After having talked a lot about general things in managerial accounting, we are now approaching one of the core concepts of this course namely, the idea of total cost. Well, in this episode, we will discuss some important ideas of concept with respect to costs that we must keep in mind and we'll see how costs are treated in the managerial accounting. Then we will proceed and we'll see some specific ideas about costs, the behavior, the break down and how people properly approach them. This is costs intro. First of all, here we will have some important definitions and comments of them. First of all, this is the idea of cost object. This is the question of, with respect to what are we studying cost? Remember this question. Something costs 100 dollars so this something is an object and that must be specified. Some examples, there are many product, service, project, customer and here for example, activity. Later on in our fifth week, we'll talk about ABC, Activity Based Costing and that's a very advanced and widely used approach in which it is the activity that is studied as an object. Then for example, department or program. So there may be many. You can see that the important idea that we can immediately emphasize right now is that, with respect to different objects, costs behave differently. They are differently traced, they are differently assigned, they are differently allocated and so on and so forth. Now the next thing here is cost accumulation and assignment. The idea here is as follows, overall, we may know what our total costs are. We can just physically calculate them or just recognize them. But then if we, let's say this is a company and if we take the company as a whole as a cost object, then we can say well then managerial accounting is not that far from financial accounting and that's something that we talked about in the second episode. But we win this company, if we take different objects then we can see that it is a huge and challenging question, how we can study costs that are associated with this object only, within the company. Sometimes, we may not be able to properly fix this cost to this object. We will have to follow certain procedures how we will make the decision of what part of the total cost we charge with respect to this object. Here we basically have two stages. Stage one, this is accumulation when we actually take into account and recognize all costs. And then stage two, this is assignment. That's what I said, this is how we charge certain objects with these costs. We can see that we just started but we already emphasized the key issues here and the key issue as you can imagine right now,although I will be reemphasizes further on is that, how we can properly charge certain objects with the share of the total cost that we observe in the activity of this company division or whatever. Now the next thing is cost tracing and allocation. Here, for the first time, we introduce the core concepts in managerial accounting. This is the direct cost for example. Direct costs are the ones that can be immediately associated with the cost object. Let's say that this is the unit that produces something and in this unit there are some people working and these people are paid by hour. You can say that the total cost of this direct labor with respect to that. This is a direct cost charged to this unit. I would put "can be traced to cost object." Now, a much more challenging topic is the idea of indirect costs that sometimes are also called overhead. Now, these costs either cannot be traced directly or in theory, you can trace them but that's economically inefficient. For example, you produce some classic example, you produce blue jeans and their clips or zippers for them and again, they arrive in a huge container. So strictly speaking, you can identify the cost of each of them but it may be easier to take the whole batch and then calculate this and then divide that by the number of pieces produced or by the department. In some cases, it may be easier not to specifically trace that but to assume something and then use some approximate procedures. Here we can say for the first time that with the development of technology, now it's easier to trace many more costs that previously have been treated as indirect as direct. The classic example that we quote many time is a barcode for example. With a barcode, when you go to the cash register then immediately you can associate the exact cost of this widget of this piece. You don't have to take the overall amount and then find the way what was spoilt and what still is in the warehouse. So that may be easier. Although, remember, we talked in the previous episode, it all is the trade-off and the balance. How much does it cost? Maybe theoretical or even practical, technology can allow you to do whatever you like and maybe to make as many costs direct as you wish but it also depends upon what is the amount of resources that is going to be spent for that. And that in itself, may prove economically inefficient. Now, the next idea here is allocation and the idea is that if we have indirect costs, then we have to assign their share to a certain object and that is one of the core objectives in managerial accounting. How to find the right share of the direct cost charged against this cost objects? There are some factors that influence that. But first of all, it's an important distinction between these costs and that does not mean that costs are either direct or indirect. The key challenge is that one and the same cost may be direct with respect to one cost object and indirect with respect to the other. Let me give you an example. There are a couple of manufacturing units and they are all in the same division. Now, in this division there is the management so the costs incurred for this management for their pay, for the bonuses and something with respect to the whole division, may well be treated as a direct cost. It can be easily traced. But if you like to see the portion of these costs that are charged against each product line, that's going to be indirect. We will see that the whole process that openly recognizes this dichotomy that you can see that one in the same cost is direct with respect to one object and indirect in respect to the other. Here like I said, we have to keep in mind that technology plays an important role and this trade-off that we talked about before. That's basically it. Now, the next thing that plays an important role here. This is and again, for the moment it will be maybe one of the most important topics. This is the cost driver. The cost driver is something that is sort of a generator or a determinant of cost so you can say, well, for example, if there's a certain procedure you do something then obviously all costs that are important to incur in this process, they are charged to this. So this is actually a generator or determinant. This is what affects cost. This is sort of a clear idea. For example, that maybe number of people, number of projects, the project complexity, so all that contributes to the overall cost. And then the next thing is costs and output. Well, that is widely studied and well-known. You know that if you change the output of your manufacturing process, then that has a effect on costs. Here we have a major distinction. We have fixed costs that do not depend upon the volume of output. And then we have variable costs that do depend upon that. All that leads us to the next part and then in next part, we will talk specifically about this. So we will analyze the so-called cost behavior. Because this is for the first time, the area in which we will see how we have to keep in mind certain things that on the surface seem to be absolutely trivial but oftentimes, are mistreated by people. So in the next episode we'll say a few words about cost and output, cost benefit analysis and then the cost behavior.
