Cost Concepts and Cost Allocation
REVIEWING THE CHAPTER
Objective 1: Describe how managers use information about costs.
Because costs affect profitability, having accurate and up-to-date cost information is
important to managers in all types of for-profit organizations. Managers in manufacturing,
retail, and service businesses use information about operating costs to plan, perform,
evaluate, and communicate the results of operating activities.
In the planning stage, managers develop budgets and estimate selling prices for goods
or services based on estimates of operating costs.
In performing operating activities, managers use cost information in several ways,
including estimating the profitability of a product or service, deciding whether to drop
a product line or service, and determining selling prices.
When managers evaluate performance, they want to know about significant variances
between estimated costs and actual costs. Such variances help them ascertain the
reasons for cost overruns, which may enable them to avoid such problems in the
In external reports, managers expect income statements that communicate the actual
cost of operating activities and balance sheets that show the value of inventory. They
expect internal reports that summarize their plans, summarize performance outcomes,
and evaluate variances.
Objective 2: Explain how managers classify costs and how they use these cost classifications.
A single cost can be classified in several ways: by cost traceability, by cost behavior, by
whether it is value-adding or nonvalue-adding, and by whether it is a product cost or a
By tracing costs to cost objects, such as products or services, managers can obtain a fairly
accurate cost measurement on which to base decisions about pricing and about reallocating
resources to other cost objects.
are costs that can be conveniently or economically traced to a specific
cost object. The wages of production workers, which can be directly traced to an
individual product, are an example.
are costs that cannot be conveniently or economically traced to a cost
object. Rivets used in the production of airplanes and glue used in the production of
furniture are examples. Although difficult to trace, indirect costs must be included in
the cost of a product or service; to do so, managers use a formula to assign them to a
Cost behavior is the way costs respond (or do not respond) to changes in volume or activity.
A cost that changes in direct proportion to a change in productive output (or to any other
measure of volume) is a
is one that remains constant within a