Cost Accounting Direct material includes raw material (sheet metal), purchased components

CHAPTER 2 Cost Terminology & Cost Behaviors from contract manufacturers (batteries), and manufactured subassemblies
Cost- reflects the monetary measure of resources used to attain an (engines and transmissions).
objective such as making a good or performing a service. Direct labor refers to the time spent by individuals who work specifi cally on
- the term cost must be defined more specifically before “the cost” of a manufacturing a product or performing a service. Th e people bolting the
product or service can be determined and communicated to others. chassis to the frame are considered direct labor and their associated wages
The balance sheet value of an asset is an unexpired cost. are direct labor costs.
The portion of an asset’s value consumed or sacrificed during a period is an Conversion cost the sum of direct labor and overhead costs.
expense or expired cost, which is shown on the income statement. -those costs that are incurred to convert materials into products.
Cost Management System is a set of formal methods developed for Prime cost the sum of direct material and direct labor cost.
planning and controlling an organization’s cost-generating activities relative Distribution cost is any cost incurred to warehouse, transport, or deliver a
to its strategy, goals, and objectives. product or service. Financial accounting rules require that distribution costs
-This system is designed to communicate all value chain functions about be expensed as incurred.
product costs, product profitability, cost management, strategy Manufacturer can be defined as any company engaged in a high degree of
implementation, and management performance. conversion of raw material input into a tangible output. Manufacturers
Cost object is anything for which management wants to collect or typically use people and machines to convert raw material to output that
accumulate costs. Production operations and product lines are common has substance and can, if desired, be physically inspected.
cost objects. Service company is a firm that uses a significant amount of labor to engage
Direct costs are conveniently and economically traceable to the cost object. in a high or moderate degree of conversion. A service company’s output can
Indirect costs cannot be economically traced to the cost object but instead be tangible (an architectural drawing) or intangible (insurance protection).
are allocated to the cost object. Service firms can be either for-profit businesses or not-for-profit
Relevant range assumed range of activity that refl ects the company’s organizations.
normal operating range. The production or conversion process occurs in three stages:
Variable cost- cost that varies proportionately with activity. 1. work not started (raw material)
Fixed cost- a cost that remains constant in total within the relevant range of 2. work started but not completed (work in process)
activity. 3. work completed (finished goods)
Mixed cost has both a variable and a fixed component. Manufacturers normally use three inventory accounts to accumulate costs
Step cost shifts upward or downward when activity changes by a certain as goods flow through the manufacturing process:
interval or “step.” 1. Raw Material Inventory
Predictor is an activity that, when changed, is accompanied by a consistent, 2. Work in Process Inventory (for partially converted goods), and
observable change in a cost item. However, simply because two items 3. Finished Goods Inventory.
change together does not prove that the predictor causes the change in the Prevention costs are incurred to improve quality by precluding product
other item. defects and improper processing from occurring. Amounts spent on
Cost driver a predictor that has an absolute cause-and-effect relationship. implementing training programs, researching customer needs, and acquiring
Product costs are related to making or acquiring the products or providing improved production equipment are prevention costs.
the services that directly generate the revenues of an entity. Appraisal costs amounts incurred for monitoring or inspecting. These costs
Product costs are also called inventoriable costs and include direct costs are incurred to find mistakes not eliminated through prevention.
(direct material and direct labor) and indirect costs (overhead). The inability to control quality results in failure costs, which may be internal
Direct material any material that can be easily and economically traced to a (such as scrap and rework) or external (such as product return costs caused
product. by quality problems, warranty costs, and complaint department costs).
Cost allocation refers to the assignment of an indirect cost to one or more
cost objects using some reasonable allocation base or driver.
Actual cost system, actual direct material and direct labor costs are
accumulated in Work in Process (WIP) Inventory as the costs are incurred.
Normal cost system which combines actual direct material and direct labor
costs with overhead that is assigned using a predetermined rate or rates.
Predetermined overhead rate (or overhead application rate) is a charge per
unit of activity that is used to allocate (or apply) overhead cost from the
Overhead Control account to Work in Process Inventory for the period’s
production or services.
Cost of goods manufactured (CGM) is the total production cost of the goods
that were completed and transferred to FG Inventory during the period. Th
is amount is similar to the cost of net purchases in the cost of goods sold
schedule for a retailer.
Beginning WIP Inventory cost is added to total current manufacturing costs
to obtain a subtotal amount referred to as total cost to account for.
CHAPTER 3 Reducing theoretical capacity by ongoing, regular operating interruptions
Predetermined Overhead Rates, Flexible Budgets, and (such as holidays, downtime, and start-up time) provides the practical
Absorption/Variable Costing capacity that could be achieved during regular working hours.
Consideration of historical and estimated future production levels and the
Normal costing is a costing system that is an alternative to actual costing. cyclical fluctuations provides a normal capacity measure that encompasses
- assigns actual direct material and direct labor to products but allocates the firm’s long-run (5–10 years) average activity and represents an
manufacturing overhead (OH) to products using a predetermined rate. attainable level of activity.
Four primary reasons for using predetermined OH rates in product costing. Expected capacity is a short-run concept that represents the fi rm’s
• First, a predetermined rate facilitates the assignment of overhead during a anticipated activity level for the coming period based on projected product
period as goods are produced or sold and services are rendered. demand.
• Second, predetermined OH rates adjust for variations in actual overhead y = a + Bx
costs that are unrelated to fluctuations in activity. Overhead can vary where y = total cost (dependent variable),
monthly because of seasonal or calendar (days in a month) factors. a = fixed portion of total cost,
• Third, predetermined OH rates overcome the problem of fluctuations in b = unit change of variable cost relative to unit changes in activity
activity levels that have no impact on fixed overhead costs. Even if total X = activity base to which y is being related (the predictor, cost
manufacturing overhead were the same for each period, changes in activity driver, or independent variable).
levels between periods would cause a perunit change in fixed overhead If a cost is entirely variable, the a value in the formula is zero. If the cost is
cost. entirely fixed, the b value in the formula is zero. If a cost is mixed, it is
• Finally, using predetermined OH rates—especially when the bases for necessary to determine formula values for both a and b.
those rates truly refl ect the drivers of costs—often allows managers to be High–low method analyzes a mixed cost by first selecting the highest and
more aware of individual product or product line profi tability as well as the lowest levels of activity in a data set if these two points are within the
profi tability of business with a particular customer or vendor. relevant range. Activity levels are used because activities cause costs to
Predetermined OH rate change, not vice versa.
=Total Budgeted OH Cost at a Specified Activity Level Such nonrepresentative or abnormal observations are called outliers and
Volume of Specified Activity Level should be disregarded when analyzing a mixed cost.
Applied overhead is the dollar amount of overhead assigned to WIP Least squares regression analysis is a statistical technique that analyzes the
Inventory using the activity measure that was selected to develop the relationship between independent (causal) and dependent (eff ect)
application rate. variables.
Underapplied overhead means that the overhead applied to WIP Inventory The least squares method is used to develop an equation that predicts an
is less than the actual overhead incurred. unknown value of a dependent variable (cost) from the known values of
Overapplied overhead means that the overhead applied to WIP Inventory is one or more independent variables (activities that create costs).
more than actual overhead incurred. Simple regression analysis uses one independent variable to predict the
Theoretical capacity the estimated maximum potential activity for a dependent variable based on the y = a + bX formula for a straight line.
specified time. This measure assumes that all production factors are Multiple regression two or more independent variables are used to predict
operating perfectly. Theoretical capacity disregards realities such as the dependent variable.
machinery breakdowns and reduced or stopped plant operations on Regression line is any line that goes through the means (or averages) of the
holidays. independent and dependent variables in a set of observations.
Flexible budget is a planning document that presents expected variable and
fixed overhead costs at different activity levels. Activity levels shown on a
flexible budget usually cover the contemplated range of activity for the
upcoming period.
Absorption costing treats the costs of all manufacturing components (direct
material, direct labor, variable overhead, and fixed overhead) as
inventoriable, or product, costs in accordance with GAAP.
- is also known as full costing.
Functional classifi cation is a group of costs that were all incurred for the
same principal purpose. Functional classifications generally include cost of
goods sold, selling expense, and administrative expense.
variable costing is a cost accumulation method that includes only direct
material, direct labor, and variable overhead as product costs.
- also known as direct costing
Product Contribution Margin sales minus variable cost of goods sold.; it
indicates how much revenue is available to cover all period expenses and to
provide net income.
Total contribution margin is the difference between total revenues and
total variable expenses.
PG83 Total contribution margin is the diff erence between total revenues
and total variable expenses