2-1
CHAPTER 2
AN INTRODUCTION TO COST TERMS AND PURPOSES
2-1 A cost object is anything for which a separate measurement of costs is desired. Examples
include a product, a service, a project, a customer, a brand category, an activity, and a department.
2-2 Direct costs of a cost object are related to the particular cost object and can be traced to
that cost object in an economically feasible (cost-effective) way.
Indirect costs of a cost object are related to the particular cost object but cannot be traced
to that cost object in an economically feasible (cost-effective) way.
Cost assignment is a general term that encompasses the assignment of both direct costs and
indirect costs to a cost object. Direct costs are traced to a cost object, while indirect costs are
allocated to a cost object.
2-3 Managers believe that direct costs that are traced to a particular cost object are more
accurately assigned to that cost object than are indirect allocated costs. When costs are allocated,
managers are less certain whether the cost allocation base accurately measures the resources
demanded by a cost object. Managers prefer to use more accurate costs in their decisions.
2-4 Factors affecting the classification of a cost as direct or indirect include
• the materiality of the cost in question
• available information–gathering technology
• design of operations
2-5 A variable cost changes in total in proportion to changes in the related level of total activity
or volume. An example is a sales commission that is a percentage of each sales revenue dollar.
A fixed cost remains unchanged in total for a given time period, despite wide changes in
the related level of total activity or volume. An example is the leasing cost of a machine that is
unchanged for a given time period (such as a year) regardless of the number of units of product
produced on the machine.
2-6 A cost driver is a variable, such as the level of activity or volume, that causally affects total
costs over a given time span. A change in the cost driver results in a change in the level of total
costs. For example, the number of vehicles assembled is a driver of the costs of steering wheels on
a motor-vehicle assembly line.
2-7 The 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. Costs are
described as variable or fixed with respect to a particular relevant range.
2-8 A unit cost is computed by dividing some amount of total costs (the numerator) by the
related number of units (the denominator). In many cases, the numerator will include a fixed cost
that will not change despite changes in the denominator. It is erroneous in those cases to multiply
the unit cost by activity or volume change to predict changes in total costs at different activity or
volume levels.
2-2
2-9 Manufacturing-sector companies purchase materials and components and convert them
into various finished goods, for example automotive and textile companies.
Merchandising-sector companies purchase and then sell tangible products without
changing their basic form, for example retailing or distribution.
Service-sector companies provide services or intangible products to their customers, for
example, legal advice or audits.
2-10 Manufacturing companies have one or more of the following three types of inventory:
1. Direct materials inventory. Direct materials in stock and awaiting use in the
manufacturing process.
2. Work-in-process inventory. Goods partially worked on but not yet completed. Also
called work in progress.
3. Finished goods inventory. Goods completed but not yet sold.
2-11 Inventoriable costs are all costs of a product that are considered as assets in the balance
sheet when they are incurred and that become cost of goods sold when the product is sold. These
costs are included in work–in-process and finished goods inventory (they are “inventoried”) to
accumulate the costs of creating these assets.
Period costs are all costs in the income statement other than cost of goods sold. These costs
are treated as expenses of the accounting period in which they are incurred because they are
expected not to benefit future periods (because there is not sufficient evidence to conclude that
such benefit exists). Expensing these costs immediately best matches expenses to revenues.
2-12 Direct material costs are the acquisition costs of all materials that eventually become part
of the cost object (work in process and then finished goods) and can be traced to the cost object in
an economically feasible way.
Direct manufacturing labor costs include the compensation of all manufacturing labor that
can be traced to the cost object (work in process and then finished goods) in an economically
feasible way.
Manufacturing overhead costs are all manufacturing costs that are related to the cost object
(work in process and then finished goods) but cannot be traced to that cost object in an
economically feasible way.
Prime costs are all direct manufacturing costs (direct material and direct manufacturing
labor).
Conversion costs are all manufacturing costs other than direct material costs.
2-13 Overtime premium is the wage rate paid to workers (for both direct labor and indirect labor)
in excess of their straight–time wage rates.
Idle time is a subclassification of indirect labor that represents wages paid for unproductive
time caused by lack of orders, machine breakdowns, material shortages, poor scheduling, and the
like.
2-14 A product cost is the sum of the costs assigned to a product for a specific purpose. Purposes
for computing a product cost include
• pricing and product mix decisions,
2-3
• contracting with government agencies, and
• preparing financial statements for external reporting under GAAP.
2-15 Three common features of cost accounting and cost management are
• calculating the costs of products, services, and other cost objects
• obtaining information for planning and control and performance evaluation
• analyzing the relevant information for making decisions
2-16 (15 min.) Computing and interpreting manufacturing unit costs.
Minnesota Office Products (MOP) produces three different paper products at its Vaasa lumber
plant: Supreme, Deluxe, and Regular. Each product has its own dedicated production line at the
plant. It currently uses the following three-part classification for its manufacturing costs: direct
materials, direct manufacturing labor, and manufacturing overhead costs. Total manufacturing
overhead costs of the plant in July 2014 are $150 million ($15 million of which are fixed). This
total amount is allocated to each product line on the basis of the direct manufacturing labor costs
of each line. Summary data (in millions) for July 2014 are as follows:
Supreme
Deluxe
Regular
Direct material costs
$ 89
$ 57
Direct manufacturing labor costs
$ 16
$ 26
Manufacturing overhead costs
$ 48
$ 78
Units produced
125
150
Required:
1. Compute the manufacturing cost per unit for each product produced in July 2014.
2. Suppose that, in August 2014, production was 150 million units of Supreme, 190 million units
of Deluxe, and 220 million units of Regular. Why might the July 2014 information on
manufacturing cost per unit be misleading when predicting total manufacturing costs in August
2014?
SOLUTION
1.
(in millions)
Supreme Deluxe Regular Total
Direct material cost $ 89.00 $ 57.00 $60.00 $206.00
Direct manuf. labor costs 16.00 26.00 8.00 50.00
Manufacturing overhead costs 48.00 78.00 24.00 150.00
Total manuf. costs 153.00 161.00 92.00 406.00
Fixed costs allocated at a rate
of $15M
$50M (direct mfg.
labor) equal to $0.30 per
dir. manuf. labor dollar
(0.30
$16; 26; 8) 4.80 7.80 2.40 15.00
Variable costs $148.20 $153.20 $89.60 $391.00
Units produced (millions) 125 150 140
2-4
Cost per unit (Total manuf.
costs ÷ units produced) $1.2240 $1.0733 $0.6571
Variable manuf. cost per unit
(Variable manuf. costs
Units produced) $1.1856 $1.0213 $0.6400
(in millions)
Supreme Deluxe Regular Total
2. Based on total manuf. cost
per unit ($1.2240
150;
$1.0733
190; $0.6571
220) $183.60 $203.93 $144.56 $532.09
Correct total manuf. costs based
on variable manuf. costs plus
fixed costs equal
Variable costs ($1.1856
150; $177.84 $194.05 $140.80 $512.69
$1.0213
190; $0.64
220)
Fixed costs 15.00
Total costs $527.69
The total manufacturing cost per unit in requirement 1 includes $15 million of indirect
manufacturing costs that are fixed irrespective of changes in the volume of output per month, while
the remaining variable indirect manufacturing costs change with the production volume. Given the
unit volume changes for August 2014, the use of total manufacturing cost per unit from the past
month at a different unit volume level (both in aggregate and at the individual product level) will
overestimate total costs of $532.09 million in August 2014 relative to the correct total
manufacturing costs of $527.69 million calculated using variable manufacturing cost per unit times
units produced plus the fixed costs of $15 million.
2-17 (15 min.) Direct, indirect, fixed, and variable costs.
Wonder Bakery manufactures two types of bread, which it sells as wholesale products to various
specialty retail bakeries. Each loaf of bread requires a three-step process. The first step is mixing.
The mixing department combines all of the necessary ingredients to create the dough and processes
it through high-speed mixers. The dough is then left to rise before baking. The second step is
baking, which is an entirely automated process. The baking department molds the dough into its
final shape and bakes each loaf of bread in a high-temperature oven. The final step is finishing,
which is an entirely manual process. The finishing department coats each loaf of bread with a
special glaze, allows the bread to cool, and then carefully packages each loaf in a specialty carton
for sale in retail bakeries.
Required:
1. Costs involved in the process are listed next. For each cost, indicate whether it is a direct
variable, direct fixed, indirect variable, or indirect fixed cost, assuming “units of production of
each kind of bread” is the cost object.
Costs:
Yeast Mixing department manager
Flour Materials handlers in each department
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Packaging materials Custodian in factory
Depreciation on ovens Night guard in factory
Depreciation on mixing machines Machinist (running the mixing machine)
Rent on factory building Machine maintenance personnel in each department
Fire insurance on factory building Maintenance supplies for factory
Factory utilities Cleaning supplies for factory
Finishing department hourly laborers
2. If the cost object were the “mixing department” rather than units of production of each kind of
bread, which preceding costs would now be direct instead of indirect costs?
SOLUTION
1. Yeast—direct, variable
Flour—direct, variable
Packaging materials—direct (or could be indirect if small and not traced to each unit), variable
Depreciation on ovens—indirect, fixed (unless “units of output” depreciation, which then would
be variable)
Depreciation on mixing machines—indirect, fixed (unless “units of output” depreciation, which
then would be variable)
Rent on factory building—indirect, fixed
Fire Insurance on factory building—indirect, fixed
Factory utilities—indirect, probably some variable and some fixed (e.g., electricity may be
variable but heating costs may be fixed)
Finishing department hourly laborers—direct, variable (or fixed if the laborers are under a union
contract)
Mixing department manager—indirect, fixed
Materials handlers—depends on how they are paid. If paid hourly and not under union contract,
then indirect, variable. If salaried or under union contract, then indirect, fixed
Custodian in factory—indirect, fixed
Night guard in factory—indirect, fixed
Machinist (running the mixing machine)—depends on how they are paid. If paid hourly and not
under union contract, then indirect, variable. If salaried or under union contract, then
indirect, fixed
Machine maintenance personnel—indirect, probably fixed, if salaried, but may be variable if
paid only for time worked and maintenance increases with increased production
Maintenance supplies—indirect, variable
Cleaning supplies—indirect, most likely fixed because the custodians probably do the same
amount of cleaning every night
2. If the cost object is Mixing Department, then anything directly associated with the Mixing
Department will be a direct cost. This will include:
• Depreciation on mixing machines
• Mixing Department manager
• Materials handlers (of the Mixing Department)
• Machinist (running the mixing machines)
2-6
• Machine Maintenance personnel (of the Mixing Department)
• Maintenance supplies (if separately identified for the Mixing Department)
Of course the yeast and flour will also be a direct cost of the Mixing Department, but it is already
a direct cost of each kind of bread produced.
2-18 (15–20 min.) Classification of costs, service sector.
Market Focus is a marketing research firm that organizes focus groups for consumer-product
companies. Each focus group has eight individuals who are paid $60 per session to provide
comments on new products. These focus groups meet in hotels and are led by a trained,
independent marketing specialist hired by Market Focus. Each specialist is paid a fixed retainer to
conduct a minimum number of sessions and a per session fee of $2,200. A Market Focus staff
member attends each session to ensure that all the logistical aspects run smoothly.
Required: Classify each cost item (A–H) as follows:
a. Direct or indirect (D or I) costs of each individual focus group.
b. Variable or fixed (V or F) costs of how the total costs of Market Focus change as the number
of focus groups conducted changes. (If in doubt, select on the basis of whether the total costs
will change substantially if there is a large change in the number of groups conducted.)
You will have two answers (D or I; V or F) for each of the following items:
Cost Item
D or I V or F
A. Payment to individuals in each focus group to provide comments on new products
B. Annual subscription of Market Focus to Consumer Reports magazine
C. Phone calls made by Market Focus staff member to confirm individuals will attend a focus
group session (Records of individual calls are not kept.)
D. Retainer paid to focus group leader to conduct 18 focus groups per year on new medical
products
E. Recruiting cost to hire marketing specialists
F. Lease payment by Market Focus for corporate office
G. Cost of tapes used to record comments made by individuals in a focus group session (These
tapes are sent to the company whose products are being tested.)
H. Gasoline costs of Market Focus staff for company-owned vehicles (Staff members submit
monthly bills with no mileage breakdowns.)
I. Costs incurred to improve the design of focus groups to make them more effective
SOLUTION
Cost object: Each individual focus group
Cost variability: With respect to the number of focus groups
There may be some debate over classifications of individual items, especially with regard
to cost variability.
2-7
Cost Item
D or I
V or F
A
D
V
B
I
F
C
I
Va
D
I
F
E
I
V
F
I
F
G
D
V
H
I
Vb
I I F
aSome students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost
if Market Focus has a flat monthly charge for a line, irrespective of the amount of usage.
bGasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes,
and detailed records may be required to examine how costs vary with changes in one of the many purposes served.
2-19 (15–20 min.) Classification of costs, merchandising sector.
Band Box Entertainment (BBE) operates a large store in Atlanta, Georgia. The store has both a
movie (DVD) section and a music (CD) section. BBE reports revenues for the movie section
separately from the music section.
Required: Classify each cost item (A–H) as follows:
a. Direct or indirect (D or I) costs of the total number of DVDs sold.
b. Variable or fixed (V or F) costs of how the total costs of the movie section change as the total
number of DVDs sold changes. (If in doubt, select on the basis of whether the total costs will
change substantially if there is a large change in the total number of DVDs sold.)
You will have two answers (D or I; V or F) for each of the following items:
Cost Item
D or I V or F
A. Annual retainer paid to a video distributor
B. Cost of store manager’s salary
C. Costs of DVDs purchased for sale to customers
D. Subscription to DVD Trends magazine
E. Leasing of computer software used for financial budgeting at the BBE store
F. Cost of popcorn provided free to all customers of the BBE store
G. Cost of cleaning the store every night after closing
H. Freight-in costs of DVDs purchased by BBE
SOLUTION
Cost object: DVDs sold in movie section of store
Cost variability: With respect to changes in the number of DVDs sold
There may be some debate over classifications of individual items, especially with regard
to cost variability.
Cost Item
D or I
V or F
A
D
F
B
I
F
C
D
V
D
D
F
E
I
F
F
I
V
G
I
F
H
D
V
2-20 (15–20 min.) Classification of costs, manufacturing sector.
The Kitakyushu, Japan, plant of Nissan Motor Corporation assembles two types of cars (Teanas
and Muranos). Separate assembly lines are used for each type of car.
Required: Classify each cost item (A–H) as follows:
a. Direct or indirect (D or I) costs for the total number of Teanas assembled.
b. Variable or fixed (V or F) costs depending on how total costs change as the total number of
Teanas assembled changes. (If in doubt, select on the basis of whether the total costs will
change substantially if there is a large change in the total number of Teanas assembled.)
You will have two answers (D or I; V or F) for each of the following items:
Cost Item
D or I V or F
A. Cost of tires used on Teanas
B. Salary of public relations manager for Kitakyushu plant
C. Annual awards dinner for Teana suppliers
D. Cost of lubricant used on the Teana assembly line
E. Freight costs of Teana engines shipped from Yokohama to Kitakyushu
F. Electricity costs for Teana assembly line (single bill covers entire plant)
G. Wages paid to temporary assembly-line workers hired in periods of high Teana production
(paid on hourly basis)
H. Annual fire-insurance policy cost for Kitakyushu plant
SOLUTION
Cost object: Type of car assembled (Teana or Murano)
Cost variability: With respect to changes in the number of Teanas assembled
There may be some debate over classifications of individual items, especially with regard
to cost variability.
Cost Item
D or I
V or F
A
D
V
2-9
B
I
F
C
D
F
D
D
V
E
D
V
F
I
V
G
D
V
H
I
F
2-21 (20 min.) Variable costs, fixed costs, total costs.
Bridget Ashton is getting ready to open a small restaurant. She is on a tight budget and must choose
between the following long-distance phone plans:
Plan A: Pay 10 cents per minute of long–distance calling.
Plan B: Pay a fixed monthly fee of $15 for up to 240 long-distance minutes and 8 cents per minute
thereafter (if she uses fewer than 240 minutes in any month, she still pays $15 for the
month).
Plan C: Pay a fixed monthly fee of $22 for up to 510 long-distance minutes and 5 cents per minute
there- after (if she uses fewer than 510 minutes, she still pays $22 for the month).
Required:
1. Draw a graph of the total monthly costs of the three plans for different levels of monthly long-
distance calling.
2. Which plan should Ashton choose if she expects to make 100 minutes of long–distance calls?
240 minutes? 540 minutes?
SOLUTION
1.
Minutes/month
0
50
100
150
200
240
300
327.5
350
400
450
510
540
600
650
Plan A ($/month)
0
5
10
15
20
24
30
32.75
35
40
45
51
54
60
65
Plan B ($/month)
15
15
15
15
15
15
19.80
22
23.80
27.80
31.80
36.60
39
43.80
47.80
Plan C ($/month)
22
22
22
22
22
22
22
22
22
22
22
22
23.50
26.50
29
0
10
20
30
40
50
60
0100 200 300 400 500 600
Total Cost
Number of long-distance minutes
Plan A
Plan B
Plan C
2. In each region, Ashton chooses the plan that has the lowest cost. From the graph (or from
calculations)*, we can see that if Ashton expects to use 0–150 minutes of long-distance each
2-10
month, she should buy Plan A; for 150–327.5 minutes, Plan B; and for more than 327.5 minutes,
Plan C. If Ashton plans to make 100 minutes of long–distance calls each month, she should choose
Plan A; for 240 minutes, choose Plan B; for 540 minutes, choose Plan C.
*Let x be the number of minutes when Plan A and Plan B have equal cost
$0.10x = $15
x = $15 ÷ $0.10 per minute = 150 minutes.
Let y be the number of minutes when Plan B and Plan C have equal cost
$15 + $0.08 (y – 240) = $22
$0.08 (y – 240) = $22 – $15 = $7
y – 240 =
$7 87.5
$0.08 =
y = 87.5 + 240 = 327.5 minutes
2-22 (15–20 min.) Variable costs and fixed costs.
Beacher Motors specializes in producing one specialty vehicle. It is called Surfer and is styled to
easily fit multiple surfboards in its back area and top–mounted storage racks. Beacher has the
following manufacturing costs:
Plant management costs, $1,200,000 per year
Cost of leasing equipment, $1,800,000 per year
Workers’ wages, $700 per Surfer vehicle produced
Direct materials costs: Steel, $1,500 per Surfer; Tires, $125 per tire, each Surfer takes 5 tires (one
spare).
City license, which is charged monthly based on the number of tires used in production:
0–500 tires
$ 50,000
501–1,000 tires
$ 74,500
more than 1,000 tires
$200,000
Beacher currently produces 110 vehicles per month.
Required:
1. What is the variable manufacturing cost per vehicle? What is the fixed manufacturing cost per
month?
2. Plot a graph for the variable manufacturing costs and a second for the fixed manufacturing
costs per month. How does the concept of relevant range relate to your graphs? Explain.
3. What is the total manufacturing cost of each vehicle if 100 vehicles are produced each month?
225 vehicles? How do you explain the difference in the manufacturing cost per unit?