48. Cost Drivers & Cost Flows

Question 1

What are some of the main challenges of accurately classifying costs as variable or fixed?

Answer 1

• Costs are typically classified as either variable or fixed, but many costs exhibit both variable and fixed characteristics.
• Fixed costs can shift in total as an organization moves between significant cost structures. As volume increases or decreases, there are “step-up” or “step-down” costs.
• The time horizon for the performance report or decision analysis. Costs tend to be fixed in very short horizons and variable over long horizons.
• The distinction as fixed or variable is based on the cost object.

Question 2

Briefly describe what is meant by the terms “cost pools,” “cost objects,” and “cost drivers.”

Answer 2

• Cost Pools: Sets of costs that are related together, both functionally and behaviorally.
• Cost Objects: The target of the cost assignment system. They are typically tied to the organization’s income statement and also represent the revenue objects.
• Cost Drivers: Establish a relationship between cost pools and cost objects. They represent a consumption relationship if the cost is variable. If the cost is fixed, they represent an allocation method

Question 3

How are cost drivers used? Briefly describe the two-step process that is used to calculate an assigned cost to the cost object.

Answer 3

• Cost drivers are used to establish cost driver rates, and the cost driver rates are used to track or allocate costs to the cost object.
• The first step is to calculate the Cost Driver Rate. This rate is calculated as the Cost Pool Total ÷ Cost Driver Volume.
• The second step is to use the rate to track or allocate costs to the cost object. The Assigned Cost is calculated as Cost Driver Rate × Cost Object Activity.

Question 4

Describe the difference between a cost driver tracking and allocating costs to the cost object

Answer 4

Tracking: If there is a direct consumption relationship between the cost pool and the cost object, the cost driver is tracking the direct costs to the cost object.
•Allocating: If there is not a direct consumption relationship (i.e., the cost pool is fixed with respect to activity in the cost object), then the cost driver rate is allocating indirect costs to the cost object.

Question 5

Describe what costs are and how they flow through most organizations.

Answer 5

• Costs are not the same as expenses; rather, they represent spending made by the organization.
• The three types of product costs are direct materials, direct labor, and manufacturing overhead.
• The costs are added in the work-in-process inventory account and then flow to the finished goods inventory account.
• The costs will eventually flow to the cost of goods sold account and represent an expense on the income statement

Question 6

Describe how cost flows are accounted for in Actual, Normal, and Cost Accounting Systems and identify what types of organizations would typically use each type of system.

Answer 6

• Actual: Simplest cost accounting approach as cost flows are based on actual cost inputs for all three cost flows. These systems are rarely used.
• Normal: Cash flows are based on actual costs for direct materials and direct labor and budgeted costs for overhead. These systems are common in smaller and newer companies.
• Standard: Cash flows use budgeted costs for all three flows going into work-in-process inventory accounts. These systems are common in large, advanced organizations.