1. Chapter 2

2. Basic Cost Terminology
Cost – resource sacrificed to achieve a specific objective
Actual cost – a cost that has occurred
Budgeted cost – a predicted cost
Cost object – anything of interest for which a cost is desired

3. Manufacturing Overhead
Manufacturing Costs
Direct Materials
Direct Labor
Manufacturing Overhead
The Product

4. Further Classification of Labor Costs
Idle Time
Treated as manufacturing overhead cost
Overtime Premium of Factory Workers
Treated as manufacturing overhead cost
Labor Fringe Benefits
Treated as manufacturing overhead or direct labor

5. Nonmanufacturing Costs
Marketing and Selling Cost
Costs necessary to get the order and deliver the product.
Administrative Cost
All executive, organizational, and clerical costs.
R&D

6. Manufacturing Cost Flows
Balance Sheet Costs Inventories
Income Statement Expenses
Material Purchases
Raw Material
Work in Process
Direct Labor
Manufacturing Overhead
Cost of Goods Sold
Finished Goods
Selling and Administrative
Period Expenses
Selling and Administrative

7. Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead.
Period costs are not included in product costs. They are expensed on the income statement.
Inventory
Cost of Good Sold
Balance Sheet
Income Statement
Sale
Expense
Income Statement

8. Balance Sheet Merchandiser Manufacturer Current assets Current Assets
Cash
Receivables
Prepaid expenses
Merchandise inventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
Inventories
Raw Materials
Work in Process
Finished Goods

9. The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of goods sold for merchandisers.

10. Cost of Goods Manufactured
Calculates the cost of Direct Materials Used
Accumulates the three product costs for the current period
Adjusts the current period manufacturing costs to account for units actually completed

11. Income Statement
Figure carries forward from the Schedule of Cost of Goods Manufactured
Period Costs are expensed as incurred

12. Cost Behavior
Variable costs – changes in total in proportion to changes in the related level of activity or volume
Fixed costs – remain unchanged in total regardless of changes in the related level of activity or volume
Costs are fixed or variable only with respect to a specific activity or a given time period

13. Cost Behavior, continued
Variable costs – are constant on a per-unit basis. If a product takes 5 pounds of materials each, it stays the same per unit regardless of one, ten or a thousand units are produced
Fixed costs – change inversely with the level of production. As more units are produced, the same fixed cost is spread over more and more units, reducing the cost per unit

14. Total Variable Cost Graph Unit Variable Cost Graph
Variable Costs
Total Variable Cost Graph
Unit Variable Cost Graph
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
$20
$15
$10 $5
Total Costs
Cost per Unit
Units Produced (000)
Units Produced (000)
Units Total Cost
Produced Cost per Unit
5, $ 50,000 $10
10, ,
15, ,
20, ,
25, ,
30, ,

15. Fixed Costs Total Fixed Cost Graph Unit Fixed Cost Graph $150,000
$125,000
$100,000
$75,000
$50,000
$25,000
$1.50
$1.25
$1.00
$.75
$.50
$.25
Total Costs
Cost per Unit
Units Produced (000)
Units Produced (000)
Units Total Cost
Produced Cost per Unit
50, $75,000 $1.500
100, ,
150, ,
200, ,
250, ,
300, ,

16. Types of Fixed Costs Committed Discretionary Examples Examples
Long-term, cannot be significantly reduced in the short term.
Discretionary
May be altered in the short-term by current managerial decisions
Part I One type of fixed cost is known as committed fixed costs. These are long-term fixed costs that cannot be significantly reduced in the short term. Some examples include depreciation on manufacturing facilities and real estate taxes on factory property.
Part II Another type of fixed cost is known as discretionary fixed costs. These types of fixed costs may be altered in the short-term by current management decisions. Some examples of discretionary fixed costs include advertising and research and development costs.
Examples
Depreciation on Equipment and Real Estate Taxes
Examples
Advertising and Research and Development

17. A Cost Caveat
Unit costs should be used cautiously. Since unit costs change with a different level of output or volume, it may be more prudent to base decisions on a total dollar basis.
Unit costs that include fixed costs should always reference a given level of output or activity
Unit Costs are also called Average Costs

18. Cost Behavior Patterns Example
Bicycles by the Sea incurs variable costs of
$52 for each of its bicycles.
Bicycles by the Sea also incurs $94,500 in
fixed costs per year

19. Use Unit Costs Cautiously
What is the unit cost when Bicycles
assembles 1,000 bicycles in a year?

20. Use Unit Costs Cautiously
Assume that Bicycles management uses a
unit cost of $146.50
Management is budgeting costs for
different levels of production.
What is their budgeted cost for an
estimated production of 600 bicycles?
600 × $ = $87,900?

21. Use Unit Costs Cautiously
What is their budgeted cost for an estimated
production of 3,500 bicycles?
3,500 × $ = $512,750?

22. Direct & Indirect Costs
Direct costs – can be conveniently and economically traced (tracked) to a cost object
Indirect costs – cannot be conveniently or economically traced (tracked) to a cost object. Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner

23. Assigning Costs to Cost Objects
Cost accumulation – a collection of cost data in an organized manner
Cost assignment – a general term that includes associating accumulated costs with a cost object. This includes:
Tracing accumulated costs with a direct relationship to the cost object and
Allocating accumulated costs with an indirect relationship to a cost object

24. BMW: Assigning Costs to a Cost Object

25. Direct or Indirect?
Consider a supervisor’s salary in the canning department of Campbell Soup Company.
If the cost object is the department, the supervisor’s salary is a direct cost.
If the cost object is a can of soup (the “product” of the company), the supervisor’s salary is an indirect cost.

26. Relationships of Types of Costs
Direct
Variable
Fixed
Indirect

27. Different Definitions of Costs for Different Applications
Pricing and product-mix decisions – may use a “super” cost approach (comprehensive)
Contracting with government agencies – very specific definitions of cost for “cost plus profit” contracts
Preparing external-use financial statements – GAAP-driven product costs only

28. Additional Cost Terminology
Variable Costs – costs that change in total in relation to some chosen activity or output
Fixed Costs – costs that do not change in total in relation to some chosen activity or output
Mixed Costs – costs that have both fixed and variable components; also called semivariable costs

29. Cost Function La Playa Hotel offers an airline
three alternative cost structures to
accommodate its crew overnight:
1. $60 per night per room usage
y = $60x
The slope of the cost function is $60.

30. Cost Function

31. Cost Function 2. $8,000 per month y = $8,000
$8,000 is called a constant or intercept.
The slope of the cost function is zero.

32. Cost Function

33. Cost Function 3. $3,000 per month plus $24 per room
This is an example of a mixed cost.
y = $3,000 + $24x
y = a + bx

34. Cost Function

35. The Linear Cost Function
y = a + bX
The Dependent
Variable:
The cost that is
being predicted
The Independent
Variable:
The cost driver
The slope of
the line:
variable cost
per unit
The Intercept:
Fixed Costs