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Chapter 2, 3, 4, 5, 6, 7, 8, 9 and 16

Cost accounting systems

provide information to help managers make better decisions.


a sacrifice of resources. The price of each item measures the sacrifice we must make to acquire it.


a cost charged against revenue in an accounting period.

The focus on cost accounting is on

costs, not expenses.

Two Major categories of costs

outlay costs and opportunity costs

Outlay costs

a past, present, or future cash flow.

Opportunity cost

forgone benefit that could have been realized from the best forgone alternative use of a resource.

Operating profit

excess of operating revenues over the operating costs necessary to generate those revenues.

Three types of income statements where the organization sell (what we focus on)

Service, Product that it acquires from anther organization (retailer), A product that it builds using materials from other organization (manufacturer)

Service Organizations

provides customers an intangible product. While retail and wholesale companies sell but do not make intangible products, also they have additional information which is cost of goods sold.

Cost of goods sold

expense assigned to products sold during a period.

Product costs

costs assigned to the manufacture of products and recognized for financial reporting when sold.

Period costs

costs recognized for financial reporting when incurred.

Two types of product costs

direct manufacturing costs and indirect manufacturing costs

Direct manufacturing costs

product costs that can be feasibly identified with units of production.

Indirect manufacturing costs

all product costs except direct costs.

Direct costs are classified further into

direct materials cost and direct labor costs:

Direct materials

materials that can be identified directly with the product at reasonable cost

Direct labor

labor that can be identified directly with the product at reasonable cost

Manufacturing overhead

all production costs except those for direct labor and direct materials. Such as indirect labor, indirect materials and other manufacturing costs

Two categories of cost in manufacturing

prime and conversion costs

Prime costs

sum of direct materials and direct labor

Conversion costs

sum of direct labor and manufacturing overhead

Two elements of nonmanufacturing costs

marketing costs and administrative costs

Marketing costs

costs required to obtain customer orders and provide customers with finished products, including advertising, sales commissions, and shipping costs

Administrative costs

costs required to manage the organization and provide staff support, including executive salaries, costs of data processing and legal costs

Nonmanufacturing costs are expensed


Cost allocation

process of assigning indirect costs to products, services, people, business units, etc

Cost object

any end to which a cost is assigned

Cost pool

collection of costs to be assigned in the cost objects

Cost allocation rule

method used to assign costs in the cost pool to the cost objects

Cost flow diagram

diagram or flowchart illustrating the cost allocation process.

Direct costs

any cost that can be directly (unambiguously) related to a cost object at reasonable cost.

Indirect costs

any cost that cannot be directly related to a cost object.

Work in process

product in the production process but not yet complete

Finished goods

product fully completed but not yet sold.

Inventoriable costs

costs added to inventory accounts.

Fixed costs

costs that are unchanged as volume changes within the relevant range of activity

Variable costs

costs that change in direct proportion with a change in volume within the relevant range of activity

Relevant range

activity levels within which a given total fixed cost or unit variable cost will be unchanged

Semi variable cost

cost that has both fixed and variable components; also called mixed costs.

Step cost

cost that increases with volume in steps; also called semi fixed costs

Full cost

sum of all costs of manufacturing and selling a unit of product (includes both fixed and variable costs)

Full absorption cost

all variable and fixed manufacturing costs; used to compute a product's inventory value under GAAP

Gross margin

revenue minus cost of goods sold on income statements. Per unit, the gross margin equals sales price minus full absorption cost per unit.

Contribution margin

sales price minus variable costs per unit

How to make cost information more useful for managers

full absorption costing, variable costing, and managerial costing

Full absorption costing

all fixed and variable costs are product costs, all others are period costs

Variable costing

only variable manufacturing costs are product costs, others are period costs

Managerial costing

assumes that management determines which costs are associated with the product and should be considered product costs

Cost management system

system to provide information about the costs of process, products, and services used and produced by an organization.

The following three points relate to designing a new cost system for managerial purposes

Cost systems should have a decision focus, Different cost information is used for different purposes and Cost information for managerial purposes must meet the cost benefit test

Basic Cost Flow Model (basic inventory equation)

Beginning Balance + Transfers In - Transfers Out = Ending Balance

Predetermined Overhead Rate

cost per unit of the allocation base used to charge overhead to products.

Predetermined Overhead Rate

equals Estimated Overhead / Estimated Allocation Base

Two Stage Cost Allocation

process of first allocating costs to intermediate cost pools and then to the individual cost objects using different allocation bases


unit of a product that is easily distinguishable from another units

Job costing

accounting system that traces costs to individual units or to specific jobs, contracts, or batches of goods.

Process costing

accounting system used when identical units are produced through a series of uniform production steps

Continuous flow processing

system that mass produces a single, homogeneous output in a continuing process

Operation costing

hybrid costing system often used in manufacturing goods that have some common characteristics plus some individual characteristics


standardized method or technique that is repetitively performed


unit of a product that is easily distinguishable from other units

Job shop

firm that produces jobs

Job cost sheet

record of the cost of the job kept in the accounting system

Subsidiary ledger account

account that records financial transactions for a specific customer, vendor or job

Control account

account in the general ledger that summarizes a set of subsidiary ledger accounts

Underapplied overhead

excess of actual overhead costs incurred over applied overhead costs

Overapplied overhead

excess of applied overhead costs incurred over actual overhead during a period.

Normal cost

cost of job determined by actual direct material and labor cost plus overhead applied using a predetermined rate and an actual allocation base

Actual cost

cost of job determined by actual direct material and labor cost plus overhead applied using an actual overhead rate and an actual allocation base

Standard cost

cost of job determined by standard (budgeted) direct material and labor cost plus overhead applied using a predetermined overhead rate and a standard (budgeted) allocation base.


complex job that often takes months or years to complete and requires the work of many different departments, divisions or subcontractors

equivalent units

number of complete physical units to which units in inventories are equal in terms of work done to date. A number of physical units multiplied by the estimated percentage that an "average" unit in inventory is "complete" with respect to the individual resource.

Five Steps to determining equivalent units

1) measure the physical flow of resources, 2) compute the equivalent unit of production, 3) identify the product costs for which to account, 4) compute the costs per equivalent unit: weighted average, 5) assign product cost to batches of work (Weighted Average Process Costing

Inventory Equation

Beginning WIP inventory + Units Started = Units Transferred Out + Ending WIP

weighted-average process costing

inventory method that for product costing purposes combines costs and equivalent units of a period with the costs and the equivalent units in the beginning inventory.

first in, first out (FIFO) process costing

inventory method whereby the first goods received are the first one charged out when sold or transferred. keeps the costs and the work separate and, in effect, computes separate unit costs for the two periods

production cost report

report that summarizes production and cost results for a period; generally used by managers to monitor production and cost flows.

Assigning Costs Using First-in, First-Out (FIFO) Process Costing

A disadvantage of weighted average costing is that it mixes current period costs with the costs of product in beginning inventory, making it impossible for managers to know how much it cost to make a product THIS PERIOD.


purpose of presenting the T-accounts is to give you an overview of the cost flows associated with the process costing computations.

Determining Which is Better: FIFO or Weighted Average

Either methods are acceptable for assigning costs to inventories and cost of goods sold. Weighted average has been criticized for masking current period costs. If computational and record keeping costs are about the same under both FIFO and weighted average, FIFO costing generally offers greater decision making benefits

Prior Department costs

manufacturing costs incurred in one department and transferred to a subsequent department in the manufacturing process

Job costing

costs are collected for each unit produced. Process costing accumulates costs in a department for an accounting period and then spreads them evenly, or on an average basis, over all units produced that period. process costing assumes that each unit produced is relatively uniform.

Process costing

has less detailed recordkeeping, so it is cheaper than job costing. But still does not provide as much information as job costing does. Job costing records the cost of each unit produced. the choice of process versus job costing system involves a comparison of the costs and benefits of each system as well as the production process being utilized.

operation costing

hybrid costing system used in manufacturing goods that have some common characteristics and some individual characteristics


standardized method of making a product that is repeatedly performed.

operation costing is used in

manufacturing goods that have some common characteristics plus some individual characteristics.

The key difference between operation costing and the two methods

is that for each work order or batch passing through a particular operation, direct materials are different but conversion costs (direct labor and manufacturing overhead) are the same.

Operation costing system assigns

materials cost to the specific products for which the underlying materials are used.

death spiral

process that begins by attempting to increase price to meet reported product costs, losing demand, reporting still higher costs, and so on until the firm is out of business. Can begin in many ways, but easy to avoid.

Two-Stage Cost Allocation

the basic approach in product costing is to allocate costs in the cost pool to the individual cost objects, which are the products or services of interest. we assign, or allocate, these costs to the individual cost objects by using appropriate cost allocation bases or cost drivers.

plantwide allocation method

allocation method that uses one cost pool for the entire plant by using one overhead allocation rate, or one set of rates, for all of a plant's departments

Department Allocation Method

allocation method that has a separate cost pool for each department, which has its own overhead allocation rate or set of rates

A Cost-Benefit Decision

the choice of whether to use a plantwide rate or departmental rates depends on the products and the production process. If the company manufactures products that are quite similar and that use the same set of resources, the plantwide rate is probably sufficient. if multiple products use the manufacturing facilities in many different ways, departmental rates provide a better picture of the use of manufacturing resources by the different products.

Activity based costing (ABC)

costing method that first assigns costs to activities and then assigns them to products based on the products' consumption of activities.

cost driver

factor that causes, or "drives" an activity's costs

Activity based costing involves the following four steps

1)identify the activities 2)identify the cost drivers associated with each activity 3)compute a cost rate per driver unit or transaction 4)assign costs to products by multiplying the cost driver rate by the volume of cost driver units consumed by the product.

cost hierarchy

classification of cost drivers into general levels of activity, such as volume, batch, or product

Master budget

is the first step in the budgetary planning and control cycle. The budgeting process provides a means to coordinate activities among units of the organization, to communicate the organization's goals to individual units, and to ensure that adequate resources are available to carry out the planned activities.

Master budget is typically set up before

the beginning of the accounting period, common to be revised during.

operating budgets

budgeted income statement, production budget, budgeted cost of goods sold, and supporting budgets.

financial budgets

budgets of financial resources, such as the cash budget and the budgeted balance sheet.

Two parts of master budget are

operating and financial budgets


difference between planned result and actual outcome. Uses this difference to evaluate the performance of individuals and business units and identify possible sources of deviations between budgeted and actual performance.

favorable variance

variance that, taken alone, results in an addition to operating profit

unfavorable variance

variance that, taken alone, reduces the operating profit.

static budget

budget for a single activity level; usually the master budget

flexible budget

budget that indicates revenues, costs, and profits for different levels of activity, including the ex post actual activity level

flexible budget line

expected monthly costs at different output levels.

sales activity variance

difference between operating profit in the master budget and operating profit in the flexible budget that arises because the actual number of units sold is different from the budgeted number; also known as sales volume variance

Profit Variance Analysis as a Key Tool For


profit variance analysis

analysis of the causes of differences between budgeted profits and the actual profits earned.

sales price variance

difference between the actual revenue and actual units sold multiplied by budgeted selling price.

Fixed costs are treated as

period costs, should not be affected by activity levels within a relevant range. That is why fixed costs is always the same in the master and flexible budgets

Marketing and Administrative costs are treated like

production costs. Variable costs are expected to change as activity changes.

standard cost sheet

form providing standard quantities of inputs used to produce a unit of output and the standard prices for the inputs.

cost variance analysis

comparison of actual input amounts and prices with standard input amounts and prices

price variance

difference between actual costs and budgeted costs arising from changes in the cost of inputs to a production process or other activity

efficiency variance

difference between budgeted and actual results arising from differences between the inputs that were budgeted per unit of output and the inputs actually used.

total cost variance

difference between budgeted and actual results (equal to the sum of the price and efficiency variances)

flexible production budget

standard input price times standard quantity of input allowed for actual good output

The direct labor price variance is caused by

the difference between actual and standard labor costs per hour.


labor productivity. it is one of the closely watched variances because production managers usually can control it.

spending (budget) variance

price variance for fixed overhead

production volume variance

variance that arises because the volume used to apply fixed overhead differs from the estimated volume used to estimate fixed costs per unit. also called "capacity variance", "idle capacity" or a "denominator variance"

standard costing

an accounting method that assigns costs to cost objects at predetermined amounts

Cost volume profit (CVP) analysis

study of the relations among revenue, cost, and volume and their effect on profit.

Profit equation

operating profit equals total revenue less total costs

Unit contribution margin

difference between revenues per unit (price) and variable cost per unit

Total contribution margin

difference between revenues and total variable costs

Break-even point

volume level at which profits equal zero

Contribution margin ratio

contribution margin as a percentage of sales revenue

Profit volume analysis

version of CVP analysis using a single profit line

Cost structure

proportion of an organization's fixed and variable costs to its total costs

Operating leverage

extent to which an organization's cost structure is made of fixed costs

Margin of safety

the excess of projected or actual sales over the break even volume

Margin of safety percentage

the excess of projected or actual sales over the break even volume expressed as a percentage of actual sales volume

Differential analysis

process of estimating revenues and costs of alternative actions available to decision makers and of comparing these estimates to the status quo

Short run

period of time over which capacity will be unchanged, usually one year

Differential costs

with two or more alternatives, costs that differ among or between alternatives

Sunk costs

costs incurred in the past that cannot be changed by present or future decisions

Full cost

sum of all fixed and variable costs of manufacturing and selling an unit

Special order

order that will not affect other sales and is usually a short run occurrences

Product life cycle

time from initial research and development to the time that support to the customer ends

Target price

price based on customers' perceived value for the product and the price that competitors charge

Target cost

equals the target price minus the desired profit margin

Predatory pricing

practice of setting price below cost with the intent to drive competitors out of business


exporting a product to another country at a price below domestic cost

See more

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