Chapter 2: Basic Cost Terms and Concepts - Fixed - Variable Cost Concepts Management Implications

Profit = (Sales Revenue-Variable Cost) - Fixed Cost Cost Terms Fixed Costs: costs that remain constant regardless of the quantity of product produced. Variable Costs: costs that increase linearly and proportionately as production volume increases. Profit = (Sales Revenue-Variable Cost) - Fixed Cost Total Contribution Margin

Cost Terms (Continued) Cost Driver: Manufacturing Cost: Sales and General Administrative Costs: Direct and Indirect Costs: Controllable and Uncontrollable Costs: Product/Period Cost: Any activity or event that causes costs to be incurred. Direct material (DM), direct labor (DL), and manufacturing overhead (MOH). All costs associated with running the business, excluding production costs. Costs that can either be traced (direct) or not traced (indirect) to a specific department in the organization. Costs used to describe the extent of a manager’s influence on cost. Refers to the timing which costs become expenses.

Economic Terms Opportunity Cost: Sunk Cost: Differential and Incremental Cost: Marginal Cost: Average Cost per Unit: Benefit lost because the choice of one action precludes another action. Costs that have already been incurred and can not be altered by current or future decisions. Difference in the costs incurred under two alternative actions. Cost associated with producing one additional unit. Total cost for the quantity produced, divided by the number of units produced.

Bala’s Bare Bones Manufacturing Facility Direct Material Purchased Direct Material Storage It’s a Warehouse! Raw Materials Direct Material Used Finished Goods Inventory Direct Material WIP Manufacturing Overhead Costs

Cost Concept Direct Material Inventory Work in Process Inventory Beginning Transfer to Inventory WIP $1,000 $78,000 Purchases $79,000 Ending Inventory $2,000 Work in Process Inventory Beginning Transfer to Inventory Finished $40,000 Goods Inventory Direct $350,000 Material $78,000 Direct Labor $82,000 MOH Incurred $170,000 Ending $20,000 Finished Goods Inventory Beginning Cost of Inventory Goods Sold $1,000 (shipped) $340,000 Goods Completed From WIP $350,000 Ending Inventory $11,000

Raw Material Inventory Finished Goods Inventory Allocation of Costs Storeroom Direct Material Used (DMU) Raw Material Inventory Factory WIP Inventory Cost of Goods Manufactured (COM) Direct Material Purchased (DMP) Warehouse Direct Labor (DL) Cost of Goods Sold (COGS) Finished Goods Inventory Manufacturing Overhead (MOH)

Managerial Implications Is it better to under or over-apply overhead? If OH is over-applied (allocated >actual), you will be “surprised” how well you actually did when making end of period adjustments. If OH is under-applied (allocated<actual), you will be “surprised” how well you thought you did when making end of period adjustments. If your compensation or incentive plan is based on profit, which would you choose?