Chapter 2 - Basic cost management concepts. After completing this chapter, you should be able to: Explain what is meant by the word cost; distinguish among product costs, period costs, and expenses; describe the role of costs in published financial statements.
Chapter Basic Cost Management Concepts Copyright © 2014 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 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 $ 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 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 $ 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 $ 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 $ 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 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 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 ... Schedule Total manufacturing overhead $ 23 0,000 Raw material used $ Direct labor Total manufacturing overhead 134,980 50,000 23 0,000 Total manufacturing costs Add: Work -in- process inventory, January... 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 2? ?20 Controllable and... Goods Manufactured Raw material used $ Direct labor Total manufacturing overhead 134,980 50,000 23 0,000 Total manufacturing costs Add: Work -in- process inventory, January $ 414,980 120 Subtotal Deduct: