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Define cost behavior
Way costs change when some other level of activity changes
Define variable costs
- total cost increases
- cost per unit unchanged
Define fixed costs
- total cost unchanged
- cost per unit decreases
Define semi-variable costs which are also called mixed Costs
- total cost increases
- cost per unit decreases
Define linear costs
Cost behavior that can be described using equation of a line
Name 4 methods of determining a cost function
1. Account Analysis method
2. Engineering Method
3. High-Low Analysis
4. Regression Analysis
Why do we want to estimate a cost function?
1. estimate future costs
2. determine usefulness of a possible cost driver
What 2 assumptions are used in estimating cost functions?
1. Variations in single activity (cost driver) explain variation in costs
2. cost behavior is linear within relevant range of the activity
How should the intercept of a cost function be interpreted?
intercept represents fixed costs of operating in relevant range
Discuss the advantages and disadvantages of the high-low and regression methods for estimating a cost function.
Both quite simple
- High-low: 2 data points
- Regression: the more data points = the better result
- High-low: quality limited (only 2 data points)
- Regression: the more the better quality (uses all data points available)
Regression results can be used to select between two potential cost drivers. Doing this with high-low method not accurate due to too little data points
In the high-low method, which data points should be used?
- highest and lowest level of activity
- points define relevant range of cost function
What is an inventorable cost?
Costs that are considered as assets on balance sheet when incurred, but become expenses when product is sold
What are the three types of companies and which of their costs are inventorable?
Service: no inventorable costs
Merchandising: cost of purchasing + delivering inventory
Manufacturing: direct labor, direct materials, manufacturing overhead.
Are all inventorable costs manufacturing costs?
No. Merchandising has inventorable costs but not manufacturing
Are all manufacturing costs inventorable under GAAP?
When are manufacturing/inventorable costs expensed?
When product is sold
What do we call costs that are not inventorable?
Period cost (expensed as soon as incurred)
Do service companies have any inventorable costs?
What are the three types of inventorable manufacturing costs?
1. Direct Material
2. Direct Labor
3. Manufacturing overhead
What is absorption costing?
Inventory costing method
all variable & fixed manufacturing costs assigned to each unit and included as inventory
requirement of GAAP
What does cost flow show us, in general?
how manufacturing costs move through inventory accounts on balance sheet before being expensed as COGS
What are the total manufacturing costs?
direct material + direct labor + MOH of period
What does cost of goods manufactured represent?
cost of units that were completed in the period
What does cost of goods sold represent?
cost of units that were sold during period
What is the most likely cost behavior for direct material?
What is the most likely cost behavior for direct labor?
process used forces it to be variable
What is the most likely cost behavior for manufacturing overhead?
What is idle time and how is the cost of idle time determined?
indirect labor cost, arises when workers not working
normal wage x number of idle hours
Why might absorption costing methods motivate mangers to over-produce inventory?
allows fixed manufacturing costs to be stored in inventory
overproduction => less fixed manufacturing costs expensed => higher income
managers rewarded based on income have incentive to overproduce (increase income)
What are some ways to discourage overproduction of inventory?
1. Careful budgeting & inventory planning => prevent managers from overproducing
2. counter earnings based incentives with penalties for excess inventory, spoilage or obsolescence
3. more frequent evaluation periods of manager (>annually)
4. Include inventory related non-financial measures of performance in manager's evaluation process
5. evaluate managers using internal measures of income (from variable or throughput costing instead of absorption)
Can variable costing be used for financial statement preparation?
No (does not meet GAAP requirements of inventorying all manufacturing costs)
What is the only difference between absorption and variable costing?
treatment of fixed cost
- variable costing: treated like period cost (expensed in lump sum)
- absorption costing: only expensed when units are sold
What costs are inventorable in absorption costing?
variable manufacturing overhead
fixed manufacturing overhead (often inventoried as fixed cost per unit)
What costs are inventorable in variable costing?
- direct materials
- direct labor
- variable manufacturing overhead
Note: fixed costs not inventorable
; treated as period cost
Why is the contribution margin format of the income statement used in variable costing?
emphasize lump sum treatment of fixed manufacturing costs
What is another name for variable costing?
What is throughput costing?
similar to direct costing except only inventorable cost is direct materials.
overhead and labor treated like period cost (expensed in the period incurred)
aka super-variable costs
What is super-absorption costing?
treats costs from all links of value chain as inventorable
How do differences in sales volume versus production volume affect income calculations from absorption and variable costing?
If sales > production => net income variable > absorption
If production > sales => net income absorption > variable
What is cost assignment?
assigning direct & indirect costs to a cost object
direct cost assignment = tracing
indirect cost assignment = allocation
What is a cost object?
Anything for which a measurement of cost is desired (units, departments)
What is a direct cost of a cost object?
can be traced specifically to the cost object
What is an indirect cost of a cost object?
cannot be specifically traced to the cost object (are allocated)
What are the four reasons we allocate costs?
1. Provide information for economic decisions
2. Motivate managers and other employees
3. Justify cost or compute reimbursement acts
4. Measure income and assets
What criteria should be used in allocating cost?
1. Cause and effect
2. Benefit received
3. Fairness and equity
4. Ability to bear cost
Is any criterion generally more important than the others?
Yes, cause and effect is best criterion if available
What is a cost pool?
Costs associated with a grouping of indirect cost items
What is an allocation base?
systematic way of linking indirect costs to a cost object
an activity that is expected to affect indirect costs and is measurable for all cost objects
allocation base is a cost driver
To allocate indirect cost to a cost object, what must we know?
- total cost pool
- total allocation base
- quantity of allocation base used by cost object
What do we get if we divide cost pool by the total allocation base?
cost pool / total allocation base = ?
- cost pool / total allocation base
- = allocation rate
- to assign indirect cost to cost object:
- allocation rate x quantity used by cost object
What do we get if we divide quantity of allocation used by the cost object by the total allocation base?
quantity used by cost object / total allocation base = ?
- quantity used by cost object / total allocation base
- = % total allocation base used by CO
x cost pool =
When might a company use a job cost system?
When primary cost object is a unit/several units of a distinct product or service produced as a single job
How do we trace direct costs in a job cost system?
- direct material: material requisition forms
- direct labor: time cards
What is a subsidiary ledger account?
Account that records transactions for a specific customer, vendor, job, or type of material ("daughter account")
What is a control account?
Account that summarizes a set of subsidiary accounts ("mother account")
What is a job cost sheet?
- subsidiary ledger account of WIP control account
- tracks costs of a specific job
What are examples of types of companies that might use job cost system?
Describe a normal costing system?
- traces direct costs to cost object
- allocates indirect costs based on budgeted costs and budgeted quantity of allocation base
Describe an actual costing system?
- traces direct costs to cost object
- allocates indirect costs based on actual costs and actual quantity of allocation base
What are the trade-offs between using a normal and actual costing system?
Timing and accuracy
How do manufacturing costs flow to the income statement in a job cost system?
- assigned to specific jobs
- => cost of those jobs flow through inventory accounts with the jobs
tracked using subsidiary ledgers called job costs sheets
- total manufacturing costs =
- direct labor + direct materials + MOH assigned to jobs during the period
costs of jobs not yet complete
cost of jobs completed
finished goods = BI + COGM not shipped
COGS = finished goods sold/shipped
Describe an over-costed product
product that has been assigned more cost than it should relative to the resources that it required
What problems can occur if products are over-costed?
1. death spiral: over-costed => over-priced => lost sales => raise prices further to cover fixed cost => more lost sales
2. mistakenly discontinue an over-costed product
3. valuable resources wasted trying to unnecessarily reduce costs
Describe an under-costed product:
assigned less cost than it should based on the relative resources that it required
When a company makes one product that is simple and sold in high volume and another product that is complex but sold in low volume and uses plant-wide costing, what is generally true about the costs assigned to each product?
high volume product: over-costed
low volume product: under-costed
What problems can occur if products are under-costed?
1. under-costed => under-priced => less profit
2. not cost saving actions are pursued
If you have multiple products and at least one of them is over-costed, what must be true about at least one other product?
at least one product is also under-costed
What are three signs that a company might need a refined cost system?
- Increase in product diversity
- Increase in indirect costs
What are three guidelines for refining a cost system?
- direct cost tracing
- more indirect cost pools that are homogenous - have the same cost driver
- allocate costs based on cost driver, if available, then benefits received
Why is departmental costing better than plant wide costing, if products differ in the resources that they use in each department?
1. indirect costs can be more accurately traced and allocated to department cost objects not to individual units
2. department cost pools can be more accurately allocated to products based on departmental resources used by the product
What is the primary difference between activity based costing (ABC) and departmental costing?
departmental costs better than plant-wide, but still volume based
ABC recognizes that all costs are not driven by volume
Describe an activity based costing system.
refined costing system that identifies cost pools whose costs are categorized:
- volume related costs
- batch-related costs
- product-related costs
- facilitating related costs
What is a volume related cost?
cost of activities performed on each unit of product
Example: Machine operation, packaging
What is a batch-related cost?
cost of activities related to a group of products
Example: machine setups, order entry, invoicing
What is a product-related cost?
Cost of activities to support an individual product regardless of units or batches produced.
Examples: Design, research product specific testing
What is a facility cost?
cost associated with having a manufacturing capability
Example: Building depreciation, plant manager.
What non-manufacturing costs might be considered when determining product costs?
Can product costs that include non-manufacturing costs be used in the financial statements?