Ch. 2 Notes - Cost Concepts
Ch. 2 Notes - Cost Concepts ACCT 202
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This 10 page Class Notes was uploaded by Georgia Goodman on Tuesday January 12, 2016. The Class Notes belongs to ACCT 202 at Clemson University taught by Kyle Anderson in Summer 2015. Since its upload, it has received 45 views. For similar materials see Managerial Accounting in Accounting at Clemson University.
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Date Created: 01/12/16
Ch. 2: Cost Concepts 1/12/16 3:57 PM DUE: January 20 Assignments: • In-class assignments • Discussion: How It’s Made video – finished just have to reply to two classmates • Ch. 2 EOC • Ch. 2 LearnSmart Reading notes: Manufacturing costs: • Direct materials o Raw materials – materials that go into the final product (any materials used in the final product) o Direct materials – materials that become an integral part of the finished product and whose costs can be conveniently traced o Indirect materials – included as part of manufacturing overhead • Direct labor o Consists of labor costs that can be easily traced to individual units of product o Touch labor – because direct labor workers typically touch product while its being made o Assembly line workers o Indirect labor – labor costs that cannot be physically traced to particular products (Ex. Janitors, supervisors, night security guards) • Manufacturing overhead o Includes all manufacturing costs except direct materials and direct labor o Indirect materials, indirect labor, maintenance, repairs on production equipment, heat and light o Only costs associated with operating the factory are included in manufacturing overhead Nonmanufacturing costs • Selling costs o Includes all costs that are incurred to secure customer orders and get finished product to customer (advertising, shipping, sales, travel, etc.) • Administrative costs o All costs associated with the general management of an organization rather than with manufacturing or selling (executive compensation, general acct., secretarial, PR) • SG&A Generally, costs are recognized as expenses on the income statement in the period that benefits from the costs Matching principle – based on the accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized • If a cost is incurred to acquire something that will be eventually sold, then the cost should be recognized as an expense only when the sale takes place (product costs) Product costs vs. Period costs • Product costs – include all costs involved in acquiring or making a product o Direct materials, direct labor, manufacturing overhead o Attach to units of product as the goods are purchased/manufactured and they remain attached as the goods go to inventory awaiting sale o Inventoriable costs o Not necessarily treated as expenses in the period in which they are incurred, but treated as expenses in the period in which the related products are sold • Period costs – all the costs that are not product costs o Selling and administrative expenses o Sales commission, advertising, executive salaries, PR o Not included as part of the cost of either purchased or manufactured goods o Period costs are expensed on the income statement in the period in which they are incurred (accrual acct.) Prime cost vs. Conversion costs • Prime cost – sum of direct materials cost and direct labor cost • Conversion cost – sum of direct labor cost and manufacturing overhead cost o Used to describe direct labor and manufacturing overhead b/c these costs are incurred to convert materials into the finished product Cost Behavior • Variable Cost – varies in direct proportion to changes in the level of activity o Ex) COGS, direct materials, direct labor, some manufacturing overhead variables (commission, shipping costs) o It must be variable in respect to something § Activity base – measure of whatever causes the incurrence of a variable cost = COST DRIVER § Ex) direct labor hours, machine hours, number of miles driven, number of calls handled o While total variable costs change as the activity level changes, variable cost is constant if expressed on a per unit basis • Fixed Cost – cost that remains constant regardless of changes in level of activity o Ex) straight line depreciation, insurance, property tax, rent, supervisor salaries o Fixed costs are not affected by changes in activity o As the activity level rises and falls, total fixed costs remain constant unless influenced by some outside force; such as landlord increasing monthly rent o Average fixed cost per unit becomes smaller as activity level increases • Committed fixed costs – represent organizational investments with a multi year planning horizon that cant be significantly reduced even for short periods w/o making fundamental changes o Ex) facilities, equipment, real estate taxes, insurance expenses o Remain largely unchanged in the short term because the costs of restoring them later are likely to be far greater than any short run savings • Discretionary fixed costs – usually arise from annual decisions by management to spend on certain fixed cost items o Ex) advertising, research, PR, internships o Can be cut for short periods of time w/ minimal damage to the long run goals of the organization • Mixed Cost – contains both variable and fixed cost elements o Semivariable costs o Y = a + bX (used to express relationship between a mixed cost and level of activity § Y = total mixed cost § a = total fixed cost § b = variable cost per unit of activity § X = level of activity Relevant range • Relevant range – the range of activity within which the assumption that cost behavior is strictly linear is reasonably valid • Outside the relevant range, a fixed cost may no longer be strictly fixed or vice versa with variable costs • Its approximated by a straight line • Within the relevant range of activity, fixed costs remain constant in total • Within the relevant range of activity, variable costs remain constant per unit and change in total Methods of estimating fixed/variable components of mixed costs: • Account analysis – an account is classified as either variable/fixed based on analysts prior knowledge of how the cost in the acct behaves • Engineering approach – detailed analysis of what cost behavior should be, based on an industrial engineers evaluation of production methods to be used (material specs, labor req, equipment usage, etc.) • High low and least squares methods estimate fixed/variable elements by analyzing past records and activity data • High low method – two points recorded (lowest level of activity and period with highest level of activity o Variable cost = slope of line = rise/run = Y2-Y1/X2-X1 o Variable cost = change in cost/change in activity • Least squares regression – uses all data to separate a mixed cost into its fixed and variable components o Computes regression line that minimized the sum of squared errors Traditional and Contribution format income statements Traditional income statements only used for external reporting • COGS = Beginning merchandise inventory + purchases – ending merchandise inventory • Doesn’t distinguish between fixed and variable costs Contribution format income statement • It provides managers with an income statement that clearly distinguishes between fixed and variable costs • Aids planning, controlling, and decision making • Separates costs into fixed/variable categories; first deducting variable expenses from sales to obtain contribution margin • Contribution margin – amount remaining from sales revenues after variable expense has been deducted o This amt contributes toward covering fixed expenses and then toward profits for the period • Used as an internal planning and decision making tool • Emphasis on cost behavior aids and cost volume profit analysis, management performance appraisals, and budgeting • Helps managers organize data pertinent to numerous decisions, such as pricing, use of scarce resources, etc. Cost objects – anything for which cost data are desired • Direct cost – a cost that can be easily and conveniently traced to a specified cost object o A regional sales manager salary would be a direct cost of the regional office in which the sales manager works • Indirect cost – cost that cannot be easily and conveniently traced to a specified cost object o Common cost – cost that is incurred to support a number of cost objects but cannot be traced to them individually • An individual cost may be indirect to one cost object and direct to another Cost classifications for decision making • Differential cost – difference in costs between any two alternatives o Differential revenue – difference in revenues between to alternatives o Incremental cost = increases o Decremental cost = decreases o Can be fixed or variable • Opportunity cost – potential benefit that is given up when one alternative is selected over the other o Usually not found in acct records, but are costs that must be heavily considered in every decision a manager makes • Sunk cost – cost that has already been incurred and that cannot be changed by any decision now or in the future o Not differential costs o Should always be ignored 1/12/16 3:57 PM 1/12/16 3:57 PM
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