Chapter

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

The Product Direct Materials Direct Labor Manufacturing Overhead Manufacturing Costs

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

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

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

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

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

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

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

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

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

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

Variable Costs Total Variable Cost Graph Total Costs $300,000 $250,000 $200,000 $150,000 $100,000 $50, Unit Variable Cost Graph $20 $15 $10 $5 0 Cost per Unit ,000 $ 50,000 $10 10, , , , , , , , , , Units Total Cost Produced Cost per Unit Units Produced (000)

Fixed Costs Total Fixed Cost Graph Total Costs 0 Unit Fixed Cost Graph Cost per Unit 50,000 $75,000 $ ,000 75, ,000 75, ,000 75, ,000 75, ,000 75, Units Total Cost Produced Cost per Unit $150,000 $125,000 $100,000 $75,000 $50,000 $25, $1.50 $1.25 $1.00 $.75 $.50 $ Units Produced (000)

Examples Advertising and Research and Development Examples Advertising and Research and Development Examples Depreciation on Equipment and Real Estate Taxes Examples Depreciation on Equipment and Real Estate Taxes Types of Fixed Costs Discretionary May be altered in the short-term by current managerial decisions Discretionary May be altered in the short-term by current managerial decisions Committed Long-term, cannot be significantly reduced in the short term. Committed Long-term, cannot be significantly reduced in the short term.

A Cost Caveat Unit costs should be used cautiously Unit costs change with a different level of volume (activity) –Unit costs that include fixed costs should always reference the given level of activity –Unit Costs are also called Average Costs

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

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

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

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

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

Determining Product Costs Product Direct materials Direct labor Traced directly to product Manufacturing overhead (OH) Applied to product using a predetermined rate

BMW: Assigning Costs to a Cost Object

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.

Relationships of Types of Costs Direct Indirect VariableFixed

Other Cost Definitions Differential cost Controllable/Uncontrollable costs Opportunity costs Sunk cost Marginal cost

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

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

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.

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.

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

Cost Function

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