Cost Terminology and Concepts. Basic Cost Terminology Cost – resource sacrificed to achieve a...

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$





Direct labor 50,000




Subtotal 415,100$




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





Direct labor 50,000




Subtotal 415,100$




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


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


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


Schedule of Cost of Goods Sold


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

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