ch02im11(cost term)

8/9/2019 Ch02im11(Cost Term)

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CHAPTER 2

AN INTRODUCTION TO COST TERMS AND PURPOSES

LEARNING OBJECTIVES

1. Define and illustrate a cost object

2. Distinguish between direct costs and indirect costs

3. Explain variable costs and fixed costs

4. Interpret unit costs cautiously

. Distinguish a!ong !anufacturing co!panies" !erchandising co!panies" and service#sector co!panies

$. Describe the three categories of inventories co!!only found in !anufacturing co!panies

%. Differentiate between inventoriable costs and period costs

&. Explain why product costs are co!puted in different ways for different purposes

'. (resent )ey features of cost accounting and cost !anage!ent

CHAPTER OVERVIEW

*hapter 2 provides concepts and ter!s" the tools for wor)ing with costs. +wo basic concepts are explained,

-1 cost is a relative ter! and !ust be used in relationship to so!ething" a cost object/ and -2 co!!on

understanding of the ter!s and concepts facilitates co!!unication.

*osts are critical infor!ation in !ost decisions. Everything has a cost. +he critical need for accurate and

reliable score)eeping in which historical costs are properly identified and !easured is underscored as decision

support. +his chapter clearly defines the ter!s and concepts typically used in identifying costs.

0s !entioned in *hapter 1" costs are ideally accu!ulated in a database -data warehouse or infobarn"

!easured and identified with various labels. +hese data are assigned -slice or dice to a specific cost object

defined for a specific purpose. *hapter 2 uses the product of a !anufacturing co!pany as an exa!ple of

cost accounting.

0 good basic understanding of the ter!s and concepts introduced in this chapter are essential to an

understanding of the concepts contained in this text. +he ter!s" relationships" and !odels developed in the

re!aining chapters are built upon the definitions and explanations in this chapter. +he classification of costsin Exhibit 2#1 is !ost useful.


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CHAPTER OUTLINE

Learning Objective 1:

Define and illustrate a cost object

I. *osts and cost ter!inologygeneral

TEACHING TIP: +he use of jargon in the co!!unication process can privilege a group of individuals whounderstand the !eaning of the ter!s. 5argon is used within fa!ilies" co!panies" 6ree) fraternities andsororities" clubs" professional associations" etc. 0s) students to give exa!ples of expressions or ter!s theyuse that carry special !eaning to the! within a particular group. 7or exa!ple" a fa!ily !ay use the wordinteresting to !ean I do not li)e the thing in 8uestion but I a! not willing to say that to you. 9neco!pany uses the ter! irate to indicate a particularly troubleso!e custo!er. +he word carries special!eaning to those who wor) within that depart!ent but the custo!er is unaware of being so branded. +he useof !enus on co!pany telephone syste!s is another way of branding callersone !ust fit within a givencategory. *ost concepts and ter!s are exa!ples of jargon or branding that !anagers can learn to understandfor being infor!ed through the co!!unication process.

0. :se of cost concepts and ter!s to provide infor!ation

1. 0ble to best use infor!ation if !anagers understand concepts and ter!s

2. 7acilitate co!!unication a!ong !anagers and !anage!ent accountants if co!!onunderstanding

;. Definition of ter! cost

1. desired[Exhibit 2-1]

D. ?tages of accounting for costs in a costing syste!

1. Cost accumulation, collection of cost data in so!e organi@ed !eans in an accounting syste!

2. Cost assignment: designation of cost object to aid in decision !a)ing [Exhibit 2-2]

a. +racing accu!ulated costs that have a direct relationship to a cost object

b. 0llocating accu!ulated costs that have an indirect relationship to a cost object

Do multiple choice 1. Assignmentsee fixed/variable section.

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II. *osts and cost ter!inologyspecific


Distinguish between direct costs and indirect costs

0. 0ssign!ent to a cost object, accuracy i!portant for decision !a)ing

1. Direct costs of a cost object, econo!ically feasible to trace to cost object via cost tracing

2. Indirect costs, related to cost object but not econo!ically feasible to trace/ assigned via costallocation

3. 7actors affecting direct>indirect classification

a. =ateriality of the cost in 8uestion

b. 0vailable infor!ation#gathering technology

c. Design of operations

d. *hoice of cost object, generally the broader the definition of the cost object" the higher theproportion of total costs that are direct costs and !ore confidence in cost accuracy

Do multiple choice #. Assign $xercise #%1&.


Explain variable costs and fixed costs

;. ;ehavior pattern in relation to changes in the related level of total activity or volu!e

1. *osting syste!s, record cost of resources ac8uired and trac) how then used

2. ;asic types of cost#behavior with respect to a specific cost object and given ti!e period

a. 'ariable[Exhibit 2-3]

i. *hanges in total in proportion to changes in the related level of total activity

ii. :se as per unit for esti!ates of total costs

b. (ixed[Surveys of Company Practice]

i. :nchanged in total for a given ti!e period despite wide changes in related level of totalactivity

ii. 0lways focus on total costs when !a)ing cost esti!ates for fixed costs

3. Individual costs not inherently variable or fixed but dependent upon related activity

An Introduction to Cost erms and !urposes 1)


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4. *hoice of cost driver, a variable with cause#and#effect relationship between change in level ofactivity and change in level of total costs [Concepts in Action]

. *onsideration of relevant range, band of nor!al activity level with specific relationshipbetween level of activity and particular cost a!ount [Exhibits 2-4 an 2-!]

Do multiple choice *. Assign $xercises #%## and #%#* +ith special emphasis on identification of

the cost object.


Interpret unit costs cautiously

*. +otal costs and unit costs

1. 6enerally total cost a!ounts should be used in decision !a)ing

2. ?o!e decisions need unit costs-average costs but should be used cautiously

Do multiple choice ". Assign $xercises #%#" and #%#).

III. 0ccounting for the cost of a product


Distinguish a!ong !anufacturing co!panies" !erchandising co!panies" and service#sector co!panies

0. (roduct defined in three types of co!panies [Exhibit 2-"]

1. ,anufacturing%sector companies, convert !aterials and co!ponents into finished good

2. ,erchandising%sector companies, purchase product and sell without changing basic for!

3. -ervice%sector companies, provide services or intangible products

Do multiple choice ). Assign $xercises #%1 #%10 #%# and #%#&.


Describe the three categories of inventories co!!only found in !anufacturing co!panies

;. (roduct inventories for !anufactured goods, stages in the conversion process

1. Direct materials, direct !aterials in stoc) and awaiting use in the !anufacturing process

2. 2or3 in process, goods partially wor)ed on but not yet fully co!pleted

3. (inished goods, goods fully co!pleted but not yet sold

*. (roduct as cost object, classifications of !anufacturing costs

1. Direct materials costs

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2. Direct manufacturing labor costs

3. Indirect manufacturing costs manufacturing overhead costs orfactor5 overhead costs

Do multiple choice 4. Assign $xercises #%# #%#0 and #%* #%*4 and #%*&.

Learning Objective 7:Differentiate between inventoriable costs and period costs

D. (roduct costs for financial state!ent place!ent [Exhibit 2-#]

1. Inventoriable costs, all costs of a product that are regarded as an asset -balance sheet whenincurred and then beco!e cost of goods sold -inco!e state!ent when product sold

a. =anufacturing co!pany, all !anufacturing costs are inventoriable costs

b. =erchandising co!pany, costs of purchasing goods resold in their sa!e for!

c. ?ervice co!pany, no inventoriable costs because no inventories of product

2. !eriod costs, all costs in the inco!e state!ent other than cost of goods sold

Do multiple choice & and . Assign $xercise #%#4.

E. (roduct cost reported, ?chedule of cost of goods !anufactured and sold [Exhibit 2-"]

1. +hree categories of !anufacturing costs A !anufacturing costs incurred during period

a. Direct !aterials B both as inventory and !anufacturing cost

b. Direct !anufacturing labor costs

c. Indirect !anufacturing costs

2. +hree categories of !anufacturing inventoriesstages of the conversion process

a. Direct !aterials B used to calculate direct !aterials used at beginning of schedule

b. Cor) in process

c. 7inished#goods [Exhibit 2-$]

7. 9ther ter!inology for product costs

1. !rime costs, all direct !anufacturing costs

2. Conversion costs, all !anufacturing costs other than direct !aterial costs

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I. 5udg!ent factors

0. Differences in way costs can be defined and classified [Exhibit 2-1%]

1. *areful to define and understand way costs are !easured in a co!pany or situation

2. Illustrate by !anufacturing labor costs

a. Detailed classification to enhance cause#effect relationship to extent possible

b. Detailed classification agreed upon to pro!ote co!pany#wide co!!unication

c. Detailed classification for clarity to preclude disputes

;. Differences in uses of product cost, su! of costs assigned to a product for a specific purpose


Explain why product costs are co!puted in different ways for different purposes

1. (roduct cost for purpose of pricing and product#!ix e!phasis [Exhibit 2-&]

2. (roduct cost for purpose of contracting with govern!ent agencies

3. (roduct cost for purpose of preparing financial state!ents for external reporting under 600(

Do multiple choice 0. Assign $xercise #%**.


(resent )ey features of cost accounting and cost !anage!ent

. 7eatures of a fra!ewor) for cost !anage!ent

0. *alculating the costs of products" services" and other cost objects

;. 9btaining infor!ation for planning and control and perfor!ance evaluation

*. 0naly@ing the relevant infor!ation for !a)ing decisions

Do multiple choice 1. Assign !roblem #%*.

CHAPTER QUIZ SOLUTIONS: 1.a 2.d 3.a 4.b .b $.c %.d &.a '.b 1.a

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CHAPTER QUIZ

1. +anner *o. !anage!ent desires cost infor!ation regarding their


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%. Inventoriable costs are

a. either finished goods or purchased goods for resale.

b. a category of costs used only for !anufacturing co!panies.

c. recorded as expenses when incurred and later reclassified as assets.

d. recorded as assets when incurred.

&. (eriod costs are

a. all costs in the inco!e state!ent other than cost of goods sold.

b. defined as !anufacturing costs incurred this period on the schedule of cost of goods !anufactured.

c. always recorded as assets when first incurred.

d. those costs that benefit future periods.

'. +he cost of a product can be !easured as any of the following except as cost

a. gathered fro! all areas of the value chain.

b. identified as period cost.c. designated as !anufacturing cost only.

d. explicitly defined by contract.

1. +he pri!ary focus of cost !anage!ent is to

a. help !anagers !a)e different decisions.

b. calculate product costs.

c. aid !anagers in budgeting.

d. distinguish between relevant and irrelevant infor!ation.

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WRITING/DISCUSSION EXERCISES

1. Defie !" i##$%&'!&e ! ()%& )*+e(&

Describe and give an example of cost other than one with a conventional meaning (cash

outla!" Everything has a cost. Lot all costs are evident or can they be identified and !easured in a !oreconventional !anner B but they are costs nevertheless.

?o!e costs are na!ed but not accounted for in the traditional sense. 9ne exa!ple is opportunity costMdefined in text at later pointN that can be associated with any cost object. +hough financial a!ounts !ay beassociated with this cost" they do not appear in the accounting records.

Ju!an costs are another exa!ple of costs that !ay be associated with !ost cost objects. +he texte!phasi@es the i!portance of using a !anage!ent accounting syste! to help individuals do their jobs better.?o!eti!es co!panies engage in cost !anage!ent that benefits the co!pany by costing their e!ployees -andsociety on a personal basis. +he use of so!e types of che!icals can result in !ore efficient processing butthey !ay have detri!ental effects on the health of those who use the! as prescribed by the co!pany. +he!anner in which the butter flavoring for !icrowave popcorn is applied !ay be such an exa!ple.

:ntil recently" unused capacity was not identified as a cost. In a later chapter costs are attached to thissituation and cost objects identified.

2. Di%&i,$i%- *e&ee "i'e(& ()%&% !" i"i'e(& ()%&%

#hat is so important about the wa in which costs are categori$ed% In their boo)" ?orting+hings 9ut, *lassification and Its *onse8uences" 6eoffrey ;ow)er and ?usan ?tar describe the constantactivity of labeling and sorting of all that we have and do in life. +hey note that not all classifying is for!alor even noticed by us. 7or those for!al classification syste!s we can usually find so!e gaps in the syste!and are unable to assign everything to a specific category. +he exa!ple is given of disease classifications for

!edical records. Ce do not have perfect )nowledge of all diseases and the interaction of various ail!entsyet a category !ust be pic)ed. ?ha)espeares Chats in a na!e, +hat which we call a rose by any otherna!e would s!ell as sweet -'omeo an (u)iet !ay not be so poetic when so!ething or so!eone is!ista)enly assigned to what is perceived as an undesirable category -student grades" for exa!ple. Instudying the classification of costs" consideration should be given to such proble!s as i!perfect )nowledge"inaccurate description" and si!plistic classification syste!s. +hese do not negate the usefulness of the presentclassification syste! but can be used to infor! it" especially when critical decisions are being !ade on thebasis of that present syste!.

;ow)er" 6eorge O ?tar" ?usan. 1'''. Sortin* +hin*s ,ut C)assification an .ts Conse/uences. *a!bridge =0, =I+ (ress

An Introduction to Cost erms and !urposes #1


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. E0#!i !'i!*#e ()%&% !" fi0e" ()%&%

&ow can a cost driver'cost relationship be developed% +he develop!ent of a relationship is si!ilarto that of developing a wor)ing !odel -often labeled the scientific !ethod. +houghtful observation ispri!ary. 0s one observes recorded data" both financial and nonfinancial" noting relevant changes in relatedfactors" causal relationships can be inferred. 7ro! the inferences" assess!ent can be !ade about theplausibility of such a cause#effect relationship.

=ost relationships are co!plex and all of the interrelationships cannot be discerned" therefore a !odel cannotbe as accurate and reliable as the actual relationship. =odels !ust be si!plistic in order to be useful -cost#benefit approach. +hey !ust also be updated fro! ti!e to ti!e or cast off for a new approach as thingschange. =odels can be relied upon to eli!inate so!e errors that could occur without their use. If a !odel isused li)e a chec)list then inexperienced wor)ers can be productive !ore 8uic)ly by following anexperience !odel before they gain co!plete understanding. 0rtificial intelligence is based upon hu!an!odels of thin)ing about a particular tas). In the exa!ple of filling out inco!e tax returns" the !odel gaveright answers !ore often than the professionals did because the professionals so!eti!es forget to include a!inor ite! or consideration.

3. I&e''e& $i& ()%&% (!$&i)$%#4

xplain wh a variable cost stas the same per unit and a fixed cost changes per unit"#hich cost would decision ma)ers prefer to use as a e' $i&cost and wh% In calculating aper unit cost" division is used. ariable costs derive the na!e variable fro! their total cost behavior. 0s thenu!erator changes -the cost" the deno!inator -the cost driver also changes in proportion so that the 8uotientis the sa!e at any level within the relevant range. 0 fixed cost" however" !eans that the nu!erator is fixed intotal within the relevant range. 0s the deno!inator changes" the nu!erator does not" and the resulting8uotient changes with each change in the deno!inator. +he na!e of the cost is based upon total cost behaviorand does not apply to per unit cost behavior" but in fact" the unit behavior can be described as the opposite ofhow the total behavior is described.

=ost decision !a)ers would do well to use only variable costs on a per unit basis. Decisions are about the

future" and in predicting costs" one would want to use a cost for which the behavior was !ore easilypredictable. 7ixed costs can be predicted !ore accurately in total. +o use the! as unit costs" one would haveto carefully predict a level of activity for the cost driver. If another activity level were to be considered" theper unit cost would have to be recalculated/ whereas for the variable cost" several levels of activity could beused without recalculating the per unit cost -relevant range concept.

5. Di%&i,$i%- !6), 6!$f!(&$'i, ()6!ie%7 6e'(-!"i%i, ()6!ie%7 !" %e'i(e8%e(&)'

()6!ie%

#h would a service*sector compan need cost accounting when it does not have productinventories or cost of goods sold%?ervice#sector co!panies do have products and need to )now if therevenues generated by those products or services exceed the cost of furnishing the service. 7or financial

accounting the service cannot be inventoried because it does not exist until it is perfor!ed" at which ti!e itbeco!es an expense. +he expense is not labeled cost of goods sold because it is not a good in thetraditional !eaning. *ost accounting is !ore than costing a product that can be inventoried. *osts !ust beaccu!ulated and assigned for service#sector co!panies. +he greater context of cost !anage!ent is alsoi!portant for service#sector co!panies.

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4. De%('i*e &-e &-'ee (!&e,)'ie% )f ie&)'ie% ()66)#4 f)$" i 6!$f!(&$'i, ()6!ie%

#hat effect+ if an+ does having a two*part classification of manufacturing costs (Directmaterials and ,anufacturing overhead! rather than a three*part classification ofmanufacturing costs (Direct materials+ Direct manufacturing labor+ and ,anufacturingoverhead! have on the categories of inventories commonl found in manufacturingcompanies% -ould classifications of manufacturing costs be changed such as to affect the

inventor categories% In general" the nu!ber of classifications of !anufacturing costs does not affect thecategories of inventories. +he a!ount of the cost !ay be so!ewhat changed in that a !ore detailedclassification could result in !ore accurate costing" though be !ore expensive to !aintain. +he specificchange of a three#part to a two#part classification syste! as noted in the text does no !ore than reclassify thelabor cost fro! direct to indirect. If labor constitutes less cost due to changes in the !anufacturing process" achange fro! a three#part to a two#part is clearly justified.

*hanges resulting fro! just#in#ti!e or throughput costing !ay indeed change the inventory categories byeli!inating the wor) in process category" for exa!ple. Cith just#in#ti!e costing" a two#part classification ofcosts !ay be used. +he two#part classification could be raw and in#process and finished goodsnecessitating only those two inventories rather than the typical three.

9. Diffe'e&i!&e *e&ee ie&)'i!*#e ()%&% !" e'i)" ()%&%.

.sing the value chain concept of business functions explain wh costs preceding thefunction of production are not considered inventoriable costs for external financialstatements" +he definition of an asset" of which inventory is one" is the right to future benefit. 0 productthat can be sold for !ore than it cost pro!ises future benefit" thus inventory is classified as an asset. +he costof research and develop!ent as well as design !ay indeed i!part future benefit" but such benefit is difficultto !easure. 6enerally accepted accounting principles would expense those costs rather than capitali@e the!-classified as assets.

:. E0#!i -4 ')"$(& ()%&% !'e ()6$&e" i "iffe'e& !4% f)' "iffe'e& $')%e%

/f costs can be assigned in different was for different purposes+ how does one )now whatcosts to combine% +he purpose for which costs are to be developed !ust be clearly defined. 7ro! thatclear purpose" a cost object can be identified so costs can then be appropriately assigned. In the situations inwhich the cost object !ay be defined co!!only as the product cost but for which differing a!ounts of thesa!e costs are assigned" one can loo) !ore closely at the particular purposes. +he cost object" thoughappearing to be the sa!e product in various situations" is not. 7or purposes of pricing" the product !ustcover allcosts of the organi@ation for that is the !eans by which the co!pany would earn a profit. 7orpurposes of costing the product for a specific contract" the ter!s of the contract would have to be !et. 7orfinancial accounting purposes" the cost of the product would have to !eet the definition given under 600(.:sing a co!!on label for a cost object such as product cost is not enough to define the co!bining of costbut one !ust loo) to the particular purpose and its full !eaning.

;. P'e%e&


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BEWARE O= UNIT COSTS

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SUGGESTED READINGS

;ow)er" 6. O ?tar" ?." Sortin* +hin*s ,ut C)assification an .ts Conse/uences -1''' =I+ (ress"*a!bridge =0.

;rierley" 5." *owton" *. O Drury" *." Jow (roduct *osts 0re *alculated and :sed in Decision =a)ing, 0(ilot ?tudy"0ana*eria) Auitin* (ourna)-0pril 21 p.22 MpN.

6ordon" K. and Koeb" =." Distinguishing between Direct and Indirect *osts Is *rucial for Internet*o!panies"0ana*ement Accountin* uarter)y-?u!!er 21 p.12 M$pN.

Jull" 6." Chats in a KabelF *o!plicating Lotions of the ?)ills#(oor Cor)er" ritten Communication-9ctober 1''' p.3%' M34pN.

#4 Chapter #

ch02im11(cost term)

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