CHAPTER 2 Cost Terms and Purpose

7/22/2019 CHAPTER 2 Cost Terms and Purpose

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Chapter 2 Introduction to Cost Terms andPurposes

A. Cost and Cost TerminologyB. Types of costs in an organization

C. Business Sectors, Types of Inventoriable costs

D. Financial statements of a manufacturingorganization

E. Overtime premium and idle time


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Costs and Cost Terminology

ACOSTis a resource given up so that a business

can achieve its objectives. ACOST OBJECT is anything for which a

measurement of cost is required. Examples of cost objects: Product: BMW X 5 sports activity vehicle Service: Dealer-support telephone hotline Project: R&D project on DVD system enhancement Customer: Herb Chambers Motors, a dealer that

purchases a broad range of BMW vehicles Activity: Setting up production machines Department: Environmental, Health and Safety


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An ACTUAL COSTis a cost that has been

incurred.For Example: wages paid to assembly lineworkers, office supplies purchased on

credit. A BUDGETED COSTis a predicted or

estimated cost such as 2012 estimated

wages. COST ACCUMULATION - a collection of cost

data in an organized manner


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COST ASSIGNMENT- charging both direct costs

and indirect costs to cost objects COST TRACINGcharging direct costs to cost

objects

COST ALLOCATIONcharging indirect costs to

cost objects

COST DRIVERa factor that is responsible for a

particular cost


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Manufacturing Company Costs

Manufacturing costs : Nonmanufacturing costs

Direct costs : Selling costs >Direct materials costs: > Sales Commision

>Direct labor costs : > Shipping costs

Indirect costs : Administrative costs >Factory overhead : > CFO Salary


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Some Differences Between FinancialAnd Managerial Accounting

Financial accounting: Managerial accounting

Governed by GAAP: Not governed by GAAP

Mandatory: Not mandatory Historical in nature: Focuses more on the future

For external reporting: For internal reporting


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Direct Costs

Direct costs can be conveniently and

economically traced (tracked) to a costobject. Direct materials cost are those materials

that become an integral part of the

manufactured product and their costs can betraced to that product in an economicallyfeasible manner. Examples:

Wood used in the production of desks Drawer handles for the desks Drawer locks


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Direct Costs

Direct manufacturing labor cost are those

labor costs that can be traced to the creationof products in an economically feasible way.

Examples of direct labor costs:

Assembly line workers wages


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Indirect Costs

Factory overhead are costs that relate to a product

but cannot be traced to it in an economically feasiblemanner, such as: Indirect materials:

- Cleaning supplies- Lubricants

Indirect Labor:- Plant supervisor salary- Materials handlers wages

Other indirect costs:- Factory utilities- Factory insurance- Depreciation of factory facilities &

machinery


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Direct and Indirect Costs

The distinction between direct cost and

indirect costs is important because directcosts are charged directly to cost objectswhereas indirect costs are pooled and thenallocated to the cost object


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Cost behavior - Variable Costs

Cost behavior is the manner in which a cost

changes as the related activity changes A variable cost is a cost that changes in total in

proportion to the changes in the level of therelated activity

Variable costs are constant on a per-unit basis.If a product takes 5 pounds of materials each, itstays the same per unit regardless if one, ten, or

a thousand units are produced.


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Cost behavior

Number of Direct Materials Total Direct

Desks produced Cost per desk Materials costs 200 Desks $15 $3,000

300 Desks $15 $4,500

400 Desks $15 $6,000

Total variable cost changes as the level ofactivity changes but unit variable cost does notchange.

Percentage change in the desks produced: (300-200 =100) 100/200 = 50%

Percentage change in the materials costs: (4,500-3,000 =1,500) 1,500/3,000 = 50%


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Cost behavior

Fixed costs remain unchanged in total regardless

of changes in the related level of activity orvolume.

Number of Total Factory rentDesks produced Factory rent per desk

200 Desks $15 ,000 $75

300 Desks $15,000 $50

400 Desks $15,000 $37.50

Unit fixed costs decreases as more desks areproduced.


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Cost Behavior Summarized

Total Dollars Cost per UnitTotal Dollars Cost Per Unit

Variable Costs

Change in

proportion withoutput

More output = More cost

Unchanged in

relation to output

Fixed Costs Unchanged inrelation to output

Change

inversely withoutput

More output = lower cost

per unit


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Other Cost Concepts

Prime cost is a combination of direct materials

and direct labor costs Conversion cost consists of direct labor and

factory overhead

Cost driver - a variable that causally affectscosts over a given time span

Relevant range - the band of normal activitylevel (or volume) in which there is a specific

relationship between the level of activity (orvolume) and a given cost

For example, fixed costs are considered fixed

only within the relevant range.


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Relevant Range Visualized


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Other Cost Concepts

Costs may be classified as:

>Direct/Indirect, and >Variable/Fixed

These multiple classifications give rise to

important cost combinations: >Direct and variable >Direct and fixed

>Indirect and variable >Indirect and fixed


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Total Costs and Unit Costs

Total costs consists of all costs.

Example: Total costs of producing 300 desks:

Variable costs 300 desks x $15 = $4,500

Fixed costs 15,000 Total costs $19,500

Unit cost is an average cost that is computed bydividing total costs by the number of units.

Example:

Total costs $19,500/300 desks = $65 per desk


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A Cost Caveat

Unit costs should be used cautiously. Because

unit costs change with a different level ofoutput or volume, it may be more prudent tobase decisions on a total dollar basis.

Unit costs that include fixed costs shouldalways reference a given level of output oractivity.

Unit costs are also called average costs.

Managers should think in terms of total costsrather than unit costs.


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Different Types of Companies

Manufacturing companies purchase materialsand other components and converts them intofinished products through the efforts ofworkers and other productive resources

Merchandising companies purchase productsin large quantities and sells them tocustomers in smaller amounts withoutchanging their basic forms

Service companies provide a service, anintangible product. For example accounting,legal and consulting services


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Types of Manufacturing Inventories

Direct materials - resources in-stock andavailable for use in production

Work-in-process (or progress) - productsstarted but not yet completed, often

abbreviated as WIP Finished goods - products completed and

ready for sale


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Types of product costs Also called inventoriable costs:

Inventoriable costs are first treated as anasset when incurred and expensed as costs ofgoods sold when the products are sold.

Direct materialsacquisition costs of all

materials that will become part of the costobject. Direct laborcompensation of all manufacturing

labor that can be traced to the cost object.

Indirect manufacturingfactory costs that arenot traceable to the product in an economicallyfeasible way. Examples include lubricants,indirect manufacturing labor and utilities.


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Cost of Goods Manufactured(P2-32)

STEP 1

PANEL B: COST OF GOODS MANUFACTURED

Direct materials:

Beginning inventory, January 1, 2011 $22,000

Purchases of direct materials $75,000

Cost of direct materials available for use $97,000

Ending inventory, December 31, 2011 $26,000

Direct materials used $71,000

Schedule of Cost of Goods Manufactured*

For the Year Ended December 31, 2011 (in Thousands)

Conseco Company


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Cost of Goods Manufactured(P2-32)

STEP 1

STEP 2


Direct materials:





Direct materials used $71,000Direct manufacturing labor $25,000

Manufacturing overhead costs:

Indirect manufacturing labor $15,000

Plant insurance $9,000

Depreciation-plant, building and equipment $11,000

Repairs and maintenance - plant $4,000

Total manufacturing overhead costs $39,000



Conseco Company


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Cost of Goods Manufactured Problem 2-32

STEP 1

STEP 3

STEP 2


Direct materials:





Direct materials used $71,000Direct manufacturing labor $25,000

Manufacturing overhead costs:

Indirect manufacturing labor $15,000

Plant insurance $9,000

Depreciation-plant, building and equipment $11,000

Repairs and maintenance - plant $4,000

Total manufacturing overhead costs $39,000

Manufacturing cost incurr3ed during 2011 $135,000

Beginning work-in-progress inventory, January 1, 2011 $21,000Total manufacturing costs to account for $156,000

Ending work-in-progress inventory, December 31, 2011 $20,000

Cost of goods manufactured (to income Statement) $136,000



* Note that this s chedule can becom e a Schedule of Co st o f Goo ds M anufactured and Sold simply by including the beginning and

ending finished goo ds invento ry figures in the supporting schedule rather than in the body of the inco me statement.

Conseco Company


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Multiple-Step Income Statement (P2-32)

STEP 4

Revenues $300,000

Costs of goods sold:

Beginning finished goods inventory, January 1, 2011 $18,000

Costs of goods available for sale $136,000Costs of goods manufactured (see Panel B) $154,000

Ending finished goods inventory, December 31, 2011 $23,000

Cost of goods sold $131,000

Gross margin (or gross profit) $169,000

Operating costs

Mktg., dist., & cust.-service cost $93,000

Total operating costs $93,000

Operating income $76,000

Conseco Company

Income Statement

For the Year Ended December 31, 2011 (in thousands)


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Other Cost Considerations Prime cost is a term referring to all direct

manufacturing costs (materials and labor). Conversion cost is a term referring to direct

labor and indirect manufacturing costs.

Overtime labor costs are considered part of

indirect overhead costs. Idle time costs are considered part of indirect

overhead costs.

L b l f


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Labor Costs Classification Mark Hansen works on the companys assembly line.

Marks basic wage rate is $20 an hour. He is paid time

and a half (i.e. $30 per hour) for any work in excess of40 hours per week.

This week Mark works 48 hours but is idle for 3 hoursdue to machine breakdowns. How much of his wages

would be allocated to direct labor costs? To overhead? Productive time (48 hrs 3hrs) 45 hrs x $20 = $900

Idle time 3 hrs x $20 = 60

Overtime premium 8 hrs x $10 = 80 Total pay $1,040

Direct labor costs $900; Overhead $60+80 = $140


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Different Definitions of Costsfor Different Applications

Pricing and product-mix decisionsdecisionsabout pricing and maximizing profits

Contracting with government agenciesveryspecific definitions of allowable costs for costplus profit contracts

Preparing external-use financial statementsGAAP-driven product costs only


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Three Common Features ofCost Accounting and Cost Management

Calculating the cost of products, services, andother cost objects

Obtaining information for planning and control,

and performance evaluation Analyzing the relevant information for making

decisions


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Different Definitions of Costsfor Different Applications

Documents

CHAPTER 2 Cost Terms and Purpose