Traditional Cost ManagementTraditional Cost Management

C H A P T E R 6

Learning Objective 1

Outline the different cost flow patterns in manufacturing, merchandising, and service organizations and understand how these costs are reflected in the income statement and balance sheet.

What are Cost Flow Patterns of Manufacturing, Merchandising, and Service Organizations?

Direct MaterialsDirect LaborManufacturing Overhead

SuppliesWages & Salaries Overhead

Manufacturing

Merchandising

Inventory Purchase CostInventory Shipping Cost

Service

Work-in-ProcessInventory

Cost of Goods Sold

FinishedGoodsInventory

Cost of Goods Sold

Merchandise InventoryMerchandise Inventory

Work-in-Process Services

Cost of Services Sold

Learning Objective 2

Interpret a cost of goods manufactured schedule and analyze the levels of raw materials, work-in- process, and finished goods inventories in a manufacturing organization.

Cost of Goods Manufactured Schedule

Shows specific costs incurred to manufacture goods.

Provides calculations that support flow of costs.

Total costs of goods manufactured should include only those costs that have gone through work-in-process during the period.

Underapplied MOH is subtracted from actual MOH costs. Overapplied MOH is added to actual MOH costs.

Cost of goods available for sale = beginning finished goods inventory (adjusted for over- or underapplied MOH) + total cost of goods manufactured.

Analyzing COGS

COGS is not useful for internal decision making. Management wants to determine cost of goods

manufactured on a product-by-product basis; on a department-by-department basis; on a period-by-period basis.

Other criteria examined besides cost: product quality. speed of production.

Learning Objective 3

Understand how merchants manage cost information in their organization.

Inventory Management IssuesCarrying Too Much Inventory

Increased overhead costs Increased financial holding

costs Increased risk of loss of

market value Decreased inventory

flexibility Increased inventory

shrinkage

Carrying Too Little Inventory Increased risk of lost

sales Increased ordering costs Increased risk of supplier

price increases Increased exposure to

nondelivery Decreased bulk order

discounts

Return on Investment It is just as important to manage the money outflow for

asset investment as it is to manage the money inflow from profits.

Good management accounting can provide real value in the management effort to improve a merchandising operation.

Profit margin X Asset turnoverROI =

Profit

RevenueProfit margin =

Revenue

Total assetsAsset turnover =

Define Net Operating Profit

The difference between normal business sales and normal business expenses.

Learning Objective 4

Measure profitability and personnel utilization in a service organization.

Describe the Characteristics of Service Organizations

Professional Services

Service Shops

Mass Services

People Equipment

Process Product

High Customization

Low Customization

What Two Concepts Are Used to Develop Cost Management Evaluation

Tools for Service Organizations?

1) Profitability

2) Efficiency

- While management of materials inventories, equipment, and building space are important in a service organization, where must the emphasis be placed?

- Management of the people and their related cost to obtain the most efficient use of this critical resource.

What is the Formula for Profit Percentage from Professionals (PPP)?

What is a Personnel Utilization Report (PUR)?

PUR =Actual billable hours

Budgeted billable hours

PPP =Revenue – Professional compensation cost

Revenue

Learning Objective 5

Calculate and interpret holding costs in merchandising and service businesses.

Match These Terms with Their Correct Formula or Definition

Economic Profit

Cost of Capital

Financial Holding Cost

The Cost of Using Money

Average Investment x Annual Rate x Number of Periods

Net Operating Profit – Holding Cost of Inventory and Other Asset Investments

Match These Terms with Their Correct Formula or Definition

Economic Profit

Cost of Capital

Financial Holding Cost

The Cost of Using Money

Average Investment x Annual Rate x Number of Periods

Net Operating Profit – Holding Cost of Inventory and Other Asset Investments

Define Segment and Economic Value Added

_____________________ is a commercialized performance measurement system emphasizing incremental profits above the profit necessary to meet cost of capital requirements.

__________ is a part of a business that requires separate reports by management for evaluation purposes.

Segment

Economic Value Added

Expanded MaterialLearning Objective 6

Use classic quantitative tools in inventory management (economic order quantity, reorder point, and safety stock).

%%

Economic Order Quantity

What must firms balance?

costsof carrying too much inventory

costs of carrying too

little inventory

EOQ attempts to balance these costs:overhead costs, holding costs,risk of lost market values, shrinkage, etc.

EOQ attempts to answer what questions?How much inventory should we order?When do we place the inventory order?

Calculating EOQ

EOQC

QP2

Q = The market demand in units for the period

P = The overhead cost of placing one order

C = The total carrying cost for one unit for the period

Q = The market demand in units for the period

P = The overhead cost of placing one order

C = The total carrying cost for one unit for the period

How much inventory should we order?What is the formula for EOQ?

What do the terms mean?

How much inventory should we order?What is the formula for EOQ?

What do the terms mean?

Reorder Point

When do we place the inventory order? What is the formula?

Reorder point = Average lead time in days

x Average daily sales

Define Lead Time:

time lag between initiating a purchase order and when inventory is delivered and ready for sale.

Safety Stock

Because a surge in customer demand or problems in order processing or shipping may cause fulfillment problems, a manager may see the need for a little cushion in reorder point.

Safety stock — calculation has two parts:

1. To handle possible problems in the reorder process.

2. To handle an unexpected spike in sales demand.

Why does a business want to hold safety stock?

Define Safety StockThe minimal level of inventory required to ensure against the organization running out of inventory in the case of unforeseen problems in receiving its next purchase order.

Reorder point = (Average lead time in days x Average daily sales) + Safety stock

Combining the two calculations is acceptable, assuming management is not interested in knowing the specific level for safety stock. However, management usually wants to know when sales are eating into the safety stock.

EOQ, Reorder Points, and Safety Stock Inventory Levels

EOQReorder

Point

Safety Stock

Inventory (Units)

0 units

3 days

6 days

9 days

12 days

Average Lead Time (3 days)

Reorder Point with Safety Stock