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Costs Terms, Concepts andClassifications
Chapter Two
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Learning Objective
Identify and give examplesof each of the three basicmanufacturing cost
categories.
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Classification of COST
ManufacturingCost
Non
ManufacturingCost
1. Direct Labor2. Direct Material
3. Mfg. OH
SellingAdministrative
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Cost Classification according to Purpose
Financial Statement Product CostPeriod Cost
Predicting Cost BehaviorVariable Cost
Fixed Cost
Assigning Cost tocost object
Direct Cost
Indirect Cost
Making Decision Sunk Cost
Opportunity Cost
Differential Cost
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The Product
DirectMaterials DirectLabor ManufacturingOverhead
Manufacturing Costs
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Direct Materials
Raw materials that become an integral part of theproduct and that can be conveniently traced
directly to it.
Example: Engine installed in an automobile
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Direct Labor
Those labor costs that can be easily traced toindividual units of product.
Example: Wages paid to automobile assembly workers
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Manufacturing costs that cannot be traced directlyto specific units produced.
Manufacturing Overhead
Examples: Indirect labor and indirect materials
Wages paid to employeeswho are not directly
involved in productionwork.
Examples: maintenanceworkers, janitors and
security guards.
Materials used to supportthe production process.
Examples: lubricants andcleaning supplies used in theautomobile assembly plant.
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Classifications of Costs
DirectMaterial
DirectLabor
ManufacturingOverhead
PrimeCost
ConversionCost
Manufacturing costs are oftenclassified as follows:
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2-10 Comparing Merchandising andManufacturing Activities
Merchandisers . . . Buy finished goods.
Sell finished goods.
Manufacturers . . . Buy raw materials.
Produce and sellfinished goods.
MegaLoMart
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Balance Sheet
Merchandiser
Current assets
Cash
Receivables
Prepaid Expenses
MerchandiseInventory
Manufacturer
Current Assets
Cash
ReceivablesPrepaid Expenses
Inventories
Raw Materials
Work in Process
Finished Goods
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Merchandiser
Current assets
Cash
Receivables
Prepaid Expenses
MerchandiseInventory
Manufacturer
Current Assets
Cash
ReceivablesPrepaid Expenses
Inventories
Raw Materials
Work in Process
Finished Goods
Balance Sheet
Partially completeproducts some
material, labor, oroverhead has been
added.
Completed productsawaiting sale.
Materials waiting tobe processed.
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Non-manufacturing Costs
SellingCosts
Costs necessary to get
the order and deliverthe product.
AdministrativeCosts
All executive,
organizational, andclerical costs.
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Learning Objective
Distinguish betweenproduct costs and periodcosts and give examples
of each.
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Product Costs Versus Period Costs
Product costs includedirect materials, direct
labor, and
manufacturingoverhead.
Period costs include allselling costs and
administrative costs.
Inventory Cost of Good Sold
BalanceSheet
IncomeStatement
Sale
Expense
IncomeStatement
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Quick Check
Which of the following costs would be considered aperiod rather than a product cost in a manufacturingcompany?
A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
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Quick Check
Which of the following costs would be considered aperiod rather than a product cost in a manufacturingcompany?
A. Manufacturing equipment depreciation.B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
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Learning Objective
Understand the
differences betweenvariable costs and fixed
costs.
2 19 C t Cl ifi ti f P di ti C t
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2-19 Cost Classifications for Predicting CostBehavior
How a cost will react tochanges in the level of
activity within the
relevant range. Total variable costs
change when activitychanges.
Total fixed costsremainunchanged when activitychanges.
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Variable Cost
Yourtotal long distance telephone bill is basedon how many minutes you talk.
Minutes Talked
TotalL
ongDistance
TelephoneBill
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Variable Cost Per Unit
Minutes Talked
Pe
rMinute
Teleph
oneCharge
The cost per long distance minute talked isconstant. For example, 10 cents per minute.
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Fixed Cost
Your monthly basic telephone bill probablydoes not change when you make more local
calls.
Number of Local Calls
Mon
thlyBasic
Tele
phoneBill
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Fixed Cost Per Unit
Number of Local Calls
MonthlyBasicTelephone
Billp
erLocalCall
The average fixed cost per local call decreasesas more local calls are made.
2-24 Cost Classifications for Predicting Cost
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2 24 Cost Classifications for Predicting CostBehavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
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Learning Objective
Understand thedifferences between directand indirect costs.
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Assigning Costs to Cost Objects
Direct costs
Costs that can beeasily and convenientlytraced to a unit of
product or other costobject.
Examples: directmaterial and direct labor
Indirect costs
Costs that cannot beeasily and convenientlytraced to a unit of
product or other costobject.
Example: manufacturingoverhead
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Learning Objective
Define and give examplesof cost classifications used
in making decisions:differential costs,
opportunity costs, and
sunk costs.
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Differential Cost and Revenue
Costs and revenues that differ amongalternatives.
Example: You have a job paying $1,500 per month inyour hometown. You have a job offer in a neighboringcity that pays $2,000 per month. The commuting costto the city is $300 per month.
Differential revenue is:$2,000 $1,500 = $500
Differential cost is:
$300
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Opportunity Cost
The potential benefitthat is given up when
one alternative isselected over another.
Example: If you werenot attending college,you could be earning
$15,000 per year.Your opportunity costof attending college forone year is $15,000.
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Sunk Costs
Sunk costs have already been incurred andcannot be changed now or in the future.
They should be ignored when makingdecisions.
Example: i) Cost of getting license of a business.
iii) Suppose you bought a technology by $ 20,000which is obsolete now.
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Quick Check
Suppose you are trying to decide whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want to
waste money needlessly. Is the cost of the trainticket relevant in this decision? In other words,should the cost of the train ticket affect the decisionof whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant.
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Quick Check
Suppose you are trying to decide whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want to
waste money needlessly. Is the cost of the trainticket relevant in this decision? In other words,should the cost of the train ticket affect the decisionof whether you drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.B. No, the cost of the train ticket is not relevant.
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Quick Check
Suppose you are trying to decide whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want to
waste money needlessly. Is the annual cost oflicensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
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Quick Check
Suppose you are trying to decide whether to driveor take the train to Portland to attend a concert. Youhave ample cash to do either, but you dont want to
waste money needlessly. Is the annual cost oflicensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
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Further Classification of LaborCosts
Appendix 2A
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Idle Time
The labor costs incurredduring idle time are ordinarily
treated as manufacturing
overhead.
MachineBreakdowns
MaterialShortages
PowerFailures
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Overtime
The overtime premiums for all factoryworkers are usually considered to be part
of manufacturing overhead.
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L b F i B fi
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Labor Fringe Benefits
Fringe benefits include employer paidcosts for insurance programs, retirement
plans, supplemental unemployment
programs, Social Security, Medicare,workers compensation andunemployment taxes.
Some companiesinclude all of these
costs inmanufacturing
overhead.
Other companies treatfringe benefit
expenses of directlaborers as additional
direct labor costs.
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THANK YOU ALL