Chapter 2

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 Costs Terms, Concepts and
Classifications

Chapter Two

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 Manufacturing Costs

Manufact
Direct Direct
uring
Materials Labor
Overhead

The Product

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 Direct Materials

Raw materials that become an integral part of the

product 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 to

individual units of product.

Example: Wages paid to automobile assembly workers

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 Manufacturing Overhead

Manufacturing costs that cannot be traced directly

to specific units produced.

Examples: Indirect labor and indirect materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work. Examples: lubricants and
Examples: maintenance cleaning supplies used in the
workers, janitors and automobile assembly plant.
security guards.

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 Classifications of Costs

Manufacturing costs are often

classified as follows:

Direct Direct Manufacturing

Material Labor Overhead

Prime Conversion
Cost Cost

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 Non-manufacturing Costs

Marketing or Administrative
Selling Cost Cost

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.

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 Product Costs Versus Period Costs

Product costs include Period costs include all

direct materials, direct marketing or selling
labor, and manufacturing costs and
overhead.
administrative costs.

Inventory Cost of Good Expense

Sold

Sale

Balance Income Income

Sheet Statement Statement
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 Quick Check ✔

Which of the following costs would be considered a

period rather than a product cost in a manufacturing
company?
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.

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 Quick Check ✔

Which of the following costs would be considered a

period rather than a product cost in a manufacturing
company?
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.

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 Comparing Merchandising and
Manufacturing Activities
Merchandisers . . . Manufacturers . . .
⬥ Buy finished goods. ⬥ Buy raw materials.
⬥ Sell finished goods. ⬥ Produce and sell
finished goods.

MegaLoMart

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 Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
◆ Cash ● Cash
◆ Receivables ● Receivables
● Prepaid Expenses
◆ Prepaid Expenses
● Inventories
◆ Merchandise
Inventory Raw Materials
Work in Process
Finished Goods

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 Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
◆ Cash ● Cash
◆ Receivables ● Receivables
Materials waiting to
● Prepaid Expenses
be processed.
◆ Prepaid Expenses
● Inventories
◆ Merchandise
Partially complete
Inventory Raw Materials
products – some
Work in Process
material, labor, or
overhead has been Finished Goods
added.
Completed products
awaiting sale.
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 The Income Statement

Cost of goods sold for manufacturers differs only

slightly from cost of goods sold for merchandisers.

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 Inventory Flows

Beginning
Additions Available
balance + $$$ = $$$$$
$$

Available _ Withdraw Ending

$$$$$
als = balance
$$$ $$

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 Quick Check ✔

If your inventory balance at the beginning of the

month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would
be the balance at the end of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.

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 Quick Check ✔

If your inventory balance at the beginning of the

month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would
be the balance at the end of the month?
A. $1,000. $1,000 + $100 =
B. $ 800. $1,100
C. $1,200. $1,100 - $300 = $800
D. $ 200.

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 Schedule of Cost of Goods
Manufactured

Calculates the cost of raw

material, direct labor and
manufacturing overhead used
in production.

Calculates the manufacturing

costs associated with goods
that were finished during the
period.
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 Product Cost Flows

As items are removed from raw

materials inventory and placed into
the production process, they are
called direct materials.

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 Product Cost Flows

Conversion
costs are costs
incurred to
convert the
direct material
into a finished
product.

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 Product Cost Flows

All manufacturing costs incurred

during the period are added to the
beginning balance of work in
process.

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 Product Cost Flows

Costs associated with the goods that

are completed during the period are
transferred to finished goods
inventory.

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 Product Cost Flows

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 Manufacturing Cost Flows

Balance Sheet Income

Costs Inventories Statement
Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
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 Quick Check ✔

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. 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 ✔

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. 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 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.

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 Quick Check ✔

Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
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 month
were $835,000. There were $200,000 of
partially finished goods remaining in work
in process inventory at the end of the
month. What was the cost of goods
manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
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 Quick Check ✔

Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work
in process inventory at the end of the
month. What was the cost of goods
manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
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 Quick Check ✔

Beginning finished goods inventory was

$130,000. The cost of goods manufactured
for the month was $760,000. And the ending
finished goods inventory was $150,000.
What was the cost of goods sold for the
month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.

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 Quick Check ✔

Beginning finished goods inventory was

$130,000. The cost of goods manufactured
for the month was $760,000. And the ending
finished goods inventory was $150,000.
What was the cost of goods sold for the
month?
$130,000 + $760,000 =
A. $ 20,000. $890,000
B. $740,000. $890,000 - $150,000 =
C. $780,000. $740,000
D. $760,000.

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 Cost Classifications for Predicting Cost Behavior

Cost behavior refers

to how a cost will
react to changes in
the level of activity.
The most common
classifications are:
⬥ Variable costs.
⬥ Fixed costs
⬥ Mixed costs.

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 Variable Cost

Your total texting bill is based on how

many texts you send.
Total Texting Bill

Number of Texts Sent

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 Variable Cost Per Unit

The cost per text sent is constant at

5 cents per text message.

Cost Per Text Sent

Number of Texts Sent

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 The Activity Base (Cost Driver)

Units Machine
produced hours

A measure of what
causes the
incurrence of a
variable cost

Miles Labor
driven hours

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 Fixed Cost

Your monthly contract fee for your cell phone

is fixed for the number of monthly minutes in
your contract. The monthly contract fee does
not change based on the number of calls you
make.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

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 Fixed Cost Per Unit

Within the monthly contract allotment, the

average fixed cost per cell phone call made
decreases as more calls are made.

Contract Fee per call

Monthly Cell Phone

Number of Minutes Used

Within Monthly Plan
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 Types of Fixed Costs

Committed Discretionary
Long-term, cannot be May be altered in the
significantly reduced in short-term by current
the short term. managerial decisions

Examples Examples
Depreciation on Buildings Advertising and
and Equipment and Real Research and
Estate Taxes Development

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 Fixed Costs and the Relevant Range

For example, assume office space is available at

a rental rate of $30,000 per year in increments of
1,000 square feet.

Fixed costs would

increase in a step fashion
at a rate of $30,000 for
each additional 1,000
square feet.

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 Fixed Costs and the Relevant Range

90
Rent Cost in Thousands

The relevant range

Relevant of activity for a fixed
60
of Dollars

cost is the range of

Range activity over which
the graph of the
cost is flat.
30

0
0 1,000 2,000 3,000
Rented Area (Square Feet)

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 Cost Classifications for Predicting Cost Behavior

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 Quick Check ✔

Which of the following costs would be

variable with respect to the number of cones
sold at a Baskins & Robbins shop? (There
may 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 be

variable with respect to the number of cones
sold at a Baskins & Robbins shop? (There
may 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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 Mixed Costs
(also called semivariable costs)

A mixed cost contains both variable and fixed

elements. Consider the example of utility cost.
Y
Total Utility Cost

os t
d c
ixe
al m
Tot
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge

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 Mixed Costs

Y
Total Utility Cost

os t
d c
ixe
al m
Tot
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge

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 Mixed Costs – An Example

If your fixed monthly utility charge is $40, your

variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?

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 Learning Objective 5

Prepare income
statements for a
merchandising company
using the traditional and
contribution formats.

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 The Traditional and Contribution Formats

Used primarily for

external reporting.
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 Learning Objective 7

Understand cost
classifications used in
making decisions:
differential costs,
opportunity costs, and
sunk costs.

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 Cost Classifications for Decision Making

• Every decision involves a choice

between at least two alternatives.

• Only those costs and benefits

that differ between alternatives
are relevant in a decision. All
other costs and benefits can and
should be ignored as irrelevant.

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 Differential Cost and Revenue

Costs and revenues that differ

among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.

Differential revenue is: Differential cost is:

$2,000 – $1,500 = $500 $300

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 Opportunity Cost

The potential benefit that is

given up when one alternative
is selected over another.

Example: If you were

not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.

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 Sunk Costs

Sunk costs have already been incurred

and cannot be changed now or in the
future. These costs should be ignored
when making decisions.

Example: Suppose you had purchased gold for

$400 an ounce, but now it is selling for $250 an
ounce. Should you wait for the gold to reach $400 an
ounce before selling it? You may say, “Yes” even
though the $400 purchase is a sunk costs.

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 Quick Check ✔

Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the cost of the train ticket
relevant in this decision? In other words,
should the cost of the train ticket affect the
decision 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 whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the cost of the train ticket
relevant in this decision? In other words,
should the cost of the train ticket affect the
decision 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 whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the annual cost of licensing
your 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 whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either,
but you don’t want to waste money
needlessly. Is the annual cost of licensing
your 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 now for

$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 now for

$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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 Summary of the Types of Cost Classifications

Financial Predicting Cost

Reporting Behavior

Assigning Costs Making Business

to Cost Objects Decisions

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 End of Chapter 2

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