ch 2 accounting final
Understand cost classifications used to prepare financial statements: product costs and period costs.
-Product Costs: are manufacturing costs and include acquiring or making a product. It includes direct materials (engine), direct labor (employees making the car), and manufacturing overhead (lights and electricity in the factory). These "attach" to units of product as the goods are purchased or manufactured, and remain attached until they go to inventory, awaiting sale. Product costs are initially assigned to an inventory account on the balance sheet. Inventory includes finished goods mostly. When the cars are sold, the costs are released from inventory as expenses, and matched against sales revenue. This is in accordance with the matching principle. The matching principle is based on the accrual concept, costs incurred to generate a particular revenue should be recognized as expenses the same period that revenue is recognized. -Period Costs: Period costs are simply all the costs that are not product costs. They are non-manufacturing costs. All selling and administrative expenses are treated as period costs. Such as sales commissions, advertising, executive salaries, or rental costs of administrative offices. All period costs are expensed on the income statement in the period in which they are incurred, using the usual rules of accrual accounting. For example, the costs of advertising the sale of a new car is expensed in the same year, and not carried forward to another year. Keep in mind, however, that the period in which the cost is incurred is not necessarily the period in which cash exchanges hands. For example, if a company pays for supplies such as printer paper, in year one, it is not all recognized as an expense that year, instead, each year after that, part of the expense will be recognized in each year as the company benefits from the supplies. They are expensed when used. The unused supplies are carried in the balance sheet as an asset called "supplies".
Analyze a mixed cost using a scatterplot and the high-low method.
. Managers can use a variety of methods to determine the fixed and variable components of a mixed cost. These include: account analysis, the engineering approach, the high-low method, and the least-squares regression. The high-low and least squares determine the fixed and variable elements by analyzing past records of cost activity and data. On a scatterplot graph, the y line is the dependent variable. The activity is the independent variable and it goes on the horizontal axis, or x. You use the high-low and least squares to separate the mixed cost into its variable and fixed components. The High-Low method assumes that you can approximately determine the cost formula based on the cost and activity data for the months with the highest and lowest activity. It is based on the rise over run formula on the slope of a straight line. In other words, the variable cost is estimated by dividing the difference in cost between the high and low levels of activity by the change in activity between those two points. First, we identify the periods with the highest and the lowest activity. Then, you subtract the activities and the costs and find the changes in both activities and costs. Computations will show the variable cost component. Then, we determine the fixed cost estimate by taking the total cost at either the high or low activity level and deducting the variable cost element. So basically, you get the highest and lowest stats, you subtract them, and then you take the cost answer and divide it by the activity answer to get the variable cost component. To find the fixed cost element (if they ask for it), you have to take the total cost, and then subtract the fixed cost element. You can get the total cost from either high or low, it does not matter. The answer should be presented as Y = calculated answer + variable that needs to multiply with x that they give you, multiplied by x. The high-low method is simple to apply, but it suffers from a major defect. It uses only two data points. The least squares regression is generally more accurate than the high-low method. The least-squares method uses all of the data to separate the mixed cost into its fixed and variable costs. It is used with a computer software and is super accurate. It draws a line that minimizes the least square errors of the plotted points.
Understand cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.
A difference in cost between any two alternatives is known as a differential cost. If the difference between the cost of A and B is 100 dollars, then 100 dollars is the differential cost. Same thing goes for differential revenue. Differential costs can be either fixed or variable. Only the differences between alternatives are relevant in decisions. Those items that are the same in all alternatives and are not affected by the decision can be ignored. Opportunity cost is the potential benefit given up when one alternative is selected over the other. Ford wants to invest in land. The opportunity cost of buying land is the investment income of purchasing securities or some other asset instead. Opportunity costs are not included in accounting but they must be explicitly considered in every decision that a manager makes. Virtually any alternative involves an opportunity cost. A sunk cost is a cost that has already be incurred and cannot be changed by any decision. They are not differential costs. And because only differential costs are relevant in the decision-making process, you should always ignore sunk costs in decision making.
understand cost classifications used for assigning costs to cost objects: direct costs and indirect costs
A direct cost is a cost that can be easily and conveniently traced to a specified cost object (if Nike assigns costs to its various regional and national sales offices, then the salary of its sales manager in its Paris office would be a direct cost of that office). An indirect cost is the opposite, it is a cost that cannot be easily and conveniently traced to a specified cost object. (A Nike factory may produce dozens of varieties of footwear and other apparel. RULE OF THUMB: To be traced to a certain cost object such as a particular product, the cost must be caused by the cost object.
Understand cost classifications used to predict cost behavior: variable costs, fixed costs, and mixed costs.
A variable cost varies in total, in direct proportion to changes in the level of activity. Some examples include direct materials, direct labor supplies, power, sales commissions, and shipping costs. For a cost to be variable, it must be variable with respect to something. That "something", is what we call an activity base. An activity base, or a cost driver, is a measure of whatever causes the incurrence of a variable cost. Total variable costs change as the activity level changes. (for example, whitewater rafting rentals that come with $30 catering, and 200 people would be the activity level. It is called activity because it is what shifts. The catering price stays the same, but the number of guests can deviate along the way, changing the overall variable costs.) However, a variable cost is constant when expressed in a per-unit basis. Fixed costs: a fixed cost is a cost that remains constant in total, regardless of the changes in the level of activity. Examples include straight-line depreciation, insurance, rent, and administrative salaries. (for example, with the whitewater rafting example, the company stores its equipment in a shed that costs $500 a month. The total amount of rent is paid the same regardless of the amount of guests that take the trip. Because total fixed costs remain the same for large variations in the level of activity, the average fixed cost per unit becomes progressively smaller as the level of activity changes. For 250 guests in a month, the $500 fixed rental cost will amount to an average of $2 per guest. Now, if there are 500 guests, the fixed rental cost would average to $1 per guest. Sometimes, however, it appears that a fixed cost is not always fixed, as it depends on its relevant range. The relevant range is the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid. A mixed cost contains both variable and fixed cost elements. They are known as the semi-variable costs. The equation y = mx + b can be used to describe the relationship between the mixed cost and the level of activity.
identify and give examples of each of the three basic manufacturing cost categories
Manufacturing costs are separated into three categories: Direct Materials, Direct Labor, and Manufacturing Overhead (which is Indirect). Direct materials: Direct materials are those materials that become an integral part of the finished product. Its costs can be conveniently traced back to the finished product. You can trace the car seat or a steering wheel back, but you cannot trace the glue or the welding material used to put the car together (this is an example of an indirect cost.) These indirect materials are included in manufacturing overhead. The next manufacturing cost category is called Direct Labor. Direct labor consists of labor costs that can be easily traced to individual units of a product. It is sometimes called "touch labor" because it is the labor that includes physical touch, such as assembly lines, carpenters, or electricians. Labor costs that cannot be directly traced back to particular products because of pure inconvenience are called indirect labor. This is part of manufacturing overhead (MOH), along with Indirect Materials. Indirect labor includes the labor costs of individuals like janitors, materials handlers, and night security. Although their jobs are essential to the company, it would be impractical or impossible to trace their labor costs back to their products. Manufacturing Overhead includes all manufacturing costs except direct materials and direct labor. Manufacturing overhead includes items such as indirect materials, indirect labor, maintenance, and repairs on production equipment, heat and light, depreciation, and insurance on manufacturing facilities. Note that only those costs associated with operating the company are included in the manufacturing overhead. Costs associated with the company's selling and administrative functions are called non-manufacturing costs. Non-Manufacturing costs are often divided into selling and administrative costs. Selling costs include all costs that are incurred to secure customer orders and get the finished product to the customer (salespeople, shipping, advertising, etc.) Administrative costs are all costs associated with the general management of an organization, rather than with manufacturing, or selling.
Prepare income statements for a merchandising company using the traditional and contribution formats.
Traditional format income statements organize everything with a cost of goods section, and a selling and administrative expenses section. It begins with sales, then - cost of goods sold then = gross margin then minus selling and administrative expenses which equals net operating income. Now the cost of goods sold for a company can be calculated in two ways: you can directly multiply the number of units sold by their unit cost. Also, you can indirectly find it by adding the Beginning inventory to your purchases, then getting the GAFS or goods available for sale, then subtracting the ending inventory to get the COGS. Traditional income statements are primarily for external reporting purposes. It, however has serious limitations when used for internal purposes. Both fixed and variable costs are lumped together and this is problematic because managers need this cost data separate. The contribution statement clearly separates the fixed and variable expenses.
