1-1 The three major types of product costs 1-4
in a manufacturing company are direct a. Variable cost: The variable cost per unit is
materials, direct labor, and manufacturing constant, but total variable cost changes in
overhead. direct proportion to changes in volume.
b. Fixed cost: The total fixed cost is constant
1-2 within the relevant range. The average fixed
a. Direct materials are an integral part of a cost per unit varies inversely with changes
finished product and their costs can be in volume.
conveniently traced to it. c. Mixed cost: A mixed cost contains both
b. Indirect materials are generally small variable and fixed cost elements.
items of material such as glue and nails. They
may be an integral part of a finished product but 1-5
their costs can be traced to the product only at a. Unit fixed costs decrease as the activity level
great cost or inconvenience. increases.
c. Direct labor consists of labor costs that b. Unit variable costs remain constant as the
can be easily traced to particular products. activity level increases.
Direct labor is also called ―touch labor.‖ c. Total fixed costs remain constant as the
d. Indirect labor consists of the labor costs activity level increases.
of janitors, supervisors, materials handlers, and d. Total variable costs increase as the activity
other factory workers that cannot be level increases.
conveniently traced to particular products.
These labor costs are incurred to support 1-6
production, but the workers involved do not a. Cost behavior: Cost behavior refers to the
directly work on the product. way in which costs change in response to
e. Manufacturing overhead includes all changes in a measure of activity such as
manufacturing costs except direct materials and sales volume, production volume, or orders
direct labor. Consequently, manufacturing processed.
overhead includes indirect materials and indirect b. Relevant range: The relevant range is the
labor as well as other manufacturing costs. range of activity within which assumptions
about variable and fixed cost behavior are
1-3 A product cost is any cost involved in valid.
purchasing or manufacturing goods. In the case
of manufactured goods, these costs consist of 1-7 An activity base is a measure of
direct materials, direct labor, and manufacturing whatever causes the incurrence of a variable
overhead. A period cost is a cost that is taken cost. Examples of activity bases include units
directly to the income statement as an expense produced, units sold, letters typed, beds in a
in the period in which it is incurred. hospital, meals served in a cafe, service calls
made, etc.
1-8 The linear assumption is reasonably
valid providing that the cost formula is used only
within the relevant range.
,1-9 A discretionary fixed cost has a fairly 1-11 The traditional approach organizes costs
short planning horizon—usually a year. Such by function, such as production, selling, and
costs arise from annual decisions by administration. Within a functional area, fixed
management to spend on certain fixed cost and variable costs are intermingled. The
items, such as advertising, research, and contribution approach income statement
management development. A committed fixed organizes costs by behavior, first deducting
cost has a long planning horizon—generally variable expenses to obtain contribution margin,
many years. Such costs relate to a company’s and then deducting fixed expenses to obtain net
investment in facilities, equipment, and basic operating income.
organization. Once such costs have been
incurred, they are ―locked in‖ for many years. 1-12 The contribution margin is total sales
revenue less total variable expenses.
1-10 Yes. As the anticipated level of activity
changes, the level of fixed costs needed to 1-13 A differential cost is a cost that differs
support operations may also change. Most fixed between alternatives in a decision. A sunk cost
costs are adjusted upward and downward in is a cost that has already been incurred and
large steps, rather than being absolutely fixed at cannot be altered by any decision taken now or
one level for all ranges of activity. in the future. An opportunity cost is the potential
benefit that is given up when one alternative is
selected over another.
1-14 No, differential costs can be either
variable or fixed. For example, the alternatives
might consist of purchasing one machine rather
than another to make a product. The difference
between the fixed costs of purchasing the two
machines is a differential cost.
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