AFM 191 - 5.2: preparing a gross margin income statement

Question 1

define product costs

Answer 1

all costs related to purchasing or producing a good

Question 2

why are product costs often referred to as inventoriable costs?

Answer 2

product costs are recorded on balance sheets as inventory before the units are sold to customer

product cost is transferred from the balance sheet to the income statement as an expense (COGS)

Question 3

define period costs

Answer 3

costs that are not related to purchasing or producing a good

Question 4

where are period costs expensed?

Answer 4

on income statement in the same period in which they are incurred

Question 5

what are the 2 categories of period costs

Answer 5

1. operating expenses (OPEX)
2. non-operating expenses (interest expense + income taxes)

Question 6

define operating expenses

Answer 6

period costs necessary to operate a business

Question 7

what is an alternate name for operating expenses?

Answer 7

selling, General + administrative (SG&A) expenses

Question 8

what costs do operating expenses include?

Answer 8

research + development costs
selling + marketing costs
General + administrative costs- employee wages, rent, depreciation, legal - professional fees, utilities, office supplies, etc

Question 9

define non-operating costs - what is included

Answer 9

period costs not related to core operations of a business

financing costs, income taxes + other income not associated with core operations, these expenses are deducted at the end of an income statement to calculate net income

Question 10

does ASPE require private companies to report revenue + COGS on external financial statement?

Answer 10

yes

Question 11

what’s the formula for gross marginal income statement

Answer 11

revenue or sales - COGS or COS
= gross margin - operating operating expenses
= earnings before interest + taxes - interest, taxes, other income/expenses
= net income (or net loss)

Question 12

what are some metrics that help internal + external stakeholder to understanding the profitability of the company

Answer 12

1. gross margin percentage
2. EBIT (operating income) percentage
3. net income percentage

Question 13

define gross margin percentage, give the formula + the purpose

Answer 13

the difference between revenue (price paid by customer) and COGS (cost to purchase/produce a good

formula: gross margin/revenue

purpose: demonstrate how effective a company is at generating a profit after recognizing product costs

Question 14

define EBIT(operating income) percentage, give formula, and purpose of this metric

Answer 14

represents the amount of profit a company generates strictly from its operations, (deduct operating expenses from gross margin or deducting fixed costs from contribution margin)

formula: EBIT/Revenue

purpose: demonstrates how effective a company is at generating a profit form its oeprations

Question 15

define net income percentage, formula, and purpose

Answer 15

the difference between EBIT + non-operating expenses

formula: net income/revenue

purpose: demonstrates how effective a company is at generating a profit after recognizing all expenses

Question 16

define a cost object

Answer 16

something that gets costs assigned to it

Question 17

define direct costs

Answer 17

costs that can be easily traced to a cost object

Question 18

define indirect costs

Answer 18

costs that cannot be easily traced to a cost object

Question 19

what is a cost object made up of?

Answer 19

direct + indirect costs

Question 20

define Manufacturing businesses

Answer 20

companies which produce finished goods + sell them to merchandising businesses or directly to customers

Question 21

define the product costs for manufacturing companies and provide examples

Answer 21

costs to produce the product in a factory

direct materials, direct labour, manufacturing overhead (indirect materials/labour, other indirect factory costs)

Question 22

what are the 3 inventory accounts for manufacturing companies

Answer 22

1. raw materials inventory - costs of raw materials before they are used to produce a good
2. work in process inventory - cost of direct materials, labour + allocated manufacturing overhead as a good is being produced
3. finished goods inventory - total cost of a finished good before it’s sold

Question 23

What’s the cost flow of manufacturing companies?

Answer 23

for a manufacturing company, product costs consist of direct (raw) materials purchases, direct labour + manufacturing overhead

these product costs = recorded in inventory accounts on the balance sheet until the product is sold

when materials are purchased + not been used in production, the costs are recorded in the raw material inventory account

when material are placed in production the material costs is transferred from raw materials inventory to work in process inventory

Question 24

define service businesses

Answer 24

companies which provide a service to customers

Question 25

define cost of sales (COS)

Answer 25

costs directly related to providing a service

Question 26

what is COS sometimes referred as and what is included in COS?

Answer 26

referred as cost of revenue

includes:
direct material, direct labour, direct travel, depreciation of long-term assets

Question 27

why do many service companies include COS on their income statement even though ASPE does not require service companies to show a cost of sales section in income statement + no specific guidance on the costs that should be included in COS

Answer 27

allows external + internal stakeholder to understand gross margin, an important metric for analysis