Chapter 2

Why do managers consider direct costs to be more accurate than indirect​ costs?

1) When costs are​ allocated, managers are less certain whether the cost allocation base accurately measures the resources demanded by a cost​ object, and​ therefore, direct costs are considered to be more accurate. 2) Allocating indirect costs is more subjective and generally more difficult to assign to a cost object than are direct costs.​ Therefore, direct costs are deemed by managers to be more accurate costs than indirect costs. 3) Cost​ tracing, which is used when assigning direct costs to a particular cost​ object, is more accurate than cost​ allocation, which is used to assign indirect costs to the same cost object.

Define product cost. Describe three different purposes for computing product costs.

A product cost is the sum of the costs assigned to a product for a specific purpose. Purposes for computing a product cost include​ (1) pricing and product mix​ decisions, (2) contracting with government​ agencies, and​ (3) preparing financial statements for external reporting under GAAP.

Prime costs

All direct manufacturing costs. (DM+DL)

Conversion costs

All manufacturing costs other than direct material costs. (DL + MO)

Manufacturing overhead costs

All manufacturing costs related to the cost object but cannot be traced to the cost object.

inventoriable costs

Are all costs of a product that are considered as assets in the balance sheet when they are incurred and that become cost of goods sold when the product is sold. (total manufacturing costs incurred in the period)

Revelant Range

Band of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost in question Within the range, total fixed cost does not change

Direct manufacturing-labor costs

Compensation of all manufacturing labor that can be traced to the cost object.

Design costs and​ R&D costs are not considered product costs for financial statement purposes. When might some of these costs be regarded as product​ costs? Give an example.

Contracting with government agencies. For​ example, if the Air Force negotiated to contract with a company to build a new type of supersonic fighter​ plane, design costs and​ R&D costs may be included in the contract as product costs.

Direct material costs

Costs of all materials that can be traced to the cost object.

What are three different types of inventory that manufacturing companies​ hold?

Direct​ materials (Raw material), work-in-process, and finished goods

Why must unit costs often be interpreted with​ caution?

Unit costs are computed by dividing some amount of total costs by the related number of units. In many​ cases, the total costs include a fixed cost that will not change despite changes in the number of units.​ Therefore, it can be misleading to multiply the unit cost by activity or volume change to predict changes in total costs at different activity or volume levels.

Cost object

anything for which a separate measurement of costs is desired. Examples include a​ product, a​ service, and a customer.

Period Costs

are all costs in the income statement other than cost of goods sold. They are treated as expenses of the accounting period in which they are incurred. Ex. design costs, marketing, distribution, customer service costs, etc

inventoriable costs and period costs.

are all costs of a product that are considered as assets in the balance sheet when they are incurred and that become cost of goods sold when the product is sold. Period costs are all costs in the income statement other than cost of goods sold.

Direct Cost

are related to the particular cost object and can be traced to that cost object in a​ cost-effective way

Indirect Cost

are related to the particular cost object but cannot be traced to that cost object in a​ cost-effective way.

Period Cost

are treated as expenses of the accounting period in which they are incurred because they are expected to not benefit future periods.

Cost Driver

a​ variable, such as the level of activity or​ volume, which causally affects total costs over a given time span. A change in the cost driver results in a change in the level of total costs. For​ example, the number of vehicles assembled is a driver of the costs of steering wheels on a​ motor-vehicle assembly line.

Variable Cost

changes in total in proportion to changes in the related level of total activity or​ volume, such as a sales commission that is a percentage of each sales revenue dollar.

What is the relevant​ range? What role does the​ relevant-range concept play in explaining how costs​ behave?

is the band of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost in question. Costs are described as variable or fixed with respect to a particular relevant range.

Factors affecting the classification of a cost as direct or indirect include

materiality of the​ cost, available​ information-gathering technology, and design of operations.

Service Companies

provide services or intangible products to their​ customers, for example legal advice or accounting firm

Merchandising Companies

purchase and then sell tangible products without changing their basic​ form, for example retail stores and distribution companies

Manufacturing Companies

purchase materials and components and convert them into various finished​ goods\ (DM, DL, MO) automotive companies and textile companies

Fixed Cost

remains unchanged in total for a given time​ period, despite wide changes in the related level of total activity or​ volume, such as a fixed annual leasing cost of a machine.