An Introduction to Cost Terms and Purposes

Reference Definition Classification of Cost Cost Terms Cost Statement

COST ACCOUNTING A Managerial Emphasis

Chapter 2: An Introduction to Cost Terms and Purposes

HORNGREN

DATAR

FOSTER

Eleventh Edition

Cost Accounting

An Introduction to Cost Terms and Purposes

measures and reports financial and non financial information relating to the cost of acquiring and utilizing resources in an organization. Accumulation of Cost Allocation of Cost

Cost Management
Reference: Cost Accounting A Managerial Emphasis Chapter 1; Page no. 3

An Introduction to Cost Terms and Purposes

Cost and Cost Terminologies Cost is a resource sacrificed or forgone to achieve a 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 separate measurement of costs is desired.
Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 30

An Introduction to Cost Terms and Purposes

Classification of Cost Manufacturing cost and Non manufacturing cost Product cost and Period cost Direct cost and Indirect cost Variable cost and Fixed cost

Direct Material, Direct Labor, Manufacturing Overhead Office and Administrative Overhead, Selling and Marketing Overhead
Reference: Cost Accounting A Managerial Emphasis Chapter 2

An Introduction to Cost Terms and Purposes

Product Cost
Product costs include all the costs that are involved buying or making a product. In the case of manufactured goods, these costs consist of direct materials, direct labor and manufacturing overheads. Product costs are viewed as those which are attached as the goods are bought or manufactured. This is the cost at which products are shown in the balance sheet---known as inventoriable costs.
Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 39

An Introduction to Cost Terms and Purposes

Period Cost
These are all the costs that are not included in the product costs. Such costs are expensed in the P&L account, during the period in which they occur. Period costs are not included as part of the product.
E.g.: telephone bill, sales commissions, depreciation office rent are good examples .

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 39

An Introduction to Cost Terms and Purposes

Direct Cost Direct Costs Example: Paper on which Sports Illustrated magazine is printed (Product cost)
Indirect Cost Indirect Costs Example: Lease cost for Time-Warner building housing the senior editors of its magazine (Period cost)

COST OBJECT Example: Sports Illustrated magazine

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 39

An Introduction to Cost Terms and Purposes

Cost Behavior Pattern Bicycles Ltd. buys a handlebar at $52 for each of its bicycles.
What is the total handlebar cost when 1,000 bicycles are assembled?

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Cost Behavior Pattern

1,000 units $52 = $52,000 What is the total handlebar cost when 3,500 bicycles are assembled? 3,500 units $52 = $182,000

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Cost Behavior Pattern

Bicycles Ltd. 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.

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Cost Driver 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.

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Relevant Range 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.

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Relevant Range
120000 100000 80000 60000 40000 20000 0 0 1000 2000

Fixed Costs

$94,500

3000 Volume

4000

5000

6000

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Total Cost and Unit Cost 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

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Cost Behavior
Y = a + bX Y = the total mixed cost a = the total fixed cost b = the variable cost per unit of activity X = the level of activity

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Use of Unit Cost Concept Assume that Bicycles management uses a 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
Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Use of Unit Cost Concept

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?

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Use of Unit Cost Concept

Total fixed cost $ 94,500 Total variable cost ($52 600) 31,200 Total $ 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.
Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Use of Unit Cost Concept

What should the budgeted cost be for an estimated production of 3,500 bicycles? Total fixed cost Total variable cost (52 3,500) Total $ 94,500 182,000 $ 276,500

$276,500 3,500 = $79.00

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes

Types of Inventory For Manufacturer: For Merchandiser: Raw Material Finished Goods Work in Process Finished Goods

Types of Cost
Direct Material Direct Labor Manufacturing Overhead
Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

Office and Administrative Overhead Selling and Marketing Overhead

An Introduction to Cost Terms and Purposes

Direct Material Cost

Direct Manufacturing Total Labor Cost Overhead Cost Manufacturing Conversion Cost Prime Cost Cost WIP Inventory

Cost of Goods Sold

Finished Goods Inventory

Cost of Goods Manufactured

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32

An Introduction to Cost Terms and Purposes A distraught employee, Fang W. Arson, put a torch to a manufacturing plant on a blustery February 26. The resulting blaze destroyed the plant and its contents. Fortunately, certain accounting records were kept in another building. They reveal the following for the period from January 1, 2004 to February 26, 2004:
Direct materials purchased Work in process 1.1.04 Direct materials 1.1.04 Finished goods 1.1.04 $160,000 34,000 16,000 30,000

Example (2 35)

Indirect manufacturing costs

Revenues Direct manufacturing labor Prime costs Gross margin percentage based on revenues Cost of goods available for sale

40% of conversion costs

$500,000 180,000 294,000 20% 450,000

Calculate the cost of (as on 2/26/2004): Finished goods inventory; Work in process inventory & Direct material inventory.

Reference: Cost Accounting A Managerial Emphasis Chapter 2; Page no. 32