Chapter 2: Cost Concepts Flashcards
Costs can be classified in four broad categories
1) Behaviour
2) Traceability
3) Relevance
4) Function
Cost behaviour
How a cost reacts or responds to changes in the level of business activity.
(such as how the number of passengers flying on a plane will change costs)
Variable Cost definition
A cost that varies, in total, in direct proportion to changes in the level of activity.
Examples: # of customers served, units produced or sold, beds occupied
Remains constant when expressed per unit of activity
Fluctuates / increases or decreased when in TOTAL proportion to changes in activity level
The amount IN TOTAL (not per unit)
Fixed cost definition
A cost that remains constant, in total, regardless of changes in the level of activity within a relevant range.
If a fixed cost is expressed on a per-unit basis, it varies inversely with the level of activity.
Examples: Rent! No matter how many customers are served I still need the same monthly payment
Examples: Straight-line depreciation / amortization, insurance, property taxes, rent
Fixed within some relevant range
Remains constant in total, but fluctuate when expressed per unity of activity
Relevant range
The range of activity within which assumptions about variable and fixed cost behaviour are valid.
I can produce between x and y in this facility, if not i will need to expand my facility apparent
Cost object
Anything for which cost data are desired.
Examples of cost objects are services, product lines, customers, jobs, and organizational subunits, such as departments or divisions of a company.
Costs can be classified by in two ways
Direct costs
Indirect costs
Direct cost
A cost that can be easily and conveniently traced to a particular cost object.
Example:Fuel costs can be traced to individual flights and are direct costs
Indirect cost
A cost that cannot be easily and conveniently traced to a particular cost object.
Examples: Salaries of baggage handlers, ticketing staff, or expenses incurred from running the airline’s marketing cannot be traced to any one specific flight
Common cost
A cost that is incurred to support a number of cost objects but cannot be traced to them individually.
For example, the salary and benefit package of the receptionist in a bank is common to all the different services provided by that bank.
Differential cost
A difference in cost between any two alternatives.
Which one is cheaper, option A or B
Differential revenue
The difference in revenue between any two alternatives.
Opportunity cost
The potential benefit given up when one alternative is selected over another.
Choosing an hour of studying or an hour or tv. By watching tv i miss out on an hour of studying, by studying i miss out on an hour of tv
Sunk cost
Any cost already incurred that cannot be changed by any decision made now or in the future.
NOT DIFFERENTIAL COST (sunk costs of irrelevant to decision making)
Value chain
A sequence of major activities undertaken by an organization to fulfill its mission.
Cost classification by function
Consists of associating costs with the type of activity for which the cost is incurred
Example include: manufacturing, marketing, administration
Manufacturing costs
Costs incurred in production during a certain period, including direct materials, direct labour, and manufacturing overhead.
Raw materials
Materials used to make a product.
String and cotton which becomes a shirt eventually
Direct materials
Those materials that become an integral part of a finished product and can be conveniently traced to it.
Considered a variable cost
Indirect materials
Small items of materials, such as glue and nails. These items may become an integral part of a finished product but are traceable to the product only at great cost or inconvenience.
Direct labour (aka touch labour)
Those factory labour costs that can be easily traced to individual units of product.
FINGER PRINT THEY NEED TO TOUCH THE PRODUCT
Wages and benefits of individuals who are directly involved in rolling sheets of metal, or touch the product along the way!!!!!!!!!
For our purposes, we will generally classify direct labour as a
Variable cost
Indirect labour
The labour costs of janitors, supervisors, materials handlers, and other factory workers that cannot be traced directly to particular products.
DO NOT TOUCH PRODUCT AKA NO FINGERPRINT
Manufacturing overhead
AKA indirect manufacturing cost
AKA Factory Overhead
AKA factory Burden
All costs associated with manufacturing, except direct materials and direct labour.
Contains indirect material, indirect labour, rent for the factory, utilities (electric bill for factory), depreciation, and maintenance
Only those costs related to operating the factory
Conversion cost (equation)
Direct labour cost + manufacturing overhead cost.
Prime cost (equation)
Direct materials cost + direct labour cost.
Nonmanufacturing cost two categories
1) Marketing (selling costs)
2) Administrative cost
1) Marketing (selling costs)
order-getting cost
order-filling cost
marketing costs
All costs necessary to secure customer orders and get the finished product or service into the hands of the customer. Also called order-getting and order-filling costs.
Examples: Market research, advertising, shipping, sales travel, sale commissions, sale salaries, and costs of finished goods
Administrative costs
All executive, organizational, and clerical costs associated with the general management of an organization, rather than with manufacturing, marketing, or selling.
Examples: executive compensation, general accounting, secretarial, public relations
Matching principle
Based on the accrual concept and states that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized
Only recognize the costs as an expense only when the sale takes place (product cost)
Product cost (Manufacturing costs)
Aka Inventoriable costs too
All costs involved in acquiring or making a product. In the case of manufactured goods.
These costs consist of direct materials, direct labour, and manufacturing overhead.
Carried forward to an inventory account that appears on the balance sheet
Inventoriable costs
Costs that can be carried forward to inventory. Also see product costs
Period costs (non-manufacturing costs)
All costs not included in product costs, for example all selling and administrative expenses.
Expensed on the income statement in the period in which they are incurred
Not included as part of the cost of either purchased or manufactured goods
Examples: Sales commission and office rent
All nonmanufacturing costs are considered to be period costs - therefore, advertising, executive salaries, public relations all count
How is the balance sheet different between manufacturing and merchandising companies?
A merchandising company only has one type of inventory – goods purchased from suppliers that await resale
Three types of inventory for manufacturing companies
1) Raw materials,
2) work in process,
3) finished goods
Work in process (aka goods in process)
Units of product that are only partially complete and will require further work before they are ready for sale to a customer.
FInished goods
Units of product that have been completed but have not yet been sold to customers.
Basic equation for inventory accounts (equation)
Cost of goods sold (COGS)
Beginning balance + Additions to inventory - withdrawals from inventory = ending balance
Two methods to track inventory and compute cost of goods sold (COGS)
1) Perpetual inventory system
2) Periodic inventory system
1) Perpetual inventory system
An inventory system wherein a continuous record of inventory is maintained.
- Additions to inventory are debited to the account
- Withdrawals from inventory and transferred to the COGS account
2) Periodic inventory system
An inventory system wherein the inventory accounts are updated at the end of every period.
Costs of goods manufactured
The manufacturing costs associated with the goods that were finished during the period.
Schedule of cost of goods sold (COGS)
A schedule showing the direct materials, direct labour, and manufacturing overhead costs incurred for a period and assigned to work in process and finished goods.
Product costs are often called inventoriable costs because
these costs go directly into inventory accounts as they are incurred (first into work in process and then into finished goods), rather than going into the expense accounts
Merchandising COGS
Adding the cost of merchandise purchases in a given period to beginning inventory and subtracting the ending merchandise inventory
Cost of goods manufactured (COGM)
Include costs of direct materials, direct labour, and manufacturing overhead
Beginning Work-in-Process (WIP) Inventory + (DM + DL + MOH) – Ending WIP Inventory = COG Manufactured
If shipping is happening in the production facility, yes it is a _______.
But if you ship the product out after its finished than it is a _______
product cost
period cost
Direct material and direct labour are always
Variable costs
Manufacturing and merchandising equation
Sales - COGS = Gross Margin
Gross margin - operating expense = Net Income
Direct materials + direct labour =
manufacturing overhead
Direct materials inventory Beg + purchases =
Direct materials available for production
Direct materials available for production - direct materials inventory END =
Direct materials used
Product costs /manufacturing costs equation =
Direct Materials + direct labour + manufacturing overhead
Merchandising companies equation
Beginning inventory + purchases - COGS = ending inventory
Manufacturing companies equation
Beginning finished goods inventory + COG manufactured - COGS = Ending finished gods inventory
COGM equation
Beginning work-in-process (WIP) inventory + (DM + DL +MOH) - ending WIP inventory
