2. 2009 Foster Business School Cost Accounting L.DuCharme A Review of Cost Terms and Purposes Chapter 2

3. 2009 Foster Business School Cost Accounting L.DuCharme 2 Outline Cost terminology –Cost object –Assignment –Direct vs. Indirect –Variable vs. Fixed –Drivers –Relevant range –Average cost

4. 2009 Foster Business School Cost Accounting L.DuCharme 3 Outline (continued) Manufacturing companies vs. others Inventory vs. period costs Flow of Costs: T-accounts Prime & conversion costs Different costs for different purposes

5. 2009 Foster Business School Cost Accounting L.DuCharme 4 Cost and Cost Terminology Cost is a resource sacrificed or forgone to achieve a specific objective. An actual cost is the cost incurred (a historical cost) as distinguished from budgeted costs. A cost object is anything for which a separate measurement of costs is desired.

6. 2009 Foster Business School Cost Accounting L.DuCharme 5 Cost and Cost Terminology Cost Assignment is both: Cost Object Tracing Direct Costs Allocating Indirect Costs

7. 2009 Foster Business School Cost Accounting L.DuCharme 6 Direct vs. Indirect costs Distinguish between direct costs and indirect costs.

8. 2009 Foster Business School Cost Accounting L.DuCharme 7 Direct and Indirect Costs Direct Costs Example: Oak wood used to Mfg. of chairs. Indirect Costs Example: salary of the Plant night watchperson. COST OBJECT Example: 50 Oak Chairs produced in May.

9. 2009 Foster Business School Cost Accounting L.DuCharme 8 Direct and Indirect Costs Example Direct Costs: Maintenance Department$40,000 Personnel Department$20,600 Assembly Department$75,000 Finishing Department$55,000 Assume that Maintenance Department costs are allocated equally among the production departments. How much is allocated to each department?

10. 2009 Foster Business School Cost Accounting L.DuCharme 9 Direct and Indirect Costs Example Allocated $20,000 Maintenance $40,000 Assembly Direct Costs $75,000 Finishing Direct Costs $55,000 $20,000

11. 2009 Foster Business School Cost Accounting L.DuCharme 10 Cost Behavior Patterns Example Bicycles by the Sea buys a handlebar at $52 for each of its bicycles. What is the total handlebar cost when 1,000 bicycles are assembled? Variable vs. Fixed costs

12. 2009 Foster Business School Cost Accounting L.DuCharme 11 Cost Behavior Patterns Example 1,000 units × $52 = $52,000 What is the total handlebar cost when 3,500 bicycles are assembled? 3,500 units × $52 = $182,000

13. 2009 Foster Business School Cost Accounting L.DuCharme 12 Cost Behavior Patterns Example Bicycles by the Sea incurred $94,500 in a given year for the leasing of its plant. This is an example of fixed costs with respect to the number of bicycles assembled.

14. 2009 Foster Business School Cost Accounting L.DuCharme 13 Cost Behavior Patterns Example What is the leasing (fixed) cost per bicycle when Bicycles assembles 1,000 bicycles? $94,500 ÷ 1,000 = $94.50 What is the leasing (fixed) cost per bicycle when Bicycles assembles 3,500 bicycles? $94,500 ÷ 3,500 = $27

15. 2009 Foster Business School Cost Accounting L.DuCharme 14 Cost Drivers The cost driver of variable costs is the level of activity or volume whose change causes the (variable) costs to change proportionately. The number of bicycles assembled is a cost driver of the cost of handlebars.

16. 2009 Foster Business School Cost Accounting L.DuCharme 15 Relevant Range Example Assume that fixed (leasing) costs are $94,500 for a year and that they remain the same for a certain volume range (1,000 to 5,000 bicycles). 1,000 to 5,000 bicycles is the relevant range.

17. 2009 Foster Business School Cost Accounting L.DuCharme 16 Relevant Range Example $94,500

18. 2009 Foster Business School Cost Accounting L.DuCharme 17 Relationships of Types of Costs Direct Indirect VariableFixed

19. 2009 Foster Business School Cost Accounting L.DuCharme 18 “Average Costs” Interpret unit costs cautiously.

20. 2009 Foster Business School Cost Accounting L.DuCharme 19 Total Costs and Unit Costs Example What is the unit cost (leasing and handlebars) when Bicycles assembles 1,000 bicycles? Total fixed cost $94,500 + Total variable cost $52,000 = $146,500 $146,500 ÷ 1,000 = $146.50

21. 2009 Foster Business School Cost Accounting L.DuCharme 20 Total Costs and Unit Costs Example $94,500 $94,500 + $52x $146,500

22. 2009 Foster Business School Cost Accounting L.DuCharme 21 Use Unit Costs Cautiously Assume that Bicycles management uses a unit cost of $146.50 (leasing and wheels). Management is budgeting costs for different levels of production. What is their budgeted cost for an estimated production of 600 bicycles? 600 × $146.50 = $87,900

23. 2009 Foster Business School Cost Accounting L.DuCharme 22 Use Unit Costs Cautiously What is their budgeted cost for an estimated production of 3,500 bicycles? 3,500 × $146.50 = $512,750 What should the budgeted cost be for an estimated production of 600 bicycles?

24. 2009 Foster Business School Cost Accounting L.DuCharme 23 Use Unit Costs Cautiously Total fixed cost$ 94,500 Total variable cost ($52 × 600) 31,200 Total$125,700 $125,700 ÷ 600 = $209.50 Using a cost of $146.50 per unit would underestimate actual total costs if output is below 1,000 units.

25. 2009 Foster Business School Cost Accounting L.DuCharme 24 Use Unit Costs Cautiously What should the budgeted cost be for an estimated production of 3,500 bicycles? Total fixed cost$ 94,500 Total variable cost (52 × 3,500) 182,000 Total$276,500 $276,500 ÷ 3,500 = $79.00

26. 2009 Foster Business School Cost Accounting L.DuCharme 25 Manufacturing vs. others Distinguish among manufacturing companies, merchandising companies, and service-sector companies.

27. 2009 Foster Business School Cost Accounting L.DuCharme 26 Manufacturing Manufacturing companies purchase materials and components and convert them into finished goods. A manufacturing company must also develop, design, market, and distribute its products.

28. 2009 Foster Business School Cost Accounting L.DuCharme 27 Merchandising Merchandising companies purchase and then sell tangible products without changing their basic form.

29. 2009 Foster Business School Cost Accounting L.DuCharme 28 Service Service companies provide services or intangible products to their customers. Labor is the most significant cost category.

30. 2009 Foster Business School Cost Accounting L.DuCharme 29 Inventoriable Costs Differentiate between inventoriable costs and period costs.

31. 2009 Foster Business School Cost Accounting L.DuCharme 30 Types of Inventory Manufacturing-sector companies typically have one or more of the following three types of inventories: 1. Direct materials inventory 2. Work in process inventory (work in progress) 3. Finished goods inventory

32. 2009 Foster Business School Cost Accounting L.DuCharme 31 Types of Inventory Merchandising-sector companies hold only one type of inventory – the product in its original purchased form. Service-sector companies do not hold inventories of tangible products.

33. 2009 Foster Business School Cost Accounting L.DuCharme 32 Classification of Manufacturing Costs Direct materials costs Direct manufacturing labor costs Indirect manufacturing costs

34. 2009 Foster Business School Cost Accounting L.DuCharme 33 Inventoriable Costs Inventoriable costs (assets)… become cost of goods sold… after a sale takes place.

35. 2009 Foster Business School Cost Accounting L.DuCharme 34 Period Costs Period costs are all costs in the income statement other than cost of goods sold. Period costs are recorded as expenses of the accounting period in which they are incurred.

36. 2009 Foster Business School Cost Accounting L.DuCharme 35 Flow of Costs T-account diagram (in class)

37. 2009 Foster Business School Cost Accounting L.DuCharme 36 Prime Costs (all direct mfg. costs) Direct Materials Direct Labor Prime Costs +=

38. 2009 Foster Business School Cost Accounting L.DuCharme 37 Conversion Costs (all mfg. cost except DM) Direct Labor Manufacturing Overhead += Conversion Costs Indirect Labor Indirect Materials Other

39. 2009 Foster Business School Cost Accounting L.DuCharme 38 Different Costs? Product costs are computed in different ways for different purposes/uses.

40. 2009 Foster Business School Cost Accounting L.DuCharme 39 Many Meanings of Product Cost A product cost is the sum of the costs assigned to a product for a specific purpose. 1. Pricing and product emphasis decisions 2. Contracting with government agencies 3. Preparing financial statements for external reporting under generally accepted accounting principles

41. 2009 Foster Business School Cost Accounting L.DuCharme End of Chapter 2 That’s all Folks!