Managerial Accounting: Chapter 1

Direct Cost

A cost that can be easily and conveniently traced to a specific cost object

Indirect Cost

A cost that cannot be easily and conveniently traced to a specified cost object

Common Cost

A cost that is incurred to support a number of cost objects but cannot be traced to them individually. A common cost is a type of indirect cost

Differential Cost (incremental cost)

A future cost that differs between any two alternatives, differential costs are always relevant costs

Mixed Costs (semi-variable costs)

A mixed cost contains both variable and fixed cost element

Equation for cost of goods sold for a merchandising company

COST OF GOODS SOLD=BEGINNING MERCHANDISE INVENTORY + PURCHASES - ENDING MERCHANDISE INVENTORY

Direct Labor

Consists of labor costs that can be easily traced to individual units of product.

Categories of manufacturing costs:

Direct materials, direct labor, and manufacturing overhead (indirect)

Product Costs (inventoriable costs)

For financial accounting purposes, product costs include all costs involved in acquiring or making a product. Product costs "attach" to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sale.

A manufacturer's product costs flow through 3 inventory accounts on the balance sheet:

Raw materials, work in process, and finished goods- prior to being recorded in the cost of goods sold on the income statement

Indirect Labor

Refers to employees, such as janitors, supervisors, material handlers, maintenance workers, and night security guards that play an essential role in running a manufacturing facility, however the cost of compensating these people cannot be easily or conveniently traced to specific units of product.

Nonmanufacturing Costs are often divided into 2 categories:

Selling Costs and Administrative Costs

The Contribution Format Income Statement

The contribution approach separates costs into fixed and and variable categories, first deducting all variable expenses from sales to obtain the contribution margin. For a merchandising company, cost of goods sold is a variable cost that gets included in the "variable expenses" portion of the contribution format income statement.

Cost Structure

The relative proportion of each type of cost in an organization

Transition from raw materials, work in process, and finished goods

When direct materials are used in production, their costs are transferred from raw materials to work in process. Direct labor and manufacturing overhead costs are added to work in process to convert direct materials into finished goods. When a manufacturer sells its finished goods to customers, the costs are transferred from Finished Goods to cost of goods sold.

Equation that expresses the relationship between a mixed cost and the level of activity

Y= A + BX Y= the total mixed A=the total fixed cost B=the variable cost per unit of activity X=the level of activity

Period Costs

are all the costs that are not product costs. All selling and administrative expenses are treated as period costs. For example, sales commissions, advertising, executive salaries, public relations, and the rental costs of administrative are all period costs. Period costs are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting. Keep in mind that the period in which a cost is incurred is not necessarily the period in which cash changes hands.

Contribution format income statements

are prepared for internal management purposes. They use cost classifications for predicting cost behavior to better inform decisions affecting the future

Indirect Materials

are raw materials, such as the glue used to assemble an Ethan Allen chair, whose costs cannot be easily or conveniently traced to finished products

For manufacturing companies, product costs include:

direct materials, direct labor, and manufacturing overhead

Differential Revenue

future revenue that differs between any two alternatives

Administrative Costs:

include all costs associated with the general management of an organization rather than with manufacturing or selling. Examples include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall, general administration as a whole

Selling Costs

include all costs that are incurred to secure customer orders and get the finished product to the customer. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.

Sunk Cost

is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Sunk costs can always be ignored

Fixed Cost

is a cost that remains constant, in total, regardless of changes in the level of activity. Manufacturing overhead usually includes various fixed costs such as depreciation, insurance, property taxes, rent, and supervisory salaries. Similarly, selling and administrative costs such as administrative salaries, advertising, and depreciation of nonmanufacturing assets

Activity Base

is a measure of whatever causes the incurrence of a variable cost

Cost Object

is anything for which cost data are desired-including products, customers, and organizational subunits

The Matching Principle

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 something that will eventually be sold, then the cost should be recognized as an expense only when the sale takes place-that is, when the benefit occurs. Such costs are called product costs.

The Contribution Margin

is the amount remaining from sales revenues after all variable expenses have been deducted

Opportunity Cost

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

Relevant Range

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

Manufacturing Overhead also includes:

other indirect costs that cannot be readily traced to finished products such as depreciation of manufacturing equipment and the utility costs, property taxes, and insurance premiums incurred to operate a manufacturing facility.

Cost Behavior

refers to how a cost reacts to changes in the level of activity. To help make distinctions, costs are often categorized as variable, fixed, or mixed.

Committed Fixed Cost

represent organizational investments with a multiyear planning horizon that can't be significantly reduced even for short periods of time without making fundamental changes. Examples include investments in facilities and equipment, as well as real estate taxes, insurance premiums, and salaries of top management

Direct Materials

the materials that go into the final product are called raw materials. refers to raw materials that become an integral part of the finished product and whose costs can be easily traced to the finished product.

Prime Cost

the sum of direct materials cost and direct labor cost

Manufacturing Overhead

this is the third manufacturing cost category, includes all manufacturing costs except direct materials and direct labor. Manufacturing overhead includes a portion of raw materials known as indirect materials as well as indirect labor.

Traditional Income statement for merchandising companies

this type of income statement organizes costs into two categories -cost of goods sold and selling and administrative expenses. SALES-COST OF GOODS SOLD=GROSS MARGIN. GROSS MARGIN-SELLING AND ADMINISTRATIVE EXPENSES=NET OPERATING INCOME

Discretionary Fixed Costs

usually arise from annual decisions by management to spend on a certain fixed cost item. Examples include advertising, research, public relations, management development programs, and internships for students. discretionary fixed costs can be cut for short periods of time with minimal damage to the long-run goals of the organization

Variable Cost

varies, in total, in direct proportion to changes in the level of activity. Examples 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