3, Cost Terminology
Transcript of 3, Cost Terminology
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Costs Terms, Concepts and
Classifications
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The ProductThe Product
DirectMaterials
DirectMaterials
DirectLabor
DirectLabor
Manufacturing
Overhead
Manufacturing
Overhead
Manufacturing Costs
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Direct Materials
Raw materials that become an integralpart of the product and that can beconveniently traced directly to it.
Example: A radio installed in an automobile
Example: A radio installed in an automobile
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Direct Labor
Those labor costs that can be easilytraced to individual units of product.
Example: Wages paid to automobile assembly workers
Example: Wages paid to automobile assembly workers
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Manufacturing costs that cannot betraced directly to specific units
produced.
Manufacturing Overhead
Examples: Indirect labor and indirect materials
Examples: Indirect labor and indirect materials
Wages paid to employeeswho are not directly
involved in productionwork.
Examples: maintenanceworkers, janitors and
security guards.
Materials used to supportthe production process.
Examples: lubricants andcleaning supplies used in theautomobile assembly plant.
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Classifications of Costs
DirectMaterialDirect
MaterialDirectLaborDirectLabor
ManufacturingOverhead
ManufacturingOverhead
PrimeCost
ConversionCost
Manufacturing costs are oftenclassified as follows:
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Non-manufacturing Costs
Marketing or Selling Cost
Costs necessary to get
the order and deliverthe product.
Administrative Cost
All executive,
organizational, andclerical costs.
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Quick Check
Which of the following costs would beconsidered a period rather than a productcost in a manufacturing company?
A. Manufacturing equipmentdepreciation. B. Property taxes on corporate
headquarters. C. Direct materials costs. D. Electrical costs to light the
production
facility.
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Quick Check
Which of the following costs would beconsidered a period rather than a productcost in a manufacturing company?
A. Manufacturing equipmentdepreciation. B. Property taxes on corporate
headquarters. C. Direct materials costs. D. Electrical costs to light the
production
facility.
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Comparing Merchandising andManufacturing Activities
Merchandisers . . . Buy finished
goods.
Sell finishedgoods.
Manufacturers . . . Buy raw
materials.
Produce and sellfinished goods.
MegaLoMart
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Balance Sheet
Merchandiser
Current assets
uCashuReceivablesuPrepaid
Expenses
uMerchandiseInventory
Manufacturer Current Assets
xCash
xReceivablesxPrepaid Expenses
xInventoriesRaw Materials
Work in ProcessFinished Goods
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Balance Sheet
Merchandiser
Current assets
uCashuReceivablesuPrepaid
Expenses
uMerchandiseInventory
Manufacturer Current Assets
xCash
xReceivablesxPrepaid Expenses
xInventoriesRaw Materials
Work in ProcessFinished Goods
Partially completeproducts some
material, labor, oroverhead has been
added.
Completed productsawaiting sale.
Materials waiting tobe processed.
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The Income Statement
Cost of goods sold for manufacturers differs onlyslightly from cost of goods sold for
merchandisers.
Manufacturing Compan
Cost of goods sold:
Beg. finished
goods inv. 14,2$
+ Cost of goods
manufactured 234,1Goods available
for sale 248,3$
- Ending
finished goods
inventory (12,1
Merchandising Company
Cost of goods sold:Beg. merchandise
inventory 14,200$
+ Purchases 234,150
Goods available
for sale 248,350$
- Endingmerchandise
inventory (12,100)
= Cost of goods
sold 236,250$
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Inventory Flows
Beginningbalance
$$
Beginningbalance
$$
Additions$$$
Additions$$$+
Available$$$$$
Available$$$$$=
Endingbalance
$$
Endingbalance
$$=
Withdrawals$$$
Withdrawals$$$
_Available
$$$$$
Available$$$$$
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Quick Check
If your inventory balance at the beginningof the month was $1,000, you bought $100during the month, and sold $300 during themonth, what would be the balance at the endof the month?
A. $1,000. B. $ 800.
C. $1,200. D. $ 200.
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Quick Check
If your inventory balance at the beginningof the month was $1,000, you bought $100during the month, and sold $300 during themonth, what would be the balance at the endof the month?
A. $1,000. B. $ 800.
C. $1,200. D. $ 200.
$1,000 + $100 = $1,100$1,100 - $300 = $800
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Schedule of Cost of GoodsManufactured
Calculates the cost of rawmaterial, direct labor and
manufacturing overhead used
in production.
Calculates the manufacturingcosts associated with goodsthat were finished during the
period.
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Manufacturing Work
Raw Materials Costs In Process
Beginning raw Direct materials
materials inventory
+ Raw materialspurchased
= Raw materials
available for use
in production
Ending raw materials
inventory= Raw materials used
in production
As items are removed from rawmaterials inventory and placed into
the production process, they arecalled direct materials.
As items are removed from rawmaterials inventory and placed into
the production process, they arecalled direct materials.
Product Cost Flows
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Manufacturing
Raw Materials Costs In
Beginning raw Direct materials
materials inventory + Direct labor+ Raw materials + Mfg. overhead
purchased = Total manufacturing
= Raw materials costs
available for use
in production Ending raw materials
inventory
= Raw materials used
in production
Conversioncosts are costs
incurred toconvert thedirect materialinto a finished
product.
Conversioncosts are costs
incurred toconvert the
direct materialinto a finished
product.
Product Cost Flows
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Work
In P ro cess F in ish ed Go o d s
Be ginn ing w ork in Be ginn ing fin ishe d
p ro ce ss in ve n to ry g oo ds in ve n to ry
+ M a nufa cturing costs + Cost of goo dsfor the pe riod manufactured
= T o ta l w o r k i n p ro ce ss = C o st o f g o o ds
fo r the pe riod a va i la ble fo r sa le
Ending w ork in - End ing fin ishe d
p ro ce ss in ve n to ry g oo ds in ve n to ry
= Cost of goo ds Cost of goo dsmanufactured sold
Product Cost Flows
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Manufacturing Cost Flows
FinishedGoods
Cost of
GoodsSold
Selling andAdministrative
Period CostsSelling andAdministrative
ManufacturingOverhead
Work inProcess
Direct Labor
Balance SheetCosts Inventories
IncomeStatementExpenses
Material Purchases Raw Materials
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Quick Check
Beginning raw materials inventory was$32,000. During the month, $276,000 of rawmaterial was purchased. A count at the endof the month revealed that $28,000 of raw
material was still present. What is the cost ofdirect material used?
A. $276,000
B. $272,000 C. $280,000 D. $ 2,000
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Quick Check
Beginning raw materials inventory was$32,000. During the month, $276,000 of rawmaterial was purchased. A count at the endof the month revealed that $28,000 of raw
material was still present. What is the cost ofdirect material used?
A. $276,000
B. $272,000 C. $280,000 D. $ 2,000
Beg. raw materials 32,000$
+ Raw materials
purchased 276,000
= Raw materials available
for use in production 308,000$
Ending raw materials
inventory 28,000
= Raw materials used
in production 280,000$
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Quick Check
Direct materials used in productiontotaled $280,000. Direct labor was$375,000 and factory overhead was
$180,000. What were totalmanufacturing costs incurred for themonth?
A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined.
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Direct materials used in productiontotaled $280,000. Direct labor was$375,000 and factory overhead was
$180,000. What were totalmanufacturing costs incurred for themonth?
A. $555,000 B. $835,000 C. $655,000 D. Cannot be determined.
Direct Materials 280,000$+ Direct Labor 375,000
+ Mfg. Overhead 180,000
= Mfg. Costs Incurred
for the Month 835,000$
Quick Check
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Quick Check
Beginning work in process was$125,000. Manufacturing costsincurred for the month were
$835,000. There were $200,000 ofpartially finished goods remainingin work in process inventory at theend of the month. What was the
cost of goods manufactured duringthe month?
A. $1,160,000 B. $ 910,000 C. $ 760,000
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Beginning work in process was$125,000. Manufacturing costsincurred for the month were
$835,000. There were $200,000 ofpartially finished goods remainingin work in process inventory at theend of the month. What was the
cost of goods manufactured duringthe month?
A. $1,160,000 B. $ 910,000 C. $ 760,000
Quick Check
Beginning work in
process inventory 125,00$
+ Mfg. costs incurred
for the period 835,00
= Total work in process
during the period 960,00$
Ending work in
process inventory 200,00
= Cost of goods
manufactured 760,00$
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Quick Check
Beginning finished goodsinventory was $130,000. The cost ofgoods manufactured for the month
was $760,000. And the endingfinished goods inventory was$150,000. What was the cost ofgoods sold for the month?
A. $ 20,000. B. $740,000. C. $780,000.
D. $760,000.
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Quick Check
Beginning finished goodsinventory was $130,000. The cost ofgoods manufactured for the month
was $760,000. And the endingfinished goods inventory was$150,000. What was the cost ofgoods sold for the month?
A. $ 20,000. B. $740,000. C. $780,000.
D. $760,000.
$130,000 + $760,000 =$890,000
$890,000 - $150,000 =$740,000
os ass ca ons or
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os ass ca ons orPredicting Cost Behavior
How a cost will reactto changes in the
level of activity within
the relevant range. Total variable
costschangewhen activitychanges.
Total fixed costsremainunchanged whenactivity changes.
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Total Variable Cost
Your total long distance telephonebill is based on how many minutes youtalk.
Minutes Talked
TotalL
ongDistanc
e
Teleph
oneBill
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Variable Cost Per Unit
Minutes Talked
Pe
rM
inute
Teleph
oneC
harge
The cost per long distanceminutetalked is constant. Forexample, 10 cents per minute.
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Total Fixed Cost
Your monthly basic telephonebillprobably does not change when
you make more local calls.
Number of Local Calls
Mon
thlyBasic
Tele
phoneB
ill
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Fixed Cost Per Unit
Number of Local Calls
Month
ly
Bas
icTelephon
e
Billp
erLoca
lCall
The average fixed cost per local calldecreases as more local calls are
made.
C Cl ifi i f
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Cost Classifications forPredicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
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Quick Check
Which of the following costs would bevariable with respect to the number of conessold at a Baskins & Robbins shop? (Theremay be more than one correct answer.)
A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.
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Quick Check
Which of the following costs would bevariable with respect to the number of conessold at a Baskins & Robbins shop? (Theremay be more than one correct answer.)
A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.
A i i C t t C t
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Assigning Costs to CostObjects
Direct costs
Costs that can beeasily andconveniently traced
to a unit of product orother cost object.
Examples: directmaterial and directlabor
Indirect costs
Costs that cannot beeasily andconveniently traced
to a unit of product orother cost object.
Example:manufacturingoverhead
C t Cl ifi ti f
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Every decision involves a choicebetween at least two alternatives.
Only those costs and benefits thatdiffer between alternatives arerelevant in a decision. All other costs
and benefits can and should beignored.
Cost Classifications forDecision Making
Diff ti l C t d
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Differential Costs andRevenues
Costs and revenues that differamong alternatives.
Example: You have a job paying $1,500 per month inyour hometown. You have a job offer in a neighboringcity that pays $2,000 per month. The commuting costto the city is $300 per month.
Example: You have a job paying $1,500 per month inyour hometown. You have a job offer in a neighboringcity that pays $2,000 per month. The commuting costto the city is $300 per month.
Differential revenue is:$2,000 $1,500 = $500
Differential cost is:
$300
Opportunity Costs
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Opportunity Costs
The potential benefit that isgiven up when onealternative is selected overanother.
Example: If you werenot attending college,you could be earning
$15,000 per year.Your opportunity costof attending college forone year is $15,000.
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Sunk Costs
Sunk costs have already been incurred andcannot be changed now or in the future. They
should be ignored when making decisions.
Example: You bought an automobile that cost$10,000 two years ago. The $10,000 cost is sunkbecause whether you drive it, park it, trade it, or sellit, you cannot change the $10,000 cost.
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Quick Check
Suppose you are trying to decide whetherto drive or take the train to Portland to attenda concert. You have ample cash to do either,but you dont want to waste money
needlessly. Is the cost of the train ticketrelevant in this decision? In other words,should the cost of the train ticket affect thedecision of whether you drive or take the
train to Portland? A. Yes, the cost of the train ticket is
relevant. B. No, the cost of the train ticket is not
relevant.
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Quick Check
Suppose you are trying to decide whetherto drive or take the train to Portland to attenda concert. You have ample cash to do either,but you dont want to waste money
needlessly. Is the cost of the train ticketrelevant in this decision? In other words,should the cost of the train ticket affect thedecision of whether you drive or take the
train to Portland? A. Yes, the cost of the train ticket is
relevant. B. No, the cost of the train ticket is not
relevant.
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Quick Check
Suppose you are trying to decide whetherto drive or take the train to Portland to attenda concert. You have ample cash to do either,but you dont want to waste money
needlessly. Is the annual cost of licensingyour car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
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Quick Check
Suppose you are trying to decide whetherto drive or take the train to Portland to attenda concert. You have ample cash to do either,but you dont want to waste money
needlessly. Is the annual cost of licensingyour car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
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Quick Check
Suppose that your car could be sold nowfor $5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
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Quick Check
Suppose that your car could be sold nowfor $5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
S f th T f C t
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Summary of the Types of CostClassifications
Financial reporting
Predicting cost behavior
Assigning costs to cost objects
Decision making
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Idle Time
The labor costs incurredduring idle time are ordinarily
treated as manufacturingoverhead.
Machine Breakdowns Material Shortages
Power Failures
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Overtime
The overtime premiums for all factoryworkers are usually considered to be part
of manufacturing overhead.
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Labor Fringe Benefits
Fringe benefits include employer paidcosts for insurance programs, retirement
plans, supplemental unemployment
programs, Social Security, Medicare,workers compensation andunemployment taxes.
Some companiesinclude all of these
costs inmanufacturing
overhead.
Other companies treatfringe benefit
expenses of directlaborers as additional
direct labor costs.
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Quality of Conformance
When the overwhelming majority ofproducts produced conform to design
specifications and are free fromdefects.
Prevention and Appraisal
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Prevention and AppraisalCosts
PreventionCosts
Support activitieswhose purpose is to
reduce the number ofdefects
Appraisal Costs
Incurred to identifydefective products
before the products areshipped
Internal and External Failure
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Internal and External FailureCosts
Internal FailureCosts
Incurred as a result ofidentifying defects
before they are shipped
External FailureCosts
Incurred as a result ofdefective productsbeing delivered to
customers
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Examples of Quality Costs
Prevention CostsQuality trainingQuality circlesStatistical processcontrol activities
Appraisal CostsTesting & inspecting
incoming materialsFinal product testingDepreciation of testing
equipment
Internal Failure CostsScrapSpoilageRework
External Failure Costs
Cost of field servicing &handling complaints
Warranty repairsLost sales
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Distribution of Quality Costs
When quality of conformance is low,total quality cost is high and consistsmostly of internal and external failure.
Companies can reduce theirtotal quality cost by
focusing on prevention andappraisal. The cost savings
from reduced defectsusually swamps the costsof the additional prevention
and appraisal efforts.
Ventura CompanyQuality Cost Report
For Years 1 and 2
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Quality costreports providean estimate of
the financialconsequences
of thecompanys
current defect
rate.
Amount Percent* Amount Percent*
Prevention costs:
Systems development 400,000$ 0.80% 270,000$ 0.54%
Quality training 210,000 0.42% 130,000 0.26%
Supervision of prevention activities 70,000 0.14% 40,000 0.08%
Quality improvement 320,000 0.64% 210,000 0.42%
Total prevention cost 1,000,000 2.00% 650,000 1.30%
Appraisal costs :
Inspection 600,000 1.20% 560,000 1.12%
Reliability testing 580,000 1.16% 420,000 0.84%
Supervision of testing and inspection 120,000 0.24% 80,000 0.16%
Depreciation of test equipment 200,000 0.40% 140,000 0.28%
Total appraisal cost 1,500,000 3.00% 1,200,000 2.40%
Internal failure costs:
Net cost of scrap 900,000 1.80% 750,000 1.50%
Rework labor and overhead 1,430,000 2.86% 810,000 1.62%
Downtime due to defects in quality 170,000 0.34% 100,000 0.20%
Disposal of defective products 500,000 1.00% 340,000 0.68%
Total internal failure cost 3,000,000 6.00% 2,000,000 4.00%
External failure costs:
Warranty repairs 400,000 0.80% 900,000 1.80%
Warranty replacements 870,000 1.74% 2,300,000 4.60%
Allowances 130,000 0.26% 630,000 1.26%
Cost of field servicing 600,000 1.20% 1,320,000 2.64%
Total external failure cost 2,000,000 4.00% 5,150,000 10.30%
Total quality cost 7,500,000$ 15.00% 9,000,000$ 18.00%
* As a percentage of total sales. In each year sales totaled $50,000,000.
Year 2 Year 1
Quality Cost Reports:
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Quality Cost Reports:Graphic Form
$10
9
8
7
6
5
4
3
2
1Appraisal
0Prevention Prevention
1 2
Year
QualityCost(in
millions)
Appraisal
Internal
Failure
External
Failure
Internal
Failure
External
Failure
20
18
16
14
12
10
8
6
4
2Appraisal
0Prevention Prevention
1 2
Year
QualityCostasaPercentageofSales
Appraisal
Internal
Failure
External
Failure
Internal
Failure
External
Failure
Qualityreports
can also
beprepared
ingraphic
form.
Uses of Quality Cost
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Uses of Quality CostInformation
Help managers see thefinancial significance of
defects.
Help managers identifythe relative importance of
the quality problems.
Help managers seewhether their quality
costs are poorlydistributed.
Limitations of Quality Cost
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Limitations of Quality CostInformation
Simply measuring qualitycost problems does notsolve quality problems.
Results usually lagbehind quality
improvement programs.
The most importantquality cost, lost sales, is
often omitted fromquality cost reports.