McGraw-Hill/Irwin 2-1 Basic Cost Management Concepts and Accounting for Mass Customization...

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2-2-11

Basic Cost Management Concepts and Accounting for Mass Customization Operations

2Chapter Two

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Process of Management

DecisionMaking

Directing

ControlPlanning

Managers need cost information toperform each of these functions.

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What Do We Mean By a Cost?

A Costis the measure ofresources givenup to achieve a

particular purpose.

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Manufacturing Costs

TheProduct

DirectLabor

DirectMaterial

Manufacturing Overhead

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Direct Material

Example:Steel used tomanufacture

the automobile.

Example:Steel used tomanufacture

the automobile.

Cost of raw material that is used tomake, and can be convenientlytraced, to the finished product.

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Cost of salaries, wages, and fringebenefits for personnel who work

directly on manufactured products.

Direct Labor

Example:Wages paid to an

automobile assemblyworker.

Example:Wages paid to an

automobile assemblyworker.

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All other manufacturing costsAll other manufacturing costs


Materials used to support the production process. Examples: lubricants and

cleaning supplies used in an automobile assembly plant.

IndirectLabor

IndirectMaterial

OtherCosts

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Cost of personnel who do not work directly on

the product. Examples: maintenance workers, janitors and security

guards.

IndirectLabor

IndirectMaterial

OtherCosts

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Examples: depreciation on plant and equipment,

property taxes, insurance, utilities,

overtime premium, and unavoidable idle time.

IndirectLabor

IndirectMaterial

OtherCosts

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Classifications of Costs in Manufacturing Companies

PrimeCost

ConversionCost

Manufacturing costs are oftenManufacturing costs are oftencombined as follows:combined as follows:

DirectMaterial

DirectLabor

ManufacturingOverhead

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MerchandiserMerchandiser Current AssetsCurrent Assets

CashCash ReceivablesReceivables Prepaid ExpensesPrepaid Expenses MerchandiseMerchandise Inventory Inventory

ManufacturerManufacturer Current AssetsCurrent Assets

CashCash ReceivablesReceivables Prepaid ExpensesPrepaid Expenses InventoriesInventories

Raw MaterialsRaw Materials

Work in ProcessWork in Process

Finished GoodsFinished Goods

Cost Classifications on Financial Statements – Balance Sheet

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Manufacturer Current Assets

Cash Receivables Prepaid Expenses Inventories

Raw Materials

Work in Process

Finished Goods




Those materials waiting to be processed.

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Raw Materials

Work in Process

Finished Goods


Partially complete products – material to

which some labor and/or overhead has

been added.

Merchandiser Current Assets

Cash Receivables Prepaid Expenses Merchandise Inventory

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Raw Materials

Work in Process

Finished Goods




Completed products awaiting sale.

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Manufacturing Cost Flows


Material Purchases

Direct Labor

Balance Sheet Costs Inventories

FinishedGoods

Cost of GoodsSold

Income StatementExpenses

Selling andAdministrative


Period Expenses

Work in Process

Raw Material

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Period Expenses


Raw Material

Work in Process

FinishedGoods

Cost of GoodsSold

Material Purchases

Direct Labor



Material, labor andmanufacturingoverhead costs

remain in inventoryuntil the product is

sold, so they aresometimes called

inventoriable costs.

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Period ExpensesPeriod expenses are not associated with manufacturing the product and are expensed in the period incurred.


Raw Material

Work in Process

FinishedGoods

Cost of GoodsSold

Material Purchases

Direct Labor



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Raw Material

Work in Process

FinishedGoods

Cost of GoodsSold


Material Purchases

Direct Labor




Period Expenses

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Types of Production ProcessesType of Production Description of Example of

Process Process Manufacturer

Job Shop Low volume DisneyLittle standardization

Unique products

Batch Multiple products CaterpillarLow volume

Assembly Line A few major products FordHigher volume

Mass Customization High volume DellMany standardized components

Customized combination of components

Continuous Flow High volume ExxonHighly standardized commodity products

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Schedule of Cost of Goods Manufactured

Let’s look at aSchedule of Cost of

Goods Manufactured forComet Computer Corporation.

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Comet Computer Corporation


Raw material used 134,980$

Direct labor 50,000

Total manufacturing overhead 230,000

Total manufacturing costs 414,980$

Add: Work-in-process inventory, January 1 120

Subtotal 415,100$

Deduct: Work-in-process inventory, December 31 100

Cost of goods manufactured 415,000$


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Direct labor 50,000




Subtotal 415,100$




Computation of Cost of Raw Material Used

Raw-material inventory, January 1 6,000$

Add: Purchases of raw materials 134,000

Raw material available for use 140,000

Deduct: Raw material inventory, December 31 5,020


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Direct labor 50,000




Subtotal 415,100$




Include all direct labor costs incurred during the

current period.

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Direct labor 50,000




Subtotal 415,100$



Schedule of Cost of Goods ManufacturedComputation of Total Manufacturing Overhead

Indirect material 10,000$

Indirect labor 40,000

Depreciation on factory 90,000

Depreciation on equipment 70,000

Utilities 15,000

Insurance 5,000

Total manufacturing overhead 230,000$

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Direct labor 50,000




Subtotal 415,100$




Beginning work-in-process inventory is carried over from the

prior period.

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Direct labor 50,000




Subtotal 415,100$




Ending work-in-process inventory contains the cost of unfinished

goods, and is reported in the current assets section of the balance sheet.

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Now let’s look at an income statement for Comet Computer

Corporation.

Income Statement for a Manufacturer

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Income Statement for a Manufacturer


Income Statement

For the Year Ended December 31, 20X2

Sales revenue 700,000$

Less: Cost of goods sold 415,010

Gross margin 284,990$

Selling and administrative expenses 174,490

Income before taxes 110,500$

Income tax expense 30,000

Net income 80,500$

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Income Statement


Sales revenue 700,000$

Less: Cost of goods sold 415,010

Gross margin 284,990$

Selling and administrative expenses 174,490

Income before taxes 110,500$

Income tax expense 30,000

Net income 80,500$

Income Statement for a ManufacturerComet Computer Corporation

Schedule of Cost of Goods Sold


Finished-goods inventory, Jan. 1 200$

Add: Cost of goods manufactured 415,000

Cost of goods available for sale 415,200

Deduct Finished-goods inventory, Dec. 31 190

Cost of goods sold 415,010$

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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.

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Cost behavior means Cost behavior means how a cost will react to how a cost will react to changes in the level of changes in the level of business activity.business activity. Total Total variable costs variable costs

change when activity change when activity changes.changes.

TotalTotal fixed costs fixed costs remain remain unchanged when unchanged when activity changes.activity changes.

Activities thatcause costs to be

incurred are calledcost drivers.

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Identifying Cost Drivers

Cost Driver Examples

Activity Cost Driver

Machining operations Machine hoursSetup Setup hoursProduction scheduling Manufacturing ordersInspection Pieces inspectedPurchasing Purchase ordersShop order handling Shop ordersValve assembly support Customer requisitions

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Total Variable Cost Example

Your total long distance telephone bill is Your total long distance telephone bill is based on how many minutes you talk.based on how many minutes you talk.

Minutes Talked

Tot

al L

ong

Dis

tanc

eT

elep

hone

Bill

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Variable Cost Per Unit Example

Minutes Talked

Per

Min

ute

Tel

epho

ne C

harg

e

The cost per long distance minute talked is The cost per long distance minute talked is constant. For example, 5 cents per minute.constant. For example, 5 cents per minute.

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Total Fixed Cost Example

Your monthly basic telephone bill probably Your monthly basic telephone bill probably does not change when you make more local does not change when you make more local

calls. calls.

Number of Local Calls

Mon

thly

Bas

ic

Tel

epho

ne B

ill

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Fixed Cost Per Unit Example

Number of Local Calls

Mon

thly

Bas

ic T

elep

hone

B

ill p

er L

ocal

Cal

l

The average cost per local call decreases as The average cost per local call decreases as more local calls are made.more local calls are made.

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Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Total variable cost changes Variable cost per unitVariable as activity level changes. remains the same over

wide ranges of activity.

Total fixed cost remains Fixed cost per unitFixed the same even when the goes down as activity

activity level changes. level goes up.

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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.

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Fixed costs are usually characterized by:

a. Unit costs that remain constant.





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Variable costs are usually characterized by:

a. Unit costs that decrease as activity increases.




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Variable costs are usually characterized by:

a. Unit costs that decrease as activity increases.





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Direct and Indirect Costs

Direct costsDirect costs Costs that can beCosts that can be

easily and conveniently easily and conveniently traced to a product or traced to a product or department.department.

Example: Example: cost of paint cost of paint in the paint department in the paint department of an automobile of an automobile assembly plant.assembly plant.

Indirect costsIndirect costs Costs that must be Costs that must be

allocated in order to be allocated in order to be assigned to a product or assigned to a product or department. department.

Example: Example: cost of cost of national advertising for national advertising for an airline is indirect to a an airline is indirect to a particular flight.particular flight.

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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.

Direct and Indirect Costs

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A cost that can be significantly influencedA cost that can be significantly influencedby a manager is a controllable cost.by a manager is a controllable cost.

Controllable andUncontrollable Costs

Cost item Manager Classificaton

Cost of food used Restaurant Controllablein a restaurant manager

Cost of national Restaurant Uncontrollableadvertising by a managerrestaurant chain

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Opportunity Cost

The potential benefit that is The potential benefit that is given up when one given up when one alternative is selected over alternative is selected over another.another. Example: Example: If you wereIf you were

not attending college,not attending college,you could be earningyou could be earning$20,000 per year. $20,000 per year. Your opportunity costYour opportunity costof attending college for one of attending college for one year is $20,000.year is $20,000.

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Sunk Costs

All costs incurred in the past that cannot be changed All costs incurred in the past that cannot be changed by any decision made now or in the future.by any decision made now or in the future.

Sunk costs should not be considered in decisions. Sunk costs should not be considered in decisions.

Example: Example: You bought an automobile that cost You bought an automobile that cost $12,000 two years ago. The $12,000 cost is $12,000 two years ago. The $12,000 cost is sunk because whether you drive it, park it, trade sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $12,000 cost.it, or sell it, you cannot change the $12,000 cost.

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Differential Costs

Costs that differ between alternatives. Costs that differ between alternatives.

Example: You can earn $1,500 per month in yourhometown or $2,000 per month in a nearby city.

Your commuting costs are $50 per month in yourhometown and $300 per month to the city.

What is your differential cost?

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Differential Costs

Costs that differ between alternatives. Costs that differ between alternatives.

Example: You can earn $1,500 per month in yourhometown or $2,000 per month in a nearby city.

Your commuting costs are $50 per month in yourhometown and $300 per month to the city.

What is your differential cost? $300 - $50 = $250

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Marginal Costs and Average Costs

The extra costincurred to produceone additional unit.

The total cost toproduce a quantity

divided by thequantity produced.

Marginal and average costs arelargely a function of cost behavior

-- variable and fixed costs.

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Costs and Benefits of Information

Costs Benefits

More information does not mean more benefits if information overload results.

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End of Chapter 2

McGraw-Hill/Irwin 2-1 Basic Cost Management Concepts and Accounting for Mass Customization...

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