2009 foster business school cost accounting l.ducharme a review of cost terms and purposes chapter 2

2009 Foster Business School Cost Accounting L.DuCharme

A Review of CostTerms and Purposes

Chapter 2


Outline

• Cost terminology– Cost object– Assignment– Direct vs. Indirect– Variable vs. Fixed– Drivers– Relevant range– Average cost


Outline (continued)

• Manufacturing companies vs. others

• Inventory vs. period costs

• Flow of Costs: T-accounts

• Prime & conversion costs

• Different costs for different purposes


Cost and Cost Terminology

Cost is a resource sacrificed or forgone to achievea 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 separatemeasurement of costs is desired.


Cost and Cost Terminology

CostAssignment is both:

Cost ObjectTracing

Direct Costs

AllocatingIndirect Costs


Direct vs. Indirect costs

Distinguish between direct costsand indirect costs.


Direct and Indirect Costs

Direct CostsExample: Oak wood used to Mfg. of chairs.

Indirect CostsExample: salary of thePlant night watchperson.

COST OBJECT

Example: 50 Oak Chairs produced inMay.


Direct and Indirect CostsExample

Direct Costs:Maintenance Department $40,000Personnel Department $20,600Assembly Department $75,000Finishing Department $55,000

Assume that Maintenance Department costs areallocated equally among the production departments.

How much is allocated to each department?


Direct and Indirect Costs Example

Allocated$20,000

Maintenance$40,000

AssemblyDirect Costs

$75,000

FinishingDirect Costs

$55,000

$20,000


Cost Behavior Patterns Example

Bicycles by the Sea buys a handlebarat $52 for each of its bicycles.

What is the total handlebar cost when1,000 bicycles are assembled?

Variable vs. Fixed costs



1,000 units × $52 = $52,000

What is the total handlebar costwhen 3,500 bicycles are assembled?

3,500 units × $52 = $182,000



Bicycles by the Sea incurred $94,500 ina given year for the leasing of its plant.

This is an example of fixed costs withrespect to the number of bicycles assembled.



What is the leasing (fixed) cost per bicyclewhen Bicycles assembles 1,000 bicycles?

$94,500 ÷ 1,000 = $94.50

What is the leasing (fixed) cost per bicyclewhen Bicycles assembles 3,500 bicycles?

$94,500 ÷ 3,500 = $27


Cost Drivers

The cost driver of variable costs is the levelof activity or volume whose change causes

the (variable) costs to change proportionately.

The number of bicycles assembled is acost driver of the cost of handlebars.


Relevant Range Example

Assume that fixed (leasing) costs are $94,500for 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.


Relevant Range Example

020000400006000080000

100000120000

0 1000 2000 3000 4000 5000 6000

Volume

Fix

ed C

osts

$94,500


Relationships of Types of Costs

Direct

Indirect

Variable Fixed


“Average Costs”

Interpret unit costs cautiously.


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


Total Costs and Unit CostsExample

0

50000

100000

150000

200000

0 500 1000 1500

Volume

Tot

al C

osts

$94,500

$94,500 + $52x$146,500


Use Unit Costs Cautiously

Assume that Bicycles management uses aunit cost of $146.50 (leasing and wheels).

Management is budgeting costs fordifferent levels of production.

What is their budgeted cost for anestimated production of 600 bicycles?

600 × $146.50 = $87,900



What is their budgeted cost for an estimatedproduction of 3,500 bicycles?

3,500 × $146.50 = $512,750

What should the budgeted cost be for anestimated production of 600 bicycles?



Total fixed cost $ 94,500Total variable cost ($52 × 600) 31,200Total $125,700

$125,700 ÷ 600 = $209.50

Using a cost of $146.50 per unit wouldunderestimate actual total costs if output

is below 1,000 units.



What should the budgeted cost be for anestimated production of 3,500 bicycles?

Total fixed cost $ 94,500Total variable cost (52 × 3,500) 182,000Total $276,500

$276,500 ÷ 3,500 = $79.00


Manufacturing vs. others

Distinguish among

manufacturing companies,

merchandising companies, and

service-sector companies.


Manufacturing

Manufacturing companiespurchase materials and components and

convert them into finished goods.

A manufacturing company must also develop,design, market, and distribute its products.


Merchandising

Merchandising companiespurchase and then sell tangible products

without changing their basic form.


Service

Service companiesprovide services or intangibleproducts to their customers.

Labor is the most significant cost category.


Inventoriable Costs

Differentiate between

inventoriable costs

and period costs.


Types of Inventory

Manufacturing-sector companiestypically 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


Types of Inventory

Merchandising-sector companies holdonly one type of inventory – the

product in its original purchased form.

Service-sector companies do nothold inventories of tangible products.


Classification ofManufacturing Costs

Direct materials costs

Direct manufacturing labor costs

Indirect manufacturing costs


Inventoriable Costs

Inventoriable costs (assets)…

become cost of goods sold…

after a sale takes place.


Period Costs

Period costs are all costs in the incomestatement other than cost of goods sold.

Period costs are recorded as expenses of theaccounting period in which they are incurred.


Flow of Costs

• T-account diagram (in class)


Prime Costs(all direct mfg. costs)

DirectMaterials

DirectLabor

PrimeCosts+ =


Conversion Costs(all mfg. cost except DM)

DirectLabor

ManufacturingOverhead+ =

ConversionCosts

IndirectLabor

IndirectMaterials Other


Different Costs?

Product costs are

computed in different ways

for different purposes/uses.


Many Meanings of Product Cost

A product cost is the sum of the costsassigned to a product for a specific purpose.

1. Pricing and product emphasis decisions

2. Contracting with government agencies

3. Preparing financial statements for external reporting under generally accepted accounting principles


End of Chapter 2That’s all Folks!

2009 foster business school cost accounting l.ducharme a review of cost terms and purposes chapter 2

Documents

cost drivers

historical cost

actual cost

cost object example

cost driver of variable

leasing fixed cost

total handlebar cost

review of cost terms