Complete Managerial Accounting Course 10 Hour Full Tutorial for Beginners

Welcome to our course in management accounting and welcome to module one. Whether your course is called management accounting, cost accounting, managerial accounting, you are in the right place. Those are all the same thing as far as I'm concerned. I'm college professor. I've been teaching management accounting for years and I'm so excited that you're with me today. So when start my class, we start just by talking about accounting generally. And actually hone in on financial accounting because all of my students will have already done financial accounting class. And ask them like why' we do that? Like why do why does financial accounting exist? And lot of students say, well, it's to do journal entries because obviously that's huge topic in financial accounting course. And some say, well, it's to produce financial statements. And think they're right, but also want to know the who. Like who's using this stuff? Why do have to make an income statement, balance sheet, statement of cash flow? Who am doing it for? And then students will often raise their hands and say, well, we do it for investors, of course. And certainly investors are an interested party and investors observe the financial reports and they make decisions, right? They decide whether they want to buy the stock or sell the stock or short the stock, whatever. They make decisions about buying and selling shares. So, definitely yes. But say, well, wait minute. own my own business tonybell.com my YouTube channel. don't have any investors. It's just me and don't produce financial reports for me. don't need to do that. And they say well what about the bank right? You might have lenders and lenders will be very interested in your financial reports. And say that is very true but am debtree. don't have any lenders. So do need to make financial statements because don't have any investors? Well I'm the only investor. don't need to see my own financials. don't have any lenders. Do need financial statements? And the answer is yes, do because there's one more interested third party who's very interested in my financial results. Can you guess who I'm going to say? All right, enough enough suspense. the government. have to even if don't have investors, even if don't have lenders, got to produce financial reports for the government. Why? Because the government wants to tax. They want to take their 20% off the top. So, I'm obligated to make financial reports for the government. So, these are really the three key outside constituents who are interested in our financial reporting. And you'll notice they all have something in common. Whoa, that's an ugly little thing. But anyway, these are all outsiders to the company and they're all using my financial statements, my financial information to make decisions about the company, right? They're deciding whether to invest, whether to loan the company money, and how much to tax in the case of the government. So that's what financial accounting is all about. Financial accounting exists for the outsiders. So guess you're going to guess what my next step is because we're in management accounting class. Why does management or managerial accounting exist? Well, hope you're saying for the insiders. Managerial accounting exists. For I'm bad at drawing these things. for the insiders and the investor, the banker, the government, they're making decisions about the company. Insiders are making decisions for the company. And they need very different information. They have very different information needs. So want to work on this table and just discuss the like needs of these users and the differences between financial and managerial accounting. So we've said the who financial accounting interested in supplying information for outsiders, people outside the business. Managerial accounting interested in providing information for people inside the business. And we also said the types of decisions. Outsiders are making decisions about your company, about the company again, whether to invest, whether to lend, how much to tax. Insiders are making decisions for the company. And let's talk about the types of decisions manager might make. Let's say I'm the manager of an Apple store in downtown Vancouver, British Columbia, Canada. I'm in British Columbia, Canada. Now, some people will hear that and they go, no. This guy's teaching me Canadian accounting." Management accounting is universal. You don't need to worry about, it's if you're in the US, if you are in Europe, Asia, Africa, wherever you are in the world, this stuff will apply. And it's very much universal concept. so, I'm the manager of an Apple store in Vancouver, Canada, and decide one day want to move the display of iPads from the back of the store to the front of the store. decide, okay, iPads are going to the front and the headphones are going to the back. Well, that's decision might make as manager because just, it's my gut feeling. iPads belong at the front. can track that decision through data, right? can get sales data on my iPad sales versus my headphone sales and can say well before made the change this was the sales after made the change this was the sales. Was this good decision or was this bad decision? That would be very much using managerial accounting data to make decision for the company. Should keep it going or should switch back? Right? Like that that's decision might make. could make staffing decisions based on that. you know, can use accounting data to determine, this person hasn't missed day of work in year. Maybe they deserve reward, right? At the annual party, I'm going to specially remark on on an employees performance, and use accounting data to do that. So, that's managerial accounting. Now, the investor, they don't really care that the Vancouver, Canada manager put the iPads at the front or the back. They want to know did Apple make $98 billion and was their earnings per share above $355 this quarter. that's what they're interested in, right? They don't care what happened in one specific store in one specific city in one specific province in one specific country in the world. They want the whole thing and they want to say how's Apple doing big picture. The insider, they don't care the big picture. They want to know, the iPad sales in my location are up or down, right? Very specific data. So, the scope here is totally different. Outsiders want to get information about the whole company. Insiders want segment information. I'm going to say small segment even, right? Like they just want their specific area and maybe even just sub area within it. They don't even want the whole Vancouver store. They want to know iPad Pro within the Vancouver downtown location, right? Like they're they're not even interested in iPhone sales or something like this. so very much smaller segment. because of the nature of who the outsiders are, bankers, investors, government, and because they're not part of the company, standard setters have said they need to be protected. And how do they get protected? We're going to put rules on how you make your financial reports. Your financial reports have to be consistent from one company to another. Apple can't report one way and have Google reporting totally different way. The companies have to follow generally accepted accounting principles. GAP, whether that be US GAAP, Canadian GAP, IFRS, or some other rule. And if they're going to be on financial stock markets, they have to follow SEC rules, right? Or stock exchange rules. so yeah, there's lots of rules to be followed and I'm just going to say strict, right? Like the rules are fairly strict around financial accounting. Well, what about managerial accounting? There's no rule that says, "Hey, when the manager moves the iPads from the back of the store to the front of the store to see how they're going to sell, there's no rule they have to follow up on that. There's no obligation to do any of that. They don't have to track any data. The manager can just say, feel like that's going to be better." and they move them to the front and they go, think it was better and they don't have to look at any data. There's no obligation. So, I'm going to say loose rules here. Now, my goodness, my writing of the word loose. So, maybe I'll say no obligation to even use management accounting data. So, the rules here are loose. Maybe optional would be better way of saying it because you don't have to follow up and check the data or the sales better or worse. You don't have to do budgeting or planning or performance management to see how your company is doing or to see how your little segment within the company's doing, but you should and that's what this course is all about, right? It's all about tracking those small microlevel decisions. How about the timing? Well, financial accounting because of its nature, because we need to have reliable information because we're protecting those outsiders because of who the users are, we need to protect them. And so, because of that, we want reliable numbers. And if you want reliable numbers, you got to be talking about the past. You got to be talking about stuff that already happened. So, when you look at financial accounting, it's about last month, last year, last quarter, right? It's it's all set in the past. Managerial accounting is often about the future. It's about our plans for next month. we think we're going to bring these in next month. You're you're budgeting, you're planning, you're predicting the future. It can also be about the present. What are we doing today? And it can involve the past, but future is like pretty key feature in management accounting because it's about making your plan. next month I'm going to bring in extra iPads. I'm going to set them up at the front. I'm going to make new display. Okay. Well, I'm planning for the future. Then when it happens, in the present got to execute and then look back on it month from now and see did it work. And that's sort of looking at the past. So, it's future, present, and past. But big focus actually on the future here. what about reporting? Well, the financial reporting, financial accounting reporting is delayed. It's slow. And what does that mean? Well, let's say know Apple's year end isn't December 31st. Let's pretend it is. So, Apple's fiscal year end, let's say, is December 31st. So, they want to prepare financial reports. Well, it takes couple of weeks for them to clean up their year end. Then, KPMG or Deote or PWC, their auditor comes out and audits their financial statements, and it's going to be three to six weeks, maybe even more, before they're telling shareholders anything about the numbers. So financial reports, you're learning what happened month ago, two months ago, three months ago. You're learning about the past tense and it can be like the distant past. Managerial accounting information you get immediately in the moment. If move those iPads up to the front of the store, know today how's it working today? Right? You you might want to wait little bit and know, okay, well, how was it week or month later, but you can get data on day one. It is immediate. And so I'll just say fast or faster, right? depending on the company. Okay. So those are key differences between financial and managerial accounting and that's going to be cornerstone of chapter one of any managerial accounting class. Other major topic we are going to cover in chapter 1. We talked about you know it's called management accounting. When took this class 20 years ago it was called cost accounting. big topic of conversation in chapters one, two, three, four, think maybe even chapter five is cost. How much stuff costs. So, it's quirky tricky concept and it's trickier than you might think. But we'll address that in future videos in this chapter and in future chapters. The best way though, the absolute best way to do accounting, the best way to learn accounting is to do lots and lots of problems. So in our next video, it's problem on financial versus managerial accounting and in future videos. In this chapter, it's problems on costs and figuring out cost of goods manufactured and cost of goods sold. But we'll worry about that in future video as we're working through problems together. I'm so happy you're here. I'm thrilled you're with me. think it's going to be great journey together and can't wait to see you in the next video. Bye for now. Let's run through problem 11A, financial versus managerial accounting. Here we are. The first question of this new workbook. I'm so excited and happy to be with you. we're asked to distinguish between what is financial accounting activity and management or managerial accounting activity. And let's remember the big picture. Financial accounting concerned with those outside users. The outside users want big picture financial statements. big picture reliable financial statements. Insiders want segmented planning financial information. So, let's see how we do. preparing staffing budget. Okay. Well, if I'm buying Apple stock, don't care who's working next Tuesday at the Apple store in my city. want the big picture stuff. So, this is clearly management accounting report, right? Like this is management would be interested in that. Preparing cash flow statement. Yeah. As an investor, want to know their cash flows. This is financial accounting report. Preparing year-end adjusting journal entries. Journal entries serve financial statements. That is usually financial accounting activity and this certainly would be that preparing bid on future contract. Okay. So, bidding it's about the future. Something might happen, might not happen. Financial accounting is all about what already happened. Reporting what happened. bidding about something in the future is like well you need accounting information but it is about the future. This is management accounting activity. preparing the management discussion and analysis section of the annual report. This one's funny one because people read the word management and they go management it's got to be management accounting. It's not the annual report. So managers know what they're going to do and they make internal plans. The management discussion analysis section of the annual report is like I've got to report my plans to the investor, the banker, the government, the people that are reviewing my financial statements, those outsiders. So this section is section of the annual report prepared for the outside users. So again, the annual reports all about the outsiders. Insiders don't really use the annual report that heavily. So this would be absolutely financial accounting. And there we've done it. We've solved 118. Look at that. twominut problem. There won't be many of these this chapter. So enjoy. Luxuriate in our very short problem and I'll see you in the next one. Thanks for watching. Bye-bye. The problems for my videos can be downloaded from my website tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's jump into problem 2A. This has us identifying costs and going over some cost concepts. It says the following are costs of big rig trucks manufacturer of large diesel vehicles and there's list of costs and says for each cost identify whether it's variable or fixed now it dawns on me as start the problem we haven't introduced these concepts so I'm going to briefly introduce them if you feel like know variable or fixed know product and period and know material labor overhead selling and min and R&D if you know all those terms like and you're good at them skip ahead about three minutes till I'm making like X's in this table But if you're little shaky, think this will be very useful to you. promise it will be, in fact. So, first talking about variable and fixed, fairly straightforward concept. We're making trucks. great example of fixed cost is property tax. So, let's say our property tax for our factory is $10,000. If make hundred extra trucks, my property tax is still $10,000. My property tax doesn't change just because made more trucks. Now, let's say there's airbags in every truck. Well, my airbag cost changes with every truck. Every truck gets more airbags. And would expect my airbag cost if made hundred more trucks, well, guess what? I'm going to have 100 more airbags or more than that, and that's cost will rise with the trucks. So, variable cost changes the more trucks make. Fixed cost stays the same. Probably you knew that. But the next category might be little shakier for some people, and it's really worth diving into. product cost is factory cost. It's cost of making the product, right? And that should make some logical sense. So, it's cost involved in the always call it in the factory. That's how want you thinking of it. Now, it could be if you make burger as we'll discuss in minute. it's kitchen cost like wherever you make the product, it's cost associated with running that building essentially running that production. period costs are outside of the factory. So the factory costs include material, direct material, direct labor, and manufacturing overhead. And you're going to see me use these abbreviations all class. DM, direct material, DL, direct labor, MO, manufacturing overhead. And let's just discuss that in terms of making our burger. always put this up and ask my students, well, what's the direct material of making the burger? And every student gets it right. You're probably getting it right at home right now. Can you guess what are the direct material costs of making burger? Well, let's see. have some pictures here. Yeah, these are the typical direct material costs of making burger. We got the meat, we got the cheese, we got the tomato, we got the bun, there see some lettuce in there. You know, those are the direct material costs. And these are pretty obvious and in fact very easy to track, right? can say, well, there's, you know, $1 worth of meat in every burger. There's 25 cents worth of cheese in every burger. like you can even cost it out and you don't have to be an accounting wizard to like get close with your material cost. So that's material and we could do the tomato and the bun as well and figure out well what's the material cost in our burger and again be pretty close. The next category of cost is the labor cost and that's the cook's cost for the time they're making the burger. So, let's say the cook makes $20 an hour and they make the burger for six minutes, say, so 10% of an hour. Well, the cook's cost on that burger is $2, right? The cook spent six minutes. That's 10% of an hour. Their wage is $20 an hour. It's it's about $2 worth of chef's cost that we track to the burger. And we call this cost direct labor. Now, when they're working on different food or when they're cleaning the store, when they're sitting there looking at their phone, not direct labor. But when they're cooking the burger, that time is direct labor cost. The third category of cost, this is our overhead cost. We call these indirect factory costs. So if want to cook burgers, if want to have kitchen, got to have gas for the stove, right? got to heat the grill or whatever that utility cost is. Now, how many dollars worth of gas went into that one burger? don't know. It's hard to figure out. got to keep the lights on, right? can't have kitchen that's like in the dark. So, there's there's lights in the ceiling. got to pay the utilities on those lights. How many dollars worth of lighting went into that burger? don't know. got to keep clean kitchen. got to buy cleaning supplies and use them every day in the kitchen. How many dollars worth of Mr. Clean or whatever cleaning implement use? How many dollars worth of cleaning supply went into the burger? don't know. That is overhead. And in fact, overhead is where we're going to spend ton of the early part of this course cuz material and labor you can figure out like you don't need your accounting degree to figure out there's dollar worth of beef in this burger. You know what you paid for it. You know how much you put in. It's not complicated. Labor, you just know how long it takes cook to make the burger and you do some math on their hourly wage and okay, that's how much wage went into this. How much heat and electricity went into this burger? that's different proposition and that we spend lot of time on. So wanted to introduce that concept here. will be introducing this again in future videos. You'll see this explanation come up but think this is our first time discussing so thought it was worth spending the extra minute or two. selling admin and R&D are our period categories and these are outside of the factory. So selling, think of advertising or marketing. Think of salespeople's salaries and delivery costs are key part of selling. Administrative costs always think of as office costs or business related costs. So president's salary or the president's you know secretary or personal assistant. those costs or you know accounting office those costs those would be admin costs. R&D researching new product. We are spending money to make new product line or improve our product line. That's an R&D cost. And again, that's not factory cost. Okay, now that was enough preamble. Let's jump into it. Aluminum used in manufacturing each truck's body. Okay, so aluminum pretty core part of the truck. If made 10% more trucks, if made, you know, 100 more trucks, am going to use more aluminum? The answer is yes, absolutely. And if make 100 fewer trucks, I'll use less aluminum. This is variable, right? It varies with the amount of trucks make. Is this product cost? Is aluminum going into the truck? Yes. Is it material, labor, or over? This is material. So, fairly straightforward one to start us off. Let's move on to the factory supervisor salary. This one's less straightforward. I'm here to tell you, you read the word salary. Your assumption should be fixed. It's not always the case, but it should be the assumption should be fixed. If we made, you know, let's say 10% more trucks, am paying my factory supervisor more? Presumably not, right? They have an $80,000 year salary. If they make 10% more trucks or 10% fewer trucks, their salary is going to be their salary. product or period? well, did it happen in the factory? You'll hear me ask that question lot. If it happened in the factory, assume product. If it happened outside of the factory, assume period. The factory supervisor salary happened in the factory. So we assume product. Is it material? No. Is it labor? Well, kind of. Is it overhead? Maybe. Let's debate and discuss. If the factory supervisor is putting their hands on the product, we would call it direct labor. Direct labor is the cost of the person who's spending time putting their hands on the product. The name supervisor suggests to me they're not very hands-on. Maybe they troubleshoot and solve problems. they're supervising other people who have their hands on the product. If that's the case, and that's most likely the case since they're supervisor, we would call them an indirect factory cost. We would call them overhead. They're not having their hands on the product. Number three, company president salary. Again, salary. My is fixed. If made 10% more trucks or if made one more truck, don't pay the president more money. If made one fewer truck, don't pay the president less money. Salary is fixed. product or period. President's in an office somewhere. They're not in the factory. it's period and it's business cost. This is admin. This is president's an administrator. This is an admin cost. Let's continue. think put that on the wrong line. four cleaning supplies used for daily cleanup. Okay, let's say made couple extra truck trucks today. Do spend more on cleanup? Probably not. This is probably fixed, right? clean up once day. whether made 10 trucks or 20 trucks that day. would call this fixed. If you know the business better and you go, "No, it's actually goes up and down the more trucks," then make it variable. But my assumption would be fixed reading this. And so, but if it's real company and you know, then then you make it whatever it should be. But think fixed makes most sense here. is this in the factory? I'm going to assume yes. They didn't say office cleaning expenses. If it was office, we would call it admin. But assume this is cleanup of the factory, in which case we call it product. Is this direct material? No. The the cleaning supplies don't go into the truck. It's not part of the truck. Is it labor? No. It's got to be indirect. It's overhead. Wages of workers who build the engines. This is another source of frequent debate in my class, but I'm here to tell you wages of workers building the engines. This is variable cost in every intro accounting course, intro management accounting course. And the idea is if you're making more trucks, you're going to be spending more on labor. If you make fewer trucks, you're going to spend less on your labor. You're bringing in more people as you get busier. You're bringing in fewer people, giving fewer shifts as you are less busy. Wages are generally assumed to be variable, particularly wages of frontline workers, which again is debatable. And know sort of opens political discussion that don't want to have today. So just read your textbook. You'll see they'll they'll call wages of workers variable. is it product cost? Yeah, they're building engines. And would call this direct labor cost for sure. Patent lawyer's cost. It doesn't matter if make more trucks, pay my patent lawyer the same thing. I'm patenting some new invention. Doesn't matter if you make one truck or 50 trucks, you're you're paying the patent lawyer the same. Or if you make an extra truck, right? There's no extra cost. product or period. Well, it's patent lawyer is not working in the factory. This is period. And would say patent lawyer is R&D. This is related to new product line, right? You're patenting something new presumably. That's what patent is. Accounting fees absolutely fixed. Doesn't matter if you make one or two new trucks or one or two fewer trucks. One or two more or one or two fewer. You're paying your accountant the same thing. Is there accountant working in the factory building the truck? No. They're outside of the factory. This is business cost. This is administrative. Shipping paid on deliveries to customers. You make more trucks, you're going to make more deliveries. You make fewer trucks, you're going to make fewer deliveries. This would be variable. The more trucks you make, the more you're spending on delivery. The less trucks you make. And it would be directly proportional. think variable is clearly the answer there. Is the shipping happening in the factory? No, it's happening outside of the factory. This is period cost and shipping, you will see this over and over again, is selling cost. All right, you've made it to the end. I've made it to the end. Thank you so much for watching, folks, and I'll see you in the next video. Thanks for watching. Bye-bye. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take look at problem 13A. This video will have us preparing schedule of cost of goods manufactured. I'm going to break it into three parts. Part two, we'll do the schedule of cost of goods sold and finally in part three, we'll do the income statement. But before we begin our schedule of cost of goods manufactured, think it's important to kind of take step back and think about what we are doing here. So, in intro financial accounting, we learned how to account for inventory from the perspective of retailer like Walmart. Walmart buy shoes from Nike for say $40. They sell it to their customer for $75. And we go sales $75, cost of goods sold $40 and and so on. Gross profit 35 guess in that case. now we're looking at inventory from the perspective of manufacturer, company that makes their own product and dealing with their inventories is little bit harder. So, few concepts before we can prepare our schedule of cost of goods manufactured that will be important to understand. One, if we're making product, let's say our product is the burger, there are three really crucial components to its cost. We got the meat, the cheese, the tomato, the bun. This would abbreviate to DM. Can you guess what DM stands for? DM stands for direct materials. And it's very easy to figure out, well, how many dollars worth of direct materials are in your burger? You just like, okay, got quarter pound of beef. That's dollar. got 25 cents worth of cheese. got, you know, however much worth of tomato and bun, right? it's very straightforward to do. You don't need to be sophisticated to figure out how much material cost went into your burger. the chef cost, we would call that DL. DL stands for direct labor. And this is also very straightforward to figure out. Well, okay, my chef, paid them $20 an hour. They worked on the burger for 15 minutes or 10 minutes, however long. And you just do math puzzle, right? you go, okay, well, there's, you know, $2 worth of wages or $3 worth of wages in this burger, right? The chef's time, and this is what pay the chef. Now, the final category is the trickiest. We call these indirect kitchen cost or indirect factory cost. If we're not making burgers, we're in factory. these indirect costs, like, you got to have gas to heat the grill. Well, how much gas went into the burger? Difficult to measure. or you got to have lights on to like so the chef can see what they're doing. How many dollars worth of lighting went into that burger? Very difficult. Cleaning supplies as well would be an important indirect cost. There's no cleaning supplies in the burger, but you need cleaning supplies to make burgers. And we call all of these indirect cost. So direct material, direct labor. These are indirect cost. We call them in our accounting class MO. And MO stands for manufacturing overhead. I'll call it overhead all the time for short. And what we learn is that the cost of product is the material, the labor, and the overhead. That's how you figure out how much product costs. And we spend good chunk of our course just trying to figure out how to deal with these indirect costs. That's the tricky bit. The material and labor are straightforward. The overhead little bit trickier. Okay, so that's premise one. hope you're hanging in there. The cost of the product is the cost of the material, the labor and the overhead. The second thing we want to introduce here and want you to think of like Boeing or Airbus. They manufacture these massive airplanes. Well, they have inventory and they sell airplanes. This would be inventory for them. But their inventory takes on three different forms. They have inventory that looks like this, right? Like that's stuff that they have that they're planning to resell eventually, which is the metal, the screws that they make into airplanes. And they call this their raw materials inventory. They also at any given time will have some halffinished airplanes because it takes months and months and months to build these massive airplanes. They're going to have some that are kind of started but not yet finished. So they're not raw materials anymore, but they're they're started. We call these sort of half-finished airplanes or halffinish products. We call them work in process. common misconception here is people call this work in progress. In accounting, we'll call it work in process. Sort of the half finished airplane. And that's different type of inventory. The final type of inventory is called finished goods. And so there's this flow of inventory. It goes from metal to half finishedish plane, work in process to finished goods, from raw material to work in process to finished goods inventory. And we'll follow that flow through in our course as we go on. So okay, two concepts so far. The cost of the product is the material, the labor and the overhead. The overhead being the tricky part. The second concept is, these companies that make their own product, their inventory goes through three phases. It's raw material, it's work in process, and it's finished good. the final concept, and this is useful calculation that's going to follow you through the course, is this calculation. So, let's say we're you know, bakery, right? We're we're baking cakes. And so our beginning raw material and and this is in dollars. Let's say we have, you know, fridge full of eggs and butter and sugar. Well, guess it's on the fridge flour. You know, we got supplies, baking supplies. That's our raw material. And we go out and count and we go, I've got $200 worth of baking supplies, you know, that I'm going to use in making cakes at any given time. That's what I've got." And during the the month, purchase $1,000 worth of baking supplies. go to Costco and buy $1,000 worth of, you know, again, eggs, sugar, that type of stuff. That's my purchases of raw materials. So, in total, have $1,200 of raw materials could possibly use during the period. But I'm not keeping track every day. used two eggs here. used one egg here. I'm just making this stuff. And at the end of the month, go out to my shelf and count and say, have $100 of raw material sitting in my shelf." Right? have $100 of raw material sitting there ready to go. Well, can infer, and this is the important part of the calculation. can infer from the fact that had $200 of material. bought a,000. So, had 1,200 ready to go. got hundred left over. How many dollars worth of raw material did use up? And the answer is must have used up $1,100 just filling in the blank. That calculation is going to follow us. We're going to be always adding beginning inventory and we're always going to be deducting ending inventory. And we do this calculation all over our accounting course. In fact, in this problem that we're about to do, we'll do this calculation three times. We do it with raw materials, we do it with work in process, and we do it with finished goods. So, it's calculation. You obviously we're just introducing it now. You don't have it locked in now, but after you've done few of these, you really want to have that calculation locked in. You're always adding beginning inventory. You're always deducting in ending inventory. That's enough preamble. Let's jump into the problem. So, it's problem 138. As with all my problems, tonybell.com, there'll be link below. There's no sign in, no sign up. You just click PDF and this will pop up. Outdoor Supplies Manufacturers Gear for Hunting and Camping. The company shows the following data related to its December 31st fiscal year. And there's big long list of accounts. It says, based on the information above, prepare schedule of cost of goods manufactured. We'll do that in this video. Schedule of cost of goods sold. That's next video. And two videos from now we'll do an income statement. Before we can do our schedule of cost of goods manufacturer though we kind of got to identify each account. So raw materials inventory will just annotate that as RM raw materials. Raw materials inventory December 31st. So it's beginning of the year end of the year raw materials. and and looking back to that previous calculation we just did. We're always thinking add beginning and deduct ending. That's what we're always doing here. whip, work in process. You'll hear me call work in process whip, just cuz that's what it looks like when you spell it out. And we got some finished goods. As you work through problems in your own textbook or in your own class, sometimes the the problem will like mix the inventories in with the other accounts. just put them all at the top, but you know, your professor may lay this out slightly differently from what have done. Okay. let's continue. So, direct labor. What is direct labor? And we say to ourselves, is it material, labor, or overhead? Is it selling or administrative costs? If if these jargon I'm saying right now is unfamiliar to you, we did problem 12A from our workbook. It's free open problem. You should work through that one. The jargon I'm giving out here will be familiar. Anyway, what is direct labor? Well, it's direct labor. It's in the name. factory supervisors wages. Okay. So, the question always ask myself is, did it happen in the factory? Well, yes. If it happened in the factory, is it direct labor or direct materials? We will argue in this class, supervisor's wages is not direct labor. They are observing other people doing the work. They're making sure the other people who are hands-on with the product are doing good job, but they're not hands-on themselves. So, if that's the case, they're not direct labor. They're certainly not direct materials. They must be overhead. Those are the three options here for costs in our factory. Material, labor or overhead. So that's overhead. Company president salary. Well, the president is not in the factory. so it's not material labor overhead. It's then going to be selling or administrative admin. Think of as office costs. Selling think of salespeople related costs. president salary. This is this is an office cost. This is an administrator. So this is admin purchases of raw materials. This is related to raw material direct material depreciation 60% factory 40% office. Okay, let's break this down little bit. 60% This is going to be maybe I'll zoom in bit. 60% of 240. Where's my calculator? can't do that math in my head. 6 * 240 is $144,000. $144,000 of depreciation relates to the factory. So, did it happen in the factory? Yes. Is it direct material? No. Is it direct labor? No. It's overhead. So, 144K is overhead. and the rest which can't do the math in my head 240 * 04 40% is office well office is admin so 96k of this is an admin cost now admin costs show up on the income statement as expenses overhead costs show up as product costs and they go into cost of goods manufactured and cost of goods sold as we will soon see property taxes okay this one can do in my head 80% factory fac. It's $20,000. 16, right? $16,000. Is the 80% relate to the factory? So, did it happen in the factory? Yes. Is it material? No. Is this labor? No. This is overhead. Overhead's kind of like catchall, right? Material and labor should be pretty obvious if you're don't know what this company does, but you know, you imagine bakery like the material is eggs and buns and flour and direct labor is wages of person who works on the product. Everything else is overhead, right? Everything else in the kitchen is overhead. So overhead gets lot of stuff going through it. so 16k to overhead, 20% office, 4k and that's admin, right? We had said that office costs are admin costs. Sales commissions. Okay. Does sales commissions happen in the factory? No, we don't do our selling in the factory. so what is that then? It's either selling or admin. Well, hope you're saying selling. Sell. repairs and maintenance 100% relates to the factory. Okay. So, did it happen in the factory? Yes. Is it material or is it labor? No. It's got to be overhead. Utilities expense 90% factory, 10% office. All right. Well, again, the stuff in the factory, that's 27K in the factory. Did it happen in the factory? Yes. Is it material or labor? No. Then it's overhead. 10% office happened in the office. That is going to be administrative. sales revenue is just revenue. We just sort of treat that separately. We'll it'll find its way onto the income statement. Advertising. What is advertising? It's an expense and it is selling expense, right? You don't do advertising inside the factory. It's not factory cost. It's something else and it's selling cost. Okay. At that point, we have identified all our accounts. Now, we are at long last 14 minutes in ready to prepare our schedule of cost of goods manufactured. Worry not though, we'll we'll get through this in well, you'll see the time stamp probably in the next 10 minutes or so. let's get to it though. all financial statements get beautiful threeline title. If you've taken an accounting class with me, you know this. Outdoor supplies, name of our company. I'd like this to be notch thicker. I'm going to just change my pen. Let's see. Pen properties. One notch up. got to change this one, too. Okay. outdoor supplies and we are asked to prepare schedule of cost of goods manufactured. And what schedule of cost of goods manufactured is is it just tells us the material labor and overhead that we used in making the product. So, it's the product cost, right? We said material, labor, and overhead. Those are the product costs. got to date this. And so, this is for the year ended December 31st. Now, many of these will be for the month ended and some will be for the quarter ended. So, you just have to read carefully. But the fact that we got January to December is giveaway that this is fiscal year end report that we're being asked to prepare. So the starting point is material. We want to figure out the material we used, the labor we used, and the overhead we used. So we start with our raw materials inventory on at the beginning of the year, beginning inventory Jan 1st. And it's actually this calculation that showed you down here. come on up here. This is the calculation. So, beginning raw materials, add purchases, we'll sub total raw materials available minus ending inventory tells us the raw materials we used. So, we're putting that formula to good use immediately. So, our raw materials on January 1st, $14,000, the top number in the table. We're going to add purchases. We purchased $425,000 of raw materials. Let's subtotal. Our subtotal is called raw materials available for use. And allow my students just to say raw materials available. So 14 plus 425 is 439. We're going to deduct raw materials on December 31st, our ending inventory. And our December 31st was 17,000. 439US 17 is 422. We put this total on the la on the right. This is very key number. This is our raw materials used in production. Again, allow my students to shorthand that and just say raw materials used. So, we used $422,000 worth of material. Well, again, really important to know how much material, labor, and overhead you expended in period because that tells you what your cost of goods is. Cuz we're not Walmart just buying good that's already finished, right? Walmart, when they buy shoes from Nike, they're not buying cotton or whatever, you know, polyester. They're buying shoes that are already done. Our company's buying raw materials and turning them into finished goods. So, we got to track costs little differently. So, our raw materials 422. What about our labor cost? And see it right here. Our direct labor is 275. Generally speaking, in these questions, you are just given direct labor as single line item. It can come sort of in multiple pieces, but generally speaking, you'll just be given labor or frontline worker wages, some line like that. This one just gave us labor. Well, what if overhead then? So, we said material, labor, and overhead. Those are the costs of the product. Well, now we're on to overhead. We just have to list our overhead costs. And our overhead costs are all the ones we highlighted as Mo. In fact, I'm going to highlight them little further here. We got the factory supervisor wages. We got depreciation which was 144 to be clear in the factory. We got property tax which was 16 in the factory. We got utilities which was 27. almost missed repairs and maintenance. And think that's it. got 1 2 3 4 five. So I'm going to have five line items here under overhead. just list them out. factory supervisors wages and I'm going to list on the left and total on the right. So, 64,000 depreciation which is 144 for MO. For whatever reason, like to work write the word expense. You don't have to, though. property tax 16. repairs and maintenance 15. Some props are very particular here. They might not like even seeing an and symbol. So be careful. Just depends on how particular your prof is. And utilities are 27. Okay, let's add up our overhead cost. 64 + 144 + 16 + 15 + 27, we land on 266, 266,000. That's our total MO, total manufacturing overhead for the period. All right, we said the total cost of product is the material plus the labor plus the overhead. So this is the key total, right? We got the material, we got the labor, we got the overhead. We call this our total manufacturing cost. 422 + 275 + 266, it's $963,000. Now, it's funny thing because you might think, I'm done. That's my manufacturing cost. I'm doing cost of goods manufactured. There's one more step and it's those halffinished goods. It's that work in process inventory. Because if end with some half-finish goods, which did, $20,000, those goods were not manufactured, right? We're looking for the cost of goods manufactured. Well, those $20,000 are unfinished. spent material, labor, and overhead costs on them, but shouldn't count them as goods that manufactured because they're not done yet. So, got to take out the 20. And in fact, got to add the opening inventory because that's from last year. And did finish manufacturing those this year. So remember what said. We're always adding beginning inventory, deducting ending inventory. That's what we're going to do for whip. And then we'll finish this. So we take our manufacturing cost, we add whip inventory Jan 1. We add our beginning whip which was 31,000. We subtotal and just call this subtotal. I've never seen name for this. just call it subtotal. like our subtotal up here was called raw materials available for use down here subtotal. 963 + 31 $994,000. and we're going to deduct our ending whip whip inventory December 31st and our December 31st work in process inventory was $20,000. So 994 minus 20 is $974. And at long last, we've made it to our cost of goods manufactured. And that's what this schedule was all about. So it said, how much did it cost us to make whatever it is that we make? And the answer is we spent $974,000 making goods that would become finished goods. Right? We we spent $974,000 manufacturing our goods during this year. Now, it's still financial statement. We need double underlines at the bottom. We need dollar sign at the top of each column and dollar sign beside anything double underlined. So, I'm expecting to see three dollar signs on this statement. And at that point, we've got ourselves beautiful, hopefully you think it's beautiful. think it's beautiful schedule of cost of goods manufactured. All right, thanks so much for watching. Hit the thumbs up and stay tuned for the next video when we go on and prepare and this will be much shorter, schedule of cost of goods sold. Thanks for watching. See you in the next video. Bye-bye. Welcome back. We've been working through problem 13A and we've just completed our schedule of cost of goods manufactured. The next step in this problem, as you can see, is to prepare. We've done the schedule of cost of goods manufactured. We're asked to do schedule of cost of goods sold. This expect to be short video, but we'll see. we need threeline title before we jump into it. So, name of the company, Outdoor Supplies, name of the financial statement, schedule of cost of goods sold, and then the date. And it's just the same as the one above. So for the year ended and then the date. Now again your question might be for month end or for quarter end but this one was for the year ended December 31st. Okay. The schedule of cost of goods sold says well this is the stuff made right. spent $974,000 making stuff. Did sell all of it? And the answer is, well, if have any finished goods inventory, no. Right? Because we have these three inventory streams we introduced last video. And what we said was, well, our finished goods inventory started at 84 and our finished goods inventory ended at 68. Well, if end the period with 68,000, obviously didn't sell everything made because have some left over. So, we do that little calculation I've been telling you about with inventory. We're adding beginning inventory and we're deducting inventory, ending inventory. So, let's get to it. we start with our beginning inventory. So, we start with finished goods inventory at the beginning of the year, which was January 1st. We're going to add that number. That's positive number. $84,000. We're going to add that to our cost of goods manufactured. That's $974,000. 84 + 974 is think that's 1058, but I'm going to double check here. 84 + 974. 1058. Okay, good. This is called our goods available for sale. AALable for sale. Now, let's again think about what that means. At the end of last year, had $84,000 worth of stuff like on the shelf, ready to be sold. It was finished. It was not under manufactured. It was ready to go, but it was unsold. This year, made $974,000 worth of new finished goods. So, in total, got over million worth of stuff available to be sold. Did sell out? No. How do know didn't sell all million? Well, because we have ending finished goods inventory. We must have, and this is where we infer something, we must have sold some of the inventory because we're sitting down at 68,000. So, we deduct, and this is that calculation we do over and over again here. We deduct ending finished goods inventory. And actually, shouldn't say ending, should say finished goods inventory December 31st. Same difference, though. And forgot the amount because was distracted there. 68,000. So 1058US 68 is 990. And that is our cost of goods sold. Dollar sign at the top, dollar sign at the bottom. Make sure the bottom line is double underlined. And we've got beautiful schedule of cost of goods sold. Let's just go over what it means one last time. We started with $84,000 in finished goods that were ready to be sold. That's what we started the year with. We hadn't sold them yet. We made during the year $974,000 worth of stuff. Meaning if sold out of everything, could have possibly sold million58,000 worth of my finished goods. know didn't sell million58,000. Why? Because had ending inventory of 68,000. So, because know had a,58 ready to sell, I'm left with 68,000. can work backwards to say, well, must have sold 990. My cost of goods sold is $990,000. And as you know from preparing income statements in the past, cost of goods sold is very important number in the financial statements. We'll prepare the income statement in the next video, though. So, hit the like button, hit the subscribe button, and stay tuned for the next video. Thanks for watching. Bye-bye. Welcome back. We have been working through problem 13A. We've completed beautiful schedule of cost of goods manufactured. blew out my microphone when said that. We've completed beautiful schedule of cost of goods manufactured. Summarizes the material, labor, and overhead usage during period. We've computed beautiful schedule of cost of goods sold. And now we're on to the last part, the income statement. It says, "Prepare an income statement assuming tax rate of 20%." So there's going to be some income taxes, and those weren't provided for up above, but we'll do some calculations at the end. So let's prepare our income statement. As always, you know, income statement is the summary of revenues and expenses, but we have to do it in logical way. And that logical way starts with title. Name of our company, Outdoor Supplies. Outdoor Supplies. name of our financial statement, income statement. This can also be called statement of operations, but like good old income statement. And this gets dated the exact same as our others for the year ended. And then the date, December 31st. Okay, this is going to start for any manufacturer of products. It's going to start with sales revenue. Now, there's things that can make it more complicated, net sales and things like this, but with for us, sales revenue is reasonable starting point. And you can see the sales revenue there, $2,50,000. The next line down after sales is always cost of goods sold, which we frequently abbreviate as COGS. Our cost of goods sold comes from the schedule of cost of goods sold. Our cost of goods sold here was $990,000. Sales minus COGS is gross profit, also called gross margin, but we're going to call it gross profit here today. and in my class, 2050 minus 99.90 is 1060. So our gross profit here is 1060. And that like if you're merchandi, you you sell like you manufacture stuff, people who run the company will stare at these numbers and they'll be like, our gross profits are up by half percent or they're down by percent, right? They obsess over these numbers. These are very important numbers to business and that's why we spend so much time just coming up with cogs, right? Like two big financial statements to come up with cost of goods sold. Okay, on to the expenses portion. So sales minus cost of goods sold is gross profit. Then in our if you took intro financial accounting we would call the next section operating expenses. In our management accounting class it's essentially the same section. We're going to call this selling and admin expenses. It's essentially the same category. You can think of these pretty much in the same way. And so we just go to our our table here. And hopefully my hopefully my eraser can take away some of these highlights. Yeah, I'm going to highlight all of the selling and admin costs. So I'm just looking for the word selling or admin. So got the president's salary there as admin. got depreciation which has some admin element to it. have property taxes which again have little bit of min. got sales commissions admin. got utilities with some admin and have advertising which is selling cost. think that's it. don't think I'm missing any. So got one two three four five six selling and admin costs. We just have to write them all out. So president's salary expense. We'll start there. Now on income statements really like my students to use the word expense for all the expenses. So, president salary expense and the president salary expense was $120,000. We're going to list on the left and we're going to total on the right here. depreciation expense 96,000. property taxes 4,000. feel like missed one. Let's see. Did miss one? no, didn't miss any. Sales commissions 98,000. Utilities 30,000 and advertising 215. Okay, so that's all of my expenses. Just make sure got them all. think so. Wow, it's flipped back down there. didn't touch anything. It's zooming me back down. It knows we're supposed to be here. Okay, let's add this up. 120 + 96 + 4 + 98 + 3 + 215. My total selling and admin expenses are $536,000. All right. And now hope you're guessing what to do next. And it's amazing to me how frequently students miss this subtotal. It's gross profit minus selling an admin is going to equal income before tax. Income before tax, pre-tax profit. So 1060US is 524. $524,000. okay. Next step up is to calculate our income tax expense. Now, hope you remembered from the start of this video, we said the tax rate was 20%, so we just take 20% from pre-tax profit here. 524 times.2 two 104800 and income before tax minus income tax expense brings us to very important number. The profit we call profit of course net income. How much money did they make? 524 minus 104800 equals 419200. That is our net income. That's how much money this company made. So, we got beautiful income statement. We need dollar signs. So, dollar sign at the top of each column. There's going to be two columns and dollar sign beside anything double underlined. And the bottom line, the net income is always double underlined. At that point, we've completed the problem. We were asked to prepare schedule of cost of goods manufactured. Done. schedule of cost of goods sold. Done. And an income statement done. And we're asked to do one last thing. We're asked to hit the thumbs up button on our way out of here. Thanks for watching. hope these videos help. That's why make them. If they help you, hope you'll help me with some of those thumbs. Have great day. Bye for now. Welcome to module two of our course in management accounting. This is all about job order costing. big chunk of the first part of our course is on just how much stuff costs. So, you'll remember this. hope you'll remember this. We said that there's really three fundamental components to product's cost. the material, the labor, and the overhead. So, when we look at our burger, the cost of the meat, the cheese, the tomato, the bun, we would call these all direct material cost. And the good news about materials is it's pretty straightforward. In the moment, know my actual materials cost because went to the store, bought the ground beef, know that there's, you know, it's quarter pound of beef and it cost me dollar in beef. know the cheese slices that use cost 25 cents. So, use 25 cents worth of cheese. Maybe use 15 cents worth of tomato and let's say 10 cents worth of bun. So, in total, used buck 50, a$150 of material. And you would know that the second you make the burger. You go, okay, there's $150 material. you might be off by, you know, might have used few extra grams of beef in this one and few fewer grams of beef in that one, but you're going to be pretty darn close. And you just use your actual numbers. So, it's pretty straightforward. Labor also straightforward. You just use the actual labor cost. And how do you do it? You time how long it took to do the job. So, let's say the chef is paid $20 per hour and they took six minutes to make the burger. Well, how much labor is in that burger? Well, you go, okay, it was six minutes. That's 10% of an hour, and their wage is $20 an hour. $20 time 10%, it's $2 of labor in the burger. It's trickier, of course, in real life where the chef's doing like eight jobs at once. But, you know, you could make reasonable estimate here and say, okay, this is 10% of an hour. We pay $20 an hour. Therefore, 10% of $20 is $2 in direct labor. And that's the actual amount that pay the chef. What is harder is those indirect costs, which we called overhead costs, manufacturing overhead costs. And we said, "Okay, well, got to keep the lights on. got to keep the air conditioner on. got to pay utilities. How many dollars worth of my monthly utilities bill went into that one burger?" One of many things I'm going to make. This is much harder proposition. And that is the fundamental question of this chapter. Now we the truth is we don't know. And so we have to make an estimate. Now the estimate there's some specific jargon here. We say well we use the actual material we use the actual labor. With overhead we make an estimate and we say we apply the estimate. So it's applied overhead. You'll read that word. You'll hear that term all through. and just the estimated amount of overhead that we're going to include in the burger's cost. But how do make that estimate? That's again fundamental concept of of costing. And the way we would do it, the default way to do it is called using something called predetermined overhead rate. So before the year, you would estimate your total overhead cost for the year. So, the cost of utilities in the kitchen, the cost of supplies in the kitchen, the cost of depreciation of kitchen equipment, and all of those overhead costs we listed out. And let's just say the company estimates all of its overhead costs, and it says there's going to be I'm going to say $100,000 of manufacturing overhead for the period. Okay? So, there's $100,000 of utilities and depreciation of equipment and supplies and all those other costs that that we consider to be overhead cost. We also estimate some driver of overhead. We say, well, what's some activity that we do that we think correlates to overhead? And can tell you the most common one you'll see in textbooks and certainly the one that would be appropriate for kitchen would be direct labor hours. So the more time you're spending working, the more time your frontline employees are spending working, the more overhead costs there are going to be because it just means you're open more, you're you're using more utilities, that type of thing, using more supplies. It certainly seems like it would correlate and it would be logical choice. So you choose something like that. The three very common options you see in an intro class are direct labor hours, direct labor cost, and machine hours. Those are the the most common ones. And machine hours for, you know, factories where there's not lot of direct labor, right? It's it's machined. So machine hours makes lot of sense for those contexts. So our company though, let's you know, it's mostly humans doing the work. and let's say we estimate that for the year there's going to be 4,000 direct labor hours. Okay, so we've got $100,000 divided by 4,000 direct labor hours. And this is before the year happens, right? It predetermined, so it's beforehand. We do the ratio and we go, okay, well, four 100,000 divided by four, it's $25 per direct labor hour. So, for every direct labor hour spend, estimate there's going to be $25 worth of overhead. And so, that's what we apply here. And the reason we have to apply it, the reason we can't just say, well, why don't just use the actual, why do have to use estimated numbers? Is you don't know the actual when you make the burger. Let's say it's July 15th, right? And it's very hot in your city and you've had the AC, the air conditioner, air con pumping and you go, my gosh, my utilities bill is going to be super high this month." Like that's what you would be thinking and you would know it was coming. You don't know what your utilities bill is going to be. And yet you just made the burger on July 15th and you know you used utilities whilst making that burger, but how many dollars worth of utilities went into the burger? You don't even know the actual amount of the utility. So you have to estimate. So we had said it's $25 per direct labor hour. And in the moment we know the burger took six minutes, 0.1 hours. And we know the rate. It's $25 per direct labor hour. Now, how do know it took six minutes? Because the chef timed it, right? We timed out the chef. It took the chef six minutes. We say, well, we applied at rate of $25 per hour, 0.1 hours. The manufacturing overhead cost in this job is going to be $250. So, what's the total cost of my burger? Well, the total cost of my burger is the material plus the labor plus the applied overhead. The total cost of my burger is $6. So, when turn around and charge my customer $10, know how much money it cost me. know how much money I'm making or losing on the deal and it's reasonable estimate. Now, you may be saying to yourself, wait minute, what happens if our applied overhead, because this was just guess at the end of the year, we tally up all of our overhead applied and we go, our actual overhead was way different from this because we were making an estimate. What happens when our estimate is bad? Well, we'll learn all about overapplied and underapplied, overestimated and underestimated overhead as the chapter goes on. But as with all things in accounting, the best way to learn is to learn by doing. In the next video, we'll go through examples. Thanks so much for being here and I'll see you in the next video. Bye for now. Let's take look at problem 21A. Job order versus process costing. in our textbook. Chapter two, we do job order costing. Chapter three, we do process costing. What you'll find is they're quite different. Job order costing is for when every customer is little bit different. Everybody has custom needs and we make the product for them to order. They tell us what they want and we make the product for them. In those cases, we have to use job order costing. Even though it's slower and less efficient, because every customer is different, they use different amount of labor hours. They use different amount of materials. Every customer needs tweaks just for them. Processed costing is when you walk into the store and you buy something out of package. They didn't make that just for you. They made those ramen noodles for everybody and just go grab whatever pack you want. Well, they don't have to say, "Well, package number one, this is our material labor and overhead and package number two, this is our material labor and overhead." can just go we made million packages we spent million dollars therefore our cost is dollar per package process costing way more efficient but it just doesn't work for lot of types of companies. So this question says should the company use job order costing i.e. do they make custom product or should they use process costing? Is their product more of one-sizefits-all? If you can get away with it, you would rather use process costing than job order costing. Let's go. so we're going to denote what's more appropriate. Job order with and process with company that does car repair. Somebody brings in their car, their car's got problem, you got to fix it. Every customer is different. Every customer needs different parts. Every customer needs different amount of labor. This has got to be custom job order. company that does architectural design. Well, even if you're designing like kind of one-sizefits-all product, you still every customer is going to be different, right? An architect's going to need to look at the lay of the land. Every customer is going to be different. This will be job order. Company that makes yoga mats. They're not making the yoga mat custom for me. go to the store, pick the yoga mat off the shelf, and you know, they're making hundreds and hundreds of yoga mats at time. This is process costing. company that gives immigration consulting advice. Well, my goodness, hope it's custom, right? If you are coming immigrating from one country, it might be different for from if you're immigrating from different country, you need custom advice. This would be job order costing. Company that refineses oil into gasoline. Well, when pump the gas, they didn't make that gas custom for me. This is process costing. An accounting firm, well, everybody's taxes are little bit different. you the accounting firm will spend different amount of times with different kinds of clients. This has got to be job order. Every job is different and has different costs. company that manufactures crayons, well, again, the pack of crayons is the end product. It costs the same no matter the customer. You're not making custom crayon packs presumably for your customer. So, this would be process costing. Company that makes designer handbags. don't know that much about designer handbags. If it was custom made for you, think it would be job order. But my impression of designer handbags, even fancy like Louis Vuitton or what is that fancy brag, Birkin bag, think is like the most fancy bags in the world. They're not made custom for their customer. The customer comes in and buys them. Uhhuh. think could be wrong about that, but in any event, my impression is even fancy designer handbag is ought to be using process costing. and they're making them dozens, maybe hundreds at time, without the final customer in mind, without customizations for that customer. If they're, if I'm wrong about that, if they're all custom, you can let me know in the comments. My impression is even fancy handbags are process costed or ought to be. okay, there we have it. We've solved 21A. Thanks for watching. See you in the next video. Bye-bye. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's examine problem 25B. Journal entries of job order costing two wonderful topics in one hopefully wonderful problem. You can download it. Tonybell.com. Click the PDF link. No signins, no login, no nothing. Let's go. Ace Cakes makes cakes and desserts for all festive occasions. The company uses job order costing system to allocate manufacturing overhead costs to jobs on the basis of direct labor cost. Again, many of our questions, we've done this on the basis of direct labor hours. This one is based on direct labor cost. What is that saying? It's saying our predetermined overhead rate estimated total overhead divided by the estimated driver of overhead. In this case, it's the estimated direct labor cost. And it further says the company anticipates its overhead costs for the upcoming year are going to be $150,000 and its direct labor cost expects to see direct labor costs of $500,000. So 150 divided by 500 gives us 0.3. What does that number even mean? It means for every dollar spend on labor, expect to spend 30 cents on overhead. Another way of putting it, if do job, you know, make some big batch of cupcakes or beautiful cake, guess, for customer and it cost me $100 in labor, add $30 as my guess for overhead because don't know the overhead in the minute. don't have my property tax bills. don't have my utilities bills for the month. There's lot of things don't know. So, estimate when do job, if it cost me $100 in labor, it's going to cost an additional $30 in overhead. That's what this is telling us. For every dollar spend on labor, expect to spend $.330 on over. That's what that means. The following costs were incurred or events rather occurred during the year. And there's through And it says first we're going to do journal entries for through So, let's get going and do journal entries for all of those items. If you're shaky on journal entries, search my name, Tony Bell, journal entry boot camp. think it'll be helpful to you. But let's jump into it. Purchase $250,000 of raw materials. Eggs, flour, sugar. That's the raw material of bakery on account. Okay, so we bought raw materials. Raw materials are an asset. We're going to debit raw materials inventory $250,000 and we're going to credit if we bought them on account and it didn't say here unless otherwise noted assume all transactions are on account. We're going to credit then accounts payable. If we had paid cash, we of course would credit cash. But here we're assuming everything's on account. Let's move on to purchased $11,000 of cleaning supplies on account. Debit cleaning supplies, which is almost like type of inventory, and we credit AP. Credit accounts payable for $11,000. Cleaning supplies are an asset until we use them up. Okay, on to And this is where things start to get interesting. Requisition, $240,000 of direct materials. So, eggs, flour, and sugar, and $10,000 of supplies for use in production. Okay, let me take big step back here. The the question is good question. wrote it, but the question think is good question. However, something confusing about this question is the company is not buying $250,000 of eggs, flour, sugar in one transaction. They're doing it couple times week, couple thousand dollars at time, right? They're not going to Costco and walking out with $200,000 worth of stuff. They're going to Costco twice week and walking out with a,000 and $2,000 worth of stuff. Still lot, but not hundreds of thousands of dollars. This is summary of what's happened. So requisition $240,000 worth of direct materials means we took the $240,000 out of our fridge and we started making cakes, right? We took $240,000 worth of eggs out of the fridge. We started making eggs again. We making cake. We do this thousand or $2,000 at time, you know, as we make cakes and batches of cupcakes or whatever it is that we are making. Fancy cakes for weddings, maybe. okay. So, what does that look like? Well, what we're saying is when it's sitting in the storage, you know, in refrigerator or pantry, we call it raw material. When we bring it into the kitchen, we start making batter out of it. We start making cakes out of it. It becomes work in process. So, when you requisition it, you're saying it's no longer raw material. I'm starting to work on it now. It's work in process. We debit whip inventory here for $240,000 and we credit raw materials inventory for $240,000. But wait, you say, what about the second part of the sentence? We not only requisition 240 grand of material, we also requisitioned $10,000 worth of supplies, cleaning supplies. What does that look like? Well, cleaning supplies don't go into the cakes and therefore they are not direct material in the cake. The the eggs, flour, and sugar that's goes into whip. Cleaning supplies goes into MO. They're an indirect factory cost. They are manufacturing overhead cost. We abbreviate that as Mo. so, debit Mo 10,000. And now they're no longer unused cleaning supplies. that asset has been used up. So, he credits cleaning supplies to say, don't have as much Mr. Clean or Windex or whatever it is used. I've used those up. So, credit cleaning supplies. On to Incurred employee costs, direct labor, indirect labor, admin salaries, salespeople's wages. All right. Direct costs go into work in process. So, direct material went into whip. Direct labor cost goes into whip inventory. Again, the the pastry chef who has their hands on the product while they're working on the product, we debit whip 450. Again, in no single day does somebody get paid 450 grand. This is all of my chefs for all of the year. And you know, would charge it every two weeks essentially. You know, I'm paying them. So, it just looks unusual. the number so big. These are summary journal entries for II indirect labor. So this is the cost of their wages while they're cleaning or setting up. You know, they're not actually making cakes. They're doing other stuff. That's indirect labor. That's overhead. Those are still kitchen costs. Those are still factory costs. The factory of our cake company is kitchen. But you know, these are still costs of the production area. And we call that overhead. Admin salaries. Those are office costs. Those are outside of the production area. Therefore, it's not material. It's not labor. It's not overhead. These get expensed. So, debit admin salaries expense for $200,000. Sales wages, same thing. Didn't happen in the factory. Therefore, we just debit the expense related to the item, 80,000 in this case. Let's total these up. 450 + 50 + 280 it's 780 in total. Oops, did that funny. don't want to draw line underneath. we credit though. we didn't pay it, right? Assume this is on account. And so if these are on account then it's salaries and wages payable. Now, don't get me wrong. We definitely would pay this every two weeks, but just for this journal entry purpose, credit salaries and wages payable or wages and salaries payable 780. Okay, let me move this stuff up because want to continue to work here beside the question. So, I'm just going to move those up to the top and we will keep going. So, we've just done We're on to Advertising. Advertising is 3,000. So on what is advertising? Is it material, labor, overhead? No, it's outside of the factory. Therefore, we just debit the expense or debit the appropriate account related to advertising and it's advertising expense. It's selling cost, of course. 3,000. Now, normally would think credit cash, but it's on account. So, credit AP for 3,000. On to property taxes. Okay. pay property tax is $10,000. 90% of the spa space is kitchen space. So 90% of our property tax applies to the kitchen. That's $9,000 in kitchen cost. Is it material? No. Is it labor? No. It's got to be over. Then it's indirect kitchen cost. 9,000. And what about the rest of it? Well, the 10% is office cost. You debit the sales office. guess you don't debit sales office expense or admin expense or selling expense. You debit property tax expense. That's something that students do get wrong from time to time. Property tax expense a,000 bucks. The credit here is to would expect probably accounts payable 10,000. Some people might say prop tax payable. think that's okay. would expect would treat this as normal account payable in my list of payables if were the company. But prop tax payable is is totally fine there too in my opinion. and you're watching my video so obviously you care about my opinion. Depreciation $55,000 80% kitchen 20% office. Okay. well let's deal with the kitchen first. it's depreciation. Is this direct material? No. Is it direct labor? But it happened in the kitchen. It's got to be overhead. So 55,000 times. 08 44,000 of overhead. Debit Mo. 44,000. The other 11,000 was office. So we don't debit office expense, we debit depreciation expense. 11,000. The credit here is funny. And you have to remember your intro accounting class. You don't credit depreciation payable or something like this. You credit accumulated depreciation. That's the credit that goes with depreciation. And you just have to remember it. If you don't remember it, you're going to screw it up. Credit accumulated depreciation. That is so messy. I'm going to fix that. GH was. If you ever notice write neat in some things and messy in some, it's cuz zoom in really close and make extra sure. So, let's make extra sure on this one. Depreciation. I'm running out of space. There we go. That looks much better. Okay. Accumulated depreciation. that's On to Insurance expired. $15,000. 80% kitchen, 20% office. So, we're getting into this habit of going, "Well, it's in the kitchen, but it's not material. It's not labor. It's got to be overhead." And that's the case here. 80% of 15,000. can't do the math in my head. Yes, can. 12 12,000 debit 12. The other three, we just debit the expense related to insurance, insurance expense. The other three was office office equipment. It was we had insured some office equipment. Anyway, there you go. $3,000 insurance expense. the credit related to insurance that's expiring is not accounts payable. It didn't say we bought new insurance. It said insurance expired. And if you think back to your intro class, insurance expiring is prepaid expense that is expiring. You credit the prepaid asset. You credit prepaid insurance. If you're shaky on journal entries, generally search up my name and journal entry boot camp. If you're shaky on this concept of prepaid insurance, search up my name and adjusting journal entries. We go over that concept. but you can just get there by practicing along with our management accounting. But that's that's financial accounting concept that might you might have forgotten. would forgive you if you had forgotten it from all those months ago when you were in your financial accounting class. manufacturing overhead costs were applied to production. This is the milliondoll moment here. Now, in reality, every time we make cake, we just go, what was my labor cost in the cake? Add 30 cents an hour for overhead, you know, or add 30 cents dollar. So, if spent $100 on labor, add 30 bucks for overhead. That's the overhead charge. Now, they're saying, well, what's the overall overhead charges that added, you know, across all of the cakes made? And the answer is, well, what's my overall labor cost? 450. And what we had said was our our predeterminable overhead rate said for every dollar spend on labor, expect to send 30% 30 cents on overhead. So spend 450 grand on labor, expect to spend 30 cents 30% on overhead. So 450 *.3 expect my overhead cost if did 450 grand of labor my overhead cost would be 135. This journal entry got cough and like tickle in my throat. This journal entry is like the key entry. It's saying how much estimated cost are we putting into our jobs? In other words, when I'm estimating the cost of my jobs, how much overhead goes into it? Because can use the actual labor. can use the actual material in the moment. have to estimate the overhead. And I've said the total estimated overhead here is 135. When put the material into the job, debit whip. When put the labor into the job, debit whip. When put overhead into the job, guess what? Debit whip. 135. The credit here is to Mo. And that's just one you're going to have to remember. You're going to have to remember. You're going to be doing this. If you do journal entries and job order costing, you will do that journal entry for sure. For sure. For sure. On to Jay says, "Deserts costing 7.90 were completed." This is saying they're not whip anymore, right? We were not sitting there with hundreds and hundreds of thousands of dollars of cake batter uncooked and going rotten. No, we cooked the cake. We finished the goods. So, it's no longer whip. It is finished goods inventory. So, debit finished goods inventory. The total value is $790. Again, we did not make single $790,000 cake or have single $790,000 wedding. We had hundreds of weddings, each of which we charged few thousand. These are obviously fancy cakes, suppose. $790,000 of finished goods inventory. Credit whip inventory. 790. Okay. that's the finished goods inventory entry. On to the last one. On to says the company had sales on account of $1.8 million. big company. $1.8 million of sales. All right, first we can just stop there. There's journal entry to be done. We had sales on account. If we had sales for cash, debit cash, we had sales on account, debit AR, $1.8 million. And we credit sales rev. This is us doing what we do to earn money. We're selling cakes and lots of them. $1.8 million. According to cost data, the jobs cost $720,000. The cost of the cakes that we sold, our cost of goods sold was 720. And what do we credit? Well, whenever debit COGS, credit inventory typically. And in this case, we got to be specific. We didn't credit raw materials. didn't sell eggs and milk and sugar. sold finished goods. So, we credit finished goods inventory. That's the type of inventory we sell. We're only really in the business of selling finished goods here. Okay. So, we've done part We've done journal entries through Let's move on and figure out if overhead was overapplied or underapplied. To do it, you just make big for overhead. So, let's make big for overhead and see where we're at. and we just go through all of our journal entries looking for Mo. Let me let me see how this goes. Is this too big? that's perfect. picked the perfect size highlighter. I'm on today. So, anytime have Mo, I'm just going to highlight it. There's MO. There's Mo. There, overhead. There, there, there, and there. think that's all of my overhead. So, let's put these all into the account and kind of discuss what we see. So, got debit of 10, debit of 50, debit of nine, debit of 44, debit of 12, and credit of 135. think I've got them all, but one, two, three, four, five debits. Five debits, one credit. Yeah, that's looks like got them all. Okay, so this is what my tea account looks like. And let's remember what's happening on the left side. These were actual overhead costs that came in over the course of the year. And again, they drip in bit at time. These are big numbers that are summaries of like things that would have happened on weekly or monthly basis. this one is my applied overhead. And this would have been in hundreds of pieces. With every little job do, apply little bit more overhead, little bit more overhead. This question summarizes things. So my my overall overhead that guessed was 135. My actual overhead though was different number. 10 + 50 + 9 + 44 + 12. Okay, there you go. My actual overhead was 125. My applied overhead was 135. applied $10,000 too much overhead, right? And my guess on overhead was $10,000 off. Now, that's not terrible, but it's off. so if look at this account, just take the big side minus the small side. end up with credit of $10,000 in my MO account. And we always comment on overhead being overapplied or underapplied. Well, what do you think the case is here? applied 135. actually had 125. perfect applied would have been 125. overapplied. applied too much. Right? So this is $10,000 of overapplied overhead. So that's the answer to the question. Was overhead overapplied or underapplied for the period by how much is $10,000 over applied? says, record journal entry to close overhead to cost of goods sold. In my questions, we're always going to close it to cost of goods sold. You will see some questions where they say, "Well, we're going to close some percentage of this to whip and some to finished goods and some to cost of goods sold." In my questions, we're just going to close to cost of goods sold. think it's simpler. so what does that look like? Well, it just means make this account zero. Make this Mo account go to zero. How do make it go to zero? I'm going to debit Mo and I'm going to close it to cost of goods sold. Let's sort of think about Well, let's do it and then we'll sort of think about why. So, I'm gonna make this an journal entry. That's an It doesn't look like an There's an That's an journal entry. There wasn't really an entry. I'm just making it up. I'm closing MO to cost of goods sold. So, debit Mo 10,000 and credit cost of goods sold 10,000. Now, what is actually happening here? During the year, estimated my overhead cost was 135 based on these, you know, transactions that happened. was off by 10 grand. charged too much overhead to my jobs. Just one little job at time. $10,000 overall. Too much overhead was charged to my jobs. In other words, thought my jobs cost $10,000 more overall than they really cost. So, if want to fix this, well, remember, I've sold most of those things. I've charged cost of goods sold based on having too much overhead. I've charged cost of goods good sold $10,000 too much. How do fix it? Well, I've reduced my cost of goods sold in journal entry. debit Mo to make it zero. credit cost of goods sold to reduce it to its more accurate number. And there we have it. We've fixed our cost of goods sold. So, it said record journal entry to to close overhead to cost of goods sold. Done. Final step based and this is long step based on the information above. Prepare an income statement for the company. Assume 20% tax rate and assume year end of December 31st. Okay, let's do it. Start with the name of the company. Ace Cakes. Ace Cakes. Next line down, income statement. Income statements get dated for the month ended or in this case for the year end. And it could be for the quarter ended too, but they told us for the year ended December 31st. We could even give year if we knew the year. okay. Income statements start with sales rev at the top. Well, whatever revenue we have, we have sales revenue $1.8 million. Next line down, cost of goods. Cost of goods sold. Our cost of goods sold, we thought it was 720, but we just said, "No, we overstated it by 10 because overapplied overhead." It is really 720 debit minus $10,000 credit is really 710. Now, interestingly, we overapplied our overhead. Had we underapplied the overhead, we would have gone debit cogs and credit and we would have had to add to our COGS total. Here we're deducting 720 minus 10. Under different circumstances under applied overhead, you would be adding your cost of goods sold adjustment there. 720US 10 though is 710. That's our cost of goods sold. what is this? 1090 is our gross profit. I'm going to double check that number just to make sure got it right. feel pretty good about it, but sometimes make silly mistakes. 1,800 minus 710. It is 1090. That's good news. Then we go on to just our expenses, our selling and admin expenses. And I'm going to have to just dig through my journal entries looking for expenses. So, let me grab yellow highlighter and we will go fishing for some expenses here. no expenses, no expenses, no expenses. Here we go. Admin salaries expense. sales wages expense, advertising expense. Notice they're all debits. Property tax expense, depreciation expense, insurance expense. That's it. Okay. So, I've got my expenses. Now, just have to list them all out, total them up, and we'll be almost done here. Admin salaries expense. Sales wages expense. lied. said when zoom in write lot neater. Well, it's not that much neater. It's not that much. It's not that bad, though. 280. I've done worse. I've done worse. 200,000. Sometimes look back at some of my questions, go, "What was even writing?" It makes sense when listen to the audio and I'm explaining it. But sometimes you look back, it's hard to tell. advertising expense, property tax expense. I'm doing them two at time here just to save me from scrolling up and down. Advertising expense, and think it was property tax expense. forgot the amount. So, let's go up three and one. Now, our property taxes were much higher than that, but because it was on the kitchen, we said, that's part of the cost of making the cakes, and therefore, it becomes part of the cost of the cakes, and it's buried in cost of goods sold." Is where that expense or that other 9,000 is. depreciation expense and insurance expense. Those are our last two. think it was 11,000. And forget what insurance expense was. So, I'll go back up and check. 11,000 and 3,000. Okay, so that's it. 1 2 3 4 5 6. Yeah, that's how many thought would have. Our total selling and admin expenses are 200 + 80 + 3 + 1 + 11 + 3 $298,000. We have very profitable bakery. This is unrealistically profitable bakery. Insanely profitable bakery in fact. But there you go. so our income before tax minus 298 is 792. $792,000. We've got an income tax expense which we said was 20% believe unless I've forgotten. Yeah, it said assume 20% tax rate. So 20% of our pre-tax profit here, 792*2 158,400. That brings us down to our profit, our net income here, which is 792 minus 1584 633600. double underline at the bottom, dollar sign at the top of each of my two columns, dollar sign beside anything double underlined. And there we have beautiful income statement. I'm just going to scroll through everything as you're reaching for that thumbs up button. there's our income statement. We've calculated whether overhead was overapplied or underapplied. It was overapplied by thousand. And we did all of these beautiful journal entries. What problem. That was long one. 28 minutes and 40 seconds according to my clock. If you made it to the end, for goodness sake, smash one of those buttons. Let me know you made it. always wonder if anybody makes it to the end. Thank you for watching. I'm so happy you're here and I'll see you in the next video. Bye for now. Welcome to module three of our course in management accounting. This module is called process costing. Now, you'll recall last chapter we introduced job order costing. And job order costing is for companies trying to figure out the cost of whatever there is they're selling when they have custom product. Every customer is little bit different. customize it for them. Process costing is for companies that make onesizefitsall product. So when bought this beautiful water bottle, hopefully you can see that clearly. When bought this water bottle, the company didn't say, we're making this custom for Tony Bell." just went to the store and bought water bottle. Well, that is company that would certainly use process costing. And here's the idea behind process costing. They're not making the bottles one at time. They're making them hundreds or even thousands of bottles at time. So, let's say in given period, this company makes 10,000 bottles, right? They make 10,000 units in this hypothetical example. They don't, if this was job order costing, they'd look at every bottle and they'd say, "How much material, how much labor, how much overhead went into that bottle." That's what job order costing requires of us because every client's little different and the costs are going to be little different for every client. Process costing says, "I'm not going to do this 10,000 times for every bottle and say how much material, labor, and overhead went into each and every one. What I'm going to say is, okay, over this period, made 10,000 bottles. They're all the same over the period. Let's just say spent 50 grand on DM. spent 20 grand on DL direct labor. And applied let's say let's make the number 40,000 in overhead. So my total product cost here is $110,000. that's my product cost to make 10,000 bottles. My cost per bottle is $11 per unit, right? $11 per bottle. And that's how process costing works. And you can see how time-saving it is. If had to do the material labor over at 10,000 different times, because they're all going to be slightly different. there will be slight differences in manufacturing depending on the day or the week. it would just be nightmare to account for. So process costing says no if we're making kind of all the same product or all one sizefits-all products don't need to be doing each individual item as individual cost profile. So it's actually very straightforward process costing except for one concept. So the key concept of the whole chapter is concept called equivalent units. Equivalent units. And to discuss equivalent units, I'm going to discuss these two sisters, Gabby and Bianca. And Gabby and Bianca, they're sisters. They get they like each other, but they don't always agree on things. And they didn't agree when their father told them they had to paint the fence. Gabby said, think we should paint with vertical strokes." Bianca said, "No, think we should go from left to right." And so, the girls said, "Okay, well, let's split the fence. You do There's eight boards here. You do four, Gabby. You do four Bianca, and we'll see where we're at." And at lunchtime they had followed their strategy and Gabby had done finished two vertical boards and Bianca had sort of half finished and she had worked on four vertical boards. Their father came out and looked at them and said, "Gabby, you have done terrific job. You've completed two boards." And he looked at Bianca and said, "Bianca, you haven't finished anything. You've done terrible job. Now, obviously, you and can see we're going to be much more fair than their father. And we would look at this and go, "They kind of did the same amount of work, didn't they?" Gabby had two boards that were 100% finished. Two boards at 100% completion means she did two boards. Bianca had done four boards. Whoa. That were at 50% completion. And if we do the math, four *.5, four * 50%. That is the equivalent of two boards. But we wouldn't call it two boards. We would call it two equivalent boards. This concept of equivalent units is going to return to us when we get into our problems. And the reason is when we return to our factory that makes these water bottles, what we find is of course if we completed 10,000 water bottles, the math is really easy. You go, okay, it's this many dollars divided by this many bottles. The issue is at the end of any given month, we don't have just finished bottles. We got bunch of half finishedish stuff. We got bunch of caps, bottles, they haven't been put together. They're in various states of completion. And as consequence, the accountant can't run out and say, "Okay, let's everybody finish everything. We'll stop work. We were not going to put any new things into the product line. Just stop and we'll finish everything." No, no, no. The accountant doesn't get to do that. The company wouldn't put up with that. So, the the account's got to deal with the fact, got bunch of half finishedish stuff, but my math doesn't work very well on half finished stuff. And so what does the accountant do? They look at their half fitness stuff and they go, "Okay, well the bottles, these are about 60% done and these caps are about 80% done." And they make an estimate and they go, "Okay, well that's the equivalent units of what I've made and do their calculations on what the product cost based on those equivalent units for the partially complete work in process. So that's the challenge of our chapter. hope I've explained it well, but better way to explain it is to do problems. So in this group of videos, you're going to do lots of examples of calculating the equivalent unit and the cost per equivalent unit. can't wait to get started. I'm so happy you're here. Thanks so much for being with me and hope these videos are helpful to you. Have great day and I'll see you in the next video. It'll be an example. promise. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take look at problem 31A. We're asked to prepare production report. When was student, never liked this topic because never got this topic. just didn't understand it. And maybe that's the position you're in. Hopefully, by the end of this video, you'll have better understanding of what you're up against when you're up against production report. Big picture, here's what's happening. We know the cost of product is the material, the labor, and the overhead. We also know for when we're doing process costing, and that's what we're doing here. We don't want to track each individual unit. This company is making, let's see, 90 plus thousand units. We don't want to track every single one, the material, the labor, and the overhead. What we do is we say, okay, well, what was our total material, labor, and overhead for the month? And divide by the number of units. That's essentially what we're doing here. And the challenge is, well, there's lots of little quirks. And so this report helps us work through the quirks together. The big quirk is you'll have halffinish units. So how do you deal with those? Well, this table deals with that that whip that might not be fully complete. okay. Let's jump into the problem and kind of work through it together. All my problems download from tonybell.com. I'm going to be working off template in this video. You can also download the template from my website. It should everything should be linked below. 31A production report. Bertusi Tires has three departments. Its first department, the processing department, shows the following data for the month of July. So I'm actually going to start with title before even read any of the data. Name of our company, Bertusi Tires. Name of the report we're preparing, production report, and sometimes called the production cost report. processing department. It's important to note the department because we're going to prepare one of these for every department in our company. If it goes from processing to finishing to packaging, for example, you know, there's different steps that this thing goes through. Each one of those is going to have its own report. and this is for the month of July. So, for the month ended July 31st. Okay. So, there's beautiful title. And in fact, before jump into the question, let's sort of look at this table. And there's two big distinct sections. think there's four steps really, but two really big distinct sections. The top half and the bottom half. When I'm filling in the top half of the report, the yellow half here, I'm looking for units. So, as I'm scanning the question, I'm going to be looking for unit stuff. When look at the bottom half, I'm looking for costs. So, I'm looking for dollar amounts. And can sort of separate the two in my brain. can go, I'm in the top half. don't want to look at dollars, right? don't want to put any dollar numbers in the top half. And when I'm in the bottom half, don't want to put any well, I'm just looking for dollars. That's essentially it." So, as highlight this, I'm going to read through the question. Okay. Bertusi tires has three departments. First department chose the following data for July work in process. and it says units in process. So I'll highlight that yellow, right? That's going to be relevant for the yellow section. Now it gives us stage of completion. in the intro to the chapter, had mentioned something. said, you know, key component here is equivalent units. So, if have, for example, 2,000 units and I've done, let's say, 50% of the work, 50% complete, the math doesn't work very well. And so, for our calculations, we're going to pretend that this is 1,000 equivalent units. And so, when we're doing calculations, we just treat it as if there's 2,000 units that are half done. we just treat it as thousand equivalent units and we just put it in the calculation as as thousand. And so we'll do that and you can see there's funny percent like that was 50% when there was 80 and 35 and 90 and 60. so that's something whirling around in the back of my mind. Those percentages matter when we have to calculate equivalent units and we will do that. The other quirky thing is there's equivalent units for materials. There's also equivalent units it says here for conversion. material, you know, the cost of product is DM plus DL plus MO. Material is obviously DM. Conversion is DL and MO. And isn't that weird that you can have something that's 50% done as to materials, but 80% done as to conversion or vice versa, right? You can have something where the materials are totally done and the conversion is only half done. think of the halfbaked cookie, right? got cookie, it's in the oven. Well, the materials are 100% there. don't have half the cookie materials in. Once put it in the oven, it's done. But the cooking is only half done. So the conversion might be 50 or 60% done. So that's sort of an interesting thing and and it creates interesting challenges for us in accounting, which is why we may need to make this table. Okay. Anyway, that's enough preamble. Let's actually start filling in our table. So units in process 8,000. These percentages with our beginning whip, right? is beginning whip. We don't need them for weighted average production reports, which is probably what you're going to prepare first. When you're learning this, you learn weighted average first. If you're working on FIFO problem, you're in the wrong spot. Problem 34 is FIFO. So, if you have to do FIFO in your class, skip ahead to problem 34. But we we'll focus on weighted average. That's one most people have to learn, and certainly most people have to learn it first because it's easier. so we can ignore these for weighted average. These are needed for FIFO. costs. Okay, so cost information. I'm going to highlight blue. We got material, labor, and overhead costs. Those are dollar amounts. well, I've got the blue highlighter out. see some costs down here as well. Those are costs in our beginning inventory. These are costs added during the month. And then see some more units information. And see units started. see units completed. And see units in process ending with some question marks. So, okay, I've highlighted the stuff yellow that kind of goes on the top. I've highlighted the stuff blue that's going to go on the bottom. There's lot of preamble. think once we get into the question, it's not that bad. It's probably too much setup on my part. let's start though. Units in units to account for from beginning with. We're going to start by filling in this physical unit section. That's going to be step one here. so units to account for from beginning work in process. It's this. I'm looking for yellow numbers there. Whip beginning units in process 8,000. So 8,000's my number. Units started again. I'm looking for yellow numbers. Units there's one called units started. Let's go with that. 94,000. 8,000 plus 94,000. my total units to account for 8,000 + 94,000 it's 102. Now I've done this few times. You haven't, but have the advantage of knowing, this total units to account for 102 is got to match this total units accounted for. This has got to be 102. And that's going to serve us well in second because units completed and transferred out is 92. And often you'll be given this ending whip number. In this case, we weren't given our ending whip, which is what we're looking at here. That's our missing number in our Excel, right? Ending whip. We're looking for that number. It's question marks in the in the question. We can fill in the blank. Often, you'll just be given the number and you can say, "Okay, yeah, it worked." Here, got to say, well, know it's got total to 102. I'm sitting at 92. What's the number got to be? Fill in the blank. It's got to be 10,000 units. So again, haven't used dollar amount and we're underway. So this is the first step, just getting that little reconciliation at the top. Total units to account for, total units accounted for. On to equivalent units. I'm going to fill in here. So the equivalent units completed and transferred out, it's sort of like the cookies. You wouldn't call it completed unless it was 100% complete. Right? We said 2,000 units, 50% complete. That's equivalent of a,000 units. Well, 92,000 units if completed and transferred out, must have done all the material. must have done all the labor and overhead, the conversion. so this has got to be 100% complete. So 92,000 time 100%. It's fully complete as to material. 92,000 * 100% it's fully complete as to conversion. So you just write that number across because it's complete. Our ending whip though has some percentages. It says our ending whip is 90% complete as to material. So if have 10,000 units on the go and I'm 90% done, that's the equivalent of having 10,000 * 90% that's the equivalent of having 9,000 units that are fully complete. So we use that number for our calculations for conversion. And remember conversion is just material not material sorry it's labor plus overhead to give us our total like you know material labor and overhead that's been theme of our class. Our conversion here is 60%. So we have 10,000 units that are 60% complete. 10,000 * 60% is 6,000 units. my equivalent. So, the total physical units are 102,000 units. For material, I've done 101,000 units worth of work. In other words, got to add some more work to those last couple thousand units. And for conversion, I've done 98,000 equivalent units of work. That's what we're saying here. This is key number for our future calculations. And we're done the yellow section. So, this whole bit just never Oops. Let's see if can make that work. Yeah, this whole bit that I'm filling in. Maybe I'll shade it black. Like it just never gets filled in. Like those will just be blank. When you do FIFO method, you fill more of it in. But for for weighted average, no, that's it. Okay. So, we've done the top half. You'll see in future problems, I'll go much more quick, but I'm trying to explain it as we go. Cost to account for dollar amounts. We're looking for dollar amounts. So cost beginning whip under direct materials let's see cost beginning whip and cost and beginning inventory materials 110500 conversion costs it's labor and overhead 33 and 26 so plus 33,000 plus 26,000 it's 59,000 so material labor and overhead the total cost material plus conversion which is labor and overhead is1 16,9500 costs incurred. That's these blue highlights halfway down the page. 950, right? Costs added to production during the month. For material, 950 for labor and overhead 310 + 170 480. Now just need totals. 950 + 480 1430. 110 + 95060500 59 + 48539 and totaling across 1599500. Okay, so those are just totaling the blue numbers essentially just giving different totals to them. cost per equivalent unit. This is the most important line on the table at least as far as I'm concerned. It's the most interesting one. As manager, you made 100,000 units approximately during the month. What was the cost? Well, the material cost, so you take the cost, million bucks, divide by the equivalent units, 101. So, it's million1060500 divided by 101,000 and you get cost per unit, right? That's the cost per equivalent unit. total costs divided by total equivalent units it's 10.5. Now you see in Excel I've I've left like bunch of decimals. You'll often get long weird decimal answer. What would say to you is more is better. Take as many decimals as you think is reasonable. At least three though, you know. So that's why leave so many in Excel just for other questions where the answer is not so easy as 10.5. let's do the cost per equivalent unit for conversion. 539 divided by 98 5.5. And our total cost $15.99 divided by no, there's nothing to divide by. How do get total here? just add them. 10.5 + 5.5, it's $16. So what does this tell me? Well, it tells me I'm Bertusi tires. the processing department when the stuff comes through the processing department. The processing department's cost per unit coming out of there is $16. So, it's useful to know how much your stuff costs. And we would go department to department to department and add up the cost as we go. We say, this is what it costs us to make our product." So, this is what the processing department adds to it. we got two more departments to add on afterwards and they're going to add on their cost and at the end of it we're going to have our our our internal cost on the tire. That's not the price we charge to the customer. That's what it costs us to make the tire. Now, it's important to remember why do we do this? We made 102,000 tires. We're not going to track each one individually. We're going to say during the month made 100,000 tires. During the month had $1.6 $6 million in costs. So, it cost me $16 tire. Real companies, this number is not going to be 16. It's going to be 15.972463. But, you know, we're doing this the first time. It's nice to have the numbers work out evenly. Okay. so that's the key number, but we got one more step to do, and it's little reconciliation at the bottom that feeds an important journal entry. Here's the reconciliation at the bottom. It says cost of units completed and transferred out. take my cost 10.5 for materials multiply by complete in transferred out 92,000. take my cost my computer froze. Hopefully it unfreezes. There it goes. 5.5. multiply by completed and transferred out 92. add these two together. Okay. So then do the same thing here. Cost and ending whip. take my cost. multiply by the units ending whip 9,000. So 10.5 * 9,000 is 94500. 5.5 * 6,000 ending whip. So again, cost and ending whip. take the cost per unit times the ending whip. So times 6,000. add these together. The one thing left to do is to add down. 966 + 94 is 1060. 506 + 33 is 539. And 1472 + 127 is 1599. What we notice is these numbers. Let me unhighlight everything. no fill. Yeah. So, these two numbers match at the start and these two whole rows match at the bottom. And so if you did it right and and it's important the less you round the more accurate this is going to be. we didn't round at all so the numbers match perfectly. If you don't round at all these numbers have to match perfectly mathematically. You did something wrong if those aren't matching. think the key number on the whole table is this one that I'm highlighting in orange because again if you're the manager of this department you want to know what your costs are, right? That's you are probably in charge of keeping costs down and and you're you're wanting to monitor this number very closely. It's useful and important number for the company. One last thing to do, we've done the question. So the question said prepare production cost report. That's what this is is production report. We've done it. Good job by us. Just as little bonus, sometimes ask my students to do the journal entry to transfer out completed goods. And that's this maybe I'll highlight this in blue this blue highlighted line. So here's the journal entry if you're asked. we credit whip for this department processing department. Oops. Processing department for 1472. Just that number right there. What we completed and transferred out. And we debit whip inventory for the next department. Whatever the next department is, is it the packaging department? Often the question will tell you, it goes from this department to that one to that one. Well, whatever the next department is, it just what was our whip and we finished it becomes the whip of the next department. So, we debit whip for the next department. So, sometimes you'll be asked for that journal entry. There are some other quirky journal entries you might be asked, but that's by far the most common. And there we go. We finished 31A. If you made it to the end, hit the like button and I'll see you in the next video. Thanks for watching. Bye-bye. Let's take look at problem 32A. Sometimes give midterm questions and the layout is funny, but it's, you know, the same question. This is very much the same question as 31, just laid out little bit differently. There's one new quirk in this problem, and we'll get to it here. Stable platforms manufactures tables. Materials are added at the beginning of the process. Now this sentence it takes on huge meaning in our answer. What this means always think of cookies. I'm cookie eater. When make cookies and start to cook cookies, have the eggs, the sugar, the see don't know what goes in cookies. Flour, chocolate chips. have that all ready to go. And as soon as begin, I've used 100% of the material. All the material just goes into the bowl. Step one, right? Essentially, so if you have product like that, you know, if you're making some product where there's plenty of products where you just need all the materials on hand to start, if an ice sculpture, you got to have the block of ice before you begin. and so materials are always 100%. This question is going to give us different percentage of completions. That's not for materials. For us, materials are 100%. That's the only quirky bit of the question. Everything else is straightforward. Conversion costs are incurred evenly throughout the process. Data for February follows. And there's some data for February. And it notes units in process beginning whip. Well, beginning whip we don't worry about with weighted average production reports. That's for FIFO. That's for problem 34. units in process end of the month 50%. That's for conversion. How do know? Well, materials are 100% complete. Quick cough. Okay. So, there's our units data there. There's our costs in beginning with there's our cost added. We've got it all. Let's solve this thing. let's start with title and our title is name of the company stable platforms. Name of the financials report we're making. This is production cost report. just call it production report. Generally speaking, we're going to want to give department. This question doesn't give us department. So just call it production report. and this is for the month of February. For the month ended Feb 28. Okay, so there's our title. now we got to fill in this section, right? just that little reconciliation of units to account for. So this is all unit stuff. Units in process February 1st 120. Units started 380. 120 plus 380 is 500. say to myself, well, my total units to account for has to match my total units accounted for. So this has got to be 500. We have units in process Feb 28th 100. We're going to have to work backwards and figure out completed and transferred out is four. Now we're on to the equivalent units portion. This is where we use percentages. Completed and transferred out. For it to be completed and transferred out, it's got to be 100%. wouldn't call it completed if it wasn't 100%. So it's 400 times 100% both ways. You just write the same number across. Ending whip 100 units and for materials it's 100%. This is the one that students screw up. They'll put 50 here because this number 50%. No, no, no. It's 100% materials cuz materials were added at the beginning of the process. So it's 100 time 100%. Kind of weird calculation. And this one is 100 time 50%. So that's 50. Let's add them together to get our total equipment units. 400 plus plus 100 is 500. 400 + 50 is 450. And now we're halfway done. And that was the hard half. Hopefully wasn't too hard. Now we just use our cost data from the question. Materials 1,100 in beginning whip, right? Whip February 1st. labor and overhead 7820. That's 1520 in labor and overhead. Conversion of course is labor plus overhead. Cost incurred during the month. Materials 4,000. Labor and overhead again. Conversion 2,800. Total costs. Add them together. 5,100 in materials. That's the 1,100 plus the 4 grand. And conversion, that's everything else. Now just need totals to the right. 1,100 plus 15 is 26. 4 + 2 is 6,800 and 26 + 6800 is 9420. Now the key number on the whole table cost per equivalent unit. Take my cost information total cost divide by equivalent units 10.2 9.6. Add them together. 10.2 + 9.6 is 19.8. You can't divide 9420 by some number that's not there. So it's it's adding across. 10 + 9 is 19. Okay. Now the little reconciliation at the bottom. cost of units completed and transferred out. take my cost 10.2 times completed and transferred out 400. Take my cost 9.6 times completed and transferred out 400. cost in ending whip. Take my cost 10.2 multiply by ending whip units 100. Take my cost 9.6 6 for conversion multiplied by 50 my ending whip. Now add all the way around. So 4 + 3 is 7. 1 + 4 is 1,500. Add down 4 + 1 is 5. 3 + 400 is 4,000. And add down. And what we find is if we've done it right and we have this row matches with this row. And they do match because we did great job. All right, we've come to the end of 3 2 As always, thanks for being here. Thanks for watching. always used to think this was very, very difficult when was student. Now I'm professor. just don't see it that way. think this is one of the more straightforward topics in our intro management accounting class. As always though, hope the video helped and if it did, hope you help me with thumb. See you. Bye for now. Let's take run through problem 34. another production report, but this time FIFO FIFO method is little bit more challenging, but think you're going to be up for it. Here we go. Pari Brakes has three departments. Its first department, the processing department, shows the following data for the month of May. All righty. have enough information to prepare threeline title. Let's do it. Parro breaks. We are doing production report. You don't need to note that it's FIFO. You can if you want. You do want to say the department though, processing department. And this is for the month ended May 31st. Okay. So, there's beautiful title. Now, with the FIFO method, we need to keep track of how much work we did and on which units each period. And this method is more accurate than weighted average, but you'll see it's little bit more complicated. First things first though, we do very similar reconciliation at the top. Total units to account for, total units accounted for, very similar with one little different quirk. And we'll get to that quirk in moment. want to highlight my units information. So, units in process was 8,000. my units started 94,000. units completed 92 and my ending whip question mark. So that's my units information and my cost information materials labor and overhead cost in beginning inventory materials labor and overhead costs added. So, okay, those are my units and cost information. And just as we did before, like units at the top half, costs in the bottom half, but you can see this is longer table like there's more going on here, but let's get started with what we can do. units to account for from beginning whip. All right, so 8,000 units started during the month, let's see, 94,000. That subtotals of course to equals that plus that 102. And that's going to be my total units accounted for as well. Just same as we would have done before. from now this is interesting from beginning whip. It's like the same number we just did 8,000 which is weird. That's different from what came before. If we look over at our weighted average method, it's completed transferred out ending whip. This is from beginning whip started and completed and ending whip. So it's it is little different the units that we're tracking started and completed is totally new started and completed it's none of these right it's these are started certainly that's true that this is started but not completed started 94,000 but how many of those 94,000 did complete well the answer is not all of them because got 92,000 completed and transferred out and of those 92 eight were from beginning whip because FIFO, right? First in, first out. My and that makes sense. If had beginning whip, would have finished those 8,000 first. So, of the 92,000 completed, 8,000 had already been started. So, 92,000 minus 8,000 equals 84,000 that started this period and completed. That's what it is. So the math is you take the units completed minus what you already had started work in process and that gives you the units that we started and completed within this period and it is 84,000. That gives us the chance to calculate ending whip. 84 + 8 is 92. Our total is 102. Our ending whip's got to be 10. Okay. So now we're looking for equivalent units and we're saying had mentioned before when we did this type of problem said just ignore the percentages with our beginning whip because we don't need them but when we get to FIFO we're going to need them. Well we're going to need them now but we'll save that one for last. Units started and completed. What percentage of the work do you think did this year this month? The answer is did 100% of the work. So started and completed 100%. Ending whip. What percentage of the work did do this period? Well, 90% and 60%. So, that's pretty straightforward. 9,000 90%, right? 90% of 10,000 is 9,000. 60% of 10,000 is 6,000. So, that's pretty straightforward. The beginning whip one's little bit tricky. How much work did do this period? Well, if my beginning whip had 80% of the materials already in before started the period, how many dollars worth of materials did add? What percentage? added 20% this period. Again, 80% was already done as of last period. did 20% more this period. So, use the number 20% here. It's for work did this period. For this 35%, did 65% of the work this period. So, those are the numbers apply here. $8,000 times 20%. And sorry, 8,000 units. think said dollars time Oops, got to have equals equals 8,000 time 65%. All right. And so that's the only tricky bit, right? Started and completed. Yeah, did 100% of the work this period. Ending whip, well, whatever percentage you've got, you just apply it and it's very much the same as weighted average method. The beginning whip though, you're saying, how much work did it take to complete this product? And the answer is, well, if had already done 80% of the work, need to do 20% more. If I've done 35% of the work, need to do 65% more. So, how much more work needs doing essentially? Or how many more materials need adding? That gives us our total equivalent units. Just summing that up, 94,600 and 95,200. And we're halfway there. The bottom has similar quirks to this. So again, you know, first time through it can be little tricky. When you practice this though, it does become straightforward. this section largely the same until we get to cost per equivalent unit. So cost to account for from beginning with let's see it's 10500. labor and overhead 33 + 26 that's 59. 33,000 + 26,000 it's our conversion 59. costs incurred 964,920 333200 plus 19400 conversion is 523600 and now just need to add all the way around 110 + 59 169 964 + 523 110 + 964 1075 big numbers here 59 + 523 is 582 and summing down there 16582. Okay, so we've got our subtotals in place. Cost per equivalent unit is little bit strange and it's different this time. We're not interested in the cost in beginning with because we accounted for that last period, right? We did the work last period. So we're saying how much cost did add this period to the amount of work did this period. So it's cost incurred during the period divided by total equivalent units. And these are the total equivalent units worked on this period. So it does make sense but it is just different. So 964920 cost incurred divided by 946 there's 10.2 2 and 523600 divided by 952 5.5. Now the numbers worked out beautifully and evenly. They certainly don't have to. That's why have that big long decimal in my Excel. would expect students to be going to three or four decimals if it's sort of long decimal. okay. So that's that's quirky and that's different, right? It's cost incurred during the period. And when we did this for weighted average, it wasn't cost incurred. It was just total costs. simpler, more blunt force, but this FIFO is more accurate. All right, let's do costs accounted for. Now, cost in beginning whip 110,500 59,16,9500. That's not work did this period. So, don't use this cost per equivalent unit because that's from this period. These costs are from last period. Cost to complete beginning whip 10.2 2 * 1,600. for conversion, it's 5.5 * 5200. the total there then 16 + 28 is 44. Cost to complete units started and completed 10.2 time 84,000. 5.5 * 84,000 and summing those together 1.3 million total cost of units completed and transferred out. So it's our beginning whip and you can see the total cost to complete our beginning whip is just the first two rows there or first two columns guess. but the total cost of everything completed and transferred out. So the beginning whip that finished and transferred out can see them in the way. Let me scroll down little bit. There we go. let's add these together. And we just add these three together. And we just add these three together to get our total cost of units completed and transferred out. And remember, that's key number for our journal entry. We debit whip of the next department. We credit whip of this department for that number. 1533 220. cost inating whip. Pretty straightforward. You take your cost per equivalent unit times our ending whip. Cost per equivalent unit 5.5 times our ending whip and add them across. And there you have it. Now we just sum it all up and hopefully hopefully these numbers are matching what they should be matching and they are. Take look at this. that row total costs accounted for matches perfectly with total costs to account for. Certainly, it doesn't mean we got it right, but it's very good sign. And if they're mismatched, it does mean we got it wrong. But there we go. challenging problem 34A. There's another FIFO method example. Like said, all things in accounting get easier with practice. So, please take chance to practice this and please practice hitting the thumbs up button. I'll see you in the next video. Thanks for watching. Bye-bye. Welcome back to our course in management accounting and welcome to module four, activitybased costing. Let's return to our hamburger and figure out the components of the cost. And at this point, you should have it locked down. The key components of the cost is direct material, which we've abbreviated as DM, direct labor, and manufacturing overhead. And we've gone over that concept few times by now, but we know the material is the cost of the burger meat, the cheese, the bun. And when you make your burger, you know the actual material cost. So there's no drama there. You just, as an accountant, you use the actual cost and you're good to go. When you make the burger, you also know your actual labor cost. You know how much you pay your cook and how many minutes or how long it took the cook to make the burger. So you can figure out, okay, well, this is how much cook cost goes into the burger. So the material labor, not hard to figure out. Overhead though, is hard to figure out. And the reason is when cook the burger, let's say it's in the middle of July and I've had the air conditioning on, but haven't received my utilities bill that month. you know, I've had to keep the kitchen cool. It's really hot in my hometown in July. Well, if that's the case, know that needed to have utilities cost to cook the burger, but don't know what the cost is, and I'm not going to get the bill for like three more weeks. So, how do know how much utilities cost went in the burger? The answer is don't. estimate. And when we estimate how much utilities cost went into the burger, we call that applying overhead. So we use actual material, actual labor and applied overhead to figure out the cost of the product. And when we learned how to apply overhead, we said, we use something called the predetermined overhead rate. And the predetermined overhead rate is the estimated total overhead divided by we choose something that we think is an overhead driver. So I'm just going to say estimated MO driver. and we say, "Okay, well, for example, direct labor hours, right? So, the more direct labor hours have, the more overhead should have." So, I'm going to take my estimated overhead, divide by my direct labor hours, and then when make the burger, just apply it based on how many labor hours the burger took. So, we've gone over examples of applying overhead in the past. What activity-based costing brings that's new is activity- based costing says we have many different types of overhead. Why do only have one overhead driver? When in fact, if look at my like cleaning cost, which is definitely an overhead cost, that's driven not by labor hours, but by the number of setups, right? Every time set up the kitchen, got to clean the kitchen or maybe tear downs or whatever, but it's definitely not directly proportional to labor hours. So, why don't use different driver for my cleaning cost, for utilities cost? Maybe that's better reflected in number of machine hours and for gas cost maybe that is driven by number of direct labor hours. And so what we find is and companies don't just have three sources of overhead, they might have dozens. We could come up with categories of overhead and come up with different drivers for each category. Activity based costing says why don't we do it that way? We might get more accurate estimates. Most companies don't use activity based costing because it's more data to gather and most companies traditional one overhead rate is good enough. It gives them good enough data. But when companies are unhappy with their costing system, activity-based costing is something that they might explore. And that's something module 4 is all about. The best way to learn accounting, you know what I'm going to say, is to do examples. So stay tuned for the next video where we do an example comparing traditional costing, that's one overhead, with activitybased costing. can't wait to get started. See you in the next video. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take look at problem 41A. This problem has us comparing traditional costing, which uses one overhead rate to apply overhead to our products to activity based costing, which says, well, wait second. We got lots of different things that drive our overhead. Let's use several overhead rates and apply overhead that way. So, we'll start. Part one has us doing traditional costing and we'll do that now. ES scoot makes electric scooters for urban commuters. The company has two models, the commuter and the range models. The company uses traditional plantwide overhead rate and allocates its estimated $160,000 of overhead costs on the basis of direct labor hours. Okay, remember we learned the concept last chapter or two chapters ago of the predetermined overhead rate where we take our estimated total overhead. So our estimated overhead divided by the estimated driver over this one they just told us it was applied on the basis of direct labor hours. So divided by estimated direct labor hours. Okay. So what is our estimated overhead? They give it to us $160,000. And what's the estimated direct labor hours? Well, we don't know yet, but the next sentence tells us the direct labor workforce is expected to work for 10,000 hours next year. Okay, so there's our direct labor hours. So, we get rate $16 per direct labor hour, right? 160 / 10 is 16. Now, this is not my labor pay rate, right? This isn't their wage rate. this is my guess or my estimate for overhead. So, when make product and it takes me five hours, would go, well, 5 time 16. estimate there's $80 of overhead in the product, right? We know the actual material because we just bought the materials. And you can make reasonable estimate of how much material went into product. You know the labor because you know how much time the employee spent. they know how much you're paying the employee. The overhead though, you have to sort of apply. You have to estimate the overhead. And we've said, well, if make if spend five hours on product, estimate there's 5* 16 $80 of of overhead cost in the product. Let's read on. It says the estimated product costs are below, and we got material labor, which we know the amount, $600 of material for the commuter. direct labor, 25 bucks an hour, $250 of labor cost. Overhead, we don't know anything. And then it tells us the number of units produced. it says, compute the predetermined overhead rate. Okay, done. $16 per hour. And it says, calculate the product cost for both models. Well, material plus labor plus overhead. Now, we also know this is no longer question question. This is 16, right? It's $16 per direct labor hour. to figure out how much overhead needs to be applied, got to figure out how many hours did it take me to make the commuter. Well, we can do it couple of ways. think the easiest way though is to look at, well, it was $25 an hour for labor and spent $250 on labor for the commuter. You can back into it and say, "Well, that must have taken 10 hours." And how did get that? Well, it was $250 in cost divided by $25 an hour tells us we took 10 hours. This one takes 16 hours. And again, the math is the same. $400 in cost divided by $25 an hour, 16 hours to get there. So now, once got the hours, it really unlocks this part of the question. And you just go, "Okay, well, my overhead was 16 bucks an hour. took 10 hours. So, my overhead no longer in question. My overhead's got to be applied overhead $160." Just $16*10. I'll take away the dollar sign actually. And for the range, it's 16 hours at $16 an hour. It's $256 in total. So, what's the cost of the product? It's the material plus the labor plus the overhead. 600 + 250 + 160. It's 1010. Whoops, not 110. 10 10 for the commuter. And for the range 900 + 400 + 256,56 is my internal cost for the range, 1556. Okay. So, we've added up the cost using traditional one overhead rate for the company. And for most companies, that is satisfactory. And that's what most companies will do. They'll estimate overhead using one driver. But sometimes companies are finding wonky things in their numbers and they go, those cost numbers aren't trustworthy." Right? Because it's based on an estimate and their estimates are either off or there's something that smells funny just to the account. They look at and they go, "There's something that smells funny about our numbers. Something's not quite right here." And in those cases, those companies might consider activity based costing, which uses more overhead rates, more than just one to apply overhead because they say, we got lots of different types of overhead. Why do just use one overhead rate? Why can use many if want to?" And and some companies choose to. So, this company said the company's considering switching to activity based costing and gathers the following information about its estimated overhead. So, again, it's $160,000. Same estimated overhead, but they break it down into three categories. They say, "Okay, we got overhead caused by labor, overhead caused by inspection, and overhead caused by parts administration." And we're not going to use one overhead rate to figure out our overhead cost, how how much we're going to apply. We're going to use many. So, let's figure out three different overhead rates for assembly. $20,000 divided by 10,000 hours is what is that? $2 per direct labor hour. Two bucks an hour. and just quick aside, this is answering part Here it says, compute the activity rates for each activity. So, rather than one big predetermined overhead rate, we're going to have three because we have three activities here. inspection. $40,000 in overhead divided by 5,000 inspection hours is $8 per inspection hour. And the last one, parts and men, $100,000 divided by 100 parts, it's $1,000 per part. Okay. So, now we want to figure out, well, what's each product line's share of the overhead? So, if our commuter has 6,000 hours and it's two bucks an hour, that's $12,000 of overhead that goes on the computer. 6,000 * 2. For the range, it's 4,000 * 2, that's $8,000 of overhead that needs to land on the range. 1,00* 8 is $8,000 of overhead for the inspections. And 4,000* 8, that's $32,000. 25 * 1,000 is 25,000 in parts and min. And this one gets $75,000 in parts and min. So, my total overhead to be applied to each product line 12 + 8 is 20 + 25 is $45,000. 8 + 32 is 40 + 75 is $115,000. And if we total it up, 45 +15, we do get 160. Just little check figure here. We said we wanted to apply $160,000 of overhead and we have. Now, this is all based on our estimates. This is based on our planning. In reality, our numbers will be different because, you know, we're not going to work exactly 10,000 hours or 6,000 commuter hours. We might work 6127 commuter hours, right? The numbers aren't going to work out so perfectly, but in planning, they should work out perfectly and and they do here. okay. So that's our total overhead applied. Now remember the cost of product is the material, labor, and overhead. And right now, here's what we've got. We know the material. We know the labor. We don't yet know the overhead. And I'll show you what mean in second. The material, $600 for commuter. I'll put for commuter, for range. The labor 250 for commuter. And we don't know the overhead under activity based cost. We know the overhead under the old method was 160. for range the material is 900 and the labor is 400. Now it doesn't matter which costing method we use. Material and labor is the same. You just use the actual number. Overhead though you apply and because it's based on estimate we can use different methods of estimating. And that's what we're doing here. Our applied overhead under activity based costing. Well, we calculated it and we said 45,150,000. You can see the numbers don't make sense. And that's because that's the total overhead applied to the product line. We need overhead per unit. So, how many units of commuter were there? And the answer is 600. How many units of range? 250. So got to divide by the number of units 600 and 250 45,000 divided by 600 $75 per unit. So this is our MO per unit for commuter 75 bucks and 115 divided by 250 $460 unit for our range. So let's plug those numbers in. So it's Mo is 75 for commuter and 460 for range. So what is our cost? Right? material plus labor plus overhead gives us our product cost 600 + 250 + 75. Our commuter should cost 925 if we use activity based costing and our range 900 + 400 + 460. Our range should cost 1760 if we use again activity based costing. How does these compare? Let me highlight in blue. Our traditional method said these should cost 1010 and 1556. Activity based costing said no no no we're going to use few more overhead rates get bit more data and we have slightly different numbers. And so what does that mean? Well, it means our costs are likely off by little bit under traditional costing. That that's the conclusion would reach here. And it says compare your answers in parts one and two. Under traditional costing part one, which product is overcosted and which is under costed and by how much? So under traditional costing, thought the commuter cost 1010. Activity based costing says no no it's closer to 925. So would say under traditional costing the commuter is overcosted. In other words, under traditional costing, thought it cost more than activity based costing reveals that it's costed. So, it's overcosted by 85 bucks. And range is undercosted by more than that like 204 bucks. And again, the math, it's just difference, right? 1760US, 1556 is $24. You might be thinking, why is one over by 85 and the other under by 200? Shouldn't it be over by 85, under by 85? Like, shouldn't they match? They match in total. The issue is overcosted 600 units. So if just go 600 * 85, my total amount was overcosted was 51,000. And let's see, 250 made 250 range units at 204. 250 * 204 is 51,000. So in total, the total value was over and the total value was under is the same. It's just the fact that there were more commuter units to soop up that overcosting made it slightly lower number. So what are the implications of this? Well, it means we might be making bad decisions. If you don't have good cost data, how can you make good decisions if you don't know what your stuff costs? So most companies don't use activity based costing unless they see problem, right? And why don't they use it unless they see problem? Because it's expensive. You're gathering more data. It's pain in the neck. and and if you don't see problem, it wouldn't be worth it. But if companies think they have big costing problem, they might be wise to see what activity based costing has to say. All right, we've made it to the end of the video. Thank you for watching. See you in the next video. Bye for now. Welcome to module five of our course in management accounting. This module is all about costs and understanding our costs. So, so far the key concept has been material, labor, and overhead. That equals our product costs. Now, we're just going to talk about how costs behave in this chapter. And I'll show you what mean. And lot of these concepts will already be familiar to you. So, let's imagine we're company like Coke or Pepsi. We make beverages. And let's talk about the canned beverages. So, we have some factory somewhere and it makes beverages in can. Well, let's imagine, okay, we're Coke or Pepsi and we make aluminum canned beverages and we're wanting to track the cost of aluminum in our factory. Well, of course, the cost of aluminum is going to move in proportion to the amount of beverages we make, right? If make thousand cans of Pepsi, need thousand, you know, pieces of aluminum. suppose would be one way of putting it. And so if look at my aluminum cost compared to my activity, which is making cans of Pepsi, it's going to graph like this. If make zero cans of Pepsi, spend 0 in aluminum. And if make million cans of Pepsi, spend whatever it is, hundreds of thousands of dollars, I'm sure, in aluminum. But the cost is going to behave like this. And you and know that this would be an example of variable cost. It's cost that moves directly in proportion. One more can of Pepsi means one more piece of aluminum needs to be supplied here and therefore my aluminum cost goes up. It goes up directly proportional to what make. That's variable cost. Now for Pepsi, they presumably they own that factory and they pay property taxes on the factory. So their property tax cost, if they make one more can of Pepsi, it doesn't change. They could make zero cans of Pepsi and if they own the factory they got to pay the same amount of property tax as if they made million cans of Pepsi. Their property tax graph looks like this. And we would call that fixed cost. Now Pepsi is also going to have something like mixed cost which is an example here might be their utilities bill where they have to pay some fixed amount to be even hooked up to the grid. and then they pay based on usage. And so mixed cost looks something like this where it's like there's fixed element where they pay some minimum fee to be hooked up to the grid and then as soon as they start, you know, using the utilities, they start using electricity, they pay additional cost based on usage. And of course, the more cans of Pepsi they make, the more utilities cost there's going to be. And so those are three cost concepts we're introducing this chapter. But there's, you know, costs can come in funny shapes and sizes. Again, if go back to Pepsi, let's say, the the factory works for eight hours day and then shuts down, right? And somebody says, you know what? We might add second shift. We might go from, you know, 9 to 5 and then have your, you know, 8 to 4 and then have somebody go in from 4:00 to midnight." And maybe it works. And they go, they get the bright idea, maybe we'll add third shift. We'll do an overnight shift from midnight to 8 in the morning. we're going to run our factory 24 hours day, which some factories do. Well, then their supervisory costs kind of look like this. For the first shift, you know, let's say we pay flat salary to our supervisor group. And then when we add the second shift, it's not like the same people can just get paid the same amount. No, we got to bring in whole second group of supervisors and the supervisory cost would double. And let's say we add third shift. Well, then the super revisory costs go up again on that third shift. And so the cost curve looks like this, right? It looks like big staircase. And we would call that step cost or step fixed cost in this case. We can have similar step variable costs that just look like, you know, small staircase. I'm not drawing it very well, but think you're getting the picture that it like has like just goes up in chunks. We would call that step variable costs and costs don't have to be made up of straight lines. Costs can curve to reflect like learning curves, right? So you're you're beginning to learn to make the product. It's very expensive and then you figure out how to make it. And then sometimes companies reach capacity and any additional product they make actually gets more expensive because you just don't have the facilities to make it and so it gets harder and harder to squeeze out an extra product. And we would call this curved cost. Sometimes these are called curve linear cost but just call it curved cost curve. Okay. And so, and there's, as we'll go over in the chapter, there's all kinds of shapes and sizes to costs, but it's going to be important and and the key concept of the chapter is based on these two key assumptions we're going to make about costs. One is that companies operate in relevant range. In other words, if go to my Pepsi factory, they're not making zero cans of Pepsi. Like, zero is ludicrous number for them. I'm like, they're going to make, you know, every year they make between 1 million and 1.5 million cans at this factory. Say, don't need to even really think about zero. also don't really need to think about billion. can say, well, in the relevant range, this is how the cost behaves. And so, you know, they might say, okay, the relevant range for us is somewhere between here and here, right? Which is 1 million cans and 1.5 million cans. And so don't need to consider factors really outside of that because sometimes these like, you know, if look at the curve linear one, you know, Pepsi doesn't need to consider making zero cans down here and they don't need to be considering making 100 million cans up here. If they're always making between 1 and 1.5 million, that's what they should be thinking about. Okay? So there's relevant range to to think about the costs. And the second one is key and this is an assumption and we know it's not perfect assumption but it's that costs are linear in the relevant range. And what what do we mean by costs are linear? It means straight line would be good enough way to draw this graph. Drawing perfectly straight line is good enough. But like look, some costs look like staircase. That's not straight line. This cost is clearly curved. That's not straight line. Well, the idea is let's just let me grab my ruler here. messed up something. you can see the zoom change. got to click something. okay. Here's my ruler. let's let's look at the step variable cost. The idea is, if did good job drawing it, if draw line that looks like this, right, that's good enough for making decisions, could pretend that even though know the costs are going to be little bit off from my line, drawing line close enough, can make good judgments and can understand my cost if just drew that line instead of drawing the staircase. And the same is true for my curve cost because if just look at the relevant range where Pepsi operates and just go, okay, I'm gonna just draw line through this. That red line I've drawn, we would say close enough. Like it doesn't need to be perfect because I'm making predictions and plans for the future. And if can use linear data, can do very powerful things. And we're going to learn about those powerful things next chapter. This chapter is all about wrangling funny shaped costs into straight lines. And it's little bit mathy. If you've taken math class before, you've seen this formula before. This formula is cornerstone of our class. So, in accounting, is our, total cost. It's our cost. is our cost per unit of activity. So for Pepsi, it's like, you know, cost per can produced, right? If we're thinking about the canned Pepsi. is the activity level. So that's how many cans am making? And is the fixed cost. If you've taken math class, you'll know is called the dependent variable. is the slope of the line, is the independent variable, and is the intercept. So those and it's all the same sort of math that's going on. So it's linear math. And what we find by the end of the chapter, actually next chapter is we're going to use this information about our fixed cost, our variable cost per unit to do some powerful decisionmaking for company. But all hinges on this. We have to assume that within that relevant range costs linear line does good enough job of explaining the costs. We know it's not perfect, right? This red line doesn't perfectly match the green line underneath, but we think straight line does good enough job. So, this class or this module all about wrangling these funny shaped costs into lines. So big focus here. That's mod five. The best way to learn, as always say, is to do examples. And got lots of them waiting for you. Can't wait to get started. Bye-bye. Let's work through problem 51A. This has us graphing various costs. Students actually struggle with this topic quite lot when test on it, and it can be little tricky, but let's work through this together and see how we do. For each of the following costs, prepare rough graph that illustrates the cost behavior. The y-axis will be cost and the x-axis activity level. This is very normal thing to do in management accounting class. Just figure out what costs look like. So the first one, cost of cell phone plan. The plan charges flat rate of $10 month for unlimited calling and texting and $5 gigabyte for data. Okay. So what is that going to look like in terms of graph? Well, at minimum we're paying $10 month. So, there's fixed cost element to this. So, it's going to start here. It doesn't start from zero. I'm always curious if the cost starts from zero. It's going to start somewhere up the axis. And the more data you use, the more you pay. So, it's going to look something like that. So, that's on to Cost of plastic used in manufacturing small garbage bins. Each bin takes 600 of plastic. So, I'm imagining little desk, you know, garbage can that might be sitting beside desk cuz 600 grams is not much. so, for each bin, you need more plastic. And would think the plastic will be, you know, linearly related to the bin. The more bins, the more plastic. If we make zero bins, zero plastic. But it just goes up from there. Now, don't compare these two and say, the slope of this line's steeper than that one." These are just rough graphs, right? They're they're meant to sort of just be highle view of the cost. Cost of rent on an automotive parts manufacturing factory. The activity is the number of good parts produced. Well, my landlord doesn't get to see how busy am before they charge me rent. They go, you're really busy. I'm going to jack up the rent." No, no, no. Rent is fixed, right? The rent is whatever it is. Let's say it's big facility, it's $20,000 month. it doesn't matter if make one part or a,000 parts, the rent is the same, right? It doesn't make difference. So, this is fixed cost and it will graph out something like that, straight line. Cost of professor salaries to teach introductory accounting. Cost is $5,000 per class section. Sections have maximum size of 50 student. the university has between 120 and 220 students enrolled in the course at any given time. And so this is classic example of step fixed. If have zero to 50 students, got to pay one professor $5,000. 50 to 100 students, got to pay two professors. The total is 10,000. Three you know 150 to 200 student or whatever the number is, right? It it just steps up every you know additional section. you got to add an additional professor and you got to pay that additional salary amount. So it ends up looking like big staircase in terms of the cost and we call that step fixed and lots of costs behave that way where you just clear threshold and then all of sudden you got to double your cost essentially. or rather staffing costs at pipe manufacturer. Each employee can make 10 pipes day and is paid salary of $80 day. activity is the number of pipes ordered per day. Okay, so we can we have capacity of 10 pipes per employee and the idea is well if need more pipes than 10, got to bring in more employees. So for the first 10, I'm just bringing in the one person paying $80 day and as soon as get up to 20 pipes, got to bring in second employee. 80 bucks for them. 30 pipes, 40 pipes, and so on. And this is almost like our step fixed. The only difference here is the steps are little bit smaller. and so we would call this step variable cost. It has more of the characteristics of variable than fixed cost, but very very similar to our step fixed. The just difference is the scale. cost of private jet rental. this is problem run into all the time renting private jets as do. the cost is $500 per hour for the first four hours. think that's ridiculously low number. I've recently my Tik Tok provides me with private jet videos, which I'm not the market for this, but do watch them, so obviously Tik Tok knows I'm interested in them. there's no way it's $500 an hour. Anyway, whatever. the cost in this pretend example is $500 an hour for the first four hours and then $300 an hour thereafter. Okay. So the cost is fixed or it's it's $500 per hour for the first four hours. So the cost starts at zero, right? don't have to pay anything if don't rent the jet. After one hour it's 500. After two hour a,000 after three hours 1,500 and after four hours 2,000. It's going up from zero and then it gets cheaper. Actually, $300 per hour thereafter means the slope of my line, it doesn't go down, the slope of my line reduces. So, this is what would expect from my students. Sort of straight line. Maybe should make this line little straighter. Straight line up from the axis and then sort of kink right there. Right? There's sort of cut off where the slope decreases because my hourly rate decreases. The cost of rental car cost is flat fee of $50 day. and the first 40 kilometers are included. Then 50 cents per kilometer after the first 40. Okay, so the cost is $50. We're driving along. We're driving along. We're driving along. Then we hit some threshold where once we go over, we got to pay per kilometer. And it goes like that. And there we have it. We have completed problem 51A. As always, thanks for watching and if these videos help, hope you'll help me with thumb or sub. All right, have great day. See you in the next video. Bye-bye. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take look at problem 52A. We're asked to do the high low method, the scatterraph method, and the least squares regression method to deal with cost data. Now, something interesting and challenging. This is the challenge of module five is we have this cost information and it's little bit all over the map and what we want to do is tame it. We want to bring it into the formula for line. Now these costs are not linear necessarily. We want to tame them and make them linear so we can make some judgment about our cost information. And that's what this is all about. Hy low scatterraph le squares regression is taking some nonlinear costs and making them look like line. Now why do we do that? Well of course companies have pure variable cost and that's linear cost right it's line and they have pure fixed cost. So again the variable cost is like the cost of tires for car. Well every car has the same amount of tires. If make one car it's got you know $500 worth of tires. Two cars $1,000 worth of tires. It's linear cost. Same thing with fixed costs, like the rent on my factory building. It doesn't matter if make one car or 100 cars, pay the same rent. So, those are straightforward and there's no drama there. We learned though lot of our costs aren't like that. lot of our costs behave like, don't know, maybe like this little staircase, right? Like we saw costs that did this and we saw step fix costs that were more like this. And don't know if we did it in the the problem. I'm I'm referencing problem 51, but there's certainly costs that like curve and do all sorts of weird things. And what an assumption we make in management accounting is in the relevant range. So in the range at which this company operates, I'll make this go out little longer. We can use straight line as reasonable estimator for cost. So, for example, with this step variable cost, if were just draw straight line right up the middle, that's good enough for most estimates, most assumptions we're going to make about the company. We could just draw line through it. And same thing for this step fixed cost where we can say, okay, well, if know, you know, every 50 students got to hire new professor and the class always has 90 students. Well, know I'm always going to be in this range of the chart, right? If if this is, you know, 50 students, hire new professor and now I'm up to 90. if know I'm always going to be in this range, well, can just say, well, through that range, this behaves like fixed cost. And even the curved cost like this, can say, well, I'm never operating down here. I'm never making zero units. I'm never making billion units. My company's always operating kind of between here and here. Well, if draw straight line through it, that does good enough job estimating my cost. So, it's kind of long intro here, but it's way of saying, okay, we want our costs, we want to, we think it's reasonable that most costs can be estimated with straight line. And as soon as you can make your cost be estimated with straight line, you can do lots of powerful things. We're going to learn about it called CVP analysis, cost volume profit analysis or break even analysis. We'll learn that in mod 6. Right now though is taking nonlinear cost and this is nonlinear and making it into the formula for line. So the formula for lines says y= mx plus In math they call the dependent variable, the independent variable, is the slope, is the intercept. In accounting though, we don't use that jargon. is our total cost. It's the cost of whatever we're looking at. is our variable cost per unit. So it's our cost per unit of activity. is the activity level and is our fixed cost. So, sort of if you've done linear stuff lately, if you're familiar with y= mx plus or y= + bx, big advantage here. If you sort of have memories of that and you're like, I'm pretty solid on that. This will be easy for you. If you're shaky on it though, still don't think it's that hard. It just might require some refreshing here. Okay, so that was long intro. We're four minutes in. We haven't started the problem. Let's start the problem. We're going to do high low method here. Danny office supply shows the following data related to shipping costs for the first six months of the year. And we have this data and again it's not going to be perfectly straight line. we want to massage this to make perfectly straight line. Emulate it. The high low method that's what we're doing in part one. It says using the high low method give me y= mx plusb. Estimate the cost formula in = mx plusb format. the high low method says well let's just take the highest point on this you know the highest point on the table and the lowest point on the table and draw line between them and that's going to be our line. We'll ignore everything else. So let's do that. Let's take the high activity level whatever month has the highest activity level not cost. We ignore cost right now. The highest activity level was April. So I'm going to make that my high. The lowest activity level was June. I'm going to make that my low. So again, high low. The high low method says take the high cost, whatever the highest co the the yellow highlighted line, the month with the highest activity level, whatever the related cost was, we'll call that high cost minus low cost. want to be careful here. We could have some month like if for example January had $1,800 cost for some reason we would ignore it. We're just taking the month with the highest activity level its cost. So 1,500 minus, 1100 divided by the activity level which is the high activity level minus the low activity level. And in terms of our graph, the cost is And the number of package shift, that's our activity level. That's our And if you're thinking back to math class, this is rise overrun calculation. The change in divided by the change in gives you the slope of the line. It's going to give us our So this equals in terms of the formula. So let's let's do it. And again, think my explanation is over complicating matters. think you will see when you do it. It's not that hard. It's just there's lot going on here if you can't remember line math. Okay. High cost minus low cost. 1,500 - 1100 is 400. So 1,500 -,00 = 400. That's my numerator. My denominator is 130. My high activity minus low activity. 130 - 90 = 40. And let's remember what this is. $400 divided by 40 packages shipped. I'll just say packages, but we know it's packages shipped. So, our is $10 per package shipped. All right. So, that is our variable cost per unit. It cost me $10 per package in additional costs. So looking at the formula = mx + We have = Now we have the 10 + We got to solve for to get our formula for the line. And to do it, we just plug in either the high or the low point. So let's choose the low. I'm just randomly choosing the low. So I'm going to take June. And in June, was 90, was,00. So plug in 1,100 as to replace my 10 is still my The is 90 plus So, 1100 = 10 * 90 is 900 + = 200. So the answer to part = mx + is = which was 10 10 + 11 no 200 plus 200. So = 10 + 200 that is my answer to part okay moving on to Using your answer from part above, assuming in July the company expects to ship 150 packages, what will the cost be? Okay, so it's giving us this is This is the activity level. We have our cost formula = 10x + 200. So = 10 in July. is going to be 150 + 200. =,500 + 200. =700. That's my answer to part So we've answered and we've answered that like subp part Okay, that's it for 52A part one. We've done the high low method. In the next part of the video, we will do scatter graph. Thanks so much for watching. If these videos help you, hope you'll help me. And I'll see you in the next video. Thanks for watching. Bye-bye. Okay, we just worked through 52A doing the high low method. In this part of the video, we're going to do the scatter graph method. So, it says using the scatterraph method, estimate the cost formula. 10 by 10 grid is provided below. This question, students lose marks probably not for the scatterraph, but for not doing good job on their axis, not doing good job with their labels. And here's what mean. let's look at the cost. So cost is the ais. So cost goes on the and packages shipped goes on the And what students screw up here is you can see it's like goes from 1,100 at the low to 1500 at the high. They'll like do something like this. They'll go this is wrong. So don't do this. They'll go zero. That's starts there and then they'll go a,00200,300 something like this, right? And that's, you know, it seems like reasonable thing to do, except for it's totally wrong. And what is totally wrong about it? The gap between here and here is thousand, but it's one square, right? On my graph paper, the graph between here and here is 100, and it's also one square. We need to draw this to scale or you will screw up your line. You will mess things up. I've seen it. I've I'm professor. I've been doing this for years. People screw things up. So, what does that mean in terms of their cost? Don't skip anything. So, I'm going to say, okay, it goes up to 1500. I'm going to make this 2,000 at the top. 2,000. So, halfway down, 1 2 3 4 5 because it's 10 10. This is a,000. And that means every cell is worth 200. So, 200, 400, 600, 800, 1,000, 1,200, 14, 16, and 1800. Okay, now I'm setting myself up for success because haven't skipped anything, right? 0 to 200. Every every jump is 200 jump increment. Skipping up, if had started at th00and things get wonky. so don't skip if you're asked to do scatter graph and you have to label the axis. So for packages 130 is our high point. I'm just gonna make it 200 again. Or yeah, two, it was 2,000. I'm going to make this one 200. so I'm going to go so this is again 0 20 40 60 80 100 120 140 160 180 200. Okay, so there we have it. have this labeled beautifully. Now need to plot my points. Scatter graph method, you just plot the points into the graph. So January is 100, 1200. So 1,200 on my ais, 100 on the x- axis. It's right there. sorry, something weird happened with my calculator. 120 and 1300. Okay, so 120 1300 is halfway in between. There we go. 125 1350. this is kind of ugly. and 1350. All right. Right there. I'm guessing 130 and500. 130,500. So it's halfway right in the middle of that one. 110 and 1,400. 110 halfway and 1,400 right on the line there. And last but not least, 90 and 1100. 90 and 1100. So it's halfway. It's right in the middle of this one. Okay. So there is my data. Now have to and this is the toughest part of this. got to draw line through it. So it's useful if you have ruler. but you just got to draw straight line that you think represents this data well straight line through this information which is not always easy right but we'll do our best. So draw got ruler out. I'm going to draw line through. Let's see. want to make it sort of match the what perceive to be the slope. Now again, this is human perception and it could be, you know, flawed, but yeah, think I'm can't decide. I'm going to go there. I'm going to do it right there. All right. So, let me draw the line maybe in pink ink. Let's make it stand out bit. this is way too thick. got the wrong pen. let me make this pen smaller. There we go. Okay. So, drawing my line, doing my best. Sure, there's my line. think I've done reasonable job drawing line through that data. You're just doing your best. They call it visual inspection line. You're saying, I'm drawing line that think fits this data. And, you know, it's straight line, and you got to draw it all the way to the axis, right? okay. So, we want to do our y= mx plusb formula here. So, I'm looking for = mx plusb. And the first thing is we have the Wherever it crossed the line is our I'm going to say it's basically right on 400. Maybe 399 if I'm being real particular. I'm Yeah, I'm going to say let's say 400. It really does look like it it crossed right at the didn't do that on purpose, by the way. It's just kind of how it how the cookie crumbled there. So, I'm going to say based on this equals 400 for me. Now, your line might be different. It's useful maybe if you're following along with me, you draw the same line, but your line might be slightly different. That's why it's pain for professor because, you know, you can have lot of students with slightly different lines and you mark them right because they're close enough. but there you go. My line says is 400. Okay, so 400 goes into the formula. Now, what about the other one? have to pick point where the line goes through. So, either this one or this one. I'm going to pick this one just cuz it really looks like it went through it, but this one could be just about as good. So, I'm going to choose point where think the data went through. And figure out what it was. It was 1,1200. What month was that? Oops, moved that by mistake. 1,00 or 11,200. It was January. Okay. So, I'm choosing January as good point. So in January, was 100 and was 1,200. So there we go. My and my 100 and 1,200. So plug that in here. go, okay, well my is 1,200. My is 100. And now solve for right? is unknown. So got the the intercept is 400. got mean the fixed cost is 400. got my and my Now just have to solve for So, okay, let's take away 400 from both sides. have 800 = 100 = 8. There we go. So, my formula for the line using scatter graph is = mx. So, 8x + + 400. That would be my formula and my answer for part All right, we've we've made it to the end of our scatter graph. Now, your answer could be slightly different. And as mentioned, all student answers when do this in class are going to be slightly off. They might you might look at this exact same line and say 399. You might look at this exact same line and you might have chosen that point and think that's better point. And would mark students right with variety of answers here. That's challenge of visual inspection. And that's knock against visual inspection. Every answer is going to be little bit different. The advantage of visual inspection of scatter graph method is uses all the data right high low you just take the the two extremes the highest and lowest scatterraph you kind of use everything to to shape your line. The disadvantage of the scatterraph method is it uses human judgment right your eyeballs might see something different here than my eyeballs see. So in part we'll do the least squares regression which is sort of the best of all worlds solution. So stay tuned for part Thanks for watching. Bye-bye. Welcome back. We've been working through problem 52A. In part one of the video, we learned the high low method and we estimated our cost formula y= mx plusb using the high low method. In part we plotted this on graph and did the scatterraph method. Now, in part we're going to use Excel to do least squares regression. At the very end of the video, I'll show you how do this if had to do it by hand, but honestly wouldn't want to. Doing le squares regression by hand is just tedious. It's not that hard, but it is tedious. There's lots of steps, but I'll show you those steps at the end of the video for those that need it. But if you're just wanting to lease squares regression the simplest way, spreadsheet software is the way to go. So, I've loaded this data, this cost data into an Excel file and I've put it on my website. You can download it there. So, tonybell.com. You click on templates and scroll down and ma mod 5 excel data. That one. Click that to download it. I've already got it open here. where is it? Here it is. Oops. Here's the data. So, that it's got 52A, 52B, 53, and so on. But we're we're looking at 52. So, the simplest way to do this I'll show you two ways. think the easiest quickest way is we're looking for y= mx plus right? = mx + And there's two kind of quick ways to get at it. First way is you go, okay, well, what we need is the slope, the and the intercept, the And excel has functions for that. So you go slope equals slope, and it says known y's. Well, y's are the shipping cost, comma, known x's. So you just highlight your y's, you highlight your x's, you hit enter. That's the slope. So that's the So that's our And what's our Well, you do the exact same thing, but this time you type intercept. So equals intercept bracket known y's, comma, known x's, close bracket, and that's our So, = mx plus = 8.105x + 396.49. That's the formula. We've done it. So, there you go. actually don't do it this way, though. like to see the graph. So, tell Excel to make graph. Here's how you tell Excel to make graph. You highlight your data. You say insert. And then there's charts here. And it's this one. We're looking for scatter graph. And you can see it's scatter graph. So there's our scatter graph. Lovely scatter graph. And it's actually very similar to the one that we drew by hand. And now just want Excel to like draw line. So click on the data. rightclick. say add trend line. And Excel adds trend line. And on it can just say set inter not set intercept rather display equation on chart. And that's the information was looking for. Right? Here's the number. = 8.1x + 396. It's the same, right? Like it's it's the number we got there. = 8.1x + 396.49. And so that's my answer, right? That is the answer. And you know, good news was we did good job on our scatterraph. We don't don't always do so well, but you can see my scatterraph answer quite close to the better answer here, the least squares regression method answer. So, it's not that hard when you get Excel to do the work. we'll do part and then I'll show you how if had to do that least squares regression by hand. I'll show you how would do it and the math behind it. So, are there any factors other than the number of packages shipped? So I'm doing that may contribute to variation in shipping cost. Yes, there are number of factors. so when ask question like this, I'm just looking for students to give plausible reason, right? I'm not looking for perfection here, but here's the reasons that are coming to my mind. What could cause shipping costs to go up? Well, the distance shipped. Maybe you have customer that's in Tokyo and you've been normally shipping just, you know, in your region and all of sudden you got to ship around the world. Like that would cause the cost to go up. Fuel costs, you know, oil costs going up. Well, shipping costs are going up. Maybe even minimum wages changing and the shipper therefore has to raise their wages and and therefore prices go up. That's possibility. Maybe that's longer shot. Could be weather. Weather can screw with shipping, make it slower. Anyways, think fuel cost immediately comes to mind and shipping distance think are great answers. The other two maybe I'm stretching, but would accept those as answers, but I'm just looking for like students to spitball reason that this might have happened. Okay, think at this point, if you don't want to work through the regression by hand, think you should say goodbye. think, you know, smash the thumbs up button, hit the subscribe button, share with your friends, whatever you want to do. but if you're hardcore person that wants the math, let's do the math of the regression by say by hand. I'm going to do it in Excel, but I'm not going to make Excel do the work. I'm going to do the work myself. So, let me put the chart title down there. I'll move this maybe down just touch. Get it because want to work here. So, the first thing you need is averages. And and let's remember number of packages shipped before do that is our variable, right? If we're thinking of and and shipping cost, of course, is our variable. just want to remind you of that. Okay, so need my average and need my average So, oops, averageages. And to do it in Excel, take an average. Now, again, if had to do this by hand, could do an average. You add the six numbers up, you divide by six, you would get that number. But Excel makes it quicker. Now want to know the difference between any item and the average how what the dispersion is between the two. So we take minus average and what do mean by that? Well, again, 100 - 112, right? So, it's -12. And we do use negative number. 120 - 112. And guess can fill this down in Excel. need to put dollar signs to lock in the formula. and we fill down. And there you go. Right. So, 125 - 112 is 12.5 and so on. Okay. - Now need to do the same thing with my minus average And we're just getting an idea for the variability and the distance from that average of each item. so again, minus average equals this minus this. So 108. don't like the format here. Let's see. Can change this? got to change this cell to format cells general. That's what I'm looking for. okay. So, let me put dollar signs here and fill this one down. it it changed like just told it to not do this. format cells general. Yeah, that's all I'm looking for. Okay, there we go. So we got our minus average And again, that's to get the sort of the distance between each number and the average. Now, here's where I'm not mathematician. know what to do, but kind of don't deeply understand the why we have to do column squared. That's the next one. Wrap text here. Column squared. And then the next column is column times column And again, it's like math professor might be able to give you deep intellectual reasons as to why. just know, we're doing aggression. This is what we do. So, equals that squared. So, column squared. can fill that down. and then column times column And we fill that one down. And you know, said I'm going to show you how to do this by hand. know this isn't being done by hand. could do all this in calculator, right? This is not hard math. It would just take few more minutes, and don't want to spend that time. don't worry I'm wasting the time. so now we need totals. have vivid memories of learning about this in school and my professor saying you take the sum of the squared differences and that's what we're doing here, right? We're taking the sum here. So sum this up 118.57. We sum this one up and then take this number which did involve our variable. This one only involved x's. This one involved y's. Take this one divided by that one and you get the slope. So the is going to be this number divided by that number 8.105263. And you can see that's what we had got just when we did the slope calculation earlier. So there's the slope. How do get the oops sorry that's got to fill this or not fill this down but pull it down. How do get the Well, the I'm doing y= mx plus And we just plug in the averages for the average and the average We plug those in as the and the And we can solve for because again, we know the formula for line is = mx + And if we use the we know it's 1308 blah blah blah. Let's get couple decimals here. 13.08.333. 08.333 equals 8.1 no wait we know 112.5 plus right so now we just have to solve for doing algebra so equals 1308.3333 actually can just use the the actual number 1308.333 3 33 3 minus 8.1 * 112. so that's what equals. Let's see what it equals. 396.49. And look, we got that earlier. 396.49. So that's how you you could do that by hand if you were sort of forced to or had to for your class. It's long, right? It's pretty tedious process to do in calculator. Was long and tedious in Excel. think could do it more quickly in Excel if wasn't explaining each step. But anyway, we we've done it now. And do hope this video helped. If you made it to the end, for goodness sakes, good for you. That's I'm impressed. think most people will have left once we started doing it by hand. But now you know how to do le squares regression by hand. do hope the video helped and if it helped you, hope you'll help me. Thanks for watching. See you in the next video. Goodbye. Welcome to module six of our class on management accounting. This is, think, my favorite module of the whole course. think by the end of this video, you're going to be racing to the comments saying, "Wow, this is so cool." And feel lucky. If you haven't heard of CVP analysis or break even analysis, feel like I'm lucky guy because I'm the first guy who gets to share it with you. What cool opportunity have. hope do it justice because it's great topic. So last chapter we got pretty fixated on separating our costs into variable and fixed. said we get to you do powerful stuff with that information and I'm going to show you now. So it's very real. had friend who was thinking about renting out floor of her house as an Airbnb, right? She was thinking about doing short-term rentals with part of her house. And she said, "Well, you're CPA. You're an accountant. maybe you can help me crunch some of the numbers. said, "Absolutely. You've come to the right guy." Because was thinking in my mind, "Oo, get to CVP. This is like such fun topic for me." And so asked her, first question is like, "What are you going to charge?" Like, "How much do will you charge per night?" And she said her, her guess was she'd charge about $75. So her sales price is going to be $75 night. And then said, "Okay, well, what are your nightly costs?" you know, maybe in terms of making up the rooms, laundry, Airbnb fees, you know, what do you think the costs are per customer out of the 75? And she said, the variable costs, you know, would be about $25 per customer. And said, okay, well, that means you'll have contribution margin of $50. You're making 50 bucks off every customer. Okay. Then we started discussing fixed costs things like well what's that you know the share of for example depreciation you're having people stay in the room for the year it's wearing and tearing your asset what do you think your depreciation cost is and various other fixed costs you know we said we should allocate some share of the property taxes they're taking your space this you know this 2,000 foot house they're taking 500 square feet they should get 25% of the property taxes allocated to and we allocated bunch of fixed costs and we came to $15,000 of fixed expenses associated with just giving up that four. So, okay, those were our costs and that's where that's all we needed to do some very powerful things. And always think of CVP analysis, break even analysis as sniff test. Is this idea on paper, just on paper, is it good idea? Is it going to work? And if not, can tweak anything to make it work? And I'll provide you with some formulas for CVP analysis. And we'll go through each of these in the videos for the chapter. but the key one, and this is probably the number one formula of the whole chapter is this concept of break even point. Break even point just says this is the amount of sales need to make not to make money, but not to lose money. This is the amount of sales where profit is zero. And it's an important number to know. Not that you're dreaming of having zero dollars in profit, but it's just good to like set the table. Can get to this level? If can get to this level, then I'm breaking even. And and you hear businesses, people talk about like breaking even all the time. It's an important number to know. So, let's figure out my friend's break even point. Fixed expenses divided by CM per unit. So, break even is fixed expenses. Sorry, my writing's little messy. I'm not going to apologize. It's my writing. like it. Fixed expenses divided by CM per unit. Fixed expenses are $15,000. CM per unit per night is $50. It's 300. Now, normal companies, 300 units, right? You're selling bottles of pop or whatever it is. You're selling 300 units. This is 300 nights of rental, right? nights, rental nights. So, this is 300 nights that my Airbnb is rented out. And so, asked her, said, "Is that reasonable? Do you think you can rent it out for 300 nights?" She said, "Yeah." said, "Well, it still isn't great news, even though we think you could break even if you ran this." And the reason is you ought to make money, don't you? Like, you're not doing this for free. At this point, you're doing some basically charity labor to to put people up in your house. maybe maybe you're into it and you're you want to meet new people, but if you're looking to make money, you know, 300 means you're breaking even. said, "Well, how much money would you like to make? Would you like to make some money?" And she said, "Yes, I'm hoping to make and you know, we're again just spitballing at this point. We're not locked in, but she said, "I'd like to make 20 25,000 year." said, "Okay, let's use 25 as our number." And again back to the formula sheet went and it's this formula that we used which is fixed expenses which were 15k plus target profit how much money you want to make she operating income pre-tax profit she wanted to make 25 grand divided by cm per unit which for her was we said $50 was her contribution margin per unit. So, let's crunch those numbers now. 15,000 + 25,000 divided by 50 is 800. So, she would have to if she wants to hit her goal of making $25,000, she would have to have 800 rental nights on the property in the year. Now, hope you're seeing the problem. There aren't 800 nights in year. She would have to like double the capacity or basically something's got to change. Maybe she could split the thing in two and rent out to two people at once. don't know. But it wasn't going to work as it was conceived. And that's what CVP analysis allows you to do. It sort of allows you to take an idea. So, whenever student's making business plan for class, always say, "You got to do this. You got to do this." Because you can really see if the idea stinks or not. And her idea as conceived was not going to work. And so said, "Well, look, like what can we change about this? You can either increase your price or reduce some of the costs." Now, the variable costs really were not negotiable, right? Airbnb takes fee. The got to do laundry, got to do cleaning. All those costs were not negotiable. There were some fixed costs that we were able to reduce, and we brought down the fixed cost. But the big thing for her was we looked up the price of other Airbnbs in our neighborhood, and they were all like $200. She was way underpriced for the market. And so said, "Well, you should price $200." They're all priced $200. She's like kind person. She priced at like $140 or something, maybe 150. She did raise her proposed price. And at that point, the numbers started to pencil out. Things started to make sense when she priced it more reasonably, but it didn't pass the sniff test. Right? That's how we knew, she's got to change some things to make this make sense. So, find this to be one of, if not the most useful tool we learn in the course. It's certainly on the list, and it is my favorite subject. The best way to learn it, though, is to do examples. I'm so glad you're here with me, and can't wait to get started. See you in the next video. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take look at problem 61A. Charming Clotheers manufactures neck ties. The company has the following information. Company's sales price is $30 unit. The variable cost of producing the neck ties is $18 unit. Company expects to have fixed cost of $60,000 next year and the company expects to sell $8,000 neck ties next year. Assume no taxes. So before jump into any of the ABCD stuff, the required here when get CVP problem, always want to lay it out my own way. always want to lasso the information and organize it. And here's how I'd encourage you to organize it. This is an optional step, but think it's useful one. So start by constructing an income statement. And I'm going to do sales variable expenses. Sales minus variable expenses is contribution margin as we will learn this chapter or have learned in the intro video to the chapter. minus fixed expenses equals our operating income. And if we had taxes we would take away taxes to get net income. But there's no taxes in this one. And do sort of three section income statement. The first section is per unit. So want to know sales per unit, variable cost per unit. Then do total and then do percentages. So let's see if we can lasso this information into this form. so my sales per unit is $30. My variable expenses per unit $18 and the CM the contribution margin per unit is 12. In total, this person expects to sell 8,000 units. So I'll just put 8,000 oops 8,000 units at the top here. And 30 time 8,000. guess that's $240,000. 30 time 8,000. Yeah. 240,000. Our variable expenses $18 per unit. And again, we're going to sell $8,000. So $144,000. Our CM 12* $8,000. That's $96,000. Now, you'll notice didn't do fixed expenses or operating income per unit. We do not need to do this, but we we absolutely do need to do it for totals. Our fixed expenses are 60. And therefore, our operating income, our income before tax is 36. And as percentages, we just state the top three items as percentage of sales. So sales is, of course, 100%. variable expenses 144 divided by 240 60% and therefore our contribution margin is going to be 40%. We can just double check that 96 divided by 240 yes it's 40%. Okay. So, always try to lay this out before begin the question. And if have this laid out in this way, and sometimes there'll be like one missing piece of information. You got to fill in the blanks or work backwards. But once you have this laid out, find the math here very straightforward, particularly if I'm given formula sheet. If you're not given formula sheet, there's few key formulas to memorize. So, take it as like once you've done few of these, you'll know sales minus variable expenses, contribution margin. The key formula outside of that is this one. Break even units is sort of like the cornerstone of the whole thing. Really focus on that one. You'll see it as you're practicing. You're going to see this over and over again. It's fixed expenses divided by CM per unit. And that's the first one we're asked for. It says calculate break even units. All right. So our break even units is fixed expenses divided by CM per unit. Our company's fixed expenses 60,000. Our CM per unit 12 60,000 / 12 5,000 units. So we need to sell 5,000 units to break even. Now it says calculate the break even dollars. don't need to look back at my formula table to go, well, if need 5,000 units to break even and sell these things for $30 each, that's $150,000 in sales. So, my break even sales in dollars, my break even point in dollars is $150,000. This is great moment if you are starting your own business and you just sort of crunch these numbers. You know, you're roughing in the numbers. It's useful to go, do think can sell 5,000 units? You know, yes or no. If can't sell 5,000 units, this is money loser and maybe shouldn't do it. If can't make $150,000 in sales revenue in the first year, I'm in trouble, right? So, that's something to contemplate. And and that's why this is so useful when you're starting business or you're planning ahead. What useful tool to have if you're able to be honest with yourself about those estimates. how many units must the company sell to reach target operating income of $50,000? Okay, so our target operating income is $1 and no, it's it's 50,000, not 150. And we're looking at formula 7. Now, if you're looking for where these formulas are, they're just in my workbook, tonybell.com. And it's just at the start of the chapter, you'll see this formula list. fixed expenses plus target operating income divided by CM per unit. forget what were my fixed expenses. They were 60. My target operating income was 50. And my CM per unit, think, was 12. Yeah, 12 was my CM per unit. So 50 60 + 50 / 60,000 + 50,000 divided by 12 91666.666 so need to sell 9167 units to hit that target profit. So the answer here is 9167 units. we do round up when we get decimal answer for break even points because you can't sell 6 neck ties. Even it was like 3 91.33 we would round up to the next number. Even though.3 you normally round down with break even. You round up. okay. So let's see. How many units do have to sell to reach target income of $50,000? Now again, can say to the entrepreneur or if I'm the entrepreneur, can say to myself, well, only think I'm going to sell 8,000, but really want to sell 9,100, is this reasonable? And the answer here maybe is yes, right? It's like, okay, got to be 10% better than what I'm planning on. You know, think could get there theoretically. But if the answer here is, whoa, this is outrageous, you might have to twe tweak your business plan, right? You might have to change some element of the business plan. Or maybe that's signal it's not good business. This one though, would think well, we're in the ballpark. Anyway, let's move on to says, "Prepare budgeted contribution format income statement." We've kind of done rough one. When an accounting textbook asks you to prepare an income statement, though, it's typically looking for like threeline title and proper formatting. So, let's provide that. mean, this is the information. It's right here in this middle column. We've done it. We got all the information we need, but let's do it play ball with the question. So, threeline title, we would start with the name of our company, Charming Clotheers. Then we do the name of the statement we're preparing, which is contribution format income statement or budgeted contribution format income statement. and then the year end and the date. So for the year ended and then the date, we'll just assume it's calendar year. December 31st. I'll make sure this is for year, right? Following information. Yeah, it's for year. Okay. so then we just go down our accounts, right? So it's going to be sales rev variable expenses. Now again traditional income statement conventional one would be sales minus cogs is gross profit. Then our operating expenses. This is sales variable expenses. The subtotal is not gross margin or gross profit but contribution margin minus fixed expenses equals operating income. Now if we had taxes we would go minus income tax equals net income. But this is it. Like we just stop there. So our sales, well we have it all here. It's all these numbers. 240 for sales, 144 for variable expenses. what is it? 96 for contribution margin, 60 for fixed expenses and 36,000 for our operating income. Dollar signs at the top and bottom of each of these because we do want to have good formatting here. And there we've got our answer for on the screen. And so that's what was asked for. We kind of did that in setting up the question, but here we've done it properly formatted and nobody can complain about that. Well, our professor can't complain about that if that's what we hand in. Let's do email. Compute the margin of safety. State your answer as percentage. All right. Safety margin. Budgeted sales minus break even sales divided by budgeted sales. That's this formula here. That's our margin of safety. What is our budgeted sales? Our budgeted sales is well, we expect to sell 8,000 units, so $240,000. So our budget sales, I'm going to do it here. Budget sales is $240,000. What about our break even sales? We want the answer to part $150,000. That's how many That's how much have to sell to break even. So that's my break even sales 150. and we divide by budgeted sales. So again 240 minus 150 divided by 240 240 minus 150 divided by 240.375 and it says state that as percentage. So 0.375 which is 37.5%. Okay, so that's our answer. But what the heck does it mean? 37.5% is the answer. That's our margin of safety. What does it mean? It means can blow the budget. can miss the budget by 37% and I'm still breaking even. So, it means it's how much wiggle room you have, right? How much room for error. You know, we're we're projecting the future. We can be about 37% off and we're still okay. We're still breaking even. That's what the margin of safety is. It's how much room do have to be wrong about my sales estimates? Okay. so we've gone through 618 parts ABCDE Part asks us to compute the degree of operating leverage. And that's confusing tricky concept. So I'm going to pause this video here. Well, I'll stop it here and we're going to pick up parts and in its own video just on operating leverage because think it's challenging concept. It's one that my students get wrong all the time and want to devote longer amount of time to explain it and then to solve parts and But that'll be in the next part of this video. Thanks so much for watching and I'll see you there. Welcome back. We've been working through problem 61A and it has been going fantastically well. We got down to part and said, operating leverage, that's kind of tricky. want to devote its own video to and which are both related to operating leverage and want to explain the concept of operating leverage. want to illustrate it with these two companies. think by the end of this you're going to have pretty good understanding what operating leverage is. so we have two companies. Let's assume they're in the same industry. Let's assume they're competitors. And on the face of it they look pretty similar. They sell the exact same amount. They both have the exact same amount of operating profit. very similar companies except for variable company has most of its expenses are variable and fixed expense fixed company and most of its expenses are fixed that's the big difference between the two companies well we would say that fixed inc has much higher operating leverage than variable company and that's not compliment or an insult that's just an observation and let's explain by calculating the operating leverage of both of these companies it's PM divided by operating income. So for variable company it's 30 divided by 10. It's operating leverage is three, right? 30,000 divided by 10,000 CM divided by operating income. So again 30 divided by 10 think we can all do the math in our head. It's three 3.0 and it's and that's just number. It's not percentage or dollar amount. That's just number. And for fixed ink their operating leverage CM80 divided by 10 you can see it's eight. So it has higher operating leverage. What does operating leverage mean? It means how swingy are profits compared to change in sales. So here's how to think of it. For every x% increase in sales, operating income will increase by times the operating leverage. So if sales for example go up 10%, let's just say both companies are projecting sales are going to go up 10% next year. So they both think sales are going to go up by 10%. Operating income will increase by 10% times that operating leverage factor. So for variable company, operating income is going to go up by 10% times 3%. For fixed company, operating income is going to go up by 10% times 8%. Now, it also works going down. So, fixed company is riskier than variable company, but they have bigger upside as well. And that should make intuitive sense, right? If fixed company's sales really, really drop, well, it's stuck with all these fixed costs. The fixed costs don't drop. If variable company sales really really drop, well their variable costs drop with them and most their costs are variable. This is way of discussing that relationship. So let me just prove what just said. So let's just say both companies sales do go up by 10%. So this goes up by 10%. So it becomes $110,000. This is plus 10% because variable costs go up if sales go up. So this is $77,000. 110 minus 77 is 33,000. Fixed expenses remain the same. So fixed expenses are 20 and our our operating income goes up to 13,000. Well, wouldn't you know it, that's 30% increase. So we we didn't need to recreate the income statement to go, variable company, if its sales go up by 10%. Its operating profits are going up by 30%. Let's look at fixed company which we said operating profits are going to go up by 80%. The sales go up by 10% so again to 110. Variable expenses go up by 10% so to 22,000. 110 minus 22,000 is 88,000. fixed expenses stay at 70 because they're fixed and our operating income goes up to my handwriting is little messy. $18,000. So yeah, it went up from 10 to 18. That is an 80% increase, right? And the math is 10,000 times.8 $8,000. It went up by $8,000. That's an 80% increase. So that's how operating leverage works. The higher the operating fac operating leverage factor, the more the profits will swing based on change in sales. And there are companies with very low operating leverage factors, very high. And that speaks to their strategies or just operating styles. so let's return to our problem. Now, we were working through Charming Clothe years, and it says, compute the degree of operating leverage, which is just that formula, the operating leverage factor there. CM divided by operating income. So what is our CM? 96,000. Our operating income is 36,000. So 96,000 / 36,000. Our operating leverage is 2.6666. So the answer is 2.6667. And that's our operating leverage factor. it says if sales go up by 20% next year, how much is operating income going to increase? Well, if sales go up by 20%. operating income is going to go up by 20% times 2.6667 is going to go up by 53.333%. Now, what does that look like? Well, it was at 36,000. So, 36,000 time 53333 is $19,200. So, we think operating income is going to go up plus $19,200. so again, OP, Inc. is going up by $19,200. That's it. We've answered but let's just kind of prove it. Let's say sales do go up by 20%. What are our new sales? If sales go up by 20%, they were 240 times 1.2 they're going to be 288. If sales go up by 2%, variable expense or 20%, variable expenses also go up by 20%. So, times 1.2 172800. minus 172800 gives us our new contribution margin 115200 and our fixed expenses remain 60. So 115 minus 1152 minus 60 is 55,200 which the math works both ways was an increase of $19,200 and was also an increase of 53.333 repeating percent. So yes, we've solved it. This step was not asked for. This was just me sort of freestyling to explain to you what's going on here. But this actually you could do very quickly. You could say our operating leverage factor was 2.66. If sales go up 20%, operating income's going up 53%. There we have it. We've solved the operating leverage portion of problem 61A. As always, hope my videos are helping. That's why make them. If they're helping you, hope you'll help me with thumb or sub. Have great day. See you in the next video. Bye-bye. Let's examine problem 63A. CVP analysis with some whatif analysis. So because we've broken our costs into variable and fixed components, it enables us to sort of test things out, say, what if made this change? What would my income statement look like then? And so that's what we'll be doing in this problem after we do some break even calculations. Humans inc projected contribution format income statement for the upcoming year is shown below and we can see the income statement there. Now, always like to do per unit as well as percentages. So, $2 million and we're selling 10,000 units. $2 million divided by 10,000 units means our price is $200 unit. Our variable expense is 1400, no 14 1.4 million rather, divided by 10,000 units. It's $140 unit. And you can see it's going to be $60 unit here. Let me make that 200 even clearer. Okay. As percentages, we set everything as percentage of sales. This is 100%. 2 million divided by 2 million. 1.4 million divided by 2 million is 70 and 600,000 divided by 2 million is 30%. So question didn't ask for it, but you know it's implied there with those blank spaces. It says compute the break even point in units. Hopefully you've got this memorized by now, but if you don't, there is formula sheet at the start of the chapter and this is the key formula, probably the key formula of the whole chapter. Break even point in units is fixed expenses divided by contribution margin per unit. Our company's fixed expenses $480,000. Our contribution margin per unit 60. Okay. So, $480,000 divided by 60 means we need to sell 8,000 units if we wish to break even. Our break even point in units is 8,000 units. And I'll just prove that right now. You don't have to do this. This wasn't asked, but break even point in units is the point at which profit is at zero. So, if sold 8,000 units, that's 1.6 million. 8,000 * 200 8,000 * 140 is our variable cost 1120120 sales minus variable expenses 160 minus 1120 is 480 that's our contribution margin and look at that our fixed expenses are our profit therefore is zero row. So, just wanted to prove that at 8,000 units, we were breaking even. We weren't making any profit. We weren't making any loss. What's the break even point in dollars? Should be pretty easy here. we sell at $200 unit. We need to sell 8,000 units to break even. just did it. It's 1.6 million would be our break even point in dollars. And that's just 8,000 units times 200 bucks unit. If the company wishes to earn target operating income of $300,000, how many units must be sold? okay. Well, let's see. We're going to use this formula. Our fixed expenses, and our fixed expenses were 480 plus target income. Our target income was 300 divided by CM per unit. And CM per unit was 60. So 480,000 plus 300,000 780 / 60 13,000 units. So let's remind ourselves what that means. It means, of course, we're not in this business to break even. We have goals and our goal is to make 300 grand. If want to make $300,000, I've got to sell 13,000 units in order to do so. And you can see that's higher than what I'm expecting to sell. I'm expecting to sell 10,000 units. So, need 30% uplift in my sales if want to hit my goal of making $300,000. Compute the margin of safety. The margin of safety is budget sales minus break even sales divided by budget sales. Here's the formula. And so it's just our plan sales, which were, think, $2 million, minus our break even sales, which I'm going off memory here. 1.6 million divided by budgeted sales. Oops, 2 million. Let's just make sure I've got those numbers right. Yes, 2 million is the budget sales. 1.6 is our break even sales in dollars. So 2 million minus 1.6 6 million 400,000 of course this was in brackets divided by 2 million 20%. What the heck does that mean? It's percentage. So the margin of safety is percentage and it's 20%. It means if miss my sales target by 20%. If I'm 20% worse than projected, I'm still okay. I'm still going to break even. That's the how much wiggle room have, right? To be wrong. It's our margin of safety. It's how safe we are. our projections can be wrong by 20%. And we'll still be breaking even. We won't be losing money. Okay, so that was the first part and those were all just calculations we learned in problem like 61 and 62. what we add to it is just we are going to redo our income statement couple of different ways because having variable and fixed expenses split out allows us to like what if this happened? What if that happened? So the ENF here are the what if parts. It says the company's manager thinks that increasing advertising by $150,000, that's fixed expense, will increase sales by $250,000. If he's correct, what's the dollar advantage or disadvantage of making the change? All right, few ways to do it. I'll tell you the way would do it, but and then I'll show you quicker way. The way would do this is I'd go, "Well, how many units are we going to sell? What's the increase in sales in units?" Well, if we're increasing sales and revenue by 250 and we're still selling for 200 bucks unit, he's saying can add 1,250 units to the sales. So, the the old sales were 10,000. The new sales are at,1250 units. Then just redo the income statement at 11250 units. And keep in mind my fixed costs are going up by 150k. So, let's let's do that. so if know I'm selling,250 units times by $200 unit, it means my new sales are $2250. And of course, that's an increase of $250,000 as projected. Our variable expenses 140 * 11250750 minus15750 means we're making $675,000 in contribution margin. What about our fixed expenses? Our fixed expenses were 480 and we're saying they're going up by 150. So 480 + 150 is 630. So our new fixed expenses are 630. 675 minus 630 $45,000. Well, you can see we're worse off if we do this right. If we just stick to the plan, we're thinking we'll make 120. If we follow this person's plan and everything goes perfectly, we're making 45 grand. It's bad idea. We're going to make less money. How much less? 20US 45,000 $75,000 worse off. So we would say there's disadvantage disadvantage of $75,000. Don't do it. Okay. So that is my answer for Now, id said there's shorter way to do this, and there is. The way might do, actually, would do the income statement. That's the way my brain operates. But you could do it much more simply than that. You could go, okay, if sales go up by 250, CM is going to go up by 250 times the CM ratio times that 30%. So 250 times.3 CM goes up by $75,000. And if if CM goes up by $75,000 and at the same time fixed expenses go up by what is it? 150. So fixed expenses go up by 150. So my contribution goes up by 75. Fixed expenses go up by 150. You can see like contribution margin is good. fixed expenses is bad. Well, the the bad outweighs the good by $75,000, right? That's you know, quick way to do it. And again, if were doing this by in my head, wouldn't even write it all out. I'd just go, yeah, we are going to be 75 grand worse off." Okay, last one. part refer to the original data. the company's manager believes that it is slight using slightly cheaper direct material will decrease variable expenses per unit by 10%. and it will reduce units sold by 5%. So if we use cheaper direct material, our costs are going to go down, but we will sell bit less because you know customers might be turned off by the cheaper material. If he's correct, what's the dollar advantage or disadvantage of making the change? So, we're going to drop our variable expenses by 10%. And we're going to drop our units sold by 5%. Okay. So, make new income statement. What's my new unit sold? So, we're starting from again it says refer to the original data. So, we're starting from 10,000 not 11250. So, 10,000. I'm going to drop my sales in units by 500. So, it's going to be units, right? reduction of 5%. My price doesn't change. So my sales is 200 * 9500 200 * 9500 1.9 million. And again that's sales of $200 unit. And my variable expenses those do drop by 10%. They go from 140 down by 10%. So 140 time.1 they go down by $14 dollar unit. So down to what is that 126 right? 140 minus4 126 and I'm selling 9500 units. So times 9500. So it's 1 comma 1 197 sales minus variable expenses equals contribution margin. So I'm at 703,000. Okay. Onto our fixed expenses. Our fixed expenses do not change. So they were 480. They are still 480. And that brings us down to our new net operating income or income before tax. And there is no tax in this question. So 703 minus 480 is $223,000. So that compares quite favorably to our old operating income of 120 to 223. We have an advantage. It looks like we're $103,000 apart, right? 223 minus1 120. Yeah, it's $103,000. If we make this change and if all the things that this person's saying come to pass, we will be at an advantage of $103,000. So, do it would be our feedback here. Now again, million other variables exist in these whatifs, like what if there's an internet campaign saying, "Hey, they changed to sucky material and we don't like the product and maybe our sales drop by more than 5%." That's possible. There's lot of things that could happen, but just on the numbers, we would say do it. Now, there's qualitative factors have to be considered. They're not considered here, but one would absolutely have to think about that. You know, changing the machining, buying new material, maybe it's new supplier. There's lot of things that you'd have to consider. And there's one last thing for you to consider. Hit the thumbs up on the way out. Well, at least hope you'll consider it. All right, thanks for watching. See you in the next video. Bye for now. Let's take run through problem six for multi-product CVP. So, it takes that break even analysis that we've been learning all chapter and it adds an extra quirk, which is what happens when the company sells bunch of different products? How do get break even point? Well, we're about to find out. Awesome. Axes sells electric guitars. The company sells three models of guitar. The Enthusiast, the Jammer, and the Pro. Information related to next year's budget for all three models follows. there's our sales in units, sales price, variable cost. know based on how we've done so far this chapter that I'm going to want CM per unit, which is just the sales price minus the variable cost. don't know when I'm going to need it, but think I'm going to need it. 200 - 120 is 80. 500 - 200 is 300. And 3,000 - 800, wow, it's fancy, is 2200. So, that's just sort of number that expect I'm going to need. Well, spoiler alert, we are going to need it. anyway, let's continue. The company has annual fixed cost of $200,000 and tax rate. no. Taxes 25%. So we'll we'll cope with that as well. It says compute the company's expected profit net income for the upcoming fiscal year. Okay. To calculate the profit want to construct little income statement. So again this is very roughed in income statement. sales minus variable expenses equals CM minus fixed expenses equals OI operating income minus taxes equals NI net income. Okay, so want to do that. But for this company, they got three product lines. So I'm going to do little mini income statements for the enthusiast, the jammer, the pro, and then totals. Let's get to work. This is how we'll calculate our net income. We're going to sell 600 enthusiasts at price of $200 each. 600 time 200 is $120,000 worth of enthusiast guitars are going to be sold. How about the jammer? $350* 500. $175,000 worth of jammers. What about the pro? 50 time 3,000. Geez. $150,000 worth of pros are going to be sold. So my total sales here, what is this? 195. No, 295 plus 150. think it's 345, but don't trust myself. 120 + 175 + 150. should have Wow, was wait second. Is that right? 445. was way off. I'm glad didn't trust myself. Thought had it right. 445. Our variable cost. Well, again, 600 *1 120. We just take the units sold by the price. $72,000. 200* 350, that's 70,000. don't trust myself anymore. 200* 350 70,000. It is right. for the pro 800* 50 is 40,000. So total here 1401 182. Sales minus variable expenses is contribution margin. 120 minus 72 that's 48,000. 175 - 70 that's 105,000. 150US 40 that's 110,000. And 445 minus 182 is 263. Can also add it across. I'm going to just because I'm feeling shaky. did too much math in my head there. 48 + 105 + 110. Got 263 both ways. good sign. Fixed expenses are $200,000. Now, we don't apply them to the various product lines. We just take fixed expenses from the total and we end up with operating income. Our income before tax, our pre-tax profit is 63 grand. We're going to take 25% of that out for taxes. Times 0.25. 15,750 comes out for taxes. And our net income, that's the number we were after here. 63,000US 15750. 47250. That is our projected profit. And that's our answer to part Part does us favor. We're about to calculate the break even point. And in order to get break even point, you need to know the sales mix when you have multiple products. So lot of times in my class, don't ask just jump right on to see and it's like, well, you have to calculate sales mix, but but this one sort of feeds it to us. So let's calculate the sales mix. And the sales mix just means what percentage of my sales belong to each category. So, for example, in total, sold I'm planning to sell 600 plus 350 + 50. I'm planning to sell 1,000 units, right? 1,000 guitars. And 60% of them are enthusiasts. 600 out of the,000, 60% are enthusiast guitars. So again, the math is 600 divided by the total a,000, it's 6 or 60%. 35% are jammer and 5% are pro. And that of course adds up to 100. This is my sales mix. So we've answered part so again, if were to write out the answer to part I'd say enthusiast 60%, jammer 35%, pro 5%. Assuming consistent sales mix, how many units of each product type must the company sell to break even? So this uses the same formula we've been using all chapter, but there's just slight twist. Here's our break even unit. So, it's fixed expenses, which for this company was like $200,000 divided by CM per unit. The issue is we have three different CM per units. We got 80, we got 300, and we got 2200. How do figure out my overall CM per unit? The answer is take weighted average. And what weighted average is is you multiply the mix by the CM per unit. So weighted average cm per unit 60% of my guitars that sell or enthusiast and on each of those make 80 bucks. So 60% time 80 is 48. 35% * is 105. 5% * 2200 110. Add them all together. Now, these numbers on their own don't mean much, but when they're added together, they do. 48 + 105 plus10 equals $263. On average, when customer walks out the door, they're contributing $263 to my bottom line. Now, you can see the vast majority of customers buy the enthusiast, which only contributes 80 bucks. big chunk of them by the jammer which contributes 300. But what's really helping my average is these pros. Each one of those pro guitars contributes $2,200. So this is the weighted average contribution margin per unit. Our formula here, the math is we take our fixed expenses, which were $200,000, divided by CM per unit, which is this number. This is what we're working towards. This is what's novel or new in this multi-product CVP is figuring out contribution margin per unit. And we've just done it. So 200 divid 200,000 divided by 263 gives us 760.5 units. We round up. We say 761 units is what need to sell to break even. But the question didn't ask how many total units. It asked for how many units of each product type. So, have to apply my sales mix to that number. go, well, 7 if sell 760 units, 60% of them are going to be enthusiast. 35% of them are going to be jammers and 5% of them are going to be pros. So, how many of each type do need to sell? 761*6 456.6. So, we round everything up with break evens. It's going to mean we have slightly positive net income, but that's fine. I'm willing to live with that. so 457 for the enthusiast, 761 times.35, for the jammer, and 761 time. 005 38 Well, we round up 39 for the pro. okay. So, that is how many units of each type that need to sell to break even. Now, it is funky to round up even when something's 0.05, but that's just challenge with break even points. okay. So, that's what we need to sell to break even. think we've answered part Part says, "Assuming consistent sales mix, if the company wishes to earn net income of $300,000, how many units of each product type must be sold?" Okay, so we're we're expecting make income of $47,000. We're going to have to sell lot more units than what we had planned. If we want to make $300,000, what's the formula here? Well, it's our fixed expenses plus target operating income divided by CM per unit. Our fixed expenses still was it 100? think it was 200 $200,000. Our target operating income, we don't know. Our CM per unit though is the same as it had been before. It is $263. It's that weighted average CM per unit. What's our target operating income? You might be saying, well, they gave it to us 300,000. No, no, no. That was our target net income after tax. target operating income. We got to figure out if want to make net income of $300,000. What is my operating income? And the answer is, well, we can work backwards because we know our taxes are 20%. Here's the math. You take 300,000 divided by one minus the tax rate. Actually, our taxes are 25%. Pardon me. 300,000 divided by one minus the tax rate. So 300,000 divided by 75, right? 1 minus 0.25, 1 - 25%, oops, equals 75. So I'm going to go 300,000 divided by 1 minus the tax rate. 300,000 divided by 75, get 400,000. Now, this strikes me as true. Now, that's the number I'm going to put in my formula, but 400,000 times 0.25. Sorry, I'm messing this up. Times 0.25, that's my tax rate, equals 100,000. And yeah, sure enough, 400 minus 100 equals 300. The math maths, right? The math works. okay. So, our operating income needs to be 400,000. Target operating income. This is the math. 200,000 plus 400,000 divided by 263. and get 2282. That's how many units need to sell in order to make $400,000 in net income. 2282. But the same as did above, got to say, okay, well, I'm got to sell 2282, but which 2282 do sell? 60% of them are enthusiast, 35% of them are jammer, and 5% go to the pros. So, let's crunch those numbers. 2282 times 6370. We round up.35 times 2282 for the jammer. And for the pro 2282 times 0.05 115. And there we go. That's how many units of each type need to sell to make my target profit of $400,000. So that's my answer to part Part says, compute the margin of safety margin of safety budgeted sales minus break even sales divided by budgeted sales. We got the budgeted sales in dollars. We got the break even sales in units and we got the budgeted sales in dollars. So for this formula, I'm going to take the budgeted sales in dollars just from the income statement we projected at the start. It's 445. So, it's going to be 445 minus something divided by 445. We just have to plug in the something. What is the break even sales in dollars? And we know our break even units. We said 761 units. and in fact we we know the breakdown here is 457 units of in was it enthusiast 267 of jammer and 39 of pro. Well now we can math it out. We can say well my enthusiast costs or the price is $200. Oops. The price there is $200 and for the jammer 500 and for the pro 3000. So, just multiply by the prices and I'll get my break even sales in dollars. So, it's just the units sold times the price. So 457 * 200 $91,400 sold there 267 * 500 133500 there and 39 * 300 $17,000 there. My total sales here in dollars plus 133500 plus 1170 is 341900. Now it is possible to do this with CM ratios. You will get slightly different numbers because I'm rounding up twice here. round up to get to 761 then round up each one of these. So there are slightly different answers that are possible here. think this is better answer. 34,1900 is my break even sales in dollars. 341900 goes in here and let's math it out. 445. So this is what I'm planning to sell. This is what need to sell to break even. 341900 divide by what I'm planning to sell and we'll get percentage 23.2%. So, what does that tell me? It says my sales can be 23.2% worse than expected and I'm still going to break out even. So, that's, you know, desirable number to know. You can say your projections are off by 23%. And you're still going to be okay. All right. Thank you so much for watching as always. And if you've liked the video, hope you don't mind hitting one of those buttons. Have great day and I'll see you in the next video. Bye for now. Welcome to module seven of our course on management accounting. This module is variable versus absorption costing. It's short module, but think you're going to find it useful. It combines what we've already discussed about the product cost, material, labor, and overhead, and what we've added to that in recent chapters, which is variable versus fixed cost. And it looks at quirky challenge. And this is the challenge. This is the issue right here. So we know the cost of our hamburger is the cost of the material, right? The meat, the cheese, the bun, etc. The cost of the labor, which is the chef's wages at for the time they're cooking that burger. And the cost of the overhead, which we said are indirect factory costs or indirect kitchen costs. And so one imagines maybe well obviously utilities or cleaning supplies would be indirect costs and it's difficult to trace them. also like kitchen rent. You know, if pay $2,000 month to rent the kitchen, how many dollars worth of that rent went into the burger? It's difficult to trace. And so, we've learned all different ways of tracking or applying that overhead cost into the cost of our burger. this chapter though focuses on like is this variable or fixed cost? Because we know the material plus the labor plus the overhead that equals our cost, right? That's our product cost and that ultimately becomes our cost of goods sold. So is cost of goods sold variable or fixed. And the answer is actually it's kind of complicated. It's mix of variable and fixed costs. Materials, for example, are variable. We would definitely think of direct materials as being variable. Labor also is variable. The more burgers we make, the more chef's wages we have to pay. Overhead, however, is mix of variable and fixed costs. Overhead contains things like factory rent or kitchen rent. Totally fixed cost. Absolutely fixed cost, but it contains costs that also vary with production. You know, you're going to use more gas to heat the grill if you're cooking more burgers. there is variable element to that cost. So it it contains both variable and fixed both. So there's variable MO and there's fixed MO. And so this creates small problem for us. If you think back to last chapter where we calculated break even point, we used variable and fixed cost. Well, determining your variable and fixed cost is tricky because cost of goods sold has this combo of variable and fixed cost. So, this chapter shows us kind of how to split it out. So, we have these categories of costs, right? We got material plus labor. Actually, I'll do it down here. prepared this in advance for absorption costing, which is the traditional costing. And this is GAAP. This was is what is allowed within the rules of accounting. So, all companies do it this way. And this is what we've learned thus far. We've said, okay, what what counts as part of the cost of goods, cost of product is material plus labor plus overhead. And I'm going to break this down plus variable overhead plus fixed overhead. And that is the cost of our product. Variable costing, which is the number we're going to want to use for like break even analysis, is slightly different. So this is non-GAAP. So it's not under the rules of accounting but it's it's useful for manager to make some analysis. the variable costing says just use the variable cost which is material. We said that was variable labor and variable overhead but it excludes cost fixed overhead in calculating our cost of goods sold. So variable cost of goods sold is different from traditional accounting cost of goods sold. That concept, the fact that this one has fixed overhead included and this one doesn't, that's the main topic of the chapter. As always say, the best way though to learn this stuff is to do examples. And I've got several examples ready to go for you. can't wait to get started and I'll see you in the next video. Bye for now. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take run through problem 71A, variable versus absorption costing problem. May company began operations at the start of the year. Details about the company's activities are below. And let's just read the required. We're going to calculate the cost per unit under variable and absorption costing. And just want to mention at the top like how to determine the cost under variable versus absorption. So absorption costing is what we've learned all along because that's what GAP requires for companies to do. And under absorption costing, the cost is the material, the labor, and the overhead. But it's all of the overhead. the variable overhead as well as the fixed overhead and that's the cost of our product. Under variable costing, we include material because it's variable cost. We include direct labor, which is variable. We include variable overhead, of course, but we exclude fixed overhead. So that's the variable cost of product. So fairly straightforward. Let's solve part here then and we'll focus in on these manufacturing costs. So the manufacturing costs say give us the material, the labor and the overhead. So let's use them. material is four, labor is two, overhead is three, variable overhead is three. So 4 plus 2 plus 3 that's nine. So there we go. Cost per unit or variable costing nine. What about under absorption costing? The material is four, the labor is two, the variable over it is three, and the fixed overhead is 400,000. Well, that doesn't compute here, right? Like it doesn't match up. We've got to figure out the cost per unit that would have been applied. And this would have been applied throughout the year, but we want to figure out overall cost per unit that would have been applied through the year. So, the total cost is 400,000. The number of units produced is 100,000. hope you see where I'm going here. It's got to be $4 unit, right? We made 100,000 units. It cost us $400,000 in fixed overhead. So, it's four bucks unit. So, the total cost here, 4 plus 2 is 6 + 3 is 9 + 4 is 13. So, there you go. We've answered part Part says, what's the ending inventory value under variable versus absorption costing? Well, it talks about inventory up here, and it says beginning inventory was zero, $100,000 produced, 95,000 units sold, sales price was $20 unit. Ending inventory is question mark. We can quickly figure out that question mark because we started with zero inventory. We made 100,000. We sold 95. What do have left? Hopefully, you're all shouting at your screens. 5,000 units is what's left over. So, what's the value of my ending inventory? Well, inventory value under variable costing, and we've just said variable is $9. and under absorption 13. So we think our cost of goods is $9 under variable. So we have 5,000 units left over. 9 * 5,000 is $45,000. And under absorption 13 * 5,000 would be 65,000. Let me make sure on that number. 13 * 5. Yeah, it's 65. got insecure there. hate to calculate number wrong, but there you go. So, under variable costing, my ending inventory is worth 45,000 and under absorption, 65,000. That's going to be relevant in minute. the final thing, assuming no taxes, prepare an income statement under variable and one under absorption costing. So, big picture, what do we expect our income statements to look like? Well, variable income statement looks like this. sales minus variable expenses equals contribution margin minus fixed expenses equals operating income or income before tax. But here there's no taxes, so we're just going to say that equals net income. An absorption income statement looks like this. sales minus COGS equals gross profit minus our selling and admin expenses or our operating expenses, but we'll call them selling and admin for our management accounting class. SNA expenses equals net income. That's the ugliest SNA of my life. I'm going to do that again. SNA. so much better. Okay, so there we go. So, we just got to make income statements in those formats. So, let's do the let's do absorption first. Absorption is little bit easier. They're both easy, though. So, here's our company's absorption income statement. I'm just going to try to match that format. So, sales rev. Let's see. zero beginning one. There's our units sold. 95,000 at $20 unit. $1.9 million in sales revenue. Our cost of goods COGS it's the number of units sold 95,000 times our absorption cost 13. So 95,000 times 13 1 2 35 sales minus COGS is gross profit 1.9 million minus one two35 minus selling and admin expenses and our selling and admin is down here $5 unit. We sold 95,000 units. So variable, of course, is going to be things like commissions on units sold. So five * 95,000 475,000 plus there's 120K in fix. So our total selling in min here is 595. All right. So 595 brings us down to net income. And our net income 665US 595 it's $70,000. And there we have beautiful absorption income statement. Let's do our variable income statement. And it's just going to follow the format above. sales rev which is the same 1.9 million right doesn't matter the method here the sales are the same but then the next line down is totally different variable expenses we got to say what are our variable expenses well 4 2 and three is our variable cost 9 4 plus 2 plus 3 is 9 plus our variable selling and men so our total variable expenses are 14 right 4 plus 2 plus 3 plus five our variable expenses are 14 per unit And we sold rather $95,000. So 14 * $95,000 1330. 1330. All right. Sales minus variable expenses equals contribution margin. Our contribution margin 1 1900 minus 1330 minus our fixed expenses and that's just these two 4 and120 right the fixed overhead and the fixed selling it's 520 and that CM minus fixed expenses is net income again could be operating income or income before taxes depending on the layout here but since there's no taxes it's our net income 50,000. Now, always ask my students like, why are these net incomes different? And the answer is down to this. Our our ending inventory under absorption costing is $20,000 higher. Our net income under absorption costing is $20,000 higher. These two things are related. Under absorption costing, we have $20,000 less in expenses. Why? Because we put what is expensed under variable costing into our ending inventory. So again, it's it's to make balance sheet balance. We've said our ending inventory is $20,000 higher and therefore our expenses are $20,000 lower and our profits are $20,000 higher. Now absorption is gap. Companies are required to do this for GAP. Variable is something you would choose to do for management accounting. And why would you choose to do this? You know, we just went through all this. Why would go to the effort? And the answer is so can do things like break even analysis and target profit analysis. lot of analyses are only possible if you split your fixed and variable costs. So, doesn't it make sense to do that here? And the answer is yes. That's why we do it in in typical intro management accounting class. Okay, we've made it to the end though. We've solved parts and As always, hope the videos are helpful. And if they are, hope you'll help me with thumb or sub. Have great day. Thanks for watching. I'm going to eat ice cream now. Goodbye. Let's run through problem 72A. Variable versus absorption costing. And we're covering multiple months. You can see this company we're looking at August and September. So details about peak companies activities for the first two months in business are below. and we can see some inventory and production information, units produced, units sold, sales price. we got manufacturing cost. In the previous question, we had material, labor, and variable over it all spread out. Here, we've just combined them into one line. Makes our life little bit easier, honestly. we got fixed overhead costs, and we got some selling and admin cost info. It says, calculate the cost per unit under variable costing and absorption costing. Remember, the cost per unit is the production cost per unit. The selling cost isn't counted as part of the product's cost. So under variable costing, the variable cost per unit is the material, the labor, which we assume are variable, and the variable overhead. So this is the number. So under variable costing, they just gave us the answer. It's $20. And you can see the costs are the same both months. If we had changed them, and certainly in real company, it will vary over time. It just makes the question more complicated. And and you know, in an intro class, we don't want to over complicate matters. But if you move on and do intermediate advanced accounting, you might have to tackle that situation. Here they've they've kept it easy. You can see the costs are just consistent from one month to the next. under absorption costing, absorption just means it's absorbing the fixed overhead costs as well. All the manufacturing costs including fixed cost become part of the cost of product. And what is our fixed overhead here? Well, it's $100,000 to make 10,000 units. We're making 10,000 units both year. So it's 10 extra dollars, right? $10 per unit in fixed overhead. So it's not just the 20 that are involved in variable costing. It's 30 cuz we got 10 extra dollars worth of fixed cost. So that's our cost per unit. What's the ending inventory for August under variable costing and absorption costing? Well, the units are pretty easy. We start with zero units. We produce 10,000. We sell 9,000. So 0 + 10 - 9 means we end up with a,000 units. What's the value of a,000 units under variable costing? It's $20,000, right? A,000 time 20, it's worth $20,000 under variable costing. Under absorption costing, it's worth $30,000. It's the same units. It's just different values. And of course, when we go to prepare income statement, we'll see that their profits are going to be $10,000 different because absorption costing is including 10 extra,000 in its inventory value where variable costing isn't including it there. It's saying no, that's cost and it's expensing it on the income statement. So, it's reducing the profit. And we'll see that when we go to part part though, what's the ending value of inventory in September under variable and absorption costing? Okay. Well, we'll do the same thing in September though. We start with a,000 units, right? Because we we had a,000 left over. We add the 10,000 we make minus 10250 and we end up with $750 of inventory. So what's the value of that inventory under variable costing? 750 * 20. It's $15,000 worth of inventory under variable. And 750 * 30 is 22,500 under fixed costing. Okay. So there we've, you know, this is all table setting stuff. Let's get to the meat of the matter. Let's do income statements. So it wants us to do for each month an income statement under variable and then under absorption cost. So variable and this is going to be for August and September. And variable income statement looks like this. sales minus variable expenses equals contribution margin minus fixed expenses equals operating income. But in this case, we're assuming no taxes. So operating income and net income will be basically one and the same. for absorption costing, what does an income statement look like there? It's sales minus COGS equals gross profit minus selling and admin expenses equals again operating income but assuming no taxes net income. so I'll just put the headings August and September up there. So now we just solve right. So what were our sales for August? Well 10,000 units at 50 bucks unit. That's 500,000 or sorry, almost screwed it up. 10,000 was what we produced. 9,000 is what we sold. 9,000 times 50 is 450,000. I'm feeling shaky now. Let me do the math in the calculator. 9,000 * 50. Yeah, 450,000. Our variable expenses we're doing variable costing, so it's 20 and six. It's 26. So 26 * 9,000 234,000 sales minus variable expenses is contribution margin $450US 234 $216,000. Our fixed expenses are the big ones. 150 $150 leaves us profit of $66,000. Let's do September. We sold sold 10250 at 50 bucks piece 512500. Our variable expenses again 10250 times the variable cost per unit which was 20 and six. So times 26 266500 minus 266500 is 246,000. This is still 150. You can see it's just right here. 150. So 246US 150 is 96,000 bucks. Okay. So we're setting the table hopefully beautifully. Let's do the same thing for absorption costing our sales. same numbers 450 and 512500. And same math, right? Just the number of units sold, 9,000 times the price, and then 10,250 times the price. Our cost of goods sold, it's the number of units sold times the absorption cost and cost of goods, 30. So 9,000 * 30 10 250 * 30 9,000 * 30 is 270,000 and 10250 * 307500 sales minus COGS of course is gross profit 450 minus 270 180,000 here minus - 307500 205,000 here. Selling and admin expenses. So that's these ones. $6 unit time 9,000 units sold. 6 * 9,000 is 54,000 plus 50. So it's 104,000. 180 minus 104. What is that? $76,000. And on this side, it's $6 unit. We sold 102500. So 6 * 102500. 650. that can't be right. 6 * 10250. Sorry, 10250. like that number is way too high. 61,500. That makes more sense. Plus 50,000 is Let's do it in the calculator. 111500. 111500. That makes lot more sense. 2050 minus 111500 93,500. Okay. so we've solved. But the final question says like what's going on here? Which method has higher net income in August? Well, 66,000 compared to 76,000. we would say for part for August absorption for I'll just put August absorption is higher by $10,000 right and question I'd like to know is why and we we discussed this earlier we said well under variable costing our ending inventory is 20 under absorption it's 30 under variable costing we had $10,000 of extra expenses that in absorption costing were kept in ending inventory. So that's what's happening here. Now what's happening in September? so so that's sort of my answer for August. Which method has higher net income in September? Well, it's actually variable costing by 2500. Is that right? September variable is higher by and yeah think the math is 2500. Well what's going on here? And the answer is well in September my inventory actually shrinks by 250 units. Right? So in August inventory went up by thousand units. So we said, well, it went up by a,000 and so therefore or times 10 rather. Our fixed cost per unit is $10 per unit. So times 10 means that absorption looks $10,000 better because $10,000 extra dollars sitting in ending inventory. In September, our inventory went down by 250. We sold more than we produced by 250. And 250 * 10 is 2500. And that makes absorption look 2500 worse. So that's what's happening in August. More when we have more inventory, we have more fixed costs in our inventory, not on the income statement. That's why they're different. In September, those fixed costs come out of our inventory and appear on the income statement, making absorption costing look worse. So there we go. We've solved 72A. As always, I'm thrilled that you're watching and I'll see you in the next video. Thanks for watching and bye-bye. Let's take look at problem 73A. very interesting problem. What we're going to do in this problem is we're going to have the company, they're going to sell 8,000 units, and we're going to look at what happens if that year they produce 10,000 units. What does their cost and income statement look like? And what if they overproduced way overproduced and they made 20,000 units when really, you know, they were only going to sell eight, but they just overproduced for some, you know, they misjudged the the consumer demand. And what we're going to find is weirdly net income profit is higher when the company overproduces. And so that's this is weird thing about absorption costing that this problem illustrates. And think it illustrates it well. August company began operations at the start of the year. Details about the company's activities are below and so we got no beginning inventory. It's new company. number of units produced well under first scenario be 10,000. Then we'll look at when they produce 20. Number of units sold only eight. So you know under you make 10, you sell eight, you're pretty happy. You make 20,000 you sell eight. You sold less than half what you made. You're not so happy. Our sales price is $100 unit. Our ending inventory well it's going to be different depending on whether we made 10 or 20,000 units. material used, labor, overhead. These are all variable production costs. And then our fixed overhead is fixed production cost. But under absorption costing, it's part of the cost of the product. Variable selling them in fixed selling them in. Okay. so first question says, calculate the cost under absorption costing assuming the company produced 10,000 units. Okay. So, if we made 10,000 units, let's see, our cost is material plus labor plus overhead. 25 + 12 + 10, that's 47. That's our variable cost. And then we go 150 grand divided by the number of units made, 10,000. So, it's going to be 150 divided by 10 is 15. So, 47 + 15. What is that? $62 unit. and if we had made 20, and here's where this kind of quirky thing is going to come in, our fixed cost spread out over more units. So, our cost actually goes down here. And so, it's 47 + 150 / 20 in this case. 150 / 20,000 is 7.5. So, it's 47 + 7.5, it's $5450. So is $62 even $54.50 per unit. so now we're really going to illustrate the point. assuming no taxes, prepare an income statement under 10,000 units. So $62 units and under 20,000. And it's important to say it's the exact same company, right? Exact same product, exact same sales, exact same expenses, exact same costs. Under one scenario though, we make heck of lot more units than under the other. So, 10,000 units, produced. We're doing two side by side, and this one's going to be 20,000 units produced. okay. so we'll do two income statements. So, our sales minus our cost of goods sold is gross profit minus our selling and admin. Yeah, selling and admin. Sorry, that and is so ugly. And that's so much more beautiful. Minus our selling and admin expenses equals our operating income. But since there's no taxes, it's also our net income. Okay. So, if make 10,000 units, what are my sales? Well, I'm selling 8,000 units at $100 unit. That's $800,000 in sales. My cost of goods, well, $62 unit time 8,000 units sold. 62 * 8,000 $496,000. 800US $496 is $34,000 in gross profit. selling and admin expenses $5 unit sold. So 5 * 8 is 40,000 plus 100 it's 140,000 and 304 minus1 140 is 164. Okay, so we make $164,000. What tidy profit. Now what we find is if we just overproduce we make more money and that is not good. That is weird. so scenario two, sell the exact same. sell 8,000 units at $100 unit. sell $800,000 worth of stuff, but because my fixed cost spread out over stuff sold, but also stuff that's in inventory, so it's not expensed, right? It's it's sitting in inventory as an asset. Because those fixed costs spread out over more units, look more profitable. so let's do the math. sold 8,000 units, and if make 20,000 units, my cost is 5450. So 8,000 units divided by 54.5 or not divided by times 8,000 units times 54.5 $436,000. So 800 minus 436 is gives me gross profit of 364. Our selling and min just stayed the same. 5 unit times 8,000 units is 40 and $100,000 of fixed selling in so it's 140 364 minus 140 is 224 and you can see if just overproduce $60,000 more profit right more net income if just make too many units so this illustrates something in in any textbook that goes into variable versus absorption costing. We'll say one of the weird things about absorption costing is if you just make more units, you look more profitable. The problem is in the long run, if you overproduce, overproduce, overproduce, you're sitting on extra inventory and just carrying extra inventory has huge costs and huge risks. Companies don't want to do it. But if you're manager in the very short term and you're incentivized by profits, here's an incentive to overproduce. So why are the answers from in part so different? The reason is you produce more fixed costs spread out over more units and they spread out over units that weren't sold and therefore not track through cost of goods sold. They don't find their way on the income statement. So you're keeping some of your fixed costs off of the income statement. You're looking better in that scenario. Why is this difference potential problem? There's an incentive to overproduce inventory, at least in the short run. In the long run, it's going to catch up to you, but it's just weird quirk of absorption costing. So, there you go. We've solved 73A. It's not weird quirk to hit one of those buttons on your way out of here. Thanks for watching. See you in the next video. Bye-bye. Welcome to module 8, module all about budgeting. And very important module, right? big part of management accounting is about planning for the future and that's what this module does very well. something you might not know about me and something little bit personal is my wife works for an animal shelter. And if you work for an animal shelter, you often have to bring animals home to take care of them until they're ready to be adopted. So I've had every kind of animal in this house that you can imagine. And learned something about myself and it was something something did not expect. always thought of myself as big dog person, you know, lab or retriever or, you know, larger sized dog was what thought liked. But now having had every kind of dog, every kind of cat, every kind of creature in my house, one animal shines above the rest in Tony Bell's heart, and that animal is the guinea pig. love guinea pigs. And in fact, we have lovely guinea pig staying with us. Hopefully temporarily. Hopefully, he gets adopted soon. but he's in our house now. His name is Elvis Parsley. And if you're good, if you stick around till the end of the video, might even give you look at the real Elvis Parsley. But dealing with Elvis, our guinea pig, has made me think about the business of animal food. and thought, wouldn't it be fun to just think about how this hay company, Elvis eats and all guinea pigs eat this product called Timothy hay, very common, food for small animal?" And thought, well, what would Timothy hay business or budget have to think about? So, I'm going to share some things think they might think about. All the numbers will be wacky because, of course, I'm not hay expert. I'm not in hay business, but let's say we're the Timothy Hay Company. All budgets, doesn't matter if you're hay company or some other company, is going to start with sales budget. And somebody's going to need to project how many units, how many boxes of hay in this case, we think we can sell. So, just to use round numbers, let's assume we're the hay company and we think we can sell 10,000 packs of hay to, you know, animal owners during the month. So, that's our budget. We're planning to sell 10,000 units. So, our our budget is to sell 10,000 units, which for us is box of hay. Now, let's say and and that's big you know, animal shelter size box of hay. The smaller consumer packages of hay you can get are around retail for about 10 bucks unit. Let's say we sell it. We're the wholesaler. We sell it for $5 and then they turn around and mark it up to the customers for 10. So, our sales revenue is going to be $5 package. Let's say, again, I'm making numbers up here. Okay. Well, we can do our first budget with that information. our sales budget or sales revenue budget. We'll we'll just call it sales budget in our class, but our budget of sales revenue, we would say, hey, it's 10,000 units at $5 unit. We're budgeting to have $50,000 in revenue. The next budget that will just fall out of here is when are we going to get the money? Are we going to get the money right away? And most companies, they'll get some of the money now and some will be on account and some later and some will be months from now. But they have to plan for that. Like when is the cash flow coming? So they'll do budget to tell you when they make the sale. They'll also do the budget to tell you when they think they're going to collect the money. And that's schedule of expected cash collections. So I'll I'll call it here cash collections budget but in the module we'll call it schedule of expected cash collections but cash collections budget when are we going to see that money okay so we're planning to sell 10,000 units send 10,000 packages of this Timothy hay well if want to sell 10,000 packages got to make 10,000 packages don't in fact if I'm planning to sell 10,000 packages. I'm going to plan to make more in case I'm little bit busier than thought. In case have some problems, I'm probably going to plan to make at least 11,000 packages. So, let's assume we make production budget and we go, well, we want to have little extra just in case. We're going to produce 11,000 packages this month. So, I'm just going to put that in brackets. 11,000 packages or 11,000 units in this case. Okay, so we've already got three budgets, right? From our initial number where we said we're going to make 10,000 units, 10,000 packages this month. We got our revenue budget, our sales budget, our cash collections budget, when am going to see the money, our production budget, that's third budget. What do need to produce? And let's get ready for fourth budget, materials purchases budget. got to go to hay farms and got to say, okay, I'm buying 10 I'm going to produce actually 11,000 packages. This is how much my packages weigh. This is how many bales of hay need to buy from farmers, right? got to plan that out. Do have good farm supply that can supply me with that? If not, do have to go to another farmer? So, have materials purchases budget. How many kilograms or bales or pounds or tons of hay do need to buy to make 10,000 packages that I'm going to sell on to customers? That's an important thing to plan on. Right? This is all just the planning that need to do. And by the way, these are all things we're going to do this chapter, right? We're going to prepare these types of budgets this chapter. What's the next budget might want to do? Well, if I'm going to make 11,000 packages, got to have employees, right? Right? got to figure out, well, how many employees am going to need? How many hours do they need to work? Do need to hire somebody new? Do need to bring in temporary workforce? What do need to do about labor? So, need to make direct labor budget. We've just done material and labor. Can you guess what I'm going to say next? Hopefully, you guessed. Overhead. We will budget our overheads likely based on the labor, right? Labor drives overhead. So, we're going to prepare Whoops, that's terrible manufacturing overhead budget likely based on labor which is based on the production. We'll also have to budget the rest of our expenses, our selling and admin expenses. So look at that. Just from that one data point, I'm not done, but from that one data point, we've generated one, two, three, four, five, six, seven different types of budgets. And in fact, there's an eighth that will be responsible for this chapter. It's called cash budget. If you just think about this, right? The cash collections budget tells us when the money's coming in. Well, the materials purchases, that's going to have some money going out. We got to buy material. Labor, of course, you got to pay your employees. Mo overhead costs do have financial costs. Yes, that's going to be cash going out. And you're selling an administrative expense. lot of wages in there as well. lot of monetary costs. So, we're saying this is how much money is coming in. This is how much money is going out. The cash budget says, can float this? Am going to run out of money? That's an important thing. We'll do two more budgets. We'll do budgeted income statement and budgeted balance sheet. So, an income statement budget and balance sheet budget. This chapter, it's lot. When students look at this, they sometimes get overwhelmed because you work through and each of these budgets has different labels and things like that. And want to stress to you, it's not about memorizing labels. It's about just getting the process down. So, try to understand where the budget is going, what we're trying to do with the budget, but we're going to learn lot of different budgets. And bet you my Timothy Haye company that was showing you earlier, they would do some, if not all of these budgets, if they're big company, they would do them every month, you know, and they would do them several months at time. So, very common tool used by business and an important tool used by business. But fundamentally, you want to make sure you're properly staffed, that you're not going to run out of money, that you're not going to run out of materials. These are all things that real companies do, and we're going to learn to do this chapter. But at the start of the video, said if you were good, said if you would stick around till the end, would show you the guinea pig that we're taking care of right now. So, let me zoom in and I'm going to sneak off. I'll grab the guinea pig and then I'll show them to you and we'll say goodbye. Thanks for watching. Goodbye. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's jump into problem 81A. sales budget and schedule of expected cash collections. The sales budget, they don't come much more simple than sales budget in terms of the work we'll have to do. Schedule of expected cash collections is much more interesting. Let's get started. Baker Company shows the following estimates for its unit sales for the next year. And we can see there's quarterly sales. Now, quarter is threemonth period. We'll assume that they're working on calendar year. So, quarter one is January, February, March. Quarter 2, April, May, June, etc. and it says the company expects to sell its goods for $50 unit. And it says prepare sales budget. What sales budget is saying is what's my revenue going to be for the year and for each quarter. And you can simply do this by multiplying the units sold by the price per unit. let's do it and we'll do it in sort of more formal budget form. So we start with the name of our company, Baker Company. It's going to have threeline title like any financial report. then the name of what we're preparing and this is sales budget and this is for the yearended and we'll assume it's calendar year December 31st. Okay. so there's the headings for these budgets are the quarters. So Q1, Q2, Q3, Q4. Sometimes we'll do monthly budgets and the headings will be the month and the year is sort of our totals column and we start with units sold with the given information here units sold and so in Q1 that's 11,000 units Q2,000 Q3 14,000 Q4 13,000 and in total for the year 50,000 units. Okay, this is starting point for the budgeting process for most companies is like how much are we going to sell? And if you know how much you're going to sell, then you kind of know well how much money you have to spend potentially. And you also know like okay, if I'm going to sell 50,000 units, got to make 50,000 units during the year. So got to have workforce to make 50,000 units. got to be ready to buy the material with which I'm going to make the 50,000 units, right? Knowing I'm going to make and sell 50,000 units tells you lot, right, about your your planning process. So, if you have good idea of what you're going to make, you know, do need to hire more people or or what do need to do? So, anyway, that's our starting point. And the first thing you can do is like, well, how much money does that mean? So, 50,000 units, what is that in dollars? And that's what we're doing in the sales budget. So, we just multiply by the sales price per unit. So, our sales price is $50 unit. And we're going to get our sales revenue for the quarter and for the year. 11,000*50 $550,000. 12,000*50 is $600,000. 14,000* 50 is $700,000. And 13,000 * 50 is $650,000. 50,000*50, that's 2.5 million. In terms of formatting, you know, would put an underline under anything where the next line down is calculated. And would put double underline underneath the bottom line. In terms of dollar signs, you put dollar signs in each column. The first place dollar value appears. So 11,000 is units. It's not dollars. This is dollars. So each column gets dollar sign. And if the bottom line is dollar amount, that gets dollar sign as well. Your professor may or may not be picky about formatting here, but if they are, that's that's how would do it. okay, that's it for the sales budget. So, it says, okay, you know, pretty like the least exciting of the budgets we're going to do this entire semester. Pretty straightforward. We're planning to make $2.5 million of sales. Well, often when you make sale, you actually don't get the money right away, right? Companies sell things on account. There's collections problems. There's delay. You make the sale this month. You collect the money next month. And it's really important to know when am getting the money? Because you're going to plan on spending the money, right? I'm going to hire amount of employees. got to pay for my materials on my end, right? So, we got to track when is the money coming in and when is the money expected to go out because we want to know if we're going to run out of money. Fundamentally, that's concern of company. So, that's with this next schedule. And think the first really interesting schedule of the chapter comes in. It says the company additional information. The company expects to collect 70% of sales in the quarter of the sale, 25% in the quarter following the sale, and 5% is expected to be uncollectible. So, we're making all those sales. We're not going to see all the money. And that's normal, right? You have receivables, not every customer pays. The company's beginning accounts receivable was $125,000. All of which was expected to be collected in the first quarter. Okay, let's start with the threeline title. it says prepare schedule of expected cash collections. Baker Company schedule of expected cash collections. And this is for the year ended December 31st. And if we knew the year, we would give the year. And again, our heading is Q1, Q2, Q3, Q4, and year. Okay. So now we're interested in figuring out, okay, well, when am going to collect the money? the the first one is this. It gives us the company's beginning accounts receivable is $125,000. All of which is expected collected in the first quarter. So beginning AR, all of which is going to be collected in quarter 1. It's $125,000. So put it in quarter one. That's it for AR, right? like don't have, you know, to worry about my beginning of year accounts receivable in quarter 2, quarter 3, quarter 4. You know, if if they owed me from last December, I've probably got the money in January, February, March. don't have to worry about it in April, May, June, typically. So, that's my total for the year. What about Q1 collections? All right, so made $550,000 of sales in quarter 1. Do get $550,000 of cash in quarter 1? The answer is no. only get 70% of the money in quarter 1. So times 70% 7 385,000 of the 550 comes in in quarter 1. 3850. Well, what about this 25%. It says 25% of the money typically comes in in the quarter following the sale. So of this 550, 25% of the money is going to hit in quarter 2. So 550* 0.25 137500 comes in in quarter two. What about in quarter 3? Nothing. We're expecting in quarter 1, I'm going to get all most of the money in quarter 1, some of the money in quarter two, and some of the money won't be collected. Let's let's add this up. 385 plus 1375 get 522500. Well, wait second. was owed 550. only got 522500. What's the difference here? 550 minus 522500 27,500. don't think I'm going to collect. And that's this 5% of sales that are uncollectible, right? sold 550. I'm only going to get 522500 of cash. 275 is 5%. 550. Oops. 550 * 0.05. 275 is the 5% don't think I'm going to collect. So that's why those numbers don't match. same thing will happen with quarter 2. won't do all the math there, but quarter 2 collections, I'm going to get 70% of it in quarter 2. So 70% of 600,000 is 420 and 25% in the following quarter which is 150,000. 420 and 150 is 570. In terms of quarter three collections, when am going to see that money? Well, it's 700,000. see 70% of it in the quarter of the sale. 70% of that comes in in quarter 3. So that's 490 and 25% in the quarter following. So 70 sorry 700,000 times 0.25 is 175 totaling that up plus 490 665. And last but not least, Q4 collections. 650 is the sales and get 70% in the quarter the sales are made and the rest is coming in well 25% is coming in the next quarter. So that's receivable. the 5% would be allowed for as the allowance for doubtful accounts. We don't think we're going to collect that other 5%. so the the total though of Q4 collections that happens this year is 455,000. The 25% is next year's starting balance of the receivable. Right? Next year we start with whatever 650 times 0.25 25 162500. That would be my opening receivable for next year that would expect to collect in the first quarter of next year. okay, that's it. So now we just need totals. And so would call this maybe I'll say total cash collections. Total cash collections. So in Q1 expect to collect 125 my opening AR and of quarter 1 sales expect to collect 385. So my total collections in Q1 are $510,000. Actually let's put the underline there. 1375 plus 420 150 + 490 + 455 630. So this should add both ways to get this grand total. So if add from left to right or if add up and down should add to the same number. Let's try 510 + 557500 + 640 + 630 oops 630 2337500. The thing you might notice here is the number's lower, right? We sell $2.5 million, but we only get 2.3 million. Why is that? Well, some of the sales don't get collected the end of Q4, right? We're going to collect those Q1, the next year. And 5% we don't collect at all. So, that's why the number of the the sales revenue doesn't always reflect the cash coming in. And that's important to company, right? You run out of cash, you're dead. So, that's why we track it so closely. let me just add this thing down and make sure it adds properly both ways. 125 + + 570 + 665 plus 455 and 2337500. Yeah, it did add both ways. need dollar signs. these are dollar amounts. So, you don't have to do this in green ink. just do it to make them stick out. But dollar signs top and bottom of each column, right? Everything in here is dollar amount. So top and bottom, top and bottom, top and bottom, top and bottom. And there we have it. We've got beautiful schedule of expected cash collections. We've got beautiful sales budget. We've done beautiful job on problem 81A. One thing left to do, say goodbye and I'll see you in the next video. Thanks for watching. Bye-bye. Let's jump into problem 82A. production budget. We are asked to determine how many units the company needs to make in given month or given quarter. And to figure it out, our starting point is sales budget. So, we start by knowing what we're going to sell. And and if you know or you can anticipate what you're going to sell, that can inform what you need to make. at its most basic level, right? If know I'm going to sell 3,000 units of whatever it is make in in January, better make 3,000 units to have them ready to sell, right? That's great starting point. But why don't just use the number? Why don't say, "Well, I'm going to sell 3,000 units. Well, therefore, better make 3,000 units." And the reason is because you don't want to just sell exactly 3,000 and then sell out and go, "Well, too bad. don't have any more." No, you want to have little buffer built in. And also at the end of January, you don't want to start with zero in February. You want to have few units ready to go. So on February 1st when customer walks in, you don't go, "Well, we're making our new ones for February now." No, you want to have an ongoing production level and you want to have inventory ready to sell to customers. So that's what the production budget informs us on. Let's jump into it. Danny Company shows the following estimates for unit sales for the first quarter of its upcoming year. And you can see the monthby-month unit sales for January, February, March, quarter one of whatever year. the company's required finished goods is equal to 20% of the next month's expected sales. So this is what kind of inventory level we're comfortable with. And what we say is not only are we going to need to make the 3,000 units, but we also want to have 20% of next month ready to go. We don't want to have our shelves empty. We want to have 20% of the next months ready to go for the next month. that's what that sentence means. the company expects to begin January with 600 units in inventory. So it has some inventory ready to go from the previous month and the expected sales in April are 5,000. Well, that's going to inform what we want to end March with. But let's let's jump into this. think once you've done one line here, one month, it becomes very straightforward, but getting that first month is tricky. So, let's get to it. Name of the company, threeline title, Danny Company. name of the budget we're making. This is production budget. And this gets dated for the month for the year in this case for the quarter for the quarter ended March 31st for the quarter ended March 31st. Okay. And then our headings are just the months. January, February, March, and our totals column. It's not really total, it's for the quarter column, and we'll explain that as we go. So, think great starting point if you're given units sold, that's great starting point for most budgets. Let's start with units sold. And if we know what we're expecting to sell, so let's do January, right? And actually like to say expected units sold because of course we don't know for sure, but this is what we're expecting. By the way, you can see was little bit sloppy there with my title. my like account title here, my line title. don't expect students to get these word for word. And find students that try to memorize need this exact wording. They go wrong. It's the ones that sort of say directionally what is happening on this budget. And you can even do these in different order to what do. This is not like gap financial statement where everything needs to be just so in my opinion. Maybe talk to your professor, but my view is if you are getting to the right outcome, following logical steps, that's fine. So anyway, I'll follow some logical steps here, but expected units sold in January are 3,000. Well, if I'm expecting to sell 3,000, that's good thing. got to make 3,000, right? My production should be around 3,000. but want to have extra inventory. The company requires finished goods inventory on hand equal to 20% of the next month's expected sales. So, got to have extra. And how much extra in January? Well, want to have 20% of February ready to go. February is 3500. Multiply by 0.2 700. We would call that the desired ending inventory. desired ending inventory. So, our desired ending inventory here is 700 units. So, okay, I'm going to sell 3,000 units plus want to have 700 left over. got subtotal here of 3,700. would call this my production needs, right? need to have units ready to go, right? the 3,000 I'm going to sell in January and the 700 extra I'm hoping to have left over for February. Well, the thing that could mitigate this is what if enter January, already had some inventory, which we should, right? We don't expect the cupboards to be bare. already had 600 units in inventory beginning January. So, don't need to make those ones. Those are already ready to go. So, deduct the beginning inventory. deduct beginning inventory. So our beginning inventory was 600 units and this is my production. So my required production or desired production if you want to call it that. Like said I'm not you know required desired or if you just said production here that would be good enough for me. Again, speak to your professor before you get too far in in freestyling these ones, but I'm I'm not too picky. If the student gets to 3,100, as long as the label is reasonable as to what happened, well, then yeah, think that's fine. Our required production here though, 3100. Now, you'll notice no dollar signs on here. These are all units, right? This is units I'm planning to produce. Okay, so I'm planning to produce 3100 units in January. Let's do February. And think if you can if you got that on January, it starts to flow. February my production. Well, I'm going to make 3500 units plus want to have 20% of March ready to go. 4500 * 20% is 900. So my total needs here are 4400, but have some beginning inventory from January. The beginning inventory for February is the same as the ending inventory from January. The ending inventory from January is 700. So don't need to make that in February. If if made extra in January as planned then don't need to make it in February. So that sort of gets deducted. 4,400 minus 700 that's 3700. And there's February in the books. Let's do March. March is 4500. My desired ending inventory for March. Well, it's 20% of next month. And the question says, the expected unit sales for April are 5,000. So, it's going to be 20% of April. It's going to be a,000 units. 4500 plus a,000. Subtotal here is 5500. We deduct our beginning inventory. Well, the beginning inventory for March is the same as the ending inventory for February. There it is. It's 900. So, deduct 900. 5,500US 900 is 4,600. And there we have it. Now, we just need the for the quarter column. And truthfully, this is where more students make mistakes than the other part. So, once you practice this, you'll see the other part is actually not too bad. The for the quarter column has my most frequent mistakes, and I'll point them out now. 3,000 plus 3500 plus 4500, it is 11,000 total. our desired ending inventory for the quarter. This is where people make mistakes. They total it up. They go, it's 2600, right? 7 plus 900 plus a,000 is 2600." No, no, no. Our desired ending inventory for the quarter is how much inventory do want to have on hand at the end of the quarter? Well, what's the end of the quarter? It's March 31st. How much inventory do want to have on March 31st? Actually, just a,000 units, right? If put 700 plus 900 plus 1,000 at no point does this company want to have 2600 units of inventory sitting on the shelf. No way, never, never, never. So, lot of students will put 2600 here because they don't understand what they're looking at. The end of the quarter is the same as the end of March. want to have a,000 units sitting on my shelves at the end of the quarter, at the end of March. So, that's the number put. 11,000 plus 1,000 is 12,000. Now, what about the beginning? Well, same thing here. The beginning of the quarter, the quarter started on January 1st. What's my inventory on January 1st? 600 units. It's the the same began with at the beginning of the quarter, which was January. 12,000 minus 600 is 11,400. It's funny, you know, it's funny mistake, but this one and this one are by far the most common mistakes see as professor. So, that's something to keep your eyes open for. Don't make that common mistake if you're asked to do production budget. But there you have it. That's our production budget. How useful is that? Because then if you know what you're going to make, you can know, well, how many employees do need to have? How many hours can give them? How many shifts can give them? what do need to order in terms of material? You know, got to bring in my raw materials. How much raw material do need? You can plan based on the amount of sales you have, how much you're going to produce. And lot of your other costs and needs will be driven by this production budget. very important budget, one test all the time. And got one last test question for you. Can you find one of those buttons and hit it for me? All right. Thanks for watching. See you in the next video. Bye for now. Let's jump into problem 83A. materials purchases budget. This one's bit bigger than our previous few budgets and it's bit more involved. And always want to caution students, don't try to memorize word for word every description, every detail write. You want to just make sure you're going in the right direction. And find these things are logic puzzle. And it's better to solve the logic puzzle than to memorize the solution. Because if you memorize solution, if you forget line, it all falls apart. And I've certainly as professor seen it fall apart for students where even if you don't get the right words in this side, but you just describe what you're doing, that'll get you most of the marks. So, that's better way to learn this stuff. So, let's go. Shang Company manufactures faux leather bags. Each bag takes 0.5 yards of material. guess you measure material by the yard. and the material cost $5 per yard. The company had 1,500 yards of material on hand at the beginning of January and required enough ending monthly materials to be on hand to meet 10% of the following month's production requirements. so this sounds like production budget and it's lot like production budget. It really is similar. the company's production budget follows and there's our production budget for January, February, and March. and it notes that the company expects to produce 40,000 units in April. So we're asked to do production material purchases budget, pardon me. and we provide the number of yards and the dollar value of the inventory. So this is little bit tricky because we have required production in units. This is how many handbags we're going to make, faux leather bags. we also so our unit is the unit, the bag. We also have the unit being the yard of material. That's another unit we have to be concerned with. And third unit is the dollar value of all of this. So, dollars, yards, units, bags, it's it's jumble, right? And so, you got to really keep it straight and be clearheaded about what we're trying to do here. And first time you do it, you're not going to be clear-headed at all. But hopefully by the end of this video, you will be. So, let's start with title, though. That's very straightforward. Shang Company and then the name of the budget we're making materials purchases budget and then these get dated for the quarter ended. And then the last day of the quarter which of course is March 31st. the heading again just the months of the quarter January, February, March and quarter. So our starting point is often and and this is no exception just the given information here the required production. Now this required production is in units right it's in handbags and we're going to convert this to yards because we want to we're in our materials of course we're we're ordering yards of material so we're saying if want to make let's just do January if want to make 30,000 handbags how many yards of material is that so how how am going to figure that out well it takes half yard per bag so let's multiply this by 0.5 and here's where not that I'm totally freestyling, but like the wording here, right? What do want to say? want to multiply this by 0.5. So, want to times 0.5 in here. So, I'm going to say times and again, I'm just like off the cuff here. Times material per unit, right? And so, it's 0.5 yards per unit. And so now we have our required production not in units but in yards. So if want to make 30,000 units, I'm going to need 15,000 yards of whatever this material is that we use to make handbags. By the way, is that lot or little? have no idea. It's half yard. You know, just made up the number. I'm guy that doesn't own any handbags and doesn't know anything about sewing or material. don't know if that's lot or little in terms of the material that I've suggested. okay. So, we're going to take 15,000 yards of material. Okay. So, that's useful thing to know. So, if I'm going to make 30,000 bags, need 15,000 yards of material, but don't want to run out of material. don't want to run down to zero. And the question says, well, we want to have at least 10% left over. It gives us little bit buffer. So, want to have 10% of the next month's need. So, got to do February now. 35,000 * 0.5 is 17,500. And so, this is saying want to have 10% of that 175 on hand at the end of January. So, we'll say add desired ending. Now, rather than saying inventory, inventory, it is inventory, but I'm going to say ending materials inventory, right? It's not our desired ending inventory in units of bags. It's our desired ending yards of material. And it's 10% of February. So 10% of 175 is 1750. So our total materials needed 15,000 + 1750 is 16750. Okay. So, need 16750. What would mitigate this is if already had some materials, and we do. It says the company had 1500 yards of material to start the month. so don't need to order those. So, deduct beginning materials. And this is calculation that's appeared lot in our class, right? We're always adding ending inventory, deducting beginning inventory. Very common calculation for us to see. Sometimes we're adding beginning and deducting ending. This is very common theme anyway. So we're going to deduct 1,500 here. 16750 minus,500 is 15250. And so this is total materials to be purchased. Now again that that like heading total materials to be purchased. just came up with that clumsy way of saying it but you get the idea right. And so when my students answer these questions if get the idea and they get the right numbers I'm okay with you know myriad you know wide range of explanations. And even if they do this in slightly different order here, that's okay with me, too. As long as they've understood the thought process and there's logical thought process and they land in the right place, will be happy. Again, talk to your instructor. they might be looser or tighter than am around that. Okay, let's just sort of reiterate what's happening in January. I'm going to make 30,000 handbags. Each bag takes half yard of material. Therefore, need 15,000 yards of material. also want to have some material left over for next month. We've said 1750 is the number. So in total need 16750. have 1,500 yards of material sitting there from last month. So don't need to buy those. So I'm going to need to buy 15250. The final thing is how much am going to spend? Well, it's five bucks yard. So let's multiply by price per yard or per unit of material times $5. 15 250 * 5. It's going to be $76,250, which is materials purchased in dollars. So it says provide both the number of yards and dollar value of inventory to purchase. Maybe should have said dollar value of inventory purchase, but it's 76250. Okay, now February and March would be easy. Let's just I'll do the top part of March here. 38,000 time 0.5. 38,000*.5 is 19,000. Now have enough information to do my February. so February I'm going to make 35,000 handbags, half yard each, 17,500 yards of material are needed plus 10% of March. 10% of 19,000 is 1,900. 175 + 1900 is 19,400. deduct the beginning inventory. The beginning of February is the same as the end of January. It's$,750. So deduct minus750 is 17650 and multiply that by $5 to give me the dollar value of this order 1760 650* 5 is 88250 and hope this is sort of know it's it's easy to get like tunnel vision you're learning something new it's complicated concept but if you take step back and think, yeah. I'm going to plan on what I'm going to sell. That tells me when the money's coming in. It also tells me what got to make, plan on what got to make, and that tells me, well, what need to order, and soon we'll do like how much staff we need." Right? Big picture, this all kind of funnels together, and and it's like, well, when's the money coming in? When's the money going out? Am going to run out of money? Like, these are things you need to be concerned with. And they all sort of stem from like how much you plan to sell in the next month or the next quarter and are you going to be ready for it? That's essentially what we're trying to figure out here. Our desired ending inventory for March, well, it's going to be 10% of April. April, we're making 40,000 units, but it's not 10% of that. It's 10% of the yards in April. So again, that's where the 40,000 came from. So I'm going to need 20,000 yards for April. take 10% of that. It's 2,000. 19,000 + 2,000 is 21,000. deduct the beginning which was 1,900. The beginning of March is the end of February. End of February is 1900. 21,000 minus 1900 is what is it? 19,100. Math in one's head is is hazardous. Let's make sure on that. 21,000 - $1,900. Yeah. 19,100 * 5 $95,500. Okay. Now for the quarter, our required production for the quarter is 103,000 time 0.5. What would that be? 65,0005. No, not 65. my gosh. Let's do it in calculator. I'm way off here. 103 *.5 51,500. Why did have 60 in my mind? think had 130 in my mind maybe. in any event, our desired ending inventory for the quarter, this is the one people screw up all the time. Desired ending inventory for the quarter, ending materials for the quarter is not the sum of these three. It's the what we want at the end of March, which is 2,000. So hopefully you're getting used to seeing that. Again, very common mistake. Don't you make it. 51 plus 2 is 53,500. Our beginning materials for the quarter is the same as the beginning of January. The beginning of the quarter started on January 1st. So the beginning of January, at the beginning of the quarter, we had 1,500 yards of material on hand. Again, not the sum, not the total here. 535 minus,500 is 52,000. $5 unit. $5 yard. 52,000* 5 is $260,000. And we can just quickly double check that we didn't make any mathematical errors by adding across. Again, it's very possible for that to have this work and have an error in here somewhere. But this is nice little error check. I'm adding from left to right. That bottom row, it does add to 260. So calculated the same both way. Doesn't mean we got it right, but it's good sign. Okay. that's it. We've completed 83A. We've completed our materials, purchases, budget. One thing left to do, click one of those buttons and I'll see you in the next video. Thanks for watching. know this stuff is challenging, so appreciate that you hung in there and I'll see you in the next video. Bye-bye. Let's jump into problem 84, direct labor budget. Part is one of the most straightforward budgets of this whole batch, of all of chapter eight. And then part little bit trickier. It adds little twist. So McCcluskey company's production requirements are as follows. Units to be produced. So they've done production budget, right? They figured this is how many units we're going to sell. Then they did production budget. This is how many units we're going to make. And then they say to themselves, well, if got to make 11,000 units, how many employees do need? How many hours do need for my direct labor workforce work? That's what this problem is all about. So it says each unit requires two direct labor hours. That's particularly cruel way of doing two. when write the number as word, some percentage of my students will miss that. each unit requires two direct labor hours to produce and workers are paid 30 bucks an hour. So the first budget says, "Assuming completely flexible labor force, prepare the company's direct labor budget." In other words, if need more employees, can bring them in easily. don't need to be paying overtime or anything like this. So let's get started with title. McCluskey company we are preparing direct labor budget and this is for the quarter ended March 31st. We'll need some headings, of course, January, February, March, and for the quarter. And now we'll take what they've given us. They've said the units to be produced. So we'll start there. And for January it's 11,000. February 10,500. March is 12K. And for the quarter 33,500 units to be produced. We know it takes two direct labor hours per unit. So if I'm going to make 11,000 units in January, it's going to take 22,000 hours. Now, again, just knowing that, right, your workforce planning, you can say, "Well, it's 22,000 labor hours need. How many full-time employees is that for the month?" And you can make staffing decisions. But let's let's go ahead and lay this out on the budget. We multiply by the direct labor hours per unit, and in this case, it's two. And so this is my direct labor hours needed for the month. 22,000 for January. what would that be? 21,000 for February and 24,000 for March. 22 + 21 + 24 67,000 for the quarter. And guess could have gone 33.5* 2 and is 67,000. Well, now how much is that costing me? Well, pay my direct labor workers $30 an hour. So, multiply by the wage rate, which is $30 per hour. And we're going to get the direct labor cost for the month. 22,000 * 30 660,000. 21,000 * 30 630,000 $24,000* 30 that's 720. $720,000. Now we just need grand total here. Well, guess I'll go 67,000 times 30 2 million. 20110 0 double underline dollar sign and think we're good to go. 660 plus 630 plus 720. Yeah, got 20110 both ways. There it is. my direct labor budget. And most questions that's sufficient, but occasionally the question, and in reality, there's some quirks like, if we go over certain amount of hours, we start having to pay overtime and overtime's paid at different rate. How do deal with it? And that's what part does has us doing. So, it's just similar task, but slightly, you know, one more wrinkle for us to contend with. So, let's contend with it. It says, refer to the original data. Assume the company has permanent employees who are guaranteed to be paid for at least $20,000 $20,000 20,000 hours of work per month. Any amount of work above 20,000 hours is going to be paid at 1.5 times their normal hourly rate. We call this time and half, right? That's very typical overtime rate, at least here in Canada. Right? If you go above and beyond certain number of hours, typically you're paid by at time and half. And legally, depending on the province, you may have to be paid at time and half, 1.5 times. So, they're not going to make $30 an hour for those extra hours. They're going to make $45 an hour, right? 1.5 time 30. 30 * 1.5 means their new wage rate for those extra hours is 45 bucks an hour. So, the companies are wise to try not to get any overtime because it's just very expensive. anyway, let's go ahead and give title here. McCluskey company. We're doing direct labor budget this time with some overtime. And this is for the quarter ended March 31st. same headings as before. January, February, March, and for the quarter. And we're going to start the same way. It's actually the the first three lines are the same here. So same. So we just, you know, I'm pretending we didn't have part right? So it's like if this was new question units to be produced the given information 11,000 105 12,000 and 335. We'll multiply that by direct labor hours needed per unit which was two. And that's going to give us our direct labor hours needed. 22,000, 21,000, and 24,000 for 67,000 in total. So, same start. Now, here's where things get quirky, and that is, well, don't have 22,000 direct labor hours available. only have 20,000 direct labor hours available and I'm not able to just bring in new people. Maybe there's union contract. There's myriad. Maybe just can't hire anybody, right? I'm having hard time finding people. So, only have 20,000 direct labor per hours available, but have 22,000 hours of work to be done. might be in position where have to pay overtime. And that's certainly the case here. So, let's just sort of figure out, well, what is our regular hours? So, our nonovertime hours, and of course, we've gone over 20. So, we're going to do 20,000 hours at regular rates each month because we've gone over each month. So, that's 60,000 regular hours. And then I'm going to have some overtime hours. 2,000, 1,000, and 4,000. Just the amount we've gone over the regular hours. So, 7,000 in total. okay. So, then let's figure out the regular pay. And it's 20,000 hours at 30 bucks an hour. 20. so just put 30 in brackets and you know that means $30 an hour. So 20,000* 30 is $600,000. and it's the same like 20,000* 30 20,000* 30. So 1.8 million of just like regular pay within the normal amount of time. If they just worked the amount of hours we had, they'd have worked and earned $1.8 million. But we got to pay some overtime. And our overtime pay is $45 an hour because they get paid one and half times their regular rate. And they work 2,000 hours in January. So 2,000 times 45, it's $90,000 of overtime, it's $45,000 of overtime here. And guess it's going to be 180,000 of overtime in March. 4,000 times 45. Yeah. 180,000 for grand total here of + 45 + 180 $315,000 of overtime pay. So our total labor cost 600 + 90 is 690. 600 + 45 is 645 and 600 + 180 is 780. 1.8 million plus 315 is 215. Okay. So, we've answered it. We've solved the budget. But do know this last sentence. It says, "Please include the overtime premium for each month." Now, you may be thinking to yourself, "Well, isn't that just this overtime pay?" And the answer is no. That's not the overtime premium. The overtime premium says if we didn't have to pay any overtime. In other words, if we just paid flat rate of $30 and we we brought them in for those extra hours, what what would we have paid them? And then what did we pay extra because of the overtime? And and basically the answer is it's not $45 an hour, the full overtime pay. It's the premium you pay above regular. So, it's $15 an hour extra for all of these overtime hours. So you would multiply the $15 extra by the overtime hours. So it would be $30,000. But an easier way to do this is to look at the previous part of the question where we did direct labor budget and we go, okay, paid these guys 660 if it was completely flexible because have to deal with overtime. paid $6.90. The premium due to the overtime is $30,000. Just the difference between the two. Now, the math on it is the difference between regular pay and overtime pay times the overtime hours. So, 15 times 2,000. It is 30,000. In this case, it's we paid we would have paid 630 if we could just pay flat rate of $30 an hour. We end up paying 645. There's $15,000. should note this is overtime premium. And 780 versus 720, it's $60,000. So in total the overtime premium 115 or 2115 versus 20110 it's $105,000 in overtime premium. Now why is that relevant? Why did take the time? Because the you know the budget is done here. This is just little extra line. The reason is we don't consider that extra overtime cost to be part of direct labor. Again, direct labor is the amount we pay in normal wages when the person has their hands on with the product. The direct labor worker has their hands on with the product. So, this is considered an overhead cost. So, this 105 or the 30,000 in January, 15 in February, 60 in March, this is overhead cost. The rest though, like this amount 2010 is direct labor cost. So, sort of funky side issue on the question. but there you have it. At fundamental level, we figure out how many units we want to make. We figure out how long it's going to take to make them. And from there, we can derive our direct labor cost. We've done it. We've solved 84A. As always, if you get to the end of these videos and they helped, don't be shy about hitting that thumbs up button. See you in the next video. Bye-bye. Let's have look at problem 85A, an overhead budget. think you'll find this to be one of the more straightforward budgets in the whole batch of budgets we're going to learn. Let's read through it and we'll kind of piece together what it's asking of us. Plural, Inc. budgets direct labor hours for the first quarter as follows. And there's our labor hours. And then it notes that the company's variable overhead rate is $10 per direct labor hour. That's not our wage rate, but it's our variable overhead rate. Well, we're going to be budgeting overhead. We budget our labor hours. Our variable overhead is based on direct labor per hours. So hope you're seeing where we're going here. The company's fixed overhead is $100,000 month. This number includes depreciation of $25,000. Something we'll do when we're budgeting is we'll calculate the total overhead or the total of any cost. And then we'll try to figure out well how much what does that mean for cash flow? And you'll know that depreciation doesn't involve cash. So, we'll deduct out the depreciation because not only do want to know my overhead cost, which includes depreciation, also want to know how much cash got to pay for overhead costs, which doesn't include depreciation. And so, we'll calculate two different numbers. And that's what they're required to ask. It says, prepare the company's overhead budget for the quarter. Show both total overhead and cash paid for manufacturing overhead. Okay, let's get to it. so plural inc manufacturing overhead budget for the quarter. Quarter ended March 31st. Okay. So, we got our three months in the quarter, January, February, March. We got quarter total here. And then we just got to like start with what they gave us and they gave us direct labor hours and it's like why did they give us direct labor hours? Well, you know, and know it's to calculate the variable overhead. So, 75,000. This is big company, right? If they've got 75,000 labor hours in month, it's lot of employees to get to that number. all right. Well, want to figure out my variable overhead cost, and it's $10 an hour. So, I'm just going to multiply by the variable overhead right here, which is again $10. And that's going to give me my variable overhead. So, $750,000, $800,000, $950,000, and $2.5 million. Okay, that's my variable overhead. Well, what about fixed overhead? Now, we're going to do total fixed overhead, including depreciation. So, $100,000 is my total fixed overhead. and it's fixed, so it doesn't change from month to month. That's what makes fixed costs fixed. Well, that's one of the elements anyway. So, it's $300,000 for the quarter. And so, my total overhead, this is key number, right? When you're figuring out what your product costs, it's material plus labor plus overhead. So the total overhead we're expecting in January is 850, February 900, March 1,50,000 and in total 2.8 million. But something you're interested in is is the company going to run out of money? And so you're interested in like cash in and cash out. So we got to figure out well how much cash did we pay are we expecting to pay out for overhead? And the answer is well it's it's all these overhead costs minus the depreciation because depreciation is non-cash expense. So we deduct depreciation. So our depreciation is $25,000. And we just say okay these are all costs$ 850 in cost but how much cash am paying? Well if have 850 in in overhead costs only$8.25 25 represents negative cash flow. So that's going to be our cash paid for manufacturing overhead. okay. And what about the next month? Well, it's again $25,000 reduction because depreciation, although it's an expense, it's cost. It's non-cash item. Take out $25,000 here as well gives us 1025. And we're going to take out $75,000 in total here. So that gives us 27250. And remember, these are planning tools, right? They're not going to numbers aren't going to match this perfectly in reality, but it's useful to plan. Okay, this is how much I'm planning to spend. You know, in the quarter, got to spend about three million $2.7 million on overhead. Do have the money to spend that? Right? And as far as the total overhead goes, that's useful for costing your product, right? The total overhead cost goes into the cost of the product. So there you go. We have solved 85A. As always, I'm hoping the video helped and if it did, hope you'll help me too. Thanks for watching and I'll see you in the next video. Bye for now. Let's jump into problem 86A, selling and admin expenses budget. This has us calculating as the name suggests the selling and admin expenses and cash paid for selling and admin expenses. This is mostly just reading comprehension and you know trying to lay this thing out in way that makes sense. So let's read through it and see what we're up against. The budgeted unit sales for Jana Corporation for the upcoming quarter are as follows. And there's unit sales by month and for the quarter. And then it says details about the expenses. There's variable expenses, shipping $2 unit, sales commissions five, and other six. Fixed expenses, and you can see them there. And do know depreciation always has special place in my heart because most of our expenses, you pay with money, you pay with cash. Depreciation never involves cash. And when we're budgeting, we're not only interested in the selling and admin expenses, we're also interested in cash flow. How much are we paying for these costs? then depreciation will always count as part of the expenses but not as part of the cash flow. So that's always something to be grappled with in these types of problems and in real life. additional details also executive bonus payments of $25,000 will be made in July and September and major building repair of $35,000 will be paid in August. Okay, so it says prepare the company selling and admin budget for the upcoming quarter. disclose both total selling admin expenses and cash dispersements for selling and admin expenses. Let's get started just with title and the title is the name of the company of course Jana Corporation. We're doing selling and admin expenses budget and this is for the quarter ended what's the date? September. So September 30th and that involves the months of July, August and September and that's the quarter. Okay. So think sensible way to deal with selling and expense budget if the information is given in this way is to break it down into variable and fixed costs. So, we'll have heading here, variable, selling, and admin expenses. And we'll just list them out. We got three. Shipping, sales commissions, and others. Shipping, sales, commissions, three S's. don't think so. and other. It's funny when you're writing on these screens, some you make mistakes that don't think I'd make in real life, but it's I'm thinking about what to say next, what I'm doing next. My mind just wanders off the task of writing the word commissions, apparently. okay. So, those are my variable expenses. You can see these are fixed. And these ones down here are also fixed. They're just not monthly. They're like executive bonuses twice out of the three months and building repairs of 35,000 just in August. But, let's deal with the shipping. It's $2 unit and in July I'm going to ship 30,000 units. So that's $60,000, right? 2 time 30,000. 2 * 25,000 gives us 50,000 in August and 44,000 in September. So this totals to 154 for the quarter. You could also go 2 * 77, 154. 5 * 30 is 150 for our sales commissions. 5 * 25 is 125. And 5 * 22, guess that's 110. Can do this in my head? 385, think. 385. Let's see. 5* 77. 385. Okay, good. My brain's still working this morning. other It's been terrible in my house lately. We our air conditioner broke and it's the hottest week of the year. We're talking temps in like the 40° Celsius range, which is don't know 105 or something. 110 is really hot in my town. I'm not sleep I'm sleeping downstairs on like I'm basically camping in my own house. So if seem groggy, I'm little groggy right now. Anyway, let's keep going. Other six at 30,000 $180,000. We're having just crazy heat wave. 6* 25 is 150. 6* 22. What is that? 132. he's on. Maybe being sleepd deprived is good for my brain. Now, if get this one. 6 time 77. no. I'm in trouble, guys. No, don't have it. 462. There was no way that one was happening in my head. could have got there adding them, guess. But anyway, whatever. total variable selling and admin expenses. Let's add them up. 60 + 150 + 180. shouldn't have talked. 210, it's 390. 50 + 125 + 150. This one's easy. 325. 44 + 110 + 132. not happening today. Give me minute. could solve it, but not on not on stream, not on video. And totaling up this one. 154 + 385 + 1,01. What an interesting number. Okay. and mean 1 million and 1,000. Of course, there's three zeros at the end of that thousand and one. that's our variable. Let's do our fixed. So fixed selling and admin expenses. advertising, executive salaries and depreciation. Those are our first three anyway that we'll be worried about. advertising exec salaries depreciation and if it's just monthly it's very easy you just go okay well 75 grand month that's means 75 in July 75 in August and 75 in September that makes you know pretty pretty good sense to me so 75 * 3 225,000 for the quarter. Our executive salaries 90 90 and 270. Therefore, for the quarter and depreciation, which we are adding in now, we're going to deduct it later. We're including it because we're we're trying to figure out what our total selling admin expenses are. And we have depreciation of 60. We're going to take out that 60 at the very end to say, well, here's our selling admin expenses. Here's our cash paid for selling it in excluding depreciation because we don't pay cash for depreciation. what else do we have? We got exact bonuses. Executive bonuses. 25,000 will be made in July and September. 25,000 July. Nothing in August. 25,000 in September. So 50,000 in total there. And we've got building repair. So, building repair. And our building repair is 35,000 in August and nothing in July or September. You don't have to put zero or anything. You can just leave it blank. Sometimes do these little dashes to symbolize there's nothing there. And our total therefore is just 35,000 under building repair. So now we can total our fixed expenses. Total fixed selling and admin costs are. We're going to need to total these all up. 75 + 90 + 20. 185 + 25 is 210. this one's going to be 220. And this one's going to be 210 again. So, if I've done this right, we should total to 640. Let me just add down here. 225 + 270 + 60 + 50 + 35. Yep, feeling good about 640. so now we just need grand total of our selling and admin expenses. So, we're going to add our variable plus our fixed. Let me just highlight those lines. So, our total variable plus our total fixed is going to equal our total selling and admin expenses. And this is key number, right? This is going to go onto our budgeted income statement to tell us what our costs we're we're expecting to see are. And yeah, super important number. 390 + 210 is 600,000. 325 + 220 is 545,000. 286 + 210 is 496,000 and 1,01 + 640 is 1641. 1.641. Let me just add across. Make sure that makes sense. 600 + 545 + 496 looks okay to me. So that's key number, right? This is key number. But we also said we're obsessed, of course, with not running out of money. And so what is the cash flow related to this 1641? And the answer is, well, all these things pay in cash, right? You pay your executive bonuses in cash. You pay your building repairs in cash. You pay your shipping costs in cash. They're all cash costs except for depreciation. So take out the depreciation less depreciation of $20,000. Once again, sometimes do this in class and students, some students are like lazy like me and they're like, "Do have to put the depreciation in if just take it out?" And the answer is, yeah, this total number is really, really important. So we we do include depreciation to get the to to the total and then we take out the depreciation to get to another really really important number which is cash paid for selling and admin expenses. So both are key numbers both need to be highlighted. Sorry minus60,000 in total there. so we we do it this way. 580, 525, 476, and what would that be? 15 81. Double underline. I'm going to want dollar signs at the top and at the bottom of each column. These are all dollar figures. There's no unit figures on this budget. But there we go. We've gotten to the end. We've solved 86A. As always, hope the videos are helping. If they help you, hope you'll help me by hitting one of those buttons. Have great day. See you in the next video. Bye-bye. Let's stick around through problem 87A, cash budget. So, to do these budgets, it assumes something and it assumes we've already done all of our other budgets. So, we've done schedule of expected cash collections and we've got our cash receipts. We've done materials purchases budget, labor budget, an overhead budget, selling and admin expense budget, and we've totaled up all of our cash dispersements, and now we're saying, am based on everything I've seen so far, am going to run out of money? Right? That's the milliondoll question is, are we going to run out of money? Do we need to borrow money? Do we need to look to our shareholders for money? What's our cash flow situation? Or if you got lots of money, what are we going to do with all the extra money? Those are the that's the the question at hand. So it says Cookie Crunchers had the following estimated cash flows for the first quarter and there is cash coming in and cash going out for the quarter. And again that would have come off of other budgets we would have already prepared. the company begins the year with $20,000 in cash and requires minimum cash balance of 10,000. So once they're below 10, alarm bells start ringing and you go, better look at getting extra money because the idea is, you know, you could have $10,000 expense come out of nowhere for your business and sink you, right?" So, they want to have at least $10,000 ready to go. The company may borrow any amount from local bank at an interest rate, an annual interest rate of 6%. The borrowing must occur at the beginning of any month, and all repayments must be made at the end of any month. Interest is repaid at the time of the loan repayment. Okay, we've got to prepare cash budget. Let's start with title. Cookie crunchers. That sounds like me. am cookie cruncher. we are doing cash budget. I've been dieting and losing weight and my mom bought bunch of cookies. ate them all last night. just can't help myself around cookies. we're doing cash budget and it's for the quarter ended March 31st. Okay, so we've got January, February, March, and the quarter. And we're just trying to track our cash through the through the quarter. So we have beginning balance in cash. So cash balance beginning and at the beginning of January, the beginning of the quarter, our cash was $20,000. okay. We can't know our cash at the beginning of February until we know what we ended January with. So this this budget you kind of do all of January, you get to the end, then you do February, then you do all of February and on to March. So it's sort of there's an order of operations here. so what happens? Well, in January, we're bringing in $50,000 in cash. We have cash receipts. Actually, I'm going to say add cash receipts. So, $50,000 comes in. So, we're at $70,000 now. That's our subtotal. And we're going to deduct cash dispersements or cash payments. That's cash out. And we have 80 thou in cash out. So, where are we? Well, not in good place, right? You can see we're at -10. 70 minus 80 is -10. So this we would normally say cash available if it was positive. But since it's negative, we call it shortfall, right? We're we're short. Now, of course, when this happens, logical thing is to go back to your budget and go, well, maybe shouldn't spend the don't have the money to spend on the renovation or buy the new vehicle or whatever, right? you could change your plans at this moment or as the question suggests we can say okay well guess we've got plan to do some financing we got plan to do some borrowing so the next section is like the financing section and here we got to lay out there's really three items in the financing section we can borrow money we can pay it back and we deal with interest so those are the three things to be worried about in our cash budget which is borrowing we'll call them repayments, but it's it's principal repayments paying back what you owe and then interest repayments will be its own line. okay. So then that'll give us our total financing financing and this gives us our cash balance ending. Okay. So, let's see where we're at. We had $20,000. We had 50 grand come in, so we're going to be up to 70. We're planning to have 80,000 go out, so we're going to be at -10. The company requires minimum cash balance of 10, but that's positive 10. So, to go from -10 to positive 10, I'm going to have to borrow some money or get it from somewhere. In this example, borrow it. How much money do need to borrow? And the answer is $20,000. Right? If want to go from -10 to positive 10, got to borrow 20 grand. So, my total financing here is $20,000. I'm not repaying anything now. I'm not don't have the money to pay back. Yes, the interest clock has started ticking, but this is cash budget. I'm not paying back any interest today. So, no need to do anything with interest today. So, -10 + 20 leaves us at positive10 in cash at the end of the period. Dollar signs at the top. and bottom. Okay, February, my cash balance at the beginning of February is the same as it was at the end of January. It's $10,000. What happens in February? have $140,000 coming. February is big month, bringing me to subtotal of 150. have cash dispersements in February of 90, meaning I've I'm sitting on $60,000 in cash. The assumption in the question is we're going to repay as soon as possible. So, is it possible to repay? And the answer is, yeah, can pay back the 20 grand. got 60. got to have above 10. Yeah, if pay back the 20 plus some interest, I'm going to still be comfortable here. So, let's pay back the loan. So, of course, we're going to pay back 20 grand. But how much is the interest? Well, it's $20,000 times 6%. It is $1,200 in annual interest. That's in interest per year. We didn't borrow the money for the year. How long did we borrow the money for? Well, the question tells us the boring must occur at the beginning of any month. Now, this is not true for most companies, but it just makes the accounting question easier for our workbook. so if we borrow at the beginning of the month, it means we borrowed on January 1, right? We borrowed in January, we borrowed 20 grand. So, borrowed on January 1st. repay the money. It says the repayments happen at the end of the month. So, repay on Feb 28. So, how long did have this money out for? And the answer is two months. All right. So, we have $1,200 in interest year. We have 2 months worth of interest. 1,200 * 212 is $200. So, there's $200 of interest to be repaid. borrowed 20 grand, kept it out for two months, and now I'm paying back got to pay back the oops repayments. got to pay back the 20 grand owe and have to pay back $200 of interest at that time. So, in total, I'm paying back $20,200. So, had 60 grand, but you know, available, but I'm going to pay back my debts. So 60,000 minus 20,200 is leaving me with 39,800. Dollar sign at top, dollar sign at the bottom. Let's go on to March. March, open with $39,800. have $90,000 come in, giving me $12,9800. have $100,000 go out, leaving me with 29,800. Do need to go to the bank? The answer is no. don't need to borrow any money. don't need to pay back any loans. have no business at the bank right now. might go to the bank to make some investments if feel like have extra cash or, you know, there's things could do, but nothing that this problem is directing us to do. So, we end with $29,800 in cash. Let's look at the quarter in total. So this people can screw up and the re the way they would screw it up is they would total the cash balance beginning. They go 20 + 10 + 39 is 69,800. But no no no the cash balance at the beginning of the quarter was 10 was $20,000. Right. Cash receipts 50 + 140 + 90 is 280. Now you don't total this way. you add down 20 plus 280 is 300. That's our cash available or subtotal for the quarter. we deduct cash payments which is 270 and you can see if there was no financing we would have $30,000 in cash. But there was financing. What happened with the financing? We brought in we borrowed 20 grand. We repaid the 20 grand and we paid $200 of interest. In total, as result of financing, we're down 200 bucks the interest, right? We brought in 20, we paid back 20,200, we're down $200. And that's all on interest cost. So, where do we end up? 30,000 minus 200, $29,800. And you can see these two numbers are matching as they should, right? The money cash balance at the end of March, March 31st is the same as the end of the quarter, which is also March 31st. And think we've done it, folks. Congratulations to us. Just as you're celebrating and patting yourself on the back, pat me on the back, too. like making the videos, and love thumbs ups. All right, thanks for watching. Bye-bye. Welcome to module nine of our course in management accounting. So, friend of mine, Bill, was wanting to start food truck. And couple months into this, Bill realized he had beef problem. And in fact, it was just spending on beef. He was overspending on beef. And he came to me and he said, "Tony, got beef problem. Can you help me? know you're an accountant." said, "Bill, no worries. My charge out rate is $250 an hour. And since we're close friends, I'll do it for just 200 for you." Nah, just kidding. did it for free, of course. so he said his cost of beef should be two bucks burger, but he was like overspending on beef and he couldn't like get handle on what was going on. And so said, "Okay, well break down that two bucks burger. Why do you think it costs you two bucks burger?" And he said, "Well, this is the the situation. Beef should cost $20 kilogram and each burger make uses about 100 grams. That's about quarter pound of beef. little bit less." And so just did the math, right? 0.1 and and 100 grams of beef is 0.1 kilograms. So 0.1 kilograms at $20 kilogram is two bucks burger. And said, absolutely the math checks out. Nothing wrong with that breakdown at all. And so said, well, you know, tell me more. And so she said, here's the problem. last month sold a,000 burgers but spent 2470 on beef. And we look back and of course it should be two bucks burger. And so if it was two bucks burger and you sold 1,000 burgers, you should have spent 2,000 bucks. You spent 2470. You blew the budget by470 over budget, right? Like bad news, Bill. And wasn't breaking the news to him. He knew. He was like, "Yeah, that's that's why I'm I'm talking to you." Like, is there any way you can provide some insight as to what's going on here? And that's what variance analysis is all about. And that's key topic of the chapter. And so said, "Okay, well, let's you've given me some numbers and and we'll break it down. This is how an accountant would think of the numbers you gave us. On the left, I've got the standard like the supposed to it's supposed to cost $20 per kilogram of beef. And it's supposed to take 0.1 kg per burger. And of course, 20 * 0.1 is it's supposed to cost, as he said, 20 time is $2 per burger, right? That's what it's supposed to be. The actuals though, he made 1,000 burgers. This is what actually happened. Bought and used 130 kg. Now, had to ask him about that. That wasn't in the fact pattern, but he bought and used 130 kg of beef. This will be important in future questions, the the person who's going to buy different amount of beef or whatever material from what they use. because of course, it's very easy. He could have bought 140 kg of beef and only used 130 and he's got 10 kg in the fridge for tomorrow, right? Very common that you buy and use different amount of material and we will see that in future problems. But for this one, our first one, he bought and used the same amount of beef. That's fine. And that's actually kind of normal, too. And he spent 2470 doing it. And so we had all the information we needed to like break it down like what's going on here? Why is he seemingly overspending? Can we get to the bottom of this? And variance analysis says yes. So, here's how we're going to do variance analysis. I'm going to actually bring this up to be closer to my standards here. Let's see if can move that up. There we go. And we can have the standards and actuals on the same page. So, AQAP, AQ stands for actual quantity. AP for actual price. AQSB actual quantity standard price and SQSP standard quantity standard price. And as we compare these amounts, we can get some insight into did Bill blow the budget because he's paying too much for beef or did Bill blow the budget because he's either using too much beef or spoiled the beef. Why did he blow the budget? That's what variance analysis helps us to determine because there's no doubt he blow blew the budget by $470 dollars. So the first one aqap actual quantity of beef purchased. Now you can see break it down into dm purchased and over here dm used. In this case purchased and used will be the same but we're still going to use the prongs here. So okay the actual quantity bill purchased was 130 kilograms. Right? The beef purchased is measured in kilograms. The actual price is the actual price per kilogram. AP per unit, guess. Actual price per kilogram. I'm going to need calculator here. He purchased he spent 2470 divided by 130 kg. He spent $19 per kilogram, right? That's his actual price per kilogram. $19 per kg. So 130 * 19 is 2470. That's the amount he spent on beef. So the left prong is the amount you spent on your material. AQSP. So let's again aq is the actual quantity of materials purchased and that was 130 kg. SP is the standard price per kilogram. Well the standard price per kilogram is 20 bucks kilogram. So, AQ * SP 130 * 20 is 2600. But I'll just make sure in my calculator it is indeed $2,600. So, we've got variance here. The difference between this left prong and this kind of middle prong that is variance and the variance is $130. So, that's explains $130 of the difference. But the question is, is this good news or bad news? And in variance analysis, we don't say good news, bad news or good, bad. We say favorable or unfavorable. Is this variance favorable or unfavorable? And to figure that out, you look at what's different. So the quantities are not different. The prices are different. Bill is supposed to pay 20 bucks kilogram. Bill actually paid $19 kilogram. Is this good or bad? Well, the answer is it's good. He paid less than what he thought. And that'll happen, right? You go to the supermarket, one day, beef costs one price, the next day it costs different price. And obviously, the price of beef went down. Now, that's weird living in the inflationary times we're living in. But, okay, Bill got break on beef. This is favorable variance. He paid less than he expected. Let's move over to the quantity variance. So, AQSP. Now, as said, often material used will be different from material purchased. He could have some beef left over, but in this case, he purchased and used 130 kg. So, AQ still 130 kg. SP still 20 bucks. And yes, this prong is still 2600. Often in future questions, it'll be different number. Like these two numbers don't have to match because of course the amount purchased can be different from the amount used. SQSP. Well, okay. SP still $20 per kilogram. SQ is the trickiest prong here and you'll see me do this in all the questions to figure out SQ we say at the actual output so for Bill it's thousand burgers how much and because we'll do variances for not just material labor but also overhead how much in this case material should it take how many kilograms of beef should it take so at the actual output the given the fact that Bill actually made 1,000 burgers, how much beef should he have used according to standards? All right. So, if he made thousand burgers, if told him before the month, you're going to make thousand burgers. He doesn't know how many customers are going to come in day. How you're going to make thousand burgers. It takes 0.1 kg per burger. It should have taken 100 kilograms of beef to serve all of those customers. So his SQ here is 100 kg. 100 kg* $20 per kilogram is $2,000. So the difference here again, the variance between the left calculation and the right is $600. We're off by $600. Now, is this good variance or bad variance? said the wrong words. Is this favorable variance or an unfavorable variance? And the answer here is, well, should have used 100 kilograms of beef to serve all those customers. actually used 130 kg of beef to serve all those customers. used too much beef. This is unfavorable. So, when we're breaking it down to my good buddy Bill saying, "Bill, why'd you blow the budget?" The answer is not, "Well, you your beef was expensive." And that could be the answer. In other questions, you know, it'll be the price that's the problem. but in this case, it's not the price. Like, you know, got great price on beef. The issue is he was using too much beef. So, the question Bill would have to ask is one, did some beef get thrown out, right? Did just have to throw out some bad beef or something like this? Two, am just using too much beef in every burger? That's the most likely thing that's going on here. He's making the patties too big or bigger than what he was expecting. And if so, is it just the standards out of date? Maybe we got to change the standard from 0.1 to 0.2 or whatever, you know, bigger number. that's possible. But the bottom line, and this gives Bill some insight into his business, you're using too much beef in the burger. If you made recipe and you said the perfect burger uses 100 grams of beef and you're putting more beef in, yes, maybe your customers are getting little more value, but you're not living up to your standard. And that is the problem here. At the start, we said Bill blew his budget by $470. This breaks it down though. If you combine these, you go 600 unfavorable and 130 favorable. Take the big one minus the small one. The big one gets the balance. Yeah, we're overall $470 unfavorable, but now we know lot more about why. In this module, we'll do material, labor, and overhead variances. It's one of my favorite modules of the semester, and can't wait to get started. I'll see you in the next video. Thanks for watching and goodbye. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take run through problem 91A, direct materials variance. wonderful sample problem. do apologize. You're probably wondering what happened to Tony. Where did Tony go? Who's that cool guy in the sunglasses? It's me underneath here. just had an eye issue. I'm really sensitive to light these next few days. So, I'm going to be wearing sunglasses in my videos for little bit. apologize for that. know have gorgeous eyes. know that's big part of this channel's appeal is my beautiful eyes, but you're going to have to deal with them being behind sunglasses for the next few videos. Anyway, here we go. Steve's Sausages begins business in March. In planning his business, Steve sets the following materials standards. So, okay, we're going to need to know our standards versus our actuals. That's what materials or well, any variance is all about. Each sausage should take 250 of pork and 250 gram is 0.25 kg and pork should cost $10 per kilogram. Therefore, each sausage contains $2.50 of direct material or should contain 200 $2.50 of direct material. In March, Steve purchases 80 kilograms of pork for $740. Steve makes and sells 300 sausages and has two kilograms of pork remaining on hand at the end of the month. Compute the materials, price, and quantity variances. Now, in the workbook, I've given you this little table that you can fill in. When teach the class and when test, don't give my students this table, right? They just have to remember it. So, hopefully in practicing this, you'll get very comfortable and familiar with this. But let's begin with just the left prong of the table. You can see it's based on material purchased and the right prong is based on material used. And that's little thing that can trip you up with materials variances. You have to have two separate prongs. If you've done few of these, you'll see labor and overhead there. It's like one together. Material is little different. We got to distinguish between material purchased and used. So anyway, what's the actual quantity of material purchased? materials, you're going to measure it in some unit of measure like kilogram or pound or an ounce or liter, some unit of measure because that's, you know, how you would measure material. And in this case, we bought 80 kg. The AP is the price we paid per unit. So, how many price was the cost per kilogram? Well, we know we for 80 kg cost us $740. So, $740 divided by 80 it cost us $9.25. 25 cents per kilogram. So that's AQ. That's AP. Multiply them through 80 * 9.25 740. Okay. AQSP. Well, the actual quantity purchased is 80 kg. The standard price. How much should pork cost per kilogram? Or when Steve began business, what did he think pork cost? And it was 10 bucks kilogram. So $10 per kg and 80 * 10 is 800. Okay. Now we have our first variance and you can see the difference here is just the variance is the difference between the two prongs. The difference is 60. But we have to say is this difference good or bad? And we don't use the word good or bad because that's not sophisticated like us accountants. We say is it favorable or unfavorable? Is this favorable or unfavorable? Well, the way you do it is you just look at what's different. The AQAQ, that's the same number. So, you look at the price, you go, "Well, thought was going to pay $10 kilogram. actually paid 925. Is this good or bad for me?" We got deal. Of course, it's good. This is favorable materials price variance. Let's go over and do the quantity variance now. Now, we don't use 80 kilograms as our AQ. We have to figure out what was the quantity of material used. Not purchased, but used. And this last sentence gives it away. In March, Steve purchases 80 kg of pork for $740. Steve makes and sells 300 sausages and has 2 kg of pork remaining. Okay, so he bought 80 kg. He has 2 kg remaining. He must have used 78 kg in making those 300 sausages. So the AQ used, the actual quantity of material used is 78 kilograms. SP remains the same. It's supposed to cost $10 per kilogram. So $780 is what's on this prong of the calculation. SQSP. Well, SP remains $10 per kilogram. SQ to do SQ, we need to answer this question. At the actual level of output, how much in this case material, but we'll do it for labor and overhead. How much material should it take? So, at the actual number of good units produced, how much material should it have taken? How much material would Steve have guessed it would take? So, we actually made 300 sausages. If before the month or the week or the, you know, before March, told Steve, "Hey, you're going to make 300 sausages." How many kilograms of pork would Steve think that was going to take? And Steve figures it takes 0.25 kg, 250 gram of pork per sausage. So if Steve's making 300 sausages and it takes 0.25 kg per sausage, Steve would figure this should have taken him 75 kg of meat. Now he's off little and we're always going to be off little. There's always, you know, maybe he had to throw some in the garbage. Maybe just, you know, packed couple of the sausage casings too tightly. don't know. But generally, you're never going to be perfect here. And he's off. And so, he thought though, if he was going to make 300 sausages, it would take 75 kg. And let's just return to this because you're going to have to do this in every problem. This is the one that trips students up when they're doing variances as the SQ. it's called standard quantity allowed. at the actual level of output. So given the fact that Steve made 300 sausages, how much material should it have taken? And the answer is should have taken 75 kg. That's what Steve would have guessed it would have taken. So 75 * 10 that's 750. What's the variance 780 to 750? The variance is 30. Now is this good variance or bad one? don't shouldn't say good or bad. Is this favorable variance or an unfavorable variance? And the answer here is well you just look at what's different. The 10 and the 10 that's the same 75 versus 78. So it actually took him 78 kg of sauce of pork. It should have taken 75 kg. Too much pork, right? He was wasteful. This is unfavorable. They used too much pork. Why? They might have thrown some in the garbage. They might have just over stuffed the casings. We don't know why. But he used more pork than he he figured on using. So that is unfavorable pork usage, an unfavorable direct materials quantity variance. So overall 60F and 30U combine for 30F, right? Take the minus the and there you go. Right, we end up at 30 favorable overall for materials variances. All right, you know what would be even more favorable? If you hit one of those buttons if you think these glasses are cool, and think they're cool. Thanks for watching. See you in the next video. Bye-bye. Let's jump into problem 92A. Labor variances. So, as we read through the question, we're on the lookout for actuals and we're on the lookout for standards because, of course, we're comparing actuals to standards. And we're going to do some analysis based on that. So, here we go. Frank's Bikes makes fixed gear bicycles. The company set the following standards related to labor. Each bike should take four direct labor hours to manufacture at cost of $15 an hour. So 4 * 15, that's $60 in labor cost per bike. For August, the company produced 160 bicycles and employees worked $700 direct labor hours. The company's total labor cost for the month was $10,000. So up here looks to me like standards and down here looks to me like actuals. And we're going to fill in this table below. I've provided in the workbook. provide it to my students when they were practicing. But on tests, don't provide it. So, be careful about this as you're working through. Your professor may or may not give this to you on test situation. AQ though for labor. It's the actual quantity of labor hours worked. You often see this denoted as also actual hours. In other textbooks, just say AQ to be consistent. It's less to memorize. Everything's AQAP with me. And actually is often actual rate in other textbooks, but just say AP, price per hour of labor. So our actual quantity of labor was 700 direct labor hours. And our actual price per hour, well, we paid $10,000. $10,000 divided by 700 hours is 14.286. $14.286. So, you know, 1429 an hour essentially 700 * 14.286 blah blah blah is $10,000, right? So, that's the actual amount paid for my labor. AQSP. Take $700 and multiply by the standard price per hour of labor, which is 15. 700* 15 is $10,500. And again, this is the per hour rate, right? Per hour rate. so 700 * 15 $10,500. Now we just take the difference between the two. We go okay well we're 500 apart. That is variance of 500. Is the variance good or bad? We don't say good or bad. We say favorable or unfavorable. Well, we actually paid our employees around 1428 an hour. Our standard says we pay them 50 in an hour. This is favorable for the company. The company saved money here on wages. Now, why would that have happened? Well, maybe we had more inexperienced workforce. We had some turnover. Our wage we paid was lower than expected. By the way, this can be bad thing, right? Even though it says favorable in the variance, maybe we're underpaying people. We're going to lose people. Maybe yeah, there's all sorts of negative consequences to favorable variances. okay. SQSP. So SP $15 an hour. That's our standard wage rate or our expected wage rate for our direct labor workforce. SQ we answer the question given the actual level of output at the actual output how much in this case labor should it take? How many labor hours should it take? So given the fact you look at like whatever the company makes look at whatever the output was. company made 160 bicycles in the month and you go okay given the fact made 160 bikes how many hours should have taken and the answer is 4 hours per bike this should have taken 640 direct labor hours so if told the entrepreneur Frank before the year before the month said hey you're going to make 160 bikes next month he would have said okay that'll take 640 labor hours this is how many employees need to bring in actuality it took 700 So they were little bit off there. So 640 is our SQ. Our SP remains 15. 640 * 15 $9600. The difference here is 900. Now the question is, is this favorable or is it unfavorable? Well, it actually took 700 hours to do work that we think should have taken 640. This is unfavorable. Our employees were inefficient. Maybe that goes to the hypothesis. We brought in bunch of inexperienced workers, paid them lower. and so we were favorable as far as wage rates go, but they were slower and we were unfavorable as far as efficiency goes. That's possible, but you know, you wouldn't know unless you actually manage the company what the real cause was. Overall, you just take the big one minus the small one. So 900 minus 500 were 400. And then, you know, it's unfavorable. If they were both favorable, you'd add them together and get bigger favorable variance. In this case, we had one unfavorable, one favorable. Take the big one minus the small one. So 400 unfavorable as our overall labor variance. But there we go. It would be very favorable to me if you'd hit one of those. my gosh, hit the wrong thing. If you hit one of those buttons. Thanks for watching. See you in the next video. Hope you like my cool glasses. Bye-bye. Let's take run through problem 93A. variable overhead variances very much like the first cousin of the direct labor variance. So, if you did well on labor variances, overhead variances should be the same. adjusted my glasses. If you haven't tuned into my previous videos this module, just want to tell you I'm having eye issues. So, I'm having to wear glasses for the light, not just to look cool, although that's wonderful side effect. widgets are us applies variable overhead cost of jobs on the basis of machine hours. Okay. So, AQAP, our AQ, the actual quantity for, overhead here, variable overhead, is going to be machine hours. So, we're looking for machine hour numbers. The company's predetermined variable overhead rate is $6 per machine hour. And it is estimated that the company can produce two widgets per hour. Okay, so those are standards. for January, the company produced 600 widgets and machines were active for 320 machine hours. The company's total variable overhead cost was $1,400. Okay, think we've got everything we need. AQ, the actual quantities, the actual number of machine hours these things were running. 320 320 machine hours is AQ. AP is the actual price paid per machine hour. Well, we just know it's 1,400 in total. 1400 divided by 320 is 4.375. So that totals again to 1,400. AQSP actual quantity of hours worked 320 machine hours. Our standard rate is $6 per machine hour. So it's going to be times $6 per machine hour. 320 * 6 1920. Okay. So the difference here is 520. Now you can see this is good news difference, right? We expected to be pay spending $6 machine hour on variable overhead. We only spent $4. So yeah, we saved some money. This is favorable variance. SQSP. So SP remains $6 per machine hour. SQ I've been showing this lot at the actual output level. So the actual number of units produced, how much in this case of the overhead driver, machine hours in this case, should it take? So how many machine hours should this have taken? Well, we actually made 600 widgets, whatever our machine makes. How many machine hours would we expect it to take? Well, let's see. The company's predetermined overhead rate is $6 an hour. And it's estimated that each machine can produce two widgets per hour. So if make 600 widgets and can make two widgets per hour, would expect the machine to be working for 300 machine hours. That's what that's telling me. And that is my SQ 300 machine hours time $6 per hour is $1,800. So it actually took 320 hours to make what think should have taken 300 hours. it was used too much time right we were somewhat inefficient with our machine usage so it's the difference here is $120 this is unfavorable now overall when we combine the two 520 favorable 120 unfavorable we end up at 400 favorable and that's you can also compare the left and the right prongs of the table but there we go we've solved 93A on variable overhead variances bye-bye Bye. Hold on. Bye-bye. Thanks for watching. Bye. Let's take run through problem 94A on fixed overhead variances. Fixed overhead variances are not any harder than the material, labor, or variable overhead variances we've already learned. They're just different. And because they're different, my students tend to struggle on this one. Well, just one piece of this one. And we'll get to that in minute. But let's read through the problem and I'll show you the easy part and then I'll spend some time explaining the harder part. XY company manufactures tables. The company budgets fixed overhead to be $10,000 for the month of August. The company applies overhead cost to jobs on the basis of direct labor hours. Okay, so if we're given this type of information in an accounting question, you always want to be trying to calculate predetermined overhead rates if you can. So it says estimated overhead is $10,000. It applies overhead on the basis of directly hour. So, we're going to take our estimated overhead divided by our estimated direct labor hours, and that will be useful number in the question, so we'll use it in few minutes. But $10,000 is our estimated overhead. What is our estimated labor hours? don't know. Let's read on. The company has the following direct labor standards. It expects each table's going to take two hours to make, and the company anticipates making a,000 tables. Okay, so two hours to make. It's 1,000 tables. 2,000 labor hours. And in fact, that's what the next sentence says. Direct labor workers are budgeted to work for 2,000 hours. Okay, so 2,000 direct labor hours means our fixed overhead cost is $5 per direct labor hour. This is strange calculation to do because it's fixed overhead, right? We wouldn't expect it to go up and down with the amount of work. That's what makes fixed cost fixed. But in any event, we we do it and I'll explain why in moment. During August, the company produced 1,200 tables and the workers worked the total of 2200 hours. Actual fixed overhead was 10,500. Okay, so the first prong of this is actually very straightforward. You will generally be given the actual costs and we were the actual cost is 10,500. So that's our actual no math. Beautiful. What about our budget? Well, actually the company budgets fixed overhead is 10,000. So there we go. We don't need to do any calculations. These will generally be given numbers in the question and it was here. So comparing the two is very straightforward. We just go actually spent 10,500 on fixed overhead. budgeted to spend$10,000. The difference is 500. The question is, is this good or bad? Well, spent more than was planning to spend. This is bad. This is unfavorable. $500 unfavorable budget variance. blew the budget. for fixed overhead by 500 bucks. That's what that's saying. The applied piece, want to explain it bit. And actually, want to explain volume variance. Big picture. Volume variance just means if you have fixed cost and you make lot more product than you were planning to, your fixed cost spreads out over more products and that's good. If you make fewer products, your fixed cost doesn't spread out as much and that's bad. And the way think about this one is think about my ski pass at my ski hill. Now these numbers are little bit off. They're actually higher in real life, but just used 100,000 because it's even and it's easy to explain. And my ski hill skiing costs $100 day. Or you can buy an unlimited pass and ski as much as you want for the season. And the unlimited pass is $1,000. Now skied last year 25 times. had 25 ski days. So, of course planned knew was going to ski lot more. the 10 days would be when you kind of break even on this. knew was going to ski much higher volume. And feel good about it, right? At the end of the day year, sort of looked up online. said, ski 25 times. Isn't that good?" Now, could put number on the goodness? Well, one way of putting number on the goodness would be, well, you could say, well, if bought day passes 25 times, this would be $2,500 would pay. But only paid a,000. So, saved saved $1,500, right? $1,500 favorable variance because spread out my fixed cost of a,000 over many extra ski trips. took way more ski trips than needed to. and therefore got very good value out of my ski pass. Well, same thought process here. If we make more units of whatever it is we're making, that's good for volume variance because it means our fixed cost spread out over more units. If make fewer, that's bad for volume variance. So, what did we do? We planned to make a,000 tables. We actually made 1,200 tables. can tell you this is favorable variance. If you made more than you plan to, you got favorable volume variance. If you made less than you plan to, you got an unfavorable volume variance. How do do the calculation now? Now that long explanation's out of the way, how do do the calculation? It's an SQSP calculation. so SP is our hourly rate for fixed overhead. It is weird thing to calculate, but that's our SP, $5 per direct labor hour. SQ says given the actual number of tables made how many hours should it have taken so given that made 1,200 tables and each table is supposed to take 2 hours this should have taken 2400 direct labor hours right so 2400 * 5 is $12,000 so let's compare the two the budget is 10 the applied is 12,000 We're off by 2000. This is favorable. This is favorable variance. Why is it favorable? Because made more tables than was planning to. This is $2,000 favorable volume variance. Now, in total, our overhead variance is 1,500 favorable, right? 2,000 to the good, 500 to the bad. We're 1500 to the good overall. But there you go. We've calculated our fixed overhead variances. As always, hope the videos help. And if they do help you, hope you'll help me, too. Have great day. Hopefully, I'm out of these cool glasses soon. My eyes are giving me trouble, but should be back on track soon. Thanks for watching. Bye-bye. Let's jump into problem 95A, comprehensive variance analysis problem that has us doing material, labor, variable overhead, fixed overhead variances. So, it's the kitchen sink problem. It's got bit of everything. Chemco produces chemicals for cleaning pools. It sells the chemicals, liquid, in four liter buckets. The company's standards costs follow. And these are our standards. Whoops, misspelled standards. these are our standards. And of course, we're going to compare them to actual information. It says during the month, the company produced thousand buckets of chemicals. The following information is known. And here is bunch of actuals. And we're going to be comparing our standards to our actuals in computing materials variances, labor rate and efficiency variances, variable overhead variances, and fixed overhead variances. But we'll start rather than like reading the whole thing at once. We'll just take it piece at time. So let's think of our materials variances. And this is the table I've provided. Again, I've mentioned this few times. When test my students, don't give them this table. They'll have to remember it and produce it on the on the test. But here it is for us to fill out. So we're looking for the actual quantity of material used in lers and times the actual price per liter. Actual quantity times standard price and so on. So let's let's see if we can find that information. So we said here's the actuals. The company purchased 5,500 of direct material at cost of 21450. That certainly sounds like an actual quantity to me. 5500 lers. the quantity is or not the quantity the the total here is 21450. so we can figure out our price that we paid per liter just by dividing the two. 21450 divided by 5500. $3.90 liter is what we paid for this material. Right? We paid 21450 to buy 5500 liters. Okay. AQ remains the same. And again, this is for purchased 5,500 LERs. Our standard price per liter comes from the standard cost card. And you can see it's $4 liter. Just quick aside. Sometimes do this question in class. Students go, "Well, wait, it's 4 bucket." And we use five lers of material. And yeah, absolutely right. You might boil it down. You might sift some of that material out or refine it down. So, it's very possible to put in five liters, only get four liters of good product out. So, sometimes people get hung up on that. But the cost is $4 per liter. That's our standard price. So 5500* 4 is 22,000. Okay. So comparing the two, we're 550 apart, right? That's the difference. That is the variance. Is it good variance or bad variance? Is it favorable variance or an unfavorable variance? And the answer is again compare what's different. The four and the 3.9. I'm expecting to pay $4 liter. only pay 3.90 per liter. save some money. This is favorable. Let's move over to the other side of the equation. Now, this is onto our material used, not the same AQ as material purchased. Well, not necessarily. okay. The company purchased 5500 LER at cost of 21450. The company had no beginning inventory and had 700 lers of material on hand at the end of the year. So, of this 5,500, didn't use 700. But must use the rest which would be 4,800. 5500 minus 700 means the actual quantity used was lers. Standard price remains 4. 4,800 * 4 is 19,200. Working over to SQSP. Well, SP is still four. What we have to do for SQ and you've seen this this phrase before given the actual output given the number of good units made how much well in this case it's going to be material but in part two labor and part three overhead given the actual output how much how many lers of material should it have taken to make this well let's figure it out we made thousand buckets of chemicals and it's supposed to take five lers per bucket So, it should have taken 5,000 so that's my SQ, right? 5,000 5,000 * 4 is $20,000 worth of chemicals. The difference here is 800. Now, is this favorable or unfavorable? Again, compare what's different between the two. The four is the same. So, it's 5,000 versus 4,800. was supposed to use or expect to use 5,000 of chemicals to yield the the units got. only used 4,800. This is good. This is savings. This is favorable. So overall, am 13 thou $1350 favorable for my overall materials variances. And you can see how that breaks down. So into the problem, it says the company recently entered into contract with new suppliers eager for their business. Should the company continue to work with the supplier or should they look for new one? mean first month in this is pretty good. We would be very happy for this, right? We beat our standards. We They gave us better price and seemingly possibly better quality material because we used less of it. This is great news on the material front. Okay, let's continue on to asks us to compute the labor rate and efficiency variances. So again, AQAP, AQSP and so on. SQSP guess don't need to say and so on for that. so let's look at our labor actuals here. It says direct labor workforce work 220 hours total of 5280. So AQ of course for labor is actual hours which is 220 direct labor hours. AP is the actual rate per hour which don't know but do know the total amount paid them which was 5280. And we can work backwards to wage rate here. $5,280 divided by 220 hours. paid my workers $24 per hour. That was the wage rate. AQ remains $220. Standard price. Well, that's going to come from the standards. I'm supposed to be paying 20 bucks an hour according to the the labor in my standards there. So 220 * 20 is that 4,400 think. Yeah, 4,400. And you can see there's difference there of what is that 880. Now, is this good difference or bad? Is this favorable or unfavorable? The answer is, well, I'm supposed to pay 20 bucks there. paid 24. overpaid. This is unfavorable. overpaid compared to my standards. Good for the employees. They got more money, but bad for me. Now, maybe it's just an outdated standard. There could be lots of reasons for this, but we did overpay. the wage rate was higher than what we anticipated. SP remains 20 in the last part of this and once again we're answering that question at the actual level of output. So think we made thousand buckets of chemicals here. How much labor should it have taken? How many hours of labor should it taken? 1,000 buckets of chemicals. It's supposed to take according to the standard 0.25 hours. So 250 hours is what it's supposed to take. So SQ it's a,000 again 1000 * 0.25 25 equals sorry it's little messy 250 direct labor hours 250 * 20 is 5,000 and we'll compare the two 5,000 to 4,400 it's 600 different so let's let's remember what we do we compare what's different the 20 and the 20 are the same 250 labor hours that's my quantity is what it should have taken it only took 220 this is favorable it took me less time than what would have guessed so it's favorable able efficiency variance. Overall, it's mixed bag. Cost us more. We paid higher wages, but we did save money by being more efficient. 880 unfavorable, 600 favorable. Just combine them and we end up 280 unfavorable. So, the the second part of the question, it says, "The company experimented using more senior staff and fewer junior employees this month. Was it successful?" You know, it's mixed bag. we'd say it's more efficient, but the efficiency gains were were more than made up for by the wage rate cost. So, would say it was an experiment that that didn't work. It wasn't like home run here. It cost us more. We didn't save it in efficiency. So, this was this was costly decision. And would go back to the other way. Generally speaking, when something's favorable, you're you're in these types of questions, you're going to argue for it. When something's unfavorable, you're going to argue against it because all we have is the numbers. So, classic situation where accountants always get accused of like being myopic and only seeing the numbers. And that's why in these questions, we can't see the bigger picture. Maybe there's big picture reasons for doing it. The numbers say don't. Okay, let's continue. compute variable overhead spending and efficiency variances. So again, this will be very similar to our labor variance. AQAP, AQSP, SQSP, and the Q's because it told us our overhead was driven by labor hours. So the quantities are all labor hours. So they're all the same as they were up here. so it says variable overhead was 1050. That's the actual variable overhead cost and the actual quantity for variable overhead is the actual direct labor hours of 220. So just working backwards our our variable overhead rate per hour 1050 / 220 4.77 4.772. So again, it's 220 direct labor hours. The rate that we ended up paying was 4.772 per hour. So our labor cost was 1050. Okay. AQ remains 220 direct labor hours. SP for variable overhead. Well, our SP for overhead is $8 an hour. But wait, we got to break it down into variable overhead per hour and fixed overhead per hour. And it's got to give us some information. It says the manufacturing overhead rate, got to read this whole paragraph. The manufacturing overhead rate of $8 per direct labor hour can be further broken down. The company estimates variable overhead is five. Okay, well that's easy and then fixed therefore is three. the company expected to produce,00 buckets using 275 labor hours during the month. And based on those estimates, variable overhead was budgeted 1375, fixed overhead 825. Okay, think I've got enough information just with this five. So, let's use the five. where are we? our standard price for variable overhead is $5 per hour. Now, you might be saying, what about all that budget and actual stuff? That's for fixed, right? We compare budgets and actuals for fixed. 220 times five is $1,100. So, comparing the two, we're $50 apart. Now, is this favorable or unfavorable? Well, compare the standard 220 and 220 that matches. So, don't worry about that. It's the difference. Standard price $5 an hour and actual price $4.70 an hour. It's less. paid less for overhead. That's good. That's savings. This is favorable. SQSP. RSP remains $5 per hour. RSQ we say back to this thing at the actual output how much in this case overhead driver which is direct labor hours should it take how many direct labor hours should it take well we just did the math we said okay it's 0.25 25 hours. It's 1,000 buckets. It should take 250 hours. Same as same as with our labor variant. So, it is the same. 250 hours times five bucks an hour. 250 * 5 $1,250. So, the difference here is $150. And if it's favorable up here, it's going to be favorable down here. It is favorable. And we can just compare, right? our actual quantity. It took us 220 hours. It should have taken us 250 hours. We saved time and so we were efficient with labor and therefore with overhead. Okay, last one. Fixed overhead. The quirky one. We compare actual and budget. And these are generally going to be given amounts. What did actually spend on fixed overhead? And it's down here. Bullet point four. These are all our actuals. It says variable overhead is 1050. Fixed 800. Okay, so fixed overhead is 800. That's the actual budgeted fixed overhead. They give it in this paragraph. manufacturing overhead rate of $8 an hour can be further broken down. The company estimates $5 per labor hour for variable and therefore we said three for fix which is going to come into play in minute. the company expected to produce,00 buckets during 275 labor hours. variable overhead was budgeted at 1375. Fixed overhead was budgeted at $8.25. Okay. So, we expected to spend $825 on fixed overhead. We actually spent $800. This is $25 to the good. This is $25 favorable. Now, applied is like SQSP and it's also volume variant. So, we can tell if it's going to be favorable or not just by looking at one thing. We planned to produce,00 buckets. We actually produced 1,000 buckets. We underproduced. If we underproduce the plan, that means the volume was worse than we expected. We have less surface area to spread out our fixed costs onto. And therefore, this is going to be an unfavorable variant. So, whatever happens here, know this will be big But let's figure out the numbers here. SQ. The SQ is the same as, you know, it's based on labor hours. So it's 250 labor hours. So 0.25 hours times 1,000 buckets, our SQ is 250. SP we said is $3 an hour. And just to kind of go over that, there's few ways you could calculate it here. think the simplest way is they say the manufacturing overhead rate of $8 an hour can be further broken down. Variable is five. Therefore, fixed has got to be three. As we said, another way to look at it though is they said, okay, fixed overhead we budget to be $825. And that's if we use $275. So 8.25 divided by 275 means $3 an hour, right? So I've calculated couple different ways, we come to three. So 250 * 3 750 compared to $8.25. We're off by $75. And indeed it is unfavorable. That was lot of variances and not lot of time. hope this video helped. know it's big one. And if it helped you, hope you'll help me. Thanks for watching. See you in the next video. Bye-bye. very quick introduction to flexible budgeting. So, my friend was greenskeeper at golf course. He was in charge of maintenance. And as he grew in responsibility and grew into more of management role, they said, "Well, now you're in charge of this budget. And here's the budget for the maintenance of the golf course that you're going to oversee." And it's, you know, $175,000 budget that you're overseeing. And, you know, we anticipate the golf course is going to be open for 200 days. and you're going to have 100 grand in wages that will be available for you to spend $50,000 in supplies, you know, fertilizers and all the other things that go into keeping golf course green and beautiful. And you've got assets and we expect $25,000 of depreciation. So, that is your operating budget for the year and you'll be held to account for it, right? If things go well, you'll obviously be rewarded and if things go poorly, you'll be measured against this static budget. This is our budget. And so at the end of the period, actuals come in. You know, the the year or month goes by. guess this would be golf season. And we look at our actual numbers and we see how you did. And so in actuality, the weather was better than expected. The golf course was open 220 days. The wages were actually $105,000. The supply usage was $51,000 for and depreciation was $27,000. So the total here is $183,000. And so my friend when he was brought in and and sort of to discuss the budget, it was portrayed and he never thought this he thought this was very unfair. the budget versus actual the variance here. He was portrayed as having very negative variances because these are all costs. And so it's like, hey, you blew the wages cost by 5,000. That's 5,000 unfavorable. And it's true. Spent 5,000 more than budget. Supplies, you were a,000 over budget. So that's 6,000 over budget. For depreciation, you're 2,000 over budget. That's unfavorable. So overall, you're 8,000. Let me lean out of the way over budget. you you've blown your budget. And that is based on what we would call static budget. And my friend looked at this situation and said, "This doesn't seem fair to me. This doesn't seem right. And can you figure out why it doesn't seem right? And it doesn't seem right to me either. think my friend was right." Well, the answer is we budgeted to only be open for 200 days. We're open 220. We're open 10% longer. Shouldn't you get some leeway on some of your costs being up to 10% higher? And flexible budget says yes, this tool is terrific. Just budget, right? When you're making plan, you're setting targets, you're setting goals, it's useful thing to do, and most companies do it. flexible budget says, well, when you revisit at the end of the year to see how you did against budget, there are certain areas where you should consider like different variables like were we busier more than we thought? If so, we should revise our budget. We should be flexible enough in our budget to say, if I'm open 10% more days, would expect 10% more costs in these areas." So, let's redo this report as flexible budget report. So, I'm I'm going to get rid of that variance. Let me just change my ink and I'm going to say flex budget. And here's how flexible budget works. We redo the budget at an activity level, maintenance day level of 220 days. match that to the actual. Then pretend don't see any of these actual numbers. Now I'm going to draw lines over. Don't you do this. I'll erase that red ink in minute. And what we do is we just redo our budget at 220 days. So wages were $100,000 based on 200 days. Well, that's what is that five uh,000 day is my math right there. 5,000 time 200 200 time no, shouldn't have done the math on stream here. $500 day in wages, not 5,000. $500 per day in wages. Supplies are 250 per day in supplies. Is 50,000 divided by 200. So if know I'm going to be open for 220 days and could redo the budget, would say, well then it's going to be because it's variable cost, my wages are going to be $110,000. I'm open that many more days. So of course wages are going to be higher. and supplies usage. Of course, I'm going to use more fertilizer if I'm open 20 more days. supplies are going to be 55,000. And again, 250 * 220, 500 * 220. So, this totals to 165. my depreciation because it's fixed at the start of the year before knew any better, would say depreciation is going to be 25. Fixed costs remain the same in the flexible budgeting process. So, 165 plus 25 is 190. So if before the year started when was making my budget, told the people making the budget, hey, we're going to be open 220 days, they would have changed their numbers. So when I'm evaluating the performance of the Greenskeeper, should change the numbers also. So now let's compare the actual to the flex budget and get truer variance. So my wage is 105 versus 110. I'm 5,000 favorable here. Well, my friend is 51 versus 55, 4,000 favorable. Overall, that's 9,000 favorable. 27 versus 25. Again, the actual is higher than the budget. This is 2,000 unfavorable. And the grand total is 7,000 favorable. So, what compared to the static budget look kind of bad for my friend compared to the flexible budget looks little better. But hope you're seeing the purpose of flexible budget. Purpose of budget is clear. Let's make plan. Great to make plan. Flexible budget is when you're evaluating your performance, you might have to say, "Well, we were way busier or way less busy. What would our budget have looked like if we had known that then?" So, can we alter or flex the budget after the fact when it comes to evaluating how we did it? That's the purpose of flexible budget. got great problem waiting for you in the next video. Thanks for watching. See you there. Bye-bye. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's jump into problem 96A. flexible budgeting sample problem. Refined Touch is dating service. Rather than using algorithms, the company uses traditional matchmaker. The company had the following cost variance report for April. And you can see they were planning to have 120 matches. They actually had 150. So they're busier than expected. And yeah, they kept costs down largely. You can see 200 favorable variants. They budgeted to spend 9,500. They only spent 9,300. Linda Frost, the manager and matchmaker, comments in the report. What great month. We were busier than we expected and still managed to keep cost down. just wish every month could be this good. Comment on the flaw of the report. Well, the flaw of the report from flexible budgeting perspective is that we're not comparing apples to apples. We're looking at stagic budget based on 120 matches. when we actually had 150, you would naturally think lot of those variable costs would go up. So, why don't we recast this report? Why don't we when we're looking backwards after the fact, again, the budget's great tool for planning, but when you're looking back after the fact, why don't you adjust the budget based on what actually happened? So, flexible budget says, let's redo the budget, but pretend that before the month started, we knew we were going to have to have 150 matches. So let's do flex budget here at 150 matches and see what that looks like. So if we were asked to prepare report and we are it says prepare revised report. We're going to like redo this report. So it's name of the company refined touch. So what's the flaw in the report? Well the number of matches is very different and we haven't adjusted the budget accordingly. refined touch. We're doing flex flexible budget cost variance. So, let me spell variance the right way. Variance report. And this is for the month ended April 30th. for the month ended April 30th. Okay. so let's compare budget to actual but this time let's do flexible budget and that's based on having 150 matches not based on 120. So our flexible budget is based on 150 as our number of matches. And now we just redo the budget. We ignore all this actual stuff. We pretend we don't know. Now need those numbers for later. We ignore the old variances. We ignore everything else. We just go, okay, let's redo our budget at the level of 150 matches. What would we have said about our matching, our customer screening, and so on? So, let's work our way down our variable costs and redo them. So, we got matching. And let's just do some math here. We think our matching should cost $3,000 based on 120 matches. Well, if have more matches, it's going to cost more money. 3,000 divided by 120 means it's $25 per match, right? cost per match 25 per match. and so at 150 times 25 it's more money. It's 3750 is what we expect to spend on matching. What about customer screening? Cost screening. 2400. So that's $20 per match. And at 150 that's $3,000 that we would expect to spend on customer screening. What about payment processing? Well, that's $10 per match. So at 150 matches, that's going to be $1,500 payment processing. Now, our fixed costs because they're fixed. So, we got to total this up actually. the 3750 plus 3,000 + 1,500 is 8250. That's our total variable costs. our fixed costs are office and rent. Office expense. rent expense. And on flexible budget, because they're fixed, we just go, okay, like, you know, for instance, making two more matches doesn't change your rent cost. It does change your payment processor cost, right? So that's why this one's variable. That one's fixed. So our rent is 900. Doesn't matter how many matches make. And our office cost, we would guess, is 2,000. Doesn't matter how many matches we make. So in total, 2900 is our total fixed cost. And therefore our grand total our total costs are 8250 plus 2900 1150. Okay. So we've done our flexible budget. Now let's compare this to actual. So we go back and we just do actual. And actual is 150. And there's no variance there. And that's the idea. You you don't want variance between the flexible budget and what actually happened in terms of the driver, right? And here it's the number of matches is what drives these costs. So, the actual matching cost 3600, the actual customer screening 1,500, the actual payment processing, 1450. So, totaling up guess we have the total. was going to do it in my calculator, but 65.50. actual office expenses were 1,800, actual rent 950 for 2750 there. And the grand total of our costs 9,300 dollar sign at the top and bottom. Okay. So now we want to compare our flex budget and our actual. So let's just compare the two numbers. Based on flexible budget, we would expect matching costs to be 3750. They were actually 3,600. It's $150 variance and it's favorable. Our actual costs were lower than what you would expect. Customer screening 1,500. Very favorable there. Payment processing 50 to the good. Yeah, this is all good news for our friend Linda. 1,700 favorable. Office expenses 200 favorable. They were lower than expected. Rent expense 50 unfavorable, higher than expected. So overall here it's 150 to the good 150 favorable and as grand total it's $1850 favorable. So there we have revised flexible budget. comment on frost assertion that it was great month. Well if she's basing her great month based on this it was better. She did fantastic in terms of keeping her costs under control. Right. so if she liked this report she's going to love this one. Normally when somebody in these accounting questions says, it was great month." We, the accountant, get to bring them bad news. But here have good news for Frost. Yeah, this is great month. they did great job keeping costs under control. Now, there's bit of dark cloud in this silver lining. What variances ought to be investigated further? There's one that is just like red flag jumping out at me should be jumping out at you, too. Generally speaking, you're looking for the biggest numbers. Generally speaking, you'd be looking for the biggest unfavorable variance. But there weren't any significant unfavorable variances. Let's look for our biggest variances, though, in general. And this one is actually mildly alarming. The fact that, you know, this is matchmaking service. We expect to spend $3,000 in screening. We only spent $1,500 on screening. Were we doing good enough job screening clients? This is important, right? Customer safety is really critical in hightouch matchmaking service. You know, you're hooking people up with romantic partners and if you're not doing good job screening, it could spell problems like real world problems for the people involved. Certainly real world problems for your business. this one, even though it's very favorable, don't perceive it as good news. Now, maybe they've got better system in place and they actually no, we can do the screening better and cheaper. mean, that's possible, but alarm bells in my mind that we're skimping on customer screening, which to me would be very important part of matchmaking business. That's the variance would investigate further. One more thing want you to investigate further. Investigate your like button. Goodbye. Thanks for watching. See you. Let's jump into module 10 of our management accounting class on capital budgeting. Capital budgeting is like long-term investing for company. their planning, how to tie up their long-term funds, which projects should they tackle, which projects shouldn't they tackle? That is capital budgeting problem. And two concepts we'll introduce in this video that we'll also introduce in the chapter are payback period and net present value. So, when think of payback period, think of gym memberships. This is screenshot. actually did buy gym membership this year. You haven't gotten many comments commenting on my physique, but it is impressive and it's I'm bulking up. I'm getting bigger, stronger. I'm not. But anyway, so am of course an adult and as contemplate my gym membership, wanted to use red pen. always look at this like tradeoff, right? Single admission versus annual pass. And there's little calculation you can do if you're thinking, maybe I'll get an annual pass." And probably you do it and do it as well. take that single admission or the annual pass amount 4525 and this is my real gym. divide by 8.6 that's the cost per one entry. So can get unlimited gym use for $452 for year or can just pay $8 every time go $860. And the answer here is 52.5. So if go more than 52.5 times or 52.6 six times, the gym membership kind of pays for itself, right? The annual membership has paid off if go more than 52 times. So, if go 100 times, get amazing value out of my gym membership because it only cost me 450 per time. If go 20 times, got bad deal on the gym membership. So, every time anybody buys pass of any description, they'll do quick calculation like that to decide if the gym membership is worth it for them. By the way, don't want to brag. have been six times so far. got to go lot, right? It's it's once week basically, and I've been like once maybe once month. So, I'm I'm behind schedule on my own gym membership usage. But that little calculation is one that we all do. Well, when company makes an investment, they don't say, "How many times am going to the gym?" They say, "How many years is it going to take, if everything goes according to plan? How many years is it going to take for this investment to pay off?" And we call that the payback period. So they do very similar calculation. It's very straightforward calculation as you will see to figure out well when when is this thing going to pay off. And the idea is like look this 52 times. If this number was like 30 times it's way easier to buy the gym membership. If this number was like 200 times it makes it harder to want to buy the gym membership. And so companies will do that and they'll go hey if have project with payback period of three years that for some reason might be more attractive well I'll tell you the reason might be more attractive than payback period of five years right getting payback from your project in three years might be more attractive than five years because it's less risky the money's coming back to you lot more quickly so companies will use payback period to evaluate investments fundamental concept we'll get introduced to is net present value, NPV, net present value. And if and when you take corporate finance course or finance course or what else the financial management sometimes they call it. If you take course of that subject like this is the star when you take physics class, Isaac Newton is the star of that class. You'll learn if you take intro physics, if you take intro finance, net present value will be the star of that class. And the idea is any investment is just series of cash flows, right? You get money to make the investment, you got to spend money at the start and then over time hopefully whatever you buy, maybe it's new piece of equipment or maybe it's an actual investment, it brings money back to you. So, but the idea here is it happens over long time frame, years. And so we have to evaluate that there's time value in here that isn't in most of our management accounting questions, right? The fact that something might take years and years and years to pay back. Well, the years and years and years count for something and net present value captures that. And it captures that with this formula, present value. The idea being if give you $10,000 today and say or if you give me $10,000 today and say I'll pay you back the $10,000 in 10 years, you would say, "Well, you're going to need to pay me more than that because $10,000 10 years from now isn't worth the same as $10,000 today." And so we have to discount those future cash flows. Money 10 years from now is not worth the same thing as money today. And this is the formula. the present value of money. So money today is worth the future value divided by one plus discount rate. Now this is you know percentage is you know 5% is it 10%. Typically it's the rate at which the company can borrow money. So if they can borrow money at 8% they might use 8% here. It's more complicated than that. If you take finance course with me and Google my name in finance, you'll see go through it's weighted average cost of capital. WACC is how this rate gets derived for many companies. is the number of years. But in these questions in our management category, the will just be given. In fact, the FV will be given. So everything but PV will be given. And here's typical example, maybe shorthand example, and think it'll explain what's going on here. invest $20,000 today and will receive $11,000 at the end of this year and next. Okay. So, I'm going to receive $11,000 this year and next. That's $22,000. You go, "Okay, if give you 20 grand today, you're going to give me $22,000 over the next two years." If time value of money meant nothing, you'd go, "Yeah, I'll take the deal. I'm $2,000 ahead." But, of course, like, it's not an obvious yes or no decision here. we might want to crunch some numbers and use this formula to crunch those numbers. So here's how want you to approach these problems. want you to do timeline. So at time zero, year zero, we're going to give up $20,000. at year 1, we're going to receive $11,000. And at year two, we're going to receive $11,000. So is this deal worth taking? Well, we just sum up the the cash flows -20 + 11 + 11. The issue is we have to discount them to be present value. How much is cash flow in year worth at time zero? So, here's the math. For every one of these, we take this is the future value. We divide by 1 + our discount rate. I've just arbitrarily chosen 8%. So, 1.08 1.08 to the power of What's the time? Well, times 0 it's zero. And you'll see actually let me got to switch this to scientific 1.08 to the power of x^ to the power. So x^ the 0 is just one. So it's -20,000 / 1 and -20,000 / 1 is -20,000. So you can see this first one at time You don't have to do any of the math. You just go, okay, what's the cash flow at time Anyway, it's just wanted to show you how it works. So, this one is divided by 1.08 to the power of 1. And this one is going to be divided by 1.08 to the power of two. So, let's do the year 1 one. 11,000 / 1.08 to the x1. Now, again, 1.08 to the^ 1 is just 1.08. don't have to put the to the power of one in my calculator, but I'm just showing you how to do it without skipping anything. And it's 10185. Okay? So this is 10185. And so that was -20. The present value of that $11,000 year from now is 10,185 today. The present value of the next one 11,000 oops no 1,11,000 divided by 1.08^2 1.08xy 2 to the^ of 2 is 9431. So what's the present value of all these payments? Well, the present value of -20 today is -20 because it's today. The present value of 11,000 year from now is 10185. The present value of 11,0002 years from now is 9431. What is the net present value? The overall present value of all of this. The fundamental concept of finance courses, it does get more complicated, but this is, you know, introducing it. what is the net present value of all of these cash flows? Add them together. You just go, okay, 20,000 negative plus 10185 plus 9431. We end up at negative $384. So the question is, should do this $20,000 investment? And the answer is no. It's not worth it. It's negative netresent value. So the game plan on paper isn't good. Now, if the discount rate was, you know, 5%, think we would do it. It would be positive net present value. And the rule of thumb in these courses in finance or accounting course is if the net present value is positive at all, you do it. If it's negative, you don't. That's sort of your decision criteria. All right. we will in this chapter do somewhat more complicated problems on payback and net present value. And if you're looking for just course on this, search my name in corporate finance. can't wait to get started. Thanks for being here and I'll see you in the next video. Bye for now. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's run through problem 101A. We'll be doing payback period, internal rate of return, and net present value. Pinnacle Company is considering project that will cost $32,000 today, and it expects will provide cash flows of $10,000 per year for the next four years. All right, so we're putting out, let's actually draw, always want to draw number line here. So, always put y0 as in now time zero. And now we're putting out $32,000. So, we're giving up $32,000 in cash in exchange. In year 1, we're expecting to get positive 10,000. In year two, we're expecting to get plus 10K. In year three, we're expecting to get plus 10,000. And in year four, we're expecting to get plus 10,000. So, we've already passed the simplest test, which is is this cash flow positive? And the answer is, well, if you don't even consider time value of money, which is dollar four years from now, isn't as valuable as dollar today. Well, if we don't consider that, yeah, it's making $8,000, right? Negative - 32 and positive 40. 40 - 32, it's plus 8,000. So, it's passed test one, but there's stricter tests coming here. And the next one is, all right, well, it's going to pay itself back. How quickly does this pay itself back? With the idea that if something pays back really quickly, it's safer than something that pays off over the next 35 years. Well, if it's not paying me off in 35 years, might be dead by then, right? We want things to generally pay back reasonably quickly. Certainly more quick means more safe. That would be fair thing to say. So, how do calculate that payback period? Well, you just say, "Okay, what is my outlay?" $32,000. And you divide by the annual cash flows if they're all the same. So, divide by the annual cash flows. And they are in this example. In 102, they they won't be. And you get number 3.2. That's the years, right? It's $10,000 per year in cash flow. So, it's 3.2 years to pay this off. And that makes sense, right? After year 1, it's paid back 10,000. After year two, it's paid back 20. After year three, it's paid back 30, it's almost all the way paid back. And then, you know, 20% of the way through year four, it will have fully paid itself off. Again, when you're evaluating projects for payback, generally you would prefer shorter payback period. There's less risk in it for you. Okay. Net present value is key number when you do your management accounting class as we're doing here or if you do finance class. And what we find is the math can get fairly complicated here. will show you the the simplest way to solve these. But it's also slower way to solve it. If you want to do the quicker way, will do this in Excel in few minutes. So you can skip ahead to the Excel if you're like I'm not here for this doing it by hand stuff. We'll do it in Excel together in minute. And if you want to know how to do it in financial calculator, do that in my finance course, which there'll be free videos showing you how to use that. If you just look up Tony Bell corporate finance, you you'll find things net present value. You know, Google that and you'll you'll find what you're looking for. But we're going to do this by hand. And to do it, we're just taking into account that money four years from now is not worth the same as money one year from now. We want to discount those cash flows. In other words, money four years from now is worth less than money right now or in year from now. Here's how you discount cash flow. You take whatever the cash flow is, divide by 1 plus the discount rate, the interest rate, the the required rate of return is what we've called it here. So 1 plus in this case we're doing 6%. So 1.06 raised to the power of how long is it from now? So 1.06 this one's to the power of zero. 1.06 06 this is to the power of 1 because it's 1 year from now 1.06 to the power of two 1.06 to the power of three so again one plus that required rate of return raised to the power of how many years from now am discounting so this one 1.06 106 to the^ of 4 and that's all the cash flows and so you'll hear net present value your professor will say something like present value of future cash flows right that's the phrase this is how you take the present value of the cash flows so we'll do it and we'll do it by hand you can see though it's it's kind of like lots of calculations and if you had something that went 10 years you'd be doing 10 calcul you know it just can add up so you can quickly see why having more powerful calculator or Excel will make your life easier I'll show you how to do it in Excel in like two minutes from now but let's solve this by 32,000 negative / 1.06 to the^ of 0 divide by 1.06. This little button here is our to the power of button. to the So say to the 0. And any number raised to the power of 0 equals 1. So we're going 32,000 divided by 1 equals 32,000. Right? so would never actually calculate that number in calculator. was just doing it to show you. But in my mind, go, don't discount the time capital at time zero because it's now the $32,000 today is worth $32,000 today." What is $10,000 worth year from now? Well, we discount it by 6%. So $10,000 divided by 1.06 to the power of 1. $10,000 divided by 1.06. Now, know 1.06 to the^ of 1 is just 1.06, but I'll show you in the calculator. $10,000 divided by 1.06 to the power 1 is 9434. We'll round to the dollar here. 9434. And of course, this is positive cash flow. $10,000 divided by 1.06 to the 2 or squared, guess, is one other way to say that. 1.06 to the power of two. 88.99. So, actually, it rounds to 8,900. Kind of funny number there. 8900. next $10,000 divided by 1.06 06 to the 3 and order of operations, right? We do the 1.06 to the 3 first. Like this calculator is doing it right, but you know, just in case you're wondering, plus 8396 and $10,000 divided by 1.06. Again, that's to the power of four. 1.06. shoot. forgot the $10,000. $10,000 divided by 1.06 to the y4 7921 7921. And so what we're seeing here is $10,000 one year from now is worth more than $10,000 four years from now because of the way time value of money works, which hopefully you have been introduced to at some point in your academic career, some sort of math class or finance class. But if not, that's reality that you will see in these questions and in in real life. So now we just add up the cash flows. We go, okay, got to put out $32,000 today negative. So that's worth negative $32,000 today. In exchange, I'm going to get the equivalent of $9,400 in today's dollars year from now, equivalent of $8,900 two years from now, and so on. So let's add this all up, and we'll see if this is cash flow positive or not. 32,000 negative plus 9434 positive plus 8900 positive plus 8396 plus 7921 and end up with positive 2651 that is my net present value at required rate of return of 6% that is the answer now when you get net present value general rule rule of thumb unless the question tells you otherwise is if it's positive number we say yes this is good project it makes the company money if it's negative number you say don't do it so in the absence of other information and lot of questions will have like complicating factors but if it's just pure go no-go decision on the numbers if it's positive yes if it's negative no and if it's zero you are indifferent to the project okay let's do this in excel and if I've done this right have put in the cash flows just as we had divide by the number of years or put the number of years below and I'll just show you I'll do exactly what we did just then but in Excel. So I'm going to put in discount rate of 6%. For present value of this payment it's 32,000 divided by put this in brackets 1 + 6% so 1.06 6 to the power of and how many years from now and it was this cell here. So there we go. 32,000 plus and and I'm just going to lock in that 6%. So put dollar signs in front. When pull the formula over the 6% doesn't move. And let's just pull over and we'll get our future cash flows. So, know this isn't an Excel tutorial, but you just want to if you want to pull formula over, you move it to where that cross turns black and then you just pull it over and the formula moves with you. so those are all my cash flows. So, the net present value is just the sum of those cash flows. And hopefully, yeah, we get 2651. You can see it's still in my calculator from previous 2651. Now, the question said, well, what about if the internal or the required rate of return was 30%. Well, what would we do then? Now, could redo this, right? could go, okay, well, this is now not 1.06. It's 1.30 to the 0 and 1.30 to the one and so on. And could do that and get the the right answer for sure. And you could do it that way. If you have Excel at your hand and you've just done what we did, though, all you have to do if you've done the formula right is just change this to 30%. And there you go. -10,338. So if it's -10338 -10338 we wouldn't do it. So at 6% it's go. At 30% required rate of return it's nogo. Internal rate of return asks the question well what is the rate of return when the net present value is zero. So 6% is positive, 30% is negative. What's the number in between six and 30 that's going to make net present value be zero? Now, there's an easy way to do it in Excel and there's sort of tedious way. We'll show you the tedious way. It's not that tedious. So, know I'm I've put my formulas in properly here. know I'm shooting for number between six and 30. And we play the higher lower game like we're on some game show. So, six is too low, 30 is too high. I'm wanting to give number that makes zero. Let's make it 10. Okay, 10 is still negative number. So 10 is too high. Nine. Okay, it's between 9 and 10. 9.5. we're getting closer, right? We want the number of net present value to be zero. 96. Now we're negative, so 9.55. now we're positive, so 9.58. 9.57. 9.565. we're really close. 9.56 two. No, 9.564. Okay, there we go. 9.564%. We got there. That's ludicrous way to do it. The way you would do it in Excel, you would go equals irr bracket and then you just highlight the values. Not the discounted cash flows, but the values. Close the bracket. So again, just equals irr hit enter here and you can see the number 9.564%. And that is our answer to 101A part forgot the number. I'm going to write it down here. 9.564%. 9.564%. and there we have it. So net present value, internal rate of return, and payback period are all very key concepts in corporate finance, but they're often covered in management accounting. And so there we go. We have solved 101A. hope the video helped and if it did, hope you'll help me by hitting one of those buttons before you say goodbye. Goodbye. Welcome to module 11 of our management accounting class. We're almost there. This module all about performance measurement. And in this video, want to focus in on one aspect of performance measurement called the balanced scorecard. Okay, so congratulations. I've just promoted you. You are now CEO of bank. Wow, what promotion. You're CEO of bank. That's the good news. The bad news is revenues are down, profits are down, share price is down, you're unhappy, your board of directors is unhappy, your shareholders are unhappy, everybody's unhappy, and you're the CEO, so they're unhappy with you. but you think to yourself, wait minute, every time go by the bank, it's busy, right? There's big lineups. It seems like it's popular place to be. And what you underappreciated was, yes, it's busy, but the customers are not happy standing in the line, right? Well, suppose this character looks happy, but 90% of your customers are unhappy. That guy'd be happy no matter what, suppose. Just happy person. but your customers are not happy with your bank and for for one reason or another. And it looks to me like the level of service might not be delivering what they desire. and in fact you survey those customers and you learn that they think long lines stink. They are an unhappy group. They think long lines stink. So here you are the CEO and your board of directors, your shareholders, everybody tells you we want good financial outcomes. We want revenues up. We want stock price up. We want profits up. You know, these are the things we are looking for. And so of course you as CEO kind of lock in on those numbers. And we accountants are guilty of walking in on financial metrics. What the balance scorecard suggests is yes, financial metrics are important, but there are other things to consider. So, here's what the balance scorecard says. Not only should you be worried about financial metrics, you should also be worried about your employee metrics. I'm going to run out of space. can already tell. Employee metrics, and the key ones there are learning and growth for your employees, right? Are your employees good at their job and getting better at their job? That's something that you should be considering employee learning and growth. you should also be learning or worried about your own internal processes, your own internal efficiencies like how efficient is the company running. So I'll call that internal processes. And you should also be worried about your customer. Of course, that should make some good sense. So the balance scorecard says you should balance your concerns between these one, two, three, four items. You should be worried about all four of them basically in equal measure. But what we find is especially us accountants type, but lot of CEO types obsess over the financial and the reason is it's their job is on the line as result of the financial stuff. So they're like locked in on that because their board of directors wants them to be and so so they need to be. But what the balance scorecard suggests is we should sort of sp give equal weight to all of these items. And the balance scorecard may even suggest that the three on the left are more important than the one on the right. But let me explain by our long wait times example. So let's say we as bank have become aware like this is major issue at our bank that needs solving. Well, how would you solve it? Let's just say there's lots of branches. You're not sitting in the branch. You're in some head office in New York or something like this, but you got branches all over the the country. so you can't be there. You would have to train your managers to like, when there's line of, you know, that's more than few people deep, we got to put more tellers out. We got to sort of triage the line. We got to make keep that line moving. And so that would involve management training and likely some employee training to make them move more quickly because obviously things are going to slowly. So employee and manager training on lines, right? On lines, you know, keeping the lines short, customer weight times down. And not only do we need that when we're talking about balance scorecard, balance scorecard says, okay, figure out what you need to do and then actually try to measure it. So to say, need more employee training and manager training on lines. You would want numbers to this. You would want to say something like I'll just won't write it. Something like 100% of managers and 90% of employees all attend mandatory training on reducing lines. Now, as somebody that works at company that has lots of mandatory trainings, can tell some brighteyed person had balanced scorecard like this and they said, we need all of our employees to attend mandatory training." And the mandatory training was terrible and at times they can be counterproductive. So not only like so again us accountants we can go okay well we need 100% mandatory training and then we deliver bad ones. So that's something important right not only do we need to measure things but we need to execute as well internal processes kind of gets to execution but let's talk about that. So let's just say we did good training and you know our managers are putting out more employees and and how will we know if it's working? Well we got to measure weight time is reduced. So lower customer wait time, right? That's that's the root of the problem here. Customers are waiting too long. So we lower customer weight time. Again, we got to measure it. Our average customer weight time before this is 6 minutes and after this it's 2 minutes because we sped things up so much, right? But you would want to measure it. And by the way, both of these when you're measuring it, you've got to hold somebody accountable. If you just go, we're measuring it, but who cares?" Somebody's got to feel like they're going to be rewarded if it's successful and they're going to be in trouble if it's not, right? They're they are responsible and we need to make somebody feel responsible for this and ultimately we CEO are responsible for it because we're responsible to our shareholders. okay, so let's say we do this. Employees are better trained and and managers are better trained at keeping the line length down, the weight times down, and the weight times do drop. Well, what would expect to see? Well, would expect to see customer satisfaction go up and specifically around wait time when we survey them, you know, we will ask them 20 questions. Well, one of them is, you know, believe waited too long in line. You know, strongly agree, strongly disagree, right? And you would hope that they're saying, you know what, the wait time's not too bad, right? The the wait time is improving and that should be reflected. So maybe customer satisfaction happiness score goes from two out of five to four out of five, something like this, right? And again, you're going to measure it and you're going to make you're going to have some responsibility over that. So our employees are better trained, our customers aren't waiting in these long tedious lines as much. customers seem happier with our bank. Well, what's going to happen? hopefully revenues, share price, profit go up. now what the balance scorecard is very smart to point out, these are leading indicators. What does that mean? It means you got to do one, two, and three before you can get four, which is lagging indicator. You're you can't start with the revenues and say, want revenues to go up and work backwards from there. You actually got to start on the left side of this equation. So, that's something that again think mentioned we accountants get wrong, right? We lock in on those financial metrics. We obsess over them. We're trained on them. Boards of directors want to see them, so we focus on them. balance scorecard says you should focus on other things. And if you want to put numbers to it, this is how you would do it. So that is key concept we introduce this chapter. We also talk about return on investment, residual income, and don transfer pricing. One of the more challenging and interesting topics of the semester. But we'll start with balance scorecard problem and that's next. can't wait to get started. Thanks for being here and I'll see you in the next video. Bye-bye. Let's run through problem 111A on the balanced scorecard. For each of the balanced scorecard targets listed below, identify the matching perspective. Is it employee learning and growth, internal business processes, customer or financial? let's get started. So product returns as percentage of sales decreases by 5%. What could that be measuring? So is that about our employee learning growth? Not really. Internal processes maybe. Customer maybe. Definitely not financial. So think as read this would identify this as customer metric. It's measure of customers how happy they are with the product. Right? If they're returning it lot, that's going to lead to customer unhappiness. would say this is customer focused metric for sure. Employee satisfaction score above four and five. Four out of five on employee surveys. That's employee learning and growth. And you might think, well, why? That doesn't mean they're they're not training, they're not learning, they're not growing. Well, the idea is the happier employees are going to stick around for longer and you will grow as company with longer tenured employees for sure. Employee turnover being really high is bad for learning growth. You have no organizational memory. If everybody's constantly turning, number of complaints reduced below 10 per week. This is customers. Customers complaining less. That's certainly good for you and desirable. percentage of products with defects below 1%. Well, this is about your own internal efficiencies. Are you making good product or not? And you're measuring yourself, right? That's not the customer's return, although it's related, right? you have fewer defects, you're going to have fewer customer returns, one would imagine. Average employee training hours over 20 per year. Okay, any training stuff is learning and growth. for sure. Share price increases by two bucks. All right, the financial ones are usually the most obvious here. And that's clearly financial. sales grow by 15% also clearly financial. And the last one, setup time reduced by 20%. That's an internal process, right? That's how long it takes us to do something. That is internal business processes. And there we go. 111A in the books. It was short and sweet. It would be short and sweet. No, not short and sweet. It would be sweet if you'd hit button for me. Thanks for watching. See you in the next video. Bye-bye. The time has come to discuss transfer pricing. So, was in the store yesterday and it's difficult for parent to buy school lunches. I've got schoolage kid and just lunches every day. Making the lunches is pain. And there's product for that. Of course, there is. to simplify lunches. They're called Lunchables. You see them all over our supermarkets. And saw this Lunchables product and thought, my gosh, there's transfer pricing problem in the Lunchables on the box." couldn't believe it. And so, this is great way to introduce transfer pricing. Because when looked at the Lunchables, my eyes immediately got went down to Kool-Aid, which is an attractive brand to me. remember it from when was kid. It's just sugar water essentially. It's just drink drink mix that kids will like. And so here is the transfer pricing problem, though. Kool-Aid is its own brand and its own company. Lunchables is its own brand and its own company. And Kool-Aid is going to sell these Kool-Aid singles to Lunchables. Now the the issue is these companies are both subsidiaries of Craft. Craft owns Kool-Aid. Craft owns Lunchables. So if these were independent companies, they would just negotiate and whatever number they landed on. Kool-Aid would want to make as much profit as they could. Lunchables would want to pay as low as they could, right? And they'd bargain back and forth and they'd settle on price, suppose. But what makes this transfer pricing problem is they're all under the same parent company umbrella and it makes it more complicated. And so this is transfer pricing dilemma. How much should Kool-Aid, subsidiary of Craft, charge Lunchables, also subsidiary or division of Craft, for the Kool-Aid singles that are going in every Lunchables box or at least every Lunchables, you know, uploaded Nachos Grande with cheese dip and salsa, right? How much should they charge for that? And so, let's think of some options and the implications of the options. want to think of the highest possible price they could consider charging and then the lowest price they cons consider charging. So the highest price would be retail. So retail price looked this up now. Maybe you know my googling is not that strong. It seemed like very high price but looked online. tried to price compare the the cheapest price found as customer, just random Joe off the street for this 12pack of Kool-Aid singles was $6 for 12 of them, which is 50ents each. That seems really high to me. But anyway, that's fine. We'll use that. And it's nice even number, so it works for our It was $6 for 12. So that's 50 cents per Kool-Aid little satchel here. This little serving, right? So 50 cents each would be the absolute highest. And why is that the absolute highest? Well, because if Kool-Aid says, we'll charge you dollar per." Lunchables can go on Amazon.com like did and get them for 50 cents each. So why would the Lunchables person ever order them for more than 50 cents each? The lowest price. And so we'll call that I'll just call that like market price. The lowest price would be Kool-Aid's variable cost. Not even covering their fixed cost, just their variable cost of producing, you know, let's just say the Launchables wants 10,000. have no idea how many of these they sell. Let's just say they want 10,000 units. clearly, okay, what's the additional cost? You don't have to cover the fixed cost. We've already got the factory spun up here. what's our cost to produce 10,000 extra units for you without any profits for us, right? Without any margin for us, just our our pure variable cost. And so let's say that was 5 cents each 5 cents per unit. And we'll call that the variable cost. Okay. So, those are two options at which Kool-Aid could price their product for Lunchables. And of course, there'd be some debate and negotiation. want to introduce some characters into this play. so we've got Kool-Aid, Carl, and Carl's looking good here. Carl is the manager of Kool-Aid. His bonus is based on how much money Kool-Aid makes. you know, it's is his his he's incentivized to have Kool-Aid perform well. Yes, he knows he's in the craft foods umbrella, but daytoday he cares about Kool-Aid. He's not interested in craft peanut butter or craft cheese. He spends his life focused on the Kool-Aid brand doing well. Okay. And his counterpart here, Lunchables, Linda. And here's Linda. Maybe I'll do Linda. don't know if it makes sense. I'm going to make Linda green. was like, "You're gonna get confused between Carl and Linda because my art is so bad." This is Lunchables Linda. And Linda is Carl's counterpart here. She's the the head of Lunchables. And once again, she knows she works for Craft Foods. but she really works for Lunchables. Her day and life is obsessed with Lunchables doing well. And maybe at the top here, we've got cra Katie. Katie. we've got Katie as the big boss at Craft. And Katie, of course, would like to see Craft parent company doing well. So, okay, we've got our cast of characters here. We've got Katie at the top of Craft, Linda at the top of Lunchables, and Carl at the top of Kool-Aid. So, what are Carl's incentives? Well, Carl would love to charge 50 cents per unit to Linda to for Lunchables. and and the reason Carl wants to do that is because, you know, if they sell 10,000 units, he makes 5,000 more, it's going to be way more money than this and way more units than this. I'm realizing these numbers are way too small. let's say it's million units. You know, he's going to sell million Kool-Aid singles through to Lunchables. So, that's $500,000 in revenue if he sells at the highest price. And that means he's more profitable than if he sells at the lowest price, 5 cents each. which means he makes no money on the deal, right? So he would rather, if he's going to do the deal, go to bit of pain. He doesn't want to break even. He'd like to make money. And so the higher the price, the better for Carl. Linda's in the opposite spot. The higher the price, the worse that is for Lunchables because their cost of goods sold will go up, right? If they spend 50 cents unit, well, their cost of goods sold is higher than if they spend 5 cents unit. Linda wants it at 5 cents. Carl's going to want it at 50 cents. What does Katie think of all of this? The truth is Craft should be they're not indifferent, but financially they're indifferent. If Carl charges 50 cents or if Carl charges 5 cents for the Kool-Aid singles, Craft as parent is in the same place. Carl, let's just say they charge the highest price. Carl's revenues and profits will be higher. Linda's cost of goods sold will be higher and therefore her profits will be lower. And they just counteract each other. And so from craft parent perspective, it's as though nothing has happened. So what to do? And that's what makes transfer pricing transfer pricing. Like it's it's this quirky situation where one division will do better, one division will do worse. How do we make that determination? Well, we've already gone through two options. There's actually I'm going to introduce you to four. I'll introduce you to three right now and one at the end. So option one, charge the highest price, the market price. Charge. Option two, charge the lowest price, the variable cost. Well, options three and four are in between. Option three, maybe charge, we'll call it full cost. And let's just say it's not just our variable cost, but also our fixed cost per unit. And let's say that is 12 cents, right? In incorporating, you know, there's depreciation and amortization on equipment, there's all kinds of fixed costs. We're saying you pay your fair share of our full cost on this. And so that might be, and I'm making up numbers, 12 cents each. And that's again variable cost plus fixed cost per unit. Okay, that's an option, right? You can sort of imagine that. And option four is let these two people negotiate, right? pretend that you are not under the same craft foods banner and just pretend that you're negotiating with each other. Obviously, Carl, you're not going to charge her 50 cents per unit. That's what Tony Bell can get on Amazon.com today. She's going to order million little satchels of of stuff. You're going to give her volume discount even if she wasn't with Craft Foods. And Melinda is going to work her best to get the best bargain she can. So, it's going to be some number between five and 50. Likely some number, you know, in the in the, you know, 15 20 cent range. don't know. They'll they'll talk about it in debate. So, let's just say they negotiate number of, don't care, 20 cents. Doesn't really matter here. And so, again, that's not based on anybody's cost, not based on market price, that's just based on negotiation. Okay. So those are really our options for transfer pricing and the top two become important in our accounting class. The top two are preferred by accounting professors everywhere. but the bottom two are relevant for our conversation and there's fifth one I'll introduce at the very end that is very relevant. So let's look at the options we've discussed. We said the market price which was 50 cents per unit. what are the advantages of charging market price? Well, the first is it's objective, right? You can go out and, you know, Carl can credibly say this is the price 50 cents. You can see it everywhere, right? It's posted everywhere. you pay the fair price. now this is the important thing and this is why market price is useful. If there's no excess capacity, and you'll hear me say that word few times here, it leads to good decisions. what do mean by that? If Carl is selling out of Kool-Aid all over town, can't make enough Kool-Aid, if he wanted to supply Linda at Lunchables, if you wanted to supply the Kool-Aid to Lunchables at lower price, he's giving up better sales. There's huge opportunity cost for Carl. So, if there's no excess capacity, if Kool-Aid is selling out everywhere, this is the right number to use because he can just get 50 cents from somebody else. If Kool-Aid does have excess capacity, in other words, they can make more, they're not selling out, you know, they got room, this is not the best option. But again, if there is no excess capacity, if Carl is selling out everywhere, can't make any more Kool-Aid, and he's able to sell everything at 50 cents unit, he shouldn't sell to Linda for anything less than 50 cents unit. That's the theory of transfer pricing. disadvantages of using the market price. There may be no market. There are products that you can't just look up on Amazon.com, right? It's like one company builds it to serve another company and there's no external market. Internal transfers happen all the time. work at university and to sort of track costs the university will say you know the business school's part of the university they'll say okay business school you're going to pay rent on this room and this is what we're going to charge you for rent just to sort of keep track of costs well there's no external market for rent at the university there's one university one room there's there's no external market price so it's it's sort of weird thing so they couldn't use market price because there's there's no market and there's lots of products that are like that. it also doesn't capture the relationship, right? Market price gives no value to the fact that like why does Lunchables exist to big picture? Well, I'll tell you Lunchables is subsidiary of Oscar Meyer who makes like lunch meats. So, originally some bright person Oscar Meyer said we should sell lunch. We sell lunch meat. Why don't we box it up, package it different way, and we can sell our lunch meat this way? different lunch meat delivery system, if you will. And it was good idea. Well, Craft smartly said, "Well, if we're selling bunch of lunches, we're Craft. We own tons of little food companies. Why don't we put our products into these popular lunch products?" So, the fact that Kool-Aid is part of Craft and Lunchables is part of Craft, it makes lot of sense to put Kool-Aid in here instead of CocaCola, for example. Right? Lunchables could go, "Okay, well, you're going to charge me 50 cents. can get Coca-Cola product, you know, Coca-Cola tea or something like this because Coca-Cola is not just Coke, but you know, some other Coca-Cola product. can get it for 40 cents. Let's go with Coca-Cola because it's cheaper." And it's like, if you were craft, you would hate that, you know. No, no, no. Coco is an external company. We want bunch of craft products in this Lunchables box. So, if you're charging just market price, you're not capturing the fact that there's relationship between these companies. Well, what about variable cost? So, we said variable cost was 5 cents per unit. And it's sort of the flip side of market price. This is the best price if there is excess Whoa, sorry, excess capacity. In other words, we're not selling out. We got room to make more at Kool-Aid. this leads to good decisions. And when say leads to good decisions, mean leads to decisions that put Craft Parent Company in the best position. So if Kool-Aid has room to make more Kool-Aid, you know, they can make the million little extra satchels of Kool-Aid without building new factory or something like this. the the academically right number to charge is 5 cents. just your variable costs. Now it has huge advantages obviously for the buying deci division and therefore you know as again it captures lot of that relationship that we discussed earlier where like they get good deal they have an incentive to use craft products in their boxes and because they get good deal it it sort of passes on to customers. It's sort of good for the the value chain in that sense and it's good for Lunchables and Lunchables doing well is of course good for craft. So it's it's desirable thing for the company if there's excess capacity. the disadvantages here is on the seller side, right? seller doesn't recover fixed expenses. The seller doesn't get his fixed cost back, right? It's purely variable that it gets back. And because of it, and people have seen this, the seller has weird incentive. The seller is incentivized to misclassify costs as fixed. Misclassify costs sorry as variable. And what do mean there? Well, if their variable cost is really 5 cents, they have every incentive to like classify stuff as variable that's not variable to call it 6 cents, 7 cents, 8 cents just to make little more money. And so it creates like accounting tricks and people start to play games, right? And that's the worry if you go with this method where you know people might play accounting games to make themselves look little better. Okay, let's go on to full cost the variable plus the fixed. And we said that was going to be 12 cents per unit in this example. What are the examples of the advantages of full cost? Well, we just said people might mclassify stuff as variable. Mclassifying here is less of problem, right? Because you're include your variable and fixed. So, you're less likely to mclassify because, you know, if you called something fixed variable, doesn't matter. You're you're getting the full cost. And it's kind of simple, right? You know your cost of goods. You've calculated your cost of goods sold. We've gone through the whole class saying the cost of goods is the material, labor, and overhead. You don't have to break it into variable and fixed components. You're already calculating your cost of goods. So, you know, divide the cost by the number of units. There's your cost of goods and you can, you know, full cost to the seller. one of the problems with full cost is seller may be inefficient and if the seller is inefficient they pass on those inefficiencies just to down the line with the idea like it's less of case for Kool-Aid which has to operate in market and you know there's lots of competition but lots of these transfer pricing decisions happen in divisions where there's no market there's not lot of competition. And if the if the selling side is really wasteful and inefficient, well, the full cost of their inefficiency just goes onto the buying side and it's it's problem. So that's that's part of the reason full cost has problem. last couple here, negotiated price. well, with negotiated price, everybody's looking out for number one, right? We had our our two actors in this story. Our two key actors were forgot their names, Carl and Linda. Linda wants to do what's best for Lunchables. Carl wants to do what's best for Kool-Aid. They can come to some agreement that is mutually beneficial. Just like any other deal, why would you shake hands on deal? You would do it if it's mutually beneficial. So both interest or both sides act in their own interest and if they sign off on the deal and it's good for both parties, they'll both be happy, right? Like that's that's the idea. You don't make deal if you're going to be deeply unhappy about it. what's the disadvantage? Well, the big disadvantage is it's negotiation. Negotiations are slow, right? This is our own company. You're crafting. You think, we're going to spend months hammering out deal for our own product." Like, this should be easy and quick. Negotiations can be slow and painful. It's also negotiation. And that means there can be winners and losers. am terrible negotiator. know that about myself. Well, what if Carl is terrible negotiator? Lind is an unbelievable negotiator. It can leave hard feelings, right? we're stuck supplying this company and we don't even want to supply Lunchables. You know, it can you if you have contentious negotiation, people can leave hating each other's guts. Like that happens, right? And so there's problems with negotiation as well. And obviously, if you're negotiating some point like the theoretical best numbers are right here and right here. You have excess capacity, you should do variable cost. If you the seller, if the seller doesn't have excess capacity, they should use market price, right? That's it. Like problems solved academically. Those lead to the correct decisions. Okay. The final option and companies will do this more often than anything else in modern times. They'll transfer price at tax efficient price. And so the idea here is if Kool-Aid, now think these are American companies. I'm not actually sure, but let's just say for my example, Kool-Aid is headquartered in Ireland, let's say, and Lunchables is headquartered in Belgium, just for our conversation. Well, Belgium has higher taxes in this example. think this is true. And Ireland has lower taxes on businesses. Craft would go, we don't care what you guys negotiate. We want to show more profit in Ireland. And why? Because we want to pay less taxes. So, we're going to sort of force through this transfer at whatever price maximizes Kool-Aid's profit and whatever price minimizes Lunchable's profit. And that is often what is happening. So, the advantage here is it saves the company money on taxes. the disadvantage, this is just my own personal bias. don't like it. don't think it's right. Right. It doesn't reflect what's happening at the company, right? What's fair price to transfer at? It just reflects tax avoidance. So, and I'll use the word tax avoidance. And some people might think of this as bad thing. Well, it's it's certainly legal. It's it's legal. think it's ethically gray area in my own opinion. but again, I'm an accounting professor, not practitioner. But, it can also be expensive, right? Expensive. It saves you money ultimately, but you're you're paying thousands of dollars an hour for expensive CPAs to go, what if we set up shell company in this and we license our intellectual property?" You know, and it gets complicated and convoluted and it doesn't reflect what's actually happening at the company. It just becomes its own exercise, right? It's tax avoidance exercise. So, this is one that we don't discuss much in our management accounting class, but it is one that companies absolutely are pursuing. It's something personally don't like. don't like to reveal much about my personal politics, but think accounting should reflect what's actually happening at the company, and lot of these tax avoidant avoidance exercises don't do that. So in summary though, there really are two key options that you need to lock in on in your management accounting class. And those are the market price, which is best if the company doesn't have any excess capacity. Our factories are already pumping out or selling out at 50 cents unit. don't want to sell to you for 5 cents unit. Now, if I'm not at if have tons of excess capacity and can just make more without too much pain, variable cost is the appropriate one to charge. So, if there's no excess capacity, charge the market price. If there is excess capacity, charge the variable cost. That's longer than my normal intro, but transfer pricing is trickier than normal topic. As always, hope the video helped and I'll see you in the next video. Bye for now. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link. You'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take run through problem 113A, transfer pricing problem. Phony Inc. was massive media company that controlled cable company, wireless data network, and several other related businesses. so sounds like complicated web of companies. That's how transfer pricing works. And you're wise, if you know you're doing transfer pricing, to try to draw diagram of like what the various companies are and where they sit and what the relationships to each other are. So I'll try to do that as we go. so phontail Inc. was highly decentralized organization. That sentence that phrase will come into play lot when you have transfer pricing problems where managers were encouraged to where managers were encouraged to make decisions that were most profitable for their own divisions. One of phonetail Inc.'s subsidiary companies, Phony Data. All right, so we've already got two companies. We got Phonetail Inc. They look like the parent company. Then we've got Phonetail Data. That's the next company down, think. Okay. One of Phony Inc.'s subsidiary comp businesses was Phony Data, an installer of data servers. Phony Data's manager, Steve Frost, had large job that would require the installation of 2,000 servers. The request received three bits. One from Phonel Networking, subsidiary of Ponytail, Inc., okay. One from Little Guys Data, and one from Big Name Competitor. my goodness. Okay. Okay. So, let's sort of already want to like draw little part of this. So, we've got Phony Inc., which I'm just going to call PI actually rather than writing phony tail all the time. PI that's the parent company. And then we got Steve Frost, who's phonytail data. Phony Data that's below them. And phony data is looking for three bits. one from Phony Networking, one from which is obviously part of our company, one from Little Guys Data, and one from big name competitor. okay, so we're taking three bids. Phony data is one bids coming in from us. So phontail networking. So three bids, one from Phony Networking, one from what was it? Little Guys Data. Little Guys Data. And one from Big Name Competitor. And obviously Ponytail Data reports up to Ponytail Inc.. my goodness. These questions do tend to be tangled web. If you looked at my last video where introduced the concept of transfer pricing, we looked at some craft food subsidiaries and if you look at the whole company, it is web of companies and divisions. It's crazy. but they would have lots of transfer pricing issues. anyway, the request received three bids. One from Phony Networking, subtlety, Inc., one from Little Guys Data, and one from bigname competitor. Here are the bids. Phony Networking bid $1,800. And the company would purchase the processors from phonetail chips. my goodness, there's another subsidiary of Phony Inc. the product would be of very high quality. Okay, so not only do we buy or they're bidding but they're going to buy from Phony Chips, which of course is relevant to us at Phony Inc. and their bid is $1,800. So the bid here is $1,800. little guy's data and it says the company would purchase the processors from phonetail chips. Okay, phonytail chips is underneath. So I've colored them red. Red is all us, right? We're all under the phonetail inc umbrella. So if little guys data wins the bid, they're going to be buying stuff from phonetail chips. and their bid is just $1600. All right. So, their bid is $1,600 and it notes the final product would be of equal quality to that produced by Phony Networking. So, already we're like, wait, we can get product for we're we're Steve Frost, Phonel Data. We're we're here and we can choose $1,800 or $1,600 for equivalent quality products. Of course, we're going to want the cheaper one if they're both equally good. But you can see the tension here. It's like, shouldn't we buy our own stuff? That's the dilemma here. Shouldn't we buy our own stuff? Okay, let's look at the bigname competitor bid. They're bidding $1,550 and the company would manufacture its own part. So, they're not going to buy stuff from phonetail chips. That makes the deal little worse, right? We don't get the the internal sale of chips. And it says the product would be of equal quality and high quality as the same as what we would get from our own internal supplier phone networking. And they're only bidding 1550. So let's put their bid up there.$1,550. Okay. So hope you're seeing the tension here. obviously if you're just purely price based and they're equally good products and you're Steve Frost, you would just go let's take the cheapest one, 1550. But clearly there's something going on here where you might want to take the internal bids. Let's read them. Frost was frustrated by the bids and phoned Kiana Chang the manager of phonetail networking. So again, Frost is phony what is the stand for again? Data. Frost is phony data. He phones Chang phony networking about her uncompetitive bid. and says, how on earth is it the that the only internal bid is by far the highest? You're nowhere near capacity." not near capacity. If you watched my previous video, and hope you did, you know what that means. If company is not at if they have excess capacity, which clearly Kiana Chang and Phony Networking does have, they should be pricing at variable cost. Transfers should happen at variable cost. That way, the company makes the smartest, most profitable decisions, as we will demonstrate here. Shouldn't you be cutting me deal? You've got to drop below 1550 or I'll buy from BNC, bigname competitor. Chang replied, "Look, understand where you're coming from, but have margins to protect. can't simply offer you better deal. The bosses are stressing focus on higher margins and higher average selling prices. can't tell all my salespeople to pitch the high-end only to kill the firm's average selling price just to make you guys look good." frustrated, Frost called Tegan Bertusi, the CFO of the parent company. So now this Tegan Bertusi up at here, Phony Tale, Inc. and the CFO of the parent company. I'll have to I'll have look at the issue, said Bertusi. And she noted the following details. Phony Data would incur $300 in variable costs on top of its purchase price and sell the installation for $2,400 per server. Okay. So, they're going to sell out to customers for $2400. So, when they get their thing, they have $300 of cost and they're going to sell to customers. There's some outsiders for $2,400. So, that's important to know. Like, if they buy internally for $1,800, well, they add $300 in cost. So, that's 21,100 their total cost, right? 1,800 what they pay. if they bought the internal bid, they're still making money here, just not as much as if they bought from the outsiders. okay. Phony Networking's variable cost would be $1,400 and included the cost of processors purchased from Phony Chips. So, Phony Networking, their cost is $1,400 and their revenue is $1,800. So, they make 400 bucks on this deal. That's Kiana Chang again, tangled web of people, but Kiana Chang maximizing her own profits, which fair enough. That's typically what they're going to want to do. Phony Chips sold this type of processor for $500. Their margins were typically 20%. So 500 time 20% means they're making $100 on the deal, meaning their cost is $400. so again, they sell their chip for 500 and their cost is 400. And guess they're involved over here. Now, we're not privy to little guy's data cost. We're not privy to BNC's cost because they're competitors. So, and it's not relevant to us, but we're the right company, right? We're Tegan Frost or Tegan Bertusi, pardon me, I'm getting my names mixed up. We're Tegan Bertusi or at least taking on her shoes. Like, what should she do here? that's ultimately going to be the question. Now, first it says, "Give the dollar advantage or disadvantage of accepting each deal for the parent company, Phonetel Inc." All right. So, how much money ultimately does Phonyell Inc. make whether they take the deal from internally phony networks, whether they take the deal from Little Guys Data or whether they take the deal from big name competitor. Okay, let's go through them. Let's say we take the deal from Phony Network. We'll analyze that deal here. Let's analyze the deal from little guys data here. And let's analyze the deal from big name competitor here. And there's really three subsidiaries we're worried about looking at it from the again top level. Phony Inc. parent company profits. So, Phony Inc.'s profits. If we take the deal, the bid from Phony Networks, Little Guys Data, bigname competitor, that's what we're looking at. And to do it, we'll break it down into our sub company. So, PC what is the name of that sub again? where is it? phontail chips. phonytail chips profit. If we take the deal from phonetail networks, phony phonytail chips will be purchased. We make $100 on that deal. So $100 $100 because little guy's data. If we take that deal, we get $100 there. bigname competitor, we don't get anything. okay. Well, what about Phony Network's profit? Again, their total cost is $1,400. They're selling it to us. They're bidding $1,800. So, their profit is $400. If we take their bid, Little Guys Data, we don't make any money. Ponytail Networks doesn't make any money. And obviously, Big Dame competitor, we don't make any money. Now, what about PD's profit? This is Steve Frost division phonel data profit. Let's see. So, if they take the deal from Phony Networks, they're bidding $1,800. So, you pay $1,800 plus you add $300 to your cost. So, it's $2,100 in total. $2,100 in total and you're selling it for $2,400. You're making $300 on the deal. Little guys data, they bid, 1600, you're adding $300 of your cost. So, that's 1,900. 24,400 you're selling it for. It's cost you $1,900 in total. That's $500 in profit there. And bigname competitor $1,550 is their bid. You add $300 of your own cost. So that's $1,850 selling for 2400. That's $550 in profit. So you can see this is where Steve Frost lives, right? This is Steve Frost. This is Kiana Chang. And we don't know who the CEO of or the the head of Phony GIPS is. Well, you can see what Steve Frost is looking at. He's just looking at this line. Like, he exists for this line. He's like, "Well, if buy from Phony Networks, I'm only making 300. If buy from bigname competitor, I'm making 550." But the total for the company, right, the Phony Inc., which is where Tegan Berusi resides, Tegan Berusi is looking at it as whole and going, "Well, the company's making 800 bucks extra. If we take phonetail networks, we're making 600 bucks if we take little guys data and 550. And again, remember this is times 2,000. There's 2,000 of these servers. So, you know, times 20,000 equals 1.6 million versus 1.2 million versus 1.1 million. So, the dollar advantages are clear, right? It's so you should take Phony Networks. It's $200 better than Little Guy's data. It's 250 better than bigname competitor. Or in total, it's $400,000 better than Little Guys Data. And it's $500,000 better than bigname competitor. If you're Tegan Bertusi, you like the internal deal. You want the internal deal to happen, but the incentives are all wrong, right? Steve Frost certainly doesn't like it. He thinks he's getting screwed, and he kind of is. He's got point, and that's the the purpose. these transfer pricing dilemmas. So given the dollar advantage disadvantage of accepting each deal for the parent company Phony Inc. they're better off in all cases, right? Like they should want they should want them doing this job. It's they're all profitable jobs, but you can see the internal job is the most profitable. Bigname competitor is the least profitable and you can see it on perunit basis and in total there. what are Tegan Busi's options here? What should she do? Well, okay. What are some options? And this is just like puzzle your way through. What could she do? One is, and this is very logical thing. lot of companies would do this. Force the internal deal through. Why would you want to force the internal deal through? You force Steve Frost. You say, "You got to take the internal bid, Steve. Too bad for you." What's the advantages? Well, it's the most profitable. That's the obvious and clear advantage, right? The company makes the most money. And there there's brand reasons for this. You know, you imagine you think of this as know it's sort of funny example where we have all these fake companies that I've made up here. Phony Dell, phony name, right? but you imagine, let's just put Dell or some big tech, you know, big, server company. Dell shows up and they install bunch of Lenovo servers. No way. Dell's going to sell Dell products. So when Dell, you know, phony Dell data, when Dell data shows up, they're going to sell Dell boxes to you. the fact that they would be, you know, Dell would sell some Samsung stuff would be weird, right? It's bad for the brand. So, there's brand reasons why you would want to force the deal through. What about disadvantages of forcing the deal through? Well, certainly Steve Frost feels bad, right? Ponytail data feels like, hey, we're getting squeezed. You're picking winner. it's bad for us. And sort of going with that, the company says it's decentralized. So decentralized means Tegan Bertusi doesn't call the shots. She lets the the subsidiaries run as they would. And there there's advantages to saying you are your own CEO. You're an independent company. We want you to run as an independent company. You are profit center. Do what's best for your own bottom line. And that's great. And then you say, do what's best for your own bottom line except for this one, right? and it sort of like loses some of the benefits of decentralization. If you're saying you're coming down from on high saying you're forced to do this deal this way, that's negative. Certainly, that's disadvantage. Option two, let the companies do what's best for them, right? And in other words, basically Steve Frost is going to take the best bid, the cheapest bid, which is bigname competitor, and we end up in the worst spot, but it might be worth it for the company. You know, this is $500,000 bid. don't think so, but it could be worth it for the company to say, "No, decentralization is important to us." So again advantages of like letting the chips fall where they may is maintains decentralization and in this case Steve Frost is happy. He gets to pick the best bid. and and presumably the the bidder Tegan Chang is fine with it. She obviously would know the market and know that her bid was little higher. Although it could cause internal company problems, right? You're not buying your own stuff. It could cause internal problems. And often when an advantage is on one side, it's disadvantage on the other side. least profitable the least profitable option gets chosen. There's branding issues as we've mentioned above. So yeah, there there's lot of lot of issues with letting the company do what's best for them. third option here certainly exists and that's just some midpoint, right? We can say you got to do an internal deal but maybe we renegotiate the price. So force internal deal at different price. And here, like tons of options exist. So, let's just think about the options that that you could do it at. You could say, okay, we're going to make phonytail networking sell to phonytail data, but we're going to make them match the best bid, right? We're going to just have them come in at$,550. And look, your cost is 1,400 and we won't penalize you, Tegan Bertusi. We won't even consider this part of your sales. We'll just consider this weird side deal. And your numbers don't get hurt, right? Because margins are like percentages. Well, you're taking big markdown here. Your percentages are all lower. Your statistics are off. We could say, "Okay, we need to do the deal internal, but don't worry about your numbers, right? We we won't count these numbers against you." that's definitely plausible option. Force the deal through at 1550. We could well we looked at the implications of forcing the deal through at 1,800. That was option one. And or we could have them negotiate price, right? We could literally say, okay, 1550 is too low. Maybe 1,800 is too high. What's good middle ground? And we could negotiate price between them. So it has lot of the advantages and disadvantages that we've already mentioned. the big advantages are you could potentially well you will be the most profitable because again if we negotiate different price between them our overall profits are locked in they're going to be $800 unit 1.6 6 million in total. So it is the most profitable option whether you know phonetail data is showing more profit or phonetail networking showing more profit. So that's desirable for the company. The disadvantage is very much the same as before. You lose decentralization if it's negotiation. Negotiations are time consuming can be perceived as unfair. Can be perceived as playing favorites. Right? There can be all kinds of internal problems. Now, let's just read on. So, it says, "What are Tensus's options?" We've sort of looked at three, think, legitimate options. What should she do? think ultimately, and in my opinion, it's clear, this deal needs to be internal. And there are disadvantages to that. like why did you even go out for bids if it was always going to be an internal deal? But just when you think of the logic of this, why would you again if I'm Dell, why would be installing Samsung equipment when have just as good Dell equipment ready to go? Doesn't make any sense to me. So you would think this ought to be done internally. The fact that it's not is harmful. So would really hone in on option one or three for that reason. Now, which one could you go with? Honestly, as professor, would accept just about anything logical, right? The student sort of follows through logical. I'm more looking for the analysis than am for like picked number one because like want them to have logical reason why they pick number one, but want to see the analysis of multiple options here. All right, we've done it. Long video. hope the video was useful. Kind of an interesting and challenging issue, transfer pricing. hope the video helped. And if it did, hope you'll consider hitting one of those buttons. See you in the next video. Bye-bye. Welcome to module 12, the final module of our management accounting class. And it is one of my favorites. Relevant costs for decisionmaking. And it's my favorite because it's fairly straightforward. There's two criteria for cost to be relevant when we're making decision. We're choosing between two options or three options. What costs are relevant to those decisions? criteria one, the cost cannot be sunk. You've probably heard of the sunk cost fallacy. I'm going to give you an example from my own life in minute, but if the cost is sunk, you shouldn't consider it when you're making your decision. And two, the costs need to be different between the options. If the costs are the same, then you know, there's nothing to choose there financially anyway. It'll be some qualitative reason. But I'll give you some real examples from my real life of both of these criteria. So, the first one involves Halloween costume, and we're going back few years. This is Halloween 2018. My daughter was at that time toddler. She was little kid. And bought her this costume. You can see you purchased this costume on August 12th, 2018. The price here looks like 30 bucks. remember paid $40 at the time. And what we had done was we were discussing Halloween. don't know why we were discussing it in August. said, "What would you like to be?" And we kind of went on Amazon, got inspired, and thought, "I'm going to be smart." because always was buying costumes on like October 29th, going to the Spirit Halloween store and everything was picked over and it was expensive and it was nightmare. was like, I'm buying the Halloween costume in August. So smart. Except for it turned out to be dumb decision. And here's why. Canadian Thanksgiving is in early October, early to mid-occtober. And we went to visit her cousins in early to mid-occtober. And her cousins were little kids also. And they had this box of costumes and they were just playing like costume play, you know, as cousins will play with cousins. And she really got attached to butterfly costume in this, you know, October Thanksgiving party. And her cousin said, "Well, you can take the costume. Like, we've all grown out of that one. That's you can take it. Take it home. Enjoy the costume." So Halloween's getting closer and it's like October 29th, October 30th. I'm like, "All right, time for the Marshall costume for Halloween." And she says to me, she says,"I don't want to be Marshall. want to be butterfly." And said something that good accountant wouldn't have said. good accountant wouldn't have said this, but this is what said. said, "No, already paid $40 for the Marshall costume. You are going to be Marshall." And at that moment, realized was in trouble because was in an argument with toddler. And got down on the toddler's level and was just like arguing to the death over this $40 costume. Now, good accountant would look at this situation and say, "Well, Tony, you were arguing about sunk cost. You had fallen into the sunk cost fallacy, which had, right? Because the the Marshall costumes, the cost is sunk. can't return the thing. We're in October. bought it in August, so the return period is over. We're fighting over sunk cost. should not have used that sunk cost in affecting my decision. should have said, "Well, we own these two costumes now. They're both worth zero dollars in, you know, to me at this point. she should be allowed to pick whichever one she would prefer, right? but would got heated up and fell into the sunk cost fallacy. let sunk cost affect my decision. By the way, she ended up going as butterfly. She was very happy. was unhappy. And then realized as I'm teaching the class, my gosh, fell into the sunk cost fallacy. teach this stuff. should know better. But this was sunk cost and it should not have impaired my decision. Businesses do this all the time. saw it, you know, saw it in myself in that situation. Businesses do this all the time. They spend bunch of money on thing and they go, "Well, we're stuck with it now. We better make it work." And the answer sometimes is like, "No, that's sunk cost. You should not consider that in making your future decisions." We'll go through many examples where companies will have to juggle and determine whether the cost is sunk or or not. The other criteria here is it needs to be different. textbooks will call this differential. It needs to be differential cost. It needs to be different between the options. And again, another decision we had to make was around that time. So, same era, she was toddler. And we thought we would like to go to Disney. And we didn't really care between Disney in LA, California Disney or Disney World in Florida. Disneyland in LA, Disney World in Orlando, Florida. we were debating between the two. So we got California Disney and we got Florida Disney. And you know, so really we would have been happy with either. It was down to cost. And so here are some of the costs associated with going to California. Of course, we all had to get our passport situation together. So we we had acquired three passports because I'm from Canada, so traveling to the US, you need passport. So $300 in passports and we had those. we would also have to drive to the airport in Vancouver. And don't live in Vancouver, so drive and park, and we'd leave our car at the airport. So, that's expensive, too. And let's say that's $100, I've already said. And then the California flight, hotel, tickets, etc. was going to cost around $2,000 for I'm just going to say flight, hotel, parks, right? Theme parks. Okay. So that was to be the California number. The Florida number, we would also need our $300 worth of passports. We would also need to drive and park in Vancouver. And we would also need to buy flight, hotel, and parks. But the Florida flights were little bit more cuz, you know, going from Vancouver to the the remember the flights were little bit more. Actually, the hotels were little bit less. LA hotels tend to be expensive. So, it was actually kind of close, but think we were around 2400 when we priced out the Florida option flight, hotel, and theme parks for our trip. So, that was our trip and think costs more now. That was, you know, years ago and little less inflation in our world. so as we turn to our accounting decision maker hat, we go, okay, well, there's two criteria. It can't be sunk and it needs to be different between the options. Let's look for for sunk costs. And there are some sunk costs. We already own the passports. We are passport holders anyway. So shouldn't consider the passport part of the cost. already had my passport, right? So in either option, the passport shouldn't be considered because we already have passports. The drive and park though that is not sunk cost. haven't driven to Vancouver yet. haven't parked my car at the airport. So it is not sunk. So it fits that criteria. The issue here is it's not different between the options. So, you don't need to consider when you're choosing, you know, the option is go to California or go to Florida. The option was not stay home, right? Those were the two options I'm choosing between. So, if I'm going to be going to California or I'm going to be going to Florida, got to drive and park anyway, don't need to consider that $100. do when I'm budgeting, right? Regardless of where go, this $100 hasn't been spent yet. got to be ready to for the gas and the the parking and all that stuff. but when I'm choosing between California and Florida, should disregard it. Why? because it ain't different, right? It's the same between the options. So, let's cancel that one. And what does that leave us with? Well, California is little bit cheaper, assuming we're going to be equally happy in either theme park, in either state. Assuming that should go to California because it's cheaper. That should be my criteria. And I'm an accountant. am cheap. That was my criteria. We went to California and we had great time. Thanks so much for watching. in the next video. It might be my favorite problem of the whole course. 121A is certified banger. hope you stay tuned for that one and I'll see you there. Bye for now. The problems for my videos can be downloaded from my website, tonybell.com. Go to the website, click the PDF link, you'll see there's no sign in, no sign up, nothing like that. Just 100 plus pages of accounting exercises. Many of the exercises are free and open, about 40%. And if you're working through those and finding you're getting great value out of them, you might consider joining and getting channel membership that has access to the other 60% of the videos. All right, let's jump into today's exercise. Let's take run through problem 121A. This problem has us identifying which costs are relevant and which costs are not in making decision. So, just want to remind you, think introduced this in the module intro video, but in case you missed it or forgot, really two criteria to determine if cost is relevant cost. One is that the cost is not sunk. In other words, sunk cost, you've already paid the money, so it's not going to be relevant to future decision. And two is that the cost is differential between the alternatives. That just means different, right? So, if I'm deciding between two options and the cost is the same in the two options, then it's not relevant to the decision because it doesn't make difference to your analysis. So, those criteria are floating around in the back of my mind as jump into problem 121A, which of course you can download from tonybell.com. Tammy Smith has recently gotten into wine- making at home. She has completed her first batch of wine. And while it was culinary success, it tasted good. Her husband Steve is not happy because her wine-making area has been encroaching on the space that had been previously exclusively used for his man cave. no. He knows his wife well and knows that she is costconcious. So he makes the following argument to appeal to her financial frugality. Sounds like she's cheap. Tammy, think you need to sell all that wine- making equipment. know the hobby is fun, but it's financially wasteful. figure it's costing us $36 per bottle and we could get equivalent quality wine for $15 per bottle in the store. I've run the numbers and here they are. So, he's trying to appeal to her financial side and saying this wine is really expensive. So, let's go through the list of numbers and obviously we're going to determine some of the costs he's bringing to the table will be relevant to this decision. Some will not though and so we got to sift through and determine what's relevant and what's not. okay. So, first wine making equipment $400. And there's fermenttor, carboy, siphon, corker, and more were purchased. Grapes and juice, $150. Those rezling grapes were expensive. Property taxes, $230. Our annual taxes are 2,300. Your wine- making is taking up 10% of the house's space. Okay, so 2,300 time 10% is $ 230. Yeast and additives, $20. $20 of yeast and additives per batch is brutal. It stinks up the house, making it smell like bakery. What mess. bottles and corks, $60. $50 for the bottles, $10 for the corks. And it says, know the bottles are reusable, but the corks are thrown out each batch. Specialized cleaning equipment, $40." And he says, "Those bottle washes are weird." the numbers don't lie. 400 plus 150 plus 230 plus 20 plus 60 plus 40, that's all the numbers that are bolded there. Is $900. Your first batch was 25 bottles. And don't get me wrong, they were delicious. But that's $900 for 25 bottles of wine. $36 bottle. That's more than double the price of your favorite Rezling, which only costs $15 at the wine store. Tammy, love you, but hope you'll consider giving up this wasteful hobby. All right, so he's making financial argument. think the bottom line is he just wants his man cave back by the sounds of this. But let's break down the financial argument. Let's go through each of those bullets and determine is this cost relevant or not to decision. Now, here's the decision. Calculate the relevant cost of producing the next batch of wine. to whether she should produce even single other batch of wine. What costs are relevant to that? So, is the wine-making cost relevant to whether she's going to make another batch of wine? The answer is no. She already owns the wine- making equipment. This is sunk cost. Not relevant. NR not relevant. We'll put for relevant. Grapes and juice, $150. Yeah, she's going to have to get more grapes if she wants to make more wine, right? If she's used up all her grapes and her juice from the last one, this will be relevant. She's going to have to buy more grapes, more juice for sure. Property taxes. Well, if she quits making wine or she keeps making wine, they still got to pay $2,300 in property taxes. It's It is relevant. It's not sunk. Like, they're going to pay the taxes in the future. So, it's not sunk cost, but what it is is it's not relevant because it's not different between the options. Whether she makes the wine or quits making wine, their property tax bill stays the same. It's not different. So, it's not different cost, not differential cost. It's not relevant. yeast and additives. $20 of yeast and additives per batch. So yeah, if she makes another batch, that's 20 more bucks of yeast. think it is relevant. Absolutely. Bottles and corks. $50 for the 60 bucks. 50 for bottles, 10 for corks. Interestingly, one of these is relevant. One is not. The bottles that are reusable. Well, that's not relevant. You've already bought the bottle. You don't got to buy new bottles for the next batch. You've got the bottles. It's sunk cost. the corks though, that is relevant. You got to buy new corks for each batch. That $10 is relevant. So, I'm going to note this one is NR and this one is So, 10 bucks per batch is relevant. The 50 bucks for the bottles per batch is not. Specialized cleaning equipment, $40. Well, you already own the bottle washer now. It's not relevant. That's sunk cost. So, lot of these costs are relevant for sure. He definitely didn't make them up, but there's lot of these costs that are not relevant. So, let's add up the relevant costs for this decision. will highlight them now as soon as find my highlighter. grapes and juice, that's relevant. 150 bucks. Yeast, that's relevant. And just the corks. The corks are relevant. The bottles are not. So adding that up, just did the math in my head. It's these three costs are the relevant ones. It's $180 per batch of relevant costs. The rest that he brought up not relevant. So, if every batch makes 25 bottles, got some bad news for old Steve. think she's getting bargain. think it's actually good deal to make wine at home. let me open up my calculator app. There it is. $180 batch divided by 25 bottles per batch. $7.20 per bottle. Uhoh. That's better than the $15 at the store. So if these are equally good products, as he said, they're getting better deal making it at home. So it's the frugal decision would be to continue making these at home. So it says calculate the relevant cost of producing the next batch of wine. Okay, the next batch is $180. We broke it down per bottle, though 720 per bottle, but the answer to the question is it's $180 is relevant cost per batch. Are there any non-financial items that would be relevant to this decision? Sure, there are. Yeah. well, listen, the the space that it's taking up is non-financial item that is relevant to the decision. How much pleasure is it giving her? You know, if she loves making wine, maybe the cost doesn't matter. Maybe if it even was $50 bottle, legitimately $50 bottle and she could buy it for 15, she'd still be happier doing it. It's hobby. It's an outlet. It's something that she enjoys that brings value outside of the financial to her life. he could be right. non-financial item is what if it is stinking up the house, right? That might be completely legitimate concern he's ra raising and that is relevant to decision to quit making wine, right? Absolutely. If it stinks up your house, if it makes big mess, you're staining your carpets with grape juice, all this type of stuff going on. Totally relevant to the decision. He didn't bring that to the table, though. He said financially it's going to be ruinous ruinous for us to keep making wine. And he is dead wrong about that. There are plenty of good reasons to keep making wine that are non-financial. There are plenty of good reasons to stop making wine that are non-financial, but the financial reasons, his idea stinks. All right, thank you so much for watching. Hit one of those buttons on your way out of here and I'll see you in the next video. Bye for now. Let's jump into problem 12. drop or retain segment. So common financial dilemma that companies find themselves in is they've got one division, one arm, one branch, one part of their company seems to be struggling and the question is when should we stop doing that thing? When should we drop the segment? When should we drop the product line? When to stop something that's already going and relevant costs can help us to make those types of decisions. So Walmart is department store with three major departments. We're doing 122A from my accounting workbook, tonybell.com. their three departments are housewares, hardware, and electronics. Company management is very concerned about the performance of the electronics department, noting that it seems to be drag on the company based on its most recent fiscal quarter. companywide segmented income statement follows. And you can see electronics is yeah, losing 30 grand. And the company's only making 30. So if you got rid of electronics, you'd like go, okay, well, if get rid of that, got 40 and 20, I'm making 60, right? I'm doubling my profits. And so you could understand how it would be cause for concern if you were running this company. The company notes that if the electronics department were dro dropped, the other departments could expect 10% decrease in foot traffic in the sales. That makes sense, right? If you got store with lots of different departments and you drop one of the main departments, less people will come to the store and you'll lose business in your other departments for sure. So, okay, 10% down is their best guess. Also, $20,000 of the electronics department's fixed costs are allocated and would continue even if the department was dropped. So, even if we get rid of electronics, some of those fixed costs stay. And some might be like, you know, management costs where the salaried manager that that operates across departments. you you can't lose that manager. Or it could be property tax, you know, on the building. Maybe we're still in the same building. Well, our property taxes remain. So, that's something to to be concerned with. so in any event, $20,000 of these fixed costs will remain. the company has no planned use for the space currently used by the electronics department. It says compute the net dollar advantage or disadvantage of dropping this department. I'm going to do this two ways. The first way is the way my brain processes it. And it's little bit of longer way, but think it's it's good way to do it. And then I'll show you shortcut way to do it that lot of textbooks will show you how to do it the the second way. But I'm going to do the first way because think it's it's easier for me to explain and it's the way make sense of this. So try to recreate the income statement. We got sales, variable expenses, contribution margin, fixed expenses, and we got our operating income or loss in the case of electronics. We got the houseear, we got the hardware, and we got the electronics department. And we're going to do totals. And I'm just going to recreate this income statement as if had dropped electronics. So, let's start with Houseware. What's its income statement going to look like? What's its sales going to be if we drop electronics? Well, it's going to be down by 10%. So, it's 150 now. Dropping 10% means it's dropping 15,000. The new sales are going to be 135 if things go according to plan. The hardware is going to lose 22,000. So, 220 minus 10% minus 22,000 is 198. And what about the electronics? Well, it's going to zero. It's not going to exist after this. So 135 + 198 is 333. That's kind of funny number to have, but 333,000. What about our variable expenses? Well, the good news is if sales drop, so too do variable costs, cuz again, you don't have as many goods being sold. So your cost of goods sold, that's key variable expense, will go down, of course. so it's 60, it's going to go down by 10%. It's going to go down to 54, right? 60,000 times 10% is six. So we reduce by 6,000, it's 54. 000. this was 100, it's going down by 10%, so it's going to be 90. And this was 140, it's going down to zero because it doesn't exist anymore. 54 + 90 is 144. All right, let's total these. 135US 54. 81,000 is our contribution margin for housewares. For hardware, 198US 90 is 108. And electronics has zero contribution margin because it's not contributing anymore. $89,000. Fixed expenses are fixed. So, our housewares stays at 50. Our hardware stays at 100. And our electronics, it says, you know, part of the reason, big part of the reason we're getting rid of electronics is to drop the expenses. And we do get rid of most the expenses. But remember, $20,000 of electronics fixed costs remain in the company. They're allocated costs. Now, realistically, the company's not going to keep an an income statement going for electronics. They're just going to share this 20 grand to hardware and houseware. So, they might go, "Well, hardware is fixed expenses now 60 and or houseware is now 60 and hardware is now 110 or something like that." Like, they'll split the 20 grand across the two. But for us, we can just say, "Okay, it stays in the company. How they share it between the departments is is up to their management. We don't have to worry about it. We just know the total fixed expenses for the company are going to be 170 after this." So doing the math here, 81 - 50 is 31,000 in operating income for houseware. 108 minus 100 is 8,000 for hardware. And 0 - 20 is -20 for electronics. So we end up with 19,000 just adding it all together of overall profit for the company. So should we do it? Well, what are we comparing to? It says compute the dollar advantage or disadvantage of dropping electronics department. We were making 30,000 with it. we are going to be making $19,000 without it. We're $11,000 worse off if we drop it. So, it's disadvantage of $11,000. Therefore, we shouldn't drop the department. Now, having said all that, of course, the company should consider replacing the department with something new, they if they're going to keep the department, they should be saying, "Well, how do we get it back on its feet? How do we make sure it becomes profitable again?" This isn't like, everything's great." No, no, no. It's all bad news, but if you drop the department, you will be worse off, at least in the short run, until you figure out what to do with that space. But there you go. there's dollar disadvantage of $11,000 to drop the department. mentioned at the start, will show you sort of quicker way to do this, but my brain doesn't process it this way. But here's quicker way to do this. You would say, what's the reason we drop the electronics department? big reason is you're going to save some fixed expenses. So this is what's relevant, right? We've actually looked at irrelevant costs. this $20,000 that stays in the company, it's it's not different between the alternatives. So, it's not differential cost. so, it should be irrelevant from that perspective. This way is just looking at incrementally what are the relevant items. And the big relevant item is you save bunch of fixed expenses. So, we're going to save what is it? Not 90,000, but 70,000 in fixed expenses, right? 20,000 stay in the company. 90,000 go away. So, well, 70 of the 90 go away. So $70,000 is fixed expenses saved. If we drop the department, we're going to lose some contribution margin. So contribution margin lost for the electronics department is $60,000. That's bad for us, right? The fixed expenses saved is good. We don't have to spend 70 grand of fixed expenses that we used to have to spend. We also lose contribution margin in hardware and in housewares. In hardware, our contribution margin is 120. We're losing 10%. So, we're losing $12,000 because we lose 10% of our foot traffic and sales. In housewares, we lose $9,000. So, if we add up our total CM lost, it is 6072 uh72 + 9 81. We're losing $81,000. We're saving $70,000 in fixed cost to lose $81,000. Overall, there is disadvantage. And the reason I'm saying disadvantage is because it's negative number here of $11,000. So don't do it. So that's the net dollar disadvantage of dropping the electronics department. We did it the way again like to do it this way, but this way is is quicker. And if if my student did it either way, would would accept both answers. This way is the incremental approach. And think textbooks do tend to favor this way. like doing it this way because that's how my brain processes it though. So there you go. We've solved 122A. As always, thanks for watching. I'll see you in the next video. Bye-bye. Let's take run through problem 123A, make or buy decision. Carol's Cupcake sells cupcakes and other desserts through its retail store. The company has always made all of the ingredients from scratch, but has recently been approached by supplier that specializes in icing. Carol believes that the supplers's icing is of equal quality to her own and believes their offer of $3 per liter may save her company money. Carol is evaluating the her own cost of producing icing. And so you can see the dilemma appearing here and this is the make or buy dilemma. An outside supplier offers you price and you're making similar product and it's seemingly costing you more. And so the dilemma is should we make it ourselves or should we bring it in from an outside supplier? okay. it goes on to say, examining the report, Carol says the icing is just as good and it would save me $150 per liter. Yeah, that's true. $450 versus three. that's over $7,500 for the year. think I'm going to take the deal. Okay. Well, let's see if that's fair statement or not using relevant costs here. Assuming there's no other use for the icing equipment or or the extra space it uses in the kitchen, what is the net dollar advantage or disadvantage of accepting the supplier's offer? Okay, let's always like to just prepare little table. Make versus buy. Make versus buy. and let's just go through our costs and determine which costs are relevant and which are not. So materials cost think is relevant, right? If she buys, she's not going to buy the sugar and whatever else goes in icing. have no idea. She's not going to buy the supplies to make her own icing. So yeah, this dollar of materials just goes away. So it's dollar under make. It's zero dollars under buy. Direct labor. Well, there's no labor cost if you're buying, right? Like you're just bringing the stuff in. If you're making, yeah, it costs you 50 cents per unit, per liter, variable overhead. Variable costs tend to be relevant. Fixed cost tend not to be relevant. That's sort of rule of thumb. we'll see. It's it's, you know, tend to be there. There are exceptions as we will soon find out. But our variable overhead, that's relevant cost. You know, you make more icing, you pay more variable costs. You make less icing, you're going to make less variable cost. So, yeah, and and if you buy, you're you're not making anything. So, so the cost is different there, right? The cost would go to zero. fixed overhead traceable had little asterisk, and I'd like to read the asterisk before make determination here. It says 40% relates to cleaning and maintenance of the icing equipment. Okay, let's just talk about that 40%. So, it's dollar of fixed overhead per unit per 5,000 liters. 40% of this is for cleaning and maintenance of icing equipment. We're not going to be cleaning or maintaining our icing equipment if we're not making icing, right? There's not no need to clean it. so that 40 cents can go away. That absolutely that is relevant cost. If we buy the stuff, we're not going to be maintaining it. If we continue to make that 40 cents continues to be relevant cost. and 60% relates to depreciation of icing equipment with no resale value. Depreciation almost always not relevant. In this case, it is not relevant. It's sunk cost. You already bought the equipment, right? This depreciation cost is it's sunk. You already paid for the equipment. So, this is not relevant cost to this decision. This 60 cents this 60% should be ignored. So, fixed over traceable the relevant portion is 40% and or 40 cents it is 40%. And for buy, you're not going to be doing any cleaning or maintenance. fixed overhead allocated. Allocated fixed costs never relevant. An allocated fixed cost is where you arbitrarily say for example our property taxes are you know whatever it is $50,000 you take up 10% of the space. So therefore you get to pay $5,000. we're just going to allocate $5,000 in fixed costs to your department, you know, and we have all kinds of different fixed costs that we might allocate and say that's your department's share of this cost. But importantly, if the department goes away, the cost remains. That's what makes it an allocated cost. So if this department goes away, all the allocated costs would just get allocated to other departments. This is not relevant. Like this cost will continue in the company. So it's not different between the alternatives. If we make, it's $1.75 unit. If we buy, it's $1.75 unit. So we we make it zero. We don't consider irrelevant costs here. So, let's add this up. hold on. missed one thing. There's highly relevant cost, and that's the cost of buying, which is $3 liter. Obviously, if that number was different, it would change our mind. If it was $10 liter, we'd say no way. If it was 10 cents liter, we'd say yes, please. that number is highly relevant, right? The purchase price. And if we make zero, we're not going to buy from an outside supplier. And if we buy, the purchase price was $3 liter. So let's add this up. The total relevant cost of making dollar plus 50 is $150. $1.75. $1.75 plus4 is $2.15 and 003. yeah. So you can see make is 85 cents per liter better than buy. Let's read the question. It says assuming there's no other use for icing equipment or for the space in the kitchen what's the net dollar advantage or disadvantage of accepting the supplers's offer? So if we accept the offer, we sorry my writing will be 85 cents per liter worse off. And what is that overall? How many liters are we moving here? 5,000 lers. So times 5,000 L.85 * 5,000 4250 worse off overall. 4250 worse off overall. So do we do it? No. Right. We're $4250 worse off if we do it. Now importantly if we can find some use for that space that the the icing used to be made in. Right. Maybe we start making some other dessert or something, right? if that's the case and we start making money with that space, well, it changes the math here. And that's what's going to happen here. says, "If the offer is accepted, Carol's Cupcakes could use the space that had previously been used for making icing as bacon frying space. Carol believes new bacon line of cupcakes, that sounds good to me, would produce margins of $5,000 year. Should Carol's cupcakes accept the spies offer or not?" Well, now that changes the the math. We said that buying was 4250 worse off if we have an option if there's an option to improve the buy alternative, right? Which this is, right? This makes buy better, right? If if we end up buying, we can use the space we use for icing to generate $5,000 year. So by $5,000, all of sudden it was 4250 worse off. Well, we've just improved it by $5,000. Where's it going to be now? Buy will be 750 better than make. And the math there, hope, is straightforward. We said buy was 4250 negative, right? Negative to our company. But we just came up with an option that improves the buy option by 5,000. Negative 4250 plus 5,000 means we're 750 to the good side. So what's the should Carol's Cupcakes accept the offer? Yeah. If we think we can use the space and generate five grand, yes. Right. That's the answer. The company's going to be 750 better off. And there you go. And there's lots of things she should consider like does she really trust the supplier? She says the icings is good, but you know, if the chips are down and the supplier fails to deliver, that's going to cause problems. If she's getting rid of all this old equipment, she's using the space to fry bacon. And how confident is she in the bacon cupcake? Maybe it's going to be way bigger than she planned, and that would be good thing. So, there's upside here as well. It's not all downside, but the risks are you got to trust that supplier, and you got to trust your judgment on the bacon cupcake. All right, that's it for 123A. As always, thank you for watching and I'll see you in the next video. Bye for now. Let's examine problem 12 for special order decision. You make product and customer comes in and says, "I'd like thousand." And you're like, "Normally, sell them one at time. You want thousand?" They go, "Yeah, want thousand and want special price." and not only that, but want some special feature in the product. And okay, there's some some accounting numbers to be crunched. There's certainly qualitative decisions. Can we serve this client? Is it going to, you know, cannibalize our own sales? There's million non-quantitative aspects to this decision, but we'll look at the quant elements of like should you take the order and what should you be thinking about. Eversharp is knife manufacturer. The company sells normally sells 5,000 sets of highquality knives each year and with its current staff and machinery has capacity to produce up to 6,000 sets. That's important, right? You'll never take special orders if you're already running at capacity. I'm not going to cut you special deal. It's like I'm already sold out. you know, you don't get volume discount because already have enough volume, right? don't need your extra order. So, so the fact that we do have extra capacity means well, we might be open to to taking special order. at this level of output, the company estimates its cost producing and selling one set of knives as follows. So, our costs are $15 and it says the selling price is $20 unit. So, we're making five bucks per knife set. These are not expensive knives. an order has been received for 500 units. That's like 10% of our our capacity. So that's, you know, or 10% of our production. So that's big order. but because it's bulk purchase, the buyer has requested 40% price discount. Let's just do the math on that. 20 time 40%. That's an $8 discount. So if we're selling for 20 and we're taking $8 off, they're asking for us to sell it to them for 12 bucks. Well, it costs us 15. but are all these costs relevant? Well, time will tell. Let's read on. if the order were accepted, it would not affect the company's regular sales. That's important, right? We don't want to give somebody great deal and then they turn around and sell it to our same customers for cheaper. They undercut us and be crazy. we wouldn't want to do that. So, it's not going to affect our regular sales. There would be no sales commissions. Okay. So, one of these costs is just totally eliminated because obviously it's not going through our sales people. It's going through different channel on this deal. And fixed costs would not be affected. Okay. Well, fixed costs are not affected. That means fixed costs aren't relevant to this decision. And that makes sense. Most of these decisions, fixed costs are not going to be relevant because if you sell few more units, your fixed costs don't change. So, they're not different between the alternatives. It's not differential cost and therefore not relevant. the purchasing company would like their logo engraved into the handle of each knife, which would increase labor by 25 cents unit. So, labor is going up to buck 75. and they would require purchase of new machine for engraving, suppose, for $2,000 and saying crunch the numbers. So, let's run these numbers. let's start with just let's just do the relevant costs. Okay, so relevant costs and let's go down the line. Materials like almost always going to be relevant. I'll do per unit and also total for the order. So total for 500 unit order and our material cost is $5 unit. And that is relevant. And why is it relevant? Well, if take the order, I'm going to sell 500 more knives and got to put in my material for each knife. So yeah, there's there's more materials running through my company for sure. so that's $2500 of material. What about labor? Well, labor is relevant. if take the order, got more knives to sell. got to, you know, pay employees to to work on the the line. yeah, labor cost is generally considered relevant in these scenarios. And it's going up, right? It's it's taking little extra time because we're doing some extra engraving work. So, we're estimating it's buck 75 unit. I'm just going to have little cough. Mute my mic. Where is it? Excuse me. so yeah, our labor cost 175 unit times 500 is 875. Variable overhead variable costs tend to be relevant. The more units you make, the more the variable costs are. The less units you make, the less variable costs are. So yeah, if more knives means more variable costs, well, we're making more knives, we're going to have more variable cost. They didn't say anything about variable overhead either. So dollar, that's 500 in total. fixed overhead, not relevant. Don't don't use it. And and why is that? It says there would be no sales commissions on this deal and fixed costs would not be affected. So fixed costs are not affected. There's no sales commissions and fixed costs would not be affected. So all three of those just not relevant. but there are couple of other relevant costs. the purchasing company would like their logo engraved, which would increase the labor cost by 25 cents. I've already considered that. And would require the purchase of new machine for $2,000. So new machine And assuming the machine's not used for any other purpose, we can say, okay, this machine basically is used exclusively for this order. And that's $4 unit that the machine adds to the order costs. So, let's run the numbers here. And our total costs 5 + 1.75 + 1 + 4 and of course times 500 is 5875. Now what's the incremental revenue? the additional revenue here. They've said they want the price $12 unit and that's $6,000 in additional revenue. So overall the profit on the deal and know I'm working little bit backwards here, but you know the the revenue minus the new cost the relevant cost should say and the relevant revenue numbers are given here. 25 cents unit or $125 in total. So this is funny situation. And so the net dollar advantage of accepting the order is $125. Almost certainly if these were the numbers given to me, would say no. Generally speaking, in an accounting exercise, you say you made dollar, take the deal. You lose dollar, don't take the deal. Basically, if it's positive, say yes. If it's negative, say say no. And so this question didn't say, should we take the deal or not? in an accounting exercise context, think we take the deal. In real life, would never take this deal. Right? And so this is weird spot. so if you were in position to like ask to explain or rationalize decision here, would say yes, we make money on the deal. If our decision criteria is to make money, we will be better off to take the deal. However, there's risk associated with this. You're buying new machine. There's new engraving process. One little mistake will just mean this becomes an unprofitable deal. And you know, why would do all this extra work, go through all this extra pain in the neck to make hundred bucks? don't think so, right? Like, you know, you making hundreds of units of whatever the product is, you're making 25 cents unit. Like 25 cents for full set of knives. It's ridiculous. So, think we would likely say no to this deal if offered in real life. But that's not the question. It's the question is is what's the net advantage or disadvantage, dollar advantage or disadvantage of accepting the order? The net advantage is $125. We're $125 better off if we say yes to the order. No need to editorialize like just editorialized. On to Separate. Separate. Separate from Good lord. Sorry about that. Assume the company finds box from 1994 containing thousand old steak knives. Although styles have changed, the knives are still of reasonably good quality and sharpness. Assuming manufacturing cost that was similar in 1994 to the chart above, what's the minimum selling price that should be accepted? Okay, so you find this old dusty box of knives. You look and you go, "Well, actually, they're all in good shape here." what should you do? Well, pretty much every cost listed here, the material, the labor, the variable overhead, all these fixed costs are certainly not relevant. Everything here is sunk except for one, selling costs. So, you would literally take anything and and maybe there's no commissions on this deal, but anything you can make from this is good, right? Because it's just big sunk cost and you're like, wow. found some old thing." so anything you could make that would be above and beyond, you know, and maybe there's the selling costs like shipping, you know, the person has to pay their shipping and and so anything you could make selling these knives that would cover the sales commissions would be good because everything else has already happened, right? the material labor overhead. These are sunk costs in this example. They were sunk in the 90s. the fixed overhead costs weren't relevant to begin with. So it is just the sales commissions which is the only future cost. So would say anything above $1.50 50 should and maybe I'll just put selling costs should be considered. That's the minimum though. wouldn't want to lose money on this sale. And the only way you lose money is, for example, somebody buys it from you for dollar and it cost you $150 in shipping per unit, right? Then why would you do it? But otherwise, you pretty much take anything and you're you're going to be ahead of the game. All right. Thank you for watching. It would be great if you'd hit one of those buttons for me. Have great day and I'll see you in the next video. Bye for now. Let's examine problem 125A. This is sell or process further problem and these are also considered scrap or rework problems. They're very similar to those and so consider them basically the same thing. Andrews Antiques is an antique furniture dealer. it purchased 1902 oak table from client for $800. The table was in terrible disrepair. Andrew's antique dealer friend noticed the table in the back room and offered to buy it for $1,200 as is. So, we could sell sort of something junky right now, or we can put some work into it ourselves. That's seller process. Further decision. Andrew thinks he may be able to do better if he puts some work into repairing the table. He believes with 10 hours of employee work, $25 an hour, and $100 of supplies, the table could be spruced up and sold at higher price. The company applies variable over cost of jobs at rate of $20 per direct labor hour. If all this is done and he believes the table will sell for $2,000. Okay, let's just compare where we're at. If we take the deal today, we're going to make $1,200 on table that cost us $800. We're making $400 in profit. In fact, that original cost is not even relevant cost because it's sunk. It's not different between the options. I'll include it here just to like, you know, as number crunch, but you'll see this 800 is is not relevant to this future decision. in any event, the second alternative is we can take $2,000 if we do some work on it. And again, that includes the $800 cost. That's why it's not relevant. If we eliminate it from both sides, we we'd come to the same conclusion, but I'll I'll keep it in there just for the conversation. So, again, it's $2,000 table. Well, we have $800 into it already, and we're going to invest, let's see, 10 hours employee time at $25 an hour, $250 in employee time, $100 of supplies, $100 of material, and $20 per direct labor hour in variable overhead, and it's 10 hours, so $200 in variable overhead. So, where are we at here? 2,00 - 800 - 250 - 100 - 200 650. So we're at 650. If we take the money today, we make 400. If we do the work, we think we can make 650. There's $250. Let's see. Determine the net dollar advantage disadvantage of selling the table now. $250 disadvantage to sell now. Processing further is $250 better decision as far as this number crunch goes. What are qualitative considerations Andrew should be giving to this decision? What other things should he be thinking about? Well, there's definitely like value to having money in your pocket today. You have no risk, right? Maybe you start to repair the table and you realize there's termites inside and you just got to throw it out. That's the other guy's problem. That's not your problem if you sell it as is, right? so maybe you will lose friend that way, but certainly that's the truth. You no longer have the risk of the table. You also yeah, like these are all estimates. lot of times you go, it's going to take 10 hours and it takes 20." Well, you know, that risk resides with you that you're going to go over budget. You know, this is all about the future. Maybe there's no market for the table at $2,000. So, that's risk. Another consideration, though, and us accountants are good at pointing out downsides. There's also upside here. Maybe when you refinish the table, it's worth more than 2,000. That's possibility. This happens in the real world, right? You do work and you go, "This came out better than thought. got buyer for this now beautiful oak table at $5,000." You know, there's big upside. Obviously, it's an attractive table. If your dealer friend was like, "I'll give you $1,200 on the spot for this ugly looking table." maybe it's actually better than we anticipated. So those are all things would be thinking about if were Andrew. Ultimately, probably would process further just given the the numbers, right? If believed my numbers in my heart, if were Andrew, I'd say let's do it. You know, that's what we're in the antiquing business to do. would say let's do it. but there you go. We've solved 1258. We want Andrew to do it. There's one thing want you to do. Hit those buttons. Share with your friends. Thanks for watching. Bye-bye. Let's jump into problem 126A. constrained resource problem. very nice problem to have. Your customers are have more demand than you have supply. And so it says, well, constrained resource says, well, let's narrow our focus to whatever resource is being constrained. Here in this question, it's time. But we're saying not necessarily what product is most profitable for us, but what product uses our constrained resource most efficiently? That is the question we seek to answer here. Here we go. Anthony Bertusi is very busy man. He runs an event planning business that organizes weddings, birthday parties, and corporate events. Anony's business is so busy that he is recently starting turning started turning away customers. Anthony tried to bring in partner, but customers wanted Anony's magic touch. Anthony enjoys all three types of events, weddings, birthdays, birthday parties, and corporate events equally, and would like your help in determining which events he should prioritize. Although all events are different, he laid out the following information about typical event of each type. So, here's typical wedding, typical birthday party, typical corporate event. It says, "Typically, weddings take 40 planning hours, birthday parties take 16 planning hours, and corporate events take 20 planning hours." So, all we want to know here is which event uses his his time, his planning hours most efficiently. And basically, we don't want to know the profit because obviously if if all else equal, you'd rather make 4,000 than three than one, right? Like all else being equal, but all else is not equal. One of these takes more time, one takes less. So, let's sort of evaluate based on how much money we're making per hour, not how much money we're making. 4,000 1,000 3,000 but how much we're making per planning hour and you simply divide by your constrained resources. If you go on and do 126b, our constrained resource isn't somebody's time. It's number of grams of some supply that goes in the product. And you go, okay, well, what's our contribution margin per gram? In this case, our constrained resource is Anony's hours. So, we're going to divide by the number of hours. Divide by planning hours. How long is this taking him? And if he enjoys them all equally, as he's saying, he should be prioritizing one over the other. So, let's let's divide by the hours. So divide it by 40 hours for weddings, divide by what is it? 16 hours for parties and divide by 20 hours for corporate events. And the picture becomes clear here. 4,000 / 40 is $100 per hour is what he's making off weddings. $1,000 / 16 $62.50 50 cents is what he's making. and that's not what he's charging, but that's what he's making after all his costs are considered. 6250 per planning hour and 3,000 divided by 20 is $150 an hour for corporate events. So, if he's being honest about this and if he enjoys them all equally, he should be taking corporate business first. That should be one, two, three. Now, he always has the option to change his prices, right? Like maybe he's just priced to what the market will bear, but he could raise prices on birthday parties or raise prices on weddings to make them more attractive or drop prices on corporate events and make them less attractive, suppose. But if he's got unlimited demand for his time, corporate events is what he should take first. so there you go. First, second, third. We've ranked them. It says, assume Anthony has 1,600 available planning hours per year. So 1,600 year hours year he wants to be doing this type of work. And obviously there's other work to be done. how much money will he make assuming he specializes exclusively on weddings, birthday parties, or corporate events? Well, let's figure out if he has 1,600 hours. And if he only did weddings, how many weddings could he do? Well, the math is pretty straightforward. You say he's got 1,600 hours, weddings take 40 hours. He could do 40 weddings. 1,600 divided by 40. So if he does 40 weddings, so guess we'll do capacity and it's weddings, birthday, bday, and corporate. So if he only does weddings, he could do 40 weddings. If he only does birthday parties, they take 16 hours each and he's got 1,600 hours, he could do 100red birthdays, right? Again, he has 1,600 available hours. birthday takes 16 hours. he has 1,600 hours and corporate events take 20 hour 20 hours. So he could do 80 corporate events. CM per event, CM per unit here is weddings make him $4,000 in contribution margin. Birthdays make him $1,000 in contribution margin. And corp events make him $3,000 in contribution margin. So if he has the capacity to do 40 weddings, he does 40 weddings. he makes four grand an event, he's going to make $160,000. That's how much money he makes. That's his total contribution margin. You know, he's got fixed cost to worry about after this. if he only does birthdays, he makes $100,000 in contribution margin. And if he does corporate events, he makes $240,000 in contribution margin. So, this is different way of answering the same question. Sometimes we work through the first part and students aren't quite clear on like 150 bucks an hour. Why are corporate events better? Well, this way is another way of looking at it, which is if he has limited amount of time, 1,600 hours and unlimited demand, you know, if he used all of his time for corporate events, he'd make 240. If he use all his time for weddings, he'd make 160. If he use all his times for birthdays, he'd make 100. Clearly, corporate events are the ones making him more money. If all else is equal, he should focus on those. And you should focus on hitting the like or subscribe button. Thanks for being here. Thanks for watching. And I'll see you in the next video. Bye for now. was just doing the edit and realized didn't really mark that this is the end of 10hour video. Holy mackerel. Congratulations on making it this far. Let me know in the comments you made it to the end. This is the very very end. Thanks for watching. It's an honor to get to spend time with you and really appreciate that you watch the videos. All right. Thanks for watching. Bye-bye.