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LEARNING OBJECTIVES

1. Explain what is meant by the word "cost."

2. Distinguish among product costs, period costs, and expenses.

3. Give examples of three types of manufacturing costs.

4. Preparation of cost sheet.

5. Describe the behavior of variable and fixed costs, in total and on a


per-unit basis.

6. Distinguish among direct, indirect, controllable, and uncontrollable


costs.

7. Know about opportunity cost, an out-of-pocket cost, a sunk cost, a


differential cost, a marginal cost, and an average cost.
WHAT IS COST?

A cost is the sacrifice made to achieve a


particular purpose.
Resource consumed?
Expenses incurred?
Cash or Notional ?
Any other ?
WHAT DO WE MEAN BY A COST?

A cost
is the measure of
resources given
up to achieve a
particular purpose.
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.
COST CLASSIFICATIONS

Product Costs
Period Costs
Cost of goods sold
Examples ???

period oriented expenses-


not a part of product
valuation-
Examples ???
TYPES OF PRODUCTION PROCESSES

Type of Production Description of Example of


Process Process Manufacturer

Job Shop Low volume ?


Little standardization
Unique products

Batch Multiple products Caterpillar


Low volume

Assembly Line A few major products Ford


Higher volume

Mass Customization High volume Dell


Many standardized components
Customized combination of components

Continuous Flow High volume Tata steel


Highly standardized commodity products
MANUFACTURING COSTS

Direct Direct Manufacturing


Material Labor Overhead

The
Product
DIRECT MATERIAL

Cost of raw material that is used to


make, and can be conveniently
traced, to the finished product.
DIRECT LABOR

Cost of salaries, wages, and fringe


benefits for personnel who work
directly on manufactured products.

Example:
Wages paid to an
automobile assembly
worker.
MANUFACTURING OVERHEAD

All other manufacturing costs


Indirect Indirect Other
Material Labor Costs

Materials used to support the


production process. Examples:
lubricants and cleaning supplies
used in an automobile assembly
plant.
MANUFACTURING OVERHEAD

All other manufacturing costs


Indirect Indirect Other
Material Labor Costs

Cost of personnel who do


not work directly on the
product. Examples:
maintenance workers,
janitors and security guards.
MANUFACTURING OVERHEAD

All other manufacturing costs


Indirect Indirect Other
Material Labor Costs

Examples: depreciation on
plant and equipment,
property taxes, insurance,
utilities, overtime premium
and other factory related
expenses
CLASSIFICATIONS OF COSTS IN MANUFACTURING
COMPANIES

Manufacturing costs are often


combined as follows:

Direct Direct Manufacturing


Material Labor Overhead

Prime Conversion
Cost Cost
MANUFACTURING COST FLOWS

Direct Material
Work in
Direct Labor Process
Inventory

Manufacturing
Overhead
MANUFACTURING COST FLOWS

Direct Material
Work in
Direct Labor Process
Inventory
Manufacturing
Overhead
Finished
Goods
Inventory
MANUFACTURING COST FLOWS

Direct Material
Work in
Direct Labor Process
Inventory
Manufacturing
Overhead
Finished Cost of
Goods Goods
Inventory Sold
SCHEDULE OF COST OF GOODS MANUFACTURED

Comet Computer Corporation


Schedule of Cost of Goods Manufactured

Raw material used $ 1,34,980


Direct labor 50,000
Total manufacturing overhead 2,30,000
Total manufacturing costs $ 4,14,980
Add: Work-in-process inventory, January 1 120
Subtotal $ 4,15,100
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured $ 4,15,000
SCHEDULE OFComputation
COST OFofGOODS MANUFACTURED
Cost of Raw Material Used
Raw-material inventory, January 1 $ 6,000
Add: Purchases of raw materials 134,000
Raw material available for use 140,000
Deduct: Raw material inventory, December 31 5,020
Raw material used $ 134,980
Comet Computer Corporation
Schedule of Cost of Goods Manufactured
Raw material used $ 134,980
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs $ 414,980
Add: Work-in-process inventory, January 1 120
Subtotal $ 415,100
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured $ 415,000
SCHEDULE OF COST OF GOODS MANUFACTURED

Include all direct labor costs


incurred during the current
period.Corporation
Comet Computer
Schedule of Cost of Goods Manufactured
Raw material used $ 134,980
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs $ 414,980
Add: Work-in-process inventory, January 1 120
Subtotal $ 415,100
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured $ 415,000
Computation of Total Manufacturing Overhead
Indirect material $ 10,000
Indirect labor 40,000
Depreciation on factory 90,000
Depreciation on equipment 70,000
Comet Computer Corporation
Utilities 15,000
Insuranceof Cost of Goods Manufactured
Schedule 5,000
Total manufacturing overhead $ 230,000
Raw material used $ 134,980
Direct labor 50,000
Total manufacturing overhead 230,000
Total manufacturing costs $ 414,980
Add: Work-in-process inventory, January 1 120
Subtotal $ 415,100
Deduct: Work-in-process inventory, December 31 100
Cost of goods manufactured $ 415,000
SCHEDULE OF COST OF GOODS MANUFACTURED

Beginning work-in-process
inventory is carried over
from the prior period.
Comet Computer Corporation
Schedule of Cost of Goods Manufactured

Raw material used $ 134,980


Direct labor 50,000
Total manufacturing overhead 230,000
Ending work-in-process
Total manufacturing inventory
costs $ 414,980
contains the cost of unfinished
Add: Work-in-process inventory, January 1 120
goods, and is reported in the
Subtotal $ 415,100
current
Deduct:assets section of the
Work-in-process inventory, December 31 100
balance sheet.manufactured
Cost of goods $ 415,000
INCOME STATEMENT FOR A MANUFACTURER

Comet Computer Corporation


Income Statement
For the Year Ended December 31, 20X2
Sales revenue $ 700,000
Less: Cost of goods sold 415,010
Gross margin $ 284,990
Selling and administrative expenses 174,490
Income before taxes $ 110,500
Income tax expense 30,000
Net income $ 80,500
Comet Computer Corporation
Schedule of Cost of Goods Sold
For the Year Ended December 31, 20X2
Finished-goods inventory, Jan. 1 $ 200
Add: Cost of goods manufactured 415,000
Cost of goods available for sale 415,200
Comet Computer Corporation
Deduct Finished-goods inventory, Dec. 31 190
Income Statement
Cost of goods sold $ 415,010
For the Year Ended December 31, 20X2
Sales revenue $ 700,000
Less: Cost of goods sold 415,010
Gross margin $ 284,990
Selling and administrative expenses 174,490
Income before taxes $ 110,500
Income tax expense 30,000
Net income $ 80,500
ACTIVITIES THAT CAUSE COSTS TO BE
INCURRED ARE CALLED COST DRIVERS:

Cost Driver Examples


Activity Cost Driver
Machining operations Machine hours
Setup Setup hours
Production scheduling Manufacturing orders
Inspection Pieces inspected
Purchasing Purchase orders
Shop order handling Shop orders
Valve assembly support Customer requisitions
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.
TOTAL VARIABLE COST EXAMPLE

Your factory’s total EB bill is based on how many units you consumed. What about minimum
charge?
Bill amount

Units consumed
VARIABLE COST PER UNIT EXAMPLE
The cost per unit is constant. For example, Rs 7.00 per unit.

Per unit Charge

Units consumed
FIXED COST PER UNIT EXAMPLE

The average cost per decreases as production increases.

Average labour cost

Production level
COST CLASSIFICATIONS

Summary of Variable and Fixed Cost Behavior


Cost In Total Per Unit

Total variable cost changes Variable cost per unit


Variable as activity level changes. remains the same over
wide ranges of activity.
Total fixed cost remains Fixed cost per unit
Fixed the same even when the goes down as activity
activity level changes. level goes up.
DIRECT AND INDIRECT COSTS

Direct costs Indirect costs


Costs that can be Costs that must be
easily and conveniently allocated in order to be
traced to a product or assigned to a product
department. or department.
Example: cost of paint in Example: cost of national
the paint department advertising for an
of an automobile airline is indirect to a
assembly plant. particular flight.
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 Controllable
in a restaurant manager
Cost of national Restaurant Uncontrollable
advertising by a manager
restaurant chain
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
$20,000 per year.
Your opportunity cost
of attending college for one year is
$20,000.
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: You bought an automobile that cost $12,000 two years ago. The
$12,000 cost is sunk because whether you drive it, park it, trade it, or sell it,
you cannot change the $12,000 cost.
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
MARGINAL COSTS AND AVERAGE COSTS

The total cost to


The extra cost
produce a quantity
incurred to produce
divided by the
one additional unit.
quantity produced.

Marginal and average costs are


largely a function of cost behavior
-- variable and fixed costs.
LEARNING OBJECTIVES – TESTING THE OUTCOMES
1. Explain "cost."

2. product costs and period costs.

3. Three types of manufacturing costs.

4. Preparation of cost sheet. Or schedule of cost

5. Variable and fixed costs, in total and on a per-unit basis.

6. Direct, indirect, controllable, and uncontrollable costs.

7. Opportunity cost, an out-of-pocket cost, a sunk cost, a


differential cost, a marginal cost, and an average cost.

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