Cost Classification & Statements

Contents
2.1 Introduction
2.2 Definition of Cost
2.3 Cost – Asset – Expense Interrelationship
2.4 Classification of Costs
2.5 Cost Sheet
2.6 Illustrations
Illustration – 1
Illustration – 2: Meriwell Company
Illustration – 3: Swift Company
Illustration – 4: Superior Company
Illustration – 5: Visic Corporation
Illustration – 6: Richman Décor Limited
Illustration – 7: Tampa Office Equipment
2.7 Exercise
2.8 Case

2.1 Introduction
Cost is a customary term that we like to use in our day to day life. But, in business, cost has very
specific meaning and its scope is very much wide. To start a fresh business, we need costs and even
to close it we have to incur costs. And, within the life span of the business, costs take different
patterns. In this chapter, costs have been defined from business perspective with a detailed
classification of costs under different circumstances.

2.2 Definition of Cost

Defining cost is an art as the definition bases on lot of apparatus. Cost may be defined in a very
simple way as ‘spending’ and in a complex way as ‘sacrificing’. But the scope for defining cost is
very much open and one has enough room of defining it. To make the definition in right tune with
the objective of the course and the necessity of the target group (students), I have identified the
following definition of costs.

“Cost is the current sacrifice in terms of money, time, effort, wealth or anything that
holds value to its owner for getting benefits in monetary term in future.”

Cost is defined as the “value” of the sacrifice made to acquire goods or services, measured in
dollars by the reduction of assets or incurrence of liabilities at the time the benefits are acquired
(Polimeni et. al, 1991).

2.3 Cost – Asset – Expense Interrelationship:

Costs, expenses and assets have special meaning in business. Costs and expenses are sometimes
used to mean the same thing erroneously. But, they are not same. Costs become expense when the
benefits are consumed for which the expenditure is made. It may be through the acquisition of
assets or may be expensed directly. The utilized portion of the asset (depreciation) is referred to as
 Cost Classifications and Statements

expense whereas the unutilized portions of the costs that can give future benefits are classified as
assets.

Assets Benefits yet to be received

Costs Expenses Benefits already received

Losses Benefits neither received nor to be received

2.4 Classification of Costs

In accounting, the term cost is used in many different ways. The reason is that there are many types
of costs, and these costs are classified differently according to the immediate needs of management.
For example, managers may want cost data to prepare external financial reports, to prepare
planning budgets, or to make decisions. Each different use of cost data demands a different
classification and definition of costs. For example, the preparation of external financial reports
requires the use of historical cost data, whereas decision making may require predictions about
future costs.
Cost is classified into different heads with reference to the basis of classification. It depends on the
user who uses cost for taking decisions. The major classifications of costs are discussed here that
are very much relevant to the course. Look at the following chart to identify basic cost
classifications, followed by a discussion thereon.

COSTS

1 2 3

Functional/General Cost Classification on the Behavioral

Classification basis of Reporting Classification
1. Manufacturing Costs
 Direct Material 1. Product Costs
1. Variable Costs
 Direct Labor 2. Period Costs
2. Fixed Costs
 Factory Overhead 3. Out of Pocket Costs
3. Semi Variable Costs
2. Non Manufacturing Costs 4. Historical Costs
 Selling and Marketing
 Office and Administrative

4 5 6

Classification on the basis of Classification on the Classification for

Control basis of Traceability Decision Making
1. Differential Costs
1. Controllable Costs
1. Direct Costs 2. Opportunity Costs
2. Uncontrollable Costs
2. Indirect Costs 3. Sunk Costs
4. Relevant Costs

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1. General / Functional classifications:

On the basis of this classification cost can be classified as follows:

Direct Material Prime

Costs
Direct Labor
Manufacturing Costs
Conversion
Manufacturing
Costs
Overhead
Costs
Selling or
Marketing Costs
Non-manufacturing
Costs Administrative
Costs

1.1. Manufacturing costs: These are related to the production of an item. These are the sum of
direct materials, direct labor and factory overhead.
(a) Direct materials: Those materials that become an integral part of the finished product and
that can be physically and conveniently traced to it.
(b) Direct labor: Those labor costs that can be physically and conveniently traced to individual
units of product.

(c) Factory overhead: Includes all cost of manufacturing except direct material and direct
labor. Such as, indirect labor, indirect material, factory rent etc.
1.2. Non-manufacturing costs: These include all expenditures incurred in formulating the plans,
directing the organization and controlling the operations.
(a) Selling costs: Include all costs necessary to secure customer orders and get the finished
product or service into the hands of the customer. Such as, advertising, salaries &
commission of Sales men, store expenses etc
(b) Administrative costs: Include all executive, organizational and clerical costs associated
with the general management of an organization rather than with manufacturing, marketing
or selling. Such as, office rent, postage, legal expenses, audit fees, directors remuneration
etc.
1.3. Prime cost: Prime cost consists of direct materials plus direct labor.
1.4. Conversion cost: Conversion cost consists of direct labor plus manufacturing overhead.

2. Classification on the basis of Reporting:

2.1.Product costs: It includes all the costs that are involved in acquiring or making a product.
Product costs are added to units of product (i.e., “inventoried”) as they are incurred and are not
treated as expenses until the units are sold. This can result in a delay of one or more periods
between the time in which the cost is incurred and when it appears as an expense on the income
statement. In the case of manufactured goods, these costs consist of direct materials, direct labor
and manufacturing overhead. Since product costs are initially assigned to inventories, they are
also known as inventoriable costs.

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 Cost Classifications and Statements

2.2.Period costs: These are not directly related to the product and therefore, not inventoriated.
These costs are expensed on the income statement in the period in which they are incurred. In
this regard, all selling and administrative expenses are considered to be period costs.
2.3.Out-of-pocket costs: those costs that represent cash outflow during the current period.
2.4.Historical costs: the original cost of acquiring a product or service.

3. Behavioral classification:
Generally as per behavior cost is classified into Variable, Fixed and semi-variable / Mixed cost.
They are briefly discussed below:
3.1.Variable costs: A variable cost is a cost that varies, in total, in direct proportion to changes in
the level of activity. In other words when volume of output increases total variable cost also
increases and vice versa. But the variable cost per unit remains fixed. Ex. Direct material cost,
direct wages, Power etc.
3.2.Fixed costs: A fixed cost is a cost that remains constant, in total, regardless of changes in the
level of activity. These costs remain fixed in total and do not increase or decrease when the
volume of production increases or decreases. Ex; Rent, Managerial salaries etc.
3.3.Semi-variable / mixed costs: They are neither wholly variable nor wholly fixed in nature. They
have the characteristics of both fixed and variable costs. The fixed part of semi-variable costs
represents a minimum fee for making a particular item or service available. Ex. In case of
telephone expenses, there is a minimum rent and after a specified number of calls, charges are
according o the number of additional calls made. Thus telephone costs are semi variable /
mixed.

4. Classification on the basis of responsibility / control:

4.1.Controllable costs: Costs are said to be controllable when the amount of the cost incurred can
be influenced by the action of a specified member (manager or supervisor) of the undertaking.
Variable costs are generally controllable by departmental heads. Examples; Cost of raw
materials may be controlled by purchasing in large quantities.
4.2.Uncontrollable costs: Costs which cannot be influenced by the action of a specified member
(manager or supervisor) of an undertaking are known as uncontrollable costs. Fixed costs are
generally uncontrollable. Examples; It is very difficult to control cost like factory, rent,
managerial salary etc.

5. Classification on the basis of traceability / identifiability:

5.1.Direct cost: A direct cost is a cost that can be easily and conveniently traced to the particular
cost object under consideration. E.g. direct labor
5.2.Indirect cost: An indirect cost is a cost that cannot be easily and conveniently traced to the
particular cost object under consideration. E.g supplies expense.

6. Classifications for decision making:

6.1.Differential cost: A different in cost between two alternatives is differential cost. If a decision
results in an increased cost, the differential cost may be called incremental cost. If the cost is
decreased, the differential cost may be referred to as a decremental cost.
6.2.Opportunity cost: The sacrifice of a return or benefit from a rejected alternative is known as
the opportunity cost of the alternative accepted.
6.3.Sunk cost: A sunk cost is a cost that has already been incurred and that cannot be changed by
any decision made now or in the future.
6.4.Relevant costs: These are those future costs that differ across alternative courses of action.

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 Cost Classifications and Statements

Cost formulas / algorithms:

Prime Cost = Direct Material + Direct Labor

Conversion Cost = Direct Labor + Factory Overheads
Total Overhead = Factory Overhead + Administrative Overheads + Marketing (S & D) Overhead.

Equations to explain cost behavior:

Variable Costs : Y = bX
Fixed Costs :Y=a
Mixed Costs : Y = a + bX; where
Y = Costs (dependant variable)
b = Variable Costs per Unit (slope)
a = Fixed cost (Constant)
X = number of units (independent variable)

2.5 Cost Sheet:

A cost sheet is a statement showing the detail of various elements of cost in the manufacture of a
product. It is defined as a document, which provides for the assembly of the detailed cost of a cost
center or cost unit. A cost sheet provides the split up of cost as prime cost, total manufacturing cost,
cost of goods manufactured cost of goods sold etc. A cost sheet will reveal the cost per unit and
well as total cost. A cost sheet consists of following statements:
1. Schedule of cost of goods manufactured
2. Schedule of cost of goods sold
3. Income statement

Format of Schedule of cost of goods manufactured: The cost of goods manufactured schedule is
used to calculate the cost of producing products for a period of time.

Schedule of Cost of Goods Manufactured

Direct materials consumed:
Beginning raw materials inventory ***
Add: Purchases of raw materials ***
Raw materials available for use ***
Deduct: Ending raw materials inventory ***
Raw materials used in production *** DM
Direct labor *** DL
Prime Cost *** PC
Manufacturing overhead:
Indirect materials ***
Indirect labor ***
Utilities, factory ***
Property taxes, factory ***
Insurance, factory ***
Equipment rental ***
Depreciation, factory ***
Total overhead costs *** MOH
Total manufacturing costs *** TMC
Add: Beginning work in process inventory ***

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 Cost Classifications and Statements

***
Deduct: Ending work in process inventory ***
Cost of goods manufactured *** COGM

Schedule of Cost of Goods Sold:

Schedule of Cost of Goods Sold
Beginning finished goods inventory ***
Add: Cost of goods manufactured ***
Goods available for sale ***
Deduct: Ending finished goods inventory ***
Cost of goods sold ***

Income Statement:
Income Statement
Particulars Amoun Amou Amount
Sales t ($) nt ($) ($)***
Less: Cost of Goods Sold ***
Gross Profit ***
Less: Operating Expenses
Marketing / Selling Overhead:
Delivery expenses ***
Sales Persons Salary ***
Advertisement ***
Promotional Expenses ***
Guarantee and Warrantee ***
Total Marketing Overhead ***
Administrative Overhead
Salary ***
Rent ***
Depreciation ***
Taxes ***
Interest ***
Total Admin Overhead ***
Total Operating/Commercial Expenses ***
Net Profit ***

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 Cost Classifications and Statements

Illustration – 1: Fill up the circle under each of the following categories for the given example of
cost items:

Product Period Direct Indirect

Costs VC FC
Cost Cost Cost Cost
1. Direct labor
($1,00,000 per year)
2. Depreciation of factory
machine
($80,000 per year)
3. Indirect material
($10 per unit)
4. Utility costs in office
($1.20 per hour)
5. Salary of Office Manager
($25,000 per year)

Illustration – 2:
Various cost and sale data for Meriwell Company for the just completed year are presented below:

Items Amount ($)

Finished Goods Inventory, Beginning…… 20,000
Finished Goods Inventory, Ending………. 40,000
Depreciation, factory……………………… 27,000
Administrative expenses…………………... 110,000
Utilities, factory…………………………… 8,000
Maintenance, factory……………………… 40,000
Supplies, factory…………………………… 11,000
Insurance, factory…………………………. 4,000
Purchase of raw materials……………......... 125,000
Raw Materials Inventory, Beginning……… 9,000
Raw Materials Inventory, Ending……......... 6,000
Direct labor………………………………… 70,000
Indirect labor……….……………………… 15,000
Work In Process Inventory, Beginning …… 17,000
Work In Process Inventory, Ending…......... 30,000
Sales……………………………………….. 500,000
Selling expense…………………………..... 80,000

Required
1. Prepare a Schedule of Cost of Goods manufactured.
2. Prepare an income statement.
3. Assume that the company produced the equivalent of 10,000 units of product during the year
just completed. Compute the average cost per unit for direct materials and the average cost per
unit for factory depreciation.
4. Assume that the following year the company expects to produce 15,000 units. What average
cost per unit and total cost would you expect to be incurred for direct materials? For rent factory
depreciation? (Assume that direct material is a variable cost and the rent is a fixed cost.)
5. As the manager in charge of production costs, explain to the president the reason for any
difference in average cost per unit between (3) and (4) above.

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Solution – 2:
Requirement – 1:

Meriwell Company
Schedule of Cost of Goods Manufactured
For the year ended on ………
Particulars $ $
Raw materials consumed:
Beginning inventory 9,000
Add: Raw materials purchase 125,000
Raw materials available for use 134,000
Less: Ending inventory 6,000
Raw materials used in the production 128,000
Direct labor 70,000
Prime Cost 198,000
Manufacturing overhead:
Depreciation, factory 27,000
Utilities, factory 8,000
Maintenance, factory 40,000
Supplies, factory 11,000
Insurance, factory 4,000
Indirect labor 15,000
Total manufacturing overhead 105,000
Total manufacturing cost 303,000
Add: Beginning inventory of WIP 17,000
320,000
Less: Ending inventory of WIP 30,000
Cost of Goods Manufactured 290,000

Requirement – 2:
Meriwell Company
Income Statement
For the year ended on ………
Particulars $ $
Sales 500,000
Less: Cost of Goods Sold
Beginning inventory of Finished Goods 20,000
Add: Cost of Goods Manufactured 290,000
Cost of goods available for sale 310,000
Less: Ending inventory of Finished Goods 40,000
Cost of Goods Sold 270,000
Gross profit/margin 230,000
Less: Operating expenses
Selling expenses 80,000
Administrative expenses 110,000
Total operating expense 190,000
Net income 40,000

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 Cost Classifications and Statements

Requirement – 3:
Direct materials : $128,000 ÷ 10,000 = $12.8 per unit
Factory Depreciation : $27,000 ÷ 10,000 = $2.7 per unit

Requirement – 4:
At the production level of 15,000 units
Direct materials : Unit cost = $12.8 (unchanged)
: Total: 15,000 units × $12.8 = $192,000
Factory depreciation : Total = $27,000 (unchanged)
: Unit cost: $27,000 ÷ 15,000 = $1.8 per unit
Requirement – 5:
Per unit cost for depreciation dropped from $2.7 to $1.8, since there is an increase in the level of
production. Since fixed cost do not change in total as activity level changes, they will decrease on a
unit basis as the activity level increases.

Illustration – 3:
Swift Company was organized on March 1 of the current year. After 5 months of start up losses,
management had expected to earn a profit during August. Management has disappointed, however,
when the income statement for August also showed a loss. August’s income statement follows:
Swift Company
Income Statement
For the Month Ended August 31
Sales $ 450,000
Less: Operating expenses
Indirect labor cost $ 12,000
Utilities 15,000
Direct labor cost 70,000
Depreciation, factory equipment 21,000
Raw materials purchased 165,000
Depreciation, sales equipment 18,000
Insurance 4,000
Rent on facilities 50,000
Selling and administrative salaries 32,000
Advertising 75,000
Total operating expenses 462,000
Net operating loss $ (12,000)
After seeing the $12,000 loss for August, Swifts president was disappointed and took the decision
to dispose the company off. The company’s Chief Accountant has resigned a month ago, and the
income statement above was prepared by a new executive considering the following additional
information:
1. Some 60% of the utilities cost and 75% of the insurance apply to factory operations. The
remaining amounts apply to selling and administrative activities.
2. Inventory balances at the beginning and end of August were:
Inventories Beginning Inventory Ending Inventory
Raw materials $8,000 $13,000
Work in process $16,000 $21,000
Finished goods $40,000 $60,000
3. Only 80% of the rent on facilities applies to factory operations; the remainder applies to selling
and administrative activities.

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 Cost Classifications and Statements

The president has asked you to check over the income statement and make a recommendation as to
whether the company should look for a buyer for its assets.

Required:
1. As one step in gathering data for a recommendation to the president, prepare a Schedule of Cost
of Goods manufactured for August.
2. As a second step, prepare a new income statement for August.
3. Based on your statements prepared in (1) and (2) above, would you recommend that the
company should look for a buyer?

Solution – 3:
Requirement – 1:
Swift Company
Schedule of Cost of Goods Manufactured
For the year ended on August 31,………
Particulars $ $
Raw materials consumed:
Beginning inventory 8,000
Add: Raw materials purchase 165,000
Raw materials available for use 173,000
Less: Ending inventory 13,000
Raw materials used in the production 160,000
Direct labor 70,000
Prime Cost 230,000
Manufacturing overhead:
Indirect labor 12,000
Utilities, factory ($15,000 × 60%) 9,000
Depreciation, factory 21,000
Insurance, factory ($4,000 × 75%) 3,000
Rent on facilities, factory ($50,000 × 80%) 40,000 85,000
Total manufacturing cost 315,000
Add: Beginning inventory of WIP 16,000
331,000
Less: Ending inventory of WIP 21,000
Cost of Goods Manufactured 310,000

Requirement – 2:
Swift Company
Income Statement
For the year ended on August 31………
Particulars $ $
Sales 450,000
Less: Cost of Goods Sold:
Beginning inventory of Finished Goods 40,000
Add: Cost of Goods Manufactured 310,000
Cost of goods available for sale 350,000
Less: Ending inventory of Finished Goods 60,000 290,000
Gross profit/margin 160,000
Less: Selling and Administrative expenses:
Utilities ($15,000 × 40%) 6,000
Depreciation, sales equipment 18,000

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 Cost Classifications and Statements

Insurance ($4,000 × 25%) 1,000

Rent on facilities ($50,000 × 20%) 10,000
Selling and Administrative salaries 32,000
Advertising 75,000
Total selling and administrative expenses 142,000
Net income 18,000

Requirement – 3:
No, since the correct format of income statement is indicating that the company is profitable.

Illustration – 4:
Selected account balances for the year ended December 31 are provided below for Superior
Company:

Items Amount ($)

Salesmen’s and administrative salary........ $110,000
Insurance, factory………………….......... $8,000
Utilities, factory…………………………. $45,000
Purchase of raw materials……………….. $290,000
Indirect material………………………… $40,000
Indirect labor…………………………….. $20,000
Direct labor………………………………. ?
Advertising expense…………………….. $80,000
Cleaning supplies, factory……………..... $7,000
Sales commissions………………………. $50,000
Rent, factory building………………….... $120,000
Maintenance, factory……………………. $30,000

Inventories at the beginning and end of the year were as follows:

Beginning Ending
Inventories
Inventory Inventory
Raw materials $40,000 $10,000
Work in process ? $35,000
Finished goods $50,000 ?

The total manufacturing costs for the year were $683,000; the cost of goods available for sale
totaled $740,000; and the cost of goods sold totaled $660,000.

Required:
1. Prepare a Schedule of Cost of Goods manufactured and the cost of goods sold section of the
company’s income statement of the year.
2. Assume that the dollar amounts given above are for the equivalent of 40,000 units produced
during the year. Compute the average cost per unit for direct materials used and the average
cost per unit for rent on the factory building.
3. Assume that the following year the company expects to produce 50,000 units. What average
cost per unit and total cost would you expect to be incurred for direct materials? For rent on the
factory building? (Assume that direct material is a variable cost and the rent is a fixed cost.)
4. As the manager in charge of production costs, explain to the president the reason for any
difference in average cost per unit between (b) and (c) above.

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Solution – 4:
Requirement – 1:
Superior Company
Schedule of Cost of Goods Manufactured
For the year ended on December 31………
Particulars $ $
Raw materials consumed:
Beginning inventory 40,000
Add: Raw materials purchase 290,000
Raw materials available for use 330,000
Less: Ending inventory 10,000
Raw materials used in the production 320,000
Direct labor 93,000
Prime Cost 413,000
Manufacturing overhead:
Insurance, factory 8,000
Utilities, factory 45,000
Indirect material 40,000
Indirect labor 20,000
Cleaning supplies, factory 7,000
Rent, factory 120,000
Maintenance, factory 30,000 270,000
Total manufacturing cost 683,000
Add: Beginning inventory of WIP 42,000
725,000
Less: Ending inventory of WIP 35,000
Cost of Goods Manufactured 690,000

Requirement – 2:

Particulars $
Cost of Goods Sold:
Beginning inventory of Fin. Goods 50,000
Add: Cost of Goods Manufactured 690,000
Cost of goods available for sale 740,000
Less: Ending inventory of Fin. Goods 80,000
Cost of Goods Sold 660,000

Requirement – 3:
Direct materials: $320,000 ÷ 40,000 = $8.0 per unit
Factory Rent: $120,000 ÷ 40,000 = $3.0 per unit

Requirement – 4: Requirement – 5:
At the production level of 50,000 units Per unit cost for rent dropped from $3.0
Direct materials: to $2.4, since there is an increase in the
Unit cost: $8.0 (unchanged) level of production. Since fixed cost do
Total: 50,000 units × $8.0 = $400,000 not change in total as activity level
Factory rent: changes, they will decrease on a unit
Total: $120,000 (unchanged) basis as the activity level increases.
Unit cost: $120,000 ÷ 50,000 = $2.4 per unit

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 Cost Classifications and Statements

Illustration – 5:
Visic Corporation, a manufacturing firm, produces a single product. The following information has
been taken from the company’s production, sales, and cost records for the just completed year
2009:

Inventories at the beginning and end of the year were as follows:

Beginning Ending
Inventory Inventory
Raw materials $20,000 $30,000
Work in process 50,000 40,000
Finished goods 0 ?

Other cost data are as follows:

Items Amount ($)
Advertising 105,000
Entertainment and travel 40,000
Direct labor 90,000
Indirect labor 85,000
Raw material purchased 480,000
Building rent (production uses 80% of the space and the rest of the 40,000
space is used by administrative and sales offices)
Utilities, factory 108,000
Royalty paid for use of production patent 1.50 per unit produced
Maintenance, factory 9,000
Rent for special production equipment 7,000 per year plus 0.30
per unit produced
Selling and administrative salaries 210,000
Other factory overhead costs 6,800
Other selling and administrative expense 17,000

Other data:
Number of units produced 29,000
Sales in units ?
Ending finished goods inventory in units ?
Sales for the year (in $) 1,300,000
Selling price per unit (in $) 50

The finished goods inventory is being carried at the average unit production cost of the year.

Required:
1. Prepare a Schedule of Cost of Goods manufactured for the year.
2. Compute the following:
(a) The number of units in the finished goods inventory at the end of the year.
(b) The cost of the units in the finished goods inventory at the end of the year.
3. Prepare an Income Statement for the year.

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Solution – 5:
Requirement – 1:
Visic Corporation
Schedule of Cost of Goods Manufactured
For the year ended on,………

Particulars $ $
Raw materials consumed:
Beginning inventory 20,000
Add: Raw materials purchase 480,000
Raw materials available for use 500,000
Less: Ending inventory 30,000
Raw materials used in the production 470,000
Direct labor 90,000
Prime Cost 560,000
Manufacturing overhead:
Indirect labor 85,000
Building rent, factory ($40,000 × 80%) 32,000
Utilities, factory 108,000
Royalty (29,000 units × $1.50) 43,500
Maintenance, factory 9,000
Special Rent [$7,000 + (29,000 × $0.30)] 15,700
Other factory overhead costs 6,800
Total manufacturing overhead 300,000
Total manufacturing cost 860,000
Add: Beginning inventory of WIP 50,000
910,000
Less: Ending inventory of WIP 40,000
Cost of Goods Manufactured 870,000

Requirement – 2 (a):
Sales in units = $1,300,000 / $50
= 26,000 units
Beginning inventory + Production – Ending inventory = Sales
 0 + 29,000 - Ending inventory = 26,000
 Ending inventory = 3,000 units

Requirement – 2(b):
Per unit product cost = Cost of goods manufactured / No. of units produced
= $870,000 / 29,000
= $30 per unit
Cost of Ending Finished Goods Inventory = 3,000 units × $30
= $90,000

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Requirement – 3:
Visic Corporation
Income Statement
For the year ended on ………
Particulars $ $
Sales 1,300,000
Less: Cost of Goods Sold
Beginning inventory of Finished Goods 0
Add: Cost of Goods Manufactured 870,000
Cost of goods available for sale 870,000
Less: Ending inventory of Finished Goods 90,000 780,000
Gross profit/margin 520,000
Less: Selling and Administrative expenses
Advertising 105,000
Entertainment and travel 40,000
Building rent ($40,000 × 20%) 8,000
Selling and Administrative salaries 210,000
Other Selling and Administrative expenses 17,000
Total selling and administrative expenses 380,000
Net income 140,000

Illustration – 6:
Richman Décor Limited, a manufacturing firm, produces a single product. The following
information has been taken from the company’s production, sales and cost records for the just
completed month, September.

Units produced 6,000

Units sold ?
Ending finished goods inventory ?
Sales revenue $180,000

Cost data:
Variable costs:
Purchase of raw materials $70,000
Direct labor 54,000
Indirect material 3,000
Sales commission 9,000
Utility (40% selling and administrative) 7,000

Fixed Costs:
Depreciation, factory $18,000
Rent, office 5,000
Office Staff’s Salary 12,000
Entertainment 3,000
Advertisement 8,500
Mixed Costs:
Maintenance $1,500 per month plus $1.25 per unit produced
Royalty $2,000 per month plus $2.00 per unit produced
Shipping Expense $500 per month plus $3.00 per unit sold

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 Cost Classifications and Statements

Inventories:
Beginning Inventory Ending Inventory
Raw material $3,500 $4,100
Work in process ? 2,750
Finished goods 0 ?

Other data:
(a) Cost of goods manufactured for the month is $174,000.
(b) Selling price per unit $45.
(c) Entire entertainment expense is for selling and administrative purposes.
(d) The finished goods inventory is being carried at the average unit production cost for the month.

Requirements:
1. Find out the number of units sold during the month and also number of units as ending
inventory for finished goods.
2. Prepare a schedule for cost of goods manufactured for the month.
3. Prepare an income statement for the month of September.

Solution – 6:
Richman Decore Limited
Cost of Goods Manufactured Statement
For the month ended September, 200X
Particulars $ $
Direct Material Consumed:
Opening Inventory of Raw materials 3,500
(+) Purchase 70,000
Raw materials available for use 73,500
(-) Ending inventory of raw materials 4,100
Raw Materials consumed 69,400
Direct Labor 54,000
Prime Costs 123,400
Manufacturing Overhead:
Indirect material 3,000
Utility (60%) 4,200
Depreciation 18,000
Maintenance [$1,500 + (1.25 × 6,000)] 9,000
Royalty [$2,000 + (2 × 6,000)] 14,000
Total manufacturing overhead 48,200
Total Manufacturing Costs 171,600
(+) Opening work in process inventory 5,150
Costs of goods in production process 176,750
(-) Ending work in process inventory 2,750
Cost of Goods Manufactured 174,000

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Richman Decore Limited

Cost of Goods Sold Statement
For the month ended September, 200X

Opening Inventory of Finished Goods $0

(+) Cost of Goods Manufactured 174,000
Cost of Goods available for sales 174,000
(-) Ending Inventory of Finished Goods 58,000
Cost of Goods Sold 116,000

Richman Decore Limited

Income Statement
For the month ended September, 200X
Particulars $ $
Sales 180,000
(-) Cost of Goods Sold 116,000
Gross Profit 64,000
Less: Operating Expenses
Sales commission 9,000
Utility (40%) 2,800
Rent 5,000
Office staff salary 12,000
Advertisement 8,500
Entertainment 3,000
Shipping Expense [$500 + (3 × 4,000)] 12,500
Total operating expenses 52,800
Net Profit 11,200

Workings:
Number of units Produced 6000 units
Total Sales ($) 180,000
Per unit selling price ($) 45
Number of units sold [1,80,000/45] 4,000
Ending Inventory of finished goods [6,000 - 4,000] 2000 units
Cost of goods manufactured $174,000
Number of units Manufactured 6,000 units
Per unit manufacturing costs [174,000/6,000] 29
Cost of ending inventory [2,000 × 29] $58,000

Illustration – 7:
Tampa Office Equipment manufactures and sells metal shelving. It began operations on January 1,
2009. Costs incurred for 2009 are as follows (V stands for variable, F stands for fixed):

Direct material costs $140,000 V

Direct manufacturing labor costs 30,000 V
Plant energy costs 5,000 V
Indirect manufacturing labor costs 10,000 V
Indirect manufacturing labor costs 16,000 F
Other indirect manufacturing costs 8,000 V
Other indirect manufacturing costs 24,000 F

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 Cost Classifications and Statements

Marketing, distribution, and customer-service costs 122,850 V

Marketing, distribution, and customer-service costs 40,000 F
Administrative costs 50,000 F

Variable manufacturing costs are variable with respect to units produced. Variable marketing,
distribution, and customer-service costs are variable with respect to units sold.

Inventory data are:

January 1, 2009 December 31, 2009
Direct materials 0 lb. 2,000 lbs
Work in process 0 units 0 units
Finished goods 0 units ? units

Production in 2009 was 100,000 units. Two pounds of direct materials are used to make one unit of
finished product.
Revenues in 2009 were $436,800. The selling price per unit and the purchase price per pound of
direct material were stable throughout the year. The company’s ending inventory of finished goods
is carried at the average unit manufacturing costs for 2009. Finished goods inventory at December
31, 2009 was $20,970.

Required:
1. Calculate direct materials inventory, total cost, December 31, 2009
2. Calculate finished goods inventory, total units, December 31, 2009
3. Calculate selling price per unit, 2009
4. Calculate operating income, 2009

Solution – 7:
If 2 pounds of direct materials are used to make each unit of finished product, 100,000 units × 2
lbs., or 200,000 lbs. were used at $0.70 per pound of direct materials ($140,000 ÷ 200,000 lbs.).
(The direct material costs of $140,000 are direct materials used, not purchased.) Therefore, the
ending inventory of direct materials is 2,000 lbs. × $0.70 = $1,400.

Manufacturing costs
for 100,000 units
Variable Fixed Total
Direct material costs $140,000 - $140,000
Direct manufacturing labor costs 30,000 - 30,000
Plant energy costs 5,000 - 5,000
Indirect manufacturing labor costs 10,000 16,000 26,000
Other indirect manufacturing costs 8,000 24,000 32,000
Cost of goods manufactured $193,000 $40,000 $233,000

Average unit manufacturing cost: = $233,000 ÷ 100,000 units

Finished goods inventory in units:
Units sold in 2009
Selling price in 2009
= $2.33 per unit
= $20,970 (given)/$2.33 per unit
= 9,000 units
= Beginning inventory + Production – Ending inventory
= 0 + 100,000 – 9,000 = 91,000 units
= $436,800 ÷ 91,000
= $4.80 per unit

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 Cost Classifications and Statements

Income Statement
Particulars $ $
Revenues (91,000 units sold × $4.80) 436,800
Less: Cost of Goods Sold
Beginning inventory of Finished Goods 0
Add: Cost of Goods Manufactured 233,000
Cost of goods available for sale 233,000
Less: Ending inventory of Finished Goods 20,970
Cost of Goods Sold 212,030
Gross profit/margin 224,770
Less: Operating expenses
Marketing, distribution, and customer service costs 162,850
Administrative costs 50,000
Total operating expenses 212,850
Net income $11,920

Note: Although not required, the full set of unit variable costs is:
Direct materials cost $1.40
Direct manufacturing labor cost 0.30
Plant energy cost 0.05
Indirect manufacturing labor cost 0.10
Other indirect manufacturing cost 0.08
Manufacturing cost per unit $1.93
Marketing, distribution, and customer-service costs per unit sold $1.35

EXERCISE:

E2 – 1: Porter Company manufactures furniture, including tables. Selected costs associated with
the manufacturing of the tables and the general operations of the company are given below:

1. Wood is used in the manufacture of the tables, at a cost of Tk. 1,500 per table.
2. The tables are assembled by workers, at a wage cost of Tk. 400 per table.
3. Workers assembling the table are supervised by a factory supervisor who is paid Tk. 25,000 per
month.
4. Electrical costs of Tk. 5 per machine hour are incurred to manufacture the tables. (Four machine
hours are required to produce a table.)
5. The depreciation cost of the machines used to make the tables totals Tk. 100,000 per year.
6. The salary of the president of Porter Company is Tk. 150,000 per month.
7. Porter Company spends Tk. 500,000 per year to advertise its products.
8. Salespersons are paid a commission of Tk. 150 for each table sold.

Required:
Fill up the following table, considering example of the above costs and its classification. [Put tick
on the correct category of cost]

Number MC NMC PdC PrC VC FC DC IDC

1
2
3

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 Cost Classifications and Statements

4
5
6
7
8

Here,
MC: Manufacturing Cost; NMC: Non Manufacturing Cost; PdC: Product Cost; PrC: Period
Cost; VC: Variable Cost; FC: Fixed Cost; DC: Direct Cost; and IDC: Indirect Cost.

E2 - 2: Almy Company, a manufacturing firm, produces a single product. The following

information has been taken from the company’s production, sales and cost records for the just
completed month.

Cost data:
Purchase of raw material : 9,000 pound @ $10 per pound
Direct labor :?
Indirect Material : 5% of raw material consumed
Indirect labor : $0.30 per unit produced
Maintenance : $2,000 per month plus $0.10 per unit produced
Royalty : $3,000 per month plus $0.15 per unit produced
Sales commission : $4,000 per month plus $0.20 per unit sold
Shipping expenses :?
Advertisement : $15,400 per month
Entertainment : 12,000 per month
Rent : 6,000 per month
Utility, factory : 6,000 per month
Salary, office : 50,000 per month
Depreciation : 9,000 per month

Inventories:

Beginning Inventory Ending Inventory

Raw material $9,000 $12,000
Work in process 19,400 10,000
Finished goods 0 ?

Other data:
(a) Production units 20,000.
(b) Sales for the month $300,000.
(c) Total manufacturing costs $210,600.
(d) Selling price per unit $20.
(e) Rent 40% and Depreciation 100% is for factory.
(f) The finished goods inventory is being carried at the average unit production cost for the month.

Shipping expense is a mixed cost that remains fixed by some amount and varies with respect to
number of units sold in a month. Details of shipping expense for last few months are given below:

Month Units sold Shipping expense ($)

August 8,000 4,800
September 10,500 5,925

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 Cost Classifications and Statements

October 18,000 9,300

November 12,200 6,690
December 16,000 8,400

Requirements:
1. Find out the number of units sold during the month and ending inventory for finished goods.
2. Prepare a schedule for cost of goods manufactured for the month.
3. Develop the cost formula for shipping expense (use high-low method) and calculate shipping
expense for the month.
4. Prepare an income statement for the month.

E2 – 3: Visic Company, a manufacturing firm, produces sports product. The following information
has been taken from the company’s production, sales and cost records for the just completed month.

Cost data:
Variable costs Mixed costs Fixed costs (per month)
Purchase of raw material: Maintenance: Advertisement $15,400
7,000 pound @ $10 per pound $2,000 per month plus Entertainment 7,000
Direct labor: $0.10 per unit produced Rent, factory 6,000
23 workers @ $500 each Royalty: Utility, factory 6,000
Indirect Material: $3,000 per month plus Salary, office 10,000
$0.30 per unit produced $0.15 per unit produced Depreciation, factory 9,000

Inventories:

Beginning Ending
Raw material $5,000 ?
Work in process 9,800 4,000
Finished goods 9,570 ?

Other data:
 Production units 14,000.
 Sales for the month $180,000.
 Selling price per unit $15.
 Prime cost for the month $79,500.
 There were 1,100 units in finished goods beginning inventory
 The finished goods inventory is being valued at FIFO cost flow method.

Requirements:
1. Find out the number of units sold during the month and ending inventory for raw material and
finished goods.
2. Prepare a schedule of goods manufactured for the month.
3. Prepare an income statement for the month.

E2 – 4: DOEL, a manufacturing firm, produces plastic swimming pool. The following information
has been taken from the company’s production, sales and cost records for the just completed month.

Cost data for the month:

Purchase of raw material : 7,000 pounds @ 10 per pound
Direct labor :?
Indirect Material : $4,200

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 Cost Classifications and Statements

Royalty for production patent : $2,500

Advertisement : $5,400
Rent : $6,000
Utility, factory : $4,500
Salary, office : $10,000
Depreciation : $4,000
Maintenance, factory : $1.25 per unit produced

Inventories:
Beginning Ending
Raw material $5,000 $8,500
Work in process $600 $6,000
Finished goods $0 $7,020

Other data:
(a) Sales for the month $144,300.
(b) Rent 60% and depreciation 80% is for factory.
(c) Prime cost for the month $79,500.
(d) Total manufacturing overhead cost is 60% of conversion costs.

Requirements:
1. Prepare a schedule of goods manufactured for the month.
2. Prepare an income statement for the month.
3. Find out how many units produced during the month.
4. Calculate number of units sold during the month.
5. Calculate selling price per unit.

E2 – 5: Consider the following data to prepare:

(a) cost of goods manufactured statement and
(b) income statement.

Beginning raw material inventory : $3,000

Beginning work-in-process inventory : $5,000
Beginning finished goods inventory : $4,500
Direct material purchase : $40,000
Indirect manufacturing costs : 70% of conversion costs
Total manufacturing costs : $95,000
Ending inventory of raw material : $3,000
Ending inventory of work-in-process : $2,500
Ending inventory of finished goods : $3,000
Gross profit : 40% of sales revenue
Net profit : 15% of sales revenue

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 Cost Classifications and Statements

Case Study

Cost Statement

Hector P. Wastrel, a careless employee, left some combustible materials near an open flame in
Salter Company’s plant. The resulting explosion and fire destroyed the entire plant and
administrative offices. Justin Quick, the company’s controller, and Constance Trueheart, the
operations manager, were able to save only a few bits of information as they escaped for the
roaring blaze.

“What a disaster,” cried Justin. “And the worst part is that we have no records to use in filing
an insurance claim.” “I know,” replied Constance. “I was in the plant when the explosion
occurred, and I managed to grab only this brief summary sheet that contains information on
one or two of our costs. It says that our direct labor cost this year has totaled $180,000 and that
we have purchased $290,000 in raw materials. But I’m afraid that doesn’t help much; the rest
of our records are just ashes.”

“Well, not completely,” said Justin. “I was working on the year-to-date income statement when
the explosion knocked me out of my chair. I instinctively held onto the page I was working on,
and from what I can make out, our sales to date this year have totaled $1,200,000 and our gross
margin rate has been 40% of sales. Also, I can see that our goods available for sale to
customers has totaled $810,000 at cost. “

“Maybe we’re not so bad off after all,” exclaimed Constance. “My sheet says that prime cost
has totaled $410,000 so far this year and that manufacturing overhead is 70% of conversion
cost. Now if we just had some information on our beginning inventories…” “Hey, look at
this,” cried Justin. “It’s a copy of last year’s annual report, and it shows what our inventories
were when this year started. Let’s see, raw materials was $18,000, work in process was
$65,000, and finished goods was $45,000.

“Super,” yelled Constance. “Let’s go to work.”

Required:
Determine the amount of cost in the raw materials, work in process and finished goods inventory as
of the date of fire and also identify the total amount that the company can claim from the insurance
company.

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