Raw Materials

materials that go into the final product. Includes direct and indirect materials. Direct materials become an integral part of the finished product and whose cost can be conveniently traced to the finished product. Indirect materials are included in manufacturing overhead, things like glue.

Direct Labor

labor that can be easily traced to individual units of the product. Labor costs that cannot be traced to particular products are indirect labor. This is put in manufacturing overhead.

Manufacturing Overhead

Includes indirect materials, indirect labor, maintenance and repairs, heat and light, property taxes, depreciation, and insurance. Only costs associated with operating the factory are included in manufacturing overhead.

Selling Costs

includes all costs that are incurred to secure customer orders and to get the finished product to the customer. Examples are: advertising, shipping, sales, travel, sales commissions, sales salaries, and cost of finished goods.

Administrative Costs

include all costs associated with the general management of an organization. Examples are: executive compensation, general accounting, secretarial, and public relations.

Product Costs

involved in acquiring or making a product: direct materials, direct labor, and manufacturing overhead. Product costs are initially assigned to an inventory account on the balance sheet. When the goods are sold, the costs are released from inventory as expenses (COGS) and matched against sales revenue.

Period Costs

all the costs that are not product costs. All selling and administrative expenses are treated as period costs. Period costs are expensed on the income statement in the period in which they are incurred using accrual accounting.

Prime Cost

Direct materials + Direct labor

Conversion Costs

Direct labor + Manufacturing Overhead

Cost Behavior

refers to how a cost reacts to changes in the level of activity. As the activity level rises and falls, a particular cost may rise and fall as well. A manager must be able to anticipate which one of these will happen. They do this by categorizing costs into variable, fixed, or mixed. The relative proportion of each type of cost in an organization is the cost structure.

Variable Cost

direct proportions to changes in the level of activity. Examples are: goods sold for a merchandising company, direct materials, supplies, and power, and variable elements of selling and administrative expenses such as commissions and shipping costs.

activity base (cost driver)

a measure of whatever causes the incurrence of a variable cost. Examples are: direct labor hours, machine hours, units produces, units sold, and number of (miles).

Fixed Costs

Examples are: straight line-depreciation, insurance, property taxes, rent, supervisory salaries, and advertising.

Mixed Costs

contains both variable and fixed cost elements. The high-low and least squares regression methods estimate the fixed and variable elements of a mixed costs by analyzing past records of cost and activity data.

Y = a + bX

Y = total mixed cost
A= total fixed costs
B= variable cost per unit of activity
X= level of activity

Contribution Format Income Statement

Separates costs into fixed and variable costs.

Direct Costs

can be conveniently traced to a specific cost object.

Indirect Costs

cannot be traced to a specific cost object.

Sunk Cost

a cost that has already been incurred and cannot be changed.

Computing Predetermined Overhead Rate

Manufacturing Overhead is an indirect cost.
Consists of many items ranging from grease used in machines to annual salary of the production manager.
Total manufacturing overhead costs tend to remain relatively constant from one period to the next.

Predetermined overhead rate = (estimated total manufacturing overhead) ÷ (estimated total amount of allocation base)

4 Step Process

1. Estimate the total amount of the allocation base (the denominator) that will be required for next period's estimated level of production.
2. Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base.
3. Use the cost formula to estimate the total manufacturing overhead cost for the coming period.

Y=a+bX

Y=estimated total manufacturing overhead cost
A=estimated total fixed manufacturing overhead cost
B= estimated variable manufacturing overhead cost per unit of the allocation base
X= estimated total amount of the allocation base

4. Compute the predetermined overhead rate.

Applying Manufacturing Overhead

The predetermined overhead rate is computed before the period begins. The predetermined overhead rate is then used to apply overhead cost to jobs throughout the period.

Overhead applied to a particular job = (Predetermined overhead rate) x (Amount of the allocation base incurred by the job)

If the predetermined overhead rate is $8 per direct labor-hour, then the $8 of overhead cost is applied to a job for each direct labor-hour incurred on the job. When the allocation base is direct hours the formula becomes:

Overhead applied to a particular job = (Predetermined overhead rate) x (Actual direct labor hrs charged to the job)