END3972 – Cost & Management Accounting

Week 2 – 6/3/2023

Assist. Prof. Mert Edalı

medali@yildiz.edu.tr

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 Outline
 Recap of Last Week’s Lecture
 Variable Costs & Fixed Costs
 Inventoriable Costs and Period Costs
 Flow of Costs

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 CHAPTER 2

An Introduction to Cost Terms and Purposes

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© 2012 Pearson Prentice Hall. All rights reserved.
 BMW: Assigning Costs to a Cost Object

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 Direct and Indirect Costs
 Direct costs
 can be conveniently and economically traced (tracked) to a cost object.
 e.g.,
 the cost of steel (BMW X5)
 the cost of bread, the cost of cheese (toast)
 cost tracing; the assignment of direct costs to a particular cost object.
 Indirect costs
 cannot be conveniently or economically traced (tracked) to a cost object.
 e.g.,
 plant administration costs, rent, electricity, insurance
 Instead of being traced, these costs are allocated to a cost object in a rational and
systematic manner.

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 Basic Cost Terminology
 How does a cost system determine the costs of various cost objects?
 Cost Accumulation:First costs are accumulated.
 Cost Assignment: Then we assign them to cost objects.

 Cost accumulation: a collection of cost data in an organized manner (like

categories) through an accounting system
 e.g., BMW collects (accumulates) costs in various categories such as
 different types of materials,
 different classifications of labor,
 costs incurred for supervision

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 Basic Cost Terminology
 Cost assignment: assigning accumulated costs to a cost object, i.e., different
models of cars.
 Cost information is used in making and implementing decisions,
 how to price different models of cars or
 how much to invest in R&D and marketing
 by rewarding employees for reducing costs.

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 Cost-Behavior Patterns:
Variable Costs and Fixed Costs

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 Cost Behavior
 Variable costs
 change 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.

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 Cost Behavior
 Variable and fixed costs behave differently when we consider them per-unit
basis!
 Variable costs are constant on a per-unit basis.
 If a sandwich needs one slice of cheese, it stays the same per unit regardless if one, ten, or a
thousand units are produced.
 Unit fixed costs change inversely with the level of production.
 As more units are produced, the same fixed cost is spread over more and more units,
reducing the cost per unit.

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 Cost Behavior

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 Cost Behavior Summarized

Total Dollars
Total Dollars Cost per
Per Unit
Unit
Change in
Change in Unchanged in
Variable Costs proportion with
proportion with relation to output
Variable Costs output
output
Moreoutput
More output==More
Morecost
cost
Change
Change inversely
Fixed Costs Unchanged in inversely with
Unchanged in with output
Fixed Costs output
relation to output More output = lower cost
relation to output More output = lower cost
per unit
per unit

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 Cost Behavior
 Unlike variable costs, fixed costs cannot be quickly and easily changed to match the
resources needed or used
 variable costs go away automatically if the resources are not used
 reducing fixed costs requires active intervention on the part of managers
 Individual cost items are not inherently (i.e., naturally) variable or fixed,
 e.g., workers paid on per-shirt-sewed basis (variable), labor costs at a plant (fixed)
 High fixed costs increases the risk of losses during economic downturns as revenues
decrease, because fixed costs remain unchanged.
 The recent global economic crisis has made companies very cautious of locking-in fixed
costs.
 car-sharing service offers companies the opportunity to convert the fixed costs of owning
corporate cars into variable costs by renting cars on an as-needed basis

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 Cost Behavior
 A particular cost item could be variable or fixed based on the activity.
 Registration and license costs for a fleet of planes
 Variable with respect to the number of planes owned
 Fixed with respect to the miles flown by that plane

 Mixed/Semivariable costs:
 Telephone costs.
 A fixed monthly cost + cost based on per phone-minute used

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 Cost Behavior Visualized

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 Cost Behavior Visualized

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 Other Cost Concepts
 Cost driver: a variable (e.g., the level of activity/volume) that causally affects
costs over a given time span
 the number of vehicles assembled is the cost driver of the total cost of steering wheels
 miles driven is often a cost driver of distribution costs
 Costs that are fixed in the short run have no cost driver in the short run but may have a
cost driver in the long run.
 e.g., testing department costs

 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 the cost in
question.
 For example, fixed costs are considered fixed only within the relevant range

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 Relevant Range Visualized
 The maximum annual usage of each truck is
120,000 miles
 each truck has annual fixed rental costs of
$40,000
 miles ≤ 120,000 → 1 truck
 120,000 < miles ≤ 240,000 → 2 trucks
 240,000 < miles ≤ 360,000 → 3 trucks
 …
 In 2011 (next year), the predicted total hauling is
170,000 miles → 2 trucks

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 Multiple Classification of Costs
 Costs may be classified as:
 Direct/Indirect, and
 Variable/Fixed
 These multiple classifications give rise to important cost combinations:
 Direct and variable (cheese, bread)
 Direct and fixed (workers working just for the sandwich-making)
 Indirect and variable (electricity, water)
 Indirect and fixed (workers working for tea, sandwich, chocolate, …)

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 Multiple Classification of Costs,
Visualized

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 Total Costs and Unit Costs
 Unit Cost (average cost):
 dividing total cost by the related number of units
 Units:
 automobiles assembled, packages delivered, or hours worked
 e.g., assume $40M of manufacturing costs are incurred to produce 500K speaker
systems at Manisa plant of Vestel.

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 Total Costs and Unit Costs
 Unit cost are used to:
 Determine profitability and decide the products in which they should invest more
resources,
 such as R&D and marketing,
 Prices can be set unit costs.
 Unit costs should be used carefully!
 They include both fixed cost per unit and variable costs per unit!!!
 Managers should think in terms of total costs rather than unit costs.

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 Total Costs and Unit Costs

 Assume we produced 500,000 units last year.

 Suppose that this year “total fixed cost” and “variable cost per unit” remain at the same
levels (e.g., plant rent and cost of one steering wheel, respectively)
 Costs for different production levels;
 Assume we produced 1,000,000 units this year → Unit cost is $70
 Assume we produced 200,000 units this year → Unit cost is $110

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 Total Costs and Unit Costs

 If we use $80 as the unit cost;

 1,000,000 × $80 = $80,000,000. However, the actual total cost should be
1,000,000 × $70 = $70,000,000. We overestimated the total cost!
 200,000 × $80 = $16,000,000. However, the actual total cost should be
200,000 × $110 = $22,000,000. We underestimated the total cost!

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 Business Sectors, Types of Inventory,
Inventoriable Costs and Period Costs

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 Different Types of Firms
 Manufacturing-sector companies
 purchase materials and components and convert them into finished products.
 e.g., automotive (TOFAŞ), cellular phone (Nokia), food processing (Superfresh)
 Merchandising-sector companies
 purchase and then sell tangible products without changing their basic form.
 e.g., bookstores (Pandora), department stores (Boyner), wholesaling (Metro)
 Service-sector companies
 provide services (intangible products).
 e.g., law firms, internet service providers (TTNET), airlines (Turkish Airlines),
accounting (Ernst & Young)

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 Types of (Manufacturing) Inventories
 Direct materials
 resources in-stock and available for use
 e.g., computer chips needed to manufacture cellular phones
 Work-in-process (or progress)
 products started but not yet completed, often abbreviated as WIP
 e.g., cellular phones at various stages of completion in the manufacturing process
 Finished goods
 products completed and ready for sale
 e.g., cellular phones
 Merchandising companies hold only merchandise inventory, products in their
original purchased form.
 Service-sector companies do not hold inventories of tangible products.

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