02 Cost Concepts Chap002_7e_edited

8/8/2019 02 Cost Concepts Chap002_7e_edited

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Copyright 2008 by The McGraw-Hill Companies, Inc. AllMcGraw-Hill/Irwin

Basic Concepts of

Cost ManagementandAccounting forMass Customized Operations

2


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Process of ManagementProcess of Management

DecisionMaking

DirectingControl

PlanningStrategyFormulation

Managers need cost information toperform each of these functions.


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What Do We Mean By a Cost?What Do We Mean By a Cost?

A costis the measure ofresources given

up to achieve aparticular purpose.


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Expense:Expense:

Expense is the cost incurred when an asset isused up or is sold for the purpose ofgenerating revenue

An Asset used upDepreciation treated as expense for using anasset

When goods are soldCost of goods sold is treated as expenseagainst revenue


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Product CostsProduct Costs

Cost of goods sold

(Material, Labour, Mfg Exp)

Cost Classifications on FinancialCost Classifications on Financial

Statements Income StatementStatements Income Statement

The term product cost and period cost are used todescribe the timing with which various expenses arerecognised in the books of accounts.

Product costs are costs associated with goods for

sale until the products are sold, at which time thecosts are recognised as expenses.


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Product Costs, Period Costs and ExpensesProduct Costs, Period Costs and Expenses

Period costs are costs that are expensed duringthe time period in which they are incurred.

Period CostsPeriod Costs (Other than product costs)(Other than product costs)

Operating expenses

(other than cost cost of goods sold(Selling, Admin, Distribn. R&D)


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Product Costs, Period Costs and ExpensesProduct Costs, Period Costs and Expenses

Period CostsPeriod Costs(Other than product costs)(Other than product costs)

Operating expenses(Selling, Admin, Distribn. R&D)

Treated as expenses onexpiry of accountingperiod

Product CostsProduct Costs

Cost of goods sold

(Material, Labour, Mfg Exp)

Recognised as expensewhen goods are sold


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Current assets

MerchandiserMerchandiser

Current Asset CashCash

ReceivablesReceivables

Prepaid ExpensesPrepaid Expensesid

Expenses MerchandiseMerchandise

InventorInventoryy

Current AssetsCurrent Assets

ManufacturerManufacturer

Current Assetsq CashCash

q ReceivablesReceivables

q Prepaid ExpensesPrepaid Expenses

q

InventoriesInventoriesRaw MaterialsRaw Materials

Work in ProcessWork in Process

Finished GoodsFinished Goods


Statements Balance SheetStatements Balance Sheet


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Current Assets Cash Receivables

Prepaid Expenses

MerchandiseMerchandiseInventoryInventory





q






Those materialswaiting to beprocessed.


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Prepaid Expenses






q






Partially complete

products material towhich some labor

and/or overhead hasbeen added.


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Prepaid Expenses






q






Completed productsawaiting sale.


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Manufacturing CostsManufacturing Costs

TheProduct

DirectLabor

DirectMaterial Manufacturing

Overhead


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Direct MaterialDirect Material

Example:Steel used tomanufacture

the automobile.

Example:Steel used tomanufacture

the automobile.

Cost of raw material that is used tomake, and can be conveniently

traced, to the finished product.


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Direct MaterialDirect MaterialDirect materials (used at factory)

All materials or components specifically purchased,produced or taken from stores

Primary packing material like carton, wrapping,

cardboards boxes

process materials, production materials,stores materials, construction materialse.g Silicon chip for computer system

Tyres, gear assembly, window glasses, steering

wheels for a carWoodfor furniture

Plasticfor plastic toys,

Bricks, marble, cement, steel, for a construction project


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Cost of salaries, wages, and fringebenefits for personnel who work

directly on manufactured products.

Direct LaborDirect Labor

Example:

Wages paid to anautomobile assemblyworker.

Example:

Wages paid to anautomobile assemblyworker.


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All other manufacturing costs

Manufacturing OverheadManufacturing Overhead

Materials used to support

the production process.Examples: lubricants andcleaning material supplies

used in an automobileassembly plant.

Indirect

Labor

Indirect

Material

Other

Costs


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Indirect materialsIndirect materials

That may be part of product but can be traced atgreat cost and inconvenience are called indirect

materials

e.g. Glue, nails, Welding material

Orlike repair material that can not be identified with

any one unit of product because it is used for

benefit of all products rather than any specificproduct

lubricants, oil, consumable stores


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All other manufacturing costs

Manufacturing OverheadManufacturing Overhead

Cost of personnel who

do not work directly onthe product. Examples:maintenance workers,janitors and security

guards.

Indirect

Labor

Indirect

Material

Other

Costs


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Indirect labour: (factory)Indirect labour: (factory)

cost that can not be traced physically tothe creation of the product i.e wages of all

employees who assist in mfg. process

e.g.

Maintenance people, production supervisors,

canteen workers,

medical staff,

engineers,

security guards

who are essential to production process but it isimpractical to accurately relate their cost to specificproduct


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Other overheadsOther overheads

Indirect mfg. expensesIndirect mfg. expensesTaxes, Power, water , lighting,

employee fringe benefits like

health and insurance, pension benefits,

inventory handling costs

N M f iN M f t i t


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Non Manufacturing costsNon Manufacturing costs

period costsperiod costs

Selling and distribution costsCosts to market and sell finished products

Or Order getting and order filling costs

Advertisement.Salesmen salary and commission,

costs for warehousing the finished goods

Shipping, transportation charges to delivergoods,


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NonNonManufacturing costsManufacturing costs

period costsperiod costs

Administrative costsCosts for general management of the Firm

Top management expenses,Accounting expenses,

General secretarial services,

Public relations

Stationery expenses

Telephone and General expenses etc.


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Classifications of Costs inClassifications of Costs in

Manufacturing CompaniesManufacturing Companies

PrimeCost

ConversionCost

Manufacturing costs are oftencombined as follows:

DirectMaterial

DirectLabor

ManufacturingOverhead


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Manufacturing Cost FlowsManufacturing Cost Flows


Direct Material

Direct LaborWork inProcess

Inventory


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Direct Material

Direct Labor

FinishedGoods

Inventory

Work inProcess

Inventory


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Direct Material

Direct Labor

FinishedGoods

Inventory

Cost ofGoods

Sold

Work inProcess

Inventory

Exh


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Comet Computer Corporation

Schedule of Cost of Goods Manufactured

Raw material used 134,980$

Direct labor 50,000

Total manufacturing overhead 230,000

Total manufacturing costs 414,980$

Add: Work-in-process inventory, January 1 120

Subtotal 415,100$

Deduct: Work-in-process inventory, December 31 100

Cost of goods manufactured 415,000$

Schedule of Cost of GoodsSchedule of Cost of GoodsManufacturedManufactured

Exh.

2-7

Exh


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Direct labor 50,000




Subtotal 415,100$




Computation of Cost of Raw Material Used

Raw-material inventory, January 1 6,000$

Add: Purchases of raw materials 134,000

Raw material available for use 140,000

Deduct: Raw material inventory, December 31 5,020


Exh.

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Exh


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Direct labor 50,000




Subtotal 415,100$




Include all direct laborcosts incurred during the

current period.

Exh.

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Schedule of Cost of Goods ManufacturedSchedule of Cost of Goods Manufactured

Exh.


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Direct labor 50,000




Subtotal 415,100$



Schedule of Cost of Goods ManufacturedSchedule of Cost of Goods Manufactured

Computation of Total Manufacturing Overhead

Indirect material 10,000$

Indirect labor 40,000Depreciation on factory 90,000

Depreciation on equipment 70,000

Utilities 15,000

Insurance 5,000

Total manufacturing overhead 230,000$

Exh.

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S h d l f C f G d

Exh.


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Direct labor 50,000




Subtotal 415,100$




Beginning work-in-process inventory iscarried over from the

prior period.

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S h d l f C t f G d

Exh.


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Direct labor 50,000




Subtotal 415,100$




Ending work-in-process inventorycontains the cost of unfinished

goods, and is reported in the currentassets section of the balance sheet.

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S fI St t t fExh.


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Income Statement for aIncome Statement for aManufacturerManufacturer


Income StatementFor the Year Ended December 31, 20X2

Sales revenue 700,000$

Less: Cost of goods sold 415,010

Gross margin 284,990$

Selling and administrative expenses 174,490

Income before taxes 110,500$

Income tax expense 30,000

Net income 80,500$

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I S f M f

Exh.


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Income StatementFor the Year Ended December 31, 20X2

Sales revenue 700,000$

Less: Cost of goods sold 415,010

Gross margin 284,990$

Selling and administrative expenses 174,490

Income before taxes 110,500$

Income tax expense 30,000

Net income 80,500$

Income Statement for a ManufacturerIncome Statement for a Manufacturer


Schedule of Cost of Goods Sold

For the Year Ended December 31, 20X2

Finished-goods inventory, Jan. 1 200$

Add: Cost of goods manufactured 415,000

Cost of goods available for sale 415,200

Deduct Finished-goods inventory, Dec. 31 190

Cost of goods sold 415,010$

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Identifying Cost DriversIdentifying Cost Drivers

Cost Driver Examples

Activity Cost Driver

Machining operations Machine hoursSetup Setup hours

Production scheduling Manufacturing orders

Inspection Pieces inspected

Purchasing Purchase ordersShop order handling Shop orders

Valve assembly support Customer requisitions

Activities that

cause costs to beincurred are called

cost drivers.


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Cost ClassificationsCost Classifications

Cost behavior meanshow a cost will reactto changes in thelevel of businessactivity.


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Cost behavior means howa cost will react tochanges in the level of

business activity. Totalvariable costschange

when activity changes.

Totalfixed costsremainunchanged when activity

changes.


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Total Variable Cost ExampleTotal Variable Cost Example

Your total long distance telephone bill isbased on how many minutes you talk.

Minutes Talked

TotalLongD

istan c

e

Tel

eph

oneBill


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Variable Cost Per Unit ExampleVariable Cost Per Unit Example

Minutes Talked

Pe

rM

inute

Teleph

one

Charg e

The cost per long distance minute talked isconstant. For example, 5 cents per minute.


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Total Fixed Cost ExampleTotal Fixed Cost Example

Your monthly basic telephone bill probablydoes not change even if you do not make

any calls

Number of Local Calls

upto 100 per month

Mon

thlyBasic

Tele

phone

Bill


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Fixed Cost Per Unit ExampleFixed Cost Per Unit Example

Number of Local

Calls

Month

lyBasicTe

leph

one

Billp

erLoc

alCal

l

The average cost per local call decreases asmore local calls are made.


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Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Total variable cost changes Variable cost per unit

Variable as activity level changes. remains the same over

wide ranges of activity.

Total fixed cost remains Fixed cost per unit

Fixed the same even when the goes down as activity

activity level changes. level goes up.


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Direct and Indirect CostsDirect and Indirect Costs

Direct costs Costs that can be

easily andconveniently traced to

a product ordepartment.

Example: cost ofpaint in the paint

department of anautomobile assemblyplant.

Indirect costs Costs that must be

allocated in order tobe assigned to a

product ordepartment.

Example: cost ofnational advertising

for an airline isindirect to a particularflight.


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A cost can be direct to the department,but indirect to units of product producedin the department.

Example: department managers salary.

Tracing costs directly to departments orproducts helps to identify and eliminate

non-value added costs.

Direct and Indirect CostsDirect and Indirect Costs

C t ll bl dControllable and


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A cost that can be significantly influencedby a manager is a controllable cost.

Controllable andControllable and

Uncontrollable CostsUncontrollable Costs

Cost item Manager Classificaton

Cost of food used Restaurant Controllable

in a restaurant manager

Cost of national Restaurant Uncontrollable

advertising by a manager

restaurant chain


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Opportunity CostOpportunity Cost

The potential benefit that isgiven up when onealternative is selected over

another. Example: If you were

not attending college,you could be earning$20,000 per year.

Your opportunity costof attending college for one yearis $20,000.


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Sunk CostsSunk Costs

All costs incurred in the past that cannot bechanged by any decision made now or in thefuture are sunk costs. Sunk costs should not be

considered in decisions. Example: You bought an automobile that cost

$12,000 two years ago. The $12,000 cost issunk because whether you drive it, park it, tradeit, or sell it, you cannot change the $12,000cost.


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Differential CostsDifferential Costs

Costs that differ between alternatives.

Example:You can earn $1,500 per month in yourhometown or $2,000 per month in a nearby city.

Your commuting costs are $50 per month in yourhometown and $300 per month to the city.

What is your differential cost?$300 - $50 = $250

Cost unit


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Cost unita unit or quantity of product for which costs may be

ascertained or with which costs may be identified

e.G Brick work-per1000 bricks

Collieries- pertonne of coal

Textile mills- peryard / lb. ofcloth or yarn

Electricity companies perunit of elec. Watt hour unit

Transport co.- per tonne, perpassenger

Steel mills- per tonne of steel mass Weight-Dairy products- kilogram, litre, tonne,

Length/dimension-metre, yard, M3

Number -number of pieces / units

Hotel- per room per day,nursing home- per bed per day

Gas- per cft / m3 ,

timber - per m3

Marginal Costs and AverageMarginal Costs and Average


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Marginal Costs and AverageMarginal Costs and Average

CostsCosts

The extra costincurred to produceone additional unit.

The total cost toproduce a quantity

divided by thequantity produced.

Marginal and average costs arelargely a function of cost behavior

-- variable and fixed costs.

AND NOW


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AND, NOWAND, NOW

???????


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We believe

that its morethan

enough!!!!


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f


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Do you feel happy

at the end?


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End of Chapter 1End of Chapter 1

02 Cost Concepts Chap002_7e_edited

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