Mastering Cost Accounting & Managerial Decisions

Essential Cost Management Principles

Core Concepts for Multiple Choice

Cost Driver Concept

A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed.

Flow of Overhead Costs in ABC

Understand the flow of overhead costs in an Activity-Based Costing (ABC) system:

1. Identify and classify the activities involved in the manufacture of specific products and assign overhead cost pools.
2. Identify the cost driver that has a strong correlation to the costs accumulated in each cost pool.
3. Compute the activity-based overhead rate for each cost pool.
4. Allocate overhead costs to products using the overhead rates determined for each cost pool.

Most Difficult Product Cost to Compute

Of the three product costs, manufacturing overhead (MO) is typically the most difficult to compute.

Understanding Overhead Cost Pools

An overhead cost pool is the overhead cost attributed to a distinct type of activity or related activities.

Calculating Activity-Based Overhead

Activity-based overhead is calculated as:

Estimated Overhead per Activity / Expected Use of Cost Driver per Activity

This involves assigning indirect costs to activity cost pools, then dividing each cost pool by a cost driver to obtain the rates used for allocation.

Fixed Costs Defined

Fixed costs are costs that remain the same in total, regardless of changes in the activity level.

Variable Costs Defined

Variable costs are costs that vary in total directly and proportionately with changes in the activity level. However, variable costs remain the same per unit at every level of activity.

Cost Behavior Analysis

Cost behavior analysis is the study of how specific costs respond to changes in the level of business activity.

The Relevant Range

The relevant range is the range over which the company expects to operate during a year.

Key Definitions for Managerial Decisions

Relevant Cost

A relevant cost refers to the only factors to be considered: those costs and revenues that differ across alternatives.

Opportunity Cost

An opportunity cost is the benefit that a company must give up from some other course of action.

Sunk Cost

A sunk cost refers to costs that have already been incurred and will not be changed or avoided by any present or future decisions.

Incremental Revenue and Cost

Incremental revenue refers to the additional revenues from an additional quantity. An incremental cost is the increase in total costs resulting from an increase in production or other activity.

Stages in Management Decision-Making

The stages in the management decision-making process are:

1. Identify the problem and assign responsibility.
2. Determine and evaluate possible courses of action.
3. Make a decision.
4. Review results of the decision.