Chapter 2: Cost Terms, Concepts, and Classifications

1) Identify and give examples of each of the three basic manufacturing cost categories.


Manufacturing Costs

  • Direct Materials – Those materials that become an integral part of a finished product can be conveniently traced to it.
  • i.e. Passenger seats, electronic components in a stereo.
  • Indirect Materials – small items of material that may become an integral part of a finished product but whose costs of tracing exceed the benefits.
  • i.e. Solder and glue.
  • Direct Labour – Factory labour costs that can be traced easily to individual units of product.
  • i.e. Cost of assembly line workers, welders, operators.
  • Indirect LabourLabour costs of janitors, supervisors, materials handlers, and other factory workers that cannot be conveniently be traced directly to particular products.
  • Manufacturing Overhead – All costs associated with manufacturing except direct materials and direct labour.
  • Includes indirect materials (materials used to support the production process) and indirect labour (wages paid to employees not directly involved in production work)
  • Does not include operating costs.
  • Conversion CostManufacturing overhead + direct labour cost.
  • Prime Cost Direct materials + direct labour cost.


Classification of Manufacturing Labour Costs

  • Relatively straightforward classification of labour costs.
  • Overtime Premiums – Extra hourly wage rate paid to workers who must work more than their normal time requirements.
  • Employee benefit costs for indirect labour are classified as additional indirect overhead. (For direct labour, it’s added to base direct labour rate.)


Non-manufacturing cost

  • Marketing or Selling Costs – All costs necessary to secure customer orders and get the finished product or service to the customer.
  • i.e. Order filling costs such as packing and shipping
  • Administrative Costs – All executive, organizational, and clerical costs associated with general management of an organization rather than with manufacturing, marketing, or selling.
  • i.e. executive compensation, accounting, HR, public relationships


2) Distinguish between product costs and period costs and give examples of each.

Matching Principle – Costs incurred to generate revenue should be recognized as expenses in the same period that the revenue is recognized.

Image result for inventoryProduct Costs

  • All costs involved in the purchase or manufacture of goods.
  • In the case of manufactured goods, these costs consist of direct materials, direct labour, and manufacturing overhead.
  • A.k.a. inventoriable costs or manufacturing costs (Present in inventories and cost of goods sold)


Period Costs

  • All costs that are expensed on the income statement in the period in which they are incurred or accrued.
  • Selling (marketing) and administrative expenses are period costs.
  • They are not included on cost of purchased/manufactured costs – they are expenses on the income statement in the period in which they are incurred.


Cost Classification on Financial Statements

  • The Balance Sheet
  • A manufacturing company’s BS is similar to that of a merchandising one.
  • However, merchandising companies have one class of inventory and manufacturing companies have 3.
  • Raw (direct) materials inventory – Materials used to make a product that have not yet been placed into production.
  • Work in Progress Inventory – Inventory consisting of units of product that are only partially complete and require further work before sale.
  • Finished Goods Inventory – Inventory consisting of units of product that have been completed but not yet sold.


3) Prepare an income statement, including the calculation of Cost of Goods Sold


The Income Statement

  • Basic Equation for Inventory Accounts: Beginning Balance + Additions to Inventory = Ending Balance + Withdrawals from Inventory
  • Basic Equation for COGS
  • Merchandising Company - Beginning Balance Inventory + Purchases = Ending Merchandise Inventory + COGS
  • Or COGS = Beginning Merchandise Inventory + Purchases – Ending Merchandise Inventory
  • Manufacturing Company - Beginning Finished Goods Inventory + Cost of Goods Manufactured = Ending Finished Goods Inventory + COGS
  • Or COGS = Beginning Finished Goods Inventory + Cost of Goods Manufactured – Ending Finished Goods inventory
  • Cost of Goods Manufactured – costs that include the direct materials, direct labour, and manufacturing overhead used for the products finished during the period.
  • Sales – COGS = Gross Margin
  • Gross margin – selling and administrative expenses = Operating Income

4) Prepare a schedule of Cost of Goods Manufactured


Schedule of Cost of Goods Manufactured

  • A schedule that shows direct materials, direct labour, and manufacturing overhead costs incurred for a period and assigned to work in process and completed goods.
  • Direct Materials cost refers to cost of materials used during the period.
  • Total Manufacturing Costs – Costs that represent the direct materials, direct labour, and manufacturing overhead used to perform the production work for finished/unfinished products for the period.


Product Costs – Closer Look

  • Cost Flow identifies how product costs move through various accounts and how they affect BS and IS.
  • Product costs → Balance Sheet inventories → Income Statement as COGS
  • Period Costs → Income Statement as Selling and Administrative Expenses

Inventoriable Costs

  • Product costs go directly into inventory accounts as they are incurred rather than into expense accounts.
  • First into work in process and then into finished goods.
  • Costs can end up on the BS as assets if goods are either partially completed or unsold at the end of a period.
  • Selling & Administrative costs are period costs expensed as they are incurred.


Cost Flows

  • As goods are being worked on, costs for direct materials, direct labour, and manufacturing overhead are Debited to Work in Process Inventory.
  • Once completed, Credit work in process inventory with the Debit to finished goods inventory.
  • Once sold, credit finished goods inventory for the cost of the items, with the Debit to cost of goods sold, an income statement amount.
  • Selling/administrative expenses are expensed to income statement.

5) Explain the differences between variable and fixed costs.

  • Cost Behaviour – The way in which a cost reacts or responds to changes in the level of activity
  • A manager must anticipate changes in cost and by how much it changes.


Variable Cost

  • A cost that varies, in total, in direct proportion to changes in level of activity.
  • Expressed in many ways, i.e. units produced, units sold, kilometres driven
  • Cost of Direct Materials used during a period varies in direct proportion to number of units produced.
  • As more is produced, more materials must be used.
  • Costs may be variable with respect to products and services provided or other activities such as number of hours.


Fixed Cost

  • A cost that remains constant, in total, regardless of changes in the level of activity.
  • i.e. straight-line depreciation, insurance, property tax
  • Very few costs are completely fixed – many change if there is a large level of activity, it is only fixed in a relative range.
  • Relative Range – range of activity within which assumptions about variable and fixed cost behaviour are valid.
  • Mixed Cost – costs that contain both variable and fixed cost elements.
  • i.e. total wages paid to sales staff, some may be fixed salary and some may be commission.


6) Identify the differences between direct and indirect costs.

Cost Object – Any unit of analysis for which cost data are desired.

  • Costs are classified as direct or indirect, and products, customers, jobs, and other organizational subunits may be analyzed.


Direct Cost

  • A cost that can be easily and conveniently traced to the particular cost object under consideration.
  • Includes direct materials, direct labour, and other directly traceable items, such as salary.


Indirect Cost

  • A cost that cannot be easily and conveniently traced to the particular cost object under consideration.
  • To be directly traced, the cost must be caused by the cost object.
  • Common Cost – Cost incurred to support a number of cost objects but cannot be traced to any of them individually.
  • i.e. salary of a factory manager is not caused by one variety of product but is a consequence of running the whole factory.


7) Describe the cost classifications used in making decisions: differential costs, opportunity costs, and sunk costs.


Differential Cost and Revenue

  • A difference in cost between any two alternatives.
  • Differential Revenue – A difference in revenue between any two alternatives
  • Incremental Cost – An increase in cost between two alternatives.
  • Similar to concepts of Marginal Cost and Marginal Revenue (cost and revenue of producing and selling one more unit respectively)
  • Analyze the differences in operating income to determine the advantageous alternative.
  • We can ignore the items that are the same under all alternatives and that are not affected by the decision.


Opportunity Cost

  • The potential benefit that is given up when one alternative is selected over another.
  • Not explicitly entered, but they must be explicitly considered in managerial decisions.
  • Every alternative has an associated opportunity cost.


Sunk Cost

  • Any cost that has already been incurred and that cannot be changed by any decision made now or in the future.
  • As they are not differential costs and therefore not relevant in decisions, they should always be ignored.



Note Created by
Is this note helpful?
Give kudos to your peers!
00
Wanna make this note your own?
Fork this Note
272 Views