CHPT 2 Definitions

Sales............................................. CGS............................................+ Gross Margin............................= positive No. Selling & admin exp: Selling................... Administrative....+ = <neg. no. > Net Operating Income.............neg or positive

Traditional Income Statement

Fixed costs are

costs that remain constant, in total, regardless of changes in the level of activity. Ex. straight-line depreciation, insurance, property taxes, rent, supervisory salaries, admin salaries, and adevertising.

Each alternative will have costs and benefits that must be compared to the costs and benefits of the other available alternatives. A difference in costs between any two alternatives is known as a

differential cost.

A difference in revenues (usually just sales) between any two alternatives is known as

differential revenue.

Overall cost of providing x-ray services to patients is:

mixed cost, combination of fixed and variable costs.

For a cost to be variable it......

must be variable with respect to something. That something is the activity base.

GM - selling and admin expenses =

net operating income

Discretionary fixed costs

referred to as managed fixed costs, usually arise from annual decisions by management to spend on certain fixed cost iitems. Ex. advertising, research, public relations, management development programs, and internships for students. Can be cut for short period of time with minimal damage to the long-run goals of the organization.

Cost Behavior

refers to how a cost reacts to changes in the level of activity.

Cost behavior

refers to how a cost reacts to changes in the level of activity.

Activity base

is the total volume of goods and services provided by the organization.

Conversion Cost =

ConCost = DL + MO

Traditional income statements organize data into categories, what are they?

Cost of Goods Sold (CGS) and Selling and Admin expenses.

Committed fixed costs

For planning purposes, fixed costs can be viewed as committed. 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. investment facilities and equipment, real estate taxes, insurance expenses, and salaries of top management.

Sales - CGS =

Gross Margin

High low method is very simple to apply but suffers from a major defect. What is it?

It only utilizes two data points.

Period Cost =

PerCost = SE + AE

Prime Cost =

PriCost = DM + DL

Product Cost =

ProCost = DM + DL + MO

Given: Direct Materials $69k Direct Labor $35k Manufactoring overhead $14k Selling Expenses $29k Admin Expenses $50k What is product cost, period cost, conversion cost, prime cost?

Product Cost = Direct Materials + Direct Labor + manufacturing overhead ProCost = DM + DL + MO Period Cost = Selling expenses + Admin Expenses PerCost = SE + AE Conversion Cost = Direct Labor + manufacturing overhead ConCost = DL + MO Prime Cost = Direct Materials + Direct Labor PriCost = DM + DL

Gross Margin =

Sales - CGS

Contribution Income Statement

Sales.................................................Post. No. Variable expenses: CGS....................... Variable selling...+ Variable admin...+ =<neg> Contribution Margin.....................Post - neg Fixed expenses: Fixed selling........ Fixed admin.......+ = <neg no.> Net operating income..............= CM - <neg no>

Fixed Cost

Total fixed cost is not affected by changes in the activity level within the relevant range. Fixed cost per unit decreases as the activity levels rises and increases as the activity falls.

Variable cost

Total variable cost increases and decreases in proportion to changes in the activity level. Variable cost per unit remains constant.

Y = a + bX

Y = Total Mixed Cost a = the total fixed cost (the vertical intercept of the line) b = the variable cost per unit of activity (the slop of the line) X = the level of activity

An activity base is

a measure of whatever causes the incurrence of a variable cost. An activity base is sometimes referred to as a cost driver. Ex. direct labor hours, machine hours, units produced, and units sold, number of miles driven, number of pounds of laundry cleaned, number of calls handled, number of beds occupied,

Contribution margin is the

amount remaining from sales revenues after variable expenses have been deducted.

The contribution margin is the

amount remaining from sales revenues after variable expenses have been deducted.

account analysis

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

Period costs

are all the costs that are not product costs. Ex. All selling an admin expenses are treated as period costs. (Sales commissions, advertising, executive salaries, public relations, and the rental costs of admin offices)

Variable cost =

change in cost divided by change in activity.

Mixed cost

contains both variable and fixed cost elements. Mixed costs are known as semivariable costs. Ex. fees paid to the sate (fixed + variable). Overall cost of providing x-ray services to patients (cost of equipment depreciation, radiologists' and technicians salaries are fixed, but the costs of the X-ray film, power and supplies are variable).

On the traditional income statement, the CGS reports the product costs attached to the merchandise sold

during the period.

Traditional income statements are prepared for

external reporting purposes.

x-ray services: equipment depreciation

fixed cost

x-ray services: technician salaries

fixed cost

In Y = a + bX, the steeper the slope, the ____ the variable cost per unit.

higher

Period costs are not included as part of the cost of their purchased or manufactured goods; instead period costs are expensed on the ____ ____ in the period in which they are incurred using the usual rules of accural accounting.

income statement Ex. Liability insurance is spread out across the period that benefit from the insurance -- regardless of the period in which the insurance premium is paid.

A differential cost is also known as an

incremental cost or decremental cost

Sunk cost

is a cost that has already been incurred and that cannot be changed by any decision, they are not differential costs. Sunk costs should always be ignored.

Cost Structure

is the relative proportion of each type of cost in an organization.

Opportunity cost is

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

Relevant range is

the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid. Note: managers should always keep in mind that assumptions made about cost behavior may be invalid if activity falls outside of the relevant range.

Prime cost is

the sum of direct materials cost and direct labor costs.

Conversion cost is

the sume of direct labor cost and manufactoring overhead cost. Note: used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.

least-squares regression method

uses all of the data to seperate a mixed cost into its fixed and variable components.

x-ray services: power

variable

x-ray services: supplies

variable

x-ray services: x-ray film

variable

Variable cost

varies, in ntotal, in direct proportion to changes in the level of activity. Ex. Cost of goods sold for merchandising, 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.