Cost Classifications

 External reporting  Predicting cost behavior  Assigning costs to cost objects  Decision making

Cost Classifications  External reporting  Product vs. period costs  Predicting cost behavior  Variable vs. fixed costs  Assigning costs to cost objects  Direct vs. indirect costs  Decision making  Relevant vs. irrelevant costs

Aussie Pies’ Costs  Ingredients  Utilities for cooking  Utilities for lighting the store  Pie boxes  Rent on store  Rent on cooking equipment  Rent on fixtures  Chefs salaries  Sales assistant salary

Let’s start by looking at these costs from an external reporting perspective.

Cracker Barrel

The Cheesecake Factory

Cost Classification Summary ProductPeriodVariableFixedDirectIndirectRelevantIrrelevant Ingredients Utilities for cooking Utilities for lighting in store Pie boxes Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary

Product vs. Period Costs (external reporting) ProductPeriod Ingredients Utilities for cooking Utilities for lighting in store Pie boxes Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary

Product vs. Period Costs (external Reporting) ProductPeriod Ingredients√ Utilities for cooking√ Utilities for lighting in store√ Pie boxes√ Rent on store√ Rent on cooking equipment√ Rent on fixtures√ Chefs salaries√ Sales assistant salary√

What are the profit implications of treating a cost such as utilities for cooking as a period cost rather than a product cost?

Product Costs (excluding raw materials inventory) Product Costs (excluding raw materials) Cost of goods sold Ending work in process inventory or ending finished goods inventory Period Costs Selling & Admin. expense Income StatementBalance Sheet

Does a restaurant have work in process or finished goods inventory?

A Matching Perspective  Why not include the rental cost of cooking equipment in COGS?

A Matching Perspective  Why not include the rental cost of cooking equipment in COGS?  A manufacturer treats manufacturing equipment depreciation as a product cost because some units may be produced in the current period but not sold until a later period.

A Matching Perspective  Why not include the rental cost of cooking equipment in COGS?  A manufacturer treats manufacturing equipment depreciation as a product cost because some units may be produced in the current period but not sold until a later period.  A software developer incurs costs to develop products that will be sold in a later period.  So in these two instances there is a need to match costs with revenues.

A Matching Perspective  Why not include the rental cost of cooking equipment in COGS?  A manufacturer includes equipment depreciation in product cost because some units may be produced in the current period but not sold until a later period.  A software developer incurs costs to develop products that will be sold in a later period.  So in these two instances there is a need to match costs with revenues.  There is no such matching concern with a restaurant. Furthermore, cost of goods sold is more useful if not confounded with various non-food costs.

From an external reporting perspective, what would be Aussie Pie’s unit product cost?

Unit Product Cost Amount Ingredients Pie boxes Unit product cost

Unit Product Cost Amount Ingredients$1.20 Pie boxes$0.02 Unit product cost$1.22

Let’s look at Aussie Pies’ costs from a cost behavior standpoint.

Variable vs. Fixed Costs (with respect to the number of pies produced)VariableFixed Ingredients Utilities for cooking Utilities for lighting in store Pie boxes Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary

Variable vs. Fixed Costs (with respect to the number of pies produced)VariableFixed Ingredients√ Utilities for cooking√ Utilities for lighting in store√ Pie boxes√ Rent on store√ Rent on cooking equipment√ Rent on fixtures√ Chefs salaries√ Sales assistant salary√

Fixed Costs Amount Utilities for lighting in store Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary Total fixed costs

Fixed Costs Amount Utilities for lighting in store$300 Rent on store11,900 Rent on cooking equipment8,000 Rent on fixtures5,000 Chefs salaries3,600 Sales assistant salary1,200 Total fixed costs$30,000

Variable Costs Amount Ingredients$1.20 Utilities0.03 Packaging0.02 Total variable cost per pie$1.25

Cost Behavior Total VCVC/UnitTotal FCFC/UnitCost/Unit 5,000 units 10,000 units 15,000 units 20,000 units 25,000 units 30,000 units

Cost Behavior Total VCVC/UnitTotal FCFC/UnitCost/Unit 5,000 units$ ,000 units$ ,000 units$ ,000 units$ ,000 units$ ,000 units$1.25

Cost Behavior Total VCVC/UnitTotal FCFC/UnitCost/Unit 5,000 units$1.25$30,000 10,000 units$1.25$30,000 15,000 units$1.25$30,000 20,000 units$1.25$30,000 25,000 units$1.25$30,000 30,000 units$1.25$30,000

Cost Behavior Total VCVC/UnitTotal FCFC/UnitCost/Unit 5,000 units$6,250$1.25$30,000 10,000 units$12,500$1.25$30,000 15,000 units$18,750$1.25$30,000 20,000 units$25,000$1.25$30,000 25,000 units$31,250$1.25$30,000 30,000 units$37,500$1.25$30,000

Cost Behavior Total VCVC/UnitTotal FCFC/UnitCost/Unit 5,000 units$6,250$1.25$30,000$ ,000 units$12,500$1.25$30,000$ ,000 units$18,750$1.25$30,000$ ,000 units$25,000$1.25$30,000$ ,000 units$31,250$1.25$30,000$ ,000 units$37,500$1.25$30,000$1.00

Cost Behavior Total VCVC/UnitTotal FCFC/UnitCost/Unit 5,000 units$6,250$1.25$30,000$6.00$ ,000 units$12,500$1.25$30,000$3.00$ ,000 units$18,750$1.25$30,000$2.00$ ,000 units$25,000$1.25$30,000$1.50$ ,000 units$31,250$1.25$30,000$1.20$ ,000 units$37,500$1.25$30,000$1.00$2.25

Let’s look at the topic of assigning costs to cost objects.

Direct vs. Indirect Costs  If Aussie Pies eventually opened a second store and hired two additional chefs for that store, then what would be the direct and indirect costs with respect to a specific store?

Direct vs. Indirect Costs DirectIndirect Ingredients Utilities for cooking Utilities for lighting in store Pie boxes Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary

Direct vs. Indirect Costs DirectIndirect Ingredients√ Utilities for cooking√ Utilities for lighting in store√ Pie boxes√ Rent on store√ Rent on cooking equipment√ Rent on fixtures√ Chefs salaries√ Sales assistant salary√

Let’s look at the topic of cost classifications for decision making.

Relevant vs. Irrelevant Costs  Assume the Aussie Pies’ owners claimed that the cost per Aussie Pie (at a volume of 30,000 units sold) is $2.25 per pie.

Relevant vs. Irrelevant Costs  Assume the Aussie Pies’ owners claimed that the cost per Aussie Pie (at a volume of 30,000 units sold) is $2.25 per pie.  Assume that Aussie Pies turned down a corporate client that wanted to buy 1,000 pies at $2.00 each because the price was below $2.25 per pie.  Comment on the wisdom of this decision.

Relevant vs. Irrelevant Costs  Assume the Aussie Pies’ owners claimed that the cost per Aussie Pie (at a volume of 30,000 units sold) is $2.25 per pie.  Assume that Aussie Pies turned down a corporate client that wanted to buy 1,000 pies at $2.00 each because the price was below $2.25 per pie.  Comment on the wisdom of this decision.  Does the concept of “opportunity cost” affect your answer?

Relevant vs. Irrelevant Costs  If Aussie Pies is considering staying open 2 additional hours everyday, what costs on the next slide would be potentially relevant to this decision?

Relevant vs. Irrelevant Costs RelevantIrrelevant Ingredients Utilities for cooking Utilities for lighting in store Pie boxes Rent on store Rent on cooking equipment Rent on fixtures Chefs salaries Sales assistant salary

Relevant vs. Irrelevant Costs RelevantIrrelevant Ingredients√ Utilities for cooking√ Utilities for lighting in store√ Pie boxes√ Rent on store√ Rent on cooking equipment√ Rent on fixtures√ Chefs salaries√ Sales assistant salary√ Assumes that Chefs would demand an increase in salary to work two extra hours everyday.

Cost Classification Summary ProductPeriodVariableFixedDirectIndirectRelevantIrrelevant Ingredients √√√√ Utilities for cooking √√√√ Utilities for lighting in store √√√√ Pie boxes √√√√ Rent on store √√√√ Rent on cooking equipment √√√√ Rent on fixtures √√√√ Chefs salaries √√√√ Sales assistant salary √√√√

Let’s take a closer look at the value of understanding cost behavior.

Equation Method (P)(Q) ̶ (V)(Q) ̶ F = Profit

Equation Method ($3.25)(Q ) ̶ ($1.25)(Q) ̶ $30,000 = 0 2Q = $30,000 Q = 15,000 pies What is the breakeven point in sales dollars?

Equation Method ($3.25)(Q ) ̶ ($1.25)(Q) ̶ $30,000 = 0 2Q = $30,000 Q = 15,000 pies 15,000 pies × $3.25 = $48,750

Equation Method ($3.25)(Q) ̶ ($1.25)(Q) ̶ $30,000 = ($0.65)Q 1.35Q = $30,000 Q = 22,223 pies

Equation Method ($3.25)(25,000) ̶ ($1.75)(25,000) ̶ $35,000 = Profit Profit = $2,500

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 20,000 units$3.25

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 26,000 units$ ,500 units$ ,000 units$ ,500 units$ ,000 units$ ,500 units$ ,000 units$ ,500 units$ ,000 units$4.25

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 26,000 units$2.25$ ,500 units$2.50$ ,000 units$2.75$ ,500 units$3.00$ ,000 units$3.25$ ,500 units$3.50$ ,000 units$3.75$ ,500 units$4.00$ ,000 units$4.25$1.25

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 26,000 units$2.25$1.25$ ,500 units$2.50$ ,000 units$2.75$1.25$ ,500 units$3.00$1.25$ ,000 units$3.25$1.25$ ,500 units$3.50$1.25$ ,000 units$3.75$1.25$ ,500 units$4.00$1.25$ ,000 units$4.25$1.25$3.00

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 26,000 units$2.25$1.25$1.00$26,000 24,500 units$2.50$1.25 $30,625 23,000 units$2.75$1.25$1.50$34,500 21,500 units$3.00$1.25$1.75$37,625 20,000 units$3.25$1.25$2.00$40,000 18,500 units$3.50$1.25$2.25$41,625 17,000 units$3.75$1.25$2.50$42,500 15,500 units$4.00$1.25$2.75$42,625 14,000 units$4.25$1.25$3.00$42,000

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 26,000 units$2.25$1.25$1.00$26,000$30,000 24,500 units$2.50$1.25 $30,625$30,000 23,000 units$2.75$1.25$1.50$34,500$30,000 21,500 units$3.00$1.25$1.75$37,625$30,000 20,000 units$3.25$1.25$2.00$40,000$30,000 18,500 units$3.50$1.25$2.25$41,625$30,000 17,000 units$3.75$1.25$2.50$42,500$30,000 15,500 units$4.00$1.25$2.75$42,625$30,000 14,000 units$4.25$1.25$3.00$42,000$30,000

Optimal Price VolumePrice VC per Unit CM per Unit Total CM Fixed CostsProfit 26,000 units$2.25$1.25$1.00$26,000$30,000$(4,000) 24,500 units$2.50$1.25 $30,625$30,000$625 23,000 units$2.75$1.25$1.50$34,500$30,000$4,500 21,500 units$3.00$1.25$1.75$37,625$30,000$7,625 20,000 units$3.25$1.25$2.00$40,000$30,000$10,000 18,500 units$3.50$1.25$2.25$41,625$30,000$11,625 17,000 units$3.75$1.25$2.50$42,500$30,000$12,500 15,500 units$4.00$1.25$2.75$42,625$30,000$12,625 14,000 units$4.25$1.25$3.00$42,000$30,000$12,000

Assume that Aussie Pies decides to pay its sales assistant a commission of $0.06 per pie sold instead of a salary and each chef is paid a salary of $1,000 plus a commission of $0.04 per pie sold. If Aussie Pies sells 22,000 units, how would it prepare an income statement for external reporting purposes?

Traditional Income Statement Amount Sales Cost of goods sold Gross margin Operating expenses: Chefs compensation Utilities expense Rent expense Selling expense Total operating expenses Net operating income

Traditional Income Statement Amount Sales (22,000 × $3.25)$71,500 Cost of goods sold (22,000 × $1.22)26,840 Gross margin44,660 Operating expenses: Chefs compensation (($2,000 + (22,000 × $0.04 × 2))$3,760 Utilities expense ($300 + (22,000 × $0.03))$960 Rent expense ($11,900 + $8,000 + $5,000)$24,900 Selling expense (22,000 × 0.06)$1,320 Total operating expenses$30,940 Net operating income$13,720

Given the same assumptions, how would Aussie Pies prepare a contribution format income statement?

Contribution Margin Income Statement Amount Sales Cost of goods sold Chefs commission Cooking utilities Selling commission Total variable cost Contribution margin Chefs salaries Utilities expense Rent expense Total fixed cost Net operating income

Contribution Margin Income Statement Amount Sales (22,000 × $3.25)$71,500 Cost of goods sold (22,000 × $1.22)26,840 Chefs commission (22,000 × $0.04 × 2)1,760 Cooking utilities (22,000 × $0.03)660 Selling commission (22,000 × $0.06)1,320 Total variable cost30,580 Contribution margin40,920 Chefs salaries2,000 Utilities expense300 Rent expense24,900 Total fixed cost27,200 Net operating income$13,720