Factors in Inventoriable Costs

1.) Definition of inventory-able cost

In accounting, inventoriable expenses are the costs incurred when companies purchase products or produce products prior to selling them. Therefore, inventoriable expenses are related to the cost of manufacturing which includes direct labor, direct material, and manufacturing overhead.

cost of inventory is included in the inventory accounts as assets in balance sheets prior to when products are sold to cover costs of selling goods, which are reported as expenses in the income statement. (Wilkinson, 2013)

2.) Examples of expenses are provided and not included in the inventoriable cost.

  • Costs are included as inventoriable costs, such as raw materials and direct labor. For instance, raw materials like zippers and fabric are bought by hang bag factories. Direct laborers who are employed make use of these raw materials to create handbags. Handbags that are finished can’t be recorded as expenses up until the time they’re sold and will be recorded as costs of the sale of goods in the income statement.
  • Administrative and selling expenses are not part of inventory-based costs . They are period-related costs that are recorded as expenditures directly in income statements. Some examples of expenses are not included in inventory costs, like the salaries of salespersons, advertisement expenses that are not associated with production costs.

Cost drives that are based on activity could be classified as volume-based cost drivers and non-volume cost drivers. Cost drives that are based on volume comprise inputs and output.

Drivers based on volume cost

O outputs are among the price drivers like the number of units that are produced. If a company has just one item, opting to employ outputs cost drives, this will be the most effective approach. However, if companies have multiple products, and each product has to allocate different overhead resources, then outputs do not cost drivers.

Noodle shops in the market at night in Auckland could make use of outputs as cost-drives because they only sell one type of noodles and the ingredients and labor cost in every bowl of noodles are identical. But, there is various bread used in bakeries, therefore the bakery cannot make use of outputs as cost drivers.

Inputs.

  1. Direct hourly labor or direct cost. A lot of businesses use direct labor hours or costs as manufacturing costs or overhead drivers. For instance, tax agencies charge their clients based on their cost of time.
  2. Machine hour. Certain businesses have equipment that is more automated and requires less direct labor costs, which is why they use machine hours for overhead expense drivers. For instance, Fuji Xerox charges their customers based on the meter reading of their printer.
  3. Direct quantities of material or costs. Some companies require huge amounts of materials, and they employ directly-sourced materials to serve as driving factors. (Langfiled-Smith, 2012)

Example:

Management accountants make use of the input of volume cost-based drivers to determine the cost of custom furniture to their customers in the ABC Furniture Design Shop. The price of a custom chair are as follows:

There is a direct material cost of $50 and $100 labor cost. 20 machine hours. The management accountant will determine the price of the chair to exceed $170.

  1. Examples: the following are the costs of electricity for making cookies for a company that makes cookies.

Variable cost

Electrical power per batch ($7400-5400)(or (1320-750) =3.51 in each batch.

For the lowest level of batch 750, the total variable cost was $2633 ($3.51×750) after subtracting the costs for the lowest activity. The lowest cost was $5400. The difference was $2767.

Monthly electricity cost = $2767+ ($3.51 multiplied by the number of batches made in a month)

  1. The weakness of the high low method: This method is not recommended for the estimation of cost behavior because this method only uses two variables (highest and the lowest) and disregards the rest of the information. Therefore, we cannot be sure that this method will present costs in a precise manner.

a. Costs that are unavoidable and preventable

  • Costs that are avoidable are not likely to occur if a particular choice is made. (Langfiled-Smith, 2012)

Example: Bank of New Zealand has decided to shut down some branches and reduce opening hours since they are using a digital bank more. BNZ employs this strategy to reduce the cost of unnecessary expenses like wages, rates, and rents in certain branches by closing these branches. (Parker, 2017)

  • Unavoidable expenses: will costs remain a constant expense, regardless of the decisions or actions are taken.

Example: Residential property owner, regardless of whether the decision for renting or to not rent the property the council rate and insurance charges aren’t a thing to be avoided.

  1. Costs of sunk and opportunity
  • Sunk costs are the costs that have are already in place and cannot be modified at this time or in the near future. They are the resources that have been purchased and won’t be affected by the different decisions that are taken. Thus, when making decisions, they ignore these costs. (Langfiled-Smith, 2012)

Example: An accountant purchases the printing machine for $1,000. The $1000 price is the sunk cost.

Month Electricity cost for a month Numbers of batches produced for the month
January $7200 1210
February 6950 1050
March 6100 980
April 7300 1350
May 5990 810
June 6530 990
July 5700 790
August 5400 750
September 6800 990
October 7150 1190
November 5800 820
December 7400 1320
  • Opportunities costs can be a source of benefits. They occur when an alternative choice is taken over by another. (Langfiled-Smith, 2012)

Example: If your accountant didn’t purchase the printer for $1000, the accountant will save $1000, which is an opportunity cost.

  1. Costs that are relevant and non-relevant
  • Relevant costs: Costs are affected by the management decisions made. Usually, there are two or more managerial choices, and the managers make the decision to choose the more profitable alternatives. Costs that are relevant will be incurred in one managerial decision, but stay clear of in another.

Examples: the costs of branches that are closed BNZ branches are significant costs due to the fact that BNZ can cut costs and earn more profits when they shut down the branches.

  • Costs that are irrelevant: they do not change due to different choices. In the same way, a cost that is irrelevant will continue to occur regardless of which decision is taken.

Example: CEO’s salary is unimportant regardless of whether BNZ decides to close certain branches

References

Langfiled-Smith, K. (2012). Management Accounting: Information to create and manage value. Sydney, NSW 2113, Australia: Rosemary Noble.

Parker, T. (2017, March 17). BNZ closes branches and hours of operation. Retrieved from nzherald.co.NZ: http://www.nzherald.co.nz/personal-finance/news/article.cfm?c_id=12&objectid=11820201

Relevant VS Irrelevant costs. (n.d.). Retrieved from accounting explained: http://accountingexplained.com/managerial/costs/relevant-irrelevant-costs

Wilkinson, J. (2013, July 24). The Strategic CFO. Retrieved from Inventoriable costs: https://strategiccfo.com/inventoriable-costs/

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