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The relevant range is the range of activity levels throughout which the assumptions for cost behavior are valid. Outside the relevant range, total fixed costs may change and/or variable costs per unit may change. Cost Classifications on the Balance Sheet Manufacturing companies have three inventory accounts which appear as current assets on the balance sheet: Raw Materials, Work in Process, Finished Goods. These accounts replace Merchandise Inventory which is used in a retailing company. Finished goods account is most similar to the merchandise inventory account because it contains the value of goods to be sold to customers. However, the purchases added to merchandise inventory are replaced by the cost of goods manufactured when dealing with a manufacturing rather than a retailing company because the goods to be sold are manufactured, not purchased. Rather than purchasing inventory to sell, manufacturing companies purchase raw materials which will be used to produce finished goods. Cost Classifications on the Income Statement Certain activities in these accounts appear on the Income Statement as Cost of Goods Sold or Cost of Goods Manufactured, a component of Cost of Goods Sold.
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Revised Summer 2010 Debit balance account Begin balance Additions Withdrawals End balance
Since inventory is a current asset account with a normal debit balance, the basic equation for all inventory accounts is: Beginning balance + Additions = Ending balance + Withdrawals OR Beginning balance + Additions - Withdrawals = Ending balance OR Beginning balance + Additions - Ending balance = Withdrawals OR Withdrawals + Ending balance - Beginning balance = Additions OR Withdrawals + Ending balance Additions = Beginning balance Example #1 The finished goods inventory of company XYZ on May 1 was $ 40,000. During May, $100,000 of completed goods was added. The balance on May 31 was $30,000. Determine the value of goods sold from the finished goods inventory during May. Solution #1 Beginning balance Cost of goods manufactured Goods available Deduct: Ending inventory Cost of goods sold during May $40,000 100,000 140,000 30,000 $110,000
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=Ending Balance
=Ending Balance
=Ending Balance
$20,000 40,000 70,000 110,000 80,000 30,000 10,000 50,000 20,000 10,000 10,000 38,000 60,000
Solution #2A: Schedule of Cost of Goods Sold Beginning finished goods inventory $70,000 Add: Cost of goods manufactured 270,000 Goods available for sale 340,000 Deduct: Ending finished goods inventory 30,000 Cost of goods sold $310,00
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Solution #2B:
Schedule of Cost of Goods Manufactured Direct materials: Beginning raw materials inventory $20,000 Add: Purchases of raw materials 80,000 Raw materials available for use 100,000 Deduct: Ending raw materials inventory 10,000 Raw (direct) materials used production Direct labor Manufacturing overhead: Rent, factory 50,000 Indirect labor 20,000 Depreciation, factory 10,000 Utilities, factory 10,000 Total manufacturing overhead cost Total manufacturing cost Add: Beginning work in process inventory Deduct: Ending work in process inventory Cost of goods manufactured
$90,000 110,000
Cost Classifications for Decision Making Differential Costs and Revenues differ among alternatives Opportunity Costs are the potential benefits given up by making a decision Sunk Cost is a cost previously incurred; it cannot be changed by a present or future decision
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Example #3 Classify the following costs according to the cost terms. 1. Wood used for making tables. 2. Wages of the assembly workers in a furniture factory. 3. Salary of the factory supervisor. 4. Electricity to run factory equipment. 5. Janitorial salaries. 6. Rent on a factory building. 7. Plastic parts used to make toys. 8. Glue used to make toys. 9. Lubricants on production machines. Solution #3 1. 2. 3. 4. 5. 6. 7. 8. 9.
*
These materials would usually be considered indirect. They are insignificant in amount and it would not be cost-effective to trace them to individual products.
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Practice Problems
Practice Problem #1: The Art Factory has provided the following financial information for 2009. Raw materials inventory, January 1 Work in process inventory, January 1 Finished goods inventory, January 1 Direct labor incurred Accumulated depreciation Indirect materials purchases Direct materials purchases Indirect materials used Sales commissions expense Finished goods inventory, December 31 Raw materials inventory, December 31 Rent expense, sales offices Rent expense, factory Indirect labor expense Rent expense, corporate office Depreciation expense, factory Utilities expense, factory Utilities expense, corporate office Utilities expense, sales offices Prepaid insurance Work in process inventory, December 31 $40,000 20,000 70,000 110,000 40,000 15,000 80,000 10,000 100,000 30,000 10,000 35,000 50,000 20,000 50,000 10,000 10,000 10,000 10,000 38,000 60,000
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Practice Problem #2 Black Company has provided the following information regarding activity in the inventory and expense accounts during the year: Raw Materials $100 4,200 $800 Work-inProcess Finished Goods $2,700 13,300 Cost of Goods Sold $0 6,000
$0
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16. Selling and administrative expenses are included in the schedule of cost of goods manufactured. True False 17. Factory rent is part of manufacturing overhead. True False 18. Depreciation on administrative offices equipment is a product cost. True False 19. Finished goods inventory consists of units completed that have not been sold to a customer. True False 20. Raw materials can be direct or indirect. True False
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7. At production level of 2000 units a cost is $20,000; at production level of 4500 units the same cost is $45,000. This is an example of a: a) Variable cost b) Direct cost c) Fixed cost d) Sunk cost 8. Which of the following is an example of a fixed cost in a manufacturing company: a) The cost of raw materials b) The cost of electricity for running machines c) Wages of assembly line workers d) Depreciation on factory equipment 9. Mary works at a convenience store and is paid $400 a week. She considers enrolling in a college to earn a degree. She thinks she will have to quit her job if she goes to college. The wages that she will lose if she chooses college are: a) Sunk cost b) Opportunity cost c) Indirect cost d) Prime cost 10. Which cost is not relevant to the decision whether to purchase a new chocolate dipping machine or continue using the old one: a) The cost of the new machine b) Lower maintenance costs for the new machine c) The cost of the old machine d) Additional training required for operating the new machine
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11. At the end of June XYZ company had the following balances: Direct materials used $30,000 Direct labor 18,000 Factory rent 7,000 Indirect materials 5,000 Salary of production supervisor 4,000 Advertising costs 12,000 Rent on administrative office 3,500 Depreciation on factory equipment 6,100 The total manufacturing cost was: a) $85,600 b) $70,100 c) $48,000 d) $68,600 12. Company ABC had the following balances for the month of April: Finished goods, April 1 $45,000 Cost of goods manufactured 20,000 Finished goods, April 30 14,000 The cost of goods sold for April is: a) $ 51,000 b) $ 20,000 c) $34,000 d) $ 65,000 13. Conversion costs consist of: a) Direct materials and direct labor b) Direct materials and manufacturing overhead c) Manufacturing and nonmanufacturing costs d) Direct labor and manufacturing overhead 14. A cost that goes into Work in Process inventory and then into the Finished Goods inventory before appearing on the income statement as cost of goods sold is a: a) Period cost b) Fixed cost c) Opportunity cost d) Product cost
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15. Fixed cost: a) Remains the same per unit b) Decreases per unit as the activity level rises c) Increases per unit as the activity level rises d) Varies in total 16. The following information was taken from company XYZs records for the current month. Raw materials used in production $ 35,000 ($25,000 direct, $10,000 indirect); direct labor costs incurred $20,000; selling expenses $5,000; insurance on factory $4,000; administrative salaries $12,000; Rent $15,000 (80% factory, 20% administrative offices). The total inventoriable costs for the current month were: a) $88,000 b) $61,000 c) $71,000 d) $74,000 17. Period costs are reported: a) On the balance sheet b) On the income statement c) As part of the schedule of cost of goods manufactured d) When the related products are sold 18. Commissions paid to salespersons ($10 per unit sold) are: a) Fixed cost b) Variable cost c) Sunk cost d) Differential cost 19. Which of the following statements is true: a) Product costs are expensed as incurred. b) Selling costs are considered sunk costs. c) Manufacturing overhead is a prime cost. d) Product costs are sometimes called inventoriable costs. 20. An a) b) c) d) increase in cost between two alternatives is a: Direct cost Sunk cost Incremental cost Period cost
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Practice Problem #2 Balance January 1 Additions Withdrawals Balance December 31 (1) (2) (3) (4) (5) (6) (7) Raw Work-inFinished Materials Process Goods $100 $0 $2,700 $4,200 (7) $13,300 $13,300 (1) $3,500 (6) $13,300 (4) $6,000 $800 $0 (5) $10,000 Cost of Goods Sold $0 $6,000 (2) $0 (3) $6,000
$100 + $4,200 - $800 = $3,500 $0 since there were no sales returns $0 + $6,000 - $0 = $6,000 $6,000 from Cost of Goods Sold $2,700 + $13,300 - $6,000 = $10,000 $13,300 from cost of goods manufactured in Finished Goods $13,300 as beginning and ending account balances are equal
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