Lecture Managerial accounting: Creating value in a dynamic business environment (10th edition): Chapter 2 - Ronald W. Hilton, David E. Platt

Chapter 2
Basic Cost
Management Concepts

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What Do We Mean By a Cost?
A cost
is the measure of
resources given
up to achieve a
particular purpose.

2­2


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.

2­3


Cost Classifications on Financial

Statements – Income Statement

Product Costs

Period Costs

Cost of goods sold

Operating expenses

2­4


Types of Production Processes
Type of Production
Process

Description of
Process

Example of
Manufacturer

Job Shop

Low volume
Little standardization
Unique products

Disney

Batch

Multiple products
Low volume

Caterpillar

Assembly Line

A few major products
Higher volume

Ford

Continuous Flow

High volume
Highly standardized commodity products

Exxon

2­5


Manufacturing Costs
Direct
Material

Direct

Labor

Manufacturing
Overhead

The
Product
2­6


Direct Material
Cost of raw material that is used to
make, and can be conveniently
traced, to the finished product.
Example:
Example:
Steel
Steel used
used to
to
manufacture
manufacture
the
theautomobile.
automobile.

2­7


Direct Labor

Cost of salaries, wages, and fringe
benefits for personnel who work
directly on manufactured products.
Example:
Example:
Wages
Wagespaid
paidto
toan
an
automobile
automobileassembly
assembly
worker.
worker.

2­8


Manufacturing Overhead
All other manufacturing costs
Indirect
Material

Indirect
Labor

Other
Costs

Materials used to support
the production process.
Examples: lubricants and
cleaning supplies used in an
automobile assembly plant.
2­9


Schedule of Cost of Goods
Manufactured
Comet Computer Corporation
Schedule of Cost of Goods Manufactured
Raw material used

$

Direct labor
Total manufacturing overhead

134,980
50,000
230,000

Total manufacturing costs
Add: Work-in-process inventory, January 1

$

414,980
120

Subtotal
Deduct: Work-in-process inventory, December 31

$

415,100
100

Cost of goods manufactured

$

415,000
2­10


Schedule of Cost of Goods
Manufactured
Computation of Cost of Raw Material Used
Raw-material inventory, January 1
Add: Purchases of raw materials

$

Raw material available for use
Deduct: Raw material inventory, December 31
Raw material used

Comet Computer Corporation

6,000
134,000
140,000
5,020

$ 134,980

Schedule of Cost of Goods Manufactured
Raw material used

$

Direct labor
Total manufacturing overhead

134,980
50,000
230,000

Total manufacturing costs
Add: Work-in-process inventory, January 1

$

414,980
120

Subtotal
Deduct: Work-in-process inventory, December 31

$

415,100
100

Cost of goods manufactured

$

415,000
2­11


Schedule of Cost of Goods
Manufactured
Include all direct labor
costs incurred during the
Cometcurrent
Computer
Corporation
period.
Schedule of Cost of Goods Manufactured
Raw material used

$

Direct labor
Total manufacturing overhead

134,980
50,000
230,000

Total manufacturing costs
Add: Work-in-process inventory, January 1

$

414,980
120

Subtotal
Deduct: Work-in-process inventory, December 31

$

415,100
100

Cost of goods manufactured

$

415,000
2­12


Computation of Total Manufacturing Overhead
Indirect material

$

10,000

Indirect labor

40,000

Depreciation on factory

90,000

Depreciation on equipment

70,000

Utilities
15,000
Comet Computer Corporation
Insuranceof Cost of Goods Manufactured
5,000
Schedule
Total manufacturing overhead
$ 230,000

Raw material used

$

Direct labor
Total manufacturing overhead

134,980
50,000
230,000

Total manufacturing costs
Add: Work-in-process inventory, January 1

$

414,980
120

Subtotal
Deduct: Work-in-process inventory, December 31

$

415,100
100

Cost of goods manufactured

$

415,000
2­13

Schedule of Cost of Goods
Manufactured
Beginning work-inprocess inventory is
carried over from the
Comet Computer Corporation
prior period.
Schedule of Cost of Goods Manufactured
Raw material used

$

Direct labor
Total manufacturing overhead

Ending
work-in-process
Total manufacturing
costs
inventory
contains the
cost ofJanuary 1
Add: Work-in-process
inventory,
unfinished
goods, and is
Subtotal
reported
in the current inventory,
assets December 31

Deduct: Work-in-process
section
of themanufactured
balance sheet.
Cost of goods

134,980
50,000
230,000

$

414,980
120

$

415,100
100

$

415,000
2­14


Income Statement for a
Manufacturer
Comet Computer Corporation
Income Statement

For the Year Ended December 31, 20X2
Sales revenue
Less: Cost of goods sold

$

700,000
415,010

Gross margin
Selling and administrative expenses

$

284,990
174,490

Income before taxes
Income tax expense

$

110,500
30,000

Net income

$

80,500

2­15


Comet Computer Corporation
Schedule of Cost of Goods Sold
For the Year Ended December 31, 20X2
Finished-goods inventory, Jan. 1
Add: Cost of goods manufactured

$

Cost of goods available for sale
Comet Computer Corporation
Deduct Finished-goods inventory, Dec. 31

200
415,000
415,200
190

Income Statement
$ 415,010
For the Year Ended December 31, 20X2

Cost of goods sold

Sales revenue
Less: Cost of goods sold

$

700,000
415,010

Gross margin
Selling and administrative expenses

$

284,990
174,490

Income before taxes
Income tax expense

$

110,500
30,000

Net income

$

80,500
2­16


Activities that cause costs to be incurred
are called COST DRIVERS:

Cost Driver Examples
Activity

Cost Driver

Machining operations
Setup
Production scheduling
Inspection
Purchasing
Shop order handling
Valve assembly support

Machine hours
Setup hours
Manufacturing orders
Pieces inspected
Purchase orders
Shop orders
Customer requisitions

2­17


Cost Classifications
Cost behavior means
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.

2­18


Cost Classifications
Summary of Variable and Fixed Cost Behavior
Cost

In Total

Per Unit

Variable

Total variable cost changes
as activity level changes.

Variable cost per unit
remains the same over
wide ranges of activity.

Total fixed cost remains
the same even when the

activity level changes.

Fixed cost per unit
goes down as activity
level goes up.

Fixed

2­19


Direct and Indirect Costs
Direct costs

Indirect costs

Costs that can be

Costs that must be

Example: cost of paint in

Example: cost of national

easily and conveniently
traced to a product or
department.
the paint department of an
automobile assembly plant.

allocated in order to be
assigned to a product or
department.
advertising for an airline is
indirect to a particular
flight.

2­20


Controllable and
Uncontrollable Costs
A cost that can be significantly influenced
by a manager is a controllable cost.

Cost item

Manager

Classificaton

Cost of food used Restaurant
in a restaurant
manager

Controllable

Cost of national
advertising by a
restaurant chain

Uncontrollable

Restaurant
manager

2­21


Opportunity Cost
The potential benefit that is
given up when one
alternative is selected over
another.
Example: If you were

not attending college,
you could be earning
$30,000 per year.
Y our opportunity cost
of attending college for one year
is $30,000.
2­22


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.

Example: Y ou bought an automobile that cost $22,000 two

years ago. The $22,000 cost is sunk because whether you drive
it, park it, trade it, or sell it, you cannot change the $22,000
cost.

2­23


Differential Costs
Costs that differ between alternatives. 
Example: You can earn $1,500 per month in your
hometown or $2,000 per month in a nearby city.
Your commuting costs are $50 per month in your
hometown and $300 per month to the city.
What is your differential cost?
$300 - $50 = $250

2­24


Marginal Costs and Average Costs
The extra cost
incurred to produce
one additional unit.

The total cost to
produce a quantity
divided by the
quantity produced.

Marginal and average costs are
largely a function of cost behavior
-- variable and fixed costs.
2­25