1. Chapter 2: Basic Cost Terms and Concepts
- Fixed
- Variable
Cost Concepts
Management Implications

2. Profit = (Sales Revenue-Variable Cost) - Fixed Cost
Cost Terms
Fixed Costs: costs that remain constant regardless of the quantity of product produced.
Variable Costs: costs that increase linearly and proportionately as production volume increases.
Profit = (Sales Revenue-Variable Cost) - Fixed Cost
Total Contribution Margin

3. Cost Terms (Continued)
Cost Driver:
Manufacturing Cost:
Sales and General Administrative Costs:
Direct and Indirect Costs:
Controllable and Uncontrollable Costs:
Product/Period Cost:
Any activity or event that causes costs to be incurred.
Direct material (DM), direct labor (DL), and manufacturing overhead (MOH).
All costs associated with running the business, excluding production costs.
Costs that can either be traced (direct) or not traced (indirect) to a specific department in the organization.
Costs used to describe the extent of a manager’s influence on cost.
Refers to the timing which costs become expenses.

4. Economic Terms Opportunity Cost: Sunk Cost:
Differential and Incremental Cost:
Marginal Cost:
Average Cost per Unit:
Benefit lost because the choice of one action precludes another action.
Costs that have already been incurred and can not be altered by current or future decisions.
Difference in the costs incurred under two alternative actions.
Cost associated with producing one additional unit.
Total cost for the quantity produced, divided by the number of units produced.

5. Bala’s Bare Bones Manufacturing Facility
Direct Material Purchased
Direct Material Storage
It’s a Warehouse!
Raw Materials
Direct Material Used
Finished Goods
Inventory
Direct Material
WIP
Manufacturing Overhead Costs

6. Cost Concept Direct Material Inventory Work in Process Inventory
Beginning Transfer to
Inventory WIP
$1,000 $78,000
Purchases
$79,000
Ending
Inventory
$2,000
Work in Process Inventory
Beginning Transfer to
Inventory Finished
$40,000 Goods
Inventory
Direct $350,000
Material
$78,000
Direct
Labor
$82,000
MOH
Incurred
$170,000
Ending
$20,000
Finished Goods Inventory
Beginning Cost of
Inventory Goods Sold
$1,000 (shipped)
$340,000
Goods
Completed
From WIP
$350,000
Ending
Inventory
$11,000

7. Raw Material Inventory Finished Goods Inventory
Allocation of Costs
Storeroom
Direct Material Used (DMU)
Raw Material Inventory
Factory
WIP Inventory
Cost of Goods Manufactured (COM)
Direct Material Purchased (DMP)
Warehouse
Direct Labor (DL)
Cost of Goods Sold (COGS)
Finished Goods Inventory
Manufacturing Overhead (MOH)

8. Managerial Implications
Is it better to under or over-apply overhead?
If OH is over-applied (allocated >actual), you will be “surprised” how
well you actually did when making end of period adjustments.
If OH is under-applied (allocated<actual), you will be “surprised” how well you thought you did when making end of period adjustments.
If your compensation or incentive plan is based on profit, which would you choose?