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Chapter 2 Cost Terminology and Cost Behaviors

Cost Accounting Foundations and Evolutions Kinney, Prather, Raiborn. Chapter 2 Cost Terminology and Cost Behaviors. Cost. Monetary measure of resources given up to attain an objective (such as acquiring a good or delivering a service). Learning Objectives.

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Chapter 2 Cost Terminology and Cost Behaviors

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  1. Cost Accounting Foundations and Evolutions Kinney, Prather, Raiborn Chapter 2 Cost Terminology and Cost Behaviors

  2. Cost Monetary measure of resources given up to attain an objective (such as acquiring a good or delivering a service)

  3. Learning Objectives • List the cost classifications and explain why the classifications are useful • List product cost categories and their components • Calculate the Cost of Goods Manufactured and explain how it is used in the Income Statement

  4. Cost Classifications • Association with cost object Cost object is anything for which management wants to collect or accumulate costs • Direct - traceable to a cost object • Indirect - not conveniently or practically traceable to a cost object • treated as overhead • allocated

  5. Cost Categories • Association with cost object • Reaction to changes in activity • Variable • Fixed • Mixed • Step Relevant Range – normal operating range

  6. Cost Reaction to Changes in Activity Total Variable Cost Fixed Cost $ # of Units $ # of Units Within the relevant range

  7. Cost Reaction to Changes in Activity Total Unit Variable Cost Fixed Cost $ $ # of Units # of Units $ $ # of Units # of Units Within the relevant range

  8. Total and Unit Cost Behavior Total Cost Unit Cost Remains constant throughout the relevant range Varies in direct proportion to changes in activity Variable Cost Varies inversely with changes in activity throughout the relevant range Remains constant throughout the relevant range Fixed Cost

  9. Cost Reaction to Changes in Activity Step Cost (Fixed) $ Units Within the relevant range

  10. Cost Reaction to Changes in Activity Mixed Cost variable $ fixed Units Within the relevant range

  11. Cost Predictor Activity accompanied by consistent, observable changes in a cost item Predicts but may not cause the cost to change Cost Driver Activity that has a direct cause-effect relationship on cost Directly causes the cost to change Determining Cost Behavior

  12. Cost Classifications • Association with cost object • Reaction to changes in activity • Classification on the financial statements • Unexpired • Expired • Product • Period

  13. Cost Classifications • Classification on the financial statements • Unexpired – balance sheet assets • Expired – income statement expenses • Product – inventoriable costs • Prime – direct material and direct labor • Conversion – direct labor and overhead • Period – expensed in period incurred

  14. Product Costs • Direct material • Measurable part of a product • Direct labor • Labor used to manufacture a product or perform a service • Overhead • Indirect production cost

  15. Product Costs • First appear on the balance sheet in inventory accounts • Transferred to the income statement when product is sold

  16. Period Costs • Selling and administrative costs • Distribution costs • Cost to warehouse, transport, and/or deliver a product or service • Major impact on managerial decision making

  17. Period Costs • Appear on the income statement when incurred • Expensed when incurred

  18. Output Input Purchase raw materials or supplies Product or Service CONVERSION Conversion Process Change Inputs into Outputs

  19. Low Degree of Conversion • Department stores • Gas stations • Jewelry stores • Travel agencies

  20. Moderate Degree of Conversion • Florists • Meat markets • Oil-change businesses

  21. High Degree of Conversion • Manufacturing • Construction • Agriculture • Architecture • Auditing • Mining • Printing • Restaurants

  22. Product Cost - Direct • Direct Material • Conveniently and economically traced to cost object

  23. Product Cost - Direct • Direct Material • Conveniently and economically traced to cost object • Direct Labor • to manufacture a product or perform a service • includes wages paid to direct labor employees, production bonuses, payroll taxes • may include holiday and vacation pay, insurance, retirement benefits

  24. Product Cost - Indirect • Overhead - indirect production costs • Fringe benefits, if cannot be easily traced to product • Overtime, if due to random scheduling • Cost of quality • Prevention costs • Appraisal costs • Failure costs

  25. Product Cost Behavior • Direct Material Variable • Direct Labor Variable • Overhead Variable, fixed, or mixed

  26. Overhead Cost Allocation Assign indirect costs to one or more cost objects • To determine full absorption cost (GAAP) • To motivate management • To compare alternative courses of action for planning, controlling, and decision making Allocation process should be rational and systematic

  27. Product Cost Direct Materials Direct Labor Overhead Cost Used Actual Actual Actual Allocating OverheadActual Cost System

  28. Allocating OverheadActual Cost System • The Actual Cost System is not timely • All costs must be known before calculating product cost

  29. Allocating OverheadActual vs. Normal Product Cost Direct Materials Direct Labor Overhead Actual Cost System Actual Actual Actual Normal Cost System Actual Actual Predetermined Overhead Rate

  30. Predetermined Overhead Rate • Allows overhead to be assigned during the period • Compensates for fluctuations • that are not related to activity level • in activity level that do not affect fixed overhead

  31. Flow of Product Costs Raw Materials Inventory Accounts Payable Work in Process Inventory Raw Materials Inventory

  32. Flow of Product Costs Work in Process Inventory Variable Overhead Control Fixed Overhead Control Finished Goods Inventory Work in Process Inventory

  33. Flow of Product Costs Matches revenues and expenses on the income statement • Accounts Receivable • Sales • Cost of Goods Sold • Finished Goods Inventory

  34. Statement of Cost of Goods Manufactured • Beginning work in process $ 145,000 • Raw materials used $284,000 • Direct labor 436,000 • Variable overhead 115,200 • Fixed overhead 98,880 • Current period manufacturing costs 934,080 • Total costs to account for $1,079,080 • Ending work in process 20,880 • Cost of goods manufactured $1,058,200

  35. Statement of Cost of Goods Manufactured Raw Materials Used Beginning balance $ 73,000 Purchases of materials 280,000 Raw materials available $353,000 Ending balance 69,000 Total raw materials used $284,000 To Statement of Cost of Goods Manufactured

  36. Schedule of Cost of Goods Sold Beginning Finished Good $ 87,400 Cost of Goods Manufactured 1,058,200 Cost of Goods Available for Sale $1,145,600 Ending Finished Goods 91,600 Cost of Goods Sold $1,054,000 From Schedule of Cost of Goods Manufactured

  37. Income Statement • Revenue xxxx • Cost of Goods Sold <1,054,000> • Gross Profit xxxx • Operating Expenses <xxxx> • Operating Income xxxx From Schedule of Cost of Goods Sold

  38. Questions • What is the difference between a fixed and variable cost? • What are the three components of product cost? • What are the three inventory accounts for a manufacturing company?

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