Week 6 non mid-term Flashcards
Variable vs Absorption costing
Absorption- Fixed manufacturing costs are assigned to inventory (Each unit produced absorbs some FOH
Variable- Costs not assigned to inventory (FOH is a period expense)
Problems with Absorption costing
- Can lead to death spiral
- Discourages the use of OH Drivers
- Encourages inventory build-up
- Discourages work with positive but low CM
Death Spiral meaning
Low demand > Report low gross margins > firm eliminates product line > Firm lowers activity base, causing full costs of remaining lines to rise > firm raises prices on remaining products > Low demand again
Gross Margin formula
Revenue - COGS (Cogs includes allocated fixed costs)
Contribution margin formula
Revenue - Variable costs
Projected production approach
Use budgeted/expected driver use as denominator in PDR formula
PDR formula
??
Budgeted production meaning
The amount we expect to produce next period (Bad denominator)
Theoretical capacity
The amount tht could be produced under ideal impossible to achieve conditions (bad denominator)
Practical capacity
What we’d probably have if the market could support it, allowing for surge buffer mistakes (good denominator)
Problems with variable costing
- Easy to forget FOH and not charge enough to cover the costs
- Encourages overuse of limited resources
- Violates GAAP standards
When use absorbtion or variable costing
Absorption costing - for long-run pricing decisions and costing system used for external reporting
Variable costing - closer to true cost behavior, for short-term decisions, no incentive to build up inventory and no denominator effects
Variable vs Absorption costing
Variable:
(Direct labor, direct material, variable MOH,) - Inventoriable
(Fixed MOH, fixed manufacturing costs, fixed M&S expenses) - Expenditure
Absorption:
(Direct labor, direct material, variable&fixed MOH) - Inventoriable
(Fixed manufacturing costs, fixed M&S expenses) - Expenditure
Direct method of Cost allocation
allocates the costs of service departments directly to production departments, ignoring any services rendered between service departments.
Step down method of cost allocation
Allocates service department costs to both production departments and other service departments, but in a predefined order. After a department is allocated, it’s closed — no costs are allocated back to it.
Reciprocal method of cost allocation
Fully accounts for mutual services provided between service departments using simultaneous equations.
Activity based costing (ABC) costing method
assigns overhead and indirect costs to products or services based on the activities that drive those costs (Not using labor hours but instead traces to specific activities and cost drivers, like orders)
Operating income formula
Revenues - Operating costs
Denominator level
the amount of activity (like machine hours or labor hours) that you use to allocate fixed manufacturing overhead to products
