COST ACCOUNTING- A MANAGERIAL

EMPHASIS, 16TH EDITION,

SRIKANT/ GEORGE/ MADHAV/
CHRISTOPHER

Chapter 2

An Introduction to Cost Terms and

Purposes
COSTS AND COST TERMINOLOGY
• Cost can be defined as a resource sacrificed or forgone to achieve a
specific objective.
• An actual cost is a historical cost or past cost.
• A budgeted cost is a predicted or forecasted cost.
• A cost object is anything for which cost data are desired-including
products, customers, jobs, and organizational subunits.
• Determining costs of a cost object includes two steps-
➢ Costs Accumulation
➢ Costs Assignment
DIRECT COSTS AND INDIRECT COSTS
• For the purpose of assigning cost to cost objects, costs are classified as:

▪ Direct Cost: A cost that can be easily and conveniently traced to a

specified cost objects. The term cost tracing is used to describe the
assignment of direct costs.

▪ Indirect Cost: A cost that can not be easily and conveniently traced to a
specified cost objects. The term cost allocation is used to describe the
assignment of indirect costs.

✓ A common cost is a cost that is incurred to support a number of cost

objects but can not be traced to them individually .

❖ A particular cost can be direct or indirect depending on the cost

object.
FACTORS AFFECTING DIRECT
/INDIRECT COST CLASSIFICATIONS
• The Materiality of the Cost in Question- The smaller the amount of
a cost, the less likely that it is economically feasible to trace the cost
to a particular cost object.

• Available Information Gathering Technology- Improvements in

information gathering technology make it possible to consider more
and more costs as direct costs.

• Design of Operations- Classifying a cost as direct is easier if a

company’s facility is used exclusively for a specific cost object.
 COST BEHAVIOR PATTERNS:
VARIABLE COSTS AND FIXED COSTS
• Cost behavior refers to how a cost reacts to changes in the level

of activity within the relevant range.

➢ Total variable costs change when activity changes.

➢ Total fixed costs remain unchanged when activity changes.

VARIABLE COST
▪ Total cost of batteries is based on the number of
autos produced in a month.
Total Cost of
batteries

Number of Autos
produced in a month
 Variable Cost
• Variable Cost Per Unit: The per unit cost of
batteries remains constant at $24.
Per Unit Cost of
Batteries

Number of Autos
produced in a month
FIXED COST
• Total cost of monthly rent is fixed for the number of lab tests
performed in a month. The monthly rent does not change based on the
number of lab tests that may be performed during the month.

Total cost of rent

Number of lab tests

performed in a month
 Fixed Cost
• Fixed Cost per Unit increases and decreases inversely and changes
in activity. For example the average cost per unit will fall as the
number of test performed increases.

Monthly Rent For the

Machine

Number of lab tests

performed in a month
 COST BEHAVIOR PATTERNS:
VARIABLE COSTS AND FIXED COSTS

• A particular cost item could be variable with respect to one level of

activity and fixed with respect to another.

• Mixed or semivariable costs have both fixed and variable

elements.

• Cost Driver is a variable, such as the level of activity or volume,

that casually affects costs over a given time span.

• Relevant Range 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.
RELATIONSHIPS OF TYPES OF COSTS
• Direct and Variable

• Direct and Fixed

• Indirect and variable

• Indirect and fixed

MANUFACTURING-,
MERCHANDISING-, AND
SERVICE-SECTOR COMPANIES
• Manufacturing-sector companies purchase materials and
components and converts them into various finished goods.

• Merchandising sector companies purchase and then sell

tangible products without changing their basic form.

• Service-sector companies provide services (intangible

products) to their customers.
TYPES OF INVENTORY
• Inventories for a manufacturing Company:

✓ Direct Materials: Materials waiting to be processed.

✓ Work in Process: Partially complete products – some material,
labor, or overhead has been added.
✓ Finished Goods: Completed products awaiting sale.

• Merchandising companies hold only one type of inventory, which is

products in their original purchased form, called merchandise
inventory.

• Service-sector companies do not hold inventories of tangible products.

 COMMONLY USED CLASSIFICATIONS
OF MANUFACTURING COSTS
Manufacturing costs can be classified into three broad
categories:
1. Direct Materials: Raw materials that become an integral part of
a cost object (work-in-process and then finished goods) and that
can be conveniently traced directly to it. For example: A radio
installed in an automobile.

2. Direct Labor: Those labor costs that can be easily traced to the
cost object. For example: Wages paid to automobile assembly
workers.
 COMMONLY USED CLASSIFICATIONS OF
MANUFACTURING COSTS

3. Indirect Manufacturing Costs: Manufacturing costs that

cannot be traced directly to specific cost object. For example:
Indirect materials and indirect labor, plant insurance, property
taxes on the plant, plant rent etc.

▪ This costs are also known as manufacturing overhead or

factory overhead costs.
INVENTORIABLE COSTS AND PERIOD
COSTS
• 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 only when the product is sold.
➢ For manufacturing companies all manufacturing costs are
inventoriable costs.
➢ For merchandising-sector companies, inventoriable costs are the costs
of purchasing the goods that are resold in their same form.
• Period costs are all costs in the income statement other than cost
of goods sold.
PRIME COSTS AND CONVERSION
COSTS

o Prime Costs are all direct manufacturing costs.

o Conversion costs are all manufacturing costs other than direct

material costs. These costs represent all manufacturing costs
incurred to convert direct materials into finished goods.
OVERTIME PREMIUM AND IDLE TIME
• Overtime premium is the wage rate paid to workers (for
direct labor and indirect labor) in excess of their
straight-time wage rates.

• Idle time is wages paid for unproductive time caused by lack

of orders, machine breakdowns, material shortages, poor
scheduling, and the like.

• Both overtime premium and idle time are usually considered

to be a part of indirect costs or overhead.