Lecture 2

2
Cost Classification Costs for stock valuation Cost for decision making Cost for control

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The Meaning of Cost?

Product Costs The cost assigned to goods that were either purchased or manufactured for resale.

The sacrifice made, usually measured by the resources given up, to achieve a particular purpose.

Period Costs Costs that are not product cost. Ex: sales commission and rental of admin office

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Manufacturing Companies
Costs

Manufacturing cost

Non Manufacturing Cost

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Manufacturing Costs
Direct Materials Direct Labor Manufacturing Overhead

The Product

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Manufacturing Companies
Manufacturing costs/Production cost

Direct Materials resources that can be feasibly observed being used to make a specific product.

Direct Labor The cost of paying employees who convert direct materials into finished product.

Manufacturing Overhead
Indirect material Indirect labor Other overhead

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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 materials and indirect labor
Materials used to support the production process.
Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Wages paid to employees who are not directly involved in production work.
Examples: maintenance workers, janitors and security guards.

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Nonmanufacturing Costs
Selling Costs Administrative Costs

Costs necessary to secure the order and deliver the product.

All executive, organizational, and clerical costs.

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Manufacturing Companies
Non-Manufacturing costs/ Non Production cost

Selling Costs Cost to secure customer orders

advertising shipping commissions

Administrative cost General mgmt cost

General acctg Secretarial Public relations

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Manufacturing Companies
Costs

Product cost Cost of acquiring or making a product

D. Materials D.Labour Mfg OH

Period cost Not product cost

Sales Comm Rent admin office Sellg & dist. cost

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Product Costs Versus Period Costs

Product costs include direct materials, direct labor, and manufacturing overhead.
Inventory Sale
Cost of Good Sold

Period costs include all selling costs and administrative costs.

Expense

Balance Sheet

Income Statement

Income Statement

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Manufacturing Companies
Costs

Prime cost

Conversion cost

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Classifications of Costs
Manufacturing costs are often classified as follows:
Direct Material Direct Labor Manufacturing Overhead

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Manufacturing Companies
Prime Costs include:

Direct Materials

Direct Labor

Manufacturing Overhead

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Manufacturing Companies
Conversion Costs include:

Direct Materials

Direct Labor

Manufacturing Overhead

These cost are incurred to convert materials to Finished Product

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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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Manufacturing Cost Flows

Costs
Material Purchases Direct Labor Manufacturing Overhead

Balance Sheet Inventories

Raw Materials Work in Process

Income Statement Expenses

Finished Goods

Cost of Goods Sold Selling and Administrative

Selling and Administrative

Period Costs

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Cost for Decision Making

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Cost for Decision Making

Relevant costs Avoidable cost Sunk cost

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Cost Concepts for Decision Making

A relevant cost is a cost that differs between alternatives.

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Cost Classifications for 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.

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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: $2,000 $1,500 = $500

Differential cost is: $300

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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.

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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.

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Sunk Costs
Sunk costs are past payments for resources that cannot be undone. I dont want to replace John. We just spent $30,000 to train him on the new equipment! But dont you see? That $30,000 is gone. It is irrelevant to our decision.

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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 dont 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.

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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 dont want to 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.

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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.

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Cost for control

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Costs for control

cost Variable cost
Fixed

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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 texting bill is based on how many texts you send.
Total Texting Bill Number of Texts Sent

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Variable Cost Per Unit

The cost per text sent is constant at 5 cents per text.
Cost Per Text Sent Number of Texts Sent

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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 Monthly Plan

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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 Within Monthly Plan

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Cost for Control

Summary of Variable and Fixed Cost Behavior

Cost Variable In Total Total variable cost is proportional to the activity level within the relevant range. Total fixed cost remains the same even when the activity level changes within the relevant range. Per Unit Variable cost per unit remains the same over wide ranges of activity. Fixed cost per unit goes down as activity level goes up.

Fixed

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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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Cost for Control

Exercise : Cadbury Chocolate Gardenia bread Transport company Malaysian Airlines Telephone call

Variable cost
Fixed Cost

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Exercise

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Exercise
Exercise : 2-13

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The End

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Tutorial
1) 2) 3) 4) 5) 6) Exercise : 2-3 Exercise : 2-6 Exercise : 2-7 Exercise : 2-8 Exercise : 2-9 Exercise : 2-15

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