Chapter 2

Basic Cost
Management Concepts
and Accounting for Mass
Customization Operations

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Learning
Objective
1

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Process of Management
Strategy Planning
Formulation

Managers need cost information to

perform each of these functions.

Control Directing
Decision
Making

1-3
 Learning
Objective
2

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Product Costs, Period Costs and Expenses

Product costs are costs associated with goods for

sale until the time period during which the products
are sold, at which time the costs become expenses.

Period costs are costs that are expensed during the

time period in which they are incurred.

Expenses are the consumption of assets for the

purpose of generating revenue.

1-5
 Learning
Objective
3

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost Classifications on Financial
Statements – Balance Sheet

Merchandiser Manufacturer
Current Assets Current Assets
– Cash  Cash
– Receivables  Receivables
– Prepaid Expenses  Prepaid Expenses
– Merchandise  Inventories
Inventory Raw Materials
Work in Process
Finished Goods

1-7
Learning
Objective
4

1-8
Types of Production Processes
Type of Production Description of Example of
Process Process Manufacturer

Job Shop Low volume Disney

Little standardization
Unique products

Batch Multiple products Caterpillar

Low volume

Assembly Line A few major products Ford

Higher volume

Mass Customization High volume Dell

Many standardized components
Customized combination of components

Continuous Flow High volume Exxon

Highly standardized commodity products 1-9
 Learning
Objective
5

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Manufacturing Costs

Direct Direct Manufacturing

Material Labor Overhead

The
Product

1-11
 Classifications of Costs in
Manufacturing Companies
Manufacturing costs are often
combined as follows:
Direct Direct Manufacturing
Material Labor Overhead

Prime Conversion
Cost Cost

1-12
 Manufacturing Cost Flows
Direct Material
Work in
Direct Labor Process
Inventory
Manufacturing
Overhead
Finished Cost of
Goods Goods
Inventory Sold

1-13
 Learning
Objective
6

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Schedule of Cost of Goods
Computation of Cost of Raw Material Used

Manufactured
Raw-material inventory, January 1 $ 6,000
Add: Purchases of raw materials 134,000
Raw material available for use 140,000
Deduct: Raw material inventory, December 31 5,020
Raw material used $ 134,980
Comet Computer Corporation
Schedule of Cost of Goods Manufactured

Raw material used $ 134,980

Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs $ 414,980
Add: Work-in-process inventory, January 1 120
Subtotal $ 415,100
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured $ 415,000

1-15
 Schedule of Cost of Goods
Computation of Total Manufacturing Overhead
Manufactured
Indirect material $ 10,000
Indirect labor 40,000
Depreciation on factory 90,000
Depreciation on equipment 70,000
Utilities Comet Computer Corporation
15,000
Schedule of Cost of Goods Manufactured
Insurance 5,000
Total manufacturing overhead $ 230,000
Raw material used $ 134,980
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing
Beginning costs
work-in-process $ 414,980
inventory
Add: is carried over from
Work-in-process inventory, January 1 120
the prior period.
Subtotal $ 415,100
Deduct: Work-in-process inventory, December 31 100
Ending work-in-process inventory
Cost of goods
contains the costmanufactured
of unfinished goods, $ 415,000
and is reported in the current assets
section of the balance sheet. 1-16
 Income Statement for a
Manufacturer

Comet Computer Corporation

Income Statement
For the Year Ended December 31, 20X2
Sales revenue $ 700,000
Less: Cost of goods sold 415,010
Gross margin $ 284,990
Selling and administrative expenses 174,490
Income before taxes $ 110,500
Income tax expense 30,000
Net income $ 80,500

1-17
 Income Statement for a
Manufacturer
Comet Computer Corporation
Schedule of Cost of Goods Sold
For the Year Ended December 31, 20X2
Finished-goods inventory, Jan. 1 $ 200
Add: Cost of goods manufactured 415,000
Cost of goods available for sale 415,200
Comet Computer Corporation
Deduct Finished-goods inventory, Dec. 31 190
Income Statement
Cost of goods sold $ 415,010
For the Year Ended December 31, 20X2
Sales revenue $ 700,000
Less: Cost of goods sold 415,010
Gross margin $ 284,990
Selling and administrative expenses 174,490
Income before taxes $ 110,500
Income tax expense 30,000
Net income $ 80,500

1-18
Learning
Learning
Objective
Objective
37

1-19
 Activities that cause costs to be
incurred are called COST DRIVERS
Cost Driver Examples
Activity Cost Driver
Machining operations Machine hours
Setup Setup hours
Production scheduling Manufacturing orders
Inspection Pieces inspected
Purchasing Purchase orders
Shop order handling Shop orders
Valve assembly support Customer
Requisitions
1-20
 Learning
Objective
8

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Cost Classifications

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Total variable cost changes Variable cost per unit

Variable as activity level changes. remains the same over
wide ranges of activity.
Total fixed cost remains Fixed cost per unit
Fixed the same even when the goes down as activity
activity level changes. level goes up.

1-22
 Learning
Objectives
9 and 10

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Various Costs
Direct costs: Costs that can be easily and conveniently traced to a
product or department.
Indirect costs: Costs that must be allocated in order to be assigned to a
product or department.
Controllable and Uncontrollable Costs: A cost that can be significantly
influenced by a manager is a controllable cost.
Opportunity Costs: The potential benefit that is given up when one
alternative is selected over another.
Sunk Costs: All costs incurred in the past that cannot be changed by any
decision made now or in the future are sunk costs. Sunk costs should
not be considered in decisions.
Differential Costs: Costs that differ between alternatives.
Marginal Cost: The extra cost incurred to produce one additional unit.
Average Cost: The total cost to produce a quantity divided by the
quantity produced.

1-24
End of Chapter 2

1-25