A—Introduction to Managerial Accounting

PROBLEM 1 TRUE/FALSE
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1. Management accounting information is only used by manufacturing organizations.
2. The managerial activity of monitoring a plan's implementation and taking corrective action as
needed is referred to as decision making.
3. The process of choosing among competing alternatives is decision making.
4. Managerial accounting information is not important for not-for-profit organizations.
5. Managerial Accounting is designed primarily for internal users.
6. Managerial accounting has its emphasis on the future.
7. Financial accounting is governed by GAAP.
8. The value chain is the set of activities required to design, develop, produce, market, and deliver
products and service to customers.
9. Time is not a crucial element in all phases of the value chain.
10. Activity-based costing is a less detailed approach to determining the cost of goods and services
than traditional cost accounting.
11. Excellent customer service is an example of a value-added activity.
12. A cost accountant would normally occupy a staff position within an organization.
13. Positions that have direct responsibility for the basic objectives of an organization are referred to
as line positions.
14. Virtually all managerial accounting practices were developed to assist managers in maximizing
profits.
15. The belief that each member of a group bears no responsibility for the well-being of other
members is a common principle underlying all ethical systems.
16. The four emphasized areas of the CMA examination reflect the needs of managerial accounting
and highlights that managerial accounting has more of an interdisciplinary flavor than other areas
of accounting.
17. The purpose of the Certificate in Public Accounting is to provide minimal professional
qualification for external auditors.
18. Direct materials and direct labor are the only product costs.
19. Total period costs are deducted from total cost of work in process to calculate cost of goods
manufactured.
20. Period costs are not inventoriable costs.

PROBLEM 2 MULTIPLE CHOICE

1. Which of the following is not an objective of managerial accounting?

a. To prepare external reports for investors, creditors, government agencies, and other
outside users.
b. To provide information for costing of services, products, and other objects of
interest to management.
c. To provide information for planning, controlling, evaluating and continuous
improvement.
d. To provide information for decision making.
2. Which of the following is an example of the management activity referred to as planning?
a. Developing a strategy for disposing of hazardous waste.
b. The decision to eliminate an unprofitable segment of an organization.
c. The decision to outsource an organization's payroll processing.
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d. All of these are correct

3. Developing a company strategy for responding to anticipated new markets is an example of

a. planning.
b. controlling.
c. decision making.
d. all of these are correct.

4. Investigating production variances and adjusting the production process is an example of

a. planning.
b. controlling.
c. decision making.
d. all of these.

5. The primary objective of managerial accounting is

a. to provide stockholders and potential investors with useful information for
decision making.
b. to provide banks and other creditors with information useful in making credit
decisions.
c. to provide management with information useful for planning and control of
operations.
d. to provide the Internal Revenue Service with information about taxable income.

6. Managerial accounting
a. is primarily for external users.
b. has no mandatory rules.
c. provides information based on historical information.
d. must adhere to GAAP.

7. Managerial accounting reports are prepared

a. according to GAAP guidelines.
b. to meet the needs of decision makers within the firm.
c. for external users.
d. all of these are correct

8. Financial accounting
a. is concerned with the information about the firm as a whole.
b. has to adhere to GAAP policies.
c. focuses on external users.
d. all of these are correct
 9. Which of the following would not be an example of a value-added activity?
a. timely delivery of products
b. offering the customer a variety of products
c. storage of finished products
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d. excellent customer service

10. Total quality management emphasizes

a. zero defects.
b. continuous improvement.
c. elimination of waste.
d. all of these are correct.

11. Activity-based costing

a. strives to create an environment that will enable works to manufacture zero-defect
products.
b. is the process of choosing among competing alternatives.
c. was established in response to financial scandals.
d. encourages process-value analysis.

12. Which of the following would normally occupy a line position?

a. staff accountant
b. accounting manager
c. vice-president of marketing
d. treasurer

13. Which of the following would normally occupy a staff position?

a. assembly worker
b. cost accounting manager
c. factory manager
d. all of these

14. Which of the following would occupy a line position in a hospital?

a. manager of the cafeteria
b. hospital administrator
c. chief of surgery
d. none of these

15. The controller of an organization participates in

a. planning.
b. controlling.
c. decision making.
d. all of these are correct

16. The objective of profit maximization

a. should be the only goal of an organization.
b. is an objective of financial accounting but not managerial accounting.
 c. should be achieved through legal and ethical means.
d. should outweigh the goal of product quality.

17. The standards of ethical conduct for managerial accountants include

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a. competence and performance.
b. integrity and respect for others.
c. confidentiality, confidence, integrity, and observance.
d. competence, confidentiality, integrity, and credibility.

18. Which of the following areas is not emphasized on the CMA examination?
a. external auditing and business law
b. economics, finance, and management
c. decision analysis and information systems
d. financial accounting and reporting

19. Accountants that have a Certificate in Public Accounting (CPA):

a. are the only accountants permitted to serve as external auditors.
b. must pass a national examination and be licensed by the state in which they
practice.
c. may be held responsible to provide assurance concerning the reliability of a firm's
financial statements.
d. all of these statements are true.

20. Persons in the United States who provide assurance service are designated as
a. Certified Public Accountants.
b. Certified Financial Accountants.
c. Chartered Accountants.
d. Certified Management Accountants.

PROBLEM 3
Indicate whether each of the following costs of a pencil manufacturer would be classified as direct
materials (DM), direct labor (DL), or manufacturing overhead (MO).
a. ____ Depreciation of pencil painting machinery
b. ____ Lead inserted into pencils
c. ____ Factory utilities
d. ____ Wages of assembly line worker
e. ____ Salary of supervisor
f. ____ Factory machinery maintenance
g. ____ Wood
h. ____ Eraser compound

PROBLEM 4
Identify whether each of the following is classified as a product cost or a period cost.
______________ 1. Direct labor
______________ 2. Direct materials
______________ 3. Factory utilities
______________ 4. Repairs to office equipment
______________ 5. Property taxes on factory building
______________ 6. Sales salaries

PROBLEM 5. Match the items in the two columns below by entering the appropriate code
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letter in the space provided.

A. Managerial accounting F. Work in process inventory

B. Financial accounting G. Direct materials
C. Planning H. Manufacturing overhead
D. Directing I. Period costs
E. Controlling J. Value chain

_____ 1. The cost of products that are partially complete.

_____ 2. The function of keeping activities in accordance with plans.

_____ 3. Primarily concerned with internal users and reports pertain to subunits of the entity.

_____ 4. Materials that can be physically and directly associated with manufacturing a product.

_____ 5. The function of setting goals and objectives.

_____ 6. Indirect costs of manufacturing a product.

_____ 7. Primarily concerned with external users and reports pertain to the entity as a whole.

_____ 8. Costs that are non inventoriable.

_____ 9. All activities associated with providing a product or service.

_____ 10. The function of coordinating diverse activities to produce a smooth-running

operation.

PROBLEM 6
Financial accounting information and managerial accounting information have a number of
distinguishing characteristics. For each of the characteristics listed below, indicate which
characteristics are more closely related to financial accounting by placing the letter "F" in the space
to the left of the item and indicate those characteristics which are more closely associated with
managerial accounting by placing the letter "M" to the left of the item.
____ 1. General-purpose reports
____ 2. Reports are used internally
____ 3. Prepared in accordance with generally accepted accounting principles
____ 4. Special purpose reports
____ 5. Limited to historical cost data
____ 6.
____ 7.
____ 8.
Reporting standard is relevance to the decision to be made
Financial statements
Reports generally pertain to the business as a whole
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____ 9. Reports generally pertain to subunits
____ 10. Reports issued quarterly or annually
PROBLEM 7
Raynor Manufacturing Company has the following data:
Direct labor $46,000
Direct materials used 84,000
Total manufacturing overhead 60,000
Ending work in process 30,000
Beginning work in process 40,000
Instructions Compute (a) total manufacturing costs and (b) cost of goods manufactured.

PROBLEM 8
Isaac Company manufactures boats. During September, 2008, the company purchased 100 cellular
phones at a cost of $100 each. Isaac withdrew 70 phones from the warehouse during the month.
Twenty of these phones were installed in salespersons’ cars and the remaining 50 phones were put
in boats manufactured during the month. Of the boats put into production during September, 2008,
80% were completed and transferred to the company's storage lot. Fifty percent of the boats
completed during the month were sold by September 30.
Instructions Determine the cost of cellular phones that would appear in each of the
following accounts at September 30, 2008:
Raw materials inventory Work in process inventory Finished goods
inventory
Cost of goods sold Selling expenses
Problem 9
The following costs and inventory data were taken from the accounts of Reser Company for 2018:
January 1, 2018 December 31, 2018
Inventories: Raw materials
$ 8,000 $ 7,000
Work in process 15,000 13,000
Finished goods 16,000 10,000
Costs incurred:
Raw materials purchases $93,000
Direct labor 42,000
Factory rent 8,000
Factory utilities 7,000
Indirect materials 4,000
Indirect labor 6,000
Selling expenses 5,000
Administrative expenses 12,000
Instructions
a. Prepare a schedule showing the amount of direct materials used in production during the
year.
b. Compute the amount of manufacturing overhead incurred during the year.
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c. Prepare a schedule of Cost of Goods Manufactured for Reser Company for the year ended
December 31, 2018 in good form.
d. Prepare the Cost of Goods Sold section of the Income Statement for Reser Company for the
year ended December 31, 2018 in good form.

INTRODUCTION TO MANAGEMENT ACCOUNTING

A. Introduction
1. Accounting provides essential information and is known as the language of
business.
2. Financial accounting focuses on external users and, as such, must comply with
GAAP. Financial accounting information is:
a. typically, historical, verifiable, quantifiable, and monetary;
b. usually quite aggregated and related to the organization as a whole; and
c. often a business essential because it is necessary for obtaining loans,
preparing tax returns, and understanding how well or how poorly the
business is performing.
3. Management accounting focuses on the information needs of an organization's
internal managers’ needs that are related to their planning, controlling, and
decision-making functions.
a. Some management needs are satisfied by historical, monetary information
based on generally accepted accounting principles.
b. Other needs require forecasted, qualitative, and frequently nonfinancial
information that has been developed and computed for their specific
decision purposes.
c. A company's business intelligence (BI) system is a formal process for
gathering and analyzing information and producing intelligence to meet
decision making needs.
4. Relationship of Financial and Management Accounting. Accounting information
is supposed to address three different functions:
a. provide information to external parties (stockholders, creditors, and various
regulatory bodies) for investment and credit decisions;
b. estimate the cost of products produced and services provided by the
organization; and
c. provide information useful for making decisions and controlling operations.
1. Cost accounting creates an overlap between financial accounting and managerial
accounting.
a. Cost accounting integrates with financial accounting by providing product
costing information for financial statements and with management accounting
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by providing some of the quantitative, cost-based information managers need
to perform their tasks.
b. The boundaries between financial and managerial accounting are not clearly
and definitively drawn.
6. Relationship of Management and Cost Accounting
a. The Institute of Management Accountants (IMA) is an organization
composed of individuals interested in the field of management accounting;
was previously the National Association of Accountants (NAA);
coordinates the Certified Management Accountant (CMA) program through
its affiliate organization, the Institute of Certified Management Accountants
(ICMA)
b. Management accounting is defined by the IMA as a discipline that
includes almost all manipulations of financial information for use by
managers in performing their organizational functions and in assuring the
proper use and handling of an entity's resources. The objectives of
management accounting reflect its comprehensive nature..
c. The functions of cost accounting focus primarily on the determination of
the cost of making products or performing services; cost accounting is an
integral part of the broader field of management accounting.
d. Cost accounting is defined as "a technique or method for determining the
cost of a project, process, or thing... This cost is determined by direct
measurement, arbitrary assignment, or systematic and rational allocation."
e. Cost accounting creates an overlap between financial accounting and
management accounting.
f. The cost accounting overlap causes the financial and management
accounting systems to be joined together to form a complete informational
network.
g. This discipline integrates with financial accounting by providing product
costing information for financial statements.
h. Cost accounting also integrates with management accounting by providing
some of the quantitative, cost based information managers need to perform
their tasks.
7. Management accountants should strive to recognize:
a. what information is needed by managers;
b. why the information is needed; and
8.
c. how to provide the information in the best possible form and in the timeliest
manner to enhance understandability and usefulness in decision making.
Managers need information to make decisions about:
a. acquiring and financing production capacity;
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b. determining which products to market;
c. pricing jobs, products, or services;
d. determining the best method of delivering finished goods to warehouses;
e. locating the best property for production facilities; and
f. financing the costs of production.
9. Data and information are clearly different.
a. Data are bits of knowledge or facts that have not been summarized and
categorized in a manner useful to a decision maker.
b. Information represents knowledge or facts that have been carefully chosen
from a body of data and arranged in a meaningful way.
10. Management accountants should provide both quantitative and qualitative
information to assist managers in decision making.
a. Quantitative information allows managers to witness the numerical impact
of alternative choices.
b. Qualitative information furnishes facts that help eliminate some of the
inherent uncertainty related to such choices.
11. Management accountants play an important role in controlling and performance
evaluation.
a. Controlling is the process of exerting managerial influence on operations
so that they conform to previously prepared plans.
b. Controlling involves setting performance standards, measuring
performance, periodically comparing actual performance with standards,
and taking corrective action when operations do not conform with
established standards.
c. A performance evaluation is the process of determining the degree of
success in accomplishing a task; equates to both effectiveness and
efficiency. Such evaluations are conducted to determine if operations are
proceeding according to plan or if actual results differ materially from
expected results. Once performance has been measured by the control
process, managers must evaluate the effectiveness and efficiency of that
performance.
d. Effectiveness is a measure of how well an organization's goals and
objectives are achieved; compares actual output results to desired results;
determination of the successful accomplishment of an objective.
 e. Efficiency is a measure of the degree to which tasks were performed to
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produce the best yield at the lowest cost from the resources available; the
degree to which a satisfactory relationship occurs when comparing outputs
to inputs.
12. Management accountants play an important role in decision
making.
a. Decision making is the process of choosing among the alternative solutions
available to a course of action or a problem situation. A manager’s ability
to manage depends on good decision making.
b. Managers are the information users while accountants are the information
providers.
c. The quantity of information? Desired is partially based on the expected
consequences of the decision.
d. The purpose of management accounting is basically two-fold: First, it must
provide the basis for appropriate cost estimations that are needed for the
financial statement presentations of inventory and cost of goods/services
sold. Second, it must provide adequate, useful information to assist
managers in performing the basic functions of planning, controlling,
evaluating performance, and decision making.
13. Management accountants are not required to adhere to GAAP in providing
information for managers' use internally.
14. The Certified Management Accountant (CMA) is a professional designation in
the area of management accounting that recognizes the successful completion of an
examination, acceptable work experience, and continuing education requirements.
B. The Global Environment of Business
1. E-commerce has increased the globalization of business. E-commerce is any
business activity that uses the internet and world-wide web to engage in financial
transactions.
2. The transition in the United States from a manufacturing-based to a service-oriented
economy is a significant development.
3. The world has become effectively smaller due to technology development, with
firms and consumers taking an international, rather than domestic, market view.
a. Globalization of markets involves a changeover in local markets from
competition among national or local suppliers to competition among
international suppliers.
b. The global economy represents an economy characterized by the
international trade of goods and services, the international movement of
labor, and international flows of capital and information.
 4.

5.
Companies are now emphasizing performance from the perception of the consumer
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rather than from the perspective of quantity of output or the ability to meet budget
figures.
Good quality is necessary in both manufacturing and service environments; and if
poor quality occurs, a company should acknowledge and correct its failures.
C. Organizational Strategy
1. Management accountants play an important role in planning.
a. Planning is the process of translating the goals and objectives for an
organization and developing a strategy for achieving them in a systematic
manner.
b. The planning functions differ in large and small organizations.
c. Managers depend heavily on management accountants when planning is
being conducted. Long-term plans usually address such issues as market
share, which is based on projections of costs, prices, volume, quality, and
service. Short-term plans may be in the form of budgets for such resources
as cash, inventory, and personnel.
2. A strategy is a long-term plan that is formulated to fulfill the goals and objectives of
the organization.
a. Strategy involves all three organizational functions in which accountants
interact with managers: planning, controlling, and decision making.
b. Strategy is the link between the organization's goals and objectives and the
activities actually conducted by the organization; therefore strategies
frequently determine the extent to which an organization is successful in
achieving its goals.
c. Each organization has a unique set of opportunities and constraints that play
a role in determining which alternative strategies are feasible and likely to
be successful.
D. Influences on Organizational Strategy
1. Organizational structure refers to how authority (and responsibility) for making
decisions is distributed in the organization.
a. Segments need to be organized according to their missions in order to
effectively define segments, manage resources, and implement strategies.
b. Managers set goals and objectives when planning for the future.
c. Goals are desired abstract achievements.
d. Objectives are desired quantifiable achievements for a period of time.
Objectives should logically result from goals.
2. The most desired types of business intelligence include:
a. competitor activities,
 b.
c.
d.
changing market structure,
customer/supplier activities,
emerging technology initiatives,
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e. regulatory climate,
f. political climate, and
g. global economic conditions.
3. Managers must acknowledge and deal with organizational constraints in making
strategic decisions for their firms.
a. Level of capital availability is a major constraint faced by all organizations.
Management must answer the following: two questions before attempting
to eliminate a capital constraint: can the capital be obtained at a reasonable
cost, and would reallocation of current capital be more effective and
efficient?
b. The level of a firm’s intellectual capital or the intangible assets of skill,
knowledge, and information that encompasses human capital and structural
capital represents another significant constraint on organizational strategy.
c. Technology availability is another meaningful constraint on organizational
strategies, and the acquisition of new technology is one way to create new
strategic opportunities.
4. Management style and organizational culture are two significant and related
variables in determining organizational strategy.
a. Management style can be described as a preference in the manner that
management interacts with other stakeholders in the organization.
b. Organizational culture is the set of basic assumptions about the
organization and its goals and ways of doing business; describe the norms
of an organization in both internal and external, as well as formal and
informal, transactions.
c. Management style and organizational culture are heavily influenced by the
national culture of the organization, the extent of diversity in the work
force, and the experiences and philosophies of the top management team.
5. An environmental constraint is any limitation on strategy options caused by
cultural, fiscal, legal/regulatory, or political situations.
a. The operating environment of an organization does not operate in isolation
from the other factors affecting corporate strategy.
b. Management, through its actions and the organizational culture, influences
the organization and may work to affect the operating environment through
numerous activities.
D. Role of Accounting in Organizations
1. Strategy formulation is the foundation level of organizational
planning.
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2. Measurement of profitability is a function of the accounting information system.
3. Organizational management must consider the financial implications of its actions
in determining what strategies to pursue.
4. Operating plans contain the details necessary to implement and maintain an
organization's strategies.
5. Accounting information plays a vital role in linking the objectives of top managers
to the incentives of segment managers.
a. Accounting information is normally the basis for measuring or evaluating
segment managers in terms of efficiency and effectiveness.
b. The accounting measurements must be tied to the segment's mission for
accounting to provide the correct incentives to a segment manager.
c. Long-term performance measures are more appropriate for build missions,
while shorter-term performance measures are more appropriate for harvest
missions.
d. Responsibility accounting is the use of accounting information to evaluate
the performance of segment managers.
e. Opportunity cost is an amount that represents the potential benefit
foregone because one course of action is chosen over another.
f. Companies deciding to implement empowerment concepts
characteristically introduce teams to the organization structure.
6. A company can determine its core competencies only by analyzing its activities and
comparing hem to internal or external benchmark measurements.
7. New strategic initiatives including development of new products and services are
possible only if both monetary and intellectual capital is available for new
investment.
a. Corporate managers depend: on public capital markets to acquire the funds
necessary to pursue new investment.
b. Companies are concerned about the cost of capital (COC) they can acquire
since capital is a primary organizational constraint.
c. The expected average annual growth rate is an estimate of the increase
expected in dividends or in market value per share of stock; is a function of
a company's predicted earnings, dividend policy, and market price
appreciation per share.
d. Strategic resource management (SRM) involves the organizational
planning for deployment of resources to create value for customers and
shareholders.
e.
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SRM is concerned with: how to deploy resources to support strategies; how
resources are used in, or recovered from, change processes; how customer
value and shareholder value will serve as guides to the effective use of
resources; and how resources are to be deployed and redeployed over time.
f. The focus of SRM is the value chain, the set of processes that convert inputs
(hence, the term conversion activities) into products and services
consumed by the firm's customers.
g. The value chain includes the processes of suppliers as well as internal
processes, and managers are able to relate activities in the firm to value
created for customers by focusing on the value chain.
h. Employees earn compensation and suppliers earn revenues for their
contributions to the value chain.
i. Synergies or economies in operation may be somewhat obvious in the
vertical value chain, but they may be much more difficult to recognize in
conglomerates.
j. The build mission is an organizational segment mission that implies a goal
of increased market share, even at the expense of short-term earnings and
cash flow.
k. The hold mission is an organizational segment mission that is geared to the
protection of the business unit's market and competitive position.
l. The harvest mission is an organizational segment mission that implies a
goal of maximizing short-term earnings and cash flow, even at the expense
of market share.
m. The product life cycle refers to the sequential stages that a product passes
through from the time that the idea is conceived until production of the
product is discontinued.
n. Top managers are constantly challenged to identify ways to persuade each
segment manager to operate the segment according to that segment's
mission.
o. An organizational structure in which all authority for making decisions is
retained by top management is referred to as centralization.
p. At the other end of the continuum, an organizational structure in which the
authority for making decisions is distributed to many people in the
organization including lower level managers is referred to as
decentralization.
q. Empowerment of employees involves giving people the authority and
responsibility to make decisions about their work.
r. The authority structure in the organization is a short-term constraint on
organizational strategy, and the structure can therefore be changed in the
long term.
 s.
decentralized organizations, lower level managers are frequently
responsible for strategy implementation.
8. The balancing of short-run and long-run demand for resources is one of the most
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Strategy creation is often the responsibility of only top management, but in

meaningful challenges of efficiently and effectively managing organizational

resources.
9. A rational application of resources must prioritize strategic resource needs and balance
short-term and long-term value considerations.
10. Managers must also take care to structure strategic initiatives such that they allow
flexibility in operational management.
11. A core competency is a higher proficiency relative to competitors in a critical function
or activity.
a. Core competencies are the roots of competitiveness and competitive
advantage.
b. The core competencies may be industry-specific or firm-specific.
c. Core competencies are apt to be both firm-specific and industry-specific.
12. Management accounting provides information for internal users.
a. Managers are often concerned with individual segments of the business
rather than the organization as a whole, so management accounting
information normally addresses specific concerns rather than the "big
picture" of financial accounting.
b. Management accountants are expected to be flexible in providing
information that serves the needs of management and is useful to managers'
functions.
c. Cost-benefit analysis is the analytical process of comparing the relative
costs and benefits that result from a specific course of action (such as
providing information or investing in a project). Information should be
developed and provided only if the cost of producing the information is less
than the benefit of having it.
13. The objectives and nature of financial and management accounting differ, but all
accounting information tends to rely on the same basic accounting system and set
of accounts.
Terminology
COST TERMINOLOGY AND COST FLOWS
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Actual cost system a valuation method that uses actual direct materials, direct labor, and
overhead charges in determining the cost of Work in Process Inventory
Allocate cost assignment based on the use of a cost predictor or an arbitrary method
Applied overhead the amount of overhead assigned to Work in Process Inventory as a result of
productive activity; credits for this amount are made to an overhead account
Capacity a measure of production volume or some other activity base
Conversion cost the sum of direct labor and factory overhead costs; the costs incurred in
changing raw materials or purchased parts into salable finished products
Cost a monetary measure of the resources given up to attain some objective such as acquiring a
good or service
Cost allocation the assignment of an indirect cost to one or more cost objects using some
reasonable basis
Cost driver a factor that has a direct cause-effect relationship to a cost
Cost of goods manufactured (CGM) the total cost of the goods that were completed and
transferred to Finished Goods Inventory during the period
Cost object anything to which costs attach or are related
Cost pool a collection of monetary amounts incurred either for the same purpose or at the same
organizational level
Dependent variable an unknown variable that is to be predicted using one or more independent
variables
Direct cost a cost that is distinctly traceable to a particular, specified cost object
Direct labor the cost of the time spent by individuals who work specifically on manufacturing a
product or performing a service
Direct material any readily identifiable part of a product
Distribution cost a cost incurred to warehouse, transport, or deliver a product or service
Expected capacity a short-run concept that represents the anticipated level of capacity to be
used by the firm in the upcoming year
Expired cost an expense or a loss
Fixed cost a cost that remains constant in total within a relevant range of activity
High-low method a technique used to determine the fixed and variable portions of a mixed cost;
uses only the highest and lowest levels of activity and related costs within the relevant range
Historical cost a cost that was incurred in the past, is objective and verifiable, and is usually
used in financial accounting
Independent variable a variable that, when changed, will cause consistent, observable changes
in another variable; a variable used as the basis of predicting the value of a dependent variable
Indirect cost a cost that cannot be traced explicitly to a particular, specified cost object common
cost
Inventoriable cost a cost associated with making or acquiring inventory (see product cost)
Least squares regression analysis a statistical technique that analyzes the association between
dependent and independent variables; determines the line of "best fit" for a set of observations by
minimizing the sum of the squares of the vertical deviations between actual points and the
regression line; can be used to determine the fixed and variable portions of a mixed cost
Manufacturer any company engaged in a high degree of conversion of raw material input into
other tangible output
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Mixed cost a cost that has both a variable and a fixed component; changes with changes in
activity, but not proportionately
Multiple regression a statistical technique that uses two or more independent variables to
predict a dependent variable
Normal capacity the average activity of the firm over a long period of time such as five to ten
years.
Normal cost system a valuation method that uses actual costs of direct materials and direct labor
in conjunction with a predetermined overhead rate or rates in determining the cost of Work in
Process Inventory
Outliers abnormal or nonrepresentative observations within a data set that may be inadvertently
used in the application of the high-low method
Overapplied overhead the amount of overhead that remains at the end of the period when the
applied overhead is greater than the actual overhead
Overhead any factory or production cost that is indirect to manufacturing a product or providing
a service; does not include direct materials or direct labor
Period cost any cost other than one associated with making or acquiring inventory
Practical capacity the activity level that can be achieved during regular working hours.
Practical capacity is less than theoretical capacity by the amount of ongoing, regular operating
interruptions such as holidays, downtime, and start-up time.
Predetermined overhead rate an estimated, average constant charge per unit of activity used to
assign overhead cost to production or services of the period, and can be calculated by dividing
total budgeted annual overhead by the related measure of volume or activity
Predictor an activity measure that, when changed, is accompanied by consistent, observable
changes in a cost item
Prime cost the total cost of direct materials and direct labor
Product cost a cost associated with making or acquiring inventory (see inventoriable cost)
Relevant range the specified range of activity over which a variable cost remains constant per
unit or a fixed cost remains fixed in total
Regression line any line that goes through the means (or averages) of the set of observations for
an independent variable and its dependent variables; mathematically, there is a line of "best fit"
which is the least squares regression line
Relevant range the range of activity over which fixed costs remain fixed.
Replacement cost an amount that a firm would currently have to pay to replace an asset or to
buy one that performs functions similar to an asset currently held
Service company a firm engaged in a high or moderate degree of conversion that uses a
significant amount of labor
Simple regression a statistical technique that uses only one independent variable to predict a
dependent variable
Standard error of the estimate (Se) a measure of dispersion that reflects the average difference
between actual observations and expected results provided by a regression line (From Appendix)
Step cost a type of cost that shifts upward or downward when activity changes by a certain
interval or "step"
Theoretical capacity the estimated maximum potential activity level for a specified period of
time. This measure assumes that all factors are operating in a technically and humanly perfect
manner and ignores realities such as machinery breakdowns and holidays.
Underapplied overhead the condition wherein actual overhead is greater than overhead charged
18
to production.
Unexpired cost an asset
Variable cost a cost that varies in total in direct proportion to changes in activity

A. Cost Classifications on the Financial Statements

1. Cost reflects a monetary measure of the resources given up to attain some
objective such as acquiring a good or service.
2. Cost classifications are used to define costs in terms of their relationships to the
following four items:
a. time of incurrence,
b. reaction to changes in activity,
c. classification on the financial statements, and
d. impact on decision making.
3. Some costs are associated with the time of incurrence.
a. A historical cost represents a cost that was incurred in the past, is
objective and verifiable, and is usually used in financial accounting.
b. A replacement cost is an amount that a firm would currently have to pay
to replace an asset or to buy one that performs functions similar to an asset
currently held.
c. A budgeted cost is a planned future expenditure that might be the same
amount as the replacement cost.
4. Some costs demonstrate reactions to changes in activity within a normal operating
or relevant range of activity.
a. The relevant range is the specified range of activity over which a variable
cost remains constant per unit or a fixed cost remains fixed in total.
b. A variable cost is a cost that varies in total in direct proportion to changes
in activity.
c. A fixed cost remains constant in total within a relevant range of activity.
d. A mixed cost is a cost that has both a variable and a fixed component;
changes with changes in activity, but not proportionately. A mixed cost is
assumed by accountants to be linear.
e. A step cost is a type of cost that shifts upward or downward when activity
changes by a certain interval or "step." Step variable costs have small
steps, while step fixed costs have large steps.
 f.

g.
consistent, observable changes in a cost item. 19
A predictor is an activity measure that, when changed, is accompanied by

A cost driver is a factor that has a direct cause-effect relationship to a

cost.
5. Some costs are identified as to how they are classified on the financial statements.
a. The balance sheet is a statement of unexpired costs, and an unexpired
cost is an asset.
b. The income statement is a statement of revenues and expired costs, and an
expired cost is an expense or a loss.
c. A product cost is a cost that is associated with producing or acquiring
inventory, and is therefore referred to as an inventoriable cost. Product
costs include direct material, direct labor, and overhead costs.
d. A direct material is any readily identifiable part of a product.
e. Direct labor refers to the cost of the time spent by individuals who work
specifically on manufacturing a product or performing a service. The
wages (or salaries) of these individuals are considered direct labor cost.
f. Overhead is any factory or production cost that is indirect to
manufacturing a product or providing a service; does not include direct
materials or direct labor. Overhead may be variable or fixed.
g. A period cost is any cost other than one associated with making or
acquiring inventory. Period costs are related to other business operations
and are more closely associated with a particular time frame rather than
with the production or acquisition of a product or the performance of a
service.
h. A distribution cost is a cost incurred to warehouse, transport, or deliver a
product or service. Even though distribution costs are expensed as
incurred (like many other period costs), managers cannot lose sight of the
fact that these costs relate directly to products and services.
B. The Conversion Process
1. Different types of firms have low, moderate, or high degrees of conversion.
a. Firms that engage in a low-to-moderate degree of conversion conveniently
expense insignificant labor and overhead costs related to conversion. Such
firms usually have just one inventory account--Merchandise Inventory.
b. High conversion firms reap informational benefits by assigning labor and
overhead costs to the output produced. Such benefits significantly exceed
the clerical costs of assigning these costs. Such manufacturers normally
use three inventory accounts--Raw Materials, Work in Process, and
Finished Goods.
c. A manufacturer refers to any company engaged in a high degree of
conversion of raw material input into a tangible output.
d. A service company refers to a firm engaged in a high or moderate degree
of conversion that uses a significant amount of labor. The output of a
service business may be either tangible or intangible and usually cannot be
inspected prior to its use.
e. Service companies may be profit-making or not-for-profit organizations.
 2. Retail companies purchase goods in finished or nearly finished condition that
normally need little or no conversion before being sold to customers, while
manufacturers and service companies engage in activities that involve the
20
physical conversion or transformation of inputs into finished products or services.
a. The primary difference between retail companies and manufacturers and
service companies is the absence or presence of a production center that
involves the conversion of raw material inputs into final products.
b. Several differences in accounting for production activities exist between
manufacturers and service companies. A manufacturer must account for
raw materials, work in process, and finished goods to maintain control
over the production process. Most service firms need only to keep track of
their work in process (incomplete jobs).
C. Stages of Production
1. Production processing or conversion can be perceived as existing in three basic
stages of production:
a. Work not started (raw materials);
b. Work in process; and
c. Finished work.
2. The total costs incurred in stages one and two are equal to the total production
cost of finished goods in the third stage.
3. The primary accounts involved in the cost accumulation process
are:
a. Raw Materials Inventory,
b. Work in Process Inventory, and
c. Finished Goods Inventory.
4. Service firms usually do not have the same degree of cost complexity as do
manufacturing firms.
a. Supplies are inventoried in the work not started stage until they are placed
into a work in process stage, where labor and overhead are added to
achieve finished results.
b. Service firms usually have a Supplies Inventory account (no Raw
Materials Inventory) and a Work in Process account (no Finished Goods
Inventory).
5. Firms in merchandising, manufacturing, and service can all use management
accounting concepts and techniques, although to varying degrees.
D. Cost Reactions to Changes in Activity
1. Accountants describe a given cost’s behavior pattern according to the way its total
cost (rather than its unit cost) reacts to changes in a related activity measure.
2. A fixed cost remains fixed in total within the relevant range of activity under
consideration.
3. A variable cost varies as production changes, but the cost per unit remains the
same.
4. A mixed cost has both a variable and a fixed component.
5. Separating Mixed Costs--Mixed costs contain both a variable and a fixed cost
element and are assumed by accountants to be linear rather than curvilinear.
 6. The high-low method is a technique used to determine the fixed and variable
21
portions of a mixed cost; uses only the highest and lowest levels of activity and
related costs within the relevant range.
a. The method uses the highest and lowest observed levels of actual activity
to determine the change in costs which reflects the variable cost element b
as follows.
(Cost at high activity level) - (cost at low activity level)
b= __________________________________________
(High activity level) - (low activity level)

Change in total cost

b= ________________________
Change in activity level
b. The fixed portion of a mixed cost is found by subtracting total variable
cost from total cost.
7. Outliers are abnormal or non representative observations within a data set that
may be inadvertently used in the application of the high-low method.
E. Components of Product Cost
1. A cost object is anything to which costs attach or are related.
a. A direct cost is a cost that is distinctly traceable to a particular, specified
cost object.
b. An indirect cost is a cost that cannot be traced explicitly to a particular,
specified cost object and, therefore, must be allocated to the cost object
using one or more predictors or arbitrarily chosen bases. An indirect cost
is a common cost.
c. The term allocate means that a cost assignment is made based on the use
of a cost predictor or an arbitrary method.
2. A direct material is any readily identifiable part of a product.
3. Direct labor refers to the cost of the time spent by individuals who work
specifically on manufacturing a product or performing a service. The wages (or
salaries) of these individuals are considered direct labor cost.
4. Overhead is any factory or production cost that is indirect to manufacturing a
product or providing a service; does not include direct materials or direct labor.
Overhead may be variable or fixed.
5. Quality cost is an important type of overhead cost.
a. Prevention cost is a quality control cost that is incurred to improve quality
by preventing defects from occurring.
b. An appraisal cost is a quality control cost that is incurred for monitoring or
inspection. Appraisal costs compensate for mistakes not eliminated
through prevention.
c. A failure cost is a quality control cost that is associated with goods or
services that have been found not to conform or perform to the required
standards as well as all related costs (such as that of the complaint
department). Such cost may be internal or external.
6. Prime cost is the total cost of direct materials and direct labor.
F.
7.
incurred in changing raw materials or purchased parts into salable finished
products.
Accumulation and Allocation of Overhead
22
Conversion cost is the sum of direct labor and factory overhead costs; the costs

1. Cost of Goods Sold cannot be calculated until ending inventories are determined
by physical count in a periodic inventory system. All product costs flow through
Work in Process Inventory to Finished Goods Inventory and, ultimately, to Cost
of Goods Sold in a perpetual inventory system.
2. Overhead costs are allocated to cost objects for three reasons.
a. to determine a full cost of the cost object.
b. To motivate the manager in charge of the cost object to manage it
efficiently, and
c. To compare alternative courses of action for management planning,
controlling, and decision making.
3. Using Flexible Budgets in Setting Predetermined Overhead
Rates
a. A flexible budget is a series of individual budgets that present costs
according to their behavior at different levels of activity.
b. A flexible budget presents variable and fixed costs at various levels of
activity within a relevant range of activity.
c. Flexible budgets are prepared for both product and period costs.
d. A step fixed cost is a distinct change in a fixed cost due to increased
activity.
e. Capacity is a measure of production volume or some other activity base.
f. Expected annual capacity is a short-run concept that represents the
anticipated level of capacity to be used by the firm in the upcoming year.
4. Applying Overhead to Production
a. Applied overhead is the amount of overhead assigned to Work in process
Inventory as a result of productive activity; credits for this amount are
made to an overhead account.
b. The amount of applied overhead is determined by multiplying the
predetermined rate by the actual activity level.
c. The cost accountant can record overhead in the accounting system in
separate accounts for actual and applied overhead or in a single overhead
account.
d. The general ledger may contain a single overhead account or separate
accounts for variable and fixed overhead.
5. Actual overhead incurred during a period will rarely equal applied overhead; this
difference represents under-applied or over- applied overhead.
a. Under-applied overhead is the amount of overhead that remains at the
end of the period when the applied overhead is less than the actual
overhead.
b. Over-applied overhead is the amount of overhead that remains at the end
of the period when the applied overhead is greater than the actual
overhead.
6. Disposition of under-applied or over-applied overhead is recorded
 annually.
a.

b.
The method of disposition of under-applied or over-applied overhead
depends upon the materiality of the amount involved.
The amount is closed to Cost of Goods Sold if it is
23
immaterial.
c. The amount, if it is material, should be allocated among the accounts
containing applied overhead: Work in process Inventory, Finished Goods
Inventory, and Cost of Goods Sold.
7. There are three causes of under-applied or over-applied overhead:
a. A difference between actual and budgeted variable overhead cost per unit;
b. A difference between actual and budgeted total fixed overhead cost; and
c. A difference between actual activity and the budgeted capacity used to
calculate the fixed overhead application rate--only if the company's actual
activity level exactly equals the expected activity level will the total
budgeted amount of fixed overhead be applied to production.
G. Accumulation of Product Costs—Actual Cost System
1. Product costs can be accumulated using either a perpetual or a periodic inventory
system.
H. Cost of Goods Manufactured and Sold
1. A schedule of cost of goods manufactured needs to be prepared as a preliminary
step to the determination of cost of goods sold (CGS) for a company using the
periodic inventory system. Cost of goods manufactured (CGM) is the total cost
of the goods that were completed and transferred to Finished Goods Inventory
during the period.
2. Accountants will prepare a formal schedule of cost of goods manufactured and a
formal schedule of cost of goods sold for management regardless of the type of
inventory valuation method employed.
I. Accumulation of Product Costs—Normal Cost System
1. There is little difference between a normal cost system and an actual cost system.
Only the application of overhead to work-in-process differs between the two
methods.
J. Least Squares Regression Analysis is a statistical technique that analyzes the association
between dependent and independent variables. It determines the line of "best fit" for a set of
observations by minimizing the sum of the squares of the vertical deviations between actual
points and the regression line. It can be used to determine the fixed and variable portions of a
mixed cost.
1. A dependent variable is an unknown variable that is to be predicted using one or
more independent variables.
2. An independent variable is a variable that, when changed, will cause consistent,
observable changes in another variable; a variable used as the basis of predicting
the value of a dependent variable.
3. Simple regression is a statistical technique that uses only one independent
variable to predict a dependent variable.
4. Multiple regression is a statistical technique that uses two or more independent
variables to predict a dependent variable.
 5.
of observations for an independent variable and its dependent variables. 24
A regression line is any line that goes through the means (or averages) of the set

Mathematically, there is a line of "best fit" which is the least squares regression
line.

A scatter graph is a graph that plots all known activity observations and the associated costs;
used to separate mixed costs into their variable and fixed components and to examine patterns
reflected by the plotted observations