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Costs Terms, Concepts andClassifications

Chapter Two

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The Product

DirectMaterials DirectLabor ManufacturingOverhead

Manufacturing Costs

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Direct Materials

Raw materials that become an integral part of theproduct and that can be conveniently traced

directly to it.

Example: A radio installed in an automobile

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Direct Labor

Those labor costs that can be easily traced toindividual units of product.

Example: Wages paid to automobile assembly workers

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Manufacturing costs that cannot be traced directlyto specific units produced.

Manufacturing Overhead

Examples: Indirect labor and indirect materials

Wages paid to employeeswho are not directly

involved in productionwork.Examples: maintenance

workers, janitors andsecurity guards.

Materials used to supportthe production process.

Examples: lubricants andcleaning supplies used in theautomobile assembly plant.

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Classifications of Costs

DirectMaterial

DirectLabor

ManufacturingOverhead

PrimeCost

ConversionCost

Manufacturing costs are oftenclassified as follows:

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Non-manufacturing Costs

Marketing orSelling Cost

Costs necessary to get

the order and deliverthe product.

AdministrativeCost

All executive,

organizational, andclerical costs.

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Product Costs Versus Period Costs

Product costs includedirect materials, direct

labor, and manufacturing

overhead.

Period costs include allmarketing or selling

costs andadministrative costs.

Inventory Cost of Good Sold

BalanceSheet

IncomeStatement

Sale

Expense

IncomeStatement

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Quick Check

Which of the following costs would be considered aperiod rather than a product cost in a manufacturingcompany?

A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the production

facility.

E. Sales commissions.

C i M h di i d

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Comparing Merchandising andManufacturing Activities

Merchandisers . . . Buy finished goods.

Sell finished goods.

Manufacturers . . . Buy raw materials.

Produce and sellfinished goods.

MegaLoMart

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The Income Statement

Cost of goods sold for manufacturers differs onlyslightly from cost of goods sold for merchandisers.

Manufacturing Company

Cost of goods sold:Beg. finished

goods inv. 14,200$

+ Cost of goods

manufactured 234,150

Goods available

for sale 248,350$- Ending

finished goods

inventory (12,100)

= Cost of goods

sold 236,250$

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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Quick Check

If your inventory balance at the beginning of themonth was $1,000, you bought $100 during themonth, and sold $300 during the month, what wouldbe the balance at the end of the month?

A. $1,000.

B. $ 800.

C. $1,200.

D. $ 200.

S h d l f C t f G d

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Schedule of Cost of GoodsManufactured

Calculates the cost of rawmaterial, direct labor andmanufacturing 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 Beginning work in

materials inventory + Direct labor process inventory

+ Raw materials + Mfg. overhead + Total manufacturingpurchased = Total manufacturing costs

= Raw materials costs = Total work in

available for use process for the

in production period

Ending work in

process inventory= Cost of goods

manufactured

Product Cost Flows

Costs associated with the goods thatare completed during the period are

transferred to finished goodsinventory.

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Work

In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory+ Manufacturing costs + Cost of goodsfor the period manufactured

= Total work in process = Cost of goodsfor the period available for sale

Ending work in - Ending finished

process inventory goods inventory= Cost of goods Cost of goods

manufactured sold

Product Cost Flows

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Manufacturing Cost Flows

FinishedGoods

Cost of

GoodsSold

Selling and

Administrative

Period CostsSelling and

Administrative

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 raw material waspurchased. A count at the end of the monthrevealed that $28,000 of raw material was stillpresent. What is the cost of direct material used?

A. $276,000

B. $272,000

C. $280,000

D. $ 2,000

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Quick Check

Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What were

total manufacturing costs incurred for themonth?

A. $555,000

B. $835,000

C. $655,000

D. Cannot be determined.

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Quick Check

Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 of

partially finished goods remaining in workin process inventory at the end of themonth. What was the cost of goodsmanufactured during the month?

A. $1,160,000B. $ 910,000C. $ 760,000D. Cannot be determined.

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Quick Check

Beginning finished goods inventory was$130,000. The cost of goods manufacturedfor the month was $760,000. And the ending

finished goods inventory was $150,000.What was the cost of goods sold for themonth?

A. $ 20,000.

B. $740,000.C. $780,000.

D. $760,000.

Cost Classifications for Predicting Cost

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Cost Classifications for Predicting CostBehavior

How a cost will react tochanges in the level of

activity within the

relevant range. Total variable costs

change when activitychanges.

Total fixed costsremainunchanged when activitychanges.

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Total Variable Cost

Yourtotal long distance telephone bill is basedon how many minutes you talk.

Minutes Talked

TotalL

ongDistance

TelephoneBill

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Variable Cost Per Unit

Minutes Talked

Pe

rMinute

Teleph

oneCharge

The cost per long distance minute talked isconstant. For example, 10 cents per minute.

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Total Fixed Cost

Your monthly basic telephone bill probablydoes not change when you make more local

calls.

Number of Local Calls

Mon

thlyBasic

Tele

phoneBill

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Fixed Cost Per Unit

Number of Local Calls

MonthlyBasicTelephone

Billp

erLocalCall

The average fixed cost per local call decreasesas more local calls are made.

Cost Classifications for Predicting Cost

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Cost Classifications for Predicting CostBehavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas 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 be variable withrespect to the number of cones sold at a Baskins &Robbins shop? (There may be more than onecorrect 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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Assigning Costs to Cost Objects

Direct costs

Costs that can beeasily and convenientlytraced to a unit of product

or other cost object. Examples: direct material

and direct labor

Indirect costs

Costs that cannot be easilyand conveniently traced toa unit of product or other

cost object. Example: manufacturing

overhead

Cost Classifications for Decision

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Every decision involves a choice between atleast two alternatives.

Only those costs and benefits that differbetween alternatives are relevant in a decision.All other costs and benefits can and should be

ignored.

Cost Classifications for DecisionMaking

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Differential Costs and Revenues

Costs and revenues that differ amongalternatives.

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

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Opportunity Costs

The potential benefit that is givenup when one alternative isselected over another.

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 and cannot bechanged 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 whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want to

waste money needlessly. Is the cost of the trainticket relevant in this decision? In other words,should the cost of the train ticket affect the decisionof 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 whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want to

waste money needlessly. Is the annual cost oflicensing your car relevant in this decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.