Note on cost terms in advanced management accounting

Note on cost terms in advanced management accounting

 

Briefly describe the following cost terms in advanced management accounting study

(Terms used in Chapter 2)

1.    Cost object

2.    Cost accumulation

3.    Cost assignment

4.    Cost tracing and cost allocation

5.    Direct and indirect cost classifications

6.    Cost drivers

7.    Cost management

8.    Variable cost

9.    Fixed cost

10.          Relevant range

11.          Capitalised costs

12.          Operating costs

13.          Inventoriable costs

14.          Period costs

 

These terms form the foundation for measuring, analysing, and managing costs for products, services, customers, departments, and decisions.

Cost identification and assignment

1.    Cost object — Anything for which management wants a separate cost measurement, such as a product, service, customer, project, department, activity, or sales territory.

2.    Cost accumulation — The organised collection of cost data through the accounting system. For example, a job-costing system accumulates direct materials, direct labour, and overhead by individual job; a process-costing system accumulates them by department or process.

3.    Cost assignment — The overall process of linking accumulated costs to cost objects. It includes direct tracing where feasible and allocating indirect/shared costs on a reasonable, consistent basis.

4.    Cost tracing and cost allocation —

o   Cost tracing assigns a cost directly to a cost object when a clear, economically feasible link exists—for example, fabric used for a particular garment order.

o   Cost allocation assigns shared indirect costs using a chosen allocation base, such as allocating factory power by machine-hours. The allocation base need not perfectly cause the cost, but should be rational and consistently applied.

5.    Direct and indirect cost classifications —

o   Direct costs can be specifically and economically traced to a particular cost object, such as components in a product or wages on a specific client project.

o   Indirect costs support multiple cost objects and cannot be feasibly traced to one of them; examples include factory rent, supervision, and general utilities.

6.    Cost drivers — Factors or activities that cause, or are strongly associated with, changes in total cost. Examples include units produced, labour-hours, machine-hours, customer orders, deliveries, or production setups.

Cost behaviour and control

7.    Cost management — The use of cost information to plan, control, reduce, and strategically deploy resources while maintaining required quality and performance. It supports budgeting, performance assessment, pricing, process improvement, and managerial decisions.

8.    Variable cost — A cost that changes in total with activity volume, assuming other factors are constant. For example, total packaging cost normally rises as more units are shipped; variable cost per unit is usually constant within the relevant range.

9.    Fixed cost — A cost that remains constant in total over a specified short-term period despite changes in activity volume, within the relevant range. Examples include monthly factory rent and a manager’s salary. Fixed cost per unit falls as output increases.

10.                    Relevant range — The normal band of activity or output over which assumed cost behaviour is valid. For instance, rent may remain fixed from 0 to 10,000 units of output, but producing beyond that capacity may require extra premises and create a higher fixed-cost level.

Cost recognition

11.                    Capitalised costs — Expenditures recorded initially as an asset, rather than immediately as an expense, because they are expected to provide future economic benefits. They are subsequently charged to expense over time, commonly through depreciation, amortisation, or cost of goods sold. Example: the purchase cost of production equipment.

12.                    Operating costs — Recurring costs incurred in running ordinary business operations. They commonly include selling, administrative, distribution, maintenance, utilities, and payroll costs; whether a specific operating cost is expensed immediately or capitalised depends on its nature and applicable accounting rules.

13.                    Inventoriable costs — Costs attached to goods purchased or manufactured for resale. For a manufacturer, these are product costs: direct materials, direct labour, and manufacturing overhead. They are recorded in inventory first and become cost of goods sold when the goods are sold.

14.                    Period costs — Costs associated with a time period rather than with producing or acquiring inventory. They are expensed in the period incurred—commonly selling, marketing, and administrative expenses.

Quick illustration

For an online retailer, a particular customer order can be a cost object. The merchandise purchase price and order-specific delivery charge are direct, inventoriable costs that may be traced to that order. Warehouse rent and the salary of a general operations manager are typically indirect costs; they may be allocated across orders using floor space, orders processed, or units shipped as a cost driver. Advertising expenditure is normally a period/operating cost, expensed when incurred.

 

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