Overview
This lecture covers essential cost concepts in cost accounting, focusing on cost classifications, behaviors, cost components, and methods for separating mixed costs. It also introduces key cost terminologies and calculation methods frequently used in exams and decision-making.
Cost Classifications
- Product costs are all costs incurred to manufacture a product; includes materials, labor, and overhead.
- Period costs are operating expenses not related to production, associated with time periods (e.g., rent, salaries of office staff).
- Product costs appear in cost of goods sold; period costs appear in operating expenses.
Components of Product Cost
- Direct materials: raw materials traceable to the finished product.
- Indirect materials: materials used in production but not directly traceable.
- Direct labor: wages of workers directly creating the product.
- Indirect labor: wages for factory staff not directly making the product (e.g., supervisors).
- Manufacturing overhead: all indirect production costs (indirect materials/labor, depreciation, factory utilities, repairs).
Prime Cost & Conversion Cost
- Prime cost = Direct materials + Direct labor.
- Conversion cost = Direct labor + Manufacturing overhead.
- Total manufacturing cost = Direct materials + Direct labor + Manufacturing overhead.
Behavior of Costs
- Variable costs: change in total with production volume; per unit amount is constant.
- Fixed costs: remain constant in total within a relevant range; per unit cost decreases as volume increases.
- Mixed costs: contain both fixed and variable elements (e.g., utilities).
- Step costs: remain constant within activity ranges but jump to new levels as activity volume changes.
Methods to Separate Mixed Costs
- High-Low Method: Use highest and lowest activity levels to estimate variable cost per unit and fixed cost.
- Least Squares Regression: Statistical method using all data points to separate variable and fixed components; more accurate than high-low.
Cost Equation
- Total cost (Y) = Fixed cost (A) + Variable cost per unit (B) × Activity level (X).
Key Terms & Definitions
- Product Cost — Costs incurred to manufacture products.
- Period Cost — Costs not related to production, expensed in the period incurred.
- Direct Cost — Costs traceable directly to a product or service.
- Indirect Cost — Costs not directly traceable to a product, allocated among products.
- Prime Cost — Direct materials plus direct labor.
- Conversion Cost — Direct labor plus manufacturing overhead.
- Variable Cost — Changes in total with production, constant per unit.
- Fixed Cost — Constant in total, varies per unit with volume.
- Mixed Cost — Has both variable and fixed elements.
- Step Cost — Increases in steps as output volume changes.
- Opportunity Cost — Potential benefit lost by choosing one action over another.
- Sunk Cost — Costs already incurred and not recoverable.
- Committed Cost — Long-term, cannot be easily changed.
- Discretionary Cost — Costs decided by management, adjustable.
- Controllable Cost — Costs that can be influenced by a manager.
- Non-controllable Cost — Costs that cannot be influenced by a specific manager.
Action Items / Next Steps
- Review the cost equations and practice applying high-low and least squares regression methods.
- Prepare for the next lecture on the manufacturing accounting cycle, including journal entries, account titles, T-accounts, and the statement of cost of goods manufactured and sold.