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An Introduction to Cost Terms and Purposes

An Introduction to Cost Terms and Purposes. Chapter 2. Define and illustrate a cost object. Learning Objective 1. 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)

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An Introduction to Cost Terms and Purposes

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  1. An Introduction to CostTerms and Purposes Chapter 2

  2. Define and illustrate a cost object. Learning Objective 1

  3. 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.

  4. Cost and Cost Terminology Cost Object Cost Accumulation Cost Object Cost Object Cost Assignment Tracing Allocating

  5. Distinguish between direct costs and indirect costs. Learning Objective 2

  6. Direct and Indirect Costs COST OBJECT Example: Sports Illustrated magazine Direct Costs Example: Paper on which Sports Illustrated magazine is printed Indirect Costs Example: Lease cost for Time-Warner building housing the senior editors of its magazine

  7. 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?

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

  9. Explain variable costs and fixed costs. Learning Objective 3

  10. 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. Learning Objective 4

  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. Learning Objective 5

  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. Merchandising 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. Learning Objective 6

  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. Describe the three categories of inventories commonly found in manufacturing companies. Learning Objective 7

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

  35. 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.

  36. Flow of Costs Example Bicycles by the Sea had $50,000 of direct materials inventory at the beginning of the period. Purchases during the period amounted to $180,000 and ending inventory was $30,000. How much direct materials were used? $50,000 + $180,000 – $30,000 = $200,000

  37. Flow of Costs Example Direct labor costs incurred were $105,500. Indirect manufacturing costs were $194,500. What are the total manufacturing costs incurred? Direct materials used $200,000 Direct labor 105,500 Indirect manufacturing costs 194,500 Total manufacturing costs $500,000

  38. Flow of Costs Example Assume that the work in process inventory at the beginning of the period was $30,000, and $35,000 at the end of the period. What is the cost of goods manufactured? Beginning work in process $ 30,000 Total manufacturing costs 500,000 Ending work in process 35,000 Cost of goods manufactured $495,000

  39. Flow of Costs Example Assume that the finished goods inventory at the beginning of the period was $10,000, and $15,000 at the end of the period. What is the cost of goods sold? Beginning finished goods $ 10,000 Cost of goods manufactured 495,000 Ending finished goods 15,000 Cost of goods sold $490,000

  40. Flow of Costs Example Work in Process Beg. Balance 30,000 495,000 Direct mtls. used 200,000 Direct labor 105,500 Indirect mfg. costs 194,500 Ending Balance 35,000

  41. Flow of Costs Example Finished Goods 10,000 490,000 495,000 15,000 Work in Process 495,000 Cost of Goods Sold 490,000

  42. Manufacturing Company BALANCE SHEET INCOME STATEMENT Inventoriable Costs Revenues when sales occur deduct Materials Inventory Finished Goods Inventory Cost of Goods Sold Equals Gross Margin deduct Work in Process Inventory Period Costs Equals Operating Income

  43. Merchandising Company BALANCE SHEET INCOME STATEMENT Inventoriable Costs Revenues when sales occur deduct Merchandise Purchases Inventory Cost of Goods Sold Equals Gross Margin deduct Period Costs Equals Operating Income

  44. Prime Costs Direct Materials Prime Costs Direct Labor + =

  45. Prime Costs What are the prime costs for Bicycles by the Sea? Direct materials used $200,000 + Direct labor 105,500 = $305,000

  46. Conversion Costs Manufacturing Overhead Direct Labor Conversion Costs + = Other Indirect Materials Indirect Labor

  47. Conversion Costs What are the conversion costs for Bicycles by the Sea? Direct labor $105,500 + Indirect manufacturing costs 194,500 = $300,000

  48. Measuring CostsRequires Judgment Manufacturing labor-cost classifications vary among companies. The following distinctions are generally found: Direct manufacturing labor Manufacturing overhead

  49. Measuring CostsRequires Judgment Manufacturing overhead Indirect labor Managers’ salaries Payroll fringe costs Forklift truck operators (internal handling of materials) Janitors Rework labor Overtime premium Idle time

  50. Measuring CostsRequires Judgment Overtime premium is usually considered part of overhead. Assume that a worker gets $18/hour for straight time and gets time and one-half for overtime.

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