ACCT2112 Week 2 - Introduction to Cost Terms and Purposes PDF

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This note mentioned the detailed Manager and management accounting. It distinguishes financial accounting from management accounting. Understand how management accountants help firms make strategic decisions....

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ACCT2112 Management Accounting Week 2 An Introduction to Cost Terms and Purposes Chapter 2

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An Introduction to Cost Terms and Purposes Learning Objectives • • • • • • • • •

Define and illustrate a cost object Distinguish between direct costs and indirect costs The concepts of cost drivers and relevant range Cost behaviour patterns: variable costs and fixed costs Unit and total cost behaviour Prime costs and conversion costs Define inventoriable costs Relationships of inventoriable and period costs Preparation of schedules of cost of goods manufactured and sold

2

A Definition of Cost • Cost is defined as resources sacrificed or

forgone, usually measured in monetary terms, to achieve a specific cost object

3

What is a Cost Object?  Cost object - an activity or “thing” for which we

want to know the cost information  Products or services (e.g. computer, car, or tax

consulting fees)  Departments (e.g. production department, assemble department)

4

Uses of Cost Information • Information on cost associated with the cost

object facilitates decisions – What price should be charged for the product or

service – Which department uses its resources most efficiently

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Cost Accumulation and Cost Assignment • Cost accumulation is the collection of cost

information in some organized way by means of an accounting system • Cost assignment – Tracing accumulated costs to a cost object – Allocating accumulated costs to a cost object

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Cost Assignment to a Cost Object Cost Assignment Direct Costs

Cost Tracing

e.g. Paper on which Textbook is printed

Cost Object

Indirect Costs

e.g. Cost Accounting: A Managerial Emphasis

e.g. Rental for the printing office

Cost Allocation 7

Direct and Indirect Costs Costs

Direct Costs

Indirect Costs

Readily traceable - Trace in an economically feasible [cost effective] way (e.g. Direct materials)

Not readily traceable - cannot be traced in an economically feasible [cost effective] way (e.g. Telephone expenses)

Cost Object 8

Direct and Indirect Costs - [Cont.] • Costs can be direct in one situation and indirect in

another situation depend upon the cost object

E.g. Departmental supervisor salary: – Direct cost - if cost object is the “department” – Indirect cost - if the cost object is the “output of the

department”

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Indirect Manufacturing Costs and Other Overheads • Indirect manufacturing costs (Factory

manufacturing overheads) (FOH)

– Associated with factory or production unit (e.g. heating

and lighting of factory)

• Administrative costs – Associated with the administration of the business (e.g. telephone expenses in administrative office)

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Indirect Manufacturing Costs and Other Overheads – [Cont.]  Selling and distribution costs  Associated with acquiring orders and delivering finished goods to customers (e.g. advertising, warehousing)  Finance costs  Associated with getting funds into the business (e.g. interest expenses)

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Cost Examples  Direct costs  Parts  Assembly line wages

 Indirect costs  Electricity  Rent  Property taxes 12

Direct Materials +

SUGAR

+

FLOUR

=

Direct materials include the cost of materials in the product, less purchase discounts, plus freight and a reasonable allowance for scrap and defective units.

13

Direct Labour

Direct labour includes the cost of labour used to manufacture the product or to provide the service. 14

Indirect Materials

I ndirect materials are materials used in manufacturing that are not part of the finished product. 15

Indirect Labour

I ndirect labour includes supervision, quality control, inspection, purchasing and receiving, and other manufacturing support costs. 16

LECTURE ILLUSTRATION EXAMPLE 1 XYZ Company manufactures and retails clothing. You are required to group the costs, which are listed below into the following classifications:  a. Direct labour  b. Direct material  c. Selling and distribution costs  d. Administration costs  e. Finance costs  f. Manufacturing overhead 17

Cost Classification

1.

Lubricant of sewing machines.

2.

Interest on bank overdraft.

3.

Wages of security guards for factory.

4.

Cost of advertising products on television.

5.

Cost of raw materials.

6.

Wages of operatives in the Cutting Department.

7.

Cost of painting advertising slogans on delivery vans.

8.

Wages of fork lift truck drivers who handle raw materials.

9.

Cost of fabric used in T-shirts.

10.

Chief accountant salary. 18

What is a Cost Driver? • Cost driver - any factor whose change causes a change in total cost of a related cost object Total cost e.g., Wages paid to an account Y2 clerk

Y1

Cost driver X1

X2

e.g. number of hours worked by an account clerk 19

The Concept of Relevant Range  Relevant range  the range of activity within which management expects the

company to operate Relevant range Total cost

Y2 Y1

Cost driver X1

X2

X3

X4

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Cost Behaviour Patterns: Fixed Costs and Variable Costs  Fixed Cost  A cost which does not change in total despite changes in a cost

driver (e.g. rent, taxes and insurance) Total Fixed Cost

$Y1

Cost driver X1

X2 21

Cost Behaviour Patterns: Fixed Costs and Variable Costs – [Cont.]  Variable Cost  A cost which changes in direct proportion to a cost driver (e.g. direct materials) Total variable cost Y2

Y1

Cost driver X1

X2

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Total and Unit Costs Behaviour

Total Cost Unit Cost Behaviour Behaviour

Variable cost

“Varies”

Same

Fixed cost

“Fixed”

Change

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Total Cost Behaviour $30

Total Cost (thousands)

25 *

$25 $20 $15

13 * 9 8 * * 5 5 * * *4

$10 $5

17 * 12 * 5 *

21 20 * * 16 *

5 *

Total cost Raw materials (Variable cost) Office salaries (Fixed cost)

5 *

$0

Cost Driver 0

2

4

6

8

10

Units (thousands) 24

Unit Cost Bahaviour Cost Per Unit 4.50

$5 $4

3.25 $3

2.50

$2

2 *

$1

Total cost

2.83 2 2 * * 1.25 0.83

2.63 2.50 2 2 * *

Raw materials (Variable cost) Office salaries (Fixed cost)

0.63 0.50

$0

Cost Driver 0

2

4

6

8

10

Units (thousands) 25

LECTURE ILLUSTRATION EXAMPLE 2 XYZ Company manufactures leather belts. Relevant information as follows:  Raw material for leather $5.00 per unit  Rent $450.00 (1) When production volume = 1 unit (i.e., 1 leather belt) Total cost Behaviour $

Unit cost behaviour $

Leather (VC)

Leather (VC)

Rent (FC)

Rent (FC)

(2) When production volume = 10 unit (i.e., 10 leather belts) Total cost Behaviour $

Unit cost behaviour $

Leather (VC)

Leather (VC)

Rent (FC)

Rent (FC)

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Prime Costs and Conversion Costs • “Prime” costs – Direct material costs (DM) and direct manufacturing labour costs (DL) – Traceable to cost object • “Conversion” costs – Direct manufacturing labour costs (DL) and indirect manufacturing costs or factory overheads (FOH) – All manufacturing costs other than direct materials – Converts raw materials into finished product 27

Classifications of Costs Manufacturing costs are often combined as follows: Direct Materials

Direct Labor

Prime Cost

Factory Overhead

Conversion Cost 28

Product Costs and Period Costs • Product costs – Costs of manufacturing a company’s products – Report as either inventory (i.e., before the units are sold) or cost of goods sold (i.e., after the units are sold) • Period costs – Costs of selling and administration activities – Recognize on the income statement during the fiscal period in which they are incurred

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What are Inventoriable Costs?  Inventoriable costs  Product costs  All costs of a product that regarded as an asset when they are incurred and become cost of good sold when the product is sold

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Manufacturing, Merchandising and Service Sector Companies • Manufacturing sector companies

– Conversion of raw material into finished goods (e.g., Pepsi) – All manufacturing costs – inventoriable costs

• Merchandising sector companies

– Purchase product and sell without changing basic form (e.g., David Jones,

Target) – Costs of purchasing the goods - inventoriable costs

• Service sector companies

– Services or intangible product (e.g., Arthur Andersen, Commonwealth

Bank) – No inventoriable costs

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Comparison of Merchandising and Manufacturing Firms

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Relationships of Inventoriable & Period Costs (Manufacturing Company) BALANCE SHEET Direct materials purchases

INCOME STATEMENT

DM Inventory

Sales Revenue deduct

Other direct manufacturing Costs

WIP Inventory

FG Inventory

Indirect manufacturing costs Inventoriable costs Refer Exhibit 2-7, p. 61 of Horngren 16e

COGS (an expense) = Gross Margin deduct

When sales Occur

•Mktg exp •Admin exp •etc. = Op. Income

Period costs 33

Relationships of Inventoriable & Period Costs (Merchandising Company - Retailer or Wholesaler) BALANCE SHEET

INCOME STATEMENT Sales Revenue deduct

Merchandise Purchases

Merchandise Inventory When sales Occur

Inventoriable costs

Refer Exhibit 2-10, p. 65 of Horngren 16e

COGS (an expense) = Gross Margin deduct •Mktg exp •Admin exp •etc. = Op. Income

Period costs 34

Types of Manufacturing Inventories  Direct materials (DM)– resources in-stock

and available for use  Work-in-process (WIP) – products started but not yet completed.  Finished goods (FGS)– products completed and ready for sale 35

Cost Flows Formulae  DM (used) = DM (b/b) + DM purchases - DM

(c/b)  Total Manufacturing costs (TMC) = DM (used) + DL + MOH  COGM = WIP (b/b) + TMC - WIP (c/b)  COGS = FGS (b/b) + COGM - FGS (c/b)

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Cost Flows  The cost of goods manufactured and the cost of

goods sold section of the income statement are accounting representations of the actual flow of costs through a production system  Note how inventoriable costs to through the balance

sheet accounts of work-in-process and finished goods inventory before entering the cost of goods sold in the income statement.

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Cost flows illustrated

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Multiple-step income statement (1)

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Multiple-step income statement (2)

40

LECTURE ILLUSTRATION EXAMPLE 3 The following data are taken from the books of XYZ Company for the year 2015: REQUIRED: 1. Prepare a schedule of cost of goods manufactured for the year ended 30 June, 2015. 2. Prepare the cost of goods sold section of XYZ Company for the year ended 30 June 2015. 3. Prepare the profit and loss statement for the year ended 30 June 2015 assuming the sales revenue is $1,000,000.

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Cost incurred:

$

Purchases of raw materials 132,000 Direct labour 90,000 Advertising expense 100,000 Rent-factory building 80,000 Sales commission 35,000 Utilities-factory 9,000 Indirect labour 56,300 Maintenance-factory equipment 24,000 Supplies-factory 700 Depreciation-factory equipment 40,000 Depreciation-office equipment 8,000

July 1, 2014 $ Inventories: Raw materials

June 30, 2015 $

8,000

10,000

Work-in-process

5,000

20,000

Finished goods

70,000

25,000 42...