Cost Concepts, Behaviours, and Estimation (Session 2) Flashcards
Cost
A cost is a resource sacrificed or forgone to
achieve a specific objective.
Expense
An expense is a resource being
consumed/used under accrual accounting.
What would be incurred at every stage of the business process
Costs
Should cost be classified into different categories?
Yes, to help assist with strategic decision-making
Classifying Costs
1) Relevance
2) Behaviour
3) Traceability
4) Function
5) Controllability
Classifying Costs: Relevance
- Relevant costs:
o Costs that differ between two alternatives (e.g., opportunity cost) - Irrelevant costs:
o Will not make a difference to either alternative no bearing on
decision-making (e.g., sunk cost)
Opportunity Cost
Organization forgoes benefit when it chooses one alternative over
another
Sunk Cost
The cost has already been incurred and cannot now be avoided
Classifying Costs: Traceability
- Cost object:
o Any one thing or activity for which we measure costs
o Include such things as individual products, product lines, projects,
customers, departments, and even the entire company
Classifying Costs: Traceability
- Direct cost:
o A cost that can be easily traced to a cost object because a clear cause-
and-effect relationship generally exists between the two - Indirect cost:
o Incurred for the benefit of more than one cost object and not easily
or economically traced to a particular cost object
Classifying Costs: Function
- Manufacturing cost (Product cost):
o Costs that are easily traced to a product (e.g., direct labour, direct materials,
manufacturing overhead costs) - Non-manufacturing cost (Period cost):
o Costs that cannot be assigned to products
Useful question: Can this product be PRODUCED without incurring the cost? If not, it is manufacturing
(product) cost. Otherwise, it is non-manufacturing (period) cost.
Classifying Costs: Controllability
- Controllable costs:
o Managers have the authority to cut and manage costs - Uncontrollable costs:
o Managers do not have the authority to cut or manage these costs
Classifying Costs: Behaviour
- Fixed costs: Total cost will not change within the relevant range
- Variable costs: Varies in proportion to the production level
Cost Behaviour
- Cost behavior is the variation in costs relative to the variation in an
organization’s activities
o Useful for decision-making such as production, merchandise sales, and services
Relevant Range
a span of activity for a given cost object where total fixed costs remain constant and
variable costs per unit of activity remain constant
Marginal costs
o the incremental cost of an activity
- Within the relevant range, variable cost approximates marginal cost, and, accordingly,
accountants often use variable cost as a measure of marginal cost. - Are often relevant in decision making
Total Variable Costs
change proportionally with changes in activity levels
Total fixed costs
do not vary with small changes in activity levels (e.g. rent)
Mixed costs (sometimes):
costs that are partly fixed and partly variable
Total costs
total variable costs plus total fixed costs
Cost function
A cost function is an algebraic representation of the total cost of a cost
object over a relevant range of activity
TC = F + VQ
Sometimes nonlinear costs exhibit linear cost behaviour over a range of the cost driver, that is …
The relevant rage of activity
Committed Fixed Costs
Cannot be reduced easily without significantly impacting operations and objectives
Discretionary fixed costs
Can be reduced more easily in the short run without significant changes to operations and objectives.
- Examples include advertising, R&D, and executive travel
- These expenditures are often based on past profitability and can be altered during the period
