Cost Terms and concepts

Question 1

Cost unit (definition)

Answer 1

a measurement of output, e.g., a ton of steel, a litre of paint, a kg of sugar.

Question 2

Cost object (definition)

Answer 2

any activity for which a separate measurement of cost is required (e.g. cost of making a product or providing a service)

Question 3

Cost centre (definition)

Answer 3

a part of the business for which a measurement of cost is required.

Question 4

A cost collection system normally accounts for costs in two broad stages:

Answer 4

• Accumulates costs by classifying them into certain categories (e.g. labour, materials and
  overheads);
• Assigns costs to cost objects.

Question 5

What is the difference between direct costs and indirect costs?

Answer 5

Direct costs

• can be specifically and exclusively identified with a given cost object.

Indirect costs

• cannot be specifically and exclusively identified with a given cost object.
• are assigned to cost objects on the basis of cost allocations.

Question 6

Costs incurred in a manufacturing business diagram

Answer 6

Question 7

Cost allocation (definition)

Answer 7

• the process of assigning costs to cost objects that involve the use of surrogate, rather than direct measures.

Question 8

The distinction between direct and indirect costs depends on …?

Answer 8

The distinction between direct and indirect costs depends on what is identified as the cost object.

Question 9

Product costs (definition)

Answer 9

those that are identified with products and included in the stock (inventory) valuation

Question 10

Prime cost (definition)

Answer 10

the direct cost of a commodity in terms of the materials and labour involved in its production, excluding fixed costs

Eg. Direct materials + Direct labour = Prime cost

Question 11

Period costs (definition)

Answer 11

• not specifically related to the product and are not included in the inventory valuation.
• They are treated as expenses in the period in which they are incurred

Question 12

Figure 2.2 - Treatment of period and product costs

Answer 12

• Manufacturing cost is a product cost
• Non-manufacturing costs are period costs

When a product cost is unsold it is recorded as an asset in the balance sheet but becomes an expense when the product is sold in the profit and loss account

A period cost is recorded as an expense in the profit and loss account in the current accounting period

Question 13

Why is cost behaviour important?

Answer 13

• to predict costs and revenues at different activity levels for many decisions.

Question 14

Examples of production overheads and non-production overheads?

Answer 14

Production overheads:

• Rent and rates
• Factory power
• Factory heat and light
• Factory expenses
• Depreciation of plant

Non-production overheads:

• Selling and distribution
• Advertising
• Admin expenses (salaries of office staff and office expenses)

Question 15

Variable costs (definition)

Answer 15

Costs that vary in direct proportion with activity.

Question 16

Fixed costs (definition)

Answer 16

Costs that remain constant over wide range of activity

Question 17

Semi-fixed costs (definition)

Answer 17

Costs that are fixed within specified activity levels, but they eventually increase or decrease by some constant amount at critical activity levels

Question 18

Semi-variable costs (definition)

Answer 18

Costs that include both a fixed and a variable component (e.g. telephone charges)

Question 19

Variables Costs diagrams

Answer 19

Question 20

Fixed Costs diagrams

Answer 20

Question 21

Step-fixed costs diagram

Answer 21

Question 22

Sunk costs (definition)

Opportunity costs (definition)

Incremental cost (definition)

Marginal costs (definition)

Answer 22

Sunk costs

• costs that have been incurred and cannot be changed by any decision in the future

Opportunity costs

• Costs that measure the opportunity that is sacrificed when the choice of one course of action requires that an alternative course of action is given up

Incremental cost

• the difference between costs of alternative courses of action

Marginal costs

• the cost of one extra unit of output

Question 23

What is the difference between relevant/avoidable costs & revenues and irrelevant/unavoidable costs & revenues

Answer 23

Relevant/ Avoidable costs and revenues:

• are changed by a future decision

Irrelevant/ unavoidable costs and revenues:

• are not changed by a future decision

Question 24

A cost and management accounting system should generate information for meeting the following
requirements: (4)

Answer 24

• Inventory valuation for internal and external profit measurement.
• Provide relevant information to help managers make better decisions.
• Provide information for planning, control, and performance measurement.

A database should be maintained, with costs appropriately coded and classified so that relevant information can be extracted to meet each of the above requirements.

Question 25

There are three main costs that businesses incur:

Answer 25

• Materials
• Labour
• Expenses

Correctly identifying these, working out the right amount of cost and treating them correctly is critical for all
businesses

Question 26

There are two reasons why knowing the cost of inventory is vital:

Answer 26

• Value of goods ‘issued’
• Value of goods held

Question 27

Features of manufacturing, merchandising and service organisations

Answer 27

What type of materials are held by businesses will depend on the type of business

Manufacturing:

• Raw materials
• Work in progress
• Finished goods

Merchandising/retail:

• Tangible products for resale i.e. finished goods inventory

Service organisations:

• Provide a service that cannot be stored, but may have work in progress

Question 28

Material costs – valuation

• Actual cost
• The First In First out method FIFO (what is it?)
• The Last in First out method LIFO (what is it?)
• The Weighted Average Cost method WAS (what is it?)

Answer 28

FIFO:

• assumes that the oldest items are used first, so that inventory is VALUED at the most recent prices

LIFO:

• assumes that the latest items are used first, so that inventory is valued at the oldest prices
• (this method is not allowed by IAS Inventories 2)

WAS:

• assumes no pattern of the order in which items are used, so all are VALUED at the same value, which is the average one.

Question 29

Labour costs

This can be one of the most expensive elements within the cost of unit, especially for service industries.

Labour costs can be worked out per hour or per unit – read the question carefully.

For example, a question could state that each unit has a labour cost of £20. Or, the question could state that each unit takes 2 hours to make and labour costs are £10 per hour

What factors can affect labour costs? (5)

Answer 29

• Wages rates paid by other businesses
• National / living wages imposed by Government
• Government incentives
• Local employment conditions – availability of unskilled and / or skilled workforce
• Employer costs above gross salaries (about 20%)