An Introduction To Cost Terms and Purposes

An Introduction to Cost
Terms and Purposes
15/09/14
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 1
Learning Objective 1
Define and illustrate
a cost object.
Cost and Cost Terminology

Cost is a resource sacrificed or forgone to achieve
a specific objective. i.e., amount paid
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. i.e., products,
services, activities, processes, segments, etc.
Cost and Cost Terminology

Cost Object
Cost Accumulation
(Collecting cost data)
Cost Object
Cost Object
Cost Assignment
(tracing and allocating costs)
Tracing
Allocating
Distinguish between direct costs
and indirect costs.
Direct and Indirect Costs

Direct Costs
Example: Paper on which
Sports Illustrated magazine
is printed
Indirect Costs
Example: Lease cost for
Time-Warner building
housing all their senior
executives, including Sports
Illustrated
COST
COSTOBJECT
OBJECT
Example:
Example:Sports
Sports
Illustrated
Illustratedmagazine
magazine
Allocated
Allocated

Example
Direct Costs:
Maintenance Department
$40,000
Personnel Department (Admin)
$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?

Example
Maintenance
$40,000
Assembly
Direct Costs
$75,000
Finishing
Direct Costs
$55,000
$20,000
$20,000
Allocated
Other Factors
Materiality the larger the cost per unit, the
more likely it will be traced as a direct cost
Information gathering technology the
more sophisticated, the more items that can
be traced directly to cost objects, i.e. bar
coding
Design of operations all in one building,
makes it easy to trace
Explain variable costs and fixed
costs.
Variable Costs change in total in proportion to
changes in the level of activity or volume.
Fixed costs remain unchanged in total despite
wide changes in the level of activity or volume.
Cost Behavior Patterns

Variable Cost Example
Bicycles by the Sea buys a handlebar
at $52 for each of its bicycles.
Note: variable cost per unit of
activity is constant
What is the total handlebar cost when
1,000 bicycles are assembled?

Variable Cost 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

Fixed Cost 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.
Note: In total, fixed costs wont change.
But on a per unit of activity basis,
fixed costs will change

Fixed Cost 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
$94,500 3,500 = $27
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.
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
of activity within which the fixed cost in
total will not change.
Fixed Costs
Relevant Range Example

120000
100000
80000
60000
40000
20000
0
$94,500
1000
2000
3000
4000
5000
Volume
6000
Interpret total unit costs
cautiously.
Remember, variable costs per unit
are
constant and fixed costs per unit will
vary
2 - 18
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Total Costs and Unit Costs

Example
What is the total unit cost (leasing and handlebars)
Total fixed cost $94,500
+ Total variable cost $52,000 = $146,500
$146,500 1,000 = $146.50
Use Unit Costs Cautiously

Assume that Bicycles management uses a
total 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?

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?

Total fixed cost
$ 94,500
Total variable cost ($52 600)
31,200
Total Cost
$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.

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
What do unit costs tell you?

Note in the changes in total unit cost
At 600, unit cost is $206.50
At 1,000, unit cost is $146.50
At 3,500, unit cost is $ 79.00
The greater the volume or level of activity within
the relevant range, the lower the unit cost and vice
versa
These changes are very useful in planning, pricing,
budgeting, and evaluating performance
Distinguish among
manufacturing companies,
merchandising companies, and
service-sector companies.
Manufacturing
Manufacturing
Manufacturing companies
companies
purchase
purchase materials
materials and
and components
components and
and
convert
convert them
them into
into finished
finished goods.
goods.
Examples?
Examples?
A
Amanufacturing
manufacturing company
company must
must also
also develop,
develop,
design,
design, market,
market, and
and distribute
distribute its
its products.
products.
Merchandising
Merchandising
Merchandising companies
companies
purchase
purchase and
and then
then sell
sell tangible
tangible products
products
without
without changing
changing their
their basic
basic form.
form.
Examples?
Examples?
Service
Service
Service companies
companies
provide
provide services
services or
or intangible
intangible
products
products to
to their
their customers.
customers.
Examples?
Examples?
Labor
Labor isis the
the most
most significant
significant cost
cost category.
category.
Describe the three
categories
of inventories commonly
found in manufacturing
companies
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
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.
Differentiate between
inventoriable costs
and period costs
Inventoriable Costs
Inventoriable costs (assets)
become cost of goods sold
after a sale takes place.
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.
Flow of Costs Example

See Exhibit 2-6, p. 41, Panel B example
Bicycles by the Sea had $50,000 of direct
materials inventory at the beginning of the period.
Purchases during the period amounted to
$180,000 and ending inventory was $30,000.
How much direct materials were used?
$50,000 + $180,000 $30,000 = $200,000

Direct labor costs incurred were $105,500.
Indirect manufacturing costs were $194,500.
What are the total manufacturing costs incurred?
Direct materials used
$200,000
Direct labor
105,500
Indirect manufacturing costs
194,500
Total manufacturing costs
$500,000

Assume that the work in process inventory
at the beginning of the period was $30,000,
and $35,000 at the end of the period.
What is the cost of goods manufactured?
Beginning work in process
$ 30,000
Total manufacturing costs
500,000
Ending work in process
35,000
Cost of goods manufactured $495,000

Assume that the finished goods inventory
at the beginning of the period was $10,000,
and $15,000 at the end of the period.
What is the cost of goods sold?
Beginning finished goods
$ 10,000
Cost of goods manufactured
495,000
Ending finished goods
15,000
Cost of goods sold
$490,000

Work in Process
Beg. Balance
30,000 495,000
Direct mtls. used
200,000
Direct labor
105,500
Indirect mfg. costs
194,500
Ending Balance
35,000

Work in Process
495,000
Finished Goods
10,000 490,000
495,000
15,000
Cost of Goods Sold
490,000
Manufacturing Company
BALANCE SHEET
Inventoriable
Costs
Materials
Inventory
Work in
Process
Inventory
INCOME STATEMENT
Revenues
Finished
Goods
Inventory
when
sales
occur
deduct
Cost of
Goods Sold
Equals Gross Margin

deduct
Period
Costs
Equals Operating Income
Merchandising Company
BALANCE SHEET
Inventoriable
Costs
Merchandise
Purchases
INCOME STATEMENT
Revenues
Inventory
when
sales
occur
deduct
Cost of
Goods Sold
Equals Gross Margin

deduct
Period
Costs
Equals Operating Income
Explain why product costs are
computed in different ways
for different purposes.
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
Present key features of
cost accounting and
cost management.
A Framework for Cost

Management
Three features of cost accounting
and cost management:
1. Calculating the costs of products
2. Obtaining information for planning,
control, and performance evaluation
3. Analyzing information
End of Meeting 3

An Introduction To Cost Terms and Purposes

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An Introduction to Cost

Terms and Purposes

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 2

Cost and Cost Terminology

Cost and Cost Terminology

(tracing and allocating costs)

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 4

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 5

Direct and Indirect Costs

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 6

Direct and Indirect Costs

Direct and Indirect Costs

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 8

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 9

Cost Behavior Patterns

Cost Behavior Patterns

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 12

Cost Behavior Patterns

Cost Behavior Patterns

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 15

Relevant Range Example

Relevant Range Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Total Costs and Unit Costs

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 19

Use Unit Costs Cautiously

Use Unit Costs Cautiously

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 21

Use Unit Costs Cautiously

Use Unit Costs Cautiously

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 23

What do unit costs tell you?

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 24

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 27

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 29

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 31

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 32

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 34

Flow of Costs Example

Flow of Costs Example

Flow of Costs Example

Flow of Costs Example

Flow of Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 39

Flow of Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 40

Equals Gross Margin

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 41

Equals Gross Margin

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 43

Many Meanings of Product Cost

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 45

A Framework for Cost

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 47

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