Cost Terms and Classifications

Learning Objectives

• Cost Object: Define and illustrate a cost object.

• Direct and Indirect Costs: Distinguish between direct costs and indirect costs.

• Cost Behavior: Explain variable costs and fixed costs.

• Unit Costs: Interpret unit costs cautiously (vs. total costs).

• Cost Classification: Distinguish inventoriable costs from period costs.

• Cost Flow: Illustrate the flow of inventoriable and period costs.

• Product Costs: Explain why product costs are computed in different ways for different purposes.

Basic Cost Terminology

• Cost: Monetary value of resources sacrificed to achieve a specific objective.

• Actual Cost: Historical costs that have already been incurred.

• Budgeted Cost: Forecasted costs estimated in advance for planning (e.g., travel plans).

Cost Object

• Definition: Anything for which a cost measurement is desired.

Cost Assignment

• Cost Accumulation: Organized collection of cost data.

• Cost Assignment Techniques:

  • Cost Tracing: Direct costs that can be easily traced to the cost object.

  • Cost Allocation: Indirect costs that are allocated systematically to the cost object.

Direct and Indirect Costs

• Direct Costs: Easily traced to a cost object (e.g., direct labor and materials).

• Indirect Costs: Cannot be easily traced and are allocated to cost objects (e.g., plant-level costs).

Challenges in Cost Allocation

• Accuracy in assigning indirect costs can be challenging; some can be reasonably allocated, while others cannot.

Factors Affecting Cost Classifications

• Materiality: Smaller costs are more likely to be classified as indirect.

• Information Technology: Improvements can influence costs classification.

• Design of Operations: Exclusivity of use makes cost tracing straightforward.

• Choice of Cost Object: A direct cost for one may be indirect for another.

Cost Behavior Patterns

Variable Costs

• Change in total with changes in production volume.

• Cost per unit remains constant regardless of production level.

Fixed Costs

• Remain unchanged in total for a specific period.

• Cost per unit decreases as production increases, spreading the fixed cost across more units.

Summary of Cost Behavior

• Variable Costs: Total costs change with output; per unit costs remain unchanged.

• Fixed Costs: Total costs remain unchanged; per unit costs decrease with more output.

Total Costs vs. Unit Costs

• Unit costs should be interpreted cautiously and generally calculated from total costs based on production levels.

Mixed Costs

• Have both fixed and variable components.

Relevant Range

• Costs are considered fixed or variable only within specific activity levels.

Relationships Between Cost Types

• Classifications: Cost can be direct/indirect and variable/fixed, leading to varied cost combinations (e.g., direct-variable, indirect-fixed).

Business Sectors

• Manufacturing Sector: Converts materials into finished goods (e.g., Tesla).

• Merchandising Sector: Purchases and sells products without changing form (e.g., Amazon).

• Service Sector: Provides intangible services (e.g., banks).

Types of Inventory

• Manufacturing Companies: Hold direct materials, work-in-process, and finished goods inventories.

• Merchandising Companies: Hold merchandise inventory in original form.

• Service Companies: Do not hold tangible inventories.

Classification of Manufacturing Costs

1. Direct Materials Costs: Acquisitions that become part of the product.

2. Direct Labor Costs: Manufacturing labor compensation directly tied to products.

3. Indirect Manufacturing Costs: Costs related to production but not easily traced.

Inventoriable Costs vs. Period Costs

• Inventoriable Costs: Capitalized as assets; expensed as COGS when products are sold.

• Period Costs: Charged as expenses in the income statement; does not include COGS.

Cost Flow for Manufacturing Companies

• Period costs are expensed as incurred; inventoriable costs flow through inventory accounts.

Prime Cost and Conversion Costs

• Prime Costs: Direct manufacturing costs (direct materials + labor).

• Conversion Costs: Total manufacturing costs minus direct materials (direct labor + MOH).

Judging and Defining Costs

• Costs defined based on specific situations; indirect overheads elaborate on rework, overtime, etc.

Different Meanings of Product Costs

• Vary based on pricing, government contracts, and financial statements adherence to GAAP.

Summary of Key Cost Classifications

1. Business Function

2. Assignment to Cost Object

3. Behavior in Relation to Activity Level

4. Total vs. Unit Cost

5. Assets vs. Expenses

Q&A

• Homework assignments noted at the end of the lecture.