Cost Accounting

Foundations and Evolutions

Kinney, Prather, Raiborn

Chapter 2
Cost Terminology and
Cost Behaviors
 Learning Objectives (1 of 2)

• Explain assumptions about cost behavior an

d why these assumptions are necessary
• List the cost classifications and explain why
the classifications are useful
• Describe the conversion process in service a
nd manufacturing companies
 Learning Objectives (2 of 2)

• List product cost categories and their compo

nents
• Calculate the Cost of Goods Manufactured
and explain how it is used in the Income Sta
tement
 Cost Categories
• Association with cost object
Cost object is anything for which management wants to col
lect or accumulate costs
• Reaction to changes in activity
• Classification on the financial statements
 Cost Categories
• Association with cost object
– Direct - traceable to a cost object
– Indirect - not conveniently or practically tracea
ble to a cost object
• treated as overhead
• allocated
 Cost Categories
• Reaction to changes in activity
– Variable
– Fixed
– Mixed
– Step

Relevant Range – normal operating range

 Total and Unit Cost Behavior
Total Cost Unit Cost

Varies in direct Remains constant

Variable proportion to throughout the
Cost changes in activity relevant range

Fixed Remains constant Varies inversely

Cost throughout with changes in
the relevant range activity throughout
the relevant range
 Cost Categories
• Classification on the financial statements
– Unexpired – balance sheet assets
– Expired – income statement expenses
– Product – inventoriable costs
• Prime – direct material and direct labor
• Conversion – direct labor and overhead
– Period – expensed in period incurred
 Product Costs
• Direct material
– Measurable part of a product
• Direct labor
– Labor used to manufacture a product or perfor
m a service
• Overhead
– Indirect production cost
 Period Costs
• Selling and administrative costs
• Distribution costs
– Cost to warehouse, transport, and/or deliver a p
roduct or service
– Major impact on managerial decision making
 Conversion Process
Change Inputs into Outputs
Input Output
Purchase
Product or
raw materials
Service
or supplies

CONVERSION
Manufacturer
Significant amount of labor and machinery
Tangible output
Input Output
Purchase Finished
raw materials product
and supplies

Production
Center
Sell to
add labor and
overhead customer
 Cost Accumulation in a
Manufacturing Company
Materials
Inventory

Work in Process
Inventory Cost of
Goods
Finished Sold
Goods
Income
Inventory
Balance Sheet Statement
 Product Cost - Direct
• Direct Material
– Conveniently and economically traced
to cost object
• Direct Labor
– to manufacture a product or perform a service
– includes wages paid to direct labor employees,
production bonuses, payroll taxes
– may include holiday and vacation pay, insuranc
e, retirement benefits
 Product Cost - Indirect
• Overhead - indirect production costs
– Fringe benefits, if cannot be easily traced to pro
duct
– Overtime, if due to random scheduling
– Cost of quality
• Prevention costs
• Appraisal costs
• Failure costs
 Product Cost Behavior

• Direct Material Variable

• Direct Labor Variable

• Overhead Variable, fixed, or mixed

 Overhead Cost Allocation
Assign indirect costs to one
or more cost objects
• To determine full absorption cost (GAAP)
• To motivate management
• To compare alternative courses of action for
planning, controlling, and decision making
Allocation process should be
rational and systematic
 Allocating Overhead
Actual vs. Normal
Product Cost Actual Cost S Normal Cost Syst
ystem em
Direct Materials Actual Actual

Direct Labor Actual Actual

Overhead Actual Predetermined

Overhead Rate
 Predetermined Overhead Rate
• Allows overhead to be assigned during the p
eriod
• Compensates for fluctuations
– that are not related to activity level
– in activity level that do not affect fixed overhea
d
 Questions

• What is the difference between a fixed and

variable cost?
• What are the three components of product c
ost?
• What are the three inventory accounts for a
manufacturing company?