1/22/23, 5:59 PM print.html Accumulating and Assigning Costs Accumulating costs: is the way that costs are measured and recorded. - When a telephone bill comes to the company, an addition to the telephone expense account and an addition to the liability account, Accounts Payable is made. - The cost is accumulated and it would be easy to tell, at the end of the year, the total spending on the telephone expense. Assigning costs: is the way that a cost is linked to some cost object. A cost object is something for which a company wants to measure the cost. - Assigning costs tells the company why the money was spent. In this case, cost assignment tells whether the money spent on telephone expense was to support the manufacturing or the selling of the product. file:///C:/Users/perfctblu/Desktop/print.html Assigning Costs to Cost Objects All equations The objective is to measure and assign costs as well as possible, given management’s priorities. Which method you choose will depend on how important it is to you to assign the specific meal costs to each individual and the additional effort required to be more accurate. 1/9 1/22/23, 5:59 PM print.html Cost The amount of cash or cash equivalent sacrificed for goods and/or services that are expected to bring a current or future benefit to the organization (revenue). COGS The COGS is the cost of producing the units that were sold during the time period. - It includes direct materials, direct labour, and manufacturing overhead. It does not include any selling or administrative expenses. Cost is a dollar measure of the resources used to achieve a given benefit. Managers strive to minimize the cost of achieving benefits. Reducing the cost required to achieve a given benefit means that a firm is becoming more efficient. Expenses: Expired costs; on the income statement, expenses are deducted from revenues to determine net income (also called net profit). Revenues must be greater than expenses. Price: The revenue per unit. The price of an item (e.g., a cellphone) is the cost to us. For the company, revenue and price are the same. Cost Classification Different costs are used for different purposes. Cost definitions can vary according to the objective being served. Thus, costs can be classified into groups using a variety of criteria. The classification of costs helps make sense of the great variety of costs, which facilitates decision making and strategic planning. ● direct costs (materials and labour) ● indirect costs (manufacturing overhead) ● prime costs ● conversion costs ● product costs ● period costs ● variable costs ● fixed costs ● mixed costs ● selling costs ● administrative costs On the income statement, expenses are deducted from revenues to determine net income (also called profit). file:///C:/Users/perfctblu/Desktop/print.html 2/9 1/22/23, 5:59 PM print.html Cost Objects Managerial accounting systems are structured to measure and assign costs to entities called cost objects. Cost Flow for Manufacturing Company A cost object: is any item such as a product, service, customer, department, project, geographic region, plant, and so on, for which costs are measured and assigned. For example, if the Royal Bank of Canada wants to determine the cost of a platinum credit card, then the cost object is the platinum credit card. All costs related to the platinum card are added in, such as the cost of mailings to potential customers, the cost of customer service telephone lines dedicated to the card, the portion of the computer department that processes platinum card transactions and bills, and so on. Gross Margin Percentage A company can compare gross margin percentage to the average for its industry to see whether its experience is within the ballpark range for other firms in the industry. • Gross margin percentage varies significantly by industry. • Gross margin percentage is calculated as Grocery stores have low profit margins. They earn a few pennies per food item. Luxury stores enjoy a high gross profit margin of 75 percent and more. The profitability of low-margin companies is driven by high turnover, that is, high sales. The overall profitability of a high-margin company is driven by the high profit margin. Opportunity cost: a benefit given up or sacrificed when one alternative is chosen over another file:///C:/Users/perfctblu/Desktop/print.html 3/9 1/22/23, 5:59 PM print.html Income Statement for a Manufacturing Business Gross margin The difference between sales revenue and cost of goods sold. It shows how much the firm is making over and above the cost of the units sold. Gross margin does not equal operating income or profit, as it is computed without subtracting selling and administrative expenses. • If gross margin is positive, the firm is charging prices that cover the product cost. file:///C:/Users/perfctblu/Desktop/print.html The income statements for merchandising and manufacturing businesses differ mainly in how they report the cost of goods purchased and the cost of goods manufactured during the period. Balance Sheet Reporting of Inventories: Cost of goods manufactured (COGM): The total cost of making products that are available for sale during the period. A manufacturer makes the products it sells, using direct materials, direct labour, and manufacturing overhead. Income Statements: Merchandising and Manufacturing Income Statement of a Service Organization In a service organization, there is no product to purchase or to manufacture. • This means there are no beginning or ending inventories. • As a result, there is no cost of goods sold or gross margin on the income statement. • Instead, the cost of providing services appears along with the other operating expenses of the company. A merchandising business purchases merchandise ready for resale to customers. The total cost of goods available for sale during the period is determined by adding beginning inventory to net purchases. The cost of goods sold is determined by subtracting ending inventory from cost of merchandise available for sale 4/9 1/22/23, 5:59 PM print.html Other Categories of Costs Costs are often analyzed with respect to their behaviour patterns, or the way in which a cost changes when the level of the output changes. Inventory and COGS consideration Management accountants will decide what types of managerial accounting information to provide to managers, how to measure such information, and when and to whom to communicate the information. Every company will determine for itself what information is relevant to the particular decision or situation being analyzed. There is one major exception: Management accountants must follow external reporting rules (i.e., GAAP) to provide outside parties with cost information about the amount of ending inventory on the balance sheet and the cost of goods sold (COGS) on the income statement. - In order to calculate these two amounts, management accountants must subdivide costs into functional categories: production and period (i.e., nonproduction) costs. Number of units sold Variable cost: is one that, in total, varies in direct proportion to changes in output. In other words, it increases in total as output increases, and decreases in total as output decreases. - For example, the denim used in making jeans is a variable cost. As the company makes more jeans, it uses more denim. Fixed cost: is a cost that does not increase in total as output increases, and does not decrease in total as output decreases. - For example, the cost of property taxes on the factory building stays the same no matter how many pairs of jeans the company makes. Product costs: Inventoriable costs such as direct materials, direct labour, and manufacturing overhead Period costs: Noninventoriable costs (expensed immediately) Prime: Direct materials and direct labour Conversion: Direct labour and manufacturing overhead file:///C:/Users/perfctblu/Desktop/print.html 5/9 1/22/23, 5:59 PM print.html Period Costs Product costs Period costs: Costs that are not product costs (i.e., all areas of the value chain except for production). - The costs of office supplies, research and development activities, the CEO’s salary, and advertising are examples of period costs. Period costs typically are expensed in the period in which they are incurred. However, if a period cost is expected to provide an economic benefit (i.e., revenues) beyond the next year, then it may be recorded as an asset (i.e., capitalized) and allocated to expense through depreciation or amortization throughout its useful life. - The cost associated with the purchase of a delivery truck is an example of a period cost that would be capitalized when incurred and then recognized as an expense over the useful life of the truck. Selling costs: Costs necessary to market, distribute, and service a product or service - Examples of selling costs include salaries and commissions of sales personnel, advertising, warehousing, shipping, and customer service. Administrative costs: All costs associated with research, development, and general administration of the organization that cannot reasonably be assigned to either selling or production file:///C:/Users/perfctblu/Desktop/print.html Product (manufacturing) costs: Costs, both direct and indirect, of producing a product in a manufacturing firm, or of acquiring a product in a merchandising firm and preparing it for sale. Assets that are carried in inventories until the goods are sold. - Therefore, only costs in the production section of the value chain are included in product costs. - A key feature of product costs is that they form the value of inventory (or are inventoried). The total product cost equals the sum of direct materials, direct labour, and manufacturing overhead. - The unit product cost equals total product cost divided by the number of units produced. Prime cost: is the sum of direct materials cost and direct labour cost. Conversion cost: is the sum of direct labour cost and manufacturing overhead cost. Products and Services Products: Goods produced by converting raw materials through the use of labour and other manufacturing resources. - Organizations that produce products are called manufacturing organizations Services: Tasks or activities performed for a customer, or an activity performed by a customer using an organization’s products or facilities. - Organizations that provide services are called service organizations Product costs initially are added to an inventory account and remain in inventory until they are sold, at which time they are transferred to COGS. Product costs can be further classified as direct materials, direct labour, and manufacturing overhead, which are the three cost elements that must be assigned to products for external financial reporting (e.g., inventories or COGS). 6/9 1/22/23, 5:59 PM print.html Tracing Direct Costs and Assigning Indirect costs Statement of Cost of Goods Manufactured Direct costs are those costs that can be easily and accurately traced to a cost object. - The purchase cost of the fresh fruits and vegetables for a restuarant would be relatively easy to determine. The statement of COGM is prepared using these three steps Step 1. Determine the cost of direct materials used: Step 2. Determine the total manufacturing costs incurred: Step 3. Determine the cost of goods manufactured: All in all (finding COGS, gross margin, and net income/operating income): file:///C:/Users/perfctblu/Desktop/print.html The Impact of Product vs. Period Costs on the Financial Statements Indirect costs: are costs that cannot be easily, accurately, or economically traced to a cost object. - Courtney incurs additional costs in scouting the outlying farms and farmers’ markets Allocation: means that an indirect cost is assigned to a cost object by using a reasonable and convenient method. Since no clearly observable causal relationship exists, allocating indirect costs is based on observation and/or some assumed causal linkage that can be traced to the cost object. - Suppose that this utility cost is to be assigned to these five products. It may be difficult to see any direct causal relationship between utility costs and each unit of product manufactured. Therefore, a convenient way to allocate this cost may be to assign it in proportion to the direct labour hours used by each product. 7/9 1/22/23, 5:59 PM print.html What constitutes product costs Direct materials: Materials that are part of the final product and can be directly traced to the goods being produced. The cost of these materials can be directly charged to products because physical observation can be used to measure the quantity used by each product. ● easily traceable and recognizable, as well as integral to the finished product ● reflect a significant portion of the total cost of the product. - Insignificant costs such as the glue used to produce a TV or the lubricants used to make automobile tires shine would be classified as indirect materials, and form a part of manufacturing overhead costs. Direct labour: Is the labour that can be directly traced to the goods being produced. ● easily traceable to production, and an integral part of the finished product ● reflect a significant portion of the total cost of the product - Cleaning and security costs are not an integral part of, or a significant cost of, each TV or car produced. Such costs are classified as indirect labour, a part of manufacturing overhead cost. Manufacturing overhead: All production costs, other than direct materials and direct labour. Costs are included as manufacturing overhead if they cannot be easily traced to the cost object of interest file:///C:/Users/perfctblu/Desktop/print.html 8/9 1/22/23, 5:59 PM print.html (e.g., unit of product). - In a manufacturing firm, manufacturing overhead is also known as factory overhead, factory burden, or indirect manufacturing costs. - The manufacturing overhead cost category contains a wide variety of items such as depreciation on plant buildings and equipment, janitorial and maintenance labour, plant supervision labour, materials handling, power for plant utilities, and plant property taxes. When you total direct materials, direct labour, and manufacturing overhead, you arrive at manufacturing costs. file:///C:/Users/perfctblu/Desktop/print.html 9/9
