2 an introduction to cost terms and purposes - Pearson Learning ...

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Costs and Cost Terminology
Accountants define cost as a resource sacrificed or forgone to achieve a specific objective.
A cost (such as direct materials or advertising) is usually measured as the monetary
amount that must be paid to acquire goods or services. An actual cost is the cost incurred
(a historical or past cost), as distinguished from a budgeted cost, which is a predicted or
forecasted cost (a future cost).
To guide their decisions, managers want to know how much a particular thing (such
as a product, machine, service, or process) costs. We call this thing a cost object, which is
anything for which a measurement of costs is desired. Exhibit 2-1 lists examples of different
types of cost objects for which Procter & Gamble, the consumer-products company,
wants to know the costs.
A costing system typically accounts for costs in two basic stages: accumulation followed
by assignment. Cost accumulation is the collection of cost data in some organized
way by means of an accounting system. For example, a publishing company that
purchases rolls of paper for printing magazines collects (accumulates) the costs of individual
rolls used in any one month to obtain the total monthly cost of paper. Beyond
accumulating costs, managers with the help of management accountants assign costs to
designated cost objects (such as the different magazines the company publishes) to
help them make strategic decisions (such as the pricing of different magazines and
which magazines to emphasize). Managers also assign costs to cost objects to implement
strategy. For example, costs assigned to a department aid in decision making
about department efficiency. Costs assigned to customers help managers understand
the profit earned from different customers and help them make decisions about how to
allocate resources to support different customers. Cost assignment is a general term
that encompasses both (1) tracing accumulated costs that have a direct relationship to
a cost object and (2) allocating accumulated costs that have an indirect relationship to
a cost object.
Direct Costs and Indirect Costs
We now describe how costs are classified as direct and indirect costs and the methods
used to assign these costs to cost objects.
Cost Tracing and Cost Allocation
■ Direct costs of a cost object are related to the particular cost object and can be traced
to it in an economically feasible (cost-effective) way. For example, the cost of cans or
bottles is a direct cost of Pepsi-Colas. The cost of the cans or bottles can be easily
traced to or identified with the drink. The term cost tracing is used to describe the
assignment of direct costs to a particular cost object.
■ Indirect costs of a cost object are related to the particular cost object but cannot be
traced to it in an economically feasible (cost-effective) way. For example, the salaries
of supervisors who oversee production of the many different soft drink products bottled
at a Pepsi plant are an indirect cost of Pepsi-Colas. Supervision costs are related
to the cost object (Pepsi-Colas) because supervision is necessary for managing the
production and sale of Pepsi-Colas. Supervision costs are indirect costs because
supervisors also oversee the production of other products, such as 7-Up. Unlike the
cost of cans or bottles, it is impossible to trace supervision costs to the Pepsi-Cola
line. The term cost allocation is used to describe the assignment of indirect costs to
a particular cost object.
Exhibit 2-2 depicts direct costs and indirect costs and both forms of cost assignment—
cost tracing and cost allocation—using the example of Sports Illustrated magazine, which
is published by Time Warner. The cost object is the Sports Illustrated magazine. The paper
on which the magazine is printed is a direct cost. The cost of the paper can be traced in a
cost-effective way to Sports Illustrated magazine. Consider the cost of leasing the building
An understanding of this
chapter’s cost terms and
concepts provides the foundation
for the remaining chapters.
Study Tip: Go to www.
prenhall.com/harris and
print Chapter 2 of the Student
Guide. Use the Highlights (pp.
9–12) to preview the chapter.
In the definition of cost,
“sacrificed” refers to a
resource that is consumed—for
example, a company paying
$3,000 to lease a warehouse.
“Forgone” refers to giving up an
opportunity to use a resource—
for example, after spending the
$3,000 to lease a warehouse,
the company could not use that
$3,000 for another purpose.
1
Define and illustrate a
cost object
. . . examples of cost
objects are products,
services, activities,
processes, parts of the
organization, and
customers
In each of the following
questions, the cost object
is in italics: What selling price
should be charged for a product?
Which machine is the least
expensive to operate?
2
Distinguish between
direct costs
. . . costs that are traced
directly to the cost object
and indirect costs
. . . costs that are allocated
to the cost object
Consider the audits performed
by a public accounting
firm. The firm traces
direct professional labor costs
to each audit using time records.
Indirect costs, such as
rent on the firm’s office space
and depreciation on its computers,
cannot be traced to individual
audits, so these costs must
be allocated to the audits.
An Introduction to Cost Terms and Purposes
27
Cost Accounting: A Managerial Emphasis, Twelfth Edition, by Charles T. Horngren, Srikant M. Datar, and George Foster.
Copyright © 2006 by Pearson Education, Inc. Published by Prentice Hall.