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
Materials Labor

Product Marketing R&D Admin

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

B
Fixed

Product Marketing R&D Admin

Cost Concepts - 6

PRIOR PERIOD

COST RELATIONSHIPS: MANUFACTURING COMPANY

WIP (Beg) Direct Mat. (Beg)

Fin Goods (Beg)

+
Direct Mat. Purchases

Direct Mat. Used

+
Tot. Mfg. Costs incurred

+
Cost of Goods Mfg. Cost of Goods Sold

+
Direct labor incurred

Direct Mat. (End)

+
Overhead costs applied

WIP (End)

Fin Goods (End)

NEXT PERIOD

Cost Concepts - 7

Income Statement
Manufacturing Company
$4,000,000 Sales
Beg. Fin. Goods

$2,600,000 Cost of Goods Sold

+
$2,400,000 Cost of Goods Mfg.

=
$1,400,000 Gross Margin

End. Finished Goods

=
$2,600,000 Cost of Goods Sold

Beg. WIP + Direct Matl Used + Direct Labor + Mfg. Overhead - End. WIP

Cost of Goods Mfg.

$900,000 Other Oper.Expenses

=
$500,000 Net Income

Selling expenses
Admin. expenses Income taxes

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 Cost Behavior Patterns

Total fixed costs do not respond to changes in unit level cost drivers within a period.

Total fixed costs (Y)

0 0 Total activity (X)

Cost Concepts - 10

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

Cost Concepts - 11

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

Cost Concepts - 12

Basic Cost Behavior Patterns

Total variable costs increase in proportion to increases in unit level cost drivers.

Total variable costs (Y)

0 0 Total activity (X)

Cost Concepts - 13

Basic Cost Behavior Patterns

Total mixed costs contain fixed and variable cost elements. They increase, but not in direct proportion to increases in unit level cost drivers.

Total mixed costs (Y)

Sometimes called semivariable costs

0 Total activity (X)

Cost Concepts - 14

Basic Cost Behavior Patterns

Total step costs are constant over a range of activity for a unit level cost driver but moves to a different amount at different ranges.

Total step costs (Y)

0 0 Total activity (X)

Cost Concepts - 15

Basic Cost Behavior 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 Cost Behavior With A Single Unit Level Cost Driver

Slope, b= Y X Variable costs are layered on top of fixed costs. Total costs Y = a + bX Variable costs (b)

Total costs (Y)

Fixed costs (a) 0 0 Value of independent variable (X)

Cost Concepts - 17

Equation for Total 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 $8,000

Scatterplot Method
Important: Cost function is only relevant within relevant range

6,000

4,000

.
. .
200 400 600 Units Produced

.
Analyst can fit line based on his or her experience

2,000

800

1,000

Cost Concepts - 21

High-Low Cost Estimation

Number of Shipments
Low activity period

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

Cost Concepts - 22

High-Low Cost 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 Cost Estimation

Y = $2,000 x $2.50X

Total packing department costs

Number of shipments

Cost Concepts - 24

Composition of Manufacturing Costs

Direct materials, the cost of primary raw materials converted into finished Manufacturing overhead goods. The word direct includes all manufacturing costs indicates costs that are other than direct materials and easily or directly traced to a direct labor. finished product or service. Direct labor, the wages earned by production employees for the time they spend converting raw materials into finished products.

Cost Concepts - 25

Conventional Product Costing

Direct Materials
Traceable Direct Labor
Work in Process

Finished Goods

Indirect

Overhead to be Assigned

Cost Concepts - 26

Composition of Manufacturing Costs

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

Cost Concepts - 27

Changing Composition of Total Manufacturing 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

Possible Measures of Production Activity

Select An Appropriate Activity Base

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
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

Contemporary

Cost Concepts - 32

Impact of Computers on Manufacturing

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

Cost Concepts - 33

Impact of Computers on Manufacturing

Computer-aided design (CAD) involves the use of computers to design products.

Cost Concepts - 34

Impact of Computers on Manufacturing

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

Cost Concepts - 35

Impact of Computers on Manufacturing

In their advanced stages, factories utilizing flexible manufacturing systems and computer-integrated manufacturing Flexible manufacturing are sometimes systems (FMS) are an extension referred to as lights-out Computer-integrated factoriesbecause they can be operated of computer-aided manufacturing (CIM) is the in the dark . manufacturing techniques extension of CAD, CAM, through a seriesultimate of and FMS concepts to a completed manufacturing operations. automated and computercontrolled factory.