Cost Accounting – Part (II)

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 Direct materials—resources in-stock and
available for use
 Work-in-process (or progress)—products
started but not yet completed, often
abbreviated as WIP
 Finished goods—products completed and
ready for sale

 Note: Merchandising-sector companies hold

only one type of inventory: merchandise
inventory
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 Also known as inventoriable costs
 Direct materials—acquisition costs of all
materials that will become part of the cost
object.
 Direct labor—compensation of all manufacturing
labor that can be traced to the cost object.
 Indirect manufacturing—factory costs that are
not traceable to the product in an economically
feasible way. Examples include lubricants,
indirect manufacturing labor, utilities, and
supplies.

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 Inventoriable costs are all costs of a product
that are considered assets in a company’s
balance sheet when the costs are incured and
that are expensed as cost of goods sold only
when the product is sold. For manufacturing
companies, all manufacturing costs are
inventoriable costs.
 Period costs are all costs in the income
statement other than cost of goods sold. They
are treated as expenses of the accounting
period in which they are incurred.
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 The Cost of Goods Manufactured and the
Cost of Goods Sold section of the Income
Statement are accounting representations of
the actual flow of costs through a production
system.
 Note how inventoriable costs to through the
balance sheet accounts of work-in-process and
finished goods inventory before entering the cost
of goods sold in the income statement.

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 Prime cost is a term referring to all direct
manufacturing costs (materials and labor).
 Conversion cost is a term referring to direct
labor and indirect manufacturing costs.
 Overtime labor costs are considered part of
indirect overhead costs.

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Because there are alternative ways for
management to define and classify costs,
judgment is required.

Managers, accountants, suppliers and others

should agree on the classifications and
meanings of the cost terms introduced in this
chapter and throughout the book.

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Costs are assumed to be fixed or variable
within the relevant range of activity

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Step costs change abruptly at intervals
of activity because the resources and
their costs come in indivisible chunks.

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Mixed costs contain elements of both fixed and variable costs.
The fixed-cost element is unchanged over a range of cost-driver
activity levels.
The variable-cost element of the mixed cost varies proportionately
with cost-driver activity within the relevant range.

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 Planning and controlling the activities
of an organization require accurate
and useful estimates of future
fixed and variable costs.

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Understanding relationships between costs
and their cost drivers allows managers to...

Make better operating, marketing,

and production decisions

Plan and evaluate actions

Determine appropriate costs for

short-run and long-run decisions.

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The first step in estimating or predicting
costs is measuring cost behavior as a
function of appropriate cost drivers.

The second step is to use these cost

measures to estimate future costs at
expected levels of cost-driver activity.

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 Let:
Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units

The mixed-cost function is called a linear-cost function.

Mixed-cost function:
Y = F + VX
Y = $10,000 + $5.00X

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The cost function must be believable.

A cost function’s estimates of costs

at actual levels of activity must reliably
conform with actually observed costs.

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1. Engineering analysis
2. Account analysis
3. High-low analysis
4. Visual-fit analysis
5. Least-squares regression analysis

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Engineering analysis measures cost behavior
according to what costs should be,
not by what costs have been.

Engineering analysis entails a systematic

review of materials, supplies, labor,
support services, and facilities
needed for products and services.

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 The simplest method of account analysis selects a plausible
cost driver and classifies each account as a variable or fixed cost.

Parkview Medical Center

Monthly cost Amount Fixed Variable

Supervisor’s salary and benefits $ 3,800 $3,800

Hourly workers’ wages and benefits 14,674 $14,674
Equipment depreciation and rentals 5,873 5,873
Equipment repairs 5,604 5,604
Cleaning supplies 7,472 7,472
Total maintenance costs $37,423 $9,673 $27,750

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 3,700 patient-days

Fixed cost per month = $9,673

Variable cost per patient-day

= $27,750 ÷ 3,700
= $7.50 per patient-day

Y = $9,673 + ($7.50 × patient-days)

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 Plot historical data points on a graph.

Focus on the highest- and lowest-activity points.

High month: April

Maintenance cost: $47,000
Number of patient-days: 4,900

Low month: September

Maintenance cost: $17,000
Number of patient-days: 1,200
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The point at which the line intersects the Y axis is
the intercept, F, or estimate of Fixed Costs, and the
slope of the line measures the variable cost.
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 What is the variable cost (V)?
Using algebra to solve for variable and fixed costs.

Variable costs = Change in costs

change in activity

V = ($47,000 – $17,000) ÷ (4,900 – 1,200)

= $30,000 ÷ 3,700 = $8.1081

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 What is the fixed cost (F)?

F = Total mixed cost – total variable cost

At X (high): F = $47,000 - ($8.1081× 4,900 patient-days)
= $47,000 – $39,730
= $7,270 a month

At X (low): F = $17,000 - ($8.1081× 1,200 patient-days)

= $17,000 – $9,730
= $7,270 a month

Cost function measured by high-low method:

Y = $7,270 per month + ($8.1081 × patient-days)
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In the visual-fit method, the cost analyst
visually fits a straight line through a plot
of all of the available data, not just
between the high point and the
low point, making it more reliable
than the high-low method.

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 Regression analysis measures
a cost function more objectively
by using statistics to fit a cost
function to all the data.

Regression analysis measures

cost behavior more reliably than
other cost measurement methods.

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 One measure of reliability,
or goodness of fit, is the
coefficient of determination,
R² (or R-squared).

The coefficient of determination

measures how much of the
fluctuation of a cost is explained
by changes in the cost driver.

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