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Chapter 2

Chapter 2

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Ryerson University
ACC 410
Vanessa Magness

Chapter 2: The Cost Function Using Relevant Costs to make Decisions about the future Steps For Better Thinking: • Knowing • Identifying (recognize key threats and opportunities) • Exploring (pros and cons) • Prioritizing (choose best option) • Envisioning (remain open to future events and opportunities for improvement) Cost Concepts and Terminology Cost can be classified in 5 broad categories 1. relevance need relevant information on both revenue and costs to make decisions Relevant revenues and cost: differentiate about two alternatives that will occur in the future Irrelevant revenues and cost: not make a difference to either alternative, and they therefore have no bearing on the decision (ex: sunk cost because cost already have been incurred and cannot be avoided) 2. behaviour must know how cost behave in order to estimate costs at given production level fixed cost: behaves such that the total cost will not change within a certain range of activity Variable cost: varies in proportion to the production level (ex: cost of fuel) 3. traceability managers need to know whether a cost could be traced to a cost object; helps estimate the cost more accurately cost object: thing or activity for which we measure costs (ex: individual products, product lines, projects, customers) Direct Cost: cost that can be directly traced to a cost object Indirect cost: incurred for the benefit of more than one cost object and therefore cannot be easily and economically traced to a particular cost object 4. function manufacturing (or product, or inventory) costs and non- manufacturing (or period) cost can determine the cost of goods manufactured and price products accordingly include direct materials, direct labour which are prime costs, and manufacturing overhead costs which is conversion costs 5. controllability www.notesolution.com controllable cost vs. uncontrollable cost managers have the authority to cut costs if the cost are controllable Classifying Costs: Fixed (ex: rent, salaried) Variable (ex: labour, utilities) Direct (ex: direct labour, tires) Indirect (ex: rent, salary, utilities) Relevant Range: span of activity given cost object, where total fixed costs remain constant and variable costs per unit of activity remain constant Marginal Cost: incremental cost of an activity, such as producing a unit of goods or services variable cost approx. marginal cost Estimating Relevant Costs: relevant cost involves the future, we cannot perfectly predict them carefully identify and estimate how costs will be affected by a decision Direct Costs: easily traced to individual cost objects because a clear cause and effect relationship generally exists between cost object and the cost Indirect Costs: not easily traced to individual cost objects (more than one cost object, such as multiple products or services) (ex: maintenance and electricity) Overhead Costs: all production costs except direct material costs and direct labour costs are often combined into groups (cost pools) in the accounting system Opportunity Costs: benefits we forgo when we choose one alternative over the next best alternative Sunk Costs: expenditures made in the past Cost behaviour: variation in costs relative to the variation in an organization’s activities analyze
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