Chapter 2

Basic Cost Management Concepts and Accounting for Mass Customization Operations

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Process of Management
Strategy Formulation
Planning

Managers need cost information to perform each of these functions.

Control Decision Making

Directing
Learning Objective 01
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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.

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Cost Classifications on Financial Statements Balance Sheet

Merchandiser
Current Assets
Cash Receivables Prepaid Expenses Merchandise Inventory

Manufacturer
Current Assets
Cash Receivables Prepaid Expenses Inventories
Raw Materials Work in Process Finished Goods
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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

Caterpillar

Low volume

Assembly Line

A few major products Higher volume

Ford

Mass Customization

High volume
Many standardized components Customized combination of components

Dell

Continuous Flow

High volume Highly standardized commodity products

Exxon
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Manufacturing Costs
Direct Material
Direct Labor Manufacturing Overhead

The Product
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Classifications of Costs in Manufacturing Companies

Manufacturing costs are often combined as follows:
Direct Material Direct Labor Manufacturing Overhead

Prime Cost

Conversion Cost
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Manufacturing Cost Flows

Direct Material Direct Labor Manufacturing Overhead Finished Goods Inventory Cost of Goods Sold Work in Process Inventory

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Schedule of Cost of Goods Manufactured

Computation of Cost of Raw Material Used Raw-material inventory, January 1 Add: Purchases of raw materials $ Raw material available for use Deduct: Raw material inventory, December 31 Raw material used

6,000 134,000 140,000 5,020

Comet Computer Corporation

$ 134,980

Schedule of Cost of Goods Manufactured Raw material used Direct labor Total manufacturing overhead Total manufacturing costs Add: Work-in-process inventory, January 1 Subtotal Deduct: Work-in-process inventory, December 31 Cost of goods manufactured $ $ $ $ 134,980 50,000 230,000 414,980 120 415,100 100 415,000
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Computation of Total Manufacturing Overhead Indirect material Indirect labor Depreciation on factory Depreciation on equipment Utilities $ 10,000 40,000 90,000 70,000

Comet Computer Corporation 15,000

Raw material used

Insurance 5,000 Schedule of Cost of Goods Manufactured Total manufacturing overhead $ 230,000

134,980 50,000 230,000

Direct labor Total manufacturing overhead Total manufacturing costs Beginning work-in-process inventory is carried over inventory, January 1 Add: Work-in-process from Subtotal Deduct: Work-in-process inventory, December 31
the prior period.

$ $ $

414,980 120 415,100 100 415,000

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Ending work-in-process inventory Cost of the cost of unfinished goods, contains goods manufactured and is reported in the current assets section of the balance sheet.

Income Statement for a Manufacturer

Comet Computer Corporation Income Statement For the Year Ended December 31, 20X2 Sales revenue Less: Cost of goods sold Gross margin Selling and administrative expenses Income before taxes Income tax expense Net income $ $ $ $ 700,000 415,010 284,990 174,490 110,500 30,000 80,500
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Income Statement for a Manufacturer

Comet Computer Corporation Schedule of Cost of Goods Sold For the Year Ended December 31, 20X2 Finished-goods inventory, Jan. 1 Add: Cost of goods manufactured $ 200 415,000 415,200 190

Cost of goods available for sale Comet Computer Corporation Deduct Finished-goods inventory, Dec. 31 Cost of goods sold

Income Statement $ 415,010 For the Year Ended December 31, 20X2 $ $ $ $

Sales revenue Less: Cost of goods sold Gross margin Selling and administrative expenses Income before taxes Income tax expense Net income

700,000 415,010 284,990 174,490 110,500 30,000 80,500

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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
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Cost Classifications
Summary of Variable and Fixed Cost Behavior
Cost Variable In Total Total variable cost changes as activity level changes. Total fixed cost remains the same even when the activity level changes. Per Unit Variable cost per unit remains the same over wide ranges of activity. Fixed cost per unit goes down as activity level goes up.

Fixed

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Various Costs
Direct costs: Costs that can be easily and conveniently traced to a product or department. Indirect costs: Costs that must be allocated in order to be assigned to a product or department. Controllable and Uncontrollable Costs: A cost that can be significantly influenced by a manager is a controllable cost. Opportunity Costs: The potential benefit that is given up when one alternative is selected over another. 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. Differential Costs: Costs that differ between alternatives. Marginal Cost: The extra cost incurred to produce one additional unit. Average Cost: The total cost to produce a quantity divided by the quantity produced.

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