Chapter 2 An Introduction to Cost Terms and Purposes

Costs and Cost Objects Cost a resource sacrificed or foregone to achieve a specific objective Cost Object any product, machine, service or process for which cost information is accumulated cost objects can vary in size from an entire company, to a division or program within the company, or down to a single product or service Copyright 2003 Pearson Education Canada Inc. Page 32 Slide 2-16

Direct and Indirect Costs Direct Cost a cost which is related to a particular cost objective and can be traced to it in an economically feasible way Indirect Cost a cost which is related a particular cost objective but cannot be traced to it in an economically feasible way indirect costs are allocated to cost objectives Direct Cost Indirect Cost Trace Allocate Cost Object Copyright 2003 Pearson Education Canada Inc. Page 33 Slide 2-17

Cost Drivers and Cost Management Cost driver (cost generator or cost determinant) a factor which causes the amount of cost incurred to change production costs are driven by the number of products produced, labour costs, number of setups required, and the number of change orders Cost Reduction Programs focus on two things: 1. Doing only value-added activities 2. Efficiently manage the use of cost drivers in those value-added activities Copyright 2003 Pearson Education Canada Inc. Page 34 Slide 2-18

Variable and Fixed Costs Variable Cost a cost which is constant per unit but changes in total in proportion to changes in the cost driver materials (parts), fuel costs for a trucking company $ Volume Fixed Cost a cost which does not change in total as volume changes but changes on a per-unit basis as the cost driver increases and decreases amortization, insurance $ Volume Copyright 2003 Pearson Education Canada Inc. Page 35 Slide 2-19

Relevant Range and Cost Behaviour the range of the cost driver in which the a specific relationship between cost and driver is valid $ Relevant Range $ Relevant Range Volume Volume Variable Cost Fixed Cost Copyright 2003 Pearson Education Canada Inc. Page 37 Slide 2-20

Total Costs and Unit Costs Unit Cost (or Average Cost) Total cost / some number of units Average cost = Total manufacturing costs / Number of units produced = $980,000 / 10,000 = $98 per unit Unit or average costs must be interpreted with caution As volume increases, the unit or average cost falls as the fixed costs are spread over a larger number of units Copyright 2003 Pearson Education Canada Inc. Pages 38-39 Slide 2-21

Types of Inventory Retailer Merchandising inventory Manufacturer Direct material inventory (stock awaiting use in the manufacturing process) Work-in process inventory (partially completed goods on the shop floor) Finished goods inventory (goods completed but not yet sold) Copyright 2003 Pearson Education Canada Inc. Page 39 Slide 2-22

Period and Product Costs Period Costs are expensed on the income statement as they are incurred also called operating costs (excluding cost of goods sold) examples: selling, general and administrative costs Product Costs are inventoried on the balance sheet and expensed only when the product or service is sold also called inventoriable costs Examples: materials and labour (manufacturing) Copyright 2003 Pearson Education Canada Inc. Pages 40-41 Slide 2-23

Costs in a Retail / Wholesale Company Balance Sheet Income Statement Revenue Merchandise Purchases Merchandise Inventory Cost of Goods Sold Inventoriable (Product) Costs Period Costs Gross Margin Marketing and Administrative Costs Operating Income Copyright 2003 Pearson Education Canada Inc. Page 41 Slide 2-24

Costs in a Manufacturing Company Balance Sheet Direct Material Purchases Materials Inventory Income Statement Revenue Direct Labour Indirect Manufacturing Costs Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Gross Margin Inventoriable Period Costs Marketing and Administrative Costs (Product) Costs Operating Income Copyright 2003 Pearson Education Canada Inc. Page 44 Slide 2-25

The Many Meanings of Product Costs Important theme of this book is different costs for different purposes Three examples of product cost 1. Product pricing and product emphasis include all costs incurred 2. Contracting with government agencies May exclude marketing costs and include only a portion of R&D costs 3. Financial Statements Under GAAP, only manufacturing costs are included in inventory Copyright 2003 Pearson Education Canada Inc. Page 47 Slide 2-26

Alternative Classifications of Costs 1. Business function a. R&D b. Design c. Production d. Marketing e. Distribution f. Customer service 2. Assignment to a cost object a. Direct costs b. Indirect costs 3. Behaviour pattern a. Variable costs b. Fixed costs 4. Aggregate or average a. Total costs b. Unit costs 5. Assets or expenses a. Inventoriable costs b. Period costs Copyright 2003 Pearson Education Canada Inc. Pages 48-49 Slide 2-27