Chapter 2:
Cost Terminology and Cost
Behaviors
Cost Accounting:
Foundations and Evolutions, 9e
Kinney ● Raiborn
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accessible website, in whole or in part.
Learning Objectives
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Why are costs associated with a cost object?
What assumptions do accountants make about cost
behavior, and why are such assumptions necessary?
How are costs classified on financial statements, and why
are such classifications useful?
How does the conversion process occur in manufacturing
and service companies?
What are the product cost categories, and what items
comprise those categories?
How and why does overhead need to be allocated to
products?
How is cost of goods manufactured calculated and used in
preparing an income statement?
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accessible website, in whole or in part.
Cost
Monetary measure of resources given up to attain an objective (such as
acquiring a good or delivering a service)
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accessible website, in whole or in part.
Cost Categories
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Association with cost object
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Cost object is anything for which management
wants to collect or accumulate costs
Reaction to changes in activity
Classification on the financial statements
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accessible website, in whole or in part.
Association with a Cost Object
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Direct—traceable to a cost object
Indirect—not conveniently or practically
traceable to a cost object
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Treated as overhead
Allocated
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accessible website, in whole or in part.
Reaction to Changes in Activity
Variable
 Fixed
 Mixed
 Step
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Relevant Range—normal operating range
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accessible website, in whole or in part.
Cost Reaction to Changes in Activity
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Variable cost
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Fixed Cost
$
$
# of Units
# of Units
Within the
relevant range
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accessible website, in whole or in part.
Cost Reaction to Changes in Activity
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Variable cost
Total
$
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Total
Fixed Cost
$
# of Units
Unit $
# of Units
Unit $
Within the
# of Units relevant range # of Units
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accessible website, in whole or in part.
Total and Unit Cost Behavior
Total Cost
Variable
Cost
Fixed
Cost
Varies in direct
proportion to
changes in activity
Remains constant
throughout
the relevant range
Unit Cost
Remains constant
throughout the
relevant range
Varies inversely
with changes in
activity throughout
the relevant range
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accessible website, in whole or in part.
Cost Reaction to Changes in Activity
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Step Cost (fixed)
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Mixed Cost
variable
$
$
fixed
# of Units
# of Units
Within the
relevant range
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accessible website, in whole or in part.
Determining Cost Behavior
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Cost Predictor
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Cost Driver
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Activity accompanied
by consistent,
observable changes in
a cost item
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Activity that has a
direct cause-effect
relationship on cost
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Predicts but may not
cause the cost to
change

Directly causes the
cost to change
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accessible website, in whole or in part.
Classification on the Financial
Statements
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Unexpired—balance sheet assets
Expired—income statement expenses
Product—inventoriable costs
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Prime—direct material and direct labor
Conversion—direct labor and overhead
Product costs are unexpired before sale
Product costs are expired when sold
Period—expensed in period incurred
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accessible website, in whole or in part.
Product Costs
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Product costs
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Direct material—Measurable part of a product
Direct labor—Labor used to manufacture a
product or perform a service
Overhead—Indirect production cost
First appear on the balance sheet in
inventory accounts
Transferred to the income statement when
product is sold
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accessible website, in whole or in part.
Period Costs
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Period costs
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Selling and administrative costs
Distribution costs
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Cost to warehouse, transport, and/or deliver a product or
service
Major impact on managerial decision making
Appear on the income statement when
incurred
Expensed when incurred
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accessible website, in whole or in part.
The Conversion Process
 Change
inputs into outputs
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accessible website, in whole or in part.
The Conversion Process
Input
Output
Purchase
raw materials
or supplies
Product
or
Service
CONVERSION
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accessible website, in whole or in part.
Degrees of Conversion
Low
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Low
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Department stores
Gas stations
Jewelry stores
Travel agencies
Moderate
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High
Moderate
Moderate
Florists
Meat markets
Oil-change businesses
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High
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Manufacturing
Construction
Agriculture
Architecture
Auditing
Mining
Printing
Restaurants
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Service Company
Input
Purchase
supplies
Use supplies,
labor, overhead
to provide service
Significant amount of labor
Tangible or intangible output
Output
Sell to
customer
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accessible website, in whole or in part.
Retail Company
Input
Purchase
products
for resale
Purchase finished goods
Resell to customers
Output
Warehouse
and/or display
Sell to
customer
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accessible website, in whole or in part.
Manufacturer
Significant amount of labor and machinery
Tangible output
Input
Output
Purchase
raw materials
and supplies
Finished
product
Production
Center
add labor and
overhead
Sell to
customer
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accessible website, in whole or in part.
Cost Accumulation in a
Manufacturing Company
Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
Balance Sheet
Cost of
Goods Sold
Income
Statement
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accessible website, in whole or in part.
Product Cost—Direct
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Direct Material
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Conveniently and economically traced
to cost object
Direct Labor
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To manufacture a product or perform a service
Includes wages paid to direct labor employees,
production bonuses, payroll taxes
May include holiday and vacation pay, insurance,
retirement benefits
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accessible website, in whole or in part.
Product Cost—Indirect
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Overhead—indirect production costs
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Fringe benefits, if cannot be easily traced to
product
Overtime, if due to random scheduling
Cost of quality
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Prevention costs
Appraisal costs
Failure costs
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accessible website, in whole or in part.
Product Cost Behavior
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Direct Material
Variable
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Direct Labor
Variable
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Overhead
Variable, fixed, or mixed
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accessible website, in whole or in part.
Overhead Cost Allocation
Assign indirect costs to one or more
cost objects
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To determine full absorption cost (GAAP)
To motivate management
To compare alternative courses of action for
planning, controlling, and decision making
Allocation process should be
rational and systematic
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Allocating Overhead
Actual Cost System
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Product Cost
Cost Used
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Direct Materials
Actual
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Direct Labor
Actual
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Overhead
Actual
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accessible website, in whole or in part.
Allocating Overhead:
Actual Cost System
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The Actual Cost System is not timely
All costs must be known before calculating
product cost
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accessible website, in whole or in part.
Allocating Overhead:
Actual vs. Normal
Product Cost
Direct Materials
Actual Cost
System
Actual
Normal Cost
System
Actual
Direct Labor
Actual
Actual
Overhead
Actual
Predetermined
Overhead Rate
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Predetermined Overhead Rate
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Allows overhead to be assigned during the
period
Compensates for fluctuations
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that are not related to activity level
in activity level that do not affect fixed overhead
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Flow of Product Costs
Raw Materials Inventory
Accounts Payable
XXX
Work in Process Inventory
Raw Materials Inventory
XXX
XXX
XXX
Work in Process Inventory
XXX
Variable Overhead Control
XXX
Fixed Overhead Control
XXX
Salaries/Wages Payable
XXX
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accessible website, in whole or in part.
Flow of Product Costs
Variable Overhead Control
XXX
Fixed Overhead Control
XXX
Utilities Payable
XXX
Supplies Inventory
XXX
Accumulated Depreciation–Equipment
XXX
Other accounts
XXX
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Flow of Product Costs
Work in Process Inventory
Variable Overhead Control
Fixed Overhead Control
XXX
Finished Goods Inventory
Work in Process Inventory
XXX
XXX
XXX
XXX
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accessible website, in whole or in part.
Flow of Product Costs
Accounts Receivable
Sales
XXX
Cost of Goods Sold
XXX
Finished Goods Inventory
XXX
XXX
Matches
revenues
and
expenses
on the
income
statement
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accessible website, in whole or in part.
Statement of Cost of Goods
Manufactured—Raw Materials
Used
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Beginning balance
Purchases of materials
Raw materials available
Ending balance
Total raw materials used
$ 73,000
280,000
$353,000
<69,000>
$284,000
To Statement of Cost of Goods Manufactured
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accessible website, in whole or in part.
Statement of Cost of Goods
Manufactured
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Beginning work in process
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Raw materials used
Direct labor
Variable overhead
Fixed overhead
$145,000
$284,000
436,000
115,200
98,880
Current period manufacturing costs
Total costs to account for
Ending work in process
Cost of goods manufactured
934,080
$1,079,080
<20,880>
$1,058,200
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accessible website, in whole or in part.
Schedule of Cost of Goods Sold
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Beginning Finished Goods
$ 87,400
Cost of Goods Manufactured
1,058,200
Cost of Goods Available for Sale $1,145,600
Ending Finished Goods
<91,600>
Cost of Goods Sold
$1,054,000
From Schedule of Cost of Goods Manufactured
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accessible website, in whole or in part.
Income Statement
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Revenue
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Income
XXXX
<1,054,000>
XXXX
<XXXX>
XXXX
From Schedule of Cost of Goods Sold
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accessible website, in whole or in part.
Questions
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What is the difference between a fixed and
variable cost?
What are the three components of product
cost?
What are the three inventory accounts for a
manufacturing company?
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accessible website, in whole or in part.
Ethical Issues
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Expired costs—not on the balance sheet
Period costs—not inventory
Product costs—not selling or administrative
costs
Direct labor—not overstated
Ending inventory—not overstated
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.