Basic Costs Concepts

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Introduction to Managerial Accounting and Cost Concepts Module 1
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Basic Cost Concepts

Transcript of Basic Costs Concepts

Page 1: Basic  Costs  Concepts

Introduction to Managerial Accounting

and Cost Concepts

Module

1

Page 2: Basic  Costs  Concepts

2

Management Accounting

It is the process of identifying, measuring,accumulating, analyzing, preparing,interpreting, and communicatinginformation that managers use tofulfill organizational objectives.

What is Management Accounting?

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Differences Between Financial and Managerial Accounting

Financial ManagerialAccounting Accounting

1. Users External persons who Managers who plan formake financial decisions and control an organization

2. Time focus Historical perspective Future emphasis

3. Verifiability Emphasis on Emphasis on relevance versus relevance verifiability for planning and control

4. Precision versus Emphasis on Emphasis on timeliness precision timeliness

5. Subject Primary focus is on Focuses on segments the whole organization of an organization

6. Requirements Must follow GAAP Need not follow GAAPand prescribed formats or any prescribed format

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Planning and Controlling

It is the purposeful choice from amonga set of alternative courses of actiondesigned to achieve some objective.

What is decision making?

This is the core of the management process.

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Work of Management

Planning

Controlling

Directing and Motivating

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Planning and Control CycleFormulating Long-and

Short-Term Plans (Planning)

MeasuringPerformance (Controlling)

Comparing Actualto

Planned Performance (Controlling)

Implementing the Plans

(Directing and Motivating)

Begin

DecisionMaking

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Planning and Controlling

The Management Process Internal Accounting System

Planning•Increase Productivity

Controlling•Actions•Evaluations

Cor

rect

ion

s an

d

Rev

isio

ns

of P

lan

s an

d A

ctio

ns

Budgets,Special Reports

FinancialAccountingSystem

PerformanceReports

Customersurveys

Competitoranalysis

Advertisingimpact

New itemsreport

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Role of Budgets

A budget is a quantitative expression of a plan of action and is an aid to coordinating and implementing the plan.

Budgets are the chief devices for compelling and disciplining management planning.

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Role ofPerformance Reports

Performance reports formalize controls andprovide feedback by comparing results withplans and by highlighting variances.

Variances are deviations from the plan.

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Performance Report

Budgeted Actual Variance Amount Amount Amount

Revenues 25,000 19,000 6,000 UExpenses 20,000 15,000 5,000 FNet Income 5,000 4,000 1,000 U F = Favorable U = Unfavorable

Page 11: Basic  Costs  Concepts

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Cost and Cost Terminology

Cost is a resource sacrificed or forgone to achievea 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 separatemeasurement of costs is desired.

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Cost and Cost Terminology

CostAccumulation

Cost Object

Cost Object

Cost Object

CostAssignment

Tracing

Allocating

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Direct Costs and Indirect Costs

Direct costsCosts that can be

easily and conveniently traced to a unit of product or other cost objective.

Examples: direct material and direct labor

Indirect costsCosts cannot be easily

and conveniently traced to a unit of product or other cost object.

Example: manufacturing overhead

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Direct and Indirect Costs

Direct CostsExample: Paper on whichSports Illustrated magazineis printed

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

COST OBJECT

Example: Sports Illustrated magazine

COST OBJECT

Example: Sports Illustrated magazine

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Direct and Indirect CostsExample

Direct Costs:Maintenance Department $40,000Personnel Department $20,600Assembly Department $75,000Finishing Department $55,000

Assume that Maintenance Department costs areallocated equally among the production departments.

How much is allocated to each department?

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Direct and Indirect Costs Example

Allocated$20,000

Maintenance$40,000

AssemblyDirect Costs

$75,000

FinishingDirect Costs

$55,000

$20,000

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MegaLoMart

Comparing Merchandising and Manufacturing Activities

Merchandisers . . .Buy finished goods.Sell finished goods.

Manufacturers . . .Buy raw materials.Produce and sell

finished goods.

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The ProductThe Product

DirectMaterials

DirectMaterials

DirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

Manufacturing Costs

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Direct Materials

Those materials that become an integral part of the product and that can be conveniently

traced directly to it.

Example: A radio installed in an automobileExample: A radio installed in an automobile

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Direct Labor

Those labor costs that can be easily traced to individual units of product.

Example: Wages paid to automobile assembly workersExample: Wages paid to automobile assembly workers

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Manufacturing costs that cannot be traced directly to specific units produced.

Manufacturing Overhead

Examples: Indirect labor and indirect materialsExamples: Indirect labor and indirect materials

Wages paid to employees who are not directly

involved in production work.

Examples: maintenance workers, janitors and

security guards.

Materials used to support the production process.

Examples: lubricants and cleaning supplies used in the automobile assembly plant.

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Classifications of Costs

DirectMaterialDirect

MaterialDirectLaborDirectLabor

ManufacturingOverhead

ManufacturingOverhead

PrimeCost

ConversionCost

Manufacturing costs are oftenclassified as follows:

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Nonmanufacturing Costs

Marketing and selling costs . . .Costs necessary to get the order and deliver the

product.

Administrative costs . . .All executive, organizational, and clerical costs.

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Quick Check

Which of the following costs would be considered manufacturing overhead at Boeing? (More than one answer may be correct.)

A. Depreciation on factory forklift trucks.

B. Sales commissions.

C. The cost of a flight recorder in a Boeing 767.

D. The wages of a production shift supervisor.

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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

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Inventoriable Costs

Inventoriable costs (assets)…

become cost of goods sold…

after a sale takes place.

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Period Costs

Period costs are all costs in the incomestatement other than cost of goods sold.

Period costs are recorded as expenses of theaccounting period in which they are incurred.

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Quick Check

Which of the following costs would be considered a period rather than a product cost in a manufacturing company?

A. Manufacturing equipment depreciation.

B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the production facility.

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Merchandiser Current assets

CashReceivablesPrepaid expensesMerchandise inventory

Manufacturer Current Assets

Cash Receivables Prepaid Expenses Inventories

Raw Materials

Work in Process

Finished Goods

Balance Sheet

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Merchandiser Current assets

CashReceivablesPrepaid expensesMerchandise inventory

Manufacturer Current Assets

Cash Receivables Prepaid Expenses Inventories

Raw Materials

Work in Process

Finished Goods

Balance Sheet

Partially complete products – some material, labor, or

overhead has been added.

Completed products awaiting sale.

Materials waiting to be processed.

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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$

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Selling andAdministrative

Period Costs

Manufacturing Cost Flows

FinishedGoods

Cost of GoodsSold

Selling andAdministrative

ManufacturingOverhead

Work in Process

Direct Labor

Balance Sheet Costs Inventories

Income StatementExpenses

Material Purchases Raw Materials

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Manufacturing Company

MaterialsInventory

FinishedGoods

Inventory

Revenues

Cost ofGoods Sold

INCOME STATEMENT

PeriodCosts

InventoriableCosts

BALANCE SHEET

Equals Operating Income

whensalesoccur

deduct

Equals Gross Margindeduct

Work inProcess

Inventory

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Merchandising Company

INCOME STATEMENTBALANCE SHEET

whensalesoccur

InventoriableCosts

MerchandisePurchases Inventory

Revenuesdeduct

Cost ofGoods Sold

Equals Gross Margindeduct

PeriodCosts

Equals Operating Income

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Many Meanings of Product Cost

A product cost is the sum of the costsassigned 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

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Quick Check

Which of the following transactions would immediately result in an expense? (There may be more than one correct answer.)

A. Work in process is completed.

B. Finished goods are sold.

C. Raw materials are placed into production.

D. Administrative salaries are accrued and paid.

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Inventory Flows

Beginningbalance

$$

Beginningbalance

$$

Additions$$$

Additions$$$+ Available

$$$$$

Available$$$$$=

Endingbalance

$$

Endingbalance

$$=Withdrawals

$$$

Withdrawals$$$

_Available$$$$$

Available$$$$$

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Quick Check

If your bank balance at the beginning of the month was $1,000, you deposited $100 during the month, and withdrew $300 during the month, what would be the balance at the end of the month?

A. $1,000.

B. $ 800.

C. $1,200.

D. $ 200.

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Manufacturing WorkRaw Materials Costs In Process

Beginning raw materials inventory

Product Costs - A Closer Look

Beginning inventory is the inventory

carried over from the prior period.

Beginning inventory is the inventory

carried over from the prior period.

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Manufacturing WorkRaw Materials Costs In Process

Beginning raw Direct materials materials inventory

+ Raw materials purchased

= Raw materials

available for use in production

– Ending raw materials inventory

= Raw materials used

in production

As items are removed from raw materials inventory and placed into

the production process, they arecalled direct materials.

As items are removed from raw materials inventory and placed into

the production process, they arecalled direct materials.

Product Costs - A Closer Look

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Quick Check

Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material was purchased. A count at the end of the month revealed that $28,000 of raw material was still present. What is the cost of direct material used?

A. $276,000

B. $272,000

C. $280,000D. $ 2,000

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Manufacturing WorkRaw Materials Costs In Process

Beginning raw Direct materials materials inventory + Direct labor

+ Raw materials + Mfg. overhead purchased = Total manufacturing

= Raw materials costs

available for use in production

– Ending raw materials inventory

= Raw materials used

in production

Product Costs - A Closer Look

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Manufacturing WorkRaw Materials Costs In Process

Beginning raw Direct materials materials inventory + Direct labor

+ Raw materials + Mfg. overhead purchased = Total manufacturing

= Raw materials costs

available for use in production

– Ending raw materials inventory

= Raw materials used

in production

Conversion costs are costs

incurred to convert the

direct material into a finished

product.

Conversion costs are costs

incurred to convert the

direct material into a finished

product.

Product Costs - A Closer Look

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Quick Check

Direct materials used in production totaled $280,000. Direct labor was $375,000 and factory overhead was $180,000. What were total manufacturing costs incurred for the month?

A. $555,000

B. $835,000

C. $655,000

D. Cannot be determined.

Page 45: Basic  Costs  Concepts

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Manufacturing WorkRaw Materials Costs In Process

Beginning raw Direct materials Beginning work in materials inventory + Direct labor process inventory

+ Raw materials + Mfg. overhead + Total manufacturing purchased = Total manufacturing costs

= Raw materials costs = Total work in

available for use process for the in production period

– Ending raw materials inventory

= Raw materials used

in production

Product Costs - A Closer Look

All manufacturing costs incurred during the period are added to the

beginning balance of work in process.

All manufacturing costs incurred during the period are added to the

beginning balance of work in process.

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Manufacturing WorkRaw Materials Costs In Process

Beginning raw Direct materials Beginning work in materials inventory + Direct labor process inventory

+ Raw materials + Mfg. overhead + Total manufacturing purchased = Total manufacturing costs

= Raw materials costs = Total work in

available for use process for the in production period

– Ending work in process inventory

= Cost of goods

manufactured.

Product Costs - A Closer Look

Costs associated with the goods that are completed during the period are

transferred to finished goods inventory.

Costs associated with the goods that are completed during the period are

transferred to finished goods inventory.

Page 47: Basic  Costs  Concepts

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Quick Check

Beginning work in process was $125,000. Manufacturing costs incurred for the month were $835,000. There were $200,000 of partially finished goods remaining in work in process inventory at the end of the month. What was the cost of goods manufactured during the month?

A. $1,160,000B. $ 910,000C. $ 760,000D. Cannot be determined.

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Product Costs - A Closer Look

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Quick Check

Beginning finished goods inventory was $130,000. The cost of goods manufactured for the month was $760,000. And the ending finished goods inventory was $150,000. What was the cost of goods sold for the month?

A. $ 20,000.

B. $740,000.

C. $780,000.

D. $760,000.

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Cost Drivers

Output measures of resources and

activities are called cost drivers.

What are cost drivers?

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Cost Behavior

It is how costs are related to, and affectedby, the activities of an organization.

What is cost behavior?

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Production Example

Example costs:Labor wagesSupervisory salariesMaintenance wagesDepreciation Energy

Example cost drivers:Labor hoursNo. of people supervisedNo. of mechanic hoursNo. of machine hoursKilowatt hours

Cost Drivers

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Cost Drivers

How well the accountant does at identifying

the most appropriate cost drivers determines

how well managers understand cost behavior

and how well costs are controlled.

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Cost Classifications for Predicting Cost Behavior

How a cost will react to changes in the level of

business activity.Total variable costs

change when activity changes.

Total fixed costs remain unchanged when activity changes.

How a cost will react to changes in the level of

business activity.Total variable costs

change when activity changes.

Total fixed costs remain unchanged when activity changes.

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Comparison of Variable and Fixed Costs

A variable cost is a cost that changes in directproportion to changes in the cost driver.

A fixed cost is not immediately affectedby changes in the cost driver.

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Rules of Thumb

Total fixed costs remain unchangedregardless of changes in cost-driver activity.

Think of fixed costs as a total.

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Rules of Thumb

The per-unit variable cost remainsunchanged regardless of changesin the cost-driver activity.

Think of variable costs on a per-unit basis.

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Relevant Range

This rule of thumb holds true only within reasonable limits.

The relevant range is the limit of cost-driver activity within which a specific relationship between costs and the cost driver is valid.

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Fix

ed

Cos

ts

Volume in Units

$16,000 –

$12,000 –

$8,000 –

$4,000

0 500 1,000 1,500 2,000 2,500

– – –

Relevant Range

Relevant Range

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Total Variable Cost

Your total long distance telephone bill is based on how many minutes you talk.

Minutes Talked

Tot

al L

ong

Dis

tanc

eT

elep

hone

Bill

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Variable Cost Per Unit

Minutes Talked

Per

Min

ute

Tel

epho

ne C

harg

e

The cost per long distance minute talked is constant. For example, 10 cents per minute.

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Total Fixed Cost

Your monthly basic telephone bill probably does not change when you make more local

calls.

Number of Local Calls

Mon

thly

Bas

ic

Tel

epho

ne B

ill

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Fixed Cost Per Unit

Number of Local Calls

Mon

thly

Bas

ic T

elep

hone

B

ill p

er L

ocal

Cal

l

The average cost per local call decreases as more local calls are made.

Page 64: Basic  Costs  Concepts

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Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Fixed cost per unit goesthe same even when the down as activity level goes up. activity level changes.

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Cost Behavior

MerchandisersCost of Goods Sold

ManufacturersDirect Material, Direct Labor, and Variable

Manufacturing Overhead

Merchandisers and Manufacturers

Sales commissions and shipping costs

Service Organizations Supplies and travel

Examples of normally variable costs

Examples of normally fixed costs

Merchandisers, manufacturers, and service organizations

Real estate taxes, Insurance, Sales salariesDepreciation, Advertising

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The Activity Base

Machinehours

Laborhours

Milesdriven

A measure of the event causing the incurrence of a variable cost – a cost driver

Unitsproduced

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ExamplesAdvertising and Research and Development

ExamplesDepreciation on Buildings and

Equipment

Types of Fixed Costs

Fixed Costs

DiscretionaryMay be altered in the short-term by current managerial decisions

CommittedLong-term, cannot be reduced in the short

term.

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Quick Check

Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.)

A. The cost of lighting the store.

B. The wages of the store manager.

C. The cost of ice cream.

D. The cost of napkins for customers.

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Quick Check

Which of the following costs would be variable with respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.)

A. The cost of renting the film.

B. Royalties on ticket sales.

C. Wage and salary costs of theater employees.

D. The cost of cleaning up after the show.

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Example: Office space is available at a rental

rate of $30,000 per year in increments of 1,000 square feet. As

the business grows more space is rented,

increasing the total cost.

Fixed Costs and Relevant Range

Continue

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Ren

t C

ost

in

T

ho

usa

nd

s o

f D

oll

ars

0 1,000 2,000 3,000 Rented Area (Square Feet)

0

30

60

Fixed Costs and Relevant Range

90

Relevant

Range

Total cost doesn’t change for a wide range of activity,

and then jumps to a new higher cost for

the next higher range of activity.

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Quick Check Which of the following statements about cost

behavior are true?

a. Fixed costs per unit vary with the level of activity.

b. Variable costs per unit are constant within the relevant range.

c. Total fixed costs are constant within the relevant range.

d. Total variable costs are constant within the relevant range.

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Cost Behavior Patterns Example

Bicycles by the Sea buys a handlebarat $52 for each of its bicycles.

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

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Cost Behavior Patterns Example

1,000 units × $52 = $52,000

What is the total handlebar costwhen 3,500 bicycles are assembled?

3,500 units × $52 = $182,000

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Cost Behavior Patterns Example

Bicycles by the Sea 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.

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Cost Behavior Patterns Example

What is the leasing (fixed) cost per bicyclewhen Bicycles assembles 1,000 bicycles?

$94,500 ÷ 1,000 = $94.50

What is the leasing (fixed) cost per bicyclewhen Bicycles assembles 3,500 bicycles?

$94,500 ÷ 3,500 = $27

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Cost Drivers

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

the (variable) costs to change proportionately.

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

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Relevant Range Example

Assume that fixed (leasing) costs are $94,500for 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.

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Relevant Range Example

020000400006000080000

100000120000

0 1000 2000 3000 4000 5000 6000

Volume

Fix

ed C

osts

$94,500

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Relationships of Types of Costs

Direct

Indirect

Variable Fixed

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Interpret unit costs cautiously.

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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

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Total Costs and Unit CostsExample

0

50000

100000

150000

200000

0 500 1000 1500

Volume

Tot

al C

osts

$94,500

$94,500 + $52x

$146,500

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Use Unit Costs Cautiously

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

Page 85: Basic  Costs  Concepts

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Use Unit Costs Cautiously

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?

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Use Unit Costs Cautiously

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.

Page 87: Basic  Costs  Concepts

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Use Unit Costs Cautiously

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

Page 88: Basic  Costs  Concepts

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Prime Costs

DirectMaterials

DirectLabor

PrimeCosts+ =

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100

Conversion Costs

DirectLabor

ManufacturingOverhead+ =

ConversionCosts

IndirectLabor

IndirectMaterials Other

Page 90: Basic  Costs  Concepts

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Sunk Costs Sunk costs cannot be changed by any decision. They are not

differential costs and should be ignored when making decisions.

Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.

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102

Quick Check

Suppose that your car could be sold now for $5,000. Is this a sunk cost?

A. Yes, it is a sunk cost.

B. No, it is not a sunk cost.