A&MIS 5251W. F. Bentz A&MIS 525 William F. Bentz September 24, 2001 Fisher College of Business

A&MIS 5252W. F. Bentz Key Issues in Product Costing  Terminology  Cost assignment process  Drivers of activity costs incurred  Accounts  Points of potential confusion

A&MIS 5253W. F. Bentz Terminology--Cost  Cost is a sacrifice; a measurable cost is the relinquishment of a measurable asset or the creation of a measurable liability. Cost is an outflow or reduction in the service potential of the entity of interest.

A&MIS 5254W. F. Bentz Terminology--Cost  In accounting, service potential can be thought of as the present value of the cash flows from an activity, at some level of risk, or adjusted for risk.

A&MIS 5255W. F. Bentz Terminology--Cost  Actions that decrease the present value of cash outflows, at a given level of risk, are actions that decrease cost. Actions that increase the present value of future cash outflows, at a given level of risk, are actions that increase cost.

A&MIS 5256W. F. Bentz Terminology—Cost  Actions that increase the risk of future cash flows are actions that increase cost. Actions that decrease the risk of future cash flows are actions that decrease cost. and so on.

A&MIS 5257W. F. Bentz Terminology—Costing  Costing is the process of estimating the cost (sacrifice) of taking action. Costs are the result of undertaking and maintaining activities. Thus, costing is largely a matter of assigning costs (sacrifices) with the activities which caused those sacrifices.

A&MIS 5258W. F. Bentz Terminology—Cost Object  A cost object is any activity for which a separate measurement of cost is desired.  An activity involves doing something  Cost objects are derived from the purposes for which the cost information is to be used (different costs for different purposes).

A&MIS 5259W. F. Bentz Terminology—Costing Systems  Costing systems are the information systems used to accumulate cost data either regularly or intermittently. Usually cost systems are flexible enough to collect information for a variety of purposes.

A&MIS 52510W. F. Bentz Terminology—Costing Systems  A variety of costing systems may exist in any one organization (engineering, accounting, production, distribution).  In general, the idea is to index cost information so it can be used in a variety of ways.

A&MIS 52511W. F. Bentz Terminology—Cost Analysis  Cost analysis is the process of assessing the expected impact of managerial decisions on the financial performance of an entity. Decision analysis includes cost analysis.

A&MIS 52512W. F. Bentz Terminology—Cost Incurred  Cost incurred is the cost that an entity has experienced as a result of the execution of some activity for a specified period of time. Although it is in the past, cost incurred may have to be estimated. Accurate, valid measures of cost incurred require information about separable activities.

A&MIS 52513W. F. Bentz Costing Objects Next, let us consider how one associates the costs incurred to a set of cost objects in the costing process. Costs Incurred Object 1 Object 2 Object 3

A&MIS 52514W. F. Bentz Cost Assignment  Tracing – direct costs can be traced to cost objects 1.Ability to trace with acceptable accuracy, validity, and cost Technology is improving our ability to trace The more complex the production process, the more difficult and costly the tracing process

A&MIS 52515W. F. Bentz Cost Assignment  Tracing (continued) 2.Cost-effective to trace costs The greater the cost, the greater the value of tracing Technology is reducing the cost of tracing The value of tracing increases with competition More complex mfg. systems increase the need to trace

A&MIS 52516W. F. Bentz Cost Assignment  Cost allocation is the process of assigning costs to cost objects when those costs cannot be traced cost-effectively.  Cost allocation ranges from relatively unambiguous, with high face validity, to relatively arbitrary.  Most distortions in product and service costing are related to cost allocation, not cost tracing.

A&MIS 52517W. F. Bentz Cost Drivers  There are seven primary cost drivers at the macro level. The one considered most often in accounting is the time-rate of activity. Think of this as the volume of activity experienced during a time period. The driver volume is considered next.

A&MIS 52518W. F. Bentz Cost Drivers - Volume  The issue is: How should we expect costs to behave (vary) with respect to changes in the time-rate of activity all else being equal. In traditional accounting terms: “How do costs behave with respect to changes in volume?” First, we consider the effects of volume changes on total costs.

A&MIS 52519W. F. Bentz Total variable cost Activity Volume Total cost Slope is the rate of change

A&MIS 52520W. F. Bentz Total variable cost Variable costs are those costs that vary in direct proportion to changes in activity volume. Such costs are normally rep- resented by a simple affine linear equation, y = vQ, where y represents the total variable cost, v represents the variable cost per unit of activity and Q represents the volume of activity during a period.

A&MIS 52521W. F. Bentz Total step-variable cost Step-variable costs are those costs that vary in small increments with respect to changes in activity volume. Such costs are also normally represented by a simple affine linear equation, y = vQ, where y represents the total variable cost, v represents the variable cost per unit of activity and Q represents the volume of activity during a period.

A&MIS 52522W. F. Bentz Total step-variable cost However, at a micro level, the increments may be relatively large and a local manager might treat the cost like a semi-fixed cost ( slide 28). It is a matter of perspective and required level of precision. Manager’s salaries effectively are variable from McDonald’s corporate perspective, but not from the perspective of a local franchisee with two restaurants.

A&MIS 52523W. F. Bentz Total fixed cost Activity Volume Total cost

A&MIS 52524W. F. Bentz Total fixed cost Fixed costs are those costs that do not vary in total with respect to modest changes in activity volume. Such costs are represented by y = F, where y represents total cost, and F represents total fixed cost. Fixed costs do change over time, due to price changes and as a result of decisions, but they are relatively constant with respect to changes in activity volume, all else being equal.

A&MIS 52525W. F. Bentz Total mixed cost Activity Volume Total cost Total cost curve

A&MIS 52526W. F. Bentz Total mixed cost Activity Volume Total cost Total cost curve Fixed component Variable component

A&MIS 52527W. F. Bentz Total mixed cost Semivariable or mixed costs are those costs that contain both a fixed and a variable component. Such costs are normally represented by a simple linear equation of the form Y = F + vQ, where y represents total cost, F represents total fixed cost, and v represents the variable cost per unit of activity, and Q is the volume of activity during a period.

A&MIS 52528W. F. Bentz Total semi-fixed cost Activity Volume Total cost Total cost curve

A&MIS 52529W. F. Bentz Total cost (micro) Activity Volume Total cost Total cost curve Relevant range

A&MIS 52530W. F. Bentz Average cost (micro) Volume Average Unit Cost Total cost curve Relevant range

A&MIS 52531W. F. Bentz OSU Bumper Sticker I am not lost, I am exploring

A&MIS 52532W. F. Bentz “Product Costs (GAAP)  Product (inventoriable) costs include all manufacturing costs regardless of traceability or behavior. Direct materials Direct labor Indirect labor, materials, depreciation, services, etc. ConversionConversion Prime cost

A&MIS 52533W. F. Bentz “Product Costs (GAAP)  Period (non-inventoriable) costs are not part of the (inventoriable) cost of goods for financial reporting purposes  Administrative costs (expenses)  Marketing costs (order-getting expenses)  Distribution costs (order-filling expenses)

A&MIS 52534W. F. Bentz Meanings of Product Cost R&DDesign Produc- tion Consumer Service Distri- bution Market- ing Inventoriable product costs Reimbursable government contract costs Decision-relevant costs

A&MIS 52535W. F. Bentz Accounting-Speak Costs Incurred Period Expenses Product Costs (Inventory) Expensed During a Period Assets ( Prepaids) ( PP&E)

A&MIS 52536W. F. Bentz The Flow of Costs Inventory System Work in Process Finished Goods Inventory Cost of Goods Sold Payroll System Indirect Costs Assigned

A&MIS 52537W. F. Bentz