AN INTRODUCTION TO COST TERMS AND PURPOSES

Copyright © 2016 Pearson Canada Inc.17

CHAPTER 2

AN INTRODUCTION TO COST TERMS AND PURPOSES

SHORT-ANSWER QUESTIONS

2-1 A cost object is anything for which a separate measurement of costs is desired.Examples include a product, a service, a project, a customer, a brand category, an activity, a department, and a program.

2-2 Direct costs of a cost object are related directly to the particular cost object and can be traced to it in an economically feasible way. Indirect costs of a cost object are costs that arise from common costs shared among distinct types of cost objects and cannot be traced to each type of cost object in an economically feasible way.

2-3 When direct costs are traced to a particular cost object, the resources used are unique to the distinct type of cost object and can be accurately assigned to it. When costs of resources shared unequally among distinct types of cost objects are allocated, managers are less certain whether the cost allocation base, a measure of direct resources consumed, accurately measures the benefit or value added to the distinct type of cost object from its share of common resources consumed. Managers prefer to use more accurate costs in their decisions.

2-4 Factors affecting the classification of a cost as direct or indirect include:

• the materiality of the cost in question
• available information-gathering technology
• design of operations
• the type of costing system in use.

2-5 A cost driver is a variable that causes a change in total cost, measured throughout a specific time. A change in the quantity of a cost driver used results in a change in the level of total costs. For example, the number of tires per vehicle is a driver of the total cost of tires for each vehicle.

2-6 The relevant range is the range over which the changes in the quantity of the cost driver used have a causal relationship with changes in total cost. Relevant range is important to accurately defining cost behaviour as a linear cost function. Linear cost Cost Accounting A Managerial Emphasis Canadian 7th Edition Horngren Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Instructor’s Resource Manual for Cost Accounting, Seventh Canadian Edition Copyright © 2016 Pearson Canada Inc.18 functions are applied when examining cost–volume–profit (CVP) relationships as long as the volume levels are within the relevant range.

2-7 The usefulness of a unit cost or rate per unit of resource used depends on whether the causal relationship is true, for example, with fully variable costs. The rate per unit for variable costs is computed by dividing some total cost of the resource used (the numerator) by a corresponding quantity of units of a resource used (the denominator).But when total cost is fully or partially fixed it is wrong to use a constant rate per unit.There is no direct causal relationship between a fixed cost, which is constant, and any quantity of any cost object, either input or output. The fixed cost in the numerator is unchanged but the fixed cost rate will vary as the denominator quantity changes.

2-8 Manufacturing companies purchase materials and components and convert them into various finished goods; pharmaceutical, automotive, and textile companies are examples.Merchandising-sector companies purchase and then sell tangible products without changing their basic form; retailing or distribution companies are examples.Service-sector companies produce and provide services or intangible products to their customers; for example, service-sector companies provide engineering design, legal advice, and audits.

2-9 Manufacturing companies typically have one or more of the following three types

of inventory:

• Direct materials inventory. Direct materials on site and awaiting use in the

production process.

• Work-in-process inventory. Goods partially converted from direct materials to

goods available for sale, but not yet finished. This is also called work in progress

(WIP).

• Finished goods inventory. Goods completed and available for sale but not yet sold.

2-10 No. Service sector companies have no inventories and, hence, no inventoriable costs.

2-11 Overtime premium is the wage rate paid to workers (for both direct labour and indirect labour) in excess of their straight-time wage rates.Idle time is a sub-classification of indirect labour that represents wages paid for unproductive time caused by lack of orders, machine breakdowns, material shortages, poor scheduling, and the like.

Chapter 2: An Introduction to Cost Terms and Purposes

Copyright © 2016 Pearson Canada Inc.19 2-12 Either a product or a service cost is the sum of the costs assigned to it for a

specific purpose. Purposes for computing a product cost include:

 Pricing and product mix decisions, which should include the costs of all value-chain functions  Contracting with government agencies, which will be defined by a contract and may include only total costs of the production business function in the value chain  Preparing GAAP-compliant financial statements for external reporting which will be defined by a contract and, because there is no inventory for the service, will exclude all inventoriable costs.

2-13 Financial accountants classify the actual or historical costs of business transactions during a specific time period in a standardized way. The costs are accumulated for only transactions in a specific classification in general ledger accounts. Management accountants are free to reclassify the reliable costs in general ledger accounts by distinguishing and including only those costs that are relevant to identifying and solving a specific cost-management problem.

EXERCISES

2-14 (10 min.) Terminology.

• Conversion costs
• fixed cost
• Inventoriable costs
• Prime costs
• Period costs
• variable cost
• Indirect
• Relevant cost

2-15 (15 min.) Inventoriable costs versus period costs.

• Spring water purchased for resale by Sobeys—inventoriable cost of a merchandising

company. It becomes part of cost of goods sold when the mineral water is sold.

• Electricity used at a Toyota assembly plant—inventoriable cost of a manufacturing

company. It is part of the manufacturing overhead that is included in the manufacturing cost of a truck finished good.

• Depreciation on Google’s computer equipment—period cost of a service company.

Google has no inventory of goods for sale and, hence, no inventoriable cost.

Instructor’s Resource Manual for Cost Accounting, Seventh Canadian Edition Copyright © 2016 Pearson Canada Inc.20

• Electricity for Sobeys store aisles—period cost of a merchandising company. It is a

cost that benefits the current period and is not traceable to goods purchased for resale.

• Depreciation on Toyota’s assembly testing equipment—inventoriable cost of a

manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a truck finished good.

• Salaries of Sobeys marketing personnel—period cost of a merchandising company. It

is a cost that is not traceable to goods purchased for resale. It is presumed not to benefit future periods (or at least not to have sufficiently reliable evidence to estimate such future benefits).

• Water consumed by Google’s engineers—period cost of a service company. Google

has no inventory of goods for sale and, hence, no inventoriable cost.

• Salaries of Google’s marketing personnel—period cost of a service company. Google

has no inventory of goods for sale and, hence, no inventoriable cost.

2-16 (15–20 min.) Classification of costs, service sector.

Cost object: Each individual focus group

Cost variability: With respect to the number of focus groups

There may be some debate over classifications of individual items, especially with regard to cost variability.

Cost Item D or I V or F A D V B I F C I V a

D I F E D V F I F G D V H I V b

a Some students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost if Buyer Research has a flat monthly charge for a line, irrespective of the amount of usage.b Gasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes, and detailed records may be required to examine how costs vary with changes in one of the many purposes served.