Cost Accounting Basics

Cost Concepts

• Cost Object: Any item or project for which costs are measured, such as products or services produced.
• Cost Function: Mathematical expression showing how costs vary with activity levels or volume.
• Cost Assignment: Process of gathering and relating accumulated costs to a specific cost object.

Cost Tracing and Allocation

• Tracing: Identification of direct costs (e.g., materials and labor) associated with a cost object.
• Allocating: Distribution of indirect costs (e.g., manufacturing overhead) to cost objects in a systematic way.
• Cost Allocation: Assigning indirect costs to cost objects, which cannot be traced directly, commonly constitutes a significant part of total costs.

Direct and Indirect Costs

• Direct Costs: Easily traceable to a cost object, including materials and specific labor costs, like components in a car.
• Indirect Costs: Cannot be directly traced, include shared factory expenses (e.g., maintenance, rent) attributable to overall operations rather than individual products.
• Overhead Costs: A category of indirect costs not specifically related to a particular product's production.

Fixed and Variable Costs

• Variable Costs: Change in direct proportion to activity level (e.g., costs increase with production volume).
• Fixed Costs: Remain constant regardless of production levels (e.g., rent), but can fluctuate over time due to external factors.
• Variable Cost Per Unit: Stays constant regardless of quantity produced, while total costs vary.
• Fixed Cost Per Unit: Inversely varies with production levels; more units produced lowers fixed cost per unit.

Cost Drivers and Other Cost Concepts

• Cost Driver: A factor that leads to changes in cost over time, such as distance driven affecting petrol costs.
• Relevant Range: The operational range where fixed costs remain constant relative to production activity.
• Conversion Costs: Costs tied to transforming raw materials into finished goods.
• Prime Cost: Total of all direct costs, including materials and labor.

Inventory Types

• Manufacturing Inventory: Stock of resources available for production.
• Work-in-process: Items that are in production but not yet complete.
• Finished Goods: Completed products ready for sale.

Costing Methods

• Job Costing: Tracks costs for individual or customized products.
• Process Costing: Used for mass production of identical or similar items.
• CVP Analysis: Studies profit changes in relation to sales volume variations of costs and pricing.

Important Analysis Tools

• Margin of Safety (MOS): Measures the buffer between budgeted sales and breakeven point.
• Sensitivity Analysis: Examines how different variables affect profit.

Costing Techniques

• Weighted Average Process-Costing Method: Calculates cost per equivalent unit, allocating costs to completed and incomplete units.
• Operating Leverage: Relationship between fixed and variable costs influencing profit changes with sales volume.

Relevant and Irrelevant Information

• Relevant Information: Future-oriented and varies among alternatives, affecting decision-making.
• Irrelevant Information: Historical costs; past data that don't impact current decisions.

Revenue and Cost Differentials

• Incremental Revenue/Cost: Additional revenue or costs from specific business activities.
• Differential Revenue/Cost: The difference in revenue or costs between two alternatives.

Costing Issues

• Overcosting: When low resource-consuming products have disproportionately high allocated costs.
• Undercosting: Occurs when high resource-consuming products receive insufficient cost allocation.
• Activity-Based Costing (ABC): Allocates costs based on actual resource usage by activities; provides detailed insights but can be costly and time-consuming to implement.

Value Chain Analysis

• Research & Development: Focuses on business improvements and product enhancement.
• Design: Involves the layout and manufacturing details of a product.
• Production: Everything related to raw materials, labor, and actual manufacturing processes.
• Marketing: Understanding customer preferences, pricing strategies, and promotional activities.
• Distribution: Costs associated with the delivery of products.
• Customer Service: Addresses the handling of customer inquiries and post-sales support.

Cost Concepts

• Cost Object: Refers to anything for which a cost is calculated, such as producing a specific product.
• Cost Function: A mathematical representation of how costs change with varying levels of activity related to that cost.
• Cost Assignment: Involves gathering accumulated costs tied to a specific cost object.

Cost Tracing and Allocation

• Tracing: Direct costs, like raw materials and labor, are traced back to cost objects (e.g., plastics in a water bottle).
• Allocating: Indirect costs are assigned to cost objects based on rational methods, covering expenses like factory maintenance.
• Cost Allocation: Indirect costs are assigned to cost objects; these costs usually comprise a significant part of total expenses.

Direct and Indirect Costs

• Direct Costs: Easily traced to a cost object; examples include materials and specific labor costs.
• Indirect Costs: Cannot be traced directly to a specific product; include general factory expenses (e.g., rent, utilities).
• Overhead Costs: Another term for indirect costs, not directly tied to production.

Variable and Fixed Costs

• Variable Costs: Fluctuate directly with changes in production volume; more units lead to increased costs.
• Fixed Costs: Remain constant despite changes in activity level; examples include rent, although they can change over time.
• Variable Cost Per Unit: Cost remains consistent regardless of total production quantity.
• Fixed Cost Per Unit: Reduces as production increases, spreading total fixed costs over more units produced.

Cost Drivers and Relevant Range

• Cost Driver: A variable that influences costs, such as distance driven affecting petrol costs.
• Relevant Range: The activity level range where cost relationships remain constant.

Conversion and Prime Costs

• Conversion Costs: Expenses related to turning raw materials into finished products.
• Prime Cost: Sum of all direct costs, specifically materials and labor.

Inventory Types

• Inventoriable Costs: Costs included in inventory calculations, covering direct materials, labor, and manufacturing overhead.
• Work-in-Process: Products that are in the production stage but not yet completed.
• Finished Goods: Products that have been completed and are ready for sale.

Costing Methods

• Job Costing: Assesses costs for individual products or unique projects.
• Process Costing: Suitable for mass production of identical items across multiple processes.

CVP Analysis

• CVP (Cost-Volume-Profit) Analysis: Evaluates profit changes based on fluctuating sales volume and pricing.
• Assumptions: Sales price and cost behaviors remain linear and constant within the relevant range.

Margin of Safety

• Margin of Safety (MOS): Indicates the difference between budgeted sales and breakeven sales; calculated in units or revenue.

Sensitivity Analysis

• Sensitivity Analysis: Examines the effects of changing key variables on profit, such as sales volume and costs.

Weighted Average Process-Costing Method

• Computes costs per equivalent unit, accounting for both completed and incomplete units in process.

Operating Leverage

• Reflects the relationship between fixed and variable costs; higher leverage means profit increases more with sales, but risks losses if sales drop.

Relevant vs. Irrelevant Information

• Relevant Information: Future-oriented and differs among alternatives; includes relevant costs and revenues.
• Irrelevant Information: Historical costs that bear no impact on current decision-making.

Incremental Analysis

• Incremental Revenue: Extra total revenue generated from a specific activity.
• Incremental Cost: Additional costs incurred for an activity.

Costing Approaches

• Over and Under Costing: Over costing misallocates costs to low resource-consuming products, while under costing does the opposite.
• Peanut Butter Costing: Uses broad averages for cost allocations.
• Activity-Based Costing (ABC): Allocates costs based on resource usage tied to specific activities, providing more precise cost insights.

Value Chain Components

• Research & Development: Focuses on business innovation and product enhancement.
• Design: Encompasses product and delivery design elements.
• Production: Involves the actual production of goods.
• Marketing: Targets customer preferences and pricing strategies.
• Distribution: Addresses logistics of delivering products.
• Customer Service: Manages post-sale support and customer feedback.