Study%20Guide%20Exam%202%20102.pdf

Primary Users of Accounting Information

• Financial Accounting

  • Used by external users:

    • Investors

    • Creditors

    • Regulators

    • Tax authorities

• Managerial Accounting

  • Used by internal users:

    • Company managers

    • Employees

  • Purpose: To aid in informed business decisions

Regulation of Accounting

• Financial Accounting Regulation

  • Heavily regulated by standards:

    • GAAP (Generally Accepted Accounting Principles)

    • IFRS (International Financial Reporting Standards)

• Managerial Accounting Regulation

  • Not regulated

  • Developed for internal use; companies can design systems for specific needs

Period Costs vs. Product Costs

• Period Costs

  • Defined as costs not directly tied to the production process

  • Examples:

    • Administrative expenses

    • Selling expenses

  • Accounting treatment: Expensed in the period incurred

• Product Costs

  • Costs that are capitalized as inventory

  • Expensed as cost of goods sold when the product sells

Depreciation on Manufacturing Equipment

• Treatment of Depreciation

  • Depreciation is considered a product cost

  • Included in the cost of inventory

  • Expensed as part of cost of goods sold when the product is sold, not when depreciation occurs

Indirect Costs

• Definition

  • Costs that cannot be traced directly to a specific product

  • Examples:

    • Factory utilities

    • Supervisor salaries

• Accounting for Indirect Costs

  • Allocated to products using cost allocation methods

  • Included in manufacturing overhead

Upstream Costs

• Definition

  • Costs incurred before the production process

  • Examples:

    • Research and development

    • Product design

    • Supply chain planning

• Specific Upstream Costs for a Software Company

  • Software development

  • Licensing

  • Planning or market research

Cost Behavior

• Fixed Costs

  • Total Fixed Cost Behavior with Volume Increases

    • Remains constant regardless of production volume changes

  • Fixed Cost Per Unit with Decreasing Volume

    • Increases as total cost remains constant, spread over fewer units

• Variable Costs

  • Total Variable Cost with Increasing Volume

    • Increases proportionally

  • Variable Cost Per Unit with Decreasing Volume

    • Remains constant

Mixed Costs

• Definition

  • Costs that have both fixed and variable components

  • Example: Utility bill with a fixed base charge and a variable cost for usage

Cost Structure

• Definition

  • Proportion of fixed and variable costs in total cost mix

Contribution Margin Approach in Income Statement

• Format

  • Sales

  • Variable Costs

  • Contribution Margin = Sales - Variable Costs

  • Fixed Costs

  • Operating Income = Contribution Margin - Fixed Costs

Relevant Range

• Definition

  • Range of activity where cost behaviors remain consistent

• Effects on Fixed Costs

  • Fixed costs remain constant within the relevant range

  • Outside of the relevant range, costs may increase due to capacity constraints

Significance of Estimating Fixed and Variable Components of Mixed Costs

• Importance

  • To improve budgeting, forecasting, and decision-making accuracy

  • Necessary for break-even and cost-volume-profit analyses

Break-Even Point

• Definition

  • Level of sales at which total revenues equal total costs, resulting in zero profit

Prestige Pricing

• Definition

  • Strategy of setting higher prices to indicate higher quality or exclusivity

• Application Circumstances

  • Appropriate for luxury or premium products where customer perception of value is critical

Pricing Strategies Comparison

• Cost-Plus Pricing

  • Adds a markup to the cost to determine the price

• Target Pricing

  • Begins with a market-based price and subtracts desired profit

  • Focus:

    • Cost-plus: internally focused

    • Target pricing: market-driven

Impact of Variable Costs on Break-Even Point

• Increase in Variable Costs

  • Causes the break-even point to rise, as more sales revenue is needed to cover higher variable costs and fixed expenses

Effect of Total Fixed Costs on Break-Even Point

• When Total Fixed Costs Increase

  • Break-even point increases, requiring higher sales to cover elevated fixed costs

Margin of Safety

• Definition

  • Measurement of how much sales can decrease before reaching the break-even point

  • Reflects business risk

Cost-Volume-Profit Analysis for Multiple Products

• Usability

  • Useful as companies can utilize a weighted average contribution margin based on sales mix to perform CVP analysis across multiple products