...... 34 Standard Costing ...... 35 The Retail Inventory Method ...... 35 Valuation Step 2b: Inventory Costing ...... 36 Job Costing ...... 36 Process Costing ...... 36 By-Product and Joint Product Costing ...... 37 Valuation Step 3: Overhead Allocation ...... 37 Valuation Step 4: Inventory Valuation ...... 39 The Lower of Cost or Market Rule ...... 39 Obsolete Inventory Accounting ...... 41 Summary ...... 42 Review Questions...... 43 Review Answers ...... 44

Chapter 5 – Job Costing ...... 45 Learning Objectives ...... 45 Introduction ...... 45 Overview of Job Costing ...... 45 When Not to Use Job Costing ...... 46 Accounting for Direct Materials in Job Costing ...... 46 Accounting for Labor in Job Costing...... 47 Accounting for Actual Overhead Costs in Job Costing ...... 48 Accounting for Standard Overhead Costs in Job Costing ...... 49 The Importance of Closing a Job ...... 50 The Role of the Subsidiary Ledger in Job Costing ...... 50 Job Costing Controls ...... 51 Summary ...... 51 Review Questions...... 52 Review Answers ...... 53

Chapter 6 – Process Costing ...... 55 Learning Objective ...... 55 Introduction ...... 55 Overview of Process Costing ...... 55 The Weighted Average Method ...... 56 The Standard Costing Method ...... 57 The First In, First Out Method ...... 58 The Hybrid Accounting System ...... 60 Problems with Process Costing ...... 61 Summary ...... 62 Review Questions...... 63 Review Answers ...... 64

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Chapter 7 – Standard Costing ...... 65 Learning Objectives ...... 65 Introduction ...... 65 Overview of Standard Costing ...... 65 Advantages of Standard Costing...... 65 Disadvantages of Standard Costing ...... 66 How to Create a Standard Cost ...... 67 Historical, Attainable, and Theoretical Standards ...... 67 How to Account for Standard Costs ...... 68 Overview of Variances ...... 68 The Purchase Price Variance ...... 69 Material Yield Variance ...... 70 Labor Rate Variance ...... 70 Labor Efficiency Variance ...... 71 Variable Overhead Spending Variance ...... 72 Variable Overhead Efficiency Variance ...... 72 Fixed Overhead Spending Variance...... 73 Selling Price Variance...... 73 Sales Volume Variance ...... 74 Problems with Variance Analysis ...... 75 The Controllable Variance ...... 75 The Favorable or Unfavorable Variance ...... 76 Where to Record a Variance ...... 76 Which Variances to Report ...... 76 How to Report Variances ...... 77 Summary ...... 78 Review Questions...... 79 Review Answers ...... 80

Chapter 8 – Joint and By-Product Costing ...... 81 Learning Objectives ...... 81 Introduction ...... 81 Split-Off Points and By-Products ...... 81 Why We Allocate Joint Costs ...... 82 How to Allocate Joint Costs ...... 82 How to Determine Prices for Joint Products and By-Products...... 83 Special Concerns With By-Product Costing...... 83 Summary ...... 84 Review Questions...... 85 Review Answers ...... 86

Chapter 9 – Waste Accounting ...... 87 Learning Objectives ...... 87 Introduction ...... 87 Definition of Spoilage ...... 87 Accounting for Normal Spoilage ...... 87 Accounting for Abnormal Spoilage ...... 88 Accounting for the Sale of Spoilage ...... 89 Cost Allocation to Spoilage ...... 89 Definition of Rework ...... 89 Reporting Rework ...... 90 Accounting for Rework ...... 90 Definition of Scrap ...... 91 Accounting for Scrap ...... 91 Impact of Waste on Manufacturing Systems ...... 92 Summary ...... 92 Review Questions...... 93 Review Answers ...... 94

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Chapter 10 – Product Pricing ...... 95 Learning Objectives ...... 95 Introduction ...... 95 What Does This Cost? ...... 95 The Issue of Pricing Duration ...... 95 The Issue of Overhead Costs ...... 97 The Issue of Overhead Application ...... 97 Corporate Overhead Costs ...... 99 What Does This Cost, Part Two ...... 100 The Issue of the Bottleneck ...... 101 What Does This Cost, Part Three ...... 101 Summary ...... 102 Review Questions...... 103 Review Answers ...... 104

Chapter 11 – Target Costing ...... 105 Learning Objectives ...... 105 Introduction ...... 105 The Basic Steps of Target Costing ...... 105 Value Engineering Considerations ...... 106 The Cost Reduction Program...... 107 The Milestone Review Process ...... 107 Problems with Target Costing ...... 108 The Members of a Design Team ...... 109 The Role of the Cost Accountant in Target Costing ...... 109 Data Sources for Target Costing ...... 110 The Product Life Cycle and Target Costing ...... 111 Summary ...... 111 Review Questions...... 112 Review Answers ...... 113

Chapter 12 – Transfer Pricing ...... 115 Learning Objectives ...... 115 Introduction ...... 115 Overview of Transfer Pricing ...... 115 Market Price Basis for Transfer Pricing ...... 116 Adjusted Market Price Basis for Transfer Pricing ...... 117 Negotiated Basis for Transfer Pricing ...... 117 Contribution Margin Basis for Transfer Pricing ...... 118 Cost Plus Basis for Transfer Pricing ...... 118 Cost Anomalies in a Cost-Based Transfer Price ...... 118 Pricing Problems Caused by Transfer Pricing ...... 119 The Tax Impact of Transfer Prices ...... 120 Summary ...... 121 Review Questions...... 122 Review Answers ...... 123

Chapter 13 – Direct Costing ...... 125 Learning Objectives ...... 125 Introduction ...... 125 Overview of Direct Costing ...... 125 Contribution Margin versus Gross Margin ...... 126 Direct Costing as an Analysis Tool ...... 126 Direct Costing Pitfalls...... 131 Summary ...... 133 Review Questions...... 134 Review Answers ...... 135

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Chapter 14 – Activity-Based Costing ...... 137 Learning Objectives ...... 137 Introduction ...... 137 The Problem with Overhead Allocation ...... 137 Overview of Activity-Based Costing...... 139 Activity-Based Management ...... 144 Advantages of Activity-Based Costing ...... 144 Problems with Activity-Based Costing ...... 146 The Incremental Cost Reduction Fallacy ...... 147 The Bill of Activities ...... 148 System Scope Issues ...... 149 System Integration Issues ...... 149 Summary ...... 150 Review Questions...... 151 Review Answers ...... 152

Chapter 15 – Constraint Analysis ...... 153 Learning Objectives ...... 153 Introduction ...... 153 Constraint Analysis Operational Terminology ...... 153 Overview of Constraint Analysis...... 153 The Cost of the Bottleneck ...... 155 Local Optimization ...... 156 Constraint Analysis Financial Terminology ...... 157 Constraint Analysis from a Financial Perspective ...... 157 The Constraint Analysis Model ...... 157 The Decision to Sell at a Lower Price ...... 159 The Decision to Outsource Production ...... 160 The Capital Investment Decision...... 161 The Decision to Cancel a Product ...... 162 Comparison of Activity-Based Costing to Constraint Analysis ...... 163 Summary ...... 163 Review Questions...... 164 Review Answers ...... 165

Chapter 16 – Capital Budgeting Analysis ...... 167 Learning Objectives ...... 167 Introduction ...... 167 Overview of Capital Budgeting ...... 167 Bottleneck Analysis ...... 168 Net Present Value Analysis ...... 168 The Payback Method ...... 170 Accounting Rate of Return ...... 171 Capital Budget Proposal Analysis ...... 172 The Outsourcing Decision ...... 173 The Capital Budgeting Application Form ...... 173 Capital Rationing ...... 175 Capital Budgeting with Minimal Cash ...... 176 The Post Installation Review ...... 177 The Lease versus Buy Decision ...... 178 Summary ...... 179 Review Questions...... 180 Review Answers ...... 181

Chapter 17 – Cost Collection Systems ...... 183 Learning Objectives ...... 183 Introduction ...... 183

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Data Entry Accuracy ...... 183 Data Entry with Bar Codes ...... 184 Data Entry with Radio Frequency Identification (RFID) ...... 185 Document Imaging ...... 186 Special Considerations for Labor Tracking ...... 187 The Duration of Cost Collection ...... 190 The Chart of Accounts ...... 191 The Account Code Structure ...... 191 The Account Code Format ...... 192 Accounts for the Cost Accountant ...... 192 Backflushing ...... 194 Other Sources of Cost Information ...... 195 Summary ...... 196 Review Questions...... 197 Review Answers ...... 198

Chapter 18 – Cost Variability ...... 199 Learning Objectives ...... 199 Introduction ...... 199 Mixed Costs ...... 199 Labor-Based Fixed Costs ...... 200 Costs Based on Purchase Quantities ...... 201 Costs Based on Production Batch Sizing ...... 202 Cost Based on Step Costs ...... 202 Time-Based Costs ...... 203 Experience-Based Costs ...... 204 Incorporating Cost Variability into Cost Reports ...... 205 Summary ...... 207 Review Questions...... 208 Review Answers ...... 209

Chapter 19 – Cost of Quality ...... 211 Learning Objectives ...... 211 Introduction ...... 211 Types of Quality ...... 211 Costs Impacted by Quality ...... 212 Reporting on the Cost of Quality ...... 212 Summary ...... 215 Review Questions...... 216 Review Answers ...... 217

Glossary ...... 219

Index ...... 223

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