Unit Ii: Basic Cost Management Concepts: Learning Objectives

P R O F 3 – M A N A G E R I A L A C C O U N TI N G
UNIT II: BASIC COST MANAGEMENT CONCEPTS
Overview
Many of you will work in manufacturing companies or provide services for them.
Others will work in retail or service organizations that do business with
manufacturers. This unit will help you understand how manufacturing companies
work and how to prepare managerial reports for both internal and external users.
Learning Objectives_
At the end of the unit, I am able to:
1. understand the flow of goods from raw materials inventory to goods in process
inventory to finished goods inventory;
2. classify costs as direct or indirect, fixed or variable, prime or conversion, and
product or period;
3. identify product costs as direct materials, direct labor or overhead;
4. calculate cost of goods manufactured and cost of goods sold; and
5. prepare a manufacturing statement with cost of goods manufactured
calculated.
Lesson Proper
Merchandiser and Manufacturer Accounting: Differences in Cost Concepts
Before you study the different costs that businesses incurred, you must first need to
understand the difference between merchandising and manufacturing companies.
Assume you own a bicycle store and purchase bicycles and accessories to sell to
customers. To determine your profitability, you would subtract the cost of bicycles and
accessories from your gross sales as cost of goods sold. However, if you owned the
manufacturing company that made the bicycles, you would base your cost of goods sold on
the cost of manufacturing those bicycles. Accounting for manufacturing costs is more
complex than accounting for costs of merchandise purchased that is ready for sale.
Perhaps the most important accounting difference between merchandisers and

manufacturers relates to the differences in the nature of their activities. A merchandiser
purchases finished goods ready to be sold. On the other hand, a manufacturer must purchase
raw materials and use production equipment and employee labor to transform the raw
materials into finished products.
UNIT II: BASIC COST MANAGEMENT CONCEPTS 16

Figure 2.1 Comparing Merchandisers and Manufacturers

Source: The McGraw-Hill Companies, Inc., 2003
Nature of Costs, Cost Pools, Cost Objects and Cost Drivers
In the most basic level, a cost may be defined as a value forgone or sacrifice of resources
for the purpose of achieving some economic benefit which will promote the profit-making
ability of the firm. It is also an outlay of expenditure of money to acquire goods and services
that assist in performing operations. (Cabrera, 2017)
In managerial accounting, the term cost may be used in different ways depending on the
immediate needs of the organization and type of organization involved. Cost data that are
classified and recorded in a particular way for one purpose may be inappropriate for another
use.
Costs are measured and analyzed to help managers in decision making. Thus, you must
know the cost terms used in preparing managerial reports.
 Cost object is anything for which cost is computed. Examples are product, product
line or a segment of an organization.
 Cost driver pertains to any variable, such as level of activity or volume, that usually
affect costs over a period of time. Some examples are production level, sales, number
of hours and floor space occupied.
 Cost pool is a grouping of individual cost items similar in nature that is accumulated
for reporting purposes. Work in process and Factory overhead control accounts are
some examples. You will encounter these terms later as you go on.
 Activity refers to an event, action, transaction, task or unit of work with a specified
purpose. This can classified into two: value-adding and non-value-adding. Value-
adding activities are necessary to produce a product and cannot be eliminated like
assembling the different component parts of a product. On the other hand, non-

value-adding activities do not make the product or service more valuable to the
customer, therefore, can be eliminated. Moving materials from the warehouse to the
factory is one example.
 Cost assignment is the process of assigning costs to cost pools or from cost pools to
cost objects. For example, utilities like electric bill incurred by the company is
distributed to the assembly and finishing department.
 Cost allocation is the assignment of indirect costs to cost pools. Cost drivers are used
to allocate costs.
Classification of Costs According to their Purposes
Cost classifications are necessary for the development of cost information to serve the
needs of management. Understanding these classifications enables you to provide
appropriate data to managers who will need them. Basic cost and terminologies are
presented in Figure 2.2.
Manufacturing vs. Nonmanufacturing Costs
Manufacturing costs are often classified as direct materials, direct labor and factory
head. These are all the costs incurred in the factory to convert raw materials into finished
goods.
Direct materials are those materials used only in making the product and are clearly
and easily traceable to a particular product. For example, iron ore is a direct material to
a steel company because the iron ore is clearly traceable to the finished product, steel. In
turn, steel becomes a direct material to an automobile manufacturer.
Some materials (such as glue and thread used in manufacturing furniture) may
become part of the finished product, but tracing those materials to a particular product
would require more effort than is sensible. Such materials, called indirect materials or
supplies, are included in manufacturing overhead.
Direct labor costs include the labor costs of all employees actually working on
materials to convert them into finished goods. As with direct material costs, direct labor
costs of a product include only those labor costs clearly traceable to, or readily
identifiable with, the finished product. The wages paid to a construction worker, a pizza
delivery driver, and an assembler in an electronics company are examples of direct labor.
Many employees receive fringe benefits—employers pay for payroll taxes, pension
costs, and paid vacations. These fringe benefit costs can significantly increase the direct
labor hourly wage rate. Some companies treat fringe benefit costs as direct labor. Other
companies include fringe benefit costs in overhead if they can be traced to the product
only with great difficulty and effort.

Figure 2.2 Cost Classifications
Source: https://images.app.goo.gl/ZFGB1vvEjBJntfMb8

Firms account for some labor costs (for example, wages of materials handlers,
custodial workers, and supervisors) as indirect labor because the expense of tracing
these costs to products would be too great. These indirect labor costs are part of
overhead.
Figure 2.3 Manufacturing Costs
In a manufacturing company, overhead is generally called manufacturing overhead.

(You may also see other names for manufacturing overhead, such as factory overhead,
factory indirect costs, or factory burden.) Service companies use service overhead, and
construction companies use construction overhead. Any of these companies may just use
the term overhead rather than specifying it as manufacturing overhead, service overhead,
or construction overhead. Some people confuse overhead with selling and administrative
costs. Overhead is part of making the good or providing the service, whereas selling costs
result from sales activity and administrative costs result from running the business.
In general, overhead refers to all costs of making the product or providing the service
except those classified as direct materials or direct labor. (Some service organizations
have direct labor but not direct materials.) In manufacturing companies, manufacturing
overhead includes all manufacturing costs except those accounted for as direct materials
and direct labor. Manufacturing overhead costs are manufacturing costs that must be
incurred but that cannot or will not be traced directly to specific units produced. In
addition to indirect materials and indirect labor, manufacturing overhead includes
depreciation and maintenance on machines and factory utility costs. Look at Table 2 for
more examples of manufacturing overhead costs.
Direct materials and direct labor are both composition is prime cost. It is called that
way because it pertains to the basic cost that you will incur to produce a product or
deliver a service. Some products or services need only materials and labor to be
completed. As illustrated in Figure 2.3, if you combine direct labor and manufacturing
overhead, you will derived conversion cost. It is the cost that you will incur to convert
your materials into finished products.
Nonmanufacturing costs are all costs which are not incurred in transforming
materials into finished goods but are essential in the business operations.

Table 2. Examples of Manufacturing Overhead Costs
Indirect Materials Indirect Labor Others

 Oil  Supervisors and  Repairs and
 Nails janitors in factory maintenance on factory
 Glue buildings buildings and
 Paint  Materials storeroom equipment
 Liquefied personnel  Depreciation on factory
Petroleum Gas  Cost accountant salary buildings and
(LPG)  Payroll taxes and fringe equipment
 Packaging benefits for  Insurance and taxes on
materials like manufacturing factory property and
plastic wraps and employees inventories
boxes  Utilities for factory
buildings
Selling expenses are costs incurred to obtain customer orders and get the finished
product in the customers’ possession. Advertising, market research, sales salaries and
commissions, and delivery and storage of finished goods are selling costs. The costs of
delivery and storage of finished goods are selling costs because they are incurred after
production has been completed. Therefore, the costs of storing materials are part of
manufacturing overhead, whereas the costs of storing finished goods are a part of selling
costs. Remember that retailers, wholesalers, manufacturers, and service organizations all
have selling costs.
Administrative expenses are nonmanufacturing costs that include the costs of top
administrative functions and various staff departments such as accounting, data
processing, and personnel. Executive salaries, clerical salaries, office expenses, office rent,
donations, research and development costs, and legal costs are administrative costs. As
with selling costs, all organizations have administrative costs.
Product Costs vs Period Expenses
Companies also classify costs as product costs and period costs. Product costs are
the costs incurred in making products. If you will notice these are the same also as
manufacturing cost.
Period expenses are closely related to periods of time rather than units of products.
For this reason, firms expense (deduct from revenues) period costs in the period in which
they are incurred. Accountants treat all selling and administrative expenses as period
costs for external financial reporting.
To illustrate, assume a company pays its sales manager a fixed salary. Even though
the manager may be working on projects to benefit the company in future accounting
periods, it expenses the sales manager’s salary in the period incurred because the
expense cannot be traced to the production of a specific product.

Looking at Figure 2.4, product costs are not expensed until the item is sold where the
product costs are recorded as cost of goods sold. Period costs not related to creating a
product are shown in the income statement along with cost of goods sold.
Figure 2.4 Product vs. Period Costs
Cost Classifications Used for Planning and Control
1. Fixed vs. Variable Costs
A fixed cost remains the same in total but changes per unit. Fixed costs examples
include your monthly rent, salaried employees, straight-line depreciation as these
amounts do not change based on volume. A variable cost remains the same per unit
but changes in total. Variable cost examples include sales commissions, hourly workers,
units-of-production method depreciation as these amounts will change based on total
volume but the amount charged per unit does not change.
Behavior of Cost (within the relevant range)

Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as 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.
Figure 2.5 Classification of Cost as to Behavior

Figure 2.6 Product Cost Flow

Figure 2.7 Change in Total Cost as the Activity Level Changes
Figure 2.8 Change in Cost per unit as the Activity Level Changes
2. Direct vs Indirect Costs
A direct cost is an amount that can be traced to a specific department, process or

job. Direct costs can be product costs like direct materials or direct labor or they can be
period costs like an accountant’s salary would be traced to the accounting
department. Indirect cost is an amount that cannot be traced to a specific department,
process or job. These costs are typically allocated (or estimated) to the departments,
processes or jobs using those items. Indirect costs can be product costs like overhead or
period costs like an IT employee’s salary to the sales department. The sales department
needs the services provided by IT and the IT employee’s time would be an indirect
expense to the sales department.

3. Controllable vs Non-controllable Costs
When evaluating the performance of an executive or manager under managerial

accounting, it is helpful to recognize that some costs and expenses may be out of the
control of that manager or executive. One example is the manager’s salary. The manager
has no control over his own salary and has no power to change or stay within the budget
for the salary. Controllable costs are things the executive, manager, or department even
can control or change. If the executive, manager or department cannot change or control
the cost, it is an uncontrollable cost. An example of an uncontrollable cost would be an
allocation of administrative expenses to each job or department.
4. Differential Costs including Sunk and Opportunity Costs
Differential costs represent the difference between two alternatives. We will

analyze what is relevant to our decision making including any opportunity costs.
Assume you have a job paying ₱ 1,500 per month in your hometown. You have a job
offer in a neighboring city that pays ₱ 2,000 per month. The commuting cost to the city
is ₱ 300 per month.
Differential revenue = P 2,000 – P 1,500 = P 500

Differential cost is P 300.
Opportunity costs are what you give up by choosing one alternative over another
(think about what you are giving up by taking this course — what else could you be
doing?).If you were not attending college, you could be earning ₱15,000 per year.
Your opportunity cost of attending college for one year is ₱15,000.
Sunk costs are not relevant for decision making as the cost cannot be recovered at a
later date. They are not differential costs and should be ignored when making decisions.
Let’s assume that you bought an automobile that cost ₱ 600,000 two years ago. The
₱600,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot
change the ₱ 600,000 cost.
5. Relevant Costs
Every decision involves a choice between at least two alternatives. Only those future
costs and benefits that differ between alternatives (i.e., Differential costs and benefits)
are relevant in a decision. All other costs and benefits can and should be ignored. Also,
cost already incurred are considered irrelevant as they will not matter anymore in the
decision making.
Suppose you are trying to decide whether to drive or take the train to Portland to
attend a concert. You have ample cash to do either, but you don’t want to waste money
needlessly. Is the cost of the pizza you ate last night relevant in this decision? In other
words, should the cost of the pizza affect the decision of whether you drive or take the
train to Portland?
The answer is no. The cost of pizza is already a sunk cost and has nothing to do with
your decision of whether to drive or take in train to Portland.

Characteristics of Managerial Accounting Reports
While a merchandiser has only one type of inventory—merchandise available for sale—
a manufacturer has three types—raw materials, partially complete work in process, and
ready-for-sale finished goods. Instead of one inventory account, three different inventory
accounts are necessary to show the cost of inventory in various stages of production. Looking
at Figure 2.8, you can see how the inventory cost flows differ between manufacturing and
merchandising companies.
You compare a manufacturer’s cost of goods sold section of the Statement of

Comprehensive Income (also known as the income statement) to that same section of the
merchandiser’s income statement in the chart below. There are two major differences in
these cost of goods sold sections: (1) goods ready to be sold are referred to as merchandise
inventory by a merchandiser and finished goods inventory by a manufacturer, and (2) the net
cost of purchases for a merchandiser is equivalent to the cost of goods manufactured by a
manufacturer.
Unlike a merchandiser’s statement of financial position (commonly known as the balance

sheet) that reports a single inventory amount, the balance sheet for manufacturer typically
shows raw materials, work in process, and finished goods inventories separately.
Figure 2.9 Income Statements of Merchandising and Manufacturing Company

Figure 2.10 Balance Sheets of Merchandising and Manufacturing Company
Figure 2.11 Product and Period Cost Flows

As summary, manufacturing cost incurred in producing products that are not yet finished,
and finished goods that are not yet sold will be presented in the balance sheet. The cost of
finished goods already sold is shown in the income statement under the Cost of Goods Sold
account. Period costs is presented as expenses in the income statement as they are incurred
and will not appear in the balance sheet.
The Statement of Cost of Goods Manufactured
The statement of cost of goods manufactured supports the cost of goods sold figure on
the income statement. The two most important numbers on this statement are the total
manufacturing cost and the cost of goods manufactured. Be careful not to confuse the terms
total manufacturing cost and cost of goods manufactured with each other or with the cost of
goods sold.
Total Manufacturing Cost includes the costs of all resources put into production during
the period (meaning, the direct materials, direct labor and overhead applied). Cost of goods
manufactured consists of the cost of all goods completed during the period. It includes total
manufacturing costs plus the beginning work in process inventory minus the ending work in
process inventory. Cost of goods sold are the costs of all goods SOLD during the period and
includes the cost of goods manufactured plus the beginning finished goods inventory minus
the ending finished goods inventory. Cost of goods sold is reported as an expense on the
income statements and is the only time product costs are expensed. Refer to Figure 2.6 on for
a detailed illustration of the formula of cost of goods manufactured and cost of goods sold.
Ready your calculator and let’s have an exercise! This exercise will serve as a practice for
you to understand clearly how to compute and prepare managerial reports.
Assume ABC Manufacturing Company has developed the following information for the
year ended December 31, 2019:
Raw materials Inventory, January 1 P 125,000

Purchases 150,000
Raw materials Inventory, December 31 65,000
Direct Labor 70,000
Factory Overhead (150% of direct labor cost)
Work in process inventory, January 1 90,000
Work in process inventory, December 31 120,000
Finished Goods Inventory, January 1 100,000
Finished Goods Inventory, December 31 80,000
Sales 1,000,000
Selling and general expenses 200,000
You are required to do the following:

1. Compute the
a. Raw materials Used e. Cost of goods manufactured
b. Prime cost f. Cost of Goods Available for sale
c. Conversion Cost g. Cost of Goods Sold
d. Total Manufacturing cost h. Net income

2. Prepare Statement of Cost of Goods Manufactured

3. Prepare Statement of Cost of Goods Sold
4. Prepare an Income Statement
In computing the first requirement, you will use the formula shown in Figure 2.6. Before
continuing reading this module, try to answer first the problem on your own. Do not forget
to use a timer every time you solve a problem so you can monitor your progress. After
finishing solving the problem, you can continue to the next part of this module.
You are now going to verify if you got it for the first time or missed some questions. Do
not worry and be disappointed as this is your first attempt. The next thing that you must do
is compare you answers with the suggested answers below. Look at every detail especially to
the questions that you missed, solve it again. Continuous practice will help you master the
topic.
To begin with, first compute the raw materials used in the production following the
formula. Take note that in accounting, a parenthesis denotes subtraction.
Beginning raw materials inventory ₱ 125,000
Raw materials purchased 150,000
Raw materials available for use in production ₱ 275,000
Ending raw materials inventory ( 65,000)
Raw materials used in production ₱ 210,000
You are now ready to compute prime cost and conversion cost. As a guide, you can refer
to Figure 2.3. After which, you will proceed directly with the computation of total
manufacturing costs.
Raw materials used in Direct Labor ₱ 70,000
production ₱ 210,000
Manufacturing Overhead 105,000
Direct Labor 70,000
(70,000* 150%)
Prime Cost ₱ 280,000 Conversion Cost ₱ 175,000
Do not be confuse in computing the manufacturing overhead, there are companies who
are actually computing the overhead based on their direct labor cost as this is more efficient
than itemized manufacturing overhead cost. Since the problem states that the factory
overhead is charged based on 150% direct labor cost, you must obey. Simply multiply direct
labor of P 70,000 to 1.5 or 150% to arrive at P 105,000.
In computing the total manufacturing cost, do not attempt to add prime cost and
conversion cost. Always remember that direct labor is a part of prime cost as well as the
conversion cost. Adding the two will means that you will charge direct labor to manufacturing
cost twice!

Raw materials used in production ₱ 210,000

Direct Labor 70,000
Manufacturing Overhead (70,000* 150%) 105,000
Total Manufacturing Cost (TMC) ₱ 385,000
Moving forward, remember that a manufacturing company has three types of inventories,
one of which is the work in process inventory. This pertains to the partially completed
goods at the end of the year to which the company has already incurred cost. The beginning
balance is added to the work in process as this pertains to the partially completed goods last
year and assumed that is completed this current year. The ending balance is subtracted as
this is not yet completed on the current year and should not be part of the cost of goods
manufactured. You may wonder why you need to subtract it. Because the company already
incurred cost for it and charged them to the total manufacturing cost.
Total Manufacturing Cost (TMC) ₱ 385,000

Beginning work in process inventory 90,000
Cost of goods put in process ₱ 475,000
Ending work in process inventory ( 120,000
Cost of Goods Manufactured (COGM) ₱ 355,000
The statement of cost of goods manufactured only accounts for the goods that the
company completed during the current year. In order to compute the cost of goods sold we
must consider the finished goods balances at the beginning and ending of the year. Finished
goods are those that are already completed and are available for sale.
Cost of Goods Manufactured ₱ 355,000

Beginning finished goods inventory 100,000
Cost of Goods Available for Sale (CGAS) ₱ 455,000
Ending finished goods inventory ( 80,000)
Cost of Goods Sold (COGS) ₱ 375,000
In arriving at cost of goods sold, the finished inventory beginning is added to the COGM
to compute the goods available for sale and the ending balance is subtracted because this are
not yet sold. CGAS account for all the goods that are available for sale regardless when they
are finished or completed while COGS pertains only those that are already sold.
You may have already observed that the key in computing COGM and CGAS is by knowing
and memorizing the formula. This will help you also in preparing the Statements of Cost of
Goods Manufactured and Cost of Goods Sold. Some companies are preparing these two
separately, but since COGM is needed to compute COGS, it is advisable to prepare one
statement to save time.

ABC Manufacturing Company

Statement of Cost of Goods Manufactured and Sold
For the Year Ended December 31, 2019
Raw materials inventory, 1/1/2019 ₱ 125,000

Raw materials purchases 150,000
Less: Raw materials inventory, 12/31/2019 275,000
Raw materials used 210,000
Direct labor 70,000
Manufacturing overhead 105,000
Total Manufacturing Cost 385,000
Work in Process, 1/1/2019 90,000
Cost of Goods Put in Process 475,000
Less: Work in Process, 12/31/2019 ( 120,000)
Cost of Goods Manufactured ₱ 355,000
Finished goods inventory, 1/1/2019 100,000
Cost of Goods Available for Sale ₱ 455,000
Less: Finished goods inventory, 12/31/2019 ( 80,000)
Cost of Goods Sold ₱ 375,000
ABC Manufacturing Company

Income Statement
For the Year Ended December 31, 2019
Sales ₱ 1,000,000
Less: Cost of Goods Sold 375,000
Gross Profit 625,000
Less: Selling and Administrative expenses 200,000
Net income (loss) ₱ 425,000
Cost Accounting Systems (as stated by Roque, 2010)
1. Job-Order Costing
This product costing is used by firms that provide limited quantities of products or
services unique to a customer’s needs or specifications. Costs are assigned or traced into
individual products. Examples are automobile repair shops, tailoring/dressmaking
business and customized products.

2. Process Costing
This system is used by firms that produce many units of a single product (or nearly
identical products) for long periods of time. In this costing system, costs are accumulated
in a particular operation or department for an entire period (a week, a month, etc.). The
total cost incurred in each operation or department is then divided by the total number
of units produced (or the total equivalent units produced) to determine the average cost
per units. Examples may include Beverages Company, toy manufacturers, Cosmetics
Company and more.
3. Hybrid-Product-Costing System
This costing system incorporate features from two or more alternative product costing
systems, such as job-order and process costing. Clothing and food processing operations
usually this type of cost system.
4. Standard Costing
This can be used with other cost accounting systems like job-order and process
costing. Standard costing uses predetermined factors (quantity and price) to compute the
standard cost of materials, labor and factory overhead, so that such costs may be assigned
to the various inventory accounts and cost of goods sold.
5. Backflush Costing
This is a streamline cost accounting method that simplifies, speeds up and reduces
accounting efforts/procedures in accumulating product costs. Unlike in the traditional
job-order and process costing systems, backflush costing eliminates the detailed tracking
of the cost of work in process. Backflush is usually used by companies applying Just-in-
Time System (JIT).
6. Activity-Based Costing System
This costing system is a two-stage procedure that uses multiple drivers to predict and
allocate costs to products and services. It is a costing method that assigns indirect costs
to activities and to the products based on each product’s use of activities. Activity-based
costing is based on the premise: Products consume activities; activities consume
resources.

References
Books
Cabrera, M. E., & Cabrera, G. A. (2017). Basic Cost Management Concepts. Management
Accounting: Concepts and Applications (2017 ed., pp. 306-308). Manila, Philippines:
GIC Enterprises & Co., Inc.
Roque, R. S. (2010). Cost in Managerial Accounting: Concepts, Classifications,

Accumulation. Reviewer in Management Advisory Services (2010 ed., pp. 154-155,
171-173). Manila, Philippines: GIC Enterprises & Co., Inc.
Webpage
Managerial Accounting Chapter 1: Nature of Managerial Accounting and Costs. (2017,

September 25). Retrieved from
https://courses.lumenlearning.com/managacct/chapter/characteristics-of-
managerial-accounting-reports/

https://courses.lumenlearning.com/managacct/chapter/costs-and-expenses/

https://courses.lumenlearning.com/managacct/chapter/cost-classifications-
used-for-planning-and-control/

https://courses.lumenlearning.com/managacct/chapter/the-statement-of-cost-
of-goods-manufactured/

Assessing Learning
Activity 4
Name: ______________________________________ Date: ___________________________
Course and Section: ______________________ Score: _________________________
Direction: Briefly answer the following questions.
1. Define the terms sunk cost and differential cost.

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2. Identify the three elements of cost incurred in manufacturing a product and indicate
the distinguishing characteristics of each.
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3. Distinguish fixed costs from variable costs.

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4. Why are certain costs referred to as period costs? What are the major types of period
costs incurred by a manufacturer?
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5. Explain why the income statement of a manufacturing company differs from the
income statement of a merchandising company.
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6. What is the general content of a statement of cost of goods manufactured? What is its
relationship to the income statement?
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7. A variable cost is a cost that varies per unit of product, whereas a fixed cost is constant
per unit of product.” Do you agree? Explain.
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8. Assume Domino’s Pizza is considering offering a new product—a 6-inch (15.24 cm)
pizza. Why would it matter if Domino’s Pizza knows how much it costs to produce and
deliver this 6-inch (15.24 cm) pizza?
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9. Thalia Aldama is employed by Bella Company. Last week, she worked 34 hours
assembling one of the company’s products and was idle 6 hours due to material
shortages. Bella’s employees are engaged at their workstations for a normal 40-hour
week. Ms. Angeles is paid P15 per hour. Allocate her earnings between direct labor
cost and manufacturing overhead cost.
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10. Suppose you are trying to decide whether to drive or take the train to Portland to
attend a concert. You have ample cash to do either, but you don’t want to waste money
needlessly. Is the cost of the train ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision of whether you drive or take the
train to Portland?
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Assessing Learning
Activity 5
Name: ______________________________________ Date: ___________________________
A. Direction: The following costs are incurred by an electrical appliance manufacturer.

Classify these costs as direct materials (DM), direct labor (DL), manufacturing overhead
(MOH), selling (SE) or administrative (AE). Write only DM, DL, MOH, SE or AE.
________ 1. President’s salary

________ 2. Cost of electrical wire used in making appliances
________ 3. Cost of janitorial supplies (the janitors work in the factory)
________ 4. Wages of assembly-line workers
________ 5. Cost of promotional displays
________ 6. Assembly-line supervisor’s salary
________ 7. Cost accountant’s salary (the accountant works in the factory)
________ 8. Cost of cleaner used to clean appliances when they are completed.
________ 9. Cost of aluminum used for toasters
________ 10. Cost of market research survey
B. Direction: UV Block, Inc., is considering a new sunscreen packet that contains a skin wipe
with sunscreen on it. These would be particularly useful for people who do not want to
carry a bottle of sunscreen, according to its marketing manager. Classify the following
costs of this new product as product cost or period cost. Write product or period on the
space provided before the number.
________ 1. Sales manager’s salary

________ 2. Packages used to hold the skin wipes
________ 3. Cleaning materials used to clean the skin wipe packages
________ 4. Wages of workers who package the product
________ 5. Cost of advertising the product.
________ 6. The salary of the supervisor of the workers who package the product
________ 7. Cost accountant’s salary (the accountant works in the factory)
________ 8. Cost of a market research survey
________ 9. Sales commissions paid as a percent of sales
________ 10. Depreciation of administrative office building

Assessing Learning
Activity 6
Name: ______________________________________ Date: ___________________________
A. Direction: The following are terms used to describe various economic characteristics of
costs. Choose one to characterize each of the amounts described below.
Opportunity cost Differential Cost

Out-of-pocket cost Marginal Cost
Sunk Cost Average Cost
_________________________ 1. The cost of including one extra child in a day-care center

_________________________ 2. The cost of merchandise inventory purchased two years ago,
which is now obsolete
_________________________ 3. The cost of feeding 500 children in a public school cafeteria is
P800 per day, or P1.60 per child per day. What economic term
describes this P 1.60 cost?
_________________________ 4. The management of a high-rise office building uses 2,500 square
feet of space in the building for its own management functions.
This space could be rented for P 250,000. What economic term
describes this P 250,000 in lost rental revenue?
_________________________ 5. The cost of building an automated assembly line in a factory is P
800,000. The cost of building a manually operated assembly line
is P 375,000. What economic term is used to describe the
difference between these two amounts?
_________________________ 6. Referring to the preceding question, what economic term is used
to describe the P 800,000 cost of building the automated assembly
line?
B. Direction: For each of the following costs incurred in a manufacturing operation, indicate
whether the costs would be fixed or variable. Write F or V only.
____ 1. Freight-in costs on materials purchased

____ 2. Assembly-line worker’s wages
____ 3. Property taxes on work in process inventories
____ 4. Salaries of top executives in the company
____ 5. Overtime premium for assembly workers
____ 6. Sales commissions
____ 7. Depreciation on furniture for sales staff
____ 8. Packaging materials for finished products
____ 9. Power to operate factory equipment

Assessing Learning
Activity 7
Name: ______________________________________ Date: ___________________________
For the month of October, Tablea Corporation had the following information:
Inventories October 1 October 31

Materials P 48,000 P 40,000
Work in Process 24,000 16,000
Finished Goods 72,000 80,000
Materials purchased P 112,000
Direct Labor (at a uniform rate of P 6.40 per hour) 80,000
Marketing and administrative expenses 10% of sales
Sales P 400,000
Direction: You are required to compute the following items listed below. Show your
computations.
1. Prime Cost
2. Conversion Cost
3. Total Manufacturing cost
4. Cost of goods manufactured
5. Cost of Goods Sold
6. Period Costs
7. Gross Profit
8. Net Income

Assessing Learning
Activity 8
Name: ______________________________________ Date: ___________________________
Tiktok Pamore Corporation asked your assistance in the preparation of its financial
statements for the year ended December 31, 2019. The following facts were disclosed:
Selling expenses P 70,000

Raw materials inventory, January 1 45,000
Raw materials inventory, December 31 30,000
Work in Process inventory, January 1 90,000
Work in Process inventory, December 31 50,000
Finished Goods Inventory, January 1 130,000
Finished Goods Inventory, December 31 105,000
Factory utilities 18,000
Direct Labor Cost 75,000
Depreciation – factory 81,000
Purchase of raw materials 375,000
Sales 1,250,000
Insurance – factory 20,000
Supplies – factory 7,500
Administrative expenses 135,000
Indirect labor 150,000
Maintenance – factory 43,500
Requirements:
1. Prepare a statement of cost of goods sold in good form.

2. Prepare an income statement in good form.

UNIT III: COST BEHAVIOR AND COST-VOLUME-PROFIT ANALYSIS
Overview
Managers are constantly faced with decisions about selling prices, variable costs
and fixed costs. To be able to choose from among alternative actions, it is necessary
to have a good estimate of the probable costs that would result from each choice.
Furthermore, management needs to know the cost that are likely to be incurred under
normal operating conditions and how they might vary if conditions change. This unit
will discuss how costs behave after a change in level of activity, the relationship of
cost and level of production to generate target profit and compute the break-even to
avoid losses.
Learning Objectives_
At the end of the unit, I am able to:
1. define cost behavior, relevant range, contribution margin, contribution margin
ratio, break-even point, margin of safety and operating leverage;
2. identify the cost behavioral patterns;
3. discuss the cost volume profit analysis;
4. explain how changes in volume affect contribution margin;
5. analyze the relationship between product cost and volumes and how they will
affect the overall plan/budget of a given company;
6. compute the contribution margin, break-even point in units and in pesos;
7. calculate margin of safety and the level of sales necessary to achieve a targeted
income or profit; and
8. make business decisions using cost-volume-profit analysis.
Lesson Proper
Cost Behavior
According to Cabrera (2017), cost behavior means how a cost will react as changes take
place in the level of business activity. Managers who understand how cost behave are better
able to predict what costs will be under various operating circumstances. An understanding
of cost behavior under varying conditions is essential to adequate decision making in the
planning and control of firm activity.
UNIT III: COST BEHAVIOR AND COST-VOLUME-PROFIT ANALYSIS 40

Unit Ii: Basic Cost Management Concepts: Learning Objectives

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P R O F 3 – M A N A G E R I A L A C C O U N TI N G

UNIT II: BASIC COST MANAGEMENT CONCEPTS

Merchandiser and Manufacturer Accounting: Differences in Cost Concepts

Perhaps the most important accounting difference between merchandisers and

UNIT II: BASIC COST MANAGEMENT CONCEPTS 16

Figure 2.1 Comparing Merchandisers and Manufacturers

Nature of Costs, Cost Pools, Cost Objects and Cost Drivers

UNIT II: BASIC COST MANAGEMENT CONCEPTS 17

Classification of Costs According to their Purposes

Manufacturing vs. Nonmanufacturing Costs

UNIT II: BASIC COST MANAGEMENT CONCEPTS 18

Figure 2.2 Cost Classifications

UNIT II: BASIC COST MANAGEMENT CONCEPTS 19

Figure 2.3 Manufacturing Costs

In a manufacturing company, overhead is generally called manufacturing overhead.

UNIT II: BASIC COST MANAGEMENT CONCEPTS 20

Table 2. Examples of Manufacturing Overhead Costs

Indirect Materials Indirect Labor Others

Product Costs vs Period Expenses

UNIT II: BASIC COST MANAGEMENT CONCEPTS 21

Figure 2.4 Product vs. Period Costs

Cost Classifications Used for Planning and Control

1. Fixed vs. Variable Costs

Behavior of Cost (within the relevant range)

Figure 2.5 Classification of Cost as to Behavior

UNIT II: BASIC COST MANAGEMENT CONCEPTS 22

Source: The McGraw-Hill Companies, Inc., 2003

Figure 2.6 Product Cost Flow

UNIT II: BASIC COST MANAGEMENT CONCEPTS 23

Source: The McGraw-Hill Companies, Inc., 2003

Figure 2.7 Change in Total Cost as the Activity Level Changes

Source: The McGraw-Hill Companies, Inc., 2003

2. Direct vs Indirect Costs

A direct cost is an amount that can be traced to a specific department, process or

UNIT II: BASIC COST MANAGEMENT CONCEPTS 24

3. Controllable vs Non-controllable Costs

When evaluating the performance of an executive or manager under managerial

4. Differential Costs including Sunk and Opportunity Costs

Differential costs represent the difference between two alternatives. We will

Differential revenue = P 2,000 – P 1,500 = P 500

UNIT II: BASIC COST MANAGEMENT CONCEPTS 25

Characteristics of Managerial Accounting Reports

You compare a manufacturer’s cost of goods sold section of the Statement of

Unlike a merchandiser’s statement of financial position (commonly known as the balance

Figure 2.9 Income Statements of Merchandising and Manufacturing Company

UNIT II: BASIC COST MANAGEMENT CONCEPTS 26

Source: The McGraw-Hill Companies, Inc., 2003

Figure 2.10 Balance Sheets of Merchandising and Manufacturing Company

Source: The McGraw-Hill Companies, Inc., 2003

Figure 2.11 Product and Period Cost Flows

UNIT II: BASIC COST MANAGEMENT CONCEPTS 27

The Statement of Cost of Goods Manufactured

Raw materials Inventory, January 1 P 125,000

You are required to do the following:

UNIT II: BASIC COST MANAGEMENT CONCEPTS 28

2. Prepare Statement of Cost of Goods Manufactured

UNIT II: BASIC COST MANAGEMENT CONCEPTS 29

Raw materials used in production ₱ 210,000

Total Manufacturing Cost (TMC) ₱ 385,000

Cost of Goods Manufactured ₱ 355,000

UNIT II: BASIC COST MANAGEMENT CONCEPTS 30

ABC Manufacturing Company

Raw materials inventory, 1/1/2019 ₱ 125,000