Cost Terms, Concepts and

Classifications

Chapter Two

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Manufacturing Costs

Direct Direct Manufacturing

Materials Labor Overhead

The Product

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Direct Materials

Raw materials that become an integral part of the

product and that can be conveniently traced
directly to it.

Example: A radio installed in an automobile

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Direct Labor

Those labor costs that can be easily traced to

individual units of product.

Example: Wages paid to automobile assembly workers

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Manufacturing Overhead

Manufacturing costs that cannot be traced directly

to specific units produced.

Examples: Indirect labor and indirect materials

Wages paid to employees Materials used to support

who are not directly
involved in production
work.
Examples: maintenance
workers, janitors and
security guards.
the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.

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Non-manufacturing Costs

Selling Administrative
Costs Costs

Costs necessary to get All executive,

the order and deliver organizational, and
the product. clerical costs.

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Learning Objective 2

Distinguish between
product costs and period
costs and give examples
of each.

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Product Costs Versus Period Costs

Product costs include Period costs include all

direct materials, direct selling costs and
labor, and administrative costs.
manufacturing
overhead.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
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Quick Check 

Which of the following costs would be considered a

period rather than a product cost in a manufacturing
company?
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 a

period rather than a product cost in a manufacturing
company?
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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Classifications of Costs

Manufacturing costs are often

classified as follows:
Direct Direct Manufacturing
Material Labor Overhead

Prime Conversion
Cost Cost

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Comparing Merchandising and
Manufacturing Activities

Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

MegaLoMart

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Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash

 Receivables  Receivables
 Prepaid Expenses
 Prepaid Expenses
 Inventories
 Merchandise
Inventory • Raw Materials
• Work in Process
• Finished Goods

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Balance Sheet

Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash

 Receivables  Receivables
Materials waiting to
 Prepaid
be processed.
Expenses
 Prepaid Expenses
Partially complete  Inventories
 Merchandise
products – some
Inventory • Raw Materials
material, labor, or • Work in Process
overhead has been • Finished Goods
added.
Completed products
awaiting sale.
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Learning Objective 3

Prepare an income
statement including
calculation of the cost of
goods sold.

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The Income Statement

Cost of goods sold for manufacturers differs only

slightly from cost of goods sold for merchandisers.

Merchandising Company Manufacturing Company

Cost of goods sold:

Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $236,250

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Basic Equation for Inventory Accounts

Withdrawals
Beginning Additions Ending
balance + to inventory = balance + from
inventory

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Quick Check 

If your inventory balance at the beginning of the

month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would
be the balance at the end of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.

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Quick Check 

If your inventory balance at the beginning of the

month was $1,000, you bought $100 during the
month, and sold $300 during the month, what would
be the balance at the end of the month?
A. $1,000.
$1,000 + $100 = $1,100
B. $ 800. $1,100 - $300 = $800
C. $1,200.
D. $ 200.

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Learning Objective 4

Prepare a schedule of cost

of goods manufactured.

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Schedule of Cost of Goods Manufactured

Calculates the cost of raw

material, direct labor and
manufacturing overhead
used in production.

Calculates the manufacturing

costs associated with goods
that were finished during the
period.

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Product Cost Flows

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.

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Product Cost Flows

Manufacturing Work
Raw Materials Costs In Process
Conversion
Beginning raw Direct materials
materials inventory + Direct labor
costs are costs
+ Raw materials + Mfg. overhead incurred to
purchased = Total manufacturing convert the
= Raw materials costs
direct material
available for use
in production into a finished
– Ending raw materials product.
inventory
= Raw materials used
in production

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Product Cost Flows

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory All manufacturing costs incurred
= Raw materials used during the period are added to the
in production
beginning balance of work in
process.

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Product Cost Flows

Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory
Costs associated with the goods that process inventory
= Raw materials used = Cost of goods
areincompleted
production
during the period are manufactured
transferred to finished goods
inventory.

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Product Cost Flows

Work
In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold

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Manufacturing Cost Flows

Balance Sheet Income

Costs Inventories Statement
Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
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Quick Check 

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000

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Quick Check 

Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the costBeg.
of direct material used?
raw materials $ 32,000
A. $276,000 + Raw materials
purchased 276,000
B. $272,000 = Raw materials available
for use in production $ 308,000
C. $280,000 – Ending raw materials
D. $ 2,000 inventory 28,000
= Raw materials used
in production $ 280,000

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Quick Check 

Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.

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Quick Check 

Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000.
Direct Materials What were
$ 280,000
total manufacturing+ costs incurred for the
Direct Labor 375,000
+ Mfg. Overhead 180,000
month? = Mfg. Costs Incurred
A. $555,000 for the Month $ 835,000

B. $835,000
C. $655,000
D. Cannot be determined.

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Quick Check 

Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work
in process inventory at the end of the
month. What was the cost of goods
manufactured during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000
D. Cannot be determined.
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Quick Check 

Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work
Beginning work in
in process inventory at the end of the $ 125,000
process inventory
month. What was the +cost of goods
Mfg. costs incurred
for the period 835,000
manufactured during the month?
= Total work in process
A. $1,160,000 – Ending
during the period
work in
$ 960,000

B. $ 910,000 = Costprocess inventory

of goods
200,000

C. $ 760,000 manufactured $ 760,000

D. Cannot be determined.
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Quick Check 

Beginning finished goods inventory was

$130,000. The cost of goods manufactured
for the month was $760,000. And the ending
finished goods inventory was $150,000.
What was the cost of goods sold for the
month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.
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Quick Check 

Beginning finished goods inventory was

$130,000. The cost of goods manufactured
for the month was $760,000. And the ending
finished goods inventory was $150,000.
What was the cost of goods sold for the
month?
A. $ 20,000. $130,000 + $760,000 = $890,000
B. $740,000. $890,000 - $150,000 = $740,000
C. $780,000.
D. $760,000.
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Learning Objective 5

Understand the
differences between
variable costs and fixed
costs.

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Cost Classifications for Predicting Cost
Behavior

How a cost will react to

changes in the level of
activity within the
relevant range.
 Total variable costs
change when activity
changes.
 Total fixed costs remain
unchanged when activity
changes.

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Variable Cost

Your total long distance telephone bill is based

on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
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Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
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Fixed Cost

Your monthly basic telephone bill probably

does not change when you make more local
calls.
Telephone Bill
Monthly Basic

Number of Local Calls

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Fixed Cost Per Unit

The average fixed cost per local call decreases

as more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
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Cost Classifications for Predicting Cost
Behavior

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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Quick Check 

Which of the following costs would be variable with

respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one
correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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Quick Check 

Which of the following costs would be variable with

respect to the number of cones sold at a Baskins &
Robbins shop? (There may be more than one
correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

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Learning Objective 6

Understand the
differences between direct
and indirect costs.

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Assigning Costs to Cost Objects

Direct costs Indirect costs

• Costs that can be • Costs that cannot be
easily and conveniently easily and conveniently
traced to a unit of traced to a unit of
product or other cost product or other cost
object. object.
• Examples: direct • Example: manufacturing
material and direct labor overhead

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