Chapter 2 Introduction to Cost Terms and Purposes A. B. C. D.

Cost and Cost Terminology Types of costs in an organization Business Sectors, Types of Inventoriable costs Financial statements of a manufacturing organization E. Overtime premium and idle time

Costs and Cost Terminology

A COST is a resource given up so that a business can achieve its objectives. A COST OBJECT is anything for which a measurement of cost is required. Examples of cost objects:
Product: Service: Project: Customer:

BMW X 5 sports activity vehicle Dealer-support telephone hotline R&D project on DVD system enhancement Herb Chambers Motors, a dealer that purchases a broad range of BMW vehicles Activity: Setting up production machines Department: Environmental, Health and Safety

Costs and Cost Terminology

An ACTUAL COST is a cost that has been incurred. For Example: wages paid to assembly line workers, office supplies purchased on credit. A BUDGETED COST is a predicted or estimated cost such as 2012 estimated wages. COST ACCUMULATION - a collection of cost data in an organized manner

Costs and Cost Terminology

COST ASSIGNMENT COST TRACING

and indirect costs to cost objects

- charging both direct costs

objects

charging direct costs to cost

charging indirect costs to

COST ALLOCATION

cost objects

COST DRIVER

particular cost

a factor that is responsible for a

Manufacturing Company Costs

Manufacturing costs : Nonmanufacturing costs Direct costs : Selling costs >Direct materials costs: > Sales Commision >Direct labor costs : > Shipping costs Indirect costs : Administrative costs >Factory overhead : > CFO Salary

Some Differences Between Financial And Managerial Accounting

Financial accounting: Managerial accounting Governed by GAAP: Not governed by GAAP Mandatory: Not mandatory Historical in nature: Focuses more on the future For external reporting: For internal reporting

Direct Costs

Direct costs can be conveniently and economically traced (tracked) to a cost object. Direct materials cost are those materials that become an integral part of the manufactured product and their costs can be traced to that product in an economically feasible manner. Examples: Wood used in the production of desks Drawer handles for the desks Drawer locks

Direct Costs

Direct manufacturing labor cost are those labor costs that can be traced to the creation of products in an economically feasible way. Examples of direct labor costs: Assembly line workers wages

Indirect Costs

Factory overhead are costs that relate to a product but cannot be traced to it in an economically feasible manner, such as: Indirect materials: - Cleaning supplies - Lubricants Indirect Labor: - Plant supervisor salary - Materials handlers wages Other indirect costs: - Factory utilities - Factory insurance - Depreciation of factory facilities & machinery

Direct and Indirect Costs

The distinction between direct cost and indirect costs is important because direct costs are charged directly to cost objects whereas indirect costs are pooled and then allocated to the cost object

Cost behavior - Variable Costs

Cost behavior is the manner in which a cost changes as the related activity changes A variable cost is a cost that changes in total in proportion to the changes in the level of the related activity Variable costs are constant on a per-unit basis. If a product takes 5 pounds of materials each, it stays the same per unit regardless if one, ten, or a thousand units are produced.

Cost behavior

Number of Direct Materials Total Direct Desks produced Cost per desk Materials costs
200 Desks 300 Desks 400 Desks $15 $15 $15 $3,000 $4,500 $6,000

Total variable cost changes as the level of activity changes but unit variable cost does not change. Percentage change in the desks produced:
(300-200 =100) 100/200 = 50%

Percentage change in the materials costs:

(4,500-3,000 =1,500) 1,500/3,000 = 50%

Cost behavior
Fixed costs remain unchanged in total regardless of changes in the related level of activity or volume. Number of Total Factory rent Desks produced Factory rent per desk

200 Desks 300 Desks 400 Desks

$15 ,000 $15,000 $15,000

$75 $50 $37.50

Unit fixed costs decreases as more desks are produced.

Cost Behavior Summarized

Total Unit Total Dollars Dollars Cost Cost per Per Unit
Variable Costs Change in proportion with output
More output = More cost

Unchanged in relation to output Change inversely with output

More output = lower cost per unit

Fixed Costs

Unchanged in relation to output

Other Cost Concepts

Prime cost is a combination of direct materials and direct labor costs Conversion cost consists of direct labor and factory overhead Cost driver - a variable that causally affects costs over a given time span Relevant range - the band of normal activity level (or volume) in which there is a specific relationship between the level of activity (or volume) and a given cost For example, fixed costs are considered fixed only within the relevant range.

Relevant Range Visualized

Other Cost Concepts

Costs may be classified as: >Direct/Indirect, and >Variable/Fixed These multiple classifications give rise to important cost combinations:

>Direct and variable >Direct and fixed >Indirect and variable >Indirect and fixed

Total Costs and Unit Costs

Total costs consists of all costs. Example: Total costs of producing 300 desks: Variable costs 300 desks x $15 = $4,500 Fixed costs 15,000 Total costs $19,500 Unit cost is an average cost that is computed by dividing total costs by the number of units. Example: Total costs $19,500/300 desks = $65 per desk

A Cost Caveat

Unit costs should be used cautiously. Because unit costs change with a different level of output or volume, it may be more prudent to base decisions on a total dollar basis. Unit costs that include fixed costs should always reference a given level of output or activity. Unit costs are also called average costs. Managers should think in terms of total costs rather than unit costs.

Different Types of Companies

Manufacturing companies purchase materials and other components and converts them into finished products through the efforts of workers and other productive resources Merchandising companies purchase products in large quantities and sells them to customers in smaller amounts without changing their basic forms Service companies provide a service, an intangible product. For example accounting, legal and consulting services

Types of Manufacturing Inventories

Direct materials - resources in-stock and available for use in production Work-in-process (or progress) - products started but not yet completed, often abbreviated as WIP Finished goods - products completed and ready for sale

Also called inventoriable costs: Inventoriable costs are first treated as an asset when incurred and expensed as costs of goods sold when the products are sold. Direct materialsacquisition costs of all materials that will become part of the cost object. Direct laborcompensation of all manufacturing labor that can be traced to the cost object. Indirect manufacturingfactory costs that are not traceable to the product in an economically feasible way. Examples include lubricants, indirect manufacturing labor and utilities.

Types of product costs

Cost of Goods Manufactured (P2-32)

PANEL B: COST OF GOODS MANUFACTURED Conseco Company Schedule of Cost of Goods Manufactured* For the Year Ended December 31, 2011 (in Thousands) Direct materials: Beginning inventory, January 1, 2011 $22,000 Purchases of direct materials $75,000 Cost of direct materials available for use $97,000 Ending inventory, December 31, 2011 $26,000 Direct materials used

STEP 1

$71,000

Cost of Goods Manufactured (P2-32)

PANEL B: COST OF GOODS MANUFACTURED Conseco Company Schedule of Cost of Goods Manufactured* For the Year Ended December 31, 2011 (in Thousands) Direct materials: Beginning inventory, January 1, 2011 $22,000 Purchases of direct materials $75,000 Cost of direct materials available for use $97,000 Ending inventory, December 31, 2011 $26,000 Direct materials used Direct manufacturing labor Manufacturing overhead costs: Indirect manufacturing labor $15,000 Plant insurance $9,000 Depreciation-plant, building and equipment $11,000 Repairs and maintenance - plant $4,000 Total manufacturing overhead costs

STEP 1

$71,000 $25,000

STEP 2

$39,000

Cost of Goods Manufactured

Problem 2-32

STEP 1

STEP 2

STEP 3

PANEL B: COST OF GOODS MANUFACTURED Conseco Company Schedule of Cost of Goods Manufactured* For the Year Ended December 31, 2011 (in Thousands) Direct materials: Beginning inventory, January 1, 2011 $22,000 Purchases of direct materials $75,000 Cost of direct materials available for use $97,000 Ending inventory, December 31, 2011 $26,000 Direct materials used $71,000 Direct manufacturing labor $25,000 Manufacturing overhead costs: Indirect manufacturing labor $15,000 Plant insurance $9,000 Depreciation-plant, building and equipment $11,000 Repairs and maintenance - plant $4,000 Total manufacturing overhead costs $39,000 Manufacturing cost incurr3ed during 2011 $135,000 Beginning work-in-progress inventory, January 1, 2011 $21,000 Total manufacturing costs to account for $156,000 Ending work-in-progress inventory, December 31, 2011 $20,000 Cost of goods manufactured (to income Statement) $136,000
* No te that this schedule can beco me a Schedule o f Co st o f Go o ds M anufactured and So ld simply by including the beginning and ending finished go o ds invento ry figures in the suppo rting schedule rather than in the bo dy o f the inco me statement.

Multiple-Step Income Statement (P2-32)

Conseco Company Income Statement For the Year Ended December 31, 2011 (in thousands) Revenues Costs of goods sold: Beginning finished goods inventory, January 1, 2011 Costs of goods available for sale Costs of goods manufactured (see Panel B) Ending finished goods inventory, December 31, 2011 Cost of goods sold Gross margin (or gross profit) Operating costs Mktg., dist., & cust.-service cost Total operating costs Operating income $300,000 $18,000 $136,000 $154,000 $23,000 $131,000 $169,000 $93,000 $93,000 $76,000

STEP 4

Other Cost Considerations

Prime cost is a term referring to all direct manufacturing costs (materials and labor). Conversion cost is a term referring to direct labor and indirect manufacturing costs. Overtime labor costs are considered part of indirect overhead costs. Idle time costs are considered part of indirect overhead costs.

Labor Costs Classification

Mark Hansen works on the companys assembly line. Marks basic wage rate is $20 an hour. He is paid time and a half (i.e. $30 per hour) for any work in excess of 40 hours per week. This week Mark works 48 hours but is idle for 3 hours due to machine breakdowns. How much of his wages would be allocated to direct labor costs? To overhead? Productive time (48 hrs 3hrs) 45 hrs x $20 = $900 Idle time 3 hrs x $20 = 60 Overtime premium 8 hrs x $10 = 80 Total pay $1,040 Direct labor costs $900; Overhead $60+80 = $140

Different Definitions of Costs for Different Applications

Pricing and product-mix decisionsdecisions about pricing and maximizing profits Contracting with government agenciesvery specific definitions of allowable costs for cost plus profit contracts Preparing external-use financial statements GAAP-driven product costs only

Three Common Features of Cost Accounting and Cost Management

Calculating the cost of products, services, and other cost objects Obtaining information for planning and control, and performance evaluation Analyzing the relevant information for making decisions

Different Definitions of Costs for Different Applications