Chapter 1:

Cost Terminology and Cost

Behaviors
Cost Accounting:
Foundations and Evolutions, 9e
Kinney ● Raiborn

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Learning Objectives
 Why are costs associated with a cost object?
 What assumptions do accountants make about cost
behavior, and why are such assumptions necessary?
 How are costs classified on financial statements, and why
are such classifications useful?
 How does the conversion process occur in manufacturing
and service companies?
 What are the product cost categories, and what items
comprise those categories?
 How and why does overhead need to be allocated to
products?
 How is cost of goods manufactured calculated and used in
preparing an income statement?
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Cost

Monetary measure of resources given up to attain an objective (such as

acquiring a good or delivering a service)
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Cost Categories

 Association with cost object

 Cost object is anything for which management
wants to collect or accumulate costs
 Reaction to changes in activity
 Classification on the financial statements

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Association with a Cost Object

 Direct—traceable to a cost object

 Indirect—not conveniently or practically
traceable to a cost object
 Treated as overhead
 Allocated

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Association with a Cost Object

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accessible website, in whole or in part.
Association with a Cost Object

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accessible website, in whole or in part.
Reaction to Changes in Activity

 Variable
 Fixed

 Mixed

 Step

Relevant Range—normal operating range

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Cost Reaction to Changes in Activity

 Variable
Fixed Cost
cost

$
$

# of Units # of Units
Within the
relevant range
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 Cost Reaction to Changes in Activity

 Variable
Fixed Cost
cost
$ $
Total Total

# of Units # of Units

Unit $ Unit $
Within the
# of Units relevant range # of Units
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 Total and Unit Cost Behavior
Total Cost Unit Cost

Variable Varies in direct Remains constant

Cost proportion to throughout the
changes in activity relevant range

Fixed Varies inversely

Remains constant
Cost with changes in
throughout
activity throughout
the relevant range
the relevant range

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Cost Reaction to Changes in Activity

 Step Cost
Mixed Cost(fixed)

variable
$ $
fixed
# of Units # of Units

Within the
relevant range
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 Determining Cost Behavior
 Cost Predictor  Cost Driver
 Activity accompanied  Activity that has a
by consistent, direct cause-effect
observable changes in relationship on cost
a cost item
 Predicts but may not
 Directly causes the
cause the cost to cost to change
change

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Classification on the Financial
Statements
 Unexpired—balance sheet assets
 Expired—income statement expenses
 Product—inventoriable costs
 Prime—direct material and direct labor
 Conversion—direct labor and overhead
 Product costs are unexpired before sale
 Product costs are expired when sold
 Period—expensed in period incurred

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Product Costs

 Product costs
 Direct material—Measurable part of a product
 Direct labor—Labor used to manufacture a
product or perform a service
 Overhead—Indirect production cost
 First appear on the balance sheet in
inventory accounts
 Transferred to the income statement when
product is sold
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Period Costs

 Period costs
 Selling and administrative costs
 Distribution costs
 Cost to warehouse, transport, and/or deliver a product or
service
 Major impact on managerial decision making
 Appear on the income statement when
incurred
 Expensed when incurred

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The Conversion Process

 Change inputs into outputs

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 Cost Accumulation in a
Manufacturing Company
Materials
Inventory

Work in Process
Inventory
Finished Goods Cost of
Inventory Goods Sold
Income
Balance Sheet Statement
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Product Cost Behavior

 Direct Material Variable

 Direct Labor Variable

 Overhead Variable, fixed, or mixed

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Overhead Cost Allocation
Assign indirect costs to one or more
cost objects
 To determine full absorption cost (GAAP)

Allocation process should be

rational and systematic

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Flow of Product Costs
Raw Materials Inventory XXX
Accounts Payable XXX

Work in Process Inventory XXX

Raw Materials Inventory XXX

Work in Process Inventory XXX

Variable Overhead Control XXX
Fixed Overhead Control XXX
Salaries/Wages Payable XXX

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 Flow of Product Costs

Variable Overhead Control XXX

Fixed Overhead Control XXX
Utilities Payable XXX
Supplies Inventory XXX
Accumulated Depreciation–Equipment XXX

Other accounts XXX

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Flow of Product Costs

Work in Process Inventory XXX

Variable Overhead Control XXX
Fixed Overhead Control XXX

Finished Goods Inventory XXX

Work in Process Inventory XXX

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 Flow of Product Costs
Accounts Receivable XXX Matches
Sales XXX revenues
and
Cost of Goods Sold XXX expenses
Finished Goods Inventory XXX on the
income
statemen
t

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 Statement of Cost of Goods
Manufactured—Raw Materials
Used
 Beginning balance $ 73,000
 Purchases of materials 280,000
 Raw materials available $353,000
 Ending balance <69,000>
 Total raw materials used $284,000

To Statement of Cost of Goods Manufactured

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 Statement of Cost of Goods
Manufactured
 Beginning work in process $145,000
 Raw materials used $284,000
 Direct labor 436,000
 Variable overhead 115,200
 Fixed overhead 98,880
 Current period manufacturing costs
934,080
 Total costs to account for $1,079,080
 Ending work in process
<20,880> Cost of goods manufactured
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$1,058,200
 Schedule of Cost of Goods Sold
 Beginning Finished Goods $ 87,400
 Cost of Goods Manufactured

1,058,200
 Cost of Goods Available for Sale $1,145,600
 Ending Finished Goods

<91,600>
 Cost of Goods Sold

$1,054,000
From Schedule of Cost of Goods Manufactured

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Income Statement
 Revenue XXXX
 Cost of Goods Sold <1,054,000>
 Gross Profit XXXX
 Operating Expenses <XXXX>
 Operating Income XXXX

From Schedule of Cost of Goods Sold

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Questions

 What is the difference between a fixed and

variable cost?
 What are the three components of product
cost?
 What are the three inventory accounts for a
manufacturing company?

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Ethical Issues

 Expired costs—not on the balance sheet

 Period costs—not inventory
 Product costs—not selling or administrative
costs
 Direct labor—not overstated
 Ending inventory—not overstated

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