2. Costing Flashcards

1
Q

What is a cost object?

A

Anything for which a separate measurement of costs is desired.

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2
Q

What are direct costs?

A

Direct costs of a cost object are costs that are related to the particular cost object and can be traced to the particular cost object in an economically feasible way

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3
Q

What are indirect costs?

A

Indirect costs of a cost object are costs that are related to the particular cost object but cannot be traced to it in an economically feasible way (bulk of the activity)

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4
Q

What are cost pools?

A

Cost pool is a grouping of individual cost items (=cost center)

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5
Q

What is cost allocation base / cost driver?

A

A factor that is the “common denominator” for systematically linking an indirect cost or group of indirect costs to a cost object

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6
Q

What are the different cost pool types?

A

Product cost pools: collects costs that are associated with any set of products

  • Direct product cost pool: a product cost pool that is associated with a single product (i.e. direct costs are traceable to a single product)
  • Indirect product pool costs: collects indirect costs, i.e. those that are not directly traceable to individual products but allocated to them according to an allocation base determined as part of the accounting system

Period costs: Expenses that are neither traceable nor allocated to products, but are associated with the time period

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7
Q

What is the matching principle?

A

Product costs are expenses in the period in which the revenue is realized, period-related expenses. Period costs are charged against the income of the period.

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8
Q

What is the difference in treatment between Product costs and Period costs?

A

Product costs: Included in inventory value in BS and COGS in IS

Period costs: Directly assigned to the income statement

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9
Q

What are examples of cost objects?

A
  • a product
  • a customer
  • a product-category
  • a period of time
  • a project (R&D or reorganization)
  • an activity (quality control)
  • a department
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10
Q

What is the assignment of direct and indirect costs to cost objects called?

A

Direct: Tracing
Indirect: Allocation

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11
Q

What is the central problem of cost allocation?

A

How to include (allocate) indirect costs that often cannot be allocated to products/services (i.e. cost objects) without ambiguity. We try to look for a causal relationship between the indirect cost and the cost object (where/if there might be one), but otherwise the choice of how to allocate can be arbitrary (degree of ambiguity in indirect cost allocation).

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12
Q

What is the objective of cost accounting?

A

To assign costs to their cost objects

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13
Q

What does it mean to classify costs by traceability?

A

To differentiate between direct and indirect costs

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14
Q

What does traceability classification depend on?

A
  • The choice of cost object
  • The materiality of the cost in question
  • Available information-gathering technology
  • Design of operations
  • Contractual agreements
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15
Q

Cause-and-effect relationships may arise in several ways to determine cost drivers, like:

A
  • Physical relationships (but correlation is not equal to causation)
  • Contractual agreements
  • Logic and knowledge of operations
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16
Q

What are some examples of costs and corresponding drivers?

A
  • Direct materials: # of units
  • Direct labor: # of labor hours
  • Quality control: # of units inspected
  • Distribution: # of shipments
  • Advertising: # of advertisements
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17
Q

When may a job costing system be applied?

A

Distinct unit of a product or service

The product is differentiated, customised or unique, and individual jobs use different quantities of resources

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18
Q

When may a process costing system be applied?

A

Masses of identical or similar units of a product or service

The product is homogeneous, and each unit presumed to receive the identical quantities of resources

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19
Q

What is the 7 steps of the general approach to job costing?

A
  1. Identify the job (=the cost object)
  2. Identify the direct costs of the job
  3. Identify the total indirect costs to be allocated
  4. Select the cost allocation base (= cost driver) to use in allocating indirect costs to the job
  5. Develop the rate per unit of the cost allocation base used to allocate indirect costs
  6. Calculate the indirect costs allocated to the job
  7. Compute the total costs of the job
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20
Q

What may be a problem with job costing in the manufacturing industry?

A

Particularly in this sector we might have more than one cost driver

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21
Q

What is actual costing?

A

Actual costing uses actual costs to determine the cost of individual jobs

  • This method traces direct costs to a cost object and allocates indirect costs to a cost object based on the actual indirect cost rate * the actual quantity of the cost allocation base
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22
Q

What is the difficulty with actual costing?

A

That you have to wait until the end of the reporting period to allocate total indirect costs, but managers often want more timely information before the end of the reporting cycle

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23
Q

What is normal costing?

A

Normal costing traces direct costs to a cost object and allocates indirect costs to a cost object based on budgeted indirect cost rate * the actual quantity of the cost allocation base

  • Direct costs are treated the same as under actual costing
24
Q

What are complications of normal costing?

A
  • Underallocated indirect costs: allocated amount of indirect costs is lower than the amount actually incurred
  • Overallocated indirect costs: allocated amount of indirect costs is higher than the amount actually incurred
25
Q

How do we deal with under/overallocation of indirect costs?

A
  • Write off the under- or overallocation to cost of goods sold in the income statement – especially if trivial
  • Adjust all jobs to reflect actual costs at the end of the accounting period
  • Adjust individual job costs to account for (absorb) the under-/overallocation
26
Q

What are pros and cons of job order costing?

A

For highly distinct, customizable products (jobs), helps company:

  1. Determine the profitability of each job
  • More precise data on unique jobs = better precision in pricing
  1. Keep track of productivity/efficiency of job teams
  • Requires greater tracking of materials and labor
  • Easier to identify and eliminate waste and inefficiency
  1. Use of normal costing for benchmarking job costs in “real time”
  • Increases administrative costs
  • Can be imprecise, leading to risk of error
  • Over-under applied OH that needs to be adjusted
27
Q

What are the different types of inventories?

A
  • Direct materials inventory (raw materials)
  • Work-in-process inventories (could be for range of products)
  • Finished goods inventory (ready and available for sale)
28
Q

What is the general stock flow equation?

A

Opening stock + Purchases = Sales + Closing stock

29
Q

What are the three main inventory flow methods?

A
  • FIFO: first in, first out
  • LIFO: last in, first out
  • Weighted average method

Attempt to mimic the physical flow of goods/resources through a process

30
Q

What are the basic assumptions for process costing?

A
  • Each sub-process/department has its own work-in-process inventory account
  • Direct materials added at beginning of process (or at discrete points)
  • Direct labor and factory overhead (called conversion costs) incurred continuously throughout production
31
Q

What can we say about process costing with multiple sub-processes/departments?

A

They involve “transferred-in costs”

  • As a product passes from one sub-process to another the accumulated cost (work-in-process) passes from department to department
  • Transferred-in costs (or prior sub-process/department costs) are costs of work performed in earlier departments that are transferred into the current sub-process/department
  • These costs are treated like direct materials added at the beginning of a process
32
Q

What can we say about inefficiencies in process costing?

A
  • We might expect that there is waste or spoilage in the productive process; we would call this normal (or budgeted) production losses
  • In normal costing, it is usual to try and anticipate this level of normal losses: that is, the waste in production that reflects the usual or expected level of productive inefficiency
  • For purposes of process costing, we may need to adjust the product costs to reflect the actual level of waste; which might leave the company with either abnormal losses or abnormal gains.
33
Q

What are normal losses and how are they treated?

A

Normal losses (expected waste) occur under regular operating conditions and are not easily controllable. These losses should be absorbed into product(ion) cost and will impact gross profit

  • Product costs included in the income statement in Cost of Sales/COGS when the sale is made.
  • Accumulated costs of unsold goods goods are included in the value of inventory
34
Q

What are abnormal losses/gains and how are they treated?

A

Abnormal losses (or gains) are written off to the income statement as a period cost/benefit and will impact operating income

  • Period costs are not included in the calculation of product cost or the value of inventory
  • Directly assigned to the income statement typically through Operating Expenses
35
Q

What do we use to determine process cost with semi-completed goods?

A

In order to determine process costs when WIP remains at the end of a period, we need to consider equivalent units in the calculation

  • An equivalent unit is a measure that converts units partially complete into equivalently fully complete units (e.g. 4 units 25% complete are equivalent to 1 unit fully complete)

Simplifying assumptions:

  • DM costs are added at the beginning of the process
  • Conversion costs (direct labor + OH) are added continuously during processes
36
Q

What are the steps of costing semi-completed goods?

A
  1. Summarize output in physical units
  2. Calculate equivalent units
  3. Calculate equivalent unit costs
  4. Assign costs to completed units
  5. Assign costs to units in closing WIP
37
Q

What are the three general approaches for allocating overhead costs to products?

A
  1. Volume-based approach: allocates overhead from a single pool of costs/drivers (job costing and process costing)
  2. Departmental approach: allocates overhead from service departments to production departments and then from production departments to products
  3. Activity-based approach: allocates overhead to production activities and then from production activities to products
38
Q

When may a volume-based cost allocation approach be good?

A
  • Costs to be allocated are relatively small when compared to directly traceable costs

Or

  • Activities supporting the product/service line are homogeneous across different product/service lines
39
Q

What are production departments?

A

A unit of a manufacturing company that is involved in producing the company’s product or service

40
Q

What is a service department?

A

A unit of the company that performs one or more support tasks for production departments

41
Q

Why is it important for decision makers to determine accurate production and service department costs?

A

To use as a basis for evaluating the cost efficiency of departments and the profitability of different products

42
Q

Why do service department exist and how are their costs treated?

A
  • Service departments exist to support production departments; thus, a portion of their costs are allocated to production
  • Allocating indirect costs from service departments requires a cost allocation base that reflects each production department’s share of service
43
Q

What are the 3 phases of departmental overhead allocation?

A

Phase 1:

  • Trace direct costs from production departments to products
  • Assign/allocate indirect costs to production departments and service departments (based on relevant drivers)

Phase 2:

  • Allocate service department costs to production departments

Phase 3:

  • Allocate production department costs to products
44
Q

What are the two methods to deal with the allocation issue of when multiple service departments provide services to each other?

A
  1. Direct method: Ignore all interaction between service departments
  • Allocate directly to production departments
  1. Step down method: Ignore two-way interaction between service departments
  • Allocate between service departments in one direction only
  • Allocate in stages - usually starting with the largest service department first
45
Q

What is the strategic role of cost allocation?

A
  1. Determine accurate department costs (and product costs) as a basis for evaluating the cost efficiency of departments (and the profitability of different products)
  • Determine which parts of the business are responsible for which costs
  1. Motivate managers to exert a high level of effort to achieve the goals of top management
  • Get managers in different departments to focus on costs incurred within their department and understand their relationship to other departments
  1. Provide the right incentive for managers to make decisions that are consistent with the goals of top management
  • Design contracts that reward departmental cost control and increased profitability
  1. Fairly determine the rewards earned by managers for their effort and for the effectiveness of their decision making
46
Q
A
47
Q

What is the development behind activity-based costing?

A
  • Departmental approached acknowledge the growth of indirect costs (“overhead creep”) and drivers beyond volume, but distortion may still occur in the cost center/departmental approach (pools together unrelated activities)
  • Allocation shortcomings: changes in manufacturing due to product complexity, product mix heterogeneity, factory layout and automation and advanced manufacturing technologies as lending
  • Activities drive most costs rather than volume; Products and services are created through performing activities, which require resources, and resources change based on a driver/factor causing the change
48
Q

What is the brief description of ABC and its aim?

A
  • In brief, ABC systems assign overhead costs to activities using resource consumption drivers and then assign these costs to cost objects (e.g. products)
  • The aim is to project more accurate cost flows by tracing a higher amount of costs directly to the cost objects
49
Q

How can we define the activities in ABC?

A
  1. Value chains help cut the production process into stages based upon their value-added. Enables to focus on activities where companies realize competitive advantages:
  • Better customer value at equivalent cost
  • Equivalent customer value at lower costs
  1. Production flow charts enable managers to divide the production process into various components or activities. The aim is to go into as much detail as possible
50
Q

What are some considerations about mapping value creation activities?

A
  • Where to stop?
  • How many activities should be included?
  • Can be costly and difficult to understand
  • Not all firms need ABC - preference for cost-based decision-making tool
  • However, ABC is not only a method of costing, but a technique for managing the firm better
51
Q

What are the 6 steps of ABC costing?

A
  1. Decompose organization into activities
  2. Identify activity drivers
  3. Assign costs to activities
  4. Calculate activity rates
  5. Calculate rate per unit of activity
  6. Assign costs to products based on the activities consumed by each product
52
Q

How is ABC a technique for managing the firm?

A
  • Cost reduction and process improvement decisions: Can help identify what areas need attention and where to realize cost reductions
  • Design decisions: Can help identify new designs to improve performance by evaluating how product and process changes affect costs
  • Market decisions: Can help identify the benefits of alternative products and market preferences by focusing on items and activities which are value and non-value adding
  • Performance evaluations: Can be used to develop new forms of measuring and monitoring performance
  • Product-mix decisions: Highlights product complexity issues through analysis of activities and transactions
53
Q

How can ABC help create more thorough analysis of customer profitability (CPA)?

A
  • Customers are not all the same; their costs vary along with the kind of customers (customer profiles) that a firm deals with
  • Allows a firm to better understand which revenues and costs are related with which customers
  • Enables the measurement of the profitability of a firm’s customers or customer groups
  • Make more informed decisions with regards to sales and customers (e.g. who receives discounts)
54
Q

What does CPA (customer profitability analysis) help with?

A

Helps assess a customer’s value to the company and business conditions for the company to consider

  • How important is the customer as a future sales reference?
  • What is the customer’s growth potential?
  • What are the possible reactions of the customer to changes in sales terms or services?
  • Interventions and process improvements in ABC implementation

In conjunction with ABC, requires close cooperation among management accountants, engineers, and operating managers, but also with service activities.

55
Q

What are the parts of a Statement of Cost of Goods Manufactured and Sold?

A

+ Direct Materials
+ Direct Labor
+ Factory OH
= Manufacturing costs incurred

Add: Opening WIP
Less: Closing WIP
= Cost of finished goods (completed)

Add: Opening finished inventory
Less: Closing finished inventory
= Cost of Goods Sold (should match with sum of finished jobs)