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A Review of Cost Terms and Purposes

A Review of Cost Terms and Purposes. Chapter 2. Outline. Cost terminology Cost object Assignment Direct vs. Indirect Variable vs. Fixed Drivers Relevant range Average cost. Outline (continued). Manufacturing companies vs. others Inventory vs. period costs Flow of Costs: T-accounts

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A Review of Cost Terms and Purposes

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  1. A Review of CostTerms and Purposes Chapter 2

  2. Outline • Cost terminology • Cost object • Assignment • Direct vs. Indirect • Variable vs. Fixed • Drivers • Relevant range • Average cost

  3. Outline (continued) • Manufacturing companies vs. others • Inventory vs. period costs • Flow of Costs: T-accounts • Prime & conversion costs • Different costs for different purposes

  4. Cost and Cost Terminology Cost is a resource sacrificed or forgone to achieve a 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 separate measurement of costs is desired.

  5. Cost and Cost Terminology Cost Assignment is both: Tracing Direct Costs Cost Object Allocating Indirect Costs

  6. Distinguish between direct costs and indirect costs. Direct vs. Indirect costs

  7. Direct and Indirect Costs COST OBJECT Example: 50 Oak Chairs produced in May. Direct Costs Example: Oak wood used to Mfg. of chairs. Indirect Costs Example: salary of the Plant night watchperson.

  8. Direct and Indirect CostsExample Direct Costs: Maintenance Department $40,000 Personnel Department $20,600 Assembly Department $75,000 Finishing Department $55,000 Assume that Maintenance Department costs are allocated equally among the production departments. How much is allocated to each department?

  9. Direct and Indirect Costs Example Maintenance $40,000 Assembly Direct Costs $75,000 Finishing Direct Costs $55,000 $20,000 $20,000 Allocated

  10. Variable vs. Fixed costs Cost Behavior Patterns Example Bicycles by the Sea buys a handlebar at $52 for each of its bicycles. What is the total handlebar cost when 1,000 bicycles are assembled?

  11. Cost Behavior Patterns Example 1,000 units × $52 = $52,000 What is the total handlebar cost when 3,500 bicycles are assembled? 3,500 units × $52 = $182,000

  12. Cost Behavior Patterns Example Bicycles by the Sea incurred $94,500 in a given year for the leasing of its plant. This is an example of fixed costs with respect to the number of bicycles assembled.

  13. Cost Behavior Patterns Example What is the leasing (fixed) cost per bicycle when Bicycles assembles 1,000 bicycles? $94,500 ÷ 1,000 = $94.50 What is the leasing (fixed) cost per bicycle when Bicycles assembles 3,500 bicycles? $94,500 ÷ 3,500 = $27

  14. Cost Drivers The cost driver of variable costs is the level of activity or volume whose change causes the (variable) costs to change proportionately. The number of bicycles assembled is a cost driver of the cost of handlebars.

  15. Relevant Range Example Assume that fixed (leasing) costs are $94,500 for 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.

  16. Relevant Range Example $94,500

  17. Relationships of Types of Costs Direct Variable Fixed Indirect

  18. Interpret unit costs cautiously. “Average Costs”

  19. 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

  20. Total Costs and Unit CostsExample $146,500 $94,500 + $52x $94,500

  21. Use Unit Costs Cautiously Assume that Bicycles management uses a unit cost of $146.50 (leasing and wheels). Management is budgeting costs for different levels of production. What is their budgeted cost for an estimated production of 600 bicycles? 600 × $146.50 = $87,900

  22. Use Unit Costs Cautiously What is their budgeted cost for an estimated production of 3,500 bicycles? 3,500 × $146.50 = $512,750 What should the budgeted cost be for an estimated production of 600 bicycles?

  23. Use Unit Costs Cautiously Total fixed cost $ 94,500 Total variable cost ($52 × 600) 31,200 Total $125,700 $125,700 ÷ 600 = $209.50 Using a cost of $146.50 per unit would underestimate actual total costs if output is below 1,000 units.

  24. Use Unit Costs Cautiously What should the budgeted cost be for an estimated production of 3,500 bicycles? Total fixed cost $ 94,500 Total variable cost (52 × 3,500) 182,000 Total $276,500 $276,500 ÷ 3,500 = $79.00

  25. Distinguish among manufacturing companies, merchandising companies, and service-sector companies. Manufacturing vs. others

  26. Manufacturing Manufacturing companies purchase materials and components and convert them into finished goods. A manufacturing company must also develop, design, market, and distribute its products.

  27. Merchandising Merchandising companies purchase and then sell tangible products without changing their basic form.

  28. Service Service companies provide services or intangible products to their customers. Labor is the most significant cost category.

  29. Differentiate between inventoriable costs and period costs. Inventoriable Costs

  30. Types of Inventory Manufacturing-sector companies typically have one or more of the following three types of inventories: 1. Direct materials inventory 2. Work in process inventory (work in progress) 3. Finished goods inventory

  31. Types of Inventory Merchandising-sector companies hold only one type of inventory – the product in its original purchased form. Service-sector companies do not hold inventories of tangible products.

  32. Classification ofManufacturing Costs Direct materials costs Direct manufacturing labor costs Indirect manufacturing costs

  33. Inventoriable Costs Inventoriable costs (assets)… become cost of goods sold… after a sale takes place.

  34. Period Costs Period costs are all costs in the income statement other than cost of goods sold. Period costs are recorded as expenses of the accounting period in which they are incurred.

  35. Flow of Costs • T-account diagram (in class)

  36. Prime Costs(all direct mfg. costs) Direct Materials Prime Costs Direct Labor + =

  37. Conversion Costs(all mfg. cost except DM) Manufacturing Overhead Direct Labor Conversion Costs + = Other Indirect Materials Indirect Labor

  38. Product costs are computed in different ways for different purposes/uses. Different Costs?

  39. Many Meanings of Product Cost A product cost is the sum of the costs assigned 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

  40. End of Chapter 2That’s all Folks!

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