MA1 T2 MD Cost Terms Concepts and Classifications

Cost Terms,
Concepts, and
Classifications
Concepts & Techniques for

Planning & Control
2 Learning Objective 1
Identify and give examples
of each of the three basic
manufacturing cost
categories.
Management Accounting 1
General Cost
Classification
3 Management Accounting 1
4 Manufacturing Costs
Direct Direct Manufacturing

Materials Labor Overhead
The Product
5 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

6 Direct Labor
Those labor costs that can be easily traced
to individual units of product.
Example: Wages paid to automobile assembly workers
7 Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect materials and indirect labor
Materials used to support Wages paid to employees

the production process. who are not directly
involved in production
Examples: lubricants and work.
cleaning supplies used in the Examples: maintenance
automobile assembly plant. workers, janitors and
security guards.
8 Nonmanufacturing Costs
Selling Administrative
Costs Costs
Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.
Distinguish between
product costs and period
costs and give examples
of each.
Product Costs vs
Period Costs
11 Product Costs Versus Period
Costs
Product costs include direct Period costs include all selling
materials, direct labor, and costs and administrative
manufacturing overhead. costs.
Inventory Cost of Good Sold Expense
Sale
Balance Income Income

Sheet Statement Statement
12 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.
13 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.
14 Classifications of Costs
Manufacturing costs are often
classified as follows:
Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost
Comparing Merchandising and
15 Manufacturing Companies
Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.
MegaLoMart
McGraw-Hill/Irwin
Cost Classifications on
Financial Statements
17 Balance Sheet
Merchandiser Manufacturer
Current assets
Current Assets
 Cash
 Receivables  Cash
 Merchandise Inventory  Receivables
 Inventories
• Raw Materials
• Work in Process
• Finished Goods
18 Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
 Cash  Cash
Materials waiting to
 Receivables  Receivables
be processed.
 Merchandise Inventory  Inventories
Partially complete
products – some • Raw Materials
material, labor, or • Work in Process
overhead has been • Finished Goods
added.
Completed products
awaiting sale.
Prepare an income
statement including
calculation of the cost of
goods sold.
20 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
21
Basic Equation for Inventory
Accounts
Withdrawals
Beginning Additions Ending
balance + to inventory = balance + from
inventory
22 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.
23 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.
Prepare a schedule of cost

of goods manufactured.
25 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.
Product Cost Flows
27 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.
Manufacturing Work
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
Manufacturing Work
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.
Manufacturing Work
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.
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
32 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
33 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
34 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
+ Raw materials
A.$276,000 purchased 276,000
= Raw materials available
B. $272,000 for use in production $ 308,000
C. $280,000 – Ending raw materials
inventory 28,000
D.$ 2,000 = Raw materials used
in production $ 280,000
35 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.
36 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 Direct Materials $ 280,000
+ Direct Labor 375,000
+ Mfg. Overhead 180,000
= Mfg. Costs Incurred
for the Month $ 835,000
37 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
38 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 Beginning
month. work What in was the
process inventory $ 125,000
cost of goods manufactured during the month?
+ Mfg. costs incurred
A.$1,160,000 for the period 835,000
= Total work in process
B. $ 910,000 during the period $ 960,000
C. $ 760,000 – Ending work in
process inventory 200,000
= Cost of goods
manufactured $ 760,000
39 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.
40 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. $130,000 + $760,000 = $890,000
C. $780,000. $890,000 - $150,000 = $740,000
D. $760,000.
Understand the
differences between
variable costs and fixed
costs.
Cost Classifications for
Predicting Cost Behavior
43
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.
44 Variable Cost
Your total texting bill is based on how many texts you

send.
Total Texting Bill
Number of Texts Sent

45 Variable Cost Per Unit
The cost per text sent is constant at

5 cents per text.
Cost Per Text Sent

Number of Texts Sent
46 Fixed Cost
Your monthly contract fee for your cell phone is fixed for the number of
monthly minutes in your contract. The monthly contract fee does not change
based on the number of calls you make.
Monthly Cell Phone
Contract Fee
Number of Minutes Used

Within
Management Monthly
Accounting 1 Plan
47 Fixed Cost Per Unit
Within the monthly contract allotment, the average fixed cost per cell phone call
made decreases as more calls are made.
Monthly Cell Phone

Contract Fee
Number of Minutes Used
Management Accounting 1 Within Monthly Plan
48 Cost Classifications for
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.
49 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.
50 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.
Mixed – has both a variable and fixed component. On a per unit basis, it
does not fluctuate in direct proportion to changes in activity, nor does it
remain constant with changes in activity. (e.g. electric bill -
$5,000/month plus $0.018 per kwh)
 Step – shifts upward or downward when activity changes by a
certain interval or “step”. Step variable costs have small steps; Step
fixed costs have large steps.
Step Variable Costs Step Fixed Costs
per gallon gallons No. of supervisor No. of workers Supervisor salaries
$0.002 Up to 1,000
1 supervisor 10 workers $5,000/supervisor
$0.003 1,001 – 2,000
$0.005 2,001 – 3,000 2 supervisors 15 workers $10,000
3 supervisors 22 workers $15,000
53 Activity measures
– Common activity measures include production volume, service and sales

volumes, hours of machine time used, pounds of material moved, and the
number of purchase orders processed.
54 Cost Reaction to Changes in
Activity
– Variable cost – Fixed Cost
$ Total
$
Total
# of Units # of Units
Unit $ Unit $
Within the
Management Accounting 1 relevant range
55 Cost Reaction to Changes in
Activity
– Step Cost (fixed) – Mixed Cost

variable
$ $
fixed
Within the relevant

range
56 Determining Cost Behavior
– Cost Predictor – Cost Driver

– Activity measure that, when – Activity or cost predictor that has a
changed, is accompanied by direct cause-effect relationship on
consistent, observable changes in a cost
cost item
– Predicts but may not cause the cost – Directly causes the cost to change
to change (e.g. production volume has direct
effect on the total cost of raw
materials used)
57 Analyzing Mixed Costs
A mixed cost contains both
a variable and fixed component
variable
Mixed Cost $
fixed
# of Units
58 Separating Mixed Costs
– To determine variable and fixed costs, separate

mixed costs into variable and fixed components
– Use formula for a straight line:
y = a + bX
y = total cost
a = fixed portion of total cost
b = variable cost
X = activity base to which y is related
59 Methods for Separating Mixed
Costs
– High-Low Method – Least Squares Regression

Analysis
– Actual cost observations
– Statistical technique that analyzes
– Considers only two data the relationship between
points dependent and independent
variables
– Highest and lowest levels of – Dependent variable—Cost
activity
– Independent variables—Activities
– Disregard outliers when – Regression line provides line of
analyzing mixed costs best fit for the data
Using the High–Low Method
60 Machine
Hours Cost
High 9,000 $3,500
Low 4,600 2,180
Difference 4,400 $1,320
$1,320
= $0.30/unit Variable cost per unit
4,400
3,500 = a + ($0.30)(9,000)
a = 800 Fixed cost
Y = $800 + $0.30X (X = machine hours)
61 Regression Analysis
Assumptions
– Independent variable must be a valid predictor
of the dependent variable
– Coefficient of correlation
– Reliable only within the relevant range
– Useful only as long as circumstances existing at
the time of its development remain constant
62 SIMPLE LINEAR
REGRESSION
ŷ = a + bx
where
– ŷ = value of the dependent variable
– a = y-axis intercept
– b = slope of the regression line
– x = independent variable
PREDICTOR VARIABLES – Variables

REGRESSION – Technique for fitting a that can be used to predict values of
line to a set of points the variable of interest
63
64 Estimated Total Costs
High—Low Method Regression Analysis

$800.00 + $0.30X $354.62 + $0.35X
More data points

(X = machine hours) mean a
better estimate
of total costs
65 Correlation Coefficients for
Regression Lines
– The regression equation is one way of expressing the nature of the relationship
between two variables.
– Regression lines are not “cause-and –effect” relationships. They merely describe
the relationships among variables. The regression equation shows how one variable
relates to the value and changes in another variable.
– Another way to evaluate the relationships between two variables is to
compute the coefficient of correlation.
– This measure expresses the degree or strength of the linear relationship.
– Usually identified as r, the coefficient of correlation can be any number between +1
and -1.
66 Coefficient of Correlation
– To compute r, we use much of the

same data needed earlier to
calculate a and b for the regression
line. The rather lengthy equation
for r is:
67
68 Coefficient of Determination
 Although the coefficient of correlation is the measure most commonly used to

describe the relationship between two variables, another measure does exist. It
is called the coefficient of determination and is simply the square of the
coefficient of correlation – namely, r2.
 The value of r2 will always be a positive number in the range 0 ≤ r2 ≤ 1. The
coefficient of determination is the percent of variation in the dependent
variable (y) that is explained by the regression equation.
Understand the
differences between direct
and indirect costs.
Assigning Costs to Cost
Objects
Assigning Costs to Cost Objects
71
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:
material and direct manufacturing
labor overhead
McGraw-Hill/Irwin
Define and give examples

of cost classifications used
in making decisions:
differential costs,
opportunity costs, and
sunk costs.
Cost Classifications
for Decision Making
Decision Making
– Every decision involves a choice
between at least two alternatives.
– Only those costs and benefits that

differ between alternatives are
relevant in a decision. All other
costs and benefits can and should
be ignored.
75 Differential Cost and Revenue
Costs and revenues that differ among alternatives.

Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.
Differential revenue is: Differential cost is:

$2,000 – $1,500 = $500 $300
76 Differential Cost and Revenue
Assume that Nature Way Cosmetics, Inc. is thinking about changing the network of neighborhood sales
representatives. Present costs and revenues are compared to projected costs and revenues in the
following table:
Retailer Sales Representatives Differential Costs and
Distribution (proposed) Revenues
(present)
Revenues (variable) $700,000 $800,000 $100,000
Cost of Goods Sold (variable) 350,000 400,000 50,000
Advertising (fixed) 80,000 45,000 (35,000)
Commissions (variable) 0 40,000 40,000
Warehouse depreciation (fixed) 50,000 80,000 30,000
Other expenses (fixed) 60,000 60,000 0
Total expenses 540,000 625,000 85,000
Net Operating income $160,000 $175,000 $15,000
77 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
$15,000 per year.
Your opportunity cost
of attending college for one year
is $15,000.
78 Sunk Costs
Sunk costs have already been incurred and cannot be changed now or in
the future. These costs should be ignored when making decisions.
Example: You bought an automobile that cost $10,000 two years

ago. The $10,000 cost is sunk because whether you drive it, park it,
trade it, or sell it, you cannot change the $10,000 cost.
79 Quick Check 
Suppose you are trying to decide whether to drive or
take the train to Portland to attend a concert. You
have ample cash to do either, but you don’t want to
waste money needlessly. Is the cost of the train
ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of 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.
80 Quick Check 
waste money needlessly. Is the cost of the train
ticket relevant in this decision? In other words,
should the cost of the train ticket affect the decision
of 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.
81 Quick Check 
waste money needlessly. Is the annual cost of
licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
82 Quick Check 
waste money needlessly. Is the annual cost of
licensing your car relevant in this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.
83 Quick Check 
Suppose that your car could be sold now for $5,000.
Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
84 Quick Check 
Suppose that your car could be sold now for $5,000.
Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.
85 Summary of the Types of Cost
Classifications
Predicting Cost
Financial Reporting
Behavior
Assigning Costs to Making Business

Cost Objects Decisions
Further
Classification
of Labor
Costs
Appendix 2A
(Appendix 2A)
Properly account for labor
costs associated with idle
time, overtime, and fringe
benefits.
88 Idle Time
Machine Material
Breakdowns Shortages
Power
Failures
The labor costs incurred

during idle time are ordinarily
treated as manufacturing
overhead.
89 Idle Time: Illustrative Example
– Assume that a press operator earns $12 per hour. If the press operator is paid
for a normal 40 hour workweek but is idle for 3 hours during a given work week
due to breakdowns, labor cost would be allocated as follows:
Direct labor ($12 per hour x 37 hours)

Manufacturing overhead (idle time: $12 per hour x 3 hrs)
Total cost per week
90 Overtime
The overtime premiums for all factory
workers are usually considered to be part
of manufacturing overhead.
91 Overtime: Illustrative Example
– Assume that a press operator in a plant earns $12 per hour. She is paid time and
a half for overtime (time in excess of 40 hours a week). During a given week, she
works 45 hours and has no idle time. Her labor cost for the week would be
allocated as follows:
Direct labor ($12 pe hour x 45 hours)

Manufacturing overhead (overtime premium: $6 per hour x 5 hours)
Total cost for the week
92 Labor Fringe Benefits
Fringe benefits include employer paid costs for
insurance programs, retirement plans,
supplemental unemployment programs, Social
Security, Medicare, workers’ compensation, and
unemployment taxes.
Some companies Other companies treat

include all of these fringe benefit
costs in expenses of direct
manufacturing laborers as additional
overhead. direct labor costs.
Cost of
Quality
Appendix 2B
(Appendix 2B)
Identify the four types of
quality costs and explain
how they interact.
95 Quality of Conformance
When the overwhelming majority of products

produced conform to design specifications
and are free from defects.
96 Quality Costs
Quality cost refers to all of the cost that are
incurred to prevent defects or that result from
defects in products.
1st Group: are incurred in an 2nd Group: are incurred

effort to keep defective because defects are
products from falling into produced despite efforts to
the hands of customers. prevent them.
Prevention Appraisal Internal External

costs costs failure costs failure costs
97 Prevention and Appraisal Costs
Support activities
Prevention whose purpose is to
Costs reduce the number of
Most defects
effective way
to manage
quality costs
Incurred to identify
defective products
Appraisal Costs before the products are
shipped to customers
Internal and External Failure
98
Costs
Incurred as a result of
Internal Failure
identifying defects
Costs before they are shipped
Incurred as a result of
External Failure defective products
Costs being delivered to
customers
99 Examples of Quality Costs
Appraisal Costs
Prevention Costs
• Testing and inspecting
• Quality training
incoming materials
• Quality circles
• Final product testing
• Statistical process
• Depreciation of testing
control activities
equipment
External Failure Costs

Internal Failure Costs
• Cost of field servicing and
• Scrap
handling complaints
• Spoilage
• Warranty repairs
• Rework
• Lost sales
100 Notes about Quality Costs:
First, quality costs don’t relate to just manufacturing; rather,

they relate to all the activities in a company from initial
research and development through customer service.
Second, the number of costs associated with quality
is very large; total quality costs can be quite high
unless management gives this area special attention.
Finally, the costs in
the four groupings
are quite different.
101 Distribution of Quality Costs
(Appendix 2B)
Prepare and interpret a
quality cost report.
Quality Cost Report
For Years 1 and 2
103
Year 2 Year 1
Amount Percent* Amount Percent*
Prevention costs:
Systems development $ 400,000 0.80% $ 270,000 0.54%
Quality training 210,000 0.42% 130,000 0.26%
Supervision of prevention activities 70,000 0.14% 40,000 0.08%
Quality improvement 320,000 0.64% 210,000 0.42%
Total prevention cost 1,000,000 2.00% 650,000 1.30%
Quality cost Appraisal costs:

Inspection 600,000 1.20% 560,000 1.12%
reports provide Reliability testing 580,000 1.16% 420,000 0.84%
Supervision of testing and inspection 120,000 0.24% 80,000 0.16%
an estimate of Depreciation of test equipment 200,000 0.40% 140,000 0.28%
Total appraisal cost 1,500,000 3.00% 1,200,000 2.40%
the financial
consequences Internal failure costs:
Net cost of scrap 900,000 1.80% 750,000 1.50%
of the Rework labor and overhead
Downtime due to defects in quality
1,430,000
170,000
2.86%
0.34%
810,000
100,000
1.62%
0.20%
company’s Disposal of defective products
Total internal failure cost
500,000
3,000,000
1.00%
6.00%
340,000
2,000,000
0.68%
4.00%
current defect
External failure costs:
rate. Warranty repairs 400,000 0.80% 900,000 1.80%
Warranty replacements 870,000 1.74% 2,300,000 4.60%
Allowances 130,000 0.26% 630,000 1.26%
Cost of field servicing 600,000 1.20% 1,320,000 2.64%
Total external failure cost 2,000,000 4.00% 5,150,000 10.30%
Total quality cost $ 7,500,000 15.00% $ 9,000,000 18.00%
* As a percentage of total sales. In each year sales totaled $50,000,000.
Quality Cost Reports in
104 Graphic Form
$10 20
9 18
Quality Cost as a Percentage of Sales

8 16
Quality Cost (in millions)

Quality
7 14
External External reports External External
6 Failure Failure 12 Failure Failure
can also
5 10
be
4 Internal 8 Internal
Failure prepared Failure
3 Internal 6 Internal
Failure in Failure
2 4
Appraisal graphic Appraisal
Appraisal
Appraisal 2
1
form. Prevention Prevention
Prevention Prevention 0
0
1 2 1 2
Year 1 Year
Management Accounting
105 Uses of Quality Cost
Help Information
managers see the
financial significance of
defects.
Help managers identify

the relative importance
of the quality problems.
Help managers see
whether their quality
costs are poorly
distributed.
Limitations of Quality Cost
106 Information
Simply measuring and
reporting quality cost
problems does not solve
quality problems.
Results usually lag

behind quality
improvement programs.
The most important

quality cost, lost sales, is
often omitted from
quality cost reports.
107 WHAT IS THE ISO 9000
STANDARDS SERIES?
– ISO 9000 is a set of international standards on quality management and quality

assurance developed to help companies effectively document the quality
system elements to be implemented to maintain an efficient quality system.
They are not specific to any one industry and can be applied to organizations of
any size.
– ISO 9000 can help a company satisfy its customers, meet regulatory
requirements, and achieve continual improvement. However, it should be
considered to be a first step, the base level of a quality system, not a complete
guarantee of quality.
108 ISO 9000 Standards
ISO 9000 standards have become international
measures of quality.
To become ISO 9000 certified, a company must
demonstrate:
1. A quality control system is in use, and the
system clearly defines an expected level of
quality.
2. The system is fully operational and is
backed up with detailed documentation of
quality control procedures.
3. The intended level of quality is being
achieved on a sustained basis.
109 ISO 9000 Standards
– The key to receiving certification under the ISO 9000 standards is

documentation.
– Under the ISO 9000, this documentation must be so detailed and precise that if
all the employees in a company were suddenly replaced, the new employees
could use the documentation to make the product exactly as i
110 ISO 9000 vs. 9001
– ISO 9000 is a series, or family, of standards. ISO 9001 is a standard within the
family. The ISO 9000 family of standards also contains an individual standard
named ISO 9000. This standard lays out the fundamentals and vocabulary of
quality management systems (QMS).
111 ISO 9000 Series standards
– The ISO 9000 family contains these standards:

– ISO 9001:2015: Quality management systems - Requirements
– ISO 9000:2015: Quality management systems - Fundamentals and
vocabulary (definitions)
– ISO 9004:2009: Quality management systems – Managing for the sustained
success of an organization (continuous improvement)
– ISO 19011:2011: Guidelines for auditing management systems
– ASQ is the only place to get the American National Standard versions of these
standards in the ISO 9000 family.
112 ISO 9000 certification
– Individuals and organizations cannot be certified to ISO 9000. ISO 9001 is the
only standard within the ISO 9000 family to which organizations can certify.
113 References:
– Garrison, R. H., Noreen, E. W. & Brewer, P. C., 13th edition (2010). Managerial
Accounting, McGraw-Hill/Irwin
– Kinney & Raiborn, 8th edition (2011). Cost Accounting: Foundations and
Evolutions, Cengage Learning
– Stevenson, W. J., 8th edition (2005). Operations Management, McGraw-Hill/Irwin

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Cost Terms,

Concepts & Techniques for

Direct Direct Manufacturing

Raw materials that become an integral

Example: A radio installed in an automobile

Example: Wages paid to automobile assembly workers

Materials used to support Wages paid to employees

Costs necessary to All executive,

Inventory Cost of Good Sold Expense

Balance Income Income

Merchandising Company Manufacturing Company

Prepare a schedule of cost

Calculates the manufacturing

Beginning raw Direct materials

Beginning raw Direct materials Beginning work in

Beginning raw Direct materials Beginning work in

Beginning work in Beginning finished

Direct Labor Work in

Selling and Period Costs Selling and

Your total texting bill is based on how many texts you

Number of Texts Sent

The cost per text sent is constant at

Cost Per Text Sent

Number of Minutes Used

Monthly Cell Phone

– Common activity measures include production volume, service and sales

– Step Cost (fixed) – Mixed Cost

Within the relevant

– Cost Predictor – Cost Driver

– To determine variable and fixed costs, separate

– High-Low Method – Least Squares Regression

PREDICTOR VARIABLES – Variables

High—Low Method Regression Analysis

More data points

– To compute r, we use much of the

 Although the coefficient of correlation is the measure most commonly used to

Define and give examples

– Only those costs and benefits that

Costs and revenues that differ among alternatives.

Differential revenue is: Differential cost is:

The potential benefit that is given up when one alternative is selected

Example: If you were

Example: You bought an automobile that cost $10,000 two years

Assigning Costs to Making Business

The labor costs incurred

Direct labor ($12 per hour x 37 hours)

Direct labor ($12 pe hour x 45 hours)

Some companies Other companies treat

When the overwhelming majority of products

1st Group: are incurred in an 2nd Group: are incurred

Prevention Appraisal Internal External

External Failure Costs

First, quality costs don’t relate to just manufacturing; rather,

Quality cost Appraisal costs:

Quality Cost as a Percentage of Sales

Quality Cost (in millions)

Help managers identify

Results usually lag

The most important

– ISO 9000 is a set of international standards on quality management and quality

– The key to receiving certification under the ISO 9000 standards is

– The ISO 9000 family contains these standards:

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