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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.
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Classifications of Costs
DirectMaterial
DirectLabor
ManufacturingOverhead
PrimeCost
ConversionCost
Manufacturing costs are oftenclassified as follows:
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Nonmanufacturing Costs
Marketing and
Selling Cost
Costs necessary to get the
order and deliver theproduct.
Administrative
Cost
All executive,
organizational, andclerical costs.
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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.
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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.
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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
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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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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
ManufacturingOverhead
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
Raw Materials Costs In Process
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.
Product Costs - A Closer Look
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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
Raw Materials Costs In Process
Beginning raw Direct materials
materials inventory + Direct labor
+ Raw materials + Mfg. overheadpurchased = Total manufacturing
= Raw materials costs
available for use
in production
Ending raw materials
inventory= Raw materials used
in production
Conversioncosts are costs
incurred toconvert the
direct materialinto a finished
product.
Product Costs - A Closer Look
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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
Raw Materials Costs In Process
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 raw materials
inventory= Raw materials used
in production
Product Costs - A Closer Look
All manufacturing costs incurredduring the period are added to thebeginning balance of work in
process.
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Manufacturing Work
Raw Materials Costs In Process
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.
Product Costs - A Closer Look
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
Product Costs - A Closer Look
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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
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
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 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
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 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
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 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
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 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
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 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
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 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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