Chapter 2 Cost Terminology and Cost Behaviors Cost

Chapter 2: Cost Terminology and Cost Behaviors Cost Accounting: Foundations and Evolutions, 8 e Kinney ● Raiborn © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objectives n n n n Why are costs associated with a cost object? What assumptions do accountants make about cost behavior, and why are such assumptions necessary? How are costs classified on financial statements, and why are such classifications useful? How does the conversion process occur in manufacturing and service companies? What are the product cost categories, and what items comprise those categories? How and why does overhead need to be allocated to products? How is cost of goods manufactured calculated and used in preparing an income statement? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Cost Monetary measure of resources given up to attain an objective (such as acquiring a good or delivering a service) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Cost Categories n Association with cost object q n n Cost object is anything for which management wants to collect or accumulate costs Reaction to changes in activity Classification on the financial statements © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Association with a Cost Object n n Direct—traceable to a cost object Indirect—not conveniently or practically traceable to a cost object q q Treated as overhead Allocated © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Reaction to Changes in Activity Variable n Fixed n Mixed n Step n Relevant Range—normal operating range © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Cost Reaction to Changes in Activity n Variable cost n Fixed Cost $ $ # of Units Within the relevant range © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Cost Reaction to Changes in Activity n Variable cost Total $ n Total Fixed Cost $ # of Units Unit $ Within the # of Units relevant range # of Units © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Total and Unit Cost Behavior Total Cost Variable Cost Fixed Cost Varies in direct proportion to changes in activity Remains constant throughout the relevant range Unit Cost Remains constant throughout the relevant range Varies inversely with changes in activity throughout the relevant range © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Cost Reaction to Changes in Activity n Step Cost (fixed) n Mixed Cost variable $ $ # of Units fixed # of Units Within the relevant range © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Determining Cost Behavior n Cost Predictor q q Activity accompanied by consistent, observable changes in a cost item Predicts but may not cause the cost to change n Cost Driver q q Activity that has a direct cause-effect relationship on cost Directly causes the cost to change © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Classification on the Financial Statements n n n Unexpired—balance sheet assets Expired—income statement expenses Product—inventoriable costs q q n Prime—direct material and direct labor Conversion—direct labor and overhead Product costs are unexpired before sale Product costs are expired when sold Period—expensed in period incurred © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Product Costs n Product costs q q q n n Direct material—Measurable part of a product Direct labor—Labor used to manufacture a product or perform a service Overhead—Indirect production cost First appear on the balance sheet in inventory accounts Transferred to the income statement when product is sold © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Period Costs n Period costs q q Selling and administrative costs Distribution costs n n Cost to warehouse, transport, and/or deliver a product or service Major impact on managerial decision making Appear on the income statement when incurred Expensed when incurred © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Conversion Process n Change inputs into outputs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Conversion Process Input Output Purchase raw materials or supplies Product or Service CONVERSION © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Degrees of Conversion Low q q n Department stores Gas stations Jewelry stores Travel agencies Moderate q q q High Moderate Florists Meat markets Oil-change businesses n High q q q q Manufacturing Construction Agriculture Architecture Auditing Mining Printing Restaurants © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Service Company Input Purchase supplies Use supplies, labor, overhead to provide service Significant amount of labor Tangible or intangible output Output Sell to customer © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Retail Company Input Purchase products for resale Purchase finished goods Resell to customers Output Warehouse and/or display Sell to customer © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Manufacturer Significant amount of labor and machinery Tangible output Input Output Purchase raw materials and supplies Finished product Production Center add labor and overhead Sell to customer © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Cost Accumulation in a Manufacturing Company Materials Inventory Work in Process Inventory Finished Goods Inventory Balance Sheet Cost of Goods Sold Income Statement © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Product Cost—Direct n Direct Material q n Conveniently and economically traced to cost object Direct Labor q q q To manufacture a product or perform a service Includes wages paid to direct labor employees, production bonuses, payroll taxes May include holiday and vacation pay, insurance, retirement benefits © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Product Cost—Indirect n Overhead—indirect production costs q q q Fringe benefits, if cannot be easily traced to product Overtime, if due to random scheduling Cost of quality n n n Prevention costs Appraisal costs Failure costs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Product Cost Behavior n Direct Material Variable n Direct Labor Variable n Overhead Variable, fixed, or mixed © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Overhead Cost Allocation Assign indirect costs to one or more cost objects n n n To determine full absorption cost (GAAP) To motivate management To compare alternative courses of action for planning, controlling, and decision making Allocation process should be rational and systematic © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Overhead Cost Allocation Assign indirect costs to one or more cost objects n n n To determine full absorption cost (GAAP) To motivate management To compare alternative courses of action for planning, controlling, and decision making Allocation process should be rational and systematic © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Allocating Overhead Actual Cost System n Product Cost Used n Direct Materials Actual n Direct Labor Actual n Overhead Actual © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Allocating Overhead: Actual Cost System n n The Actual Cost System is not timely All costs must be known before calculating product cost © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Allocating Overhead: Actual vs. Normal Product Cost Direct Materials Actual Cost System Actual Normal Cost System Actual Direct Labor Actual Overhead Actual Predetermined Overhead Rate © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Predetermined Overhead Rate n n Allows overhead to be assigned during the period Compensates for fluctuations q q that are not related to activity level in activity level that do not affect fixed overhead © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Flow of Product Costs Raw Materials Inventory Accounts Payable XXX Work in Process Inventory Raw Materials Inventory XXX XXX Work in Process Inventory XXX Variable Overhead Control XXX Fixed Overhead Control XXX Salaries/Wages Payable XXX © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Flow of Product Costs Variable Overhead Control XXX Fixed Overhead Control XXX Utilities Payable XXX Supplies Inventory XXX Accumulated Depreciation–Equipment XXX Other accounts XXX © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Flow of Product Costs Work in Process Inventory Variable Overhead Control Fixed Overhead Control XXX Finished Goods Inventory Work in Process Inventory XXX XXX © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Flow of Product Costs Accounts Receivable Sales XXX Cost of Goods Sold XXX Finished Goods Inventory XXX Matches revenues and expenses on the income statement © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Statement of Cost of Goods Manufactured—Raw Materials Used n n n Beginning balance Purchases of materials Raw materials available Ending balance Total raw materials used $ 73, 000 280, 000 $353, 000 <69, 000> $284, 000 To Statement of Cost of Goods Manufactured © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Statement of Cost of Goods Manufactured n Beginning work in process q q n n n Raw materials used Direct labor Variable overhead Fixed overhead $145, 000 $284, 000 436, 000 115, 200 98, 880 Current period manufacturing costs Total costs to account for Ending work in process Cost of goods manufactured 934, 080 $1, 079, 080 <20, 880> $1, 058, 200 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Schedule of Cost of Goods Sold n n n Beginning Finished Goods $ 87, 400 Cost of Goods Manufactured 1, 058, 200 Cost of Goods Available for Sale $1, 145, 600 Ending Finished Goods <91, 600> Cost of Goods Sold $1, 054, 000 From Schedule of Cost of Goods Manufactured © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Income Statement n n n Revenue Cost of Goods Sold Gross Profit Operating Expenses Operating Income XXXX <1, 054, 000> XXXX <XXXX> XXXX From Schedule of Cost of Goods Sold © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Questions n n n What is the difference between a fixed and variable cost? What are three components of product cost? What are three inventory accounts for a manufacturing company? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Ethical Issues n n n Expired costs—not on the balance sheet Period costs—not inventory Product costs—not selling or administrative costs Direct labor—not overstated Ending inventory—not overstated © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.