chapter 1, 2

Scattergraph plot

AKA quick and dirty method. Might use this method sparingly this semester.

Mixed costs

Contains both Variable and fixed costs elements (E.g utility bills) The fixed portion of the utility bill is constant regardless of kilwatt hours consumers. This costs represents the minimum ost that is incurred to have the service ready and available for use. The variable portion of the bill varies in direct proprtion to the consumption of the kilowatt hours.

Manufacturing overhead(MOH)

Include all manufacturing costs except DM and DL. These costs cannot be easily traced to specific units produced (AKA indirect manufacturing cost, Factory Overhead, Factory burden) Includes indirect materials that are part of the finished product, but cannot be easily traced to it. Includes indirect labor costs that cannot be physically or conveniently traced to the creation of products. Other E.G include: maintenance and repairs on production equipment, heat and light, property taxed, depreciation and insurance on manufacturing facilities.

V C

Is a cost whose total dollar amount varies in direct prportion to changes in the activity level.

relevant range definition

Is that range of activity within which the assumptions made about cost behavior are valid.

The trend toward FC

The trend in many industries is toward greated FC relative to VC. EG: H&R block employees used to fill out tax returns for customers by hand. Now, computer software is used to complete tax returns. Safeway and Kroger employees used to key-in prices by hand on cash registers. Now barcode readers enter price and other product info automatically. As machines take over many mundane tasks previously performed by humans, "knowledge workers" are demanded for their minds rather than their muscles. Knowledge workers tend to be salaried, highly-trained and difficult to replace; consequently, the cost of compensating these valued employees is relatively Fixed rather than Variable.

Committed FC

These costs are long-term in nature(greater than one year). These costs cannot be significantly reduced even for short periods of time without seriously impairing the profitability or long-run goals of the organization. (E.g. Commited FC include depreciation on buildings and equipment and real estate taxes)

Discretionary FC

These costs usually arise from annual decisions by management to spend in certain FC areas. These costs can be cut from short periods of time with minimal damage to the long-run goals of the organization. (E.G. Discretionary FC include advertising and reserach and development)

Merchandising companies v manufacturing companies

merchandising companies: purchase finished goods from suppliers for resale to customers. (walmart). These companies do not have to distinguish between raw materials, work in process and finished goods. They report one inventory number on their balance sheet. Manufacturing companies- Purchase raw materials from supplier; then produce and sell finished goods to customer.(focus of this semester) They typically report 3 types of inventory on their balance sheet.(RM, WIP, FG)

managers activites: planning

specify the organization's objectives Identify possible alternatives expected to best achieve the organization's objectives. Once alternatives have been selected, the plans of management are often expressed formally in budgets. Budgets prepared under the direction of the controller. Typically, budgets prepared annually

Step-fixed vs step-variable costs

step variable costs can often be adjusted quickly as conditions change, whereas fixed costs cannot be changed easily. The width of the steps for fixed costs is wider than the width of the steps for step-variable costs.

Traditional approach differs from contribution approach

traditional approach organizes costs in a functional format. Costs relating to production, administration, and sales are grouped together without regard to their cost behavior. The traditional approach is used primarily for external reporting purposes.

The linearity assumption and the relevant range

Economists correctly piont out that many costs that accountants classify as VC actually behavr in a curvilinear fashion. Nonetheless, within a narrow band of activity known as the relvant range, a curvilinear cost can be satisfactorily approximated by a straight line.

Income statement: Merchandising vs Manufacturing companies calculation of COGS

Merchandisers: Beginning inventory +Costs of goods purchased =cost of goods available for sale -ending inventory =COGS Manufactures: Beginning FG inventory +Costs of goods manufacutred =costs of goods available for sale -ending FG inventory =COGS

Common examples of VC

Merchandising companies- COGS Manufacturing companies- DM, DL. Variable overhead. Merchandising and manufacturing companies- commission, shipping costs, and clerical costs such as invoicing. Service companies- supplies, travel and clerical.

3 methods just discussed provide slightly different estimates of the fixed and variable cost componen ts of the mixed cost

This is to be expected because each method uses differing amounts of the data points to provide estimates. Least squares regression provides the most accurate estimates because it uses all of the data points.

High-low method steps

1. Choose the data points pertaining to the highest and lowest activity levels. 2. Determine the total Costs associated with the 2 chosen points. 3. Calculate the change in cost between the 2 data points and divide it by the change in activity level between the two data points. The quotient represents an estimate of VC/Unit activity. 4. Take the total cost at either activity level and deduct the VC component. The residual represents the estimate of total FC. The VC component is determined by multiplying the level of activity by the estimated VC/ Unit of activity. 5. Construct an equation that can be used to estimate the total cost at any activity level.

Process costing system typically used when:

A company produces manu units of a single product One unit of a product is indistinguishable(same) from other units of products. The identical nature of each unit of product enables assigning the same average cost per unit across the units produced. (EG paper manufacturing and Coca Cola bottling)

The proportion of VC differs across organizations

A public utility like Florda Power and Light, with large investments in equipment, will tend to have fewer VC. A manufacturing company like Black and Decker will often have many VC associated with the manufacture and distrubition of its products to customers. A merchandising company like Wal-Mart will usually have a high proportion of VC such as the cost of merchandise purchased for resale. Some service companies, such as restaurants, have a high proportion of VC due to their raw material costs. Other service companies such as an architectural firm, have a high proportion of FC in the form of highly trained salaried employees.

nonmanufacturing costs

AKA selling and adminstrative costs selling costs-include all costs necessary to secure customers orders and get the finished product into the hands of the customer. administrative cost-include all executive, organization, and clerical costs associated with the general management of an organization.

Account analysis v engineering approach

Account analysis: Each account under consideration is classified as variable or fixed based on the analyst's prior knowledge about how costs behave. This approach is limited in value in the sense that it glosses over the fact that some accounts may have both fixed and variable components. Engineering approach: Classifies costs based on an industrial engineer's evaluation of production methods, material specifications, labor requirements, equipment usage, power consumption, etc. This appraoch is particularly useful when no pst experience is available concerning activity and costs.

Cost object

Anything for which cost cata are desired including products, customers, jobs, organizational subunits. For purposes of assigning costs to cost objects, costs are classified in 2 ways: Direct costs: Costs that can be easily and conveniently traded to a unit of product or other cost objects. Indirect costs: Costs that cannot be easily and conveniently traded to a unit of product or other cost object. (Common costs- indirect costs incurred to support a number of cost objects. These costs cannot be traded to any individual cost object)

cost classifications for decision making

It is important to realize that every decision involves a choice between at least two alternatives.

A cost may be dirscretionary or committed depending on managements strategy (E.G)

For example, some construction companies may layoff workers during months with minimal customer demand. However, other construction companies may opt(choose or decide) to retain their workers all year.

Activity base AKA cost driver

Is a measure of what cuases the incurrence of VC. As the level of the activity base increase, the VC increase proportionally. Units produced or sold is not the only activity base within companies. A cost can be considered variable if it varies with activity bases such as miles driven, machine hours, or labor hours.

Direct Labor

Labor costs that can be easily traced to individual units of product(AKA touch labor)

managers activities: directing and motivating

Managers oversee day-today activities to keep the organization functioning smoothly. Managerial accounting data, such as daily sales reports, often used in this type of day-today decision making

managers activities: controlling

Managers use feedback to determine whether operations are on track. A performance report compares budget to actual results. It helps identify which parts of tthe organization may require additional attention.

Job order costing systems typically used when:

Many different products are produced each period Products are manufactured to order The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job. (E.G. Walt Disney studios movie production)

Prime cost v conversion cost

Prime cost=DM+DL Conversion cost=DL+ Manufacturing Overhead

Product costs v Period costs

Product costs(AKA inventoriable costs)- Include all the costs that are involved in acquiring or making a product. In the case of manufacgured goods, it includes DM, DL, Manufacturing overhead. Its consistent with the matching principle, product costs are recognized as expenses when the products are sold. Period cost- Includes all selling and administrative costs. These costs are expensed on the income statement in the period incurred.

RM v WIP v FG

RM- The materials used to make the product. WIP- Consists of units of product that are partially complete, but that will require additional work before they are ready for sale to customers. FG- Consists of units of product that have been completed but are not yet sold to customers.

Direct Material

Raw materials that become an integral part of the finished product and whose costs can be conveniently traced to it.

VC remain constant if expressed on a per unit basis.

Referring to the wireless example, the cost per minute used is constant (e.g. 10 cents per minute)

Cost behavior

Refers to how a cost will react to changes in the level of activity within the relevant range(defined as the range of activity within which the assumption that have been made about VC and FC are valid) VC: A cost that varies, in total, in direct proportion to changes in the level of activity. However, VC/unit is constant. FC: A cost that remains constant, in total, regardless of changes in the level of the activity. However, if expressed on a per unit basis, the Average FC/Unit varies inversely with changes in activity. If activity changes enough(that is, it moves outside the relevant range), FC might change. For example, if production were doubled, another factory building might have to be rented.

High-low method

Relies on 2 data points to estimate the fixed and variable portions of a mixed cost, as opposed to one data point with the scattergraph method.

Average FC per unit decreases as the activity level increse- E.g.

The FC per local call decreases as more local calls are made.

Is labor a variable or a fixed cost?

The behavior of wage and salary costs differ across countries, depending on labor regulation, labor constracts, and customs. E.G: In france, Germany, China, and Japan management has little flexibility in adjusting the size of the labor force; hence, labor costs are more fixed in nature. Within countries managers can view labor costs differently depending on their strategy. Nonetheless, most companies in the U.S. continue to view direct labor as a VC.

Least-square regression method

This method uses all the data points to estimate the fixed and variable cost components of a mixed cost. This method is superior to the scattergraph plot method that relies on only one data point and the high-low method that uses only two data points to estimate the fixed and variable cost components of a mixed cost. The basic goal of this method is to fit a straight line to the data that minimized the sum of the squared errors. The regression errors are the vertical deviations from the data points to the regression line. The formulas that are used for least-squares regression are complex. Fortunately, computers can perform the calculations quickly. The observed values of the X and Y variable are entered into the computer and the software does the rest. The output from the regression analysis can be used to create an equation that enables you to estimate total costs at any activity level. Our focus this semester will not be on this method.

True VC v Step VC

True VC- amount used during the period varies in direct proportion to the activity level. The long distance phone bill was one example of a true VC. DM is another example of a cost that behaves in a true variable pattern. DM purchased but not used can be stored and carried forward to the next period as inventory. Step VC- Resource obtainable only in large chunks and whose costs change only in response to fairly wisde changes in activity. (E.g, maintenance workers are often considered to be a VC, but this labor cost does not behave as a true VC.) Small changes in the level of production are not likely to have any effect on the number of maintence workers employed. Maintenance workers are obtainable only in large chunks of a whole person who is capable of working approxinmately 2,000 hours a year.

Total mixed cost equation

Y(Total mixed cost)=a(total fixed cost-verticle intercept of the line)+b(the variable cost per unity of activity-slope of the line)X(level of activity) Y=a+bX

The goal of making decisions is to:

identify those costs that are either relevant to irrelevant to decision. To make decisions, it is essential to have a grasp on three concepts: Differential costs(incremental costs)- A difference in cost between any w alternatives( a difference in revenue between w alternatives is called differential revenue) Differential costs can be either fixed or variable. Oppurtunity costs- The potential benefit that is given up when one alternative is selected over another. These cots are not usually entered into the accounting records of an organiztaion, but must be explicitly considred in all decisions. Sunk cost- A cost that has already been incurred and that cannot be changed by any deciision now or in the future.

managers carry out 3 main activites which include

planning: directing and motivating: controlling:

Contribution approach

provides an income statement format geard directly to cost behavior, which has been the focus of discussion in this chapter. This approach seperates costs into fixed and variable categories. contribution margin= sales-VC Net operating income=CM-FC This approach is used as an internal planning and decision making tool. (E.G. this approach could be useful for: cost-volume-profit analysis, budgeting)

Comparision of financial and managerial accounting: 7 key differences LIST

users: Financial accounting reports are prepared for external parties, whereas managerial accounting reports are prepared for internal users. emphasis on the future: Financial accounting summarizes past transactions. Managerial accounting has a strong future orientation. relevance of data: Financial accounting data are expected to be objective and verifiable. Managerial accountants focus on providing relevant data even if it is not completely objective or verifiable. Less emphasis on precision: Financial accounting focuses on precision when reporting to external parties. Managerial accounting aids decision makers by providing good estaimates as soon as possible rather than waiting for precise data. Segments of an organization: Financial accounting is concerned with reporting for the company as a whole. Managerial accounting focuses more on the segments of the company. Examples of segments include: Produce lines, sales territories, divisions, departments. Generally Accepted accounting principles(GAAP): Financial accounting conforms to GAAP. Managerial accounting is not bound by GAAP. Managerial accounting- not mandatory: Financial accounting is mandatory because various outside parties require periodic financial statements. Managerial is not mandatory.