Accounting Exam 1

Mixed cost on a per unit basis

A mixed cost expressed on a per unit basis decreases as the activity level increases. Do you know why? Although the variable portion of a mixed cost stays constant on a per unit basis as the activity level increases, the fixed portion of a mixed cost decreases on a per unit basis as the activity level increases. This occurs because the fixed cost is being spread across more units.

The fixed portion of a mixed cost represents the minimum cost of having a service ready and available for use. The variable portion represents the cost incurred for actual consumption of the service, thus it varies in proportion to the amount of service actually consumed (T/F)

True

The high-low method is very simple to apply, but it suffers from a major (and sometimes critical) defect—it utilizes only two data points. Generally, two data points are not enough to produce accurate results. Additionally, the periods with the highest and lowest activity tend to be unusual. A cost formula that is estimated solely using data from these unusual periods may misrepresent the true cost behavior during normal periods. Such a distortion is evident in Exhibit 1-7. The straight line should probably be shifted down somewhat so that it is closer to more of the data points. For these reasons, least-squares regression will generally be more accurate than the high-low method (T/F)

True

Concept of Clearing House

When a job is completed (or at the end of an accounting period), overhead cost is applied to the job using the predetermined overhead rate, and Work in Process is debited and Manufacturing Overhead is credited. This sequence of events is illustrated below:

Equation to Represent relationship between a mixed cost and level of activity

Y=A+BX Y= total mixed cost a= total fixed cost b= variable cost x= level of activity

Contribution Margin

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

High-Low Method

Finding the slope of the line Variable Cost = change in cost/change in activity estimated by dividing the difference in cost between the high and low levels of activity by the change in activity between those two points.

High-Low Method Continued (finding fixed cost after variable)

Fixed cost element = total mixed cost- variable cost

Sometimes the high and low levels of activity don't coincide with the high and low amounts of cost. For example, the period that has the highest level of activity may not have the highest amount of cost. Nevertheless, the costs at the highest and lowest levels of activity are always used to analyze a mixed cost under the high-low method (T/F)

True

Cost Behavior

The way in which a cost reacts to changes in the level of activity

Per Unit Measurement of Variable Costs

While total variable costs change as the activity level changes, it is important to note that a variable cost is constant if expressed on a per unit basis.

Fixed Costs

a cost that remains constant, in total, regardless of changes in the level of activity. Examples of fixed costs include straight-line depreciation, insurance, property taxes, rent, supervisory salaries, administrative salaries, and advertising. Unlike variable costs, fixed costs are not affected by changes in activity. Consequently, as the activity level rises and falls, total fixed costs remain constant unless influenced by some outside force, such as a landlord increasing your monthly rental expense.

Allocation Base

a measure such as direct labor-hours (DLH) or machine-hours (MH) that is used to assign overhead costs to products and services. The most widely used allocation bases in manufacturing are direct labor-hours, direct labor cost, machine-hours, and (where a company has only a single product) units of product.

Traditional Income Statement

This type of income statement organizes costs into two categories—cost of goods sold and selling and administrative expenses. Sales minus cost of goods sold equals the gross margin. The gross margin minus selling and administrative expenses equals net operating income. http://textflow.mheducation.com/figures/1259291219/exh1-9_lg.jpg GOOD FOR EXTERNAL REPORTING, BUT NOT GOOD FOR INTERNAL REPORTING.

Cost behavior is considered linear whenever a straight line is a reasonable approximation for the relation between cost and activity (T/F).

True

The steeper the slope, the greater the variable cost (T/F)

True

Raw Materials

Any materials that go into the final product

Relevant Range

the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid. Outside of the relevant range, a fixed cost may no longer be strictly fixed or a variable cost may not be strictly variable. Managers should always keep in mind that assumptions made about cost behavior may be invalid if activity falls outside of the relevant range.

Mixed Costs

(semi-variable costs) - the company incurs a mixed cost called fees paid to the state. It includes a license fee of $25,000 per year plus $3 per rafting party paid to the state's Department of Natural Resources. If the company runs 1,000 rafting parties this year, then the total fees paid to the state would be $28,000, made up of $25,000 in fixed cost plus $3,000 in variable cost

Variable Costs

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

Per Unit Measurement of Fixed Costs

Because total fixed costs remain constant for large variations in the level of activity, the average fixed cost per unit becomes progressively smaller as the level of activity increases.

Contribution Income Statement

Income statement that organizes costs by their behavior. Costs are separated into variable and fixed categories rather than being separated into product and period costs.

Activity Base

A measure of whatever causes the incurrence of a variable cost. An activity base is sometimes referred to as a cost driver. Some of the most common activity bases are direct labor-hours, machine-hours, units produced, and units sold. Other examples of activity bases (cost drivers) include the number of miles driven by salespersons, the number of pounds of laundry cleaned by a hotel, the number of calls handled by technical support staff at a software company, and the number of beds occupied in a hospital.

Least-squares Regression

A regression line of the 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. The basic idea underlying the least-squares regression method is using hypothetical data points.

What are the methods to estimate the fixed and variable components of a mixed cost

Account Analysis Engineering Approach High-low method Least-squares regression

Account Analysis

An account is classified as either variable or fixed based on the analyst's prior knowledge of how the cost in the account behaves. For example, direct materials would be classified as variable and a building lease cost would be classified as fixed because of the nature of those costs.

Step-costs

Cost behavior patterns such as salaried employees are often called step-variable costs. Step-variable costs can often be adjusted quickly as conditions change. Furthermore, the width of the steps for step-variable costs is generally so narrow that these costs can be treated essentially as variable costs for most purposes.

Predetermined Overhead Rate

Estimated total manufacturing cost/estimated total amount of the allocation base

How to calculate overhead applied to a particular job

Predetermined Overhead Rate X Amount of the allocation base incurred by the job

Cost Structure

Relative proportion of fixed, variable, and mixed costs in an organization

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. Notice that direct labor costs are added directly to Work in Process—they do not flow through Raw Materials inventory. Manufacturing overhead costs are applied to Work in Process by multiplying the predetermined overhead rate by the actual quantity of the allocation base consumed by each job

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, production efficiency, power consumption, and so on.

Cost Driver

is a factor, such as machine-hours, beds occupied, computer time, or flight-hours, that causes overhead costs.