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Cost Accounting Home


Cost - Volume - Profit
Basic Terms and Definitions

 

Terminology

  • Cost – a resource is given up or forgone
    • Given up – you spent something
    • Forgone – you lost the opportunity (e.g. interest)
    • There are actual and budgeted (forecasted) costs
  • Cost Object – very general term – it is whatever a measurement of cost is calculated for (e.g. Rubber Tread, a Tire, a Car Frame, the whole car)
    • Likewise, a Product Cost, is the sum of costs assigned to a product – however the definition of the product may vary depending on its use – evaluation for internal/external reporting
  • Cost Accumulation – Costs which are added up to a given point in time or production.  Management evaluates how the cost data will be combined to produce valuable information for decision making
  • Direct Costs – Costs which can be traced to a specific product or service
    • Cost-Benefit Analysis is an important concept in this regard
  • Indirect Costs – Costs which cannot be directly traced to a specific product or service and therefore must instead be allocated.
  • Cost assignment – The tracing of direct costs to a cost object and the allocation of indirect costs to a cost object
  • Costing System – Records the costs of resources and tracks how they are used
  • Inventoriable costs – Costs which occur during production (direct materials, direct labor, and an allocation of indirect overhead) and are capitalized (put on the balance sheet) as inventory until they are sold.
  • Period Costs – Costs which are recognized as expenses in the period they occur

Costs:

Direct/Indirect Costs:

  • Classification of cost between direct and indirect may be affected by these factors
    • The company setup – the more segregated each activity/product/service is, the easier it is to identify direct costs
    • The ease of collecting cost information – Computers have enabled companies to gather data easier and therefore track specific costs, which were previously untrackable
    • The greater the value of the cost – There is a larger emphasis on tracing components of production which involve the greatest percentage of total costs
    • What is the cost object? – What may be an indirect cost for one cost object, may be a direct cost for another cost object.
      • Example – Electricity may be an indirect cost for a bicycle, but it is a direct cost for the manufacturing plant
  • Why do we classify?  Because the larger the portion of direct costs, the more reliant management can be about the cost object and making related informed decisions.

Variable and Fixed Costs:

  • Variable Costs – A cost which is directly affected in total by activity or volume.  The cost per unit will remain the same.
    • Example – if each toy car require $1 worth of plastic, then if you produce another car, expenses will go up by another $1
  • Fixed Costs – A cost which is not affected in total by activity or volume.  The cost per unit will change.
    • Example – A warehouse costs $10,000 per month no matter how much of the capacity you use.
    • In the short run, fixed costs have no cost drivers
  • The classification is affected by the cost object, time period, and relevant range chosen.
    • What may be variable for one cost object may be fixed for another
      • Example – While the cost per car is variable with regard to a fleet of rental cars, the cost per car is fixed with regard to how many miles that car is driven.
    • Timing can effect the determination
      • In the short-run manufacturing equipment is a fixed cost, however, over a long period of time as management looks to increase or decrease production, the costs become variable
    • Relevant Range
      • The normal range of activity/volume
        • For example, a bus holds a maximum of 80 people.  So the relevant range for the bus would be from 0 to 80.  However, if we had to transport 100 people, we would be outside the relevant range and, therefore, have to buy another bus.  Our new relevant range would be from 80 to 160.
      • This concept is normally refers to fixed costs, since the cost stays the same while activity/volume increases or decreases within the range.
      • However, the concept may also be applied to variable costs, since the cost per unit stays the same for a given quantity.  If we buy smaller or larger quantities, the price from our supplier may change.
  • Generally, decisions should be made by considering the total cost, rather than the unit cost.  This is particularly important when viewing fixed costs.
  • A unit cost may be calculated dividing the total cost by the number of cost object units
    • Note that this would give us a weighted average cost per unit, therefore sometimes we refer to unit cost as average cost

Manufacturing:

 

Inventories:

  • There are three classification for inventories for manufacturers
    • Direct Materials/Raw Goods
      • These are the basic materials which will be converted into the finished product
      • May be as basic as lumber or subunits, such as semiconductors to go into a video game console
    • Work-In-Process/Work-In-Progress
      • Goods which are anywhere from 1 to 99% complete.  Depending upon level of completion, we can estimate value.
    • Finished Goods / Inventory
      • The fully completed product
      • This is the only type of inventory a retailer or distributor carries
  • Inventoriable costs are all costs incurred during production – direct materials, direct labor, and an allocation of indirect manufacturing overhead.
  • Many times we have to calculate for an unknown amount, for instance:
    • Beginning Finished Goods + Goods Manufactured this Period – Ending Finished Goods = Cost of Goods Sold
    • Beginning Direct Materials + Purchases – Ending Direct Materials = Direct Materials Used
    • Get used to this common type of setup:
    • Beginning + Additions – Ending = Used

Manufacturing Costs

  • Direct Material Costs
    • Cost of materials which can be directly traced to the specific cost object.  Valued at acquisition cost, which is any cost it took to get the material there – acquisition cost, shipping/insurance, taxes, unloading, ect.
  • Direct Labor Costs
    • Cost of labor which can be directly traced to the specific cost object.  For example, any compensation paid to an assembly line employee is traceable to the products going through the assembly line.
  • Indirect Manufacturing Overhead
    • Manufacturing costs which are related to the cost object, but cannot be directly traced thereto.  Such as the cost of the factory or electricity to run the lights.
      • Employee Overtime – Since overtime pay is a premium above the normal wage rates and is typically untraceable to a specific unit, the premium is normally considered and indirect manufacturing cost.
      • Idle Time – Where an employee is paid despite being unproductive due to machine downtime, material shortages, ect. is an indirect cost
  • Prime Costs
    • All direct manufacturing costs, so
    • Direct Materials + Direct Labor
    • Recalling that the greater the portion of direct costs, the greater the confidence in the cost accuracy – the greater the amount of Prime costs, the greater the confidence in cost accuracy
  • Conversion Costs
    • All manufacturing costs except for direct materials, so
    • Direct Labor + Indirect Manufacturing Overhead

Basic Concepts


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