Fundamentals of Cost Analysis for Decision Long-Run Pricing Decisions

Making - Full cost is the total cost to produce and sell

a unit.
Differential Analysis - Includes fixed and variable costs
- Process of estimating revenues and costs of
alternative actions available to
decision-makers and of comparing these
estimates to the status quo.

Short Run
- The period of time over which capacity will
- Full costs are relevant for long-term pricing
be unchanged is usually one year.
decisions.
- Should ensure that the selling price
Differential Costs
covers the full cost, allowing the
- Costs that differ among or between
business to be sustainable and
alternatives
profitable in the long run
- Costs that change in response to an
alternative course of action
Life-Cycle Product Costing and Pricing
- The product life cycle is concerned with
covering costs in all categories.
● Research and Development
Sunk Cost - Refers to the initial phase where the
- Costs incurred in the past that cannot be company invests resources to develop the
changed by present or future decisions product concept, conduct research, and
- Not relevant in making decisions. create prototypes.
● Design
Note: - Involves finalizing the appearance,
- Variable costs must always be covered. functionality, and technical specifications of
- Covered for each unit produced to the product.
avoid immediate losses. - Bridge between R&D and manufacturing.
- Fixed costs must be covered in the long run. ● Manufacturing
- Covered in the long run for the - Process of producing the product at scale.
business to remain viable and This phase incurs both variable and fixed
sustainable. costs.
● Marketing and Distribution
Special Orders - Involve promoting the product to customers
- An order that will not affect other sales and and delivering it through various channels.
is usually a one-time occurrence ● Customer Service
- Post-sales support provided to customers,
including warranty services, technical
support, and returns management.
● Take Back (Disposal)
- Company manages the disposal, recycling,
or reuse of the product.
Target Costing from Target Pricing ● Product Choice
Target Price - Decision on what products or services to
- Price based on customers’ perceived value offer (product mix)
for the product and the price that
competitors charge.
- What would a customer pay?
- How much profit do i need?
- Can I make it at this cost

Target Costing
- Process of managing costs to ensure the
product can be produced profitably at the
target price.
Target Cost = Target Price - Desired Profit

Use of Differential Analysis for Production

Decision
● Make or Buy
- Decision to make goods or services
internally or purchase them externally
● Add or Drop a Segment
- Decision to add or drop a product line or
close a business unit

Theory of Constraints
- Focuses on revenue and cost management
when faced with bottlenecks

Bottleneck
- Operation where the work required limits
production
- Constraining resource

Throughput Contribution
- Focuses on how much each unit contributes
to covering fixed costs and generating profit.
- Formula: Sales Revenue - Direct material
Costs - Variable Cost (Energy and
Piecework Labor)
Joint Cost Analysis - Physical measures (weight, volume,
or quantity)
Joint Process - Monetary measures (sales value of
- Single process in which one product cannot product)
be manufactured without producing others. - Interpret costs allocated to joint products
- Found in the following industries: carefully
● Extractive industries - Product profitability is determined
● Agriculture industries largely by the allocation method
● Food industries
● Chemical industries Joint Process Products
● Industries that produce both first quality and ● Joint Products
factory seconds merchandise in a single - Primary outputs of a joint process;
operation substantial revenue-generating ability
○ When the process is unstable and is ● By-Products
unable to maintain output at a - Incidental output of a joint process with a
uniform quality level higher sales value than scrap but less than
○ The output quality varies joint products
○ First quality refers to products that ● Scrap
meet the manufacturer’s standards - Incidental output of a joint process with low
without defects sales value
○ Factory seconds items with minor ● Waste
flaws or imperfections sold at a - Residual output with no sales value
discount.
Cost at Various Stages of Production
Separate Cost
- Incurred in later states of production to
further process or refine the primary
products.
- Assignable to specific primary products
Split-Off Point
- When joint products are first identifiable as
individual products
- At split-off, joint costs are allocated to joint
products based on physical or monetary
measures.
- Joint costs are sunk costs once the
split-off point is reached
- Joint costs may be reduced by the
sales value of byproducts and/or
scrap

Joint Costs
- Material, labor, and overhead incurred
during a joint process.
- Allocate to primary products of a joint
process using:
Joint Process (Illustration) ○ If primary products are marketable at
split-off, process further only if value
added to the product (incremental
revenue exceeds incremental cost)

Allocating Joint Costs

- Each method may allocate a different cost
to joint products
● Physical Measure
○ Common physical characteristic
● Monetary Measure

Physical Measures
- Treats each unit as equally desirable
- Assign same cost to each unit
- Provides an unchanging yardstick of output
over time
- Use for products with unstable selling prices
- Use in rate-regulated industries
- Ignores the revenue-generating ability of
joint product
To Process or Not to Process - Examples
Decide before the joint process is started - Tons of meat, bone and etc.
● Will revenues exceed total costs? - Tons of ore
○ Revenue from the sale of joint - Board feet in lumber milling
process outputs - Barrels of oil
○ Costs - Number of computer chips
■ Joint process Formula: Joint Costs
■ Processing costs after Pound
split-off
■ Selling Costs Monetary Measures
● What is the opportunity cost? - Recognizes the revenue-generating ability
○ Is income from the joint process of joint products
greater than income from other - The base is not constant, it is unchanging
uses? - Choices:
○ Is the joint production process the ● Sales value at split-off
best use of capacity? - Uses relative sales value at split-off
Decide at the split-off point
● How to classify outputs - All joint products must be
○ Primary marketable at split-off
○ By-Product - Uses a weighting technique based
○ Scrap on both
○ Waste - Quantity produced
○ Joint costs, reduced by the value of - Selling price of production
by-products and scrap are assigned
to primary products only
● Sell at split-off or process further?
 ● Net realizable value (NRV) at Monetary Measure Allocation Example
split-off
- Assigns joint costs based on the
proportional NRVs of the joint
products at the split-off point
- All joint products must be
marketable at split-off
- Formula: Sales Revenue at split-off -
product disposal costs
● Approximated NRV at split-off
- Approximated NRV at split-off
- Some or all joint products are not
marketable at split-off
- Uses simulated NRV at split-off in
place of actual NRV at split-off
- Incremental separate cost
equals all processing and
disposal costs incurred
between split-of point and
point of sale
- Assumes that incremental revenue
from further processing is equal to or
greater than the incremental costs of
further processing and selling
- Formula: Final sales price -
incremental separate costs Accounting for By-Products and Scrap

Monetary Measure Allocation Process

- Choose a monetary allocation base
- List values that compromise the base for
each joint product
- Sum the values
- Divide each individual value by the total
value; this is the numerical proportion for
each value
- Multiply joint costs by each proportion, this
is the amount to allocate to each product
- Divide the allocated joint cost for each
product by the number of equivalent units to
obtain a cost per equivalent unit
 Joint Costs in Not-for-Profit Organizations
- Joint costs related to
● Fund-raising
● Organizational programs (program
activities)
● Conducting an administrative
function
- Joint costs must be allocated for NPFs and
state and local government entities
- Method must be rational and systematic
By-Product and Scrap: Realized Value - Clearly show the amount spent for various
activities
- Three tests for allocation—purpose,
audience, and content
- If tests not met, the costs are
fund-raising
- Compensation tied to contributions
is automatically fund-raising
- Purpose is to ensure that users of
financial statements can identify
fund-raising costs

Potential Ethical Issues

● Product decisions based on sum of joint and
separate processing costs
Impact of Realized Value and NRV ● Misclassifying a joint product as by-product
or scrap
● Misclassifying products as waste and selling
“off the books”
● Manipulating joint costs in ending inventory
● Using sales values of by-products and scrap
to manipulate overhead allocation rates
● Disposing of hazardous waste in a harmful
way
● Misallocating costs to programs or
management activities to reduce
Joint Costs in Retail Organizations fund-raising costs reported by a
- Joint costs include not-for-profit organization
● Advertising for multiple products
● Printing for multipurpose documents
● Events held for multiple purposes
- Not required to allocate joint costs
- Allocation base
● Physical (number of locations)
● Monetary (sales volume)
Answer:

Answer:

Answer:
Master Budget Human Factors in Budgeting
The success of budgeting depends upon three
Budget important factors:
- Detailed quantitative plan for acquiring and ● Top management must be enthusiastic and
using financial and other resources over a committed to the budget process.
specified forthcoming time period ● Top management must not use the budget
to pressure employees or blame them when
Budgeting something goes wrong.
- Act of preparing a budget ● Highly achievable budget targets are usually
preferred when managers are rewarded
Budgetary Control based on meeting budget targets.
- Use of budgets to control an organization’s
activity

Planning
- Involves developing objectives and
preparing various budgets to achieve these
objectives.

Control
- Involves the steps taken by management
that attempt to ensure the objectives are
attained.

Advantages of Budgeting
● Define goals and objectives
● Think about and plan for the future
Budgeting Example
● Means of allocating resources
● Uncover potential bottlenecks
● Coordinate activities
● Communicate plans

Responsibility Accounting
- Managers should be held responsible for
those items, and only those items, that the
manager can actually control to a significant
extent.

Choosing the Budget Period

- The annual operating budget may be
divided into quarterly or monthly budgets.
- A continuous budget is a 12-month budget
that rolls forward one month (or quarter) as
the current month (or quarter) is completed
Sales Budget
The individual months of April, May, and June are
summed to obtain the total projected sales in units
and dollars for the quarter ended June 30th

Direct Materials Budget

Expected Cash Collections

Expected Cash Disbursement for Materials

Production Budget
- Financial plan that estimates the number of
units to be produced during a specific period
to meet forecasted sales demand and
maintain the desired level of ending
inventory.
- Production must be adequate to meet
budgeted sales and provide for sufficient
ending inventory.
Direct Labor Budget Selling and Administrative Expense Budget

Manufacturing Overhead Budget

Format of the Cash Budget
Four sections of the cash budget:
● Cash receipts listing all cash inflows
excluding borrowing
● Cash disbursements listing all payments
excluding repayments of principal and
interest
● Cash excess or deficiency
● The financing section listing all borrowings,
repayments and interest

Cash Budget

Ending Finished Goods Inventory Budget

 Budgeted Balance Sheet

Budgeted Income Statement