Lecture 2 - Cost concepts Flashcards
What are cost objects?
A cost object is essentially a subject, a topic sentence of which will dictate what costs are required.
e.g. How much did it cost to run that advertisement, each tennis ball made, the quality control test for an individual bottle.
Two cost measurement tasks;
Cost Accumulation:
- Collection of cost data in some organised way.
- E.g. an accounting system
Cost Assignment
- Tracing accumulated costs to cost objects. (Direct costs)
- Then allocating these accumulated costs to the cost object. (Indirect costs)
What is the difference between tracing and allocating costs?
Are there any repercussions.
Direct vs indirect costs:
- The key difference is the cost’s traceability.
- If it can be traced directly it is a direct cost
- E.g. raw materials used in a shoe
- If they must be allocated, they are indirect costs
- E.g. insurance for the manufacturing building
What are direct costs?
How would you trace direct materials and direct labour?
Direct Costs:
Directly traced to the cost object.
- Direct materials
- Normally a part of the product
- E.g. record how much actual material is used for each cost object and multiply with actual material cost.
- Direct labour
- Work done to produce the product/service
- E.g. record how many actual hours did worker A spends on the cost object and multiply with his/her actual hourly wage.
What are indirect costs?
Indirect Costs:
Indirectly assigned to each cost object based on a cost driver.
- Indirect material
- Lubricants, cleaning materials, delivery of services.
- Indirect labour
- Supervision, maintenance, security, etc.
- Other
Licences, rent, insurance, utilities, depreciation of factory equipment.
Factors that influence traceability
3 factors
Factors that affect traceability:
- The cost objects
- Identify the cost object
- E.g. salary of factory supervisor that supervises 5 different product line.
- Physically feasibility
- Can you physically trace the cost object?
- E.g. can you trace equipment depreciation to each loaf of bread produced.
- Economic feasibility
- Is it economically viable to trace?
- E.g. is it economically feasible (benefit > cost) of measuring hair gel per haircut.
What are cost drivers?
3 criterion:
Cost drivers provides a measure of activity that explains the cost object’s use of the indirect cost.
- E.g. the number of hours worked is a driver of salary costs.
The strongest relationship between the cost driver and its cost object will usually be used as the allocation base, to which we allocate indirect costs.
Criteria is based on (CFB)
- Cause and effect
- Fairness or equity
- Behavioural factors.
How to determine the allocation rate?
- Develop the cost allocation formula:
- Identify indirect costs
- Select appropriate cost driver
- Calculate indirect cost rate:
- Allocate cost to the cost object:
- Product line A produced 300k bears
Therefore IC rate * 300k
What are cost pools?
What purpose do they serve?
Cost pools are grouping of similar individual costs.
An allocation formula and IC cost rate is developed for each pool.
The more cost pools, the more accurate the cost information is è mainly due to a stronger cause and effect relationship between the cost driver and the pool.
What are fixed cost?
Fixed:
- Total fixed costs do not change with the volume of production.
- But does change on a per unit basis.
- Within a relevant range.
What are variable cost?
Variable costs
- Cost item that does not change per unit, but it’s total variable costs do change with volume.
- Per unit can also change, if outside the relevant range.
What are sticky costs?
Stick costs
- Costs that may not behave the same way when activity increases as when activity decreases.
- Effected by cost to change prices
- e.g. having to change the price tags incurs a cost.
What is a relevant range?
What is it’s importance?
Relevant Range
- Is the range at which the relationship between the cost and the level of activity (cost driver) is valid or consistent.
- E.g. a truck can only transport so many deliveries, at some point a company requires another truck to increase deliveries, at which point fixed costs like insurance would change.
What is the difference between engineered and discretionary costs?
St George Case.
Engineered costs have a clear input-output relationship (e.g. if I put in 3 hours, I can produce 9 toys).
Discretionary costs have a ambiguous input-output relationship (i.e. are not certain to produce a explicit output). E.g. R&D department or training.
St George Hospital Case:
- Funding was moved from a discretionary cost (i.e. how much does it cost to perform the operations annually, and provide a grant), and towards, we will give you a set amount per operation (engineered).
What is the difference between avoidable and unavoidable costs?
Avoidable and unavoidable costs:
Avoidable are costs that we can get rid of.
- E.g. if we stop manufacturing toy cars in a toy factory, we can reduce the cost of materials and labour, but cannot reduce the cost of machinery already purchased.
- Consider if the cost has been incurred already (sunk) and/or whether the cost is relevant to other functions.
- E.g. rent of the manufacturing plant may now be allocated more towards another service line.
- Typical unavoidable costs: admin expense, CEO salaries.
