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  • What we're going to do today is talk about a whole bunch a different areas that we need

  • to understand because it will lead us into other areas where we talk about something

  • called variance analysis, so it's going to be important to understand it for that. What

  • is our goal here? Our goal, our objective is to accumulate the cost. That way we can

  • value inventory and costs of goods sold. So, for example, you've got beginning, plus purchase

  • is available, minus ending, is costs of goods sold, so our goal is going to be to come up

  • with our ending inventory so we can back into things like costs of goods sold. And we will

  • use this again and again, in job order costing, process costing, different manufacturing operations

  • and so on, but that's what we're really looking at. Now, when we talk about cost accounting,

  • we're looking at not just one type of inventory, but three. In financial accounting, were

  • mainly looking at purchases, like you have one type of item...I'm buying a calculator,

  • I sell the calculator. What is costs of goods sold? Whatever it cost me...FIFO, LIFO, oh

  • yeah, I remember that stuff. So it cost me 3 dollars, and then cost in, cost out. Here,

  • were manufacturing the calculator. So what do I have to manufacture it? I have some raw

  • materials. I have some work in process. I have some finished goods inventory, raw materials

  • inventory, work in process inventory, finished goods inventory and then finally costs of

  • goods sold. So, you can see here that we have a manufacturing process, so we're going to

  • have to look more at the actual cost as we produce the goods. It says here, the primary

  • purpose of cost measurement is to allocate the cost of production, direct materials,

  • direct labor, overhead to the units produced. It also provides important information for

  • management decisions, such as product pricing decisions, so we can kind of figure out how

  • much we should charge you for this product. Now, a formula that’s going to be very important

  • who will come back to haunt us again and again and again and again is y=a + bx. Now, what

  • does that mean? y=a + bx or total cost equals fixed plus variable times x. Now, what does

  • this mean? It means fixed cost. Now what are fixed costs? Fixed cost...we've talked about

  • those in the past. Those are costs that are fixed in total but variable per unit. So let's

  • say, for example, we're all hungry, we haven't had lunch or dinner yet, so I buy 1 pizza.

  • Mmm hmm. How much is that? Fixed price, 10 bucks. Little pepperoni, little sausage, little

  • vegetables, yum, yum, yum. Ten bucks. So how much is it a person? One person, 10 dollars.

  • Hey, it still cost us 10 dollars, but now there’s 2 people. Fixed cost 10 bucks, now

  • it’s 5 dollars apiece. Oh, there’s 4 people. Now it’s 2.50 apiece. So, notice that it's

  • fixed in total 10 bucks, but it’s variable per unit depending on how many people need

  • to eat. We have variable costs. What are variable cost? Variable costs are fixed per unit but

  • variable in total. For example, my electricity, it cost me what? It cost me a dollar an hour.

  • Now, depending on how many hours I use this office, it's one hour's a dollar, 2 dollars,

  • 2 hours is two dollars, 10 hours is 10 dollars...so notice it fixed per unit, but varies in total.

  • Now, that's fixed, that’s variable. Why do we care? Because when I say y=a + bx, that’s

  • total cost equals fixed plus variable times x. Remember in economics...wasn’t that ago,

  • BEC 1. We had something like this. That was x and that was y. So if you look at this formula...Can

  • you see all that? Mmm hmm...here, y=a + bx. a is fixed, b is variable times x. What is

  • x? x is some activity level. Now, remember we talked about quantity and price, so for

  • example, if it is a fixed cost, means it’s the same amount, then if you go across, boom,

  • that would be a fixed cost because no matter what the quantity is, the price is the same.

  • It cost me how much, for example, is my rent? 10,000 dollars, 100,000 for the year, whatever,

  • so 100,000 for the year. It's fixed. No matter how my production is, it's fixed in total,

  • but as I have more production, the variable cost per unit drops. Remember we talked about

  • average variable cost and so on. What about variable cost? Let's look at it this way...boom.

  • Here is your x, here’s your y. What's it say? It says that it’s 0 production, 0 cost.

  • At this production, this cost. At this production, this cost, and so on. So that would be x and

  • y. Notice here, again, x is your cost driver. What is a cost driver? It drives the cost.

  • It could be direct labor dollars, direct labor hours, machine hours, some kind of quantity.

  • That is called the cost driver. What cost driver basis will we use? Whatever base is

  • best for your industry. So, it just depends on what you're doing, which youre manufacturing

  • and so forth. What is y? y would be, in this case, my total costs. So as we look at this,

  • that's called variable. So this one’s fixed, this one's variable. What would total cost

  • look like? Let’s put them together...boom, boom...here's x, here's y. Here would be my

  • fixed costs, and this angle would be my variable costs. That’s total cost. What’s total

  • cost? It says that at this level of activity, boom, boom is total cost. At this level of

  • activity, boom, boom, that's total cost. So, notice that’s your total cost, that’s

  • your y, x and y. So when we come back over to this formula, total cost equals fixed plus

  • variable times x. x is called your cost driver. x is your independent variable. Why? Because

  • your y is total cost. That’s dependent. What is that dependent upon? The x. So ifyou

  • come back over here, independent, dependent. Why? Because total cost is dependent upon

  • the x, so this is called the independent variable, this is called the dependent variable. What

  • are we looking at? The cost driver. So let's look at the terms on page 1. It says y=a +

  • bx, total cost equals fixed plus variable times x. The y is equal to total cost and

  • is referred to as the what? Dependent variable since it’s amount is dependent upon other

  • factors. The x is equal to volume, which is referred to as independent variable, since

  • it can be increased or decreased at the company’s discretion. It's also called the what? Cost

  • driver. a is called the fixed cost, b our variable cost. Note: these cost assumptions

  • only remain valid between the...within the what? Relevant range. Now, what is the relevant

  • range? That is defined as the range in which your cost assumptions remain valid. For example,

  • fixed are fixed in total but variable per unit. Variable are fixed per unit but vary

  • in total. So, for example, fixed costs are fixed in total. So the relevant range means

  • that I assume if my factory rent’s 100,000 dollars, fixed is a 100,000. What if, in my

  • capacity, I can only manufacture 100,000 units, but I want to manufacture 105,000? Then what's

  • going to happen to total costs? They have to go up, because now, instead of manufacturing

  • 100,000, I want to manufacture 105, I need a new factory. So we're assuming that your

  • costs are within the relevant range, where fixed are fixed in total, variable are also

  • fixed per unit. So what's electricity? A dollar an hour. That is the assumption within the

  • relevant range. Now the next thing down the page is called a mixed cost or semi-variable

  • cost. Now, with a mixed cost, that's a cost that is both fixed and variable components,

  • fixed and variable components. Now, when we talk about a mixed cost, basically this would

  • be like, let's say your phone bill. Ok? In the olden days, when you had a phone and you

  • had to pay a monthly fee. So, you pay 20 dollars a month. That's my fixed, and every minute

  • on the phone, you're paying an extra dollar, let's say. So, that's when I pick up the phone,

  • and I would call my girlfriend because you can't see her because you're studying, “Hi

  • Pookie!” “No, youre Pookie.” “I love you [kissing sounds].” “I love you,

  • too [kissing sounds.]” So what happens? Youve got a fixed and a variable component.

  • So what we're trying to do is, we use this thing called the high-low method in order

  • to break out the fixed and variable components. Because when you think about your phone bill,

  • youve got a fixed portion and a variable portion. What is consistent between the low

  • and the high activity? What costs are fixed? The fixed costs. So if we, for example, let's

  • look at this graph. We're going to look at our high level of activity. We're going to

  • look at our low level activity. Now, within both of these, what costs are the same? This

  • fixed cost is the same. So what we do is, we're going to take the high from the low.

  • When you take the high from the low, your fixed costs disappear. You're just left with

  • the variable costs. Then what we're going to do is were going to try to force the

  • slope of the angle because the slope of the angle are what? Your variable costs. Because

  • this is fixed, that angle is variable. This is total because it starts with the fixed

  • and the variable. So notice that we're going to try to force the slope of the line. That'll

  • give us an estimate of what our variable costs are. This method is called the high hyphen

  • low, high hyphen low method. Now, in the high hyphen low...What is a hyphen in mathematics?

  • It’s a minus. Very good. So, it's a high minus low. Hmmm....that sounds interesting.

  • Let's look at it. It says high-low method, total cost and total hours. Here's our total

  • cost. Here's our hours. What it says is, at the high 110 and 30,000 hours. At the low...what

  • is it? 80,000 total cost and 20,000 hours. So if you take the high hyphen low, then that

  • gives us 30,000 dollars and 10,000 hours. Now, if you divide the high and the low, that

  • gives us 3 dollars per base. What's our base? Hour. 3 dollars an hour. That is an estimate

  • of your variable costs because what happens is, back on this picture, at the high minus

  • low, you...your fixed costs disappear, you're left with variable costs. Now, incidentally,

  • mark this in your notes, what is this point right here called? The intercept, because

  • that is where it crosses the y-axis. That is called the intercept. Important to understand

  • that. So, if I wanted to then take this and set up a formula, my formula could be...oh,

  • right here. What is it? You would say total cost, 110, equals my fixed plus variable,

  • which we just figured as 3, times activity level is either one of these. Well, at 110,

  • it must be 30. So, 30 times 3 is 90, 110, this must be 20. Let's try it again. Let's

  • see if it works. Let's try the other one. 80 equals fixed plus 3 times x. What's x?

  • 20 times 3 is 60 plus 20 is, so it works. So if I want to set up a formula, what is

  • the formula I'm going to use? Youre going to say, total cost equals fixed, 20, plus

  • 3 times x. Now, what does x represent? Any activity level. What will this formula give

  • me? It'll give me anything on this line. Mmmmm....so, if I were to pick a point here, go up, boom,

  • that's going to give me total cost. What's the formula? Total cost equals 20 plus variable

  • times x...well not variable, times 3 times x. So, whatever this is, you plug it in here.

  • That'll tell you what this total cost should be. Remember, this is called the what? Dependent.

  • What is this? Independent. This is independent. This is dependent upon this. Now that's an

  • important concept. Why? Because later on, this becomes something called our flexible

  • budget equation. It’s flexible. Wooo! What does that mean? It tells you what total cost

  • will be at different levels of activity based on your cost driver, so that is called your

  • flexible budget equation. So, as we go through this later on, we're going to be doing something

  • called variance analysis and all of your overhead variances are done using the flexible budget

  • equation. So you're going to see, as we go through time, that this formula will be used

  • again and again and again and again and again and again. Woo! Woo! Alrighty, let's turn

  • to the next page. Cost classifications. Now, with our cost classifications, we are looking

  • at different types of costs and we have here what we call manufacturing costs, and those

  • are going to be called our manufacturing or our product costs. We also have what we call

  • non-manufacturing costs. Those are called our period costs. So what I want to compare

  • are the manufacturing costs, also called a product cost, versus our non-manufacturing

  • costs, also called a period cost. So, we're going to look at what are the differences.

  • Well, what is a non-manufacturing cost? A non-manufacturing cost is considered a period

  • cost. It is considered an expense in the period whether you sell them or not. What’s an

  • example? SG & A. What is SG & A? Selling general administrative expenses. Those are considered

  • an expense in the period. It says theyre marketing costs, freight out, re-handling.

  • Also, very important, abnormal spoilage, and I’m going to talk about that throughout

  • the course, but abnormal versus normal spoilage. Those are all non-manufacturing. Those are

  • all period costs and expense in the period whether you sell it or not. SG & A, selling

  • general administrative marketing cost and abnormal spoilage versus, the other cost is

  • called a product cost. Those are manufacturing costs. They become part of the cost of the

  • product. The product that you are manufacturing. Now, as far as manufacturing costs, they include

  • 3 basic elements...direct materials, direct labor, and manufacturing or factory overhead.

  • So, I’m going to call that direct materials, DM, direct labor and factory overhead. Those

  • are the 3 different types of manufacturing costs. For example, I'm going to build this

  • wooden lectern I have right here. Now, if I want a build that podium or that lectern,

  • what do I need? I need 1, 2, 3, 4, 5, 6 pieces of fake wood, alright? That’s 6 pieces.

  • That is called my direct material. What is direct materials? Those are the materials