Week 2 Lecture

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Week 2 - Lecture

• Chapters 2 and 3

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Chapter 2 - Basic Cost Concepts
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Chapter 2 - Learning Objectives

• Explain the cost assignment process.
• Define tangible and intangible products and
  explain why there are different product cost
  definitions.
• Prepare income statements for manufacturing and
  service organizations.
• Describe the relationship between activity
  drivers and cost behavior.
• Explain the differences between traditional and
  contemporary management accounting systems.

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Cost and Cost Classification
Cost Definitions and Concepts

• Cost cash or cash-equivalent value sacrificed
  for goods and services that are expected to bring
  a current or future benefit to the organization.
• Private Cost a cost that is both incurred (or
  caused) and borne by the same entity. Example
  clean up costs of Exxon oil spill paid by Exxon.
• Social Cost a cost that is incurred (or caused)
  by an entity but which is not borne by that
  entity. Example clean up costs of Exxon oil
  spill not paid by Exxon.

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Cost Concepts

• Cost Object Any item such as products,
  customers, departments, projects, activities, and
  so on, for which costs are measured and assigned.
  Example a bicycle is a cost object when
  determining the cost to produce a bicycle.
• Activity This is a basic unit of work performed
  within an organization. Example setting up
  equipment, moving materials, maintaining
  equipment, designing products, etc.

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Cost Classification - 1

• Expense An expired cost, a cost used up in the
  generation of revenue. Example cost of
  materials in a product that was sold.
• Loss A cost that expires without producing a
  benefit or revenue. Example cost of uninsured
  building destroyed by fire.
• Asset An unexpired cost. Example cost of
  ending inventory of goods not sold.
• Opportunity Cost The benefit given up or
  sacrificed when one alternative is chosen over
  another. Example Wages or salary foregone by
  attending university instead of working.

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Cost Classification - 2

• Differential Cost The amount by which a cost
  differs between two alternatives. Example
  difference in cost of purchasing versus making a
  part.
• Out-of-Pocket Cost A cost that involves a
  current cash outlay. Examples payment of wages
  of assembly workers.
• Sunk Cost A cost for which an outlay has
  already been made. Example cost of equipment
  acquired one year ago.

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Cost Classification - 3

• Controllable Cost A cost heavily influenced by
  a manager. Example plant manager and direct
  labour costs.
• Noncontrollable Cost A cost over which the
  manager has no significant influence. Example
  Plant manager and corporate legal costs.
• Manufacturing Costs(Product Costs) Costs
  associated with the production function in the
  plant or factory.
• Direct materials (DM)
• Direct labour (DL)
• Manufacturing overhead (MOH)
• DM DL are called prime cost
• DL MOH are called conversion cost
• Nonmanufacturing Costs (Period Costs) Costs
  associated with the functions of selling and
  administration.
• Selling costs
• Administrative costs

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Cost Classification - 4

• Direct Cost A cost that can easily and
  accurately be traced to a cost object. Example
  The salary of a supervisor of a department, where
  the department is defined as the cost object.
• Indirect Cost A cost that cannot be easily and
  accurately traced to a cost object. Example the
  salary of a plant manager, where departments
  within the plant are defined as the cost objects.

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Cost Tracing

• Tracing is the assignment of costs to a cost
  object using an observable measure of resources
  consumed by the cost object.
• Direct Tracing is the process of identifying and
  assigning costs to a cost object that are
  specifically or physically associated with the
  cost object.
• Driver Tracing uses drivers to assign costs to
  cost objects. Two types of drivers can be used
• Resource Drivers measure the demands placed on
  resources by activities and are used to assign
  the cost of resources to activities.
• Activity Drivers measure the demands placed on
  activities by cost objects and are used to
  assign the cost of activities to cost objects.

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Assignment of Costs Using Driver Tracing
Resource Drivers
Allocation of Costs
Activity Drivers
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Some Activities with Potential Activity Drivers
Activity Potential
Activity Driver
Setting-up equipment
Number of set-ups Ordering materials
Number of purchase
orders Drilling holes
Number of machine hours Redesigning
products Number of
engineering hours Paying bills
Number of
invoices Inspecting finished goods
Number of batches produced
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Cost Assignment Methods
Cost of Resources
Direct Tracing
Driver Tracing
Allocation
Cost Objects
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Characteristics of Services

• Intangible
• Perishable
• Inseparable
• Heterogeneous

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Product Costing Definitions
Value Chain Operations
Traditional Product Costs
Research and Development
Production
Production
Production
Marketing
Marketing
Customer Service
Customer Service
Pricing Decisions Product Mix Strategic
Profitability
External Financial Reporting
Tactical Decisions
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Statement of Cost of Goods ManufacturedFor the
Year Ended December 31, 1998
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Income Statement Manufacturing OrganizationFor
the Year Ended December 31, 1998
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Income Statement Service OrganizationFor the
Year Ended December 31, 1998
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Classification of Costs for aManufacturing
Organization
Sales
Product Costs
Inventoriable Costs
Period Costs
Charged Against Sales for the Period
Net Income
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Functional Classification of Costs for a
Manufacturing Organization
Sales
Direct Materials Direct Labour Indirect
Manufacturing Costs (Overhead)
Manufacturing Costs
Selling Costs Administrative Costs
Nonmanufacturing Costs
Net Income
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Income Statement Classified by Functional Areas
4,000,000 Sales
Beginning Finished Goods Inventory Cost of
Goods Manufactured - Ending Finished Goods
Inventory
2,600,000 Cost of Sales
1,400,000 Gross Margin
900,000 Operating Expenses
Selling Expenses Administrative Expenses
500,000 Net Income
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Schedule for the Cost of Goods Manufactured
4,000,000 Sales
BWIP Direct Matl
Used Direct Labour Mfg.
Overhead - EWIP
Beg. Finished Goods Inv.
2,400,000 Cost of Goods Mfg.
2,600,000 Cost of Sales
- End. Finished Goods Inv.
1,400,000 Gross Margin
- 900,000 Operating Expenses
Selling Expenses Administrative Expenses
500,000 Net Income
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Functional Classification for aMerchandising Firm
5,000,000 Sales
Beginning Inventory Purchases of
Merchandise - Ending Inventory
- 3,150,000 Cost of Sales
1,850,000 Gross Margin
- 1,250,000 Operating Expenses
Selling Expenses Administrative Expenses
600,000 Net Income
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Functional Classification for a Service
Organization
300,000 Sales
All Product Costs are Effectively Period Costs
Direct Materials and Supplies Direct Labour
Indirect Costs or Overhead
- 250,000 Cost of Services
50,000 Gross Margin
- 21,500 Operating Expenses
Selling Expenses Administrative Expenses
28,500 Net Income
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Income Statement Classification by Cost
Behaviour
10,000,000 Sales
- Variable Cost of Goods Sold - Variable Selling
Expenses - Variable Administrative Expenses
6,600,000 Variable Expenses
3,400,000 Contribution Margin
- 2,050,000 Fixed Expenses
- Fixed Overhead - Fixed Selling Expenses - Fixed
Administrative Expenses
1,350,000 Net Income
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Classification of Cost by Cost Behaviour
Fixed Costs Behaviour
Variable Cost Behaviour


Relevant Range
Number of Bats Produced Number
of Bats Produced
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The Behaviour of Mixed Costs
Total Costs

Fixed Costs
Variable Costs
Number of Bats Produced
Total Costs Fixed Amount Variable Cost Per
Unit x Number of Units Total Costs Fixed Costs
Variable Costs Y FC
VC(X) (X) Cost Driver
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Activity Categories

• Unit-Level Activities (activities performed each
  time a unit is produced)
• Power machine hours are used each time a unit
  is produced. DM DL
• Batch-Level Activities (activities performed each
  time a batch is produced)
• Set-ups, inspections, production scheduling,
  material handling
• Product-Level (Sustaining) Activities (activities
  performed as needed to support various products,
  and consume inputs that develop products or
  allows them to be produced sold)
• Engineering changes, maintenance of equipment,
  and expediting
• Facility-Level Activities (activities that
  sustain a factorys general manufacturing
  processes)
• Plant management, landscaping, maintenance,
  security, property taxes, and plant depreciation

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Comparison of Traditional and Contemporary Cost
Management Systems
Traditional
Contemporary
Cost Information System
1. Unit-based drivers 2. Allocation intensive 3.
Narrow view of product costs 4. Focus on
cost mgmt.. 5. Little activity information 6.
Maximizes unit production 7. Uses financial
measures of performance
1. Uses nonunit drivers 2. Tracing intensive 3.
Expanded product costing 4. Focus on managing
activities 5. Detailed activity information 6.
System-wide performance appraisals 7. Uses
financial and non-financial measures of
performance
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The End