cost accounting,

1. Chapter Two
Cost Behaviour, Cost
Estimation, and Product
Costing
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2. Chapter Outline






Introduction
Classification of costs
Determining product and service costs
Cost estimation methods
Data collection problems
Conclusion
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3. What Do We Mean By a Cost?
A Cost
is the measure of
resources given
up to achieve a
particular purpose.
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4. Why Do We Need the information?
To assist managers in planning,
controlling and decision making
e.g. Naza Motors need to decide on
the selling price of the Naza Sutera
– require the total production costs
of the model
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5. Cost Objects

A cost object is something for which a company wants to know
the cost. It may be a product, service, customer, department
and so on, for which costs are measured and assigned.

E.g. To know the cost of its Bachelor of Accounting
programme, then the Bachelor of Accounting programme is the
cost object.

All costs related to the Bachelor of Accounting programme are
accumulated and assigned to the cost object, such as the cost
of the salaries of lecturers teaching in the programme, the cost
of printing brochures on the programme, the cost of salaries of
administrative staff servicing the programme, and so on.
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6. Cost terms and classifications
Fixed and Variable
Direct vs Indirect
Product vs Period
Manufacturing vs Non-manufacturing
Opportunity cost
Sunk cost
Prime costs
Conversion costs
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7. Cost Classifications
Cost behavior means
how a cost will react
to changes in the
level of business
activity.


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Total variable costs change
when activity changes.
Total fixed costs remain
unchanged when activity
changes.
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8. Variable Costs (a)total (b) per unit
Paper
Costs
Paper
Costs
No. of students
(a)
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No. of students
(b)
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9. Fixed Costs (a) Total (b) Per unit
Professor’s
salary (RM)
Professor’s
salary (RM)
No. of students
(a)
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No. of students
(b)
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10. Cost Classifications
Summary of Variable and Fixed Cost Behavior
Cost
In Total
Per Unit
Variable
Total variable cost changes
as activity level changes.
Variable cost per unit
remains the same over
wide ranges of activity.
Total fixed cost remains
the same even when the
activity level changes.
Fixed cost per unit
goes down as activity
level goes up.
Fixed
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11. Semi variable

Some costs are neither
fixed nor variable but a
little bit of both.
 A semivariable cost is
partly fixed and partly
variable
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.
Consider the
following electric
utility example.
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12. Total Utility Cost
Semivariable(mixed) Cost
Slope is
variable cost
per unit
of activity.
Variable
Utility Charge
Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
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13. Semi fixed or step fixed costs

Within a given time period and within specific
activity level, they are fixed, but that
eventually increase or decrease by a constant
amount at various critical activity levels
Supervisor’s Salary
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Output
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14. Step-variable Cost
Total Cost
Nearly variable but
increases in small
steps instead of
continously.
e.g. part time
employees called upon
for relatively small
increments of time such
as few hours (delivery
truck drivers of a
bakery )
Activity (Hours)
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15. Product Costs, and Period Costs
Product costs are costs associated with
goods for sale until the time period during
which the products are sold, at which time the
costs become expenses. e.g. costs of raw
materials
Period costs are costs that are expensed
during the time period in which they are
incurred. Includes all non manufacturing costs
e.g. salary of clerks
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16. Cost Classifications on Financial
Statements – Income Statement
Product Costs
Cost of goods sold
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Period Costs
Operating expenses
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17. Direct and Indirect Costs
Direct costs
Indirect costs

Costs that can be
easily and
conveniently traced to
a product or
department.

Costs that must be
allocated in order to
be assigned to a
product or
department.

example: cost of paint
in the paint
department of an
automobile assembly
plant.

example: cost of
national advertising
for an airline is
indirect to a particular
flight.
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18. Manufacturing Costs
Direct
Labor
Direct
Material
Manufacturing
Overhead
The
Product
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19. Manufacturing Companies
There are 3 major categories of
manufacturing costs:
Direct Materials
resources that
can be feasibly
observed being
used to make a
specific product.
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Direct Labor
The cost of
paying
employees who
convert direct
materials into
finished product.
Manufacturing
Overhead
Indirect material
Indirect labor
Other overhead
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20. Direct Material
Cost of raw material that is used to
make, and can be conveniently
traced, to the finished product.
Example:
Steel used to
manufacture
the automobile.
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21. Direct Labor
Cost of salaries, wages, and fringe
benefits for personnel who work
directly on manufactured products.
Example:
Wages paid to an
automobile assembly
worker.
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22. Committed Costs
Fixed costs that have been incurred to
provide facilities to enable firms to
produce its products.
e.g.: space, equipment, factory buildings
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23. Discretionary costs
Costs that are decided by management
Sometimes called “managed costs”
e.g.: advertising, repairs, research and
development expenses
May be changed when company is
experiencing a difficult time
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24. Opportunity Cost
The potential benefit that
is given up when one
alternative is selected
over another.

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Example: If you were
not attending college,
you could be earning
$60,000 per year.
Your opportunity cost
of attending college for one
year is $60,000.
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25. Sunk Costs
All costs incurred in the past that cannot be changed
by any decision made now or in the future are sunk
costs.
Sunk costs should not be considered in decisions.

Example: You bought an automobile that cost $72,000
two years ago. The $72,000 cost is sunk because
whether you drive it, park it, trade it, or sell it, you
cannot change the $72,000 cost.
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26. Cost estimation, cost behaviour and
cost prediction
Cost
estimation
Cost
behavior
Cost
prediction
Process of
determining
cost behavior,
often focusing
on historical
data.
Relationship
between
cost and
activity.
Using knowledge
of cost behavior
to forecast
level of cost at
a particular
activity. Focus
is on the future.
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27. Assumptions in Cost-Behavior
Estimation
Changes in total costs can be explained by
changes in the level of a single activity.
Cost behavior can adequately be
approximated by a linear function of the
activity level within the relevant range.
Using equation TC = TFC + TVC
TC = TFC + VC per unit x Q (Q = activity level)
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28. Cost Estimation Methods
Account classification method
 Conference method
 Industrial engineering method
 Visual fit method
 High low method
 Least squares regression method
 Multiple regression

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29. Cost Estimation Approaches
These methods differ in terms of:
The costs of undertaking the analysis
 The assumptions they make
 The accuracy of the estimated cost

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30. Account classification method
Estimates cost by classifying cost
accounts in the subsidiary ledger as
variable, fixed or mixed with respect to
the identified level of activity
 Use qualitative analysis when making
cost classifications

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31. Account Classification Method
Example
Account
Indirect Labor
Indirect Material
Depreciation
Property Taxes
Insurance
Utilities
Maintenance
Totals
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Overhead
Total
Cost
$
450
700
1,000
200
300
400
600
$ 3,650
Costs for 1,000 Units
Variable
Fixed
Cost
Cost
$
450
700
1,000
200
300
350
50
500
100
$ 2,000
$ 1,650
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32. Conference Method

Estimates cost functions on the basis of
ANALYSIS and OPINIONS about costs
and their drivers gathered from various
departments of a company (e.g.
purchasing dept, process engineering,
production dept and so on)
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33. Industrial Engineering Method


Also known as work measurement method
Estimates cost functions by analyzing the
relationship between inputs and outputs in
physical terms
 e.g. carpet manufacturer use INPUTS –
cotton, wool, dyes, direct labor, machine time,
power to produce OUTPUT- square yards of
carpet
 TIME AND MOTION STUDY may conclude
that to produce 10 square yards require 1
hour of direct labor
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34. Quantitative Analysis Method
Uses a formal mathematical method to
fit cost functions to past data
observations
 Visual fit method
 High low method – the simplest
method
 Regression analysis – simple and
multiple regression

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35. Visual-Fit Method
Total Cost in
1,000’s of Dollars
Plot the data points on a
graph (total cost vs. activity).
20
10
* *
* *
* ** *
**
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
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36. Visual-Fit Method
Total Cost in
1,000’s of Dollars
Draw a line through the plotted data points so that about
equal numbers of points fall above and below the line
20
10
* *
* *
* ** *
**
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
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37. Visual-Fit Method
Total Cost in
1,000’s of Dollars
Total variable cost = Total cost – Total fixed cost
Total variable cost = $16,000 – $10,000 = $6,000
Unit variable cost = $6,000 ÷ 3,000 units = $2
Estimated fixed cost =
$10,000
20
* ** *
Vertical distance
**
is total cost,
* *
* *
10
approximately
$16,000.
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
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38. The High-Low Method
MiraCo recorded the following production
activity and maintenance costs for two
months:
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
Using these two levels of activity, compute:
 the variable cost per unit.
 the total fixed cost.
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39. The High-Low Method
High activity level
Low activity level
Change
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Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
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40. The High-Low Method
Question 1
If sales commissions are $10,000 when 80,000
units are sold and $14,000 when 120,000 units
are sold, what is the variable portion of sales
commission per unit sold?
a.
b.
c.
d.
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$.08 per unit
$.10 per unit
$.12 per unit
$.125 per unit
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41. The High-Low Method
Question 2
If sales commissions are $10,000 when 80,000
units are sold and $14,000 when 120,000 units
are sold, what is the fixed portion of the sales
commission?
a.
b.
c.
d.
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$ 2,000
$ 4,000
$10,000
$12,000
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42. Least-Squares Regression
Method

Statistics courses and
computer courses deal
with detailed regression
computations using
computer spreadsheet
software.
 Accountants and
managers must be able
to interpret and use
regression estimates.
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43. Regression Analysis
The regression equation and regression line
are derived using the least-squares technique.
The objective of least-squares is to develop
estimates of the parameters a and b.
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44. Least-Squares Regression
Method
Regression is a statistical procedure used
to determine the relationship between
variables such as activity and cost.
Total Cost
The objective of
the regression
method is the
general cost equation:
Y = a + bX
in cost terms
TC = F + VX
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Activity
44

45. Data collection problems





Missing data
Outliers
Allocated and discretionary costs
Inflation
Mismatched time periods
All cost-estimation methods are based on
simplifying assumptions so that the benefits of
use outweigh the costs of data collection and
manipulation.
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46. End of Chapter 2
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