Chapter

2
Cost Terms, Concepts, and
Classifications
 Comparing Merchandising and
Manufacturing Activities
Merchandisers . . .
 Buy finished goods.
 Sell finished goods.
MegaLoMart
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Manufacturers . . .
 Buy raw materials.
 Produce and sell
finished goods.
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 Balance Sheet

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

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 Balance Sheet

Merchandiser Manufacturer
Current Assets Current Assets
 Cash  Cash
 Receivables Materials
Receivables
waiting to
 Prepaid Expenses  Prepaid
be processed.
Expenses
 Merchandise Inventory
Partially complete  Inventories
products – some Raw Materials
material, labor, or Work in Process
overhead has been Finished Goods
added.
Completed products
awaiting sale.
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 Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product

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 Direct Materials

Those materials that become an integral part

of the product and that can be conveniently
traced directly to it.

Example: A radio installed in an automobile

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 Direct Labor
Those labor costs that can be easily traced to
individual units of product.

Example: Wages paid to automobile assembly workers

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 Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect labor and indirect materials

Wages paid to employees Materials used to support

who are not directly the production process.
involved in production
work. Examples: lubricants and
Examples: maintenance cleaning supplies used in the
workers, janitors and automobile assembly plant.
security guards.

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 Direct Costs and Indirect Costs

Direct costs Indirect costs

 Costs that can be  Costs cannot be easily
easily and conveniently and conveniently traced
traced to a unit of to a unit of product or
product or other cost other cost object.
objective.  Example:
 Examples: direct manufacturing
material and direct labor overhead

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 Nonmanufacturing Costs

Marketing and selling costs . . .

 Costs necessary to get the order and deliver the
product.
Administrative costs . . .
 All executive, organizational, and clerical costs.

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 Product Costs Versus Period Costs

Product costs include Period costs are not

direct materials, direct included in product
labor, and costs. They are
manufacturing expensed on the
overhead. income statement.
Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

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 Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
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 Inventory Flows

Beginning
Additions Available
balance + $$$ = $$$$$
$$
_
Withdrawals
$$$

=
Ending
balance
$$

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 The Income Statement
Cost of goods sold for manufacturers differs only
slightly from cost of goods sold for merchandisers.

Merchandising Company Manufacturing Company

Cost of goods sold:

Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $236,250

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 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.
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 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process
Conversion
Beginning raw Direct materials
costs are costs
materials inventory + Direct labor
+ Raw materials + Mfg. overhead incurred to
purchased = Total manufacturing convert the
= Raw materials costs
direct material
available for use
in production into a finished
– Ending raw materials product.
inventory
= Raw materials used
in production

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 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory All manufacturing costs incurred
process inventory
= Raw materials used during the period are added
= Cost to the
of goods
in production manufactured.
beginning balance of work in
process.

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 Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory
Costs associated with the goods that process inventory
= Raw materials used = Cost of goods
areincompleted
production
during the period are manufactured.
transferred to finished goods
inventory.

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 Product Costs - A Closer Look
Work
In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold

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 Resource Flows

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
a. $276,000
b. $272,000
c. $280,000
d. $ 2,000
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 Resource Flows

Direct materials used in production totaled

$280,000. Direct Labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
a. $555,000
b. $835,000
c. $655,000
d. Cannot be determined.

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 Resource Flows
Beginning work in process was $125,000.
Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
a. $1,160,000
b. $ 910,000
c. $ 760,000
d. Cannot be determined.

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 Cost Classifications for Predicting
Cost Behavior

How a cost will react to

changes in the level of
business activity.
 Total variable costs
change when activity
changes.
 Total fixed costs
remain unchanged
when activity changes.

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 Total Variable Cost

Your total long distance telephone bill is

based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
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 Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
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 Total Fixed Cost
Your monthly basic telephone bill probably
does not change when you make more local
calls.
Telephone Bill
Monthly Basic

Number of Local Calls

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 Fixed Cost Per Unit
The average cost per local call decreases as
more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
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 Cost Classifications for Predicting
Cost Behavior

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.

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 Cost Behavior

Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activity
decreases.
c. Total costs that increase as activity
increases.
d. Total costs that remain constant.

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 Cost Behavior

Variable costs are usually characterized by:

a. Unit costs that decrease as activity
increases.
b. Total costs that increase as activity
decreases.
c. Total costs that increase as activity
increases.
d. Total costs that remain constant.

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 End of Chapter 2

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