1. Identify the types of costs firms incur when producing goods or services. Firms that produce goods and services commonly incur three types of manufacturing costs: direct labor, direct materials, and overhead. Direct labor and direct materials are the human and physical resources whose use can be directly traced to the production of an item or delivery of a service. Since direct materials and direct labor represent the primary costs of production or service delivery, they frequently are referred to as prime costs. Overhead includes other indirect costs of production not directly traceable to a product or service.
   
   
2. Describe the flow of production costs in a manufacturing firm. As a manufacturing firm begins the production process, it acquires raw materials inventory. To these resources, direct labor and overhead are applied to create work-in-process inventory. When the production process is complete, the work-in-process items become finished goods inventory. The total cost of the items produced in a fiscal period is referred to as the cost of goods manufactured. The cost of any finished goods inventory actually sold in a fiscal period is called the cost of goods sold. The cost of goods manufactured will only equal the cost of goods sold when all of the items produced in a fiscal period are sold in the same period, a situation more common for service companies that manufacturers.
   
   
3. Explain the traditional method of overhead allocation. Traditional overhead allocation assigns overhead to products or services based on some characteristic that the products or services have in common (that is the allocation base). Since the allocation base is used to proportionately distribute overhead costs to each product made or service rendered, it should be strongly associated with overhead cost. Direct labor hours, direct labor cost (in dollars), direct materials cost (in dollars), and machine hours are the most common allocation bases used to allocate overhead using the traditional method.
   
   
4. Illustrate how activity-based costing is used in assigning overhead. Activity-based costing (ABC) allocates overhead to products or services based on the activities that cause the overhead cost. Unlike the traditional approach that relies on single allocation base to assign all overhead costs (that is, using a single cost pool), ABC assigns the overhead costs of major production or service activities to multiple cost pools. Next, multiple overhead allocation rates are computed by dividing the amount in each cost pool by a measure of the activity that "drives" the overhead cost in each pool. Overhead is then assigned to a product or service based on
   
   
5. Discuss two systems used to measure the cost of products or services. Companies commonly use one of two systems to measure and record the cost of products or services produced: job-order costing or process costing. A job order costing system accumulates manufacturing or service costs for each job performed, each unit produced, each order received, or simply each product or service. The method generally is used when a company delivers goods or services to a customer's unique requirements. In a process costing system costs are accumulated by each operation, rather than by each job, with the unit cost of items determined by dividing the operation's total production costs by the number of identical items produced. This method is commonly used by manufacturers whose products are subjected to a uniform set of operations.