Domain IV − Financial Management − Section B.1 General Concepts Flashcards
Manufacturing Costs
in a manufacturing entity, costs that generally need to be allocated to cost objects are the manufacturing costs. Manufacturing costs may be classified as follows: direct material (dm), direct labor (dl), factory overhead (foh), prime costs, conversion costs
Direct Material (DM)
includes all raw materials that are feasibly traceable to the final product. Direct materials are usually variable costs.
Direct Labor (DL)
includes all costs associated with labor time that is feasibly traceable to the final product. Direct labor costs are usually variable costs.
Factory Overhead (FOH)
includes indirect materials, indirect labor, and all other related manufacturing costs that are usually accumulated for assigning to the individual products. Factory overhead may further be divided to variable factory overhead and fixed factory overhead.
Prime Costs
refer to the combination of direct material and direct labor costs.
Conversion Costs
refer to the combination of direct labor and factory overhead costs.
Spoilage and/or Shortage
refers to a reduction in the number of produced units as compared to the input units resulting from breakage, theft, damage, defection, shrinkage during production or storage.
- Normal Spoilage refers to regular spoilage that is considered normal as customary in the production process. The costs of normal spoilage and associated rework costs are added to the cost of goods manufactured or (if considered material) prorated between the cost of goods sold, inventory, and ending WIP.
- Abnormal Spoilage refers to spoilage that exceeds typical limits as customary in the production process. Abnormal spoilage costs should be reported separately in the income statement as a special loss account.
Overhead
includes all indirect manufacturing costs (i.e., indirect material, indirect labor, and other indirect manufacturing costs). Overhead costs may include a fixed portion and/or a variable portion.
Overhead is allocated to production using a variety of methods.
Cost drivers are typically identified to form the basis of overhead application.
- Cost driver is a measurable factor (financial or other quantitative non‐financial) for an activity base that has a high correlation with the incurrence of overhead costs.
- Examples of cost drivers: area (or floor space), resources usage (electricity, direct materials, etc.), direct labor dollars, direct labor hours.
Service Department Cost Allocation
refers to the practice of accumulating the costs of
service departments in cost pools and then allocating those costs to production departments.
Direct Method
allocates service department costs directly to the producing departments.
Step‐Down (Sequential) Method
allocates service department costs to other service departments in addition to production departments. Other service departments are also allocated until all service department costs are allocated.
Reciprocal (Simultaneous Equations or Linear Algebra) Method
allocates service department costs to each other and to producing departments simultaneously using algebraic equations.
Fixed Costs (FC)
a. Costs which do not change as a result of a change in output.
b. Fixed costs are the same in total but vary per unit of output.
c. Total fixed costs are divided by the total output, thus, as total output increases, fixed cost per unit will decrease.
Variable Costs (VC)
a. Costs that change proportionally as a result of a change in output.
b. Variable costs change in total but remain constant per unit of output.
c. Regardless of the volume of output, the variable cost per unit will remain the same, but total variable costs will increase as a result of an increase in production volume.
Relevant Range
is the range of output or production over which cost‐relationships remain valid.
NB:
- In the long‐run, all costs are considered variable.
- Most costs have fixed and variable components and are referred to as either semivariable, or semi‐fixed.
The High‐Low Method
is used to identify the fixed and variable rates within a relevant range.
Marginal vs. Average Costs
- Marginal Cost (MC) is the extra cost incurred in producing one extra output unit.
- Average Cost (AC) or Average Total Cost (ATC) is the total cost of production divided by the number of units produced.
Product costs
are costs that attach to the product. They include all manufacturing costs (direct materials, direct labor, indirect material, indirect labor and factory overhead).
=> Examples of product costs are raw materials, salaries of factory workers and factory manager, depreciation on factory equipment, and property taxes on the factory.
Period costs
are costs incurred in the regular course of operations that are not related to manufacturing and are not normally capitalized as assets.
=> Examples of period costs are advertising expenses, officers’ salaries, insurance on the corporate headquarters building, sales staff salaries/commissions, depreciation on office buildings or salespeople’s vehicles
Cost‐Volume‐Profit (CVP) analysis
is a managerial accounting technique that deals with the relationship between quantity sold, variable costs, fixed costs and the operating income of a business.
Breakeven Point
is the sales level that yields neither a profit nor a loss. The breakeven point is generally when sales are equal to the sum of the variable costs and fixed costs:
Sales = Total Fixed Costs + Total Variable Costs.
Contribution Margin
is the dollar amount contributed by each unit of sales. It is sales less variable costs.
Contribution Margin/unit = Price/unit – Variable Costs/unit
Breakeven point may be expressed in either units of output or in dollars:
- Breakeven Point in Units of output = Total Fixed Costs / Per unit Contribution Margin
- Breakeven Point in Dollars = Total Fixed Costs / Contribution Margin %
Budget
is a quantitative expression of a business plan that produces projected values over a specific period of time.
=> A budget includes data such as: production level, sales, cost, resources, cash flow, balance sheet, etc. It can be done at a high corporate level, at a business unit level, or for a specific event or a project.
Master Budget
The master budget is a summary of all interdependent budgets that lay out the company’s operational and financial goals. The master budget usually has two sections, the operating budgets and the financial budgets.
Static (fixed) budget
- Provides a budget for only one level of activity
- May significantly differ from actual results especially when the anticipated level of activity differs significantly
Flexible budget
- Provides a series of budgets capable of comparing many levels of activity
- It is usually a formula with the activity level as the unknown
Zero‐based budgets
The budget is prepared every year from zero thus:
- Managers are forced to reassess the sub‐functions for importance, priority, and efficiency
- The practice of adding an increment of prior year’s budget is eliminated
Priority choice analysis
provides for prioritizing functions and programs to allocate scarce resources amongst them by priority.
Continuous (rolling) budget
an additional period is added to the existing budget upon the lapse of a current and equivalent period i.e., a new quarter is added when the current quarter lapses.
Life‐cycle (cradle‐to‐grave) budgets
budgets a product’s revenues and expenditures throughout the product’s life‐cycle i.e., from the research and development through the final decline stage.
Probabilistic budgets
budgets prepared from expected values calculated by estimates and their respective probabilities.
