concerned with providing information to managers within an organization so that they can formulate plans, control operations, and make decisions.
1. Cost classification:
For assigning costs to cost objects
Cost object is anything for which cost data are desired - including products, customers, plants, office locations, and departments
The elements of cost are those elements which constitute the cost of the manufacture of a product
Cost objects are divided into 3 principle elements:
Material cost: direct (becomes a part of the product, ex: iphone camera in iphone) vs indirect (necessary but not in the product, ex: glue, screws,…)
cost varies according to the level out output
Labor cost: direct (engage in production for that product, ex: assembler) vs indirect (engage to help production but labor cannot be easily traced to job process or individual product; also including benefits like holiday, overtime, …)
Salary
Expense: expenditure other than material and labor. Direct (directly identified with a unit of output, ex: patent, ) vs indirect (rent, power, lighting, depreciation)
selling and administrative expense
Direct vs Indirect cost:
depends on the cost object, direct cost of 1 cost object might be indirect cost of another object
A direct cost is a cost that can be easily and conveniently traced to a specified cost object
example: salary of a sales manager for a regional office, cost of paper for printing for a customer,…
An indirect cost is a cost that cannot be easily and conveniently traced to a specified cost object, doesnt become a part of the product
example: salary of manager for many varieties of products, …
To be traced to a cost object such as a particular product, the cost must be caused by the cost object
A common cost is a cost that is incurred to support a number of cost objects but cannot be traced to them individually
For Manufacturing company:
Manufacturing cost (expense in Uk):
Direct material cost are raw materials that become an integral part of the product and that can be conveniently traced directly to it
Direct labor (touch labor) costs are those labor costs that can be easily traced to individual units of product
typically when a worker only work on the production line
Manufacturing overhead (indirect manufacturing cost, factory overhead, factory burden) includes all manufacturing costs except direct material and direct labor. These costs cannot be readily traced to finished products.
Includes indirect materials that cannot be easily or conveniently traced to specific units of product
overhead materials
Includes indirect labor costs that cannot be easily or conveniently traced to specific units of product
example: janitors, supervisors, material handlers, maintenance workers, and night security guards,…
Also include depreciation of equipment for production, utility costs within factory, property tax, insurance premium,…
*Prime cost is sum of direct materials cost and direct labor cost
*Conversion cost is sum of direct labor cost and manufacturing overhead
Nonmanufacturing costs
Selling costs (order-getting cost, order-filling costs) include all costs that are incurred to secure customer orders and get the finished product to the customer
Can be either direct or indirect cost. example: cost of ads for 1 product is direct for that product, but ads for multiple product is indirect cost for that product
Administrative costs include all costs associated with the general management of an organization rather than with manufacturing or selling
Can be direct or indirect, example: salary of manager is direct cost for that region while all-region manager is indirect cost
example: executive compensation, general accounting, legal counsel, secretarial, public relations, and similar costs involved in the overall, general administration of the organization as a whole
include all costs involved in acquiring or making a product
recorded as expenses in the period in which the related products are sold
flow raw material to COGS
Product costs “attach” to a unit of product as it is purchased or manufactured and they stay attached to each unit of product as long as it remains in inventory awaiting sale.
Period costs
outside of production
All selling and administrative expenses are treated as period costs.
For example, sales commissions, advertising, executive salaries, public relations, and the rental costs of administrative offices are all period costs
Do not flow through inventory accounts on balance sheet, not a part of COGS
For predicting cost behavior:
Variable cost:
A variable cost varies, in total, in direct proportion to changes in the level of activity.
a variable cost per unit is constant to a relevant range
Fixed cost
A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity
with in a relevant range only
The linearity assumption and the relevant range
The relevant range is the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid.
Mixed costs
A mixed cost contains both variable and fixed elements. Consider the example of utility cost with a fixed monthly charge.
y=a+bX
a = 0 → variable cost
Cost terminology
Cost classification for Decision making
Differential cost and revenue
A future cost that differs between any two alternatives is known as a differential cost(incremental cost).
Differential costs are always relevant costs.
Future revenue that differs between any two alternatives is known as differential revenue.
both are relevant to decision making
Differential net operatin income = Differential revenue - Differential cost
Opportunity cost and sunk cost
Opportunity cost is the potential benefit that is given up when one alternative is selected over another.
A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future.