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Unformatted text preview: CHAPTER 3: BASIC COST MANAGEMENT CONCEPTS QUESTIONS 3-1 Cost assignment refers to the general case of assigning costs to cost pools or cost objects. When there is a direct and traceable link between the cost and the cost pool or cost object, then the management accountant traces that cost to the cost pool or cost object. When there is an indirect link between the cost and the cost pool or cost object, then the management accountant uses cost allocation. Cost allocation uses cost drivers to assign the cost. 3-2 Direct costs can be physically identified with and/or traced to the cost object because there is a direct causal link between them. Indirect costs cannot be traced to each cost object. Direct costs for a manufactured product include the materials (called direct materials) which are part of the product and the labor (called direct labor) which is used to assemble the product. Indirect costs include the machinery, plant and other labor necessary to manufacture the product, but which is not directly traceable to the product, such as labor for inspection and supervision. 3-3 All direct costs are variable by definition since they can be directly traced to the cost object, and thus must vary with the cost driver. 3-4 All fixed costs must be indirect, since the increase in the cost driver or volume of output does not affect the level of fixed cost. 3-5 A cost driver is any activity that has the effect of changing the level of total cost. 3-6 Variable costs are those for which total cost changes with each change in the cost driver. Fixed costs are the portion of total cost which remains constant as the cost driver changes. 3-7 A step-fixed cost varies with the cost driver, but in discrete steps. Costs remain fixed over narrow ranges of the cost driver. However, total costs increase by a constant amount at set intervals. Examples of step-fixed costs are the costs for certain clerical tasks, order filling, and other administrative tasks. At specific levels of the cost driver, an additional clerk must be added. Therefore, total costs increase by a constant amount at these points. 1 3-8 The relevant range is the range of the cost driver for which total cost is approximately linear. The relevant range is used to provide a useful range of activity for the cost driver in which it can be assumed that variable costs will be constant per unit of the cost driver. This is an assumption since the behavior of actual costs is likely to be non-linear (see Exhibit 3-6) over the range of the cost driver. The concept of the relevant range allows the management accountant to use the concept of constant unit variable cost for a defined range of operations, even though actual unit variable costs change over the entire range of the cost driver....
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