Chapter Two

Cost determination: The costing of resource

inputs

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 1. Manufacturing costs
• Those costs associated with the manufacturing activities of the company.
There are three elements involved for the products produced by a
manufacturing concern.
• The three elements of products cost are
▫ Direct material costs
▫ Direct labour cost and
▫ Manufacturing overhead costs, which are indirect manufacturing costs.

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Commonly used classification of Manufacturing Costs

Direct Materials Direct Labors Factory Overhead

Prime Costs Conversion Costs

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 A) Direct Material Costs
• All manufactured products are made from basic direct materials. Direct materials are the
acquisition costs of materials that can be conveniently and economically traced to
specific unit of product.
• Acquisition cost of direct materials includes freight –in charges, sales taxes and customs
duties.
• Some examples of direct materials are iron ore for steel, sheet steel for automobiles, the
wood to make furniture.and sugar for candy.
• Direct materials are all materials that become an integral part of the finished product.

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A) Direct Material Costs

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 (b) Direct Labour Costs
• The manufacturing process includes all activities required to make a product, including
maintenance, handling, inspection, moving and storing.
• Direct labour costs are the costs of labour to complete production activities that can be
conveniently and economically traced to specific units of product.
• The wages of machine operators and other workers involved in actually shaping the
product are direct labour costs.
• Like a direct materials cost, a direct labor cost must be both of the following:
➢ An integral part of the finished product
➢A significant portion of the total cost of the product
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 (C) Manufacturing Overhead Costs
• The third elements of product cost include all manufacturing costs that cannot be
classified as direct materials or direct labour costs.
• Some of the examples include depreciation, rent, taxes, insurance, fringe benefits, payroll
taxes, and cost of idle time.
• This assortment of costs is also called factory overhead, or indirect manufacturing costs
and Factory burden.
• Two common components of manufacturing overhead costs are indirect material costs
and indirect labour costs.

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I) Indirect material
• Indirect material costs are the costs of materials that cannot be
conveniently or economically traced to a unit of product e.g. cost
of nails, reverts, lubricants and small tools.

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ii) Indirect labour Costs
• Indirect labour Costs are labour costs for production related
activities that cannot be conveniently or economically traced to a
unit of product. E.g. cost of labour for maintenance, inspection,
engineering design, supervision, materials handling and machine
handling.

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iii) Other indirect manufacturing costs
• Cost of building maintenance,
➢ machine and tool,
➢ maintenance,
➢ property taxes,
➢ property insurance,
➢ depreciation on plant and equipment, rent and utilities.
• As indirect costs, manufacturing overhead cost is allocated
to a products cost using traditional or activity based costing
methods.
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Marketing/Selling Costs Administrative Costs

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2. Nonmanufacturing Costs
• Generally, nonmanufacturing costs are sub classified
into two categories:
1. Marketing or selling costs.
2. Administrative costs.

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1. Marketing or Selling Costs: include all costs necessary to secure customer orders
and get the finished product or service into the hands of the customer.
▫ These costs are often called order-getting and order-filling costs. Examples include
advertising, shipping, sales travel, sales commissions, sales salaries, and costs of
finished goods warehouses.
2. Administrative Costs: include all executive, organizational, and clerical costs
associated with the general management of an organization rather than with
manufacturing, marketing, or selling.
▫ Examples include executive compensation, general accounting, secretarial, public
relations, and similar costs involved in the overall, general administration of the
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organization as a whole.
 Prime Cost and Conversion Costs
• Product costs of direct materials, direct labor, and manufacturing overhead are sometimes
grouped into prime cost and conversion cost:
▫ Prime cost is the sum of direct materials cost and direct labor cost.
Prime cost = Direct materials + Direct labor
▫ Conversion cost is the sum of direct labor cost and manufacturing overhead cost.
▫ Conversion cost = Direct labor + Manufacturing Overhead

Direct Materials Direct Labors Factory Overhead

Prime Costs Conversion Costs

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 Prime Cost and Conversion Costs

Required:
1. Calculate the total prime cost for last week.
2. Calculate the per-unit prime cost.
3. Calculate the total conversion cost for last week.
4. Calculate the per-unit conversion cost.
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Prime Cost and Conversion Costs

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 Financial Statements for Manufacturing Enterprises
• In the case of manufacturing organization, manufacturing costs are accumulated to
determine the cost of goods manufactured for completed goods and for partially
completed goods.
• The cost of goods manufactured can be divided into two portions – the sold portion
called cost of goods sold and the portion remaining is called finished goods inventory.
• The finished goods inventory of a manufacturing enterprise consists of the finished
products on hand that have not been sold.

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Cont.
• The cost of partially completed goods is an asset called work in process inventory. The
work in process inventory for a manufacturing enterprise consists of the direct
material costs, the direct labour costs and the factory overhead cost incurred but they
have not been finished.
• Since a manufacturing organization manufactures the product that it sells, the
manufacturing costs must be properly accounted for and reported in the financial
statements. These manufacturing costs primarily affect the balance sheet and income
statement, which are explained as follows.
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BIODM, January1 + PDM in year – EIODM, December 31 = DMU, in year
Step 1

Step 2 DMU, year + DMLU, year + MOH, year =TMC, year

Beginning work-in-process inventory, January 1,

+ Total manufacturing costs incurred in year
= Total manufacturing costs to account for
Step 3
– Ending work-in-process inventory, December 31,
= Cost of goods manufactured in year
Beginning inventory of finished goods, January 1,
+ Cost of goods manufactured in year
Step 4
– Ending inventory of finished goods, December 31
= Cost of goods sold in year 19
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 Recording of Costs and Schedule of Costs of Products.
Cost of Goods Sold Schedule and Income Statement
Example 1
• Direct materials:
Beginning raw materials inventory . . . . . . . . $ 60,000
Add: Purchases of raw materials . . . . . . . . . . . 400,000
Raw materials available for use . . . . . . . . . . . . 460,000
Deduct: Ending raw materials inventory . . . . 50,000
Raw materials used in production . . . . . . . . . $ 410,000
• Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000

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 • Manufacturing overhead:
Insurance, factory . . . . . . . . . . . . . . . . . . . . . . . . 6,000
Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
Machine rental . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Utilities, factory. . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000
Supplies factory. . . . . . . . . . . . . . . . . . . . . . . . . . . 21,000
Depreciation, factory . . . . . . . . . . . . . . . . . . . . . . 90,000
Property taxes, factory . . . . . . . . . . . . . . . . . . . . . 8,000
• Total overhead costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350,000
Total manufacturing costs:. . . . . . . . . . . . . . . . . . . . 820,000
Add: Beg work in process inventory . . . . . 90,000 910,000
Deduct: End WIP inventory . . . . . . . . . . . . 60,000
Cost of goods manufactured . . . . . . . . . . . . . . . . . . . . . $ 850,000
+ Beginning Finished Goods Inventory . . . . . . . . . . . . . . . . . 125,000
- Ending Finished Goods Inventory . . . . . . . . . . . . . . . . . . .175,000
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 800,000

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Illustration: Prepare Cost of Goods sold statement and Income statement
• The following information has been taken from the accounting records of AAA
Corporation for last year:
• Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . $ 140,000
• Raw materials inventory, January 1 . . . . . . . . . . . $ 90,000
• Raw materials inventory, December 31 . . . . . . . $ 60,000
• Purchases of raw materials . . . . . . . . . . . . . . . . . $ 750,000
• Utilities, factory . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 36,000
• Direct labor cost . . . . . . . . . . . . . . . . . . . . . . . . . . $ 150,000
• Depreciation, factory . . . . . . . . . . . . . . . . . . . . . . $ 162,000
• Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,500,000
• Insurance, factory . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40,000
• Supplies, factory . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,000

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• Administrative expenses . . . . . . . . . . . . . . . . . . . $ 270,000
• Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 300,000
• Maintenance, factory . . . . . . . . . . . . . . . . . . . . . . $ 87,000
• Work in process inventory, January 1 . . . . . . . . . $ 180,000
• Work in process inventory, December 31 . . . . . . .$ 100,000
• Finished goods inventory, January 1 . . . . . . . . . . $ 260,000
• Finished goods inventory, December 31. . . . . . . $ 210,000
Required:
1. Prepare a schedule of cost of goods manufactured.
2. Compute the cost of goods sold.
3. Prepare an income statement.

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 AAA Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials inventory, January 1 . . . . . . . . .. . . . . . .$ 90,000
Add: Purchases of raw materials . . . . . . . . .. . . . . . . . . 750,000
Raw materials available for use. . . . . . . . . .. .. . . . . . . . 840,000
Deduct: Raw materials inventory, December 31 . . . . . 60,000
Raw materials used in production . . . . . . . . . . . . . . . . $ 780,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... 150,000

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Utilities, factory . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 36,000
Depreciation, factory . . . . . . .. . . . . . . . . . . . . . . . . . 162,000
Insurance, factory . . . . . . . . . . . . . .. . . . . . . . . . . . . . 40,000
Supplies, factory . . . . . . . . . . . .. . . . . . . . . . . . . . . . . 15,000
Indirect labor . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . .300,000
Maintenance, factory . . . . . . . . . . . . . . .. . . . . . . . . . .87,000
Total manufacturing overhead cost . . . .. . . . . . . . . 640,000
Total manufacturing cost . . . . . . . . . . . . . . . . . . . . . 1,570,000
Add: Work in process inventory, January 1 . . . . . . . 180,000
Deduct: Work in process inventory, December 31 . . 100,000
Cost of goods manufactured . . . . . . . . . . . . . . . . . . . $ 1,650,000

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Finished goods inventory, January 1 . . . . . . . . . . . . . . $ 260,000
Add: Cost of goods manufactured . . . . . . . . . . . . . . . . 1,650,000
Goods available for sale . . . . . . . . . . . . . . . . . . . . . . . . . 1,910,000
Deduct: Finished goods inventory, December 31 . . . . 210,000
Cost of goods sold. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,700,000

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 AAA Corporation
Income Statement
For the Year Ended December 31
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,500,000
Cost of goods sold . . . .. . . . . . . . . . . . . . . . . . . . . . . . 1,700,000
Gross margin . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
Selling and administrative expenses:
Selling expenses . . . . . . . . . .. . . . . . . . . . . . . . . . . . . $ 140,000
Administrative expenses . . . . . . . .. .. . . . . . . . . . . . 270,000 410,000
Net operating income . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . $ 390,000

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Exercise: Use the following data and compute CGS for Grey company
Direct labor cost . . . . . . . . . . . . . . . . . . . . . . . . . . $70,000
Purchases of raw materials . . . . . . . . . . . . . . . . . $118,000
Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,000
Maintenance, factory equipment . . . . . . . . . . . . $6,000
Advertising expense . . . . . . . . . . . . . . . . . . . . . . . $90,000
Insurance, factory equipment . . . . . . . . . . . . . . . $800
Sales salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000
Rent, factory facilities . . . . . . . . . . . . . . . . . . . . . . $20,000
Supplies factory . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,200
Depreciation, office equipment . . . . . . . . . . . . . $3,000
Depreciation, factory equipment . . . . . . . . . . . . $19,000
Beginning of the Year End of the Year
Raw materials $ 7,000 $15,000
Work in process $10,000 $5,000
Finished goods $20,000 $35,000
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Solution
Grey Company
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning.................. $ 7,000
Add: Purchases of raw materials ...................... 118,000
Raw materials available for use........................ 125,000
Deduct: Raw materials inventory, ending.......... 15,000
Raw materials used in production..................... $110,000
Direct labor............................................................. 70,000

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Manufacturing overhead:
Indirect labor ....................................................... 30,000
Maintenance, factory equipment ...................... 6,000
Insurance, factory equipment ........................... 800
Rent, factory facilities.......................................... 20,000
Supplies factory ................................................... 4,200
Depreciation, factory equipment ...................... 19,000
Total overhead costs ........................................... 80,000
Total manufacturing costs.................................. 260,000
Add: Work in process, beginning ..................... 10,000
Deduct: Work in process, ending....................... 5,000
Cost of goods manufactured .............................. $265,000

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Cost of goods manufactured .............................. $265,000
+ Finished goods inventory, beginning ............. $ 20,000
Goods available for sale........................................285,000
Deduct: Finished goods inventory, ending ........ 35,000
Cost of goods sold.................................................. $250,000

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END
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