Chapter 17
Full Costs and
Their Uses
McGraw-Hill/Irwin
Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.
Cost
• A measurement,
• In monetary terms,
• Of the amount of resources used for
some purpose.
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Cost Object
 Product, project, organizational unit, or
other activity or purpose for which costs
are measured.
 Can be defined broadly or narrowly.
 E.g., an entire production run of jeans vs.
one pair of jeans.
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Full Cost
 All the resources used for a cost object.
 Includes:
 Direct production costs.
 Indirect production costs.
 Selling cost.
 General and administrative cost.
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Direct Costs
 Costs specifically traced to (caused by)
the cost object.
 E.g., denim cloth used in jean
manufacturing.
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Indirect Costs
 Costs associated with (or caused by) two
or more cost objects jointly.
 Not possible or feasible to trace directly
to a single cost object.
 Terms “direct” and “indirect” are only
meaningful in context of a specific cost
object (i.e., can change as cost object(s)
change).
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What is GAAP Cost?
 Limited guidance.
 Any “systematic and rational” method
of cost assignment is allowed.
 Cost Accounting Standards Board
(CASB).
 Statements on Management
Accounting issued by Institute of
Management Accountants (IMA).
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Elements of product cost
 Cost organized into categories (i.e.,
materials, labor, overhead, etc.).
 Collected in a product costing system.
 Accumulates and reports costs of product
cost objects.
 Cost object can be a physical product or a
service.
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Direct Material Cost
 Quantities of material that can be
specifically identified with a cost object
in an economically feasible manner.
 Also know as raw materials.
 Usually priced at unit price of material.
 Question: Are supplies used in
production part of direct material cost?
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Direct Labor Cost
 Quantities of labor that can be
specifically identified with a cost object
in an economically feasible manner.
 Usually priced at unit price of labor.
 Question: Is a factory’s production
supervisor a direct labor cost?
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Overhead Costs
 All other production costs.
 Indirect production costs.








Indirect materials.
Indirect labor.
Utilities.
Maintenance.
Depreciation.
Insurance.
Taxes.
Etc.
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Other Cost Terminology
 Conversion costs.
 All production costs needed to convert
direct material into finished goods.
 Direct labor cost + overhead cost.
 Full production cost.
 Also called inventory cost, product cost.
 Direct materials + direct labor +
overhead.
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Nonproduction Costs
 Also known as period costs.
 Includes:
 Selling costs.
 Marketing (order-getting) costs.
 Logistics (order-filling) costs.
 General and administrative costs.
 Research and development costs.
 Interest costs.
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Summary
• Full cost:
 Production costs.
 Direct materials.
 Direct labor.
 Overhead.
 Nonproduction costs.
 Selling cost.
 General and administrative cost.
 Research and development costs.
 Interest costs.
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Product Costing Systems
• Involves accounting for the:
1.
2.
3.
Acquisition of resources needed for
production.
Production process.
Sale of completed products.
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Production Inventory
Accounts
• Materials inventory.
– Increased by acquisition of materials.
– Decreased when materials are used in production.
• Work in process inventory.
– Collects all costs of production
– Increased when material, labor, and overhead are added
to (used in) the production process.
– Decreased when product is completed.
• Finished goods inventory.
– Increased when product is completed.
– Decreased when product is sold.
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Overhead Account
 Clearing account (i.e., temporary holding account).
 Increased (debit) by incurrence of overhead costs
(e.g., usage of indirect materials, incurrence of
indirect labor costs, factory utilities cost,
depreciation cost on factory assets, etc.).
 Decreased (credit) when costs are applied to the
product(s) being produced (i.e., placed into Work in
Process Inventory).
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Product Costing Systems:
Visual Representation
Materials
Inventory
Wages
Payable
Work in
Process
Inventory
Finished
Goods
Inventory
Cost of
Sales
Overhead
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Nonmanufacturing Companies
• Merchandising companies.
• Since cost of goods sold is invoice cost, only
requires simple system (relative to
manufacturing company).
 Service organizations.
 Cost object is “job” (e.g., “patient” in a
hospital, “vehicle” in a auto repair shop,
“client” for an law office.
 Job cost record kept for each job.
 Cost record serves as work in process
inventory account.
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Nonprofit Organizations
• E.g., healthcare, educational, performing arts,
government.
• Cost object is programs not products.
• Similar cost accounting practices to profit
organizations.
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Life Cycle Costing
• Cost system considers all of a product’s
costs from “birth to abandonment.”
– Birthing costs.
• Necessary to develop product and bring it to
market.
• Includes research and development, product
testing, initial market creation, salesperson training.
– Abandonment costs.
• Incurred after product is discontinued and doesn’t
produce significant revenues.
• Disposal of plant and equipment, severance costs,
restoring polluted land.
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Uses of Full Costs
 Financial reporting.
 Determine cost of inventory and cost of
sales.
 Analysis of profitability.
 Entire business and parts of the
business (e.g., product, product line,
plant, division, sales territory, etc.).
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Uses of Full Costs
 Product pricing.
 Cost plus contracts.
• Contribution pricing.
• Price set below full cost, but above
variable costs.
 Setting regulated prices (e.g., utilities,
cable).
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Uses of Full Costs
 Product pricing.
 Normal pricing.
 Recover direct costs, recover applicable
indirect costs, make a satisfactory profit.
 Applicable for differentiated products (i.e.,
has distinct characteristics.
 For undifferentiated products (i.e.,
commodities), price set by market.
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Uses of Full Costs
 Product pricing.
• Time and material pricing.
• Price material cost and labor cost separately (i.e.,
material loading charge, billing rate).
• Used by repair shops, physicians, lawyers,
consultants, etc.
• Target pricing (costing).
• Price set first (based on competitive strategy).
• Then product is designed to cover full cost and
profit.
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Uses of Full Costs
 Strategic positioning.
 Strategic cost management.
 Use of cost management to help better
understand one’s advantages and
disadvantages relative to competitors.
 Covers entire value chain.
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