Chapter 2

Basic Cost
Management Concepts
and Accounting for Mass
Customization Operations

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Process of Management
Strategy
Formulation

Planning

Managers need cost information to

perform each of these functions.

Directing

Control
Decision
Making

Learning Objective 01
2-2

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.

2-3

Cost Classifications on Financial

Statements Balance Sheet
Manufacturer

Merchandiser
Current Assets

Cash
Receivables
Prepaid Expenses
Merchandise
Inventory

Current Assets

Cash
Receivables
Prepaid Expenses
Inventories
Raw Materials
Work in Process
Finished Goods
2-4

Types of Production Processes

Type of Production

Description of

Example of

Process

Process

Manufacturer

Job Shop

Low volume

Disney

Little standardization
Unique products

Batch

Multiple products

Caterpillar

Low volume

Assembly Line

A few major products

Ford

Higher volume

Mass Customization

High volume

Dell

Many standardized components

Customized combination of components

Continuous Flow

High volume
Highly standardized commodity products

Exxon
2-5

Manufacturing Costs
Direct
Material

Direct
Labor

Manufacturing
Overhead

The
Product
2-6

Classifications of Costs in
Manufacturing Companies
Manufacturing costs are often
combined as follows:
Direct
Material

Direct
Labor

Prime
Cost

Manufacturing
Overhead

Conversion
Cost
2-7

Manufacturing Cost Flows

Direct Material
Direct Labor

Work in
Process
Inventory

Manufacturing
Overhead
Finished
Goods
Inventory

Cost of
Goods
Sold

2-8

Schedule of Cost of Goods

Manufactured
Computation of Cost of Raw Material Used

Raw-material inventory, January 1

Add: Purchases of raw materials

Raw material available for use

Deduct: Raw material inventory, December 31
Raw material used

6,000
134,000
140,000
5,020

$ 134,980

2-9

Computation of Total Manufacturing Overhead

Indirect material

10,000

Indirect labor

40,000

Depreciation on factory

90,000

Depreciation on equipment

70,000

Utilities

15,000

Insurance
Total manufacturing overhead

5,000
$ 230,000

Beginning work-in-process
inventory is carried over from
the prior period.
Ending work-in-process inventory
contains the cost of unfinished goods,
and is reported in the current assets
section of the balance sheet.

2-10

Income Statement for a

Manufacturer
Comet Computer Corporation
Income Statement
For the Year Ended December 31, 20X2
Sales revenue
Less: Cost of goods sold

700,000
415,010

Gross margin
Selling and administrative expenses

284,990
174,490

Income before taxes

Income tax expense

110,500
30,000

Net income

80,500
2-11

Income Statement for a Manufacturer

Comet Computer Corporation
Schedule of Cost of Goods Sold
For the Year Ended December 31, 20X2
Finished-goods inventory, Jan. 1
Add: Cost of goods manufactured

Cost of goods available for sale

Comet Computer Corporation
Deduct Finished-goods inventory, Dec. 31

200
415,000
415,200
190

Income Statement
$ 415,010
For the Year Ended December 31, 20X2

Cost of goods sold

Sales revenue
Less: Cost of goods sold

700,000
415,010

Gross margin
Selling and administrative expenses

284,990
174,490

Income before taxes

Income tax expense

110,500
30,000

Net income

80,500
2-12

Activities that cause costs to be

incurred are called COST DRIVERS
Cost Driver Examples
Activity
Cost Driver
Machining operations
Machine hours
Setup
Setup hours
Production scheduling
Manufacturing orders
Inspection
Pieces inspected
Purchasing
Purchase orders
Shop order handling
Shop orders
Valve assembly support Customer
Requisitions
2-13

Cost Classifications
Summary of Variable and Fixed Cost Behavior
Cost

In Total

Per Unit

Variable

Total variable cost changes

as activity level changes.

Variable cost per unit

remains the same over
wide ranges of activity.

Total fixed cost remains

the same even when the
activity level changes.

Fixed cost per unit

goes down as activity
level goes up.

Fixed

2-14

Various Costs
Direct costs: Costs that can be easily and conveniently traced to a
product or department.
Indirect costs: Costs that must be allocated in order to be assigned to a
product or department.
Controllable and Uncontrollable Costs: A cost that can be significantly
influenced by a manager is a controllable cost.
Opportunity Costs: The potential benefit that is given up when one
alternative is selected over another.
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.
Differential Costs: Costs that differ between alternatives.
Marginal Cost: The extra cost incurred to produce one additional unit.
Average Cost: The total cost to produce a quantity divided by the
quantity produced.
2-15