Final Review

Things You Must Know

Product Costs:

All costs required to manufacture the product –
Direct Material, Direct Labor, Manufacturing Overhead

Reported as inventory (inventoriable) on the balance sheet until sold
When products are sold – costs become cost of goods sold on income statement


Period Costs:

Reported on the income statement in the period incurred, not related to manufacturing the product.

Warehouse costs and people who move inventory inside the company

Selling Costs –
costs related to selling, marketing & getting products to customer

Administrative Costs –
support the organization; “corporate”, “administrative”


Other Terms That Are Used:

Prime Costs – direct materials plus direct labor
Conversion Costs – direct labor plus manufacturing overhead
Direct Cost – easily and conveniently traced to one product (DM & DL)
Indirect Cost – cannot be easily and conveniently traced to one product (MOH, Period)



Incurred to manufacture products. Anything that becomes part of the product, anyone who touches the product to make it, and all the costs of the facilities and management incurred to make the product.

Direct Materials –
Raw materials that become a part of the finished product
It is easy to track how much material is required to make one product.

Direct Labor –
Touch the product to make the product, operate the machine to make it

Manufacturing Overhead –
All costs to manufacture, except DM & DL. If the cost has word
“factory”, “plant”, “manufacturing”, or “indirect” it will be part of manufacturing overhead.

Indirect – cannot easily determine how much of these costs it takes to make 1

Indirect labor – Involved in making the product at the plant, does not touch the product to make it. Example: salaries of the managers, supervisors, QC

Indirect Material – Not easy to track the material quantity required to make one

Variable Cost –
The same per unit, changes in total as volume changes

Fixed Cost –
The same in total, varies per unit as volume changes

Relevant Range –
the range of activity where the fixed costs will not change
“assumption about cost behavior remains the same”

Opportunity Cost –
Benefit given up because you chose another alternative, not recorded

Sunk Cost –
Cost that will not change –
Already paid for and can’t recover the cost

Committed –
Can’t be significantly reduced without changing the long-term goals

Discretionary –
Management can decide not to spend without impacting long term goals

A cost that says “per unit or per activity” will always be a variable cost
Direct materials, direct labor, sales commissions paid based on sales

A cost that is paid annually/monthly in a lump sum will always be a fixed cost
Almost all administrative costs are fixed
All salary is fixed

Mixed Costs (also known as semi-variable costs):
Contains both variable and fixed costs

Fixed – minimum cost of having a service ready and available for use
Variable – cost incurred for additional or actual consumption of the service


Mixed costs behave like variable costs – as activity increases so does the cost
and as activity decreases so does the cost (until you hit the fixed cost amount)

Raw (Direct) Materials: materials on the shelf that will go into the product
Work in Process: material, labor and manufacturing overhead added to make product
Finished Goods: completed product, put in warehouse until sold
When sold: becomes “Cost of Goods Sold” on the income statement

Lists the cost to make a product: consists of DM, DL, MOH applied

Manufacturing Overhead: These are indirect costs which are impossible to trace to
one particular product – allocated to each job using a “predetermined overhead rate

Applying overhead puts manufacturing O/H into the cost of the product so that it
becomes part of WIP, and then FG, and then CGS.

General rules for journal entries at a manufacturing company
Debit WIP for the use of product costs – direct material, direct labor, apply manufacturing O/H
Debit manufacturing overhead for actual manufacturing overhead incurred
Debit finished goods, credit WIP when completed.
Debit CGS and credit finished goods when the goods are sold,
Expense all period costs; selling, administrative, warehouse, shipping

When you have more than one job – Use more than one WIP account. “WIP-xxx”

Under or over applied manufacturing overhead
Compare the applied manufacturing O/H incurred to actual manufacturing O/H

The difference in the actual and the estimate is stated in terms of
Underapplied – applied overhead (estimated) costs is less than actual costs
Overapplied — applied overhead (estimated) costs is more than actual costs

Get the manufacturing overhead account to –0- compare the debit and credit

If immaterial, put to CGS,
If material, allocate to WIP, FG, and CGS

Traditional product costing – one overhead allocation rate per one activity
Only manufacturing costs are assigned to products (required by GAAP)
Costs is spread equally over all products whether or not they require equal effort

Activity Based costing – more than one overhead allocation rate and activity
Non manufacturing costs and manufacturing costs are assigned to products
This is not according to GAAP, but useful for internal management)

Cost of doing an activity is allocated to the product based on how often the activity occurs

Activity: something that is done in support of a product or customer
Cost Driver/Transaction Driver: quantifiable event that occurs causing costs
Activity Cost Pool: All costs relate to a single type of activity

Types of Activities for Activity Based Costing:

Unit level activities:
performed each time a unit is produced
(electricity to run equipment, direct labor, direct materials)

Batch level activities:
performed each time a batch is handled or processed
(purchase orders, equipment set-up, customer invoicing)

Product level activities:
relate to specific products and must be carried out even for 1
(design a product, advertising, plant manager’s salary)

Customer level activities:
relate to specific customers
(sales calls, catalog mailings)

Organization Sustaining:
carried out regardless of how many products are sold
(computer network, executive salaries, corporate expenses)

Determine a cost per activity for each cost pool

Multiply the cost per activity by the quantity of activity for each product to apply


Estimated: expect to pay and the quantity you expect to use to make one product A “standard” is normally a “per each” amount

Quantity (Efficiency) Standard – how much you expect to use to make
on Cost (Price) Standard – how much you expect to pay for each one



difference in actual dollars incurred and the standard/budgeted dollars to make the product.

Variance analysis compares actual to budgeted costs.


Variable Cost Variances

AQ x AP      AQ x SP      SQ x SP

SQ = Actual units made x Standard Quantity for one unit

Material: price & quantity
Labor: rate & efficiency
Variable Overhead: spending & efficiency

Fixed Manufacturing Overhead Variances

Actual Budget SQ x SP
Fixed Overhead: budget & volume

Budgeted Fixed Overhead Dollars

Total expect to spend for an estimated level of production

Applied Fixed Overhead

Estimate of what should have been spent for actual units made
(units made x quantity per unit of activity x rate per activity)


Budget Variance

Actual compared to Budget. This variance tells you if you spent more or less total dollars than expected.

Volume Variance

Budget compared to Applied. The difference is caused by not producing as much or producing more actual units than expected.

Unfavorable: spent more than standard/budgeted; it actually cost you more- Left > Right
Favorable: spent less than standard/budgeted; it actually cost you less – Left  Right>

Absorption Costing (also called Full Costing) – includes all product costs –direct materials, direct labor, variable manufacturing overhead and fixed manufacturing overhead as inventory costs, in accordance with GAAP – sorts by product and period

Variable Costing – includes direct materials, direct labor and variable manufacturing overhead as product costs and considers fixed manufacturing overhead to be a period expense. This is not in accordance with GAAP – sorts by cost behavior, variable & fixed

When preparing the income statement: Total variable costs = cost per unit x unit sold

The real difference in the two methods:
Fixed manufacturing overhead costs is different:
Absorption costing – product cost, becomes part of inventory
Variable costing – it is a period cost and is ALL expensed as incur

Inventory decrease – absorption is lower
Inventory increase – absorption is higher

Centralized Organization:

Executive management make all decisions

Decentralized Organization:

Decisions are made at many levels of management

Segments –

Part or activity of the business where revenue or cost data is necessary
A segment will be a cost, profit, or investment center

Responsibility Accounting System:

Reports by cost, profit, and investment centers.

Cost Center

Manager is responsible for costs, but generates no revenue
Expected to minimize costs while providing service to the organization

Revenue Center:

Manager is responsible for sales but cannot determine sales price

Profit Center

Manager is responsible for both revenues and costs

Investment Center

Manager is responsible for revenues, cost, investment in assets

Traceable (direct) costs:

Costs that would not be incurred if the segment were closed
Only traceable or direct costs are written in the segment column

Common (allocated) costs:

Costs incurred in support of more than one segment.
If the segment is discontinued, the costs will be allocated to other segments.
Common costs are not allocated to segments. Report only in total company column
Common costs are also called nontraceable, allocated, corporate, indirect


Segment Margin: the profitability of the segment after it has covered all its direct costs.

Process costing

Used when products are mass produced, homogenous
Separate work in process accounts are used for each department/process


Equivalent Units

The number of whole units you would have if all units in process were complete
The number of whole units that could have been produced from the material added and the effort put in this period


Equivalent Units Schedule (all quantity, no dollars)

Beginning Inventory   #
+Started In Production   #  
=Total Units to be accounted for: (1)  #
Equivalent Units
Quantity Material Conversion
Beginning Inventory # # #
+Started and Completed # # #
+Ending Inventory  #   #   # 
=Total units accounted for (1) # # #

Weighted Average:      Beginning inventory = 100% of the quantity
FIFO:                              Beginning inventory = the % done this period only times quantity
Always:                          Started/Completed = 100% of the quantity
Always:                         Ending inventory = the % complete this period times the quantity


Calculate total production costs           (labor + OH)

Costs: Materials Conversion
Beginning Inventory  $  $
+ Current Period  $   $ 
= Total Costs  $  $

FIFO only used current period costs. W.A. uses both beginning and current.

Cost per equivalent unit: =      Total Costs $
                                                       Equivalent Units


Cost Reconciliation Report: (Value work in process and finished goods)

Equivalent unit quantity
x cost per unit in the row for the type of cost
= Value of Inventory


1st – Value WIP –

# equivalent units in Ending WIP row x $ per unit = total cost for each type

Do this for each type of cost; material, labor, overhead, conversion


2nd – Value finished goods:
Do differently for W.A. and FIFO

Weighted Average:

Add BI + SC eq. units together = total equivalent units.
Do at 100% and can be considered together.
All units received all costs.
Total E.U. x total $ per unit (material + conversion) = FG value


Finished goods is valued using a three step process:

1) Add in beginning inventory $, this is given

2) Take the equivalent units from the beginning inventory row x the cost per eq. unit = BI this period cost (do for each type)

3) Take the equivalent units from the started/completed row x the total cost per equivalent unit = S/C cost:

Add all three together to get the total cost of finished goods.


Process Costing Journal Entries:

Record Costs added this period:

WIP                                                  (total added)
       Raw Materials.                       ($ this period)
       Cash, A/P, wages pay            ($ this period)

Record Finished Goods:

       WIP                      (amount calc. for FG)


Transfer Price:

Internal change for the exchange of goods or services between organizational units of a company

Used for internal reporting purposes only in companies having more than one segment or division

The final pricing arrangement should always reflect organization goals, which will vary among companies and business circumstances.


General Rules for Determining the Transfer Price—Excess Capacity:

Maximum—no higher than the lowest price it can be purchased outside the company
Minimum—the total of incremental costs: all variable costs plus any added fixed costs
Negotiated—between the minimum and maximum is usually acceptable


General Rules for Determining the Transfer Price—No Excess Capacity:

Maximum—no higher than the lowest price it can be purchased outside the company
Minimum—no lower than the current price to external customers
Negotiated—between the minimum and maximum is usually acceptable


Common Methods for Determining the Transfer Price:

Cost Based: Costs may be variable/incremental costs only
Costs may be full absorption

Market Based: use the current market sales price
Consider the most objective

Negotiated: Managers of the two segments negotiate a price


Dual Pricing Arrangement:

The selling division records a transfer at a market price and the buying division records the transfer based on cost. The difference is recorded to an inter-company transfer account.


Advantages of a well thought out transfer price:

Allows for fair evaluation of segment performance
Allows for rational use of goods among segments/divisions
Motivates managers to achieve goal congruence in decentralized organization


International Transfer Pricing:

Consider tax rates of each country of operations
Lowest tax rate should earn highest profits


A good transfer pricing system will accomplish:

Approximately utilizes company resources
Minimizes goal conflicts among divisions/segments
Balances short and long-term goals and perspectives of the entire company