Cost Terms and Concept

7/29/2019 Cost Terms and Concept

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Cost Terms, Concepts,and Classifications

Chapter 2


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The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Comparing Merchandisingand Manufacturing Activities

Merchandisers . . .

Buy finished

goods. Sell finished goods.

Manufacturers . . .

Buy raw materials.

Produce and sellfinished goods.

MegaLoMart


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The Product

DirectMaterials

DirectLabor

ManufacturingOverhead

Manufacturing Costs


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Direct Materials

Those materials that become an integral partof 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 toindividual units of product.

Example: Wages paid to automobile assembly workers


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Manufacturing costs that cannot be traceddirectly to specific units produced.

Manufacturing Overhead

Examples: Indirect labor and indirect materials

Wages paid to employeeswho are not directly

involved in productionwork.Examples: maintenance

workers, janitors andsecurity guards.

Materials used to supportthe production process.

Examples:lubricants andcleaning supplies used in theautomobile assembly plant.


7/64 The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Classifications of Costs

DirectMaterial

DirectLabor


PrimeCost

ConversionCost

Manufacturing costs are oftenclassified as follows:



Nonmanufacturing Costs

Marketing and

Selling Cost

Costs necessary to get the

order and deliver theproduct.

Administrative

Cost

All executive,

organizational, andclerical costs.



Quick Check

Which of the following costs would beconsidered 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.



Product Costs Versus PeriodCosts

Product costs includedirect materials, direct

labor, andmanufacturing

overhead.

Period costs are notincluded in product

costs. They areexpensed on theincome statement.

Inventory Cost of Good Sold

BalanceSheet

IncomeStatement

Sale

Expense

IncomeStatement



Quick Check

Which of the following costs would beconsidered a period rather than a product costin a manufacturing company?

A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.

C. Direct materials costs.

D. Electrical costs to light the productionfacility.


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Balance Sheet

Merchandiser

Current assets

Cash

Receivables Prepaid expenses

Merchandise inventory

Manufacturer

Current Assets

Cash

ReceivablesPrepaid Expenses

InventoriesRaw Materials

Work in ProcessFinished Goods


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Merchandiser

Current assets

Cash

Receivables Prepaid expenses

Merchandise inventory

Manufacturer

Current Assets

Cash

ReceivablesPrepaid Expenses

InventoriesRaw Materials

Work in ProcessFinished Goods

Balance Sheet

Partially completeproducts some

material, labor, oroverhead has been

added.

Completed productsawaiting sale.

Materials waiting tobe processed.


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The Income Statement

Cost of goods sold for manufacturers differs onlyslightly from cost of goods sold for merchandisers.

Manufacturing Company

Cost of goods sold:Beg. finished

goods inv. 14,200$

+ Cost of goods

manufactured 234,150

Goods available

for sale 248,350$- Ending

finished goods

inventory (12,100)

= Cost of goods

sold 236,250$

Merchandising Company

Cost of goods sold:Beg. merchandise

inventory 14,200$

+ Purchases 234,150

Goods available

for sale 248,350$

- Endingmerchandise

inventory (12,100)

= Cost of goods

sold 236,250$


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Selling and

Administrative

Period Costs

Manufacturing Cost Flows

FinishedGoods

Cost of

GoodsSold

Selling and

Administrative


Work inProcess

Direct Labor

Balance SheetCosts Inventories

IncomeStatementExpenses

Material Purchases Raw Materials


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Quick Check

Which of the following transactions wouldimmediately result in an expense? (There maybe 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 andpaid.


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Quick Check

Which of the following transactions wouldimmediately result in an expense? (There maybe 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 andpaid.


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Inventory Flows

Beginningbalance

$$

Additions$$$+

Available$$$$$=

Endingbalance

$$=

Withdrawals$$$

_Available$$$$$


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Quick Check

If your inventory balance at the beginning of themonth was $1,000, you bought $100 during themonth, 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 themonth was $1,000, you bought $100 during themonth, 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


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Manufacturing Work

Raw Materials Costs In Process

Beginning raw

materials inventory

Product Costs - A Closer Look

Beginning inventoryis the inventory

carried over from

the prior period.


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Manufacturing Work


Beginning raw Direct materials

materials inventory

+ Raw materialspurchased

= Raw materials

available for use

in production

Ending raw materials

inventory= Raw materials used

in production

As items are removed from rawmaterials inventory and placed into

the production process, they arecalled direct materials.



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Quick Check

Beginning raw materials inventory was $32,000.During the month, $276,000 of raw material waspurchased. A count at the end of the monthrevealed that $28,000 of raw material was stillpresent. What is the cost of direct materialused?

A. $276,000

B. $272,000C. $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 waspurchased. A count at the end of the monthrevealed that $28,000 of raw material was stillpresent. What is the cost of direct materialused?

A. $276,000

B. $272,000C. $280,000

D. $ 2,000

Beg. raw materials 32,000$

+ Raw materials

purchased 276,000

= Raw materials available

for use in production 308,000$ Ending raw materials

inventory 28,000

= Raw materials used

in production 280,000$


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Manufacturing Work


Beginning raw Direct materials

materials inventory + Direct labor

+ Raw materials + Mfg. overheadpurchased = Total manufacturing

= Raw materials costs

available for use

in production



in production

Conversioncosts are costs

incurred toconvert the

direct materialinto a finished

product.



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Quick Check

Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What were

total manufacturing costs incurred for themonth?

A. $555,000

B. $835,000C. $655,000

D. Cannot be determined.


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Direct materials used in production totaled$280,000. Direct labor was $375,000 andfactory overhead was $180,000. What were

total manufacturing costs incurred for themonth?

A. $555,000

B. $835,000C. $655,000

D. Cannot be determined.

Direct Materials 280,000$

+ Direct Labor 375,000

+ Mfg. Overhead 180,000

= Mfg. Costs Incurredfor the Month 835,000$

Quick Check


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Manufacturing Work


Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory

+ Raw materials + Mfg. overhead + Total manufacturingpurchased = Total manufacturing costs

= Raw materials costs = Total work in

available for use process for the

in production period



in production


All manufacturing costs incurredduring the period are added to thebeginning balance of work in

process.


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Manufacturing Work


Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory

+ Raw materials + Mfg. overhead + Total manufacturingpurchased = Total manufacturing costs

= Raw materials costs = Total work in

available for use process for the

in production period

Ending work in

process inventory= Cost of goods

manufactured.


Costs associated with the goods thatare completed during the period are

transferred to finished goodsinventory.


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Quick Check

Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 of

partially finished goods remaining in work inprocess inventory at the end of the month.What was the cost of goods manufacturedduring the month?

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


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Beginning work in process was $125,000.Manufacturing costs incurred for the monthwere $835,000. There were $200,000 of

partially finished goods remaining in work inprocess inventory at the end of the month.What was the cost of goods manufacturedduring the month?

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

Quick Check

Beginning work inprocess inventory 125,000$

+ Mfg. costs incurredfor the period 835,000

= Total work in processduring the period 960,000$

Ending work in

process inventory 200,000= Cost of goods

manufactured 760,000$


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WorkIn Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory+ Manufacturing costs + Cost of goods

for the period manufactured

= Total work in process = Cost of goodsfor the period available for sale

Ending work in - Ending finished

process inventory goods inventory= Cost of goods Cost of goods

manufactured sold



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Quick Check

Beginning finished goods inventory was$130,000. The cost of goods manufactured forthe month was $760,000. And the ending

finished goods inventory was $150,000. Whatwas 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 forthe month was $760,000. And the ending

finished goods inventory was $150,000. Whatwas the cost of goods sold for the month?

A. $ 20,000.

B. $740,000.

C. $780,000.

D. $760,000.

$130,000 + $760,000 = $890,000$890,000 - $150,000 = $740,000

Cost Classifications for


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Cost Classifications forPredicting Cost Behavior

How a cost will react tochanges in the level of

business activity.

Total variable costschange when activitychanges.

Total fixed costsremain unchangedwhen activity changes.


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Total Variable Cost

Yourtotal long distance telephone billis based on how many minutes you talk.

Minutes Talked

TotalL

ongDistance

TelephoneBill


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Variable Cost Per Unit

Minutes Talked

Pe

rMinute

TelephoneCharge

The cost per long distance minute talked isconstant. For example, 10 cents per minute.


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Total Fixed Cost

Your monthly basic telephone bill probablydoes not change when you make more local

calls.

Number of Local Calls

Mon

thlyBasic

Tele

phoneBill


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Fixed Cost Per Unit

Number of Local Calls

Monthly

BasicTelephone

Billp

erLocalCall

The average cost per local call decreases asmore local calls are made.

Cost Classifications for


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Cost Classifications forPredicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Fixed cost per unit goes

the same even when the down as activity level goes up.

activity level changes.


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Quick Check

Which of the following costs would be variablewith respect to the number of cones sold at aBaskins & 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 variablewith respect to the number of cones sold at aBaskins & 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 variablewith respect to the number of people who buy aticket for a show at a movie theater? (There

may be more than one correct answer.)A. The cost of renting the film.

B. Royalties on ticket sales.

C. Wage and salary costs of theateremployees.

D. The cost of cleaning up after the show.


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Quick Check

Which of the following costs would be variablewith respect to the number of people who buy aticket for a show at a movie theater? (There

may be more than one correct answer.)A. The cost of renting the film.

B. Royalties on ticket sales.

C. Wage and salary costs of theateremployees.

D. The cost of cleaning up after the show.

The royalties on ticket sales is directly related to the number oftickets sold.

The cost of cleaning up MAY also be variable if the theater payscleaning crews by the hour. The more tickets sold would

increase the time it would take to clean up the theater.

Direct Costs and Indirect


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Direct Costs and IndirectCosts

Direct costs

Costs that can beeasily and convenientlytraced to a unit ofproduct or other costobjective.

Examples: directmaterial and direct labor

Indirect costs

Costs cannot be easilyand conveniently tracedto a unit of product orother cost object.

Example:manufacturingoverhead

Differential Costs and


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Differential Costs andRevenues

Costs and revenues that differ amongalternatives.

Example:You have a job paying $1,500 per month inyour hometown. You have a job offer in a neighboringcity that pays $2,000 per month. The commuting costto the city is $300 per month.

Differential revenue is:$2,000 $1,500 = $500

Differential cost is:

$300


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Quick Check

Suppose you are trying to decide whether todrive or take the train to Portland to attend aconcert. You have ample cash to do either, but

you dont want to waste money needlessly. Isthe cost of the pizza you ate last night relevantin this decision? In other words, should the costof the pizza affect the decision of whether you

drive or take the train to Portland?A. Yes, the cost of the pizza is relevant.

B. No, the cost of the pizza is not relevant.


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Quick Check


you dont want to waste money needlessly. Isthe cost of the pizza you ate last night relevantin this decision? In other words, should the costof the pizza affect the decision of whether you

drive or take the train to Portland?A. Yes, the cost of the pizza is relevant.

B. No, the cost of the pizza is not relevant.


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Quick Check


you dont want to waste money needlessly. Isthe cost of the train ticket relevant in thisdecision? In other words, should the cost of thetrain 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


you dont want to waste money needlessly. Isthe cost of the train ticket relevant in thisdecision? In other words, should the cost of thetrain 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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Every decision involves a choicebetween at least two alternatives.

Only those costs and benefits that differbetween alternatives (i.e., Differentialcosts and benefits) are relevant in a

decision. All other costs and benefitscan and should be ignored.

Teaching Note


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Quick Check


you dont want to waste money needlessly. Isthe annual cost of licensing your car relevant inthis decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.

Q C


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Quick Check


you dont want to waste money needlessly. Isthe annual cost of licensing your car relevant inthis decision?

A. Yes, the licensing cost is relevant.

B. No, the licensing cost is not relevant.

Q i k Ch k


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Quick Check


you dont want to waste money needlessly. Isthe depreciation on your car relevant in thisdecision?

A. Yes, the depreciation is relevant.

B. No, the depreciation is not relevant.

Q i k Ch k


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Quick Check


you dont want to waste money needlessly. Isthe depreciation on your car relevant in thisdecision?

A. Yes, the depreciation is relevant.

B. No, the depreciation is not relevant.

Depreciation that

is a function of miles driven

would be relevant.

Depreciation that is a

function of the passage oftime would not be relevant.

O t it C t


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Opportunity Costs

The potential benefit that isgiven up when one alternativeis selected over another.

Example: If you werenot attending college,you could be earning

$15,000 per year.Your opportunity costof attending college forone year is $15,000.

S k C t


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Sunk Costs

Sunk costs cannot be changed by any decision.They are not differential costs and should be

ignored when making decisions.

Example: You bought an automobile that cost$10,000 two years ago. The $10,000 cost issunk because whether you drive it, park it, tradeit, or sell it, you cannot change the $10,000 cost.

Q i k Ch k


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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.

Q i k Ch k


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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.

Further Classification of Labor


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Further Classification of LaborCosts

Idle TimeTreated as

manufacturingoverhead cost

OvertimePremium of

Factory Workers

Treated asmanufacturingoverhead cost

Labor FringeBenefits

Treated as indirectlabor or direct labor

Cost of Quality


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Cost of QualityAppendix B

Prevention Costs Appraisal Costs

Internal

Failure Costs

External

Failure Costs

Four Typesof Quality

Costs

ISO 9000 standards have become aninternational measure of quality.

E d f Ch t 2


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End of Chapter 2

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Cost Terms and Concept