Ch.2 Cost terms

In the context of financial statement interpretation, what is vertical analysis?

A technique that expresses related financial amounts as a percentage of a significant base value, such as total revenue.

When performing vertical analysis on an income statement, which value is typically set as $100\%$?

Total revenue

According to the FASB, what is the definition of an asset?

Probable future economic benefits obtained or controlled by an entity as a result of past transactions or events.

What is the primary accounting difference between a cost and an expense?

Costs with future benefit are assets on the balance sheet, while costs with no remaining future benefit are expenses on the income statement.

An _____ refers to any cash outflow, regardless of whether it is used to purchase an asset or incur an expense.

expenditure

Why is a continuing education course typically expensed in the period it occurs rather than being recorded as an asset?

Because the future benefit is difficult to quantify objectively and assign to specific future periods.

How is opportunity cost defined in decision-making?

The net benefit of the alternatives or paths not taken.

True or False: Opportunity costs are recorded in a company's formal accounting books.

FALSE

What is a sunk cost?

A cost that has already been incurred and cannot be changed or recovered by any present or future decision.

Why should sunk costs be disregarded in current decision-making?

Because they cannot be undone and do not impact the incremental costs or benefits of today's choices.

Which type of business entity commonly carries no inventory or Cost of Goods Sold (COGS) accounts?

Service providers

For some service providers like accounting firms, what does Work-in-Process (WIP) Inventory represent?

Costs for work performed to date that have not yet been invoiced to the client.

How do merchandisers primarily generate profit?

By buying goods and reselling them at marked-up prices.

In a merchandising company, what specific costs are included in 'Merchandise Inventory'?

The invoiced purchase cost of the goods plus freight-in (transportation-in) costs.

When a merchandiser sells a product, where does the cost move from and to?

From Merchandise Inventory on the balance sheet to Cost of Goods Sold (COGS) on the income statement.

What is the primary business activity of a manufacturer?

The conversion of raw inputs into a final product with additional value for customers.

List the three categories of inventory typically found on a manufacturer's balance sheet.

Raw Materials (RM), Work-in-Process (WIP), and Finished Goods (FG).

What are the three components of product costs for a manufacturer?

Direct materials (DM), direct labor (DL), and manufacturing overhead (MOH).

Manufacturing overhead is a synonym for _____ costs in the factory.

indirect

What is the synonym for nonmanufacturing costs?

Period costs

Where are period costs reported in the financial statements?

On the income statement, typically under Selling, General, and Administrative (SG&A) expenses.

What defines a cost as a 'direct cost'?

It is an obvious component that can be easily and accurately traced to a specific cost object.

What is a 'cost object'?

The specific item (product, service, or activity) to which costs are being assigned.

What are the only two categories of direct product costs?

Direct materials (DM) and direct labor (DL).

Provide three examples of manufacturing overhead (MOH) costs.

Factory utilities, factory rent, and depreciation on factory equipment.

Formula: Prime Costs

$Direct Materials (DM) + Direct Labor (DL)$

Formula: Conversion Costs

$Direct Labor (DL) + Manufacturing Overhead (MOH)$

Why is adding total Prime Costs to total Conversion Costs an error in calculating total product cost?

It would result in double-counting the Direct Labor (DL) component.

How do total variable costs behave in relation to volume?

They change in total in direct proportion to changes in the volume of activity.

How does the variable cost per unit behave when volume changes?

It remains constant per unit.

How do total fixed costs behave within the relevant range?

They remain constant in total regardless of changes in volume.

How does the fixed cost per unit behave as the volume of activity increases?

It decreases as the total fixed cost is spread over more units.

What is 'capacity' in a manufacturing context?

The upper limit on the number of units that can be produced given existing space and equipment.

What is the 'relevant range'?

The range of activity (units) over which the company's current fixed costs and variable cost per unit remain constant.

A _____ cost contains both a fixed component and a variable component.

mixed

Which cost behavior type is usually cut first when managers need to reduce costs quickly?

Variable costs

Why is it difficult to reduce fixed costs overnight?

Because they are tied to capacity and long-term commitments like rent and depreciation.

Formula: Total Variable Costs

$$Variable Cost per Unit \times Volume of Cost Driver$$

Formula: Direct Materials Used

$Beginning DM Inventory + DM Purchases - Ending DM Inventory$

Formula: Total Manufacturing Costs (Current Period)

$Direct Materials Used + Direct Labor + Manufacturing Overhead$

What does Cost of Goods Manufactured (COGM) represent?

The total cost of the goods that were completed and transferred from WIP Inventory to FG Inventory during the period.

Formula: Cost of Goods Manufactured (COGM)

$Beginning WIP Inventory + Total Manufacturing Costs - Ending WIP Inventory$

What happens to costs in Work-in-Process (WIP) when a product is finished?

They are credited out of WIP Inventory and debited into Finished Goods (FG) Inventory.

Formula: Cost of Goods Available for Sale

$Beginning FG Inventory + Cost of Goods Manufactured (COGM)$

Formula: Cost of Goods Sold (COGS) for a manufacturer

$Beginning FG Inventory + COGM - Ending FG Inventory$

Which accounting principle dictates moving costs from the balance sheet to the income statement at the time of sale?

The expense recognition (matching) principle.

What is the primary focus of a traditional GAAP income statement?

Organizing costs by function (Product vs. Period).

What is the primary focus of a contribution margin income statement?

Organizing costs by behavior (Variable vs. Fixed).

Formula: Gross Margin

$Sales - Cost of Goods Sold (COGS)$

Formula: Contribution Margin (CM)

$Sales - Total Variable Costs$

Why is the contribution margin income statement typically for internal use only?

Because it discloses proprietary information about a company's cost structure.

What does the 'Contribution Margin' represent conceptually?

The amount of sales revenue remaining after variable costs are covered to contribute toward fixed costs and profit.

What is 'full cost' per unit?

The per-unit cost of all activities in the value chain, including both product and period costs.

Concept: Inventoriable Costs

Definition: Costs that are initially recorded as assets (inventory) on the balance sheet and only expensed (COGS) when the product is sold.

In a manufacturing firm, where are indirect materials like glue and staples recorded before they are used?

Raw Materials (RM) Inventory

At what stage of production are NO MORE product costs added to a unit?

When the unit is finished and moved to Finished Goods (FG) Inventory.

Cost of Goods Manufactured (COGM) is the sum of items transferred from _____ Inventory to _____ Inventory.

Work-in-Process (WIP); Finished Goods (FG)

Which income statement subtotal measures a company's ability to mark up products above their manufacturing costs?

Gross Margin

If a factory supervisor's salary is a fixed cost, how is it classified in terms of product vs. period costs?

It is a product cost (specifically Manufacturing Overhead).

How does the 'Full Cost' of a product differ from its 'Product Cost'?

Full cost includes SG&A (period) costs in addition to manufacturing (product) costs.

The _____ point is the level of sales where the revenue line intersects the total cost line.

break-even

What is the accounting synonym for 'Total cost of revenues'?

Cost of Goods Sold (COGS)

Raw Materials Inventory components: _____ + Freight-In.

RM Invoice price

Is 'shipping expenses for digital sales' typically a product cost or a period cost for a merchandiser like Kohl's?

Period cost (Selling, General, and Administrative expense).

True or False: All costs incurred in a factory are manufacturing overhead.

False (They could also be Direct Materials or Direct Labor).

If a manufacturer has $1,000$ in total fixed costs and produces $100$ units, the fixed cost per unit is _____.

$$10$

Continuing the previous example: If the manufacturer increases production to $200$ units, what is the new fixed cost per unit?

$$5$

What document is used to authorize the release of materials from storage to the production floor?

Materials requisition form

Which cost category includes the 'marketing, selling, and administrative' expenses of Royal Caribbean?

Period costs (Nonmanufacturing costs)

In the 'Let's Walk Through It 2.9' cake example, why did total profit more than double when the number of slices doubled?

Because the fixed cost per slice was halved, increasing the profit margin on every slice sold.

Why are 'Mixed Costs' separated into fixed and variable components?

To allow for accurate budgeting, what-if analysis, and the creation of contribution margin income statements.

Which inventory account is the 'landing place' for all product costs during the conversion process?

Work-in-Process (WIP) Inventory

True or False: Depreciation on the 'front office' equipment is a product cost.

False (It is a period cost).

In vertical analysis, if total revenue is $$1,818$ and ticket revenue is $68.83\%$, what is the dollar amount of ticket revenue?

$$1,251.33$

What is the 'value chain'?

A series of activities (R&D, Design, Production, Marketing, Distribution, Customer Service) that add value to a product or service.

Which type of cost does not change in total when activity levels fluctuate within the relevant range?

Fixed costs

Is 'factory supervisor salary' a direct or indirect cost of a single unit of product?

Indirect cost

For a service firm like FedEx, why might there be no COGS on the income statement?

Because they provide services rather than physical goods, and their costs are typically expensed as incurred.

Which financial statement reports RM, WIP, and FG inventory balances?

The Balance Sheet (specifically under Current Assets).

Concept: Sunk Cost Fallacy

The tendency to continue an endeavor once an investment in money, effort, or time has been made, even if the current costs outweigh the benefits.

What is the subtotal found on a traditional income statement but NOT on a contribution margin income statement?

Gross Margin

What is the subtotal found on a contribution margin income statement but NOT on a traditional income statement?

Contribution Margin

If Sales = 1,000$, Variable Costs = 400$, and Fixed Costs = $$300$, what is the Contribution Margin?

$$600$

Using the data from the previous card, what is the Operating Income?

$$300$

Why is the cost of 'freight-in' considered an inventoriable cost for a merchandiser?

Because it is a necessary cost to get the merchandise ready for sale.