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Cost Terms and Concepts Explained

This document discusses basic cost accounting terms and concepts. It defines fixed and variable costs, and explains that fixed costs remain constant while variable costs increase proportionally with production volume. It also discusses other cost concepts like cost drivers, direct and indirect costs, product and period costs. Finally, it provides examples to illustrate cost allocation and the managerial implications of over- or under-applying manufacturing overhead.

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7 views8 pages

Cost Terms and Concepts Explained

This document discusses basic cost accounting terms and concepts. It defines fixed and variable costs, and explains that fixed costs remain constant while variable costs increase proportionally with production volume. It also discusses other cost concepts like cost drivers, direct and indirect costs, product and period costs. Finally, it provides examples to illustrate cost allocation and the managerial implications of over- or under-applying manufacturing overhead.

Uploaded by

tegegn mogessie
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd

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?

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