Lecture 1 Flashcards
The science of accounting
Accounting is the science of measuring, reporting and controlling performance
Financial accounting
External reporting (e.g. investors, creditors, SEC, ESMA)
Defined by GAAP/IFRS
Only focus is financial performance
Management accounting
Internal reporting (e.g. compensation, production decisions, pricing and forecasting
Defined by management
Financial and non-financial performance
Cost accounting
One piece of management accounting
Costs of acquiring or using resources in an organization
Often used synonymously with management accounting, but its really just a subset of management accounting
Why management accounting works
Rolls into external financing reporting (for most firms, COGS is the single largest expense)
Important roles outside of financial accounting
- Decision-facilitating: Information improves decisions
- Decision-inlfluencing: Motivate employees to work hard, prevent and detect unethical behavior
- Coordination-facilitating: Coordinate decisions across units (e.g. sales lets production know how many units to make)
What management accoutning used to be
Bookkeeping
Historical costs to create financial statements
Modern management accounting (strategic management accounting)
Future-oriented
Improving decision-making
Problem-solving
Adding value
Cost terms
You have to understand accounting and you have to understand the nuances of accounting. It’s the language of business (warren buffet
Cost
A sacrifice in order to achieve a specific purpose
Expense
Reducting in wealth; hits the income statement
Opportunity cost
the road not taken”
The options you gave up when you made a decision
When you go to a party, the opportunity cost is studying for this class
Cost object
Something were trying to figure out the cost of. Something that “accumulates costs”
Variable cost
A cost that increases when you make one additional item
Total variable costs increase when production increases
E.g. Materials, electricity or hourly wages
Fixed cost
A cost that does not increase when you make one additional item
Total fixed costs remain the same when production increases
E.g. Rent or salaries
Average cost
How much the average unit costs. Found by adding up all costs and dividing by the number of units produced
Marginal cost
Is what it costs to make one more unit
Calculated as the change in total costs if you make one extra unit
Cost driver
A variable, such as the level of activity or volume, that causes costs to change
E.g. number of hours worked causes total wages to change
Relevant range
The brand or range of normal activity (or volume) in which there is a specific relationship between the level of activity (or volume) and the cost in question
E.g. Once employees go over 40 hours in a week, then we have to pay overtime
Direct costs
Can be t raced directly to a cost object
e.g. Wood when making a bookshelf
Indirect costs
Are not traced to a cost object, often because it is not economically or technologically feasible
E.g. Glue, electricity or sandpaper
Factors affecting direct/indirect costs classification
Materiality of the cost in question
Availability of information-gathering technology
Design of operation
Note: A specific cost may be both a direct cost of one cost object and an indirect cost of another cost object
A mass-produced bookshelf may have screws be a direct costs
(We know exactly how many screws go where)
A custom build bookshelf may have screws be an indict cost
(not worth our time to count them as we go)
How to know if a product was direct or indirect
If we know which product was used: direct
If we do not know which product it was used for: indirect
Do we know which product it was used for?
Yes: direct
No: indirect
How to know if a cost is variable or fixed
Does the cost increase with more production:
Yes: variable
No: fixed
Categorization
Dell computers make custom order computers equipment. Classify each cost as a direct/indirect and variable/fixed
Inventoriable costs (aka product costs)
Costs used in the manufacturing of a product. These costs stay on the balance sheet as assets (i.e. they are capitalized) until they are sold. Then they hit COGS as an expense
Period costs
SG&A costs that generally don’t hit the balance sheet
E.g. sales commissions, CEO salary, advertising costs, etc.
Expenses as incurred
Important for decision-making, but not our main focus since they are not part of COGS
Direct material (inventory costs)
Raw materials that will be turned into finished goods; can be traced to individual jobs
Direct labor (inventory costs)
Labor costs that can be traced to individual jobs
Manufacturing overhead (inventory costs)
All other manufacturing costs: all costs that are indirect and/or fixed
Prime costs
DM + DL (everything but MOH; also called “direct costs”)
DM = Direct material
DL = direct labor
Conversion costs
DL + MOH (everything but DM; cost of turning DM into finished goods)
DL = Direct Labor
MOH = Manufacturing overhead
Service companies (types of inventory)
No inventory
Merchandising companies (types of inventory)
Merchandising companies (merchandise inventory (purchased inventory))
Manufacturing companies (types of inventories)
Raw materials (RM) sometimes called “direct materials” (DM)
Resources in stock and available for sue
Work-in-process (or progress, WIP)
Products started but not yet completed
Finished goods (FG)
Products completed and ready for sale
Calculating costs of merchandising company
Calculating costs is easy!
What we paid for stuff, plus a few extras (E.g. Shipping and insurance to get the stuff)
Calculating costs of manufacturing company
Calculating costs is hard!
We buy raw materials, and work to turn those raw materials into finished goods
We have overhead (e.g. factory rent)
The cost of the inventory includes all of those costs added up!
