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An Introduction to Cost Terms and Purposes

An Introduction to Cost Terms and Purposes. Chapter 2. 1/31/05. Define and illustrate a cost object. Learning Objective 1. Cost and Cost Terminology. Cost is a resource sacrificed or forgone to achieve a specific objective. i.e., amount paid.

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An Introduction to Cost Terms and Purposes

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  1. An Introduction to CostTerms and Purposes Chapter 2 1/31/05

  2. Define and illustrate a cost object. Learning Objective 1

  3. Cost and Cost Terminology Cost is a resource sacrificed or forgone to achieve a specific objective. i.e., amount paid An actual cost is the cost incurred (a historical cost) as distinguished from budgeted costs. A cost object is anything for which a separate measurement of costs is desired. i.e., products, services, activities, processes, segments, etc.

  4. Cost and Cost Terminology Cost Object Cost Accumulation (Collecting cost data) Cost Object Cost Object Cost Assignment (tracing and allocating costs) Tracing Allocating

  5. Distinguish between direct costs and indirect costs. Learning Objective 2

  6. Direct and Indirect Costs COST OBJECT Example: Sports Illustrated magazine Allocated Direct Costs Example: Paper on which Sports Illustrated magazine is printed Indirect Costs Example: Lease cost for Time-Warner building housing all their senior executives, including Sports Illustrated

  7. Direct and Indirect CostsExample Direct Costs: Maintenance Department $40,000 Personnel Department (Admin) $20,600 Assembly Department $75,000 Finishing Department $55,000 Assume that Maintenance Department costs are allocated equally among the production departments. How much is allocated to each department?

  8. Direct and Indirect Costs Example Maintenance $40,000 Assembly Direct Costs $75,000 Finishing Direct Costs $55,000 $20,000 $20,000 Allocated

  9. Other Factors • Materiality – the larger the cost per unit, the more likely it will be traced as a direct cost • Information gathering technology – the more sophisticated, the more items that can be traced directly to cost objects, i.e. bar coding • Design of operations – all in one building, makes it easy to trace

  10. Explain variable costs and fixed costs. Variable Costs change in total in proportion to changes in the level of activity or volume. Fixed costs remain unchanged in total despite wide changes in the level of activity or volume. Learning Objective 3

  11. Cost Behavior Patterns Variable Cost Example Bicycles by the Sea buys a handlebar at $52 for each of its bicycles. Note: variable cost per unit of activity is constant What is the total handlebar cost when 1,000 bicycles are assembled?

  12. Cost Behavior Patterns Variable Cost Example 1,000 units × $52 = $52,000 What is the total handlebar cost when 3,500 bicycles are assembled? 3,500 units × $52 = $182,000

  13. Cost Behavior Patterns Fixed Cost Example Bicycles by the Sea incurred $94,500 in a given year for the leasing of its plant. This is an example of fixed costs with respect to the number of bicycles assembled. Note: In total, fixed costs won’t change. But on a per unit of activity basis, fixed costs will change

  14. Cost Behavior Patterns Fixed Cost Example What is the leasing (fixed) cost per bicycle when Bicycles assembles 1,000 bicycles? $94,500 ÷ 1,000 = $94.50 What is the leasing (fixed) cost per bicycle when Bicycles assembles 3,500 bicycles? $94,500 ÷ 3,500 = $27

  15. Cost Drivers The cost driver of variable costs is the level of activity or volume whose change causes the (variable) costs to change proportionately. The number of bicycles assembled is a cost driver of the cost of handlebars.

  16. Relevant Range Example Assume that fixed (leasing) costs are $94,500 for 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 of activity within which the fixed cost in total will not change.

  17. Relevant Range Example $94,500

  18. Interpret total unit costs cautiously. Remember, variable costs per unit are constant and fixed costs per unit will vary with the amount of activity or volume. Learning Objective 4

  19. Total Costs and Unit Costs Example What is the total 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

  20. Use Unit Costs Cautiously Assume that Bicycles management uses a total unit cost of $146.50 (leasing and wheels). Management is budgeting costs for different levels of production. What is their budgeted cost for an estimated production of 600 bicycles? 600 × $146.50 = $87,900?

  21. Use Unit Costs Cautiously What is their budgeted cost for an estimated production of 3,500 bicycles? 3,500 × $146.50 = $512,750? What should the budgeted cost be for an estimated production of 600 bicycles?

  22. Use Unit Costs Cautiously Total fixed cost $ 94,500 Total variable cost ($52 × 600) 31,200 Total Cost $125,700 $125,700 ÷ 600 = $209.50 Using a cost of $146.50 per unit would underestimate actual total costs if output is below 1,000 units.

  23. Use Unit Costs Cautiously What should the budgeted cost be for an estimated production of 3,500 bicycles? Total fixed cost $ 94,500 Total variable cost (52 × 3,500) 182,000 Total $276,500 $276,500 ÷ 3,500 = $79.00

  24. What do unit costs tell you? • Note in the changes in total unit cost At 600, unit cost is $206.50 At 1,000, unit cost is $146.50 At 3,500, unit cost is $ 79.00 • The greater the volume or level of activity within the relevant range, the lower the unit cost and vice versa • These changes are very useful in planning, pricing, budgeting, and evaluating performance

  25. Distinguish among manufacturing companies, merchandising companies, and service-sector companies. Learning Objective 5

  26. Manufacturing Manufacturing companies purchase materials and components and convert them into finished goods. Examples? A manufacturing company must also develop, design, market, and distribute its products.

  27. Merchandising Merchandising companies purchase and then sell tangible products without changing their basic form. Examples?

  28. Service Service companies provide services or intangible products to their customers. Examples? Labor is the most significant cost category.

  29. Describe the three categories of inventories commonly found in manufacturing companies Learning Objective 6

  30. Types of Inventory Manufacturing-sector companies typically 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

  31. Types of Inventory Merchandising-sector companies hold only one type of inventory – the product in its original purchased form. Service-sector companies do not hold inventories of tangible products.

  32. Differentiate between inventoriable costs and period costs Learning Objective 7

  33. Inventoriable Costs Inventoriable costs (assets)… become cost of goods sold… after a sale takes place.

  34. Period Costs Period costs are all costs in the income statement other than cost of goods sold. Period costs are recorded as expenses of the accounting period in which they are incurred.

  35. Flow of Costs ExampleSee Exhibit 2-6, p. 41, Panel B example Bicycles by the Sea had $50,000 of direct materials inventory at the beginning of the period. Purchases during the period amounted to $180,000 and ending inventory was $30,000. How much direct materials were used? $50,000 + $180,000 – $30,000 = $200,000

  36. Flow of Costs Example Direct labor costs incurred were $105,500. Indirect manufacturing costs were $194,500. What are the total manufacturing costs incurred? Direct materials used $200,000 Direct labor 105,500 Indirect manufacturing costs 194,500 Total manufacturing costs $500,000

  37. Flow of Costs Example Assume that the work in process inventory at the beginning of the period was $30,000, and $35,000 at the end of the period. What is the cost of goods manufactured? Beginning work in process $ 30,000 Total manufacturing costs 500,000 Ending work in process 35,000 Cost of goods manufactured $495,000

  38. Flow of Costs Example Assume that the finished goods inventory at the beginning of the period was $10,000, and $15,000 at the end of the period. What is the cost of goods sold? Beginning finished goods $ 10,000 Cost of goods manufactured 495,000 Ending finished goods 15,000 Cost of goods sold $490,000

  39. Flow of Costs Example Work in Process Beg. Balance 30,000 495,000 Direct mtls. used 200,000 Direct labor 105,500 Indirect mfg. costs 194,500 Ending Balance 35,000

  40. Flow of Costs Example Finished Goods 10,000 490,000 495,000 15,000 Work in Process 495,000 Cost of Goods Sold 490,000

  41. Manufacturing Company BALANCE SHEET INCOME STATEMENT Inventoriable Costs Revenues when sales occur deduct Materials Inventory Finished Goods Inventory Cost of Goods Sold Equals Gross Margin deduct Work in Process Inventory Period Costs Equals Operating Income

  42. Merchandising Company BALANCE SHEET INCOME STATEMENT Inventoriable Costs Revenues when sales occur deduct Merchandise Purchases Inventory Cost of Goods Sold Equals Gross Margin deduct Period Costs Equals Operating Income

  43. Explain why product costs are computed in different ways for different purposes. Learning Objective 8

  44. Many Meanings of Product Cost A product cost is the sum of the costs assigned 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

  45. Present key features of cost accounting and cost management. Learning Objective 9

  46. A Framework for Cost Management Three features of cost accounting and cost management: 1. Calculating the costs of products 2. Obtaining information for planning, control, and performance evaluation 3. Analyzing information

  47. End of Chapter 2

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