11 Accounting Decisions...................................
This chapter explains how accountants classify costs and determine the costs of
products/services through differentiating product and period costs, and direct
and indirect costs. The chapter emphasizes the overhead allocation problem:
how indirect costs are allocated over products/services. In doing so, it contrasts
absorption with activity-based costing. The chapter concludes with an overview
of contingency theory, Japanese approaches to management accounting and the
behavioural consequences of accounting choices.
Cost classification
Product and period costs
The first categorization of costs made by accountants is between period and
product.Period costsrelate to the accounting period (year, month).Product costs
relate to the cost of goods (or services) produced. This distinction is particularly
important to the link between management accounting and financial accounting,
because the calculation of profit is based on the separation of product and period
costs. However, the value given to inventory is based only on product costs, a
requirement of accounting standards (see later in this chapter).
Although Chapters 8, 9 and 10 introduced the concept of the contribution (sales
less variable costs), as we saw in Chapter 6 there are two types of profit: gross
profit and net profit:
gross profit=sales−cost of salesThecost of salesis the product (or service) cost. It is either:
žthe cost of providing a service; or
žthe cost of buying goods sold by a retailer; or
žthe cost of raw materials and production costs for a product manufacturer.
net (or operating) profit=gross profit−expensesExpensesare the period costs, as they relate more to a period of time than
to the production of product/services. These will include all the other (selling,