Chapter 2:
Basic Cost Terms and Concepts
• Cost Terms
- Fixed
- Variable
• Cost Concepts
• Management Implications
Cost Terms
Fixed Costs: costs that remain
constant regardless of the quantity of
product produced.
$
Output
Variable Costs: costs that increase
linearly and proportionately as
production volume increases.
$
Output
Profit = (Sales Revenue-Variable Cost) - Fixed Cost
Total Contribution Margin
Cost Terms (Continued)
•
Cost Driver:
Any activity or event that causes costs to be incurred.
•
Manufacturing
Cost:
Direct material (DM), direct labor (DL), and
manufacturing overhead (MOH).
•
Sales and General
Administrative
Costs:
All costs associated with running the business,
excluding production costs.
•
Direct and Indirect
Costs:
Costs that can either be traced (direct) or not traced
(indirect) to a specific department in the organization.
•
Controllable and
Uncontrollable
Costs:
Costs used to describe the extent of a manager’s
influence on cost.
•
Product/Period
Cost:
Refers to the timing which costs become expenses.
Economic Terms
• Opportunity
Cost:
Benefit lost because the choice of one action
precludes another action.
• Sunk Cost:
Costs that have already been incurred and can
not be altered by current or future decisions.
• Differential and
Incremental Cost:
Difference in the costs incurred under two
alternative actions.
• Marginal Cost:
Cost associated with producing one additional
unit.
• Average Cost per
Unit:
Total cost for the quantity produced, divided by
the number of units produced.
Bala’s Bare Bones Manufacturing Facility
Direct Material
Purchased
Direct Material Storage
Raw Materials
It’s a Warehouse!
Direct Material Used
Finished Goods
Direct Material
WIP
Inventory
Manufacturing Overhead Costs
Cost Concept
Direct Material Inventory
Work in Process Inventory
Finished Goods Inventory
Beginning
Inventory
$1,000
Beginning
Inventory
$40,000
Beginning
Inventory
$1,000
Purchases
$79,000
Ending
Inventory
$2,000
Transfer to
WIP
$78,000
Direct
Material
$78,000
Transfer to
Finished
Goods
Inventory
$350,000
Goods
Completed
From WIP
$350,000
Direct
Labor
$82,000
MOH
Incurred
$170,000
Ending
Inventory
$20,000
Ending
Inventory
$11,000
Cost of
Goods Sold
(shipped)
$340,000
Storeroom
Raw
Material
Inventory
Allocation of Costs
Direct
Material
Used
(DMU)
Factory
WIP
Inventory
Direct
Material
Purchased
(DMP)
Direct
Labor
(DL)
Manufacturing
Overhead
(MOH)
Cost of Goods
Manufactured
(COM)
Warehouse
Finished
Goods
Inventory
Cost of Goods
Sold (COGS)
Managerial Implications
• Is it better to under or over-apply overhead?
If OH is over-applied (allocated >actual), you will be “surprised” how
well you actually did when making end of period adjustments.
If OH is under-applied (allocated<actual), you will be “surprised” how
well you thought you did when making end of period adjustments.
• If your compensation or incentive plan is based on profit,
which would you choose?