What is cost?

1. What is cost? Cost is the cash (or cash equivalent) sacrificed for goods or services that are expected to produce current or future benefits. Expenses are expired costs.

2. What is expense? • An expired cost or a cost used up in the production of revenues (e.g., cost of merchandise inventory of a retailer).

3. Cost Object • A cost object is any item such as products, departments, customers, and activities for which costs are measured and assigned. • Example: A bicycle is a cost object when you are determining the cost to produce a bicycle.

5. Cost Traceability • Traceability means that costs can be assigned easily and accurately, using a causal relationship. • Methods of tracing: • Direct tracing: relies on physical observance of causal relationships to assign costs to cost objects. • Driver tracing: relies on drivers as causal factors to assign costs to cost objects.

6. Assigning Indirect Costs • Allocation is used to assign indirect costs to a cost object, such as a product or department, using a reasonable and convenient method.

7. Tracing Direct Costs • Identifying and assigning costs to a cost object that are specifically or physically associated with the cost object • Direct costs can be easily and accurately traced to a cost object. • The more costs that can be traced to a cost object, the more accurate are the cost assignments.

8. Direct versus Indirect Costs Direct Costs Indirect Costs Indirect costs: Costs that cannot be easily and accurately traced to a cost object (e.g., the salary of a plant manager, where departments within the plant are defined as the cost objects). • Direct costs: Costs that can be easily and accurately traced to a cost object (e.g., the salary of a • supervisor of a department, where the department is defined as the cost object, or bricks delivered to a house that is being constructed by a contractor, where the house is the cost object).

9. Cost Tracing • Direct tracing is the process of identifying and assigning costs to a cost object that are • specifically or physically associated with the cost object. This is the most precise method as it relies on physically observable causal relationships.

10. Cost Tracing • Driver tracing is the use of drivers to assign costs to cost objects. The precision of driver tracing • depends on the strength of the causal relationship described by the driver.

11. Cost Allocation • Allocation is the least accurate cost assignment method. • Often, no causal relationship exists between the cost and the basis used to assign the cost to the cost object.

12. Product Costs • Direct materials: those materials directly traceable to the goods or services being produced. • Example: The cost of wood in furniture. • Direct labor: labor that is directly traceable to the goods or services being produced. • Example: Wages of assembly-line workers. • Overhead: all other manufacturing costs. • Example: Plant depreciation, utilities, property taxes, indirect materials, indirect labor, etc.

13. Nonproduction Costs • Amount and timing of benefit cannot be reasonably estimated • Period costs • Not inventoried • Expensed as incurred • Examples • Research and development • Marketing costs • Administrative costs

15. Product costs include direct materials, direct labor, and manufacturing overhead. Period costs include all selling costs and administrative costs. Inventory Expense Cost of Good Sold Sale BalanceSheet IncomeStatement IncomeStatement Product Costs Versus Period Costs

17. MegaLoMart Comparing Merchandising and Manufacturing Companies Merchandisers . . . • Buy finished goods. • Sell finished goods. Manufacturers . . . • Buy raw materials. • Produce and sell finished goods. McGraw-Hill/Irwin

18. External Financial Statements • Income Statement of Manufacturing Firm • Functional categories of expense • Cost of goods sold • Operating expenses • Supporting schedules • Cost of goods manufactured • Cost of goods sold • Income Statement of Service Organization • No finished goods inventory

20. Material Purchases Raw Materials Direct Labor Work in Process ManufacturingOverhead Cost of GoodsSold FinishedGoods Period Costs Selling andAdministrative Selling andAdministrative Manufacturing Cost Flows Income StatementExpenses Balance Sheet Costs Inventories

21. Income Statement: Manufacturing Firm From the Cost of Goods Sold Schedule

22. The Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

23. Product Cost Flows As items are removed from raw materials inventory and placed into the production process, they arecalled direct materials.

24. Product Cost Flows All manufacturing costs incurred during the period are added to the beginning balance of work in process.

25. Product Cost Flows

26. The Income Statement Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

27. Cost Driver • A causal factor that measures the output of activity that causes costs to change • Need to identify and manage cost drivers in order to predict and control cost.

28. Cost Classification By Behaviour • Cost behavior refers to whether a cost changes when the level of output changes. • Four categories of costs: • fixed costs, • variable costs, • mixed costs, and • step costs. These categories are • reasonably accurate within a relevant range of activity.

29. Cost Classifications for Predicting Cost Behavior

30. Total Texting Bill Number of Texts Sent Variable Cost Your total texting bill is based on how many texts you send.

31. Cost Per Text Sent Number of Texts Sent Variable Cost Per Unit The cost per text sent is constant at 5 cents per text.

32. Schedule of Cost of Goods Manufactured Calculates the cost of raw material, direct labor, and manufacturing overhead used in production. Calculates the manufacturing costs associated with goods that were finished during the period.

33. Relevant Range • The range of output over which the the assumed cost relationship is valid for normal operation of the firm.

34. Methods for Separating Mixed Costs into Fixed and Variable components • The high-low method • Scattergraph Method • The method of least squares (Regression)

35. Illustration of the high-low method BlueDenim makes blue jeans. The company controller wants to calculate the fixed and variable cost associated with electricity used in the factory. Data for the past eight months were collected:

36. Cost Classification for Decision Making • Relevant cost • Future costs that differ between alternatives • Influence decision • Example : Opportunity Costs • Irrelevant costs • Do not differ between alternatives • Sunk costs is a relevant costs