Cost Concepts

JOSEPH FRANCIS S. PAMAONG, CPA, MBA, LLB

INSTRUCTOR
 WHAT IS COST?
COST – is the amount of
resources given up in
exchange for some goods
and services.
 Manufacturing Cost (Product Costs)
 Product costs include all costs involved in
acquiring or making a product.

 Product costs are initially assigned to inventories,

they are also known as inventoriable costs.

 Product costs “attach” to a unit of product as it is

purchased or manufactured and they stay attached
to each unit of product as long as it remains in
inventory awaiting sale. When units of product are
sold, their costs are released from inventory as
expenses (typically called cost of goods sold).
 E.G: Manufacturing Cost
(Product Costs)

1. DIRECT MATERIAL

2. DIRECT LABOR
3. FACTORY OVERHEAD
OR MANUFACTURING
OVERHEAD.
Direct Materials

Raw 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 MATERIALS
Direct materials are raw
materials that become an
integral part of the finished
product and whose costs
can be conveniently traced
to it.
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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 DIRECT LABOR
 Direct labor consists of that
portion of labor cost that can be
easily traced to a product. Direct
labor is sometimes referred to as
“touch labor,” since it consists of
the costs of workers who “touch”
the product as it is being made.
 Manufacturing Overhead (Factory
Overhead)
Manufacturing costs that cannot be traced
directly to specific units produced.

Examples: Indirect materials and indirect labor

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 FACTORY OVERHEAD
Manufacturing overhead
includes all manufacturing costs
except direct materials and direct
labor. These costs cannot be
easily traced to specific units
produced (also called indirect
manufacturing cost, factory
overhead, and factory burden).
 FACTORY OVERHEAD
Manufacturing overhead
includes indirect materials that are
part of the finished product, but
that cannot be easily traced to it. It
includes indirect labor costs that
cannot be conveniently traced to
the creation of products.
FACTORY OVERHEAD
Other examples of manufacturing
overhead include: maintenance
and repairs on production
equipment, heat and light,
property taxes, depreciation and
insurance on manufacturing
facilities, etc.
 THREE INVENTORY ACCOUNT
 Raw materials include any materials that go into the final
product.

 Work in process consists of units of product that are

only partially complete and will require further work
before they are ready for sale to the customer.

 Finished goods consist of completed units of product

that have not yet been sold to customers.

 WHERE FOUND?
Nonmanufacturing Costs

Administrative
Costs

All executive,
organizational, and
clerical costs.

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A manufacturing company incurs many other
costs in addition to manufacturing costs. For
financial reporting purposes, most of these
other costs are typically classified as selling
costs and administrative costs. These costs
are also called selling, general and
administrative costs, or SG&A. Selling and
administrative costs are incurred in both
manufacturing and merchandising firms.
 Selling costs include all costs necessary to
secure customer orders and get the finished
product into the hands of the customer. These
costs are also referred to as order-getting and
order-filling costs. Examples of selling costs
include advertising, shipping, sales travel,
sales commissions, sales salaries, and costs
of finished goods warehouses.
 Administrative costs include all
executive, organizational, and clerical costs
associated with the general management
of an organization. Examples of
administrative costs include executive
compensation, general accounting,
secretarial, public relations, and similar
costs involved in the overall general
administration of the organization as a
whole.
 Period Costs
 Period costs are all the costs that are not
product costs. All selling and administrative
expenses are treated as period costs. For
example, sales commissions, advertising,
executive salaries, public relations, and the
rental costs of administrative offices are all
period costs.
 Period costs are expensed on the income
statement in the period in which they are
incurred using the usual rules of accrual
accounting.
Product Costs Versus Period Costs

Product costs include Period costs include all

direct materials, direct selling costs and
labor, and manufacturing administrative costs.
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement

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Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash
 Receivables  Receivables
 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  Receivables
 Merchandise Inventory  Inventories
• Raw Materials
• Work in Process
• Finished Goods

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

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Schedule of cost of goods manufactured
Direct materials:
Raw materials inventory, beginning -
Add: Purchases of raw materials -
Raw materials available for use -
Deduct: Raw materials inventory, ending -
Raw materials used in production -
Direct labor -
Manufacturing overhead -
Total manufacturing cost -
Add: Work in process inventory, beginning -
Total -
Deduct: Work in process inventory, ending -
Cost of goods manufactured -

Computation of cost of goods sold

Finished goods inventory, beginning -
Add: Cost of goods manufactured -
Goods available for sale -
Deduct: Finished goods inventory, ending -
Cost of goods sold -

Income statement
Sales -
Less: Cost of goods sold -
Gross margin -
Less: Administrative expenses -
Selling expenses -
Net operating income -
 PRIME COST = MATERIAL COST + LABOR COST

 CONVERSION COST = LABOR COST + FACTORY

OVERHEAD

 TOTAL MANUFACTURING COST = MATERIAL

COST + LABOR COST + FACTORY OVERHEAD
Manufacturing Cost Flows
Balance Sheet Income
Costs Inventories Statement
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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Cost Classifications for Predicting Cost
Behavior

How a cost will react to

changes in the level of
activity within the
relevant range.
 Total variable costs change
when activity changes.
 Total fixed costs remain
unchanged when activity
changes.

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Variable Cost

Your total texting bill is based on how

many texts you send.
Total Texting Bill

Number of Texts Sent

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 TOTAL VARIABLE COST
 A variable cost varies in direct
proportion to changes in the level of
activity. For example, if you don’t have
a texting plan on your cell phone, text
messaging costs 1 PESO per text.
Your total texting bill increases with the
number of texts you send.
Variable Cost Per Unit

The cost per text sent is constant at

P1 per text.

Cost Per Text Sent

Number of Texts Sent

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 Although variable costs change in
total as the activity level rises and
falls, variable cost per unit is
constant. For example, the cost per
text message sent is constant at 1
PESO per text.
Fixed Cost
Your monthly contract fee for your cell phone is fixed for the
number of monthly minutes in your contract. The monthly
contract fee does not change based on the number of calls
you make.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
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 A fixed cost is constant within the relevant range. In
other words, fixed costs do not change for changes
in activity that fall within the “relevant range.” For
example, your monthly contract fee for your cell
phone is a fixed amount for a certain number of
minutes. The monthly contract fee does not change
based on the number of calls you make.
Fixed Cost Per Unit
Within the monthly contract allotment, the average fixed cost per
cell phone call made decreases as more calls are made.

Monthly Cell Phone

Contract Fee
Number of Minutes Used
Within Monthly Plan
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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 Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.

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Schedule of cost of goods manufactured
Direct materials:
Raw materials inventory, beginning -
Add: Purchases of raw materials -
Raw materials available for use -
Deduct: Raw materials inventory, ending -
Raw materials used in production -
Direct labor -
Manufacturing overhead -
Total manufacturing cost -
Add: Work in process inventory, beginning -
Total -
Deduct: Work in process inventory, ending -
Cost of goods manufactured -

Computation of cost of goods sold

Finished goods inventory, beginning -
Add: Cost of goods manufactured -
Goods available for sale -
Deduct: Finished goods inventory, ending -
Cost of goods sold -

Income statement
Sales -
Less: Cost of goods sold -
Gross margin -
Less: Administrative expenses -
Selling expenses -
Net operating income -
Manufacturing overhead 200,000.00
Work in process inventory, beginning 30,000.00
Work in process inventory, ending 20,000.00
Finished goods inventory, beginning 100,000.00
Finished goods inventory, ending 70,000.00
Sales 950,000.00
Administrative expenses 180,000.00
Selling expenses 140,000.00
REQUIRED:
Required:
a. Prepare a Schedule of Cost of Goods
Manufactured in good form.
b. Compute the Cost of Goods Sold.
c. Using data from your answers above as needed,
prepare an Income Statement in good form.
DIRECT MATERIAL?

DIRECT LABOR?

FACTORY OVERHEAD/MANUFACTURING
OVERHEAD?

SELLING COST?

ADMINISTRATIVE COST?
 PRODUCT
COST OR
PERIOD COST?
FIXED COST OR
VARIABLE
COST?
End of Chapter

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