Chapter - 2 Cost Terms

An Introduction to An Introduction to Cost Terms and PurposesCost Terms and Purposes

Cost Terms Cost Terms DefinitionDefinition

Classification of Cost Classification of Cost Cost StatementCost Statement

Reference Reference

HORNGREN DATAR FOSTER

Eleventh Edition

HORNGREN DATAR FOSTER

Eleventh Edition

Chapter – 2:Chapter – 2:An Introduction to Cost An Introduction to Cost

Terms and PurposesTerms and Purposes

COST ACCOUNTINGCOST ACCOUNTINGA Managerial Emphasis

An Introduction to Cost An Introduction to Cost Terms and PurposesTerms and Purposes

Reference: Cost Accounting – A Managerial EmphasisChapter – 1; Page no. – 3

Cost Cost AccountinAccountin

g g measures and reports financial and non financial information relating to the cost of acquiring and utilizing resources in an organization.

Accumulation Accumulation of Costof Cost

Allocation Allocation of Costof Cost

CostCostManagementManagement



Cost and Cost Terminologies Cost and Cost Terminologies

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.


Reference: Cost Accounting – A Managerial EmphasisChapter – 2

Manufacturing cost and

Non manufacturing cost

Direct cost and

Indirect cost

Product costand

Period cost

Variable costand

Fixed cost

Classification of Cost Classification of Cost

Direct Material, Direct Labor, Manufacturing OverheadOffice and Administrative Overhead, Selling and Marketing Overhead



Product CostProduct CostProduct costs include all the costs that are involved buying or making a product. In the case of manufactured goods, these costs consist of direct materials, direct labor and manufacturing overheads. Product costs are viewed as those which are “attached” as the goods are bought or manufactured.

This is the cost at which products are shown in the balance sheet---known as “inventoriable costs”.



Period CostPeriod Cost

These are all the costs that are not included in the product costs. Such costs are expensed in the P&L account, during the period in which they occur. Period costs are not included as part of the product.

E.g.: telephone bill, sales commissions, depreciation office rent are good examples .



Direct CostsExample: Paper on whichSports Illustrated magazineis printed (Product cost)

Indirect CostsExample: Lease cost forTime-Warner buildinghousing the senior editorsof its magazine (Period cost)

COST OBJECT

Example: Sports

Illustrated magazine

Direct CostDirect Cost

Indirect CostIndirect Cost



Cost Behavior PatternCost Behavior Pattern

Bicycles Ltd. buys a handlebar at $52 for each of its bicycles.

What is the total handlebar cost when1,000 bicycles are assembled?




1,000 units × $52 = $52,000

What is the total handlebar costwhen 3,500 bicycles are assembled?3,500 units × $52 = $182,000




Bicycles Ltd. incurred $94,500 ina given year for the leasing of its plant.

This is an example of fixed costs withrespect to the number of bicycles assembled.



Cost DriverCost Driver

The cost driver of variable costs is the levelof activity or volume whose change causes

the (variable) costs to change proportionately.

The number of bicyclesnumber of bicycles assembled is acost drivercost driver of the cost of handlebars.



Relevant RangeRelevant Range

Assume that fixed (leasing) costs are $94,500for a year and that they remain the same for asame for acertain volume range (1,000 to 5,000 bicycles).certain volume range (1,000 to 5,000 bicycles).

1,000 to 5,000 bicycles is the relevant range.1,000 to 5,000 bicycles is the relevant range.



Relevant RangeRelevant Range

020000400006000080000

100000120000

0 1000 2000 3000 4000 5000 6000

Volume

Fix

ed C

osts

$94,500



Total Cost and Unit CostTotal Cost and Unit Cost

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



Y = a + bXY = the total mixed costa = the total fixed costb = the variable cost per unit of activityX = the level of activity

Cost BehaviorCost Behavior



Use of Unit Cost ConceptUse of Unit Cost Concept

Assume that Bicycles management uses aunit cost of $146.50 (leasing and wheels).

Management is budgeting costs fordifferent levels of production.

What is their budgeted cost for anestimated production of 600 bicycles?

600 × $146.50 = $87,900




What is their budgeted cost for an estimatedproduction of 3,500 bicycles?

3,500 × $146.50 = $512,750

What should the budgeted cost be for anestimated production of 600 bicycles?




Total fixed cost $ 94,500Total variable cost ($52 × 600) 31,200Total $ 125,700

$125,700 ÷ 600 = $209.50

Using a cost of $146.50 per unit wouldunderestimate actual total costs if output

is below 1,000 units.




What should the budgeted cost be for anestimated production of 3,500 bicycles?

Total fixed cost $ 94,500Total variable cost (52 × 3,500) 182,000Total $ 276,500

$276,500 ÷ 3,500 = $79.00



For Manufacturer:Raw MaterialWork in ProcessFinished Goods

Types of Types of InventoryInventory

For Merchandiser:Finished Goods

Direct MaterialDirect Labor

Manufacturing Overhead

Types of Types of CostCost

Office and Administrative

OverheadSelling and

Marketing Overhead



Direct Direct Material CostMaterial Cost

Prime Cost

Direct Direct Labor CostLabor Cost

ManufacturingManufacturingOverhead CostOverhead Cost

Total Total Manufacturing Manufacturing

CostCostConversion Cost

WIPWIPInventoryInventory

Finished GoodsFinished GoodsInventoryInventory

Cost of GoodsCost of GoodsSoldSold

Cost of GoodsCost of GoodsManufacturedManufactured



Example (2 – 35)A distraught employee, Fang W. Arson, put a torch to a manufacturing plant on a blustery February 26. The resulting blaze destroyed the plant and its contents. Fortunately, certain accounting records were kept in another building. They reveal the following for the period from January 1, 2004 to February 26, 2004:

Direct materials purchased $160,000

Work in process 1.1.04 34,000

Direct materials 1.1.04 16,000

Finished goods 1.1.04 30,000

Indirect manufacturing costs

40% of conversion costs

Revenues $500,000

Direct manufacturing labor 180,000

Prime costs 294,000

Gross margin percentage based on revenues

20%

Cost of goods available for sale

450,000

Calculate the cost of (as on 2/26/2004):Finished goods inventory;Work in process inventory & Direct material inventory.

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Chapter - 2 Cost Terms