Kinney8e PPT Ch02

Chapter 2:
Cost Terminology and Cost

Behaviors
Cost Accounting:
Foundations and Evolutions, 8e
Kinney Raiborn
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
Why are costs associated with a cost object?

What assumptions do accountants make about cost behavior,
and why are such assumptions necessary?
How are costs classified on financial statements, and why are
such classifications useful?
How does the conversion process occur in manufacturing
and service companies?
What are the product cost categories, and what items
comprise those categories?
How and why does overhead need to be allocated to
products?
How is cost of goods manufactured calculated and used in
preparing an income statement?
2011 Cengage Learning. All Rights Reserved. May not be copied, scanned,
or duplicated, in whole or in part, except for use as permitted in a license
Cost
Monetary measure of resources given up to attain an objective (such as

acquiring a good or delivering a service)
Cost Categories
Association with cost object
Cost object is anything for which management

wants to collect or accumulate costs
Reaction to changes in activity

Classification on the financial statements
Association with a Cost Object
Directtraceable to a cost object

Indirectnot conveniently or practically
traceable to a cost object
Treated as overhead
Allocated
Reaction to Changes in Activity

Variable
Fixed
Mixed
Step
Relevant Rangenormal operating range

Cost Reaction to Changes in Activity
Variable cost
Fixed Cost
# of Units
# of Units
Within the
relevant range
Variable cost
Total
Fixed Cost
$
Total
$
# of Units
Unit $
# of Units
Unit $
Within the
# of Units relevant range # of Units
Total and Unit Cost Behavior

Total Cost
Variable
Cost
Fixed
Cost
Varies in direct
proportion to
changes in activity
Remains constant
throughout
the relevant range
Unit Cost
Remains constant
throughout the
relevant range
Varies inversely
with changes in
activity throughout
the relevant range
Step Cost (fixed)
Mixed Cost
variable
$
# of Units
fixed
# of Units
Within the
relevant range
Determining Cost Behavior
Cost Predictor
Cost Driver
Activity accompanied
by consistent,
observable changes in
a cost item
Activity that has a

direct cause-effect
relationship on cost
Predicts but may not

cause the cost to
change
Directly causes the

cost to change
Classification on the Financial

Statements
Unexpiredbalance sheet assets

Expiredincome statement expenses
Productinventoriable costs
Primedirect material and direct labor

Conversiondirect labor and overhead
Product costs are unexpired before sale
Product costs are expired when sold
Periodexpensed in period incurred
Product Costs
Product costs
Direct materialMeasurable part of a product

Direct laborLabor used to manufacture a
product or perform a service
OverheadIndirect production cost
First appear on the balance sheet in

inventory accounts
Transferred to the income statement when
product is sold
Period Costs
Period costs
Selling and administrative costs

Distribution costs
Cost to warehouse, transport, and/or deliver a product or

service
Major impact on managerial decision making
Appear on the income statement when

incurred
Expensed when incurred
The Conversion Process
Change inputs into outputs
The Conversion Process

Input
Output
Purchase
raw materials
or supplies
Product or
Service
CONVERSION
Degrees of Conversion
Low
Low
Department stores
Gas stations
Jewelry stores
Travel agencies
Moderate
High
Moderate
Moderate
Florists
Meat markets
Oil-change businesses
High
Manufacturing
Construction
Agriculture
Architecture
Auditing
Mining
Printing
Restaurants
Service Company
Input
Purchase
supplies
Use supplies,
labor, overhead
to provide service
Significant amount of labor

Tangible or intangible output
Output
Sell to
customer
Retail Company
Input
Purchase
products
for resale
Purchase finished goods

Resell to customers
Output
Warehouse
and/or display
Sell to
customer
Manufacturer
Significant amount of labor and machinery
Input
Tangible output
Purchase
raw materials
and supplies
Output
Finished
product
Production
Center
add labor and
overhead
Sell to
customer
Cost Accumulation in a
Manufacturing Company
Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
Balance Sheet
Cost of
Goods Sold
Income
Statement
Product CostDirect
Direct Material
Conveniently and economically traced

to cost object
Direct Labor
To manufacture a product or perform a service

Includes wages paid to direct labor employees,
production bonuses, payroll taxes
May include holiday and vacation pay, insurance,
retirement benefits
Product CostIndirect
Overheadindirect production costs
Fringe benefits, if cannot be easily traced to

product
Overtime, if due to random scheduling
Cost of quality
Prevention costs
Appraisal costs
Failure costs
Product Cost Behavior
Direct Material
Variable
Direct Labor
Variable
Overhead
Variable, fixed, or mixed
Overhead Cost Allocation

Assign indirect costs to one or more
cost objects
To determine full absorption cost (GAAP)

To motivate management
To compare alternative courses of action for
planning, controlling, and decision making
Allocation process should be
rational and systematic
Overhead Cost Allocation

Assign indirect costs to one or more cost objects
To determine full absorption cost (GAAP)

To motivate management
To compare alternative courses of action for
planning, controlling, and decision making
Allocation process should be rational and

systematic
Allocating Overhead
Actual Cost System
Product Cost
Cost Used
Direct Materials
Actual
Direct Labor
Actual
Overhead
Actual
Allocating Overhead:
Actual Cost System
The Actual Cost System is not timely

All costs must be known before calculating
product cost
Allocating Overhead:
Actual vs. Normal
Product Cost
Direct Materials
Actual Cost
System
Actual
Normal Cost
System
Actual
Direct Labor
Actual
Actual
Overhead
Actual
Predetermined
Overhead Rate
Predetermined Overhead Rate
Allows overhead to be assigned during the

period
Compensates for fluctuations
that are not related to activity level

in activity level that do not affect fixed overhead
Flow of Product Costs

Raw Materials Inventory
Accounts Payable
XXX
Work in Process Inventory

Raw Materials Inventory
XXX
XXX
XXX

XXX
Variable Overhead Control
XXX
Fixed Overhead Control
XXX
Salaries/Wages Payable
XXX

XXX
XXX
Utilities Payable
XXX
Supplies Inventory
XXX
Accumulated DepreciationEquipment
XXX
Other accounts
XXX

XXX
Finished Goods Inventory

XXX
XXX
XXX
XXX

Accounts Receivable
Sales
XXX
XXX
Cost of Goods Sold

XXX
Finished Goods Inventory
XXX
Matches
revenues and
expenses on
the income
statement
Statement of Cost of Goods

ManufacturedRaw Materials
Used
Beginning balance
Purchases of materials
Raw materials available
Ending balance
Total raw materials used
$ 73,000
280,000
$353,000
<69,000>
$284,000
To Statement of Cost of Goods Manufactured

Statement of Cost of Goods

Manufactured
Beginning work in process
Raw materials used

Direct labor
Variable overhead
Fixed overhead
$145,000
$284,000
436,000
115,200
98,880
Current period manufacturing costs

934,080
Total costs to account for
$1,079,080
Ending work in process
<20,880>
Cost of goods manufactured
$1,058,200
Schedule of Cost of Goods Sold
Beginning Finished Goods

$ 87,400
Cost of Goods Manufactured
1,058,200
Cost of Goods Available for Sale $1,145,600
Ending Finished Goods
<91,600>
Cost of Goods Sold
$1,054,000
From Schedule of Cost of Goods Manufactured

Income Statement
Revenue
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Income
XXXX
<1,054,000>
XXXX
<XXXX>
XXXX
From Schedule of Cost of Goods Sold

Questions
What is the difference between a fixed and

variable cost?
What are the three components of product
cost?
What are the three inventory accounts for a
manufacturing company?
Ethical Issues
Expired costsnot on the balance sheet

Period costsnot inventory
Product costsnot selling or administrative
costs
Direct labornot overstated
Ending inventorynot overstated

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Chapter 2:

Cost Terminology and Cost

Why are costs associated with a cost object?

Monetary measure of resources given up to attain an objective (such as

Association with cost object

Cost object is anything for which management

Reaction to changes in activity

Association with a Cost Object

Directtraceable to a cost object

Reaction to Changes in Activity

Relevant Rangenormal operating range

Cost Reaction to Changes in Activity

Cost Reaction to Changes in Activity

Total and Unit Cost Behavior

Cost Reaction to Changes in Activity

Step Cost (fixed)

Determining Cost Behavior

Activity that has a

Predicts but may not

Directly causes the

Classification on the Financial

Unexpiredbalance sheet assets

Primedirect material and direct labor

Periodexpensed in period incurred

Direct materialMeasurable part of a product

First appear on the balance sheet in

Selling and administrative costs

Cost to warehouse, transport, and/or deliver a product or

Appear on the income statement when

The Conversion Process

Change inputs into outputs

The Conversion Process

Significant amount of labor

Purchase finished goods

Conveniently and economically traced

To manufacture a product or perform a service

Overheadindirect production costs

Fringe benefits, if cannot be easily traced to

Product Cost Behavior

Variable, fixed, or mixed

Overhead Cost Allocation

To determine full absorption cost (GAAP)

Overhead Cost Allocation

To determine full absorption cost (GAAP)

Allocation process should be rational and

The Actual Cost System is not timely

Predetermined Overhead Rate

Allows overhead to be assigned during the

that are not related to activity level

Flow of Product Costs

Work in Process Inventory

Work in Process Inventory

Flow of Product Costs

Flow of Product Costs

Finished Goods Inventory

Flow of Product Costs

Cost of Goods Sold

Statement of Cost of Goods

To Statement of Cost of Goods Manufactured

Statement of Cost of Goods

Beginning work in process

Raw materials used

Current period manufacturing costs