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Product costs
- all costs related to obtaining or manufacturing a product intended for sale to customers
- accumulated in inventory accounts and expensed as cost of goods sold at the point of sale
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period cost
general, selling, and administrative costs that are expensed in the period in which the economic sacrifice is incurred
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product costs in manufacturing companies
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costs can be assets or expenses
- product cost -> asset -> COGS
- period cost ----> expense
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cost flow in manufacturing companies
- raw materials: materials waiting to be processed
- work in process: partially complete products - material to which some labor and/or overhead has been added
- finished goods
- finished goods: completed products awaiting sale
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the inventory equation
BI + cost added = cost transferred + EI
- Materials Inventory:
- BI + Material Purchase - Material Used = EI
- Work In Process Inventory:
- BI + Material Used + Labor + Overhead - Cost of goods manufactured = EI
- Finished Goods Inventory:
- BI + cost of goods manufactured - cost of goods sold = EI
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Overhead costs
- Indirect costs
- depreciation- supervisor's salary- utilities
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to explain how product costing differs in service, merchandising, and manufacturing companies
- service companies: provide services to customers
- merchandising companies: sell products other companies make
also incur materials, labor, and overhead costs, these costs are normally treated as general, selling and administrative expenses rather than accumulated in inventory accounts
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To identify and describe fixed, variable, and mixed cost behavior
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fixed cost behavior
- total fixed cost remains constant
- fixed cost per unit:
- activity increases: cost per unit decreases
- activity decreases: cost per unit increases
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variable cost behavior
- total variable cost:
- activity increases: increases proportionately
- activity decreases: decreases proportionally
- variable cost per unit: remains constant
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variable cost behavior
total variable cost increases in direct proportion to the number of tickets sold
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mixed costs
a mixed cost has both fixed and variable components
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fixed cost are usually characterized by:
total costs that remain constant
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variable costs are usually characterized by
total costs that increase as activity increases
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to demonstrate the effects of operating leverage on profitability
operating leverage
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operating leverage
- a measure of the extent to which fixed costs are being used in an organization
- greatest in companies that a have a high proportion of fixed costs in relation to variable costs
- when all costs are fixed, every additional sales dollar contributes one dollar to gross profit
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highly leveraged
- more risk and more reward
- low risk and less reward
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high revenue =
high profit
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risk and reward assessment
- risk: refers to the possibility that sacrifices may exceed benefits
- risk may be reduced and potential for profits by converting fixed costs into variable costs
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when a number of units sold increase a fixed company
will gain the most
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if sales decrease the income decreases greater in
the all fixed company
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to prepare an income statement using the contribution margin approach
- sales revenue
- less: variable costs
- Contribution margin
- less: fixed costs
- Net Income/ operating profit
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gross margin (gross profit)
- the excess of sales over the cost of goods sold
- revenue - COGS = GM
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cost of goods sold
the cost of the merchandise that is acquired or manufactured and resold
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contribution margin
- focuses on sales in relation to all variable costs
- format emphasizes cost behavior
- covers fixed costs and provides income
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income statement using GM
- sales revenue
- Less: COGS (V+F)
- Gross Margin:
- Less: SGA (V+F)
- Operating Profit
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Using Fixed Cost to Provide a Competitive Operating Advantage
Fixed costs are better if volume is increasing, but variable costs may be better if business is declining
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measuring operating leverage using contribution margin
- operating leverage = Contribution margin/ net income
- operating leverage is a measure of how a percentage change in sales will effect profits
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fixed cost are not always fixed
relevant range
total fixed cost doesn't change for a range of activity, and then jumps to a new higher cost for the next higher range of activity
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variable cost per unit are not always fixed
Relevant range
- our variable cost assumption (constant unit variable cost) applies within the relevant range
- economy of scale -> get better price
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