Chapter 1 Study Guide

Kubin Company's relevant range of production is 16,000 to 24,500 units. When it produces and sells 20,250 units, its average costs per unit are as follows: Direct materials $7.70 Direct labor $4.70 Variable manufacturing overhead $2.20 Fixed manufacturing overhead $5.70 Fixed selling expense $4.20 Fixed administrative expense $3.20 Sales commissions $1.70 Variable administrative expense $1.20 1. If 16,000 units are produced and sold, what is the variable cost per unit produced and sold? 2. If 24,500 units are produced and sold, what is the variable cost per unit produced and sold? 3. If 16,000 units are produced and sold, what is the total amount of variable cost related to the units produced and sold? 4. If 24,500 units are produced and sold, what is the total amount of variable cost related to the units produced and sold? 5. If 16,000 units are produced, what is the average fixed manufacturing cost per unit produced? 6. If 24,500 units are produced, what is the average fixed manufacturing cost per unit produced? 7. If 16,000 units are produced, what is the total amount of fixed manufacturing overhead incurred to support this level of production? 8. If 24,500 units are produced, what is the total amount of fixed manufacturing overhead incurred to support this level of production?

1) Direct Material + Direct Labor + Variable MOH+ Sales Comission + Variable Administrative Expenses = 17.5 2) Will be the same as #1 = 17.5 3) Total Variable Cost * Number of Units = 17.5 * 16,000 = 280,000 4) Total Variable Cost * Number of Units = 17.5 * 24,500 = 428,750 5) Average fixed manufacturing cost per unit = (20250*5.7)/16000 = 7.21 per unit 6) Average Fixed manufacturing cost per unit = (20250*5.7)/24500 = 4.71 per unit 7) Total amount of fixed manufacturing overhead = 20250*5.7 = $115425 8) Total amount of fixed manufacturing overhead = $115425

Warner Corporation purchased a machine 7 years ago for $342,000 when it launched product P50. Unfortunately, this machine has broken down and cannot be repaired. The machine could be replaced by a new model 300 machine costing $334,550 or by a new model 200 machine costing $300,200. Management has decided to buy the model 200 machine. It has less capacity than the model 300 machine, but its capacity is sufficient to continue making product P50. Management also considered, but rejected, the alternative of dropping product P50 and not replacing the old machine. If that were done, the $300,200 invested in the new machine could instead have been invested in a project that would have returned a total of $432,600. 1. What is the total differential cost regarding the decision to buy the model 200 machine rather than the model 300 machine? 2. What is the total sunk cost regarding the decision to buy the model 200 machine rather than the model 300 machine? 3. What is the total opportunity cost regarding the decision to invest in the model 200 machine?

1. Cost of Model 300 machine - Cost of model 200 machine = 334550-300200=34350 2. Sunk Cost = Cost of machine purchased $342,000 3. Opportunity cost = Return from new project $432,600

Cost per unit

= (Total Fixed Costs + Total Variable Costs) / Total Units Produced Cost per unit, also referred to the cost of goods sold or the cost of sales, is how much money a company spends on producing one unit of the product they sell. Companies include this figure on their financial statement.

Contribution Margin Income Statement

A contribution margin income statement is an income statement in which all variable expenses are deducted from sales to arrive at a contribution margin, from which all fixed expenses are then subtracted to arrive at the net profit or net loss for the period.

Sunk cost

A cost that has already been incurred and that cannot be changed by any decision made now or in the future. ***Classified by relevance!

Variable Cost

A cost that varies, in total, in direct proportion to changes in the level of activity. A variable cost is constant per unit. Examples: Direct Labor Direct Materials

Differential cost

A future cost that differs between any two alternatives. *Always relevant costs

Activity base

A measure of whatever causes the incurrence of a variable cost. *For example, the total cost of surgical gloves in a hospital will increase as the number of surgeries increase. Therefore, the number of surgeries is the activity base that explains the total cost of surgical gloves.

Product costs

All costs that are involved in acquiring or making a product. ***In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead.

Administrative costs

All executive, organizational, and clerical costs associated with the general management of an organization rather than with manufacturing or selling. Can be direct or indirect costs. Examples: Executive compensation General accounting Secretarial Public relations

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.

Cherokee Inc. is a merchandiser that provided the following information: Amount Number of units sold 12,000 Selling price per unit $18 Variable selling expense per unit $1 Variable administrative expense per unit$1 Total fixed selling expense $20,000 Total fixed administrative expense $15,000 Beginning merchandise inventory $11,000 Ending merchandise inventory $25,000 Merchandise purchases $87,000 2. Prepare a contribution format income statement.

Cherokee Inc. Contribution Format Income Statement Sales Variable Expenses: Costs of Goods Sold Selling Expenses Administrative Expenses Contribution Margin Fixed Expenses: Selling Expenses Administrative Expenses Net Operating Income *Sales = $216,000 *COGS = $73,000 *Selling Expenses = (Number of units sold * Variable selling expense per unit) $12,000 *Administrative Expenses = (Number of units sold * Variable administrative expense per unit) $12,000 *Contribution Margin = (Sales- Variable Expenses) $119,000 *Selling Expenses = Total fixed selling expense $20,000 *Administrative Expenses = Total fixed administrative expense $15,000 *Contribution Margin - Fixed Expenses = Net operating Income $84,000

Cherokee Inc. is a merchandiser that provided the following information: 2. Prepare a contribution format income statement. Amount Number of units sold 12,000 Selling price per unit $18 Variable selling expense per unit $1 Variable administrative expense per unit$1 Total fixed selling expense $20,000 Total fixed administrative expense $15,000 Beginning merchandise inventory $11,000 Ending merchandise inventory $25,000 Merchandise purchases $87,000 1. Prepare a traditional income statement.

Cherokee Inc. Traditional Income Statement Sales Cost of Goods Sold Gross Margin Selling and Administrative Expenses: Selling Expenses Administrative Expenses *Sales = (number units sold * Selling price per unit) $216,000 *COGS = (Beg. merchandise inventory + merchandise purchases - ending merchandise inventory) $73,000 *Sales - COGS = Gross Margin $143,000 *Selling Expenses = (Variable selling expense per unit * number units sold) + Total fixed selling expense $32,000 *Administrative Expenses = (Variable administrative expense per unit * number of units sold) + Total fixed administrative expense $27,000 *Net Operating Income = Gross Margin - Total selling and administrative expenses $84,000

Conversion Cost

Direct Labor + Manufacturing Overhead the cost to convert direct materials into a finished product. *It takes BOTH labor and MOH to turn materials into something that can be sold.

Prime (Primary) Cost

Direct materials cost + Direct Labor Cost (The sum of the two "directs")

Manufacturing Overhead (MOH)

Manufacturing costs that cannot be easily traced to specific units produced. (PRODUCT COST) Example: Indirect materials and indirect labor

Committed fixed costs

Investments in facilities, equipment, and basic organizational structure that can't be significantly reduced even for short periods of time without making fundamental changes.

Total cost (and equation)

It is typically expressed as the combination of all fixed costs (e.g., the costs of a building lease and of heavy machinery) (Average fixed cost + Average variable cost) x Number of units = Total cost

Direct Labor

Labor costs that can be easily traced to individual units of product. (PRODUCT COST ) Example: Wages paid to an automobile assembly worker

Product Costs vs. Period Costs

Product costs (also called inventoriable costs) are costs assigned to the manufacture of products and recognized for financial reporting when sold. They include direct materials, direct labor, factory wages, factory depreciation, etc. Period costs are on the other hand are all costs other than product costs. They include marketing costs and administrative costs, etc.

Direct Materials

Raw materials become an integral part of the product and can be conveniently traced directly to it. (PRODUCT COST) *Direct materials are rolled into the total cost of goods produced, which is then subdivided into the cost of goods sold (which appears in the income statement) and ending inventory (which appears in the balance sheet). Example: A radio installed in an automobile

Indirect materials

Small items of material such as glue and nails that may be an integral part of a finished product, but whose costs cannot be easily or conveniently traced to it.

Contribution margin

The amount remaining from sales revenues after all variable expenses have been deducted.

Indirect Labor

The labor costs of janitors, supervisors, materials handlers, and other factory workers that cannot be conveniently traced to particular products.

Managerial Accounting

The phase of accounting that is concerned with providing information to managers for use within the organization. ***Planning, Controlling, decision making

Financial Accounting

The phase of accounting that is concerned with reporting historical financial information to external parties, such as stock holders, regulators and creditors.

Discretionary fixed costs (Managed fixed costs)

Those fixed costs that arise from annual decisions by management to spend on certain fixed cost items, such as advertising and research.

Mixed cost

a cost that contains both variable and fixed cost elements

Common costs

a cost that has incurred to support a number of cost objects but that cannot be traced to them individually. Example: The cost of rent for a production facility is not directly associated with any single unit of production that is manufactured within that facility, and so is considered a common cost.

Fixed cost

a cost that remains constant, in total, regardless of changes in the level of activity within the relevant range.

selling costs

all costs that are incurred to secure customer orders and get the finished product or service into the hands of the customer. Examples: Advertising Shipping Sales Travel Sales Commissions Sales Salaries Costs of finished goods warehouses

Incremental cost

an increase in cost between two alternatives

Raw Materials

any materials that go into the final product

Cost object

anything for which cost data are desired Examples: Products Customers Geographic regions Departments Divisions

Period Costs

costs that are taken directly to the income statement as expenses in the period in which they are incurred or accrued *All selling and administrative expenses are treated as period costs

Direct Costs

costs that can be easily and conveniently traced to a unit or product. Examples: Direct labor Direct materials Manufacturing supplies Wages for the production staff Fuel or power consumption

Indirect costs

costs that cannot be easily traced to a unit of production. Examples: rent and utilities officers' salaries accounting department costs personnel department costs

Differential revenue

future revenue that differs between any two alternatives

Relevant range

level of activity within which assumptions about variable and fixed cost behavior are valid

inventoriable costs

synonym for product costs

Opportunity cost

the potential benefit that is given up when one alternative is selected over another

Cost structure

the relative proportion of fixed, variable, and mixed costs in an organization

Cost Behavior

the way in which a cost reacts to changes in the level of activity *Variable, Fixed, Mixed

Work in Process (WIP)

units of product that are only partially complete and will require further work before they are ready for sale to the customer

Finished goods

units of product that have been completed but not yet sold to customers