Accounting 202 Exam 1 Study Guide

Chapter 1: Managerial Accounting and Cost Concepts (12 Questions)

This chapter explains how managers need to rely on different cost classifications for different purposes. The four
main purposes emphasized in this chapter include assigning costs to cost objects, preparing external financial
reports, predicting cost behavior, and decision making.

Can I:

Understand cost classifications used for assigning costs to cost objects: direct costs and indirect costs.

A direct cost such as direct materials is a cost that can be easily and conveniently traced to a cost object. An
indirect cost is a cost that cannot be easily and conveniently traced to a cost object. For example, the salary of
the administrator of a hospital is an indirect cost of serving a particular patient.

Identify and give examples of each of the three basic manufacturing cost categories.

Manufacturing costs consist of two categories of costs that can be conveniently and directly traced to units of
product—direct materials and direct labor—and one category that cannot be conveniently traced to units of
product—manufacturing overhead.

Understand cost classifications used to prepare financial statements: product costs and period costs.

For purposes of valuing inventories and determining expenses for the balance sheet and income statement,
costs are classified as either product costs or period costs. Product costs are assigned to inventories and are
considered assets until the products are sold. A product cost becomes an expense—cost of goods sold—only
when the product is sold. In contrast, period costs are taken directly to the income statement as expenses in the
period in which they are incurred.

In a merchandising company, product cost is whatever the company paid for its merchandise. For external
financial reports in a manufacturing company, product costs consist of all manufacturing costs. In both kinds of
companies, selling and administrative costs are considered to be period costs and are expensed as incurred.

Understand cost classifications used to predict cost behavior: variable costs, fixed costs, and mixed costs.

For purposes of predicting how costs will react to changes in activity, costs are classified into three categories—
variable, fixed, and mixed. Variable costs, in total, are strictly proportional to activity. The variable cost per unit
is constant. Fixed costs, in total, remain the same as the activity level changes within the relevant range. The
average fixed cost per unit decreases as the activity level increases. Mixed costs consist of variable and fixed
elements and can be expressed in equation form as Y = a + bX, where X is the activity, Y is the total cost, a is the
fixed cost element, and b is the variable cost per unit of activity.

Analyze a mixed cost using the high-low method.

To use the high-low method, first identify the periods with the highest and lowest levels of activity. Second,
estimate the variable cost element by dividing the change in total cost by the change in activity for these two
periods. Third, estimate the fixed cost element by subtracting the total variable cost from the total cost at either
the highest or lowest level of activity.

The high-low method relies on only two, often unusual, data points rather than all of the available data and
therefore may provide misleading estimates of variable and fixed costs.

1
Prepared by: Don Campbell
 Accounting 202 Exam 1 Study Guide
Prepare income statements for a merchandising company using the traditional and contribution formats.

The traditional income statement format is used primarily for external reporting purposes. It organizes costs
using product and period cost classifications. The contribution format income statement aids decision making
because it organizes costs using variable and fixed cost classifications. The contribution margin is the amount
remaining from sales revenues after variable expenses have been deducted. This amount contributes toward
covering fixed expenses and then toward profits for the period.

Understand cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.

The concepts of differential cost and revenue, opportunity cost, and sunk cost are vitally important for purposes
of making decisions. Differential costs and revenues refer to the costs and revenues that differ between
alternatives. Opportunity cost is the benefit that is forgone when one alternative is selected over another. Sunk
cost is a cost that occurred in the past and cannot be altered. Differential costs and opportunity costs are
relevant in decisions and should be carefully considered. Sunk costs are always irrelevant in decisions and should
be ignored.

The various cost classifications discussed in this chapter are different ways of looking at costs. A particular cost,
such as the cost of cheese in a taco served at Taco Bell, can be a manufacturing cost, a product cost, a variable
cost, a direct cost, and a differential cost—all at the same time. Taco Bell essentially manufactures fast food.
Therefore, the cost of the cheese in a taco would be considered a manufacturing cost as well as a product cost.
In addition, the cost of cheese would be considered variable with respect to the number of tacos served and
would be a direct cost of serving tacos. Finally, the cost of the cheese in a taco would be considered a
differential cost of the taco.

Chapter 2: Job Order Costing (10 Questions)

Managers need to assign costs to products to facilitate external financial reporting and internal decision making.
This chapter illustrates an absorption costing approach to calculating product costs known as job-order costing.

Can I:

Compute a predetermined overhead rate.

Manufacturing overhead costs are assigned to jobs using a predetermined overhead rate. The rate is
determined at the beginning of the period so that jobs can be costed throughout the period rather than waiting
until the end of the period. The predetermined overhead rate is determined by dividing the estimated total
manufacturing overhead cost for the period by the estimated total amount of the allocation base for the period.

Apply overhead cost to jobs using a predetermined overhead rate.

Overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the
allocation base used by the job.

2
Prepared by: Don Campbell
 Accounting 202 Exam 1 Study Guide
Compute the total cost and average cost per unit of a job.

The total cost of a job includes the actual direct materials and direct labor costs assigned to the job plus the
applied overhead. The average cost per unit of a job is computed by dividing the total cost of a job by the
number of units included in the job. Importantly, the average cost per unit does not represent the additional
cost that would be incurred if another unit were produced.

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record
costs.

Direct materials costs are debited to Work in Process when they are released for use in production. Direct labor
costs are debited to Work in Process as incurred. Actual manufacturing overhead costs are debited to the
Manufacturing Overhead account as incurred. Manufacturing overhead costs are applied to Work in Process
using the predetermined overhead rate. The journal entry that accomplishes this is a debit to Work in Process
and a credit to Manufacturing Overhead.

Use T-accounts to show the flow of costs in a job-order costing system.

See Exhibits 2–10 and 2–14 for summaries of the cost flows through the T-accounts.

Prepare schedules of cost of goods manufactured and cost of goods sold and an income statement.

See Exhibits 2–11 and 2–12 for an example of these schedules and an income statement.

Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in
Manufacturing Overhead to the appropriate account.

The difference between the actual overhead cost incurred during a period and the amount of overhead cost
applied to production is referred to as underapplied or overapplied overhead. Underapplied or overapplied
overhead is closed out to Cost of Goods Sold. When overhead is underapplied, the balance in the Manufacturing
Overhead account is debited to Cost of Goods Sold. This has the effect of increasing the Cost of Goods Sold and
occurs because costs assigned to products have been understated. When overhead is overapplied, the balance

3
Prepared by: Don Campbell
 Accounting 202 Exam 1 Study Guide
in the Manufacturing Overhead account is credited to Cost of Goods Sold. This has the effect of decreasing the
Cost of Goods Sold and occurs because costs assigned to products have been overstated.

Students struggle to understand two key points with respect to underapplied or overapplied overhead. First,
underapplied or overapplied overhead is not computed for each job. It is computed for the company as a whole
(if a plantwide overhead rate is used) or for each department (if departmental overhead rates are used). Second,
students often fail to grasp the chronology of events in a normal costing system. Predetermined overhead rates
are computed at the beginning of the period. Overhead is applied to jobs throughout the period. Underapplied
or overapplied overhead is computed at the end of the period.

4
Prepared by: Don Campbell