A detailed summary of all the relevant theory needed for the midterm. Based on the book and the lecture slides.
Note: this is a summary of the *theory* needed to understand the questions of the midterm. This summary does not include any worked out exercises.
WEEK 1 ..................................................................................................................................................................... 3
CHAPTER 2 – AN INTRODUCTION TO COST TERMS AND PURPOSES .................................................................................... 3
Cost terminology............................................................................................................................................. 3
Direct and indirect costs ................................................................................................................................. 4
Variable costs and fixed costs......................................................................................................................... 4
Business sectors & inventory costs ................................................................................................................. 6
Inventoriable costs vs. period costs ................................................................................................................ 7
Decision points................................................................................................................................................ 9
CHAPTER 3 – COST-VOLUME-PROFIT ANALYSIS ........................................................................................................... 11
CVP analysis .................................................................................................................................................. 11
CVP relationships .......................................................................................................................................... 12
Breakeven point ............................................................................................................................................ 14
CVP and income taxes................................................................................................................................... 14
Sensitivity analysis ........................................................................................................................................ 15
Operating leverage ....................................................................................................................................... 15
CVP with multiple products .......................................................................................................................... 16
Contribution margin vs. gross margin .......................................................................................................... 16
Decision points.............................................................................................................................................. 17
WEEK 2 ................................................................................................................................................................... 19
CHAPTER 5 – ACTIVITY-BASED COSTING AND MANAGEMENT ......................................................................................... 19
Broad averaging and its consequences ........................................................................................................ 19
Refining a cost system .................................................................................................................................. 20
Activity-based costing systems ..................................................................................................................... 20
Cost hierarchies ............................................................................................................................................ 21
Implementing ABC ........................................................................................................................................ 21
ABC vs. simple costing .................................................................................................................................. 22
Decision points.............................................................................................................................................. 24
WEEK 3 ................................................................................................................................................................... 26
CHAPTER 7 – FLEXIBLE BUDGETS, DIRECT-COST VARIANCES AND MANAGEMENT CONTROL ................................................. 26
Static budgets and variances ........................................................................................................................ 26
Flexible budgets ............................................................................................................................................ 27
Flexible-budget variances and sales-volume variances................................................................................ 27
Management’s uses of variances ................................................................................................................. 29
Benchmarking and variance analysis ........................................................................................................... 30
Decision points.............................................................................................................................................. 31
CHAPTER 15 – COST ALLOCATION, CUSTOMER-PROFITABILITY ANALYSIS AND SALES-VARIANCE ANALYSIS.............................. 32
Sales variances.............................................................................................................................................. 32
Market-share and market-size variances ..................................................................................................... 34
Decision points.............................................................................................................................................. 35
WEEK 4 ................................................................................................................................................................... 36
CHAPTER 9 – INVENTORY COSTING AND CAPACITY ANALYSIS .......................................................................................... 36
Variable and absorption costing................................................................................................................... 36
Inventory costing: differences in operating income ..................................................................................... 37
Absorption costing and performance measurement.................................................................................... 38
Throughput costing....................................................................................................................................... 39
Capacity concepts ......................................................................................................................................... 39
Choosing a capacity level.............................................................................................................................. 40
Planning and control of capacity costs ......................................................................................................... 42
Decision points.............................................................................................................................................. 43
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Week 1
Chapter 2 – An Introduction to Cost Terms and Purposes
Key terms
▪ Cost object
▪ Cost assignment: tracing & allocating
▪ Direct & indirect costs
▪ Variable & fixed costs
▪ Cost driver
▪ Relevant range
▪ Manufacturing, merchandising and service sectors
▪ Direct materials inventory, work-in-process inventory and finished goods inventory
▪ Direct material costs, direct manufacturing labor costs and indirect manufacturing costs
▪ Inventoriable & period costs
▪ Prime costs & conversion costs
Learning objectives
1. Define and illustrate a cost object
2. Distinguish between direct costs and indirect costs
3. Explain variable costs and fixed costs
4. Interpret unit costs cautiously
5. Distinguish the financial accounting concepts of inventoriable costs and period costs
6. Illustrate the flow of inventoriable and period costs in financial accounting
7. Explain why product costs are computed in different ways for different purposes
8. Describe a framework for cost accounting and cost management
Cost terminology
▪ Cost: A sacrificed or forgone resource to achieve a specific object.
▪ Actual cost: A cost that has occurred
▪ Budgeted cost : A predicted cost
▪ Cost object: Anything for which a cost measurement is desired. E.g. product, service,
activity, process, customer.
▪ Cost accumulation: The collection of cost data in an organized way by means of an
accounting system.
▪ Cost assignment: A general term that encompasses the gathering of accumulated
costs to a cost object in two ways:
o Tracing costs with a direct relationship to the cost object.
o Allocating accumulated costs with an indirect relationship to the cost object.
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Direct and indirect costs
▪ Direct costs of a cost object: can be conveniently and economically traced to a cost
object. E.g. material or labor.
▪ Indirect costs of a cost object: cannot be easily and unambiguously be traced to the
cost object. E.g. electricity, rent, property taxes or plant administration expenses.
The assignment of direct costs to a particular cost object is called cost tracing.
The assignment of indirect costs to a particular cost object is called cost allocation.
Cost assignment is a general term that encompasses both tracing and allocating costs.
Several factors affect whether a cost is classified as direct or indirect:
▪ The materiality of the cost in question.
o The smaller the amount of the cost (the more immaterial) the more likely it is
to be classified as an indirect cost. E.g. invoice paper included in each
package. Could be traced to each order, but is not cost effective to do so.
▪ The availability of information-gathering technology.
o The availability makes it economically worthwhile to consider smaller
amounts of costs as direct costs.
▪ Design of operations.
o If a company’s facility is used exclusively for a specific cost object it is
straightforward to classifying the costs as direct costs.
Note: a specific cost may be both a direct cost of one cost object and an indirect cost of
another cost object. The classification depends on the cost object that one is trying to
determine the cost of.
Variable costs and fixed costs
Variable costs and fixed costs are the two basic ways in which costs behave.
A variable cost changes in its total level in proportion to changes in the volume of the cost
object. They are constant on a per-unit basis.
A fixed cost remains unchanged in its total level for a given time period, despite changes in
the volume of the cost object. They cost per unit changes with the level of production.
Note: costs are classified as fixed or variable with respect to a specific cost object and for a
given time period.
Costs Total Per unit
Variable costs Change in proportion with output: Unchanged in relation to output.
more output = more costs.
Fixed costs Unchanged in relation to output. Change inversely with output: more
output = lower cost per unit.
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