Management Accounting 2 (ACC3023H)
Cost and Cost Behaviour
Cost Terminology
Cost Object
- Any activity for which a separate measurement of costs is desired.
Product Costs
- Costs that are identified with goods purchased or produced for resale and which are
attached to products and included in the inventory valuation off goods.
Period Costs
- Costs that are not included in the inventory valuation of goods and which are treated as
expenses for the period in which they are incurred.
Cost Behaviour
Fixed Costs
- Costs that remain constant for a specified time period and which are not affected by the
volume of activity.
Variable Costs
- Costs that vary in direct proportion to the volume of activity.
Mixed (Semi-variable) Cost
- Costs that contain both a fixed and a variable component; also known as a semi-variable
cost.
Step-fixed Costs
- Costs that remain fixed within specified activity levels for a given amount of time, but
which eventually increase or decrease by a constant amount at critical activity levels;
also known as semi-fixed costs.
,Product Costing and Accounting Basis
Direct Costs
- Costs that can be specifically and exclusively identified with a particular cost object; can
be directly traced to a particular unit.
Indirect Costs
- Costs that cannot be identified specifically and exclusively with a given cost object (also
known as overheads).
Manufacturing Costs
- Costs that are incurred during the manufacturing process.
Non-manufacturing Costs
- Costs that are incurred in another (perhaps administrative) area of the business i.e. not
manufacturing.
Full (Absorption) Cost
- Unit cost including fixed manufacturing overheads.
Direct (Variable) Cost
- Unit cost excluding fixed manufacturing overheads.
Decision Making
Differential Cost
- The difference between the costs of each alternative action under consideration; also
known as incremental costs.
Sunk Costs
- Costs that have been incurred by a decision made in the past and that cannot be
changed by any decision that will be made in the future.
Irrelevant Costs and Revenues
- Future costs and revenues that will not be affected by a decision.
,Opportunity Costs
- Costs that measure the opportunity that is sacrificed when the choice of one course of
action requires that an alternative is given up.
Unavoidable Costs
- Costs that cannot be saved, whether or not an alternative is adopted.
, Absorption and Variable Costing
Absorption (full) costing and variable (direct) costing determine how fixed manufacturing
overhead costs are treated:
Variable Costing
- Also known as direct or marginal costing.
- Traces all variable costs to products.
- Treats fixed manufacturing overheads and non-manufacturing overheads as a period
cost, which means that all fixed overheads are expensed in the year that they are
incurred.
Absorption Costing
- Also known as traditional or full costing.
- Allocates all manufacturing costs, including fixed manufacturing costs, to products and
values unsold stocks at their total cost of manufacture.
- Absorption costing treats fixed manufacturing overheads as a product cost, which
means they are capitalised to the cost of inventory. This effectively defers the expense
until the inventory is sold at which point the overheads are expensed as cost of sales.
IFRS requires absorption costing to be used (see IAS 2: para13). Thus, while variable costing
may be used for internal reporting, it is not acceptable for financial statements drawn up for
external reporting.
Difference in Profits
The costing method used will arrive at different profits; if there is a difference between the
units produced and the units sold, i.e. the opening and closing balances of inventory have
changed:
- If the level of inventory is increasing (i.e. opening balance < closing balance),
absorption costing will lead to higher profits than variable costing. This is because
increasing inventory levels implies that units produced exceed the units sold, hence, if
absorption costing is used there are production costs that are being deferred in the cost
of units not yet sold, while the same costs would be completely expensed on the
variable costing method.
Cost and Cost Behaviour
Cost Terminology
Cost Object
- Any activity for which a separate measurement of costs is desired.
Product Costs
- Costs that are identified with goods purchased or produced for resale and which are
attached to products and included in the inventory valuation off goods.
Period Costs
- Costs that are not included in the inventory valuation of goods and which are treated as
expenses for the period in which they are incurred.
Cost Behaviour
Fixed Costs
- Costs that remain constant for a specified time period and which are not affected by the
volume of activity.
Variable Costs
- Costs that vary in direct proportion to the volume of activity.
Mixed (Semi-variable) Cost
- Costs that contain both a fixed and a variable component; also known as a semi-variable
cost.
Step-fixed Costs
- Costs that remain fixed within specified activity levels for a given amount of time, but
which eventually increase or decrease by a constant amount at critical activity levels;
also known as semi-fixed costs.
,Product Costing and Accounting Basis
Direct Costs
- Costs that can be specifically and exclusively identified with a particular cost object; can
be directly traced to a particular unit.
Indirect Costs
- Costs that cannot be identified specifically and exclusively with a given cost object (also
known as overheads).
Manufacturing Costs
- Costs that are incurred during the manufacturing process.
Non-manufacturing Costs
- Costs that are incurred in another (perhaps administrative) area of the business i.e. not
manufacturing.
Full (Absorption) Cost
- Unit cost including fixed manufacturing overheads.
Direct (Variable) Cost
- Unit cost excluding fixed manufacturing overheads.
Decision Making
Differential Cost
- The difference between the costs of each alternative action under consideration; also
known as incremental costs.
Sunk Costs
- Costs that have been incurred by a decision made in the past and that cannot be
changed by any decision that will be made in the future.
Irrelevant Costs and Revenues
- Future costs and revenues that will not be affected by a decision.
,Opportunity Costs
- Costs that measure the opportunity that is sacrificed when the choice of one course of
action requires that an alternative is given up.
Unavoidable Costs
- Costs that cannot be saved, whether or not an alternative is adopted.
, Absorption and Variable Costing
Absorption (full) costing and variable (direct) costing determine how fixed manufacturing
overhead costs are treated:
Variable Costing
- Also known as direct or marginal costing.
- Traces all variable costs to products.
- Treats fixed manufacturing overheads and non-manufacturing overheads as a period
cost, which means that all fixed overheads are expensed in the year that they are
incurred.
Absorption Costing
- Also known as traditional or full costing.
- Allocates all manufacturing costs, including fixed manufacturing costs, to products and
values unsold stocks at their total cost of manufacture.
- Absorption costing treats fixed manufacturing overheads as a product cost, which
means they are capitalised to the cost of inventory. This effectively defers the expense
until the inventory is sold at which point the overheads are expensed as cost of sales.
IFRS requires absorption costing to be used (see IAS 2: para13). Thus, while variable costing
may be used for internal reporting, it is not acceptable for financial statements drawn up for
external reporting.
Difference in Profits
The costing method used will arrive at different profits; if there is a difference between the
units produced and the units sold, i.e. the opening and closing balances of inventory have
changed:
- If the level of inventory is increasing (i.e. opening balance < closing balance),
absorption costing will lead to higher profits than variable costing. This is because
increasing inventory levels implies that units produced exceed the units sold, hence, if
absorption costing is used there are production costs that are being deferred in the cost
of units not yet sold, while the same costs would be completely expensed on the
variable costing method.
