Lecture 6

Question 1

Absorption costing

Answer 1

Fixed manufacturing costs are assigned to inventory

Each unit produced absorbs some FOH

Question 2

variable costing

Answer 2

Fixed manufacturing costs are not assigned to inventory

FOH is a period expense (directly goes to the income statement)

Question 3

Variable costing (measuring costs)

Answer 3

WIP balance = v*Q

Question 4

Incurred (economics) measuring costs

Answer 4

Incurred = FOH + v*Q

Question 5

Absorption costing (measuring costs) (wip balance)

Answer 5

WIP balance = PDRQ + vQ

Question 6

units produced to costs (measuring costs)

Answer 6

Absorption costing costs the most for units producced

Incurred/actual costing costs the second most for units produced

Variable costing costs the least for units produced

Question 7

Problems with absorption costing

Answer 7

1) Discourages work with positive contribution margin (CM) but negative gross margin (can lead to death spiral)
2) Discourages the use of OH drivers
(Machine hours are really free (fixed costs –> pay the same whether or not we use them, but we act like they are expensive)
3) Encourages inventory build-up
4) Subject to denominator effects

Question 8

Death sprial

Answer 8

Low demand causes a product line to report low (absorption) gross margins

1) Confusing gross margin and contribution margin
The firm eliminates the product line

2) Using expected sales as the base
The firm lowers its activity base, causing full costs to remaining lines to rise

3) Basing prices on absorption costs
The firm raises prices on remaining products

Question 9

Gross margin formula

Answer 9

Revenue minus COGS, where COGS includes allocated fixed costs

Question 10

Contribution margin

Answer 10

Revenue minus variable costs

Question 11

PDR demonimators

Answer 11

Budgeted production

Theoretical capacity

Practical capacity

Question 12

Budgeted production

Answer 12

The amount we expect to produce next period - bad denominator

Question 13

Theoretical capacity

Answer 13

The amount that could be produced under ideal, impossible-to-achieve conditions - bad denominator

Question 14

Practical capacity

Answer 14

What wed probably have if the market could support it. Allows for surge, buffer, mistakes, etc. - Good denominator

Question 15

using something other than budgeted production as our denominator means were expecting a

Answer 15

Write off

Question 16

Problems with variable costing

Answer 16

1) easy to forget about FOH and not charge enough to cover the costs

2) Encourages overuse of fixed (limited) resources

3) Violates GAAP

Question 17

Absorption costing is good for

Answer 17

Long run pricing decisions and recovering fixed costs

Costing system used for external reporting

Question 18

Variable costing is good for

Answer 18

Closer to true cost behavior

Useful for short term decisions

No incentive to build up inventory

no denominator effects

Question 19

Cost accounting

Answer 19

Costs for inventory and external reporting

Informs important decisions in a business

Question 20

Management accounting

Answer 20

Budgeting: Translate plans into concrete action

Variance analysis: deviations of operations against original plan

Short/long term production decisions

Performance management and evaluation

Internal and external pricing

Question 21

The budgeting cycle

Answer 21

Planning the performance of the organization: starts with vision/strategy

Frame of reference: A set of specific expectations against which actual results are compared

Analysis of variance

Correcting actions