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# An introduction to cost terms and purposes

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### An introduction to cost terms and purposes

1. 1. An Introduction to Cost Terms and Purposes 2-1
2. 2. Learning Objective 1Define and illustrate a cost object. 2-2
3. 3. Cost and Cost Terminology Cost is a resource sacrificed or forgone to achieve a specific objective.An actual cost is the cost incurred (a historical cost) as distinguished from budgeted costs. A cost object is anything for which a separate measurement of costs is desired. 2-3
4. 4. Cost and Cost Terminology Cost Object CostAccumulation Cost Object Cost Object Cost TracingAssignment Allocating 2-4
5. 5. Learning Objective 2Distinguish between direct costs and indirect costs. 2-5
6. 6. Direct and Indirect Costs COST OBJECT Direct CostsExample: Paper on which Example: SportsSports Illustrated magazine Illustrated magazineis printed Indirect CostsExample: Lease cost forTime-Warner buildinghousing the senior editorsof its magazine 2-6
7. 7. Direct and Indirect Costs ExampleDirect Costs:Maintenance Department \$40,000Personnel Department \$20,600Assembly Department \$75,000Finishing Department \$55,000 Assume that Maintenance Department costs areallocated equally among the production departments. How much is allocated to each department? 2-7
8. 8. Direct and Indirect Costs Example Maintenance \$40,000 Assembly Finishing Direct Costs Direct Costs \$75,000 \$55,000 \$20,000 \$20,000 Allocated 2-8
9. 9. Learning Objective 3Explain variable costs and fixed costs. 2-9
10. 10. Cost Behavior Patterns Example Bicycles by the Sea buys a handlebar at \$52 for each of its bicycles. What is the total handlebar cost when 1,000 bicycles are assembled? 2 - 10
11. 11. Cost Behavior Patterns Example 1,000 units × \$52 = \$52,000 What is the total handlebar costwhen 3,500 bicycles are assembled? 3,500 units × \$52 = \$182,000 2 - 11
12. 12. Cost Behavior Patterns Example Bicycles by the Sea incurred \$94,500 in a given year for the leasing of its plant. This is an example of fixed costs withrespect to the number of bicycles assembled. 2 - 12
13. 13. Cost Behavior Patterns ExampleWhat is the leasing (fixed) cost per bicyclewhen Bicycles assembles 1,000 bicycles? \$94,500 ÷ 1,000 = \$94.50What is the leasing (fixed) cost per bicyclewhen Bicycles assembles 3,500 bicycles? \$94,500 ÷ 3,500 = \$27 2 - 13
14. 14. Cost Drivers The cost driver of variable costs is the level of activity or volume whose change causesthe (variable) costs to change proportionately. The number of bicycles assembled is a cost driver of the cost of handlebars. 2 - 14
15. 15. Relevant Range Example Assume that fixed (leasing) costs are \$94,500 for a year and that they remain the same for acertain volume range (1,000 to 5,000 bicycles). 1,000 to 5,000 bicycles is the relevant range. 2 - 15
16. 16. Relevant Range Example 120000 100000Fixed Costs 80000 60000 40000 \$94,500 20000 0 0 1000 2000 3000 4000 5000 6000 Volume 2 - 16
17. 17. Relationships of Types of Costs Direct Variable Fixed Indirect 2 - 17
18. 18. Learning Objective 4Interpret unit costs cautiously. 2 - 18
19. 19. Total Costs and Unit Costs ExampleWhat is the unit cost (leasing and handlebars) when Bicycles assembles 1,000 bicycles? Total fixed cost \$94,500 + Total variable cost \$52,000 = \$146,500 \$146,500 ÷ 1,000 = \$146.50 2 - 19
20. 20. Total Costs and Unit Costs Example \$146,500 200000 2x ,50 0 + \$5 150000 \$94Total Costs 100000 \$94,500 50000 0 0 500 1000 1500 Volume 2 - 20
21. 21. Use Unit Costs CautiouslyAssume that Bicycles management uses aunit cost of \$146.50 (leasing and wheels). Management is budgeting costs for different levels of production. What is their budgeted cost for an estimated production of 600 bicycles? 600 × \$146.50 = \$87,900 2 - 21
22. 22. Use Unit Costs CautiouslyWhat is their budgeted cost for an estimated production of 3,500 bicycles? 3,500 × \$146.50 = \$512,750 What should the budgeted cost be for an estimated production of 600 bicycles? 2 - 22
23. 23. Use Unit Costs CautiouslyTotal fixed cost \$ 94,500Total variable cost (\$52 × 600) 31,200Total \$125,700 \$125,700 ÷ 600 = \$209.50 Using a cost of \$146.50 per unit would underestimate actual total costs if output is below 1,000 units. 2 - 23
24. 24. Use Unit Costs Cautiously What should the budgeted cost be for an estimated production of 3,500 bicycles?Total fixed cost \$ 94,500Total variable cost (52 × 3,500) 182,000Total \$276,500 \$276,500 ÷ 3,500 = \$79.00 2 - 24
25. 25. Learning Objective 5 Distinguish among manufacturing companies,merchandising companies, and service-sector companies. 2 - 25
26. 26. Manufacturing Manufacturing companies purchase materials and components and convert them into finished goods.A manufacturing company must also develop, design, market, and distribute its products. 2 - 26
27. 27. Merchandising Merchandising companiespurchase and then sell tangible products without changing their basic form. 2 - 27
28. 28. Merchandising Service companies provide services or intangible products to their customers.Labor is the most significant cost category. 2 - 28
29. 29. Learning Objective 6Differentiate between inventoriable costs and period costs. 2 - 29
30. 30. Types of Inventory Manufacturing-sector companies typically have one or more of thefollowing three types of inventories:1. Direct materials inventory2. Work in process inventory (work in progress)3. Finished goods inventory 2 - 30
31. 31. Types of InventoryMerchandising-sector companies hold only one type of inventory – theproduct in its original purchased form. Service-sector companies do nothold inventories of tangible products. 2 - 31
32. 32. Classification of Manufacturing Costs Direct materials costsDirect manufacturing labor costs Indirect manufacturing costs 2 - 32
33. 33. Learning Objective 7Describe the three categories of inventories commonly found in manufacturing companies. 2 - 33
34. 34. Inventoriable CostsInventoriable costs (assets)…become cost of goods sold… after a sale takes place. 2 - 34
35. 35. Period Costs Period costs are all costs in the income statement other than cost of goods sold. Period costs are recorded as expenses of theaccounting period in which they are incurred. 2 - 35
36. 36. Flow of Costs Example Bicycles by the Sea had \$50,000 of directmaterials inventory at the beginning of the period. Purchases during the period amounted to \$180,000 and ending inventory was \$30,000. How much direct materials were used? \$50,000 + \$180,000 – \$30,000 = \$200,000 2 - 36
37. 37. Flow of Costs Example Direct labor costs incurred were \$105,500. Indirect manufacturing costs were \$194,500.What are the total manufacturing costs incurred?Direct materials used \$200,000Direct labor 105,500Indirect manufacturing costs 194,500Total manufacturing costs \$500,000 2 - 37
38. 38. Flow of Costs ExampleAssume that the work in process inventoryat the beginning of the period was \$30,000, and \$35,000 at the end of the period. What is the cost of goods manufactured?Beginning work in process \$ 30,000Total manufacturing costs 500,000Ending work in process 35,000Cost of goods manufactured \$495,000 2 - 38
39. 39. Flow of Costs Example Assume that the finished goods inventoryat the beginning of the period was \$10,000, and \$15,000 at the end of the period. What is the cost of goods sold?Beginning finished goods \$ 10,000Cost of goods manufactured 495,000Ending finished goods 15,000Cost of goods sold \$490,000 2 - 39
40. 40. Flow of Costs Example Work in ProcessBeg. Balance 30,000 495,000Direct mtls. used 200,000Direct labor 105,500Indirect mfg. costs 194,500Ending Balance 35,000 2 - 40
41. 41. Flow of Costs Example Finished GoodsWork in Process 10,000 490,000 495,000 495,000 15,000 Cost of Goods Sold 490,000 2 - 41
42. 42. Manufacturing Company BALANCE SHEET INCOME STATEMENTInventoriable Costs Revenues when deduct Finished sales Materials occur Cost of Goods Inventory Goods Sold Inventory Equals Gross Margin deduct Work in Period Process Inventory Costs Equals Operating Income 2 - 42
43. 43. Merchandising Company BALANCE SHEET INCOME STATEMENTInventoriable Costs Revenues when deduct salesMerchandise occur Cost of Inventory Purchases Goods Sold Equals Gross Margin deduct Period Costs Equals Operating Income 2 - 43
44. 44. Prime Costs Direct Direct PrimeMaterials + Labor = Costs 2 - 44
45. 45. Prime CostsWhat are the prime costs for Bicycles by the Sea?Direct materials used \$200,000+ Direct labor 105,500= \$305,000 2 - 45
46. 46. Conversion CostsDirect Manufacturing ConversionLabor + Overhead = Costs Indirect Indirect Labor Materials Other 2 - 46
47. 47. Conversion Costs What are the conversion costs for Bicycles by the Sea?Direct labor \$105,500+ Indirect manufacturing costs 194,500= \$300,000 2 - 47
48. 48. Measuring Costs Requires Judgment Manufacturing labor-cost classifications vary among companies.The following distinctions are generally found: Direct manufacturing labor Manufacturing overhead 2 - 48
49. 49. Measuring Costs Requires Judgment Manufacturing overheadIndirect labor Managers’ salaries Payroll fringe costsForklift truck operators (internal handling of materials) Janitors Rework labor Overtime premium Idle time 2 - 49
50. 50. Measuring Costs Requires Judgment Overtime premium is usually considered part of overhead.Assume that a worker gets \$18/hour for straight time and gets time and one-half for overtime. 2 - 50
51. 51. Measuring Costs Requires Judgment How much is the overtime premium? \$18 × 50% = \$9 per overtime hour If this worker works 44 hours on a given week, how much are his gross earnings?Direct labor 44 hours × \$18 = \$792Overtime premium 4 hours × \$ 9 = 36Total gross earnings \$828 2 - 51
52. 52. Learning Objective 8Explain why product costs are computed in different ways for different purposes. 2 - 52
53. 53. Many Meanings of Product Cost A product cost is the sum of the costs assigned to a product for a specific purpose.1. Pricing and product emphasis decisions2. Contracting with government agencies3. Preparing financial statements for external reporting under generally accepted accounting principles 2 - 53
54. 54. Learning Objective 9Present key features of cost accounting and cost management. 2 - 54
55. 55. A Framework for Cost Management Three features of cost accounting and cost management: 1. Calculating the costs of products 2. Obtaining information 3. Analyzing information 2 - 55