Basic Cost Management Concepts

LO:
1. Basic cost management concepts
2. Cost driver
3. Product / service costing
4. Cost flow

LO1: Basic Concepts

1. Cost: incurred when resource is used
2. Cost pool: groups of costs assembled by type (cost category)
3. Cost driver: a factor that has effect of changing the level of total cost (drives
the total cost)
4. Cost object: the object to which costs are assigned (for management purpose)
5. Cost accumulation: the collection of cost data in an organized way, such as
in categories. Example of such categories:
a. Materials
b. Labor
c. Overheads
6. Cost assignment: the process of assigning costs to cost pools or from cost
pools to cost objects associates accumulated costs with certain cost objects.

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7. A cost system determines the cost of a cost object by accumulating and then
assigning costs.

8. Types of costs
a. Direct costs: can be directly traced to a cost pool / object (outputs)
i. Direct material
ii. Direct labor
iii. The assignment of direct costs to the chosen cost object is called
cost tracing.
b. Indirect costs: cannot be directly traced to a cost pool /object
i. Manufacturing overheads
 Indirect labor (forklift drivers, maintenance crew, janitorial
staff, etc.)
 Indirect material (Cleaning supplies, small replacement
parts, etc.)

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  Other indirect costs (property taxes of the facility, rent of
the warehouse, machine maintenance, rent, etc.)
ii. Cost allocation: the assignment of indirect costs to cost
pools/objects through the use of cost drivers (also known as
“allocation bases”)
 Note that indirect costs are always allocated.
c. Classifying a cost as either direct or indirect depends upon whether the
cost can be traced to a particular cost object in an economically feasible
way.

9. Manufacturing product costs (inventory + COGS):

Prime
costs a. Direct Materials
WIP FG COGS
b. Direct Labor

Conversion
c. Manufacturing Overhead
costs

Common Flow of Costs Identified by Cost Objects

Note: difference between product costs and period costs.

LO2: Cost Drivers

1. Two roles:
a. Assigning costs to cost objects
b. Explaining cost behavior (i.e., how total cost changes as the cost driver
changes)
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2. 4 types of cost drivers:
a. Activity-based
Compare
b. Volume-based
c. Structural
Compare
d. Executional
3. Volume-based cost drivers
a. Cost driver is the volume (the amount produced or quantity of service
provided)
b. Example: hourly direct labor costs, direct material costs
c. Linear approximation and relevant range

d. Classification of cost drivers by cost behavior:

i. Variable cost
 Annual depreciation of equipment, where the amount of depreciation
charged is computed by the machine-hours method

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 ii. Fixed cost
 Annual depreciation of equipment, where the amount is computed by
the straight-line method.

iii. Mixed cost

 Electricity bill—a flat fixed charge, plus a variable cost after a
certain number of kilowatt-hours are used, in which the quantity of
kilowatt-hours used varies proportionately with quantity of units
produced.

iv. Step cost

 Salaries of repair personnel, where one person is needed for every
1,000 machine-hours or less (that is, 0 to 1,000 hours requires one
person, 1,001 to 2,000 hours requires two people, and so on).

1. Total costs vs. unit costs

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4. Activity-based cost (ABC) drivers
a. Activity: is any work performed inside a business entity.
b. ABC:
i. A cost-assigning system emphasizes long-term product analysis
ii. Based on activity level as the fundamental cost object
iii. Assumes that costs are caused by the resource-consuming
activities (tasks, units of work, etc.) with specific purposes.
iv. Costs are assigned based on the consumption of resources.
c. Cost drivers used in ABC are activity bases that are closely correlated
with the incurrence of manufacturing overhead costs.
5. Structural cost drivers
a. Strategic
b. Involve decisions with long-term effect (on costs)
c. Structural decisions:
i. Scale
ii. Experience
iii. Technology
iv. Complexity
6. Executional cost drivers
a. Factors the firm can manage in short-term, operational decision
making:
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 i. Workforce empowerment
ii. Design of the production process
iii. Supplier relationships

LO3: Product and Service Costing

1. Product costs vs. period costs
a. Product costs = inventory + COGS = DM + DL + Mfg. OVH
b. Period costs = Expenses (selling, admin, interests)
2. Manufacturing vs. merchandising
a. Manufacturing costs is product costs

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LO4: Cost flow
1. Manufacturing: cost flows through 3 inventory accounts:
RM (+DM)  WIP (+DM, +DL, +OVH)  FG
2. Merchandising: one inventory account---inventory held for sale
3. Inventory and related accounts: