Lecture 2 - Cost Concepts And Decision Making Flashcards
What is the definition of a cost?
‘Cost’ is the amount of resource in monetary terms that are given up to achieve an objective
What does the term ‘cost object’ mean?
‘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
What is a ‘Cost system’?
A 2-part system through which information about cost is collected.
The ‘Cost System’ usually had two broad stages, what are they?
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
What does the distinction between ‘direct’ and ‘indirect’ costs depend on?
The cost object.
Example:
Warehouse rent : Direct cost in distribution channel, Indirect cost for a product
When do things become ‘indirect’ costs?
When it is not efficient to trace the cost, to cost objects
What is a ‘conversion cost’? And how is it calculated?
A conversion cost is the cost of converting raw materials into finished goods.
Conversion cost = Direct labour + Indirect manufacturing
What is the difference between the classification of ‘Period’ and ‘Product’ costs? And define them both
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
When a ‘product cost’ is unsold, what is it classified as and in which financial statement?
Asset on the balance sheet
When a ‘product cost’ is sold, what is it classified as and in which financial statement?
Expense in the Income statement
What is a ‘Period cost’ classified as and in which financial statement?
Expense in the income statement for the current accounting period
What method is used to separate Fixed and variable costs from semi-variable costs? And what is the formula we must use?
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
What are the 6 reasons why costs are important to know?
- Inventory Valuation
- Pricing decisions
- Budgeting
- Profit Planning
- Control of costs
- Cost reduction
What is a ‘Direct Cost’?
A cost that can be specifically identified with a particular cost object (direct materials, direct labour)
What is an ‘Indirect cost’?
Overheads, costs that cannot be specifically identified with a particular cost object (Indirect labour, Indirect materials)
What is meant by the term ‘Prime Cost’?
The prime cost is the sum of:
Direct Materials cost + Direct Labour Costs
What does ‘Prime cost + Indirect Costs’ sum to?
Total Cost
The second stage of a cost system is to…
Assign costs to a cost object (Product/Service)
Direct costs are ……. to the cost object
Traced
Indirect costs are …… to the cost object
Allocated (using an estimate of the amount of resources that cost object consumes)
Which is included in the inventory valuation, Product or Period costs?
Product costs
What does the distinction between product and period costs affect?
Inventory Valuation
Product costs are eventually recognised as what?
Expenses (When Sold)
What 2 things are recorded as product costs?
Direct Manufacturing (Traced)
+
Indirect Manufacturing (Allocated) depreciation, electricity, repair+maintenance
What is included in the ‘Period Cost’?
Indirect non-manufacturing expenses (allocated) selling, admin, interest expense
What is the need for ‘period’ costs?
It is not certain whether non-manufacturing costs will generate future revenue.
What does the term ‘Cost behaviour’ refer to?
Whether a cost is Fixed, Variable etc
Under what circumstance are FCs not represented by a straight horizonatal line on a graph?
If the X-axis holds ‘Units Produced’
Fixed costs are not constant per unit therefore…
They must be interpreted with caution and it is best to use Total Fixed costs for decision making.
What is meant by the term ‘Step or Semi-Variable costs’?
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.
A semi-variable cost can also be known as a…
Step cost
What does the distinction between ‘Variable cost’ and ‘Fixed cost’ rely on?
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.
