Part 1 Study Unit 1 Ethics for Management Accountants and Cost Management Concepts

Part 1 Study Unit 1

Ethics for Management Accountants and

Cost Management Concepts

ICMA’s Requirements for CMA Designation

• Become a Member! Preferably of a local chapter (there are benefits).

• Pass both parts of the exam within 3 years (of starting the process).

• Satisfy the education requirements.• Satisfy the experience requirements.• Comply with IMA’s Statement of Ethical Professional

Practice.• To remain a CMA you have to maintain active member, full-

fill the requirements for CE, comply with IMA’s Ethics statements and applicable state laws.

Gleim CMA Review System

• Gleim Suggested Study Steps – see page 8– Alternative steps – per Ron

• Multiple Choice Quizzes• Audiovisual Presentation• True/False Study Questions• Knowledge Transfer Outline• Essay• CMA Test Prep Online

– Practice Exam vs. Study Session

Table of ContentsStudy Unit 1 - Ethics for Management Accountants and Cost Management

ConceptsStudy Unit 2 - Cost Accumulation SystemsStudy Unit 3 - Cost Allocation TechniquesStudy Unit 4 - Operational Efficiency and Business Process PerformanceStudy Unit 5 - Budgeting Concepts and Forecasting TechniquesStudy Unit 6 - Budget Methodologies and Budget PreparationStudy Unit 7 - Cost and Variance MeasuresStudy Unit 8 - Responsibility Accounting and Performance MeasuresStudy Unit 9 - Internal Controls – Risk and Procedures for ControlStudy Unit 10 - Internal Controls – Internal Auditing and Systems Controls

* See class schedule for dates

Part 1 Exam

• Topics– Planning, Budgeting and Forecasting 30% Level C– Performance Management 25% Level C– Cost Management 25% Level C– Internal Controls 15% Level C– Professional Ethics 5% Level C

Exam format• 3 hrs - 100 multiple choice questions = approx. 1.5 minutes per question

(on average).– Find ways to “bank” time– Look for short-cuts– You will find that you most question do not seem “easy”, don’t get discouraged– You “earn” points for each question answered correctly– Some questions are “test” questions that carry no point value. You will not

know which ones they are– Extra time can be carried forward to the Essay portion

• 1 hr - 2 Essay questions with up to 8 sub-parts– You can’t go back to multiple-choice part once you enter this portion of the

exam– Whatever you have typed on the screen will be saved as your answer,

irrespective if the timer runs out on you

Exam format

– If you find you have weaknesses in any topic ref. Appendix A for ref. the appropriate sub –units.

– The coverage percentage given for each major topic within each examination part represents the relative weight given to that topic in an examination part. The number of questions presented in each major topic area approximates this percentage.

– You will be expected to understand the “impact” of taxes when reporting and analyzing financial results.

– You are “assumed” to have knowledge of preparation of financial statements, business economics, time-value of money concepts, statistics and probability.

Most common reasons for missing questions

1. Misreading the requirement (stem) – Read the question first2. Not understanding what is required3. Making a math error – Try to not do calculations of paper first, with the idea

of “transferring” to the exam later. If you know how to use your memory button(s) well on your calculator, use it (i.e. save sub-calculations in your calculator).

4. Applying the wrong rule or concept5. Being distracted by one or more of the answers – the most common wrong

answers are the incorrect alternatives6. Incorrectly eliminating answers from considerations – read all answers first,

some are more correct or complete then others7. Not having any knowledge of the topic tested – don’t agonize over it. If

possible try to make an educated guess by eliminating obvious wrong answers. If you guess, use the same letter each time.

8. Employing bad intuition when guessing

Required Cognitive Skills• Knowledge: Ability to remember previously learned material such as

specific facts, criteria, techniques, principles, and procedures (identify, define).

• Comprehension: Ability to grasp and interpret the menaing of material (classify, explain, distinguish).

• Application: Ability to break down material into its component parts so that its organizational structure can be understood…(differentiate, estimate, order).

• Synthesis: Ability to put parts together to form a new whole or proposed set of operations; ability to relate ideas and formulate hypothesis (combine, formulate, revise).

• Evaluation: Ability to judge the value of material for a given purpose on the basis of consistency, logical accuracy, and comparison to standards (criticize, justify, conclude).

Test Coverage

• Level A: Requiring the skill levels of knowledge and comprehension.

• Level B: Requiring the skill levels of knowledge, comprehension, application, and analysis.

• Level C: Requiring all six skill levels – Knowledge, comprehension, application, analysis, synthesis, and evaluation.

• Examples of each are given in Appendix C, page 407.

Exam Strategies

• Budget your time, know your “time hacks”• See how many Essay sub-questions you will be given.

There are two parts with different amounts of sub-parts• Answer the questions in consecutive order, and limit the

number you want to come back to no more than say 10, but make sure you answer it before going on to the next.

• Never leave a question unanswered, score is based on number of correct answers.

• Do not allow the answer choices to affect your reading of the question

The essays• Remember, 2 essay questions with up to 8 parts each!• The ICMA grades on both subject matter and writing skills on the essay portion of the CMA exam. For writing

skills to be graded, the response must be relevant to the question asked. The criteria for grading are as follows:– Use of standard English – includes proper grammar, punctuation, and spelling– Organization – response is arranged logically and coherently– Clarity – analysis is clearly communicated with well-constructed sentences and appropriate vocabulary.

• Ref. Scenario for Essay Questions 16-19– Handout for in-class students– Separate file for online students

• The CMA exam uses essays to reflect a more "real-world" environment in which candidates must apply the knowledge they have acquired. Essays are graded on both writing skills and subject matter. Partial credit IS available for essays that have some correct and some incorrect points. Finally, it is important to remember that essays are not intended to test typing ability, so the time you allocated for essay response is adequate to complete the questions even if you do not have the best typing skills.

• Answering multiple-choice questions is an effective method to study the material for both the multiple-choice and essay sections of the exam. They are an excellent diagnostic tool that will allow you to quickly identify your weak areas. Also, think about what your answer would be if the question were not multiple-choice. When reviewing the correct and incorrect answer explanations, your "essay answers" should be somewhat equivalent to the detailed answer explanations.

Prepping for the exam• Decide if you will be using one of the approved financial calculators on

the exam?• Focus on what you don’t know• Realize that you will be more proficient in some topics more than others• Read, quiz, evaluate (what you don’t know), sit for lecture, re-quiz,

identify anything you need help with one on one?• Practice the Essay questions – use the Gleim Essay Wizard• Mid-way through the course, create a short mock multiple choice exams

(say no more than 50 questions) to condition for the longer 100 question exam.

• Right after our cram session take the Gleim online CMA Practice Exam that came with your Gleim study material. It is a 4 hour exam.

• Contact instructor and review anything not quite clear.

Ethics tested on the Exams

• Ethics is tested from:– Individual Perspective – Part 1– Organizational Perspective – Part 2

• Questions could be either Multiple Choice or Essay• Make sure you study the IMA Framework on Ethics, ref. the IMA

website, or following URL: http://www.imanet.org/PDFs/Public/Press_Releases/STATEMENT%20OF%20ETHICAL%20PROFESSIONAL%20PRACTICE_2.2.12.pdf

http://www.imanet.org/resources_and_publications/ethics_center_helpline.aspx – Have it “conceptually” memorized.– Similar to the AICPA version– You will then be able to answer any question from there– Stay “within” an objective view, and don’t get side-tracked in

emotional distractors

http://www.imanet.org/PDFs/Public/Press_Releases/STATEMENT%20OF%20ETHICAL%20PROFESSIONAL%20PRACTICE_2.2.12.pdf



1.1 Ethics for Management Accountants

• Candidates need to be prepared to answer ethics questions that will be integrated with any of the other topics tested on Part 1. This includes multiple-choice or essay type questions.

• You have to:– Identify the exact nature of ethical dilemma– How to resolve it

• Memorize content of IMA’s Statement of Ethical Professional Practices (see page 20)


Question 1 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts In accordance with IMA’s Statement of Ethical Professional Practice, a member who fails to perform professional duties in accordance with relevant standards is acting contrary to which one of the following standards?

A. Competence.B. Confidentiality.C. Integrity.D. Credibility.


• Correct Answer: A

One of the responsibilities of an IMA member under the competence standard is to “maintain an appropriate level of professional expertise by continually developing knowledge and skills.” (S)he must also “perform professional duties in accordance with relevant laws, regulations, and technical standards.” The third requirement under this standard is to “provide decision support information and recommendations that are accurate, clear, concise, and timely.”

Incorrect Answers:

B: The confidentiality standard concerns an IMA member’s responsibility not to disclose or use the firm’s confidential information.

C: The integrity standard pertains to conflicts of interest, avoidance of acts discreditable to the profession, and refraining from activities that prejudice the ability to carry out duties ethically.

D: Credibility is the fourth standard of IMA’s Statement of Ethical Professional Practice. It requires that information be communicated “fairly and objectively,” and that all information that could reasonably influence users be disclosed.


Question 2 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts According to IMA’s Statement of Ethical Professional Practice, a member has a responsibility to recognize professional limitations. Under which standard of ethical conduct would this responsibility be included?

A. Competence.B. Confidentiality.C. Integrity.D. Credibility.


• Correct Answer: A

The competence standard pertains to an IMA member’s responsibility to “recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity.”

Incorrect Answers:

B: The confidentiality standard concerns an IMA member’s responsibility not to disclose or use the firm’s confidential information.

C: The integrity standard deals with conflicts of interest, avoidance of acts discreditable to the profession, and refraining from activities that prejudice the ability to carry out duties ethically.

D: Credibility is the fourth standard of IMA’s Statement of Ethical Professional Practice. It requires that information be communicated “fairly and objectively,” and that all information that could reasonably influence users be disclosed.


• See Essay Scenario 1 & 2

• See Essay Scenario 16, 17, 18, 19

1.2 Cost Management Terminology

• Financial Accounting– Reporting to external users– Financial statements– Historical focus

• Management Accounting– Reporting to internal users– Improve organizational decision making– Future focus

• Cost Accounting– Supports both financial and management accounting

“Information about the cost of resources acquired and consumed by an organization underlies effective reporting for both internal and external users”.


IMA Definition of Cost

Management Accounting: Measurement in monetary terms of the amount of resources used for some purpose. The term by itself is not operational. It becomes operational when modified by a term that defines the purpose, such as acquisition cost, incremental cost, or fixed cost.


• Cost Object– Entity to which costs can be attached

– Examples:• Products• Processes• Employees• Departments • Facilities


• Manufacturing v. Nonmanufacturing– Direct materials– Direct labor– Manufacturing overhead

• Indirect materials– Tangible inputs unable to trace

• Indirect labor– Labor that cannot be traced

• Factory operating costs– Utilities, real estate taxes, insurance, depreciation


Manufacturing Costs

• Prime cost– Direct materials + direct labor– Costs attributable to the product

• Conversion cost– Direct labor + manufacturing overhead– Costs of converting raw materials into finished product


Nonmanufacturing Costs• Selling (Marketing) expenses

– How much to get the product to the consumer– Sales Personnel

• Salaries• Expensive dinners• Fancy sporting events• Morale boosting trips to exotic locations

– Product Transportation• Administrative Expenses• Other costs not related to producing or marketing the product• Adrien’s salary• Adrien’s expensive dinners• Fancy sporting events for Adrien to attend• Trips to exotic locations to boost Adrien’s morale


Product v. Period• To capitalize or to expense?

– Product Costs – Capitalized as part of finished goods inventory. Become

component of cost of goods sold

• Period Costs– Expensed as incurred– Not capitalized and excluded from cost of goods sold


• Distinction between product costs and period costs important for external reporting purposes.– GAAP

• All manufacturing costs must be treated as product costs, and all selling and administrative costs must be treated as period costs.

• ABSORPTION COSTING

– Internal Reporting• Capitalize only variable manufacturing costs as product

costs, treat all other costs (variable S&A and the fixed portion of both production and S&A expenses) as period costs.

• VARIABLE COSTING


Direct Costs - Can be TRACED• Direct materials• Direct Labor

Indirect Costs - Cannot be associated with a particular cost objective• Indirect materials• Indirect labor


Indirect costs collected in cost pools• Cost Pool

– Account where similar cost elements are accumulated

Example - Manufacturing Overhead


Common Costs• Indirect cost• Shared by two or more users• Rationally allocated

• Examples:• Depreciation for HQ building• Allocated amongst departments


Question 1 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts Inventoriable costs

A. Include only the prime costs of manufacturing a product.

B. Include only the conversion costs of manufacturing a product.

C. Are expensed when products become part of finished goods inventory.

D. Are regarded as assets before the products are sold.


• Correct Answer: D

Under an absorption costing system, inventoriable (product) costs include all costs necessary for good production. These include direct materials and conversion costs (direct labor and overhead). Both fixed and variable overhead is included in inventory under an absorption costing system. Inventoriable costs are treated as assets until the products are sold because they represent future economic benefits. These costs are expensed at the time of sale.

Incorrect Answers:

A: Overhead costs as well as prime costs (direct materials and labor) are included in inventory.

B: Materials costs are also included.

C: Inventory costs are expensed when the goods are sold, not when they are transferred to finished goods.


Question 2 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts A company experienced a machinery breakdown on one of its production lines. As a consequence of the breakdown, manufacturing fell behind schedule, and a decision was made to schedule overtime to return manufacturing to schedule. Which one of the following methods is the proper way to account for the overtime paid to the direct laborers?

A.The overtime hours times the sum of the straight-time wages and overtime premium would be charged entirely to manufacturing overhead.

B. The overtime hours times the sum of the straight-time wages and overtime premium would be treated as direct labor.

C.The overtime hours times the overtime premium would be charged to repair and maintenance expense, and the overtime hours times the straight-time wages would be treated as direct labor.

D.The overtime hours times the overtime premium would be charged to manufacturing overhead, and the overtime hours times the straight-time wages would be treated as direct labor.



Direct labor costs are wages paid to labor that can feasibly be specifically identified with the production of finished goods. Factory overhead consists of all costs, other than direct materials and direct labor, that are associated with the manufacturing process. Thus, straight-time wages would be treated as direct labor; however, because the overtime premium cost is a cost that should be borne by all production, the overtime hours times the overtime premium should be charged to manufacturing overhead.

Incorrect Answers:

A: The straight-time wages times the overtime hours should still be treated as direct labor.

B: Only the straight-time wages times the overtime hours is charged to direct labor.

C: Labor costs are not related to repairs and maintenance expense.

1.3 Cost Behavior and Relevant Range

• Relevant Range – Limits within which per-unit variable cost remain constant and fixed cost are not changeable.

– “In the short-run” (All costs are considered variable in the long-run)

– “The efficiency of a company’s current manufacturing plant”

“Cost behavior and estimates are valid only within a relevant range, or the normal level of operating activity. Beyond the relevant range, cost relationships are likely to change, and with them, cost estimates”.

Ask yourself – “How wide is the relevant range of activity? When does the company leave one relevant range and enter another one with a different cost function? The answer is company specific, and greatly affects the cost estimates used in decision making.”


Types of Costs and their characteristics

• Variable cost– Total cost varies in proportion to changes in the level of

activity– The cost per unit remains constant, regardless of the level of

activity

Exhibit 1 - Variable Cost



• Fixed cost– Total cost remains fixed, regardless of changes in the level

of activity.– The cost per unit varies inversely with changes in the level

of activity.

Exhibit 2 – Fixed Cost



• Mixed or semivariable cost– Have both a fixed and variable component.– Both the total cost and unit cost will vary changes in the

level of activity.• Two methods of estimating mixed:

– Regression or scattergraph method – more complex, usually applied using computers and not tested on the exam.

– High-low method – less accurate, but quicker.

Cost at highest activity level – Cost at lowest activity levelDriver at highest activity level – Driver at lowest activity level

What is a driver? Machine Hours for examples

Exhibit 3 - Mixed CostHigh-Low Method Example (p. 138)

High Month: MayLow Month: July

Numerator: $3,400 -$1,900 = $1,500Denominator: 1,600 –800 = 800 hours

Variable Costs: $1,500 / 800 = $1.875 per hourFixed Costs: $1,900 –(800 x $1.875) = $400

Exhibit 3 - Mixed Cost


Types of Costs and their characteristics (continued)

• Step cost– Total cost remain constant over the.

– Unit cost decrease a usage within the step range.

Exhibit 4 – Step Cost



• Linear vs. Nonlinear Cost Functions

– Fixed cost per unit and step cost have non-linear-cost functions

– Fixed costs• Has asymptotic (linear asymptote is not parallel to the x- or y-axis, it is called an oblique

asymptote or slant asymptote ) character – it will never intersect the X-axis.

– Step cost – if steps are relatively narrow, cost are usually treated as variable, but if steps are wide they more similar to fixed costs.

Question #1

The difference between variable costs and fixed costs is?

1. Variable costs per unit fluctuate and fixed costs per unit remain constant.

2. Variable costs per unit are fixed over the relevant range and fixed costs per unit are variable.

3. Total variable costs are variable over the relevant range and fixed in the long term, while fixed costs never change.

4. Variable costs per unit change in varying increments, while fixed costs per unit change in equal increments.

Question #2

The difference between the sales price and total variable costs is?

1. Net profit.2. The breakeven point.3. The contribution margin.4. Gross operating profit.

Question #3

Ace, Inc. estimates its total materials handling costs at two production levels as follows:

Cost Gallons$160,000 80,000$132,000 60,000

What is the estimated total cost for handling 75,000 gallons?(Hint: High/Low Method)

Question #3 (continued)

1. Numerator: $160k -$132k = $28k2. Denominator: 80k gallons –60k gallons = 20k3. Variable Costs: $28k / 20k gallons = $1.40 per gallon4. Fixed Costs = Total Cost –Variable Portion $160k –(80k x

$1.40) = $48k5. $48k + (75k x $1.40) = $153,000



• Relevant Range and Marginal Cost (MC)

– Marginal cost is the cost incurred by a one-unit increase in the activity level of a particular cost driver.

– Similar to variable cost in the relevant range it stays constant across the relevant range.

Question 1 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts Which one of the following categories of cost is most likely not considered a component of fixed factory overhead?

A. Rent.B. Property taxes.C. Depreciation.D. Power.




A fixed cost is one that remains unchanged within the relevant range for a given period despite fluctuations in activity. Such items as rent, property taxes, depreciation, and supervisory salaries are normally fixed costs because they do not vary with changes in production. Power costs, however, are at least partially variable because they increase as usage increases.

Incorrect Answers:

A: Rent is an example of fixed factory overhead.

B: Property taxes are an example of fixed factory overhead.

C: Depreciation is an example of fixed factory overhead.


Question 2 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts Jackson Co. has the following information for the first quarter of this year:

Machine CleaningHours Expense

January 2,100 $ 900February 2,600 1,200March 1,600 800April 2,000 1,000

Using the high-low method, what is Jackson’s variable cost of cleaning per

machine hour?

A. $.40B. $.48C. $2.00D. $2.50


Correct Answer: A

The high-low method is used to segregate the fixed and variable components of a mixed cost. In this problem, March had the lowest activity level and February had the highest.

February $1,200 for 2,600 hoursMarch (800) for (1,600) hours

Difference $ 400 for 1,000 hours

The variable portion is thus $.40 per machine hour.

Incorrect Answers: B: The average of the high and low

months is $.48. C: The March machine hours

divided by the March cost is $2.00. D: The increase

in hours divided by the increase in cost is $2.50.

1.4 Cost of Goods Calculations

Cost of Goods Sold

– Beginning Balance+ Purchases (Costs added during the period)= available– Ending= Used

– Or Beginning Balance+ Purchases (Costs added during the period)- Costs removed during the period= Ending balance

– Straight forward for a retailer but more complex for a manufacturers since they have three distinct classes of inventory:

• Raw material

• Work in Process Inventory

• Finished Goods Inventory

Exhibit 5 – Mfg. Cost flow


****See handout on Mfg. Cost of goods calculation****

Remember: Total manufacturing cost are calculated on a separate statement called a cost of Goods Manufacturing Statement (or Manufacturing Statement, which compiles three major elements of manufacturing costs:

New MaterialDirect LaborFactory overhead

Calculations through cost of goods manufactured are found on the Manufacturing Statement. The total and the remainder are found on the income statement.


Madtack Company’s beginning and ending inventories for the month of November are

Production data for the month of November follows:

1-Nov 30-Nov Direct labor $200,000

Actual factory

overhead 132,000

Direct materials $67,000 $62,000 Direct materials purchased 163,000

Work-in-process 145,000 171,000 Transportation in 4,000

Finished goods 85,000 78,000 Purchase returns and allowances 2,000

Madtack uses one overhead control account and charges overhead to production at 70% of direct labor cost. The company does not formally recognize over- or underapplied overhead until year end.


Madtack Company’s prime cost for November is

A. $370,000B. $168,000C. $363,000D. $170,000

Madtack Company’s prime cost for November is


Correct Answer: A

Prime costs are the combined costs of direct materials and direct labor.

Beginning materials inventory $ 67,000

Add: purchases 163,000

Add: transportation in 4,000

Less: purchase returns (2,000)

Materials available $232,000

Less: ending materials inventory (62,000)

Materials used in production $170,000

Direct materials $170,000

Direct labor 200,000

Total prime costs $370,000


Madtack Company’s cost of goods sold for November is

A. $484,000

B. $491,000

C. $502,000

D. $476,000


Correct Answer: B

This solution requires a series of computations. Total manufacturing cost is the sum of direct materials cost, direct labor cost, and manufacturing overhead.

Beginning materials $ 67,000Add: purchases 163,000Add: transportation in 4,000Less: purchase returns (2,000)

Materials available $232,000Less: ending materials (62,000)

Materials used in production $170,000

Direct materials $170,000Direct labor 200,000Manufacturing overhead (DL × 70%) 140,000

Total manufacturing costs $510,000


Total manufacturing costs $510,000

Add: beginning work-in-process 145,000

Less: ending work-in-process (171,000)

Costs transferred to finished goods $484,000

Beginning finished goods inventory $ 85,000

Add: cost of goods manufactured 484,000

Goods available for sale $569,000

Less: ending finished goods inventory (78,000)

Cost of goods sold $491,000

1.5 Cost Classifications

• Controllable VS. Noncontrollable

• Avoidable Vs. Committed

• Incremental vs. Differential

• Engineered s. Discretionary

• Outlays vs. Opportunity

• Relevant vs. Sunk


• Joined vs. Separable

• Normal vs. Abnormal Spoilage

• Rework, Scrap, and Waste

• Other– Carrying costs– Transferred-in costs– Value-adding costs

• Manufacturing Capacity– Normal capacity– Practical capacity– Theoretical (ideal) capacity


Question 1 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts In joint-product costing and analysis, which one of the following costs is relevant when deciding the point at which a product should be sold to maximize profits?

A. Separable costs after the split-off point.B. Joint costs to the split-off point.C. Sales salaries for the period when the

units were produced.D. Purchase costs of the materials

required for the joint products.


Correct Answer: A

Joint products are created from processing a common input. Joint costs are incurred prior to the split-off point and cannot be identified with a particular joint product. As a result, joint costs are irrelevant to the timing of sale. However, separable costs incurred after the split-off point are relevant because, if incremental revenues exceed the separable costs, products should be processed further, not sold at the split-off point.

Incorrect Answers:

B: Joint costs have no effect on the decision as to when to sell a product.

C: Sales salaries for the production period do not affect the decision.

D: Purchase costs are joint costs.


Question 2 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts A company produces stereo speakers for automobile manufacturers. The automobile manufacturers reject approximately 3% of the stereo speakers received as being of unacceptable quality. The company inspects the rejected speakers to determine which ones should be reworked and which ones should be discarded. The discarded speakers are classified as

A. Waste.B. Scrap.C. Spoilage.D. Rework costs.


Correct Answer: C

Rejected units that are discarded are classified as spoilage. Spoilage is separated into abnormal or normal spoilage. Normal spoilage is an inherent result of the normal production process. Abnormal spoilage is spoilage that is not expected to occur under normal, efficient operating conditions.

Incorrect Answers:

A: Waste is input material that is either lost in the production process or has no sales value.

B: Scrap is input material that has a relatively minor sales value at the end of the production process.

D: Rework costs are incurred to make unacceptable units appropriate for sale or use.

1.6 Costing Techniques

• Absorption vs. Variable Costing– Need to understand:

• Under absorption costing, which costs are considered product costs and which are considered period costs?

• Under variable costing, which costs are considered products and which are considered period costs?

• When is income under variable costing higher than income under absorption costing?

• What formula can be used to calculate the difference between income under variable costing and income under absorption costing?

• What managerial behavior does variable costing render ineffective?


• Absorption vs. Variable Costing (continued)

• Absorption costing– Also called full costing treats all manufacturing costs as

product costs.

– Inventoried cost of the product thus includes all prodcution costs, fixed and variable. Required by GAAP.

– Gross Margin (gross profit) = Sales revenue and absorption cost of COGS, and covers S, G & A.


• Absorption vs. Variable Costing (continued)

• Variable costing – Also called direct costing considers only variable

manufacturing cost as product cost.

– Fixed cost are period costs and expensed as incurred.

– Simple and easy to calculate. First consideration in determining whether product should be manufactured (does it cover variable production costs).

– Contribution margin = net sales revenue minus all variable costs (mfg. & S, G & A). “Contributions toward covering fixed costs”.


Question 1 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts Which one of the following considers the impact of fixed overhead costs?

A. Full absorption costing.B. Marginal costing.C. Direct costing.D. Variable costing.


Correct Answer: A

Full absorption costing treats fixed factory overhead costs as product costs. Thus, inventory and cost of goods sold include (absorb) fixed factory overhead.

Incorrect Answers:

B: Marginal costing considers only the incremental costs of producing an additional unit of product. In most cases marginal costs are variable costs.

C: Direct (variable) costing treats only variable costs as product costs.

D: Direct (variable) costing treats only variable costs as product costs.


Question 2 - CMA1 Study Unit 1: Ethics for Management Accountants and Cost Management Concepts A standard costing system is most often used by a firm in conjunction with

A. Management by objectives.

B. Target (hurdle) rates of return.

C. Participative management programs.

D. Flexible budgets.


Correct Answer: D

A standard cost is an estimate of what a cost should be under normal operating conditions based on accounting and engineering studies. Comparing actual and standard costs permits an evaluation of the effectiveness of managerial performance. Because of the impact of fixed costs in most businesses, a standard costing system is usually not effective unless the company also has a flexible budgeting system. Flexible budgeting uses standard costs to prepare budgets for multiple activity levels.

Incorrect Answers:

A: MBO is a behavioral, communication-oriented, responsibility approach to employee self-direction. Although MBO can be used with standard costs, the two are not necessarily related.

B: Rates of return relate to revenues as well as costs, but a standard costing system concerns costs only.

C: Participative management stresses multidirectional communication. It has no relationship to standard costs.

What to do next

• If you have not read the material for Study Unit 1, do so this Sunday.

• Make sure you complete the two multiple choice quizzes.

• Identify anything that you don’t understand and email it to Ron.

• Read Study Unit 2 and complete both multiple choice quizzes for next week.

Documents

Part 1 Study Unit 1 Ethics for Management Accountants and Cost Management Concepts