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Cost Concepts - 1

COST CONCEPTS
AND CLASSIFICATIONS
Fixed vs
Variable

Direct vs
Indirect

Functional vs Behavioral

Cost Concepts - 2

COST CLASSIFICATIONS
Functional

Product
Marketing
R&D
Admin

Cost Concepts - 3

COST CLASSIFICATIONS
Functional Product Detail

Mfg.
Overhead

Product
Marketing
R&D
Admin

Materials
Labor

Prime costs = Dir. Materials + Dir. Labor


Conversion costs = Dir. Labor + Total Mfg.
Overhead

Cost Concepts - 4

COST CLASSIFICATIONS
Behavioral
Variable

Product
Marketing
R&D
Admin
Fixed

Cost Concepts - 5

COST CLASSIFICATIONS
Responsibility
Variable

Product
Marketing
R&D
Admin

B
Fixed

Cost Concepts - 6

PRIOR
PERIOD

COST RELATIONSHIPS: MANUFACTURING COMPANY

WIP (Beg)

Fin Goods
(Beg)

Direct Mat.
(Beg)

+
Direct Mat.
Purchases

Direct Mat.
(End)

Direct Mat.
Used

+
Direct labor
incurred

Tot. Mfg. Costs


incurred

+
Overhead costs
applied

WIP (End)

Cost of Goods
Mfg.

Cost of Goods
Sold

Fin Goods
(End)

NEXT
PERIOD

Cost Concepts - 7

Income Statement
Manufacturing Company
$4,000,000
Sales

$2,600,000
Cost of Goods Sold

=
$1,400,000
Gross Margin

$900,000
Other Oper.Expenses

=
$500,000
Net Income

Beg. Fin. Goods

$2,400,000
Cost of Goods Mfg.

End. Finished Goods


=

$2,600,000
Cost of Goods Sold

Selling expenses
Admin. expenses
Income taxes

Beg. WIP
+ Direct Matl
Used
+ Direct Labor
+ Mfg. =
Overhead
- End.
WIP Mfg.
Cost
of Goods

Cost Concepts - 8

INCOME STATEMENT
Service Organization
$4,000,000
Sales

$2,600,000
Cost of Services

=
$1,400,000
Gross Margin

Direct Materials/ Supplies


Direct Labor
Indirect Costs or Overhead

$900,000
Operating Expenses

=
$500,000
Net Income

Selling Expenses
Administrative Expenses
Income taxes

Cost Concepts - 9

Basic
Basic Cost
Cost Behavior
Behavior Patterns
Patterns
Total
Total fixed
fixed costs
costs do
do not
not respond
respond to
to changes
changes
in
in unit
unit level
level cost
cost drivers
drivers within
within aa period.
period.

Total
fixed
costs (Y)
0

Total activity (X)

Cost Concepts - 10

Fixed
Fixed Costs
Costs
Committed
Committed fixed
fixed costs
costs are
are
required
required to
to maintain
maintain the
thecurrent
current
service
service or
or production
production capacity
capacity to
to
fill
fill previous
previous legal
legal commitments.
commitments.

Cost Concepts - 11

Fixed
Fixed Costs
Costs
Discretionary
Discretionary fixed
fixed costs
costs are
are set
set
at
at aa fixed
fixed amount
amount each
each year
year atat the
the
discretion
discretion of
ofmanagement.
management.

Cost Concepts - 12

Basic
Basic Cost
Cost Behavior
Behavior Patterns
Patterns
Total
Total variable
variable costs
costs increase
increase in
in proportion
proportion
to
to increases
increases in
in unit
unit level
level cost
cost drivers.
drivers.

Total
variable
costs (Y)
0

Total activity (X)

Cost Concepts - 13

Basic
Basic Cost
Cost Behavior
Behavior Patterns
Patterns
Total
Total mixed
mixed costs
costs contain
contain fixed
fixed and
and variable
variable
cost
cost elements.
elements. They
They increase,
increase, but
but not
not in
in direct
direct
proportion
proportion to
to increases
increases in
in unit
unit level
level cost
cost drivers.
drivers.
Total
mixed
costs (Y)
0

Sometimes
called
semivariable
costs
0

Total activity (X)

Cost Concepts - 14

Basic
Basic Cost
Cost Behavior
Behavior Patterns
Patterns
Total
Total step
step costs
costs are
are constant
constant over
over aa range
range of
of
activity
activity for
for aa unit
unit level
level cost
cost driver
driver but
but moves
moves to
to
aa different
different amount
amount at
at different
different ranges.
ranges.

Total
step
costs (Y)
0

Total activity (X)

Cost Concepts - 15

Basic
Basic Cost
Cost Behavior
Behavior Patterns
Patterns
Pizza Hut
Variable costs--The cost of the
ingredients used to make the pizzas
Fixed costs--Depreciation, property
taxes, and property insurance
Mixed costs--Cost of electricity
Step costs--Employee wages

Cost Concepts - 16

Total
Total Cost
Cost Behavior
Behavior With
With A
A
Single
Single Unit
Unit Level
Level Cost
Cost Driver
Driver
Slope,
b=

Variable
Variablecosts
costsare
are
layered
layeredon
ontop
topof
of
fixed
fixedcosts.
costs.

Y
X

Total costs
Y = a + bX

Total
costs
(Y)

Variable costs (b)

Fixed costs (a)


0

Value of independent variable (X)

Cost Concepts - 17

Equation
Equation for
for Total
Total Costs
Costs

Y = a + bX
slope
(an of
value
totalvertical
costs axis intercept
approximation
of
independent
(an approximation
of
per unit
variable
fixedvariable
costs) costs
of X)

Cost Concepts - 18

Methods for Separating Mixed


Cost Into Fixed and Variable
Components
Scatterplot Method
The High-Low Method
Specific quantitative
methods
The Method of Least Squares

Cost Concepts - 19

Mixed Costs: An Example


Month
January
February
March
April
May

Utility Costs
$2,000
2,500
4,500
5,000
7,500

Unit Produced
200
400
600
800
1,000

Cost Concepts - 20

Utility
Cost

Scatterplot Method

$8,000

6,000

Important: Cost function is only


relevant within relevant range

4,000

2,000

200

Analyst can fit line


based on his or her
experience

400
600
800
Units Produced

1,000

Cost Concepts - 21

High-Low
High-Low Cost
Cost Estimation
Estimation
Number of
Shipments

Packaging
Costs

January
6,000
$17,000
February
9,000
26,000
High activity period
March
12,000
32,000
April
l0,000
20,000
Variable cost
Difference in total costs
per unit (b) = Difference in activity
Continued on next
$32,000
$17,000
b=
slide
12,000 - 6,000
Low activity period

Cost Concepts - 22

High-Low
High-Low Cost
Cost Estimation
Estimation
Variable cost
$2.50
=
per unit (b)
January
a = Total costs - Variable costs
$17,000 = a + ($2.50 x 6,000 shipments)
a = $2,000
March
Same answer!
$32,000 = a + ($2.50 x 12,000 shipments)
a = $2,000

Cost Concepts - 23

High-Low
High-Low Cost
Cost Estimation
Estimation

Y
Y == $2,000
$2,000 xx $2.50X
$2.50X

Total packing
department costs

Number of
shipments

Cost Concepts - 24

Composition
Composition of
of
Manufacturing
Manufacturing Costs
Costs
Direct
Directmaterials,
materials,the
thecost
cost
of
ofprimary
primaryraw
rawmaterials
materials
converted
convertedinto
intofinished
finished
Manufacturing
overhead
Manufacturing
overhead
goods.
The
word
direct
goods. The word direct includes all manufacturing costs
includes all manufacturing costs
indicates
indicatescosts
coststhat
thatare
are
other
than
direct
materials
and
other
than
direct
materials
and
easily
easilyor
ordirectly
directlytraced
tracedto
toaa
direct
directlabor.
labor.
finished
product
or
service.
finished product or service.
Direct
Directlabor,
labor,the
thewages
wagesearned
earnedby
by
production
productionemployees
employeesfor
forthe
thetime
time
they
theyspend
spendconverting
convertingraw
raw
materials
materialsinto
intofinished
finishedproducts.
products.

Cost Concepts - 25

Conventional Product Costing


Direct
Materials
Traceable
Direct
Labor

Indirect

Overhead to
be Assigned

Work in
Process

Finished
Goods

Cost Concepts - 26

Composition
Composition of
of
Manufacturing
Manufacturing Costs
Costs
Prime costs = Direct materials +
Direct labor
Conversion costs = Direct labor +
Manufacturing
overhead
(fixed & variable)

Cost Concepts - 27

Changing
Changing Composition
Composition of
of
Total
Total Manufacturing
Manufacturing Costs
Costs
100
Manufacturing overhead has
increased
Total
manufacturing
costs
Direct labor has decreased

Percent of Total
Manufacturing
Costs

Direct materials has increased


0

1900

1950
Year

2000

Cost Concepts - 28

The Basic Concept of


Overhead Application
Applied overhead = Overhead rate x Actual
activity
Key considerations
Applied overhead is the basis for computing perunit overhead cost
Applied overhead is rarely equal to a period's
actual overhead costs.

Cost Concepts - 29

CONVENTIONAL PRODUCT
COSTING
Overhead Application
Predetermined
Overhead Rate

Total budgeted overhead


= Expected level of activity *

Conventional costing typically used volume (or a


surrogate for volume such as DLH)
Problems
- Budgeted overhead contains both fixed and
variable costs
- Selection of expected level of activity

Cost Concepts - 30

Select An Appropriate Activity


Base

Possible Measures
of
Production Activity

Criterion:
Cause and Effect
Relationship

1. Units produced
2. Direct labor
hours
3. Direct labor dollars
4. Machine hours
5. Direct materials

Choice of Activity
Base to be Used
for Computing the
Predetermined
Overhead Rate

Cost Concepts - 31

Comparison of Traditional and


Contemporary Cost Management
Systems
Traditional

Contemporary
Cost
Information
System

1. Unit-based drivers
2. Allocation intensive
3. Narrow view of
product costs
4. Focus on cost mgt.
5. Little activity information
6. Maximizes unit
production
7. Uses financial measures
of performance

1. Uses of nonunit drivers


2. Tracing intensive
3. Expanded product costing
4. Managing activities
5. Detailed activity
information
6. System-wide performance
appraisals
7. Use of nonfinancial
measures of performance

Cost Concepts - 32

Impact
Impact of
of Computers
Computers on
on
Manufacturing
Manufacturing
Automatic
identification systems
(AIS) allow inventory
and production
information to be
entered into a
computer without
writing or keying.

Cost Concepts - 33

Impact
Impact of
of Computers
Computers on
on
Manufacturing
Manufacturing
Computer-aided
design (CAD)
involves the use of
computers to
design products.

Cost Concepts - 34

Impact
Impact of
of Computers
Computers on
on
Manufacturing
Manufacturing

Computer-aided manufacturing
(CAM) involves the use of computers
to control machine operations.

Cost Concepts - 35

Impact
Impact of
of Computers
Computers on
on
Manufacturing
Manufacturing
In
Intheir
theiradvanced
advancedstages,
stages,factories
factories
utilizing
utilizingflexible
flexiblemanufacturing
manufacturing
systems
Flexible
Flexiblemanufacturing
manufacturing
systemsand
andcomputer-integrated
computer-integrated
manufacturing
systems
an
systems(FMS)
(FMS)are
are
anextension
extension are
manufacturing
aresometimes
sometimesreferred
referred
Computer-integrated
to
factoriesbecause
of
ofcomputer-aided
computer-aided
Computer-integrated
toas
aslights-out
lights-out
factoriesbecause
isdark.
they
can
in
manufacturing
manufacturingtechniques
techniques
manufacturing
(CIM)
isthe
the
theymanufacturing
canbe
beoperated
operated(CIM)
inthe
thedark.
extension
through
of
throughaaseries
seriesultimate
of
ultimate
extensionof
ofCAD,
CAD,CAM,
CAM,
and
manufacturing
manufacturingoperations.
operations.
andFMS
FMSconcepts
conceptsto
toaacompleted
completed
automated
automatedand
andcomputercomputercontrolled
controlledfactory.
factory.