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Copyright 2008 by The McGraw-Hill Companies, Inc. AllMcGraw-Hill/Irwin
Basic Concepts of
Cost ManagementandAccounting forMass Customized Operations
2
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Process of ManagementProcess of Management
DecisionMaking
DirectingControl
PlanningStrategyFormulation
Managers need cost information toperform each of these functions.
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What Do We Mean By a Cost?What Do We Mean By a Cost?
A costis the measure ofresources given
up to achieve aparticular purpose.
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Expense:Expense:
Expense is the cost incurred when an asset isused up or is sold for the purpose ofgenerating revenue
An Asset used upDepreciation treated as expense for using anasset
When goods are soldCost of goods sold is treated as expenseagainst revenue
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Product CostsProduct Costs
Cost of goods sold
(Material, Labour, Mfg Exp)
Cost Classifications on FinancialCost Classifications on Financial
Statements Income StatementStatements Income Statement
The term product cost and period cost are used todescribe the timing with which various expenses arerecognised in the books of accounts.
Product costs are costs associated with goods for
sale until the products are sold, at which time thecosts are recognised as expenses.
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Product Costs, Period Costs and ExpensesProduct Costs, Period Costs and Expenses
Period costs are costs that are expensed duringthe time period in which they are incurred.
Period CostsPeriod Costs (Other than product costs)(Other than product costs)
Operating expenses
(other than cost cost of goods sold(Selling, Admin, Distribn. R&D)
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Product Costs, Period Costs and ExpensesProduct Costs, Period Costs and Expenses
Period CostsPeriod Costs(Other than product costs)(Other than product costs)
Operating expenses(Selling, Admin, Distribn. R&D)
Treated as expenses onexpiry of accountingperiod
Product CostsProduct Costs
Cost of goods sold
(Material, Labour, Mfg Exp)
Recognised as expensewhen goods are sold
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Current assets
MerchandiserMerchandiser
Current Asset CashCash
ReceivablesReceivables
Prepaid ExpensesPrepaid Expensesid
Expenses MerchandiseMerchandise
InventorInventoryy
Current AssetsCurrent Assets
ManufacturerManufacturer
Current Assetsq CashCash
q ReceivablesReceivables
q Prepaid ExpensesPrepaid Expenses
q
InventoriesInventoriesRaw MaterialsRaw Materials
Work in ProcessWork in Process
Finished GoodsFinished Goods
Cost Classifications on FinancialCost Classifications on Financial
Statements Balance SheetStatements Balance Sheet
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MerchandiserMerchandiser
Current Assets Cash Receivables
Prepaid Expenses
MerchandiseMerchandiseInventoryInventory
ManufacturerManufacturer
Current Assetsq CashCash
q ReceivablesReceivables
q Prepaid ExpensesPrepaid Expenses
q
InventoriesInventoriesRaw MaterialsRaw Materials
Work in ProcessWork in Process
Finished GoodsFinished Goods
Cost Classifications on FinancialCost Classifications on Financial
Statements Balance SheetStatements Balance Sheet
Those materialswaiting to beprocessed.
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MerchandiserMerchandiser
Current Assets Cash Receivables
Prepaid Expenses
MerchandiseMerchandiseInventoryInventory
ManufacturerManufacturer
Current Assetsq CashCash
q ReceivablesReceivables
q Prepaid ExpensesPrepaid Expenses
q
InventoriesInventoriesRaw MaterialsRaw Materials
Work in ProcessWork in Process
Finished GoodsFinished Goods
Cost Classifications on FinancialCost Classifications on Financial
Statements Balance SheetStatements Balance Sheet
Partially complete
products material towhich some labor
and/or overhead hasbeen added.
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MerchandiserMerchandiser
Current Assets Cash Receivables
Prepaid Expenses
MerchandiseMerchandiseInventoryInventory
ManufacturerManufacturer
Current Assetsq CashCash
q ReceivablesReceivables
q Prepaid ExpensesPrepaid Expenses
q
InventoriesInventoriesRaw MaterialsRaw Materials
Work in ProcessWork in Process
Finished GoodsFinished Goods
Cost Classifications on FinancialCost Classifications on Financial
Statements Balance SheetStatements Balance Sheet
Completed productsawaiting sale.
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Manufacturing CostsManufacturing Costs
TheProduct
DirectLabor
DirectMaterial Manufacturing
Overhead
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Direct MaterialDirect Material
Example:Steel used tomanufacture
the automobile.
Example:Steel used tomanufacture
the automobile.
Cost of raw material that is used tomake, and can be conveniently
traced, to the finished product.
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Direct MaterialDirect MaterialDirect materials (used at factory)
All materials or components specifically purchased,produced or taken from stores
Primary packing material like carton, wrapping,
cardboards boxes
process materials, production materials,stores materials, construction materialse.g Silicon chip for computer system
Tyres, gear assembly, window glasses, steering
wheels for a carWoodfor furniture
Plasticfor plastic toys,
Bricks, marble, cement, steel, for a construction project
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Cost of salaries, wages, and fringebenefits for personnel who work
directly on manufactured products.
Direct LaborDirect Labor
Example:
Wages paid to anautomobile assemblyworker.
Example:
Wages paid to anautomobile assemblyworker.
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All other manufacturing costs
Manufacturing OverheadManufacturing Overhead
Materials used to support
the production process.Examples: lubricants andcleaning material supplies
used in an automobileassembly plant.
Indirect
Labor
Indirect
Material
Other
Costs
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Indirect materialsIndirect materials
That may be part of product but can be traced atgreat cost and inconvenience are called indirect
materials
e.g. Glue, nails, Welding material
Orlike repair material that can not be identified with
any one unit of product because it is used for
benefit of all products rather than any specificproduct
lubricants, oil, consumable stores
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All other manufacturing costs
Manufacturing OverheadManufacturing Overhead
Cost of personnel who
do not work directly onthe product. Examples:maintenance workers,janitors and security
guards.
Indirect
Labor
Indirect
Material
Other
Costs
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Indirect labour: (factory)Indirect labour: (factory)
cost that can not be traced physically tothe creation of the product i.e wages of all
employees who assist in mfg. process
e.g.
Maintenance people, production supervisors,
canteen workers,
medical staff,
engineers,
security guards
who are essential to production process but it isimpractical to accurately relate their cost to specificproduct
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Other overheadsOther overheads
Indirect mfg. expensesIndirect mfg. expensesTaxes, Power, water , lighting,
employee fringe benefits like
health and insurance, pension benefits,
inventory handling costs
N M f iN M f t i t
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Non Manufacturing costsNon Manufacturing costs
period costsperiod costs
Selling and distribution costsCosts to market and sell finished products
Or Order getting and order filling costs
Advertisement.Salesmen salary and commission,
costs for warehousing the finished goods
Shipping, transportation charges to delivergoods,
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NonNonManufacturing costsManufacturing costs
period costsperiod costs
Administrative costsCosts for general management of the Firm
Top management expenses,Accounting expenses,
General secretarial services,
Public relations
Stationery expenses
Telephone and General expenses etc.
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Classifications of Costs inClassifications of Costs in
Manufacturing CompaniesManufacturing Companies
PrimeCost
ConversionCost
Manufacturing costs are oftencombined as follows:
DirectMaterial
DirectLabor
ManufacturingOverhead
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Manufacturing Cost FlowsManufacturing Cost Flows
ManufacturingOverhead
Direct Material
Direct LaborWork inProcess
Inventory
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Manufacturing Cost FlowsManufacturing Cost Flows
ManufacturingOverhead
Direct Material
Direct Labor
FinishedGoods
Inventory
Work inProcess
Inventory
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Manufacturing Cost FlowsManufacturing Cost Flows
ManufacturingOverhead
Direct Material
Direct Labor
FinishedGoods
Inventory
Cost ofGoods
Sold
Work inProcess
Inventory
Exh
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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$
Schedule of Cost of GoodsSchedule of Cost of GoodsManufacturedManufactured
Exh.
2-7
Exh
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1-29
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$
Schedule of Cost of GoodsSchedule of Cost of GoodsManufacturedManufactured
Computation of Cost of Raw Material Used
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$
Exh.
2-7
Exh
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1-30
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$
Schedule of Cost of GoodsSchedule of Cost of GoodsManufacturedManufactured
Include all direct laborcosts incurred during the
current period.
Exh.
2-7
Schedule of Cost of Goods ManufacturedSchedule of Cost of Goods Manufactured
Exh.
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1-31
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$
Schedule of Cost of Goods ManufacturedSchedule of Cost of Goods Manufactured
Computation of Total Manufacturing Overhead
Indirect material 10,000$
Indirect labor 40,000Depreciation on factory 90,000
Depreciation on equipment 70,000
Utilities 15,000
Insurance 5,000
Total manufacturing overhead 230,000$
Exh.
2-7
S h d l f C f G d
Exh.
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1-32
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$
Schedule of Cost of GoodsSchedule of Cost of GoodsManufacturedManufactured
Beginning work-in-process inventory iscarried over from the
prior period.
2-9
S h d l f C t f G d
Exh.
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1-33
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$
Schedule of Cost of GoodsSchedule of Cost of GoodsManufacturedManufactured
Ending work-in-process inventorycontains the cost of unfinished
goods, and is reported in the currentassets section of the balance sheet.
2-9
S fI St t t fExh.
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1-34
Income Statement for aIncome Statement for aManufacturerManufacturer
Comet Computer Corporation
Income StatementFor 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$
2-7
I S f M f
Exh.
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1-35
Comet Computer Corporation
Income StatementFor 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$
Income Statement for a ManufacturerIncome 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
Deduct Finished-goods inventory, Dec. 31 190
Cost of goods sold 415,010$
2-7
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Identifying Cost DriversIdentifying Cost Drivers
Cost Driver Examples
Activity Cost Driver
Machining operations Machine hoursSetup Setup hours
Production scheduling Manufacturing orders
Inspection Pieces inspected
Purchasing Purchase ordersShop order handling Shop orders
Valve assembly support Customer requisitions
Activities that
cause costs to beincurred are called
cost drivers.
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1-37
Cost ClassificationsCost Classifications
Cost behavior meanshow a cost will reactto changes in thelevel of businessactivity.
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Cost ClassificationsCost Classifications
Cost behavior means howa cost will react tochanges in the level of
business activity. Totalvariable costschange
when activity changes.
Totalfixed costsremainunchanged when activity
changes.
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Total Variable Cost ExampleTotal Variable Cost Example
Your total long distance telephone bill isbased on how many minutes you talk.
Minutes Talked
TotalLongD
istan c
e
Tel
eph
oneBill
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1-40
Variable Cost Per Unit ExampleVariable Cost Per Unit Example
Minutes Talked
Pe
rM
inute
Teleph
one
Charg e
The cost per long distance minute talked isconstant. For example, 5 cents per minute.
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Total Fixed Cost ExampleTotal Fixed Cost Example
Your monthly basic telephone bill probablydoes not change even if you do not make
any calls
Number of Local Calls
upto 100 per month
Mon
thlyBasic
Tele
phone
Bill
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Fixed Cost Per Unit ExampleFixed Cost Per Unit Example
Number of Local
Calls
Month
lyBasicTe
leph
one
Billp
erLoc
alCal
l
The average cost per local call decreases asmore local calls are made.
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Cost ClassificationsCost 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.
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Direct and Indirect CostsDirect and Indirect Costs
Direct costs Costs that can be
easily andconveniently traced to
a product ordepartment.
Example: cost ofpaint in the paint
department of anautomobile assemblyplant.
Indirect costs Costs that must be
allocated in order tobe assigned to a
product ordepartment.
Example: cost ofnational advertising
for an airline isindirect to a particularflight.
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A cost can be direct to the department,but indirect to units of product producedin the department.
Example: department managers salary.
Tracing costs directly to departments orproducts helps to identify and eliminate
non-value added costs.
Direct and Indirect CostsDirect and Indirect Costs
C t ll bl dControllable and
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A cost that can be significantly influencedby a manager is a controllable cost.
Controllable andControllable and
Uncontrollable CostsUncontrollable Costs
Cost item Manager Classificaton
Cost of food used Restaurant Controllable
in a restaurant manager
Cost of national Restaurant Uncontrollable
advertising by a manager
restaurant chain
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Opportunity CostOpportunity Cost
The potential benefit that isgiven up when onealternative is selected over
another. Example: If you were
not attending college,you could be earning$20,000 per year.
Your opportunity costof attending college for one yearis $20,000.
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Sunk CostsSunk Costs
All costs incurred in the past that cannot bechanged by any decision made now or in thefuture are sunk costs. Sunk costs should not be
considered in decisions. Example: You bought an automobile that cost
$12,000 two years ago. The $12,000 cost issunk because whether you drive it, park it, tradeit, or sell it, you cannot change the $12,000cost.
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Differential CostsDifferential Costs
Costs that differ between alternatives.
Example:You can earn $1,500 per month in yourhometown or $2,000 per month in a nearby city.
Your commuting costs are $50 per month in yourhometown and $300 per month to the city.
What is your differential cost?$300 - $50 = $250
Cost unit
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Cost unita unit or quantity of product for which costs may be
ascertained or with which costs may be identified
e.G Brick work-per1000 bricks
Collieries- pertonne of coal
Textile mills- peryard / lb. ofcloth or yarn
Electricity companies perunit of elec. Watt hour unit
Transport co.- per tonne, perpassenger
Steel mills- per tonne of steel mass Weight-Dairy products- kilogram, litre, tonne,
Length/dimension-metre, yard, M3
Number -number of pieces / units
Hotel- per room per day,nursing home- per bed per day
Gas- per cft / m3 ,
timber - per m3
Marginal Costs and AverageMarginal Costs and Average
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Marginal Costs and AverageMarginal Costs and Average
CostsCosts
The extra costincurred to produceone additional unit.
The total cost toproduce a quantity
divided by thequantity produced.
Marginal and average costs arelargely a function of cost behavior
-- variable and fixed costs.
AND NOW
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AND, NOWAND, NOW
???????
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We believe
that its morethan
enough!!!!
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f
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Do you feel happy
at the end?
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End of Chapter 1End of Chapter 1