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    Chapter 5 An Introduction To Cost Terms and Purposes

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    Gosaye Desalegn
    This document provides an overview of key cost accounting concepts and terminology: 1. Cost accounting provides managers with the cost of producing and selling products and services. It involves accumulating and assigning costs. 2. Costs are resources sacrificed or forgone to achieve an objective and are usually measured monetarily. Direct costs can be traced to a specific cost object, while indirect costs are assigned using allocation methods. 3. Variable costs change with activity volume while fixed costs remain constant over a relevant range of activity. Cost drivers are the variables that influence costs, such as production hours affecting labor costs.

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    Chapter 5 An Introduction To Cost Terms and Purposes

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    Gosaye Desalegn
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    This document provides an overview of key cost accounting concepts and terminology: 1. Cost accounting provides managers with the cost of producing and selling products and services. It involves accumulating and assigning costs. 2. Costs are resources sacrificed or forgone to achieve an objective and are usually measured monetarily. Direct costs can be traced to a specific cost object, while indirect costs are assigned using allocation methods. 3. Variable costs change with activity volume while fixed costs remain constant over a relevant range of activity. Cost drivers are the variables that influence costs, such as production hours affecting labor costs.

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    Chapter 5 An Introduction to Cost Terms and Purposes

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    This document provides an overview of key cost accounting concepts and terminology: 1. Cost accounting provides managers with the cost of producing and selling products and services. It involves accumulating and assigning costs. 2. Costs are resources sacrificed or forgone to achieve an objective and are usually measured monetarily. Direct costs can be traced to a specific cost object, while indirect costs are assigned using allocation methods. 3. Variable costs change with activity volume while fixed costs remain constant over a relevant range of activity. Cost drivers are the variables that influence costs, such as production hours affecting labor costs.

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    Download as docx, pdf, or txt
    137 views4 pages

    Chapter 5 An Introduction To Cost Terms and Purposes

    Uploaded by

    Gosaye Desalegn
    This document provides an overview of key cost accounting concepts and terminology: 1. Cost accounting provides managers with the cost of producing and selling products and services. It involves accumulating and assigning costs. 2. Costs are resources sacrificed or forgone to achieve an objective and are usually measured monetarily. Direct costs can be traced to a specific cost object, while indirect costs are assigned using allocation methods. 3. Variable costs change with activity volume while fixed costs remain constant over a relevant range of activity. Cost drivers are the variables that influence costs, such as production hours affecting labor costs.

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    Chapter 5

    An Introduction to Cost Terms and Purposes

    Management accounting is a discipline that includes almost all manipulations of financial


    information for use by managers. It includes the discipline of cost accounting Cost
    accounting provides management and others with the cost of producing and/or selling each
    product and rendering a particular service.

    Costs and Cost Terminology

    A cost is a resource sacrificed or forgone to achieve a specific objective. A cost (such as the
    cost of labor or advertising) is usually measured as the monetary amount that must be paid to
    acquire goods or services. An actual cost is the cost incurred (a historical or past cost), as
    distinguished from a budgeted cost, which is a predicted, or forecasted, cost (a future cost).

    When you think of a cost, you invariably think of it in the context of putting a price on a
    particular thing. We call this “thing” a cost object, which is anything for which a cost
    measurement is desired. Examples of cost objects are products, services, activities,
    processes, and customers.

    How does a cost system determine the costs of various cost objects?

    Typically in two stages: accumulation followed by assignment. Cost accumulation is the


    collection of cost data in some organized way by means of an accounting system.
     Collects (accumulates) in various categories the costs of different types of materials,
    different classifications of labor, the costs incurred for supervision, and so on.
    managers use this cost information in two main ways: (1) when making decisions, for
    instance, about how to price different models of products/services or how much to invest in
    R&D and marketing and (2) for implementing decisions, by influencing and motivating
    employees to act, for example, by providing bonuses to employees for reducing costs.

    Direct Costs and Indirect Costs

    Direct costs of a cost object are related to the particular cost object and can be traced to it
    in an economically feasible (cost-effective) way. For example, the cost of steel or tires is a
    direct cost of marathon care. The term cost tracing is used to describe the assignment of
    direct costs to a particular cost object.
    Indirect costs of a cost object are related to the particular cost object but cannot be traced
    to it in an economically feasible (cost-effective) way. For example, the salaries of plant
    administrators (including the plant manager) who oversee production of the many different
    types of cars produced at the marathon car plant are an indirect cost of marathon cars.
    The term cost allocation is used to describe the assignment of indirect costs to a particular
    cost object. Cost assignment is a general term that encompasses both (1) tracing direct
    costs to a cost object and (2) allocating indirect costs to a cost object.

    Cost Assignment to a Cost Object

    Facto
    rs Affecting Direct/Indirect Cost Classification

     The materiality of the cost in question. The smaller the amount of a cost—that is,
    the more immaterial the cost is—the less likely it is economically feasible to trace it
    to a particular cost object.
     Available information-gathering technology.
     Design of operations. Classifying a cost as direct is easier if a company’s facility (or
    some part of it) is used exclusively for a specific cost object, such as a specific
    product or a particular customer.
    Be aware that a specific cost may be both a direct cost of one cost object and an indirect cost
    of another cost object That is, the direct/indirect classification depends on the choice of the
    cost object.
    Cost-Behavior Patterns: Variable Costs and Fixed Costs

    Variable costs—change in total in proportion to changes in the related level of activity or


    volume of output produced. Fixed costs—remain unchanged in total, for a given time period,
    despite changes in the related level of activity or volume of output produced. Costs are fixed
    or variable only with respect to a specific activity or a given time period
    Variable costs are constant on a per-unit basis. If a product takes 5 pounds of materials
    each, it stays the same per unit regardless if one, ten, or a thousand units are produced.
    Fixed costs per unit change inversely with the level of production. As more units are
    produced, the same fixed cost is spread over more and more units, reducing the cost per unit.
    Other Cost Concepts
    A cost driver is a variable, such as the level of activity or volume that causally affects costs
    over a given time span. An activity is an event, task, or unit of work with a specified purpose
    —for example, designing products, setting up machines, or testing products.
    The level of activity or volume is a cost driver if there is a cause-and-effect relationship
    between a change in the level of activity or volume and a change in the level of total costs.
    For example, if product-design costs change with the number of parts in a product, the
    number of parts is a cost driver of product-design costs. Similarly, miles driven are often a
    cost driver of distribution costs.
    The cost driver of a variable cost is the level of activity or volume whose change causes
    proportionate changes in the variable cost. For example, the number of vehicles assembled is
    the cost driver of the total cost of steering wheels. If setup workers are paid an hourly wage,
    the number of setup hours is the cost driver of total (variable) setup costs.
    Costs that are fixed in the short run have no cost driver in the short run but may have a cost
    driver in the long run.
    In the long run, volume of production is indeed a cost driver of testing costs. Costing systems
    that identify the cost of each activity such as testing, design, or setup are called activity-based
    costing systems.
    Relevant Range
    Relevant range is the band or range 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. For
    example, a fixed cost is fixed only in relation to a given wide range of total activity or
    volume (at which the company is expected to operate) and only for a given time span (usually
    a particular budget period).
    The relevant range also applies to variable costs. Outside the relevant range, variable costs,
    such as direct materials costs, may no longer change proportionately with changes in
    production volumes. For example, above a certain volume, the cost of direct materials may
    increase at a lower rate because a firm may be able to negotiate price discounts for
    purchasing greater amounts of materials from its suppliers.
    Total Costs and Unit Costs
    Unit Costs
    A unit cost, also called an average cost, is calculated by dividing the total cost by the related
    number of units produced.

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