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CHAPTER 2

PREPARED BY:

MONAL PATEL

MOHSHINALI MOMIN

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Basic Cost Terminology

Cost sacrificed resource to achieve aspecific objective

Actual Cost a cost that has occurred

Budgeted Cost a predicted cost

Cost Object anything of interest for which acost is desired

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Cont

Cost Accumulation a collection of cost datain an organized manner

Cost Assignment a general term that

includes gathering accumulated costs to acost object. This includes:

Tracing accumulated costs with a directrelationship to the cost object and

Allocating accumulated costs with an indirectrelationship to a cost object

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Direct and Indirect Costs

Direct Costs can be conveniently andeconomically traced (tracked) to a cost object

Indirect Costs cannot be conveniently or

economically traced (tracked) to a cost object.Instead of being traced, these costs areallocated to a cost object in a rational andsystematic manner

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Cost Examples

Direct Costs

Parts

Assembly line wages

Indirect Costs

Electricity

Rent

Property taxes

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Factors Affecting Direct/Indirect Cost

Classification

Cost Materiality

Availability of Information-gatheringTechnology

Operational Design

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Cost Behavior

Variable Costs changes in total inproportion to changes in the related level ofactivity or volume

Fixed Costs remain unchanged in totalregardless of changes in the related level ofactivity or volume

Costs are fixed or variable only with respect

to a specific activity or a given time period

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Cost Behavior, continued

Variable costs are constant on a per-unit basis. If aproduct takes 5 pounds of materials each, it stays thesame per unit regardless of whether one, ten, or athousand units are produced

Fixed costs change inversely with the level ofproduction. As more units are produced, the samefixed cost is spread over more and more units,reducing the cost per unit

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Cost Behavior Summarized

Total Dollars Cost per Unit

VariableCosts

Change in

proportion withoutputMore output = More cost

Unchanged inrelation to output

Fixed Costs Unchanged inrelation to output

Change inverselywith output

More output = lower cost

per unit

Total Dollars Cost per Unit

VariableCosts

FixedCosts

Change in

proportion withoutputMore output = Morecost

Unchanged inrelation to output

Unchanged in

relation to output

Change inverselywith outputMore output = lowercost per unit

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Other Cost Concepts

Cost Driver a variable that causally affectscosts over a given time span

Relevant Range the band of normal activity

level (or volume) in which there is a specificrelationship between the level of activity (orvolume) and a given cost

For example, fixed costs are fixed only withinthe relevant range.

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A Cost Caveat

Unit costs should be used cautiously. Sinceunit costs change with a different level ofoutput or volume, it may be more prudent to

base decisions on a total dollar basis.

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Different Types of Firms

Manufacturing-sector companies createand sell their own products

Merchandising-sector companies product

resellersService-sector companies

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Types of Inventories

Direct Materials resources in stock andavailable for use

Work-in-Process (or progress) products

started but not yet completed. Oftenabbreviated as WIP

Finished Goods products completed andready for sale

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Types of Product Costs

Direct Materials

Direct Labor

Indirect Manufacturing factory costs that are

not traceable to the product. Also known asManufacturing Overhead costs or FactoryOverhead costs

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Distinctions Between Costs

Inventoriable Costs product manufacturingcosts. These costs are capitalized as assets(inventory) until they are sold and transferred

to Cost of Goods SoldPeriod Costs have no future value and are

expensed as incurred

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Cost Flows

The Cost of Goods Manufactured and theCost of Goods Sold section of the incomestatement are accounting representations of

the actual flow of costs through a productionsystem.

Note the importance of inventory accounts inthe following accounting reports, and in the

cost flow chart

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Cost Flowchart

BalanceSheet

IncomeStatement

InventoriableCosts

DirectMaterials

Purchases

Other DirectManufacturing

Costs

ManufacturingOverhead

Costs

DirectMaterialsInventory

Work-in-ProcessInventory

Revenues

Cost ofGoodsSold

R&D CostsDesign Costs

Marketing CostsDistribution CostsCustomer-Service

Costs

PeriodCosts

FinishedGoods

Inventory

Equals Operating

Income

Stored

Incurred

Applied

Deduc

t

Equals

Gross

Margin

Thend

educt

Requisiti

oned

SoldCompleted

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Other Cost Considerations

Prime cost is a term referring to all directmanufacturing costs (labor and materials)

Conversion cost is a term referring to direct

labor and factory overhead costs, collectivelyOvertime labor costs are considered part of

overhead

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Different Definitions of Cost for

Different Applications

Pricing and product-mix decisions may usea super cost approach (comprehensive)

Contracting with government agencies very

specific definitions of cost for cost plus profitcontracts

Preparing external-use financial statementsGAAP-driven product costs only

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Three Common Features of Cost

Accounting and Cost Management

Calculating the cost of products, services,and other cost objects

Obtaining information for planning and

control, and performance evaluationAnalyzing the relevant information for making

decisions

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