2018 LAST MINUTE CPA EXAM NOTES

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1 2018 LAST MINUTE CPA EXAM NOTES

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3 2018 LAST MINUTE CPA EXAM NOTES BEC (Volume 1)

4 Copyright 2018 by Glomont LLC. First edition Notice of Rights. All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher. For permission requests, write to the permissions department, Glomont LLC. Published by Glomont LLC. Glomont CPA Exam Review: 2018 Last Minute CPA Exam Notes BEC (Volume 1) ISBN-13: ISBN-10: Acknowledgements Material from Uniform CPA Examination, Selected Questions, and Unofficial Answers, copyright by the American Institute of Certified Public Accounts Inc., is reprinted and/or adapted with permission. Printed in the United States of America

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6 Contents 1. Cost Measurement Concepts, Methods, and Techniques Comparison between Managerial, Financial, and Cost Accounting 1 Managerial Accounting 1 Financial Accounting 1 Cost Accounting 1 The Difference between Product Costs and Period Costs 3 Product Costs 3 Period Costs 3 Relevant Definitions 5 Prime Costs 5 Conversion Costs 5 Full Costing 5 Traditional Methods of Assigning Costs to Products or Services 6 Actual Costing 6 Normal Costing 6 Standard Costing 6 Job Order Costing vs. Process Costing 13 Job Order Costing 13 Process Costing 17 Other Techniques and Methods to Allocate Indirect Product Costs 21 Service Department Cost Allocation Methods 21 Activity-Based Costing 23 Backflush Costing 27 By-Product Costing vs. Joint Costing 28 Benchmarking 31 Definition 31 Allocation of Costs by Behavior 32 Introduction 32 Variable Costs 33 Fixed Costs 33 Mixed Costs 33 The Difference between Absorption Costing and Variable Costing 39 Absorption Costing 39 Variable Costing 39 Net Income Effects 43

7 2. Variance Analysis Variance Analysis and Standard Costing 47 Standard Direct Materials Cost per Unit 47 Standard Direct Labor Cost per Unit 47 Standard Manufacturing Overhead Cost per Unit 47 Favorable vs. Unfavorable Variances 49 Formulas and Terminology 50 Direct Materials Variances 50 Direct Labor Variances 53 Manufacturing Overhead Variances 57 Sales Price and Sales Volume Variances 64 Contribution Margin Variance Forecasting and Projection Contribution Margin 67 Definition 67 Formulas 67 Breakeven Point 67 Definition 67 Formulas 68 Calculating Profit Based on Sales Volume above the Breakeven Point 70 Margin of Safety 71 Definition 71 Formulas 71 Target Profit 72 Definition 72 Formulas 72 Cost-Volume-Profit Analysis 75 Target Costing and Pricing 76 Introduction 76 Target Costing 76 Target Selling Price 76 Relevant Cost Decisions and Incremental Analysis 78 Introduction 78 Definitions 78 Types of Incremental Analysis 80 Probability Analysis 87 Inventory Management 90 Introduction 90 The Difference between Periodic and Perpetual Inventory Systems 90 Forecasting 91

8 Safety Stock 91 Reorder Point 91 Economic Order Quantity 91 Just-in-Time Inventory Management 93 Materials Requirements Planning (MRP) 94 Supply Chain Management 94 Introduction 94 Supply Chain Operations Reference (SCOR) Model Budgeting and Analysis Budgets 96 The Importance of Budgets 96 The Budget Period 96 Master Budgets 96 Definition 96 Components of the Master Budget 96 Preparing the Operating Budgets 97 Sales Budget 97 Production Budget 97 Direct Materials Budget 98 Direct Labor Budget 101 Manufacturing Overhead Budget 101 Ending Finished Goods Inventory Budget 102 Cost of Goods Sold Budget 103 Selling and Administrative Budget 104 Budgeted Income Statement 104 Preparing the Financial Budgets 105 Capital Expenditures Budget 105 Cash Budgets 105 Budgeted Balance Sheet 109 Budgeted Statement of Cash Flows 109 Flexible Budgeting 110 Static Budget vs. Flexible Budget 110 Flexible Budgeting and Production Levels 111 The Advantages and Disadvantages of Flexible Budgeting 112 Flexible Budget Variances and Sales Volume Variances 112 Static Budget Variances 115 Participative Budgeting 116 Introduction 116 Definition 117 Advantages and Disadvantages of Participative Budgeting 117 Index 9

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10 Glomont CPA Exam Review 1 1. Cost Measurement Concepts, Methods, and Techniques Comparison between Managerial, Financial, and Cost Accounting Managerial Accounting The focus of managerial accounting is on the needs of the organization s internal parties. Managerial accounting helps internal users plan for the future, develop effective business strategies, and make appropriate decisions. Managerial accounting is more likely to sort accounting data by behavior (e.g., fixed vs. variable). Financial Accounting Financial accounting is predominantly for external users, and it always sorts accounting data by function (product cost vs. period cost). While financial accounting must follow U.S. Generally Accepted Accounting Principles (GAAP), managerial accounting need not do so. LAST MINUTE NOTE Summary of Differences between Managerial Accounting and Financial Accounting Managerial Accounting Financial Accounting Primary Focus Internal users External users (investors, lenders, and other creditors) Standards to Follow Accounting Data Type of Reports Created Is not subject to any binding accounting standards. More likely to sort accounting data by behavior (e.g., fixed vs. variable). Performance, budget, and cost reports (forward looking) Must follow U.S. Generally Accepted Accounting Principles (GAAP). Always sorts accounting data by function (e.g., product cost vs. period cost). Financial statements (backward looking) Cost Accounting Cost accounting is the allocation of costs by function in order to determine costs to be inventoried for the purpose of determining cost of goods sold. Cost accounting is where managerial accounting and financial accounting intersect. Because cost accounting is useful to managers in making effective business decisions and strategies, cost accounting can be seen as part of managerial accounting. At the

11 2 Glomont CPA Exam Review same time, cost accounting is useful for matching product-related costs with revenue, which is part of financial accounting. a. Definitions Cost accounting is the process of determining the product costs, which include direct materials, direct labor, and production overhead (indirect product costs). These three are detailed below: (1) Direct Materials: The material that goes directly into producing the products and becomes part of a manufactured product (e.g., freight-in, scrap, and normal spoilage). Freight-out is a selling expense (e.g., free shipping to customer at company s expense). If spoilage is avoidable, then it is abnormal spoilage. Abnormal spoilage is a period cost and is recorded to a loss for abnormal spoilage account. (2) Direct Labor: Any labor that is directly involved in manufacturing a product or producing a service. (3) Manufacturing Overhead: Includes all indirect product costs (also called production overhead). These are all other costs that are necessary for the production of a product or service and cannot be traced directly to the product or service. Indirect product costs include: (a) Indirect Materials: Materials used in the production process that are not directly traceable to the product. For example, equipment lubricants and manufacturing supplies are indirect materials. (b) Indirect Labor: The labor of those who are not directly involved in the production of the products. Examples include production supervisors, factory supervisors, equipment maintenance personnel (such as machine mechanics), factory janitorial personnel, process engineers, and inspectors. (c) Other Indirect Costs: Costs such as factory utilities, leases, and insurance. It also includes property taxes, rent, depreciation on the factory, and manufacturing equipment. EXAMPLE What Can Be Traced Directly into a Product or a Service? AICPA released question Following are Mill Co. s production costs for October: Direct materials $100,000 Direct labor 90,000 Factory overhead 4,000 What amount of costs should be traced to specific products in the production process? a. $ 90,000 b. $100,000 c. $190,000 d. $194,000

12 Glomont CPA Exam Review 3 solution Correct answer: c. Direct materials and direct labor can be traced directly to the product (that is why they are called direct costs). Factory overhead is an aggregate term for indirect product costs. The Difference between Product Costs and Period Costs Product Costs In the case of manufactured products, product costs include direct materials, direct labor, and manufacturing overhead. Product costs are inventoriable costs and are recorded within the inventory asset account when incurred. When the goods are sold, these costs are released from the inventory asset account on the balance sheet to the cost of goods sold account on the income statement. They are then matched against revenue so that the entire effect of a sales transaction appears within one income statement. Product costs could be incurred during one accounting period but not expensed until the next accounting period when the inventory is sold. Product costs include all costs involved in acquiring or producing a product. Freight-in, for example, is a product cost and is added to the cost of goods purchased. Period Costs Period costs include all non-manufacturing or non-product costs, and they are not part of the cost of either purchased or manufactured goods. Period costs are expensed in the period in which they are incurred and matched with the revenue of the same time period. Period costs include selling and administrative expenses. Selling expenses include: All costs incurred to fulfill customer orders and ship inventory to customers, such as: Freight and transportation out (e.g., free shipping to customer at company s expense) Order-filling costs (e.g., shipping supplies, postage, and stationary) All expenses incurred to increase sales, such as: Advertising and promotional materials Sales commission Selling expenses related to the sold product, sales department, and facilities, such as: Warranty expense Uncollectible accounts expense (bad debt expense), if associated with losses from normal credit sales Sales salaries and payroll taxes Depreciation on sales equipment or sales showroom Depreciation on the sales staff s automobiles Utilities (e.g., showroom)

13 4 Glomont CPA Exam Review Administrative expenses include all costs required to administer a business and are not associated with the manufacturing costs or the selling expenses. Examples include: Consulting fees (e.g., accounting, audit, and legal fees) Rental and depreciation expense on administrative office Insurance and utilities on administrative office Depreciation on headquarters building and office equipment (e.g., depreciation on a machine used in the accounting department) Officers salaries, accounting staff wages, and officers compensation (e.g., corporate management and legal staff salaries and payroll taxes) Administrative office supplies LAST MINUTE NOTE Summary of Differences between Product Costs and Period Costs Terminology Timing of Expense Components Product Costs Manufacturing costs Inventoriable costs Are not necessarily expensed in the period in which they are incurred. Product costs become expenses in the period in which the inventory is sold. Direct materials Direct labor Manufacturing overhead Indirect materials Indirect labor Other indirect costs Period Costs Non-manufacturing costs Non-product costs Are expensed in the period in which they are incurred. Selling expenses Administrative expenses LAST MINUTE NOTE Product costs include costs that will be part of the cost of goods sold once the merchandise is sold. Goods purchased for resale or goods manufactured are product costs. Product costs include scrap and normal spoilage, but not abnormal spoilage. Abnormal spoilage is a loss and it is not an inventoriable product cost.

14 Glomont CPA Exam Review 5 EXAMPLE Normal Spoilage vs. Abnormal Spoilage AICPA released question Hoyt Co. manufactured the following units: Saleable 5,000 Unsaleable (normal spoilage) 200 Unsaleable (abnormal spoilage) 300 Manufacturing costs $99,000 What amount should Hoyt debit to finished goods? a. $90,000 b. $93,600 c. $95,400 d. $99,000 solution Correct answer: b. Normal spoilage is a product cost while abnormal spoilage is a period cost. To calculate the cost per unit, divide total manufacturing costs by the number of units. Cost per unit = $18 ($99,000 5,500 units) Saleable and normal spoilage units should be treated as a product cost. Consequently, the amount that should be debited to finished goods is $18 5,200 units = $93,600. The cost of abnormal spoilage of $5,400 ($18 300), which is a period cost, is removed from the manufacturing costs. Relevant Definitions Prime Costs = Direct materials + Direct labor Prime costs are the components that are direct in nature. Conversion Costs = Direct labor + Indirect product costs Conversion costs are the components used to change raw materials to finished goods. Indirect materials and indirect labor are conversion costs. Full Costing Including indirect product costs as well as direct labor and direct materials is called full costing or absorption costing.

15 6 Glomont CPA Exam Review EXAMPLE Conversion Costs AICPA released question If a product required a great deal of electricity to produce, and crude oil prices increased, which of the following costs most likely increased? a. Direct materials b. Direct labor c. Prime costs d. Conversion costs solution Correct answer: d. Electricity used in production is an indirect product cost. Conversion costs are equal to the sum of indirect product costs and labor costs. Traditional Methods of Assigning Costs to Products or Services Actual Costing Actual direct materials, actual direct labor, and actual indirect product costs are assigned to the product or service as it is produced. Normal Costing Actual direct materials and actual direct labor are assigned to the product or service, but indirect product costs are allocated based on one or more allocation rates 1 estimated as of the beginning of the accounting period. Standard Costing Direct materials and direct labor are assigned based on predetermined estimates ( standard cost 2 ). Indirect costs are assigned based on one or more predetermined overheads rates. Everything is estimated under this method. a. Determining a Predetermined Overhead Rate Predetermined overhead rate = Both the denominator and numerator are estimates. Budgeted indirect product costs (factory overhead)3 Budgeted allocation base Called the predetermined overhead rate or absorption rate. Standard costs are determined based on an ideal (practical) or a historical average basis and are adjusted periodically based on changes in supply and demand, economic factors, and improvements in process technology. Generally, a practical basis is preferred. Budgeted indirect product costs (factory overhead) are typically estimated as of the beginning of the operating cycle and should be allocated on a basis that is logically related to the costs being allocated.

16 96 Glomont CPA Exam Review 4. Budgeting and Analysis Budgets The Importance of Budgets Budgets are used for planning and control purposes and can be used to compare budgeted goals with actual results. Such comparison will help management determine the causes of discrepancies and take corrective actions. Budgets are an important basis for evaluating performance and help management make better decisions. The Budget Period A budget can be prepared for any period. The length of the budget period is influenced by many factors, such as the type of budget and the nature of the business. The most common budget period is one year, corresponding to the company s fiscal year. Some companies use a continuous budget. 27 A continuous budget is a 12-month budget that drops the month just ended and adds an additional month in the future. The continuous budget approach helps management plan one year ahead constantly as new information becomes available. Master Budgets Definition The master budget is a one year or less 28 budget planning document for the company encompassing a set of interconnected budgets that outline the company s sales, production, and financial goals. The master budget is an integrated business plan. Components of the Master Budget A master budget can be divided into operating budgets and financial budgets: a. Operating Budgets Operating budgets are used as the basis for preparing the budgeted income statement. They include the sales budget, production budget, cost of goods sold budget, and the selling and administrative expense budget, which are used to prepare the budgeted income statement. The ultimate output of the operating budgets is a pro forma (i.e., budgeted) income statement A continuous budget is also called a rolling budget. The master budget is usually prepared for one year, corresponding to the company s fiscal year.

17 Glomont CPA Exam Review 119 Index An n associated with a page number indicates the information is found in the notes. A abnormal spoilage, 4 5 absorption costing defined, 5, 39 variable costing versus, 39 41, absorption rate, 6n1 accounts payable calculation, 9 cost of goods sold and, activities, levels of, 25, 33n10, activity, defined, 23 activity cost pool, 23, 27 activity-based costing, actual costing, 6, 7 actual overhead, 57n15 administrative expense budget, 104 administrative expenses, 4, 41n12 B backflush costing, 27 balance sheet, budgeted, 109 batch-level activities, 25 benchmarking, breakeven point, budget variance, fixed overhead, budgetary slack, 117 budgeted allocation base, 47n13 budgeted balance sheet, 109 budgeted cost, 99 budgeted income statement budgets, 104 budgeted indirect product costs, 6, 6n3 budgeted production (units), 98n28 budgeted statement of cash flows, budgets financial, 97, flexible budgeting, , 110n32 importance of, 96 master, 96 97, 96n27 operating, participative budgeting, , 116n34 preparation period, 96 sequential order of, 110 buy-or-make decisions, by-product costing joint costing versus, joint product, physical net realizable value method, 31 joint product, physical units method, 30 by-product treatment, by-products, defined, 28 C capital expenditures budgets, 105 cash budgets, cash disbursements, cash flows, budgeted statement of, cash receipts, closing overhead variance, 14n6 contribution margin, 40, 67 contribution margin variance, contribution margin volume variance, 66 conversion costs, 5 6 cost accounting, 1 2 cost decisions, cost driver, cost flow, cost of goods manufactured, 9, 10, 13 cost of goods purchased, 9, 9n4 cost of goods sold accounts payable and, budget, calculation, 10 merchandiser, 9 cost pools, 23, 27 costs allocation of by behavior, categorization of, 112 cost-volume-profit analysis, customer-level activities, 25 D differential costs, direct costing, direct labor budget, 101 costing, 6, 47 defined, 2 overtime premium, 15 variable costing and, variances, direct materials assigning costs, 6, 6n2 budget for, calculating, 9 10 defined, 2 3 per unit costing, 47 standard costing method, 6, 47, 62 variances, 50 53

18 120 Glomont CPA Exam Review E economic order quantity (EOQ), efficiency (usage) variances, 49, 59 eliminate or keep a segment, ending finished goods inventory, equivalent units under FIFO, under weighted average, excess capacity, expected value, 87 F factory overhead, defined, 3 favorable variances, 49 financial accounting, 1 financial budgets, 97, financing budgets, fixed costs, 33, 79, 111 fixed overhead variances, flexible budgeting, , 110n32 forecasting breakeven point, contribution margin, 40, 67 cost-volume-profit analysis, incremental analysis, inventory management, margin of safety, 71 probability analysis, relevant cost decisions, supply chain management, target costing, 76 target profit, target selling price, unit sales, 97 full capacity, 81, full costing, 5 6 G Generally Accepted Accounting Principles (GAAP) absorption costing, 39, 44 activity-based costing, 25 financial accounting, 1 variable costing, 39, 44 gross margin percentage, 43 H heterogeneous, term usage, 25n8 I income statement, budgeted, 104 incremental analysis, incremental costs, 76 80, 85n23 incremental revenue, 85n22 indirect costs, other, 2 indirect labor, 2 indirect materials, 2, 15 indirect product costs, 6, 6n3 inventoriable costs, 3, inventory budget, ending finished goods, inventory management, 27, J job order costing, 13 17, 21 joint costing, by-product costing versus, joint costs, 28, 85n21 joint product costing physical net realizable value method, 31 physical units method, 30 joint products, defined, 28 just-in-time (JIT) inventory, 27, K keep or eliminate a segment, L labor. See direct labor; indirect labor M make-or-buy decisions, managerial accounting, 1 manufacturing costs, calculation, 14 manufacturing overhead fixed variances, per unit cost, 47 49, 47n13 production costs, 2 3 type of, 2 3 variable variances, variances, manufacturing overhead account, 8 manufacturing overhead budget, margin of safety, 71 marketing expense budget, 104 master budgets, 96 97, 96n27 materials direct (See direct materials) indirect, 2, 15 price (rate) variances, quantity variance, rate (price) variances, materials requirements planning (MRP), 94 materials variances, mixed costs correlation coefficient, defined, 33 high-low method, regression analysis, 36 single regression vs. multiple regression, 38 39

19 Glomont CPA Exam Review 121 N normal costing, 6 normal spoilage, 4 5 O operating budgets, operating income, 113 opportunity costs, 79 organizational-level activities, 25 overhead actual, 57n15 closing variance to COGS, 14n6 indirect production costs, 6, 6n3 manufacturing (See manufacturing overhead) manufacturing account, 8 overapplied, 14n7 predetermined rate, 6 8, underapplied, 14n5 P participative budgeting, , 116n34 performance reports, 111n33, 112 period costs, 3 4, 41n12 periodic inventory system, 90 perpetual inventory system, 90 predetermined overhead rate actual production, 60n16, 61n19 budgeted production, 60n17, 61n18 determining, 6 8 price (rate) variances defined, 49 labor, materials, overhead, prime costs, 5 probability analysis, process costing, process-further-or-sell decisions, 85 product costs, 3 4, 7 production budget, production levels and flexible budgeting, production overhead. See manufacturing overhead product-level activities, 25 profit, calculating, projections. See forecasting Q quantity variance labor, materials, R rate (price) variances defined, 49 labor, materials, overhead, raw materials. See direct materials; indirect materials regression analysis, 36 relevant range, defined, 33n9 reorder point, 91, 91n26 required units to be produced, 98n28 risk analysis, S safety, margin of, 71 safety stock (inventory), 91 sales budget, 97 sales price variance, sales unit, forecasting, 97 sales volume variances, 14, 65 SCOR model, 95 segments, keep or eliminate, selling and administrative budgets, 104 selling expenses, 3, 41n12 sell-or-process-further decisions, 85 separable costs, 28 service department cost allocation methods direct method, reciprocal method, 23 step-down method, services costs, 7 special order decisions, spending variance, 56, 58, 60 61, split-off point, 28 spoilage, 4 5 standard costing defined, 6 direct labor, assigning costs, 6 direct labor per unit, 47 direct materials, assigning costs, 6, 6n2 direct materials per unit, 47 manufacturing overhead per unit, 47 49, 47n13 manufacturing overhead, type of, 2 3 predetermined overhead rate, 6 8 uses, 8 statement of cash flows, static budgets flexible budgets vs., , 110n31, 110n32 sales volume and, 114 variances, storage costs (inventory), 91, 91n24, 91n25

20 122 Glomont CPA Exam Review sunk costs, 79 supply chain management, supply chain operations reference (SCOR) model, 95 T target costing, 76 target profit, target selling price, time lag, sales and collections, 106n30 U unfavorable variances, 49 unit sales, forecasting, 97 unit-level activities, 25 usage (efficiency) variances, 49, 59 V variable costing absorption costing versus, 39 41, direct labor and, gross margin percentage, 43 inventoriable costs, 3, net income effects, unit cost under, variable costing income statement, 40 variable costs, 33 variances closing to COGS, 14n6 contribution margin, contribution volume margin, 66 direct labor, direct materials, favorable vs. unfavorable, 49 fixed overhead, flexible budget, identifying from standards, 50 manufacturing overhead, sales price, sales volume, 14, 65 spending variance, 56, 58, 60 61, static budget, usage (efficiency), 49, 59 volume variance, fixed overhead, 61 62

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