Cost Concepts, Behaviour and Terminology

Question 1

What is a cost?

Answer 1

A measure of resources used or given up to achieve a stated purpose

Question 2

What is a cost objective?

Answer 2

Any activity for which a separate measurement of costs is required e.g what is the cost of manufacturing these trainers?

Question 3

What is a cost object?

Answer 3

Anything for which cost data are desired – including products, product lines, customers, jobs and organizational subunits e.g. R&D-in a factory setting=product unit produced

Question 4

What is cost classification?

Answer 4

A matter of grouping together costs which share the same attribute(s) relative to a stated cost objective e.g. Nike wants to find out revenue of footwear for different sports so may group products into football, running etc

Question 5

How does cost classification relate to cost objectives?

Answer 5

• The cost objective should determine the classification to be used
• Changing the cost objective may alter the categorisation of a specific cost within a given classification

Question 6

What are the main cost objectives?

Answer 6

1. Assigning costs to cost objects - traceability (direct or indirect)
2. Financial reporting - inventoriable or expensed (product or period)
3. Predicting cost behaviour in response to changes in activity (fixed or variable)
4. Assessing performance (controllable or uncontrollable)e.g. storm event in order to be fair
5. Making decisions (differential, sunk, opportunity)

Question 7

What is the activity of a manufacturing, retailing and services firms respectively?

Answer 7

•Manufacturing
  -Buy raw materials
  -Produce and sell finished goods
• Retailing
 -Buy finished goods
 -Sell finished goods
• Services
  -Provide tasks or activities for customers

Question 8

What of costs in a manufacturing, retailing and services firm respectively?

Answer 8

• Manufacturing
 -Production costs: materials, labour
 -Non-production costs: Admin? Marketing? R&D?
• Retailing 
 -Selling costs: in-store employees
 -Others:  Admin? Marketing?
• Services
 -Project costs: Consultants assigned to specific customers (labour)
 -Others:  Admin? Marketing

Question 9

What is the inventory in a manufacturing, retailing and services firm respectively?

Answer 9

• Manufacturing
 -3 Types: raw material, work in progress (WIP), finished goods 
• Retailing 
 -1 Type: finished goods 
• Services
 -NO physical inventory but some WIP

Question 10

What happens to the cost of unsold goods and cost of goods sold in terms of financial statements for retail and manufacturing firms?

Answer 10

• The cost of unsold goods is reported on the balance sheet

* The cost of goods sold is reported on the profit and loss account/income statement

Question 11

How is the cost of sales calculated for manufacturing and retail firms respectively?

Answer 11

• Retail
 -Opening stock +purchases
-minus closing stock
• Manufacturing
 -Opening FG stock +Cost of goods manufactured
 -Minus closing FG stock

Question 12

How does the focus change in terms of costs when moving from financial to management accounting?

Answer 12

More focus on product costs than financial statement costs

Question 13

In terms of the objective of the first cost, what are the reasons to assign costs to cost objects?

Answer 13

• To determine prices-allowing products to be sold for the right price
• Work out profitability-of each product
• Greater awareness of costs allows greater control

Question 14

What costs are traced to cost objects?

Answer 14

Direct and indirect (much harder to assign and requires estimations/assumptions)

Question 15

What are the indirect and direct costs categories in manufacturing?

Answer 15

• Direct materials
• Direct labour
• Manufacturing Overheads (indirect)

Question 16

What are direct materials?

Answer 16

Those materials that become an integral part of the product and that can be conveniently traced directly to it e.g. car wheels (visible element)

Question 17

What is direct labour?

Answer 17

Labour costs that can be easily traced to individual units of product e.g. salary of car assembly workers

Question 18

What are manufacturing overheads?

Answer 18

• Manufacturing costs that cannot be traced directly to specific units produced e.g.

• indirect labour (Wages of employees who are not directly involved in production work e.g. cleaners)
• indirect materials (Materials used to support the production process e.g. lubricants/cleaning products used in car assembly formation)

Question 19

How are manufacturing costs often combined (classified)?

Answer 19

• Direct materials+ direct labour=prime cost
• Direct labour + manufacturing overheads=conversion cost (need for labour plus factory operations to convert raw materials to FG)

Question 20

What are non-manufacturing costs?

Answer 20

• Marketing and selling costs
Costs necessary to get the order and deliver the product
• Administrative costs
All executive, organisational and clerical costs

Question 21

In terms of the second cost objective, what are the two cost types in financial reporting?

Answer 21

Product and period costs

Question 22

What are product costs?

Answer 22

• Includes direct materials, direct labour, and manufacturing overheads
• Stock ->SOFP
• Cost of goods sold ->SOPL

Question 23

What are period costs?

Answer 23

• Costs that cannot be capitalised on a firms balance sheet.
• They are expensed on the profit statement

Question 24

What stock is put on a manufacturers balance sheet?

Answer 24

• Raw Materials-Materials waiting to be processed
• Work in Progress-Partially complete products
• Finished Goods- Completed products awaiting sale

Question 25

For the 3rd cost objective, what are the different cost classifications when predicting cost behaviour?

Answer 25

• Total variable costs change when activity changes

* Total fixed costs remain unchanged when activity changes

Question 26

what are the components of the activity base (cost drivers of variable costs) ?

Answer 26

• Units produced
• Miles driven
• Machine Hours
• Labour hours

Question 27

What is variable cost per unit?

Answer 27

Variable cost per unit is the production cost for each unit produced that is affected by changes in a firm’s output or activity level e.g. cost per minute talked may be fixed

Question 28

What is the fixed cost per unit?

Answer 28

Average fixed cost deceases as output increases e.g. month fixed phone rate will decrease on average per unit as more calls are made

Question 29

What are some example fixed and variable costs for manufacturers and retailers?

Answer 29

• Variable
-manufacturers-Direct Material, direct labour, and variable manufacturing overhead
-retailers-Cost of Goods Sold, shipping costs
• Fixed
Retailers, manufacturers, and -taxes, insurance, sales salaries, depreciation, advertising

Question 30

what is the importance of a relevant range?

Answer 30

• Relevant range is the volume range within which actual operations are likely to occur
• Seldom is a fixed cost fixed over all levels of activity and so may jump to a new higher cost when the activity goes above/below the relevant range

Question 31

What are the two types of fixed costs?

Answer 31

Committed and discretionary

Question 32

What is a committed fixed cost?

Answer 32

Long-term, cannot be reduced in the short term e.g. Depreciation on buildings and equipment

Question 33

What is a discretionary fixed cost?

Answer 33

May be altered in the short-term (e.g. in recession) by current managerial decisions e.g. advertising and R&D

Question 34

In terms of the 5th cost objective in making business decisions what are the different costs?

Answer 34

• Differential costs (and revenue)
• Sunk costs
• Opportunity costs

Question 35

What are differential costs/revenue?

Answer 35

Difference in revenue and costs between two options e.g. choice may have higher initial costs but also higher differential revenue

Question 36

What are opportunity costs?

Answer 36

The potential benefit that is given up when one alternative is selected over another e.g. choosing a plane engine from one manufacturer may be cheaper but has less capacity (future revenue)

Question 37

What are sunk costs?

Answer 37

Sunk costs cannot be changed by any decision. They are not differential costs and should be ignored when making decisions e.g. boots spend 10k on market research- that cost should not impact decisions taken from the research