Cost Accounting: Chapter 3

Volume Based Cost Drivers

A cost driver is the amount produced, or quantity of service provided. Management accountants commonly call this volume or volume of output. Good examples of volume-based cost are direct materials cost and direct labor cost- these costs increase with each unit of the volume of output. Note that the three cost drivers- the output of complete units, the quantity of direct materials, and the hours of direct labor are all volume based cost drivers and are proportional to each other.

Four types of cost drivers

Activity based, volume based, structural, and executional.

Overhead/Factory Overhead

All indirect costs are commonly combined into a single cost pool called overhead, or in a manufacturing firm, factory overhead.

Period Costs

Are all non product expenditures for managing the firm and selling the product.

Executional Cost Drivers

Are factors the firm can manage in the short term to reduce costs, such as workforce empowerment, design of the production process, and supplier relationships.

Activity Based Cost Drivers

Are identified by using activity analysis- a detailed description of the specific activities performed in the firm's operations. The activity analysis includes each step in manufacturing the product or in providing the service. For each activity, a cost driver is determined to explain how the costs incurred for that activity change.

Cost Pools

Are meaningful groups into which costs are often collected.

Structural Cost Drivers

Are strategic in nature and involve plans and decisions that have a long term effect with regard to issues such as scale, experience, technology, and complexity.

Allocation Bases

Are the cost drivers used to allocate costs.

Inventory Formula

Beginning Inventory+ Cost Added=Cost transferred out+ ending inventory

Direct Cost

Can be conveniently and economically traced directly to a cost pool or a cost object.

Indirect Cost

Cannot be conveniently or economically traced to a cost pool or cost object.

Work-In-Process Inventory

Contains all costs put into the manufacture of products that are started but no complete at the financial statement date.

Product Costs

For a manufacturing firm include only the costs necessary to complete the product: direct materials, direct labor, and factory overhead.

Indirect Labor Cost

Includes supervision, quality control, inspection, purchasing and receiving, and other manufacturing support costs.

Direct Materials Cost

Includes the cost of the materials in the product and a reasonable allowance for scrap and defective units.

Direct Labor Cost

Includes the labor used to manufacture the product or to provide the service.

Cost

Incurred when a resource is used for some purpose.

Periodic Inventory System

Involves a count of inventory at the end of each accounting period to determine the ending balance in inventory.

Value Stream

Is a group of related products.

Internal Accounting Controls

Is a set of policies and procedures that restrict and guide activities in the processing of financial data with the objective of preventing or detecting errors and fraudulent acts.

Cost Driver

Is any factor that causes a change in total cost.

Cost Object

Is any product, service, customer, activity, or organizational unit to which costs are assigned for some management purpose.

Cost Allocation

Is the assignment of indirect costs to cost pools and cost objects.

Variable Cost

Is the change in total cost associated with each change in the quantity of the cost driver.

Cost of goods manufactured

Is the cost of goods finished and transferred out of the Work-in-Process Inventory account this period.

Finished Goods Inventory

Is the cost of goods that are ready for sale.

Cost of Goods Sold

Is the cost of the product transferred to the income statement when inventory is sold.

Materials Inventory

Is the cost of the supply of materials used in the manufacturing process or to provide the service.

Fixed Cost

Is the portion of the total cost that does not change with a change in the quantity of output within the relevant range.

Cost assignment

Is the process of assigning costs to cost pools or from cost pools to cost object.

Relevant Range

Is the range of the cost driver in which the actual value of the cost driver is expected to fall and for which the relationship to total cost is assumed to be approximately linear.

Total manufacturing cost

Is the sum of materials used, labor, and overhead for the period.

Mixed Cost

Is the term used to refer to total cost when total cost includes both variable and fixed cost components.

Unit Cost (Average Cost)

Is the total manufacturing cost (materials, labor, and overhead) divided by the number of units output.

Cost Drivers

Provide two important roles for the management accountant: 1) enabling the assignment of costs to cost objects. 2) explaining cost behavior: how total costs change as the cost driver changes. Generally, an increase in a cost driver will cause an increase in total cost. Occasionally, the relationship is inverse; for example, assume the cost driver is degree of temperature, then in the colder times of the year, increases in this cost driver will decrease total heating cost. Cost drivers can be used to provide both the cost assignment and cost behavior roles at the same time.

Prime Costs

Refer to direct materials and direct labor that are combined into a single amount.

Conversion Cost

Refers to direct labor and overhead combined into a single amount.

Indirect Materials Cost

Refers to the cost of materials used in manufacturing that are not physically part of the finished product.

Perpetual Inventory System

Updates the finished goods inventory account for each sales transaction.

Step Cost

Varies with the cost driver but in steps.