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Chapter 2 Outline
Basic Cost Terms and Concepts
a. Activities that cause costs are cost drivers.
- Example: A college student pays $700 per month to rent a two-bedroom apartment. The student can advertise for roommates to split the rent and monthly expenses. The monthly rent will be a fixed cost. The fixed cost per individual will decline, but the total cost remains unchanged ($700). The costs for other monthly expenses, such as food, will vary based upon the number of people consuming the food. Thus, food would be a variable cost.
- Example: A controllerís salary would be an indirect cost of managing the organization; however, the controllerís salary would be a direct cost of the accounting department.
- Example: Travel costs constitute one of the largest manageable corporate expenses. Companies try to control travel costs by periodic evaluation of travel policies and negotiating deals with vendors.
- Example: A building with a ten-year lease is not controllable in the short term (once the lease is signed). The payments must be made until the lease expires. These costs are controllable at the time the lease is negotiated. Thus in the long-run, these costs are controllable.
- Direct distinct from raw: Before material is entered into the production process, it is called raw material. After it enters, production, it becomes direct material.
- Raw materials cost = direct-material cost: Thus, the cost of raw materials used is equal to the direct-material cost.
- Fringe benefits are direct costs: The cost of fringe benefits for direct-labor personnel, such as employee-paid health-insurance premiums and the employerís pension contributions, should also be classified as direct-labor costs.
- Practice differs: While conceptually correct, this treatment of fringe benefit is not always observed in practice. Many companies classify all fringe-benefits as overhead.
- Indirect materials insignificant: The cost of required materials not forming an integral part of the finished product is classified as indirect materials.
- Indirect labor supports: The cost of personnel who do not work directly on the product, but whose services are necessary for the manufacturing process is indirect labor.
- Example: These costs include depreciation of plant and equipment, property taxes, insurance, and utilities such as electricity, as well as the costs of a service department.
- Service departments perform maintenance: These are departments perform maintenance of manufacturing equipment.
- Overtime premium is overhead: An overtime premium is the extra compensation paid to an employee who works beyond the time normally scheduled. Only the extra compensation is classified as an overtime premium. (i.e., the regular wage paid during overtime hours is still direct labor.)
- Idle time is overhead: The time spent unproductively by employees (typically due to equipment break downs or new production setups) is idle time. The cost of the overtime is classified as overhead to spread over the cost of all production runs.
- Rationale for overhead classification: Both overtime premiums and the cost of idle time should be included in manufacturing overhead because these costs incur on jobs rather randomly.
- Inventoriable costs = product costs: The term inventoriable cost is used interchangeably with product cost because a product is stored as the cost of inventory until the goods are sold.
- Cost of goods sold: Product costs are recognized in the period of sale as an expense called cost of goods sold.
- Merchandise inventory includes shipping: The product cost of merchandise inventory acquired by a retailer or wholesaler for resale consists of the purchase cost of the inventory plus any shipping charges.
- Manufactured inventory includes direct costs & overhead: The product cost of manufactured inventory consists of direct material, direct labor, and manufacturing overhead.
- Research & Development: These costs include all costs of developing new products and services (e.g., running a lab, building prototypes, testing products).
- Selling Costs: These costs include salaries, commissions and travel costs of sales personnel, and the costs of advertising and promotion.
(1) Practical use: Leading supermarkets have adopted new approaches to improve profitability by reducing selling and administrative costs. They have invested in technology to reduce inventory and improve distribution. By combining scanners with frequent-shopper cards [that they use to track buying habits], grocers offer discounted items to loyal customers.
- Administrative Costs: These costs refer to running the organization as a whole (e.g., salaries of top-management, accounting, legal, and public relations).
- Raw-material: This includes inventory of all materials before they are placed into production.
- Work-in-process: This includes all materials before they are placed into production.
- Finished-goods: This includes manufactured goods that are complete and ready for sale.
- Valuation: The values of work-in-process and finished-goods inventories are measured by their product costs.
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