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Group Assignment


Prepared for: Dr. Norshafizah Binti Hanafi

06th November 2016
Prepared by:
Mohd Shamsul Fahmi Bin Shamsudin 819915
Mohd Fahmi Bin Idris 820289
Nur Aeidah Binti Sabri 819439
Norita Binti Rasli 822130
Norazimah Binti Mohamad Tahir 819385

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Question 2-5

Master of Business Administaration (MBA)

Define the following

(a) Direct Materials
Direct materials are an integral part of a finished product and their costs can be
conveniently traced to it.
All items such as raw materials, standard and specialized parts, and sub-assemblies
required to assemble or manufacture a complete product. These are not materials that
used in the production process. Direct materials are goods that physically become the
finished product at the end of manufacturing process. In other words, these are tangible
pieces or component of a finished product. E.g. In motorcycle manufacturing, handle
bars, fenders, pipes and gas tank consider as direct material.
(b) Indirect Materials
Indirect materials are generally small items of material such as glue and nails. They
may be an integral part of a finished product but their costs can be traced to the product
only at great cost or inconvenience.
Indirect materials used in manufacturing processes which does not become an integral
part of the product and the cost of which is not identifiable with or directly chargeable to
it. These materials are usually small, inexpensive and bought in mass quantities. They
also dont add much overall value to the product being produced. This is why the
materials are rarely counted in inventory or cost of goods sold. E.g.: tools, cleaning
supplies, lubricants.

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( c) Direct Labor
Direct labor consists of labor costs that can be easily traced to particular products.
Direct labor is also called "touch labor."
Direct labor is the amount of effort exerted by employees to convert raw materials into
finished goods. In other word, Its the employees work that goes into making the
products a manufacturer sells This work can be traced back directly to the products they
help produce. For example, a welder, machinist, or painter all help produce a specific
(d) Indirect Labor
Indirect labor consists of the labor costs of janitors, supervisors, materials handlers, and
other factory workers that cannot be conveniently traced to particular products. These
labor costs are incurred to support production, but the workers involved do not directly
work on the product.
In contrast of direct labor, indirect labor refers to workers hours that spent on working
projects that cannot be traced back to a single product. Its intangible concept, for
instance, worker who help the machinist by cleaning out their machines cant be traced
back to a single product due to they do not produce anything.
(e) Manufacturing Overhead
Manufacturing overhead includes all manufacturing costs except direct materials and
direct labor. Consequently, manufacturing overhead includes indirect materials and
indirect labor as well as other manufacturing costs.
Overhead is basically the costs of running a business that cant be directly attributed to
a product or service. Manufacturing overhead relates to costs that business has to incur
in order to produce its product, the cost of manufacturing overhead must be assigned to
each produce so that Inventory and Cost of Goods Sold are valued and reported
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manufacturing overhead in producing motorcycle, how much electric use to produce

one specific motorcycle. Yet, the overhead costs are unavoidable.

Question 2-6

Explain the difference between a product cost and a period cost

A product cost is any cost involved in purchasing or manufacturing goods. In the case of
manufactured goods, these costs consist of direct materials, direct labor, and
manufacturing overhead. A period cost is a cost that is taken directly to the income
statement as an expense in the period in which it is incurred.
Product cost refers to the costs used to create a product. These costs include direct
labor, direct materials, consumable production supplies and manufacturing overhead.
Product cost including labor cost to deliver a service to a customer in later part. The
cost of a product on a unit basis is typically delivered by compiling the costs associated
with a batch of unites that were produced as a group, and dividing by the number of
unites manufactured. The calculation is :
(Total direct labor + Total direct materials + consumable supplies +Total allocated
overhead)/Total number of units = Product unit costs
Product cost can be recorded as an inventory asset if the product has not yet been sold.
It is charged to the cost of goods sold as soon as the product is sold.
Period cost is any cost that cannot be capitalized into prepaid expenses, inventory or
fixed assets. This type of cost is not included within the cost of goods sold on the
income statement. Example of period costs are :

Selling expenses
Advertising expenses
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Travel and entertainment expenses

Depreciation expenses
General and administrative expenses
Executive and administrative salaries and benefit
Office rent

The key difference between product costs and period costs is that product cost are only
incurred if product are acquired produces and period costs are associated with the
passage of time. Thus, a business that has no production or inventory purchasing
activities will incur no product cost, but will still incur period costs.
Product costs are initially recorded within the inventory asset. Once the related goods
are sold, these capitalized costs are charged to expense. Example of product cost is
direct material, direct labor and allocated factory overhead. Example of period cost are
general and administrative expenses, such as rent, office depreciation, office supplies
and utilities.
Period cost sometimes broken out into additional subcategories for selling activities and
administrative activities. Administrative activities are more pure form of period costs.

Question 2-13
Define the following terms: differential cost, opportunity cost and sunk cost
Costs may be classified as differential cost, opportunity cost and sunk cost. This
classification is made for decision making purposes.
Differential cost is the difference between the cost of two alternative decisions or of a
change in output levels. The concept is used when there are multiple possible options to
pursue, and a choice must be made to select one option and drop the others. The
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deferential cost can be fixed cost or variable cost. Example, if cost of alternative A is
$10,000 per year and the cost of alternative B is $8,000 per year. The difference of
$2,000 would be differential cost. Costs may be classified as differential cost,
opportunity cost and sunk cost. This classification is made for decision making
purposes. Explanation and examples of differential, opportunity and sunk costs are
given below:
Differential cost:
The work of managers includes comparison of costs and revenues of different
alternatives. Differential cost (also known as incremental cost) is the difference in cost of
two alternatives. For example, if the cost of alternative A is $10,000 per year and the
cost of alternative B is $8,000 per year. The difference of $2,000 would be differential
cost. The differential cost can be a fixed cost or variable cost.
Similarly the difference in revenue of two alternatives is known as differential revenue.
For example, if alternative As revenue is $15,000 and alternative Bs revenue is
$10,000. The difference of $5,000 would be differential revenue.
When different revenue generating alternatives are compared, the differential cost as
well as differential revenues associated with each alternative is taken into account.
The terms differential cost and differential revenue used in managerial accounting
are similar to the terms marginal cost and marginal revenue used in economics.
Example computation of differential cost, differential revenues and differential net
operating income:
The management of Galaxy Company has two alternatives to choose from. Compute
differential revenue, differential cost and differential net operating income from the
information of two alternatives given below:

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In the above example, total differential revenue is $200,000 (1,600,000 1,400,000),

differential cost is $130,000 (1,240,000 1,110,000) and differential net operating
income is $70,000 ($360,000 $290,000).
If a decision is made on the basis of above computations, alternative 2 would be
selected because it promises to generate more net operating income.
Opportunity cost:
Unlike other types of cost, opportunity cost does not require the payment of cash or its
equivalent. It is a potential benefit or income that is given up as a result of selecting an
alternative over another. For example, You have a job in a company that pays you
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$25,000 per year. For a better future, you want to get a Masters degree but cannot
continue your job while studying. If you decide to give up your job and return to school
to earn a Masters degree, you would not receive $25,000. Your opportunity cost would
be $25,000.
Almost every alternative has an opportunity cost. It is not entered in the accounting
records but must be considered while making decisions.
Sunk cost:
The costs that have already been incurred and cannot be changed by any decision are
known as sunk costs. For example, a company purchased a machine several years
ago. Due to change in fashion in several years, the products produced by the machine
cannot be sold to customers. Therefore the machine is now useless or obsolete. The
price originally paid to purchase the machine cannot be recovered by any action and is
therefore a sunk cost.
These costs should not be taken into account while making any decision because no
action can reverse them.

Question 2-14
Only variable costs can be differential costs. Do you agree? Explain.
No. A variable cost is a cost that varies in total amount in direct proportion to changes in
the level of activity. A differential cost is the difference in cost between two alternatives.
If the level of activity is the same for the two alternatives, a variable cost will not be
affected and it will be irrelevant.
Variable costs are corporate expenses that vary in direct proportion to the quantity of
output. Unlike fixed cost, which remain constant regardless of output, variable costs a a
direct function of production volume, rising whenever production expands and falling
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whenever it contract. Example of common variable costs includes raw materials,

packaging and labor directly involved in a companys manufacturing process.
The formula calculating variable cost is :
Total variable cost =Total Quality of Output x Variable Cost per unit of output.
How its Works (Example)
Lets assume ABC Limited has received an order of 5,000 widgets for a total sales price
$5,000 and want to determine the gross profit that will be generated by completing the
order. First,variable cost per widget must be determined.
Lets assume the following
Annual Widgets Produced: $100,000
Raw Material Costs:$10,000
Direct Labor Costs:$50,000
From above information, we can conclude that each widget costs 10 cents
($10,000/100,000 widgets) in raw materials and 50 cents ($50,000/100,000 widgets) in
direct labor costs. Using the formula above, we can calculate that ABC Limited total
variable cost on the order is:
5,000 x (0.10 + $0.50) = $3,000
Therefore the company can reasonably expect to earn a $2,000 gross profit ($5,000 $3,000) from the order.
Variable can be also in one of differential cost items only in term of overall calculation. In
essence, you can line up the revenues and expenses from one decision next to similar
information for the alternative decision, and the difference between all line items in the
two columns is the differential cost. Differential cost in short run include price covering
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fixed costs and generating profit. In long run the price must cover all costs, because
both fixed and variable costs become differential in the long run.
Characteristic differential cost:
1. Since a differential cost is only used for management decision making, there is no
accounting entry for it. There is also no accounting standard that mandates how the
cost is to be calculated. Differential cost may, however, be incorporated in the flexible
2. Total differential cost are considered in differential cost analysis. Cost per unit is not
taken into consideration.
3. The changes in costs are measured from a common base point which may be a
present course of action or present level of production
4. Differential cost analysis is related to the future course of action or future level of
output,so it deals with future costs. Historical costs or standard costs may be used but
they should be suitably adjusted to future conditions
5. For making a choice among the various alternatives, the alternatives which gives the
maximum difference between the incremental revenue and incremental cost is
recommended to be adopted.

Question 2-2
Arden Company reported the following costs and expenses for the most recent
Direct material
Direct labour
Manufacturing overhead
Selling expenses
Administrative expenses

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Cost terminology for manufacturers

1. What is the total amount of products costs ?
Direct Materials

$ 80,000

Direct Labor


Manufacturing Overhead


2. What is the total amount of period costs?

Total Product Costs
Selling Expense
Administrative Expenses
3. What is the total amount of conversion costs?
Total Period Costs
Direct Labor
Manufacturing Overhead
4. What is the total amount of prime costs?
Total Conversion Costs
Direct Materials
Direct Labor
Total Prime Costs

$ 22,000
$ 57,000
$ 42,000
$ 61,000
$ 80,000
$ 122,000

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Question 7-4
What are unit level, batch level, product level, customer level and organizationsustaining activities?
Unit level, batch level, product level, customer level and organization-sustaining
activities are cost Hierarchy in Activity-Based Costing. Thousands of activities are
carried out in most organizations. It would not be practical to track all of them in an
activity-based costing system. A great deal of simplification is necessary. Activities and
their costs must be combined to reduce complexity and record-keeping requirements.
One way to simplify is to group activities into a hierarchy. Activities, and their costs, can
be combined within each level of the hierarchy into activity cost poolshopefully with
minimal loss in accuracy. The cost hierarchy used in the text is not the only scheme that
could be used, but it is reasonably comprehensive. The levels in the hierarchy are as
1. Unit-level activities. These activities are performed each time a unit is produced.
For example, providing power to run processing equipment is likely to be a unit-level
2. Batch-level activities. These activities are performed each time a batch is handled
or processed, regardless of how many units are in the batch. For example, tasks such
as placing purchase orders, setting up equipment, and arranging for shipments to
customers are batch-level activities.
3. Product-level activities. These activities relate to specific products and must be
carried out regardless of how many batches or units of product are produced or sold.
For example, designing a product, advertising a product, and maintaining a product
manager and staff are all product-level activities.
4. Customer-level activities. These activities relate to specific customers and include
sales calls, catalog mailings, and general technical support not tied to any specific

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5. Organization-sustaining activities. These activities are carried out regardless of

which products are produced, how many batches are run, or how many units are made.
This category of activities includes cleaning executive offices, providing a computer
network, arranging for loans, preparing annual reports to shareholders, and so on.

The hierarchy described in the text is reasonable is closed to the activity based costing
systems, described by Robin Cooper and Robert Kaplan in the 1980's and 1990's, has
attracted much attention. These systems identifies the major activities of a facility's
production process and then classifies these activities into one of the following

unit-level activities;
batch-level activities;
product-sustaining level activities and;
facility-sustaining level activities.

The unit-level activities are performed each time a unit of a product is produced. The
number of times unit-level activities (such as drilling holes and inspecting every part) are
performed varies according to the number of units produced. The batch-level activities
are performed each time a batch of goods is produced. The number of times batch-level
activities (such as setting up a machine) are performed varies according to the number
of batches made. The costs of these activities can be assigned to individual batches but
they are fixed regardless of the number of units in the batch. Product-sustaining
activities are performed as needed to support the production of each different type of








specifications, performing engineering change notices and developing special testing

routines. These costs can be assigned to individual products but are not proportional to
the number of units or batches produced. Facility-sustaining activities support a facility's
general manufacturing process. Examples of facility-sustaining activities are lighting and
cleaning the facility, facility security and managing the facility.

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The costs of the unit-level, batch-level and product-sustaining level activities are
attributed to products based on each product's consumption of those activities. The
costs of facility-sustaining activities are allocated to products arbitrarly or treated as
period costs.

Why are

Why are there two stages of allocation in activities-based costing?

Activity-based costing is an improved method for allocating overhead costs. Instead of
using one factor for cost allocation, this new method focuses on different aspects of the
production process and allocates the overhead based on each products reliance on
different overhead aspects. The first stage of allocation determines the cost of each
occurrence of an overhead event during the process. The second stage allocates the
cost of each occurrence to individual items produced by the business.
Traditional Costing Method
Activity-based costing is the newest means of calculating how overhead expenses are
allocated to different products at the time of publication. The traditional allocation
method requires the business to pick one metric to use as a means to allot overhead
costs. Generally, the business would try to select a metric that is the underlying cause of
overhead costs. For example, a business might choose direct labor hours as the
allocation metric. The total overhead expense would be divided by the total number of
direct labor hours for the financial period. Using the per-hour overhead rate, overhead
cost would be applied to each item based on the number of direct labor hours used in
producing the good.
Activity-Based Costing
Activity-based costing is a more nuanced approach to allocating overhead. Instead of
using a single factor, activity-based costing uses several factors to determine how to
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allocate overhead. Each factor is tied directly to an aspect of overhead. Then each
product is evaluated based on how much of each element of overhead is used to
produce the good, and the price is adjusted accordingly.

Stage 1: Allocation to Activities

The first step in Activity-Based Costing is to divide the expenses of certain overhead
activities to a per-event cost. For example, say that the overall cost of resetting a
machine for production during the year was $1 million. You have two products and you
had to switch the machine over 100 times. The first stage of allocation would stipulate
that the cost of one setting switch is $10,000.
Stage 2: Allocation to Production
The second step in activity-based costing is to allocate the activity cost to each product.
Using the same example, a uniform batch of each product would be produced after
every switch. So after every switch, 1,000 units of Product A or 10,000 units of Product
B would be produced. The switching cost allocated to a single item of Product A would
be $10, while the switching cost for a single item of Product B would be $1.

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