COST TERMINOLOGY AND COST BEHAVIORS

13 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

COST TERMINOLOGY AND COST BEHAVIORS

QUESTIONS

• The term cost is used to refer to so many different concepts that an adjective must be

attached to identify which particular type of cost is being discussed. For example, there are fixed costs, variable costs, period costs, product costs, expired costs, and opportunity costs, to name just a few.

• A cost object is anything for which management wants to collect or accumulate costs.

Before a cost can be specified as direct or indirect, the cost object must be identified.Since direct costs must be conveniently and economically traceable to the cost object, not knowing what the cost object in question is would make it impossible to identify direct costs. For example, if multiple products are made in the same production area, the salary of the area’s manager would be direct to the production area but indirect to the different products. Indirect costs must be allocated in some rational and systemat- ic manner to the cost object.

• The assumed range of activity that reflects the company’s normal operating range is

referred to as the relevant range. Outside the relevant range, costs may be curvilinear because of purchase discounts, improved worker skill and productivity, worker crowding, loss in employee efficiency during overtime hours, etc. Although a curvi- linear graph is more indicative of reality, it is not as easy to use in planning or con- trolling costs. Accordingly, accountants choose the range in which these fixed and variable costs are assumed to behave as they are defined (linear) and, as such, repre- sent an approximation of reality.

• It is not necessary for a causal relationship to exist between the cost predictor and the

cost. All that is required is that there is a strong correlation between movement in the predictor and the cost. Alternatively, a cost driver is an activity that actually causes costs to be incurred.

The distinction between cost drivers and predictors is important because it relates to one of the objectives of managers: to control costs. By focusing cost control efforts on cost drivers, managers can exert control over costs. Exerting control over predic- tors that are not cost drivers will have no cost control effect.

• A product cost is one that is associated with inventory. In a manufacturing company,

product costs would include direct material, direct labor, and overhead. In a merchan- dising company, product costs are the costs of purchasing inventory and the related freight-in costs. In a service company, product costs are those costs that are incurred to generate the services provided such as supplies, service labor, and service-related overhead costs.

Cost Accounting Foundations and Evolutions 9th Edition Kinney Solutions Manual Visit TestBankDeal.com to get complete for all chapters

14 Chapter 2

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

In all three types of organizations, a period cost is any cost that is not a product cost.These costs are noninventoriable and are incurred in the nonfactory or nonproduction areas of a manufacturing company or in the nonsales or nonservice areas, respective- ly, of a retailer or service company. In general, these costs are incurred for selling and administrative activities. Many period costs are expensed when incurred, although some may be capitalized as prepaid expenses or other nonfactory assets.

• Conversion costs are all production costs other than direct material costs; thus, con-

version costs include the costs of direct labor and manufacturing overhead. These items are called conversion costs because they are needed to convert direct material into a salable product.

• Factory overhead has been growing most rapidly because of the costs of technology.

This cost category includes depreciation of factory and plant equipment, machinery maintenance cost, repair cost, some training costs, utilities expense to operate the ma- chinery, and many costs related to quality control.

• The only difference between the two systems is in their treatment of overhead. Under

an actual cost system, actual overhead is added to production. Because actual over- head cannot be determined until the period ends, the overhead allocation occurs and product cost can be determined only at period-end. Under a normal cost system, a predetermined overhead rate is calculated before a period begins and is then used to apply overhead to products as production occurs.

The major advantage of using a normal cost system is that it allows a product’s cost to be determined (estimated) at the time of production. Another major advantage is that a normal cost system provides a product cost that is stable across fluctuating lev- els of production and sales.

• The cost of goods manufactured is the total production cost of the goods that were

completed and transferred to Finished Goods Inventory during the period. This amount is similar to the cost of net purchases in the cost of goods sold schedule for a retailer. Since CGM is used in computing cost of goods sold, it appears on the income statement.

Chapter 2 15

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

EXERCISES

• a. Direct
• Direct
• Direct
• Indirect
• Direct
• Direct
• Indirect
• Direct
• Direct

11. COST OBJECT

Notebook Plant Touch pad and buttons Direct Direct Glue Indirect Direct Network connector Direct Direct Battery Direct Direct Paper towels used by line employees Indirect Direct AC adapter Direct Direct CD drive Direct Direct Motherboard Direct Direct Screws Indirect Direct Oil for production machinery Indirect Direct

12. COST OBJECT

Kennedy Tax Services Firm

• Four hours of Perkins’s time Direct Unrelated Direct
• Six hours of assistant’s time Direct Direct Direct
• Three hours of Morris’s time Indirect Indirect Direct
• Eight hours of CPE for Tompkin Indirect Direct Direct
• One hour at lunch Unrelated Unrelated Unrelated
• Two hours of Perkins’s time Direct Unrelated Direct
• One-half hour of Tompkin’s time Direct Direct Direct
• Janitorial wages Indirect Indirect Direct
• Seven hours of Tompkin’s time Direct Direct Direct

• a. Cardboard, $0.40; cloth, $1; plastic, $0.50; depreciation, $0.60; superviors’ sala-

ries, $1.60; and utilities, $0.30; total cost, $4.40.

• Cardboard, variable; cloth, variable; plastic, variable; depreciation, fixed; supervi-

sors’ salaries, fixed; and utilities, mixed.

• If the company produces 10,000 caps this month, the total cost per unit will in-

crease. The variable costs (cardboard, cloth, plastic) will remain constant per unit.The total cost for depreciation and supervisors’ salaries will remain fixed, and,

16 Chapter 2

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

thus, will result in a higher cost per unit. The utility cost will go down in total but, because it is mixed, it is impossible (without other information) to estimate its total or per-unit cost. Without knowing the cost formula for utility costs, it is impossible to determine the total cost of making 10,000 caps.

• a. and b.

Per Unit Per Set Cardboard boxes ($1,000  2,000) $0.50 $ 0.50 Mallets ($12,000  4,000) 3.00 6.00 Croquet balls ($9,000  12,000) 0.75 4.50 Wire hoops ($3,600  24,000) 0.15 1.80 Production worker wages ($8,400  2,000) ? 4.20 Supervisor’s salary ($2,600  2,000) ? 1.30 Building and equipment rental ($2,800  2,000) ? 1.40 Utilities ($1,300  2,000) ? 0.65 Total $20.35

• Estimated cost per set in March is

Cardboard boxes ($1,000  2,000) $ 0.50 Mallets ($12,000  4,000; $3  2) 6.00 Croquet balls ($9,000  12,000; $0.75  6) 4.50 Wire hoops ($3,600  24,000; $0.15  12) 1.80 Production worker wages ($8,400  2,000) 4.20 Supervisor’s salary ($2,600  2,500) 1.04 Building and equipment rental ($2,800  2,500) 1.12 Utilities ($1,400  2,500) 0.56 Total $19.72

• a. Total fixed cost $ 37,500

Total variable cost (15,000 tickets  $10) 150,000 Total cost $187,500

• Total cost $187,500

Desired profit margin (15,000 tickets  $8) 120,000 Total sales price $307,500 Divided by assumed number of tickets sold ÷ 15,000 Selling price per ticket $ 20.50

• Total revenue (5,000 tickets  $20.50) $102,500

Total cost:

Fixed $37,500 Variable (5,000  $10) 50,000 (87,500) Net profit $ 15,000