Chapter 2 Classifying Costs

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Chapter 2 Classifying Costs ©2017 Mark Friedman and Michael Werner, Management Accounting , Friedman/Werner

Learning Objectives 1. Classify costs by cost objects, and distinguish between direct and indirect costs. 2. Distinguish between product costs and period costs, and contrast their accounting treatment. 3. Explain the differences between product cost for a merchandiser and for a manufacturer. 4. Describe the components of the costs included in each of the three types of inventory in a manufacturing operation. 5. Calculate cost of goods manufactured and cost of goods sold. 6. Describe the components of the cost of services provided by a service firm. 7. Prepare basic journal entries for a manufacturer. ©2016 Michael Werner and Mark Friedman, Management Accounting , Werner/Friedman

Assigning Costs to Cost Objects LO1 Classify costs by cost objects, and distinguish between direct and indirect costs. A cost object is any activity or item for which a separate measurement of costs is desired. Activity Product Service Project Geographic region Department ©2016 Michael Werner and Mark Friedman, Management Accounting , Werner/Friedman

Assigning Costs to Cost Objects LO1 Assigning Costs to Cost Objects Direct costs Indirect costs (common costs) ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Product Costs Product costs are the costs associated LO2 Distinguish between product costs and period costs, and contrast their accounting treatment. Product costs are the costs associated with making the product available and ready to sell. Product costs are inventoriable costs. ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Period costs are not considered product costs. LO2 Period Costs Period costs are not considered product costs. Selling Costs Administrative Costs ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Product Cost Identification for Merchandising Firms LO3 Explain the differences between product cost for a merchandiser and for a manufacturer. Product cost includes the cost of the merchandise, freight costs, and any other costs incurred to get the product ready to sell. ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

The Flow of Product Costs Invoice cost of merchandise Other costs to prepare merchandise for sale Freight-in Merchandise Inventory Cost of Goods Sold (Income Statement) Goods sold Ending Inventory (Balance Sheet) Goods not yet sold ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Sold Schedule LO3 Cost of Goods Sold Schedule JASON’S SUPPLY COMPANY Cost of Goods Sold Schedule For the Year Ending December 31, 2016 Beginning inventory, Jan. 1, 2016 $ 23,000 + Purchases during 2016 300,000 = Goods available for sale in 2016 $323,000 – Ending inventory, Dec. 31, 2016 30,000 = Cost of goods sold for 2016 $293,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Product Cost Identification for Manufacturing Firms LO3 Product Cost Identification for Manufacturing Firms Direct material cost Direct labor cost Manufacturing overhead ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Prime Cost and Conversion Cost LO3 Prime Cost and Conversion Cost Direct material cost labor Manufacturing overhead Prime cost Conversion cost ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Inventory Classifications LO4 Describe the components of the costs included in each of the three types of inventory in a manufacturing operation. Raw materials inventory or stores Work-in-process inventory Finished goods inventory ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Manufacturing Overhead or Burden LO4 Manufacturing Overhead or Burden Indirect material Indirect labor Other overhead costs ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

The Flow of Product Costs –Manufacturing Company Beginning direct material inventory + Purchases = Direct materials available for use – Ending inventory = Direct materials used ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

The Flow of Product Costs –Manufacturing Company Raw materials inventory Ending raw materials Balance sheet purchases Work-in-process inventory Direct materials Direct materials cost Manufacturing overhead cost Indirect materials ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

The Flow of Product Costs –Manufacturing Company Direct materials cost Work-in-process inventory ● Direct materials ● Direct labor ● Manufacturing overhead Direct labor cost Manufacturing overhead cost ● Indirect materials ● Indirect labor ● Factory rent ● Depreciation ● Factory taxes ● Factory insurance ● Other factory costs ©2016 Michael Werner and Kumen Jones, Introduction to Management Accounting , 3e Werner/Jones

The Flow of Product Costs –Manufacturing Company Work-in-process inventory ● Direct materials ● Direct labor ● Manufacturing overhead Ending work-in-process Balance sheet Finished goods ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

The Flow of Product Costs –Manufacturing Company Finished goods inventory Ending finished goods inventory Cost of goods sold Balance sheet Income statement ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Manufactured Schedule LO5 Calculate cost of goods manufactured and cost of goods sold. ZHANG MANUFACTURING, INC. Cost of Goods Manufactured Schedule For the Year Ended December 31, 2016 Beginning inventory, Jan. 1, 2016 $ 13,000 Inventory purchases during 2016 400,000 Materials available during 2016 $413,000 Ending inventory, Dec. 31, 2016 –20,000 Direct materials used during 2016 $393,000 Direct Materials Section ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Manufactured Schedule LO5 Cost of Goods Manufactured Schedule ZHANG MANUFACTURING, INC. Cost of Goods Manufactured Schedule For the Year Ended December 31, 2016 Direct Labor Section Direct labor during 2016 $220,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Manufactured Schedule LO5 Cost of Goods Manufactured Schedule ZHANG MANUFACTURING, INC. Cost of Goods Manufactured Schedule For the Year Ended December 31, 2016 Manufacturing Overhead Section Indirect materials $ 5,000 Indirect labor 20,000 Factory rent 144,000 Other 344,000 Total 2016 manufacturing overhead $513,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Manufactured Schedule LO5 Cost of Goods Manufactured Schedule ZHANG MANUFACTURING, INC. Cost of Goods Manufactured Schedule For the Year Ended December 31, 2016 Manufacturing Costs Summary Direct materials used during 2016 $ 393,000 Direct labor used during 2016 220,000 Total manufacturing overhead 513,000 Manufacturing cost for current period $1,126,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Manufactured Schedule LO5 Cost of Goods Manufactured Schedule ZHANG MANUFACTURING, INC. Cost of Goods Manufactured Schedule For the Year Ended December 31, 2016 Cost Summary and Work-in-Process Section Manufacturing cost for current period $1,126,000 Beginning WIP, (01/01/16) 41,000 Cost of goods to be finished $1,167,000 Less: Ending WIP, (12/31/16) 65,000 Cost of goods manufactured in 2016 $1,102,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Goods Manufactured Schedule LO5 Cost of Goods Manufactured Schedule ZHANG MANUFACTURING, INC. Cost of Goods Sold Schedule For the Year Ended December 31, 2016 Beginning finished goods inventory $ 70,000 Cost of goods manufactured in 2016 1,102,000 Goods available for sale in 2016 $1,172,000 Less: Finished goods inventory 28,000 Cost of goods sold for 2016 $1,144,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Product Cost Identification for Service Firms LO6 Describe the components of the cost of services provided by a service firm. Service products lack physical substance. Materials are incidental supplies. Labor costs are high. Overhead costs are similar to those for a manufacturer. ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

The Flow of Service Costs Supplies inventory Cost of services provided Direct supplies cost Direct labor cost Ending supplies inventory Overhead cost ● Indirect supplies ● Indirect labor ● Office rent ● Depreciation ● Office taxes ● Office insurance ● Other indirect costs Balance sheet Income statement ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Cost of Services Schedule LO6 Cost of Services Schedule Direct labor cost $ 940,000 Overhead cost 70,000 Direct supplies cost 20,000 Cost of services provided $1,030,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Hybrid Firms Companies that generate significant LO6 Hybrid Firms Companies that generate significant revenues from both services and products are known as hybrid firms. ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Prepare basic journal entries for a manufacturer. Transaction 1: On January 3, transferred $70,000 of direct material to production. Jan 2 Raw Materials Inventory 90,000 Accounts Payable 90,000 To record the purchase of raw material ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Recording Manufacturing Costs Transaction 2: On January 3, transferred $70,000 of direct material to production. Jan 3 Work-In-Process Inventory 70,000 Raw Material Inventory 70,000 To record the transfer of direct material to production ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Recording Manufacturing Costs Transaction 3: On January 31, paid $80,000 for direct labor cost incurred during January 2016 Jan 31 Work-In-Process Inventory 80,000 Cash 80,000 To record wages paid for direct labor in January ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Recording Manufacturing Costs Transaction 4: In January, paid $10,000 of overhead costs in cash and balance of $100,000 on account. Jan 31 Work-In-Process Inventory 110,000 Cash 10,000 Accounts Payable 100,000 To record overhead for January ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Recording Manufacturing Costs Transaction 5: On January 31, transferred $230,000 of goods from work in process to finished goods. Jan 31 Finished Goods Inventory 230,000 Work-in-Process Inventory 230,000 To transfer completed goods from production to finished goods ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Recording Manufacturing Costs Transaction 6: On January 31, sold finished goods costing $210,000 to manufacture for $300,000. Jan 31 Accounts Receivable 300,000 Sales 300,000 Cost of Goods Sold 210,000 Finished Goods 210,000 To record sales on account and cost of goods sold. ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

Recording Manufacturing Costs LO7 Recording Manufacturing Costs Work-in-Process Inventory Accounts Receivable 1/03/16 70,000 1/31/16 80,000 1/31/16 110,000 Balance 30,000 230,000 1/31/16 1/31/16 300,000 Sales 300,000 1/31/16 Finished Goods Inventory Cost of Goods Sold 1/31/16 230,000 Balance 20,000 210,000 1/31/16 1/31/16 210,000 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman

End of Chapter 2 ©2016 Michael Werner and Mark Friedman, Management Accounting Werner/Friedman