Basic Cost Terminology

Cost
a resource sacrificed or foregone to achieve a
specific objective

Cost Object
Anything for which a separate measurement
of cost is made.
example: product, machine, service or
process, project, and program
 cost objects can vary in size from an entire
company, to a division or program within the
company, or down to a single product or
service
Basic Cost Terminology
Cost accumulation – a collection of cost
data in an organized manner
Cost assignment – a general term that
includes tracing and allocating the
accumulated costs to a cost object. This
includes:
Tracing: assigning direct costs (costs
with a direct relationship to the cost
object)
Allocating: assigning indirect costs
(costs with an indirect relationship to a
cost object)
Direct & Indirect Costs
Direct costs – can be conveniently and
economically traced (tracked) to a cost object
Direct Costs examples: Parts and Assembly line
wages
Indirect costs – cannot be conveniently or
economically traced (tracked) to a cost object.

 Instead of being traced, these costs are

allocated to a cost object in a rational and
systematic manner.
 Indirect Costs examples: Electricity, Rent
and Property taxes
BMW: Assigning Costs to a Cost
Object
Factors Affecting Direct / Indirect
Cost Classification
Cost Materiality

Availability of information-gathering
technology

Operational Design
Cost Behavior
Variable costs – changes in total in
proportion to changes in the related
level of activity or volume
Fixed costs – remain unchanged in
total regardless of changes in the
related level of activity or volume
Costs are fixed or variable only with
respect to a specific activity or a
given time period
Cost Behavior, continued
Variable costs – are constant on a per-unit
basis. If a product takes 5 pounds of
materials each, it stays the same per unit
regardless of one, ten or a thousand units
are produced
Fixed costs per unit – change inversely
with the level of production. As more units
are produced, the same fixed cost is spread
over more and more units, reducing the cost
per unit
Cost Behavior Summarized
Total Dollars
Total Dollars Cost per
Per Unit
Unit
Change in
Change in Unchanged in
Variable Costs proportion with
proportion with relation to output
Variable Costs output
output
More
Moreoutput
output==More
Morecost
cost
Change
Change
inversely inversely
with
Fixed Costs Unchanged in with output
Unchanged in output
relation to output More output = lower cost
Fixed Costs
relation to output More output = lower cost
perunit
per unit
Cost Behavior Visualized
Other Cost Concepts
Cost Driver – a variable that causally affects
costs over a given time span
Relevant Range – the 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.
Relevant Range Visualized
Multiple Classification of Costs
Costs may be classified as:
Direct / Indirect, and
Variable / Fixed
These multiple classifications give rise to
important cost combinations:
Direct & Variable
Direct & Fixed
Indirect & Variable
Indirect & Fixed
Multiple Classification of Costs,
Visualized
Different Types of Firms
Manufacturing-sector companies – create and
sell their own products
Merchandising-sector companies – product
resellers
Service-sector companies – provide services
(intangible products)
Types of Manufacturing
Inventories
Direct Materials – resources in-stock and
available for use
Work-in-Process (or progress) – products
started but not yet completed. Often
abbreviated as WIP
Finished Goods – products completed and
ready for sale
Accounting Distinction Between Costs
Period Costs
have no future value and are expensed as incurred.
are expensed on the income statement as they are
incurred
also called operating costs (excluding cost of
goods sold)
examples: selling, general and administrative costs
Product Costs
Are capitalized as assets (inventory) until they are
sold and transferred to Cost of Goods Sold
Expensed only when the product or service is sold
Are product manufacturing costs (inventoriable
costs)
Examples: materials and labour (manufacturing)
Types of Product Costs
Also known as Inventoriable Costs
Direct Materials
Direct Labor
Indirect Manufacturing – factory costs that are
not traceable to the product. Other common
names for this type of cost include
Manufacturing Overhead costs or Factory
Overhead costs.
Cost Flows
The Cost of Goods Manufactured and the
Cost of Goods Sold section of the Income
Statement are accounting representations of
the actual flow of costs through a production
system.
Note the importance of inventory accounts in
the following accounting reports, and in the
cost flow chart
Assume the ff information about the year 2009 to
see how costs flow in the manufacturing firm
Revenue $
210,000
Direct materials purchased
73,000
Period costs 70,000
Direct manufacturing labor cost
Inventories Jan 1, 2009 Dec 31, 2009
9,000
DM $ 11,000 $8,000
Manufacturing overheads
WIP
20,000 6,000 7,000
FG 22,000 18,000
Cost Flows Visualized
Cost of Goods Manufactured
Multiple-Step Income Statement
Other Cost Considerations
Prime cost is a term referring to all direct
manufacturing costs (labor and materials)
Conversion cost is a term referring to direct
labor and factory overhead costs, collectively

Overtime labor costs are considered part of

overhead due to the inability to precisely
know the true cause of these costs
Different Definitions of Costs
for Different Applications
Pricing and product-mix decisions – may use
a “super” cost approach (comprehensive)
Contracting with government agencies – very
specific definitions of cost for “cost plus
profit” contracts
Preparing external-use financial statements –
GAAP-driven product costs only
Different Definitions of Costs
for Different Applications
Three Common Features of
Cost Accounting & Cost Management
1. Calculating the cost of products, services,
and other cost objects
2. Obtaining information for planning &
control, and performance evaluation
3. Analyzing the relevant information for
making decisions
Illustration
 Assume the following information is available for the HH Company for February 200X.
Indirect manufacturing costs:
Beginning inventories: Indirect materials $15,000
Direct materials $10,000 Indirect labor 40,000
Work in process 30,000 Depreciation 50,000
Finished goods 26,000 Electric power 60,000
Ending inventories: Property taxes & Insurance 5,000
Direct materials 20,000 Repair and maintenance 25,000
Work in process 40,000 Miscellaneous 8,000
Finished goods 20,000

Selling and Administrative expenses 45,000

Direct materials purchased 90,000 Sales 650,000

Direct labor used 100,000

Required
Assume full absorption costing is used prepare an Income Statement and separate
Schedule of Cost of Goods Manufactured for the HH Company for February.
Exercise
Ayesha Products Limited purchased materials of $
440,000 and incurred direct labor of $ 320,000 during
the year ended June 30, 2006. Total factory overheads
for the year were $280,000.
The inventory balances are as follows:
July 1, 2005 June 30,
2006
Finished goods $ 90,000 $105,000
Work in process 121,000 110,000
Materials 100,000 105,000
Required: determine
1) The Cost Of Goods Manufactured.
2) The Cost Of Goods sold