Chapter Two: An introduction to cost terms and purposes.

Basic Cost Terminology Cost Cost is a sacrificed resource (used resources) to achieve a specific objective. Sacrificed resourcescouldbe:Material,employeeefforts,ormachine. A cost is usually measured as a monetary amount that must be paid to acquire goodsandservices.

Cost can be viewed as:

Actual Cost Actualcostisthehistoricalamount orcostincurred.

Budgeted Cost Budgetedcostisapredicted, plannedorestimatedcost.

Cost Accumulation Cost accumulation describes the process of accumulating costs in some organized mannersthroughtheaccountingsystem. Cost object Costobjectisthepurposeforwhichcostsarebeingmeasured.Statedanotherway, itisanythingforwhichameasurementofcostisdesired: Costobjectcanbe: Vehicleplant ToushepaEl-Araby Blocksplant 1 Productline Privatecars LCDTV CementBlocks 2 Product ToyotaCorolla 32HD 1000Blocks 3 Customer ABo-Ghally OmrAfandi ArabConstructors 4 Service Hotline Hotline Hotline 5 Activity Settingup Warehousing Maintenance 6 Department Env. Health Safetydepartment department department

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Cost Classifications

Accordingto Businessfunction

Accordingtoits nature

1st Classification

Accordingtoits relationwith costobject

Aggregationor average

Accordingto itsbehavioral

Assets or expense

Costcanbeclassifiedaccordingtoitsbusinessfunctioninto:

Research& Development

Design costs

Production costs

Marketing costs

Distribution costs

Customer service costs

Exercise 1-17 Wilson,amanufacturingcompany,incursthefollowingcosts: Cost of redesigning decorative grills to make the product more appealing to customer(L.E.5000). Cost of DVDs sent to department stores to promote sales of a new model (L.E. 7500). Cost of a toll-free telephone line used for customer inquires about product usage andpoten alhazards(L.E.7500). Equipmentpurchasedtotesttheattributesofmaterialbeingconsideredtoreplace theexis ngproductsmaterial(L.E.25000). Paymenttoactorsforatelevisioninfomercialpromo nganewmodel(L.E.5000). Laborcostforworkersinthepackingareaofaproduc onfacility(L.E.15000). Bonuspaidtoproductlinemanagerforobtainingalucra vecontract(L.E.10000). Cost of UPS courier service to deliver a replacement part to a customer having problems(L.E.2000). Required: Findthetotalcostofeachfunction.

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Total cost of each function Amounts CostItem Sub. Research and Development Cost Equipmentpurchasedtotesttheattributesofmaterial Design of products Costofredesigningdecorativegrills Production Cost Laborcostforworkersinthepackingareaofaproductionfacility Marketing CostofDVDssenttodepartmentstores Paymenttoactorsforatelevisioninfomercialpromotinganewmodel Bonuspaidtoproductlinemanagerforobtainingalucrativecontract Distribution CostofUPScourierservicetodeliverareplacementparttoacustomer Customer Service Costofatoll-freetelephonelineusedforcustomerinquires Total Cost 7500 5000 25000 5000 15000 Tot.

10000 22500 2000 7500 77000

2nd Classification
Costcanbeclassifiedaccordingtoitsnatureinto:

Material Physicalitems Exercise 2.17

Labor Employeeefforts

Service/Expenses Others

BlackKnightCompanymanufacturessixtypesofhand-paintedchesspiecesinatwostepprocess.Thefollowingarecostsincurredduringthe2009.

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Costs Wood Paint Packingmaterials Depreciationonmachineryandmolds Rentonfactory Insuranceonfactory Factoryutilities Painters Painting WoodworkingDepartmentmanager Materialhandlers Custodianinfactory Nightguardinfactory Machinist(runningthemillingmachine) Machinemaintenancepersonnel Maintenancesuppliesforthefactory Cleaningsuppliesforthefactory Required:Indicatewhethereachcostisamaterial,labororservice. Classification of costs according its nature Costitem Wood Paint Packingmaterials Depreciationonmachineryandmolds Rentonfactory Insuranceonfactory Factoryutilities Painters PaintingDepartmentmanager WoodworkingDepartmentmanager Materialhandlers Custodianinfactory Nightguardinfactory Machinist(runningthemillingmachine) Machinemaintenancepersonnel Maintenancesuppliesforthefactory Cleaningsuppliesforthefactory Classificationofcosts Material Labor Service

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4th Classification Costcanbeclassifiedaccordingtoitsbehaviorinto: VariableCosts Variable cost changes in proportion with changes in the activity level. For example, if the number of units produced doubles, direct materials (a variable cost) would double in total. Note, however, that the variable cost perunitstaysthesame.

FixedCosts Fixed costs do not change due to changes in the activity level. If units produced doubles, fixed costs remain the same in total. However, when expressed on a per-unit basis, fixed costswoulddeclinewithanincreasein activity.

Major differences between variable cost and fixed cost Point of comparison Total Dollars Cost per Unit Variable Cost Changeinproportionwithoutput Moreoutput=Morecost Unchangedinrelationtooutput Fixed Cost Unchangedinrelationtooutput Changeinverselywithoutput Moreoutput=lowercostperunit

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Variable Cost Units 0 100 500 Cost per Total unit Variable Cost 10 10 10 0 1000 5000
Costs

Fixed Cost Units 0 100 500 Total Cost per Fixed Cost unit 5000 5000 5000

50 10

Total Costs

Costs

Units Costs

Units Units

Costs

Costper Unit

Units

Units

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Exercise 2.20 TheFremontCalifornia,plantaNewUnitedMotorManufacturing,Inc.(NUMMI),a jointventureofGeneralMotorsandToyota,assemblestwotypesofcars(Corollas andGeoPrisms).Separateassemblylinesareusedforeachtypeofcar. Required: Classifyeachofthefollowingcostitemsas: a. Directorindirect(DorI)costswithrespecttohowthetotalnumberofeach typeassembled. b. Variableorfixed(VorF)costswithrespecttohowthetotalcostsoftheplant changeasthetotalnumberofcarseachtypeassembledchanges. Cost item A B C D E F G H CostoftiresusedonGeoPrisms Salaryofpublicrelationmangerfortheplant AnnualrewardsdinnerforCorollaSuppliers SalaryofengineerwhomonitorsdesignchangesonGeoPrisms FreightcostsofCorollaenginesshippedfromToyotaCitytoCalifornia Electricitycostsfortheplant(singlebillcoversentireplant) Annualfireinsurancepolicycostsfortheplant. Wages paid to temporary assembly-line workers hired in periods of highproduction(paidonhourlybasis) The answer
Cost Item
A B C D E F G H

D or I

V or F

Explanation Costoftires Salaryofpublicrelationmanger AnnualrewardsdinnerforCorollaSuppliers SalaryofengineerwhomonitorsdesignchangesonGeoPrisms FreightcostsofCorollaenginesshippedfromToyotaCity Electricitycostsfortheplant Annualfireinsurancepolicycosts Wagespaidtotemporaryassembly-lineworkers

D or I
D I D D D I I D

V or F
V F F F V V F V

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Exercise 2.17 BlackKnightCompanymanufacturessixtypesofhand-paintedchesspiecesinatwostep process. The first step takes place in Woodworking Department where saws, lathes,andmillingmachinesareusedtocreatethepieces.InPaintingDepartment the wooden fabricated pieces are hand painted. After they dry, the pieces are packedandshippedtocustomers.BlackKnighttwodepartments,Woodworkingand painting,areinasinglefactorybuilding. Costs Wood Paint Packingmaterials Depreciationonmachineryandmolds Rentonfactory Insuranceonfactory Factoryutilities Painters Painting WoodworkingDepartmentmanager Materialhandlers Custodianinfactory Nightguardinfactory Machinist(runningthemillingmachine) Machinemaintenancepersonnel Maintenancesuppliesforthefactory Cleaningsuppliesforthefactory Required Indicate whether each cost is a direct or indirect, assuming "units of productionofeachkindofchesspiece"isthecostobject.

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Classification of Cost Elements

Wood Paint Packingmaterials(*) Depreciationonmachineryandmolds Rentonfactory Insuranceonfactory Factoryutilities(*) Painters PaintingDepartmentmanager WoodworkingDepartmentmanager Materialhandlers Custodianinfactory Nightguardinfactory Machinist(runningthemillingmachine) Machinemaintenancepersonnel(**) Maintenancesuppliesforthefactory Cleaningsuppliesforthefactory ClassificationofCostElements Variable Fixed

(*)Factoryutilitiesprobablysomevariableandsomefixed(e.g.electricitymay bevariablebutheatingcostsmaybefixed). (**) Machine maintenance personnel probably fixed, if salaried, but may be variable if paid only for time worked and maintenance increases with increasedproduction Notes: Itisimportanttodistinguishbetweenbehaviorsofcostwhenexpressedasunitcost andwhendealingwithtotalcosts.Generallydecisionmakersshouldthinkinterms oftotalcost.However,inmanydecisionscalculatingunitcostisessential. Costsarenotinherentlyfixedorvariable;itdependsonthedefinedcostobject.A particular cost item may be variable with respect to level of activity and fixed for another.

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A cost driver is what causes a cost to be incurred. Stated another way there is a cause-and-effectrelationshipbetweenthelevelofactivityofthecostdriverandthe costincurred. Relevant Range Relevant Range is the range of activity within which costs behave as predicated. Outside this level of activity (range), costs behave differently. Observation of the actualcostsmustbedoneinordertodeterminethisrange. 9000 7000 5000 3000 1000 1000 2000 3000 Relevant Range 4000 5000 6000

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