CHAPTER 3: COSTS, COST

DRIVERS, COST OBJECTS, AND

2 TYPES OF ASSIGNMENT
COST ASSIGNMENT
1) DIRECT TRACING – used for
COST – incurred when a resource is
assigning direct costs.
used for some purpose.
2) ALLOCATION – used for indirect
COST POOLS – meaningful groups into costs.
which costs are collected.
DIRECT COST – cost that can be
Costs can be grouped in many ways: conveniently and economically traced
directly to a cost pool or a cost object.
1) TYPE OF COST
 Labor cost in one pool EX: the number of cartons of tide
 Material costs in another produced by P&G or the number of
2) BY SOURCE passengers on flight 617 for delta air
 Department 1 lines.
 Department 2 INDIRECT COST – not conveniently or
3) BY RESPONSIBILITY economically traceable to a specific cost
 Manager 1 pool or cost object.
 Manager 2
EX: cost of supervising manufacturing
Ex: an assembly department or a employees and cost of handling
product engineering department might materials
be treated as a cost pool.
COST ALLOCATION – process of
COST DRIVER – factor that causes or assigning indirect costs to cost pools
relates to a change in the total cost of and cost objects.
an activity.
ALLOCATION BASES – cost drivers
COST OBJECT – any product, service, used to allocate or assign cost to cost
customer, activity, or organizational unit objects.
to which costs are accumulated for
some management purpose.
VALUE STREAM – group of related
products; useful for preparing
profitability reports as part of lean
accounting; all the activities required to
create customer value for a family of
products or services.
COST ASSIGNMENT – process of
assigning costs to cost pools or from
cost pools to cost objects.

DIRECT MATERIAL COST – cost of
materials in the product and a
reasonable allowance for scrap and
defective units.
 Less purchase discounts but
including freight and related
charges.
INDIRECT MATERIAL COST – cost of
materials used in manufacturing that are
not part of the product or are not easily
or economically traceable to the finished
product, a component of total
manufacturing overhead.
DIRECT LABOR COST – used to
manufacture the product or to provide
the service.
 Plus, some portion of non-
value-added time that is
normal and unavoidable, such
as coffee breaks.
INDIRECT LABOR COST – associated
with production that are not considered
direct labor.
EX: supervision, quality control,
inspection, purchasing and receiving
OTHER INDIRECT COSTS
OVERHEAD – all the indirect cost
commonly combined into a single cost
pool; called factory overhead in a
manufacturing firm.
FACTORY OVERHEAD – all the indirect
manufacturing cost commonly combined
into a single cost pool in a
manufacturing firm.
THREE TYPES OF COST
1) Direct materials
2) Direct labors
3) Factory overhead
*sometimes combined for simplicity
and convenience.
PRIME COST - Sum of direct materials
and direct labor.
CONVERSION COST - direct labor and
factory overhead combined into a single
amount.
COST DRIVERS AND COST
BEHAVIOR
Cost drivers provide two important roles
for the management accountant:
1) Enabling the assignment of costs
to cost object
2) Explaining the cost behavior –
that is the change in the total
amount of a cost associated with
changes in the level of a cost
driver.
Generally, an increase in a cost driver
will cause an increase in total cost.
FOUR TYPES OF COST DRIVERS
1) ACTIVITY-BASED COST
DRIVERS – developed at a
detailed level of operations and
are associated with a given
manufacturing activity
 Those factors that cause or
contribute to the changes in
an activity.
 ACTIVITY ANALYSIS, a
detailed description of the
specific activities performed in
the firm’s operations.

2) VOLUME-BASED COST
DRIVERS – developed at an
aggregate level and relate to the
amount produced or quantity of
service provided.
 Management accountants
commonly call this volume,
volume of output or simply
output.
The three cost drivers are all volume-
based cost drivers and are proportional
to each other.
 The output of complete units
 The quantity (in pounds, etc)
of direct materials
 The hours of direct labor
RELEVANT RANGE – the range of the
cost driver in which the actual value of
the cost driver is expected to fall, and for
which the relationship between the cost
and the cost driver is assumed to be
approximately linear.
3) STRUCTURAL COST
4) EXECUTIONAL COST- both are
involved strategic and operational
decisions that affect the
relationship between these cost
drivers and total cost.
VARIABLE COST – changes in total
in response to changes in or more
cost drivers.
FIXED COST – portion of the total
cost that, within the relevant range,
does not change with a change in
the quantity of a designated cost
driver.
TOTAL FIXED COST and UNIT
VARIABLE COSTS are expected to
remain approximately constant within
the relevant range.
MIXED COST – cost that within the
relevant range, includes both
variable and fixed cost components.
The determination if whether a cost is
variable depends on the nature of the
cost object.
When we want to understand the cost of
behavior of a certain cost object, we
have to consider the following three
questions:
1) What is the cost driver (or cost
drivers if there are two or more)
for this cost object?
2) What is the relevant range if the
cost driver for which we are
developing the cost estimate?
3) What time horizon (usually one
year) are we using for fixed
costs?
STEP COSTS – cost that varies with the
cost driver, but in discrete steps within
the relevant range; also called semi-
fixed cost.
UNIT COST – total cost (materials,
labor, and overhead) divided by the
number of units of output.
- Aka AVERAGE COST
STRUCTURAL COST DRIVERS-
strategic plans and decisions that have
a long-term effect regarding issues such
as scale, experience, technology, and
complexity.
Four examples of decision involving
structural cost drivers:
1) SCALE – larger firms have lower
overall costs as a result of
economies of scale.
2) EXPERIENCE – firms having
employees with greater
manufacturing and sales
experience will likely have lower
development, manufacturing, and
distribution cost.
3) TECHNOLOGY – new
technologies can reduce design,
manufacturing, distribution, and
customer service costs
significantly.
4) COMPLEXITY – firms with many
products have higher costs of
scheduling and managing the
production process.
EXECUTIONAL COST DRIVERS –
factors that the firm can manage in the
short term to reduce costs such as
workforce involvement, design of the
production process, and supplier
relationships.
Three examples of executional cost
drivers:
1) WORKFORCE EMPOWERMENT
– firms with strong employee
relationships can reduce
operating costs significantly.
2) DESIGN OF THE PRODUCTION
PROCESS – speeding up the
flow of product through the firm
can reduce costs.
3) SUPPLIER RELATIONSHIP –
maintain a low-cost advantage
partially through agreements with
their suppliers to provide
products that meet the
companies’ requirements.
THE FIVE STEPS OF STRATEGIC
DECISION MAKING FOR PROCTER
AND GAMBLE
1) Determine the strategic issues
surrounding the problem.
2) Identify the alternative actions
3) Obtain information and conduct
analyses of the alternatives
4) Based on strategy and analysis,
choose, and implement the
desired alternative
5) Provide an ongoing evaluation of
the effectiveness of
implementation in step 4
1) Manufacturing departments can
be considered either cost pools
or cost objects.
2) A cost is only incurred when cash
changes hands. (FALSE)
3) Which of the following is not an
indirect cost when the cost object
is an airline passenger?
- Cost of food and beverages
served on the plane.
4) When direct tracing is not
economically feasible, indirect
cost is used to assign cost to cost
pools and cost objects.
5) The concept of cost objects
includes products and groups of
products which are called value
stream/streams.
6) Assembly workers’ wages are
always direct labor but some
labor costs such as payroll taxes
and training may be treated as
indirect labor.
7) Cost drivers are also called
allocation base/ bases.
8) A clothing manufacturer would
most likely treat the cost of thread
as a(n) indirect material.
9) Indirect costs are assigned using
cost drivers.
10) Enabling the assignment of costs
to cost objects and explaining
cost behavior are the two
important roles provided by cost
drivers.
11) Conversion costs do not include
direct materials.
12) When direct tracing is not
economically feasible, cost
allocation is used to assign cost
to cost pools and cost objects.
13) Activity analysis:
- Helps improve operational and
management control in the firm.
- Used to identify activity-based
cost drivers.
14) Indirect labor includes factory
supervisors and material
handlers. (TRUE)
15) Labor can sometimes be both
direct and indirect depending on
the cost object. (TRUE)
16) The law of diminishing marginal
productivity occurs at higher
levels of the cost driver. (TRUE)
17) At low values for the cost driver,
costs increase at a decreasing
rate. (TRUE)
18) The total cost curve is
approximately linear within the
relevant range.
19) The pattern of increasing costs
at a decreasing rate is often
referred to as increasing marginal
productivity.
20) Within the relevant range of
activity total fixed and per unit
available cost are expected to
remain approximately constant.
21) At low values for the cost driver,
costs increase at a decreasing
rate. (TRUE)
22)The law of diminishing marginal
productivity occurs at higher
levels of the cost driver. (TRUE)
23) The cost driver for a variable
cost can be either volume-based
or activity-based. (TRUE)
24) The determination of whether a
cost is variable on the cost driver
chosen. (FALSE)
- The determination depends on
the nature of the cost object.
25) Within the relevant range of
activity, per unit variable costs
and total fixed costs are expected
to remain approximately
constant.
26) Costs that are defined for a
period of time rather than in
relation to volume of output are
fixed costs.
27) Total cost within the relevant
range that includes both variable
and fixed components is referred
to as a fixed cost.
28) Total cost of resources
consumed divided by the number
of units of output is the
average/unit cost.
29) Costs that are consumed during
operations are variable cost.
30) FIXED COSTS
- Are generally not expected to
change within a year
- Are defined for a period of time
31) A cost that varies in increments
greater that the number of units
as the volume of the cost driver
changes is a step cost.
32) To properly interpret total
average unit cost, it must be
separated into unit variable and
unit fixed costs. (TRUE)
33) Costs that provide capacity for
operations are fixed cost.
34) Because they involve decisions
that have long-term effects on the
firm’s total costs, structural cost
drivers are strategic in nature.
35) The dollar amount of a product
transferred to the income
statement at the time of a sale is
called cost of goods sold.
36) For a manufacturer, upstream
and downstream costs are not
product costs.
37) Cost of goods sold is an asset.
(FALSE)
38) Factors the firm can manage in
the short term to reduce costs are
activity-based cost drivers.
39) The value chain of a
manufacturer begins with
upstream activities such as
design and ends with
downstream activities including
customer service.
40) Costs that are expensed as
incurred are called period costs.
41) Workforce empowerment, not an
example of a decision involving
structural cost drivers.
42) Cost of items are ready for sale
are held in finished goods
inventory.
43) Supplier relationships, example
of an executional cost driver.
44) Costs added to work-in-process
inventory include direct labor cost
and overhead cost.
45) Product costs for a
merchandising company include
transportation costs to get the
product to where it will be sold.
 46) Selling and administrative costs
are never product costs.
47) The sum of direct materials used
direct labor and overhead is
called total manufacturing costs.
48) Manufacturing companies use
three inventory accounts:
Materials Inventory, Work in
process inventory and finished
goods inventory.
49) Beginning inventory + cost
added = cost transferred out +
ending inventory
50) The accounting records of
Caldwell company revealed the ff
costs:
Direct labor used – 170000
Direct materials used – 350000
Manufacturing overhead –
4000000
Selling and administrative
expenses – 250000
Product costs total = 920000
51) Cost of goods manufactured:
215
+Direct materials used – 75
+Direct labor – 80
+Manufacturing overhead – 100
+Beginning work in process – 10
-Ending work in process – 50
52) The calculation of cost of goods
sold is
Beginning finished goods + cost
of goods manufactured + ending
finished goods.
52) Costs added to work in process
inventory include direct labor cost
and overhead cost.
53) Internal accounting controls:
- Restrict and guide financial
processing activities
- Consist of policies and
procedures
- Are designed to prevent or detect
errors and fraud.
54) The cost of goods finished and
transferred out of the work in
process inventory account during
a specified period is called cost of
goods manufactured.
55) Cost of goods sold: 821000
+Cost of goods manufactured –
854000
+Finished goods 1/1 – 135000
-Finished foods 1/31 – 168000
*changes in work process are
incorporated in cost of goods
manufactured.
56) The cost of delay can be
significant in many decisions if
information is not timely.
57) A primary way to ensure accurate
data is to have effective internal
accounting controls.
58) Having necessary information
available to management to facilitate
effective decision making is timeliness.
59) Costs added to work in process
inventory include overhead cost and
direct labor cost.
60) Because of the value of cost
management information, preparation
costs should not be a consideration
(FALSE)
61) Point of sale updates to the
inventory levels is occur when using a
perpetual inventory system.
62) Cost of goods manufactured
includes only product costs.
63) Factors that influence the cost of
preparing information for decision
making include:
- level of desired accuracy
- timeliness
- level of aggregation
64) The ending balance of inventory is
determined by a count when using a
periodic inventory system.