Cost Terminology and Cost Behaviors: Cost Accounting Principles, 9e

Chapter 2:
Cost Terminology and

Cost Behaviors
Cost Accounting Principles, 9e
Raiborn ● Kinney
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Learning Objectives
 What assumptions do accountants make about cost
behavior, and why are such assumptions necessary?
 How are costs classified on financial statements, and why
are such classifications useful?
 What are the product cost categories, and what items
comprise those categories?
 How and why does overhead need to be allocated to
products?
 How is cost of goods manufactured calculated and used in
preparing an income statement?
Cost
Monetary measure of resources given up to attain an objective (such as

acquiring a good or delivering a service)
Association with a Cost Object
 Direct—traceable to a cost object

 Indirect—not conveniently or practically
traceable to a cost object
 Treated as overhead
 Allocated
Reaction to Changes in Activity
 Variable
 Fixed
 Mixed
 Step
Relevant Range—normal operating range
Cost Reaction to Changes in Activity
 Variable
Fixed Cost
cost
$
$
# of Units # of Units
Within the
relevant range
 Variable
Fixed Cost
cost
$ $
Total Total
Unit $ Unit $
Within the
# of Units relevant range # of Units
Total and Unit Cost Behavior
Total Cost Unit Cost
Variable Varies in direct Remains constant

Cost proportion to throughout the
changes in activity relevant range
Fixed Varies inversely

Remains constant
Cost with changes in
throughout
activity throughout
the relevant range
the relevant range
 Step Cost
Mixed Cost(fixed)
variable
$ $
fixed
Within the
relevant range
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
 Product costs are unexpired before sale
 Product costs are expired when sold
 Period—expensed in period incurred
Product Costs
 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
 First appear on the balance sheet in
inventory accounts
 Transferred to the income statement when
product is sold
Period Costs
 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
 Appear on the income statement when
incurred
 Expensed when incurred
The Conversion Process
 Change inputs into outputs
The Conversion Process
Input Output
Purchase Product or
raw materials Service
or supplies
CONVERSION
Service Company
Input
Purchase
supplies
Significant amount of labor
Tangible or intangible output
Use supplies,
labor, overhead Output
to provide service
Sell to
customer
Retail Company
Input
Output
Purchase
Warehouse
products
and/or display
for resale
Purchase finished goods Sell to

Resell to customers customer
Manufacturer
Significant amount of labor and machinery
Input
Tangible output Output
Purchase Finished
raw materials product
and supplies
Production
Center Sell to
add labor and
overhead
customer
Cost Accumulation in a
Manufacturing Company
Materials
Inventory
Work in Process
Inventory
Finished Goods Cost of
Inventory Goods Sold
Income
Balance Sheet Statement
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 Variable
 Direct Labor Variable
 Overhead Variable, fixed, or mixed
Allocating Overhead:
Actual vs. Normal
Product Cost Actual Cost Normal Cost
System System
Direct Materials Actual Actual
Direct Labor Actual Actual
Overhead Actual Predetermined

Overhead Rate

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Chapter 2:

Cost Terminology and

Monetary measure of resources given up to attain an objective (such as

 Direct—traceable to a cost object

Relevant Range—normal operating range

Variable Varies in direct Remains constant

Fixed Varies inversely

 Change inputs into outputs

Purchase finished goods Sell to

 Overhead—indirect production costs

 Direct Material Variable

 Direct Labor Variable

 Overhead Variable, fixed, or mixed

Direct Labor Actual Actual

Overhead Actual Predetermined

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