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Chapter Three: Basic Cost Management Concepts
Chapter Three: Basic Cost Management Concepts
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
• Understand the strategic role of basic cost concepts
• Explain cost-driver concepts at the activity, volume,
structural, and executional levels
• Explain the cost concepts used in product and
service costing
• Demonstrate how costs flow through the accounting
system
• Prepare and interpret an income statement for both
a manufacturing firm and a merchandising firm
3-2
Basic Definitions
• A cost is incurred when a firm uses a resource for some
purpose
3-3
Product/Service Costing:
Cost Assignment
The process of assigning costs to cost pools or
from cost pools to cost objects
– Direct costs can be conveniently and economically
traced to a cost pool or a cost object
– Indirect costs cannot be traced conveniently or
economically to a cost pool or a cost object
– Because indirect costs cannot be traced, assignment is
made through the use of cost drivers (cost allocation)
– These cost drivers are often called allocation bases
3-4
Cost Assignment: General Principles
Costs Cost Drivers and Cost Assignment
Materials
Handling Assembly Dishwasher
Supervision
Packing
Materials Washing
Packing
Machine
Final
Inspection
3-5
Direct and Indirect Product
Costs for a Manufacturer
• Direct material costs = cost of materials that can be readily
traced to outputs = purchase price of materials + freight –
purchase discounts + reasonable allowance for scrap and
defective units
• Indirect material costs = cost of materials that cannot
readily be traced to outputs (e.g., rags, lubricants, and small
tools)
• Direct labor costs = labor that can be readily traced to
outputs = wages paid plus a reasonable allowance for
nonproductive time
• Indirect labor costs = labor costs that cannot be readily
traced to outputs (i.e., they are manufacturing support costs)
3-6
Direct and Indirect Product Costs:
(continued)
• All indirect costs for the manufacturer, including
indirect materials, indirect labor, and other indirect items
are often combined in a cost pool referred to as overhead
(or, factory overhead, or indirect manufacturing costs)
3-7
Cost Behavior: Cost Drivers
• Cost drivers provide two roles for the management
accountant
– Assigning costs to cost objects
– Explaining cost behavior, i.e., how total cost changes as the
cost driver changes
• There are four types of cost drivers:
– Activity-based
– Volume-based
– Structural
– Executional
3-8
Cost Drivers (continued)
• Activity-based cost (ABC) drivers are developed
at a detailed level of operations using activity
analysis–a cost driver is determined for each
activity
• Volume-based cost drivers relate to the amount
produced or quantity of service provided:
– The relationship between the cost driver and
total cost is approximately linear within the
relevant range
3-9
Volume Based Cost Drivers:
Classification by Behavior
• Fixed cost is the portion of total cost that does
not change with changes in output
• Variable cost is the change in total cost
associated with each change in quantity of the
cost driver
• Mixed cost is used to refer to a total cost figure
that includes both a fixed and variable
component
• Step costs vary with the cost driver but do so in
steps
3-10
Cost Drivers (continued)
• Structural cost drivers facilitate strategic decision
making because they involve plans and decisions that
have long-term effects
– Scale, experience, technology, and complexity are
considered in hopes of improving competitive position
3-11
Fixed Costs
Total
Cost
$6,600
$6,500
$3,000
3,500 3,600
Units of the Cost Driver
3-12
Variable Costs
Total
Total Cost
Cost
$6,600
$6,500
Total Variable Cost
$3,000
3,500 3,600
Units of the Cost Driver
3-13
Product and Service
Costing Concepts
• Product costs include only the costs necessary to
complete the product at the manufacturing step in
the value chain (manufacturing) or to purchase and
transport the product to the location of sale
(merchandising)
3-14
Manufacturing vs.
Merchandising
3-15
Inventory and Related Expense
Accounts
3-16
Qualitative Characteristics of
Cost Information
3-17
Chapter Summary
• Cost assignment: the tracing (direct) or allocation
(indirect) of costs to cost pools using cost drivers
3-18
Chapter Summary (continued)
3-19
End of cost terms...
3-20