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Nature and Scope of Cost

Accounting
Unit 1 Part B

Cost Concepts and Classifications


Cost are associated with all types of
organizations business, nonbusiness,
service, retail and manufacturing. Generally,
the kinds of costs that are incurred and the
way in which costs are classified will depend
on the type of organization involved.

Basic Cost Terminology


Costsacrificed resource to achieve a

specific objective
Actual costa cost that has occurred
Budgeted costa predicted cost
Cost objectanything of interest for
which a cost is desired (product, customer
order, contract, product line and others).

Basic Cost Terminology


Cost accumulationa collection of cost data

in an organized manner
Cost assignmenta general term that
includes gathering accumulated costs to a
cost object. This includes:
Tracing accumulated costs with a direct
relationship to the cost object and
Allocating accumulated costs with an indirect
relationship to a cost object

Learning Objective 1

Cost classified in relation


to a product

A. Manufacturing Costs/Product Costs

Manufacturing costs are often


classified as follows:
Direct
Material

Direct
Labor

Prime
Cost

Manufacturing
Overhead

Conversio
n
Cost

Manufacturing Costs
Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

Manufacturing
Manufacturing
Overhead
Overhead

Direct Materials
Raw materials that become an
integral part of the product and
that can be conveniently traced
directly to it.

Example:
Example: A
A radio
radio installed
installed in
in an
an automobile
automobile

Direct Labor
Those labor costs that can be
easily traced to individual units of
product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

Manufacturing Overhead
Manufacturing costs that cannot be
traced directly to specific units
produced.
Examples:
Examples: Indirect
Indirect materials
materials and
and indirect
indirect labor
labor
Materials used to support
the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.

Wages paid to employees


who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.

B. Nonmanufacturing Costs/Period Costs

Selling
Costs

Administrati
ve Costs

Costs necessary to
secure the order and
deliver the product.

All executive,
organizational, and
clerical costs.

Product Costs Versus Period Costs


Product costs
include direct
materials, direct
labor, and
manufacturing
overhead.

Inventory

Cost of Good Sold

Period costs include all


selling costs and
administrative costs.

Expense

Sale

Balance
Sheet

Income
Statement

Income
Statement

Learning Objective 2

Cost classified as to
variability

Cost Classifications for Predicting Cost


Behavior

How
How aa cost
cost will
will react
react
to
to changes
changes in
in the
the
level
level of
of activity
activity
within
within the
the relevant
relevant
range.
range.
Total variable costs
Total variable costs

change
change when
when activity
activity
changes.
changes.
Total fixed costs
Total fixed costs
remain
remain unchanged
unchanged
when
when activity
activity
changes.
changes.

Fixed Cost and the Relevant Range

Cost drivera variable that affects costs over a


given time span

Relevant rangethe band of normal activity


level (or volume) in which there is a specific
relationship between the level of activity (or
volume) and a given cost
For example, fixed costs are considered fixed only
within
the relevant range.

The Activity Base (also called a cost driver)


Machine
hours

Units
produced
A measure of what
causes the
incurrence of a
variable cost
Miles
driven

Labor
hours

Fixed Costs and the Relevant Range


For example, assume office space is available at
a rental rate of $30,000 per year in increments of
1,000 square feet.
Fixed costs would
increase in a step fashion
at a rate of $30,000 for
each additional 1,000
square feet.

Cost Classifications for Predicting Cost


Behavior

Behavior of Cost (within the relevant range)


Cost

In Total

Per Unit

Variable

Total variable cost changes


as activity level changes.

Variable cost per unit remains


the same over wide ranges
of activity.

Fixed

Total fixed cost remains


the same even when the
activity level changes.

Average fixed cost per unit goes


down as activity level goes up.

Learning Objective 3

Assigning Costs to Costs


Objects

Direct costs

Costs that can be


easily and
conveniently
traced to a unit of
product or other
cost object.
Examples: direct
material and direct
labor

McGraw-Hill/Irwin

Indirect costs

Costs that cannot be easily and


conveniently traced to a unit of product or
other cost object.
Example: manufacturing overhead

Learning Objective 4

Cost Flow of
Manufacturing Firm

Manufacturing Cost Flows


Balance
Sheet
MaterialCosts
Purchases
Inventories
Direct Labor
Manufacturing
Overhead

Selling and
Administrative

Raw Materials

Income
Statement
Expenses

Work in
Process
Finished
Goods

Period
Costs

Cost of
Goods
Sold
Selling and
Administrativ
e

Product Cost Flows


Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs

Work
In Process

Direct materials

As
As items
items are
are removed
removed from
from raw
raw
materials
materialsinventory
inventoryand
andplaced
placedinto
into
the
the production
production process,
process,they
theyare
are
called
calleddirect
direct materials.
materials.

Product Cost Flows


Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Work
In Process

Conversion
Conversion
costs
costs are
are costs
costs
incurred
incurred to
to
convert
convert the
the
direct
direct material
material
into
into aafinished
finished
product.
product.

Product Cost Flows


Raw Materials

+
=

Beginning raw
materials inventory
Raw materials
purchased
Raw materials
available for use
in production
Ending raw materials
inventory
Raw materials used
in production

Manufacturing
Costs
Direct materials
+ Direct labor
+ Mfg. overhead
= Total manufacturing
costs

Work
In Process
Beginning work in
process inventory
+ Total manufacturing
costs
= Total work in
process for the
period

All
Allmanufacturing
manufacturingcosts
costsincurred
incurred
during
during the
theperiod
periodare
areadded
addedto
tothe
the
beginning
beginning balance
balanceof
of work
workin
in
process.
process.

Product Cost Flows


Raw Materials

Manufacturing
Costs

Beginning raw
Direct materials
materials inventory
+ Direct labor
+ Raw materials
+ Mfg. overhead
purchased
= Total manufacturing
= Raw materials
costs
available for use
in production
Ending raw materials
inventory
Costs
associated
with
associated
with the
the goods
goods that
that
=Costs
Raw materials
used
are
areincompleted
completed
during the
theperiod
periodare
are
production during

transferred
transferredto
tofinished
finished goods
goods
inventory.
inventory.

Work
In Process

+
=

Beginning work in
process inventory
Total manufacturing
costs
Total work in
process for the
period
Ending work in
process inventory
Cost of goods
manufactured

Product Cost Flows


Work
In Process

+
=

Beginning work in
process inventory
Manufacturing costs
for the period
Total work in process
for the period
Ending work in
process inventory
Cost of goods
manufactured

Finished Goods
Beginning finished
goods inventory
+ Cost of goods
manufactured
= Cost of goods
available for sale
- Ending finished
goods inventory
Cost of goods
sold

Learning Objective 5

Manufacturing and
Merchandising
Statement

Comparing Merchandising and Manufacturing


Companies

Merchandisers . . .
Buy

finished
goods.
Sell finished
goods.
MegaLoMart

McGraw-Hill/Irwin

Manufacturers .
..
Buy

raw
materials.
Produce and
sell finished
goods.

Balance Sheet
Merchandiser
Current assets
Cash
Receivables
Merchandise

Inventory

Manufacturer
Current Assets
Cash
Receivables
Inventories
Raw Materials
Work in Process
Finished Goods

Balance Sheet
Merchandiser
Current assets
Cash
Receivables
Merchandise Inventory

Partially complete
products some
material, labor, or
overhead has been
added.

Manufacturer
Current
Assets
Materials waiting to
Cash
be processed.
Receivables

Inventories
Raw Materials
Work in Process
Finished Goods

Completed products
awaiting sale.

The Income Statement


Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for
merchandisers.
Merchandising Company
Cost of goods sold:
Beg. merchandise
inventory
+ Purchases
Goods available
for sale
- Ending
merchandise
inventory
= Cost of goods
sold

$ 14,200
234,150
$ 248,350

(12,100)
$ 236,250

End of the chapter