Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Basic Cost Management Concepts and Accounting for Mass Customization Operations Chapter 2

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 1

Process of Management Decision Making Directing Control Planning Strategy Formulation Managers need cost information to perform each of these functions.

What Do We Mean By a Cost? A cost is the measure of resources given up to achieve a particular purpose.

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Product Costs, Period Costs and Expenses Product costs are costs associated with goods for sale until the time period during which the products are sold, at which time the costs become expenses. Period costs are costs that are expensed during the time period in which they are incurred. Expenses are the consumption of assets for the purpose of generating revenue.

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Product Costs Product Costs Cost of goods sold Period Costs Period Costs Operating expenses Cost Classifications on Financial Statements – Income Statement

Merchandiser Merchandiser Current Assets –Cash –Receivables –Prepaid Expenses –Merchandise Inventory Manufacturer Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Cost Classifications on Financial Statements – Balance Sheet

Merchandiser Merchandiser Current Assets –Cash –Receivables –Prepaid Expenses –Merchandise Inventory Manufacturer Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Cost Classifications on Financial Statements – Balance Sheet Those materials waiting to be processed.

Merchandiser Merchandiser Current Assets –Cash –Receivables –Prepaid Expenses –Merchandise Inventory Manufacturer Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Cost Classifications on Financial Statements – Balance Sheet Partially complete products – material to which some labor and/or overhead has been added.

Merchandiser Merchandiser Current Assets –Cash –Receivables –Prepaid Expenses –Merchandise Inventory Manufacturer Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Cost Classifications on Financial Statements – Balance Sheet Completed products awaiting sale.

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Types of Production Processes

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Manufacturing Costs The Product Direct Labor Direct Material Manufacturing Overhead

Direct Material Example: Steel used to manufacture the automobile. Example: Steel used to manufacture the automobile. Cost of raw material that is used to make, and can be conveniently traced, to the finished product.

Cost of salaries, wages, and fringe benefits for personnel who work directly on manufactured products. Direct Labor Example: Wages paid to an automobile assembly worker. Example: Wages paid to an automobile assembly worker.

All other manufacturing costs Manufacturing Overhead Materials used to support the production process. Examples: lubricants and cleaning supplies used in an automobile assembly plant. Indirect Labor Indirect Material Other Costs

All other manufacturing costs Manufacturing Overhead Cost of personnel who do not work directly on the product. Examples: maintenance workers, janitors and security guards. Indirect Labor Indirect Material Other Costs

All other manufacturing costs Manufacturing Overhead Examples: depreciation on plant and equipment, property taxes, insurance, utilities, overtime premium, and unavoidable idle time. Indirect Labor Indirect Material Other Costs

Classifications of Costs in Manufacturing Companies Prime Cost Conversion Cost Manufacturing costs are often combined as follows: Direct Material Direct Labor Manufacturing Overhead

Manufacturing Cost Flows Manufacturing Overhead Direct Material Direct Labor Work in Process Inventory

Manufacturing Cost Flows Manufacturing Overhead Direct Material Direct Labor Finished Goods Inventory Work in Process Inventory

Manufacturing Cost Flows Manufacturing Overhead Direct Material Direct Labor Finished Goods Inventory Cost of Goods Sold Work in Process Inventory

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Schedule of Cost of Goods Manufactured Exh. 2-7

Schedule of Cost of Goods Manufactured Exh. 2-7

Schedule of Cost of Goods Manufactured Include all direct labor costs incurred during the current period. Exh. 2-7

Schedule of Cost of Goods Manufactured Exh. 2-7

Schedule of Cost of Goods Manufactured Beginning work-in- process inventory is carried over from the prior period. Exh. 2-9

Schedule of Cost of Goods Manufactured Ending work-in-process inventory contains the cost of unfinished goods, and is reported in the current assets section of the balance sheet. Exh. 2-9

Income Statement for a Manufacturer Exh. 2-7

Income Statement for a Manufacturer Exh. 2-7

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Identifying Cost Drivers Activities that cause costs to be incurred are called cost drivers.

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Cost Classifications Cost behavior means how a cost will react to changes in the level of business activity.

Cost Classifications Cost behavior means how a cost will react to changes in the level of business activity. –Total variable costs change when activity changes. –Total fixed costs remain unchanged when activity changes.

Total Variable Cost Example Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked Total Long Distance Telephone Bill

Variable Cost Per Unit Example Minutes Talked Per Minute Telephone Charge The cost per long distance minute talked is constant. For example, 5 cents per minute.

Total Fixed Cost Example Your monthly basic telephone bill probably does not change when you make more local calls. Number of Local Calls Monthly Basic Telephone Bill

Fixed Cost Per Unit Example Number of Local Calls Monthly Basic Telephone Bill per Local Call The average cost per local call decreases as more local calls are made.

Cost Classifications

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Direct and Indirect Costs Direct costs Costs that can be easily and conveniently traced to a product or department. Example: cost of paint in the paint department of an automobile assembly plant. Indirect costs Costs that must be allocated in order to be assigned to a product or department. Example: cost of national advertising for an airline is indirect to a particular flight.

A cost can be direct to the department, but indirect to units of product produced in the department. –Example: department manager’s salary. Tracing costs directly to departments or products helps to identify and eliminate non-value added costs. Direct and Indirect Costs

A cost that can be significantly influenced by a manager is a controllable cost. Controllable and Uncontrollable Costs

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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 All costs incurred in the past that cannot be changed by any decision made now or in the future are sunk costs. Sunk costs should not be considered in decisions. –Example: You bought an automobile that cost $12,000 two years ago. The $12,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $12,000 cost.

Differential Costs Costs that differ between alternatives. Example: You can earn $1,500 per month in your hometown or $2,000 per month in a nearby city. Your commuting costs are $50 per month in your hometown and $300 per month to the city. What is your differential cost? $300 - $50 = $250

Marginal Costs and Average Costs The extra cost incurred to produce one additional unit. The total cost to produce a quantity divided by the quantity produced. Marginal and average costs are largely a function of cost behavior -- variable and fixed costs.

Costs and Benefits of Information Costs Benefits More information does not mean more benefits if information overload results.

End of Chapter 2

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Resource Flows 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

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 Resource Flows

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.

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. Resource Flows

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.

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. Resource Flows

Cost Behavior Fixed costs are usually characterized by: a.Unit costs that remain constant. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant.

Fixed costs are usually characterized by: a.Unit costs that remain constant. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Cost Behavior

Variable costs are usually characterized by: a.Unit costs that decrease as activity increases. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant.

Variable costs are usually characterized by: a. Unit costs that decrease as activity increases. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Cost Behavior