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Cost Accounting Foundations and Evolutions

Kinney, Prather, Raiborn

Chapter 2 Cost Terminology and Cost Behaviors

Cost
Monetary measure of resources given up to attain an objective (such as acquiring a good or delivering a service)

Learning Objectives
List the cost classifications and explain why the classifications are useful List product cost categories and their components Calculate the Cost of Goods Manufactured and explain how it is used in the Income Statement

Cost Classifications
Association with cost object
Cost object is anything for which management wants to collect or accumulate costs

Direct - traceable to a cost object Indirect - not conveniently or practically traceable to a cost object
treated as overhead allocated

Cost Categories
Association with cost object Reaction to changes in activity
Variable Fixed Mixed Step

Relevant Range normal operating range

Cost Reaction to Changes in Activity


Total Variable Cost

$
# of Units

Fixed Cost

$
# of Units

Within the relevant range

Cost Reaction to Changes in Activity


Total Variable Cost

Unit
$

$
# of Units

# of Units

Fixed Cost

$
# of Units

$
# of Units

Within the relevant range

Total and Unit Cost Behavior


Total Cost Variable Cost Varies in direct proportion to changes in activity Unit Cost Remains constant throughout the relevant range

Fixed Cost

Remains constant throughout the relevant range

Varies inversely with changes in activity throughout the relevant range

Cost Reaction to Changes in Activity


Step Cost (Fixed)
$
Units

Within the relevant range

Cost Reaction to Changes in Activity


variable

Mixed Cost

$
fixed

Units

Within the relevant range

Determining Cost Behavior


Cost Predictor Cost Driver Activity accompanied by Activity that has a direct consistent, observable cause-effect relationship changes in a cost item on cost
Predicts but may not cause the cost to change Directly causes the cost to change

Cost Classifications
Association with cost object Reaction to changes in activity Classification on the financial statements
Unexpired Expired Product Period

Cost Classifications
Classification on the financial statements
Unexpired balance sheet assets Expired income statement expenses Product inventoriable costs
Prime direct material and direct labor Conversion direct labor and overhead

Period expensed in period incurred

Product Costs
Direct material
Measurable part of a product

Direct labor
Labor used to manufacture a product or perform a service

Overhead
Indirect production cost

Product Costs
First appear on the balance sheet in inventory accounts Transferred to the income statement when product is sold

Period Costs
Selling and administrative costs Distribution costs
Cost to warehouse, transport, and/or deliver a product or service Major impact on managerial decision making

Period Costs
Appear on the income statement when incurred Expensed when incurred

Conversion Process
Change Inputs into Outputs

Input
Purchase raw materials or supplies

Output
Product or Service

CONVERSION

Low Degree of Conversion


Department stores Gas stations Jewelry stores Travel agencies

Moderate Degree of Conversion


Florists Meat markets Oil-change businesses

High Degree of Conversion


Manufacturing Construction Agriculture Architecture Auditing Mining Printing Restaurants

Product Cost - Direct


Direct Material
Conveniently and economically traced to cost object

Product Cost - Direct


Direct Material
Conveniently and economically traced to cost object

Direct Labor
to manufacture a product or perform a service includes wages paid to direct labor employees, production bonuses, payroll taxes may include holiday and vacation pay, insurance, retirement benefits

Product Cost - Indirect


Overhead - indirect production costs
Fringe benefits, if cannot be easily traced to product Overtime, if due to random scheduling Cost of quality
Prevention costs Appraisal costs Failure costs

Product Cost Behavior


Direct Material
Direct Labor Overhead

Variable
Variable Variable, fixed, or mixed

Overhead Cost Allocation


Assign indirect costs to one or more cost objects

To determine full absorption cost (GAAP) To motivate management To compare alternative courses of action for planning, controlling, and decision making
Allocation process should be rational and systematic

Allocating Overhead Actual Cost System


Product Cost
Direct Materials Direct Labor Overhead

Cost Used
Actual Actual Actual

Allocating Overhead Actual Cost System


The Actual Cost System is not timely All costs must be known before calculating product cost

Allocating Overhead Actual vs. Normal


Product Cost
Direct Materials Direct Labor Overhead

Actual Cost System Actual


Actual

Normal Cost System Actual


Actual

Actual

Predetermined Overhead Rate

Predetermined Overhead Rate


Allows overhead to be assigned during the period Compensates for fluctuations
that are not related to activity level in activity level that do not affect fixed overhead

Flow of Product Costs


Raw Materials Inventory Accounts Payable Work in Process Inventory Raw Materials Inventory

Flow of Product Costs


Work in Process Inventory Variable Overhead Control Fixed Overhead Control
Finished Goods Inventory Work in Process Inventory

Flow of Product Costs


Accounts Receivable Sales
Cost of Goods Sold Finished Goods Inventory

Matches revenues and expenses on the income statement

Statement of Cost of Goods Manufactured


Beginning work in process
Raw materials used Direct labor Variable overhead Fixed overhead $284,000 436,000 115,200 98,880

$ 145,000

Current period manufacturing costs Total costs to account for Ending work in process Cost of goods manufactured

934,080 $1,079,080 20,880 $1,058,200

Statement of Cost of Goods Manufactured


Raw Materials Used
Beginning balance Purchases of materials Raw materials available Ending balance Total raw materials used $ 73,000 280,000 $353,000 69,000 $284,000

To Statement of Cost of Goods Manufactured

Schedule of Cost of Goods Sold


Beginning Finished Good Cost of Goods Manufactured Cost of Goods Available for Sale Ending Finished Goods Cost of Goods Sold $ 87,400 1,058,200 $1,145,600 91,600 $1,054,000

From Schedule of Cost of Goods Manufactured

Income Statement
Revenue Cost of Goods Sold Gross Profit Operating Expenses Operating Income xxxx <1,054,000> xxxx <xxxx> xxxx

From Schedule of Cost of Goods Sold

Questions
What is the difference between a fixed and variable cost? What are the three components of product cost? What are the three inventory accounts for a manufacturing company?