Chapter 1&2 - Cost Concepts

Question 1

What is DM? Give examples of what is not DM.

Answer 1

materials that become an integral part of the finished product and the costs can be conveniently traced to the finished product.

Glue used to make a chair - hard to trace, relatively insignificant

Question 2

What is DL? Give examples of what is not DL.

Answer 2

must be integral to the production and conveniently traced (Salaries of janitors, supervisors are indirect labor costs)

Question 3

What is MOH? Give examples of what is not MOH and instead SG&A?

Answer 3

Indirect materials and indirect labor are classified as manufacturing overheads

Maintenance and repairs on production equipment, heat and light, property taxes, depreciation, and insurance on manufacturing facilities – Key here is that all these random costs must be associated with operating the factory, otherwise it will be part of SG&A

Question 4

Within SG&A, how can it be split? Give examples.

Answer 4

Selling costs and administrative costs.

1. Shipping, advertising, sales travel, sales salaries, costs of finished goods warehouses
2. Just general costs associated with the whole organization

Question 5

What are product costs? Are DM, DL,MOH considered?

Answer 5

Aligned with the matching principle where the cost should be recognized as an expense only when the sales takes place – that is, these costs are incurred to make something and is when the benefit occurs. Such costs are called product costs

Yes. DM,DL,MOH all product costs and sticks with the unit as they go into inventories.o The stress here is that a product cost such as dm or dl might be incurred during one period but not recorded as an expense until a following period when the completed product is sold

Question 6

What are period costs? Examples?

Answer 6

All costs that are not product costs. Sales commissions, rental costs of administrative offices
Key here is that the period in which a cost is incurred is not necessarily the period in which cash changes hands - Pre-paid insurance for example – u expense the IS and create an asset in which u minus with cash when they are used

Question 7

What is Prime cost?

Answer 7

Sum of DM and DL.

Question 8

What is conversion cost?

Answer 8

Sum of DL plus MOH. These costs are incurred to convert materials into the finished product

Question 9

Formula for total Manufacturing costs?

Answer 9

DM + DL + MOH

Question 10

How do i get COGM? Whats the intuition?

Answer 10

COGM = TMC + Changes in WIP. Basically all your TMC is your costs of goods manufactured but also need to add any existing WIP inventory that is converted to final goods into this number

Question 11

How to get COGS?

Answer 11

Same intuition as COGM but also need to add in changes in final goods inventory.

Question 12

What is the purpose of knowing 1. Product & period costs, 2. Variable and fixed costs, 3. Direct and indirect costs and 4. Differential costs, sunk costs, and opportunity costs?

Answer 12

1. Prepare external financial statements
2. Predicting cost behaviour in response to changes in activity
3. Assigning costs to cost objects such as departments or products
4. Making decisions

Question 13

Is it true for total variable costs to change in proportion of activity level but unit vc stay constant? what about for fixed costs?

Answer 13

Yes true. For fixed costs, total stays the same but unit changes based on activity level

Question 14

What is a key concept to understand in fixed costs? What are considered fixed costs?

Answer 14

The relevant range. Fixed costs are only fixed if output stays within the relevant range.
Straight-line depreciation, insurance, property taxes, rent, supervisory salaries, administrative salaries, advertising

Question 15

Explain true variable costs and step variable costs

Answer 15

True vc is like the cost for DM. Varies based on activity level and if not used, can be stored.

Step variable costs are costs obtained in large chunks and can only change in large changes in activity level. Even if unused, costs will be expensed.

Question 16

What kind of graph does costs usually mimic? What are assumptions must be true?

Answer 16

Curvilinear graph with volume and linearity assumptions only holds in the relevant range

Question 17

What types of fixed costs are there?

Answer 17

Committed and discretionary.

1. Investments in facilities, equipment and cannot be reduced even for short periods of time without making fundamental changes
2. Arise from annual decisions made by management to spend on certain fixed cost items - advertising, research, internships

Question 18

Mixed costs formula?

Answer 18

Y = Mx + C
Y = total mixed costs
c = Fixed cost
M = variable cost per unit
X = number of units

Question 19

What methods can we use to diagnose cost behaviour? Any limitations?

Answer 19

1. High-low method - use only if scatter plot confirms approximately linear relationship
2. Least squares regression method
3. Scatterplot

Question 20

How to use the high low method?

Answer 20

Step 1: Identify the points with highest and lowest activity levels
Step 2: (Cost at highest level - cost at lowest level)/(High activity level - low activity level) = Variable cost
Step 3: Sub in all known variables (choosing either high or low activity) into formula Y=mx + C to get fixed cost c

Question 21

What does a CM ratio of 0.4 tell me?

Answer 21

Every dollar of sales increase will increase CM by 0.4 and NOI by 0.4 (Assuming fixed costs are unchanged)

Question 22

Derive profit using CM ratio in the formula.

Answer 22

Profit = (CM Ratio * Sales) - FE

Question 23

Target profit analysis formula for unit sales? What is the relationship with Breakeven analysis What about dollar sales?

Answer 23

Unit sales to attain TP = (TP + FE)/ Unit CM.
For breakeven analysis, TP = 0
Dor dollar sales divide by CM ratio

Question 24

What is the MOS? formula?

Answer 24

The excess of sales dollars over breakeven volume of sales dollars: Sales - Breakeven sales
As a percentage: MOS in dollars/ Total Sales

Question 25

What is operating leverage? Formula? What affects operating leverage if sales and total expense is the same?

Is degree of operating leverage constant?

Answer 25

Measure of how sensitive net operating income is to percentage changes in levels of sales.
CM/NOI

Cost structure. Higher degree of fixed costs means greater operating leverage.

No. Highest at points near breakeven sales as still largely dependent on clearing fixed costs

Question 26

What are some CVP analysis assumptions?

Answer 26

1. Selling price is constant even as volume changes
2. Costs are linear and ca be accurately divided into variable and fixed elements
3. In multi product companies, the sales mix is constant
4. In manufacturing companies, inventories do not change. Number of units produced equals the number of units sold

Question 27

Express the contribution format income statement in equation form

Answer 27

Profit = Sales - variable expenses - fixed expenses

= (P X Q - V X Q) - FE

Question 28

If CM increases by 3200 and fixed expenses stay the same, how will NOI change?

Answer 28

Increase by 3200

Question 29

Why does structuring sales commissions by sales get unproductive?

Answer 29

Because lower sales but higher CM is better, sales person might intentionally sell the one with higher sales instead of higher CM

Question 30

What is process costing used for? formula?

Answer 30

For companies that produce alot of one product - coke. Thus to get the unit product cost, we just divide total manufacturing cost by number of total units produced.