An Introduction To Cost Terms and Purposes

CHAPTER 2
An Introduction to Cost Terms and Purposes
Basic Cost Terminology

Cost sacrificed resource to achieve a
specific objective Actual Cost a cost that has occurred Budgeted Cost a predicted cost Cost Object anything for which a measurement of costs is desired ( a product, service, project, department, etc.)
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright 2006 by Pearson Education. All rights reserved.
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Basic Cost Terminology

Cost Accumulation a collection of cost data
in an organized manner Cost Assignment a general term that includes gathering accumulated costs to a cost object. This includes:

Tracing accumulated costs with a direct relationship to the cost object and Allocating accumulated costs with an indirect relationship to a cost object
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Direct and Indirect Costs

Direct Costs can be conveniently and
economically traced (tracked) to a cost object Indirect Costs cannot be conveniently or economically traced (tracked) to a cost object. Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner
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Cost Examples
Direct Costs
Parts Assembly line wages Electricity Rent Property taxes
Indirect Costs
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Factors Affecting Direct/Indirect Cost Classification

Cost Materiality
Availability of Information-gathering
Technology Operational Design
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Cost Behavior
Variable Costs changes in total in
proportion to changes in the related level of activity or volume Fixed Costs remain unchanged in total regardless of changes in the related level of activity or volume Costs are fixed or variable only with respect to a specific activity or a given time period
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Cost Behavior, continued

Variable costs are constant on a per-unit basis. If a
product takes 5 pounds of materials each, it stays the same per unit regardless of whether one, ten, or a thousand units are produced Fixed costs change inversely with the level of production. As more units are produced, the same fixed cost is spread over more and more units, reducing the cost per unit
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Cost Behavior Summarized

Total Dollars Total Dollars Cost per Unit Cost per Unit
Unchanged in Unchanged in relation to output relation to output
Variable Variable Costs Costs
Change Change in in proportion with proportion with output output More output = More cost
More output = More cost
Fixed Fixed Costs Costs
Unchanged in Unchanged in relation to output relation to output
Change inversely Change inversely with output with output More output = lower cost
More output = lower per unit cost per unit
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Other Cost Concepts

Cost Driver
a variable that causally affects costs over a given time span e.g. The no. of vehicles assembled is a cost driver of the costs of steering wheels on a motor vehicle assembly line
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Different Types of Firms

Manufacturing-sector companies
purchase materials and components and convert them into various finished goods. Merchandising-sector companies purchase and then sell tangible products without changing their basic form, e.g. retailers. Service-sector companies
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Types of Inventories
Direct Materials direct materials in stock
and awaiting use in the manufacturing process Work-in-Process products started but not yet completed. Often abbreviated as WIP Finished Goods products completed and ready for sale
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Types of Product Costs

Direct Materials
Direct Labor
Indirect Manufacturing factory costs that are
not traceable to the product. Also known as Manufacturing Overhead costs or Factory Overhead costs
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Distinctions Between Costs

Inventoriable Costs are all costs of a
product that are considered as assets in the balance sheet when they are incurred and that become COGS when the product is sold. Period Costs are treated as expenses of the accounting period in which they are incurred because they are expected not to benefit future periods
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Cost of Goods Manufactured

Cellular Products Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2007 (in thousands) Direct Materials: Beginning Inventory, January 1 $ 11,000 Add: Purchases 73,000 Cost of Direct Materials Available for Use 84,000 Less: Ending Inventory, December 31 8,000 Direct Materials Used 76,000 Direct Labor 9,000 Manufacturing Overhead: Indirect Labor 7,000 Supplies 2,000 Heat, Light & Power 5,000 Depreciation - plant building 2,000 Depreciation - plant equipment 3,000 Miscellaneous 1,000 Total Manufacturing Overhead Costs 20,000 Manufacturing costs incurred during 2007 105,000 Add: Beginning WIP, January 1 6,000 Total Manufacturing Costs to account for 111,000 Less: Ending WIP, December 31 7,000 Cost of Goods Manufactured $ 104,000
Calculates the cost of Direct Materials Used
Accumulates the three product costs for the current period
Adjusts the current period manufacturing costs to account for units actually completed
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Income Statement
Cellular Products Income Statement For the Year Ended December 31, 2007 (in thousands) Revenues Cost of Goods Sold Beginning Finished Goods, January 1 Cost of Goods Manufactured Cost of Goods Available for sale Ending Finished Goods, December 31 Cost of Goods Sold Gross Profit Operating Costs: Marketing, distribution, and customer-service Total operating costs Operating Income $210,000 22,000 104,000 126,000 18,000 108,000 102,000 70,000 70,000 $32,000
Figure carries forward from the Schedule of Cost of Goods Manufactured Period Costs are expensed as incurred
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Other Cost Considerations

Prime cost is a term referring to all direct
manufacturing costs (labor and materials) Conversion cost is a term referring to direct labor and factory overhead costs, collectively Overtime labor costs are considered part of overhead
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Three Common Features of Cost Accounting and Cost Management

Calculating the cost of products, services,
and other cost objects Obtaining information for planning and control, and performance evaluation Analyzing the relevant information for making decisions
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CHAPTER 2

An Introduction to Cost Terms and Purposes

Basic Cost Terminology

Basic Cost Terminology

Direct and Indirect Costs

Parts Assembly line wages Electricity Rent Property taxes

Factors Affecting Direct/Indirect Cost Classification

Technology Operational Design

Cost Behavior, continued

Cost Behavior Summarized

Variable Variable Costs Costs

Fixed Fixed Costs Costs

Unchanged in Unchanged in relation to output relation to output

Other Cost Concepts

Different Types of Firms

Types of Product Costs

Distinctions Between Costs

Cost of Goods Manufactured

Calculates the cost of Direct Materials Used

Accumulates the three product costs for the current period

Other Cost Considerations

Three Common Features of Cost Accounting and Cost Management

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