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Learning Objective 1
Define and illustrate
a cost object.
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Cost and Cost Terminology
Costis a resource sacrificed or forgone to achieve
a specific objective.An actual costis the cost incurred (a historical cost)
as distinguished from budgeted costs.
A cost objectis anything for which a separatemeasurement of costs is desired.
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Cost and Cost Terminology
CostAccumulation
Cost Object
Cost Object
Cost Object
CostAssignment
Tracing
Allocating
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Learning Objective 2
Distinguish between direct costs
and indirect costs.
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Direct and Indirect Costs
Direct Costs
Example: Paper on which
Sports Illustratedmagazineis printed
Indirect Costs
Example: Lease cost for
Building housing the
senior editors
of its magazine
COST OBJECT
Example: SportsIllustrated magazine
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Direct and Indirect Costs
ExampleDirect Costs:
Maintenance Department $40,000
Personnel Department $20,600Assembly Department $75,000
Finishing Department $55,000
Assume that Maintenance Department costs areallocated equally among the production departments.
How much is allocated to each department?
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Direct and Indirect Costs
Example
Allocated$20,000
Maintenance
$40,000
Assembly
Direct Costs$75,000
Finishing
Direct Costs$55,000
$20,000
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Learning Objective 3
Explain variable costs
and fixed costs.
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Cost Behavior Patterns Example
Bicycles by the Sea buys a handlebar
at $52 for each of its bicycles.What is the total handlebar cost when
1,000 bicycles are assembled?
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Cost Behavior Patterns Example
1,000 units $52 = $52,000
What is the total handlebar costwhen 3,500 bicycles are assembled?
3,500 units $52 = $182,000
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Cost Behavior Patterns Example
Bicycles by the Sea incurred $94,500 in
a given year for the leasing of its plant.This is an example of fixed costs with
respect to the number of bicycles assembled.
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Cost Behavior Patterns Example
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 1,000 bicycles?$94,500 1,000 = $94.50
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
$94,500 3,500 = $27
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Cost Drivers
The cost driver of variable costs is the level
of activity or volume whose change causesthe (variable) costs to change proportionately.
The number of bicycles assembled is a
cost driver of the cost of handlebars.
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Relevant Range Example
Assume that fixed (leasing) costs are $94,500
for a year and that they remain the same for acertain volume range (1,000 to 5,000 bicycles).
1,000 to 5,000 bicycles is the relevant range.
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Relevant Range Example
0
20000
40000
6000080000
100000
120000
0 1000 2000 3000 4000 5000 6000
Volume
FixedCo
sts
$94,500
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Relationships of Types of Costs
Direct
Indirect
Variable Fixed
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Learning Objective 4
Interpret unit costs.
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Total Costs and Unit Costs
Example
What is the unit cost (leasing and handlebars)
when Bicycles assembles 1,000 bicycles?Total fixed cost $94,500
+ Total variable cost $52,000 = $146,500
$146,500 1,000 = $146.50
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Total Costs and Unit Costs
Example
0
50000
100000
150000
200000
0 500 1000 1500
Volume
TotalCosts
$94,500
$146,500
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Use Unit Costs
Assume that Bicycles management uses a
unit cost of $146.50 (leasing and wheels).
Management is budgeting costs for
different levels of production.
What is their budgeted cost for anestimated production of 600 bicycles?
600 $146.50 = $87,900
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Use Unit Costs
What is their budgeted cost for an estimated
production of 3,500 bicycles?
3,500 $146.50 = $512,750
What should the budgeted cost be for an
estimated production of 600 bicycles?
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Use Unit Costs
Total fixed cost $ 94,500
Total variable cost ($52 600) 31,200
Total $125,700
$125,700 600 = $209.50
Using a cost of $146.50 per unit wouldunderestimate actual total costs if output
is below 1,000 units.
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Use Unit Costs
What should the budgeted cost be for an
estimated production of 3,500 bicycles?
Total fixed cost $ 94,500
Total variable cost (52 3,500) 182,000Total $276,500
$276,500 3,500 = $79.00
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Learning Objective 5
Distinguish among
manufacturing companies,
merchandising companies, and
service-sector companies.
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Manufacturing
Manufacturing companies
purchase materials and components and
convert them into finished goods.
A manufacturing company must also develop,
design, market, and distribute its products.
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Merchandising
merchandise /Trading companies
purchase and then sell tangible products
without changing their basic form.
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Merchandising
Service companies
provide services or intangible
products to their customers.
Labor is the most significant cost category.
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Learning Objective 6
Differentiate between
Product costs
and Period costs.
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Product Cost and Period Cost
Cost
Unexpired
(Product)
Recorded as an asset inthe balance sheet and
become an expense in theprofit and loss account in
a later accounting period
Expired
(Period)
Recorded as an expense in theprofit and loss account of theCurrent accounting period
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Inventoriable Costs OR Product
Cost
Inventoriable costs (assets)
become cost of goods sold
after a sale takes place.
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Period Costs
Period costs are all costs in the income
statement other than cost of goods sold.Period costs are recorded as expenses of the
accounting period in which they are incurred.
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Classification of
Manufacturing Costs
Direct materials Costs
Direct Labor Costs
Factory Overhead Costs
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Learning Objective 7
Describe the three categories of
inventories commonly found
in manufacturing companies.
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Types of Inventory
Manufacturing-sector companies
typically have one or more of the
following three types of inventories:
1. Direct materials inventory
2. Work in process inventory (workin progress)
3. Finished goods inventory
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Types of Inventory
Merchandising-sector companies hold
only one type of inventorythe
product in its original purchased form.
Service-sector companies do not
hold inventories of tangible products.
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Flow of Costs Example
Bicycles by the Sea had $50,000 of direct
materials inventory at the beginning of the period.Purchases during the period amounted to
$180,000 and ending inventory was $30,000.
How much direct materials were used?$50,000 + $180,000$30,000 = $200,000
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Flow of Costs Example
Direct labor costs incurred were $105,500.
Indirect manufacturing costs were $194,500.What are the total manufacturing costs incurred?
Direct materials used $200,000
Direct labor 105,500Indirect manufacturing costs 194,500
Total manufacturing costs $500,000
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Flow of Costs Example
Assume that the work in process inventory
at the beginning of the period was $30,000,
and $35,000 at the end of the period.What is the cost of goods manufactured?
Beginning work in process $ 30,000
Total manufacturing costs 500,000Ending work in process 35,000
Cost of goods manufactured $495,000
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Flow of Costs Example
Assume that the finished goods inventory
at the beginning of the period was $10,000,
and $15,000 at the end of the period.What is the cost of goods sold?
Beginning finished goods $ 10,000
Cost of goods manufactured 495,000Ending finished goods 15,000
Cost of goods sold $490,000
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Manufacturing Company
MaterialsInventory
FinishedGoods
Inventory
Revenues
Cost ofGoods Sold
INCOME STATEMENT
PeriodCosts
InventoriableCosts
BALANCE SHEET
Equals Operating Income
whensalesoccur
deduct
Equals Gross Margin
deductWork inProcess
Inventory
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Merchandising Company
INCOME STATEMENTBALANCE SHEET
whensalesoccur
InventoriableCosts
MerchandisePurchases
Inventory
Revenues
deductCost of
Goods Sold
Equals Gross Margin
deduct
PeriodCosts
Equals Operating Income
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Prime Costs
Direct
Materials
Direct
Labor
Prime
Costs+ =
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Prime Costs
What are the prime costs for Bicycles by the Sea?
Direct materials used $200,000+ Direct labor 105,500
= $305,000
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Conversion Costs
Direct
Labor
Manufacturing
Overhead+ =Conversion
Costs
IndirectLabor
IndirectMaterials Other
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Conversion Costs
What are the conversion costs for
Bicycles by the Sea?Direct labor $105,500
+ Indirect manufacturing costs 194,500
= $300,000
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Measuring Costs
Requires Judgment
Manufacturing labor-cost classifications
vary among companies.The following distinctions are generally found:
Direct manufacturing labor
Manufacturing overhead
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Measuring Costs
Requires Judgment
Manufacturing overhead
Indirect labor Managers salaries Payroll fringe costs
Forklift truck operators (internal handling of materials)
Rework labor
Overtime premium Idle time
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Measuring Costs
Requires Judgment
Overtime premium is usually
considered part of overhead.Assume that a worker gets $18/hour
for straight time and gets
time and one-half for overtime.
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Measuring Costs
Requires Judgment
How much is the overtime premium?
$18 50% = $9 per overtime hourIf this worker works 44 hours on a given
week, how much are his gross earnings?
Direct labor 44 hours $18 = $792Overtime premium 4 hours $ 9 = 36Total gross earnings $828
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Learning Objective 9
Illustrate:- Relevant and Irrelevant Cost and Revenues
- Avoidable and Unavoidable Costs
- Sunk Cost
- Opportunity Costs
- Incremental and Marginal Cost
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Relevant and Irrelevant Cost and
Revenues
Example: if one is faced with a choice ofMaking a journey by car or by public transport,
the car tax and insurance costs are irrelevant,since they will remain the same whatever
alternative is chosen. However, petrol costs for the
Car will differ depending on which alternative is
chosen, and this cost will be relevant for
decision-making.
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Avoidable and Unavoidable Cost
Sometimes the terms avoidable and unavoidableCosts are used instead of relevant and irrelevant
cost.
Avoidable costs are those costs that may be saved
by not adopting a given alternative, whereas
unavoidable costs cannot be saved. Therefore only
avoidable costs are relevant for decision-making
purposes.
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Avoidable and Unavoidable Cost
Example:
The material Cost of $ 100 are unavoidable and
irrelevant, but the conversion cost of $200 areavoidable and hence relevant.
The decision rule is to accept those alternatives
that generate revenues in excess of the
avoidable costs.
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Sunk Cost
These costs are the cost of resources alreadyAcquired where the total will be unaffected by
the choice between various alternatives.
They are costs that have been created by a
Decision made in the past and that cannot be
Changed by any decision that will be made inthe future.
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Sunk Cost-EXAMPLE
The written down values of assets previouslyPurchased are sunk costs. For example, if a
machine was purchased four years ago for $100,00
with an expected life of five years and nil scrapvalue then the written down value will be $20,000
If straight line depreciation is used. This written
down value will have to be written off, no matter
what possible alternative future action might be
chosen. Sunk cost is irrelevant for decision
making but they are distinguished from irrelevant
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Sunk Costs
Costs because not all irrelevant costs are sunk cost.For example , a comparison of two alternative
production methods may result in identical direct
Material expenditure for both alternatives, so theDirect material cost is irrelevant because it will
remain the same whichever alternative is chosen,
but material cost is not a suck cost since it will be
incurred in the future.
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Opportunity Costs
An opportunity Cost is a cost that measures theopportunity that is lost or sacrificed when the
choice of one course of action requires that an
alternative course of action be given up.
Opportunity Costs EXAMPLE
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Opportunity Costs- EXAMPLE
A company has an opportunity to obtain a contract
for the production of a special component. ThisComponent will require 100 hours of processing on
machine X. Machine X is working at full capacity on
The production of product A, and the only way inwhich the contract can be fulfilled is by reducing
the output of product A. This will mean a loss of
revenue $200. The contract will also result in
additional variable cost of $1000.
If the company takes on the contract, it will sacrifice
Opportunity Costs
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Opportunity CostsRevenue of$200 from the lost output of
product A. This represents an opportunity cost,and should be included as part of the cost when
negotiating for the contract. The contract price
should at least cover the additional costs of$1000 plus the $200 opportunity cost to ensure
that the company will be better off in the short
term by accepting the contract.
Opportunity Costs
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Opportunity Costs
It is important to note that opportunity costs
only apply to the use of scarce resources. Whereresources are not scarce , no sacrifice exists from
using these resources.
In our previous example If machine X wereoperating at 80% of its potential capacity then the
decision to accept the Contract would not have
resulted in reduced production of product A.
Consequently, there would have been no loss of
revenue, and the opportunity cost would be
ZERO.
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Incremental and Marginal Costs
Incremental (also called differential) costsand revenues are the difference between
costs and revenues for the corresponding
items under each alternative beingconsidered. For example the incremental
costs of increasing output from 1000 to 1100
units per week are the additional costs ofproducing an extra 100 units per week.
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Incremental and Marginal Costs
Incremental costs and revenues are similar inprinciple to the economists concept of
marginal cost and marginal revenue. The
main difference is that marginal cost/revenuerepresents the additional cost/revenue of one
extra unit of output whereas incremental
cost/revenues resulting from a group ofadditional units of output.
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End