Cost Terminology and Concepts
Basic Cost Terminology
• Cost – resource sacrificed to achieve a specific objective
• Actual cost – a cost that has occurred
• Budgeted cost – a predicted cost
• Cost object – anything of interest for which a cost is desired
Manufacturing Costs
DirectMaterial
Manufacturing Overhead
Further Classification of Labor Costs
Idle TimeTreated as
manufacturing overhead cost
Overtime Premium of
Factory Workers
Treated as manufacturing overhead cost
Labor Fringe Benefits
Treated as manufacturing
overhead or direct labor
Classifications of Costs in Manufacturing Companies
PrimeCost
ConversionCost
Manufacturing costs are oftencombined as follows:
DirectMaterial
DirectLabor
ManufacturingOverhead
Nonmanufacturing Costs
Marketing and Selling Cost
Costs necessary to get the order and deliver the
product.
Administrative Cost
All executive, organizational, and
clerical costs.
R&D
Manufacturing Cost Flows
ManufacturingOverhead
Material Purchases
Direct Labor
Balance Sheet Costs Inventories
FinishedGoods
Cost of GoodsSold
Income StatementExpenses
Selling andAdministrative
Selling andAdministrative
Period Expenses
Work in Process
Raw Material
Product Costs Versus Period Costs
Product costs include direct materials, direct
labor, and manufacturing
overhead.
Period costs are not included in product
costs. They are expensed on the
income statement.Inventory Cost of Good Sold
BalanceSheet
IncomeStatement
Sale
Expense
IncomeStatement
Balance Sheet Merchandiser Current assets
– Cash
– Receivables
– Prepaid expenses
– Merchandise inventory
Manufacturer Current Assets
Cash Receivables Prepaid Expenses Inventories
Raw Materials
Work in Process
Finished Goods
The Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.
Merchandising Company
Cost of goods sold: Beg. merchandise inventory 14,200$ + Purchases 234,150 Goods available for sale 248,350$ - Ending merchandise inventory (12,100) = Cost of goods sold 236,250$
Comet Computer Corporation
Schedule of Cost of Goods Manufactured
Raw material used 134,980$
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs 414,980$
Add: Work-in-process inventory, January 1 120
Subtotal 415,100$
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured 415,000$
Schedule of Cost of Goods Manufactured
Comet Computer Corporation
Schedule of Cost of Goods Manufactured
Raw material used 134,980$
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs 414,980$
Add: Work-in-process inventory, January 1 120
Subtotal 415,100$
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured 415,000$
Schedule of Cost of Goods Manufactured
Computation of Cost of Raw Material Used
Raw-material inventory, January 1 6,000$
Add: Purchases of raw materials 134,000
Raw material available for use 140,000
Deduct: Raw material inventory, December 31 5,020
Raw material used 134,980$
Comet Computer Corporation
Schedule of Cost of Goods Manufactured
Raw material used 134,980$
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs 414,980$
Add: Work-in-process inventory, January 1 120
Subtotal 415,100$
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured 415,000$
Schedule of Cost of Goods Manufactured
Computation of Total Manufacturing Overhead
Indirect material 10,000$
Indirect labor 40,000
Depreciation on factory 90,000
Depreciation on equipment 70,000
Utilities 15,000
Insurance 5,000
Total manufacturing overhead 230,000$
Income Statement for a Manufacturer
Comet Computer Corporation
Income Statement
For the Year Ended December 31, 20X2
Sales revenue 700,000$
Less: Cost of goods sold 415,010
Gross margin 284,990$
Selling and administrative expenses 174,490
Income before taxes 110,500$
Income tax expense 30,000
Net income 80,500$
Comet Computer Corporation
Income Statement
For the Year Ended December 31, 20X2
Sales revenue 700,000$
Less: Cost of goods sold 415,010
Gross margin 284,990$
Selling and administrative expenses 174,490
Income before taxes 110,500$
Income tax expense 30,000
Net income 80,500$
Income Statement for a Manufacturer
Comet Computer Corporation
Schedule of Cost of Goods Sold
For the Year Ended December 31, 20X2
Finished-goods inventory, Jan. 1 200$
Add: Cost of goods manufactured 415,000
Cost of goods available for sale 415,200
Deduct Finished-goods inventory, Dec. 31 190
Cost of goods sold 415,010$
Cost Behavior
• Variable costs – changes in total in proportion to changes in the related level of activity or volume
• Fixed costs – remain unchanged in total regardless of changes in the related level of activity or volume
Cost Classifications
Activities thatcause costs to be
incurred are calledcost drivers.
Variable CostsVariable Costs
Total Variable Cost GraphTotal Variable Cost GraphT
otal
Cos
ts
$300,000$250,000$200,000$150,000$100,000 $50,000
10 20 300
Unit Variable Cost GraphUnit Variable Cost Graph
$20$15$10$5
0Cos
t pe
r U
nit
10 20 30
5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10
Units Total CostProduced Cost per Unit
Units Produced (000)
Units Produced (000)
Fixed CostsFixed Costs
Total Fixed Cost GraphTotal Fixed Cost GraphT
otal
Cos
ts
0
Unit Fixed Cost GraphUnit Fixed Cost Graph
Cos
t pe
r U
nit
50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250
Units Total CostProduced Cost per Unit
$150,000$125,000$100,000$75,000$50,000
$25,000
100 200 300
$1.50$1.25$1.00$.75$.50
$.25
100 200 3000
Units Produced (000) Units Produced (000)
ExamplesAdvertising and Research and Development
ExamplesAdvertising and Research and Development
ExamplesDepreciation on Equipment and
Real Estate Taxes
ExamplesDepreciation on Equipment and
Real Estate Taxes
Types of Fixed Costs
DiscretionaryMay be altered in the short-term by current managerial decisions
DiscretionaryMay be altered in the short-term by current managerial decisions
CommittedLong-term, cannot be significantly reduced
in the short term.
CommittedLong-term, cannot be significantly reduced
in the short term.
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Total variable cost changes Variable cost per unitVariable as activity level changes. remains the same over
wide ranges of activity.
Total fixed cost remains Fixed cost per unitFixed the same even when the goes down as activity
activity level changes. level goes up.
Assigning Costs to Cost Objects
Direct costs• Costs that can be
easily and conveniently traced to a unit of product or other cost object.
• Examples: direct material and direct labor
Indirect costs• Costs that cannot be
easily and conveniently traced to a unit of product or other cost object.
• Example: manufacturing overhead
Determining Product Costs
Product
Directmaterials
Direct labor
Traced directly to product
Traced directly
to product
Manufacturingoverhead (OH)
Applied to product
using apredetermined
rate
BMW: Assigning Costs to a Cost Object
Direct or Indirect?
Consider a supervisor’s salary in the canning department of Campbell Soup Company.
If the cost object is the department, the supervisor’s salary is a direct cost.
If the cost object is a can of soup (the “product” of the company), the supervisor’s salary is an indirect cost.
Differential Cost and RevenueCosts and revenues that differ
among alternatives.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
Example: You have a job paying $1,500 per month in your hometown. You have a job offer in a neighboring city that pays $2,000 per month. The commuting cost to the city is $300 per month.
Differential revenue is: $2,000 – $1,500 = $500
Differential cost is: $300
A cost that can be significantly influencedby a manager is a controllable cost.
Controllable and Uncontrollable Costs
Cost item Manager Classificaton
Cost of food used Restaurant Controllablein a restaurant manager
Cost of national Restaurant Uncontrollableadvertising by a managerrestaurant chain
Opportunity Cost
The potential benefit that is given up when one alternative is selected over another.– Example: If you were
not attending college,you could be earning$20,000 per year. Your opportunity costof attending college for one year is $20,000.
Sunk Costs All costs incurred in the past that cannot be changed by
any decision made now or in the future.
Sunk costs should not be considered in decisions.
– Example: You bought an automobile that cost $12,000 two years ago. The $12,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $12,000 cost.
Marginal Costs and Average Costs
The extra costincurred to produceone additional unit.
The total cost toproduce a quantity
divided by thequantity produced.
Marginal and average costs arelargely a function of cost behavior
-- variable and fixed costs.
Additional Cost Terminology
• Variable Costs – costs that change in total in relation to some chosen activity or output
• Fixed Costs – costs that do not change in total in relation to some chosen activity or output
• Mixed Costs – costs that have both fixed and variable components; also called semivariable costs
Fixed Charge
Variable
Cost per Mile
Activity (Miles Driven)
Tot
al C
ost
X
Y
A mixed cost has both fixed and variablecomponents. Consider the example of renting a car.
A mixed cost has both fixed and variablecomponents. Consider the example of renting a car.
Mixed Costs
Total mixed cost
Fixed Charge
Variable
Cost per Mile
Activity (Miles Driven)
Tot
al C
ost
X
Y
Mixed Costs
Total mixed cost
Mixed Costs ExampleIf your fixed daily rental charge is $40, your variable cost is $0.20 If your fixed daily rental charge is $40, your variable cost is $0.20
per mile, and your activity level is 100 miles, what is the amount of per mile, and your activity level is 100 miles, what is the amount of your rental cost?your rental cost?
If your fixed daily rental charge is $40, your variable cost is $0.20 If your fixed daily rental charge is $40, your variable cost is $0.20 per mile, and your activity level is 100 miles, what is the amount of per mile, and your activity level is 100 miles, what is the amount of
your rental cost?your rental cost?
Y = a + bX
Y = $40 + ($0.20 × 100)
Y = $60$60