AN INTRODUCTION TO COST TERMS AND PURPOSES

LEARNING OBJECTIVES
1. Define and illustrate a cost object 2. Distinguish between direct costs and indirect costs 3. Explain variable costs and fixed costs 4. Interpret unit costs cautiously . Distinguish a!ong !anufacturing co!panies" !erchandising co!panies" and service#sector co!panies $. Describe the three categories of inventories co!!only found in !anufacturing co!panies %. Differentiate between inventoriable costs and period costs &. Explain why product costs are co!puted in different ways for different purposes '. (resent )ey features of cost accounting and cost !anage!ent

CHAPTER OUTLINE
Learning Objective 1: Define and illustrate a cost object I. *osts and cost ter!inology+general ,. -se of cost concepts and ter!s to provide infor!ation 1. ,ble to best use infor!ation if !anagers understand concepts and ter!s 2. .acilitate co!!unication a!ong !anagers and !anage!ent accountants if co!!on understanding /. Definition of ter! cost 1. 0esource sacrificed or forgone to achieve a specific objective 2. 1easure!ent" usually a !onetary a!ount" that !ust be paid to ac2uire goods and services 3. -se of ter! actual cost3 cost incurred" historical" rather than budgeted or forecasted cost *. Identification of cost object3 anything for which a separate !easure!ent of costs is needed4desired D. 5tages of accounting for costs in a costing syste!

1. Cost accumulation3 collection of cost data in so!e organi6ed !eans in an accounting syste! 2. Cost assignment: designation of cost object to aid in decision !a)ing a. b. 7racing accu!ulated costs that have a direct relationship to a cost object ,llocating accu!ulated costs that have an indirect relationship to a cost object

II. *osts and cost ter!inology+specific Learning Objective 2: Distinguish between direct costs and indirect costs ,. ,ssign!ent to a cost object3 accuracy i!portant for decision !a)ing 1. Direct costs of a cost object3 econo!ically feasible to trace to cost object via cost tracing 2. Indirect costs3 related to cost object but not econo!ically feasible to trace8 assigned via cost allocation 3. .actors affecting direct4indirect classification a. b. c. d. 1ateriality of the cost in 2uestion ,vailable infor!ation#gathering technology Design of operations *hoice of cost object3 generally the broader the definition of the cost object" the higher the proportion of total costs that are direct costs and !ore confidence in cost accuracy

Learning Objective 3: Explain variable costs and fixed costs /. /ehavior pattern in relation to changes in the related level of total activity or volu!e 1. 2. *osting syste!s3 record cost of resources ac2uired and trac) how then used /asic types of cost#behavior with respect to a specific cost object and given ti!e period a. Variable i. *hanges in total in proportion to changes in the related level of total activity

ii. -se as per unit for esti!ates of total costs b. Fixed [Surveys of Company Practice]

i.

-nchanged in total for a given ti!e period despite wide changes in related level of total activity

ii. ,lways focus on total costs when !a)ing cost esti!ates for fixed costs 3. 4. . Individual costs not inherently variable or fixed but dependent upon related activity *hoice of cost driver3 a variable with cause#and#effect relationship between change in level of activity and change in level of total costs [Concepts in Action] *onsideration of relevant range3 band of nor!al activity level with specific relationship between level of activity and particular cost a!ount

Learning Objective 4: Interpret unit costs cautiously *. 7otal costs and unit costs 1. 9enerally total cost a!ounts should be used in decision !a)ing 2. 5o!e decisions need unit costs :average costs; but should be used cautiously

III. ,ccounting for the cost of a product Learning Objective 5: Distinguish a!ong !anufacturing co!panies" !erchandising co!panies" and service#sector co!panies ,. (roduct defined in three types of co!panies 1. Manufacturing-sector companies3 convert !aterials and co!ponents into finished good 2. Merchandising-sector companies3 purchase product and sell without changing basic for! 3. Service-sector companies3 provide services or intangible products Learning Objective 6: Describe the three categories of inventories co!!only found in !anufacturing co!panies /. (roduct inventories for !anufactured goods3 stages in the conversion process 1. Direct materials3 direct !aterials in stoc) and awaiting use in the !anufacturing process 2. or! in process3 goods partially wor)ed on but not yet fully co!pleted

3. Finished goods3 goods fully co!pleted but not yet sold *. (roduct as cost object3 classifications of !anufacturing costs

1. Direct materials costs 2. Direct manufacturing labor costs 3. Indirect manufacturing costs" manufacturing overhead costs or factor# overhead costs

Learning Objective 7:

Differentiate between inventoriable costs and period costs D. (roduct costs for financial state!ent place!ent 1. Inventoriable costs3 all costs of a product that are regarded as an asset :balance sheet; when incurred and then beco!e cost of goods sold :inco!e state!ent; when product sold a. 1anufacturing co!pany3 all !anufacturing costs are inventoriable costs b. 1erchandising co!pany3 costs of purchasing goods resold in their sa!e for! c. 5ervice co!pany3 no inventoriable costs because no inventories of product 2. $eriod costs3 all costs in the inco!e state!ent other than cost of goods sold E. (roduct cost reported3 5chedule of cost of goods !anufactured and sold 1. 7hree categories of !anufacturing costs < =!anufacturing costs incurred during period > a. Direct !aterials ? both as inventory and !anufacturing cost b. Direct !anufacturing labor costs c. Indirect !anufacturing costs 2. 7hree categories of !anufacturing inventories+stages of the conversion process a. Direct !aterials ? used to calculate direct !aterials used at beginning of schedule b. @or) in process c. .inished#goods .. Ather ter!inology for product costs 1. $rime costs3 all direct !anufacturing costs 2. Conversion costs3 all !anufacturing costs other than direct !aterial costs IB. Cudg!ent factors

,. Differences in way costs can be defined and classified 1. 2. *areful to define and understand way costs are !easured in a co!pany or situation Illustrate by !anufacturing labor costs a. Detailed classification to enhance cause#effect relationship to extent possible

b. Detailed classification agreed upon to pro!ote co!pany#wide co!!unication c. Detailed classification for clarity to preclude disputes

/. Differences in uses of product cost3 su! of costs assigned to a product for a specific purpose Learning Objective 8: Explain why product costs are co!puted in different ways for different purposes 1. (roduct cost for purpose of pricing and product#!ix e!phasis 2. (roduct cost for purpose of contracting with govern!ent agencies 3. (roduct cost for purpose of preparing financial state!ents for external reporting under 9,,(

CHAPTER QUIZ
1. 7anner *o. !anage!ent desires cost infor!ation regarding their 0awhide brand. 7he 0awhide brand is a:n; a. cost object. b. cost driver. c. cost assign!ent. d. actual cost.

2. 7he cost of replace!ent light bulbs on ca!pus would be a direct cost to a college but would need to be allocated as an indirect cost to a. depart!ents. b. buildings. c. schools. d. individual student instruction.

3. @hat is the total fixed cost of the shipping depart!ent of ED#1ail *lothing *o. if it has the following infor!ation for 2EE2F 5alaries (ac)aging (ostage 0ent of warehouse space a. G& E"EEE G&EE"EEE % H of e!ployees on guaranteed contracts G4EE"EEE depending on si6e of ite!:s; shipped G EE"EEE depending on weight of ite!:s; shipped G2 E"EEE annual lease b. G'EE"EEE c. G1"E E"EEE d. G1"' E"EEE

4. 1orton 9raphics successfully bid on jobs printing standard noteboo) covers during the year using last yearIs price of GE.2% per cover. 7his a!ount was calculated fro! prior year costs" noting that no changes in any costs had occurred fro! the past year to the current year. ,t the end of the year" the co!pany !anager was shoc)ed to discover that the co!pany had suffered a loss. =Jow could this beF> she exclai!ed. =@e had no increases in cost and our price was the sa!e as last year. Kast year we had a healthy inco!e.> @hat could explain the co!panyIs loss in inco!e this current yearF a. b. c. d. 7heir costs were all variable costs and the a!ount produced and sold increased. 7heir costs were !ostly fixed costs and the a!ount produced this year was less than last year. 7hey used a different cost object this year than the previous year. 7heir costs last year were actual costs but they used budgeted costs to !a)e their bids.

. @hich type of co!pany does not have inventoriable costsF a. Lot#for#profit b. 5ervice c. 1erchandising d. 1anufacturing

$. 7he three categories of inventories co!!only found in !any !anufacturing co!panies are a. b. c. d. %. direct !aterials" direct labor" and indirect !anufacturing costs. purchased goods" period costs" and cost of goods sold. direct !aterials" wor)#in#process" and finished#goods. KI.A" .I.A" and weighted average.

Inventoriable costs are a. b. c. d. either finished goods or purchased goods for resale. a category of costs used only for !anufacturing co!panies. recorded as expenses when incurred and later reclassified as assets. recorded as assets when incurred.

&. (eriod costs are a. b. c. d. all costs in the inco!e state!ent other than cost of goods sold. defined as !anufacturing costs incurred this period on the schedule of cost of goods !anufactured. always recorded as assets when first incurred. those costs that benefit future periods.

'. 7he cost of a product can be !easured as any of the following except as cost a. b. c. d. gathered fro! all areas of the value chain. identified as period cost. designated as !anufacturing cost only. explicitly defined by contract.

1E. 7he pri!ary focus of cost !anage!ent is to a. help !anagers !a)e different decisions. b. calculate product costs.

c. aid !anagers in budgeting. d. distinguish between relevant and irrelevant infor!ation.

CHAPTER QUIZ SOLUTIONS:

1%a 2.d 3.a 4.b

.b $.c %.d &.a '.b 1E.a

BEWARE OF UNIT COSTS

Total Varia l! Fi&!'
"Vari!#$ "Fi&!'$

Unit
Sa%! C(an)!#
DANGER ZONE *or +#in) +nit ,o#t#

S,(!'+l! o* Co#t o* Goo'# Man+*a,t+r!' an' Sol'

B!)innin) 'ir!,t %at!rial# in-!ntor. / P+r,(a#!# A-aila l! *or +#! En'in) 'ir!,t %at!rial# in-!ntor. Dir!,t %at!rial# +#!' Dir!,t %an+*a,t+rin) la or In'ir!,t %an+*a,t+rin) ,o#t# 0Listing1 Varia l!

Fi&!' Total Man+*a,t+rin) ,o#t# in,+rr!' '+rin) ,+rr!nt 2!rio' / B!)innin) 3or45in52ro,!## in-!ntor. Total %an+*a,t+rin) ,o#t# to a,,o+nt *or En'in) 3or45in52ro,!## in-!ntor. Co#t o* )oo'# %an+*a,t+r!' / B!)innin) *ini#(!' )oo'# in-!ntor. Goo'# a-aila l! *or #al! En'in) *ini#(!' )oo'# in-!ntor. Co#t o* )oo'# #ol' 0to in,o%! #tat!%!nt1

In,o%! Stat!%!nt
R!-!n+! 0Sal!#1 Co#t o* )oo'# #ol' 0*ro% #,(!'+l!1 Gro## %ar)in O2!ratin) ,o#t# O2!ratin) in,o%!