COST TERMINOLOGY AND COST BEHAVIORS
is used to refer to so many different concepts that an adjective
must be attached to identify which particular type of cost is being discussed. For
example, there are fixed costs, variable costs, period costs, product costs,
expired costs, and opportunity costs, to name just a few.
A cost object is anything for which management wants to collect or accumulate
costs. Before a cost can be specified as direct or indirect, the cost object must be
identified. Since direct costs must be conveniently and economically traceable to
the cost object, not knowing what the cost object in question is would make it
impossible to identify direct costs.
For example, if multiple products are made in
the same production area, the salary of the area’s manager would be direct to
the production area but indirect to the different products. Indirect costs must be
allocated in some rational and systematic manner to the cost object.
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,
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 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.
control over predictors that are not cost drivers will have no cost control effect.
A product cost is one that is associated with inventory.
In a manufacturing
company, product costs would include direct materials, direct labor, and
In a merchandizing 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.