Cost Terms, Concepts, and
Classifications
Comprehensive Explanation Sheet (Managerial Accounting)
Study Guide
June 18, 2026
Overview
This comprehensive explanation sheet synthesizes class lecture notes with core textbook
frameworks from Chapters 1 and 2 to clarify how costs are classified, tracked, and reported
on corporate financial statements.
1 Types of Business Organizations
Before assessing costs, the nature of the business model must be identified, as inventory treat-
ment and balance sheets vary drastically:
• Service Organizations: Deliver intangible skills or expertise rather than physical items
(e.g., medical clinics, transportation/travel agencies, hair salons). They carry no inventory
on their Balance Sheets.
• Merchandising Organizations: Purchase completed physical products from suppli-
ers and resell them directly to consumers without altering their structural form (e.g.,
Shwapno, grocery stores).
• Manufacturing Organizations: Purchase raw inputs and employ labor and factory
machinery to convert them into entirely new finished goods (e.g., Toyota, RMG/Textile
factories, Hatil furniture).
2 Manufacturing vs. Non-Manufacturing Costs
Costs are fundamentally split between operations inside the factory walls (Product Costs)
and operations within the corporate headquarters or commercial markets (Period Costs).
2.1 A. Manufacturing Costs (Product Costs)
These encompass all outlays completely associated within a manufacturing unit or factory fa-
cility. They attach to the product and are capitalized as inventory.
1. Direct Materials (DM): Raw materials that form an integral part of the finished prod-
uct and can be easily, cost-effectively traced to a single unit.
Class Example (Hatil Chair): Wood and fabrics easily traceable to a specific unit (e.g.,
Chair A).
2. Direct Labor (DL): Wages paid to physical laborers who work directly on assembling,
cutting, or tailoring the product.
Class Example: Wages paid to the specific carpenter or tailor constructing Chair A.
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3. Manufacturing Overhead (MOH): All factory costs that cannot be easily or practi-
cally traced to a single unit. These are indirect factory inputs:
• Indirect Materials: Small items where tracking exact per-unit consumption is unfea-
sible (e.g., glue, epoxy, or paint used on a table/chair).
• Indirect Labor: Wages of factory support staff who do not physically build the items
(e.g., factory supervisors, security guards, maintenance crews).
• Factory Operations: Factory building rent, machine utilities (electricity, gas, water
consumed in the plant).
2.2 B. Non-Manufacturing Costs (Period Costs)
These costs are incurred outside the factory—specifically in the corporate office or showroom.
They do not belong to manufacturing costs and are fully expensed as incurred.
• Marketing / Selling Costs: Costs to secure customer orders and distribute products
(e.g., ads, sales commissions, showroom rent, delivery freight).
• Administrative Costs: General executive management, legal, and clerical expenditures
(e.g., corporate headquarters executive salaries, corporate rent, HR payroll).
3 The Operational Flow of Inventory
A manufacturing firm cycles expenditures sequentially through three asset categories on the
Balance Sheet before costs hit the Income Statement:
Raw Materials (RM) −→ Work in Process (WIP) −→ Finished Goods (FG)
• Raw Materials Inventory: Sits in storage waiting to be pulled into production.
• Work in Process Inventory: Comprises goods actively on the production floor. These
units have absorbed Direct Materials, Direct Labor, and Manufacturing Overhead but are
not yet finished.
• Finished Goods Inventory: Completed units held in the warehouse awaiting final sale.
3.1 Key Cost Milestone Transfers
• Cost of Goods Manufactured (COGM): The cumulative cost transferred from WIP
into Finished Goods once units cross the manufacturing finish line.
• Cost of Goods Sold (COGS): The final step where product costs transfer off the
Balance Sheet into an expense on the Income Statement at the exact moment a customer
sale occurs.
4 Financial Statement Comparison: Case Studies
4.1 Case 1: Merchandising Company (e.g., Shwapno Grocery Store)
A merchandiser tracks a single ledger balance because goods are bought shelf-ready.
• Acquisition Phase: A merchandiser purchases 5,000 units at a cost of $0.50 each.
Total Capitalized Inventory Cost = 5, 000 × $0.50 = $2, 500
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• Sales Phase: Units are sold at a retail price of $1.00 each.
Sales Revenue = 5, 000 × $1.00 = $5, 000
• Income Statement Realization:
Sales Revenue = $5, 000
Less: Cost of Goods Sold (COGS) = ($2, 500)
Gross Margin = $2, 500
4.2 Case 2: Manufacturing Company (e.g., Hatil Furniture / Toyota)
A manufacturer must accumulate distinct factory inputs before deriving product profitability.
Gross Margin = Sales Revenue − Cost of Goods Sold
Net Operating Income = Gross Margin − Period Costs (Selling & Administrative)
Definition of Gross Margin: The structural profitability of core manufacturing or procure-
ment operations before administrative and commercial expenses are subtracted. It illustrates
the cushion available to fund corporate operations and generate a net profit.