Ch. 2 An Introduction to Cost Terms and Purposes

Question 1

Cost object

Answer 1

• When you think of a cost, you invariably think of it in the context of putting a price on a particular thing. We call this “thing” a cost object, which is anything for which a cost measurement is desired.
• Includes cost of : Product, service, project, customer, activity, or department.

Question 2

How does a cost system determine the costs of various cost objects?

Answer 2

2 stages:

• Accumulation: collection of cost data in some organized way by means of an accounting system. Accumulate costs in various categories (different types of materials, different classifications of labor, costs incurred by supervision)
• Assignment: accumulated costs are assigned to designated cost objects (different models of cars) by cost tracing for direct costs, or cost allocation for indirect costs.

Question 3

Direct Costs

Answer 3

• Can be traced to it in an economically feasible (cost effective) way.
• Direct Materials: steel and tires for car
• Direct labor: workers who build the car
• Costs are assigned by cost tracing.

Question 4

Indirect Costs

Answer 4

• Cannot be traced to it in an economically feasible (cost effective) way.
• Indirect costs: Lease for plant where multiple models of cars are made
• Indirect Materials:
• Indirect labor: Salaries of plant administration (including plant manager) who oversee production of the many different types of cars produced. They oversee the production of other products.
• Costs are assigned by cost allocation.
• The smaller the amount of a cost–that is, the more immaterial the cost is–the less likely it is economically feasible to trace it to a particular cost object.

Question 5

Cost Tracing

Answer 5

• How Direct costs are assigned to cost objects

- Based on material requisition document

Question 6

Cost Allocation

Answer 6

• How Indirect costs are assigned to cost objects

- No requisition document

Question 7

Variable Costs

Answer 7

• Changes in total in proportion to changes in the related level of total activity or volume of output produced
• Stays the same per unit.

Question 8

Fixed Costs

Answer 8

• Remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume of output produced.
• Changes per unit

Question 9

Cost Driver

Answer 9

• A variable, such as the level of activity or volume, that causally affects costs over a given time span. (number of parts, miles driven, number of setup hours)
• An activity is an event, task, or unit of work with a specified purpose (designing products, setting up machines, or testing products)
• Variable: the cost drier of a variable cost is the level of activity or volume whose change causes proportionate changes in the variable cost
• Fixed: costs that are fixed in the short run have no cost driver in the short run but may have a cost driver in the long run.

Question 10

Relevant Range

Answer 10

-Band or range of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost in question.

Question 11

Unit/Average Cost

Answer 11

• Calculated by dividing the total cost by the related number of units produced.
• Can be useful for particular decisions, but managers should think in terms of total variable costs, total fixed costs, and total costs rather than unit cost.
• If unit costs is used, actual total cost could be understated or overstated if units produced increases or decreases (pg. 37)
• As a general rule, first calculate total costs, then compute the unit cost, if it is needed for a particular decision.

Question 12

3 Types of Manufacturing costs

Answer 12

• Direct Materials
• Direct Labor
• Manufacturing Overhead (Indirect costs)

Question 13

Note for Direct Materials

Answer 13

-Costs of direct materials include not only the cost of the materials themselves but the freight-in (inward delivery) charges, sales taxes, and customs duties that must be paid to acquire them.

Question 14

Direct manufacturing labor costs

Answer 14

• Include compensation of all manufacturing labor that can be traced to the cost object (WIP and then finished goods) in an economically feasible way.
• Examples include wages and fringe benefits paid to machine operators and assembly-line workers who convert direct materials to finished goods

Question 15

Manufacturing Overhead (Indirect costs)

Answer 15

• All manufacturing costs that are related to the cost object (WIP and then finished goods) but cannot be traced to that cost object in an economically feasible way.
• Examples include: supplies, indirect materials such as lubricants, indirect manufacturing labor such as plant maintenance and cleaning labor, plant rent, plant insurance, property taxes on the plant, plant depreciation, and compensation of plant managers.

Question 16

Inventoriable Costs

balance sheet then income statement (COGS)

Answer 16

• All costs of a product that are considered assets in a company’s balance sheet when the costs are incurred and that are expensed as cost of goods sold only when the product is sold.
• Go through the B/S accounts of WIP inventory and finished goods inventory before entering the COGS in the income statement.
• For manufacturing-sector companies, all manufacturing costs are inventoriable costs.
• The costs first accumulate as WIP inventory assets (in other words, they are “inventoried”) and then as finished goods inventory assets.
• Note that COGS includes all manufacturing costs (direct materials, direct mfg labor, and mfg overhead costs)

Question 17

Period Costs
income statement costs (not COGS)
(fin. acc. SG&A)

Answer 17

• All costs in the income statement other than cost of goods sold.
• Expensed directly in the income statement (no B/S)
• Period costs, such as marketing, distribution, and customer service costs, are treated as expenses of the accounting period in which they are incurred b/c manager expect these costs to increase revenues in only that period and not in future periods. R&D costs, labor costs of sales-floor personnel, advertising costs.
• For manufacturing-sector companies, all nonmanufacturing costs (ie design costs and costs of shipping products to customers) in the income statement are period costs.
• In fin. acc. period costs are typically called selling, general, and administrative expenses in the I/S

Question 18

Flow of direct materials (steps)

Answer 18

Step 1: Cost of direct materials used
Step 2: Total manufacturing costs incurred
Step 3: Cost of goods manufactured
Step 4: Cost of goods sold

Question 19

Step 1: Cost of direct material used

Answer 19

Direct materials:
   \+Beginning inventory, Jan.1, 2014
   \+Purchases of direct materials
   =Cost of direct materials available for use
   --Ending inventory, Dec.31, 2014
          =Direct materials used

Question 20

Step 2: Total manufacturing costs incurred

Answer 20

\+Direct materials used
\+Direct manufacturing labor
\+Manufacturing OH costs:
    Indirect mfg labor
    Supplies
    Heat, light, and power
    Depreciation--plant building
    Depreciation--plant equip.
    Miscellaneous
          =Total manufacturing costs incurred

Question 21

Step 3: Cost of goods manufactured

Answer 21

*Refers to the cost of goods brought to completion, whether they were started before or during the current accounting period.

\+Beginning WIP inventory, Jan.1, 2014
\+Total mfg costs incurred
=Total mfg costs to account for
--Ending WIP inventory, Dec.31, 2014
=Cost of goods manufactured

Question 22

Step 4: Cost of goods sold

Answer 22

+Beginning inventory of finished goods, Jan.1, 2014
+Cost of goods manufactured
–Ending inventory of finished goods, Dec.31, 2014
=Cost of goods sold

Question 23

Gross margin

gross profit in fin. acc.

Answer 23

= Revenues – Cost of goods sold

*Measures how much a company can charge for its products over and above the cost of acquiring or producing them.

Question 24

Operating Income

Answer 24

Revenues from operations
--COGS
=Gross profit
--Operating (period) costs (excluding intr. exp. & income     taxes)
=Operating income

Question 25

Prime costs

Answer 25

*All direct manufacturing costs

= Direct materials costs + Direct mfg. labor costs

Question 26

Conversion costs

Answer 26

*All manufacturing costs other than direct material costs.
*Represents all manufacturing costs incurred to convert direct materials into finished goods.
= Direct mfg. labor costs + mfg. overhead costs

Question 27

2 classes of indirect labor

Answer 27

• Overtime premium: wage rate paid to workers (for both direct labor and indirect labor) in excess of their straight-time wage rates
• Generally mostly treated as indirect (overhead) labor, but can be direct labor in some instances
• Idle time: for both direct and indirect labor, refers to the wages paid for unproductive time caused by lack of orders, machine or computer breakdowns, work delays, poor scheduling etc.
• Both overtime premium and idle time are considered overhead costs.

Question 28

Product Cost

Answer 28

• The sum of the costs assigned to a product for a specific purpose.
• Different purposes can result in different measures of product cost