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Chapter 3 - Basic Cost Management Concepts
3-1
CHAPTER 3: BASIC COST MANAGEMENT CONCEPTS
QUESTIONS
3-1 Cost assignment refers to the general case of assigning costs to cost pools or
cost objects. When there is a direct and traceable link between the cost and the
Cost allocation uses cost drivers to assign the cost.
3-2 Direct costs can be physically identified with and/or traced to the cost object
because there is a direct causal link between them. Indirect costs cannot be
traced to each cost object. Direct costs for a manufactured product include the
which is not directly traceable to the product, such as labor for inspection and
supervision.
3-3 All direct costs are variable by definition since they can be directly traced to the
cost object, and thus must vary with the cost driver.
3-4 All fixed costs must be indirect, since the increase in the cost driver or volume of
output does not affect the level of fixed cost.
3-7 A step-fixed cost varies with the cost driver, but in discrete steps. Costs remain
fixed over narrow ranges of the cost driver. However, total costs increase by a
constant amount at set intervals. Examples of step-fixed costs are the costs for
Chapter 3 - Basic Cost Management Concepts
3-2
3-8 The relevant range is the range of the cost driver for which total cost is
approximately linear. The relevant range is used to provide a useful range of
activity for the cost driver in which it can be assumed that variable costs will be
3-9 Conversion costs are the sum of direct labor and overhead costs. Prime costs
are the sum of direct materials and direct labor.
3-10 Average cost can be misleading unless the activity level (denominator) is known.
Because average cost includes a fixed cost component, it will be different at each
to the firm. Since period costs are not directly or indirectly related to the
production process, they are sometimes called non-manufacturing costs.
3-14 Cost of goods manufactured is the cost of the units produced this period and
transferred into finished good inventory. Cost of goods sold is the cost of the
units sold this period. Cost of goods sold will differ from cost of goods
manufactured because of changes in finished goods inventory. If finished goods
Chapter 3 - Basic Cost Management Concepts
3-3
3-15 The types of inventory in manufacturing firms are:
1. materials inventory
2. work-in-process inventory
3. finished products inventory
3-16 Both accuracy and timeliness are important attributes of cost information.
Accuracy is important because effective planning and decision making require
3-20 Indirect labor includes labor that is used in the manufacturing process but cannot
be traced to each product as it is produced; indirect labor includes supervision,
inspection (by batch, because inspection of each and every product would be a
variable cost), training, etc.
Chapter 3 - Basic Cost Management Concepts
3-4
BRIEF EXERCISES
3-21 The answer depends on what you consider the cost object. Suppose we
consider the flight as the cost object, then the variable costs should include fuel
and the flight team, and any meals or other products provided to passengers on
the flight. If the object is the individual passenger, then the list of variable costs
with the flight.
3-22 We start with the cost object, which in this case could be the item of merchandise
sold. Then the variable costs are the cost of merchandise and the selling costs
for the cashiers and restocking. For a large discount retailer, most other costs
3-23 The cost object for a movie theater could be the number of films being shown, or
the number of screens. The cost of renting the movie from the film producer is
the main cost. The key driver of revenue (not cost) is the number of ticket
holders – for ticket revenue and also revenue from sales of food and beverages.
Some costs will also be driven by the number of ticket holders, such as the cost
of ticket holders, or number of films being shown.
3-24 The cost object here is more readily identified – the beer product, whether
measured in individual bottles or larger quantities. The variable costs will be
significant here, including the ingredients that go into the brewing of beer. Other
costs for the brewery are likely to be fixed for this cost object, but there are
important activity costs which will vary with, for example, the number of
Chapter 3 - Basic Cost Management Concepts
3-5
3-25 Here it is plausible to consider the individual lesson as the cost object. Variable
costs would include that portion of the trainers’ pay which is based on each
lesson (the salary portion of the trainers’ pay would be fixed for this cost object).
3-26 $200 + $13,400 -$400 = $13,200
3-30 Period cost includes interest, advertising, and office expense: $4,000 + $2,500 +
$14,000 = $20,500
Chapter 3 - Basic Cost Management Concepts
3-6
EXERCISES
3-31 Fares and Fees in the Airline Industry (15 min)
Very much like the consumer products industry (Procter & Gamble as an
example) introduced at the start of the chapter, the airline industry is
characterized by a high degree of complexity in pricing – both fares and
fees.
1. It is likely most will argue that the airline industry is a cost leadership
industry. Most passengers look for the lowest price ticket and see
very little difference between airlines in terms of quality, reliability, or
service. On the other hand, airlines would very much like to build a
“brand loyalty” by providing certain free services and customer
service. Whether this will work is a good question for class
discussion. One point that should arise in the discussion is to
development of new search engines and away from airlines that did
not participate in trusted, independent Web search sites. If the
number of Web sites increases, as some in the travel industry expect,
then it is likely to place more price pressure on the airlines and
reinforce the commodity view of the industry.
2. The complexity of fees and fares presents a challenge for the
consumer, and an opportunity for search sites such as Expedia to
3-7
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-31 (continued -1)
It is likely that the additional complexity in fares and fees will affect
the airlines’ costs for the cost of additional time and materials in
processing fee payments and in assisting customers. Of course, the
additional fees are very likely to cover these additional costs.
Source: Jad Mouawad and Claire Cain Miller, “Search for Low
Airfares Gets More Competitive,” The New York Times, February
10, 2011; Gary Stoler, “Fee-fi-fo-fum, Airline Charges Leave Some
Travelers Numb,” USA Today, September 20, 2011, p B1.
For a contrasting view, see, Loizos Hereacleous and Jochen
Wirtz, “Singapore Airlines Balancing Act,” Harvard Business Review,
July-August 2010, pp. 145-149. The authors argue that Singapore
Airlines simultaneously competes on cost leadership and
differentiation. The authors further argue that this competition is
common in Asian airlines. The authors call this a “dual strategy.”
3-8
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-32 Complexity of Operations and the Effect on Cost (15 min)
The observations made by the consultant show that the manufacturer was
incurring large costs in operations, distribution, and administration due to
the high level of complexity in its products. Maintaining relationships with
10 vendors for a single item contributed to high purchasing and stocking
costs. Similarly, most of the firm’s volume was made up of products with
five color combinations, with the result that manufacturing, warehousing,
shipping and selling costs were high relative to fewer color combinations.
Also, the high product variety required smaller batch production and more
demands for smaller batch sizes without increasing overall costs. The
result of the program was that overall profit margins improved. The firm
had found a way to deal with the cost consequences of its strategic
initiative.
Also, the firm adopted new cost management practices that included
new non-financial measures such as set-up time and frequency, percent of
orders shipped on time, percent of orders on just-in-time, and number of
vendors for the top 20 commodity raw materials items. In addition, the firm
3-9
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Based on information in: Barry Berman, “Products, Products Everywhere,”
The Wall Street Journal, August 23, 2010, p R8; “Managing Complexity
Through Performance Measurement,” by Frank A. J. Gonsalves and Robert
G. Eiler, Management Accounting, August 1996, pp 34-39.
3-33 Classification of Costs (10 min)
Parts 1 and 2:
1. Print machine setup costs: activity; product
2. Cost of complexity; the number and variety of products: structural;
product
7. Redesign of the print process to improve efficiency: executional;
product
8. Machine operation labor: volume; product
9. Order taking: activity; period
10. Purchasing and stocking paper and other supplies – activity;
product
3. The ink could have a harmful environmental impact. The company
could choose to use environmentally friendly ink, or dispose of the
3-10
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-34 Classification of Costs (10 min)
1. period
2. product and indirect
3. product and indirect
4. product and direct
13. period
14. period
3-35 Classification of Costs (10 min)
1. direct and variable
2. indirect and fixed
3. indirect and variable
4. indirect and fixed
5. direct and variable
3-11
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3-36 Classification of Costs (10 min)
1. direct
2. indirect
3. direct
8. direct
9. indirect
10. indirect
3-37 Activity Levels and Cost Drivers (10 Min)
Cost Object
Cost Driver
1
product line or
customer
trace to product line, or each custom order
requiring design
2
product line or
customer
trace to product line, or each custom order
requiring testing
3
product line
product line
4
product line
number of purchase orders
5
customer order
trace directly to customer
6
customer order
trace directly to customer
7
customer order
trace directly to customer
8
customer order
trace directly to customer
9
each customer
trace directly to customer
10
customer order
trace directly to customer
11
not allocated
cannot be traced to product or customer; must be
allocated using some reasonable method, for
example, number of units produced
12
not allocated
cannot be traced to product or customer; must be
allocated using some reasonable method, for
example, the number of units produced
3-12
3-38 Application of the Direct Cost Concept in the Fashion Industry
(15 min)
It is always possible, by definition, to trace direct materials and direct labor
costs to each unit produced. In some cases, as this one, the most
practical approach is to trace the materials and labor costs directly to the
3-39 Direct Manufacturing Labor: Fixed or Variable? (10 min)
The effect of the policy on cost is that labor expense, while fixed in total
expenditure, is in reality a variable expense. Labor is flexible and can be
moved from job to job or plant to plant as demand dictates; that is, labor
time labor is added when needed.
Source: Clara Asbury, “In the Workplace, Jobs Morph to Suit Rapid Pace
of Change,” The Wall Street Journal, March 22, 2002, p1.
Chapter 3 - Basic Cost Management Concepts
3-13
3-40 Average and Total Costs (15 min)
1. Total cost:
$ 1,500 (fixed cost of space rental)
+ 1,500 (variable cost of refreshments = $15 x 100)
$ 3,000
Average cost: $3,000/100 people = $30.00 per person
2. Total cost:
$ 1,500 (fixed cost of space rental)
Average cost: $4,500/200 people = $22.50 per person
3. Average costs decrease as attendance increases because the
fixed cost component to total costs is now spread over 100 extra
people.
Fixed cost per person: $1,500/100 people = $15
$1,500/200 = $ 7.50
Decrease in fixed cost per person $ 7.50
Chapter 3 - Basic Cost Management Concepts
3-14
3-41 Cost Classification for Dance Studio (15 min)
1. While a variety of possible cost objects are possible for the dance
studio, the most reasonable choice is the studio since management’s
goal is to analyze the profitability of the studios.
2. Studios as the cost object
1. a,c
2. a,c
3. a,c
Or,
Lessons as the cost object
1. a,d
2. b,d
3. b,d
Chapter 3 - Basic Cost Management Concepts
3-15
3-42 Relevant Range (20 min)
This exercise is intended to develop the student’s appreciation of the
complexities in cost determination and the importance of considering
foreign exchange effects when doing business abroad.
1. The volume-based costs include:
a. Fixed costs: administrative costs of management in Austin and
depreciation expense, insurance, maintenance, security, etc.
2. The relevant range is applicable for PGI because PGI’s operations
centers must grow as demand increases. This means higher
variable costs due to the cost of adding small computer servers and
the cost of hiring additional staff, etc. Note that the cost of the
variable cost and total fixed cost for a limited range of activity – a
range in which there is no need for additional servers or hiring costs,
etc.
