absorption costing

expensing method where both variable manufacturing expenses and fixed manufacturing expenses are considered as inventory expenses. It is used to show inventory valuation that is reported on the balance sheet.

accounting period

time period covered by financial statements, such as monthly, quarterly, semiannual, or annual statements

allocation base

standard unit that provides the system for the way overhead costs of a product or service are divided

conversion cost

expenses necessary to transform raw material to a finished product, generally equal to direct labor cost plus manufacturing overhead

cost of goods manufactured (COGM)

amount spent to produce a product from start through completion and entry into finished goods inventory

cost of goods sold (COGS)

total money spent to purchase or produce the products that were sold during an accounting period

costing system

method a company uses to track expenses and thereby calculate the cost of its products or services

direct materials

raw goods that can be traced directly to, or easily identified with, a specific product

finished goods

goods that have completed 100% of the production process but have not yet been sold

fixed cost

expense of operating a company for a specific period of time that remains unchanged despite changes in the company's activity level

generally accepted accounting principles (GAAP)

rules and standards adopted by the Securities and Exchange Commission that companies must follow when reporting financial information

indirect materials

materials used in a production process that cannot easily be traced to a product. The company applies them to the product by including them as part of overhead costs.

inventory management system

any system used to track the increase or decrease of inventory

job order costing

system that companies use when they can trace costs to a specific product or service

manufacturing overhead

indirect, factory-related production costs that come from making an item

overapplied overhead

result of the overhead costs applied to work in process (WIP) inventory being higher than the actual costs


operating costs or expenses, such as rent, electricity, and taxes

overhead application

overhead costs that are assigned to a product based on a predetermined rate or other formula

predetermined overhead rate

estimated ratio established before an accounting period begins and used to allocate costs involved in producing goods or services. The accountant calculates it by dividing the estimated manufacturing overhead costs for the accounting period by the allocation base.

process costing

system used when large quantities of similar products are manufactured and expenses are applied to a series of actions instead of an individual product

raw materials

raw goods that can be traced directly to, or easily identified with, a product

underapplied overhead

result of the overhead costs applied to work in process (WIP) inventory being less than the actual costs

variable cost

expense that increases or decreases with the level of production

variable costing

method in which all fluctuating expenses from manufacturing are considered as part of inventory expenses

work in process (WIP) inventory

means of keeping track of products that have started through production but are not yet complete