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Cost Overview And Terminology
I. Cost/Managerial Overview
It has evolved due to changes in the environment and the needs of the firms.
Firms need information about all activities in the value chain that affect production costs.
Note: An emphasis only on manufacturing no longer suffice.
Quality and time.
Because of rapid technological change and shorter product life cycles, new products and services must be delivered more quickly, and firms must exact flexibly change.
- Real-time monitoring, control, and reporting.
- Better quality and scheduling.
- Lower inventories and costs.
- Small-lot production of customized goods.
Demand pulls units through production, and each operation’s output consists only of what is demanded by the next operation.
Inventory is reduced or eliminated, the output should be defect-free, and the process must be reorganized or improved.
Activity-based management.
It is based on activity-based costing (ABC) and process value analysis.
It emphasizes many activities that cause consumption of resources or costs.
Process value analysis is a systematic understanding of the activities involved in making a product or rendering a service.
Note: It identifies activities that add value and eliminate those that are non-value added.
II. Cost/Managerial Accounting
Financial accounting primarily relates to 1). historical accounting, and 2). external financial reporting to creditors and shareholders.
Managerial accounting applies primarily to the planning and controlling organizational operations, considers non-quantitative information, and is usually less precise than cost accounting or financial accounting.
- Internal and external reporting objectives.
- Product costing.
- Assessment of department efficiency.
- Inventory valuation.
- Income determination.
- Planning, evaluating, and controlling operations.
The cost-benefits analysis indicates the benefits of changing to a new accounting system exceed its cost.
- The unique aspect of job-order costing is identifying costs to specific units or particular jobs.
- The job-order costing system of accounting is appropriate when products have varied characteristics or when identifiable groups are possible.
Educating users.
Activity-based costing (ABC).
Cycle-time costing.
- Collects financial and operating data on the basis of the underlying nature and extent of the cost drivers.
- Identifies the casual relationship between the insurance of costs and activities.
- Determines the cost driver for each activity.
- Applies costs to products on the basis of resources (drivers) consumed.
Total quality management.
- Costs are accumulated by processes rather than by jobs, work-in-process is stated in terms of equivalent units, and unit costs are established.
- Process costing is an averaging process that calculates the average cost of all units.
Just-in-time manufacturing.
- Perpetual inventory records provide continuous record-keeping of the inventory quantities, and it requires a journal entry every time items are added to or taken from inventory.
- The periodic system relies on physical counts to determine quantities.
Controllers are usually in charge of budgets, accounting, accounting reports, and related controls.
Treasurers are involved with control over cash, receivables, short-term investments, financing, and insurance.
III. Cost Definitions
Life-cycle costing estimates a product’s revenue and expenses over its expected life.
Upstream, manufacture, and downstream costs.
Because as a result, price products to cover all costs, not just production.
Note: Also, life-cycle costing highlights upstream and downstream costs in the cost planning process that often receive insufficient attention.
Life-cycle is useful when revenues and related costs do not occur in the same periods.
- To simply costing procedure and expedite cost reports.
- To prepare budgets.
- To help measure over-and under-applied overhead.
- To differentiate the expected costs from the actual cost.
- To identify deviation from expected or attainable results on a routine basis.
The potential effect on the decision.
Incremental cost or differential cost.
Opportunity cost.
Information economics applies to cost-benefit analysis of obtaining information for decision-making.
Markov analysis is useful when a problem involves a variety of states of nature, and the probability of moving from one state to another depends only on the current state.
Regression analysis.
The cost of direct labor and overhead costs to convert the materials into a finished product.
Indirect costs.
Controllable costs.
The committed costs are those for which management has made a long-term commitment.
Note: Typically result when firm hold fixed assets. Typically it is a fixed cost.
Examples: Long-term lease payments, depreciation, property, plant, and equipment.
Engineered costs.
Incremental costs or differential costs.
Direct material and direct labor costs.
Because total overhead costs usually contain both fixed and variable indirect costs.
A cost of carrying inventory.
A sunk cost is a past cost or a cost that the entity has irrevocably committed to incur.
Avoidable costs.
Discretionary costs.
Examples: R&D, advertising, and promotion costs.
IV. Cost of Goods Manufactured And Sold
Purchase + beginning inventory + freight-in – ending inventory.
Material + direct labor + overhead.
Actual overhead (debit)- overhead applied (credit)= If it is (- or credit=overapplied) or (+ or debit =under-applied)
COGM = beginning work-in-process + direct material + direct labor + overhead – ending work-in-process.
Because the net method is preferable to recording inventories as payable at gross amounts, the net amounts are the most accurate exchange price.
The discounts not taken will be recorded as losses in the income statement.
Cost of goods manufactured (COGM).
Merchandise inventory or goods held for resale account.
V. Variable vs. Fixed Costs
Total variable costs vary directly with activity but are fixed per unit within a given range. Whereas fixed costs remain unchanged within the relevant range for a given period despite fluctuations in activity, but per-unit, fixed costs do change as the level of activity.
Sales revenue minus all variable costs.
- Vary inversely with the activity level when stated on a per-unit-basis.
- A unit fixed cost equals total fixed costs divided by an appropriate denominator or activity level.
The relevant range is the range of activity over which unit variable costs and total fixed costs are constant.
Select the product that has the greater contribution margin per hour of manufacturing capacity.
A marginal cost is incurred by producing and/or selling an additional unit.
Note: Marginal cost excluding fixed costs in product cost.
Average costs per unit.
As production levels increase, total fixed costs are allocated over more units.
The economist’s marginal cost is costs to produce one additional unit excluding fixed costs. Whereas, the accountant’s unit cost includes allocation of fixed costs to the unit of productions for financial statements purposes.
Note: Marginal costs are equivalent to the accountant’s unit variable cost, which is also an incremental unit cost.
VI. Product vs. Period Costs
The inventories represent future economic benefits.
Product costs are properly assigned to inventory when incurred, whereas period costs are always expensed in the same period in which they are incurred.
Because overhead costs are allocated to all products produced, they are not identifiable or traceable to specific products instead of direct materials and direct labor.
Revenue expenditures and capital expenditures.
Revenue expenditures are charged to the income statement in the period the costs are incurred and capital expenditures are initially recorded as assets and then charged to expense as they are consumed, used, disposed of.
They are not inventorable because they are not sufficiently identifiable with specific production.
Indirect cost or overhead cost is not directly traceable to a specific unit of production. The overtime premium and idle time are considered indirect or overhead costs because the occurrence resulted from an abnormal volume of work and is thus borne by all units produced.