Manerial accounting 11e garrison noreen brewer chap002

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11th Edition Chapter McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Costs Terms, Concepts and Classifications Chapter Two McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Manufacturing Costs Direct Direct Materials Materials Direct Direct Labor Labor Manufacturing Manufacturing Overhead Overhead The Product McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Direct Materials Raw materials that become an integral part of the product and that can be conveniently traced directly to it Example: Example: A A radio radio installed installed in in an an automobile automobile McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Direct Labor Those labor costs that can be easily traced to individual units of product Example: Example: Wages Wages paid paid to to automobile automobile assembly assembly workers workers McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Manufacturing Overhead Manufacturing costs that cannot be traced directly to specific units produced Examples: Examples: Indirect Indirect labor labor and and indirect indirect materials materials Wages paid to employees who are not directly involved in production work Examples: maintenance workers, janitors and security guards McGraw-Hill/Irwin Materials used to support the production process Examples: lubricants and cleaning supplies used in the automobile assembly plant Copyright © 2006, The McGraw-Hill Companies, Inc Classifications of Costs Manufacturing costs are often classified as follows: Direct Direct Material Material Direct Direct Labor Labor Prime Cost McGraw-Hill/Irwin Manufacturing Manufacturing Overhead Overhead Conversion Cost Copyright © 2006, The McGraw-Hill Companies, Inc Non-manufacturing Costs Marketing or Selling Cost Administrative Cost Costs necessary to get the order and deliver the product All executive, organizational, and clerical costs McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Product Costs Versus Period Costs Product costs include direct materials, direct labor, and manufacturing overhead Inventory Cost of Good Sold Period costs include all marketing or selling costs and administrative costs Expense Sale Balance Sheet McGraw-Hill/Irwin Income Statement Income Statement Copyright © 2006, The McGraw-Hill Companies, Inc Quick Check  Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A Manufacturing equipment depreciation B Property taxes on corporate headquarters C Direct materials costs D Electrical costs to light the production facility E Sales commissions McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Summary of the Types of Cost Classifications • • • • Financial reporting Predicting cost behavior Assigning costs to cost objects Decision making McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Idle Time Machine Breakdowns Material Shortages Power Failures The labor costs incurred during idle time are ordinarily treated as manufacturing overhead McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Overtime The overtime premiums for all factory workers are usually considered to be part of manufacturing overhead McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Labor Fringe Benefits Fringe benefits include employer paid costs for insurance programs, retirement plans, supplemental unemployment programs, Social Security, Medicare, workers’ compensation and unemployment taxes Some companies include all of these costs in manufacturing overhead McGraw-Hill/Irwin Other companies treat fringe benefit expenses of direct laborers as additional direct labor costs Copyright © 2006, The McGraw-Hill Companies, Inc Quality of Conformance When the overwhelming majority of products produced conform to design specifications and are free from defects McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Prevention and Appraisal Costs McGraw-Hill/Irwin Prevention Costs Support activities whose purpose is to reduce the number of defects Appraisal Costs Incurred to identify defective products before the products are shipped Copyright © 2006, The McGraw-Hill Companies, Inc Internal and External Failure Costs McGraw-Hill/Irwin Internal Failure Costs Incurred as a result of identifying defects before they are shipped External Failure Costs Incurred as a result of defective products being delivered to customers Copyright © 2006, The McGraw-Hill Companies, Inc Examples of Quality Costs Prevention Costs • Quality training • Quality circles • Statistical process control activities Internal Failure Costs • Scrap • Spoilage • Rework McGraw-Hill/Irwin Appraisal Costs • Testing & inspecting incoming materials • Final product testing • Depreciation of testing equipment External Failure Costs • Cost of field servicing & handling complaints • Warranty repairs • Lost sales Copyright © 2006, The McGraw-Hill Companies, Inc Distribution of Quality Costs When quality of conformance is low, total quality cost is high and consists mostly of internal and external failure Companies can reduce their total quality cost by focusing on prevention and appraisal The cost savings from reduced defects usually swamps the costs of the additional prevention and appraisal efforts McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Ventura Company Quality Cost Report For Years and Year Amount Percent* Prevention costs: Systems development Quality training Supervision of prevention activities Quality improvement Total prevention cost $ Year Amount Percent* 400,000 210,000 70,000 320,000 1,000,000 0.80% $ 270,000 0.42% 130,000 0.14% 40,000 0.64% 210,000 2.00% 650,000 0.54% 0.26% 0.08% 0.42% 1.30% Appraisal costs: Inspection Reliability testing Supervision of testing and inspection Depreciation of test equipment Total appraisal cost 600,000 580,000 120,000 200,000 1,500,000 1.20% 1.16% 0.24% 0.40% 3.00% 560,000 420,000 80,000 140,000 1,200,000 1.12% 0.84% 0.16% 0.28% 2.40% Internal failure costs: Net cost of scrap Rework labor and overhead Downtime due to defects in quality Disposal of defective products Total internal failure cost 900,000 1,430,000 170,000 500,000 3,000,000 1.80% 2.86% 0.34% 1.00% 6.00% 750,000 810,000 100,000 340,000 2,000,000 1.50% 1.62% 0.20% 0.68% 4.00% External failure costs: Warranty repairs Warranty replacements Allowances Cost of field servicing Total external failure cost Total quality cost 400,000 870,000 130,000 600,000 2,000,000 7,500,000 0.80% 900,000 1.74% 2,300,000 0.26% 630,000 1.20% 1,320,000 4.00% 5,150,000 15.00% $ 9,000,000 1.80% 4.60% 1.26% 2.64% 10.30% 18.00% $ Quality cost reports provide an estimate of the financial consequences of the company’s current defect rate * As a percentage of total sales In each year sales totaled $50,000,000 McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Quality Cost Reports: Graphic Form $10 20 Quality Cost (in millions) External Failure External Failure Internal Failure Internal Failure Appraisal Appraisal 18 16 14 12 Prevention Year External Failure External Failure 10 Internal Failure Internal Failure Prevention McGraw-Hill/Irwin Quality reports can also be prepared in graphic form Quality Cost as a Percentage of Sales Appraisal Appraisal Prevention Prevention Year Copyright © 2006, The McGraw-Hill Companies, Inc Uses of Quality Cost Information Help managers see the financial significance of defects Help managers identify the relative importance of the quality problems Help managers see whether their quality costs are poorly distributed McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Limitations of Quality Cost Information Simply measuring quality cost problems does not solve quality problems Results usually lag behind quality improvement programs The most important quality cost, lost sales, is often omitted from quality cost reports McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc ISO 9000 Standards ISO 9000 standards have become an international measure of quality To become ISO 9000 certified, a company must demonstrate: A quality control system is in use, and the system clearly defines an expected level of quality The system is fully operational and is backed up with detailed documentation of quality control procedures The intended level of quality is being achieved on a sustained basis McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc End of Chapter McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc
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