A Review of Cost
Terms and Purposes
Chapter 2
2009 Foster Business School
Cost Accounting
L.DuCharme
Outline
• Cost terminology
–
–
–
–
–
–
–
Cost object
Assignment
Direct vs. Indirect
Variable vs. Fixed
Drivers
Relevant range
Average cost
2
2009 Foster Business School
Cost Accounting
L.DuCharme
Outline (continued)
•
•
•
•
•
Manufacturing companies vs. others
Inventory vs. period costs
Flow of Costs: T-accounts
Prime & conversion costs
Different costs for different purposes
3
2009 Foster Business School
Cost Accounting
L.DuCharme
Cost and Cost Terminology
Cost is a resource sacrificed or forgone to achieve
a specific objective.
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.
4
2009 Foster Business School
Cost Accounting
L.DuCharme
Cost and Cost Terminology
Cost
Assignment is both:
Tracing
Direct Costs
Cost Object
Allocating
Indirect Costs
5
2009 Foster Business School
Cost Accounting
L.DuCharme
Direct vs. Indirect costs
Distinguish between direct costs
and indirect costs.
6
2009 Foster Business School
Cost Accounting
L.DuCharme
Direct and Indirect Costs
COST OBJECT
Direct Costs
Example: Oak wood used
to Mfg. of chairs.
Example: 50 Oak
Chairs produced in
May.
Indirect Costs
Example: salary of the
Plant night watchperson.
7
2009 Foster Business School
Cost Accounting
L.DuCharme
Direct and Indirect Costs
Example
Direct Costs:
Maintenance Department
$40,000
Personnel Department
$20,600
Assembly Department
$75,000
Finishing Department
$55,000
Assume that Maintenance Department costs are
allocated equally among the production departments.
How much is allocated to each department?
8
2009 Foster Business School
Cost Accounting
L.DuCharme
Direct and Indirect Costs
Example
Maintenance
$40,000
Assembly
Direct Costs
$75,000
Finishing
Direct Costs
$55,000
$20,000
$20,000
Allocated
9
2009 Foster Business School
Cost Accounting
L.DuCharme
Variable vs. Fixed costs
Cost Behavior Patterns Example
Bicycles by the Sea buys a handlebar
at $52 for each of its bicycles.
What is the total handlebar cost when
1,000 bicycles are assembled?
10
2009 Foster Business School
Cost Accounting
L.DuCharme
Cost Behavior Patterns Example
1,000 units × $52 = $52,000
What is the total handlebar cost
when 3,500 bicycles are assembled?
3,500 units × $52 = $182,000
11
2009 Foster Business School
Cost Accounting
L.DuCharme
Cost Behavior Patterns Example
Bicycles by the Sea 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.
12
2009 Foster Business School
Cost Accounting
L.DuCharme
Cost Behavior Patterns Example
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 1,000 bicycles?
$94,500 ÷ 1,000 = $94.50
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
$94,500 ÷ 3,500 = $27
13
2009 Foster Business School
Cost Accounting
L.DuCharme
Cost Drivers
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.
14
2009 Foster Business School
Cost Accounting
L.DuCharme
Relevant Range Example
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.
15
2009 Foster Business School
Cost Accounting
L.DuCharme
Fixed Costs
Relevant Range Example
120000
100000
80000
60000
40000
20000
0
$94,500
0
1000
2000
3000
4000
5000
6000
Volume
16
2009 Foster Business School
Cost Accounting
L.DuCharme
Relationships of Types of Costs
Direct
Variable
Fixed
Indirect
17
2009 Foster Business School
Cost Accounting
L.DuCharme
“Average Costs”
Interpret unit costs cautiously.
18
2009 Foster Business School
Cost Accounting
L.DuCharme
Total Costs and Unit Costs
Example
What is the unit cost (leasing and handlebars)
when Bicycles assembles 1,000 bicycles?
Total fixed cost $94,500
+ Total variable cost $52,000 = $146,500
$146,500 ÷ 1,000 = $146.50
19
2009 Foster Business School
Cost Accounting
L.DuCharme
Total Costs and Unit Costs
Example
Total Costs
200000
$146,500
150000
100000
$94,500
50000
0
0
500
1000
1500
Volume
20
2009 Foster Business School
Cost Accounting
L.DuCharme
Use Unit Costs Cautiously
Assume that Bicycles management uses a
unit cost of $146.50 (leasing and wheels).
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
21
2009 Foster Business School
Cost Accounting
L.DuCharme
Use Unit Costs Cautiously
What is their budgeted cost for an estimated
production of 3,500 bicycles?
3,500 × $146.50 = $512,750
What should the budgeted cost be for an
estimated production of 600 bicycles?
22
2009 Foster Business School
Cost Accounting
L.DuCharme
Use Unit Costs Cautiously
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.
23
2009 Foster Business School
Cost Accounting
L.DuCharme
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
24
2009 Foster Business School
Cost Accounting
L.DuCharme
Manufacturing vs. others
Distinguish among
manufacturing companies,
merchandising companies, and
service-sector companies.
25
2009 Foster Business School
Cost Accounting
L.DuCharme
Manufacturing
Manufacturing companies
purchase materials and components and
convert them into finished goods.
A manufacturing company must also develop,
design, market, and distribute its products.
26
2009 Foster Business School
Cost Accounting
L.DuCharme
Merchandising
Merchandising companies
purchase and then sell tangible products
without changing their basic form.
27
2009 Foster Business School
Cost Accounting
L.DuCharme
Service
Service companies
provide services or intangible
products to their customers.
Labor is the most significant cost category.
28
2009 Foster Business School
Cost Accounting
L.DuCharme
Inventoriable Costs
Differentiate between
inventoriable costs
and period costs.
29
2009 Foster Business School
Cost Accounting
L.DuCharme
Types of Inventory
Manufacturing-sector companies
typically have one or more of the
following three types of inventories:
1. Direct materials inventory
2. Work in process inventory (work
in progress)
3. Finished goods inventory
30
2009 Foster Business School
Cost Accounting
L.DuCharme
Types of Inventory
Merchandising-sector companies hold
only one type of inventory – the
product in its original purchased form.
Service-sector companies do not
hold inventories of tangible products.
31
2009 Foster Business School
Cost Accounting
L.DuCharme
Classification of
Manufacturing Costs
Direct materials costs
Direct manufacturing labor costs
Indirect manufacturing costs
32
2009 Foster Business School
Cost Accounting
L.DuCharme
Inventoriable Costs
Inventoriable costs (assets)…
become cost of goods sold…
after a sale takes place.
33
2009 Foster Business School
Cost Accounting
L.DuCharme
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.
34
2009 Foster Business School
Cost Accounting
L.DuCharme
Flow of Costs
• T-account diagram (in class)
35
2009 Foster Business School
Cost Accounting
L.DuCharme
Prime Costs
(all direct mfg. costs)
Direct
Materials
+
Direct
Labor
=
Prime
Costs
36
2009 Foster Business School
Cost Accounting
L.DuCharme
Conversion Costs
(all mfg. cost except DM)
Direct
Labor
+
Manufacturing
Overhead
Indirect
Labor
2009 Foster Business School
Cost Accounting
Indirect
Materials
L.DuCharme
=
Conversion
Costs
Other
37
Different Costs?
Product costs are
computed in different ways
for different purposes/uses.
38
2009 Foster Business School
Cost Accounting
L.DuCharme
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
39
2009 Foster Business School
Cost Accounting
L.DuCharme
End of Chapter 2
That’s all Folks!
2009 Foster Business School
Cost Accounting
L.DuCharme