P A R T O N E

An Introduction CHAPTER
to Cost Terms
and Purposes
After studying this chapter, you should be able to

1. Define and illustrate a cost object

2. Distinguish between direct costs and indirect costs
3. Explain variable costs and fixed costs
4. Interpret unit costs with caution
5. Distinguish among manufacturing-, merchandising-,
and service-sector companies
6. Describe the three categories of inventories commonly found
in manufacturing companies
7. Differentiate between inventoriable
costs and period costs
8. Explain why different ways of computing
product costs are appropriate for
different purposes

2 CHAPTER 2
Learning concepts
Understanding terms discussed in this
chapter provides the foundation for the
rest of the course.
1. Define and illustrate a cost
objective.
Cost objects
Iinclude: activities or processes; outputs
of processes, such as products, services,
and projects; parts of the organization
(e.g., departments or programs); and
customers.
Teaching Tip
Help students internalize these concepts
by making them concrete. Divide the
class into groups of about four students
each. Assign one set of cost terms to
each group (e.g., direct/indirect costs,
cost objects/cost drivers, VC/FC, etc.) Ask
each group to (1)define the terms (with
books closed), (2) give examples based
on their work experience, and (3) think of
a specific decision where the concepts
would be relevant.
2. Distinguish between direct
costs and indirect costs.
AN INTRODUCTION TO COST
TERMS AND PURPOSES 3
ifferent cost concepts and terms are often used in accounting reports. EXHIBIT 2-2
D Managers who understand these concepts and terms are able to (a)
best use the information provided, and (b) avoid misuse of that infor-
mation. Communication among managers is greatly facilitated by there being
common understanding on the meaning of cost concepts and terms. This
Cost Assignment to a Cost Object
COST ASSIGNMENT COST OBJECT
Cost assignment
Cost assignment is a general term for
attaching either direct or indirect costs to
Direct Costs
chapter discusses cost concepts and terms found in both internal and external cost objects. The distinction between
Example: Paper on Cost Tracing
uses of accounting information. which Sports Illustrated
direct and indirect costs is important
magazine is printed because direct costs are directly traced
Example: Sports Illustrated to the cost object, while indirect costs
COSTS AND COST TERMINOLOGY ______________________ magazine are ofter posted and then allocated to the
Accountants define cost as a resource sacrificed or forgone to achieve a spe-
Indirect Costs cost object with less precision. Mgt.
cific objective. It is usually measured as the monetary amount that must be Example: Lease cost for therefore, has more confidence in the
paid to acquire goods and services. An actual cost is the cost incurred (a his- Cost Allocation
Time-Warner building accuracy of direct costs. The text uses
torical cost) as distinguished from budgeted or forecasted costs. housing the senior editors the term cost tracing to refer specifically
To guide their decisions, managers want to know how much a particular of its magazines to assigning direct costs to cost object.
thing (such as a product, machine, service, or process) costs. We call this Cost allocation is reserved for assigning
“thing” a cost object, which is anything for which a separate measurement of indirect costs to cost objects.
costs is desired. Exhibit 2-1 provides examples of seven different types of cost
objects at Procter & Gamble, the consumer products company. drink. The cost of the cans or bottles can be easily traced to the Pepsi
soft drink. The term cost tracing is used to describe the assignment of
EXHIBIT 2-1 direct costs to the particular cost object.
Examples of Cost Objects at Procter & Gamble
■ Indirect costs of a cost object are related to the particular cost object but can-
COST OBJECT ILLUSTRATION
not be traced to it in an economically feasible (cost-effective) way. For exam-
Product Crest Tartar Control: Original Flavor toothpaste product ple, the cost of quality-control personnel who conduct taste and content tests
on multiple soft drink products bottled at a Pepsi plant is an indirect cost of a
Service Telephone hotline providing information and assis-
tance to users of Pampers Diapers products Pepsi soft drink. Unlike cans or bottles, it is difficult to trace quality-control Correcting Student
personnel costs to a specific Pepsi soft drink. The term cost allocation is Misconceptions
Project Research and development project on alternative used to describe the assignment of indirect costs to the particular cost object. Students have trouble with the distinc-
scent-free formulations of Tide detergent products tions between direct/indirect costs and
In Exhibit 2-2 we illustrate direct and indirect costs and both forms of cost tracing/cost allocation. Familiar
Customer Safeway, the retailer, who purchases a broad range of examples can help. Public accounting
Procter & Gamble products cost assignment (cost tracing and cost allocation), using the example of Sports
firms directly trace direct professional
Illustrated, the magazine published by Time-Warner. The cost object in labor costs to each audit engagement
Brand category Vidal Sasson range of hairstyle products
Exhibit 2-2 is the Sports Illustrated magazine. The paper on which the mag- (through time sheets). In contrast, rent on
Activity Development and updating of Procter & Gamble’s azine is printed is a direct cost. This paper can be traced to each magazine the firm’s office and depreciation on its
website on the Internet issue being printed in an economically feasible way. Consider now the cost of computers cannot be traced to individual
Department Environmental, Health, and Safety Department of leasing the building that houses the senior editorial staff of such Time- engagements. These are indirect costs
Procter & Gamble Warner magazines as Time, People, and Sports Illustrated. This leasing cost that must be allocated to the different
would be an indirect cost of Sports Illustrated. It is not possible to trace the engagements. Allocation of indirect costs
A costing system typically accounts for costs in two basic stages— lease amount to a specific magazine’s editorial staff. It is possible, however, to is a difficult but important topic that is
accumulation and then assignment. Cost accumulation is the collection of allocate the lease cost among each magazine product of Time-Warner using covered in more detail in Chaps. 5 and 14.
cost data in some organized way by means of an accounting system. For the relative percentage of total floor space occupied by the editorial group of
example, a plant that purchases paper rolls for printing magazines collects each magazine.
(accumulates) the costs of individual rolls purchased in any one month to
Factors Affecting Direct/Indirect Cost Classifications
obtain the total monthly paper purchase costs. Beyond accumulating costs,
managers assign costs to designated cost objects to help decision making. Several factors affect the classification of a cost as direct or indirect:
Teaching Tip
Cost assignment is a general term that encompasses both (1) tracing accu- Help students internalize these concepts
1. The materiality of the cost in question. The greater the cost in question, the
mulated costs to a cost object, and (2) allocating accumulated costs to a cost by making them concrete. Divide the
more likely that it is economically feasible to trace that cost to a particular
object. For example, costs may be assigned to a department to facilitate class into groups of about four students
cost object. Consider a mail-order catalog company. It would probably be
decisions about departmental efficiency. Also, costs may be assigned to a each. Assign one set of cost terms to
economically feasible to trace the courier charges for delivering each package each group (e.g., direct/indirect costs,
product or a customer to facilitate product or customer-profitability analy-
directly to the individual customer. In contrast, the cost of invoice paper cost objects/cost drivers, VC/FC, etc.).
sis. A key question in cost assignment is whether costs have a direct or an
included in the package sent to the customer is likely to be classified as an Ask each group to (1) define the terms
indirect relationship to a particular cost object.
indirect cost because it is not economically feasible to trace the cost of this (with books closed), (2) give examples
paper to each customer. The benefits of knowing the exact number of, say, 0.5 based on their work experience, and (3)
DIRECT COSTS AND INDIRECT COSTS __________________ cents worth of paper included in each package do not exceed the costs of think of a specific decision where the
concepts would be relevant.
Cost Tracing and Cost Allocation money and time in tracing the costs to each package.
■ Direct costs of a cost object are related to the particular cost object and 2. Available information-gathering technology. Improvements in this technol-
can be traced to it in an economically feasible (cost-effective) way. For ogy are increasing the percentage of costs classified as direct. Bar codes, for
example, the cost of the cans or bottles is a direct cost of a Pepsi soft example, allow many manufacturing plants to treat certain materials previ-
 AN INTRODUCTION TO COST
4 CHAPTER 2 SURVEYS OF COMPANY PRACTICE TERMS AND PURPOSES 5

EXHIBIT 3-4
Purposes
Purposes for
for Companies
Companies Distinguishing
Distinguishing Spreadsheet Analysis of CVP Relationships for Do-All Software

between
between Variable
Variable Costs
Costs and
and Fixed
Fixed Costs
Costs Revenues Required at $200 Selling Price Points to Stress
to Earn Operating Income of Merchandisers’ and mfg. firms’ income
Many chapters in this book illustrate the insights gained from distinguishing between statements differ only in the CGS section.
Variable Manufacturing firms’ CGS is based on the
variable costs and fixed costs. One survey of U.S. companies reported the following Fixed Costs cost of goods they manufactured,
ranking of purposes for distinguishing between variable and fixed costs (1 5 most Costs Per Unit $0 $1,000 $1,500 $2,000 whereas merchandisers’ CGS is based on
important purpose). their purchases of FG from others. Note
$2,000 $100 $ 4,000 $ 6,000 $ 7,000 $ 8,000
also the difference in the inventory
Chapter(s) in This Book 120 5,000 7,500 8,750 10,000 accounts (3 for mfg. firms and 1 for mer-
Rank Purpose Discussing the Purpose in Detail 140 6,667 10,000 11,667 13,333 chandising firms).
1 (equal) Pricing 4, 5, 11, 12, and 13 2,500 100 5,000 7,000 8,000 9,000
1 (equal) Budgeting 6 120 6,250 8,750 10,000 11,250
3 Profitability analysis—existing products 4, 5, 11, 12, and 13 140 8,333 11,667 13,333 15,000
3,000 100 6,000 8,000 9,000 10,000
4 Profitability analysis—new products 11, 12, and 13
120 7,500 10,000 11,250 12,500
5 Cost-volume-profit (CVP) analysis 3
140 10,000 13,333 15,000 16,667
6 Variance analysis 7, 8, and 16

Surveys of Australian, Japanese, and United Kingdom companies provide additional ILLUSTRATING THE FLOW OF INVENTORIABLE COSTS
evidence on the ranking by managers of the many purposes for distinguishing between AND PERIOD COSTS _____________________________________
variable costs and fixed costs (1 5 most important purpose):b
Manufacturing-Sector Example
Ranking by The income statement of a manufacturer, Cellular Products, is shown in Correcting Student
Misconceptions
Australian Japanese United Kingdom Exhibit 2-6. Revenues of Cellular are (in thousands) $210,000. Revenues are
Students are often confused about the
Purpose Companies Companies Companies inflows of assets (almost always cash or accounts receivable) received for category of inventory used in a mfg. firm’s
Pricing decisions 1 5 1
products or services provided to customers. Cost of goods sold in a manufac- CGS section. Normally, only FG are sold,
turing company is often computed as follows: so FG is the inventory used to adjust CGM
Budgeting 2 2 3
to obtain CGS.
Making profit plans 3 1 2 Beginning Cost of Ending Cost of
Cost reduction 6 3 5 (equal) finished goods
goods  finished goods  goods
inventory manufactured inventory sold
CVP analysis 4 (equal) 4 4
Cost-benefit analysis 4 (equal) 6 5 (equal) For Cellular Products in 2001, the corresponding amounts (in thousands)
in Exhibit 2-6 (Panel A) are:
These surveys highlight the wide range of decisions for which managers feel an under- $22,000
$104,000  $18,000  $108,000
standing of cost behavior is important.
aAdapted from Mowen, Accounting for Costs as Fixed and Variable.
Cost of goods manufactured refers to the cost of goods brought to 3. Cost of goods manufactured
bBlayney and Yokoyama, “Comparative Analysis of Japanese and Australian Cost Accounting and Management Practices.” completion, whether they were started before or during the current account- about brought to completion,
Full citations are in Appendix A at the end of the book. ing period. In 2001, these costs amount to $104,000 for Cellular Products whether they were started.
(see the Schedule of Cost of Goods Manufactured in Panel B of Exhibit 2-6).
A line item in Panel B is “Manufacturing costs incurred during the period” of
ously classified as indirect costs as direct costs of products. Many component $105,000. This item refers to the direct manufacturing costs and the indirect
manufacturing costs that were incurred during 2001. Correcting Student
parts now come with a bar code on them that can be scanned at every point in Misconceptions
the production process. Types of Inventory Do total costs = prime costs + conver-
Correcting Student
sion costs? Only under the two-part
Misconceptions\Example 3. Design of operations. For example, classifying a cost as direct is facilitated if Manufacturing-sector companies purchase materials and components and classification where prime costs =
Students are frequently confused by two an organization’s facility (or part thereof) is used exclusively for a specific cost convert them into different finished goods. They typically have one or more direct material costs and conversion
aspects of direct/indirect costs. First, the object, such as a specific product or a particular customer. of the following three types of inventor: costs = indirect manufacturing costs
distinction is based on a judgment
4. Contractual arrangements. For example, a contract stating that a given (including direct mfg. labor). In the
regarding the economic feasibility of 1. Direct materials inventory. Direct materials in stock and awaiting use
component (an Intel Pentium chip) can be used only in a specific product three-part classification, direct mfg.
specifically tracing the cost in that par- in the manufacturing process.3 labor is both a prime cost and a con-
ticular situation. (an IBM PC) makes it easier to classify the component
2. Work-in-process inventory. Goods partially worked on but not yet version cost. Thus, in the three-part
1Cost-behavior questions appear in professional examinations with regularity. For example, fully completed. Also called work in progress. classification, prime costs and con-
see the supplement to this textbook: J. K. Harris, Student Guide and Review Manual (Upper version costs are not mutually exclu-
Saddle River, N.J.: Prentice Hall, 2000). The first three chapters of this supplement are avail- 3. Finished goods inventory. Goods fully completed but not yet sold.
sive categories.
able, free of charge, at Prentice Hall’s website: (www.prenhall.com/harris).
 AN INTRODUCTION TO COST
6 CHAPTER 2 CONCEPTS IN ACTION TERMS AND PURPOSES 7

EXHIBIT 2-8
Relationships of Inventoriable Costs and Period Costs
PANEL A: MANUFACTURING COMPANY
Harley-Davidson Eliminates the Direct Manufacturing
Labor Cost Categorya
Harley-Davidson’s Motorcycle Division for many years used a three-part cost
BALANCE SHEET INCOME STATEMENT
classification in its manufacturing facilities—direct materials, direct manufac-
turing labor, and manufacturing overhead. In the mid-1980s, a task force of
Direct Direct Harley-Davidson managers analyzed how its manufacturing product-cost
Materials Materials
Purchases Inventory Revenues structure compared with the administrative costs required to collect, inspect,
and report data in its accounting system, with the following results:
deduct
Inventoriable Manufacturing
Costs Other Direct when Product-Cost Administrative
Manufacturing sales Structure Cost Effort
Costs Work in Finished occur Cost of
Process Goods Goods Sold Direct materials 54% 25%
Indirect Inventory Inventory (an expense)
Manufacturing Manufacturing overhead 36 13
Costsa Direct manufacturing labor 10 62
Equals Gross Margin
deduct
The administrative costs associated with tracking direct
R&D Costs manufacturing labor as a separate cost category included:
Design Costs
Marketing Costs Period ■ Operator’s time to fill out labor tickets
Distribution Costs Costs ■ Supervisor’s time to review labor tickets
Customer-Service Costs
■ Timekeeper’s time to enter the labor data and review
Equals Operating Income the output reports for errors
■ Cost accountant’s time to review the direct-labor
and variance data
aExamples: Indirect manufacturing labor, plant supplies, insurance and depreciation on plant. (Note particu-
larly that where insurance and depreciation relate to the manufacturing function, they are inventoriable, but Harley-Davidson concluded that tracing direct manufacturing labor to products
where they relate to nonmanufacturing business functions (for example, marketing and distribution), they are did not meet the cost-benefit test. Direct manufacturing labor costs were only
not inventoriable. 10% of total manufacturing costs but required 62% of the administrative effort
used to track all manufacturing costs. The company now includes all manufac-
PANEL B: MERCHANDISING COMPANY (RETAILER OR WHOLESALER) turing labor costs as part of manufacturing overhead costs. It uses a two-part
classification of direct materials and manufacturing overhead.

BALANCE SHEET INCOME STATEMENT aAdapted from W. Turk, “Management Accounting Revitalized: The Harley-Davidson Experience,”
Journal of Cost Management, Vol. 3. No. 4.

Revenues
MEASURING COSTS REQUIRES JUDGMENT
deduct
Judgment is frequently required when measuring costs. Differences can exist
when in the way accounting terms are defined. Care should be taken to define and
sales
Cost of understand the way costs are measured in any organization or situation in
Inventoriable Merchandise Merchandise occur
Goods Sold which costs are an issue. We first illustrate this point with respect to labor
Costs Purchases Inventory
(an expense) cost measurement.

Equals Gross Margin Measuring Labor Costs

deduct
Design Costs
Operating Costs
(such as Purchasing Dept. Costs)
Marketing Costs
Distribution Costs
Customer-Service Costs
Equals Operating Income
Manufacturing labor cost classifications vary among companies, but the fol- Direct Manufacturing
lowing distinctions are generally found: Points to Stress The text uses the term
Direct manufacturing labor (defined earlier) direct manufacturing labor because labor
Manufacturing overhead (examples of prominent labor components of incurred in other elements of the value
Period
Costs this manufacturing overhead follow): chain can also be traced directly to cost
Indirect labor (compensation) objects. For example, in some cases,
Forklift truck operators (internal handling of materials) sales labor can be traced directly to
Janitors specific customers.
Plant guards
Rework labor (time spent by direct laborers redoing defective work)
 AN INTRODUCTION TO COST
8 CHAPTER 2 PROBLEM FOR SELF STUDY TERMS AND PURPOSES 9

(Try to solve this problem before examining the solution that follows.)

PROBLEM 3. The direct material costs are variable, so they would increase in total from $450,000 to $500,000
Campbell Company is a metal and wood cutting manufacturer, selling products to the home (1,000,000  $0.50). However, their unit costs would be unaffected: $500,000  1,000,000 units 
construction market. Consider the following data for the year 2001: $0.50.
Sandpaper $ 2,000 Plant-leasing costs 54,000
In contrast, the plant-leasing costs of $54,000 are fixed, so they would not increase in total.
Materials-handling costs 70,000 Depreciation — plant equipment 36,000 However, the plant-leasing costs per unit would decline from $0.060 to $0.054: $54,000 
Lubricants and coolants 5,000 Property taxes on plant equipment 4,000 1,000,000  $0.054.
Miscellaneous indirect Fire insurance on plant equipment 3,000 4. The explanation would begin with the answer to requirement 3. As a consultant, you should stress
manufacturing labor 40,000 Direct materials purchased 460,000 that the unitizing (averaging) of costs that have different behavior patterns can be misleading. A
Direct manufacturing labor 300,000 Revenues 1,360,000 common error is to assume that a total unit cost, which is often a sum of variable unit costs and
Direct materials, Jan. 1, 2001 40,000 Marketing promotions 60,000 fixed unit costs, is an indicator that total costs change in a wholly variable way as production levels
Direct materials, Dec. 31, 2001 50,000 change. The next chapter demonstrates the necessity for distinguishing between cost-behavior pat-
Marketing salaries 100,000
terns. You must be wary especially about average fixed costs per unit. Too often, unit fixed costs are
Finished goods, Jan. 1, 2001 100,000 Distribution costs 70,000
erroneously regarded as being indistinguishable from unit variable costs.
Finished goods, Dec. 31, 2001 150,000 Customer-service costs
Work in process, Jan. 1, 2001 10,000 100,000
Work in process, Dec. 31, 2001 14,000

REQUIRED 1. Prepare an income statement with a separate supporting schedule of cost of goods manufactured. DECISION GUIDELINES SUMMARY SUMMARY
For all manufacturing items, indicate by V or F whether each is basically a variable cost or a fixed Accounting for Current and Contingent Liabilities, Including Payroll
cost (where the cost object is a product unit). If in doubt, decide on the basis of whether the total
cost will change substantially over a wide range of units produced. DECISION
2. Suppose that both the direct materials and plant-leasing costs are tied to the production of 900,000 What are the two main issues in accounting for current liabilities?
units. What is the unit cost for the direct materials assigned to each unit produced? What is the
unit cost of the plant-leasing costs? Assume that the plant-leasing costs are a fixed cost. GUIDELINES
3. Repeat the computation in requirement 2 for direct materials and plant-leasing costs, assuming • Recording the liability on the balance sheet
that the costs are being predicted for the manufacturing of 1,000,000 units next year. Assume that • Current liabilities of known amount:
the implied cost-behavior patterns persist. Accounts payable Accrued expenses
4. As a management consultant, explain concisely to the president why the unit costs for direct mate- Shor-term notes payable (accrued liabilities)
rials did not change in requirements 2 and 3 but the unit costs for plant-leasing costs did change. Sales tax payable Payroll liabilities
Current portion of long-term debt Salary, wages, commission, and bonus payable
SOLUTION Unearned revenues
DECISION
1.
What are the two basic categories of current liabilities?
Campbell Company
Income Statement
For the Year Ended December 31, 2001 GUIDELINES
• Current liabilities that must be estimated:
Revenues $1,360,000 Estimated Warranty payable
Cost of goods sold: Estimated warranty payable
Beginning finished goods, January 1, 2001 $ 100,000 Estimated vacation pay liability
Cost of goods manufactured (see schedule below) 960,000 Income tax payable (for a corporation)
Cost of goods available for sale 1,060,000 DECISION
Ending finished goods, December 31, 2001 150,000 910,000 How to account for contingent (potential) liabilities?
Gross margin (or gross profit) 450,000
GUIDELINES
Marketing, distribution and customer-service costs
Report contingent liabilities either
Marketing promotions 60,000
• Short (with no dollar amount) on the balance sheet, along with an explanatory note,
Marketing salaries 100,000 or
Distribution costs 70,000 • With only the explanatory note
Customer-service costs 100,000 330,000 DECISION
Operating income $ 120,000 What is the ethical and legal challenge in accounting for current and contingent liabilities?

GUIDELINES
2. Direct material unit cost  Direct materials used  Units produced
 $450,000  900,000  $0.50 To ensure that the balance sheet (and the related notes) reports the full amount of all
Plant-leasing unit cost  Plant-leasing costs  Units produced the business’s current and contingent liabilities.
 $54,000  900,000  $0.06
 AN INTRODUCTION TO COST
10 TERMS TO LEARN 11
CHAPTER 2 TERMS AND PURPOSES

1. What is the unit cost to ECG of Wang’s software code included in its REQUIRED
This chapter contains more basic terms than any other in this book. Do not
e.procurement package if it sells (a) 2,000 packages, (b) 6,000 packages, (c)
proceed before you check your understanding of the following terms. Both 10,000 packages, and (d) 20,000 packages? Comment on the results.
the chapter and the Glossary at the end of the book contain definitions. 2. To predict ECG’s total cost of using Wang’s software code in e.procurement,
actual cost (p. 28) cost of goods manufactured (37) indirect costs of a cost object (29) which unit cost (if any) of (a) to (d) in requirement 1 would you recommend
average cost (33) direct costs of a cost object (28) indirect manufacturing costs (36) ECG use? Explain.
conversion costs (39) direct manufacturing labor costs (36) inventoriable costs (36)
cost (28) direct materials costs (36) manufacturing overhead costs (36) 2-18 Computing and interpreting unit manufacturing costs. Finish Forest
cost accumulation (28) direct materials inventory (35) manufacturing-sector company (35) Products (FFP) produces three different paper products at its Vaasa lumber
cost allocation (29) factory overhead costs (36) merchandising-sector company (35) plant — Supreme, Deluxe, and Regular. Each product has its own dedicated pro-
cost assignment (28) finished goods inventory (35) operating income (38) duction line at the plant.
cost driver (31) fixed cost (30) overtime premium (42)
cost object (28) idle time (42) INTERNET EXERCISE
Starbucks Corporation is the number 1 specialty coffee retailer, operating
more than 2,800 shops. The company also sells coffee beans to restaurants,
ASSIGNMENT MATERIAL businesses, airlines, and hotels, and offers mail order and on-line shopping.

QUESTIONS 1. Go to http://www.forbes.com and under “Stocks” type SBUX, the

2-1 Define cost object and give three examples.
2-2 Define direct costs and indirect costs. How are these terms related?
2-3 Why do managers consider direct costs to be more accurate than indirect
costs?
2-4 Name three factors that will affect the classification of a cost as direct or
indirect.
2-5 Describe how manufacturing-, merchandising-, and service-sector compa-
nies differ from each other.
2-6 What is a cost driver? Give one example.
2-7 Define variable cost and fixed cost. Give an example of each.
2-8 What is the relevant range? What role does the relevant range concept play
in explaining how costs behave?
2-9 Explain why unit costs must often be interpreted with caution.
2-10 What are three different types of inventory that manufacturing companies
hold?
2-11 Distinguish between inventoriable costs and period costs.
2-12 Do service-sector companies have inventoriable costs? Explain.
2-13 Define the following: direct materials costs, direct manufacturing labor costs,
indirect manufacturing costs, prime costs, and conversion costs.
2-14 Describe the overtime premium and idle time categories of indirect labor.
2-15 Define product cost. Describe three different purposes for computing prod-
uct costs.
EXERCISES
2-16 Total costs and unit costs. A student association has hired a musical
group for a graduation party. The cost will be a fixed amount of $4,000.
REQUIRED 1. Suppose 500 people attend the party. What will be the total cost of the
musical group? The unit cost per person?
2. Suppose 2,000 people attend. What will be the total cost of the musical
group? The unit cost per person?
3. For prediction of total costs, should the manager of the party use the unit
cost in requirement 1? The unit cost in requirement 2? What is the major
lesson of this exercise?
2-17 Total costs and unit costs. Agree to a contract where ECG pays Wang a flat
fee of $100,000 for the right to use her code in up to 10,000 packages. If e.procure-
ment sells more than 10,000 packages, Wang receives an additional $8 for each pack-
age sold beyond the 10,000.
stock symbol for Starbucks Corporation. Click on Go. In the left hand
column, click on Company Info, and scan the information provided.
What one-year sales growth was reported?
2. In the left-hand column, click on Financials. For the most recent year
identify or compute the amounts reported for total revenue, cost of
goods sold, and operating expenses. Calculate operating income.
EXCELL APPLICATION PROBLEM
GOAL: Create an Excel spreadsheet that compares gross profit, ending
inventory, and cost of goods sold under the LIFO, FIFO, and weighted-aver-
age methods of inventory valuation.
SCENARIO: John Kalinich, Chief Operations Officer at Teva Sport Sandals
in Flagstaff, Arizona, has a decision to make. He’s in charge of Teva’s on-line
store, and is responsible for the inventory sold through the Web. John must
decide which inventory method to use for the business.
Your task is to create a spreadsheet and embedded graph that compares
gross profit, ending inventory, and cost of goods sold under three methods:
weighted average, FIFO, and LIFO. John has provided the following data
from the most recent month of operations for your use in creating the
spreadsheet:
July 1 Beginning inventory 2,000 units @ $30.00 cost per unit
6 Purchase 600 units@ $31.25 cost per unit
17 Purchase 400 units @ $33.50 cost per unit
28 Purchase 200 units@ $34.75 cost per unit
Sales for July: 1,800 pairs of sandals sold @ $69.00 each
After you have prepared your spreadsheet, answer these questions:
1. Which method produces the lowest cost of goods sold?
2. Which method produces the lowest ending inventory?
3. If john Kalinich wants to maximize gross profit for Teva, which
method should he choose? Does this method do a good job of matchi
ng inventory expense (cost of goods sold) t sales revenue?
STEP-BY-STEP:
1. Open a new Excel Spreadsheet.
2. Create a heading for your spreadsheet that contains the following:
a. Chapter 9 Decision Guidelines
b. Inventory Management
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C5M0Y40K0 C25M0Y50K0 C30M10Y0K0 C45M0Y5K0 C100M0Y0K0

C0M10Y40K0 C20M40Y100K0 C100M50Y0K0 C100M100Y5K0

C0M10Y100K0 C70M60Y0K0

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