AC102-CAC-MODULE-1-OVERVIEW-OF-COST-ACCOUNTING-ANSWER-KEY.pdf

1 PSBA-MANILA First Semester SY 2024-2025 COST ACCOUNTING & CONTROL WEE...

1 PSBA-MANILA First Semester SY 2024-2025 COST ACCOUNTING & CONTROL WEEK 1 MODULE: OVERVIEW OF COST ACCOUNTING Cost Accounting Cost accounting is linked to tax accounting, financial accounting and managerial accounting because it is an important component of each discipline. Why? Because cost accounting involves determining the cost of something, such as a product, a service, an activity, a project, or some other cost object. These costs are needed for several purposes. For example, the costs of products and services produced and sold are needed for both tax and external financial statements. In other words, tax and financial accounting depend on cost accounting to provide cost information. Information about costs is also needed for a variety of management decisions. For example, cost estimates are needed to determine whether or not a product or service can be produced and sold at a profit. Unit costs of a product (or service) are also needed for product pricing and product discontinuance decisions. In addition, accurate cost information is required to determine whether or not a company should make (produce) or buy the raw materials, parts and subassemblies that become part of its major products and services. None of the other disciplines including tax accounting, financial accounting or managerial accounting could exist without cost accounting. Cost Management Cost management is a term that has been popularized by CAM-I (Consortium For Advanced Manufacturing – International). Cost management is said to be a more comprehensive concept than cost accounting in that the emphasis is on managing and reducing costs rather than reporting costs. In other words, it is a long run proactive approach rather than a short run reactive approach. For example, a great deal of attention is given to reducing costs at the design stage of a product's life cycle rather than simply attempting to measure and control cost during the production stage. James Brimson, who originally served as CAM-I's Cost Management Systems (CMS) project director, defines cost management as, "the management and control of activities to determine an accurate product cost, improve business processes, eliminate waste, identify cost drivers, plan operations, and set business strategies. Based on Brimson's definition, the concept of activity management is part of the cost management discipline Cost Department The cost department, under the direction of the controller, is responsible for keeing records of a company’s manufacturing and non-manufacturing activities.This department must also analyze all costs of manufactuing, marketing, and administration. It must issue significant control reports and other decision-making data to those managers who assist in controlling and improving costs and operations. Classification Of Costs Cost classifications are needed for the development of cost data that will aid management in  2 achieving its objectives. These classifications are based on the relationship of costs to: 1. The product 2. Volume of production 3. Manufacturing departments 4. An accounting period  Cost in relation to products Product costs orInventoriable Costs  Manufacturing costs (production cost or factory cost, is the sum of the three cost elements: direct materials, direct labor, and factory overhead. Direct materials and direct labor maybe combined into another classification called prime cost. Direct labor and factory overhead may be combined into a classification called conversion cost.  Direct materials- are all materials that form an integral part of the finished product and that can be included directly in calculating the cost of the product, eg. lumber to make furniture, and crude oil to make gasoline.  Direct labor- is labor expended to convert direct materials into the finished product. It consists of employees’ wages which can feasibly be assigned to a specific product, eg. wages of machine operators or assembly line workers.  Factory overhead- also called manufacturing overhead, manufacturing expenses, or factory burden, consists of cost of indirect materials (indirect materials are those materials needed for the completion of a product, but the consumption of which is so minimal or so complex that treating them as direct materials is futile, e.g. factory supplies such as lubricating oils, grease, cleaning rags, and brushes needed to maintain the working area and machinery in a usable and safe condition, sandpaper in a furniture used in furniture-making, threads, screws, rivets, nails, glue, etc.); indirect labor (labor which does not directly affect the construction or the composition of the finished product, eg.. wages of supervisors, shop clerks, general helpers, inspectors, and maintenance personnel in the production area. It also includes defective work and experimental work..); and all other manufacturing costs that cannot be charged directly to specific products such as: factory rent, insurance, property tax, depreciation of machineries and equipment, depreciation of factory buiding, maintenance and repairs, power, light, heat, employer’s share in SSS, ECC, Phil Health, and Pag-ibig fund of factory personnel, etc. Period Costs or Non-Inventoriable Costs  Commercial expenses. Commercial expenses are classified into: (1) marketing (distribution or selling) expenses and (2) administrative (general and administrative) expenses. i. Marketing expenses begin when at the point where the factory costs end, that is, when manufacturing has been completed and the product is in salable condition. These expenses include the expenses of selling and delivery, such as: sales salaries, sales commissions, employer’s share in the SSS, ECC, Phil. Health, Pag-ibig Fund of marketing personnel, advertising, samples, entertainment, travel expenses, rent, depreciation, property tax, telephone and telegraph, stationery and printing, postage,  3 freight-out, miscellaneous marketing expenses, etc. ii. Administrative expenses include expenses incurred in directing and controlling the organization, such as: administrative and office salaries, employer’s share in SSS, ECC, Phil Health, Pag-ibig fund of administrative personnel, rent, depreciation, property tax auditing expenses, legal expenses, uncollectible accounts, telephone & telegraph, stationery and printing, postage, miscellaneous administrative expenses, etc.. THE FIVE PARTS OF A COST ACCOUNTING SYSTEM A cost accounting system requires five parts that include: 1) an input measurement basis, 2) an inventory valuation method, 3) a cost accumulation method, 4) a cost flow assumption, and 5) a capability of recording inventory cost flows at certain intervals. These five parts and the alternatives under each part are summarized in Exhibit 2-1. Note that many possible cost accounting systems can be designed from the various combinations of the available alternatives, although not all of the alternatives are compatible. Selecting one part from each category provides a basis for developing an operational definition of a specific cost accounting system. 1) INPUT MEASUREMENT BASES The basis of a cost accounting system begins with the type of costs that flow into and through the inventory accounts. There are three alternatives including: pure historical costing, normal historical costing and standard costing. Pure Historical Costing In a pure historical cost system, only historical costs flow through the inventory  4 accounts.Historical costsrefers to the costs that have been recorded. Normal Historical Costing Normal historical costing uses historical costs for direct material and direct labor, but overhead is charged, or applied to the inventory using a predetermined overhead rate per activity measure. Typical activity measures include direct labor hours, or direct labor costs. The amount of factory overhead charged to the inventory is determined by multiplying the predetermined rate by the actual quantity of the activity measure. The difference between the applied overhead costs and the actual overhead costs represents an overhead variance. Standard Costing In a standard cost system, all manufacturing costs are applied, or charged to the inventory using standard or predetermined prices, and quantities. The differences between the applied costs and the actual costs are charged to variance accounts. 2) FOUR INVENTORY VALUATION METHODS The Throughput Method. The throughput method was developed to complement a concept referred to as the theory of constraints. In this method only direct material costs are charged to the inventory. All other costs are expensed during the period. The concept is symbolized in the enlargement below. Sales, less direct material costs is referred to as throughput which reflects how the method got its’ name. The throughput method does not provide proper matching (as defined by GAAP) because all manufacturing cost, other than direct material are expensed when incurred rather than capitalized in the inventory. Therefore, the throughput method is not acceptable for external reporting although advocates argue that it provides many advantages for internal reporting. The Direct or Variable Method In the direct (or variable) method, only the variable manufacturing costs are capitalized, or charged to the inventory. Fixed manufacturing costs flow into expense in the period incurred. This method provides some advantages and some disadvantages for internal reporting, However, it does not provide proper matching because the current fixed costs associated with producing the inventory are charged to expense regardless of whether or not the output is sold during the period. For this reason direct costing is not generally acceptable for external reporting. The Full Absorption Method Full absorption costing (also referred to as full costing and absorption costing) is a traditional method where all manufacturing costs are capitalized in the inventory, i.e., charged to the inventory and become assets. This means that these costs do not become expenses until the inventory is sold. In this way, matching is more closely approximated. The Activity Based Method The technique was developed to provide more accurate product costs. This improved accuracy  5 is accomplished by tracing costs to products through activities. In other words, costs are traced to activities (activity costing) and then these costs are traced, in a second stage, to the products that use the activities. In traditional full absorption costing and direct (or variable) costing systems, indirect manufacturing costs are allocated to products on the basis of a production volume related measurement such as direct labor hours. Thus, the fundamental differences between traditional systems and activity based systems are: 1) how the indirect costs are assigned (ABC uses both production volume and non-production volume related bases) and 2) which costs are assigned to products (in ABC systems, an attempt is made to assign all costs to products including engineering, marketing, distribution and administrative costs, although some facility related costs may not be assigned). 3) FOUR COST ACCUMULATION METHODS Cost accumulation refers to the manner in which costs are collected and identified with specific customers, jobs, batches, orders, departments and processes. The center of attention for cost accumulation can be individual customers, batches of products that may involve several customers, the products produced within individual segments during a period, or the products produced by the entire plant during a period. The company’s cost accumulation method, or methods are influenced by the type of production operation and the extent to which detailed cost accounting information is needed by management. Job Order In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that the work is done to the customer's specifications. As a result, each job tends to be different. For example, job order costing is used for construction projects, government contracts, shipbuilding, automobile repair, job printing, textbooks, toys, wood furniture, office machines, caskets, machine tools, and luggage. Accumulating the cost of professional services (e.g., lawyers, doctors and CPA's) also fall into this category. Process In process costing, costs are accumulated by departments, operations, or processes. The work performed on each unit is standardized, or uniform where a continuous mass production or assembly operation is involved. For example, process costing is used by companies that produce appliances, alcoholic beverages, tires, sugar, breakfast cereals, leather, paint, coal, textiles, lumber, candy, coke, plastics, rubber, cigarettes, shoes, typewriters, cement, gasoline, steel, baby foods, flour, glass, men's suits, pharmaceuticals and automobiles. Process costing is also used in meat packing and for public utility services such as water, gas and electricity. Back Flush Back flush costing is a simplified cost accumulation method that is sometimes used by companies that adopt just-in-time (JIT) production systems. However, JIT is not just a technique, or collection of techniques. Just-in-time is a very broad philosophy, that emphasizes simplification and continuously reducing waste in all areas of business activity. JIT systems were developed in Japan and depend on the communitarian concepts of teamwork and continuous improvement. In fact, many of the assumptions, attitudes and practices of  6 communitarian capitalism are included in the JIT philosophy. One of the many goals of JIT systems is zero ending inventory. In a backflush cost system, manufacturing costs are accumulated in fewer inventory accounts than when using the job order or process cost methods. In fact, in extreme backflush systems, most of the accounting records are eliminated. The production facilities are also arranged in self contained manufacturing cells that are dedicated to the production of a single, or similar products. In this way more of the manufacturing costs become direct product costs and fewer cost allocations are necessary. Thus, more accurate costing is obtained in spite of the fact that the cost accumulation method is simplified. Hybrid, or Mixed Methods Hybrid or mixed systems are used in situations where more than one cost accumulation method is required. For example, in some cases process costing is used for direct materials and job order costing is used for conversion costs, (i.e., direct labor and factory overhead). In other cases, job order costing might be used for direct materials, and process costing for conversion costs. The different departments or operations within a company might require different cost accumulation methods. For this reason, hybrid or mixed cost accumulation methods are sometime referred to as operational costing methods. 4) FOUR COST FLOW ASSUMPTIONS A cost flow assumption refers to how costs flow through the inventory accounts, not the flow of work or products on a production line. This distinction is important because the flow of costs is not always the same as the flow of work. The various types of cost flow assumptions include: specific identification (e.g., by job),first in, first out (FIFO), and weighted average. Costs flow through the inventory accounts by the job in a job order cost system which represents an example of specific identification. The requirements of the various jobs determines the timing of the cost flows. Simple jobs tend to move through the system faster than more complex jobs. The first-in, first-out (FIFO) and weighted average cost flow assumptions are used in process costing. Since costs are accumulated by the process or department in a process cost environment, a cost flow assumption is needed to determine the treatment of the beginning inventory. When FIFO is used, it is assumed that the units of product in the beginning inventory are finished first and transferred to the next department before any of the units that are started during the period.The group of units in the beginning inventory maintain their separate identity and prior period costs. However, when the weighted average cost flow assumption is used, the beginning inventory units lose their separate identity because they are lumped together with the units of product started during the period. 5) RECORDING INTERVAL CAPABILITY Inventory records can be maintained on a perpetual or a periodic basis. Conceptually, the perpetual inventory method provides a company with the capability of maintaining continuous records of the quantities of inventory and the costs flowing through the inventory accounts.The periodic method, on the other hand, requires counting the quantity of inventory before inventory records can be updated. In the past, manufacturers tended to keep perpetual inventories, while retailers used the periodic method. However, today a variety of modern point of sale devices and dedicated microcomputer software are readily available to provide any  7 company with perpetual inventory capability. FUNCTIONS OF INFORMATION OR COST ACCOUNTING SYSTEMS The term information system is used to emphasize that although the accounting system is likely to be the organization’s major source of information, it is not the only source of information. In fact, for some purposes, accounting information is not as useful as other types of information. Generally the purposes, or functions of an information or cost accounting system fall into four categories. These include providing information for: 1) external financial statements, 2) planning and controlling activities or processes, 3) short term strategic decisions and 4) long term strategic decisions. These four functions relate to different audiences, emphasize different types of information, require different reporting intervals and involve different types of decisions. These characteristics and requirements of the four functions are summarized in Exhibit 2-4 and discussed individually below. PLANNING AND CONTROLLING ACTIVITIES AND PROCESSES Plant, production and operating managers and workers need information for planning and controlling specific activities and processes. These users need dis-aggregated quantitative and qualitative non-financial information on a timely basis. In some cases, information is needed daily, hourly or even on a real time (continuous) basis. For example, the operating managers of a nuclear power plant, a computer integrated factory and a jumbo jet need continuous non- financial information to monitor performance. Although standard costing was developed to aid in planning and measuring the financial consequences of performance variations, cost accounting reports and financial statements do not satisfy the requirements of these users. Cost accounting reports and financial statements are useful to plant managers for planning and measuring financial results, but they are not designed to control the activities, processes and work performed on a day to day basis. CLASS ACTIVITY INSTRUCTION: Answer the following Class Exercises EXERCISE 1 Asian Manufacturing Company manufactures office furniture. Recently, the company decided to develop a formal cost accounting system and classify all costs into three categories. Categorize each of the following items as being appropriate for (1) cost tracing to the finished furniture, (2) cost allocation of an indirect manufacturing cost to the finished furniture, or (3) as a nonmanufacturing item. (1) Cost (2) Cost (3) Nonmanu- Item Tracing Allocation facturing Example : Carpenter wages ____X____ ________ ________  8 Depreciation - office building ________ ________ ________ Glue for assembly ________ ________ ________ Lathe department supervisor ________ ________ ________ Lathe depreciation ________ ________ ________ Lathe maintenance ________ ________ ________ Lathe operator wages ________ ________ ________ Lumber ________ ________ ________ Samples for trade shows ________ ________ ________ Metal brackets for drawers ________ ________ ________ Factory washroom supplies ________ ________ ________ Answer: Cost Cost Nonmanu- Item Tracing Allocation facturing Carpenter wages X Depreciation - office building X Glue for assembly X Lathe department supervisor X Lathe depreciation X Lathe maintenance X Lathe operator wages X Lumber X Samples for trade shows X Metal brackets for drawers X Factory washroom supplies X  9 EXERCISE 2 Arctic Hospital wants to estimate the cost for each patient stay. It is a general health care facility offering only basic services and not specialized services such as organ transplants. Required: a. Classify each of the following costs as either direct or indirect with respect to each patient. b. Classify each of the following costs as either fixed or variable with respect to hospital costs per day. Direct Indirect Fixed Variable Example: Electronic monitoring ___X___ ______ ______ ___X___ Meals for patients ______ ______ ______ ______ Nurses' salaries ______ ______ ______ ______ Parking maintenance ______ ______ ______ ______ Security ______ ______ ______ ______ Answer: Direct Indirect Fixed Variable Electronic monitoring X X Meals for patients X X Nurses' salaries X X Parking maintenance X X Security X X EXERCISE 3 Each of the following items pertains to one of these companies: Bedell Electronics (a manufacturing company), Gregory Food Retailers (a merchandising company), and Larson Real Estate (a service sector company). Classify each item as either inventoriable (I) costs or period (P) costs. inventoriable (I) costs or period (P) costs a. Salary of Bedell Electronics president b. Depreciation on Bedell Electronics assembly equipment. c. Salaries of Bedell’s assembly line workers d Purchase of frozen food for sale to customers by Gregory Food Retailers e Salaries of frozen food personnel at Gregory Food Retailing  10 f Depreciation on freezers at Gregory Food Retailing g. Salary of a receptionist at Larson Real Estate h. Depreciation on a computer at Larson Real Estate i. Salary of a real estate agent at Larson Real Estate Answer: inventoriable (I) costs or period (P) costs a. Salary of Bedell Electronics president P b. Depreciation on Bedell Electronics assembly I equipment. c. Salaries of Bedell’s assembly line workers I d Purchase of frozen food for sale to customers by I Gregory Food Retailers e Salaries of frozen food personnel at Gregory P Food Retailing f Depreciation on freezers at Gregory Food P Retailing g. Salary of a receptionist at Larson Real Estate P h. Depreciation on a computer at Larson Real P Estate i. Salary of a real estate agent at Larson Real P Estate EXERCISE 4 Antartic Manufacturing produces electronic storage devices, and uses the following three-part classification for its manufacturing costs: direct materials, direct labor, and factory overhead costs. Total factory overhead costs for January were P300 million, and were allocated to each product on the basis of direct labor costs of each line. Summary data (in millions) for January for the most popular electronic storage device, the Big Box, was: Big Box Direct material costs P9,000,000 Direct labor costs P3,000,000 Factory overhead costs P8,500,000 Units produced 40,000  11 Required: a. Compute the manufacturing cost per unit for each product produced in January. DM DL FO /Units produced =Unit Cost b. Suppose production will be reduced to 30,000 units in February. Speculate as to whether the unit costs in February will most likely be higher or lower than unit costs in January; it is not necessary to calculate the exact February unit cost. Briefly explain your reasoning. Answer: Answer: a. Unit costs for January were: ($9,000,000 + $3,000,000 + $8,500,000) / 40,000 = P512.50 per unit b. Unit costs should be higher in February if only 30,000 units are to be produced. Indirect manufacturing costs most likely include both fixed and variable components. Since fewer units are expected to be produced in February, total fixed costs will be spread over fewer units. This will result in an increase in total cost per unit since variable costs per unit will most likely not change with the decreased production. EXERCISE 5 The list of representative cost drivers in the right column below are randomized with respect to the list of functions in the left column. That is, they do not match. Function Representative Cost Driver 1. Purchasing A. Number of employees 2. Billing B. Number of shipments 3. Shipping C. Number of customers 4. Computer Support D. Number of invoices 5. Personnel E. Number of desktop computers 6. Customer Service F. Number of purchase orders Required: Match each business function with its representative cost driver. Function Insert letter of appropriate driver (A through F) 1. Purchasing  12 2. Billing 3. Shipping 4. Computer Support 5. Personnel 6. Customer service Answer: Function Insert letter of appropriate driver (A through F) 1. Purchasing F 2. Billing D 3. Shipping B 4. Computer support E 5. Personnel A 6. Customer service C EXERCISE 6 Arctic, Inc., reports the following information for September sales: Sales P15,000 Variable costs 3,000 Fixed costs 4,000 Operating income P 8,000 Required: If sales double in October, what is the projected operating income? ANSWER: Answer: (P15,000 x 2) – (P3,000 x 2) – P4,000 = P20,000 EXERCISE 7 Greenland Wheel Manufacturing currently produces 1,000 axles per month. The following per unit data apply for sales to regular customers: Direct materials P200 Direct labor 30 Variable manufacturing overhead 60 Fixed manufacturing overhead 40 Total manufacturing costs P330 ==== The plant has capacity for 2,000 axles. Required:  13 a. What is the total cost of producing 1,000 axles? b. What is the total cost of producing 1,500 axles? c. What is the per unit cost when producing 1,500 axles? a. b. c. Answer: a. [(P200 + P30 + P60) x 1,000 units] + (P40 x 1,000 units) = P330,000 b. [(P200 + P30 + P60) x 1,500 units] + P40,000 = P475,000 c. P475,000 / 1,500 units = P316.67 per unit EXERCISE 8 Marianas, Inc., had the following activities during 20X9: Direct materials: Beginning inventory P 40,000 Purchases 123,200 Ending inventory 20,800 Direct labor 32,000 Manufacturing overhead 24,000 Beginning work-in-process inventory 1,600 Ending work-in-process inventory 8,000 Beginning finished goods inventory 48,000 Ending finished goods inventory 32,000 Required: a. What is the cost of direct materials used during 20X9? RM, beg + Net RM Purchases =Total RM available for use – RM, end = DM used b. What is cost of goods manufactured for 20X9? DM used + DL + FO = Total mfg cost + W/P, beg= Total costs placed in process - W/P, end = CGM c. What is cost of goods sold for 20X9? FG Invty, beg + CGM= Total Good Available for Sale – FG Invty, end = Cost of Goods Sold (or Cost of Goods Manufactured and Sold) d. What amount of prime costs was added to production during 20X9? DM + DL = Prime cost e. What amount of conversion costs was added to production during 20X9? DL + FO = Conversion costs  14 a. b. c. d. e. Answer: a. $40,000 + $123,200 – $20,800 = $142,400 b. $142,400 + $32,000 + $24,000 + $1,600 – $8,000 = $192,000 c. $192,000 + $48,000 – $32,000 = $208,000 d. $142,400 + $32,000 = $174,400 e. $32,000 + $24,000 = $56,000 EXERCISE 9 Orion Manufacturing Company had the following account balances for the quarter ending March 31, 20X9 unless otherwise noted: Work-in-process inventory (January 1) P 140,400 Work-in-process inventory (March 31) 171,000 Finished goods inventory (January 1) 540,000 Finished goods inventory (March 31) 510,000 Direct materials used 378,000 Indirect materials used 84,000 Direct manufacturing labor 480,000 Indirect manufacturing labor 186,000 Property taxes on manufacturing plant building 28,800 Salespersons' company vehicle costs 12,000 Depreciation of manufacturing equipment 264,000 Depreciation of office equipment 123,600 Miscellaneous plant overhead 135,000 Plant utilities 92,400 General office expenses 305,400 Marketing distribution costs 30,000 Required: a. Prepare a Schedule of Cost of Goods Manufactured for the quarter.  15 b. Prepare a Schedule of Cost of Goods Sold for the quarter. Orion Manufacturing Company Schedule of Cost Goods Manufactured For the quarter ended March 31, 20X9 Orion Manufacturing Company Schedule of Cost Goods Sold For the quarter ended March 31, 20X9 RESOURCES: th Horngren, Charles T. Cost Accounting: A Managerial Emphasis. 14 Edition (e-book) Powerpoint Presentation on Introduction to Cost https://www.youtube.com/watch?v=Xlpb3KDcDC0. Introduction to Cost Accounting | Cost Accounting | CPA Exam BEC | CMA Exam by Farhat’s Accounting Lectures. https://www.youtube.com/watch?v=BhvvHmBJWZ8. Cost terms, concepts, and classifications. Chapter 2. part 1 by Honest Citizen. https://www.youtube.com/watch?v=CZztOq4gREw. Cost terms, concepts and classifications. Chapter 2. Part 2 by Honest Citizen.  16 Answer: a. Orion Manufacturing Company Cost of Goods Manufactured Schedule For quarter ending March 31, 20X9 Direct materials used P 378,000 Direct manufacturing labor 480,000 Manufacturing overhead Depreciation of manufacturing equipment P264,000 Indirect manufacturing labor 186,000 Indirect materials 84,000 Miscellaneous plant overhead 135,000 Plant utilities 92,400 Property taxes on building 28,800 790,200 Total Manufacturing costs P1,648,200 Add beginning work-in-process inventory 140,400 Total costs placed in-process P1,788,600 Less ending work-in-process inventory 171,000 Cost of goods manufactured P1,617,600 b. Orion Manufacturing Company Cost of Goods Sold Schedule For the quarter ending March 31, 20X9 Beginning finished goods inventory P 540,000 Cost of goods manufactured 1,617,600 Cost of goods available for sale 2,157,600 Ending finished goods inventory (510,000) Cost of goods sold P1,647,600  17 EXERCISE 10 (CRITICAL THINKING) a. Explain the difference between an inventoriable cost and a period cost. What potential problems does an inaccurate classification of product and period costs cause? ANSWER: Answer: Inventoriable costs are all costs of a product that are considered as assets in the balance sheet when they are incurred and which become cost of goods sold only when the product is sold. Period costs are treated as expenses of the accounting period in which they are incurred. An inaccurate classification of inventoriable and period costs could lead to violations of the matching principle, which states that costs used in producing revenue should be matched on the income statement when the revenue is recognized. In extreme cases, net income for a given period might be significantly misstated if proper matching does not occur. b. What are the differences between direct costs and indirect costs? Give an example of each. ANSWER: Answer: Direct costs are costs that can be traced easily to the product manufactured or the service rendered. Examples of direct costs include direct materials and direct manufacturing labor used in a product. Indirect costs cannot be easily identified with individual products or services rendered, and are usually assigned using allocation formulas. In a plant that manufactures multiple products, examples of indirect costs include the plant supervisor’s salary and the cost of machines used to produce more than one type of product. c. Describe a variable cost. Describe a fixed cost. Explain why the distinction between variable and fixed costs is important in cost accounting. ANSWER:  18 Answer: Total variable costs increase with increased production or sales volumes. Fixed costs are not influenced by fluctuations in production or sales volumes. Without the knowledge of cost behaviors, budgets and other forecasting tools will be inaccurate and unreliable. Understanding whether a cost behaves as a variable or a fixed cost is essential to estimating and planning for business success.