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Chapter 2

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COMM 112
Teri Shearer

COST  The among of cash or cash equivalent sacrificed to produce revenue  If an asset is traded for another asset, then the cost is the value of the asset you lost  Cost = dollar measure of the resources used to achieve benefit  As costs are used up in the production of revenues, they are said to expire o Expired costs = expenses  Price = the revenue per unit o You may think cost and price are the same, but they are not! o Instead, the revenue and price are the same ACCUMULATING AND ASSIGNING COSTS  Is the way that costs are measure and recorded  When you get a phone bill, the bookkeeper records an addition to the phone expense and addition to accounts payable  Therefore, cost is accumulated o This lets us tell at the end of the year how much the total cost has turned out to be  Companies want to know WHY there was a cost o SO, you have to link some cost to the cost object = process of assigning costs COST OBJECTS  Any time such as a product, customer, department, project, geographic region, plan, etc. for which the costs are measured and assigned to  Whatever the cost for made for  Ex: you paid $20, cost object is the food you bought COST CLASSIFICATION  Different costs are used for different purposes  Therefore, costs are classified into categories o Direct costs o Product costs o Mixed costs o Indirect costs o Period costs o Selling costs o Prime costs o Variable costs o Administrative o Conversion costs o Fixed costs costs Direct costs  Those costs that can be easily and accurately tracted to a cost object  Easily traced = the relationship between the cost and the obkect can be physically observed and is easy to track  The most costs that can be traced to the object,the most accurate the cost assignments are  You can see the direct costs just by looking at the cost object  EX: coffee mug is the cost object o The direct costs related to this are: plastic, rubber, steel, etc.  EX: Lululemon Shop is the cost object o The direct costs related to this are: clothes, rent, wages, utilities Indirect costs  Costs that cannot be easily and accurately traced to the cost object  They are difficult to assign to the cost object  EX: coffee mug is the cost object o Indirect costs: wages, plant costs, shipping costs  EX: Lululemon shop is the cost object o Indirect costs: legal fees, admin costs, high level office costs Allocating indirect costs:  Even though indirect costs cannot be traced to cost objects, it is still important to assign them  You have to do this by allocation  Allocation: an indirect cost is assigned to a cost object by using a reasonable and convenient method  Since there is no observable causal relationship, allocating indirect costs is based on convenience or some assumed causal link  EX: the cost of heating and lighting a plant in which 5 products are manufactured o The utility cost is to be assigned to these 5 products o It is hard to see a casual relationship between utility costs and each unit of product o SO, a convenient way to allocate this cost is to assign it in proportion to the direct labour hours used by each product  The cost will stay, even if the cost object is gone – there is no direct link  Allocating indirect costs is needed to determine the value of inventory and of cost of goods sold  Indirect costs = large percent of company costs FIXED COST  A cost that does NOT increase/decrease as output increases/decreases  EX: the cost of property taxes on the factory stays the same no matter how your produce  The cost might change, but it is not caused by the production changes  Most costs and fixed and variable = MIXED (chapter 3) VARIABLE COSTS  A cost that increases/decreases as total output increases/decreases  EX: the cost of fabric to make pants – it is related directly to the actually making of the product OPPORTUNITY COST  The benefit given up or sacrificed when one alternatice is chosen over the other  EX: the opp cost of being in accounting class is the wages you would have earned if you went to work instead  Opportunity cost is NOT the same as accouting cost o It is NOT included in financial records – the cost didn’t actually happen PRODUCT/SERVICE  Output represents one of the most important cost objects o 2 types of output = products and services  Product: good produced by converting raw material through the use of labour and indirect manufacturing resources, such as the plant, land, machinery o Manufacturing organizations: companies that produce products o Products have inventories o It is easier to see the costs associated with products than services  Services: tasks or activities performed for a customer or an activity performed by customer using an organization’s products/facility o Services don’t have inventories o They are intangible and perishable (cannot be stored for future use) o You need to be in direct contact with the customer  If you are doing someone’s nails, you have to be there with the customer  But if you are selling a car, the manufacturer doesn’t have to be present o Service organizations: companies that produce services Product costs  Managerial accounting doesn’t follow GAAPS because it is mostly info for themselves o BUT, they have to follow those rules when they are presenting this info to outside parties o This is done by: classifying between product costs and period costs  Product costs: AKA manufacturing costs: costs, both direct and indirect, of producing a product in a manufacturing firm OR of acquiring a product in a merchandising firm and preparing it for sale  Only costs in the production section of the value cahin are included in product costs  Key feature: they are inventoried  Initially added to an inventory account and remind in inventory until they are sold o THEN, they are transferred to COGS  Can be further classified as direct materials, direct labour, and manufacturing overhead o These are 3 cost elements that can be assigned to products for external financial reporting (ex: inventory or cogs) Direct materials  Those materials that are a part of the final product and can be directly traced to the goods being produced  The cost of these materials can be directly charged to products because physical observation can be used to measure the quantity used by each product  Materials that become part of a product are classified as direct materials  Ex: the tires of a car, the alcohol in perfume, the denim for jeans  Raw materials: closely related term – the inventory of materials is often called raw materials o Materials are “raw” until they are withdrawn from the inventory and actually used to make the product Direct labour  The labour that can be directly traced to the goods being produced  Physical observations can be used to measure the amunt of labour used to product a product  Direct labour: those employees who convert direct material itno a product  There is also indirect labour – it is not direct labout because the workers do not actually make the product o BUT, their contribution is necessary for production Manufacturing overhead  All product costs other than direct materials and direct labour  AKA factory burden or indirect manufacturing costs  These costs can't be traced to the cost object  Contains a wide variety of items o EX: depreciation on plant, materials handling, electricity, taxes, janitors, maintenance labour, etc.  All costs are classified as direct costs, direct labour or manufacturing overhead  Indirect materials are included in overhead – such as the glue used for the toys, or the grease for cookie sheet Total product cost  Total product cost = direct materials + direct labour + manufacturing overhead  Unit product cost = total product cost/# of units produced  One the product is finished, there are no more costs attached to it o SO, any cost associated with selling, storing, delivering are NOT product costs – they are PERIOD costs Prime and conversion costs  Product costs can be grouped into prime and conversion costs  Prime Costs = direct labour + direct materials  Conversion costs = direct labour + manufacturing overhead o Costs of converting raw material into a final product PERIOD COSTS  The costs of production are assets that are carried in inventories until the goods are sold o There are other costs of running a company that are NOT carried in inventory – period costs  Period costs: all costs that are not product costs – all areas of the value chain except for production  Ex: office supplies, R&D, CEO’s salary, advertising, etc.  Period costs cannot be assigned to products or appear as part of the reported vale of inventories on balance sheet o INSTEAD, they are xpensed in the
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