chap2 hilton ed 9

Basic Cost Management Concepts and Accounting for Mass Customization Operations

Chapter 2

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

Learning Objective

1

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Process of ManagementProcess of Management

DecisionMaking

DirectingControl

PlanningStrategy Formulation

Managers need cost information toperform each of these functions.

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What Do We Mean By a Cost?What Do We Mean By a Cost?

A costis the measure ofresources givenup to achieve a

particular purpose.

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Learning Objective

2

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Product Costs, Period Costs and ExpensesProduct 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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Learning Objective

3

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Product CostsProduct Costs

Cost of goods sold

Period CostsPeriod Costs

Operating expenses

Cost Classifications on Financial Cost Classifications on Financial Statements – Income StatementStatements – Income Statement

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MerchandiserMerchandiser Current Assets

– Cash– Receivables– Prepaid Expenses– Merchandise Merchandise

InventoryInventory

ManufacturerManufacturer Current Assets

CashCash ReceivablesReceivables Prepaid ExpensesPrepaid Expenses InventoriesInventories

Raw MaterialsRaw MaterialsWork in ProcessWork in ProcessFinished GoodsFinished Goods

Cost Classifications on Financial Cost Classifications on Financial Statements – Balance SheetStatements – Balance Sheet

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InventoryInventory





Those materials waiting to be processed.

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InventoryInventory





Partially complete products – material to

which some labor and/or overhead has

been added.

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InventoryInventory





Completed products awaiting sale.

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Learning Objective

4

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Types of Production ProcessesTypes of Production ProcessesType of Production Description of Example of

Process Process Manufacturer

Job Shop Low volume DisneyLittle standardization

Unique products

Batch Multiple products CaterpillarLow volume

Assembly Line A few major products FordHigher volume

Mass Customization High volume DellMany standardized components

Customized combination of components

Continuous Flow High volume ExxonHighly standardized commodity products

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Learning Objective

5

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Manufacturing CostsManufacturing Costs

TheProduct

DirectLabor

Manufacturing Overhead

DirectMaterial

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Direct MaterialDirect Material

Example:Steel used tomanufacture

the automobile.

Cost of raw material that is used tomake, and can be convenientlytraced, to the finished product.

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Cost of salaries, wages, and fringebenefits for personnel who work

directly on manufactured products.

Direct LaborDirect Labor

Example:Wages paid to an

automobile assemblyworker.

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All other manufacturing costs

Manufacturing OverheadManufacturing Overhead

Materials used to support the production process. Examples: lubricants and

cleaning supplies used in an automobile assembly plant.

IndirectLabor

IndirectMaterial

OtherCosts

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Cost of personnel who do not work directly on

the product. Examples: maintenance workers, janitors and security

guards.

IndirectLabor

IndirectMaterial

OtherCosts

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Examples: depreciation on plant and equipment,

property taxes, insurance, utilities,

overtime premium, and unavoidable idle time.

IndirectLabor

IndirectMaterial

OtherCosts

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Classifications of Costs in Classifications of Costs in Manufacturing CompaniesManufacturing Companies

PrimeCost

ConversionCost

Manufacturing costs are oftencombined as follows:

DirectMaterial

DirectLabor

ManufacturingOverhead

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Manufacturing Cost FlowsManufacturing Cost Flows


Direct Material

Direct Labor Work in Process Inventory

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Direct Material

Direct Labor

FinishedGoods

Inventory

Work in Process Inventory

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Direct Material

Direct Labor

FinishedGoods

Inventory

Cost of GoodsSold

Work in Process Inventory

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Learning Objective

6

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Comet Computer CorporationSchedule 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 Schedule of Cost of Goods ManufacturedManufactured

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Computation of 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$

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Schedule of Cost of Goods Schedule of Cost of Goods ManufacturedManufacturedInclude all direct labor

costs incurred during the current period.

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Computation of Total Manufacturing Overhead

Indirect material 10,000$ Indirect labor 40,000 Depreciation on factory 90,000 Depreciation on equipment 70,000 Utilities 15,000 Insurance 5,000 Total manufacturing overhead 230,000$

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Beginning work-in-process inventory is carried over from the

prior period.

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

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Income Statement for a Income Statement for a ManufacturerManufacturer

Comet Computer CorporationIncome Statement

For the Year Ended December 31, 20X2Sales 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$

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Comet Computer CorporationIncome Statement

For the Year Ended December 31, 20X2Sales 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 CorporationSchedule 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 Deduct Finished-goods inventory, Dec. 31 190 Cost of goods sold 415,010$

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Learning Objective

7

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Activities that cause costs to be Activities that cause costs to be incurred are called incurred are called COST DRIVERSCOST DRIVERS::

Cost Driver ExamplesActivity Cost Driver

Machining operations Machine hoursSetup Setup hoursProduction scheduling Manufacturing ordersInspection Pieces inspectedPurchasing Purchase ordersShop order handling Shop ordersValve assembly support Customer requisitions

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Learning Objective

8

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Cost ClassificationsCost 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.

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Total Variable Cost ExampleTotal Variable Cost Example Your total cable pay-per-view bill is based on

how many movies you watch.

Pay-Per-View Movies Watched

Tota

l Pay

-Per

-Vie

w

Bill

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Variable Cost Per Unit ExampleVariable Cost Per Unit Example

Movies Watched

Per

Mov

ie C

harg

e

The cost per movie watched is constant. For example, $4.00 per movie.

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Total Fixed Cost ExampleTotal Fixed Cost Example Your monthly cable bill probably does not change

when you watch movies on channels that you have elected to be paid on a monthly basis (HBO).

Number of HBO Movies Watched

Mon

thly

Cha

rge

for

HB

O B

ill

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Fixed Cost Per Unit ExampleFixed Cost Per Unit Example

Number of HBO Movies Watched

Mon

thly

HB

O B

ill p

er M

ovie

W

atch

ed

The average cost per HBO movie decreases as more HBO movies are watched.

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Cost ClassificationsCost Classifications

Summary of Variable and Fixed Cost BehaviorCost In Total Per Unit

Total variable cost changes Variable cost per unitVariable as activity level changes. remains the same over

wide ranges of activity.

Total fixed cost remains Fixed cost per unitFixed the same even when the goes down as activity

activity level changes. level goes up.

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Learning Objective

9

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Direct and Indirect CostsDirect and Indirect CostsDirect costs• Costs that can be

easily and conveniently traced to a product or department.

• Example: cost of paint in the paint department of an automobile assembly plant.

Indirect costs• Costs that must be

allocated in order to be assigned to a product or department.

• Example: cost of national advertising for an airline is indirect to a particular flight.

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A cost that can be significantly influencedby a manager is a controllable cost.

Controllable andControllable andUncontrollable CostsUncontrollable Costs

Cost item Manager ClassificatonCost of food used Restaurant Controllablein a restaurant managerCost of national Restaurant Uncontrollableadvertising by a managerrestaurant chain

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Learning Objective

10

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Opportunity CostOpportunity 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 costof attending college for one year is $20,000.

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Sunk CostsSunk 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.

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Differential CostsDifferential CostsCosts that differ between alternatives.

Example: You can earn $1,500 per month in yourhometown or $2,000 per month in a nearby city.

Your commuting costs are $50 per month in yourhometown and $300 per month to the city.

What is your differential cost? $300 - $50 = $250

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Marginal Costs and Average Marginal Costs and Average CostsCosts

The extra costincurred to produceone additional unit.

The total cost toproduce a quantity

divided by thequantity produced.

Marginal and average costs arelargely a function of cost behavior

-- variable and fixed costs.

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Costs and Benefits of InformationCosts and Benefits of Information

Costs Benefits

More information does not mean more benefits if information overload results.

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End of Chapter 2End of Chapter 2

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chap2 hilton ed 9

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