Cost Concepts & Objectives

BA 115 Lecture 1
Financial vs. Management Accounting
Financial Accounting Management Accounting
External users (creditors, investors, etc.) Internal users (managers of the
organization)
Must comply with IFRS May not be IFRS-based
Historical Prospective
Annual and quarterly reports Varying time span
Covers the entire company Focus may be on a department, process,
product, etc.
Basic Cost Terminology
• Cost – sacrificed resource to achieve a specific objective
• Actual Cost – a cost that has occurred
• Budgeted Cost – a predicted cost
• Cost Object – any item or activity for which costs are accumulated
and measured
• Cost Pools – Meaningful groups into which costs are assembled (e.g.,
by type of cost or source)
Basic Cost Terminology
• Cost Accumulation – a collection of cost data in an organized manner
• Cost Assignment – a general term that includes gathering
accumulated costs to a cost object. It covers:
• Tracing accumulated costs with a direct relationship to the cost object; and
• Allocating accumulated costs with an indirect relationship to a cost object
Basic Cost Terminology
• Cost Driver – a variable that causally affects costs over a given time
span
• Relevant Range – the band of normal activity level (or volume) in
which there is a specific relationship between the level of activity (or
volume) and a given cost. For example, total fixed costs are
considered fixed only within the relevant range
 Costs Cost Drivers and Cost Assignment

Cost Pools Cost Objects

Electric Motor

Materials
Handling Assembly Dishwasher

Supervision

Packing
Materials Washing
Packing
Machine
Final
Inspection
Direct vs. Indirect Costs
• Direct Costs can be conveniently and economically traced to a cost
object
• Indirect Costs cannot be conveniently or economically traced to a
cost object. Instead of being traced, these costs are allocated to a
cost object in a rational and systematic manner
Factors - Direct/Indirect Cost Classification
• Cost Materiality – The smaller the amount of a cost, the less likely
that it is economically feasible to trace that cost to a particular cost
object
• Availability of Information-Gathering Technology – Improvements in
information-gathering technology make it possible to consider more
and more costs as direct costs
• Operational Design – Classifying a cost as direct is easier if a
company’s facility is used exclusively for a specific cost object, such as
a specific product or a particular customer
Variable vs. Fixed Costs
• Variable Cost – changes in total in proportion to changes in the
related level of activity or volume; remains constant on a per-unit
basis
• Fixed Cost – remains unchanged in total regardless of changes in the
related level of activity or volume; changes inversely with the level of
production
Cost Behavior within a Relevant Range
Total Cost Cost Per Unit
Variable Costs Directly related with the Remains constant
level of output: more
output, higher total cost
Fixed Costs Remains the same Inversely related with the
level of output: more
output, lower cost per unit
Inventoriable vs. Period Costs
• Inventoriable Costs – product manufacturing costs. These costs are
capitalized as assets (inventory) until they are sold and transferred to
Cost of Goods Sold.
• The following are inventoriable costs for manufacturing companies:
• Direct Materials
• Direct Labor
• Indirect Manufacturing Costs – factory costs that are not traceable to the
product. Also known as Manufacturing Overhead or Factory Overhead.
• Period Costs – have no future value and are expensed as incurred
Prime vs. Conversion Costs
• Prime Cost – a collective term referring to all direct manufacturing
costs (labor and materials)
• Conversion Cost – a collective term referring to direct labor and
factory overhead costs
Costs in Decision-Making
• A difference in costs between any two alternatives is known as a
differential cost.
• Opportunity cost is the potential benefit that is given up when one
alternative is selected over another.
• A sunk cost is a cost that has already been incurred and that cannot
be changed by any decision made now or in the future.
Cost Accumulation Methods
Job Order Process
Cost Object A specific job, batch, lot, or A process or department
contract of a production facility
Quantity of Output One job, batch, lot, or Thousands or hundreds of
Produced contract thousands of units of
output
Job vs. Process Costing
• Job Costing – system accounting for distinct cost objects called Jobs.
Each job may be different from the next, and consumes different
resources
• Process Costing – system accounting for mass production of identical
or similar products
Cost of Goods Manufactured Cost of Goods Sold
Direct Materials, Beginning Finished Goods, Beginning
+ Direct Materials Purchased + Cost of Goods Manufactured
- Direct Materials, Ending = Cost of Goods Available for Sale
= Direct Materials Used - Finished Goods, Ending
+ Direct Labor = Cost of Goods Sold
+ Factory Overhead
= Total Manufacturing Costs
+ Work in Process, Beginning
- Work in Process, Ending
= Cost of Goods Manufactured