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Basic Cost Management Concepts and Accounting for Mass

Customization Operations
Learning Objective 1. Explain what is meant by the word cost.
Process of Management
The process of management involves formulating strategy, planning, control, decision making and
directing operational activities. Management accounting information helps managers perform each of
these functions more effectively.
What Do We Mean By a Cost?
- A cost is the measure of resources given up to achieve a particular purpose.
Learning Objective . Distingish among prodct costs! period costs! and expenses.
A prodct cost is a cost assigned to goods that !ere either purchased or manufactured for resale.
Another term for product cost is in"entoriable cost, since a product cost is stored as the cost of
inventory until the goods are sold. "n the period of the sale, the product costs are recogni#ed as an
e$pense called
%roduct costs are costs associated !ith goods for sale until the time period during !hich the products
are sold, at !hich time the costs become e$penses.
Period costs are costs that are e$pensed during the time period in !hich they are incurred.
An expense is the cost incurred !hen an asset is used up or sold for the purpose of generating
revenue. &$penses are the consumption of assets for the purpose of generating revenue.
Learning Objective '. Describe the role of costs on pblished financial statements.
Cost Classifications on #inancial $tatements % &ncome $tatement

Prodct costs appear on the income statement as cost of goods sold in the period in !hich the
products !ere sold. This is true for merchandising and manufacturing companies.
Period costs appear on the income statement in the period in !hich they !ere incurred. (elling and
administrative e$penses are an e$ample of period costs.
Cost Classifications on #inancial $tatements % Balance $heet
Merchandiser Manfactrer
)urrent Assets )urrent Assets
)ash )ash
*eceivables *eceivables
%repaid &$penses %repaid &$penses
Merchandise "nventory "nventories
'aw Materials
Wor( in Process
#inished )oods
(ince retailers, !holesalers, and manufacturers sell inventoriable products, their balance sheets are
also affected by product costs. Merchandisers, such as +al,Mart, list the product cost as
merchandise inventories on the balance sheet in the current assets section.
'aw-material inventory includes all materials before they are placed into production.
Wor(-in-process inventory refers to manufactured products that are only partially completed at the
date !hen the balance sheet is prepared.
#inished-goods inventory refers to manufactured goods that are complete and ready for sale. The
values of the !ork,in,process and finished,goods inventories are measured by their product costs.
Learning Objective -. )i"e examples of three types of manfactring costs.
Managerial accountants classify costs by the functional area of the organi#ation to !hich costs relate.
(ome e$amples of functional areas are manufacturing, marketing, administration, and research and
development. Manfactring costs are frther classified into the following three categories*
direct material! direct labor! and manfactring o"erhead.
Direct Material
- *a! material that is consumed in the manufacturing process, is physically incorporated in the
finished product, and can be traced to products conveniently is called direct material.
Cost of raw material that is sed to ma(e! and can be con"eniently traced! to the finished
Example* $teel sed to manfactre the atomobile
Direct +abor
- The cost of salaries, !ages, and fringe benefits for personnel !ho !ork directly on the
manufactured products is classified as direct,labor cost.
Cost of salaries! wages! and fringe benefits for personnel who wor( directly on manfactred
Example* Wages paid to an atomobile assembly wor(er.
All other costs of manufacturing are classified as manfactring o"erhead! !hich includes three
types of costs. indirect material! indirect labor! and other manfactring costs.
1. The cost of materials that are re/uired for the production process but do not become an
integral part of the finished product are classified as indirect material costs. Materials that do
become an integral part of the finished product but are insignificant in cost are also often classified as
indirect material.
Materials sed to spport the prodction process.
Examples* lubricants and cleaning supplies used in an automobile assembly plant.
. The costs of personnel !ho do not !ork directly on the product, but !hose services are
necessary for the manufacturing process, are classified as indirect labor.
)ost of personnel !ho do not !ork directly on the product.
Examples. maintenance !orkers, janitors and security guards.
'. All other manufacturing costs that are neither material nor labor costs are classified as manufacturing
Examples* depreciation on plant and e/uipment, property ta$es, insurance, utilities, overtime premium, and
unavoidable idle time.
Manfactring costs are often combined as follows*
0irect material and direct labor are often referred to as prime costs. 0irect labor and overhead are
often called con"ersion costs! since they are the costs of 1converting2 ra! material into finished products.
Manfactring Cost #lows*
As direct material is consumed in production, its cost is added to !ork,in,process inventory.
(imilarly, the costs of direct labor and manufacturing overhead are accumulated in !ork in process.
+hen products are finished, their costs are transferred from !ork,in,process inventory to
finished,goods inventory. The total cost of direct material, direct labor, and manufacturing overhead
transferred from !ork,in,process inventory to finished,goods inventory is called the cost of goods
The costs then are stored in finished goods until the time period !hen the products are sold. At that
time, the product costs are transferred from finished goods to cost of goods sold, !hich is an e$pense of the
period !hen the sale is made.
Learning Objective 3. Prepare a schedle of cost goods manfactred! a schedle of cost of goods sold!
and an income statement for a manfactrer.