ACT503 Chap.2 Cost Terms, Cost Objects and Cost Behaviour
Cost Terms, Cost Objects and Cost Behaviour
Two questions, asked separately and in this order
A cost is a resource sacrificed or forgone to achieve a specific objective. Everything else in this chapter qualifies that sentence in one of two ways.
The first asks whether the cost can be conveniently and economically traced to a named cost object, which makes it direct, or must instead be apportioned on some reasoned and consistently applied basis, which makes it indirect. The second asks whether the total changes in proportion to an activity level, which makes it variable, or holds for a given period within the relevant range, which makes it fixed.
The two questions are independent, so all four combinations exist and none of the cells is empty. Students who have collapsed the pairs believe direct means variable, and that belief survives quietly until a question asks for the fixed portion of direct costs.
The classification is a relationship, not a property
Nothing is a cost object until someone names it.
The same electricity bill is an indirect cost of a single product and a direct cost of the plant that consumes it; the same supervisor salary is indirect to each of twelve products on a line and direct to the line itself. Three factors move the boundary in borderline cases: the materiality of the cost, the information gathering technology available, and the design of operations.
A question that gives you the same cost twice against two different cost objects is testing whether you understood that, and answering both halves while naming the cost object in each sentence is what distinguishes a correct reclassification from a contradiction.
Behaviour is stated twice and the two statements look contradictory
A variable cost changes in total in proportion to activity and is constant per unit.
A fixed cost is unchanged in total for a given period and moves inversely per unit. Both statements describe the same cost, and which one a question wants is signalled by the phrase in total or the phrase per unit. Every fixed cost statement carries a qualifier: the relevant range is the band of normal activity within which the stated relationship holds, so a fixed cost is a horizontal segment rather than a horizontal line.
A mixed cost has both elements and is written as a total fixed amount plus a variable rate multiplied by the activity level, where separating the intercept from the slope is exactly the work that makes the next chapter possible.
Three inventories, three subtractions, three places to go wrong
A manufacturer carries raw materials, work in process and finished goods where a merchandiser carries one inventory.
The three inventoriable costs, which are the same thing as product costs, are direct materials, direct labour and manufacturing overhead, and overhead includes indirect materials such as lubricants and indirect labour such as maintenance and security. Prime cost and conversion cost are bracket terms that overlap deliberately and are not a fourth category.
Inventoriable costs sit on the balance sheet until the units are sold and then become cost of goods sold; period costs are expensed when incurred. The operative test on any line is whether the cost is attached to the plant.
What this chapter covers
- 01
Cost, actual cost, budgeted cost and cost object
- 02
Cost accumulation against cost assignment
- 03
Tracing a direct cost against allocating an indirect one
- 04
Three factors that move the direct and indirect boundary
- 05
Variable, fixed and mixed, in total and per unit
- 06
The relevant range, and what happens at the edge of it
- 07
The mixed cost line, its intercept and its slope
- 08
Three inventories and the three relationships that empty them
- 09
Inventoriable costs against period costs
Build both statements and name the two lines a careless reader moves
- 2Direct materials used, then add direct labour.
- 3Subtotal the indirect manufacturing block using only plant attached costs.
- 2Add opening and deduct closing work in process to reach the manufactured cost.
- 3Build cost of goods sold and the operating cost block below gross margin.
Key terms
- Cost Object
- Anything for which a measurement of cost is desired. Because direct and indirect are claims about the relationship between a cost and a named object, the classification of a cost can change when the object changes without any error having been made.
- Cost Assignment
- The umbrella term covering both tracing, which attaches a direct cost to a cost object, and allocating, which apportions an indirect cost to it. Tracing is an observation and allocating is a decision that can be argued with.
- Relevant Range
- The band of normal activity within which a stated relationship between activity and cost holds. It is the qualifier that makes a fixed cost statement honest, because outside the band a fixed cost steps to a new amount.
- Mixed Cost
- A cost with both a fixed element and a variable element, written as a total fixed amount plus a rate per unit of activity multiplied by the activity level. The intercept is the price of being connected and the slope the price of using it.
- Inventoriable Cost
- A cost treated as an asset on the balance sheet when incurred and charged against income as cost of goods sold at the point the units leave. For a manufacturer all manufacturing costs are inventoriable, which makes attachment to the plant the operative test.
- Conversion Cost
- Direct labour plus manufacturing overhead, answering what it costs to turn material into product. It deliberately overlaps with prime cost, so neither belongs in a schedule alongside the three manufacturing costs.
Cost Terms, Cost Objects and Cost Behaviour FAQ
Can the same cost be both direct and indirect?
Yes, and reclassifying it when the cost object changes is not an error. A production line supervisor is indirect to each individual product on the line, because no convenient economic route traces the salary to one unit, and direct to the line itself, because the supervisor works on nothing else.
Name the cost object in each sentence, because a marker cannot otherwise distinguish a correct reclassification from a contradiction.
If output doubles, what happens to a fixed cost?
In total it is unchanged and per unit it halves, because a fixed cost per unit moves inversely with activity. The answer fails in one circumstance: if the extra volume pushes the business outside the relevant range, so that a second building or a higher risk band is needed, the amount steps to a new level and the per unit figure has to be recomputed from that new step rather than from the old one.
Why do prime cost and conversion cost overlap?
Because they answer different questions. Prime cost is direct materials plus direct labour and describes what the product is made of; conversion cost is direct labour plus manufacturing overhead and describes what it costs to turn material into product. Direct labour belongs to both. Neither is a fourth category, and putting either into a manufacturing cost schedule counts labour twice.
What is the fastest way to tell a product cost from a period cost?
Ask whether the cost is attached to the plant. For a manufacturer every manufacturing cost is inventoriable and sits on the balance sheet until the units sell, while selling costs that secure the order and deliver the product, and administrative costs covering executive and clerical work, are expensed when incurred. An insurance or depreciation line without the word plant is almost always a period cost.
Which items in a scrambled data list are there to be discarded?
Working capital balances. Accounts payable and accounts receivable, both opening and closing, appear in these data sets and in neither statement, because both statements are built from inventory balances and cost flows. The same list usually mixes dated balances with figures for the year, so sort the list into stock items and flow items first and strike out anything that is neither.
Exam move
Take one real product you can see and write its cost sheet twice, once with the product as the cost object and once with the department that makes it. The lines that move between direct and indirect are the ones this chapter is about. Then draw a fixed cost as a step function rather than a flat line, and mark where your own business would have to hire, lease or expand.
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