Cost Terminology and Cost Behaviors
A cost object is anything for which
management wants to collect or accumulate
Direct costs are conveniently and
economically traceable to the cost object
whereas indirect costs are not.
costs must be allocated to the cost object.
The assumed range of activity that reflects
the company’s normal operating range is
referred to as the relevant range.
the relevant range, costs may be curvilinear
because of purchase discounts, improved
crowding, loss in employee efficiency during
overtime hours, etc.
Although a curvilinear
graph is more indicative of reality, it is not as
easy to use in planning or controlling costs.
Accordingly, accountants choose the range
in which these fixed and variable costs are
assumed to behave as they are defined
(linear) and, as such, represent an
approximation of reality.
It is not necessary for a causal relationship
to exist between the cost predictor and the
All that is required is that there is a
strong correlation between movement in the
predictor and the cost.
Alternatively, a cost
driver is an activity that actually causes
costs to be incurred.
The distinction between cost drivers and
predictors is important because it relates to
one of the objectives of managers: to control
By focusing cost control efforts on
cost drivers, managers can exert control
Exerting control over predictors
that are not cost drivers will have no cost
A product cost is one that is associated with
In a manufacturing company,
product costs would include direct materials,
direct labor, and overhead.
merchandising company, product costs are
the costs of purchasing inventory and the
related freight-in costs.
In a service
company, product costs are those costs that
are incurred to generate the services
provided such as supplies, service labor,
and service-related overhead costs.
In all three types of organizations, a period
cost is any cost that is not a product cost.
These costs are noninventoriable and are
incurred in the nonfactory or non-production
areas of a manufacturing company or in the
nonsales or nonservice areas, respectively,
of a retailer or service company.
these costs are incurred for selling and
Many period costs
are expensed when incurred, although some
may be capitalized as prepaid expenses or
other nonfactory assets.
Conversion cost is the sum of direct
materials and direct labor.
Conversion is the
process that converts raw materials and
other inputs into salable products (output).
The only difference between the two
systems is in their treatment of overhead.
Under a normal cost system, a level of