a&mis 5251w. f. bentz a&mis 525 william f. bentz september 24, 2001 fisher college of...
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A&MIS 525 1W. F. Bentz
A&MIS 525
William F. BentzSeptember 24, 2001
Fisher College of Business
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Key Issues in Product Costing
TerminologyCost assignment processDrivers of activity costs incurredAccountsPoints of potential confusion
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Terminology--Cost
Cost is a sacrifice; a measurable cost is the relinquishment of a measurable asset or the creation of a measurable liability. Cost is an outflow or reduction in the service potential of the entity of interest.
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Terminology--Cost
In accounting, service potential can be thought of as the present value of the cash flows from an activity, at some level of risk, or adjusted for risk.
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Terminology--Cost
Actions that decrease the present value of cash outflows, at a given level of risk, are actions that decrease cost. Actions that increase the present value of future cash outflows, at a given level of risk, are actions that increase cost.
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Terminology—Cost
Actions that increase the risk of future cash flows are actions that increase cost. Actions that decrease the risk of future cash flows are actions that decrease cost. and so on.
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Terminology—Costing
Costing is the process of estimating the cost (sacrifice) of taking action. Costs are the result of undertaking and maintaining activities. Thus, costing is largely a matter of assigning costs (sacrifices) with the activities which caused those sacrifices.
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Terminology—Cost Object
A cost object is any activity for which a separate measurement of cost is desired. An activity involves doing something
Cost objects are derived from the purposes for which the cost information is to be used (different costs for different purposes).
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Terminology—Costing Systems
Costing systems are the information systems used to accumulate cost data either regularly or intermittently. Usually cost systems are flexible enough to collect information for a variety of purposes.
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Terminology—Costing Systems
A variety of costing systems may exist in any one organization (engineering, accounting, production, distribution).
In general, the idea is to index cost information so it can be used in a variety of ways.
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Terminology—Cost Analysis
Cost analysis is the process of assessing the expected impact of managerial decisions on the financial performance of an entity. Decision analysis includes cost analysis.
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Terminology—Cost Incurred
Cost incurred is the cost that an entity has experienced as a result of the execution of some activity for a specified period of time. Although it is in the past, cost incurred may have to be estimated. Accurate, valid measures of cost incurred require information about separable activities.
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Costing Objects
Next, let us consider how one associates the costs incurred to a set of cost objects in the costing process.
Costs
Incurred
Object 1
Object 2
Object 3
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Cost Assignment
Tracing – direct costs can be traced to cost objects
1. Ability to trace with acceptable accuracy, validity, and cost• Technology is improving our ability to trace• The more complex the production process, the
more difficult and costly the tracing process
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Cost Assignment
Tracing (continued)2. Cost-effective to trace costs
• The greater the cost, the greater the value of tracing
• Technology is reducing the cost of tracing• The value of tracing increases with competition• More complex mfg. systems increase the need
to trace
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Cost Assignment
Cost allocation is the process of assigning costs to cost objects when those costs cannot be traced cost-effectively. Cost allocation ranges from relatively
unambiguous, with high face validity, to relatively arbitrary.
Most distortions in product and service costing are related to cost allocation, not cost tracing.
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Cost Drivers
There are seven primary cost drivers at the macro level. The one considered most often in accounting is the time-rate of activity. Think of this as the volume of activity experienced during a time period. The driver volume is considered next.
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Cost Drivers - Volume
The issue is: How should we expect costs to behave (vary) with respect to changes in the time-rate of activity all else being equal. In traditional accounting terms: “How do costs behave with respect to changes in volume?” First, we consider the effects of volume changes on total costs.
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Total variable cost
Activity Volume
Total cost
Slope is the rate of change
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Total variable cost
Variable costs are those costs that vary in direct proportion to changes in activity volume. Such costs are normally rep-resented by a simple affine linear equation, y = vQ, where y represents the total variable cost, v represents the variable cost per unit of activity and Q represents the volume of activity during a period.
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Total step-variable cost
Step-variable costs are those costs that vary in small increments with respect to changes in activity volume. Such costs are also normally represented by a simple affine linear equation, y = vQ, where y represents the total variable cost, v represents the variable cost per unit of activity and Q represents the volume of activity during a period.
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Total step-variable cost
However, at a micro level, the increments may be relatively large and a local manager might treat the cost like a semi-fixed cost ( slide 28). It is a matter of perspective and required level of precision. Manager’s salaries effectively are variable from McDonald’s corporate perspective, but not from the perspective of a local franchisee with two restaurants.
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Total fixed cost
Activity Volume
Total cost
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Total fixed cost
Fixed costs are those costs that do not vary in total with respect to modest changes in activity volume. Such costs are represented by y = F, where y represents total cost, and F represents total fixed cost. Fixed costs do change over time, due to price changes and as a result of decisions, but they are relatively constant with respect to changes in activity volume, all else being equal.
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Total mixed cost
Activity Volume
Total cost Total cost curve
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Total mixed cost
Activity Volume
Total cost
Total cost curve
Fixed component
Variable component
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Total mixed cost
Semivariable or mixed costs are those costs that contain both a fixed and a variable component. Such costs are normally represented by a simple linear equation of the form Y = F + vQ, where y represents total cost, F represents total fixed cost, and v represents the variable cost per unit of activity, and Q is the volume of activity during a period.
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Total semi-fixed cost
Activity Volume
Total cost
Total cost curve
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Total cost (micro)
Activity Volume
Total cost
Total cost curveRelevant range
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Average cost (micro)
Volume
Average Unit Cost Total cost curve
Relevant range
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I am not lost, I am exploring
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“Product Costs (GAAP)
Product (inventoriable) costs include all manufacturing costs regardless of traceability or behavior. • Direct materials• Direct labor• Indirect labor, materials, depreciation,
services, etc.
Conversion
Prime cost
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“Product Costs (GAAP)
Period (non-inventoriable) costs are not part of the (inventoriable) cost of goods for financial reporting purposes Administrative costs (expenses) Marketing costs (order-getting expenses) Distribution costs (order-filling expenses)
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Meanings of Product Cost
R&D DesignProduc-
tionConsumer
ServiceDistri-bution
Market-ing
Inventoriable product costs
Reimbursable government
contract costs
Decision-relevant costs
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Accounting-Speak
Costs Incurred
Period Expenses
Product Costs
(Inventory)
Expensed During a Period
Assets (Prepaids)
(PP&E)
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The Flow of Costs
Inventory System
Work in Process
Finished Goods
Inventory
Cost of Goods Sold
Payroll System
Indirect Costs
Assigned
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