Jan 17, 2018

How is EQQ calculated and what are the underlying assumptions associated with the use of this tool?

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C. T., Datar, S. M., &Rajan, M. V. (2015). Cost accounting: A managerial
emphasis (15th ed.). Boston: Pearson

1). Using this week’s lecture, discuss
the concept of equivalent units and how that concept relates to management
decision making. Be sure to include information in your discussion about the
weighted-average method in comparison to the FIFO method of accounting for work
residing in work-in-process units.


costing deals with batches of like products.
For example, paint is produced in large quantities and you can’t tell
one gallon of white paint from another gallon of white paint. A barrel of oil would be another
example. The essence of this costing
method is that costs are accumulated by process rather than by job. Accounting is very definitive, so process costing
becomes a little out of the comfort zone for many accountants because we don’t
have anything that is exact. At month
end under job costing, we know how much in materials have been charged to a
specific job. However, under process
costing we only know that a certain quantity of materials has been entered into
the process. As a result, we have to estimate how far along we are in the
process for direct materials and direct labor.
To do this we introduce the concept of equivalent units. Equivalent units is just fancy terminology
for how far along we are in the process. Since accountants like to think of
completed units for costing purposes, we estimate, based on where we are in the
process, how many equivalent units of completed materials we would have if we
combined all the partially completed units into a smaller number of completed
units. For example, we might estimate
that 200 units ½ complete would be equivalent to 100 fully completed
units. See, that wasn’t so bad.

is a short video on the basics: Process Costing Part 1 – Managerial Accounting

entries under process costing are also a little different than under job order
costing. Materials are issued to a
process, rather than a job, so materials requisitioned would be debited to WIP
(some department) and credited to Materials Inventory. There are a series of five steps we use for
this type of costing:

  1. Measure the
    physical flow of resources
  2. Compute the
    equivalent units of production
  3. Identify
    the product costs to be accounted for
  4. Compute the
    cost per equivalent unit: weighted average
  5. Assign
    product cost to batches of wor

a problem that will demonstrate this process:
Process Costing Part 2 – Managerial Accounting

other concept that bears some additional discussion is called an Economic Order
Quantity (EOQ). The idea behind the EOQ
is that there is some specific quantity of materials that should be orderedeach
time an order is placed in order to minimize inventory holding costs and
inventory ordering costs. This concept dovetails nicely with our ABC discussion
in an earlier week actually.

formula for the EOQ is:

= the square root of (2DS/H) where D=annual quantity demanded, S=flat fixed
cost per order and H is the annual holding cost.

are several assumptions that underlie this formula. First, the order cost is constant per
order. Next, demand is known and is
evenly distributed throughout the period.
Third, the lead time for the order is fixed, and, fi

2). Using this week’s lecture, answer
the following:

  • What
    is an (EOQ)?
  • How
    is EQQ calculated and what are the underlying assumptions associated with
    the use of this tool?
  • From
    a management perspective, why might the EOQ conflict with a manager’s
    performance evaluation goals?

3). Capital budgeting is an integral
part of the strategic planning and budgeting process of most firms. Explain and provide a numerical example of
the use of the internal rate-of-return method and the Net Present Value (NPV)
method of analyzing capital budget projects.
Which one is a better indicator for management decision-making related
to capital acquisition decisions? Why?

4). Using this week’s lecture, explain
what a transfer price is, what the criteria should be for evaluating potential
transfer price, and provide an example of transfer pricing in action assuming:
a) excess capacity and b) no excess capacity. Review the Forbes article:
Transfer Pricing as Tax Avoidance and explain how transfer pricing might be
used for tax avoidance.


down the home stretch this week we take a look at combining all these
activities and concepts into a management tool we call a budget, or plan. It has been said that if we don’t know where
we are going, then it doesn’t really matter how we get there. A budget not only tells us where we are
heading (in financial terms) but also gives us measures of performance along
the way to help managers stay on track.
Think about this in terms of your own personal situation. If you did not know how much money you were
going to make this month, how would you know what to buy and what not to buy,
right? So this budget becomes a tool to
manage performance.

a budget causes us to think about our operations in broad terms, we can call
this strategic management. In the
perfect world a company establishes its long-term strategic objectives in terms
of financial profitability and then budgets are prepared that indicate how each
manager/department will perform in order to help the company reach those
goals. So, we need a process that will
lead us to our end result, which is a master budget. To get to this, we start with a sales
forecast of units expected to be sold.
Once we have this figured out, then we can figure out the revenue those
sales will generate. To meet that sales
demand, we figure out how much needs to be produced, then we break this down
into the main components, direct materials, direct labor and manufacturing
overhead. Once we have these figures, then we can put dollar values to them and
create a budget for each. A budget must
also be prepared for administrative overhead and for capital spending
(machinery and so on), and from this, we create a cash flow budget (inflows and
outflows). The end result of this activity will be a budgeted (forecasted)
income statement, balance sheet, and statement of cash flows.

short video will summarize this process:
Responsibility Accounting: Master Budget – Managerial Accounting Video

final topic is transfer pricing. Let’s
suppose we have a sister plant that makes a part for a widget that we need to
produce our widgets. Presently we are purchasing that part from an outside
supplier. If we were to switch and buy
that part internally from our sister plant, what price should be charged to us
that would make us willing to purchase the part internally and would also make
our sister plant happy to do business with us?
That price is the subject of much debate among plant managers, but the
“fair” price is actually dependent on the level of capacity the producing plant
has available. In
general terms, the transfer price
should be the sum of the outlay costs (usually variable costs to produce) plus
the opportunity cost of the resource at the transfer point.

Take a look
at a quick example: Pricing – 6: Transfer Pricing

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