EN.662.611 Chap.9 Cost Behavior and Product Costing
Cost Behavior and Product Costing
Managerial accounting looks forward
Week 9 contrasts two branches of accounting. Financial accounting is external, reports past performance for the whole organization, follows GAAP and is mandatory.
Managerial accounting is internal, focuses on future performance and on segments, follows no required rules and is optional, because it exists to support decisions.
Four ways to classify a cost
By traceability, direct materials and direct labor are direct costs, while manufacturing overhead is indirect and must be allocated.
By behavior, variable costs such as materials, labor, utilities, supplies and freight change in proportion to activity, and fixed costs such as depreciation, insurance, rent and property taxes do not; total cost follows the line Y equals a plus bX. For external reporting, product costs pass through inventory to cost of goods sold, while period costs such as selling, general and administrative expenses are expensed as incurred.
For decisions, only relevant costs matter: differential and opportunity costs count, while non-differential and sunk costs do not.
Absorption costing in four steps
Week 10 assigns all three manufacturing costs to products, a method called absorption or full costing that some form of external reporting requires. Direct materials are traced through requisition forms and direct labor through time tickets.
Overhead is applied with a predetermined rate, estimated overhead divided by the estimated quantity of an allocation base, set once a year so that seasonal swings do not distort product costs and results can be reported on time.
Applied overhead is the rate times each product's use of the base; total product cost adds materials, labor and applied overhead; and cost per unit divides by units produced.
Choosing the cost driver
The lecture calls the choice of allocation base an art.
Direct labor hours or dollars are easy to collect, but in a capital-intensive process, where overhead is mostly depreciation and maintenance, machine hours usually reflect consumption better. Per-unit cost then supports pricing by markup and comparisons of gross profit across products.
Using product cost to price and compare
Once per-unit cost is known, the lecture shows two uses.
A company can set price as a markup on cost, so a product costing $10 with a 50% markup sells at $15. It can also compare products by gross profit percentage, since two products with the same gross profit per unit can earn very different percentages if their prices differ. Both uses depend on overhead being allocated with a sensible driver, which is why the driver choice deserves care.
What this chapter covers
- 01
Managerial versus financial accounting
- 02
Direct and indirect costs
- 03
Variable and fixed costs and the total cost line
- 04
Product and period costs
- 05
Relevant, sunk and opportunity costs
- 06
The predetermined overhead rate
- 07
Four steps to per-unit product cost
- 08
Choosing a cost driver
Worked example · free
Cost a job with a plantwide rate
- 1Rate: $420,000 divided by 14,000 hours is $30 per hour.
- 1Applied overhead: 300 hours times $30 is $9,000.
- 1Total cost: $18,000 plus $9,000 plus $9,000 is $36,000.
- 1Cost per unit: $36,000 divided by 2,000 is $18.00.
- 1Price: $18.00 times 1.30 is $23.40.
Key terms
- Product Cost
- A cost of making goods, held in inventory until the goods are sold and then expensed as cost of goods sold.
- Period Cost
- A selling, general or administrative cost expensed in the period it is incurred.
- Allocation Base
- The activity measure, or cost driver, used to assign overhead to products, such as machine hours.
- Sunk Cost
- A cost already incurred that no current decision can change, and so irrelevant to the choice.
- Conversion Costs
- Direct labor and manufacturing overhead together, the costs of turning materials into finished goods.
Cost Behavior and Product Costing FAQ
Why is overhead applied with an estimated rate instead of actual costs?
Actual overhead is known only at year end and swings with the seasons. A rate set in the annual budget lets each job be costed as it is finished and keeps unit costs stable across the year.
When is an opportunity cost relevant?
Whenever choosing one option means giving up a benefit from another. It never appears in the ledger, but the lost benefit is a real cost of the option chosen and belongs in the comparison.
Does fixed cost per unit stay fixed?
No. Total fixed cost stays constant within the relevant range, so fixed cost per unit falls as volume rises. Variable cost behaves the other way: constant per unit, rising in total.
Exam move
Classify twenty costs from one business all four ways, then cost two jobs with two different allocation bases and explain in a sentence which base better matches how that business consumes overhead.
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