Basic Cost Terms and Concepts by AhsanTareen

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									                 Chapter 2:
       Basic Cost Terms and Concepts
• Cost Terms
  - Fixed
  - Variable
• Cost Concepts
• Management Implications
                      Cost Terms

$                                   Fixed Costs: costs that remain
                                    constant regardless of the quantity of
                                    product produced.

    Output




                                    Variable Costs: costs that increase
$                                   linearly and proportionately as
                                    production volume increases.


    Output



         Profit = (Sales Revenue-Variable Cost) - Fixed Cost



                 Total Contribution Margin
                   Cost Terms (Continued)
•   Cost Driver:          Any activity or event that causes costs to be incurred.

•   Manufacturing         Direct material (DM), direct labor (DL), and
    Cost:                 manufacturing overhead (MOH).


•   Sales and General     All costs associated with running the business,
    Administrative        excluding production costs.
    Costs:

•   Direct and Indirect   Costs that can either be traced (direct) or not traced
    Costs:                (indirect) to a specific department in the organization.

•   Controllable and      Costs used to describe the extent of a manager’s
    Uncontrollable        influence on cost.
    Costs:

•   Product/Period        Refers to the timing which costs become expenses.
    Cost:
                      Economic Terms
• Opportunity         Benefit lost because the choice of one action
  Cost:               precludes another action.

• Sunk Cost:          Costs that have already been incurred and can
                      not be altered by current or future decisions.


• Differential and    Difference in the costs incurred under two
  Incremental Cost:   alternative actions.


• Marginal Cost:      Cost associated with producing one additional
                      unit.

• Average Cost per    Total cost for the quantity produced, divided by
  Unit:               the number of units produced.
        Bala’s Bare Bones Manufacturing Facility
                                        Direct Material
                                          Purchased

Direct Material Storage
                                                                   Raw Materials
It’s a Warehouse!


                          Direct Material Used




Finished Goods                                   Direct Material
                                                 WIP
    Inventory                                    Manufacturing Overhead Costs
                             Cost Concept
Direct Material Inventory   Work in Process Inventory    Finished Goods Inventory
Beginning     Transfer to   Beginning      Transfer to   Beginning    Cost of
Inventory     WIP           Inventory      Finished      Inventory    Goods Sold
$1,000        $78,000       $40,000        Goods         $1,000       (shipped)
                                           Inventory                  $340,000
Purchases                   Direct         $350,000      Goods
$79,000                     Material                     Completed
                            $78,000                      From WIP
                                                         $350,000
                            Direct
Ending                      Labor
Inventory                   $82,000
$2,000                                                   Ending
                            MOH                          Inventory
                            Incurred                     $11,000
                            $170,000

                            Ending
                            Inventory
                            $20,000
Storeroom
                  Allocation of Costs

    Raw         Direct
   Material    Material
                Used        Factory
  Inventory
               (DMU)




                              WIP
                            Inventory
                                          Cost of Goods
                                          Manufactured
     Direct
    Material
                                             (COM)        Warehouse
   Purchased
    (DMP)
                Direct
                Labor                                       Finished   Cost of Goods
                (DL)                                         Goods     Sold (COGS)
                          Manufacturing                    Inventory
                           Overhead
                            (MOH)
             Managerial Implications

• Is it better to under or over-apply overhead?
       If OH is over-applied (allocated >actual), you will be “surprised” how
       well you actually did when making end of period adjustments.

       If OH is under-applied (allocated<actual), you will be “surprised” how
       well you thought you did when making end of period adjustments.


• If your compensation or incentive plan is based on profit,
  which would you choose?

								
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