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Abi Hamdani - Ismail Wardhana Ikromi Abdul Ghani Muhammad Luthfi Yasin

Basic Cost-Management Concepts

Basic Definitions: A cost is incurred when a firm uses a resource for some purpose Costs are assembled into meaningful groups called cost pools (e.g., by type of cost or source) Any factor that has the effect of changing the level of total cost is called a cost driver A cost object is any product, service, customer, activity, or organizational unit to which costs are assigned for some management purpose There are four main ways to classify costs (different costs for different purposes): For product and service costing (GAAP) For strategic decision-making (cost-driver analysis) For planning and decision-making For control/feedback

The process of assigning costs to cost pools or from cost pools to cost objects Direct costs can be conveniently and economically traced to a cost pool or a cost object Indirect costs cannot be traced conveniently or economically to a cost pool or a cost object Because indirect costs cannot be traced, assignment is made through the use of cost drivers (cost allocation) These cost drivers are often called allocation bases Product and Service Costing Concepts (GAAP) Product costs include only the costs necessary to complete the product at the manufacturing step in the value chain (manufacturing) or to purchase and transport the product to the location of sale (merchandising) Period costs include all other costs incurred by the firm in managing or selling the product (indirect costs outside the manufacturing step of the value chain) Direct and Indirect Product Costs for a Manufacturer Direct material costs = cost of materials that can be readily traced to outputs = purchase price of materials + freight purchase discounts + reasonable allowance for scrap and defective units Indirect material costs = cost of materials that cannot readily be traced to outputs (e.g., rags, lubricants, and small tools) Direct labor costs = labor that can be readily traced to outputs = wages paid plus a reasonable allowance for nonproductive time Indirect labor costs = labor costs that cannot be readily traced to outputs (i.e., they are manufacturing support costs)

Direct and Indirect Product Costs: Further Comments All indirect costs for the manufacturer, including indirect materials, indirect labor, and other indirect items are often combined in a cost pool referred to as overhead (or, factory overhead, or indirect manufacturing costs) The three main types of costs, direct materials, direct labor, and overhead, are often condensed even further: Direct materials + Direct labor = Prime costs Direct labor + Overhead = Conversion costs Costs for Strategic Decision-Making Cost drivers provide two roles for the management accountant Assigning costs to cost objects Explaining cost behavior, i.e., how total cost changes as the cost driver changes There are four types of cost drivers: Activity-based Volume-based Structural Executional

What is meant by cost behavior? Common classifications of cost behavior: Fixed (capacity) cost is the portion of total cost that does not change with changes in output Variable cost is the change in total cost associated with each change in quantity of the cost driver Mixed cost is used to refer to a total cost figure that includes both a fixed and variable component Step costs vary with the cost driver but do so in steps Applications: Budgeting Cost-Volume-Profit analysis (profit planning) Short-Run Decision-Making Cost Concepts Relevance is the most important characteristic for information used in decision making Relevant costs have two properties: they differ for each decision option and they will be incurred in the future Opportunity cost is the benefit lost when choosing one option precludes receiving the benefits from the alternative option Sunk costs are costs that have been incurred or committed in the past and are therefore irrelevant in current decision making

Qualitative Characteristics of Cost Information for Planning and Decision-Making There are three other characteristics that are important for planning and decision making Accuracy (and the need to monitor internal accounting controls) Cost and value of cost information (the cost of information should be monitored by the management accountant to ensure that costs do not outweigh the associated benefits) Timeliness (often involves sacrificing in the other two areas) Cost Information for Control/Feedback Purposes Controllability is a basic consideration in evaluating managers and providing feedback A cost is considered controllable if the manager or employee has discretion in choosing to incur it or can influence the amount in a short period of time There are different ways to classify (or categorize) cost information, depending on the information needs of management (different costs for different purposes): To prepare financial statements (GAAP) For strategic decision-making For short-term planning For short-term decision-making For control/feedback purposes

Product and service costing (GAAP) focuses on differentiating product costs from period costs Costs flow through three inventory accounts in a manufacturing firm; merchandising firms have one inventory account