Accounting Summary Session 4

Performance objects
Performance object: is a specific aspect of the company that managers need to
focus their attention on to meet their business goals. (products/services)
The range of performance objects is not limited to products and services, it also
includes departments and divisions, customers, and geographical regions.

Direct and indirect costs

The profitability of a performance object compares the value of the resources that it
generates against the value of the resources it consumes.
Profitability = revenues of the object – costs of the object
Direct costs: are the cost of resources that a performance object uses exclusively
(e.g. materials and direct labor for products)
Indirect costs: are the costs of resources that various performance objects share
(e.g. cost of machines used to produce different products)
Overhead costs: are costs of resources other than material and direct labor. They
are often indirect costs.
A cost is not inherently direct or indirect, rather, it is direct or indirect with respect to a
particular performance object.

Cost pool, allocation bases and allocation rates

Cost pool: is a combination of various indirect costs that have a similar cost behavior
Allocation bases: trace the indirect costs accumulated in cost pools to performance
objects. Each cost pool has a unique allocation base.
The rougher the allocation base, the less accurate the cost system might be.
Traditional allocation bases include:
- Cost of direct materials
- Cost of direct labor
- Number of hours of direct labor
- Number of machine hours
- Square meters of manufacturing space
Allocation rates: are the estimated cost per unit of allocation base
Remember: if indirect costs are fixed, then the volume of the allocation bases to
estimate the allocation rates has to be normal capacity, so that the cost system does
not lead to a death spiral.
Job costing system
When each unit is different, companies use a job-order costing system. (jobs like
design studio, consulting company)
The direct costs are directly traced to each job, and the indirect costs are shared by
various jobs.
Job-order costing systems also have cost pools, allocation bases and allocation
rates. Cost pools accumulate indirect costs that behave similarly. The only unique
characteristic of a job-order costing system is that the cost of each unit (e.g. each
design, custom-made piece of furniture) is individually estimated.
Full cost = direct costs + (allocation rate for first cost pool * volume of allocation base
used) + (for as many cost pools as the design includes)

Process costing system

Process costing is used when all units produced are the same or the variation
among them is minimal
Most manufacturing settings are a mix of job and process costing characteristics. E.g.
cars, they have many common pieces but also customized parts.
Another characteristic of process costing is the use of equivalent units
Equivalent units are used to take into account units that are work in progress at the
end of a period
If a unit is half way through a process, it is counted as half an equivalent unit