Accounting Classifications and Purposes Quiz

Financial Accounting vs. Managerial Accounting

• Financial accounting reports financial information to external parties, such as stockholders, creditors, and regulators.
• Managerial accounting provides information to employees within an organization to formulate plans, control operations, and make decisions.

Purposes of Cost Classification

• Assigning costs to cost objects.
• Accounting for costs in manufacturing companies.
• Preparing financial statements.
• Predicting cost behavior in response to changes in activity.
• Making decisions.

Cost Classification

• Direct Costs: can be easily and conveniently traced to a unit of product or other cost object (e.g. direct material, direct labor).
• Indirect Costs: cannot be easily and conveniently traced to a unit of product or other cost object (e.g. manufacturing overhead).
• Common Costs: indirect costs incurred to support a number of cost objects, which cannot be traced to any individual cost object.

Direct Materials and Direct Labor

• Direct Materials: raw materials that become an integral part of the product and can be conveniently traced directly to it (e.g. a seat in an aircraft).
• Direct Labor: labor costs that can be easily traced to the individual units of product (e.g. wages paid to automobile assembly workers).

Manufacturing Overhead, Selling Costs, and Administrative Costs

• Manufacturing Overhead: includes all manufacturing costs except direct material and direct labor, which cannot be readily traced to finished products.
• Selling Costs: costs necessary to secure the order and deliver the product, which can be either direct or indirect costs.
• Administrative Costs: all executive, organizational, and clerical costs, which can be either direct or indirect costs.

Cost Classifications for Financial Statements

• Product Costs: include all costs involved in acquiring or making a product, which "attach" to a unit of product as it is purchased or manufactured and remain attached to each unit of product as long as it remains in inventory awaiting sale.
• Period Costs: not related to product costs.

Cost Behavior

• Cost Behavior: refers to how a cost will react to changes in the level of activity.
• Variable Costs: a cost that varies, in total, in direct proportion to changes in the level of activity, with a constant variable cost per unit.
• Fixed Costs: a cost that remains constant, in total, regardless of changes in the level of activity, with an average fixed cost per unit that varies inversely with changes in activity.
• Mixed Costs: a combination of variable and fixed costs.

Differential Cost and Revenue, Opportunity Costs, and Sunk Costs

• Differential Cost (or Incremental Costs): the difference in cost between any two alternatives.
• Differential Revenue: the difference in revenue between two alternatives.
• Opportunity Costs: the potential benefit that is given up when one alternative is selected over another, not usually found in accounting records, but must be explicitly considered in every decision.
• Sunk Costs: costs that have already been incurred and cannot be changed now or in the future, which should be ignored when making decisions.