Full Costs and Their Uses 17 Full Costs and Their Uses

Cost & Cost Object Cost = a measurement, in monetary terms, of amount of resources used for some purpose. Cost object = cost objective = product, project, organizational unit, or other activity or purpose for which costs are measured. Can be defined broadly or narrowly, e.g. one pair of jeans or a batch of a single style of jeans.

Cost Concepts Full cost = all resources used for a cost object = direct costs + fair share of indirect costs. Direct costs of a cost object = items of cost specifically traced to, or caused by, cost object.

Indirect Costs Costs associated with or caused by, 2 or more cost objects jointly but not directly traceable to each of them individually. Not possible or feasible to trace directly to a cost object. Terms direct and indirect are only meaningful in context of a specific cost object.

GAAP Inventory Costs Applicable accounting principles Limited guidance. Any systematic and rational method is allowed. Absorption cost accounting required. Full production cost of inventory items. Direct + Indirect production costs. Full cost = full production costs +non-production costs. Non-production costs = all costs other than inventory. Marketing (order getting), logistics (order filling), R&D, general & administrative.

Elements of product cost Product costing system = the system that accumulates and reports costs of product cost objects. Direct material = raw materials = quantities of material that can be specifically identified with a cost object in an economically feasible manner, priced at unit price of direct material. Distinguished from supplies, or indirect materials.

Conversion Costs Direct labor costs of a cost object = labor quantities * unit price of direct labor. Usually only DM & DL are direct costs. Overhead costs = all indirect production costs. Conversion costs = direct labor cost + overhead cost = all production costs needed to convert direct material into finished goods. Full production cost = DM + conversion cost = inventory cost = product costs.

Full Cost = Full production cost + Selling cost (marketing & logistics) + General and administrative cost

Product costing systems 3 sections: acquisition, production, sale. Acquisition: accounts related to the acquisition of resources. Materials inventory xxx Other assets & liability accounts xxx Cash or account payable xxx

Production: accounts related to the production process. Work-in-process inventory xxx Materials inventory xxx Wages payable xxx Work in process inventory xxx Overhead Clearing xxx Finished goods inventory xxx

Overhead Clearing Account Costs are cleared out of this account at the end of each month (i.e. the clearing account is cleared or zeroed out). Costs accumulated: Overhead clearing xxx Wages payable xxx Materials inventory xxx Acc. Depr. xxx Cash xxx

Sale: accounts related to the sale of products. Cost of goods sold xxx Finished goods inventory xxx Accounts receivable xxx Sales xxx

Non-manufacturing Companies Merchandising companies: costs of sales is essentially merchant’s invoice cost of goods sold. Simple system (relative to manufacturing company) . Cost record kept for each job: auto repair shop, hospital, medical clinic. Cost record is WIP inventory account. No cost record for each job: hospital laboratory. Non-profit: tracks programs not products.

Life Cycle Costing Cost system considers all of a product’s costs from “birth to abandonment.” Birthing costs: Necessary to develop product and bring it to market. Research and development, product testing, initial market creation, salesperson training. Abandonment costs: incurred after product is discontinued and doesn’t produce significant revenues. Disposal of plant and equipment, severance costs, restoring polluted land.

Nonprofit Organizations Healthcare, educational, performing arts, government. Similar cost accounting. Often rather than client specific transactions, determines full costs of programs. Program: Goal oriented set of activities. Lending of books by library, periodical reading room.

Uses of full costs Financial reporting: inventory/COGS. Analysis of profitability: by product. product line, plant, division, sales territory. Cost plus contracts. Setting regulated prices: utilities, cable.

Product Pricing Differentiated product: Normal price = direct costs + applicable indirect costs + profit. Target pricing = price set and then product designed to cover full cost + profit, e.g. apparel industry. Undifferentiated product = commodities. Company does not set price, market does.

Product Pricing (continued) Time and material pricing Automobile/TV repair, service business. Price material and labor, separately. Labor rate: wages, fringes, indirect costs, profit. Material: invoice cost, handling, storage, profit. Contribution pricing Price below full, above variable costs.

17 End of Chapter 17