Chapter 2

Cost Terms, Concepts and

Classifications
 Summary of the Types of Cost
Classifications

Financial Predicting Cost

Reporting Behavior

Assigning Costs to Making Business

Cost Objects Decisions
 Manufacturing Costs
Direct Direct Manufacturing
Materials Labor Overhead

The Product
 Classifications of Manufacturing Costs

Direct Direct Manufacturing

Material Labor Overhead

Prime Conversion
Cost Cost
 Nonmanufacturing Costs
Marketing and Administrative
Selling Cost Cost

Costs necessary to get the All executive,

order and deliver the organizational, and
product. clerical costs.
 Product Costs Versus Period
Costs
Product costs include Period costs are not
direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
 Problem: Product or Period

Depreciation on salespersons’ cars

Rent on factory equipment
Lubricants used for machine maintenance
Salaries of finished goods warehouse personnel
Soap and paper towels used by factory personnel
Factory supervisors’ salaries
Heat, water, and power consumed by the factory
 Problem: Continued
Advertising costs
Worker’s compensation insurance for factory
employees
Depreciation on chairs and tables in the factory
lunchroom
Salary of the switchboard operator
Depreciation of a Lear Jet used by company execs
Rent for rooms at a Florida resort for the annual
sales conference
Box designed for packaging breakfast cereal
 Pop Quiz ✓
Which of the following costs would be considered
manufacturing overhead at Boeing? (More than one
answer may be correct.)
A. Depreciation on factory forklift trucks.
B. Sales commissions.
C. The cost of a flight recorder in a Boeing 767.
D. The wages of a production shift supervisor.
 Pop Quiz ✓
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.
 Pop Quiz ✓
Which of the following transactions would
immediately result in an expense? (There may be
more than one correct answer.)
A. Work in process is completed.
B. Finished goods are sold.
C. Raw materials are placed into production.
D. Administrative salaries are accrued and paid.
 Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
– Cash Cash
– Receivables Receivables
– Prepaid expenses Prepaid Expenses
– Merchandise inventory Inventories
Raw Materials
Work in Process
Finished Goods
 Balance Sheet
Manufacturer
Merchandiser Current Assets
Cash
Current assets Receivables
Materials waiting to
◆Cash be processed.
Prepaid Expenses
◆ Receivables
Partially complete Inventories
◆products – some
Prepaid Expenses Raw Materials
material, labor, or Work in Process
◆Merchandise
overhead has been Finished Goods
Inventory
added.
Completed products
awaiting sale.
 The Income Statement
Cost of goods sold for manufacturers differs only slightly
from cost of goods sold for merchandisers.

Merchandising Company Manufacturing Company

Cost of goods sold:

Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $236,250
Basic Equation for Inventory Accounts

Withdrawals
Beginning Additions Ending
balance + to inventory = balance + from
inventory
Schedule of Cost of Goods Manufactured
Income Statement for Manufacturing Company
Inventory
 Pop Quiz ✓
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
 Pop Quiz ✓
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.
 Pop Quiz ✓
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.
 Pop Quiz ✓
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.
Cost Classifications For Predicting Behavior

Cost behavior means

how a cost will react to
changes in the level of
business activity.
– variable costs
– fixed costs
 Total Variable Cost
The total cost of mufflers is based on how
many cars are produced in a month.
Total Cost of Mufflers

No. of Autos Produced

 Variable Cost Per Unit
The cost per muffler is constant. For example,
$12 per muffler.
Cost per Muffler

No. of Autos Produced

 Total Fixed Cost
The monthly rent for the machine does not
change when you make more dolls.
Total Cost of Rent

Number of Dolls Produced

 Fixed Cost Per Unit
The fixed cost per doll decreases as more
dolls are made.
Fixed Cost per Doll

Number of Dolls Produced

 Cost Classifications for
Predicting 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.
 Pop Quiz ✓
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.
 Problem: Fixed or Variable

Hamburger buns in McDonald’s restaurant

Advertising by a dental office

Apples processed and canned by Del Monte

Shipping apples from Del Monte plant to customers

Insurance on a Bausch and Lomb factory producing contact

lenses
 Problem: Continued

Insurance on IBM’s corporate headquarters

Salary of supervisor overseeing production of circuit boards at

HP

Commissions paid to Encyclopedia Brit salespeople

Depreciation of factory lunchroom facilities at GE plant

Steering wheels installed in BMWs

 Cost Classification for Assigning Costs to
Cost Objects
Direct costs Indirect costs
Costs that can be Costs that cannot be easily
easily traced to a cost object traced to a cost object
Examples: Cost of paint in Examples: Cost of national
the paint department of an advertising for an airline is
automobile assembly plant, indirect to a particular flight,
direct labor, direct material manufacturing overhead
 Cost Concepts for Decision Making

Differential Cost/Differential Revenue – Costs and revenues

that differ between two (or more) alternatives

Opportunity Cost – the potential benefit given up when one

alternative is selected over another

Sunk Cost – a cost that has already been incurred and cannot
be changed by any decision made now or in the future
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.
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
 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
$20,000 per year.
Your opportunity cost
of attending college for one
year is $20,000.
 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: You bought an automobile that cost $10,000
two years ago. The $10,000 cost is sunk because whether
you drive it, park it, trade it, or sell it, you cannot change
the $10,000 cost.
Further Classification of Labor
Costs
Appendix 2A
 Idle Time
Machine Material
Breakdowns Shortages

Power Failures

The labor costs incurred during

idle time are ordinarily treated as
manufacturing overhead.
 Overtime Premium
The overtime premiums for all factory
workers are usually considered to be part of
manufacturing overhead.
 Labor Fringe Benefits
Fringe benefits include employer paid
costs for insurance programs, retirement
plans, supplemental unemployment
programs, Social Security, Medicare,
workers’ compensation, and
unemployment taxes.

Some companies include Other companies treat

all of these costs in fringe benefit expenses
manufacturing of direct laborers as
overhead. additional direct labor
costs.