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Becker – 2008 Edition Chapter 5 Page 1 of 26
Chapter 5 – Planning, Budgeting, and Cost Management
Cost Measurement and Cost Measurement ConceptsCost Measurement Concepts:
Cost of goods manufactured and budgeting cost vs. actual cost.
Managerial accounting and internal reporting
Future orientation: usefulness and future orientation
Most accounting reports are for externals (creditors, etc)
Managerial accounting reports are for internal usersCost drivers:
Cost drivers change total costs
Direct causal relationship between change in cost driver and total costs
May be based on volume, activity, or other operational characteristic
Types of cost driver: executional (short-term) and structural (long-term)
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Executional: manage short-term costs
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Structure: decisions having long-term effects on cost
Type of operational cost driver: volume-based and activity-based
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Volume-based: aggregate volume of output. Associated with traditional cost accountingsystems
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Activity-based: activity that adds value to output. Associated with contemporary costaccounting systems
Cost drivers as overhead (OH) allocation bases:
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OH costs are indirect and must be applied on some basis.
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OH must be added to direct material (DM) and direct labor (DL) to arrive at COGM
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Allocation basis
cost drivers.
Traditional industries use direct labor hours as allocation base for overhead
Cost driver = direct labor hours
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Activity centers
production departments (advertising, inspection, packaging).
Are activity bases closely correlated with incurrence of manufacturing OH
Contemporary industries accumulate OH with manufacturing and add value toits products
Cost drivers = machine hoursCost objects: resources or activities that serve as the basis for management decisions
i.e. products, product lines, departments, geographic territories
product costing + cost control measurement = maximize effectiveness of managementaccounting systems
Valuation = cost of goods manufactured
Cost control = cost comparison to standards and budgets
Becker – 2008 Edition Chapter 5 Page 2 of 26
Common Flow of Costs Identified by Cost Objects
Prime Costs = DM/DL Conversion Costs = DL/OHDirect Materials Direct Labor Factory OverheadWork in Process
Finished Goods
Cost of Goods SoldProduct costs = not expensed until the product is sold (manufacturing costs)
They sit on the balance sheet as an asset before being sold
Costs attach to the units of output
Consist of DM, DL, and mfg OH appliedPeriod costs = non-mfg costs
Expensed in the period incurred and are NOT inventorial
Expenses include selling and administrative expenses, interest expense
Consist of selling the product and administering and managing the operations of the firmManufacturing costs = treated as product costs
Sit as inventory until sold
Consist of direct and indirect costsNon-manufacturing costs = treated as period costs
Expensed in the period incurred
i.e. selling, general, administrative expenses***Cost accounting systems are designed to meet the goal of measuring cost objects or objectives. Themost frequent objectives include:
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product costing (inventory and COGM and sold)
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efficiency measurements (comparisons to standards)
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income determination (profitability)Tracing Costs to Cost Objects (Product)Direct costs
Easily traced to cost pool or object
direct raw materials
used in production or purchased (incl. Freight-in net of any discounts)
direct labor
directly related to product or performance of a service plus reasonable amountof expected “down time” for labor
Becker – 2008 Edition Chapter 5 Page 3 of 26Indirect costs
in the “factory” – mfg. OH
NOT easily traceable to cost pool or cost object
Indirect materials
not used specifically or could not be easily traced to the completed product
Indirect labor
supports the manufacturing process but not directly on specific jobOther indirect costs
in the “factory” (not materials, not labor) = i.e. depreciation of the factory***Prime Cost = Direct Labor + Direct Material***Conversion Cost = Direct Labor + Manufacturing OverheadIndirect costs are allocated to benefit cost pools or cost objects using cost drivers that are considered tohave a strong relationship to the incurrence of these costs.
Allocation basis = cost drivers that are used to allocate indirect costs
Accounting = all indirect costs = OH.Cost Behavior (Fixed vs. Variable)
DM and DL are variable costs
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As volume
, Total variable costs (DM & DL)
Indirect costs, incl. mfg., are fixed and variable costs
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Fixed costs (rent, insurance) are not related to volume
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Variable costs (indirect labor, indirect material, utilities) dependent on volume
Total costs = FC + VCVariable Costs:
Behavior: Changes proportionally with the cost driver
Amount: Constant per unit, Total varies
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An item costs $25. If produce 10, total cost = $250. If produce 100, total cost = $2500
Long-run characteristics: short-run and long-run impacts of VC are sameFixed Costs:
Behavior: In short-term, fixed cost does not change when the cost driver changes
Amount: Varies per unit, total remains constant
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Rent is $1000. If produce 10 items, unit cost = $100. If produce 100, unit cost = $10.
Long-run characteristics: given enough time, any cost can be considered variableSemi-variable Costs:
Contain fixed and variable components
SEE EXAMPLES ON PAGE B5-9Relevant Range:
Range which the assumptions of cost driver are valid
If cost driver activity is no longer in relevant range, the VC and FC assumptions cannot allocatecosts to cost objects
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