Cost accounting information pool

• The cost accounting information pool consists of past

revenue and costs necessary for product costing and
performance evaluation as well as projected revenue and
costs necessary for managerial decision making.
• More useful when it is classified into various categories
for analysis purposes.

➢ Eight categories are:

1- Elements of a product
The 3 integral components, or cost elements of a
product are:
1. Materials
- These are the principal substances used in production that
are transformed into finished goods by the addition of
direct labor and factory overhead.
A. Direct materials
- All materials that can be identified with the production of a
finished product, that can be easily traced to the product,
and that represent a major material cost of producing that
product.
B. Indirect materials
- All materials involved in the production of a product that are
not direct materials. Indirect materials are included as part of
factory overhead. An example of an indirect material is the
glue used to build a bunk bed.
2. Labor
- Labor is the physical or mental effort expended in the
production of a product.
a. Direct labor
- All labor directly involved in the production of a finished
product that can be easily traced to the product and that
represents a major labor cost of producing that product.
The work of machine operators in a manufacturing
company would be considered direct labor.
b. Indirect labor
- All labor involved in the production of a product that is not
considered direct labor. Indirect labor is included as part of
factory overhead. The work of a plant supervisor is an
example of indirect labor.
3. Factory overhead
Consist of:
1- Indirect materials.
2- Indirect labor.
3- All other indirect manufacturing costs.
- All other indirect manufacturing costs involved in
production, but cannot be directly identified with specific
products.
EXERCISE 1-3 COST ELEMENTS
Hill Corporation has the following classifications of cost
elements:
a- Production supervisor's salary
b- Cost accountant's salary
c- Fire insurance on factory building
d- Machine operator's wages
e- Packaging for product
f- Raw materials for the product mix

Required: Indicate whether the above cost elements are

direct material, direct labor or factory overhead.

ANSWERS:
a- Factory overhead b- Factory overhead
c- Factory overhead d- Direct labor
e- Direct material f- Direct material
2- RELATIONSHIP TO PRODUCTION
• The analysis in this category is similar to the analysis of
costs by element.
• This grouping aids in the management objective of
planning and controlling. The two categories, on the basis
of their relationship to production, are prime costs and
conversion costs.
A. Prime costs:
- Are the sum of direct materials and direct labor.
- These costs are directly related to production.
B. Conversion costs:
- These are costs that related to the transforming of direct
materials into finished products.
- Conversion costs are the sum of direct labor and factory
overhead.
- Summarizing these costs is for analysis purposes only, it
is not used to accumulate costs for determining the cost of
a product therefore, including direct labor in both analyses
does not result in double counting because this
classification is used for planning and control, not for cost
accumulation.
For example, if the costs presented in Table 1-1 were
classified according to their relationship to production,
prime costs and conversion costs would be computed as
follows:
Prime costs:
Direct materials ............................ $100,000
Direct labor .................................... $350,000
Total .............................................. $450,000
Conversion costs:
Direct labor .................................... $350,000
Factory overhead ........................... $150,000
Total .............................................. $500,000
3- RELATIONSHIP TO VOLUME
• Costs vary with changes in the volume of production. To
understand the relationship of change in volume to
change in costs.
➢ To understand this concept, costs are classified into 3
categories:
1- VARIABLE COSTS:
- Those in which the total cost changes in direct proportion
to changes in volume, or output, within the relevant range,
while the unit cost remains constant, total variable costs
are controlled by the individual department head
responsible for incurring them.
- Relevant range is defined as that interval of (i.g: units of
production) activity within which total fixed costs and per
unit variable costs remain constant. Once production
exceeds the relevant range, a new total fixed cost and per
unit variable cost must be used for new relevant range.
2- FIXED COSTS:
- These costs in total remain constant over a relevant range
of output, while having a unit cost that varies with
production (output).
- Beyond (More) the relevant range of output, fixed costs
will vary.
- Upper-level management controls the volume of
production and is, therefore, responsible for the level of
fixed costs.
3- MIXED COSTS:
- These costs have characteristics of both fixed and
variable costs over various relevant ranges of operation.
➢ Two types of mixed costs exist:
a. Semi variable Costs:
- The fixed portion of the cost is the cost actually using the
service. For example, most telephone service charges are
made up of two elements: a fixed charge for being allowed
to receive or make a phone call, plus an additional or
variable charge for each phone call made.
EXAMPLE: Assume that a company rents a delivery truck
at a flat fee of $3,000 per year plus $1.5 for each mile
driven.
ANSWER
Flat fee (fixed component) .............. $3,000
Mileage charge (variable component)
(10,000 miles x $1.5) ...................... $15000
Total cost ........................................ $18000
b. Step Costs:
- These costs are fixed for a very small interval or relevant
range, then they change abruptly as the activity level
changes.
- An example of a step cost is a supervisor's salary. For
certain time period, if one supervisor is needed for every 10
workers, then two supervisors would be required if, for
example, 15 workers are used. If an additional worker is
hired (increasing the number of workers to 16), still only
two supervisors would be needed. However, if the number
of workers increases to 21, three supervisors would be
needed. Instead of hiring an additional supervisor for
example, an organization may pay current supervisors’ time
and a half to work for a little extra time.
EXAMPLES of Variable, Fixed, Semi variable and Step
costs:

EXAMPLE:
Company x has two alternative levels of production under
consideration as follows:
Projected production level:
Plan A ……………………………... 50,000 units
Plan B ………………………………. 80,000 units
Fixed costs (relevant range is 40,000 to 100,000 units) are
$200,000 and variable costs are $1 per unit.
ANSWER
Production costs under both plans are as follows:
Plan A Total cost
per unit
Variable costs (50,000 units x $1) $50,000 $1.00
Fixed costs ($200,000) $200,000 $4.00
Total production costs $250,000 $5.00
Plan B Total cost
per unit

Variable costs (80,000 units x $1) $80,000 $1.00

Fixed costs ($200,000) $200,000 $2.50
Total production costs $280,000 $3.50
Total production costs are lower for plan A than plan B, but
the cost per unit under plan A is higher than the cost per
unit under plan B. Note that total fixed costs remain the
same under both plans while total variable costs change.
Fixed costs per unit are lower under plan B because fixed
costs are allocated over more units than plan A.