CHAPTER 2
An Introduction to
Cost Terms and Purposes
Basic Cost Terminology
 Cost – sacrificed resource to achieve a specific
objective. Such as (direct materials or
advertising).
 Actual Cost – a cost that has occurred ( a
historical or past cost)
 Budgeted Cost – a predicted cost or forecasted
cost ( a future cost).
 Cost Object – anything of interest for which a
measurement of cost is desired.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-2
Basic Cost Terminology
 Cost Accumulation – a collection of cost data
in an organized manner by means of an
accounting system.
 Cost Assignment – a general term that
includes gathering accumulated costs to a
cost object. This includes:
 Tracing accumulated costs with a direct
relationship to the cost object and,
 Allocating accumulated costs with an indirect
relationship to a cost object.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-3
Direct and Indirect Costs
 Direct Costs – can be conveniently and
economically feasible (cost-effective) way
traced (tracked) to a cost object
 Indirect Costs – cannot be conveniently or
economically feasible (cost-effective) way
traced (tracked) to a cost object.
Instead of being traced, these costs are
allocated to a cost object in a rational and
systematic manner.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-4
Cost Examples
 Direct Costs


Parts
Assembly line wages
 Indirect Costs



Electricity
Rent
Property taxes
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-5
Direct and Indirect Costs
COST OBJECT
Direct Costs
Example: Paper on which
Sports Illustrated magazine
is printed
Tracing
Indirect Costs
Example: Lease cost for
Time
Example: Sports
Illustrated
magazine
Allocating
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-6
Learning objective 3:
Explain variable and fixed
costs
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-7
Cost Behavior
 Variable Costs – changes in total in proportion
to changes in the related level of activity or
volume
 Fixed Costs – remain unchanged in total
regardless of changes in the related level of
activity or volume
 Costs are fixed or variable only with respect
to a specific activity or a given time period
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-8
Cost Behavior
 Variable Costs:
 If BMW buys a steering wheel at $60 for each
of its BMW X5 vehicles, then the total cost of
steering wheels is $60 times the number of
vehicles produced, as the following table
illustrates:
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-9
Cost Behavior
Number of X5s
Produced
)1(
Variable Cost per
Steering Wheel
)2(
Total Variable Cost
of Steering Wheels
)2( )1( = )3(
1
$ 60
$ 60
1000
$ 60
$ 60000
3000
$ 60
$ 18000
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-10
Cost Behavior
 The steering wheel cost is an example of a
variable cost because total cost changes in
proportion to changes in the number of
vehicles produced.
 The cost per unit of a variable cost is
constant.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-11
Cost Behavior
 It is precisely because the variable cost per
steering wheel in column 2 is the same for
each steering wheel that the total variable
cost of steering wheels in column 3 changes
proportionately with the number of X5s
produced in column 1.
 When considering how variable costs
behave, always focus on total costs.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-12
Cost Behavior
 Fixed Costs:
 Suppose BMW incurs a total cost of $2,000,000
per year for supervisors who work exclusively on
the X5 line.
 These costs are unchanged in total over a
designated range of the number of vehicles
produced during a given time span.
 Fixed costs become smaller and smaller on a per
unit basis as the number of vehicles assembled
increases, as the following table shows.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-13
Cost Behavior
Annual Total Fixed Supervision
Costs for BMW X5 Assembly Line
)1(
Number of X5s Fixed Supervision
Produced
Cost per X5
)2(
)2( ÷ )1( = )3(
$ 2000000
10000
$ 200
$ 2000000
25000
$ 80
$ 2000000
50000
$ 40
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-14
Cost Behavior
 Fixed Costs:
 Suppose BMW incurs a total cost of $2,000,000
per year for supervisors who work exclusively on
the X5 line.
 These costs are unchanged in total over a
designated range of the number of vehicles
produced during a given time span.
 Fixed costs become smaller and smaller on a per
unit basis as the number of vehicles assembled
increases, as the following table shows.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-15
Cost Behavior
 It is precisely because total line supervision costs
are fixed at $2,000,000 that fixed supervision
cost per X5 decreases as the number of X5s
produced increases.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-16
Cost Behavior Summarized
Variable
Costs
Total Dollars
Cost per Unit
Change
Change
in in
proportion
with
proportion
with
output
output
More output = More cost
Unchanged in
Unchanged
in
relation
to output
relation to output
constant
constant
More output = More
cost
Fixed
Costs
Unchanged in
Unchanged
in
relation
to output
relation to output
constant
Change inversely
Change inversely
with output
with
output
More output = lower cost
More output = lower
per unit
cost per unit
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-17
Other Cost Concepts
 Cost Driver –
is a variable such as the level of activity or volume
that causally affects costs over a given time span.
 An activity is an event, task, or unit of work with a
specified purpose—for example, designing products,
setting up machines, or testing products.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-18
Other Cost Concepts
 The level of activity or volume is a cost driver if there
is a cause-and-effect relationship between a
change in the level of activity or volume and a
change in the level of total costs.
 For example, if product-design costs change with the
number of parts in a product, the number of parts is a
cost driver of product-design costs.
 Similarly, miles driven is often a cost driver of
distribution costs.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-19
Other Cost Concepts
 Relevant Range – is the band of normal activity level
(or volume) in which there is a specific relationship
between the level of activity (or volume) and a given
cost
 For example, a fixed cost is fixed only in relation to a
given wide range of total activity or volume (at which
the company is expected to operate) and only for a
given time span.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-20
Relationships of Types of Costs
 We have introduced two major classifications of





costs: direct/indirect and variable/fixed.
Costs may simultaneously be as follows:
Direct and variable
Direct and fixed
Indirect and variable
Indirect and fixed
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-21
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-22
Learning objective 4:
Interpret unit costs
Cautiously
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-23
Interpret unit costs Cautiously
 Unit cost, also called an average cost, is
calculated by dividing total cost by the
related number of units.
 The units might be expressed in various
ways. Examples are automobiles assembled,
packages delivered, or hours worked.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-24
Interpret unit costs Cautiously
 Suppose that, in 2011, its first year of
operations, $40,000,000 of manufacturing
costs are incurred to produce 500,000
speaker systems at the Memphis plant of
Tennessee Products.
 Then the unit cost is $80:
 Total manufacturing costs ÷ Number of units
manufactured =
 40,000,000$ ÷ 500,000 units = $80 per unit
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-25
Interpret unit costs Cautiously
 If 480,000 units are sold and 20,000 units
remain in ending inventory, the unit-cost
concept helps in the determination of total
costs in the income statement and balance
sheet.
Cost of goods sold in the income statement.
480000 units × $ 80 per unit
$38400000
Ending inventory in the balance sheet
20000 units × $ 80 per unit
$1600000
Total manufacturing costs of 500000 units
$ 40000000
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-26
Interpret unit costs Cautiously
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-27
Cost Behavior Patterns Example(1)
Bicycles by the Sea buys a handlebar
at $52 for each of its bicycles.
What is the total handlebar cost when
1,000 bicycles are assembled?
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-28
Cost Behavior Patterns
Example(2)
1,000 units × $52 = $52,000
What is the total handlebar cost
when 3,500 bicycles are assembled?
3,500 units × $52 = $182,000
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-29
Cost Behavior Patterns
Example(3)
Bicycles by the Sea incurred $94,500 in
a given year for the leasing of its plant.
This is an example of fixed costs with
respect to the number of bicycles assembled.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-30
Cost Behavior Patterns
Example(4)
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 1,000 bicycles?
$94,500 ÷ 1,000 = $94.50
What is the leasing (fixed) cost per bicycle
when Bicycles assembles 3,500 bicycles?
$94,500 ÷ 3,500 = $27
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-31
Cost Drivers
The cost driver of variable costs is the level
of activity or volume whose change causes
the (variable) costs to change proportionately.
The number of bicycles assembled is a
cost driver of the cost of handlebars.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-32
Relevant Range Example
Assume that fixed (leasing) costs are $94,500
for a year and that they remain the same for a
certain volume range (1,000 to 5,000 bicycles).
1,000 to 5,000 bicycles is the relevant range.
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-33
Total Costs and Unit Costs
Example(1)
What is the unit cost (leasing and handlebars)
when Bicycles assembles 1,000 bicycles?
Total fixed cost $94,500
+ Total variable cost $52,000 = $146,500
$146,500 ÷ 1,000 = $146.50
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-34
Learning objective 5:
Business Sectors, Types of
Inventory, Inventoriable Costs,
and Period Costs
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
2-35