4. Cost Management Concept

Question 1

Cost Management Termenologies

Answer 1

• Financial accounting - used for external users prepared under GAAP, have historical focus
• Management accounting - used for internal users to improve organizational decisions, future oriented
• Cost accounting - Supports both financial and management accounting
• Cost definition by IMA:
  Management accounting - Measurement of monetary terms of the amount of resources used for some purposes
  Financial accounting - The price paid t acquire goods or service
• Cost object - Is an object in which the cost can be attached to
• Cost driver is the basis used to assign cost to cost object - it have direct cause and effect relationship between the quantity of the driver consumed and the amount of total cost. Cost increase as the activity increases
• Overtime premium are OH costs
• Direct costs can be associated with a particular cost object such as DM, DL and can be traced directly to the final object
• Indirect costs can’t be associated with a particular cost object such as indirect material, indirect and can’t be traced directly to the final object
• Cost pool is an account in which a variety of similar cost elements with a common cause are accumulated
• Common costs are another type of indirect costs that incurs for the benefit of more than cost object

Question 2

Cost Behavior and Relevant Range

Answer 2

• Relevant Range is the level of volume or activity in which a company is expected to operate and cost relationships remains constant - used in describing foxed costs.
• Variable costs in total vary with change in volume and remains constant per unit within relevant range.
• Fixed costs in total remains unchanged and varies indirectly within the relevant range - per unit decrease when production increases. Fixed cost is the cost line that crosses the vertical axis
• Fixed cost per unit shape is called curvilinear
• Stockout cost are either lost revenue from missed sales or the express shipping costs of making product available on urgent basis.
• Mixed (Semivariable) costs combine fixed and variable portion - because of the fixed portions, per unit cost of the mixed cost decreases as productions increase.
• Two methods used for estimating mixed costs:
  1) Regression method - more complex
  2) High low method - less complex but quicker
• Marginal cost is the cost incurred by a one unit increase in the activity level

Question 3

Cost Classifications

Answer 3

• Avoidable cost may be eliminated by not engaging in the activity or performing it more efficiently.
• Committed cost arises from holding PPE, they can’t be reduced by lowering short term level of production -
  fixed costs arises as a result of past decisions and it can’t be alerted at short run
• Incremental cost is the additional cost inherent in a given decision - In the short run management decisions are made in reference to incremental cost
• Differential cost is the difference in total cost between 2 decisions
• Engineered cost have a direct, observable cause and effect relationship level of input-output
• Discretionary cost arises from budgeting decisions that have NO cause and effect relationship between input-output
• Outlay cost requires actual cash disbursements - EXPLICIT cost
• Opportunity cost is the maximum benefit forgone by using the next best alternative, IMPLICIT cost
• Imputed costs are type of opportunity cost
• Economic cost is the sum of explicit and implicit costs
• Relevant cost are future costs that will vary depending on the action taken
• Sunk cost either already paid or irrecoverbale committed to occur or unavoidable not vary with the option chosen, they are NOT relevant to future decisions
• Historical cost is a sunk cost - actual price already paid for an asset
• Joint costs are costs incurred BEFORE split off point, NOT traceable to end products
• Separable costs incurred BEYOND the split off point - have high sales value and relevant in deciding at which point the product should be sold
• Normal spoilage occurs under normal operating conditions - UNCONTROLLABLE at the short run, expected under EFFICIENT operations and treated as PRODUCT cost
• Abnormal spoilage NOT expected to occur under normal spoilage - CONTROLLABLE by production management and treated as PERIOD cost
• Rejected end product are discarded and treated as spoliage
• Rework are END PRODUCTS that DON’T meet standards of salability but can be brought to salable condition with extra effort - The decision to rework is based on whether the marginal revenue to be gained from selling the reworked units exceeds the marginal cost
• Scrap are RAW MATERIALS left over from the production cycle but still usable for purpose OTHER THAN those for which it was originally - there is no systematic relationship between dollar sales and scrap
• Waste are RAW MATERIALS left over the production cycle for which there is NO further use
• Carrying costs are the cost of storing or holding inventory.
• Transferred in costs are the money spent on switching the processing of particular product or service between departments
• Value adding costs CAN’T be eliminated without reducing quality, responsiveness or the quantity of the product
• Types of manufacturing capacity:
  1) Normal capacity - Includes seasonal, cyclical and trend variations
  2) Practical capacity - allows for UNAVOIDABLE delays, and DOESN’T consider idle time caused by inadequate sales demand. Is the most realistic capacity to derive application OH rate
  3) Practical (ideal) capacity - assumes continuous operations with no holiday’s, downtime/ Will result in a lower inventory value per unit

Question 4

Costing Techniques

Answer 4

• Absorption costing (full costing) treats all manufacturing costs as product cost. FOH multiplied by unit produced and ending inventory
• Variable costing (direct costing) treats ONLY variable manufacturing costs as product cost - the phase direct costing is considered misleading because it implies traceability. FOH are only multiplied by units sold.
• Ending finished goods will differ between two methods due to the different treatment of FOH.
• Actual costing record product costs based on ACTUAL prices and ACTUAL quantities. Using this method will result in a large fluctuation from period to period, this volatility can lead to the reporting of misleading financial information. Least timely and most volatile method. Used with Job order costing
• Normal costing records product costs based on ACTUAL prices for DM, DL and STANDARD prices for OH based on ACTUAL quantities. Immaterial efficiency variances are accounted for as an addition to COGS. it DOESN’T improve accuracy of job and product costing
• Extended normal costing record product costs based on STANDARD prices and ACTUAL quantities
• Standard costing record product costs based on STANDARD prices and STANDARD quantities
• Standard costing is a system designed to alert management when actual costs of production differs significantly from standard cost
• Standard costing is determined independently from the budget and it is NOT just an average of past costs - least likely to involve top management in establishing it
• Standard costing is used with Job ordering, process costing and ABC
• Setting ideal level of standard costing DOESN’T motivate employees, it is used to facilitate flexible budgeting.
• Standard costing represents what cost should be, budget cost represent expected actual cost.
• Under standard costing usually there is difference between budget OH and actual OH, if the difference is immaterial it should be allocated to COGS. If it is material it should be allocated between COGS, work in process and Ending inventory
• ABC system collect financial and operating data on the basis of underlying nature and extent of cost driver

Question 5

Rules for Calculation

Answer 5

• High low method = (cost at highest level of activity - cost at lowest level of activity) / (driver at highest level of activity - driver at lowest level of activity)
• Units sold = units in beginning inventory + Units produced - units in finished inventory
• Number of units o finished goods = Total manufacturing costs / finished goods cost
• OVERTIME is ALWAYS treated as DL, OVERTIME PREMIUM is treated as OH