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SU 18
Costing Fundamentals
62
Accounting
Undergraduate 4
05/16/2015

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Term
cost-volume-profit analysis
Definition
allows an entity to identify the level of production at which all its fixed costs are covered.
Term
direct materials (DM)
Definition
tangible inputs (and costs of bringing those inpts) to the manufacturing process, that can practicably be traced to the product
Term
direct labor (DL)
Definition
cost of human labor that can feasibly be traced to the product.
Term
manufacturing overhead (MO)
Definition
onsists of all mfg. costs that are not DM or DL
Term
indirect materials (IM)
Definition
tangible inputs to the mfg. process that cannot practicably be traced to the product.
Term
indirect labor (IL)
Definition
cost of human labor connected with the mfg. process that cannot be practicably be traced to the product
Term
prime cost
Definition
DM + DL = costs directly attributable to a product
Term
conversion cost
Definition
DL + MO = costs of converting raw materials into the finished product
Term
selling/marketing costs
Definition
incurred in getting the product from the factory to the consumer.
Term
administrative expenses
Definition
not directly related to producing or marketing the product.
Term
direct costs
Definition
can be traced to a particular cost object in an economically feasible way.
Term
indirect costs
Definition
cannot be traced to a particular cost object in an economically feasible way. Thus, they must be allocated to that object.
Term
cost pool
Definition
account in which similar indirect cost elements with a common cause are allocated; MO is a common cost pool for mfg. costs.
Term
important issue in mgmt. accounting
Definition
whether to capitalize costs in finished goods (FG) inventory or to expense them as incurred.
Term
product/inventoriable costs
Definition
capitalized as part of FG inventory, eventually becoming part of CoGS.
Term
period costs
Definition
expensed as incurred and are therefore excluded from CoGS
Term
absorption/full costing
Definition
all mfg. costs (DM, DL, variable and fixed overhead) must be recognized as product costs. All S&A costs are period costs; required for GAAP reporting
Term
variable/direct costing
Definition
only variable mfg. costs are treated as product costs; often used for internal reporting
Term
gross margin (GM)
Definition
excess of sales over CoGS that consists of var. and fixed mfg. costs.
Only calculation can be used in GAAP.
Term
contribution margin (CM)
Definition
excess of sales over sum of var. mfg. and var. S&A costs

CM = amount available to cover fixed costs
Often used in managerial reporting purposes.
Term
CoGS (retail)
Definition
beg. inv.
+ purchases
– end. inv.
Term
CoGS (mfg./simple)
Definition
beg. WIP inv.
+ total mfg. costs
– end. WIP inv.
Term
CoGS (mfg./complex)
Definition
beg. DM inv.
+ net purchases (purchases – returns/discounts)
+ freight-in
= DM avail. for use
– end DM inv.
= DM used in production
+ DL
+ MO
= total mfg. costs
+ beg. WIP
– end. WIP
= CoGM
+ beg. FG
= GAFS
– end. FG
= CoGS.
Term
relevant cost
Definition
future costs that vary depending on the action taken. All other costs are constant and irrelevant.
Term
sunk cost
Definition
have already been incurred or are committed to be incurred
Term
value-added costs
Definition
cannot be eliminated w/out reducing the quality, responsiveness, or quantity of the output required by a customer or by an organization
Term
incremental (differential) cost
Definition
difference in total cost between two decisions; incremental cost never includes fixed costs or sunk costs
Term
opportunity cost
Definition
maximum benefit forgone by using a scarce resource for a given purpose
Term
How do variable costs per unit vary in the short-run? How do total variable costs vary?
Definition
Var. cost per unit remains constant in the short-run. But variable costs in total vary directly and proportionally with changes in volume.
Term
How do fixed costs per unit vary in the short-run? How do total fixed costs vary?
Definition
Fixed costs in total remain unchanged in the short run regardless of production level. Accordingly, the amount paid for an assembly line is the same even if production is halted entirely. But fixed cost per unit varies indirectly with the activity level.
Term
example variable costs
Definition
DM, DL, and mfg. supplies
Term
example fixed costs
Definition
rent, depreciation, and insurance.
Term
mixed (semivariable) costs. How can mixed costs be estimated?
Definition
combine fixed and variable elements.
Fixed and variable portions of a mixed cost can be estimate using the high-low method.
Term
relevant range
Definition
W/in relevant range, per-unit variable costs and fixed costs do not change. It is synonymous with the short run b/c all costs are variable in the long run.
Term
With greater investments in equipment...
Definition
FCs rise and lower total and per-unit VCs go down.
Term
normal spoilage
Definition
occurs under normal operating conditions. Essentially uncontrollable in the short run. Treated as a product cost.
Term
abnormal spoilage
Definition
not expected to occur under normal, efficient operations; it is typically treated as a periodic cost
Term
scrap
Definition
consists of materials left over from the production process

If scrap is sold, it reduces factory overhead. If it is discarded, it is absorbed into the cost of the good output.
Term
relevant costs
Definition
In decision making, an organization must focus on only relevant revenues and costs. To be relevant, the revenues and costs must
Be made in the future.
Differ among the possible alternative courses of action.
Term
avoidable costs
Definition
may be saved by not adopting a particular option. Avoidable costs might include variable raw material costs and DL costs.
Term
unavoidable costs
Definition
one that cannot be avoided if a particular action is taken
Term
incremental (marginal or differential) costs
Definition
Through the relevant range, the incremental cost of an additional unit of output is the same. Once a certain output level is reached, however, the current production capacity is insufficient and another increment of fixed costs must be incurred.
Term
disinvestment decisions
Definition
opposite of capital budgeting decisions- to terminate an operation, product or product line, business segment, branch, or major customer rather than start one.

In general, if the marginal cost of a project exceeds the marginal revenue, the firm should disinvest.
Term
four steps in a disinvestment decision
Definition
Identify fixed costs that will be eliminated by the disinvestment decision.
Determine the revenue needed to justify continuing operations. In the short run, this amount should at least equal the variable cost of production or continued service.
Establish the opportunity cost of funds that will be received upon disinvestment.
Determine whether the carrying amount of the assets is equal to their economic value. If not, re-evaluate the decision using current fair value rather than the carrying amount.
Term
relevant cost in a disinvestment decision
Definition
When a firm disinvests, excess capacity exists unless another project uses this capacity immediately. The cost of idle capacity should be treated as a relevant cost.
Term
special orders when excess capacity exists
Definition
When a mfg. has excess production capacity, no opportunity cost involved when accepting a special order.
Company should accept the order if the minimum price for the product is equal to the variable costs.
Term
special orders in the absence of excess capacity
Definition
When a mfg. lacks excess production capacity, the differential (marginal or incremental) costs of accepting the order must be considered.
B/c variable costs of the production run, the firm must consider the opportunity cost of redirecting productive capacity away from (possibly more profitable) products.
Term
CVP/breakeven analysis
Definition
explains the effects of changes in assumptions about cost behavior and the ranges about which those assumptions are valid. These changes may affect their relationships among revenues, variable costs, and fixed costs at various production levels.
Thus, CVP analysis allows management to determine the probable effects of changes in sales volume, sales price, product mix, etc.
Term
CVP assumptions
Definition
Cost and revenue relationships are predictable and linear; these relationships are true over the relevant range of activity and specified time span.
Unit selling prices and market conditions are constant.
Change in inventory and insignificant in amount, so production = sales.
Total var. costs change proportionally w/volume, but unit var. costs are constant over the relevant range. DM and DL are var. costs.
Fixed costs remain constant over the relevant range of volume, but unit fixed costs vary indirectly w/volume. Classification of fixed vs. variable can be affected by the time frame being considered.
Term
breakeven point
Definition
level of output at which all fixed costs and cumulative variable costs have been covered. Op. inc. = 0.
Each additional unit above the breakeven point generates operating profit.
Term
breakeven (units)
Definition
breakeven (units) = fixed costs / UCM

unit CM = unit selling price – unit var. cost
Term
breakeven ($)
Definition
breakeven (dollars) = fixed costs / CMR

CM ratio = UCM / unit selling price
Term
margin of safety ($)
Definition
total $ sales – breakeven point in $
Term
margin of safety (%)
Definition
MoS $ / total $ sales
Term
target operating/pre-tax income
Definition
treated as an additional fixed cost
sales - var. costs - fixed costs = OI
Term
target unit volume for OI
Definition
(fixed cost + target OI)/UCM
Term
target dollar sales volume for OI
Definition
(fixed cost + target OI)/CMR
Term
target net/after-tax income
Definition
NI = OI- (OI * Tax rate)
= OI * (1 - Tax rate)
OI = NI / (1 - Tax rate)
Term
target unit volume for NI
Definition
(fixed costs + [target NI / (1- Tax rate)]) / UCM
Term
CVP for multiple products
Definition
When adapting CVP analysis to a multiproduct situation w/ var. costing, it is assumed that the product mix is maintained throughout the relevant range.
Term
multiproduct UCM
Definition
weighted average of individual UCMs for individual products
Term
target unit volume for multiproduct CVM
Definition
(FC + Target OI) / weighted-average UCM
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