Prepared by Diane Tanner University of North Florida Review Concepts Basic Cost Terminology

2 What is a Cost? Asset  Expected to provide future economic benefits (not used up) Expense  Not expected to provide future economic benefits (used up)  Can be an asset or an expense  Dependent upon whether it has future economic benefits or not

3 Cost Terms Based on Behavior Variable costs  Total cost increases when production/sales increases  Cost per unit stays the same  Examples: cost of products, hourly wages Fixed costs  Total cost stays the same when production increases  Cost per unit decreases  Examples: Rent, depreciation, insurance, salaries, advertising More activity (sales) causes total costs to increase 3

Cost Terms Cost object – Any product or service for which a company wants to know its cost Cost pool – A group of indirect costs to be allocated to cost objects Cost driver – An activity that causes a cost to change 4

5 Cost Terms Based on Function Product Costs Inventoriable costs Period Costs Non-inventoriable costs Expensed when the product is sold Expensed in a period unrelated to sales; i.e., when used 5

6 Product Costs on the Financials  Merchandising company  ‘Inventory’ on the balance sheet  ‘Cost of goods sold’ on the income statement  Manufacturing company  ‘Raw Materials’, ‘Work in Process’, ‘Finished Goods’ on the balance sheet  ‘Cost of goods sold’ on the income statement 6

7 Period Costs on the Financials Includes all costs that are non- inventoriable Often reported as prepaids or plant assets on the balance sheet until used Reported as operating expenses on the income statement once used Some examples – Corporate, selling, administrative 7

8 Manufacturing Costs Direct costs Consist of Direct materials Direct labor Are traced to products/services Indirect costs Manufacturing overhead costs Are allocated to products/services 8 Prime Costs Conversion Costs Conversion Costs

9 Product Costs for Manufacturers Traced to products Easily identified with specific products Direct Materials Traced to products Easily identified with specific products Direct Labor Allocated to products Not easily identified with specific products Manufacturing Overhead Only product costs (not period costs) are labeled as direct or indirect.

10 Direct Material Costs  Material costs that can be traced to products or services provided  Includes all materials costs directly related to getting the materials ready to use (ultimately to get the product ready to sell)  Invoice cost to buy materials  Less cash discount  Plus sales taxes  Plus freight-in Parallels accounting for merchandise inventory

11 Direct Labor  Labor costs that can be directly traced to products or services provided  Includes all direct labor needed to get the product ready to sell  Assumed to be hourly wages  Fringe benefits should be included as part of the hourly rate Overtime related to a rush job is part of direct labor. Idle time related to equipment failure is indirect labor. Overtime related to a rush job is part of direct labor. Idle time related to equipment failure is indirect labor.

12 INDIRECT manufacturing (product) costs that cannot be traced directly to specific units produced, but are costs of production Manufacturing Overhead Indirect materials Indirect labor Factory-related costs Factory supplies Oil, lubricants, blades Glue, staples Janitor labor Production supervisor labor Dedicated cost accountant labor Factory and equipment depreciation Factory insurance Factory rent and utilities Other factory costs

Other Cost Classifications Opportunity Costs An amount or benefit given up when choosing a particular course of action Never recorded in accounting records Always part of management decision making Sunk Costs  Amounts incurred in the past  Costs that exist no matter which decision is made  Generally ignored in decision making 13

14 The End