The office manager's salary is a general and administrative cost.

The office
manager's salary will not be affected by the number of tests performed; it is fixed. Direct
labor cost includes all labor that is physically traceable to the product in an economically
feasible manner. Overhead cost is the sum of all indirect production costs (i.e. all testing
costs except direct materials and direct labor) that is not physically traceable to the
product in economically feasible manner.
The cost of electricity to run laboratory euipment is an overhead cost for testing.
The electricity to run laboratory euipment changes in total with the changes in total with
a change in the number of tests; it is a variable cost. !eneral and administrative costs are
non"production costs.
Direct labor cost includes all labor that is physically traceable to the product in an
economically feasible manner. The hourly wages of part"time technicians who perform
tests is a direct labor cost. The wages will change in total with a change in the number of
tests performed; the cost is variable.
Overhead cost is the sum of all indirect production costs (i.e. all testing costs
except direct materials and direct labor) that is not physically traceable to the product in
economically feasible manner. The cost of lubricant used on laboratory euipment is an
overhead cost for testing. The cost of lubricant used on laboratory euipment changes in
total with a change in the number of tests; it is a variable cost.
The water is physically traceable to the tests; it is a direct material cost. The water
used in tests changes in total with a change in total with a change in the number of tests;
it is a variable cost.
The costs of the office manager#s salary are a general and administrative cost. The
office manager's salary will not be affected by the number of tests performed; it is fixed.
Direct labor cost includes all labor that is physically traceable to the product in an
economically feasible manner. Overhead cost is the sum of all indirect production costs
(i.e. all testing costs except direct materials and direct labor) that is not physically
traceable to the product in economically feasible manner.
The cost of electricity to run laboratory euipment is an overhead cost for testing.
The electricity to run laboratory euipment changes in total with the changes in total with
a change in the number of tests; it is a variable cost. !eneral and administrative costs are
non"production costs.
Direct labor cost includes all labor that is physically traceable to the product in an
economically feasible manner. The hourly wages of part"time technicians who perform
tests is a direct labor cost. The wages will change in total with a change in the number of
tests performed; the cost is variable.

Overhead cost is the sum of all indirect production costs (i.e. all testing costs
except direct materials and direct labor) that is not physically traceable to the product in
economically feasible manner. The cost of lubricant used on laboratory euipment is an
overhead cost for testing. The cost of lubricant used on laboratory euipment changes in
total with a change in the number of tests; it is a variable cost.
The water is physically traceable to the tests; it is a direct material cost. The
water used in tests changes in total with a change in total with a change in the number of
tests; it is a variable cost.
The cost of the binders is a direct material cost. The cost of the binders changes in
total with a change in the number of tests; it is a variable cost.
$ince total fixed costs remain constant within the relevant range of activity% an
increase in the level of production decreases the fixed costs per unit because the same
total fixed are allocated over more units. &ariable costs do not change on a per unit basis
with changes in the level of activity within a relevant range.
'rime costs are the sum of direct materials costs and direct labor costs.
(onversion costs are the sum of direct labor and overhead.
'roduct costs are costs that are inventoriable (directly or indirectly related to
physical units). They become an expense when the related goods are sold. )elevant costs
are expected future costs that will differ among alternatives; they may be either product
costs or period costs. 'eriod costs are costs that are not incurred in the purchase or
production of physical units and are not inventoried; they are expensed in the period
incurred. Opportunity costs are the foregone net benefits from alternatives not selected;
they are not included in the financial statements.
*ssuming that the finished goods inventory level remains constant% beginning
inventory plus total production costs less cost of goods sold euals ending inventory.
Direct labor is the component of total production costs.
Direct labor and overhead are the only conversion costs. *n analysis of finished
goods inventory reveals that goods finished and removed from wor+ in process(,-') cost
./0%0112 beginning balance of /%011 3 goods finished of ./0%011 " cost of goods sold of
/0%111 4 ending balance of /%511. *s beginning ,-' and ending ,-' are the same% all
costs of goods finished and removed from ,-' are the material and conversion costs
added to ,-'. *n analysis of raw material ()6) inventory reveals that )6 added to ,-'
cost .7%8112 beginning balance .711 3 purchases of .9%111 " )6 added to ,-' of .7%811
4 ending balance of .:11. *ll ,-' costs less )6 costs eual conversion costs2 /0%011 "
.7%811 4 .9%711.
Direct materials% direct labor% and manufacturing overhead are the three ma;or
elements in the cost of a manufactured product. 6anufacturing overhead consists of all
manufacturing costs other than direct materials and direct labor. Thus% manufacturing
overhead is both necessary and an indirect element in production and an indirect cost of
production.
Direct labor overtime premium is generally considered to be attributable to the
heavy overall volume of wor+% and its cost is thus regarded as part of manufacturing
overhead% which is borne by all units produced. <owever% sometimes the direct labor
overtime premium is not random. =or example% a special or rush ;ob may clearly be the
sole source of the overtime. -n such instances% the premium is regarded as a direct cost of
the products made for that ;ob.
Direct costs are those costs that can be traced easily to a cost ob;ect. &alue"adding
costs are costs for which a customer would be willing to pay. The payments to the
employees who develop these programs can be easily traced to the cost of the computer
programs. (osts incurred for employees who wor+ directly on a product desired by a
customer are value"adding costs. Therefore% the payments to the employees who develop
these computer programs are both direct and value"adding costs.
The amount of service hour#s depreciation on the laboratory euipment will be
affected by the number of tests; therefore% it is variable.
Depreciation is an overhead cost. The amount of straight"line depreciation on the
building will not be affected by the number of tests; it is fixed.
The learning curve pertains to the assembly operation. *s wor+ers learn to
assemble components faster% they will assemble more components in successive time
periods. >earning how to assemble components faster has no effect on the number of
components needed to produce a unit of output. The binders are a direct material cost.
The cost of the binders changes in total with a change in the number of tests; it is a
variable cost.
$ince total fixed costs remain constant within the relevant range of activity% an
increase in the level of production decreases the fixed costs per unit because the same
total fixed are allocated over more units. &ariable costs do not change on a per unit basis
with changes in the level of activity within a relevant range.
'rime costs are the sum of direct materials costs and direct labor costs.
(onversion costs are the sum of direct labor and overhead.
'roduct costs are costs that are inventoriable (directly or indirectly related to
physical units). They become an expense when the related goods are sold. )elevant costs
are expected future costs that will differ among alternatives; they may be either product
costs or period costs. 'eriod costs are costs that are not incurred in the purchase or
production of physical units and are not inventoried; they are expensed in the period
incurred. Opportunity costs are the foregone net benefits from alternatives not selected;
they are not included in the financial statements.
*ssuming that the finished goods inventory level remains constant% beginning
inventory plus total production costs less cost of goods sold euals ending inventory.
Direct labor is the component of total production costs.
Direct labor and overhead are the only conversion costs. *n analysis of finished
goods inventory reveals that goods finished and removed from wor+ in process(,-') cost
./0%0112 beginning balance of /%011 3 goods finished of ./0%011 " cost of goods sold of
/0%111 4 ending balance of /%511. *s beginning ,-' and ending ,-' are the same% all
costs of goods finished and removed from ,-' are the material and conversion costs
added to ,-'. *n analysis of raw material ()6) inventory reveals that )6 added to ,-'
cost .7%8112 beginning balance .711 3 purchases of .9%111 " )6 added to ,-' of .7%811
4 ending balance of .:11. *ll ,-' costs less )6 costs eual conversion costs2 /0%011 "
.7%811 4 .9%711.
Direct materials% direct labor% and manufacturing overhead are the three ma;or
elements in the cost of a manufactured product. 6anufacturing overhead consists of all
manufacturing costs other than direct materials and direct labor. Thus% manufacturing
overhead is both necessary and an indirect element in production and an indirect cost of
production.
Direct labor overtime premium is generally considered to be attributable to the
heavy overall volume of wor+% and its cost is thus regarded as part of manufacturing
overhead% which is borne by all units produced. <owever% sometimes the direct labor
overtime premium is not random. =or example% a special or rush ;ob may clearly be the
sole source of the overtime. -n such instances% the premium is regarded as a direct cost of
the products made for that ;ob.
Direct costs are those costs that can be traced easily to a cost ob;ect. &alue"adding
costs are costs for which a customer would be willing to pay. The payments to the
employees who develop these programs can be easily traced to the cost of the computer
programs. (osts incurred for employees who wor+ directly on a product desired by a
customer are value"adding costs. Therefore% the payments to the employees who develop
these computer programs are both direct and value"adding costs.
The amount of service hour#s depreciation on the laboratory euipment will be
affected by the number of tests; therefore% it is variable.
Depreciation is an overhead cost. The amount of straight"line depreciation on the
building will not be affected by the number of tests; it is fixed.
The learning curve pertains to the assembly operation. *s wor+ers learn to
assemble components faster% they will assemble more components in successive time
periods. >earning how to assemble components faster has no effect on the number of
components needed to produce a unit of output.
?nder variable costing% no fixed manufacturing costs are applied to inventory.
<ence% brea+"even analysis need not assume that sales volume euals production volume.
@rea+"even analysis assumes that costs behave in a linear relationship within the
relevant range. @rea+"even analysis assumes that fixed costs remain constant in total and
that variable costs are fixed or unchanged on a per"unit basis.
Total actual sales eualed budgeted sales and sales prices and cost behavior were
as budgeted. Thus% the increase in profit cannot be due to additional sales% and neither the
contribution margin per unit of either of the products not total fixed costs changed. The
only plausible explanation of the increase in profit is that the sales mix of the two
products changed. Total sales must have consisted of a greater percentage of the high
contribution margin product and a lower percentage of the low contribution margin
product. *t the brea+"even point% contribution margin euals total fixed costs.
(ost"volume"profit ((&') analysis assumes that both the selling price and
variable cost per unit do not change with volume changes; therefore% variable costs are
the same percentage of sales revenues at points * and @. (&' analysis also assumes that
fixed costs remain unchanged over the relevant range. Therefore% fixed costs are greater
percentage of revenues at point * than point @ because revenues are lower at point *.
The brea+"even point is computed by dividing fixed costs by the contribution
margin. $ince fixed costs are the numerator of the formula% a decrease in fixed costs
would decrease the brea+even point. $ince the contribution margin is the denominator of
the formula% an increase in this amount would also decrease the brea+even point. $ince
both the decrease in fixed costs and the increase in the contribution margin decrease the
brea+even point% the brea+even point decreases.
Sunk costs are costs incurred as a result of past decisions and not relevant to
future decisions. The carrying amount of the machine (/15%111 A 81%111) is a sun+ cost
with no bearing on the decision to +eep or replace. -n order to be relevant for decision
ma+ing% an item must meet both of the following criteria2
a) -t is an expected future cost or revenue
b) -ts amount will differ among alternatives.
Incremental (differential) cost is the difference in total cost between the two
alternatives. The total amount of fixed costs does not differ between the two alternatives.
The carrying amount of the old machine is irrelevant because it is past (historical)
cost. The disposal value of the new machine is relevant because it is an expected future
cash inflow that differs between alternatives.
Opportunity costs are the costs of foregone net benefits from alternatives not selected;
hence% they are involved in almost very decision. *ccounting profit is revenue minus
expenses. Opportunity costs are not limited to external costs or explicit costs. Bote2 -f
encounter unfamiliar phrases on the exam% those options probably are incorrect.
,hen only differential manufacturing costs are ta+en into account for special
order pricing% it is essential to assume that acceptance of the order will not affect regular
sales. -t is not necessary to assume that costs are linear or that they will not change.
-n a special order decision% the minimum price should cover only incremental
variable costs% unless additional fixed costs are incurred or another use for the production
capacity exists% the minimum price also should cover the contribution margin that
otherwise would be earned on that use.
,ith respect to the income statement prepared using the variable costing method%
the manufacturing company#s sales revenues and total contribution margin approximated
budgeted figures; therefore% the company#s total variable expenses also approximated
budgeted figures. Thus% it is unli+ely that the higher net income figure was due to a
decrease in a variable manufacturing or variable selling and administrative expenses.
,ith respect to the income statement prepared using the absorption costing method% sales
revenues and gross profit approximated budgeted figures; therefore% the company#s total
manufacturing expenses also approximated budgeted figures. Thus% it is unli+ely that the
higher net income figure was due to a decrease in fixed manufacturing expenses. $ince it
is unli+ely that the higher net income figure was due to a decrease in either variable
manufacturing expenses% variable selling and administrative expenses% or fixed
manufacturing expenses% the most li+ely explanation of the higher net income figure is
that fixed selling and administrative expenses had decreased.
?nder the variable costing method only variable production costs are treated as
inventoriable or product costs. =ixed overhead cost is treated as a period cost. &ariable
factory overhead costs are assigned to inventory. <owever% under variable costing% as
well as under absorption costing% selling and administrative costs (whether variable or
fixed) are period costs% not product costs assigned to inventory.
&ariable (or direct) costing is not acceptable for external financial reporting
(!**') or federal income tax reporting. *bsorption costing inventories both fixed and
variable costs% in accordance with !**'.
?nder direct costing% only variable product costs (direct materials% direct labor%
and variable manufacturing overhead) are inventoried. The fixed manufacturing overhead
and variable selling costs are considered to be period costs and are expensed when
incurred.
The difference in reported income between the absorption and variable costing
methods is due solely to their difference in accounting for fixed manufacturing overhead
costs. ?nder the variable costing method% fixed manufacturing overhead is considered to
be a period cost and% thus% is expensed immediately in the period incurred. ?nder the
absorption costing method% fixed manufacturing overhead is considered to be a product
cost and% thus% is released to expense on a per unit basis when the goods are sold. During
Cear 0% the variable costing method resulted in a higher reported income than the
absorption costing method. This means that a greater amount of fixed manufacturing
overhead was released to expense under absorption costing. This would only occur when
inventory levels are drawn down. Thus% the units sold exceeded the units produced.
?nder direct costing% both the ./11%111 of fixed manufacturing overhead costs
and the .:1%111 of variable selling costs are classified as period costs. ?nder direct
costing% only variable manufacturing costs (direct materials% direct labor% and variable
manufacturing overhead) are inventoried as product costs. =ixed manufacturing overhead
and all selling and administrative costs are considered to be period costs% rather than
product costs% and are therefore expensed when incurred.
,hen there is no change in standard costs and inventories% the absorption costing
method and variable costing will give the same net income. <owever% the cost of
inventory will be greater under absorption costing because inventory includes fixed
overhead cost under absorption costing but not under variable costing. -nventory is a
current asset. (osting methods have no effect on other current assets or on the amount of
current liabilities. The current ratio is the ratio between current assets and current
liabilities. @ecause inventory is greater under absorption costing% the current ratio will
also be greater under absorption costing. @ecause inventory is greater under absorption
costing% stoc+holders# euity will also be greater under absorption costing. )eturn on
stoc+holders# euity is net income divided by stoc+holders# euity. $ince the income is
the same under both methods% the return on stoc+holders# euity will be smaller under
absorption because of the greater denominator.
,hen there are products competing for a scarce resource% the company should
produce and sell the product that has the greater contribution margin per unit of the scarce
resource. -n this case% manufacturing capacity is the scarce resource. Therefore% Dago (o.
should manufacture the product with the greater contribution margin per hour of
manufacturing capacity. This will result in a greater total contribution margin and thus a
greater short"run profit.
,hen sales exceed production ( the uantity of beginning inventory is more than
ending inventory)% the operating income reported using direct costing will generally be
higher than operating income reported using absorption costing. ,hen more inventory is
sold than is produced% inventories are drawn down% and the amount of fixed
manufacturing overhead cost released to expense using absorption costing is greater than
the amount that was incurred during the period.
*bsorption costing includes manufacturing costs in inventory. -f there is ending
inventory% the fixed manufacturing costs associated with that inventory do not get
expensed on an absorption cost income statement. Direct ( or variable) costing expenses
all fixed costs as expenses of the period% including the fixed manufacturing costs of
ending inventory. *s there was no beginning inventory% the difference in the amounts of
income calculated under the two methods is the amount of fixed manufacturing costs
associated with the inventory on hand.
?nder direct costing% product and period costs must be separated into their fixed
and variable components; this can be difficult and often is sub;ect to individual
;udgement.