Term Definition
Absorption Costing An approach to product costing that assigns a representative portion of all types
of manufacturing costs—direct materials, direct labor, variable factory overhead,
and fixed factory overhead—to individual products.
Activity The actual work task or step performed in producing and delivering products and
services.
Activity Analysis The identification and description of activities in an organization, involving
interviews, questionnaires, observation, and review of physical records.
Activity-Based Costing A cost accounting method that measures the cost and performance of
process-related activities and cost objects, assigning costs based on activity use.
Actual Cost An amount determined on the basis of cost incurred, including standard cost
adjusted for applicable variance.
Allocation Base Measures and quantifies activities (e.g., machine hours, kilowatt hours, square
footage) for allocating costs to cost objects.
Avoidable Cost A cost associated with an activity that would not be incurred if the activity were
not performed.
Common Cost The cost of resources employed jointly in the production of two or more outputs,
not directly traceable to any one output.
Controllable Cost A cost that can be influenced by the action of the responsible manager, always
referring to a specified manager.
Conversion Costs The sum of direct labor and factory overhead.
Cost Current or future expenditure of cash for something that will ultimately generate
revenue.
Cost Accounting Procedures used for rationally classifying, recording, and allocating current or
predicted costs that relate to a certain product or production process.
Cost Allocation Allocates cost object balance to others using an allocation base, supports
reciprocal allocation method, automatic order determination, and iteration.
Cost Behavior Classifies costs by response to changes in activity level: fixed (e.g., rent),
variable (e.g., direct materials), semi-variable (partly fixed, partly variable).
Cost Classification Groups costs by shared characteristics: by elements (materials, labor, expenses),
by traceability (direct, indirect), by behavior (fixed, variable, semi-variable).
Cost Driver Any factor causing a change in the cost of an activity or output, e.g., quality of
parts received.
Cost Element Tracks and categorizes costs; includes primary (cost flow from financial
accounting) and secondary (internal cost flow in cost accounting) types.
Cost Finding Techniques producing cost data by analytical or sampling methods, appropriate
for indirect costs or costs below thresholds.
Cost Object Any object selected for cost control (e.g., products, projects, departments, cost
centers); used for quantifying costs and profitability analysis.
Differential Cost The cost difference expected if one course of action is adopted instead of others.
Direct Costs Expenditures in a factory specifically traced to a manufactured item, part of its
overall cost.
Direct Labor Costs The labor cost for specific work that can be easily and economically traced to an
end product.
Direct Material A material that will become part of a finished product and can be easily and
economically traced to specific product units.
Direct Overhead Portion of overhead costs allocated to manufacturing, by the application of a
standard factor termed a burden rate or overhead application rate.
Estimated Cost The process of projecting future cost based on available information, sometimes
used for credits to work-in-process accounts.
Expense Outflow or using up of resources or incurring liabilities, benefits applying to
current accounting period, not extending to future periods.
Factory Overhead Costs Various production-related costs that cannot be practically or conveniently traced
to an end product.
Fixed Costs Costs that do not change with the level of production or sales.
Full-Absorption Costing A method assigning all labor, material, and service/manufacturing facilities and
support costs to products or cost objects.
Full Cost The sum of all costs required by a cost object, including costs of activities
performed by other entities regardless of funding sources.
Incremental Cost The increase or decrease in total costs from a decision to increase/decrease
output, add a service, or change operations.
Indirect Cost Any cost that cannot be conveniently and economically traced to a specific
department; a manufacturing cost that is not easily traced to a specific product
and must be assigned using an allocation method.
Indirect Labor Costs Labor costs for production-related activities that cannot be connected with or
conveniently and economically traced to a specific end product.
Indirect Manufacturing Costs Various production-related costs that cannot be practically or conveniently traced
to an end product.
Indirect Materials Minor materials and other production supplies that cannot be conveniently and
economically traced to specific products.
Job Order Costing A method accumulating costs for individual jobs or lots, e.g., repair of equipment
or treatment of a patient.
Manufacturing Overhead Another term for Factory Overhead Costs.
Marginal Cost Increase or decrease in the total costs of a business firm as the result of one
more or one less unit of output.
Markup The amount added to the price of a product by a retailer to arrive at a selling
price.
Matching Principle A fundamental concept of basic accounting. Match revenue with expenses it took
to generate that revenue in the same or benefiting periods. Example:
depreciation expense over a building's estimated useful life.
Materials Inventory Account An inventory account made up of the balances of materials, parts, and supplies
on hand at a given time.
Microeconomic Pricing An accounting model based on the economic theory that profit will be greater
Model when the difference between total revenue and total cost is the greatest.
Mixed Costs Costs that result when both variable costs and fixed costs are charged to the
same general ledger account.
Modified Accelerated Cost A mandatory system of depreciation for income tax purposes, enacted by
Recovery System Congress in 1986.
Moving Average Method A modified version of the weighted-average-cost method. Used to compute the
average cost of a perpetual inventory.
Opportunity Cost The value of alternatives foregone by adopting a particular strategy or employing
resources, also called Alternative or Economic Cost.
Overhead Cost Ongoing business expenses not directly linked to specific activities (e.g.,
accounting fees, depreciation, insurance, rent).
Period Costs Selling and administrative expenses unrelated to the production process, e.g.,
utilities, insurance, property taxes, depreciation, supplies, maintenance, salaries,
etc., incurred outside factory production.
Prime Cost The sum of direct labor and direct materials.
Product Costs Costs incurred when manufacturing goods, classified as direct or indirect.
Semi-variable Costs Costs that have both fixed and variable components.
Variable Costs Costs that vary with the level of production or sales.
Systems of Accumulating Costs
1. Historical (Actual) Costing
What It Is: Historical costing, also called actual costing, records the actual costs incurred during
production, including direct materials, direct labor, and factory overhead (both variable and
fixed). Costs are tracked as they happen, based on real expenses, with no estimates or
predetermined rates.
Simple Explanation: Imagine you’re baking cakes for a bakery. You track every penny spent on
ingredients (flour, eggs), labor (bakers’ wages), and overhead (electricity, rent) after the cakes
are made. The total actual cost of making a cake is what you paid for everything, no guesswork
involved.
2. Standard Costing
What It Is: Standard costing uses predetermined (estimated) costs for materials, labor, and
overhead, based on expected or standard rates, rather than actual costs. Actual costs are later
compared to these standards to identify variances (differences) for analysis.
Simple Explanation: Think of planning a budget for making pizzas. You estimate it’ll cost $2 for
ingredients, $1 for labor, and $0.50 for overhead per pizza based on past experience. You use
these “standard” costs to price your pizzas. After making them, you compare the actual costs to
your estimates to see if you overspent or saved money.
3. Normal Costing
What It Is: Normal costing uses actual costs for direct materials and direct labor but applies
factory overhead using a predetermined overhead rate (based on estimated overhead costs and
an allocation base like machine hours or labor hours). It’s a hybrid of historical and standard
costing.
Simple Explanation: Picture making custom furniture. You track the exact cost of wood and
workers’ wages for each piece, but for overhead (like factory utilities), you use an estimated rate
(e.g., $10 per hour of work) because actual overhead isn’t known until later. This balances
accuracy with speed.
Inventory Valuation Methods
1. Throughput Costing
What It Is: Throughput costing, also known as super-variable costing, only includes direct
material costs as part of inventory value. All other costs (direct labor, variable overhead, and
fixed overhead) are treated as period costs and expensed immediately, not included in
inventory.
Simple Explanation: Imagine you’re making t-shirts. Only the cost of fabric goes into the value
of the t-shirts in inventory. The wages of workers sewing the shirts, electricity for machines, and
factory rent are expensed right away, not added to the t-shirts’ cost.
Example:
● A t-shirt factory makes 1,000 shirts.
● Costs: $5,000 for fabric (direct materials), $3,000 for labor, $2,000 for variable overhead,
$4,000 for fixed overhead.
● Inventory value: Only $5,000 (fabric) ÷ 1,000 = $5 per shirt.
● Labor ($3,000), variable overhead ($2,000), and fixed overhead ($4,000) are expensed
immediately, not included in inventory.
2. Direct (Variable) Costing
What It Is: Direct costing, also called variable costing, includes all variable manufacturing costs
(direct materials, direct labor, and variable factory overhead) in inventory value. Fixed overhead
costs are treated as period costs and expensed in the period they occur.
Simple Explanation: Back to the t-shirt factory. The cost of fabric, workers’ wages, and
electricity for machines (variable costs) are included in the t-shirt’s inventory value. But the
factory rent (fixed cost) is expensed right away, not added to the t-shirts.
Example:
● Same t-shirt factory: $5,000 for fabric, $3,000 for labor, $2,000 for variable overhead,
$4,000 for fixed overhead.
● Inventory value: ($5,000 + $3,000 + $2,000) ÷ 1,000 = $10 per shirt.
● Fixed overhead ($4,000) is expensed in the period, not included in inventory.
3. Full Absorption Costing
What It Is: Full absorption costing, also called absorption costing, includes all manufacturing
costs—direct materials, direct labor, variable overhead, and fixed overhead—in the inventory
value. All costs related to production are assigned to the products.
Simple Explanation: In the t-shirt factory, the cost of fabric, workers’ wages, electricity, and a
share of the factory rent are all included in the cost of each t-shirt in inventory. Everything it
takes to run the factory is part of the t-shirt’s value.
Example:
● Same t-shirt factory: $5,000 for fabric, $3,000 for labor, $2,000 for variable overhead,
$4,000 for fixed overhead.
● Inventory value: ($5,000 + $3,000 + $2,000 + $4,000) ÷ 1,000 = $14 per shirt.
● All costs are included in the inventory value.
4. Activity-Based Costing (ABC)
What It Is: Activity-based costing assigns manufacturing costs to products based on the
activities they require (e.g., machine setups, inspections). It allocates both variable and fixed
overhead more accurately by linking costs to specific activities, rather than using a single
overhead rate.
Simple Explanation: In the t-shirt factory, some t-shirts need more machine setups (e.g., for
custom designs) or inspections. ABC calculates the cost of each activity (like $100 per setup)
and assigns it to t-shirts based on how many setups or inspections they need, instead of
spreading all overhead costs evenly.
Example:
● T-shirt factory makes 500 plain t-shirts and 500 custom t-shirts.
● Costs: $5,000 for fabric, $3,000 for labor, $2,000 for variable overhead, $4,000 for fixed
overhead.
● Activities: Machine setups ($2,000, 10 setups, custom t-shirts need 8, plain need 2),
Inspections ($4,000, 200 hours, custom need 150 hours, plain need 50).
Cost Accumulation Methods
1. Job Order Costing
What It Is: Job order costing tracks costs for specific, distinct jobs or orders, where each job is
unique or customized. Costs (direct materials, direct labor, and overhead) are accumulated for
each job separately.
Simple Explanation: Imagine a custom furniture shop making a unique dining table for a
customer. You track the wood, labor hours, and overhead (like shop electricity) specifically for
that table. Each job (table, chair, etc.) has its own cost record.
Example:
● A print shop produces 100 custom wedding invitations (Job #123).
● Costs: $200 for specialty paper (direct materials), $150 for labor (printing staff), $100 for
overhead (based on labor hours).
● Total cost for Job #123 = $200 + $150 + $100 = $450, or $4.50 per invitation.
● If another job (e.g., posters) is different, it gets its own cost sheet.
2. Process Costing
What It Is: Process costing accumulates costs for a continuous or repetitive production process,
where products are identical or similar. Costs are averaged over all units produced in a period,
rather than tracked for individual units.
Simple Explanation: Picture a soda factory making thousands of bottles of cola. You don’t
track costs for each bottle but instead collect all costs (ingredients, labor, overhead) for a
production stage (like mixing or bottling) and divide them across all bottles made.
Example:
● A paint factory produces 10,000 gallons in a mixing department.
● Costs: $5,000 for pigments (materials), $3,000 for labor, $2,000 for overhead.
● Total cost = $5,000 + $3,000 + $2,000 = $10,000.
● Cost per gallon = $10,000 ÷ 10,000 = $1 per gallon.
● Costs are then transferred to the next department (e.g., packaging).
3. Backflush Costing
What It Is: Backflush costing is a simplified method that delays cost recording until after
production is complete, “flushing” costs backward from finished goods to raw materials. It’s used
in lean manufacturing with short production cycles, assigning costs based on standard costs or
output.
Simple Explanation: Imagine a toy factory using just-in-time (JIT) production. Instead of
tracking costs during production, you wait until the toys are finished, then assign costs
(materials, labor, overhead) based on how many toys were made, using standard estimates.
4. Hybrid Costing
What It Is: Hybrid costing, also called operation costing, combines elements of job order and
process costing. It’s used when production involves both standardized processes (like process
costing) and customized elements (like job order costing).
Simple Explanation: Think of a shoe factory making sneakers. The soles are mass-produced
(process costing), but the uppers are customized with different colors or designs for each order
(job order costing). You track costs for the standard process and the custom jobs separately,
then combine them.
