An Introduction To Cost Terms and Purposes

An Introduction to Cost
Terms and Purposes
Chapter 2
2-1
Learning Objective 1
Define and illustrate

a cost object.
By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2-2

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 Tracing
Assignment
Allocating
Distinguish between direct costs

and indirect costs.

Direct and Indirect Costs
COST
COSTOBJECT
OBJECT
Direct Costs
Example: Paper on which
Example:
Example:Sports
Sports
Sports Illustrated magazine
Illustrated
Illustratedmagazine
magazine
is printed
Indirect Costs
Example: Lease cost for
Time-Warner building
housing the senior editors
of its magazine

Example
Direct Costs:
Maintenance Department Rs40,000
Personnel Department Rs20,600
Assembly Department Rs75,000
Finishing Department Rs55,000
Assume that Maintenance Department costs are
allocated equally among the production departments.
How much is allocated to each department?
Example
Maintenance
Rs40,000
Assembly Finishing
Direct Costs Direct Costs
Rs75,000 Rs55,000
Rs20,000 Rs20,000
Allocated
Explain variable costs

and fixed costs.

Cost Behavior Patterns Example
Bicycles by the Sea buys a handlebar

at Rs52 for each of its bicycles.
What is the total handlebar cost when
1,000 bicycles are assembled?
By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 10

1,000 units × Rs52 = Rs52,000

What is the total handlebar cost
when 3,500 bicycles are assembled?
3,500 units × Rs52 = Rs182,000

Bicycles by the Sea incurred Rs94,500 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.

What is the leasing (fixed) cost per bicycle

when Bicycles assembles 1,000 bicycles?
Rs94,500 ÷ 1,000 = Rs94.50
What is the leasing (fixed) cost per bicycle
Rs94,500 ÷ 3,500 = Rs27

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 Rs94,500

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
Fixed Costs
80000
60000
40000 Rs94,500
20000
0
0 1000 2000 3000 4000 5000 6000
Volume

Relationships of Types of Costs
Direct
Variable Fixed
Indirect

Interpret unit costs cautiously.

Total Costs and Unit Costs
Example
What is the unit cost (leasing and handlebars)

Total fixed cost Rs94,500
+ Total variable cost Rs52,000 = Rs146,500
Rs146,500 ÷ 1,000 = Rs146.50

Total Costs and Unit Costs
Example
Rs146,500
200000 2x
Rs 5
4 ,50 0+
150000 Rs9
Total Costs
100000 Rs94,500
50000
0
0 500 1000 1500
Volume
Use Unit Costs Cautiously
Assume that Bicycles management uses a

unit cost of Rs146.50 (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 × Rs146.50 = Rs87,900
What is their budgeted cost for an estimated

production of 3,500 bicycles?
3,500 × Rs146.50 = Rs512,750
What should the budgeted cost be for an
estimated production of 600 bicycles?

Total fixed cost Rs 94,500

Total variable cost (Rs52 × 600) 31,200
Total Rs125,700
Rs125,700 ÷ 600 = Rs209.50
Using a cost of Rs146.50 per unit would
underestimate actual total costs if output
is below 1,000 units.

What should the budgeted cost be for an

estimated production of 3,500 bicycles?
Total fixed cost Rs 94,500
Total variable cost (52 × 3,500) 182,000
Total Rs276,500
Rs276,500 ÷ 3,500 = Rs79.00

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

Manufacturing
Manufacturing
Manufacturing companies
companies
purchase
purchase materials
materials and
and components
components andand
convert
convert them
them into
into finished
finished goods.
goods.
A
A manufacturing
manufacturing company
company must
must also
also develop,
develop,
design,
design, market,
market, and
and distribute
distribute its
its products.
products.
Merchandising
Merchandising
Merchandising companies
companies
purchase
purchase and
and then
then sell
sell tangible
tangible products
products
without
without changing
changing their
their basic
basic form.
form.

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

Differentiate between
inventoriable costs
and period costs.

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.

Classification of
Manufacturing Costs
Direct materials costs
Direct manufacturing labor costs
Indirect manufacturing costs

Describe the three categories of

inventories commonly found
in manufacturing companies.

Inventoriable Costs
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.

Flow of Costs Example
Bicycles by the Sea had Rs50,000 of direct

materials inventory at the beginning of the period.
Purchases during the period amounted to
Rs180,000 and ending inventory was Rs30,000.
How much direct materials were used?
Rs50,000 + Rs180,000 – Rs30,000 = Rs200,000

Direct labor costs incurred were Rs105,500.

Indirect manufacturing costs were Rs194,500.
What are the total manufacturing costs incurred?
Direct materials used Rs200,000
Direct labor 105,500
Indirect manufacturing costs 194,500
Total manufacturing costs Rs500,000
Assume that the work in process inventory
at the beginning of the period was Rs30,000,
and Rs35,000 at the end of the period.
What is the cost of goods manufactured?
Beginning work in process Rs 30,000
Total manufacturing costs 500,000
Ending work in process 35,000
Cost of goods manufactured Rs495,000
Assume that the finished goods inventory
at the beginning of the period was Rs10,000,
and Rs15,000 at the end of the period.
What is the cost of goods sold?
Beginning finished goods Rs 10,000
Cost of goods manufactured 495,000
Ending finished goods 15,000
Cost of goods sold Rs490,000
Work in Process
Beg. Balance 30,000 495,000
Direct mtls. used 200,000
Direct labor 105,500
Indirect mfg. costs 194,500
Ending Balance 35,000

Finished Goods
Work in Process 10,000 490,000
495,000 495,000
15,000
Cost of Goods Sold

490,000

Manufacturing Company
BALANCE SHEET INCOME STATEMENT
Inventoriable
Costs Revenues
when deduct
Finished sales
Materials occur Cost of
Goods
Inventory Goods Sold
Inventory
Equals Gross Margin
deduct
Work in
Process Period
Inventory Costs
Equals Operating Income
Merchandising Company
BALANCE SHEET INCOME STATEMENT
Inventoriable
Costs Revenues
when deduct
sales
Merchandise occur Cost of
Inventory
Purchases Goods Sold
Equals Gross Margin
deduct
Period
Costs
Equals Operating Income
Prime Costs
Direct Direct Prime

Materials + Labor = Costs

Prime Costs
What are the prime costs for Bicycles by the Sea?

Direct materials used Rs200,000
+ Direct labor 105,500
= Rs305,000

Conversion Costs
Direct Manufacturing Conversion

Labor + Overhead = Costs
Indirect Indirect
Labor Materials Other
Conversion Costs
What are the conversion costs for

Bicycles by the Sea?
Direct labor Rs105,500
+ Indirect manufacturing costs 194,500
= Rs300,000

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)
Janitors Rework labor
Overtime premium Idle time

Measuring Costs
Requires Judgment
Overtime premium is usually

considered part of overhead.
Assume that a worker gets Rs18/hour
for straight time and gets
time and one-half for overtime.

Measuring Costs
Requires Judgment
How much is the overtime premium?

Rs18 × 50% = Rs9 per overtime hour
If this worker works 44 hours on a given
week, how much are his gross earnings?
Direct labor 44 hours × Rs18 = Rs792
Overtime premium 4 hours × Rs 9 = 36
Total gross earnings Rs828
Explain why product costs are

computed in different ways
for different purposes.

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
Present key features of

cost accounting and
cost management.

A Framework for Cost
Management
Three features of cost accounting

and cost management:
1. Calculating the costs of products
2. Obtaining information
3. Analyzing information

Thank You
2 - 56

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An Introduction to Cost

Terms and Purposes

Define and illustrate

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2-2

Cost is a resource sacrificed or forgone to achieve

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2-3

Distinguish between direct costs

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2-5

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2-6

Explain variable costs

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2-9

Bicycles by the Sea buys a handlebar

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 10

1,000 units × Rs52 = Rs52,000

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 11

Bicycles by the Sea incurred Rs94,500 in

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 12

What is the leasing (fixed) cost per bicycle

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 13

The cost driver of variable costs is the level

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 14

Assume that fixed (leasing) costs are Rs94,500

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 15

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 16

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 17

Interpret unit costs cautiously.

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 18

What is the unit cost (leasing and handlebars)

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 19

Assume that Bicycles management uses a

What is their budgeted cost for an estimated

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 22

Total fixed cost Rs 94,500

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 23

What should the budgeted cost be for an

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 24

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 25

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 27

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 28

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 29

Merchandising-sector companies hold

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 31

Direct materials costs

Direct manufacturing labor costs

Indirect manufacturing costs

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 32

Describe the three categories of

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 33

Inventoriable costs (assets)…

become cost of goods sold…

after a sale takes place.

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 34

Period costs are all costs in the income

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 35

Bicycles by the Sea had Rs50,000 of direct

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 36

Direct labor costs incurred were Rs105,500.

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 40

Cost of Goods Sold

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 41

Direct Direct Prime

By R K Joshi , M.Com, PGDBM(FM), FICWA,CMA 2 - 44

What are the prime costs for Bicycles by the Sea?