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7/22/2019 CHAPTER 2 Cost Terms and Purpose
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Chapter 2 Introduction to Cost Terms andPurposes
A. Cost and Cost TerminologyB. Types of costs in an organization
C. Business Sectors, Types of Inventoriable costs
D. Financial statements of a manufacturingorganization
E. Overtime premium and idle time
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Costs and Cost Terminology
ACOSTis a resource given up so that a business
can achieve its objectives. ACOST OBJECT is anything for which a
measurement of cost is required. Examples of cost objects: Product: BMW X 5 sports activity vehicle Service: Dealer-support telephone hotline Project: R&D project on DVD system enhancement Customer: Herb Chambers Motors, a dealer that
purchases a broad range of BMW vehicles Activity: Setting up production machines Department: Environmental, Health and Safety
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Costs and Cost Terminology
An ACTUAL COSTis a cost that has been
incurred.For Example: wages paid to assembly lineworkers, office supplies purchased on
credit. A BUDGETED COSTis a predicted or
estimated cost such as 2012 estimated
wages. COST ACCUMULATION - a collection of cost
data in an organized manner
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Costs and Cost Terminology
COST ASSIGNMENT- charging both direct costs
and indirect costs to cost objects COST TRACINGcharging direct costs to cost
objects
COST ALLOCATIONcharging indirect costs to
cost objects
COST DRIVERa factor that is responsible for a
particular cost
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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
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Some Differences Between FinancialAnd 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
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Direct Costs
Direct costs can be conveniently and
economically traced (tracked) to a costobject. Direct materials cost are those materials
that become an integral part of the
manufactured product and their costs can betraced to that product in an economicallyfeasible manner. Examples:
Wood used in the production of desks Drawer handles for the desks Drawer locks
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Direct Costs
Direct manufacturing labor cost are those
labor costs that can be traced to the creationof products in an economically feasible way.
Examples of direct labor costs:
Assembly line workers wages
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Indirect Costs
Factory overhead are costs that relate to a product
but cannot be traced to it in an economically feasiblemanner, 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
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Direct and Indirect Costs
The distinction between direct cost and
indirect costs is important because directcosts are charged directly to cost objectswhereas indirect costs are pooled and thenallocated to the cost object
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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 therelated activity
Variable costs are constant on a per-unit basis.If a product takes 5 pounds of materials each, itstays the same per unit regardless if one, ten, or
a thousand units are produced.
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Cost behavior
Number of Direct Materials Total Direct
Desks produced Cost per desk Materials costs 200 Desks $15 $3,000
300 Desks $15 $4,500
400 Desks $15 $6,000
Total variable cost changes as the level ofactivity changes but unit variable cost does notchange.
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%
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Cost behavior
Fixed costs remain unchanged in total regardless
of changes in the related level of activity orvolume.
Number of Total Factory rentDesks produced Factory rent per desk
200 Desks $15 ,000 $75
300 Desks $15,000 $50
400 Desks $15,000 $37.50
Unit fixed costs decreases as more desks areproduced.
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Cost Behavior Summarized
Total Dollars Cost per UnitTotal Dollars Cost Per Unit
Variable Costs
Change in
proportion withoutput
More output = More cost
Unchanged in
relation to output
Fixed Costs Unchanged inrelation to output
Change
inversely withoutput
More output = lower cost
per unit
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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 affectscosts over a given time span
Relevant range - the band of normal activitylevel (or volume) in which there is a specific
relationship between the level of activity (orvolume) and a given cost
For example, fixed costs are considered fixed
only within the relevant range.
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Relevant Range Visualized
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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
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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 bydividing total costs by the number of units.
Example:
Total costs $19,500/300 desks = $65 per desk
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A Cost Caveat
Unit costs should be used cautiously. Because
unit costs change with a different level ofoutput or volume, it may be more prudent tobase decisions on a total dollar basis.
Unit costs that include fixed costs shouldalways reference a given level of output oractivity.
Unit costs are also called average costs.
Managers should think in terms of total costsrather than unit costs.
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Different Types of Companies
Manufacturing companies purchase materialsand other components and converts them intofinished products through the efforts ofworkers and other productive resources
Merchandising companies purchase productsin large quantities and sells them tocustomers in smaller amounts withoutchanging their basic forms
Service companies provide a service, anintangible product. For example accounting,legal and consulting services
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Types of Manufacturing Inventories
Direct materials - resources in-stock andavailable for use in production
Work-in-process (or progress) - productsstarted but not yet completed, often
abbreviated as WIP Finished goods - products completed and
ready for sale
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Types of product costs Also called inventoriable costs:
Inventoriable costs are first treated as anasset when incurred and expensed as costs ofgoods sold when the products are sold.
Direct materialsacquisition costs of all
materials that will become part of the costobject. Direct laborcompensation of all manufacturing
labor that can be traced to the cost object.
Indirect manufacturingfactory costs that arenot traceable to the product in an economicallyfeasible way. Examples include lubricants,indirect manufacturing labor and utilities.
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Cost of Goods Manufactured(P2-32)
STEP 1
PANEL B: COST OF GOODS MANUFACTURED
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
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
Conseco Company
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Cost of Goods Manufactured(P2-32)
STEP 1
STEP 2
PANEL B: COST OF GOODS MANUFACTURED
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 $71,000Direct 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
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
Conseco Company
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Cost of Goods Manufactured Problem 2-32
STEP 1
STEP 3
STEP 2
PANEL B: COST OF GOODS MANUFACTURED
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 $71,000Direct 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 $21,000Total 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
Schedule of Cost of Goods Manufactured*
For the Year Ended December 31, 2011 (in Thousands)
* Note that this s chedule can becom e a Schedule of Co st o f Goo ds M anufactured and Sold simply by including the beginning and
ending finished goo ds invento ry figures in the supporting schedule rather than in the body of the inco me statement.
Conseco Company
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Multiple-Step Income Statement (P2-32)
STEP 4
Revenues $300,000
Costs of goods sold:
Beginning finished goods inventory, January 1, 2011 $18,000
Costs of goods available for sale $136,000Costs of goods manufactured (see Panel B) $154,000
Ending finished goods inventory, December 31, 2011 $23,000
Cost of goods sold $131,000
Gross margin (or gross profit) $169,000
Operating costs
Mktg., dist., & cust.-service cost $93,000
Total operating costs $93,000
Operating income $76,000
Conseco Company
Income Statement
For the Year Ended December 31, 2011 (in thousands)
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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.
L b l f
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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 of40 hours per week.
This week Mark works 48 hours but is idle for 3 hoursdue 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
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Different Definitions of Costsfor Different Applications
Pricing and product-mix decisionsdecisionsabout pricing and maximizing profits
Contracting with government agenciesveryspecific definitions of allowable costs for costplus profit contracts
Preparing external-use financial statementsGAAP-driven product costs only
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Three Common Features ofCost Accounting and Cost Management
Calculating the cost of products, services, andother cost objects
Obtaining information for planning and control,
and performance evaluation Analyzing the relevant information for making
decisions
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Different Definitions of Costsfor Different Applications