Cost-Accounting-Chapter 1 PDF

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COST ACCOUNTING Basic Concepts & Cost Behavior Analysis

Cost - is cash or cash equivalent necessary to attain an objective such as acquiring goods or services, performing a function or producing and distributing a product. Cost Accounting - is an expanded phase of financial accounting which informs management promptly with the cost of rendering a particular service, buying and selling a product, and producing a product. It is the field of accounting that measures, records and reports information about costs. Cost of Sales, Operating Expenses and Losses - Cost of sales or costs of goods sold are those production costs incurred related to the units sold. Expenses are those incurred in selling goods, distributing goods and managing a business (operating expenses). - Both costs and expenses give benefits to the business. - Losses do not give any benefit to the business. Different Costs for different purposes (Classifications of Costs) A. As to type 1. Product Costs – costs incurred to manufacture the product. Product costs of the units sold are recognized as expense (COGS) while product costs of the unsold units become the costs of inventory. 2. Period Costs – non-manufacturing costs that include selling, administrative and research and development costs. These costs are expensed in the period of incurrence and do not become part of the cost of inventory. B. As to function 1. Manufacturing Costs 2. Non-manufacturing Costs C. As to traceability 1. Direct Costs – related to a particular cost object and can economically and effectively be traced to that object. (Direct Materials and Direct Labor) 2. Indirect Costs – related to a cost object, but cannot practically, economically and effectively be traced to such cost object. Cost assignment is done by allocating the indirect cost to the related cost objects. D. For decision-making 1. Relevant Costs – future costs that will differ under alternative courses of action. 2. Differential Costs – difference in costs between any two alternative courses of action. a. Incremental Cost – increase in cost from one alternative to another. b. Decremental Cost – decrease in cost from one alternative to another. 3. Opportunity Costs – income or benefit given up when one alternative is selected over another. 4. Sunk, Past or Historical Costs – already incurred and cannot be changed by any decision made now or to be made in the future. E. As to relation to an accounting period: 1. Capital Expenditure 2. Revenue Expenditure F. As to behavior (Reaction to changes in Cost Driver) 1. Variable Cost 2. Fixed Cost a. Committed Fixed Cost b. Discretionary Fixed Cost 3. Mixed Cost Cost Behavior - refers to the way costs change with respect to a change in the activity level, such as production or sales volume, labor or machine hours, etc. There are costs which remain constant, some change directly or proportionately with the activity level, and others change in different patterns. Types of Cost 1. FIXED 2. VARIABLE 3. MIXED

Total amount Constant Increases as production increases Increases less proportionately (vs. total variable costs) as production increases

Amount per unit Decreases as production increases Constant Decreases less proportionately (vs. fixed cost per unit) as production increases

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Cost Behavior Assumptions A. Relevant Range Assumption Relevant range refers to the range of activity within which the cost behavior patterns are valid. Any level of activity outside this range may show a different cost behavior pattern. B. Time Assumption The cost behavior patterns identified are true only over a specified period of time. Beyond this, the cost may show a different cost behavior pattern. C. Linearity Assumption The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to show otherwise over the long run. Equation “Y = a + bX” Y = total costs (dependent variable) a = total fixed costs (y-intercept-vertical axis-intercept) b = variable cost per unit (slope of the line) X = activity or cost driver (independent variable) Illustration: Variable, Fixed and Mixed Costs Problem I: Caped Baldy Manufacturing Company has the following information available regarding costs at various levels of monthly production:

Direct materials Direct labor Indirect materials Supervisor’s salaries Depreciation on plant assets Maintenance Utilities Insurance on plant assets Property taxes on plant assets Totals

Production 14,000 units P 70,000 56,000 21,000 12,000 10,000 32,000 15,000 1,600 2,000 P 219,600

Volume 20,000 units P 100,000 80,000 30,000 12,000 10,000 44,000 21,000 1,600 2,000 P 300,600

Required: 1. Identify each cost as being variable, fixed or mixed cost. 2. Determine the variable cost per unit and the fixed cost per month. 3. Predict the total cost for a monthly production volume of 16,000 units. Problem II: Boros Co. manufactures and sells a single product. A partially completed schedule of the company’s total and per unit costs over a relevant range of 60 to 100 units produced and sold each year is given below: Units produced and sold 60 80 100 Total costs: Variable Fixed Total Cost per unit: Variable Fixe d

P120 600

Required: Based on the above data, 1. Complete the schedule on total and unit costs (Fill in the blanks). 2. Identify two specific costs that remain constant over the relevant range. 3. Identify two specific costs that are directly related with unit production. 4. Identify the specific cost that is inversely related with unit production.

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5. 6.

Express the cost formula based on the line equation for “Y = a + bX”. If the company produces 90 units, then the total cost is expected to be P

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Cost Estimation: Segregation of Mixed Costs into Fixed and Variable Elements 1. High-Low Method 4. Engineering Method 2. Least-Squares Method 5. Account Analysis Method 3. Scattergraph (Scatter Diagram) Method High-Low Method The fixed and variable elements of the mixed costs are computed from two sampled data points – the highest and lowest points as to activity level or cost driver. For analysis purposes, the high-low method usually produces a reasonable, not precise estimate. However, this method is criticized because it ignores much of the available data by concentrating on only the extreme points. Illustration: Separation of the Fixed and Variable Components of Mixed Costs Problem I: Machine hours and electricity costs for Tatsumaki Industries for 2019 were as follows: Month January February March April May June July August September October November December

Machine Hours 2,500 2,900 1,900 3,100 3,800 3,300 4,100 3,500 2,000 3,700 4,700 4,200

Utility Costs P 36,800 42,000 27,000 46,000 56,500 44,000 49,500 45,500 31,000 52,000 62,000 55,500

Required: Using the high-low method; 1. Compute for the variable cost per machine hour. 2. Compute the total variable cost at the highest and lowest level of activity. 3. Determine the fixed cost at each level of activity. 4. Develop an equation to determine the total cost at any level of activity. Problem II: Silverfang Company wants to conduct an analysis of the behavior of the maintenance cost of its factory equipment in relation to the number of units produced using such equipment. Historical cost and production data were gathered for the past 10 months. Month March April May June July August September October November December

Maintenance Cost P 2,750 2,250 5,000 3,500 4,000 3,250 4,500 125 2,500 3,000

Units Produced 450 200 700 700 600 400 800 25 350 300

Required: Compute for the variable maintenance cost per unit and monthly fixed cost using high-low method. Least-Squares Method Least-squares method is a statistical technique that investigates the association between dependent and independent variables. This method determines the line of best fit for a set of observations by minimizing the sum of the squares of the vertical deviations between actual points and the regression line.  If there is only one independent variable, the analysis is known as SIMPLE REGRESSION.  If the analysis involves multiple independent variables, it is known as MULTIPLE REGRESSION.

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In the method of least squares, the deviation is the difference between the predicted and actual costs. Formula: ∑y = na + b∑x ∑xy = a∑x + b ∑x² Illustration: Least-Squares Method The following activity and cost data that were provided by Atomic Corp. would help in estimating its future maintenance costs: Units Maintenance Cost 3 P 450 7 530 11 640 15 700 Using the least-squares regression method, the expected total cost for an activity level of 10 units would be: Illustration: High-Low vs. Least-Squares Method Child Emperor Company’s total overhead costs at various levels of activity are presented below: Month Machine Hours Total Overhead Costs March 500 P 970 April 400 851 May 600 1,089 June 700 1,208 The breakdown of the overhead costs in April at 400 machine hour level of activity is as follows: Supplies (variable) P 260 Salaries (fixed) 300 Utilities (mixed) 291 Total P 851 Required: 1. Determine how much of June’s overhead cost of P1,208 consisted of utilities cost. 2. Using high-low method, determine the cost function for utilities cost. 3. Using high-low method, determine the cost function for total overhead cost. 4. Using least squares method, determine the cost function for total overhead cost. 5. What would be the total overhead costs if operating level is at 450 machine hours? Scattergraph (Scatter Diagram) Method All observed costs at various activity levels are plotted on a graph. Based on sound judgment, a regression line is then fitted to the plotted points to represent the line function. Its principal advantage over the high-low method is that it considers more than two points. The major objective of this method is to develop an equation to predict future costs. Engineering Method This method is best used for estimating costs for totally new activities. It can detail each step required to perform an operation and sometimes can be quite expensive to use. Account Analysis Method Each account is classified as either fixed or variable based on experience and judgment of accounting and other qualified personnel in the organization. Conference Method Costs are classified based on opinions from various company departments such as purchasing, process engineering, manufacturing, employee relations and so on.

REVIEW QUESTIONS 1.

Cost is the monetary measure of the amount of resources given up in obtaining goods and services. Cost may be classified as unexpired or expired. Which of the following costs is not always considered to be expired immediately upon being recognized? a. Salesmen’s commission c. Cost of goods sold

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b. Depreciation expense for factory equipment

d. Salary of the company president

2.

Product costs or inventoriable costs a. are charged to expense when products become part of the FG inventory. b. include only the prime costs of producing a product. c. are treated as assets before the products are sold. d. include only the conversion costs of producing products.

3.

Product costs a. are always expensed in the same period in which they are incurred. b. are inventoriable costs. c. vary directly with changes in the cost driver. d. are always charged to an asset account in the same period in which thy are incurred.

4.

Manufacturing costs do not include a. prime costs b. conversion costs c. indirect materials d. salary of the company president, under whom is the vice president for production

5.

Direct labor cost is a a. prime cost

b. conversion cost

c. product cost

d. all of the above

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A fixed cost that would be considered a direct cost is a. salary of the sales manager when the cost object is the sales department. b. salary of the controller when the cost object is a unit of product. c. fees of the board of directors when the cost object is the production department. d. the rental cost of the finished goods warehouse when the cost object is the accounting department.

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Which of the following is a direct product cost? a. Wood in a furniture factory. b. Salary of the foreman in the assembly division of an automobile company. c. Depreciation of factory equipment. d. Salesmen’s commission

8.

The variable portion of the semi-variable cost of electricity for a manufacturing plant is a Product Cost Prime Cost Conversion Cost a. No No Yes b. Yes Yes No c. Yes Yes Yes d. Yes No Yes

9.

Depreciation computed using the straight-line method is classified as a. variable cost b. fixed cost c. relevant cost

d. opportunity cost

10. These costs are long-term in nature and cannot be eliminated even for short periods of time without affecting the profitability or long-term goals of the firm. a. Avoidable costs b. Committed fixed costs c. Variable costs d. Controllable costs

Items 11 to 13 are based on the following information: Metal Knight Company is preparing a budget for the next year and requires a breakdown of the factory maintenance cost into the fixed and variable elements. The maintenance costs and machine hours (the selected cost driver) for the past six months are as follows:

Jan Feb Mar Apr May June

Maintenance Costs P 15,500 10,720 15,100 15,840 14,800 10,600

Machine Hours 1,800 1,230 1,740 2,190 1,602 1,590

Using the high-low method, compute for the following: 11. Variable rate of maintenance cost per machine hour

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12. Average annual fixed maintenance cost 13. Average rate per hour at a level of P1,500 machine hours 14. When production (in units) decreases, the average cost per unit of product increases. This increase in the average cost per unit is due to the a. increase in variable cost per unit c. increase in total variable costs b. increase in fixed cost per unit d. increase in total fixed costs 15. The salaries of the factory janitorial and maintenance staff should be classified as a. direct labor cost b. period cost c. prime cost

d. factory overhead cost

16. Which of the following items is typically an example of an indirect cost of a cost object? a. courier charges for shipment delivery c. direct labor b. Manufacturing plant electricity d. wood used for furniture manufacturer 17. Which one of the following is a variable cost in an insurance company? a. Rent b. sales commissions c. president’s salary 18. All of the following statements are correct, except a. costs may be indirect and variable b. costs may not be indirect and fixed

d. property taxes

c. costs may be direct and variable d. costs may be direct and fixed

19. Which of the following statements would be incorrect in a manufacturing plant? a. completed goods are included in the finished goods inventory b. partially completed goods are part of the work in process category c. work in process may also be called goods in process d. materials put into product are included in the direct materials category 20. Selling and administrative costs are classified as a. period costs b. product costs

c. conversion costs

d. prime costs

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