An Introduction to Cost terms and
Purposes
Session 2
Cost Accounting
Horngreen, Datar, Foster
Learning Objectives
?
?
?
?
?
?
?
?
Define and illustrate a cost object
Distinguish between direct costs and indirect costs
Explain variable costs and fixed costs
Interpret unit costs with caution
Distinguish among manufacturing, merchandising, and servicesector companies
Differentiate between inventoriable costs and period costs
Describe the three categories of inventories commonly found in
manufacturing companies
Explain why different ways of computing product costs are
appropriate for different purposes
Cost Accounting
Horngreen, Datar, Foster
Cost and Cost Terminology
? Cost is a resource sacrificed or forgone to achieve a
specific objective.
? It is usually measured as the monetary amount that
must be paid to acquire goods and services.
? An actual cost is the cost incurred (a historical cost)
as distinguished from budgeted costs.
? A cost object is anything for which a separate
measurement of costs is desired.
Cost Accounting
Horngreen, Datar, Foster
Cost and Cost Terminology
?There are two basic stages of accounting for costs:
1 Cost accumulation
2 Cost assignment to various cost objects
Cost Object
Cost
Accumulation
Cost Object
Cost Object
Cost Assignment
Cost Accounting
Horngreen, Datar, Foster
Cost and Cost Terminology
? Cost accumulation is the collection of cost data in
some organized way by means of an accounting
system.
? Cost assignment is a general term that
encompasses...
– tracing accumulated costs to a cost object, and
– allocating accumulated costs to a cost object.
Cost Accounting
Horngreen, Datar, Foster
Direct Costs
? Direct costs of a cost object are those that are
related to a given cost object (product, department,
etc.) and that can be traced to it in an economically
feasible way.
? Cost-Tracing describes the assignment of direct
costs to the particular cost object.
Cost Accounting
Horngreen, Datar, Foster
Indirect Costs...
– are related to the particular cost object but cannot be
traced to it in an economically feasible way.
Cost Accounting
Horngreen, Datar, Foster
Indirect Costs
? Cost allocation describes the assigning of indirect costs to the
particular cost object.
? Ponce, Inc. has two production departments, Assembly and
Finishing, and two service departments, Maintenance and
Personnel.
• Direct Costs:
Maintenance Department
$30,000
Personnel Department
$24,600
Assembly Department
$70,000
Finishing Department
$50,000
• Assume that Maintenance Department costs are allocated equally
among the production departments.
• How much is allocated to each department?
Cost Accounting
Horngreen, Datar, Foster
Direct and Indirect Costs
Maintenance
$30,000
Assembly
Direct Costs
$70,000
Finishing
Direct Costs
$50,000
$15,000
$15,000
Allocated
Cost Accounting
Horngreen, Datar, Foster
Direct and Indirect Costs
? Several factors affect the classification of a cost as
direct or indirect:
–
–
–
–
The materiality of the cost in question
Available information-gathering technology
Design of operations
Contractual arrangements
? The direct/indirect classification depends on the
choice of the cost object.
Cost Accounting
Horngreen, Datar, Foster
Cost Behavior Patterns
? Variable costs change in total in proportion to changes in the
related level of total activity or volume.
? Fixed costs do not change in total for a given time period despite
wide changes in the related level of total activity or volume.
? Assume that Metairie Bicycles buys a handlebar at $52 for each
of its bicycles.
? Total handlebar cost is an example of a cost that changes in
total in proportion to changes in the number of bicycles
assembled (variable cost).
? What is the total handlebar cost when 1,000 bicycles are
assembled?
Cost Accounting
Horngreen, Datar, Foster
Cost Behavior Patterns
? 1,000 units x $52 = $52,000
? What is the total handlebar cost when 3,500 bicycles
are assembled?
? 3,500 units x $52 = $182,000
Cost Accounting
Horngreen, Datar, Foster
Cost Behavior Patterns
Total costs ($000)
$182
$52
0
1,000
Cost Accounting
3,500
Units
Horngreen, Datar, Foster
Cost Behavior Patterns
? Assume that Metairie Bicycles incurred $94,500 in a given
year for the leasing of its plant.
? This is an example of fixed costs with respect to the number of
bicycles assembled.
? These costs are unchanged in total over a designated range of
the number of bicycles assembled during a given time span.
• What is the leasing (fixed) cost per bicycle when Metairie assembles
1,000 bicycles?
• $94,500 ÷ 1,000 = $94.50
• What is the leasing (fixed) cost per bicycle when Metairie assembles
3,500 bicycles?
• $94,500 ÷ 3,500 = $27
Cost Accounting
Horngreen, Datar, Foster
Cost Drivers
? A cost driver is a factor, such as the level of activity or
volume, that causally affects costs (over a given time
span).
? The cost driver of variable costs is the level of
activity or volume whose change causes the
(variable) costs to change proportionately.
? The number of bicycles assembled is a cost driver of
the cost of handlebars.
Cost Accounting
Horngreen, Datar, Foster
Relevant Range...
? is the band of the level of activity or volume in which a
specific relationship between the level of activity or volume
and the cost in question is valid.
? Assume that fixed (leasing) costs are $94,500 for a year and
that they remain the same for a certain volume range (1,000
to 5,000 bicycles).
? 1,000 to 5,000 bicycles is the relevant range.
? If annual demand for Metairie’s bicycles increases, and the
company needs to assemble more than 5,000 bicycles, it
would need to lease additional space which would increase
its fixed costs.
Cost Accounting
Horngreen, Datar, Foster
Relevant Range
Total fixed costs ($000)
Relevant range
$ 94.5
0
1,000
Cost Accounting
5,000 Volume
Horngreen, Datar, Foster
Relationships of Types of
Costs
Direct
Variable
Fixed
Indirect
? Costs
may be simultaneously:
variable and direct, variable and indirect,
fixed and direct, fixed and indirect
Cost Accounting
Horngreen, Datar, Foster
Total Costs and Unit Costs
? A unit cost (also called an average cost) is computed by dividing
some amount of cost total by some number of units.
? The “units” may be expressed in various ways:
– Hours worked
– Packages delivered
– Bicycles assembled
? What is the unit cost (leasing and handlebars) when Metairie
Bicycles assembles 1,000 bicycles?
? Total fixed cost $94,500 + Total variable cost $52,000 =
$146,500
? $146,500 ÷ 1,000 = $146.50
Cost Accounting
Horngreen, Datar, Foster
Total Costs and Unit Costs
Total costs ($000)
$146.5
$ 94.5
0
1,000
Cost Accounting
Volume
Horngreen, Datar, Foster
Use Unit Costs Cautiously
? Assume that Metairie Bicycles management uses a
unit cost of $146.50 (leasing and handlebars).
? Management is budgeting costs for different levels of
production.
? What is their budgeted cost for an estimated
production of 600 bicycles?
• 600 × $146.50 = $87,900
• What is their budgeted cost for an estimated production of
3,500 bicycles?
• 3,500 × $146.50 = $512,750
Cost Accounting
Horngreen, Datar, Foster
Use Unit Costs Cautiously
? What should the budgeted cost be for an estimated
production of 600 bicycles?
? Total fixed cost
$ 94,500
Total variable cost ($52 × 600) =
31,200 Total
$125,700
? $125,700 ÷ 600 = $209.50
? Using a cost of $146.50 per unit would underestimate
actual total costs if output is below 1,000 units.
Cost Accounting
Horngreen, Datar, Foster
Use Unit Costs Cautiously
? What should the budgeted cost be for an estimated production
of 3,500 bicycles?
? Total fixed cost
$ 94,500
Total variable cost (52 × 3,500) =
182,000
Total
$276,500
? $276,500 ÷ 3,500 = $79.00
? Using a cost of $146.50 per unit instead of $79.00 would
overestimate actual total costs if output is above 1,000
units.
? For decision making, managers should think in terms of
total costs rather than unit costs.
Cost Accounting
Horngreen, Datar, Foster
Manufacturing
? Manufacturing-sector companies purchase materials
and components and convert them into finished
goods.
? A manufacturing company must also develop, design,
market, and distribute its products.
Cost Accounting
Horngreen, Datar, Foster
Merchandising
? Merchandising-sector companies purchase and then
sell tangible products without changing their basic
form.
Cost Accounting
Horngreen, Datar, Foster
Service Companies...
– provide services or intangible products to their
customers.
• Labor is the most significant cost category.
Cost Accounting
Horngreen, Datar, Foster
Types of Inventory
? Manufacturing-sector companies typically have one
or more of the following three types of inventories:
• Direct materials inventory
• direct materials in stock and awaiting use in the
manufacturing process
• Work-in-process inventory (work in progress)
• goods partially worked on but not yet fully completed.
• Finished goods inventory
• goods fully completed but not sold.
Cost Accounting
Horngreen, Datar, Foster
Types of Inventory
? Merchandising-sector companies hold only one type
of inventory – the product in its original purchased
form.
? Service-sector companies usually do not hold
inventories of tangible products.
Cost Accounting
Horngreen, Datar, Foster
Classification of Manufacturing
Costs
? Direct materials costs
• Direct materials costs are the acquisition costs of all
materials that eventually become part of the cost
object.
• Direct materials costs can be traced economically.
• Acquisition costs include freight-in (inward delivery)
charges, sales taxes, and customs duties.
Cost Accounting
Horngreen, Datar, Foster
Classification of Manufacturing
Costs
Direct materials costs
Direct manufacturing labor costs
• Direct manufacturing labor costs include the compensation of all
manufacturing labor that can be traced to the cost object in an
economically feasible way.
• Wages and fringe benefits paid to:
– Machine operators
– Assembly-line workers
Cost Accounting
Horngreen, Datar, Foster
Classification of Manufacturing
Costs
Direct materials costs
Direct manufacturing labor costs
Indirect manufacturing costs
Indirect manufacturing costs are all manufacturing costs that
are considered to be part of the cost object, but that cannot
be traced to that cost object in an economically feasible way.
• Other terms for this cost category include manufacturing
overhead costs and factory overhead costs.
•
Cost Accounting
Horngreen, Datar, Foster
Inventoriable Costs
? Inventoriable costs are all costs of a product that are
regarded as an asset when they are incurred and then
become cost of goods sold when the product is sold.
• For manufacturing-sector companies, almost all manufacturing costs
are inventoriable costs.
• Inventoriable costs (direct materials, direct labor and indirect
manufacturing costs) are included in work-in-process and finished
goods inventory.
• For merchandising-sector companies, inventoriable costs are the
costs of purchasing the goods which are resold in their same form.
• For service-sector companies, the absence of inventories means there
are no inventoriable costs.
Cost Accounting
Horngreen, Datar, Foster
Period Costs
? Period costs are all costs in the income statement
other than cost of goods sold.
? Period costs are recorded as expenses of the
accounting period in which they are incurred.
– For manufacturing-sector companies, period costs
include all non-manufacturing costs (research and
development, distribution, etc.).
– For merchandising-sector companies, period costs
include all costs not related to the cost of goods
purchased for resale.
– For service-sector companies, all of their costs are
period costs.
Cost Accounting
Horngreen, Datar, Foster
Categories of Inventory
? The three categories of inventory found in many
manufacturing companies depict stages in the
conversion process:
• materials
• Direct materials inventory costs are used to compute the
cost of materials used.
• Beginning direct materials inventory
?+ Purchases of direct materials
?? Ending direct materials inventory
?= Direct materials used
Cost Accounting
Horngreen, Datar, Foster
Categories of Inventory
? The three categories of inventory found in many
manufacturing companies depict stages in the
conversion process:
• materials
• work-in-process
• Work-in-process inventory costs are used to compute the cost of
goods manufactured.
• Beginning work-in-process inventory
?+ Manufacturing costs incurred during the period
?? Ending work-in-process inventory
?= Cost of goods manufactured
Cost Accounting
Horngreen, Datar, Foster
Categories of Inventory
? The three categories of inventory found in many
manufacturing companies depict stages in the
conversion process:
• materials
• work-in-process
• finished goods
• Finished goods inventory costs are used to compute the cost of
goods sold.
• Beginning finished goods inventory
?+ Cost of goods manufactured
?? Ending finished goods inventory
?= Cost of goods sold
Cost Accounting
Horngreen, Datar, Foster
Measuring Costs Requires
Judgment
? Judgment is frequently required when measuring
costs.
? Differences can exist in the way accounting terms
are defined.
Cost Accounting
Horngreen, Datar, Foster
Measuring Costs Requires
Judgment
? Manufacturing labor-cost classifications vary
among companies.
? The following distinctions are generally found:
• Direct manufacturing labor
• Manufacturing overhead
• Indirect labor
• Managers’ salaries
• Payroll fringe costs
Cost Accounting
Horngreen, Datar, Foster
Measuring Costs Requires
Judgment
? Overtime premium consists of the wages paid to all workers
(for both direct labor and indirect labor) in excess of their
straight-time wage rates.
• Overtime premium is usually considered part of overhead.
• Why is overtime premium of direct labor usually considered an
indirect rather than a direct cost?
• Because it does not “penalize” (add to) the cost of a particular
batch of work solely because it happened to be worked on during
the overtime hours.
• Sometimes overtime is not random; for instance a rush job may
clearly be the sole source of the overtime.
• In this case the overtime premium is regarded as a direct cost of
the services on that job.
Cost Accounting
Horngreen, Datar, Foster
Many Meanings of Product Cost
? A product cost is the sum of the costs assigned to a
product for a specific purpose.
1 Pricing and product emphasis decisions
2 Contracting with government agencies
3 Preparing financial statements for external
reporting under generally accepted accounting
principles
Cost Accounting
Horngreen, Datar, Foster
Many Meanings of Product Cost
? For pricing and product emphasis decisions, the
costs included are all areas of the value chain.
? When contracting with government agencies,
companies must follow the guidelines provided on the
allowable and non allowable items in a product-cost
amount.
Cost Accounting
Horngreen, Datar, Foster
Many Meanings of Product Cost
? When preparing financial statements for external
reporting, the focus is on inventoriable costs.
? Usually under generally accepted accounting
principles, only manufacturing costs are assigned to
inventories in the financial statements.
Cost Accounting
Horngreen, Datar, Foster
A little Check: True of False???
? Cost assignment involves only tracing accumulated costs with direct
relationship to a cost objective.
? Cost allocation describes the assignment of direct costs to a particular
cost object.
? The cost object has no bearing on whether a cost is direct or indirect.
? All fixed costs are considered indirect.
? A unit cost is only valid at one level of production.
Cost Accounting
Horngreen, Datar, Foster
Pick your Choice I:
? A cost that is constant in total amount is always considered a(n)
• direct
• indirect
• variable
• fixed
? The cost of materials that have been started into production, but are not
completely processed, would be found in which inventory account on the
balance sheet?
• Direct materials inventory
• Work-in-process inventory
• Supplies inventory
• Finished goods inventory
Cost Accounting
Horngreen, Datar, Foster
Pick your Choice II:
?
An average cost is also known as a(n)
• fixed cost
• variable cost
• unit cost
• total cost
? The term used to describe the assignment of direct costs to
the particular cost object is
• cost allocation
• cost tracing
• cost accumulation
• cost assignment
Cost Accounting
Horngreen, Datar, Foster