Chapter 2
what is the equation used to calculate the variable cost per unit for the high low method
(Y2-Y1) / (X2-X1) = change of cost / change in activity
what cost classifications are used for predicting cost behavior
--Variable (vary with the activity level) --Fixed (constant in total) --Mixed costs (include variable and fixed portions)
what are examples of committed fixed costs
-Depreciation on buildings and equipment and real estate taxes -Payroll costs based on wages that bind the firm contractually (e.g., union wages) -Material costs based on prices that bind the firm contractually (e.g., contracts with suppliers or rear earth elements)
which cost classifications do we use for decision making?
-Differential revenues or costs (revenues or costs that differ among alternatives) -Opportunity costs (forgone benefits) -Sunk costs (past costs not affected by a decision) -Irrelevant costs (do not differ among alternatives)
what cost classifications are used for decision making
-Differential revenues or costs (revenues or costs that differ among alternatives) -Opportunity costs (forgone benefits) -Sunk costs (past costs not affected by a decision) -Irrelevant costs (do not differ among alternatives
how do product costs affect the financial statements
-begin in inventory on the balance sheet and then once they are sold, the cost moves to COGS on the income statement as an expense
what are common example of variable costs
-cost of goods sold for a merchandising company -DM -DL -variable elements of manufacturing overhead such as indirect materials, supplies, power -variable elements of SG&A such as shipping costs or commissions
what does the cost line intersection with the y axis mean for mixed costs
-fixed cost is where the line intersects (still have to pay this regardless)
what are the 2 types of indirect costs
-indirect manufacturing overhead: PRODUCT -indirect (non manufacturing) SG&A costs: PERIOD
what is the biggest problem with the high low method
-it only utilizes 2 data points and the periods with the highest and lowest level of activity tend to be unusual
the _____ ____ is based on 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 -this means that if a cost is incurred to acquire or make somethign that will eventually be sold, then the cost should be recognized as an expense only when the sale takes place when the benefit occurs
-matching principle such costs are called PRODUCT COSTS
what happens to a product cost when the product is sold
-moves from the balance sheet (inventory) to the income statement (COGS)
why does the regression method produce more accurate results
-provides more accurate cost estimates than the high low method because rather than relying on just 2 data points, it uses all of the data points to fit a line that minimizes the sum of the squared errors
which cost classifications do w use for predicting cost behavior? (3)
-variable (vary with the activity level) -fixed (constant in total) -mixed costs (include variable and fixed portions)
nonmanufacturing costs are divided into 2 categories
1 selling costs: all costs that are incurred to secure customer orders and get the finished product to the customer 2. administrative costs: all costs associated with the general management of an org. rather than with manufacturing or selling
what are the 2 important summaries to know for the behavior of variable costs
1. IN TOTAL: total variable cost increases and decreases in proportion to changes in the activity level 2. PER UNIT: variable cost per unit remains constant
how would you find the fixed component of a total overhead cost that is mixed
1. calculate the variable cost per unit by taking two data points (direct labor hours and the total costs) and do y1-y2/x1-x2 2. then you have the variable cost per unit so to find the total fixed cost, you take the total overhead cost - variable cost so the variable cost per unit times the units
Dechico Corp., purchased machine A for $40,000 three years ago to produce product J-100. The machine has broken down and cannot be repaired. The broken machine can be replaced by a new machine B that costs $50,000. Alternatively, the company can stop producing product J-100 and use the funds that would be spent to buy the new machine in another project that is expected to return a total of $200,000. In the decision whether to buy the new machine and continue producing product J-100 or drop product J-100 and invest the funds in the alternative project, which oneof the following statements is true: (A)The $40,000 is a sunk cost and the $50,000 is a differential cost. (B)Both the $40,000 and the $50,000 are differential costs. (C)The $40,000 is a differential cost and the $200,000 is an opportunity cost. (D)Both the $40,000 and the $20,000 are opportunity costs.
A 40,000 is a sunk cost and 50,000 is a differential cost
what does tan(x) equal?
B, the slope of the line -variable cost per unit of activity base
Direct Labor, Direct Materials, MOH, Selling, or Admin cost? the wages of employees who assemble computers from components
DL
Direct Labor, Direct Materials, MOH, Selling, or Admin cost? the cost of a hard drive installed in a computer
DM
most manufacturing companies separate their manufacturing costs into 2 direct cost categories and one indirect cost category
Direct materials (direct) Direct labor (direct) MOH (indirect)
all costs incurred in the past are sunk. T/F
FALSE -not all costs incurred in the past are sunk; there are past costs that can be changed now or in the future BIGGEST EXAMPLE: MY FAVORITE - REFUNDS
Total fixed costs change with changes in activity. T/F
FALSE they do not change
-indirect materials -indirect labor -maintenance and repairs on production equipment -heat and light -property taxes -depreciation -insurance on manufacturing facilities
MOH
Direct Labor, Direct Materials, MOH, Selling, or Admin cost? the wages of the assembly shop's supervisor
MOH
includes all manufacturing costs except direct materials and direct labor
MOH
just like indirect materials, indirect labor is treated as part of ___________
MOH ex: labor costs of janitors, supervisors, materials handlers, night security guards
because TFC remain constant for large variations in the level of activity, the average fixed cost _____ ____ becomes progressively smaller as the level of activity increases
PER UNIT -ex: 250 guests a month, $500 fixed rental cost would amount to an average $2 per guest. but if there are 1,000 guests, fixed rental cost would average only 50c per guest
the selling and administrative expenses report all _____ costs that have been expensed as incurred.
PERIOD
"salaries of employees" at a restaurant if the salaries are for waiters.. product or period
PERIOD (finished product)
the cost of goods sold reports the _____ costs attached to the merchandise sold during the period
PRODUCT
Initially capitalized as assets (inventory) and remain on the balance sheet until the product is sold at which point they are expensed in Cost of Goods Sold
PRODUCT COSTS
Direct materials Direct labor Indirect (manufacturing) overhead
PRODUCT Costs -manufacturing overhead
"salaries of employees" at a restaurant if the salaries are for chefs.. product or period
PRODUCT and DIRECT
what are the cost classifications under financial reporting
Product costs (inventoriable) --Direct materials (easily traced) --Direct labor (easily traced) --Manufacturing overhead (indirect, cannot be easily traced) Period costs (expensed) --SG&A (indirect, cannot be easily traced)
---- costs have already been incurred and cannot be changed now or in the future. These costs should be ignored when making decisions.
Sunk
as the activity level rises and falls, _____ remains constant unless influenced by some outside force
TFC total fixed cost
It's easy to predict future total mixed costs for a level of activity X once we know the ___ and ___
a: total fixed cost (vertical intercept) b: the variable cost per unit of activity (the slope of the line)
____ costing takes accounting information and transforms it into
absorption external reporting
for a cost to be variable it must be variable in respect to something. what is that something
activity base: measure of whatever causes the incurrence of a variable cost
examples of ____ costs include executive compensation, general accounting, secretarial, public relations
adminsitrative
Every decision involves a choice between at least two _____
alternatives -First, determine what is your decision set -Complete a cost versus benefit analysis
product costs "____" to units of product as the goods are purchased or manufactured
attach and remain attached as the goods go into inventory awaiting sale
although the traditional income statement is useful for external purposes, it has limitations when used for internal purposes. why
because it does not distinguish between variable and fixed costs -they are lumped together -managers need cost data organized by cost behavior to aid in planning, controlling, and decision making (so the contribution income statement has been developed)
why do managers even want to use the equation for mixed costs
because it helps with budgeting and planning
how can you compute COGS
beginning merchandise inventory + purchases - ending merchandise inventory
Total Variable costs _____ in direct proportion to changes in activity
change
even if operations are interrupted or cut back, ____ ____ costs remain largely unchanged largely unchanged in the short term because the costs of restoring them later are likely to be far greater than any short-run savings that might be realized
committed fixed
examples include investments in facilities and equipment as well as real estate taxes, insurance expenses, and salaries of top management
committed fixed costs
represent organizational investments with a multiyear planning horizon that cant be significantly reduced even for short periods of time without making fundamental changes
committed fixed costs
Within the relevant range, the variable cost per unit remains _____
constant
the _____ format income statement is used as an internal planning and decision making tool
contribution
the unique thing about the _____ ______ is that it provides managers with an income statement that clearly distinguishes between fixed and variable costs and therefore aids in planning, controlling, and decision making
contribution approach for preparing an income statement
the contribution approach separates costs into fixed and variable categories first deducting variable expenses from sales to obtain the -----
contribution margin
the amount remaining from sales revenues after variable expenses have been deducted
contribution margin -this amount contributes toward covering fixed expenses and then toward profits for the period
refers to how a cost reacts to changes in the level of activity
cost behavior -as the activity level rises and falls, a particular cost may rise and fall as well or it may remain constant
an activity base is sometimes referred to as a _____ ____. some of the most common activity bases are direct labor-hours, machine-hours, units produced, and units sold
cost driver
BOOK a ___ ____ is anything for which cost data are desired --- including products, customers, jobs, and organizational subunits
cost object -for the purpose of assigning costs to cost objects, costs are classified as either indirect or direct
BOOK the relative proportion of each type of cost in an organization is known as its
cost structure
in business decisions, each alternative has ____ and ____ that must be compared to the _____ and _____ of the other available alternatives
costs and benefits
for planning purposes, a manager must be able to anticipate which of these will happen and if a cost can be expected to change, the manager must be able to estimate how much it will change. what do we use to help make such distinctions?
costs are categorized as variable, fixed, or mixed
Within the relevant range, total fixed costs per unit _____ as the number of units increases
decline -economies of scale
the first step in applying the high low method or the least squares regression method is to....
diagnose cost behavior with a scatterplot graph
in general, only the ______ Between alternatives are relevant in decisions
differences
______ cost emcompasses both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives
differential
a difference in costs between any 2 alternatives is known as a
differential cost
which cost? different under each alternative
differential cost
a difference in revenues between any 2 alternatives
differential revenue
You are considering two job offers, A and B. A offers $150,000 is San Francisco and B offers $120,000 in Houston. CA has a 10% state income tax. Currently, you are making $110,000 in Dallas. what are the differences between these alternatives?
differential revenue = 150,000 - 120,000 = 30,000 differential cost = 10% x 150,000 = 15,000 irrelevant information = 110,000 (not an option to continue to work at the company in dallas)
a ____ cost is a cost that can be easily and conveniently traced to a specified cost object
direct
if a printing company made 10,000 brochures for a specific customer, then the cost of paper used to make the brochures would be a _____ cost of that customer
direct
labor costs that can be easily (physically and conveniently) traced to individual units of product
direct labor
worker time, effort expenses that can be tied directly to the product
direct labor
what is this an ex of? Production line worker wages
direct labor -helpful hint: direct labor workers typically touch the product while it is being made
ingredients of the product and can be directly traced ex: iphone all of the components
direct materials
those materials that become an integral part of the finished product and whose costs can be conveniently traced to the finished product
direct materials -ex: the seats that airbus purchases from subcontractors to install in its commercial aircraft and the electronic components that Apple used to make the iphone
in the case of manufactured goods, PRODUCT cost =
direct materials, direct labor, and manufacturing overhead
____ fixed costs can be cut for short periods of time with minimal damage to the long-run goals of the organization
discretionary
______ fixed costs may be altered in the short term by current managerial decisions
discretionary
_______ fixed costs usually arise from annual decisions by management to spend on certain fixed cost items
discretionary
examples of ____ fixed costs are advertising, research, PR, management development programs, and internships for students
discretionary
Advertising, Research and development, Travel expense are examples of
discretionary fixed costs
Recognized as ______ in the period in which they are incurred irrespective of whether the product is sold in the same period
expense -PERIOD -attached to the period
how do period costs affect the financial statements
expensed on the income statement
while total variable costs change as activity level changes, it is important to note that a variable cost is constant if...
expressed on a PER UNIT basis.
Product and period costs are used for external/internal reporting
external
product costs are recorded as expenses on the income statement in the period in which they are incurred. T/F
false -rather they are recorded as expenses in the period in which the related products are sold
the high and low levels of activity coincide with the high and low amounts of cost. T/F
false -sometimes they dont -the period that has the highest level of activity may not have the highest amount
selling costs and administrative costs are indirect. T/F
false - they can be indirect or direct for ex. the salary of a accounting manager in chage of accounts receivable collection in the east region is a direct cost of that region whereas the salart of a CFO overseeing all regions is an indirect cost
differential costs are fixed. T/F
false they can be fixed or variable
_____ ____ is GAAP driven and encompasses these cost classifications -Product costs (inventoriable) -Direct materials (easily traced) -Direct labor (easily traced) -Manufacturing overhead (indirect, cannot be easily traced) -Period costs (expensed) -SG&A (indirect, cannot be easily traced)
financial reporting
variable or fixed? TVC/unit
fixed
variable or fixed? total FC
fixed
once you determine the variable cost through the high low method, you can then compute the total fixed cost by using what equation?
fixed cost element = total cost - variable cost -take the total cost at either the high or low activity level and deduct the variable cost element
costs that remain unchanged (in total) when the level of activity changes
fixed costs -plant manager's salary, plant rent, plant equipment depreciation
a cost that remains constant, in total, regardless of changes in the level of activity
fixed costs, not affected by changes in activity -straight line depreciation -insurance -property taxes -rent -supervisory salaries -administrative salaries -advertising
the ____ method is based on the rise-over-run formula for the slope of a straight line
high low
if the scatterplot reveals linear cost behavior then it makes sense to perform the ______ calculations to separate mixed costs into its variable and fixed components
high low (or least squares regression)
in essence the _____ _______ draws a straight line through 2 points (low and high levels of activity)
high low method
r^2 varies from 0% to 100%, and the ______ the percentage the better
higher
what is cost behavior
how costs react when we change the level of activity (ex: the number of units produced) -activity can be anything: units produced, units sold, hours worked, pounds of materials used as input
an ____ cost is a cost that cannot be easily and conveniently traced to a specified cost object
indirect
period costs, by definition, are ____
indirect
campbell soup factory produces dozens of varieties of canned soups the factory manager's salary would be an ____ cost of a particular variety such as chicken noodle
indirect -the reason is that the factory manager's salary is incurred as a consequence of running the ENTIRE factory -it is not incurred to produce any one soup variety -TO BE TRACED TO A COST OBJECT SUCH AS A PARTICULAR PRODUCT THE COST MUST BE CAUSED BY THE COST OBJECT
- Corporate office rent, property tax, insurance, and accountants' salaries - Sales commissions, advertising, shipping
indirect cost -SG&A (non manufacturing) indirect cost (PERIOD cost)
labor costs that can not be physically traced to particular products or that can be traced only at a great cost and inconvenience are termed
indirect labor
Plant utility bills, plant supervisor salary, plant rent expense
indirect manufacturing overhead (product cost)
because product costs are initially assigned to inventories, they are known as ____ costs
inventoriable
are costs that are neither differential nor sunk nor opportunity costs with respect to deciding between two alternatives
irrelevant and should be ignored
if costs and benefits arent differential then they are
irrelevant and should be ignored -In complex business setting it is costly to look at all costs and benefits rather than just relevant versus irrelevant
what is r^2 in the regression method?
is the percentage of the variation in total cost explained by the activity -calculates square because you need a positive number always
what does the high low method do
it is a method used to estimate the fixed and variable components of a mixed cost -other methods include account analysis, engineering approach, and the least-squares regression analysis (starts with scatterplot just like high low)
computes the line that minimizes the sum of squared errors
least squares regression method
unlike the high low method it uses all of the data to separate a mixed cost into its fixed and variable components
least-squares regression method -a regression line of the form y=a+bx is fitted to the data where a represents the TFC and b represents the variable cost per unit of activity
what does x stand for in the mixed cost equation
level of activity
cost behavior is considered ____ whenever a straight line is a reasonable approximation for the relation between cost and activity
linear
A ---- cost has both fixed and variable components
mixed -No matter how much you use you still have to pay fixed cost
The potential benefit that is given up when one alternative is selected over another.
opp. cost
virtually every decision involves a ____ cost
opportunity
Assume that you are a full-time MBA student. If you were not attending college, you could be earning $150,000 per year.
opportunity cost (but possibly you will make more money in the future otherwise why would you be doing it)
are not costs per se rather they represent a lost benefit that results from the fact that you can either take one alternative or the other (never both)
opportunity cost -The lost benefit can be many things: e.g. lost revenue, lost income, lost satisfaction
the potential benefit that is given up when one alternative is selected over another
opportunity cost -must be explicitly considered
funds tied up in inventory are not available for use elsewhere in the business.
opportunity cost -business example of opp. cost is inventory -could be using money for other purposes
all selling and administrative expenses are treated as ___ costs
period -NON MANUFACTURING COSTS
Variable, fixed, and mixed costs are used in ===
planning
for financial accounting purposes, _____ costs include all costs involved in acquiring or making a product
product costs
inventoriable and manufacturing costs are
product costs
the materials that go into the final product are called ____ materials ex unprocessed sheets of steel
raw -any materials that are used in the final product and the finished product of one company can become the raw materials of another company
Only those costs and benefits that differ between alternatives are ________ (or -------) in a decision
relevant or differential
Even if a cost is not strictly linear (many times they are curvilinear - a curve) it can be approximated within a narrow band of activity known as the ____ ____
relevant range
the activity range within which the assumptions for variable and fixed costs are valid
relevant range
the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid
relevant range
Within the relevant range, the variable cost per unit ________ _______
remains constant
how do you calculate gross margin
sales - cost of good sold
Direct Labor, Direct Materials, MOH, Selling, or Admin cost? the cost of advertising in the puget sound computer user newspaper
selling
examples of ___ costs include shipping, advertising, cost of finished goods warehouses
selling (also sales travel, sales commission, sales salaries)
the gross margin minus _________ equals net operating income
selling and administrative expenses
nonmanufacturing costs are also called
selling, general, and administrative costs (SG&A)
Differential, sunk, and opportunity costs are used for
specific decision making
50,000 originally paid for a machine is a ___ cost that should be ignored in current decisions
sunk
have been incurred in the past and cannot be recovered under either alternative
sunk cost
cost that has already been incurred and cannot be changed by any decision made now or in the future
sunk cost -because they cant be changed by any decision they are NOT differential
You are considering whether to drive, park, trade or sell an automobile that cost you $40,000 two years ago.
sunk cost The $40,000 cost is sunk because whether you drive the car, park it, trade it, or sell it, you cannot change the $40,000 cost. -Can not be recovered by either of the 2 alternatives -Ignore them and treat them as irrelevant costs
you signed a lease and made a full payment for one year, but the lease is cancellable after six months and any remaining prorated amount can be refunded to you. If you are considering to cancel the lease after six months, one half of the amount of the lease payment is _____ cost and the other half is _______ cost
sunk cost that can be changed in the future -sunk, differential
$1.575 is the cost/meal regardless of how many produced. what does this show
that TVC/unit is fixed
assumptions made about cost behavior may be invalid if....
the activity level falls outside of the relevant range
the variable portion of a mixed cost represents....
the cost incurred for actual consumption of the service, thus it varies in proportion to the amount of service actually consumed
tan(x) = (Y2 - Y1) / (X2 - X1) what does this equation represent
the high-low method
a cost formula that is estimated solely using data from these unusual points may misrepresent the true cost behavior during normal periods. what is this an issue for? what is the more accurate method?
the high-low method -least-squares regression is generally more accurate than the high low method
to analyze mixed costs with the high-low method, begin by identifying the period with ----
the lowest level of activity and the period with the highest level of activity
the fixed portion of a mixed cost represents....
the minimum cost of having a service ready and available for use
if the relationship between cost and activity can be represented by a straight line then ---
the slope of the straight line is equal to the variable cost per unit of activity
GAAP differentiates product and period costs based on ---
the timing of their recognition as expenses in the income statement
when the high low method is used, ---
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
what does b stand for in the mixed cost equation
the variable cost per unit of activity (the slope of the line)
Monthly insurance costs are the same regardless of miles driven (assume 6-mo. contract)
this show the fact that total fixed costs dont change with changes in activity
what does the intercept equal for the mixed cost equation
total fixed cost (a in the equation y=a + bx)
what does y stand for in the mixed cost equation
total mixed cost
product costs are initially assigned to an inventory account on the balance sheet. T/F
true -when the goods are sold, the costs are released from inventory as expenses (typically cost of goods sold) and matched against sales revenue on the income statement
BOOK -A ____ _____ is a cost that is incurred to support a number of cost objects but cannot be traced to them individually
type of indirect cost -common
why do we use the high and low points of activity for the high low method
using data that reflects the greatest possible variation in activity level -also, you are utilizing maximum amount of information in terms of activity
a ____ cost varies, in total, in direct proportion to changes in the level of activity
variable
variable or fixed? TFC/unit
variable
variable or fixed? total VC
variable
costs that CHANGE when the level of the activity changes
variable -eg. operator's hourly wages w hours operating a machine
____ & _____costing takes accounting information and transforms it into planning, controlling, and decision making
variable and relevant
because the ______ equals the slope of the straight line in the graph for mixed costs, the steeper the slope, the higher the -----
variable cost per unit
what is the objective of chapter 2
what cost classifications do i use for different management purposes? -Understand different cost classifications and how to use them for external reporting and internal decision making: categorizes information differently to make it easier for us to use in different ways
in a scattergraph, what is plotted on the x and y for diagnosing cost behavior
x axis is the activity, y axis is the total cost or Y
what does y=a + bx stand for (this is the equation to express the relationship between a mixed cost and the level of activity
y=total mixed cost a=total fixed cost (the vertical intercept of the line) b=the variable cost per unit of activity (the slope of the line) x=the level of activity
as a manager, because TFC/unit is variable...
you are incentivized to produce as much as possible -the more you produce/capacity you utilize, the lower your fixed cost/unit