ACCOUNTANCY 2203REVIEW WORKSHOPSINDHU BALA

OVERVIEW OF COST CATEGORIES FOR A MANUFACTURING FIRM

All costs incurred by the firm must be accounted for in its financial statementsMANUFACTURING COSTS

Direct Labor (DL)Direct Materials (DM)Overhead (OH)

Indirect MaterialsIndirect LaborOther

NON-MANUFACTURING COSTSMarketing or Selling CostsAdministrative Costs

MANUFACTURING COSTS1. Direct Materials (DM) Materials that are consumed in the manufacturing

process and physically incorporated in the finished product

Materials whose cost is sufficiently large to justify the record keeping expenses necessary to trace the costs to individual products

2. Direct Labor (DL) Labor time that is physically traceable to the

products being manufactured Labor time whose cost is sufficiently large to

justify the record keeping expenses necessary to trace the costs to individual products

Example:Direct labor for manufacturing Honda Accords Line workers, robot operators, painters,

assembly workersAny labor probably not included in direct labor? Factory janitors, factory supervisors, factory

secretaries

MANUFACTURING COSTS

KEY ISSUES IN DETERMINING DIRECT LABORIs idle time generally considered as direct labor?

Why or why not? Usually not. It is not usually due to one product,

hence it is not traceableWhat are the typical fringe benefits an assembly

line worker receives? Health insurance, pension plan, disability

insuranceIs the cost of fringe benefits for the assembly line

workers generally considered direct labor? Usually yes, the costs can be traced

KEY ISSUES IN DETERMINING DIRECT LABOR

When an assembly line worker works overtime, he/she is paid a regular wage plus an overtime premium. Would most companies treat his/her regular wage as a direct labor cost?

Yes, the amount of time an employee works can be traced to the products.

What about the overtime premium? Treated as OH, cannot be traced to a specific

product.

3. Manufacturing Overhead (OH)All of costs of manufacturing excluding direct

materials and direct labor

a. Indirect Materials (IM) – Materials, used in the manufacturing of products, which are difficult to trace to particular products in an economical way

Glue, nails, cleaning supplies

b. Indirect Labor (IL) – Labor, used in the manufacturing of products, which is difficult to trace to particular products in an economical way

Wages for maintenance workers, factory supervisor’s salary, idle time

MANUFACTURING COSTS

MANUFACTURING COSTSC. All other types of manufacturing

overhead Depreciation on machinery, depreciation on

factory building, factory insurance, utilities for factory

NON-MANUFACTURING COSTS1. Marketing or Selling Costs – Costs

incurred in securing orders from customers and providing customers with the finished product

Sales commissions, costs of shipping products to customers, storage of finished goods, depreciation of selling equipment (cash register)

2. Administrative Costs – Executive, organizational, and clerical costs that are not related to manufacturing or marketing

CEO’s salary, cost of controller’s office, depreciation on administrative building.

CLASSIFICATION EXERCISE

Classify the following cost items Depreciation on factory building Depreciation on office equipment Property tax on finished goods

warehouse Wages paid to forklift operator in

finished goods warehouse Wages paid to forklift operator in

factory Wages paid to welders when welding

equipment is not working Paper used in textbook production Paper used in central office computer Wages paid to assembly line workers Maintenance cost for machines

OTHER COST CONCEPTSProduct Costs or Inventoriable Costs – costs assigned

to products that were either purchased for resale (merchandising firm or retailer) or manufactured for sale (manufacturing firm)

When products are sold, product costs are recognized as an expense (cost of goods sold or COGS). The costs of unsold products remain in inventory and are not expensed (i.e. not deducted from revenue in calculating net income)

Period Costs – costs that are not product costs and that are associated with the period in which they are incurred

Period costs such as selling and administrative costs are expensed (i.e. deducted from revenue in calculating net income) in the period they are incurred

PRODUCT COSTS VERSUS PERIOD COSTS

Expense

IncomeStatement

InventoryCost of

Goods Sold

BalanceSheet

IncomeStatement

Sale

Product costs include direct materials, direct

labor, and manufacturing

overhead.

Period costs are not included in product

costs. They are expensed on the

income statement.

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.

COSTS RELATED TO DECISION MAKING

Opportunity Costs - costs when taking one action requires giving up the opportunity to earn profits from a different action

Nike Inc. has limited production capacity. What would be Nike’s opportunity cost of accepting a special order from the military for combat boots?

If Nike accepts the special order, they may not be able to produce enough product for other sales. So, Nike would lose the profit from the other sale.

COSTS RELATED TO DECISION MAKING

Incremental Costs or Differential Costs – additional costs incurred when choosing a certain course of action over another (Note that incremental costs can include opportunity costs)

What would be Macy’s incremental costs of expanding its fragrance department and shrinking its accessories department?

The costs of stocking and staffing the new fragrance area, opportunity costs of lost profit from the decrease in sales of accessories

COSTS RELATED TO DECISION MAKING

Incremental Benefits or Differential Benefits – additional benefits reaped when choosing a certain course of action over another

What would be Macy’s incremental benefits of expanding its fragrance department and shrinking its accessories department?Profits Macy’s expects to earn on the new fragrances it displays/stocks

Sunk Costs – Costs that have been incurred and that are not affected by any current/future action

What would be considered sunk cost if Macy’s decides to expand its fragrance department and shrink its accessories department?Depreciation on the building, cost of the building

COST FLOWS IN A MANUFACTURING COMPANY

3. Inputs such as labor and capital equipment are also incurred to make the product. The costs of all the inputs used in the manufacturing facilities are recorded in WORK IN PROCESS INVENTORY

4. As products are finished, they are moved to finished goods warehouse and their costs are recorded in FINISHED GOODS (FG) INVENTORY

COST FLOWS IN A MANUFACTURING COMPANY

RAW MATERIALS INVENTORY Beg. Bal. - RM Materials used in Production (DM) Materials Purchased End. Bal. - RM

WORK IN PROCESS INVENTORY Beg. Bal. - WIP DM

Cost of Goods Manufactured (COGM)

DL OH End. Bal. - WIP

FINISHED GOODS INVENTORY Beg. Bal. - FG Cost of Goods Sold (COGS) COGM End. Bal. - FG

THE INVENTORY EQUATION

Beginning Inventory +

Additions to Inventory

=

Ending Inventory

+ Items Removed from Inventory

The inventory equation allows us to put together the following schedules:

Schedule of Total Manufacturing Costs (of the period)

Schedule of Cost of Goods Manufactured

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.

$1,000 + $100 = $1,100$1,100 - $300 = $800

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. $276,000B. $272,000C. $280,000D. $ 2,000

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

VARIABLE AND FIXED COSTSActivity – a quantitative measure of a firm’s output of goods or services Number of Chrysler vans Pairs of Nike shoes Tons of cement producedVariable Costs – costs that change proportionately (in total) with the activity level within a relevant range of activityFixed Costs – costs that do not change in total as activity level changes within a relevant range of activityExample: Publishing a magazineVariable costs Fixed CostsCost of paper Rent on buildingCost of ink Salaries to reportersSales Commissions Depreciation on printing equipmentCost of lubricants for machineCost of operating press

TOTAL VARIABLE AND FIXED COSTS

Total Variable Cost

Number of units Number of units

Total Fixed Cost

Per Unit Variable Cost

Number of units Number of units

Per Unit Fixed Cost

VARIABLE AND FIXED COSTS PER UNIT

RELEVANT RANGEThe range of activity within which the firm’s cost structure

(i.e. variable cost per unit and total fixed cost) remains unchanged

Publishing a small number of magazines (cost structure of a small publisher)

Total Variable Cost

Number of units

Total Fixed Cost

Number of unitsRelevant Range Relevant Range

TOTAL COSTSTo get total costs you need to add variable costs

and fixed costs

Total Cost

Number of units

Fixed costsThe Slope is the variable cost per unit