SMG AC 222 Chapter 2,3,5: AC222 class notes

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AC222 notes
Chapter 2
Cost object: something we want to know the cost of
Direct cost: Costs that are easily and conveniently traced to a unit of product or other cost object
o E.g., direct material and direct labor
Indirect cost cannot be easily and conveniently traced to a unit of product or other cost object
o E.g., manufacturing overhead
o Common cost supports a number of cost objects just cannot be easily traced to one an indirect cost
Manufacturing cost is the cost to make the product or produce the service
Direct materials are the raw materials used to make the product that are easily traceable to units of product
o Indirect materials are materials that were used in the product, but are not easily or economically traced
Direct labor is the cost of those workers who actually work hands on on the product or service (e.g., wages paid to
automobile assembly workers)
o Indirect labor (similar to indirect materials) is not easy or convenient to trace, even though it helps in
making the product or generating the service
Manufacturing Overhead
o Consists of indirect materials and indirect labor as well as all other costs that although they contribute to the
making of the product, cannot easily be measured and traced to units of product.
o E.g., indirect materials (materials used to support the production product) and indirect labor (wages paid to
employees who are not directly involved in production work)
Prime costs: direct materials and direct labor
Conversion costs: direct labor and manufacturing overhead
Nonmanufacturing costs (period costs)
Cost Classifications for preparing financial statements
Product costs include direct materials, direct labor, and manufacturing overhead
o In the factory
o Raw materials, work in progress, finished goods
Period costs include all selling costs and administrative costs
o Outside the factory
o Selling costs: costs necessary to secure the order and deliver the product (can be
either direct or indirect costs)
o Administrative costs: all executive, organizational and clerical costs (can be either
direct or indirect costs)
o *Expensed to the I/S in the period the cost incurred
Prime costs and conversion costs
Variable cost
A cost that will change directly and proportionately with activity (same direction, same rate); Your total
texting bill may be based on how many texts you send
o Variable cost per unit remains constant; the cost per text sent may vary at 5 cents per text message
The Activity Base (Cost Driver)
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Fixed Cost
A cost that remains constant, in total, regardless of changes in the level of activity. Your monthly contract fee for
you cell pone may be fixed for the number of monthly minutes in your contract
Fixed costs can change, but the change is not directly linked to activity management decision, outside force
(landlord raises the rent)
Relevant range: all costs change eventually even fixed costs. We therefore specify a range of activity over
which fixed costs in total remain fixed, and variable cost per unit remains same
Fixed cost per unit will change inversely with volume.
o The average fixed cost per cell phone call made decreases as more calls are made
Types of fixed costs
Committed: long-term, cannot be significantly reduced in the short term
o E.g., depreciation on buildings and equipment and real estate taxes
Discretionary: may be altered in the short term by current managerial decisions
o E.g., advertising and research and development
The Linear Assumption and the relevant range
Cost Classification for Predicting Cost Behavior
Mixed Costs
A mixed cost contains both variable and fixed elements
Consider the example of utility cost
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Analyze a mixed cost using a scattergraph plot and the high-low method
Assume the following hours of maintenance work and the total maintenance costs for six months
The High-Low method an example
High Low Method
1. Identify high activity level and low activity level
a. POOL = change in cost
b. BASE = change in activity
2. Utilize Y = a + bX
3. Identify variable cost per unit [POOL/BASE] (b)
4. Solve for total fixed cost (a) using high activity X and Y
5. The final equation (using the determined a and b)
a. Used as tool to project cost (manage cost)
b. Managing fixed/variable cost efficiently and effectively
The Traditional and Contributional Formats
Contribution margin = Net Operating Income FC
Decision-making
Differential cost or differential revenue: the difference between two available alternatives
o The economist’s marginal cost
Incremental cost: this has a more narrow definition than differential cost, in that it indicated the increase in cost
from one alternative to another
Opportunity cost: forgone benefit when you choose one alternative over another
o These costs are not usually entered into the accounting records or an organization, but must be explicitly
considered in all decisions
Sunk cost: a cost that has already been incurred, and this cannot be differential when considering two alternatives for
the future
Cost behavior: how costs react to changes in the level of activity (usually means how many units of product are made and sold)
Step 1: Identify fixed cost which are fixed across the range (a)
Step 2: Identify variable cost per unit (b)
Step 3: Apply the volume/Activity (X) to the VC/Unit VC/unit × X (Activity)
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