LEVEL 5COST TERMS, CONCEPTS,AND CLASSIFICATIONSLESSON ONEAIM OF THE MODULE• Managers are more likely to make a positivecontribution to achieving this objective if theyunderstand and can analyse the factors affectingprofitability and the creation of shareholder wealthin their part of the organisation.• The module considers four main areas ofmanagement accounting: costing decisions as thebasis of profitability, budgets and controlmechanisms, investment decisions and financialperformance appraisal.LEARNING OUTCOMESOn successful completion of this module students willbe able to:• Understand the different types of costs and theirrelevance to pricing decisions• Understand the role and prepare budgets tocontrol operations• Analyse capital investment decisions, includingcarrying out a risk assessment, using appropriateaccounting ratios.• Analyse and compare internal and externalperformance indicators and the role of pricing onperformanceASSESSMENT METHOD, WEIGHT &DEADLINESThere are TWO assignments to be completed in thismodule:• Assignment 1 – (Case Study) 2000 words +/- 10%• Total Weighting: 50%• Intended Learning Outcomes: 1 and 2• •Assignment 2 – (Case study) 2000 words +/- 10%• Total Weighting: 50%• Intended Learning Outcomes: 3 and 4LEARNING OUTCOME 1• Understand the different types of costs and theirrelevance to pricing decisionsMANUFACTURING COST CONCEPTSFinancialAccountingCost is a measure ofresources used orgiven up to achieve astated purpose.ManagerialAccountingProduct costs are thecosts a companyassigns to unitsproduced.The ProductDirectMaterialsDirectLaborManufacturingOverheadMANUFACTURING COSTSDIRECT MATERIALSThose materials that become an integral part of theproduct and that can be conveniently traced directlyto it.Example: A radio installed in an automobileDIRECT LABORThose labor costs that can be easily traced to individualunits of product.Example: Wages paid to automobile assembly workersMANUFACTURING OVERHEADManufacturing costs that cannot be traced directly tospecific units produced.Examples: Indirect labor and indirect materials Wages paid to employeeswho are not directlyinvolved in productionwork.Examples: maintenanceworkers, janitors andsecurity guards. Materials used to supportthe production process.Examples: lubricants andcleaning supplies used in theautomobile assembly plant. CLASSIFICATIONS OF COSTSManufacturing costs are oftencombined as follows:DirectMaterialsDirectLaborManufacturingOverheadPrimeCostConversionCostNONMANUFACTURING COSTSMarketing and selling costs . . .• Costs necessary to get the order and deliverthe product.Administrative costs . . .• All executive, organizational, and clericalcosts.QUICK CHECK ✓Which of the following costs would beconsidered manufacturing overhead atBoeing? (More than one answer may becorrect.)A. Depreciation on factory forklift trucks.B. Sales commissions.C. The cost of a flight recorder in a Boeing 767.D. The wages of a production shift supervisor.PRODUCT COSTS VERSUS PERIOD COSTSProduct costs includedirect materials,direct labor, andmanufacturingoverhead.Period costs are notincluded in productcosts. They areexpensed on theincome statement.Inventory Cost of Good SoldBalanceSheetIncomeStatementSaleExpenseIncomeStatementQUICK CHECK ✓Which of the following costs would beconsidered a period rather than a productcost in a manufacturing company?A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.C. Direct materials costs.D. Electrical costs to light the production facility.COST CLASSIFICATIONS FORPREDICTING COST BEHAVIORHow a cost will reactto changes in thelevel of businessactivity.• Total variable costschange when activitychanges.• Total fixed costsremain unchangedwhen activitychanges.TOTAL VARIABLE COSTYour total long distance telephone bill is based onhow many minutes you talk.Minutes TalkedTotal Long DistanceTelephone BillVARIABLE COST PER UNITThe cost per long distance minute talked is constant.For example, 10 cents per minute.Minutes TalkedPer MinuteTelephone ChargeTOTAL FIXED COSTYour monthly basic telephone bill probably does notchange when you make more local calls.Number of Local CallsMonthly BasicTelephone BillFIXED COST PER UNITThe average cost per local call decreases as morelocal calls are made.Number of Local CallsMonthly Basic TelephoneBill per Local CallCOST CLASSIFICATIONS FORPREDICTING COST BEHAVIORBehavior of Cost (within the relevant range)Cost In Total Per UnitVariable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide rangesof activity.Fixed Total fixed cost remains Fixed cost per unit goesthe same even when the down as activity level goes up.activity level changes.QUICK CHECK ✓Which of the following costs would bevariable with respect to the number ofpeople who buy a ticket for a show at amovie theater? (There may be more thanone correct answer.)A. The cost of renting the film.B. Royalties on ticket sales.C. Wage and salary costs of theateremployees.D. The cost of cleaning up after the show.DIRECT COSTS AND INDIRECT COSTSDirect costs• Costs that can beeasily andconveniently tracedto a unit of product orother cost objective.• Examples: directmaterial and directlaborIndirect costs• Costs cannot beeasily andconveniently tracedto a unit of product orother cost object.• Example:manufacturingoverheadDIFFERENTIAL COSTS AND REVENUESCosts and revenues that differ among alternatives.Example: You have a job paying 1,500 per month inyour hometown. You have a job offer in a neighboringcity that pays 2,000 per month. The commuting costto the city is 300 per month.Differential revenue is:2,000 – 1,500 = 500DIFFERENTIAL COSTS AND REVENUESCosts and revenues that differ among alternatives.Differential revenue is:2,000 – 1,500 = 500Differential cost is:300Example: You have a job paying 1,500 per month inyour hometown. You have a job offer in a neighboringcity that pays 2,000 per month. The commuting costto the city is 300 per month.QUICK CHECK ✓Suppose you are trying to decide whetherto drive or take the train to Portland toattend a concert. You have ample cash todo either, but you don’t want to wastemoney needlessly. Is the annual cost oflicensing your car relevant in this decision?A. Yes, the licensing cost is relevant.B. No, the licensing cost is not relevant.QUICK CHECK ✓Suppose you are trying to decide whetherto drive or take the train to Portland toattend a concert. You have ample cash todo either, but you don’t want to wastemoney needlessly. Is the depreciation onyour car relevant in this decision?A. Yes, the depreciation is relevant.B. No, the depreciation is not relevant.OPPORTUNITY COSTSThe potential benefitthat is given up whenone alternative isselected over another.Example: If you werenot attending college,you could be earning15,000 per year.Your opportunity costof attending college forone year is 15,000.SUNK COSTSSunk costs cannot be changed by anydecision. They are not differential costs andshould be ignored when making decisions.Example: You bought an automobile that cost10,000 two years ago. The 10,000 cost is sunkbecause whether you drive it, park it, trade it, orsell it, you cannot change the 10,000 cost.QUICK CHECK ✓Suppose that your car could be sold nowfor 5,000. Is this a sunk cost?A. Yes, it is a sunk cost.B. No, it is not a sunk cost.FURTHER CLASSIFICATION OF LABORCOSTS Idle Time Treated as overheadcost OvertimePremium of LabWorkers Treated as overheadcost Labor FringeBenefits Treated as indirectlaborCOST OF QUALITYAPPENDIX BPrevention Costs Appraisal CostsInternalFailure CostsExternalFailure CostsFour Typesof QualityCostsISO 9000 standards have become aninternational measure of quality.
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