Accounting Exam 1 Study Guide
Chapter One
Financial Accounting
 Reports to those outside company
 Emphasizes consequences of past
 Precision
 Must follow GAAP
 Mandatory for external reports
Managerial Accounting
 Reports to managers inside company
 Decisions for the future
 Timeliness
 Doesn’t need GAAP
 Not mandatory
Lean Production (Just in Time Production) – wait until they get response from
customer to start production = low inventory, less wasted effort
Theory of Constraints (Bottleneck) – anything that prevents you from getting
more of what you want. Identify weakest link and improving it and make it no
longer the weakest link and find the next weakest link
4 keys in ethical behavior
 Competence
 Confidentiality
 Integrity
 Credibility
Customer Value Propositions
Customer Intimacy Strategy – understand and respond to individual customer
needs
Operational Excellence Strategy – deliver products and services faster, more
conveniently, and at lower prices
Product Leadership Strategy – offer higher quality products
Enterprise Risk Management – a process used by a company to proactively
identify and manage risk
Corporate Social Responsibility – a concept whereby organizations consider the
needs of all stakeholders when making decisions
Chapter Two
Direct Materials – raw materials that become an integral part of the product and
that can be conveniently traced directly to it. (the flour in the dough)
Direct Labor – those labor costs that can be easily traced to individual units of
product. (wages paid to bakers)
Manufacturing Overhead – manufacturing costs that cannot be easily traced
directly to specific units produced. (Indirect materials and indirect labor)
 Indirect Materials – materials used to support the production process.
(lubricants and cleaning supplies to maintain the bakery and equipment)
 Indirect Labor – wages paid to employees who are not directly involved in
production (clean-up workers, janitors, security guards)
Nonmanufacturing Costs
Selling Costs – costs necessary to secure the order and deliver the product
Administrative Costs – all executive, organizational, and clerical costs
Product Costs Versus Period Costs
Product Costs – direct materials, direct labor, and manufacturing overhead
Period Costs – all selling costs and administrative costs (nonmanufacturing costs)
Manufacturing costs are often classified as follows:
Direct Material
Direct Labor
Prime Cost
Manufacturing Overhead
Conversion Cost
Cost Classifications for Predicting Cost Behavior
Cost behavior refers to how a cost will react to changes in the level of activity. Most
common classifications are:
Variable costs – a cost that varies, in total, in direct proportion to changes in the
level of activity. In some cases your texting bill is based on how many texts you send
However, variable cost per unit is constant. (cost per text sent is constant). So graph
would be a straight line
Fixed Cost – a cost that remains constant, in total, regardless in the level of the
activity. However, if expressed on a per unit basis, the average fixed cost per unit
varies inversely with changes in activity (downward slope)
Types of Fixed Costs:
 Committed – long term, significantly reduced in the short term (depreciation
on buildings and equipment and real estate taxes)
 Discretionary – may be altered in the short-term by current managerial
decisions (advertising and research and development)
The Linearity Assumption and the Relevant Range
The relevant range of activity for a fixed cost is the range of activity over which the
graph of the cost is flat
Mixed Costs – contains both variable and fixed elements. The total mixed cost line
can be expressed as an equation: y = a + bx
Y= the total mixed cost
A= the total fixed cost (the vertical intercept of the line)
B= the variable cost per unit f the activity (the slope of the line)
X= the level of activity
Analysis of Mixed Costs
Account Analysis – each account is classified as either variable or fixed based on
the analyst’s knowledge of how the account behaves
The High-Low Method
Steps:
1. Choose high and low data points based on activity
2. Choose corresponding cost amounts related to High Low data points
3. Calculate variable cost per unit: = change in cost/change in activity
4. Calculate total fixed cost: = total cost – total variable cost
5. Create mixed cost equation: Y = a + bx
Least Squares Regression Method - used to analyze mixed costs if a scattergraph
plot reveals linear relationship (most accurate estimate)
Traditional and Contribution Formats
Assigning Costs to Cost Objects
Direct Costs – costs that can be easily and conveniently traced to a unit of product
or other cost object (direct material and direct labor)
Indirect Costs – costs that cannot be easily and conveniently traced to a unit of
product or other cost object (manufacturing overhead)
Differential Cost and Revenue
Costs and revenues that differ among alternatives
Example: You have a job paying $1,500 per month in your hometown. You have
a job offer in a neighboring city that pays $2,000 per month. The commuting
cost to the city is $300 per month.
Differential Revenue is: $2,000 - $1,500= $500
Differential Cost is $300
Opportunity Cost – potential benefit that is given up when 1 alternative is selected
over another
Sunk Costs – costs that have already been incurred and cannot be changed. Not
used for decision making
Chapter Three
Basics of Cost-Volume-Profit Analysis
Contribution Income Statement
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles)
$
250,000
Less: Variable expenses
150,000
Contribution margin
100,000
Less: Fixed expenses
80,000
Net operating income
$
20,000
Contribution Margin – the amount
remaining from sales revenue after
variable expenses have been deducted
CM is used first to cover fixed expenses.
Any remaining CM contributes to net
operating income
The Contribution Approach
Sales, variable expenses, and CM can also be expressed on a per unit basis
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total
Per Unit
Sales (500 bicycles)
$
250,000
$
500
Less: Variable expenses
150,000
300
Contribution margin
100,000
$
200
Less: Fixed expenses
80,000
Net operating income
$
20,000
Profit = (sales-VE) – fixed
expenses
Sales = quantity sold x price/unit
(QxP)
VE = quantity sold x ve/unit
We do not need to prepare an income statement to estimate profits at a particular
sales volume. Simply multiply the number of units sold above break-even by the
contribution margin per unit.
CVP Relationships in Equation Form
Profit = (Sales – Variable expenses) – Fixed expenses
Profit = (sales-VE) – fixed expenses
Sales = quantity sold x price/unit
(QxP)
VE = quantity sold x ve/unit
Preparing the CVP Graph
In a CVP graph, unit volume is represented on the X axis and Dollars on the Y axis
1. Draw a line parallel to the volume axis to represent total fixed expenses
2. Choose some sales volume, ex. 400 units, and plot the point representing
total expenses (fixed and variable). Draw a line through the data point back
to where the fixed expenses line intersects the dollar axis
3. Choose some volume, ex. 400 units, and plot the point representing total
sales. Draw a line through the data point back to the point of origin
Profit = Unit CM x Q – fixed costs
Break even point – where profit is 0
Contribution Margin Ratio
Total CM/Total Sales
Sales increase x CM ratio = increase in Net Operating Income
The Variable Expense Ratio – variable expenses/sales (total or unit)
Profit = (CM ratio x sales) – fixed expenses
Target Profit Analysis
We can compute the number of units that must be sold to attain a target profit using
1. Equation Method or,
2. Formula Method
The Formula Method
Equation Method
Example
The Margin of Safety in Dollars
The excess of budgeted (actual) sales over the break-even volume of sales
Margin of safety in dollars = Total sales - Break-even sales
Cost Structure and Profit Stability
Cost Structure – the relative proportion of fixed and variable costs in an
organization
Operating Leverage – a measure of how sensitive net operating income is to
percentage changes in sales. A measure, at any given level of sales, of how a
percentage change in sales volume will affect profits
Degree of operating leverage = CM/Net operating income
Key Assumptions of CVP Analysis
1. Selling price is constant
2. Costs are linear and can be accurately divided into variable (constant per
unit) and fixed (constant in total) elements
3. In multiproduct companies, the sales mix is constant
4. In manufacturing companies, inventories do not change (units produced =
units sold)
Chapter Four
Job-Order Costing
Used When:
1. many different products are produced each period
2. products are manufactured to order
3. the unique nature of each order requires tracing or allocating costs to each
job, and maintaining cost records for each job
Examples of companies that would use job-order costing:
1. Boeing (aircraft manufacturing)
2. Bechtel International (large scale construction)
3. Walt Disney Studios (movie production)


Charge direct materials and labor costs to each job as work is performed
Indirect materials and labor (manufacturing overhead) are allocated to jobs
rather than directly traced to each job
Allocation Base – used to assign manufacturing overhead to products
Manufacturing Overhead Application
The Need for a POHR
Using a POHR makes it possible to estimate total job costs sooner
Actual overhead for the period is not known until the end of the period
Computing Predetermined Overhead Rates
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 a cost formula to estimate the total manufacturing overhead cost for the
coming period
4. Compute the predetermined overhead rate
Key Definitions
1. Raw Materials – any materials that go into the final product
2. Work in Process – consists of units of production that are only partially
complete and will require further work before they are ready for sale to
customers
3. Finished Goods – completed units of product that have not been sold to
customers
4. Cost of Goods Manufactured – the manufacturing costs associated with the
goods that were finished during the period
The difference between the manufacturing overhead cost applied to jobs and the
actual manufacturing overhead costs of a period is called wither underapplied or
overapplied overhead
Underapplied Overhead – when the amount of overhead applied to production is
less than the actual manufacturing overhead costs
Overapplied Overhead – when the amount of overhead applied to production is
greater than the actual manufacturing overhead costs
Overapplied overhead is deducted from COGS
Underapplied overhead is added to COGS
The Direct Method of Determining Cost of Goods Sold
The Indirect Method of Determining Cost of Goods Sold
Cost of goods manufactured = total manufacturing cost charged to jobs + Beginning
work in process inventory – ending work in process inventory
Computing Net Operating Income