Methods and Models for Measuring Costs

Methods and Models for Measuring be constitutes atomic number 18 associated with all fictitious characters of cheeks business, non-business, manufacturing, retail and service. Generally, the kinds of be that atomic number 18 incurred and the way in which these courts be classified depend on the lawsuit of organization involved.In your maintainment you should explain with examples (use dollar value in your examples)How to mea trustworthy live behaviour ( equal measurement)?In charge accountancy, the classification and measurement of fixed and unsettled m championtary value is found on a body of k presentlyledge that involves a number of assumptions. In many cases, the value of fixed and variable follow data depends on the validity of these assumptions. In baffle to avoid poor operating results and faulty decision-making that is likely to occur when anomalous follow assumptions atomic number 18 do, the ability to recognize and measure comprise behavior is essenti al. Various theories of Cost behavior be as follows Variable Cost varies proportionally in score but last outs constant on a per unit stem.a. True variable live proportionately variable (ex. Raw actual) derive utilize orchestrately increases as take increases by the same percentage.b. Step variable comprise be contractable in large segments (ex. Labor be of maintenance workers) and that increase or decrease in response to fairly wide changes in natural action levels. NOTE these terms atomic number 18 constant for a certain activity level (relevant range) and then divert in a step like fashion as volume increases.2. Fixed be remain constant in total but vary inversely on a per unit soil (if output signal increases, then per unit be decreases if production decreases, then per unit cost increases)a. Committed fixed be relate to the investment in plant, equipment and the basic organizational structure of the firm (ex. Depreciation of structure and equipment , real estate taxes, insurance, management salaries, etc.) be long term in nature butt endnot be reduced immediately over a short stage of time without seriously impairing either the profitability or the long run goals of a firm.b. Discretionary Fixed Costs ( Managed Fixed Costs )arise orchestrate annual decisions by management to spend in certain fixed cost areas (ex. Advertising, research, management development programs)short term in nature, usually a single yearpossible to cut back on certain cost for short periods of time with minimum disruptions to long term goals.c. Semi variable or Mixed Costs contains both variable and fixed cost elementsat certain levels of activity mixed costs display the same characteristics as a fixed costat certain levels they display same characteristic as a variable cost(examples electricity, heat, telephone, maintenance, car rental,copy machine rental)3. acquire or In hold Costsa. Direct Costs can be physically traced to the incident segment u nder consideration (product line, sales territory, division, etc.)b. In count on Costs must be allocated in order to be assigned to the segment under consideration (indirect cost is manufacturing belt). NOTE Indirect Costs are too called Common Costs.4. Additional Cost Termsa. Controllable Costs if management at a certain level as the power to authorize and yield the costb. Noncontrollable Costs if management at a certain level is unable to influence the incurrence of the cost.c. Differential Cost present under one resource but is absent under an alternative course of action.NOTE Differential costs are besides known as incremental costs.d. Opportunity Cost potential benefit that is lost or sacrificed whenzselecting one course of action makes it necessary to give up a variouscourse of action.Opportunity cost is not recorded in the books of an organization, but isconsidered in every decision.e. Sunk Cost already incurred and cannot be changed by any decision made now or in the future. An irrelevant cost in decision-making.The econometrical case which is used to analyze costs is a model in which explanatory variable opposes total costs and endogenous variables represent factors that influence their level. Production quantity is the about authorized factor which determines the level of total costs. Total costs consist of both parttotal fixed costs, which appear independently of the production quantity (when production level is zero)total variable costs, which are dependent only if on the production quantityCost Function K = F + VX(Where K is total cost, F is Fixed Cost , V is Variable Cost and X is volume)What is cost score scheme and cost parceling?(Managerial Accounting)SolCost accounting is linked to tax accounting, monetary accounting and managerial accounting because it is an in-chief(postnominal) component of each(prenominal) discipline as cost accounting involves determining the cost of several(prenominal)thing, such as a product, a service, an activity, a project, or rough other cost object. These costs are needed for several purposes. For example, the costs of products and services produced and sold are needed for both tax and out-of-door financial statements. In other words, tax and financial accounting depend on cost accounting to endure cost information. Information about costs is excessively needed for a phase of management decisions. For example, cost estimates are needed to determine whether or not a product or service can be produced and sold at a profit. Unit costs of a product (or service) are besides needed for product pricing and product discontinuance decisions. In addition, accurate cost information is required to determine whether or not a company should make (produce) or buy the raw genuines, separate and subassemblies that choke part of its major products and services. From this perspective, cost accounting is perhaps underrated as a discipline since none of the other disciplines in cluding tax accounting, financial accounting or managerial accounting could exist without cost accounting.The costs associated with a manufacturing firm are separated into two broad categories. These intromit manufacturing costs and selling and administrative costs. This functional separation is important because each category of cost is treated differently in the accounting records. The different treatments are required to obtain square-toed matching.Manufacturing CostsThere are three types of manufacturing costs. These include 1) direct tangible or raw material, 2) direct labor, and 3) indirect manufacturing costs, or factory hit. Direct material becomes the product, or becomes a part of the product. Direct labor converts the direct material into a finished product. Factory overhead represents all the other factory costs that cannot be directly identified with a particular product. This indirect category includes a variety of costs that are discussed in more detail in subseque nt chapters. These three types of costs are also referred to as product costs, or inventorial costs, because they are capitalized in (or charged to) the bloodline, i.e., they become assets.MatchingAccountants capitalize manufacturing costs to obtain proper matching. The matching concept is pervasive in accrual accounting and requires that costs and benefits are matched or brought together on the income statement. In a production setting, the idea is to match the costs of producing a product (or service) against the benefits, i.e., revenue derived from the sale. When the roll is sold, these costs are charged to an expense account referred to as cost of goods sold. At the end of the accounting period, cost of goods sold is closed to the income summary where, theoretically, matching takes place. Remember that unexpired costs represent assets. Expired costs represent expenses. When the inventory is sold, we say these costs have expired, i.e., the benefits to be obtained (from the effo rt that generated the costs) have been recognized. Thus, manufacturing costs become expenses when they reach cost of goods sold, but represent assets until the sale takes place. marketing and Administrative CostsIn traditional accounting systems, selling and administrative costs are expensed in the period in which they are incurred. Theoretically, if there are future benefits associated with a cost, the cost should be capitalized as an asset rather than expensed. Certainly there are some future benefits associated with costs such as research and development, training, market promotion and advertising. However, these costs are expensed as incurred because it is difficult if not impossible to relate them to the future benefits. As a result, these costs are referred to as period costs.COST BEHAVIOR AND PREDICTIONIn addition to separating costs into categories such as direct and indirect and manufacturing and non-manufacturing, costs are also frequently identified by their behavior in r elation to changes in an activity level. This separation is helpful for planning and budgeting purposes. The major types of costs, in terms of cost behavior, are 1) variable costs, and 2) fixed costs, 3) semi-variable costs and 4) semi-fixed costs. These concepts are illustrated graphically in Exhibit 1-3 and discussed individually below.Variable CostsVariable costs are those costs that vary with changes in the level of activity. Variable costs tend to increase at various rates that generate linear (straight line) or a variety of non-linear cost functions when the costs are plotted on a graph. The major activity that affects manufacturing costs is production volume, i.e., producing output. Production volume is frequently measured in terms of units produced, direct labor hours used, machine hours used, materials costs or some other production volume tie in measure. However, other activities that are not related to production volume powerfulness also be important in analyzing cost b ehavior. The recognition that non-production volume related activities also cause, or drive costs is a fundamental idea associated with activity based be (ABC)Fixed CostsFixed costs are defined as those costs that do not vary with changes in the activity level. However, this does not mean that fixed costs remain constant. If a production volume based measure is used as the activity, a cost that changes for some reason other than a change in production activity is considered fixed. This simply means that the cost is drive by a non-production volume related phenomenon. For example, property taxes are considered fixed in traditional cost accounting systems that are typically based on production volume related activities. However, property taxes change when the taxing authority changes the tax rate or reassesses the property. The idea to grasp is that the designation of a particular cost as fixed or variable can change when it is analyzed in relation to a different activity. It is als o important to agnise that the notion of fixed and variable costs is a short run concept. All costs tend to be variable in the long run.Semi-Variable and Semi-Fixed CostsSemi-variable costs are part fixed and part variable. There is a minimum cost (the fixed portion) and a variable portion that increases as activity increases. There are also semi-fixed costs that do not change continuously as the level of activity changes, but do increase in steps as activity increases beyond various levels. These costs are sometimes referred to as step cost and step functions. For example, a single production supervisor (whos salary normally represents a fixed cost) might be adequate until production reaches a certain level, then a present moment supervisor would need to be hired. Supervisory costs might be driven by the number of production shifts.Cost accounting system requires five parts that include 1) an input measurement basis, 2) an inventory valuation method, 3) a cost accumulation metho d, 4) a cost electric current assumption, and 5) a capability of recording inventory cost returns at certain intervals. These five parts and the alternatives under each part are summarized in Exhibit 2-1. Note that many possible cost accounting systems can be designed from the various combinations of the available alternatives, although not all of the alternatives are compatible. Selecting one part from each category provides a basis for developing an operational definition of a specific cost accounting system.1) INPUT MEASUREMENT BASESThe basis of a cost accounting system begins with the type of costs that flow into and done the inventory accounts. There are three alternatives including pure historical be, normal historical costing and standard costing.Pure historical CostingIn a pure historical cost system, only historical costs flow through the inventory accounts. Historical costs refers to the costs that have been recorded. The term actual costs is sometimes used instead, b ut the term actual seems to imply that there is one true cost associated with a particular output. But determining the cost of a product, or service requires many cost allocations, e.g., allocating the cost of fixed assets to time periods, and allocating indirect manufacturing costs, or overhead to products. Since there are many alternative allocation methods, (e.g., straight line or accelerated depreciation) the calculated cost of a unit of product or service simply represents an attempt to approximate the true cost.Normal Historical CostingNormal historical costing uses historical costs for direct material and direct labor, but overhead is charged, or utilize to the inventory use a predetermined overhead rate per activity measure. Typical activity measures include direct labor hours, or direct labor costs. The amount of factory overhead charged to the inventory is determined by multiplying the predetermined rate by the actual quantity of the activity measure. The difference betw een the applied overhead costs and the actual overhead costs represents an overhead variance.Standard CostingIn a standard cost system, all manufacturing costs are applied, or charged to the inventory using standard or predetermined prices, and quantities. The differences between the applied costs and the actual costs are charged to variance accounts as shown symbolically in the enlarged graphic below. The variances provide the basis for the concept of accounting control, that is somewhat different from the statistical control concept2) FOUR INVENTORY VALUATION METHODSThe four inventory valuation methods that appear in Exhibit 2-1 are arranged in the order of the amount of cost that is traced to the inventory. The throughput method involves shadow the least amount of cost to the inventory, art object the activity based method includes tracing the greatest amount of costs to the inventory. In direct (or variable) costing, a greater amount of cost is traced than in the throughput me thod, but a lesser amount than in the full tightness method. Direct costing and full absorption costing are the traditional methods, while the throughput and activity based methods are relatively new. These inventory valuation methods are very important because they control the manner in which net income is determined. As we shall see is this chapter and subsequent chapters, the amount of net income can vary substantially for different inventory valuation methods.The Throughput MethodThe throughput method was developed to complement a concept referred to as the theory of constraints. In this method only direct material costs are charged to the inventory. All other costs are expensed during the period. The concept is symbolized in the enlargement below. Sales, less direct material costs is referred to as throughput which reflects how the method got its name. The throughput method does not provide proper matching (as defined by GAAP) because all manufacturing cost, other than direct material are expensed when incurred rather than capitalized in the inventory. Therefore, the throughput method is not acceptable for external describe although advocates argue that it provides many advantages for immanent reporting.The Direct or Variable MethodIn the direct (or variable) method, only the variable manufacturing costs are capitalized, or charged to the inventory. Fixed manufacturing costs flow into expense in the period incurred. This method provides some advantages and some disadvantages for internal reporting. However, it does not provide proper matching because the current fixed costs associated with producing the inventory are charged to expense regardless of whether or not the output is sold during the period. For this reason direct costing is not generally acceptable for external reporting.The Full Absorption MethodFull absorption costing (also referred to as full costing and absorption costing) is a traditional method where all manufacturing costs are capital ized in the inventory, i.e., charged to the inventory and become assets. This means that these costs do not become expenses until the inventory is sold. In this way, matching is more closely approximated. All selling and administrative costs are charged to expense. Technically, full absorption costing is required for external reporting, although many companies apparently use something less than a pure full absorption costing system. The full absorption method is also frequently used for internal reporting. The second major section of this chapter compares the income statements for full absorption costing with those used for direct costing because they are by far the dominant methods.The Activity Based MethodActivity based costing is a relatively new type of procedure that can be used as an inventory valuation method. The technique was developed to provide more accurate product costs. This improved the true is accomplished by tracing costs to products through activities. In other wo rds, costs are traced to activities (activity costing) and then these costs are traced, in a second stage, to the products that use the activities. The concept of ABC is illustrated in the enlarged graphic below. Another way to express the idea is to say that activities consume resources and products consume activities. Essentially, an attempt is made to treat all costs as variable, recognizing that all costs vary with something, whether it is production volume or some non-production volume related phenomenon. Both manufacturing costs and selling and administrative costs are traced to products in an ABC system. Note that treating selling and administrative costs in this way is not acceptable for external reporting.3) FOUR COST ACCUMULATION METHODSCost accumulation refers to the manner in which costs are collected and identified with specific customers, jobs, batches, orders, departments and processes. The center of attention for cost accumulation can be individual customers, batches of products that may involve several customers, the products produced within individual segments during a period, or the products produced by the entire plant during a period. The companys cost accumulation method, or methods are influenced by the type of production operation and the extent to which detailed cost accounting information is needed by management.Job OrderIn job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that the work is done to the customers specifications. As a result, each job tends to be different. For example, job order costing is used for construction projects, government contracts, shipbuilding, automobile repair, job printing, textbooks, toys, wood furniture, office machines, caskets, machine tools, and luggage. Accumulating the cost of professional services (e.g., lawyers, doctors and CPAs) also fall into this category. Chapter 4 illustrates a cost accounting system that includes normal historical costing as the basic cost system, full absorption costing as the inventory valuation method and job order costing as the cost accumulation method.ProcessIn process costing, costs are accumulated by departments, operations, or processes. The work performed on each unit is standardized, or uniform where a continuous circumstances production or assembly operation is involved. For example, process costing is used by companies that produce appliances, alcoholic beverages, tires, sugar, breakfast cereals, leather, paint, coal, textiles, lumber, candy, coke, plastics, rubber, cigarettes, shoes, typewriters, cement, gasoline, steel, baby foods, flour, glass, mens suits, pharmaceuticals and automobiles. Process costing is also used in meat packing and for public utility services such as water, gas and electricity.Back FlushBack flush costing is a simplified cost accumulation method that is sometimes used by companies that adopt just-in-time (JIT) production systems. However, JIT is not just a technique, or par ade of techniques. Just-in-time is a very broad philosophy, that emphasizes simplification and continuously reducing waste in all areas of business activity. JIT systems were developed in Japan and depend on the communitarian concepts of teamwork and continuous improvement. In fact, many of the assumptions, attitudes and practices of communitarian capitalism are included in the JIT philosophy.One of the many goals of JIT systems is zero ending inventory. In a backflush cost system, manufacturing costs are accumulated in fewer inventory accounts than when using the job order or process cost methods. In fact, in extreme backflush systems, most of the accounting records are eliminated. The production facilities are also arranged in self contained manufacturing cells that are dedicated to the production of a single, or similar products. In this way more of the manufacturing costs become direct product costs and fewer cost allocations are necessary. Thus, more accurate costing is obtaine d in outrage of the fact that the cost accumulation method is simplified. The just-in-time philosophy and related accounting methods are discussed in Chapter 8.Hybrid, or Mixed MethodsHybrid or mixed systems are used in situations where more than one cost accumulation method is required. For example, in some cases process costing is used for direct materials and job order costing is used for conversion costs, (i.e., direct labor and factory overhead). In other cases, job order costing might be used for direct materials, and process costing for conversion costs. The different departments or operations within a company might require different cost accumulation methods. For this reason, loanblend or mixed cost accumulation methods are sometime referred to as operational costing methods.4) FOUR COST FLOW ASSUMPTIONSA cost flow assumption refers to how costs flow through the inventory accounts, not the flow of work or products on a production line. This distinction is important because the flow of costs is not always the same as the flow of work. The various types of cost flow assumptions include specific identification (e.g., by job), low gear in, first out, last in, first out and plodding average.Costs flow through the inventory accounts by the job in a job order cost system which represents an example of specific identification. The requirements of the various jobs determines the timing of the cost flows. Simple jobs tend to move through the system faster than more complex jobs. The first-in, first-out (FIFO) and weighted average cost flow assumptions are used in process costing. Since costs are accumulated by the process or department in a process cost environment, a cost flow assumption is needed to determine the treatment of the beginning inventory. When FIFO is used, it is assumed that the units of product in the beginning inventory are finished first and transferred to the next department before any of the units that are started during the period. The g roup of units in the beginning inventory fight down their separate identity and prior period costs. However, when the weighted average cost flow assumption is used, the beginning inventory units lose their separate identity because they are lumped together with the units of product started during the period. Process costing tends to be fairly challenging, therefore you may find these introductory concepts to be confusing.Although last-in, first-out (last in first out) is frequently used for tax reporting purposes, it is not normally used in the accounting records. For this reason, we consider the FIFO and weighted average cost flow assumptions in Chapter 5, but leave the LIFO cost flow assumption for courses that emphasize financial and tax reporting.5) RECORDING INTERVAL CAPABILITYInventory records can be maintained on a perpetual or a periodic basis. Conceptually, the perpetual inventory method provides a company with the capability of maintaining continuous records of the quanti ties of inventory and the costs flowing through the inventory accounts. The periodic method, on the other hand, requires counting the quantity of inventory before inventory records can be updated. In the past, manufacturers tended to keep perpetual inventories, while retailers used the periodic method. However, today a variety of modern point of sale devices and dedicated microcomputer software are readily available to provide any company with perpetual inventory capability.Cost allocation is the assigning of a common cost to several cost objects. For example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that use the system. A company with only one electric meter might allocate the electricity bill to several departments in the company.Allocation implies that the assigning of the cost is somewhat arbitrary. Some people describe the allocation as the spreading of cost, because of the arbitrary nature of the allocat ion. Efforts have been made over the years to improve the bases for allocation. In manufacturing, the overhead allocations have moved from plant-wide rates to departmental rates, from direct labor hours to machine hours to activity based costing. The goal is to allocate or assign the costs based on the root causes of the common costs instead of merely spreading the costs.Direct costs can be physically traced to each department.Indirect costs must be allocated. Many companies develop allocation methods to assign service department costs to the producing departments. All organizations accumulate costs for their products or services for financial reporting purposes. An accounting system will assign to a departments output all its direct costs plus all the indirect costs allocated to it. A cost driver that has a logical, cause-effect relationship to the cost will be used as a cost-allocation base.Linking costs with cost objectives is accomplished by selecting cost drivers.When used for allocating costs, a cost driver is a great deal called a cost-allocationbase. Major costs, such as newsprint for a newspaper and direct professionallabour for a law firm, may each be allocated to departments, jobs, and projects on an individual(a) basis, using obvious cost drivers such as tonnes of newsprint consumed or direct-labour-hours used. Other costs, taken one at a time, are not important enough to justify being allocated individually. These costs are pooled and then allocated together.A cost pool is a group of individual costs that is allocated to cost objectives using a single cost driver. For example, building rent, utilities cost, and janitorial services may be in the same cost pool because all are allocated on the basis of square metres of space occupied. Or a university could pool all the operating costs of its registrars office and allocate them to its colleges on the basis of the number of students in each faculty. In summary, all costs in a given cost pool should be caused by the same factor. That factor is the cost driver. Many different terms are used by companies to describe cost allocation in practice. You may encounter terms such as allocate, attribute, reallocate, trace, assign, distribute, redistribute, load, burden, apportion, and reapportion, which can be used interchangeably to describe the allocation of costs to cost objectives.The allocation of costs is necessary when the linkage between the costs and the cost objective is indirect. In this case, a basis for the allocation, such as direct-labour-hours or tonnes of raw material, is used even though its selection is arbitrary. A cost allocation base has been depict as incorrigible, since it is impossible to objectively determine which base perfectly describes the link between the cost and the cost objective. Given this subjectivity in the selection of a cost-allocation base, it has always been difficult for managers to determine When should costs be allocated? and On what basis sh ould costs be allocated? The answers to these questions depend on the principal purpose or purposes of the cost allocation.Costs are allocated for three main purposes1. To obtain desired motivation. Cost allocations are sometimes made to influence management behaviour and thus publicize goal congruence and managerial effort. Consequently, in some organizations there is no cost allocation for legal or internal auditing services or internal management consulting services because top management wants toencourage their use. In other organizations there is a cost allocation for such items to spur managers to make sure the benefits of the specified services exceed the costs.2. To compute income and asset valuations. Costs are allocated to products and projects to measure inventory costs and cost of goods sold. These allocations frequently service financial accounting purposes. However, the resulting costs are also often used by managers in planning, performance evaluation, and to motivat e managers, as described above.3. To justify costs or obtain reimbursement. Sometimes prices are based directly on costs, or it may be necessary to justify an accepted bid. For example, government contracts often specify a price that includes reimbursement for costs plus some profit margin. In these instances, cost allocations become substitutes for the usual working of the marketplace in setting prices..What is activity based costing? (ABC system)?Sol In the past, the vast majority of departments used direct labour hours as the only cost driver for applying costs to products. But direct labour hours is not a very good measure of the cause of costs in modern, highly automated departments. Labour-related costs in an automated system may be only 5 percent to 10 percent of the total manufacturing costs and often are not related to the causes of most manufacturing overhead costs. Therefore, many companies are beginning to use machine-hours as their cost-allocation base. However, some ma nagers in modern manufacturing firms and automated service companies believe it is inappropriate to allocate all costs based on measures of volume. Using direct labour hours or cost-or even machine hours-as the only cost driver seldom meets the cause/effect mensuration desired in cost allocation. If many costs are caused by non volume-based cost drivers, Activity-Based Costing (ABC) should be consideredActivity Based Costing (ABC) is an economic model that identifies the cost pools or activity centers in an organization and assigns costs to cost drivers based on the number of each activity used. It identifies activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption by each it assigns more indirect costs (overhead) into direct costs.In this way, an organization can precisely estimate the cost of individual products and services so they can identify and eliminate those tha