COST ACCOUNTING- A MANAGERIAL

EMPHASIS, 16TH EDITION,

SRIKANT/ GEORGE/ MADHAV/
CHRISTOPHER

Chapter 2

An Introduction to Cost Terms and

Purposes
COSTS AND COST TERMINOLOGY
 Cost can be defined as a resource sacrificed or forgone to
achieve a specific objective.
 An actual cost is a historical cost or past cost.
 A budgeted cost is a predicted or forecasted cost.
 A cost object is anything for which cost data are desired-
including products, customers, jobs, and organizational
subunits.
 Determining costs of a cost object includes two steps-
 Costs Accumulation
 Costs Assignment
DIRECT COSTS AND INDIRECT COSTS
 For the purpose of assigning cost to cost objects, costs are
classified as:

 Direct Cost: A cost that can be easily and conveniently traced

to a specified cost objects. The term cost tracing is used to
describe the assignment of direct costs.

 Indirect Cost: A cost that can not be easily and conveniently

traced to a specified cost objects. The term cost allocation is used
to describe the assignment of indirect costs.

 A common cost is a cost that is incurred to support a number of

cost objects but can not be traced to them individually .

 A particular cost can be direct or indirect depending on

the cost object.
FACTORS AFFECTING DIRECT /INDIRECT
COST CLASSIFICATIONS

 The Materiality of the Cost in Question- The smaller

the amount of a cost, the less likely that it is economically
feasible to trace the cost to a particular cost object.

 Available Information Gathering Technology-

Improvements in information gathering technology make it
possible to consider more and more costs as direct costs.

 Design of Operations- Classifying a cost as direct is easier

if a company’s facility is used exclusively for a specific cost
object.
 COST BEHAVIOR PATTERNS: VARIABLE
COSTS AND FIXED COSTS

• Cost behavior refers to how a cost reacts to changes in

the level of activity within the relevant range.

Total variable costs change when activity changes.

Total fixed costs remain unchanged when activity

changes.
VARIABLE COST
 Total cost of batteries is based on the number
of autos produced in a month.
Total Cost of
batteries

Number of Autos
produced in a month
 Variable Cost
 Variable Cost Per Unit: The per unit cost
of batteries remains constant at $24.
Per Unit Cost of
Batteries

Number of Autos
produced in a month
FIXED COST
 Total cost of monthly rent is fixed for the number of lab
tests performed in a month. The monthly rent does not change
based on the number of lab tests that may be performed
during the month.
Total cost of rent

Number of lab tests

performed in a month
 Fixed Cost
 Fixed Cost per Unit increases and decreases inversely and
changes in activity. For example the average cost per unit
will fall as the number of test performed increases.

Monthly Rent For the

Machine

Number of lab tests

performed in a month
 COST BEHAVIOR PATTERNS: VARIABLE
COSTS AND FIXED COSTS

 A particular cost item could be variable with respect to

one level of activity and fixed with respect to another.

 Mixed or semivariable costs have both fixed and

variable elements.

 Cost Driver is a variable, such as the level of activity or

volume, that casually affects costs over a given time span.

 Relevant Range is the band of normal activity level or

volume in which there is a specific relationship between
the level of activity or volume and the cost in question.
RELATIONSHIPS OF TYPES OF COSTS

 Direct and Variable

 Direct and Fixed

 Indirect and variable

 Indirect and fixed

MANUFACTURING-, MERCHANDISING-,
AND SERVICE-SECTOR COMPANIES

 Manufacturing-sector companies purchase

materials and components and converts them into
various finished goods.

 Merchandising sector companies purchase and

then sell tangible products without changing their
basic form.

 Service-sector companies provide services

(intangible products) to their customers.
TYPES OF INVENTORY
 Inventories for a manufacturing Company:

 Direct Materials: Materials waiting to be processed.

 Work in Process: Partially complete products – some
material, labor, or overhead has been added.
 Finished Goods: Completed products awaiting sale.

 Merchandising companies hold only one type of inventory,

which is products in their original purchased form, called
merchandise inventory.

 Service-sector companies do not hold inventories of tangible

products.
 COMMONLY USED CLASSIFICATIONS OF
MANUFACTURING COSTS

Manufacturing costs can be classified into three broad

categories:
1. Direct Materials: Raw materials that become an
integral part of a cost object (work-in-process and then
finished goods) and that can be conveniently traced
directly to it. For example: A radio installed in an
automobile.

2. Direct Labor: Those labor costs that can be easily

traced to the cost object. For example: Wages paid to
automobile assembly workers.
COMMONLY USED CLASSIFICATIONS OF
MANUFACTURING COSTS

3. Indirect Manufacturing Costs: Manufacturing

costs that cannot be traced directly to specific cost
object. For example: Indirect materials and indirect
labor, plant insurance, property taxes on the plant,
plant rent etc.

 This costs are also known as manufacturing

overhead or factory overhead costs.
INVENTORIABLE COSTS AND PERIOD
COSTS

 Inventoriable costs are all costs of a product that are

considered as assets in the balance sheet when they are
incurred and that become cost of goods sold only when
the product is sold.
 For manufacturing companies all manufacturing costs are
inventoriable costs.
 For merchandising-sector companies, inventoriable costs are
the costs of purchasing the goods that are resold in their
same form.
 Period costs are all costs in the income statement
other than cost of goods sold.
PRIME COSTS AND CONVERSION COSTS

o Prime Costs are all direct manufacturing costs.

o Conversion costs are all manufacturing costs other

than direct material costs. These costs represent all
manufacturing costs incurred to convert direct
materials into finished goods.
OVERTIME PREMIUM AND IDLE TIME
 Overtime premium is the wage rate paid to
workers (for direct labor and indirect labor) in excess
of their straight-time wage rates.

 Idle time is wages paid for unproductive time

caused by lack of orders, machine breakdowns,
material shortages, poor scheduling, and the like.

 Both overtime premium and idle time are usually

considered to be a part of indirect costs or overhead.