Lecture 2 - Cost Concepts And Decision Making

Question 1

What is the definition of a cost?

Answer 1

‘Cost’ is the amount of resource in monetary terms that are given up to achieve an objective

Question 2

What does the term ‘cost object’ mean?

Answer 2

‘Cost object’ refers to any activity for which a separate measure of costs is desired.
E.g. Cost object of production or cost of operating a particular department

Question 3

What is a ‘Cost system’?

Answer 3

A 2-part system through which information about cost is collected.

Question 4

The ‘Cost System’ usually had two broad stages, what are they?

Answer 4

1) Accumulate costs.
Classify costs into categories (Direct labour, direct material, indirect costs etc).
Classify costs by cost behaviour.
2) The cost system assigns these costs to products.
By summing All direct and indirect costs

Question 5

What does the distinction between ‘direct’ and ‘indirect’ costs depend on?

Answer 5

The cost object.

Example:
Warehouse rent : Direct cost in distribution channel, Indirect cost for a product

Question 6

When do things become ‘indirect’ costs?

Answer 6

When it is not efficient to trace the cost, to cost objects

Question 7

What is a ‘conversion cost’? And how is it calculated?

Answer 7

A conversion cost is the cost of converting raw materials into finished goods.

Conversion cost = Direct labour + Indirect manufacturing

Question 8

What is the difference between the classification of ‘Period’ and ‘Product’ costs? And define them both

Answer 8

Product costs: Costs relating to goods purchase or produced for sale. Product costs are included in inventory valuation.
Classified as assets until they’re sold

Period costs: Costs relating to things such as admin, selling and distribution costs. Period costs aren’t included in inventory valuation.
Classified as expenses in the current accounting period

Question 9

When a ‘product cost’ is unsold, what is it classified as and in which financial statement?

Answer 9

Asset on the balance sheet

Question 10

When a ‘product cost’ is sold, what is it classified as and in which financial statement?

Answer 10

Expense in the Income statement

Question 11

What is a ‘Period cost’ classified as and in which financial statement?

Answer 11

Expense in the income statement for the current accounting period

Question 12

What method is used to separate Fixed and variable costs from semi-variable costs? And what is the formula we must use?

Answer 12

The High-Low method.

Formula:
1) Calculate the variable cost per unit.
VC unit = Difference in cost (between periods)/Difference in activity (between periods)
For example:
Jan = 2000 sales
Feb = 2500 sales       Difference =500
2) Subtract VC from TC to leave FC

Question 13

What are the 6 reasons why costs are important to know?

Answer 13

• Inventory Valuation
• Pricing decisions
• Budgeting
• Profit Planning
• Control of costs
• Cost reduction

Question 14

What is a ‘Direct Cost’?

Answer 14

A cost that can be specifically identified with a particular cost object (direct materials, direct labour)

Question 15

What is an ‘Indirect cost’?

Answer 15

Overheads, costs that cannot be specifically identified with a particular cost object (Indirect labour, Indirect materials)

Question 16

What is meant by the term ‘Prime Cost’?

Answer 16

The prime cost is the sum of:

Direct Materials cost + Direct Labour Costs

Question 17

What does ‘Prime cost + Indirect Costs’ sum to?

Answer 17

Total Cost

Question 18

The second stage of a cost system is to…

Answer 18

Assign costs to a cost object (Product/Service)

Question 19

Direct costs are ……. to the cost object

Answer 19

Traced

Question 20

Indirect costs are …… to the cost object

Answer 20

Allocated (using an estimate of the amount of resources that cost object consumes)

Question 21

Which is included in the inventory valuation, Product or Period costs?

Answer 21

Product costs

Question 22

What does the distinction between product and period costs affect?

Answer 22

Inventory Valuation

Question 23

Product costs are eventually recognised as what?

Answer 23

Expenses (When Sold)

Question 24

What 2 things are recorded as product costs?

Answer 24

Direct Manufacturing (Traced)

+

Indirect Manufacturing (Allocated) depreciation, electricity, repair+maintenance

Question 25

What is included in the ‘Period Cost’?

Answer 25

Indirect non-manufacturing expenses (allocated) selling, admin, interest expense

Question 26

What is the need for ‘period’ costs?

Answer 26

It is not certain whether non-manufacturing costs will generate future revenue.

Question 27

What does the term ‘Cost behaviour’ refer to?

Answer 27

Whether a cost is Fixed, Variable etc

Question 28

Under what circumstance are FCs not represented by a straight horizonatal line on a graph?

Answer 28

If the X-axis holds ‘Units Produced’

Question 29

Fixed costs are not constant per unit therefore…

Answer 29

They must be interpreted with caution and it is best to use Total Fixed costs for decision making.

Question 30

What is meant by the term ‘Step or Semi-Variable costs’?

Answer 30

A Step cost includes an element of FC and an element of VC

For example:
Moving to a bigger factory that costs more to rent will be representative of a step-cost.

Question 31

A semi-variable cost can also be known as a…

Answer 31

Step cost

Question 32

What does the distinction between ‘Variable cost’ and ‘Fixed cost’ rely on?

Answer 32

Whether the cost is long-term or short term.

All FCs are variable In the long term (rent rises) and therefore the distinction between them is only valid in the short term.