MA-Ch 5
Lesson 1: Types of Costs
Technical Competencies
3.3.1: Evaluates cost classifications and costing methods for management of ongoing operations.
3.3.2: Evaluates and applies cost management techniques appropriate for specific costing decisions.
Learning Outcomes
Differentiate between product costs and period costs incurred by a manufacturing business.
Describe fixed, variable, and mixed costs in the manufacturing process.
Explain how the relevant range of costs affects cost behaviour.
5.1 Types of Costs in a Manufacturing System
5.1.1 Product Costs
Product costs are all costs associated with the purchase or production of a good.
Includes:
Direct Labour: Wages paid for direct production efforts.
Direct Materials: Raw materials directly traceable to the finished product.
Manufacturing Overhead: Indirect costs allocated to production.
Forms the cost of inventory until it is sold, after which it's recorded as Cost of Goods Sold (COGS).
Importance: Accurate determination of product costs is essential for inventory valuation and financial reporting.
5.1.1.1 Prime Costs
Prime costs consist of direct costs involved in manufacturing:
Direct Materials
Direct Labour
Significant in industries where material and labour costs are substantial, e.g., food processing or crafts.
Additional resources like factory supplies can also be tracked as prime costs if deemed necessary.
5.1.1.2 Conversion Costs
Conversion costs are manufacturing costs excluding direct materials:
Direct Labour Costs
Variable Manufacturing Overhead Costs
Fixed Manufacturing Overhead Costs
Direct labour is both a prime and conversion cost due to its dual role in production.
5.1.2 Period Costs
Period costs are non-manufacturing costs and include:
Selling, administrative, and research and development costs.
Expensed as incurred and not included in inventory costs.
Management accountants often allocate costs based on activities or cost drivers where appropriate.
Terms for period costs may include operating expenses or non-manufacturing costs.
Examples
5.1a Example - Cost Classification for Troy & Troy Co.
Classification of costs incurred in June:
Commissions (Period Cost)
Wages paid (Prime and Conversion)
Rent for factory equipment (Conversion)
Steel used (Prime)
Lubricants (Conversion)
Plant manager salary (Conversion)
Quality Control (Conversion)
Freight for materials (Prime)
5.1b Example - Bahadur Co.'s Costing Data
Cost factors:
Direct materials: $776,500 (Prime).
President's salary: $150,000 (Period).
Salaries for head office: $650,000 (Period).
Wages for direct labor: $456,000 (Prime).
Factory supervisors: $234,000 (Conversion).
Indirect labor: $23,450 (Conversion).
Total Prime Costs: $1,232,500.
5.1.3 Fixed, Variable, and Mixed Costs
Fixed Costs: Remain constant regardless of activity level.
Variable Costs: Increase proportionate to changes in activity level while maintaining a consistent cost per unit within the relevant range.
5.1.4 Relevant Range of Costs
The relevant range refers to the activity levels where cost behavior remains consistent.
Costs can change once the activity levels exceed this range.
Lesson 2: Cost Function and Estimating Costs
5.2 Cost Function
Cost Function Equation: A mathematical relationship depicting how costs behave in relation to activity level.
Total product costs include fixed and variable components.
5.2.1 Cost Function and Behaviour
Cost behavior changes based on unit volume, affecting total and average costs.
5.2a Example - Cost Analysis of Speed Co.
Overview of Direct Materials, Direct Labour, and Fixed Costs.
5.3 Estimating Costs
5.3.1 High-Low Method
Simple method to estimate cost functions based on the highest and lowest activity levels.
Steps involve determining variable cost, fixed cost, and final cost function.
5.4 Cost Terms Used in Planning and Control
5.4.1 Controllable vs Non-Controllable Costs
Controllable costs can be changed by management; non-controllable costs cannot be adjusted in the short term.
Relevant in performance evaluation and responsibility accounting.
5.4.2 Discretionary, Committed, and Engineered Costs
Discretionary costs are incurred at management's discretion (e.g., advertising).
Committed costs are due to past commitments (e.g., lease payments).
Engineered costs are driven directly by production levels.
5.5 Cost Terms Used in Decision-Making
5.5.1 Relevant Information
Quantitative and qualitative factors that influence decision-making processes.
Relevant revenues and costs that differ based on alternatives considered.
5.6 Job Costing
5.6.1 Job Costing System Definition
Method for tracking costs associated with specific jobs.
5.7 Application of Job Costing
5.7a Henry Co.'s Custom Chair Manufacturing
Overhead estimation using direct labour hours as a cost driver.