Domain IV − Financial Management − Section B.1 General Concepts

Question 1

Manufacturing Costs

Answer 1

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

Question 2

Direct Material (DM)

Answer 2

includes all raw materials that are feasibly traceable to the final product. Direct materials are usually variable costs.

Question 3

Direct Labor (DL)

Answer 3

includes all costs associated with labor time that is feasibly traceable to the final product. Direct labor costs are usually variable costs.

Question 4

Factory Overhead (FOH)

Answer 4

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.

Question 5

Prime Costs

Answer 5

refer to the combination of direct material and direct labor costs.

Question 6

Conversion Costs

Answer 6

refer to the combination of direct labor and factory overhead costs.

Question 7

Spoilage and/or Shortage

Answer 7

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.

Question 8

Overhead

Answer 8

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.

Question 9

Overhead is allocated to production using a variety of methods.

Answer 9

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.

Question 10

Service Department Cost Allocation

Answer 10

refers to the practice of accumulating the costs of

service departments in cost pools and then allocating those costs to production departments.

Question 11

Direct Method

Answer 11

allocates service department costs directly to the producing departments.

Question 12

Step‐Down (Sequential) Method

Answer 12

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.

Question 13

Reciprocal (Simultaneous Equations or Linear Algebra) Method

Answer 13

allocates service department costs to each other and to producing departments simultaneously using algebraic equations.

Question 14

Fixed Costs (FC)

Answer 14

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.

Question 15

Variable Costs (VC)

Answer 15

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.

Question 16

Relevant Range

Answer 16

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.

Question 17

The High‐Low Method

Answer 17

is used to identify the fixed and variable rates within a relevant range.

Question 18

Marginal vs. Average Costs

Answer 18

1. Marginal Cost (MC) is the extra cost incurred in producing one extra output unit.
2. Average Cost (AC) or Average Total Cost (ATC) is the total cost of production divided by the number of units produced.

Question 19

Product costs

Answer 19

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.

Question 20

Period costs

Answer 20

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

Question 21

Cost‐Volume‐Profit (CVP) analysis

Answer 21

is a managerial accounting technique that deals with the relationship between quantity sold, variable costs, fixed costs and the operating income of a business.

Question 22

Breakeven Point

Answer 22

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.

Question 23

Contribution Margin

Answer 23

is the dollar amount contributed by each unit of sales. It is sales less variable costs.
Contribution Margin/unit = Price/unit – Variable Costs/unit

Question 24

Breakeven point may be expressed in either units of output or in dollars:

Answer 24

1. Breakeven Point in Units of output = Total Fixed Costs / Per unit Contribution Margin
2. Breakeven Point in Dollars = Total Fixed Costs / Contribution Margin %

Question 25

Budget

Answer 25

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.

Question 26

Master Budget

Answer 26

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.

Question 27

Static (fixed) budget

Answer 27

• Provides a budget for only one level of activity

- May significantly differ from actual results especially when the anticipated level of activity differs significantly

Question 28

Flexible budget

Answer 28

• Provides a series of budgets capable of comparing many levels of activity
• It is usually a formula with the activity level as the unknown

Question 29

Zero‐based budgets

Answer 29

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

Question 30

Priority choice analysis

Answer 30

provides for prioritizing functions and programs to allocate scarce resources amongst them by priority.

Question 31

Continuous (rolling) budget

Answer 31

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.

Question 32

Life‐cycle (cradle‐to‐grave) budgets

Answer 32

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.

Question 33

Probabilistic budgets

Answer 33

budgets prepared from expected values calculated by estimates and their respective probabilities.