2. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 1 An Introduction to Cost Terms and Purposes Chapter 2 1/31/05

3. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 2 Learning Objective 1 Define and illustrate a cost object.

4. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 3 Cost and Cost Terminology Cost is a resource sacrificed or forgone to achieve a specific objective. i.e., amount paid An actual cost is the cost incurred (a historical cost) as distinguished from budgeted costs. A cost object is anything for which a separate measurement of costs is desired. i.e., products, services, activities, processes, segments, etc.

5. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 4 Cost and Cost Terminology Cost Accumulation (Collecting cost data) Cost Object Cost Assignment (tracing and allocating costs) Tracing Allocating

6. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 5 Learning Objective 2 Distinguish between direct costs and indirect costs.

7. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 6 Direct and Indirect Costs Direct Costs Example: Paper on which Sports Illustrated magazine is printed Indirect Costs Example: Lease cost for Time-Warner building housing all their senior executives, including Sports Illustrated COST OBJECT Example: Sports Illustrated magazine Allocated COST OBJECT Example: Sports Illustrated magazine Allocated

8. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 7 Direct and Indirect Costs Example Direct Costs: Maintenance Department$40,000 Personnel Department (Admin)$20,600 Assembly Department$75,000 Finishing Department$55,000 Assume that Maintenance Department costs are allocated equally among the production departments. How much is allocated to each department?

9. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 8 Direct and Indirect Costs Example Allocated $20,000 Maintenance $40,000 Assembly Direct Costs $75,000 Finishing Direct Costs $55,000 $20,000

10. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 9 Other Factors l Materiality – the larger the cost per unit, the more likely it will be traced as a direct cost l Information gathering technology – the more sophisticated, the more items that can be traced directly to cost objects, i.e. bar coding l Design of operations – all in one building, makes it easy to trace

11. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 10 Learning Objective 3 Explain variable costs and fixed costs. Variable Costs change in total in proportion to changes in the level of activity or volume. Fixed costs remain unchanged in total despite wide changes in the level of activity or volume.

12. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 11 Cost Behavior Patterns Variable Cost Example Bicycles by the Sea buys a handlebar at $52 for each of its bicycles. Note: variable cost per unit of activity is constant What is the total handlebar cost when 1,000 bicycles are assembled?

13. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 12 Cost Behavior Patterns Variable Cost Example 1,000 units × $52 = $52,000 What is the total handlebar cost when 3,500 bicycles are assembled? 3,500 units × $52 = $182,000

14. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 13 Cost Behavior Patterns Fixed Cost 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. Note: In total, fixed costs won’t change. But on a per unit of activity basis, fixed costs will change

15. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 14 Cost Behavior Patterns Fixed Cost 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

16. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 15 Cost Drivers The cost driver of variable costs is the level of activity or volume whose change causes the (variable) costs to change proportionately. The number of bicycles assembled is a cost driver of the cost of handlebars.

17. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 16 Relevant Range Example Assume that fixed (leasing) costs are $94,500 for a year and that they remain the same for a certain volume range (1,000 to 5,000 bicycles). 1,000 to 5,000 bicycles is the relevant range of activity within which the fixed cost in total will not change.

18. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 17 Relevant Range Example $94,500

19. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 18 Learning Objective 4 Interpret total unit costs cautiously. Remember, variable costs per unit are constant and fixed costs per unit will vary with the amount of activity or volume.

20. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 19 Total Costs and Unit Costs Example What is the total 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

21. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 20 Use Unit Costs Cautiously Assume that Bicycles management uses a total unit cost of $146.50 (leasing and wheels). Management is budgeting costs for different levels of production. What is their budgeted cost for an estimated production of 600 bicycles? 600 × $146.50 = $87,900?

22. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 21 Use Unit Costs Cautiously 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?

23. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 22 Use Unit Costs Cautiously Total fixed cost$ 94,500 Total variable cost ($52 × 600) 31,200 Total Cost$125,700 $125,700 ÷ 600 = $209.50 Using a cost of $146.50 per unit would underestimate actual total costs if output is below 1,000 units.

24. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 23 Use Unit Costs Cautiously 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) 182,000 Total$276,500 $276,500 ÷ 3,500 = $79.00

25. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 24 What do unit costs tell you? l Note in the changes in total unit cost At 600, unit cost is$206.50 At 1,000, unit cost is$146.50 At 3,500, unit cost is $ 79.00 l The greater the volume or level of activity within the relevant range, the lower the unit cost and vice versa l These changes are very useful in planning, pricing, budgeting, and evaluating performance

26. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 25 Learning Objective 5 Distinguish among manufacturing companies, merchandising companies, and service-sector companies.

27. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 26 Manufacturing Manufacturing companies purchase materials and components and convert them into finished goods. Examples? Manufacturing companies purchase materials and components and convert them into finished goods. Examples? A manufacturing company must also develop, design, market, and distribute its products. A manufacturing company must also develop, design, market, and distribute its products.

28. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 27 Merchandising Merchandising companies purchase and then sell tangible products without changing their basic form. Examples? Merchandising companies purchase and then sell tangible products without changing their basic form. Examples?

29. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 28 Service Service companies provide services or intangible products to their customers. Examples? Service companies provide services or intangible products to their customers. Examples? Labor is the most significant cost category.

30. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 29 Learning Objective 6 Describe the three categories of inventories commonly found in manufacturing companies

31. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 30 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 (work in progress) 3. Finished goods inventory

32. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 31 Types of Inventory Merchandising-sector companies hold only one type of inventory – the product in its original purchased form. Service-sector companies do not hold inventories of tangible products.

33. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 32 Learning Objective 7 Differentiate between inventoriable costs and period costs

34. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 33 Inventoriable Costs Inventoriable costs (assets)… become cost of goods sold… after a sale takes place.

35. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 34 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.

36. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 35 Flow of Costs Example See Exhibit 2-6, p. 41, Panel B 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

37. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 36 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 105,500 Indirect manufacturing costs 194,500 Total manufacturing costs$500,000

38. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 37 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 500,000 Ending work in process 35,000 Cost of goods manufactured$495,000

39. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 38 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 495,000 Ending finished goods 15,000 Cost of goods sold$490,000

40. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 39 Flow of Costs Example Work in Process Beg. Balance 30,000495,000 Direct mtls. used200,000 Direct labor105,500 Indirect mfg. costs194,500 Ending Balance 35,000

41. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 40 Flow of Costs Example Work in Process 495,000 Finished Goods 10,000490,000 495,000 15,000 Cost of Goods Sold 490,000

42. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 41 Manufacturing Company Materials Inventory Finished Goods Inventory Revenues Cost of Goods Sold INCOME STATEMENT Period Costs Inventoriable Costs BALANCE SHEET Equals Operating Income when sales occur deduct Equals Gross Margin deduct Work in Process Inventory

43. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 42 Merchandising Company INCOME STATEMENTBALANCE SHEET when sales occur Inventoriable Costs Merchandise Purchases Inventory Revenues deduct Cost of Goods Sold Equals Gross Margin deduct Period Costs Equals Operating Income

44. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 43 Learning Objective 8 Explain why product costs are computed in different ways for different purposes.

45. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 44 Many Meanings of Product Cost A product cost is the sum of the costs assigned to a product for a specific purpose. 1. Pricing and product emphasis decisions 2. Contracting with government agencies 3. Preparing financial statements for external reporting under generally accepted accounting principles

46. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 45 Learning Objective 9 Present key features of cost accounting and cost management.

47. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 46 A Framework for Cost Management Three features of cost accounting and cost management: 1. Calculating the costs of products 2. Obtaining information for planning, control, and performance evaluation 3. Analyzing information

48. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 2 - 47 End of Chapter 2