Sunday, December 10, 2006

Management accounting -- Chapter 6

Differential cost (revenue) -- the difference in total cost or revenue between two alternatives
incremental cost -- another term for differential cost when one alternative includes all the costs of the other plus some additional costs
outlay cost -- a cost and requires a future cash disbursement
opportunity cost -- the maximum available contribution to profit forgone (or passed up) by using limited resources for particular purpose
joint products -- 2 or more manufactured products that: have relatively significant sales values and are not separately identifiable as individual products until they're split off point
split off point -- the juncture of manufacturing or the joint products become individually identifiable
separable costs -- any cost beyond the split off point
joint costs -- the costs of manufacturing joint products prior to split off point
depreciation -- the periodic cost of equipment that accompany spreads over the future periods in which the company will use the equipment
book value (net book value) -- the original cost of equipment less accumulated depreciation
accumulated depreciation -- the sum of all depreciation charge to pass periods
sunk cost -- a historical or passed cost, that is, a cost that the company has already incurred and, therefore, is irrelevant to the decision-making process
absorption approach -- a cost of approach that considers all indirect manufacturing costs (both variable and fixed) to be product costs that become an expense in the form of manufacturing cost of goods sold only as sales occur
contribution approach -- a method of internal reporting that emphasizes the distinction between variable and fixed costs for the purpose of better decision-making

One should always consider opportunity costs when deciding on the use of limited resources. The opportunity cost of a course of action is the maximum profit forgone from other alternative actions. Decision-makers may fail to consider opportunity costs because accountants do not report them in the financial accounting system.

One of the most important production decisions is the make or buy decision. Should a company make its own parts or products or should they buy them from outside sources? Both qualitative and quantitative factors affect this decision. In applying relevant cost analysis to make or buy situation, he key factor to consider is the use of facilities.

Another typical production situation is deciding whether to process further a joint product or sell it at the split off point. The relevant information for this decision includes the costs that differ beyond the split off point. Joint costs that occur before split off are irrelevant.

In certain production decisions, it is important to recognize and identify irrelevant costs. In the decision to dispose of obsolete inventory, the original cost of the inventory is irrelevant because there is no way to restore the resources used to buy or produce that inventory.

And the decision to keep or replace equipment, the book value of old equipment is irrelevant. This sunk cost is a past or historical cost that a company has are ready incurred. Relevant costs normally include the disposal value of old equipment, the cost of new equipment, and the difference in the annual operating costs.

Unit fixed costs can be misleading because of the differences in the assumed level of volume on which they are based. The more units a company makes, the lower the unit fixed cost will be. If a salesperson assumes a company will produce 100,000 units and actually produces only 30,000 units, the unit costs will be understated. You can avoid being misled by unit costs by always using total fixed costs.

If companies evaluate managers using performance measures that are not in line with relevant decision criteria, there could be a conflict of interest. Managers often make decisions based on how the decision affects their performance measures. Thus, performance measures work best when they are consistent with the long-term good of the company.

The major difference between the absorption and contribution formats for the income statement is that the contribution format focuses on cost behavior (fixed and variable), whereas the absorption format reports cost by business functions. The contribution approach makes it easier for managers to evaluate the effects of changes in volume on income and dust it is better for decision-making.