1. Basic Cost Management Concepts CHAPTER 2 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. What Do We Mean By a Cost? A cost is the measure of resources given up to achieve a particular purpose. 2-2

3. 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. 2-3

4. Cost Classifications on Financial Statements – Income Statement Product Costs Product Costs Cost of goods sold Period Costs Period Costs Operating expenses 2-4

5. Cost Classifications on Financial Statements – Balance Sheet Merchandiser Current Assets Cash Cash Receivables Receivables Prepaid Expenses Prepaid Expenses Merchandise Inventory Merchandise Inventory Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods 2-5

6. Cost Classifications on Financial Statements – Balance Sheet Merchandiser Current Assets Cash Receivables Prepaid Expenses Merchandise Inventory Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Those materials waiting to be processed. 2-6

7. Cost Classifications on Financial Statements – Balance Sheet Merchandiser Current Assets Cash Receivables Prepaid Expenses Merchandise Inventory Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Partially completed products – material to which some labor and/or overhead has been added. 2-7

8. Cost Classifications on Financial Statements – Balance Sheet Merchandiser Current Assets Cash Cash Receivables Receivables Prepaid Expenses Prepaid Expenses Merchandise Inventory Merchandise Inventory Manufacturer Current Assets l Cash l Receivables l Prepaid Expenses l Inventories Raw Materials Work in Process Finished Goods Completed products awaiting sale. 2-8

9. Types of Production Processes 2-9

10. Manufacturing Costs The Product Direct Labor Manufacturing Overhead Direct Material 2-10

11. Direct Material Example: Steel used to manufacture the automobile. Example: Steel used to manufacture the automobile. Cost of raw material that is used to make, and can be conveniently traced, to the finished product. 2-11

12. Cost of salaries, wages, and fringe benefits for personnel who work directly on manufactured products. Direct Labor Example: Wages paid to an automobile assembly worker. Example: Wages paid to an automobile assembly worker. 2-12

13. Manufacturing Overhead All other manufacturing costs Materials used to support the production process. Examples: lubricants and cleaning supplies used in an automobile assembly plant. Indirect Labor Indirect Material Other Costs 2-13

14. Manufacturing Overhead All other manufacturing costs Cost of personnel who do not work directly on the product. Examples: maintenance workers, janitors, and security guards. Indirect Labor Indirect Material Other Costs 2-14

15. Manufacturing Overhead All other manufacturing costs Examples: depreciation on plant and equipment, property taxes, insurance, utilities, overtime premium, and unavoidable idle time. Indirect Labor Indirect Material Other Costs 2-15

16. Classifications of Costs in Manufacturing Companies Manufacturing costs are often combined as follows: Prime Cost Conversion Cost Direct Material Direct Labor Manufacturing Overhead 2-16

17. Manufacturing Cost Flows Manufacturing Overhead Direct Material Direct Labor Work in Process Inventory 2-17

18. Manufacturing Cost Flows Manufacturing Overhead Direct Material Direct Labor Finished Goods Inventory Work in Process Inventory 2-18

19. Manufacturing Cost Flows Manufacturing Overhead Direct Material Direct Labor Finished Goods Inventory Cost of Goods Sold Work in Process Inventory 2-19

20. Schedule of Cost of Goods Manufactured 2-20

21. Schedule of Cost of Goods Manufactured 2-21

22. Schedule of Cost of Goods Manufactured Include all direct labor costs incurred during the current period. 2-22

23. 2-23

24. Schedule of Cost of Goods Manufactured 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. 2-24

25. Income Statement for a Manufacturer 2-25

26. 2-26

27. 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. 2-27

28. Total Variable Cost Example Your total cable pay-per-view bill is based on how many movies you watch. Pay-Per-View Movies Watched Total Pay-Per-View Bill 2-28

29. Variable Cost Per Unit Example The cost per movie watched is constant. For example, $4.00 per movie. Movies Watched Per Movie Charge 2-29

30. Total 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 Monthly Charge for HBO Bill 2-30

31. Fixed Cost Per Unit Example The average cost per HBO movie decreases as more HBO movies are watched. Number of HBO Movies Watched Monthly HBO Bill per Movie Watched 2-31

32. Cost Classifications 2-32

33. Direct and Indirect Costs Direct 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. 2-33

34. Controllable and Uncontrollable Costs A cost that can be significantly influenced by a manager is a controllable cost. 2-34

35. 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 $30,000 per year. Your opportunity cost of attending college for one year is $30,000. 2-35

36. 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. Example: You bought an automobile that cost $22,000 two years ago. The $22,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $22,000 cost. 2-36

37. 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 2-37

38. 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. 2-38

39. Costs and Benefits of Information Costs Benefits More information does not mean more benefits if information overload results. 2-39

40. End of Chapter 2 2-40