Chapter 2 - An introduction to cost terms and purposes Flashcards
2.1 Define cost object and give three examples.
A cost object is anything for which a separate measurement of costs is desired. It could be a product, a service, or even a project or a customer. It could also be a Brand category, an Activity, a Department or a Programme.
2.2 Define direct and indirect costs and give an example of each.
Direct costs of a cost object are those that are related to a given cost object (product, department, etc.) and that can be traced to it in an economically feasible way*. Could be materials used to produce a car.
Indirect costs are related to the particular cost object but cannot be traced to it in an economically feasible way. They are allocated. Could be the light in a production plant.
2.3 Describe how a given cost item can be both a direct cost and an indirect cost.
The direct/indirect classification depends on the choice of the cost object! I.e. what could be a direct cost for one cost object is not for another.
2.4 Give three factors that will affect the classification of a cost as direct or indirect.
The materiality of the cost in question
Available information-gathering technology
Design of operations
2.5 What is a cost driver? Give an example for each function in the value chain
A cost driver is a factor, such as the level of activity or volume, that affects costs (over a given time span).
The cost driver of variable costs is the level of activity or volume whose change causes the (variable) costs to change proportionately.
- Research and development - labour hours
- Design of products, services or processes - labour hours
- Production - kg. of steel used
- Marketing - number of advertising campaigns
- Distribution - number of kilometres driven by trucks
- Customer service - number of customer enquiries
2.6 What is the relevant range? What role does the relevant range concept play in explaining how costs behave?
Relevant range is the band of the level of activity or volume in which a specific relationship between the level of activity or volume and the cost in question is valid. Costs are described as variable or fixed with respect to a particular relevant range.
Explain variable and fixed costs
A variable cost is a cost that does change in total in proportion to changes in a cost driver. A fixed cost is a cost that does not change in total despite changes in the cost driver.
2.7 Explain why unit costs must often be interpreted with caution.
Unit costs of a cost object should be interpreted with caution when they include a fixed-cost component. When making total cost estimates, think of variable costs as an amount per unit and fixed costs as a total amount.
2.8 Describe how service-, merchandising- and manufacturing-sector companies differ from each other.
Service companies provide services or intangible products to their customers. Labour is often the most significant cost category. The operating-cost line items for service companies will include costs from all areas of the value chain.
Merchandising-sector companies purchase and sell products without changing their basic form. “Cost of goods sold” is often the most significant cost category. Merchandise purchased from suppliers but not sold at the end of an accounting period is held as stock
Manufacturing companies purchase materials and components and convert them into finished goods. Materials and labour costs is often the most significant cost category. Stock can include direct materials, work in progress or finished goods. A manufacturing company must also develop, design, market and distribute its products.
2.9 What are the three major categories of the inventoriable costs of a manufactured product?
Direct materials cost are the acquisition costs of all materials that eventually become part of the cost object. Direct materials costs can be traced economically. Purchase costs include inward delivery charges, VAT and other customs duties.
Direct manufacturing labour costs include the compensation of all manufacturing labour that can be traced to the cost object in an economically feasible way. Wages and fringe benefits paid to: Machine operators and Assembly-line workers.
Indirect manufacturing costs are all manufacturing costs that are considered to be part of the cost object, but that cannot be traced to that cost object in an economically feasible way. Other terms for this cost category include manufacturing overhead costs and factory overhead costs.
2.10 Define prime costs and conversion costs.
Prime costs are all direct manufacturing costs. Conversion costs are all manufacturing costs other than direct materials cost.
Distinguish between capitalised costs and period (revenue) costs
Capitalised costs (direct materials, direct labour and indirect manufacturing costs) are included in work-in-progress and finished goods stock. Capitalised costs flow to the profit and loss account as “cost of goods sold”. For merchandising-sector companies, capitalised costs are the costs of purchasing the goods which are resold in their same form. For service-sector companies, the absence of stock means there are no capitalised costs. Revenue costs are all costs in the profit and loss account other than cost of goods sold. Revenue costs are recorded as expenses of the accounting period in which they are incurred. For manufacturing-sector companies, revenue costs include all non-manufacturing costs (research and development, distribution, etc.). For merchandising-sector companies, revenue costs include all costs not related to the cost of goods purchased for resale. For service-sector companies, all of their costs are revenue costs.
Explain how different ways of computing product costs are appropriate for different purposes
For product pricing and product emphasis (product pricing and product-mix decisions) all costs of those areas of the value chain required to bring a product to a customer should be included.
For contracting with government agencies, there are often detailed guidelines on what is allowed to be included in a product-cost amount.
For financial statements, the focus is on inventoriable costs. In most countries, generally accepted accounting principles in manufacturing companies allow only manufacturing costs to be assigned to products reported in financial statements.
How to calculate the cost of materials used?
Opening value of direct materials stock + purchases of direct materials - closing value of direct materials stock
How to calculate the cost of goods manufactured?
Opening value of WIP stock + manufacturing costs incurred during the period - closing value of WIP stock
