Chapter 1

Differential Cost

A relevant future fixed or variable cost that differs between any two alternatives including both incremental and decremental costs.

Incremental Cost

An increase in cost from one alternative to another.

Raw Materials

Any materials that go into the final product, such as microprocessors. A product cost on the balance sheet.

Merchandising Company

Buys finished products from manufacturers in order to resell them to end consumers.

Decision Making

Choosing between alternatives.

Contribution Net Operating Income

Contribution Margin minus fixed selling and administrative expenses (contribution format income statement).

Costs of goods sold

Costs of sold finished product in inventory matched against the sales income balanced on the income statement.

Differential Revenue

Future revenue that differs between any two alternatives; a relevant benefit.

Net Operating Income

Gross margin minus sales and administrative expenses (traditional income statement).

Cost Behavior

How a cost reacts to changes in the level of activity, such as an increase in sales to direct materials cost.

Committed fixed cost

Organizational investments with a multiyear planning horizon that cannot be significantly reduced even for short periods of time without making fundamental changes, including investments in facilities and equipment, real estate taxes, insurance premiums, and salaries of top management.

Selling and Administrative Expenses

Report all period costs that have been expensed as incurred.

Gross Margin

Sales minus cost of goods sold (traditional income statement).

Contribution Margin

Sales minus costs of goods sold and variable expenses (contribution format income statement). The amount remaining from sale revenue after all variable expenses have been deducted, contributing toward covering fixed expenses and then towards profits for the period.

Marginal Cost

The cost involved in producing one more unit of product.

Marginal Revenue

The revenue that can be obtained from selling one more unit of product.

Five types of cost classifications

1) Assigning costs to cost objects 2) Manufacturing companies 3) Preparing financial statements 4) Predicting cost behavior 5) Making decisions

Two broad categories that manufacturing companies (Ford, TI) separate their costs as:

1) Manufacturing costs 2) Non-manufacturing costs

The cost classifications used to prepare financial statements

1) Product costs 2) Period costs Used for preparing balance sheets and income statements.

Non-manufacturing Costs

1) Selling costs 2) Administrative costs Often called selling, general, and administrative (SG&A) costs or just selling and administrative costs. Category of period costs on income statment.

Sunk Cost

A cost that has already been incurred and that cannot be changed by any decision made now or in the future so it cannot be a differential cost so is irrelevant and should be ignored, such as buying a machine to make a product that soon becomes inferior.

Common Cost

A type of indirect cost incurred to support a number of cost objects but cannot be traced to them individually, such as a pilot of a commercial airliner.

Product Costs/Inventoriable Costs

All costs involved in acquiring or making a product; attached to the product as long as it remains in inventory - includes all manufacturing costs. Not necessarily recorded in income statement during incurred period, rather, in the period in which the products are sold.

Strictly Linear Cost

Assumption that costs are strictly linear and that the relation between cost and activity can be represented by a straight line with a band called the relevant range.

Step-variable cost

Costs that increase in set increments, like a salaries employee contracted to work a certain amount of hours for a certain salary; to increase hours must increase wage.

Direct Labor

Labor costs that can be easily traced to individual units of product, such as assembly-line workers; sometimes called touch labor because direct labor workers typically touch the product while it is being made.

Mixed Costs/Semivariable Costs

Mixed costs contain both variable and fixed costs elements, such as paying a set fee for any use along with added fees for increased use. Y = a + bX

Roles of managers

Predict future costs, compare actual costs to budgeted costs, assign costs to segments of the business (such as product lines, geographic regions, and distribution channels), and properly contrast the costs associated with competing alternatives.

Indirect Materials

Raw materials whose costs cannot be easily or conveniently traced to finished products, such as glue in a chair.

Opportunity Cost

The potential benefit that is given up when one alternative is selected over another in virtually every decision, such as choosing a beach trip over a work week.

Cost classifications used in making decisions:

1) Differential costs 2) Sunk costs 3) Opportunity costs

Three basic manufacturing cost categories:

1) Direct Materials 2) Direct Labor 3) Manufacturing Overhead

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

1) Direct costs 2) Indirect costs

The cost classifications used to predict cost behavior:

1) Variable costs 2) Fixed costs 3) Mixed costs

Direct Cost

A cost that can be easily and conveniently traced to a specified cost object, such as the cost of the paper when making brochures.

Indirect Cost

A cost that cannot be easily and conveniently traced to a specified cost object, such as a manager who supervises multiple division's salary.

Fixed Cost

A cost that remains constant regardless of changes in the level of activity such as manufacturing overhead costs like depreciation, insurance, property taxes, rent, and supervisory sales, and selling and administrative costs such as administrative salaries, advertising, and depreciation of non-manufacturing assets.

Decremental Cost

A decrease in cost from one alternative to another.

Activity Base/Cost Driver

A measure of whatever causes the incurrence of a variable cost, such as direct labor-hours, machine-hours, units produced, units sold, the number of miles driven by salesmen, number of pounds of laundry cleaned by a hotel, number of calls handled by technical support staff at a software company, and the number of beds occupied at a hospital.

Administrative Costs

All costs associated with the general management of an organization rather than with manufacturing or selling such as executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration of the organization as a whole. Can be either direct (accountant) or indirect (CFO).

Selling Costs/Order-getting Costs/Order-filling Costs

All costs incurred to secure customer orders and get the finished product to the customer such as advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses. Can be either direct (advertising campaign) or indirect (regional sales manager).

Manufacturing Overhead/Indirect Manufacturing Cost/Factory Overhead/Factory Burden

All manufacturing costs except direct materials and direct labor such as indirect materials, indirect labor, depreciation and utility costs of manufacturing equipment, property taxes, insurance premiums incurred to operate a manufacturing facility, and costs to open the factory.

Period Costs

All the costs that are not product costs like selling and administrative expenses such as sales commissions, advertising, executive salaries, public relations, and the rental costs of administrative offices. Not included in the cost of either purchased or manufactured goods and instead expensed on the income statement in the period in which they are incurred which is not necessarily the same period that the cash changes hand (prepaid insurance premium over multiple years).

Most important difference between financial and managerial accounting:

An emphasis on recording past performance versus an emphasis on making predictions and decisions that affect future performance.

Contribution Approach

An income statement format that organizes costs by their behavior by separating them into variable and fixed categories rather than being separated into product and period costs for external reporting purposes. It provides managers with an income statement that clearly distinguishes between fixed and variable costs and therefore aids planning, controlling, and decision making. Helps managers organize data pertinent to numerous decisions such as product-line analysis, pricing, use of scarce resources, and make or buy analysis.

Cost Object

Anything or which cost data are required--including products, customers, geographic regions, and parts of the organization such as departments or divisions.

Discretionary fixed costs/Managed fixed costs

Arise from annual decisions by management to spend on certain fixed cost items that can be cut short with incurring only minimal damage including advertising, research, public relations, management development programs, and internships for students.

Finished Goods

Completed units of product that have not yet been sold to customers; when sold becomes cost of goods sold.

Intelligent Choices

Considering relevant costs and benefits while ignoring irrelevant costs and benefits.

Indirect Labor

Employees that play an essential role in running a manufacturing facility but the cost of compensating them cannot be easily and conveniently traced to specific units of product, such as janitors, supervisors, materials handlers, maintenance workers, night security guards, and other factory workers.

Why are costs assigned to cost objects?

Pricing, preparing profitability studies, and controlling spending.

Relevant Range

Range of activity within which the assumption that cost behavior is strictly linear is reasonably valid.

Direct Materials

Raw materials that become an integral part of the final product and whose cost can be conveniently traced to the finished product, such as the electrical products in iPhones. (Raw materials to work in process)

Cost Structure

Relative proportion of fixed, variable, and mixed costs in an organization to help managers estimate cost behavior.

Traditional Income Statement

Relies on product and period cost classifications for preparing financial statements to depict the financial consequences of past transactions for external reporting purposes. Does not distinguish between fixed and variable cost.

Cost of Goods Sold

Reports the product costs attached to the merchandise sold during the period. (# of units sold * cost / unit). Beginning merchandise inventory + purchases - ending merchandise inventory.

Prime Costs

Sum of the direct manufacturing cost categories - direct materials cost and direct labor cost.

Matching Principle

The accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized, such as an expense for selling something only be recognized once the product is sold.

Classification

The action or process of classifying something according to shared qualities or characteristics.

Financial Accounting

The phase of accounting concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators.

Managerial Accounting

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

Conversion Cost

The sum of direct labor and manufacturing overhead; the costs incurred to convert direct materials into finished products. (Work in process to finished product)

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. Product cost on the balance sheet.

Contribution Format Income Statement

Uses variable and fixed costs classifications for predicting cost behavior to better inform decisions affecting the future and are prepared for internal management purposes. Used as an internal planning and decision-making tool by emphazising cost behavior to aid cost-volume-profit analysis, management performance appraisals, and budgeting.

Variable Cost

Varies in direct proportion to changes in level of activity including cost of goods sold for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead, such as indirect materials, supply, and labor, and variable elements of selling and administrative expenses, such as commissions and shipping costs.