‘This is the first of four chapters that describe the construction and use of fall cost information—the type cof management accounting information used for many cost measurement purposes. Iti discussed fist because financial accounting (the subject of Part 1 ofthis book) uses full cost information; full cost ac- counting thus provides a bridge between financial and management accounting. Moreover, the calest ‘management accounting systems focused on the collection and reporting of fll cost information. ‘Apart from its use in financial accounting, full cost accounting information is useful to managers. The ‘most important use isto help set selling prices for goods and services, including prices set by contractas the sum of full costs plus a specified profit. ‘This chapter introduces full cost concepts and describes in general how full costs are recorded ina cost accounting system. It also discusses the uses of full cost information. How direct and indirect costs ‘are measured for the costing of products and how this information can be analyzed to aid in controling costs are described in more detail in subsequent chapters. Cost Concepts Cost is the most slippery word in accounting; it is used for many different notions. If someone says, without elaboration, “The cost of a widget is $1.80,” it is impossible to understand exactly what is ‘meant. The word cost becomes more meaningful when preceded by a modifier in phrases such as direct cost, full cost, opportunity cost, or differential cost. However, even these phrases do not convey a clear ‘meaning unless the context in which they are used is clearly understood. General To understand cost, we begin with a broad definition: Cost is a measurement, in Definition monetary terms, of the amount of resources used for some purpose. This definition includes three important ideas. First and most basi is the notion that cost measures the use of resources. The cost elements of producing a tangible good or intangible service are physical quantities of materia, hours of labor service, and quantities of other resources. Cost measures how ‘many, ot how much, of these resources were used. The second idea is that cost measurements are expressed in monetary terms. Money provides a common denominator that permits the amounts ofindividual resources, each measured according to its own scale, to be combined so that the total amount. ofall resources used can be determined. Five pounds of material and one hour of labor cannot be added together to produce a meaningful total; but if the amounts are converted to money at, say, $2 per pound for material and $17 per hour for labor, they can be added to produce a total cost of $27. Third, cost mea- surement always relates to a purpose, These purposes include products, departments, projects, or any other thing or activity for wich a monetary measurement of resources used is desired. [Post object” Cost object is the technical name forthe produc, project, organizational unt, or . ‘other activity or purpose for which costs are measured. (Some people prefer cost ob- {estive.) In each instance, the cost object must be carefully stated and clearly understood. In a blue jeans factory for example, the manufacture of a batch composed of four dozen pairs of Style 607 jeans may be one cost object, the mamafacture of one batch of Style 608 jeans may be another, and the manufac- ture and sale ofa batch of Style 607 jeans may be still another. ‘Acost object can be defined broadly or narrowly. Atone extreme all the jeans manufactured in a jeans factory ina given time period could be considered asa single cost object. But ifsuch a broad definition \wete used, differences in the resources used forthe various styles of jeans would not be measured. Atthe other extreme, each individual pair of jeans manufactured could be considered as a single cost object. But if such a narrow definition were used, the amount of recordkeeping involved in measuring costs ‘would be tremendous. As it happens, many jeans factories use a baich of a single style and material as the unit of costing. Although different sizes of jeans use slightly different amounts of materials, usually the cost object definition does not differentiate among sizes of the same material. For example, one batch of Style 703 corduroy jeans, waist 32”/inseam 31”, would not be a different cost object from one batch of Style 703 corduroy jeans, waist 34”/inseam 32”. Similarly, ina service organization, a variety of cost object definitions are possible. Ina hospital, for ‘example, any ofthe following could be cost objects: the hospital asa whole, the nursing staf, the X-ray department, the emergency room, the personnel office, the cardiovascular ward, treatment of a type of lisease, care of an individual patient, or the performance ofa certain batery of blood tests. Full Cost Full cost means all the resources used for a cost object. In some circumstances, full cost is easily measured. If Ms. Chen pays $35 fora pair of jeans at a store, $35 is the full cost ofthe pair of jeans to Ms. Chen because she used $35 of her resources to ac~ ire the pair of jeans. But suppose we ask: What was the full cost of producing the pair of jeans? This is amuch more difficult question. A jeans factory may make thousands of pairs of jeans a month, Some are plain while others have intricate pocket stitching; some are made of denim whereas others ate made of different material. Clearly, for these different styles of jeans, different amounts of resources are used and they have different costs. Direct and The various items of cost can be divided into two categories: direct costs and indirect Indirect Costs costs. The full cst of a cost abject isthe sum of its direct costs plus a fair share of applicable indirect costs The direct costs of « cost object are items of costs that ate specifically traced to, or caused by, that cost object. Denim used in manufacturing a batch of jeans isa direct cost of that batch of jeans, and so are the earnings of the employees who worked directly in making that batch of jeans.Indirect costs are elements of costs that are associated with, or caused by, two oF more cost objects jointly but that are not directly traced to each of them individually The nature of an indirect cost is such that it isnot possible, or at least not feasible, to measure directly how much ofthe costs attributable to single cost object. Examples of indirect costs ofa batch of jeans include the factory manager's salary ‘and insurance on the factory building and equipment. In the example above, the cost object was explicitly stated as being a batch of jeans. Ifthe cost objet ‘were instead specified to be the factory where the jeans are produced, then the factory manager's salary and the insurance costs are direct costs of that cost object. Ths ilustates that the terms direct and ind- rect até meaningful only in the context of a specified cost object. ‘Although obviously the cost elements directly traced toa cost object area part ofits cos, it isnot ob- vious that some fraction of the elements of indirect east are part ofthe cost. One can actually see the denim in a pair of jeans, and labor services obviously were involved in fashioning tis denim into jeans. ‘Thus, there is no doubt about counting such material and labor as part ofthe cost ofthe jeans, But what is the connection between, say, the salary ofthe purchasing agent (who buys denim and other materials) and the cost ofthe jeans? The purchasing agent did not work on the jeans; the purchasing office may not even bein the building where the jeans were made. The basic rationale is that indirect costs are caused jointly by the several cost objects; to argue ober- wise would be to assert that indirect costs are sheer waste, For example, the purchasing agent's salary i not traceable to specific batches of jeans; but without the purchasing agent, there would be no materials ‘on hand from which to make the jeans. Thus, some fraction ofthe purchasing agent's salary—along with ‘other indirect costs—must be part of the total cost of each batch of jeans. These comments also apply to cost objects that are unrelated to the manufacture of goods. The full cost of occupancy of @ hotel room includes a fair share of the costs of the hotel lobby and registration desk. The full cost of s university accounting course includes a fair share of the school’s administrative, secretarial, maintenance, and utilities costs. We shall defer until later the question of how the fai share of indirect costs applicable to each cost object is measured. ‘Applicable’ 2» The cost concept and the matching concept generally govern the measurement ofthe ‘Accounting _©°st8 applicable to an accounting period and to the products produced in tht period Principles ‘These concepts and the principles related to them do not, however, give much guid- ance on how total product costs are to be assigned to individual products or groups of ‘products. They permit any “systematic and rational” method of cost assignment. In 1970 Congress created the Cost Accounting Standards Board (CASB) to develop cost accounting standards (aterm synonymous with principles) that would lead to consistency in estimating, accumulating, and reporting costs. Although the CASB's authority initially included only the measurement of full costs. on defense contracts all government agencies are now required to adhere to its pronouncements, and many ‘companies also follow them? This is because the problems of measuring the full cost of defense contracts are much the same as the problems of measuring full costs in other situations. In 1980 the CASB was leg- islated out of existence, but it was reactivated in 1988,