D.1. Cost Classifications and Costing Methods

Question 1

What is the primary function of cost management systems?

Answer 1

To provide reliable financial reporting and track costs for management decision-making.

Cost management helps managers focus on factors that contribute to the company’s success by identifying, summarizing, and reporting on critical success factors.

Question 2

Define:

Critical success factors

Answer 2

Characteristics, conditions, or variables that have a direct and important impact on the efficiency, effectiveness, and viability of an organization.

Critical success factors are actions an organization needs to take to achieve its goals and objectives. They are essential to its competitive advantage.

Question 3

What are the two aspects of operations important for evaluating operating performance?

Answer 3

• Effectiveness
• Efficiency

Effectiveness is achieving or exceeding set goals, while efficiency is making effective use of resources.

Question 4

What is the difference between costs and expenses?

Answer 4

• Costs are resources given up to achieve an objective
• Expenses are costs charged against revenue in a specific accounting period

A cost need not be an expense, but every expense was a cost before it became an expense.

Question 5

What are inventoriable costs?

Answer 5

They are product costs, costs for the production process without which the product could not be made, including direct materials, direct labor, and manufacturing overhead.

Product costs are carried on the balance sheet as inventory until the unit is sold, at which point they are classified as cost of goods sold.

Question 6

List the main types of product costs.

Answer 6

• Direct labor
• Direct material
• Manufacturing overhead

Manufacturing overhead includes costs related to the production process that are not direct material or direct labor but are necessary costs of production. Examples are indirect labor, indirect materials, rework costs, utilities, depreciation of plant equipment, and factory rent.

Question 7

What are period costs?

Answer 7

Costs for activities other than the actual production of the product. They are expensed as incurred.

Period costs include general, administrative, and selling expenses. They are all costs that are not included in the calculation of cost of goods sold.

Question 8

What are fixed costs?

Answer 8

Costs that do not change in total within the relevant range of activity.

Fixed costs remain constant in total as long as the activity level remains within the relevant range, but the cost per unit decreases as activity increases.

Question 9

What are variable costs?

Answer 9

Costs incurred only when the activity to which they pertain takes place, with the per unit cost remaining unchanged as activity changes.

Total variable costs increase with activity level increases and decrease with activity level decreases.

Question 10

What are mixed costs?

Answer 10

Costs with both a fixed and a variable component.

An example is a contract for electricity with a basic fixed fee that is charged whether any electricity is used or not, that covers a certain number of kilowatts of usage per month, and usage over that allowance is billed at a specified amount per kilowatt used.

Question 11

What are prime costs?

Answer 11

The costs of direct material and direct labor.

Prime costs are the direct inputs or direct costs of manufacturing.

Question 12

What are conversion costs?

Answer 12

Costs required to convert direct materials into the final product, including manufacturing overhead and direct labor.

Direct labor is both a prime cost and a conversion cost.

Question 13

True or False:

All costs eventually become expenses.

Answer 13

False

Some costs, such as opportunity costs, never become expenses in the accounting records.

Question 14

Define:

Semi-variable cost

Answer 14

It is a type of mixed cost. It has both a fixed component and a variable component.

It includes a basic fixed amount that must be paid regardless of activity and an amount that varies with activity.

Question 15

What is a semi-fixed cost?

Answer 15

Aalso called a step cost, it is fixed over a small range of activity and jumps when activity exceeds that range. It stays fixed again for a while at the higher range of activity and then jumps again.

A semi-fixed cost is fixed, but over a smaller range than the relevant range of a wholly fixed cost.

Question 16

How are total costs calculated?

Answer 16

Total costs consist of total fixed costs plus total variable costs.

In theory at least, total costs graph as a straight line beginning at the fixed cost level on the Y intercept and rise at the rate of the variable cost per unit.

Question 17

What are direct costs?

Answer 17

Costs that can be traced directly to a specific cost object.

Examples include direct materials and direct labor used in production.

Question 18

What are indirect costs?

Answer 18

Costs that cannot be identified with a specific cost object.

Manufacturing overhead is an indirect cost. Manufacturing overhead costs are grouped into cost pools for allocation.

Question 19

What are explicit costs?

Answer 19

They involve payment of cash and include wages, office supplies, and payments to vendors.

They are also called out-of-pocket costs.

Question 20

Define:

Implicit costs

Answer 20

They do not involve specific cash payments and are not recorded in accounting records.

They are also known as imputed or economic costs.

Question 21

What is an opportunity cost?

Answer 21

It is the contribution to income lost by not using a resource in its best alternative use.

It is a type of implicit cost considered an economic cost.

Question 22

What are carrying costs?

Answer 22

They are costs incurred when holding inventory, including rent and utilities related to storage; insurance and taxes on the inventory; other storage costs; and the opportunity cost (an implicit cost) of having money invested in inventory.

Carrying costs that are explicit costs are expensed on the income statement as incurred.

Question 23

What are sunk costs?

Answer 23

They are costs that have already been incurred and cannot be recovered.

They are irrelevant in decision-making processes.

Question 24

What are infrastructure costs?

Answer 24

They are costs that are required to establish and maintain business readiness.

They are fixed costs usually on the balance sheet as assets.

Question 25

What are **discretionary** costs?

Answer 25

They are costs that may or may not be incurred at the manager's discretion. ## Footnote Examples include advertising, R&D, and employee training.

Question 26

What are **engineered** costs?

Answer 26

They are variable costs that result from activities that have well-defined cause and effect relationships between inputs and outputs and between costs and benefits. ## Footnote They are “engineered costs” because engineers specify how many inputs are required to generate a specific output. Direct materials and direct labor are examples because the quantities required for production of a specific output are part of the engineering specifications for that output.

Question 27

What are **marginal** costs?

Answer 27

They are the additional costs necessary to produce one more unit.

Question 28

What is **product costing**?

Answer 28

It involves accumulating, classifying, and assigning costs to products, jobs, or services. ## Footnote Product costing includes direct materials, direct labor, and factory overhead costs.

Question 29

When is **job order costing** used?

Answer 29

When units of a product or service are distinct and separately identifiable. ## Footnote Costs are accumulated by job.

Question 30

When is **process costing** used?

Answer 30

When many identical or similar units of a product or service are being manufactured, such as on an assembly line. ## Footnote Costs are accumulated by department or process.

Question 31

What is **standard** costing?

Answer 31

It involves assigning standard, or planned, costs to units produced. ## Footnote It is based on the standard cost allowed for each input required to produce an output unit.

Question 32

What is the standard cost of an input for one unit of output?

Answer 32

Standard price per unit of the input × standard quantity of the input allowed per unit of output.

Question 33

How is overhead generally **allocated** in a standard cost system?

Answer 33

By calculating a predetermined manufacturing overhead rate that is applied to the units produced on the basis of the standard amount of the allocation base allowed for the actual output.

Question 34

What is the best cost driver to use as the **allocation base**?

Answer 34

The measure that best represents what causes overhead costs to be incurred.

Question 35

What are the **most frequently used** allocation bases?

Answer 35

* Direct labor hours * Direct labor costs * Machine hours

Question 36

How is the **predetermined overhead application rate** calculated?

Answer 36

Predetermined overhead application rate per unit of the allocation base = Budgeted Monetary Amount of Manufacturing Overhead ÷ Budgeted Activity Level of Allocation Base.

Question 37

How may **immaterial variances** be resolved?

Answer 37

They may be closed out 100% to cost of goods sold expense on the income statement.

Question 38

What is the emphasis on in standard costing?

Answer 38

Flexible budgeting, where the flexible budget for the actual production is equal to the standard cost per unit of output multiplied by the actual production volume.

Question 39

How is the predetermined overhead application rate per unit of the allocation base used in normal costing, and what is the purpose of using a predetermined manufacturing overhead application rate in normal costing?

Answer 39

In normal costing, the predetermined overhead application rate per unit of the allocation base is multiplied by the **actual** amount of the allocation base that was used in producing the product. The purpose is to normalize factory overhead costs and avoid month-to-month fluctuations in cost per unit.

Question 40

What is the **main difference** between normal costing and standard costing in terms of overhead application?

Answer 40

Both normal and standard costing use a predetermined overhead application rate per unit of the allocation base that is calculated the same way: Budgeted Monetary Amount of Manufacturing Overhead ÷ Budgeted Activity Level of Allocation Base. In normal costing, the amount applied to production is the predetermined overhead application rate multiplied by the **actual** amount of the allocation base used for the actual production. In standard costing, the amount applied to production is the predetermined overhead application rate multiplied by the **standard** amount of the allocation base that was allowed for the actual production.

Question 41

What is the **main disadvantage** of actual costing?

Answer 41

It can produce costs per unit that fluctuate significantly, leading to potential errors in management decisions.

Question 42

What types of costing are generally used for **job order costing**?

Answer 42

Normal or actual costing.

Question 43

When standard costing is used, how are the direct input costs (direct materials and direct labor) that are applied to each unit produced calculated, and how is the total cost applied to the total actual production calculated?

Answer 43

When standard costing is used, the direct input costs applied to each unit produced will be the **standard** cost per input unit multiplied by the **standard quantity** of the input **allowed** per unit produced. Total direct input cost applied = Standard cost per input unit × Standard input quantity allowed per output unit × Number of units actually produced

Question 44

When normal or actual costing is used, how are the direct input costs (direct materials and direct labor) that are applied to each unit produced calculated, and how is the total cost applied to the total actual production calculated?

Answer 44

When normal or actual costing is used, the direct input costs applied to each unit produced will be the **actual** cost per input unit multiplied by the **actual quantity** of the input **used** per unit produced. Total direct input cost applied = Actual cost per input unit × Actual input quantity used per output unit × Number of units actually produced

Question 45

When standard costing is used, how is overhead to be applied to each unit produced calculated, and how is the total cost applied to the total actual production calculated?

Answer 45

When standard costing is used, the overhead applied to each unit produced will be the predetermined overhead application rate per unit of the allocation base multiplied by the standard quantity of the allocation base allowed per unit produced. Total overhead applied = Predetermined OH application rate per unit of allocation base × Standard quantity of allocation base allowed per output unit × Number of units actually produced

Question 46

When normal costing is used, how is overhead to be applied to each unit produced calculated, and how is the total cost applied to the total actual production calculated?

Answer 46

When normal costing is used, the overhead applied to each unit produced will be the predetermined overhead application rate per unit of the allocation base multiplied by the actual quantity of the allocation base used per unit produced. Total overhead applied = Predetermined OH application rate per unit of allocation base × Actual quantity of allocation base used per output unit × Number of units actually produced

Question 47

When actual costing is used, how is overhead to be applied to each unit produced calculated, and how is the total cost applied to the total actual production calculated?

Answer 47

When actual costing is used, the overhead applied to each unit produced will be the actual overhead cost per unit of the allocation base used multiplied by the actual quantity of the allocation base used per unit produced. Total overhead applied = Actual cost per unit of the allocation base used × Actual quantity of allocation base used per output unit × Number of units actually produced **Or simply: Actual Overhead Cost Incurred**

Question 48

What are the **benefits** of using standard costing?

Answer 48

* It enables management to compare actual costs with what the costs **should have been** for the actual production. * Production can be accounted for as it occurs. * It prescribes expected performance and provides control. * Standards can provide benchmarks for employees to use to judge their own performance. * It facilitates management by exception, because as long as the costs remain within standards, managers can focus on other issues. * Standard costing can be used in either a process costing or a job-order costing environment.

Question 49

What is a **limitation** of standard costing related to fixed overhead?

Answer 49

Using a predetermined fixed overhead rate per unit of the allocation base can cause total fixed overhead applied to be greater or less than the actual fixed overhead incurred, depending on production levels.

Question 50

How does normal costing affect variance reporting for direct material and direct labor?

Answer 50

When normal costing is being used, direct materials and direct labor costs are applied to production at their actual rates multiplied by the actual amount of the direct inputs used in the production. Therefore, under normal costing, no direct material or direct labor variances can exist because actual costs incurred are equal to the costs applied to production.

Question 51

What are the **benefits** of normal costing?

Answer 51

* It avoids the fluctuations in cost per unit that occur under actual costing. * Manufacturing costs of a job are available earlier than would be under an actual costing system. * It allows management to keep direct product costs current because actual costs incurred are used in costing the production, while the actual incurred overhead costs that would not be available until much later are applied based on a predetermined rate.

Question 52

What are the **limitations** of actual costing?

Answer 52

* Cost information is not available as quickly after the end of a period as it is with standard costing. * Actual costing leads to fluctuations in job costs because the amount of actual overhead incurred fluctuates throughout the year. * Actual costing is not appropriate for process costing because the actual costs would be too difficult to trace to individual units produced.

Question 53

What does **cost of goods sold** (COGS) include?

Answer 53

COGS includes the direct material and direct labor costs of each unit sold and an allocation of a portion of manufacturing overhead costs.

Question 54

What is the **difference** in reporting between COGS and COGM?

Answer 54

* COGS is an externally reported expense on the income statement. * COGM is an internal number not reported in financial statements.

Question 55

What is the formula for calculating **cost of goods sold**?

Answer 55

Beginning FG Inventory + Purchases* − Ending FG Inventory ## Footnote *or, for a manufacturer, Cost of Goods Manufactured

Question 56

What is the formula for calculating **cost of goods manufactured**?

Answer 56

Beginning Work-in-Process Inventory + Total Manufacturing Costs − Ending Work-in-Process Inventory ## Footnote Total manufacturing costs = Direct materials used + Direct labor used + Manufacturing OH applied. Direct materials used = Beginning direct materials inventory + Purchases + Transportation-In − Net returns − Ending direct materials inventory