Accounting 231: Chapter 1

The Activity Base (Cost Driver):

A measure of what causes the incurrence of a variable cost. - Units produced - Machine hours - Miles driven - Labor hours - Units sold

> Period costs:

All costs that are not product costs. Cost that are taken directly to the income statement as expenses in the period in which they are incurred or accrued.

> Manufacturing Overhead:

All manufacturing costs EXCEPT direct material and direct labor. These costs CANNOT be readily traced to finished products.

Indirect cost examples:

For example, 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.

Selling costs can either be direct or indirect costs. Example:

For example, the cost of an advertising campaign dedicated to one specific product is a direct cost of that product, whereas the salary of a marketing manager who oversees numerous products is an indirect cost with respect to individual products.

COST CLASSIFICATIONS FOR PREPARING FINANCIAL STATEMENTS: (2) Inventory --> Sale --> Cost of Goods Sold

Inventory- Balance Sheet --> Sale --> Cost of Goods Sold- Income Statement

Total mixed cost line formula:

Y= a + bX Y: Total mixed cost A: Total fixed cost B: Variable cost per unit of activity X: Level of activity

> Direct Materials:

Raw materials that become an integral part of the product and that can be conveniently traced directly to it. - A radio installed in an automobile.

Examples of selling costs:

- Advertising - shipping - sales travel - sales commissions - sales salaries - costs of finished goods warehouses Selling costs can either be direct or indirect costs.

Examples of manufacturing overhead:

- Depreciation of manufacturing equipment - Utility costs - Property taxes - Insurance premiums incurred to operate a manufacturing facility Only those indirect costs associated with OPERATING THE FACTORY are included in manufacturing overhead.

Manufacturing overhead includes...

- Indirect material - Indirect labor that cannot be easily or conveniently traced to specific units of product.

Examples of administrative costs:

- executive compensation - general accounting - secretarial - public relations - similar costs involved in the overall, general administration of the organization as a whole

Example of period costs:

- sales commissions - advertising - executive salaries - public relations - the rental costs of administrative offices Period costs are not included as part of the cost of either purchased or manufactured goods.

Manufacturing costs are often classified as follows:

> Prime Cost > Conversion Cost

> Fixed Cost:

A cost that remains constant, in total, regardless of changes in the level of the activity. If expressed on a per unit basis, the average fixed cost per unit varies inversely with changes in activity. the average fixed cost per unit becomes progressively smaller as the level of activity increases.

- Differential revenue:

A difference in revenue between two alternatives. - Relevant to decisions - Example of relative benefit.

CONCEPT CHECK 4: Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don't want to waste money needlessly. Is the annual cost of licensing your car relevant in this decision? A. Yes, the licensing cost is relevant. B. No, the licensing cost is not relevant.

B. No

CONCEPT CHECK 5: Suppose that your car could be sold now for $5,000. Is this a sunk cost? A. Yes, it is a sunk cost. B. No, it is not a sunk cost.

B. No

Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions.

B. property taxes on corporate headquarters E. Sales commissions

Which of the following costs would be variable with respect to the number of ice cream cones sold at a Baskin & Robbins? A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.

C. The cost of ice cream. D. The cost of napkins for customers.

COST CLASSIFICATIONS FOR DECISION MAKING:

Decisions involve choosing between alternatives. The goal of making decisions is to identify those costs that are either RELEVANT or IRRELEVANT to the decision. It is important to understand the terms - differential cost/revenue - sunk cost - opportunity cost

- Sunk costs:

HAVE ALREADY BEEN INCURRED and cannot be changed by any decision now or in the future. - These costs should be ignored when making decisions.

Learning Objective 2:

Identify and give examples of each of the three basic manufacturing cost categories.

Direct cost examples:

If Adidas is assigning costs to its various regional and national sales offices, then the salary of the sales manager in its Tokyo office would be a direct cost of that office. 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.

> Product costs:

Include all the costs involved in acquiring or making a product. Product costs "attach" to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sale. Because product costs are initially assigned to inventories, they are also known as inventoriable costs

- Indirect materials:

Raw materials whose cost cannot be easily or conveniently traced to finished products. EXAMPLES: - the solder used to make electrical connections in a Samsung HDTV - the glue used to assemble an Ethan Allen chair

MIXED COST- EXAMPLE: If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?

Y = a + bX Y= $40 + ($0.03 x 2,000) Y= $100

Managerial accounting:

concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions

Financial accounting:

concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators

Mixed costs (semi variable costs):

contains both variable and fixed elements. Consider the example of utility cost.

Examples of variable cost:

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.

Cost behavior:

how a cost will react to changes in the level of activity

Manufacturing overhead is also known as:

indirect manufacturing cost, factory overhead, and factory burden

COST CLASSIFICATIONS FOR PREPARING FINANCIAL STATEMENTS: (3) Period costs include:

selling expense + administrative expense

Cost structure:

the relative proportion of fixed, variable, and mixed costs in an organization - For example, an organization might have many fixed costs but few variable or mixed costs. Alternatively, it might have many variable costs but few fixed or mixed costs.

> Variable Cost:

varies, in total, in direct proportion to changes in the level of activity A variable cost per unit is constant.

Types of Fixed Costs:

> Committed: MULTI-YEAR, Long-term, cannot be significantly reduced in the short term. > Discretionary: ANNUAL, May be altered in the short term by current managerial decisions

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*CHAPTER 1*

A manufacturer's product costs flow through three inventory accounts on the balance sheet prior to being recorded in cost of goods sold on the income statement. For manufacturing companies, product costs include:

- RAW MATERIALS: include any materials that go into the final product. - WORK IN PROCESS: consists of units of product that are only partially complete and will require further work before they are ready for sale to the customer. - FINISHED GOODS: consist of completed units of product that have not yet been sold to customers.

Committed fixed cost examples:

- investments in facilities/ equipment - real estate taxes - insurance premiums - salaries of top management.

TRANSFER OF PRODUCT COSTS: (1) When direct materials are used in production, their costs are transferred from Raw Materials to Work in Process.

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TRANSFER OF PRODUCT COSTS: (2) Direct labor and manufacturing overhead costs are added to Work in Process to convert direct materials into finished goods.

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TRANSFER OF PRODUCT COSTS: (3) Once units of product are completed, their costs are transferred from Work in Process to Finished Goods.

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TRANSFER OF PRODUCT COSTS: (4) When a manufacturer sells its finished goods to customers, the costs are transferred from Finished Goods to Cost of Goods Sold.

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When preparing a balance sheet and an income statement, companies need to classify their costs as...

> Product Cost > Period Cost To understand the difference, we must first discuss the matching principle from financial accounting.

The most common cost classifications are:

> Variable costs. > Fixed costs. > Mixed costs.

Purposes of Cost Classification:

1. Assigning costs to cost objects 2. Accounting for costs in manufacturing companies 3. Preparing financial statements 4. Predicting cost behavior in response to changes in activity 5. Making decisions

The contribution format income statement is used as an internal planning and decision-making tool. We will use this approach for:

1. Cost-volume-profit analysis (Chapter 6). 2. Segmented reporting of profit data (Chapter 7). 3. Budgeting (Chapter 8). 4. Special decisions such as pricing and make-or-buy analysis (Chapter 11).

Nonmanufacturing Costs:

1. Selling Costs 2. Administrative Costs

For purposes of assigning costs to cost objects, costs are classified as either:

> direct costs > indirect costs.

CONCEPT CHECK 3: Suppose you are trying to decide whether to drive or take the train to Portland to attend a concert. You have ample cash to do either, but you don't want to waste money needlessly. Is the cost of the train ticket relevant in this decision? In other words, should the cost of the train ticket affect the decision of whether you drive or take the train to Portland? A. Yes, the cost of the train ticket is relevant. B. No, the cost of the train ticket is not relevant.

A. Yes

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 object:

Anything for which cost data are desired. This includes... - products - customers - organizational subunits

In a Contribution Format Income Statement:

Contribution margin= Sales - Variable Expenses

> Direct costs:

Costs that can be easily and conveniently traced to a unit of product or other cost object. - Direct material - Direct labor

> Indirect costs:

Costs that cannot be easily and conveniently traced to a unit of product or other cost object. - Manufacturing overhead

- Indirect labor:

Employees that play an essential role in running a manufacturing facility; however the cost of compensating these people cannot be easily or conveniently traced to specific units of product. EXAMPLES: - janitors - supervisors - materials handlers - maintenance workers - night security guards

COST CLASSIFICATIONS FOR PREPARING FINANCIAL STATEMENTS: (4) Expense

Expense- Income Statement

In a Traditional Format Income Statement:

Gross margin= sales - cost of goods sold Net operating income= gross margin -selling/administrative expenses DOES NOT distinguish between fixed and variable costs.

> Common costs:

INDIRECT COSTS incurred to support a number of cost objects. - These costs cannot be traced to any individual cost object.

Managers occasionally refer to their two direct manufacturing cost categories as:

PRIME COST= direct materials cost + direct labor cost

Learning Objective 5:

Prepare income statements for a merchandising company using the traditional and contribution formats.

Classifications of Manufacturing Costs:

THE PRODUCT > Direct Materials > Direct Labor > Manufacturing Overhead

2. Administrative Costs:

The costs associated with the GENERAL MANAGEMENT of an organization rather than with the manufacturing or selling.

1. Selling Costs:

The costs incurred to secure customer orders and get the finished product to the customer. aka "order-getting costs" and "order-filling costs"

- Differential costs (or incremental cost if an increase/decremental costs if a decrease):

The difference in cost between any two alternatives. - Relevant to decisions - Can be fixed or variable.

Common costs example:

The factory manager's salary is called a common cost of producing the various products of the factory.

Opportunity Cost:

The potential benefit that is given up when one alternative is selected over another. - These costs are not usually found in accounting but must be explicitly considered in every decision.

Administrative costs can be either direct or indirect costs. Example:

The salary of an accounting manager in charge of accounts receivable collections in the East region is a direct cost of that region, whereas the salary of a chief financial officer who oversees all of a company's regions is an indirect cost with respect to individual regions.

> Direct Labor:

Those labor costs that can be easily traced to individual units of product. - Aka "touch labor" - Wages paid to automobile assembly workers.

Learning Objective 1:

Understand cost classifications used for assigning costs to cost objects: direct costs, indirect costs.

Learning Objective 5:

Understand cost classifications used in making decisions: differential costs, sunk costs, and opportunity costs.

Learning Objective 4:

Understand cost classifications used to predict cost behavior: variable costs, fixed costs, and mixed costs.

Learning Objective 3:

Understand cost classifications used to prepare financial statements: product costs and period costs.

A particular cost may be direct or indirect, depending on the... cost object.

While the Campbell Soup factory manager's salary is an indirect cost of manufacturing chicken noodle soup, it is a direct cost of the manufacturing division. - In the first case, the cost object is chicken noodle soup. - In the second case, the cost object is the entire manufacturing division.

For a cost to be variable, it must be variable WITH RESPECT TO SOMETHING. That "something" is its...

activity base

Discretionary fixed cost examples:

advertising - research - public relations - management development programs - internships for students Discretionary fixed costs can be cut for short periods of time with minimal damage to the long-run goals of the organization.

Raw materials:

any materials that go into the final product

Examples of Direct Labor:

assembly-line workers at Toyota carpenters at the home builder KB Home electricians who install equipment on aircraft at Bombardier Learjet.

Cost of goods sold=

beginning merchandise inventory + purchases - ending inventory

> Conversion cost:

direct labor cost + manufacturing overhead cost Used to describe direct labor and manufacturing overhead because these costs are incurred to CONVERT direct materials into finished products.

COST CLASSIFICATIONS FOR PREPARING FINANCIAL STATEMENTS: (1) Product costs include:

direct materials + direct labor + manufacturing overhead

Variable manufacturing cost=

direct materials + direct labor + variable manufacturing overhead

> Prime Cost:

direct materials cost + direct labor cost