Chapter 2

An introduction to Cost Terms, Concepts, and Classifications

• What is costs? Give examples on costs.

• A cost object is anything for which cost data are desired – including products, product lines, customers, jobs and organizational subunits.

• Why is it very important to know the costs according to a cost object? Who determines the selling price?

• Cost classifications Income statement (showing the profit) Behaviour – variable or fixed Assigning costs to cost object as departments or

products – direct or indirect Making decisions

MegaLoMart

Comparing Merchandising and Manufacturing Activities

Merchandisers . . . Buy finished goods. Sell finished goods.

Manufacturers . . . Buy raw materials. Produce and sell

finished goods.

Costs classification: Income statements (absorption costing)

The Product (cost object)The Product (cost object)

DirectMaterials

DirectMaterials

DirectLabourDirectLabour

ManufacturingOverhead

ManufacturingOverhead

Manufacturing or product Costs

Direct Materials

Those materials that become an integral part of the product and that can be conveniently traced directly

to it.

Example: A radio installed in a carExample: A radio installed in a car

Direct Labour

Those labour costs that can be easily traced to individual units of product.

Example: Wages paid to car assembly workersExample: Wages paid to car assembly workers

Manufacturing Overhead

Absorption Costing: Cost classification

in connection with income statement

• Manufacturing costs = Direct labour + direct materials + manufacturing overhead

• Gross margin = sales – manufacturing costs

• More details about the method in chapter 6

Cost Classifications for Predicting Cost Behaviour

Contribution margin = sales – variable cost

How a cost will react to changes in the level of

business activity.

A variable cost is constant per unit of activity but change when activity changes.

A fixed cost is constant in total for changes in activity within the relevant range.

How a cost will react to changes in the level of

business activity.

A variable cost is constant per unit of activity but change when activity changes.

A fixed cost is constant in total for changes in activity within the relevant range.

Cost Classifications for Predicting Cost Behaviour

Behaviour of Cost (within the relevant range)

Cost In Total Per Unit

Total variable cost changes Variable cost per unit remainsVariable as activity level changes. the same over wide ranges

of activity.

Total fixed cost remains Fixed cost per unit goesFixed the same even when the down as activity level goes up.

activity level changes.

Cost BehaviourFixed costs are usually characterised by:

a. Unit costs that remain constant.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Cost Behaviour

Variable costs are usually characterised by: a. Unit costs that decrease as activity

increases.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Categories the following costsVariable costs Fixed costs

Materials

Depreciation Yes

Leasing cost Yes

Salary Yes

Wages labour Yes

Insurances Yes

Semi-manufactured Yes

Maintenance Yes

Marketing Yes

Rent Yes

Administration Yes

Heat Yes

Categories the following costs

  E2-4 p. 46 Cost  Behavior

  Cost item Variable Fixed1 X-ray film used in the radiology lab Yes2 The costs of advertising a rock concert Yes3 Depreciation on the a restaurant building Yes4 The electrical costs of running a roller coaster Yes5 Property taxes on your local cinema Yes6 Commission paid to salespersons at McGraw-Hill Yes7 Property insurance on a Coca-Cola bottling plant Yes

8The costs of synthetic materials used to make Nike running shoes Yes

9The costs of shipping Panasonic televisions to retail stores Yes

10The cost of leasing an ultra-scan diagnostic machine at a hospital Yes

Cost classifications for assigning costs to cost objects such as departments or

products

Direct costs•Costs that can beeasily and conveniently traced to a unit of product or other cost objective.

•Examples: direct material and direct labour.

Indirect costs•Costs cannot be easily and conveniently traced to a unit of product or other cost object.

•Example: manufacturing overhead.

Cost classifications for making decisions – Differential Costs and Revenues

Costs and revenues that differ among alternatives.

Differential revenue is: £2,000 – £1,500 = £500

Differential cost is:£300

Example: You have a job paying £1,500 per month in your hometown. You have a job offer in a neighboring city that pays £2,000 per month. The commuting cost to the city is £300 per month.

Example: You have a job paying £1,500 per month in your hometown. You have a job offer in a neighboring city that pays £2,000 per month. The commuting cost to the city is £300 per month.

Cost classifications for making decisions –

opportunity costs

• Opportunity Costs.The potential benefit that is given up when one alternative is selected over another.

•Example: If you werenot attending university,you could be earning£15,000 per year. Your opportunity costof attending university for one year is £15,000.

Cost classifications for decisions making – Sunk Costs

• Sunk costs: Historical costs, cannot be changed by any decision. They are not differential costs and should be ignored when making decisions.

Example: You bought a car that cost £10,000 two years ago. The £10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the £10,000 cost.

            Period     Cost identifikation     Product cost     (Selling      Variable Fixed Direct Direct Mfg. and Admin. Opportu- SunkName of the cost P2-8 Cost Cost Materials Labour Overhead Cost) nity cost costRental revenue foregone £30,000/year Yes Direct material cost, £80/unit Yes Yes Rental cost warehouse £500/month Yes Yes Rental cost equipment, £4,000/month Yes Yes Direck labour cost £60/unit Yes Yes Deprecialtion annex space, £8,000/year Yes Yes YesAdvertising cost, £50,000/year Yes Yes Supervisor´s salary, £1,500/month Yes Yes Electricity machines, £1.20/unit Yes Yes Shipping cost, £9/unit Yes Yes Return earned on investment, £3,000/year Yes

Problem 2-10 s. 49 – production 2 000 unit/year

  Cost behaviour   Product costCosts Variable Fixed S&A Direct IndirectDirect labour production £118,000 £118,000Advertising £50,000 £50,000Factory supervision £40,000 £40,000Property taxes, factory £3,500 £3,500Sales commissions £80,000 £80,000Insurance factory £2,500 £2,500Depreciation office equipment £4,000 £4,000Lease cost factory equipment £12,000 £12,000Indirect materials factory £6,000 £6,000Depreciation factory building £10,000 £10,000General office supplies (billing) £3,000 £3,000General office salaries £60,000 £60,000Direct materials used £94,000 £94,000Utility factory £20,000 £20,000 321,000 182,000 197,000 212,000 94,000

Problem 2-10(2)

Produktion unit/year 2.000Product costs $/unitDirect (212,000/2,000) $106Indirect (94,000/2,000) $47Total $153Required 3.Product costs per unit increase. Reason : fixed costs are allocated to fewer units.

Production= 1,000. Calculate the total production costs £/unit. :

Total production costs £/unit = 200 (106+(94,000/1,000))

Exercise Zenith

• Go to Blackboard and opload: • Zenith Business Eco. autumn 2012 • Zenith Business Eco.templet students

autumn 2012

• Solve the following problems:• 1: Job order costing alternativ I• 2: Job order costing alternativ II

End of Chapter 2