Costs Terms, Concepts and

Classifications
Chapter Two

2-2

Learning Objective

Identify and give examples

of each of the three basic
manufacturing cost
categories.

2-3

Classification of COST

Manufacturing
Cost

Non
Manufacturing
Cost

1. Direct Labor
2. Direct Material
3. Mfg. OH

Selling
Administrative

2-4

Cost Classification according to Purpose

Financial Statement

Product Cost
Period Cost

Predicting Cost Behavior

Variable Cost
Fixed Cost

Assigning Cost to
cost object

Direct Cost
Indirect Cost

Making Decision

Differential Cost
Sunk Cost
Opportunity Cost

2-5

Manufacturing Costs

Direct
Direct
Materials
Materials

Direct
Direct
Labor
Labor

The Product

Manufacturing
Manufacturing
Overhead
Overhead

2-6

Direct Materials
Raw materials that become an integral part of the
product and that can be conveniently traced
directly to it.

Example:
Example: Engine
Engine installed
installed in
in an
an automobile
automobile

2-7

Direct Labor
Those labor costs that can be easily traced to
individual units of product.

Example:
Example: Wages
Wages paid
paid to
to automobile
automobile assembly
assembly workers
workers

2-8

Manufacturing Overhead
Manufacturing costs that cannot be traced directly
to specific units produced.
Examples:
Examples: Indirect
Indirect labor
labor and
and indirect
indirect materials
materials

Wages paid to employees

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

Materials used to support

the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.

2-9

Classifications of Costs

Manufacturing costs are often

classified as follows:
Direct
Material

Direct
Labor

Prime
Cost

Manufacturing
Overhead

Conversion
Cost

2-10

Comparing Merchandising and

Manufacturing Activities

Merchandisers . . .
Buy finished goods.
Sell finished goods.

MegaLoMart

Manufacturers . . .
Buy raw materials.
Produce and sell
finished goods.

2-11

Balance Sheet
Merchandiser
Current assets

Manufacturer
Current Assets

Cash

Cash

Receivables

Receivables

Prepaid Expenses
Merchandise

Inventory

Prepaid Expenses
Inventories
Raw Materials
Work in Process
Finished Goods

2-12

Balance Sheet
Merchandiser
Current assets

Manufacturer
Current Assets

Cash

Cash

Receivables

Receivables
Materials
waiting to
be processed.
Prepaid
Expenses

Prepaid Expenses

Partially complete
products some
Inventory
material, labor, or
overhead has been
added.

Merchandise

Inventories
Raw Materials
Work in Process
Finished Goods

Completed products
awaiting sale.

2-13

Non-manufacturing Costs

Selling
Costs

Administrative
Costs

Costs necessary to get

the order and deliver
the product.

All executive,
organizational, and
clerical costs.

2-14

Learning Objective

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

2-15

Product Costs Versus Period Costs

Product costs include

direct materials, direct
labor, and
manufacturing
overhead.
Inventory

Cost of Good Sold

Period costs include all

selling costs and
administrative costs.

Expense

Sale

Balance
Sheet

Income
Statement

Income
Statement

2-16

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.

2-17

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.

2-18

Learning Objective

Understand the
differences between
variable costs and fixed
costs.

2-19

Cost Classifications for Predicting Cost

Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
activity
activity within
within the
the
relevant
relevant range.
range.
Total
Totalvariable
variablecosts
costs
change
changewhen
whenactivity
activity
changes.
changes.
Total
Totalfixed
fixedcosts
costsremain
remain
unchanged
unchangedwhen
whenactivity
activity
changes.
changes.

2-20

Variable Cost

Total Long Distance

Telephone Bill

Your total long distance telephone bill is based

on how many minutes you talk.

Minutes Talked

2-21

Variable Cost Per Unit

Per Minute
Telephone Charge

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Minutes Talked

2-22

Fixed Cost

Monthly Basic
Telephone Bill

Your monthly basic telephone bill probably

does not change when you make more local
calls.

Number of Local Calls

2-23

Fixed Cost Per Unit

Monthly Basic Telephone

Bill per Local Call

The average fixed cost per local call decreases

as more local calls are made.

Number of Local Calls

2-24

Cost Classifications for Predicting Cost

Behavior

Behavior of Cost (within the relevant range)

Cost

In Total

Per Unit

Variable

Total variable cost changes

as activity level changes.

Variable cost per unit remains

the same over wide ranges
of activity.

Fixed

Total fixed cost remains

the same even when the
activity level changes.

Average fixed cost per unit goes

down as activity level goes up.

2-25

Learning Objective

Understand the
differences between direct
and indirect costs.

2-26

Assigning Costs to Cost Objects

Direct costs

Indirect costs

Costs that can be

easily and conveniently
traced to a unit of
product or other cost
object.

Costs that cannot be

easily and conveniently
traced to a unit of
product or other cost
object.

Examples: direct
material and direct labor

Example: manufacturing
overhead

2-27

Learning Objective

Define and give examples

of cost classifications used
in making decisions:
differential costs,
opportunity costs, and
sunk costs.

2-28

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

2-29

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.

2-30

Sunk Costs
Sunk costs have already been incurred and cannot be
changed now or in the future. They should be ignored
when making decisions.

Example: i) Cost of getting license of a business.

iii) Suppose you bought a technology by $ 20,000
which is obsolete now.

2-31

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.

2-32

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.

2-33

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.

2-34

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.

Further Classification of Labor

Costs
Appendix 2A

2-36

Learning Objective

(Appendix 2A)
Properly account for labor
costs associated with idle
time, overtime, and fringe
benefits.

2-37

Idle Time
Machine
Breakdowns

Material
Shortages
Power
Failures

The labor costs incurred

during idle time are ordinarily
treated as manufacturing
overhead.

2-38

Overtime

The overtime premiums for all factory

workers are usually considered to be part
of manufacturing overhead.

2-39

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
include all of these
costs in
manufacturing
overhead.

Other companies treat

fringe benefit
expenses of direct
laborers as additional
direct labor costs.

2-40

THANK YOU ALL