Financial Accounting Glossary

1 Cost Types

Variable costs: - Total cost changes in proportion to volume of activity. Fixed costs: Total cost does not change in proportion to volume of activity. Mixed costs: Cost consists of both a variable and a fixed element.

2 Product Costs

Direct materials: Raw materials costs directly linked to finished product.

Direct labor: Employee costs directly linked to finished product.

Overhead: Production costs indirectly linked to finished product.

3 Costing Systems

Job order costing: Costs assigned to each unique unit or batch of units.

Process costing: Costs assigned to similar products that are mass-produced in a continuous manner.

4 Costing Ratios

Contribution margin ratio = (Net sales – Variable costs)/Net sales

Predetermined overhead rate = Estimated overhead costs/Estimated activity base

Break-even point in units = Total fixed costs/Contribution margin per unit

5 Planning and Control Metrics

Cost variance = Actual cost – Standard (budgeted) cost

Sales (revenue) variance= Actual sales – Standard (budgeted) sales

6 Capital Budgeting

Payback period = Time expected to recover investment cost

Accounting rate of return = Expected annual net income/Average annual investment

Net present value (NPV) = Present value of future cash flows – Investment cost

NPV rule:

1. Compute net present value (NPV in $)
2. If NPV > 0, then accept project; If NPV < 0, then reject project ### Internal rate
3. Compute internal rate of return (IRR in %) of return rule:
4. If IRR > hurdle rate, accept project; If IRR < hurdle rate, reject project ## 7 Costing Terminology Relevant range: Organization’s normal range of operating activity.

Direct cost: Cost incurred for the benefit of one cost object.

Indirect cost: Cost incurred for the benefit of more than one cost object.

Product cost: Cost that is necessary and integral to finished products.

Period cost: Cost identified more with a time period than with finished products.

Overhead cost: Cost not separately or directly traceable to a cost object.

Relevant cost: Cost that is pertinent to a decision.

Opportunity cost: Benefit lost by choosing an action from two or more alternatives.

Sunk cost: Cost already incurred that cannot be avoided or changed.

Standard cost: Cost computed using standard price and standard quantity.

Budget: Formal statement of an organization’s future plans.

Break-even point: Sales level at which an organization earns zero profit.

Incremental cost: Cost incurred only if the organization undertakes a certain action.

Transfer price: Price on transactions between divisions within a company.

8 Standard Cost Variances



9 Sales Variances

Sales price variance=[AS×AP]−[AS×BP] Sales volume variance=[AS×BP]−[BS×BP] where AS = Actual Sales units; AP = Actual sales Price; BP = Budgeted sales Price; BS = Budgeted Sales units (fixed budget).

Where

AS = Actual Sales units; AP = Actual sales Price; BP = Budgeted sales Price; BS = Budgeted Sales units (fixed budget).