ACCT 2102 Chapter 1

product costs

For financial purposes, includes all costs involved in acquiring or making a product. In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. Product costs "attach" to units of product as the goods are purchased or manufactured, and they remain attached as the goods go into inventory awaiting sale. Product costs are initially assigned to an inventory on the balance sheet. When sold, costs are released from inventory as expenses and matched against sales revenue on income statement

account analysis

In this method estimating mixed cost, an account is classified as either variable or fixed based on the analyst's prior knowledge of how the cost in the account behaves.

Sunk cost

a cost *that has already been incurred* and that cannot be changed by any decisions made now or in the future. Because they cannot be changed, they are not differential costs; and because only differential costs are relevant in a decision, sunk costs should always be ignored

direct cost

a cost that can be easily and conveniently traced to a specified cost object.

indirect cost

a cost that cannot be easily and conveniently traced to a specified cost object. (Example: a factory manager's salary.) *To be traced to a cost object such as a particular product, the cost must be caused by the cost object.*

common cost

a cost that is incurred to support a number of cost objects but cannot be traced to them individually. A common cost is a type of indirect cost.

fixed cost

a cost that remains constant, in total, regardless of changes in the level of activity. Examples include straight-line depreciation, insurance, property, taxes, rent, supervisory salaries, administrative salaries, and advertising.

variable cost

a cost that varies, in total, in direct proportion to changes in the level of activity. It must be variable *with respect to the activity base*.

differential cost

a difference in costs between any two alternatives; can be compared to economists marginal cost concept

differential revenue

a difference in revenues (usually just sales) between any two alternatives

activity base

a measure of whatever causes the incurrence of a variable cost. An activity base is sometimes referred to as a cost driver. Common examples are direct labor-hours, machine-hours, units produced, and units sold. *(NOTE: While there are many such of these w/in organizations, throughout the textbook, unless stated otherwise, you should assume that the activity base under consideration is the total volume of goods and services provided by the organization.)*

high-low method

a method for analyzing mixed costs, that begins by identify the period with the lowest level of activity and the period w/ the highest level of activity. The period w/ the lowest activity is selected as the first point in the slope formula, and the period w/ the highest activity is selected as the second point.

engineering approach

a method of estimating mixed costs that involves a detailed analysis of what cost behavior should be, based on an industrial engineer's evaluation of the production methods to be used, the materials specifications, labor requirements, equipment usage, production efficiency, power consumption, and more

period costs

all the costs that are not product costs. *All selling and administrative expenses are treated as period costs.* These costs are not included as part of the cost of either purchased or manufactured goods; instead, period costs are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting. The period in which a cost is incurred is not necessarily the period in which the cash changes hands

contribution approach

an approach for preparing income statements; provides managers w/ an income statement that clearly distinguishes between fixed and variable costs and therefore aids planning, controlling, and decision making. Separates costs into fixed and variable categories, first deducting variable expenses from sales to obtain the contribution margin.

Inventoriable costs

another name for product costs because they are initially assigned to inventories

incremental cost

another term for differential cost, but should only be used to refer only to an increase in cost from one alternative to another; decreases should be called *decremental costs*

direct labor

consists of labor costs that can be easily (ie physically and conveniently) traced to individual units of product. Sometimes called touch labor because direct labor workers typically touch the product while it is being made.

mixed cost

contains both variable and fixed cost elements. AKA semivariable costs. Denoted by the formula Y = a + bX, where Y is the total mixed cost, a is the fixed cost (vertical intercept of the line), b is the variable cost per unit of activity (slope of the line), and X is the level of activity

Matching principle

costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized. This means that if a cost is incurred to acquire or make something that will be eventually sold, then the cost should be recognized as an expense only when the sale takes place;

Cost classifications

for assigning costs to objects, for manufacturing companies, for preparing financial statements, for predicting cost behavior, and for making decisions

selling costs

include all costs that are incurred to secure customer orders and get the finished product to the customer. AKA order-getting and order-filling costs. Includes advertising, shipping, sales travel, sales commission, sales salaries, and costs of finished goods warehouses.

administrative costs

includes all costs associated with the general management of an organization rather than w/ manufacturing or selling. Examples include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the organization *as a whole*. Can be direct or indirect costs. Also called selling, general, and administrative costs (SG&A).

Manufacturing overhead

includes all manufacturing costs except direct materials and direct labor. Includes such items as indirect materials; indirect labor; maintenance and repairs on production equipment; and heat, light, property taxes, depreciation, and insurance on manufacturing facilities. Only costs associated with *operating the factory* are included. AKA indirect manufacturing cost, factory overhead, and factory burden

indirect labor

labor costs that cannot be traced to particular products, or that can be traced only at great cost and inconvenience; treated as part of manufacturing overhead. Includes the labor costs of janitors, supervisors, materials handlers, and night security guards.

indirect materials

materials such as solder and glue; included as part of manufacturing overhead

committed fixed costs

represent organizational investments w/ a multiyear planning horizon that can't be significantly reduced even for short periods of time without making fundamental changes. Examples include: investments in facilities and equipment as well as real estate taxes, insurance expenses, and salaries of top management.

Types of non-manufacturing costs

selling costs and administrative costs

contribution margin

the amount remaining from sales revenues after variable expenses have been deducted. This amount *contributes* toward covering fixed expenses and then toward profits for the period. Used as an internal planning and decision making tool

raw materials

the materials that go into the final product; may refer to any materials that are used in the final product; and the finished product of one company can become the raw material of another company

opportunity cost

the potential benefit that is given up when one alternative is selected over another.

relevant range

the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid. Outside of this range, a fixed cost may no longer be strictly fixed or a variable cost may not be strictly variable. Managers should always keep in mind that assumptions made about cost behavior may be invalid if activity falls outside of the relevant range

conversion cost

the sum of direct labor cost and manufacturing overhead cost. Used to describe these two costs because of these are incurred to convert materials into the finished product

Prime cost

the sum of direct material cost and direct labor cost

Cost and managerial accounting

the word "cost" is used a in a multitude of ways because there are many types of costs. Each type demands different classification and definition of costs. There are different costs for different purposes.

least-squares regression method

uses all of the data to separate a mixed cost into fixed and variable components. A regression line of the form Y = a +bX is fitted to the data, where *a* represents the total fixed cost and *b* represents the variable cost per unit of activity. This method computes the regression line that minimizes the sum of these squared errors.

discretionary fixed cost

usually arise from annual decisions by management to spend on certain fixed cost items. examples include advertising, research, public relations, management development programs, and internships. These can be cut for short periods of time w/ minimal damage to long-run goals of organization;aka managed fixed cost

high-low formula

variable cost = slope of line = (y2-y1/x2-x1); Refined: variable cost = ((cost at highest activity - cost at lowest activity)/(high level - low level))