Management Accounting
Chapter 2:
cost: a resources sacrificed or forgone to achieve a specific objective (monetary amounts)
cost object: anything for which a separate measurement of costs is desired
A costing system typically accounts for costs in two basic stages:
1. It accumulates costs by some 'natural' (often self-descriptive) classification such as
materials, labour, fuel, advertising or shipping
2. It assigns these costs to cost objects
Cost accumulation: the collection of cost data in some organized way through an accounting
system
Cost assignment: a general term that encompasses both 1) tracing accumulated costs to a cost
object and 2) allocating accumulated costs to a cost object
Actual costs: costs incurred (historical costs) as distinguished from budgeted or forecasted costs
Direct costs: costs that are related to the particular cost object and that can be traced to it in an
economically feasible (cost-effective) way
Indirect costs: costs that are related to a particular cost object but cannot be traced to it in an
economically feasible way
Managers prefer to make decisions on the basis of direct costs rather than indirect costs (more
accurate).
Cost tracing: the assigning of direct costs to the chose cost object
Cost allocation: the assigning of indirect costs to the chosen cost object
Factors that affect the classification of a cost as direct or indirect:
– the materiality of the cost in question
– available information-gathering technology
– design of operations
value-added activities: activities that customers perceive as adding value to the products or
services they purchase
cost driver: (also cost generator, cost determinant) any factor that affects total costs
variable costs: a cost that changes in total in proportion to changes in the related level of total
activity or volume
fixed costs: a cost that does not change in total despite changes in the related level of total activity
or volume
Assumptions for variable or fixed costs:
1. Costs are defined as variable or fixed with respect to a specific cost object
2. The time span must be specific
3. Total costs are linear
4. There is only one cost driver
5. Variations in the level of the cost driver are within a relevant range
Relevant range: the range of the cost driver in which a specific relationship between cost and the
level of activity or volume is valid
unit cost (average cost): calculated by dividing some amount of total cost by the related number of
units
While unit costs are often useful, they must be interpreted with extreme caution if they include fixed
costs per unit.
Capitalized costs: are first recorded as an asset (capital) when they are incurred, they are presumed
to provide future benefits to the company
Revenue costs: are recorded as expenses of the accounting period when they are incurred
Service-sector companies: provide services or intangible products to their customers
Merchandizing-sector companies: provide tangible products they have previously purchased in
the same basic form from suppliers
Manufacturing-sector companies: provide tangible products that have been converted to a
different form from that of the product purchased from suppliers
Stock-related costs: (inventoriable costs) those costs associated with the purchase of goods for
resale (in the case of merchandize stock) or costs associated with the acquisition and conversion of
materials and all other manufacturing inputs into goods for sale (in the case of manufacturing
stocks)
Operating costs: all costs associated with generating revenues, other than cost of goods sold
Manufacturer's having one or more of the following type of stock:
– Direct materials stock: direct materials in stock and awaiting use in the manufacturing
process
– Work-in progress stock (work in process): goods partially worked on but not yet fully
completed
– Finished goods stock: goods fully completed but not yet sold
The term absorption costing is used to describe the method in which all manufacturing costs are
inventoriable.
Fixed manufacturing costs under variable costing are treated as period costs, that is, they are
treated as expenses in the period in which they are incurred rather than being inventoried
Direct material costs: are acquisition costs of all materials that eventually become part of the cost
object (say, units finished or in process) and that can be traced to the cost object in an economically
feasible way
Direct manufacturing labour costs: include the compensation of all manufacturing labour that is
specifically identified with the cost object (say, units finished or in process) and that can be traced
to the cost object in an economically feasible way
Indirect manufacturing costs: are all manufacturing costs considered to be part of the cost object
(say, units finished or in process) but that cannot be individually traced to that cost object in an
economically feasible way. Other terms for this cost category include manufacturing overhead
costs and factory overhead costs.
Overhead costs: indirect costs that you can't trace
Prime costs: are all direct manufacturing costs
Conversion costs: are all manufacturing costs other than direct materials costs
product cost: the sum of the costs assigned to a product for a specific purpose
Three different purposes:
– Product pricing and product emphasis
– Contracting with government agencies
– Financial statements
