Cost Accounting Concepts, CVP & Decision-Making Formulas
Cost Accounting Concepts & CVP Analysis
KEY: DM = Direct Materials, DL = Direct Labor, MOH = Manufacturing Overhead, RM = Raw Materials, WIP = Work in Process, FG = Finished Goods, COGM = Cost of Goods Manufactured, COGS = Cost of Goods Sold, Beg = Beginning, End = Ending, Inv = Inventory, Avg = Average, Mfg = Manufacturing, CM = Contribution Margin, SP = Selling Price, VC = Variable Costs, FC = Fixed Costs, MOS = Margin of Safety, DOL = Degree of Operating Leverage
Chapter 14 – Cost Concepts
- Prime Cost = DM + DL.
- Conversion Cost = DL + MOH.
- Product Cost = DM + DL + MOH.
- Period Cost = Selling Expenses + General & Administrative Expenses.
- DM Used = Beginning RM Inventory + RM Purchases – Ending RM Inventory.
- Total Manufacturing Costs = DM Used + DL + MOH.
- Total Cost of WIP = Beginning WIP Inventory + Total Manufacturing Costs.
- COGM = Total Cost of WIP – Ending WIP Inventory.
- Goods Available for Sale = Beginning FG Inventory + COGM.
- COGS = Beginning FG Inventory + COGM – Ending FG Inventory.
- Raw Materials Inventory Turnover = RM Used ÷ Average RM Inventory, where Average RM Inventory = (Beginning RM Inventory + Ending RM Inventory) ÷ 2.
- Days’ Sales in RM Inventory = (Ending RM Inventory ÷ RM Used) × 365.
Chapter 18 – Cost Behavior & CVP Analysis
- Fixed Cost equation: Y = f (constant total).
- Variable Cost equation: Y = v x (where v = VC per unit, x = units).
- Mixed Cost equation: Y = v x + f.
- High-Low Method: v = Change in Total Cost ÷ Change in Activity = (Cost at High – Cost at Low) ÷ (High Activity – Low Activity).
- Fixed Cost (f) = Total Cost – (v × Activity Level).
- CM = Sales – Variable Costs.
- CM per unit = Selling Price per unit – VC per unit.
- CM Ratio (%) = CM ÷ Sales OR CM per unit ÷ SP per unit.
- Operating Income = (CM per unit × Units) – FC OR (Sales × CM Ratio) – FC.
- Break-Even in Units = FC ÷ CM per unit.
- Break-Even in Sales Dollars = FC ÷ CM Ratio.
- Target Income in Units = (FC + Target Income) ÷ CM per unit.
- Target Income in Sales $ = (FC + Target Income) ÷ CM Ratio.
- Margin of Safety (units or $) = Expected Sales – Break-Even Sales.
- MOS % = MOS ÷ Expected Sales.
- Degree of Operating Leverage (DOL) = CM ÷ Operating Income.
- % Change in Operating Income = DOL × % Change in Sales.
- Expected Income = Current Income + (Current Income × DOL × % Change in Sales).
KEY: CM = Contribution Margin, FC = Fixed Costs, VC = Variable Costs, MOH = Manufacturing Overhead, DM = Direct Materials, DL = Direct Labor, Rev = Revenue, Inc = Income
Core Concepts
Incremental Profit = Incremental Revenue – Incremental Cost.
Sunk costs (already incurred) are always irrelevant.
Opportunity costs (benefits forgone) are always relevant.
Avoidable costs are relevant. Unavoidable/allocated common costs are irrelevant.
Special Order Decision
Decision rule: Accept if Special Order Price > VC per unit + Incremental FC per unit.
Income Increase = (Special Price × Special Units) – (VC per unit × Special Units) – Any Incremental FC.
Regular fixed costs are irrelevant (sunk). Only accept when excess capacity exists.
Make or Buy Decision (Outsourcing)
- Total Cost to Make = (VC per unit × Units) + Avoidable FC + Opportunity Cost.
- Total Cost to Buy = (Supplier Price × Units) – Opportunity Cost Benefit (if capacity has alternative use).
- Choose the option with the lower total cost. Book value and unavoidable FC are irrelevant.
- Maximum outsourcing price = Cost to Make per unit including opportunity cost per unit.
Sell or Process Further Decision
Incremental Revenue = Revenue if Process Further – Revenue if Sell As Is.
Incremental Cost = Additional Processing Costs.
Process further if Incremental Revenue > Incremental Cost. Costs already incurred are sunk and irrelevant. Decision is based only on additional revenues vs additional costs.
Scrap or Rework Decision
Income from Scrap = Scrap Revenue (no additional costs).
Income from Rework = Sales Revenue after Rework – Rework Costs.
Choose the option with higher income. Original production costs are sunk and irrelevant.
Keep or Replace Equipment
Cost to Keep = Variable operating costs over remaining life.
Cost to Replace = New purchase price – Old sale price + New variable costs over life.
Replace if Cost to Replace < Cost to Keep OR if income increase is positive. Book value of old equipment is a sunk cost and irrelevant.
Eliminate Segment Decision
Income Impact = Fixed Costs Avoided – CM Lost.
Eliminate the segment if Avoidable FC > CM Lost (positive income impact). Keep the segment if CM Lost > Avoidable FC (income would decrease). Common fixed costs that will be reallocated are irrelevant.
Constrained Resources (Sales Mix)
CM per Unit of Constraint = CM per unit ÷ Units of constrained resource required per unit (e.g., CM per machine hour = CM per unit ÷ Machine hours per unit).
Rank products by CM per constraint unit from highest to lowest. Produce the highest-ranked product first until demand is met or the constraint is exhausted, then move to the next product.
Total CM = Sum of (Units × CM per unit) for all products produced.
Pricing Decisions
- Cost-Plus Pricing: Sales Price per Unit = (Total Costs ÷ Expected Units) × (1 + Markup %).
- Target Costing (price taker): Target Total Cost = Target Sales Revenue – Desired Profit.
- Target VC per unit = (Target Total Cost – FC) ÷ Expected Units.
- Desired profit often = Target ROI × Total Assets.