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

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$College of Marin Study Guide for Math 95 A,B - Pearson Learning ...$

F CUS ON VALUES AND BEHAVIORS OVERCHARGING THE U.S. GOVERNMENT Distinguishing direct costs from indirect costs and deciding how to allocate indirect costs to products requires management accountants to work closely with managers. Sometimes, however, managers may have a personal financial incentive to propose a cost allocation method that will allocate fewer costs to some products and higher costs to others. For example, General Electric (GE), a top Fortune 500 company with multimillion-dollar government aerospace contracts, was found to have overcharged employee direct labor hours on projects. Top management responded by developing the company’s ethics and integrity policy, which all employees must now sign when hired. In addition, the company posts its policy publicly on the Web and includes a section urging employees to be on the lookout for improper, incomplete, or unauthorized cost charging on contracts. Consider another example. The U.S. Department of Defense (DoD) has contracts with private companies such as Lockheed Martin, General Dynamics, and Boeing to supply military equipment such as fighter jets, submarines, and tanks. Through its own internal Defense Contract Audit Agency (DCAA), the DoD discovered that some of its equipment suppliers had overallocated indirect costs to the DoD products and underallocated indirect costs to their other commercial products. The reason: The DoD paid suppliers on the basis of a cost-plus profit margin. The higher the costs the supplier allocated to the DoD business, the higher the revenues the supplier earned. In a recent case, the DCAA, through its normal audit process, found that Halliburton KBR overcharged the U.S. government as much as $61 million for fuel sold to Iraq as part of the government’s rebuilding contract. Management accountants must always make careful and professional judgments when choosing among alternative cost-allocation methods. The failure of the defense contractors’ management accountants to properly allocate costs to the DoD led to severe penalties and fines for their companies and, in some cases, criminal prosecution. Sources: For Halliburton and DCAA; Lawrence DiRita, Acting ASD (Public Affairs) Thursday, December 11, 2003; www.defenselink.mil/transcripts/2003/ tr20031211-0985.html. For General Electric: www.ge.com/en/commitment/social/integrity/workwith_govt.htm. ISBN: 0-536-53243-5 Factors Affecting Direct/Indirect Cost Classifications Several factors affect the classification of a cost as direct or indirect: ■ The materiality of the cost in question. The smaller the amount of a cost—that is, the more immaterial the cost is—the less likely that it is economically feasible to trace that cost to a particular cost object. Consider a mail-order catalog company like Lands’ End. It would be economically feasible to trace the courier charge for delivering a package to an individual customer as a direct cost. In contrast, the cost of the invoice paper included in the package would be classified as an indirect cost. Why? Because although the cost of the paper can be traced to each customer, it is not costeffective to do so. The benefits of knowing that exactly, say, 0.5 cent worth of paper is included in each package do not exceed the data processing and administrative costs of tracing the cost to each package. ■ Available information-gathering technology. Improvements in information-gathering technology make it possible to consider more and more costs as direct costs. Bar codes, for example, allow manufacturing plants to treat certain low-cost materials such as clips and screws, which were previously classified as indirect costs, as direct costs of products. At Dell, component parts such as the computer chip and the CD- ROM drive display a bar code that can be scanned at every point in the production process. Bar codes can be read into a manufacturing cost file by waving a “wand” in the same quick and efficient way supermarket checkout clerks enter the cost of each item purchased by a customer. ■ Design of operations. Classifying a cost as direct is easier if a company’s facility (or some part of it) is used exclusively for a specific cost object, such as a specific product or a particular customer. For example, the cost of the General Chemicals facility that is dedicated to manufacturing soda ash is a direct cost of soda ash. Be aware that a specific cost may be both a direct cost of one cost object and an indirect cost of another cost object. That is, the direct/indirect classification depends on the choice of the cost object. For example, the salary of an Assembly Department supervisor at BMW is a direct cost if the cost object is the Assembly Department, but it is an indi- An Introduction to Cost Terms and Purposes 29 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.
ect cost if the cost object is a product such as the BMW X5 sport-utility vehicle (SUV) because the Assembly Department assembles many different models. A useful rule of thumb is that the broader the definition of the cost object—the Assembly Department rather than the X5 SUV—the higher the proportion of total costs that are direct costs and the more confidence management has in the accuracy of the resulting cost amounts. 3 Explain variable costs and fixed costs . . . the two basic ways in which costs behave The distinction between variable costs and fixed costs is necessary to address key questions. For example, how much would manufacturing costs change if the output level increased by 5%? Cost-Behavior Patterns: Variable Costs and Fixed Costs Costing systems record the cost of resources acquired, such as materials, labor, and equipment, and track how those resources are used to produce and sell products or services. Recording the costs of resources acquired and used allows managers to see how costs behave. Consider two basic types of cost-behavior patterns found in many accounting systems. A variable cost changes in total in proportion to changes in the related level of total activity or volume. A fixed cost remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume. Costs are defined as variable or fixed with respect to a specific activity and for a given time period. The Global Surveys of Company Practice on page 31 indicate that identifying a cost as variable or fixed helps in making many management decisions. To illustrate these two basic types of costs, consider costs at the Spartanburg, South Carolina, plant of BMW. 1. Variable Costs: If BMW buys a steering wheel at $60 for each of its BMW X5 vehicles, then the total cost of steering wheels should be $60 times the number of vehicles produced, as the following table illustrates. Number of Variable Cost per Total Variable Cost X5s Produced Steering Wheel of Steering Wheels (1) (2) (3) = (1) × (2) 1 $60 $ 60 1,000 60 60,000 3,000 60 180,000 The steering wheel cost is an example of a variable cost because total cost changes in proportion to changes in the number of vehicles produced. The cost per unit of a variable cost is the same. Focus on the table. It is precisely because the variable cost per steering wheel in column 2 is the same that the total variable cost of steering wheels in column 3 changes proportionately with the number of X5s produced in column 1. When considering how variable costs behave, always focus on total costs. Exhibit 2-3, Panel A, graphically illustrates the total variable cost of steering wheels. The cost is represented by a straight line that climbs from left to right. The phrases “strictly variable” and “proportionately variable” are sometimes used to describe the variable cost in Panel A. CHAPTER 2 30 EXHIBIT 2-3 Graphs of Variable and Fixed Costs PANEL A: Variable Cost of Steering Wheels at $60 per BMW X5 Assembled Total Cost of Steering Wheels $200,000 $150,000 $100,000 $50,000 $0 0 1,000 2,000 3,000 4,000 X5s Assembled PANEL B: Fixed Leasing Costs of Spartanburg Plant (in millions) Total Leasing Costs $150 $100 $50 $0 0 20,000 40,000 X5s Assembled 60,000 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.
Page 1 and 2: Because of permissions issues, some
Page 3: EXHIBIT 2-1 Examples of Cost Object
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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