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Cost Pool
Often costs are collected into meaningful groups called cost pools.
Indirect costs of a cost object (not easily traceable to a cost pool or cost object)
Indirect costs are related to the particular cost object but cannot be traced to a cost object in an economically feasible (cost-effective) way. Indirect costs are typically incurred to benefit two or more cost pools or objects.
Cost allocation is necessary for, among other things, product costing (P1 CMA), pricing(P2 CMA),, investment and disinvestment decisions(P2 CMA),, managerial performance measurement(P1 CMA),, make-or-buy decisions(P2 CMA), determination of profitability(P2 CMA), and measuring income and assets for external reporting(P1 CMA).
Cost allocation is less meaningful for internal purposes because responsibility accounting systems emphasize controllability, a process often ignored in cost allocation.
Cost Tracing
Cost Allocation
Reasons for indirect cost allocation to cost objects measure income and assets for external reporting purposes. justify costs for reimbursement purposes. provide information for economic decision making To motivate managers and employees
Common practice (single cost pool) Usually all indirect costs-for indirect materials, indirect labor, and other indirect items-are commonly combined into a single cost pool called overhead.
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 4
The previous costs can be combined as follows 1. Prime costs which include (DM & DL) and 2. Conversion cost which include (DL & MOH).
Nonmanufacturing costs (selling, general, and administrative (SG&A) costs) (Treated as Period Costs)
Nonmanufacturing costs are often divided into two categories: (1) Selling costs and (2) General & administrative costs. Nonmanufacturing costs can be viewed by the value chain costs other than manufacturing: o o o o o o Research and development costs Design costs Marketing costs Distribution costs Customer service costs Administrative costs
PASS KEY Cost accounting systems are designed to meet the goal of measuring cost objects or objectives. The most frequent objectives include: Product Costing (inventory and cost of goods manufactured and sold) Efficiency Measurements (comparisons to standards) Income Determination (profitability)
Variable costs in total, on the other hand, vary directly and proportionally with changes in volume. Straight line, sloping upward to the right.
B. FIXED COST
1. Behavior In the short-term and within a relevant range, a fixed cost does not change when the cost driver changes. A fixed cost is a cost that remains constant, in total, for a given time period despite, regardless of changes in the level of activity. 2. Amount (Varies per Unit, Total Remains Constant) PASS KEY The distinction between variable costs and fixed costs allows managers to determine the effect of a given percentage change in production output on costs. Be careful! The examiners often attempt to trick candidates by providing a fixed cost per unit for a given volume of production. As fixed costs are "fixed," the candidate must convert this format to a dollar amount that will not change as production volume changes within a relevant range.
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 7
3. Long-Run Characteristics Given enough time (and a long enough relevant range), any cost can be considered variable.
Fixed cost per unit, on the other hand, varies indirectly with the activity level, the unit cost decreases as volume increases.
Step Costs a cost is said to be a step cost when it varies with the cost driver but does so in discrete steps (Exhibit 3-15).step costs is another type of nonlinear-cost function, one that is constant over small ranges of output but increases by steps (discrete amounts) as levels of activity increase.
The numerator can be derived by subtracting the cost at the lowest level
(July) from the cost at the highest level (May) [$3,400 $1,900 = $1,500].
The variable portion of the cost is therefore $1.875 per machine hour ($1,500 800). The fixed portion can be calculated by inserting the appropriate values for either the high or low month in the
range:
Prepared by: Sameh.Y.El-lithy. CMA,CIA. 9
Fixed portion = Total cost Variable portion = $1,900 ($1.875 800 hours) = $1,900 $1,500 = $400 The regression (scattergraph) method The regression (scattergraph) method is considerably more complex and determines the average rate of variability of a mixed cost rather than the variability between the high and low points in the range.
Exhibit 3-9 shows examples of costs in each of these four cost classifications for the Ford Windstar.
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Relevant Cost
The concept of relevant cost arises when the decision maker must choose between two or more options. To determine which option is best, the decision maker must determine which option offers the highest benefit, usually in dollars. Thus, the decision maker needs information on relevant costs. A relevant cost has two properties: (1) it differs for each decision option and (2) it will be incurred in the future. If a cost is the same for each option, including it in the decision only wastes time and increases the possibility for simple errors. Costs that have already been incurred or committed are irrelevant because there is no longer any discretion about them.
Sunk Cost
Sunk costs are costs that have been incurred or committed in the past and are therefore irrelevant because the decision maker no longer has discretion over them. For example, if a company purchased a new machine without warranty that failed the next day, the purchase price is irrelevant for the present decision to replace or to repair the machine.
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Avoidable vs. Committed (establish the current level of operating capacity/ typically fixed costs)
Avoidable costs are those that may be eliminated by not engaging in an activity or by performing it more efficiently. An example is direct materials cost, which can be saved by ceasing production. Committed costs Committed costs are Costs which are governed mainly by past decisions that established the present levels of operating and organizational capacity and which only change slowly in response to small changes in capacity. Committed costs are those which are required as a result of past decisions and cannot be altered in the short run. Committed costs arise from holding property, plant, and equipment. Examples are insurance, real estate taxes, Long-term lease payments, and depreciation. They are by nature long-term and cannot be reduced by lowering the short-term level of production.
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Other Costs
Carrying costs are the costs of storing or holding inventory. Examples include the cost of capital, insurance, warehousing, breakage, and obsolescence. Transferred-in costs are those incurred in a preceding department and received in a subsequent department in a multi-departmental production setting. Value-adding costs are the costs of activities that cannot be eliminated without reducing the quality, responsiveness, or quantity of the output required by a customer or the organization.
Practical capacity is the level of capacity that reduces theoretical capacity by unavoidable operating interruptions, such as scheduled maintenance time, shutdowns for holidays, so It allows for unavoidable delays in production for maintenance, holidays, etc. is the maximum level at which output is produced efficiently. Is the upper limit of a companys productive output capacity given its existing resources. Use of practical capacity as a denominator value usually results in underapplied overhead because it always exceeds the actual level of use (U.7)
These two capacity utilization levels can differ-for example, when an industry has cyclical periods of high and low demand or when management believes that the budgeted production for the coming period is not representative of long-run demand.
Costing Techniques
The rest of the current chapter provide you with a brief explanation with the various topics that will be studied in more details in the rest of the current part, the major topics are: 1. Inventory Costing: absorption costing (AC) Vs. variable costing (VC), (Ch.5) 2. Cost Accumulation, Cost Measurement and Overhead Assignment in traditional costing system and in ABC. (Ch.4& 5) 3. Cost Allocation (Ch .5) a. Allocating joint costs b. Allocating service department costs 4. Standard Costing, Flexible Budgeting, and Variance Analysis (Ch.7) 5. Target costing :market price of the product is taken as a given.(P2 CMA)
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