Cost Concepts and Cost Allocation

1. Cost Concepts and Cost Allocation 2

2. Cost Information OBJECTIVE 1: Explain how managers classify costs and how they use these cost classifications.

3. Figure 1: Overview of Cost Classifications

4. Table 1: Examples of Cost Classifications for a Candy Manufacturer

5. Cost Information • Managers’ use of cost information • Different organizations have different operating costs • Service industries use the estimated costs of services • Retail organizations work with the estimated cost of merchandise • Manufacturing use estimated product costs

6. Cost Information • All organizations use cost information to determine profits and selling prices and to value inventory.

7. Cost Information • A single cost can be classified as • Direct or indirect, depending on its traceability. • Variable or fixed, depending on its behavior. • Value-adding or nonvalue-adding, depending on whether it adds value to a product or service. • Product or period, depending on whether it is inventoriable.

8. Cost Information • Managers use cost classifications to • Control costs by determining which are traceable to a particular cost object. • Calculate the number of units that must be sold to obtain a certain level of profit.

9. Cost Information • Managers use cost classifications to (cont.) • Identify the costs of activities that do and do not add value to a product or service. • Prepare financial statements.

11. Financial Statements and the Reporting of Costs OBJECTIVE 2: Compare how service, retail, and manufacturing organizations report costs on their financial statements and how they account for inventories.

12. Figure 2: Financial Statements of Service, Retail, and Manufacturing Organizations

13. Exhibit 1: Statement of Cost of Goods Manufactured and Partial Income Statement for a Manufacturing Organization

14. Exhibit 1: Statement of Cost of Goods Manufactured and Partial Income Statement for a Manufacturing Organization

15. Financial Statements and the Reporting of Costs • A manufacturer maintains three inventory accounts on its balance sheet: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. • Because a service organization sells services rather than products, it maintains no inventory accounts.

16. Financial Statements and the Reporting of Costs • A manufacturer maintains three inventory accounts on its balance sheet: Materials Inventory, Work in Process Inventory, and Finished Goods Inventory. (cont.) • A retail organization, which purchases products ready for resale, maintains only a Merchandise Inventory account.

17. Financial Statements and the Reporting of Costs • Cost of goods manufactured is a key component of a manufacturing company’s income statement. • Determining the cost of goods manufactured involves three steps: • Computing the cost of direct materials used during the period • Computing total manufacturing costs for the period • Computing cost of goods manufactured, adjusting for beginning and ending work in process inventory

18. Financial Statements and the Reporting of Costs • The cost of goods manufactured is used on the income statement to compute the cost of goods sold. • Manufacturing, retail, and service organizations use the same income statement format.

20. Inventory Accounts in Manufacturing Organizations OBJECTIVE 3: Describe the flow of costs through a manufacturer’s inventory accounts.

21. Figure 3: Activities, Documents, and Cost Flows Through the Inventory Accounts of a Manufacturing Organization

22. Figure 4: Manufacturing Cost Flow: An Example Using Actual Costing for The Choice Candy Company

23. Inventory Accounts in Manufacturing Organizations • Transforming materials into finished products ready for sale requires a number of production and production-related activities, including the following: • Purchasing, receiving, inspecting, storing, and moving materials • Converting materials into finished products using labor, equipment, and other resources • Moving, storing, and shipping the finished products

24. Inventory Accounts in Manufacturing Organizations • Manufacturing cost flow begins when costs are incurred for direct materials, direct labor, and overhead. • Materials costs flow first into the Materials Inventory account. • All manufacturing-related costs then flow into the Work in Process Inventory account.

25. Inventory Accounts in Manufacturing Organizations • Manufacturing cost flow begins when costs are incurred for direct materials, direct labor, and overhead. • When goods are completed, their costs are transferred to the Finished Goods Inventory account. • When goods are sold, their costs are transferred to the Cost of Goods Sold account.

26. Inventory Accounts in Manufacturing Organizations • Documents used to track the flow of manufacturing costs include the following: • Purchase request • Purchase order • Receiving report • Vendor’s invoice • Materials request form

27. Inventory Accounts in Manufacturing Organizations • Documents used to track the flow of manufacturing costs include the following: (cont.) • Time cards • Job order cost card • Sales invoice • Shipping document

29. Elements of Product Costs OBJECTIVE 4: Define product unit cost, and compute the unit cost of a product or service.

30. Figure 5: Relationships Among Product Cost Classifications

31. Table 2: Use of Actual and Estimated Costs in Three Cost-Measurement Methods

32. Elements of Product Costs • The three elements of product cost are direct materials costs, direct labor costs, and overhead costs. • Direct materials costs can be conveniently and economically traced to specific units of a product. • Direct labor costs can be conveniently and economically traced to specific units of a product.

33. Elements of Product Costs • The three elements of product cost are direct materials costs, direct labor costs, and overhead costs. (cont.) • Overhead costs are all manufacturing costs not classified as direct materials or direct labor costs. They include the following: • Indirect materials costs • Indirect labor costs • The costs of property taxes, depreciation on plant and equipment, insurance, rent, and utilities

34. Elements of Product Costs • The three elements of manufacturing costs can be classified as prime costs or conversion costs.

35. Elements of Product Costs • A product’s unit cost equals the sum of direct materials, direct labor, and overhead costs divided by the number of units produced. • The actual costing method uses actual cost information available at the end of an accounting period or at the end of a job to calculate the unit cost of a product.

36. Elements of Product Costs • A product’s unit cost equals the sum of direct materials, direct labor, and overhead costs divided by the number of units produced. (cont.) • The normal costing method combines the actual direct materials and direct labor costs with estimated overhead costs to calculate product unit cost.

37. Elements of Product Costs • A product’s unit cost equals the sum of direct materials, direct labor, and overhead costs divided by the number of units produced. (cont.) • The standard costing method uses estimated costs of direct materials, direct labor, and overhead to calculate product unit cost.

38. Elements of Product Costs • A service business does not have a physical product that can be assembled, stored, and valued as inventory. • The most important cost in a service business is the professional labor cost. • Service-related overhead is the other principal component of the cost of services rendered.

40. Cost Allocation OBJECTIVE 5: Define cost allocation and explain how the traditional method of allocating overhead costs figures into calculating product or service unit cost.

41. Figure 6: Allocating Overhead Costs: A Four-Step Process

42. Figure 6: Allocating Overhead Costs: A Four-Step Process

43. Table 3: Allocating Overhead Costs and Calculating Product Unit Cost: Traditional Approach

44. Cost Allocation • Cost allocation is the process of assigning a collection of indirect costs to a specific cost object using an allocation base known as a cost driver. • A cost object (the destination of an assigned indirect cost) is a product, process, department, or activity that the organization wishes to cost.

45. Cost Allocation • Cost allocation is the process of assigning a collection of indirect costs to a specific cost object using an allocation base known as a cost driver. (cont.) • A cost driver is a volume-related activity base, such as direct labor hours, direct labor costs, or units produced.

46. Cost Allocation • Cost allocation is the process of assigning a collection of indirect costs to a specific cost object using an allocation base known as a cost driver. (cont.) • As the cost driver increases in volume, it causes the cost pool—the collection of indirect costs assigned to a cost object—to increase in amount.

47. Cost Allocation • The allocation of overhead costs requires the following: • The pooling of overhead costs that are affected by a common activity • The selection of a cost driver whose activity level causes a change in the cost pool

48. Cost Allocation • The allocation of overhead costs requires the following: (cont.) • Allocating overhead costs is a four-step process: • Managers estimate overhead costs and calculate a predetermined overhead rate (a single, plantwide rate in traditional settings) at which those costs will be assigned to products. • As units of the product or service are produced, the estimated overhead costs are assigned to the product or service’s costs at the predetermined rate.

49. Cost Allocation • The allocation of overhead costs requires the following: (cont.) • Allocating overhead costs is a four-step process: (cont.) • Actual overhead costs are recorded as they are incurred.

50. Cost Allocation • The allocation of overhead costs requires the following: (cont.) • Allocating overhead costs is a four-step process: (cont.) • At the end of the accounting period, the difference between the actual and applied overhead costs is calculated and reconciled. • If the difference is immaterial, the Cost of Goods Sold account is adjusted. • If the difference is material, adjustments are made to the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts.