BUAD 281 Chapter 1, 2: Cost Concepts

Manufacturing Cost Relatioships

DM + DL = Prime Costs DL + MOH = Conversion Costs All costs involved in turning raw materials into the final product DM + DL + OH = Total Manufacturing Costs (product cost) Total overhead --> VC OH + FC OH total --> FC SGA is NOT in OH (period cost)

Non-Manufacturing Production Costs

Notice that service firms can have direct material and direct labor costs just as manufacturing firms do. These costs can be traced to the company's service outputs, so they comprise part of the Operating Expenses that match with the Operating Revenues from the sale of services (see Exhibit 2-3). But as noted earlier, they are not product costs but rather they are period costs that are recorded in the accounting period of the expenditure. The reason? Services cannot be inventoried for future sale like a tangible product, so their costs don't flow though the work-in-process and finished-goods inventory accounts like products do.

Cost Information

Profit = Revenue - Cost Cost information is essential for many aspects of managing and organizing businesses: - Determining pricing and production volumes - Making investment decisions - Planning resource requirements (materials, labor, etc.) ==> Determining costs typically requires making estimates. - sacrifice made to achieve particular purpose - can have different meanings depending on the context - may be appropriate for one use but inappropriate for another

Which of the following inventories would a discount retailer report as an asset? Raw Materials WIP FG Merchandise Inventory All of the above

Retailers purchase their merchandise inventories from wholesalers, who get the inventory from manufacturers. Merchandise Inventory

Manufacturing Cost Example

Suppose the cost object is Boat A (two boats assembled) 1. Wages of employees who built Boat A - DL 2. Cost of aluminum mast installed in Boat B - DM 3. Wages of factory supervisor - OH 4. Cost of renting factory - OH 5. Depreciation on power tools use to build the sailboats - OH **If only assembled one boat instead of two, everything would be a DIRECT cost (since we know it's all going exclusively to this one boat)

Step Fixed Costs

Costs that remain the same over a wide range of activity, but jump to a different amount outside that range, are known as:

Accounting for Manufacturing Costs

Accounting for manufacturing costs involves three primary inventory (balance sheet) accounts: 1. Raw Materials inventory (RM) Any materials included in final product (raw lumber to make desk) --> Direct Material Costs Direct material costs are computed using the raw materials (RM) inventory account: Direct material cost = Beginning RM Inv - Ending RM Inv + Purchases -Purchase of raw materials are not product costs -Product costs are only recorded when materials are consumed/used up in production 2. Work in Process inventory (WIP) Production that is only partially complete and not yet ready for sale DM, DL, MO is all incorporated into work in process inventory --> Cost of Goods Manufactured (COGM): cost when going from work in process to finished goods Cost of goods manufactured (COGM) is computed using the work in process (WIP) inventory account COGM = Beginning WIP Inv - Ending WIP Inv + DM Cost + DL Cost + MOH Cost 3. Finished Goods inventory (FG) Completed production that is ready for sale but is not yet sold At time of sale: cost of goods is transferred from finished goods to COGS --> Cost of Goods Sold (COGS): cost of desks you actually sold (the 60 desks you sold out of 100 produced) Cost of goods sold (COGS) is computed using the finished goods (FG) inventory account COGS = Beginning FG Inv - Ending FG Inv + COGM

3. Traceability

Can the cost be traced to a specific cost object? Direct costs can be traced directly and completely to a specific cost object in a cost-effective manner Indirect costs cannot be traced directly and completely to a specific cost object Can be referred to as overhead costs Indirect cost is allocated or assigned to a cost object Indirect costs dominate the cost structure → helium is indirect cost in blowing up balloons (Ralphs used to blow up balloons for free - can't add up cost of using helium) Ex. In a competitive business (surgery): Mark ups are huge usually (surgery costs $10k to do, but cost $50k on average to public with markup) → you can be more competitive by making your mark up smaller than your competitors Indirect costs: VCR carts, unnecessarily costly bone cement, delays dispatching physical therapists to get patients moving, etc. (it's not feasible to follow employees around all the time)

Cost vs. Cost Object

Costs are any resources sacrificed or consumed to achieve a specific objective Once you use something up it's a cost Cost object is anything of interest for which a measure of cost is desired Anything you want to know the cost of - particular product to which a cost is assigned to

Manufacturing Goods

Direct Materials (DM) Raw materials that can be easily traced to each product Direct Labor (DL) Labor costs that can be easily traced to each product The cost of fringe benefits associated with any labor spending classified as direct labor should also be classified as direct-labor costs. Fringe benefits include the costs of providing health insurance, making pension and social security contributions, and other non-salary benefits provided by the employer to the employee. - plant supervisor, material guards, corporate executive are NOT DL, production supervisor salary is in OH Manufacturing Overhead (MOH or OH) All other costs required to product the product but cannot be easily traced - Depreciation of building and equipment, property taxes, insurance, and utilities such as electricity, as well as the costs of operating service departments. - Other manufacturing overhead costs include overtime premiums and the cost of idle time. Includes indirect labor: --> The cost of materials that are required for the production process but do not become an integral part of the finished product are classified as indirect material - Factory equipment is NOT part of MOH

2. Cost Behavior

Does the cost depend on the same cost driver? --> relationship between cost and activity Cost driver is a something that "causes" the total amount of a cost to change. - The simplest and most common cost driver is volume (units sold/produced) - costs may be classified as variable or fixed Variable Costs -Total variable costs (VC) increase as volume increases -We will typically assume variable costs change proportionally to changes in volume If you increase volume... Total cost will increase Variable cost PER unit → stays the same (constant inclining slope) (VC/unit → horizontal line graph (slope is the same)) - Variable costs are constant on a per-unit basis and they change in total as activity changes. Fixed Costs -Total fixed costs (FC) do not change as volume changes -FC/unit can change as volume increases or decreases -Capacity cost (renting warehouse for space - overall one cost) (FC/Unit → downward sloping curve (as volume increases)) Per-unit fixed costs can be misleading because such amounts appear to behave as variable costs when, in actuality, the amounts are related to fixed expenditures. --> Book Total Cost = Total Variable Cost + Total Fixed Cost Total Cost = VC/unit x Units + Total FC Total cost/unit = VC/unit + Average FC/unit

Costs can be classified based on:

Financial statement treatment → is the cost capitalized or expensed immediately? Behavior → does the cost depend on some cost driver? What makes this cost move around A cost driver is a characteristic of an activity or event that causes costs to be incurred Traceability → can the cost be traced to a specific object? Relevance → is the cost economically relevant to decision-making?

1. Financial Statement Treatment

Is the cost capitalized or expensed immediately? Product (inventorial cost or cogs) are all costs incurred manufacturing a product or providing a service Ex. wage of someone building desk, labor costs, depreciation on equipment being used - Product costs are initially recorded as inventory and expensed as cost of goods sold (COGS - cost to make the good sold ==> NOT AN INVENTORIABLE COST, COGS is an expense - Do not record as an expense until it's "used" (you eat the food or you sell the item) - Ex. iPhone 7 costs $800 - product cost (left out all period costs) Be careful when looking at how much it costs to build something (may be leaving some costs out) - at the time of a sale cost of goods are transferred from finished goods to COGS All other costs are period costs - Period costs are expensed immediately (typically as selling and administrative (S&A) expense) Ex. engineering, administrative, marketing costs Services cannot be inventoried for future sale like a tangible product, so their costs don't flow though the work-in-process and finished-goods inventory accounts like products do - All research and development, selling, and administrative costs are treated as period costs. - Selling costs include salaries, commissions, and travel costs of sales personnel, shipping costs incurred by a manufacturer, and the costs of advertising and promotion - Administrative costs refer to all costs of running the organization as a whole. The salaries of top-management personnel and the costs of the accounting, legal, and public relations activities are examples of administrative costs. - period costs DO NOT include inventoriable cost or COGS REMEMBER: *period costs will show up on I/S as an expense regardless of whether the company sells anything*

4. Relevance

Is the cost economically relevant to decision-making? Relevant costs: a future cost that differs among alternatives Opportunity costs are benefits sacrificed by taking one action instead of another (ex. cost of office space for sales personnel) Opportunity costs are not necessarily out-of-pocket costs (those that consume cash or other resources) Relevant --> Photo: The $15,000 in rental cost for sales office space is an opportunity cost. It measures the opportunity cost of using the former sales office space for raw-material storage. Differential (or incremental) costs are the difference in costs between alternative actions Cost differs under two alternative actions What changes? (what costs that vary are relevant?) - Only look at costs that vary to increase efficiency Relevant Sunk costs are costs that have occurred in the past and cannot be changed by future actions (development costs, market study costs) --> cannot get your money back Irrelevant --> should be ignored when choosing among alternatives (compared to opportunity costs, out of pocket costs, or relevant costs which should be considered) Marginal costs are the incremental costs of producing one additional unit or providing one additional service Marginal costs are one type of incremental cost. Average costs (per unit) are total costs divided by the number of units produced or number of services provided

Managerial Accounting

Managerial accounting provides information that helps managers make sound business decisions. One important piece of information is the costs of the goods and services that firms produce for their customers. Managerial accounting supports three primary management activities: -Planning -Decision-making -Control Internal managers vs. external parties (financial acct) Future oriented No GAAP or other standards Objective of influencing behavior of employees Role: Managerial Accountants collect data and provide information so that decisions can be made and often serve as a cross-functional team member, making a wide range of decisions. --> Book An accounting information system should be designed to provide information that is useful. To be useful the information must be: relevant, accurate, and timely.