2 Chapter Two Basic Cost Management Concepts and Accounting for Mass Customization Operations

Managers need cost information to perform each of these functions. Process of Management Decision Making Directing Control Planning Managers need cost information to perform each of these functions.

What Do We Mean By a Cost? A Cost is the measure of resources given up to achieve a particular purpose.

Manufacturing Overhead Manufacturing Costs Direct Labor Direct Material Manufacturing Overhead The Product

Steel used to manufacture the automobile. Direct Material Cost of raw material that is used to make, and can be conveniently traced, to the finished product. Example: Steel used to manufacture the automobile.

Wages paid to an automobile assembly worker. 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 Material Indirect Labor Other 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 Material Indirect Labor Other 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 Material Indirect Labor Other Costs Examples: depreciation on plant and equipment, property taxes, insurance, utilities, overtime premium, and unavoidable idle time.

Classifications of Costs in Manufacturing Companies Manufacturing costs are often combined as follows: Direct Material Direct Labor Manufacturing Overhead Prime Cost Conversion Cost

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

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 Those materials waiting to be processed.

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 Partially complete products – material to which some labor and/or overhead has been added.

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 Completed products awaiting sale.

Manufacturing Cost Flows Finished Goods Cost of Goods Sold Income Statement Expenses Balance Sheet Costs Inventories Material Purchases Work in Process Raw Material Direct Labor Manufacturing Overhead Selling and Administrative Selling and Administrative Period Expenses

Manufacturing Cost Flows Income Statement Expenses Balance Sheet Costs Inventories Material Purchases Material, labor and manufacturing overhead costs remain in inventory until the product is sold, so they are sometimes called inventoriable costs. Raw Material Direct Labor Work in Process Manufacturing Overhead Cost of Goods Sold Finished Goods Selling and Administrative Period Expenses Selling and Administrative

Manufacturing Cost Flows Income Statement Expenses Balance Sheet Costs Inventories Material Purchases Raw Material Direct Labor Work in Process Manufacturing Overhead Cost of Goods Sold Finished Goods Period expenses are not associated with manufacturing the product and are expensed in the period incurred. Selling and Administrative Period Expenses Selling and Administrative

Manufacturing Cost Flows Income Statement Expenses Balance Sheet Costs Inventories Material Purchases Raw Material Direct Labor Work in Process Manufacturing Overhead Cost of Goods Sold Finished Goods Selling and Administrative Period Expenses Selling and Administrative

Types of Production Processes

Schedule of Cost of Goods Manufactured Let’s look at a Schedule of Cost of Goods Manufactured for Comet Computer Corporation.

Schedule of Cost of Goods Manufactured

Schedule of Cost of Goods Manufactured

Schedule of Cost of Goods Manufactured Include all direct labor costs incurred during the current period.

Schedule of Cost of Goods Manufactured

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

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

Income Statement for a Manufacturer Now let’s look at an income statement for Comet Computer Corporation.

Income Statement for a Manufacturer

Income Statement for a Manufacturer

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.

Activities that cause costs to be incurred are called cost drivers. Cost Classifications Activities that cause costs to be incurred are called cost drivers. 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.

Identifying Cost Drivers

Total Variable Cost Example Your total long distance telephone bill is based on how many minutes you talk. Total Long Distance Telephone Bill Minutes Talked

Variable Cost Per Unit Example The cost per long distance minute talked is constant. For example, 5 cents per minute. Per Minute Telephone Charge Minutes Talked

Total Fixed Cost Example Your monthly basic telephone bill probably does not change when you make more local calls. Monthly Basic Telephone Bill Number of Local Calls

Fixed Cost Per Unit Example The average cost per local call decreases as more local calls are made. Monthly Basic Telephone Bill per Local Call Number of Local Calls

Cost Classifications

Cost Behavior Question Fixed costs are usually characterized by: a. Unit costs that remain constant. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant.

Cost Behavior Question Fixed costs are usually characterized by: a. Unit costs that remain constant. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant.

Cost Behavior Question Variable costs are usually characterized by: a. Unit costs that decrease as activity increases. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant.

Cost Behavior Question Variable costs are usually characterized by: a. Unit costs that decrease as activity increases. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant.

Direct and Indirect 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.

Direct and Indirect Costs A cost can be direct to the department, but indirect to units of product produced in the department. Example: department manager’s salary. Tracing costs directly to departments or products facilitates responsibility accounting.

Controllable and Uncontrollable Costs A cost that can be significantly influenced by a manager is a controllable cost.

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. 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?

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 extra cost incurred to produce one additional unit. The total cost to produce a quantity divided by the quantity produced. Marginal and average costs are largely a function of cost behavior -- variable and fixed costs.

Costs and Benefits of Information More information does not mean more benefits if information overload results.

End of Chapter 2