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

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ISBN: 0-536-53243-5 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.
EXHIBIT 2-1 Examples of Cost Objects at Procter & Gamble Cost Object Product Service Project Customer Brand category Activity Department Illustration Crest Tartar Control: Original Flavor toothpaste product Telephone hotline providing information and assistance to users of Pampers Diapers products R&D project on alternative scent-free formulations of Tide detergent products Safeway, the retailer, which purchases a broad range of Procter & Gamble products Vidal Sassoon range of hairstyle products Development and updating Web site on the Internet or setting up machines for production Environmental, Health, and Safety Department that houses the editorial staffs of magazines published by Time Warner, such as Time, People, and Sports Illustrated. This leasing cost is an indirect cost of Sports Illustrated. The company can trace the lease amount paid to the building, but there is no separate lease agreement for the space used solely by the editorial staff of Sports Illustrated. Therefore, the company cannot trace the lease cost to Sports Illustrated. Time Warner can, however, allocate to Sports Illustrated a part of the lease cost of the building, for example, on the basis of an estimate of the relative percentage of the building’s total floor space occupied by the Sports Illustrated editorial staff. Managers want to assign costs accurately to cost objects. Inaccurate product costs will mislead managers about the profitability of different products; as a result, managers might unknowingly promote unprofitable products while deemphasizing profitable products. Generally, managers are more confident about the accuracy of direct costs of cost objects, such as the paper cost of Sports Illustrated magazine. Indirect costs pose more problems. Consider the lease. Allocating the cost of the lease on the basis of the total floor space occupied by the staff of each magazine makes sense. This approach measures the building resources used by each magazine reasonably accurately. The more floor space a department occupies, the more lease costs that should be assigned to it. This allocation assumes that the quality of the space (such as the layout and the number of windows offering a good view) used by the different magazines is fairly similar. Accurately allocating other indirect costs, such as the cost of Time Warner’s top management, to Sports Illustrated magazine is more difficult. Should these costs be allocated on the basis of the size of the editorial staff? The number of magazines sold? Some other measure? It is not so clear how to measure the share of top management’s time used by each magazine. The Focus on Values and Behaviors feature (p. 29) describes some additional issues managers might face when allocating costs. EXHIBIT 2-2 Cost Assignment to a Cost Object TYPE OF COST Direct Costs Example: Paper on which Sports Illustrated magazine is printed COST ASSIGNMENT Cost Tracing COST OBJECT CHAPTER 2 28 Indirect Costs Example: Lease cost for Time Warner building housing the editors of Sports Illustrated, Time, People, and other magazines Cost Allocation Example: Sports Illustrated magazine ISBN: 0-536-53243-5 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.
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Page 5 and 6: ect cost if the cost object is a pr
Page 7 and 8: Again examine the table. It is prec
Page 9 and 10: EXHIBIT 2-4 $160,000 Fixed-Cost Beh
Page 11 and 12: Study Tip: Practice is helpful if y
Page 13 and 14: EXHIBIT 2-6 Assignment of Costs to
Page 15 and 16: Step 3: Cost of goods manufactured
Page 17 and 18: Prime Costs and Conversion Costs Tw
Page 19 and 20: Benefits of Defining Accounting Ter
Page 21 and 22: 9 Describe a framework for cost acc
Page 23 and 24: SOLUTION 1. Foxwood Company Income
Page 25 and 26: direct materials inventory (p. 37)
Page 27 and 28: . Variable or fixed (V or F) costs
Page 29 and 30: Required 1. What is the unit cost t
Page 31 and 32: 2-33 Income statement and schedule
Page 33 and 34: Required 2-38 Cost analysis, litiga

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