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Cost assignment refers to the general case of assigning costs to cost pools or
cost objects. When there is a direct and traceable link between the cost and the
cost pool or cost object, then the management accountant traces that cost to the
cost pool or cost object. When there is an indirect link between the cost and the
cost pool or cost object, then the management accountant uses cost allocation.
Cost allocation uses cost drivers to assign the cost.
3-2
Direct costs can be physically identified with and/or traced to the cost object
because there is a direct causal link between them. Indirect costs cannot be
traced to each cost object. Direct costs for a manufactured product include the
materials (called direct materials) which are part of the product and the labor
(called direct labor) which is used to assemble the product. Indirect costs include
the machinery, plant and other labor necessary to manufacture the product, but
which is not directly traceable to the product, such as labor for inspection and
supervision.
3-3
All direct costs are variable by definition since they can be directly traced to the
cost object, and thus must vary with the cost driver.
3-4
All fixed costs must be indirect, since the increase in the cost driver or volume of
output does not affect the level of fixed cost.
3-5
A cost driver is any activity that has the effect of changing the level of total cost.
3-6
Variable costs are those for which total cost changes with each change in the
cost driver. Fixed costs are the portion of total cost which remains constant as
the cost driver changes.
3-7
A step-fixed cost varies with the cost driver, but in discrete steps. Costs remain
fixed over narrow ranges of the cost driver. However, total costs increase by a
constant amount at set intervals. Examples of step-fixed costs are the costs for
certain clerical tasks, order filling, and other administrative tasks. At specific
levels of the cost driver, an additional clerk must be added. Therefore, total costs
increase by a constant amount at these points.
3-1
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3-8
The relevant range is the range of the cost driver for which total cost is
approximately linear. The relevant range is used to provide a useful range of
activity for the cost driver in which it can be assumed that variable costs will be
constant per unit of the cost driver. This is an assumption since the behavior of
actual costs is likely to be non-linear (see Exhibit 3-6) over the range of the cost
driver. The concept of the relevant range allows the management accountant to
use the concept of constant unit variable cost for a defined range of operations,
even though actual unit variable costs change over the entire range of the cost
driver.
3-9
Conversion costs are the sum of direct labor and overhead costs. Prime costs
are the sum of direct materials and direct labor.
3-10 Average cost can be misleading unless the activity level (denominator) is known.
Because average cost includes a fixed cost component, it will be different at each
possible activity level. The term average cost is meaningless if the denominator
is unknown. An increase in volume does not increase total cost by the amount of
the increase in volume multiplied by total unit cost; total cost increases by the
increase in volume multiplied by the unit variable cost.
3-11
3-12 Unit cost is the additional cost that is incurred as the cost driver increases by one
unit.
3-13 Product costs are costs which are capitalized as assets, or inventoried. They are
referred to as manufacturing costs in manufacturing firms and merchandise
inventory in merchandising firms. Period costs are expensed as they are
incurred because there is no expectation that they will provide any future benefit
to the firm. Since period costs are not directly or indirectly related to the
production process, they are sometimes called non-manufacturing costs.
3-14 Cost of goods manufactured is the cost of the units produced this period and
transferred into finished good inventory. Cost of goods sold is the cost of the
units sold this period. Cost of goods sold will differ from cost of goods
manufactured because of changes in finished goods inventory. If finished goods
inventory is very nearly the same from the beginning to the end of the period,
then cost of goods sold and cost of goods manufactured will be very nearly the
same.
3-2
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Indirect labor includes labor that is used in the manufacturing process but cannot
be traced to each product as it is produced; indirect labor includes supervision,
inspection (by batch, because inspection of each and every product would be a
variable cost), training, etc.
3-3
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BRIEF EXERCISES
3-21
3-22 We start with the cost object, which in this case could be the item of merchandise
sold. Then the variable costs are the cost of merchandise and the selling costs
for the cashiers and restocking. For a large discount retailer, most other costs
will be driven by the number of hours open each week, and the variety of
merchandise handled.
For other types of retailers (not discounters), sales
commissions might be an applicable variable cost.
3-23 The cost object for a movie theater could be the number of films being shown, or
the number of screens. The cost of renting the movie from the film producer is
the main cost. The key driver of revenue (not cost) is the number of ticket
holders for ticket revenue and also revenue from sales of food and beverages.
Some costs will also be driven by the number of ticket holders, such as the cost
of food and beverages. The cost of staff is likely to be a step cost, which
depends on the expected number of ticket holders for each different day in the
week, and time of day. Other facilities costs are likely to be fixed for the number
of ticket holders, or number of films being shown.
3-24
The cost object here is more readily identified the beer product, whether
measured in individual bottles or larger quantities. The variable costs will be
significant here, including the ingredients that go into the brewing of beer. Other
costs for the brewery are likely to be fixed for this cost object, but there are
important activity costs which will vary with, for example, the number of
customers/distributors (delivery and account management costs), the number of
different types of beer, or the complexity of the brewing process for the brewery
(a brewery that specializes in the more expensive beers require more costly
ingredients, processing time, and different packaging).
3-4
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3-25 Here it is plausible to consider the individual lesson as the cost object. Variable
costs would include that portion of the trainers pay which is based on each
lesson (the salary portion of the trainers pay would be fixed for this cost object).
Other variable costs could include any materials that are used for each lesson,
and perhaps the travel cost to each client, if the company reimburses the trainers
for miles traveled.
3-26 $200 + $13,400 -$400 = $13,200
3-27 $2.6 + $10 = $12.6 million
3-28 $66,000 + $98,000 +($22,000 - $1,000) - $2,000 = $183,000
3-29 $400,000 + $1,600,000 - $200,000 = $1,800,000 cost of goods sold
3-30 Period cost includes interest, advertising, and office expense: $4,000 + $2,500 +
$14,000 = $20,500
3-5
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EXERCISES
3-31 Fares and Fees in the Airline Industry (15 min)
Very much like the consumer products industry (Procter & Gamble as an
example) introduced at the start of the chapter, the airline industry is
characterized by a high degree of complexity in pricing both fares and
fees.
1.
It is likely most will argue that the airline industry is a cost leadership
industry. Most passengers look for the lowest price ticket and see
very little difference between airlines in terms of quality, reliability, or
service. On the other hand, airlines would very much like to build a
brand loyalty by providing certain free services and customer
service. Whether this will work is a good question for class
discussion. One point that should arise in the discussion is to
determine whether the airline business is a commodity business.
Can a customer differentiate the different carriers?
Another issue is the airlines desire for more control over the
purchasing of tickets. Could this approach help them develop a
brand, or simply add to the complexity and frustration of the
consumer? On the other hand, some travel analysts have
questioned the impartiality of the available Web sites passengers use
to purchase tickets; arguments of this nature could drive the
development of new search engines and away from airlines that did
not participate in trusted, independent Web search sites. If the
number of Web sites increases, as some in the travel industry expect,
then it is likely to place more price pressure on the airlines and
reinforce the commodity view of the industry.
3-6
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-7
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-8
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-10
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Cost Object
1 product line or
customer
2 product line or
customer
3 product line
4 product line
5 customer order
6 customer order
7 customer order
8 customer order
9 each customer
10 customer order
11 not allocated
12
not allocated
Cost Driver
trace to product line, or each custom order
requiring design
trace to product line, or each custom order
requiring testing
product line
number of purchase orders
trace directly to customer
trace directly to customer
trace directly to customer
trace directly to customer
trace directly to customer
trace directly to customer
cannot be traced to product or customer; must be
allocated using some reasonable method, for
example, number of units produced
cannot be traced to product or customer; must be
allocated using some reasonable method, for
example, the number of units produced
3-11
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3-12
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$30.00
7.50
$ 22.50
3-13
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-14
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3-15
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-16
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fixed
variable
mixed
mixed
variable
mixed
mixed
fixed
variable
variable
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-20
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-21
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This example illustrates that two companies that may have the same total
variable costs, and facing the same changes in materials or labor costs, will
be affected differently if the mix of variable costs are not the same for the
two companies.
This example is sometimes called the fallacy of averages. The takeaway is that averages should be interpreted carefully, and in particular, the
management accountant should always consider the components of cost
which make up that average, as in the example above.
3-22
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-23
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
2. Pet Partner could use the information to identify costs that are
traceable to each customer (the direct costs) and determine over a
period of a month (or year) whether the direct costs traced to the
customer are less than or greater than the revenues from the
customer, that is, to determine if the customer is profitable or not. A
much more thorough means of determining customer profitability
analysis is covered in chapter 5, together with activity-based costing.
3-24
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Product (P) or
Period (PD)
N*
N*
N*
F
V
7. Advertising
8. Discount coupons
9. Food handling licenses,
inspections, and fees
10. Accounting and payroll services
11. Cooking supplies
12. Cleaning supplies
13. Mortgage payments
14. Insurance on facilities
F
V
F
PD
PD
P
P
P/PD (allocated to kitchen
and other space)
PD
PD
P
F
V
V
F
F
PD
P
P
PD
PD
*Note for Class Discussion: these costs are fixed unless Papas manager
schedules drivers, operators, and cooks so as to eliminate slack time, in
which case the cost of the drivers, operators, and cooks could be
considered variable costs
3. There are a number of possible answers. Inefficiency and waste in
the use of utilities or food products could be considered an
environmental issue. Also, cleaning supplies should be
environmentally-friendly and/or disposed of properly.
3-25
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
1.Technicians
2.Parts
3.Purchase of oil and tires
4.Supplies
5.Tools
6.Rental of each location
7.Advertising
8. Utilities
9.Licenses and fees
10.Employee training*
11.Security service
12. Software for sales and reports
13. Disposal of waste oil and used
tires
Fixed(F) or
Variable (V)
Product (P)
Period (PD)
F
V
V
V
F
F
F
F
F
F
F
F
V
P
P
P
P
P
PD
PD
PD
PD
P
PD
PD
PD
3-26
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
PROBLEMS
3-52 Executional Cost Drivers: Internet Retailer (20 min)
The example of an internet retailer such as Bikes.com is a good
example of the type of firm that must pay close attention to
executional cost drivers. The reason is that its success depends on
customer service prompt response to customer requests, and
prompt and accurate filling of customer orders. Customer loyalty is a
key success factor for a firm such as this, and loyalty comes from
superior customer service in all its dimensions. Amazon.com
introduced the successful internet retailing business model, and has
built a successful business on the basis of customer loyalty. This is
the approach Bikes.com needs to follow and this means execution,
execution, execution. The fall off in sales growth could be an
indication of problems in customer sales returns, that is customer
satisfaction and loyalty. Bikes.com can review sales records to
investigate.
Specific executional steps that Bikes.com can take include
looking for possible improvements in the purchase and stocking of
merchandise and the shipping of customer orders the upstream and
downstream activities that must work smoothly to get the orders to
the customers quickly and accurately. Also, Bikes.com should
consider the work flow in the company. Can it be streamlined? Are
there non-value-adding activities that can be eliminated? What are
the bottlenecks, if any, that slow the process of accurately filling a
customers order? Also, are employees aware of the importance of
executional issues? Are the employees working together to achieve
the required speed and accuracy necessary for the firms success?
Executional cost drivers are important to Bikes.com in two
ways. First, these are the executional issues which the firm must
achieve in a superior way in order to compete effectively in internet
retailing. And second, effective attention to the cost drivers and
effective cost management can lower the costs of operation and
speed the arrival of profits.
3-27
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3-28
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3-29
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3-30
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3-31
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3-32
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3-35
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3-58(continued -1)
3-36
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