MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 8
COST CONCEPTS AND CLASSIFICATIONS
I.

Questions
1. The phrase different costs for different purposes refers to the fact that
the word cost can have different meanings depending on the context in
which it is used. Cost data that are classified and recorded in a particular
way for one purpose may be inappropriate for another use.
2. Fixed costs remain constant in total across changes in activity, whereas
variable costs change in proportion to the level of activity.
3. Examples of direct costs of the food and beverage department in a hotel
include the money spent on the food and beverages served, the wages of
table service personnel, and the costs of entertainment in the dining room
and lounge. Examples of indirect costs of the food and beverage
department include allocations of the costs of advertising for the entire
hotel, of the costs of the grounds and maintenance department, and of the
hotel general managers salary.
4. The cost of idle time is treated as manufacturing overhead because it is a
normal cost of the manufacturing operation that should be spread out
among all of the manufactured products. The alternative to this treatment
would be to charge the cost of idle time to a particular job that happens to
be in process when the idle time occurs. Idle time often results from a
random event, such as a power outage. Charging the cost of the idle time
resulting from such a random event to only the job that happened to be in
process at the time would overstate the cost of that job.
5. a. Uncontrollable cost
b. Controllable cost
c. Uncontrollable cost
6. Product costs are costs that are associated with manufactured goods until
the time period during which the products are sold, when the product costs
become expenses. Period costs are expensed during the time period in
which they are incurred.
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Chapter 8 Cost Concepts and Classifications

7. The most important difference between a manufacturing firm and a

service industry firm, with regard to the classification of costs, is that the
goods produced by a manufacturing firm are inventoried, whereas the
services produced by a service industry firm are consumed as they are
produced. Thus, the costs incurred in manufacturing products are treated
as product costs until the period during which the goods are sold. Most of
the costs incurred in a service industry firm to produce services are
operating expenses that are treated as period costs.
8. Product costs are also called inventoriable costs because they are assigned
to manufactured goods that are inventoried until a later period, when the
products are sold. The product costs remain in the finished goods
inventory account until the time period when the goods are sold.
9. A sunk cost is a cost that was incurred in the past and cannot be altered by
any current or future decision. A differential cost is the difference in a
cost item under two decision alternatives.
10. a.
b.
c.
d.

Direct cost
Direct cost
Indirect cost
Indirect cost

11. The two properties of a relevant cost are:

1. it differs between the decision options
2. it will be incurred in the future
12. The three types of product costs are:
1. direct materials the materials used in manufacturing the product,
which become a physical part of the finished product.
2. direct labor the labor used in manufacturing the product.
3. factory overhead the indirect costs for materials, labor, and facilities
used to support the manufacturing process, but not used directly in
manufacturing the product.
13. The three types of manufacturing inventories are:
1. materials inventory the store of materials used in the manufacturing
process or in providing the service.

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Cost Concepts and Classifications Chapter 8

2. work in process inventory accounts for all costs put into the
manufacturing of products that are started but not complete at the
financial statement date.
3. finished goods inventory the cost of goods that are ready for sale.
14. Direct materials include the materials in the product and a reasonable
allowance for scrap and defective units, while indirect materials are
materials used in manufacturing that are not physically part of the finished
product.
15. The income statement of a manufacturing company differs from the
income statement of a merchandising company in the cost of goods sold
section. A merchandising company sells finished goods that it has
purchased from a supplier. These goods are listed as purchases in the
cost of goods sold section. Since a manufacturing company produces its
goods rather than buying them from a supplier, it lists cost of goods
manufactured in place of purchases. Also, the manufacturing company
identifies its inventory in this section as Finished Goods inventory, rather
than as Merchandise Inventory.
16. Yes, costs such as salaries and depreciation can end up as part of assets
on the balance sheet if these are manufacturing costs. Manufacturing costs
are inventoried until the associated finished goods are sold. Thus, if some
units are still in inventory, such costs may be part of either Work in
Process inventory or Finished Goods inventory at the end of a period.
17. No. A variable cost is a cost that varies, in total, in direct proportion to
changes in the level of activity. A variable cost is constant per unit of
product. A fixed cost is fixed in total, but the average cost per unit
changes with the level of activity.
18. Manufacturing overhead is an indirect cost since these costs cannot be
easily and conveniently traced to particular units of products.

19.

Direct labor cost (34 hours P15 per hour)...........................

Manufacturing overhead cost (6 hours P15 per hour).........
Total wages earned.................................................................

20.
8-3

P510
90
P600

Chapter 8 Cost Concepts and Classifications

Direct labor cost (45 hours P14 per hour).........................

Manufacturing overhead cost (5 hours P7 per hour).........
Total wages earned...............................

P630
35
P665

II. Exercises
Exercise 1 (Schedule of Cost of Goods Manufactured and Sold; Income
Statement)
Requirement 1
Amazing Aluminum Company
Schedule of Cost of Goods Manufactured
For the Year Ended December 31, 2005
Direct material:
Raw-material inventory, January 1..........................
Add: Purchases of raw material..............................
Raw material available for use.................................
Deduct: Raw-material inventory, December 31

P 60,000
250,000
P310,000
70,000

Raw material used

P240,000

Direct labor.....................................................................
Manufacturing overhead:
Indirect material

400,000
P 10,000

Indirect labor

25,000

Depreciation on plant and equipment

Utilities
...........................................................................
...........................................................................
Other
...........................................................................
...........................................................................
Total manufacturing overhead
Total manufacturing costs...............................................
Add: Work-in-process inventory, January 1..................
Subtotal...........................................................................
..................................................................................
Deduct: Work-in-process inventory, December 1..........
Cost of goods manufactured...........................................
8-4

100,000
25,000
30,000
190,000
P830,000
120,000
P950,000
115,000
P835,000

Cost Concepts and Classifications Chapter 8

Requirement 2
Amazing Aluminum Company
Schedule of Cost of Goods Sold
For the Year Ended December 31, 2005
Finished goods inventory, January 1...................................................
Add: Cost of goods manufactured.....................................................
Cost of goods available for sale..........................................................
Deduct: Finished goods inventory, December 31..............................
Cost of goods sold...............................................................................

P150,000
835,000
P985,000
165,000
P820,000

Requirement 3
Amazing Aluminum Company
Income Statement
For the Year Ended December 31, 2005
Sales revenue.......................................................................................
Less: Cost of goods sold.....................................................................
Gross margin.......................................................................................
Selling and administrative expenses...................................................
Income before taxes.............................................................................
Income tax expense.............................................................................
Net income ........................................................................................

P1,105,000
820,000
P 285,000
110,000
P 175,000
70,000
P 105,000

Exercise 2

a.
b.
c.
d.
e.
f.
g.
h.
i.

Cost Item
Transportation-in costs on materials
purchased
Assembly-line workers wages
Property taxes on work in process
inventories
Salaries of top executives in the company
Overtime premium for assembly workers
Sales commissions
Sales personnel office rental
Production supervisory salaries
Controllers office supplies

8-5

Fixed (F)
Variable (V)

Period (P)
Product (R)

V
V

R
R

V
F
V
V
F
F
F
Fixed (F)

R
P
R
P
P
R
P
Period (P)

Chapter 8 Cost Concepts and Classifications

j.
k.
l.
m.
n.
o.
p.
q.
r.
s.
t.

Cost Item
Executive office heat and air conditioning
Executive office security personnel
Supplies used in assembly work
Factory heat and air conditioning
Power to operate factory equipment
Depreciation on furniture for sales staff
Varnish used for finishing product
Marketing personnel health insurance
Packaging materials for finished product
Salary of the quality control manager
who checks work on the assembly line
Assembly-line workers dental insurance

Variable (V)
F
F
V
F
V
F
V
F
V

Product (R)
P
P
R
R
R
P
R
P
R

F
F

R
R

Exercise 3 (Cost Classifications; Manufacturer)

1.
2.
3.
4.
5.
6.
7.
8.
9.

a, d, g, i
a, d, g, j
b, f
b, d, g, k
a, d, g, k
a, d, g, j
b, c, f
b, d, g, k
b, c and d*, e and f and g*, k*
* The building is used for several purposes.

10.
11.
12.
13.
14.

b, c, f
b, c, h
b, c, f
b, c, e
b, c and d, e and f and g, k

The building that the furnace heats is used for several purposes.

15. b, d, g, k
Exercise 4 (Economic Characteristics of Costs)
1. marginal cost
2. sunk cost
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Cost Concepts and Classifications Chapter 8

3.
4.
5.
6.

average cost
opportunity cost
differential cost
out-of-pocket cost

Exercise 5 (Cost Classifications; Hotel)

1.
2.
3.
4.
5.
6.
7.
8.

a, c, e, k
b, d, e, k
d, e, i
d, e, i
a, d, e, k
a, d, e, k
d, e, k
b, d, e, k

Unless the dishwasher has been used improperly.

9. h
10. a, d, e*, j
* The hotel general manager may have some control over the total space
allocated to the kitchen.

11.
12.
13.
14.

i
j
a, c, e
e, k

Exercise 6
Pickup Truck Output
Variable production costs
Fixed production costs

3,000 trucks
P 29,640,000
39,200,000
8-7

6,000 trucks
P 59,280,000
39,200,000

9,000 trucks
P 88,920,000
39,200,000

Chapter 8 Cost Concepts and Classifications

Variable selling costs
Fixed selling costs
Total costs

4,500,000
13,660,000
P 87,000,000

9,000,000
13,660,000
P121,140,000

13,500,000
13,660,000
P155,280,000

Selling price per truck

46,000

40,100

35,900

Unit cost

29,000

20,190

17,253

Profit per truck

17,000

19,910

18,647

Exercise 7
(see next page)
Exercise 8
1. The wages of employees who build the sailboats: direct labor cost.
2. The cost of advertising in the local newspapers: marketing and selling
cost.
3. The cost of an aluminum mast installed in a sailboat: direct materials cost.
4. The wages of the assembly shops supervisor: manufacturing overhead
cost.
5. Rent on the boathouse: a combination of manufacturing overhead,
administrative, and marketing and selling cost. The rent would most likely
be prorated on the basis of the amount of space occupied by
manufacturing, administrative, and marketing operations.
6. The wages of the companys bookkeeper: administrative cost.
7. Sales commissions paid to the companys salespeople: marketing and
selling cost.
8. Depreciation on power tools: manufacturing overhead cost.

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Cost Concepts and Classifications Chapter 8

Exercise 7
Variable
Cost
1.
2.
3.
4.
5.
6.
7.
8.
9.
*
1

Wood used in a table (P200

per table)
Labor cost to assemble a
table (P80 per table)
Salary of the factory
supervisor (P76,000 per
year)
Cost of electricity to
produce tables (P4 per
machine-hour)
Depreciation of machines
used to produce tables
(P20,000 per year)
Salary of the company
president (P200,000 per
year)
Advertising expense
(P500,000 per year)
Commissions paid to
salespersons (P60 per table
sold)
Rental income forgone on
factory space

Fixed Cost

Period
(Selling and
Administrative) Cost

Product Cost
Direct
Manufacturing
Labor
Overhead

Sunk Cost

Opportunity
Cost

X
X

X
X

Direct
Materials

X*

X
X1

This is a sunk cost because the outlay for the equipment was made in a previous period.
This is an opportunity cost because it represents the potential benefit that is lost or sacrificed as a result of using the factory space to produce tables. Opportunity cost
is a special category of cost that is not ordinarily recorded in an organizations accounting books. To avoid possible confusion with other costs, we will not attempt to
classify this cost in any other way except as an opportunity cost.

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Chapter 8 Cost Concepts and Classifications

Exercise 9

1.
2.

Cost
The salary of the head chef
The salary of the head chef

3.
4.
5.
6.

Room cleaning supplies

Flowers for the reception desk
The wages of the doorman
Room cleaning supplies

7.

Fire insurance on the hotel

building
Towels used in the gym

8.

Cost Object
The hotels restaurant
A particular restaurant
customer
A particular hotel guest
A particular hotel guest
A particular hotel guest
The housecleaning
department
The hotels gym

Direc
t
Cost
X

The hotels gym

Indirec
t
Cost
X

X
X
X
X

Note: The room cleaning supplies would most likely be considered an indirect
cost of a particular hotel guest because it would not be practical to keep track
of exactly how much of each cleaning supply was used in the guests room.
III. Problems
Problem 1
The relevant costs for this decision are the differential costs. These are:
Opportunity cost or lost wages (take home)
[P1,500 x 70% x 12 months]........
P12,600
Tuition.....................................................
2,200
Books and supplies..................................
300
Total differential costs....................... P15,100
Room and board, clothing, car, and incidentals are not relevant because these
are presumed to be the same whether or not Francis goes to school. The
possibility of part-time work, summer jobs, or scholarship assistance could be
considered as reductions to the cost of school. If students are familiar with the
time value of money, then they should recognize that the analysis calls for a
comparison of the present value of the differential after-tax cash inflows with
the present value of differential costs of getting the education (including the
opportunity costs of lost income).
Problem 2
Requirement (a)
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Cost Concepts and Classifications Chapter 8

Only the differential outlay costs need be considered. The travel and other
variable expenses of P22 per hour would be the relevant costs. Any amount
received in excess would be a differential, positive return to Pat.
Requirement (b)
The opportunity cost of the hours given up would be considered in this
situation. Unless Pat receives more than the P100 normal consulting rate, the
contract would not be beneficial.
Requirement (c)
In this situation Pat would have to consider the present value of the contract
and compare that to the present value of the existing consulting business. The
final rate may be more or less than the normal P100 rate depending on the
outcome of Pats analysis.
Problem 3
Utilities for the bakery
Paper used in packaging product
Salaries and wages in the bakery
Cookie ingredients
Bakery labor and fringe benefits
Bakery equipment maintenance
Depreciation of bakery plant and equipment
Uniforms
Insurance for the bakery
Boxes, bags, and cups used in the bakery
Bakery overtime premiums
Bakery idle time
Total product costs in pesos

2,100
90
19,500
35,000
1,300
800
2,000
400
900
1,100
2,600
500
66,290

Problem 4
Administrative costs
Rent for administration offices
Advertising
Office managers salary
8-11

1,000
17,200
1,900
13,000

Chapter 8 Cost Concepts and Classifications

Total period costs in pesos

33,100

Problem 5
Requirement (a)
Sunk costs not shown could include lost book value on traded assets,
depreciation estimates for new investment, and interest costs on capital needed
during facilities construction.
Requirement (b)
The client might be used to differential cost as a decision tool, and believes
(correctly) that use of differential analyses has several advantages --- it is
quicker, requires less data, and tends to give a better focus to the decision. The
banker might suspect the client of hiding some material data in order to make
the proposal more acceptable to the financing agency.
Problem 6
Requirement (1)
EH Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31
Direct materials:
Raw materials, inventory, January 1
Add: Purchases of raw materials
Raw materials available for use
Deduct: Raw materials inventory,
December 31
Raw materials used in production
Direct labor
Manufacturing overhead:
Utilities, factory
Depreciation, factory
Insurance, factory
Supplies, factory
Indirect labor
Maintenance, factory
Total manufacturing overhead cost
Total manufacturing cost
8-12

P 45,000
375,000
420,000
30,000
P 390,000
75,000
18,000
81,000
20,000
7,500
150,000
43,500
320,000
785,000

Cost Concepts and Classifications Chapter 8

Add: Work in process inventory, January 1

90,000
875,000

Deduct: Work in process inventory,

December 31
Cost of goods manufactured

50,000
P825,000

Requirement (2)
The cost of goods sold would be computed as follows:
Finished goods inventory, January 1
Add: Cost of goods manufactured
Goods available for sale
Deduct: Finished goods inventory, December 31
Cost of goods sold

P130,000
825,000
955,000
105,000
P850,000

Requirement (3)
EH Corporation
Income Statement
For the Year Ended December 31
Sales
Cost of goods sold (above)
Gross margin
Selling and administrative expenses:
Selling expenses
Administrative expenses
Net operating income

P1,250,000
850,000
400,000
P 70,000
135,000
P

8-13

205,000
195,000

Chapter 8 Cost Concepts and Classifications

Problem 7
Note to the Instructor: Some of the answers below are debatable.

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.

Variable or
Cost Item
Fixed
Depreciation, executive jet............................................................................
F
Costs of shipping finished goods to customers..............................................
V
Wood used in manufacturing furniture..........................................................
V
Sales managers salary..................................................................................
F
Electricity used in manufacturing furniture...................................................
V
Secretary to the company president...............................................................
F
Aerosol attachment placed on a spray can produced by the company............
V
Billing costs..................................................................................................
V
Packing supplies for shipping products overseas...........................................
V
Sand used in manufacturing concrete............................................................
V
Supervisors salary, factory...........................................................................
F
Executive life insurance................................................................................
F
Sales commissions........................................................................................
V
Fringe benefits, assembly line workers..........................................................
V
Advertising costs...........................................................................................
F
Property taxes on finished goods warehouses................................................
F
Lubricants for production equipment............................................................
V

*Could be an administrative cost.

**Could be an indirect cost.

Selling
Cost

Administrative
Cost
X

Manufacturing
(Product) Cost
Direct
Indirect

X
X
X
X
X
X
X*
X
X
X
X
X
X**
X
X
X

Cost Concepts and Classifications Chapter 8

Problem 8
Requirement (1)

Variable
Cost

Name of the Cost

Lings present salary of P400,000 per
month...........................................................................
Rent on the garage, P15,000 per month...........................
Rent of production equipment, P50,000 per
month...........................................................................
Materials for producing flyswatters, at
P30.00 each.................................................................
X
Labor cost of producing flyswatters, at
P50.00 each.................................................................
X
Rent of room for a sales office, P7,500 per
month...........................................................................
Answering device attachment, P2,000 per
month...........................................................................
Interest lost on savings account, P100,000
per year........................................................................
Advertising cost, P40,000 per month...............................
Sales commission, at P10.00 per flyswatter.....................
X
Legal and filing fees, P60,000.........................................

Fixed
Cost

Direct
Materials

Product Cost
Direct
Mfg.
Labor
Overhead

Period
(Selling
and
Admin.)
Cost

Opportunity
Cost

Sunk
Cost

X
X

X
X
X

X
X

X
X

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Chapter 8 Cost Concepts and Classifications

Requirement (2)
The P60,000 legal and filing fees are not a differential cost. These legal and
filing fees have already been paid and are a sunk cost. Thus, the cost will not
differ depending on whether Ling decides to produce flyswatters or to stay
with the consulting firm. All other costs listed above are differential costs since
they will be incurred only if Ling leaves the consulting firm and produces the
flyswatters.
Problem 9
Requirement (1)
Ms. Rios first action was to direct that discretionary expenditures be delayed
until the first of the new year. Providing that these discretionary
expenditures can be delayed without hampering operations, this is a good
business decision. By delaying expenditures, the company can keep its cash a
bit longer and thereby earn a bit more interest. There is nothing unethical
about such an action. The second action was to ask that the order for the parts
be cancelled. Since the clerks order was a mistake, there is nothing unethical
about this action either.
The third action was to ask the accounting department to delay recognition of
the delivery until the bill is paid in January. This action is dubious. Asking the
accounting department to ignore transactions strikes at the heart of the
integrity of the accounting system. If the accounting system cannot be trusted,
it is very difficult to run a business or obtain funds from outsiders. However,
in Ms. Rios defense, the purchase of the raw materials really shouldnt be
recorded as an expense. He has been placed in an extremely awkward position
because the companys accounting policy is flawed.
Requirement (2)
The companys accounting policy with respect to raw materials is incorrect.
Raw materials should be recorded as an asset when delivered rather than as an
expense. If the correct accounting policy were followed, there would be no
reason for Ms. Rio to ask the accounting department to delay recognition of
the delivery of the raw materials. This flawed accounting policy creates
incentives for managers to delay deliveries of raw materials until after the end
of the fiscal year. This could lead to raw materials shortages and poor
relations with suppliers who would like to record their sales before the end of
the year.
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Cost Concepts and Classifications Chapter 8

The companys manage-by-the-numbers approach does not foster ethical

behaviorparticularly when managers are told to do anything so long as you
hit the target profits for the year. Such no excuses pressure from the top
too often leads to unethical behavior when managers have difficulty meeting
target profits.
IV. Multiple Choice Questions
1.
2.
3.
4.
5.
6.

B
D
B
A
C
D

7.
8.
9.
10.
11.
12.

C
D
C
C
A
C

13. D
14. D
15. B
16. A
17. C
18. C

19.
20.
21.
22.
23.
24.

A
A*
B
B
C
C

25.
26.
27.
28.
29.
30.

C
B
B
A **
A
B

Controllable costs are those costs that can be influenced by a specified

manager within a given time period.
** The answer assumes absorption costing method is used.

Supporting Computations
14. P60 + P10 + P18 + P4 = P92
16. P60 + P10 + P18 + P32 = P120
15. P32 + P16 = P48
17. P4 + P16 = P20

8-17