Chapter 2:

Basic Cost Terms and Concepts

• Cost Terms
- Fixed
- Variable
• Cost Concepts
• Management Implications
 Cost Terms

$ Fixed Costs: costs that remain

constant regardless of the quantity of
product produced.

Output

Variable Costs: costs that increase

$ linearly and proportionately as
production volume increases.

Output

Profit = (Sales Revenue-Variable Cost) - Fixed Cost

Total Contribution Margin

 Cost Terms (Continued)
• Cost Driver: Any activity or event that causes costs to be incurred.

• Manufacturing Cost: Direct material (DM), direct labor (DL), and

manufacturing overhead (MOH).
• Sales and General
Administrative Costs:
All costs associated with running the business,
excluding production costs.
• Direct and Indirect
Costs:

• Controllable and Costs that can either be traced (direct) or not traced
Uncontrollable Costs: (indirect) to a specific department in the organization.

• Product/Period Cost: Costs used to describe the extent of a manager’s

influence on cost.

Refers to the timing which costs become expenses.

 Economic Terms
• Opportunity Benefit lost because the choice of one action
Cost: precludes another action.

• Sunk Cost: Costs that have already been incurred and can
not be altered by current or future decisions.

• Differential and Difference in the costs incurred under two

Incremental Cost: alternative actions.

• Marginal Cost: Cost associated with producing one additional

unit.

• Average Cost per Total cost for the quantity produced, divided by
Unit: the number of units produced.
 Bala’s Bare Bones Manufacturing Facility
Direct Material
Purchased

Direct Material Storage

Raw Materials
It’s a Warehouse!

Direct Material Used

Finished Goods Direct Material

WIP
Inventory Manufacturing Overhead Costs
 Cost Concept
Direct Material Inventory Work in Process Inventory Finished Goods Inventory
Beginning Transfer to Beginning Transfer to Beginning Cost of
Inventory WIP Inventory Finished Inventory Goods Sold
$1,000 $78,000 $40,000 Goods $1,000 (shipped)
Inventory $340,000
Purchases Direct $350,000 Goods
$79,000 Material Completed
$78,000 From WIP
$350,000
Direct
Ending Labor
Inventory $82,000
$2,000 Ending
MOH Inventory
Incurred $11,000
$170,000

Ending
Inventory
$20,000
Storeroom
Allocation of Costs

Raw Direct
Material Material
Used Factory
Inventory
(DMU)

WIP
Inventory
Cost of Goods
Manufactured
Direct
Material
(COM) Warehouse
Purchased
(DMP)
Direct
Labor Finished Cost of Goods
(DL) Goods Sold (COGS)
Manufacturing Inventory
Overhead
(MOH)
 Managerial Implications

• Is it better to under or over-apply overhead?

If OH is over-applied (allocated >actual), you will be “surprised” how
well you actually did when making end of period adjustments.

If OH is under-applied (allocated<actual), you will be “surprised” how

well you thought you did when making end of period adjustments.

• If your compensation or incentive plan is based on profit,

which would you choose?