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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Basic CostManagement Conceptsand Accounting for MassCustomization Operations
Chapter 2
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Process 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?
A cost
is the measure ofresources givenup to achieve a
particular purpose.
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Product Costs, Period Costs and Expenses
Product costs are costs associated with goods forsale until the time period during which the productsare sold, at which time the costs become expenses.
Period costs are costs that are expensed during thetime period in which they are incurred.
Expenses are the consumption of assets for thepurpose of generating revenue.
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Product Costs
Cost of goods sold
Period Costs
Operating expenses
Cost Classifications on FinancialStatements Income Statement
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Merchandiser
Current Assets Cash
Receivables
Prepaid Expenses
MerchandiseInventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
InventoriesRaw Materials
Work in Process
Finished Goods
Cost Classifications on FinancialStatements Balance Sheet
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Merchandiser
Current Assets Cash
Receivables
Prepaid Expenses
MerchandiseInventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
InventoriesRaw Materials
Work in Process
Finished Goods
Cost Classifications on FinancialStatements Balance Sheet
Those materialswaiting to beprocessed.
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Merchandiser
Current Assets Cash
Receivables
Prepaid Expenses
MerchandiseInventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
InventoriesRaw Materials
Work in Process
Finished Goods
Cost Classifications on FinancialStatements Balance Sheet
Partially complete
products
material towhich some labor
and/or overhead hasbeen added.
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Merchandiser
Current Assets Cash
Receivables
Prepaid Expenses
MerchandiseInventory
Manufacturer
Current Assets
Cash
Receivables
Prepaid Expenses
InventoriesRaw Materials
Work in Process
Finished Goods
Cost Classifications on FinancialStatements Balance Sheet
Completed productsawaiting sale.
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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
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Manufacturing Costs
TheProduct
DirectLabor
DirectMaterial
ManufacturingOverhead
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Direct Material
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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Cost of salaries, wages, and fringebenefits for personnel who work
directly on manufactured products.
Direct Labor
Example:Wages paid to an
automobile assemblyworker.
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All other manufacturing costs
Manufacturing Overhead
Materials used to support
the production process.Examples: lubricants andcleaning supplies used in anautomobile assembly plant.
Indirect
Labor
Indirect
Material
Other
Costs
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All other manufacturing costs
Manufacturing 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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All other manufacturing costs
Manufacturing Overhead
Examples: depreciation
on plant and equipment,property taxes,insurance, utilities,
overtime premium, andunavoidable idle time.
Indirect
Labor
Indirect
Material
Other
Costs
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Classifications of Costs inManufacturing Companies
PrimeCost
ConversionCost
Manufacturing costs are oftencombined as follows:
DirectMaterial
DirectLabor
ManufacturingOverhead
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Manufacturing Cost Flows
ManufacturingOverhead
Direct Material
Direct LaborWork inProcess
Inventory
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Manufacturing Cost Flows
ManufacturingOverhead
Direct Material
Direct Labor
FinishedGoods
Inventory
Work inProcess
Inventory
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Manufacturing Cost Flows
ManufacturingOverhead
Direct Material
Direct Labor
FinishedGoods
Inventory
Cost ofGoods
Sold
Work inProcess
Inventory
E h
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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 GoodsManufactured
Exh.
2-7
E h
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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 GoodsManufactured
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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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 GoodsManufactured
Include all direct laborcosts incurred during the
current period.
Exh.
2-7
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 GoodsManufacturedComputation 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
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 GoodsManufactured
Beginning work-in-process inventory iscarried over from the
prior period.
Exh.
2-9
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 GoodsManufactured
Ending work-in-process inventorycontains the cost of unfinished goods,and is reported in the current assets
section of the balance sheet.
Exh.
2-9
Exh
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Income Statement for aManufacturer
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$
Exh.
2-7
Exh
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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 aManufacturerComet 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$
Exh.
2-7
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Identifying 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 thatcause costs to beincurred are called
cost drivers.
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Cost Classifications
Cost behavior meanshow a cost will reactto changes in thelevel of businessactivity.
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Cost Classifications
Cost behavior meanshow a cost will reactto changes in thelevel of businessactivity.
Total variable costschange when activitychanges.
Total fixed costs remainunchanged whenactivity changes.
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Total Variable Cost Example
Your total long distance telephone bill isbased on how many minutes you talk.
Minutes Talked
TotalL
ongDistance
TelephoneBill
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Variable Cost Per Unit Example
Minutes Talked
Pe
rMinute
Teleph
oneCharge
The cost per long distance minute talked isconstant. For example, 5 cents per minute.
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Total Fixed Cost Example
Your monthly basic telephone bill probablydoes not change when you make more local
calls.
Number of Local Calls
Mon
thlyBasic
Tele
phoneBill
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Fixed Cost Per Unit Example
Number of Local Calls
Monthly
BasicTelephone
Billp
erLocalCall
The average cost per local call decreases asmore local calls are made.
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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.
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Direct 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 Costs
C t ll bl d
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A cost that can be significantly influencedby a manager is a controllable cost.
Controllable andUncontrollable 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 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 oneyear is $20,000.
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Sunk 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 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
Marginal Costs and Average
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Marginal Costs and AverageCosts
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.
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Costs and Benefits of Information
Costs Benefits
More information does not mean morebenefits if information overload results.