Ch02 - CHAPTER 2 Cost Terminology and Cost Behaviors...

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CHAPTER 2 Cost Terminology and Cost Behaviors Questions 1. A cost object is anything for which management wants to collect or accumulate costs. Direct costs are conveniently and economically traceable to the cost object whereas indirect costs are not. Indirect costs must be allocated to the cost object. 2. The assumed range of activity that reflects the company’s normal operating range is referred to as the relevant range. Outside the relevant range, costs may be curvilinear because of purchase discounts, improved worker skill and productivity, worker 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. 3. It is not necessary for a causal relationship to exist between the cost predictor and the cost. 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 costs. By focusing cost control efforts on cost drivers, managers can exert control over costs. Exerting control over predictors that are not cost drivers will have no cost control effect. 4. A product cost is one that is associated with inventory. In a manufacturing company, product costs would include direct materials, direct labor, and overhead. In a 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. In general, these costs are incurred for selling and administrative activities. Many period costs are expensed when incurred, although some may be capitalized as prepaid expenses or other nonfactory assets. 5. 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). 6. The only difference between the two systems is in their treatment of overhead. Under a normal cost system, a level of
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This note was uploaded on 02/28/2009 for the course ACCTG 1 taught by Professor Lupin during the Spring '09 term at De La Salle Lipa.

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Ch02 - CHAPTER 2 Cost Terminology and Cost Behaviors...

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