[justify] Cost Management Terminology
.A cost object is any entity to which costs can be attached. A cost driver is the basis used to assign costs to a cost object. The cost driver is the cause of the cost.
• The [gdwl]costs of manufacturing [/gdwl]a product can be classified as one of three types: direct
materials, direct labor, and manufacturing overhead. Overhead typically consists of indirect materials, indirect labor, and factory operating costs.
• Manufacturing costs are often grouped as either prime costs (direct materials plus direct
labor) or conversion costs (direct labor plus manufacturing overhead).
• Operating a manufacturing concern also requires the incurrence of non manufacturing
costs, consisting of selling (marketing) costs and administrative expenses.
• Product costs (also called inventoriable costs) are capitalized as part of finished goods
inventory. They eventually become a component of cost of goods sold. Period costs are expensed as incurred, i.e., they are not capitalized in finished goods inventory and are thus
[gdwl]excluded from cost of goods sold[/gdwl].· .
• For external reporting, all manufacturing costs (direct materials, direct labor, variable
overhead, and fixed overhead) must be treated as product costs, and all selling and administrative (S&A) costs must be treated as period costs. This approach is called absorption costing (also called full costing).
• For internal reporting, only variable manufacturing costs are capitalized as product
costs. All other costs (variable S&A and the fixed portion of both production and S&A expenses) are treated as period costs. This approach is called variable costing (also called direct costing).
• Direct costs are ones that can be associated with a particular cost object in an
economically feasible way, i.e., they can be traced to that object. Indirect costs are ones that cannot be associated with a particular cost object in an economically feasible way and thus must be allocated to that object.
• To simplify the allocation process, indirect costs are often collected in cost pools. A cost
pool is an account into which a variety of similar cost elements with a common cause are accumulated. Manufacturing overhead is a commonly used example.
Cost Behavior and Relevant Range
• The relevant range defines the limits within which per-unit variable costs remain constant
and fixed costs are not changeable. It is synonymous with the short run.
• Variable cost per unit remains constant in the short run regardless of the level of
production. Variable costs in total, on the other hand, vary directly and proportionally with changes in volume.
• Fixed costs in total remain unchanged in the short run regardless of production
level. Fixed cost per unit, on the other hand, varies indirectly with the activity level.
• Mixed (semivariable) costs combine fixed and variable elements.
• Marginal cost is the cost incurred by a one-unit increase in the activity level of a particular
cost driver. Necessarily then, marginal cost remains constant across the relevant range.

Cost Classification

Cost of goods sold is a straightforward computation for a retailer because retailers have only a single class of inventory. The calculation is more complex for a manufacturer because manufacturers have three distinct classes of inventory. The manufacturer's
cost of goods manufactured is analogous to the retailer's purchases account.
Costs can be defined in conceptual groupings.
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Controllable vs. noncontrollable costs
Avoidable vs. committed costs
Incremental vs. differential cost
Engineered vs. discretionary costs
Outlay vs. opportunity cost (explicit vs. implicit)
Economic vs. imputed cost
Relevant vs. sunk costs (historical cost is a sunk cost)
Manufacturing processes their own particular cost groups.
Joint costs, separable costs, and by-products
Normal vs. abnormal spoilage
Rework, scrap, and waste
Costing Techniques
• Absorption vs. Variable Costing

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• Absorption costing treats all manufacturing costs as product costs. The inventoried
cost of the product thus includes all production costs, whether variable or fixed. This technique is required under GAAP.
• Variable costing considers only variable manufacturing costs to be product costs, i.e.,
inventoriable. Fixed manufacturing costs are considered period costs and are thus expensed as incurred. This technique is permitted for internal reporting only.
• Normalized Costing
• Actual costing is the most accurate, but also the least timely and most volatile,
method of accumulating costs.
• Normal costing charges actual direct materials and direct labor to a cost object, but
applies overhead on the basis of budgeted (normalized) rates.
• Extended normal costing extends the use of normalized rates to manufacturing
overhead so that ail three major input categories use normalized rates.
• Cost Accumulation Systems
Job-order costing for manufacturing customized products
Process costing for mass production
Activity-based costing (ABC) when overhead is a high proportion of the total cost
life-cycle costing to ,track a product's lifetime costs
• Standard costing is a system designed to alert management when the actual costs of
production differ significantly from target ("standard") costs. Standard costs are predetermined, attainable unit costs.
• Four methods for allocating joint costs are
Physical unit method
Sales-value at split-off method '
Estimated net realizable value (NRV) method
Constant gross-margin percentage NRV method
• Three methods for allocating service department costs are in common use:
Direct method
Step-down method
Reciprocal method

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