Chapter 1

Differential Cost

a difference in cost between two alternatives. Always relevant costs.

Differential Revenue

a difference in revenue between any two alternatives. A relevant benefit.

Period Costs

all the costs that are not product costs. All selling and administrative expenses are treated as period costs. Ex. sales commissions, advertising, executive salaries, PR, and rental costs of administrative offices.

Relevant Range

range of activity within which the assumption that cost behavior is strictly linear is reasonably valid. That is, the relation between cost on the one hand and activity on the other can be represented by a straight line within a narrow band of activity.

Conversion Cost

sum of direct labor and manufacturing overhead

Prime Cost

sum of direct materials cost and direct labor cost.

Variable Cost

varies, in total, in direct proportion to changes in level of activity. Usually increases, in total, in proportion to activity. Ex. cost of goods sold for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead, such as indirect materials, supplies, and power, and variable elements of selling and administrative expenses, such as commissions and shipping costs.

Conversion Cost Equation

Conversion cost = direct labor + manufacturing overhead

Total Fixed Cost Equation

Total fixed cost = fixed manufacturing overhead + fixed selling expense + fixed administrative expense

Indirect Cost

a cost that cannot be easily and conveniently traced to a specified cost object. Ex. a Campbell Soup factory may produce dozens of varieties of canned soups. The factory manager's salary would be an indirect cost of a particular variety, such as chicken noodle soup.

Product Costs

all costs involved in acquiring or making a product. When units of product are sold, their costs are released from inventory as expenses (called costs of goods sold). For manufacturing companies, product costs include direct materials, direct labor, and manufacturing overhead. A manufacturer's product costs flows through 3 inventory accounts on the balance sheet - Raw Materials, Work in Process, and Finished Goods.

Contribution Margin

amount remaining from sales revenues after all variable expenses have been deducted. Contributes toward covering fixed expenses and then toward profits for the period.

Finished Goods

completed units of product that have not yet been sold to customers.

Nonmanufacturing Costs

divided into two categories: selling costs and administrative costs

Manufacturing Costs

divided into two direct cost categories: direct materials and direct labor and one indirect cost category: manufacturing overhead.

Gross Margin Equation

gross margin = sales - cost of goods sold

Cost Behavior

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 remain constant.

Net Operating Income Equation

net operating income = gross margin - selling and administrative expenses

Indirect Labor

refers to employees that play an essential role in running the manufacturing facility. Ex. janitors, supervisors, materials handlers, maintenance workers, and night security guards.

Cost Structure

relative proportion of each type of cost in an an organization (variable, fixed, or 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. Ex. investments in facilities and equipment, real estate taxes, insurance premiums, and salaries of top management.

Activity Base (Cost Driver)

A measure of whatever causes the incurrence of a variable cost. Ex. the total cost of surgical gloves in a hospital will increase as the number of surgeries increases.

Contribution Approach

An income statement format that organizes costs by their behavior. Costs are separated into variable and fixed categories rather than being separated into product and period costs for external reporting purposes.

Cost of Goods Sold Equation

Cost of goods sold = beginning merchandise inventory + purchases - ending merchandise inventory

Period Costs on Income Statement

Period Costs- Selling and administrative -> Income Statement- Selling and Administrative Expenses

Period Cost Equation

Period cost = selling expense + administrative expense

Prime Cost Equation

Prime cost = direct materials + direct labor

Contribution Format

Sales Variable expenses: -cost of goods sold -variable selling -variable administrative Contribution margin Fixed expenses: -fixed selling -fixed administrative Net operating income

Variable Manufacturing Cost Equation

Variable manufacturing cost = direct materials + direct labor + variable manufacturing overhead

Mixed Cost Equation

Y = a + bX Y= total mixed cost a= total fixed cost (vertical intercept of line) b= variable cost per unit of activity (slope of line) X= level of activity

Direct Cost

a cost that can be easily and conveniently traced to a specified cost object. Ex. if a printing company made 10,000 brochures for a specific customer, then the cost of the paper used to make the brochures would be a direct cost of that customer.

Sunk Cost

a cost that has already been incurred and that cannot be changed by any decision made now or in the future.

Common Cost

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

Administrative Costs

all costs associated with general management of an organization rather than with manufacturing or selling. Ex. executive compensation, general accounting, legal counsel, secretarial, and public relations.

Selling Costs

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

Raw Materials

any materials that go into the final product

Cost Object

anything for which cost data are desired - including products, customers, plants, office locations, and departments. For purposes of assigning costs to cost objects, costs are classified as either direct or indirect.

Direct Labor

consists of labor costs that can be easily traced to individual units of product. Ex. assembly-line workers at Toyota.

Mixed Cost

contains both variable and fixed cost elements.

Fixed Cost

cost that remains constant, in total, regardless of changes in the level of activity. For planning purposes, viewed as either committed or discretionary. Selling and administrative costs often include fixed costs such as administrative salaries, advertising, and depreciation of nonmanufacturing assets.

Manufacturing Overhead

includes all manufacturing costs except direct materials and direct labor. Includes indirect costs that cannot be readily traced to finished product such as depreciation of manufacturing equipment and utility costs, property taxes, and insurance premiums incurred to operate manufacturing facility. Ex. includes portion of raw materials known as indirect materials and indirect labor.

Traditional Format Income Statement

organizes costs into two categories - cost of goods sold and selling and administrative expenses. Sales Cost of goods sold Gross margin Selling and administrative expenses: -Selling -Administrative Net operating income

Direct Materials

raw materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product. Ex. the electronic components that Samsung uses in its cell phones.

Indirect Materials

raw materials whose costs cannot be easily or conveniently traced to finished products.

Opportunity Cost

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

Work in Process

units of product that are only partially complete and will require further work before they are ready for sale to the customer.

Discretionary Fixed Costs

usually arise from annual decisions by management to spend on certain fixed cost items. Ex. advertising, research, PR, management development programs, and internships for students.

Product Costs on Balance Sheet

Product Costs- Raw materials purchases, direct labor, manufacturing overhead -> Balance Sheet- Raw Materials inventory (direct materials used in production) -> Work in Process inventory (goods completed) -> Finished Goods inventory (goods sold) -> Income Statement- Cost of Goods Sold

Product Cost Equation

Product cost = direct materials + direct labor + manufacturing overhead