Learning Objective 1

Define and illustrate a cost object.

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.

Cost and Cost Terminology

Cost Object Cost Accumulation

Cost Object
Cost Object

Cost Assignment

Tracing
Allocating

Learning Objective 2

Distinguish between direct costs and indirect costs.

Direct and Indirect Costs

Direct Costs Example: Paper on which Sports Illustrated magazine is printed Indirect Costs Example: Lease cost for Building housing the senior editors of its magazine COST OBJECT Example: Sports Illustrated magazine

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?

Direct and Indirect Costs Example

Maintenance $40,000

Assembly Direct Costs $75,000 $20,000 Allocated

Finishing Direct Costs $55,000 $20,000

Learning Objective 3

Explain variable costs and fixed costs.

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?

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

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.

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

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.

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.

Relevant Range Example

120000 100000 80000 60000 40000 20000 0 0 1000 2000

Fixed Costs

$94,500

3000 Volume

4000

5000

6000

Relationships of Types of Costs

Direct

Variable

Fixed

Indirect

Learning Objective 4 Interpret unit costs.

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

Total Costs and Unit Costs Example

$146,500

200000

Total Costs

150000 100000 50000 0 0 500 Volume 1000 1500

$94,500

Use Unit Costs

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

Use Unit Costs

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?

Use Unit Costs

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.

Use Unit Costs

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

Learning Objective 5

Distinguish among manufacturing companies, merchandising companies, and service-sector companies.

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.

Merchandising
merchandise /Trading companies purchase and then sell tangible products without changing their basic form.

Merchandising
Service companies provide services or intangible products to their customers. Labor is the most significant cost category.

Learning Objective 6

Differentiate between Product costs and Period costs.

Product Cost and Period Cost

Unexpired (Product) Expired (Period)
Recorded as an asset in the balance sheet and become an expense in the profit and loss account in a later accounting period

Cost

Recorded as an expense in the profit and loss account of the Current accounting period

Inventoriable Costs OR Product Cost

Inventoriable costs (assets) become cost of goods sold

after a sale takes place.

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.

Classification of Manufacturing Costs

Direct materials Costs Direct Labor Costs

Factory Overhead Costs

Learning Objective 7

Describe the three categories of inventories commonly found in manufacturing companies.

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

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.

Flow of Costs Example

Bicycles by the Sea had $50,000 of direct materials inventory at the beginning of the period. Purchases during the period amounted to $180,000 and ending inventory was $30,000. How much direct materials were used?

$50,000 + $180,000 $30,000 = $200,000

Flow of Costs Example

Direct labor costs incurred were $105,500.
Indirect manufacturing costs were $194,500.

What are the total manufacturing costs incurred?

Direct materials used Direct labor Indirect manufacturing costs Total manufacturing costs $200,000 105,500 194,500 $500,000

Flow of Costs Example

Assume that the work in process inventory at the beginning of the period was $30,000, and $35,000 at the end of the period. What is the cost of goods manufactured? Beginning work in process Total manufacturing costs Ending work in process Cost of goods manufactured $ 30,000 500,000 35,000 $495,000

Flow of Costs Example

Assume that the finished goods inventory at the beginning of the period was $10,000, and $15,000 at the end of the period. What is the cost of goods sold? Beginning finished goods Cost of goods manufactured Ending finished goods Cost of goods sold $ 10,000 495,000 15,000 $490,000

Manufacturing Company
BALANCE SHEET
Inventoriable Costs

INCOME STATEMENT

Revenues
Finished Goods Inventory
when sales occur deduct

Materials Inventory

Cost of Goods Sold

Equals Gross Margin deduct

Work in Process Inventory

Period Costs
Equals Operating Income

Merchandising Company
BALANCE SHEET
Inventoriable Costs

INCOME STATEMENT

Revenues
Inventory
when sales occur deduct

Merchandise Purchases

Cost of Goods Sold

Equals Gross Margin deduct

Period Costs
Equals Operating Income

Prime Costs
Direct Materials Direct Labor Prime Costs

Prime Costs
What are the prime costs for Bicycles by the Sea? Direct materials used + Direct labor = $200,000 105,500 $305,000

Conversion Costs
Direct Labor Manufacturing Overhead Conversion Costs

Indirect Labor

Indirect Materials

Other

Conversion Costs
What are the conversion costs for Bicycles by the Sea? Direct labor $105,500 + Indirect manufacturing costs 194,500 = $300,000

Measuring Costs Requires Judgment

Manufacturing labor-cost classifications vary among companies. The following distinctions are generally found: Direct manufacturing labor Manufacturing overhead

Measuring Costs Requires Judgment

Manufacturing overhead
Indirect labor Managers salaries Payroll fringe costs

Forklift truck operators (internal handling of materials)

Rework labor Overtime premium Idle time

Measuring Costs Requires Judgment

Overtime premium is usually considered part of overhead. Assume that a worker gets $18/hour for straight time and gets time and one-half for overtime.

Measuring Costs Requires Judgment

How much is the overtime premium?
$18 50% = $9 per overtime hour

If this worker works 44 hours on a given week, how much are his gross earnings? Direct labor 44 hours $18 = $792 Overtime premium 4 hours $ 9 = 36 Total gross earnings $828

Learning Objective 9

Illustrate:
-

Relevant and Irrelevant Cost and Revenues Avoidable and Unavoidable Costs Sunk Cost Opportunity Costs Incremental and Marginal Cost

Relevant and Irrelevant Cost and Revenues

For decision making, costs and revenues can be classified according to whether they are relevant to a particular decision.
Relevant Cost and Revenues are those future costs and revenues that will be changed by a decisions, whereas irrelevant costs and revenues are those that will not be affected by the decision.

Relevant and Irrelevant Cost and Revenues

Example: if one is faced with a choice of

Making a journey by car or by public transport, the car tax and insurance costs are irrelevant, since they will remain the same whatever alternative is chosen. However, petrol costs for the Car will differ depending on which alternative is chosen, and this cost will be relevant for decision-making.

Avoidable and Unavoidable Cost

Sometimes the terms avoidable and unavoidable Costs are used instead of relevant and irrelevant cost.

Avoidable costs are those costs that may be saved by not adopting a given alternative, whereas unavoidable costs cannot be saved. Therefore only avoidable costs are relevant for decision-making purposes.

Avoidable and Unavoidable Cost

Example: The material Cost of $ 100 are unavoidable and irrelevant, but the conversion cost of $200 are avoidable and hence relevant. The decision rule is to accept those alternatives that generate revenues in excess of the avoidable costs.

Sunk Cost
These costs are the cost of resources already Acquired where the total will be unaffected by the choice between various alternatives.

They are costs that have been created by a Decision made in the past and that cannot be Changed by any decision that will be made in the future.

Sunk Cost-EXAMPLE
The written down values of assets previously Purchased are sunk costs. For example, if a machine was purchased four years ago for $100,00 with an expected life of five years and nil scrap value then the written down value will be $20,000 If straight line depreciation is used. This written down value will have to be written off, no matter what possible alternative future action might be chosen. Sunk cost is irrelevant for decision making but they are distinguished from irrelevant

Sunk Costs
Costs because not all irrelevant costs are sunk cost. For example , a comparison of two alternative production methods may result in identical direct Material expenditure for both alternatives, so the Direct material cost is irrelevant because it will remain the same whichever alternative is chosen, but material cost is not a suck cost since it will be incurred in the future.

Opportunity Costs
An opportunity Cost is a cost that measures the opportunity that is lost or sacrificed when the choice of one course of action requires that an alternative course of action be given up.

Opportunity Costs- EXAMPLE

A company has an opportunity to obtain a contract for the production of a special component. This Component will require 100 hours of processing on machine X. Machine X is working at full capacity on The production of product A, and the only way in which the contract can be fulfilled is by reducing the output of product A. This will mean a loss of revenue $200. The contract will also result in additional variable cost of $1000. If the company takes on the contract, it will sacrifice

Opportunity Costs
Revenue of $200 from the lost output of product A. This represents an opportunity cost, and should be included as part of the cost when negotiating for the contract. The contract price should at least cover the additional costs of $1000 plus the $200 opportunity cost to ensure that the company will be better off in the short term by accepting the contract.

Opportunity Costs
It is important to note that opportunity costs only apply to the use of scarce resources. Where resources are not scarce , no sacrifice exists from using these resources. In our previous example If machine X were operating at 80% of its potential capacity then the decision to accept the Contract would not have resulted in reduced production of product A. Consequently, there would have been no loss of revenue, and the opportunity cost would be ZERO.

Incremental and Marginal Costs

Incremental (also called differential) costs and revenues are the difference between costs and revenues for the corresponding items under each alternative being considered. For example the incremental costs of increasing output from 1000 to 1100 units per week are the additional costs of producing an extra 100 units per week.

Incremental and Marginal Costs

Incremental costs and revenues are similar in principle to the economists concept of marginal cost and marginal revenue. The main difference is that marginal cost/revenue represents the additional cost/revenue of one extra unit of output whereas incremental cost/revenues resulting from a group of additional units of output.

End