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Chapter 2
Basic Cost Terminology
• Cost – resource sacrificed to achieve a
specific objective
• Actual cost – a cost that has occurred
• Budgeted cost – a predicted cost
• Cost object – anything of interest for which
a cost is desired
Manufacturing Costs
Direct
Materials
Direct
Labor
The Product
Manufacturing
Overhead
Further Classification of Labor
Costs
Idle Time
Treated as
manufacturing
overhead cost
Overtime
Premium of
Factory Workers
Treated as
manufacturing
overhead cost
Labor Fringe
Benefits
Treated as
manufacturing
overhead or direct
labor
Nonmanufacturing Costs
Marketing and
Selling Cost
Administrative
Cost
R&D
Costs necessary to get the
order and deliver the
product.
All executive,
organizational, and
clerical costs.
Manufacturing Cost Flows
Costs
Material Purchases
Direct Labor
Balance Sheet
Inventories
Raw Material
Work in
Process
Manufacturing
Overhead
Finished
Goods
Selling and
Administrative
Income
Statement
Expenses
Period Expenses
Cost of
Goods
Sold
Selling and
Administrative
Product Costs Versus Period
Costs
Product costs include
direct materials, direct
labor, and
manufacturing
overhead.
Cost of Good Sold
Inventory
Period costs are not
included in product
costs. They are
expensed on the
income statement.
Expense
Sale
Balance
Sheet
Income
Statement
Income
Statement
Balance Sheet
Merchandiser
Current assets
–
–
–
–
Cash
Receivables
Prepaid expenses
Merchandise inventory
Manufacturer
Current Assets
 Cash
 Receivables
 Prepaid Expenses
 Inventories
Raw Materials
Work in Process
Finished Goods
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
Manufacturing Company
Cost of goods sold:
Beg. finished
goods inv.
+ Cost of goods
manufactured
Goods available
for sale
- Ending
finished goods
inventory
= Cost of goods
sold
$ 14,200
234,150
$248,350
(12,100)
$236,250
Cost of Goods Manufactured
Cellular Products
Schedule of Cost of Goods Manufactured
For the Year Ended December 31, 2007 (in thousands)
Direct Materials:
Beginning Inventory, January 1
$ 11,000
Add: Purchases
73,000
Cost of Direct Materials Available for Use
84,000
Less: Ending Inventory, December 31
8,000
Direct Materials Used
76,000
Direct Labor
9,000
Manufacturing Overhead:
Indirect Labor
7,000
Supplies
2,000
Heat, Light & Power
5,000
Depreciation - plant building
2,000
Depreciation - plant equipment
3,000
Miscellaneous
1,000
Total Manufacturing Overhead Costs
20,000
Manufacturing costs incurred during 2007
105,000
Add: Beginning WIP, January 1
6,000
Total Manufacturing Costs to account for
111,000
Less: Ending WIP, December 31
7,000
Cost of Goods Manufactured
$ 104,000
Calculates the cost of Direct
Materials Used
Accumulates the three
product costs for the
current period
Adjusts the current period
manufacturing costs to
account for units actually
completed
Income Statement
Cellular Products
Income Statement
For the Year Ended December 31, 2007 (in thousands)
Revenues
Cost of Goods Sold
Beginning Finished Goods, January 1
Cost of Goods Manufactured
Cost of Goods Available for sale
Ending Finished Goods, December 31
Cost of Goods Sold
Gross Profit
Operating Costs:
Marketing, distribution, and customer-service
Total operating costs
Operating Income
$210,000
22,000
104,000
126,000
18,000
108,000
102,000
70,000
70,000
$32,000
Figure carries
forward from the
Schedule of Cost
of Goods
Manufactured
Period Costs are
expensed as
incurred
Cost Behavior
• Variable costs – changes in total in
proportion to changes in the related level of
activity or volume
• Fixed costs – remain unchanged in total
regardless of changes in the related level of
activity or volume
• Costs are fixed or variable only with respect
to a specific activity or a given time period
Cost Behavior, continued
• Variable costs – are constant on a per-unit basis. If
a product takes 5 pounds of materials each, it stays
the same per unit regardless of one, ten or a
thousand units are produced
• Fixed costs – change inversely with the level of
production. As more units are produced, the same
fixed cost is spread over more and more units,
reducing the cost per unit
Variable Costs
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
Unit Variable Cost Graph
Cost per Unit
Total Costs
Total Variable Cost Graph
$20
$15
$10
$5
0
10 20
30
Units Produced (000)
0
10 20
30
Units Produced (000)
Units
Produced
5,000
10,000
15,000
20,000
25,000
30,000
Total Cost
Cost per Unit
$ 50,000 $10
100,000 10
150,000 10
200,000 10
250,000 10
300,000 10
Fixed Costs
$150,000
$125,000
$100,000
$75,000
$50,000
$25,000
Unit Fixed Cost Graph
Cost per Unit
Total Costs
Total Fixed Cost Graph
$1.50
$1.25
$1.00
$.75
$.50
$.25
0
100 200 300
Units Produced (000)
0
100 200 300
Units Produced (000)
Units
Produced
Total Cost
Cost per Unit
50,000 $75,000 $1.500
100,000 75,000
.750
150,000 75,000
.500
200,000 75,000
.375
250,000 75,000
.300
300,000 75,000
.250
Types of Fixed Costs
Committed
Discretionary
Long-term, cannot be
significantly reduced
in the short term.
May be altered in the
short-term by current
managerial decisions
Examples
Examples
Depreciation on
Equipment and
Real Estate Taxes
Advertising and
Research and
Development
A Cost Caveat
• Unit costs should be used cautiously. Since
unit costs change with a different level of
output or volume, it may be more prudent to
base decisions on a total dollar basis.
– Unit costs that include fixed costs should
always reference a given level of output or
activity
– Unit Costs are also called Average Costs
Cost Behavior Patterns Example
Bicycles by the Sea incurs variable costs of
$52 for each of its bicycles.
Bicycles by the Sea also incurs $94,500 in
fixed costs per year
Use Unit Costs Cautiously
What is the unit cost when Bicycles
assembles 1,000 bicycles in a year?
Use Unit Costs Cautiously
Assume that Bicycles management uses a
unit cost of $146.50
Management is budgeting costs for
different levels of production.
What is their budgeted cost for an
estimated production of 600 bicycles?
600 × $146.50 = $87,900?
Use Unit Costs Cautiously
What is their budgeted cost for an estimated
production of 3,500 bicycles?
3,500 × $146.50 = $512,750?
Direct & Indirect Costs
• Direct costs – can be conveniently and
economically traced (tracked) to a cost
object
• Indirect costs – cannot be conveniently or
economically traced (tracked) to a cost
object. Instead of being traced, these costs
are allocated to a cost object in a rational
and systematic manner
Assigning Costs to Cost Objects
• Cost accumulation – a collection of cost
data in an organized manner
• Cost assignment – a general term that
includes associating accumulated costs with
a cost object. This includes:
– Tracing accumulated costs with a direct
relationship to the cost object and
– Allocating accumulated costs with an indirect
relationship to a cost object
BMW: Assigning Costs to a Cost
Object
Direct or Indirect?
Consider a supervisor’s salary in the canning department of
Campbell Soup Company.
If the cost object is the department, the supervisor’s salary
is a direct cost.
If the cost object is a can of soup (the “product” of the
company), the supervisor’s salary is an indirect cost.
Relationships of Types of Costs
Direct
Variable
Fixed
Indirect
Different Definitions of Costs
for Different Applications
• Pricing and product-mix decisions – may use a
“super” cost approach (comprehensive)
• Contracting with government agencies – very
specific definitions of cost for “cost plus
profit” contracts
• Preparing external-use financial statements –
GAAP-driven product costs only
Additional Cost Terminology
• Variable Costs – costs that change in total
in relation to some chosen activity or output
• Fixed Costs – costs that do not change in
total in relation to some chosen activity or
output
• Mixed Costs – costs that have both fixed
and variable components; also called
semivariable costs
Cost Function
La Playa Hotel offers an airline
three alternative cost structures to
accommodate its crew overnight:
1. $60 per night per room usage
y = $60x
The slope of the cost function is $60.
Cost Function
y = Cost
$20,000
$15,000
$10,000
$5,000
$0
0
100
200
x = Number of rooms
300
Cost Function
2. $8,000 per month
y = $8,000
$8,000 is called a constant or intercept.
The slope of the cost function is zero.
Cost Function
y = Cost
$20,000
$15,000
$10,000
$5,000
$0
0
100
200
x = Number of rooms
300
Cost Function
3. $3,000 per month plus $24 per room
This is an example of a mixed cost.
y = $3,000 + $24x
y = a + bx
Cost Function
y = Cost
$20,000
$15,000
$10,000
$5,000
$0
0
100
200
x = Number of rooms
300
The Linear Cost Function
y = a + bX
The Dependent
Variable:
The cost that is
being predicted
The Independent
Variable:
The cost driver
The Intercept:
Fixed Costs
The slope of
the line:
variable cost
per unit