Managerial Accounting and cost concepts

Distinguish between discretionary fixed costs and committed fixed costs.

A discretionary fixed cost has a fairly short planning horizon—usually a year. Such costs arise from annual decisions by management to spend on certain fixed cost items, such as advertising, research, and management development. A committed fixed cost has a long planning horizon—generally many years. Such costs relate to a company's investment in facilities, equipment, and basic organization. Once such costs have been incurred, they are "locked in" for many years.

What is meant by an activity base when dealing with variable costs? Give several examples of activity bases.

An activity base is a measure of whatever causes the incurrence of a variable cost. Examples of activity bases include units produced, units sold, letters typed, beds in a hospital, meals served in a cafe, service calls made, etc.

What is the difference between a contribution format income statement and a traditional format income statement?

The contribution approach income statement organizes costs by behavior, first deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net operating income. The traditional approach organizes costs by function, such as production, selling, and administration. Within a functional area, fixed and variable costs are intermingled.

Managers often assume a strictly linear relationship between cost and volume. How can this practice be defended in light of the fact that many costs are curvilinear?

The linear assumption is reasonably valid providing that the cost formula is used only within the relevant range.

What are the three major elements of product costs in a manufacturing company?

The three major elements of product costs in a manufacturing company are direct materials, direct labor, and manufacturing overhead.

Define the following terms: ( a ) cost behavior and ( b ) relevant range.

a. Cost behavior: Cost behavior refers to the way in which costs change in response to changes in a measure of activity such as sales volume, production volume, or orders processed. b. Relevant range: The relevant range is the range of activity within which assumptions about variable and fixed cost behavior are valid.

Define the following terms: differential cost, opportunity cost, and sunk cost.

A differential cost is a cost that differs between alternatives in a decision. An opportunity cost is the potential benefit that is given up when one alternative is selected over another. A sunk cost is a cost that has already been incurred and cannot be altered by any decision taken now or in the future.

Explain the difference between a product cost and a period cost.

A product cost is any cost involved in purchasing or manufacturing goods. In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. A period cost is a cost that is taken directly to the income statement as an expense in the period in which it is incurred.

Only variable costs can be differential costs. Do you agree? Explain.

No, differential costs can be either variable or fixed. For example, the alternatives might consist of purchasing one machine rather than another to make a product. The difference between the fixed costs of purchasing the two machines is a differential cost.

What is the contribution margin?

The contribution margin is total sales revenue less total variable expenses.

Give the general formula for a mixed cost. Which term represents the variable cost? The fixed cost?

The formula for a mixed cost is Y = a + bX. In cost analysis, the "a" term represents the fixed cost and the "b" term represents the variable cost per unit of activity.

What is meant by the term least-squares regression?

The term "least-squares regression" means that the sum of the squares of the deviations from the plotted points on a graph to the regression line is smaller than could be obtained from any other line that could be fitted to the data.

Does the concept of the relevant range apply to fixed costs? Explain.

Yes. As the anticipated level of activity changes, the level of fixed costs needed to support operations may also change. Most fixed costs are adjusted upward and downward in large steps, rather than being absolutely fixed at one level for all ranges of activity.

Define the following: ( a ) direct materials, ( b ) indirect materials, ( c ) direct labor, ( d ) indirect labor, and ( e ) manufacturing overhead.

a. Direct materials are an integral part of a finished product and their costs can be conveniently traced to it. b. Indirect materials are generally small items of material such as glue and nails. They may be an integral part of a finished product but their costs can be traced to the product only at great cost or inconvenience. c. Direct labor consists of labor costs that can be easily traced to particular products. Direct labor is also called "touch labor." d. Indirect labor consists of the labor costs of janitors, supervisors, materials handlers, and other factory workers that cannot be conveniently traced to particular products. These labor costs are incurred to support production, but the workers involved do not directly work on the product. e. Manufacturing overhead includes all manufacturing costs except direct materials and direct labor. Consequently, manufacturing overhead includes indirect materials and indirect labor as well as other manufacturing costs.

What effect does an increase in volume have on— a. Unit fixed costs? b. Unit variable costs? c. Total fixed costs? d. Total variable costs?

a. Unit fixed costs decrease as volume increases. b. Unit variable costs remain constant as volume increases. c. Total fixed costs remain constant as volume increases. d. Total variable costs increase as volume increases.

Distinguish between ( a ) a variable cost, ( b ) a fixed cost, and ( c ) a mixed cost.

a. Variable cost: The variable cost per unit is constant, but total variable cost changes in direct proportion to changes in volume. b. Fixed cost: The total fixed cost is constant within the relevant range. The average fixed cost per unit varies inversely with changes in volume. c. Mixed cost: A mixed cost contains both variable and fixed cost elements.