11 CH 02

An Introduction to Cost Terms and Purposes Chapter 2
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
2-1
Learning Objective 1 Define and illustrate a cost object.
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.
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2-3
Cost and Cost Terminology

Cost Object Cost Accumulation Cost Assignment Cost Object Cost Object Tracing Allocating
Learning Objective 2 Distinguish between direct costs and indirect costs.
2-5
Direct and Indirect Costs

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

Direct Costs: Maintenance Department Personnel Department Assembly Department Finishing Department $40,000 $20,600 $75,000 $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
2-8
Learning Objective 3 Explain variable costs and fixed costs.
2-9
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?
2 - 10

1,000 units $52 = $52,000 What is the total handlebar cost when 3,500 bicycles are assembled? 3,500 units $52 = $182,000
2 - 11

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.
2 - 12

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
2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 13
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.
2 - 14
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.
2 - 15
Relevant Range Example

120000 100000 80000 60000 40000 20000 0 0 1000 2000 Fixed Costs
$94,500
3000 Volume
4000
5000
6000
2 - 16
Relationships of Types of Costs

Direct
Variable
Fixed
Indirect
Learning Objective 4 Interpret unit costs cautiously.
2 - 18
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
2 - 19
Total Costs and Unit Costs Example

$146,500 200000 otal osts 150000 100000 50000 0 0 500 Vol
$94,500
1000
1500
Use Unit Costs Cautiously

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

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?
2 - 22

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.

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
2 - 24
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
Merchandising companies purchase and then sell tangible products without changing their basic form.
2 - 27
Merchandising
Service companies provide services or intangible products to their customers. Labor is the most significant cost category.
2 - 28
Learning Objective 6 Differentiate between inventoriable costs and period costs.
2 - 29
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.
2 - 31
Classification of Manufacturing Costs

Direct materials costs Direct manufacturing labor costs Indirect manufacturing costs
Learning Objective 7 Describe the three categories of inventories commonly found in manufacturing companies.
2 - 33
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.
2 - 35
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

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
2 - 37

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
2 - 38

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
2 - 39

Beg. Balance Direct mtls. used Direct labor Indirect mfg. costs Ending Balance Work in Process 30,000 495,000 200,000 105,500 194,500 35,000
2 - 40

Work in Process 495,000 Finished Goods 10,000 490,000 495,000 15,000 Cost of Goods Sold 490,000
Manufacturing Company
BALANCE SHEET
Inventoriable Costs
INCOME STATEMENT Revenues

when sales occur deduct
Materials Inventory
Finished Goods Inventory
Cost of Goods Sold
Equals Gross Margin deduct
Work in Process Inventory
Period Costs
Equals Operating Income
2 - 42
Merchandising Company
BALANCE SHEET
Inventoriable Costs
INCOME STATEMENT Revenues

when sales occur deduct
Merchandise Purchases
Inventory
Cost of Goods Sold
Equals Gross Margin deduct
Period Costs
Equals Operating Income
Prime Costs
Direct Materials Direct Labor Prime Costs
2 - 44
Prime Costs
What are the prime costs for Bicycles by the Sea? Direct materials used + Direct labor = $200,000 105,500 $305,000
2 - 45
Conversion Costs
Direct Labor Manufacturing Overhead Conversion Costs
Indirect Labor
Indirect Materials
Other
2 - 46
Conversion Costs
What are the conversion costs for Bicycles by the Sea? Direct labor $105,500 + Indirect manufacturing costs 194,500 = $300,000
2 - 47
Measuring Costs Requires Judgment

Manufacturing labor-cost classifications vary among companies. The following distinctions are generally found: Direct manufacturing labor Manufacturing overhead
2 - 48

Manufacturing overhead
Indirect labor Managers salaries Payroll fringe costs Forklift truck operators (internal handling of materials) Janitors Overtime premium Rework labor Idle time
2 - 49

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.
2 - 50

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 8 Explain why product costs are computed in different ways for different purposes.
2 - 52
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
Learning Objective 9 Present key features of cost accounting and cost management.
2 - 54
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
2 - 55
End of Chapter 2
2 - 56

11 CH 02

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An Introduction to Cost Terms and Purposes Chapter 2

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 1 Define and illustrate a cost object.

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost and Cost Terminology

Cost and Cost Terminology

Learning Objective 2 Distinguish between direct costs and indirect costs.

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Direct and Indirect Costs

COST OBJECT Example: Sports Illustrated magazine

Direct and Indirect Costs Example

Direct and Indirect Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 3 Explain variable costs and fixed costs.

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Behavior Patterns Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Behavior Patterns Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Behavior Patterns Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Behavior Patterns Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Relevant Range Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Relevant Range Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Relationships of Types of Costs

Learning Objective 4 Interpret unit costs cautiously.

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Total Costs and Unit Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Total Costs and Unit Costs Example

Use Unit Costs Cautiously

Use Unit Costs Cautiously

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Use Unit Costs Cautiously

Use Unit Costs Cautiously

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Learning Objective 6 Differentiate between inventoriable costs and period costs.

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Classification of Manufacturing Costs

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flow of Costs Example

Flow of Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flow of Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flow of Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flow of Costs Example

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Flow of Costs Example

INCOME STATEMENT Revenues

Finished Goods Inventory

Cost of Goods Sold

Equals Gross Margin deduct

Work in Process Inventory

2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster