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FULL COST AND

THEIR USES
F A I S A L A R S YA (1706131654)
R I A N DY A R R A S Y I D (1706131875)
S I S PA N U R A D I A N A (1706131944)
COST

• Cost is a measurement
– in monetary terms, of the amount of resources used for some
purposes
• The notion that cost measures the use of resources
• Cost measurements are expressed in monetary terms
• Cost measurement always relates to a purpose
COST OBJECT
• Technical name for the product, project, organizational unit, or
other activity or purpose for which costs are measured
• Can be defined as broadly or as narrowly as one wishes
– Entire production run of jeans and one pair of jeans.
• In a service organization a variety of cost object definitions is
possible
– The hospital as a whole, the nursing staff, the X-ray department, the
emergency room, the personnel office, the cardiovascular ward,
treatment of a type of disease, care of an individual patient, or the
performance of a certain battery of blood tests
FULL COST

• All the resources used for a cost object


• In some circumstances full cost is:
– easily measured : If Ms. Chen pays $35 for a pair of jeans at a
store, $35 is the full cost of the pair of jeans
to Ms. Chen
– more difficult : Jeans manufacturing
DIRECT AND INDIRECT OF COST OBJECT
Items of costs that are specifically traced to, or caused by,
that cost object.
Direct Denim used in manufacturing of jeans & the earnings of the
employees who worked directly in one batch is a direct cost
of that batch of jeans

Elements of costs that are associated with, or caused by, two


or more cost objects jointly but that are not directly traced
to each of them individually.
Indirect Indirect costs of a batch of jeans include the factory
manager’s salary and insurance on the factory building and
equipment
ELEMENT OF PRODUCT COST
Direct
labor
cost Inven-
Conver-
• The system that sion cost tory
cost*

Full Cost
accumulates and
reports the costs of
Over-
product cost objects = head
Direct
product costing system cost
material
cost
Selling
cost

General &
administrative
*Or full production cost cost
DIRECT MATERIAL COST

• Quantities of material that can be specifically identified with a cost


object in an economically feasible manner
– Usually priced at unit price of material
• Also know as raw materials
• Supplies are indirect material
DIRECT LABOR COST

• The labor quantities that can be specifically identified with a cost


object in an economically feasible manner
– Usually priced at unit price of labor
• Example:
– The earnings of workers who assemble parts into a finished good or
operate machines in its production
– The cost of a technician’s time spent repairing an automobile
OVERHEAD COST

• All production costs other than direct costs are included in


overhead cost
• Examples:
– supervisors, janitors, materials handlers, stockroom personnel,
inspectors, and crane and forklift operators
– heat, light, power, maintenance, depreciation, taxes, and insurance
related to assets used in the production process
CONVERSION COST

• The sum of direct labor cost and overhead cost is conversion cost
– It includes all production costs needed to convert direct materials into
finished goods
• As factories become automated, the distinction between direct labor
and
• indirect labor becomes blurred. As a result, some companies no longer
distinguish between direct labor and overhead cost; instead, the single
category of conversion cost is used
FULL PRODUCTION COST

• The sum of direct material cost and conversion cost is full


production cost.
• In a manufacturing, full production cost often is called inventory cost
• In financial accounting these full production costs that flow through
inventory accounts are called product costs
– which do not flow through inventory accounts but rather are
charged as expenses of the period in which they are incurred
• Direct materials + direct labor + overhead.
NON PRODUCTION COST

 Also called period costs


 All costs incurred in an organization other than inventory costs
 Include selling costs, research and development costs, general and
administrative costs, and interest costs
 In a manufacturing firm, selling costs include both marketing (order-getting)
costs and logistics (order-filling) costs
CYCLE OPERATION (MANUFACTURING)
1. $52,000 of materials were purchased on open account, $20,000 of various other
assets were purchased for cash, and $60,000 of accounts payable were paid.
Dr: Materials Inventory 52,000
Cr: Accounts Payable 52,000
Dr: (Other Asset and Liability Accounts) 20,000
Cr: Cash 20,000
Dr: Accounts Payable 60,000
Cr: Cash 60,000
2. Direct materials costing $49,000 (principally felt tips, plastic, ink, and wicks) were
withdrawn from inventory and sent to the factory to be converted into pens
Dr: Work in Process Inventory 49,000
Cr: Materials Inventory 49,000
CYCLE OPERATION (CONT.)
3. During the month direct labor employees converted this material into pens. The
$20,000 that they earned adds to the amount of Work in Process Inventory, and the
resulting liability increases Wages Payable
Dr: Work in Process Inventory 20,000
Cr: Wages Payable 20,000
4. Overhead (indirect production) costs amounting to $27,000 were incurred during the
month. Of the total $10,600 was documented by current invoices for such things as
rent, electricity, and telephone bills, so the offsetting credits were to Accounts Payable.
Indirect labor and supervision costs were $11,000, with the offsetting credit to Wages
Payable. All of items are here summed up in Overhead, but in practice they are usually
recorded in separate indirect cost accounts, one for each type of cost
Dr: Overhead 27,000
Cr: Wages Payable 11,000
(Other Asset and Liability Accounts) 16,000
CYCLE OPERATION (CONT.)
5. Factory employees (direct and indirect) were paid $32,000 cash.
Dr: Wages Payable 32,000
Cr: Cash 32,000
6. Since the overhead costs incurred during the month are a part of the cost of the pens
worked on during that month, at month-end the total overhead cost incurred is
transferred to Work in Process Inventory.
Dr: Work in Process Inventory 27,000
Cr: Overhead 27,000
7. Pens whose total cost was $110,000 were completed during the month and
transferred to Finished Goods Inventory.
Dr: Finished Goods Inventory 110,000
Cr: Work in Process Inventory 110,000
CYCLE OPERATION (CONT.)
8. Pens with a cost of $115,000 were sold during the month. These pens were removed
from inventory and shipped to customers.
Dr: Cost of Sales 115,000
Cr: Finished Goods Inventory 115,000
9. For these same pens, sales revenue of $180,000 was earned; this is recorded in the
accounts as a credit to Sales Revenue and a debit to Accounts Receivable.
Dr: Accounts Receivable 180,000
Cr: Sales Revenue 180,000
10. Accounts receivable collected during the month amounted to $150,000.
Dr: Cash 150,000
Cr: Accounts Receivable 150,000
CYCLE OPERATION (CONT.)
11. During the month $30,000 of selling and administrative (period) expenses were incurred.
Dr: Selling and Administrative Expense 30,000
Cr: (Other Asset and Liability Accounts) 30,000
12. Since SGA expenses are always applicable to the current period, the Selling and Administrative
Expense account is closed to the Income Summary account.
Dr: Income Summary 30,000
Cr: Selling and Administrative Expense 30,000
13. The balances in the Sales Revenue and Cost of Sales accounts are also closed to Income
Summary. The $30,000 balance in Income Summary then reflects pretax income for the period.
Dr: Sales Revenue 180,000
Cr: Income Sumary 180,000
Dr: Income Summary 115,000
Cr: Cost of Sales 115,000
NON MANUFACTURING COST
• The guiding principle remains the same: The full cost of a cost object
is the sum of its direct costs plus an equitable share of indirect costs.
• Merchandising companies.
– Since cost of goods sold is invoice cost, only requires simple system
(relative to manufacturing company).
• Service organizations.
– Cost object is “job” ( “vehicle” in a auto repair shop, “client” for an
law office), job cost record kept for each job.
– Cost record serves as work in process inventory account for that
particular job
NON PROFIT ORGANIZATION
• Organization whose primary objective is something other than
earning a profit.
– Most nonprofit organizations provide services rather than
manufacture tangible goods
• Cost object is programs not products.
• Similar cost accounting practices to profit organizations.
– Both nonprofit and profit-oriented organizations use resources
– Both cases the problem of cost measurement is to identify the
amount of resources used for each of the various cost objects that
the organization has
USES OF FULL COST

Determine cost of inventory and cost of sales.


Financial
reporting
Measure the income of the principal segments of the
business.

Entire business and parts of the business (e.g.,


product, product line, plant, division, sales territory,
Analysis of etc.).
profitability
Direct costs and an appropriate share of the indirect
costs of a part can be determined.
USES OF FULL COST (CONT.)
Answered by measuring the full cost of the cost
object.
“What did it
cost?” The method to be used in the contract must be
spelled out in some detail so as to avoid
misunderstanding

Many prices are set not by the forces of the


Setting marketplace but by regulatory agencies.
Regulated
Prices (such as the Federal Communications Commission or
state public utility or insurance commissions)
USES OF FULL COST: PRODUCT PRICING
• Cost measurements are used in arriving at the price of differentiated
products
– A differentiated product is a product that consumers prefer over
competing products
• Normal pricing
– Recover direct costs, recover applicable indirect costs, make a
satisfactory profit.
– Applicable for differentiated products
– For undifferentiated products (example: commodities), price set by
market.
USES OF FULL COST: PRODUCT PRICING (2)
• Time and material pricing
– In this method of setting prices, one pricing rate is established for direct labor
and a separate pricing rate for direct material
– Used by repair shops, physicians, lawyers, consultants, etc.
– Time component is expressed as a labor rate per hour, which is calculated as
the sum of
(1) Direct salary and fringe benefit costs of the employee
(2) An equitable share of all indirect costs, except those related to material
(3) An allowance for profit. In professional-service firms this rate is usually
called a billing rate.
USES OF FULL COST: PRODUCT PRICING (3)
• Adjusting cost to price
– The process works in reverse
• The selling price that is believed to be the best from the standpoint of
competitive strategy is taken as a given
• The problem then is to determine how much cost the company can
afford to incur if it is to earn a satisfactory profit at the given price.

TARGET COSTING
• First set price based on competitive strategy, then product is designed
to cover full cost and profit.
USES OF FULL COST: PRODUCT PRICING (4)

• Importance of timely cost data


– The relevant cost data are current costs and estimates of near-term
future costs
– Consider inflationary times
– Every year hundreds of businesses (most of them small) go bankrupt
because their managers did not know the current costs of producing the
firms’ goods or services and hence set inadequate prices