Managerial Accounting Chapter 2

Subtypes of Manufacturing Costs

Direct materials, Direct labor, Manufacturing overhead

Direct Materials

Those materials that become an integral part of the finished product and whose costs can be easily traced to the finished product. Such as seats in an airplane or the speaker on an iPhone

Incremental Cost

Another name for differential cost, although should technically only refer to an increase in cost from one alternative to another.

Cost Object

Anything for which cost data are desired, including products, customers, jobs and organizational subunits. Are classified as either direct or indirect.

Layout of Contribution Format Income Statement

-Sales -Variable Expenses -Contribution Margin = (Sales - Variable Expenses) -Fixed Expenses -Net Operating Income (Contribution Margin - Fixed Expenses)

Direct Cost

A cost that can easily and conveniently be traced to a specific cost object

Indirect Cost

A cost that can't be easily and conveniently traced to a specific cost object. To be traced to a cost object such as a particular product, the cost must be caused by the cost of the object itself.

Variable Cost

A cost that varies, in total, in direct proportion to changes in the level of activity. Common examples include cost of goods sold for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead, supplies and power and variable elements of selling and administrative expenses such as commissions and shipping costs.

Differential Cost

A difference in revenues (usually just sales) between any two alternatives. Encompasses both incremental and decremental costs. Can be compared to the economist's marginal cost concept and marginal cost and marginal revenue. Can be either fixed or variable.

Activity Base

A measure of whatever causes the incurrence of a variable cost. Sometimes referred to as a cost driver. Most common examples include direct labor hours, machine hours, units produced and units sold. In this book, you should assume that the activity base under consideration is the total volume of goods and services provided by the organization.

Methods available to estimate the fixed and variable components of mixed costs

Account analysis, engineering approach, high-low method, least squares regression analysis

Account Analysis method

Account is classified as either variable or fixed based on the analyst's prior knowledge of how the cost in the account behaves

Period Costs

All the costs that are not product costs. All selling and administrative expenses. For example, sales commissions, advertising, executive salaries, public relations and the rental costs of administrative offices. Not included as part of the cost of either purchased or manufactured goods, and are instead expenses on the income statement in the period in which they are incurred using the usual rules of accrual accounting.

High-Low Method

Assuming that the scattergraph indicates a linear relation between cost and activity, begin by identifying the period with the lowest level of activity and the period with the highest level of activity. The period with the lowest level is selected as the first point and the period with the highest activity is selected as the second point. Then, once you find the variable cost per pday, Fixed Cost Element = Total Cost - Variable Cost Element

Subtypes of nonmanufacturing costs

Selling costs and administrative costs

Mixed Cost

Contains both variable and fixed costs elements. Also known as semivariable costs. Can be expressed as equation, Y = A + bX Y = total __________ a = total fixed cost b = variable cost per unit of activity X = the level of activity The steeper the slope, the higher the variable cost per unit

Common Cost

Cost incurred to support a number of cost objects but can't be traced to them individually. Type of indirect cost.

Sunk Cost

Cost that has already been incurred and that cannot be undone by any decision made now or in the future. Because sunk costs can't be changed by any decision, they are not differential costs.

Engineering Approach

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, etc

Net Operating Income

Gross margin minus selling and administrative expenses

Administrative Costs

Include all costs associated with the general management of an organization rather than with manufacturing or selling costs. Examples include executive compensation, general accounting, secretarial, public relations and similar costs involved in the overall, general administration of the organization as a whole.

Product Costs

Include 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. Since they are usually assigned to inventories, they are also known as inventoriable costs. They are not necessarily recorded as expenses on the income statement in the period of which they are incurred, but rather, they are recorded as expenses in the period in which the related products are *sold*

Selling Costs

Include all costs that are incurred to secure customer orders and get the finished product to the customer. Examples include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses. Can be either direct or indirect.

Manufacturing Overhead

Includes all manufacturing costs except direct materials and direct labor. Only the costs associated with operating the factory.

Direct labor

Labor costs that can be easily traced to individual units of product. Sometimes called touch labor since these workers typically touch the product being made

Indirect labor

Labor costs that can't be easily traced to particular products. Treated as part of manufacturing overhead. These include janitors, security guards, supervisors, materials handlers...etc

Indirect Materials

Minor items for which it isn't worth it to trace their cost to specific items. Included in manufacturing overhead.

Discretionary Fixed Costs

Often referred to as managed fixed costs, 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 for students. Can be cut for short periods of time with minimal damage to the long-run goals of the organization.

Opportunity Cost

Potential benefit that is given up when one alternative is selected over another. Going to college is a great example

Traditional Format Income Statement

Prepared primarily for external reporting purposes. Organizes costs into two categories, cost of goods sold and selling and administrative expenses.

Contribution Format Income Statement

Provides managers with 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. Used as an internal planning and decision-making tool. Emphasizes cost behavior to help cost volume profit analysis. And helps make decisions.

Cost Behavior

Refers to how a cost reacts to changes in the level of activity. As the activity level rises and falls, a particular cost may rise and fall as well, or may remain constant. A manager must be able to anticipate which of these will happen and estimate how much it will change.

Cost of goods sold

Reports Product Costs attached to the merchandise sold during the period

Gross Margin

Sales minus cost of goods sold

Conversion cost

Sum of direct labor cost and manufacturing overhead cost. Used because direct labor and manufacturing overhead are used to convert materials into finished product.

Prime Cost

Sum of direct materials cost and direct labor cost.

Contribution Margin

The amount remaining from sales revenue after variable expenses have been deducted. This amount contributes toward covering fixed expenses and then toward profits for the period

Raw Materials

The materials that go into the final product, any materials used in the final product. May include both direct and indirect materials.

Relevant Rnage

The range of activity within which the assumption that cost behavior is strictly linear is valid. Outside this, a fixed cost may no longer be strictly fixed or a variable cost strictly variable.

Least-Squares Regression Method

Uses all of the data to separate a mixed cost into its fixed and variable elements. A regression line of 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.

Weakness of High-Low Method

Uses two points only, which is usually not enough to produce accurate results. Additionally, the points of highest and lowest points of activity tend to be unusual.

Variable Cost Equation

Variable Cost = Change in Cost / Change in Activity

Three Cost Structures

Variable, Fixed, Mixed

Committed Fixed Costs

represent organizational investments with 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.