Kinney ● Raiborn Cost Accounting: Foundations and Evolutions, 8e © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Chapter 2: Cost Terminology and Cost Behaviors

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives Why are costs associated with a cost object? What assumptions do accountants make about cost behavior, and why are such assumptions necessary? How are costs classified on financial statements, and why are such classifications useful? How does the conversion process occur in manufacturing and service companies? What are the product cost categories, and what items comprise those categories? How and why does overhead need to be allocated to products? How is cost of goods manufactured calculated and used in preparing an income statement?

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cost Monetary measure of resources given up to attain an objective (such as acquiring a good or delivering a service)

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cost Categories Association with cost object  Cost object is anything for which management wants to collect or accumulate costs Reaction to changes in activity Classification on the financial statements

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Association with a Cost Object Direct—traceable to a cost object Indirect—not conveniently or practically traceable to a cost object  Treated as overhead  Allocated

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reaction to Changes in Activity Variable Fixed Mixed Step Relevant Range—normal operating range

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cost Reaction to Changes in Activity Variable cost Fixed Cost $ $ # of Units Within the relevant range

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cost Reaction to Changes in Activity Variable cost Fixed Cost $ # of Units Total Unit $ # of Units $$ Total Unit Within the relevant range

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Total and Unit Cost Behavior Varies in direct proportion to changes in activity Remains constant throughout the relevant range Remains constant throughout the relevant range Varies inversely with changes in activity throughout the relevant range Variable Cost Fixed Cost Total CostUnit Cost

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cost Reaction to Changes in Activity Step Cost (fixed) Mixed Cost $ fixed variable $ # of Units Within the relevant range

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Determining Cost Behavior Cost Predictor  Activity accompanied by consistent, observable changes in a cost item  Predicts but may not cause the cost to change Cost Driver  Activity that has a direct cause-effect relationship on cost  Directly causes the cost to change

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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  Product costs are unexpired before sale  Product costs are expired when sold Period—expensed in period incurred

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Product Costs Product costs  Direct material—Measurable part of a product  Direct labor—Labor used to manufacture a product or perform a service  Overhead—Indirect production cost First appear on the balance sheet in inventory accounts Transferred to the income statement when product is sold

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Period Costs Period costs  Selling and administrative costs  Distribution costs Cost to warehouse, transport, and/or deliver a product or service Major impact on managerial decision making Appear on the income statement when incurred Expensed when incurred

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Conversion Process Change inputs into outputs

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Purchase raw materials or supplies Input Product or Service CONVERSION The Conversion Process Output

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Degrees of Conversion Low  Department stores  Gas stations  Jewelry stores  Travel agencies Moderate  Florists  Meat markets  Oil-change businesses High  Manufacturing  Construction  Agriculture  Architecture  Auditing  Mining  Printing  Restaurants Moderate LowHigh Moderate

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Purchase supplies Use supplies, labor, overhead to provide service Sell to customer Input Output Service Company Significant amount of labor Tangible or intangible output

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Sell to customer Purchase products for resale Warehouse and/or display Input Output Purchase finished goods Resell to customers Retail Company

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Purchase raw materials and supplies Finished product Sell to customer Input Output Production Center add labor and overhead Significant amount of labor and machinery Tangible output Manufacturer

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Materials Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Balance Sheet Income Statement Cost Accumulation in a Manufacturing Company

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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, insurance, retirement benefits

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Product Cost—Indirect Overhead—indirect production costs  Fringe benefits, if cannot be easily traced to product  Overtime, if due to random scheduling  Cost of quality Prevention costs Appraisal costs Failure costs

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Product Cost Behavior Direct MaterialVariable Direct LaborVariable OverheadVariable, fixed, or mixed

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Overhead Cost Allocation To determine full absorption cost (GAAP) To motivate management To compare alternative courses of action for planning, controlling, and decision making Assign indirect costs to one or more cost objects Allocation process should be rational and systematic

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Allocating Overhead Actual Cost System Product Cost Direct Materials Direct Labor Overhead Cost Used Actual

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Actual Cost System is not timely All costs must be known before calculating product cost Allocating Overhead: Actual Cost System

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Allocating Overhead: Actual vs. Normal Product Cost Direct Materials Direct Labor Overhead Actual Cost System Actual Normal Cost System Actual Predetermined Overhead Rate

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Predetermined Overhead Rate Allows overhead to be assigned during the period Compensates for fluctuations  that are not related to activity level  in activity level that do not affect fixed overhead

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Flow of Product Costs Raw Materials Inventory XXX Accounts Payable XXX Work in Process Inventory XXX Raw Materials Inventory XXX Work in Process Inventory XXX Variable Overhead Control XXX Fixed Overhead Control XXX Salaries/Wages Payable XXX

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Flow of Product Costs Variable Overhead Control XXX Fixed Overhead Control XXX Utilities Payable XXX Supplies Inventory XXX Accumulated Depreciation–Equipment XXX Other accounts XXX

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Flow of Product Costs Work in Process Inventory XXX Variable Overhead Control XXX Fixed Overhead Control XXX Finished Goods Inventory XXX Work in Process Inventory XXX

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Flow of Product Costs Accounts Receivable XXX Sales XXX Cost of Goods Sold XXX Finished Goods Inventory XXX Matches revenues and expenses on the income statement

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Statement of Cost of Goods Manufactured—Raw Materials Used Beginning balance $ 73,000 Purchases of materials 280,000 Raw materials available $353,000 Ending balance Total raw materials used $284,000 To Statement of Cost of Goods Manufactured

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Statement of Cost of Goods Manufactured Beginning work in process $145,000  Raw materials used $284,000  Direct labor 436,000  Variable overhead 115,200  Fixed overhead 98,880 Current period manufacturing costs 934,080 Total costs to account for $1,079,080 Ending work in process Cost of goods manufactured $1,058,200

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Schedule of Cost of Goods Sold Beginning Finished Goods $ 87,400 Cost of Goods Manufactured1,058,200 Cost of Goods Available for Sale $1,145,600 Ending Finished Goods Cost of Goods Sold $1,054,000 From Schedule of Cost of Goods Manufactured

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Income Statement Revenue XXXX Cost of Goods Sold Gross Profit XXXX Operating Expenses Operating Income XXXX From Schedule of Cost of Goods Sold

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Questions What is the difference between a fixed and variable cost? What are the three components of product cost? What are the three inventory accounts for a manufacturing company?

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Ethical Issues Expired costs—not on the balance sheet Period costs—not inventory Product costs—not selling or administrative costs Direct labor—not overstated Ending inventory—not overstated